What Inflation Rate Should You Assume For College Expense Planning?

What Inflation Rate Should You Assume For College Expense Planning?

Executive Summary

With the rise of 529 plans and increased focus amongst parents on saving for college, financial advisors have increasingly included college expense planning as a part of the comprehensive financial planning process for clients. And while the mathematics of funding education are relatively straightforward (at least in contrast to more complex retirement planning projections), the reality is that most advisors rely on some very simplistic college expense inflation assumptions for planning purposes (e.g., CPI + 3.0%). Yet, the increasing availability of college expense data reveals that the pace of inflation for college expenses may be slowing – at least for some types of college degrees – and that it’s necessary to take a more nuanced approach to college inflation assumptions.

In this post, Derek Tharp – a Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University – explores the historical data on the rising cost of a college education, and particularly the ways in which college inflation rates have varied based on institution type, location, and even the family income of the student.

For instance, according to the data in the Trends in College Pricing 2016 report (published annually by the CollegeBoard), the reality is that for students looking at private institutions, the common CPI + 3.0% inflation rate typically assumed by financial advisors has actually not been the case for some time now. Instead, the inflation rate for private colleges has been trending substantially lower for more than two decades! Yet by contrast, for high-income families looking at public institutions, a CPI + 3.0% inflation assumption for the cost of college may actually be too low!

In addition to variations by institution type and family income, considerable variability exists by location. For instance, over the past 12 years, annual real college expense inflation at public institutions has ranged from a low of 0% in Ohio to a high of nearly 8%/year in D.C. and Hawaii. Additionally, location-specific trends are made more complex by the role that declining (or increasing) public funding has in increasing (or decreasing) the amount of aid that may be available to students to offset college expenses (which impacts the typical “discount” between the published cost of college and the actual net price that students typically pay).

Of course, just because we’ve seen trends in the past does not mean that those trends will be the same in the future, but particularly given the unique dynamics of college inflation rates for above-average-income families (who most typically work with financial advisors), and the risk that for some clients there may be several college inflation trends moving in the same direction that may substantial increase (or decrease) the savings that clients need to fund their educational goals, the annual CollegeBoard’s Trends in College Pricing report provides a tremendous amount of data that advisors can (and should) use to customize their college inflation assumptions!

Education Planning For College Expenses

With the increasingly burdensome cost of college, parents have become more interested in long-term planning for how to fund their children’s education. Which, in turn, has led financial planners to increasingly see college planning as an important value-add that can be provided to their clients in the financial planning process. And given that tuition inflation has continued to outpace CPI for some time now, setting an assumption for college expense inflation is crucially important for helping clients with their educational goals.

At its core, college expense planning is a fairly straight forward NPV calculation: How much does it take to fund four years of college expenses subject to some special rate of education inflation (to account for the above-CPI-growth rate in college tuition and related expenses)? In contrast to more complex financial planning methodologies that have been developed for retirement planning – such as historical analyses, Monte Carlo simulation, and dynamic programming – college planning seems almost painfully simple.

Once a student is in high school, parents generally at least have a decent idea of what’s next for the student. On top of that, both the timing and the expense are fairly predictable – at least for students who aren’t still many years out from college. Early on, advisors tend to make some basic assumption about college. For instance, attending school for 4 years, at age 18, based on the cost of either a particular in-state school (e.g., a major university) or the client’s own alma mater (“I went to State University and I want little Johnny to go there, too!”). All that’s left is to make assumptions about the growth rate of college savings and the inflation rate for the cost of college itself.

And yet, as many parents are beginning to save into vehicles such as 529 plans earlier and earlier, it is worth taking a closer look at college expense planning assumptions. In particular, the assumed inflation rate, as the reality is that the data in recent decades does not actually support some common financial advisor assumptions. Furthermore, the college inflations trends are not the same for all students, which means that assuming one standard college inflation rate runs the risk of over (or under) saving and potentially penalties (or shortfalls) that could leave parents unhappy when writing tuition checks or withdrawing excess college saving funds in the future.

Typical College Inflation Planning Assumptions

As rising college expenses have garnered much attention over the recent years, financial planners have typically assumed some college inflation rate that is materially higher than the general level of inflation (e.g., CPI + 3%) when planning for college expenses. With a long-term average inflation rate at 3%, this means a typical college inflation rates assumption of 6%.

But the reality is that college inflation varies significantly based on the income and wealth of the student (or at least his/her family), the location of the college, and even the type of educational institution they want to attend.

Examining Historical College Inflation Rates

The CollegeBoard’s Trends in College Pricing 2016 provides an extensive overview of changes in college pricing over time. Anyone deeply interested in this topic is encouraged to review this report in full, but some key findings are highlighted here.

What does the data tell us about historical tuition inflation rates? First, many may be surprised by the current trends in pricing changes. For instance, looking back over the past 30-years, how would you guess current inflation-adjusted tuition inflation rates compare? If you guessed we are near 30-year lows, you would be correct!

Rolling Annualized 5-Year Real Inflation Rates

Of course, this is not the impression that many people have, but the five-year real change in published tuition, fees, and room and board from 2011-12 to 2016-17 was a cumulative 13% (2.4% annually) for private nonprofit four-year institutions and 9% (1.9% annually) for public institutions. By contrast, those inflation rates from 1981-82 to 1986-87 were 35% (6.2% annually) at private institutions and 30% (5.4% annually) at public institutions.

And notably, the rolling 5-year inflation rate at private colleges has hovered around 2.5%/year (or about 13% cumulatively over 5 years) for more than 2 decades now! Similarly, rolling 5-year college inflation rates at public institutions has been on a fairly steady downward trend since the early 2000s, though it remains to be seen whether inflation rates will remain at lower levels (as has been the case with private colleges) or rebound as they did coming out of the late ‘90s.

In other words, even though the “typical” assumption of financial advisors is for college costs to increase at a real rate of 3% (i.e., CPI + 3%), the real rate of change for college expenses is now below that level (and for private colleges, has been for almost 25 years now)!

Beyond this general trend of declining college inflation rates, though, there are at least three key sub-trends that financial advisors need be aware of as well: the variability of inflation by institution type, by location, and by income level of the student’s family.

Varying College Inflation By Type Of Educational Institution

The first factor to consider when helping a client determine the proper rate of college expense inflation is the type of institution their child is targeting. The Trends in College Pricing 2016 report analyzes many different types of institutions, each of which can exhibit different rates of inflation. For most advisors, the most relevant categories are likely:

  1. Public Four-Year In-State
  2. Public Four-Year Out-of-State
  3. Private Nonprofit Four-Year

Notably, the differences in published price levels between these groups are considerable. The average published price for public four-year in-state tuition, fees, and room and board was $20,090, whereas the same cost at private institutions was $43,870. Yet while it is generally well known that there are differences in price levels – and advisors can easily look these prices up for any target school a client is interested in – the reality is that the rate inflation for these costs going forward may also vary significantly!

Based on the long-term data available, we can examine real (i.e., inflation-adjusted) increases in published tuition and fees going back through 1990-91 amongst public four-year and private (nonprofit) four-year institutions:

Annual Real Inflation Rates For Public And Private Colleges

In contrast to the smoothed inflation rates first shown earlier, actual year-to-year inflation is noticeably choppier.

Looking at the historical data since 1990 allows us to make several observations. First, since 1990, changes in average published tuition and fees at public institutions has been more volatile than private institutions. In fact, the standard deviation of real changes over this time period was 2.8% for public institutions and 1.4% for private institutions.

This isn’t entirely surprising, though. Given that public institutions have lower price levels and may operate on the tighter budgets, it is likely that these institutions have less “slack” in their budgets, which may necessitate needing to make more immediate adjustments in pricing. By contrast, private universities, with the highest overall price levels, may be able to make more subtle adjustments in pricing (perhaps by economizing in other areas during lean times).

 Overall Real Change In Published Tuition And Fees From 1990-91 to 2016-17

Additionally, when we examine the cumulative change in prices since 1990-91, it becomes apparent how different small divergences in inflation rates can be compounded over longer time horizons. The geometric average real inflation rates at public four-year and private four-year institutions were 3.95% and 2.59%, respectively. As a result, in real terms, published tuition and fees at public four-year institutions rose 274% since 1990-91 while the rate was only 194% at private four-year institutions.

The bottom line: While the baseline cost of public universities is lower than that of private colleges, advisors may want to consider using a higher inflation rate for children planning to go to public schools rather than private colleges (e.g., 4.0% vs 2.5% above CPI, respectively).

Differences In College Inflation Rates By Location

In addition to variation based on institution type, considerable differences in college inflation rates exist based on the location of the school.

From 2004-05 to 2016-17, cumulative real tuition and fee inflation at four-year public institutions ranged from a low of a 2% decline in Ohio (0% annually) to an increase of a 148% (7.9% annually) in Hawaii, followed by an increase of 145% (7.8% annually) in D.C.

State Level Changes In Published Tuition And Fees From 2004-2005 to 2016-2017

Or, put another way, the geometric average real inflation rates of published tuition at public schools, on a state-by-state basis, have ranged from roughly 0% to 7.9% per year over the past 12 years.

Notably, though, the variability in state-level college inflation isn’t entirely random. There is a weak correlation (r = 0.43) between real price increases in four-year public tuition and fees between 2005-06 to 2015-16 and state population growth from 2005 to 2016.

Which suggests that about 19% of the variation in public tuition and fee growth might be predicted by population growth. Of course, prices generally wouldn’t be rising merely because of population growth, but it’s quite possible that population growth rates may be indicators of a state’s attractiveness as a place to live, including its attractiveness amongst youth as a college destination – potentially meaning that at least some colleges must (or can) raise their prices as a result.

State and local finances also play an important role when it comes to in-state students at public universities. Trends in state level fiscal health and public policy can influence tuition inflation going forward. One notable trend is that, on average, state and local funding for higher education per $1,000 of personal income has been declining over the last 30 years

Average State And Local Funding For Higher Education From 1984-1985 to 2014-2015

What this chart is showing is that from total state and local taxes (which average about $100 per $1,000 of income), a little more than 5% of that is going towards higher education. Of course, these levels (and the changes in these levels) vary by location as well. While overall funding per $1,000 of personal income was $5.28 nationwide, individual states ranged from a low of $1.59 in New Hampshire to a high of $11.41 in Wyoming.

State And Local Funding For Higher Education Per $1,000 Of Personal Income

Not surprisingly, decreasing state and local funding for higher education shifts the cost burden onto students, and we do see that reduced state and local funding is correlated with higher levels of tuition inflation (r = 0.34).

One additional factor included in the total cost of attendance (but not captured in tuition and fees) is room and board. Because of the localized nature of changes in economic factors which influence college prices at the local level (e.g., rental prices), specific local trends will tend to wash out in state level relationships (e.g., the trends in San Francisco are not the same as the trends in Fresno). Factoring in localized changes that influence the cost of college adds yet another level of complexity to planning for college expenses.

Of course, that doesn’t necessarily mean that previous trends will continue in the future, but the key point is that location does matter, and that lots of nuance is lost in the aggregate level statistics that are often used as the foundation for planning assumptions.

Variation In College Inflation Rates By Student/Family Income Level

While “sticker prices” (i.e., the official prices listed by a college) generally get most of the attention when it comes to education inflation, the reality is that these prices are only paid by a small subset of college attendees – most commonly, international students and domestic students with expected family contributions (EFCs) based on their prior-prior year incomes that eliminate them from financial aid eligibility. And notably, students with EFCs that eliminate them from financial aid eligibility are disproportionately the clients of financial advisors.

Accordingly, the CollegeBoard’s Trends in College Pricing 2016 report indicates that there’s a considerable gap between the sticker prices published and the prices students actually pay (even for relatively affluent students).

For instance, while average published tuition and fees for in-state students at public four-year institutions increased 41% (3.5% annually) in inflation-adjusted dollars between 2006-07 and 2016-17, average net tuition and fees – that is, what the average student actually paid after accounting for the aid they received – only rose by 30% (2.7% annually). In other words, nearly 25% of the increase in tuition and fees paid by the average student was actually covered by increasing amounts of student aid.

4-Year Published Versus Net Tuition And Fees (2016 Dollars)

Notably, looking at the “average” student further masks considerable variability that exists amongst students given their family circumstances. For instance, while the average dependent student at a public four-year institution received a 16% discount off of published prices in 2011-12, a student whose family was in the lowest income quartile received a 20% discount, whereas a student in the highest income quartile received a 13% discount. Of course, even segmenting students into quartiles masks some of the true variability, as a student at the 76th percentile may not be receiving the same discount as a student at the 96th percentile (though some aid may be merit based, which, based on relationships between socioeconomic factors and criteria for awarding merit aid, disproportionately goes to wealthier students). But still, even top-quartile students are, on average, paying 13% less than the published sticker price of a public institution.

And the gap was even wider in private four-year institutions, with an average discount rate amongst students in 2011-12 of 39%, though the discount was actually 47% for students with families in the lowest income quartile, and 33% for students with families in the highest. In other words, even families in the highest income quartile are, on average, receiving discounts of 33% off of published prices at private colleges – and those discounts (in percentage terms) have been increasing over time.

Discount Rate By Income Quartile

Still, though, the pace of discounting has been more aggressive for lower-income students than upper-income students, which results in different inflation rates based on the income level of the student. As a result, the net real tuition and fees at four-year public institutions (in-state) rose by 41% (2.9% annually) for the lowest quartile families and 59% (3.9% annually) for the highest quartile families from 1999-00 to 2011-12. Which means that not only have the historical college inflation rates differed based on income, but that for the families that advisors disproportionately work with (highest quartile families), the “standard” 6% inflation rate (CPI + 3%) actually could be too low in some circumstances!

By contrast, at private nonprofit universities, tuition and fee inflation rates were actually lower for families in the highest income quartile. Real tuition and fee inflation rates (based on the net cost of private college) were 3.0% for families in the lowest quartile, but only 1.3% for families in the highest income quartile, over the same time period.

Making College Expense Inflation Assumptions In Practice

One of the main benefits of simple college expense inflation assumptions is that they are just that: simple.

Yet as the CollegeBoard’s Trends in College Pricing 2016 report so aptly demonstrates, there is a lot of complexity in understanding the true changes in college pricing over time. And while there’s always a risk that trends may reverse or may not be predictive of the future, the data still suggests it’s not best to simply use one rate of college expense inflation for all clients. In reality, we may want to at least “shade” our estimates in certain directions based on historical averages and current trends. And there are many situations where the standard “CPI + 3%” assumption is not a good fit at all.

Consider two examples where the underlying factors are the same with the exception of whether a student is interested in a private or public institution:

Example 1. Suppose a child is interested in a public college. We may start by looking at the average tuition and fee inflation at public four-year institutions since 1990-91. Since the geometric average real rate of tuition and fee inflation was roughly 4.0%, perhaps we feel comfortable starting with an assumption of CPI + 4.0%. Next, we note that the client is in the highest income quartile, which, in recent history, has experienced higher inflation rates by about 1.0 percentage point, so we bump the assumption up to CPI + 5.0%. Next, we note that, over the past decade, schools within the state of interest have lagged national inflation rates by about 0.5% (see CollegeBoard’s Trends in College Pricing 2016 for state-specific details), so perhaps we decrease the assumption down to CPI + 4.5%. Finally, we note that state budget cuts have been reducing funding available for education and there is little indication that trend will change soon, so perhaps we adjust the final estimate up to CPI + 5.0%.

Example 2. Suppose instead that the child is interested in private school. Since the geometric average real rate of tuition and fee inflation was roughly 2.5% since 1990-91, perhaps we feel comfortable starting with an assumption of CPI + 2.5%. Next, we note that the client is in the highest income quartile, which, in recent history, has experienced lower inflation rates by about 0.5 percentage points at private institutions, so we adjust the assumption down to CPI + 2.0%. Next, we note that, over the past decade, schools within the state of interest have lagged national inflation rates by about 0.5%, so we decrease the assumption further to CPI + 1.5%. Finally, though the state has recently seen budget cuts and there is little indication that trend will change, since state and local funding has less impact on private education costs, we make no adjustment for this trend (though perhaps similar trends regarding an institution’s endowment and donor activity would warrant similar adjustments!).

College Inflation Summary Graphic

Notably, the baseline inflation rate has been lower in recent history than what is indicated above and some of the relationships between different factors can be more complex than a simple chart can capture, but the key idea here is to illustrate the different steps and adjustments advisors may want to consider, customized to reflect their own views on college expenses going forward and the unique circumstances of their clients.

Of course, on average, we would actually expect different factors to cancel out in many cases (as that is quite literally what an “average” is getting at). Nonetheless, the most important thing to guard against is situations where all the indicators are mostly point in one direction – and to recognize that the inflation trends for above-average-income students is not always what one might expect (e.g.., the inflation rate for the net cost of private colleges for upper-income students has only been 1.3% since 1999, but lower-income students at public institutions are still trending at close to 3% inflation above CPI!). In other words, at least a subset of college students may need to be prepared for significantly higher or lower college expense inflation going forward than the average figures imply.

Additionally, advisors may want to spend some further time investigating current trends in both their local market and key college destinations for their clientele. Of particular interest may be states like California and Texas, which, according to the CollegeBoard’s Trends in College Pricing 2016 report, enroll 22% of the nation’s public college students. Additionally, the Census Bureau has lots of great data for looking at certain demographic trends, and most state governments provide fairly extensive information regarding local budgets online.

In the end, there’s no one right way to do college expense planning, but the data is available to help advisors try to identify trends and customize the all-important inflation assumption for college expenses to a particular client’s situation.

So what do you think? Should financial advisors use one college expense inflation assumption for all clients? What college inflation assumption do you use? Do you adjust inflation rates with your clients? Please share your thoughts in the comments below!

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The Conflicts Of Interest Between RIAs And Their Custodians (and Brokers And Their B/Ds)

The Conflicts Of Interest Between RIAs And Their Custodians (and Brokers And Their B/Ds)

Executive Summary

The need to manage conflicts of interest is a central issue in meeting an advisor’s fiduciary obligation to clients, whether it’s part of an RIA’s fiduciary duty under the Investment Advisers Act of 1940, or any financial advisor’s obligation when serving any retirement investors under the Department of Labor’s fiduciary rule. Yet the reality is that prospective conflicts of interest go beyond just those that financial advisors may face with the product compensation they receive for implementing various insurance and investment products. In fact, financial advisors often face direct conflicts of interest with the very platforms they’re affiliated with, particularly when it comes to practice management advice in how to grow their own business and serve their clients!

In this week’s discussion, we discuss the conflict of interest that exists between RIA firms and their RIA custodian platforms (as well as between brokers and their broker-dealers), and why advisors should perhaps be a bit less reliant on their platforms for financial planning education and practice management insight, given the “conflicted advice” they’re receiving!

A straightforward example comes up in the context of whether financial advisors should aim to serve “next generation” clients – in particular, the next generation heirs of their existing clients. Concerned about the assets that might leave their platform, RIA custodians regularly encourage and urge advisors to build relationships with the heirs of their clients, so that the assets don’t leave. Yet ultimately, that just emphasizes that to the custodian, the “client” isn’t even the client – it’s simply their pot of money, that the custodian wants to retain, regardless of who owns it… which means pursuing the assets down the family tree. By contrast, financial advisors who are focused on their clients – the actual human beings – would often be better served by simply focusing on who they serve well… which means if the firm is retiree-centric, the best path forward is not to chase pots of money to next-generation heirs when their retired clients pass away, and instead is simply to go find more new retirees! In other words, advisors are getting advice from their RIA custodians to pursue next-generation clients is often based more on what’s in the custodian’s best interests, not necessarily what the advisor’s best interests for their practices!

Another way that RIAs sit in conflict with their RIA custodial platforms is that in the end, one of a fiduciary advisor’s primary goals is actually to proactively minimize the profit margins of our RIA platforms! Thus, advisors try to minimize transaction costs, lobby for lower ticket charges on trading, pick the lowest-cost share classes that don’t have 12b-1 fees or revenue-sharing agreements, find the optimal balance in selecting No Transaction Fee (NTF) funds versus paying transaction fees based on the size of the clients’ accounts and what will be cheapest for them, obtain best execution pricing regardless of order routing kickbacks, and minimize client assets sitting in cash. And all of this matters, because how do RIA custodians actually make money? Ticket charges, revenue-sharing from asset managers, getting basis points on NTF funds, order routing revenue on execution, and making a 25+ basis point interest rate spread on money market funds. Which means the better the job that the RIA does for its clients, the less profitable they are for their RIA custodian (a fact that advisors are often reminded of by their RIA custodian relationship managers!), and RIAs have a fundamental conflict of interest between being “good advisors” for their custodial platform and watching out for their clients’ best interests.

Notably, this phenomenon is not unique to RIAs. It’s perhaps more noticeable because we usually talk about RIAs as being fiduciaries that are minimizing their conflicts of interest, but it’s equally relevant for those who work on a broker-dealer platform as well. Because as product intermediaries, broker-dealers ultimately make their money off of transactions, and it is impossible to sell financial service products without a broker-dealer! Yet the challenge is that the B-D can make more when they are offering both compliance oversight and getting a slice of GDC on all transactions, as opposed to just a compliance oversight slice of advisory fee business. Which means that while a fee-based business model may be more stable and valuable in the long run for a financial advisor, able to grow to a larger size and sell for a higher multiple, B-Ds are often at risk for making less money as their advisors shift to fee-based business that makes more for them (or alternatively, forces the B-D to increasingly try to reach into the advisor’s fee-based business with ever-expanding “compliance oversight”).

The point is not to paint every B-D or RIA custodian in a nefarious light – as they’re just trying to run their businesses – but it’s crucial to understand that in many situations, what’s best for the broker-dealer or RIA custodian is not necessarily best for the advisor on the platform. Which is concerning, because too many advisors don’t seem to acknowledge these inherent conflicts of interest, especially since advisor platforms are often the primary place they go for financial planning education and practice management insight, not realizing the conflicted advice they are receiving. And so, while it can be great to take advantage of some of the resources that these platforms provide, advisors should still be careful to consider whether the advice they receive is really in their best interests as an advisor, or ultimately about maximizing revenue for the platform instead!

Is Your Client The Person Or Their Pot Of Money? [Time – 0:56]

I’ll give you an example. In recent years, there’s been a huge amount of buzz in the industry about the need for financial advisors to build relationships with their “next-generation” clients; i.e., the heirs of their current clients who are likely to inherent the wealth of their existing clients over the next 10 or 20 or 30 years. Now on the one hand, it sounds kind of intuitive. The typical RIA is focused on doing retirement planning, which by its nature means a somewhat older set of clientele who are at greater risk of passing away. So why not try to build a relationship with their heirs so that you can retain the assets?

But let’s think about this for a moment. I’m going to translate it to another industry. Let’s pretend that you run a nursing home for affluent seniors who can pay the full price you’re charging for your high-quality service. Now, this nursing home is likely to be a very profitable business since you’re serving affluent clientele, but it’s got one fundamental problem: Like a retiree-centric advisory firm, the people who pay you in a nursing home tend to keep passing away. Kind of a problem. And then their assets that they were using to pay you vanish to the next generation, and you won’t get paid for that nursing home room anymore.

So you say, “Hey, I’ve got a great idea. Let’s become a really tech-savvy nursing home. We’ll wire up every room with Apple TV and we’ll make it so you can lock and unlock your room with your iPhone, and we’ll make a cool website that lets you sign up and choose your room entirely digitally, and we’ll start doing classes on how to make responsible housing choices for young people.” In other words, we’re going to do whatever it takes to make this nursing home one that our patients’ next-generation kids would want to move into once their parents or their grandparents pass away by building a relationship with them and then making our services more tech-savvy to appeal to a younger generation.

But of course, there’s one thing that this nursing home exercise is kind of forgetting in the endeavor. It’s a nursing home. It doesn’t matter how tech-savvy and Millennial-centric it tries to be, it’s a nursing home. Give the Millennials a little credit to realize that they probably don’t want to live in a nursing home. They want to live somewhere that’s relevant for them. Which means the best strategy for the nursing home with patients who keep passing away isn’t to try to get their next-generation heirs to use their inherited money to keep paying for the nursing home room; it’s to find new, affluent seniors who would want to move into the empty nursing home room.

And I find this analogy fits quite well for financial advisors. How many advisors have retiree-centric, baby boomer-centric firms and are rolling out next-generation client initiatives to try to build a relationship with the heirs of their clients and trying to be more tech-savvy to retain them, and somehow assume that the next-generation heirs aren’t going to notice that you’re still an advisory firm for retirees that isn’t focused on their needs?

I’ve written about this before. You can’t just make your website tech-savvy and put a robo advisor button between the images of the lighthouse and the Adirondack chairs overlooking the beach on your website and expect to get Millennial clients. It’s not going to happen. Or, viewed another way, the key point here is that when you try to pursue the money down the family tree, what you’re really saying is “My client isn’t actually the human being I’m serving. My client is their pot of money. And I’m just going to chase the pot of money wherever it goes, regardless of who’s actually holding it. I don’t even care who the person is. I’m just serving the pot of money.”

Because again, if you were really focused on trying to be the best you can at serving your ideal client than your clients or retirees who sometimes pass away, your goal would be to find more retirees because that’s who you serve. Not chase the pot of money.

But here is the important distinction. For the RIA custodian, they don’t have the relationship with the client; we do as the advisors. They, the custodian, literally hold the pot of money because they’re a custodian, it’s what they do. So for them, the “client” isn’t the person, it actually is the pot of money.

And that’s why when you look closely, you realize that virtually everything being written about how advisors must pursue their next-generation clients is all coming from the RIA custodians. Because their client is the pot of money. They don’t have a relationship with the person. They rely on the advisor for the relationship with the person.

And so, what do the custodians do? They egg on the advisors to chase the pot of money instead of focusing on their ideal client because the custodian is concerned about the demographics of their own pot of money and not the advisor’s business. It’s a fundamental conflict of interest around practice management advice. Advisors serve their ideal clients until they retire themselves in 10 or 20 years. Custodians serve pots of money and are ongoing, indefinite businesses. So the custodians care a lot more about multi-generational pots of money than advisors ever need to do. And as advisors, we care about our clients.

But the end result? Sometimes, we get what I think is actually really bad advice from our custodians based on what’s in their best interests instead of what’s in our interest as advisors and advisory firm business owners.

Fiduciary Advisors Exist To Optimize Away RIA Custodian Profit Margins

Now, another way that RIAs sit in conflict with our custodial platforms is that in the end, one of our primary goals as advisors is essentially to proactively minimize the profit margins of our RIA platforms. Think about it a moment…for instance, as fiduciary RIAs, it’s common for us to do whatever we can to minimize transaction costs. So we push for lower ticket charges, we pick the lowest-cost share classes that don’t have 12b-1 fees or rev sharing to platforms. We choose no transaction fee or NTF funds for our small clients where a ticket charge would be cumbersome. But then we flip back and pay the transaction fees for our larger clients where that would be cheaper than the higher basis point expense ratio of NTF funds.

Similarly, we try to minimize the amount of client assets that sit in cash. We tend to discourage clients from taking on additional risks through margin loans. We even have an obligation from the SEC to obtain best execution pricing, regardless of whether how much the platform might be getting paid for order routing to certain exchanges.

And all this matters because how do RIA custodians actually make money? Ticket charges, revenue sharing from mutual funds, making margin loan interest, getting basis points and NTF funds, making their 25 basis point interest rates spread on money market funds, and order routing revenue on execution. Basically, our primary goal as RIAs is to minimize every point of revenue generation for an RIA custodian. Because every dollar that doesn’t go to the RIA custodian as a cost is another dollar that accrues to client. Which improves their wealth, which makes our performance look better, and even to a slight degree, the size of the portfolio that we get to bill on in the future because it didn’t to go to RIA platform fees.

And it’s a fact that RIA custodians often remind us about. How many RIA owners out there have had a recent conversation with their RIA custodian where they were reminded from the custodian about whether how profitable they are as an RIA on the custodian’s platform? Usually right before you begin to negotiate your soft dollar agreements or whether the custodian is willing to make some concession you were requesting for a client.

Because the realities of the RIA custodian business model is built on these incredibly thin margins that rely on huge amounts of dollars in these profit centers to work, even as we try to minimize them. I mean, think about just the cash position alone for a minute. So Schwab has upwards of $1.3 trillion in advisor assets. Now let’s imagine for a moment that the typical advisor keeps 3% in cash in their client portfolios. Maybe a little bit is a holdback for fees, some is to fund the client’s ongoing retirement distributions. Maybe a little bit of it is new savings or portfolio additions that haven’t been invested yet.

Now across $1.3 trillion, a 3% cash position amounts to $39 billion in cash. And so, if Schwab makes 25 basis points on that cash as an interest rate spread in their money market, that’s almost $100 million of revenue just from the small percentage of idle cash in money markets. And then, what happens if the advisory firm adopts rebalancing software that makes it easier to identify clients that have idle cash and get it invested? If widespread use of rebalancing software drops the average cash balance by 1%, making client portfolios more efficient and better invested, Schwab loses about $30 million of profit straight off the bottom line by not getting the money market spread. And heaven forbid, services like MaxMyInterest get off the ground.

For those who aren’t familiar, MaxMyInterest connects a client’s investment accounts to a bunch of outside banks and then tries to automate the process of moving the cash in and out of the custodian’s investment accounts and amongst the outside banks to maximize the yield on the client’s cash. So if some online bank offers a slightly better yield, MaxMyInterest just automatically shifts the money over to wherever it gets the best yield. Great service for clients, increases their returns, and it’s a nice value-add for the advisor. And if it takes the average cash balance down by 2% on average because that money moves to external banks with better yields, Schwab loses $65 million in profits like that. It’s a huge conflict.

Now I don’t mean to paint an antagonistic picture here between RIAs and their custodians. But it’s crucial to recognize that as advisors, what profits the RIA custodian takes money out of our clients’ pockets. And what keeps money in our clients’ pockets that we try to fight for our clients takes it away from the custodian’s profitability.

And so, like it or not, we have a fundamental conflict of interest between being good advisors for our custodial platform and being good advisors that watch out for our clients’ best interests. Whether it’s trying to minimize cash balances, move money off-platform for better yields, optimize when to pay ticket charges and when to use NTF funds for smaller clients; all of those things that we do minimize profit for the platform.

How Broker-Dealers Are In Conflict With Their Brokers

Now, it’s worth noting that this phenomenon actually isn’t unique to RIAs either. It’s maybe more noticeable because we usually talk about RIAs as being fiduciaries that are minimizing conflicts of interest. But it’s equally relevant for those that work for broker-dealer platforms as well. Because, in the end, the fundamental model of a broker-dealer is that they’re an intermediary for financial services’ product distribution. You can’t sell a financial services product without a broker-dealer. And every time you do, the broker-dealer gets a slice of that GDC. The more products you move, the more money they make by getting a piece of every transaction.

By contrast, because their business model is built around being a product intermediary, there’s not much money for a broker-dealer when advisors shift to advisory fees, and especially when they start charging separate fees for financial planning. Because the broker-dealer can’t make as much by taking a slice of planning fees as they do from products. Not only because payouts from products tend to be lower than payouts from financial planning fees which means the broker-dealer keeps a little more, but also because the slice of GDC isn’t even the only way that a broker-dealer makes money on that transaction. When the brokers on the platform do a higher volume of product transactions, the broker-dealer gets to go to the asset manager or product manufacturer and get them to pay money to sponsor conferences, to pay for shelf space and due diligence, or to pay for better revenue sharing terms. Simply put, the broker-dealers profit more from their advisors having them get paid through products for financial planning than when advisors get paid fee-for-service financial planning advice.

And in that context, it’s maybe no great surprise that broker-dealers have been so negative on the Department of Labour’s fiduciary rule. Because if the advisor on the platform shifts from product commissions to fees, even if they generate the same revenue and do the same services for the same clients, the broker-dealer doesn’t make as much money. The client may be just as well served, and the advisor may be just as capable, but the BD gets squeezed. Which results in this bizarre environment that we currently have where one advisor serving after another shows that the overwhelming majority of advisors support a fiduciary rule that acts in the best interest of their clients, including both advisors at RIAs and at broker-dealers. But the broker-dealer community has been the most vocal in fighting the fiduciary rule and the most active lobbying in Washington against it. Not because it’s necessarily for the advisors at the broker-dealer, but because it’s bad for the broker-dealer itself. And so, the broker-dealer community has been trying to convince its brokers that it would be bad for them too, when it’s really not the brokers that are challenged; it’s the broker-dealers that need to reinvent themselves after DoL fiduciary.

And these problems crop up in other areas as well. This is why a lot of broker-dealers are pushing their advisors to pursue next-generation clients. They have the same generational challenges as the RIA custodian whose client is really the pot of money, even though the advisor’s client is the actual human. And at least some broker-dealers limit product selection on their platforms based not necessarily on what products are best for their advisors or clients, but which ones are most willing to pay shelf space, better revenue sharing terms, or more money at the next conference to sponsor.

And David Grau has written extensively on how succession planning departments at a lot of broker-dealers are encouraging their advisors to take what are actually very bad succession planning deals for the advisor because it facilitates an on-platform transaction which keeps the clients and assets for the broker-dealer, even if it fails to maximize the value of the deal for the advisor who’s selling the practice.

Now again, as with RIA custodians, I don’t want to paint every broker-dealer in a nefarious light. They’re just trying to run their business model as RIA custodians do, and the reality is that they need to make money somehow and it has to come from somewhere, whether it’s the advisor or the client or both.

But is the key point to recognize the conflicts of interest that do exist between RIAs and their custodians, and between brokers and advisors and their broker-dealer platforms. Which is concerning, because, for so many advisors, their platforms are the primary place they go for education and insight and practice management advice, often not realizing the “conflicted advice” that they’re receiving from their platforms. And these platforms are also the primary advertisers for most of the trade publications, and the ones that push these same issues and topics into the industry media. Again, done in the manner that’s ultimately about maximizing revenue for the platform, not necessarily actually giving the best practice management advice for the advisor. This is actually one of the reasons that I originally launched the Nerd’s Eye View blog in the first place, because I felt there was a need for some kind of platform where advisors can actually hear objective advice from a colleague not colored by the economics of their RIA custodian or broker-dealer platform.

I hopes this provides some food for thought, as well as an understanding that while a lot of RIA custodians/broker-dealers really do try to help their advisors succeed, it’s important, as with any form of conflicted advice, to take it with a grain of salt, and to recognize the potential conflicts that may underlie whatever practice management advice you’re getting. Especially since the conflicts of interest between advisors and their platforms do not necessarily get disclosed the way that so many other conflicts of interest get disclosed to clients.

This is “Office Hours with Holman Skinner” at normally 1:00 p.m. East Coast time on Tuesdays, although obviously, I was a little bit late today. But thanks again for joining us and have a great day, everyone.

So what do you think? Do fiduciary advisors inherently eat away at RIA custodian profits? Do many advisors realize these conflicts of interest exist? What could be done to avoid these conflicts? Please share your thoughts in the comments below!

Differentiating The Next Generation Of Financial Planning Software

Differentiating The Next Generation Of Financial Planning Software

Executive Summary

Financial planning software has changed substantially over the years, from its roots in demonstrating why a client might “need” certain insurance and investment products, to doing detailed cash flow projections, goals-based planning, and providing account-aggregation-driven portals. As the nature of financial planning itself, and how financial advisors get paid for their services, continues to evolve, so too does the software we use to power our businesses.

However, in the past decade, few new financial planning software companies have managed to gain traction and market share from today’s leading incumbents – MoneyGuidePro, eMoney Advisor, and NaviPlan. In part, that’s because the “switching costs” for financial advisors to change planning software providers is very high, due to the fact that client data isn’t portable and can’t be effectively migrated from one solution to another, which means changing software amounts to “rebooting” all client financial plans from scratch.

But perhaps the greatest blocking point to financial planning software innovation is that few new providers have really taken an innovative and differentiated vision of what financial planning software can and should be… and instead continue to simply copy today’s incumbents, adding only incremental new features while trying to forever be “simpler and easier” – without even any clear understanding of what, exactly, is OK to eliminate in the process.

Nonetheless, tremendous opportunity remains for real innovation in financial planning software. From the lack of any financial planning software that facilitates real income tax planning, to the gap in effective household cash flow and spending tools, a lack of solutions built for the needs of Gen X and Gen Y clients, and a dearth of specialized financial planning software that illustrates real retirement distribution planning (using actual liquidation strategies and actual retirement products). In addition, most financial planning software is still written first and foremost to produce a physical, written financial plan – with interactive, collaborative financial planning often a seeming afterthought, and even fewer financial planning software solutions that are really built to do continuous ongoing planning with clients (not for the first year they work with the financial advisor, but the next 20 years thereafter), where the planning software monitors the client situation and tells the advisor when there’s a planning opportunity!

Fortunately, though, with industry change being accelerated thanks to the DoL fiduciary rule, the timing has never been better for new competitors to try to capture new market share for emerging new financial advisor business models. Will the coming years mark the onset of a new wave of financial planning software innovation?

The Evolutionary Progression of Financial Planning Software

In the early days of financial planning, the reality was that virtually no one actually got paid to deliver a financial plan. Instead, financial advisors were compensated by the financial planning products they implemented – i.e., insurance and investment solutions – and the role of the “financial plan” was actually to demonstrate the financial need. Thus why the early financial planning software tools like Financial Profiles (founded in 1969) focused on retirement projections (to show the investor he/she needed to save and invest more… with the financial advisor), insurance needs (to show a shortfall in insurance coverage), and estate tax exposure (as life insurance held inside of an Irrevocable Life Insurance Trust was a very common strategy when estate tax exemptions were lower). Financial planning software was product-centric.

By the 1980s, though, there was an emerging movement for financial planners to actually get paid for their financial plans, from the birth of NAPFA in 1983, to the rise of financial-planning-centric brokerage firms like Ameriprise (then IDS) and insurance companies like Connecticut General (later Cigna Financial Advisors, then Sagemark Consulting and now Lincoln Financial). The challenge, however, is that to get paid for a financial plan, the rigor of the financial planning analysis had to stand as a value unto itself, beyond just demonstrating a product need. Fortunately, though, the rise of the personal computer meant that financial advisors could purchase and use complex analytical tools that could analyze financial planning strategies with greater depth than what virtually any consumer to do themselves. Accordingly, 1990 witnessed the birth of EISI’s NaviPlan, the first “cash-flow-based” financial planning software, which was substantively differentiated from its predecessors in its ability to model detailed long-term cash flow projections.

The virtue of cash-flow-based financial planning software like NaviPlan was that it allows for incredible detail of every cash flow in the client household. Income, expenses, and savings could all be projected, along with the growth on those savings over time, creating a rigorous financial plan that substantiated a standalone financial planning fee. The problem, however, was that by modeling every cash flow, it was necessary to input and project every cash flow – as projecting income without the associated expenses would imply “extra” money for saving that might not really be there. And NaviPlan didn’t really have a means of just projecting the cash flows that were relevant to a particular goal; instead, it implicitly modeled all cash flows, and then showed whether all of the future goals could be supported. As a result, the arduous and time-consuming nature of inputting data into cash-flow-based financial planning tools led to the advent of MoneyGuidePro in 2000, and the birth of “goals-based” financial planning software, where the only cash flows that had to be inputted were the specific saving inflows and spending outflows of that particular goal.

The birth of goals-based financial planning software made it much easier for financial planners who wanted to just focus on a particular goal – most commonly, retirement – to create a financial plan around just that goal. Accordingly, the software was especially popular amongst the independent RIA community (which operates on an AUM model and is primarily paid for demonstrating a need to save and accumulate assets for retirement), along with retirement-planning-centric broker-dealers and insurance companies. The caveat, however, is that once a goals-based financial planning projection is delivered, there isn’t much to do with the software on an ongoing basis. As long as the client remains reasonably on track to the original plan in the first place, each updated planning projection will simply show the same retirement and wealth trajectory as the last. And from a practical perspective, a long-term multi-decade plan just doesn’t move much from year to year anyway (not to mention quarter-to-quarter or month-to-month). Consequently, a gap emerged for financial planning software that could actually show meaningful tracking of what is changing in the client’s plan on a year-to-year and more frequent basis… and thus was the rise of eMoney Advisor, which was also founded in 2000 but really gained traction in the 2010s as account aggregation tools like Mint.com made consumers (and financial advisors) increasingly aware of the value and virtue of continuously tracking and updating a household’s entire net worth and cash flows… a Personal Financial Management (PFM) dashboard that goes beyond just their portfolios, or their progress towards ultra-long-term goals.

From the perspective of financial planning software differentiation, this progression from product-needs-based to cash-flow-based to goals-based to account-aggregation-driven helps to define when and why certain companies have grown and excelled over the past several decades, while others have languished and struggled to gain market share. Because the reality is that as long as the client data in financial planning software isn’t portable and able to be migrated, changing financial planning software solutions is an absolutely massive and potentially firm-breaking risk (as it disrupts the foundation on which many advisors build their value), which means it takes substantial differentiation in tools and capabilities to attract advisors away from competing solutions. In other words, in a world where the switching costs of financial planning software are so high, it’s not enough to be 10% or 20% better, and barely sufficient to even be 10X better… it’s necessary to be fundamentally different, in a way that advisors can create new value propositions they simply couldn’t deliver in the past (as was the case in the progression from financial planning software focused on product needs, then cash flows, then goals, and then account aggregation).

The Progression Of Differentiation In Financial Planning Software

Real Financial Planning Software Differentiators Of The Future

The reason it’s necessary to understand the progression of financial planning software differentiators of the past, is that it’s essential when trying to identify what prospective differentiators might allow financial planning software to break out in the future – which is one of the most common questions I’ve been receiving lately in my FinTech consulting engagements with various (new and existing) financial planning software firms.

Because the fundamental challenge is that, as noted earlier, it’s not enough to just be 10% better or faster or easier or more efficient. Due to the incredibly high switching costs for most financial advisors already using financial planning software, it’s crucial to be fundamentally different to grow and compete.

Fortunately, though, the reality is that there are still ample areas in which financial planning software providers could substantively compete and be meaningfully differentiated. Just a few of the options include:

Real Tax-Focused Financial Planning. One of the easiest ways for financial advisors to show clear value in today’s environment is through proactive income tax planning strategies, as real-dollar tax savings can easily more-than-offset most or all of a comprehensive financial planning fee. Yet unfortunately, most financial planning software today is very weak when it comes to detailed income tax planning, especially when considering the impact of state income taxes. A tax-focused financial planning software solution would project actual taxable income and deductions from year to year in the future, with future tax brackets (adjusting for inflation), and include the impact of state income taxes (which most financial planning software companies complain is “arduous” to program, despite the fact that companies like US Trust publish an annual tax guide with the state tax tables of all 50 states!). Of course, the reality is that the tax law can change in the future, and there is such thing as trying to be overly precise in estimating financial planning software inputs. Nonetheless, “simple” assumptions like an effective tax rate in retirement grossly miscalculate tax obligations over time, and utterly fail to represent the positive impact of prospective tax strategies; after all, how can you possibly show the value of the backdoor Roth contribution strategy, or systematic partial Roth conversions in low income years, if the software always assumes the same (static average) tax rate in retirement? How can any financial advisor illustrate strategies that minimize the adverse impact of RMDs, when the financial planning software assumes that the client’s tax rate won’t be going up when RMDs begin!? And failing to account for the fact that moving from New York or California to Texas or Florida in retirement saves nearly 10% in state income taxes is an egregious oversight. Simply put, tax planning has real value, and financial planners shouldn’t be constrained to illustrating the value of tax strategies in isolated software tools like BNA Income Tax Planner, when it could – and should – be part of the holistic financial plan.

Spending And Cash Flow Planning. Historically, financial advisors have focused their advice on investments and insurance, for the remarkably simple reason that that’s how most advisors get paid (either for implementing such products and solutions, or managing them on an ongoing basis), and as a result that’s where most financial planning software has focused. However, from the consumer perspective, the center of most people’s financial lives is not their long-term financial plan, nor their insurance and investments; it’s their household cash flow, which is their financial life blood. Thus why Mint.com grew to 10 million active users in just their first 5 years – which would be almost 10% of all US households – while the typical financial advisory firm struggles to get 20% – 30% of their clients to log into their (non-cash-flow-based) financial planning portal once or twice a year. And there’s substantial evidence that regular use of financial planning software to track spending matters – one recent study on Personal Capital’s mobile PFM app by noted behavioral finance researchers Shlomo Bernatzi and Yaron Levi found that the average Personal Capital user cut their household spending by 15.7% in the first four months after using the mobile app to track their spending. And that’s just from using the software, without the further support of a financial advisor (and without even specifically setting a budget of targeted spending cuts!)! Imagine the enhanced value proposition of the typical financial advisor if the average client boosted their savings rate by over 15% in just the first few months of the relationship, because the financial planning software gave them the tools to collaborate on the process! In today’s world, most financial advisors don’t work with clients on their cash flow – in part because it’s difficult to show value, and in part because it’s very challenging to get clients to track their spending in the first place… but as tools like Mint.com and Personal Capital have shown, software can effectively help to solve both of these challenges!

Planning For Gen X and Gen Y Clients. The overwhelming majority of financial advisors are focused on Baby Boomer and Silent Generation clients, for the remarkably obvious reason that “that’s where the money is”. Yet the end result of this generational focus is that virtually all financial planning software tools are built for the needs of Baby Boomers with assets, particularly when it comes to retirement planning – from illustrating the sustainability of retirement withdrawals, to the timing of when to begin Social Security. And as a result, not a single financial planning software solution can effectively illustrate the core financial planning issues of Gen X and Gen Y clients, such as strategies to manage the nearly $1.4 trillion of student loan debt (which is more than all credit card debt in the US across all generations, but student loan debt is concentrated almost entirely amongst just Gen X and especially Gen Y clients!). Similarly, financial planning software lacks other tools relevant for planning for younger clients, including other debt management tools, budgeting and cash flow support, and helping to project the financial consequences of major career decisions (e.g., how much does the primary breadwinner need to earn to stay on track if one spouse makes a change to stay home with children, or how much does a new career need to pay in salary to make up for the cost of taking time out of the work force to go back to school for a career change in the first place?). More generally, financial planning software is entirely devoid of any “human capital planning”, despite the fact that for most Gen X and Gen Y clients, their human capital is their single largest asset.

True Retirement Distribution Planning. While virtually all financial planning software solutions include “retirement planning” as a key module, most actually do very little to illustrate actual retirement distribution planning strategies. For instance, is it better to liquidate an IRA first, or a brokerage account, or use the brokerage account while simultaneously doing partial Roth conversions? How can an advisor really evaluate if a particular annuity product would be better for the client’s plan, when no financial planning software can actually illustrate specific annuity products (ditto for loan-based life insurance strategies for retirement income). Would the client be better off using a bucket strategy instead of a traditional total return portfolio? Will the retirement plan come out better if the equities are in the IRA or the brokerage account? If there was a severe market downturn, most clients would likely trim their retirement spending for a few years… so why doesn’t any financial planning software allow advisors to model dynamic spending strategies where clients plan, up front, to trim or increase their spending based on what the markets provide (or what the various Monte Carlo scenarios project), to help simulate how much (or how little) of an adjustment would be necessary to actually stay on track in a bear market (and then produce a Withdrawal Policy Statement for the client to sign). More generally, why doesn’t any comprehensive financial planning software illustrate strategies like the 4% rule or Guyton’s guardrails, despite the robust retirement research literature to support them? Simply put – financial advisors provide a tremendous range of specific, implementable retirement strategies that have to be illustrated and explained in a piecemeal process outside of financial planning software, because today’s tools aren’t capable of illustrating what advisors actually do.

Collaborative Financial Planning Software (No More Paper Reports!). Financial advisors have been going increasingly “paperless” and digital in recent years, aided in no small part by the explosion of digital onboarding tools as the advisory industry has stepped up to match robo-advisor innovations. However, today’s financial planning software tools are still built with a “printed report first” philosophy, leading the bulk of the output to be in the form of static page printouts, rather than created with a visually appealing on-screen interface that allows the advisor and client to collaboratively make changes on the spot. Yet the reality is that financial planning done collaboratively can both save time (avoid preparing alternative scenarios that turn out not to even be relevant!), and break down the fundamental flaw of goals-based financial planning (that most clients don’t even know what their goals are until they use planning software to explore the possibilities, first!). Similarly, the truth is that the greatest blocking point for doing financial planning with most clients is that they don’t even have the data to provide to the advisor to input into the software, and even for clients who provide the data, keying the data from paper statements it into the planning software is one of the most time-consuming steps of the process; a digital-first planning software could be built to collaboratively gather the data modularly over time, helping to draw clients proactively into the process by showing them incremental value as the plan is created before their eyes. What would financial planning software look like (and how much more efficient and engaging could it be) if the tools were designed to not generate any printed reports, and all of the information had to be engaged via a shared computer monitor, or a client portal?

Comprehensive Planning Software That Actually Creates A Comprehensive Written Plan. For financial advisors who do continue to produce written financial plans for clients, the primary challenge in today’s marketplace is that planning software doesn’t actually produce the entire financial plan… just the pages associated with the financial projections. Thus, financial planners who craft firm-branded financial plans must create and collate together a graphics template with firm colors and branding, a Word document with financial planning recommendations, Excel documents for customized charts, and financial planning software output itself, into either a physically printed document, or a cobbled-together PDF document. Ideally, financial planning software that is designed to produce holistic financial plans should also be a plan collating platform, that makes it easy for the advisor to integrate together the advisory firm’s branding and colors, the written aspects of the financial plan (e.g., plan recommendations, customized client education) along with any custom-created graphs and charts, all assembled into a single document with consistent visual elements. Otherwise, financial advisors who do produce comprehensive financial plans – where the advisor adds value beyond just the printed output of the financial planning software – will continue to face lost productivity and immense amounts of wasted time trying to put together the separate pieces of “the plan” since the planning software can’t do it directly.

Ongoing Financial Planning With Opportunity Triggers. In the past, “financial planning” was primarily about getting paid for the plan itself – either via a planning fee, or for the products implemented pursuant to the plan. As a result, financial planning software was (and still is) very focused on the upfront financial plan, with the occasional “updated” plan that occurs if the client indicates that his/her situation has substantively changed (and there might be a new opportunity to do business and earn a planning fee or product commission). Yet for financial planners that actually do ongoing comprehensive financial planning – most commonly as a planning-centric AUM fee, or an ongoing retainer feethe bulk of the financial planning relationship is what happens in all the years after the first one, not the initial planning year! Unfortunately, though, no financial planning software is really built to do effective ongoing financial planning, where the client’s “plan” is a live, continuous plan that is perpetually updated (via account aggregation), and shows both progress towards goals over time, and the progress of goals already achieved (which is crucial to validate the ongoing planning relationship!). In other words, what would financial planning software look like if it was continuously updated via account aggregation, and clients could log in at any time and see trends over time, ongoing financial planning recommendations that still need to be implemented, and accomplishments of recommendations already implemented? Similarly, if the planning software was continuously updated, at what point could the planning software tell the advisor when there is a planning opportunity to engage the client about, from milestone birthdays (e.g., age 59 ½ when penalty-free withdrawals from IRAs can begin, age 65 when Medicare enrollment is available, or age 70 ½ when RMDs begin), to changes in client circumstances (where the planning software detects a promotion or job change because the monthly salary deposit changes), proactive planning opportunities (e.g., where interest rates fall to the point that the client can refinance a mortgage, or updated year-end tax projections notify the advisor of a capital loss or capital gains harvesting opportunity), or warning indicators for clients veering off track (e.g., where dollars saved this year are behind on the annual savings goal, or where spending rises precipitously, or if the portfolio falls below a critical threshold of success in retirement). In the end, financial planners shouldn’t have to meet with clients regularly just to find out if there are any new planning needs or opportunities… because ongoing financial planning software should be continuously monitoring the client’s situation, and notifying the advisor of the planning opportunity!

Potential Disruptive Differentiators For Next Generation Of Financial Planning Software

Pick A Focus To Differentiate (And Being Simpler And Easier Doesn’t Count)

Sadly, the reality is that today, most financial planning software companies will claim that they do most of the items listed above. Yet financial planners know in practice that most financial planning software doesn’t do (m)any of these things very well – thus why so many financial advisors still use Excel, and why the combination of “Other” or “None” categories is still the most common response to advisor surveys on “What Financial Planning Software Do You Use?” And the companies that try usually try to do them all, and end out with an excessive amount of feature bloat, with the associated decline in adoption and usability.

But the key point here is that true differentiator of financial planning software isn’t a feature issue. It’s a focus issue, that is expressed in clear features that support the differentiated vision. After all, building truly tax-focused planning software means the tax tables need to permeate every part of the software, from the input, to the analytical tools, to providing output that shows and communicates tax benefits and tax savings (since that’s what the tax-centric advisor will want to show). True retirement distribution software needs to invest heavily in integrations to bring in and accurately model all the various retirement products and strategies that exist today, which again is both a user interface, output, integration, and data analytics challenge. Collaborative-first software would have a substantially different UX/UI design if it was intended to never print a report, and be used solely in a collaborative nature. And so on and so forth for the other differentiation types.

The other reason why setting a differentiated vision is so crucial is that it escapes what has become the greatest malaise of financial planning software companies trying (and failing) to differentiate: the Quixotic effort to be the “best” software at being simpler and easier to use.

The problem with a financial planning software mission of being “simpler and easier to use” is that doing so requires making trade-off decisions and sacrifices, and without a clear understanding of the type of advisor the software is meant to actually serve, it ends out serving no one. Thus why NaviPlan made their software “easier to use” in their transition from the desktop to the cloud, and actually lost market share – because the complexity that was eliminated was a level of cash-flow and tax detail that its core users wanted, driving them to alternatives like eMoney Advisor and MoneyTree. While players like GoalGami Pro tried to create “simpler” financial planning software to distribute to broker-dealers whose reps were complaining that MoneyGuidePro and eMoney Advisor were “too hard to use” – only to discover that the real problem was those sales-oriented reps didn’t actually care about financial planning at all, and weren’t going to adopt any financial planning software, regardless of its ease of use (and consequently didn’t gain much market share, either). And why the new “simpler and easier to use” Figlo platform hasn’t grown much market share since Advicent bought it several years ago, either.

Not to say that it’s “bad” for software to try to make itself simpler and easier to use. But simpler and easier isn’t a real differentiator in today’s financial planning software landscape, because some advisors want “simpler” to mean shorter and faster, while others want “simpler” to mean easier to collaborate with clients and have less upfront data entry, still others want “easier to use” to mean easier to enter the complex detailed data inputs they want to model… and because the cost of switching software is exponentially higher than the improvements of “easier to use” in most cases anyway. Thus why most financial planning software newcomers continue to struggle with growth, and why shifting market shares of the leading providers change at a glacial pace.

Nonetheless, the good news is that, as discussed in this article, there are a substantial number of opportunities for financial planning software newcomers to meaningfully differentiate – both as an opportunity for reinvention amongst the large incumbents (MoneyGuidePro, eMoney Advisor, and NaviPlan), today’s still-nascent emerging players, and startups that are still building behind the scenes and haven’t even launched yet. But at the same time, for the sake of new company growth – and the betterment of the financial planner community itself – it’s time for financial planning software companies to take a bold step forward to the future of financial planning, and not keep building features to compete for enterprises, and against competitors, that are stuck in the past. On the plus side, though, with the DoL fiduciary rule as a catalyst, a large swath of financial advisors (and financial services institutions) are being driven to shift from simply distributing financial products, to truly getting paid for financial planning advice… which means the demand for financial planning software, including new solutions, should only rise from here!

So what do you think? What would it take for you to switch to a new financial planning software provider? Where do you see the biggest gaps? Which of the differentiated financial planning software solutions above would you want to buy? Please share your thoughts in the comments below!

Three Degrees Of Bad Retirement Outcomes

Three Degrees Of Bad Retirement Outcomes

When doing retirement planning, it is common to talk about retirement plan outcomes as either “successes” or “failures”, where Monte Carlo analysis aims to determine the probability of success. Yet Cotton notes that from the client’s perspective, “failure” really occurs in degrees: the first is failing to achieve the household’s desired standard of living; the second is failing to at least maintain the household’s basic standard of living “floor” (i.e., the basic necessities); and the third is an outright bankruptcy (where everything is lost that isn’t specifically protected from creditors). The distinctions matter, because the reality is that many plans that might “fail” because a portfolio is depleted (and can no longer maintain the desired standard of living) may still have enough guaranteed income streams to sustain at least a reasonable floor (e.g., thanks to Social Security benefits). And in fact, some retirees will even choose to arrange their assets in a manner that increases the risk of “failing” at the top tier, in order to better secure at least achieving the second tier (e.g., by choosing to annuitize a portion of assets, and give up upside in exchange for a more secure floor). Even just discussing the phenomenon with clients – where a risk of “failure” is really just a risk of making some adjustment between the desired standard of living and the floor level standard of living – can change their attitude about how comfortable they are with a strategy, recognizing that “failure” may really just be about an “adjustment” (from the desired standard of living down closer to the presumably-still-tolerable floor). Though at the same time, it’s important to recognize that the need for expenses isn’t guaranteed, either – in other words, a “safe” floor might no longer turn out to be safe if a change in health necessitates higher expenses than what the floor provides. Nonetheless, the key point remains that not all “failures” are equally failing, and similarly that there can be a big difference between depleting the portfolio, and the total depletion of wealth or bankruptcy. Which means it’s necessary to discuss all of these dynamics and trade-offs with clients, if you want to help them make a good decision about how to allocate assets in retirement!

Why You Need To Be Different Rather Than Better Than Your Competition

Why You Need To Be Different Rather Than Better Than Your Competition

In a competitive situation for a client, it’s only natural to want to try and explain why your advisory firm is better than the competition, whether it’s better products, better service, better communication, or better affiliates that you work with. Yet the unfortunate reality is that most consumers are tired of hearing how everyone says they’re better than everyone else – just as when you’re walking down the aisle of a grocery story and see a jug of Tide detergent with a label “NEW AND IMPROVED” you don’t just immediately buy it expecting that now, finally, your clothes will get cleaner. Because in the end, the consumer doesn’t really believe it’s that much better, and it’s stressful to make a change (whether it’s to another laundry detergent, or another financial advisor). So what’s the alternative? Rather than trying to be better, be different. Because if we can truly share something that is unique about who we are and what we do, then the connection that makes with a prospective client is more likely to win them over than all the “better than” claims anyway. Especially since in the end, most consumers choose their advisor based on the connection with the advisor anyway, and not his/her “better” products and solutions.

The Equifax Breach: What You Should Know

The Equifax Breach: What You Should Know

The big news this past week was that credit bureau Equifax revealed a data breach that may have released key personal data, including Social Security numbers, birth dates, addresses, and even some driver’s license numbers, on as many as 143 million Americans, to hackers who intend to sell the data to identity thieves. As an initial response to the issue, Equifax is offering one free year of their credit monitoring service, and has posted a new website where people can input their information to determine if they were affected (although initially the site appeared to be broken, and was returning different results for the same data). Notably, there was also an initial discussion that entering your information into the Equifax website would itself force you to waive your rights to sue the company, although Equifax has since clarified that identifying if you were impacted by the cybersecurity breach will not waive your legal rights regarding the incident. Yet the caveat is that even by enrolling yourself into a credit monitoring service, you will not actually stop data thieves; all the solution will do is notify you (generally relatively quickly) after an identity thief has stolen your identity and is taking actions that may impact your credit. Accordingly, the best way to actually prevent identity theft is to file for a “security freeze”, which blocks any potential creditors from being able to view or “pull” your credit file, unless you affirmatively unfreeze or thaw your file beforehand – which means identity thieves won’t be able to apply for credit cards or loans in your name, because creditors generally won’t issue loans if they can’t gauge the risk by viewing your (now frozen) credit file. In order to freeze your credit, it’s necessary to notify each of the major bureaus (one at a time to Equifax, Experian, Trans Union, and Innovis), which can be done online in some cases but for others requires reaching out by telephone or by writing. Some states permit credit bureaus to charge a small fee (up to $15) for placing a freeze as well. Once frozen, each bureau will provide you a unique Personal Identification Number (PIN) that you can use to thaw your credit file in the event that you actually want/need to apply for credit in the future. A less arduous alternative is to obtain a fraud alert – rather than a credit freeze – which tells lenders not to grant credit in your name without first contacting you to obtain approval (by telephone or whatever other method you indicate in the fraud alert), and the process can be completed quickly online or via telephone, and notifying one bureau automatically propagates the fraud alert to other bureaus; however, the caveat is that fraud alerts only last for 90 days and then must be renewed (though you can obtain an extended fraud alert for 7 years, but only if you’ve already been a victim of identity theft and can provide a police report to substantiate it), and while a fraud alert requests lenders to contact you before granting credit, they are not legally required to do so (which makes the credit freeze far more secure).

Replacing The Data Gathering Meeting With A “Get Organized” Client Experience

Replacing The Data Gathering Meeting With A “Get Organized” Client Experience

Executive Summary

Creating a financial plan starts with gathering the client data, which many advisors request by providing clients with a “data gathering form”, typically structured in a manner that makes it easy to input the data into their financial planning software.

The caveat, however, is that in practice clients often don’t fill out the data gathering form. For some, they feel it’s too much work. For most, the problem is simply that they aren’t organized enough to provide all the requisite information. And may even feel guilty or embarrassed about the fact that they’re “failing” in the very first step of the financial planning process.

So what’s the alternative? Ditch the data gathering meeting, and have a “Get Organized” meeting instead. In other words, make the first meeting with the client about getting them financially organized in the first place. Have them bring in their jumbled files, and give them a file box with sorted folders to organize the information. Scan the key documents and statements and put them into a newly created client vault. Set up a client PFM portal, show them how to use it, and help them to begin connecting their accounts on the spot.

By having the Get Organized meeting, the financial planner still has the opportunity to collect all the data that’s needed to move forward with the financial planning process – but done in a client-centric manner that recognizes the client’s challenges and provides them an immediate, tangible benefit. In fact, for some people, a “Get [Financially] Organized” service might be so valuable, advisors could even charge for it separately and get paid to market and demonstrate their value to prospective clients!

The Problem With The Data Gathering Meeting

The 6-step process of financial planning starts with establishing the client-planner relationship, and then immediately proceeds to gathering client data. This natural sequence forms the basis for all the actual financial planning “work” that will follow – after all, it’s impossible to analyze a client’s situation, make recommendations, and implement them, if the advisor doesn’t have the underlying data in the first place.

Unfortunately, there’s a major problem with the typical data gathering with clients: many clients don’t actually have the data in the first place, or at least don’t have an easy way to put their hands on it. Their financial lives are not well organized. “Important” documents like Wills and life insurance policies are stashed away in a filing box… somewhere. There are paper statements for a few of the investment accounts, but the rest require an online login… using a password long since forgotten. Sometimes clients aren’t even certain exactly where all their assets are. “I think there’s still some money left in that old 401(k) from my job back in 2007?”

Which means when the financial advisor asks a new client to fill out a data gathering form and bring it to the first meeting to start the financial planning process, the process hits an immediate wall. The client doesn’t know all the details to fill out the form! Even the thought of getting the data together may seem daunting, as it will clearly require a lot of work. In other words, the desire to “do” financial planning with the advisor has turned into a giant homework assignment for the client on Day 1!

And sadly, the implicit pressure from the financial advisor can even make the situation worse. Clients who aren’t organized enough to comply with the “simple” advisor request of “fill out this form and bring us all your data so we can begin the process” may feel guilty or inadequate.

 “Does everyone else have this information put together except for me? My planner seems to expect that I should have all this material at my fingertips. I feel like I’m failing and I haven’t even started yet!”

And then the natural human responses start to kick in.

“This is going to take a ton of time and effort. I’ll just put this off until later.” (Procrastination)

“Ugh, I’m realizing now that I don’t even know where some of this stuff is! I’m going to have to reschedule the meeting. It’s too humiliating to go into the advisor’s office and have to admit my financial house is in such disarray.” (More procrastination, rescheduled meeting)

“I’m so embarrassed I don’t have all the data my advisor needs to start the process. If I ignore the advisor and how awkward this whole experience has become, maybe it’ll just go away.” (Client never agrees to reschedule)

Of course, many experienced advisors have long since “learned” that asking clients to bring in all their data up front rarely works, precisely because clients usually don’t have the data handy and available. So instead, we just say “bring in what you can” and try to flesh out the rest of the rough details verbally in the meeting.

Yet in practice, this still drags out the financial planning process. The initial analysis turns out to be ‘wrong’ because crucial information was accidentally left out, or turned out to be incorrect based on subsequent details that changed the client’s original foggy recollection. The subsequent implementation stalls, as the final steps can’t be taken because some key data and materials are still outstanding.

The fundamental problem: starting financial planning with a data gathering meeting implicitly assumes that clients are organized enough to provide that data, even though we know the reality is that many people aren’t actually that organized. We’re trying to solve “our” problem as advisors – gathering the data – rather than truly focusing on the client’s problem of being financially disorganized (and the feelings of shame that can arise from “getting [financially] naked” in front of an advisor and admitting to being so disorganized).

Introducing The ‘Get Organized’ Meeting

So if the reality from the client’s perspective is that they often aren’t financially organized enough to begin the financial planning process with data gathering, then why not make the first meeting about getting organized!? In other words, forget the advisor-centric data gathering meeting, and offer a client-centric “Get Organized” meeting instead.

The starting point would simply be introducing the concept to clients, and what they should expect. For example, a prospective new client might be sent the following:

In order to move forward with your financial plan, we need to understand the details of your financial life.

However, we realize that like most people, your financial life probably isn’t in perfect order already. Statements end out buried in drawers and at the bottom of piles. Insurance policies are buried who-knows-where. Sometimes we even lose track of old accounts.

So at our first meeting, we’re going to work together to help you Get Organized. Please bring with you whatever financial information you can easily put your hands on. If you just want to bring in a box full of scattered papers (or even unopened envelopes!), that’s absolutely fine, we’ll work with you to sort through it. If your accounts are mostly set up online, we’ll help you track those down too.

By the end of the meeting, though, our goal is to help you Get Organized. Together we’ll start you on your way to getting your financial information in good order, and set you up with a system to keep things organized in the future. And along the way, we’ll gather the details we need to take your financial plan to the next stage.”

And then in the meeting itself, the goal is to get the client organized – both their physical paper documents, and their online financial world.

Getting Paper Statements And Physical Files Organized

The first step to helping clients to their physical paper statements and files in order is to literally help clients get their statements and files in order.

Accordingly, the advisory firm process would begin with setting up a file box for clients – for instance, a storage box like this with ample room for hanging files – which would be pre-configured with labeled folders for the typical categories of client financial information, including Wills & Trusts, Insurance Policies, Bank Accounts, Investment Accounts, etc. (The box could even be privately branded to the advisor, for additional marketing value.) Keep a label maker handy to add labels to new folders relevant for the client’s particular information.

From there, it’s time to actually go through the client’s piles of files. Having an intern or associate planner involved may help with the process of sorting through all the information and getting it filed properly. (And it’s a good experience and learning opportunity for the intern or newer advisor!) Guide clients about what information really needs to be kept, and what does not. Have a shredder there in the conference room so old information can be trashed on the spot (no reason for the client to carry it back home!).

Once the files have been initially organized, ask the client if there appear to be any significant accounts or insurance policies that are missing. If they are, look up the contact information for the financial services firm on the spot (from the computer in the conference room), and either call the company or submit a request online immediately to request the information. Make an empty folder with an appropriate label so the client knows exactly where to put the file when it arrives. Remember, the goal is to make it easier for the client to be organized, and minimize the post-meeting homework they don’t want to do anyway!

Notably, handling all these key client files and information also provides an important data-gathering opportunity for the advisor. In addition to sorting through all the various historical files, the advisor should have a high-quality portable scanner in the conference room, to allow for the most recent statements and other key documents to be scanned on the spot. This allows the advisor to have as much up-to-date information as possible coming out of the Get Organized meeting to continue the financial planning process!

Configuring The Client Vault And Online Portal

In addition to scanning key documents and recent statements for the advisor’s data gathering needs, the scanning process creates the opportunity for the advisor to set up an online vault for the client’s digitized financial information. Depending on the advisor’s technology setup, this might be done with a standalone “vault” solution like Sharefile or EverPlans, or a client document vault tied to portfolio accounting tools like Orion Advisor Services or financial planning software like eMoney Advisor.

In fact, as the process of organizing the client’s physical files nears its completion (or at least, once your intern or associate advisor is busy going through the rest of the files and sorting or shredding the documents as appropriate), the next stage of the “Get Organized” meeting is introducing your client vault and showing clients how to access and navigate it (including where you’ve already put their initial files).

Once the vault is configured to capture the digital version of paper files, it’s time to get the client fully organized in the digital world as well, by setting them up to use a full Personal Financial Management (PFM) dashboard, such as the one that eMoney Advisor includes with their financial planning software, or a standalone solution like Wealth Access.

As with the organizing of physical files, the goal of configuring the PFM portal is to get clients organized at the meeting – not just give them homework to do later. So if possible, the advisor should actually help the client log into the portal for the first time, and begin connecting accounts on the spot. (Show the client that you’re using the “private browsing” or “incognito mode” for your web browser, to ensure the protection of their private information and that their login details are not saved in the local browser.)

And of course, as with the process of getting physically organized, connecting client accounts through a PFM is appealing for the client because it gets them (digitally) organized, but also for the advisor because it provides a means to get additional data for the client’s financial plan (that will be continuously updated thanks to account aggregation!).

The “Get Organized” Meeting Template – Checklist For Advisors

Benefits Of The Get Organized Meeting

For some advisors, I suspect that completing the steps on the “Get Organized” meeting checklist will feel too “basic” or beneath them. Is it really valuable to spend your time as a CFP certificant helping a client file some documents and scan them? Or showing clients how to log into a website and connect their accounts?

The short answer: Yes. Because the meeting isn’t about the advisor. It’s about what an often-not-very-financially-organized client needs.

After all, consider this experience from the client’s perspective. The data gathering meeting isn’t just a bunch of homework anymore, or a stressful and embarrassing situation where the advisor asks for information the client can’t (easily) produce. Instead, it becomes a meeting where the client is expected to be less-than-completely organized, and has a clear, tangible outcome to become more organized.

This cannot be emphasized enough. The benefit to the client of the Get Organized meeting is that the client will literally be more organized at the end of the meeting, and walk out holding the box of files that makes them more financially organized than they may have ever been in their lives, and set up with a system to maintain that organization in the future. Now the client leaves the first meeting with a sense of accomplishment, that they’re actually taking measurable, tangible positive steps towards improving their financial future!

Along the way, of course, as the advisor you actually did get all the information you would have been seeking in a data gathering meeting anyway. The client did bring in all the statements. You did get to scan all the key documents to reference in the future development of the plan. The client has connected all of their accounts via aggregation so you can get continuously updated client data in the future.

The distinction is that rather than gathering data in a manner that’s focused on the advisor – fill out this ‘data gathering form’ in a format that’s convenient for my financial planning software – it’s done in a client-centric manner, resolving an actual pain point of the client: the all-too-common feeling of being financially disorganized.

What Happens After The Get Organized Meeting?

Of course, one important caveat is that spending this much time on just the raw financial information and data – between sorting out physical paperwork and files, and connecting client vaults and online account aggregation – means there may be little time to do a deep discovery process of talking through the client’s actual goals, and all the important non-financial information.

But this isn’t necessarily a problem. Now that you have the financial information, the next meeting can be spent mind mapping through the client’s non-financial details, and even beginning to use the planning software in a real-time collaborative manner with the client to explore the possibilities and identify potential goals! This second stage “Personal Discovery” meeting should actually be even more effective, because you’ll already have the underlying data in place. And the client will likely be even more interested in progressing to this next stage of this reimagined client-centric planning process… having achieved such a positive tangible outcome from the first Get Organized meeting!

Re-Imagining The Client-Centric Financial Planning Process And Meetings

Skipping The Get Organized Meeting… Or Sometimes Getting Paid For It?

Notably, for that subset of clients who really are financially organized already – and don’t need the “Get Organized” meeting – they may be able to just skip directly to the second meeting and begin exploring their potential goals.

In other words, the point of the “Get Organized” meeting is not to be mandatory for every client, but simply to be available for what are likely the large number of prospective clients who could benefit from it.

On the other hand, you may even find that for some prospective clients – many of whom are likely daunted by how much “work” it is just to find a financial planner and begin the financial planning process – the availability of a “Get Organized” meeting actually turns them into clients. Because they weren’t about to do all the homework required to get themselves organized, and weren’t going to admit to they couldn’t complete the advisor’s data gathering form. But when the data gathering meeting is about the client, and valuable to the client, the process is far more appealing.

In fact, some advisors might find they can even charge for the Get Organized meeting as a separate service for clients! This could become an option for existing clients (some of whom are still not financially organized), or a ‘pre-engagement’ service for prospective clients – a form of getting paid to market by offering a useful and relevant service for non-clients that’s worth paying for and can turn them into full clients.

The bottom line, though, is simply this: the data gathering process is fundamentally broken for many potential clients, who simply aren’t organized enough to provide the requisite data in the first place. So if the reality is that most clients aren’t actually financially organized in the first place, don’t pressure them or make them feel guilty about being unable to complete your data gathering form in a manner that’s convenient for your financial planning software. Have a Get Organized meeting and offer them a service that actually solves their problem… and gets you the data you need along the way!

So what do you think? Do you struggle to get clients to go through the Data Gathering process and provide all their information? Do you think the Get Organized meeting would be a viable alternative? Please share your thoughts in the comments below!