Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with a recap from the recent “Deals and Dealmakers” Summit on mergers and acquisitions in the advisory industry, which suggests that demand remains strong for advisory firms, though buyers are increasingly focusing on the largest ($1B+ AUM) sellers. Also in the news this week was a fascinating interview with Matt Lunch of Strategy & Resources about the future of the Independent Broker-Dealer (IBD) model, and the announcement that the CFP Board’s Center for Financial Planning is finally launching its new academic journal, dubbed “Financial Planning Review” (FPR), and will have a Call For Papers in October to be considered for the inaugumidral issue coming mid-2018.
From there, we have several technical planning articles this week, including a look at the projected Social Security COLA for 2018 (which will ironically increase payments for upper-income individuals, but likely not for lower- and middle-income households due to the looming unwind of Medicare Part B’s Hold Harmless provisions from 2016-2017), strategies to reduce clients’ state income taxes by changing their state of residence (and what it takes for HNW clients to really substantiate their change in address), and what affluent clients should bear in mind as the IRS increasingly targets its resources on focused examinations of high-income individuals (but with fewer full-tax-return audits).
We also have several practice management articles, from a discussion of whether the traditional A/B/C client segmentation approach is actually just a relic of the old commission-based world and needs to be re-designed for modern advisory firms, to a look at the concept of “Client Journey Mapping” and why there are many opportunities for advisory firms to innovate by focusing on how technology can be used to improve the client’s experience in interacting with the firm, and a fascinating discussion from advisor consultant Stephanie Bogan about how for many advisors the best strategy for handling prospects who ask for discounts or exceptions to the advisor’s minimums is simply to have a stringent “no exceptions” policy.
We wrap up with three interesting articles, all focused on thinking about the ways the advisory industry is changing: the first looks at how the recent Equifax breach was actually an excellent “micro-moment” opportunity for advisors to demonstrate their value and relevance for clients beyond just their investment portfolios… yet few seem to have stepped up to provide proactive guidance to their clients on issues like credit freezes; the second is a look at the real-world consequences of “non-fiduciary” conflicted advice, where the problem is not just that occasional “bad actors” make highly questionable (but still “suitable”) sales to clients, but the fact that because of a current lack of fiduciary standard, they get away with it and keep doing it over and over again; and the last is a good reminder that ultimately, in trying to help clients stick to their investment plan, the best solution is not just about trying to change the portfolio to fit the client’s investment behaviors, but also figuring out how to use the behavioral finance research to help clients adjust their behaviors so they are less stressed about (or focused on) their portfolios in the first place!
Enjoy the “light” reading!
Weekend reading for September 23rd/24th:
Market Downturn Fears, Other Hot-Button Issues Divide RIA Dealmakers (Charles Paikert, Financial Planning) – This past week was the annual “Deals & Dealmakers Summit” hosted by Echelon Partners (which providers investment banking, management consulting, and valuation services for advisory firms). The conference is known for bringing together most of the leading firms engaged in Mergers & Acquisitions for independent advisory firms, and featured extensive discussion about current trends in advisory M&A. Weighing heavily on everyone’s minds is the potential risk of a bear market – given that the current bull market cycle is more than 8 years long – and what that might do to advisory firm valuations. The prevailing view is that a potential stock market reversal will not likely hurt M&A valuations (or at least, valuation multiples), though buyers are increasingly careful of how they structure M&A deals to not “over-value” companies that could experience a substantial “near-term” revenue decline if a bear market unfolded shortly after the deal closed. On the other hand, the clearer trend is that the most robust demand for advisory firm acquisitions continues to be for “larger” advisory firms – those with more than $1B of AUM, or more specifically with at least $3M of revenue – as larger firms are not only “large enough” to attract deep-pocketed buyers (whereas smaller deals are “too small” to be material for them), but are also more likely to be professionally managed (and less dependent on founders or a single key employee) and better able to leverage economies of scale. Another key trend expected to continue – the ongoing wirehouse breakaway broker trend, although notably “older” brokers (in their 50s or beyond) appear increasingly likely to stick out the remainder of their careers at wirehouses, while it’s younger wirehouse advisors in their 30s and 40s who are increasingly looking to independent channels.
The Future Of The Independent Broker-Dealer (David Armstrong, Wealth Management) – A hot topic at the upcoming Wealth Management Executive Forum is the future of the independent broker-dealer model itself, with a notable panel to be moderated by industry consultant Matt Lynch of Strategy & Resources on the topic. Overall, Lynch suggests that the predicted extinction of the Independent Broker-Dealer (IBD) is overstated, though the trend of smaller broker-dealers filing Form BDW (to withdraw their registration as a standalone broker-dealer) and tuck into a larger IBD as an OSJ is clearly underway. Yet for the registered representatives of those smaller broker-dealers, the tuck-in to become an OSJ of a larger firm is so smooth that many of them simply end out with better technology and services, and the business gains better economies of scale. The more notable trend, though, is that IBDs are being compelled to reinvent their underlying business models, to the point that while “broker-dealer” may continue to be a regulatory label, it’s no longer necessarily an accurate description of their business model, with more and more shifting to advisory fee-based business with affiliated corporate RIAs and internal TAMPs. In other words, IBDs are essentially converting from actual “broker-dealers” into intermediaries that provide support to advisors, to the extent that someday they might even drop their broker-dealer registration yet continue as an advisor affiliation entity. Accordingly, broker-dealers are increasingly reinvesting themselves into a wider range of advisor support services, from consulting on succession planning and practice management, executive coaching, and other marketing and technology advice. At the same time, broker-dealers are becoming increasingly RIA friendly – either with their own corporate RIAs, or by allowing their reps to be hybrid RIAs… though in the end, the whole independent broker-dealer model and large RIA networks may all collapse into one.
CFP Board To Launch Academic Journal In 2018 (Karen Demasters, Financial Advisor) – As a part of its effort to become the “Academic Home” of financial planning, the CFP Board’s Center for Financial Planning has announced that it will begin producing a new peer-reviewed academic journal, “Financial Planning Review”, beginning in mid-2018. As a counterpart to the FPA’s Journal of Financial Planning – which is focused on practitioner-centric research – the new FPR Journal is intended to focus more on scholarly academic research, albeit on a very wide range of financial planning topics including behavioral finance, household finance, psychology and human decision making, financial therapy, literacy and wellness, consumer finance and regulation, human sciences, and other “relevant” subjects. The FPR will be available electronically from publisher Wiley Online Library, and a new “Financial Planning Body of Knowledge” website that will also be launching in 2018. A “Call For Papers” for those who want to submit to the first issue of FPR will be coming in early October, with all submissions subject to a peer-review process from the FPR’s Editorial Review Board.
Social Security COLA Could Get Wiped Out By Rising Medicare Costs (Mary Beth Franklin, Investment News) – With the latest CPI release for August now available, analysts project that the annual Social Security Cost-Of-Living Adjustment, or COLA (which is calculated annually from the beginning of September from the prior year to the end of August of the current year), should be approximately 1.8% in 2018, which would actually make it the largest COLA since 2012 (when it was 1.7%), and up substantially from 0% in 2016 and just 0.3% in 2017. However, because the past two years have had especially low inflation and small COLAs, most Social Security recipients have benefitted from the so-called “Hold Harmless” provisions that cap their Medicare Part B premiums at the dollar amount increase in annual Social Security payments – which meant with near-zero inflation for two years, the $104/month Medicare Part B premium from 2015 has risen to “just” $109/month (while the roughly 30% of Medicare enrollees not protected by Hold Harmless have been paying $134/month, plus any income-related surcharges). Yet with inflation now looming for 2018, the rise in Social Security payments next year will be enough to “unwind” the prior Hold Harmless rules, reverting most Social Security recipients from $109/month to $134/month in Medicare Part B premiums, which ironically will consume most or all of their pending 1.7% COLA increase. On the other hand, higher income individuals, who were not eligible for Hold Harmless in the first place and were already paying the full $134/month in Medicare Part B, will continue to pay the same amount next year (albeit plus income-related surcharges again), but actually will see the 1.7% COLA increase in their Social Security checks!
How A Change Of Address Can Save HNW Clients Millions (Tobias Salinger, Financial Planning) – With some states assessing income taxes at rates higher than 10% (e.g., New York and California), a substantial amount of potential tax savings is available for advisors who can help their clients set up residency in states with lower tax rates. And the higher the client’s net worth and income, the more the financial impact of changing states of residence to lower-tax-rate states like Florida. However, because of the substantial amount of tax dollars at stake – especially for HNW clientele – states will potentially challenge a client’s change in state of residency, and force them to actually prove they made a bona fide switch. The starting point to validating a change in residency is whether the client spend more or less than 183 days in the state, as well as where they actually maintain their primary residence, and store their prized possessions (which affirms that what they claim is their primary residence really is their primary residence). In the context of HNW clients, this may mean relocating where a boat is moored (to a dock/marina near the house in the new state), to relocating works of art, in addition to getting new driver’s licenses and voter registrations. Some clients go so far as to use a location-tracking app like Monaeo specifically to help validate that they spent the requisite minimum number of days in the new state, and try to book flights for trips that leave early in the morning (rather than the night before) to ensure they can count the prior day/night towards their 183-day requirement. Because, again, the sheer amount of dollars at stake – particularly for HNW and high-income clients – means there is an elevated risk of audit from the prior state that doesn’t want to lose its tax revenue!
Are Your Wealthy Clients Prepared When The IRS Comes Knocking? (Debra Estrem & Spencer Paul, Investment News) – Since 2010, the IRS budget has been cut by about 18% (after adjusting for inflation), and has lost 14% of its employees, with cuts expected to continue for the foreseeable future. The IRS’ diminishing resources have in turn led to a number of notable shifts in how the IRS conducts examinations and audits, including more electronically-geared exams, and more of a focus on specific high-yield-potential issues rather than broader audits of the entire tax return. In addition, in 2010 the IRS also created the “Global High Wealth Industry Group”, which is focusing specifically on tax audit opportunities for high net worth individuals and especially those that have related businesses, foundations, and trusts (as the Global High Wealth group is actually based within the IRS’ Large Business and International division). And the IRS’ Small-Business/Self-Employed division also continues to focus its resources on high-net-worth taxpayers, especially large estate and gift tax returns. As a result, in 2016 the IRS actually examined nearly 20% of individual returns with $10M or more in adjusted gross income! Given these dynamics, it is arguably prudent for financial advisors themselves to help their HNW clients do periodic risk assessments to understand their audit risk, and what they should do to be well-prepared (to deal with the IRS exam, and ideally to prevail!) if audited. Key steps include: 1) Examine publicly available information, as the reality is that the IRS is using search engines and other public sources to find visible taxpayers that may have transactions and income events worth auditing, so it’s good for clients to be cognizant of what they’re sharing (that’s tax- and business transaction related) online or in the media, as the IRS really may use it as a means to determine whether the client should be audited; 2) Identify areas that are at highest risk for exam, as the reality is that with the number of general tax return audits on the decline, it’s at least easier to anticipate what the IRS will likely target (e.g., valuation, management fees between related entities, hobby-loss rules, at-risk rules for passive business losses, etc.); and Organize documentation for sensitive areas (i.e., if the client is knowingly engaging in a riskier tax strategy, be certain to have contemporaneous records, appropriate supporting tax research, and other documentation that may help to substantiate the transaction/event if it is audited).
The Huge Flaw In Most Ongoing Service Offers (Stewart Bell, Audere) – Historically, most financial advisors were paid on commission, which means they didn’t even have the flexibility to set a fee for their own services, and instead had to accept their revenue opportunities as defined by a third party (the product manufacturer). Consequently, there was no real ability to create a fee-for-service model specific to any particular target clientele, and instead the best advisors could do was review all the compensation they received from all of their clients, and then “reinvest” by trying to provide additional services to the “biggest” clients who paid the most, which evolved into segmenting clients into A/B/C (or Platinum, Gold, and Silver) tiers, and then providing different service levels for each based on how much money they had placed with the advisor. The problem, though, is that such a model entirely ties services to what clients can afford to pay, and not what they actually want, and is the functional equivalent of insisting Warren Buffet buy a Bugatti Veron (base price: $1.7M) instead of the mid-range Cadillac he actually wants to drive. Similarly, it presumes that the only “real” clients are the ones who will give the advisor all their money – in order to buy the most products, to hit the highest revenue levels, and receive the most service – instead of allowing those with financial wherewithal to buy high-value but more piecemeal services if they want, and more generally recognizing that consumers are a mixture of Do-It-Yourselfers, and Validators (who want to keep control but seek collaborative advice), and Delegators (who advisors have traditionally worked with). So what’s the alternative? Bell suggests a three-tier framework instead: 1) a “DIY” offer (for those who are mostly self-directed, and have low levels of complexity, where they’re responsible for monitoring their own situation and notifying you when assistance is desired/required, and they simply pay as needed); 2) a “Done With You” offer (for Validators, where you do some of the work, but clients keep control of parts as well, and the scope of engagement is clear about where and how you’ll work together on an ongoing basis); and 3) the full “Done For You” offer (a holistic financial planning/wealth management solution for delegators). Notably, each of these would have their own pricing model, structured to align to the nature of that particular advisor-client relationship (and not just based on the amount of total assets/business the client is willing to place with you!).
Will You Stand Out Or Fade Out? (Julie Littlechild, Absolute Engagement) – The rising wave of advisor technology tools are a huge potential boon for the efficiency of financial advisory firms, allowing for substantial innovation in how advisors deliver their services. But Littlechild suggests that “innovation” is not just about how advisors run their businesses, but also how they reshape the client’s interactions with the firm. The starting point, though, is just to understand all the different ways that prospects and clients actually do interact with the firm, or what Littlechild calls “Client Journey Mapping”. The starting point is just to sit down and think through all the different steps that someone goes through in the process of becoming your prospect and then your new client and then your ongoing client, and what the experience is like from that prospect/client’s perspective. First and foremost, it’s important to recognize that from the prospect’s point of view, the “experience” begins when they first become aware of your firm – in fact, by the time the prospect actually interacts with the advisor, he/she may have already visited the firm’s website, and communicated with other staff members… all of which must then be considered in the client experience. In addition, it’s crucial to consider what else the prospect or client deals with, from their perspective, throughout the journey – for instance, the advisor’s process might start with gathering data, but how does the prospect feel when they receive that long detailed data-gathering form, and is that turning the initial planning process into a negative from the client’s point of view? Littlechild suggests that for most advisors, the client journey map has at least 7 stages: recognizing a Need, gaining Awareness of the advisor’s firm, Initial Contact, Onboarding, Financial Plan Creation, Review Meetings, and Ongoing Communication. Have you really considered what the client may be thinking and experiencing at each step along the way, what the touchpoints are (with you or your staff), and how each step along the way might be improved?
Time To Change The Conversation On Fees & Referrals (Stephanie Bogan, Investment News) – The human brain is hardwired for survival. Which means whenever we’re confronted by a challenging request, our brains tend to go on the defensive and try to remove us from the conflict zone… often limited our success in the process. For instance, how often as a financial advisor have you found yourself in a meeting with a prospect explaining your value, where the prospect asks for a discount on the fees, and putting you on the spot to figure out how much of a discount you must offer in order to win the client’s business. Or a prospective client is referred to you, and you meet with the person and only discover after the fact that he/she doesn’t meet your client minimums, and now you must determine how much of a concession you’re willing to make on your established minimums. Bogan suggests that a better way to handle the situation is, ironically, to simply have a policy of not compromising at all, and to tell that to the prospect – explaining how your minimums and fees are set based on the value you’re confident that you deliver, and the cost you know it takes to deliver your services, and that therefore your fees (and minimums) are what they are, and that you’re happy to refer the prospect to someone else if it’s not a good fit. The end result in most cases is that the good-fit clients will step up to your minimums or your full fee anyway, while those who decline were less likely to fully value your services in the first place… and by being clear about who you serve and the value you provide, you may even find that it helps to stoke more referrals and new business, by being crystal clear about who you serve (and especially if you go back to the person who referred you the below-minimum prospect and explain to/remind them again who you primarily serve, what you do for them, and what it costs).
Equifax: A Teachable Micro-Moment For Advisors (John Anderson, SEI Practically Speaking) – For the past two weeks, the media has been consumed (and consumers have been inundated) with news of the data breach at Equifax that impacted over 140 million consumers and put them at risk of financial identity theft. Yet Anderson points out that, despite the high-anxiety financial ramifications of the Equifax breach for the typical consumer – and especially the affluent clientele of financial advisors – relatively few advisors actually proactively reached out to communicate with their clients about the Equifax breach and what they should do to protect their credit and identity (despite the fact it’s clearly been on most peoples’ minds!). In fact, at a series of conferences last week, Anderson surveyed advisors and found that out of 200+ advisors, only four of them actually communicated with clients proactively about the Equifax hack and what to do about it! Which is not only concerning about simply getting valuable information to clients about an important issue, but represents a substantial missed opportunity for what Anderson calls a “micro-moment” – those fleeting moments, that come between the usual routine of face-to-face meetings and reviews, where advisors have a brief opportunity to take immediate action and demonstrate substantial value (beyond just the portfolio alone). Of course, at this point, the Equifax micro-moment has largely passed, but nonetheless going forward Anderson suggests this is still a teachable moment for us as financial advisors, to be better prepared for next time, including: 1) Build your list, so you actually have an easy and efficient means to communicate to all your clients and prospects if/when you do have another micro-moment opportunity to demonstrate value; 2) Put a “SWAT Team” together now (i.e., the internal people in your firm who are tasked to quickly mobilize and create content for fast-moving opportunities like this); 3) Be on the lookout (with an eye towards not just what’s on your mind as an advisor, but what might be in the news that’s on the mind of your clients?); 4) Be useful (which means don’t just send clients a clipping of some other article of note on the subject, but spend a little time to customize it and really make it relevant to your clientele); and 5) make it direct to address your client’s concerns, as the point is that this isn’t meant to be a sales/marketing opportunity, but simply a chance to demonstrate clear value (though if that happens to bring in new business as well, so be it!).
The Awful Consequences Of Non-Fiduciary Advice (Bob Veres, Inside Information) – One of the most controversial aspects of the Department of Labor’s fiduciary rule is whether or how damaging “conflicted advice” from brokers and insurance agents really is, and whether it’s necessary to try to regulate “best interests advice” in a world where arguably most advisors try to give good advice in the first place, simply because it’s usually good business to do so anyway. Yet one of the fundamental problems with the industry’s current suitability standard, and why a fiduciary standard is needed, is that while many/most advisors may proactively choose to act in their clients’ best interest, there is a subset who do not, and legally make recommendations that end up causing substantial harm. Veres details a number of such scenarios, drawn from actual situations that (fiduciary) advisors have come across and had to untangle, including: a client who already had more than enough money to secure her retirement through TIAA-CREF, but was persuaded to move a large slice of her money into a variable annuity with a 3.7%/year annual cost (paying both a hefty commission, and paying for an income rider she didn’t need because she already had ample assets to achieve her retirement goals), which was implemented by having the client take taxable withdrawals from her retirement account to reinvest into a non-qualified version of the variable annuity; a 30-year-old resident doctor, unmarried and loaded with student loan debt, who was directed to buy a $1.5M permanent life insurance policy with $32,000/year premiums (but no discussion about saving money in his 401(k) or creating an emergency fund, and with no desire to leave a financial bequest to any beneficiaries); a 94-year-old in a nursing home who received $250,000 after the death of her husband, which was immediately solicited by a broker to be invested into an illiquid variable annuity, forcing the widow to subsequently pay surrender penalties just to get her money back for her ongoing nursing home expenses); a recent widow who, just weeks after a car accident that killed her husband, could have rolled over an inherited annuity from her deceased husband but instead was persuaded to buy a completely new annuity instead (with a new commission and new surrender charges); and the stories go on and on. The good news is that in at least a few instances (but not all), the insurance/annuity company was willing to rescind the policy and/or refund surrender charges for an inappropriate sale. But in all the circumstances noted, there was no known disciplinary action taken against the broker or agent, whose actions were deemed “suitable” and not at fault because he/she was not actually liable for his/her advice as a fiduciary. Which helps to emphasize the real point of a fiduciary standard for those who hold out as an advisor: such rules cannot realistically “force” all advisors to always do the right thing, but at a minimum, they can create legal consequences for those who give blatantly bad and inappropriate advice and hold them accountable.
Change The Portfolio Or Change The Investor (Dan Egan) – When trying to design the “right” portfolio, there is a balancing act that investors must consider: to what extent should they change the portfolio to adapt to their personal behaviors (e.g., tolerance for risk), and to what extent should they try to change their own behavior instead? The classic example is the investor who “needs” an aggressive portfolio to achieve their goals, but is very skittish about market volatility, and must figure out whether he/she will try to change the behavior (i.e., figure out how to be less nervous during market declines), or change the portfolio (i.e., make it more conservative so there’s less volatility in the first place). Of course, the true answer likely falls somewhere in between the extremes… but Egan lays out an interesting framework of strategies that investors (and their advisors) can consider on both sides. For instance, when it comes to “changing the portfolio”, the investor might: try to adapt the portfolio to match a certain level of “drawdown tolerance” (i.e., diversify, increase bond allocations, and do whatever is necessary to reduce the risk of a decline that would cause panic); avoid mark-to-market assets (as the irony is that if the client can’t see the volatility, it’s not as scary, which helps explain the popularity of everything from hold-to-maturity bonds where the investor “knows” their future value, or holding real estate where the investor can’t see the day-to-day or even month-to-month volatility); converting price returns to income returns (as capital gains often don’t feel “real” until they’re liquidated and closed out, but dividends and bond interest that are credited as cash to the account feel more real to us); impose lock-ups (which obviously risk bad incentives for managers, but self-committed lock-ups from investors can help eliminate their own temptation to take bad investment actions). Other strategies that Egan suggests include: detail a process for how you will invest, so you have something to rely on in times of uncertain (thus why Investment Policy Statements are popular for financial advisors!); focus on goals rather than (short-term) investment returns to keep results in proper context; consider changing investment performance to show progress relative to goals or liabilities (rather than just tracking to markets). And of course, don’t forget the opportunities to “change the investor” as well, from building new financial knowledge (makes markets seem less scary!), establishing prudent investment habits, and be prepared to at least learn from the inevitable “ego-destroying” bad experiences that will come along the way!
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
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 as well.