Michael Kitces: Does Portfolio Customization Pay Off? | Morningstar

2022-08-26 08:19:08 By : Bery Zhao

The financial advice guru discusses his time-management hacks, the benefits and limitations of direct indexing, and the myth of fee compression in the advice space.

Listen Now: Listen and subscribe to Morningstar's The Long View from your mobile device: Apple Podcasts | Spotify | Google Play | Stitcher

Today on the podcast, we welcome back Michael Kitces, who was one of our first guests on The Long View. Michael is the head of planning strategy for Buckingham Wealth Partners. In addition, he is a co-founder of the XY Planning Network, AdvicePay, New Planner Recruiting, fpPathfinder, and XY BeanCounters. Kitces also oversees the leading industry blog for financial advisors, Nerd's Eye View at kitces.com, which reaches more than 250,000 readers each month. He also has two podcasts, Financial Advisor Success and Kitces & Carl, the latter of which he produces with Carl Richards. He has received numerous financial planning designations, including the Certified Financial Planner, Chartered Financial Consultant, and Chartered Life Underwriter designations. He received his bachelor's degree in psychology from Bates College and subsequently earned master's degrees in taxation and financial planning.

"Resolving the Paradox—Is the Safe Withdrawal Rate Sometimes Too Safe?" by Michael Kitces, kitces.com, May 6, 2008.

"To Roth or Not To Roth," by Michael Kitces, kitces.com, May 2009.

"Maximizing Your Productivity by Leveraging Your Time Not Your Technology, With Patty Kreamer," Financial Advisor Success podcast, kitces.com, June 15, 2021.

"7 Big Rocks—The Productivity System," by Stephen Covey, youtube.com, Dec. 27, 2013.

"Financial Advisor Fee Trends and the Fee Compression Mirage," by Derek Tharp, kitces.com, Feb. 8, 2021.

"The 3 Domains of Financial Advisor Value: Why Human Advisors Continue to Thrive Amid Competition From Robos," by Adam Van Deusen, kitces.com, May 23, 2022.

"The Four Types of Direct Indexing and Technology Solutions for Advisors," by Michael Kitces and Adam Van Deusen, kitces.com, Feb. 16, 2022.

"Why Tax-Loss Harvesting During Down Markets Isn't Always a Good Idea," by Ben Henry-Moreland, kitces.com, July 13, 2022.

"Financial Advisor Trends in Constructing Mutual Fund vs. ETF Investment Portfolios," by Michael Kitces, kitces.com, July 25, 2018.

"What This Week's Market Volatility Teaches About Making Customized Portfolios for Every Client," by Michael Kitces, kitces.com, Feb. 8, 2018.

"Kitces & Carl Ep 65: Handling Clients Who Bring Their Own 'Hot' Investment Ideas," Kitces & Carl podcast, kitces.com, July 29, 2021.

"10 Key Performance Indicators for Financial Advisory Firms to Compare With Industry Benchmarking Studies," by Ben Henry-Moreland, kitces.com, March 28, 2022.

Christine Benz: Hi and welcome to The Long View. I'm Christine Benz, director of personal finance and retirement planning for Morningstar.

Jeff Ptak: And I'm Jeff Ptak chief ratings officer for Morningstar Research Services.

Benz: Today on the podcast, we welcome back Michael Kitces, who was one of our first guests on The Long View. Michael is the head of planning strategy for Buckingham Wealth Partners. In addition, he is a co-founder of the XY Planning Network, AdvicePay, New Planner Recruiting, fpPathfinder, and FA BeanCounters. Michael also oversees the leading industry blog for financial advisors, Nerd's Eye View at kitces.com, which reaches more than 250,000 readers each month. Michael also has two podcasts, Financial Advisor Success and Kitces & Carl, the latter of which he produces with Carl Richards. He has received numerous financial planning designations, including the Certified Financial Planner, Chartered Financial Consultant, and Chartered Life Underwriter designations. He received his bachelor's degree in psychology from Bates College and subsequently earned master's degrees in taxation and financial planning.

Michael, welcome to The Long View.

Michael Kitces: Thank you. It's great to be here. Appreciate the opportunity to come back. I was trying to remember. It's been a few years.

Benz: It's been three years.

Kitces: Three years. So, it was pre-pandemic.

Kitces: That was the pre-COVID interview. This is the postpandemic interview.

Benz: Exactly. You were among our first guests. We wanted to talk about how you apportion your time. You have a lot of plates spinning all the time. Can you talk about how you divide your time in a given month or a given year? So how much time you spend speaking, consulting, researching and so on? How do you think about that?

Kitces: I essentially think of my time and actually try to pretty consciously allocate my time across, I'll call it, five broad buckets. Bucket number one is content that we create, like writing, and podcasting, and video, and all the different content that we do on Nerd's Eye View on kitces.com. The second 20% slice for me is trying to help get that content out into the advisor community. So, speaking—podcasts to join for opportunities like this, calls that I have externally with people that we could be partnering with or doing work with or engaging with the advisor community, so that's the second bucket.

The third bucket for me is actually managing the team internally, so we've had quite a bit of growth on just the kitces.com platform and team over the past couple of years. We're literally in the process of hiring number 22 and number 23 on the team. It means there's a nontrivial amount of managing that has to happen just of managing the team and managing the business. I've got a fantastic managing director, who is my second half and probably better half, in making sure that actually gets done the right way.

The fourth bucket for me is some of the other businesses that I'm involved with. So XY Planning Network and AdvicePay and Buckingham Strategic Wealth, in providing wealth management to individual clients and consumers. fpPathfinder, which makes flowcharts and checklists for advisors. New Planner Recruiting, as the name implies on what it does. Multiple different buckets, but all of that's supporting the other, we'll call it, Kitces-related businesses that I'm involved with. And then the fifth bucket is essentially the flexible bucket in part because I just need some flex time to actually do tasks and get things done between the other four buckets, but also that space to just be able to think about the business, to be able to think about new industry ideas for me to do my kind of nerd out and research and come up with new things that I want to think about and analyze and dig into.

I really manage it across those five domains of creating the content, helping to get the content out, managing the team, supporting the other Kitces-related businesses, and then consciously trying to have about 20% flex time so I don't go completely insane trying to keep the other four buckets together.

Ptak: To what extent do you have contact with advice clients these days and how do you aim to stay plugged into client concerns, even as your activities have largely moved away from that direct client contact that you had earlier in your career? And if I've gotten any of that wrong and we're mischaracterizing the way you're spending your time, by all means set us straight.

Kitces: No, I think that's a fair characterization. The first, nearly 10 years of my career, was almost all client-facing and delivering financial plans as well as training and developing our advisor team and their work delivering plans to clients. For a middle 10 years, my client involvement was scaled back and more limited as I fondly put it, I was the geek of last resort on complex technical questions and client issues. So, when the firm had challenging client situations that they were involved with, I would still get plugged into client meetings and some of those conversations, but I wasn't necessarily delivering every financial plan that our firm was building for clients the way that I did in the early years.

About two years ago—coincidental to pandemic environment—I had made a shift from the firm I'd been with for 17 years over to where I am now, which is Buckingham Strategic Wealth. And when I went to Buckingham, it was actually a conscious decision of I'm not going to be in a direct client-facing role; I'm not taking on clients directly at this point. If you want to work with me, we at the firm would love to work with you. Very proud of the advisor team that we have there and the advisors that are there. And they get to build on the research that we do on kitces.com and a lot of the work that we've done.

But I'm not taking clients directly at this point, in part because of, we just mentioned with the buckets of time. There's a lot of different businesses and stuff I'm involved with and so at some point, something's got to give on available time capacity. Part of what's always been important to me though, is staying anchored and rooted in an advisory firm even above and beyond the sheer number of hours I spend talking to advisors, being immersed in the advisor community. Because it's always been important to me that even as I take less client interaction directly than I have in the past, I don't want to ever get too far away from what it's like to, as I put it, sit in the chair, be in the chair across from clients, and what's going on.

Obviously, a little bit less of it now for where the role is these days after 22 years in the business. But being anchored directly in advisory firm still very much helps to keep my ear directly to the ground, literally in a firm, like what's going on? What are the conversations that are coming up with clients? As well as while I'm not sitting client-facing on a lot of those conversations now, there's still a good amount of advisors that are reaching out, they're saying: "These are the conversations I'm having with my clients, this is where I'm stuck." Or "This is the challenge I'm having." Or “How do you handle the situation?” So I still get to very much keep good perspective on the conversations that are coming up in practice with clients, even if I'm not taking clients directly now.

Benz: I'm curious, Michael, what are some of those key themes that are coming out today?

Kitces: It's no great surprise. It's market volatility. Although depending on the day or the week, that feels a little bit like better or worse, but it's market volatility. It's inflation that a lot of different people are processing different ways, because inflation shows up differently and some people just, practically speaking, are feeling it, and they're spending more than others. For some clients that's a spending conversation. For some clients, that's a sustainability conversation, like if everything is getting more expensive, what's this going to do to the sustainability of my retirement in the future? For others, its inflation as it translates into investment returns. So, look at what's going on with my bond allocation. What's happening with market volatility because of this inflation stuff.

Inflation is showing up a lot of different ways in client conversations now and some of that is just frame of client, practically speaking. Depending on where your wealth level is, inflation shows up a little bit differently in that conversation. But inflation and market volatility have been huge drivers right now. Taxes are pretty much always ever present, and obviously there's some particular tangible tax conversations in volatile markets like tax-loss harvesting and Roth conversions, and some things that we get to do a little bit more tactically. But also, the better part of, not just in recent weeks, but recent months in the past year, of discussions around tax reform and various pieces of Biden tax legislation that have been moving forward and then not. And then maybe in the not, but a lot of those have some very real tax-planning implications as well. And so, tax conversations are often cropping up as hey, is there a thing we should be doing with this legislation that may or may not be going through depending on what's going on in Washington this week?

Benz: And we want to hit on some of those topics later in the conversation and get your perspective on them. I wanted to ask first about your various areas of subject-matter expertise. There are a number of them. There's practice management, nitty-gritty financial planning matters, the state of financial advice, which is something we discussed in depth when you were first on the podcast. So what are the key areas for you and how do you think about dividing your time and attention across all of them?

Kitces: It's been an interesting evolution over time, candidly. I think part of that is just, to me, where the opportunities are in the industry to be analyzing and talking about interesting stuff. Part of that is frankly just where my own interests and mental intellectual curiosity happen to be going at the time. When I launched kitces.com, it was almost 14 years ago, it was early 2008—a lot of my focus then was taxes and retirement. I was publishing research on retirement income sustainability and safe withdrawal rates. We put out the first study connecting Shiller Cape ratios to sustainable withdrawals back when nobody was talking about that or bringing that into retirement conversations. We wrote a newsletter in 2009 when the Roth conversion rules were about to change, that said, in this change into the Roth conversion rules, it's going to open this door where you'll be able to do Roth contributions even if your income is too high. Because you could do a contribution and immediately convert it and backdoor your way around the Roth contribution limit, which now we widely talk about as backdoor Roths. I was writing about that before they even existed based on this legislation that just passed this thing is going to become possible in a couple of years.

And so super-deep into taxes and retirement, trying to really look forward on where were new planning opportunities, where were new ideas, what else could we be doing? And I did that for many, many years. When I look over the past, probably four or five years in particular, that has shifted for me. I spend a lot more time on the practice management and industry-trend side of the business than I did before. I spend a lot more time on advisor technology, in part because I was one of the few people writing back in 2012, 2013 when Wealthfront and Betterments and the robo-advisors first showed up. And, the discussion was they're going to take over the world and cause advisor fees to collapse.

I was one of the only people saying nope, advisor fees aren't going to collapse. We're just going to shift our value proposition. These robo-advisors are all going to get buried by their client-acquisition costs. They're really only competitors to do-it-yourself platforms like Schwab and Vanguard. And then sure enough, three years later, the first two people launch competing offers were Schwab and Vanguard. And I ended up getting pretty deeply immersed into the advisor-technology domain as well and that's continued to be a pretty active writing theme for us.

It is an evolution, as the platform has grown, we've been able to evolve what I'm writing about without losing what the platform is writing about. Folks like Jeff Levine are on our team now, who do super-deep analysis on new tax laws when they come out, which was something I used to write for years and now Jeff tackles. We have other folks in the team that are going deeper into client communication and life-planning skills. We have folks that are going deeper into the issues and challenges that newer advisors face in particular. Part of my role with the team is evolved to be a little bit more focusing on the broader, call it, editor-in-chief role of making sure we're covering the full range of things that are important to the advisor community. But my personal writing has gone a lot more into financial planning, practice management, evolution and trends in the industry, and advisor technology.

Ptak: Kitces.com is full of resources for advisors looking to up their game. Where do you go for your own knowledge download, so to speak? Who or what are your must-reads each week or each month?

Kitces: Jeff, I guess where I go for knowledge information for me, it's really more of a breadth thing than a depth thing. There's lots and lots of different places that I go. Because for me, I'm always trying to look out and just spot what else are the snippets that are interesting? Who's saying something that's interesting that I haven't seen before that I think we could say more about as well or just amplify? Because we do a weekend reading recap for the advisor community—here's the 12 most interesting things that I read this week—that other advisors might be interested in as well.

We'll try to highlight other writings, sometimes we go deeper on our own. For me, I guess it's a little bit old school, per se, like I live in RSS readers. There's Google, well, not Google Reader anymore, because it went away, but the Google Reader-style things where you just get RSS feeds of all these different blogs and media platforms. And most of them still have RSS feeds on the back end, even though RSS readers are not as popular as they were before. I used one called Inoreader—it's pretty good, capable, customizable RSS reader.

There are literally dozens and dozens of blogs and websites that I feed in there. So, every week as I sit down, I've got a routine on Thursday mornings for a couple hours where I go through all the blogs and websites that I follow on Inoreader. Scan through headlines; read through articles; some of them I queue up to share out to the advisor community on social media; some of them we write about in weekend reading. But for me, the driver is really the breadth of what we follow, because what happens to crop up that's interesting in any particular week really varies. I follow most of our industry, pretty much all of our industry, trade publications. There's, InvestmentNews, Financial Planning, Financial Advisor, Wealth Management, AdvisorHub, Advisor Perspective. We got a coterie of different publications there.

There's a couple of just broad-based consumer publications like CNBC and MarketWatch, where I'm interested to see what's floating and going on around there. There's a really wide range of advisor blogs in the industry that I follow, some who write fairly infrequently; some who write often. There's some higher-profile folks like Josh Brown and Barry Ritholtz, and the folks over there. I'm a big fan of Tadas Viskanta’s Abnormal Returns, and he does a wonderful job curating articles for others as well.

But then there's a very long tale of advisor blogs—of advisors that are writing in the community about what they're working on and digging into—and sometimes I get glimmers, ideas of inspiration from there or something that's an opportunity to share out. And I would be remiss truly if I didn't give a shout out for Morningstar and what you guys do here as well. So, following Christine and what John Rekenthaler and some others on the Morningstar platform write about as well, to me gives a great perspective on some of the conversations both around the personal finance and around the investment industry trends.

Because we're very focused on financial planning, we really actually cover very little, almost nothing, on pure investing on the Kitces platform in part because I think there are a lot of other platforms that cover that deeper and better than we can as well. But looking to a lot of the Morningstar writers that talk about either financial planning or broader investment industry trends to me is super interesting. And I follow a couple of folks in the Morningstar end as well.

Benz: Thanks for that, Michael. I wanted to ask about productivity because you are incredibly productive, incredibly efficient, and I think you also really edit your time and activities, and you're thoughtful about that. Can you share a hack or two for getting everything done that you need to, and also just share your thoughts on this whole editing process, like how you edit your time and decide what to commit to and what to say no to?

Kitces: At a high level, the biggest thing for me that really was a life lesson takeaway that I pretty much had to do wrong for like five-plus years of my career before finally figuring it out, is that just like the whole phenomenon of time management and productivity management isn't really a thing or doesn't yield meaningful results. I tried all the apps and the fancy tools and the stuff like that—some of them gave very small incremental improvements or changes; they're minuscule. The secret to time management is that it's not actually time management, it's focus management. It's being conscious about where you spend your time and what you're spending your time on. It's essentially taking control of your own calendar to say here's where I'm going to focus the time, and here are the things that are most important to focus the time on. And here's where I'm not spending the time.

I'm a big fan of there's a Stephen Covey analogy out there about rocks and pebbles and sand. I won't tell the whole story, but go look up the Stephen Covey jars, rocks, pebbles, sand analogy. There's some YouTube videos and great articles about it. But the essence of it is most people end up filling their days with the never-ending series of things that are coming at them. Messages from Team and emails and maybe some social media and notifications on our phone. All this different stuff we're constantly responding to all the different things that are coming out at us.

And then every now and then, there's a couple of tasks that we need to do today, and we get around to them because they're important, we had to do them today. and then basically everything else, we never get around to it. And what that means is the big weighty things that actually matter are the things you almost never actually get to because they're so big and weighty, there is never enough time left after you do the constant barrage of stuff that comes at you that fills most of the time. And so the secret of focus management is figure out what the big things are and clear the space first for that, which for me literally means writing on my calendar: this whole day is just a day of writing; this whole day is just a day of business planning; this whole day is just a day of podcast recordings.

And, actually, I mostly still plan themes to my day. Here's the big rock thing that I'm focused on for the day and you commit to do that and you block everything else out. And what happens is a version of what always happens to all of us, which is, there's always going to be more things in the day than there is time to do it. The onslaught never really ends. But the difference is for most of us, in the way I lived for most of my career, you're constantly putting out the fires and reacting to things and the message and the emails and all the rest. And then maybe, sort of you get to some of the things that matter sometimes, and if you can get to it or it spills over an evening or a weekend, and you do it because you're investing in your career.

And now my entire approach is just completely upside down for that—I place the big things that matter first. I literally mark my calendar that way so nothing else can come on the calendar. No one else is allowed to put anything else on my calendar because that time is already taken. And when I get to the things that don't fit in at the end of the day—because there's always going to be something—almost by definition, the things that don't fit at the end of the day are the ones that mattered the least. Because I was already so cognizant to put on my calendar the stuff that matters the most, that what's left that doesn't fit in is by definition what matters the least.

And when you do that on a continuous compounding basis, it adds up in really material ways to grow business and grow career over time. And so that's why, even as we were starting and talking about, where does time go and how do I divide my time across those buckets? It's because I very consciously have set targets about how much time I'm spending in each of those buckets, and I manage my focus that way so that I really am allocating my time to the things that move the needle the most.

Benz: That's helpful. So that blocking thing, where you have podcasting day, for example, is that intentional too, so that you're doing the same type of task in a block of time versus switching from task to task that might be different?

Kitces: Absolutely. Again, in that theme, multitasking doesn't exist. And I am fairly severe ADHD. School was really rough for me for a long, long time because I don't sit still very long. Well, I certainly don't sit in classrooms for extended periods of time. I'm as sensitive to the desire and allure of multitasking as pretty much anybody out there. But in practice, multitasking doesn't exist. Your brain literally can't thread two things at once. It only focuses on one thing at once, and so all multitasking really is like high-volume task-switching, like repetitively going back and forth between tasks. And there is a level of just really basic task work where that works fine.

Our company's task-management system of choice happens to be Asana, and so if I've got an afternoon where I just need to crank on a whole bunch of Asana tasks, I can still be a little ADHD scatter-brained. I'm going to do part of this task, then I'm going to go wrap that task,  and then go back to the other one. It's not heavy brain-load task work; it's just some stuff I need to knock through and check off. And sometimes the ADHD gets a little better of me and I'm buzzing around for a while. But when you get to the heavy stuff that matters, it's like, in Cal Newport terms, it's the deep work, when you get to the deep work stuff, task-switching is just horrifically destructive.

If I'm in the zone on writing and I let something pull me out of the zone on writing, it can take 30 minutes to an hour to really get my head back into the zone of what I was working on. It's those sorts of moments of flow that some of us get in whatever our chosen focal thing is—sometimes it's flow when you're exercising or doing sports, sometimes that can be even sitting across from clients and in a meeting, sometimes it's in a creative space.

And so, particularly when I get down to spaces where I need to do deep work, it's very conscious for me to block at least half days, if not whole days. That says this is all I'm doing. The whole team knows this is all I'm doing. In fact, if you try to reach me and ping me on something, I ain't responding; all messages are off, all notifications are off. There's nothing that's popping in unless I'm taking a breather on it, so that I can avoid task-switching when I have to be doing deep work. That's the part where it really matters.

So, it's deep work for writing. It's deep work for podcasting, a lot of our creative work. What that means in practice is I also end up time-blocking meetings to happen consistently on one day so that I can have entire days that are meeting-free to need to do that focus work. For me, Monday is the day that basically; the whole day is blocked for meetings from start to finish. Tuesdays and Wednesdays are typically my deep workdays, Thursdays is a day of doing lots of internal team meetings and collaborations. If we need to come together and work on projects, I've got blocks of space to do that. But it's not a full day of free space. It's a day of this is when I schedule those collaborative projects and things we're working on with the team.

And then Fridays are a little bit more of a flex day for me with some task catch-up that I need to do through the week. So setting that free workspace. For a lot of advisors that essentially means making Tuesdays, Wednesdays, and Thursdays your client meeting days and just making Tuesdays, Wednesdays, and Thursdays your client meeting days and knowing that you don't have to do anything else that day except be completely, fully present for the client meetings that you've got. And let Monday be your team meeting day and prep work, and let Friday be your wrap-up day and close out the planning work that you can do. And it's incredible how much it lifts your mind and focus when you don't have to make extra decisions and task-switch around and you can really be focused and fully present in whatever it is that you're trying to do.

Most of us don't realize how much we lose to essentially the toll of task-switching, particularly for deep work, because we don't block out the time on our calendar to be focused.

Ptak: Well it’s working. I'm in awe of your productivity. It's incredible. I did want to shift and talk about the advice business, which is another area where you've done a great job of analyzing, chronicling. And one of the things that you've kept everyone abreast of is developments over the past decade where we've seen a huge amount of consolidation in the RIA space. Do you think the pace of these rollups, is it slowing down at all given this year's poor market conditions?

Kitces: The short answer from what we're seeing in the data, is not much. There was at least a little bit of a slowdown in the first half of the year, at least compared with where we were in the second half of last year. But deal pace overall is still running similar or hotter than it was, annualized this year versus annualized last year. Deal terms and structure have shifted a little bit. Buyers and sellers are reacting a bit to the market environment, but the overall driver for the consolidation is just look at the very top of the industry. There's a lot of money that's pouring into the advisor industry, because again ironically relative to 10 years ago where we were all supposed to be gone by now due to the rise of the robo-advisor.

In practice, advisory firms are doing so well and thriving and are strong, profitable recurring revenue, stable, successful enterprises that there's just an immense hunger for buying advisory firms right now. It's coming from private equity firms. It's coming, to some extent, from strategic acquirers. It's coming to a large extent, just from advisory firms that are growing successfully but want to scale up to the next level so they're trying to acquire other advisory firms to achieve those economies of scale. Just the health of the advisor business is very, very good right now, most predictions notwithstanding. And I think that's the biggest driver of consolidation of the advisory space.

And those underlying factors have not changed. So, a couple of more deals are getting structured with some different terms that says, if the market rebounds as the seller, I want to participate a little bit in the rebound, so I don't have to feel like I'm selling my firm at a low point in the middle of the market pullback. But they're still selling, and the deals are still getting done, and the buying hunger is still there. Terms are just getting shifted a little bit, so everybody still feels good with the timing. But the deal flow is still happening. There's still a hunger for firms and there's still a drive for economies of scale.

Benz: You referenced, Michael, that this fee compression that many people had warned would happen in the advice space has yet to really materialize. So, I'd be curious to get your thoughts on why that hasn't happened? That the Jack Bogle revolution in terms of asset-management products has not come to the advice business.

Kitces: I think there's a couple of different reasons for this, and in part you have to look at the underlying drivers, even of where the fee-compression discussion came from in the first place. If I look over the past 10 years, certain people of the industry been pounding the table around fee compression. It primarily comes from two places. It was either robo-advisors are providing this low-cost solution, so all advisor prices are going to have to come down, or it's been look at all the fee compression that's happening in the product space, advisors are the next inevitable domino to fall in that chain.

So, if you start drilling into each of those, though, you get a little bit of a different perspective. If you start on the robo-advisor and why will consumers keep paying the proverbial 1% to advisors when you can get it from a robo advisor for 25 basis points? Well, what you really find when you drill into that is, you think who chooses a robo-advisor? Because there's a certain pressure that's still on you if you're going to choose a robo advisor. You have to choose the right robo-advisor. You have to do an analysis of the different robo-advisors to figure out the pros and cons of each one and their investment performance, and their allocations, and their services, and their capabilities. You have to do all this analysis to figure out what the right robo-advisor is and whether they are going to manage your assets well—which, frankly, is not that different than how a lot of investment selections looked historically.

Right now we look at robo-advisors and how they manage ETFs. Ten and 20 years before that we were looking at mutual fund managers and how they're going to manage their portfolio. There's a segment of consumers that like doing that. Rolling up their sleeves using the available resources—now a lot of online resources, including from Morningstar—to analyze their own portfolios. We have a label for them: they're called do-it-yourselfers. They're also known as people who don't hire advisors and never have and never will.

The whole robo-advisor movement at the end of the day was built to serve do-it-yourselfers. I don't think that's what the robo-advisors thought they were going to do when they began. They thought they were going to be competing with individual advisors, but who showed up in practice were do-it-yourselfers and that's why the primary platforms that launched competing options were do-it-yourselfer platforms like Vanguard and Schwab's retail offering.

And so, at a core level, robo-advisors were never in competition with human financial advisors because human advisors by and large tend to work with delegators, people who don't want to make these decisions and figure it out. They'd rather hand it off to someone and pay them for that service. Robo-advisors were appealing to do-it-yourselfers who wanted to do it themselves and don't want to pay advisors and so, of course, if you want to do it yourself and don't want to hire someone else to do it for you, it's going to be cheaper. That's what I would logically expect in that situation, but that doesn't mean robo-advisor fee compression translates to financial advisors because the people who buy robo-advisors don't hire financial advisors, or alternatively and ironically, the version even that we see in some places now has consumers that literally do both—like I'm comfortable with my investment stuff, I can pick a robo-advisor. I want to hire a financial advisor to give me financial planning on all the other stuff besides the investment portfolio, because I still want and need help with that and I'm willing to pay an advisor for that. But that's a separate service from it allocates my portfolio for me. I might be good with that part.

And so, there are even advisors who have thrived with clients who use robo-advisors for their investments. But this whole idea that robos were in competition with financial advisors, I think was a misunderstanding of consumer psychographics and who buys what and engages with what. To me, sure enough financial advisors didn't end up getting fee compressed by robo-advisors because we weren't competing with them and their offerings and the fees that they charge. I do think there's been pressure on advisors to, I'll call it value-add, our way up; there is still a price gap. If all you're going to do for me for 1% is asset-allocate my portfolio, I could just hire a robo-advisor to do that for a fraction of the fee.

There has been pressure on advisors to value-add their way up to justify what services, capabilities are you delivering for me to justify this fee? I think by and large, the advisor community has stepped up, and I'm not saying that to pat ourselves on the back. I'm saying that by look at the actual growth of advisors relative to the growth of robo-advisors. Advisors have stepped up and consumers are voting accordingly with their feet. That's deeper financial planning and better client communication, and proactivity, and tax services, and estate services that are showing up—lots of different ways that advisors are value-adding their way up. So, you get a lot more for your 1% fee than you did 10 and certainly 20 years ago.

But we didn’t get fee-compressed. We got value-challenged, and firms have reinvested to step up on the value. When you get to the product end of it where this prediction was, well look at all the fee compression that's happening from products. Isn't that inevitably going to happen to financial advisors as well? To me, what most of the industry just fundamentally missed is the product fee compression, it's not products compressed fees and then advisors get their fees compressed. We, as the advisors, we’re the ones causing the fee compression in the products. It's not coming at us; we're causing it to everyone else and it's because of that fundamental shift that's happened in the advisor world.

If I go back 20 years ago, virtually all of us worked for insurance companies or broker/dealers. We wrote financial advisor on the business card, but the truth is, literally, legally we were in the product sales-distribution business. We sat on the product side of the table and our job was to sit across from a client and pitch that product to the client and the product companies paid us for that in what we know as commissions. As the advisor business has shifted from products to the actual advice business, by and large from the brokerage side of the industry to the RIA side of the industry, and we take on those things like fiduciary duty and different obligations. If you think of this like a table where it used to be I sat on one side of the table with my product lineup behind me, and I tried to sell things to my client sitting on the other side of the table.

What's happened now is as an advisor I got up, I walked around to the other side of the table. I now sit next to my client on the client side of the table. And my job is to look at all those product companies coming at me and trying to sell stuff to me and my clients and defend my client and gatekeep my client to protect them and make sure they're getting a good deal. And frankly we have a lot of incentive to do that as advisors, because one of the easiest ways to make my fee look good is to strip out the costs of everybody upstream and get lower-cost products for my clients, because that can recover some or all of my fee, depending on how expensive the client's portfolio is.

And so, what you're seeing happen over the past 10 and 20 years is not like product fee compression is magically happening and advisors come next. Its advisor stood up, got to the other side of the table, sit next to their client to protect the clients, and go back to the product companies and say you got to get me a cheaper version of this that makes me look good in front of my client or I'm going to fire you and find someone else who gives my client a better, cheaper offering. Advisors aren't experiencing the downstream effects of fee compression, because we're the ones causing the upstream effects of fee compression in the first place.

Likewise, there's been all this discussion of advisors going passive with the growth of ETFs. We're not going passive. If you literally look at the industry trend data, we're not going passive at all. What's happening is we used to sell a mutual fund to a client in a C share that was 2% to 2.5% all in, between my 12b-1 trail as the advisor, plus what went to the fund manager, plus what went for distribution to my platform. Now I sit on the other side of the table next to my client and say, here's the deal. I'm going to save you 40% on your investment cost. And here's how it's going to work. Right now, you pay 2%-plus in that C share mutual fund, but what you're going to do instead, is you're going to pay me 1%.

And then I'm going to build you a portfolio of asset-allocated ETFs that I will manage on your behalf, which I can do super-efficiently thanks to the growth of rebalancing software and portfolio management tools. I'm going to manage all this stuff on your behalf. The average expense ratio of these ETFs was 20 basis points. Now we're probably getting down to 10 to 15 basis points, even lower for certain funds. So, you used to pay 2% all in. Now you're only going to pay 1.2% all in. But as advisor, my cut didn't go down. I used to get 1% from the C share. Now I get 1% on the advisory fee, but the product side went down from 1%-plus to 0.2%. And I manage the client's ETFs on their behalf, because, frankly, it's a little bit more manageable for us to manage ETFs than it is individual stocks. And we have tools and technology to be able to do that well and efficiently.

And so that's the trends that you're seeing. We're not going passive, we're proactively managing ETFs, as the new stock, as the new building block for clients and saving clients 40% of their all-in costs to do it, which is why you're seeing so much growth in that direction. But again, if I want to look even better in front of my clients, I don't necessarily have to cut my fee. I just say well, instead of 1.2, I found a new thing that's only 1.1. I got a lower cost out of the product manager, and I drove that down even further. So, just all these predictions around fee compression were mostly built around robo-advisors are going to compete with us, except it turns out they're not. Or product compression is going to come down on us, except it turns out that we're the cause of the fee compression in products.

At the end of the day, the pressure is certainly on us advisors to do more than we did before, and I look back to even what our firm did 10 years ago and certainly what we did 20 years ago. And we do so much more than we did before. There's more advice, more expertise, more training, more knowledge, we hire people who have more degrees and designations. There has been a lot of pressure on us to up our game to justify what we do for that 1%. But the industry has been stepping up and that's why the advice business is doing so well despite and notwithstanding product fee compression and the rise of robo-advisors.

Ptak: I suppose one of the ways in which you might up your game is in customizing. We wanted to ask you about direct indexing, where we've seen an explosion over the past few years. It essentially allows investors to assemble bespoke portfolios that aim to deliver tax efficiencies or might incorporate non-pecuniary preferences like ESG. Is the hype justified in your view and can you discuss how you think about the pros and cons of these services?

Kitces: To me, a short answer is I think the hype is justified, but I don't think the killer app has been been built yet. I think it's going to get built. I think we'll see it. But it hasn't quite been built yet. Whoever it is that's going to figure it out hasn't quite nailed the formula. And I think that's happening in part because there's actually a couple of different types of direct indexing that are really evolving in practice as offerings into the marketplace. And we're still even figuring out which ones actually get the most demand and the most drive. We wrote about this on our site in the past year, and I just call it the four types of direct indexing.

Because to me they are really distinct offerings. One is what I'd call the tax-centric direct indexing. This is essentially direct indexing story of you're going to own all the things that you would have owned otherwise in whatever fund or ETF or index you were going to own. We're just going to own them in the component parts of the individual stocks that you can do granular or tax-loss harvesting at the individual stock level. If you're having a low tax year, you can do capital gains harvesting at 0% rates. If you're charitably inclined, we can cherry-pick the most appreciated securities and donate them.

So, a whole bunch of strategies and tools that are all built around the idea of I'm going to create for you the identical index funds that you already own, but I'm going to do it in the component parts in a way that creates more tax benefits. And there's some layer of tax alpha around that. Frankly, I think most of the industry grossly overstates the amount of tax alpha because they talk about how much tax savings you have in the year that you harvest the loss and kind of forget if you harvest a loss, your basis steps down, which means your future gains are bigger by the exact amount that your loss was harvested. Which means if you end up paying the same tax rate in the future, you didn't actually save anything on taxes, all you created was the growth on the tax savings while you had it in your pocket before eventually the recovery gain shows up.

But there is a value to that tax deferral. We’ve published some research on it for our site. We generally estimated somewhere in the neighborhood between 10 to 20 basis points, maybe slightly higher for people in high tax brackets with high state rates. Overstated for some of the companies that talk about like 100-plus basis points of tax savings, because you don't actually get that in the long run when you consider the step down in basis from loss harvesting. But there is some value there, and it's worth paying for. As long as you can get the service for lower than the cost. There's one group that is just tax-focused, but from an investment perspective, like you may literally just own an index fund. That's where companies like Parametric and Aperio got started 20-plus years ago doing this.

The second version of this is what I would call personalized indexing. Shout out for Schwab who managed to grab and settle on the name for that, but I think it's a good reflection. This is where my portfolio gets customized specifically for my individual investment preferences and style. And I can express whatever I want there—that might be certain ESG-style preferences, that might be just particular industries that I want to favor or that I want to filter out. That could even be by other frameworks like, I like small cap and value, and I want to express that in my portfolio. But the ability to take what would have otherwise been a standard investment offering and change it by overweighting, underweighting, or outright screening or removing certain stocks or certain groups of stocks by industry sector or screen, whatever it is you want.

The distinction here is like a tax-focused direct indexing offering. You may still literally own the index; we're just doing it for the tax savings. Personalized indexing looks very, very different. I'm going to own something that might be materially different than the underlying index, because I'm expressing my own individual preferences. The third version of direct indexing is what I would call rules-based direct indexing systems.

This is where my portfolio might actually change in ways over time, but I create a rules-based system that says how my investments are going to get picked. For example, I might get a piece of technology that says I want to overweight value stocks and overweight small-cap stocks—going back to the roots of DFA, but I don't want to buy it with DFA. I want a piece of software that's going to continuously track all the stocks, pull in data from, perhaps wonderful data feeds like Morningstar. And I want the software to continuously adjust my allocations so that I maintain this overweighting to value and this overweighting to small cap. And have the software manage it dynamically as the stocks move and gyrate over time.

And you could do that with factor weightings. You could do that with a lot of other drivers. Advisors frankly could use technology like this to create their own dynamic rules-based strategies and then express them. It’s almost sort of a version of if you imagine a build-your-own smart beta tool. To jump back to our smart beta world from a couple of years ago, it would be a version of that where the software expresses it. Again, very different in style than the personalized portfolios or the tax-focused portfolios.

And then I see a fourth version of direct indexing that's starting to crop up that's a little bit more around client-specific customizations—granted, I'm viewing this a little bit more from the advisor lens than necessarily what would be sold out to consumers. But as an advisor that's just worked in the industry for long time, there's a lot of client-specific exceptions that come up. I'm based in the Washington, D.C., area. For many years, I had a lot of clients that worked for agencies with three-letter acronyms, and there's a whole bunch of special rules around that. Like clients at the FDA can't own drug stocks and clients at DOD can't own defense stocks. And so, we would have to create portfolios that are adjusted for particular super client-specific restrictions.

And it's a little bit different than personalized indexing. Because they weren't overweighting or underweighting certain industries because they had an investing preference to own more or less of it. They needed a portfolio that looked different because they had a legal employer obligation to own certain stocks or more directly than not own certain stocks. When you look broadly across these tax-focused, personalized, rules-based, and more customization tools for client restrictions and client exceptions, just from a platform and software design perspective, those are really different user experiences. Those are really different user journeys of what the tool needs. In an advisor context you need a very different client interface and a very different advisor interface for those.

To me, what I'm seeing in the marketplace so far is either tools that have been trying to emulate the tax-focus version, will be Parametric or Aperio, but we'll democratize it for investors. With the small caveat that if you really try to democratize it and you bring it down market, you bring it to people who don't actually have high capital gains rates. So that doesn't work as well. Or folks that have been going more into the personalized direction but with a wide range of offerings that are not necessarily really built to the use case of specifically personalizing, and so they're not being done in terribly consistent manners yet in a way that that creates a breakout in the category.

The question to me is which of those categories even will be victorious? I actually think there's room for successes in all of them. But so many vendors are basically just trying to build a lightweight version of all of them at once and then see which one gains traction. When the reality is the winner is probably going to be the ones that do one of those especially well and dominate in that category and we just haven't seen it yet, but I do think it's coming.

Benz: I have a follow-up question, which is about accountability. You know at Morningstar we have spent so much time holding fund managers’ feet to the fire. If their performance is bad, we talk about it. Are we losing some accountability? It feels like we're in a Wild West zone. If everyone out creating these custom portfolios does the client necessarily know some of the risks that are coming onboard with some of these choices that are being made?

Kitces: I do have concerns about that from the consumer end, although frankly I don't find it to be a new concern with direct indexing. Frankly, I think this has been concern for—I'll just own it in our space—for the advisor community, for a long time, and even when I started my career, and I'm going back 20-plus years ago, we implemented mutual funds for clients. We would build mutual fund portfolios. Candidly, a lot of it was driven by whatever was in the discussion at the time. Clients who saw us in 2000 got one set of mutual funds; clients who saw us in 2002 got a separate set of mutual funds; clients who saw us in 2004 got a different set of mutual funds. Because we were implementing whatever was compelling at the time, but there was no technology to manage that on a systematized basis.

So as clients came in for reviews, we make updates to their portfolio and say this manager isn't doing as well. We're going to let this one go. We're going to put this one in, who's been doing really well lately, and we've got more confidence in them. But portfolios were super not systematized. The fund analysis was really deep. In fact, when I started my career, I was the guy who would get the Morningstar Principia pro discs and take them around to all the computers and install the updates and everyone was super excited because we got all the new data from all the quarterly numbers of the mutual fund performance so that we could take it out to clients in the upcoming meetings and then figure out who had good mutual funds and who needed some funds to be replaced.

But it was all client by client and so the truth was if you looked at the funds, we would do a pretty good job of trying to pick fund because you want to pick things that are good for clients. But if you had tried to benchmark any of us at a portfolio level, like 100 clients had a 100 different portfolios based on whatever we were recommending on the day they came in because I couldn't systematize their portfolios even if I wanted to, because there was no way to do it in a standardized centralized manner, nor did I have discretion to do it because I was a broker at the time and clients had to approve every single trade. So that's why we did it with the reviews.

This phenomenon that clients own varying different portfolios isn't new; it's been around for a while. I think we had a window over the past 10 years where client portfolios got more consistent and standardized because essentially the rise of trading model management software and just the rise of advisors. Using model as the good news is clients do end up with more consistent portfolios, which frankly makes it a little bit more feasible to benchmark the advisor and figure out how their portfolios are doing. But part of the drive from the advisor end has always been some level of customization and personalization. We've managed a bit of a balancing act for that in recent years because we're trying to standardize model portfolios while also customizing it to client financial planning needs and circumstances.

But this idea that client portfolios get customized and therefore it's hard to benchmark us, that's actually been happening for a long time. It's not really new, and I actually do just share that concern from an accountability end. Yes, we were super customized 20 years ago, you could measure the funds, but you couldn't really benchmark us on portfolios. The pendulum swung the other way for a while, and we became a lot more standardized around models. It was a little easier to benchmark us. I do think the pendulum is swinging the other way now, back toward customization and personalization. Part of that's direct indexing, part of that's just technology in general that lets us do it in a more scalable manner.

And from the advisor end, it's very appealing to do more customization for clients for lots of very good, well-intentioned, positive reasons. But one of the challenging byproducts of that is it gets a lot harder to benchmark which advisors are actually constructing good, effective portfolios when you can't really benchmark us. Well, you can't benchmark me to an index because I don't own the index and I don't own the index because your financial plan said you needed to do this and not own that.

Even when I think back to the scenarios like Mr. and Mrs Client, you can't hold it against me that your portfolio underperformed because drug stocks did really well, and I couldn't buy you any of them because you work for the FDA. That ain't on me; that was your constraints of your employment situation. But that also means you can't really benchmark my portfolio as effectively because I don't own a standard benchmark. And I can't because I customized it for you for appropriate reasons, but now it gets harder to benchmark.

I do think there's a challenge around this. I think there are some opportunities just rooted in the very core metrics around portfolio measurement. It's not the prettiest stuff, but the alpha and beta and Sharpe ratios and the like that is still a relatively crude but a reasonable baseline measurement of overall portfolio rewards relative to risk that I think may need to come back a little bit more in the advisor world at the advisor-reporting level to understand who's doing well relative to who—with the caveat that not a lot of advisors necessarily have an incentive to do that, particularly the ones who aren't performing well.

Morningstar, I think, did great with this with mutual funds, because you became such a force in the market that mutual fund managers had to participate. You couldn't exclude yourself from that measurement or that became a knock unto itself. I think that will be harder in the advisor realm, because there are so many of us it's pretty hard to drive us into a standard benchmarking format or formula. But if you can't benchmark us consistently, we're building customized portfolios for clients. It's going to get hard on the investment-result accountability.

Ptak: Michael, what's a topic or issue that you think is important for financial advisors but doesn't get enough attention?

Kitces: When I look overall at topics of importance and challenge for advisors, right now I see two primary themes that are cropping up and challenging advisory firms. The first is differentiation's getting really hard for most advisors. The more that we're all doing comprehensive customized individualized personal financial planning, plus, helping you allocate your investments, it's a good holistic offering. Advisors have high retention rates. There's been good growth in the industry overall. Consumers are engaging with the service, but it's really hard to tell one advisor apart from the other because we're all doing this fairly similar broad-based thing now. And we even see this on the consumer end.

If you look at Google for how consumers search for financial advisors, the number one search for financial advisors, is “financial advisor near me.” Which essentially says all the stuff that we do to try to add value in the marketplace—create value for clients, do good things, bring expertise, all the stuff that we do—and the primary way that clients are selecting us, in practice can't tell you all apart just going to pick the one that's most geographically convenient to my home or office. That hurts a little from the advisor end. like I'd like to think my value proposition is not just the zip code of my office. But if you look on most find advisor platforms. Literally the primary search criteria is location and zip code.

We have differentiation problems. I think it's hard for advisors because we can't differentiate from each other to grow our businesses, and I think it's hard for consumers because they can't figure out who the heck to pick. So, they just end up picking things like geographic convenience instead of actual expertise in problems like mine for people like me. I think part of the trend that you're going to see in the coming years is more growth of niches and specializations in ways that we go deeper in order to both differentiate ourselves and frankly add more value to consumers overall.

We go very deep in retirement planning for what we do at Buckingham. And I think we can be very effective there by knowing this is the thing that we're good at. And we're going to do some awesome stuff for our clients in that space. And that's what we do, and we can differentiate around that. A lot of advisory firms really struggle with differentiation because they're afraid, if I pick a thing, I'm going to be good at, then I'm going to lose all the clients. Anything else that I was doing and not realizing that the truth is like 99.9% of clients can't figure out what we do and leave our website as soon as they visit us because we weren't clear in our messaging.

Just the whole phenomenon of we're not differentiating well, it's not good for us, and it’s not good for consumers is, I think, a big challenge. And the second one that goes along in that vein is as we're increasingly shifting away from putting "just building portfolios" and into increasingly more holistic financial advice and ongoing financial planning, the truth is our tools, our technology, our systems, our platforms are not actually built very well for delivering ongoing financial advice.

Most of our tools and technology are built for how we build and deliver the financial plan in the initial engagement, and then what we implement with clients in the initial engagement, and then the only real way we have to do ongoing financial planning is every now and then the client is supposed to come back in and we "redo the plan"—we make a new plan for the clients because it's been a couple of years. And maybe we should do this analysis again. Frankly, that's how we did it 20 years ago, because every time the client came in, I could do a new plan, find a new gap, and sell them a new thing like it was a sales strategy. That's where that came from.

And when you drill down to what really do we need just as advisors to scale our businesses to really efficiently serve clients on an ongoing basis and do it efficiently, we really lack tools and technology for it right now. So, we've even been tracking this on kitces.com. It's a broad category that we call advice engagement tools. That is, technology that scales up, like the ongoing delivery of value to clients in this last 29 years after the first year that we worked with them, since so many clients work with advisors for multi-decade stints. And I think there's a huge gap in advice engagement and way too much focus in the industry on what is still basically our sales roots of getting out in front of clients to sell them something new. And that's not what we're doing now. We're trying to give them ongoing, enriching, valuable advice on a continuous basis to clients, and we're really weak on the tools about how to do that efficiently.

Benz: Well Michael, this has been such an illuminating conversation. Jeff and I have like another two hours’ worth of questions for you. But we so appreciate your time today.

Kitces: Absolutely my pleasure. Appreciate the opportunity to share. Thank you.

Benz: Thank you for joining us on The Long View. If you could, please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

You can follow us on Twitter @Christine_Benz.

Ptak: And @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)

Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.

We’d like to share more about how we work and what drives our day-to-day business.

We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.

How we use your information depends on the product and service that you use and your relationship with us. We may use it to:

To learn more about how we handle and protect your data, visit our privacy center.

Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.

To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.

Read our editorial policy to learn more about our process.

© Copyright 2022 Morningstar, Inc. All rights reserved. Dow Jones Industrial Average, S&P 500, Nasdaq, and Morningstar Index (Market Barometer) quotes are real-time. This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

Terms and Conditions Privacy Center Disclosures Member User Agreement Corrections Cookies Accessibility