Since the onset of the economic crisis last fall, many CPAs who are personal financial planning specialists have been working overtime to reassure clients overwhelmed with fear about the future and safety of their investments and to reassess and reorient investment portfolios when necessary. Members of the AICPA’s Personal Financial Planning (PFP) Section recently reflected on their experiences from the past year and their outlook for the future. Lyle Benson, a member of the AICPA’s PFP Section for 20 years, moderated the discussion on behalf of the JofA. Here are some excerpts from that gathering:
COMMUNICATE WITH CLIENTS
JofA: When the economy took a downturn, what was the reaction of your clients? What steps did you take to work with them through the turbulent market?
Jerry Love: I strongly emphasized the overstatement of the state of the economy by the mainstream news media and my firm belief in the existence of underlying economic principles that would prevent the country from going into another Great Depression. When I reminded my clients in West Texas of what we experienced during the late ’80s—an oil and gas industry crash, along with a major collapse of commercial real estate and the almost complete disappearance of the savings and loan industry causing many community banks to fail and resulting in double-digit unemployment and a major contraction of the available lending options, most would say, “You’re right. It can be very bad and still recover.”
Michael Goodman: We spent a lot of time reaching out to clients during this period, taking the focus off what was happening “today” in their portfolios and putting it back on their original goals and the time frame for when they actually need money and where the markets will be when they likely need their funds, whether it’s seven, 10, 20 or 30 years out.
Beth Gamel: People were really worried that they were going to run out of money and not have enough to provide for themselves. Because people were so agitated, it was important to have more frequent meetings, phone calls, and e-mail exchanges with clients because they needed a lot of handholding and to know that you were available to them and that you were listening.
Scott Sprinkle: We wanted to reach out to our clients in as many ways as possible to make sure they understood their investment policy statement and overall investment plan. While the market pullback was severe and the degree of the pullback unexpected, the risk had been planned for in advance. We “stress tested” the client’s portfolio, looked at asset allocations, and made sure that clients understood the construction of their portfolio. Specifically, for retired individuals, our plans recommend three to five years of living expenses allocated between cash, short-term bonds and other high-quality, low-risk assets. We reminded clients of the amount of work completed to establish their investment plan and that the plan accounted for market volatility. This provided some comfort and allowed clients to stay prudently allocated until the market rebounded. The last thing we wanted any client to do was panic and sell out at the bottom. That’s where CPAs in general do a better job than most advisers: focusing on the front end and the development of a comprehensive plan versus just buying assets. This allows clients to focus on what is important in tough times and allows them to stay disciplined in their investment approach.
RE-EDUCATE, REASSESS AND REVISE WHEN NECESSARY
JofA: Did anyone else follow this approach of stepping back and re-educating clients on their portfolios in light of market changes or in terms of their overall goals and planning? What did you do to help reorient investment portfolios in light of these times?
Gamel: In my practice, I only do financial planning and investment advisory work. In order for a client to become an investment advisory client, we have to go through an initial financial plan, which involves retirement projections and asset allocation development. Even if you’d done that within the last couple of years, many clients no longer had confidence in those numbers. One of the most important first steps was to sit down and reassess people’s risk tolerances. In many cases that meant starting with what their asset base is today and redoing those projections to see if they might be at risk of running out of money or if some tweaking of their asset allocation or their spending could give them the confidence to believe that they could manage with their current assets.
Goodman: We had our clients go through an independent score-based risk tolerance test. We sat down and discussed the reconciliation between what their risk tolerance is saying their portfolios could be and their required rate of return. For example, if their risk tolerance says they need a portfolio that’s only 40% stocks but we know that their need from a rate of return standpoint is 60% or 70% stocks, the difference has to be reconciled.
Susan Tillery: When the downturn hit, our clients did not get anxious due to our firm’s philosophy. When we initially sit down with our clients, we discuss a conservative approach: seeking the lowest rate of return with the least amount of risk (standard deviation) to be able to achieve their goals. Because this is a long-term approach, no changes were necessary in their asset allocation or portfolios. Our clients understand the purpose of their investment portfolio is not to get rich quick, or accumulate money for money’s sake. We also use software to determine a client’s risk tolerance/indifference curves.
DEVELOP A DEFENSIVE STRATEGY GOING FORWARD
JofA: If a client’s risk tolerance has changed as a result of stock market volatility, how are you advising them?
Goodman: It’s become standard in some portfolios to put aside a certain amount of a year’s cash flow for clients that are taking income aside. Such that the client could say, “For the next five years, I can see where my cash flow is coming from. So I’m not so worried about this other money I have invested for the present because I don’t need it at a minimum until year 6.” We were doing this in the past but are being more diligent about it now. Also, within the portfolio asset allocation there’s always been stocks, bonds, and “other,” which is a bucket of things like commodities and real estate that are less correlated to the movement of stocks and bonds. Now we are looking harder at trying to mix different things like structured notes into the “other” bucket in order to give clients some diversification from traditional stocks and bonds.
Sprinkle: During volatile times, diversification and understanding what you are investing in becomes even more important. We reduced client municipal bond allocations in the last quarter of 2008 due to quality concerns and looked for additional diversification and more secure asset classes. Part of the allocation was moved to well- diversified investment-grade corporate bonds, and the rewards were immense. Additionally, we analyzed cash returns. While during the meltdown, cash was the place to be, real returns were still zero, particularly after tax and inflation. We completed significant due diligence on high-quality, ultra-short funds. By increasing the duration of the investment paper from 30-day instruments to 90-day instruments, we were able to pick up 300 to 400 basis points of return. We are continuing to communicate with clients on their risk tolerance while looking for investment alternatives that further diversify their portfolio and take advantage of pricing discrepancies in the market. There are significant opportunities in many misunderstood sectors. Currently, long-term investors have an opportunity to achieve significant returns with reduced levels of risk in several market sectors and asset classes.
JofA: Some of you don’t get directly involved in managing the clients’ assets. What role do you play in the planning process?
Tillery: As part of our financial planning process, we sit down with the client and write their investment policy statement. We then meet with their investment professional to discuss the client’s asset allocation. The investment professional then brings back suggestions for each asset class with an explanation of why they’re making the suggestion. We always make sure that the portfolio has some negatively correlated assets within each asset class.
Love: Our strategy is not to manage investments, so we pair the client with a broker to help ensure that the products and the overall mix make sense for the client. I’ve seen an increase in people who have been trading and picking their own investments who are now more willing to go to an active manager. They have begun to see the value of having the funds actively managed by someone who’s got a good track record who knows how to figure out the market.
PURSUE TAX-PLANNING OPPORTUNITIES
JofA: What tax and estate planning strategies/ opportunities do CPAs need to act on with clients?
Gamel: This is where CPAs who don’t have all of the credentials or whose practice doesn’t incorporate investment planning can provide a lot of services to clients. Probably the only positive thing about last year’s market meltdown was it gave people the opportunity to make some changes or reposition their portfolio or simply take capital losses, which offset gains earned earlier in the year or provided capital loss carryforwards. The other thing is talking to clients about the gifting and valuation opportunities, where you would then use less of your unified credit or your GST (generation-skipping tax) because you’re transferring assets that have a depressed value. And while the section 7520 rate has gone up a little bit, it was really, really low, and so there were opportunities to create charitable lead trusts and GRATs (grantor retained annuity trusts) and consider other sorts of estate planning and gifting strategies. Lastly, we’re all poised to be talking to clients about Roth conversions in 2010 because of the ability to do that regardless of what your AGI is and the two years to pay the tax on the conversion. But there’s a good reason to be talking to clients who might have the ability to keep their AGI below $100,000 even this year to do a conversion with the depressed value of their portfolios.
Love: The depressed economic environment is giving an opportunity for conversion from C corporation to sub S. Just like the stock market, most businesses would have a lesser value right now for a number of factors than they might have earlier, so if you do your valuation on a C corporation and convert to a sub S, you’ve got a great window for that.
Sprinkle: When clients are panicking, it is a hard time to convince them to take advantage of historically low interest rates and estate planning techniques that should be a slam dunk to implement. Congress is currently reviewing several tried-and- true estate planning techniques that have been used successfully for years. Examples include GRATs, GRUTs (grantor retained unitrusts), SCINs (self-canceling installment notes), charitable trusts and family limited partnerships. Clients who hesitate may lose the opportunity to implement some of these techniques. It is a beneficial time for several of these techniques, and CPAs should be reviewing alternatives with clients while opportunities still exist.
SEIZE OPPORTUNITIES FOR GROWTH
JofA: These last 12 months have had a significant impact on the things CPAs are doing with their clients. Has it caused you to rethink your business models? For example, the assets under management (AUM) business model has a huge impact on revenue streams, which may have been affected by the uncertainty in the market. Is this causing you to reassess your business models going forward?
Goodman: If your firm operates under the assets under management revenue model, compensation and revenue have most likely been down. It’s been a tough period, but I have no intention of changing my model. With any business there are risks to revenue streams. While the markets are down, it is also a good opportunity to get out into the marketplace and bring in new revenue through people who are looking to potentially change advisers. One might even argue that this downturn has been a significant opportunity to grow the business, and when the markets do get back, we’ll all potentially be way ahead of where we would have been anyway.
JofA: When you’re taking a new client, there’s a lot more work done upfront especially in terms of financial planning. How does this type of work relate to your compensation model (retainer- based, AUM-based, or hourly)?
Gamel: Our firm has a variety of ways to get compensated. We have pure AUM, and those fees clearly have gone down. Fortunately, the performance of our accounts is better than the typical market, so our fees are not down as much as 30%, for example. We also have fixed fees, retainers and a few hourly clients, so our income stream hasn’t gone down nearly as much as if we were in a pure AUM environment. The bigger struggle is that we do a lot of financial planning along with investment advisory work, and yet many of our fees are strictly AUM. So there is a disconnect, where you’re doing more work than ever on the financial planning side, but your fees keep going down. The current environment presents a struggle between the amount of work you’re doing and the fees you’re getting.
Sprinkle: As a family office that provides several client services, it is very important for us to have our fee model unbundled and to separate investment management from the other projects. That is not to say that we don’t offer some free planning advice to investment clients. However, when we get involved in significant financial, estate or tax planning projects, we bill separately. Some of these projects may require hundreds of hours, and including them under an AUM model would be cost-prohibitive. All of our services are billed on a fee-only basis (AUM, hourly or a fixed fee). Additionally, we spend a significant amount of upfront time communicating and disclosing to clients how they will be billed for services. Managing client expectations and providing value for services rendered will be the key to your success. There are several fee models available for CPA firms, and it is important to analyze which model fits your firm’s practice.
JofA: What’s the outlook for the future?
Love: Because of the downturn in the economy and what’s happening in the market, people are cutting back greatly on their spending. The second quarter savings rate was 5.2% in the U.S., compared with 4.0% in the first quarter. A USA Today article indicated about 27% to 32% of people are spending less now and intending to continue saving. I think the AICPA’s financial literacy program is starting to make sense to a lot of people because they’ve had a life lesson here to make it make sense.
Tillery: There is an incredible opportunity, especially for small to medium CPA firms, to viably grow their practices through financial planning. It is time for CPAs, as the client’s trusted adviser, to merge financial planning into the process. CPAs who want to offer financial planning should become certified through the PFS credential.
Lyle K. Benson Jr. CPA/PFS, CFP, is president and founder of L.K. Benson & Co., a CPA financial planning firm based in Baltimore. He works with high-net-worth families and individuals in the areas of personal financial planning, investment advisory and tax services. He has been an active member of the AICPA PFP Section for more than 20 years and currently serves on the AICPA Advanced Personal Financial Planning Conference planning committee.
Beth C. Gamel, CPA/PFS, is co-founder and executive vice president of Pillar Financial Advisors in Waltham, Mass. She has been a financial planner for 25 years, helping wealthy individuals evaluate, coordinate and implement sophisticated investment, estate, income tax and charitable giving strategies. For seven consecutive years Worth Magazine has named her one of the “best financial advisers” in the country. From 1996 to 2001 she wrote “Money Makeovers” for The Boston Globe, which described her as one of “New England’s leading financial planners.”
Michael E. Goodman, CPA/PFS, CFP, is president of Wealthstream Advisors Inc., a wealth management firm in New York. He is also a member of the AICPA PFP Executive Committee and chair of the Advanced Personal Financial Planning Conference.
Jerry Love, CPA/ABV/PFS/CFF, CVA, CFP, is the president and CEO of Davis Kinard & Co. PC, which is the largest CPA firm in Abilene, Texas. In 2006–07, he was chairman of the Texas Society of CPAs (TSCPA). He received the TSCPA “Distinguished Public Service Award” in 2000. CPA Magazine named him one of the Top 100 Most Influential Practitioners in the country for 2006, and in May 2009 the magazine named him one of the Top 40 CPAs to Know During a Recession.
Scott Sprinkle, CPA/PFS, CFP, is a co-founder and managing member of Sprinkle & Associates LLC and Sprinkle Financial Consultants LLC. He has more than 20 years of experience serving high-net-worth individuals and family offices. He is a member of the AICPA’s Personal Financial Planning Executive Committee and the AICPA Investment Resource Panel. He is also a trustee and board member of the Colorado Society of CPAs and an editorial adviser to the JofA.
Susan Tillery, CPA/PFS, CFP, is a fee-only comprehensive financial planner. She and her firm do not manage assets or sell products. She is president and CEO of Paraklete Financial Inc.
“CPA’s Guide to Investment Adviser Registration,” for PFP Section members. Go to tinyurl.com/lcphn9.
PFP Center and PFS credential
Membership in the Personal Financial Planning (PFP) Section provides access to specialized resources in the area of personal financial planning, including complimentary access to Forefield Advisor, a client education and communication tool. Visit the PFP Center at aicpa.org/PFP. Members with a specialization in personal financial planning may be interested in applying for the Personal Financial Specialist (PFS) credential. Information about the PFS credential is also available at aicpa.org/PFP.
PFP Practice Portal
The AICPA PFP Practice Portal, aicpa.org/PFP/PracticePortal, provides information on how to become a PFS, the regulatory requirements involved, business models, technology tools and more. Resources are available to add value to a new, existing or growing personal financial planning practice or wealth management firm. PFP practitioners will find content to assist them in better serving existing clients’ needs and to navigate through the issues faced as a PFP practitioner.
- The Economic Crisis and Recovery Center is the most comprehensive online resource for the CPA profession in this economic environment. The site has more than 200 items, providing content that addresses the concerns of every member segment. Go to economy.aicpa.org.
- The Current Market Conditions site offers resources for advising and communicating with clients during these uncertain economic times. Go to tinyurl.com/nonzyz.
- 360 Degrees of Financial Literacy is the CPA profession’s complimentary financial literacy Web site for consumers. It offers tools and tips to help your clients make business and financial decisions. Go to 360financialliteracy.org.