HomeFinancial AdvisorWeekend Reading For Financial Planners (June 18-19) 2022

Weekend Reading For Financial Planners (June 18-19) 2022

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Executive Summary

Enjoy the current installment of “Weekend Reading For Financial Planners” – this week’s edition kicks off with the news that Charles Schwab has agreed to pay $187 million to settle allegations that it misled users of its Schwab Intelligent Portfolios robo-advisor platform by falsely claiming that the cash allocations in its model portfolios (which were significantly higher than its competitors) were determined through a ‘disciplined portfolio construction methodology’ when regulators ultimately determined they were pre-set to generate a desired amount of revenue for Schwab. In other words, even as Schwab advertised that it was not charging a platform fee for the service, Schwab’s large cash allocations in the portfolios were still set to incur a cost for its clients, serving as a ‘hidden’ fee for an otherwise ‘free’ service, which the regulators treated as a violation of the antifraud (no-misleading-advertising) provisions of the Investment Advisers Act. Which in turn raises questions of whether regulators will eventually apply a similar scrutiny to the similar pricing model offered to RIAs using custodial platforms as well?

Also in industry news this week:

  • Why it is important for advisory firms to review their compliance and disclosure practices in the wake of a new Department of Labor regulation regarding rollovers of workplace retirement plans and IRAs
  • How the term ‘ESG’ has lost much of its meaning and how advisors can serve clients who want to take a values-based investment approach

From there, we have several articles on this year’s market volatility:

  • The tools advisors are using to help clients stay the course during the current market downturn
  • While the 60/40 portfolio has come under fire amid the poor performance of stocks and bonds this year, the classic asset allocation could now be more attractive given improved stock and bond valuations
  • Why the day the market seems to be at its worst is often one of the best times to buy

We also have a number of articles on bear markets:

  • Five things advisors can keep in mind during bear markets to provide clients with a long-term perspective
  • Why a trend following strategy can be an effective risk management tool for a portion of some client portfolios
  • Why reading books and prioritizing sleep can help advisors and their clients lower their stress levels during bear markets

We wrap up with three final articles, all about putting money in perspective:

  • While it seems like the worst of times when it comes to the economy and world affairs, the historical record shows how much things have improved over time
  • How those with better numeracy skills tend to have higher incomes and greater happiness
  • Why building wealth is not an end in itself and how money can be used to facilitate health and happiness

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.

(Andrew Welsch | Barron’s)

Robo-advisors have traditionally offered consumers the opportunity to have their assets managed in an allocation aligned with their growth goals and risk tolerance. In return, the robo platforms typically charged an annual fee (often about 0.25%) based on the assets under their management for the self-directed automated service.

But Charles Schwab took a different approach with its Schwab Intelligent Portfolios (SIP) robo offering, offering robo services with “no platform fee”, raising questions about how the service would generate revenue. Notably, an additional difference between Schwab’s model portfolios and those of other robo-competitors was a significantly larger portion of the portfolio – between 6% and 29.4% – that was held in cash, whereas other platforms often kept less than 1% of client assets in cash. Which Schwab would then sweep to its affiliate bank, to lend out at a higher interest rate than it paid to clients, with the difference in net interest (between what it paid and what it loaned out at) generating revenue for the firm. But from a client’s perspective, those levels of otherwise ‘uninvested’ cash holdings could be detrimental to returns, particularly at a time when available interest rates on cash were so low, and equities and bonds (that weren’t being bought with that investment cash) were otherwise performing well.

And according to a Securities and Exchange Commission (SEC) order released this week, between March 2015 and November 2018 Schwab falsely claimed that the cash allocations were determined through a ‘disciplined portfolio construction methodology’ when in reality the regulators state that those cash allocations were pre-set for Schwab’s own business reasons (to generate a desired amount of revenue)… from which Schwab profited by almost $46 million from the spread on the SIP cash allocation as a de facto ‘robo advisor fee’ that had never been advertised as such.

In response to the SEC’s enforcement action, Schwab has agreed (without admitting or denying guilt) to pay $187 million to settle charges that it misled its clients (of which $52M is for disgorgement and prejudgment interest, and the remaining $135M is a civil penalty), and agreed to retain an independent consultant to review their policies and procedures relating to SIP’s disclosures, advertising, and marketing. To put the magnitude and severity of the fine into perspective, it would represent 100% of revenue on $75 billion of robo-AUM (using a 0.25% fee), and 100% of profits on $375 billion of AUM if their profit margin were 20%… while in practice Schwab Intelligent Portfolios has ‘only’ about $65B of AUM!

So, as robo platforms continue to serve consumers and advisors alike, this case demonstrates the importance of understanding both the direct and indirect ‘fees’ involved in these offerings. Because while nobody likes paying fees, the potential drag on long-term returns from a cash-heavy portfolio could significantly outweigh a direct fee on the portfolio! Which, in turn, also raises questions of whether similar scrutiny will someday be applied to how Schwab and other RIA custodians generate similar revenue streams from RIAs using their “free” custody platform as well!

(Tracey Longo | Financial Advisor)

For financial advisors, retirement account rollovers are a regular part of the client onboarding process. For example, new clients might have a 401(k) from a previous employer that the advisor would like to roll into a traditional IRA with the firm’s custodian. But as of February 1, 2022, financial advisors who give advice to clients about whether to roll over 401(k) plan assets into an IRA are subject to a new set of regulations from the U.S. Department of Labor (DOL).

Under the new regulation, Prohibited Transaction Exemption 2020-02, advisors who would receive increased compensation as a result of recommending a rollover (such as a commission or advisory fee) are prohibited from doing so… unless qualify for an exemption from the Department Of Labor’s (DOL) prohibited transaction rules by complying with the new rollover standards outlined by DOL. Notably, the regulation covers not only rollovers of 401(k) plans, but also extends the prohibited transaction rules to advising clients on moving from one IRA to another.

To qualify for an exemption, advisors must comply with six key conditions, which include, among other items, written disclosures to clients of why the recommendation to roll over assets is in their best interest, and any (material) conflicts of interest the advisor has in making such a recommendation. And while many advisors may already be following some of these conditions (for example, RIAs who have fiduciary status by virtue of the SEC’s fiduciary rule may already acknowledge that status in writing, and provide disclosures of material conflicts of interest in Form ADV), DOL has its own specific requirements, including model language to use in disclosure documents, that are required to comply with the prohibited transaction exemption.

But according to a recent blog post by Fred Reish, a lawyer and expert on the DOL rule, many firms are failing to comply with the new regulation. Examples of compliance failures include not providing retirement investors with the new fiduciary agreement; lack of awareness that the rules apply to IRAs as well as workplace retirement plans; failure to have policies and procedures to mitigate the conflicts of interest of both the firms and the individuals; and a failure to disclose that retirement plan-to-IRA rollover and IRA-to-IRA transfer recommendations are conflicts of interest in the first place.

Firms that violate the new regulations can correct the violations and notify the DOL by email within 30 days after making the corrections (which itself must occur within 90 days of the firm discovering the violation). To avoid possible enforcement actions, firms must self-correct and compensate investors who lost money because of recommendations that fell outside the rule’s bounds.

The key point is that with the DOL’s documentation and disclosure requirements having first taken effect in February, and now approaching the deadline to be fully compliant with the new rules (by June 30, 2022), it is important for advisors to be proactive about putting their firm’s standards in place (which might need to be adjusted as DOL releases more guidance in the future) and self-correct any previous violations if necessary in any situation where a 401(k) or IRA rollover may increase the fees they’re earning from new or existing clients!

(Harriet Agnew, Adrienne Klasa, and Simon Mundy | Financial Times)

Environmental, Social, and Governance (ESG) investing has seen a boom in the past few years, with assets in ESG funds growing 53% to $2.7 trillion in a single year between 2020 and 2021. But as the number of funds with the ESG moniker (and their total assets) has skyrocketed, questions have been raised about the criteria that different funds use and, more specifically, exactly what the term ESG means.

Funds with a wide range of strategies use the ESG label, from those who negatively screen investments (avoiding investments in non-ESG sectors or companies) to those who positively screen investments (choosing sectors or companies that meet certain ESG criteria). Further, the criteria that these funds use varies across fund managers, to the point that investors (and their advisors) have to scrupulously assess the criteria and execution used to ensure the fund is meeting the investor’s goals.

In addition, investors must consider potential ‘greenwashing’ practices, where asset managers and individual companies make unrealistic or misleading ESG-related claims, especially about their environmental credentials. For instance, German authorities in May raided the offices of asset manager DWS and its majority owner, Deutsche Bank, as part of a probe into whether the company made misleading statements about ESG investing in its 2020 annual report.

Further, ESG fund managers have faced an increasingly difficult time determining the companies and sectors that qualify under their ESG criteria. For example, ESG funds often exclude weapons manufacturing companies, but amid Russia’s invasion of Ukraine, some are considering whether supporting companies that allow countries to defend themselves could qualify as a ‘sustainable’ investment. Relatedly, ESG funds that had invested in Russian companies have to grapple with whether to keep them in the portfolio given the Russian government’s actions in Ukraine.

So while the ESG fund industry reckons with this wide range of challenges, investor interest in aligning their investments with their values is likely to continue. Given the time required to craft and implement an ESG strategy, some advisory firms might decide to make ESG investing central to their investment process and value proposition (while others, given the growing time commitment needed to effectively implement an ESG strategy, might decide to eschew it altogether!). And for these advisors who do make a commitment to ESG investing, direct indexing (which allows an advisor to adjust the companies in an index to meet a client’s specific needs) could become an increasingly valuable alternative given the increasing difficulty of finding the ‘right’ ESG fund for a given client!

(Jeff Benjamin | InvestmentNews)

Many investors recognize that taking a long-term approach is often key to sustained investment success. At the same time, short-term market swings can be incredibly painful to experience, testing the resolution of many advisory clients. It’s at these times when advisors can serve as a steadying force to remind clients of the big picture and how their financial plan is designed to meet their goals, even amid a bear market.

The market environment so far this year has been particularly painful for investors, as bonds, often thought of as the ‘safer’ complement to stocks, have fallen in value alongside equity markets (and, given elevated inflation, clients’ real returns are even worse). For some advisors, this increases the importance of analyzing client cash allocations, as having sufficient cash on hand can prevent clients from having to sell investments that have declined in value (thereby ‘locking in’ the losses). Similarly, advisors who have taken ‘bucket’ approaches with their clients (segmenting off a portion of a client’s portfolio into low-risk assets to cover near-term expenses while exposing other assets to greater risk) can reassure clients that they have sufficient assets to cover their expenses until the market (eventually) rebounds. Still other advisors are using buffered ETFs and structured products to provide a degree of downside protection.

The key point is that advisors can not only serve as empathetic listeners during periods of market stress, but also serve as a reassuring force to remind clients how their plan was designed to weather tumultuous periods and help them achieve their goals. In addition, advisors can not only provide a historical perspective on previous market declines (and eventual recoveries), but also work with clients to help them recall how they acted during previous downturns and empower themselves to keep their plans on track in the current bear market!

(Dinah Wisenberg Brin | ThinkAdvisor)

Financial advisors are well versed in the benefits of portfolio diversification, investing in a range of low-correlation or non-correlated asset classes to make it less likely that all of a client’s investments will decline at the same time. One of the classic formulations of portfolio diversification is the ‘60/40 portfolio’, with a 60% allocation to equities and 40% to bonds, which is meant to provide exposure to higher-returning stocks with the relative stability of less-volatile bonds. But this portfolio is not totally immune to volatility, and in 2022 has experienced a 15% drop amidst declines in both the stock and bond markets simultaneously.

The 60/40 portfolio’s performance this year has led some industry observers to suggest that it is no longer viable, and that investors could consider adding alternative assets to their portfolios. But LPL Financial Strategists Barry Gilbert and Jeffrey Buchbinder suggest in a recent commentary that calls for the death of the 60/40 portfolio are premature, and that lower valuations mean that the long-term prospects for the 60/40 asset allocation have improved since the beginning of the year.

For example, while rising interest rates have depressed bond prices so far this year, the greater yields on newly issued bonds have risen, offering increased returns for 60/40 investors going forward. The same trend exists for stocks, as the forward price-to-earnings (P/E) ratio for the S&P 500 has fallen by about 20% in the past year, the fastest one-year improvement in the forward P/E since 2009, suggesting improved prospects for long-term returns compared to a year ago (albeit from a now-lower price base). They also note that other areas of the market, such as small-cap stocks, have seen their valuations dip well below long-term averages, suggesting a potential opportunity to ‘buy low’.

The key point is that while many investors have experienced pain given the declines in the stock and bond markets so far in 2022, the prospects for future long-run returns have improved based on valuation models as a result of those declines when looking forward from here. In addition, this could be an opportunity for advisors to review the relationship between valuations and client asset allocations, particularly for those clients who are likely to be most exposed to sequence of return risk!

(Blair duQuesnay | The Belle Curve)

No market downturn is fun, but some are worse than others. Experienced investors (and advisors) can likely recall how they felt during a range of bear markets, from the 17-month bear market associated with the Great Financial Crisis to the sharp, but brief, pandemic-related decline in 2020.

During these bear markets, there is often a day when the stock market’s performance (and perhaps the news) is so bad that an investor feels like puking (hopefully metaphorically). But duQuesnay suggests that while these are the times when investors might feel like throwing in the towel and selling their stocks, in reality, they are often excellent opportunities to be buyers. Because while those days might not literally represent the bottom of the market, they do provide an occasion for investors with a long-term investment horizon to put cash to work buying equities at a significantly lower price than before the bear market. And for advisors with clients who might be nervous about buying stocks with a lump sum of money when the market could decline further, starting a dollar-cost averaging (DCA) program can allow clients to buy stocks at decreased valuations while minimizing regret if the market falls further (because they will buy shares through the DCA program at even lower prices).

In the end, bear markets are painful for clients as well as their advisors (particularly those with AUM fee models, as a market decline reduces the asset base to charge on). But sometimes, what seems like the darkest point for the stock market can in reality be an opportunity to buy equities for the long term and benefit from a future market recovery (because many clients with money on the sidelines will need to get back into the market at some point)!

(Jack Forehand | Validea)

It’s much easier to recognize that bear markets are a regular part of investing in risk assets during placid market environments. But it can be more difficult to look at the big picture during the throes of a sharp market downturn, which gives advisors an opportunity to remind clients of longer-term market trends and why a client’s asset allocation was designed for their specific needs.

For clients who are souring on stocks as a whole, advisors can note that while equities come with risk, stocks offer the best long-term returns (and one of the best long-term inflation hedges), handily outperforming bonds, gold, and cash. Similarly, while it is common for stocks to have negative returns on short time horizons (e.g., since 1928, the S&P 500 has a 32% chance of experiencing negative returns in a given calendar quarter), longer-term returns are much better, as the S&P 500 has had positive returns in 87% of rolling five-year periods and 100% of rolling 20-year periods.

It’s also important to be wary of comparisons to previous bear markets. For example, given today’s elevated inflation figures, some observers might compare today’s environment to the 1970s, while others focusing on the valuations of technology stocks might make a comparison to the early 2000s. But all bear markets are different and follow their own path (in terms of depth and duration), so predictions of future returns based on the most severe bear markets of the past might not be useful.

Beyond providing a historical perspective, advisors can remind clients why they chose their asset allocation in the first place and how it is aligned with their risk tolerance and goals. This can give clients more confidence in their investment approach and make it less likely they will want to make potentially damaging changes in the middle of a bear market. The key point is that while the market is unpredictable in the short run, advisors can add significant value to clients by helping them stay focused on their long-term goals!

(Joshua Brown | The Reformed Broker)

Many financial advisors recommend that their clients take a ‘buy and hold’ approach. By regularly investing within the guidelines of a selected asset allocation over a long period, clients can grow their assets without having to think about if or when to sell them (at least until they are needed to support the client’s lifestyle, perhaps in retirement). The downside of this approach is that clients are exposed to painful market drawdowns along the way, which can test their mettle in remaining true to the chosen investment approach.

One alternative is to allocate some client assets to a ‘trend-following’ approach. With this strategy, funds are invested in a risk asset when it is in an ‘uptrend’ while moving to cash or another lower-risk asset when it is in a ‘downtrend’. For example, an investor could choose to invest in an S&P 500 index fund as long as it is above its 200-day moving average at the end of the month, and otherwise move to cash when it dips below that trendline. While such a trend-following approach does not remove all downside (as almost by definition, the investor will experience at least some of every decline between the investment’s peak and when it is determined that it is in a protracted “downtrend”), such tactical approaches can prevent investors from experiencing the worst drawdowns of a bear market.

However, this downside protection does come at a cost in the form of ‘whipsaws’. This occurs when the chosen asset shifts into a downtrend and quickly returns to an uptrend, leading the investor to repurchase the asset at a higher price than they sold it. These can be frustrating for trend-following investors during bull markets, when the chosen investment has a brief and shallow drop before returning to its upward trajectory. In addition, because trend following results in more trades than a buy-and-hold approach, using trend following in a taxable account can lead to the potentially costly realization of capital gains.

Ultimately, the key point is that while trend following can be a useful strategy to insulate against steep drawdowns, this protection comes at a price of potential whipsaws and more frequent trading than a buy-and-hold approach. Though Brown notes that ultimately, the potential benefits of this approach are not just financial (in avoiding steep drawdowns), but also behavioral, as clients who know that a portion of their portfolio is ‘protected’ by a trend-following strategy might be less likely to panic when a bear market does arrive!

(Anthony Isola | A Teachable Moment)

There are many ways that bear markets can cause stress, from the dire warnings emanating from media coverage to the actual declines in an individual’s portfolio. This can lead some investors to want to take action, perhaps by selling off a portion (or all) of their stocks (or calling their advisor to ask them to do so!).

But instead of remaining glued to the latest market news (and experiencing a commensurate increase in blood pressure) or making sudden portfolio changes that could have long-lasting effects, Isola suggests two different actions: sleep and reading. Following the latest bear market news can increase an investor’s stress and make it harder to sleep, which can have physiological consequences that can lead to even more stress. On the other hand, turning away from stressful news can lead to a better night’s sleep and more energy for work or leisure activities the next day. In addition, reading a book (preferably one on a topic other than bear markets!) can turn your attention away from the latest financial news and instead allow you to immerse yourself in the topic of the book.

The key point is that because bear markets are inherently stressful (for advisors and clients alike), it is important to take time away from focusing on the market. With this in mind, reading books and focusing on getting better sleep can not only help you avoid the constant barrage of negative news but also help your mental and physical health!

(Joachim Klement | Klement On Investing)

A barrage of bad news can feel like the current situation around the world is bleak. From the war in Ukraine to the continued presence of COVID to high levels of inflation and a slumping stock market, it can seem like we’re in the ‘worst of times’. But Klement suggests that looking back on history can put the current environment into perspective.

For example, while it is unclear whether a recession will occur in the current period, they have become much more rare overall. From the late 1800s through the Great Depression, recessions occurred every 3 to 5 years, but now only occur every 10 years or so (of course they are still painful when they do occur!). And while the COVID pandemic has caused significant death and economic damage around the world, it’s only the second pandemic to occur since the 1920s. In addition, while wars have been regular features of global affairs in the past century, those who live in North America and Western Europe can be grateful that there has not been a war in their countries in more than 70 years.

So while the current state of economic, health, and geopolitical affairs might seem dire, the historical record suggests that progress has been made in all three of these areas and that a brighter future might be on the horizon if the previous trends continue. Just as it’s helpful to be reminded during a bear market that they are a part of the investment process, it’s important to recognize that economic, health, and geopolitical crises are apt to occur (although hopefully in the future they won’t happen at the same time!).

(Patricia Sanchez | PsyPost)

Math is one of the core subjects students study growing up, and while most workers don’t use calculus in their day-to-day work, numeracy – the ability to understand and use mathematical concepts – is a key part of many jobs. And one study has found that greater numeracy is linked with higher incomes, which tends to lead to greater happiness.

Using a sample of American adults, the study found that for every one point higher on an eight-item numeracy test, individuals reported more than $4,000 of additional annual income, controlling for education and verbal intelligence. The researchers found that higher incomes were (perhaps unsurprisingly) associated with greater life and income satisfaction. Interestingly, the study found that among the highly numerate, satisfaction with income depended on their relative income level; while those with the highest incomes and high numeracy were more satisfied with their income than those with similar incomes and worse numeracy scores, low-income, highly numerate individuals were less satisfied with their income than their less-numerate counterparts.

While the findings were only correlational (the authors could not determine whether greater numeracy caused greater income and life satisfaction), the study suggests that the ability to work with numbers is an important factor in generating additional income and related life satisfaction. And for advisors, the closely related concept of risk literacy can help clients understand the probabilities associated with their financial plan. In the end, who would have thought in third grade that math might be one of the keys to happiness?

(Jack Raines | Young Money)

It’s easy to find examples of ‘rich’ people who are unhappy with their life as well as less-wealthy individuals who are leading a life full of joy. Because while some individuals try to amass as much money as possible in the pursuit of happiness, it is important to recognize that some features of a happy life cannot be purchased. Instead, as Raines suggests, money can provide the freedom and flexibility to pursue the things it can’t buy.

Many of the things that money can’t buy have to do with relationships. For example, it’s hard to buy a loving marriage or lifelong friends. At the same time, having money can facilitate experiences with these individuals or allow you to create time to spend with them. Similarly, while money can’t buy good health, it can allow you to buy healthier food and the flexibility to exercise. And while you can’t use money to buy more years for your own life, you can ‘purchase’ more free time by outsourcing tasks, taking a sabbatical, or retiring early.

And so, an important task for advisors is not just helping clients build wealth, but maximizing how they use it in a way that gives them the option to pursue the skills and traits that money can’t buy directly. Whether it is by spending money on experience, giving to others, ‘buying’ time, or other priorities, the key point is that money is a means to an end, not an end in itself!


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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