You’ve heard the joke about the guy who jumped off the Empire State Building. As he passed the 18th floor on the way down, he said, “So far, so good!” You may have a few clients who don’t see the need for financial planning. They assume the good times will last forever. They may not remember there’s an old saying: “Money talks. It says goodbye.” How can you make clients aware they could suddenly be in serious financial trouble if they don’t embrace financial planning and follow cautionary advice?
Eight Ways Your Client Could Lose A Bundle
Let's just look at several scenarios that could cause a reversal of fortunes for a client. Unfortunately, a few may seem very familiar.
1. They owe a lot. It’s all in variable interest rate debt. Your client has a home equity line of credit (HELOC) with a credit line of $400,000. They owe about $400,000 because they pretend the money is savings and they access it often. When their rate is 4% annually, they are paying $16,000 a year in interest. If the interest rate rises to 8%, they are paying $32,000 a year in interest. Where will the extra money to pay the interest come from? They have already maxed out their credit line.
Financial Planning: This is an ideal time to refinance variable rate debt with a fixed loan. They will need to reduce their spending and set aside a cash reserve.
2. Your client is heavily leveraged and trades on margin constantly. They are used to the stock market bouncing back and continuing its upward climb. You know “No tree grows to the sky.” They may have forgotten when stocks decline, the losses affect their equity. The loan doesn’t get smaller. They may face margin calls at inconvenient times. There are times when the firm can close out positions.
Financial Planning: In volatile markets, clients need to reduce their margin exposure or have plenty of free cash available to meet margin calls.
3. The retired client who thinks 10% is a reasonable withdrawal rate for their retirement assets. They figured out the logic all by themselves! If the stock market historically returned 10% annually over decades, they can withdraw that amount without touching their principal. Imagine the following scenario when the stock market declines 10% for two years in a row. Your client started with $100,000. They withdraw 10% at the start of the year, leaving $90,000. The market declines 10%, bringing their equity down to $81,000. They withdraw $10,000 at the start of the second year because they define 10% as the same amount they withdrew when they started the process. Now their balance is $71,000. The market declines another 10%, leaving them with $63,900. It seems we have invaded the principal after all. Even worse, the third year’s withdrawal of $10,000 is not a 10% withdrawal, it will be almost a 16% withdrawal!
Financial Planning: Your client needs a couple of years’ worth of distributions set aside as an emergency fund. They also need to see those articles indicating 4% or maybe 5% is a more realistic drawdown rate.
4. The self-directed day trader who doesn’t realize capital gains are taxed. Your client loves to trade! They are in and out of the market all the time! They call the shots. When tax time rolls around, they are surprised they have a significant bill for short-term capital gains. The rate is about the same as ordinary income. They are in a high tax bracket.
Financial Planning: A good advisor helps the client keep track of YTD gains and losses. They talk about year-end tax selling. They advise the client they need to have cash set aside to pay their tax bill.
5. Your client whose asset allocation is 100% equities. The client loves the stock market. It’s been kind to them for more than a decade. They think bonds are boring. They don’t realize if the stock market declines by 20%, their account will likely travel in lockstep and be down 20% too.
Financial Planning: A good advisor makes the case how asset allocation can decrease volatility, although it cannot eliminate risk entirely. They also talk with the client about sector rotation, although selling and buying to reposition will have tax consequences.
6. They earn a good income from their job and assume it’s a job for life. This client sees no need to set aside a rainy-day fund or save for retirement beyond their 401(k) contributions at work. They spend everything they earn, even running up large credit card balances, which they pay down when their annual bonus arrives. What could possibly go wrong?
Financial Planning: The pandemic has taught us companies can close because of external events. History has taught us firms reorganize, often laying off lots of people to reduce expenses. When firms merge, there is often downsizing. Your client spends at a high rate. What happens if the money stops? They will need to spend their assets to stay afloat. Oops! They have no assets because they don’t save. This client needs a cash reserve.