Many Americans wait until they have accumulated a significant level of assets or are nearing retirement age before they begin working with a financial advisor. Professional advice is helpful at any stage but as advisors already know, the sooner an individual starts on a realistic retirement plan, the easier and more likely it is to attain those goals. That’s probably more true now than ever when it comes to demographic groups commonly referred to as Generations X and Y.
For these children of the baby boomers, Social Security is unlikely to provide the same safety net as it has for their parents and grandparents. As a result, they will need to take a much greater degree of personal responsibility for funding their retirement years.
For an advisor to effectively help Gen X and Gen Y, one of the first steps should be to formulate a goal plan. The goal plan should reflect the financial dreams of the client -- for example the cost of a home purchase, a new car, college funding and a certain retirement lifestyle. This helps keep the focus where it belongs -- on the client -- and not on the short-term returns of any particular investment. It’s vitally important that the advisor have a process and a construct that allows for the evaluation of the individual’s goals in the context of both the current pool of resources and what may be available in the future.
The most convenient tool for doing this is probably the household balance sheet because it offers an instant snapshot of the client’s financial circumstances. This helpful tool provides an initial diagnosis of the affordability of the goal plan and allows an easy side-by-side comparison of expenses and goals versus the client’s assets and resources.
The household balance sheet should be structured so that on one side are listed the resources that are expected to be available to fund goals. These would include the purchasing power (current balance minus deferred tax liability) of accounts, such as brokerage and bank accounts, retirement accounts (401(k) or IRA), future savings and future benefits (Social Security and pensions). On the debit side of the ledger would be the household’s goals and the levels of funding required to reach them. Ideally the advisor would break the goal section into three priority classes: Necessary Goals (the minimum amount of funding needed to meet living expenses in retirement, for example), Target Goals (the plan the household expects to follow), and Aspirational Goals (a best case scenario including the things and level of funding that the client aspires to should enough resources be available).
One of the advantages of the balance sheet construct is that it allows the client and advisor to easily change the income parameters and run various “what if” scenarios. The advisor can show the client what type of retirement would be affordable based on the current income stream. They can also approach it from the opposite direction and look at the desired retirement lifestyle and work back to determine the proper income stream and savings plan to achieve that goal. The household balance sheet can also be used to demonstrate how current lifestyle expenses will impact retirement funding.
Among the necessary discussions between the advisor and client is one on risk mitigation. This is particularly important for younger clients where future income and savings are so critical to goal achievement. The advisor can gain the client’s trust by measuring the household, evaluating all its resources and identifying steps that can be taken to help improve security and control, such as the purchase of life or long-term disability insurance.
Given Gen X and Gen Y clients still have the bulk of their working years in front of them, much of the resource pool on their balance sheet may be “human capital,” which is expressed in the form of future savings. At the end of the client’s working career, those projected future savings need to be fully converted into financial capital. Failure to do that would substantially impact the ability to fund long-term goals. Putting future savings as a resource on the balance sheet to meet future goals means taking action now, and making a savings commitment required to meet future goals.
This is another area where the household balance sheet can be a valuable tool. The advisor can use it to demonstrate the importance to the client of maximizing contributions to a 401(k) plan, since any employer matching funds are essentially free money. This can also help facilitate a discussion about the tax implications of retirement savings. It is important that the advisor explains how the purchasing power of a million dollars in a 401(k) is not the same as that of the same amount in a brokerage account or a Roth 401(k) or Roth IRA.
These are important discussions for the advisor and younger client to have, and in which the household balance sheet can be used, because at the end of the day, retirement goals are paid for with after tax dollars. That’s why it is vital that the client understand what purchasing power his resources will provide and what actions need to be taken to provide adequate funding for those after tax dollar goals.
When it comes to the retirement needs of Gen X and Gen Y, they aren’t that different from their parents who might already be the advisor’s clients. They are, however, at a different stage of life. It is incumbent upon the advisor to remain cognizant that clients at this stage of life also have numerous pre-retirement goals that require funding such as a mortgage and higher education for their children. The message from advisors to these generational cohorts should be “don’t ignore retirement while you’re focused on your pre-retirement goals. It’s a long road, but I’m here to help you.”
Neal Ringquist is president and chief operating officer of Advisor Software Inc., a leading provider of wealth management solutions for the advisor market.