NAPFA, the National Association of Personal Financial Advisors, is the nation's leading organization dedicated to the advancement of Fee-Only comprehensive financial planning. Consumers and the media look to NAPFA for access to financial advisors who meet the highest standards for professional competency, comprehensive financial planning and Fee-Only compensation.
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Is there a sense of “swimming upstream” when trying to propagate goal-based investing--as described in your new book Risk Less and Prosper--among existing financial advisors? Conventional practices and economic incentives are so heavily skewed towards modern portfolio theory and growing assets under management. 

Bodie and Taqqu:  We read your question as a riff on what it would take to move mainstream personal investing toward a more customer-centric, goal based model.  You’ve marked some ways that we may be swimming against the tide—and against the interests of today’s investment industry.

But tides turn. It’s true that investment industry incentives don’t always align well with goal based products and advice. Yet, we can expect the coming waves of Boomer retirements to pack a shape-shifting wallop to the entire industry. Demand for products with insurance components (including fixed and variable annuities) is likely to expand quickly. In addition, demand for more customized advisory services and for greater attention to risk management are both likely to soar.

Also, as major dollar amounts move from accumulation to decumulation portfolios, it’s not unreasonable to expect the AUM fee model to lose some practitioner appeal. Retainer fees begin to make more sense in this new scenario. At the same time, new information technology has improved client communication tools and made them less expensive, giving advisors more flexibility.

Annuity Digest:  Looking forward, which segment of the advisor industry is most likely to run with the concept of goal-based investing for retirement planning?  Do you think the larger broker-dealers and wire-houses will be receptive? 

Bodie and Taqqu:  As it responds to these anticipated new demands, the advisory business may be about to undergo great change. Your question may turn out to be more backward-looking than we realize.

For instance, there is now a renewed emphasis in the advisor community on client intimacy and personal counseling. Consider Charley Ellis’s article in last summer’s FAJ (July-Aug 2011). Ellis’s point--that advising should be mostly about counseling (figuring out ‘who you are’ before you worry about where the market is)--is entirely consonant with goal-based investing. (In fact, the article indirectly answers your question about which segment of the advisory industry is going to be most receptive to goal-based investing: it’s the advisors who style themselves counselors, whether they are “financial life coaches” or more traditional investment counselors.) As Ellis notes, the need for investor counseling is made all the more acute by the shift from Defined Benefit to Defined Contribution pensions. 

Annuity Digest:  The risk management orientation of goal-based investing seems to require that practicing advisors develop insurance capabilities.  In reality, though, many of the fee-oriented advisors (both fee-only and fee-based) you reference in the book are not set-up to deal with insurance transactions.  Many NAPFA advisors, for example, outsource insurance transactions to third-parties.  How is the need for insurance product expertise and transactions reconciled with the reality of fee-oriented practices? 

Bodie and Taqqu:  You are absolutely right about the need for advisors to enhance their insurance capabilities. 

Zvi has been insisting for a long time that personal investment advice needs to encompass insurance activities, and his arguments have been gaining a lot of traction lately. Almost all the CFPs we know, for example, are highly motivated right now to learn as much as they can about insurance products, including the many flavors of annuities currently available. We don’t see structural constraints limiting dual certification, and outsourcing remains a viable option as does partnering. 

Annuity Digest:  Asset gathering and management is a very scalable business—both for the fund managers and intermediaries.  In contrast, tasks associated with goal-based investing such as personal budgeting, asset-liability matching and actual execution (e.g. insurance products, laddered TIPS, etc) are not exactly scalable.  How does the industry address this scalability challenge, and how do advisors “do the right thing” without doing missionary work? 

Bodie and Taqqu:  As for barriers posed by an absence of scalability, have a look at Bob Veres’s 2010 review of where the industry stands today. Veres concludes that the proliferation of off-the-shelf software, cloud computing, and outsourced compliance and reporting has removed the competitive edge once held by very large and often impersonal firms. The counseling model, with its dedication of more resources to client interaction, is no longer impractical, and Veres believes we are on the brink of a client services revolution.

Efficiency remains an issue, but plenty of tools for streamlining goal-based advising do exist. There are software solutions for TIPS laddering, goal-identification and personal balance-sheet creation--and more. In addition, PIMCO has launched two funds composed of laddered TIPS. Others may follow. Veritat, a small advisory firm founded by Wharton professor Kent Smetters (Zvi is on its Advisory Board), provides mass customization--by offering goal-driven and relationship-based advisory services online to small investors. These trends should continue. 

Annuity Digest:  Are there pockets among the existing financial advisor landscape where goal-based investing is thriving? 

Bodie and Taqqu:  There are many forward-looking goal-based advisors in practice today, and many are in positions of influence. Through their leadership, goal based educational material is already being incorporated into the essential next step of broad advisor training (for example, in the readings for the CFA exams). We fully expect our book Risk Less and Prosper to help boost advisors’ understanding and skills.

Old paradigms fade slowly. And gradual change can be imperceptible. But as investor demands shift while new educational materials proliferate, we think the scales may tip toward goal-based principles sooner than most people think.

Annuity Digest:  Thank you very much Rachelle and Zvi.

7,291 reads

Veritat is a start-up seeking to leverage process and technology innovation to scale a business model that is typically saddled with persistent and burdensome variable costs.  If successful, Veritat will be able to deliver premium services to a mass audience.

As a registered investment advisor (RIA) that adheres to the fiduciary standard, Veritat provides comprehensive financial planning services through financial advisors who are employed by the company and share a common sense of mission.

We spoke with Dr. Kent Smetters who is the President of Veritat and a professor at the Wharton School at the University of Pennsylvania. 


Annuity Digest: How did Veritat come into existence?

Dr. Kent Smetters: Until about five years ago, I had been doing research in the area for years, but have been involved with few real world applications. Then, with the struggles of tenure finally behind me, I looked at the space closer and was shocked.  A close friend of my family received services from an advisor at Ameriprise.  This person had diligently managed to sock-away $125,000 and yet was charged an astounding $7,000 in loads on this money.  It blew me away that this practice was actually legal.

Our financial system provides the rich with a wonderful fee-only model and a financial advisor who is a fiduciary. But it is too expensive for everyone else. Our mission is to make this model accessible for everyone while still having continuous access to a dedicated financial advisor along the way. A web-only solution will never work. People want to talk to an expert that listens and is truly on their side.

We have spent a year and a half developing technology.  In some instances we have been lucky because our skill sets fit so well with our product development efforts.  At same time, the experience has been painful.  There are so many inefficiencies and problems in the industry, and fixing them took a lot of work. The outcome and validation has been terrific. But it was a struggle.


Annuity Digest: Who is involved with the venture?

Dr. Kent Smetters: At the moment, we have around 10 full-time equivalent employees. The staff is evenly split between technology and business.  The co-founder, Danielle Qi, was a former student of mine who worked at McKinsey Consulting for a few years before joining me at Veritat. She is terrific at operations and establishing scalable processes; my strengths tend to focus on product and partnerships.

Our technology team is very senior and our development framework is Ruby on Rails.


Annuity Digest: Can you talk about your financial advisors – how many are there, are they all independent contractors, are they all independent RIAs serving as fiduciaries, etc?

Dr. Kent Smetters: All of our financial advisors are employees—not independent contractors or affiliates. They are paid base salary plus a bonus that is a function of the number of happy customers.

Some advisors have contacted us about partnerships.  We have declined because of our concern about maintaining objectivity through a purely fee-based relationship and fiduciary status.

We have a few financial advisors now and will have a dozen more in a month and a half.  We will grow over the next year and half to around 50.  Going forward, I envision several hundred advisors and we will scale-up faster if the need arises.

We’ll never attract the highly compensated sales person as an advisory, but there are a ton of advisors out there who are on board with the mission and the industry average salaries we pay. We get a lot a resumes and screen carefully to make sure that the advisor is really mission-driven like us.


Annuity Digest: Are there any institutional partnerships in place to build the advisor base—NAPFA for example?

Dr. Kent Smetters: Again, there are no partnerships for advisors, but all of our advisors will be NAPFA members and the company is a NAPFA company (fee-only, no commissions and a fiduciary role). However, we are open to a reasonable white label business-to-business relationship that allows large financial services company to use our scalable technology and processes, provided that our name is not being used if they are not fee-only.


Annuity Digest: Is there a limit or hard-stop on the amount of time a financial advisor can spend with a client, and are there additional fees for your client-requested on demand appointments?

Dr. Kent Smetters: There is no limit on the financial advisors’ time.

The point you raise is good, however, as this issue will test our business model over time.

So far, we have had no issues with the customers who want to talk a lot.  We will just have to tackle this issue if and when we encounter it.


Annuity Digest: Can you comment on your approach to risk management?

Dr. Kent Smetters: My strong belief is that conventional risk management approaches are incorrect as they dial-up risk too much. The reason is that there is too much focus on expected returns and Monte Carlo analysis.  Those concepts focus a client’s attention on a safety margin at the end of life.  In other words, more stocks equates to higher expected return and more assets at end of life. 

This does not make sense to an economist.  How could you possibly call this safety?  It should be interpreted just the opposite, as a pure compensation for risk.

Clients do not understand Monte Carlo analysis—so they simply focus on the expected returns.  In addition, Monte Carlo analysis assumes a normal distribution which is empirically rejected by data.  Also, Monte Carlo analysis does not talk about the actual downside severity.  Severity must be taken into account, not just the number of times assets fall short toward the end of life.

Conventional approaches also assume that the portfolio is completely constant throughout the entire pre-retirement period, and the same across many goals.  There is no logical way of life-cycle planning that would keep a portfolio fixed throughout all pre-retirement years.  Traditional methods generally also ignore human capital and how it depreciates over the lifetime. 

At Veritat, we adjust a portfolio’s risk exposure based on a variety of factors: human capital, time to goal, priorities, and risk preferences. Each goal has a portfolio that is appropriate for it. We also stress test more rigorously by using risk-neutral probability measures that extract out any appearance of a “free lunch” coming from taking on additional risk. We really want the risk management conversation to come down to a discussion of the sacrifice that the client needs to make today in order to achieve goals, and what portfolio allocation is reasonable to achieve those goals.


Annuity Digest: Can you comment on the retirement income aspects of Veritat’s services?

Dr. Kent Smetters: When it comes to the decumulation phase, we will use a type of phased withdrawal that cushions longevity risk.

Next, we will recommend some level of annuitization to clients.  However, we will not recommend any of the heavy loaded annuities out there.  We are comfortable with annuity recommendations to the extent that the annuity is low load and truly a life annuity rather than a certain term.


Annuity Digest: As a fee-only RIA, does Veritat refer annuity product transactions to outside partners?

Dr. Kent Smetters: Yes, any insurance transaction is referred-out to partners.  We develop relationships with brokers who use annuity products that either are low load to begin with, or have expense structures that can be negotiated with the insurance company. We won’t accept any commission from the service provider on any recommendation we give, including from insurers.


Annuity Digest: Can you talk about customer acquisition strategy and the scalability of your business model?

Dr. Kent Smetters: Regarding the cost of customer acquisition, we hope to get lower than industry norms.

Our customer acquisition strategy is premised on transparency and differentiation through white-hat processes.  The number one reason that broker-dealers and commission-based advisors must spend so much on acquisition is that the customer does not know how the advisor will be making money.  As a result, quite a bit of relationship building is required. 

That ambiguity is expensive—industry average acquisition cost is up to $500 per customer.

Our approach is to let customers know exactly how we’re making money and our model is different from a commission-based platform.

We hope this will help cut through some acquisition costs.

With respect to scalability, we rely heavily on technology to support process innovation.  For example, the number of clients per advisor is relatively higher in our model because our advisors spend about 93% of their time in front of clients.  We do not need to focus on the traditional time sinks.  We have pros who spend a lot of time looking at the financial plans as they come out.  All plans are reviewed by humans and presented by humans to clients within a dedicated and repeated relationship.

With our model, it is also true that each client touch is shorter than industry norms, despite the overall number of touches throughout the year being higher than average. 

Again, we don’t need to focus as much on the traditional sales efforts.  Our initial assessment is 15 minutes and it is substantive.

In terms of attrition and conversion rates, our business model is rather conservative assumes industry averages in the near-term.  In later years we make some more aggressive assumptions.  That said, there is no question that time spent with clients who do not convert or fall-off is a cost to us.


Annuity Digest: Can you talk about distribution strategy – does it involve direct-to-consumer, worksite, financial institution partnerships, plan sponsor, etc?

Dr. Kent Smetters: It involves all of the above.

We are looking at different partnerships, including worksites and smaller financial institutions.

We are also interested in the direct market.

We have some conversations with smaller insurance companies as well.


Annuity Digest: Are there any additional thoughts or comments that you would like to share?

Dr. Kent Smetters: I would simply say that at a high level, the company was created for the purpose of bringing an honest, objective financial planning service to households who in the past would not have been able to afford these services.

We are very mission driven.

But we are not a web only solution—we believe that a strong human touch is an important part of financial planning.


Annuity Digest: Many thanks for your time Dr. Smetters.

11,385 reads

NAPFA is the National Association of Personal Financial Advisors.

NAPFA membership consists of financial advisors who provide comprehensive financial planning services on a fee-only basis.

NAPFA member David B. Jacobs serves as a representative for this interview.  David serves on the committee for both the School of Retirement and the School of Risk Management for NAPFA University.

Annuity Digest: Please tell us a bit about NAPFA and how the organization serves financial services consumers.

David: NAPFA holds its members to the highest standard available in the industry.  All financial advisors need to:

  • Hold the Certified Financial Planner (CFP) designation.
  • Develop a comprehensive financial plan that is subject to peer review and approval.
  • Have practices that are strictly fee-only.
  • Serve as fiduciaries and registered investment advisors (RIAs)
  • Fulfill continuing education requirements on an ongoing basis.

Annuity Digest: Do NAPFA advisors receive and compensation outside of fees?

David: None whatsoever—all NAPFA advisors are strictly fee-only.  There is no compensation from commission or any form of product transaction.  Fee-only can include hourly rates, fixed retainers and fees on assets under management.

Annuity Digest: Are there any recommended or required procedures, analytic tools, software, presentation formats, etc? 

David: There are no required financial planning formats.  There are minimum required components of the financial plan that are peer reviewed. 

NAPFA is focused on advisors being able to provide comprehensive planning.  Comprehensive planning involves all the components of the CFP program.  This does not mean that all client engagements are completely comprehensive—some clients will come in for specific services.

Annuity Digest: What about broker-dealer relationships, insurance company relationships, licensing, etc?

David: A broker-dealer is needed but a registered investment advisor is not a series 7 rep.  Schwab, Fidelity or TD Ameritrade are used by NAPFA RIAs with a dozen or so smaller custodians.  With insurance, some advisors may have a license but they are not selling insurance – it is there because if a state requires licensing to render advice.  Some states say that CFPs are able to render insurance advice.

Annuity Digest: What is the governing regulatory body for NAPFA advisors?

David: Either the Securities and Exchange Commission (SEC) if the advisor has client assets exceeding $25 million, or state regulatory bodies

Annuity Digest: Are asset management services always outsourced to a third party manager, or do any of the advisors manage funds directly?

David: It’s really all over the map.  Some advisors invest in individual stocks and bonds, some stick to mutual funds, some get into alternative investments (e.g. movie deals, hedge funds), and some outsource to third party managers.  It is really the full gamut—there is no unified investment philosophy at NAPFA.

Annuity Digest: What are the safeguards for objectivity within the area of asset management?

David: There is nothing that NAPFA imposes in terms of due diligence.  Objectivity is driven by fee-only compensation and fiduciary obligation.

Annuity Digest: How are product and service transactions handled by NAPFA advisors?   

David: With insurance, it is always outsourced to a third party because advisors are not able to receive commissions. 

Some NAPFA members who are CPAs will handle client tax issues, although many will outsource that as well.  There are attorney referrals for estate planning, although the advisor remains very close to that estate planning process.

Annuity Digest: Are NAPFA advisors required to refer all implementation issues to a third party?

David: Not in all cases.  For example, a CPA may provide tax services on a fee-only basis.

Annuity Digest: Are there preferred relationships or networks in place for different products and services? 

David: There are a few. 

For example, in the annuities arena a company called Income Solutions provides NAPFA members with immediate annuity wholesale quotes at a low (1%) transaction fee.  This allows NAPFA advisors to avoid being at the mercy of individual insurance agents.

Annuity Digest: How are annuity products and transactions handled by network members?

David: It is completely up to the advisor.  Some advisors have relationships with individual agents, some leave it up to the client’s agent relationship, some use wholesalers, etc.  There is no single standard.

Annuity Digest: How is quality control maintained at the advisor level?

David: Nothing is imposed by NAPFA—once initial membership vetting process is over the advisor runs their business as they see fit.

Annuity Digest: Do NAPFA advisors receive any referral fees on outside transactions? 

David: A NAPFA planner cannot receive a referral fee period (all fees from client directly).  However, the reverse can be different.  For example, a NAPFA advisor may pay a fee to Schwab for a client referral.  In other words, referral fees are OK in one direction but not the other.

Annuity Digest: How do advisors typically deal with sequence of returns risk and longevity risk?

David: Many NAPFA members deal with clientele who are fairly well-off and these risks tend not to be a huge issue.  In these cases, longevity risk can be self-funded. 

There is some use of immediate annuities to provide a floor of protection for certain.

There are also some 1035 exchanges of life insurance policies.  For example, when cash values reach certain levels an inexpensive variable annuity might be used.

Annuity Digest: What are NAPFA’s views regarding life-cycle planning, human capital, consumption smoothing?

David: It is difficult to make a generalization on an organizational level.  That said, there are likely a much higher percentage of NAPFA advisors who pay attention to life-cycle tenets than the typical wire-house.  On other hand, there are likely NAPFA advisors who completely ignore it.

Annuity Digest: What are NAPFA’s views regarding modern portfolio theory and mean-variance optimization in light of the financial crisis?

David: Again, there is nothing at an organizational level.  There are probably higher percentage of NAPFA advisors with passive, weak market efficiency beliefs.  Again, though, there are some who believe in active management and the ability to deliver alpha.

Annuity Digest: Do you see overall momentum within the industry and among consumers towards the fee only model – particularly in light of the financial crisis?

David: I definitely see momentum away from commission-based advice.  In the 1990s, there was a successful push at creating a line in the media between commission people and fee people.  By the late 1990s, wire-houses started implementing fee systems with wrap accounts.  Most people cannot tell difference between a wrap or brokerage account an advisory account.  The language that is used is essentially identical between Merrill and an advisor account through a registered investment advisor.  I would say there is not necessarily a huge move away from wire-houses per say.

Annuity Digest: Can you provide some high-level comments on annuities?

David: There is a general hesitancy to recommend or use variable annuities—particularly putting new money into a variable annuity.

Unless there is a huge need for tax deferral, it is rare that a NAPFA advisor will use a variable annuity unless the variable annuity already exists or is part of a life insurance Section 1035 exchange. If an advisor is going to use a variable annuity, it will be a product with no surrender fees. 

Fixed indexed products are used even less than variable annuities because of the high fees.  Structured products are the closest thing to fixed indexed products, and NAPFA advisors do use structured products. 

There is fairly frequent use of immediate annuities on a relative basis and this use has been growing over past decade. 

There is not any widespread use of standalone living benefits at this point. 

The same holds true for longevity insurance—there are relatively few NAPFA advisors playing with longevity annuities at this point.

Annuity Digest: Thank you David.

9,280 reads

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