Comment Letter To CFP Board On Its Proposed Fiduciary Standards Of Conduct

Comment Letter To CFP Board On Its Proposed Fiduciary Standards Of Conduct


In December of 2015, the CFP Board announced that it was beginning a process to update its Standards of Professional Conduct for all CFP certificants, the first such update since the last set of changes took effect in the middle of 2008. And on this past June 20th, the CFP Board published proposed changes (including an expanded fiduciary duty) to its Standards of Conduct, with a public comment period that would last until August 21st.

And so as the CFP Board’s Public Comment period closes today, I have published here in full my own comment letter to the CFP Board. And as you will see in the Comment Letter, I am overall very supportive of the CFP Board advancing the fiduciary standard of care for CFP professionals, and view this as a positive step forward for the financial planning profession.

However, the CFP Board’s proposed changes do introduce numerous new questions and concerns, from key definitions that (in my humble opinion) still need to be clarified further, to new wrinkles in what does and does not constitute a fee-only advice relationship (and whether and to what extent certain types of compensation must be disclosed), to uncertainties about how CFP professionals are expected to navigate important conflicts of interest, and how CFP professionals should interpret the 29(!) instances where the CFP Board’s new standards are based on “reasonableness”… with no explanation of how “reasonable” is determined, and a non-public CFP Board Disciplinary and Ethics Commission that doesn’t even allow CFP professionals to rely on prior case histories for precedence.

Ultimately, I am hopeful that the CFP Board will end up moving forward with its proposed changes to expand the scope of fiduciary duty for CFP certificants, but only after publishing another round of the proposal for a second comment period, given the substantive nature of both the changes themselves, and the concerns that remain.

In the meantime, I hope you find this public comment letter helpful food for thought. And if you haven’t yet, remember that you too can submit your own Public Comment letter to the CFP Board by – but today (August 21st) is the last day to submit!

Comment Letter To CFP Board On Its Proposed Fiduciary Standards Of Conduct

In December of 2015, the CFP Board announced that it was beginning a process to update its Standards of Professional Conduct for all CFP certificants, the first such update since the last set of changes took effect in the middle of 2008. And on this past June 20th, the CFP Board published proposed changes (including an expanded fiduciary duty) to its Standards of Conduct, with a public comment period that would last until August 21st.

And so as the CFP Board’s Public Comment period closes today, I have published here in full my own comment letter to the CFP Board. And as you will see in the Comment Letter, I am overall very supportive of the CFP Board advancing the fiduciary standard of care for CFP professionals, and view this as a positive step forward for the financial planning profession.

However, the CFP Board’s proposed changes do introduce numerous new questions and concerns, from key definitions that (in my humble opinion) still need to be clarified further, to new wrinkles in what does and does not constitute a fee-only advice relationship (and whether and to what extent certain types of compensation must be disclosed), to uncertainties about how CFP professionals are expected to navigate important conflicts of interest, and how CFP professionals should interpret the 29(!) instances where the CFP Board’s new standards are based on “reasonableness”… with no explanation of how “reasonable” is determined, and a non-public CFP Board Disciplinary and Ethics Commission that doesn’t even allow CFP professionals to rely on prior case histories for precedence.

Ultimately, I am hopeful that the CFP Board will end up moving forward with its proposed changes to expand the scope of fiduciary duty for CFP certificants, but only after publishing another round of the proposal for a second comment period, given the substantive nature of both the changes themselves, and the concerns that remain.

In the meantime, I hope you find this public comment letter helpful food for thought. And if you haven’t yet, remember that you too can submit your own Public Comment letter to the CFP Board by – but today (August 21st) is the last day to submit!

Narrowing The Definition Of “Family Member”

The Related Party rules under the proposed Standards of Conduct include a rebuttable presumption that any family members, or business entities that family members control, will be treated as a “Related Party” for the purposes of both compensation disclosures, and the potential determination of the CFP Professional’s status as being “Fee-Only”.

However, “Family Member” is simply defined as:

A member of the CFP® professional’s family and any business entity that the family or members of the family control.

In practice, this raises numerous questions.

First and foremost, to what depth in the “family tree” is it necessary to look to determine “member of the family” status. Parents, siblings, and children? Grandparents and grandchildren? What about aunts, uncles, nieces, and nephews? Do cousins count? Only 1st cousins? What about 2nd or 3rdcousins? Do the family members of the CFP spouse’s family count, if the spouse is not themselves a CFP professional (such that the family members are “only in-laws”)?

Similarly, what constitutes “family control” of an entity? Must it be controlled by a single family member? What if multiple family members each own a minority share, but their combined ownership constitutes a majority ownership? Does “control” mean ownership of voting shares that actually control the entity? Does that mean a CFP professional could avoid “Related Party” status by owning a 99% limited partnership interest in the entity but NOT the 1% controlling general partner interest? (And does that distort the original intent of these Related Party rules, since the CFP professional would not control the entity, but would receive the bulk of the financial benefits of the entity?)

Notably, Internal Revenue Code Section 318 provides substantial guidance about where these dividing lines are drawn with respect to family members, family attribution, and constructive ownership of stock, and may serve as a guiding template for the CFP Board.

But the nature and scope of “family” and “control” must be clarified further, lest CFP professionals simply direct (without being required to fully disclose) a substantial portion of their compensation to entities in which they own 99% limited partner interests but no controlling interests to avoid the Related Party rules!

Key Point: Clarify the scope of “family member” (how much of the family tree counts?), what constitutes “control” of a business entity as a Related Party, and whether a non-controlling but majority financial interest should also be deemed a Related Party.

Disclosing How An Advisor Is Compensated, or What An Advisor Is Compensated?

A key aspect of the fiduciary duty is to fully disclose conflicts of interest to the client (to the extent they cannot be avoided), and is articulated as such in the CFP Board’s required Duty of Loyalty to clients.

However, the actual disclosures required in Sections 10 and 11 (Introductory Information to the Prospect, and Disclosure Information to the Client) regarding compensation merely require that the advisor disclose “how the Client pays, and how the CFP professional and the CFP Professional’s Firm are compensated, for providing services and products.” Notably absent is a requirement to disclose what, exactly, the CFP professional and his/her firm will be compensated for providing services and products.

This may have simply been an unintended error of wording, but sections 10(b)(ii) and 11(a)(ii) of the final rules should be updated to clearly require the CFP professional to not merely disclose how they are compensated – e.g., “with fees” or “with commission” or “by my company” – but disclosewhat the CFP professional is compensated: i.e., disclosing to the client theactual compensation arrangements for what, exactly, the CFP professional is compensated (and not merely “how”).

Notably, if/when compensation disclosures are required that explain what, exactly, the CFP Professional and the CFP Professionals firm are paid, an additional distinction may need to be made between what the CFP Professional is paid, and what the CFP Professional’s Firm is paid, given that not all CFP Professionals are privy to the details of all revenue sources of their Firms (particularly in the case of a broker-dealer, if a broker-dealer is deemed the CFP professional’s “firm”). This may include (for firms) revenue-sharing or shelf-space agreements, 12b-1 or sub-TA fees, conference sponsorships based on sales volume, commission overrides (in the case of certain annuity and insurance products), etc. Consider whether additional clarifications are needed to specify the exact scope of compensation disclosures for the CFP profession as distinct from the CFP Professional’s Firm, especially given the breadth of some firm’s overall business models.

Key Point: Does the CFP Board expect the CFP professional to merely disclose how they are compensated (fees or commissions or both?), orwhat they are compensated (disclosure of actual compensation arrangements)? And to what extent must the CFP Professional determine the prospective compensation relationships of the CFP Professional’s Firm?

Financial Advice Outside The Scope Of A Financial Plan

In the glossary, Financial Advice is defined as follows:

A communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the Client take or refrain from taking a particular course of action with respect to:

  1. The development or implementation of a financial plan addressing goals, budgeting, risk, health considerations, educational needs, financial security, wealth, taxes, retirement, philanthropy, estate, legacy, or other relevant elements of a Client’s personal or financial circumstances;

Technically, this would suggest that any suggestion that a client take or refrain from a particular course of action not pursuant to a [comprehensive] financial plan would not be deemed advice. In other words, if the CFP professional simply gives direct advice to the client regarding budgeting, risk, wealth, taxes, retirement, etc., but not specifically pursuant to the “development or implementation of a financial plan”, it would not be financial advice subject to a fiduciary duty (unless captured in one of the other subclauses of Financial Advice regarding the investment of Financial Assets or the selection of other professionals).

Given that many forms of financial advice are given more modularly, and not necessarily as a part of a comprehensive financial plan (nor is what constitutes a “financial plan” even defined in the proposed Standards), this section should be modified to simply recognize that the subjects themselves are what trigger financial advice, not specifically the creation of a financial plan.

The most straightforward resolution would simply be to remove the words “development or implementation of a financial plan addressing”, such that the section would simply read:

A communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the Client take or refrain from taking a particular course of action with respect to:

  1. The goals, budgeting, risk, health considerations, educational needs, financial security, wealth, taxes, retirement, philanthropy, estate, legacy, or other relevant elements of a Client’s personal or financial circumstances;

Notably, in the context of this change, the word “goals” should be also modified, to stipulate “financial goals” (as otherwise, even advice about a client’s “goal to lose weight” could be treated as a financial advice goal under this definition!), or alternatively the final clause could be adjusted to state “…or other relevant financial elements of a Client’s personal or financial circumstances”).

In addition, advice regarding loans, debt, and other mortgages (or more generally, “liabilities”) should be included in the list of topics which are treated as “financial advice” in this section (as the remaining subsections defining Financial Advice all pertain to a client’s Financial Assets, and not his/her Financial Liabilities).

Key Point: The delivery of financial planning advice should be treated as financial advice, regardless of whether it is actually delivered pursuant to a financial plan.

New Issues Created By Proposed Compensation Disclosure Rules

Beyond the aforementioned definitional issues regarding the Proposed Standards, a number of unique new issues arise in the CFP Board’s new approach to compensation definitions, including its “negative framing” approach to fee-only (where a “fee-only” advisor is not one who “only” receives fees, but one who does not receive any form of Sales-Related Compensation), the labels that advisors use (or may potentially use in the future) to describe their compensation methodologies.


Section 14(b) of the Proposed Standards defines Sales-Related Compensation, which is stated as:

Sales-Related Compensation is more than a de minimis economic benefit for purchasing, holding for purposes other than providing Financial Advice, or selling a Client’s Financial Assets, or for the referral of a Client to any person or entity. Sales-Related Compensation includes, for example, commissions, trailing commissions, 12(b)1 fees, spreads, charges, revenue sharing, referral fees, or similar consideration.

The fact that revenue-sharing and referral fees, along with any other kind of compensation for the referral of a Client to any person or entity, constitutes “Sales-Related Compensation”, presents substantial potential difficulties for a number of common investment arrangements that would otherwise, to an objective observer, appear to constitute a Fee-Only advisory relationship (were it not for this new compensation definition).

For instance, many financial-planning-centric CFP professionals choose to outsource their investment management implementation, rather than hiring a CFA to assist with it internally. If the advisor wants to retain operational responsibilities and “just” have a third party help with investment models and implementation, the advisor might use a Separately Managed Account. However, for advisors who want to fully outsource investment management responsibilities, it is common to use a TAMP (Turnkey Asset Management Platform), which handles both the investment management and other operational tasks of the investment portfolio, including billing.

In some cases, TAMPs will apply two tiers of fees to the advisory account – one for the TAMP’s portion of investment responsibilities, and the other for the CFP Professional’s fees. But more commonly, the TAMP will simply conduct the entire fee sweep, and then remit a portion back to the CFP professional in the form of either a revenue-sharing or solicitor fee.

The end result of this arrangement is that the CFP Professional that uses a TAMP for investments in order to focus on financial planning would be deemed to receive sales-related compensation and not be fee-only (due to the fact that the TAMP swept the fees and remitted them to the advisor), whereas if the advisor retained billing responsibility and remitted a portion of the advisor’s fee to the TAMP as an expense, he/she would be treated as fee-only. This seems to create a substantial distinction in compensation disclosure arrangements, without any actual substantive difference in what the client pays, or the nature of any conflicts of interest (particularly where the advisor retains advisory authority to hire/fire/change the TAMP manager).

Furthermore, the irony is that if the CFP professional was not independent, and instead worked for the TAMP, and was paid compensation directly by the firm for which he/she worked (even if it was a percentage of revenue), the compensation disclosure rules would (correctly) recognize that the client is paying only a fee to the CFP professional and his/her firm. Thus, an independent CFP professional who objectively chooses a third-party TAMP (for which the TAMP handles billing and shares the CFP professional’s share of the fee back to him/her) is treated as receiving sales-related compensation, yet an employee of the TAMP who only solicits for that TAMP, and receives a share of the fee revenue (a classic salesperson arrangement) would not be sales-related compensation (because as an employee, the employee’s compensation within the firm is not treated as revenue-sharing, even though it functionally is).

In other words, the CFP Board’s Proposed Standards have (perhaps unwittingly) created a substantial distinction between “first-party” revenue-sharing (CFP professional is internal to a firm), and “third-party” revenue sharing (CFP professional is external from the firm), even though the actual services rendered, fees paid by the client, and compensation paid to the CFP professional, are exactly the same… and in fact, the external advisor would be more independent and less prone to sales-related conflicts of interest!

While in theory, it might be ideal to try to “require” all advisors to structure third-party investment management agreements in certain ways – such as requiring that the advisor’s fee and the TAMP’s fee always be billed separately, or that the advisor always sweep fees and remit the TAMP’s portion to the TAMP, rather than the other way around – from a practical perspective, such changes would be substantial operational changes for many TAMPs, and not feasible to implement in a timely manner in accordance with the CFP Board’s Proposed Rules. Even though, again, the end result to the client is still that he/she is paying only fees and no actual sales-related compensation.

Accordingly, the CFP Board should consider amendments to this definition of “Sales-Related Compensation”, to more accurately reflect the underlying substance and economic reality of the arrangement for the client, and not recharacterize fees as sales-related compensation simply due to operational implementation decisions.

Reasonable safe harbors to further modify this rule might include:

– If the CFP professional receives a referral or solicitor fee from another firm, and that firm itself receives no sales-related compensation in connection with services rendered to the client, then the CFP professional’s participation in a portion of the fee-only relationship does not convert it to sales-related compensation (i.e., participating in a portion of the fees in a fee-only relationship is still a fee-only relationship);

– In order to be deemed a permissible fee-only revenue-sharing agreement, the CFP professional should retain discretion to hire or fire the third-party manager (to affirm that the CFP professional is in an independent relationship, and not operating as a captive salesperson); and

– In order to not be deemed Sales-Related Compensation for participating in the sharing of a client fee, the CFP Professional’s share of the compensation should not materially vary by the assets of the client or total assets of the relationship (to avoid sales incentives for directing client investment fees towards a particular provider)

Key Point: Treat CFP professionals who outsource to third-party managers the same as CFP professionals whose firms hire internal investment staff, if the client is actually paying the same fees either way.


Continuing the prior theme, it’s also notable that all forms of “Sales-Related Compensation” implicitly assume that payments will come fromthird parties, without recognizing that for advisors who work directly for product manufacturers, “sales-related compensation” comes in the form of direct bonuses from their employer for certain levels of sales production.

In other words, when an independent advisor is paid to sell a third-party product, sales-related compensation is typically in the form of a commission. When a captive advisor is paid to sell his/her company’s ownproprietary product, sales-related compensation is typically in the form of bonuses (which firms assign based on sales targets, the profitability of products, etc.). Yet the CFP Board’s current definition of compensation would not characterize the compensation of the latter as sales-related compensation, even if the bulk of the advisor’s compensation actually was tied directly to sales (and paid in the form of employee bonuses, rather than product commissions).

Accordingly, CFP Board’s definitions for sales-related compensation need to consider the types of internal compensation bonuses paid to employees for business development and production, including common practices such as paying advisors a percentage of revenue they bring in (an indirect form of solicitor fee), and paying bonuses based on total products implemented (an indirect form of commissions). And to the extent such compensation arrangements would be deemed sales-related compensation in a third-party independent context, they should be reflected as sales-related compensation in a first-party context as well.

Otherwise, a firm could operate entirely as “fee-only” simply by manufacturing all of its own proprietary products, and rather than paying commissions to third-party advisors, simply pay its own CFP professionals a salary plus bonus (or a share of revenue) to sell its products (even though the nature of the advisor’s role is purely sales).

Key Point: Treat RIA solicitors of a fee-only firm the same as employees of a fee-only firm, given that both may be paid the exact same way (a percentage of revenue). And recognize for captive employees of firms that manufacturer proprietary product, even salary and bonus compensation can constitute sales-related compensation (even if there are no direct commissions, because the company is distributing its product directly through its own salaried salespeople).


One of the greatest challenges that may arise from the proposed definitions for fee-only and sales-related compensation is for advisors who wish to change to become fee-only, even though they previously operated as a commission-and-fee advisor who received sales-related compensation.

The reason is that, under the proposed definitions, a fee-only CFP professional cannot hold out as such if they receive any “sales-related compensation”, including trailing commissions and 12b-1 fees, even if 100% of the CFP professional’s ongoing relationships with new clients involve no new sales-related compensation. In other words, any CFP professional who wantsto operate on a fee-only basis in the future still cannot actually be fee-only unless they terminate all ongoing 12b-1 and other trailing commission payments to themselves.

Yet from a practical perspective, this is neither positive for the client, nor the advisor. To the extent the client has already purchased a commission-based product in the past, with a 12b-1 or other commission trail built into the existing pricing of the product, even if the advisor terminates the trailing commission relationship, the client will still pay the trail anyway. It will simply be collected by the product manufacturer as a “house account”, instead of being paid to the original CFP professional who sold it.

In addition, a CFP professional who terminates their commission trail relationship is required to remove themselves from being the broker-of-record or agent-of-record on the investment or insurance product, which eliminates the advisor’s ability to actually provide basic service, and answer ongoing financial planning questions, of the client.

All of which means compelling newly-fee-only CFP professionals to actually terminate their trailing commissions and 12b-1 fees results in a decrease in the ability of the advisor to service the client and address their financial planning needs, without even saving the client the cost of those trailing commissions or 12b-1 fees in the first place!

And notably, even the SEC characterizes a 12b-1 fee as a combination of a “distribution fee” (i.e., a commission, of up to 0.75%/year), and a “shareholder servicing fee” (which FINRA caps at 0.25%/year). In other words, a 12b-1 fee of up to 0.25%/year isn’t actually even “sales-related compensation” in the first place; it’s a servicing fee. (The same is true for many insurance commission trails as well, though the split between [levelized] commissions and servicing trails are not always delineated explicitly.)

Thus, given that ongoing 12b-1 and commission trails are typically for servicing anyway, and advisors who retain servicing relationships with products previously sold to clients maintain better ability to render financial planning advice on those products, a more appropriate definition of “fee-only” (or limitation on sales-related compensation” would recognize a distinction between receiving servicing 12b-1 fees and commission trails on prior transactions, from new commissions generated from new transactions (which would clearly be sales-related compensation).

Accordingly, the CFP Board should consider adding an additional exclusionary condition under Section 14(b) of its proposed rules (i.e., a new paragraph iv), which stipulates that the mere presence of 12b-1 servicing fees (in an amount no more than the FINRA-capped 0.25%), and ongoing commission trails (for servicing previously sold products), will not be treated as sales-related compensation, as long as no new sales-related compensation is introduced going forward.

Conversely, though, the CFP Board should also consider amending the rules to stipulate that if an advisor’s compensation status changes, all prospective and existing clients must be notified of the change. Otherwise, the limitations on “sales-related compensation” and the definition of “fee-only” also risks being rendered moot by an advisor who claims to be “fee-only”, then “temporarily” changes their compensation to be commission-and-fee for one client (who does a purchase of a large commission-based product), and then switches “back” to fee-only after the purchase has occurred. In other words, CFP Board needs to consider introducing some provision to clarify whether or how quickly an advisor can change their status to/from fee-only, to minimize any risk of routine “hat-switching” from one client to the next. (A notification requirement to all clients of the change in compensation methodology would likely be sufficient to reduce any advisor incentive for making regular client-by-client changes.)

Key Point: Provide clear guidance about how CFP professionals who previously received sales-related compensation, and still receive ongoing 12b-1 servicing fees and insurance commission trails for servicing, can transition to fee-only status, without being required to terminate their broker-of-record and agent-of-record affiliations that are necessary to ensure previously-sold contracts can be properly serviced by the advisor.


One of the “unintended consequences” of the changes to compensation disclosures in the last update to the CFP Standards of Conduct was that, once the definition of “fee-only” became more clearly defined, advisors who wanted to market on a “similar” basis began to adopt the label “fee-based” instead.

To address this issue, the CFP Board’s new rules would require, in Section 14(a)(ii), that:

A CFP® professional who represents that his or her compensation method is “fee-based” must: a) Not use the term in a manner that suggests the CFP® professional or the CFP® Professional’s Firm is fee-only; and b) Clearly state that either the CFP® professional earns fees and commissions, or the CFP® professional is not fee-only.

While this is a reasonable way to address the concern of CFP professionals who use the label “fee-based” to imply something similar to “fee-only”, it fails to recognize the underlying challenge: that given currently favorable media coverage of the “fee-only” label, there is a substantial marketing advantage for non-fee-only advisors who can come up with a fee-only-like similar label.

Which means even if the CFP Board cracks down on “fee-based”, it’s only a matter of time before a new, alternative term arises instead. Advisors who receive fees and commissions, but want to accentuate the fee aspect of their advisory relationships, may simply instead adopt terms like “fee-oriented” or “fee-compensated” or “fee-for-service” (without acknowledging they’re also commission-compensated). Which leaves the CFP Board in the unenviable position needing to update its compensation disclosure rules every few years just to try to crack down on the latest “innovative” fee-related marketing term.

The alternative, which the CFP Board should seriously consider instead, is to standardize the terminology in compensation disclosures – a path the organization had started down previously with its 2013 “Notice To CFP Professionals” regarding compensation disclosures, with its specific disclosure types of “fee-only”, “commission-and-fee”, and “commission-only”.

In a world where those options are the only options that advisors are permitted to use – or at least, where those disclosure types must be statedfirst, before any other compensation labels – there is little risk of alternative compensation labels arising. Or at a minimum, if a CFP professional chooses in the future to call themselves “fee-oriented” or “fee-compensated” or “fee-for-service” but first must acknowledge they are commission-and-fee advisors, the risk of consumer confusion over compensation labels is greatly diminished.

Notably, though, the one caveat of this approach is that in practice, it means most advisors will end out in the “middle” category of being commission-and-fee, and that advisors will be in that category regardless of whether they receive 99% of their compensation in commissions, or 99% of their compensation in fees (even though, in practice, those are substantively different business models, with substantively different potential conflicts of interest to disclose to the client). Accordingly, to avoid rendering the “commission-and-fee” label meaningless (even as it’s used by the majority of CFP Professionals), CFP Board might consider at least adjusting to four categories: fee-only, fee-and-commission, commission-and-fee, and commission-only (where the difference between fee-and-commission versus commission-and-fee is determined based on which compensation type formed the majority of the advisor’s compensation over the prior calendar year, or some other stipulated measuring period).

Nonetheless, the fundamental point is simply this: in order to prevent the “creative” use of potentially misleading compensation labels, the CFP Board needs to standardize a fixed nomenclature of compensation models (as it has for “fee-only”, but including all the other possible categories as well), and require those labels of the first/primary explanation of compensation for the CFP professional. Anything less simply invites a never-ending oversight challenge of adapting new rules to ever-changing terms and labels in the marketplace.

Key Point: Standardize a series of required compensation disclosures, rather than merely defining “fee-only” and limiting “fee-based”, or the advisory community will simply keep coming up with new terms that may or may not be deemed misleading in the future. A standard nomenclature – such as fee-only, commission-and-fee, fee-and-commission, and commission-only – eliminates any room for innovating new questionable terms.

Limiting An Advice Engagement To A Compensated Engagement

One of the biggest practical caveats to enforcing a fiduciary duty for any professional service provider is being clear about when a professional service engagement actually begins. This helps to ensure not only that “general education” is not unwittingly treated as a fiduciary professional service, but also that “free” services (which may or may not constitute a formal professional services engagement) aren’t subject to professional standards when they shouldn’t be.

Fortunately, the flush language of the definition of “Financial Advice” in the Glossary of the proposed standards does clearly state that “…the provision of services or the furnishing or making available of marketing materials, general financial education materials, or general financial communications that a reasonable person would not view as Financial Advice, does not constitute Financial Advice.” This helps to limit any concern that a practitioner would have that general financial education will not constitute fiduciary financial advice.

However, Section 1 of the Standards still require that a fiduciary duty applies to any “Client”, where a Client is defined as “any person… to whom the CFP professional renders Professional Services pursuant to an Engagement”, and an “Engagement” is defined as “a written or oral agreement, arrangement, or understanding”. Yet at no point is there an actual requirement that such an engagement be a formal businessrelationship for compensation.

As a result, the delivery of “free financial advice” – e.g., on a pro bono basis, in an informal relationship with a friend or colleague, or even just ad hoc in a conversation with a stranger – could potentially constitute a fiduciary financial advice relationship. The conversation merely needs to start with an informal statement “Hey, let me ask your advice about something…” and if the advisor responds, an oral understanding that advice is about to be delivered exists, which attaches the advisor’s fiduciary duty.

Notably, such an (investment) advice relationship would not exist for that advisor under the Investment Advisors Act of 1940, because Section 202(a)(11) of that law stipulates that one is only an investment adviser if he/she engages in the business of advising others for compensation. Similarly, the Department of Labor’s recently introduced fiduciary rule also limits the scope of fiduciary duty to situations where the advisor “renders investment advice for a fee or other compensation…”

Accordingly, the CFP Board should adjust its definitions to clarify that “free” advice, or other non-compensated informal advice arrangements, do not (and cannot) rise to the level of being fiduciary financial advice, if the advice is not provided for consideration (i.e., for compensation). Practically speaking, this is probably best handled by adjusting the definition of a Client to be:

Client: Any person, including a natural person, business organization, or legal entity, to whom the CFP® professional renders Professional Services for compensation pursuant to an Engagement.

Key Point: A financial planning “engagement” should be limited to one where the CFP professional renders professional services for compensation, to avoid the risk that “free advice” is deemed an advice relationship.

What Does It Mean To “Manage” Conflicts Of Interest

One of the fundamental principles of a fiduciary duty is the recognition that advisors have a duty of loyalty to their clients, to act in their clients’ best interests, such that conflicts of interest must be managed, and unmanageable conflicts of interest must be avoided altogether.

Accordingly, the Investment Advisers Act of 1940 (and subsequent SEC guidance over the years) provides an extensive series of rules regarding what kinds of conflicts of interest are prohibited for investment advisers. Similarly, the Department of Labor’s new fiduciary rule (and the prior/existing rules under ERISA) prohibit a wide range of unmanageably-conflicted activities, subject to various Prohibited Transaction Exemptions if certain safe harbor stipulations are met.

When it comes to the CFP Board’s requirements, though, Section 9 of the Proposed Standards merely requires CFP professionals to disclose conflicts of interest, with a brief paragraph (out of a 17-page document) directing that “a CFP® professional must adopt and follow business practices reasonably designed to prevent Material Conflicts of Interest from compromising the CFP® professional’s ability to act in the Client’s best interests.” And while Section 1(a)(ii) does go a bit further in stating that a CFP professional should “Seek to avoid Conflicts of Interest, or fully disclose Material Conflicts of Interest to the Client, obtain the Client’s informed consent, and properly manage the conflict”, this still constitutes the entire guidance of the Proposed Standards of Conduct.

Thus, the questions arise: what, exactly, are CFP professionals expected todo to manage their conflicts of interest, what constitutes an “insufficient” business practice that fails to reasonably prevent Materials Conflicts of Interest from compromising the CFP professional, and what types of conflicts are CFP professionals actually expected to “avoid” versus merely “manage”? Will the CFP Board publish a list of prohibited transactions, akin to the Department of Labor, or create further regulations limiting CFP professionals from certain (highly conflicted) activities (as the SEC does)?

Without any guidance from the CFP Board, the risk to the CFP professional is that they will be found “guilty” of failing to manage their conflicts of interest, in a ruling from the Disciplinary and Ethics Commission that only explains what was “impermissible” behavior after the fact.

CFP professionals should not be left to wonder what will turn out, after the fact, to have been deemed an unacceptable or improperly managed conflict of interest. At a minimum, the CFP Board needs to provide additional, supplemental guidance. And the CFP Board should seriously consider whether certain especially-conflicted arrangements with clients are “so conflicted” that the Standards of Conduct should simply bar them altogether (as the Department of Labor did with its fiduciary rule).

Key Point: Provide further clarity about what it really means to “manage” conflicts of interest, and what types of conflicts the CFP Board expects CFP professionals to avoid. Don’t force CFP professionals to find out what is deemed unacceptable after the fact with an adverse DEC ruling.

Navigating Conflicting Duties Of Loyalty Between CFP Professionals And Their Broker-Dealer Or Insurance Company

The first requirement of the CFP professional’s Duty of Loyalty in the proposed Standards of Conduct is that the CFP professional must “Place the interests of the Client above the interests of the CFP® professional and the CFP® Professional’s Firm”.

Yet the reality is that for a substantial number of CFP professionals, they operate as a registered representative of a broker-dealer, or an agent of an insurance company, and legally have an obligation (a bona fide agency relationship) to represent the CFP professional’s firm first and foremost, and not the client.

Clearly, it is often “good business” for firms to act in the best interests of their clients, regardless of the scope of relationship, but CFP Board’s proposed Standards of Conduct are nonetheless placing a large subset of CFP professionals in a potentially untenable conflict between the requirements of the Standards, and their legal employment agreement and relationship to the Professional’s firm.

At a minimum, the CFP Board should provide additional guidance about how, realistically, CFP professionals are expected to navigate this particular conflict of interest, and in what situations a CFP professional is expected to decline a business opportunity, or outright terminate their employment relationship, if a conflict of interest emerges where the CFP professional cannot effectively fulfill both his/her duty of loyalty to the client, and his/her agency relationship and employment agreement with the firm.

Key Point: With an explicit duty of loyalty to the client for the CFP professional, clarify how CFP professionals working at a broker-dealer or insurance company, where the CFP professional has a legal employment contract that requires him/her to operate as an agent of the company and represent the company (not the client), is expected to navigate prospective conflicts of interest.

Anonymous Case Histories And Setting Precedents For Reasonableness

The final concern worth recognizing in the CFP Board’s Proposed Standards is the fact that substantial portions of the rules are based on subjective standards – beyond just the question of what is a “manageable” conflict of interest vs one to avoid – such that CFP professionals may not even know which behaviors and actions are safe and appropriate until it’s too late.

For instance, the word “reasonable” or “reasonably” is used a whopping 29 times in the Proposed Standards, pertaining to the everything from the aforementioned issue of whether a conflict of interest is Material (based on whether a “reasonable” client would have considered the information material), to whether a related party is related based on whether a “reasonable” CFP professional would interpret it that way, to requirements that CFP professionals diligently respond to “reasonable” client inquiries, follow all “reasonable” and lawful directions of the client, avoid accepting gifts that “reasonably” could be expected to compromise objectivity, and provide introductory information disclosures to prospects the CFP professional “reasonably” anticipates providing subsequent financial advice to. In addition, the entire application of the rules themselves depend on the CFP Board’s “determination” of whether Financial Advice was provided (which triggers the fiduciary obligation for CFP professionals), and CFP professionals with Material conflicts of interest will or will not be found guilty of violating their fiduciary duty based on the CFP Board’s “determination” of whether the client really gave informed consent or not.

In other words, the CFP Board’s new Standards of Conduct leave a lot of room for the Disciplinary and Ethics Commission to make a final (after-the-fact) subjective assessment of what is and isn’t reasonable in literally several dozen instances of the rules.

Of course, the reality is that it’s always the case that regulators and legislators write the rules, and the courts interpret them in the adjudication process. And using “reasonableness” as a standard actually helps to reduce the risk that a CFP professional is found guilty of something that is “reasonably” what another CFP professional would have done in the same situation. “Reasonableness” standards actually are peer-based professional standards, which is what you’d want for the evaluation of a professional.

However, when courts interpret laws and regulations, they do so in a public manner, which allows everyone else to see how the court interpreted the rule, and provides crucial guidance for everyone who follows thereafter. Because once the court interprets whether a certain action or approach is or isn’t permitted, it provides a legal precedent that everyone in the future can rely upon. Except in the case of the CFP Board’s Standards of Conduct, because the CFP Board’s disciplinary process is not public in the first place!

Which means even as the DEC adjudicates 29 instances of “reasonableness”, no one will know what the DEC decided, nor the criteria it used… which means there’s a risk that the DEC won’t even honor its own precedents, and that rulings will be inconsistent. And even if the DEC is internally consistent, CFP professionals won’t know how to apply the rules safely to themselves until they’re already in front of the DEC trying to defend themselves!

Fortunately, since 2010 the CFP Board has been providing a limited number of “Anonymous Case Histories” to provide some guidance on prior DEC rulings. However, the CFP Board’s current Anonymous Case History (ACH) database is still limited (it’s not all cases), and the database does not allow CFP professionals (or their legal counsel) any way to do even the most basic keyword searches OF the existing case histories (instead, you have to search via a limiting number of pre-selected keywords, or by certain enumerated practice standards… which won’t even be a relevant search format once the newly proposed Standards replace the prior format!).

Which means if the CFP Board is serious about moving forward with the new Conduct Standards, including the application of a fiduciary duty and a few dozen instances of “reasonableness” to determine whether the CFP professional met that duty, it’s absolutely crucial that the Commission on Standards require a concomitant expansion of the CFP Board’s Anonymous Case Histories database to include a full listing of all cases (after all, we don’t always know what will turn out to be an important precedent until after the fact!), made available in a manner that is fully indexed and able to be fully searched (not just using a small subset of pre-selected keywords and search criteria).

In addition, the CFP Board should further formalize an additional structure to provide periodic guidance to CFP professionals – akin to the Notice to CFP Professionals issued in 2013 regarding compensation disclosure, but on a more regular basis – to allow for a further fleshing out of the CFP Board’s views of what constitutes “reasonableness” in various areas, so that CFP professionals don’t have to solely rely on after-the-fact adjudication to understand how best to navigate the 29 instances where “reasonableness” is the essential criterion for determining whether the standards were met.

Key Point: With 29 instances of “reasonable” or “reasonably” in the proposed Standards, CFP professionals need further guidance on what constitutes “reasonableness” in a wide variety of situations. Establish a mechanism for providing proactive ongoing guidance, and expand the framework of Anonymous Case Histories to include all case histories, in a searchable and properly indexed archive, so CFP professionals (and the DEC itself) can have a growing body of case law that can be properly cited and reasonably relied upon for precedence. 

Thank you for providing us as CFP professionals and stakeholders the opportunity to provide public comments regarding the CFP Board’s Proposed Standards of Conduct, and I look forward to seeing how the next version of the proposed changes will address the substantive concerns raised here!

– Michael Kitces

For CFP Professionals who are interested in submitting their own comments, the official comment period closes today (August 21st), but there’s still time!

You can submit your feedback directly through the CFP Board website here, or by emailing Comments and public forum feedback will then be used to re-issue a final version of the standards of conduct (or even re-proposed if the Commission on Standards deems it necessary to have another round of feedback) later this year.

And for those who want to read through a fully annotated version of the proposed Standards of Conduct themselves, the CFP Board has made a version available on their website here, and/or you can review our prior in-depth commentary about the proposed changes here.

So what do you think? Do you favor the CFP Board’s proposed Standards of Conduct moving forward in their current form? Do you see any potential issues or loopholes? Please share your thoughts in the comments below!


The Challenges Of Integrating Advisory Fee Schedules And Billing During A Merger Or Acquisition

The Challenges Of Integrating Advisory Fee Schedules And Billing During A Merger Or Acquisition

Executive Summary

There are many challenges in navigating a successful advisory firm merger or acquisition, from ensuring that the firms align on investment, financial planning, and service philosophies, to finding an agreeable valuation and terms to the transaction, and navigating the post-transaction integration process. Yet in practice one of the biggest blocking points is simply figuring out how to effectively align the advisory fee schedules and fee calculations of the two firms – for instance, when one advisory firm charges substantially more or less than the other – to the point that one of the biggest blocking points of an otherwise-well-aligned merger or acquisition is simply whether it’s feasible to integrate their billing processes (especially when the firms have differences in their underlying business model, such as an AUM firm acquiring a retainer-fee firm).

In this week’s, we discuss the major issues to consider when integrating advisory fee schedules and billing processes, from strategies to adjust when one firm has an advisory fee schedule that charges more (or less) than the other, to reconciling differences in billing timing (i.e., billing in advance versus in arrears), and the unique acquisition problems that arise when trying to acquire retainer-fee firms.

For most, though, the biggest challenge is simply reconciling differences in fee schedules between the two firms. In situations where the acquirer charges more than the firm being acquired, there’s typically a desire to lift the newly acquired clients up to the fee schedule of the existing firm – which can make the transaction a strategically positive deal for the acquirer, if it can generate more revenue from the same clients, but also increases the risk that clients will reject the new fee schedule and not transition at all (which means it may be a good idea to leave the original fee schedule in place for a year or two, to allow clients the time to adjust, and build a relationship with the new firm). On the other hand, when the acquirer charges less than the firm being acquired, it gets even messier, as if the acquirer pays “full price” for the new firm’s revenue and then immediately cuts their fee schedule, the acquirer faces a substantial loss on the transaction (unless they can bring down costs in the merger business by even more than the loss in revenue!).

Even where advisory firms reasonably align on fee schedules, though, it’s also necessary to consider whether they have the same billing timing – in particular, whether both firms consistently bill in arrears or in advance. Because differences between the two firms in their billing process can lead to substantial disruptions in cash flow for either the acquirer, or the newly acquired clients! After all, if the acquirer needs to switch the new firm from billing in advance to billing in arrears, the firm could be forced to wait up to six months without receiving any new revenue from the new clients! And if the acquirer needs to switch in the other direction – from billing in arrears to billing in advance – then the first invoice to the clients may have to be a “double-billing” of the last arrears fee and the first advance fee all at once (which increases the transition risk for the acquiring firm!). In fact, even differences in the billing calculation process – such as when one firm bills on end-of-quarter balance, and the other uses average daily balance – can create billing gaps between expected and actual revenues!

And of course, this all assumes that both the acquiring and selling firms were both charging AUM fees in the first place. In the case where the acquiring firm charges AUM fees but the acquired firm charged retainers, it can be even more challenging to transition the retainer clients onto the AUM firm’s fee schedule (especially since many retainer-based firms proactively “sell against” the disadvantages of AUM fees, which effectively chases away potential buyers who may want to convert the business to their own AUM fee schedule). In turn, this means the marketplace of potential acquirers for retainer fee firms is drastically smaller, and retainer fee firms may have more difficulty finding an acquirer that will pay them a “fair” price – particularly for firms that charge retainer fees to clients who do have assets and “could” pay AUM fees (as the situation is different when using retainer fees to serve younger clients, or other “non-AUM” types of clientele).

Ultimately, though, the key point is simply to recognize how important differences in advisory fee schedules and billing processes can be when you’re looking at a potential merger or acquisition. As a result, doing detailed due diligence on advisory fee schedules is crucial. In particular, advisors should be evaluating any differences in the level of fees charged to clients, the timing of those fees, how those fees are calculated, and whether two firms have fundamentally different approaches to billing altogether. Of course, fee schedules don’t need to be identical in order to successfully navigate a merger, but approaching a merger with a clear understanding of the potential risks and opportunities involved is crucial!

Billing In Advance Vs Arrears (and on Daily Balance vs End-Of-Quarter Values)

Now, the second area that advisors need to watch when it comes to merging advisory fee schedules is the actual billing process. Because there are two issues that can crop here, one big and one a little bit smaller. The really big one is whether you bill in advance or in arrears. In other words, when a client starts with you, is their first quarterly billing for the prior partial quarter that they were with you or is their first billing in advance for the upcoming quarter, and if they decide to terminate the next quarter, do you refund them a pro rata portion of their fees?

Now, some firms just prefer to bill in arrears and they have a philosophy, “We’re not going to bill our clients until we’ve started doing the work,” other firms I know say, “I have a strong preference for billing in advance, that way I never have any accounts receivable, and I never have to collect from clients. I just refund pro rata if someone terminates, and not many people do because I’ve got a good retention.” On an ongoing basis, most firms don’t even think about this. You just bill your clients quarterly, whether it’s in arrears or in advance. After the first billing, no one really cares unless they’re going to terminate you and then you have to figure out if you will pro rata portion the last fee back if you billed them in advance.

But in a merger or an acquisition, this matters a lot, because if you bill in arrears and you acquire a firm that bills in advance, then when you buy them, you immediately take on the liability of refunding any clients who terminate in the quarter right after you’ve billed them. Unless you immediately convert the clients to arrears billing, you also have this potential liability in the future. But if you want to convert the clients, this gets even messier.

Imagine I bill in arrears and I acquire a firm that bills in advance. We’re in negotiations now, the deal closes in October, shortly after fourth quarter billing has happened at the end of September 30th. So the clients of the firm I just bought have already paid for Q4, they paid it in advance, which means if I want to bill them in arrears, my next billing isn’t going to happen for five months, until the end of Q1, March 31st, when I can bill them in arrears for the first billing as the acquired firm.

If I bought the firm in October, I don’t get any revenue at the end of the fourth quarter. There’s no Q4 billing in arrears because the firm already billed Q4 before they sold it to me. That seller has that money gone with it. And if I don’t bill in advance, I can’t bill them for Q1 at the end of the year. Instead, I have to wait three months into Q1. So you have to be cognizant of whether there were gaps between the firms billing in advance and in arrears.

And unfortunately, it’s not much better going the other direction. If the acquiring firm bills in advance and the firm being acquired bills in arrears, then the only way to true-up clients is that as the acquirer, you have to double-bill them. So in my earlier example, if you buy a firm in October that bills in arrears when you bill in advance, and at the end of Q4, on December 31st, you’re going to bill Q4 in arrears, because the clients haven’t paid for that yet, and you’re going to bill Q1 in advance because that’s what you do on an ongoing basis. And so the clients are going to get hit with two bills to get them on track the first time you do billing with them as the acquirer.

Now, it’s worth noting that you’re not cheating them or anything here. You’re not like literally double-charging them. They’re paying the Q4 fees because services were rendered in Q4, and you’re billing them in advance for Q1 because that’s what you do with all of all your clients, and if they terminate you you partially refund. But it does mean you have to be prepared to communicate that to transition them from arrears into an advance, there has to be a double-billing that occurs. You have to go two-quarters of fees to get an arrears closed out and an advance set up going forward. And so that’s a real risk, a real transition risk if you’re an acquirer, and you have to convince clients to stick around when the first thing you’re going to do is bill them for two-quarters when they’re still getting to know you. Now, it can be done. I know firms that have done it and they were able to get through it, and they were able to have retention. But at a minimum, it’s a really sensitive issue.

The other piece that goes along with these sort of mundane billing processes is you need to be aware of whether there’s alignment in how the fees are calculated. Specifically, when you do that billing, whether it’s in advance or in arrears, do you calculate based on end of quarter balance, or do you calculate based on average daily balance? Now, in theory, on average, these things average out, but not always. If your clients are net savers, end of quarter balances tend to be higher than average daily balances within the quarter because clients keep contributing lifting up the balance so that the end of quarter tends to be the highest one because it’s got all the contributions.

But if you’re mostly working with retirees, it may be the other way around. Average daily balances tend to be higher than end of quarter balances because at the end of the quarter all the withdrawals have occurred. And then, of course, in any particular quarter, you can get big gaps if the market moved sharply in the last couple of weeks in either direction and the end of quarter balance is very different than the average daily balance. In general, this adjustment tends to be more administrative (particularly in the quarter where the transition is occurring), but you need to know that the billing process is going to change. First, because you have to communicate it, second, because you probably need to reflect it in an updated advisory agreement, but you also need to consider whether there’s a risk that it may distort revenue in the first billing period after you acquire.

The Acquisition Problem With Retainer Fees In Lieu Of AUM Fees

Before I wrap up, there’s actually one other important dynamic I want to note here as well, and it’s the unique challenges that crop up when you’re trying to merge advisory firms where their fee schedule isn’t AUM fees in the first place, it’s retainer fees. Now, we know from industry research that the overall majority of advisory firms are still AUM-centric. And in fact, that the larger the advisory firm, the more affluent their clients, the more likely they are to charge AUM fees. Which means, on average, most buyers of retainer firms are still going to be AUM firms. And AUM firms acquire other firms to get more AUM. That’s what they do.

But what that means is that when an AUM acquires a retainer firm of clients who actually have assets, there’s usually a plan to convert those retainer clients over to an AUM fee structure. Except, unfortunately, that’s often very difficult because the firms that use retainer fees, particularly for affluent clients, tend to aggressively sell against AUM fees to convince their clients that the retainer model is superior, which means you effectively poison the well for most of your acquirers.

And this is one of the major drawbacks to pivoting from AUM to retainer fees that I find very rarely ever comes up in conversation (although I know a number of advisors who switched to retainer fees years ago and now want to retire and can’t find anyone to buy their firm because most firms charging retainer fees are relatively small, don’t have great margins, and don’t have the size and scale and cash flow to buy…while the AUM firms who’ve got dollars to buy, don’t want to buy retainer fee firms where the clients have been told that the AUM model is bad).

This isn’t necessarily an issue for those who are doing retainer fees for younger clients who don’t have assets, because the truth is, no AUM buyer is going to be acquiring a practice of clients who don’t have assets (or if they do, they’re going to acquire because they want to actually do the retainer model the way the retainer model is being executed). But if you’re a firm that works with affluent clients who have assets and simply charges retainer fees, this gets a lot harder to find prospective buyers because the AUM buyers want to convert but are afraid of the risk, and there aren’t very many non-AUM buyers. You risk drastically reducing the appeal for the bulk of prospective buyers.

And in fact, even other retainer firms often have trouble acquiring those who do complexity-based retainer fees because different firms characterize complexity differently. And so, even two firms doing annual retainer fees for affluent clients might charge very differently for some of those clients. Which means if you’re the acquirer, this is a really messy, one-client-at-a-time process of figuring out what each acquired client would be charged under the new firm’s model, and whether it’s more or less than what the old firm was charging.

Indirectly, this is actually one of the reasons why the AUM model happens to work so well because, by its nature, it’s actually a really systematized billing model. At worse, you have to change a few rates or break points on your AUM fee schedule, but there’s a standard fee structure for all clients. And that’s often not the case with retainer firms. And so, it can make the billing process much harder to reconcile for an acquiring firm. Sometimes so difficult that it may narrow the number of buyers, which means you have to spend more time trying to sell your firm and have fewer bidders competing and hopefully bidding up your price, which is not good news if you hope to be a seller some day. So do understand that most firms tend to get acquired by those who have comparable billing styles or business models, and make sure you know that you’re going to have buyers if you’re making business model decisions.

But anyway, the bottom line is just to recognize how important it is when you’re looking at a potential merger or an acquisition to do this kind of detailed due diligence on the advisory fee schedules and the billing processes. Do the firms have the same fee schedule? If not, who’s higher and lower all the way up and down the spectrum? Do they both bill in arrears or in advance, or is there a gap? Do they both bill on quarter and/or average daily balance or is there another gap? And if the firm charges retainer fees or separate planning fees (or a blended AUM plus retainer), are those fee structures and the way the fees are set consistent across the firms? Because, if they’re not, those kind of manually assigned retainer fees and planning fees are often the hardest parts to line up.

So be aware of that, and particularly if you’re thinking about moving away from AUM fees and towards the emerging range of “non-traditional” fee structures, as you may limit the potential market for buyers. It doesn’t necessarily mean it’s a bad thing to do if you think you can grow the business well enough in that direction. You may grow up on more than enough to make up for the fact that you’ve got a smaller market, but it’s really hard to find firms that will want to acquire you because of all these challenges in integrating fee schedules and billing if you use a substantially different fee model than everybody else.

I hope that’s helpful as some food for thought.

So what do you think? Are differences in fee schedules a potential problem when looking at mergers and acquisitions? Have you been in a similar situation? How did you manage the transition from one fee schedule to another? Please share your thoughts in the comments below!

How The Human-to-Human Connection Helps Facilitate Positive Behavior Change

How The Human-to-Human Connection Helps Facilitate Positive Behavior Change

Executive Summary

As financial advisors, we understand that one of the most important (and difficult) things we can do for our clients is help facilitate positive behavior change. And not just change that keeps clients from doing “bad” things (like selling at a market bottom), but also change that enables them to do “good” things (like saving more for retirement).

Unfortunately, behavior change is hard, but the good news is that the difficulty of enacting behavior change also means it is one of the most valuable things we can do as financial advisors. And the human-to-human connection – and the social commitments we feel – provide some powerful incentives to enact behavior change… which means financial advisors serving as an “accountability partner” to their clients have the potential to drive more successful behavior change than what clients can do on their own.

In this guest post, Derek Tharp – our Research Associate at, and a Ph.D. candidate in the financial planning program at Kansas State University – analyzes some existing research in the contexts of weight loss and alcoholism to explorer the power of the human-to-human connection in holding us more accountable (than we can be to ourselves alone) to accomplish our goals and behavior our behavior.

In other words, the unique power of the human-to-human connection means clients can achieve better behavior-change outcomes with a financial advisor than they may be able to achieve by themselves or through the use of technological tools. Because when a human is involved, we often have few options for totally avoiding the unfavorable perceptions we think others may have about us if we don’t follow through on our goals… which can be highly motivating. In the case of technology, while it may provide useful behavior change reminders… we can always just turn off the technology, and feel very little guilt. But it’s far harder to just “turn off” an existing relationship with another person.

Of course, this still doesn’t mean that enacting behavior change is easy. It is very difficult, but by acknowledging the social pressure that exists within an advisor-client relationship, we can use strategies – such as setting clear action items for clients based on “SMART” criteria, and encouraging clients to leverage social forces in contexts outside of the advisor-client relationship – to can help clients improve their financial well-being. Ultimately, we human beings are herd animals, and as financial advisors we should keep that in mind as we develop strategies to help clients achieve their financial goals!

The Difficult Dynamics of Positive Behavior Change

One of the most important (and difficult) things financial advisors help do for their clients is facilitate positive behavior change. And not just change that keeps clients from doing “bad” things (like selling during a market decline), but also change that enables them to do “good” things (like saving more for retirement).

At a high level, the fundamentals of what most people need to do in order to achieve better financial outcomes (save more and spend less) are incredibly simple. Further, most people are already aware of what they must do, but that doesn’t make behavior change any easier.

Whether it is eating better, exercising more, or saving for retirement, some insidious dynamics underlie many of the situations in which we must make a change in order to improve our well-being. Namely, the cost of waiting a day is often small, while the cost of never getting started is very large.

Example. John is a recent graduate earning $50,000 per year. John would like to start saving 10% of his income, but he hasn’t gotten started yet. As John is getting accustomed to his new lifestyle, he continues to have small expenses come up that keep him from starting saving, but he plans to start saving soon.

Suppose John were to break up his annual saving goal on a daily basis. To save 10% of his gross income, he would need to save a little less than $14 per day. However, the tricky thing about saving is that the cost of waiting one more day to get started ($14) is incredibly small and will have virtually no impact on his life, while the cost of never getting started (a life of poverty in retirement) is incredibly large. John can rationally decide to wait until tomorrow to get started saving, but once tomorrow rolls around, the dynamics are exactly the same.

And even once John does get started saving for the future, the same dynamics can get him back off track. Inertia is at least working in our favor once we have made a good decision, but the cost of getting off track for just one day remains low, while the long-term costs of getting off track remain very high.

Of course, as mentioned before, these dynamics are not unique to saving. They underlie a wide range of life decisions where what we would prefer to do and what we know we ought to do are in tension. And these dynamics illustrate why we are often so bad at holding ourselves accountable – even when we know what to do, the decision to “start tomorrow” is often rational (at least for our short-term, hyperbolic discounting selves).

Human-to-Human Accountability is a Powerful Motivator of Behavior Change

Fortunately, there are many ways we can shift the dynamics of choices which are rational in the short-term and irrational in the long-term, in order to make ourselves more likely to enact and maintain positive behavior change. One powerful way is to use some of our social tendencies—namely our desire to avoid “failure” in the eyes of others—to hold ourselves more accountable when enacting change that we know would be good for us.

We can see this dynamic in play with many popular programs aimed at helping people make positive behavioral changes. For instance, Weight Watchers’ “Support Squad”, Financial Peace University’s “Accountability Partner”, and Alcoholics Anonymous’ (AA) “sponsors”. In each case, the social connection with someone else is intended to promote a greater level of accountability and success within the program.

And there is some empirical evidence that a human-to-human connection (e.g., in the form of an “accountability partner”) helps improve behavioral outcomes. A study from Rena Wing of the University of Pittsburgh School of Medicine and Robert Jeffrey of the University of Minnesota School of Public Health found that incorporating social support strategies improved weight loss outcomes over a standard behavioral treatment by itself. Specifically, the researchers found that among those who did not receive social support strategies with their weight loss program, only 76% completed the 4-month program and only 24% maintained their weight loss from months 4 through 10. By contrast, among those who received social support strategies, 95% completed the 4-month program and 66% maintained their weight loss from months 4 through 10.

The Power Of Human To Human Accountability - Weight Loss Outcomes With and Without Social Support

Additionally, a 2012 study from Witbrodt, Kaskutas, Bond, and Delucchi evaluated sponsorship status and success in abstaining from alcohol consumption among AA members based on prospective, 1-year, 3-year, 5-year, and 7-year follow-ups. The researchers found that sponsorship (where the individual in treatment has a “sponsor” – an accountability partner – to help them stay on track) improved outcomes even after controlling for attendance at AA meetings. When compared to alcoholics in the study with the lowest levels of sponsorship over time, those with the highest levels of sponsorship were 7 times more likely to remain sober.

The precise psychological mechanisms that lead us to be more accountable to others than we are to ourselves isn’t fully understood, though something to the effect of Charles Cooley’s “looking glass self” (whereby we evaluate ourselves based on how we believe others will perceive us) or perhaps Adam Smith’s “impartial spectator” (whereby we evaluate ourselves based on how a perfectly virtuous outsider would perceive us, while also aiming for social acceptance when it would be virtuous to do so) would both seem to be relevant. The bottom line, however, is that human beings are herd animals, and we truly do seem to be more accountable to others than we are to ourselves alone.

Thus, while it was rational (in the short-term) for John to delay saving in the example above, if John has met with his financial advisor and committed to a plan to start saving, then it may no longer be rational for John to put off saving in the short-term. While the financial cost of delaying each day is still small ($14), the social cost of failing to save has been increased. John knows that his financial advisor is aware of his goal to save, and has helped him put a plan in place. If John shows up to his next meeting with no progress to report, John’s assessment of himself through the eyes of his advisor is likely not positive. Instead of just encountering just a trivial financial cost for not saving, John encounters a financial cost paired with the social cost of seeing himself as a failure through the eyes of his advisor.

In this way, we can view the decision to share our goals with others and involve them in the process of accomplishing those goals – including the decision to hire a financial advisor – as a form of social “commitment device” (i.e., a self-imposed means of altering our short-term incentives in a way that makes us more likely to accomplish our long-term goals). In other words, acknowledging that we aren’t the best at holding ourselves accountable, we can involve other people in our goals to make ourselves feel a greater sense of obligation to accomplish them.

How Advisors Can Utilize Human-to-Human Accountability When Working with Clients

Fortunately for advisors, human-to-human accountability is beneficial in several ways. First, it represents a key value-add that advisors can provide which will be hard for computers to ever mimic. While technology can provide some useful commitment devices as well  (e.g., software which can block distracting websites and help you be more productive), social commitments with other humans will be inherently more useful in some circumstances. For instance, a known limitation of much productivity enhancing software is that it requires the user to continually opt-in to using it. If a user is getting annoyed that their productivity software is blocking certain websites, they can simply turn the software off. While one may feel a little self-imposed guilt for doing so, the dynamics are different than when working with a human.

Additionally, sometimes the well-intentioned use of technology can actually make matters worse. A 2016 study on the use of wearable fitness technology in The Journal of the American Medical Association found that when compared to a standard weight loss intervention (low-calorie diet, increased physical activity, and group counseling sessions), participants in a technology-enhanced intervention group (same treatments as before, with the addition of a fitness tracker) actually lost less weight! Specifically, participants in the standard behavioral intervention group had lost an average of 13lbs at the end of a 24-month period, whereas the technology-enhanced group had only lost an average of 5.3lbs. While the reason for this difference is unknown, one possible explanation is that the technological confirmation of “good” behavior leads people to engage in some motivated reasoning aimed at rationalizing “bad” behavior. For instance, seeing that I exceeded my step goal for the day might make me less inclined to turn down dessert, with the net result that I eat more “bonus” calories than I lost from the technology-measured exercise in the first place!

But the key point is to acknowledge that social accountability is different than self-imposed or technological accountability. When a human is involved, we often have few options for totally avoiding the unfavorable perceptions we think others may have about us if we don’t follow through on our goals. In the extreme, we can do our best to disappear and never see someone again, but we still know that other person knows we dropped off the face of the earth and likely has some negative perceptions about why we may have done so (not to mention the social impropriety of such a disappearance). This creates a permanence associated with human-to-human accountability that can’t be easily replicated in other ways.

Human-to-human accountability provides some important ways in which advisors can help their clients achieve better outcomes. Notably, an advisor doesn’t actually have to have harsh judgments of their clients for human-to-human connection to be effective. Indeed, AA sponsors are encouraged to express kindness, respect, and empathy towards their sponsees – though the ability and willingness to deliver the “hard truth” is important as well. But the fact that the social connection is there means that clients may still wish to avoid “failure” in the eyes of others, even if they know those others will be compassionate and respectful towards them.

Using “Action Items” to Generate Clearly Articulated Expectations

One particular way advisors can encourage behavior change through human-to-human connection is by not only giving clients recommendations of what they “should” do, but helping clients develop explicit “action items” that they commit to completing. If advisors allow clients to leave action items in vague terms, the influence that social pressure can have on these goals is diminished. For instance, a vague goal to “start saving more” doesn’t define when or how much a client would need to shoot for in order to successfully fulfill their goal. By contrast, a goal to boost savings in one’s 401(k) to the annual maximum by the end of the month gives a client a clear goal which can actually be evaluated.

Goals and their supporting action items should ideally adhere to “SMART” criteria, meaning they are specific, measurable, achievable, results-focused, and time-bound. When these criteria are met, then a client who doesn’t incorporate the agreed upon changes will feel a sense of failure for not having done so. However, if the criteria are not clear or an advisor just provides an open-ended recommendation with no buy-in and commitment from the client, then the social pressure is greatly diminished. After all, the client can simply say to themselves, “Sure, my advisor recommended I start saving, and I’m saving 2% now, so I guess that’s good, right?” Or, “My advisor suggested I start saving 15% and I thought that was a good idea, but we never said when I should start. That’s probably something that’s best to start next year.”

Creating SMART Financial Planning Action Items

Of course, advisors don’t need to dictate these goals to clients (and there are good reasons to believe that approaches such as solution-focused financial therapy which allow clients to develop their own goals and solutions will result in better outcomes, but the key point here is that the goals which are ultimately developed should be made explicit. If those goals are not made explicit, then clients have no way of truly evaluating whether they accomplished them or not, and the social pressure of not wanting to see oneself having failed through the eyes of their advisor is diminished.

But that doesn’t mean an advisor needs to be dictating action items to clients and telling them what to do. Perhaps something akin to the following conversation could set clear action items, even if the client themselves generated the goal: “John, you mentioned that you should probably start boosting your savings in order to reach your retirement goal. I ran the projections and I agree. My projections show you should probably be saving closer to 15% compared to your current 10%. You felt that 15% was a reasonable savings amount, so would you be comfortable setting an action item that you’ll boost your savings to 15% by the end of the month?” This approach is not dictatorial, but it also ensures a SMART goal is generated so that a client feels some social pressure to actually follow through.

It is also important to note that it is assumed here that a goal aligns with what a client wants to accomplish, and therefore “failure” does not inherently imply any particular type of behavior. For a client who struggles to spend, “failure” may mean the client didn’t follow through on their goal to take their family on a trip or give more to a cause that is important to them, even though “failing to spend” would likely have a positive impact on their net worth.

Leveraging Social Forces Outside of The Advisor-Client Relationship

Another important source for enhancing client outcomes through human-to-human connection is to encourage relationships outside of the advisor-client relationship which can help clients engage in better behaviors.

While advisors tend to have mixed (and often very strong) feelings about programs such as Financial Peace University (FPU), arguably one of the most powerful aspects of such programs is the social reinforcement of the principles taught. Dave Ramsey lays down some hard rules for the group and once per week (or more) the group can help encourage each other, reinforce group norms, and hold each other accountable.

Advisors often object to some of the hard rules established in programs such as FPU (e.g., avoid all debt), but I suspect such criticism largely misses the point. People attending programs like FPU generally aren’t looking to explore the most sophisticated ways they can utilize debt to enhance their financial situation. Instead, they’ve often found themselves in a tough spot and realize they need to fundamentally change their behavior. Unlike cutting up credit cards and only using cash, a complex decision tree of all the various and nuanced ways in which debt can be prudently utilized is unlikely to generate the type of group norms which can be socially reinforced.

Since most advisors can’t realistically spend as much time with their clients as group based financial programs do, suggesting clients attend such programs is one way advisors can encourage their clients to develop some fundamentally good financial practices. While there may only be a small number of such courses, other options include things like YNAB (You Need a Budget) and even blogs such as Mr. Money Mustache which facilitate “Meetups” for community members to get together.  If a client trusts their advisor, then adding nuance to overly simplified rules once the client has achieved the behavior change they are looking for will likely not be a huge barrier to overcome.

Similarly, advisors can encourage clients to evaluate the ways in which various social groups they belong to are currently influencing their spending – regardless of whether it is positive or negative. For instance, an individual may want to reconsider how they engage with a social group which puts them in situations where they continually feel the need to stretch their budget, just as it’s hard to quit smoking if you still spend time with smokers, or to quit drinking if you spend time with friends who regularly drink (right in front of you while you’re trying not to!). Additionally, they may want to look for other social groups they can join which will provide positive reinforcement for behaviors an individual is trying to develop.

Ultimately, human-to-human connection plays an important role in how develop and foster good financial behaviors. Fortunately for advisors, this not only means there will likely always be a role which cannot be fulfilled by technology (further suggesting the cyborg advisor has far more potential than the robo advisor), but also that human-to-human connection can help clients achieve better financial outcomes. Advisors may be able to help clients improve outcomes by setting clearly defined goals that encourage clients to feel as though they have some objective criteria to be evaluated by, and also by encouraging clients to consider the ways in which social connections in other areas of their life can help encourage or discourage prudent financial behaviors.

So what do you think? Can the social influence of human-to-human connection help clients make better financial decisions? Are we more accountable to others than we are to ourselves? Do you use action items to help hold clients accountable? Please share your thoughts in the comments below!

4 Ways Financial Advisors Can Benefit From Finding Their Flow State

4 Ways Financial Advisors Can Benefit From Finding Their Flow State

Winning athletes are known for being able to “get in the zone”, an extreme state of focus that researcher Mihaly Csikszentmihalyi dubbed a state of “flow” in his book by that name. But notably, achieving a state of flow is not unique to athletes; it’s possible for anyone to reach a similar level of focus and performance in their given endeavor. Accordingly, Iskowitz highlights a recent TD Ameritrade LINC conference session by Steven Kotler and Jamie Wheal, who apply the principles of Flow research across a wide range of professions based on Kotler’s recent book “The Rise Of Superman: Decoding The Science Of Ultimate Human Performance“. However, not everyone reaches a state of flow in the same manner; Kotler and Wheal have found four different types of Flow profiles, including Hard Chargers (the classic adrenaline junkies), Deep Thinkers (the virtuoso that loses themselves in full concentration on their task at hand), Flow Goers (free spirits like yogis and artists who try to live their lives in an ongoing state of flow), and Crowd Pleasers (extroverted performers who find moments of flow in engaging the crowd). The reason why it’s important to understand your “Flow Profile” is that it allows you to better oriented your time and energy towards the kinds of activities most likely to create a Flow state, and identify your Flow triggers – the psychological, environmental, social, and creative areas that can help people enter a state of Flow (and once you understand your own Flow triggers, you can try to re-create those trigger circumstances more often). Notably, though, even for the best, Flow states do not sustain. Even neurochemically, the process of flow is a four stage cycle of Struggling to reach flow (when cortisol and norepinephrine are released), Release (where you de-stress to prepare to enter a flow state), the Flow itself (which includes a global release of nitric oxide, which flushes out stress hormones and resets the nervous system), and Recovery (where the neurotransmitters must build up again). For those who are curious to better understand their own Flow profile, Kotler and Wheal have launched the Flow Genome Project, which provides a Flow s self-assessment tool here.

DoL Seeks To Delay Fiduciary Rule Until July 2019

DoL Seeks To Delay Fiduciary Rule Until July 2019

The Department of Labor has been embroiled in several lawsuits challenging its new fiduciary rule, and in a brief filled in its Minnesota lawsuit with Thrivent Financial this week, the DoL indicated that it is submitting to OMB a proposal to delay the remaining parts of the rule from the current January 1st, 2018 implementation date, out to July 1 of 2019, instead. Notably, the core of the DoL fiduciary rule has already taken effect, but compliance is currently in a “transition period”, such that firms and advisors are required to adhere to the Impartial Conduct Standards (that they give best-interests advice, for reasonable compensation, and make no misleading statements), but don’t have to comply with the full scope of disclosure and other requirements of the Best Interests Contract Exemption. The proposed delay would extend the current transition period, allowing firms another 18 months before being required to step up to full compliance (and, notably, also extending the time period during which DoL fiduciary opponents can continue in their attempts to derail the rule further), and would also extend the time period before the indexed annuity industry must complete its transition from the existing PTE 84-24 rules to the full BIC requirements. Yet the latest proposal of the DoL to delay the rule is just that – a proposal – which still has to be reviewed by OMB (for up to 90 days), and then the DoL would release it to a public comment period (with comments being submitted by both fiduciary advocates and adversaries), and then a final change rule would have to be re-submitted to OMB if the comments were supportive of further delay… and it’s not clear yet whether the DoL actually has a substantive and legally justifiable reason to engage in a further delay (not to mention one as long as 18 months). Which means at this point, the latest proposed delay just adds another layer of uncertainty to the potential timing of the DoL fiduciary rule, and it won’t likely be clear if the new delay is even going to be a delay until this fall.

Why Broker-Dealers Launching Robo-Advisors Are Missing The #FinTech Point

Why Broker-Dealers Launching Robo-Advisors Are Missing The #FinTech Point

Executive Summary

Broker-dealers launching their own “robo-advisor-for-advisors” solutions for their reps has been a growing and accelerating trend. From prior announcements like the LPL deal with FutureAdvisor after Blackrock bought them, to Voya stating that they are looking to acquire a robo-advisor solution, and this week Kestra Financial announcing that it is working on a robo solution in the coming year as well. Yet the irony is that even as broker-dealers increasingly hop onto the “robo tools” bandwagon, they may actually be the worst positioned to capitalize on the trend, especially if their goal is to increase their volume of next-generation Millennial clients for their reps!

In this week’s post we discuss why broker-dealers are missing the point by launching “robo” solutions, how broker-dealers will struggle to gain any traction with Millennials – even with a robo-advisor – because of their digital marketing woes, and why broker-dealers should really be framing “robo solutions” as simply an upgrade to their entire technology stack instead!

Given the popular notion that “robo-advisors” are an effective means to grow a Millennial client base, it’s certainly understandable that broker-dealers want to pursue “robo” solutions. After all, the reality is that while the average advisor may simply be able to keep working with affluent retirees until the advisor themselves retires, broker-dealers are going-concern businesses that must focus on the long run – and recognize that eventually, the coming shift in generational wealth (as Baby Boomers pass away and bequeath assets to their Millennial children) means that they must find a way to grow their Millennial client base. And for the average broker-dealer rep who struggles to efficiently serve small accounts, who wouldn’t want a “robo” solutions where clients can come to the broker’s website and sign up and onboard themselves?

Yet the truth is that robo-advisor tools don’t actually attract Millennial clients. At best, they’re a highly efficient means to onboard and manage a Millennial client’s account, but the firm must still figure out how to market and attract Millennial clients in the first place. Which has been a challenge even for the most established robo-advisors, as companies like Betterment and Wealthfront have only averaged $1B to $2B per year in net new asset flows (and even then at “just” a 25bps price point!), and even the more eye-popping growth of Schwab Intelligent and Vanguard Personal Advisor Services has been driven primarily by clients who already had their assets with those brands, and simply moved them to their new “robo” offerings. And in point of fact, Vanguard’s solution wasn’t even the rollout of a robo-advisor, but the addition of human financial planners to clients who already worked with Vanguard digitally – a “cyborg” (tech-augmented human CFP professional) solution that is taking over the industry, with Personal Capital, Schwab, and even Betterment now offering tech-augmented human CFP advisors (and not just a robo solution alone).

In fact, when it comes to marketing to Millennials, even the robo-advisors have struggled with client acquisition costs, and they have entire companies (or at least entire divisions) with dedicated direct-to-consumer marketing, and the ability to leverage substantial existing brands (in the case of Schwab and Vanguard). By contrast, most broker-dealers have little brand recognition with consumers, a decentralized marketing process (where every rep is responsible for their own marketing and business development), and a cumbersome compliance process that makes it almost impossible to rapidly iterate the broker’s digital marketing efforts to attract Millennials online. Which means broker-dealers that launch “robo” initiatives are unlikely to see much of any asset flows whatsoever.

All this point said, it doesn’t mean that the “robo” tools themselves are bad for a broker-dealer to adopt. To the contrary, there are tremendous operational efficiencies to be gained with “robo” technology that expedites the process of onboarding clients and efficiently managing (model) portfolios. But again, that’s because robo tools are all about operational efficiencies… not marketing and business development! Which means broker-dealers announcing they are going to roll out “robo” tools will at best underdeliver on its promise of bringing in new young clients without needing to do any work – because it’s not a marketing solution for Millennials, it’s an operational solution after you do the marketing to Millennials yourself (which, most advisors don’t do well in the first place)! And at worst, brokers themselves just won’t adopt the tools, because they feel threatened by “robo” tools that imply the broker can be replaced (even if real advisors aren’t at risk of being replaced by robos). Instead, what broker-dealers should do is simply say “we’re upgrading our technology to make you more operationally efficient in opening and managing investment accounts.” Because that’s what it’s really about. And that’s the outcome that really matters!

Why Broker-Dealers And Their Reps Want A Robo-Advisor To Work

Now, I do get the appeal for a broker-dealer of launching a robo-advisor. First and foremost, I hear a number of broker-dealer reps asking for it, but not all because many are very happy with who they’re currently serving and what they’re doing. But instead, whether it’s an easier way to handle accommodation clients, those small clients where it’s hard to spend the time with them, or just the appeal of being able to have a robo-advisor button on your website to take on young millennial clients. There is a pain point, a valid pain point, for a lot of advisors in trying to work with small accounts that are time-consuming where a robo solution that automates it seems appealing.

I mean if the technology is entirely automated anyways, who wouldn’t want to put a button on their website that gets young people to open up small accounts that will grow with systematic contributions over time? And it takes no time from the advisor because they’re just clicking on a button. And from the broker-dealer’s perspective, ideally, this helps them address I think what’s actually a much broader issue, the coming generational shift of assets from baby boomers down to millennials.

For the individual advisor, however, I think the significance of this trend is grossly overstated. The average baby boomer is 62 years old. A retired couple at that age still has as joint life expectancy of about 25 years. The average age of a financial advisor is mid-50s, which means the average advisor will long since be retired themselves before their average baby boomer client start passing away and bequeathing assets to millennial children. Even a 40-something advisor will likely be retired before a material rotation of assets happens.

And of course, during retirement, although we talk about how clients are in a decumulation phase, the truth is retirees don’t actually withdraw that much at a 4% withdraw rate. Account balances actually tend to remain stable where you can grow when retirees are in their 60s and 70s because a 4% withdrawal is less than the long-term growth rate on a retirement portfolio.

But broker-dealers are corporate entities and they have a much longer time horizon. If you’re an advisor who in ten years is watching your client be slowly attritioned down due to the occasional death and ongoing withdrawals, and maybe you’re losing 3% to 5% a year in assets and revenue because of it, it’s not really that big of a deal. You’re probably already 50- or 60-something, you’re making good money anyways, your clients have been with you for a long time, they might not even be all that time-demanding anymore, and there are still 10,000 baby boomers turning 62 every day, so you can always find a few replacement clients if necessary. Simply put, the average advisor cruises it out.

But if you’re a broker-dealer that in the aggregate is losing 3% to 5% a year in assets in a decade from now, it’s a crisis because the advisors are going to retire soon and the broker-dealer still has a multi-decade open-ended timeframe as an ongoing business entity. There’s a difference in time horizons. And in point of fact, I think this is why we see broker-dealers, as well as RIA custodians, so obsessively beating the drum about advisors needing to focus more on younger clients. It’s not actually because we as advisors desperately need younger clients for our businesses to survive. It’s because they, the broker-dealers and RIA custodians, need us to get younger clients for them so their businesses survive and so they have younger clients after we’re gone and retired.

Now, from the broker-dealer’s perspective, if all the buzz is that millennials are pursuing robo-advisor solutions, then the broker-dealer wants to roll out a robo-advisor to get those younger clients.

Broker-Dealers Struggle With Digital Marketing

I get it, but here’s the problem with the strategy: robo-advisor solutions live and die by their ability to get clients online, and that’s not easy. Even Betterment is up to just 10 billion dollars of assets after 6 years. Wealthfront is at barely 6 billion total over that time period. Schwab has made news for $15 billion dollars of assets, but has actually noted that only about a third of that, maybe five billion dollars, was new assets. The rest were just existing Schwab clients that happened to switch to the robo solution. Vanguard now is over 60 billion dollars, but it’s rumored to have an even higher percentage of assets that were already at Vanguard. They were simply upsold to human advice because, remember, Vanguard already is direct-to-consumer through the Internet. Their solution, Vanguard Personal Advisor Services, wasn’t adding a robo. It was adding humans to what was already a robo-digital solution at Vanguard.

And even when you look at firms like Edelman Financial, they’ve struggled. A 15-plus billion dollar RIA working on building a national brand with centralized marketing and a huge digital presence launched Edelman online in early 2013, and after four years, they have barely a thousand clients and $62 million dollars of AUM, and their average robo client is actually a baby boomer anyways. In other words, even though leading robo-advisors are struggling to get millennials and are getting maybe one or two billion dollars a year in net new assets, which at 25basis point pricing, it’s a couple million dollars a year of gross revenue before the cost to build and service and support the robo technology for the broker-dealer itself, which means even for a mid-sized broker-dealer, that’s really small potatoes. And that’s based on what the growth is that the leaders in the robo movement are doing.

Even more to the point though, is how the leaders are doing it with platforms that are focused on building robo solutions with centralized marketing, but that’s not how it works in a broker-dealer environment where there are hundreds or thousands of reps, each of them have their own marketing plans, their own online marketing experience, or no online marketing experience, no digital marketing tools, and they have to get every digital initiative and every change on their website re-approved by compliance.

When you look at what robo-advisors do, their marketing is constantly iterating. They are running dozens of AB tests on their websites every day. Meanwhile, at a broker-dealer, I can’t even AB test whether it would be better for my robo-advisor to have a button that says, “Click here to open your account,” or to say, “Open your account now,” without getting compliance to pre-approve the change of the text on a little, tiny button. That is, to put it mildly, a very inhospitable environment to do rapid testing digital marketing to gain traction with a broker-dealer’s robo solution.

So what happens instead? The reality, again, the average advisor at a broker-dealer focuses on retirees. Their website probably shows pictures of couples walking on the beach towards a lighthouse, or maybe they’re sitting on Adirondack chairs, looking out over the ocean. So what exactly is this advisor supposed to do with a robo solution from the broker-dealer? Put a button on their website that says, “Millennials, open your robo account now,” right between the lighthouse and the Adirondack chairs? I mean does anybody really think a tech-savvy millennial is going to hit that button and transfer their life savings?

Simply put, the problem is robo-advisors don’t actually help advisors get millennial clients. Robo-advisors help advisors open millennial accounts after they successfully market to get millennial clients in the first place. And so until and unless broker-dealers figure out how to help their advisors get much, much savvier about digital marketing and how to actually attract and get millennial clients in the first place, and then use the robo tools to onboard and open the accounts, these broker-dealer robo initiatives are all doomed to fail.

It’s not an, “If you build it, they will come,” kind of asset gathering opportunity. I mean what we’ve actually found is the real blocking point of robo-advisors is the client acquisition cost, what it takes to market and get a young investor to invest on your platform. The robo-advisors were not only not a solution to client acquisition costs, they’ve been getting buried by client acquisition costs. It’s why we’ve been writing for the past two years that robo-advisor growth rates just keep slowing and slowing and slowing. Most of them have already sold and the ones that are left aren’t even really focusing on a robo strategy anymore.

Notwithstanding how it’s labeled, Vanguard is a human advisor service, hundreds and hundreds of CFPs that they’re hiring as quickly as they can. At best, it’s a cyborg solution, tech-augmented humans. Personal Capital is often branded as a robo, but it’s not. It hires CFPs in Denver. It’s a cyborg solution as well. Schwab pivoted from a pure robo solution to intelligent advisory which offers humans. And heck, even Betterment pivoted from a robo solution to offering human advisors this year. So, no one who’s actually succeeding at robo is doing it with a robo solution. They’re bringing in humans while broker-dealers are trying to roll out robo-advisors. This is not going to end well for them.

Robo-Technology Is About Back-Office Efficiency, Not Millennial Asset Growth

All that being said, I do want to point out that just because a robo-advisor solution to broker-dealer is doomed to fail at gathering millennial assets, it doesn’t actually mean the technology itself is worthless. To the contrary, there are tremendous operational efficiencies to be gained in a lot of robo technology.

After all, at its core, robo tools basically do two things incredibly well. They make client onboarding easier and faster, and then they make it much easier to manage model portfolios. And I think that’s part of why Betterment’s technology in particular was so shocking when it launched a couple of years ago.

You dial the clock back to 2012, as advisors, we’re mostly still opening new accounts by faxing physical paperwork with wedding signatures to do ACAT transfers, praying we don’t get any NIGOs, and that if things go well, maybe assets will show up in two weeks or so. And then Betterment launches and lets you e-sign everything from your smartphone to open the account, fund the account, and fully invest the account from your phone in about a half an hour. I mean just imagine how much operational administrative staff savings the average advisor could achieve if that was our account opening process.

Similarly, robo-advisors from the portfolio management end are really not much more than model management tools, what we in the industry would call rebalancing software, which we’ve already seen in the industry as tremendous efficiencies with billion-dollar advisory firms that manage all of their client accounts with one trader in a piece of software.

So I don’t want to be negative on the value of the technology, but the value of the technology is operational efficiency. It makes your back office staff leaner and more efficient. It speeds up transferring and managing assets. It reduces paperwork errors. It cuts down NIGOs. It reduces trade errors. It keeps clients from slipping off model or forgetting to have new cash invested. But it’s not a business development tool. The business development is still up to the advisor. The robo tools are just what you use to onboard the client and invest after the business development process.

And in fact, what I find is that usually once the average broker understands that, that just putting a robo-advisor on your site does not actually mean millennial money just starts automatically rolling over and you don’t have to do anything. They don’t even want a robo anymore. In fact, it frankly feels kind of threatening to most of us advisors. As though when you say, “We’re giving you robo-advisor tools,” we’re going to be replaced by robots.

As I’ve written repeatedly, we are not going to be replaced by robots because what robo-advisors do is fundamentally different than what we do as human advisors. But when a broker-dealer goes and says, “Hey, brokers, we’re working on a robo-advisor solution to help you,” it’s kind of like saying to a factory worker, “Hey, great news! We’re working on new automated machinery to help your job in the factory next year,” and then the following year, you find out you’re fired because you just installed the technology that eliminated your job.gain, I don’t see that’s how it actually plays out with robo-advisors and human advisors because they’re not actually winning business from human advisors now, but that is why it’s absurd for broker-dealers to tell their reps they’re rolling out robo-advisor tools. At best, it’s going to grossly under-deliver on its promise of bringing in new young clients without needing to do any work because it’s not a marketing solution for millennials. It’s an operational solution after you market to millennials, which advisors still don’t do well in the first place. But at worst, brokers just won’t adopt the tools and technology at all because they don’t see the value of the technology because it feels like they’re supposed to use something that threatens them.

Again, I don’t see that as how it actually plays out with robo-advisors and human advisors because they’re not actually winning business from human advisors now, but that is why it’s absurd for broker-dealers to tell their reps they’re rolling out robo-advisor tools. At best, it’s going to grossly under-deliver on its promise of bringing in new young clients without needing to do any work because it’s not a marketing solution for millennials. It’s an operational solution after you market to millennials, which advisors still don’t do well in the first place. But at worst, brokers just won’t adopt the tools and technology at all because they don’t see the value of the technology because it feels like they’re supposed to use something that threatens them.

Instead, what broker-dealers should really be doing is just saying, “We’re upgrading our technology to make you more operationally efficient in the opening and managing investment accounts with better onboarding tools and better portfolio management tools,” because that’s what it’s really about and that’s the outcome that matters.

I hope this is helpful as some food for thought.

So what do you think? Are broker-dealers missing the point of robo-advisor fintech? Will broker-dealers and their reps continue to struggle with digital marketing? How would you use robo-technology with your clients? Please share your thoughts in the comments below!

The Stock Market Still Seems to Believe the Fed

The Stock Market Still Seems to Believe the Fed

Economic indicators show that a slowdown might be in the offing, even though the Fed has been raising rates and the labor market continues to tighten, according to a New York Times article from earlier this month.

Despite the occasional surge in technology stocks and the steady drop in energy shares, the article says the market continued to push forward through the second quarter. But some investment advisers are developing concern that if the economic weakness persists, “it may be time to start believing their own eyes and lighten up on stocks,” that article says.

Other indicators that support the absence of economic growth include a flattening yield curve (long-term bond yields have decreased while short-term have risen). Inversion could point to a recession.

The article offers comments by Scott Klimo, co-manager of the Sextant International Fund, in which he warns ” that investors had become conspicuously complacent,” but adds that the stock market could continue plugging along for a while “absent some external shock.”

Edward Yardeni, president of Yardeni Research, believes that the economy’s performance is much like that in 2010 and that although first quarter performance was modest, slower growth in the labor force should be taken into consideration. He doesn’t, as quoted in the article, “see any particular reasons to get out of stocks or bonds at this point.”

“As long as inflation remains subdued,” Yardeni argues, “and as long as we don’t have a recession, bonds and stocks should continue to work.”