Weekend Reading For Financial Planners (Aug 27-28) 2022

Author: Adam Van Deusen

Team Kitces

Adam is an Associate Financial Planning Nerd at Kitces.com. He previously worked at a financial planning firm in Bethesda, Maryland, and as a journalist covering the banking and insurance industries. Outside of work, he serves as a volunteer financial planner and class instructor for non-profits in the Northern Virginia area. He has an MA from Johns Hopkins University and a BA from the University of Virginia. He can be reached at [email protected]

Read more of Adam’s articles here.

(Jeff Levine | Twitter)

Student loan relief has been a major part of the economic measures taken in response to the COVID-19 pandemic. From an initial freezing of Federal student loan payments (which continues to this day) to a limited waiver that will allow more borrowers to access the Public Service Loan Forgiveness (PSLF) program, the past couple of years have seen multiple actions to ease the burden on Federal student loan borrowers. But a big question that remained was whether the Biden administration would go beyond the temporary freeze and actually forgive a certain amount of Federal student loan debt for borrowers.

And so, this week the Biden administration announced on August 24 a series of steps to reduce the student loan burden for many borrowers. The most talked-about action is the forgiveness of up to $10,000 in Federal student debt per borrower (a total of $20,000 for borrowers who also received a Pell Grant). Notably, this forgiveness is limited by income, as only single borrowers with up to $125,000 of income and married borrowers with up to $250,000 of income (likely from either 2020 or 2021) will be eligible for forgiveness (while the type of income used for this calculation is unclear, the government uses Adjusted Gross Income (AGI) for student loan Income-Driven Repayment (IDR) calculations). The forgiven debt will be tax-free at the Federal level, but the impact on state income taxes is likely to vary by state.

In addition to the debt forgiveness, other aspects of the plan could have major impacts on borrowers. First, the Biden Administration extended the Federal student loan repayment freeze through the end of 2022, but said explicitly that this will be the final extension and that payments will resume in January 2023. In addition, there will be a new Income-Driven Repayment plan available for borrowers, which will offer a higher baseline for non-discretionary income (up to 225% of the Federal poverty line from 150% in most cases today), as well as maximum annual payments of 5% of discretionary income for undergraduate loans and 10% for graduate loans (down from the 10%-20% maximum payment in current IDR programs). Further, balances won’t increase (as a result of accrued interest) as long as the monthly payments (which can be as low as $0) are made on time, and the remaining balances will generally be forgiven after 20 years of payments (10 years of payments for original balances of $12,000 or less).

Ultimately, the key point is that the actions announced this week (along with other changes to the student loan system made in the past year) will impact many financial planning clients (including parents with Federal PLUS loans, who will also be eligible for the debt forgiveness, subject to the same income limits). there are several ways advisors can add value to their clients. And advisors have several ways to add value, from considering whether any clients could benefit from the new IDR plan, to assessing whether clients might benefit from the previously announced PSLF limited waiver expiring on October 31, to reviewing clients’ repayment plans to determine whether a different option might save them money once required payments resume in January!

(Philip Palaveev | The Ensemble Practice)

The financial advisory industry saw a range of disruptive trends in the first half of 2022, from weakness in both stock and bond markets, to a tight labor market, and a period of historically high inflation. But despite these headwinds, firms continue to prioritize growth, according to The Ensemble Practice’s Pulse Of The Industry: Mid-Year 2022 report.

According to a survey of participants and alumni of The Ensemble Practice’s G2 Leadership Institute, firms still say their priority is to grow and invest in their people. However, firms experienced a slowdown in client growth compared to the previous year, with the typical firm experiencing a net increase in clients of 2.4%, compared to a net increase of 6% in the first half of 2021. With the pursuit of growth often comes a need for additional hires, but new talent is becoming more costly, according to the report, with about two-thirds of survey respondents reporting a median increase in compensation for new hires of 15%. This also comes at a time of continued resignations, with 32% of firms reporting employee resignations in the first half of 2022 (including 70% of large advisory firms reporting resignations).

Altogether, the survey results suggest that advisory firms are looking ahead to future growth despite the current challenges in building their client base. With this in mind, advisory firms could consider whether their current marketing strategy is the most effective use of their time and resources as well as creating an effective hiring plan so that they are prepared to take advantage when the current economic headwinds (hopefully) reverse and turn into tailwinds!

(Oisin Breen | RIABiz)

Financial advisors spend a significant amount of time on marketing and sales to get new clients, but getting a prospect to sign on as a client is just the beginning of the process of onboarding their assets with the firm. With a mountain of paperwork to complete, moving the client’s assets from their current bank or retirement plan or brokerage firm to the advisor’s platform can take time for both the client and the advisory firm (shoutout to all of the paraplanners and client service associates!), creating frustration on both ends (along with a financial cost for the firm, as they typically do not start charging until the new client’s assets are with their custodian!).

With this in mind, several RIA custodians have started to invest in technology to make the onboarding process a smoother affair. Custodial giant Charles Schwab, in the midst of its merger with TD Ameritrade, recently rolled out significant improvements in its digital onboarding, allowing advisors on its Schwab Advisor Services platform to open and fund up to ten new accounts simultaneously in one workflow. This includes 13 of the most common account types at Schwab, including Roth and rollover IRAs, as well as living trusts. Though notably, while this upgrade has rolled out to current RIAs on the Advisor Services platform, advisors currently with TD Ameritrade will have to wait until they transition to the combined company platform (the final integration of TD Ameritrade into Schwab’s software systems is on pace to be completed in mid-to-late 2023, according to Schwab).

But Schwab is not the only custodian upping its digital onboarding game. Larger custodians, including Fidelity Institutional and BNY Mellon Pershing, as well as smaller custodians like Altruist, Apex, Betterment, Equity Advisor Solutions, and SEI, are all spending heavily on making a better digital onboarding process, as competition for advisory firm assets increases, and no advisor wants to lose clients for the frustrating friction of completing all the new account paperwork.

Overall, this competition among RIA custodians to provide a smoother digital onboarding experience is a win for advisors and clients alike. Though, notably, because the transfer of assets between custodians is just one part of onboarding a client to a firm, advisors might also consider other onboarding solutions that can collect the rest of the client data and other information without the pain of paper forms. Because in the end, providing digitally savvy clients with an onboarding experience that resembles what they are used to in other areas of life can create a positive first impression of what will (hopefully) be a many-year advisory relationship!

(Philip Palaveev | Financial Advisor)

RIAs come in all shapes and sizes, from solo practices to businesses with hundreds of employees. And while some firm owners intentionally decide to stay small, others seek significant growth. This is where benchmarking studies can come in handy, allowing firms to track where they stand compared to both their peer firms as well as the group of firms they aspire to join in the future.

According to Financial Advisor’s 2022 RIA Ranking, firms needed Assets Under Management (AUM) of at least $5.4 billion to join the ranks of the largest 100 RIAs in the country (more than $47 billion of AUM was needed to be one of the top ten firms). Amid a wave of consolidation and strong market returns during the past several years, the minimum AUM to reach these top levels has increased significantly, as a firm ‘only’ needed $2.3 billion of AUM to be in the top 100 in 2017 and $1.1 billion in 2012.

Having institutional investors on board appears to have supported the acquisition plans of many of the top firms. Of the top 100 firms, 41% reported having institutional investors, compared to 20% of firms ranked between 100 and 200 and 7% of firms ranked from 200 to 500. Of the top 100 firms, 18% said Mergers and Acquisitions (M&A) were their top growth driver, compared to less than 10% of firms ranked between 100 and 500.

Growth rates for 2021 were roughly even across the rankings, with firms in the top 200 showing a median growth rate of 22% and those ranked between 200 and 500 experiencing a median 20% growth rate. Notwithstanding the similar growth rates, the largest RIAs have attracted the wealthiest clients, as the top 100 firms have an average AUM per client of $5.6 million, compared to $3.1 million for the next hundred firms and $1.7 million for firms ranked between 200 and 500. At the same time, firms with an average client AUM of less than $1 million saw the largest growth in 2021 (23%, compared to 16% for firms with an average client AUM greater than $50 million), suggesting there is greater competition for the wealthiest clients and more opportunities with ‘mass affluent’ consumers.

Altogether, the rankings show strong growth among the largest 500 RIAs in the country in 2021, buoyed in part by healthy market returns and M&A activity. And while investment markets have seen losses so far in 2022, M&A activity remains strong, suggesting that consolidators could continue their growth trajectories amid weak market returns (and providing continued opportunities for firm owners considering a sale!).

(Bruce Kelly | InvestmentNews)

The largest RIAs have grown significantly during the past several years, with several eclipsing the $100B AUM mark by the end of 2021. Noting this growth and strong profit margins in the industry, many RIAs have attracted investments from private equity firms that have helped fund acquisitions to accelerate their growth. And now, several firms are reportedly seeking to turn this growth into additional capital (and returns for existing owners) by going public.

Historically, very few RIAs have gone public through an Initial Public Offering (IPO). One notable exception was the RIA aggregator Focus Financial, whose share price has increased by ‘only’ 27% since its IPO four years ago, with significant volatility along the way. But the past year has seen a range of deal announcements, from RIA aggregator CI Financial’s plans to file an IPO for its U.S. wealth management business, to Dynasty Financial Partners, which serves independent advisors and filed for an IPO in January.

But despite the potential for success as public companies – and the higher valuation that tends to come from public market valuation multiples – making the jump is not without hazards. For example, while the IPO market was hot in 2021, perhaps thanks in part to low interest rates and a strong equity market, offerings have cooled significantly in 2022 amid rising rates and weak market returns. Further, RIAs considering going public not only have to consider the administrative costs and information disclosure requirements of being a public company, but also consider how operating as a public company (with responsibilities to its shareholders and the infamous ‘short-term mindset’ of Wall Street) affects its ability to deliver on its fiduciary duty to clients and keep itself focused on long-term client relationships.

Nonetheless, the key point is that as the biggest RIAs grow even larger, going public could be an increasingly attractive option for firms looking to access capital, and for owners seeking to cash in on their equity (as the firm gets ‘too big’ to sell in any other way!). But given the current state of the equity market and the challenges of being a public company, it remains unclear whether the current wave of firms going public will turn into a tsunami, or fade into a mere ripple!

(Louis Diamond | Barron’s)

Advisory firm owners have several reasons to pursue outside capital for their business, from accelerating growth through new staff hires to monetizing at least a portion of their existing ownership. But historically, options for seeking liquidity were limited. However, the RIA industry has started to become more attractive to outside capital, particularly private equity firms, with these firms being either directly or indirectly (through their investments in RIA aggregators) in 67.9% of RIA mergers and acquisitions (M&A) transactions in 2021, according to The 2021 Echelon Partners RIA M&A Deal Report.

Yet while an acquisition by a private equity firm (or another partner) could be attractive for firm owners looking to sell their entire ownership stake, there are a range of options for those looking for sources of liquidity while maintaining at least some control of their firm. One option is to sell a minority stake in the firm to a strategic partner (e.g., family offices or private equity firms), which allows the firm owner to maintain majority voting and operational control (although the partner will receive certain veto powers).

Another option is to affiliate with another RIA while receiving a forgivable loan (that typically ranges from 10% to 50% of trailing 12 months’ revenue). This allows the advisor to maintain complete ownership of their practice… but would require the advisor to pay the unvested portion of the forgivable loan back were they to subsequently leave the firm. And for advisors looking to remain totally independent, the availability of loans from the Small Business Administration, banks, and a growing number of specialty lenders that serve RIAs has increased in recent years.

The breadth of options is important because “money comes with strings attached”, and the expectations of private equity firms (to generate big growth for their own exit in 5-7 years) are different from family offices (that tend to prefer getting ongoing dividend distributions with a longer investment time horizon) which is different from RIA aggregators (who may be willing to trade your equity for their equity), which is different from banks (that are typically most focused cash flow stability to ensure that they will get paid back).

In the end, while private equity investors have become a more frequent source of capital for RIAs, advisory firm owners looking for liquidity actually have a growing variety of debt and equity options at their disposal. But given the potential consequences of doing so (from taking on debt to giving up control of firm decision-making), firm owners might first consider why raising capital is important to them in the first place… and then be cognizant to select the best “capital partner” based on the exact needs of their given situation!

(Christine Benz | Morningstar)

Individuals who are required to make Required Minimum Distributions (RMDs) from their retirement accounts have several options for doing so. Many choose to sell investments within their retirement account and withdraw the proceeds in cash to fulfill the RMD. This cash can then be used to pay for ongoing expenses as well as the taxes due on the RMD (which is treated as ordinary income). Selling investments within the retirement account can also allow an individual to trim down positions that have become a disproportionately large part of their portfolio due to strong market returns. Others make Qualified Charitable Distributions (QCDs) to fulfill their RMD while reducing the tax burden.

However, those with RMDs in 2022 face a double whammy: first, their RMD is based on their account balance as of December 31, 2021, which was near the market peak (meaning the amount they are required to withdraw is likely greater than if the RMD were calculated today). In addition, selling investments in the retirement account that have declined in price this year locks in the depressed value.

But while the amount of RMDs has already been set, clients (and their advisors) could look to an alternative method of taking RMDs: an in-kind transfer. Instead of selling the investment within the retirement account, the investment can be transferred directly to the individual’s taxable brokerage account (with the taxes due on the transfer paid using outside cash). This solves the problem of selling a depressed asset (that will hopefully eventually bounce back along with the broader market) and also offers a potential tax benefit. As long as the asset is held in the taxable account for more than a year, it can receive long-term capital gains treatment when sold (or a step-up in basis if held until the owner’s death). Had the investment stayed in the RMD, its growth would have been taxed at (typically higher) ordinary income tax rates when withdrawn from the retirement account (whether by the owner or their beneficiary).

In the end, fulfilling RMDs with an in-kind transfer could provide benefits for clients who do not need to use their RMD for ongoing spending needs (and have sufficient cash available to pay the taxes due on the RMD). By leaving room for the transferred asset to appreciate and potentially benefiting from favorable tax treatment down the line, advisors can potentially soften the blow for their clients of having to take an RMD during a down market!

(Leslie Scism | The Wall Street Journal)

Fixed annuities are often used by consumers looking to reduce the volatility of their portfolios. However, the low interest rate environment of the past several years has led to low returns for these annuities, making them less attractive. But the recent increases in interest rates in 2022, as well as the concurrent declines in the stock and bond markets, appear to have spurred a surge of interest in these vehicles.

Amid continued weak markets, total annuity sales hit a record high in the second quarter, reaching a projected record high of $74 billion, up more than $10 billion from the first quarter. According to New York Life, its current top-selling annuity is a three-year fixed deferred annuity with an annual rate of 3.2%, which is up from 1.6% last year. Notably, while these annuities are not exposed to market risk, they do come with penalties if funds are withdrawn (beyond allowed levels) before the end of the annuity term, meaning that those interested will want to be prepared to have their funds unavailable for the period. But with the best savings account rates rising to about 2%, the sacrifice of liquidity could be worth it for some clients.

Ultimately, the key point is that while higher interest rates make fixed annuities and similar products more attractive (particularly when clients compare them with the recent returns of the stock and bond markets), it is important for advisors to consider whether they fit within their clients’ broader asset allocation. At the same time, because implementing a cash management strategy can provide significant value to clients, advisors will want to keep an eye on the range of interest-sensitive bank and annuity products in the months ahead!

(Kim Stewart | AdvisorHub)

Up until a few years ago, trading stocks came with a very explicit cost in the form of brokerage commissions, which could represent a significant percentage of the dollar value of the trade (particularly for small-value purchases or sales). While the rise of ‘discount brokers’ brought these charges below $10 a trade, there was still a tangible cost for each transaction. However, most brokerages today offer clients ‘free’ trading, leaving many market participants to believe that they can transact at will without the drag of trading costs.

But a recent research paper suggests that these trades might not be as ‘free’ as they seem. The researchers made thousands of simultaneous, identical trades at a range of brokerages to see the difference in the execution price received. They found that the mean account-level cost for a purchase and subsequent sale ranged from 0.07% to 0.45%. Extrapolating from the results, the researchers estimate these hidden costs could add up to as much as $34 billion per year.

Notably, while some brokerage firms and market-makers have come under suspicion for the practice of payment for order flow (where the brokerages receive compensation in return for routing orders to a specific market maker), the researchers found (by comparing brokerages that use payment for order flow with others who do not) that this practice was not responsible for the differences in the execution price they received. Rather, the reason for the discrepancy is that wholesalers systematically give different execution prices for the same trades to different brokers, according to the research.

Overall, this research suggests that it is important for advisors and consumers who buy and sell stocks, ETFs, and other investments to be aware that each ‘free’ trade they make can come with hidden costs. In addition, these market participants might consider placing limit orders, rather than market orders (which were used by the researchers) to set a desired execution price for their trade. Because in the end, while explicit trading charges have been eliminated, investors appear to be continuing to pay a price in the form of varying execution quality!

(Cedric Chin | Commoncog)

Developing a ‘personal brand’ is a popular pursuit these days. Whether it is building up a large following on Twitter or making regular media appearances, building up your personal brand is thought to be a golden ticket to career success. But Chin suggests that this type of personal branding could be fleeting, and that building up a strong reputation in your field is a better driver of long-term success.

Brands exist all over the world, from restaurants to websites. To Chin, branding is not about excellence, but rather delivering a consistent set of outcomes. For example, McDonald’s has a strong brand not because it makes the best burgers, but rather because customers have come to expect consistent quality from its products, whether they are eating at a McDonalds in New York or New Delhi. In an individual sense, a personal brand is a set of expectations around your skills, behavior, values, and worldview that are developed over time. So while offering consistent, quality content on social media can help your personal brand, gaining followers through a single viral video is unlikely to do so.

Chin also notes that the best personal brands are those that bring pricing power, in the form of career opportunities and higher salaries. Typically, the personal brands that are built up over many years are the ones that create pricing power well into the future (e.g., Warren Buffett), while those that are created quickly often lead to fleeting career success (e.g., the ‘hot’ internet stock picker du jour).

In the end, building a strong personal brand can be an important part of finding lasting career success. And it’s likely that many advisors (and firms!) are doing so right now (perhaps without even knowing it?), by offering consistent, quality service to their clients and serving the broader industry!

(Julia VanDeren | Enterprising Investor)

The board of directors can play several important roles for a company. Often consisting of business veterans, they can offer the firm and its executives their expertise, experience, and connections. And just like a business’ board of directors, individuals can create their own personal ‘boards’ as well.

A personal board of directors can consist of a group of individuals serving one or more important functions. First, these can include mentors and guides, trusted advisors who provide perspective and guidance throughout your career, offering insight into your strengths and developmental needs. Next, sponsors and advocates (who often occupy senior roles in your organization) are individuals on the ‘board’ who are willing to spend their social and political capital on your behalf, whether it is recommending you for a new opportunity or raising awareness about your potential with other senior leaders. Also, coaches and teachers on the ‘board’ can help you develop your soft or career skills, and can also help you set, achieve, and review goals. Finally, networking contacts and information sources keep you informed about the state of the job market and offer their perspective on opportunities that arise.

The key point is that a successful personal board of directors will consist of several individuals who will bring a variety of skills and feedback (including critical views!) to the table. And, in addition to the professional contacts above, this support system can also include friends (who might double as a mentor, coach, etc.) who have your best interest at heart and can offer an outside perspective on your career. Also, don’t forget to take the time to serve on the personal boards of others as a way to ‘pay it forward’ for the guidance you have received from your own board!

(Sophia Bera | Gen Y Planning)

At some point during your career, you might decide that you need an extended break. Whether it is to spend more time with family, travel around the world, or study a topic of interest, these sabbaticals can be a valuable opportunity to take a step back from the grind of the workweek. But before taking a career break, particularly one where you will not be earning income, it is important to prepare to ensure that it does not derail either your financial or career goals.

The first step in planning a career break is to give it a purpose. Doing so can not only ensure that you remain focused on your goals (as sleeping in every day might be tempting), but also prevent you from being distracted by requests (work or otherwise) that take you away from the reason for taking the sabbatical. Next, you can examine your expenses to see what you might cut out while you’re no longer earning a salary (or what naturally be reduced as a result of not going into the office), as well as assess your insurance situation to ensure you are maintaining adequate health, life, and/or disability coverage. It’s also important to set up an emergency fund (separate from your normal checking account!), as unexpected expenses will continue to pop up while you are not working.

Beyond these preventative measures, there are also potential opportunities while planning a sabbatical, such as taking advantage of a temporarily lower tax bracket to make Roth conversions or harvest capital gains. In addition, a sabbatical can be a good time to connect with members of your professional network to consider what future job opportunities might be available, or perhaps use the time off to train for an entirely new career.

Ultimately, the key point is that whether you are an advisor considering taking a sabbatical yourself or are working with clients who are thinking of doing so themselves, there are several planning considerations to keep in mind. But with proper planning, a sabbatical can provide a needed break while staying on track to meet your (or your clients’) long-term goals!

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.