Weekend Reading For Financial Planners (July 23-24) 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.

(Financial Planning Association)

Titles can convey meaningful information to consumers about a professional’s implied competency and trustworthiness. For example, those seeking accounting assistance would likely seek out a CPA, rather than someone who merely read a book about accounting, and we choose a surgeon based on their medical education and experience and not simply one’s dexterity with a blade. Further, these titles typically require formal regulation for enforcement (so not just anyone can call themselves a doctor, or attest to an audit!). But in the world of financial advice, there so far has been little regulation on advisor titles (unless someone tries to call themselves an “investment counselor”, which ironically is still regulated under the Investment Advisers Act of 1940). This means that anyone can hold themselves out as a “financial advisor” or “financial planner” – regardless of how much advice or planning they actually give, or the amount of training or experience they have – creating confusion among consumers as to the qualifications and ethical standards of an advisor (or “advisor”) they meet.

With this in mind, the Financial Planning Association (FPA) announced this week that it is launching a new advocacy initiative with the goal of achieving title protection of the term “financial planner” to ensure that “anyone proclaiming to be a financial planner meets minimum standards that protect consumers and advances the financial planning profession”. This comes on the heels of an FPA survey showing that 78% of FPA members want the title “financial planner” to be protected. While the FPA did not provide specifics on the standards for which it will advocate (though ostensibly as the membership association for CFP professionals, they will look to CFP certification as the minimum competency standard?) but did say title protection would address competency and ethical standards.

While the FPA did not scope out a specific legal path it plans to take in pursuing the regulation of the “financial planner” title (and said that it does not want to create an unnecessary regulatory burden), doing so will almost inevitably require a regulator to license the term and a regulator to enforce it (in order to create and enforce consequences for those who abuse the title). For instance, last year XY Planning Network petitioned the SEC to regulate the term “financial planner” by requiring that anyone who holds themselves out by that title would be required to register as an investment adviser (effectively subjecting all those using the title “financial planner” to a fiduciary standard, akin to how “investment counselor” is already regulated under the Investment Adviser Act), following on the heels of a prior 2005 SEC regulation that would have protected the “financial planner” title (which, ironically, was actually vacated in a lawsuit by the FPA in 2007, who had challenged the original rule for other reasons).

Ultimately, the key point is that while the road to title protection will likely be a long one, the FPA’s advocacy efforts are a significant step to aligning with other organizations toward ongoing efforts to ensure that those who hold themselves out as a “financial planner” meet the standards that consumers would reasonably expect from someone who commits to advising them on their life savings. Because doing so not only benefits consumers (who would be better able to determine who is qualified to provide them with financial planning services), but also for the development of the financial planning profession as it seeks to join the ranks of doctors, lawyers, and accountants, all of whom have regulated titles to assure consumers that when they hire a person who says they are a professional qualified to give (medical, legal, or tax) advice, they really are!

(Jeff Benjamin | InvestmentNews)

Industry benchmarking studies can be a valuable tool for advisory firm owners to make better business decisions. By compiling and publishing data on firms across the industry, the studies enable owners to compare their firms’ performance side-by-side against that of their peers, providing them with a benchmark for how their firms should perform and insight into where they might be outperforming or underperforming the competition. And the latest edition of Charles Schwab’s RIA Benchmarking Study shows that while RIAs are thriving in terms of asset growth and revenue, challenges in finding top talent could be looming on the horizon.

Firms across six size categories saw asset growth last year that outpaced the five-year compound annual growth rate (CAGR). For example, the largest firms (with more than $2.5 billion of Assets Under Management [AUM]) saw 18.7% asset growth last year, compared to a 12.2% five-year CAGR. The smallest firms (with AUM between $100 million and $250 million) also fared well, with AUM growth of 18.8% in 2021, ahead of a 14.1% five-year CAGR. Of course, asset growth is easier when the broad stock market gains more than 25% (as it did in 2021), but firms across the spectrum experienced strong organic growth as well. For instance, the smallest firms saw 8.2% organic growth (compared to 6% in 2020), while larger firms experienced a 7% organic growth rate (up from 4.5% the previous year).

Notably, when asked to prioritize their firms’ strategic initiatives, study respondents said that recruiting and increasing staff skill sets was the highest priority, the highest position for hiring in the 16 years the study has been undertaken. The study found that the median firm hired three people in 2021, with two of those being hired into newly created positions, and that the median firm will need to hire six people over the next five years.

The study also looked at the cost of firm marketing and found that top-performing firms are both more likely to have a documented marketing plan and spend more on marketing and business development than other firms. Furthermore, the cost of staff time for each new $1 million in client assets is $2,307 at top firms, compared to $3,169 at other firms.

Ultimately, while top-line AUM and revenue growth might slow for RIAs in 2022 given weak market performance so far this year, continued strong organic growth (which could see a bump as consumers try to navigate the volatile market environment?) could help steady firm metrics. And given the expected wave of advisor retirements and staffing needs to serve a growing base of firm clients, talent acquisition is likely to be an important factor in which firms thrive in the years to come!

(Jeff Benjamin | InvestmentNews)

One of the major trends in the financial advisory industry in the past several years has been the growth of mergers and acquisitions (M&A) activity, which has seen a jump in both the number of deals and the average AUM per deal. And while recent data from investment bank ECHELON Partners suggests the pace has slowed somewhat so far in 2022 amid a broader market decline and tightening monetary policy, M&A activity remains elevated compared to historical levels.

The second quarter saw 87 deals, according to ECHELON data, down from 94 deals in the first quarter and 99 in the fourth quarter of 2021, but still well above trends of previous periods. Further, total deal activity in the first half of the year (181 deals) was up 39% compared to the prior-year period. In addition, while the average AUM per deal has ticked down slightly so far in 2022 ($1.84 billion compared to $2.09 billion in 2021), this figure is still higher than in previous years. Large strategic acquirers have been the most active so far in 2022, with Creative Planning announcing 12 deals, followed by Mercer Advisors (10), Beacon Pointe Advisors (8), and Mariner Wealth Advisors (7).

The key point is that, while there has been a downtick so far this year, wealth management M&A activity remains historically strong. And so, this environment could offer options to both firm owners nearing retirement and looking to sell to a strategic partner, as well as to firms that have hit a capacity wall and want to combine with a larger firm to grow more efficiently (and for firms looking to grow their assets and talent base through acquisitions!).

(The Client Driven Practice)

When meeting with a prospective client, financial advisors are typically prepared with a list of ways they provide value to clients. From proper asset allocation to tax efficiency to estate planning, there are a wide range of areas in which an advisor can add value to a client’s life. At the same time, the client has to understand the value they are receiving and why it justifies the fees they are paying.

Many advisors have had the experience of a seemingly sudden notification from a long-time client that they are transferring their assets out of the firm. The advisor could probably think of all of the ways they added value to the client over the years, but notably, they also have to consider not only whether it was enough value, but also that they offered more to the client than another advisor. And while client retention rates remain high, continuously demonstrating value to clients can not only help advisors hold on to their current clients, but also encourage clients to make referrals.

The first step for advisors could be to take stock of their value proposition and what separates them from other advisors. For instance, some advisors might have intimate knowledge of the financial needs of certain professionals (e.g., doctors or dentists), while other advisors might have expertise in advanced retirement income planning strategies. Advisors can also ask clients what they value most in the relationship (which might not match the advisor’s list!), whether directly or through surveys. Once they are armed with the knowledge of the value they provide and what their clients seek from the relationship, it is important for advisors to regularly reinforce this value through clients with specific details. For example, an advisor could show how much the client saved in taxes thanks to the advisor’s tax strategy (and explaining the process the advisor used to do so!), or how the client’s asset allocation prevented them from feeling the full force of a market downturn. By putting the value into numbers, clients can better understand the value they are receiving for their advisory fee.

In the end, advisors can help their retention and growth by better understanding what their clients are looking for in the relationship and communicating to the clients the value they have received. And given the costs of attracting new clients (and replacing those that have left), taking time to focus on how they are adding value to their clients can be a worthwhile investment for advisors!

(Mitch Anthony | Financial Advisor)

The COVID-19 pandemic has caused massive disruptions and has led many individuals to reconsider what they want out of life. Whether it is realizing that they prefer working from home, wanting to take a sabbatical, or perhaps thinking about retiring earlier than expected, the pandemic has led many to consider what they want to get out of life. And in this environment, advisors are well-positioned to help clients discover and lead their best lives.

When advisors think about a client’s AUM, their minds probably go immediately to a dollar amount. But a client’s assets go well beyond money, and Anthony suggests a new meaning of AUM: Aligning means with meaning; Understanding what makes the client unique; and Monitoring the life changes and transitions they are experiencing both now and moving forward. Thinking about clients in these terms (rather than the amount of financial assets they bring to the table) can help advisors better craft plans that will help clients live their best lives, thereby increasing the advisors’ value proposition.

Ultimately, the key point is that at a time when many clients are reexamining their life goals, advisors can be valued partners not only in helping them develop concrete plans, but also by ensuring that they are positioned financially to achieve them. Because while some clients might think of their advisor as merely a money manager, in reality, an advisor can play a much larger role in ensuring that clients are able to live their best lives (and being prepared to support them when their goals change!)

(Brad Wales | Advisor Perspectives)

Impostor syndrome – the internal fear that you are not as competent as others perceive you to be – is common throughout the professional world, and the business of financial advice is no exception. And given the stakes involved in financial planning (i.e., being put in charge of managing a client’s entire life savings) and the thousands of dollars clients pay for the service, some advisors might question whether they really have the expertise and skills needed to add significant value to their clients.

But Wales suggests that in addition to technical expertise, an advisor brings value to the table in other areas. For example, over time advisors will build a network of affiliated professionals to recommend to clients. By knowing the best accountant or estate attorney for a client’s needs, an advisor can not only save their clients time on researching professionals in these fields, but also make it more likely they will receive a high level of service.

Further, advisors provide value to clients through their experience dealing with similar client situations. While a client might be facing a financial decision for the first time (e.g., considering how to manage equity compensation), an advisor will likely have worked on the same issue with previous clients and can offer advice based on real-world experience. This way of adding value is especially prevalent among advisors who serve client niches, as their experience in successfully helping similar clients navigate financial decisions can increase these advisors’ confidence in the value they are adding to clients.

The key point is that an advisor’s value extends well beyond portfolio balances to the broader array of financial issues a client will face over the course of their life. And by harnessing their experience and connections, an advisor can be more confident that they are not an ‘impostor’ but rather the qualified and skilled professional their clients deserve!

(Allan Roth | Advisor Perspectives)

Sequence of return risk – the idea that even if short-term volatility averages out into favorable long-term returns, that a retiree could still be in significant trouble if the bad returns come at the beginning of retirement – is always a concern for advisors creating plans for client retirement income. The recent market downturn has likely exacerbated these concerns, as clients question whether an extended bear market could sharply inhibit their retirement plans. This leaves advisors in the position of exploring different strategies to help mitigate sequence of return risk.

Often-used strategies for this risk include: creating a cash reserve (that covers the retiree’s expenses for long enough to allow the market to recover), income laddering (purchasing bonds or CDs that mature in years when the money is needed), dynamic spending rules (that prescribe higher or lower spending for clients depending on portfolio performance), reverse mortgages (that allow retirees to tap the equity in their house rather than selling investment assets that have declined in value), and annuities (that can provide a steady stream of income without regard to market performance). But Roth believes each of these strategies has significant downsides; for example, the return on a cash reserve is likely to trail inflation and long-term equity market growth, while reverse mortgages can be an expensive source of income.

Instead, Roth suggests several other strategies to reduce retirement spending risk. The first is to consider retiring slowly, reducing work hours before fully leaving the workforce or taking on a part-time job. This can make a retiree less reliant on income generated from their investment portfolio as well as smooth the often-fraught transition from a full-time job to a life without work responsibilities. Another strategy is to develop a flexible budget; for example, while flexible spending rules can help guide retiree spending, the clients need to have the flexibility in their budget to implement them. Retirees can also consider delaying claiming Social Security in order to increase their monthly benefit for the remainder of their lives (thereby further reducing their reliance on income generated from their portfolio).

In the end, advisors have a variety of ways to increase the chances that their clients will have sufficient income to meet their needs throughout retirement. And while it can be tempting to consider more complicated financial products or strategies, a client’s patience and flexibility could be the most important factors!

(Bob French | Retirement Researcher)

Retirement income planning has multiple dimensions, from the mathematical (how much a client can afford to spend annually based on their assets and historical returns or Monte Carlo scenarios) to the emotional (how much risk the client is willing to take and how they would handle a potentially permanent loss of spending power). And sometimes, these dimensions can conflict, as a strategy that might help a client sleep better at night might not be the same as a plan that would maximize their income.

With this tension in mind, the use of “buffer assets” can help balance the mathematical need to protect from sequence of return risk with the psychological desire to take some risk off the table. Buffer assets are low-risk assets that are largely uncorrelated with the client’s investment portfolio and can include a line of credit from a reverse mortgage, the cash value of a whole life insurance policy, or simple cash.

One approach to using buffer assets is to keep a segregated pool of money that can be spent in the years when the client’s portfolio is either down or below some specific return. Of course, the advisor and client have to work together to decide how much to set aside as the buffer (as having too much set aside can hinder portfolio growth, while a smaller amount of reserves could be depleted during a lengthy downturn). Using returns for the S&P 500 from 1926-2021, a 30-year retirement would have included between 5 and 12 years with a negative annual return (with an average of 7.3 years), so a retiree using this approach would likely want to set aside sufficient buffer assets to cover spending for 5 years (if they were more risk-tolerant), 12 years (if they were more risk averse), or somewhere in between.

Another approach is to set aside a pool of buffer assets to spend from in retirement, replenishing them during periods of strong portfolio performance. For example, a client might set aside three years’ worth of spending, replenishing the balance at the end of the year if the market has risen and waiting until a future year to do so if returns were negative. In this case, an advisor and their client would be most concerned about extended downturns (as it would not provide the client with the opportunity to replenish their buffer assets). Historically, the S&P 500 took an average of 37 months to drop and then recover to its initial level (26.5 months excluding the Great Depression), and 60% of downturns recovered in two years or less. This suggests that a retiree using this strategy could get away with only setting aside a few years of buffer assets, but outlier events (e.g., the early 2000s tech crash that took 74 months to recover) could give some retirees pause from creating a smaller pool of assets from which to spend.

The key point is that any strategy to mitigate sequence of return risk comes with tradeoffs and given each client’s different spending needs and risk tolerance, there is no ‘right’ amount of buffer assets to hold for every client. And while the use of buffer assets could impede the long-term growth of the client portfolio (given the upside potential of sequence of return risk) it can potentially provide clients with peace of mind that their spending needs will be covered (even during a market downturn), which might be more valuable to them!

(Nick Maggiulli | Of Dollars And Data)

After a lifetime of accumulation, retirees transition to withdrawing funds from their investment accounts each year to cover their spending needs. With this in mind, a key question is whether it is financially advantageous for clients to take money out of their accounts as a lump sum at the beginning of the year (to shield the funds from a potential market decline) or spread withdrawals throughout the year.

Using a portfolio consisting of 100% U.S. stocks, Maggiulli looked at historical data to see how a strategy of annual lump-sum withdrawals in January compared to a series of quarterly withdrawals. And it turns out that the quarterly withdrawals typically will result in a larger portfolio balance, 65% of the time in a given year but 100% of the time over a 30-year period. This is likely intuitive, given that because the market tends to increase over time, having more money exposed to the market for longer (by not withdrawing the funds all at once) will lead to greater returns. Notably, while the outperformance of the quarterly strategy is only 0.1%-0.2% on an annualized basis, those who pay close attention to investment expenses will recognize that this can compound to a significant advantage over the course of a multi-decade retirement.

So for retirees who have the flexibility to decide when to take portfolio withdrawals to cover their annual expenses, doing so in a gradual manner can result in a larger portfolio balance over time. That said, there will be some bumps along the way (such as this year, when a lump-sum withdrawal would have been nearly perfectly timed for the market’s peak), so it is important for advisors and their clients to recognize that such a strategy plays to the long-term averages and is not guaranteed to outperform in a given year (and extra-nervous clients could split the difference by taking half of the needed spending upfront and spreading further withdrawals throughout the year)!

(Sophie Kasakove and Robert Gebeloff | The New York Times)

The ability to purchase a home is often considered a part of the “American Dream” and a key marker of entry into the “middle class”. But amid rising real estate prices in many parts of the country, buyers have to save a growing amount for a down payment and have sufficient income to afford a home. And when they do look for homes, they might find that a neighborhood that was previously within their price range might not be so anymore.

In addition to a general rise in home prices, certain neighborhoods have seen particularly sharp changes over the past 30 years that have made houses there affordable largely to better-off buyers. In increasingly popular cities such as Nashville, Tennessee, and Durham, North Carolina, certain areas that were previously home to squarely middle-class homeowners have become popular with wealthier families, who sometimes tear down smaller houses to build larger units. This influx in wealth can have benefits for current residents (as increased property tax revenues can lead to more funding for public infrastructure), though broadly rising property values can increase the tax burden on legacy owners and make it hard for families with moderate incomes to purchase in the neighborhood.

In fact, the number of Americans in metropolitan areas living in ‘middle-class’ neighborhoods (those where incomes are typically within 25% of the regional median) fell from 62% in 1990 to 50% today. This trend is seen broadly across metropolitan areas, with certain cities seeing particularly sharp changes (e.g., in Charlotte, North Carolina, 69% of residents lived in these ‘middle class’ neighborhoods in 1990, but only 43% do so today). This suggests that residents are becoming increasingly segregated into neighborhoods characterized by either concentrated wealth or broadly lower incomes.

And advisors are likely to have clients affected by these trends, even if they are relatively well off. For example, in some of the most expensive U.S. cities, even well-paid professionals could struggle to find a home to purchase in their price range. In addition, retired clients with less income flexibility could face hard choices if their property taxes and the cost of living in their area increase. The key point is that because housing is often a client’s largest expense, being aware of both national and local trends can help ensure they can meet their housing goals throughout their lifetimes!

(Alice Kantor | Bloomberg News)

When someone is thinking about moving, they might consider a new house across town, or if they are more adventurous, to an entirely new city. But amid increasing housing prices in the U.S., the increasing availability of remote work, and a strong dollar, many workers and retirees are taking a leap and moving to Europe.

Italy, Portugal, Spain, Greece, and France are among the most popular destinations for Americans who decide to move to Europe. For example, the number of Americans looking to move to Greece increased 40% in the second quarter of this year compared to the prior-year period, according to Sotheby’s International Realty, which also reported that Americans made up 12% of their revenue in Italy during the first quarter of this year, compared to 5% during the same three months of 2021. Some of these buyers have been attracted to smaller towns with lower-priced homes; for example, one buyer in Sicily was able to buy a 3,100-square-foot home, a smaller home next door, and an 800-square-foot storefront for 60,000 euros (about $61,000).

For advisors, a range of clients could be interested in such a move, from families looking for adventure abroad, to early retirees seeking out a lower cost of living, to retirees who want more time in warmer weather. But such a move comes with a range of cross-border planning considerations, from balancing US and foreign taxes to coordinating Social Security benefits. Therefore, advisors who can best understand these issues and overcome logistical hurdles will be better able to attract the growing number of Americans choosing to live abroad!

(Christopher Mims | The Wall Street Journal)

While some individuals worked remotely before the pandemic, the last couple of years have seen a spike in positions that no longer require employees to report to an office. This has given employees the flexibility to move to cities in different parts of the country, some of which are offering incentives to attract these workers.

Today, 71 cities and towns have created incentive programs to attract well-paid remote workers. Some of these perks include cash payments, subsidized gym memberships, free babysitting, and office space. For cities and towns that have not been able to attract major corporations or manufacturing facilities, such incentives provide a way to draw in well-paid individuals who will contribute to the local economy through their spending and tax dollars. And for remote workers currently living in high-cost cities, the smaller cities and towns offer the possibility of a lower cost of living while maintaining their well-paid position (and while some companies adjust remote employees’ salaries depending on where they live, others offer standard pay no matter where the employee is located).

Given the number of workers with permanently remote jobs, advisors can help clients in this position consider how such a move will affect their financial plan, whether it means being able to retire earlier or having more money for travel. And given that much of the advisory business has moved online, advisors can also consider whether such a move might make sense for themselves, whether they are an employee advisor or a firm owner!

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.