As baby boomers continue into their retirement transition, two portfolio-based strategies are increasingly popular to generate retirement income: the systematic withdrawal strategy, and the bucket strategy. While the former is still the most common approach, the latter has become increasingly popular lately, viewed in part as a strategy to help work around difficult and volatile market environments. Yet while the two strategies approach portfolio construction very differently, the reality is that bucket strategies actually produce asset allocations almost exactly the same as systematic withdrawal strategies; their often-purported differences amount to little more than a mirage! Nonetheless, bucket strategies might actually still be a superior strategy, not because of the differences in portfolio construction, but due to the ways that the client psychologically connects with and understands the strategy!Read More...
Under classic Modern Portfolio Theory, there is a single portfolio that is considered to have the most efficient risk/return balance for a given target return or target risk level; any portfolio which deviates from the "optimal" allocation must, by definition, either offer lower returns for a comparable level of risk, or result in higher risk for the same level of return. Accordingly, as the theory is extended, advisors should avoid making portfolio shifts that constitute tactical "bets" in particular stocks, sectors, asset classes, etc., as it must by definition result in a portfolio that is not on the efficient frontier; one that will be accepting a lower return for a given level of risk, or higher risk for a comparable return. Unfortunately, though, this perspective on MPT with respect to making tactical portfolio shifts is not accurate, for one simple reason: it is based on an invalid assumption that there is a single answer for the "right" return, volatility, and correlation assumptions that will never change over time, even though Markowitz himself didn't think that was a good way to apply his theory!
Welcome back to the 378th episode of the Financial Advisor Success Podcast!
My guest on today's podcast is Michael Collins. Michael is the CEO & Founder of WinCap Financial, an RIA based in Boston, Massachusetts, that oversees $80M in assets under management for 70 client households.
What's unique about Michael, though, is that since 2021 he has been able to grow WinCap Financial at a rate of more than $10M of AUM per year through consistently reaching out to leads purchased through SmartAsset, spending $5K/month that turns into $10K in recurring revenue in less than 100 days, an average of more than 4X the return on financial investment than if those clients had been obtained through an acquisition buying at a traditional 2X revenue multiple.
In this episode, we talk in-depth about how Michael maintains his ongoing $5K/month marketing spend with a process that has an ultimate failure rate of 95% because the financial ROI on the prospects that do close continues to make sense (and he is ultimately not afraid of sorting through the No's to find the right Yes's for WinCap), how Michael supports his SmartAsset conversion rate with a weekly blog that is written by taking the upcoming economic calendar, automating it into a narrative article in his writing style using ChatGPT, and then simply editing it to add his own commentary (which cuts the time it takes for him to write from 2 hours down to 30 minutes), and how Michael has systematized everything from his follow-up emails to text messages to his weekly blog and an ongoing tracking sheet to ensure no prospect slips through the cracks, which allows him to generate his results with a high volume of SmartAsset leads while only spending 8–10 hours/month on the entire process.
We also talk about Michael's advisor journey that began with selling Gateway Computer "Cow Boxes" in college (and getting used to the No's that came along with computer sales) and how Michael channeled that comfort-with-hearing-No into his career shift into wealth management with a process that has a "20 leads to 3 prospects to 1 new client" marketing formula, the reason Michael's decided during the pandemic to take a chance on leaving his then-current advisory firm starting his own RIA (after realizing that he was already doing the important aspects of both client service and business development himself, which made it difficult to justify why his current firm was owed an 80% share of the revenue he was bringing in), and how, when the stress of launching his firm was at an all-time high and a concern for the sustainability of WinCap at the end of 2022 was a major challenge, Michael found that acts of service in education – by becoming a part-time adjunct professor teaching college students – became a key rewarding element of life that kept him going.
And be certain to listen to the end, where Michael shares how moving from a large, firm-supported environment to an independent practice wasn't as hard as he expected because he could easily integrate tools and platforms he was already familiar with (and had the financial ability to get a $50K bank loan to buy a big chunk of SmartAsset leads, which further helped to jump-start his new practice), how surprised Michael was with the amount of support he did get when he launched WinCap, with more than 80% of his previous client base also following him into his new firm within a year, and how Michael had long struggled to take the leap because of the perceived safety and credibility in being part of a larger advisory firm but ultimately found that he could get similar credibility by affiliating his new firm with reputable RIA custodians… which helped Michael's clients, and also Michael himself, find the necessary confidence to move forward.
So, whether you're interested in learning about how to effectively use lead generation tools like SmartAsset to grow and connect with potential clients, how to justify a shift from a large company-supported firm to an independent solo practice or how to use ChatGPT to 'Frankenstein' blog posts that communicate complicated financial information in an easier-to-understand way for your audience, then we hope you enjoy this episode of the Financial Advisor Success podcast, with Michael Collins.
Many investors are familiar with private equity as an alternative asset class, which is popular with certain high-net-worth and institutional investors as a vehicle for diversification and a source of potentially higher risk-adjusted returns than what is available on the public market. However, less well-known is the related but distinct asset class of private debt, which, like private equity, focuses on opportunities outside of what is traded on the public market but deploys its capital in the form of credit rather than taking equity stakes in companies. And in the midst of a rough market for publicly traded debt, high-net-worth individuals (and their advisors) who might be seeking alternatives for the fixed-income portions of their portfolio may be curious about what private debt might have to offer.
While public market and private equity asset classes are much more thoroughly researched, research on private debt providing reliable data on returns, volatility, fees, and other characteristics has been relatively scarce. However, a recent paper by Pascal Böni and Sophie Manigart in the Financial Analysts Journal sheds new light on how private debt has performed over time and provides insight into what factors advisors and their clients should focus on when considering private debt for their portfolios.
One of the paper’s key takeaways is that although private debt as an asset class has delivered higher risk-adjusted returns compared to traditional fixed-income investments, there is a wide range of outcomes between individual private debt funds, with a relatively small cluster of top-performing funds delivering much of the asset class’s overall outperformance. And while the maxim “past performance does not indicate future results” holds true for traditional asset classes, the reverse has proven at least somewhat true for private debt: Among private debt funds and the General Partner who manages them, prior performance was a significant indicator of future performance, with funds having a good performance history being the most likely to outperform in the future. Funds with GPs who had no history of prior private debt fund management had some of the worst performance, suggesting that not only do past returns but also the skills and experience of General Partners have much to do with which private debt funds are likely to have the best returns.
For advisors, examining the management and culture of a private debt fund can be an important way to provide value to clients through a thorough due diligence process. This can include assessing the experience and performance history of the fund’s GP and how the fund has achieved its returns (e.g., by making concentrated bets or through a more diversified approach). And while the choice of a fund may be the most significant decision regarding private debt, advisors can add value in other ways as well, such as by incorporating private debt into a client’s existing asset allocation strategy, optimizing the asset location of a private debt fund, and analyzing the fund’s fee structure.
Ultimately, what’s most important is that clients have a solid understanding of the risks involved with investing in private debt versus remaining in the public markets. Namely, the illiquidity of private funds (which can keep clients’ funds locked up for 10 years or more) makes them most appropriate for clients with a long-term investing horizon and with other liquid funds for short-term and unexpected needs. Advisors who can help their clients navigate these important considerations, and keep the client’s focus on the long term, can be an invaluable aid in ensuring those clients can realize the potential advantages that private debt can make possible!
While President Joe Biden’s recently proposed “Build Back Better” brought the possibility of a reduced estate tax exemption for 2022, insufficient support for the bill precluded the reduction, leaving taxpayers with an exemption of $12,060,000 per person. Which means that under the current rules, most taxpayers will not be subject to a Federal Estate tax liability and can instead focus their tax planning efforts on reducing their Federal income tax liability. As such, the step-up in basis at death can be a powerful planning tool for minimizing an individual’s capital gains taxes from the sale of appreciated assets. For married couples, though, the death of one spouse often only results in a partial step-up, reducing the value of this tax benefit (and thereby potentially increasing taxes on the subsequent sale of assets) for the surviving spouse. But with some proactive planning, couples can take greater advantage of the step-up rules by titling their assets in a way that maximizes their likelihood of a full step-up.
The concept of the step-up is that, when an individual dies, the basis of the assets that they owned is increased (or “stepped up”) to their value as of the date of the individual’s death. And while the concept is fairly straightforward for assets owned solely by the decedent, it can become more complicated when the assets are owned jointly with a spouse. Because in most states (which treat jointly-owned assets as “separate property”), even though the assets are owned in both spouses’ names, the amount that is included in the decedent’s estate – and therefore eligible for the step-up – is only 50% of the assets’ value, leaving the original basis intact on the surviving spouse’s remainder. Notably, ten “community property” states allow for a 100% step-up in basis on all jointly-held assets (as long as they meet the definition of community property). Which means that, based on whether or not a couple happens to live in a community property or a separate property state, they may receive a full (or just a partial) step-up in basis on their jointly-owned assets when one spouse passes away.
Fortunately, for the majority of couples who live in separate property states, there is a simple strategy that can be used to potentially receive a full step-up in basis of assets upon the death of a spouse. For couples where one spouse is expected to live longer than the other, it may be possible to transfer all of the couple’s assets solely into the name of the spouse anticipated to die first. Upon that spouse’s death, 100% of those assets would be subsequently included in their estate and therefore subject to a full step-up when the surviving beneficiary spouse receives the assets.
As with many seemingly simple strategies, however, the transfer-and-inherit strategy between spouses comes with complications and exceptions to watch out for. For example, the IRS requires that the spouse who receives the transfer of assets must own them for at least one year before they pass back to the original donor in order to receive the step-up in basis, making the strategy less useful when the spouse’s death is anticipated more imminently. Additionally, gifting assets means giving up control over how they are used and bequeathed, and so the strategy requires the surviving spouse to trust that the shorter-lived spouse will not spend the assets, give them away, or leave them to someone other than the surviving spouse at death (however unlikely that may seem at the time). And lastly, if a spouse is enrolled in Medicaid (or plans to enroll in the future), transferring assets into their name could exceed the allowable asset limit set for Medicaid eligibility, thereby disqualifying them from the program and requiring them to spend down the assets to re-enroll (making the strategy a moot point, as the assets would likely not last long enough to be stepped up at all!).
Ultimately, the difference between a full step-up in basis and a partial one (or none at all) can end out being a significant increase in the after-tax value of assets for some clients. Advisors can help deliver this value to their clients by planning and aiding with the retitling of assets (when appropriate) to take full advantage of the basis step-up. Which is important, especially because the subject of death (and repositioning assets in anticipation of death) may be complex and emotional for clients, and the role of the financial advisor often involves aiding clients to find objective solutions through difficult situations… to help clients – and their loved ones – stay on track with their goals to maximize and enjoy their wealth!Read More...
According to the latest 2021 Genworth Cost of Care study, a private room in a nursing home costs almost $300/day, or nearly $9,000 per month. Fortunately, individuals in need of such institutional health care, who don’t have the means to pay for such care themselves, can generally rely on Medicaid to cover at least most of those long-term institutional care costs. However, as a means-tested program operated as a Federal-state partnership, Medicaid places extremely low limits not just on an individual’s income, but also on their “Countable Assets” that they are entitled to keep before they can qualify for coverage. Accordingly, those who will eventually rely on Medicaid to cover their cost of care must ‘spend down’ their own income and assets first… which can have a significant impact on the individual’s (and their families’) standard of living. Which raises the question of what planning can be done to help protect at least the other members of the family in situations where a Medicaid spend-down must occur.
While the limits on Countable Assets (including most of an individual’s assets such as cash, investments, bank accounts, and real estate) vary by state, the most commonly observed is a mere $2,000 in 2021. However, to allow a healthy spouse (with an ill partner applying for Medicaid) to maintain at least a minimal level of the couple’s assets and income to live on, the Medicaid rules include standards that set the amount of income and assets that can be maintained from the couple’s assets (and the institutionalized individual’s income) to maintain the healthy spouse’s standard of living without an obligation to spend them down for the ill spouse’s care.
To prevent couples from simply trying to ‘impoverish’ themselves to qualify for Medicaid, though, Medicaid rules include a five-year “Look-Back Period” (2½ years for California), which prevents recipients from simply giving away assets to (non-spouse) family members to meet Medicaid’s asset limits. Notably, though, when it comes to spousal income, the treatment is different, with the healthy spouse’s income generally being left out of the eligibility calculation altogether.
As a result, one strategy for married couples to preserve assets in light of the Look-Back Period for asset transfers, but the exclusion of the healthy spouse’s income, is to purchase a “Medicaid Annuity”. Essentially, assets in excess of the Countable Asset limit are used to purchase a Medicaid Annuity (such that the couple’s assets are within their allowed Countable Asset limit); then, annuity payments are made payable only to the healthy spouse. In doing so, the Countable Assets that would have otherwise been required to have been spent down to pay for the care of the institutionalized spouse are removed – but not as a gift, avoiding a look-back penalty period – and instead become income of the healthy spouse (which are effectively ignored for purposes of Medicaid eligibility).
Notably, though, not all states currently permit the use of Medicaid Annuities. And in states that do, to be Medicaid-compliant, the Medicaid Annuity must name the State (in those states that permit their use) as the remainder beneficiary for no less than the amount of Medicaid benefits it paid on behalf of the institutionalized individual. Which doesn’t limit the healthy spouse’s ability to leverage the Medicaid annuity for their own standard of living… but does mean that at least if both spouses do not survive the Medicaid annuity payout period, the State can recover Medicaid benefits it paid before those assets are bequeathed to subsequent heirs.
Ultimately, the key point is that for seniors or chronically disabled individuals who may need Medicaid benefits for their long-term care but fear the impact that spending down assets will have on their healthy spouse’s own standard of living, the Medicaid Annuity is a useful tool (at least in the states that permit them) to help the couple preserve assets by converting them into an annuity income stream. Which can be a valuable option to consider, especially in light of the last-minute ‘crisis’ nature that is often characteristic of Medicaid planning, when it’s too late to simply gift assets to family members by the time it’s necessary!
Welcome back to the 239th episode of the Financial Advisor Success Podcast!
My guest on today's podcast is Ryan Frailich. Ryan is the founder of Deliberate Finances, an RIA located in New Orleans, Louisiana that serves young professionals using a monthly subscription fee model.
What's unique about Ryan, though, is that he’s intentionally built his advisory business in such a way that allows him to help people in their 20s, 30s, and 40s navigate the inevitable financial complexities in their lives… regardless of whether or not they have liquid assets that need managing.
In this episode, we talk in depth about Ryan’s experience that, while the industry typically assumes clients with limited assets have little financial complexity, in practice, it’s often the journey of getting to the point of actually having assets to manage that is the more complex part of the journey, why Ryan finds that the tendency of financial advisors to not specialize (unlike other professionals, such as doctors, who use different titles to differentiate amongst specialties), makes it challenging for consumers to find someone who can help with their particular pain points, and how Ryan has structured his subscription model with a varying price range specifically to align to the specialized and complex needs of his younger clientele as their own careers evolve and their income grows.
We also talk about Ryan’s commitment to remaining a solo advisor and how that makes focusing on making sure he is serving only his ‘ideal’ client all the more important to the success of his business, the third-party services that Ryan refers clients out to for their estate planning, insurance, and even investment needs (which ultimately allows Ryan to maximize the time he spends in the planning areas where he adds the most value), and why Ryan has implemented surge meetings in order to achieve the sort of work/life balance that is important to him and his family.
And be certain to listen to the end, where Ryan shares why he provides a Client Engagement Standard in his onboarding process as a way to set clear expectations around both his and his clients’ relationship responsibilities (especially given his lifestyle practice), the expertise that Ryan has developed around student loan planning as a way to differentiate himself even further, and why Ryan’s background as a teacher coming into the financial planning business has allowed him to eschew the industry’s ‘traditional’ definitions of success and create his own business goals to maximize his financial and family wellbeing.
So whether you’re interested in learning how Ryan’s structured his business to serve clients who aren’t good fits for the traditional AUM model, how he helps his clients with student loan planning, or why he’s committed to remaining a solo advisor, then we hope you enjoy this episode of the Financial Advisor Success podcast, with Ryan Frailich.
As advisory firms seek to refine their fee structures and find ways to add value for (and generate new revenue from) their existing clients, one of the more interesting shifts in the industry over the past couple years has been away from billing on assets under management and towards assets under advisement, which are those outside held-away assets (e.g., a 401(k) plan at a current employer) on which an advisor may make recommendations, but not necessarily effect any transactions (because it’s not under their direct management). The appeal of such an approach is understandable: qualified plans are an ever-increasing piece of clients’ nest egg, especially for those in their 30s, 40s, and 50s, and the dilemma advisors often face is that, while a potential client might have significant net worth, much of that is tied up in accounts that the advisor can’t manage directly.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss the ways in which advisors are working with clients with substantial held-away assets, the issues they may face when charging an assets-under-advisement (AUA) fee on outside assets, and some operational challenges that advisors need to think about before adding on this type of fee structure.
The quintessential example of a client where an AUA fee may be a better fit than an AUM fee is the still-working client with a moderate (e.g., $150,000) brokerage account, and a sizable (e.g., $350,000) 401(k) plan at a current employer, where the client can afford to pay the advisor a reasonable fee in the aggregate, but not necessarily “just” from the account that’s available to manage.
There are a few ways to handle situations like this. In some cases, the advisor simples takes the client on in hopes of getting that sizable roll-over down the road (even if it’s an unprofitable client for years up until that point). Others may set a minimum annual fee for clients if their available assets fall under a certain threshold, ensuring that there is a sufficient level of revenue per client to service the client, and letting those with sufficient net worth (even if not all available to manage) to decide for themselves whether to move assets, or just pay the fee.
The third approach that’s emerging, though, is simply to not charge only on the assets that the advisor manages directly, but also setting an assets under advisement fee for those outside held-away assets that might provide advice on, even if the advisor doesn’t (or can’t) have discretionary authority. For which the AUA fee is typically lower, recognizing that while the advisor does provide some services, it is less than the full-service management (for the full-service management fee) on the actual managed accounts.
However, charging an AUA fee it’s not without its potential pitfalls. In some cases, clients may not want to pay for “just” asset allocation advice they have to implement themselves. And if an advisor gets the client’s login credentials to do it for them, the service is a lot less cost efficient due to the added layers on manual work involved, and means that the advisor has custody of those assets (and as such, is subject to an annual surprise custody audit under the SEC custody rule). Moreover, if the client gets accustomed to paying a lower fee to have the outside 401(k) “advised upon”, they may not want to roll over and pay a full management fee when the time comes (if the advisor has not effectively distinguished the value). Which can be especially challenging for advisors with a more passive approach, since at least active managers can claim there is additional value in rolling over by being able to implement full investment management process (e.g., offering “tactical management of retirement assets to minimize sequence of returns risk”).
Beyond those challenges, advisors also need to figure out how they’re actually going to bill on those held-away assets. As since advisors generally can’t deduct fees directly from a 401(k) account, they will either have to bill from managed accounts they do oversee (which is bad news for the advisor’s performance numbers, since the fees for the entire pie and coming from just the advisor’s slice), or send the client an invoice and implement technology to bill them directly.
These challenges to adopting an AUA fee aren’t insurmountable, however, but do require some careful thought and planning in advance. As ultimately, charging a fee on assets under advisement may be a good way for certain advisors to expand their relationship with existing clients, especially those who are still in their working years and have a sizable 401(k) plan that is unavailable to be managed directly. However, the AUA fee has got to make sense from a business perspective as well, which means having a clear operational game plan for calculating fees, dealing with all the extra manual work, and for navigating the regulatory minefield.
In today’s increasingly competitive landscape for advisory firms, financial advisors are looking for any way they can to differentiate. Whether it’s their experience and credentials, specialization or depth of services, or simply the sheer size of the firm, based on its assets under management. After all, the reality is that – justified or not – a sizable reported AUM does imply a certain level of credibility and represents a form of social proof (the firm “must” be good, or it wouldn’t have gotten so much AUM, right!?).
As a result of this trend, though, advisory firms are increasingly pushing the line in counting – or potentially, over-counting – their stated assets under management. Which is important, because not only is overstating AUM a potential form of fraudulent advertising, but the SEC has very explicit rules to determine what should be counted as AUM (or not) for regulatory purposes.
Specifically, the SEC states in its directions for Form ADV Part 1 that regulatory AUM should only include securities portfolios for which the advisor provides continuous and regular supervisory or management services. And while most financial advisors today are regularly working with clients regarding their investment securities, not all advisors are necessarily providing “continuous and regular” services on their client accounts. In fact, if the advisor doesn’t have direct authority to implement client trades (either with discretion or after the client accepts the advisor’s recommendation), it’s virtually impossible to include the account as part of regulatory AUM.
The greater challenge, though, is that the increasingly common offering of comprehensive financial planning services – where advisors provide holistic financial planning advice on all of a client’s net worth – does not mean the advisor can claim all of those assets as regulatory AUM. In fact, most of the time the advisor should not include outside 401(k) plans and other non-managed assets that were advised upon as part of the financial plan, nor the value of brokerage accounts holding mutual funds and various types of annuities (unless the advisor truly provide ongoing management services), nor TAMP or SMA assets (unless the advisor retains the discretionary right to hire/fire the manager and reallocate to another one). In fact, even having discretion over an account doesn’t automatically ensure it being counted as regulatory AUM, particularly if it’s a passive buy-and-hold account, unless the advisor can actually substantiate that monitoring and due diligence is occurring outside of any ad-hoc or periodic client review meetings!
Fortunately, for advisors who want to report some number representing the total scope of their advice – including the amount of assets that don’t count as regulatory AUM – it is permissible to report on Assets Under Advisement (AUA) in the advisor’s marketing and in Part 2 of Form ADV, as long as the advisor can document and substantiate the calculation process. But the fact that it’s permissible to report both AUM and also a (typically large) AUA amount doesn’t change the fact that, when reporting regulatory AUM itself, it’s crucial to report the right number!
The ongoing decline in interest rates since the financial crisis have been a boon for those looking to refinance a mortgage or businesses looking to borrow, but an immense challenge for investors that rely on fixed income returns, from insurance companies to individual accumulators and retirees. And as bond returns grind lower, it has brought a renewed focus on costs (that eat up an ever-larger percentage of a smaller return), including the question of whether financial advisors should charge less for managing a bond portfolio compared to a stock portfolio.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the question of whether advisors really should be charging separate and different fees on the fixed income versus equity allocations in a portfolio, including and especially for those who also deliver extensive financial planning services as a part of their AUM fee as well.
Of course, given that the typical bond mutual fund is already less expensive than the average stock mutual fund, arguably the asset management industry has already spoken and suggested that the fees should not be the same. If only because today's low bond yields, plus the more limited volatility of bonds (at least compared to stocks), means there's just only so much opportunity to create active management value in bonds and outearn that fee in the first place.
On the other hand, the reality is that most advisors don't manage just all-bond or all-stock portfolios as a mutual fund does. Advisors typically manage blended portfolios of stocks and bonds, sometimes tactically managing amongst all those asset classes, and an increasingly large portion of the AUM fee is being allocated to financial planning services anyway... which are based on the amount of actual financial planning work to be done, and arguably remain the same regardless of how the portfolio happens to be invested.
And in fact, with the looming Department of Labor fiduciary rule taking effect in April of 2017, charging different fees for stock versus bond allocations may become a prohibited transaction anyway, at least in an IRA where the advisor has discretion over the portfolio's overall allocation in the first place. Which means that while advisors might charge less for conservative model portfolios compared to those that are more aggressive (and in theory have more active management opportunities), or begin to unbundle their planning and investment management fees altogether, but the question of whether to charge differently for bonds and stocks within the same portfolio may soon be a moot point anyway!