Tag: Retirement

Choosing An Appropriate Discount Rate For Retirement Planning Strategies

Choosing An Appropriate Discount Rate For Retirement Planning Strategies

Executive Summary

For most people, making financial planning decisions involves an evaluation of financial trade-offs. In fact, any decision about whether to save (or not) effectively boils down to a trade-off about whether to consume now, or later.

Of course, all else being equal, we virtually always choose to consume now, if we can. Delaying gratification requires at least some kind of incentive, to make it worth delaying. Or viewed another way, we “discount” the value of something in the future – because we have to wait for it – which means waiting must make something more valuable to ever be worth the wait.

Mathematically, we can quantify this “time value of money” as a discount rate, which represents the rate of growth that would have to be earned to make the waiting worthwhile. And the use of a discount rate is especially helpful when trying to compare strategies or choices that are dispersed or occur over time, where it’s not always intuitively obvious which is the better deal in the long run.

For instance, discount rates are used to evaluate whether it’s better to take a lump sum rather than ongoing pension payments, and to determine when it’s preferable to wait for (higher) Social Security payments, rather than starting early… both of which are trade-offs that entail payments over a span of years or even decades, and can be difficult to compare without a common framework. By calculating the “net present value” of the various alternatives, adjusted by an appropriate discount rate of interest, it’s feasible to make better apples-to-apples comparisons.

The caveat, however, is that conducting such analyses still requires an appropriate choice for a discount rate of interest in the first place. In the context of financial planning strategies, the proper discount rate to use is literally the “time value of the money” for that individual – in other words, what return could be generated over time by the money, if it were in fact available today to be invested. Or stated more simply: the discount rate for financial planning strategies should be the long-term rate of return being assumed in the financial plan itself. Because it’s the portfolio to which the money could be added if taken earlier, and/or it’s the portfolio that will have to be liquidated to provide for spending needs if the payments are delayed until later.

Notably, the fact that the proper discount rate is the investor’s expected rate of return, means that the “right” discount rate will vary from one person to the next, based on their investment approach and risk tolerance. For those who are more inclined towards aggressive investments, a higher discount rate may be used, while those who are conservative will use a lower discount rate of interest (and those who hold all assets in cash might well use a discount rate near 0%!). Of course, the caveat is that investors must still be cautious to pick a discount rate that is actually realistic to the portfolio in the first place – otherwise, an unrealistically high discount rate will lead to decisions that turn out to be less-than-optimal after the fact, when the money-in-hand doesn’t actually produce the expected results!

The Discount Rate And The Time Value Of Money

Evaluating any trade-off involves weighing the pros and cons of choice “A” versus choice “B”.

When the outcome of the choices is also immediate, the comparison is relatively straightforward. If I’m trying to decide whether to spend $1,000 to take a vacation, I can weigh the perceived benefits of the vacation (fun, enjoyment, relaxation, a chance to see a new part of the world) against the cost ($1,000 that I won’t have anymore), and make a decision.

However, the choice is inherently more complex when the trade-off entails outcomes that occur at different points in time. For instance, if I’m trying to decide whether to take a vacation this year, or to take one next year instead. Naturally, given a desire for (instant) gratification, there’s little incentive to wait to take a vacation, if an equivalent one is available immediately; instead, waiting is only appealing if there’s some benefit to doing so. In other words, we demand that if we’re going to wait, the value must be somehow enhanced by waiting (i.e., a better vacation a year from now than the one I could simply take today). Or viewed another way, we “discount” the value of a vacation occurring in a year compared to a vacation we can take now, which means for an otherwise-equivalent vacation, it’s more valuable to take the immediate (undiscounted) choice.

Mathematically, this discounting-the-future effect means that we can calculate a “discount rate”, which represents the breakeven rate of return that would have to be generated between now and then to compensate for the waiting period. For instance, if the discount rate was 5%, it means that I would only be willing to wait on the vacation for a year, if the vacation I got to take in a year was 5% “better” (e.g., by growing my money by 5% so I have that much more to spend on the vacation).

Of course, when it comes to something as personal and intangible as a vacation, it can be difficult to quantify an exact discount rate. And there’s some research to suggest that we are not always rational in applying discount rates to personal trade-offs over time – and that we tend to engage in “hyperbolic” discounting of the future.

On the other hand, when evaluating an investment decision or trade-off, we can much more effectively evaluate the trade-off by recognizing that future investment outcomes (or future cash flows) need to be discounted if there’s a waiting period, to recognize the implicit “time value of money”. Which means the discount rate quickly becomes an essential component to weighing investment and financial trade-offs over time.

Discounted Cash Flow (DCF) Valuations Of A Stock (Or Advisory Firm)

One of the most common applications of using a discount rate to evaluate an investment decision is the use of the Discounted Cash Flow (DCF) model to evaluate whether it’s worthwhile to buy a company’s stock (or not).

The essence of the analysis is relatively straightforward: estimate every cash flow that the business is likely to provide in the future (some combination of its ongoing dividend/profit distributions, and its terminal value for payments in perpetuity as a stable business thereafter), and then discount the value of those future cash flows back into today’s dollars. If the discounted “present value” of the future cash flows is higher than the actual price to buy the company, then it’s a good buying opportunity (because the actual price is cheaper than the intrinsic present-value-of-future-cash-flows price). If the stock costs more than the present value of its future cash flows, it’s overpriced and the investor should pass.

The caveat, however, is that estimating the discounted present value of future cash flows has two key assumptions: the first is what those future cash flows will actually be, and the second is the discount rate itself. And while determining the future cash flows of a business is beyond the scope of this discussion, the key point is that a prospective investment could be a good deal, or a bad one, depending on the discount rate alone.

Example 1. Jeremy is considering whether to buy a company for $1,000,000. Over the next 5 years, it is estimated to generate $40,000/year of profit distributions, and by the end of the time period, is projected to be worth $1.1M. Which means the cash flows are $40,000/year for the next 4 years, with a total final payment of $1,140,000 at the end of the 5th year (which represents the last profit distribution, plus the $1.1M terminal value).

At a 5% discount rate, the present value of these future cash flows is $1,035,058, which makes the stock an appealing investment at “just” a $1,000,000 price. On the other hand, if Jeremy had an opportunity to invest into another company that had a 10% expected return – such that he required at least a 10% discount rate to invest in this company as a superior alternative – the outcome would be different. Using a 10% discount rate, the company is only worth $834,645, which means buying it for $1,000,000 would be a “bad” deal that overpays for its value – even though cumulatively, Jeremy would receive back $1.3M in total payments over the next 5 years, that’s actually less than what Jeremy could have generated by simply keeping his $1,000,000 and invested it at his 10% ‘required’ rate of return over that time period.

Notably, the key determinant of the discount rate is not based on the investment itself, per se, but on the opportunity cost of using that money in lieu of some other alternative, instead. For instance, in the example above, Jeremy’s decision to use a 10% discount rate was based on having a (comparable risk) alternative investment that already had an expected return of 10%, which effectively became the “hurdle rate” that the new investment had to clear (and in this case, couldn’t surpass). In the business context, projects are often evaluating using a discount rate of the Weighted Average Cost of Capital (WACC), in recognition that if the prospective returns on the investment of capital can’t surpass the cost of the capital, then the cost will exceed the outcome, which again would make it a losing proposition.

Determining An Appropriate Discount Rate Of Interest For Financial Planning Strategies

While it may seem an abstract exercise, in reality determining an appropriate “discount rate” is actually highly relevant when evaluating many financial planning strategies, particularly ones that compare traditional investment opportunities with fixed cash flows over time, such as whether to take a lump sum pension (or not), or the value of delaying Social Security benefits (or not).

In both scenarios, the discount rate effectively forms a “hurdle rate” of expected value that the strategy must surpass to be viable/desirable (and if the discount rate can’t be exceeded, the strategy shouldn’t be implemented).

Pension Vs Lump Sum Discount Rate

A pension is a guaranteed lifetime stream of cash flows, which inherently makes it difficult to evaluate relative to other more traditional investment alternatives. Of course, as long as someone has only a pension available to them, there’s no decision to make, and the payments will simply be made. However, once there’s an option to take the pension or convert it to a lump sum, the question arises: How do you determine when/whether the lump sum is a “good deal” or not? To which the answer is: Calculate the present value of the pension at an appropriate discount rate, and see if it’s more or less than the lump sum amount being made available.

Example 2. Charlie is a 65-year-old male, and is eligible for a $40,000/year lifetime pension. The company has also offered Charlie a $500,000 lump sum option, in exchange for his pension, and he’s trying to decide if this is a “good” deal or not. According to the Society of Actuaries’ Longevity Illustrator, as a non-smoking male with reasonable health, Charlie’s life expectancy is approximately age 87, which means he can expect to receive $40,000/year for an average of 22 years.

Charlie’s alternative, if he takes the lump sum, would be investing it in a diversified portfolio, in which he estimates that he could earn a 7% average annual growth rate. Which means that potential portfolio return is the opportunity cost he’s giving up if he sticks with the pension and doesn’t take the lump sum. Thus, 7% would be Charlie’s discount rate.

If Charlie then calculates the present value of his $40,000 year for 22 years at a 7% discount rate, he’ll find that the net present value is “only” about $451,000. In other words, it would only take $451,000 to provide $40,000/year for 22 years at a 7% rate of return. Since the available lump sum provides more than that – a full $500,000 – this implies that it’s a slightly better deal to take the lump sum, since it would literally give Charlie “more than enough” to replace his 22 years of pension payments at a 7% rate of return (with almost $50,000 to spare!).

Another way of evaluating the decision of whether to take a pension lump sum or not is to calculate what discount rate is actually being used to provide the pension lump sum. After all, mathematically, if there’s a stream of pension payments already available, and a lump sum being offered as a choice, there is some discount rate that will equate the projected pension payments to the lump sum being offered. This internal rate of return on the pension lump sum itself provides the “hurdle rate” that the lump sum would have to achieve, if subsequently invested, to actually replicate the exact pension payments (to the dollar, with none left over).

Example 2b. Continuing the prior example, if Charlie’s trade-off is a $500,000 lump sum, or to receive $40,000/year for the next 22 years, we can calculate the internal rate of return (IRR) of this trade-off (the discount rate that would make the two precisely equal to each other).

In this case, the IRR would be 5.8%, which means that $500,000 growing at 5.8%/year while withdrawing $40,000/year would last for exactly 22 years (with nothing left over). To the extent that the lump sum investor could earn anything greater than 5.8%, there would be money left over; thus, as long as Charlie is confident he can earn at least 5.8% (and that 22 years is a reasonable time horizon), it’s a better deal to take the lump sum to cover his needs for the next 22 years, and invest it accordingly. (In turn, this is why it was a “good” deal to take the $500,000 if Charlie’s discount rate was 7% – because his 7% assumed return is enough to beat the 5.8% hurdle rate.)

Notably, an important caveat to applying a discount rate for valuing a pension is that it’s still necessary to determine the cash flows to discount in the first place – in other words, what are the pension payments, and how many years of expected pension payments there will be. Of course, this is ultimately an unknown, particularly for an individual; while on average 65-year-old males like Charlie may leave to age 87 (which can be predicted fairly accurately thanks to the law of large numbers), Charlie himself might live much longer or shorter than this time period. Which matters because having a longer time period, and receiving more pension payments, improves the internal rate of return of the pension compared to the lump sum, and makes the pension inherently more valuable.

As a result, effectively evaluating the discount rate on a pension-vs-lump-sum decision really requires calculating the implied value over multiple different time horizons, to understand not only whether the lump sum is a “good deal” or not at the available discount rate, but also the risk that the outcome/decision would be different if the pensioner lives longer or shorter than the mere average life expectancy.

Accordingly, the chart below shows the internal rate of return for Charlie, and how it changes as each additional pension payment is received from age 65 all the way to age 100. Not surprisingly, early on the internal rate of return of the pension is hugely negative – a tremendous loss to take “lifetime” payments and pass away after getting just a few – but if Charlie lives long enough, eventually the internal rate of return turns positive at age 76, climbs to 3% by the time he’s 80%, over 6% by the time he’s 90, and goes all the way to 7.4% by age 100! Alternatively, this means that if Charlie calculates the present value of the pension payments at his 7% discount rate, its value will be less than the pension lump sum (implying the lump sum is a “good deal” to take)… until/unless Charlie lives into his late 90s, and then suddenly the pension itself turns out to be the better deal after all!

Impact of Assumed Life Expectancy On IRR and NPV of Pension Payments

In all cases, though, the fundamental point of the discount rate remains the same: it represents the opportunity cost of not taking the lump sum and investing it (and spending from it), and should be compared to the available investment rate of return in the portfolio. The higher the expected rate of return – the better the investment opportunities for the lump sum – the more discounted (i.e., reduced in value) the guaranteed pension payments will be, and the more appealing it will be to simply take and invest the lump sum. Alternatively, the lower and more conservative the expected rate of return (and thus the discount rate), the more valuable (and literally, the “less discounted”) the guaranteed pension payments will be!

Discount Rate For Delayed Social Security

The decision of whether to delay Social Security benefits to age 70, or not, represents another kind of “discount rate” analysis. In this case, the challenge is that both alternatives – take lifetime payments early, or wait and take higher lifetime payments starting later – involve a series of lifetime payments over the span of years and decades, but with different starting points, which makes them difficult to compare.

As a result, one of the most common approaches to evaluating Social Security trade-offs is to calculate the discounted net present value (NPV) of each choice, and then see which one has the higher value. Converting each to a discounted present value allows them to be compared on equal footing.

Here again, though, the choice of a discount rate is both necessary, and critical to the analysis. The reason the discount rate matters is that its value – and the magnitude of (compounded) discounting it applies to distant future payments – can directly tilt the scales for or against strategies that give larger future payments over smaller current ones.

Example 3. Ashley is a 62-year-old female, trying to decide whether to start Social Security benefits early (now, at age 62), or delay them until age 70. Her Primary Insurance Amount (PIA, or the benefit she’ll receive at full retirement age of 66) is $1,000/month. If she starts at benefits now, her payments will be reduced by 25% to $750/month. If she waits until age 70, the payments will be increased by 32% for delayed retirement credits, all the way up to $1,320/month (plus additional cost-of-living adjustments between now and then). The fundamental question: which is more valuable, $750/month starting today, or $1,320/month starting 8 years from now?

Assuming Ashley will live to age 88 (based on the Society of Actuaries’ Longevity Illustrator for a 62-year-old female non-smoker with average health), and assuming 3%/year cost-of-living adjustments for inflation and a 7.5% discount rate, the present value of taking payments early is $135,204, while delaying them would have a value of $133,496, which tilts the scales slightly in favor of just taking the payments early, and investing them for that 7.5%/year potential return.

On the other hand, if Ashley’s opportunity cost of the money is only 4%/year – perhaps as an investor she is far more conservative – then the higher future payments are more valuable (literally, less discounted), and now the present value of starting early is only $201,764, while the value of starting at age 70 is $235,477, which tilts the scales towards delaying.

NPV Impact of Delaying Social Security Based On Varying Discount Rates

As the example here shows, the choice of the discount rate is once again crucial to the outcome of the decision. Which once again raises the question of what discount rate should be used?

Given that a discount rate represents the implicit “time value” of the dollars, and the opportunity cost of the money if it is not received until later, the discount rate should represent whatever could/would have been done with those dollars in the meantime. In other words, had Ashley not delayed Social Security, and taken the payments early instead, what would have happened to the money?

Assuming Ashley had a choice in the first place (i.e., she didn’t “need” the money as her sole source of spending, and had other resources available), choosing to take Social Security benefits early represents either an opportunity for Ashley to invest the payments into her portfolio, or alternatively meant she could have spent those payments and not had to withdraw from her portfolio instead. Either way, the opportunity cost of delaying is the dollars for the portfolio that are not saved, or the dollars from the portfolio that would have to be withdrawn/liquidated/spent while waiting for Social Security. Which means the portfolio’s expected rate of return is, once again, the appropriate discount rate.

Notably, this will provide the same decision outcome as simply projecting Ashley’s retirement planning situation, using a combination of her available retirement assets, and the Social Security payments, at the portfolio’s assumed rate of return in the financial plan.

Example 3b. Continuing the prior example, assume that Ashley’s overall goal is to spend $35,000/year, and that in addition to her Social Security payments, she also has a $500,000 portfolio. In this scenario, she will either begin to draw immediately on Social Security and supplement her spending with her portfolio, or she will draw more heavily from her portfolio early on and then much less once Social Security begins (at the higher amount) at age 70. The chart below shows the outcomes of the two scenarios, assuming either a 4% portfolio return or a 7.5% portfolio return.

Impact On Portfolio Wealth Of Delaying Social Security (Or Not) At Varying Discount Rates

Notably, the conclusion is exactly the same as shown earlier – the higher the portfolio return, the less value there is to delaying (i.e., the longer the breakeven period to recover the ‘cost’ of waiting), and the more beneficial it is to simply start Social Security early, preserving more of the portfolio to stay invested at that 7% return; conversely, when returns are lower, the increase in Social Security payments by delaying is relatively more appealing. In fact, this is the whole point of why the proper discount rate is the portfolio’s assumed rate of return – because that’s precisely what those dollars are projected to earn (either directly or indirectly) if payments start early.

Portfolio Returns And The Opportunity Cost Of Money

Ultimately, the key point is that evaluating strategies that involve trade-offs over time requires the use of a discount rate, and for the typical investor, the discount rate should be the expected return of the portfolio, which literally reflects the opportunity cost of the money for that individual (i.e., how the funds could be deployed if they were received sooner, rather than later).

Notably, this means that investors who are more aggressive and have higher expected returns will use a higher discount rate, which will naturally “bias” trade-offs towards getting money sooner rather than later – i.e., taking the lump sum in lieu of lifetime pension payments, or starting Social Security early instead of delaying it. Logically, this makes sense: for investors who are that optimistic about their ability to grow their assets, the best strategy is to get those dollars in hand as quickly as possible, and invest them (or at least, use them so other portfolio assets can stay invested and don’t have to be liquidated).

Conversely, those who are invested more conservatively – including those who don’t invest at all – will utilize potentially much lower discount rates, which inherently makes “delayed dollars” strategies more appealing (literally, “less discounted”). After all, if the money was just going to sit in cash or CDs anyway, there’s not much growth potential to having those dollars in hand, and it’s more appealing to just get higher payments later instead (even if they’re only “slightly” higher).

It’s important to note, though, that despite the fact that Social Security and pension payments are themselves “fixed income” streams, their discount rate in a financial planning analysis is not necessarily using a fixed income return, unless the individual would truly have put all of those dollars into fixed income investments if the money was available now (e.g., as a pension lump sum, or by starting Social Security early). It is true that the payment streams themselves are fixed, but evaluating the trade-off means not calculating the fixed-income “value” of Social Security or a pension, per se, but its value as a trade-off to available alternatives (that the portfolio would have otherwise funded). By analogy, if you were considering whether to liquidate a bond to purchase a stock, the fundamental question is the earning potential of the stock, not the value of the bond itself as a fixed-income investment. Similarly, the decision about whether to start Social Security early, or take a pension lump sum, is not about the fact that it’s a fixed-income payment, but the (portfolio’s) opportunity cost and potential return it can generate by getting those fixed payments in hand sooner rather than later.

Alternatively, it’s also feasible to evaluate such trade-offs by calculating the internal rate of return of the cash flows themselves – whether it’s “giving up” current Social Security payments to receive higher payments later, or giving up a lump sum now to receive pension payments for life. The internal rate of return of those cash flows reveals the implicit “hurdle rate” that an alternative strategy – e.g., an investment portfolio – would have to beat to achieve a superior outcome. (Recognizing that the IRR itself will vary depending on the time horizon chosen, at least for pension and Social Security payments that continue “for life”.)

Of course, it’s still important to choose a realistic rate of return for the portfolio as a discount rate – or risk that a strategy “looks” appealing based on a too-high discount rate, and turns out to be a bad decision because that return isn’t actually achieved. Analyzing retirement planning trade-offs using tools like Monte Carlo analysis can at least help to identify these potential issues, as Monte Carlo inherently recognizes a range of possible returns, and can spot scenarios where a strategy may only be marginally superior – for instance, there’s a big difference between a pension lump sum that has a 95% probability of being superior, versus just a 51% chance, even if both are an “odds-on” bet with a favorable discounted net present value. And more generally, conservative investors should choose more conservative discount rates, while aggressive investors select more aggressive discount rates, simply to reflect how the available dollars really would/could be invested. Those who truly hold assets in cash might well use a discount rate near zero, to reflect that (current) reality.

The bottom line, though, is simply to recognize that using a discount rate can be a very effective means of evaluating the relative value of different strategies that provide varying payments over time, and comparing strategies to each other. But when analyzing those situations, it’s crucial to use a discount rate that appropriately reflects the opportunity cost of those dollars to the individual situation (whether it’s money to invest, or otherwise preserves portfolio dollars from not being withdrawn or liquidated so that they can remain invested).

So what do you think? What do you assume as the discount rate when doing a pension or Social Security analysis? Is it different for a pension lump sum decision? How do you explain your discount rate assumption? Please share your thoughts in the comments below!

Schwab States Its RIAs See Steady Growth & Richer Clients

Schwab States Its RIAs See Steady Growth & Richer Clients

The latest results are out for the Schwab Advisor Services’ 2017 RIA Benchmarking study, and notwithstanding the industry discussion about new competitive threats, the results are strong across the board for the RIA community. The median RIA on the Schwab platform grew at a 10% average annual compound growth rate over the past 5 years, as the median firm went from $358M in 2012 to $593M in 2016. Client growth was a somewhat smaller 5.2%/year of annualized growth, as the median RIA went from 266 clients in 2012 to 357 in 2016, suggesting that as RIAs grow in AUM, they continue to move further upmarket (larger average AUM per client). In fact, while the average client relationship overall rose from $1.6M in 2015 to $1.8M in 2016, the study found that firms with over $2.5B of AUM reported an average client size of more than $3M, compared to firms with $100M to $250M in AUM averaging only $1M per client. Other notable data points included: firms are still focusing on referrals (from clients, and centers of influence) as their primary planned growth strategy; companies are now combining referrals with other market strategies are growing 2.4X faster than their peers (and the “other marketing” strategies are producing as much new business growth as client referrals now!); and the larger the advisory firm, the more they’re looking to hire new financial advisors as relationship managers.

Does Monte Carlo Analysis Actually Overstate Tail Risk In Retirement Projections?

Does Monte Carlo Analysis Actually Overstate Tail Risk In Retirement Projections?

The most common criticism of using Monte Carlo analysis for retirement planning projections is that it may not fully account for occasional bouts of extreme market volatility, and that it understates the risk of “fat tails” that can derail a retirement plan. As a result, many advisors still advocate using rolling historical time periods to evaluate the health of a prospective retirement plan, or rely on actual-historical-return-based research like safe withdrawal rates, or simply eschew Monte Carlo analysis altogether and project conservative straight-line returns instead.

In this guest post, Derek Tharp – our Research Associate at Kitces.com, and a Ph.D. candidate in the financial planning program at Kansas State University – analyzes Monte Carlo projection scenarios relative to actual historical scenarios, to compare which does a better job of evaluating sequence of return risk and the potential for an “unexpected” bear market… and finds that in reality, Monte Carlo projections of a long-term retirement plan using typical return and standard deviation assumptions are actually far more extreme than real-world historical market scenarios have ever been!

For instance, when comparing a Monte Carlo analysis of 10,000 scenarios based on historical 60/40 annual return parameters to historical returns, it turns out that 6.5% of Monte Carlo scenarios are actually worse than even the worst case historical scenario has ever been! Or viewed another way, a 93.5% probability of success in Monte Carlo is actually akin to a 100% success rate using actual historical scenarios! And if the advisor assumes lower-return assumptions instead, given today’s high market valuation and low yields, a whopping 50% to 82% of Monte Carlo scenarios were worse than any actual historically-bad sequence has ever been! As a result, despite the common criticism that Monte Carlo understates the risk of fat tails and volatility relative to using rolling historical scenarios, the reality seems to be the opposite – that Monte Carlo projections show more long-term volatility, resulting in faster and more catastrophic failures (to the downside), and more excess wealth in good scenarios (to the upside)!

So how is it that Monte Carlo analysis overstates long-term volatility when all criticism has been to the contrary (that it understates fat tails)? The gap emerges because of a difference in time horizons. When looking at daily or weekly or monthly data – the kind that leveraged investors like hedge funds often rely upon – market returns do exhibit fat tails and substantial short-term momentum effects. However, in the long run – e.g., when looking at annual data – not only do the fat tails entirely disappear, but long-term volatility actually has a lack of any tails at all! The reason is that in the long-run, returns seem to exhibit “negative serial correlation” (i.e., mean reversion – whereby longer-term periods of low performance are followed by periods of higher performance, and vice-versa). Yet by default, Monte Carlo analysis assumes each year is entirely independent, and that the risk of a bear market decline is exactly the same from one year to the next, regardless of whether the market was up or down for the past 1, 3, or 5 years already. In other words, Monte Carlo analysis (as typically implemented in financial planning software) doesn’t recognize that bear markets are typically followed by bull markets (as stocks get cheaper and eventually rally), and this failure to account for long-term mean reversion ends out projecting the tails of long-term returns to be more volatile than they have ever actually been!

The bottom line, though, is simply to recognize that despite the common criticism that Monte Carlo analysis and normal distributions understate “fat tails”, when it comes to long-term retirement projections, Monte Carlo analysis actually overstates the risk of extreme drawdowns relative to the actual historical record – yielding a material number of projections that are worse (or better) than any sequence that has actually occurred in history. On the one hand, this suggests that Monte Carlo analysis is actually a more conservative way of projecting the safety of a retirement plan than “just” relying on rolling historical returns. Yet on the other hand, it may actually lead prospective retirees to wait too long to retire (and/or spend less than they really can), by overstating the actual risk of long-term volatility and sequence of return risk!

How Some RIAs Sell Life Insurance Through A BGA Without A B/D

How Some RIAs Sell Life Insurance Through A BGA Without A B/D

Executive Summary

One of the primary blocking points for those at a broker-dealer who want to transition to an RIA is how to handle insurance once they make the switch. Investment portfolios can be shifted from commission-based products with 12b-1 fees to institutional shares with an advisory fee… but there are still virtually no “no-load” insurance products (and few fee-based annuity products) available to RIAs. However, the reality is, RIAs actually can sell – and get paid for – many types of insurance and annuity products, without a broker-dealer relationship!

In this week’s discussion, we discuss how RIAs can leverage a relationship with a Brokerage General Agency (BGA) to get paid for implementing most insurance and annuity products, without a broker-dealer relationship!

The key is to understand the different types of investment and insurance licenses that exist. The Series 7 exam (to become a “General Securities Representative”) is actually only necessary to get paid a commission to sell “securities” – stocks and bonds, along with mutual funds, ETFs, and variable annuities and insurance. In turn, those with a Series 7 (or a Series 6) must have an affiliation to a broker-dealer, as technically it’s the broker-dealer that sells the product and collects a Gross Dealer Concession (GDC) commission, a portion of which is then remitted to the selling broker.

By contrast, in order to sell insurance products, it’s only necessary to have a life (and health) insurance license from the state, and to get appointed by the insurance company to sell their products. In some cases, there’s an overlap – given that products like variable annuities are both an annuity and a securities product. However, for those who just want to implement term life insurance, whole life insurance, or universal life insurance that is not variable, then the advisor simply needs a life insurance license… but not a Series 6 or 7, and thus the advisor does not need a broker-dealer, either!

Of course, this still raises the question of how an RIA gets appointed by a company to sell insurance in the first place, and manages product selection across a wide range of companies. If the goal is to sell fixed products, the solution is for an RIA to work with a Brokerage General Agency (BGA). Conceptually, a BGA is similar to a broker-dealer, except they only work in the realm of (fixed) insurance products. Fortunately, there are a lot of BGAs out there to choose from (some work nationally, many work regionally, and some simply operate locally), of which many will work with RIAs – for which the primary differentiators are the BGA’s service, breadth of products, and commission payouts (though notably because insurance commissions are standardized with the state insurance department, the products themselves will generally still be the same price to the client, regardless of the BGA).

But the bottom line is that if an RIA wants to sell fixed insurance products, then a broker-dealer relationship isn’t necessary, as the RIA can work through a BGA relationship instead. Though it’s important to remember that a BGA relationship must still be disclosed on Form ADV Part 2, and that CFP professionals at the RIA cannot call themselves “fee-only” if there are insurance commissions involved (even if paid to a separate-but-related entity)!

So with the DoL Fiduciary Rule taking effect, a lot of broker-dealers are changing right now. Everything from compliance policies to payouts to reps. In some cases, it’s really driven directly by DoL Fiduciary itself, which limits certain types of payouts and compensation that could be deemed an incentive to not act in the client’s best interest. In other cases, the truth is it’s just the change the broker-dealer wanted to make anyways and is doing it under the guise of the DoL Fiduciary.

But regardless of the cause, I’m hearing from a lot of advisors lately who are working at broker-dealers and are considering whether to shift and become and RIA instead, with the caveat that they don’t want to lose their ability to implement insurance and annuity products for certain clients who may need it. I want to talk about that for today’s “Office Hours,” and respond to a particular question that came in from…we’ll say her name is “Patti.” So Patti asked:

“Dear Michael, I formed a hybrid RIA, but I’m finding the BD part to be expensive. While I did it to keep my Series 7 active, I was mostly interested in being able to still sell insurance and annuities. Can an RIA still sell those solutions without being a hybrid? Depending on who I ask, I keep getting conflicting answers.”

Great question, Patti. Unfortunately, this is an area where I find there is a lot of confusion out there, which isn’t helped by the fact that most advisors ask their broker-dealer for guidance and their broker-dealer, frankly, doesn’t want to lose them because it’s profitable to keep them. And, as a result, broker-dealers don’t always give the clearest guidance. So let me try to help set the record straight.

When You Need A Series 7 License

The starting point for this is the Series 7. The Series 7 exam is called the General Securities Representative Examination because it’s meant to assess your competency to be a “General Securities Representative.” Now, in this context, security is a financial asset that’s sold or traded in financial markets. And so, having a general securities license means you’re licensed to sell virtually any type of security. That would include stocks and bonds, ETFs and mutual funds that hold stocks and bonds, and even variable annuities or variable life insurance which hold stocks and bonds.

But the key here is that a Series 7 exam is all about being able to sell securities investments (stocks, bonds, vehicles that hold stocks and bonds [including mutual funds], variable life, and variable annuity contracts). And so, if you want to get paid a commission on those products, you need a Series 7 license, or at least a Series 6, which covers all the “packaged” investment products like mutual funds, variable annuities, and variable life. Technically, the Series 7 just expands on that by allowing all the other “general” types of securities; individual stocks and bonds, options and derivatives, etc.

In addition to the Series 6 or Series 7 license, you need a broker-dealer to actually facilitate as the broker for those product sales. Because technically, the company brokers the transaction and you are the registered representative of the company. That’s why when the client buys a stock or a bond, the commission is paid to the broker-dealer which then shares a portion of their income with you because you’re the representative.

Similarly, that’s why when you sell a mutual fund, the commission is paid to the broker-dealer. It’s literally called a Gross Dealer Concession, or GDC. And then the broker-dealer pays out a portion of that to you as their representative. That’s the compensation for delivering the company’s brokerage services to the client. So, if you want to sell securities products, you need a Series 6 or a Series 7 license.

Now, this is different than getting paid an Assets Under Management (AUM) fee to provide ongoing investment advice or discretionary management of an account. That requires becoming a Registered Investment Advisor, or an RIA, so that you can actually get paid an advisory fee. That’s the separation; if we’re going to get paid a commission, we need a securities license with a broker-dealer. If we’re going to get paid an advisory fee, we operate as an investment advisor and register as an RIA. And the Series licenses are specifically about getting paid a commission or receiving a 12B-1 fee, which itself is a form of a commission.

When You Need A Life Insurance License [Time – 4:23]

By contrast, when you sell insurance products, you need a life insurance license from the state. Typically, that’s a life and health insurance license which permits you to get paid to sell life insurance, disability insurance, long-term care insurance, and, as the name implies, health insurance. Annuity products generally also fall under a life and health insurance license.

In addition, you have to get appointed with an insurance company if you’re actually going to sell and get paid to sell that particular company’s products. In some cases, there’s an overlap, because products like variable annuities are both an annuity and a securities product (because it’s a variable annuity where the client’s money will be invested in the underlying stocks and bonds through an annuity contract). And as a result, selling variable annuities or variable life insurance require both a life and health insurance license for the insurance or annuity wrapper and completing at least a Series 6 exam or the broader Series 7 license to get paid a commission for the fact that it’s a security product.

But the key point here is that’s a requirement only for selling variable insurance and annuity products. If you want to implement term insurance, whole life insurance, or universal life that is not variable – either a standard UL policy or an indexed universal life policy – then you need a life and health license, but not a Series 6 or a Series 7 unless you don’t actually need a broker-dealer either.

Similarly, if you just want to sell long-term care insurance or disability insurance, then you need a life and health insurance license, but no Series exam and no broker-dealer relationship. And even in the context of annuities, you can sell a fixed annuity, indexed annuity, or a lifetime immediate annuity with only a life and health license and no Series exam or broker-dealer relationship. It’s just the variable annuity and the variable life that actually requires the Series license and the broker-dealer.

Selling Life Insurance Under An RIA Through A BGA

The key question for Patti in all of this is whether she wants to sell fixed insurance annuities under her RIA or variable insurance annuities under her RIA? If the goal is to sell fixed products, a health insurance license is necessary, but a broker-dealer relationship is not. Patti would only need the broker-dealer relationship if she wanted to sell variable products, or at least have a desire to keep trails and maybe remain broker of record for existing variable insurance or annuity products.

It’s also worth noting that Patti would really just need the Series licenses and a broker-dealer relationship to get paid a commission on a variable product. With the rise of new fee-based variable annuities under DoL Fiduciary, Patti could even recommend variable annuities with only an insurance license and no broker-dealer. Because technically, you don’t need a BD relationship to recommend an annuity, you need it to get the commission. But if you’re going to recommend the variable annuity and charge a separate advisory fee for the advice, you can do that, once again, with the standard RIA and a standalone life and health insurance license.

For many, the practical question is how exactly do you get appointed with and work with an insurance company when you’re an RIA? And the answer to that is what’s called a Brokerage General Agency (BGA). In practice, you can think of a BGA as similar to a broker-dealer. It’s a couple networks with multiple products and provides support and assistance to those affiliated with them to sell the products. Except, while a broker-dealer is built to do securities products, a BGA is built to do insurance products.


So if Patti decides that she doesn’t want or need to do variable insurance or variable annuities but still wants to be able to sell fixed annuities and non-variable insurance – so term, whole life, UL, disability, long-term care insurance, etc. – then she doesn’t need a broker-dealer, but she does need a BGA relationship.

The good news is that there are a lot of BGAs out there. A few work nationally, many work regionally, and some simply operate locally for insurance agents in the area. If you’re searching for one, you may need to ask around to a lot of BGAs in your area to find one that’s willing to work with you as an RIA. Because, the reality is, many BGAs are used to working with career insurance agents who sell a high volume of insurance and may not necessarily want to work with an RIA that will only occasionally place insurance products with them. But there are definitely BGAs out there that will work with RIAs.

In fact, a few I know like working with RIAs because by the time we evaluate the client’s situation, do the financial planning, and make a recommendation, there’s a very high likelihood that the client follows through and buys the insurance, which is a good deal if you’re a BGA in the business of getting insurance sold. And a lot of RIAs work with people who, shall we say, have above-average net worth and affluence, and consequently tend to buy above-average-sized insurance and annuity policies.

In terms of choosing a BGA, most will ultimately compete on service – their ability to know the available products, help you navigate the marketplace, assist you with all the licensing and appointments, help you actually implement the policy, and make sure you get paid.

Beyond that, the reality is that larger BGAs that do a higher volume of insurance business may also potentially be able to pay slightly better commission payouts as well, but I find there’s not a ton of variability from one BGA to the next. Though, there can be some, because insurance is still a volume business and brokers – including Brokerage General Agencies – that put through a higher volume can get better deals.

But it’s important to know that every BGA is going to get the same product for your client. It’s not as though one BGA gets a long-term care policy or term insurance policy at a discount to the others. The consumer rates, the premiums, are standardized by the insurance company and filed with the state insurance department. Therefore larger BGAs with a higher volume might be able to negotiate better payouts on what you sell, but they’re generally not going to get cheaper pricing on the policies themselves. That’s not a lot of reason to shop amongst BGAs in most cases.

Disclosing An BGA Insurance Relationship On Form ADV Part 2

For advisors who are switching to an RIA and want to keep doing fixed insurance and annuity business (but are at least ready to let go of variable products and the investment commissions and walk away from old 12B-1 trails), the path is to form an RIA and then establish a relationship with a BGA (Brokerage General Agency).

It’s important to remember that if you do go this route, you still need to disclose the BGA relationship as an outside business activity and another source of compensation in your RIA’s Form ADV Part 2. This is absolutely a conflict of interest the SEC expects you to disclose. And, in addition, it’s worth noting having an insurance relationship with your RIA means you are not allowed to call yourself “fee-only.” Even if you create a separate company for your RIA to contract with the BGA to receive insurance commissions. If you, as the CFP certificant, will ultimately participate in the commissions through a company you own when you deliver the services to clients, then you’re receiving both fee and commission compensation and you have to disclose it.

I find this gets mixed up all the time. There was an incident a couple of years ago where CNBC named their top fee-only financial advisors, and nine out of ten got insurance commissions. They were an RIA, but they had insurance commissions. And this was a whole issue that arose with Jeff and Kim Camarda and the CFP Board. The Camardas had a “fee-only RIA” as standalone, and then a separate insurance company that they also owned that was receiving commissions from their clients. And the CFP Board publicly admonished them because, as CFPs, they were still receiving commissions. It was through a related party, but they were getting the compensation.

The Camardas fought the ruling, but ultimately, the judge held the decision for the CFP Board. And the latest proposed updates to the CFP Board’s Standards of Conduct would go even further in making it crystal clear that paying commissions to a related party entity in connection with your financial advice to clients, is still a commission to the CFP and it means you are not fee-only.

You can decide whether having the fee-only label is even useful to you or not. I’ve actually written more than once; I don’t think it’s actually a great marketing term. Being a fiduciary is very important. Marketing as fee-only, not necessarily. But I do want to warn you if you decide to participate in insurance commissions as an RIA, you are not fee-only anymore, so don’t market yourself that way. Even if your RIA only gets fees, commissions those clients pay that come to you directly or indirectly via your related entity is still a commission.

Obviously, a lot of RIAs just choose to outsource this altogether and let a third party firm implement the insurance and get the commission for the work they do to implement the policy. You don’t have to participate in the commission at all. I know a lot of advisors who have a background in insurance feel like it’s natural to do. But recognize, in financial planning, we regularly give tax guidance to clients, but we still refer preparing the tax return to the CPA. We talk about estate planning strategies with clients, but we still refer out the estate planning documents to an attorney. We may review automobile and homeowner insurance policies, but we still refer out the implementation to a P&C agent.

In the same manner, you can advise regarding insurance as part of your comprehensive plan and still refer out the implementation. There’s nothing sacred about implementing the insurance and, frankly, introducing the conflicts of interest that it entails. Especially when you look at all the other stuff we don’t implement but simply advise on, and then hand off to dedicated professionals that do that for a living.

As we wrap up, getting back to Patti’s original question about whether she still needs to be a hybrid RIA with an expensive broker-dealer relationship just to implement insurance and annuities with the clients, the answer is “It depends.” Because it depends on whether she wants to do variable life insurance and variable annuities, which do require a broker-dealer relationship, or whether she’s only looking to do fixed annuities and fixed forms of insurance like term, whole life, UL, disability, and long-term care insurance. Because, for the latter, you don’t actually need a broker-dealer. You just need a Brokerage General Agency (BGA) relationship. And even if you want to do variable annuities, if you use a fee-based product with no commissions and just charge a separate advisory fee, that’s still okay with just an RIA and a BGA relationship and no broker-dealer.

And while you do have to disclose it in your RIA’s Form ADV Part 2, it’s worth noting the BGA relationship really is separate. A hybrid broker-dealer is the broker-dealer often wants to do oversight on the RIA. With a BGA, they will not require compliance oversight of your RIA the way that a lot of broker-dealers do if you hybridize with them. The BGA is just going to live in their insurance realm, because that’s what they do.

It’s worth knowing as well that there are some RIAs even that split the difference. They’ll form a BGA relationship to still do fixed insurance and annuity business, but refer out the variable insurance annuity business (particularly if they don’t do a lot of variable business as it’s just easier to occasionally refer out than to introduce the hassle of a broker-dealer relationship if it’s going to be a very small portion of their business pie).

Although, again, with the rise of fee-based annuities that don’t pay commissions since the DoL Fiduciary Rule, I suspect we’re going to see more and more RIAs that just decide to do this with the BGA relationship, and terminate their hybrid broker-dealer relationships, since that BD is going to be less and less necessary in the future as more and more products go fee-based and fixed insurance doesn’t require the BD anyways.

So what do you think? Have you considered selling insurance through a BGA? Do you think more advisors will drop their hybrid structure and move to a BGA relationship after DoL Fiduciary?

Navigating Compliance Oversight When Blogging As A Financial Advisor

Navigating Compliance Oversight When Blogging As A Financial Advisor

Executive Summary

As digital marketing for financial advisors slowly gains momentum, there is growing interest amongst financial advisors to launch their own blog as a means to showcase their expertise. Yet the challenge, for advisors at both broker-dealers and RIAs, is that any prospective advertising content to the public must first be reviewed by compliance, and the compliance oversight process can make financial advisor blogging difficult – especially for those in a large broker-dealer environment.

This week we discuss blogging as a financial advisor, the compliance rules that apply to financial advisor blogging, and the issues to consider when navigating compliance oversight, both for RIAs and those operating in the broker-dealer channel!

Because in practice blogging is more popular at this point amongst RIAs than broker-dealers, a common question is whether the compliance requirements are different between the two channels. However, the reality is that whether you’re an RIA or a broker-dealer, anything you do that advertises to prospective clients or solicits prospective clients for your business is deemed “advertising”, and is subject to compliance (pre-)review. Technically broker-dealers are covered by FINRA Rule 2210, and RIAs are covered by Rule 206(4)-1, but in the end, both have requirements that compliance should review blog content before it goes out to the public, ensure blog content isn’t misleading, and record and archive blog content for later review. Which means, the key difference between channels is not really the regulatory compliance requirements.

Instead, the key difference is actually firm size. Most RIAs are small (at least by broker-dealer standards), and operate as either solo advisors, or with just a dozen or few advisors as a large RIA. By contrast, mid-to-large-sized broker-dealers may have hundreds or even thousands or brokers. And it’s this size difference that drives major compliance differences for financial advisor blogging between channels. Because in a small (or even “large”) RIA, an advisor is either themselves the chief compliance officer, or likely knows the compliance officer very well. Which means it is easy to get buy-in from the compliance officer to take the time to review the content of a blog. By contrast, a compliance officer in a broker-dealer rarely knows the brokers who many want to blog, and the sheer magnitude of trying to oversee advertising for such a large number of brokers leads to compliance officers to adopt very strict and very limited rules that force brokers to stay inside a small box of activities!

Fortunately, there are some more progressive broker-dealers that have begun to find solutions to allow advisors to blog. But unfortunately, many of those programs have been slow to roll out. For advisors who do want to start a blog, regardless of what channel you are in, there are some things you can do to increase your odds of solving the compliance issues. First, try to work proactively with your compliance department. Explain to them what you want to write about, and, if it’s not related to products, investments, or performance, tell them, because that will make their job easier. Second, write some content well in advance, and send it to them for review. After they’ve seen your content for a while and realize it is not a compliance risk, you may find they ease up a bit.

In the end, the challenges of overseeing such a large number of advisors in the broker-dealer environment have unfortunately squelched the ability of a lot of brokers to engage in blogging, but it’s not because they can’t, or that FINRA won’t allow it. Rather, it’s because broker-dealer compliance departments are struggling to oversee a huge number of brokers that they don’t necessarily know, while the more limited span of oversight at RIAs makes it easier to expedite the process!

Financial Advisor Blogging Compliance In RIAs Vs Broker-Dealers

Now, the reality is that whether you’re at an RIA or a broker-dealer, anything you do that advertises to prospective clients or solicits prospective clients to your business is going to be deemed advertising and is subject to compliance review. In the case of broker-dealers, that’s driven by FINRA Rule 2210, which scrutinizes whether any form of advertising communication is fair and balanced, and not misleading.

In the case of RIAs, it’s slightly different. It’s Rule 206(4)-1, which limits investment advisors from engaging in deceptive or manipulative advertising, particularly with respect to how investment advisors present performance, their track record of recommendations, and any kind of testimonials about their client results. Now, both channels have requirements that firms have to oversee and supervise any advertising content to ensure it’s complying with those rules. And that advertising materials have to be retained for some period of time as well, under a books and records requirement.

While there are some nuanced differences in what’s focused on in those compliance reviews of RIA versus broker-dealer environments, substantively, the key points are actually the same:

  1. Compliance should review it before it goes out to the public.
  2. It can’t be misleading about what you do and the results you provide.
  3. And it needs to be captured, recorded, and archived for later review.

So, generally speaking, any and all blog posts of an advisory firm are going to need to go through this kind of compliance review regardless of whether you’re at an RIA or a broker-dealer.

There’s actually not a big difference in that regard. Now, that being said, there is a major difference in practice in how compliance works when reviewing potential advertising materials, including blog posts, between RIAs and broker-dealers. The difference is size. Most RIAs are small (at least by broker-dealer standards). Many are solo advisors that just have themselves or a handful of staff. Even large independent RIAs often just have a couple of advisors.

There are very few that even have more than a dozen advisors in one firm. Which means the compliance process is much more straightforward. In some cases, the advisor literally is their own chief compliance officer who needs to review their own blog post, which, not surprisingly, gets done pretty quickly when you’re reviewing your own material. Even in multi-advisor firms, the chief compliance officer is often a partner who is reviewing the work of other partners, who has an interest in expediting the compliance review process, especially for a partner who’s already known and trusted, and is trying to grow your joint business.

By contrast, in a broker-dealer, there aren’t just a handful of a dozen advisors. There may be hundreds or thousands. And for wirehouses, more than 10,000, which means compliance has a lot of advertising to review constantly. Even worse, compliance departments in most broker-dealers have very little direct connection to the advisor whose content is being reviewed. In a small RIA, every advisor is probably going to know that chief compliance officer personally, maybe for years or a decade or more. In a mid to large-sized broker-dealer, not so much.

That becomes a problem because it undermines trust between the compliance department and the broker seeking compliance approval. Think about it for a moment. Put yourself in the seat of a compliance officer at a broker-dealer. So your job, your backside, is on the line every time you review advertising for your brokers. You could potentially get fired if you slip up and fail to properly oversee whatever the one dumbest, most idiotic broker in your entire firm might do that brings the whole thing down.

So, not surprisingly, if you want to keep your job as a compliance officer, this is pretty simple. You write strict, limited rules that force advisors to stay in a small box of activities. That makes it easier to oversee and reduces your risk of getting fired. Unfortunately, though, as we see in a practice, it also kind of squelches the ability of a lot of brokers to engage in blogging. Not because they can’t or that FINRA doesn’t allow it. But because the broker-dealer’s compliance department is so struggling to oversee a huge number of brokers that they don’t even necessarily know or trust, that it leaves them to write very limiting compliance rules.

Some of the more progressive broker-dealers have come up with workarounds to this. Some have special teams that review blog content, recognizing the importance of timeliness. Others just grant greater flexibility to top producers or more experienced brokers. Recognizing that compliance doesn’t quite have to be so limiting and restrictive for a subset of brokers who have long since demonstrated that they’re trustworthy, able to follow the rules, and not engaging in risky advertising behaviors.

But unfortunately, these programs have been slow to roll out. we see a lot more of the blogging amongst RIAs than we do amongst broker-dealers. Whether or how it really is at the individual firm still depends on the broker-dealer, how they choose to write their compliance rules, and how they execute their oversight process. Again, there are more progressive broker-dealers that have been willing to grant more latitude to experienced brokers (or are otherwise running some kind of pilot test to make it easier to blog), but we’re getting there slowly.

Advisor Compliance And Allowing Blog Comments

Now, a similar theme around financial advisor compliance for blogging props up when it comes to allowing comments on the blog. This was another recent question we got from Matt, who asked:

“I’m starting to blog and I’m getting pushback from my BD on allowing comments on the blog, which we both know is extremely important to engage audience. So, is this a FINRA thing? Would it be easier if I was an RIA?”

Great question, Matt. Again, this isn’t really a FINRA versus RIA thing.

The primary concern here, from the compliance perspective, is whether the comments on the blog can potentially be construed as testimonials or otherwise misleading statements about your investment results, track record, or your recommendations. Now, as we know, unless you’re literally writing about your investment performance, most blog comments are probably going to have nothing to do with clients giving testimonials about your services. They’re probably comments about actual content of the article or some other investment theme, financial planning strategy, or whatever else it is that you’re writing about.

But nonetheless, compliance officers have an oversight obligation. There’s still an expectation that they’re overseeing your blog comments, even if it’s just to prove they’re not testimonials. Now, in a small firm environment, this can be solved pretty easily. Configure your website to automatically email new comments directly to the compliance officer to review. Most blog and content management systems can do this automatically. But again, in a larger broker-dealer context, that may not be feasible.

The firm may not be built to take all those incoming comments, or you may not be configured to give your broker-dealer compliance department access to manage your blog when those comments appear, so that they can take down the inappropriate ones. Nor does the compliance department necessarily want to do the work, because it’s potentially time-intensive and a resource drain for the broker-dealer compliance department. They may feel like they have bigger fish to fry.

So, the end result is that broker-dealer compliance departments often say, “No comments.” Not because comments are banned by regulators, but because there is something for them to oversee and it makes it more time-efficient for them to just say, “No comments,” and then they don’t have to oversee it. In theory, that can be a problem for a small RIA as well. But again, in a small RIA, I’m more likely to know my compliance officer and be able to say, “Hey, work with me. This will be good to grow our firm,” and get them to do it.

In a broker-dealer, especially when the majority of advisors don’t blog right now, asking a compliance officer to oversee your blog comments just feels like more work to them. So, unfortunately, they often just say, “No.”

Setting Up A Financial Advisor Blog Separate From Your Advisory Firm Website?

I know that for some advisors, this at least starts to raise the question, “Well, then should I just do my blogging separate from my advisory firm website, so I can avoid dealing with all this compliance hassle altogether?” To which I’d answer, “Maybe”, at best, because that will not automatically solve the compliance issue.

Because the reality is that if you’re employed in our financial services industry, whether it’s an RIA or under a broker-dealer, if you’re even going to engage in blogging as an outside business activity, that still needs to be disclosed to the firm. The compliance department still gets to decide whether that’s okay or not, and whether it’s something they need to oversee further. If the focus of your blog is to solicit clients, compliance is likely going to say it’s still part of your advisory firm or broker-dealer activity, and it’s still subject to oversight, even as a separate website.

Because it’s not ultimately about whether it’s on your business website or not. It’s about whether you are engaging in an effort to make recommendations, solicit clients, or otherwise advertise for your services. In other words, what makes compliance need to oversee the blogging is not what website it’s on. It’s how it relates to you providing services or trying to get clients. Now, that being said, I do know some advisors who have launched successful blogs that are separate from their advisory firm website and have separate compliance oversight.

The key points to this approach are, first, it’s still disclosed to compliance that it’s happening. They have to approve of this as an outside activity.

Second, if you want to go down this road, the content cannot pertain in any way to recommending specific products, providing individual investment advice, or talking about your performance or track record at all. Because that immediately scoops it back up in the normal regulation of your activities as an advisor.

Third, don’t talk about investment performance at all, in any way, because again, that has to be overseen as well.

And fourth, don’t solicit clients on that blog. Because if you lead with, “Jim is a financial advisor who’s now taking clients,” at the bottom of every article, you’re soliciting clients and you’re advertising for your services, and the firm is going to need to oversee your advertising efforts. Now, if it’s, “Jim provides this educational website for free. If you want to learn more about what he does, click here,” and the Click Here goes to your separate website with your advisory firm, with all of your advertising that is compliance overseen, that’s probably not an issue for most compliance officers.

Because they don’t need to oversee education, and they don’t need to oversee material that is outside of the scope of regular financial services and financial advising. In fact, some of the best blogs are so specific to a niche that you wouldn’t be talking at all about your advisory services. It’d be about all the non-investment issues of your niche and if the people are so interested in that, they want to talk to you, you can send them to your actual financial advisor website. However, this separate blog approach just isn’t feasible for a lot of advisors.

Because their blogging is so tied to their advisory services, their investment outlook, or their investment views, that they couldn’t separate it if they wanted to. The whole point of the blog is to actually solicit clients and advertise their services. But I thought it’s worth knowing there are at least some advisors that do this separation successfully. You just have to be very clear about drawing the line, and you still need compliance on board with the decision to maintain it separately. Now, of course, if you’re going to run the blog separate from your advisory firm, you do still need some way to get them to your advisory firm.

If you don’t, you’re just giving content away for free and you’re never actually going to capture any business, which isn’t good for business either. That’s actually why I tend to recommend that most advisors put their blogs directly on their advisory firm websites. Because if you’re really trying to get clients, at the end of the day, you want clients to see the firm and you want them to be reading the content on the firm’s website. That’s how you start building awareness of your company’s brand so that you can do business with these people in the future.

But the bottom line here is just to recognize that the obligations of compliance really aren’t that substantially different between RIAs and broker-dealers. The financial service industry as a whole has stringent rules about how advisors advertise to the public and that includes blogging, and it’s true on both sides of the channels. But it is true that RIAs tend to be much smaller than mid to large-sized broker-dealers, where most brokers work.

Which means, it is often easier to work proactively with a chief compliance officer in an RIA to come up with an oversight process that works. While at large BDs, a compliance officer often has no connection to the brokers and risks being fired for whatever the one biggest idiot in the firm might do, so the compliance policies tend to be more restrictive around a lot of things, including blogging. Not because FINRA requires it, but because that’s the dynamic of executing compliance in a very large firm.

Getting Started With A Financial Advisor Blog [Time – 12:03]

For those who do want to get started, here’s my suggestion on moving forward. First, try to work proactively with your compliance department. Contact them. Tell them what you’re trying to do. Be very clear about what you want to write about. Especially if it’s not related to products, investments, or performance, tell them. It doesn’t alleviate them of your compliance burden, but it does make it easier for them. It’s kind of a nice way of saying, “I’m not a threat to your compliance job.”

Second, plan out your expected editorial calendar of content and write your first couple of articles far in advance, and send it in for compliance to review. Yeah, it helps to produce timely blog content. But the reality is that a lot of what you should produce should be long-term, evergreen content anyways, that answers common questions of your clients and prospects, and doesn’t have to be timely. So start with that. Write your first two, four, or six articles that you’re going to put out over the next couple of months. Send them all into compliance at once. You’ll have a lot of lead time. You can start working out the process and the kinks with compliance.

I suspect what you’ll find… The pattern I’ve seen with a lot of brokers who have gone down this road, is that after the first couple of months, once compliance reads a bunch of your articles and realizes that you’re probably not talking that much about investments, performance, or product recommendations (all the stuff that they’re worried about), they may even ease up a bit. I’ve heard from a lot of brokers, in particular, and broker-dealers that say, “Compliance early on was really a pain about the blogging.” But it eased up after a few months of the process once compliance realized they weren’t a threat. And particularly if you can get a dedicated compliance officer that works with you and starts to really understand the nature of your content.

Now, if you’re going to be really focused on investment issues and you want to write an investment commentary, yeah, be prepared that you’re going to have to work much more proactively and push the process a little bit harder to get things to run in a timely manner. Because now, you truly are writing timely content. But most blog content doesn’t even actually need to be that timely, unless you’re specifically trying to promote investment content.

I hope that helps a little as some food for thought around blogging as an advisor, the differences or not between broker-dealers and RIAs, and why it’s less a difference of regulation in the channels and more just a difference of the size of firms, and the challenges that large firms have trying to oversee large numbers of advisors and brokers.

So what do you think? Are actively managed funds going to see a sudden increase in performance due to the changes in broker compensation? Will brokers start pointing to fund performance rather than account performance, since the former won’t include their fees? 

DOL Rule Forces Independent Advisors To Differentiate & Adapt

DOL Rule Forces Independent Advisors To Differentiate & Adapt

In the latest Schwab Independent Advisor Outlook study, a growing number of financial advisors report feeling compelled to do more for clients, without being able to increase their fees to pay for it. A whopping 44% of advisors state they have already begun to provide more services to clients without charging for them, and 40% of advisors are spending more time on each client without increasing fees. Notably, the study does not find that advisors are cutting their fees to compete with robo-advisors and the like; instead, advisory firms are responding to competitive pressures by trying to do more to justify their existing fees in the first place (at the risk of compromising their profit margins over time).

In fact, the pressure to do more and offer a wider range of services for clients was the dominant theme of the study’s future outlook as well, as advisors themselves are increasingly suggesting that the key to differentiation in the future – especially as DoL fiduciary forces more and more competitors into the AUM model – will be offering clients a broader range of services beyond just the portfolio, from tax planning, to philanthropic advice, and health-care planning. In the meantime, as the DoL fiduciary standard itself becomes universal, only 20% of the RIAs in Schwab’s study stated that they anticipate trying to differentiate through a commitment to more stringent standards for advice. Nonetheless, 79% of advisors reported feeling confident about the future of the industry, and expect more opportunities in the next 10 years, particularly as financial planning itself continues to mature.