Written by: Thilan Kiridena, ChFC® | Capital Elements Advisors Inc.
A framework for Financial Advisors to guide conversations with today's professionals.
In a world where "financial advice" is hard to define, most early to mid-career professionals question the value of working with a financial advisor. That is until some life event drives them to a deeper conversation.
While certain algorithms and automation can and will help clients get particular investment and planning advice. My personal belief is that the human element in advisory services will have a significant impact on our industry as we advance. But it will favor the practitioners who look at "wholistic" solutions that best fit clients rather than pushing the product agendas of institutions.
Robo-advisors and digital solutions have shaped our industry for over a decade. Therefore, we now have enough data to make an educated guess at least to predict the medium-term outlook. A 2022 Vanguard Group report by Paulo Costa and Jane Henshaw (https://advisors.vanguard.com/investors-view-on-advice/client-loyalty) studied 42 micro-interactions impacting advisor-client relationships. And out of the top 10 factors that favor human advisors the most, what caught my eye was the interaction "Encourage me to take the level of risk that is right for me."
When you think of it, most advisors don't spend too much time explaining "risks" to clients, yet it is one of the more critical "value additions" we can make.
This is the first article I wrote for the FPA NextGen viewpoints. I thought of it as an exciting topic to kick off my contributions. The following are five categories of risks (and related sub-categories) that I try to educate my clients on:
1. Longevity
Our lifestyles have an increased focus on health and well-being compared to older generations. This, coupled with advances in life sciences and healthcare services, has generally increased aging. The US Census reports that the over 65 age group in America has grown more than 34% over the past decade. Most clients take It for granted that they have the ability to work. A hard conversation that needs to be initiated is to ask them about the risk of living too long. If they are to retire in their 60s, do you have the means to support them until your 90s? Longevity "multiples" various other risks but mainly affects:
- Healthcare needs at an older age: Increased aging in today's world may not guarantee "healthy" aging. Therefore current generation is also likely to pocket much larger healthcare expenses during their lifetime than previous generations.
- Long-term care needs: If your clients have seen aged grandparents and parents, they will likely be familiar with some form of assisted living. Again the longer you live, the higher the likelihood of the need for LTC services.
2. The need for Diversified sources of Income/Wealth
Traditionally, we have looked at directing income into savings and financial investment to build wealth. But in today's day and age, the life cycle of skillsets is so short that individuals need to reinvent themselves several times during their working career. Are they doing what's necessary to ensure they have diversified sources of income? This might encourage clients to build multiple skillsets and/or look at a diversified portfolio of investments (not just financial ones).
- Will Social Security be Enough: The Social Security Administration estimates that 97 % of older adults (aged 60 to 89) either receive Social Security or receive it. Current Social Security Liability is around $22 Trillion, and Medicare Liability is $34 Trillion.
This is a much larger topic that I will write about in the future and will direct interested readers toward the SSA Policy Document, which states:
"There is no one clear solution to the problem of increased cost for retirees because of fewer workers available to support the retirees, which in turn is caused by lower birth rates. This issue is not specific to Social Security, but also affects Medicare as well as many other private and public retirement income systems. The decline in birth rates has been far more dramatic in Japan and many European countries that are struggling with the effects of aging populations because of declines in birth rates even more severe than in the United States"
3. US Government Debt and policy on taxation
The US Federal Government has $28.43 trillion in Debt. That is 127% of the GDP. This number is estimated to be increasing by USD 3.5 BILLION daily. Taxation, therefore, is not a republican or democratic issue but rather an American issue. Will the tax policies change? Will significant changes in the tax tables impact your client's ability to save/invest/withdraw? Do they have enough understanding of the IRS Code and its provisions that support building a nest egg for the long term?
4. Inflation
Milton Friedman once said: "Inflation is a tax, which is imposed without representation, and which nobody has to vote for.". We all know the basic concept of deterioration of purchasing power. By looking at international examples, we see that actions of the fed in printing money and, more specifically, the rate at which money Is printed can affect economies. Monetary actions determine how much dollars chase real assets and can cause inflation, deflation, and in specific environments, hyperinflation.
- Interest Rate: Generally, higher interest rates are a policy response to rising inflation. Conversely, central banks may lower interest rates to stimulate the economy when inflation falls, and economic growth slows. Most clients may not correctly understand the variable interest rate debt (or income streams) they have in their portfolios.
5. Marker Risk and Volatility
Most advisors are used to showing a 20 to 30-year graph and stating, "Oh, markets go up and down, and on average, it has gone up by "X" % over the past "Y" years." While this is true, volatility is a concept we do not discuss. Suppose markets are up by 15% in one year but are down 20% the following year. Will clients have the patience to execute continuing investments? Do they clearly understand the timing of withdrawals to fund their goals? Be it a down payment for a home, start a business, fund education, or take withdrawals for day-to-day expenses.
- Order of Returns: Some professionals call this the sequence of returns. Over the long term, I believe the overall market will do well and have more "up" than "down" years. However, our clients must be aware of the order in which they need returns. If portfolio withdrawals are the main cash flow for their daily expenses, they will have no option but to withdraw. But withdrawing a more significant portion in a down year will also considerably impact future years.
Related: Planning for Lifetime Income in Retirement
Thilan is the Founder/CEO of Capital Elements Advisors Inc. A New York-based financial advisory firm specializing in Life Insurance Premium Financing and other structured financing solutions for Small Businesses.