Weekend Reading for Financial Planners (May 2-3)

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 Speed Up Shift To Holistic Financial Planning (Michael Fischer, ThinkAdvisor) – In a new industry survey this week from Broadridge, 51% of financial advisors indicated that they were increasing the focus within their practices on providing holistic financial planning as a response to the coronavirus pandemic. Notably, though, survey participants younger than 40 were more than 4X as likely as advisors over age 55 to believe that holistic financial planning was the main value they provided to clients. Other notable results and trends from the survey included: the number of advisors with >75% of their assets in fee-based accounts is expected to increase (from 51% to 67%) over the next 3 years, signaling that the AUM model is becoming more popular in the midst of the pandemic (as even with market drawdowns, it’s still faring far better than advisors under commission-based models); 80% of advisors indicated that they expect to be part of a team environment in 3 years in order to deliver more comprehensive advice; 78% of advisors are looking to asset managers for support on portfolio construction (though only 25% are seeing out new relationships with asset managers); 57% are looking to asset managers for support on building a tech stack (and 41% on strategies for outsourcing); and 71% of advisory firms are showing interest in how to acquire new millennial investor clients.

Client’s Don’t Grasp Fees, And That’s Bad For Business (Emile Hallez, Investment News) – According to a recent Hearts & Wallets consumer survey, 31% of investors don’t understand what they’re paying to work with a financial advisor… which is actually up from 28% in 2019, as the rise of zero-commission trading and some zero-fee ETFs is just creating even more confusion for consumers about who’s actually being paid for what. Which is important, because the ambiguity of and confusion about pricing appears to be undermining client trust in their advisors and the organizations they’re working with. In fact, the survey results showed that transparency about compensation actually mattered more than the type of compensation itself – in other words, it mattered less about whether the advisor was compensated via commissions, AUM fees, or flat fees, and more about simply whether the client clearly understood how their advisor was being compensated in the first place (by whatever means it happened to be). Other notable results from the survey included: understanding fees (and having low fees) were amongst the top factors influencing how much a consumer trusts their advisor; consumers paying for advisors (and not simply using self-service technology) expect to be able to reach their advisors, and that the advisor’s readiness to answer the phone (or respond to emails) is a major driver of retention (beyond just tending to the portfolio itself); consumers are OK with paying higher fees for human advisors in ‘full-service’ relationships, as long as they feel they’re receiving additional service for that fee over what self-directed technology alone (e.g., robo-advisors) can provide.

Should Advisers Cut Fees To Help Clients During COVID-19? (Emile Hallez, Investment News) – With both rising unemployment and a not-fully-recovered bear market in portfolios, consumers are increasingly looking to tighten their belt around ‘discretionary’ expenses… which in some cases, may include their financial advisor. Consequently, some advisory firms are wrestling with either how to help consumers who can’t afford their services, or whether to cut fees for some existing clients who may be struggling to get by in the current environment. For instance, one advisor reaching out to his still-working clients and indicated that he would reduce his fees commensurate with any loss of income they face (e.g., if the client’s income is down by 25%, he would cut his fees by 25%), while advisors with multiple fee tiers are sometimes ‘bumping’ clients down into lower fee tiers to help reduce the load. Another advisory firm, that works primarily in the 401(k) space, is offering new clients a waiver of the first 3 months of their 401(k) fees (if they otherwise agree to a one-year contract). However, the issue of cutting fees itself is contentious in the current environment, with other firms emphasizing that this is the environment when the value of financial advice should shine… and that if clients don’t value their advisor in times like this, they may simply not be a good fit in the first place (which means they’re clients who were likely to leave soon anyway). For some, though, the focus is simply on how to help more people – who can’t necessarily afford the firm’s fees in the first place – with one advisor offering a “Pay What You Can” arrangement, allowing members of the community to sign up for time slots on her calendar every Tuesday for her advice, with a “Pay What You Can” commitment to allow those who seek help to pay whatever they feel they can afford. Notably, though, a key trend being observed from many advisors – from Pay What You Can offerings to discounting fees for existing clients experiencing difficulty – is that ironically it’s still challenging to engage existing and especially new clients, even when on a potentially discounted basis.

Financial Planning Groups Ask Advisers To Encourage Charitable Donations (Mark Schoeff Jr., Investment News) – While there has been a significant focus in the media on various businesses and entire industries, from restaurants to tourism and hospitality, that have experienced devastating impacts from the coronavirus pandemic, many nonprofit organizations – that tend to have even less in cash reserves and rely even more on external support – are struggling even more in the current environment, as many of their services are needed now more than ever. Accordingly, this week the Foundation for Financial Planning issued a call to financial advisors to encourage their clients who have Donor-Advised Funds (DAFs) – which are particularly popular amongst the clients of financial planners for various charitable planning strategies – to use those DAFs to make distributions to non-profit charities in need and trying to provide services in these difficult times. In fact, recent data shows that Donor-Advised Funds have become one of the most popular vehicles for charitable giving, with DAFs up 20% in 2018 alone (to $37.12B), with Schwab Charitable and Fidelity Charitable being amongst the largest sponsors of DAFs. And while DAFs have been criticized in recent years for not having higher mandatory payout obligations, the American Endowment Foundation (a multi-custodial DAF solution) notes that their DAF distributions in recent months have already been up 30% over the same period last year. Still, though, for advisors working with clients who are more affluent and have been better able to weather the pandemic storm themselves, a discussion about whether this is a good time to use their DAF and make distributions may be an appealing and positive talking point to cover in upcoming client meetings.

How To Field ‘That Call’ From A Frightened Client (Bob Veres, Inside Information) – Handling the situation where a panicked client calls and says they want to go to cash and the advisor is compelled to talk them off the ledge is always difficult, but one unique way of handling the situation is instead to simply respond “Yeah, we can do that.” As in practice, most clients know when they call their advisor about selling that the advisor is going to push back, giving them no resistance at all often makes the client start to backpedal. After all, clients who are fearful and want to sell often come to the call with their own pre-planned strategies to overcome what they ‘know’ will be their advisor’s objections, prepared to fight… all of which are thrown out the window when the advisor simply says “Ok, we can do that.” Which instead causes them to get through the emotional moment of fear more quickly, and then to move into the rational stage of recognizing the consequences of what they actually just proposed for themselves and whether they really want to follow through on it. In fact, one advisor who employs this strategy says he has never actually had a client follow through on it and say “Oh, good. Go do it” with the no-resistance response; instead, it usually opens up a moment for empathy (“You’re scared to death.  I get it.  I kind of am too.  And if you need to go to cash, no problem.”), and then a discussion of other tactics the client might take (do we need to change the asset allocation, modify your withdrawals, etc.). Alternatively, if clients do still insist on going to cash, try suggesting that they actually create (and look at the yield on) their alternative all-cash or all-fixed portfolio, and let them reflect whether they can really live on that yield (unlikely, given the current low-yield environment). The key point, though, is simply about changing up the dialogue away from the ‘traditional’ fight (where the client wants out, and the advisor resists), and instead disarming the fight quickly to move on to more productive (or at least more rational and considered) conversations instead.

Positioning Yourself As A Behavioral Coach (Daniel Crosby, Brinker Capital) – Financial advisors have long positioned their ‘behavioral coaching’ as a key value provided to clients, particularly in the kind of turbulent markets experienced in recent months where clients may panic and advisors try to talk them off the ledge of selling everything. Yet the caveat is that even if the act of such behavioral coaching is valuable, most consumers don’t expect to behave irrationally and make such mistakes (even if they do in the moment)… which means that while behavioral coaching may be valuable, it can nonetheless be extremely difficult to convince clients of this value upfront when explaining their value and why a prospective client should hire them; in fact, a 2014 Natixis survey found that 83% of advisors listed behavioral coaching as a value-add but only 6%(!) of clients agreed, which was reinforced more recently by a Morningstar study with similar findings. Accordingly, Crosby provides some suggestions about how to more effectively position the value of being a behavioral coach with clients in the first place, including: frame it more positively (e.g., being a guide to help them navigate difficult situations), as opposed to negatively (e.g., “I’ll be there to help you from being so irrational”); frame the relationship as a partnership instead of being one-sided, where the advisor will walk side-by-side with the client to navigate difficult environments, instead of treating it in a more binary “I’m the doctor/expert and you’re the patient/recipient of my advice” approach; share the research about how the advisor-client relationship on an ongoing basis bolsters client outcomes (beyond just addressing the behavior gap itself), as Crosby himself highlights in his “The Laws Of Wealth” book; and recognize that in the end, good behavioral coaching is rarely a medicine that anyone takes alone, and instead is better paired with a ‘spoonful of sugar’ to help the medicine go down (e.g., framing good behavioral investment advice in the context of the client’s financial plan and goals, good portfolio design metrics, etc.). The key point, though, is simply to recognize that no client wants to feel like someone who is irrational beyond their own ability to self-regulate or a ‘helpless’ patient, which means even if behavioral coaching is valuable, it’s more about delivering it in the context of an integrated financial advice solution than just to offer behavioral coaching for coaching’s sake alone.

The More You Know A Stock The Worse Your Performance Gets (Joachim Klement, Klement On Investing) – The more familiar we are with something, the more comfortable we tend to be with it (risks and all)… which helps to explain why virtually all investors have a “home country” bias (to over-invest in stocks from their own country relative to the global market index), and many investors further overweight their particular industry as well (whatever industry they already work in, and again are more familiar with). In theory, this reduced level of diversification may be compensated for by generating superior results in the country or industry of choice – i.e., where the additional information that comes with familiarity allows them to make superior investment decisions (as the famous Andrew Carnegie saying goes: “to become rich, put all your eggs in one basket… and then watch that basket!”). Yet a recent study encompassing a whopping 300,000+ investors from Finland over a nearly 20-year period (plus another 76,000 investors over a 5-year period) found that investors have a tendency to get narrower and narrower and more focused over time, with about 40% of investors selling out entirely from a stock only to buy it again at a later time and 10% engaging in at least 6 different round-trip investments. And the research found that the more investors traded in the stocks… the more short-term they became, with the average holding period of each round trip declining by 11% each time the investor went in and out, and returns becoming successively worse the more frequently (and the more round trips) the investor traded. Notably, though, the research finds that eventually, investors do stop, usually once they have an especially poor result, effectively showing that investors tend to keep trading if/when/as long as the results are good and stop when they’re not… with the caveat that they may lose so much in the last round trip it forfeits some/most/all of the prior gains.

A Comparison Of Risk Tolerance Products (Bob Veres, Advisor Perspectives) – It is both an advisor best practice, and a regulatory requirement, to “Know Your Client”, which includes an understanding of their tolerance for investment risk… which becomes especially important in the midst of volatile investment markets, to ensure that clients actually have the appropriate portfolio given their risk tolerance (and to reduce the risk that the advisor is sued for having caused the client an ‘intolerable’ level of bear market losses). Yet as Veres notes, there is a wide range of different risk tolerance software solutions in the marketplace, and not all of them have the same level of robustness when it comes to relying on the software to be able to actually defend oneself against a potential legal claim by a client. The ‘gold standard’ receiving an “A+” grade, according to Veres, is FinaMetrica (previously independent, but now owned by Morningstar), which has been through extensive psychometric testing, and is reliable enough to have been used as source data for more than 250 research reports in a variety of academic journals about risk tolerance. By contrast, the most popular competitor in the category, Riskalyze, is scored with only a “C”, as Veres notes that Riskalyze appears to have only been evaluated in one academic research paper (which Riskalyze itself commissioned), and the paper itself doesn’t actually validate whether asking clients about risk trade-offs to determine their utility curve results in a valid and reliable measurement of their actual risk tolerance (it focuses instead on the mathematics of how Riskalyze estimates the client’s individual utility curve itself), and even Riskalyze itself frames its software as a prospecting/proposal generation tool (as opposed to a pure risk tolerance measure). Other tools for consideration include: Tolerisk, which uses a two-dimensional risk tolerance approach (measuring risk capacity and risk willingness separately, as discussed previously on this blog), which Veres suggests will do a better job of clearly identifying the client’s true willingness to take risk (and not just their financial ability to do so), but only gives the tool a C+ due to the lack of academic research to support its methodology; Totum Risk, which also measures risk capacity separately from pure risk tolerance, but weighs even more heavily towards the risk-capacity dimension (without providing justification as to why actual risk tolerance of the client should receive a greater weight), resulting in a C- grade; and Andes Wealth, which builds on MIT professor Andrew Lo’s “Adaptive Markets” approach and provides visualizations for clients of potential drawdowns for them to choose from (which Veres rates a B+ given Andes’ robustness in how it calculates the ranges of possible portfolio returns). Notably, the point of Veres’ evaluation is not about the usability or quality of the software itself, but specifically the “defensibility” of the risk tolerance assessment in the event that an advisor ever needs to justify in court “why did you choose that particular risk tolerance software for your clients, and how certain were you that it would accurately assess their risk tolerance in the first place?”

Measuring Risk Tolerance Badly Is As Bad As Not Measuring It At All (Greg Davies, Oxford Risk) – Despite the fact that assessing risk tolerance of investors has been a requirement for financial advisors for decades, there has been remarkably little focus by regulators (or advisory firms themselves) about what makes a “good” risk tolerance assessment in the first place. Which is notable, because Davies finds that when delving into risk tolerance assessment tools, most commit one or more common mistakes in how they are designed and delivered for clients, including: confounding the long-term psychological trait of risk tolerance with other attitudes, behaviors, or personality dimensions (e.g., those who like to gamble in Vegas aren’t necessarily risk tolerant with investments, and short-term perceptions about markets aren’t necessarily an indicator of long-term risk tolerance, either); it’s crucial to separate one’s tolerance for risk with their investment objectives themselves (e.g., a client may ‘need’ to take a lot of risk to achieve their potentially far-reaching goals, but that doesn’t mean they’re actually tolerant of risk, it may simply mean they don’t recognize how risky their goal actually is in the first place); offering investors choices about hypothetical gambles or trade-offs doesn’t yield stable results that can be relied upon to assess risk tolerance (and/or may not reflect the reality of what investors will face in the future and therefore not predict the decisions they’ll make); “revealed” preferences from an investor’s prior behaviors don’t actually indicate risk tolerance (as the investor may not have realized the ramifications of the decision in the past, and a good or bad outcome may have reinforced or discouraged the decision but that doesn’t necessarily mean it was right/wrong either); be cautious not to have overly mathematically driven risk-tolerance assessments or the tool will end out assessing their ability to calculate math in their head instead of their actual psychological tolerance for risk (and similarly, risk tolerance questionnaires that unwittingly use a lot of industry jargon may really just be assessing the individual’s financial literacy and not their risk tolerance itself); and asking investors to make their own predictions about future returns or their own future feelings are especially unreliable. Notwithstanding these challenges, Davies notes that there are psychometrically designed risk tolerance questionnaires that do pass muster and meet these requirements… though they are not necessarily the most popular or adopted tools.

Making The Most Of The Calm Before The Storm (Steve Wershing, Client Driven Practice) – March and early April were a trying time for advisory firms, rapidly responding to clients and their market volatility fears in the midst of also being forced to rapidly shift to a work-from-home environment and adopt a wide range of videoconferencing and other digital tools. With the market rebound in April, though, the pressure has largely relented… with the caveat that, like riding a roller coaster in a thick fog, it’s not actually clear if we’re out of the danger zone, or simply in a lull before the next precipitous drop. And in practice, anyone who’s been through a severe bear market in the past knows that it’s rarely ever over after one sharp stint of volatility… instead, there are usually a number of ups and downs before it ends. Which means in the midst of this calm before what might still be the other side of the turbulent storm, Wershing suggests that this is an especially good opportunity to get proactive in communicating with clients about the further risks. As at least if there is another downdraft on the rollercoaster, it’s not nearly as scary to navigate through when you realize and are prepared for it to come. Accordingly, consider these points in upcoming calls and meetings with clients: prepare clients for at least the possibility of another big downturn (and take the ‘surprise’ out of it in case it happens); ask them how they felt in March (or when they opened their Q1 statements) and whether they think they could hang on if that happened again (and if not, consider making some portfolio changes now!); identify in advance the opportunities that can be leveraged in the next market drop (e.g., tax-loss harvesting, Roth conversions, etc.); and give clients a preview of what you are watching for (and what you plan to do in response if something happens), as having a strategy in advance (even if it’s ‘just’ to rebalance) still builds confidence with clients.

Now Is The Time For Advisors To Invest In Growth (Jeff Berman, ThinkAdvisor) – An analysis of industry benchmarking data from 2008 to 2011 (i.e., during the last bear market/recession cycle) reveals that there were two very different types of firms that emerged from the financial crisis. The so-called “standout” firms achieved a 5% client growth rate in 2009 and 11% over the entire 2008-2011 period, while ‘the rest’ have growth rates of only 0.4% over the same time period. And the difference appears to be driven by how capable the firms were to adapt to the environment, with the standout firms taking deeper owner pay cuts (from an average of 31% of revenue down to ‘just’ 19%) and even slightly trimming overhead expenses, while the rest had less flexibility and actually saw their overhead expense margins rise (from 46% to 56% as their fixed costs consumed a larger percentage of their decreased revenue in the bear market) while taking more limited pay cuts (maintaining owner distributions around 25% of revenue). Yet the standout firms were also still hiring through the downturn, expanding their team by an average of 43% (!) from 2007 to 2009 and taking advantage of the expanded pool of talent that’s available in a recession when unemployment rises (while the average firm held off on recessionary hiring altogether). Of course, these trends don’t necessarily mean advisory firms should just hire and spend profligately – especially in the midst of a recession – but instead suggests that it is important to delve deeply into an analysis of the business’ cash flows, productivity, business continuity, client engagement, and how the firm is taking care of its team, to ensure that if/when/as some growth comes, the firm is really ready to capitalize on it.

10 Predictions For Financial Advisors In A Post-Crisis World (Mindy Diamond, Investment News) – While it’s hard to predict exactly how the coronavirus pandemic will play out, the reality is that we have weathered many other crises over the years, and this too shall pass. And while the industry may well be changing by the coronavirus, the reality is that it was already in the midst of dramatic change and rapid evolution… such that in the end, the coronavirus may not necessarily derail or disrupt the industry, as much as it will simply accelerate many of the changes already underway (such that “the future will arrive even faster than anticipated”). For instance, Diamond notes that several key drivers have already been underway since the last (financial) crisis, including a growing interest in providing advice in a more client-centric (fiduciary) manner, the shift away from product-based companies and growth of the independent channel to power that more fiduciary-centric approach to advice and advisors becoming more confident in their own advisor-client relationship (regardless of whether they’re affiliated with a national-brand firm or not) which is bolstering both the willingness of advisors to switch firms (confident that their clients will come with them) and putting pressure on advisor platforms to better justify their value in the cut of (grid) revenue they take. Accordingly, Diamond predicts a number of trends and takeaways in the current environment, including: Newton’s Law of Motion will still apply (advisors in motion, unhappy with their platforms, will stay in motion and may move away faster, while those who are remaining at rest and are happy with their platforms will remain at rest); many firms have reigned back recruiting in the midst of the difficult environment, but will likely come roaring back with aggressive recruiting again as soon as the moment passes; many advisors will decide that this is the last crisis they want to deal with, accelerating a wave of retirements and triggering more and faster mergers and acquisitions as retiring advisors exit; an increase in teaming as independent advisors in particular realize the ‘pain’ of being alone and seek out employees, teams, partners, and/or communities; more advisors (albeit not all) will work more remotely, having recognized the efficiencies that come from eliminating the daily commute; and while weaker advisory firms not providing strong value may be ‘shaken out’, the best advisors that were already growing will be able to capitalize on the opportunity and grow even more and faster than they did before (potentially driving even more industry consolidation but also creating new breakout firms in the process).

Four Key Ways Financial Advisors And The Industry Can Better Serve Clients And Make A Difference (Mark Tibergien, ThinkAdvisor) – While predicting the future is difficult in general, and even more so in the midst of a turbulent environment like the current one, as industry practice management guru Mark Tibergien prepares for his own retirement, he shares his perspective on what will change in the coming decade, and what advisors and the industry at large must do to capitalize on the opportunity. Key areas to make an impact include: a better focus on (a wider range of) individuals, as financial advice models expand to serve more of the middle (and even lower) class than ‘just’ the affluent that the advisory industry has traditionally served; investment advice has historically been the foundation of the client engagement, but financial planning is increasingly taking center stage… which will eventually spawn new ways to measure, communicate, and convey the value of financial advice; the financial planning profession has never been more focused on helping people (and not money) as its primary motivation, yet being a financial advisor has lost its luster as a career choice, creating a ‘credibility gap’ that the profession needs to figure out how to fill; and the industry remains in need of real regulatory reform, not simply to add more layers on top of what advisors already face, but a total review of how the industry is managed, regulated, educated, and evaluated, because the current system is only adding cost and confusion, but the need for consumer protection – and elevating true professionals – is real.

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!

In the meantime, if you’re interested in more news and information regarding advisor technology, I’d highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisors as well.