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In September 2020, InvestCloud hosted its Elements Virtual Conference, which brought together industry leaders and influencers to examine what they referred to as the four pillars of wealth management technology: 1) a hunger for greater productivity; 2) the drive for faster growth; 3) a call for social consciousness, and 4) a compulsion to race forward into the future. This conference paid special heed to how the onset of the coronavirus delivered a monumental shock to the wealth and asset management industries and hyper-accelerated industry shifts towards remote work, artificial intelligence, and automated company processes. Companies of all sizes were forced to pivot quickly and reinvent themselves to deal with these evolving industry trends. As these changes are expected to be long-term, if not permanent, shifts, it is essential for advisors to proactively adapt to them rather than passively wait for a return to normal.
In this guest post, Craig Iskowitz – CEO and founder of Ezra Group, a financial technology consulting firm – shares his signature Twitter-driven recap of the conference, which featured five key industry experts sharing their analyses of these four central pillars. Craig commences his recap with highlights from Margaret Regan, President and CEO of The FutureWork Institute, and Douglas Contant, President and CEO of the Campbell Soup Company, on reducing the barriers created in remote work while maximizing its advantages. Paul Romer, NYU economist and co-recipient of the Nobel Prize in Economic Sciences, discussed how technology has transformed our economy from the natural limits of physical resources to the eternal growth of ideas and technology.
From there, panel discussion highlights included:
- Data Utilization – In the digital age, a proactive advisor is an advisor that uses data well to recruit clients, anticipate life events, and streamline processes, a feat which is made infinitely easier by combining data and AI technology, and frees up the advisor to maintain a deeper focus on their clients and growing their firm;
- Impression Management – Hard skills can help a firm grow far, but interpersonal skills, even one as simple as being authentic, are critical to connecting with clients over video or in-person;
- Wealth Management – As while the typical wealth management advisor is currently swamped with choices, often juggling five to 15 financial services at once, there is a great need to simplify and streamline their services under larger, more variable platforms, paying special attention to transparency, hyper-personalization, and high responsiveness to allow for the best experience for them and their clients;
- Retirement Personalization – Using AI in smart retirement planning has been getting a lot of hype because of its potential for education and personalization, but it often takes a technologically savvy advisor to make wise decisions – and to optimize their efficiency – while using AI tools.
True to the themes of the conference, the Elements Virtual Conference leveraged technology to its advantage in light of the pandemic. It spread over multiple days and featured a wide range of topics and speakers from outside the industry.
Ultimately, the Elements Virtual Conference embodies the future of the wealth management industry: leveraging technology, flexibility, and a plethora of expertise to deliver unique, applicable information that financial advisors can use to make wise decisions about helping their clients and growing their businesses.
Providing financial planning services takes time. A lot of time. By some industry benchmarking studies, the typical financial planner spends 15-20 hours, and sometimes more, just to gather data, analyze and produce a financial plan, and then deliver it to the client. Which means, not surprisingly, that it’s often necessary to charge clients a substantial financial planning fee to recover the time investment. Especially as financial advisors are increasingly shift to AUM fees and other fee-for-service models, rather than earning a (potentially sizable) commission for the products implemented after the plan is delivered.
Yet the reality is that with the rise of the AUM model in particular, and its recurring revenue potential, it’s actually not necessary to charge upfront for financial planning to get paid for it. Instead, as long as delivering financial planning still provides value, deepens the advisor-client relationship, and improves long-term retention, it’s entirely possible to be “paid well” for financial planning without charging for it separately at all. Because even a relatively small change in client retention rates can produce a sizable ROI for putting in the time and effort to do the financial planning in the first place.
In fact, charging separately for financial planning actually introduces the risk that clients will have “sticker shock” about the cost, and choose not to purchase it at all, which means ironically that charging for financial planning can actually reduce the number of clients who engage in it. By contrast, bundling financial planning into an AUM fee changes the client psychology, subtly encouraging clients to take advantage of the service by making it already included… knowing that clients who do engage in financial planning will be more likely to stick around for the long run anyway.
On the other hand, there is a simple appeal to the “purity” of having clients pay for financial planning at the time they receive financial planning. Nonetheless, the reality across a wide range of industries is that it’s quite common to bundle services together, in a manner that makes some clients more profitable and others less so in any particular year, as long as it averages out over time. And at least with a recurring revenue model, it’s the client’s less-time-intensive years that help to cross-subsidize the more-time-intensive ones – as opposed to a commission-based model, which the profitable clients cross-subsidize other clients instead.
Of course, it’s still impossible to offer “free” financial planning, that is paid by AUM fees over time, for clients who don’t have assets to manage in the first place; for those clients, a fee-for-service model is the only option. Yet for those who do have other means to pay, and other business models to reach them, it’s important to recognize how an advisory firm really can “give away” financial planning and still be paid well for their efforts over time!
It’s no great surprise that the sustainability of retirement income from a diversified portfolio is driven by the returns that the portfolio generates over time. And to the extent that stocks are the driver of long-term returns, the valuation of the markets at the beginning of retirement has a significant impact on long-term portfolio returns throughout retirement.
However, the reality is that bonds often comprise a significant portion of the retirement portfolio, and they do play at least some role in long-term retirement income sustainability. As a result, to the extent that interest rates are especially high – or in today’s environment, are unusually low – yields too can play a non-trivial role in long-term expected portfolio returns.
And the historical data really does suggest that at today’s nominal yields, long-term bond returns are likely to be suppressed, even if rates normalize in the coming years. In fact, extremely low starting bond yields, and the potential subsequent impact on prices if/when/as rates rise, are so impactful that it would be reasonable to reduce long-term 30-year real bond returns by as much as about 2%.
Notably, the eventual climb to higher yields does ultimately result in higher nominal yields in the future. Even from an extremely low starting base, long-term real government bond yields have never been worse than 1%/year over a multi-decade time horizon. Nonetheless, given that the historical real return of government bonds has been closer to __%, the potential to be several hundred basis points lower, for decades to come, is a substantial impact that should be reflected in a retiree’s prospective financial plan.
One of the questions retirees often have is how much they can afford to spend each year over the course of their retirement without depleting their portfolio during their lifetimes, and financial advisors have many tools to aid in this discussion. One classic technique is the use of withdrawal rates; based on asset allocation and historical return data, advisors can calculate a safe annual portfolio withdrawal rate that retirees can use to guide their spending throughout their retirement. However, this approach does not account for the investment returns the clients actually experience in their retirement; for example, the safe withdrawal rate could increase over time if the client experiences strong investment returns in their first few years of retirement.
To solve this problem, advisors can use withdrawal-rate guardrails, which are guidelines to increase or decrease spending when portfolio withdrawal rates reach certain levels. For example, if an initial 4% withdrawal rate calls for $5,000 in monthly spending, the spending amount could be adjusted higher if it reaches 2% of the portfolio value or lower if it hits 6%. Yet, withdrawal-rate guardrails can be flawed because the relatively steady withdrawal rate patterns used do not necessarily align with how retirees actually pull distributions from a portfolio in retirement.
In reality, what is more commonly seen is a “retirement distribution hatchet” in which the initial retirement distribution rates from a portfolio are highest early in retirement, then significantly decline when deferred Social Security is claimed (as late as age 70), and falling further yet because of the tendency for retirees’ spending to decline in real dollars as they move through retirement. A dynamic portfolio withdrawal strategy should also consider other sources of income in retirement (e.g., pensions, rental properties, part-time jobs, house downsizing, and inheritances) that can impact the size of needed portfolio withdrawals to cover spending requirements.
To compensate for this issue, advisors can consider using holistic risk-based guardrails, which reflect current longevity expectations, expected future cash flows, expected future (real) income changes, and other factors. Probability of success via traditional Monte Carlo analysis can serve as the risk metric to guide the implementation of risk-based guardrails. There is a risk of causing anxiety for clients if the risk is presented in terms of the success or failure of their plan as a whole, but advisors can instead use the language of income risk, which may be less stress-inducing. For example, an advisor could explain that if risk increases (e.g., if investment returns are weak), downward adjustments to spending will be needed; alternatively, if risk declines (e.g., because the client has reached an advanced age with a strong portfolio) spending can be safely increased.
Ultimately, the key point is that a risk-based guardrails model can provide clients with a more accurate picture of how much they can sustainably spend than can models based on static withdrawal rates or withdrawal-rate guardrails. While risk-based guardrails can be less efficient to calculate manually than withdrawal-rate guardrails because of the many factors considered in the risk-based model, when properly assisted by technology, risk-based guardrails can be implemented and maintained as efficiently as withdrawal-rate guardrails. And, given how different the retirement distribution hatchet is from the distribution patterns assumed by withdrawal-rate guardrails, the movement from withdrawal-rate guardrails to risk-based guardrails represents a significant improvement in planning quality for retirees!
State-Registered Investment Advisers (RIAs) are subject to numerous regulations in the state(s) where they do business, which, though they vary from state to state, generally have the goal of protecting investors from fraudulent sales practices. These rules require RIAs to file documents (such as Form ADV) with the state, maintain books and records, provide disclosures to clients, and act in the clients’ best interests whenever providing financial advice. Additionally, many (but not all) states set minimum financial requirements – in the form of minimum net capital and/or surety bond requirements – that RIA firms must maintain in order to become (and remain) licensed, to protect consumers from both the risk of fraud, and simply the consequences of negligent or inaccurate advice that could cause them harm. Because of the many differences between each state’s requirements, though, it’s important for RIA owners (especially the founders of new firms) to know their state’s particular rules and how to comply with them.
In this post, Kitces Senior Financial Planning Nerd Ben Henry-Moreland discusses how owners of state-registered RIAs can better understand their minimum net capital and surety bond requirements, and what protection they do (and don’t) provide for both clients and financial advisors themselves.
In states that set minimum net capital requirements, an RIA must hold a certain level of assets over its liabilities. This amount varies not only from state to state, but also often within states, depending on whether the RIA holds custody of client assets and/or has discretionary trading authority over client funds. In practice, states most commonly require RIAs to hold $35,000 of net capital if they have custody, $10,000 if they have discretionary trading authority (but not custody), and to have at least a $0 (i.e., positive and not-negative) net worth if they are an advice-only firm (no custody or discretion), which must be satisfied by holding cash or other marketable (i.e., liquid) investment assets.
In lieu of maintaining a certain amount of capital, though, some states permit RIAs to cover some or all of their net capital requirements with a surety bond instead. State rules for surety bonds can also vary widely, with some states requiring RIAs to hold a surety bond, others allowing firms to purchase a surety bond in lieu of maintaining the state’s net capital requirements, and some choosing not to sanction the use of surety bonds whatsoever. In states that do allow (or require) surety bonds, RIA owners need to know how surety bonds function, what the potential risks of having a surety bond may be, how their state’s surety bond and net capital bond requirements interact (and how to decide whether or not to buy a surety bond if they have a choice), and how to find the best surety bond provider to meet their needs. Though ultimately, surety bonds are appealing relative to net capital requirements because of their significantly lower cost – typically about 1% of the face amount, which means paying $100/year for a $10,000 surety bond.
While net capital and surety bond requirements provide some level of financial protection to RIA clients, that protection is minimal compared to what many clients may actually stake on their advisors’ recommendations. In practice, a legal claim by a dissatisfied client could result in a liability for the RIA that is many times greater than the state’s minimum financial requirements. Accordingly, RIA owners can protect themselves with additional layers of coverage (such as Errors & Omissions insurance) above the minimum amounts that may be required by the states in which they operate. Especially since a surety bond provider has the right to collect any client claims from the advisor, which means it does help ensure a client is made whole – similar to E&O insurance – but doesn’t actually protect the advisor’s own assets the way E&O coverage does!
The key point, though, is simply that because financial advisors are expected to give good advice, and can be held financially liable for advice that results in undesired financial outcomes for their clients, they must have the financial wherewithal available to cover any liabilities resulting from a client’s legal claims. State minimum financial requirements are one of the few ways to ensure that RIAs have assets available (or a surety bond in lieu of assets, where permitted) so clients can be compensated for any damages. But part of being a trusted professional is taking full accountability for the consequences of professional advice… which means it’s essential for the RIA to know not just how much coverage they need to secure to meet their state’s requirements (and in what form), but also how much additional coverage they may need to fully protect themselves (and their clients)!Read More...
