Tag: Insurance, Financial Planning

Differentiating The Next Generation Of Financial Planning Software

Differentiating The Next Generation Of Financial Planning Software

Executive Summary

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

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

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

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

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

The Evolutionary Progression of Financial Planning Software

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

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

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

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

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

The Progression Of Differentiation In Financial Planning Software

Real Financial Planning Software Differentiators Of The Future

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

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

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

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

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

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

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

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

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

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

Potential Disruptive Differentiators For Next Generation Of Financial Planning Software

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

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

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

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

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

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

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

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

MetLife Cutting Annuity Trails To Some Of Its Former Advisors

MetLife Cutting Annuity Trails To Some Of Its Former Advisors

When MetLife sold its Premier Client Group last year to Mass Mutual, a number of its registered representatives decided to leave and join other broker-dealers leading up to or in the aftermath of the deal. But now, Mass Mutual has announced that any MetLife brokers who left the company to join other broker-dealers will see their asset-based trails on five MetLife variable annuities and 11 fixed MetLife annuities reduced by a whopping 73%, down to just 27bps (from their normal 100bps trail). The change not only raises substantial questions about where the rest of the trail is now being paid – is it going to be rebated to the client, or will it simply line the pockets of the firm – but also raises troubling concerns about whether it will set a precedent for other insurance and annuity companies to arbitrarily cut trail payments for advisors who leave the insurance company’s broker-dealer, especially as a growing number of insurance companies have been cutting their broker-dealer units loose with the DoL fiduciary rule looming (from AIG selling Advisor Group, to MetLife selling Premier Client Group, and mostly recently Jackson National selling NPH).

The Five Points That Belong On Every Advisor’s Website

The Five Points That Belong On Every Advisor’s Website

The average consumer faces what Bob Veres calls “The Jaffe Dilemma”, after finance columnist Chuck Jaffe who once observed years ago how two advisors can both charge the same 1% AUM fee for the same portfolio and provide substantively different services (e.g., one provides comprehensive financial planning and ongoing portfolio management, and the other “just” delivers portfolio management using buy-and-hold index funds). Veres notes that across the entire financial planning profession, advisors offer as many as 13 different categories of service, from college planning to retirement planning to estate planning, cash flow and budgeting, insurance, and more… which might cumulatively add up to far more value than an advisor who “just” manages a portfolio for the same fee. Accordingly, Veres urges advisors to clarify both their costs, and their value, in their website marketing, with five key elements: 1) list your fee schedule, so people clearly understand what they’ll be paying (because like it or not, most want to know up front!); 2) list the services that you (or your firm’s advisors) provide for your compensation, so it’s clear what you do (and how much you actually do!); 3) try to give prospects an idea of the potential dollar value of the value that you provide, since the truth is that most clients have any idea what rebalancing is worth, or the true benefit of tax loss harvesting, not to mention the more complex forms of value an advisor provides; 4) share stories about clients who had been managing their own affairs, and how you are now helping them as a central hub to keep them organized and provide them ongoing advice (as while you can’t use testimonials, you can share anonymous “case study” examples to demonstrate and explain your value!); and 5) explain how clients should compare fees between what they pay to other advisors versus you (including what they may not even realize they’re paying!).

Why Paying Yourself 5% Interest On A 401(k) Loan Is A Bad Investment Deal

Why Paying Yourself 5% Interest On A 401(k) Loan Is A Bad Investment Deal

Executive Summary

Borrowing money has a cost, in the form of loan interest, which is paid to the lender for the right and opportunity to use the borrowed funds. As a result, the whole point of saving and investing is to avoid the need to borrow, and instead actually have the money that’s needed to fund future goals.

A unique feature of a 401(k) loan, though, is that unlike other types of borrowing from a lender, the employee literally borrows their own money out of their own account, such that the borrower’s 401(k) loan repayments of principal and interest really do get paid right back to themselves (into their own 401(k) plan). In other words, even though the stated 401(k) loan interest rate might be 5%, the borrower pays the 5% to themselves, for a net cost of zero! Which means as long as someone can afford the cash flows to make the ongoing 401(k) loan payments without defaulting, a 401(k) loan is effectively a form of “interest-free” loan.

In fact, since the borrower really just pays interest to themselves, some investors have even considered taking out a 401(k) loan as a way to increase their investment returns, by “paying 401(k) loan interest to themselves” at 5% instead of just owning a bond fund that might only have a net yield of 2% or 3% in today’s environment.

The caveat, though, is that paying yourself 5% loan interest doesn’t actually generate a 5% return, because the borrower that receives the loan interest is also the one paying the loan interest. Which means paying 401(k) loan interest to yourself is really nothing more than a way to transfer money into your 401(k) plan. Except unlike a traditional 401(k) contribution, it’s not even tax deductible! And as long as the loan is in place, the borrower loses the ability to actually invest and grow the money… which means borrowing from a 401(k) plan to pay yourself interest really just results in losing out on any growth whatsoever!

The end result is that while borrowing from a 401(k) plan may be an appealing option for those who need to borrow – where the effective borrowing cost is not the 401(k) loan interest rate but the “opportunity cost” or growth rate of the money inside the account – it’s still not an effective means to actually increase your returns, even if the 401(k) loan interest rate is higher than the returns of the investment account. Instead, for those who have “loan interest” to pay to themselves, the best strategy is simply to contribute the extra money to the 401(k) plan directly, where it can both be invested, and receive the 401(k) tax deduction (and potential employer matching!) on the contribution itself!

401(k) Loan Rules And Repayment Requirements

Contributions to 401(k) and other employer retirement plans are intended to be used for retirement, and as a result, 401(k) plans often have restrictions against withdrawals until an employee retires (or at least, separates from service). As a result, any withdrawals are taxable (and potentially subject to early withdrawal penalties), and even “just” taking a loan against a retirement account is similarly treated as a taxable event under IRC Section 72(p)(1).

Yet unfortunately, the reality is that from time to time, employees may need to access the funds in their 401(k) plan before retirement, at least temporarily. To help address the need, Congress created IRC Section 72(p)(2), which does permit employees to take loans directly against their 401(k) or other qualified plan balance from the 401(k) plan administrator, subject to certain restrictions.

The first restriction on a 401(k) loan is that the total outstanding loan balance cannot be greater than 50% of the (vested) account balance, up to a maximum cap on the balance of $50,000 (for accounts with a value greater than $100,000). For smaller 401(k) or other qualified plans with an account balance less than $20,000, up to $10,000 can be borrowed under IRC Section 72(p)(2)(A)(ii)(II), even if it exceeds the 50% limit (though the employee is still always capped at borrowing no more than the actual account balance itself). If the plan allows it, the employee can take multiple 401(k) plans, though the above limits still apply to the total loan balance (i.e., the lesser-of-$50,000-or-50% cap applies to all loans from that 401(k) plan in the aggregate).

Second, the loan must be repaid in a timely manner, which under IRC Section 72(p)(2)(B) is defined as a 401(k) loan repayment period of 5 years. In addition, IRC Section 72(p)(2)(C) requires that any 401(k) loan repayment must be made in amortizing payments (e.g., monthly or quarterly payments of principal and interest) over that 5-year time period; interest-only payments with a “balloon” principal payment is not permitted. If the loan is used to purchase a primary residence, the repayment period may be extended beyond 5 years, at the discretion of the 401(k) plan (and is available as long as the 401(k) loan for down payment is used to acquire a primary residence, regardless of whether it is a first-time homebuyer loan or not). On the other hand, there is no limit (or penalty) against prepaying a 401(k) loan sooner (regardless of its purpose).

Notably, regardless of whether it is a 401(k) home loan or used for other purposes, any 401(k) loan must be repaid “immediately” if the employee is terminated or otherwise separates from service (where “immediately” is interpreted by most 401(k) plans to mean the loan must be repaid within 60 days of termination). In other words, the 5-year repayment period for a 401(k) loan (or longer repayment period for a 401(k) loan for home purchase) only applies as long as the employee continues to work for the employer and remains a participant in the employer retirement plan.

To the extent a 401(k) loan is not repaid in a timely manner – either by failing to make ongoing principal and interest payments, not completing repayment within 5 years, or not repaying the loan after voluntary or involuntary separation from service – a 401(k) loan default is treated as a taxable distribution, for which the 401(k) plan administrator will issue a Form 1099-R. If the employee is not already age 59 ½, the 10% early withdrawal penalty under IRC Section 72(t) will also apply (unless the employee is eligible for some other exception).

Treasury Regulation 1.72(p)-1 requires that the qualified plan charge “commercially reasonable” interest on the 401(k) loan, which in practice most employers have interpreted as simply charging the Prime Rate plus a small spread of 1% to 2%. With the current Prime Rate at 4.25%, this would imply a 401(k) loan rate of 5.25% to 6.25%. And notably, these rates are typically available regardless of the individual’s credit rating (and the 401(k) loan is not reported on his/her credit history), nor is there any underwriting process for the 401(k) loan – since, ultimately, there is no lender at risk, as the employee is simply borrowing his/her own money (and with a maximum loan-to-value ratio of no more than 50% in most cases, given the 401(k) loan borrowing limits).

In fact, technically a 401(k) loan is really more akin to the employee receiving a (non-taxable) advance of their 401(k) account balance, as ultimately the plan administrator simply liquidates and distributes the employee’s own money to them, and the subsequent repayment of principal and interest simply go back to the employee’s account. In other words, the employee’s 401(k) loan repayments are really just making principal and interest payments to themselves (or rather, to their existing 401(k) account), not to a lender (as is the case with a traditional loan, or a “Bank On Yourself” life insurance policy loan). Though as a loan made by the employee to themselves, any “interest” repayments to the 401(k) plan are not deductible as loan interest, either.

On the other hand, since a 401(k) loan is really nothing more than the plan administrator liquidating a portion of the account and sending it to the employee, it means that any portion of a 401(k) plan that has been “loaned” out will not be invested and thus will not generate any return. In addition, to ensure that employees do repay their 401(k) loans in a timely manner, most 401(k) plans do not permit any additional contributions to the 401(k) plan until the loan is repaid – i.e., any available dollars for contribution are characterized as loan repayments instead, though notably this means that they would not be eligible for any employer matching contributions.

In the meantime, it’s also notable that because there is no lender profiting from the loan (by charging and receiving interest), many 401(k) plan administrators do at least charge some processing fees to handle 401(k) plans, which may include an upfront fee for the loan (e.g., $50 – $100), and/or an ongoing annual service fee for the loan (typically $25 – $50/year, if assessed).

Nonetheless, the appeal of the 401(k) loan is that, as long as the loan is in fact repaid in a timely manner, it provides a means for the employee to access at least a portion of the retirement account for a period of time, without having a taxable event (as would occur in the case of a hardship distribution, or trying to take a loan against an IRA), and without any stringent requirements on qualifying for the loan in the first place, beyond completing the brief paperwork and perhaps paying a modest processing fee.

Why Paying 401(k) Loan Interest To Yourself Really Isn’t

Beyond the appeal of the relative ease of getting a 401(k) loan (without loan underwriting or credit score requirements), and what is typically a modest 401(k) loan interest rate of about 5% to 6% (at least in today’s low-yield environment), some conservative investors also periodically raise the question of whether it would be a good idea to take a 401(k) loan just to increase the rate of return in the 401(k) account. In other words, is it more appealing to “earn” a 5% yield by paying yourself 401(k) loan interest, than it is to leave it invested in a bond fund in the 401(k) plan that might only be yielding 2% or 3%?

Example 1. John has $5,000 of his 401(k) plan invested into a bond fund that is generating a (net-of-expenses) return of only about 2%/year. As a result, he decides to take out a 401(k) loan for $5,000, so that he can “pay himself back” at a 5% interest rate, which over 5 years could grow his account to $6,381, far better than the $5,520 he’s on track to have in 5 years when earning just 2% from his bond fund.

Paying Yourself 401k Loan Interest Vs Low-Yielding Bond Funds

Yet while it is true that borrowing from the 401(k) plan and paying yourself back with 5% interest will end out growing the value of the 401(k) account by 5%/year, there is a significant caveat: it still costs you the 5% interest you’re paying, since paying yourself back for a 401(k) loan means you’re receiving the loan interest into the 401(k) account from yourself, but also means you’re paying the cost of interest, too.

After all, in the earlier example, at a 2% yield John’s account would have grown by “only” $412 in 5 year, while at a 5% return it grows by $1,381. However, “earning” 2%/year in the bond fund costs John nothing, while “earning” $1,381 with the 401(k) loan costs John… $1,381, which is the amount of interest he has to pay into the account, from his own pocket, to generate that interest.

Yet if John had $1,381 available to pay into the 401(k) account as loan interest, he also could have simply saved and invested that money for himself! In other words, John already has the $1,381 – inside of his 401(k) account as loan interest, or outside the account ready and waiting to pay. Except if he didn’t use it for “loan interest” to himself, he could have invested it for a return, too!

Example 2. Continuing the prior example, John decides that instead of taking out the 401(k) loan to “pay himself” 5% interest, he keeps the $5,000 invested in the bond fund yielding 2%, and simply takes the $1,381 of interest payments he would have made, and invests them into a similar fund also yielding 2%. After 5 years of compounding (albeit low) returns, he would finish with $5,520 in the 401(k) plan, and another $1,435 in additional savings (the $1,381 of interest payments, grown at 2%/year over time), for a total of $6,955.

Paying Yourself 401k Loan Interest Vs Contributing Loan Interest To Invest

Notably, the end result is that just investing the money that would have been paid in loan interest, rather than actually paying it into a 401(k) account as loan interest, results in total account balances that are $574 higher… which is exactly the amount of additional growth at 2%/year that was being earned on the 401(k) account balance ($520) plus the growth on the available additional “savings” ($54).

In other words, the net result of “paying yourself interest” via a 401(k) loan is not that you get a 5% return, but simply that you end out saving your own money for yourself at a 0% return – because the 5% you “earn” in the 401(k) plan is offset by the 5% of loan interest you “pay” from outside the plan! Yet thanks to the fact that you have a 401(k) loan, you also forfeit any growth that might have been earned along the way! Which means paying 401(k) loan interest to yourself is really just contributing your own money to your own 401(k) account, without any growth at all!

Taxation Of “Contributing” With 401(k) Interest Payments Vs Normal 401(k) Contributions

One additional caveat of using a 401(k) loan to pay yourself interest is that even though it’s “interest” and is being “contributed” into the 401(k) plan, it isn’t deductible as interest, nor is it deductible as a contribution. Even though once inside the plan, it will be taxed again when it is ultimately distributed in the future.

Of course, the reality is that any money that gets invested will ultimately be taxed when it grows. But in the case of 401(k) loan interest paid to yourself, not only will the future growth of those loan payments be taxed, but the loan payments themselves will be taxed in the future as well… even though those dollar amounts would have been principal if simply held outside the 401(k) plan and invested.

Or viewed another way, if the saver actually has the available cash to “contribute” to the 401(k) plan, it would be better to not contribute it in the form of 401(k) loan interest, and instead contribute it as an actual (fully deductible) 401(k) plan contribution instead! Which would allow the individual to save even more, thanks to the tax savings generated by the 401(k) contribution itself.

Example 3. Continuing the earlier example, John decides to take what would have been annual 401(k) loan interest, and instead increases his 401(k) contributions by an equivalent amount (grossed up to include his additional tax savings at a 25% tax rate). Thus, for instance, instead of paying in “just” $250 in loan interest to his 401(k) plan (a 5% rate on $5,000), he contributes $333 on a pre-tax basis (equivalent to his $250 of after-tax payments). Repeated over 5 years, John finishes with $7,434 in his 401(k) plan, even though the account was invested at “just” 2%, compared to only $6,381 when he paid himself 5% loan interest!

Paying Yourself 401k Loan Interest Vs Pre-Tax Contributions Of Loan Interest To Invest

In other words, not only is it a bad deal to “pay 401(k) interest to yourself” because it’s really just contributing your own money to your own account at a 0% growth rate, but it’s not even the most tax-efficient way to get money into the 401(k) plan in the first place (if you have the dollars available)!

Why A 401(k) Loan Should Still Be For Need, Not Investing

Ultimately, the key point is simply to recognize that “paying yourself interest” through a 401(k) loan is not a way to supplement your 401(k) investment returns. In fact, it eliminates returns altogether by taking the 401(k) funds out of their investment allocation, which even at low yields is better than generating no return at all. And using a 401(k) loan to get the loan interest into the 401(k) plan is far less tax efficient than just contributing to the account in the first place.

Of course, if someone really does need to borrow money in the first place as a loan, there is something to be said for borrowing it from yourself, rather than paying loan interest to a bank. The bad news is that the funds won’t be invested during the interim, but foregone growth may still be cheaper than alternative borrowing costs (e.g., from a credit card).

In fact, given that the true cost of a 401(k) loan is the foregone growth on the account – and not the 401(k) loan interest rate, which is really just a transfer into the account of money the borrower already had, and not a cost of the loan – the best way to evaluate a potential 401(k) loan is to compare not the 401(k) loan interest rate to available alternatives, but the 401(k) account’s growth rate to available borrowing alternatives.

Example 4. Sheila needs to borrow $1,500 to replace a broken water heater, and is trying to decide whether to draw on her home equity line of credit at a 6% rate, or borrowing a portion of her 401(k) plan that has a 5% borrowing rate. Sheila’s 401(k) plan is invested in a conservative growth portfolio that is allocated 40% to equities and 60% to bonds. Given that the interest on her home equity line of credit is deductible, which means the after-tax borrowing cost is just 4.5% (assuming a 25% tax bracket), Sheila is planning to use it to borrow, as the loan interest rate is cheaper than the 5% she’d have to pay on her 401(k) loan.

However, as noted earlier, the reality is that Sheila’s borrowing cost from the 401(k) plan is not really the 5% loan interest rate – which she just pays to herself – but the fact that her funds won’t be invested while she has borrowed. Yet if Sheila borrows from the bond allocation of her 401(k) plan, which is currently yielding just 2%, then her effective borrowing rate is just the “opportunity cost” of not earning 2% in her bond fund, which is even cheaper than the home equity line of credit. Accordingly, Sheila decides to borrow from her 401(k) plan, not to pay herself interest, but simply because the foregone growth is the lowest cost of borrowing for her (at least for the lowest-yielding investment in the account).

Notably, when a loan occurs from a 401(k) plan that owns multiple investments, the loan is typically drawn pro-rata from the available funds, which means in the above example, Sheila might have to subsequently reallocate her portfolio to ensure she continues to hold the same amount in equities (such that all of her loan comes from the bond allocation). In addition, Sheila should be certain that she’s already maximized her match for the year – or that she’ll be able to repay the loan in time to subsequently contribute and get the rest of her match – as failing to obtain a 50% or 100% 401(k) match is the equivalent of “giving up” a 50% or 100% instantaneous return… which would make the 401(k) loan drastically more expensive than just a home equity line of credit (or even a high-interest-rate credit card!).

Nonetheless, the fundamental point remains: despite the classic view that 401(k) loan interest is a cost where you are simply “paying yourself”, the reality is that it’s not a direct cost at all, nor a prospective return. Instead, the true cost of a 401(k) loan is the opportunity cost of not having funds invested to grow (including the risk of losing out on 401(k) matching as well, if applicable), which can actually be an appealing cost relative to other borrowing alternatives for those who need a loan (especially those with credit scores in the 600s or below, who may not have any good borrowing alternatives!). Nonetheless, “paying 401(k) loan interest to yourself” will never be superior to just investing the money and generating any return at all!

So what do you think? Is a 401(k) loan really more akin to an employee receiving a (non-taxable) advance of their 401(k) balance? Do your clients seem interested in 401(k) loans? In what circumstances does it make sense to utilize a 401(k) loan? Please share your thoughts in the comments below!

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

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

Executive Summary

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Broker-Dealers Struggle With Digital Marketing

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I hope this is helpful as some food for thought.

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

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).

Five Biggest Mistakes Families Make with Life Insurance

Five Biggest Mistakes Families Make with Life Insurance

The month of September is Life Insurance Awareness Month.  While it’s still a few months away, it’s not too early to start protecting yourself today. Most families are getting tons of information thrown at them around the topic of investing, far too often I see families make major mistakes when it comes to life insurance.   I had a widow come to see me just a few months ago when her husband had a tragic accident.   He left her with three young children and a $500,000 insurance policy.   With hardly any other saved money, she was left bewildered on how she would be able to make her bills, pay for her kids’ college education, and then also take care of her retirement.   While $500,000 seemed like a lot money at the time they applied for the insurance, in reality it was barely enough to get by given all of the family goals.  Here are the five biggest mistakes that families make when it comes to life insurance.

  • Not Reviewing Beneficiaries – When individuals make a beneficiary designation, they often don’t realize it is a contract of law. No matter what your will says, this is where the money will be going.  Insurance policies allow for both a primary beneficiary and a contingent beneficiary which is highly recommended to be filled out.  As your life progresses and your family situation changes with new children or a divorce, it is important to update these beneficiaries.
  • Picking the Wrong Amount of Insurance – Insurance can generally be rented or owned, with term insurance being the insurance that you rent.  Midland National® Life Insurance Company is a strong and established life insurance company, and they provide affordable, temporary coverage with level term insurance in increments of 10 year, 15 year, 20 year, and 30 year levels.   The main issue is that most families often only buy enough term life insurance to pay off their debts.  You should be doing both a needs analysis and a human life value analysis to figure out exactly how much life insurance you need.  What will the cost of college be for your children?  How much money will your spouse need to maintain your family’s standard of living?  Will you pay off the mortgage?  All of these are important questions?
  • People Think They Will Be Healthy Forever – Most families only buy term insurance, but you should have a strong consideration to get some level of permanent insurance. Even though many term insurance policies are guaranteed renewable and non-cancelable, the cost for the new premium when your term renews might be incredibly expensive.   Permanent insurance comes in all sorts of flavors, including whole life insurance, universal life insurance, indexed universal life insurance, and variable universal life insurance. If you are looking to have insurance forever and build up money for college education, for example, check out this great video.  Remember, if your health changes in your 40’s or 50’s you may not be eligible to get permanent insurance down the road.
  • Only Using Insurance Through Work —Although it can be a very cost effective strategy to get your term life insurance at work, the main problem is that the life insurance isn’t generally portable if you leave work. This means if you change jobs or move to a new employer, the new employer may not have the same level of coverage you had at your old employer, and it is possible your health had changed since you joined your employer.  It is important to consider some level of term or permanent protection on your own.  Remember, the longer you wait, the more costly the proposition will be down the road.
  • Not Factoring Inflation — If you buy a $1,000,000 insurance policy when you are 35 years old, what is it worth when you are 55 years old? People often under-insure themselves when they are younger by not factoring in the silent killer of inflation.   Make sure as you get older or when you think about how you structure your insurance policies, you consider this factor in your overall financial plan.

These are absolute ‘musts’ to consider when picking life insurance. While not a necessity, it’s helpful to consider providers with informative resources and communities that openly discuss what’s best for families and individuals. Midland National maintains a strong, interactive network of customers.  You can find Midland National on Twitter as well as Midland National’s page on LinkedIn.  If you are on Facebook, you can connect with Midland National. Midland National Life Insurance Company, part of the Sammons Financial Group also provides a wide range of financial and life insurance related videos or you can follow along on the Midland National blog and keep up to date on all Midland National company updates that help customers learn more about financial products, financially-stable living, and gives transparency into its business.