Tag: Retirement

The Military Is Overhauling Its Retirement Systems

The Military Is Overhauling Its Retirement Systems

Beginning in January of 2018, the military is switching from a traditional pension based on compensation and years of service, to a new “blended” system that combines the military pension with government contributions to a defined contribution plan account (the government’s Thrift Savings Plan [TSP]). The impetus for the change is that under the current system, the military pension isn’t vested until someone has at least 20 years of service – thus also sometimes referred to as a “20 or nothing” program – yet the reality is that more than 80% of service members leave the military short of the 20-year minimum. Accordingly, the new system will offer a pension that is 20% smaller, but service members will also receive contributions of 1% of their pay into their TSP account (with the ability to earn a match of up to 4%) in addition to any TSP contributions they make themselves, and a new midcareer bonus (to ameliorate the impact of the prior 20-or-nothing rule). Notably, the new system will also give those who reach the 20-year pension threshold the option to convert a portion of their pension into a lump sum instead. The new system will apply automatically to those who enlist in the armed forces after December 31st of 2017, while those with 12-or-more years of service by the end of this year will be grandfathered into the current system; however, those who are currently enlisted but with less than 12 years of service must decide (irrevocably) whether to stay in the current system, or switch to the new one. The switch will almost certainly be better for those who don’t expect to stay in the military for 20 years (as under the old system they wouldn’t get any military contributions), especially if they’re also ready to save and maximize the military match, while those who plan to stay may prefer the old/current system (with the caveat that if life changes and they can’t stay, the 20-or-nothing rule could adversely impact them later). And the Department of Defense has published a calculator tool to help make comparisons. Ultimately, those eligible for the switch will have the entirety of 2018 to make the decision to switch (though those who wait won’t get military contributions to their TSP in early 2018 before they actually make the change).

Does Failed Retirement Income Planning Really Result In Bankrupt Financial Ruin?

Does Failed Retirement Income Planning Really Result In Bankrupt Financial Ruin?


While it is a topic most retirees hope to avoid ever dealing with, the reality is that not all retirement income plans will be successful. Whether due to a retiree’s refusal to plan, reluctance to take the advice of a professional, or simply due to unfortunate circumstances which were outside of a retiree’s control – failures in funding retirement can and do occur. In fact, financial planners routinely do Monte Carlo projections for retirees to determine their prospective probability of failure, especially given growing awareness of sequence of return risk.

Yet given the reports of low levels of both objective measures of retirement preparedness (such as savings) and subjective measures of retirement preparedness (such as retirement confidence), many financial advisors may be surprised to learn that bankruptcy rates among those over age 65 appears to be less than 3 per 1,000, and actually declinesamong older retirees. So, what’s going on? If retirees are living longer than ever – which should be making retirement more difficult than ever to afford and sustain, especially given the long-term impact of sequence of return risk – then where are all of the bankrupt retirees?

In this guest post, an examination bankruptcy among retirees, finding that the reality is that bankruptcy may not be a great indicator of retirement income planning failure. A retiree who blows through their nest egg doesn’t necessarily end up bankrupt, they simply need to adjust their spending downwards to their new reality. Social Security plus public assistance represent the true consumption “floor” for most. Further, bankruptcy may not even be a great indicator of actual financial strain, as given the rules surrounding bankruptcy, the ways that retirees deplete their retirement assets does not necessarily trigger an actual bankruptcy filing, especially in light of the ways in which bankruptcy laws favor those in retirement.

Nonetheless, the point remains: with longer life expectancies and struggles with retirement preparedness, especially combined with the difficult markets of the past 15 years, the retiree bankruptcy rate is shockingly low. Which suggests that the overwhelming majority of retirees facing retirement shortfalls really are able to downsize their lifestyle to avoid financial ruin when the time comes. Of course, few retirees want to risk even a major lifestyle setback in retirement if they can avoid it. Still, though, if most retirees really are capable of making spending adjustments when necessary… shouldn’t those potential adjustments be better reflected in financial plans in the first place?


Chapter 7 bankruptcy is the type of bankruptcy most people generally think of when they hear the term “bankruptcy”. Also known as “liquidation” bankruptcy, the Chapter 7 bankruptcy process entails having a debtor’s assets transferred to a bankruptcy estate, where the assets are liquidated to pay to repay creditors, and any remaining (eligible) debts are discharged.

Notably, Chapter 7 doesn’t apply to all forms of debt, and there are some requirements that need to be fulfilled in order to qualify for Chapter 7 in the first place. First, an individual’s income must actually be low enough (at least relative to their debts) that they qualify for Chapter 7 bankruptcy. While the income qualification criteria can get fairly complex, in essence, the income tests assess: (1) whether the individual’s income less than the median in their state; or, (2) if the individual’s income is above the median, whether their disposable income low enough to indicate true financial strain. If either test is met, the individual “passes” and is eligible to file for bankruptcy.

Means testing was introduced in 2005 as a way to combat some abuse of the bankruptcy system – effectively reducing the ability of someone with material income and means to claim bankruptcy (notwithstanding the various bankruptcy exemptions and protections). However, an important caveat to this test—particularly from the perspective of individual’s considering bankruptcy in retirement—is that Social Security income is exempted from one’s income for means testing purposes (effectively making it easier for many retirees to file for bankruptcy).

Beyond these requirements, the debt must actually be dischargeable under Chapter 7. Many common forms of debt, such as credit cards, medical bills, and collections accounts can be discharged. However, other forms of debt or financial obligations, such as student loans, child support, and alimony, generally cannot… which means that someone struggling with those debts would still likely never end up in bankruptcy.

Under Chapter 7 bankruptcy, certain assets are also exempt from liquidation, allowing the debtor to keep those assets while going through bankruptcy. While there is a lot of variation from one state to another, exempt assets include personal property that would be of little value through liquidation (e.g., clothes, household goods, and food) as well as other assets of more substantial value (e.g., wedding rings, vehicles, retirement accounts, and equity in personal residences).


Unlike Chapter 7 bankruptcy, Chapter 13 bankruptcy is a “reorganization” bankruptcy. Chapter 13 does not involve the same liquidation process. Instead, Chapter 13 bankruptcy aims to help debtors come up with plans to get on track and repay (at least some of) their debts.

Chapter 13 bankruptcy is only available to those receiving regular ongoing income. 11 US Code Section 109(e) restricts eligibility for Chapter 13 bankruptcy to only those with less than $394,725 of unsecured debt or less than $1,184,200 of secured debt (thresholds will be updated again in 2019). Debtors are required to participate in credit counseling and development a repayment plan for their debt.

Filing for Chapter 13 generally puts a “freeze” on any current collection efforts, providing some temporary relief while the debtor goes through Chapter 13 proceedings. A trustee is appointed to administer the bankruptcy, and then debtor then makes payments to the trustee, who will then distribute those funds to debtors, according to the repayment plan developed and approved by the court. The debtor is also prohibited from acquiring new forms of debt without permission of the trustee. If a debtor fails to make payments under Chapter 13 bankruptcy, the court may convert the bankruptcy to a Chapter 7 bankruptcy, requiring the liquidation of assets to repay creditors.

The advantage of a Chapter 13 bankruptcy is that an individual may be able to keep their possessions and get back on track, without being compelled to liquidate all of their non-exempt property. Chapter 13 bankruptcy cases generally last from 3-5 years, and, similar to Chapter 7 bankruptcy, some forms of debt can be discharged (i.e., eliminated without actually being fully repaid) upon the completion of the Chapter 13 bankruptcy repayment plan (though obligations such as mortgage debt, child support, alimony, and certain taxes will need to be repaid in full).

Bankruptcy Filing Rates In Retirement

Because bankruptcy filings are a public process (in order to affirm that all debts have been satisfied, bankruptcy involves a public notice process to alert creditors who may have outstanding claims) it is possible to determine the frequency of bankruptcy filings.

Bankruptcy Filings Per 1000 US Population

The chart above reports bankruptcy filing rates by age group (non-business Chapter 7 plus Chapter 13). Thorne, Warren, and Sullivan (2008) found that in 2007, the bankruptcy rate per thousand U.S. population peaked at the age group of 35-44 with 6.5 per thousand. For individuals between ages 55-64, this rate declined to 4.9; between 75-84 the rate was 1.6 per thousand; and beyond age 85 the rate was so low it was negligible.

This declining rate of bankruptcy in among retirement-aged individuals is notable, because the greatest risk for retirees is outliving their money. Yet with bankruptcy rates decreasing among older adults, the data suggests that bankruptcy in retirement may not be (at least primarily) the result of depleting a portfolio due to longevity or inadequate savings going into retirement!

What Causes Bankruptcy In Retirement?

The fact that bankruptcy filing rates are higher in the early years of retirement and decline in the later years (even as retirement assets would also ostensibly be depleting) raises the question about what actually doestrigger bankruptcy in retirement, if not asset depletion.

A 2010 study from Deborah Thorne at the University of Ohio on theinterconnected reasons that elder Americans file for bankruptcy found that credit card debt and illness/injury (which can trigger substantial medical expenses, which may subsequently turn into unpayable medical debts) were the two leading causes of bankruptcy among the elderly (based on self-reports from those who had filed for bankruptcy). As Dirk Cotton has pointed out, sequence of return risk does not appear to be a significant contributor to bankruptcy among the elderly, as only 6.7% of filers reported “retirement” as the source of their bankruptcy, and again bankruptcy rates are highest in the early years of retirement—when failures due to sequence of return risk (based on reasonable withdrawal rates) are mostly non-existent.

As Cotton has argued (and Thorne’s study supports), it appears that thepredominant cause of bankruptcy in retirement appears to be an unanticipated shock to one’s income or expenses that results in them becoming overextended and not being able to meet their financial obligations. It’s important to note that these shocks are different than someone just living beyond their means, as running a portfolio to $0 doesn’t necessarily trigger any conditions that would even make one eligible for bankruptcy. Depletion might require a material downward adjustment in one’s level of spending, but with no debts outstanding that cannot be paid, there is no actual trigger for bankruptcy.

As indicated in the chart above, bankruptcy actually seems to decline with age. Which, consistent with the Thorne’s (2010) findings, would suggest that financial shocks are a more significant cause of bankruptcy in retirement than depleting portfolios. However, what may remain unclear is why financial shocks would decline with age as well. To address this question, it is helpful to look at who is susceptible to financial shocks in the first place.

Who Is Susceptible To Bankruptcy In Retirement?

A few factors would seem to primarily drive susceptibility to bankruptcy in retirement. The first is financial fragility, which is the degree to which a small shock in a household’s income or expenses could have a big impact on their overall situation. A household’s debt-to-income ratio (monthly debt payments divided by monthly income) is an important indicator of fragility. Another would be the Fed’s financial obligations ratio, which looks at how much income goes towards fixed payments. All else equal, the higher percentage of a household’s current income that is going towards fixed payments, the more susceptible they are to either an income or an expense shock.

Naturally, one important driver of the debt-to-income ratio is the presence of debt in the first place. Even if a household does have to rely on credit to fund an unexpected medical expense, the less debt they currently have, the better positioned they will be to meet this unexpected obligation.

By looking at data from the 2012 Health and Retirement Study (HRS), we can notice a few general trends related to the use of debt amongst individuals at different ages. First, not surprisingly, the percentage of individuals self-reporting themselves as retired increases with age. At age 55, this number is roughly 10%, but it reaches 80% by age 75. But then we can also see that the percentage of people reporting mortgage or other forms of debt also declines with age. At age 55, 37% report having a mortgage and 44% report having other debt. Among those age 70, these numbers decline to 20% and 27%, respectively.


Trends In Self-Reported Retirement Status And Use Of Mortgages And Other Debt By Age

The presence of debt is important because it is a potential source of financial fragility—as debt itself (and an inability to repay it) is the actual trigger of bankruptcy. Debt isn’t always a sign of fragility, as sometimes debt is simply used strategically and there is no material risk of insolvency, but fragility due to debt can be particularly concerning when debt is tied to a retiree’s basic living expenses.

For instance, if a retiree enters retirement with a $1,500 per month mortgage, then they have $18,000 per year earmarked towards a fixed expense (assuming they don’t move or refinance their mortgage, or use a reverse mortgage in retirement to avoid the ongoing payment obligations). It’s these fixed expenses which pose the greatest risk if a retiree experiences an income shock. And then, as Dirk Cotton has noted, things can quickly pile on top of each other and spiral out of control—perhaps as a retiree tries to make things work by taking on credit card debt, pulling equity out of other assets, or turning to high cost lending sources. In other words, while bankruptcy isn’t usually triggered by simply depleting a portfolio, having or taking on a substantial debt – either in response to a financial shock or carrying it into retirement from one’s working years – does increase the likelihood that a retiree will be unable to meet their obligations, and thus need to file for bankruptcy.

However, not all factors which drive susceptibility to bankruptcy actually have anything to do with a household’s overall financial health. For instance, the proportion of exempt to non-exempt assets would be another important factor which influences how likely a retiree may be to file for bankruptcy.

Consider the following example:

Example 1. John is 65 and recently retired. He receives modest Social Security income, has no debt, and his only substantial assets are his $250,000 401(k) and his $150,000 home in a state that offers a 100% homestead exemption. Beyond this, John only owns some personal items and a very modest used car.

Tracy is 65 and recently retired. She receives modest Social Security income, has no debt, and her substantial assets are a $250,000 taxable portfolio (proceeds from the sale of her business) and her $150,000 home in a state that offers only a small homestead exemption. Beyond this, Tracy only owns some personal items and a very modest used car.

While John and Tracy have relatively similar financial situations from a retirement income perspective, their susceptibility to bankruptcy given a financial shock are very different. Because nearly all of John’s assets are exempt assets from a bankruptcy perspective, a bankruptcy may not harm him much at all. Ignoring potential moral considerations regarding the strategic use of bankruptcy, John could choose to have large and unexpected medical expenses discharged through bankruptcy with little to no adverse impact to himself. Further, John may be able to do so regardless of his actual ability to afford the medical expenses, as his ongoing Social Security income, 401(k), and personal residence are all exempt from bankruptcy.

Meanwhile, the same is not true for Tracy. Because nearly all of her assets are non-exempt assets, bankruptcy is of little strategic use to Tracy. If her assets (less a modest homestead exemption) are sufficient to cover the medical expenses, she is better off just paying them. Thus, John’s higher proportion of exempt assets makes him more susceptible to bankruptcy as a retiree, even though his underlying financial situation is fairly similar to Tracy’s.

And this example illustrates why retiree bankruptcy may not always be a great indicator of actual financial strain. Particularly given the ways in which bankruptcy laws favor retirees (e.g., exempting the types of assets retirees most commonly own and excluding Social Security income from means testing), bankruptcy could sometimes even make sense as a wealth-maximizing strategy in retirement.

Portfolio Depletion As A Bankruptcy Trigger Or “Mere” Spending Adjustment?

In the context that most financial advisors discuss bankruptcy with retirees, the primary concern is that spending all of one’s assets will result in “financial ruin” and cause the retiree to go bankrupt. However, as the data shows, this is rarely actually the case.

Instead, spending down most or all of one’s assets merely necessitates a downward adjustment in retirement spending. Some retirees may try and fight this adjustment, turning to credit cards or other sources of debt to unsustainably prop up their standard of living, but this is different than simply running out of assets — it’s the active accumulation of more obligations beyond spending down one’s portfolio!

Of course, to the extent that a portfolio drawdown exhausts reserves which could be otherwise used to absorb a financial shock, depleting a portfolio clearly increases the potential risk of bankruptcy.

Consider another example:

Example 2. Tracy is 65 and recently retired. She receives modest Social Security income, has no debt, and her only substantial assets are her $250,000 taxable portfolio and her $150,000 home in a state that offers only a small homestead exemption. Beyond this, Tracy only owns some personal items and a very modest used car. However, Tracy’s lifestyle does not align with her savings. Tracy recently met with a financial planner who determined that her current spending would require about $50,000 per year in income from her portfolio in order to supplement her Social Security income. Tracy’s financial planner estimates that she will spend down her portfolio after 6 years by taking $50,000 per year in income from her portfolio.

Is Tracy going to face bankruptcy once she spends down her portfolio? Not necessarily.

While she is going to face a tough wake-up call regarding her spending going forward, her lack of debt means she’s not actually in trouble with any creditors. However, what spending down her portfolio does do is eliminate some assets that can be used to alleviate a financial shock, such as an unexpected medical expense, which, if she attempts to pay for with debt, can end up triggering a bankruptcy later.

Notably, if her assets were in a 401(k) or had strong homestead protections, then bankruptcy might be a viable path for Tracy to handle an expense shock such as medical bills. As a result, she may actually be moresusceptible to bankruptcy with exempt assets — though bankruptcy would actually be a wealth-enhancing strategy for her, rather than an indicator of financial strain! Of course, if Tracy is on Medicare, then this risk is limited as well, which could be one contributing factor to the explain why bankruptcy rates actually seem to decrease (rather than increase) with age.

Portfolio Depletion: Planning For Spending Adjustments Vs Bankruptcy

The key point to this discussion is that spending down a portfolio may make a retiree more susceptible to bankruptcy, but doesn’t necessarily ensure bankruptcy or total financial ruin (especially with Social Security and Medicare safety nets). In fact, the data shows that despite the natural rising risk of depleting assets as retirees age, the bankruptcy rate actuallydecreases among older retirees. Which has implications for both retirees, and the financial advisors working with them.

First, the data suggests that retirees are more capable of making adjustments than traditional financial planning models assume. We know a wide swath of people are underprepared going into retirement relative to what most financial planning models would assume they need. Yet, very low rates of bankruptcy indicate that people are somehow managing to get by. Which means models that project probabilities of “failure” really should be viewed more as probabilities of “adjustment” that real-world retirees routinely make.

Still, this does raise some interesting questions. If retirees are more adept at making adjustments than financial planning models given them credit for, then where are retirees cutting their spending? Are traditional models underestimating how much spending naturally declines later in life? Are generational transfers picking up some of the slack (i.e., children pitching in to support their parents in their later years)? What role are social insurance programs playing in protecting households, perhaps even after they have already reached a financially fragile state? Is the safety net of Medicare and Social Security more effective than what most financial planners give it credit to be?

Additionally, the lack of bankrupt retirees raises some questions for how advisors plan and communication with clients. Should we reframe how we talk about Monte Carlo analyses, focusing even more on probability of “adjustment” rather than probability of failure? Do we need tools which better allow financial advisors to model declining spending throughout retirement? Should reducing financial fragility receive more focus as a pre-retirement planning objective? How would planning advice change if the objective was re-framed as managing one’s financial affairs within a financially fragile state, rather than just focusing on avoiding financial ruin in the form of “bankruptcy” (which seems to rarely result, even after a portfolio has been depleted).

The bottom line is that given how rare bankruptcy in retirement actually is, perhaps it’s time to stop planning on how to avoid bankruptcy and “financial ruin” in retirement, and instead plan to manage the risk of future (downward) spending adjustments and to avoid fragility (as it is fragility that results from a depleted portfolio—not bankruptcy).

So what do you think? Why are bankruptcy rates so low among retirees? Should advisors frame retirement failure differently? How do you talk to your clients about failure in retirement? Please share your thoughts in the comments below!


Social Security COLA Could Get Wiped Out By Rising Medicare Costs

Social Security COLA Could Get Wiped Out By Rising Medicare Costs

With the latest CPI release for August now available, analysts project that the annual Social Security Cost-Of-Living Adjustment, or COLA (which is calculated annually from the beginning of September from the prior year to the end of August of the current year), should be approximately 1.8% in 2018, which would actually make it the largest COLA since 2012 (when it was 1.7%), and up substantially from 0% in 2016 and just 0.3% in 2017. However, because the past two years have had especially low inflation and small COLAs, most Social Security recipients have benefitted from the so-called “Hold Harmless” provisions that cap their Medicare Part B premiums at the dollar amount increase in annual Social Security payments – which meant with near-zero inflation for two years, the $104/month Medicare Part B premium from 2015 has risen to “just” $109/month (while the roughly 30% of Medicare enrollees not protected by Hold Harmless have been paying $134/month, plus any income-related surcharges). Yet with inflation now looming for 2018, the rise in Social Security payments next year will be enough to “unwind” the prior Hold Harmless rules, reverting most Social Security recipients from $109/month to $134/month in Medicare Part B premiums, which ironically will consume most or all of their pending 1.7% COLA increase. On the other hand, higher income individuals, who were not eligible for Hold Harmless in the first place and were already paying the full $134/month in Medicare Part B, will continue to pay the same amount next year (albeit plus income-related surcharges again), but actually will see the 1.7% COLA increase in their Social Security checks!

The Future Of The Independent Broker-Dealer

The Future Of The Independent Broker-Dealer

A hot topic at the upcoming Wealth Management Executive Forum is the future of the independent broker-dealer model itself, with a notable panel to be moderated by industry consultant Matt Lynch of Strategy & Resources on the topic. Overall, Lynch suggests that the predicted extinction of the Independent Broker-Dealer (IBD) is overstated, though the trend of smaller broker-dealers filing Form BDW (to withdraw their registration as a standalone broker-dealer) and tuck into a larger IBD as an OSJ is clearly underway. Yet for the registered representatives of those smaller broker-dealers, the tuck-in to become an OSJ of a larger firm is so smooth that many of them simply end out with better technology and services, and the business gains better economies of scale. The more notable trend, though, is that IBDs are being compelled to reinvent their underlying business models, to the point that while “broker-dealer” may continue to be a regulatory label, it’s no longer necessarily an accurate description of their business model, with more and more shifting to advisory fee-based business with affiliated corporate RIAs and internal TAMPs. In other words, IBDs are essentially converting from actual “broker-dealers” into intermediaries that provide support to advisors, to the extent that someday they might even drop their broker-dealer registration yet continue as an advisor affiliation entity. Accordingly, broker-dealers are increasingly reinvesting themselves into a wider range of advisor support services, from consulting on succession planning and practice management, executive coaching, and other marketing and technology advice. At the same time, broker-dealers are becoming increasingly RIA friendly – either with their own corporate RIAs, or by allowing their reps to be hybrid RIAs… though in the end, the whole independent broker-dealer model and large RIA networks may all collapse into one.

Market Downturn Fears, Other Hot-Button Issues Divide RIA Dealmakers

Market Downturn Fears, Other Hot-Button Issues Divide RIA Dealmakers

This past week was the annual “Deals & Dealmakers Summit” hosted by Echelon Partners (which providers investment banking, management consulting, and valuation services for advisory firms). The conference is known for bringing together most of the leading firms engaged in Mergers & Acquisitions for independent advisory firms, and featured extensive discussion about current trends in advisory M&A. Weighing heavily on everyone’s minds is the potential risk of a bear market – given that the current bull market cycle is more than 8 years long – and what that might do to advisory firm valuations. The prevailing view is that a potential stock market reversal will not likely hurt M&A valuations (or at least, valuation multiples), though buyers are increasingly careful of how they structure M&A deals to not “over-value” companies that could experience a substantial “near-term” revenue decline if a bear market unfolded shortly after the deal closed. On the other hand, the clearer trend is that the most robust demand for advisory firm acquisitions continues to be for “larger” advisory firms – those with more than $1B of AUM, or more specifically with at least $3M of revenue – as larger firms are not only “large enough” to attract deep-pocketed buyers (whereas smaller deals are “too small” to be material for them), but are also more likely to be professionally managed (and less dependent on founders or a single key employee) and better able to leverage economies of scale. Another key trend expected to continue – the ongoing wirehouse breakaway broker trend, although notably “older” brokers (in their 50s or beyond) appear increasingly likely to stick out the remainder of their careers at wirehouses, while it’s younger wirehouse advisors in their 30s and 40s who are increasingly looking to independent channels.

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!

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!