While Financial Plan is fully independent and separate from Pershing, we chose this business relationship after careful consideration of all custodian options.
What does a custodian do?
A custodian has physical possession of a client’s financial assets and is responsible for their safeguarding. Services provided by Pershing include holding client accounts, providing monthly account statements, tax reporting, facilitating trades at our direction and providing a dedicated service person to assist us with completing complicated transactions for our clients.
Pershing has been a leading global provider of financial custody services for over 80 years and serves many of the world’s most respected financial organizations.
Importantly, by holding our accounts with Pershing which has no proprietary products of its own, Financial Plan is able to maintain the high level of integrity our clients expect and deserve without conflicts of interest.
In February of 2003 we contacted a mutual fund company called Dimensional Fund Advisors (DFA). We were interested in their approach, but to be able to participate we were required to undergo a thorough review process. DFA is quite selective about whom they do business with. They require that an advisory firm has a disciplined, passive low turnover approach and is fee based. Upon approval, we were one of only three advisory firms in Washington State who were accepted to do DFA business.
This was highly unusual because in every other instance mutual fund companies called on us to convince us to to sell their funds to our clients. In fact almost everything about DFA proved to be different:
Neither Active Nor Passive
DFA board member and Nobel Laureate Eugene Fama developed the efficient markets hypothesis (EMH) in his doctoral thesis. An adherence to the EMH causes DFA to avoid a predictive approach which is widely used by active managers. Although not active, DFA management is not passive either. DFA develops massively diversified baskets of securities without the need to slavishly trade based upon the reconstitution of indexes. This results in low cost mutual funds with turnover rates generally lower than that of the benchmark indexes. In 1993 The Fama/French Three Factor Model was created by DFA board members Eugene Fama and Kenneth French. The model expanded on the Capital Asset Pricing Model (CAPM) by adding size and value factors to the market risk factor in CAPM. The Three Factor Model considers the fact that value and small-cap stocks outperform markets over long time periods. In 2012, Fama identified a fourth direct profitability factor, illustrating that in aggregate, companies with higher free cash flow outperform the market.
Sellers of stock shares are often impatient, causing them to sell large blocks all at once; not all of which can be sold at the current market price. Due to market push, each lot of stock is sold at an ever decreasing price. As a patient buyer, DFA takes advantage of that. When selling shares, DFA is patient, often selling over long periods of time to avoid the results of market push.
Active managers are compelled to buy and sell specific companies as a result of their security research, while passive index fund managers are compelled to buy specific names on specific dates in order to precisely match changes in their benchmark index. By contrast, DFA is flexible regarding which company shares they trade and the timing of those trades. This flexibility results in better pricing and lower trading frictions.
Active managers typically trade frequently. This high turnover rate is a major component of cost. High turnover is not always the fault of a mutual fund manager, however. Flighty investors who move money in and out of mutual funds can force a fund to buy and sell securities within the portfolio. To combat this, DFA does not offer shares to the retail investor unless they work with an approved advisor or meet very high minimums. Typical minimums are $2 million. In this way, investors in DFA funds enjoy exceptionally low turnover rates.
Financial Plan periodically reviews the 529 College Savings Plans of the fifty states. For clients who are residents of a state with an income tax, there can be advantages to investing in that state’s plan. For residents in a state without an income tax, such as Washington State, there is little motivation to restrict the selection to the home state. Our criteria in the selection process include the mutual fund companies that manage the plan, the internal investment costs, and the fee that the state exacts from the plan. Over the past ten years, Financial Plan has changed the plan that we use twice. Currently we are placing our clients into the Utah Educational Savings Plan (UESP) for its access to Dimensional Fund Advisors and Vanguard funds, its low internal costs, and the low fee .2% fee charged by the State of Utah.
Financial Plan has contracted with Morningstar as our research engine. Morningstar provides us with robust portfolio management and performance reporting, advanced research capabilities, sophisticated investment planning, and secure client communications using our Morningstar Portal.
The Morningstar Portal is one of our three client portals. It provides data including daily value of all accounts, overall asset allocation, a breakdown of assets by global region, and a breakdown of accounts by tax status. The details of each account can be viewed, including data on equity holdings such as expense ratio, turnover ratio, book to market ratio, current dividend, and total return over one year and five years. For bond holdings, data on interest rate, credit equality, duration and maturity data are also displayed. All transactions are listed including advisory expenses, and a cumulative time-weighted return chart for each account is displayed.
Financial Plan has contracted with By All Accounts to aggregate held-away accounts together with our custodial accounts. This makes it possible for Financial Plan to view holdings and effectively trade on an account regardless of where it is held. For example, in addition to accounts that are held at our custodian TD Ameritrade institutional, we manage held-away accounts such as Fidelity and Vanguard 401k plans, TIAA insurance policies, Utah 529 plans, Vanguard fee-only annuities, TRS plans, and others. The ability to aggregate is of importance in regard to objectivity: at times we will advise a rollover from a 401k to a TD Ameritrade IRA, or a “reverse” rollover from a TD Ameritrade IRA to a 401k. When we manage all accounts, regardless of where they are held, rollovers cause no change to our revenue. This eliminates a conflict of interest.
Financial Plan has contracted with eMoney to provide a robust investment and tax engine to assist in our financial plans. eMoney provides an intuitive interface, making it easy for advisors to illustrate various aspects of financial plans, including the balance sheet, cash flow statements, straight-line projections for the future, and Monte Carlo projections. Our Plan Dashboard is a personal website that allows clients to view their financial plan online. Important documents can be stored in the website vault. All information is protected behind a firewall and doubly encrypted.