Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with several articles related to the fiduciary standard (as the Institute for the Fiduciary Standard has dubbed this "Fiduciary September"), including the announcement from the Department of Labor that it is pushing back (but definitely not abandoning) its new fiduciary rule proposed, criticism from Bob Veres about how the brokerage industry seems to be simultaneously insisting that brokers already act in their small clients' interests even while claiming that those clients can't be served under the standard, and a look from Dan Moisand in the Journal of Financial Planning at how ineffective disclosure alone has been in trying to protect consumers (which, ultimately, should be the role of regulators).
From there, we have several financial planning technical articles this week, including an estate planning checklist after the loss of a client's loved one, how it's going to be harder in 2014 to buy a home due to changes rolling out from the Federal Housing Finance Agency, a look at the LTC insurance marketplace that tries to debunk some common myths, how many variable annuities over the past decade were mispriced (and therefore why clients probably shouldn't be accepting the company buyback offers), how risk management and lower volatility portfolios can result in alpha and higher returns even if they don't participate in the maximum upside, and a great discussion from Texas Tech professor Michael Finke on Social Security retirement claiming strategies for clients.
We wrap up with three interesting final articles: the first is a look at the landscape of advisor designations, suggesting that given the growing complexity of the marketplace and the need for advisors to specialize, there will - and should be - more designations, but it's crucial to have appropriate standards and accreditation to separate the wheat from the chaff; the second is a series of "dangerous ideas" in the investment world, issues that clients and advisors may not be thinking about - often due to behavioral biases - but should; and the last a good reminder that ultimately as financial planners we are all human beings and we, too, aren't perfect and can make mistakes... and suggesting that it's ok to make yourself vulnerable and share that with clients sometimes, too, as it can ultimately make you more human and easy to relate to. Enjoy the reading!
(Editor's Note: Want to see what I'm reading through the week that didn't make the cut? Due to popular request, I've started a Tumblr page to highlight a longer list of articles that I scan each week that might be of interest. You can follow the Tumblr page here.)
Weekend reading for September 14th/15th:
DoL Pushes Back Fiduciary Proposal - The big announcement this week was that the Department of Labor's fiduciary rule will not be issued in October as previously anticipated. Speaking at the Financial Services Institute's conference, Phyllis Borzi indicated that the DOL is still revising and iterating on the proposal. However, she indicated that the delay doesn't mean the DOL is backing off from issuing a strong fiduciary rule - in fact Borzi is adamant that the new rules are necessary to protect investors from advisors and brokers with conflicts of interest - the delay is simply because the DOL is placing a greater priority on "getting it right" and dotting the i's and crossing the t's than delivering on the previously announced schedule. While concerns remain - especially from many brokers attending the FSI event where the conference was being held - that the new fiduciary rule will lead to higher costs, Borzi pushed back and noted that if many/most brokers were already acting in the interests of their clients, they should see little change, and that the rules would simply codify the expectation for all and create some accountability. Notably, Borzi also promised that there would not be a total prohibition on commission-based transactions; the goal of ERISA and the new rules is not to regulate business models, but to regulate problematic behaviors about conflicted advice. Ultimately, when the new rule is re-proposed it will still go out for comment before coming final as well, so the industry will have more chances to give feedback as well.
Fighting The Industry's Financial Terrorism - In Financial Planning magazine, industry commentator Bob Veres takes an interesting look at the arguments being made against the fiduciary standard. In essence, the claim is that if regulators required them to live up to a principles-based fiduciary standard of care, they would no longer be able to "afford" to serve millions of people who don't have large portfolios, and that lower- and middle-income citizens would lose access to advice and have a more limited offering/availability of financial services products. Yet Veres suggests that these comments amount to little more than industry "blackmail" or hostage negotiations, with product providers essentially threatening to withhold services they provide to "innocent bystanders" in a form of "financial terrorism." While the analogy is perhaps somewhat extreme, Veres nonetheless makes the good point that in the end, does anyone really believe that if somebody with "only" $100,000 in their pocket wants to buy a reasonably priced variable annuity in a fiduciary future that companies will just turn the person away? In addition, Veres also suggests that perhaps the argument - or what he suggests is really just a threat - could be turned around entirely, and perhaps the groups should themselves be asked "are you really so unconcerned about the welfare of middle American consumers that you would deliberately walk away from their pressing need for financial advice simply because you don't want us to make you live up to the same standards as RIAs?" And ultimately Veres suggests that even if these large firms do walk away from the middle class consumers, that those people won't be abandoned; instead, it will simply represent a booming growth opportunity for a large number of RIAs and fee-only firms that already serve those clientele, not to mention the growing group of web-based providers trying to offer (fiduciary) financial advice directly to the public.
Regulatory Reform Is Not Complicated - In the Journal of Financial Planning, Dan Moisand looks at the ongoing debates on regulatory reform since the financial crisis and Dodd-Frank, and suggests that the matter is being made far more complicated than it actually is. The simple path is simply to recognize that in the end, regulations are supposed to protect the public, not be contorted to accommodate business models by simply allowing companies to do whatever they want and absolve themselves of any accountability through extensive disclosures. Of course, the problem is compounded by the fact that many disclosures aren't even effective as disclosures in the first place; as Moisand points out, the "disclosure" paragraph the SEC promulgated for fee-based accounts in the early 2000s before they were eliminated invited consumers to ask questions about their rights and the advisor's obligations, when ostensibly the whole point of disclosure is to explain that stuff so people don't need to ask! Moisand also notes recent legislation that has tried to delay implementation of the Department of Labor's standard (though that bill will not likely make it through Congress), and questions the recent statements that if brokers are held to a fiduciary standard exit the marketplace (if brokers claim they conduct themselves in an appropriate manner already, should their threats to leave be believed?). Ultimately, Moisand suggests that the solution may not even be as complex as drafting new legislation, and that perhaps the easiest path is simply to better enforce the current Advisers Act, including recognizing that once brokers hold themselves out as financial ADVISORS, their advice is no longer solely incidental and they should be fiduciary to the standard standard until the current rules anyway.
Financial Steps After The Loss Of A Loved One - This article from the Journal of Financial Planning provides a nice guide and checklist on how to help clients through key estate planning steps after the loss of a loved one. Key steps include: locate letters of last instruction; notify friends, family, and employer; locate the requisite information for the death certificate (e.g., decedent's parents' birthplaces, military service; make funeral arrangements; set an initial meeting with the planner and the attorney to work through the initial estate settlement steps; gather important paperwork for estate settlement (final copy of the death certificate, military discharge papers, marriage license, etc.); pay expenses and (re-)organize bills; notify financial institutions; record the Will; start the death benefit claims process for any life insurance; determine any final employer benefits; start transitioning digital accounts (e.g., miles, points, rewards, logins to online social media accounts, etc.); and notify appropriate government entities. While there may not be anything new on the list for planners, the article is a handy checklist for issues to consider and bear in mind when going through the process with a client.
It’s About To Get Harder To Buy A Home - After years of a "temporary" increases, the Federal Housing Finance Agency is planning to slash the maximum size of mortgages eligible to be backed by Fannie Mae and Freddie Mac in January, which have had loan limits as high as $625,500 in pricier parts of the country; the cut would essentially reduce the maximum size of "conforming" loans and force more clients into the "jumbo" market for mortgages. The primary purpose of the changes is to reduce the role of the Federal government in the mortgage market, as during the second quarter 2/3rds of all mortgages were funded by Fannie and Freddie, and only about 2.1% of mortgages originated in April were sold to private investors. Yet the concern is that many of the larger Fannie and Freddie loans have been for homebuyers in areas with expensive real estate, relatively small downpayments, and few assets, while most private mortgages have been to wealthier borrowers with large downpayments for expensive homes; in other words, if the loan limits come down, it's not clear whether - or at what price - the private market will step back in, especially since new rules from the CFPB also taking effect next January may reduce the availability of low-income-documentation and interest-only mortgages. Overall, borrowers with strong assets, income, and credit may see a slight increase in rates, but those with more problematic assets, income, and credit, may find new difficulty qualifying for a mortgage at all. Notably, because banks are concerned about rising rates themselves, there is also some concern that the private market may be far less willing to offer fixed rate loans, insisting instead on offering ARMs that banks can match to the rates they must pay on deposits if/when/as rates rise. The bottom line: if your clients are thinking about buying (or refinancing), it may be a good idea to get the loan wrapped up by the end of the year.
Debunking LTC Myths - From Financial Advisor magazine, this article looks at some of the hype around LTC insurance (carriers leaving, premiums 'skyrocketing', the Federal LTC plan under the CLASS act repealed), and raises the question of whether the industry is getting a bad rap, given that carriers aren't exactly defaulting and all claims really are being paid (to the tune of $6.6 billion in payments last year alone). In addition, the reality is that not all carriers have had to raise premiums, either; in fact, Northwestern Mutual has even been able to issue refunds in some cases where policies have performed better than anticipated. Coverage is expensive, but so is the potential claim against which it is designed to protect, and insurers make the case that pricing is increasingly more accurate as the data on how LTC insurance is utilized continues to improve. Another growing area of long-term care insurance is the use of hybrid policies, combining together life and LTC or annuity and LTC coverage, and LTC partnership programs with states that allow enhanced protection of Medicaid assets have been more popular as well. While companies may not be out of the woods yet - there may still be more carriers that leave and more industry consolidation in the coming years - it's also notable that pricing and success for LTC insurance companies may actually improve as interest rates increase in the coming years, given how bond-centric portfolios tend to be for LTC insurers. Overall, this article does make a few over-the-top statements advocating LTC insurance (given that many of the people interviewed are sellers of LTC coverage), but nonetheless makes a good point that perhaps the negativity against LTC insurance is overdone.
Mispricing Annuities, Then and Now - In Research Magazine, Moshe Milevsky looks at the issues of annuities and how they can be mispriced. The idea of mispricing annuities isn't new; 200 years ago, many countries financed their national debt not by selling bonds (as they do today) but instead by selling annuities (and tontines) to their citizens. The problem, however, is that given limited understanding of mortality, the government was paying out far more in life-contingent annuities than they should have; retirees were living far longer than the government tables suggested, and as a result the government's debt financing was significantly more expensive than it realized, leading the chief actuary at the time to urge a change in the payout rates and that the government should differentiate between males and females (which up to that point, had never received different annuity payout rates). Of course, annuity companies today have far more actuarial knowledge and sophistication than was the case 200 years ago, which Milevsky suggests comes down to one common fundamental problem: reasonable models with bad assumptions, whether it's 18th century annuities, long-term care insurance, or state pension funds. The problem is playing out again in the case of today's variable annuities, but Milevsky suggests this time the problem isn't misjudging human longevity, but human rationality; ironically, insurance companies expected humans to exhibit their "normal" irrational tendencies to lapse their annuities over time despite the guarantees, and the problem is that investors are disproportionately keeping their annuities, especially when the guarantees are in the money. In turn, this has led insurance companies to try to buy back their prior benefits to get off the hook for their guarantees, given that the contracts were not priced for such low lapse rates; accordingly, Milevsky notes that clients should actually be cautious not to surrender (or capitulate to a buy-back) for their old annuities, and instead "enjoy" their mispriced contracts.
Risk Management as Alpha Generator - This article from Jerry Miccolis and Marina Goodman in the Journal of Financial Planning looks at how risk management can contribute effectively to portfolios in the long run, despite recent criticism and investor concerns that risk management over the past several years has just led to lower returns and less wealth, as well-diversified portfolios have struggled to keep up with the raw total return of the S&P 500. Yet the mathematics of compounding returns show that while diversification may lag when markets just continue to rally straight up, once volatility and declines begin to occur, the outsized returns necessary to recover losses (a 20% decline requires a 25% recovery; a 40% decline requires a 67% recovery) mean that a less volatile portfolio - to the upside and the downside - can result in significantly more wealth. In other words, diversification - or more overt risk management techniques like using options and other derivatives - may lag in the short term, but compounds more favorably in the long run. Of course, the challenge - as the authors note - is that clients can become impatient, even as rising markets arguably make diversification more important as the next downturn inevitably approaches. Nonetheless, the point remains that risk management can add significantly in the long run, and the article does a good job at showing examples of how portfolios that lag in the near term (due to diversification and risk management) can win out in the end.
Mastering The Social Security Timing Game - In Research Magazine, Texas Tech professor Michael Finke digs into client strategies for claiming Social Security benefits. As Finke frames it, the primary planning opportunity for Social Security benefits is to delay their onset, which he equates to buying an inflation-protected annuity at remarkably favorable pricing (given that clients give up money up front in the form of foregone benefits in exchange for a higher cost-of-living adjusted payment in the future). The opportunity exists not because the benefits are mispriced (though some contend they're off by at least a little) but simply because Social Security benefits are actuarially priced based on the average individuals, while clients can choose to start earlier (reduced as much as 25%) or later (increased by up to 32%) based on their own individual health circumstances. And notably, as discussed previously on this blog, the lower the return environment, the more favorable the decision to delay, which suggests it's even more appealing in today's low-real-return environment (though notably, for clients optimistic about returns, it does make sense to apply early). Of course, in many cases clients start early because they're afraid Social Security will "go broke" though Finke points out that in reality, the majority of benefits are funded from current taxpayers anyway, and even under current rules the worst case scenario is just a 23% cut in benefits starting two decades from now (and in all likelihood, we'll make changes to the system before allowing something "that" extreme to happen). As the article illustrates with examples, though, the greatest planning opportunities are for married couples who can coordinate spousal benefits, survivor benefits, and strategies like File-and-Suspend and Restricted Application.
Alphabet Soup Decoded - From Investment Advisor magazine, this article takes an interesting look at the value of credentials and the so-called "alphabet soup" of certifications and designations. The basic point is that as the role of financial advising has grown increasingly complex, it's not possible to define an advisor's expertise and competence by one professional certification or designation, especially as advisors increasingly focus in specialized areas from holistic advice to constructing sophisticated portfolios to working with the ultra high net worth and more. The landscape is further complicated by the increasing competitiveness amongst advisors; while most may start out as generalists while their practices get going, at some point it becomes necessary to specialize and get deeper knowledge, especially if the advisors wish to work with increasingly higher net worth clientele. In fact, the article makes the case that the "wealth management" space itself is increasingly become a unique specialization, and deserves to be recognized as such, given the unique human dynamics, wealth management strategies, and legacy planning issues that arise. The article also notes a study by independent research firm Aite Group that found those with the Certified Investment Management Analyst (CIMA) certification from IMCA (which, to be fair, also apparently supported the publication of this article) have larger, more profitable practices, especially in the investment management space, and 57% of those advisors had at least one other designation as well (with CFP certification being most common), implying that multi-designation advisors may be increasingly common (and successful) going forward. At the end, the article does acknowledge the challenge of proliferating designations and certifications, and the fact that some are far less credible than others, and suggests that third-party accreditation from American National Standards Institute (ANSI) or some other organization might help.
The Carnival of Dangerous Ideas - From the blog of Bob Seawright, this article is a series of guest contributions from several authors about underappreciated ideas or issues that may have dangerous consequences for advisors and investors. Tom Brakke laments our never-ending tendency to use historical numbers to predict the future even as we all collectively acknowledge the limited value of doing so (or worse, testing active risk management strategies on the same basis); David Merkel of the Aleph Blog suggests that we are underestimating the consequences of delays in US infrastructure and that as much as we collectively acknowledge the problems of Social Security and especially Medicare we still don't acknowledge how dangerous it really is; Lauren Foster of CFA Institute nominates our behavioral bias and tendency to jump to conclusions too quickly and then backfill the story to explain it (also known as the narrative fallacy); financial planner James Osborne suggests our bias to take too much credit for our successes while we ignore our failures and contribute to our overconfidence in the process. Other contributions include whether Apple stock may soon go the path of GE (total return of -43% since 2000 at its peak when under Jack Welch's leadership GE could do no wrong), our bias that we can forecast far more effectively than we do, the suggestion that perhaps the government should just make three simple uniform retirement account investment options for everyone, and the idea from yours truly that perhaps the financial planning profession has staked a bit too much of its future on the stock market.
Financial Planners Aren’t Perfect - From the blog of financial planner Mary Beth Storjohann, this article provides a nice reminder that while many people may be hesitant to seek out or ask advice because they don't want to be judged on where they stand financially, and that they may feel embarrassed that their financial situation isn't more "presentable." Yet of course, the reality is that financial planners aren't perfect, either; as Storjohann points out, there are financial planners who have debt (some of it may even be accruing interest, too!), financial planners don't know everything (while we try to stay on top of pertinent news and developments, there will inevitably be situations where the planner has to call in someone else from the team of trusted professionals), and most financial planners have at some point had to pass on some of the financial opportunities that are out there, from maxxing out a 401(k) to not getting a timely refinancing done or having a business investment that didn't pay off as expected. Perhaps most significant, though, is that just as financial planners can serve as accountability coaches for their clients, the reality is that as human beings financial planners still need their own planner as an accountability coach, too. The bottom line: perhaps by showing some of our own vulnerability as financial planners, we can build a better rapport with clients who may be struggling with their own financial challenges, too.
In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors. You can see below his new Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!
I hope you enjoy the reading! Let me know what you think, and if there are any articles you think I should highlight in a future column! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!