The Law of Unintended Consequences

Andrew Rosenberger, CFA, Brinker Capital

History is littered with examples of “unintended consequences” – a term referring to the fact that decision makers (and more importantly, policymakers) tend to make decisions that later have unforeseen outcomes.  I was reminded of such a fact this weekend as my wife and I launched into our annual (and seemingly unending) springtime yard cleanup.   In addition to the mulching, planting, trimming, and other routine undertakings associated with yard maintenance, every year, we spend more time and money than I care to admit trying to rid our yard of the dreaded English Ivy.  As any other homeowner with a similar problem can sympathize with, there is no amount of weed killer, weed-whacking or online product remedies that seem to tackle the problem.  Our English Ivy problem is the unintended consequence of the prior homeowners’ decision to turn their yard into an “English Garden”.

On a much grander scale, unintended consequences pop up everywhere.  Most go unnoticed by the broader public.  As one such example, The Wall Street Journal recently ran an article titled “U.S. Ethanol Mandate Puts Squeeze on Oil Refiners”.  The article highlighted that consumers could see higher prices at the pump due to government enacted mandates that force refiners to purchase market-based ethanol credits.  The original idea was that increasing the amount of ethanol used in gasoline would make gasoline cleaner burning and be better for the environment.  However, since the policy was enacted, two unforeseen issues have unfolded.  First, prices for these ethanol-based credits have skyrocketed in the past few months.  The higher ethanol credit prices mean that refiners will be forced to pass along higher prices for gasoline to the end consumer.  Second, automakers are suggesting that cars and trucks aren’t well equipped to burn the new gasoline blend.  As a result, we have a policy that was intended to produce cleaner burning gasoline which ultimately turned into higher gas prices for a product which most cars aren’t able to use.

The reality is that the vast majority of consumers will never be informed of policy misstep.  Only industry experts and select individuals with knowledge of the matter will truly understand the costs involved.  Sometimes; however, unintended consequences have a much more visible impact on the broader economy.  That’s been the case over the past two weeks as policymakers have tried to tackle the banking problems in Cyprus.  If we rewind to last year, Greece was the conversation of topic.  Ultimately, policymakers decided that private sector bond holders should bear the brunt of the losses on Greek debt.  Fast forward to today and we have insolvent Cyprus banks.  Why?  Because Cyprus banks, which were one of the largest holders of Greek debt, were forced to write-down their assets.  So while at the time the policy of having private sector investors take the loss on Greek debt seemed like a good idea, ultimately the unintended consequence was that it would later result in Cyprus banks becoming woefully undercapitalized.

The European Union’s response to the Cyprus banking issue was subsequently just as perplexing.  As initially proposed, depositors, regardless of their size, would be taxed to cover the insolvency of the local banks.  Ultimately, while the policy was later reversed to preserve deposits below €100,000, the sanctity of small deposits suddenly disappeared.  Most market pundits will agree that Cyprus is too small and irrelevant in the grand scheme of things to bring down the European economy.  I worry, however, that the unintended consequence of Europe’s policy response will make depositors in other peripheral countries a bit more anxious when it comes to where they store their money for safekeeping.  After all, one of the tenants within economics is that if two investments have equal return, investors will choose the one with lesser risk.  With interest rates near 0% across the developed world, wouldn’t it make the most sense for depositors to store their wealth in a place with little chance of future default?  While we often like to believe that these matters are completely thought through and weighed carefully by policymakers, unfortunately, this most recent policy decision appears to driven more for domestic political purposes as opposed to European “Union” driven.

Increase Quality and Quantity of Referrals with Trigger Questions

By Sue Bergin

With 70% of new clients coming from referrals, one could assume that successful advisors have mastered the art of tapping into client contacts.[1]  A new study sheds light on how advisors might get even better at this practice.

Recently, researchers set out to test the theory that the average American knew 290 people.[2]  Instead of asking survey participants how many people they knew, the researchers asked trigger questions.  They prompted participants with specific names. Participants were asked how many Kevin’s or Karen’s or Keith’s or Brenda’s that they knew.

Researchers then extrapolated Social Security data on the percentage of the population with those names.  They concluded that the average person knows 600 people, not the previously assumed 290.

This study is instructive on how to get better results when asking for referrals.
Rather than ask a client if there is anyone that they know who could benefit from your service, prompt clients to focus on as narrowly defined groups as possible.  As Bill Cates advises in his book Get More Referrals Now!, when asking for referrals you should suggest names and categories and use trigger questions.  An example of a trigger question is “What other small business owners do you know who are contemplating retirement in the next five years?”  Well-formulated trigger questions lead clients down a path that could increase both the quantity and quality of referrals you receive.

---

[1] http://www.clientwise.com/Blog/bid/72694/An-Untapped-Source-for-Financial-Advisor-Referrals

[2] Segregation in Social Networks Based on Acquaintanceship and Trust, Thomas A. DiPrete, Andrew Gelman, Tyler McCormick, Julien Teitler, and Tian Zheng, 2011

Your Personal Iceberg: There is More to Measuring Success Than What Lies on the Surface

Jordan Wallens, Regional Director, Retirement Plan Services

This is part two of a two-part blog series.

Next time you catch yourself bemoaning a down day in the stock market, calmly ask yourself, “Did I need the money today?” Benchmarking yourself against daily fluctuations is like looking outside and wondering why that tree in your yard doesn’t look any taller today than it did yesterday.

All of this is not to suggest that you shouldn’t seek help – you should. Simply put, having two sets of eyes and experience on the bridge is always better than one. You’ll fare far better at the essential behavioral art of saving yourself from your base instinct to Buy High and Sell Low, by retaining a seasoned financial advisor to walk beside you and talk you down from the ledge of your litany of poorly-timed short-sighted misbegotten past investment decisions.

The key is to once and for all truly personalize your benchmarks, rather than sweat the screeching heads on CNBC, aka Nickelodeon for adults. Better to diligently establish and maintain your own benchmarks, chart your progress, toward your concrete unchanging goals, including past progress, not just fleeting future predictions.

Suppose for example you already have a plan in place to save for retirement. What percentage of annual portfolio growth did you assume? 7%? And how much longer do you expect to work? Well how did you do last year? Forgot already? Too bad, especially if say you earned 12%. Why? Because the good news is, that properly harnessed, last year’s out-performance could very well result in meeting your goals a year earlier than planned. Congratulations, you’re money and you didn’t even know it. (Industry should’ve told you so.) My guess is that rather than properly recognizing, accounting for, and adjusting your risk, you’ve probably already moved on to, “So what’s the best stock to own this year?”

Whenever someone touts a fresh baked personal stock pick, I have a pat response for that too. I ask the inquirer what was the top performing stock last year. For the record, in 2012 that would be homebuilder PulteGroup, yet not a single putative stockpicker polled has answered it correctly. This they rarely relish either. So let me get this straight, if you can’t figure out what was the top stock in the past, do you really think you’ve got edge on what’ll outperform the pack in the future? Sorry, ya don’t. But the best news is, it just doesn’t matter.

Get help, it’s never too late. Start early, and you couldn’t screw it up if you tried. Start too late, and there’s nothing Cramer or anyone can do to help. Rehabilitate your investor behavior. Assess via readily available online tools your personal risk tolerance. Establish and zealously maintain your personal benchmark, un-phased by the chattering masses.

Quit obsessing over schizophrenic ever-changing variables that are outside your control, beyond your comprehension, and have nothing to do with your steady consistent lifelong goals. Ignore the reports of others’ flashy investment performance, and instead manage your personal investor behavior, to achieve the glide path, experience, and inalienable progress toward the life of your dreams. You’ll find you arrive at the station on time and intact, and best of all, without ever disembarking from your righteous path at the least opportune moments.

Another wise fellow declared, “Be the change you hope to see in the world.” But in this instance, ’tis far wiser to simply “Stay the same you want to see from the world.”

Trouble in the Mediterranean

Joe Preisser, Investment Strategist, Brinker Capital

Blue-chip stocks listed in the United States stumbled on their quest to reclaim the historic heights they recently attained, as a renewal of concerns from the European continent served to unsettle investors. Proverbial wisdom contends that markets will climb a, “wall of worry”, and this statement has rung particularly true this year as the Dow Jones Industrial Average has marched steadily higher amid a torrent of potential pitfalls. Up until this week, market participants have largely disregarded the political gridlock ensnaring Washington, D.C. and the possibility of a resurgence of the European sovereign debt crisis, instead clamoring for risk assets, and in so doing, have driven stocks into record territory. The current rally has, however, paused for the moment with the increased possibility that Cyprus may become the first member of the Eurozone to exit the currency union, once again casting the shadow of doubt across the Mediterranean Sea and onto the sustainability of this collection of countries.

A decision rendered by leaders of the European Union last weekend—to attempt to impose a tax on bank deposits within the nation of Cyprus in exchange for the release of rescue funds the country desperately needs—sent tremors through global financial markets. Although the Cypriot population stands at slightly more than one million citizens, making it one of the smallest countries in the Eurozone, the repercussions of this decision were felt across continents. Policy makers representing the nations of their monetary union hastily gathered to decide what conditions would need to be met in order to disperse the necessary financial aid to Cyprus, totaling ten billion euros, and in so doing, made a significant policy error. According to The New York Times on March 19, “Under the terms of Cyprus’ bailout, the government must raise 5.8 billion euros by levying a one-time tax of 9.9 percent on depositors with balances of more than 100,000 euros. Those with balances below that threshold would pay 6.75 percent, an asset tax that would still hit pensioners and the lowest -income earners hard.” Although the intentions of the European leaders making this decision were to target large foreign depositors, who have historically used the country’s banks as a tax haven, the proposed inclusion of those on the lower end of the spectrum has created widespread uncertainty.

The imposition of a tax on deposits that would include those of 100,000 euros and less, which had been guaranteed by insurance provided by the European Union, has created concerns over the stability of the banking system in Cyprus and by extension, that of the Eurozone in its entirety. By negating the very guarantee that had been put in place to strengthen this vital portion of the Eurozone’s financial system, policy makers have increased the risk that large scale withdrawals will be taken across Cyprus, which is exactly the type of situation they had hoped to avoid. The New York Times quoted Andreas Andreou, a 26-year-old employee of a Cypriot trading company, who gave voice to the feelings of the populace when he said, “How can I trust any bank in the Eurozone after this decision? I’m lifting all my deposits as soon as the banks open. I’d rather put the money in my mattress.” In order to forestall such an event, and protect against the possibility of contagion to the other heavily indebted members of the currency union, the country’s banks have been shuttered and are scheduled to remain so until Tuesday.

Uncertainty continues to swirl in the warm Mediterranean air as the Cypriot Parliament on Wednesday rejected the original terms of the bailout, casting the nation’s leaders into direct conflict with those of the European Union. With the deadline for
the country to propose a viable plan to raise the requisite 5.8 billion euros,
set by the Continent’s Central Bank for Monday, fast approaching, the stakes of
this game of brinksmanship have been raised, as the possibility of the country
leaving the euro zone has been broached. Eric Dor, a French economist who is the head of research at the Iéseg School of Management in Lille, France offered his opinion on the rationale of Europe’s leaders in The New York Times on Thursday, “They are saying we can take the risk of pushing Cyprus out of the Eurozone, and that Europe can take the losses without going broke.” Although the raising of the possibility of Cyprus being expelled from the monetary union, is most likely a negotiating tactic designed to goad Cypriot leaders into adopting the reforms the E.U. has deemed necessary, with the more likely outcome of a compromise being reached, the current impasse serves as a reminder of the difficulties facing the Continent as it continues its unprecedented experiment in democracy.

New Ideas for Growth

@BevFlaxington, The Collaborative

Finding creative ways to continue to grow an advisory business isn’t always easy. We asked advisors all over the country what some of the more interesting ideas are for marketing and business building. This blog is devoted to those advisors who are thinking outside of the box and trying new ideas.

Leveraging Social Media
In Greenwood Village, CO, Kelly O’Connor and her team researched the power of video. They realized they already had great information and material to share, so they produced short video commentaries. They have posted these on Facebook, LinkedIn, Twitter, YouTube, and the like. Clients, prospects, and centers of influence, forward these clips to others. Kelly says they’ve found that while people may not read a report or a white paper, they’ll watch a brief video if a friend forwards it and asks them to!

Loving What you Do – and Sharing it!
Sarah Wilson, CGA and CFP of T.E. Wealth in Calgary, Alberta, says that she enjoys financial planning so much that she feels compelled to talk to others “about their lives, goals, and financial aspirations.” She claims she is naturally “nosy,” but the truth is that advisors who are truly interested in others and take the time to talk, listen, and learn, even when a sale may not be imminent, are often open to opportunities that other advisors may miss.

Finding Outside Resources
Safe Harbor Asset Management in Huntington, NY, has expanded their client base by doing everything from purchasing leads from specialized marketing companies to sponsoring seminars. They have had success using a service provided by Platinum Advisory Marketing Services, which creates a weekly market update for their clients that can be forwarded to a friend to join the mailing list and receive the same update.  John Boyd, an attorney, launched a site called MeetingWave.com that helps professional service practitioners arrange targeted networking meetings with the type of people desired as invitees. You can arrange coffee, lunch, or general networking via email.  Jennifer Dziubeck of Kel & Partners in Boston shared information about their firm – GiftsonTime.com, a free web-based tool that enables financial advisors to select and schedule clients’ gifts. This system allows you to put in a year’s worth of events, and with one click, find a vendor or gift that is appropriate for your client base.

Niche Marketing
Kristin Harad, founder of the VitaVie Financial Planning firm in California, targets new parents and families with young children in the Bay area. Because it can be challenging for parents of younger children to get out to a meeting, Kristin’s firm has created “weekend workshops at indoor play spaces.” She says, “The kids have a great time jumping around and having unsupervised play, while we get the parents’ undivided attention for a 90-minute presentation on the financial issues parents of young children face.” At a financial planning firm in Beverly Hills, Ara Oghoorian, CFA, has created marketing materials such as promotional prescription vials filled with jelly beans – the Rx sticker includes their logo and contact information. It’s a fun way to say, “We know our niche!” They also belong to ProVisors – a networking group consisting of CEO and high-level executives. Because they are speaking to the medical community, they spend time contacting medical associations and getting articles published in their newsletters on topics related to retirement, financial planning, and concerns that may resonate with medical professionals.

Try One On
What can your firm do that’s a little different to gain the attention of investors in a crowded market?

Gain Access and Build Trust

Sue Bergin

A training manual from a decade ago may have highlighted the importance of mapping your traits to one of three communication styles: aggressive, passive or assertive. Awareness of your own communication style helps you understand how others perceive your interactions, and allows you to adapt your approach with clients who have different styles.

While the advice is still relevant, there is another communication style to consider—mobile.

The mobile communicator believes in access. He or she should be accessible to clients 24/7, and vice versa.

Advisors with a more aggressive communication style should be able to alter their style when working with passive clients, but they must also demonstrate flexibility to move across the mobility spectrum.

Spectrem Group recently reported that 55% of high-net-worth clients use mobile devices to correspond with their advisors.[1]  Most mobile devices offer a variety of communication methods including telephone calls, text messages, e-mails, video chats, and social networking.  How do you know which is the best to use with which clients?

The answer is quite simple. Don’t make assumptions. Find out if the clients want their appointments confirmed via text, e-mail or a phone call. Do they want newsletters and routine correspondence delivered in their mailbox at home, or their inbox? Would they prefer Skype sessions in lieu of face-to-face meetings? Is the landline number you have on file in service, or are they exclusively mobile users?

Adjusting to your clients’ communication method of choice will win you favor in a highly valued category. According to a recent survey, clients are more forgiving of poor investment advice from their advisor than they are of poor communication skills.

25% of the survey respondents indicated inaccessibility and unresponsiveness as the top reasons for lack of trust in a financial advisor. Coming in a distant second, at 13%, was poor investment advice. The third most prevalent reason for losing trust in a financial advisor was the lack of a personalized approach.

As with behavioral nuance, you must learn to respect other styles and adjust accordingly. By using your clients’ preferred communication methods, you will gain efficiency and build trust.

---

[1] http://www.spectrem.com/news/ultra-high-net-worth-investors-are-mobile-bankers-540

Your Personal Iceberg: There is More to Measuring Success Than What Lies on the Surface

Jordan Wallens, Regional Director, Retirement Plan Services

This is part one of a two-part blog series.

As a financial professional, I’m often asked what equity markets will do next. My response never changes: “It will fluctuate”. This truth they do not relish.

A wise man once declared that the beauty of an iceberg lies in the fact that it is 8/9 submerged. Yet when it comes to our investments, we too often make ill-advised decisions driven by passing metrics, subjective outlooks, weather, inputs, and theories that concern only the 1/9 of our personal iceberg showing above the water’s surface. The true tale of the tape for all of us will ultimately be measured not by those investment results, but by our own investor behavior, which accounts for the 8/9 of the iceberg that wise man spoke of. We fret and posture over raindrops when we should in fact, focus on our vessel and navigating the ocean beneath us.

According to a recent nationwide advertising campaign conducted by a prominent global financial services firm, we, as investors, are surrounded on all sides and ever beset by a constantly changing system of confusing and complex variable equations. Whoa, really? Getting anxious? Good, that’s what they intended.

Deep breath and relax. This is but a typical modern example of the financial industrial complex’s fundamental mistruth laid bare by author Michael Lewis, who pointed out that the reason financial types speak in such stilted esoteric jargon, is to constantly remind individual investors that they should never ever consider trying to do this stuff for themselves. They tout “custom strategic solutions” yet sow widespread tactical bewilderment.

And besides, nothing could be further from the truth. Though the eddies of Finance, Economics, and Mathematics may swirl around all of us, the one and only equation that does not change is the “you” part. Your personal benchmark isn’t the S&P500, unless you trade at a 14 P/E and aspire to be one of America’s 500 largest companies. No, your personal benchmarks, like progress toward retirement, college funding, security, vacation home, trip around the world, or whatever you aspire to, are far more static than media barkers would have you believe—which is a good thing (for you, not them).

Worse, this type of indiscrete industry mongering exerts a deleterious effect on individuals’ resolve to do something, anything, to embark upon preparing for retirement, or at least take proper control of their financial future. So what can be done? The good news is things are not nearly as complicated as industry “Chicken Littles” would have you fear. Salvation begins with divorcing the benchmark, and eliminating that pesky habit of gauging your progress by how any given index performs today, this month, this quarter.

Look for Part Two of this blog next week!

Housing Market a Reason for Optimism

@AmyMagnotta, CFA, Brinker Capital

After detracting from economic growth for a number of years, the U.S. housing market is in a position to be a positive contributor to growth.  The supply and demand dynamics in the housing market are attractive.

Supply is at low levels.  According to the National Association of Realtors, the supply of available homes is currently 4.2 months, down from over 12 months at the worst of the market.  New housing starts have improved, but are still at levels last seen in the early 1990s.  There are also fewer foreclosed properties on the market. CoreLogic reported that 1.2 million properties were in some stage of foreclosure in January, a 21% year-over-year decrease.  Finally, investors (both individual and institutional) have been snapping up properties in previously distressed markets.

Source: FactSet, National Association of Realtors

Some owners are waiting for higher prices to put their homes on the market.  However, prices are firming by a number of measures.  The S&P/Case-Shiller National Home Price Index gained +7.3% in 2012.  CoreLogic’s Home Price Index gained +9.7% year over year in January, the eleventh consecutive monthly increase.
Tighter levels of inventory have likely led to higher prices in recent months.  However, rising prices will eventually encourage homeowners to sell and builders to build, adding to inventory and thereby slowing the rise in prices.

Source: FactSet, U.S. Census Bureau

The demand side of the equation is also positive.  There is pent-up demand for new housing that has built up over the last few years as households have been formed.  Additional job growth will create more demand.  Affordability is still at very high levels with interest rates at record low levels.  If interest rates start to move higher, it could be a trigger for fence sitters to move. Guidelines are strict for obtaining a loan (I can attest to this with my personal experience over the last month), but credit is being extended.

The constructive dynamics in the housing market should be a positive for the economy over the intermediate term.  There are additional benefits to the economy that stem from an improvement in housing – consumers spend on appliances, home improvement (I’ve visited Home Depot or Lowes every other day in the last few weeks), contractors, architects, etc.  In addition, stable and rising home prices will also serve as a boost to consumer net worth and confidence.

Sequestration Begins

@AmyMagnotta, CFA, Brinker Capital

Sequestration, the automatic spending cuts that were agreed to as part of the debt ceiling compromise in the summer of 2011, came into effect on Friday, March 1. The Budget Control Act of 2011 established the bi-partisan “super committee” to produce deficit reduction legislation. As incentive for the super committee to agree to deficit reduction legislation, if Congress failed to act than the across the board spending cuts (sequestration), totaling $1.2 trillion over 10 years, would come into effect on January 2, 2013. The start date was delayed two months as part of the fiscal cliff deal. The cuts are split 50/50 between defense (which was supposed to get the Republicans to act) and domestic discretionary spending (which was supposed to get the Democrats to act).

As expected, Congress and the Administration have not been able to agree on serious deficit reduction so we now face the automatic budget cuts. The public does not seem to be as focused on sequestration as they were on the fiscal cliff. In a recent poll from The Hill, only 36% of likely voters know what the sequester is. The spending cuts are broad based, as the chart below from Strategas Research Partners shows; however, it will take some time for the cuts to come into effect.

Source: Strategas Research Partners, LLC

The drag on GDP growth from the sequester is estimated to be around -0.5% this year. This is not enough drag to push us into a recession if consensus estimates for 2013 growth are correct at 2-2.5%, but the effect is not negligible. The largest hit to GDP growth will likely be in the second quarter once a majority of the spending cuts have begun to take effect. If and when voters begin to feel the impact, there may be pressure on Washington to delay or eliminate the cuts.

We also face the expiration of the continuing resolution that funds the government on March 27, which, if not addressed, could result in a government shutdown. This could be a catalyst for another short-term fix. As typical in politics, whichever party is shouldering the most blame will be more likely to compromise to get a deal done.

The idea of real tax and entitlement reform that promotes growth and puts us on a long-term, sustainable fiscal path seems highly unlikely in this environment. Our elected leaders appear to lack the tenacity to make tough decisions. Sadly, kicking the can down the road is the path of least resistance and often the one that leads to reelection.

Bottom line: Fiscal policy in the U.S. will remain a risk throughout 2013. The spending cuts from the sequester alone are not enough to derail the economic recovery. However, tepid growth is likely to persist, especially in the first half of the year, as disposable incomes have fallen due to the expiration of the payroll tax cut. An accommodative Fed and an improving housing market are positives for growth.

Question Framing and its Role in Retirement Planning

Sue Bergin

Many advisors attribute their success to their ability to listen and to ask the right questions.  Knowing the questions to ask, and when and how to ask them, are at the heart of the retirement planning and relationship building process.

When helping a client prepare for retirement, for example, you probably ask clients when they plan to retire and how long they think they are going to live.  You may not have realized this, but the way the question is framed impacts the answer.

John W. Payne of Duke University, recently found that people would give significantly different answers about their longevity depending upon how the question is asked.

Payne’s study participants gave themselves a 55% chance of living beyond age 85.  When the question was framed differently, their answers were far more pessimistic.  Study participants gave themselves a 68% chance of dying by the age 85, which translates to only 32% chance of living to age 85.[1]

In her Harvard Business Review Blog, “How to Frame a Question for Maximum Impact,” Melissa Reffoni suggests that we think about the metaphor behind the concept of question framing.

“A frame focuses attention on the painting it surrounds. Different frames draw out different aspects of the work. Putting a painting in a red frame brings out the red in the work; putting the same painting in a blue frame brings out the blue. How someone frames an issue influences how others see it and focuses their attention on particular aspects of it.”[2]

By framing the question in the, “what age will you live to” context, you bring clarity to the retirement planning task.  Their attention is focused on life post-work, not when they are going to die.

---

[1] Source: Life expectancy as a constructed belief: Evidence of a live-to or die-by framing effect

[2] http://blogs.hbr.org/hmu/2009/04/leaders-frame-your-messages-fo.html