Will fee structures change as more boomers retire?
During an interview recently, an old friend made an
interesting observation. He said, "It seems to me that baby boomers
will change the nature of financial planning and possibly fees and fee
structures, as well. Financial planning and its attendant fee
structures have always been posited on the accumulation of wealth. Yet,
with boomer retirements, this may change from accumulation to spending."
My friend went on to explain that the way we now think of "retirement planning"-planning to save enough for retirement-could very well change to planning to spend the right amount in retirement so as not to run out of money ... planning around "draw-down rates," in other words. In the accumulation-planning paradigm, the focus is on assets, so charging fees based on assets is appropriate and acceptable to the client. But if the focus shifts to withdrawals from the portfolio, a much smaller number, will advisors' fees come under scrutiny, he wondered? And will this shift ultimately lead to even greater fee compression than the industry is already experiencing with the wholesale adoption of the fee-based and fee-only planning models?
I've got my own opinion on this, which is that any changes brought on by boomer retirements won't occur overnight at the flip of a switch. The phenomenon my friend alludes to has been going on for some time. What the boomer population will contribute, as it does to everything, is that "bulge" that it's known for, i.e., the phenomenon will be heightened as boomers knock on retirement's door.
What I'm saying is that anyone who works predominantly with retirement-age folks-and that's a lot of us since that's where the money usually is-has clients living on distributions from retirement savings. One of my client couples has a $3.0 million nest egg and withdraws $6,000 a month to cover all their living expenses. They have no supplementary pension and they won't take Social Security for another year or two. My annual fee to them is $13,000.
Do the math. They're either paying me a very reasonable 43 basis points on their assets or a seemingly exorbitant 18% of their gross inflows. This is what my friend is asking: Will boomers start to focus on the 18% rather than the 43 basis points?
My clients probably focus more on the their income than their assets, and being basically frugal, Millionaire-Next-Door types, they are well aware of my fee at all times. Yet, they have no complaints because they like the service they get.
Not that all clients with this profile are a piece of cake. Says Larry West of West Financial Consulting Inc. in Huntsville, Ala., "Most of the retired clients I have that live solely off investments have sufficient assets that continue to grow even though they are drawing on those assets for living expenses. However, I have noticed that a lot more work seems to be necessary for these clients. They tend to require more of my time now mainly for cash flow planning and tax estimating. Rebalancing portfolios is more complicated now because of the cash need considerations. And one client who recently retired from an executive position doesn't have anything to do, so he spends his time second-guessing most of my investment recommendations."
But West is describing a preboomer client, much like my own client. These clients may not always have enough to occupy their time, but at least they've got financial security. But will things play out this way for the boomers?
Consider the same scenario except the client has $1.3 million instead of $3 million. A $13,000 fee is still competitive (for now, at least) at 100 basis points on the assets. And the fee is still 18% of the client's gross portfolio withdrawal; that hasn't changed. But the client's withdrawal rate has changed. At $3.0 million, he was withdrawing only 2.4% of his portfolio a year-a very safe number by almost anyone's standards. At $1.3 million, he's withdrawing 5.5%. At that withdrawal rate, he's on or over the cusp of what many advisors consider a safe withdrawal rate. That is, the client is not assured of having enough assets throughout his lifetime at that rate of withdrawal.
Within this example lies the crux of the problem and the reason why my friend's reasoning may come up just a bit short: The boomers, for the most part, aren't the savers that the previous generation was. Sure, some may even accumulate more assets than their parents, especially considering inheritances, but boomers tend to have a disproportionately more expensive lifestyle than their parents due to a whole host of economic and sociological factors.
So is the premise of our question faulty because boomers can't afford to retire? Many advisors think so. "Baby boomers are savings-short," says David Fernandez of Wealth Engineering LLC in Scottsdale, Ariz. "The national savings rate is less than 2%. How are they going to retire? One day boomers will wake up and realize they have to start spending less and saving more, and their accumulation phase will last longer than expected."
James Wilson of J.E. Wilson Advisors LLC in Columbia, S.C., would take it a step further: "In my view, many of the boomers won't ever retire. There may not be as much spending-down, since these boomers may be earning income well into their 70s or even 80s." Wilson elaborates: "The boomers we see are almost always unprepared. In many cases, it is getting close to being 'too late' for them to prepare for a reasonable retirement. I think the model of working on Friday and being retired on Monday will cease to be a reality within a decade or so ... perhaps 80% of the boomers won't be able to retire in the historical way we define retirement."
Dr. Steven Podnos, owner of Wealth Care LLC in Merritt Island, Fla., says, "I have repeated discussions with my clients on the need to keep working as long as possible. We discuss how they may live well into their 90s and that trying to protect an income stream over that long a time period is very difficult."
Of course, boomers are known for wanting what they want when they want it. Suppose they just say, "We're retiring now. We'll make do one way or another," and then begin to take withdrawals at excessive rates? "Anyone who is spending down more than 5% of his portfolio per year did not do a good job saving or was not invested properly," says Fernandez. "For those clients, the advisor has an uphill battle, depending upon their age and anticipated longevity, especially in light of expected lower future investment returns."
In fighting this uphill battle, should the advisor do anything differently than he's always done before to get boomers to spend less and save more? "I always spend a lot of time reviewing expenses and cash flow planning for my retired clients," says Fernandez. "And I don't hesitate to lay it on them if they are spending too much. As advisors we have a responsibility to the client to be up-front and honest about their situation. Nobody likes negative surprises. The sooner you can let a client know that they are spending too much, the better chance they have of correcting the situation ... which is not an easy thing to do. Nobody wants to reduce their standard of living, especially once they are retired."
If the process of watching pennies is unchanged, how about the investment philosophy advisors should apply to boomer clients? It's really no different, says F. Dennis De Stefano of De Stefano Wealth Management in Kihei, Maui, Hawaii. "Positioning a portfolio to produce current income is not appropriate. Boomers still face the risks of lost purchasing power and longevity. Thus, there's a continued need for equities in their portfolios," he says.
De Stefano invests the same way for preretirees and retirees, that is, those accumulating and those living off their assets. "During the accumulation phase, retired clients weren't concerned with whether the increase in their investments came from current income-interest and dividends-or capital appreciation, as long as the overall portfolio was within their risk-tolerance level and met their life goal of a secure retirement. By the same token, they shouldn't be concerned with the source of their investment returns, as long as they are sufficient to meet their monthly withdrawal needs."
The face of planning won't change much for another reason, say advisors. "Even when some of our baby boomer clients begin to retire, we will still be adding clients who are growing and accumulating wealth," says Melissa Hammel of Hammel Financial Advisory Group LLC in Brentwood, Tenn.
Hammel agrees that, in some cases, fees may go down for those with assets-under-management fee structures, since clients will decrease their assets by withdrawals. But most advisors expect to make up any shortfall with new client revenues, especially those advisors with already competitive fee structures. "I only charge 0.75% on the first $2 million, so my fees are [very attractive compared with those of] advisors who are charging over 1%," says Fernandez.
In conclusion, then, the advisors I surveyed don't see boomers significantly changing the planning paradigm, nor posing any threat to their income. Although fees may be an issue with retired clients lacking sufficient savings, these clients have always been around and will continue to seek help from advisors. And some of these clients will be boomers.
David J. Drucker, M.B.A., CFP, a
financial advisor since 1981, sold his practice 20 years later to
write, speak and consult with other advisors under his new banner:
Drucker Knowledge Systems. Learn more about his latest books, Tools
& Techniques of Practice Management (National Underwriters, 2004)
and The One Thing... You Need to Know from Each of Industry's Most
Influential Coaches, Consultants and Visionaries (The Financial Advisor
Literary Guild, 2005), at www.daviddrucker.com.