Michael Kitces’ weekend reading for financial advisers

This week’s edition of weekend reading for financial advisers kicks off with the release of Judge Leon’s opinion memorandum in the case of Camarda vs CFP Board, which reveals that the judge’s decision in favor of the CFP Board was based not on the merits of the case, but simply that the courts wouldn’t intervene in the ‘private internal affairs’ of the CFP Board’s disciplinary process … raising the concern that no CFP certificants may have any recourse in a court of law to hold the CFP Board accountable in situations where there is a future disciplinary dispute.

Also in the news this week was the announcement that Schwab is aiming to significantly expand its branch office network and ramp up hiring of its own advisers, raising questions of whether it may increasingly find itself competing with the RIAs using its platform. And rounding out the news this week is an article by Knut Rostad offering suggestions of how the Department of Labor can improve its “BICE” rules to ensure the fiduciary standard is not undermined.

From there, we have a few technical planning articles this week, including a discussion of whether managed payout funds are better retirement income vehicles than immediate annuities (the results don’t look good for those who top priority is retirement income!), a look at how most people with access to an Employee Stock Purchase Plan are underutilizing them and leaving “free” profits on the table, and some suggestions on how to modify the way Power of Attorney documents are used to cut down on the rising trend of elder financial abuse.

There are also a few practice management articles, from a reminder that the slow summer season is a good time to do strategic planning for your advisory business (or personal career!), to a look at the rise of “adviser blogging” as a means to market and grow an advisory firm, and a discussion of the issues that advisers should consider when it comes to compliant storage of digital client documents (from encrypting your computer, to the encryption capabilities of your cloud storage service, and how to ensure secure transmission of the data between the two!).

We wrap up with three interesting articles: the first is a good reminder that to really help clients, advisers need to focus on what really motivates them (i.e., clients aren’t necessarily motivated by setting goals; instead, figure out what motivates them, and help them to direct that energy towards achieving their goals!); the second is a high-level look at how the entire financial services industry is in transition, driven by both top-down regulatory changes still being implemented since the financial crisis, plus the bottom-up impact of the rising millennial generation and the increasing intrusion of Silicon Valley and the world of FinTech; and the last is a fascinating roundtable interview with “next generation” advisers, suggesting that the primary problem advisory firms have with retention of younger advisers is not that they’re all looking for a handout, but that firms are simply failing to articulate clear goals for young advisers to pursue and then also failing to reward the young advisers with advancement when those goals are achieved.

Enjoy the reading!

Judge Declares CFP Board ‘Above the Law,’ Plaintiff Planners Say (Ann Marsh, Financial Planning) – Earlier this month, U.S. District Judge Richard Leon ruled in favor of the CFP Board in its ongoing case against Jeff and Kim Camarda, and the now-unsealed ruling in the Camarda case reveals that the key factor in the decision was that Judge Leon didn’t believe the court should insert itself into the affairs of a voluntary private organization like the CFP Board. Legal experts suggest that the court’s ruling itself was “not remarkable” and that courts have a long history of trying not to second-guess the judgment of managers of non-profits under the so-called “internal affairs doctrine” (that courts should stay out of the internal affairs of private organizations). However, from the perspective of CFP certificants, the concern of the ruling is that it affirms the broad power and leeway that the CFP Board has to act as it sees fit, including/especially in disciplinary matters (as long as it otherwise follows its own rules), as the “internal affairs doctrine” for non-profits is more commonly applied in situations like private clubs or sororities, while the CFP Board is becoming a quasi-regulatory authority that is now affirmed to be unreviewable by a court of law. Accordingly, the Camardas reiterate that the court never actually reviewed the merits of their actual situation and the matters they raised with the CFP Board (since the court merely ruled that it would not intervene with the CFP Board’s existing process in the first place), and that it is concerning that the judge’s decision essentially means that no CFP certificant is entitled to a day in court if they believe the CFP Board has mistreated them during its own self-administered internal disciplinary proceedings. The Camardas have not yet declared whether they will appeal the ruling, though they note that they are “weary” and that the emotional toll of the case has been “staggering” for them, not to mention the financial resources it has taken to try to fight the well-funded CFP Board. And for the time being, most of the testimony and evidence in the case itself still remains confidential (even though the ruling has been unsealed); it remains to be seen whether those restrictions will ever be released to the public, though the Camardas continue to maintain that those documents would have revealed the CFP Board ignored its own rules and procedural requirements in finding them guilty.

Schwab’s Big Reveal: Hire 1,800 Financial Advisers And Unpause Branch Expansion (Brooke Southall, RIABiz) – In its recent July update to Wall Street analysts, Schwab announced its plans to increase the size of its branch network by about 55% to 500, and add upwards of 400 advisers per year for the next five years to grow its branch adviser system from 1,200 to a whopping 3,000. While some critics have already raised the question of whether that’s even feasible for Schwab — which took 20 years to grow its system to “just” the 1,200 advisers it has today, and lacks the infrastructure for doing mass training and recruiting — it makes the point that notwithstanding all the buzz about the Schwab Intelligent Portfolios “robo-adviser” solution, the reality seems to be that Schwab is really betting on hybrid advisers-plus-technology as the successful path for the future of reaching the mass affluent that aren’t served by wirehouses and most RIAs. The new internal hiring strategy is also a notable departure from Schwab’s “franchising” initiative, which apparently never really got much momentum, with only 27 franchises launched since 2011. Ultimately, Schwab’s decision to more-than-double down on its direct-to-consumer strategy also raises questions of its balance of focus between consumers and its RIA channel, and whether Schwab may be pulling back a bit from its RIAs as one analyst points out that Schwab’s recent growth in its Advisor Services division has slowed organic growth and is now merely keeping pace with the markets (and even had a dip in 2014).

4 Ways to Strengthen BICE in DOL’s Fiduciary Rule (Knut Rostad, ThinkAdvisor) – While brokerage firms have raised concerns about whether the Department of Labor’s fiduciary proposal is too restrictive, Rostad points out that relative to ERISA’s fiduciary roots of outright prohibiting a wide range of conflicting compensation, the new “Best Interest Contract Exemption” (or BICE for short) that would allow brokers to receive certain commission compensation as long as they sign a contract to act in the best interests of clients is actually a reduction in the stringency of the existing ERISA fiduciary framework. After all, a wide range of commissions that were not allowed in the past would now be permitted, as long as it is “reasonable” compensation. Yet Rostad raises the concern “reasonable” compensation is hard to define, and allowing potentially significant commissions while brokers “promise” in writing to act in the best interests of clients may still be an untenable and unmanageable conflict of interest for many. In turn, this means there’s a risk that firms may agree to the standard and hold themselves out as fiduciaries, but not actually change their practices, and instead just try to claim their commissions were “reasonable” and that consumers had received disclosure so there shouldn’t be any further accountability. To address this, Rostad ultimately suggests on behalf of the Institute for the Fiduciary Standard that “reasonable” compensation should be defined more clearly in the DOL’s final rule, and that the DOL should consider more explicitly setting forth the steps that firms are expected to take to overcome or neutralize or mitigate a material conflict of interest, possibly including a requirement that all commissions under a fiduciary standard be paid out as level fees over time.

Are Managed-Payout Funds Better than Annuities? (Joe Tomlinson, Advisor Perspectives) — The basic concept of a “Managed Payout” fund is that it will aim to pay out sustainable retirement cash flows over time, either for a fixed time horizon or even “for the lifetime” of the investor; examples income one from Pimco that offers real income based on a TIPS ladder (which means it does have an end date), Fidelity’s Retirement Income series, offerings from Vanguard and Schwab that pay out roughly 4% of the fund balance each year (with adjustments to either avoid dipping into principal or smooth out the payments with volatility over time), and a recent retirement spending account from Natixis that aims to provide inflation-adjusted income “for life” but without using an annuity. As Tomlinson notes, the first caveat of these funds is simply that the “managed payouts” vary significantly in what they actually do, from how the income is set (fixed at inception or dynamically adjusted over time, and the same for everyone or based on age?), the stock/bond allocations used (and whether additional asset classes are included), and how the asset allocation changes over time (e.g., does it have a static, decreasing, or increasing glide path). Accordingly, Tomlinson finds some notable differences from one strategy to the next in terms of its projected performance, although notably none of them appear to be nearly as effective in securing lifetime income as just buying a lifetime single premium immediate annuity (either for all or just some of the client’s assets); the reason is that while annuity payout rates are diminished in today’s low-return/low-yield environment, so too is the sustainability of managed payout funds, yet immediate annuities still offer the unique contribution of mortality credits that the bond allocation within a portfolio cannot. Of course, the caveat remains that immediate annuities are very inflexible, and thus Tomlinson suggests that combinations of portfolios and immediate annuities will probably be a more effective balancing point than all-or-none.

The Employee Perk With A Guaranteed 15% Return (Ashlea Ebeling) – A recent study by Ilona Babenko and Rik Sen entitled “Money Left on the Table: An Analysis of Participation in Employee Stock Purchase Plans” found that only 30% of those with access to an Employee Stock Purchase Plan choose to enroll, and the average employee who could participate but chose not to missed out on $3,079 of potential profit each year (even after accounting for transaction costs and taxes). The profit potential lies in the fact that many Employee Stock Purchase Plans allow employees to buy company stock for at least a 5% discount from the market price and resell it immediately after purchase to book an instant profit (which is taxed as ordinary income). In fact, an ESPP is permitted to offer as much as a 15% discount to the market price when purchasing employer stock, and investors can buy as much as $25,000/year of stock; purchases are typically funded by contributions made through payroll deductions, which are accumulated for a few months and then used to purchase chunks of stock at a market discount (the accumulation before purchase is to increase the size of trades and reduce the impact of transaction costs, and 90% of companies actually let employees get their money back if it hasn’t been invested yet and they need it for an unexpected expense). Some plans also allow a “look-back” feature, which allows the 15% discount to apply to the stock price at the lower of its price at the beginning or the end of a 6-month period. Notably, plans can impose a holding period requirement to limit immediate resale, but Fidelity notes that 3/4ths of the plans it administers have no holding restrictions. On the other hand, it’s also worth noting that buying and holding the stock can introduce investment risk; the Babenko & Sen study suggests the profit potential of participating in the ESPP and selling immediately, though in practice their study finds that 45% of employees who do participate in the ESPP never sell the stock over their entire tenure as an employee, resulting in additional concentration risk rather than using the profit potential to liquidate immediately and diversify.

Safe Powers Of Attorney (Martin Shenkman, Wealth Management) — While a Power Of Attorney document is essential to effective planning in the event that someone is disabled/incapacitated, the problem with a Power of Attorney is that it may end out vesting significant power in someone who has neither the training/skillset to effectively manage someone else’s affairs, and/or may lead that agent to succumb to the temptation to take advantage of the incapacitated individual. And in fact, statistics show that overall elder financial abuse is on the rise, with family members most commonly responsible; one study found that in more than 80% of cases, those (financially) abused by an agent under a durable power of attorney were victimized by immediate family members, including adult children, spouses, and grandchildren. And even more concerning was the fact that one study showed in 57% of the cases the victim was actually still competent when the abuse occurred; the attorney-in-fact agent simply used the Power of Attorney to abscond with funds anyway (in 70% of the cases, more than half the victim’s assets were misappropriated!). So how can abuse be minimized? Shenkman suggests several options (which advisers can suggest in working with clients!), including: use a revocable living trust instead to manage the bulk of the client’s assets, and include a corporate, institutional, or other co-trustee who can provide a check-and-balance structure (and/or rely on the corporate trustee’s internal safeguards) to protect the client; put the actual physical POA document into an escrow arrangement with the attorney who drafted it, where the document is only released to the named agent to use when it’s appropriate to do so; create additional checks and balances including bringing having the adviser and CPA and attorney be part of the team that supports the client (providing more people who can spot potential abuse), provide duplicate monthly statements to someone besides the agent to review (and ideally simplify/reduce the number of accounts so it’s easier to track them all to spot potential abuse), automate payments to the extent possible so the agent has fewer opportunities to intervene, and consider “joint agents” who can help monitor each other.

Summer Is an Ideal Time for Strategic Planning (Angie Herbers, ThinkAdvisor) — Many advisers are frustrated by their lack of success in growing their firms, which Herbers suggests is primarily because they spend more time and effort trying to grow rather than taking the steps necessary to prepare the firms for growth first. Accordingly, Herbers notes that the slow summer – when there are usually fewer new clients being onboarded, and fewer ongoing client meetings as well — is an ideal time to begin a strategic planning process, and decide how to position for growth. The key issue here is to take a pause from the overwhelming day-to-day process of running the firm, and set a vision for the business going forward, including not just what you want the business to do, but what you want your job to be within the business, how much control you need to have, how much income you want/need to make (which has a direct impact on how large the firm “needs” to be), and what your ultimate exit strategy is (which impacts the path you will take between now and then). The second step is to really think about what kinds of clients you want to serve, so that you can target your marketing accordingly (given that only a few of the largest advisory firms really have the size and scale to do mass marketing), and also to allow you to refine the business and make it easier to serve them (by cutting away all the work you don’t need to do for clients who aren’t in your target!). Once you’ve figured out who you want to serve, and what you want the business to look like (including your role in it), only then can you really begin to consider the strategic objectives necessary to move forward. And remember, part of the key of strategic objectives is to have just a few — Herbers suggests no more than three in a quarter – so that you can really focus on them and get them done!

What Makes an Advisor Blog Great? (Jane Wollman Rusoff, Research Magazine) — The phenomenon of “blogging” has been explosive over the past decade, and there are now estimated to be more than 150 million blogs, with a new blog launched every half second (according to leading blog/website software provider WordPress). Blogs span the range from celebrities like Lady Gaga and Beyonce to major organizations like the White House and the United Nations and even the Memorial Sloan Kettering Cancer Center. And while the financial services industry has lagged, blogging is now becoming increasingly popular amongst advisers as well, from Barry Ritholtz’ The Big Picture (which now racks up a whopping 1.5 million pageviews per month), to Bob Seawright’s Above The Market blog, Jeff Rose’s Good Financial Cents, Ted Jenkins and Kile Lewis’ oXYGen Finanical, and yours truly’s own Nerd’s Eye View blog. The common theme of the successful blogs is that it conveys the adviser’s authentic voice even as it showcases the adviser’s expertise, building a platform that can be found by both the media and prospective clients who search via Google. Notably, though, the most successful new blogs today are usually more specialized, targeting a particular audience (e.g., a particular niche or type of clientele) and building a following amongst them. Additional tips from the successful adviser bloggers include: be certain to continue adding content regularly; use Twitter and other social media platforms to promote the content; include visuals for readers (fortunately in financial services, charts/graphs are abundantly available!); and always be certain you’re remember the kind of client/audience you’re trying to reach, and create content that’s relevant for them (not necessarily for yourself or your peers).

Compliant Document Storage for RIAs (Alan Moore, XY Planning Network) — Cybersecurity is on the rise as a hot topic, as advisers’ clients are increasingly being targeted for wire fraud, but the issue is not just about fending off fake wire transfer requests from would-be thieves; it’s also about keeping client data secure in the first place, which means it’s important to pay attention to how client data and especially documents are being stored in the first place. Unfortunately, though, the actual guidance is still not entirely clear; Finra has indicated that they ‘prefer’ documents be stored behind a 256-bit encryption format, but it’s not unequivocally mandated, and the SEC and state securities regulators have not been consistently clear about their requirements for registered investment advisers either. More generally, though, Moore notes that advisers really need to consider the security of client documents at several levels. First and foremost, the devices (from desktop computers to laptops to tablets and smartphones) that are used to access client data must be secured, which means password protecting all devices any time they go into sleep mode (not just when they’re booting up after a shutdown). Next, documents stored on the device/computer should be encrypted as well, using tools like BitLocker Drive Encryption for PCs, the encryption capabilities built into OS X for Macs, or Symantec (which offers an encryption solution that works on both platforms); for mobile devices, make sure you have the ability to remotely wipe data if the device is stolen as well (e.g., using native tools, or a third-party app like Lookout). The next issue is to ensure that the transmission of data is secure, which means avoiding unsecured public WiFi hotspots (use a jetpack/mobile hotspot instead, and/or a service like PrivateWiFi to create your own VPN). And if/when your documents are in the cloud, you need to be certain they’re encrypted there as well; services like Google Drive use 128-bit encryption, which is fairly robust, but with regulators increasingly talking about 256-bit encryption, you may want to use a service like Boxcryptor to overlay on top of whatever you use (e.g., Google Drive, DropBox, etc.) and provide 256-bit encryption. Other cybersecurity tips include using 2-factor authentication wherever possible, and a password management system like LastPass.

The Shocking Truth about Why Most Financial Planners Fail Miserably at Helping Their Clients (Ronald Sier, See Beyond Numbers) — Most people who become financial advisers are smart, motivated, and hard-working, yet it’s still challenging to be successful. Sier suggests that the problem is our focus on facts and statistics, rather than making emotional connections; for instance, try thinking of ten people who won the Nobel or Pulitzer prizes or the last several Academy Award winners (difficult despite them all being ‘famous’ people), and then think of the last three people who helped you through a difficult time or three people who taught you something special. In other words, we don’t remember the people who are famous or have credentials or awards; we remember the people who care about and connect with us. Accordingly, if you want to grow your practice as an adviser, the key is not just to show off more credentials and awards, but to really connect and show that you care, and really help clients. Yet here, too, Sier makes the case that really helping clients means connecting with them emotionally, because the reality is that most of our decisions are not made rationally; using the famous analogy of the Elephant, the Rider, and the Path from the book “Switch: How to Change Things When Change Is Hard” written by the Heath brothers, Sier notes that most advisers try to appeal to the logical rational rider, when in reality helping clients means directing the elephant or shaping the path to guide it. Or in other words, the key is to recognize that setting financial goals with clients doesn’t necessarily motivate them; instead, it’s necessary to figure out what really does motivate the client, and then help them steer their behavior in a direction that moves towards the goal. And figuring out what really motivates clients means stepping away from the numbers and technical information, and once again aiming to connect with them emotionally.

The Quiet Financial Services Revolution Begins (Mohamed El-Erian, The Guardian) – Notwithstanding how slow it is to change, El-Erian makes the case that the financial services industry has embarked on a steady multi-year transformation, driven by both top-down and bottom-up factors. The top-down factors include a changing regulatory environment, with the regulatory pendulum swinging towards tighter supervision of large banks and insurance companies deemed “systematically important” that will de-risk the financial services industry and force it to operate more like a “utilities” model. In turn, this will impact the pricing environment, as utilities-style models face external pricing constraints, and in fact the current “financial repression” regime is already impacting pricing, leading large banks to do fewer things for fewer people due to lower net interest margins, despite being flush with liquidity from central banks (the so-called “liquidity paradox“). The bottom-up factors, which are capitalizing on these top-down constraints, include evolving customer expectations as the millennial generation increasingly accounts for a larger portion of earning, spending, borrowing, saving, and investing (and their “self-directed” mindset forces the industry to switch from a product-push mindset to more holistic solutions with greater individual customization), and the ‘threat’ from Silicon Valley and the rise of FinTech that could create disruptive surprises (a la Airbnb and Uber in their respective industries). Notwithstanding all the pain of change, though, El-Erian notes that ultimately, the financial services industry will serve more people via a larger menu of customizable solutions, but if large traditional firms don’t figure out how to how “self-disrupt” they risk being toppled by new entrants… a valuable reminder for financial advisers, whose firms face similar forces and threats as well!

Young Advisers Want A Future, Not Handouts (Liz Skinner, Investment News) — At a recent round table of next generation advisers, Investment News found a common trend: an increasing number of young advisers are putting in significant time and effort in established independent advisory firms, but ultimately are leaving to go out on their own after seeing no future in the current firm. One adviser spent years helping his firm owner grow and expand the business to be his succession plan, only to find that the adviser wouldn’t commit to a written succession plan that spelled out the future transition; another was enthusiastic about planning, but got frustrated that her firm wouldn’t let her work with her high-income (but not high-asset) millennial peers; yet another worked for six years doing what was asked of her to advance, only to find when she got there that a new series of requirements were put forth and the advancement never came. More generally, the problem is that experienced advisers often bring in a “junior” adviser to help handle clients so the firm owner can go get new ones, but then after several years the associate planner is ready to advance and the firm owner doesn’t know how to make the transition to the next stage. And if the issue can’t be resolved, the advisers eventually leave for another firm, or go out to start their own instead. Ultimately, the roundtable offered up three core suggestions to make the industry more hospitable, nurturing, and appealing for young advisers (a crucial issue give Cerulli estimates that 1/3rd of all advisers will retire in the next decade!): 1) the industry needs to be more progressive in offering at least limited opportunities for new planners to earn equity stakes; 2) firms need to expand their business models to allow younger advisors to serve their peers, the natural clientele they can attract; and 3) firms need to offer a detailed career path so the advisors know what’s expected of them to advance. In other words, the next generation of advisers aren’t looking for handouts, but they do want something to reach for, and some confidence that if they really do achieve those goals, the advancement will come.

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!