Weekend Reading For Financial Planners (Aug 13-14) 2022

Author: Ben Henry-Moreland

Team Kitces

Ben Henry-Moreland is a Senior Financial Planning Nerd at Kitces.com, where he researches and writes for the Nerd’s Eye View blog, using his experience as a financial planner and a solo advisory firm owner to help fulfill the site’s mission of making financial advicers better and more successful. In addition to his work at Kitces.com, Ben serves clients at his RIA firm, Freelance Financial Planning.

Read more of Ben’s articles here.

(Deepa Shivaram | NPR)

On Sunday, August 7, the U.S. Senate passed the Inflation Reduction Act (IRA) on a party-line, 50-50 vote. The bill represents the last opportunity before this fall’s midterm elections to enact some of the Biden Administration’s core agenda of climate and health policy, paid for by tax increases on corporations and individuals earning more than $400,000 per year. And though it has been scaled back a long way from the ambitious American Families Plan and Build Back Better Act that failed to pass the Senate in 2021, the IRA still represents the most significant climate-focused legislation ever passed in the United States.

While the IRA is light on individual financial planning-related items, it still contains some provisions that could impact financial planners and their clients. Most directly, the bill could create significant relief on prescription drug prices for Medicare enrollees by allowing the government to negotiate with pharmaceutical companies on some drugs and by placing a $2,000 per year out-of-pocket cap on prescription drug costs starting in 2025. For individuals enrolled in Affordable Care Act exchange plans, the bill would also extend the expanded Premium Tax Credit (PTC) eligibility for moderate- to higher-income taxpayers for an additional three years, until 2025.

The bill also includes provisions aimed at increasing affordability for individuals making energy efficiency improvements, including tax credits for new doors and windows, energy-efficient appliances, insulation, and solar panels. It also restructures the existing tax credit for buying an electric vehicle (EV), which will at first reduce the number of EVs eligible for the credit (because it requires certain components of batteries to be sourced in North America, which is not the case for any EV currently on the market), but is intended to increase the availability of more affordable EVs and reduce the dependency on China of EV supply chains over the long run.

The provision of the IRA with perhaps the most indirect impact on taxpayers is an additional $80 billion in funding for the IRS over the next 10 years which will be directed towards hiring more agents and investing in technology to increase audit rates on higher-income taxpayers which have sharply decreased in recent years (though Treasury Secretary Janet Yellen has explicitly directed the IRS not to increase audit rates on those making under $400,000 per year). It would also create a task force for designing a free “Direct E-file” tax return system for individuals to file their tax returns directly with the IRS – a service that has been long demanded by taxpayer advocates but heavily lobbied against by tax preparation software providers like Intuit and H&R Block that benefit from the lack of a free, government-owned option.

The bill contains many other provisions that are less directly relevant from a planning perspective, such as a 15% minimum tax on corporate ‘book’ profits, a 1% excise tax on stock buybacks, and investments in renewable energy infrastructure. The House of Representatives is scheduled to vote on the legislation on Friday, where it should face an easier road to passage than in the Senate because of the larger Democratic majority.

(Mark Schoeff | InvestmentNews)

When a registered representative of a broker-dealer is involved in a dispute with a customer or client, FINRA requirements mean the dispute typically becomes a part of the public record via the representative’s BrokerCheck page. In certain cases, however – such as when the information about the dispute in the broker’s record is clearly inaccurate – FINRA allows brokers to request for the dispute to be expunged from their record via an arbitration panel. But while expungement is only meant to be a remedy in special cases, in practice it has proven fairly easy for brokers to have disputes expunged from their records – to the extent that, as the Public Investors Advocate Bar Association found, 90% of expungement requests over a 15-month time period were ultimately granted, leading for investor advocates to call for FINRA to reform the expungement process.

Among the main problems with the process is that brokers are allowed to make a one-sided case for expungement in front of the arbitration panel, with no other party present to provide opposing information. PIABA has criticized this process as providing a “rubber stamp” to expungement requests, and when FINRA submitted an expungement reform proposal to the SEC in September 2020 that still allowed brokers to request expungement without opposition, PIABA opposed it on the grounds that it was still too lenient towards brokers, and the proposal was eventually withdrawn.

On July 29, FINRA submitted a revised version of the proposal addressing how expungement arbitration hearings would be handled in the future. Under the proposal, state regulators would be notified of any expungement requests filed by a broker-dealer or associated person and allowed the opportunity to attend and participate in arbitration hearings. The revised proposal has garnered PIABA’s endorsement as a way to improve the arbitration process for expungement, though as PIABA Director Jason Doss notes, having expungement subject to an arbitration hearing at all can be problematic given the tendency for arbitrators to come from within the financial industry and to generally be more receptive to industry arguments over those of consumers. FINRA’s proposal will now go through review by the SEC, which must approve it before it can go into effect.

(Jennifer Lea Reed | Financial Advisor)

A broad theme of the last 12 months in the national economy, alongside historic inflation and higher-than-usual market volatility, has been a difficulty in hiring and retaining workers. Economic growth since the end of the brief COVID recession has led to high demand for goods and services, but many workers who left their jobs during the pandemic – either to retire permanently, or for other reasons like caring for children or other family members – have not returned to the workforce, leading to an acute labor shortage in many industries.

Advisory firms have not been immune to the challenges of attracting talent, which has meant that despite higher-than-ever demand for financial planning services (with market volatility, high inflation, and high interest rates providing financial challenges for families of all incomes), firms have needed to slow down their business development activities in order to stay within their existing employees’ capacity. As a result, among the 74 firms surveyed in The Ensemble Practice’s semiannual benchmarking survey, business development increased by 2.4% over the first half of 2022 compared to 6% over the same period in 2022.

The decline in new business comes at a particularly tough time for AUM-based firms that have lost revenue due to market declines in the first half of the year. Add to that the higher cost of employees – according to the survey, firms were paying new hires around 15% more than in 2021 – and it is more important than ever for firms to focus on their profitability, especially when capacity limits prevent acquiring additional clients to make up for lost revenue and/or increased costs. Firms who are reluctant to simply raise fees across the board could consider letting go of smaller clients to replace them with more profitable ones, or finding ways to streamline the firm’s processes and technology in order to bring costs down. While profitability is always an important consideration no matter the economic context, today’s environment makes it particularly difficult for firms to grow simply by bringing on new clients. Because while there is still plenty of demand for financial advice, firms can only serve clients as their capacity will allow.

(Ali Hibbs | Wealth Management)

The last few years have seen a dramatic increase in RIA Mergers & Acquisitions (M&A) activity, with quarter after quarter breaking new records for the number of deals taking place. The fourth quarter of 2021 saw activity reach a high-water mark – with 76 deals executed in Q4 alone – and even though activity has receded slightly from that level with recent market volatility, the number of deals in the first half of 2022 has so far exceeded the first half of 2021 by over 30%, according to Devoe & Company’s RIA Deal Book for Q2 2022.

2022 has been notable so far not only for the sheer number of M&A deals being done, but also for the conditions under which they have occurred. Not that long ago, a year marked by high inflation, rising interest rates, and high market volatility all at once would have kept advisors who owned their own firms busy enough with their client-facing work to make M&A an afterthought, and may have similarly ‘spooked’ buyers from wanting to buy until the dust (and AUM, and revenue) settled. But as Devoe notes, the movement towards “professional management”, where firms’ strategic decisions are handled by full-time managers who don’t do client-facing advisory work, means that firm leaders have more capacity to focus on things like M&A than they traditionally would in this environment, both for those looking to sell, as well as the firms looking to buy.

Devoe translates this shift as meaning there is a ‘new normal’ of heightened transaction activity even in environments that would have previously represented headwinds for the M&A market. Which is important because there are still signs that point to lower M&A volume to come, including high current valuation multiples that may reduce buyer willingness to purchase, lower revenues for AUM-based firms caused by market declines that may reduce owner willingness to sell, and rising interest rates that make debt-financed purchases more costly (and may slow the appetite of PE firms to deploy so much capital). But if we are truly at a ‘new normal’, these factors won’t result in as much of a downturn in M&A activity as they previously would have.

(Scott Hanson | InvestmentNews)

When an RIA owner sells the firm to a buyer, the RIA owner often must give the buyer some assurance that the firm’s clients – and the assets managed by the RIA – will transition to the buyer along with the firm itself. Historically, this was accomplished with earn-out structures – where the buyer literally pays a portion of the revenue that conveys from the seller, which meant if the seller’s clients didn’t move to the buyer, the seller didn’t get paid. The consistent success of mergers and acquisitions has reined this practice in slightly, but it is still common to provide at least some of this assurance in the form of a ‘contingent payment’, payable in 12 months, where part of the purchase price is made upfront but receiving the full payment is contingent on the selling firm’s full client base and AUM transferring to the acquiring firm.

With a ‘pure’ contingent payment, however, selling firms would take on the risk of a temporary bear market reducing their AUM between the date of the sale and the contingent payment date, which would cause the selling firm to not be paid their full contingent payment even if all of their clients transitioned to the acquiring firm because AUM was still lower 12 months later at the contingent payment date. And so in recent years, as market valuations have reached higher and higher levels due to buyer demand, RIA sellers have often asked for (and received) guarantees that they would receive their full contingent payments even if market conditions caused a decline in their AUM.

When selling during a bear market, however, the risks shift from the seller’s perspective. Rather than worrying that a decline in assets will cause the buyer to reduce their contingent payment, the selling firm is now worried that an increase in assets after the selling date will cause the buying firm to get more assets – and therefore more revenue – than they ‘paid’ for on the date of the deal. During the current bear market, RIA firm sellers have increasingly structured their deals to guarantee higher payments based on markets recovering after the date of the sale, providing protection that they won’t receive a depressed price for their firm simply due to bad market timing.

So while other factors like professional management have contributed to the continued high pace of M&A deals, one under-the-radar factor may be that selling firms have continued to receive deals that are structured to protect them from future market movements – to the downside, or now for many sellers, to the upside if the market recovers in the coming year after a sale.

(Charles Paikert | Barron’s)

The pace of RIA acquisitions in recent years has been led by a small number of ‘serial acquirers’ – so-called “RIA aggregators”, along with some RIAs that are simply very focused on growing by acquisitions and tucking in like-minded firms to expand the reach of their core offerings. In fact, according to Devoe & Company’s RIA Deal Book, just nine firms accounted for more than half of the RIA deal activity in the first two quarters of 2022, with three firms – Creative Planning, Mercer Advisors, and Merchant Investment Management – executing 30 of those deals by themselves. These mega-sized firms are often funded with private equity capital, whose deep pockets allow them to outbid other buyers, meaning that smaller firms often find themselves unable to compete for M&A deals on price alone.

But that doesn’t mean that smaller firms can’t be competitive when it comes to acquiring RIAs – it often means, however, that they must be more creative in showing what they can offer to selling firms beyond just the sticker price. And in fact, smaller RIAs might actually have some advantages over serial acquirers when it comes to their value proposition.

For example, an RIA seller who wants their firm to continue to serve a particular type of niche client might have an easier time finding a fit with a smaller firm that aligns with their vision (rather than ‘just’ becoming a small niche offering within a much broader firm that may not really be as committed to the specialization, or at least feeling like they’re simply being assimilated into a Borg-like mega-firm). Additionally, firms that can offer an opportunity to join senior management – which is much more likely with a smaller firm – might stand out more to sellers who plan to stay with the firm after its acquisition. And smaller RIAs might be more likely to offer more flexible financial terms that align with the seller’s specific goals than mega-sized firms that hold most of the bargaining power in an acquisition and tend to stipulate more ‘standardized’ terms that they expect sellers to adhere to.

Ultimately, for smaller acquirers, it often comes down to finding target firms that are more interested in selling to a firm that aligns with their client focus, philosophy, and culture than those who are seeking the biggest one-time payout from deep pockets. Fortunately, though, there are a wide variety of firms (and firm owners) out there, including many that are interested in joining forces with a like-minded partner who can help them better realize and scale their vision for their firm and its clients. But it does mean that smaller acquirers may have to look harder to find their ideal match.

(Beth DeCarbo | Wall Street Journal)

One common conversation that financial advisors often have with their clients is how the client wants to spend their time during retirement. And one of the most common topics of that conversation is travel: Individuals who have spent much of their adulthood raising children and advancing their careers can often be drawn to seeing the world.

But ‘travel’ can mean a lot of different things to different people. Some may want to tour cities in Europe or other cultural destinations that were less practical when they had young kids in tow. Others might want to go on cruises, where the arrangements are all handled and all that’s required of the traveler is to show up in time to embark. For many retirees, however, buying an RV is a popular first step into a retirement of frequent travel. And like many other experiences, the type of accommodations found in an RV can range from relatively spartan to over-the-top luxury depending on what the retiree is willing to spend.

For example, Class A RVs – the largest model of motorhome – regularly sell for over $100,000, and can range up to a half-million dollars or more with added features and customizations. And that doesn’t include gas (which the vehicles burn at a rate of around 8 miles per gallon), insurance, and, in some cases, a permanent spot in a motorhome resort which can itself cost $100,000-$250,000. All told, a luxury RV can equal or exceed the cost of a good-sized vacation home.

Of course, the point of buying a luxury motorhome is to essentially have a vacation home on wheels. Instead of being fixed to one spot, it can travel to tailgates or national parks or secluded getaways – anywhere with a parking spot big enough to accommodate a 45-foot vehicle. While some retirees might recoil at the thought of spending months out of the year in a sub-400-square-foot enclosed space far away from cities and their culture and amenities, for others it might be the perfect fit for at least the early years of retirement.

When having that retirement conversation, then, it’s key to understand what ‘travel’ really means to the client, and to ask follow-up questions to dig into the client’s vision and aspirations for their life in retirement. A ‘travel’ goal is nice, but it doesn’t tell the whole story if, say, that goal involves buying a half-million-dollar asset. While follow-up questions are often framed as a way to build trust and rapport, sometimes they also reveal real-life planning goals and challenges that are material to what the advisor and client will be working toward.

(Harriet Edleson | MarketWatch)

It’s common to seek lifestyle changes in retirement, and as retirees begin to rethink how to meaningfully spend their time with the responsibilities of work removed, a subject that often comes up is relocation. We often think of retirees who move to seek warmer climates or to be closer to family, but sometimes the choice can be driven by other factors, like moving to an area with a lower cost of living (or lower taxes). Sometimes retirees move from one house to another without moving to a completely different area, in order to downsize to a smaller space or one where they can age in place. And sometimes, moving is just one part of a larger decision to open a new chapter in one’s life, which might entail new hobbies, relationships, and social groups.

But for all the higher-level importance of relocation, there are also many practical considerations that come with moving, even if it’s just from one house to another in the same town. Cost of living can obviously have a significant impact on the retiree’s long-term financial picture, but, beyond the obvious costs of housing expenses and taxes, there are also things to think about like the cost of medical care in the new location, transportation costs, and the cost of services (including, for example, what kinds of social and entertainment options are included in an active senior community).

Additionally, it’s important to think about how the lifestyle after moving will compare with what the retiree is experiencing now, and whether those changes are really what is desired. We don’t always predict well what we will value in the future, but even just taking a pause to picture the day-to-day reality of that future life can help to make a better-grounded decision. And to that end, it might be worth considering just how much flexibility ought to be built into the relocation plan. If a retiree feels strongly about their decision to move, they might be more comfortable with making bigger commitments like buying a home; whereas someone who is less certain about how their new lifestyle will align with their values might want a way to back out if it isn’t all it was cracked up to be.

Financial advisors can add a lot of value for people considering a big life change in retirement by being able to recognize the practical implications of doing so, especially with clients who might be prone to glossing over these less-exciting details. Clients may not want to hear all of these details beforehand, but they’re likely to be happy for the reassurance before making the leap to move (and or avoiding any unpleasant surprises afterward).

(Aaron Zitner and Dante Chinni | Wall Street Journal)

When deciding on a place to live in retirement, cities and their suburbs tend to be the most popular choices because of the easy access they offer to things like social groups, healthcare, and cultural attractions. But certain rural communities are rising in popularity among retirees which tend to feature a slower pace of life and lower cost of living than cities, while still offering plenty of ways for retirees to fill their leisure time.

Areas such as Sevier County, TN; Grand Traverse County, MI; and Park County, MT share several characteristics that make them attractive to retirees. First, they tend to be areas with nearby natural or manmade attractions such as mountains, national parks, or recreation areas, which provide many potential activities for active retirees (particularly if they are inclined towards exploring nature). Second, they tend to have a low cost of living, and low taxes in particular, compared to more urban areas (which is often made possible by the attractions nearby which bring in tax revenue from tourists, allowing for lower-than-average property taxes). Third, they feature a more relaxed pace of life that many retirees appreciate.

As the ‘gray wave’ of retirees comes to these areas, they might also find themselves with more opportunities to socialize and share common activities than they otherwise would in rural areas. Though it’s worth remembering that the more retirees move to an area, the more demand they will create for things like housing and healthcare, which will require more workers to move nearby to meet those demands and in turn put further pressure on housing and services…all of which might end up emulating some of the characteristics of cities and suburbs that the retirees were trying to escape from, to begin with. So while articles like this might idealize a certain kind of living and can make others want to jump on the bandwagon, it’s important for financial advisors to be able to walk through the practical implications of doing so – not necessarily to discourage the decision, but to give the retiree some grounding in the short- and long-term effects for their lifestyle.

(Jessica Stillman | Inc.)

The ‘Great Resignation’ of the past year has seen scads of workers leave their old jobs for a multitude of reasons. Some found new jobs that offered higher pay as well as other perks, like remote work and flexible schedules. Others left the job market entirely, either to care for kids or family members or to take an earlier-than-planned retirement. But numerous polls conducted by various sources have shown that, for many individuals who left their previous jobs during the pandemic, they have come to regret the decision (and that the feeling is similar for some of the companies who were offering those higher wages and perks).

For many workers who jumped ship to remote-work positions, the feeling of regret might come from the fact that many companies have not fully optimized themselves for remote work but have simply tried to replicate the traditional office environment remotely, resulting in days filled with endless Zoom meetings and email distractions and nights devoted to getting actual work done – a recipe for stress and ultimately burnout.

Employers’ regrets were often the result of pandemic-related uncertainty. With tech companies, in particular, huge increases in demand early in the pandemic led to hiring surges that brought in scores of new workers who became unnecessary when demand tapered off. And as the economy slows, many of these recent hires likely realize (or have already experienced) that they might be among the first to lose their jobs if and when layoffs occur.

In both cases, what led to the ‘Great Regret’ was an overabundance of short-term thinking on the part of both workers and employers. While workers could hardly be blamed for wanting to move to jobs with higher pay and better flexibility, understanding how a prospective employer treats remote work should be more than an afterthought – as should the consideration of giving up the stability that comes with seniority.

(Ryan Holiday)

When financial advisors get their start in the industry, they are often given two semi-conflicting pieces of advice. On one hand, they are told that certain client service models, fee structures, and marketing practices are “best practices” – that is, which have proven successful for other advisors who have come before. On the other hand, they are told to differentiate themselves; to find some aspect of their business that is unique to them so that less effort (or luck) is needed to stand out from the competition.

Business owners often feel these two pieces of advice tugging at them from both sides. Sticking with best practices generally seems like the safer option: For one thing, by their nature best practices have been tried and proven to work repeatedly for other firms over time, so it’s logical to assume that they will also work for one’s own firm; for another, because they are adopted by many other firms, following what the crowd does can leave one less vulnerable to ostracization or ridicule for doing something different.

But doing everything according to the methods that have brought success to others can make growing a successful firm an uphill battle. When a firm is indistinguishable from others in every way that matters, they must scrap for small victories like slightly higher SEO rankings just to get in front of potential customers’ eyes (or simply rely on chance to bring the right clients to them at the right time). So it’s often better to differentiate in some way. For many firms, that might be in the form of a specific client niche, but firms can also differentiate in other ways. For example, in the financial advisory world the AUM-based fee model (requiring the advisor to manage the client’s investments) has grown into the dominant business model for fee-only advisors – but while its proven success might make it difficult to depart from that model, the very fact that it remains so dominant means that any firms who do offer different fee-for-service models (like an “advice-only” financial planning approach) automatically stand out from the crowd.

What is ultimately important is to differentiate in a way that matters. It isn’t necessary for each firm to re-invent the advisory firm model from the ground up, and there are many ways that firm owners can learn from the success of others to help their own firms thrive. But if there is a way that a firm owner thinks can serve clients successfully, it shouldn’t matter whether or not it aligns with what every other firm does – indeed, it’s often better if it doesn’t, since it gives the firm a way to differentiate themselves and even a potential monopoly on the type of clients who are drawn to that model (at least, until other firm owners see the success of that model and try to emulate it themselves). Being unique doesn’t necessarily guarantee success, but it does make for an easier road than following the crowd.

(Ron Lieber | New York Times)

In recent years there has been a shift in the way many people think about retirement. Rather than a single, set date where one’s working career ends (forever) and retirement begins, the lines between work and retirement have gotten fuzzier. There are many examples of people finding second careers or starting businesses during retirement, as retirees find that it is often preferable to seek out ways to continue to do meaningful work rather than simply fill one’s idle time with leisure activities.

The pandemic has added another wrinkle to the way people view retirement. As many workers were forced to leave their jobs to care for kids or family members – or just found themselves at home with ample time to reflect on what gives their lives meaning – what started out as an involuntary interruption became a conscious choice once pandemic restrictions were lifted and schools opened up again. In other words, a growing number of people have realized the benefits of a mid-career “break” to spend time doing meaningful things outside of work without waiting until the traditional retirement age.

Though it’s exciting to think about the possibilities of this new relationship between work and retirement – whether that involves taking a one-time break like a yearlong sabbatical or a longer series of “mini-retirements” – there are also challenges in planning for this model. For one thing, much of the retirement support structure in this country is geared towards the traditional retirement approach: for example, Social Security benefits generally don’t kick in until at least age 62, and most retirement accounts can’t be accessed without penalty until age 59½. Furthermore, the way we are taught to save for retirement involves saving in small sums over time, relying on long-term appreciation to provide a sufficient pot of money at the end of our working years to draw on for the rest of our lives; if the timeline for retirement shifts, however, that model might not be sufficient to cover the gaps when we need it.

Taking a different approach to retirement might mean rethinking how those breaks are funded. Workers can focus on saving to Roth accounts, where contributions can be accessed without penalty. It might be more advantageous to own rental property to provide income between working stints. And it’s also important to be cognizant of the extra risks involved: For example, it might be more difficult to stay on a steady career path when taking regular breaks from working, especially as one gets older. Ultimately, however, the financial challenges can often be surmounted, particularly if one is willing to be flexible about when (and for how long) their breaks occur. The real challenge, then, is breaking free of the traditional notion of retirement as a fixed event and thinking about what one can do with their time when they have the freedom to do whatever is meaningful to them.

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

In the meantime, if you’re interested in more news and information regarding advisor technology, we’d highly recommend checking out Craig Iskowitz’s “Wealth Management Today” blog, as well as Gavin Spitzner’s “Wealth Management Weekly” blog.