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Exclusive Interview with Michael Kitces: DOL Fiduciary Rule a “Pivotal Moment”

Exclusive Interview with Michael Kitces: DOL Fiduciary Rule a “Pivotal Moment”
July 19
00:03 2016

If you’ve been active in the financial services industry in almost any capacity, you’ve probably seen Michael Kitces at a trade show, convention, or even local professional association meeting. I recently had the pleasure to hear him present at the Syracuse New York chapter of the FPA. Afterwards, I spoke to him and he agreed to share some of his thoughts with FiduciaryNews.com readers.

Kitces is a Partner and the Director of Research for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Maryland that oversees approximately $1.8 billion of client assets. In addition, he is a co-founder of the XY Planning Network and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

FN: Michael, we always like to start off with an easy question about the journey that has led you to where you are today. Tell us a little bit about that journey. What was the single most memorable event that caused you to do what you’re doing right now?
Kitces: I landed in the financial services industry straight out of college, after having been a psychology major, theater minor, pre-med student who only figured out by the end of college that I didn’t want to go into psychology, theater, or medicine. Becoming a financial advisor – as described by the person who recruited me into the industry – sounded appealing, given that I didn’t really know what I wanted to do. As I discovered, though, I had actually taken a job as a life insurance agent, and I was a mediocre salesperson and a terrible prospector. It took me barely a year to accept I was failing.

By sheer luck, I ended out being mentoring in that first year by an advisor who had his CFP certification, and took a more financial-planning-centric approach (at least to the extent that was feasible within a life insurance agency). It opened my eyes up to a whole new way to approach solving problems for clients. And so when I left the insurance agency, I didn’t leave the industry – instead, I went looking for a job where I could be more involved in doing financial planning, and that would support me in getting my CFP marks. That’s what ultimately set me down the career path where I find myself today! 

FN: How many speaking gigs do you do a year, what are the typical venues, and who is your typical audience?
Kitces: For the past several years, I’ve been speaking at about 70 to 75 conferences for financial advisors – a volume I’m now trying to cut down to “merely” 50 – 60 events per year going forward. The events are all for financial advisors, but span a wide range of channels, from the membership associations like FPA, NAPFA, and IMCA, to the financial advisors at broker-dealers and insurance companies. Because I like to speak about more advanced financial planning strategies and higher-level industry trends, I tend to be involved with the more “advanced” or “elite” advisor events, which gives me an opportunity to get a very unique perspective on the leading best practices of advisors across the industry – which in turn becomes fuel for everything from the content I write about on Nerd’s Eye View, to the next presentation I start working on.

FN: What’s the most surprising question you’ve ever been asked at one of these events?
Kitces: As for the most surprising question I’ve ever been asked… I once did a presentation talking about tax planning opportunities after the then-recent 2012 tax legislation. When discussing the new rules, I spoke about how “we” had changed the tax laws in certain ways. Mid-way through the session, an audience member actually raised his hand and asked if I was a staff member for the IRS or Treasury, since I kept saying “we” changed our tax laws. I responded that I’m simply a tax-paying US citizen – I say “we” because the (tax) laws of the land apply to us all!

FN: You speak to financial advisers on a regular basis. Do you think they really appreciate the potential competition they’re about to get from state-run retirement plans and how best can they respond to this?
Kitces: Most financial advisors are so immersed into their own advisory firms, it’s hard to take a step back and look around to see what’s happening in the landscape. Because of that, I think financial advisors tend to miss a lot of the broader business trends – from the shifting role of technology (which isn’t about robo-advisors, but is about leveraging technology for better efficiencies), to the ongoing “crisis of differentiation” as more and more advisors adopt comprehensive financial planning. I don’t think the looming potential of state-run retirement plans is even on the radar screen for financial advisors. Though to be fair, I’m not certain it will be a significant impact for them, either; most advisors don’t build their businesses on initial retirement account contributions, and will still be there to solicit IRA rollovers of larger accounts. But advisors who focus in the small business retirement plan market in particular are going to notice a real impact in a few years… 

FN: How do you see the movement within the advice market towards a minimum fiduciary standard playing out? In what ways does the DOL’s Fiduciary Rule promote this? In what ways does the DOL’s Fiduciary Rule set this back?
Kitces: I view the DOL’s fiduciary rule as a watershed moment for the emergence of a bona fide financial planning profession. Frankly, if the SEC properly enforced the rules on the books for the ’40 Act and had limited brokers from holding out as financial advisors (where their advice is clearly no longer just “solely incidental” to the sale of brokerage services), we may have gotten there a lot sooner. But the SEC systematically failed to enforce for the past two decades, and now the DOL has by necessity forced the issue.

Ultimately, I expect we’ll see the DOL Fiduciary Rule clear the decks of the most sales-oriented “financial advisors” – who were really just financial services product salespeople – while having only limited impact on real advice-centric financial advisors. In the long run, this is a huge plus for establishing a recognized professional status for advisors, though in the near term I hope that regulators don’t “freak out” when they see the headcount drop and recognize that those who are leaving are disproportionately the “financial advisors” who were actually giving the least real financial advice.

But the regulatory change can’t end with the DOL rule. It won’t. It has created an untenable distinction between retirement accounts (held to a fiduciary standard) and brokerage accounts (still held to a suitability standard). Advisors at a broker-dealer will actually have different legal standards for the same client based on whether they’re talking about the IRA or taxable account. That separation will not hold. It will compel the SEC to act on its own fiduciary rule, to at least bring parity to the situation, though I expect it will take several years to happen. I’m not sure we’ll see a uniform fiduciary duty across all types of investment accounts until around 2020. And even then, we still have to figure out how to unify the fiduciary advice obligations of those selling insurance and annuity products.

FN: The SEC has gotten more aggressive with 12b-1 fees. Why do you feel this is so and do you think we still need them if financial service providers can simply charge an asset-based fee in lieu of receiving a 12b-1 fee?
Kitces: The origin of the 12(b)-1 fee was a marketing expense. A distribution cost. Something that would be paid to the salesperson to encourage them to sell the fund. Over time, it morphed into not just a distribution expense, but a form of ‘service fee’ for the advisor, and now increasingly pays the advisor to deliver an ever-wider range of advice (even as the selling advisor is still regulated as a salesperson and not an advisor).

As the 12(b)-1 fee continues its shift from being a sales-and-marketing expense of the mutual fund, to an advice fee of the advisor, the pressure grows for mutual funds to stop assessing 12(b)-1 fees, and let consumers decide whether to pay an advisor (or not) for advice. The ‘traditional’ asset-based AUM fee substantively captures the function of what the 12(b)-1 fee pays for today, and as regulators recognize this, we’ll continue to see a decline in 12(b)-1 fees. The SEC’s recent push to scrutinize whether advisors giving investment advice and receiving advisory fees are using non-12(b)-1 institutional share classes is just a case-in-point example of the shift. 

FN: Staying on the topic of conflicts-of-interest, what’s the best way to identify mutual funds with revenue sharing agreements? Unlike 12b-1 fees and commissions, the SEC does not require easy-to-read disclosure of revenue sharing. Is there an easier way to find this information?
Kitces: The advisor marketplace is indirectly finding the ultimate way to identify mutual funds that don’t have revenue-sharing agreements – they’re virtually always the cheapest funds. They are cheaper in part because they don’t have those revenue-sharing costs built into their expense ratios.

I wish that revenue-sharing agreements were more transparent. Indirectly, they’re about to become a lot more transparent, because the broker-dealers receiving those revenue-sharing agreements (at least pertaining to IRA accounts) will have to start disclosing them in the new DOL fiduciary disclosure requirements. So we’ll at least see more about who’s receiving revenue-sharing agreements, if it the funds paying them don’t do a great job of disclosing their payouts.

But again, indirectly the shift towards the lowest-cost mutual fund share classes, and towards ETFs, is the marketplace efficiently squeezing out excess/unnecessary revenue-sharing costs anyway.

FN: Why has there been so much discussion on the “correct” withdrawal rate from retirement plans? What do the historic returns tell you about this? Have you determined what the most practical interpretation of this is and what might that be?
Kitces: The fundamental challenge that every retiree faces upon the transition to retirement is “how much can I spend to really enjoy my money… without spending too much and running out.” That need to translate a pool of retirement assets into sustainable retirement cash flows is a remarkably difficult challenge, given the uncertainty of time horizon, the unknown impact of inflation, and the fact that the best way we know to combat potential inflation and longevity is to include growth assets that introduce volatility and sequence-of-return risk instead.

The “safe withdrawal rate” approach tackles this question by looking to all the historical sequences of market returns and inflation, identifying the one worst scenario, and making that the baseline for a retiree. The good news of this approach is that it means, by definition, if the retiree’s sequence of returns and inflation is “as bad as the worst we’ve ever seen,” the retiree will still make it to the end of their retirement time horizon without running out of money. The bad news is that in any other scenario, it actually just results in a significant amount of “excess” wealth, borne of the conservatism that turned out after the fact to be unnecessary.

Ultimately, the end strategy I think we’ll arrive at is to utilize more dynamic spending strategies, that make adjustments to spending based on market events as they unfold, being conservative when times are bad and dialing spending up when they improve. Unfortunately, though, this is still a very under-researched segment of the retirement research, and the available financial planning software tools do a poor job of illustrating the trade-offs.

FN: Retirement plan sponsors have been edging towards focusing on retirement readiness for several years now, but it’s not all up to them. What do you see as the biggest obstacles retirement savers face to becoming “retirement ready” and how might they overcome these obstacles?
Kitces: Unfortunately, I think the biggest problem we’re discovering with trying to assess and develop retirement readiness is that the whole framework of retirement itself is changing before our eyes. For some, retirement is a forced event – due to some combination of job changes and health and the ability to work. Those are people who won’t decide to retire, but they need the tools to understand how to retire effectively if the moment happens to them (and hopefully, some reasonable safety nets if they weren’t entirely ready). For the rest, retirement is about the proactive decision to retire, and it’s becoming complicated by the fact that “work” – in some form or another – is actually positive and fulfilling for us. Retirees retire and then discover they don’t enjoy retirement, sometimes going back to work – part time and for less money, but earning enough that it completely changes when they could have “retired” in the first place. In the end, I think we’ll eventually need to rethink the entire “retirement” paradigm – I prefer the concept and framework of becoming “financially independent” and then helping people decide what they want to do to “work” and engage themselves when what they do is no longer based on the amount of money they “have to” earn, and exploring the strategies to reach that point at their desired pace. 

FN: A growing number of financial advisers are recommending “The Child IRA” [see last week’s FiduciaryNews.com stories] as a way for parents to help encourage their children to save for retirement. Current laws limit opportunities to take advantage of The Child IRA only to those children with earned income. How might The Child IRA be used to help shield today’s children against the potential implosion of Social Security?
Kitces: I love the approach of encouraging children to save early, and trying to teach them about (and take advantage of) the tax benefits we provide for retirement accounts. Though frankly, the mathematical reality is the mere fact that the savings occurs is more important than the tax-deferred growth (or even whether/how much growth there is) in the early years. And there are a lot of other goals for people to save for towards that crop up in their 20s and 30s (from college to weddings to buying a house and starting a family), which means tying up money in an IRA may be too limiting. Not every child’s first savings goal needs to be one that might not be relevant for, literally, 60 – 70 years or more. Do we have any idea what retirement will even look like in the 2070s!?

So ultimately, I’m a huge fan of starting savings activity young, and using it as a way to teach good money values. But I’m actually not entirely convinced that doing it in an IRA is necessary as a way to do it.

FN: In ten years, where do you see the fiduciary advice industry?
Kitces: By the mid-2020s, I believe we’ll have finished applying a fiduciary duty uniformly to financial advisors. The delivery of financial advice will be almost entirely separated from the sale of products – not that the implementation of products isn’t necessary, but that the advice stands alone, just as doctors diagnose and prescribe but aren’t compensated by the drug companies (even though the doctors ultimately recommend the drugs).

In that landscape, we’ll see a far more varied range of financial advisor business models, serving a much wider segment of consumers that financial advice typically reaches today. The standards for financial advisors will be higher, with the CFP marks having become the de facto minimum standard for a bona fide financial planning (though probably not as a requirement under law quite yet). And the continued rise of the CFP marks and financial planning will increasingly force advisors into niches to specialize and differentiate themselves – over the next 10 years we’ll see niche firms grow as we’ve seen the AUM model grow over the past decade.

In addition, technology will have dramatically increased its role, driven advisors even more towards a combination of offering technical expertise and the behavior change skills to help people actually implement it. Financial advisors will not be replaced by technology, but the simplest parts of advice will, along with a lot of the ‘back-office’ staff that supports advisors today (but will be increasingly automated by then).

FN: Do you have any other thoughts you’d like to share with our audience?
Kitces: As I mentioned earlier, the DOL fiduciary movement is a pivotal moment for the emergence of financial advice as a bona fide profession. It wasn’t “perfect” as a rule, but it was good enough to start in motion the regulatory changes that will culminate in the recognition of financial advisors as true advisors and not mere salespeople. That transition from sales to advice will be messy – it will displace many of today’s “advisors”, force true advisors to upgrade their skillsets (in terms of both technical competency and relationship empathy), and drive the growth of niches and specializations. But it will also make the real financial advisors more valuable than ever.

FN: Michael, thank you so much for taking the time from your busy schedule to spending a moment with us and exploring a plethora of fascinating topics impacting the financial services industry. I look forward to seeing you speak again at some future event. Our readers are encouraged to attend one of your presentations and explore your web-site.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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