General Planning

Planners have long recommended that clients save and invest, even while they have a mortgage, since the long-term return on equities generally exceeds the interest rate on a mortgage. Yet in reality, investors don't simply choose to invest in equities because the return is higher than a fixed alternative; instead, investors demand an equity risk premium over and above the risk-free rate to make equity investing worthwhile. For the traditional investor, the equity risk premium has represented the excess return of stocks over long-term government bonds. Yet for the mortgage borrower, the available "risk-free return" isn't just a government bond, but to prepay the mortgage and eliminate the interest cost! As a result, while the investor looks for an equity risk premium over government bonds paying 2%, the mortgage borrower actually shouldn't invest in stocks unless there's an expectation to earn an equity risk premium over a mortgage interest rate that might be 4% to 5%! Consequently, clients should prepay their mortgages unless they expect a full 9%-10%+ return on equities in the current environment that sufficiently rewards them for the risk! Continue reading "Why Keeping A Mortgage And A ... »

Determining a client's risk tolerance is a standard requirement in financial services, both as a matter of best practices, and regulatory minimums. In recent years, though, advisors have increasingly leaned towards doing the minimum required to assess client risk tolerance, due to the frustration that client risk tolerance itself has varied wildly through the bull and bear market cycles of recent years. However, a new study out using FinaMetrica risk tolerance data from before and after the global financial crisis joins a growing body of research suggesting that in reality, client risk tolerance is actually remarkably stable, and that what's changing through market cycles is not the client's risk tolerance, but instead risk perceptions. The significant implications of the research are that planners struggling with unstable client investment behaviors around risk  - e.g., buying more in bull markets and selling out in market declines - may actually need to focus more on managing risk perceptions, rather than blaming the instability of client risk tolerance. Continue reading "Markets May Be Volatile, But ... »

What is the value of financial planning? What do you get from it? What does it really do for you? Historically, the profession has tended to answer these questions with explanations like "financial planning brings you peace of mind" and "financial planning gets you on track for retirement [or other] goals." The problem is that these results are intangible and long-term, which makes them hard to define clearly and difficult to be held accountable to over a relevant time period. In fact, arguably one of the greatest challenges for the advancement of financial planning is our inability to clearly explain the value proposition and what clients will get out of it. So what's the solution? Financial planning needs to redefine itself from long-term intangibles to short-term tangible results; after all, clients who can really see that the outcome of the planning experience has benefited them become true advocates of our services, and build the habits that ultimately lead to long-term success! Which in turn raises the question: what are some short-term tangible results we can establish to better demonstrate the value of financial planning?

Continue reading "Would Financial Planning Be ... »

Making decisions about trade-offs that only have distant, future ramifications, and deal in abstract projections can be difficult for clients. Yet while we can always revisit decisions as time passes, the reality remains that in order to establish a plan in the first plan, we need to assess such uncertainties and make some initial decision. Would you rather have a plan that has a little risk of spending cuts and a high probability of excess wealth, or a plan with lots of risk of spending cuts that is less likely to leave over wealth you failed to use during your lifetime, none of which will be relevant for years to come? How do you weigh the risk of spending cuts against terminal wealth, or the volatility of a portfolio against the future impact it may have on spending? Recent research suggests a new way to evaluate these problems, adopting utility functions that have been applied elsewhere in economics to the financial planning world, and opening up a new body of research in the process. While we may still have a ways to go before utility functions become commonplace in planning, this may be an early glimpse at the future of how we craft recommendations for clients... at least, if we can overcome some hefty hurdles, first. Continue reading "Utility Functions in ... »

As financial planners, we have a drive to see our clients succeed, as both a mark of successful financial planning, and because no one wants to be the planner whose clients fail (for both personal fulfillment and legal liability reasons!). As a result, planners often encourage a steady path that may entail some "prudent" risk, but nothing excessive. Yet this often puts planners in a difficult position with very entrepreneurial clients, who often take significant career, business, and financial risks in an effort to build their businesses and significant wealth. Even if the planner is not directly responsible for the entrepreneurial client's business outcome, we don't necessarily want to be there when it all falls apart, either. In fact, if the client has a choice between an entrepreneurial venture or a salaried career, the planner typically recommends the path of lesser risk; it's just prudent, good planning. Yet in the end, does that mean good financial planning actually discourages entrepreneurship and makes it nearly impossible for clients to actually accumulate very significant (e.g., $10M+) wealth? Continue reading "Does Good Financial Planning ... »

In December, Congress passed the Temporary Payroll Tax Cut Continuation Act of 2011, which extended the 2 percentage point payroll tax "holiday" of 2011 into the first two months of 2012. However, to offset the nearly $20 billion cost of the payroll tax cut extension (along with a few other provisions), Congress adjusted the so-called guarantee fee charged by Fannie Mae, Freddie Mac, and the FHA, mandating that the fee must rise by at least 10 basis points. The new g-fee increase is set to apply beginning on April 1, 2012 (no fooling!), and its effects are already being felt as borrowers look to set 45- and 60-day rate lock guarantees on current purchases and refinances. The net impact to clients: if there's a purchase or refinance being considered, it could be worth many thousands of dollars to get the loan done as soon as possible. Continue reading "Looming Mortgage G-Fee ... »

With stocks experiencing a lost decade, bonds barely keeping up with inflation, and savings accounts generating virtually no yield at all, it is a daunting environment for clients to save and accumulate. Many question whether saving is even worthwhile; if the client can't earn anything on money saved, there's little economic benefit to delaying gratification, and the incentive is to just spend it now. On the other hand, low returns also mean that if the client ever hopes to retire, it may require more saving than ever, given that low returns mean less compounding. And so the real question for Generation Y - today's young adults - is which way will it go: will low returns disincentivize saving, or help people redouble their efforts to save even more?  Continue reading "Are Today's Low Rates Making ... »

As a country, our national savings rate is among the lowest in the world, and in practice the average American struggles to save much of anything. A recent survey by the National Foundation for Credit Counseling indicated that 64% of Americans don't even have enough cash on hand to handle a $1,000 emergency expense. The standard advice of financial health to address these problems is to "Spend Less, and Save More" or its extended version, "Spend Less Than You Make, And Save The Rest." Yet notwithstanding the nearly universal nature of this advice, it doesn't seem to be having much of an impact. Perhaps the problem is because in reality, the advice just isn't specific enough to be actionable, and as a result it's ineffective. In other words, if we really want people to spend less and have more money left at the end of the month, what we need to do is not just tell people to "Spend Less, and Save More" - we actually need to tell them HOW to spend! We need to create the "food pyramid" of recommended spending!

Continue reading "Is "Spend Less, Save ... »

It's a common financial planning challenge - the planner provides recommended action items for the client to implement, but the client struggles to follow through on them. In some cases, it may be because the client doesn't really believe the recommendations are best; in others, it's a matter of trust; but in most, it may simply be a matter of "buy-in" to the action items (or a lack thereof!) in the first place. After all, it's easy for a client to procrastinate about implementing recommendations if the client isn't really committed to them in the first place. But as it turns out, just a few small changes to the process of delivering action item recommendations by inviting clients to physically write down part of their commitment can potentially increase client buy-in and follow through. Continue reading "Simple Steps For Better ... »

Clients who need to improve their prospects for retirement generally have three options: spend less, save more, or retire later. Technically, there is a 4th option - grow faster - but it is typically dismissed due to the risk involved in investing for a higher return. In practice, clients rarely seem to dial up the portfolio risk trying to bridge a financial shortfall in retirement, and taking out a margin loan just to leverage the portfolio to achieve retirement success would most assuredly be deemed imprudent and excessively risky. Yet at the same time, a common recommendation for accumulators trying to bridge the gap is to keep any existing mortgages in place as long as possible, directing available cash flow to the investment portfolio, and giving the client the opportunity to earn the "risk arbitrage" return between the growth on investments and the cost of mortgage interest. There's just one problem: from the perspective of the client's balance sheet, buying stocks on margin and buying stocks "on mortgage" represent the same risk and the same leverage, even though our advice differs. Are we giving advice that contradicts ourselves?

Continue reading "Why Is It Risky To Buy ... »

The legacy that Steve Jobs left behind last week as he passed away has been truly astounding; an outpouring of emotion and tribute from the world that is rarely seen outside of the death of beloved religious or political figures, as so many were touched by the technology that he created. And at the same time, criticisms have emerged as well - painting Jobs as a relentless micromanager with an obsession for ensuring that everything was exactly as he envisioned it. Yet the outcome of his process seems clear - a melding of incredible vision, and the execution of that vision which created tools we didn't even know we wanted or needed and made them an irreplaceable part of our lives. Perhaps the most amazing part, though, was the sheer simplicity and intuitive nature of the technology; although the design of Apple devices pushed the limits of what we can build and create and were based on incredible complexity, the customer experience was unparalleled in its simplicity. Which leads me to wonder... what would financial planning look like if we were as obsessed about the client experience as Steve Jobs was? Continue reading "What Would Financial ... »

Borrowing money to invest is a risky thing for individuals to do. While it's a common path for businesses - borrowing money to plow into investments, infrastructure, staff, expansion, etc. - it is done in part because business structures allow for limited liability; in other words, we often borrow in business specifically because the debts cannot track back to business owners the way individual borrowing can. Accordingly, for most individuals, the only major debt that is taken at all is a mortgage to purchase a house, and only because that's a "long term" investment (and because we couldn't afford a house any other way); most other forms of individual debt are considered "bad" debt and only used as a necessity to be paid off quickly (e.g., credit cards or auto loans). As a result of these attitudes about debt, I'm not certain I have ever seen a financial planner tell a client "since you're low on cash flow right now, you should take out a loan so you can have money to buy stocks in your 401(k) this year." Tax deferral on retirement contributions aside, it's just viewed as too risky by most to borrow money just to invest in equities in a typical investment account. There's just one problem... by telling clients to keep their mortgages as long as possible while building their retirement accounts, we're doing the exact the same thing: telling clients to invest in the stock market by borrowing.  Continue reading "Should You Ever Take Out A ... »

A recent common refrain at conferences is that when done best, financial planning is a process, not an event - meaning that financial planning is not about delivering "THE plan" at the end, but about the ongoing process of continually aligning money with goals as life and circumstances continually change. In turn, this implies that the value of financial planning will be rooted in the ongoing experience that the client has while engaging in the planning process. But how good is that experience, recently? Perhaps not so great... as one researcher's recent focus group described financial planning as feeling "like a mix between a dental visit, math class, and marriage therapy." Ouch. Continue reading "Is The Financial Planning ... »

Some financial planners consider budgeting and cash flow the cornerstone of a client's financial plan; for others, the focus is on long-term planning, and they let client cash flow sort itself out. In many situations, planners seem to be uncomfortable in giving spending guidance to clients; as the saying goes, "It's their money; who am I to tell them how to spend it?" Yet at the same time, most would probably agree that clients can't just save their way out of their fiscal woes; you only free up money to save by first determining what to NOT spend it on. So does that mean in the end, planners can't have a broader impact until they are more active in helping clients actually set spending policies? Continue reading "Should Planners Have A More ... »

As is often said, "financial planning is a process, not an event" and therefore is predicated on an ongoing relationship between the planner and the client. Yet the in-depth nature of a financial planning relationship presents challenges as well; it takes more time, it costs more money, and it becomes less accessible to many who either can't afford or don't want such a 'deep' relationship. But does it have to be this way? Could financial planning still deliver value even if it's NOT an ongoing relationship with an individual financial planner? Continue reading "Does Financial Planning HAVE ... »