Someday Rich E-Book

Timothy Noonan

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 526

Veröffentlichungsjahr: 2011

Beschreibung

To truly be successful, today's financial advisor must strike the right balance between effectively engaging with his or her clients and finding meaningful ways to maintain their financial security. By framing your mission in this way, you can help your clients clarify their vision, build a plan to achieve it, and manage that plan so they stay on track. Nobody understands this better than authors Timothy Noonan and Matt Smith--two seasoned financial professionals with over five decades of combined experience working in the asset management business. And now, in Someday Rich, they show financial advisors with clients who are rich, or have the opportunity to become rich, how to sustain a client's desired lifestyle to, and through, retirement. Engaging and informative, Someday Rich provides the context, description, and implementation suggestions for the Personal Asset Liability Model--a process that will allow you to determine a client's funded status relative to their future spending needs as well as develop and monitor their investment plan accordingly. While the methods in the Personal Asset Liability Model may not have been practically accessible to past advisors with a large number of clients, this model now brings together the technical methods to answer important client questions in a way that is feasible and includes the communication strategies that can make the delivery of the advice model more effective. Along the way, this reliable resource discusses the business of giving good advice and addresses how to incorporate these steps into a client engagement road map. Insights on various other issues associated with this discipline are also included, such as how to develop client trust and deliver personalized service when you have so many clients, and contingency risks--life, health, disability, and long-term care--that need to be considered in the financial planning process. And in later chapters, single-topic essays, contributed by experts in the financial planning field, cover issues ranging from target date funds and the investment aspects of longevity risk to modern portfolio decumulation. Building more valuable relationships with your clients is a difficult endeavor. But with Someday Rich, you'll discover what it takes to achieve this goal as you put them on a path to a sustainable financial future.

Leseprobe

Contents

Cover

Series

Title Page

Copyright

Dedication

Foreword

Preface

Acknowledgments

Introduction

HOW THE BOOK IS ORGANIZED

Chapter 1: Time for a Real Conversation

THE GREAT EQUALIZER

IN SEARCH OF A REAL CONVERSATION

SUSTAINABILITY

THREE QUESTIONS

THREE ANSWERS: THE PERSONAL ASSET LIABILITY MODEL

FOCUSING ON THE RIGHT THING

NOTES

Chapter 2: How We Got Here

DEMOGRAPHICS: THE BABY BOOM

INCREASING LONGEVITY

INCREASING HEALTH-CARE COSTS

DECREASING WORK-LEISURE RATIO

LOWER SAVINGS RATES

SOCIAL SECURITY

REDUCED EMPLOYER-SPONSORED RETIREMENT

OTHER FACTORS

WHERE DO WE GO FROM HERE?

NOTES

Chapter 3: The Right Clients

FIVE QUALITIES OF VIABLE CLIENTS

WHY THE URGENCY ABOUT CLIENT SEGMENTATION?

FEASIBLE CLIENTS

IN THE WEDGE

THREE CONVERSATIONS

BUSINESS ISSUES WITH BEING OBJECTIVE

MOVING ON

AGE

NOTE

Chapter 4: Connecting the Dots

DASHBOARDS

ADVISORS SEEKING HELP

TECHNICAL FOUNDATION PILLARS

NOTES

Chapter 5: The Personal Asset Liability Model—Funded Status

RETIREMENT REALITY CHECK

TAX CONSIDERATIONS

DETERMINING THE FUNDED STATUS

OTHER CONSIDERATIONS WHEN DETERMINING ASSETS

OTHER CONSIDERATIONS WHEN DETERMINING LIABILITIES

FOUR APPROACHES TO CREATING A SPENDING PLAN

NOTES

Chapter 6: The Personal Asset Liability Model—Investment Plan

WAYS TO IMPROVE THE FUNDED STATUS

USING AGE AND FUNDED STATUS AS A GUIDE TO ASSET ALLOCATION

APPLYING THE MODEL

WHEN TO ANNUITIZE?

SUMMARY OF FACTORS INFLUENCING PORTFOLIO RISK

GOALS-BASED REPORTING

Chapter 7: Making a Good Business of Giving Good Advice

CHARACTERISTICS OF A SUCCESSFUL ADVISORY PRACTICE

CHARACTERISTICS OF GOOD ADVICE

EXTERNAL FACTORS

INTEGRITY

FROM EFFICIENT FRONTIER TO CLIENT ENGAGEMENT

THE ROADMAP

A LOOK AT THE NEW APPROACH

BENEFITS OF USING THE ROADMAP

NOTE

Chapter 8: Investor Archetypes

PERSONALITY TEMPERAMENTS

NOTES

Chapter 9: Tripping Over the Finish Line

RETIREMENT CONFIDENCE

SOCIAL SECURITY UNCERTAINTY

OTHER INSURABLE RISKS

AGE-RELATED COGNITIVE DECLINE

NOTES

Chapter 10: On Shaping One's Future

PROFESSOR BANDURA'S PRESENTATION

NOTES

Chapter 11: Building a Simple and Powerful Solution for Retirement Saving—Russell's Approach to Target Date Funds

TARGET-DATE FUND BASICS

THE HUMAN-CAPITAL MODEL AND GLIDE PATH

DETAILS OF RUSSELL'S GLIDE PATH

EVALUATING THE GLIDE PATH

PROVIDING FOR THE ATYPICAL INVESTOR

FROM GLIDE PATH TO TARGET-DATE FUND

CONCLUSION

ABOUT THE AUTHORS

NOTES

Chapter 12: Investment Aspects of Longevity Risk

WHY LONGEVITY RISK NEEDS TO BE UNDERSTOOD

LOOKING AT LONGEVITY DISTRIBUTIONS

ANALYSIS OF THE RISK OF A FIXED IMMEDIATE ANNUITY

THE DESIRABLE FEATURE OF FIXED IMMEDIATE ANNUITIES

HOW LARGE AN ANNUITY DO YOU NEED, AND ARE THERE OTHER SOLUTIONS?

ACKNOWLEDGMENTS

NOTES

Chapter 13: Mismeasurement of Risk in Financial Planning—A Lesson in Risk Decomposition

A BRIEF HISTORY OF FINANCIAL PLANNING TOOLS

BEWARE THE RISK MEASURE

A BRIEF HISTORY OF PROBABILITY THEORY

RISK DECOMPOSITION

ILLUSTRATIONS

IMPLICATIONS

METHODOLOGY DISCLOSURES

NOTES

Chapter 14: Modern Portfolio Decumulation*

EXECUTIVE SUMMARY

APPROACHES TO MANAGING LONGEVITY RISK

A DIFFERENT MEASURE OF RISK

A FRAMEWORK FOR PORTFOLIO DECUMULATION

CONCLUSION

APPENDIX 14A OBJECTIVE FUNCTION FOR LIFETIME PORTFOLIO DECUMULATION

APPENDIX 14B COST TO ANNUITIZE AN INCOME STREAM

ACKNOWLEDGMENTS

NOTE

Appendix A: Lessons Learned from Retirement Income Research

SOURCES OF INFORMATION

Appendix B: The New Language of Retirement

OVERVIEW OF FINDINGS

About the Authors

Index

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Copyright © 2012 by Timothy Noonan and Matt Smith. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Noonan, Timothy, 1963- Someday rich: planning for sustainable tomorrows today / Timothy Noonan, Matt Smith. p. cm.—(Wiley Finance series) Includes index. ISBN 978-0-470-92000-8 (cloth); ISBN 978-1-118-16749-6 (ebk); ISBN 978-1-118-16751-9 (ebk); ISBN 978-1-118-16752-6 (ebk) 1. Finance, Personal—United States. 2. Financial security—United States. 3. Financial planners—United States. 4. Portfolio management—United States. 5. Financial services industry—United States. I. Smith, Matthew X., 1961- II. Title. HG179.N57 2011 332.02400973—dc23 2011029930

For the remarkable Madeline and Genevieve Noonan, the full realization of their potential in the world is the object of my labor. —Tim

To my parents Paul and Nancy Smith, whose love and support made it possible for me to follow my own path. —Matt

Foreword

I would love to have written this book. But I wouldn't have done half as good a job.

The two authors are veterans, with many decades in the business of individual financial planning and helping wealth advisors in two ways: how to do more sensible things for their clients and how to run an efficient practice. And their experience shows, in the wisdom that this book contains.

It is written ostensibly for the advisor, but for many reasons it is of great appeal to me, the client.

If you are an advisor, they show you what are the characteristics of a successful practice, including how to get the market to find you. (Now there's unusual thinking—but it's how the market works. People are always asking, “How do I find a great advisor?”) They tell you what makes advice valued by clients, and how to build a roadmap that systematically gets everything discussed and done. They have lots of examples and input from teachers and from successful advisors. They even include education in stand-alone chapters by other experts at the end, going into further detail. (And I'm delighted to find some of my own early, exploratory writing on longevity risk, the uncertainty about how long we'll live—how nice!)

All of that is far beyond my own experience. So I come at this from a different perspective. I'm not an advisor, I'm a client. Of course I want my advisor to be successful; the relationship won't last otherwise. But what that takes, I don't know. The authors do, and that's a big part of this book.

For my part, I start with some questions.

Am I rich? (I use “I” to mean my wife and me together: we're an indivisible unit.) I like the authors’ definition of rich—it's not an absolute number, it just means that I'll have something to leave after I'm gone. If so, my assets will support my lifestyle for as long as I live. And that will be a huge relief to me, and a wonderful achievement. The whole book is based on that as its fundamental premise. Good!

The focal point of the authors’ assessment of richness is based on a measure that technicians have long used in defined benefit pension plans: the funded status. First, calculate how much money, how large an asset base, it will take to support the client's lifestyle. (They show you how.) What proportion of that amount do the client's actual assets represent? That's the funded status. Above 100 percent is rich, below 100 percent requires action. Well, above 100 percent also requires action, but there's a clear psychological dividing line between striving for security that you don't yet have, and buttressing security that already exists.

What's my role in all of this, as the client? I need to understand myself: my lifestyle, my goals, my psychological make-up, my decision-making quirks, how I am likely to react to good times and bad. I don't need to know as much as the advisor. I don't need to be able to create the advice myself; I do need to know enough to assess the advice I'm given, and challenge it. And then, when we agree on a plan and its implementation, I have to share responsibility for its acceptance. This is a partnership.

There's homework to be done. This book gives me the education and the tools, including fascinating insights into different human temperaments. I don't just want a good advisor; I also want to be a good client. As far as the relationship is concerned, I'm glad to find that my needs and goals are the focal point of the advisor's advice and actions. I don't want a conflict of interests. All of that becomes clear.

OK, now I'm ready. Talk to me, discuss with me, plan with me, advise me, implement my plan, monitor progress with me. As Dr. Frasier Crane used to say, “I'm listening.”

DON EZRANovember 2011

Preface

The title of this book is Someday Rich because this is a book about people who are rich or who are becoming rich. It is written for advisors who serve them, and yet, as the central thesis of the book will detail, there is no good giving of advice without skillful receiving of it.

There is a tension with how-to books. Some are so technical that readers disengage. Others try to engage the reader through story telling or analogy, which runs the risk of not having enough practical advice so the reader has any chance of reaching a materially better outcome.

We want to strike the golden balance between those two approaches; to have enough engagement to allow the advisor to be a more effective conversation partner with his or her client, but also to have enough engineering to be able to link that conversation with real knowledge about the probability of success or failure.

If you want to read about engineering approaches to superior income distribution techniques there are better places to go for that information. We are not writing this book to push forward our own engineering progression of portfolio construction or asset allocation, although we appreciate the advances being made (indeed we are making some meaningful advances of our own) and support any efforts to make them more accessible. Nor are we pretending to be behavioral finance experts, although we acknowledge that without the psychological cooperation of the client there isn't sufficient engagement and receptiveness for them to do things differently than in the past. What this book is about is improving the conversation between an advisor and a client. To do this we must define two key terms at the outset: what is rich and what is financial security.

Rich means having more resources than you can consume in your lifetime. Once you have to think about who gets what's left over when you're gone you are someone we consider being rich. This book is written for advisors with clients who have the opportunity to be rich or who are already rich, and are preoccupied with remaining so. Why? Because that is the market of most interest to financial advisors.

Financial security means the ability to stay rich, a perpetual condition in which you can forecast having more than you can consume in a lifetime. Many individuals see financial security through the lens of scarcity. For many clients, the only thing worse than not being rich is to have been rich once and to no longer be so. This is what engages the individual in a conversation about enjoying a sustainable lifestyle. The advisor who frames client conversations in terms of creating and sustaining a desired lifestyle will be more successful.

In this book we describe a strategy for sustaining financial security. It requires that you know how much your client needs to spend to support their desired lifestyle and whether their assets can be made to work hard enough to fund that lifestyle. Knowing these two amounts allows you also to know if they have more wealth than they need to annuitize. If they do, in most scenarios they are better off deferring annuitization as long as possible.

Financial security is the ability to always have enough assets to annuitize to meet essential needs. What an individual is doing when he entrusts his nest egg to an advisor is giving the advisor the responsibility to tell him if he can continue to maintain control over the retirement nest egg, that is, to avoid annuitization. The reason he desires to continue to avoid annuitization is to preserve options to do better with his assets. Once he buys the annuity he loses control and flexibility, he fixes the amount he will have to spend in the future, and subjects himself to greater fees in order to obtain the guarantee. In a way it's game over, and no one wants the game to be over.

This book is written at a time when mistrust of financial institutions and suspicion of financial advice is at an apex. However, one of the authors, Tim Noonan, began researching the subject of this book in the middle of July 2008, just two months before the great market collapse. He explains …

I was developing an interest in a framework to understand plans; the architecture of successful planning processes. A part of my thesis was that modern approaches—especially computer driven approaches to financial planning—were disastrously incomplete frameworks, bound to lead millions of investors and their advisors to destitution. In my lighter moments, I just considered them incomplete.

The longer I have been in the corporate world, the fewer original ideas I have. Even so, a habit I have developed over the past 20 years when I think that I have an important idea is to call my college classics professor, H. D. Cameron, a legendary Western Civilization professor at the University of Michigan. He still calls me “dear boy” despite my having just turned 45. I'm okay with that so long as he continues to take my calls.

“Help me qualify an idea,” I began. I could visualize him sitting into his favorite leather lounger, stroking his goatee, perhaps wondering if he had time to quietly mix a martini before I arrived at the heart of the matter.

“I'm interested in the history of plans, the architecture of planning, and the evolution of planning strategy. How do plans get better in the sense that planners incorporate simultaneously more realism while incorporating more uncertainty, more scenarios, which, in the moment, seem bizarre and remote?”

There was silence on the other end of the line. This was of course his technique. He would let me spin, straining from the diameter of my orbit around a constellation of ideas before reorienting me on one key point.

And then he did it. He said the simple thing that confirmed that I had to write this book:

You're wasting your time looking forward. All you need to know about this can be learned by looking back. Way back. Planning may have become more complex as it would through modern times, as in the technology we have to measure time. Modern contributions, especially from the field of mathematics and probability, game theory, behavioral finance, and new quantum mechanics, provide a progression of refinements. But they do not alter the structure. The sun still rises and sets once every 24 hours. The greatest and most unresolved challenge of planning is found within the story of the first recorded plan in Western literature.”

I was hooked. It was now me searching for the martini shaker—where are those olives?—listening through the phone so intensely I was afraid I would bump foreheads with my brilliant old classics teacher who once again patiently watched my crazy orbiting around 10 different ideas, only to order me back for splashdown in the cradle of civilization.

“The first recorded plan in Western literature is found in Homer's Iliad. It's Zeus's plan for the victory over the Greeks at Troy.” The most important aspect of this plan is that it fails, if not in general outcome, certainly in its explicit strategy. To fully absorb the importance of this point, you must know that Zeus was not just any god; he was the head god, the boss-god, if you will, of all the other gods, each of whom was immensely powerful in his or her own right. Of importance is not simply the lesson that even a boss-god cannot predestine his will but rather the reason Zeus's plan failed. It failed to foresee the competing plans of his god competitors, and, in doing so, he underestimated the challenges to his plan.

The story about Zeus's failed plan is the great warning about planning. It connects a number of ideas that most people today know. The most obvious is the idea of uncertainty. Events will happen that are difficult or impossible to predict. As Yogi Berra said, “It's tough to make predictions, especially about the future.” People know this but it doesn't mean that trying to understand and make plans for the future is a folly. We need to do that in order to organize our resources and priorities. However, at the same time we need to be mindful of the fact that those plans are imperfect and need constant surveillance, which is the second idea.

A plan is no good without vigilance attached to it. That's the reason advisors are paid ongoing fees. The fees pay for vigilance. What are they supposed to be vigilant about? First, whether their client continue to be financially secure (can they still be rich) and second, making sure their clients’ resources work as smart as they can to preserve their options to secure financial security into the future. Clients are paying the advisors to help them create and maintain surpluses such that they have more than enough assets to buy annuities to meet their basic needs. As the surpluses grow, so do their feelings of affluence and security. Their options expand, and in the process so, too, expands their ability to cope with difficult-to-forecast scenarios.

The third idea is what can go wrong. Individuals who do not understand the plans and the carelessness of people around them have a problem. They must consider the plans of other people in their family, those who depend on them or who they depend on. It is important that their plans are accessible and are disclosed to the people around them so expectations can be created. Then there are the plans of those in government. The government's plan, or its ability to keep in place a previously promised plan such as entitlements, may affect the individual's future purchasing power. This has potential for huge impact on your clients’ financial security because, for a significant part of the population, a large percentage of their future purchasing power is derived from Social Security and Medicare. The less affluent they are, the more concerned they should be about how those plans might change as they and their boomer peers live longer and longer in retirement.

This is the central conundrum of individual investors today: to be able to effectively plan in an uncertain world, to have the vigilance to adjust their plans when needed, and to have the awareness of how others’ plans might affect their own. The advisors’ reason for being in business is to help clients solve this conundrum.

Acknowledgments

Writing this book was truly a team effort. We were fortunate and even a bit amazed by how generous people were with their time and effort to help us make this book a reality. There are many more people who helped than we will name here (many of whom will join the team even after this is written). To all who supported us great or small with this project, thank you.

We have spent a good portion of our careers at Russell Investments. The mission espoused by George and Jane Russell, “to improve financial security for people” has served as our true north over the years: guiding us and influencing our work. We want to acknowledge Andrew Doman, Sandy Cavanaugh, and all the Russell associates who encouraged and supported this project.

The input and feedback from advisors who've dedicated their professional lives to helping individuals achieve and maintain financial security was invaluable to us during this project. We conducted many interviews with advisors, some of whom we are not allowed to thank by name. Those we can name include; Dan Baker, Bob Bishopp, Charlene Carter, Craig Cross, Ilene Davis, Russ Hill, Peter Rekstad, Marlene Shalton, Andrea Shenocca, Syd Walker, Jim Warren, Tom Weilert. Thank you all for your generosity of time and insight.

Much of the content for this book was influenced by the expert insights of our contributors including; Albert Bandura (Stanford University), Dr. Laura Carstensen (Stanford University), Don Ezra, Yuan-An Fan, Richard Fullmer, Grant Gardner, Randy Lert, Steve Moore, Sam Pittman, Meir Statman (Santa Clara University). We would like to thank these contributors for allowing us to incorporate their ideas and writings into this book.

While not a direct contributor to this project, we want to acknowledge the influence of Moshe Milevsky's work on this book. We think of Moshe as one of the foundational sources of progressive thinking in the area of retirement income and security. There are many common roots between his work and the concepts we discuss here.

Besides being a dear friend, Steve Moore taught us a great deal about working with financial advisors and how to help advisors build more valuable practices. Steve taught us that all the portfolio construction insight in the world is useless without an engaged client. And, that real client engagement is the key to establishing advisor/client trust.

Don Ezra was an original partner in this project and his influence can be found throughout this final version. This book would not have been completed without Don's input and encouragement. Don's brilliance extends beyond investments and actuarial science. He is a teacher, making concepts real by using his own life as an example in his speeches and writings. That is a rare kind of generosity and we thank Don for his tutelage over the decades we've known him.

Sam Pittman's work is core to the central theme of this book. Sam was able to accomplish one of the most difficult tasks we face in our profession, taking complex concepts and demonstrating their usefulness in the form of practical examples. Thank you Sam for playing such a key role in this project.

Randy Lert provided key insights and original thinking related to the Personal Asset Liability Model. Like Sam, Randy went beyond the conceptual by helping us articulate how the model can be practically applied to investor scenarios. Like many of the other contributors to this book, Randy's contributions came at the expense of his personal time. Thanks, Randy.

In our search for more effective ways to work with financial advisors and end investors, two firms, Mathew Greenwald & Associates, Inc. and maslansky luntz + partners, conducted research for Russell Investments that was especially helpful to us. We would like to thank the respective principals of these firms Matt Greenwald and Michael Maslansky for their work. A summary of their research is provided in the appendices of this book.

We want to thank Dallas Salisbury and the staff at the Employee Benefit Research Institute for providing us with research data and review comments. Dallas in particular gave us very thorough and thoughtful review comments that we very much appreciate.

We also want to thank the folks at John Wiley & Sons, especially Bill Falloon, for supporting this project and being patient with us throughout. In addition, Jen MacDonald, our development editor at Wiley, was very helpful during the writing of the manuscript. Jen's encouragement and guidance got us through the tougher moments.

Finally, the authors want to acknowledge each other, for the energy and delight they brought to each other in this project, which stands as a great reminder that you “get by with a little help from your friends.”

Introduction

The audience for this book is financial advisors who want to build more valuable relationships with their clients. If you are one of them, welcome. Thank you for taking time to read what we have to say.

Valuable should have a common definition for you and your client. For your client it should mean that, by working with you, they have a clearer vision of the lifestyle they want to live and of the plan for sustaining that lifestyle. For you it should mean that you are more effective at helping your clients clarify their vision, build a plan to achieve it, and manage that plan so your clients stay on track.

Combined, we have over five decades of experience working in the financial services industry. We have worked together for most of the past decade, long enough to ride the markets up and down together (a couple of times). Our experience spans many vectors: from individuals to institutions, advisors to advisor networks and platforms, United States to international, and products to processes. We have given speeches, written articles and books, and been interviewed by the media countless times. The one thing all our experience has in common is that, in some way, it has involved helping people achieve financial security. Our goal in writing this book is to bring to bear our experience in that pursuit.

This book marks a place in time in our development of helping advisors build more valuable practices. We are sure the ideas and processes we talk about in this book will continue to evolve and improve over time. We encourage you to take what you can from this book to improve your practice. Use the processes and information we provide where they make the most sense for you and your clients. It would be cliché for us to say, “If you get one good idea from this book or we help you improve the outcome of a single client, then it is worth your time reading this book.” We don't believe that. One idea is not enough; neither is improving the outcome for a single client. Our goal is to start you on a path that leads to revolutionizing the way you provide advise to clients. If you are already on that path we hope this book furthers your progress.

Much of the content in this book is focused on helping advisors manage their client's wealth in a way that gives them a higher probability of living the lifestyle they desire in the future. This advice is most relevant for individuals who are close to having enough wealth (maybe a bit more, maybe a bit less) to sustain their desired lifestyle, so this is where we spend much of our time. This does not mean we believe the only value an advisor can bring to their client is managing their portfolio or that these are the only clients that need an advisor. Wealth management is about more than ensuring your client has enough money to pay their bills. As our friend Steve Moore said, “People are designed to have an impact on the world. The advisor's role is to maximize their client's impact on the world during and after their life.”

We were fortunate to have many talented contributors to this book. There are clearly marked sections in this book that were written by contributors (authors other than Tim and Matt). In those sections, our comments are set apart in a different font to distinguish them from the contributors’ text.

HOW THE BOOK IS ORGANIZED

The first nine chapters provide the context, description, and implementation suggestions for the personal asset liability model. As we explain in Chapter 4, the concepts that form the foundation of the personal asset liability model are derived from research papers written by our colleagues. We provide these pieces of research at the back of the book as chapters for those who wish to take a deeper look at the details. Therefore, Chapters 10–14 are single-topic essays that can be read as stand-alone pieces.

Many pieces contributed to this book were written by different authors at different times. In some cases the examples they use to illustrate their concepts require assumptions such as expected equity and bond returns, expected volatility, asset class correlations, yield curves, etc. Because these research pieces were written at different times the assumptions used may differ. The point of providing this research and their examples is not to suggest the appropriateness of a particular assumption value rather it is to demonstrate the methodology. Therefore, if you wish to use any of the formulas provided in this book you should reconsider the required assumption values and adjust accordingly.

Here we provide a short summary of each chapter.

Chapter 1: Time for a Real Conversation

One of the most important lessons we've learned through our careers is that the effectiveness of advice is in direct proportion to the degree of receptiveness of the recipient. The recent global financial crisis has created an opportunity for financial advisors; individuals are now more receptive than ever to having real conversations about their financial security. What will you say to them? The real conversation is not about investment returns or market volatility; it is about sustainability—the sustainability of the individual's financial security and the sustainability of the advisor/client relationship.

A small number of advisors are reshaping the wealth management industry. We've been fortunate to be associated with some of them, and we hope we've played a small part in nudging the industry toward a more effective way for advisors and individuals to work together. The model of advice we offer is adaptive to how individuals regard their future financial security, the realities of the capital markets, and advisors’ practical limitations in providing advice.

This model of advice is most effective when provided to individuals with enough wealth (or the ability to accumulate enough wealth) to have a real chance of funding their desired lifestyle, and who have the willingness to engage with an advisor in a meaningful way. These individuals are more likely to consolidate their wealth with one advisor. The surviving advisor of the future will be the one who is able to help their clients answer three key questions: How much income do I need to fund my desired lifestyle? Will my money last as long as I do? Am I doing everything I can to ensure my financial security? The methods we describe in this book help advisors answer those questions in a masterful way with the potential for meaningful follow-through from their clients.

The foundation of this advice model is in measuring success differently than in the past. The single most important metric we want to focus advisors on is the clients’ funded status, that is, whether they have enough wealth to fund their future liabilities. Matching assets to liabilities is a lesson we've learned from consulting for some of the largest pensions in the world. The model is based on a process, not on a magical product. Products obviously have their place in implementing an individual's financial plan, but they should be a means to a destination not the destination.

Chapter 2: How We Got Here

Both advisors and their clients are preoccupied with the question, “How many of my assumptions about financial security are no longer solid?” That question takes many forms, from the most basic—“Should I regard my primary residence as a device to build up wealth, after all, the government incents me to do so through mortgage interest credits?”—to more subtle questions about asset allocation and optimization.

The global financial crisis accelerated the obsolescence of many assumptions: More people are retiring at the same time and they have little savings, longevity is increasing, health-care costs are rising faster than inflation and concentrating at the end of life when people can least afford it, savings rates are at historic lows, people are working fewer hours in their lifetime, Social Security is at risk of insolvency, fewer people are covered by an employer- provided pension, and capital markets continue to be volatile.

These conditions are leading to increased concerns about financial scarcity (or at the very least the possibility of increased scarcity). More people have barely enough to sustain their financial security. It's this scarcity that requires the prudent advisor to be more precise in their planning processes and more attentive to their clients. Precision is required because the margin for error has become smaller; for many individuals the difference between achieving sustainable financial security or not is the precision of their financial plan. Attentiveness is required because each individual's desired lifestyle is unique, and individuals now expect personalization in all aspects of their lives. Precision and attentiveness are now the joint standards of quality advice.

Chapter 3: The Right Clients

There is a wide distribution of wealth among individuals, more than ever before. When creating a plan for sustainable financial security, those with more wealth have more options. However, absolute wealth is not the only factor that must be considered when evaluating an individual's options. An individual's wealth relative to his desired lifestyle defines his alternatives. Using this perspective, we categorize individuals into one of three conditions: Those who have more wealth than they need, those who have just enough (or close to enough), and those who do not have enough to meet their future needs.

Today, advisors commonly segment clients by asset size; by itself this is often an incomplete heuristic for the desirability of a client. Asset size does not, in our experience, correlate directly to profitability of the client relationship or solvability of the client's goals. This must shift: We encourage advisors to segment clients according to their clients’ potential to reach their goals. In order to be effective in the client's eyes, advisors need to be skillful at three different conversations based on their client's condition. For individuals who have more than enough wealth, the conversation is about maintaining surplus wealth. For those who clearly do not have enough to meet their future needs, the conversation is not just about investments but also about behavior modification and adjusting expectations (saving more before retirement, working longer, and reducing spending expectations in retirement). It's for everyone else—the group in the middle—for whom the conversation may have the most meaningful impact. These individuals (by definition) have enough that, if they make the right decisions, they will be able to sustain their desired lifestyle in the future, but they do not have so much wealth that just any plan will work.

Our model for advice, the personal asset liability model described in Chapters and , is both a means for uncovering which conversation you should have with your client and a process for creating a plan that matches their situation.

Chapter 4: Connecting the Dots

There has been a progression of people, events, and ideas that influenced the personal asset liability model we describe in the Chapters and . The ideas that inform the model come from the diverse disciplines of investments, actuarial science, financial planning, communications, psychology, and linguistics. Our job has been to pluck promising ideas from each of these perspectives, as they apply to helping individuals create sustainable financial security, and connect them in an advice model that is both practical and effective.

Chapters 5 and 6: Personal Asset Liability Model

In Chapter 1 we talk about the three key questions that individuals must answer: How much income do I need to fund my desired lifestyle? Will my money last as long as I will? Am I doing everything I can to allocate my assets to improve my chances for sustainable financial security?

There is, in fact, a way to answer these questions, and the methods for doing so have been around for a long time (matching assets to liabilities). What we propose as new is twofold. First, that these three questions will become the central focus of the financial-planning process (replacing other questions such as, “Did my portfolio beat its benchmark last quarter?”). Second, that the idea of matching assets to liabilities for individuals will become the new convention for advisors and individuals to answer these fundamental financial security questions.

For a vast majority of advisors, the methods in the personal asset liability model have not been accessible in a practical way to use with a large number of clients. Our framework not only brings together the technical methods to answer these questions in a way that is feasible, but also includes the communication and language strategies that we hope can make the delivery of the advice model effective and engaging. The framework also includes a way to keep the client's focus on the single most important metric—their funded status—through the use of goals-based reporting.

Our research shows that many advisors and investors intuitively accept that the strategies that work for accumulating wealth may not be ideal when it comes to decumulation. This chapter provides a context for advisors in setting asset allocation for their clients to better solve their retirement income problem. The framework translates client preferences and constraints into portfolio-construction guidelines, and offers guidance for assessing appropriate investment strategies (which may include both investments and annuities).

Chapter 7: Making a Good Business of Giving Good Advice

Good advice is inseparable from the trustworthiness of the organization from which the advice originates. Building a quality advisory practice requires a unity of vision among the leaders of the practice, mastery of regional economy, efficient use of resources, and a passion for measuring the right business metrics. It also requires quality control of the advice including suitability, the ability to implement, and a systematic attentiveness to clients. External factors can also help or hurt the practice including economic climate, regional conditions, and the technical expertise of the team members in the advisory practice. All these factors are discussed in Chapter 7. Our motive is to share with you not simply a technical vision, but our experience about what is required for that technical vision to translate into increasing the enterprise value of your advisory practice.

Finally, the successful advisor must be able to deliver quality advice in both a personalized and scalable way. The Client Engagement Roadmap is a business process advisors can use to coordinate and harmonize all the tasks associated with the personal asset liability model and delivering wealth management to their clients. We adapt this model so its central focus is the surveillance of your client's funded status.

Chapter 8: Investor Archetypes

Technology developments have brought us to a point where consumers expect high levels of personalization in most aspects of their lives. Each individual has a vivid and unique image of what constitutes financial well-being. That has always been true, but in most cases it has not been either practical or necessary for the advisor to deal with that individual image in the way it is now. The financial crisis has increased the degree to which individuals withhold their trust until they feel they're being treated in a personalized way, until they feel seen. These realities leave you with a difficult challenge. How do you develop client trust and deliver personalized service when you have so many clients?

One way is to adapt your communication using your client's personality temperament as a guide. We describe a method developed by Professor Meir Statman of Santa Clara University for achieving personalized communication in a time efficient manner. This method saves time and is research based. The method uses psychological profiles to help you adapt your communication. Underneath these profiles is real information about how different personality temperaments process decisions.

Chapter 9: Tripping Over the Finish Line

All the good work of planning for financial security can come undone by financial accidents. The core of this book addresses the major risks in retirement such as savings, spending, investment, and longevity. However, there are other contingency risks that need to be considered. Chapter 9 discusses the challenges facing the Social Security system and the potential impact of possible changes to the system on your client's financial security. Also discussed are life, health, disability, and long-term care risks; each of which can be insured. Finally we talk about age-related cognitive decline, its prevalence, the forms it takes, the warning signs, and how to manage the risk it poses to your client's decision making and, by extension, their financial security.

Chapter 10

Albert Bandura is the David Starr Jordan Professor of Social Science in Psychology at Stanford University and past president of the American Psychological Association. He is a world-renowned expert on self-efficacy; the belief in one's capabilities to organize and execute the actions required to produce desired results. Professor Bandura gave a speech to a group of our advisor clients during the peak of the financial crisis in 2008. His talk was so inspiring, and relative to the challenges advisors face, that we wanted to share it with you in its entirety.

The development of self-efficacy (confidence) is critical to the success of your advisory practice as well as the success of your client's financial plans. We believe that excellent advisors are made, not born, and that learning to give excellent advice is an acquirable skill. The self-efficacy you cultivate for the skill to give excellent advice is vital to your success as an advisor.

Chapter 11

In August 2006, Grant W. Gardner, PhD and Yuan-An Fan, PhD authored a white paper on the design of target-date funds. We've provided in this chapter the entire text of that paper. Grant and Yuan-An's framework relates to the challenge of managing your client's financial security by establishing two foundational ideas that are reflected in the personal asset liability model. First, it incorporates human capital into the asset allocation decisions for individuals accumulating wealth for retirement. Second, it uses for its definition of success a wealth target sufficient for the individual at retirement to purchase an annuity equal to their targeted replacement income. They create rules for an intelligent evaluation for individuals to balance the value of their human capital with a basket of financial assets throughout the course of their career.

Chapter 12

In this chapter, Don Ezra discusses the “Investment Aspects of Longevity Risk.” According to Don,

After retirement, wealth is no longer the yardstick (for success). Rather, income becomes the yardstick. The trade-off is now between higher expected income and higher uncertainty of income. But in retirement, unlike in pre-retirement, it is no longer acceptable to have an approximate time horizon for planning. The time horizon extends until one's death–and that is unpredictable.

Don evaluates the danger to individuals when they lose their ability to pool their longevity risk by no longer being a member of a pension plan. The individual's inability to pool their longevity risk is a key foundation of the personal asset liability model. It's our starting position to apply our knowledge and expertise from working with institutions to conceive of a model appropriate to an individual.

Chapters 13 and 14

Both of these chapters are reprinted white papers authored by Richard Fullmer, CFA. In Chapter 13, Fullmer discusses the mismeasurement of risk in financial planning. He explains,

Financial planning is complex. Modeling tools have proliferated as a way to help wade through the complexity and facilitate sound decision-making processes. The selection of the risk measure in these tools is all-important. Poor decisions can result if the risk measure is faulty or incomplete.

Fullmer argues the risk that should be focused on when planning for retirement income should be the risk of income shortfall rather than volatility of portfolio return. The total risk measurement he proposes is the product of the probability of shortfall times the magnitude of shortfall.

Chapter 14 is Fullmer's paper, titled “Modern Portfolio Decumulation.” It is a logical extension of his mismeasurement of risk work from Chapter . It “describes a new framework for efficient portfolio construction in the ‘decumulation’ phase of the investment lifecycle, in which an investor who has accumulated assets over time wishes to use those assets to fund ongoing living expenses. It combines elements of both investment theory and actuarial science, introducing an effective way to manage longevity risk in the portfolio.” Fullmer makes the argument that the conventional standard for accumulation of wealth is not optimal for decumulation. He outlines an alternative approach for investing in the decumulation phase, developing his thinking along lines of dynamic asset allocation models.

Chapter 1

Time for a Real Conversation

What this book is about and the reason we are writing it now are inseparably related. This book offers financial advisors and their clients an alternative roadmap for the way they engage with each other. This alternative might not be right for all advisors or their clients; we suspect it won’t. But for some it will. You might guess we are motivated to write this book now because of the financial crisis and the severity of American retirement under funding. That's partly true.

This book offers financial advisors and their clients an alternative roadmap for the way they engage with each other.

The reason we are writing this book now stems from the single most valuable lesson we've learned in our combined five decades working in the asset management business, namely that the effectiveness of the advice you give is in direct proportion to the degree of receptiveness of the recipient. Most professional consultants understand that knowing how to defer giving advice until their client is indeed ready to receive it is as important as the advice itself.

In a sense, the crash of 2008 was the catalyst for this project, although not for the obvious reasons (asset losses, systemic shocks, collapse of confidence in the financial system—pick one), but rather because it created, in our opinion, this rare harmonic convergence allowing financial advisors and their clients the mutual recognition that it was time to do things differently. Our research indicates (in hopeful ways) that advisors and their clients are at least momentarily interested in a new and different framework for wealth management.

Another outcome of the global financial meltdown was its trivialization of the differences between segments of financial advisors. Whatever the points of differentiation prior to the meltdown, they faded in importance because client needs became nearly homogenous. There is a single overwhelming client concern that advisors today must be prepared to address: Will their clients be able to fund their desired lifestyles for as long as they live? Many people believe that the only thing worse than being broke is going broke. Individuals want to have real conversations with their advisors about how they can sustain their desired lifestyle for as long as they might live.

At the heart of this concern about sustainable financial security are three questions. First, “How much is enough?” The individual must first have a no- nonsense estimate of how much money they will spend each year in order to live the lifestyle they desire. Second, “Will my money last?” Knowing what they will spend and how much they have (or will have) saved, they need to know which they will run out of first, time or money. Third, “What can I do?” They need to know what they can to do to sustain their lifestyle; whether it's to save more, spend less, work longer, or invest differently, they want to know what they can do to improve their outlook on success.

This is what we mean by real conversations. Real conversations involve tough questions; the client staring at you from across the table expects answers. The good news is that there is a way to answer these questions. We call the framework for answering these questions the personal asset liability model, although we don't expect (and, indeed, discourage) you to describe it in this way to your clients, for reasons we enumerate in this book. The model is built around what we believe is the single most important metric individuals (and their advisors) should focus on: their funded status, the likelihood that the lifestyle they envision is possible. The funded status (a concept used for decades in institutional pensions) tells the individual if they have enough money to fund their desired level of spending. The model is explained briefly at the end of this chapter and covered in detail in Chapters 5 and 6.

THE GREAT EQUALIZER

Leading up to 2008, having experienced the greatest bull market in the history of modern capitalism, the financial services industry became an increasingly significant portion of the global economy. This had a couple of mixed effects: it created a broad democratization of investing whereby individuals gained unprecedented access to the capital markets, and it led to a cycle of product development and financial innovation, giving individuals a blinding number of choices about how they might participate in investing, banking, and insurance products. Advisors came to be seen as guides into that world of exciting capital markets and product complexity. In the face of that, advisors began to specialize; to develop patterns of advice that were consistent with their views (and the views they perceived to be their clients’). This led to the way the financial services industry talks about the segmentation of advisors, in terms of specialization.

If someone were to talk about segments of financial advisors 30 years ago nobody would know what they were talking about, but today it seems very natural that there are segments of advisors. The initial way that the advisors were segmented was according to their institutional affiliation: brokers, bankers, insurance, and so forth. Then along came the independents, and they confounded the definition of specialization because they could be any or all of those.

The next step in the segmentation progression occurred when advisors were seen to be either investment advisors or money managers. The investment advisors made up the larger segment. Their specialty was finding the highest returns for their clients. They were the putative experts on markets and products, and their objective was to find the most exciting capital markets products (namely returns) for the clients. The money managers made up the smaller segment. They were essentially no different than institutional money managers except that they had private clients.

Finally, the category of wealth manager emerged. What made the wealth managers different was that they were willing to accept a broader definition of success for their client. They did not focus on just returns but whatever their client's total objective or outcome was that they wished to achieve. They took a comprehensive approach to managing their clients’ financial needs by understanding their clients’ entire financial ecosystems. The clients’ portfolios were one of many things that they cared about. The portfolios were often the central vehicles for creating satisfaction for the clients yet, other times, their satisfaction related to financial planning, budgeting, taxes, estate planning, and so forth. The point here is that the clients’ abilities to achieve their overall financial visions superseded the portfolios themselves in order of importance.

The chief difference between the first two segments, investment advisors and money managers, and wealth managers was that, in the first two segments, the object of the advisors’ focus was on the returns the capital markets produced by way of the specialty of the advisors’ affiliated firms. The wealth managers, in order to be true to their claim of this more holistic advocacy for their clients, needed to focus primarily on the client-facing activities, such as fact finding, estate planning, and so on. This caused them to outsource many aspects of the investment function so they would have time necessary for these client-facing activities.

Those different types of advisors operating in those different platforms—brokerage firms, banks, insurance, independents—they were all attempting to address different versions of investment success that they perceived their clients wanted, and they were correct in doing so. The crash of 2008 in a way acted as an equalizer, unifying large numbers of people around a similar concern about their financial security. The calamity of the financial crash and the consequences were so severe that it made all of those previous distinctions trivial. What emerged as a unifying characteristic of all of the investors, regardless of what kind of advisors they were using, was the question of sustainability: “Will I have enough?”

Now, after that crash, it is predictable that investment advisors, money managers, and wealth managers will all find their own answers to this question of sustainability. They will all do that in a way that's consistent with their experiences and their focuses. The advisors we are trying to cultivate are those who believe holistic planning is the future for them, and is the basis on which they intend to build their client relationships, not those depending on either the ingenuity of the financial services industry to create exciting new products or the beneficence of the capital markets to produce huge returns. Rather, they spend time with clients and dig into the question of what type of sustainability might be possible for them and having sober discussions of what trade-offs that might involve. Finally, once they understand what kind of financial security is sustainable for their clients, they make their assets work as intelligently as possible in support of that goal.

IN SEARCH OF A REAL CONVERSATION

Before 2008, most people were focused on accumulation in which family wealth was assumed to rise based on rising values of primary residences and investment returns on assets. Many financial advisors built their practices consistent with this thought. Because their services were largely about producing superior market returns rather than the impact of those returns on personalized plans, clients had difficulty differentiating one advisor from another. As a consequence, clients often rotated from one advisor to the other, in serial monogamy, or they employed several. Indeed, today over half of affluent Americans (defined as those with over $2 million of investable assets) report working with two or more financial advisors.1 Over half of ultra-high-net-worth individuals (those with over $10 million of investable assets) report working with five or more advisors.2

One way to look at the advice we are offering in this book is that we are trying to help advisors become their clients’ surviving advisor, the one to which the individual consolidates all their assets. The future as we see it moves to a one-advisor-per-client model. The question for you is, “How do you be that advisor?”

Things are different now. The events during and since 2008 have created deep mistrust among individuals. They don't want to return to the way they did things before the onset of the financial crisis: to financial markets that jarred them, to financial advisors whose advice they seem to think did not work, to guarantees of security that were empty, or to a system in which players’ interests were (and maybe still are) conflicted. They have an accurate intuition that they should be doing something different but are unable to articulate what that different something should be.

Financial advisors are keenly aware of their clients’ dissatisfactions, and they have their own anxieties. Yet some see this scenario not as a threat but as an opportunity. They know they need to retool their practices in order to absorb new information from their clients, and they need a sensible process for managing their clients’ wealth based on this new information. Finally, they need a new way of communicating with their clients. Into this scenario in which the individual and the financial advisor want and need a new way to work together, this book provides a framework for that new way.

Prior to the financial meltdown, an idea took root that free-market capitalism was universally good and had only good effects. This merged, disastrously, into the argument that markets were perfectly omniscient, and, therefore, market prices could never be wrong. There were no victims or at least no victims that didn't deserve it, and there was no need to regulate markets. Indeed, it was argued, doing so would impede their efficiency. The markets were so intelligent and efficient that the self-interest of the market participants would regulate themselves. However, taking the fact that the market is truly hard to beat and concluding that that means the market is always right is a whale of an error!

Yale University economist Robert Shiller had this to say in 1984—nearly 25 years before the crash: “This argument for the efficient markets hypothesis represents one of the most remarkable errors in the history of economic thought. It is remarkable in the immediacy of its logical error and in the sweep and implication of its conclusion.”* Despite the dissenting opinions, this environment not only encouraged speculation to cataclysmic levels but also obscured a more fundamental thought that the purpose of modern capital markets was to maximize the value of assets.

In the modern world, financial assets have become among the most significant forms of private property: indeed, they are what human capital is exchanged for over the course of the modern lifetime. The idea that private property needs to be stewarded rather than exploited was a sacred tenet in the formation of America. It goes back to John Locke's idea that private property (as opposed to property held in common) should come about from the result of one's labor. And, no one should take more than that which can be combined with his own labor, lest it spoil from disuse. Locke also believed that no one should accumulate so much that it prevents others from having a share. This doesn't mean there shouldn't be winners and losers, but winning or losing should be the result of one's labor (or lack thereof) rather than randomness. If you choose not to work, your rewards should be commensurate. However, speculation alone is not work, by itself it creates no value.

By 2008, Locke's ideal was seemingly appropriated by a “grab as much as you can and screw everyone else” mentality. Unfortunately, or fortunately depending on how you look at it, this later mentality was a catalyst in the financial meltdown. As society reconsiders what are the appropriate levels of leverage, speculation, and regulation, it will be interesting to see if we move back toward that ideal. There are important champions wearing the white hats in the Fourth Estate; Gretchen Morgenson comes to mind. In government, Alistair Darling in the U.K. and Elizabeth Warren (President Obama's advisor to the Consumer Financial Protection Bureau) come to mind. Let us hope their points of view prevail.

*Robert J. Shiller, “Stock Prices and Social Dynamics,” Brookings Papers on Economic Activity 1984(2), 457–510.

SUSTAINABILITY