Weekend Reading For Financial Planners (Nov 12-13) 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.

(Kenneth Corbin | Barron’s)

Almost two years after it was first announced, enforcement of the SEC’s new marketing rule began on November 4. The new marketing rule presents RIAs with the opportunity to greatly expand their marketing efforts with new options, from client testimonials to promoting the reviews they’ve received on third-party websites, to provide prospective clients with evidence of the quality of their service. But now that the November 4^th enforcement date has passed, the SEC will begin to look at what RIAs are actually doing to ensure that advisors stay within the bounds of the new regulation. Accordingly, in September, the SEC issued a risk alert putting advisors on notice that examiners will be conducting a number of reviews to evaluate how firms are complying with the new rule since it was finalized nearly 2 years ago. Though given the SEC’s principles-based approach to enforcing the rule (rather than setting out explicit rules-based guidelines), some firms are wondering whether the changes they have made to their marketing and compliance policies will pass muster during their next SEC exam.

Notwithstanding the uncertainty of exactly how the marketing rule will be enforced, some firms are diving in head-first to take advantage of the new marketing opportunities presented by the rule. For instance, many are adding client testimonials to their website to give prospects an idea of the level of service they can expect from the firm (in the words of actual clients, rather than generic marketing-speak). In addition, certain firms are looking to increase their presence on third-party ratings sites (from Google to Yelp, to new third-party providers like Wealthtender), not only to build their brands with prospective clients, but also to attract talent (who might research the firm’s reviews online to see whether it has a loyal client base before reaching out). The marketing rule also gives firms the opportunity to present investment performance data (though firms are required to include both net and gross performance, and use specific time periods [e.g., one-, three-, five-, and ten-year returns] to prevent firms from using cherry-picked timelines).

At the same time, leveraging the new marketing opportunities will likely require many firms to review and potentially adjust their compliance policies and training to avoid disciplinary action from the SEC. This could be trickier for larger firms, which will have to ensure that all of their employees are properly trained on the rule and its requirements to promote adherence to the rule across the firm. Given these requirements, some RIAs are taking a ‘wait-and-see’ approach, waiting to see how the SEC enforces the new rule before changing their marketing tactics. Though some industry observers think those firms who do act early could have a ‘first-mover advantage’ by attracting clients through testimonials and third-party endorsements before other firms get their programs up and running (even if it means they might also be the guinea pigs for the SEC’s enforcement of the rule!).

Ultimately, the key point is that the SEC’s marketing rule presents firms with the opportunity to take advantage of marketing tactics that are common in many other industries (who hasn’t looked at restaurant reviews!?), but that it is important for firms to understand the SEC’s guidance for doing so and adjust the firm’s compliance program as needed. Nonetheless, given that leveraging testimonials and endorsements has the potential to be less expensive than many other marketing tactics in terms of both money and the advisor’s time, drawing in new clients through these marketing efforts could greatly outweigh the upfront and ongoing costs of remaining in compliance with the marketing rule!

(Kenneth Corbin | Barron’s)

After participating in this year’s midterm elections, Americans are now awaiting the final results as states continue to tally up votes. While the final composition of the House of Representatives and the Senate is yet to be known, it appears that neither Republicans nor Democrats received a legislative ‘mandate’ from voters and that each chamber is likely to be evenly split. But what might this legislative environment mean for advisors during the next two years?

The proposed legislation likely to have the most impact on advisors and their clients is “SECURE 2.0”, a package of retirement-related policies coming on the heels of the original SECURE Act (which passed in the final weeks of 2019) that would raise the RMD age to 75 and increase allowed ‘catch-up’ contributions for certain individuals, among other measures. Pundits broadly continue to believe that regardless of the composition of the next Congress, SECURE 2.0 will pass before the end of this year, likely attached to ‘must-pass’ legislation like the omnibus appropriations bill or the National Defense Authorization Act.

But Congress has other ways to impact advisors and their clients as well. These could include a potential showdown over the debt ceiling and a potential default on U.S. debt (which could roil markets) as well as its oversight powers of government regulators, including the two principal regulators of financial advisors, the Department of Labor (DoL) and the Securities and Exchange Commission. And given politically contentious rules under consideration (e.g., regarding whether retirement plan advisors can consider Environmental, Social, and Governance [ESG] factors), advisors could see more hearings that give Congressmen the opportunity to question the leaders of these agencies about these policies.

Altogether, it does not appear that the midterm elections will have a major impact on the legislative landscape for financial advisors, particularly given the bipartisan agreement surrounding SECURE 2.0 (which could be passed before the new Congress is seated in any case). But given the impact Congress can have on broader financial markets as well as on regulatory oversight, advisors might consider keeping an eye on the debt ceiling and other policy debates that could impact their clients!

(Mark Schoeff | InvestmentNews)

Cyberattacks regularly make news headlines, particularly when thieves are able to access major caches of personal information or steal money from a company or government. And given the amount of personal and financial information in their systems, financial advisory firms could be prime targets for cyberattacks. But according to an SEC official, many firms are not taking sufficient precautions, leaving them open to attacks and potential disciplinary action from the regulator.

Cybercriminals are likely to target both large and small firms, according to Richard Best, director of the SEC’s examinations division, and the past two years have been “incredibly active” for threats, he said, highlighting the need for firms to address internal cybersecurity policies and procedures, assess the vulnerabilities of their vendors, and consider the possibility of breaches related to weather disasters and remote work. Best outlined some of the deficiencies the regulator has seen during examinations this year, including a lack of cybersecurity policies and procedures (or not following them), allowing too many exceptions to multifactor authentication, failure to train staff, and a lack of engagement with cybersecurity among top firm officials. He also noted that advisors can increasingly expect in-person examinations following a period of remote exams during the pandemic.

So while the SEC is in the midst of considering how to modernize and expand its cybersecurity regulations, advisory firms can consider whether their cybersecurity policies are up to date and effective, not only to pass a future examination, but also to ensure that firm and client data is protected. And given the wide number of access points within the firm for a potential cybercriminal, from email to document storage, a thorough review could be warranted?

(Kerry Johnson | Advisor Perspectives)

Many financial advisors do not see themselves as salespeople, but given the need to obtain clients, sales is naturally a part of the business. And while advisors might be comfortable explaining the planning process and analyzing a prospective client’s current financial situation, they might be less experienced in ‘closing’, or getting a prospect to sign on the dotted line to become a client.

Johnson argues that ‘closing’ a client is merely the end of a longer process, which includes lead generation, fact-finding, and presenting solutions to the prospect’s needs before moving on to the close. But when it does come time to try to close the deal, he suggests first using a ‘trial close’ to test the waters. This can be done by asking questions such as, “Am I on the right track?”, “How does this sound so far?”, or “Does this make sense?”.

If the prospect gives an affirmative response to the trial close, the advisor can then choose a closing strategy based on the prospect’s wealth and financial knowledge. For those on the lower end of the wealth spectrum and/or less sophisticated, Johnson recommends an ‘assumptive’ close, in which the advisor asks questions to help fill out the client agreement paperwork, making it less likely that the prospect will become confused and stall the process. For those prospects with more sophistication, he suggests an ‘I recommend’ close, in which the advisor recommends a course of action. This tactic is most helpful when the prospect believes in the advisor’s expertise, as they will be less likely to question the recommendation (similar to how many individuals are unlikely to question a doctor’s recommendation). Finally, for the wealthiest and/or most sophisticated clients, Johnson recommends an ‘alternative of choice’ close, in which the advisor offers three options, putting their recommendation in the middle. This prevents the prospect from feeling forced into a choice and allows the advisor to differentiate their recommendation from more extreme options.

Ultimately, the key point is that ‘closing’ is the culmination of a trust-building process between an advisor and their prospect. And given that a client relationship can last for years, or even decades, advisors will want to use sales tactics that are not only effective, but also don’t breach the trust built up during the sales process (as a prospect is unlikely to work with an advisor who they feel has been manipulative for very long)!

(Eric Soda | Spilled Coffee)

Getting a new client as a financial advisor can require a significant commitment of time and hard dollars for marketing. Because of that, having a high client retention rate is important to running a successful firm. But advisors might wonder what they can do to keep their clients engaged, aside from their core planning offering. One option to promote client engagement is to send a regular newsletter, which advisors can use to demonstrate their expertise, allow room for client feedback, and add value to their clients’ lives (both financial and personal). At the same time, just sending a newsletter might not be good enough; if clients feel that the content is low-quality, they might ignore it, increasing the importance for advisors to create a high-quality offering that clients will look forward to reading.

Given the barrage of reading material a client is exposed to in a given day, it is important for advisor newsletters to be clean, clear, and interesting to read, as clients will be more likely to read something they know will be pithy and useful than a longer tome that requires more time. In terms of content, advisors can use the newsletter to demonstrate their expertise, whether it is through market commentary or discussing the latest changes to tax laws that might affect their clients’ wealth. And because financial-related topics can bore a lay reader after a while, advisors can consider including topics not related to finance in the newsletter, such as recipes, local events, or other topics that might be related to their clients’ interests (particularly effective if the advisor has a niche clientele with similar interests!). Finally, the newsletter should present clients with the opportunity to offer feedback, both in terms of the newsletter’s content as well as starting planning-related conversations with the advisor.

In the end, while advisor newsletters have been around for decades, they remain a potentially valuable tool to drive client engagement, and, ultimately, retention. The key, though, is not only to tailor the content to clients’ interests, but also to use an appropriate length and format (perhaps also considering a firm blog or podcast?) that will encourage clients (and potentially prospects) to open it in the first place!

(Ari Galper | Advisor Perspectives)

An initial conversation with a prospective client can be exciting for an advisor, as they learn more about the prospect’s needs and discuss their firm’s value proposition. But at some point, the conversation has to end, and some advisors bring the meeting to its conclusion by asking the prospect whether they have any additional questions. And while this might seem like a logical question to conclude with, it can shut down the conversation if the prospect doesn’t actually have additional questions.

Instead, Galper suggests that advisors conclude the initial prospect call with the question “Where do you think we should go from here”. Unlike asking whether the prospect has additional questions, this prompt is more open-ended, making it more likely that the prospect will keep the conversation going. Perhaps more importantly, the question opens the door for the prospect to ask about what the advisor’s client onboarding process looks like from that point on. So instead of waiting for the prospect to re-contact the advisor (or vice versa), the advisor can move the prospect closer to becoming a client without resorting to any potentially trust-breaking sales tactics.

Ultimately, the key point is that while it might feel like a relief to end a prospect call without any awkward silence, it is important to find a way to move the prospect closer to becoming a client, or else the time spent with the prospect might have been in vain. And by asking the prospect, “Where do you think we should go from here?” the advisor can put the ball back into the prospect’s court and naturally encourage them to ask about the process for them to become a client!

(Allan Roth | Advisor Perspectives)

During the past decade of relatively low interest rates, it was challenging to find sources of yield for clients without taking on significant market risk (particularly for advisors looking to optimize their clients’ safe withdrawal rates). But the rapid increase in government bond yields this year presents an opportunity for advisors and their clients to get higher yields on their fixed-income investments. At the same time, because the current elevated inflation level can eat away at nominal bond yields, Treasury Inflation-Protected Securities (TIPS), which include both a fixed real yield plus and adjustment of principle based on inflation rates, have emerged as a potentially attractive opportunity for advisors and their clients.

Roth sought to create a portfolio of TIPS to find out the ‘safe’ inflation-adjusted return he could achieve, specifically whether it would exceed 4%, the target for those looking to apply the ‘4% rule’ for their retirement spending. Because the price of TIPS can fluctuate based on interest rate movements, Roth created a TIPS ladder of individual bonds (though buying small quantities of TIPS proved to be challenging). He purchased an approximately equal number of individual TIPS maturing each year through 2052 to represent the annual spending needs for a 30-year retirement (because the TIPS would be held to maturity, interest rate risk would be greatly reduced), although because TIPS with maturities between 2033 and 2039 were not available, he had to increase the amount purchased maturing in 2032 and 2040, leaving some interest rate risk. Altogether, he was able to build a TIPS ladder that would provide for a 4.36% real annual withdrawal rate throughout the 30-year period.

The key point is that while 2022 has been unkind to client portfolios, as both stock and bond markets have been weak so far this year, the rising interest rate environment (and continued inflation) could make TIPS a more attractive investment than they might have been in years past. And while an advisor might not want to build a client portfolio entirely out of TIPS (and actually purchasing the TIPS across many client portfolios could be time-consuming), they could represent an attractive option to generate income in the current inflationary environment (and perhaps make it more likely that the client’s portfolio will support a proposed safe withdrawal rate)!

(David Blanchett | ThinkAdvisor)

To meet the needs of consumers looking for annuity products that offer more potential upside than traditional fixed index annuities (which track an investment index but cap the investor’s upside potential in exchange for guaranteeing the initial premium), in recent years insurance companies have begun to create more flexible products. For instance, the Registered Index-Linked Annuity (RILA), ‘relaxes’ the traditional principal guarantee of the fixed indexed annuity by allowing at least some limited downside potential (with a floor to prevent severe losses)… in exchange for introducing significantly more upside opportunity (e.g., higher participation rates and/or higher caps than traditional fixed indexed annuities). The caveat, though, is that these more complicated structures make calculating future expected returns (and whether they might fit within a client portfolio) much more challenging for advisors.

Some advisors might ‘backtest’ RILA returns by applying the historical returns of the index associated with the RILA (e.g., the S&P 500) to the current RILA terms available for investors, in order to estimate what the future risk/return opportunity might be. But Blanchett suggests that such an analysis could be deceiving, as the terms available on a RILA in previous periods would likely have been different, creating a false comparison with the terms available today. One of the key issues is that RILAs (similar to fixed indexed annuities) are built using options strategies, and it’s the current pricing of those options – which ties directly to current interest rates and volatility – that determines the upside participation rate, upside cap, and downside floor. And since interest rates and volatility can and have varied in the past, investors in certain previous periods may have earned more or less than what is available today (and more or less than what the return of the underlying index was in the first place).

To analyze this, Blanchett used historical options data to determine what participation rates might have looked like going back to 1870 (well before RILAs were available!). And he found that today’s participation rates are actually relatively low, as the historical median participation rate is closer to 170%, which would result in significantly more upside potential for the purchaser compared to a RILA purchased with a 100% participation rate today. In other words, while an investor today can purchase a RILA with an unlimited cap (the limit on gains the RILA purchaser could receive) and a 100% participation rate (meaning that the purchaser would receive 100% of the gains of the respective index), hypothetical RILAs purchased in the past might have had even better terms (e.g., a higher participation rate that would increase the upside potential). Which means today’s RILAs may actually still offer ‘below-average’ returns relative to the returns RILAs may have generated historically (putting them in line with the lower-return environment of asset classes more broadly).

Ultimately, the key point is that the complicated nature of RILAs makes calculating future expected returns challenging for advisors. Because these products are invested in options rather than the underlying index itself, and because the terms available for the product change over time, using the historical returns of the underlying index could lead to dubious results, and at the least incorporating current market factors (e.g., interest rates and dividend yields) to generate expected returns is a more prudent approach. On the other hand, advisors who find RILAs unattractive because of today’s participation rate might not want to write them off completely, as a higher interest rate environment could lead to better terms in the future (just as those terms would have priced better at various points in the past, too)!

(Tom Murphy | Associated Press)

The ongoing Medicare Open Enrollment Period (which runs through December 7) presents seniors with a range of options to change their Medicare coverage. And while many will stick with their current plan, others will make changes, for example, to their Part D prescription drug coverage (perhaps if one of their medications is no longer covered under their current plan). For those on ‘traditional’ Medicare, another option is to switch to a Medicaid Advantage plan, and those currently using an Advantage plan have the opportunity to switch to a new one (or switch back to traditional Medicare, though this can introduce new costs). And while Medicare Advantage plans are heavily advertised by the private insurance companies that run them, often touting $0 premiums, it is important for advisors working with clients on Medicare to understand the dynamics of these policies.

Medicare Advantage plans include their own version of Medicare Part A (coverage for hospital services), Part B (coverage for doctors’ services and other outpatient care), and, typically, Part D coverage as well. In addition, these plans sometimes include dental and/or vision coverage not offered by traditional Medicare. The price of these plans is often lower than what a senior on traditional Medicare would pay for a Medigap policy (for expenses not covered under Parts A and B) and a Part D policy, making them attractive to seniors operating on fixed incomes.

However, Medicare Advantage plans come with tradeoffs. One of the key parts of many of these plans is that care must generally be provided by an in-network provider, limiting the medical professionals and facilities a senior could use. This could surprise an enrollee who finds out that their current doctor does not participate in their Advantage plan. In addition, advisors will want to analyze the dollar amount of the benefits provided by the plan; for example, while a plan might include dental or vision coverage, the maximum annual benefit can vary across plans. Further, the deductibles and copayments associated with these plans can vary widely, so, depending on their medical expenses, a senior on an Advantage plan with a $0 premium could end up paying more for their total health-related expenses than another with a higher-premium Advantage plan (or on traditional Medicare) with lower deductibles and copays (and, notably, those on Medicare Advantage plans still have to pay their Part B premium).

The key point is that while Medicare Advantage plans with low (or no) premiums can appear attractive to seniors, a more thorough analysis of their individual health needs and alternative coverage options is necessary to determine the best course of action. And given the wide range of Medicare coverage options available, this presents an opportunity for advisors to add value to their clients by reviewing their current coverage and potential alternatives to determine the option that will ensure they can use the services they need and providers they want to use while minimizing total healthcare expenses!

(Luke Smith | Humble Dollar)

Financial advisors are familiar with the concept of compound interest, the key to which is not just earning interest on the principal invested, but also on the interest previously earned. This serves as the basis for many saving and investing decisions, as the longer the amount of time a dollar is given to compound, the larger it will tend to grow.

But the concept of compounding is not limited to finances. For example, consider eating habits. While replacing a hamburger with a salad today is unlikely to make a major difference in your overall health, making this tradeoff over the course of several years could result in significant improvements to your health. Or consider exercise; going to the gym once is not likely to improve your health, but doing so over the course of the year can lead to a level of fitness you might not have expected at the outset. Relationships also reflect a compounding process; for instance, it’s hard to become best friends with someone after a single encounter, but as the time spent together increases, the bonds between the two of you can grow exponentially.

Notably, like an individual who amasses a significant amount of high-interest debt, compounding can work against you as well. Whether it is eating unhealthy food on a regular basis or losing contact with a friend or relative over an extended period, the power of compounding can negatively affect your health and relationships.

In addition to these areas of one’s personal life, compounding can also affect an advisor’s business as well. From taking the time to gain the trust of a client (which can pay dividends for decades to come) to investing in a high-quality client experience (which can lead to client referrals that further grow your business), compounding can not only benefit your clients’ portfolios, but also support your business goals as well!

(Morgan Housel | Collaborative Fund)

The world has experienced many advances in the past hundred years. At the forefront of these might be medical care, which has progressed from a time when doctors did not believe in germs (often seeing the dirty nature of their work as a sign of success) to a time when previously fatal diseases and injuries can now be cured easily. These advances represent how the cumulative knowledge of science and medicine has grown over time. And while some medical practices today might be ridiculed in the future, it is unlikely that doctors will conduct surgeries with unwashed, ungloved hands.

Unlike the cumulative nature of medical knowledge, the world of finance demonstrates cyclical knowledge. For example, many of the financial problems of a hundred years ago, from Ponzi schemes to individuals taking on too much leverage, still exist today. While an economic and market downturn might give investors a short-term lesson in the dangers of greed, a market upturn often brings back many of these demons as investors succumb to FOMO (Fear Of Missing Out). Because unlike medicine, which has quantifiable truths, Housel suggests that finance is a combination of vague beliefs and individual circumstances.

And while financial advisors are not immune to forgetting cyclical knowledge, they can play an important role in guiding clients who might be tempted by a ‘hot’ investment product or strategy that, based on historical experience, is likely to be too good to be true. By ensuring that a client’s portfolio is aligned with their goals and overall financial plan, advisors can help them avoid the cyclical mistakes that investors continue to make!

(Mark Manson)

Whether or not you know it, certain mindsets are likely driving the way you think and act. Because mindsets can either be productive or destructive, it is important to recognize the beliefs that are driving your actions and perhaps reconsider them if they are leading you toward a negative place. You can also learn from successful individuals and see where you might be able to apply their mindsets in your own life.

One valuable mindset is to believe that you always have a choice. This ‘growth mindset’ means that you have a certain degree of personal influence over your life, regardless of the circumstances you can’t control. For example, Ursula Burns grew up in a poor family but earned an engineering degree and worked her way up to become the CEO of Xerox who would turn the company’s fortunes around. Had she adopted a ‘fixed mindset’ of not being able to move ahead because of her life circumstances, she almost certainly would not have been as successful. A similar mindset is a bias toward action; while generating ideas (for a book, artwork, or a financial planning business) can be useful, you must actually act on those ideas for them to come to fruition.

Another valuable mindset is defining success internally, rather than externally. When deciding which action to take, we often work from others’ definitions of success rather than our own. But this can leave us unhappy if, for example, we take a certain job because it will make us look successful in the eyes of others instead of one that will be internally fulfilling. For instance, Amada Rosa Perez was one of Colombia’s most famous supermodels, but abruptly cut her career short, opting instead for a life working to lift up poor communities in her country. While outsiders were shocked that she would give up a life of money and fame (which was making her unhappy), by following her own internal definition of success, she pivoted to a calling that ultimately improved her wellbeing.

Another productive mindset shift is letting go of the need to be right. For instance, those involved in the world of finance have many strong opinions, from the ‘right’ investment strategy to predictions of future macroeconomic conditions. But holding on to these opinions too tightly, or having a mindset of always needing to be right, can make you slow-footed when new evidence comes in or conditions change. As an example, the famous investor Ray Dalio went completely broke betting against the market in the early 1980s because he was certain that a market crash was on the horizon. After this embarrassment, he changed his mindset to accept outside views and actively challenge his own beliefs.

Finally, it is important to see the world for what it is rather than what you want it to be. For instance, it can be hard to change others’ views, particularly on strongly held beliefs, even if you think they are misguided. For Patrick Brown, who became a vegan for his own ethical reasons, it was challenging to convince people to give up meat. Instead, he sought to give them an alternative by founding Impossible Foods, which seeks to create artificial meat of similar quality and price as regular meat. By recognizing that he would not be able to convince the world to come around to his beliefs about the ethics of eating meat, he has created an alternative that is more likely to help him achieve his goal of reducing meat consumption.

Ultimately, the key point is that by being aware of your current beliefs and adopting new positive mindsets where appropriate, you can move your business and personal lives in a more successful direction. And while each person’s circumstances may vary, one does not have to be a CEO or a billionaire hedge fund manager to leverage mindsets to make a meaningful difference in your own life or in the lives of others!

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.