Tag: Financial Advisory

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

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


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

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

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

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

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

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

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

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

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

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

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

Narrowing The Definition Of “Family Member”

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

However, “Family Member” is simply defined as:

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

In practice, this raises numerous questions.

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

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

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

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

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

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

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

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

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

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

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

Financial Advice Outside The Scope Of A Financial Plan

In the glossary, Financial Advice is defined as follows:

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

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

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

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

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

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

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

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

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

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

New Issues Created By Proposed Compensation Disclosure Rules

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


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

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

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

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

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

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

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

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

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

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

Reasonable safe harbors to further modify this rule might include:

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

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

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

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


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

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

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

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

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


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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

Limiting An Advice Engagement To A Compensated Engagement

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

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

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

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

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

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

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

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

What Does It Mean To “Manage” Conflicts Of Interest

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

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

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

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

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

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

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

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

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

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

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

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

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

Anonymous Case Histories And Setting Precedents For Reasonableness

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

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

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

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

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

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

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

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

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

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

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

– Michael Kitces

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

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

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

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


4 Ways Financial Advisors Can Benefit From Finding Their Flow State

4 Ways Financial Advisors Can Benefit From Finding Their Flow State

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

The Stock Market Still Seems to Believe the Fed

The Stock Market Still Seems to Believe the Fed

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

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

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

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

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

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

How To Avoid A Sudden Increase In Medicare Costs

How To Avoid A Sudden Increase In Medicare Costs

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

The Impact Of Early Retirement On Projected Social Security Benefits

The Impact Of Early Retirement On Projected Social Security Benefits

Executive Summary

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

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

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

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

Calculating The Income Replacement Rate For Social Security Benefits

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

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

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

Social Security Replacement Rates Based On Highest 35-Years Income

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

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

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

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

How Social Security Benefits Are Projected At Retirement

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

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

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

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

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

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

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

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

The Impact Of Early Retirement On Calculated Social Security Benefits

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

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

Retiring Early From Declining Income Below The Highest 35 Years

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

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

Hypothetical Lifetime Inflation-Adjusted Earnings Included In Social Security AIME

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

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

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

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

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

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

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

Retiring Early Before 35 Years Of Work History

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

How Projected Social Security Earnings Replace Existing Low Earning Years

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

Planning For The Impact Of Early Retirement On Social Security

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

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

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

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

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

Social Security Wage Indexing Factors (1958-2017)

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

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

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

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

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

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

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

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

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

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

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

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

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

Executive Summary

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

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

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

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

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

How Much Do Financial Advisors Charge As Portfolios Grow?

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

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

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

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

Comparison Of Financial Advisor Fee Levels By Portfolio Size

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

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

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

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

Median AUM Fee Schedules Based On Portfolio AUM

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

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

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

Advisor Use Of Investment Products With Clients Over Time

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

Average Blended Expense Ratio Of Investments Used By Financial Advisors

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Breakdown Of Typical Financial Advisor's All-In Costs

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

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

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

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

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

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

All-In Fee Component Susceptibility To Financial Advisory Fee Compression

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

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

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

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

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

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

Executive Summary

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Can You Sell An Advisory Firm Named After The Founder?

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

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

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

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

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

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

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

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

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

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

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

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