Michael Kitces, MSFS, MTAX, CFP, CLU, ChFC, is the director of research for Pinnacle Advisory Group, a private wealth management firm located in Columbia, Maryland that oversees approximately $1 billion of client assets. He is the publisher of the e-newsletter The Kitces Report and the blog Nerd’s Eye View through his website www.Kitces.com. Kitces is also one of the 2010 recipients of the Financial Planning Association’s “Heart of Financial Planning” awards for his dedication to advancing the financial planning profession. Follow Kitces on Twitter at @MichaelKitces. Today I ask (in bold) and Michael answers what I hope are Five Good Questions.
1. In your view, what are the difference and the significance, if any, in terms like wealth manager, investment manager and financial planner?
While the exact meaning of these terms is somewhat debated, I do believe that they describe substantively different services, and require different knowledge and skills to execute effectively. And while some of it is semantics, I believe the distinctions are important – how we describe ourselves and hold ourselves out to the public matters.
I would characterize an investment manager as someone who is focused solely on investment management – the service delivered is managing the pot (or pots) of money, and the expectation is to create value in the investment management process.
A financial planner and a wealth manager, however, provide a broader range of services, typically incorporating advice regarding a broad range of financial issues, which may or may not include the hands-on investment management aspects as a part. As I wrote recently on my blog, the emerging factor that is distinguishing a financial planner from a wealth manager is the wealth level of the target client. This is more than just using lofty terms; the reality is that the body of knowledge needed to serve the ultra high net worth market – as a private wealth manager – is different than the knowledge needed to serve the rest of the public. Over time, I expect that we will increasingly differentiate between the two; an early glimpse of this is the curriculum being developed by IMCA (Investment Management Consultants Association) for their new CPWA (Certified Private Wealth Advisor) certification, which has only a limited overlap to the CFP certification curriculum.
2. Is the “4 percent rule” still an appropriate rule of thumb?
I find the “4 percent rule” continues to remain relevant today. The reality, as I recently wrote, is that such safe withdrawal rates are based not on average returns, but the worst return sequences we’ve seen in history – environments where balanced portfolios don’t even generate 1% real returns for 15 years (the entire first half of retirement!). Accordingly, if real returns on bonds stay low and the S&P 500 merely makes it back to its old high by the middle of next decade – truly a horrible return environment – we’re merely looking at results that are similar to the exact returns the 4% rule is based upon in the first place.
Ultimately, I am a little skeptical about whether those who retired in the year 2000 will ultimately violate the 4% rule, as market valuations back then truly reached levels of distortion never seen in our market history, even leading into the Crash of 1929 and the Great Depression. However, today’s market environment, while still overvalued, looks relatively similar to numerous other overvalued market environments throughout history, so while the year 2000 retiree may be at risk (although recent follow-up research by Bill Bengen has shown that actually the year 2000 is still reasonably on track!), this does not raise the same concerns for today’s retirees, as market valuations today are far less egregious. On the other hand, market valuations are still high on a long-term basis, so I wouldn’t necessarily recommend clients significantly raise spending above that benchmark, unless they have a higher tolerance for risk and a potential need to reduce spending in the future.
3. Do you think the barriers to entry to and/or the education and training components of our profession are too low?
I do believe that the educational and training requirements for financial planning need to rise, for it to become a bona fide true profession – and I don’t believe financial planning has reached the status of true profession yet, because of this. It should require more than what is essentially “just” half a dozen undergraduate-level courses in personal finance, and should have a more formalized training process than just unleashing newly educated practitioners on the public to earn their experience without necessarily being supervised (and coached and trained) in the advice being delivered. Although it will be a long time before we get there, I expect financial planning in the future, as a profession, to have both a deeper body of knowledge, and also a great deal of additional focus in trust, communication, and how to help clients actually change their behavior (to implement the advice).
Ultimately, significant training and educational requirements do effectively become a barrier to entry as well, which some have been critical of, but that’s part of the natural progression in the development of a profession. If the public doesn’t have a clear way to distinguish between the trained and untrained professional practitioner, it’s not a profession, and more importantly you can’t protect the public.
4. Appropriate regulation (whether by the SEC, the states or FINRA) is actively being questioned and considered today (obviously). How would you set things up if you were in charge?
In my ideal world, no one would be allowed to hold themselves out as a financial planner, advisor, consultant, or analogous term, unless he/she actually had the education, training, and experience to serve as a professional advisor. A national regulatory body would oversee this (although in reality state regulation may be the most likely solution), ensuring that only those meeting the appropriate minimum standards can represent themselves as advisors to the public. Anyone who delivers advice would be subject to a fiduciary standard, as almost by definition there’s no such thing as advice that isn’t delivered in the interests of the person receiving the advice! Notably, this is also why the public continues to be confused by our discussion of fiduciary and non-fiduciary standards for advice – because in the eyes of the public, there simply is no such thing as non-fiduciary advice.
That being said, I continue to see a role for people who sell and help clients to implement specific financial services product solutions. I don’t believe we need to eliminate the suitability standard or the existence of commission-based salespeople. However, such individuals should be required to hold themselves out to the public as salespeople, with a return to the labels “stockbroker” and “insurance agent” that were once used in the past. If that individual gives any advice to the client, that person becomes subject to a (fiduciary) advice standard. While I understand the origins of the exemption from the fiduciary standard for brokers and dealers who give advice that is “solely incidental” to their services as a broker/dealer, the reality in today’s world is that the exemption has become far too wide. As a result, there is significant confusion for the public as people routinely provide extensive advice while claiming they shouldn’t be subject to advisor regulation or standards and that the advice is “solely incidental” when it clearly is not.
The bottom line is that the real choice for the public shouldn’t be between fiduciary and suitability standards at all; it’s about the choice between being sold a product from a salesperson, or getting advice from an advisor. That is a valid choice for consumers – as long as the people on each side of the line are held to appropriate standards, and use titles and provide services that make it clear where the line is.
5. A recent study from the National Bureau of Economic Research found that nearly half of all Americans die with virtually no financial assets. Clearly, many people are not getting good financial advice. How can we go about improving the quality of financial advice being given overall and making it more available to those without the assets to make them attractive clients?
I think the first key to improving the financial circumstances of the average American is to understand that this is not merely a “financial literacy” problem, as though people would make the right and best decision for themselves if only they had a little more education. Yes, education helps – you certainly can’t make the right decisions if you have no idea what’s best in the first place – but it is only a necessary condition for success, not a sufficient one. If knowledge alone were sufficient, we would long since have conquered our country’s obesity problem, as there’s no lack of information regarding the harmful effects of obesity, and how “easy” it is to avoid it by simply eating less (and healthier), and exercising more. Instead, the reality is that improving financial health, like improving physical health, is about behavior change, and taking the steps necessary to help people change habits and implement changes in their lives.
Thus, to me the starting point is actually better education and training for advisors about how to effectively help clients find real success – and understand that it’s about more than just giving them information and having the technically accurate answers (although that’s also necessary). The greater the positive impact we have on changing people’s behavior and leading them to a sustained improvement in their lives, the more people understand the value of financial planning and seek it out, and the easier it is to serve a wider base of people.
In the end, the real reason that financial planners fail to serve the majority of Americans is simply that the public in the aggregate does not yet see enough value in what we do to demand our services en masse, and consequently firms and advisors seeking to serve the average American struggle with the marketing necessary to sustain enough clients for the business to be successful. To some extent, the lack of demand is simply because we haven’t done a very good job communicating the value of financial planning, so people don’t understand what we bring to the table; but I think the reality is that we could also get better at delivering real results for the average American that would make us more relevant and sought after, too.
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Terrance Odean is the Rudd Family Foundation Professor of Finance at the Haas School of Business at the University of California, Berkeley. He is a member of the Journal of Investment Consulting editorial advisory board, of the Russell Sage Behavioral Economics Roundtable, and of the WU Gutmann Center Academic Advisory Board at the Vienna University of Economics and Business. He has been an editor and an associate editor of the Review of Financial Studies, an associate editor of the Journal of Finance, a co-editor of a special issue of Management Science, an associate editor at the Journal of Behavioral Finance, a director of UC Berkeley’s Experimental Social Science Laboratory, a visiting professor at the University of Stavanger, Norway, and the Willis H. Booth Professor of Finance and Banking and Chair of the Finance Group at the Haas School of Business. As an undergraduate at Berkeley, Odean studied Judgment and Decision Making with the 2002 Nobel Laureate in Economics, Daniel Kahneman. This led to his current research focus on how psychologically motivated decisions affect investor welfare and securities prices.
Above the Market 