3 Tips for Virtual Appointments

By now you’re most likely consuming every bit of information on how to run your business from home. But how much of this information pertains to you, and your practice, as a financial advisor? General advice doesn’t always suffice, especially when the blogger or source is missing crucial information about our industry in general.

We’ve been working hard on creating content that actually relates to how a financial advisor’s business works and have been adapting our best material for the “virtual space”. For more of those articles, sign up for alerts on this page, or take some time to peruse our latest updates.

One of those crucial pieces of advice we often relay is about the appointment process. We also realize your appointments right now probably look a lot different. If you need help with how to run virtual appointments, check out our whitepaper on becoming a Virtual Advisor. Or if you prefer something a little more down to business, here’s our Communications Checklist.

In the past we’ve created material around the appointment process, including do’s and don’ts, questions to ask and more. Those rules still apply but may take on a different tone considering the virtual interface. While I’m sure you’re fearful that a video conference lacks the same intimacy as an in-person meeting, that’s simply not the case. A video conference still allows you to see facial expressions and body language, in addition to hearing tone of voice. This is what’s necessary to form that bond with a prospect, and all are accomplished in a video format.

So how do you run a virtual appointment? The answer is – a lot like how you run an in-person appointment. You want to make a good first impression, and a lot of that has to do with how you prepare for the first appointment. We always suggest running a “test” appointment with an employee or even family member if available so you can knock out any kinks that may pop up. But if you’re appointment process was struggling while you had an office to meet prospects, then keep reading. A video screen won’t correct for a bad first appointment.

  1. Send an agenda and digital welcome packet.

Having an agenda ready helps your prospect formulate questions before the meeting as well as gives them an opportunity to see how long this appointment is expected to take. It’s easier right now for people to take a lunch break meeting due to being at home, with the added benefit of not needing to commute to your office. Take advantage by giving them a succinct first appointment. A digital welcome packet prior to the meeting also helps them become familiar with the discussion that’s going to take place and you won’t need to explain little details if those materials are sent before the appointment. Get your prospect in the headspace for this first appointment by supplying them with questions to think about.

  1. Include spouses in the meeting

Encourage married prospects to include their spouse in the meeting, and make sure you set a time so both can attend. Ask this question prior to the meeting and make sure to reach out to both of them with the necessary welcome materials. You want both partners involved in the process as they tend to have different financial goals. You don’t want to help a client with a plan only to discover much later that their spouse isn’t on board. Include in your welcome packet something like this: Conditions of Satisfaction Survey. This will help clients start thinking about their planning priorities. We always ask clients to complete it independently – without their spouse. This way you’ll get each partner’s interpretation of the questions, their goals, and expectations. This will help you plan a tailored solution to meet those goals.

  1. Have the Right Questions Prepared

What you’re trying to do during your first appointment is figure out what expectations the prospect has, the opportunities they have for growth, and gauging their risk tolerance. This is incredibly challenging as you’re asking a prospect to trust you with some very personal information, and they may not feel comfortable giving it to you at first. That said, the way to discover their expectations, risk tolerance and opportunities for growth means getting to know them with questions tailored for the information you need in order to proceed with formulating a personalized plan. Here’s where Kinder’s Three Questions comes into play. Fill out the form on that page to receive the document.

Don’t be afraid to schedule in 5 to 10 minutes of general getting-to-know you questions, or a space to talk about what’s currently affecting the market. Let your prospect vent to you, and make sure you listen! Noting personal details like sports teams they’re missing out on, how many children they have and whether or not they’re in need of assistance can help you build a relationship. Even if now is a bad time for them to transfer assets, they’re more likely to leave the meeting feeling heard if you leave space for them to speak freely. They’re also more likely to remember the interaction as pleasant, which is also a plus.

Please click on the linked material in this post as a lot of the resources are incredibly valuable – especially for that first appointment. This post is meant as a bird’s eye view of the appointment process, and the related attachments get into details that are imperative for a successful first appointment. Remember: the same rules apply for virtual meetings. The only difference is the screen between you and your prospect. If you’re having difficulty setting first appointments right now, check out our post on prospecting while remote. This should help you get aligned for running a digital business.

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How to Prospect During the Pandemic

Right now you’re probably home getting used to a different work routine. While your business has been disrupted from the virus and the economic downturn, there’s a lot of uncertainty surrounding the future and even just the next two weeks. Hopefully you’ve been keeping in contact with your clients, answering their calls, emails, texts and soothing their panic. If you’ve been avoiding those conversations, you need to reassess. Hiding now will only serve to dampen your credibility. At the onset, you should have discussed risk management with your clients before investing their funds. But as we all know, even if we discuss risk and a client’s expectations prior to investment, when the market hits a slump, those expectations tend to change. At USA Financial we’ve been taking this time to get our advisors used to working remotely – and helping them navigate those tough conversations. We’ve been updating them on how to use current technology to keep their practice moving and helping them reroute marketing activities, like seminars, and placing them online. A lot of change is happening very quickly, and the speed at which technology has changed over the last ten years or so means the necessary tools are readily available. But how do you create professional contrast online? Right now, everyone’s chasing after the same communication mechanisms due to limitations on in-person meetings. This is where you have to take a moment and figure out creative ways to stand out from the crowd. Take a step back and ask yourself: why is it a good time to begin online prospecting? Well, a few good reasons include:
  • Many people are going to feel slighted by their current advisors. When economic downturns happen, a lot of advisors retreat in fear of being confronted about strategies.
  • Chasing a new demographic – perhaps a lot of your clients are older, and you see digital as an opportunity to expand your reach and help a generation that’s been hit with two recessions before they’ve barely made a career for themselves.
  • Build and scale your current practice – you’re looking to take advantage of digital opportunities to begin prospecting to clients you haven’t touched base with yet.
Whatever the reason, it’s important to track and measure that goal. Achieving success in prospecting online happens when you’re able to delineate between what’s working and what’s not. A few topics we’ve covered in the past will help you reassess those goals and create a name for yourself online. Those topics include: Perhaps you have a reputation in your community. That doesn’t always translate online where everyone self-selects their tribes based on interests rather than location. Even if that’s the case, you have to start from somewhere, and you have to build your brand to be consumer facing where your potential clients hang out. Once you’ve built a reputation for yourself online, or at least the infrastructure to showcase your brand, it’s time to work on your prospecting strategy.

Creative Digital Prospecting Strategies for Virtual Financial Advisors

  1. Referrals, referrals, referrals – From your best clients

A tried and true method is always replicating your top clients. But how do you go about getting these referrals? You could ask. But what are you doing right now for your top clients? The services you provide aren’t enough to inspire your best clients to become advocates for your practice. To do this, you need to begin going above and beyond for those clients, and they’ll return the favor in the form of friends, like them, in need of financial guidance. If those referrals aren’t coming in, and you’d still like a way to replicate your top clients that’s when client segmentation comes into play. Figure out who your top clients are and write down their similarities. Perhaps they’re in similar careers, or all have graduate degrees. Maybe they live in the same zip code or even have similar interests and hobbies. Having those traits outlined makes it easier to begin prospecting online. There are many ways to prospect using what you’ve found during that client segmentation process. You can filter out audiences on Facebook and begin running ads, you can target or remarket to those audiences using Google Ads, or if you have access to LinkedIn Sales Navigator, you can use their advanced search tools to search for potential clients that match your current best clients. Replicating those people should be your top priority, and where you drive most of your online energy.
  1. Try Sales Navigator on LinkedIn

For a small fee each month, you can gain access to LinkedIn’s Sales Navigator tool (mentioned above) and that can really make the difference between targeted ad campaigns and personalized outreach. You can use Sales Navigator to search for clients that match your current best clients, save lead lists and start reaching out through engagement with their posts, sending them connection requests or sending them a personalized messaged inviting them to a webinar you’re hosting. You can read more about how to prospect for leads in our LinkedIn whitepaper, but for now, a great way to start is to look for people in your area that are high-ranking in their company or career. Terms like “President,” “CEO,” “Owner,” or even “PHD,” are good places to start. After performing this search, you can usually see who is connected to connections you already have. The reason you want to start with connections of connections is because you can ask for that warm introduction. Reaching out to leads cold has a much lower success rate, so prioritize potential leads by who you can be introduced to.
  1. Host webinars or virtual client events

Right now, a way to show appreciation for your top clients (and a great way to give them motivation to introduce you to their friends) is to host virtual client events. Select a topic to discuss or plan to host a virtual Q&A session. Think of ways you can make those in-person events you’re used to throwing something you do through a Zoom meeting. Ask your clients to invite any friends who may be interested in attending. Ideas like a virtual happy hour, or a virtual coffee will allow you to connect when in-person events aren’t an option. You can build rapport with attendees by asking everyone to introduce themselves and have some unexpected discussion points that spark interest among the group. Perhaps everyone is a big sports fan or enjoys a new TV show. If you choose to instead host a webinar, then select a topic that’s going to be of interest to your current clients and plan on hosting it LIVE so you can interact with your attendees. Everyone is more likely to join you when they’re not too busy so select a time that makes sense, like lunch time, or late afternoon when a lot of the day’s busy work is out of the way.
  1. Check on your existing network

Have you ever referred one of your clients to a real estate agent friend of yours? How about a CPA? You have other professional friends that work with top clients of their own. If you’ve ever referred business their way, now’s the time to cash in on that favor. Build a network of your professional friends and use that to make introductions for them and ask for that service in return. A lot of professionals are probably dealing with a host of client concerns, especially financial ones, that they aren’t prepared to answer. Let your network know, you’re open for business. Offer free consults for referred clients. If you’re professional circle is small, or not quite specialized enough to pass along quality leads, go back up a step or two in this list. Instead of prospecting only for clients, try and do some networking with other business owners in your area. This may be the best time to extend a helpful hand to your community and make connections that can continue serving your practice well past this pandemic.
  1. Offer to talk to the kids

A lot of your clients, especially your top clients, have adult children who may need a financial advisor now. As you’re continuing to keep close tabs on your existing clients, and especially your top clients, let them know you’re offering a free, virtual consultation for their children and extended family. At some point your top clients will pass along a financial legacy to their children or grandchildren. By connecting with their offspring now you’ll be handling those assets when the time comes. Invite your clients to have virtual family meetings to see how you can help, or request that the kids sit in on any upcoming sessions you may already have planned. The post How to Prospect During the Pandemic appeared first on Advisor Elevation.

The Distribution Problem Part 3 – An Alternative Solution

It’s been a busy and exciting fall season at USA Financial with all kinds of projects and opportunities on the horizon.  I’ve finally had a chance to circle back around to some of my musings on social media and in particular the distribution series.

In case you need a refresher, part 1 discussed the unique challenges of the distribution stage for investors.  Then in part 2 we elaborated specifically on sequence of returns risk and how that will present an even greater challenge to investors going forward.  Finally, as promised, I will suggest an alternative solution to this problem that many retirees are facing – a solution that is simple in concept yet profound in effectiveness.

The status quo of portfolio management in the distribution stage can be summarized primarily by two strategies.  Option 1 is a constant proportion method where the portfolio is rebalanced every year to a specific equity/fixed income mix – 60% stocks, 40% bonds as an example.  The other method generally gets more conservative as the client ages so that a 60/40 mix turns into a 40/60 mix over time – age-in-bonds and linear glidepath are a couple variations that take this approach.  The shortcoming of both of these approaches is that neither allocation strategy actually adjusts according to how the market has been performing.  In fact, both of these strategies in the distribution stage actually force equities to be liquidated while they are down in value, locking in those losses, and stunting their ability to ever come back in value.

An Alternative Approach

What if instead we built a portfolio where you didn’t have to liquidate equities while they were down in value, thereby mitigating sequence of returns risk?

Here is an overview of the approach we take with our Summit Series Descent Composites:

Descent Pic

The idea is to start with 3 years of a spending reserve bucket within the portfolio that is allocated to cash.  For example: 12% allocation to cash for a 4% spend rate, 15% for a 5% spend rate, 18% for a 6% spend rate, etc.  All withdrawals come from this cash component within the portfolio.  The remainder of the portfolio is primarily geared toward equities in order to generate the growth needed to sustain the spend rate over the course of a long retirement and to offset the silent risk of inflation.

Every quarter the portfolio will be rebalanced according to what the market has been doing.  If the market is up, then the cash reserve bucket will be replenished from the equity component.  However, if the market is down, the portfolio will not be rebalanced in order to give the portfolio more time to recover losses.

This all sounds good in theory, but I’m a numbers guy.  So how has this type of distribution strategy worked historically?  Our friends at Horizon Investments have put together a detailed research report comparing the effectiveness of an intelligent rebalance to the other prevailing distribution strategies out there.  Here is a summary of their findings:

Blog Pics

Source: Horizon Investments Research, Retirement Planning: Solving for the Major Risks in Retirement

Parameters

What Horizon calls Real Spend in green is the very same concept we are discussing here.  As you can see, probability of success (defined as not running out of money) is dramatically increased when using an intelligent rebalance strategy for distributions.  This objective study looked at all the rolling 20, 25 and 30-year periods going back to 1926, so as to not cherry pick any specific time period.

There are other income distribution strategies out there that are not discussed here (annuities, insurance, alternatives, etc.) and every strategy has pro’s and con’s that need to be considered, but for those investors and advisors seeking to utilize a more traditional mix of equities and bonds to generate income, this is a strategy that should be considered.  Feel free to reach out to me for more information regarding anything discussed in this series or to request a copy of the full research report or information on our composite models.

The strategies discussed do not guarantee a profit or prevent against a loss. Investing carries an inherent element of risk, and it is possible to lose money while utilizing any strategy that includes equity or bond investments. Past performance is no guarantee of future results.

The Summit portfolio may seek to allow more time for the portfolio to recover and postpone rebalancing, increasing the duration of market exposure and potential for loss.

Summit Portfolio Series is offered through USA Financial Exchange. A Registered Investment Advisor. Eric Gritter is an Investment Advisor Representative of USA Financial Securities. USA Financial Securities and USA Financial Exchange are affiliated companies.

Not All Guarantees Are Created Equal

Not All Guarantees Are Created Equal – An Independent Review of the Brighthouse Financial Shield Annuity

financial comparison

Ever since Brighthouse Financial was established by Metlife, they have been on a marketing blitz.  I’ve seen Brighthouse ads pop up several times during various sports broadcasts.  Last summer, I was walking through the Charlotte airport and felt like there was a Brighthouse banner every ten feet – granted they are headquartered directly outside of Charlotte.

Every top selling product in the financial services industry has a good story to go along with it.  The Shield VA from Brighthouse is no exception to this principle and has been one of the company’s most successful product lines.  Right on their brochure it states, “Growth is realized in up markets… Protection is provided in down markets.”  Oh, and it comes with no annual fees.  If I didn’t know any better, I would think this is a brochure for their latest Fixed Indexed Annuity.  With that in mind, I set out to compare the Shield annuity to a run-of-the-mill FIA to determine if the product is as good as the story.

The way Shield works is fairly simple – there is an 11% cap on the upside of the S&P 500.  On the downside, Brighthouse will eat the first 10% of any loss for the contract year.  Any gain beyond 11% in the market will be forfeited and any loss below 10% will have a negative effect on the account value.  The annuity offers other term lengths and protection levels as well.  However, for the best “apples to apples” comparison, I am solely looking at annual resets based on the S&P 500 for both Shield and the FIA.  I did not use a specific FIA product, rather just made some assumptions based on what is generally available in the FIA space right now.  Current participation rates on FIAs are approximately 45% of the upside and, by definition, there is no downside risk.

FIA Return Difference by Period
Starting Year 5-year 10-year 20-year
1988 -5.4% -4.3% 0.2%
1989 -4.1% 1.5% 47.3%
1990 -5.2% -1.7% 45.0%
1991 -1.5% -1.5% 38.2%
1992 -3.9% 0.8% 37.1%
1993 1.1% 19.2% 34.1%
1994 5.8% 24.6% 42.1%
1995 3.7% 19.0% 34.6%
1996 -.1% 12.6% 29.5%
1997 4.9% 9.5% 25.4%
1998 17.9% 4.7% 19.7%
1999 17.8% 45.1%
2000 14.7% 47.5%
2001 12.7% 40.3%
2002 4.5% 36.0%
2003 -11.2% 12.6%
2004 23.2% 14.0%
2005 28.6% 13.1%
2006 24.5% 15.0%
2007 30.2% 14.5%
2008 26.7% 14.3%
2009 -7.5%
2010 -12.0%
2011 -7.6%
2012 -12.1%
2013 -9.8%
Average: 5.2% 16.0% 32.1%

(Values show in each of the 5, 10 and 20-year columns are illustrative and represent the hypothetical excess return (over the Brighthouse Shield Annuity) of a Fixed Index Annuity with a 45% participation rate when applied to a rolling period of S&P 500 index performance beginning January 1 of the starting year)

Going back 30 years, I looked at all the rolling 5, 10 and 20-year periods and determined the cumulative outperformance of an FIA compared to the Shield annuity.  As you can see from the chart, there were 15 periods – only 35% of the time – where the FIA underperformed the VA.  All of those periods were within the 5-year timeframes.  Put another way, as you stretch out the time horizon, there were only a few rolling periods over a 10 or 20-year timeframe that the VA even came close.

Before I move on to an explanation for the outperformance of an FIA vs. the Shield VA, I want to address what many readers may be thinking: “Is this comparison intellectually honest?”  After all, neither of these products were available for the last 30 years.  Furthermore, I am assuming constant cap and participation rates for both products.  True enough – varying interest rates and volatility would have had a significant impact on the options pricing behind both of these products.  But that’s the key here.  I’m more interested in the comparison on a relative basis, not so much on an absolute basis.  Any swings in interest rates and volatility would have had a similar effect on both products.

Getting back to the reasoning, it seems as though the Shield annuity was designed around both recent history as well as the average return on the market.  If the S&P 500 has averaged roughly 9-10% historically, it should stand to reason that the annuity with an 11% cap rate would capture nearly all of the upside of the market.  Except that’s not even close to being accurate.  In fact, over the last 90 years, the S&P 500 returned between -10% and +11% in only 30% of the years.  For the other 70% of the time the client would have either eaten losses below -10% or forfeited gains above 11%.  More succinctly put, markets don’t move up in a straight line.

In case there are still questions about the pricing comparison of the annuities, Brighthouse initially offered a Shield annuity with 100% downside protection.  However, the trade-off is a lower cap rate of 2.8%. In essence,  this structure is  an FIA.  FIAs structured with a cap rate (as opposed to participation rate) have been in the range of 4%-6% over the last year.  Brighthouse has since stopped offering the 100% downside protection level, likely because it shed too much light on their poor competitive pricing.

As with all sales literature, it pays to dig into the numbers behind the brochure.

Disclosure:

It is important to note that there are a number of important factors used in determining and calculating an annuity’s policy values. These factors can drastically differ insurance carrier by insurance carrier and product by product.

This hypothetical index annuity example used the following assumptions:

1) FIA product returns based on the SP500 Index generally use price returns.  Since the Brighthouse annuity also uses price returns, the historical S&P500 data used in the analysis are based on price returns, which do not include dividends.  SP500 values are for illustrative purposes only, since investors cannot directly invest in the SP500 index. Past performance is not a guarantee of future results. 2) Annuity performance is calculated using an annual point-to-point measurement. 3) The index annuity shown used a 0% asset fee.  4) The index annuity shown is calculated using annual participation rates on the interest that is credited, at 45%. Index annuity participation rates are based on a number of factors, including but not limited to: whether or not the policy offers any bonus, as well as the surrender charge percentage and duration of the surrender schedule.

In applying the information provided in this material, you should consider your clients’ other assets, income, and investments – such as the equity in their home, Social Security benefits, any IRAs, savings accounts, and other plans that may provide retirement income, as those other assets may not be included in this discussion, model, or estimate.

This analysis should not be interpreted as a recommendation or as investment advice. Before recommending any investment company product, please review and provide a copy of the prospectus.

The Distribution Problem Part 2 – Sequence of (future) Returns

A few weeks ago, I wrote the first in a series of blogs dedicated to the distribution problem that advisors and retirees are facing today.  Part 1 focused on the clarifying the unique challenge that comes with the distribution stage of investing.  Indeed, as investors begin to start liquidating their accumulated assets as a replacement paycheck after they stop working, the math changes.  Inflation and sequence of returns are two key risks associated with this investor stage.  Today, I am going to zero in on sequence of returns risk and shed some light on how many advisors are inadvertently setting inappropriate expectations for their clients in retirement.

Just in case anyone is wondering how the math changes in the distribution stage, allow me to illustrate.  The first chart that you see shows the growth of $100,000 based on historical returns of the S&P 500 Index (total return) since the beginning of 2000 in blue.  The orange line represents that same $100,000 growing over the last 18 years – except the order of returns have been reversed.  So, although the accumulation path is drastically different, both scenario’s end up with the same exact value today.  In other words, the order of returns does not matter.

Growth of $100k 

Now, take that same scenario but pull out withdrawals of 5% per year (with a 3% cost of living adjustment).  The original order of returns (2000 thru Q2 2018) runs out of money 15 years into the hypothetical.  The reverse order of returns (Q2 2018 – 2000) has a positive balance of $124000 at the end.  The order of returns clearly matters in the distribution stage.  That’s what we mean by sequence of returns risk.

5% Distribution Chart

The primary way that many advisors attempt to mitigate this risk for their clients in the distribution stage is to take some risk off the table and diversify the portfolio.  Here’s what a 60/40 mix of the S&P 500 and the US Aggregate Bond Index would look like in the same distribution scenario:

MS Hypo 60-40 SP500 US Agg 5% Withdrawal

Clearly, the diversification benefits the client in this scenario.  Instead of running out of money 15 years into retirement, the client has a little over $37,000 left after the full 18 years.  The assets won’t last much longer, but at least this is an improvement.  The problem I have with an advisor presenting this as a solution to a client for their income needs is that it’s all based on historical returns.  Yes, I get it – no one knows how stocks will perform over the next 10-20 years, so the next best thing is to use a long historical time period as a reference point.  I don’t have any better idea than the next person as to the performance of stocks going forward.  We could continue to see significant corporate earnings growth and valuation expansion that underpin high returns over the next 10 years,  or we could see a significant downturn due to any number of reasons.

The 40% allocated to fixed income is a different story.  We do have a better understanding of bond returns going forward relative to the past 15-20 years.  Either rates will continue to stay low and bonds will earn the yield they are paying.  On the flip-side, if rates increase that will increase the yield return, but will be partially offset by the decrease in the price of bonds that investors are currently holding.  In either scenario, it’s hard to imagine that the US Aggregrate Bond Index will average the 5% annualized return over the next 18 years that it has since 2000.  A more appropriate rate of return for the 40% fixed income allocation might be 3% going forward.  If we adjust to those expectations for “future” sequence of returns risk, here’s what that impact on the portfolio looks like:

MS Hypo 60-40 SP500 Cash 5% Withdrawal

As you can see, lower interest rates going forward will make it more difficult for portfolios to last through retirement compared to previous generations.  Here’s a quick read from FS Investments that I came across outlining the difficulty of the traditional 60/40 portfolio going forward.

History is a useful guide to the future when examining potential market cycles.  However, when it comes to conservative asset classes, advisors and investors should be careful to not expect the next 20 years to look like the previous 20 years.  Next time, in the final installment of this series, I will discuss some of the prevailing distribution strategies and present a viable alternative that income oriented investors should consider.

Growing Client Base? Time to Segment… Here’s How

At some point in your career, if you’ve been doing things right, you will run out of time.  Did you catch that?  You can actually run “out” of time by doing all the right things.  These are things we all focus on daily – marketing, referral generation, asset gathering, running a business, etc.  While many of us are very good at doing these things, and doing them the “right” way, we eventually run into a problem:  We’ve had success, we’ve brought on many new clients.  Now, there are so many families that we serve, that delivering the same level of service to each of them becomes impossible, and actually is something you shouldn’t be doing.

Now there is a big difference between “treating people right” and “doing the right thing” versus delivering the same level of service for everyone.  You can deliver a different client experience or service model for every one of your clients and still treat them right, and do the right thing for them.  The problem (or opportunity as I see it) is that you cannot afford to deliver the same client experience everyone.  Your A clients and some B clients need to be treated to a first class client experience.  It will be impossible and not even close to economical to deliver that same experience to ALL clients.

The first thing you need to do is figure out where your clients stand from a revenue standpoint.  Run a report of every household you work with and determine what the annual” revenue from each household is worth.  For advisors using commissionable products as part of a financial plan, you need to assess what theup front commission is worth on an annual basis.  The easy way to look at it is to divide the commission by a number of years and “amortize” it out.  For instance, if your client holds an annuity with a 10 year surrender charge, and you earned a $30,000 commission on the placement, you could stretch that out over 10 years and figure that it is worth $3,000 of annual revenue to your firm.  However you do it, remain consistent for all households in how you assess their annual worth.

Once you have all of the households and revenue numbers figured out, organize them from the top down, with the client that generates the most annual revenue at the top.  From there, you need to divide the book of business into four chunks like this:

A – Top 20% of revenue

B – Next 30% of revenue

C – Next 30% of revenue

D – Bottom 20% of revenue

You then need to assign each revenue chunk with a label.  To keep it easy, I’ll go with A, B, C, and D (as seen above).  This exercise alone will be quite eye opening.  I actually go through this process regularly with successful advisors across the country, and put the analysis together for them.  The first time they see how many clients make up these different revenue chunks, they are shocked.  The 80/20 rule holds true in so many things, especially this.

Next, you will want to go through and “upgrade” a few of your clients to first class.  Here’s what I mean by that:  Say there are a few C or D clients that you have worked with for years.  They don’t represent much revenue themselves, but maybe they continue to send you a number of quality referrals every year.  That person, in my opinion, has just upgraded themselves to first class and need to be treated like an A client.  Also, that means there could be a couple of A or B clients who represent great revenue to the firm, but you cannot stand them.  You wouldn’t want to clone them, and you avoid ever having them around your most special clients.  Those might need to get “downgraded.”  Either way, go through the process of assigning a true label to every client in your book.

Now  you need to create a different client experience and service model for each segment.  The A and most B clients should have the most elevated client experience possible.  Here is an example of how it could look:

“A” Clients – Quarterly review meetings, annual charitable giving meeting, joint meetings with a tax and/or estate planning professional, private social lunch 2x per year, inclusion in partnership program, invitations to ongoing intimate social events, preferred parking at office, invitation to annual client appreciation event, etc.

“B” Clients – Bi-annual review meetings, annual charitable giving meeting,  oint meeting with a tax professional, private social lunch 1x per year, inclusion in partnership program, invitations to ongoing intimate social events, invitation to annual client appreciation event, etc.

“C” Clients – Annual review meetings, 15-minute phone call with a tax professional, invitations to in-office lunch-n-learn events, invitation to annual client appreciation event, etc.

“D” Clients – Annual review meetings, invitations to in-office lunch-n-learn events, invitation to annual client appreciation event, etc.

It is not uncommon for advisors to ask a junior or associate advisor to handle the delivery of the client experience to C and D clients.  Bottom line is this, YOU, the rainmaker, cannot afford to overspend your time with those clients.  Take good care of them, treat them well, but spend more time with the A’s and B’s.  Make their experience first class and try to attract more families just like them.

 

The Distribution Problem Part 1 – Clarifying the Unique Challenge of the Descent

During the Q&A session of the recent June market update, I answered an open-ended question on fixed income.  Part of my answer centered around the distribution challenge that advisors and retirees are facing today.  Due to the complexities and nuances of this topic, I am going to break this up into a three-part series.

Today, my goal is to set the stage for the challenge that retirees are facing in the distribution phase.  Part two will then take a deeper dive into some of the risks pertaining specifically to distribution and shed some light on the dangers of how some advisors are setting expectations for income in retirement.  Finally, part three will present an alternative way to approach the challenge of income distribution compared to the prevailing strategies used by many advisors and investors currently.

When most people think about investing and their personal financial plan, they tend to view it as a fairly linear progression.  They take a snap shot of where they are today, financially speaking, and project what their goals are 20-30 years down the road.  Some investors will break that path up into two distinct phases – the accumulation phase and the distribution phase.  Regardless if they view their financial life as one long continuum or two distinct phases, most investors assume that the risks in investing remain constant and similar no matter where they are on the path.

Our approach to investing is quite different.  We view investing more like a mountain trek that has three distinct phases, each with its own unique challenges and risks – Ascent (Accumulation), Acclimate (Risk Mitigation), and Descent (Distribution).

During the Ascent phase, the investor is accumulating assets during their earning years.  The primary risk inherent in this phase is volatility.  Volatility in and of itself is not a bad thing despite what media often portrays.  In fact, without a certain level of volatility it would be impossible to earn more than the risk-free rate that cash or treasuries are paying over the long term.  The key is to appropriately gauge the investor’s appetite and ability to handle volatility and mirror that same level of risk within their portfolio.

Once the investor nears retirement, they enter the Acclimate phase.  The primary risk at this point during the investor trek is loss.  This is not to be confused with volatility.  Absolute loss, or drawdown, at this stage can have a permanent negative effect on an investor’s financial goals.  One reason is that they are much closer to the point in time that they will begin to take distributions from their accumulated assets to live on during retirement.  Related to that issue, negative investor behavior (i.e. panic selling after losses) becomes more acute.

The final phase of the trek is the Descent, otherwise known as the distribution phase where investors begin to convert their accumulated assets into a replacement paycheck after they stop working.  This is the phase that I will focus on for the remainder of this blog post and the two follow-up posts.  The primary risk that investors face here is longevity – at its core, this is the risk of running out of money.

Before I move on, our friends at Horizon Investments recently issued a whitepaper detailing this redefinition of risk based on the investor stage.  I would encourage you to check that out if you are interested in more information on the rationale for this investment philosophy.  Here is a visual of what we’ve discussed so far:Mountain

Longevity as a risk can be a bit abstract to think about.  I find it easier to grasp when breaking it down into the two core risk components:

  • Sequence of returns risk – experiencing early losses in the distribution phase increases the probability of running out of money due to liquidating assets that are down in value, thereby locking in those losses permanently.
  • Inflation – the loss of purchasing power over time.

The difficulty here is that these are competing risks.  On the one hand, you need conservative assets within your portfolio to mitigate sequence of returns risk.  On the other, equities are a better hedge against inflation than fixed income over time.

Hopefully that clarifies for you the unique challenge that investors are facing in retirement.  Over the course of the next couple weeks I will shed some light on how advisors are attempting to solve this distribution riddle and also present a viable alternative.

Even if you had a crystal ball…

Everyone who works even remotely close to the investment management industry inevitably gets asked the question, “So what do you think is going to happen with the market?”  A cute answer that I’m sure I’ve used along the way is, “Well, my crystal ball has a crack in it at the moment.”  In other words, no one is a clairvoyant with market predictions.  I’ll go one step further though, even if you had a working crystal ball that could foresee significant events that could move the market, you still wouldn’t be any better off.

Many financial firms have complex models with dozens of inputs, all with the goal of predicting the behavior of some niche area of the capital markets.  The difficulty with this forward-looking process is that even if you get the majority of the inputs correct, you are still under your own assumption of how the market will react to each and every input.

Here are some examples over the last several years of how even the foreknowledge of significant events could have led you astray.

2016 Election

If there’s one thing the stock market abhors, it’s uncertainty.  When outcomes of various events don’t go according to plan, the market must recalibrate in order to adjust for different inputs that were  initially forecasted.  We saw this with Brexit when the polls in the U.K. turned out to be wrong.  We saw this when Lehman Brothers filed for the largest bankruptcy in U.S. history, despite A-rated credit ratings the morning of September 15, 2008.

Enter the 2016 Presidential election where  Donald Trump was widely regarded as the most unpredictable candidate of our time.  He was down in the polls and there was no way he was going to crack the blue wall.  Then, once the dust settled early Wednesday morning, candidate Trump became President-Elect Trump.  What was the market’s reaction to this uncertainty?  The day following the election the S&P 500 was up 1.1% and a cumulative 5% increase over the following month.  So, unless you were one of the small fraction of investors who were trading futures on the night of November 8th along with Carl Icahn, the only volatility you experienced was to the upside.

US Debt Downgrade

In August of 2011, Standard & Poor’s downgraded their credit rating of US sovereign debt, marking the first time in history that the US did not enjoy the AAA rating from all thee major credit rating agencies.  Bond pricing models have to account for many factors including maturity, liquidity, inflation and credit quality.  When credit quality decreases, (i.e. the chance of default increases) the bond issuer must compensate new investors with a higher yield.  When the US Treasury received a negative outlook in April of 2011 and the formal downgrade in August from S&P, one would’ve thought that the yield on treasuries would have increased.  Instead, this is what 2011 looked like:

The 10-Year US Treasury yield began the year at 3.4% and had a steady decline to end the year substantially lower at 1.9%.

Nuclear War on Social Media

January 3, 2018

Donald J. Trump(@realDonaldTrump)

“North Korean Leader Kim Jong Un just stated that the “Nuclear Button is on his desk at all times.” Will someone from his depleted and food starved regime please inform him that I too have a Nuclear Button, but it is a much bigger & more powerful one than his, and my Button works!”

This was one of my favorite tweets from our President.  As little as a couple years ago one might have expected that a flexing of nuclear muscles on social media would have created quite a commotion in the market.  I can find humor in it and discount the seriousness because the market has done the same.  How did equities react to this tweet?  The S&P 500 was up for the first 6 trading days of the year and 7.5% through the first 3 weeks of January – clearly traders were not pricing in a potential nuclear conflict on the Korean Peninsula.

Earnings

Earnings season tends to encourage water cooler talk around stock performance.  Sometimes the outcomes are confounding when a stock drops in value after the company reports better than expected earnings, revenue growth, and forward guidance.  We are left scratching our heads.  Perhaps analysts were looking for higher growth in a particular area of the company that they viewed as critical to long term sustainable growth (i.e. health care within GE, cloud services within MSFT).  Headlines are forced to come up with some kind of explanation – usually it’s something along the lines of “the expectations were already priced into the stock leading up to the report…” leaving yourself to ask, “what’s the point of analyst consensus earnings expectations then?”  True enough.

Federal Reserve Stimulus

I found this one most interesting.  If you knew in advance what the purchasing activity of treasuries looked like for the Federal Reserve during the 6-year period covering QE2 and QE3 (QE = Quantitative Easing), would that have given you an edge in the treasury market?  In the following chart I pulled the Fed Balance sheet info and overlaid that with the yield on the 10-year treasury.

FRED, Federal Reserve Bank of St. LouisSource: FRED, Federal Reserve Bank of St. Louis

Bonds 101 tells us that an increase in demand drives up the price of bonds, thereby decreasing the yield.  At first glance, the six-year picture does show an overall decrease in yield as the Federal Reserve purchased a trillion dollars’ worth of treasuries (roughly half the balance sheet is treasuries).  However, it gets more interesting when you look at the four distinct regimes of QE2, QE3, and the periods between and after, when the Fed was not purchasing assets.

Period Beginning Yield Ending Yield Change
QE2 2.50% 3.20% 0.70%
Between QE2 & QE3 3.20% 1.60% -1.60%
QE3 1.60% 2.30% 0.70%
Post-QE3 2.30% 1.50% -0.80%

You can see that during both periods of quantitative easing, yields actually increased.  Then in the periods where the Fed let off the gas (demand went down), yields decreased.  In a vacuum, this is the exact opposite of what you would expect.

But that’s my whole point; when it comes to capital markets, nothing ever happens in a vacuum.  There are always more inputs than you think, and the market reaction to those inputs is always more nuanced than expected.  Next time you catch yourself saying “if only I had known,” don’t sweat it.  It may not have helped you anyway.

The (Misguided) Active vs Passive Debate

“A great year in the markets, but few managers beat their indexes”

“Their long-term record is even worse, according to a report on indexes versus active managers”

Source: InvestmentNews, 3/16/2018

Every year  you can count on articles like this popping up like clockwork.  The short version goes something like this: active managers for the most part, underperform their respective benchmarks or indexes.  Typically, over the last one to three years, only 40% of active managers outperform the index.  So, in conclusion, why would anyone pay higher fees for active management when they could just invest in the index and have higher returns over time?

This seems like a fair conclusion.  After all, fees will have an appreciable impact on performance over time.  Case closed.  Except it’s not because we live in the real world.  First, allow me to discuss a couple issues with these studies.  The tone of such articles seems to indicate that simply because an investment manager charges a fee, they should outperform the index.  There’s this notion that it’s possible for 100% of active managers to outperform the index.  The problem is that the performance of each index is not some arbitrary number pulled out of thin air.  The performance of an index is derived from the cumulative effect of active trades.  For every winning trade by an active manager, there must be a losing trade on the other side.  As such, we’ll never have 90% of active mangers beat an index.  I don’t believe we can even have 60% of active managers over time beat the index.  Add in the effect of costs and that number drops below 50%.

The second issue I have is that these reports aren’t asset weighted. A small startup fund with limited experience is treated the same as much larger funds.  So, when Growth Fund of America with $180B in assets outperforms the index by 4% last year, that means a whole lot of smaller funds are likely on the other side of those trades and consequently will underperform the index.

There is a more constructive conversation that I believe we need to pivot to.  Dalbar puts out a study every year that compares returns of the index (or sometimes actual equity funds) to the actual returns that investors experience.  Here is what that looks like over various time periods:Dalbar Investor Returns

Fees alone cannot come close to explaining the difference.  Dalbar cites investor behavior as the primary culprit for investor underperformance – specifically behavioral biases of loss aversion and herding.  Loss aversion simply means that the pain of a 20% loss is much greater than the pleasure of a 20% gain.  This bias typically leads to panic selling on the downside.  The herding effect is akin to chasing returns.  Investors will invariably follow the latest trends which perpetuates the cycle of buy-high, sell-low.

10% vs 4% over a 30-year time horizon – that equates to a greater than 5-fold difference.  Ultimately, that’s where a good advisor earns their keep.  You can have the best MoneyGuidePro, Emoney or name-your-software report, but if the client can’t stick to it, it’s just a 30-page pile of paper worth about 25 cents.  A good investment plan that a client can stick to is infinitely better than a perfect investment plan that they abandon.

Time Dependency of Volatility

Last year was certainly a smooth ride in the markets for investors.  Both the Dow and S&P 500 were up north of 20%.  Volatility was low.  But it’s not until you dig into the numbers that you realize what an outlier of a year 2017 was.

S&P 500 Index Realized Volatility by Quarter since 1990

Volatility chart

Source: Horizon Investments

 

Here are some data points to consider from last year:

  • Going back to 1990, we had 4 of the 7 least volatile quarters on a realized basis
  • Lowest realized volatility for the year since 1964
  • Lowest average daily VIX on record. 09.  Compare that to the historical average of 19.5
  • Lowest max drawdown since 1995. You could’ve invested in the S&P 500 last year at any point and not lost more than 2.8%

Quite a year to say the least.  Now when we compare 2017 to 2018 Q1, we see a complete market shift.

SP 500 Daily Range

This chart shows how range bound the daily returns were for 2017.  In fact, there were only 4 days last year that lost more than 1%.  By contrast, we had 11 days through the first quarter of 2018 that lost more than 1%.

However, my biggest takeaway from the first quarter is not all the fluctuations we saw, but how volatility is time dependent.  For all the hoopla we saw, the total return for the S&P 500 was      -0.76%.  Not every client watches CNBC every day.  If all of your clients do, God help you.  But for those clients who don’t pay attention to all the headlines, consider this: they have just received their quarterly statements and saw that, depending on their allocation, are virtually flat.  For those of us neck deep in this stuff daily, we see and feel the shifts in the market.  Just don’t make the mistake of proactively projecting any personal anxiety you may have about the market onto your clients – they will certainly pick up on that.