Weekend Reading for Financial Planners (June 5-6)

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.

Financial Advisors Enjoyed Record High Client Retention Rates in 2020 (Jeff Schlegel, Financial Advisor) — Based on findings from McKinsey’s 10th Annual PriceMetrix Report – “The Value of Personal Advice: Wealth Management Through the Pandemic”, encompassing 20 North American wealth management firms and 70,000 (mostly large-firm private bank and wirehouse) financial advisors, the tumultuous year of 2020 witnessed record client retention rates (94.6%), albeit alongside modest rates of new client acquisition (an average of 7.4 new client relationships per advisor, averaging $905,000 of investable assets per client). Helped by strong market returns, median assets per (large-firm) advisor hit an all-time high of $130M, a 9% increase from 2019. At the same time, though, it appears that the bull market continues to mask the industry’s organic growth challenges, with market performance explaining 75% of asset growth for advisors. Median gross revenue per advisor barely budged from 2019 levels, but still achieved a record $724k. New clients entering the advice fold are trending slightly younger, with the average age of an advisor dropping from 57.5 years old in 2019 to “just” 56.4 years old last year. The fee-based movement also continues to be a powerful force in the broader financial services industry, with fee-based revenue comprising ~75% of compensable advisor revenue (even amongst large private banks and wirehouses), up from 54% in 2016. In total, 58% of client relationships have fee-based accounts, a 15 percentage point increase versus just 5 years ago in 2016. In addition, despite ongoing industry worries about fee compression, fee pricing for new client relationships dipped only slightly, by just 1 basis point, and across all accounts, pricing held steady for the first time in five years. Importantly, McKinsey noted a growing number of what they’re calling “hybrid households”, with both fee-based and transactional accounts, suggesting the need for better tools, policies, and relationship pricing models that recognize these shifting behaviors where clients delegate some investment assets but continue to either self-manage or simply buy-and-hold (and not need managed-account advisory services) for others. And this trend was most pronounced among the affluent, where 61% of households with $2M+ are hybrid (and this upward skew in affluence means that overall, the 34% of households that are hybrid represent 55% of AUM). McKinsey concludes with the sensible suggestion that “Advisors who are putting in the work to make connections with clients who are now in their 40s and 50s will reap those rewards over the next two decades”. Though in practice, working with pre-retirees who accumulate a surge of assets in the home stretch and then retire have long been a staple of the financial advisory business already?

Niche Financial Planning Seen As The Next Frontier (Jeff Benjamin, Investment News) – In virtually every recognized profession, specialists generate more income and/or have more successful businesses than generalists… a trend that is now coming for the financial advice business, according to a recent study from Bob Veres and Matthew Jackson called “New Frontiers in Wealth Management“. In fact, most advisory firms are already struggling to maintain strong organic growth rates (which has led to an explosive wave of inorganic growth via acquisitions and mergers), where more and more advisors are offering comprehensive financial planning services, leading to a ‘crisis of differentiation’ where advisors offer and do more for clients but can’t distinguish themselves from other advisors doing the same. Yet ironically, the reality is that most of the largest fee-only comprehensive financial planning firms were actually successful because they built around niches 20 years ago – where in many cases, their niche was being a fee-only planning-centric firm (in a world where most “financial advisors” were still primarily selling insurance and mutual funds). The challenge, though, is that the more comprehensive financial planning becomes a mainstream service advisors offer, the less that particular niche ‘works’ today, and the more necessary it is to find new and different (and more focused) niches instead. For existing advisory firms, the fear of pivoting to a new niche is that existing clients will be alienated (although the report suggests that in the end, existing clients don’t care as long as they continue to be well served, and the fear is primarily in advisors’ own heads). Although ultimately, it’s new advisory firms – that don’t necessarily carry the ‘baggage’ of existing clients – that have the biggest opportunity to establish themselves in a focused niche from day 1, and reap the rewards of building their business with a more differentiated offering.

What’s Next For The Advisor’s Office (Ryan Neal, Financial Planning) – As COVID-19 vaccines go into broad distribution and the CDC’s mask mandates roll back, advisory firms are rapidly re-opening across the country, and for many, May was the first month in over a year that advisors had a substantial number of in-person, in-office client meetings. Yet even as it becomes possible for advisors to work from the office again, it’s not clear how many want to or intend to; in fact, a recent survey by Financial Planning itself found that 88% of advisors are still working at least occasionally from home, and 59% want to continue working from home even after the pandemic is over. On the other hand, in practice the data also shows that 56% of advisors were already working from home at least part of the time before the pandemic, suggesting that in practice, advisors that had a preference for working from home still wish to work from home… and advisors who were already working in an office largely want to return to doing so as well. Still, though, the research also finds that 27% of advisors are downsizing their physical office spaces, and that only 4% of advisory firms are looking to expand their office footprint, as even those who intend to maintain office presences anticipate a more hybrid work structure that won’t necessarily entail as much office space. Which in turn is leading to new challenges, like adapting training for new team members when it’s not impossible to simply sit down for quick in-person chats and address off-the-cuff questions, and growing interest in shared office and co-working spaces like Regus and finding less formal “meeting places” to engage with clients.

More Financial Advisors Are Looking To Allocate To Cryptocurrencies (Nicole Casperson, Investment News) – Despite years of growing ‘buzz’, financial advisors have remained persistently uninterested in Bitcoin and other cryptocurrencies, and as recently as 2020 fewer than 1% of advisors were expressing any interest in making ‘crypto’ allocations. However, in the latest 2021 Trends In Investing survey from the Journal of Financial Planning, advisor interest in cryptocurrency is suddenly on the dramatic rise, with 26% of advisors expecting to increase their allocations to Bitcoin in the coming year. To put that number in context, “only” 24% of advisors reported a plan to increase their allocations to EG in the coming year, and relative to other ‘alternative’ investments, only 9% are looking to invest more in private equity, only 4% are looking to invest more in hedge funds, and only 3% are looking to invest more into structured products or non-traded REITs. The primary driver of the crypto interest is clients themselves, with 49% of advisers reporting that clients had asked about investing into cryptocurrencies in the past year (up from just 17% in 2020), and in fact, the study found that 15% of advisors said they already current use or recommend cryptocurrencies with their clients, and 48% of advisors had made at least some personal investment into crypto assets.

Charles Schwab Dials In On SEC’s Signals On Bitcoin (Brooke Southall, RIABiz) – As cryptocurrencies garner more and more interest from both consumers and increasingly from advisors themselves, but remain both a controversial and outright ‘complex’ asset to own (particularly in traditional investment accounts), major firms are beginning to draw lines on which will or will not support Bitcoin and other crypto investments. Thus far, Fidelity has already begun to support cryptocurrency investing (via integrations to Coinbase accounts that can be viewed on the Fidelity platform), while Vanguard has publicly indicated that it still intends to stay far away, and while Schwab has thus far been slow to adopt, the company is signaling that it may soon go “all-in” with both crypto custody and crypto spot trading capabilities, under the philosophy of “demand deserves supply” and that Schwab will offer what its investors want access to. In the near term, though, the most likely pathway will be whenever the SEC approves a cryptocurrency ETF that Schwab could then offer via its trading platform, in part because Schwab appears wary of too-directly endorsing cryptocurrency trading out of fear that it will face lawsuits if cryptocurrencies do end out collapsing. On the other hand, if Schwab remains too concerned about the platform’s risks of offering cryptocurrency investments to investors that may blame them if something goes wrong, it raises interesting questions about how advisors should assess their own risks in making cryptocurrency recommendations to clients if/when Schwab makes some offering available?

You Have To Talk With Clients About Cryptocurrency (Steve Wershing, Client Driven Practice) – The onslaught of media coverage about cryptocurrencies in recent months has mirrored much of the debate within the advisor community as well, with some suggesting that cryptocurrencies are the next new major asset class, and others claiming that it is nothing more than the 21st-century tulip mania. Either way, though, Wershing suggests that when cryptocurrencies are so front and center in the news cycle, advisors have to talk about it with clients one way or the other, and cannot simply remain silent. Because the reality is that cryptocurrencies are almost certainly somewhere on clients’ minds – given their media prominence – and while some may be dismissing it, others may have a Fear Of Missing Out and want to invest, and others may have already done so (on their own, if their advisor didn’t broach the conversation in the first place). Which means at this point, avoiding the conversation at best leaves clients to their own (potentially more self-harmful) devices, and at worst makes the advisor seem less knowledgeable and relevant and undermines the relationship of trust and confidence with the client altogether. Especially recognizing that in the end, clients often hire advisors because they want to know what the advisor thinks – both about what to invest in, and what to avoid – and communications to clients providing interpretation and insight are some of the most valuable that an advisor can provide. Which means in the end, it’s not even necessarily about whether it’s “right” or “wrong” to invest in cryptocurrency… but that either way, clients are going to want to hear how you as their advisor stand on the issue.

The Best Investment Strategies For Inflationary Times (Henry Neville, Teun Draaisma, Ben Funnell, Campbell Harvey, & Otto Van Hemert, SSRN) – One of the most dominant economic trends of the past several decades has been the persistence of low inflation, which early on was blamed on the rise of globalization and technology automation and has managed to persist despite ‘astonishing’ levels of monetary stimulus from the Federal Reserve (particularly in the aftermath of the financial crisis) that still failed to stoke any inflationary pressures. But now, with inflation indicators flashing at least short-term warnings as the COVID-19 pandemic winds down and the American consumer begins to bounce back, inflation is suddenly becoming a hot topic again… even as advisors with decades-long careers have never actually seen and experienced what it’s like to invest in a high-inflation environment. In this study, researchers analyzed data across a wide range of asset classes over the past century, spanning three different countries (the US, UK, and Japan), to identify what fares better or worse in the face of rising inflation. Not surprisingly, the data shows that rising inflation is bad for bonds, but also shows that persistent high inflation bodes poorly for equities as well (although the transition to higher-inflation environments from lower inflation tends to provide an initial boost to stock prices). Commodities also tend to fare well in inflationary environments, but with significant variability within the commodities complex, as energy tends to perform best, precious and industrial metals perform well, but foodstuffs and agriculturals tend to perform weakest (if only because governments sometimes intervene to try to quell food inflation because it can be especially disruptive to households simply being able to afford to eat). And while real estate prices may rise on a nominal basis in inflationary environments, their real returns tend to hold quite steady (not materially better nor worse) in the face of inflation. On the other hand, the researchers find that a number of more ‘dynamic’ investment strategies tend to perform better in inflationary environments, with profitability and value factors roughly holding their own during inflationary periods, smaller companies performing poorly in inflationary environments, and trend-following strategies (that capitalize on the broader restructuring of investment markets transitioning from a low-inflation to higher-inflation regime) faring best.

Investors’ Inflation Bet Loses Some Steam (Sam Goldfarb, Wall Street Journal) – After cratering to record lows a year ago in the depths of the COVID-19 pandemic outbreak, inflation expectations – as measured by the breakeven inflation rate between nominal 10-year Treasuries and TIPS – have quickly rebounded upwards, reaching highs not seen for a decade since the initial economic rebound in the aftermath of the financial crisis. Over the past month, the 10-year forward-inflation expectation measure has reigned back slightly – from a high of 2.57% in mid-May to “just” 2.47% now – suggesting in part that markets are anticipating that the Fed will begin to engage in tighter monetary policy in order to rein in any inflation that may emerge (with the Fed already beginning to open the door to scaling back its $120B/month purchases of Treasuries and mortgage-backed securities, while also emphasizing the economy still has a long way to go just to return to its pre-pandemic levels). On the other hand, some market commentators are simply suggesting that fixed-income investors are booking profits and/or rotating portfolios, and that the uptrend in inflation expectations is still well underway. Which is expected to just focus even more attention on whether and when the Fed may act to lift interest rates, and continue to focus on the interaction between rising inflation expectations, potential Fed action, and the stock market’s potential response if the Fed does begin to take steps to cool down the current hot economic growth.

The Inflation Conversation With Clients (Sarah Newcomb, Investment News) – Albert Einstein famously quipped “compound interest is the eighth wonder of the world“, a lesson that financial advisors commonly try to teach clients to encourage them to save and invest for the long run. Yet the less-understood sibling of compounding growth is the long-term eroding effect of compounding inflation, which similarly can seem minor in the near term but add up – potentially catastrophically – in the long run, especially for retirees who may not have other sources of income and assets once they have retired (even as they must keep up with ever-rising retirement costs). Newcomb suggests that the most straightforward way to drive home the point to clients is to talk about the Rule of 72 – that if you divide a growth (or inflation) rate into 72, that’s how long it takes for the price of something to double. Accordingly, at 3% inflation, the cost of something (e.g., a hamburger) will double roughly every 25 years. Which helps to explain why grandparents remember buying a burger for a quarter, when now a $2 fast-food burger is cheap… as in practice, the 700% price increase is really just 3% inflation writ large over ~75 years (where the first 25 years doubles the price from $0.25 to $0.50, the next 25 years doubles it again from $0.50 to $1.00, and the last 25 years doubles it once more from $1.00 to $2.00). Because ultimately, calculating compounding returns (or inflation) in one’s head isn’t really feasible, but most people do understand “the price doubles” rather intuitively, such that talking about how prices will double (and perhaps then some) over the span of a retirement, even at ‘just’ 3% inflation – and asking clients to reflect how they’ve likely seen one doubling already during their working years, and two doublings since they were children – helps clients to understand the real impact that inflation can have over the long run.

Adding Advisor Alpha By Helping Clients With Their Insurance Needs As A Fee-Only Advisor (Allan Roth, Advisor Perspectives) – For many financial advisors who started out selling insurance for commissions, the shift to the AUM model and its ongoing recurring revenues was both a welcome relief to leave behind sales incentives and the sale of insurance products themselves. Yet Roth points out that even for advisors not in the business of selling insurance, the reality is that clients often need advice and help with their insurance, and doing so – even and especially as a fee-only advisor – is an opportunity to add real value. For Roth, evaluating a client’s existing insurance means embracing five core principles: 1) insurance companies need to make a profit after covering their costs and claims, which means insurance should be a losing proposition on average (and thus clients should only buy insurance for what they can’t afford to lose, such that a small ‘guaranteed’ loss is better than a large unexpected one); 2) the purpose of insurance is to protect wealth (e.g., from death or disability or liability), not to grow it; 3) insurance needs can and do change over time as clients age (e.g., life and disability insurance becomes less relevant as human capital wanes, liability protection for growing assets becomes more relevant); 4) certain types of insurance provide a better ‘deal’ in the early years (e.g., disability insurance), while others provide a better deal at the end (e.g., term life insurance); and 5) that clients often fall prey to inertia, leading them to fail to review their insurance and end out overpaying for what is no longer competitive and/or that they no longer need. In practice, this means that Roth often focuses on eliminating collision and comprehensive coverage on automobile policies (affluent clients can afford to self-insure for these amounts) but retains liability and umbrella coverage, properly and casualty insurance should also be scrutinized for deductibles (raise them) but keeping important coverage (e.g., homeowner’s insurance), life and disability insurance are often big focal points for younger clients but equally opportune to explore canceling as clients approach retirement, and health insurance is still a tough but necessary cost (but helping affluent clients manage their premiums with higher deductibles and leveraging a Health Savings Account can help). Because in the end, saving clients hard-dollar insurance premium costs can actually be one of the most tangible ways to demonstrate value for an advisor’s own fees!

The Do’s And Don’ts Of Productive Annual Client Meetings (Joe Elsasser, ThinkAdvisor) – Historically, most financial advisors were in the business of selling products, and the reality is that the annual client review meeting was really primarily an opportunity to sell more products (either by replacing a client’s existing product, or gaining more ‘wallet share’ by cross-selling additional products to the same client). As the advisory industry shifts to a more recurring revenue model with AUM or subscription fees, though, the focus of the annual client review shifts from one of seeking new business opportunities, to “just” trying to demonstrate ongoing value to retain the existing client (and their ongoing fees), and growth through client review meetings is less about cross-selling new products and more about demonstrating so much value that clients will refer their friends and family as well. Accordingly, Elsasser suggests breaking the client review meeting into two core portions: the backward-looking stage of the meeting, which covers portfolio performance, recent changes in the environment (e.g., new economic events or new tax laws), and whether the plan is still on track since the last meeting; and the forward-looking portion of the meeting agenda, which covers “What changes have occurred since we last spoke that we should be planning for now?”, “What is the client worried about in the coming year?”, “What is the client excited about in the coming year?”, and “Does the plan now need to change?”. Given the current economic environment, this might include talking points such as the current health of Social Security (and whether/how that impacts clients’ retirement plans or claiming strategies), proposed tax law changes (and whether clients should be doing more partial Roth conversions or harvesting capital gains at 0% rates?), and where/how clients are saving into (or for retired clients, withdrawing from) their retirement accounts in a tax-efficient manner.

Fees For Service Or Fees For Access? (Jim Stackpool, Certainty Advice Group) – As financial advisors increasingly charge fees for their services, the basis for comparison when it comes to business models and ‘reasonable’ fees is often what other professionals charge for their services. Yet Stackpool notes that in reality, setting appropriate fees aren’t just a matter of charging for the services actually provided, but also access to the advisor to be able to utilize their services when and as needed, akin to how golfers may pay an “access fee” to be able to golf at a particular club… in addition to still paying service fees to actually play a round of golf, use a golf cart, get supplies from the shop, or receive help from a trainer. In other words, the access fee doesn’t actually give any promised services… but it does create the expectation that the course will be ready and in good order to be used when(ever) the access-fee-payer wishes. Notably, because different types of clients have different preferences – for everything from how often meetings occur, to what is covered in those meetings, and what kind of expertise the firm provides (or not) – Stackpool suggest that access fees should be structured to align to a particular niche or type of clientele (such that there might be different access fees for younger accumulator clients who have different needs that older retired clients). More broadly, though, the power of charging Access Fees is that it further reduces the need for the advisory firm to implement any particular product or portfolio service, as revenues from each client stabilize regardless of whether or how much the firm’s products and services are used. Of course, in the long run, if clients don’t feel that they’re getting any value from the access fee – because they’re not utilizing the advisor at all – the clients will still terminate. However, an access-fee philosophy to client fees does help to fundamentally change the focus and mindset of the firm, away from selling more products or gathering more assets, and towards simply providing whatever it is the clients find valuable enough to stay engaged with (and be willing to continue to pay that ongoing access fee), in addition to compensating the firm for its ongoing oversight and management and stewardship of the client relationship. And of course, when clients need more that goes above and beyond what the Access Fee alone provides… additional Service Fees for services rendered can and do still appropriately stack on top.

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 Financial Advisors Enjoyed Record High Client Retention Rates in 2020.