Tag: Retirement

The Conflicts Of Interest Between RIAs And Their Custodians (and Brokers And Their B/Ds)

The Conflicts Of Interest Between RIAs And Their Custodians (and Brokers And Their B/Ds)

Executive Summary

The need to manage conflicts of interest is a central issue in meeting an advisor’s fiduciary obligation to clients, whether it’s part of an RIA’s fiduciary duty under the Investment Advisers Act of 1940, or any financial advisor’s obligation when serving any retirement investors under the Department of Labor’s fiduciary rule. Yet the reality is that prospective conflicts of interest go beyond just those that financial advisors may face with the product compensation they receive for implementing various insurance and investment products. In fact, financial advisors often face direct conflicts of interest with the very platforms they’re affiliated with, particularly when it comes to practice management advice in how to grow their own business and serve their clients!

In this week’s discussion, we discuss the conflict of interest that exists between RIA firms and their RIA custodian platforms (as well as between brokers and their broker-dealers), and why advisors should perhaps be a bit less reliant on their platforms for financial planning education and practice management insight, given the “conflicted advice” they’re receiving!

A straightforward example comes up in the context of whether financial advisors should aim to serve “next generation” clients – in particular, the next generation heirs of their existing clients. Concerned about the assets that might leave their platform, RIA custodians regularly encourage and urge advisors to build relationships with the heirs of their clients, so that the assets don’t leave. Yet ultimately, that just emphasizes that to the custodian, the “client” isn’t even the client – it’s simply their pot of money, that the custodian wants to retain, regardless of who owns it… which means pursuing the assets down the family tree. By contrast, financial advisors who are focused on their clients – the actual human beings – would often be better served by simply focusing on who they serve well… which means if the firm is retiree-centric, the best path forward is not to chase pots of money to next-generation heirs when their retired clients pass away, and instead is simply to go find more new retirees! In other words, advisors are getting advice from their RIA custodians to pursue next-generation clients is often based more on what’s in the custodian’s best interests, not necessarily what the advisor’s best interests for their practices!

Another way that RIAs sit in conflict with their RIA custodial platforms is that in the end, one of a fiduciary advisor’s primary goals is actually to proactively minimize the profit margins of our RIA platforms! Thus, advisors try to minimize transaction costs, lobby for lower ticket charges on trading, pick the lowest-cost share classes that don’t have 12b-1 fees or revenue-sharing agreements, find the optimal balance in selecting No Transaction Fee (NTF) funds versus paying transaction fees based on the size of the clients’ accounts and what will be cheapest for them, obtain best execution pricing regardless of order routing kickbacks, and minimize client assets sitting in cash. And all of this matters, because how do RIA custodians actually make money? Ticket charges, revenue-sharing from asset managers, getting basis points on NTF funds, order routing revenue on execution, and making a 25+ basis point interest rate spread on money market funds. Which means the better the job that the RIA does for its clients, the less profitable they are for their RIA custodian (a fact that advisors are often reminded of by their RIA custodian relationship managers!), and RIAs have a fundamental conflict of interest between being “good advisors” for their custodial platform and watching out for their clients’ best interests.

Notably, this phenomenon is not unique to RIAs. It’s perhaps more noticeable because we usually talk about RIAs as being fiduciaries that are minimizing their conflicts of interest, but it’s equally relevant for those who work on a broker-dealer platform as well. Because as product intermediaries, broker-dealers ultimately make their money off of transactions, and it is impossible to sell financial service products without a broker-dealer! Yet the challenge is that the B-D can make more when they are offering both compliance oversight and getting a slice of GDC on all transactions, as opposed to just a compliance oversight slice of advisory fee business. Which means that while a fee-based business model may be more stable and valuable in the long run for a financial advisor, able to grow to a larger size and sell for a higher multiple, B-Ds are often at risk for making less money as their advisors shift to fee-based business that makes more for them (or alternatively, forces the B-D to increasingly try to reach into the advisor’s fee-based business with ever-expanding “compliance oversight”).

The point is not to paint every B-D or RIA custodian in a nefarious light – as they’re just trying to run their businesses – but it’s crucial to understand that in many situations, what’s best for the broker-dealer or RIA custodian is not necessarily best for the advisor on the platform. Which is concerning, because too many advisors don’t seem to acknowledge these inherent conflicts of interest, especially since advisor platforms are often the primary place they go for financial planning education and practice management insight, not realizing the conflicted advice they are receiving. And so, while it can be great to take advantage of some of the resources that these platforms provide, advisors should still be careful to consider whether the advice they receive is really in their best interests as an advisor, or ultimately about maximizing revenue for the platform instead!

Is Your Client The Person Or Their Pot Of Money? [Time – 0:56]

I’ll give you an example. In recent years, there’s been a huge amount of buzz in the industry about the need for financial advisors to build relationships with their “next-generation” clients; i.e., the heirs of their current clients who are likely to inherent the wealth of their existing clients over the next 10 or 20 or 30 years. Now on the one hand, it sounds kind of intuitive. The typical RIA is focused on doing retirement planning, which by its nature means a somewhat older set of clientele who are at greater risk of passing away. So why not try to build a relationship with their heirs so that you can retain the assets?

But let’s think about this for a moment. I’m going to translate it to another industry. Let’s pretend that you run a nursing home for affluent seniors who can pay the full price you’re charging for your high-quality service. Now, this nursing home is likely to be a very profitable business since you’re serving affluent clientele, but it’s got one fundamental problem: Like a retiree-centric advisory firm, the people who pay you in a nursing home tend to keep passing away. Kind of a problem. And then their assets that they were using to pay you vanish to the next generation, and you won’t get paid for that nursing home room anymore.

So you say, “Hey, I’ve got a great idea. Let’s become a really tech-savvy nursing home. We’ll wire up every room with Apple TV and we’ll make it so you can lock and unlock your room with your iPhone, and we’ll make a cool website that lets you sign up and choose your room entirely digitally, and we’ll start doing classes on how to make responsible housing choices for young people.” In other words, we’re going to do whatever it takes to make this nursing home one that our patients’ next-generation kids would want to move into once their parents or their grandparents pass away by building a relationship with them and then making our services more tech-savvy to appeal to a younger generation.

But of course, there’s one thing that this nursing home exercise is kind of forgetting in the endeavor. It’s a nursing home. It doesn’t matter how tech-savvy and Millennial-centric it tries to be, it’s a nursing home. Give the Millennials a little credit to realize that they probably don’t want to live in a nursing home. They want to live somewhere that’s relevant for them. Which means the best strategy for the nursing home with patients who keep passing away isn’t to try to get their next-generation heirs to use their inherited money to keep paying for the nursing home room; it’s to find new, affluent seniors who would want to move into the empty nursing home room.

And I find this analogy fits quite well for financial advisors. How many advisors have retiree-centric, baby boomer-centric firms and are rolling out next-generation client initiatives to try to build a relationship with the heirs of their clients and trying to be more tech-savvy to retain them, and somehow assume that the next-generation heirs aren’t going to notice that you’re still an advisory firm for retirees that isn’t focused on their needs?

I’ve written about this before. You can’t just make your website tech-savvy and put a robo advisor button between the images of the lighthouse and the Adirondack chairs overlooking the beach on your website and expect to get Millennial clients. It’s not going to happen. Or, viewed another way, the key point here is that when you try to pursue the money down the family tree, what you’re really saying is “My client isn’t actually the human being I’m serving. My client is their pot of money. And I’m just going to chase the pot of money wherever it goes, regardless of who’s actually holding it. I don’t even care who the person is. I’m just serving the pot of money.”

Because again, if you were really focused on trying to be the best you can at serving your ideal client than your clients or retirees who sometimes pass away, your goal would be to find more retirees because that’s who you serve. Not chase the pot of money.

But here is the important distinction. For the RIA custodian, they don’t have the relationship with the client; we do as the advisors. They, the custodian, literally hold the pot of money because they’re a custodian, it’s what they do. So for them, the “client” isn’t the person, it actually is the pot of money.

And that’s why when you look closely, you realize that virtually everything being written about how advisors must pursue their next-generation clients is all coming from the RIA custodians. Because their client is the pot of money. They don’t have a relationship with the person. They rely on the advisor for the relationship with the person.

And so, what do the custodians do? They egg on the advisors to chase the pot of money instead of focusing on their ideal client because the custodian is concerned about the demographics of their own pot of money and not the advisor’s business. It’s a fundamental conflict of interest around practice management advice. Advisors serve their ideal clients until they retire themselves in 10 or 20 years. Custodians serve pots of money and are ongoing, indefinite businesses. So the custodians care a lot more about multi-generational pots of money than advisors ever need to do. And as advisors, we care about our clients.

But the end result? Sometimes, we get what I think is actually really bad advice from our custodians based on what’s in their best interests instead of what’s in our interest as advisors and advisory firm business owners.

Fiduciary Advisors Exist To Optimize Away RIA Custodian Profit Margins

Now, another way that RIAs sit in conflict with our custodial platforms is that in the end, one of our primary goals as advisors is essentially to proactively minimize the profit margins of our RIA platforms. Think about it a moment…for instance, as fiduciary RIAs, it’s common for us to do whatever we can to minimize transaction costs. So we push for lower ticket charges, we pick the lowest-cost share classes that don’t have 12b-1 fees or rev sharing to platforms. We choose no transaction fee or NTF funds for our small clients where a ticket charge would be cumbersome. But then we flip back and pay the transaction fees for our larger clients where that would be cheaper than the higher basis point expense ratio of NTF funds.

Similarly, we try to minimize the amount of client assets that sit in cash. We tend to discourage clients from taking on additional risks through margin loans. We even have an obligation from the SEC to obtain best execution pricing, regardless of whether how much the platform might be getting paid for order routing to certain exchanges.

And all this matters because how do RIA custodians actually make money? Ticket charges, revenue sharing from mutual funds, making margin loan interest, getting basis points and NTF funds, making their 25 basis point interest rates spread on money market funds, and order routing revenue on execution. Basically, our primary goal as RIAs is to minimize every point of revenue generation for an RIA custodian. Because every dollar that doesn’t go to the RIA custodian as a cost is another dollar that accrues to client. Which improves their wealth, which makes our performance look better, and even to a slight degree, the size of the portfolio that we get to bill on in the future because it didn’t to go to RIA platform fees.

And it’s a fact that RIA custodians often remind us about. How many RIA owners out there have had a recent conversation with their RIA custodian where they were reminded from the custodian about whether how profitable they are as an RIA on the custodian’s platform? Usually right before you begin to negotiate your soft dollar agreements or whether the custodian is willing to make some concession you were requesting for a client.

Because the realities of the RIA custodian business model is built on these incredibly thin margins that rely on huge amounts of dollars in these profit centers to work, even as we try to minimize them. I mean, think about just the cash position alone for a minute. So Schwab has upwards of $1.3 trillion in advisor assets. Now let’s imagine for a moment that the typical advisor keeps 3% in cash in their client portfolios. Maybe a little bit is a holdback for fees, some is to fund the client’s ongoing retirement distributions. Maybe a little bit of it is new savings or portfolio additions that haven’t been invested yet.

Now across $1.3 trillion, a 3% cash position amounts to $39 billion in cash. And so, if Schwab makes 25 basis points on that cash as an interest rate spread in their money market, that’s almost $100 million of revenue just from the small percentage of idle cash in money markets. And then, what happens if the advisory firm adopts rebalancing software that makes it easier to identify clients that have idle cash and get it invested? If widespread use of rebalancing software drops the average cash balance by 1%, making client portfolios more efficient and better invested, Schwab loses about $30 million of profit straight off the bottom line by not getting the money market spread. And heaven forbid, services like MaxMyInterest get off the ground.

For those who aren’t familiar, MaxMyInterest connects a client’s investment accounts to a bunch of outside banks and then tries to automate the process of moving the cash in and out of the custodian’s investment accounts and amongst the outside banks to maximize the yield on the client’s cash. So if some online bank offers a slightly better yield, MaxMyInterest just automatically shifts the money over to wherever it gets the best yield. Great service for clients, increases their returns, and it’s a nice value-add for the advisor. And if it takes the average cash balance down by 2% on average because that money moves to external banks with better yields, Schwab loses $65 million in profits like that. It’s a huge conflict.

Now I don’t mean to paint an antagonistic picture here between RIAs and their custodians. But it’s crucial to recognize that as advisors, what profits the RIA custodian takes money out of our clients’ pockets. And what keeps money in our clients’ pockets that we try to fight for our clients takes it away from the custodian’s profitability.

And so, like it or not, we have a fundamental conflict of interest between being good advisors for our custodial platform and being good advisors that watch out for our clients’ best interests. Whether it’s trying to minimize cash balances, move money off-platform for better yields, optimize when to pay ticket charges and when to use NTF funds for smaller clients; all of those things that we do minimize profit for the platform.

How Broker-Dealers Are In Conflict With Their Brokers

Now, it’s worth noting that this phenomenon actually isn’t unique to RIAs either. It’s maybe more noticeable because we usually talk about RIAs as being fiduciaries that are minimizing conflicts of interest. But it’s equally relevant for those that work for broker-dealer platforms as well. Because, in the end, the fundamental model of a broker-dealer is that they’re an intermediary for financial services’ product distribution. You can’t sell a financial services product without a broker-dealer. And every time you do, the broker-dealer gets a slice of that GDC. The more products you move, the more money they make by getting a piece of every transaction.

By contrast, because their business model is built around being a product intermediary, there’s not much money for a broker-dealer when advisors shift to advisory fees, and especially when they start charging separate fees for financial planning. Because the broker-dealer can’t make as much by taking a slice of planning fees as they do from products. Not only because payouts from products tend to be lower than payouts from financial planning fees which means the broker-dealer keeps a little more, but also because the slice of GDC isn’t even the only way that a broker-dealer makes money on that transaction. When the brokers on the platform do a higher volume of product transactions, the broker-dealer gets to go to the asset manager or product manufacturer and get them to pay money to sponsor conferences, to pay for shelf space and due diligence, or to pay for better revenue sharing terms. Simply put, the broker-dealers profit more from their advisors having them get paid through products for financial planning than when advisors get paid fee-for-service financial planning advice.

And in that context, it’s maybe no great surprise that broker-dealers have been so negative on the Department of Labour’s fiduciary rule. Because if the advisor on the platform shifts from product commissions to fees, even if they generate the same revenue and do the same services for the same clients, the broker-dealer doesn’t make as much money. The client may be just as well served, and the advisor may be just as capable, but the BD gets squeezed. Which results in this bizarre environment that we currently have where one advisor serving after another shows that the overwhelming majority of advisors support a fiduciary rule that acts in the best interest of their clients, including both advisors at RIAs and at broker-dealers. But the broker-dealer community has been the most vocal in fighting the fiduciary rule and the most active lobbying in Washington against it. Not because it’s necessarily for the advisors at the broker-dealer, but because it’s bad for the broker-dealer itself. And so, the broker-dealer community has been trying to convince its brokers that it would be bad for them too, when it’s really not the brokers that are challenged; it’s the broker-dealers that need to reinvent themselves after DoL fiduciary.

And these problems crop up in other areas as well. This is why a lot of broker-dealers are pushing their advisors to pursue next-generation clients. They have the same generational challenges as the RIA custodian whose client is really the pot of money, even though the advisor’s client is the actual human. And at least some broker-dealers limit product selection on their platforms based not necessarily on what products are best for their advisors or clients, but which ones are most willing to pay shelf space, better revenue sharing terms, or more money at the next conference to sponsor.

And David Grau has written extensively on how succession planning departments at a lot of broker-dealers are encouraging their advisors to take what are actually very bad succession planning deals for the advisor because it facilitates an on-platform transaction which keeps the clients and assets for the broker-dealer, even if it fails to maximize the value of the deal for the advisor who’s selling the practice.

Now again, as with RIA custodians, I don’t want to paint every broker-dealer in a nefarious light. They’re just trying to run their business model as RIA custodians do, and the reality is that they need to make money somehow and it has to come from somewhere, whether it’s the advisor or the client or both.

But is the key point to recognize the conflicts of interest that do exist between RIAs and their custodians, and between brokers and advisors and their broker-dealer platforms. Which is concerning, because, for so many advisors, their platforms are the primary place they go for education and insight and practice management advice, often not realizing the “conflicted advice” that they’re receiving from their platforms. And these platforms are also the primary advertisers for most of the trade publications, and the ones that push these same issues and topics into the industry media. Again, done in the manner that’s ultimately about maximizing revenue for the platform, not necessarily actually giving the best practice management advice for the advisor. This is actually one of the reasons that I originally launched the Nerd’s Eye View blog in the first place, because I felt there was a need for some kind of platform where advisors can actually hear objective advice from a colleague not colored by the economics of their RIA custodian or broker-dealer platform.

I hopes this provides some food for thought, as well as an understanding that while a lot of RIA custodians/broker-dealers really do try to help their advisors succeed, it’s important, as with any form of conflicted advice, to take it with a grain of salt, and to recognize the potential conflicts that may underlie whatever practice management advice you’re getting. Especially since the conflicts of interest between advisors and their platforms do not necessarily get disclosed the way that so many other conflicts of interest get disclosed to clients.

This is “Office Hours with Holman Skinner” at normally 1:00 p.m. East Coast time on Tuesdays, although obviously, I was a little bit late today. But thanks again for joining us and have a great day, everyone.

So what do you think? Do fiduciary advisors inherently eat away at RIA custodian profits? Do many advisors realize these conflicts of interest exist? What could be done to avoid these conflicts? Please share your thoughts in the comments below!

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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!

Three Degrees Of Bad Retirement Outcomes

Three Degrees Of Bad Retirement Outcomes

When doing retirement planning, it is common to talk about retirement plan outcomes as either “successes” or “failures”, where Monte Carlo analysis aims to determine the probability of success. Yet Cotton notes that from the client’s perspective, “failure” really occurs in degrees: the first is failing to achieve the household’s desired standard of living; the second is failing to at least maintain the household’s basic standard of living “floor” (i.e., the basic necessities); and the third is an outright bankruptcy (where everything is lost that isn’t specifically protected from creditors). The distinctions matter, because the reality is that many plans that might “fail” because a portfolio is depleted (and can no longer maintain the desired standard of living) may still have enough guaranteed income streams to sustain at least a reasonable floor (e.g., thanks to Social Security benefits). And in fact, some retirees will even choose to arrange their assets in a manner that increases the risk of “failing” at the top tier, in order to better secure at least achieving the second tier (e.g., by choosing to annuitize a portion of assets, and give up upside in exchange for a more secure floor). Even just discussing the phenomenon with clients – where a risk of “failure” is really just a risk of making some adjustment between the desired standard of living and the floor level standard of living – can change their attitude about how comfortable they are with a strategy, recognizing that “failure” may really just be about an “adjustment” (from the desired standard of living down closer to the presumably-still-tolerable floor). Though at the same time, it’s important to recognize that the need for expenses isn’t guaranteed, either – in other words, a “safe” floor might no longer turn out to be safe if a change in health necessitates higher expenses than what the floor provides. Nonetheless, the key point remains that not all “failures” are equally failing, and similarly that there can be a big difference between depleting the portfolio, and the total depletion of wealth or bankruptcy. Which means it’s necessary to discuss all of these dynamics and trade-offs with clients, if you want to help them make a good decision about how to allocate assets in retirement!

Why Aren’t Checklists A Financial Planning Standard?

Why Aren’t Checklists A Financial Planning Standard?

Executive Summary

As financial planning for clients grows more and more complex, it becomes increasingly difficult for planners to recognize every planning issue, opportunity, and concern from memory alone. As a result, there is an rising risk that planners commit malpractice and make a mistake – albeit by accident – in the struggle of trying to apply everything they have learned to an incredibly wide range of client situations.

However, the reality is that this challenge is not unique to financial planning. Many professions face a similar struggle, where the sheer amount of knowledge required, and the incredible number of client/customer/patient situations make it almost impossible to remember everything that’s necessary at the exact time it’s needed, mean a rising risk of mistakes, negligence, and ineptitude.

So what’s the solution to address this challenge? As it turns out, there’s a remarkably simple one: checklists. While it may seem absurd that such a basic device could enhance client outcomes – in fact, as professionals we often bristle at the thought that a checklist could tell us something we don’t already know – it turns out that checklists may be an excellent means to deal with the simple fact that we are all fallible humans.

Unfortunately, though, few checklists currently exist in the world of financial planning, especially outside of the operational aspects of an advisory firm. Nonetheless, it is perhaps time to give checklists the recognition they deserve, as a potentially critical step to ensure that we apply the proper due diligence to each and every complex financial planning situation, and that nothing accidentally slips through the cracks.


The Checklist Manifesto by Atul GawandeThe inspiration for today’s blog post is the book “Checklist Manifesto” by Atul Gawande, a doctor who was the primary driver behind the World Health Organization’s “Safe Surgery Checklist” and who makes a compelling case that checklists should probably be adopted more broadly in all industries and professional services – including financial planning – as a way to deal with the incredible complexity that we face as practitioners.

Ignorance Vs Ineptitude

It’s important to recognize that in many situations, professionals fail simply because the task at hand was beyond saving; we may have tremendous intelligence and technology available to us, but we are not omniscient or all-powerful, and some fallibility is inevitable. However, Gawande notes research by Gorovitz and MacIntyre who find in the medical context that in situations where success or failure is within our control, there are two primary drivers that lead to failure: ignorance, and ineptitude.

Ignorance has been the driving force for failure for most of medical history. Up until just the past few decades, we simply didn’t know what the true causes were for many diseases and maladies, much less how to treat them or fix the underlying causes. For instance, Gawande notes that as recent as the 1950s, we still had no idea what actually caused heart attacks or how to treat them, and even if we’d been aware of contributing factors like high blood pressure, we wouldn’t have known how to treat that, either. If someone had a heart attack and died at the time, it was our collective ignorance of the underlying problems that led to the “failure” to save the patient.

By contrast, in today’s environment, we have developed numerous drugs to treat high blood pressure, as well as heart attacks themselves. We “know” how to fix an astonishing range of maladies. If an ineffective (or even harmful) treatment is applied now, we don’t simply let the professional off the hook on the basis of “well, we didn’t really know what to do, anyway.” In other words, our collective ignorance of how to treat a problem is often no longer an acceptable answer when there is an unfortunate outcome; instead, a failure of the professional is an “error” and a sign of ineptitude.

Of course, the caveat is that many of the professional situations today are of a highly complex nature. While we might understand far more about the body and how to treat it than in the past, it is still remarkably complex, and many “failures” of a medical practitioner still walk a fine line between ignorance, ineptitude, and a situation that was never really able to be saved in the first place. As a result, Gawande notes that we’re more likely to address such situations by encouraging more training and experience for the practitioner, rather than to punish failure, as long as outright negligence was not involved. Unfortunately, though, it’s not clear if more experience and training alone are necessarily sufficient; as our knowledge increases, so too does the complexity of applying it correctly, to the point where we may be reaching our human capacity to apply such a depth of knowledge to such a breadth of situations in a consistent manner. We are still only human ourselves, after all.

Managing Through Complexity With Checklists

So what’s the best way to manage through such an incredible depth of complexity? Gawande notes that the World Health Organization’s classification of diseases now categorizes more than 13,000 ailments, and one study of 41,000 trauma patients in Pennsylvania found that doctors had to contend with 1,224 different injury-related diagnoses in 32,261 unique combinations. To say the least, the difficulty of providing 32,261 different diagnoses in 32,261 different situations is a challenge of enormous complexity for the human brain. So what’s the solution? Checklists, to at least ensure the big things don’t slip through the cracks.

Initially, Gawande notes that the idea of checklists was soundly rejected in the medical world. Given the complexity of the problems involved, how could a single checklist or a series of them possibly have much of an impact? Yet it turns out that even relatively routine checklists can have a remarkably material effect, for the simple reason that as human beings, we don’t always remember to do every single step in a process the exact same way every time, especially when most of the time it doesn’t really matter. For instance, one early study applying a simple checklist to implant a central line (a catheter placed into a large vein to deliver important medication) to patients: 1) wash hands; 2) clean patient’s skin; 3) put sterile drapes over patient; 4) wear mask, hat, gown, and gloves; and 5) put sterile dressing over insertion site after completion – was found to drop an 11% infection rate down to nearly 0%. It turned out, the doctors were mostly consistent in executing all of the steps, but they occasionally skipped a step for any number of accidental or well-intentioned reasons; nonetheless, being accountable to a simple checklist eliminated virtually all the complications, for what was actually a very simple series of steps. That doesn’t mean patients didn’t still have complex health problems, difficult diagnoses, and adverse outcomes; nonetheless, over a two year span, the initial study estimated that in one hospital alone, the checklist had prevented 43 infections, 8 deaths, and saved $2 million dollars!

And notably, the application of checklists is already widespread in other professional contexts. They are a staple of the airline industry, ensuring that even well-trained pilots never miss a single step in the proper execution of flying the plane; notably, such checklists include important guidance about how to quickly handle a wide range of emergency situations where, even if the pilots are trained, it may be difficult to recall, unassisted, the exact proper steps to execute in the heat of a high-stress moment with adrenaline rushing. Similarly, the construction industry also relies heavily on checklists to ensure that buildings are made properly, and that crucial steps aren’t missed that could result in an utter catastrophe. In addition, Gawande points out that an important ancillary benefit of using checklists in such situations is that, when the checklist requires duties of multiple individuals – and everyone is held accountable to ensure all steps of the checklist are completed – teams end out communicating better, which prevents even more unfavorable outcomes.

Creating Your Financial Planning Checklists

Granted, in the financial planning world, the client situations that present themselves are rarely as dire as landing a plane in an emergency or determining what drugs to administer to a patient who may die in minutes or hours if not properly treated. Nonetheless, the fundamental problem remains: financial planning for individuals with a nearly infinite range of situations entails tremendous complexity, to the point where it’s not clear if anyone could really remember every possible question to ask or step to take; at least, not without the assistance of a financial planning checklist.

One version of a quasi-checklist that financial planners already use is the data gathering form, which through its wide range of blanks to fill in amongst various categories, ensures a fairly thorough review of all the client’s potential financial concerns. If you don’t think checklists can be useful, imagine how effective your financial planning process would be if you had to remember, off the top of your head, to ask every question necessary to capture every single bit of information that’s requested on a thorough data-gathering form. Even those who begin using an agenda to guide client meetings often report they help – as a form of checklist – to ensure that all the key issues are covered in the meeting, and that nothing is overlooked in the midst of a potentially complex client conversation.

Similarly, many technical areas in financial planning require not only specialized knowledge, but an awareness of rare-but-potential circumstances that may arise that provide for unique planning opportunities. For instance, with respect to Social Security alone, how often do you ask an unmarried client over the age of 62 if he/she had a former marriage that lasted at least 10 years (potential divorced spouse benefits), or ask retirees over age 62 if there are they still have any children under the age of 18 (extra retirement benefits for children), or ask if the client had a prior (or current) job where he/she did not participate in the Social Security system (future retirement benefits potentially reduced under the Windfall Elimination Provision). While none of these situations are necessarily common, they do occur from time to time – frequent enough to matter, but not frequent enough to necessarily remember to ask every time. The same is true in a wide range of other planning situations, from whether the beneficiary of an inherited IRA might be eligible for an Income In Respect Of A Decent deduction, to whether a non-qualified annuity was originally funded via a 1035 exchange (which means the cost basis is not merely the premiums paid), to whether a term insurance policy is still convertible (or ever was).

In other words, having a financial planning checklist in each of the various areas of financial planning can serve as a type of “due diligence” process, to ensure that all the important planning issues and opportunities are covered. It doesn’t make the planner smarter or more skilled, but does help to ensure that the planner maximizes the knowledge and skill he/she already has. Arguably, at some point in the future, these might even be codified into a more extensive series of Practice Standards for financial planners – as in the case of doctors, this can ultimately help to distinguish between situations where an unfavorable outcome was due to an error or “ineptitude” mistake of the planner, or was simply a situation too complex to possibly be saved. In practice, effective due diligence checklists might also be integrated into a firm’s CRM software.

Atul Gawande Checklist Manifesto

Unfortunately, though, the greatest challenge is simply that we need to build our financial planning checklists – a challenging and time-intensive process. Yet perhaps this is an opportunity for the financial planning community to band together and build something collectively. Have you built any checklists in your firm that you would be willing to share? Would you volunteer time and effort to try to help create a series of financial planning checklists for all practitioners to use? Please respond in the comments if you’re interested, and perhaps we can begin this process together. In the meantime, though, it would probably be a good idea to start building some checklists for the most common challenges that arise in your own financial planning firm!

And if you’re still not convinced of the value of a financial planning checklist (or having a series of them!), I’d strongly encourage you to read “Checklist Manifesto” yourself; if you are convinced, you may also find the book provides helpful inspiration on the kinds of checklists that may be useful in your practice and with your clients.

Advisor Platform Comparison: Wirehouse vs RIA Aggregator vs Independent RIA

Advisor Platform Comparison: Wirehouse vs RIA Aggregator vs Independent RIA

Executive Summary

The wealth management industry has evolved significantly over the years, now offering a variety of different business models and platforms for advisors, from traditional wirehouses and independent broker-dealers, to independent RIAs, and increasingly the RIA aggregator and network platforms that support them. As a result, it’s become increasingly challenging for advisors to simply figure which model and path is the best to choose!

In this guest post, Aaron Hattenbach shares his experience working as an advisor in 3 different wealth management models: Wirehouse (at Bank of America Merrill Lynch); RIA Aggregator (with HighTower Advisors); and ultimately transitioning to his own fully independent RIA (his current firm, Rapport Financial).

And so if you’ve ever wanted a comparison between working at a wirehouse, an RIA aggregator, and an independent RIA, from someone who has actually had experience in all three, Aaron’s guest post here should provide some helpful perspective – whether you’re a veteran of the industry considering whether to make a change, or a new financial advisor trying to decide where to start your career.

Conducting in depth research in advance goes a long way in sparing you the potential headaches and risks that can come with moving your practice from one firm to another… given that every time you move your practice to another firm, you run the risk of losing your valuable and hard earned client relationships! And so I hope you find today’s guest post to be informative, as you consider what may be the best potential path for you!

Aaron Hattenbach PhotoThis post was written by guest blogger Aaron Hattenbach, AIF from Kitches.com. Aaron is the Founder and Managing Member of Rapport Financial, a registered investment advisory firm headquartered in San Francisco, CA, specializing in advising technology professionals at public and private companies with stock based compensation. Aaron is also a contributor for Business Insider’s Your Money Section where he writes about stock based compensation and personal finance. In his spare time, Aaron enjoys playing competitive golf, intramural sports and serving as a volunteer leader for Congregation Emanu-El’s Young Adult Community. You can view Aaron’s LinkedIn profile or follow him on Twitter @aaronhattenbach. If you’re interested in setting up a business coaching call with Aaron, go to: Clarity.fm/aaronhattenbach.)

Submitting A Resignation Letter To Leave The Merrill Lynch PMD Program And Form An Independent RIA

It was November 30, 2016. I had been dreading this exact moment, playing out how the conversation would go, what I would say to my manager, and how he would react to the news. So, when I finally entered his office and revealed my decision to resign from Merrill Lynch, I took a deep breath, paused, sat back and awaited the barrage of questioning that I had diligently prepared for in the months prior.

Our conversation lasted give or take no more than 20 minutes, during which we talked about the financial advisor program. He asked for constructive feedback—ways to improve the Practice Management Division (PMD) program and increase the rate of success amongst participants in his branch. At the time, there was substantial negative buzz at national about the PMD program and its low rate of success, and our branch was one of the worst performers in the country.

While Merrill has yet to publish official pass rates for the PMD Program, previous participants and industry professionals posting on a number of different wealth management blogs estimate the failure/dropout rate exceeds 95%. An interesting observation I came across online from a former PMD Program Participant suggests that a 95% failure rate may even be too optimistic and is “clouded by the fact that most PMDs who graduate from the program are already on teams and pre-destined to succeed. The actual fail rate is more like 99%.” My experience working in the San Francisco (SC) Branch supports this reasoning.

During my two years at Merrill Lynch I met a total of 2 PMD Graduates! One was a former Client Associate (for over a decade) working with several multi-million dollar producing financial advisors. The other, an experienced advisor, brought over a book of business from a competing wirehouse which helped him meet the aggressive monthly hurdles. Each had special circumstances that led to their graduation. In fact, I didn’t meet, nor hear of a single PMD Program graduate who started from scratch and was able to graduate the program.

While it’s known throughout the industry that in the past, Merrill had built a revered financial advisor training program producing some of the most successful advisors in wealth management, it was failing far too many quality candidates today, and I could see why. Lack of mentorship. Limited support and resources. Aggressive monthly sales goals not aligned with building long term fee-based wealth management clientele, instead favoring transactional immediate (commission) business.

It’s easy to see why both Merrill Lynch and other firms in the mature financial services industry are struggling to attract and retain millennial talent. Stuffy corporate office environments filled with clusters of cubicles where on any given afternoon the silence was so palpable you could actually hear a pin drop! If you happened to cold call to try and generate business it felt like the entire office was listening in and critiquing your phone sales skills. How is it that firms continue to operate this way and expect to compete with the Google’s and Facebook’s of the world offering hip, fun and collaborative workplace cultures and superior compensation packages?

Which got me thinking about the wealth management industry as a whole—an industry that is being turned upside down by pricing pressure, technology, and the slow but necessary evolution from product selling to finally advising clients as a fiduciary investment professional.

With the proliferation of available business models to financial advisors today, it’s no simple task to research and select with a high degree of confidence the appropriate firm and business model most fitting for the particulars of your practice. There are literally thousands of options to choose from these days: Independent Registered Investment Advisors (RIAs), Hybrid RIA/Broker Dealers, RIA aggregators, Broker-Dealers, Wirehouses, etc. Which has given rise to an entire profession of advisor consultants, professionals hired by an advisor seeking greener pastures. These advisor consultants, including wealth management practitioners and M&A specialists in the advisory industry, have their finger on the pulse. After gaining an understanding the inner workings of an advisors practice, they can then shop the advisor around to the best suitors, evaluate platforms, culture, payouts, and signing bonuses.

Sharing My Story: The Inspiration For This Article

Over the past few months, a handful of former colleagues and friends in the advisory business have reached with questions, curious about my transition from Merrill Lynch to launching and now running an independent RIA. The questions have covered everything from the percentage payout, to the steps I took to set up the entire infrastructure of my firm, Rapport Financial.

I probably take for granted the sheer difficulty and knowledge base required to leave an institution the size and scale of Merrill Lynch, which provides just about everything an advisor needs, to building and operating an RIA from the ground up. It’s a daunting process, even for someone like me, a youthful 30-year-old with 5 years of prior experience working for fully independent RIAs and an RIA Aggregator, and 2 years at Merrill Lynch. I can’t even imagine what’s it is like for the typical wirehouse advisor, leaving a firm like Merrill Lynch after an entire career there, and embarking on the build out of the infrastructure previously provided by their predecessor firm! These are certainly unchartered waters for most wirehouse advisors.

In this article, I will walk you through the 3 business models I know intimately from having worked in them:

Then I will profile the makeup/DNA of a successful advisor, and the mentality required to succeed in each model. Many advisor consultants and coaches write generic books about how to become a million-dollar producer, how to sell to the affluent, and more tips related to running a successful wealth management practice. While the suggestions and strategies suggested work at a higher level, it’s of greater importance that an advisor understands how to best leverage the firm and model they ultimately select to operate a practice within.

Let’s get started with the Wirehouse model.

Large Wirehouse Bank: Bank Of America Merrill Lynch (BAML)

What kind of advisor thrives in the wirehouse model? The generalist rainmaker/networker. This is someone that buys into and relentlessly champions the enterprise. He or she utilizes their internal partners to cross sell clients on other services the bank can offer its clients.

Based on my experience, the “generalist” advisor who wants to be the connector that brings the widest range of solutions to clients should strongly consider operating a practice in the wirehouse ecosystem.

Two Words: Production Credits (PCs)

 This is one of the few businesses in the modern era of specialization where operating as a generalist still serves you best. As an Advisor at ML your job is to uncover opportunities and refer them to your internal specialists at the bank where you can earn referral fees (that is, if the referral is successfully converted). Your value at the firm is determined by one metric: production credits (PCs). Production credits are a fancy term for the revenue you generate for the firm.

On day 1 you are taught to “sell the enterprise.” Most of the advisor training focuses on positioning you as a strategic referral partner to the bank. BAML has 8 different lines of businesses, which means that there are a number of ways for you to make money. Maybe a friend is looking for a home loan? Or a former colleague is looking to establish a 401k for their small business. At Merrill, you have the ability to sell pretty much any financial product available in the marketplace. And you make money if they buy that product or service from you or with/through your internal partners at the bank.

Forget specializing in fee-only wealth management and financial planning at Merrill Lynch, unless you are an established advisor with $1M in annual fee based production. But even if you are a $1M producer, it doesn’t necessarily make sense to be in the wirehouse model. Think about it. You’re taking a below-industry-average 42% payout on your revenue. (NOTE: % payout assumes $1M+ annual production, and it’s actually lower at 32% – 38% for sub-1mm producers, even lower still for PMD participants with 3 payout tiers based on monthly production numbers.) And why are these payouts so low? Because you’re effectively paying the salaries of all the internal specialists listed below that are employed by BAML to maximize the ROI of your business through cross selling your wealth management clients on a variety of products and services.

 The available teams of Merrill Lynch Internal Specialists include:

  • Managed Solutions Group
  • Wealth Management Banking
  • Enterprise Specialist
  • Alternative Investments
  • Insurance Specialist
  • Structured Products
  • Annuities
  • Corporate Benefits and Advisory Services
  • Custom Lending
  • Retirement Group 401k Consultant
  • Practice Management and Team Consultant
  • Estate Planning and Trust Specialist
  • Goals Based Specialist
  • Municipal Marketing
  • Wealth Management Banker (mortgage)
  • Merrill Edge (retail platform)

 BAML is a bit more discreet about its cross-selling strategy than a competitor like Wells Fargo, which averaged an impressive 6.1 products per household. However, BAML, like its competitors, sees cross-selling as a viable method to grow revenue. And if the existing compensation incentives in the form of referral fees for cross-selling aren’t enough motivation for advisors at ML to send business to the 8 different units, back in 2016 Merrill Lynch instituted a new policy requiring its brokers to make at least two client referrals to other parts of parent Bank of America Corp in 2017 to avoid a cut in pay. Merrill and other wirehouses understand its clients are stickier and less prone to being poached by the competition when they hold several products and services with the bank. With this mandatory referral policy, you face additional penalties for refusing to refer to other business lines within the bank. Ouch!

 But why, with what we know about the current state of the wirehouse – strict compliance departments, lower payouts, a rising tide of breakaway brokers due to low employee morale, advisor silos that lead to lack of collaboration and idea sharing, and less than ideal workplace cultures… would an advisor at a firm like Merrill Lynch more often than not choose to switch to another wirehouse like Morgan Stanley or UBS instead of spinning out to become more independent?

This is a question I often struggled with prior to working at Merrill Lynch. Time and again before Merrill, I had been told by my independent advisor colleagues and friends that the wirehouse model was ridden with conflicts of interest, and wasn’t a client-friendly business model. Even with this message becoming mainstream, and the financial crisis bringing to center stage the many issues with banks, wirehouse advisors still continue to favor moving their business to a familiar wirehouse competitor, rather than go to an independent channel. But as I discovered during my time at Merrill Lynch, there’s actually a reasonable explanation for this—which I’ll go over with you.

Wirehouse Ecosystem Explained

It’s crucial to understand the way a wirehouse advisor operates. There are currently over 14k advisors at Merrill Lynch. Most aren’t running fee-only wealth management practices. From an economics standpoint, you can’t really blame them. It wouldn’t make much sense to do so. You’d be leaving money on the table. For example, say your client needs a product or service that the bank can offer. More often than not when a client needs this product, they would rather purchase it through you than a complete stranger. There’s familiarity and presumably a level of trust between the advisor and client. And “someone” is going to get paid when that internal referral happens… so why not make it you?

 A large part of a wirehouse advisor’s value proposition comes from their ability to leverage the enterprise and its breadth of products to deliver value to their clients. Value can come in different forms. However, what I saw as the most common form of value-add by an advisor in the wirehouse model was being able to offer relationship-based pricing discounts to valued (larger) clients.

For example, Merrill Lynch offers a client with $1M in assets at the bank a fairly significant discount off the stated interest rate on a home loan, saving a homeowner potentially thousands of dollars over the lifetime of the loan. After implementing the discount, a client would be hard pressed to find a similar rate at a competing financial institution. Unless of course they have a relationship with a similar size at another banking institution. We can all agree that saving a client money is a great way to demonstrate your value! But this relationship-based discount pricing model isn’t unique to Merrill. Other institutions, even those with stellar reputations and a loyal customer base, like First Republic, also use relationship based pricing programs to encourage clients to do more business with the bank. 

Wirehouses Create Advisor Dependence On The Firm…

 Unfortunately for a wirehouse advisor, while cross-selling your clients can be a lucrative and effective strategy, it also makes your business less portable when you decide to change firms. This is even more the case for a wirehouse advisor departing and hanging his or her shingle with an independent (whether an independent RIA or an independent broker-dealer).

As discussed earlier, the objective of a bank’s cross selling strategy is to create stickier clients—first for the bank, second for the advisor. Stickier clients present a significant risk to a departing advisor trying to retain his or her client relationships and bring them to their new firm. A Merrill advisor whose clients have a combination of loan management accounts (LMAs), home loans, 529s, savings and checking accounts, and credit cards to go along with taxable and retirement investment accounts that the advisor manages have now become the “ideal client” for the bank, but not for you the departing advisor. And a huge paperwork problem for the departing advisor!

Paperwork is an issue often overlooked by financial advisors that leave one institution for another. Each client has different accounts with various features that you as the advisor will need to effectively and accurately establish at your new institution. Unless the departing advisor has previous experience as a client associate (which I fortunately do!) and familiarity with the paperwork and administrative side of the business, they’ll be in for a rude awakening. You the advisor are going to meet with your clients to encourage them to move their relationship to you and your new firm, and want to come prepared with the documentation that will facilitate this transfer. This is a critical moment in the relationship, where if you show up unprepared with either the wrong or incomplete documentation, you run the risk of losing the client’s confidence and trust. Based on this interaction, the client may choose to stay with your predecessor firm. It’s really unfortunate to me that so many advisors place so little value on the paperwork and administrative component of the business. Many advisors out there underpay and churn through the support staff that ends up playing a direct role in their success, especially when making a transition to a new firm!

What can a Merrill advisor do to create the least amount of disruption, friction and client inconvenience upon leaving for a competitor so that they can retain most of their existing clientele? The answer…drum roll please… is that you go to a direct competitor with a big brand name offering the same suite of products and services! In fact, if some of your clients happen to confuse Merrill Lynch with Morgan Stanley or the other way around—even better! As long as they remember your name!

Without explicitly saying so, by moving with you, the client has made it crystal clear who they work with and value. It’s you! Not the name of the firm on the monthly statement. Which is why the vast majority of wirehouse advisors jump from one wirehouse to another. They’ve spent years, more often than not decades of their careers, building a sustainable book of business. And if the advisor isn’t already running a primarily fee-only wealth management practice, the risk/reward proposition of going independent at least economically speaking isn’t worth it.

In other words, it’s not the “wirehouse mentality” or close-mindedness to the thought of going independent that keeps a wirehouse advisor from making the leap to the independent model. Trust me, if it was just a matter of economic sense, wirehouse advisors would more often than not jump at the opportunity to spin out and become independent. And a wirehouse advisor after the great recession of 2008-09 has to operate in an environment that is far from business friendly. Compliance, often half-jokingly referred to as the “sales prevention department”, makes it highly challenging to market and grow your business. Planning on holding a seminar to explain what it is you do for your clients? Anticipate a lot of red tape and pushback. Interested in writing and distributing content to your prospective clients to explain what you believe is going on in the markets? Sadly, you’re limited to sharing the same pre-approved cookie cutter content as the other 14,000 advisors at Merrill. I recently wrote my first piece as a Contributor to Business Insider’s Your Money vertical called ‘I’m an investment advisor who helps tech employees with stock option—here’s the 5-step plan I give my clients.’ It’s safe to say I probably wouldn’t have been able to publish this while at Merrill Lynch.

Oh, and be careful with who you decide to go after as prospective clients, especially over email and LinkedIn. If this prospective client already has an established relationship with Bank of America Merrill Lynch or is in talks with someone at the bank, and you reach out to them, you run the risk of termination. To give you a sense of how powerless it can feel to operate in the wirehouse ecosystem, you’re not even able to post your previous employment history on your LinkedIn Profile! This policy may have changed since I left—but still, come on! If you’re an experienced advisor that’s decided to join Merrill Lynch from another financial institution, your LinkedIn profile would show less than a year of experience in the industry—at Merrill Lynch of course. How would this at all engender confidence with prospective clients viewing your LinkedIn profile and considering working with you? 

Independence Gives You Control Of Your Creativity And Customization

 If you’re an entrepreneurial advisor looking to grow your business and passionate about providing customized solutions to individuals and families, you’ll find it difficult to deliver this in the wirehouse ecosystem. It’s a major reason why I decided to leave and start my own independent RIA, Rapport Financial. I wanted to have the ability to offer my clients several different fee structures based on the scope of work they desired, which currently includes:

  1. Full Service Wealth Management—Asset Based Percentage Flat Fee
  2. Hourly Financial Consulting—Hourly Rate
  3. Construction of a Comprehensive Financial Plan—Fee ranges based on complexity

 If you’re a practicing advisor, you’ve likely experienced, after conversations with a number of different prospective clients, that this is absolutely not a one size fits all business. While some clients need a full-time wealth manager, others may only require a regular check-up and take a more DIY approach to their finances. Other clients may only need a financial planner to build them a personalized and holistic financial plan. Yet Options 2 and 3 weren’t available to me as an advisor at Merrill Lynch. And I struggled with the reality that most of my High Earner, Not Rich Yet (H.E.N.R.Y) peers were unable to meet the strict minimums imposed by Merrill Lynch. Friends and contemporaries were being grossly underserved, and it felt short-sighted of the firm to automatically refer small accounts not meeting the Merrill Lynch advisory minimums to the retail brokerage arm, Merrill Edge, and have them serviced by overworked call center employees – which was a great way to unfortunately ruin what could have been a great client relationship for me down the road.

But after leaving Merrill in 2016, I fully understand why the wirehouses restrict many advisor activities. During my 2 years at Merrill Lynch, most of my advisor colleagues often erred on the side of caution, placing more of an emphasis on “being compliant” at the expense of focusing on sharpening their craft, advising clients, and growing their businesses. This palpable fear was enough to make you question every email you sent and phone call you made. Imagine, being an advisor in this model. Your objective should be to focus on delivering your clients actionable and quality financial advice. In the meantime, you’re distracted and worrying about making sure that every little action taken follows detailed firm protocol, otherwise you run the risk of landing in hot water with compliance, which seems to be less tolerant post 2008-09. Forget to send an email via the secured message center? Or maybe you sent your client a small birthday present–under $100 of course–but didn’t log it and get pre-approval with compliance. There are so many small mishaps that could result in termination. It’s enough to make you second guess almost everything you do! And how does this lead to optimal advisor productivity?

Which leads me to an overview of the next wealth management business model I’ll be covering:

Large RIA Aggregator: Hightower Advisors

 Who thrives in this model: An ex-wirehouse advisor embracing the fiduciary standard and running a primarily fee-only wealth management practice. This advisor often doesn’t possess experience operating a standalone business in the independent channel, and is not quite ready to form their own Independent RIA and be fully responsible for running it.

Perhaps you’re a wirehouse advisor that generates the majority of your revenue from fee-only wealth management but aren’t quite ready to go at it completely on your own. This is your first go at running an independent practice. Not to worry–there are “RIA Aggregators,” firms like Dynasty Financial Partners, Focus Financial Partners, Commonwealth Financial Network, LPL Financial and last but not least, the firm I’m most familiar with having worked there for over 2 years, HighTower Advisors, that will buy your practice or provide you a wirehouse-like platform and infrastructure you’d otherwise have to select from third party vendors or build from scratch, and offer an attractive ongoing payout.

Below is a list of the components of an advisory practice that a firm like HighTower provides right out of the gate:

  • Operations
  • Trading
  • Compliance
  • Transition consulting
  • Research and Diligence Team(s)
  • Facilities, HR and Benefits
  • Finance and Accounting
  • Legal
  • Marketing/PR/Social Media
  • Technology

 RIA Aggregators have increasingly become a popular destination for wirehouse advisors. You may be wondering why this phenomenon is occurring? A combination of the better economics of a large platform with scale, but offering more flexibility and freedom for an advisor to run his or her practice as they see best fit. Add to this a brand name not associated with the damage caused by the great recession of 2008-09, as for many advisors the wirehouse brands that were once an asset on their business card have now become a liability.

Advisors that join HighTower have two options: Join the partnership and become shareholder owners of the parent company (the Hightower Partnership Model), or join the network for a higher payout and access to the platform without an ownership interest in the company (the HighTower Network Model).

As a partner, you have direct access to the executive team, allowing you to interface with them and make suggestions that are valued and at times implemented across the firm. This is a firm where advisors come first. At the wirehouses, advisors look at each another as direct competitors—a zero-sum game of sorts. I personally had this weird feeling in my gut that the guy in the cube across from me at Merrill was secretly rooting for me to either get fired or hit by a car so he could swoop in and take my clients (maybe I’m being paranoid)! At HighTower, this inner competition is directly addressed by the partnership structure, which aligns advisor interests in order to win as a group, thereby increasing the enterprise value of the holding company for the greater good of the advisor base. During my time at the firm, I saw advisors collaborate on best practices, help each other with investment selection, and even refer business to another advisor better suited to handle the affairs of that particular client. In an industry dominated by money, this kind of culture is a rare find!

 HighTower has both an RIA, HighTower Advisors LLC, and a broker dealer, HighTower Securities, but is a major advocate of the fiduciary standard. What grew out of the depths of the financial crisis in 2008 as a firm dedicated to the fiduciary standard and advising clients as opposed to selling to its clients, has grown into a formidable wealth management firm with more than $46 billion in assets under management and offices in 28 states. I worked directly for a HighTower partner from 2012-2014 as his “right-hand man.” Together we grew the business substantially in a little over 2 years’ time, despite the name “HighTower” not holding much brand cache back then.

 In fact, I was hired to transition an advisor from his predecessor firm to HighTower, so I’m uniquely positioned to explain the advisor experience from day 1. Back in 2012, I joined the HighTower partner in opening a new office for the firm in Los Angeles. Together we ported over his clients and readied the paperwork necessary for the transfer. About 15% ultimately didn’t end up coming, which is not uncommon for advisors leaving a firm to join a competitor. It’s part of the cost of doing business. HighTower ended up absorbing the full economic requirements for transitioning and starting-up the practice. While no advisor transition experience is 100% seamless, there’s clearly a lot at stake, so Hightower equipped us with several capable members of the HT transition planning team who were on call and ready to troubleshoot any potential issues with our custodian, Charles Schwab. I’m sure in the years that have passed they’ve made improvements to this transition process, so I can’t comment on its current efficacy. But not having to focus on compliance, and some of the other items listed above that are challenges in the wirehouse environment, allowed for us to focus our efforts on educating clients about the firm, overcoming any potential objections to moving their accounts to HighTower, and providing a white glove level of client service.

After going through the process of starting my own independent RIA, Rapport Financial, in January of this year, I have a greater appreciation for what was being taken care of behind the scenes by the corporate staff at HighTower. I had to replicate many of the actions that were taken care of by the HighTower team, which I will be covering in extensive detail later, for those that decide to go the fully independent route. Stay tuned!

There are a number of clear advantages to joining a quasi-independent firm like HighTower. Since the firm’s inception in 2008, they’ve been able to curate a sophisticated platform of technology and access to some of the industry’s top resources for its advisors. Taking a page from the playbook of their wirehouse competitors, HighTower has also used its massive size and economies of scale to negotiate enterprise pricing contracts below what you would pay going direct with pretty much every outside vendor an advisor relies on to run his or her practice. Everything from best-in-class custodial/clearing firms, to TAMPs, alternative investment research and access platforms, independent research firms, data providers, all with better pricing than what a typical RIA can negotiate on its own. This is the true value proposition offered by HighTower to its advisor base.

But this ironically is also HighTower’s biggest weakness—its dependence on outside vendors to deliver technology and solutions for its advisors. Take for example several high profile and top producing HighTower teams that have recently departed and formed their own independent RIAs, resulting in billions of client assets exiting HighTower’s gates. HighTower’s lack of meaningful IP and defensibility is proving to be a direct threat to its long-term sustainability – as ironically, HighTower succeeds in attracting independent advisors because it doesn’t run like a wirehouse, it has trouble retaining them because it doesn’t run like a wirehouse!

In other words, as described in an RIABiz article, the process an advisor would need to take towards full independence becomes relatively simple after using HighTower as a “halfway house.” And because HighTower relies so much on outside vendors, the entrepreneurial advisor retains the power and flexibility to make a(nother) switch, leave HighTower and simply contract with those third-party vendors directly. In essence, the advisor is able to gain an understanding of the independent channel after operating in the HighTower model for a few years, then makes one final transition to full independence in forming his or her own RIA firm.

Which seems like the best way to transition into a discussion on the final business model I’ll be covering for you:

Fully Independent RIA: Rapport Financial

Who thrives in the independent RIA model: An advisor embracing the fiduciary standard and running a primarily fee-only wealth management practice. Ideally the advisor also possesses the following attributes:

  1. Operating experience in the independent advisory channel.
  2. Niche specialty that allows for differentiation from the competition. After all, you won’t have a big household name backing you anymore, and have to build your own brand!
  3. A client base large enough to sustain themselves. Or alternatively, the financial flexibility to patiently grow it from scratch.
  4. Entrepreneurial attitude and willing to put in the many hours necessary to succeed.
  5. The ability to effectively multi-task and prioritize.
  6. Or an advisor study group. Or at least some professional friends that can form your “unofficial advisory board.”

Which brings me to the final business model, the one I am most excited to go over with you. This is near and dear to me, as I’m currently living, breathing, eating and sleeping this model. In January of this year, I took a huge leap of faith in leaving Merrill Lynch to launch Rapport Financial, a registered investment advisory firm specializing in stock options advisory and wealth management for technology professionals in the Bay Area.

I’m proud that just 8 months in, I have been able to grow the business to profitability, recouping the original startup costs and am now on the path to generating positive net income after accounting for ongoing costs. In designing my wealth management offering, I’ve hand selected the best attributes of each of models I’ve worked in, curating an offering that I believe is consistent, repeatable, and where I can provide meaningful value beyond simply being labeled an investment manager.

  1. Operating experience in the independent advisory channel. So, before I dive into the weeds of my current practice, technology, infrastructure and so forth, you should know that I had a head start in the independent operating model having started my career in a multi-functional role for an RIA, Concentric Capital (now Telemus Capital). We were a lean operation consisting of two full time employees, and one part time receptionist/assistant. My role was dynamic and adapted daily to the needs of the business. This was where, through sheer determination, I was able to learn how to effectively carry out all of the operational components of an Independent RIA practice. In any given day, as a boutique RIA, you’ll find yourself making changes to the content on your website, contacting your compliance firm to have amendments made to your ADV, rebalancing and tax loss harvesting for client accounts, submitting documents to your custodian, conducting research, implementing changes to client portfolios, preparing for prospective client meetings, and the list goes on.
  2. Niche specialty that allows for differentiation from the competition. When I started my career in the industry, I worked with several advisors who didn’t necessarily specialize or choose a profession or other niche to target. With their practices being located in LA, they inevitably ended up advising a number of entertainment professionals. My training at Merrill Lynch made me realize the importance of specialization at least in terms of working with a specific profession or subset of the population as an advisor. “Financial advisor” is a vague term for a financial professional. There are so many different areas we can cover for a client: investment management, retirement planning, stock options, insurance, financial planning, etc. Especially in this competitive environment, it has become increasingly important to specialize and position your clients, centers of influence, and friends to refer business. If they don’t quite understand exactly who you work with and what you do, you make it very difficult for them to recommend your services to an ideal client. Which is why, when I moved to San Francisco, I pivoted from focusing entirely on advising doctors to working with professionals in the technology industry. Shortly thereafter I even narrowed my focus to advising tech professionals with various forms of stock based compensation (options).
  3. A client base. There are so many different variables to weigh here: personal expenses, income, dependents, savings, business overhead and such. It’s difficult to set a standard for how many clients, or how much revenue you’ll need to break even, or better yet, make a living. And even more difficult to give you advice without knowledge of your particular situation.

But at a minimum, you need a plan for the “income gap” that will likely emerge between what you earned previously, and what you will earn in your new independent RIA, if you’re not already bringing with you a substantial number of clients. Now, if you’ve diligently saved and set aside enough money for a year of living expenses, then you’ve made your life much easier. Giving yourself the time necessary to scale and grow your business will allow for you to focus entirely on providing a quality offering, without the added pressure of needing to constantly sign new clients to stay afloat.

  1. Entrepreneurial and willing to put in the many hours necessary to succeed. There are times where you’ll be working a 14+ hour day and feel like it’s never enough. When you’re getting started your life will be consumed by the business. But know that the hard work will eventually pay off. You’re building YOUR business. YOU own it. And the long-term compounding of building clients and assets is VERY rewarding in the long run! Currently, I’m (somehow) trying to fit in an hour or two each day to complete the CFP modules and be eligible to sit for the CFP exam as well.
  2. The ability to effectively multi-task and prioritize. See, you have to remember that in this model, you are both an advisor and business owner. A business developer, manager, and operator. Juggling all of these responsibilities requires good time management skills as a financial advisor, an intense level of focus, and last but not least the determination to persevere no matter what is thrown your way—especially during periods of market volatility when your clients are fearful and demand more of your attention. Which is why I would highly encourage you to consider transitioning your business during a bull market like the one we’ve been in for the past 8 years.
  3. Or a study group. Or at least a group of professional friends to form your “unofficial advisory board.”

The life of a sole practitioner advisor and entrepreneur can be quite lonely and especially tough without a support system. Which is why I am so lucky to have a group of friends/professionals that I can call my “unofficial advisory board.” When I’m tasked with making difficult decisions, it’s a luxury to know that I have a group in my corner looking out for my best interests. They bring a diverse set of skills to the table: Talent Acquisition, Customer Success, PR, Digital Marketing, Operations, Legal, Accounting and more. Having this group on my team has also proven pivotal in keeping my operating costs low and manageable. While I’ve developed a diverse set of skills from my 7 years in the wealth management business, there have been times when I really needed to run things by my board of confidants for assurance and peace of mind before I ultimately made an executive decision.

Forming an unofficial board of friends and professionals isn’t easy though. People are busier than ever! Especially the successful people you want on your board of advisors. So how do you convince extremely busy and successful professionals to make time for you and serve on your advisory board? The answer—be available to them through transitions, difficult decisions, and life’s inevitable ups and downs. Or simply be there to listen when they need to confide in someone. By not keeping score and giving of yourself to others, you end up building interpersonal equity that you can eventually tap into if you happen to need it.

And there’s a way you can tie this in directly with your business pursuits. For example, connecting a family looking to protect their assets with a knowledgeable Estate and Trust Attorney. Or introducing a Tech Professional friend with stock based compensation to a CPA well versed in the taxation of stock options. There are so many ways you can be helpful to friends and people in your network. And I’ve personally found that by being active in the community, volunteering, and helping others, I’m now the happiest I’ve ever been in life. Oh, and without any expectations, and by being selfless the byproduct has resulted in business opportunities, friendships, and strong relationships.

Not surprisingly, the fully independent RIA business model, while offering one of the highest payouts among the models described, is also the path least taken. An advisor choosing to be a sole practitioner ends up assuming all of the responsibilities of running a business including:

  • CEO
  • COO
  • CIO
  • CFO
  • CMO
  • CCO
  • Head of Sales

Remember, you’re building an entire business from scratch! You call all the shots, select the vendors, and build an offering designed to attract and retain clients. While there are service vendors you can outsource some of the responsibilities of the organization to, you’re directly in charge of selecting these parties and running all of the day to day operations of your business. This is an ambitious undertaking I absolutely wouldn’t have considered without the combination of having both a book of business and the direct operating experience.

Update On Where I Am Now

I’m 8 months into running my RIA, Rapport Financial, and things are off to a great start!

When I left Merrill Lynch and started my own independent firm, I complied with the Broker Protocol and was able to retain 100% of my client relationships—which is quite rare. I’ve since added 7 new clients, equating to 1 new client relationship per month. While I’m not quite meeting my aggressive client and asset gathering goals, I’m making progress each and every day towards building a brand and business that I’m both proud of and confident will pay significant dividends in the future.

I’m enjoying the benefits of being my own boss, and having the authority to take the business in the direction that I believe best serves my clients. At Merrill Lynch, I felt forced to provide a one-size-fits-all offering, and corresponding wrap fee for investment management. Now I’m able to offer prospective clients 3 different ways they can work with me depending on their personal financial needs:

  1. Hourly Financial Consulting
  2. Flat Rate Financial Planning
  3. Full Service Wealth Management

I’m also excited to announce that I signed a contributor agreement with Business Insider to write about Stock Options and Bay Area Start-Ups for their “Your Money” vertical.

Why The Fully Independent RIA Model Works For Me

I come from an entrepreneurial family. My vision for Rapport goes beyond simply a financial planning and wealth management offering. I see Rapport eventually evolving into a financial wellness brand. Schools from K-12 and even colleges fail us in not making financial literacy and teaching good financial habits a focal point of our curriculum. As a result, too many people are drowning in student loan debt, credit cards, and other forms of debt.

Back to my decision to start an RIA. This wasn’t driven by finances. Ironically, I made more money at Merrill Lynch than I’m making now. But I’m way happier than I was at Merrill. I felt that my entrepreneurial spirits weren’t encouraged at Merrill. As time passed, I found it became increasingly more difficult for me to get excited about going into work, in what I felt was an antiquated business model, where my older advisor colleagues were holding onto their legacy brokerage clientele. I desperately wanted to build a more customized offering that wouldn’t limit me to working with individuals that met the Merrill Lynch Wealth Management asset minimum of $250,000 to establish an account.

I can understand why advisors shy away from the fully independent model, given the sacrifices necessary to make this work operationally and financially. But having operated previously in the RIA Aggregator, Wirehouse, and now fully Independent model, I’ve finally found the model that gets me out of bed each morning excited to help people meet their financial goals.

So what do you think? Have you had experience working in different wealth management models? How do you think they compare? What paths do you think are best for different types of financial advisors? Please share your thoughts in the comments below!

IRS Loosens Rules For Retirement Plans To Lend Money To Hurricane Harvey Victims

IRS Loosens Rules For Retirement Plans To Lend Money To Hurricane Harvey Victims

On Wednesday, the IRS posted Announcement 2017-11, which will grant streamlined procedures for taking employer retirement plan loans and/or hardship distributions from a 401(k), 403(b), or governmental 457(b) accounts, if they live or work in disaster area localities affected by Hurricane Harvey. (In order to qualify, they must be designated for individual assistance by FEMA.) The rules also apply for those who want to use the money to help a son, daughter, parent, grandparent, or other dependent who lived or worked in the disaster area. Relief provisions include eliminating the 6-month ban on 401(k) or 403(b) contributions that normally applies to employees who take hardship distributions, eliminating any specific requirements about how the hardship distribution is used (as long as the person is part of an affected area), and plans can make such loans or distributes even if they don’t currently allow it (as long as they complete the amendment process to add such provisions by the end of the next plan year). The relief rules will apply to loans and distributions that are made from now until January 31st of 2018, and is similar to relief offered after prior disasters, including Louisiana floods, and Hurricane Matthew. Notably, though, all the other normal rules for hardship distributions and loans still apply, including the taxability and potential early withdrawal penalties for (hardship) distributions, and the loan repayment requirements for loans from a qualified plan.

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!).