As financial advisors, we never want to see a client run out of money, especially “on our watch” as the advisor. Which makes it especially challenging to deal with clients who appear to be spending “too much” and may be on an unsustainable spending trajectory… especially if you’ve done a comprehensive financial plan for them, and know that their current spending pattern is unsustainable. Even if it’s sometimes difficult medicine to give them – telling them that their spending and lifestyle need to change – it’s an essential value of good financial planning to deliver the sometimes-difficult message when it’s necessary to do so. Except, in some cases, it turns out that the problem isn’t actually that the client has a spending problem at all… instead, the real problem is simply that the client didn’t yet trust us enough to tell us about all their assets in the first place.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we explore situations where clients who have a “spending problem” actually don’t have a spending problem… they have a trust problem that leads them to be unwilling to share information about all of their assets with the advisor. A situation that may occur more and more frequently in the future, as the advisory industry continues to converge on the AUM model… and clients feel increasingly pressured to consolidate all their assets with their current advisor once the advisor “finds out” there are other assets he/she doesn’t already manage!
Learning that a client has been “hiding” assets can come as a shock for many advisors. It’s the situation where you thought you were being a good holistic financial planner, and giving them guidance about unsustainable spending, and then abruptly find out the client is terminating the relationship and consolidating all of their assets with another advisor. Which leads to three surprising and related realizations: (1) they actually had another advisor we didn’t know about, (2) they actually had other assets we didn’t know about, and (3) they weren’t actually overspending in the first place. We only thought they were overspending because they didn’t want to tell us about all of their assets for fear of being solicited about them!
And the reality is, as more and more of the advisory industry shifts to the AUM model and packages together financial planning and investment management, this problem is going to get a lot worse. When we look at the financial advisory market as a whole, about one-third of the 115 million US households are at least mass affluent, only about one-half of those have more than $100k that could be managed by a financial advisor (i.e., outside of a retirement plan), and only about one-third of those are actually delegators who are looking to hire an advisor. Which means, when you do the math, there may only be about 7 to 8 million households to divvy up among 300,000 financial advisors, resulting in about 21 clients per advisor (of which only 5 are millionaires!). Ironically, this means that if all clients did consolidate all of their assets with one advisor, many advisors would go out of business (or at least be compelled to pursue other advisor business models that can serve other types of non-AUM clientele!)!
Fortunately, in practice clients tend to split assets across multiple advisors (which keeps more advisors employed and engaged!), but clients don’t necessarily tell us, because they don’t want to be solicited to consolidate assets… which can result in a dysfunctional financial planning relationship in the process! For me, this led to the realization of the importance of being even more focused on leading with financial planning first, and to be less aggressive about insisting we “have to” be holistic and do “everything” for clients all at once. Because if clients can’t trust you to do the financial planning work first and build that relationship over time, then they may never have enough trust to consolidate their assets regardless. But if you can lead with financial planning and build that trust, then you can end up eventually winning all of their business in the long run anyway. Without clients feeling so pressured that they keep some of their assets a secret in a way that further undermines the planning relationship you’re trying to build.
The bottom line, though, is just to acknowledge that if you have a client who has a “spending problem” and is heavily overspending and just keeps ignoring your advice, it is possible they really have a spending problem, but it is also possible that they have a different problem – one where they don’t actually trust you and feel as comfortable with you as you may have thought, leading them to hide assets from you so that you don’t solicit them to consolidate. And as the industry continues to converge on the AUM model for providing both financial planning and investment management services, we’ll likely continue to see more and more clients with “spending problems” that might not actually be!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone! Welcome to Office Hours with Michael Kitces.
As you can see, I’m in a little bit different than usual location, as I was traveling this week speaking at a conference for Salesforce, and now I’m actually getting ready to teach the retirement section for Investments and Wealth Institute’s Private Wealth Advisor program.
But for today’s Office Hours, I wanted to talk about an unusual conflict I’m seeing that’s cropping up more and more as the advisory industry shifts to the AUM model. It was something that actually hit me personally in working with clients and I thought was worth talking about today.
The conflict that came up in our firm from a couple of years ago went basically like this. We had a client we’d been working with for a few years. They came on board back in 2004 to do retirement planning with us since they were retiring and rolling over at the time was a very nice $1 million retirement account. And we did the retirement plan to project the impact of their Social Security and their portfolio withdrawals to make sure that they could afford to retire and come up with an appropriate investment allocation, and then actually manage their retirement portfolio on an ongoing basis (because we’re a firm that does a combination of financial planning and investment management for a combined AUM fee). We do the planning and then we help you manage the retirement portfolio.
Except the problem was that this client was spending at a dangerously high level. They were getting about $4,000 a month in Social Security as a married couple, which, you know, back then was a pretty good number. They’d had good incomes over the years, but they were spending about $100,000 a year. So they were taking almost $60,000 a year plus their taxes from their $1 million portfolio, which if you do the math is about a 6% withdrawal rate and somewhat concerning. Technically, it still works more than half the time. The median historical safe withdrawal rate is actually pretty close to 6.5%, but most of us as advisors don’t sleep well at night when you do a Monte Carlo projection for a client and it shows up at like 60% or 70%. Theirs was just over 70%.
And despite all of our warnings, they wouldn’t change their spending behavior. They kept going. And after about 3 years of this, in 2007, they came and announced that they were terminating the relationship with us and consolidating their retirement account away to another advisor they were working with, which for me led to basically three big surprising realizations:
- They actually had another advisor that we didn’t know about.
- They had assets with another advisor that we didn’t know about.
- They didn’t actually have a spending problem in the first place.
We thought they were overspending because they didn’t want to tell us about the other assets because they were afraid that if they told us about the other held-away assets we would have pushed them to consolidate all of it with us, which is in retrospect probably true, we probably would have because that’s what we tend to do when we’re on the AUM model.
But the problem that I didn’t appreciate at the time is the conflict that crops up when clients don’t necessarily want to be solicited regarding other assets to be managed when we’re on an AUM model, so they may not tell us about all the assets because they don’t want to have that conversation, which then leads to a dysfunctional planning relationship because we don’t know about all the assets, which in retrospect for us was probably what blew up the relationship.
Because they weren’t unhappy with the work that we’d done. 2004 to 2007 was a good cycle in the markets, and investment performance was good. We’d given them good service. We were very proud of the planning work that we’d done, but they were tired of having us bug them as good advisors about their irresponsible spending because they knew they didn’t actually have a spending problem, they just couldn’t tell us that we were wrong because then they would have had to reveal the other assets that they didn’t want to reveal because they were afraid that we would solicit them to consolidate with us.
Is The AUM Model Too Overcrowded? [Time – 4:02]
And the reason I’m highlighting this problem is that as more and more of the advisory industry shifts to the AUM model and packages together financial planning and investment management, I think that this problem and the frequency of this problem is going to get a lot worse going forward from here.
As a little exercise in market sizing… There are about 115 million households in the U.S., roughly a third of them have at least $100,000 of investable assets outside their primary residence (that’s according to Spectrum research market sizing). This is the segment we call the mass affluent, at least $100,000 of investable assets. About 10% of them have at least $1 million, about 1% of them are ultra-high-net-worth, so $5 million or more.
Now, the truth is we can’t even work with all of those households. I guesstimate probably roughly half of them have that money tied up in an employer retirement plan that most of us can’t directly manage until they retire or otherwise separate from service and have a rollover opportunity.
And of course, not all of them are necessarily good prospects for us because some are going to be do-it-yourselfers who aren’t going to hire an advisor, some may occasionally want to hire advisors for advice incrementally or part-time but they don’t want to delegate all the investment management to us. Forrester Research has done some good work on this. Their estimate is only about a quarter to a third of all consumers are really delegators who want to fully delegate the investment management process to an advisor in the first place (those people that we usually call good clients because they’re easy to work with and they like to delegate to us).
So about a third of the households are at least mass affluent, but only half of those have money available outside of retirement plan, and only about a third of those are probably delegators who would have hired an advisor. So you go all the way through and you do the math, it ends out being about 7 or 8 million households. According to Cerulli, there are about 300,000 financial advisors in the U.S., which means if you go through that math, there are about 21 clients per advisor in that AUM model. That’s it, 21 clients per advisor, 5 of them are millionaires.
Ironically, that actually means that if all clients really did consolidate all assets to one advisor as many of us try for and ask them to do, a whole bunch of us would go out of business in the AUM model. I think the only reason why we can have 300,000 financial advisors chasing the same 7 or 8 million delegator or households is that basically, clients cheat on us, as those clients were. They split assets across multiple advisors and they don’t necessarily tell us about it because they don’t want to be solicited, which is technically good for financial advisor job opportunities. When each client hires multiple advisors, it keeps more of us employed, but it undermines the planning relationship.
Now in truth, it’s probably not quite as bad as I’m making it out because not all advisors are doing the AUM model right now. Some just do various financial products and don’t compete for managed accounts which means they may not literally be competing for that same pool of assets. So they may be working with other clients who need certain financial products but just don’t have investable assets in the first place. They just need life insurance or other assistance. Some advisors do hourly planning or retainer fees and serve other types of clients who don’t have assets to manage but will pay for planning from their income, or they’re just serving clients who have assets but don’t want to delegate the portfolio and just want to pay for other advice.
So we might not be competing for quite as narrow of a pie as I’m making it out. And that’s actually why I’m so upbeat about opportunities of other models like monthly retainer fees not to compete with the AUM model for AUM clients but to reach other clients the AUM model doesn’t serve, so that we don’t have to all be the same 300,000 advisors competing for the same 7 million or 8 million clients.
Nonetheless, as more and more of us converge on the AUM model and more and more advisors are approaching doing financial planning and investment management for 1% fee, the more we’re likely to have clients where we’re focusing on assets, they split assets, and we’re doing planning to add value but they’re not telling us about all the assets because they don’t want to be solicited, which undermines the planning and creates problems.
Deepening Trust And Backing Away From Soliciting Rollovers [Time – 8:05]
And the key point really is just to recognize that sometimes when clients have spending problems, it’s not actually a spending problem. That was what I missed in that client relationship. A lesson learned as we lost the client. Sometimes it’s actually a relationship problem in essence because they have other assets and they’re not comfortable telling us. That was the realization I didn’t have or discover until it was too late.
And it led from my perspective, to be even more focused actually on leading with financial planning first but to be less aggressive about trying to encourage clients to consolidate everything with us in a holistic relationship. Because I know that ultimately if we do good financial planning work and we give good advice and we have a good investment process, we do all the right things, eventually we’re going to win most of the business in the long run. And frankly, we have over the years. And to make sure we don’t lose money in the upfront planning work, we have investment minimums that we put in place. That’s just a necessary business reality to ensure that you have enough revenue per client to cover the overhead and the cost of doing business.
But in the past, regardless of our investment minimums, I’ll admit that I used to push more for, you know, a holistic nature of our relationship, both because I value holistic planning and holistically managing the portfolio and because it was good business to have clients do all their business with us. And now with a few more years of experience, I’m much more comfortable letting clients just start with us with a portion of assets where we’re doing all of the planning work that we do and some of the investment work, and use that to build trust so that they’re really open with us so at least they tell us about everything because we’re not pushing them to consolidate all at once, they don’t feel pressured, and then just do the good planning work where we know about everything and let our good work and our good service and our good planning results win the rest of the household relationship over time.
Because again, I’ll admit in my early years, I underestimated how much pushing (e.g., we have to be the holistic, we have to do everything together, we must work on everything all at once) and trying to be a good comprehensive advisor actually risked undermining the entire foundation of the client relationship because it made some clients not want to reveal everything, which then made an inaccurate plan and a very dysfunctional planning relationship.
So if you find yourself in this position, consider just how the advisor-client relationship can be impacted when you’re on the AUM model and you may be pushing too hard or harder than you realize for people to consolidate with you and be holistic and do everything with you all at once rather than getting to some productive working relationship with them and winning the rest of their business over time by just being good at what you do and delivering good results.
And if you actually have a client who has a spending problem and is heavily overspending and just keeps ignoring your advice, yeah, maybe they do have a spending problem, but if they were successful in accumulating assets in the first place to be working with you as a reasonably affluent individual, they probably actually have learned reasonable spending habits, which means this may be a different problem, one where they don’t actually trust you enough and feel comfortable with you as much as maybe you thought and they’re hiding assets.
I didn’t think this was happening until I found out it was. And now I’m a little bit more humble about the fact that sometimes when we think we have everything with the clients we’re working with, we don’t necessarily, and we still have to always be in the process of winning their trust. And I think that actually by being more flexible about not always working with them with everything all at once, we want to be holistic in the planning we do, but we don’t have to do everything in the portfolios all at once, that it’s actually improved the long-term advisor-client relationships that we have, which gets us to the point where they end up doing all their business with us anyways.
But in any event, I hope that’s helpful food for thought and perhaps a new take on a different potential issue to think about if you’ve got clients with spending problems that might not actually be spending problems, and just to understand that if you really want to be planning holistically with clients, recognize you have to build that trust and be careful about how much you’re pushing them to consolidate everything with you. You may cause them to hide assets in a way that undermines the whole thing in the first place.
This is Office Hours with Michael Kitces, normally 1 p.m. East Coast time on Tuesdays. Obviously, our timing was different this week because I’ve been speaking for Salesforce. Now I’m getting ready to speak for Investments and Wealth Institute’s Private Wealth Advisor program. But thank you for joining us, and have a great day, everyone!
So what do you think? Have you ever had a client you thought had a spending problem but was really just hiding assets from you? Does the AUM model lead clients to want to hide assets from advisors? How can advisors better gain the trust of clients so that they don’t hide assets? Please share your thoughts in the comments below!