Financial Planning Pitfalls

Many people focus on a single indicator, such as whether they are saving enough for retirement or carrying too much student-loan debt, writes financial literacy expert Annamaria Lusardi for the WSJ’s Experts blog.  The problem with such an approach is that planning must be multifaceted to be effective.   Ms. Lusardi, the Denit Trust Chair of Economics and Accountancy at the George Washington University School of Business, writes that there is a short financial checkup to effectively predict key components of an individual’s financial health.  The six-question test, which is based on a body of national and international research, evaluates four key areas:   ability to meet expenses,  advance planning, management of finances, and financial knowledge.


At North Capital, we’ve developed a proprietary financial planning framework that is simpler in approach, but more complex and robust in results.  Dubbed the PRIM system, we believe that an effective personal financial strategy has four components:   planning, research and recommendations, implementation, and monitoring.  Planning requires more than six questions:  even the simplest plan should provide for customization and nuance, as small changes in an individual’s starting plan will have dramatic impacts later in life.  Our planning process collects factual and behavioral information to discern and quantify clients’ needs and goals.  As we have in other parts of our practice, we have applied a planning approach that is widely utilized in institutional circles:  liability-based planning.


If you think about your own future financial picture as a series of obligations and objectives, with probabilities attached to each such need or want, determining future cash flow requirements becomes a (complex but solvable) problem of financial arithmetic, probability analysis, and stress and scenario testing.   Use of probability analysis allows us to analyze shortfall risk (the probability that particular needs or goals are not met) and risk sensitivity (the probability that outcomes are affected by particular inputs).   Not surprisingly, we find that most individuals’ financial futures are affected far more by their saving and spending rates, relative to their income, than by investment performance.   A solid savings plan will endure through most adverse market scenarios, while outstanding investment scenarios cannot rescue someone from under-saving and over-spending.


The implementation and monitoring part of our four-step process, where we implement a tailored risk-based and goal-based investment strategy, is where most “robo advisor” focus their attention today.  But as one cynical advisor recently remarked to me, “there’s a lot of venture money being spent to get to 60-40,”  making fun of the tendency of most robo systems to lump clients into a “moderately aggressive” bucket with an asset allocation of 60% equities / 40% fixed income.  Our model portfolios incorporate a risk component, and our moderately aggressive portfolio is close to 60-40, but we offer a more multifaceted and broadly diversified asset allocation than most, with dozens of models designed to meet the particular needs of our clients.  For example, many advisors, and virtually every robo advisor, ignore income strategies such as preferred stocks, MLPs, BDCs, international REITs, high yield munis, and other microstrategies, although retired investors usually cite “income” as one of their primary investment objectives.   Alternative strategies, such as private lending funds and peer-to-peer lending, also are generally ignored by the advisory community, even though they may deliver extra return at the margin.


One of Ms. Lusardi’s metrics, financial knowledge, is certainly an area in which all investors and advisors should continually invest.  Even though investing is one of the world’s oldest professions, insights and innovation continue to advance our collective knowledge and wisdom.





Fund Management Fees Generally not Falling, Despite the Growth of Index Funds and ETFs

Brian Herschberg writes in the Wall Street Journal that annual fees charged by active managers are not falling as one might expect, given competitive pressures from index funds and exchange traded strategies (ETFs and ETNs).  The Journal cites Morningstar research that more funds’ annual expenses went up than down between 2015 and 2016:  fees stayed the same at 2,853 U.S. stock funds, fell at 1,607 and rose at 2,306.  Annual expenses on U.S. stock funds dropped slightly, from 0.786% in 2015 to 0.774% in 2016, according to Morningstar data.


There are many possible interpretations of this data:  it could be that a significant number of funds exited their “expense waiver” period, often adopted for a year or two at the launch of a new fund.    But the fact that expenses dropped at 1,607 funds, almost a quarter of the total surveyed, suggests that there still are competitive pressures facing active managers.


One that’s not answered in this article:  what is the average expense ratio of new funds today, compared to the average expense ratio of new funds a year ago, three years ago, or five years ago?  Conventional wisdom is that expenses must be falling;  active fund formation is declining, assets are moving out of active and into passive strategies, and the entire active segment is in retreat.   But we believe there is another market development that runs counter to this expectation:  the growth of alternative fund strategies.  We have described this process as a “hollowing out” or “barbelling” of the market.


At one end of the asset management spectrum, growth of passive investments and ETF strategies continues to outpace growth of the overall market, and the assets are coming from active managers.  Index fund market share will soon top 40%, up from 4% 20 years ago.   At the other end of the spectrum, there has been an explosion of new alternative investment products.  Private equity, managed futures, direct lending, peer-to-peer, hedge strategies….. the number of distinctive strategies is limited only by managers’ creativity and perceived ability to offer alpha.   Why perceived?  Because some of these funds are just repackaged active equity exposure.  Others take advantage of market anomalies that may be ephemeral and not enduring or persistent.  Still others offer investment exposure that may or may not represent a new source of alpha.   Many quantitative analysts, including this one,  believe that it is impossible to verifiably differentiate luck and skill among fund managers without several years of performance data.


All of this potential alpha comes at an actual price, which flows through to investors in mutual funds in the form of higher expense ratios.  These higher fees could be mitigating the general, broad downward pressure on active fees.  While we do not have any hard data to support our hypothesis (although I think this will be a project for a summer intern), we have loads of anecdotal evidence.  My best guess is that research would show that where there is asset growth, except in index strategies, expense ratios are rising.  In other words, money is flowing to index funds on one end of the barbell, and to alternative strategies at the other…. and leaving active managers in the middle.   We are investigating several of these alternative strategies ourselves, testing out investment theses with our own capital before allocating any client capital to them.  You should expect to hear more from us on this topic during the coming months.

RegTech: The Latest Startup Buzzword

RegTech: The Latest Startup Buzzword

What is RegTech?

In October 2016, International Business Machines (IBM) announced that it would acquire Promontory Financial Group, a financial consulting firm specialized in financial regulation and compliance. The financial details of the deal have not been disclosed. Through this acquisition, IBM plans to integrate Promontory’s expertise in compliance with Watson’s cognitive computing technology in order to help IBM’s financial clients reduce their compliance costs.


In the past few years, financial services companies have had a difficult time keeping up with new regulation. The annual volume of regulatory changes went up by 492% from 2008 to 2015, according to data from Thomson Reuters.1 As there are more changes in the financial services industry and the rules get more complex, the costs of compliance have risen significantly. Some of the world’s biggest banks have spent a significant amount of money on compliance (see table below).2


As compliance costs continue to be a growing burden for financial services firms, there has been a rise of companies in a new startup space dubbed “RegTech.” RegTech is a subset of FinTech and can be defined as the use of technologies to help companies comply with regulatory requirements in an efficient and effective way. The term “RegTech” came from a project called Project Innovate by the Financial Conduct Authority (FCA), the United Kingdom’s equivalent of the Securities and Exchange Commission (SEC), in October 2014. Project Innovate was launched to encourage the use of new technology in financial markets. According to the FCA Feedback Statement, in the first year Project Innovate supported 177 firms, and that number rose to 300 just eight months later.3 Following Project Innovate, in the first half of 2015, the FCA continued to explore how technology could help facilitate the compliance process in the financial markets through RegTech.


Typically, the RegTech space is segmented into three main areas:

Customer Identity Verification and Suitability

Financial services companies of various types are required to verify the identity of new customers, maintain records of the information provided by customers, and determine whether the customers appear on any list of terrorist organizations maintained by the Office of Foreign Assets Control (OFAC). In addition, FINRA Rule 2111 (Suitability) requires that broker-dealers “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security is suitable for the customer, […] to ascertain the customer’s investment profile.”4 Broker-dealers have to examine a customer’s investment objectives, investment experience, time horizon, liquidity needs, tax profile, etc. before engaging in any securities transactions. Certain types of securities offerings require specific income and/or net worth tests to qualify a customer for a particular investment, while other offerings are subject to state-specific Blue Sky laws and regulations.


Customer identity verification and suitability are two areas where RegTech can facilitate regulatory compliance. Technology allows companies to monitor transactions in real-time, better attempt to identify and flag potential money laundering (AML) activity, and quickly screen prospective customers against the OFAC and other terrorist and criminal watch lists. Algorithms developed by securities firms can help determine whether a particular security is suitable for a prospective investor. Sara Borazan, a Director-Principal at North Capital, has conducted KYC (Know-Your-Customer), AML, OFAC, and suitability checks for thousands of investors in private offerings. When asked about the impact of RegTech on her job responsibilities, Ms. Borazan explained that the technology allows for continuous checking of investors. “If someone is a repeat investor, the technology will automatically query all of the information in the investor database, and also look for any new information relevant to that person. RegTech saves me hours that I can use to focus on growing our business,” Mrs. Borazan said.

Conduct Monitoring and Risk Analysis

Under SEC rule 15C3-5 in the U.S., broker-dealers and high-frequency trading firms are required to maintain a system of risk management that sets limits on broker-dealers’ financial exposure and ensures that trading firms and broker-dealers are compliant with all regulatory requirements.5 Since business activities conducted by financial services firms are heavily regulated, it is crucial that firms maintain systems to monitor those activities in real-time and manage risks appropriately.

What Are the Benefits of RegTech?

The costs of compliance keep increasing every year, and a firm’s ability to increase its compliance budget is limited. According to a survey commissioned by Thomson Reuters Regulatory Intelligence between December 2015 and February 2016, 67% of respondents indicated that they expect the cost of senior compliance staff to rise in 2017. The major reason is that there is a shortage of professionals with strong compliance skills, and regulatory requirements are changing every year. The adoption of RegTech can help firms manage the cost of compliance by standardizing compliance processes and automating manual tasks.


As a case in point, the RegTech platform developed by North Capital and utilized by many of its customers costs about $17,000 per year, compared to the average national annual salary of $49,000 for a single KYC analyst.6 The firm’s clients have saved hundreds of thousands of dollars by utilizing RegTech. Also, financial institutions spend a lot of time tracking and analyzing new regulations. For example, 38% of financial services firms spend at least one man-day per week analyzing regulation changes, according to data by BBVA.7 Utilizing RegTech helps save valuable time that employees can use to focus on other important aspects of the business.


Lastly, financial services companies are often working with extremely large data sets, and analyzing the data sets is not a simple task. RegTech makes it easier and quicker to visualize data and identify trends or red flags.

Recent Funding Activity in RegTech

Deals in the RegTech space are on the rise. In the third quarter of 2016, there was $165M raised, the third-highest in RegTech financing history. The number of deals in the RegTech space are also increasing, from 74 deals in 2014 to 78 deals in 2015 and expected to be 89 deals by the end of 2016.8

The table below shows some of the significant RegTech financings in 2016. All data come from Crunchbase.


Challenges for RegTech Moving Forward

One of the big challenges for RegTech is data security and privacy. As mentioned earlier, financial firms deal with large volumes of data, and each time a firm collects information from a customer or investor, it is crucial that sensitive and personal information is used in a compliant manner. One area of future RegTech innovation is likely to be in software and services designed to detect and report vulnerabilities before a data breach can occur. Financial data is a big money business, and the cost of a data breach can be many millions of dollars.


Another challenge for RegTech is that the regulatory environment continues to evolve, and an investment in one RegTech solution in the current environment may not be relevant a few years later. For example, a host of companies have recently emerged to help financial advisory firms address the Department of Labor’s new fiduciary rule. However, analysts have suggested that the incoming Labor Secretary is likely to repeal the rule. Companies must remain nimble and be able to adapt to a rapidly changing regulatory landscape.


Finally, there is currently a lack of “data harmonization”9 between different countries. What it means is that regulatory framework in one country might not apply to another, and the data available for compliance checks in one country might not exist in another. As a result, for a financial services firm operating under multiple regulatory regimes, it might not be possible for RegTech to work seamlessly.

Final Thoughts

Financial firms are continually attempting to increase efficiency and cut costs. As a result, the demand for RegTech products is expected to increase moving forward. The big question is, can RegTech fully automate future compliance functions? RegTech, as of now, is capable of processing big data and identifying patterns. With that being said, compliance expertise remains a vital resource at financial services firm. These firms require qualified compliance personnel to ensure technology is functioning compliantly in the current regulatory environment.



Minh Le is an Associate at North Capital Private Securities, a registered broker-dealer focused on the marketing and distribution of private funds and securities.












The views and opinions expressed in this post are the views and opinions of the author and do not necessarily reflect those of North Capital. All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision.


This may contain forward-looking statements and projections that are based on our current beliefs and assumptions and on information currently available that we believe to be reasonable. However, such statements necessarily involve risks, uncertainties and assumptions. The charts, tables, and graphs contained in this post are not intended to be used to assist the reader in determining which securities to buy or sell or when to buy or sell securities.

Start Planning for Retirement in Your 20s

Guest post from TheLifeBlogger, an events professional by day and a passionate blogger by night.  She loves writing about financial planning and other tips she has tried and tested to improve lifestyle.  Watch out for her blog soon!


The earlier you think about retirement, the sooner you will be able to enjoy a life free of financial stress. While you are in your 20s, you can already begin to plan your retirement and save up for your future. Apparently, it’s not that easy for some people though, especially the Millennials. CNBC revealed that Millennials are ready to think about their retirement early, but they have unrealistic plans for their future. Over 1/3 of all Millennials believe that winning the lottery is a viable investment strategy, or that they will “gifted” money for retirement.  This sort of mindset will make it hard for you to properly plan your future. To help get you on the right track, here are some ideas on how you can jumpstart your retirement fund:


Sign up for a retirement plan ASAP
Most employers now offer 401 (K) plans that provide for tax-advantaged investing for your retirement. Through these plans, workers can save and invest a part of their paycheck before taxes are withheld. But, how much should you contribute to your retirement fund? “As much as possible,” says a guide offered by The Wall Street Journal, but 3% of your salary is a good start, so you still have money to cover your daily expenses.


Educate yourself and learn investment fundamentals
The best way to grow your retirement portfolio is to create a diversified portfolio from among the mutual funds and other investment options available to you.   Checking the reputation of the fund manager, evaluating the investment strategy, and assessing past performance with a keen eye towards fees and expenses are basic steps you should take as a new investor. Investors also should try to develop a basic understanding of economics and government policies of the countries in which they are investing. It’s important to know if a county is in a growth or recessionary phase, as it can affect your investment prospects. A recession affects the a wide range of economic activities from the income and employment of people, to retail sales and industrial production. “A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough,” explains FXCM in their post. Having a basic understanding of economics may help you avoid certain pitfalls that could adversely affect your investment portfolio.


Free yourself from debt and save more
Getting yourself out of debt is a critically important step for many Millennials to get on the road to retirement savings. It’s important that you start with a clean financial slate. Never invest or start a retirement plan when you are still paying off high interest rate debts, such as credit card bills. You can save more money if you are free from prior commitments that require cash payments and offer no tax benefits. If you are having difficulty clearing your debts, you may need to reevaluate your spending. Some expenses aren’t necessities and may need to be taken off your list of important bills. Reducing expenses and allocating the cash flow towards outstanding loans can help you to retire your debt and build your retirement savings. It also will help your financial peace of mind.


Other helpful tips:

  • Consider using a budgeting tool such as Mint or Quicken;
  • Seek assistance from experts (financial advisor) if needed;
  • Open and contribute to a ROTH IRA if you are eligible;
  • Invest in an HSA (Health Savings Account), if available;
  • Build a strong investment portfolio and contribute to it over time.


Whether paying down debt, contributing to a retirement plan, or undertaking another investment strategy, make sure that you plan wisely and seek professional advice if you need it. We all work hard for our monthly salary, and we want to make sure we put it to good use. You can be a smart investor by thinking about retirement early in your working life and starting to plan now.