Enjoy the current installment of "weekend reading for financial planners" - this week’s edition kicks off with the recent news that robo-advisor Betterment is now expanding into the world of 401(k) plans, an environment that some argue is especially ripe for technology disruption but due to deeply entrenched players may be especially challenging for Betterment to penetrate at all.
From there, we have a couple of practice management articles, including: a discussion of how advisors can build client loyalty; why asking for referrals is a poor strategy to actually get more referrals; how some advisors are working to build proactive relationships with attorneys to generate referrals; and the importance of hiring people with complementary skillsets to really build a successful advisory firm.
There are also a number of more technical financial planning and investment articles this week, from a look at the rise of DFA funds (now the #10 mutual fund family with almost $300B of AUM!), to a look at some of the recent research on active management suggesting that the search for good active managers may not be as impossible as critics suggest, to a discussion of how some advisors are beginning to do more planning around cash flow for clients, and a research article on how to cut through the wide range of various retirement research studies to figure out which approach is most appropriate for a particular client.
We wrap up with three interesting articles: the first looks at how curiosity is becoming one of the key traits for successful leadership (as it drives leaders to always be seeking new opportunities in today’s ever-changing world); the second raises the question of whether the brokerage industry’s objections to the DoL fiduciary rule are really because they can’t serve small investors, or whether they may be struggling to do so simply because they are operating outdated business models using outdated technology and have failed to stay current; and the last makes the good point that if financial planners really believe that the value of financial planning is more than just delivering technical information and involves providing clients with an outside and objective perspective to reach their goals, that perhaps more advisors should be hiring advisors for themselves, too.
Enjoy the reading!
Weekend reading for September 19th/20th:
Betterment Jumps Headlong Into The 401(k) Business (Lisa Shidler, RIABiz) – Last week, robo-advisor Betterment announced the launch of a new 401(k) offering called “Betterment For Business”, an end-to-end bundled solution that will provide everything from participant account opening to recordkeeping to supporting advice, for an all-in fee of 60bps. Because of the need to integrate all of these components, Betterment has created a new built-from-scratch platform for the 401(k) space, and has indicated it will be “open architecture” in offering an array of low-cost ETFs – designed this way in large part because Betterment CEO Jon Stein struggled to find an appealing option for his own Betterment employees as the company grew. Notwithstanding what seems to be an appealing cost and features, though, skeptics note that the $5.5 trillion 401(k) market has very competitive and deeply entrenched service providers (from the $1.2 trillion at Fidelity, to the 60% market share that Financial Engines already has in providing an advice layer to 401(k) participants), which make it very difficult to actually pick up material market share (as even Schwab has experienced in trying to roll out its own ETF-driven 401(k) solution). In addition, because 401(k) provider decisions happen at the employer level – not the end participant/consumer – it’s not clear how willing often-risk-averse employers will be to use a brand new platform. In addition, it’s notable that while Betterment’s consumer investing platform has a partnership with financial advisors through Fidelity Institutional, the 401(k) offering will only be available directly from Betterment and not partnered with advisors… despite the fact that the small-plan marketplace Betterment is targeting is currently dominated by advisor-sold plans (though the small-plan segment is also widely viewed as being underserved, too!).
How Advisors Can Earn Client Loyalty (Gil Weinreich, Research Magazine) – In this article, Weinreich makes the point that an increasing volume of big data and sophisticated analytics are making it more feasible than ever for businesses to squeeze more dollars out of their loyal customers/clients… yet ironically, the outreach itself of these “cross-selling” opportunities can actually undermine that very loyalty. Weinreich suggests that this issue in wide swaths of business today is a result of the “shareholder value maximization” approach, which is sacrificing the relationship between businesses and customers for the sake of return (or alternatively, failing to recognize that the best path to long-term business success is to focus on the customer first and form/maintain a strong and loyal relationship with them). In the financial advisor context, these challenges are expressed in the way financial services firms are managed to “maximize shareholder value” and the industry’s current obsession with cross-selling a wider “product mix” of solutions to clients. By contrast, Aristotle’s writings on the bonds of affection notes that while there are quid pro quo transactional relationships (I do something for you, and you pay me), those are actually the lowest form and the least binding; better relationships are built around mutual enjoyment (e.g., doing something together, or working with clients who have a shared passion), and the best relationships are created by admiring each others’ virtues and best qualities (i.e., the best way to build lasting relationships is to build character). Yet sadly, while advisor skills for deepening relationship can be trained, Weinreich notes that most often, firms steeped in the (short-termist) philosophy of maximizing shareholder value are unwilling to make the investment.
Asking For Referrals: Bad Idea, Fading Fast (Bill Good, Research Magazine) – The conventional wisdom is that one of the best ways to grow an advisory firm is through referrals, and that the best way to get more referrals is to ask for them. Yet Good suggests that ultimately, asking for referrals is not really a best practice and is actually a very poor way to get them, because in the end all you’re really getting is a name provided by a client who was put in an awkward position and felt forced, not a bona fide referral that was enthusiastically endorsed. Instead, the better approach is to ensure that you’re giving clients good results and a good experience in the first place, and then focus on creating “top of mind awareness” by constantly keeping your name in front of clients, with everything from regular letters to clients (an article of interest to get their attention) to birthday cards to regular (e.g., quarterly) check-in calls. Good also notes research from Julie Littlechild finding that the best-referring clients are the ones who get the most actively engaged with the firm, which advisors can support with regular client educational and social events. Ultimately, the simple goal is just to combine giving clients a good experience, keep them regularly engaged, and keep the advisor’s name top of mind, so that rather than forcibly asking for referrals, your name as the advisor can be the first answer that automatically pops into your client’s head when his/her friend who does have a need and asks for a referral suggestion in the first place.
Bridging The Advisor-Lawyer Gap (Jane Wollman Rusoff, ThinkAdvisor) – While seeking referrals from attorneys has long been a “Centers Of Influence” (COI) strategy for financial advisors, the reality is that specialist attorneys (e.g., those working in trusts and estates, or divorce, or elder care) are often even more reliant on referrals from advisors, with one study finding that attorneys net 7 out of 10 of their clients from financial advisor referrals. Accordingly, while cross-referrals may be common, some are suggesting this co-reliance on referrals means that joint business development efforts with financial advisors and attorneys may soon become a more popular approach. For instance, an advisor and attorney might co-author an article (that each can subsequently use for marketing purposes), or the advisor meeting with a prospective client might have the estate attorney review the prospect’s estate planning documents and provide suggestions that can be raised with the prospect. Notably, though, it’s actually discouraged for the advisor and attorney to do the prospective-client approach meeting together, as this might be construed a form of fee-sharing arrangement that would violate some anti-revenue-sharing state laws for attorneys (there’s an acknowledged “fine line” between legally creating opportunities for one another, and being together on a deal that violates the rules). Of course, it’s still necessary to find/formulate these advisor-lawyer relationships in the first place, which some large firms are doing by sponsoring educational events for attorneys (e.g., local American Bar Association continuing education programs), or placing ads in legal-industry publications, though in the end it still comes down to both chemistry (to the advisor and attorney get along) and having a clear niche differentiator (so the attorney knows when to refer to you, and not all the other advisors he/she has a relationship with!). Sheer competency is also a major issue, as the reputational risk in a referral-driven relationship means the cost of making a mistake goes beyond just the impacted client, which means post-CFP professional designations are important, too. And of course, once a relationship is established, it’s crucial to nurture the relationship too, which means having periodic meetings (e.g., sitting down over lunch or dinner once or twice a year) to reinforce the connection, and talk about what’s working and what can be improved.
Productive Firms Need People With Complementary Skills (Ric Edelman, Financial Advisor) – Most financial advisors measure their productivity by how many hours they work, a world where the advisor who works 50-60 hours a week is more productive than those working “just” 40 hours a week. Yet Edelman suggests that ultimately, a better benchmark is how many hours your entire team works; accordingly, Edelman notes that his productivity is working 20,000 hours per week… the equivalent of a 40-hour work week across each/all of his firm’s 500 employees. The fundamental point is that if you measure productivity based only on your own activity, you’re grossly limiting yourself, and the real opportunity for being the most productive (or really, having the most productive business) is to hire talented people, make sure they understand the mission of the business, give them the tools they need, and then get out of their way. Of course, many advisors do ultimately hire at least some team members, from administrative support to associate planners, but Edelman points out that this is still limiting for the business, and that the real productivity comes as the firm creates the infrastructure that allows the advisors to really focus all their time on just being advisors, which means not just hiring more advisors or "mini-me" versions of yourself, but more of those with complementary skills to support them.
DFA Fund Family: An Alternative To Smart Beta? (Allan Roth, Financial Planning) – While “smart beta” and “fundamental indexing” have just recently become popular, Roth notes that these strategies are similar to the strategies that Dimensional Fund Advisors (DFA) has used for 34 years, which have evolved from a small-cap tilt in 1981 to the Fama-French Three-Factor model in 1992 and more recently adding in a profitability factor). In addition, DFA has a strong focus on low-cost investing (its domestic stock funds have an average expense ratio of just 0.32% and its international equity funds average just 0.50%), which has also become popular lately with the rise of ETFs. Accordingly, given these overlaps, and the rising popularity of both smart beta and low-cost indexing (though technically DFA’s funds are low cost and passive but not purely indexed), DFA’s recent growth has been explosive, adding more assets (on a percentage basis) that even Vanguard last year, and now ranking as the 10th largest fund family with $295B of AUM. And notably, DFA’s growth has come even though it’s generally only made available through advisors, with roughly 1,500 – 2,000 advisory firms that have gone through the DFA approval process (which includes the requirement to attend a conference where DFA explains its philosophy and the academic research supporting it). Yet despite the similarities, Roth notes that DFA is not quite the same as fundamental indexing (while DFA’s funds have various tilts that are similar, it does not completely ignore price and market cap weightings, for those who are so inclined), and while DFA has been very competitive to pure indexing solutions like Vanguard when it comes to equities, DFA’s solutions have lagged Vanguard slightly in the fixed income category.
The Active-Passive Debate Revisited (Bob Veres, Advisor Perspectives) – Notwithstanding the decline of actively managed mutual funds in recent years (with $800B of outflows since January of 2007!) and the rise of passive indexing and ETFs, Veres notes that ironically new academic research is finding that not only does active management outperformance remain possible, but that it may be more feasible to identify in advance than previously recognized. For instance, a series of recent studies that use Fi360’s “Fiduciary Scores” (which screen Morningstar data to grade mutual funds on various criteria that would be appropriate for a hypothetical prudent investor, in particular trying to screen out companies/solutions that are just chasing recent investment fads) found that the top rated funds really were providing better results (higher returns and/or lower volatility) over one-, three-, and five-year time horizons. Other research is finding that the time periods when active management itself is most likely to outperform actually varies; for instance, a study from Royce funds found that in the realm of small caps, active managers were more likely to outperform when small cap volatility was high, but struggled to outperform in lower volatility environments where markets moved in sync and there just wasn’t much opportunity on the table. And another set of notable studies from the Capital Group (which administers American Funds) found that a combination of low expense ratios and high manager ownership (where fund managers put more of their own money into their funds) was predictive of better performance results. And of course, there’s the continued research around Active Share, which finds that most mutual funds underperform simply because they’re closet indexers, but once those closet indexing funds are screened out, the potential for active management looks much better amongst the remaining funds that actually do have higher active share, especially those in the stock picker category.
Just Go With The Cash Flow (Ingrid Case, Financial Planning) – While financial planning encompasses a wide range of topics and areas, arguably virtually all of them rely directly or indirectly on the client’s ability to manage their household cash flow. As a result, a number of advisors are starting to focus more on doing cash flow planning with clients, particularly as technology tools have begun to make it easier to track cash flow, so clients can even figure out what they’re spending in the first place. Once spending habits are identified, it also becomes feasible to actually do cash flow planning and help clients strategize about being more responsible with their spending in the future. For instance, one advisory firm breaks spending into buckets, where the first covers fixed expenses like mortgage payments and utility bills, the second holds money for variable expenses like gas, restaurant meals, and clothing, and the third bucket is for future needs and wants (e.g., a reserve for major medical expenses, a vacation, or a new car). The buckets can even be represented by separate bank accounts, just to help clients more clearly account for how much money is in each (to manage progression towards savings goals, and provide a clear indicator about how much in discretionary dollars are left for the remainder of the week or month), and income/earnings can be automatically allocated to the buckets (e.g., up to 50% in the first bucket for fixed expenses, 30% in the second for variable expenses, and 20% in the third for savings goals). The approach can be especially helpful for those with higher variable spending, where a fixed dollar amount goes into the variable expense bucket every month, helping clients not to overspend when income is up (and then struggle to cut back when income declines).
A Blueprint For Retirement Spending (Luke Delorme, Journal of Financial Planning) – While many studies have been written about retirement spending strategies, many conflict, if only because they use somewhat different assumptions regarding how retirees will behave in the first place. Accordingly, Delorme suggests that the starting point in evaluating a retirement spending strategy for clients is to start by addressing two key issues. The first is whether the client prefers a “safe” spending strategy that minimizes the risk of depletion but may leave upside on the table (i.e., “underspend” in retirement) over one that “optimizes” spending by utilizing assets more aggressively (avoiding the underspending ‘problem’) but risking depletion (or at least significant cutbacks). And the second is whether the client prefers a steady/constant income throughout retirement, or if the client is willing to adopt a more flexible spending approach. Different combinations of answers on these issues lead to different strategies, from “safe and constant” (e.g., the 4% rule) “optimal and constant” (e.g., a floor-with-upside ratcheting strategy) to “optimal and flexible” (e.g., regularly updating retirement projections to adjust spending up or down), or “safe and flexible” (e.g., recalculating spending using the RMD approach). Once the foundation is established, the strategy can then be further adjusted for additional client-specific factors, such as the retirement planning time horizon (for clients who are much younger or older than the typical retiree), accounting for outside income sources (e.g., pensions and/or Social Security), and incorporating impacts like costs, bequest motives, and varying return assumptions.
Why Curious People Are Destined For The C-Suite (Warren Berger, Harvard Business Review) – A recent PwC survey of more than a thousand CEOs noted that “curiosity” and “open-mindedness” are increasingly critical leadership traits. The issue is that with the increasingly rapid pace of change in today’s business environment, no leader will realistically have all the answers, so those who are most ready to wonder and question will be the ones most capable of finding the fresh ideas to stay ahead. Or in some cases, a company’s curiosity is essential just to avoid being disrupted by competitors, and thus a curious leader who asks a lot of questions is valuable both for the ideas it generates, and the culture of curiosity it can create to support business-wide innovation. And of course, curiosity spawns a number of new businesses altogether as well; Square founder Jack Dorsey first came up with the idea for his more accessible credit card reader for small businesses after an artist friend lost a big sale because the artist couldn’t accept a credit card and Dorsey wondered why so few small businesses and entrepreneurs were able to do so. Yet the challenge is that in a world where business leaders and executives are often expected to be confident problem-solvers, many fear that asking questions will project a dangerous vulnerability or lack of expertise. And of course, being a curious leader also requires just being curious in the first place, although a recent book by Ian Leslie – aptly entitled “Curious” – finds that curiosity is not just a trait that we have or don’t, but that curiosity is driven by being exposed to new information… so if you want to stoke your own curiosity, get out of the bubble of your office and seek out opportunities to be exposed to new information and ideas in the first place.
DoL Fiduciary Proposal: How Tech Is A Game Changer (Joel Bruckenstein, Financial Planning) – Amidst the recent debates regarding the Department of Labor’s fiduciary proposal, numerous broker-dealer executives have raised concerns that their registered representatives will no longer be able to work with small investors and small business owners if the rule comes to pass. Yet Bruckenstein declares that this concern is “blatantly false” and that in reality, the challenge of broker-dealers serving smaller clients may be simply be an issue that those firms have failed to keep up with the digital revolution and the latest technology trends. In turn, this means that the roll out of a fiduciary standard may simply compel broker-dealers to evolve their business model sand finally make deeper investments into technology to support their advisors and retain their small clients… or risk being disrupted by more tech-savvy competitors who do. In other words, Bruckenstein suggests that ultimately the brokerage industry’s fears about being unable to serve smaller clients in a fiduciary world may simply be a problem of those firms’ own antiquated technology and business models.
When Advisors Have Advisors (John Kador, Wealth Management) – It’s a well-known maxim that a lawyer who represents himself has a fool for a client, and physicians are strongly discouraged from diagnosing and treatment themselves, yet Kador notes that few advisors seem willing to engage other advisors for their own needs. On the one hand, many advisors note that it could be awkward if clients found out that the advisor doesn’t even manage his/her own investments (e.g., that the advisor “doesn’t eat their own cooking”); yet on the other hand, in a world where it’s increasingly recognized that the value of a financial advisor is not just portfolio management, but the outsider’s perspective on a broad range of financial planning issues, are advisors who won’t pay for an advisor themselves being hypocritical about the value of comprehensive financial planning delivered from a third-party perspective? That being said, Kador points out that there do seem to be a small but growing number of advisors who work with other advisors themselves, both to leverage the outside perspective, and sometimes just to bring different expertise to the table. And for those who are interested the best way to do it is to really make it an official, formal engagement, where the advisor who is hired treats it like any other bona fide client relationship, including charging for the service as with any other client. Notably, advisors who have been through the process as a client point out that it often makes them better advisors themselves, providing a better understanding on what the financial planning experience is really like from the client’s perspective, and how it might be improved in their own practice.
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!
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.