How To Avoid A Sudden Increase In Medicare Costs

How To Avoid A Sudden Increase In Medicare Costs

Most retirees pay their Medicare Part B premiums directly from their Social Security checks, and as a result benefit from the “hold harmless” rules that prevent Medicare premiums from ever rising faster than the annual dollar increase in their Social Security checks. However, for higher-income individuals, they are not only ineligible for the hold harmless rules, but can potentially face a substantial “income-related monthly adjustment amount” (IRMAA), which effectively applies a surcharge on Medicare Part B (and Part D) premiums based on Adjusted Gross Income from 2 years prior (i.e., 2017 Medicare premium surcharges are based on 2015 AGI). At the extreme, the surcharges can increase Medicare Part B premiums from $134/month to as high as $428.60/month (plus another $76.20/month surcharge on Part D) for individuals with more than $214,000 of AGI (or married couples over $428,000 of AGI). And notably, the income thresholds for IRMAA are “cliff” thresholds; in other words, with the first surcharge kicking in at $85,000 of AGI (for individuals; $170,000 for couples), the entire surcharge will apply as income reaches $85,001. As a result, strategies that manage AGI become very appealing for those nearing the IRMAA thresholds, especially if income can be manipulated to come in just below one of the tiers. Potential strategies to achieve this include: do partial Roth conversions up to (but not above) the first/next AGI threshold, to reduce potential taxation of IRAs (or taxable RMDs) in future years; complete Qualified Charitable Distributions (QCDs) to satisfy RMDs and have the RMD income entirely excluded from the tax return (which means it’s not included in AGI for IRMAA calculations); and purchase a non-qualified deferred annuity to limit annual exposure of taxable growth, and then control taxable liquidations to coincide with lower income years (and/or to fill up to but not beyond the next IRMAA threshold).

The Impact Of Early Retirement On Projected Social Security Benefits

The Impact Of Early Retirement On Projected Social Security Benefits

Executive Summary

Social Security operates as an income replacement formula, with higher benefits for those who work for more years. As a result, benefits are very limited for those who don’t work for very many years, and are much higher for those with a full working career.

To avoid confusing those who haven’t worked very many years yet – but plan to – the standard Social Security benefits statement projects out anticipated future Social Security benefits based on the assumption that the individual will continue working until retirement. Which allows the individual to understand what Social Security benefit they are “on track for” as they continue to work until full retirement age. Except, of course, that not everyone actually plans to work until full retirement age!

For those who intend to retire early, the end result is that the Social Security Administration’s projected benefits calculation may turn out to be substantially higher than what someone will actually receive if they retire early, and never actually work as many years as anticipated. The lower someone’s lifetime earnings overall, and the earlier he/she retires, the more dramatic the impact can be, commonly reducing benefits by 5% to 10% when retiring early, and potentially far more for “extreme” early retirement. Although the impact is also substantially affected by whether recent earnings were higher or lower than their long-term average… and whether they’ve already paid into the Social Security system for at least 35 working years (or not).

Ultimately, the reality is that Social Security benefits aren’t actually reduced for those who retire early – they simply stop accruing additional benefits when they stop working. But given that Social Security projects the assumption of work until full retirement age, it’s crucial to recognize that actual benefits may be lower for those who retire early – even if they wait until full retirement age to actually receive those benefits. In the end, that may not stop a prospective early retiree from making the decision to stop working – and notably, continuing to “work” even after retirement can continue to increase benefits as well – but at a minimum, it’s crucial to take a moment and look at the individual’s inflation-adjusted historical earnings, to understand whether or how much of an impact not working to full retirement age may actually have on projected benefits!

Calculating The Income Replacement Rate For Social Security Benefits

Although not commonly understood, the calculation of Social Security benefits is really nothing more than an income replacement formula, similar to a pension. Just as a pension might offer an up-to-70% replacement rate (based on years of service) based on the average of your last 5 years of wages, Social Security also provides benefits that are a replacement of your earnings based on your years of service. The primary difference is simply that Social Security uses a 35-year average of earnings that accrue based on your years of service (rather than just your last-3 or last-5 years of wages), and the replacement rate itself is based on your income (with those at the lower end of the income spectrum getting a higher replacement rate).

The individual’s 35-year average of earnings is known as “AIME” – Average Indexed Monthly Earnings – and is calculated as a monthly average income over 35 years (i.e., 420 months), and is inflation-adjusted (to account for the fact that 35 years ago, wages were lower simply because of inflation that hadn’t occurred yet). Notably, the lifetime earnings used to calculate the 35-year average of inflation-adjusted income is based on the highest 35 years of historical earnings, regardless of whether they were consecutive years or not.

Replacement rates are then calculated based on the highest-35-year AIME amount – with the first $885/month replaced at 90%, the next $4,651/month replaced at 32%, and anything else (up to the maximum $127,200/year, or $10,600/month wage base) replaced at 15%.

Social Security Replacement Rates Based On Highest 35-Years Income

The final benefit is known as the Primary Insurance Amount (PIA), and becomes available to the retiree at Full Retirement Age (currently age 66, but rising to age 67 in the coming years).

Example 1. Over his lifetime, Charlie’s 35-year average income was $73,000 (once adjusted for inflation), or $6,083/month. As a result, Charlie’s Social Security benefit would be 90% of the first $885/month (which is $796.50/month in benefits), plus another 32% of the next $4,651/month of income (which is $1,488.32/month in benefits), plus 15% of the last $547.33/month in income (another $82.10/month in benefits), which means his total benefit is $796.50 + $1,488.32 + $82.10 = $2,366.92/month in Social Security benefits at Full Retirement Age. Relative to his $6,083/month of AIME, this is an effective replacement rate of 38.9% of his income in retirement.

To the extent the individual starts benefits early (i.e., before full retirement age of 66), the PIA is reduced by 6.66%/year for each year early, plus 5%/year for each additional year, up to a maximum early retirement age of 62 (which would be 6.66%/year x 3 years + 5%/year x 1 year = 25% reduction). Conversely, if the individual delays past full retirement age, benefits are increased by 8%/year for each delayed year, up to a maximum of age 70 (which would be 8%/year x 4 years = 32% increase). These formulas are ultimately adjusted down to the exact starting month of early or delayed benefits, for those who don’t have a full retirement age of exactly 66, or who start benefits a partial year early or late.

Example 1b. Continuing the prior example, if Charlie was born in 1955 (such that he’s turning 62 in 2017), his full retirement age would actually be 66 years and 2 months, which means starting his benefits as early as possible would be a reduction of 6.66%/year x 3 years + 5%/year x 1 year and 2 months early = 25.83% reduced. Thus, his $2,366.92/month benefit (at full retirement age) would be only $1,755.47 by starting as early as age 62.

How Social Security Benefits Are Projected At Retirement

As noted earlier, Social Security benefits are calculated as an income replacement rate based on 35 years of your (highest) historical earnings (adjusted for inflation). Which means when you’re just getting started in your career as a teenager or 20-something, most of your 35-year average of earnings would be $0s, and any projection of Social Security benefits based on actual earnings would be near $0 in the early years. You wouldn’t really know how well your Social Security benefits were on track to replace your income in retirement until you actually had 35 working years to see the cumulative benefit (even if you knew and were planning to be working that long up front).

Accordingly, the Social Security Administration provides a regular statement to project future Social Security benefits, assuming that you will continue to earn at your current income level (based on your earnings for the past two years). This is shown as your “estimated taxable earnings per year after 2017” on the front page of the Social Security benefits statement. And projected benefits on the Social Security statement assume that amount will continue to be earned in every year until full retirement age – which can substantially change the individual’s “historical” earnings for calculating benefits (even though the earnings haven’t happened yet!).

Example 2. Andrew is a 32-year-old whose income has averaged about $35,000/year over the past 12 years (including both work he did in college, and after college). For the past 2 years, his annual salary is up to $48,000/year.

Accordingly, when his $35,000/year of average earnings for 12 years is stretched across the 35-year formula, Andrew’s “lifetime” average inflation-adjusted earnings is only $12,000 (including 23 years of $0s), or just $1,000/month. Which means his benefits would only be 90% x $885/month (the first replacement tier) + 32% x $115/month (his earnings in the second tier) = $796.50 + $36.80 = $833.30/month.

However, if Andrew really does plan to work for the rest of his available working years until full retirement age (which will be age 67 for a 32-year-old today), he can add another 35 years of income (from here) at his current $48,000/year salary, which would overwrite all of his prior years of earnings with higher income years, and provide him with a future Social Security benefit based on $48,000/year (or $4,000/month) of earnings. Which would result in a Social Security benefit of 90% x $885/month + 32% x $3,115/month = $796.50 + $996.80 = $1,793.30/month.

As a result, Andrew’s Social Security statement will show a projected benefit of $1,793.30/month, and not $833.30/month, even though the $833.30/month is the only benefit he’s actually earned up to this point. Because $1,793.30/month is what he’s on track to earn based on his employment and earnings trajectory, assuming he continues to work at his current pace.

How Projected Future Wages Impact Projected Future Social Security Benefits For Young Workers

Notably, the future benefit a prospective retiree would actually receive at full retirement age will actually be even higher than the projected benefit amount reported on the Social Security statement, due to the additional impact of inflation between now and full retirement age. Future benefits are projected assuming future earnings but are reported in today’s dollars, and as a result do accurately project the purchasing power of future benefits (even though the actual future dollar amount will be higher as inflation continues to compound). And the current-dollar value of Social Security benefits may even be understated, as Social Security actually adjusts the benefits into today’s dollars using wage inflation rates rather than price inflation rates (which may end out understating the value of future benefits by about 1%/year).

The Impact Of Early Retirement On Calculated Social Security Benefits

It’s crucial to recognize that the standard Social Security statement projects benefits assuming continued work, as it means that not working as late as full retirement age can reduce prospective benefits. Not because future benefits are actually reduced by stopping work early (though they are reduced by starting benefits early). But simply because projected statements assume continued work by default, such that its absence will still result in a lower actual benefit in the future than what was previously projected.

However, the actual impact on Social Security benefits of stopping work before full retirement age varies heavily, depending on what the prospective retiree had already earned in benefits – or more specifically, what additional years of work (and income) would have done to that individual’s highest-35-years earnings history.

Retiring Early From Declining Income Below The Highest 35 Years

After all, the reality is that if the worker already has 35 years of work history, all of which are at least as high as current earnings (after adjusting for inflation), then the prospective retiree isn’t actually earning any further increase in benefits by continuing to work! Because the AIME formula only counts the highest 35 years and drops the rest. So if the prospective retiree isn’t adding new years that are higher than the existing ones, the additional years of work have no impact. Which means stopping work early has no adverse impact, either.

For instance, the chart below shows an individual’s historical (inflation-adjusted) earnings over a career, including a substantial ramp-up in the early years, followed by a career transition (with low income), then a steady series of raises, with a few wind-down years of consulting work at the end. The top 35 years are shown in blue, and the “low” years (not included in the top 35) are shown in orange.

Hypothetical Lifetime Inflation-Adjusted Earnings Included In Social Security AIME

As the chart above shows, additional years of work at the current consulting levels will have no impact on benefits – because there are already 35 years of historical earnings at even higher levels. As a result, quitting work after age 64 won’t have any impact on the benefits that were originally projected to begin at full retirement age of 66. (Though notably, starting benefits as early as age 64 would still reduce them by 13.3% for claiming early.)

Retiring Early From Rising Income Above The Highest 35 Years Of Earnings

On the other hand, if the prospective retiree has more than 35 years of historical earnings, but not all of those prior years were as high as today, there may still be some prospective impact to retiring early. In this case, it’s because the additional years of work are replacing prior years in the calculation of the highest 35 years of benefits. Which means eliminating them from the projection – by retiring early – loses out on some opportunity for increasing benefits.

For instance, the chart below shows the historical (inflation-adjusted) earnings of an individual who has been in his peak earnings years since a big promotion in his mid 50s, and is trying to decide whether to retire early at age 60. His current Social Security statement projects his retirement benefits to be $2,374.24, which implicitly assumes he will keep earning his $110,000/year salary until full retirement age, which means 6 more years of ‘knocking out” his $40,000/year earnings from back in his 20s.

Extra Social Security Benefits Projected From Later Years' High Wages Replacing Low-Earning Years

Of course, the reality is that the prior $40,000/year of earnings will still be included in his Social Security benefits, if he stops working early and doesn’t replace them with later earnings. However, that means at the margin, each year he continues to work replaces an “old” $40,000/year salary with a “new” $110,000/year salary, a $70,000 difference that increases the 35-year AIME average by $70,000 / 35 = $2,000/year (or $166.67/month).

Given that he’s at the 15% replacement rate level (given how high his AIME already is), it means that each additional year he works increases his benefit by $166.67 x 15% = $25/month in benefits, or $150/month for 6 more years of working. Given that his projected retirement benefits were already $2,374.24, this means his benefits will be reduced by 6% by retiring at age 60 (even if he waits until full retirement age to receive the “full” benefit!).

Retiring Early Before 35 Years Of Work History

For those who don’t even have 35 years of historical income, though, the effect of retiring early can be even more substantial. For instance, if the individual above had been aiming to retire even earlier, then the reality is that social security early retirement age 55 likely doesn’t even have 35 years of earnings history. As a result, the additional projected years of working through full retirement age would both fill out the remainder of the highest 35 years, and replace lower earning years with new higher years. The exclusion of both – if retirement occurs early – can be substantial.

How Projected Social Security Earnings Replace Existing Low Earning Years

As the chart above shows, projected Social Security benefits would include 8 more years of $125,000/year earnings to complete the 35-year earnings history, and the subsequent 8 years would further increase AIME by overriding 8 early years that were at lower income levels. As a result, projected Social Security benefits would be $2,854.42/month based on an AIME of $9,885.71/month ($118,628.57/year). However, if the individual actually retires at age 50, and simply locks in the benefits he’s actually earned, the 35-year AIME (with only 28 years of actual earnings history) would be only $8,220.24, and Social Security retirement benefits would actually be just $2,606.21/month, not $2,854.42 as projected with continued work!

Planning For The Impact Of Early Retirement On Social Security

It’s important to remember that beyond “Just” the impact of retiring early on the calculation of projected benefits, that taking Social Security early can reduce benefits by more than 25%, due to the reduction on Social Security benefits claimed before full retirement age.

However, many prospective retirees can ameliorate this impact by simply retiring early, and waiting to actually begin Social Security benefits, simply spending down other assets in early retirement instead (which is often a good deal, given both the potential impact of the Social Security earnings test, and the often-appealing internal rate of return for delayed Social Security benefits).

Yet as shown here, early retirement has a second effect – it reduces the calculated Social Security benefit too, or at least fails to accrue more benefits by continuing to work (relative to the projected benefits on the Social Security statement), even if the retiree waits until full retirement age to actually begin the benefits.

However, the actual magnitude of the reduction will depend heavily on what the early retiree’s recent (and therefore projected) income is, relative to that individual’s earnings history (to understand whether more years of work replace prior years in the high-35 formula, or not). Which means the starting point is just to log into (or create) your account at the SSA’s My Social Security website, and look up what your earnings history actually is!

Unfortunately, though, since Social Security benefits are calculated based on the highest 35 years of inflation-adjusted earnings, it’s also necessary to adjust prior income into the current year’s dollar amounts. Based on the current wage indexing factors available from Social Security, income for each year can be multiplied by the indexing factor to determine what the inflation-adjusted equivalent income would have been in today’s dollars.

Social Security Wage Indexing Factors (1958-2017)

From there, you can then assess whether or how much additional income years between now and retirement may be impacting projected Social Security benefits, and to what extent the additional income years may either be increasing AIME by adding more years to the 35-year average, increasing AIME by replacing prior lower income years with new higher income years, or not impacting AIME at all because the highest 35 years are already set from prior earnings.

It’s also important to determine whether the average historical earnings would put the individual into the 90%, 32%, or 15% replacement rate tier, as the lower the AIME, the higher the replacement rate, and the greater the impact that additional earnings years will have (or conversely, the greater the adverse impact of not generating those earnings due to early retirement).

Impact Of Retiring Early On Social Security Benefits Based On Current And Lifetime Earnings

As noted in the chart above, those who don’t even have 35 years of historical earnings will be most adversely impacted by retiring early, especially if their AIME is in the 90% or 32% replacement tiers (while the impact is more muted for those already in the more-limited 15% replacement tier, with historical annual inflation-adjusted earnings averaging in excess of $61,884/year).

Those who have at least 35 years of earnings, but new earnings are replacing prior year earnings, will have at least some benefit for continuing to work (and conversely, face some reduction for retiring early). The higher the income replacement rate, the more adverse it will be to retire early and not benefit from that rate. Although in practice, the magnitude of the impact will depend on how much higher future earnings are anticipated to be over prior historical years. If the “new” years will only be $10,000/year higher in earnings than the (inflation-adjusted) past, the impact is still limited. If new years of income have a bigger gap, the consequences of retiring early are more severe.

On the other hand, for those where new earnings would be less than any of the prior highest 35 years of earnings history, the reality is that retiring early will have no actual adverse impact on Social Security benefits. This is why it is so crucial to determine historical (inflation-adjusted) earnings to make the assessment; because it’s the only way to find out if new earnings are actually higher than any of the highest in the prior 35 years, or not.

Of course, it’s also important to remember that the earlier the retirement, the more dramatic the cumulative impact can be. While retiring one year early rarely impacts Social Security benefits by more than 0.5% to 1% of benefits (especially for those already in the 15% or 32% replacement rate tiers), retiring 5+ years early can have a more substantial impact, and “extreme” early retirement (e.g., for those who retire in their 40s or earlier) can have a very dramatic impact, with actual Social Security retirement benefits far below what is projected from Social Security.

On the other hand, it’s also important to bear in mind that with the availability of spousal and survivor benefits, as long as one spouse (typically the higher earner) delays until age 70 and works to maximize their benefits, there is often no adverse impact for the other spouse to retire early and claim Social Security benefits early (as his/her own benefit, and additional years of work, will be overwritten by the spousal benefit anyway).

For those who want a more detailed estimate of the consequences of early retirement, the Social Security Administration itself does provide access to your Earnings History via the My Social Security website, a Retirement Estimator that can calculate what benefits would be reduced to if you retire early (which simply allows you to input your early retirement age, using Social Security’s data of your earnings history, to show you what your reduced benefit would be, assuming you also start early at age 62), or a highly detailed calculator tool you can download and install locally on your computer, called AnyPIA, to analyze further.

At a minimum, though, it’s important to recognize that while retiring early technically doesn’t reduce benefits – as Social Security benefits simply accrue to the positive by continuing to work, as long as it increases your highest-35-year average – the fact that the Social Security benefit statement by default assumes that you will continue to work until full retirement age means that a decision to retire early can and often will result in lower-than-originally-projected benefits. And the fewer years of earnings history you have, and the lower your overall income (such that you’re in the 90% or 32% replacement tiers), the more dramatic the impact. For those with a substantial history of earnings – e.g., 25+ years – fortunately the impact usually isn’t too severe, but can still be 0.5% to 1% of a reduction for each year of early retirement (in addition to the further reduction for actually claiming benefits early), which adds up quickly for those who retire very early. Though on the other hand, the fact that it’s possible to continue to increase benefits after retirement – even and including if you’re already receiving benefits – also means that those who “retire” but still work, even part time, may be able to further ameliorate the adverse impact of retiring early on Social Security (especially for those who still didn’t have 35 years of earnings history yet!).

So what do you think? Do retirees understand the implications of retiring early on Social Security benefits? How do you help clients evaluate the decision to retire early? Please share your thoughts in the comments below!

Financial Advisor Fees Comparison – All-In Costs For The Typical Financial Advisor?

Financial Advisor Fees Comparison – All-In Costs For The Typical Financial Advisor?

Executive Summary

While the standard rule-of-thumb is that financial advisors charge 1% AUM fees, the reality is that as with most of the investment management industry, financial advisor fee schedules have graduated rates and breakpoints that reduce AUM fees for larger account sizes, such that the median advisory fee for high-net-worth clients is actually closer to 0.50% than 1%.

Yet at the same time, the total all-in cost to manage a portfolio is typically more than “just” the advisor’s AUM fee, given the underlying product costs of ETFs and mutual funds that most financial advisors still use, not to mention transaction costs, and various platform fees. Accordingly, a recent financial advisor fee study from Bob Veres’ Inside Information reveals that the true all-in cost for financial advisors averages about 1.65%, not “just” 1%!

On the other hand, with growing competitive pressures, financial advisors are increasingly compelled to do more to justify their fees than just assemble and oversee a diversified asset allocated portfolio. Instead, the standard investment management fee is increasingly a financial planning fee as well, and the typical advisor allocates nearly half of their bundled AUM fee to financial planning services (or otherwise charges separately for financial planning).

The end result is that comparing the cost of financial advice requires looking at more than “just” a single advisory fee. Instead, costs vary by the size of the client’s accounts, the nature of the advisor’s services, and the way portfolios are implemented, such that advisory fees must really be broken into their component parts: investment management fees, financial planning fees, product fees, and platform fee.

From this perspective, the reality is that the portion of a financial advisor’s fees allocable to investment management is actually not that different from robo-advisors now, suggesting there may not be much investment management fee compression on the horizon. At the same time, though, financial advisors themselves appear to be trying to defend their own fees by driving down their all-in costs, putting pressure on product manufacturers and platforms to reduce their own costs. Yet throughout it all, the Veres research concerningly suggests that even as financial advisors increasingly shift more of their advisory fee value proposition to financial planning and wealth management services, advisors are still struggling to demonstrate why financial planning services should command a pricing premium in the marketplace.

How Much Do Financial Advisors Charge As Portfolios Grow?

One of the biggest criticisms of the AUM business model is that when financial advisor fees are 1% (or some other percentage) of the portfolio, that the advisor will get paid twice as much money to manage a $2M portfolio than a $1M portfolio. Despite the reality that it won’t likely take twice as much time and effort and work to serve the $2M client compared to the $1M client. To some extent, there may be a little more complexity involved for the more affluent client, and it may be a little harder to market and get the $2M client, and there may be some greater liability exposure (given the larger dollar amounts involved if something goes wrong), but not necessarily at a 2:1 ratio for the client with double the account size.

Yet traditionally, the AUM business has long been a “volume-based” business, where larger portfolios reach “breakpoints” where the marginal fees get lower as the dollar amounts get bigger. For instance, the advisor who charges 1% on the first $1M, but “only” 0.50% on the next $1M, such that the with double the assets does pay 50% more (in recognition of the costs to market, additional service complexity, and the liability exposure), but not double.

However, this means that the “typical financial advisor fee” of 1% is somewhat misleading, as while it may be true that the average financial advisory fee is 1% for a particular portfolio size, the fact that fees tend to decline as account balances grow (and may be higher for smaller accounts) means the commonly cited 1% fee fails to convey the true sense of the typical graduated fee schedule of a financial advisor.

Fortunately, though, recent research by Bob Veres’ Inside Information, in a survey of nearly 1,000 advisors, shines a fresh light on how financial advisors typically set their AUM fee schedules, not just at the mid-point, but up and down the scale for both smaller and larger account balances.  And as Veres’ research finds, the median advisory fee up to $1M of assets under management really is 1%. However, many advisors charge more than 1% (especially on “smaller” account balances), and often substantially less for larger dollar amounts, with most advisors incrementing fees by 0.25% at a time (e.g., 1.25%, 1.00%, 0.75%, and 0.50%), as shown in the chart below.

Comparison Of Financial Advisor Fee Levels By Portfolio Size

More generally, though, Veres’ research affirms that the median AUM fee really does decline as assets rise. At the lower end of the spectrum, the typical financial advisory fee is 1% all the way up to $1M (although notably, a substantial number of advisors charge more than 1%, particularly for clients with portfolios of less than $250k, where the median fee is almost 1.25%). However, the median fee drops to 0.85% for those with portfolios over $

1M. And as the dollar amounts rise further, the median investment management fee declines further, to 0.75% over $2M, 0.65% over $3M, and 0.50% for over $5M (with more than 10% of advisors charging just 0.25% or less).

Notably, because these are the stated advisory fees at specific breakpoints, the blended fees of financial advisors at these dollar amounts would still be slightly higher. For instance, the median advisory fee at $2M might be 0.85%, but if the advisor really charged 1.25% on the first $250k, 1% on the next $750k, and 0.85% on the next $1M after that, the blended fee on a $2M portfolio would actually be 0.96% at $2M.

Nonetheless, the point remains: as portfolio account balances grow, advisory fees decline, and the “typical” 1% AUM fee is really just a typical (marginal) fee for portfolios around a size of $1M. Those who work with smaller clients tend to charge more, and those who work with larger clients tend to charge less.

Median AUM Fee Schedules Based On Portfolio AUM

How Much Do Financial Advisors Cost In All-In Fees?

The caveat to this analysis, though, is that it doesn’t actually include the underlying expense ratios of the investment vehicles being purchased by financial advisors on behalf of their clients.

Of course, for those who purchase individual stocks and bonds, there are no underlying wrapper fees for the underlying investments. However, the recent FPA 2017 Trends In Investments Survey of Financial Advisors finds that the overwhelming majority of financial advisors use at least some mutual funds or ETFs in their client portfolios (at 88% and 80%, respectively), which would entail additional costs beyond just the advisory fee itself.

Advisor Use Of Investment Products With Clients Over Time

Fortunately, though, the Veres study did survey not only advisors’ own AUM fee schedules, but also the expense ratios of the underlying investments they used to construct their portfolios. And as the results reveal, the underlying expense ratios add a non-trivial total all-in cost to the typical financial advisory fee, with the bulk of blended expense ratios coming in between 0.20% and 0.75% (and a median of 0.50%).

Average Blended Expense Ratio Of Investments Used By Financial Advisors

Of course, when it comes to ETFs, as well as the advisors who trade individual stocks and bonds, there are also underlying transaction costs to consider. Fortunately, given the size of typical advisor portfolios, and the ever-declining ticket charges for stock and ETF trades, the cumulative impact is fairly modest. Still, while most advisors estimated their trading costs at just 0.05%/year or so, with almost 15% at 0.02% or less, there were another 18% of advisors with trading costs of 0.10%/year, almost 10% up to 0.20%/year, and 6% that trade more actively (or have smaller typical client account sizes where fixed ticket charges consume a larger portion of the account) and estimate cumulative transaction costs even higher than 0.20%/year.

In addition, the reality is that a number of financial advisors work with advisory platforms that separately charge a platform fee, which in some cases covers both technology and platform services and also an all-in wrap fee on trading costs (and/or access to a No-Transaction-Fee [NTF] platform with a platform wrapper cost). Amongst the more-than-20% of advisors who reported paying such fees (either directly or charged to their clients), the median fee was 0.20%/year.

Accordingly, once all of these various underlying costs are packaged together, it turns out that the all-in costs for financial advisors – even and including fee-only advisors, which comprised the majority of Veres’ data set – including the total cost of AUM fees, plus underlying expense ratios, plus trading and/or platform fees, are a good bit higher than the commonly reported 1% fee.

For instance, the median all-in cost of a financial advisor serving under-$250k portfolios was actually 1.85%, dropping to 1.75% for portfolios up to $500k, 1.65% up to $1M, and 1.5% for portfolios over $1M, dropping to $1.4% over $2M, 1.3% over $3M, and 1.2% over $5M.

All-In Total Cost Of Financial Advisor AUM Fees By Portfolio Size

Notably, though, the decline in all-in costs as assets rise moves remarkably in-line with the advisor’s underlying fee schedule, suggesting that the advisor’s “underlying” investments and platform fee are actually remarkably stable across the spectrum.

For instance, the median all-in cost for “small” clients was 1.85% versus an AUM fee of 1% (although the median fee was “almost” 1.25% in Veres’ data) for a difference of 0.60% – 0.85%, larger clients over $1M face an all-in cost of 1.5% versus an AUM fee of 0.85% (a difference of 0.65%), and even for $5M+ the typical total all-in cost was 1.2% versus a median AUM fee of 0.5% (a difference of 0.70%). Which means the total cost of underlying – trading fees, expense ratios, and the rest – is relatively static, at around 0.60% to 0.70% for advisors across the spectrum!

Median All-In AUM Fees Of Financial Advisers (By Portfolio Size)

On the one hand, it’s somewhat surprising that as client account sizes grow, advisors reduce their fees, but platform fees and underlying expense ratios do not decrease. On the other hand, it is perhaps not so surprising given that most mutual funds and ETFs don’t actually have expense ratio breakpoints based on the amount invested, especially as an increasing number of low-cost no-load and institutional-class shares are available to RIAs (and soon, “clean shares” for broker-dealers) regardless of asset size.

It’s also notable that at least some advisor platforms do indirectly “rebate” back a portion of platform and underlying fees, in the form of better payouts (for broker-dealers), soft dollar concessions (for RIAs), and other indirect financial benefits (e.g., discounted or free software, higher tier service teams, access to conferences, etc.) that reduces the advisor’s costs and allows the advisor to reduce their AUM fees. Which means indirectly, platforms fees likely do get at least a little cheaper as account sizes rise (or at least, as the overall size of the advisory firm rises). It’s simply expressed as a full platform charge, with a portion of the cost rebated to the advisor, which in turn allows the advisor to pass through the discount by reducing their own AUM fee successfully.

Financial Advisor Fee Schedules: Investment Management Fees Or Financial Planning Fees?

One of the other notable trends of financial advisory fees in recent years is that financial advisors have been compelled to do more and more to justify their fees, resulting in a deepening in the amount of financial planning services provided to clients for that same AUM fee, and a concomitant decline in the profit margins of advisory firms.

To clarify how financial advisors position their AUM fees, the Veres study also surveyed how advisors allocate their own AUM fees between investment management and non-investment-management (i.e., financial planning, wealth management, and other) services.

Not surprisingly, barely 5% of financial advisors reported that their entire AUM fee is really just an investment management fee for the portfolio, and 80% of advisors who reported that at least 90% of their AUM fee was “only” for investment management stated it was simply because they were charging a separate financial planning fee anyway.

For most advisors who do bundle together financial planning and investment management, though, the Veres study found that most commonly advisors claim their AUM fee is an even split between investment management services, and non-investment services that are simply paid for via an AUM fee. In other words, the typical 1% AUM fee is really more of a 0.50% investment management fee, plus a 0.50% financial planning fee.

Self-Reported Percentage Of Advisor's AUM Fee Actually Paying For Investment Management

Perhaps most striking, though, is that there’s almost no common consensus or industry standard about how much of an advisor’s AUM fee should really be an investment management fee versus not, despite the common use of a wide range of labels like “financial advisor”, “financial planner”, “wealth manager”, etc.

As noted earlier, in part this may be because a subset of those advisors in the Veres study are simply charging separately for financial planning, which increases the percentage-of-AUM-fee-for-just-investment-management allocation (since the planning is covered by the planning fee). Nonetheless, the fact that 90% of advisors still claim their AUM fees are no-more-than-90% allocable to investment management services suggests the majority of advisors package at least some non-investment value-adds into their investment management fee. Yet how much is packaged in and bundled together varies tremendously!

More broadly, though, this ambiguity about whether or how much value financial advisors provide, beyond investment management, for a single AUM fee, is not unique to the Veres study. For instance, last year’s 2016 Fidelity RIA Benchmarking Study found that there is virtually no relationship between an advisor’s fees for a $1M client, and the breadth of services the advisor actually offers to that client! In theory, as the breadth of services to the client rises, the advisory fee should rise as well to support those additional value-adds. Instead, though, the Fidelity study found that the median advisory fee of 1% remains throughout, regardless of whether the advisor just offers wealth management, or bundles together 5 or even 9 other supporting services!

Self-Reported Advisory Fees On $1M Portfolio, By Number Of Bundled Services

The Future Of Financial Advisor Fee Compression: Investment Management, Financial Planning, Products, And Platforms

Overall, what the Veres study suggests is that the typical all-in AUM fee to work with a financial advisor is actually broken up into several component parts. For a total-cost AUM fee of 1.65% for a portfolio up to $1M, this includes an advisory fee of 1% (which in turn is split between financial planning and investment management), plus another 0.65% of underlying expenses (which is split between the underlying investment products and platform). Which means a financial advisor’s all-in costs really need to be considered across all four domains: investment management, financial planning, products, and platform fees.

Breakdown Of Typical Financial Advisor's All-In Costs

Notably, how the underlying costs come together may vary significantly from one advisor to the next. Some may use lower-cost ETFs, but have slightly higher trading fees (given ETF ticket charges) from their platforms. Others may use mutual funds that have no transaction costs, but indirectly pay a 0.25% platform fee (in the form of 12b-1 fees paid to the platform). Some may use more expensive mutual funds, but trim their own advisory fees. Others may manage individual stocks and bonds, but charge more for their investment management services. A TAMP may combine together the platform and product fees.

Overall, though, the Veres data reveals that the breadth of all-in costs is even wider than the breadth of AUM fees, suggesting that financial advisors are finding more consumer sensitivity to their advisory fees, and less sensitivity to the underlying platform and product costs. On the other hand, the rising trend of financial advisors using ETFs to actively manage portfolios suggests that advisors are trying to combat any sensitivity to their advisory fees by squeezing the costs out of their underlying portfolios instead (i.e., by using lower-cost ETFs instead of actively managed mutual funds, and taking over the investment management fee of the mutual fund manager themselves).

In turn, we can consider the potential implications of fee compression by looking across each of the core domains: investment management, financial planning, and what is typically a combination of products and platform fees.

When it comes to investment management fees, the fact that the typical financial advisor already allocates only half of their advisory fee to investment management (albeit with a wide variance), suggests that there may actually not be much fee compression looming for financial advisors. After all, if the advisor’s typical AUM fee is 1% but only half of that – or 0.50% – is for investment management, then the fee isn’t that far off from many of the recently launched robo-advisors, including TD Ameritrade Essential Portfolios (0.30% AUM fee), Fidelity Go (0.35% AUM fee), and Merrill Lynch Guided Edge (0.45% AUM fee). At worst, the fee compression risk for pure investment management services may “only” be 20 basis points anyway. And for larger clients – where the fee schedule is falling to 0.50% anyway, and the investment management portion would be only 0.25% – financial advisors have already converged on “robo” pricing.

On the other hand, with the financial planning portion of fees, there appears to be little fee compression at all. In fact, as the Fidelity benchmarking study shows, consumers (and advisors) appear to be struggling greatly to assign a clear value to financial planning services at all. Not to say that financial planning services aren’t valuable, but that there’s no clear consensus on how to value them effectively, such that firms provide a wildly different range of supporting financial planning services for substantially similar fees. Until consumers can more clearly identify and understand the differences in financial planning services between advisors, and then “comparison shop” those prices, it’s difficult for financial planning fee compression to take hold.

By contrast, fee compression for the combination of platforms and the underlying product expenses appears to be most ripe for disruption. And arguably, the ongoing shift of financial advisors towards lower cost product solutions suggests that this trend is already well underway, such that even as advisory firms continue to grow, the asset management industry in the aggregate saw a decline in both revenues and profits in 2016. And the trend may only accelerate if increasingly sophisticated rebalancing and model management software begins to create “Indexing 2.0” solutions that make it feasible to eliminate the ETF and mutual fund fee layer altogether. Similarly, the trend of financial advisors from broker-dealers to RIAs suggests that the total cost layer of broker-dealer platforms is also under pressure. And TAMPs that can’t get their all-in pricing below the 0.65% platform-plus-product fee will likely also face growing pressure.

All-In Fee Component Susceptibility To Financial Advisory Fee Compression

Notably, though, these trends also help to reveal the growing pressure for fiduciary regulation of financial advisors – because as the investment management and product/platform fees continue to shrink, and the relative contribution of financial planning services grow, the core of what a financial advisor “does” to earn their fees is changing. Despite the fact that our financial advisor regulation is based primarily on the underlying investment products and services (and not fee-for-service financial planning advice).

Nonetheless, the point remains that financial advisor fee compression is at best a more nuanced story than is commonly told in the media today. To the extent financial advisors are feeling fee pressure, it appears to be resulting in a shift in the advisor value proposition to earn their 1% fee, and a drive to bring down the underlying costs of products and platforms to defend the advisor’s fee by trimming (other) components of the all-in cost instead. Though at the same time, the data suggests that consumers are less sensitive to all-in costs than “just” the advisor’s fee… raising the question of whether analyzing all-in costs for financial advice may become the next battleground issue for financial advisors that seek to differentiate their costs and value.

In the meantime, for any financial advisors who want to access a copy of Veres’ White Paper on Advisory Fees and survey results, you can sign up here to order a copy.

So what do you think? Do you think financial advisors’ investment management fees are pretty much in line with robo advisors already? Is fee compression more nuanced than typically believed? Please share your thoughts in the comments below!

New Master’s Degree To Teach Advisers Financial Life Planning Skills

New Master’s Degree To Teach Advisers Financial Life Planning Skills

As technology automation increasingly drives financial advisors towards the “soft” interior skills of financial planning, a gap is emerging from financial planning programs between the “knowledge-centric” content typically taught, and the communication and empathy skills necessary for new financial advisors to succeed in the future. To fill the void, Golden Gate University has announced an expansion of its existing Master’s Degree in Financial Planning program, offering a “concentration in financial life planning”. The new program will combine together research on counseling and communications, positive psychology, the teachings of George Kinder and Dick Wagner, and guest lectures from financial life planning leaders like Rick Kahler, Ted and Brad Klontz, and Susan Bradley. Notably, the new degree is specifically positioned as a “post-CFP” educational program, and in fact will require having already passed the CFP exam as a prerequisite. Students can enroll to participate either in-person on the GGU campus in San Francisco, or online as distance-based students.

How To Raise Children To Be The Opposite Of Spoiled – Using Money To Teach Values

How To Raise Children To Be The Opposite Of Spoiled – Using Money To Teach Values

Executive Summary

No parent wants to knowingly raise a spoiled child. Yet in a world where money is a taboo subject, there is remarkably little guidance available about how to turn a child into the opposite. Certainly making children financially literate is a good start – so at least they understand the mechanics of money and how it works – but that still doesn’t necessarily mean they’ll make good responsible decisions. But what else can be done?

To answer this question, New York Times personal finance columnist Ron Lieber has written a new book, aptly titled “The Opposite Of Spoiled”, exploring the parenting techniques that can not only avoid spoiling a child, but can raise one to be the opposite – a child that grows up to be thrifty, modest, patient, and generous. In fact, given that being not-spoiled is basically about having “good” values, Lieber makes the case that raising fiscally responsible children is all about using money as a vehicle to teach those values.

Accordingly, Lieber’s book navigates issues from “how much should children receive as an allowance” to “should children have to do chores to get their allowance”, as well as how to guide children towards the three fundamental pillars of financial decision-making – whether to spend, to save, or to give. Ultimately, “The Opposite of Spoiled” is something of a manifesto for parents about how to introduce money conversations to children as a means to teach good values, which means it is a book that could easily become a great gift for every client who is a parent likely struggling with these issues, and is equally relevant for advisors who are parents with children of their own as well!

What IS The Opposite Of Spoiled?

Although there’s not quite a universal definition of a “spoiled” child, there are some common traits. Spoiled children tend to have relatively few responsibilities, are lavished with attention, don’t have a lot of rules to limit their behavior, and have a lot of material possessions. And unfortunately, spoiled children who are overindulged tend to grow up with a wide range of problem behaviors. As parents, we want to raise our children to be (fiscally) responsible adults, not spoiled adults… as such outcomes are not only bad for the child, but reflect poorly upon us as parents, too!

The Opposite of Spoiled: Raising Kids Who Are Grounded, Generous, and Smart About Money - by Ron LieberHowever, as Ron Lieber points out in his new book “The Opposite Of Spoiled: Raising Kids Who Are Grounded, Generous, And Smart About Money”, while there’s a general consensus about what it means to spoil a child, there’s remarkably little agreement about what the opposite would be. Meat that is not spoiled is fresh, but children who are not spoiled are… well, there’s really no single word to describe it. As Lieber notes, at best not-spoiled children are described by the values they embody, like curiosity, patience, thrift, modesty, generosity, perseverance, and perspective.

And unfortunately, there’s also remarkably little guidance about how to raise a child to be not-spoiled, as money itself is so commonly a taboo subject, there’s little discussion out there when it comes to money-related parenting techniques. In many cases, parents seem to fear that just talking about money will itself create some kind of money-grubbing obsession for their children. In other situations, talking about money becomes a necessity only because the family lives paycheck-to-paycheck and constantly faces hard choices, but even then there is often a desire to shelter children and keep them from having any awareness of the family’s difficult financial situation. And in the case of children of more affluent families, the conversations can be even more complex, since by definition any financial constraints put in place will not actually be based on necessity, but simply artificial or arbitrary limitations put in place just to try to prevent “spoiled” behavior.

Yet as Lieber ultimately points out, the decisions we model as parents to our children about money actually are opportunities to demonstrate and teach value. Deciding not to buy something for the family isn’t just a purchasing decision, it’s also a teaching moment about thrift and wants versus needs. Saving for the future isn’t just about not spending now, it’s about patience and perseverance. And the decision about when, whether, and how much to give isn’t just a family decision about charity but a chance to teach generosity. In other words, Lieber advocates that having conversations around money with children is crucial, not to talk about money for money’s sake, but because being not-spoiled is defined by values and the conversations we have around money and our financial decisions are actually values-teaching opportunities. Or as Lieber puts it, “I want to help all of you recognize that every conversation about money is also about values.”

How Much Allowance Is Right To Teach Giving, Saving, And Responsible Spending Lessons?

Perhaps not surprisingly, given his view of the importance that money conversations plays in teaching values around money, Lieber advocates that the “traditional” approach of giving children an allowance as a reward for doing their chores is the wrong way to go. Having children do their chores is important, but Lieber suggests that parents should either reward or punish as appropriate with privileges (TV time, access to the car, etc.), not through allowance. Instead, allowance should be given regularly and consistently, because of the teachable moments that come from parents guiding the child’s decisions of what to do with that allowance.

Give Save Spend Jars

Accordingly, Lieber suggests that when children are started with an allowance, they should be guided to split the money into three groups – one for Spending, one for Saving, and one for Giving – literally, by having three clear plastic containers for each. Younger children can simply split the allowance equally amongst the three containers. With older children, having a discussion around how much to allocate to each is particular part of the values-teaching opportunity. A “typical” weekly allowance might be $0.50 – $1 per year-of-age of the child, starting around kindergarten, and increased each year on the child’s birthday. (If you want to give some reward to children for work, over and above their allowance, Lieber tells the story of one parent who pays “extra” for children who spot additional/new problems and come up with solutions, as a form of teaching entrepreneurship.)

The Spend jar is, as implied, for the child to spend. Aside from setting certain items as forbidden (e.g., certain toys you just don’t want in your house, even if the child bought it themselves!), the idea of the spend jar is to give children the latitude to make their own spending decisions, even “bad” ones. Guiding children about their spending is an opportunity to distinguish between wants and needs. For older children, they can get even more flexibility; for instance, let a high-school-aged child have their entire clothes budget for the school year in a lump sum up front. Either they’ll learn to manage the money to make it last throughout the year and teach themselves a financial lesson, or they’ll mismanage the money and be stuck wearing their “old” fall clothes during the spring school season and learn perhaps an even better lesson about the consequences of mismanagement. Better to learn in the “controlled” environment of school, than after they graduate from college where the consequences of mistakes are more serious.

The Save jar is to teach children the virtue of saving, and the benefits of perseverance and patience in allowing the balance to grow. As Lieber notes, having the plastic “Save” container be clear is important for having the child be able to actually see the dollars increase (similarly, Lieber suggests that opening a bank account for the young children is less effective, because it makes the saving a less tangible lesson). As the Save container grows its balance, parents can help children formulate goals of what they’re saving up for, and then celebrate with them when the goal is reached and the purchase can be made. This is also an opportunity to teach kids about growing savings and compound interest – e.g., by paying them an interest rate on their Save jar. Just be careful that the compounding doesn’t get out of control!

The last container is the one for Giving, and is an opportunity to teach children about the value of generosity and giving to those less fortunate. Helping children decide what charitable need or cause to give to also provides teaching opportunities, and Lieber notes that many charities will work with parents to help children who are going to do their giving in person – so you can take the child in to the facility, from a pet shelter to a homeless shelter, and let them see the impact of their giving.

Helping Clients Introduce The Money Conversation With Their Children

For those who are parents, Lieber’s “The Opposite of Spoiled” provides a valuable handbook on how to think about having money conversations with children, from handling the tough questions (“are we poor?” or “how much money do we make?”) to some very practical strategies about how to teach children money values, from setting the dividing line between Wants versus Needs for children to setting up the three spending jars. While some might debate or nit-pick particular techniques and strategies that Lieber advocates, parents who will the book will certainly be far ahead of parents who are trying to make these decisions blindly and without any experience.

Ironically, though, perhaps the most contentious aspect of Lieber’s book is simply the fact that he advocates having these money conversations in the first place, and that parents need to avoid succumbing to the flawed belief that children can somehow be effectively sheltered from thinking about, talking about, or at least wondering about money. As Lieber points out, eventually children will begin to get curious, if only from conversations they have with their peers, sometime during grade school. And so they start asking questions (which Lieber notes is usually not because they want to share the answers with their peers and make themselves the outlier who is the richest or poorest, but simply because they want to make sure they can quietly fit in with their peers). And with today’s accessibility of the internet, even young kids can actually find out an astonishing amount of information, whether the parents answer the questions or not.

After all, just typing your own address into Google will typically bring up a Zillow result as the first hit, complete with an estimated value of the residence. There are any number of websites that can provide information on average salaries for a wide range of jobs. And parents who are in positions of leadership – perhaps at a public corporation or a non-profit – will have their compensation already disclosed in public documents, that children can now find rather easily. And failing anything else, many children will immediately get a clearer perspective on the family’s financial situation as soon as the time for college comes, and the financial aid forms begin. In fact, Lieber makes the case that it’s rather absurd we don’t have these conversations with children, given the incredibly high-stakes decisions we vest in them by the end of high school – where a 17-year-old is expected to make what can be a multi-hundred-thousand dollar choice about what college to attend despite “never [having] purchased anything more expensive than a bicycle!”

The Opposite of Spoiled: Raising Kids Who Are Grounded, Generous, and Smart About Money - by Ron LieberFrom the advisor’s perspective, it may not necessarily be us who have and introduce these conversations with the children of our clients, though we certainly have the opportunity to encourage our clients to have the discussions themselves, possibly even by teaching some of Lieber’s recommended strategies. Alternatively, I suspect many advisors may choose to purchase and give copies of Lieber’s book to their clients, as it’s really relevant for parents who have children of any age from preschool to high school.

And for those advisors who are parents, you may find it helpful yourself; in fact, Lieber quotes financial planners who are parents and the strategies they use to teach their children about money regularly throughout the book. So if you’re a parent, I’d definitely encourage you to check it out “The Opposite of Spoiled” for yourself as well.

Is It Really Bad To Name Your Financial Advisory Business After Yourself?

Is It Really Bad To Name Your Financial Advisory Business After Yourself?

Executive Summary

Whenever a financial advisor is starting a new firm – whether it is because they are breaking away to the independent channel, or simply just starting a new firm from scratch – there’s a lot to deal with, but one seemingly simple question that tends to stump most advisors is what to name their new advisory firm. Of course, clients will still be hiring you – the financial advisor – because of your skills and capabilities, not your firm because of its name. But nonetheless, the name represents the identity of the firm, and the brand that you will build. Which raises the question: if you are the primary advisor, should you simply name the advisory firm after yourself? And if you plan to build an advisory business beyond yourself, does that mean you need to avoid having your name on the door of the firm?

In this week’s post, we discuss when it is good idea to go ahead and name your advisory firm after yourself, the scenarios where it can create challenges, and why ultimately whether your advisory firm grows into a business or not is much more about the mindset you have for your business, than whether you put your name on the door (or not)!

From the perspective of getting clients and building business, one of the greatest challenges we face in financial planning is that we sell an intangible: “advice”. Financial advice isn’t something the prospective client can pick up and look at in a store, and consequently he/she has to look to other intangibles to decide whether to work with you as a financial advisor. Large national firms can rely on being a recognized brand to attract new clients, but most advisory firms are too small to rely on national branding alone. Instead, they get their clients by building a personal relationship with them, to become someone the client knows, likes, and trusts. As a result, most solo financial advisors simply put their own name into the advisory firm name… as in the end, if you’re John Smith, and you call your firm Smith Financial Planning, it simply helps connect the consumer to you!

Indirectly, however, this actually illustrates the second key issue when it comes to naming your advisory firm, and whether it’s a problem or not to name it after yourself. The question is: what are you really trying to build? Are you trying to build a real, standalone business? Or is your business simply an extension of yourself? If your firm is meant to be founder-centric, then by all means call it Smith Financial Planning. But if you want to build a business that is bigger than just yourself, do you need to have a more “generic” name? The prevailing view out there is “Yes”, but the reality is that there are a lot of big businesses named after founders, that have had no trouble being successful even though the founder’s name is still the company name – including Ford, Dodge, Chrysler, Deloitte & Touche, Merrill Lynch, Morgan Stanley, Edward Jones, Raymond James, and Charles Schwab, just to name a few. Ultimately, the founder’s name wasn’t just about the founder, but became a brand that represented the company itself… and in most cases, the company named after the founder has already outlived the founder themselves!

What really distinguishes companies that grow beyond their founders into businesses is not whether the founder has their name on the door or not, but whether the founder has a mindset to build a business beyond themselves. In point of fact, many advisors who do want to build big businesses ultimately create a name for the business that is not their own… but not because it’s necessary to build the business and attract talent. It’s simply that the naming decision reflects what is already their mindset to build a business. By contrast, many/most advisors who name the business after themselves have a desire to create an owner-centric practice in the first place… and so naming after themselves is only natural (but it is an outcome of the mindset, not a cause of whether the business grows or not!).

There’s also the common question of whether a founder-named business limits its ability to be sold in the future… and whether an advisor who wants to sell the firm someone needs to not have their name on the door. But the reality once again is that the answer to this question comes down to mindset – in this case, the mindset of the buyer, and what he/she is looking to do. Does the buyer want to build their own owner-centric firm? If so, then they may want their name on the door, and it is possible a generic name will make that transition easier. But if the buyer is interested in buying and growing a business, the reality is, the buyer buys the business, and its brand, not whether the founder’s name is on the door. For instance, Edelman Financial has been bought and sold more than once over the past 20 years. It still has Ric’s name on the door, but that name is not a limiting factor when buying an institutionalized business… and in fact, the brand is the asset to the buyer!

Ultimately, the fundamental point here is that what really matters is not whether the founder’s name is on the door, or whether there is some neutral name instead. But rather, what matters is your mindset as an advisory firm business owner. Are you trying to create a business that’s bigger than yourself? Or are you trying to create a practice that’s built around yourself? For many who are trying to build a business bigger than themselves, they will often pick a neutral name, but it’s really not a necessary factor for success. Instead, it is simply a signal of their intent. Because in the end, if you want to build a business that’s bigger than yourself, you can absolutely do it… “even if” your name is on the door!

Is It Good Business To Name Your Business After Your Name?

So first and foremost, let’s talk about this from the client and business development perspective. Now, as I’ve written about in the past on the blog, one of the biggest challenges that we have in just trying to get paid for advice, is the fact that we’re selling this intangible thing: “advice”.

It’s hard for consumers to know which advisory firm will give good advice and which won’t, because it’s not like a thing you can pick up, look at, and manipulate in the store. Nor is it something you can test drive before buying. Which means a prospective client who’s considering whether to do business with you has little to go on, besides judging you.

Are you someone that I, as the prospective client, want to do business with? Now, for a large national advisory firm, so a company like Fidelity or Vanguard, consumers are aided in this decision about whether to do business with the firms because the firms have known and recognized brands. So I may not know the individual advisor I’m going to work with at Fidelity or Vanguard, but I feel like I know Fidelity and Vanguard. I know the name. I trust the company’s brand, and I trust that they want to serve me as the consumer, and so I’m willing to trust the advisor that I get when I go to do business with them.

Now, if I meet that individual advisor and I don’t like him or her, that’s still a problem and I may need to find another advisor at the firm. But that’s okay too. Because I trust the brand, I trust the company, and I know that they have a lot of advisors to serve me.

Now, unfortunately, for the typical advisory firm, you probably don’t have a very big brand. People don’t do business with you because they know and trust your firm’s brand name. They do business with you because they know, like, and trust you. People do business with people they know, like, and trust.

Which means it’s crucial to put the “you” into the business. This is why we try to meet with every prospect and get to know them. This is why it’s so crucial to have pictures and video of yourself on your website. This is why I don’t think it’s a negative, at all, to have your name in your advisory firm’s name. Because in the end, if you’re John Smith and you call it “Smith Financial Planning,” I think it just helps connect the consumer to you, John Smith. Because your name is on the door, people understand who’s in charge, who’s bringing in the value, where the buck stops for accountability, if they aren’t happy with the advice they receive.

So from the consumer perspective, I don’t think it’s a detriment to building an advice business by having your name in the business. With, perhaps one caveat, which is that if you’re telling clients something like, “I’m here to serve you for the long run, for the rest of your retirement,” and they can see by looking at you that you are probably going to retire, yourself, before they’re done with their retirement… Well, if it’s Smith Financial Planning and they’re clearly not going to be working with Smith for the rest of their lives, then they do want to know who they will be working with, and whether they’re really going to be working with Smith Financial Planning for the long run or not.  Which means you at least have to demonstrate or explain what the continuity plan is for the client that you’re working with, and what your exit plan is.

Which means you at least have to demonstrate or explain what the continuity plan is for the client that you’re working with, and what your exit plan is, so that the client knows that they’re going to be served. That’s really a caveat of just solo practices, because it is accentuated to a client when you are Smith Financial Planning.

Is Your Advisory Business A Business, Or An Extension Of Yourself?

Now, indirectly, I think this actually illustrates a second key issue when it comes to naming your advisory firm, and whether it’s a problem to name it after yourself or not. The question is, what really are you actually trying to build, a business or a practice? Because if you’re trying to build a business, a real, standalone business… Not just something that’s an extension of yourself and part of identity, and a way to get more substance and gravitas to the fact that you’re the advisor, and the clients work with you, and the business is centered around you.

If you really want to build a business, it looks different. Right? Because if you just want to build a practice, if it’s meant to be owner-centric, you call it “Smith Financial Planning” because your only plan ever is to be John Smith, the guy who delivers financing planning at Smith Financial Planning, then I think clearly it’s a fine strategy, the practice is an extension of yourself.

Your name is Smith Financial Planning, because quite literally it’s a business where Smith does financial planning. You can immediately start making that connection for prospects the first time they see the name of the business, because it’s called “Smith Financial Planning.”

But what about those in the other direction? Advisors who want to build a business, a real business that is bigger than just themselves and their own individual ability to serve clients. If your plan is to have multiple advisors who all serve the client, do you need to have a more generic or neutral name for the business?

Now, I know there’s a prevailing view out there amongst the advisory community that, if you want to build a business beyond yourself, you can’t have your name in the firm name. I have to admit, I think it’s wrong. I don’t think making it a business bigger than yourself requires that you take your name out of the business. Because the truth is, actually, that there are a lot of businesses out there, big businesses, named after founders that have the founder in the name. Ever heard of Ford, Dodge, Chrysler, Toyota? All named after their founders. Rolls Royce, as well.

It’s called “Ben & Jerry’s,” but I think we’ve accepted that neither Ben nor Jerry actually make our ice cream. Anheuser-Busch, Bacardi, Dell, Disney, Harley Davidson. Heck, Tupperware was named after a guy named Earl Tupper who sold kitchenware, so he called it “Tupperware.”

It’s not just for products. It’s for service businesses as well. Deloitte & Touche was made by Mr. Deloitte and Mr. Touche. Arthur Andersen, and then even our industry. Merrill Lynch was named after Mr. Merrill and Mr. Lynch. Morgan Stanley. Anybody want to guess the relationship between the founders of Solomon Brothers? Edward Jones, Raymond James, Charles Schwab.

The common thread of all these business is that, ultimately, the founders named the business after themselves, and then they created a business that was much bigger and beyond just themselves. So even though it’s the founder’s name in the firm name, we all get that you’re not really going to be talking to and working with the founder.

I mean, I know the ad still says, “You can talk to Chuck when you go to Schwab.” But I think we all get that no consumer actually gets to talk to Chuck Schwab at this point. What you get to do is talk to someone that represents the brand that Chuck Schwab created, and provides the services that Chuck’s brand promises to deliver.

Growing An Advisory Business As A Business Is About Mindset, Not The Founder’s Name

But the fundamental point here is that what really matters is not whether the founder’s name is on the door, or whether you come up with some neutral made-up name instead. What matters is the mindset of the advisory-firm business owner. Are you trying to create a business that’s bigger han yourself, or are you trying to create a practice that’s built around yourself?

Now, I will grant that most advisors I see who are trying to build businesses bigger than themselves do typically pick a neutral name and don’t put their name on the door. But it’s not because it’s a necessary factor for success.

Instead, I think it’s actually more of a signal of their intent. Because if you’re thinking about making a big business beyond yourself, there’s really not always a reason to put your name into it, at the beginning, if your plan is to make it beyond you. But not because you can’t have your name in the business to succeed. Simply because if your plan, in the long run, is to make the business beyond you, you probably don’t feel like you need to put your name in, in the first place.

Conversely, for those who want to build a practice around themselves do tend to put their business in their name, because their whole intent is to build it around themselves. So why not name it after yourself?

But the key success factor here is the mindset of the advisor, not the name of the business. Because the truth is that if you want to build a business that’s bigger than yourself, you can absolutely do it even if your name is on the door, as was the case for Ford and Dodge, and Deloitte & Touche, and Merrill Lynch, and Raymond James, and Charles Schwab.

They built their names into brands. They made it mean something beyond just the idea that you’re going to get your car personally made by Ford, or the Dodge brothers, or your books settled by accountants named by Deloitte and Touche, or your investment accounts personally managed by a guy named Chuck Schwab.

It’s about the mindset of what you’re building, not the name on the door. Which is why even Ric Edelman has been able to build Edelman Financial Services into a $15 billion independent RIA with more than 100 advisors who work there, who are not Ric Edelman. He sold the firm and actually bought it back, and then sold it again, repeatedly over the past 20 years.

Can You Sell An Advisory Firm Named After The Founder?

Which brings us to the last point I actually want to touch on, from Scott’s original question. Does it matter if you plan to stay a solo advisor or not? Like if you want to sell the advisory firm someday, do you need to not have your name on the door? Do you need to not name the firm after yourself?

The truth is, just as whether or not you can build a business with your name on the door or not, depends on the mindset of the founder who’s building it, the truth is whether you can sell a business with your name on the door depends on the mindset of the buyer. If it’s a solo advisor who wants to buy a solo practice and build it around themselves, then, as the new owner, most owner-centric practices end up being named after the owner.

Which means if you want to buy a practice and make it owner-centric after you, you may feel the need to either rename it away from the original owner, or it may be more appealing to have a neutral name, because it’s easier to sell to a successor owner who themselves is owner-centric. But that’s only true for buyers who want to buy owner-centric practices in the first place. What happens when the buyer has a business mindset and wants to grow, and build, and buy a business? You’ll find the name is really not such a big issue.

I mean, look again at cases like Edelman Financial has been bought and sold repeatedly. It’s still got Ric’s name on the door. It’s not fatal. The thing’s cruising. He’s trying to IPO it for a billion-dollar market cap, is the prevailing view, but it keeps his name, because he built the business, even though it has been bought and sold by other businesses.

I mean, I think about it. Have you ever set up a screen on the stocks in your portfolio that says, “Exclude any stocks that have the founder’s name in them, because they can’t be real businesses?” Of course not. You buy the business based on the metrics of the business, and you treat it like a business transaction.

Now, a buyer does want to see an institutionalized business, if that’s their mindset. So it’s not so appealing to buy a business that will fall apart if the founder leaves or retires. But it’s not about whether the founder’s name is on the door, it’s whether the founder’s name has turned into a strong brand unto itself, and means something more to the business than just, “Here’s the guy or gal who gives the advice around here.” Then, the brand is an asset to the buyer, regardless of whether the brand name happens to be the founder’s name.

That’s actually why Merrill Lynch is still Merrill Lynch and Schwab is still Schwab, and Ford is still Ford, because they’re not just founder names anymore on the door. They’re brands, which are business assets, not liabilities because the owner’s name is in the name.

But the bottom line to all this is just to understand that what really determines business value and sustainability is the desire of a buyer to buy the firm. Perhaps as a financial buyer, or maybe even just to work it and become a successor to the firm. But ultimately what matters is whether you treat the business as a business or not. Because if it’s an owner-centric practice, that’s fine.

You can make some very good money. It may be harder to sell, though, and harder to find a successor, and harder to transition. But not because it’s called “Smith Financial Planning.” It’s  because you, John Smith, treated it like a practice that was an extension of yourself, John Smith, which means there’s no business when you retire and go away.

Conversely, if you want to build a business, a real business that goes beyond yourself, then it’s still not about the name and whether your name, as the founder, is on the door. It’s about what that name means, what it stands for, the brand it creates, and whether you make the whole business (including the name) have real business value independent of you as the founder. Which you can do regardless of whether your name is on the door or not and, if you don’t believe me, talk to Chuck.

So I hope this helps a little, as some food for thought around the dynamics of naming an advisory firm.

So what do you think? Are breakaway brokers driven by a desire to keep more of their GDC? Do they breakaway over something else? Will we see an uptick in breakaways as post-financial crisis retention deals expire? Please share your thoughts in the comments below!

The Complex Motivations Of Money And Retirement As The Freedom To Pursue Non-Monetary Work Rewards

The Complex Motivations Of Money And Retirement As The Freedom To Pursue Non-Monetary Work Rewards

Executive Summary

The traditional view of work is that it’s something we wouldn’t otherwise do, without the financial reward of getting paid… such that the whole point of work in the modern era is to earn and save enough to get to the point where you can “retire” and not need to work anymore.

Yet research on what actually motivates us reveals that “money” is a remarkably inferior motivator (both to incentivize and reward desired behavior, and to punish bad behavior) compared to the motivation we derive from interpersonal relationships with other people. To the point that turning social connections into financial arrangements can reduce our motivation to engage in the desired behaviors. Yet due to our inability to judge our own motivations, and what will make us happy in the future, we continue to pursue financial rewards… even as a growing base of research reveals that it doesn’t actually improve our long-run happiness.

The reason why all of this matters is that it implies the whole concept of “retirement” may be predicated on a mistaken understanding of our own motivators… a realization that most people don’t have until they actually retire (or at least, are on the cusp of it), and suddenly discover that “not working” isn’t nearly as enjoyable as expected, despite all the sacrifices of potentially undesirable work that was done to earn the money to retire along the way.

So what’s the alternative? To recognize that work – at least, some work – can be intrinsically motivating and socially rewarding, where money doesn’t have to be the driving factor. Yet at the same time, often such work does at least have some financial rewards… which is important, because if “retirement” is simply about shifting the rewards of work from “mostly financial” to “only partially financial”, then the reality is that most people may not need nearly as much to “retire” in the first place. And that the very nature of “retirement” itself isn’t really about an end to working, but simply reaching the point of financial independence where “work” can be chosen based primarily (though not exclusively) for its non-monetary rewards!

Is Money Really An Effective Reward To Motivate Work?

The conventional view of money is that it is a highly effective motivator, particularly for what is otherwise the “unpleasant” task of work. Thus, workers are paid compensation and bonuses to incentivize and motivate them to do more work (and achieve sometimes-challenging tasks). And ultimately, the presumed goal is to accumulate enough of the rewards (money) to no longer need to do the tasks (work) in the first place, and therefore be able to retire.

Payoff: The Hidden Logic That Shapes Our Motivations by Dan ArielyYet recent research finds that our motivations to work are far more nuanced and complex. For instance, in his recent book “Payoff: The Hidden Logic That Shapes Our Motivations”, psychology researcher Dan Ariely tells the story of a study he and his colleagues conducted, where workers in a semiconductor factory could earn a potential bonus on the first day of their series of four-day 12-hour work shifts. The prospective bonuses included a cash bonus of about $30, a similar-dollar-value voucher for a hot yummy pizza (to order for the family dinner that evening), or simply a complimentary text message from their boss saying “Well done!” (And of course, some people were not eligible for any bonus potential at all, to serve as the control group.)

The results revealed that that all three of the potential “bonuses” – cash, pizza, and a compliment – served comparably well to motivate on the first day, with the pizza boosting productivity by 6.7% that day, the prospective compliment generating a 6.6% boost, and the potential cash bonus coming in last (but only slightly) with a 4.9% productivity boost. However, on the subsequent day of the four-day work cycle, those who received the money performed 13.2% worse than the control group as the prospective benefit of the money wore off (and they were still 6.2% less productive on day 3, and 2.9% less productive on day 4!), such that cumulatively for the week, those who earned the cash bonus ended out being 6.5% less productive! By contrast, though, those who had received the pizza reward remained slightly more productive for the week (drifting back towards the control group as the days went by), and those who received the compliment had the highest overall productivity for the week (though they still drifted back to the control group’s productivity by the end for the four-day series of shifts).

Worker Productivity Based On Different Bonuses

In other words, the highest cumulative productivity came from those who received a compliment from their boss as a bonus, while the more financially oriented the reward, the less the money sustained any kind of motivation for increased productivity! Which means, to say the least, money alone is clearly not our only – nor even perhaps our primary – motivator, and making rewards more financially oriented can actually reduce motivation in the long run (as the productivity enhancements stop, or even ‘rebound’ to the negative, the moment the cash bonuses go away!).

And the prospective adverse impact of turning an interpersonal social reward into a financial one is not unique to situations like semiconductor factory workers. For instance, Ariely also presents the following thought experiment as well… imagine you are at your mother-in-law’s house, having just had a sumptuous and delicious Thanksgiving dinner with the family, and at the end of dinner you pull out your wallet and say “Mom, for all the love you’ve put into this family dinner, how much do I owe you? Will three hundred dollars do it? Or four hundred?” Would introducing a financial “reward”, beyond simply expressing your gratitude for a family dinner prepared with love and care, really be a “bonus” to your mother-in-law, or just help to remind everyone how inappropriate it is to try to put a price on the priceless nature of family love?

Social vs Monetary Punishments To Stop Bad Behaviors

Notably, these dynamics between monetary versus social motivators (e.g., the cash versus the compliment, expressing gratitude versus paying for a Thanksgiving family dinner) exists not only in the context of rewards to incentivize “good” behavior and work productivity. A similar effect occurs with respect to punishments to disincentivize or punish bad behavior, too.

For instance, researchers Uri Gneezy and Aldo Rustichini conducted a study looking at how to encourage parents to pick up their children on time from day care centers (or alternatively, how to discourage them from the ‘bad behavior’ of being late for pick-ups). In general, most parents were on time, but late arrivals past the official 4PM pick-up did occur from time to time.

Accordingly, the researchers introduced a fine, of approximately $3 for every 10 minutes that the parents were late. Thus, rather than simply rely on the goodwill of the parents to not inconvenience the day care center workers by being late, a financial punishment was introduced as well.

The results: once the penalty was introduced, the rate of parent tardiness more than doubled. In other words, parents were more willing to be late for a known cost of $3 per 10 minutes, rather than just the unknown-but-implied inconvenience of forcing the day care workers to stay late to wait for the pick-up.

In essence, the financial cost of the late penalty was viewed as a lesser consequence than one solely focused on the implied social contract between the parents and the day-care workers of “we close at 4PM, please be courteous and pick your children up on time.” Introducing the financial consequence turned the arrangement from a social agreement, into a financial one with a clear (and deemed to be affordable) cost – pay $3, and be absolved of any social guilt for being late. And notably, the researchers found that once the cost of being late was “set” in the minds of the parents, it persisted; even after the penalty was later removed, the parents continued to be late just as often, at double the rate they were originally, because the financial price had been “set” in their minds (and deemed an acceptable trade-off to them) at that point.

All of which goes to show that once again, the social connection between human beings can impact behavior even more than pure monetary rewards or fines/punishments. And turning a social agreement into a mere financial arrangement can actually undermine the behavioral motivation to “do the right thing”!

Predicting What We Find Rewarding: Intrinsic vs Extrinsic Motivation

Notwithstanding this dynamic that money isn’t always a great motivator (or an effective tool for punishment), one of the great challenges of motivation is that we think such extrinsic motivators – like getting a bigger paycheck, or earning a nice bonus – will feel rewarding (and that a financial penalty or fine will similarly punish and stop bad behavior). Even though when the time comes, it turns out that we’re much more motivated by intrinsic motivators (e.g., whether we actually enjoy the work and find it immersive) and social dynamics (e.g., whether the boss compliments us, or more generally whether the engagement deepens our relationships, or not wanting to let someone down based on what we have already implicitly or explicitly agreed to do).

Which matters, because from the financial planning perspective, this has rather profound implications for the real-world trade-off decisions we make about job choices and income, earning more to save more, and the very nature of retirement itself.

For instance, research by Daniel Kahneman and Angus Deaton finds that higher income is not associated with greater happiness, beyond a threshold level of about $75,000/year in household income (with perhaps some variability for cost-of-living in certain parts of the country). However, their results indicate that higher income beyond this threshold is associated with higher scores of self-reported life satisfaction. In other words, while people with higher levels of income claim to feel more satisfied with their lives, when their actual positive and negative emotions are measured on a daily basis, they aren’t actually any happier for it!

Similarly, a 2009 Bankrate Financial Literacy poll found that a whopping 75% of consumers plan to work as long as they can. In some cases, it’s because they actually need the money, but in the majority of cases, it’s simply because they actually state that they like to work. And ostensibly, the percentage who stated they will keep working because they need to might also find that they would work because they enjoy it, too… if they actually did have enough money, and could stop working in a job that was primarily about the money, and instead tried to find work that was more intrinsically motivating, too?

Financial Independence And The Freedom To Pursue The Non-Monetary Rewards Of Work

To say the least, what all of this Finology research suggests is that our relationship with money is far more complex than just the idea that we work to earn money, and earn money so we will no longer need to work. Because in reality, the intrinsic motivation and social rewards of “work” can be even more important and powerful than the extrinsic motivation of monetary rewards. We may think that the latter (money) will be more motivating, but once we get there, it rarely is.

Thus why we say we want a financial bonus to incentivize our long-term behavior, but then end up producing far less the moment after the bonus is paid. And why we say we want to generate money to pursue retirement and a “non-work” phase of life, but then when we stop working we find out it’s not as enjoyable as we thought (as we lose our identity and purpose, and reason for getting up in the morning), and thus end up going back to work anyway (but perhaps for non-monetary rewards).

Of course, financial constraints are a reality in the real world, and there are many people who can’t afford to just live to work (for non-monetary rewards) and instead must work to (afford to) live. Nonetheless, what all of this research implies is that at best, working for money is still not about retiring from work, it’s simply about gaining “financial independence” that makes it feasible to shift the priority of work to non-financial rewards, instead.

First and foremost, this is important to consider for those who strongly dislike their current jobs, but have been doing the work anyway in an effort to earn enough money to pursue a retirement that potentially won’t actually make them much happier anyway. Perhaps switching to more personally rewarding work, for less money, would be a good idea… especially if doing less-enjoyable work for more money is only to pursue a “retirement” goal that may not actually make you happy anyway.

Even more significant, though, is the simple recognition that “non-financial work” does often (though admittedly not always) end up having some kind of financial reward anyway. While the financially independent retiree might simply volunteer at church, or become a mentor, or engage in a new hobby, often in practice that turns into some part-time paid work, or a business consulting agreement, or a new business opportunity.

Which matters, because if there actually is likely going to be at least some modest financial reward coming from mostly non-monetary work, it actually means many prospective “retirees” could make the switch to meaningful non-monetary work even sooner! After all, at a 4% withdrawal rate, making “just” an extra $10,000/year in part-time work in retirement can reduce the retirement savings need by as much as $250,000! And making just $40,000/year in “retirement” can shave a cool $1,000,000 off the required nest egg!


The bottom line is simply to recognize that, as the growing base of Finology research suggests, our relationship with money is far more complex than is commonly understood – such that it can even leads us to pursue goals that we think we want, only to find out that we don’t enjoy once we get there. Because, as the research in Ariely’s book “Payoff” clearly shows, money is not the only motivator and goal – a lesson that’s hard to remember, in a world where it seems virtually “everything” is being converted into a monetary goal, reward, or punishment.

Nonetheless, as human beings, our brains do appear to be hard-wired to pursue rewards (and avoid punishments). And that drive to pursue rewards, combined with our ability to delay gratification, creates our capacity to do “work” today in order to generate the (financial) rewards that allow us to not work later. Yet recognizing that a significant portion of our rewards are social and interpersonal (and non-financial), and that we can be intrinsically motivated as well, helps to reveal why so many end up continuing to “work” even after it’s no longer financially necessary. Which is crucial to understand, because planning for work after we reach financial independence can actually make it financially possible for us to make the transition even sooner!

Which means in the future, perhaps the real question to ask is not “how much do you need to retire”, but “what kind of work would you pursue for non-monetary rewards if you were financially independent and didn’t need the money… and how much money would you likely end up earning from that effort anyway?” And then plan accordingly!

So what do you think? Is money really an effective reward to motivate work? Are we bad at predicting whether we will be motivated extrinsic or intrinsic rewards? Is our ultimate financial goal to be able to pursue work for non-financial rewards? Please share your thoughts in the comments below!