Weekend Reading for Financial Planners (Apr 17-18)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Wealth Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Gary Gensler Confirmed As SEC Commissioner To Police Wall Street Brokers (Benjamin Bain, Bloomberg) – This week, the Senate officially confirmed Gary Gensler to become the Commissioner of the Securities and Exchange Commission. Gensler spent the early part of his career at Goldman Sachs (as one of the youngest people to become a Goldman partner) but is known more in recent years for being the leader of the Commodity Futures Trading Commission during the Obama administration, where, in the aftermath of the financial crisis, he imposed controversial new rules to limit the use of derivatives in order to de-risk and better stabilize the financial system, and imposed $1.7B in enforcement actions against Wall Street firms. Accordingly, Gensler is anticipated to be a “tough cop” regulator on Wall Street in his new role as SEC commissioner, as topics from day trading Gamestop to trading Bitcoin to public company disclosures and the rise of SPACs (and associated decline in ‘traditional’ IPOs) have become recent regulatory flashpoints. From the financial advisor perspective, the summer of 2021 will mark the end of the first full year of Regulation Best Interest being in place, and as the SEC examines its efficacy over the first year, Gensler is anticipated to set a more aggressive enforcement tone at the SEC with respect to the oversight of advisors working at broker-dealers, and publicly stated in his confirmation hearings that he believes the industry standard practice of mandatory arbitration clauses should be eliminated to allow investors to sue their advisors in court to settle disputes if they so choose.

Robinhood Sues To Overturn Massachusetts Fiduciary Rule (Mark Schoeff, Investment News) – Back in December, Massachusetts securities regulators filed a complaint against Robinhood, alleging that the brokerage firm targeted young people with limited investment experience and gamified their application to encourage them to make repeated trades against their own interests, placing Robinhood in violation of Massachusetts’ new state fiduciary rule that rolled out last September. And this week, Massachusetts updated the original administrative complaint with additional allegations about how Robinhood is marketing to (inexperienced) investors to induce them into (risky) trading. In response, Robinhood declared that it is counter-suing Massachusetts to overturn its state fiduciary rule, alleging that the rule is invalid under both Massachusetts and is preempted by Federal law (Regulation Best Interest), and that in any event Robinhood serves “only” as a self-directed broker and is not providing investment advice to which a fiduciary duty should attach. Which helps to highlight the ongoing industry challenge of whether to extend the fiduciary rule to broker-dealers (providing advice) under a single uniform standard, or instead to separate brokerage sales from investment advice and allow brokers to be brokers and advisors to be advisors?

Department Of Labor Releases Guidance On Trump-Era Fiduciary Rule (Mark Schoeff, Investment News) – This week, the Department of Labor released new guidance on its recent new Investment Advice exemption under ERISA, which allows ERISA fiduciaries to now receive commissions for their advice as long as they are otherwise providing recommendations in the retirement savers’ best interests. The new series of FAQs under PTE 2020-02 highlights that the rules apply not only to sales of investment products into ERISA-regulated employer retirement plans, but also to rollover recommendations from an employer retirement plan and into an IRA if the recommendation is part of an ongoing client-advisor relationship (though notably, under the reinstated ERISA 5-part test, the fiduciary obligation would only apply if the advisor and retiree were in an ongoing relationship). Similarly, the DoL’s new FAQ also includes directions to firms offering retirement plans not to use quotas, bonuses, or prizes to incentivize sales that would be more likely to be conflicted. Overall, though, the new DoL fiduciary rule does not extend a full fiduciary obligation to IRAs automatically (just, potentially, the rollover recommendation itself), and instead is structured to conform to the SEC’s non-fiduciary Regulation Best Interest. Nonetheless, the updated DoL guidance emphasizes a more stringent take on the new ERISA rules, signaling that while the Biden administration may not roll back the DoL’s latest fiduciary rule, it does intend to at least apply it more ‘literally’ in its best-interests obligations and enforce it more aggressively.

An Emerging Divergence On Investor Preferences By Age (Michael Thrasher, RIA Intel) – This week, J.D. Power released its latest study on full-service investor satisfaction and found a growing gap in investor preferences for younger versus older investors, catalyzed by the turmoil of the coronavirus pandemic over the past year. Notable highlights include: 52% of investors under age 40 who work with an advisor committed to ESG plan to increase investments with that advisor (compared to only 24% of older investors), with younger investors far more likely to make portfolio changes accordingly (58% versus just 28% of investors over age 40); the majority of investors (55%) under the age of 40 prefer to communicate with their financial advisor digitally and not in-person (compared to just 26% for older investors), and 71% of younger investors increased frequency of communication with their advisors via those digital channels during the pandemic (compared to only 38% of older investors who increased their level of engagement in 2020); and only 42% of older investors are interested in paying outright fees for financial advice with just 34% supporting a subscription model, but amongst younger investors under age 40 a whopping 74% would prefer to pay for full-service wealth management (versus a one-time fee-for-service model) and 73% preferred a subscription model.

Wealthy Americans Reveal How They Were Picking Advisors And Investments In The Pandemic (Michael S. Fischer, ThinkAdvisor) — In the final quarter of 2020, Bank of America surveyed 2,000 affluent Americans (what most of you would deem “Mass Affluent” with $100k – $1M of investable assets) to assess financial decision-making and changes in financial behaviors and priorities since the pandemic began. It is clear that the pandemic has caused many to re-evaluate the way they save, spend, and invest. Of greatest interest to the financial advisor community, the study finds that investors generally became more engaged in their financial affairs during the pandemic (as opposed to the traditional view that investors tend to ‘ostrich’ their heads in the sand during times of market volatility). However, different consumer segments acted in very different ways. For example, while nearly half of investors reported no changes to their risk tolerance, the flip side of that is 44% did change their portfolio allocation and, interestingly, 23% (i.e., more than half) become more aggressive in their investing… which increases to 52% for millennials (aged 25-40 years old)! Furthermore, 55% of younger investors are managing their portfolios more frequently than they did prior to the pandemic (versus just 32% nationally), undoubtedly coinciding with the 2020 rise of individual stock trading apps (e.g., Robinhood). The broad group of respondents also report general satisfaction and optimism from an overall financial wellness perspective.  For instance, 84% still expect to achieve financial milestones earlier in life than their parents, 89% are satisfied with the financial decisions they’ve made over the past two decades (however 66% wish they had saved more, 59% wish they started saving earlier, and 61% wish they started investing earlier).  The study also finds that 46% report getting their financial lives in order during the last year, and from a spending and savings perspective, 81% have shifted dollars that normally would have been spent on entertainment, travel, and dining to savings accounts and emergency funds in particular. And when asked about the most important measures of personal success, the top responses weren’t financially focused, but rather Good Health (63%) and Supportive Friends and Family (59%), followed by Stable Source of Income (51%) and Money to Maintain a Desired Lifestyle (47%).  In terms of where and how Americans are investing:  40% are fully self-directed, 28% are fully delegated to a financial advisor, 16% are both self-directed and employ a financial advisor for guidance, and (only) 9% use only a robo-advisor (and while that’s the smallest of the four categories, it bears noting that was effectively 0% a decade ago before robo-advisors emerged). In terms of their investments, 20% of investors reported prioritizing SRI, with top considerations fairly consistent across environmental impact, personal interest/use of a company’s products, and racial equity, and 40% of respondents stated they would be more likely to consider investing in a company that provides pay equity for all employees and supports charitable efforts aligned with their own.

Study Finds Advisers Are Missing The Boat On ESG? (Jeff Benjamin, Investment News) – Despite a healthy amount of industry “buzz” around ESG, a 2020 study from Cerulli Associate found that 58% of advisors reported an outright lack of investor demand for ESG (which made them uninterested in adopting ESG strategies), and only 14% of advisors reported that it was at least a ‘moderate’ factor. However, according to the latest study from Cerulli Associates of consumers themselves, 44% of retail investors state that they would prefer to invest in an environmental or socially responsible way… an amount that is “far more than the handful of clients that advisers report are proactively reaching out around the topic”, and suggesting that the advisor community may be underestimating the demand that their clients have for ESG (and that the lack of proactive client questions about ESG isn’t necessarily a indicator of a lack of client interest). In fact, Morningstar data similarly shows that in 2020, ESG funds saw a record-setting $51B of inflows, more-than-double the 2019 flows of $21B (which itself was quadruple the preceding years where typical ESG flows were “only” about $5B/year). Notably, Cerulli also found that while ESG seems to be “trickling down from the top” (having emanated early on from ultra-HNW investors), ESG preferences are not necessarily a function of wealth (i.e., that only wealthy clients want to invest according to their ESG preferences), with more than half of households having $100,000 to $250,000 of investable assets also stating that they would prefer to invest in companies that have a positive social or economic impact (and also strong signals of ESG interest from entrepreneurial clients).

How To Incorporate Sustainable Investing Into Your Practice (Phuong Luong, Morningstar) – For most financial advisors, “sustainable investing” according to ESG (environmental, social, and governance) preferences is not a standard part of their investment process, and at most is something advisors might do to ‘accommodate’ a client or few who may ask for it. Yet in practice, as demand for ESG investing increases, the pressure rises on advisory firms to transition from merely accommodating clients with ESG preferences, to actually developing an investment process or set of models that more directly address and serve clients who wish to follow a more ESG-centric investment approach. The starting point, though, is to recognize “sustainable investing” itself incorporates multiple different types of approaches, including ESG (using environment, social, and governance data for security selection), socially responsible investing (which more typically focuses on excluding certain industries deemed ‘not social responsible’ based on moral or ethical values), and impact investing (private-sector investments outside of public markets that have a theme of positive outcomes on the environment or society). Which means it’s important to consider how the advisory firm wants to be positioned with respect to sustainable investing as part of its value proposition – for instance, will the firm “mix” public investments and private (impact) investments?; will the firm offer sustainable investment and ‘non-sustainable’ (traditional) options?; are there particular themes the firm wants to focus on and highlight (e.g., environmental sustainability, racial justice, gender equity, animal rights, etc.)?; does the firm plan to get involved with shareholder engagement and/or proxy voting for clients as well? Because in the end, the whole point of moving from ‘accommodation’ clients to a core offering is to get clarity on how the firm wants to add value in the (sustainable) investing process.

Saved Too Much For College In A 529 Plan… Now What? (Chief Mom Officer) – The primary benefit of 529 college savings plans is the ability to growth investments on a tax-deferred basis, and subsequently withdraw that growth tax-free… at least, as long as the withdrawals are used for qualified higher education purposes (plus, in some states, a state income tax deduction for contributions as well). However, if funds are withdrawn and used for any other purpose, the earnings suddenly become taxable as ordinary income, and face a 10% early withdrawal penalty on top (and any state income tax deduction for contributions may also be ‘recaptured’ as ordinary taxable income). In practice, the tax risks can dissuade some families from investing into a 529 plan – or at least, not “fully” investing for all their college needs – out of fear that they will end out accumulating more than they needed, and face unfavorable tax consequences as a result. Yet the reality is that there are not-necessarily-tax-adverse alternatives for those who accumulate more than they need for college tuition in a 529 plan. First and foremost, the reality is that 529 college savings plans can be reassigned to a different child as the beneficiary (e.g., rolling the 529 plan down the line to siblings), not to mention being repurposed “up the line” to parents who may want to go back to school for a career change, or further down the line as a tax-free multi-generational “dynasty 529” college savings account for future grandchildren. Alternatively, 529 plans can also be used for a wider range of college expenses than “just” tuition alone, including books and supplies, registration and similar academic fees, a computer, room and board expenses (including the amount room and board would have cost even if the child doesn’t actually stay on campus!), and even paying for study abroad. And if the reason that there’s “too much” in a 529 plan is that the child received a generous scholarship, it’s actually possible to withdrawal the amount of the scholarship from the 529 plan and at least “only” pay the income taxes (but not the early withdrawal penalty). Of course, if a family gets enough years of tax-deferred compounding growth, it’s also possible that even with ordinary income taxes and a 10% penalty, the account may still grow to as much as it would have in an annually taxable investment account (with preferential long-term capital gains rates and no 10% penalty, but taxation every year for interest, dividends, and realized capital gains)… or at least, enough years of tax-deferred compounding growth greatly reduces any “529 regret” that might have been incurred if the account really did grow “too much”?

Accessing Losses Via Direct Indexing In Real-World Client Portfolios (Barry Ritholtz, The Big Picture) – As tax season gets underway, advisory firms and their clients get very focused on the tax consequences of their portfolios, including and especially any realized capital gains that occurred in the past year. For which one increasingly popular solution to manage realized capital gains in client portfolios is “direct indexing”, where clients don’t hold an index mutual fund or ETF, but instead use technology to own the underlying individual stocks of the index… making it possible to tax-loss-harvest just the subset of stocks that are down and hold the rest that are up (whereas with a single index fund, if the index as a whole was up for the year, there is no tax loss harvesting available). Last year, Ritholtz’ firm began its own foray into Direct Indexing (via O’Shaughnessy Asset Management’s “Canvas” platform), ultimately placing more than $300M into direct indexing strategies, and now after an admittedly volatile year (which is particularly favorable to “access” tax loss harvesting in a year where the markets still finished up at the end), can look back and see the actual results. As it turned out, the average client generated almost 80bps of tax savings (though for clients who had taxable accounts invested entirely before the crash, the number was as high as 475bps!). Of course, the reality is that tax loss harvesting still reduces the stock’s basis (when it is repurchased at the lower price after the loss is harvested), which means much of that tax savings will eventually be recaptured in the future; still, though, the current-dollar tax savings is very material, if only to keep more dollars invested for subsequent growth (until the future gains eventually come), and Ritholtz notes that the firm is looking to amp up its direct indexing further in the coming year for clients with taxable accounts (particularly for clients with concentrated positions who ‘need’ losses to harvest to offset against the concentrated gains they’re trying to diversify out of).

The Sign Of A Great Thinker (Jeff Haden, Inc) – The Dunning-Kruger effect is a well-known cognitive bias where many people believe they’re smarter and more skilled at a task than they actually are (potentially leading to significant overconfidence and a failure to learn and take in new information). However, the corollary to the Dunning-Kruger effect is that those who are highly skilled tend to under-estimate how good they actually are, underrating their own competence and not realizing how much better and more effective they may be at a task than others; in essence, the smarter you are, the less you think you know (because you realize just how much there actually is to know!). Which means that one of the best ways to identify a ‘smart’ person (e.g., a good financial advisor) is the extent to which they use qualifiers like “I think”, “it seems”, or “this suggests”… which are not meant to be signs of insecurity or imposter syndrome, but of someone who is knowledgeable enough to know that it doesn’t take a significant change in facts and circumstances to change the “right” answer, and therefore is quick to caveat any statements or assertions they make. In fact, Amazon’s Jeff Bezos goes so far as to state that “consistency of thought” (e.g., always sticking to what you previously stated) is not actually a positive trait, and instead that it’s better to always be seeking new data, new analyses, and new perspectives (what Stanford’s Bob Sutton famously called “strong opinions, weakly held”). Or stated more simply, “wisdom” isn’t about knowing a lot with certainty, but knowing that while you might know a lot, there’s always a lot we don’t know as well, and the key is not being right but always trying to figure out what is right if/when/as new information comes along.

What Information Do You Need In Order To Change? (Shane Parrish, Farnam Street) – For most people, “getting better” at something means doing the studying/research/learning about how to do it, and then trying it out and learning and practicing until we get better. The caveat, though, is that sometimes we aren’t actually sure what to practice and focus on to get to the next level, which can make us stuck and unable to move forward. At that point, the key isn’t doing more research and getting more information and ideating on more strategies and tactics… it’s getting feedback from someone who can observe and help you identify what’s working, what’s not, and what you may need to do differently to get to the next level. In fact, the reality is that “feedback” is deeply ingrained in us as a mechanism for guidance and learning, from waiting to see if someone laughs at our joke to know if it was funny, to getting formal feedback at a performance review to know if we’re developing in our career. But in practice, such feedback mechanisms do not always occur ‘naturally’… which means if and when you’re stuck, it’s often necessary to proactively try to reach out and find someone to give you feedback, not only to figure out when it’s time to do something differently, but also to reinforce our good behaviors if something we’re doing is positive and just isn’t working “yet” (but should otherwise be continued). Thus why writers have editors, actors have directors, and athletes have coaches. So if you don’t have the systems in place to get feedback… is it time to get a coach or someone else who can give you the feedback you really need to get to the next level?

The Secret To Business And Artistic Success (Ryan Holiday) – One of the biggest challenges in business, especially as a business grows, is how far the leadership and decision-makers of the company get from the customers who actually buy and use their products or services. Which at best can lead to a disconnect between where the company is focused and what its customers or clients actually want, and at worst leads to damaging decisions that put the company in a bad light (e.g., Shoe Company X outsourced to Manufacturer Y who outsourced to Factory Z that in turn used slave labor to make the shoes, and the parent company is eventually called out to explain why “its” workers were being treated so poorly). And in practice, these layers of intermediation exist in a wide range of industries, from Holiday’s book-publishing world (where “buying the book in the local bookstore to support the author” actually supports the distributor that sold to the bookstore, which supports the publisher that sold to the distributor, which eventually supports the author who sold to the publisher, but only after all the others take their cut as well!). Which means the key both to understand the end customer/client and what they want, serving them well, and getting paid well for it, means getting as close to the end customer/client and minimizing the number of intermediaries who take a ‘cut’ along the way. Of course, the reality is that not everyone can do everything themselves, and both creative artists and business owners may still need external vendors and relationships to support them. Nonetheless, Holiday’s point remains: the closer the individual creator or business owner stays to the end client they serve, the fewer people take a cut, the more they tend to make, and the better connected they stay to their clients.

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 Craig Iskowitz’s “Wealth Management Today” blog, as well as Gavin Spitzner’s “Wealth Management Weekly” blog.

Gavin Spitzner contributed this week’s article recap on the Bank of America study.