Major Brokerage Trade Groups To CFP Board: Slow The Effort To Raise Mark’s Fiduciary Standard

Major Brokerage Trade Groups To CFP Board: Slow The Effort To Raise Mark’s Fiduciary Standard

As the CFP Board’s proposed Standards of Conduct (which would expand the fiduciary duty for all CFP professionals) finishes their second public comment period next week, the major lobbying organizations for broker-dealers are pushing the CFP Board to step back from its fiduciary push. While both SIFMA (which represents the brokerage industry broadly) and FSI (Financial Services Institute, which represents independent broker-dealers) both claim to support the idea that advisors should act in the best interests of their clients, they are claiming that it would be better for the CFP Board to wait for the SEC to issue a fiduciary rule instead (which is rumored to be coming soon, although notably it was the CFP Board that originally lobbied for the SEC to adopt a strict fiduciary rule over 6 years ago, which the brokerage industry opposed at the time!). Arguably, there is a legitimate concern that the overlapping patchwork of regulations that apply to financial advisors already may be even more complicated by the CFP Board inserting its own set of rules… yet at the same time, after organizations like SIFMA and FSI were successful in stalling the SEC from rulemaking for years, it was only the movement of the Department of Labor, states like Nevada, and now organizations like the CFP Board, that seems to finally be stirring the SEC to action in the first place, for which the CFP Board can obviously adjust their rules in the future (if necessary or desirable) to conform to whatever fiduciary rule the SEC ultimately issues. In fact, the CFP Board publicly responded that it does still intend to forge ahead with its own fiduciary rule, and has been engaging in several public efforts to build momentum for its rule, including a full-page ad in the Wall Street Journal last month, and another that will run in Investment News next week highlighting an open letter from 21 academicians leading programs at universities around the country that they support the higher standards of CFP certification. To say the least, though, for all those CFP Board critics who claim that the CFP Board bends its will to the demands of large (broker-dealer) firms, this should be definitive proof that while the organization does appropriately recognize them as stakeholders (and did make some concessions in its revised proposal of the standards), it is clearly not beholden to them.

Acquisition And Home Equity Mortgage Interest Tax Deductibility After TCJA

Acquisition And Home Equity Mortgage Interest Tax Deductibility After TCJA


The “American Dream” has long included the opportunity to own your own home, which the Federal government incentivizes and partially subsidizes by offering a tax deduction for mortgage interest. To the extent that the taxpayer itemizes their deductions – for which the mortgage interest deduction itself often pushes them over the line to itemize – the mortgage interest is deductible as well.

Since the Tax Reform Act of 1986, the mortgage deduction had a limit of only deducting the interest on the first $1,000,000 of debt principal that was used to acquire, build, or substantially improve the primary residence (and was secured by that residence). Interest on any additional mortgage debt, or debt proceeds that were used for any other purpose, was only deductible for the next $100,000 of debt principal (and not deductible at all for AMT purposes).

Under the Tax Cuts and Jobs Act of 2017, though, the debt limit on deductibility for acquisition indebtedness is reduced to just $750,000 (albeit grandfathered for existing mortgages under the old higher $1M limit), and interest on home equity indebtedness is no longer deductible at all starting in 2018.

Notably, though, the determination of what is “acquisition indebtedness” – which remains deductible in 2018 and beyond – is based not on how the loan is structured or what the bank (or mortgage servicer) calls it, but how the mortgage proceeds were actually used. To the extent they were used to acquire, build, or substantially improve the primary residence that secures the loan, it is acquisition indebtedness – even in the form of a HELOC or home equity loan. On the other hand, even a “traditional” 30-year mortgage may not be fully deductible interest if it is a cash-out refinance and the cashed out portion was used for other purposes.

Unfortunately, the existing Form 1098 reporting does not even track how much is acquisition indebtedness versus not – despite the fact that only acquisition mortgage debt is now deductible. Nonetheless, taxpayers are still responsible for determining how much is (and isn’t) deductible for tax purposes. Which means actually tracking (and keeping records of) how mortgage proceeds are/were used when the borrowing occurred, and how the remaining principal has been amortized with principal payments over time!

The Deductibility Of Home Mortgage Interest

The “current” form (before being recently changed by the Tax Cuts and Jobs Act of 2017, as discussed later) of the mortgage interest deduction underIRC Section 163(h)(3) has been around since the Tax Reform Act of 1986.

Under the rules established at the time, mortgage interest could be treated as deductible “Qualified Residence Interest” as long as it was interest paid on either “acquisition indebtedness” or “home equity indebtedness”.

Acquisition indebtedness was defined as mortgage debt used to acquire, build, or substantially improve the taxpayer’s primary residence (or a designed second residence), and secured by that residence. Home equity indebtedness was defined as mortgage debt secured by the primary or second residence and used for any other purpose. (And in either case, the property must actually be used as a residence, and not as investment or rental property.)

These distinctions of acquisition versus home equity indebtedness were important, because interest on up to $1M of acquisition debt principal was deductible, while home equity indebtedness interest was only deductible on the first $100,000 of debt principal. In addition, interest home equity indebtedness was not deductible at all for AMT purposes under IRC Section 56(b)(1)(C)(i), and Treasury Regulation 1.163-10T(c) limited the total amount of debt principal eligible for interest deductibility to no more than the adjusted purchase price of the residence (original cost basis, increased by the cost of any home improvements).

Example 1a. Bradley and Angela purchased their $700,000 residence by paying 20% down, and financing the rest with a traditional 30-year mortgage for $560,000. Because the $560,000 loan proceeds were used to acquire their primary residence, interest on the mortgage will be tax deductible.

Example 1b. Several years later, the residence has appreciated to $800,000, and the couple took out a $150,000 home equity line to repay some outstanding credit card debt, and finance the last two years of college for their children. Because the proceeds were not used to acquire, build, or substantially improve the primary residence, the $150,000 HELOC is treated as home equity indebtedness, which means only interest on the first $100,000 will be deductible (for regular tax purposes, and not be deductible for AMT purposes).

Notably, IRC Section 163(h)(3)(H)(i) also explicitly states that if acquisition indebtedness is refinanced, it remains acquisition indebtedness, to the extent of the original amount of acquisition indebtedness remaining.

Example 2. Continuing the prior example, if after several more years, Bradley and Angela have repaid their HELOC, and decide they want to refinance their original mortgage – which has now amortized down to a loan balance of $400,000 – they can retain acquisition indebtedness treatment on their refinanced mortgage. But only to the extent of the remaining $400,000 balance. Any additional debt – e.g., from a cash-out refinance – would not be acquisition indebtedness, even if it’s under the original $560,000 balance, because only the $400,000 remaining balance is considered acquisition indebtedness when refinancing (unless the additional funds are themselves used to substantially improve the residence).

Tax Treatment Of Mortgage Interest Is Based On Use Not Loan Terms

A key point in the tax treatment of mortgage interest is that whether or how much of the interest is deductible is determined by how the mortgage debt is used… and not necessarily by how the loan is structured.

As noted earlier, for mortgage debt to be treated as “acquisition indebtedness”, it must actually be used to acquire, build, or substantially improve that residence. (Where “substantial improvement” is based on whether the improvements are capital improvements that would add to cost basis, such as an expansion or permanent improvement, but not simply home maintenance and normal repairs.)

In the most common use case for a mortgage – a loan taken out to buy a house – the loan is clearly acquisition indebtedness, as the loan proceeds are literally used to acquire the primary residence.

Yet the reality is that because the determination of acquisition indebtedness is based on how the mortgage proceeds are used – not the structure of the loan itself – a home equity line of credit (HELOC) can alsobe acquisition indebtedness, if used to acquire, build, or substantially improve the residence!

Example 3. Jeremy has an existing but fully paid off primary residence worth $350,000. He decides to take out a $40,000 home equity line of credit, and draws on the HELOC, with a 5-year repayment period, to build an expansion to the house for his daughter and granddaughter to move in. Because the proceeds of the HELOC were used to make a substantial improvement to the primary residence (building an addition would increase the cost basis of the home), any interest on the HELOC will be treated as acquisition indebtedness, and not home equity indebtedness.

In addition, the fact that the determination of mortgage debt treatment is based on how the proceeds are used also means that there can be multipleloans that are each/all treated as acquisition indebtedness. This may be especially common in situations where buyers take out multiple loans all at once.

Example 4. Jenny is trying to qualify for a mortgage to buy her first residence, a $250,000 condo. To manage her exposure to Private Mortgage Insurance (PMI) given her limited downpayment, she takes out a $200,000 30-year primary mortgage (with no PMI), a $25,000 15-year second mortgage (with PMI), and makes a 10% ($25,000) cash downpayment at closing. Even though there are multiple loans, of which the first is a 30-year and the second is only a 15-year mortgage, because all of them were used to acquire the residence, interest on all of them will be treated as acquisition indebtedness.

In fact, there isn’t even a requirement that a mortgage loan be made by a traditional bank in order for it to be treated as acquisition indebtedness. It simply must be a loan, for which the proceeds were used to acquire (or build, or substantially improve) the primary residence, and it must be secured by that residence. Accordingly, even the interest payments on an intra-family loan can qualify for acquisition indebtedness treatment for the (family) borrower!

Example 5. Harry and Sally are hoping to purchase their first home to start a family, but unfortunately Harry has poor credit after getting behind on his credits cards a few years ago, and the couple is having trouble even qualifying for a mortgage. Fortunately, though, Sally’s parents are willing to loan the couple $250,000 to purchase a townhouse (financing 100% of the purchase), with favorable (but permitted under tax law) family terms of just 3% on a 10-year interest-only balloon loan (which amounts to a monthly mortgage payment of just $625/month before property taxes and homeowner’s insurance). To protect the parents, though – and to ensure deductibility of the interest – the intra-family loan is properly recorded as a lien against the property with the county. As a result, the $625/month of interest paymentswill be deductible as mortgage interest, because the loan is formally secured by the residence that the proceeds were used to purchase.

On the other hand, while a wide range of mortgages – including both traditional 15- and 30-year mortgages, intra-family interest-only balloon loans, and even HELOCs used to build an addition – can qualify as acquisition indebtedness when the proceeds are used to acquire, build, or substantially improve the primary residence, it’s also possible for traditional mortgage loans to be treated as at least partially as home-equity indebtedness and not acquisition indebtedness.

Example 6. John and Jenna have been living in their primary residence for 7 years. The property was originally purchased for $450,000, which was paid with $90,000 down and a $360,000 30-year mortgage at 5.25%. Now, a little over 7 years later, the loan balance is down to about $315,000, and the couple decides to refinance at a current rate of 4%. In fact, they decide to refinance their loan back to the original $360,000 amount, and use the $45,000 cash-out refinance to purchase a new car. In this case, while the remaining $315,000 of original acquisition indebtedness will retain its treatment, interest on the last $45,000 of debt (the cash-out portion of the refinance) will be treated as home equity indebtedness, because the proceeds were not used to acquire, build, or substantially improve the primary residence.

In other words, to the extent that the proceeds of a mortgage loan (or refinance) are split towards different uses, even a single loan may end out being a combination of acquisition and home equity indebtedness, based on exactly how the proceeds were used!

And the distinction applies equally to reverse mortgages as well. In the case of a reverse mortgage, often interest payments aren’t deductible annually – because the loan interest simply accrues against the balance and may not actually be paid annually in the first place – but to the extent that interest is paid on the reverse mortgage (now, or at full repayment when the property is sold), the underlying character of how the debt was used still matters. Once again, to the extent the loan proceeds are used to acquire, build, or substantially improve the residence, the (reverse) mortgage debt is treated as acquisition indebtedness (and its interest is deductible as such), while (reverse) mortgage funds used for any other purpose are at best home equity indebtedness.

Example 7. Shirley is a 74-year-old retiree who lives on her own in a $270,000 home that has a $60,000 outstanding mortgage with a principal and interest payment of about $700/month. She decides to take out a reverse to refinance the existing $60,000 debt to eliminate her $700/month payment, and then begins to take an additional $300/month draw against the remaining line of credit to cover her household bills. The end result is that any interest paid on the first $60,000 of debt principal will be acquisition indebtedness (a refinance of the prior acquisition indebtedness), but any interest on the additions to the debt principal (at $300/month in loan payments) will be home equity indebtedness payments.

Deducting Mortgage Interest Under The Tax Cuts and Jobs Act of 2017

Ultimately, the significance of these distinctions between interest on acquisition indebtedness versus home equity indebtedness isn’t merely that they have different debt limits for deductibility and different AMT treatment. It’s that, under the Tax Cuts and Jobs Act of 2017, the acquisition indebtedness limits have been reduced, and home equity indebtedness will no longer be deductible at all anymore.

Specifically, the Tax Cuts and Jobs Act (TCJA) reduces the debt principal limit on acquisition indebtedness from the prior $1M threshold, down to just $750,000 instead. Notably, though, the lower debt limitation only applies to new mortgages take out after December 15th of 2017; any existing mortgages retain their deductibility of interest on the first $1M of debt principal. In addition, a refinance of such “grandfathered” mortgages will retain their $1M debt limit (but only to the extent of the then-remaining debt balance, and not any additional debt). Houses that were under a binding written contract by December 15th and closed by January 1st of 2018 are also eligible.

On the other hand, the new TCJA rules entirely eliminate the ability to deduct interest on home equity indebtedness, effective in 2018. There are no grandfathering provisions for existing home equity debt.

Which means in practice, the distinction is no longer between acquisition indebtedness versus home equity indebtedness, per se, but simply whether mortgage debt qualifies as acquisition indebtedness at all or not. If it does – based on how the dollars are used – it is deductible interest (at least to the extent the individual itemizes deductions). If the dollars are used for any other purpose, the mortgage interest is no longer deductible. Though again, the determination is based not on how the loan is structured and characterized, but on how the loan proceeds are used (and specifically, whether they’re used to acquire, build, or substantially improve the primary or second residence).

Mortgage Interest Deductibility Before And After TJCA

In practice, this means that for many taxpayers going forward, mortgage interest will be “partially deductible”. Whether it’s a primary (acquisition) mortgage that’s deductible but a HELOC that’s not, or a HELOC that is deductible but a portion of a cash-out refinance that isn’t, the delineation of whether or how much of the mortgage debt (and its associated interest) is acquisition indebtedness or not matters more than ever. Because in the past, the fact that up to $100,000 of debt principal could still qualify as home equity indebtedness meant mortgages that were at least “close” to being all acquisition debt were fully deductible when the acquisition and home equity indebtedness limits were combined. Now, however, mortgage interest is either deductible for acquisition indebtedness, or not deductible at all.

Further complicating the matter is the fact that IRS Form 1098, which reports the amount of mortgage interest paid each year, makes no distinction between whether or how much of the mortgage principal (and associated interest) is deductible acquisition indebtedness or not. This isn’t entirely surprising, given that the mortgage lender (or the mortgage servicer) wouldn’t necessarily know how the mortgage proceeds were subsequently spent. Nonetheless, the fact that mortgage servicers will routinely report the full amount of mortgage interest on Form 1098, when not all of that interest is necessarily deductible, will almost certainly create taxpayer confusion, and may even spur the IRS to update the form. Possibly by requiring mortgage lenders or servicers to actually ask (e.g., to require a signed affidavit at the time of closing) about how the funds are intended to be used, and then report the interest accordingly (based on whether the use really is for acquisition indebtedness or not).

In addition, there are no mortgage interest calculators to help determine how much acquisition indebtedness is remaining on an existing mortgage, which is especially important if the mortgage interest is only partially deductible.

Example 8. Last year Charles refinanced his existing $325,000 mortgage balance into a new $350,000 mortgage (on his $600,000 primary residence), and used the $25,000 proceeds of the cash-out refinance to repay some of his credit cards. Now, Charles has received an unexpected $25,000 windfall (a big bonus from his job), and decides to prepay $25,000 back into his mortgage. At this point, the mortgage is technically $325,000 of acquisition indebtedness and $25,000 of non-acquisition debt (for which interest is not deductible). But the mortgage servicer simply reports a total debt balance of $350,000. If Charles makes the $25,000 prepayment of principal, will the amount be applied against his $325,000 of acquisition indebtedness, his $25,000 of non-acquisition debt, or pro-rata against the entire loan balance? Unfortunately, at this point there’s simply no guidance, even though it would materially impact how much of his mortgage interest will be deductible for the rest of the year (and in subsequent years)! More generally, as Charles makes his roughly $1,800/month mortgage payment, it’s not clear whether the principal portion of each payment reduces his $325,000 acquisition debt, the other $25,000 of debt, or applies pro-rata to all of it!

Nonetheless, the fact that Form 1098 doesn’t delineate the amount of remaining acquisition indebtedness in particular, or whether or how much of the mortgage interest is deductible (or not) – ostensibly leaving it up to taxpayers to decide, and then track for themselves – doesn’t change the fact that only mortgage interest paid on acquisition indebtedness is deductible. Taxpayers are still expected to report their deductible payments properly, and risk paying additional taxes and penalties if caught misreporting in an audit. Though with a higher standard deduction – particularly for married couples – the higher threshold to even itemize deductions in the first place means mortgage interest deductibility may be a moot point for many in the future!

So what do you think? How will the changes to tax deductions for mortgage interest under TJCA impact your clients? How are you communicating about these changes with clients and prospects? Do these changes create any new tax planning opportunities? Please share your thoughts in the comments below!

Managing The “Theater” Of A Financial Planning Meeting

Managing The “Theater” Of A Financial Planning Meeting


For financial advisors who pride ourselves on the quality of the advice we provide to clients, it can sometimes be easy to lose sight of the importance of the more physical elements of our business that seem qualitatively irrelevant to the value of the guidance and recommendations we give to clients. However, as a tremendous amount of psychological research suggests, we should be careful not to overlook the more “theatrical” elements of a financial planning meeting – from the clothes we wear and the way we present information to clients, to the design and set up of our office – as the “theater” of financial planning actually does influence our clients, and their ability to implement our advice in a meaningful manner.

In this  post, we will examine why it is important to both acknowledge and manage the theater of financial planning, particularly given the ways in which clients and prospective clients utilize the signals we as advisors send (both consciously and unconsciously) to decide everything from whom to hire, to what financial recommendations they should implement (or not!).

It is widely acknowledged that effective communication is an important aspect of what financial advisors do. However, something that is less commonly appreciated is the role that our environment plays in facilitating that communication. In his book, Suggestible You, Erik Vance examines the ways in which our suggestible minds are influenced by the stories we hear and the environments we hear those stories in. In particular, Vance examines the “theater of medicine”, and its surprisingly powerful role in shaping the perceptions and beliefs of patients, which can, in turn, influence their physical health and well-being as well!

Additionally, the physical spaces we occupy (such as our office) can actually say a lot about us. Though laboratory research in financial planning is still very young, and scholars are only beginning to delve into how the offices of financial advisors can optimally be designed, some research from other fields has found that our physical environments can actually say even more about our personalities than some commonly used tools and assessments. At the heart of this are ways in which our personality manifests in certain behaviors which leave physical evidence within our environments that is really hard to fake – from mementos we collect and things intentionally place out for others to see, to more subtle clues such as the way we dress and organize things on our desk.

Ultimately, financial advisors have many options for trying to better manage the theater of financial planning… from sending signals of our conscientiousness through our clothing (e.g., formal dress) and communication style (e.g., controlled posture and calm speech), to signals of our competence through education and professional designations (e.g., CFP certification), and even signaling our knowledge of and solidarity with niche communities that we service… there are many ways in which we can seek to manage the “theater” of our financial planning to help our clients adopt and implement wise financial planning practices!

(Derek Tharp Headshot PhotoMichael’s Note: This post was written by Dr. Derek Tharp, our Research Associate at In addition to his work on this site, Derek assists clients through his RIA Conscious Capital. Derek is a Certified Financial Planner and earned his Ph.D. in Personal Financial Planning at Kansas State University. He can be reached at

Acknowledging The “Theater” Of Financial Planning

Sometimes financial advisors—and particularly those of us who may be most interested in the technically-oriented side of financial planning—can be quick to write-off the “theater” of financial planning. After all, if we can serve our clients well and give them really good advice (far better than that slick salesman down the street, no doubt!), then why worry about the suit we wear, the car we drive, or the aesthetic of our office? These factors are all superficial and do not influence the actual quality of the advice we deliver to clients – which is what our clients are paying us for, isn’t it?

However, psychological research gives us good reason to question just how superficial the actual “theater” of financial planning is. From the costumes we wear, to the props we use, and even the way we arrange our financial planning “stage”… the performances we put on can and do influence our clients – including the emotions they feel, the perceptions they form, and the eventual decisions they make.

As a result, those of us who truly do want to help our clients make the best possible decisions should not ignore both the conscious and unconscious influences of financial planning theater.

Our Highly Suggestible Minds

Suggestible You by Erik VanceIn his 2016 book, Suggestible You, Erik Vance examines the science behind our highly suggestible minds, and finds that at all sorts of human behaviors that seem to have no scientific basis—from voodoo and shamanism, to magic healing crystals and miracle vitamin pills—surprisingly seem to actually have some real-world effects.

What’s most interesting about Vance’s approach, is that rather than just write these things off as mere pseudoscience, Vance examines whether there could be other mechanisms that might help explain why such behaviors could have effects, even though the actual treatments themselves are not scientifically supported. And in his investigation, Vance identifies a potential explanation: the power of our highly suggestible minds.

Vance explores a wide range of case studies and scientific literature which suggests that not only do our experiences influence our perceptions and beliefs, but that our experiences alone can actually improve our health and well-being. In other words, it’s not just that our minds are capable of making us think we are better when we are not, but that our brains can actually enhance (or worsen) our physical and mental well-being.

At the heart of this powerful phenomena is storytelling—which has a long history of being deeply integrated into healing and medicine. In particular, storytelling is powerful in influencing our beliefs and expectations, which researchers have been discovering are far more powerful than we realized.

For instance, most people are familiar with the concept of a placebo effect: A participant in a study receives a sham treatment (e.g., a sugar pill) and yet experiences positive medical effects which cannot be attributed to the sugar pill itself. But only recently have medical researchers begun to really gain a better understanding of how these complex effects work.

At first, researchers were naturally skeptical of what placebos actually were. Many felt placebos were likely just a form of response bias (e.g., participants were trying to provide responses researchers wanted to hear),confirmation bias (e.g., researchers were seeing the effects they wanted to see), or publication bias (e.g., studies with interesting findings get published even though the results were just the result of chance). But the research so far suggests that, at least for some placebos, the science behind them is actually much more interesting.

For instance, Vance notes a 2004 fMRI study that provided some of the first evidence of how our brains can actually self-medicate against pain by engaging our “internal pharmacy”—i.e., neurotransmitters and hormones such as opioids, dopamine, and endocannabinoids, which our brains can release to self-medicate ourselves. In summarizing the findings of the 2004 fMRI study in which participants were conditioned to believe a non-pain relieving cream could actually relieve the pain of an electric shock, Vance writes (emphasis mine):

The most interesting part was what the brain scans showed. Normal pain sensations begin at an injury and travel in a split second up through the spine to a network of brain areas that recognize the sensation as pain. A placebo response travels in the opposite direction, beginning in the brain. An expectation of healing in the prefrontal cortex sends signals to parts of the brain stem, which creates opioids and releases them down to the spinal cord.We don’t imagine we’re not in pain. We self-medicate, literally, by expecting the relief we’ve been conditioned to receive.

In other words, it’s not just that placebos can make us think we are feeling better, but that the right experiences and expectations can actually cause our minds to induce a genuine healing process, independent of any actual medical treatment provided. And the placebo effect works at least in part because our expectation that it will work literally triggers our own internal neurochemistry to help make it so.


In addition to actually being a good storyteller in the first place (financial advisors may want to note Scott West and Mitch Anthony’s book,Storyselling for Financial Advisors), another key element of storytelling is the broader “theater” in which that storytelling takes place, which can ultimately have the effect of diminishing or enhancing the power and believability of a story being told. Which is important, as ultimately it is our genuine beliefs and expectations which influence the surprisingly good (or bad!) outcomes which Vance examines.

Given Vance’s book’s focus on the physical healing process, he places a particular emphasis on the ways in which the “theater of medicine” has been found to influence our health. Simply put, the theater of medicine refers to the many factors of the environment around us which all tell our brains that it is time to get better when we enter a medical facility. From the uniforms that people wear (e.g., the authority invoked by an EMT’s uniform, the sterility invoked by crisp and clean nurse’s scrubs, and the expertise invoked by a doctor’s white lab coat), to the props that are used (e.g., stethoscope, thermometers, and other medical equipment), and even the general arrangement of a medical “stage” around us (e.g., anatomical charts, the scent of disinfectant, and degrees and other credentials prominently displayed), we are constantly reminded that it is time to get better.

Of course, these elements all serve a genuine purpose as well, but the reality is that at a well-staged medical environment can actually make a physician more effective. In most modern medical facilities, we both consciously and unconsciously receive the message that we are in a safe environment and being taken care of by qualified professionals. Certainly doctors could stage their “performance” much differently—perhaps ditching the formality of the white lab coat, storing equipment in a manner that is much less conspicuous, or eliminating the anatomical charts (which I assume are almost never actually referenced)—but this would likely be counterproductive, as it may impair the way that patients experience the medical environment.

In a medical context, theater and storytelling can be really powerful tools (though, admittedly, for both good and bad). In a famous 1955 paper in The Journal of the American Medical Association, Henry Beecher noted:

Placebos have doubtless been used for centuries by wise physicians as well as by quacks, but it is only recently that recognition of an enquiring kind has been given the clinical circumstance where the use of this tool is essential.

Beecher goes on to suggest that as many as 30% of patients will have placebo responses to a particular drug. However, Vance notes that subsequent estimates have been even higher (as high as 80% – 100%), particularly for ailments that are highly susceptible to placebo responses, such as pain and depression.

Placebos themselves may be more or less prevalent based on how they are presented. For instance, place responses are more common when the pills used are larger, made of certain colors, or are more expensive. Fascinatingly, placebos effects—supported by the broader theater in which makes such effects are possible—can even occur when people have beentold they are taking a placebo! Of course, as financial advisors, we don’t prescribe drugs to our clients or address their physical health, but the key point is that is that if our minds (both consciously and unconsciously) are so heavily influenced by belief and perception that we can literally self-medicate ourselves, it would be unlikely that storytelling (and theater in which those stories are told) wasn’t highly important in a financial context as well.

The Surprising Details Our Office Can Reveal About Us

Though laboratory research in financial planning is still very young and scholars are only beginning to delve into how the offices of financial advisors can optimally be designed, we can look to other fields for insights to consider when designing a financial advisor’s office to invoke similar “theater” effects that may help clients put themselves into the frame of mind that they’re about to change their financial behaviors for the better.

Snoop by Sam GoslingOne such line of research comes from Sam Gosling, a professor of psychology at the University of Texas at Austin. In his book, Snoop, Gosling examines what our physical spaces—including our offices—can reveal about us.

Gosling’s field research, which involved “snooping” in the actual bedrooms and offices of research participants to see what he and his colleagues could determine about the individuals who occupy those spaces, found that our physical environments actually reveal a lot about our personality. In fact, Gosling and his colleagues found that sometimes our physical environments say even more about us than tools such as self-assessments. The reason for this is that while we might bias a self-assessment in a direction that we aspire towards or think others will be more approving of, our physical environment includes many unconscious manifestations of our personality in our everyday life.

Gosling refers to these manifestations as “behavioral residue”, as it is quite literally the evidence that accumulates based on our personality-driven tendencies to engage (or not) in certain behaviors. This type of evidence can be particularly revealing, as it is often the hardest to fake.

In a 2002 paper in the Journal of Personality and Social Psychology, Gosling and his coauthors identify four specific mechanisms through which such behavioral residue can emerge: self-directed identity claims (things we display for ourselves), other-directed identity claims (things we display for others), interior behavioral residue (residue which accumulates based on behavior inside or homes and offices), and exterior behavioral residue (residue which accumulates as the result of behavior that we engage in outside of our homes and offices).

In each case, an individual possesses some underlying personality-driven disposition, which leads to a particular behavior, which then leaves some evidence of that behavior. For instance, a financial advisor may be sentimental (personality-driven disposition), which leads them to collect memorabilia (behavior), and that results in an old baseball that sits amongst some other items on their bookshelf (behavioral residue). Or a financial advisor may be sensation-seeking (personality-driven disposition), which leads them to drive a motorcycle (behavior), which results in them needing to carry a motorcycle helmet around with them (behavioral residue).

The Process Through Which Personality Driven Tendencies Manifest In Our Physical Environment

Of course, the reality is that behavior (and its resulting residue) can be highly nuanced, which can lead to a lack of clarity regarding what some behavioral residue actually says about an individual. For instance, an advisor may have a baseball in their office as a way to signal that the advisor likes to watch baseball (an other-directed identity claim which could encourage a prospect or client to start a conversation on a topic of mutual interest), as a piece of memorabilia solely with personal significance (a self-directed identity claim which may help regulate an advisor’s emotions or motivation), or simply because a colleague dropped the ball on their way out of the office and the advisor is holding onto it until it can be returned to its owner (a form of residue which, at best, just tells us a bit about the advisor’s personality). But as an outsider looking in, it isn’t immediately clear why the baseball is in the environment.

However, we may sometimes be able to gain some clues

from how things in an environment are positioned. Gosling notes that there are some interesting differences between self-directed and other-directed identity claims. Because the intended audience of self-directed and other-directed identity claims are different, individuals will tend to position such claims differently within their office. For instance, other-directed identity claims would be more visible from places where clients would sit (since clients are the intended audience), whereas self-directed identity claims may be more (or even exclusively) visible from an advisor’s perspective.

As a result, when trying to learn about an individual by viewing their office, it is helpful to view the office from multiple perspectives. While an office may look neat and tidy from the client’s chair (an example of behavioral residue which would indicate high conscientiousness), the pile of papers and an overflowing waste bin hurriedly stashed out of the client’s sight may tell a different story.

But the reality simply is that what we display in our physical spaces (both intentionally and unintentionally) can say a lot about us. Which means it’s important to carefully consider what our environment is saying about us, and whether that aligns with the message we intend (or desire) to convey!

How We Can Better Manage The Theater Of Financial Planning

When it comes to better managing the “theater” of financial planning, the first thing to do is acknowledge that it exists.

Again, particularly for those of us who are most strongly drawn to the technical side of financial planning, this can be a challenge. While the quality of our services does matter, our ability to communicate our findings to clients (storytelling) and the broader environment in which we do that storytelling (theater) may matter just as much, if not more, than our technical skills. And this may be particularly true when it comes to influencing whether our clients actually follow-through and implement the strategies we recommend.


Depending on a particular advisor’s office arrangements, they may have more or less control over how an office is set up, but there are always ways in which we can craft our environment to send better or worse signals to others.

At the most obvious level, are the signals that we intend to send to clients. While many of these signals will be common to many advisory firm offices—signaling characteristics such as competence, professionalism, trustworthiness, etc.—they are still important boxes to check. Though the doctor who wears a lab coat isn’t “unique”, the doctor who doesn’t may not put his or her clients in the best frame of mind to increase the client’s odds of healing. In the context of advisory firms, awards or degrees displayed around an office, the magazines available to customers in the reception area, and the way we dress, are all signals to consumers who have relatively little information use when assessing our intangible services.

Ideally, we are signaling information that aligns with our true goals, skills, interests, values, and personality to others. For instance, if an advisor takes pride in their professional accomplishment and proudly displays a credential worthy of admiration, Gosling notes that their inner and outer selves would be in alignment.

However, our inner and outer selves are not always aligned. In particular, our environment also contains “deceptions” that we may sometimes use to try and mask our actual traits. For instance, most people would generally like to be thought of as organized, as it’s a trait that is generally respected and rewarded in our society. As a result, regardless of how truly organized we are, most people will try and tidy up to at least give the impression they are organized. But, unfortunately for those of us who may not be naturally inclined to alphabetize bookshelves, deceptions are often fairly easy to spot. Of course, that doesn’t mean we shouldn’t still try our best to be organized, but we should be careful how we portray ourselves to others, because claiming to be organized when we are not is likely to perceived worse than being just being genuine selves.

Unfortunately, when it comes to areas where consumers lack the information needed to provide a meaningful assessment (e.g., assessing the quality of investment recommendations), deception can be harder to detect. Consider the famous CFP Board commercial in which a DJ was transformed into a financial advisor who appeared to come off as reputable to consumers based on how he was dressed and the professionalism of his (staged) office setting. The “experiment” was set up in a manner which took advantage of the “theater” of financial planning. Illustrating that since most consumers aren’t financial advisors themselves, they struggle to assess the true quality of a financial advisor. As a result, by simply being confident, looking the part, and using some industry buzzwords (e.g., asset allocation, 401k, etc.) the DJ was able to come off as knowledgeable and trustworthy.

Had the CFP Board put the same DJ in a rundown office, dressed casually, and had him perform without confidence, it’s doubtful consumers would have had the same response. In fact, you could likely put a highly qualified advisor delivering excellent advice in the same rundown/casual setting and consumers would still doubt whether the advisor was knowledgeable, because they can’t actually assess competence in the first place, though the wide range of contextual clues they can assess would be indicating something was not right. (This is also why credentials like the CFP marks help, as it provides a meaningful signal of competence in an area where consumers would struggle to make that assessment themselves. Because, as the DJ commercial notes, anyone can put on a suit and tie, but not everyone can get the CFP marks!)

Of course, financial advisors should never fake credentials or expertise that they do not have for both ethical and legal reasons, but the point remains that the “theater” of financial planning is so powerful, that it can even mask otherwise unqualified individuals. Which means it is crucial for those whoare competent and ethical to leverage all the tools at their disposal!


Gosling uses the terms “seepage” or “leakage” to refer to behavioral cues about our personality (positive or negative) that are revealed without our being aware of them. One particularly powerful way in which this can happen is through our clothing.

For instance, conscientiousness is one of the personality traits that is often found to be the most desirable in a professional context. Based on the findings of some prior studies, Gosling put together a “Snooping Field Guide” which includes both the items that snoopers most often used to assess a particular personality trait, as well as the items that were found to actually predict those traits best. In both cases, formal dress was found to be the strongest indicator of conscientiousness.

As a result, this is one more reason advisors may want to be very careful before dressing down. Particularly when we don’t like to dress up, we’re likely to engage in all sorts of motivated reasoning to convince ourselves it is okay to dress down. However, the formality of our clothing is perhaps the single greatest visual signal of high conscientiousness that we can send.

In terms of other clothing-related traits that have been found in prior research, observers have previously relied on:

  • Fashionable dress as an indicator of openness
  • Make-up as an indicator of openness and extraversion
  • Showy dress as an indicator of extraversion
  • Non-showy dress as an indicator of conscientiousness

Notably, past research indicated these weren’t actually reliable indicators, but the key point here is that those evaluating the personalities of othersthought they were. Interestingly, dark clothing was an indicator of neuroticism, though it was not picked up on by those doing the evaluations (it was identified by researchers evaluating data after the fact).


Not only does the way we communicate affect the quality of our storytelling, but it is also a way in which people tend to try and pick up clues about the personalities of others.

Again noting that conscientiousness is among the most desirable traits when making hiring decisions in a professional context, advisors may want to be aware that the following were used by reviewers to assess one’s level of conscientiousness:

  • Controlled sitting posture
  • Touches one’s own body infrequently
  • Fluent speech
  • Calm speech
  • Easy to understand

Notably, again, these weren’t actually found to be meaningful predictors of conscientiousness, but they were cues that people relied on when making assessments. In other words, right or wrong, those who exhibit these queues may be more likely to be perceived as conscientious, which can make a difference when prospects are interviewing prospective financial advisors.

While we don’t know enough about what clients look for in an advisor to have much confidence in how one might signal other traits (and preferences likely vary based on a client’s own personality), some other notable indicators included (*indicates cues that were actually found to be predictive of the underlying personality traits):

  • Openness: friendly expression, self-assured expression, extensive smiling, pleasant voice, fluent speech, easy to understand, and calm speaking
  • Extraversion: Friendly expression*, self-assured expression*, extensive smiling*, relaxed walking*, swings arms when walking*, loud and powerful voice*
  • Agreeableness: Friendly expression*, extensive smiling, pleasant voice
  • Neuroticism: Grumpy expression, timid expression, little smiling, lack of arm swinging when walking, stiffness when walking, weak voice, unpleasant voice, halting speech, difficult to understand, hectic speech


As discussed above, signaling competence is particularly tricky since the prospect or client is presumably less knowledgeable than the financial advisor. Which means, ironically, most consumers don’t even know how to determine whether a financial advisor is competent or not, and aren’t even able to judge the quality of their answers to demonstrate competency. Which means it becomes all the more important to properly “signal” competence by any means possible (especially for those who really arecompetent!).

The first is through professional designations. When consumers believe that a designation is credible (and unfortunately, it’s the belief here that actually matters), the credibility of the designation conveys credibility to the advisor who has it. Which means the CFP may be meaningless to a consumer who is unaware of the CFP or under the impression it is not a meaningful designation, whereas a meaningless designation can sway a consumer if they believe it sounds important. Fortunately, the CFP marks have become a more credible signal as consumer awareness continues to rise with the CFP Board’s public awareness campaign.

A more general way in which we signal competence/intelligence is often through college degrees. While economists continue to debate over whether college actually makes us any smarter, it is at least generally accepted that, all else equal, more intelligence makes it easier to get into more prestigious schools, and that college itself serves as a means for individuals to signal some combination of intelligence and work ethic. Given that most people know it is very hard to get into Harvard and earn a Ph.D., there is a major competency signal conveyed by having a Ph.D. from Harvard. Of course, it’s entirely possible to have a Ph.D. from Harvard and still be clueless about financial planning. But for a consumer trying to findsome meaningful signal of competence, “he/she was smart enough to get a Ph.D. from Harvard” is better than nothing.

As a result, advisors may want to think carefully about how they display professional credentials and degrees in their office. This doesn’t mean such signals need to be in front of clients at all times (nor does it mean advisors need to go out and acquire advanced degrees, as there is certainly considerable diminishing marginal returns in highly personal business like financial planning), but much like the theater of medicine is often elevated by having a doctor’s credentials visible, financial advisors may want to do the same.


As boring as it may sound, there’s a certain degree of “fitting in” that is likely helpful in managing the theater of financial planning.

While it would be nice to have some actual research to back it up, there are likely some items clients just generally associate with “finance” that would be helpful for setting the stage of financial planning. Items like tickers, charts, spreadsheets, and maybe even CNBC running in the background could be items which fall into this category.

The irony, of course, is that many advisors like to steer their clients awayfrom CNBC and a lot of these financially-related items. Nonetheless, to the extent that clients might subconsciously associate them with the theater of financial planning, hiding them from clients could actually make the advisor seem less credible. Which means that while advisors may not want to place such TVs in a waiting room where clients would actually watch it, a strategically positioned TV a client might see walking back to an advisor’s office could still help set the stage (without encouraging the potentially harmful client behavior). If anything, it may help to convey “we keep an eye on CNBC, so you don’t have to!”

Beyond those types of props, there is the general professional nature of an office. The idea here is to (accurately) create the sense that the client is here to talk about something important with a qualified professional. What that means likely varies a lot from one market and target clientele to another, but, to the extent possible, advisors should probably strive to ensure they at least match the general quality of offices that clients may be meeting with competitors in. Because while having a professional-looking office like everyone else may not ensure you get the prospective client, not having an office on par with competitors could genuinely lose the prospect.


Perhaps the most effective way to “customize” an advisor’s office is to signal to a niche. Whereas the hope for much of the setting is that it invokes the theater of financial planning without actually drawing overt attention, when signaling to a niche, advisors should be looking for key “other-directed” identity claims they can send.

Of course, these specific signals will vary based on an advisor’s target niche, but the key is to be able to send some type of signal that displays a commonality that the client is unlikely to find with other advisors (at least in their immediate market).

Additionally, as a general principle, the more “costly” a signal is to send, the more meaningful it will be to those who receive it. This could mean something like cost in terms of time (e.g., a photo/award/etc. associated with donating considerable time to a nonprofit of shared interest versus a mug with the nonprofit’s logo on it). Or, while riskier, it could also be a cost in terms of signaling a shared identity that would actually be harmful for an advisor to send to someone outside of that niche. For instance, an advisor who works with many members of a particular union could display something that signals solidarity with that union. Not only is the signal of solidarity useful on its own, but the fact that it may mean fewer business prospects for an advisor (e.g., management or business owners who may not appreciate the signal of solidarity with employee unions) makes the signal more impactful than one that is “cheap” and would be universally or nearly universally agreeable anyway.

The bottom line, though, is simply to recognize that consumers are influenced by factors which have no rational basis for evaluating a financial advisor (e.g., wearing a suit, quality of the office, etc.). But advisors should be careful assuming they can convince clients that this behavior is “irrational”. For many, the story they hear, and the broader aspects of the “theater” that it takes place in, will be influential. Further, the inherent conflict of interest between any financial planner and a potential client they are prospecting makes consumers reasonably suspicious of any attempts rationalize less desirable aspects of a particular advisor’s theater, so advisors trying to persuade clients to ignore these factors may struggle more than those who simply acquiesce to reality and leverage them instead.

Of course, the power of storytelling and staging the theater of financial planning can be used to both further and harm client interests—so advisors have to be careful to use it for good—but ultimately the theater of financial planning should not be overlooked. Whether it’s in the process of trying to get new prospects or convincing existing clients to implement an advisor’s recommendations, managing the theater of financial planning plays an important role.

So what do you think? Do you have any strategies for managing the theater of financial planning? Can it be easy to overlook this aspect of the financial planning process? What do you feel are the most important traits to signal to clients? Please share your thoughts in the comments below!


AdvisorEngine Acquires Junxure Users And Gets CRM Thrown In!?

AdvisorEngine Acquires Junxure Users And Gets CRM Thrown In!?


Kicking off the 2018 New Year was some big advisor technology news: that robo-advisor-for-advisors AdvisorEngine is acquiring Junxure CRM, the popular CRM system for financial-planning-centric RIAs (that ranked second in adoption in last year’s T3 Tech Survey, coming in behind Redtail and ahead of Salesforce). Yet while Junxure has been around for more than 15 years, AdvisorEngine is still a relative newcomer, having only pivoted away from being a consumer-oriented robo-advisor just a few years ago as it received a substantial venture capital investment from WisdomTree as a potential distribution channel for their ETFs. Which raises the question: Why did AdvisorEngine buy Junxure CRM? And what does it mean for all of Junxure’s existing Cloud and Desktop users?

In this week’s discussion, we discuss AdvisorEngine’s acquisition of Junxure CRM, including why this is likely a good development for existing users in terms of enhancing Junxure Cloud and migrating away from Desktop, but also what I think was the real motivation behind this acquisition: AdvisorEngine’s desire to grow by converting as many of Junxure’s 1,400 advisory firms over to AdvisorEngine’s technology platform with AUM pricing.

From the perspective of existing Junxure users, the AdvisorEngine acquisition should be good news. AdvisorEngine wants to grow, they’ve got capital to invest for growth, and that means they can hire more developer talent to accelerate the feature roadmap for Junxure Cloud – an area that Junxure itself has struggled as a capital-constrained advisor tech firm (and thus why still fewer than 50% of Junxure users have moved from Desktop to Junxure Cloud). With AdvisorEngine itself being a well-funded and entirely web-based platform, it has both resources and incentives to bring Junxure Cloud up to modern standards… which only benefits existing Junxure users.

That being said, it’s important to recognize that AdvisorEngine didn’t just buy Junxure to make Junxure better to get more Junxure users. They bought it to make AdvisorEngine better, and to get more AdvisorEngine users by leveraging the value of Junxure CRM. Which means AdvisorEngine is clearly also going to be spending resources to integrate Junxure Cloud with AdvisorEngine, and these improvements don’t necessarily help Junxure users. They help AdvisorEngine users (or Junxure users who decide to adopt AdvisorEngine). And as AdvisorEngine continues to flesh out its own offerings, this creates some awkward tension with AdvisorEngine’s other partners, since the company has lauded itself as being “open architecture”, yet appears in practice to be less so as it’s acquired and now is deeply integrating with its own proprietary financial planning software and now its own CRM system.

Yet at the same time, this also raises what I think is the most concerning part of this deal of AdvisorEngine acquiring Junxure CRM: AdvisorEngineneeds Junxure users to adopt AdvisorEngine for this to work out. Because the reality is that AdvisorEngine still has the clock ticking on a $20 million dollar equity investment that WisdomTree made back in late 2016. For which, after a full year, AdvisorEngine is only reporting about $3 billion of assets on their platform from 60 advisory firms. Which, even if we’re generous and assume they are receiving their full top rate of 10 bps on all assets, only amounts to about $3 million of revenue so far, which is not a good sign, relative to the amount of capital AdvisorEngine raised. The pressure on AdvisorEngine to bring more assets must be tremendous. Which I think means AdvisorEngine isn’t just acquiring Junxure to make it a more holistic platform, but to specifically convert as many of Junxure’s 1,400 advisory firms over to AdvisorEngine as they can. And if AdvisorEngine can convert just 10% of Junxure users, that’s $60 million dollar revenue opportunity, in a world where Junxure’s 12,000 users may have only been bringing $7 million of revenue or so. Cross-selling Junxure users on AdvisorEngine’s services (and pricing) is the real key to the acquisition deal.

Except, unfortunately, I’m not certain how well that’s realistically going to work for AdvisorEnginge, because Junxure users tend to be deepfinancial planning firms. However, AdvisorEngine is an investment-centric platform, with a client portal focused on investments, an onboarding process focused on investment accounts (because that AdvisorEngine onboarding data can’t even go to actual financial planning software!), and an internal “financial planning light” solution through Wealthminder that you can’t even turn off in the AdvisorEngine portal if you’re using other third-party planning software like eMoney Advisor or MoneyGuidePro (and I suspect almost all current Junxure users are using third-party planning software!). And beyond this, it’s not even clear if advisors will be interested in AdvisorEngine given its AUM pricing starting at 10 bps. Because charging 10 bps for technology when the typical RIA generates 70 to 80 basis points of revenue yield on AUM means AdvisorEngine would cost the typical advisory firm more than 15% of revenue, when the typical firm only pays 2% to 4% of revenue on all of its technology (which is more than just what AdvisorEngine provides)!

But the bottom line is just to recognize that while in the very near term Junxure users should see a big investment from AdvisorEngine into new Junxure features – particularly to finish getting all the Junxure Desktop functionality into Junxure Cloud – the real value of Junxure for AdvisorEngine is getting Junxure users to start paying basis points for AdvisorEngine’s technology. Which means Junxure users should probably expect a lot of phone calls from the AdvisorEngine sales team in 2018, making their case for consolidating more of their technology with Junxure-integrated AdvisorEngine. Ultimately, we’ll see what happens, and whether the AdvisorEngine value proposition is really compelling enough to make Junxure users break their existing technology relationships?

Implications For Junxure Desktop And Junxure Cloud Users

Perhaps not surprisingly, the biggest volume of questions I’ve actually been getting so far about the news that AdvisorEngine was buying Junxure is from existing Junxure users who’re just wondering what this means for them. I think there are a few implications to the deal. And frankly, they’re pretty much all good news for Junxure users. First and foremost, AdvisorEngine wants to grow and they’ve got capital to invest for growth. And this is a big deal for Junxure users because Junxure for years has suffered and struggled a little from the fact that they were capital-constrained. They weren’t venture capital-funded, they didn’t necessarily have the money to hire the staff to build the features as fast as users wanted.

And, as a result, while the software was originally built as a desktop application, not uncommon in the early 2000s when it was first developed, Junxure has really struggled to move to the cloud. They didn’t evenoriginally announce the launch of Junxure Cloud until 2013 when Redtail was already on the cloud by 2003, and then they didn’t really fully formally launch Junxure Cloud until 2015. And when it did launch, it still didn’t have a lot of features that the existing Junxure desktop solution already had. As a result, even RIABiz coverage of the Junxure acquisition noted that Junxure itself is reporting still more than 50% of its users remain on Junxure desktop and haven’t even moved to Junxure Cloud yet, resisting I think what’s both just a time-consuming software transition and the fact that the cloud version lagged in features compared to desktop.

So the good news of all this AdvisorEngine acquisition activity, is that this is a web-based company. Cloud software is all they do and they have capital, so I suspect we’re going to see a really significant increase in the development pace of Junxure Cloud, acceleration of that roadmap to finish getting Junxure Cloud up on par with Junxure desktop. In part, because AdvisorEngine just has more resources to do the development, and also in part, because the whole point of this acquisition is for AdvisorEngine web-based software to integrate more deeply with CRM, which means they need Junxure desktop users to move to the cloud to leverage the integrations they’re planning to build. And it’s not very effective to have a web-based API that tries to reach each advisor’s individual desktop version of the software.

So AdvisorEngine has a strong incentive to finish all those Junxure Cloud developments, to get it on par with desktop, and to help encourage desktop users to move over. Which I think, ultimately, is a good thing because this isn’t the 2000s anymore… this is the 2010s, and we’re actually almost in the 2020s now. If you’re an advisor running a modern practice, your technology should use the internet. So it’s good that Junxure gets the investment to lift up the capabilities of Junxure Cloud, and it’s good for Junxure desktop users to get the capabilities they want and need so that they can finally make the transition off of desktop.

Will AdvisorEngine Build Junxure For Junxure, Or Junxure For AdvisorEngine?

That being said, it’s important to recognize that AdvisorEngine didn’t just buy Junxure to make Junxure better for Junxure users. They bought it to make AdvisorEngine better and to get more AdvisorEngine users by leveraging the value of Junxure. Which means that while you’re going to see some investments in their Junxure Cloud to finish matching capabilities to desktop, AdvisorEngine is clearly also going to be spending resources to integrate Junxure Cloud into AdvisorEngine. And that will likely include things like being able to populate AdvisorEngine onboarding data directly into Junxure, flowing AdvisorEngine account aggregation data perhaps through Junxure, tying Junxure workflows to events that occur at AdvisorEngine. Maybe even to push some CRM workflows into AdvisorEngine in the client portal. Because again, the whole point of AdvisorEngine is to be this central technology platform that the advisor uses to run their business, so the deeper the integrations, the more the potential for efficiency.

The caveat, though, is these are all developments that don’t help Junxure users. They help AdvisorEngine users and maybe Junxure users who decide to adopt AdvisorEngine. Now, it’s important to recognize this isn’t an either/or scenario, as though AdvisorEngine will only develop AdvisorEngine features or make Junxure Cloud better for Junxure users, they’ll almost certainly be working on both in parallel. Nonetheless, though, this is the problem with… we’ll call it strategic acquisitions of advisor software solutions like Junxure CRM.

AdvisorEngine didn’t just buy Junxure to make money on Junxure by trying to make Junxure bigger and better, they’re doing it to make AdvisorEngine bigger and better by having it integrating to Junxure as part of their platform. Which means even if Junxure software continues to be available and stand on its own, which I expect will be the case, just as eMoney is still available to all advisory firms even though Fidelity acquired it three years ago… but as with Fidelity and eMoney, expect to see the deepest integrations for AdvisorEngine going to Junxure, and a lot of the Junxure enhancements being the ones that help deepen its integration value with AdvisorEngine.

Which may be a little awkward for some of AdvisorEngine’s other partners. Thus far, the company has lauded itself as being open architecture, except then over the past 12 months it acquired its own goals-based financial planning software, and now it acquired its own CRM. Which makes it a lot less appealing for other software players in those categories to actually integrate with AdvisorEngine’s open architecture because it seems pretty clear about where they’re going to be putting their deepest integration resources. And it’s not with their open architecture partners.

I can’t entirely blame AdvisorEngine for this because the reality is that it’s really hard to create efficient streamlined workflows across lots of different disparate technology tools. That’s why you’re seeing so much advisor technology consolidate. Why Fidelity bought eMoney, why Envestnet has been acquiring left and right… It’s easier to deepen these integrations when you own all the components. And that’s I think what we’re seeing here, at least in part, with AdvisorEngine buying Junxure.

The Risk Of AdvisorEngine Acquiring Junxure CRM

At the same time, I think this also raises what I view is the most concerning part of this deal, of AdvisorEngine acquiring Junxure: That AdvisorEngine needs Junxure users to adopt AdvisorEngine for this to work out. Because the reality is that AdvisorEngine still has the clock ticking on the $20 million equity investment that WisdomTree made back in late 2016, for which after a full year, AdvisorEngine is only reporting about $3 billion in assets on their platform with 60 advisory firms. So even if we’re generous and we assume all those firms are paying AdvisorEngine’s top rate of 10 basis points, which I doubt, the company only has about $3 million of revenue so far. That’s not a good sign relative to the fact that they raised $20 million of cash over a year ago. The pressure on AdvisorEngine to bring more assets fast to justify their capital investment must be tremendous right now.

And that, I think, is the real reason why AdvisorEngine bought Junxure. Not just for the potential to make AdvisorEngine a more holistic platform by deeply integrating advisor with Junxure CRM to attract more advisory firms, but specifically to convert as many of Junxure’s 1,400 existing advisory firms over to AdvisorEngine.

In fact, in a kind of subtle emphasis to the point, when AdvisorEngine announced the Junxure acquisition this week, their press release specifically noted that Junxure has a total of 12,000 users and that those users manage $600 billion of AUM. Now, think about that for a moment. Junxure Cloud users pay $65 per month per user, Junxure desktop users pay $44 per month per user, why would a CRM acquisition quote the AUM of the firms that use the software beyond just quoting the user count? Because AdvisorEngine’s business model isn’t to get paid based on user count, AdvisorEngine gets paid based on assets running across the platform in basis points, right?

If AdvisorEngine can convert just 10% of that Junxure user and asset base, that $60 billion of AUM, which at AdvisorEngine’s 10 basis point pricing is a $60 million dollar revenue opportunity. Put that in context. Junxure reported 12,000 users, so the software cost somewhere between $44 and $65 a month, so if we kind of round it off to averaging $50 per month per user, Junxure CRM only had about a $7 million annual revenue run rate. AdvisorEngine makes $60 million of revenue just converting 10% of Junxure users to their platform. That’s the real key. AdvisorEngine didn’t just buy Junxure for the Junxure business, they bought it as a marketing channel to get direct access to the opportunity to convert 1,400 Junxure firms with $600 billion of AUM, and then they got the actual CRM software thrown in for some nice capabilities.

The problem, though, is I’m not certain how well this is realistically going to work out, because Junxure users tend to be deep financial planning firms. Greg Friedman’s firm is (Private Ocean). He built Junxure to serve his firm and then others like his. AdvisorEngine is an investment-centric platform with the client portal focused on investments and onboarding process focused on investment accounts. Because it’s not like AdvisorEngine onboarding data goes to actual planning software. They have no planning software integrations and their own internal financial planning light solution through Wealthminder that you can’t even turn off in the AdvisorEngine portal if you’re actually using third-party planning software like eMoney Advisor or MoneyGuidePro. And I’d be willing to bet that virtually every Junxure user is using some third-party financial planning software. eMoney, MoneyGuidePro, maybe newer tools like Advizr or RightCapital, and will not be satisfied with the limited capabilities of Wealthminder’s planning tools inside of AdvisorEngine.

So we have this real conflict and challenge that AdvisorEngine wants to get Junxure users to switch to AdvisorEngine, but Junxure users are financial planning-centric firms and AdvisorEngine is an investment-centric onboarding tool and portal with “financial planning light”.

Heck, for all the Junxure users on eMoney, I suspect that probably most of you are already using the eMoney portal with clients because that’s an actual financial planning software portal and probably won’t have any interest in switching to an AdvisorEngine portal. And even if you look overall, you know, 1,400 reported firms, $600 billion in reported assets, the average firm using Junxure is a sizable firm with a few hundred million in AUM already. That means they’re already probably using their own rebalancing software and won’t necessarily want to switch to Smartleaf with AdvisorEngine. They probably have their own trading processes infrastructure. They probably have their own existing portals that clients are used to. All of which makes it very difficult and time-consuming and stressful for a Junxure firm to switch to AdvisorEngine.

And of course, if AdvisorEngine can really deliver greater efficiencies, it can still make business sense for Junxure users to switch, right? Obviously, the whole point of adopting better technology in advisory business over time is that you switch to the tools that serve you better. And maybe, hopefully for their sake, AdvisorEngine can win over a few.

But even if AdvisorEngine can deliver some incremental efficiencies, there’s still this other dark cloud that looms… the fundamental challenge of AdvisorEngine’s business and pricing model. Unlike Junxure (and virtually every other advisor technology which prices in dollars per month or dollars per year, like a flat software fee), AdvisorEngine charges basis points. Starting at 10 basis points and then moving down as the firm grows.

Will Advisors Pay Basis Points For Advisor #FinTech?

Certainly understandable, the technology firms would want to charge on basis points, because charging based on AUM means your revenue automatically grows each year as the market grows. And there are very few other business models out there anywhere, in any industry, where you can grow revenue per client by a real rate of return above inflation just by keeping your clients and letting the markets do the revenue lifting work. That’s why advisory firms that run on the AUM model have grown so much more than commission-based firms, and that’s why technology firms want to charge basis points instead of just flat monthly or annual software fees.

But from the advisors’ perspective, paying for software price in basis points sucks because we don’t get any scalability out of it. The virtue of fixed cost advisor technology is that as our firms and revenue grow, our technology costs don’t have to. That’s why if you look at advisor benchmarking sites like the InvestmentNews study, the average small advisory firm spends 4% to 5% of revenues on technology, but large firms only spend 2% to 3% of revenue on technology, because as the firm grows, the fixed software cost become a smaller percentage. You can’t do that if your software providers charge you in basis points though.

And certainly not at AdvisorEngine’s levels. When the typical RIA only spends, you know, maybe 2% to 4% of revenues on all technology and a typical firm charges 1% on client assets and actually averages about 70 to 80 basis points on all assets, given breakpoints for affluent clients and such, typical advisory firm really only spends the equivalent of about 2 to 3 basis points of revenue on all their technology. And AdvisorEngine’s pricing starts at 10, and it doesn’t include full financial planning. And it still requires you to use outside rebalancing software, and it still doesn’t include all the other add-on tools that advisors need, like document management. Charging 10 basis points when a typical RIA charges 70 to 80 basis points of revenue yield on AUM means AdvisorEngine would essentially cost a typical advisory firm upwards of 15% of revenue when the typical firm only spends 2% to 4% of revenue on technology.

To be fair, if AdvisorEngine charged one basis point or two basis points akin to what a comparable flat fee would be, it’s perhaps somewhat more feasible, but then I’m not sure AdvisorEngine can make its projected numbers given WisdomTree’s big $20 million equity investment. And what’s to stop an advisor from just shifting their assets out of the AdvisorEngine ecosystem once the client is already on board it just to cut AdvisorEngine out of the basis point charge? You know, it’s not clear to me how AdvisorEngine even ensures that the advisor is reporting all their assets in the software so AdvsiorEngine can bill on them, especially planning-centric firms that are more likely to use something else for planning software, something else for a planning portal, who still keep actual client assets custody at an actual RIA custodian that offers its own technology, that will replace most or all of what AdvisorEngine does once the firm is really large and those basis point fees start adding up.

You know, as I’ve written in the past, this is the fundamental problem with advisor FinTech firms trying to be a platform business when they don’t actually control the platform because they don’t actually control enough custody of the assets. You know, the custody and clearing business may not be high margin, but at least those platforms know what the assets are. You can’t hide them because they’re custodians. They literally have custody of the money. And more importantly, they have ways to cross-subsidize their revenue by making money on the actual custody and clearing business while charging little or nothing for competing technology. And to the extent that basis points are paid, it comes from the transaction cost of the client, not off the advisor’s profit and loss statement. That’s the challenge with trying to run a custodian-like model generating basis points without actually being a custodian.

And so, if advisors continue to not be willing to pay basis points on tech or if AdvisorEngine can’t compete with platforms like Wealthscape that provide similar capabilities but it’s almost entirely free because Fidelity makes their basis points on the custody and clearing instead, then the question arises, what happens to Junxure in a year or a few if AdvisorEngine can’t convert all those Junxure users paying $44 to $65 per month per user into AdvisorEngine users paying 5 to 10 basis points? Because again, that’s what AdvisorEngine actually needs to do with this acquisition, not to justify the cost of the Junxure purchase but to justify the amount of capital that WisdomTree has already put into AdvisorEngine for the AdvisorEngine core business.

Now the good news is that Junxure is a viable CRM company on its own. It has real users, it provides real value, and has real value as a company. So even if this doesn’t work out, I think Junxure lands somewhere just fine. Frankly, I suspect RIA custodians like Fidelity and Schwab were probably both already interested in buying Junxure, along with maybe other companies making platform plays right now like Envestnet and Morningstar. So Junxure can and should survive just fine even if AdvisorEngine can’t convert Junxure users and doesn’t survive itself.

But nonetheless, the bottom line here is that while in the very near term Junxure users should see a big investment from AdvisorEngine, new Junxure features, particularly to finish getting all the Junxure desktop functionality up into Junxure Cloud, the real value of Junxure for AdvisorEngine is Junxure users, and getting them to pay basis points for AdvisorEngine technology. And it’s not at all clear to me that Junxure users will be willing to pay AdvisorEngine’s basis point pricing model or the technology is that much better, that they’ll be willing to abandon their existing tools that don’t cost basis points, or even if financial planning-centric Junxure users are the best fit for an investment-centric platform like AdvisorEngine in the first place. Although given that the terms of the deal were apparently almost all cash up front for the Junxure purchase, that’s primarily just a risk for AdvisorEngine at this point, and perhaps Junxure users will have to live with the long-term consequences.

Still, at a minimum, if you’re a Junxure user, I would expect some phone calls coming from the AdvisorEngine sales team in a couple of months here in 2018 making their case for consolidating more of your technology with Junxure-integrated AdvisorEngine. And we’ll see what happens and whether the sales team is compelling enough.

In any event, I hope this is helpful food for thought. This is Office Hours with Michael Kitces. Normally 1 p.m. East Coast time on Tuesdays, but I pushed back our Office Hours this week so we could talk about this big Junxure news. Thanks for joining us, everyone. Have a great day.

So what do you think? Will AdvisorEngine’s acquisition of Junxure lead to improvements for Junxure users? Is AdvisorEngine really just hoping to get Junxure users to adopt the AdvisorEngine platform? Would you consider paying basis points instead of a fixed fee for technology? Please share your thoughts in the comments below!


Volatility Drag And Its Impact On (Arithmetic) Investment Returns In Monte Carlo Analysis

Volatility Drag And Its Impact On (Arithmetic) Investment Returns In Monte Carlo Analysis

Executive Summary

In the investment world, it’s common to discuss average rates of return, both in a backward-looking fashion (e.g., to report investment results), and in a more forward-looking manner (e.g., to project the average growth rate of investments for funding future goals in retirement planning software). However, the reality is that because returns are linked to each other – the return in one year increases or decreases the available wealth to compound in the subsequent year – it’s not sufficient to simply determine an “average” return by adding up all the historical returns and dividing by how many there are.

Instead of this traditional “arithmetic mean” approach to calculating an average, in the case of investment returns, the proper way to calculate average returns is with a geometric mean, that takes into account the compounding effects of a series of volatile returns over time. Which is important, because in practice the geometric average return is never as high as its arithmetic mean counterpart, due to the fact that volatility always produces some level of “volatility drag”, which can be estimated by subtracting ½ of the investment’s variance (standard deviation squared) from its arithmetic return.

Fortunately, the reality is that most investment returns, as commonly discussed by financial advisors, are already reported as geometric returns, typically stated as either a Compound Average Growth Rate (CAGR), an annualized return, or some similar label. Which means, intended or not, most financial advisors already project future wealth values in a retirement plan using the (proper) geometric return assumption.

However, the variance drain on a sequence of volatile returns still matters when financial advisors use Monte Carlo analysis, which by design actually projects sequences of random volatile returns (based on the probability that they will occur) to determine the outcome of particular retirement strategies. Because the fact that volatility drag is already part of a Monte Carlo analysis means that the return assumption plugged into a Monte Carlo projection should actually be the (higher) arithmetic return, and not the investment’s long-term compound average growth rate. Otherwise, the impact of volatility drag is effectively counted twice, which can understate long-term returns and overstate the actual risk of the prospective retirement plan!

The good news is that some Monte Carlo software tools, recognizing that most financial advisors report returns using the industry-standard geometric averages, already adjusts advisor-inputted return assumptions up to their arithmetic mean counterparts. However, not all Monte Carlo software automatically makes such adjustments. Of course, in many cases, financial advisors may wish to use lower return assumptions in today’s environment, given above-average market valuations and below-average yields. Nonetheless, advisors should be cognizant of whether they are unwittingly entering lower-than-intended return assumptions into their Monte Carlo retirement projections, compounding geometric returns in a manner that double-counts the impact of volatility drag!

Understanding Arithmetic Vs Geometric Return Averages

The most common version of an “average”, taught to children in their early school days, is known as the “arithmetic average” or “arithmetic mean” – where the arithmetic mean is calculated by (arithmetically) adding up all the individual items, and dividing by how many there are. Thus, for example, the average number of students in class is calculated by adding up all the students in all the classes and dividing by the number of classrooms, the average height of students in the class is calculated by adding up the heights of everyone in the class and dividing by the number of students, and the average score on the math test itself is calculated by adding up all the exam scores and dividing by the number of exam takers.

The arithmetic mean is effective in situations where each of the items being measured is independent of one another. The height of one student does not have any impact on the heights of the other students, and the exam score of one test taker doesn’t have any relationship to the others (assuming no cheating, of course!).

By contrast, in the world of investment returns, the results of one year are related to the results of the next, because both are being compounded on a dollar amount that grows in year 1 (by the returns of that year) before being reinvested (or continuing to be held for investment) in year 2. As a result, a simple arithmetic return fails to capture the compounding effects that occur from a sequence of investment returns.

Example 1. For the past 10 years from 2007 to 2016, the S&P 500 has had the following annual total returns: 5.49%, -37.00%, 26.46%, 15.06%, 2.11%, 16.00%, 32.39%, 13.69%, 1.38%, and 11.96%. The cumulative sum total of these returns is 87.54%, which would produce an average annual return of 8.75% over the 10 year time period. Which means a $10,000 investment would have grown to $23,144.74 over the 10 year time period.

Except it turns out that an actual $10,000 investment in the S&P 500 over this time period would have grown to only $19,568.08. Because the fact that the first year’s return was 5.49% meant by year 2, there wasn’t $10,000 invested to experience the -37% decline, there was $10,549. And by the third year, there wasn’t $10,000 (again) invested to experience the 26.46% recovery, as the portfolio would have been down to $6,645.87. And by the fourth year, the 15.06% return would have been experienced on only the $8,404.37 balance from the end of the prior year. And so forth.

Arithmetic Average Return Versus Annual Return

In other words, the fact that each year’s return carries over to impact the balance being invested into the subsequent year means it’s not enough to merely add up the returns of each year and divide by how many there are, to determine the average rate of growth the portfolio actually experienced. Instead, the actual average return is somewhat lower, to account for the fact that there were both higher and lower returns that compounded along the way. This is known as the geometric mean, or the geometric average return.


The geometric average represents the average annual growth rate that would have generated an equivalent amount of final wealth with a straight line series of returns, even though the returns didn’t actually occur in a straight line. Also known as the annualized return, or something the Compound Average Growth Rate (CAGR), the geometric average return may not match the actual return in any particular year, but by definition, it will compound into equivalent cumulative wealth at the end of the time period. In the earlier example, the geometric return or CAGR would have been 6.94%.

Arithmetic Average Return Versus Actual Annual Return With Geometric Return

Volatility Drag: How Variance Drains Arithmetic Investment Returns

As shown in the example above, the geometric return was lower than the arithmetic average return, by about 1.81%, due to the fact that the compounded volatile returns with the early bear market never quite added up to what the straight line return would have been.

However, the reality is that this difference between arithmetic and geometric means isn’t unique to just this particular series of volatile returns with a bear market. In point of fact, any level of ongoing volatility will cause the geometric average to lag its arithmetic mean counterpart.

Example 2. Over the past 10 years (from 2007-2016), the annual returns of the Barclays Aggregate Bond index have been 6.97%, 5.24%, 5.93%, 6.54%, 7.84%, 4.21%, -2.02%, 5.97%, 0.55%, and 2.65%. Cumulatively, those returns add up to 43.88%, which would give the Barclays Aggregate Bond index an average annual return of 4.39%, and compound a $10,000 investment up to $15,364.05. However, in reality a $10,000 investment into this sequence of Barclays Aggregate Bond would have compounded to “just” $15,301.19, which is a geometric mean, or a compound average growth rate, of just 4.35% (not 4.39%).

Notably, in this example, the geometric average return was only very slightly lower than its arithmetic mean counterpart. Nonetheless, the fact remains that even with a less volatile sequence, that had only good compounding returns up front, the geometric mean was still lower.

The inevitable gap between the arithmetic mean and the geometric average return is often called “volatility drag”, because mathematically, the more volatile the returns are, the more of a gap there will be. Although the exact amount of volatility drag will vary by the exact sequence of returns and amplitude of the volatility, it can be approximated by subtracting ½ of the variance from the arithmetic mean (where Variance is the Standard Deviation squared, or conversely Standard Deviation is the square root of Variance).

Example 3. Continuing the prior examples, the standard deviation of the S&P 500 return series was 18.86%, which equates to a variance of 3.56%. On the other hand, the Barclays Aggregate Bond returns had a standard deviation of 3.12%, or a Variance of 0.10%. Accordingly, this implies that with an arithmetic average return of 8.75% on the S&P 500, the geometric return would be 8.75% – 3.56% / 2 = 6.97%, which is quite close to the actual geometric mean of 6.94%. Similarly, the Barclays Aggregate Bond had an arithmetic return of 4.39%, which would be reduced by 0.10% / 2 to an estimated geometric mean of 4.34%, which is very close to the actual geometric mean of 4.35%.

In practice, the estimation of the geometric mean from its arithmetic counterpart and the standard deviation (and variance) may not perfectly align, because a limited set of data points may not perfectly conform to the underlying normal distribution on which this formulaic assumption is based. Nonetheless, as shown in the examples above, it is typically very close – in this case, within 3 basis points for the geometric return of a 10-year series of stock returns, and within 1 basis point for the geometric average of the 10-year bond returns.

Retirement Projections And When To Use Arithmetic Vs Volatility-Drag-Adjusted Geometric Return Assumptions

While the impact of volatility on compounded arithmetic return is often called a “volatility drag” or a “variance drain” that reduces returns to arrive at a (lower) geometric average return, the reality is simply that the arithmetic mean is an inaccurate way to describe long-term compounded returns in the first place. Because it was never actually meant to describe the average of a series of interrelated “compounded” returns in the first place; it was/is intended to quantify the average of an independent series of data points.

Fortunately, in practice virtually all “returns” that are discussed in the context of investments are already based on the geometric mean. Whether it’s a Compound Annual Growth Rate (CAGR), or discussing the annualized returns. And both time-weighted and dollar-weighted returns are inherently measures of the compound rate of growth in a portfolio.

However, the fact that returns, as typically discussed, are based on geometric returns, means that financial advisors must still be cautious in how they translate rates of return into appropriate assumptions to use in forward-looking retirement projections.

Fortunately, when doing a traditional “straight-line” retirement projection, that estimates future wealth based on some average annual compound growth rate (and ongoing contributions or withdrawals), the geometric return is the appropriate return to use. As by definition, the geometric average return is the return that would produce the correct compounded dollars at the end of the time period.

However, when it comes to Monte Carlo assumptions, the proper return assumption is the arithmetic mean, not the geometric average return. The reason is that the whole point of Monte Carlo analysis is not just to estimate the straight line return to reach final wealth, but to actually project the results of a series of randomly drawn (and therefore volatile) returns based on the probability that they occur.

In other words, the gross (arithmetic) average returns that are plugged into a Monte Carlo analysis will automatically be reduced to the equivalent geometric returns in the process of projecting annual volatility. Which means if the geometric average return is the starting assumption, along with a standard deviation volatility assumption, and then a random series of Monte Carlo returns are drawn based on that underlying volatility, the end result will be retirement projections whose geometric returns are lower than intended.

Example 4. Jeremy is running a 30-year retirement projection for a 65-year-old client, where stocks are assumed to have an average annual growth rate of 10%, and bonds are assumed to grow at 5%, consistent with their long-term 90-year historical return levels. The standard deviations are assumed to be 17% and 5%, respectively. If these assumptions – of 10% returns and 17% standard deviation for stocks, and 5% returns and a 5% standard deviation for bonds – are plugged into the Monte Carlo analysis tools, the final geometric returns (due to volatility drag) will be approximately 8.56% for stocks and 4.75% for bonds (or slightly higher once a small positive impact for rebalancing is also included). Except, as just noted, the long-term geometric returns for stocks and bonds were supposed to be 10% and 5%, not 8.56% and 4.75%!

In order to achieve a Monte Carlo analysis where the final geometric return is consistent with the desired long-term averages, Jeremy should have gone back to the original data to calculate the (higher) arithmetic average on which the returns were based, or alternatively just increased the return assumptions by ½ of the variance to estimate the original arithmetic return. This would have produced an assumed (arithmetic) return of 11.45% for stocks, and 5.25% for bonds… such that, after including the impact of volatility drag, the final returns would have ended out at approximately 10% for stocks and 5% for bonds.

And notably, the cumulative impact of this difference is substantial. If the client had a 50/50 portfolio, the client’s long-term compounded returns would be only 6.65% (or slightly higher with a small potential rebalancing bonus), whereas they should have been 7.5%, which means the impact of volatility drag turns into a 0.85% reduction on actual long-term compounded returns.

In turn, this means that if Jeremy had planned to take a 5% initial withdrawal rate, a proper Monte Carlo analysis (based on historical arithmetic means) would have had an 87% probability of success (and the proper long-term compounded return), but one that used the geometric return upfront (as though it was an arithmetic mean, even when it isn’t!) would have only an 76% probability of success (with a long-term return substantially below what the geometric return was supposed to be)!

Projected Wealth Utilizing Geometric Mean Versus Arithmetic Mean

As the graphic above shows, when geometric returns are used as a Monte Carlo input, the final results produce lower returns than intended, resulting in a higher probability of failure, as the projection effectively double counts the impact of volatility drag. Because geometric returns already include volatility drag, and using geometric returns in a Monte Carlo projection just adds a second layer of volatility drag, when the software (re-)projects the future impact of volatility. By contrast, when arithmetic returns are used as the assumption up front, the final results are consistent with the geometric returns expected in the end anyway.

Of course, in today’s environment with high market valuations and low yields, many financial advisors may wish to use below-historical-average returns when projecting a retirement plan. Nonetheless, projecting reducing returns should be the result of an intentional desire to reduce returns, not a “lucky result” of mistakenly inputting geometric returns into a tool intended to calculate using arithmetic return assumptions.

On the other hand, the reality is that some Monte Carlo software tools already increased geometric returns to their arithmetic counterpart behind the scenes – using a version of the approximation noted above – recognizing that arithmetic returns are the proper assumptions, but that most financial advisors by default discuss and use geometric returns. Which means the software may actually be projecting correctly – having adjusted for the advisor’s default (geometric) return assumption. But at a minimum, it’s crucial to clarify, for any particular Monte Carlo retirement projection, what return assumptions are actually being used, and whether it is the (proper) arithmetic return being iterated on in the random Monte Carlo return draws.

The bottom line, though, is simply to recognize that there is an important difference between arithmetic and geometric return assumptions, both in the general case of describing and explaining returns (and the role of volatility drag), and especially given the unique effect that variance drain can have on Monte Carlo projections in particular… which makes it especially important to input the right version of a return assumption up front when projecting a retirement plan!

So what do you think? What are the return assumptions that you use in a retirement plan? Are they based on arithmetic or geometric average returns? Are you going to adjust your return assumptions going forward? Please share your thoughts in the comments below!

First Look At CFP Board’s Revised Proposal For Professional Standards Of Conduct

First Look At CFP Board’s Revised Proposal For Professional Standards Of Conduct


Beginning with the CFP Board’s formation of the Commision on Standards back in late 2015, the CFP Board has been in the process of updating our Standards of Professional Conduct for CFP certificants for the first time since 2007. After an 18-month process, in early summer of this year, the Commission on Standards released its first proposal of the new Standards of Professional Conduct. Due to the complexity of adopting new standards for nearly 80,000 CFP professionals, the CFP Board put the newly proposed standards out for a 60-day comment period. During that time, the CFP Board received a lot of feedback (over 1,300 public comment letters), which was incorporated into a newly revised version of the Proposed CFP Standards of Professional Conduct. Yesterday, December 20th, the CFP Board released the 2nd version of these proposed standards, and announced that a second comment period will open on January 2nd and run for 30 days, until February 2nd of 2018.

In this week’s discussion, we look at at the changes made in the 2nd version of the Proposed CFP Standards of Professional Conduct, including the things the CFP Board got right in the revisions, some things they unfortunately walked back on, and some areas of focus for those drafting comment letters for the second comment period beginning on January 2nd of 2018.

First and foremost, when you subject a 17-page standards document to 1,300 hundred public comment letters, there are a lot of small tweaks that get made. Fortunately, the CFP Board is taking feedback seriously and should be commended for this. In the latest revision, important adjustments include: clarification was provided to the gifts and other “benefits” CFPs cannot receive from clients if it will compromise their objectivity; the requirement that CFP professionals cannot use the term “fee-based” to imply they’re fee-only was expanded to stipulate that CFPs cannot use any other not-fee-only term to imply they are fee-only either; clarification that salary-based advisors who receive bonuses for product sales must still disclose this compensation as sales-related; and a new exclusion allowing advisors who use TAMPs to not run afoul of the  fee-only rules simply for outsourcing investment management functions. Overall, these are good and reasonable changes.

However, there are a few areas in the new revised Standards of Professional Conduct that are more concerning. The first is that under theoriginal proposal, the CFP Board significantly expanded the disclosure requirements for CFP professionals. Not only at the time the client engages the advisor, but also with a new “Initial Disclosure Information” document that would have to be provided to prospects, detailing the nature of the CFP professional’s services, a description of how they are compensated, and a summary of their conflicts of interest (basically an RIA’s Form ADV Part 2). But here, the broker-dealer community pushed back very hard in their comment letters, claiming that this new initial disclosure requirement would simply be too onerous for them. Which, in reality, really is hard to supervise, as this kind of upfront information document would likely itself be treated as “advertising” communication with the public under FINRA Rule 2210. And so the CFP Board backed off the upfront disclosure requirement, albeit while still keeping the requirement for disclosure at the time the client actually engages the CFP professional. Overall, it’s very unfortunate that the CFP Board backed off this initial disclosure requirement, but understandable, as higher standards do need to be administratively feasible.

The other, perhaps more concerning change that came through under the revised Standards of Professional Conduct, is a shift in the presumption of when a CFP professional is actually doing financial planning or not. This distinction has actually been a major issue under the CFP Board’s Standards of Conduct for a long time. Under the currentrules, there is effectively a “loophole” that allows CFP professionals to escape their fiduciary duty under the CFP Board’s Standards, because the current rules state that a CFP professional only has a fiduciary duty to clients when doing financial planning or material elements of financial planning (which meant CFP professionals could avoid their fiduciary obligation by just not actually doing financial planning). Accordingly, it was a big deal that under the new Standards of Professional Conduct the new rule would become “fiduciary all the time” as a CFP professional, with a presumption that any time a CFP professional engages with clients, they are doing financial planning (unless proven otherwise). In the revised standards, though, the CFP Board has dropped this rebuttable presumption. As it stands, all CFP professionals will still be fiduciaries when providing financial advice – which includes product sales – but there’s no presumption that they’re actually doing financial planning just because they’re CFP professionals (which means they don’t have to adhere to the full Practice Standards for delivering financial planning). As a result, there are now basically have two types of CFPs: those who provide financial planning advice, and those who provide non-financial-planning financial advice and don’t have to adhere to the Practice Standards for financial planners. Confusing? Exactly.

In other words, all marketing to the contrary, the CFP Board’s revised standards are effectively telling the public “it’s not even safe to assume that engaging a CERTIFIED FINANCIAL PLANNER professional for financial advice will result in any actual financial planning.” Which is problematic both for the weakened consumer protection, and the fact that it’s not even clear how to apply a fiduciary duty to non-financial-planning financial advice, or what standards such a CFP would be held to.

If you agree that this is concerning as well, I hope you’ll submit a public comment letter next month. The point is not that every CFP professional must do financial planning for every client, but to emphasize to the CFP Board that when a CFP professional holds out to the public as a CFP, that the consumer should be able to safely assume they will be getting financial planning subject to the full standards that apply to financial planning, unless a clear advisory agreement and scope of engagement stipulates otherwise and the CFP professional clearly discloses this is notfinancial planning advice. Otherwise, the CFP marks risk simply becoming a misleading marketing label that implies to consumers a breadth of financial planning expertise and advice that the CFP Board doesn’t actually require of those CFP professionals in the first place.

Changes In The 2nd Version Of The Proposed CFP Standards Of Professional Conduct

First and foremost, when you subject 17 pages of professional standards to 1,300 public comment letters, you’re going to get a lot of small tweaks, which I actually think is good. I wish the CFP Board would put all of their proposed changes to any of the four E’s, so the experience requirement, the exam requirement, the educational requirement, and the ethics requirement through this process and not just changes to the ethics and standards of conduct. Because feedback like this helps catch both small mistakes and unintended consequences.

And so, in this context, there were a lot of small tweaks made. The requirement that a CFP professional may not accept gifts or other benefits from clients if it will compromise their objectivity was clarified. That means a gift, a gratuity, entertainment, any other non-cash compensation.

There was a requirement that CFP professionals not use the term “fee-based” to imply they’re fee-only if they’re not, and it was expanded to stipulate the CFP professional can’t use “fee-based” or any other not fee-only term that might imply or sounds like fee-only. Which I think was important because as I pointed out in my own comment letter, if all the CFP Board did was crackdown and say, “You can’t use the fee-based label,” it would just lead advisors to make up other new terms, fee-oriented, fee-compensated, fee-for-service, that might still really actually be fee and commission model. So in the second version of the standards, it’s much clearer. You can’t imply you’re fee-only if you’re not.

Now, the CFP Board notably isn’t limiting the use of commissions at all. This is not about a compensation bias of the CFP Board, this is a truth in advertising requirement. That you have to accurately state your compensation whatever it is, and, you know, the word “only” in “fee-only” has a kind of a specific meaning. So the CFP Board is just making sure that advisors are clear about their descriptions.

Some other notable changes in the compensation area, in particular, was a clarification that even salary-based advisors who receive bonuses for product sales have to still disclose that as sales-related, i.e., commission compensation, because they’re getting bonused. It’s basically the equivalent of a commission. Although other internal revenue-based compensation for fee-only firms is fine as long as they’re essentially revenue-sharing of fees.

And also a new provision that would allow advisors who use third-party TAMPs (turnkey asset management platforms), to collect and remit their fees without running afoul of the fee-only rule just because they outsource investment management to a third-party provider, instead of hiring a CFA internally to run their models.

A couple of other notable changes include the documentation requirements for CFPs were clarified and simplified a little, including some of the reporting requirements back to CFP Board. Under the existing rules, anytime you have a regulatory infraction you need to tell the CFP Board, now they reasonably exclude minor rule violations if it was a less than $2,500 fine. They clarified what constitutes family and common control business entities under the related party rules for those who might have been shifting compensation from one entity to another.

Overall, I think these are all good and reasonable changes. There were maybe a few that still need to be refined further. For instance, at the point the CFP Board says any not fee-only label has to disclose that someone receives fees and commissions, I don’t know why they don’t just say the required categories are either fee-only or commission and fee and even talk about fee-based and all. Let’s just define clear categories. But most of these new revisions I think are a positive step forward and a good example of how a rulemaking process can actually go well, when you open up for public comments and feedback.

Reduced Upfront Disclosure Requirements As A Concession To Broker-Dealers

All of that being said, I do want to highlight a few areas in the new revised Standards of Professional Conduct that I think are more concerning. The first is that under the original proposal, the CFP Board proposed that there would be expanded disclosure requirements for CFP professionals, not just when the client engages the advisor, but also with what was called a new initial disclosure information document that would have to be given to prospects detailing the nature of the CFP professional services, description of how they’re compensated, and a summary of their conflicts of interest, which should sound familiar because that’s basically what an RIA’s Form ADV Part 2 requires now.

And in fact, the proposal explicitly stated that a properly completed and delivered Form ADV Part 2 would satisfy this requirement for the client. And so the CFP Board had gone further and said, well, basically that means RIAs will comply with this with Form ADV Part 2, and for non-RIAs (i.e. the broker-dealer community), they would need to use something substantively similar, and that the CFP Board was going to make a model template that broker-dealers could use.

But here the broker-dealer community pushed back really hard in their comment letters, both directly and through their lobbying organizations like FSI and SIFMA claiming that this new initial disclosure requirement, in particular, would be too onerous for them. After all, just the reality is most RIAs make this disclosure one or two or three advisors at a time since most of us in the RIA community are small, even large RIAs have maybe a few dozen advisors and typically operate under a standardized structure for which you can have one standardized Form ADV Part 2.

If you’re a broker-dealer, though, you may have hundreds or thousands of advisors on your platform. If you’re an independent broker-dealer, each of them could have a different business model and services and disclosure document, which is really hard to supervise if you’re a broker-dealer. Especially because this kind of upfront information would likely itself be treated as advertising communication with the public under FINRA Rule 2210, which means the broker-dealer would have a duty to engage in compliance oversight of every unique CFP disclosure document for every registered rep that had the CFP marks, which is a really challenging cost layer.

And while I’m all for clear disclosures, it is a practical reality that there are advisors in RIAs and there are advisors at broker-dealers, and while RIAs may already have the systems in place for these kinds of upfront disclosures because we’re already required to produce Part 2 of Form ADV, broker-dealers don’t have this in place. And it’s tough for the CFP Board to require something that even the SEC and FINRA don’t require in the broker-dealer community right now.

As a result, the CFP Board backed off this upfront disclosure requirement and simply said that, at the time of engagements, all disclosures will still exist and they’re going to create a model pre-engagement disclosure that can be used voluntarily by broker-dealers but won’t be required of all CFP professionals. And all of the remaining disclosures that were going to be in that initial disclosure…regarding the description of services, how the advisor will be compensated, etc., gets moved to the time of engagement disclosure along with a clarification that CFP professionals providing financial planning have to clearly define the scope of their planning engagement.

Overall, I think it’s very unfortunate that the CFP Board backed off this initial disclosure requirement, but I do understand it. From a practical perspective, CFP certification is a voluntary designation, its standards are voluntary, that means they can be over and above the minimum regulatory requirements, but they still have to be administratively feasible to comply with those higher standards. And arguably, this upfront disclosure requirement was one that would create legitimate challenges for large non-RIA firms. In part, because of the conflict that what is disclosure for CFP Board purposes is actually advertising for FINRA purposes. And that’s the problem with having advisors subject to all these different regulators and standards as we are. Hopefully someday we’ll simplify that process and then perhaps upfront disclosures can be revisited, but for now, we can at least be satisfied the disclosures are required at the time that the CFP professional is actually going to engage the client.

CFPs Professionals Are Always Fiduciaries But Not Always Financial Planners?

Now, one other thing that came through under the revised standards of conduct that I do think is actually a little bit more concerning is a shift in the presumption of when a CFP professional is actually doing financial planning or not. This distinction between CFPs who do financial planning and those who don’t has actually long been a major issue under the CFP Board’s standards of conduct. Under the current rules, even as it exists today, there’s effectively a loophole that allows CFP professionals to escape their fiduciary duty under the CFP Board standards because the current rules state that a CFP professional only has a fiduciary duty to clients when doing financial planning or material elements of financial planning, which means basically you can put “CFP” on your business card, say you’re a financial planner, sell whatever you want, and then have no fiduciary duty to clients as long as you say, “Oh no, I wasn’t actually doing financial planning, I was just selling a product,” even though you were marketing yourself as a Certified Financial Planner.

In other words, the fiduciary duty for CFP professionals didn’t apply because you were being a CFP, you had to be doing financial planning. And this difference in fiduciary duty between doing planning versus being a CFP professional was viewed, appropriately, I think, as a loophole in the CFP Board’s current standards. And so it was a big deal this summer when the new Standards for Professional Conduct were released because the new rule became fiduciary at all times as a CFP professional. As long as you have the marks and you provide any kind of financial advice, which, as we noted earlier, is very broadly construed to not just doing planning, but anytime you make any kind of recommendation on any financial services product, all CFP professionals would be a fiduciary.

In addition, the CFP Board introduced a rebuttable presumption that anytime a CFP professional was engaged by a client, it is presumed that they’re doing financial planning and would have to adhere to the six-step, now seven-step financial planning process and Practice Standards unless they can prove that they were not doing financial planning. Now, this matters because in the revised standards, the second edition that just came out, the CFP Board has dropped this rebuttable presumption. So as it stands, all CFP professionals will still be fiduciaries when providing financial advice, which includes product sales, but there’s no presumption that they’re actually doing financial planning just because they’re CFP professionals, which means they don’t have to adhere to all the rest of the Practice Standards when delivering financial planning. Which I think is a problem.

The objection of this provision and the reason why it was dropped is that there are a lot of CFP professionals who don’t actually do financial planning with all of their clients or even with any of their clients, and they didn’t want to have a presumption that every client working with them as a CFP professional would get financial planning when not every client working with the CFP professional is getting financial planning. Except that’s the problem.

There are so many CFP professionals using the CFP marks and holding out to the public as Certified Financial Planners without actually doing financial planning or being accountable for it, which creates a lot of confusion for consumers. Basically the CFP Board is telling the public, “The CFP mark is the gold standard for financial planning advice, but don’t presume that you’re going to get financial planning from a CFP just because you hire one,” especially since there’s no upfront disclosure requirement to clarify whether you’re going to be getting financial planning advice from your CFP or not.

In fact, even under the revised standards, someone who’s providing what’s basically non-financial planning financial advice doesn’t even need to define and clarify the scope of their engagement as excluding financial planning advice. So it’s fine to say you’re a CFP professional, which implies you’re going to give financial planning advice, then not actually give any financial planning advice, and then not be responsible for the fact that you said you were a CFP but skipped the entire financial planning process. Basically, we’re going to end up with two types of CFPs: CFPs who provide financial planning advice and CFPs who provide non-financial planning financial advice and therefore don’t have to adhere to the Practice Standards for financial planning.

Now, you might be asking, “What’s the difference between financial planning advice and non-financial planning financial advice?” Exactly, confusing, isn’t it? If you look at the CFP Board’s definition of financial advice, it’s basically developing a financial plan, giving advice on buying or selling products, or managing portfolios or identifying third-party managers. So when you strip out the financial planning part basically what you’re left with is selling products and managing portfolios is non-financial planning financial advice. Where you can hold out as a CFP professional to gain the client’s trust not give any financial planning advice, and then have no accountability for not doing financial planning while you sold the product or managed the portfolio, even though that’s probably what the client was expecting when you wrote “CFP” on your business card, right?

We don’t waive the standards for doctors who provide non-medical health advice, we don’t waive the standards for CPAs who provide non-accounting financial advice, but we’re waiving the standards for CFPs who provide non-financial planning financial advice. And under these standards, again, there’s not even a requirement that this limited scope of engagement be disclosed to the clients, although maybe at least that’s a loophole we can close with the final revision.

All of these CFP professionals, including those who provide non-financial planning financial advice, will still be subject to a fiduciary standard, but frankly, I don’t know how the CFP Board intends to enforce that when there are no Practice Standards or any existing case law to explain how you apply a fiduciary duty to non-financial planning financial advice. I mean, this is a horrible can of worms that the CFP Board is opening for itself, at the same time it’s allowing salespeople to continue to market themselves as Certified Financial Planner professionals while not doing any actual financial planning. Which I think is horribly confusing and misleading to the public.

The point here is not literally to say every CFP professional should always have to do a comprehensive financial plan for every client, because not every client wants or needs a full scope financial plan, but the presumption that a CFP professional is doing a financial plan, unless proven otherwise, and a requirement that there’ll be a written scope of engagement to clearly define when the CFP professional is not doing financial planning, is basic consumer protection. Otherwise, the CFP Board is just encouraging misleading advertising for people to use the CFP marks to say they’re a financial planner and then not do financial planning.

First Look At CFP Board’s Revised Proposal For Professional Standards Of Conduct

Ultimately, this is where I intend to focus at least my public comment letter when the second comment period opens up on January 2nd. And if all of you agree this is concerning, I hope that you’ll submit a public comment letter as well. Not to say that every CFP professional must do financial planning for every client, but to emphasize to the CFP Board that when a CFP professional holds out to the public as a CFP, the consumer should be able to safely assume they’re going to be getting financial planning to the full standards that apply to financial planning unless a clear agreement stipulates that they’re not and the CFP professional discloses, “This is not financial planning advice.” In other words, this is both a disclosure issue and an issue of the presumption of planning when you hold out as a CFP professional in the first place.

In the meantime, for those you want to check out the full revisions to the proposed Standards of Professional Conduct, the CFP Board actually did a really good job providing a lot of detail on not just the revised proposal, but a redline version of the revisions between prior versus current… and a side-by-side document showing all the changes comparing the now proposed standards versus the ones that exist today. The 30-day comment period itself opens up January 2nd, in just a week and a half. You can submit comments directly on the CFP Board’s website, or you can email them to: And I hope all of you will!

I hope this is food for thought around this first look at the new Standards of Professional Conduct that, once implemented, are going to guide our obligations as CFP professionals for many years to come. The good news is that the fiduciary standard remains, but the bad news is that the detail still matter in how it’s defined, when it’s applied, the standards that are used to evaluate fiduciary conduct if an enforcement action comes, and the manner in which it’s enforced.

So I hope you’ll all take your time to submit your own public comment letter and state your views and how you think this should work in the future. You know, for all of you that still have concerns about CFP Board, it’s not a reason to drop your CFP marks. It’s a reason to get involved, including and especially in moments like this, and submit your comments so they’re heard. The CFP Board is reading them.

So what do you think? Are the revised Standards of Professional Conduct an improvement over the first draft? Are there things the CFP Board still needs to improve? What will you focus on in your comment letter to the CFP Board? Please share your thoughts in the comments below!












President Trump Signs Tax Cuts & Jobs Act Of 2017

President Trump Signs Tax Cuts & Jobs Act Of 2017

After a tumultuous process of drafting tax legislation, including a last-minute change to comply with Senate rules, today President Trump signed into law the Tax Cuts and Jobs Act of 2017 (TCJA), in what most are hailing as the most significant tax overhaul in decades. In practice, the primary focus of true tax reform – sweeping changes and simplification – was for corporations, which had their rates cut to just 21% (down from 35%), along with a repeal of the AMT, in an attempt to encourage especially global US-based businesses to bring their profits back home and reinvest into the US. For individuals, the new legislation was less “sweeping reform” (and the simplification that usually comes with it), and more of a series of tweaks and adjustments, which will produce new tax planning opportunities for years to come.

An expansion of the Standard Deduction, combined with a cap on the deduction for state and local taxes, a reduction in the amount of mortgage debt for which interest can be deducted (down to $750,000 of debt principal, and home equity indebtedness no longer applies), plus the repeal of miscellaneous itemized deductions, means that less tax planning will likely happen in the realm of itemized deductions in the future (with as many as 90% of households projected to just claim the Standard Deduction going forward). However, the introduction of a new “pass-through business deduction” that allows S corporations, partnerships, LLCs, and even sole proprietorships to claim a 20% “qualified business deduction” will lead to an array of new tax planning strategies, especially since while the new QBI deduction is not allowed for “specified service businesses” (including doctors, lawyers, accountants, and consultants), it is permitted for those who have less than $157,500 of taxable income (or married couples under $315,000), which creates a lot of appeal for forming small businesses (and even reshaping existing employee relationships into independent contractor status instead).

Of particular note for financial advisors will be the potential for the new QBI deduction to apply to them (as financial advisors are also a “specified service business”, which means the deduction will phase out for advisors at higher income levels), the fact that the repeal of miscellaneous itemized deductions means that investment advisory fees are no longer deductible by clients, and the loss of Roth recharacterizations of prior Roth conversions (which limits a number of proactive Roth tax planning strategies). On the other hand, the rule that would have required all investors to report investment sales on a FIFO basis – which initially created a significant uproar amongst financial advisors who would lose the ability to do tax loss harvesting with many clients – was not included in the final legislation.