I’ve talked about related topics before (most recently in Signs of a High-Quality Advisor), but I want to come at this from a different angle.

This will start with substance and end with marketing. Both are important, I think.

First, I was thinking about what attributes a high-quality (by which I mean they do an excellent job) financial planning/wealth management firm must have. I think there are three:

1. Technical excellence (including good judgement) – more than the CFP^® body of knowledge (which is just entry level)
2. Extremely caring – either caring about doing a good job, or caring about the clients personally, or (even better) both
3. Operational excellence – ability to get things done in a timely and error-free manner

Let me explain those a little further. If any one of those items is missing, the quality is a fail. For example, suppose the question is whether a client should do a Roth conversion or not (and how much):

1. An advisor/firm cares about the clients and can fill out conversion paperwork perfectly, but doesn’t know when a Roth conversion would be appropriate (technical issue) or assumes a liberal is going to win the next election and double tax rates so recommends converting 100% this year even though it puts the client into a much higher tax bracket (judgement issue) – FAIL for lack of technical competence.
2. An advisor/firm knows exactly what should be done and is capable of doing it perfectly, but it seems like a lot of work and the client won’t know, so blows it off – FAIL for lack of caring.
3. An advisor/firm knows exactly what should be done and cares about doing it, but is so disorganized the paperwork got misplaced, and then it turns out it was filled out wrong, and they forgot they would need a signature, and then it was the next calendar year so they missed a conversion opportunity at lower rates – FAIL for lack of operational competence.

The intersection of all three areas in the Venn diagram is the sweet spot.

Second, let me come to the marketing portion of this. In biology there is a concept of signaling. You can be very fit, but your genetic survival won’t be very good if no one knows you are fit. In other words, you can be a self-made multi-millionaire (economic fitness), but if everyone thinks you are broke you still might not have a boyfriend/girlfriend (and your genes don’t get propagated) unless you have some credible way of signaling your wealth. (I’m not suggesting that net worth is the only or even best definition of fitness, it’s just an easy example to use.)

A problem is that people fake fitness. For example, keeping with our economic example, they buy counterfeit name brands, ape a lifestyle they actually can’t afford (hello, fake Instagram life). So what signals fitness are things that are very easy for fit (in whatever domain) folks to do but very difficult for others to do. For example, if someone is very smart, then getting advanced degrees is easy (well, easier) than for someone who is dumb. So a graduate degree from an Ivy is a very good indicator of intelligence. An unintelligent person can’t fake that signal.

Let’s take this to the advisory realm. I’ve known advisors, as I’m sure you have as well, who talked a great game on the three items above. They could spout MPT terminology (but didn’t actually know what they were talking about), talked about how much they cared for their clients (but called them muppets behind their backs), and tried to look like they were very organized (but really weren’t).

So what credible (hard to fake) fitness signals on these three areas can we send to help clients recognize our excellence? In other words, items that are relatively easy for those with the actual skills, but difficult for others to fake:

1. Technical signals:
   1. Quality credentials (CFP, CFA, etc.)
   2. Writing analysis on a blog or newsletter (original, not purchased, content)
   3. Speaking to professional groups (not dinner seminars of lay people)
2. Caring signals:
   1. Frequent and meaningful conversations with clients (if you really don’t care about them this is hard to do over extended periods of time)
   2. Remembering details about their lives (CRM can help fake this to some extent, but going deeper than just knowing the children’s names is a credible signal)
   3. Sending thoughtful gifts or notes at opportune times (if you care then you both know what is going on with them and what would be meaningful to them)
3. Operational signals:
   1. Error-free paperwork
   2. Fast responses to phone calls and emails
   3. Timely reminders to do RMDs, conversions, retirement plan contributions, etc.
   4. Consistent follow-ups (friendly nags) to complete estate planning, get insurance coverage, change employee benefit elections, etc.

We are blessed at our firm that while we all care about each area and have multiple competencies, we have one person who really excels in each domain. (As I’m sure you would guess, I’m technical, Anitha is caring, Kaitlyn is operational. That doesn’t mean that Kaitlyn and I don’t care, or that Anitha isn’t technically competent, etc. but we each stand out in our strengths.)

Purchasing life insurance on a child is almost always foolish.  It might feel like the “responsible” thing to do, but the responsible thing it to carry appropriate life insurance (and disability insurance) on the child’s parents (or whoever is financially supporting the child).

Here is the math:

The highest odds of death, from ages 1 (after infant mortality risk has passed) to 18, is for a 1 year old male and the chance of death (all mortality figures from the RP-2014 tables) is 0.00041 or 1 in 2,439. The lowest is a 10-year-old boy with a chance of death of 0.000072 or 1 in 13,889.

So, the value of the insurance itself for a juvenile, while they are a juvenile, is the death benefit divided by somewhere between 2,439 and 13,889. In other words, if the death benefit is $20k (just to have an arbitrary number to work with) then the true cost of insurance is just $1.44 to $8.20 per year! So the vast majority of the annual premiums are just overhead. In fact, the value of the death benefit is so low, you can ignore it as immaterial and just do a straight time value of money calculation. What is the guaranteed cash value (FV) in year N for an annual premium of PMT (PV is zero)? It’s an annuity due (premiums collected up front), solve for I. I suspect it will be a negative number which means on average you would do better to just put the money in a sock drawer.

Let me do it another way. If you took out a policy for a child age 1 and held it until age 18 and it had a death benefit of $20,000 (sticking with my earlier arbitrary choice) then the total cost of insurance for the whole period is just $61.24 for a boy and $46.70 for a girl. If you have all the rest of the premiums paid in available as cash value at 18 then you still earned zero rate of return. (And I would be shocked if the cash value was that high.)

Don’t buy life insurance on children.  Fund a Coverdell or 529 plan for them instead.

My latest quarterly ramblings to my Financial Professionals list are out: Financial Professionals Fall 2020

We all go through four stages of competence as we learn something new:

1. Unconscious Incompetence – we don’t know enough to even know we are incompetent (Dunning Kruger Effect)
2. Conscious Incompetence – we know enough to recognize our incompetence (Socrates: “The only thing I know is that I know nothing.”)
3. Conscious Competence – we know we are competent, but we realize how difficult it is to be so
4. Unconscious Competence – we are competent, and can’t imagine how someone could remain incompetent when it is so simple

So how does this apply to investing? I think people go through the same four stages (if they progress):

1. “Investing is easy – just buy the investments that are obviously going to go up.” (And, as Will Rogers said after the 1929 crash, “if they don’t go up, don’t buy them.”)
2. “Investing is hard – I have no idea what is going to go up.”
3. “Investing is hard – I’ll just buy everything (index).”
4. “Investing is easy – why doesn’t everyone see the obvious, that due to the arithmetic of active management they would be better off if they just indexed?”

(There are higher levels of investment expertise than this for professionals, but I’m thinking of the investment approach of an individual investor without professional help.)

You may have heard of the strategy of “bunching” charitable contributions.  This is a tax optimization strategy for folks who are charitably inclined, but who might not itemize other than that (or even despite that). Obviously, the new tax law makes the strategy applicable to a much larger number of people. For example, suppose someone is MFJ with no mortgage. Other than their $10k of SALT (State And Local Taxes) they may well have no itemized deductions other than whatever charitable gifts they make – and if those gifts are less than $14k  each year (plus inflation to the $24k standard deduction limit, but I’m going to keep this simple and just use a limit of $24k) they will get no tax deduction for them. Suppose they regularly donate $10k/year to their place of worship – would it make sense (perhaps using a DAF as a holding vehicle) to donate $20k every second year (getting a $6k deduction)? $30k every third year (getting a $16k deduction)?

I was curious how many years should be bunched. I think it is a function of the following:

1. How much the taxpayer “normally” gives.
2. Their marginal tax bracket.
3. Their discount rate (they must come up with more cash initially to do the strategy).
4. How far they are from itemizing (if they would itemize even without the charitable contribution they needn’t – and shouldn’t – bunch).

Here is a spreadsheet which shows the NPV of the strategy for various levels of bunching and discount rates.

Yellow cells are the inputs. Discount rates are after-tax so think munis, not t-bills, for rates.

Using my previous example, with a 30% marginal tax bracket, and a 5% discount rate (which I think might be high), the taxpayer should do charitable contributions 8 years ($80k) at a time.

Other considerations and issues:

1. Less wealthy charitably-inclined clients tend (I think) to look at it in terms of dollars/year, as in, “I give (or want to give) $X/year to Y charity.” More wealthy clients may think of donations of large lump sums periodically. This calculator is more applicable to the less wealthy.

2. There is of course uncertainty as to future tax rates which is virtually impossible to handicap, but I think the risk goes both ways. Marginal rates could go up, marginal rates (not taxes maybe, but rates) could go down (perhaps in conjunction with a VAT for example). A few years ago who would have predicted the lower tax rates that now exist?! (English really needs an interrobang.) Of course the client’s situation can vary too so this is very similar to figure out whether and how much of a Roth conversion to do.

3. I’m not sure at this point what discount rate is “right” but it is an interesting question. Let me generalize a little bit which may make it clearer. I think it might be easier to think about an expense other than charitable giving. A client can prepay an expense. The expense is not large relative to their net worth. For example, a gym membership where you can pay annually (less) or monthly (cumulatively more). What is the cost of capital that should be used to figure out whether to do it or not? I can think of four possibilities plus four possible adjustments/other factors.

2. 1. Hurdle Rates:
   1. 1. The return on their checking or savings account because they now carry a lower balance.
      2. The return on a short-term bond fund because it is short-term “investment.”
      3. The HELOC rate because they now carry a higher balance.
      4. The expected return on their portfolio – i.e. what their 60/40 is expected to do. I don’t think this is right because the risk is different, but it is a possibility and would be analogous to the WACC for a company I suppose.

3. 2. Adjustments/Other Factors:
   1. 1. Convenience – I might prefer to pay the gym annually rather than monthly to simplify my checkbook balancing or avoid potential late fees if I forget (online banking may have made this issue largely moot).
      2. Optionality – I might prefer not to pay the gym annually because I might change my mind or want to go to a different gym. On the other hand, in this specific example, I might want to incent myself to go – it’s the sunk cost fallacy, but it seems to work for many folks. So the optionality value could conceivable be negative.
      3. Risk – I might prefer not to pay the gym annually because I might get injured, move, etc. so it could be wasted.
      4. Forced saving – I might prefer my checking/savings balance look lower, so I don’t spend the money on other consumption or unwise purchases. Or discourage spouse from same.

The calculation – here is the intuition behind the spreadsheet:

1. We want the present value of the difference between donating $X every year vs. doing it in lumps when we are $D distance from itemizing. For ease of calculation let’s assume someone is:
   1. $10k from itemizing (e.g. $14k of non-charitable deductions for MFJ)
   2. they would normally give $15k/year
   3. we want to know the value of bunching 5 years
   4. with a discount rate of 5%
   5. and a marginal tax bracket of 24%
2. In year one the incremental value is:
   1. An outflow of $60k (four extra years at $15k each)
   2. An inflow due to the incremental tax deduction of $14,400 ($60k*24%)
   3. So the net cash flow in year one is an outflow of $45,600
3. In the subsequent years (4 in this case) the value is:
   1. An “inflow” (really just less expense) of the $15k they aren’t donating
   2. An “outflow” of $1,200 (the $5k they would have been over the standard deduction at a 24% tax rate)
   3. So the net cash flow in subsequent years is an inflow of $13,800 (again it’s really a lower expense, but that is the same as an inflow to the household)
   4. The PV of a payment of $13,800 for four years at 5% is $48,934 [=PV(0.05,4,13800) in Excel]
4. $48,934 minus $45,600 is $3,334. I.e. the present value of bunching in this case is $3,334.

A related question is whether a taxpayer should use a Qualified Charitable Distribution (QCD) vs. Donation of Appreciated Securities (DAS).  Assuming the taxpayer has the choice of either (i.e. they are over 70½ and have securities with long-term capital gains) here is my analysis of the optimal choice:

1. Does the taxpayer itemize?
   1. No, not even with the prospective DAS → QCD
   2. Yes, or only with the prospective DAS → go to next question
2. Is the taxpayer’s LTCG rate greater than 0% (including through a future step-up)?
   1. No → QCD
   2. Yes → go to next question
3. Is the taxpayer subject to SS or other phaseouts?
   1. No → DAS
   2. Yes → uncertain (you have to run the numbers)