Income tax 2023-2024, accounting periods, get ready and some coffee so we can lessen the sting from the IRS smack with income tax preparation 2023-2024. Most of this information can be found in Publication 334, tax guide for small business for individuals who use Schedule C, tax year 2023, which you can find on the IRS website at irs.gov, irs.gov, looking at the income tax formula. Remember in the first half of the income tax formula, basically a funny income statement, most income statements having income minus expenses resulting in net income. Here having income minus various deductions resulting in taxable income, the Schedule C from the sole proprietorship ultimately rolling into line one income, which is kind of strange because the Schedule C itself is basically an income statement having business income minus business expenses, basically business deductions that is equals in essence the net business income, which rolls into line one income of the income tax formula, which is outlining the calculation on the form 1040. This being the first page of the form 1040, the Schedule C ultimately rolling into line eight additional income from Schedule 1. Here is the Schedule 1 additional income and adjustments to income part number one where the Schedule C rolls into line three business income or loss from the Schedule C. Here is a Schedule C profit or loss from business. First, a word from our sponsor. Yeah, actually, we're sponsoring ourselves on this one, because apparently the merchandisers, they don't want to be seen with us.  Like our trust me, I'm an accountant product line. Yeah, it's paramount that you let people know that you're an accountant, because apparently we're among the only ones equipped with the number crunching skills to answer society's current deep complex and nuanced questions. Looking at the accounting periods, which are as regular as the minstrel cycle and as irritating, we've got the accounting periods and methods introduction. So you must figure your taxable income and file an income tax return for an annual accounting period called a tax year. Note that when we think about the tax year, you're probably thinking calendar year, January through December, and for most sole proprietors that will be typically the year used. However, you can imagine situations where you can have the tax year and try to get it different than the calendar year. If you were able to use some other tax system or some other year, other than the calendar year, you would still have to have it having an annual calculation, meaning 12 months in the year, of course. You can't have like one year that's got 11 months and the next year have like 13 months or something strange like that. Also, you must consistently use an accounting method that clearly shows your income and expenses for the tax year. We'll talk more about methods later, the primary two methods that would come to mind or more on the bookkeeping side of things. That being a cash-based method and a cruel-based method, noting that in actuality, we're usually using some kind of hybrid method. In other words, for taxes, oftentimes we have a cash-based method, but you can think of many areas where the IRS, the tax code will force you to do an accrual thing, such as when you have property plants and equipment and can't expense it, even if you paid cash for it, but rather putting it on the books as an asset and depreciating it. That's an accrual type of activity deviating from a cash-based system. We'll talk about the methods a little bit more in future presentations. Useful items, publications that could be useful for this area. You've got five, three, eight accounting periods and methods. You can find that on the IRS website, of course. Accounting periods. When preparing a statement of income and expenses, generally your income tax return, you must use your books and records for a specific interval of time, called the accounting period. The annual accounting period for your business tax return is called a tax year. These terms sound similar, but they do have some distinctions. Most of the time, they will basically be the same. You've got a tax year. You've got a calendar year. You've got the accounting period with regards to taxes basically being a year, which is usually going to be the calendar year. You can use one of the following tax years. You've got a calendar year tax year, and then you've got a fiscal tax year. So you might have a fiscal tax year of something different than the normal calendar year. Again, that being a little bit unusual when you talk about a Schedule C type of business, possibly something you're more likely to see in other types of entities such as S corporations or possibly C corporations, but there it is. Now note that as we get into things like accounting periods and methods, we're diving into basically bookkeeping terminology, remembering that the double entry accounting system is basically a universal type of accounting system. But when we think about different methods, we can think of like a cash-based method. We can think of an accrual-based method. And we have to determine what are the regulatory authorities that we're trying to conform to in order to create our financial statements with regards to small businesses. If they're basically building their books just to do their tax return, then the people that we're trying to tailor our financials to is the tax code, right? So obviously the tax code is the thing that's going to help us to determine whether or not we have an appropriate accounting method that we will be using. I say that because that's different than what you might think of in publicly traded companies. If it was an audited publicly traded company, then they have to adhere to the rules of say generally accepted accounting principles, for example, which would be more on an accrual side of things and have very specific rules with regards to that basis. If you needed the financial statements to get a loan from the bank, for example, then the bank might have certain requirements. They would be more likely, you would think, to want an accrual type of system because that's often considered a more accurate type of system oftentimes. But in some cases they might be happy with just your tax return. Also note that as we get into the bookkeeping side of things, we note that the taxes really don't have the full set of books because we don't have the full set of financial statements. We don't have generally the balance sheet and income statement. What we have is just the income statement, the schedule C, which is the performance statement because we're doing an income tax return, which is saying how much we earned over the year and how much expenses we needed to expend in order to earn it. If you do your bookkeeping using software like a QuickBooks or some related software, you will also have a balance sheet, which is something worth keeping track of because the balance sheet is the double entry accounting system helping to make sure that your income statement accounts, income and expenses are reported properly or given you at least help with that in the proper time period. Okay, so unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. So when you file your first tax return, it becomes quite important to make sure that you double check these things, such as number one, what's your accounting period? Usually it's going to be a calendar year, but make sure that's what you want. If there's something other than that that you want after filing the first tax return, it's going to be difficult because one of the major accounting principles that will also be reflected in the tax code is consistency. One way to manipulate the books, one way to try to manipulate the taxes you would be paying is to manipulate the cutoff dates, meaning try to have income that will be before or after the cutoff date. Try to have expenses before or after the cutoff date. One way people could easily manipulate that is if they change their accounting periods. Like, yeah, I have a December year end this year, but next year it's going to be a January year end, and so on and so forth, and you can constantly play games with what period the revenue is going to be recognized in. So obviously the tax code is going to be set up like a good accounting system, which would see, no, we need consistency. The accounting period has to be the same. Doesn't mean that possibly you can't change it under any circumstances, but it will be more difficult to change after the first year. The same goes for the method that you're going to use that we'll talk more about later. It's going to be, if you choose a cash-based method, then that's the method that you're going to, that the IRS is going to be wanting you to stick with unless there's a reason to change it given the consistency principle. Okay, so a required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. So remember, we're not looking at generally accepted accounting principles here and whatnot, we're talking tax code. And that means that you might have, in certain instances, situations where your bookkeeping is different than the taxes, right? Because you might have your bookkeeping set in accordance with some other regulations, such as generally accepted accounting principles or more of a basis that would be necessary for the bank or external investors. And it might be slightly different with regards to taxes because the tax code is the thing that you're in compliance with with regards to the tax return, which again could get into situations where you have a little bit of complex accounting that you need to do at your end to adjust your books from whatever basis it is on to comply with the tax basis. Okay, so calendar tax year. A calendar tax year is 12 consecutive months beginning January 1st and ending December 31st are far the most common year that will be adopted for sole proprietor type of businesses reporting on a schedule C, the calendar year, January to December. You must adopt the calendar year if any of the following apply. You do not keep books. So if you don't have books being kept, then you're going to default to the calendar year. You have no annual accounting period. So your present tax year does not qualify as a fiscal year. So you have some fiscal year, but the IRS is like, no, that doesn't qualify there for your defaulting to the calendar year. Your use of the calendar tax year is required under the internal revenue code or the income tax regulations. If you file your first income tax return using the calendar year and you later begin business as a sole proprietor, you must continue to use the calendar tax year unless you get IRS approval to change it or are otherwise allowed to change it without IRS approval. So that's the consistency principle. You've made your choice. You filed your tax return. We're on the same page at this point in time. You can't just be changing the periods and the calendar year to some other fiscal year unless you get approval or there's some specific rationale for doing so in the tax code. For more information, you can see change in tax year later. So if you adopt the calendar tax year, you must maintain your books and records and report your income expenses for the period from January 1st through December 31st of each year. Those are the cutoff dates that you have to be reporting basically the income for in accordance with the method that we're going to be using, which we'll talk more about later, generally being some kind of cash basis or a cruel basis or some in-between basis. So fiscal tax year. A fiscal tax year is 12 consecutive months ending on the last day of any month except December. A 52-53 week tax year is a fiscal tax year that varies from 52 to 53 weeks but does not have to end on the last day of a month. So this gets a little bit technical, of course, because when we consider a year, it kind of changes in terms of the amount of days in the year, right, 365 days. There's about 52 weeks to 53 weeks in the year, so we have to be basically consistent with the number of weeks that are being in the year for choose something other than the calendar year that would be basically the same interval of time. So if you adopt a fiscal tax year, you must maintain your books and records and report your income using expenses using the same tax year. So your books should match up on how you're doing your books to what is being reported on the tax return. Otherwise, it looks like you're doing something funny just for tax reasons that doesn't line up with your books side of things. You would think that if you had a year other than the calendar year that you're doing that because you have a natural business year in in your business that doesn't coincide with the end of the year. So that would mean that you would think that your books aren't done that way as well. If your books aren't done that way, I believe the rationale of the tax code is to say, well, you must be choosing this other tax year for some weird reason that doesn't make sense. It's not the reason that we want to give the ability to do that for. So for more information on a fiscal tax year, including a 52-53 week tax year, you can see publication 538. Change in tax year. Similarly, you must file form 1128 application to adopt, change, or retain a tax year to request IRS approval to change your tax year. See the instructions for form 1128 for exceptions. So I've seen situations where people get into trouble that they filed something incorrectly or not the way they wanted to do it in the first year and then they have to go through this process of getting acceptance or approval to change something such as like with a tax year here, and that's not the position that you would like to be in because then that could take some time to do and put you in that limbo zone, stress you out, so get it right on the first tax return. So if you qualify for an automatic approval request, a user fee is not required. If you do not qualify for automatic approval, a ruling must be requested. See the instructions for form 1128 for information about user fees if you are requesting a ruling.


Welcome everyone to the 47th edition of Bogle Heads on Investing. Today we talk about the evolution of the investment advisor industry with two special guests, Michael Kitzes, head of planning strategy for Buckingham Wealth Partners, and Dr. Nicole Boyson, finance department chair at Northeastern University's De'Amour McKinn School of Business. Hi everyone, my name is Rick Ferri and I'm the host of Bogle Heads on Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501C3 non-profit organization dedicated to helping people make better financial decisions. Visit our newly designed website at bogelcenter.net to find valuable information and to make a tax deductible contribution. And don't forget about our Bogle Heads conference coming up this October 12th through the 14th, featuring many speakers that I've hot on this podcast and more. There are a few seats remaining you don't want to miss out. Visit bogelcenter.net for more information. In this episode of Bogle Heads on Investing, we're going to be talking about the evolution of the investment advisor industry and some of the conflicts of interest that exist with two special guests. Our first guest is Michael Kitzes, one of the most prominent thought leaders in the financial services industry. He is the head of planning strategy at Buckingham Wealth Partners, the co-founder of XY Planning Network and among other companies. He is the host of the Financial Adviser Success Podcast and the publisher of the Kitzes Report newsletter and the Nerds Eye View blog at kitses.com. Our second guest is Dr. Nicole Boyson. She is the chair of the finance department of Northeastern University's DMOR, McKim School of Business. She's also serves as the co-editor for the Financial Analyst Journal and is on the board of directors for the Eastern Finance Association. Her research focuses on institutional investors with current interests on investment advisors. Her paper that we'll be discussing today is titled The Worst of Both Worlds, Dual Registered Investment Advisers. So with no further ado, I'm pleased to have with us today Michael Kitzes. Welcome to the Bogle Heads on Investing Podcast, Michael. Thank you. It's great to be here. I appreciate the opportunity. It's a real pleasure to have you because you are the leader out there in the advisor community. Pardon on. You're the voice, so to speak. And rightly so, on your blog, on Nerds Eye View, and on your website kitses.com for mostly advisors in the advisor community. I know we have a good number of Bogle Heads that come over and read as well. We appreciate some of it, circulates there, and hopefully helpful ways for everybody who's reading it for themselves. The information you put out there, everything from taxes to insurance to trust work, I mean, certainly very, very helpful to individual investors and very helpful to advisors. I mean, I've learned a lot by reading your information and watching you on videos and also in person at various conferences. And by the way, how many conferences are you doing a year now? Oh man, well, historically it was 50 to 70 events that I was out for in person. I'm still doing about that many, but not everything's in person on the road anymore. It's more of an even split between in person and lots of webinars and virtual broadcasts and live streams, because that seems to be our post-pandemic era. Sure. Well, that's fantastic. Okay, so let's get first into how did Michael Kitzis become? MichaelKitzis.com, Nerds Eye View.   I was born and raised in the Washington, D.C. area. I was the son of two computer scientists. So, like, nerding out on computers and technical stuff from a very early age. Hacking my own computer games on my Commodore 64 when I was six years old. Probably kind of dates me a little. I went to college in the sort of classic New England liberal arts experience.  You know, I went to college as a psychology major, theater minor, pre-med student. And the only thing I figured out by the end of college was that I did not want to do psychology, theater, or medicine. So, I was getting ready to graduate and needed a job and landed, you know, somewhat randomly in the financial services industry. Well, before we get to that, I want to circle back to college because I remember you and I were at a conference together one time and we were walking around and we came across this big hall and they were doing ballroom dancing. Yes.  I did that in college. Yes, yes. So, I was co-captain of the College Ballroom Dancing Society. And, like, this was way before Dancing with the Stars. Like, this is all the way back in the 1990s. And, yeah, I did a lot of competitive ballroom dancing throughout college and then after graduation, took lessons and was hardcore into it and then 10 years later got married and now have been married for 11 years. So, unfortunately, very little time for it these days. Like, life got very busy. Obviously, you didn't become a professional ballroom dancer. You ended up somehow in the financial services industry. So, could you tell us how did that happen? My grandfather, my mother's father passed away when she was fairly young. And so, my grandmother suddenly found herself the young widowed single mother of two young girls and needed to provide for them. And so, back, all the way back in the 1960s, she went and had to get a job and she ended up getting a job as an assistant for a life insurance salesman from the New England Life Insurance Company. I did that for many, many years as my mother and my aunt grew up and when my mother got married shortly after college to my father, the insurance agent has this moment of what do you give your secretary's daughter when she's getting married? A life insurance policy because he was a life insurance salesman. So, he gives my father a life insurance policy.  I am now getting ready to graduate from college and my father gets a phone call from a New England life insurance agent that says, Mr. Kitts, you have a life insurance policy with us. You've had it for many, many years. It looks like no one's been out to see you in a long, long time because the original agent has retired, someone should come out and review the policy. So, the agent comes out and reviews the policy and then at the end of the meeting, the insurance agent kind of takes off so the recruiter for the local office and said, by the way, now that we've reviewed the policy I just wanted to ask, do you know anybody who might be wanting to come into the industry because our company's hiring? My father said, funny thing, my son's about to graduate from college and he has no idea what he wants to do with his life. I come home on spring vacation and my father's like, great news, I got you an interview because you need to figure out what you're going to do when you're graduating because you're not getting back here. So, I interviewed for the insurance company, got the job as I learned many years later was probably less my wonderful potential as a strong student and willing to work hard and a lot more that of the zip code that my parents lived in, they were hoping that my parents were from a fairly affluent neighborhood where I would know people with money to whom I could sell life insurance. Unfortunately for them, what they didn't realize was my parents moved to that neighborhood in the 70s before there was any money in that neighborhood. I did not have any natural market of like my parents, friends and family that I was supposed to sell life insurance to which made that very challenging. Well, let me read something that you put on your website about that job which I found striking and it goes right into what we're going to be talking about today. He wrote, when I started my career as a financial advisor more than 30 years ago, I couldn't believe the company that hired me will let me put financial advisor on my business card. The reality was I didn't actually know anything about giving financial advice or economics or money. I was a psych major, theater minor. But this is the way it was and in money cases, I mean, I guess I'll ask you this now. I mean, it still is that way. It still is for a lot of the industry. Read, like at the end of the day they put financial advisor on my business card. My job was not to give advice which frankly was good because I didn't know anything about money and got to school for that. I didn't learn anything. My training was how to sell the company's variable universal life policy because that was the kind of the big thing back in the late 1990s. It was sales training because I wasn't a financial advisor. I was an insurance sales person. It was a nice euphemism on my business card to say financial advisor, but I was a sales person. I was literally paid on commission to sell the insurance policies. And like that distinction, the term financial advisor is used very, very widely. Some people who use it literally are in the business of advice. Like they get paid for advice and they charge these for advice and they receive advice. But we also still continue to hire people in the industry. We call them as financial advisors, but they're sales people. That used to be 90% of the industry. 90% of the industry was you're being hired to sell. I mean, when I came out of the military I didn't know anything either. They hired me because I might be able to recruit veterans. Natural market, yes. And I was a pilot so go after the pilot. That's why they recruited me because I was financially savvy. I did run an antiques business when I was in college so it must be sort of related. I thought the same thing. I had good grades, I was a hard worker. I was hired for the zip code that my parents lived in. But at least to your credit you realize that and you begin on this other career. It didn't take long for me literally into the first year sitting with the prospect in their home across from on their kitchen table talking to them about quote, advice which was basically selling to them a variable universal life policy. He had accumulated about $300,000 pretty darn good amount of money 20 plus years ago. He was already well into his 50s. He wanted to retire in 10 years. He was trying to figure out how to get from here to there. This is what I've got. What do I do? What do I do for the next 10 years to get from here to there so I can retire? He was in a practice that was burning him out. I was like, I have no freaking idea what you should do. I'm a psych major theater minor who just got trained in one type of product that I'm supposed to sell you because it's literally supposed to be the answer to every single person I sit across from and I'm just supposed to do that for enough people that eventually some of them say yes inevitably and like I mean just were taught in the industry like it's a quote game of numbers. If you just pitch your thing to enough people eventually some of them will say yes and just like this crisis moment for me of my god like this is literally his financial life on the line and I have no freaking idea what I'm talking about and I probably should and so that took me down now granted I perhaps went a little overkill on it like I got my CFP certification and then a master's degree in financial planning and then five more professional designations than the second master's degree in taxation so granted I maybe went like a little bit off the deep end in that dynamic once I went down that path but just I mean to me like look financial advice is I really view as a sacred duty and like I'm not trying to be melodramatic like literally people's lives can be destroyed by finances. Money problems are the number one cause of divorce and marital strife it's a very common issue tied to suicide just in general people with more access to wealth tend to have better life expectancies and better health outcomes the accessibility that wealth creates to medical care like people's lives and livelihood are literally on the line like you can't screw around with that. You have a conscience that's the problem and yes and for whatever it's worth I did not get the sale that day he didn't buy. Let's start out the conversation with the evolution of the advisor industry you've given a talks on this listen to your talks I think they're very good and you go through four phases you think we're in the fourth phase now so why don't you go ahead and tell us how you see the evolution of the industry and by the way I've been in it for 35 years so I live the evolution. You've lived most of these transitions. I'll throw in my two cents as we go along. Go ahead and start from the beginning. The beginning of financial advisors for most of us it was pure product sales. We sold insurance, we sold annuities, we sold stocks most of the roots of the industry are essentially like it's the stock market. It's the Charlie Sheen Wall Street 1980s model or the Wolf of Wall Street model of stock brokering and I mean it paid well if you go all the way back to the 1970s for big clients we could get paid $200 a trade in 1975 dollars just to sell a stock to an individual client. That's like a thousand plus dollars today as a ticket charge. That was the fixed commission rate. That was the fixed commission on a big trade. It was scaled to the size of the trade. That would be a big one. Every firm had the same rate. Every firm had the same rate by law because FINRA back then the National Association of Securities Dealers had fixed it at a set rate. It was like part of the aftermath of the Great Depression.  Nobody paid attention to what they were paying when stocks were going to the moon in 1929 and then no one paid attention to what they were paying when stocks were going to the ground in 1931. So there was a bunch of commission gouging when people were just desperate to buy and sell and the regulatory response back in the 30s was well we're just going to set all the trading commissions at a fixed rate that every brokerage firm charges. Good news got rid of all the gouging. Bad news obliterated all the innovation that was inefficient because you were legally barred from competing on price. So by the 1970s we decide this regulatory structure has run its course. It's time to let it go. We deregulate the stock trading commissions and a startup in northern California right outside of Silicon Valley says you know hey like it's the 1970s these things are coming out called computers. I think we could use computers to replace financial advisors. Like why are we paying all these dark brokers for such money a computer could do this. Discount brokerage firm. And a lot of people are familiar with the company because the guy that said this was named Chuck Schwab and Schwab was founded the month after the deregulation trading commissions basically to create you know call it robots of the era to eliminate human financial advisors. As it turned out like it didn't kill advisors we're still here but it did obliterate stock trading commissions like you know we went from $200 a trade down to $20 a trade by the 1990s obviously over the past 20 years we took it from $20 all the way down to zero. So it did kill the stock brokerage model and it forced us all to shift and so as financial advisors we shifted into a new environment we said well you know anybody can sell you a stock I will find for you a great stock picker. Like we went in the mutual fund business and said well I'll get you mutual funds with great managers and huge growth cycle. The mutual fund industry alone in the 1990s grew from less than half a trillion dollars to five trillion dollars. Like it was a 10x growth cycle and you think the ETF shift has been big in the past 10 years the mutual fund shift in the 1990s was actually bigger when you adjust for the market size at the time all driven by technology was obliterating the financial advisor business model so we were all reinventing ourselves from stock brokers peddling stocks in a mutual fund salespeople still on the sales person side. There was actually something else going on too it was the RAPFI account and this was started in the 1980s and it really took off in the early 1990s in fact Shereson Lehman which became Smith Barney started a whole division that did this CFAs, PhDs all get together and they're going to go out and they're going to pick the managers that are going to outperform the institutional managers and we are going to let you who might have a couple of hundred thousand dollars hire these very top-notch managers and charge you only 3% RAPFI Very, very generous of them I guess stocks were making 14% a year back then it's like who cares if the house gets a 3% vague you're making 11% net it's still great So phase two is this mutual fund or manage money separate account management slash mutual fund concept and then what happened after that The internet showed up all this discount brokerage becomes online brokerage eTrade runs all of their wonderful commercials buying mutual funds is so easy a baby can do it and they have the picture of the baby day trading stocks and mutual funds from the crib all of a sudden like you could buy mutual funds and sort of more practically like Schwab again being one of the leaders in the space launched their one source program where you could get almost any mutual fund in a giant supermarket with no commission we knew them as no-load funds but the load is the commission that the advisor or mutual fund sales person gets and so a no-load mutual fund marketplace essentially said meant the internet brokerage companies were giving away 100% what advisors did for no commission when our money came from commissions which created kind of like the next crisis of business model for advisors and shifted us to where a lot of us are today which was this huge shift into the assets under management model so like anybody can pick a mutual fund on a brokerage platform I will create for you a diversified asset asset allocated portfolio of all of it brought together your goals and your time horizon and consistent with your tolerance for risk and for this aggregate service of everything brought together I will charge you you'll merely 1% lower than the 3% that she was going to charge you for the wrap account and so you see this sort of explosive growth over the past 20 years in the rise of assets under management and once you're building assets under management we tend to build them with ETFs to the point that now you see the entire mutual fund complex and net decline that's kind of the tail end of we start shifting away from the model in the late 1990s when the internet showed up natural outcome is now we're mostly in an AUM model charging these stand alone 1% assets under management fees and the whole mutual fund sales complexes and net outflow I see the ETF evolution as giving the brokerage industry the traditional branch UBS Wells Fargo brokers the ability to do this wrap fee in other words to compete with the independents who left I left the brokerage industry in 1999 to go and become one of these advisors and the ETF evolution of the ETF has allowed the traditional wire houses to kind of backtrack and get into that business and compete head on head and some of it is part of the evolution of that model itself even from the advisors end as I'm sure more than a few listeners have observed as well at some point I can just buy an ass allocated mutual fund on my own I can do this with a handful of Vanguard funds and pretty much get this done why am I paying you Mr. Advisor one version of this goes down the road of deeper financial planning advice which we'll probably come back to in a few minutes the other version of this is well I'm going to manage your asset allocation more effectively more proactively and one of the big shifts to me that's happened just over the past 10 years is a lot of financial advisors have essentially become active managers of ETFs and that's become one of the big models in our space so we used to buy the mutual funds and say the fund is the manager I just picked them now we're often building with more passive vehicles or like the ETF are structurally more passive vehicle but a lot of advisors are actively managing the ETFs and not trying to necessarily justify if it's right or wrong frankly some of them probably do it okay and a bunch of them probably not so much because we have a lot of other things we're doing as well but relative to the mutual fund model part of the big shift and focus has been the advisor come and say look you've got a bunch of mutual funds with an expense ratio of 2% because you own C shares which essentially is 1% to the manager and 1% to the advisor who sold it to you that's their trail commission and the advisor comes and says like well instead of just getting paid 1% for the mutual company for selling it to you on top of their 1% I'll manage your portfolio for you for the same 1% but if I'm going to manage it for you I don't need to give them their 1% on top of mine I'm going to buy it with a whole bunch of ETFs and I'm going to do this for 10 or 20 basis points of ETF cost and so now my all-in cost as an advisor is 2% with your mutual fund portfolio it's 1.2% with mine my fee plus the ETFs I can save you 40% off of your fees not necessarily a cut to us as advisors I mean that's the reality in the industry I mean that's why you're seeing so much of this shift within the advisor world towards ETFs we're feeding on our own the advisors the advisors that want to build lower cost portfolios are killing the mutual funds themselves as a way to bring down costs for our clients you can look at that a good or bad way obviously the cynical version is just we come up with a way to defend our 1% and stick it to everybody else but the good version of it is like hey at least we're proactively trying to earn our 1% every upstream cost structure down as little as we can and I do think just when you look structurally at the declining expense ratios across the industry right now it is that shift in the advisor business model that's driving a lot of it when I sold mutual funds I didn't get paid for finding a lower cost fund I got paid for selling a fund that had a good story because that's what's sold all the way back to like the munder net net was the big one when I was getting going in this environment for the advisors who are managing portfolios on AUM basis our incentive as the advisor is to drive at least every other cost down that we can we'll go through the pressure for ours but at a minimum we try to force every other cost out of the system and because there are so many advisors in the aggregate again I think that's part of why you see such growth in ETFs and the whole mutual fund complex and net decline we're causing it because the fee model puts you on the client side of the table and that's one company I had no reason to bring down your costs when I represent you I have every reason to bring down your cost because frankly that's one of the ways I justify my fee as an AUM advisor so along comes Betterment, Wealthfront, Vanguard and they're going to do it same thing that you just talked about not only are we going to drive down costs by having low cost funds in your portfolio but we we are going to charge you a low fee and this is another evolution and that advisors appear to be grappling with right now especially the 5,000 pound gorilla which is Vanguard at 30 basis point PAS program all of a sudden showing the world that yeah you can have some advice plus portfolio management and yeah you don't need to pay 1% you pay 0.3 and so is this a different phase now have we then moved to a different phase of advising that might include separation of asset management and advice and could you talk about that yeah we are very much in that fourth phase transition so round one was stock brokering and then computers with discount brokerage killed it round two was the mutual funds and the online internet environment killed it round three was building diversified asset allocated portfolios and then kind of the rise of robos and the technology as well as just sort of the ability to work with people virtually is now disrupting that and driving kind of this fourth phase to it the industry likes to talk about the proverbial 1% but if you really actually look at most advisory firms and just take how much assets they have in total and how much revenue they bill the average really is closer to about 70 to 80 basis points than it is 1% like there's some discounting like all handle your kids accounts with charging them separately and like there's some money where you kind of want to hold on to the stock because you've had it a long time so like I'm not really going to manage I'm going to put in a separate account and like we'll oversee it but we're not actively trading it so like the true net fee usually is a little bit lower than 1% and so what I think you're starting to see emerge in this dynamic is that the advisor fee is essentially getting disaggregated into sort of three primary components what's the raw cost to just build and manage a diversified asset allocated portfolio and you know it's not a terribly high number like just there is some staff there is some labor there's some systems that have to get built but you know that's that's kind of converging in this 20 to 30 basis point ish yeah 25 basis points a good good number you know the second component that you're seeing is all of I'll just probably call it the financial planning advice and you know that varies tremendously by firm and capability because we all use the title advisor but we may not have as much training experience and knowledge and advising and actual advice but that's everything from retirement planning advising on insurance advising on taxes covering estate issues just getting into cash flow and budgeting and where's your money going higher level questions about just is your money actually going towards the things that fulfill you you know from a cash flow basis from how your dollars are invested from what you're trying to pursue like I don't get that from a robo like that's that's a human conversation and exploration conversation let me jump in here and ask you though I mean that could be a conversation you have with somebody who has 300,000 it could be a conversation you have with somebody who has a million it could be a conversation you have somebody with has 2 million somebody who's going to inherit 10 million I mean it doesn't have anything to do really with the size of the portfolio so how do you reconcile aligning a fee with this advice part of being an advisor so I'd answer that in I guess so two primary ways one I mean just to acknowledge there is a segment of industry that's starting to decouple that a little bit that's doing things like you know I've got a financial planning fee that's whatever my number is two grand a year three grand a year five grand a year or higher for some firms and then I've got a separate fee for just managing your portfolio and that's 50 basis points or some at least much lower number relative to the proverbial 1% because like the planning stuff scales in a different way than the investment management stuff and the fees are decoupling a little so some of that is happening already you know the other answer I would give to it though just in practice so there are two interesting things to me that does happen just as wealth as wealth lifts up one is complexity does start to rise it's not a perfect proxy like you know I have had clients with 5 million dollars and their lives were simpler than people who had $200,000 because of what's going on in their world but it's actually a pretty decent correlation of the amount of complexity that's going on and the amount of wealth overall that we have in part just because more wealth is more choices more at risk frankly like more predators coming after us trying to sell us crappy things because where my advisor at I spent a lot of time explaining to clients why the thing is getting pitched them is crappy and not actually good and when you've got more wealth a lot more things often can get pitched at just the raw steaks of some strategies not necessarily the retirement conversation but you know good tax planning strategies can just literally have more mathematical impact when there's more dollars at stake so you know part of that just part of that like you know why does a 5 million dollar clients get you know pay 10x to $500,000 clients I'm charging a percentage of a portfolio that's 10x the size part of that is a proxy for complexity like there is actually more stuff going on if you look at most advisory firms they do more either they do more stuff for their more affluent clients like there is more services rendered or you are getting more senior expertise in the in the planning experience you know smaller smaller clients may work with slightly less knowledgeable experience advisors not say they're inexperienced but you know it's kind of like the law firm thing like you know if I'm a small law firm client I get the 7 year associates I'm a you know lot more at stake I get the senior partner who has 37 years of experience and like has seen my situation more times than I've been alive so so there are kind of gradations that come in both advisors usually have graduated fee schedules so frankly like 10x the portfolio usually isn't 10x the fee it may still be 5x or 7x but like it's not it's not perfectly linear but more services more experience more dollars at stake more consequences for the decision you know there cause there does come a point where if you've got a lot of dollars and you're getting advice from someone you want to make sure they have some something it's case it's taken and some skin at the game for the consequences of their of their advice and so I just for better or worse like I think that's why you see the model hold up and continue to persist as as strongly as it has now that doesn't speak to a huge segment of people who'd like literally don't need anyone to manage my portfolio like I just want to pay for advice and obviously like that whole assets under management model like that just doesn't work and so there's the growth of like advice only models and subscription models that are planning based on a whole lot of other really cool fee innovation that's happening there for the whole segment that's like I just want to pay for advice I don't I don't need investment help but for the folks that do where all of that gets bundled together like you know wealth is not a perfect a perfect proxy for for complexity in dollars that are at stake but there is a piece of that one final question the advisor industry continues to evolve the asset management industry continues to evolve fees continue to go down yes people that trying to figure out the model it doesn't seem like any of the old stuff's going away I mean they're still commissioned sales people there's still insurance people selling you know insurance whole life insurance sometimes I just want to buy a product like and I I mean sometimes I really just want to buy a product and want someone to sell it to me like there is a time like I go on to the car lot like I just want someone to sell me the car like I don't need a holistic automotive family consultants like just just sell me like I'm just here to buy a car like sell me a car tell me about the features and benefits help me make a choice and then and then take my order so yeah like sales isn't going away and then also AUM 1% advising where the advisors trying to select ETFs that adding alpha with tactical asset allocation or smart beta or whatever whatever you're doing trying to add accessory to it I mean that's not going away no it just there there will always be a segment of people who are willing to pay for the opportunity for outperformance you know lots of debate about whether they're going to find it and you know we both we both read all that research but just right it's a human nature thing there will always be a portion of us that are willing to pay for the opportunity to do better what I'm getting at here is that you know the old models have not disappeared they just overlaid a new model on top of it and then a new model on top of that and and so we've talked about the latest new model so my last question to you because we have limited time here is so what's the future you know if you look forward what's the good stuff that's happening in the advisor industry and then well maybe you could start with what's the bad stuff that's that you see happening and going on and then what's the good stuff here's the worst of the bad stuff to me right now the worst of the bad stuff is that the whole industry has figured out like the future is advice the future is just more more holistic advice because I can you know get a diversified asset like a portfolio from a platform for 25 or 30 basis points so like we ain't winning on that gotta find somewhere else to add value and so the whole industry has figured out the future is advice and our regulators are very very behind on this because there is open just open broad unfettered usage of titles like financial advisor by people who are literally not in the advice business like their legal job is to represent their company to sell a product we see it in the insurance channels we see it in the brokerage channels this like ubiquitous adoption of financial advisor financial consultants in similar sounding terms from people who are just literally legally a sales person and usually it says somewhere on their business car like registered representative of such and such or licensed agent of such and such which is a nice way of saying I literally don't work for you I work for that company in the securities offered through blah blah blah correct the brokerage industry figured out the future is advice before the advice industry figured out how to protect their own space and so the brokerage industry now so encroached into the advice space top with the titles with the marketing you go to most brokerage firms website and they're talking about the holistic value of all the stuff they do to help your wealth management picture and their literal legal purpose is to manufacture and distribute product like they are not in the business of advice that just confuses the bejesus out of the consumer landscape in ways that frankly the brokerage industry benefits from which is why they continue to do it and what do you see as the bright spots when I look at the bright spots I see a few like number one the big one by far is we are in this transition from sales to advice and relative to my roots I know your roots as well having sat on the on the sales side of the table this shift of the industry from sales to advice like what it means to me at the end of the day is I used to sit across from the client try to sell them something and now I sit on the client side of the table and we look out there at the landscape of what we can do that's best and official for them so there's also a shift to different non-asset management fee models where hourly or retainer do you see that growing as well the AUM model is basically just a tiny niche model it works for a very very small sub-segment of consumers who have a material amount of assets liquidity to actually hand it to an advisor so it's not business or real estate or a 401k plan or something else telling this to delegate it to an advisor so like you don't want to do the portfolio stuff yourself by the time you take how many people like have enough money to meet a typical advisor minimum are have it liquid and available not tied up in a 401k plan have a mental inclination towards delegating in the first place you get down to something like 5 to 10% of all households and like that's it the model does not fit literally like 90% of the marketplace and so as I look out this shift is underway towards other fees that's what the that's how the majority of consumers will need to engage advisors because just you know you want a service you pay from your available income like that's how we buy everything else assets under management is this this really specialized niche model it happens to work really well for a segment of affluent retirees that just want to delegate so they can enjoy the retirement and hire a firm that has the expertise to handle it but that's not most people and so when I look out in the I you know I see the AOM model continuing to grow but it will probably be a minority of advisors in the niche in 10 to 15 years Michael it's been wonderful having you on vocal heads on investing thank you for being on the show today absolutely my pleasure thank you our second guest is Dr. Nicole Boyson from Northeastern University I apologize for the quality of the sound on my end because I recorded it in a small room in a library while I was on vacation and the acoustics were not very good so here we go so with no further ado let me introduce Dr. Nicole Boyson welcome to the vocal heads on investing podcast thank you Rick please feel free to call me Nikki thank you Nikki I wanted you on the podcast because you are one of the rare academics out there who have studied the advisor industry as an academic so you have no skin in this game you don't work for an investment company you don't work for a mutual fund company you don't work for brokerage firm that is absolutely true before we get started on your research in the advisor industry I wanted to hear your background how did you get to this point where you are today as the department chair for finance at DMSC yeah so I think the kind of interesting part is I started out as a CPA so my first job out of undergrad was in public accounting at KPMG Pete Marwick and I worked as an auditor you know attained my CPA license did that for about three years and realized that being an auditor is a pretty good job but it's also a little bit tedious and so I went to work for one of my clients was a commercial bank and then I moved on to work for another person who does play a role here who is an investment advisor he was a fiduciary in some sense but he also was a broker and so I remember learning about that business I was like 25 years old and thinking this is a really interesting space right you probably took me about six months to understand the fees he was charging how he was charging them and I can say pretty clearly that I'm not certain his clients fully understood so I kind of took that away like 1996 went on to leave that job worked back in public accounting and there I was in the investment advisory space at Ernst & Young and so kind of little known fact but the big accounting firms do have some investment advisory space some of them are registered and some of them are more giving advice as part of their tax clients business and so I got to learn a little bit about RIAs and what that looked like ultimately turn 30 decided if I was going to go get a PhD it was a good time to do it so I went off went to Ohio State got a PhD and started immersing myself in academic research and so that was a lot of fun so you've been in academics then for more than 15 years? Yeah more than 20 years I started my PhD in 1998 and graduated call it 2002-2003 went to work for Purdue for a little while just over a year and then got my current position at North Eastern in 2004 and so I've been able to kind of move up the academic ranks which has been really wonderful started as an assistant professor get promoted with tenure and then was promoted again to be a full professor recently took on the department chair role which is as academics know it comes with pros and cons also co-editing the financial analyst journal which I'm really proud of and excited about and then yeah my research has evolved I started out being very interested in hedge funds I started my program in 1998 for those of you who know about hedge funds that's when long term capital management blew up and it was just a really interesting time to study that and I was also very fortunate to be kind of young in that area I mean I was young but the area was young as well and so I was able to do a lot of really cool work with new data sets and try to understand risk and return characteristics moved on to start focusing on hedge fund activism which I would say is probably my key body of work I worked on that for 8 or 10 years and then the last few years decided to just go back think about that investment advisory job that I had back in 1996 and I started that project which we'll talk about in detail but I started thinking about that project I'm interested broadly in investing in institutional investors in particular and I started looking at mutual fund flows for whatever reason I was just reading the ICI report because that's what academics do and I was reading this report and I noticed that funds where money was flowing into institutional share classes of mutual funds which are presumably cheaper and often in my mind what I thought we're going to institutional investors and moving out of the broker sold side and having worked for a broker way back when I thought this is probably good for clients because if brokers are no longer able and again brokers are not evil but the broker I worked for was pretty opaque about the fees he charged and so institutional funds are cheaper and often sold turns out I learned this by registered investment advisors so I thought this would be good RIAs are fiduciaries, they have their clients best interest at heart and they're selling these share classes that are cheaper and presumably more transparent in the way that they charge fees so my initial premise was this is a very good idea but let's look into it a little deeper. So what was the mutual fund flows from the investment company institute annual report ICI as you stated that got you I wonder why that is, I wonder what's going on here, this is interesting well you must also then be interested in the amount of money flowing into ETFs and the amount of money flowing into index funds in general. Absolutely so there's sort of two things that are going on I mean the one was that within a particular fund let's pick the MFS growth fund we would see more money flowing into the institutional share class of that active fund then the broker sold class and so I thought okay I'm going to write a paper about distribution and you know I kind of did so who's distributing these share classes it's not brokers anymore right that was my first thought the other piece that you mentioned which does come up in my paper but is a little more tangential is what about the composition of the investment so are there is money flowing out of active into passive I knew that was happening being an academic and studying this for years but also trying to think about then the distribution side of passive versus active and my paper focuses only on active because my premise which I know is true is that most of the folks on the brokerage side are not selling passive funds because it's kind of hard to justify your big commissions if you're just selling an index fund RIA sell passive funds but my point was trying to think about the movement out of brokerage into institutional within kind of the active space prior to this I interviewed Michael Kitzes and I know Michael for many years and we've both seen the evolution of the advisor industry I've been in the business now 35 years and started out as a broker and then went out became an RIA on my own and used index funds mostly from Vanguard and a couple of other companies and now I'm just doing advice only so I've lived through this evolution so one thing we didn't talk about was the number of people that are kind of locked into each one of these groups and I was reading the latest FINRA industry snapshot which you reference in your paper and found out that there are probably close to 700,000 people who are calling themselves advisors based on FINRA now that gets broken down into registered reps who work for brokerage firms or in your paper duly registered and there is about 720,000 of them and they could be working for big firms like UBS Wells Fargo, Merrill Lynch there's also RIAs registered investment advisors there's a considerably smaller number about 70,000 so basically about 10% of the advisor community are registered investment advisors and these people who are paid a couple of different ways but the main way is through assets under management and they're managing money they're managing portfolios and they're charging the fee based on those assets and so it's assets under management there's also people who are doing retainers and fixed fee hourly and so forth but that's a very, very small number maybe less than 1,000 even and then there are the people that you studied and these are dual registered advisors and what they are are both brokers and RIAs and here is where it becomes interesting and here is where you wrote about in your paper which I want to get into and that is that you're able to analyze what they were selling as brokers and what they were selling or using as fiduciary RIAs and you found some real conflicts of interest so could you get into the paper a little bit? Absolutely and I think you framed the industry really clearly and when I think about the industry I think about it that way as well as I was kind of following up on this money's flowing into institutional funds and out of broker sold funds I didn't realize at first that it was actually the same guy and I'm going to say guy because it's mostly men but it was actually the same guy who was selling both those share classes to different clients under the same umbrella of his firm and this is a dual registered advisor who could sell the broker commission side of the mutual fund and collected asset management fee by using the other side as well. Exactly and again so if you think about kind of the evolution would be say in the year let's just go back to say the year 2000 just to give it a clear number some guy starts working for say a company called AmeriPrize and at that time AmeriPrize and all the big dual registered firms and to be clear what I mean by dual registered firms is that as you said they have both a brokerage arm which is really their legacy business and then they've got a registered investment advisory arm which is I would call slightly newer now many of these firms have been dual registered for a very long time but the brokerage side of their business was dominant so if you go back to like the year 2000, 2004 you'll find about 80% of the revenues coming from the brokerage side of a business let's just pick on AmeriPrize and 20% coming from the RIA side and over time for various regulatory reasons you can talk about or not the balance shifted and so now what you'd find at AmeriPrize is probably most new clients walking in the door are being put into RIA accounts fewer in brokerage accounts and part of the reason is one, the RIA accounts are going to be charging 1% or 2% per year to the small clients which turns out over the long term to be more lucrative for the advisors and the other reason is that investors probably or brokers have gotten a bad name in many cases so if I'm at AmeriPrize I can say, hey look I'm a fiduciary I'm going to put you in a fiduciary account and I'm going to charge you an annual fee 1% or 2% whatever that is and so the dual registered advisors it's at the firm level the firm has both abilities but it's also at the advisor level so they've got both right it's just a matter of taking another test and so then when a client comes in they can decide presumably with the client I'll show you some load funds or do you want to be an RIA client where I do have more responsibility for you but I'm going to charge you an asset based fee and by the way let me get back to the numbers it turns out that about half of the brokers are dual registered so over 300,000 in fact it's been increasing the interesting point about your paper which I found fascinating was that you got this unique lens then to analyze investment decisions by these advisors and are they doing what's in the best interest of their clients given the fact that they could go the commission route or they could go the RIA route and charge AUM fees the question became are they actually doing what's in the best interest of their clients so I turn it over to you are they? so the overarching conclusion of my paper is no they are not so I want to be a little bit clear it's not obvious to me that they are acting in the best interest of their clients and I'll just list a few reasons why one really important reason why is that during my sample period these dual registered advisors within the RIA side of their business were also charging commissions now these commissions were small they came in the form of trail commissions for mutual funds which for those of the audience here who's not experts on mutual fund structure this is a typically 25 basis points a one quarter of one percent fee that the mutual fund family is paying to the advisor oh is that right I didn't know they could do that I thought if you were an RIA and you were charging an asset management fee you couldn't get trailing commissions as well but you're saying you can I thought that for a long time and I had a whole bunch of people you couldn't but then you know I I read everything I could find and the answer is you sure can and in fact the SEC tried to crack down on this in 2019 which I'll talk about in a sec but effectively what was happening then is you know imagine I'm at a merit prize and I've got a client come in I'm going to put that client in an institutional share class of a mutual fund but many of those institutional share classes are also paying this 25 basis point trail commission and it was not at all clear nor was it happening that the merit prize advisor would say okay I was going to charge you one percent but because I get this trail I'm going to charge you 75 basis points so that your total fee is one percent absolutely not so let me ask you about that is that a rule or a law in other words are they supposed to do that in other words if they normally charge one percent yet they getting comped from the mutual funds that they're putting money into 0.25 are they required by law to bring it down to 0.75? Nope and they still aren't Reg B.I. didn't change that they're not required by law what they're required to do is tell their clients they're doing it and so this was where the trouble came in around 2019 the SEC knew this was going on with all the big dual registrants and they said hey look dual registrants we know you're doing this and we know it's legal but the problem is you're not properly disclosing it to your clients in other words what their form ADV would say is we may choose mutual funds that pay us a trail commission in addition to your fees but what they really should have written down was we always do this or we're going to do this or most of the time we do this and so the problem interestingly as I found throughout the paper over and over isn't so much that they were doing illegal stuff although they frequently were there are tons of disciplinary actions but even the stuff they were doing that was legal in which I would call sort of at least potentially unethical and certainly conflicted they weren't disclosing it properly so what the SEC did was they had this thing called the share class disclosure initiative and they said hey all you guys who are doing this you need to come clean you need to tell us the SEC how much you were doing this and you need to reimburse clients because not because you were overcharging them but because you didn't tell them you were overcharging them how many firms are we talking about in your paper you mentioned Raymond James can I name off a few more like LPL of course yeah there are hundreds of dual registrants the top 10 which you'll see in my paper manage something like 75-80% of the assets okay they found this across the board and all these dual registered 100 dual registered firms ended up kind of being involved with this disclosure initiative and the number is still kind of happening but I believe the initial was something like 97 came forward and then three of them the SEC had to go after on their own and effectively the deal that the SEC cut was we won't charge you any civil penalties what we'll make you do is pay these folks back and going forward improve your disclosures it wasn't illegal it's still not illegal they're still doing it they just have to disclose it somewhere that they're doing this what I will say is fascinating about that is my look at some form ADVs post this incident so this got all kind of wrapped up in 2020 by 2020 most of the firms now are not doing it right so now if you read the form ADVs they realize that the next step for the SEC probably would be to make something like this illegal or at least much more you know hard to do what most of them are doing is they are they say clearly in their form ADV we're not going to do this if we can help it if we really like the fund and it has a 25 basis point trailer these are 12 these are called 12 B1 fees also we will rebate it and so I will say that this has been the most encouraging thing that's come out of this initiative has nothing to do with my paper but what what I did see happening was when the SEC cracked down on this but effectively it did seem to help and so they seem to be doing it less I'm sure it's still happening the handful that I looked at that kind of got busted seem to have kind of like gone the straight and narrow on that well let me ask you about the larger firms the wire houses like the Merrill Lynch's Wells Fargo and all that they weren't involved in this were they were absolutely all the big firms hmm interesting I want to go back I want to circle back to the conflicts of interest and I just hit maybe three or four points and conflicts of interest so the very obvious conflict there is that you would choose products that paid the highest possible commission so you would look at the menu of all the mutual funds out there and pick the one that paid the highest possible commission without regard to whether that that product was good for your client and so I think that conflict is very obvious you might choose a variable annuity which again some variable annuities are fine they have lower fees but like the historical model of variable annuities is that the biggest commissions and if you were a broker that was where you got your biggest bang for your buck one conflict that was really common in the brokerage space they would use the term churning meaning that they put you in a product and then three years later sell you out of that product put you in a new product that had another big front load commission and so without getting in the weeds on mutual funds effectively if you just think of I get paid a commission every time I trade and this would be true with trading and so if you were to tell which paid really have to commissions back in the 80s I'm going to trade as much as possible and certainly that's that's rarely good for any client even just from a pure tax perspective it's probably not a good idea and then the other thing that you know you and I had chatted about in the past was this idea about certain fund families would say you know if you have a certain number of dollars with us the commissions are lower so a client with a million dollars would pay a very low commission to use one fund family let's divide you up into six fund families so that they could maximize their commission across the total that was being invested I have seen a few not not many and I review accounts basically daily I have seen a few broker brokers just broker only not doing AUM who have actually done the right thing for clients they will put a million dollars in one fund company to get the break point I'll look at the account statement and I'll see this and I'll say wow I rarely see that I really basically most of the time I see this thing broken up so that the broker gets higher commissions by breaking it up into different fund companies but I actually have seen on a few occasions in my career where a broker has actually done the right thing so it's just because you are a broker doesn't mean that you're doing this I'd say that a lot of brokers are but there are some that are really acting much more like a fiduciary than the AUM advisors who even though they are fiduciaries I have to say that I have seen a lot of people not acting in the client's best interest even though they're charging AUM so my paper really is kind of silent on the AUM versus commissions when I compare to the RIA so I have dual registrants then I have independent RIAs that aren't affiliated I can compare their fees and the only thing I can tell you is that the dual registrants charge higher percentage fees to their retail clients but then a lot of the independent RIAs don't take small clients so oftentimes stuck between a rock and a hard place. What about fees for advice not linked to commissions and not linked to assets under management? I think that when you decouple the product from the advice that clearly is going to reduce conflicts because for obvious reasons if you're not getting paid based on assets or if you're not getting paid a commission based on a particular product your independence is going to be more of a straight line and fewer conflicts. The conflicts I guess that could occur there would just be you talk to them for an hour and charge them for two but those are that's more fraud than it is a conflict Thank you so much for joining us today and appreciate all of the work. I know it's very difficult digging up this information when the industry really doesn't want you to have it greatly appreciate your insight and thank you again for joining us. Yeah, thank you so much it was a great time and I'll keep you posted on my findings as I get through that work. This concludes this edition of Bogleheads on Investing. Join us each month as we interview a new guest. In the meantime visit Boglecenter.net Bogleheads.org The Bogleheads Wiki Bogleheads Twitter Listen live each week to Bogleheads Live on Twitter Spaces The Bogleheads YouTube Channel Bogleheads Facebook Join one of your local Bogleheads chapters and get others to join Thanks for listening.


I'm gonna show you some of the green light foods I have in my pantry to help me build daily dozen inspired meals every day. I have quinoa and whole grain pastas to make filling salads or Buddha bowls, oats for breakfast and sweet recipes, and corn for popcorn. All these cooked as well as dry legumes are great to complement those dishes and for making tacos, hummus, and hearty soups for example. Spices are key to maximize the flavor of salt-free dishes, so I have plenty of herbs and spices, but use turmeric and black pepper on almost everything. To add some crunch and healthy fats, I always have nuts and seeds around, like pepitas, cashews, black sesame seeds, and of course, ground flax seeds. Check out our evidence-based eating guide to learn more.


Welcome to Hawaii Together on the ThinkTech Hawaii Broadcast Network. I'm Kelea Ikeina, president of the Grassroot Institute and your host today. We've got a wonderful program in store. We call it Hawaii's flawed accounting practices. And we're talking about the way our state government keeps track of our finances. You know, when you balance your budget at home, it's absolutely essential that you have accurate information. You need to know how much money is coming in, how much is going out. And above all, you really need to know how much debt you have or how much reserve hopefully. Well, the same is absolutely true for governments. Unfortunately, governments don't always operate with all the right information. But our next guest says that government accounting standards sometimes make finances appear rosier than they actually are. Her name is Sheila Weinberg. She's a CPA who has been in private practice before she founded the organization Truth in Accounting in Illinois.  Actually, you might not. You might be crying by the time she's done because she's going to really give us the truth about Hawaii's finances. You see, Sheila says that Hawaii's government bases its accounting upon flawed government accounting standards. And that allows lawmakers to spend more and sweep debt under the rug. They're not really dealing with the real figures that would cause us to pause much more when we take a look at the expenditures of our state. But please join me now in welcoming Sheila. Sheila, thank you so much for joining us here today on the program. I'm delighted to see you. I know we've run into each other many times at national conferences. Your work is well known. Welcome to the program, Sheila. Well, thank you so much for having me. And before we get into this all accounting detail, I like your analogy of a household and their budget. What the governments are doing is kind of like, well, if my husband and I over the holidays, we decided that, you know, to live within our means, we're only going to spend each $500. And I'm an accountant, so I check the checkbook every day almost. And I noticed that my husband is living within that agreement and the holidays come up and his gifts seem very generous and expensive. But I looked at the checkbook and everything seems to be okay. And then in late January, I get the credit card statements. And he has spent $1,200 on the credit card. And when I approach him, I'm like, sweetheart, what did you do? And he's like, well, I only spent $500 out of our account. I'm like, yeah, but you've put money on the credit cards. He's like, well, don't worry about that. We don't have to pay that for years to come. And that's exactly what the government's doing. But instead of my credit card, instead of the elected officials' credit card, they're putting it upon every one of your listeners' credit card, all the taxpayers. Well, Sheila, that's an apt illustration. In fact, that's exactly what's gone on here in the state of Hawaii. We are paying our payroll for our government employees on credit. But we're saying because we were able to use that money this year, the books are balanced this year. And so it sounds eerily like your illustration. But before we get into the weeds right now, tell us just a little bit about truth and accounting. It's been around in almost 20 years, I think. You founded it. What does the organization do? And tell us a little bit about some of the accomplishments. Well, what we do is I started it because I was very concerned about the citizens really having the financial information they need to be knowledgeable participants in their government. I found at the federal side, at the state side and at the local side, that citizens are not just giving information, they're giving the wrong information. So when they're deciding tax or spending policy, or even who to vote for, they're doing it based upon the wrong numbers.  So people think, oh, well, everything must be fine. I'll vote for these guys again. But what we find is that instead of everything being fine, they're charging things in essence to the credit card. And we really believe it's hurting our democracy, our representative forms a government. People are cynical. People kind of understand that something's amiss, and it really gets down to the basic bad budgeting and accounting. Now, your organization, Truth and Accounting, takes a look at the accounting practices of the government, as well as the way governments in our states carry out their financial reporting. You've got a wonderful website that has some comparative data. Can you tell us a little bit about that? Yeah, so what we do is, years ago, 11 years ago, we started issuing the financial state of the states. So that included analysis of every single state. And we calculate, here's your assets, take away your liability.  So we don't include capital assets. And we calculate the money needed to pay the state's bills. And then we divide that by the number of taxpayers and come up with a taxpayer burden. Well, the first year we did that study, people in Connecticut, it was the worst state because they have a lot of taxpayers, very few taxpayers and a lot of retiree health care debt. But they were upset because they're like, well, we have higher GDP or higher average salaries. So how dare you? So we created this data-z.org website that we have our numbers on it, but we also have 7,700 other data points. So you can compare the states based on their pension debt, based on the average attorneys in the state. We do find that the more attorneys you have in the state, the worse the state off. Unemployment, demographic, economic data, and voting information. So go on there. You can create online on demand of your own charts to compare your state with other states. Now, you take a look at everything in your approach to accounting. In other words, it's not just how much money do I have in my checking account, so how big a check can I write today as some people practice. You look at what a government might owe in five years or in 10 years, unfunded liabilities we often call them. And other things, you look at how much they're borrowing and so forth and try to bring all of these variables to bear upon coming up with a figure that tells us what the financial health of a government is. Isn't that right? Yeah, and what we do is we go to the state's audited financial report and we pull off their assets. As I say, we take off capital assets because you shouldn't spend those to pay your bills. We take off restricted assets and then we include the liabilities. Now you're mentioning that these liabilities are owed in a few years and I kind of would disagree with that. They are owed today. We get this from elected officials all the time. It's like, well, that pension debt, we don't need to worry about that. We're going to pay that off in years. Well, again, it's kind of like your credit card. Even if you choose to pay the minimum balance, minimum payments, it doesn't mean you don't owe the whole balance right now. So it's all the debt that they've incurred to date and that they're choosing to pay off in the future. If they really balanced their budget, they wouldn't have any debt to pay off in the future. They would have already paid it off. Well, Sheila, this is one of the first times I really enjoy being corrected. And I'm glad you did correct my language because, you know, you're absolutely right. We all start talking like our politicians sooner or later. We say this isn't due until such and such, but the reality is if it's due, it's due. You're helping us to take a hard look at our condition and, in a sense, you're like a financial doctor. Now, let me ask you about something because a lot of people place great faith in this, government accounting standards. Don't we have a system of government accounting standards that is supposed to tell us how finances are to be accounted for and how they are to be reported? And isn't this supposed to keep governments in check in terms of the reports that they make? Just so people, people might have heard of the Financial Accounting Standards Board. They set standards for corporations. So, you know, when IBM reports their numbers, they have to follow the generally accepted accounting principles set by FASB, the Financial Accounting Standards Board. Years ago, the Financial Accounting Foundation tried to have state and local governments start to follow those standards, but state and local government officials said, oh no, we're different than corporations. We can't live by those rules. So therefore, we're going to set up our own board. So they set up their own governmental accounting standards board. Right now, there are four people who currently are former government employees from around the country. And then there are two CPAs who have CPA firms that have large government clients.  So you could question the independence of this board, but that's who sets standards. And that board, and the reason we had to start doing the financial state of the states and doing the financial state of the cities is because that board for years did not require state and local governments to put their pension and retiree health care liabilities the full amount on their balance sheets. Fortunately, we got that change, but there's other improvements that GASB also needs to improve a change. There's something that you were actually instrumental in getting the GASB, the government accounting standards board, to change what it looks at. And I'm kind of shocked in a sense that they weren't looking at the pensions as well from the beginning because one would think as you used in your earlier analogy of household, you've really got to take account of all the financial information in order to know what your condition is. So in the news recently, there has been a disturbing movement in the GASB, and that is in terms of something they're doing now to alter the accounting standards. You've written about that recently and we at Gratitude Institute did a news release in which we referred to that yesterday. Do you want to talk a little bit about that? What is the concern in terms of some of the changes that are coming about right now? As I mentioned, previously governments were not required to put their pension, retiree health care, all of it on their balance sheets, on their government consolidated financial statements. And then we were able and recently within the last five years to get that change. So now governments have to put those liabilities on their consolidated statements. Fortunately governments don't budget on a consolidated basis, they budget on a fund basis, the largest one being the general fund. Well those statements don't have to include those liabilities. Those are still done using the cash basis accounting, again that thinking of your checkbook. It includes what goes into your checkbook and it includes only what comes out. So like in your state, in the general fund statements you will have a general fund balance, which to me means that you have extra money, but those don't include all your liabilities. So those are not a good, it might be good for cash management purposes, but the legislators and the taxpayers, there's long term commitments that have to be accounted for and those are not accounted for at the general fund level. Let me just interject something here. Does this mean that we're not really seeing the full picture when our government tells us we've got a billion dollar surplus at any given point? Yes, that's exactly right. The billion dollar surplus is based upon. It's a surplus might be, it's kind of related again back to your, you know, to the individual. It's like hey, I got a thousand dollars in my checkbook, ignore my credit card debt, but I do have a surplus in my checkbook and that's what's going on. Wow, this is so incredibly simple that it's frightening. We're going to have more questions for you when I come back from a brief break. My guest today is Sheila Weinberg. I hope you find what she's saying fascinating. She's the head of truth and accounting, a firm that she started that is exposing the truth about finances and our government. Don't go away. We'll be right back on Think Tech Hawaii. Thanks for staying with us. I'm Kayleigh Ikeena, president of the Grassroot Institute. My guest is my friend Sheila Weinberg, the founder of truth and accounting. And before we go on any further, we have such popular response to the program that our inbox is getting flooded with questions. I'm sorry that I won't be able to get to all of them, but I want to get to many right now and do a speed round. Sheila, can we do a speed round with some of the questions that have just come in? Sure, sure. First of all, does the COVID-19 pandemic excuse the high debt incurred at this time? Yes and no. I would say that governments know that crises are going to happen and they should have reserves set aside. And you mentioned that they theoretically had a billion dollars of reserves, but those numbers are all bogus. So they really don't have any reserves going into this crisis. Here's another one. Is there, and I chuckled, but I know you've addressed this actually in your own research. Is there a relationship between the number of attorneys in a state and the amount of debt incurred? On our data-c.org website, we do have the number of attorneys in each state, and we do find that there is a direct relationship. The more attorneys you have in the state, the worse financial condition you are.  That sounds like a fun correlation. I'm not sure whether there's a causality there, but it's an interesting correlation.  No comment from me on that. Don't mention it. Here's another question. Are there any issues that would warrant increasing the state debt? Again, you know, right now you're going to have- Are there any circumstances that would make it justified? Well, you know, they do borrow money for capital assets, and that I would say yes, kind of like, again, borrowing for your mortgage. And in our numbers, we don't include capital assets, but we also do not include debt-related capital assets. Right. And I would think that there's a big difference between short-term operating capital that needs to be borrowed for infrastructure or for some project versus our long-range condition. And you look at both of these, and we're not looking enough at the long-range. And again, you're really not- if you're borrowing money to pay your current expenses, you're really not balancing your budget. That's a total fallacy. Here's another question. How do we determine the accurate amount of debt that our government is incurring? One, you can go to our data-z.website. You can click on Hawaii, and we also do the financial state of the city. So you can click on Honolulu, and we prepare a financial state of the state or financial state of the city for each one of those. So you can get there. If you're looking at another government, you can go to their, as accountants call it, the comprehensive annual financial report. And you can find- there's a number in there called unrestricted met position, and you can find that. We have just- in case people really want to look into it, we have a video on YouTube called How to Read a Caffe, a comprehensive annual financial report, and that would walk you through how to read- even how to read your own governments. Great. Appreciate that tool. You know, I really want to get to a few questions to help us understand the transparency level of our government's reports here in the state of Hawaii. We recently, as the Gratiot Institute, submitted some testimony to the GASB pointing out that our state borrowed money to pay for payroll costs. Now, Sheila, how is this accounted for in our financial documents? And how should it be accounted for? Well, at the fund level, which would be your general fund and your budgeted fund, it would be counted as a resource, almost like recording loan proceeds as revenues. So it would be accounted for as an inflow and it would increase your balance. They would not show the corresponding debt you incurred on these general fund statements, but they would record the loan proceeds as an inflow, so they would increase the general fund balance. You know, we also recently noticed that our state is swapping money for debt, such as when the legislature last year took $250 million out of the rental housing fund and replaced it with debt. What do you think about this practice?  And again, you have a balanced budget, it's just not a mathematical thing. You have balanced budget requirements. Every state except for Vermont has a balanced budget requirement. The 75 most populated cities that we study have balanced budget requirements and they have them for very good reasons. Number one, so governments do not get unsustainable debt. And number two, so people can hold them accountable. IE, it was said best by a former Treasury official who said the politician shouldn't have the pain, the pleasure of spending. IE, I'm going to get a vote without the pain of taxing. IE, I'm going to lose a vote. And that's how why you have a balanced budget so you can hold your elected official accountable for what they spend. But if they can go ahead and borrow and pretend the budget is balanced by borrowing, they're circumventing the intent of the balanced budget requirements. Absolutely. And we could talk a lot about that. But I want to get to some other queries that have been kind of bugging me for a while. Looking at our state's financial documents at grassroots, we noticed that Hawaii lists capital assets, like buildings, bridges on the balance sheet. I'm not an accountant, but does this raise your eyebrow a bit? Well, they listed on the consolidated government wide financial statement. And they are saying, well, we have this road, it is providing us with some value. Now, there is an organization called Strong Cities that we were just talking to. I was on one of their webinars just last week. And they really believe all those capital assets are liabilities because you have to maintain them. And then the road eventually runs out. So they're putting these assets on their books, but they're not putting a offsetting deferred maintenance or, hey, we're going to have to replace these in the future on their books. They only have the asset, not the liability side. So this is another case of not having the whole picture in one document. Now, we've talked a lot about our state's unfunded liabilities, especially for its pension system. Currently, that's $14 billion approximately and $11 billion for our other post-employment benefits such as health. Are governments allowed to sweep this debt off the books as well? Well, as I say, for decades, most of that was put, that was not included on their balance sheets.  But now we're fighting to get that done at the general fund level. So again, if your government goes ahead and says, hey, we have a billion dollar reserve in our general fund, there should be a financial statement that says, yeah, well, you might be able to say that you have that cash reserves. But here's all the debt that is dedicated to that money. So you really don't have surplus money that can be spent. It's already dedicated to some of these liabilities you've already committed the government to. Well, you recently released information from Truth and Accounting about government reporting in all 50 states. Tell me a few more things about Hawaii that our average citizen or government politician may not really realize. Well, we calculate that the state has $16.1 billion that it needs to pay its bills. Again, this is the money that the elected officials have put on the taxpayers credit card that that averages to $31,700 per taxpayer. That works out to be about per household. We give the any state that has a taxpayer what we call a taxpayer burden each taxpayer share of the debt. We give a grade of if it if a state has $20,000 or more, we give them an F so your state received an F for its financial grade. And it is 47 out of 50 state out of the 50 states. So it is one of our, we never know whether to call it a bottom or a top sinkhole state. It's that bottom or it's the worst one of the worst that the third worst in the country. Now Sheila, we happen to rank in the bottom court oil and the bottom five even and sometimes the bottom one in numerous rankings of the economy, business climate and so forth. What does this mean in terms of your accounting for our finances our financial health, so to speak to be number 47 at the bottom out of 50 in practical terms. What does that really mean for our state. Well, what this means is that in the future, taxpayers are going to have to pay third more than $31,000 in taxes, and they're not going to receive any government services and benefits for those taxes. That's going to be used to pay off the credit card debt that's already accumulated.  We did just issue our financial state of the cities. Honolulu also received an F and was the third worst city of the 75 cities that we have studied. So I hate to give you even more bad news. So if you add those up, you know, you're talking 31,000 plus another 29,000, you're talking more than 60,000 for everybody who lives in Honolulu. This is what they're going to have. This is their share of the government's debt, you know, you can think of it as oh well this is an additional credit card that I'm going to have to pay in the future in the form of additional taxes. You know, I don't think most of the people in the state of Hawaii and most of our government leaders realize the impact of what you've just revealed. I remember back when I was in college studying economics at Northwestern University, I majored in what was Keynesian called Keynesian economics. I would often go down south into Chicago to visit the University of Chicago and listen to a professor there named Milton Friedman. You know all about him because you live in Chicago right now. There was a little restaurant near his office on campus called Tanstaffel, T-A-N-S-T-A-A-F-L. And to the informed, that was the definition of economics. Tanstaffel, there ain't no such thing as a free lunch. Sheila, I think you're telling us that's what's wrong with our accounting. Well, and it doesn't just have, it has not just financial implications, like in Chicago, Illinois. A state worker, when they get health care, because the state is so far behind in paying its bills, a state worker has to pay for their health care up front. And then the state will eventually reimburse them in six months to a year. And nonprofits have gone out of business because they've been counting on state money and they don't get it. So this does have, you know, it's having ramifications right now. And also the state and local governments are not being able to provide the services that people need and want from their government because they're having to cover these prior costs that have accumulated. And we've so far somehow dodged the bullet, but we may not be able to do that all the time because these costs are going to add up in the long run. Someone will have to pay. Sheila, let's shift gears now as we go to the close of our program. What are some best practices that Hawaii could institute in order to get ourselves out of our crisis? Well, at fact-based budgeting, follow-cruel calculations and techniques, you know, you should only include the revenues that you earn in your budget, not loan proceeds. You should include all the costs that are incurred, including those pension and retiree health care costs. And just so on our website, truthandaccounting.org, you can find fact-based accounting and fact-based budgeting on how to fix that. Tell our listeners and viewers once again how to get ahold of you and a little bit about your website. Yeah, truthandaccounting.org and our data-z sister website, data-z.org. On there, you can also sign up for our daily email morning call. And there is a donate button. We're 501-C3, so always looking for additional resources. So go to those websites and help us out. Sheila, thank you so much for your time today. I hope we can host you back in Hawaii again. And until then, keep up the good work. Thank you and thank you for your comment letter. And everyone, we want to thank you for tuning in today. Sheila Weinberg, founder and CEO of Truth and Accounting, has given us some great insights, insights we need to take to our own state government in Hawaii. Until next time, I'm Kelea Iakena, president of the Grassroots Institute on Hawaii Together on the ThinkTech Hawaii Broadcast Network, aloha.


Apple execs apparently think that updates to the next round of operating systems. So iOS 18, macOS 15, watchOS 11, TVOS 18, all the ones coming next year will be ambitious and compelling in their use of AI. Allison, how excited does this prediction get you? This does make me even more excited if they're digging into generative AI and going to have that, of course, be I'm sure on board on devices. If you've got the iPhone 16, you can do it locally, but if you've got an iPhone 12, no, you're going to have to use the cloud because you just don't have the compute power. But that would be very confusing to users if they did that.