Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the recent “Fiduciary Leadership Summit” in Washington DC, hosted by TD Ameritrade and the Institute for the Fiduciary Standard, highlighting “war stories” of consumers injured by gaps in the fiduciary duty for brokers and an interesting response by former regulator Robert Plaze that perhaps the best outcome is not a uniform fiduciary standard for all but simply that the brokerage industry needs its own standalone regulatory reforms. Also in the news this week is a new NASAA working group that will look at revising broker-dealer fee disclosures for consumers after acknowledging that today’s fee disclosure documents are too long and confusing, and a recent survey by Gallup that finds “creating a financial plan” is one of the few financial issues that consumers consistently do rely on professional advice more than friends and family.
From there, we have several practice management articles this week, including one from United Capital CEO Joe Duran that the golden age for (small independent) RIAs may soon be ending with rising competitive forces putting the big squeeze on profits and margins, a response to Duran’s bleak outlook from RIABiz’s Brooke Southall who suggests that many of these competitors (from robo-advisors to Vanguard’s Personal Advisor Services) are still ultimately just a drop in the bucket compared to the sheer size of the consumer investor marketplace, and a discussion from Mark Tibergien about whether some advisors actually need to get better at having the conversation with clients about raising fees instead.
We also have several more technical articles this week, including: a discussion of what the “true diversifiers” in a portfolio really are, and whether they’re even necessary if there’s a risk-managed approach to the equities themselves; a review of a recent T. Rowe Price survey suggesting that retirees may actually be more flexible and adaptable in their retirement spending than is commonly believed; and the last looking at the current use of Monte Carlo analysis, suggesting that perhaps one of our greatest problems is not the limitations of the tool itself but that many of today’s Monte Carlo software tools do not provide a sufficient range of reporting on the outcomes beyond just the (insufficient) probability of success/failure alone.
We wrap up with three interesting articles: the first looks at how much of the disagreement amongst even the true finance experts may stem from the fact that our experience with investing and the markets can be dramatically impacted by the year in which we happen to be born (and therefore the investment returns and volatility we witness during our early formative years), and that many finance disputes may simply be a representation of two experts whose views are heavily biased and colored by their own (birth-year-sensitive) personal history and experience; the second looks at how the real significance of the robo-advisor trend may not be their actual competitive threat, but simply that they highlight what quality technology and a great client user experience looks like, and how lacking today’s tools for advisors really are; and the last is an analysis from Wealthfront about the behavior of investors in active mutual funds versus index funds during market volatility, finding that passive investors are less prone to portfolio turnover during market volatility and suggesting that despite their lack of human advisors to hand-hold clients, many of today’s (passively-based) robo-advisors may experience witness less client churn during the next bear market, not more.
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end, including a summary of the first (Orion-Advisor-Services-sponsored) “hackathon” which brought together programmers from numerous advisor tech companies to try and build the best new useful relevant technology tools and integrations for advisors in just 48 hours! Enjoy the reading!
Weekend reading for September 20th/21st:
TD Ameritrade Pulls Off Amazing Summit in DC That Reveals Rot To The Core Of SEC, FINRA And ERISA System (Sanders Wommack, RIABiz) – As a part of “Fiduciary September”, this week TD Ameritrade and the Institute for the Fiduciary Standard led a “Fiduciary Leadership Summit” in Washington DC, kicking off the session for industry leaders with a panel of four “common men” (an airline pilot, a government engineer, an ex-Congressman, and a court reporting business owner) to share their experiences and challenges in financial services and the importance of a fiduciary standard, highlighting “war stories” – one wanted to invest primarily in U.S. Treasury Bonds but eventually his broker prodded him into buying WorldCom on margin in the late 1990s, while another eventually realized that his employer’s 401(k) plan had become the dumping ground for a brokerage firm’s unwanted securities… yet highlighting rampant consumer confusion, none of them were aware of or could articulate the difference between brokers and investment advisors and their associated standards of care. Following the consumer panel were interviews and sessions with both academics and (former) regulators, including former SEC Division of Investment Management deputy director Robert Plaze who stated that the uniform fiduciary standard is a terrible idea, and that it’s just the broker-dealer standards that are evolving and need to be reformed; in other words, the standards should remain separate, but the broker standard still needs improvement. In the meantime, the DOL is still expected to establish some form of fiduciary standard, impacting a wide base of 400,000 registered reps, and Professor Mercer Bullard predicts that SEC chairwoman Mary Jo White will now wait for the DOL to act and then decide how the SEC will proceed. In the meantime, the fiduciary advocates at the conference continued to push for legislation to assess user fees on RIAs to improve the examination rate, viewing it as “the best bad option”, and a more appealing alternative than having RIA oversight shifted to FINRA, though lobbying efforts remain difficult as fiduciary opponents, including SIFMA, NAIFA, and FINRA itself, have an enormous head start on lobbying dollars, experience, and relationships. The upside for fiduciary advocates, though, is that they’ve been better at implementing grassroots campaigns where ordinary citizens can explain how the legislation will affect them, and TD Ameritrade announced a coming “eAdvocacy” platform that is intended to provide further ways for advisors to support the fiduciary lobbying efforts.
New Broker Working Group Aims For Easy-To-Read Fee Disclosure (Joyce Hanson, Investment News) – A recent research report from the North American Securities Administrators Association (NASAA) has found that fee disclosures are losing their effectiveness as they increasingly get hidden and buried in small print and lengthy documents, with fee disclosures ranging from one paragraph to 7 pages, and sometimes embedded within a bigger document that could be anywhere from 1 to 45 pages! As a result, NASAA is exploring ways to reform broker fee disclosures, and is forming a working group including the NASAA Broker-Dealer Section, FINRA, SIFMA, and FSI (along with several major broker-dealers) to explore the creation of a model fee disclosure document that would be simpler to read, easier to find, and readily available for consumers, to help facilitate apple-to-apple comparisons across broker-dealers (without focusing on specific investment products).
U.S. Investors Seek Advice for Some Things More Than Others (Lydia Saad, Gallup) – A recent Gallup poll asked investors (with at least $10,000 in investable assets) about the financial decisions they face, and how likely they are to seek out either professional advice or use informal (e.g., friends and family) advice. By numbers, the most common financial decision is buying a car (82%), planning a major vacation (80%), or buying a house (77%), though notably “creating a personal financial plan” falls just behind at 76%. And of the decisions, creating a personal financial plan was by far most likely to be done with advice (63% of the time), and of those who got advice 74% relied on professional advice. In combination, this implies that about 1/3rd of all investors have created a personal financial plan with the help of a professional (74% of 63% of 76%). Delving further, the Gallup poll also found that while men and women are about equally likely to create a personal financial plan (76% vs 75%), women are slightly more likely than men to seek out advice in doing so (66% vs 61%, respectively). The Gallup poll also found, not surprisingly, that those with a higher net worth are more likely to adopt a financial plan and seek out advice; amongst those with more than $100,000 in investable assets, 80% had created a personal financial plan, and 65% of them sought out advice to do so. Overall, the Gallup poll notes that most people who seek advice for financial decisions end out doing so informally from friends and family members, and that the creation of a personal financial plan was the “one major exception” where many investors specifically seek out professional financial advice.
The Big Squeeze: End Of The Golden Era (Joe Duran, Investment News) – While the independent advisory firm has seen much success in recent decades, Joe Duran suggests that the success of the small independent advisor has been driven in large part by the fact that most have only ever had to compete against other small independent advisors. Yet Duran suggests that this 25-year stint – from 1990 to 2015 – may ultimately be looked back upon as the golden age for the independent advisor, with no nationally dominant firms and a flood of retirees needing help. Going forward, though, four factors may “put the squeeze” on the independent advisor, including: 1) the mega Direct-To-Consumer (D2C) firm, from large mutual funds to national custodians, that are reconfiguring their business models to offer financial planning to clients of greater and greater net worth at lower and lower prices (think Vanguard’s Personal Advisor Services); 2) the Super Advisors, a growing number of $10B+ truly national wealth management firms with a broad reach of full service solutions build on the base of massive scale and quality technology; 3) the robo-advisors, which are also building a national presence, targeting young consumers that will be the advisory profession’s future lifeblood, and charging a fraction of what convention advisors charge; and 4) the big banks and brokers, which are also shifting their focus from the distribution of proprietary products to charging similar fees and rolling out their own engaging high-end wealth management tools. And in the middle of all these turbulent forces? The standalone local advisor, who may increasingly struggle to gain new clients or even get their brand noticed amongst prospects, be forced to invest “a fortune” to upgrade technology and services, and find it difficult to attract and retain professional advisory staff.
Why Joe Duran Is Dead Wrong On 2015 Marking The End Of The Golden Era Of The RIA (Brooke Southall, RIABiz) – Contrasting the prior article, Brooke Southall of RIABiz looks at Duran’s analysis of the competitive forces in the world of RIAs, agreeing on the challenges but disagreeing about the conclusions they imply. For instance, while Southall acknowledges the rising threats of new competition, he suggests that the industry built around RIAs to support them is still in the third inning and is also innovating ways to support RIAs and make them more successful, and notes (as does Duran) that prior threats have come at advisors in the past (e.g., in the 1990s when accounting and law firms were predicted to take over wealth management) and advisors have managed to innovate forward and past them. Similarly, Southall raises the question of whether the large mutual funds launching advisory services (e.g., Vanguard’s Personal Advisor Services) are really the kind of “phono-advisor” (an advisor in a call center) that consumers want, and questions whether the big banks and wirehouses shifting towards wealth management are really changing their stripes or still ultimately focused on the distribution of proprietary products from their potentially tarnished brands. And while Southall does agree with Duran’s point about the rising number of “super RIAs” with $10B+ (soon to be $25B+) of AUM, even those “mega-firms” are still a drop in the bucket when there’s $10 trillion or more in consumer investable assets out there. As for Duran’s last factor – robo-advisors – Southall suggests that even Duran himself may be skeptical of the robo-advisor threat, noting that as a serial entrepreneur if Duran really believed the robo-advisor threat, United Capital would probably be launching one as Schwab has signaled it intends to do and Ric Edelman already has.
Your Rationale for Raising Fees (Mark Tibergien, Investment Advisor) – While there are many ways that firms can make adjustments to improve their profitability, the strategy that advisors seem most hesitant about implementing is a fee increase, a problem that Tibergien suggests is only getting worse as the advisory profession increasingly attracts advisors of a ‘helper’ mindset who provide the kind of “peace of mind” value propositions that are especially hard to assign an appropriate dollar value to. In some cases, advisors may justify not raising their (AUM percentage) fees on the basis that the rising markets have already lifted the actual dollar amount of their fees, with the caveat that relying on market increases alone does not necessarily maintain the connection between pricing and the advisor’s value. For those who are considering a fee increase (or at least re-evaluating their pricing strategy), Tibergien points out three key factors: 1) the Cost of doing business (which seems clearly on the rise, from the costs of compliance to rising compensation due to the industry’s talent shortage); 2) your pricing compared to the Market (i.e., how you price compared to the competition); and 3) your Value, and what value-added services you can include to support your (higher?) fee. Tibergien points out that effective client segmentation – where, like an airplane, clients have an opportunity to choose between economy or business class, with different pricing and different services and value for each – can also help support a more robust fee structure. Once you’ve mentally committed to a price increase, Tibergien’s 5-step process to moving forward is: 1) create a transition plan for how you’ll get clients from the “old” pricing to the “new”; 2) develop a value story, so you know how you’re going to explain the fee increase and why you’re worth it; 3) be prepared to communicate that value story to reinforce your (new) pricing; 4) plan in advance for the likely client objections you may hear and be ready to respond; and 5) track the implementation of your new price structure, recognizing that it may take time to roll out (and properly communicate) across the entire client base.
“Are You Well Diversified?” What Does That Really Mean? (Jerry Miccolis & Marina Goodman, Journal of Financial Planning) – In the aftermath of the 2008 financial crisis, when a lot of portfolios turned out to be “less diversified” than previously believed, there has been a great deal of focus on what are really the “true diversifiers” and what it means to be really diversified. Perhaps the biggest key to understanding if you’re well diversified or not is whether there’s always some part of your portfolio you’re not happy with – which can actually be a good sign, as it means your portfolio probably isn’t fully aligned (and correlated) towards a particular economic outcome. In other words, if the benefit of diversification is that you’re hoping some investments will “zig” while others “zag” during a bear market, the portfolio should also be seeing the zigs and zags during a bull market, too, and that whatever is the portfolio laggard isn’t a sign of bad results but of good diversification! On the other hand, the push for “true diversifiers” also raises interesting questions about the purpose and function of diversification in the first place. In traditional portfolio design, diversification is about decreasing the overall risk of the portfolio while still pursuing a healthy return (where risk can be defined as anything from standard-deviation-based volatility, to semi-deviation, shortfall risk, or CVaR). From this perspective, fixed income can be an effective diversifier (but not segments like high-yield bonds that tend to correlate to equities!); real assets like REITs and MLPs can help protect against inflation, but may or may not effectively diversify against a recession that hits equities too; a wide range of “alternative investments [and strategies]” have emerged as diversifiers as well, though the authors note that many of these have not maintained their low correlations when the bear markets come along. In fact, the authors note that one of the most consistent and effective diversifiers against equities is today’s most unloved: the humble Treasury bond. On the other hand, the authors also point out the growing interest in more proactively risk-managed strategies, whether momentum- or volatility-based or simply focusing on deep value stocks with less downside risk, the interesting question arises: if such strategies really can effectively manage the downside risk of equities directly, does it actually make the other diversifiers less relevant and necessary altogether?
Despite Curve Balls, Most Retirees Manage (Tom Lauricella, Wall Street Journal) – While the industry and consumer media continues to lament the unpreparedness of baby boomers for retirement, a recent study from T. Rowe Price looking at actual retirees finds that despite many of the dire predictions, retirees are figuring out how to adjust and manage, even as life throws them curve balls. One retiree, whose portfolio was hit especially hard in the financial crisis and has been slow to recover, had the remarkably simple recognition that his lifestyle would probably need to change and his budget would be a bit tighter than he had hoped… but he managed to figure out ways to adjust his spending and is moving on. In fact, the T. Rowe Price study found that only 1-in-5 retirees said their post-retirement income matched their pre-retirement paycheck, and on average their retirement income was just 66% of what they had been making (remarkably close to the ‘traditional’ 70% replacement rate studies!). In retirement, 40% of the retirees stated that they have been able to adjust their lifestyle “a great deal” to match their income (especially by making changes to housing, one of the biggest ongoing expenses in retirement), and 37% agreed that they just don’t need to spend as much in retirement as they had previously to remain satisfied. Overall, the study found some retirees do struggle in retirement, especially when it is forced upon them earlier than expected for health reasons, and T. Rowe Price also found that unmarried women tended to have a harder time making ends meet; nonetheless, a whopping 90% of the recent-retiree respondents stated they were “very satisfied” or “somewhat satisfied” with their retirement.
The Key Problem with Monte Carlo Software: The Need for Better Performance Metrics (Joe Tomlinson, Advisor Perspectives) – While some recent Advisor Perspectives articles have looked at the benefits and limitations of the Monte Carlo analysis engine itself, this article looks at ways that Monte Carlo tools might improve the ways they report the outcomes of the analysis. Overall, Tomlinson notes that even the standard Monte Carlo result – the probability of success – which accounts for volatility along the way, is still an improvement over the straight-line “deterministic” projection of median wealth at the end of retirement (which by excluding market volatility along the way can lead to overconfidence in the retirement plan); but ideally, Monte Carlo results should go further, by showing not just probabilities of success (or the associated failure rate), but also the average and median bequests, and when the failures occur what the average failure is (to have a sense of the magnitude of the failure if it does occur). In addition, the Monte Carlo results should ideally show these outcomes for a series of different portfolio allocations (e.g., varying mixtures of stocks and bonds), to help illustrate the sensitivity of the outcomes to the equity allocation. This more extensive analysis of the outcomes from multiple perspectives can also add valuable color when considering strategies that include guaranteed products, like the inclusion of a single premium immediate annuity (SPIA), which may reduce average bequests (by limiting upside) but also mitigate average failures (by limiting downside), in what can be an appealing trade-off for at least some retirees. For those who wish to assume more dynamic spending strategies – such as the retirement spending decision rules approach first developed by Jon Guyton – Tomlinson notes that it’s necessary to go even further, looking at the variability of the spending in retirement (based on whatever decision rules are chosen) so that strategies can be compared accordingly; for instance, a risk-averse retiree might prefer a stable spending of $40,000, rather than a spending pattern that averages $45,000 but can vary from $30,000 to $60,000, while another retiree might prefer the higher average spending and not mind the spending volatility along the way. The bottom line – continuing the theme of prior articles on the subject by Pfau and Blanchett (and yours truly), Monte Carlo simulations remain a powerful way for advisors to illustrate the variability of potential outcomes in retirement, but we still seem to lack the best tools to actually model and appropriately illustrate and communicate the results.
Why Finance Breeds So Much Disagreement (Morgan Housel, Motley Fool) – Despite how many smart people the field attracts (not to mention many who are less so!), Morgan Housel notes that it’s astonishing how little even the true finance experts agree about relatively basic concepts like whether stocks are fairly valued or in the midst of a giant bubble (unlike physics, for instance, where all physicists agree about core concepts like gravity!). Housel suggests that one of the key reasons why finance experts disagree is that they are significantly biased by their own personal experience and history – and that because markets are so volatile and have long booms and busts, one person’s experience in the markets can be dramatically different than another, simply depending upon the year in which they were born! For instance, if you look at market results during the key learning and formative years of one’s career in finance (ages 13-29), you find that someone born in 1970 (who came of age during the great 1980s and 1990s market boom) just watched stocks go practically straight up for years, while someone born in 1950 (or the late 1980s!) has watched stocks experience a period of crashes and flat cumulative returns for more than a decade of their key learning years. The results are even more magnified over an entire working career; from age 30 to 50, those born in 1930 got no return out of stocks, while those at the same age range but born in 1950 saw stocks rise twelvefold over the same time horizon! The ultimate point – perhaps some of the great debates we see in the world of finance, especially amongst those who are not exactly the same age, may be influenced far more than anyone realizes by the person’s own unique birth-year-based experience that colors their perspective on everything.
How The New RIA Competition Is Akin To The Cup-Holder Dilemma For Automakers (Brooke Southall, RIABiz) – Despite the fact that “robo-advisors” are still a drop in the bucket compared to the total size of the investment world, and few if any advisors can cite a situation where they actually lost a client to one, the advisory world seems to remain obsessed with the robo-advisors and their potential threat. This article makes an interesting case of explaining why, citing an interesting analogy to the psychology of cupholders in cars – the idea that while a cupholder is a remarkably minor item in the grand scheme of what a car delivers, attention to simple aesthetics like whether there are enough cupholders, whether the cupholders are in reach, whether they securely hold the cup, etc., can have a remarkably strong influence on the perceived quality of the car, and are viewed as an overall indicator of good design. In the context of advisory firms, there is a parallel to the remarkable lack of basic technology tools for clients to help manage and monitor their finances, in a world where the limited Personal Financial Management (PFM) tools available to advisors, for which they may pay thousands of dollars, are still inferior to the simple free solution at Mint.com… and similarly raising the question of how good the overall quality of the advisor can be, when lacking in the delivery of simple tools and solutions with a good aesthetic and user experience. Ultimately, the point is still not necessarily that robo-advisors have to be a threat to real advisors, but simply that the appeal of the robo-advisor technology has highlighted and accentuated what quality technology can deliver and what advisors still don’t have in the currently available tools. Now, the question is just whether the technology companies (or custodians) that serve advisors will step up to deliver?
Passive Investors Need Less Hand Holding (Andy Rachleff, Wealthfront) – Given the often-levied criticism at robo-advisors that they won’t have humans available to hand-hold clients during the next inevitable bear market, Wealthfront founder Andy Rachleff digs into some of the available data to evaluate how passive investors tend to behave in bear markets (as Wealthfront and other robo-advisor platforms generally invest in portfolios of passive ETFs). Rachleff starts by looking at data from the Investment Company Institute, analyzing the narrow redemption rate (which excludes redemptions that were just switched to a similar fund) for both index funds and all mutual funds (including active and index funds) against returns of the S&P 500 over time, finding that while redemption rates do rise during market declines, the rate of increase tends to be far less for index funds than mutual funds overall; regressing the redemption rates against market returns, the data suggests that a 1% decline in S&P performance causes a 0.12% increase in withdrawals for mutual funds overall, but only a 0.07% increase in the redemption rate for index funds (and given that the mutual fund data includes the lower index fund results, separating the index funds from the active funds would theoretically produce an even greater difference). The results are further emphasized by Wealthfront’s internal analysis, which finds that there has been no relationship between weekly returns of the S&P 500 and redemptions of Wealthfront’s own client base (or even the frequency of client service activity) over the past 2.5 years and that the greatest reason for withdrawals from Wealthfront’s young client base is simply for a downpayment on a house and often from their less-than-$10,000 “free trial” accounts (though notably, while there have been some 2.5% weekly drawdowns, there have been no 10%+ corrections or significant bear market in this time period to test harsher market volatility). Nonetheless, the implied conclusion is that because the investors didn’t buy actively managed funds in the first place, they are probably less likely to try to make market-timing changes to their portfolio along the way as well, and that while Wealthfront (and other robo-advisors) will still inevitably see some client churn if markets tumble, that the pace could actually be below industry averages.
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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read “FPPad Bits And Bytes” on his blog!