Weekend Reading For Financial Planners (June 11-12) 2022



Executive Summary

Enjoy the current installment of “Weekend Reading For Financial Planners” – this week’s edition kicks off with the news that amid public interest in the potential conflicts of interest involved in ‘payment-for-order flow’ arrangements between brokerages and market-making firms, SEC Chair Gary Gensler has asked agency staff to explore various ways to make the U.S. equities market more transparent and fair, including potentially creating an order-by-order auction mechanism to help retail traders obtain the best pricing for their orders. While payment-for-order flow arrangements have likely subsidized the dramatic reduction in direct trading costs during the past several years (as well as ‘free’ custodial services for advisory firms), questions remain as to whether the practice leads to better trade execution (and lower indirect costs) for investors compared to alternative arrangements… and whether potential changes from Gensler could alter how brokerage firms (and advisors’ custodians) price their own services.

Also in industry news this week:

  • RIA aggregator Homrich Berg announced a $75 million debt financing agreement through a multi-bank syndication, demonstrating that RIAs looking to access capital do not necessarily have to give up an equity stake in the business
  • Invesco and Cerulli Associates have launched a free benchmarking tool allowing advisory firms to compare themselves to the rest of the industry on a range of metrics, from AUM growth to client services

From there, we have several articles on inflation:

  • What advisors are doing to help their clients cope with the current elevated levels of inflation
  • 8 inflation conversations advisors can have with their clients, from creating a cash management strategy to reassessing long-term inflation assumptions
  • Why recent declines in the prices of key inputs could lead to a cooling of prices for consumer goods

We also have a number of articles on retirement planning:

  • How a new study shows that a typical retirement is made up of four stages, with the first beginning during the working years
  • How recent research shows why personal health, anticipated health care costs, and legacy desires help explain why individuals choose not to smooth their consumption throughout their retirement years
  • The seven non-financial investments individuals can make during their working years that can lead to greater happiness in retirement

We wrap up with three final articles, all about advice:

  • 10 key lessons from some of the most successful companies, from Stripe’s diligent recruiting practices to why Red Bull outsources production of its own beverages
  • The big ideas that changed one author’s life, from understanding the importance of tribes to the importance of learning from history
  • 47 lessons learned over the course of one writer’s first 30 years, from when to take risks to the importance of being intentional in your decision making

Enjoy the ‘light’ reading!

Adam Van Deusen Headshot

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.

(Lydia Beyoud and Katherine Doherty | Bloomberg)

One of the major trends in investing over the past several years has been the sharp reduction in transaction ticket charges for trading, particularly for retail investors. From pre-internet, broker-assisted trades that might have cost $39 (almost 1% of a $4,000 trade!), to internet-era discount brokerages offering $19.99 and then $9.99 and eventually $4.99 trades, to today, when nearly all brokerages offer ‘free’ no-commission trading of a wide variety of securities, the trend has been consistently downward. But brokerages still have expenses to cover (and profits to make), and their search for revenue streams has led many industry observers to wonder whether these trades are really ‘free’ for consumers (and their advisors).

One area of brokerage compensation that has come under particular scrutiny is ‘payment-for-order flow’, which has been around since at least the 1980s, but has received more attention lately with the rise of commission-free trading and increased retail investor activity during the pandemic. Under the practice, brokerages accept compensation from market-making firms (e.g., Citadel Securities and Virtu) in return for routing their customers’ trades to these firms for execution (instead of routing the trades through another firm or through stock exchanges themselves).

Proponents of the practice argue that the market-makers offer consumers better execution on their trades than they would receive if the orders were executed directly on exchanges, and that retail investors also benefit by getting commission-free trades (which are subsidized in part by the revenue the brokerages receive from market-making firms). Detractors, on the other hand, suggest that payment-for-order flow creates a conflict of interest, where a brokerage might route customer orders to the market-maker providing the most compensation rather than the one that will offer the best execution price for the retail customer.

Amid this backdrop, Securities and Exchange Commission (SEC) Chair Gary Gensler said in a speech this week that he has asked SEC staff to explore various ways to make the U.S. equities market more transparent and fair, including potentially creating an order-by-order auction mechanism to help retail traders obtain the best pricing for their orders. And while he did not call for a ban on payment-for-order flow practices (while also not ruling one out), Gensler said he has asked SEC staff to find ways to mitigate conflicts of interest that he says are inherent in the arrangements.

Ultimately, it would take some time for any potential changes to come into effect (any proposals would go through a public comment period, as well as two votes by the agency’s commissioners), they could eventually increase the direct cost of trading (e.g., if brokerages had to reinstate trading fees to account for lost payment-for-order flow revenue), but perhaps ultimately save investors money if better execution practices lead to improved purchase and sale prices for their trades. And because these changes could trickle down to many advisors’ custodial arrangements, it will be important for advisors to be aware of potential changes to the net costs to themselves and their clients of receiving ‘free’ custodial services!

(Diana Britton | Wealth Management)

RIAs have many options when they want to scale the growth of their practices. While some seek to build their client, advisor, and operations staff headcount organically, others turn to acquisitions, which can provide an influx of both talent and client assets. Of course, acquisitions can be costly (particularly amid rising RIA valuations over the past few years), and so acquiring firms must consider how they will fund the acquisition. This can lead RIA owners to consider whether to offer an equity stake to an outside investor (such as a private equity firm) in exchange for fresh capital or to seek alternative financing sources. In addition, some advisory firms are ‘driven’ to work with private equity firms simply because the firm has scaled too large for its existing advisors to buy out the firm in the first place in a succession plan.

Yet while private-equity-based deals have been popular lately, RIA integrator Homrich Berg has completed a debt capital revolver, raising $75 million of debt funding through a multi-bank syndication. The deal will allow Homrich Berg to maintain majority control of the firm without ongoing equity dilution for both acquisitions and succession, after it previously sold a minority stake to an affiliate of private equity firm New Mountain Capital to facilitate ownership succession. Homrich Berg has averaged about one RIA acquisition per year for the past five years and with the financing, could increase its pace to two or three acquisitions annually.

The Homrich Berg capital raise demonstrates that even in a rising interest rate environment, debt financing could be a legitimate option for RIAs who want to raise money without giving up equity (as even if interest rates are rising, the underlying cost of capital can still be far less than the implied cost of equity for a high-growth-rate firm). Further, the availability of a range of funding sources could facilitate the continued wave of RIA consolidation, offering opportunities for larger RIAs to expand and smaller firms (or those with retiring owners) to seek a combination with a larger firm!

(Holly Deaton | RIAIntel)

Benchmarks are a commonly used tool in the world of investment management, facilitating the performance comparison of assets like stocks, funds, and managed portfolios against the broader market. But advisory firm owners can also use benchmarks as a way to assess the performance of their own firms: in this case, as a way to compare an individual firm against the industry as a whole (or against similar peer groups within the industry).

And now, asset management giant Invesco and consulting firm Cerulli Associates have created the Practice Innovation Index, a free tool that benchmarks advisory firms against each other according to their business development, wealth management, client service, and practice management. With the tool, advisors can compare themselves to a benchmark created using Cerulli’s two most recent yearly surveys of 1,500 wealth managers (while the current benchmark includes RIAs, independent broker-dealers, wirehouses, private banks, and family offices, future iterations could be segmented to give users a more accurate apples-to-apples comparison).

For advisory firms interested in using the tool, the first step will be to organize the firm’s financial data (as the tool asks questions such as the firm’s five-year compound annual AUM growth). They can then focus on a few key metrics that are most relevant to the firm’s goals, and consider what the benchmarking data says about the firm’s productivity, efficiency, and profitability in order to strengthen their business.

Ultimately, the point of using benchmarking data is to better understand how an owner can improve their business. Because, while most advisors want to make their firms better in one way or another, they may not always understand which areas are already strong, and which could benefit most from improvement. By having an ‘average’ to compare against (and the new free tool to leverage), it is possible to quickly see where these improvements can be made – meaning that the initial time investment of using benchmarking studies could ultimately save the firm owner a lot of time and effort in making their firm more profitable!

(Jeff Benjamin | InvestmentNews)

Inflation continues to run hot, with the consumer price index coming in at an annualized rate of 8.6% in May. From housing to energy to food, no category was immune in the latest monthly data. And with inflation top of mind for many clients, advisors have an opportunity to help them determine exactly how inflation is affecting them and how their portfolio can be adjusted to ensure that long-term financial goals can be met despite the current inflationary environment.

A key factor for advisors and their clients to recognize is that while the broad inflation rate might be hovering near 8%, this is a composite figure, and prices of different goods are increasing at differing rates. And so, advisors can work with clients to calculate their ‘personal’ inflation rate to see how the clients’ spending pattern is being affected by inflation (and perhaps leading to a discussion of potential ways to reduce spending in categories that are seeing the largest price increases).

In addition, advisors can also consider how client portfolios are aligned to handle an inflationary environment. In addition to reminding clients that stocks are a great long-term inflation hedge, advisors can also consider the role of bond products such as Treasury Inflation-Protected Securities (TIPS) and Series I Savings Bonds. Advisors could also consider reducing the duration of bonds in client portfolios in order to manage interest rate and inflation risk. Advisors might also consider a role for commodities, which have performed well so far in 2022, though this asset class has had more volatility and worse performance than equities in the long periods between inflation spikes.

The key point is that advisors have a range of options to support their clients during the current inflationary period. And while there is no single antidote to inflation, by helping clients understand how they are personally impacted and exploring potential ways to adjust their portfolio, advisors can offer them perspective on how they can best adjust to the current inflationary environment to ensure they stay on track to meet their financial goals.

(Ben Henry-Moreland | Nerd’s Eye View)

With inflation reaching its highest levels since the early 1980s, the topic of rising prices has been on the minds of many financial advisors and their clients. And given that it has instead persisted for longer than many originally predicted, many financial planning clients are looking to their advisors for guidance on how they can be better positioned for a potentially prolonged bout of inflation.

While some clients might be focused on investments that can be used to hedge against inflation, there are other important considerations that advisors can discuss. For example, discussing a client’s cash management strategy can ensure they have sufficient cash on hand to meet their spending and near-term savings needs while not leaving too much of their money in low-yielding savings vehicles (whose rates currently are well below inflation). In addition, with property values and construction costs rising, advisors can add value for clients by reassessing their homeowners’ insurance policies to ensure they have sufficient coverage to keep up with the home’s replacement value.

The current inflationary period could also be a good time for advisors to reassess the inflation assumptions used in client plans. While it is unclear how long the current inflation spike will last (and where inflation might settle for the long run), even a 1% increase in inflation above assumptions over the long run can have a significant effect on many financial plans. While assuming the worst could lead to overly conservative projections, showing how a plan would fare in different inflationary regimes can provide clients with perspective into what changes (if any) they might need to make depending on how inflation progresses.

Ultimately, the key point is that inflation affects all clients, from the working-age client with significant spending in areas hard-hit by inflation to the retiree with a pension that is not adjusted for inflation, and while advisors can’t see into the future, they can stay focused on what enables clients to accomplish their goals in the long term – like saving regularly, controlling risk, and investing with discipline – thereby creating extra value for clients by guiding them through challenging times in the short term!

(Michelle Jamrisko | Bloomberg)

Inflation has cut sharply into consumer spending power, not just in the United States but around the world as well. Because finished consumer goods are the products of a long production process, the prices of key inputs can serve as a bellwether for where the prices of finished products are heading.

And currently, the prices of three major inputs to global inflation have eased since recent peaks, suggesting that relief could be on the way for consumers. To start, a key semiconductor price (which helps determine the price of a range of electronics), is now half of its July 2018 peak and is down 14% from the middle of 2021. In addition, the spot rate for shipping containers (an important component of the price of imported goods) has declined 26% since its all-time high in September 2021. And finally, North American fertilizer prices (which impact the price of food) are 24% below their record high in March.

While the prices of these inputs have fallen, it could take time for the savings to be reflected in the price of finished consumer goods (and the price levels for services could remain elevated). In the meantime, advisors can use a range of economic data (including inflation) to illustrate to clients how the economic situation today compares to the past, and to demonstrate what sustainable spending looked like in past periods with economic environments similar to that of today!

(Jennifer Lea Reed | Financial Advisor)

Retirement is often thought of as a continuous period of leisure after a lifetime of work. But in reality, retirement often includes several stages based on a retiree’s activities, interests, and health. And a new study suggests not only that there are four distinct stages of retirement, but that these stages begin even before an individual stops working.

According to “Longevity and the New Journey of Retirement”, a study by Edward Jones, Age Wave, and The Harris Poll, the first phase, “Anticipation”, begins as many as ten years before an individual retires and is marked by optimism and excitement over the prospect of retiring (along with some anxiety over financial readiness). This is also the period in which financial advice is most sought, as individuals often feel they need guidance to know all of their options. The second phase, “Liberation/Disorientation”, runs for the first two years of retirement and is when retirees are excited by new freedoms and the luxury of time, but are also often uncertain about how to spend their time and money.

The heart of retirement is the third phase, “Reinvention”, where retirees learn to shift their mindset from accumulation to distribution and tend to explore their worlds of opportunity the most, while also dealing with slowly rising health issues. These retirees are frequently family-oriented, including through financial support, and advisors can help them determine the right balance of giving with the assets they need to maintain their lifestyle. Finally, retirees enter the fourth stage, “Reflection/Resolution”, about 15 years into retirement, when clients have remained resilient even in the face of loss, and have typically learned to live within their means as their lifestyle stabilizes for the later years of retirement.

Ultimately, the key point is that the phases of retirement are not just qualitative descriptions of the retirees’ experience, but also offer advisors important quantitative insights into how a client’s spending might change over the course of their retirement. In addition, advisors can consider not only how clients want to generate income to meet these spending needs to help ensure that clients feel confident that their retirement needs and financial goals will be met, but explore with clients how their retirement goals may be changing within and throughout retirement as they progress through the retirement stages!

(Jeff Horwich | Federal Reserve Bank Of Minneapolis)

Economists have long used the ‘Life Cycle Hypothesis’ when considering how individuals spend over the course of their lives. According to this concept, individuals like to ‘smooth’ their consumption during their lifetimes, which often requires borrowing early in life, then saving during the prime working years, and finally spending down their assets during retirement. But recent research suggests that a range of preferences can affect how individuals spend, particularly in retirement.

While it has long been assumed that individuals spend down their assets in retirement (e.g., wealth has been shown to peak at age 75 in the aggregate), digging into different income groups paints a somewhat different picture. For example, one study found that median middle-income U.S. couples keep building wealth well into their 80s, and high-income couples keep saving even longer. But this could be rational, as couples anticipate potentially high medical or long-term care expenses later in retirement, as well as ensuring that their assets at least keep pace with inflation. Interestingly, anticipated medical spending is also related to a desire to make bequests, with many retirees ‘over-saving’ for medical expenses, figuring that any unused funds can be given away to chosen individuals or charities at their death.

Researchers have also found an important wealth discontinuity for widows, as, on average, the wealth of a couple who experiences the death of one spouse falls by $160,000 compared to a couple who does not. And while medical and burial-related expenses make up 20% of this gap, researchers found that nearly half the loss comes from the wealth that is transferred to children or other heirs while one spouse is still living. Instead of allowing the surviving spouse to spend down these assets (as would be expected under the life-cycle hypothesis), bequests are accelerated after the first death.

In addition, retiree spending fluctuates with health. Researchers have found that health issues decrease the utility derived from spending money across all income levels and play a more important role in decreased spending on leisure activities (the enjoyment of which often declines as an individual’s health deteriorates) over the course of retirement than do the wealth-reducing costs of paying for medical care. This is reflected in the “retirement spending smile” concept, where real retiree spending decreases slowly in the early years, more rapidly in the middle years, and then less slowly in the final years.

The findings of these research studies suggest several potential opportunities for advisors, from considering changes in retirement spending when creating a retirement income plan to supporting the special planning (and psychological) needs of widows after the death of a spouse and providing projections of how much a client can expect to spend on medical expenses in retirement. Overall, the key point is that in a world where individuals don’t always maintain steady consumption over the course of their life, advisors can play an important role to ensure that clients have a financial plan designed to meet their changing spending needs!

(Arthur Brooks | The Atlantic)

Research has found that, on average, an individual’s happiness tends to be U-shaped over the course of their life: it starts high in childhood, then declines in young adulthood and middle age (as job and care responsibilities crowd out time for more pleasurable activities), bottoming out at about age 50 before rising again into one’s mid-60s. But at that point, individuals tend to split into two groups: some who get much happier and others who become much unhappier.

And according to research, that divergence is not just chance, but rather the product of a lifetime of decisions. Using data from a longitudinal study that tracks individuals over the course of their life, one study found that there are seven major decisions that individuals can control to make it more likely they will be happier in old age. Several of these are related to physical health, including refraining from (or quitting) smoking, avoiding alcohol abuse, maintaining a healthy body weight, and prioritizing movement in daily life. In addition, happier individuals developed coping mechanisms (to deal with life’s inevitable distresses), engaged in continuous learning (which promotes an active mind in old age), and cultivated stable, long-term relationships.

When people think about investing for retirement, the first thing that comes to mind is often saving money. But while determinants of happiness can vary among individuals, research on happiness suggests that in the aggregate, investments in physical and mental health can also pay significant dividends (for clients and their advisors!).

(Mario Gabriele | The Generalist)

When individuals seek advice, they often turn to another person, perhaps a family member, mentor, or trusted friend. But while you can’t directly ask a company for advice directly, you can learn best practices from their experiences. And after profiling a wide range of businesses, Gabriele homed in on 10 lessons that stood out to him.

In one case, he found that the success of the payment processing company Stripe was due in part to its care and diligence in recruiting. For example, it took the company six months to hire its first two employees and several of its employees were recruited over the course of multiple years. And while advisory firms might not want to wait that long to bring on talent, taking a thoughtful approach to the type of candidate they are looking for and what the firm has to offer can lead to more successful recruiting efforts.

The South Korean e-commerce company Coupang exemplifies a company that is obsessed with its customers. For example, its delivery workers are given a manual outlining esoteric details of the delivery process, such as the proper way to knock on a door (to avoid waking any sleeping children inside!). And while advisory firms don’t have to worry about knocking on doors, it is important to assess whether the services being provided align with what clients are actually looking for from their advisors!

Another attribute of many successful businesses is that they focus on how they can intensify their most pronounced advantage. For example, the beverage company Red Bull doesn’t actually produce its own beverages, instead outsourcing production so it can focus on its strength in marketing its products. In the case of an advisory firm, this could mean focusing on what it does best (often interacting with clients) and outsourcing other functions (from investment management to lead generation).

Ultimately, no two companies are the same, but by learning and applying lessons from successful businesses (and advisors!), advisory firms can apply these best practices to their own operations (and perhaps become a case study for other firms one day)!

(Morgan Housel | Collaborative Fund)

Many people can think about a time when they heard a revelatory idea that changed how they view the world. And for Housel, several ideas have changed how he thinks and drive what he believes.

The first of these ideas is that everyone belongs to a tribe and underestimates how influential that tribe is on their thinking. In these cases, individuals hold views persuaded by identity over pure analysis. There are a wide range of tribes, from countries to political parties and religions. In the world of financial advice, these could include investment philosophies and fee structure, or how advisors choose to approach the business of advice. And while there is nothing wrong with being part of a tribe (as there is comfort in knowing others understand your background and goals), they can be problematic when they reduce the ability to challenge ideas or diversify their views because no one wants to lose the support of the rest of the tribe (leading to unquestioned dogmas and potential stagnation within the tribe).

Another big idea is that everything has been done before, and that while the scenes change, the behaviors and outcomes do not. While those living in the past might not have had the same technologies we enjoy today, they had to deal with many of the same experiences, from trying to outwit entrenched competition to swinging from optimism to pessimism at the worst time. Therefore, history is more useful as a benchmark for how people react to risk and incentives, which is more stable over time. The current market downturn presents a good example of this idea for advisors, as they can learn from how their clients previously reacted to weak markets and apply the lessons to help them remain on track today.

Also, it is important to recognize that your personal experiences make up an infinitesimally small percentage of what’s happened in the world, but is a significant percentage of how you think the world works. This calls for accepting different points of view and understanding how others’ experiences might differ from your own. For advisors, this could mean better understanding clients’ backgrounds, as their ‘money memories’ can play a significant role in how they handle money today.

These ideas all speak to the importance of intellectual humility and an openness to changing your opinions when new evidence presents itself. Because the financial advice industry is constantly changing, those firms and advisors who are most willing and able to adapt are likely to be the most successful!

(Joseph Wells)

A lot happens in your first 30 years of life. From navigating the perils of being a teenager to finishing off your education and entering the workforce, this period is full of a wide range of experiences and life lessons. And upon reaching age 30, Wells compiled 47 lessons from his experience in a wide range of categories.

Many of these lessons relate to calculated risk-taking. From changing jobs (which can lead to gaining new skills and experiences as well as higher pay) to thinking about starting a business to making prudent financial investments, calculated risks can offer a significant upside with a known downside. For those early in their career, Wells suggests optimizing for one of three things: making a lot of money, building a marketable skill, or doing something you love. His preference is for making more money (as it opens the door to pursuing your passions without having to worry about money).

In addition, it is important to find the things you really care about in life and only focus on those things. For example, someone who values vacations more than cars might consider buying a less-expensive car and allocating more money to their vacation budget. This also applies to time; if you really don’t care about a television show you are watching, you can instead turn to a hobby that you do care about (even if the show is halfway done!).

Overall, Wells suggests that individuals be intentional in their actions, from professional activities to how they dress. And while taking lessons from someone who has made it to age 30 can be helpful, learning lessons from those who have experienced an entire financial planning career can be valuable as well!

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.

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