Managing Risk

Financial consumers tell us in our new MDRT Generational Financial Confidence Study that they are not confident in their current financial or retirement plans. This lack of confidence is likely rooted in how consumers feel about the economy these days. For example, while less than one out of three Boomers tell us that they are worrying about the U. S. economy, over half say they have personally felt the bite of it.

We also see this lack of confidence shows up in changing tolerances for risk.  The recession has impacted every generation’s tolerance of risk – almost everybody agrees with the statement: “I am less tolerant of risk.” The aversion to risk is not surprising, given that the downturn in the economy meant significant downsizing of portfolios. The “risk” consumers want to avoid, of course, is downside risk. They simply cannot afford to lose any more money. That could mean good news for the life insurance industry because the days of high risk for high returns seem to be gone.

At least, that’s how consumers say they thinking when it comes to their money. But will their actions match?

The $25,000 Question

What if a consumer had $25,000 in cash right now? What would they do with it?  We gave survey participants a list of financial options like paying down debt, or buying stocks or bonds, as well as spending options, like buying a car, going on vacations, or even hiding it under a mattress.

No surprise— the top answer (by far) for all but the Silent Generation was “pay down debt.” Consumers really want to pay down debt first. Given the current balance sheet of most American consumers, that’s good news.

However, recall that they indicated a reduced tolerance for risk. That’s what they tell us they are thinking. But the investment choices they made in response to the chance to do something with $25,000 in cash seem to indicate a much more tolerant view of risk.

Despite about nine out of ten telling us they were less tolerant of risk, one out of three turned around and reported they would buy stocks or bonds.  One out of three are ready to “roll the dice” in the market again instead of investing in assets that have virtually no downside risk – like a fixed annuity or life insurance. In fact, only a scant 2 and 4 percent, respectively, said those options were appealing.

What it means for financial advisors: Help clients match up what they are thinking in terms of risk avoidance with more rational behavior when it comes to picking products where they should invest their money. There is clearly a lack of understanding in the marketplace about the technical details of products like whole life insurance or fixed indexed annuities. Basic education on product features and benefits, instead of talking up all the bells and whistles, will get a client’s attention.

There is a disconnect between what consumers are thinking and what they think they should be doing. Your job as their trusted advisor is to rewire those connections.

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There is a growing hope that this “Great Recession” is winding down, suggesting that investors and financial services clients are slowly resurfacing and presenting new opportunities for planners, advisors and agents. That is why the Million Dollar Round Table partnered with the Boomer Project to field an important new national study this spring.

The goal was to learn who advisors and agents should be targeting today, and to better understand the generational differences that could impact making a sale, or landing a new client. This is the first in a series that will highlight what we learned.

Let’s start with the good news: Today, financial consumers of all generations tell us that having a financial or retirement plan is a priority for them. In our study, three-quarters or more of respondents said having a plan was either a priority or a high priority on a five-point scale. The older the respondent, the greater percent think having a plan is a priority.

Let's get Busy Planning

That is good news.

Now, the bad news.

Advisors and agents are not on the same page. In 2009 we asked 600 advisors and agents to tell us “how much of a priority do you think your clients would say it was to have a financial plan?”

There’s a gap. First, there is a pretty significant gap among Silent (ages 65-83 in 2010) and Boomer (ages 46-64) generations, almost all of whom think they should have a plan. But only about 65 percent of the agents and advisors think that.

There’s even a larger discrepancy when you look at the Generation X (ages 28-45) and the Millennials (under age 28, also called Gen Y). Three out of four respondents of both generations say having a plan is a priority, yet only 21 percent of advisors think Gen Xers place a priority on having a plan, and only 7 percent of advisors think Gen Y do.

Mind the Gap

Advisors and agents are underestimating the readiness of consumers to plan for their financial future – a problem that you can turn into an opportunity for your firm.

Takeaway # 1: Focus on Confidence

We also asked consumers if they think it is important to have a plan and if they are confident in it right now. Once more, we see gaps. Yes, consumers say it’s important. In fact, almost everyone says it’s important to have a financial or retirement plan. But far fewer are confident with that plan.  In fact, the younger the respondent, the less confident they are.

This lack of confidence is a tremendous door opener for advisors and agents. That’s the opportunity to talk about products and services that could help consumers become more confident in their retirement or financial plans.

Next week: Takeaway #2

Money in Your Hands

The bill President Obama signed last week creates the Consumer Financial Protection Bureau. The law specifically instructs the new agency to study the reverse mortgage industry and decide if new regulations are needed.

While we anticipate new rules to come, we also see three key signs that the reverse mortgage industry is about to set sail. Knowing more about this new opportunity might be a worthy investment of your time because your clients are going to become very interested in them in short order.

First, the big guys are now major players: Bank of America, Wells Fargo, Met Life and Genworth are now all heavily into reverse mortgages, in fact, those four join with six other firms to write 89% of reverse mortgages right now. Big players generate more marketing and more consumer awareness. This competition also means prices and fees are coming down, increasing the attractiveness to those 62 and older who qualify.

In fact, after several years of the peak age applying for reverse mortgages hovering around 72 to 74, in 2009, the industry saw the peak age shift to age 62 or 63, the Boomers. This clearly was driven by the recession, and that millions of older Boomers found themselves out of work and out of money. With a long-held mindset that the home can be a money-producing machine, it is no surprise Boomers flocked to reverse mortgages.

The generational shift of those over 62 from the frugal, responsible and practical Silent Generation to the Boomers (we leave the editorial assessment of their view of money to your own imagination), is going to drive the interest of the big financial services firms in reverse mortgages for years to come.

Boomers also report in survey after survey that they plan to “age in place.” What better source for funds to support that decision than the place itself? The economic reality of a soft real estate market is keeping more and more Boomers in their homes, enabling them to get closer to paying off those long-term mortgages, and becoming qualified for a reverse mortgage.

What is means for financial advisors. The reverse mortgage product is going legit and quick. You need to get up-to-speed now and then pay attention as the  new Consumer Financial Protection Bureau begins issuing edicts, rules and regulations.

One resource to follow is the Reverse Market Insight group and their web site, which tracks the industry.

No More Paychecks

That’s the call-to-action for Gen Xer’s and the Millennial generation in an article over the weekend in The Washington Post by Jonathan Kern, called “To retire comfortably, under-40 workers need to seriously bulk up savings.”

Kern, a recent retiree after 30 years in radio news business, admits he doesn’t have a pension and warns younger consumers that a penny saved is all they can hope for — otherwise a panhandling retirement awaits.

Kern reports more data from the new study released by the Employment Benefit and Research Institute that found that more than half of all workers say their total savings is less than $25,000. And one in four workers have nothing saved for retirement (or a rainy day).

What Kern doesn’t address in his piece is that most under-40′s today know it is up to them to fund their own retirement, and many simply plan to do it by not “retiring” in the traditional sense. They plan to work, in some capacity, until they die. There will not be a “retirement” like Kern himself is embarking on for millions upon millions of younger Americans. While frustrating, the current worry among younger generations isn’t funding tomorrow, it’s how to do better with their money today.

Many know “retirement” won’t happen for them. Some are okay with it; others are mad (read the Comments posted with the article to see what we mean). For example:

This huckster is just a salesman for the whole retirement myth our society has bought into — instead of living, we’re told to work and slave away to pile up money until we’re too old or already dead to use it while others suck off the interest. What a gratuitous and insulting article! Read Henry David Thoreau instead to gain other ideas about life and personal economy.

What this means for financial advisors: Your younger clients want help figuring out how to “make money” for their future. Rather than moan and groan about “retirement” and funding it, focus instead on the here and now — give advice on how younger clients can put their money to work for them now, and over the next 20, 30 or even 40 years, when those paychecks do ultimately stop.

In its Retirement Readiness Rating,  EBRI assumed that a household will “run out of money” when retirement income and savings no longer suffice to meet minimum retirement expenditures that include nursing-homes and home healthcare expenses. According to EBRI’s calculations, the percentage at risk includes:

•    47.2% of older Baby Boomers
•    43.7% of younger Boomers
•    44.5% of Generation Xers

Within each group, the percentage at risk varies widely by income. Three out of four older Boomers in the bottom income quartile are at risk — no surprise there. But even one out of five older Boomers in the highest income quartile could run short of money to meet retirement expectations.

EBRI also estimated how what percentage of their wages/salaries Americans would have to save over and above the savings assumed in the model in order to give themselves a 70% or a 90% probability of having adequate retirement income. Unfortunately, the short time horizon to retirement means that nearly all older Boomers except those in the top income quartile will have to save 25% or more of compensation to achieve 90% odds of adequate retirement — a super-human feat requiring wrenching lifestyle changes.

Of interest to financial advisors, whose clients tend to be more affluent than the norm, even older Boomers in the top income quartile need to save about 8% more of their income to achieve 90% probability of being able to pay for basic retirement expenditures.

What it means to financial advisors: There is nothing new in EBRI’s conclusion that Boomers and Xers need to save more. Perhaps the most important lesson is that there is no single, defined savings or income level that will allow clients to retire comfortably and securely. There is always a risk that things won’t work out as planned. Advisors should coach clients to think in terms of risk and probability.

The BU researchers claim they can identify people predisposed to exceptional longevity with 77% accuracy in controlled tests. What people will do with that information, however, is less than clear. As Robert Lee Hotz writes for the Wall Street Journal in reporting the breakthrough:

Genetic testing often reveals tantalizing but incomplete information, and it’s sometimes difficult to know how to respond. People with genes for extreme longevity could face a series of difficult decisions about their careers, retirement savings, insurance coverage, medical treatments and marriages in old age.

In theory, the test should be of tremendous assistance in long-term financial planning. One of the greatest uncertainties in planning for old age is what actuaries call “longevity risk,” in essence, the risk that clients will live so long that they will outlast their savings.

Financially, knowing that you are unlikely to live past 100 can be a relief: It reduces the odds of dying destitute. For those lucky (or unlucky) few destined to surpass the century mark, foreknowledge will give them advance warning that they either will have to save more or live a more modest lifestyle in retirement.

There is one little hitch. While the BU scientists plan to put the open-source software for analyzing your genetic code online for free, you have to provide your own genome. Getting that done may set you back some $20,000 clams. (Illumina, a publicly traded company, charges $19,500 for individuals, although it does offer group discounts through physicians and for people with serious medical conditions.)

What it means to financial advisors. When the BU software becomes available, bring it to the attention of wealthy clients who can afford the expense of getting their personal genome mapped. Explain the financial benefits in terms of risk management. Whatever the findings from a test, it gives you an opening to sit down with your client and draw up a long-term financial plan or, if he or she already has one, to review and update it.

As of June 4, only 30 consumers around the world had had their genome mapped. But as the cost of the technology drops, tests for longevity, genetic diseases and other reasons could become a mass market. Why not be the first kid on the block to work the technology into your financial planning capabilities?

A little old-fashioned attitude adjustment.

Mark Patterson authors the “Tough Money Love” blog, which dishes out take-no-prisoners retirement advice. The man obviously knows the Boomer worldview, and in a column he penned for US News & World-Report he lists five “attitude adjustments” necessary for retirement success. We offer them here, along with our own Generational Advisor spin. (Read the original column here.)

1. Your retirement is more important than your kids’ college education. “We must learn to accept when our parenting obligations are complete,” writes Patterson. If you are sacrificing your retirement nest egg to pay your kids’ college education, he says, you have the wrong priority.

We agree in part. But we also acknowledge that parents have a powerful instinct to nurture their offspring. The decision to subsidize a child’s education depends in part on what he or she is getting out of it. Earning an engineering, IT or business degree will do more to help kids enter a rewarding career than applying feminist theory to deconstruct 19th century English novelists. Likewise, expending the effort to earn straight As inspires a parental desire to help; majoring in fraternity parties does not.

2.  Your retirement is worth more than your kid’s lifestyle. Do not pay your adult child an allowance, do not pay for his cell phone, do not make her car payments, Patterson urges. Here, we totally agree. If adult children cannot afford to support themselves, they can live at home with free room and board — and they can jolly well help out around the house while they’re at it. Speaking selfishly, why should parents sacrifice their retirement lifestyle to support their child’s lifestyle? Speaking altruistically, subsidizing the kids’ lifestyles saps their motivation to improve their condition.

3. Cut costs in retirement. Patterson correctly observes that a penny saved early in retirement is worth two pennies of income later in life. Live beneath your means. Buy less stuff. Downscale your residence, drive older cars, drive fewer cars, eat out less, learn to enjoy the simpler pleasures of life.

4. Debt is your enemy. “Entering retirement with debt is like swimming upstream with one hand tied behind you,” writes Patterson. Our advice: Pay off the credit cards first, then the auto loans, and then the mortgage. Then take the money you spent on payments and invest it, don”t spend it.

5. Retirement is a journey. Retirement is not just quitting work and going on long vacations — it is a new phase of life in which you have the financial independence to redefine a new purpose in life, whether it is pursuing a hobby, starting a business, getting active in the community or helping those around you. Without a sense of purpose, retirement is meaningless and empty, no matter how much money you have. If you have something to be passionate about, the money is almost incidental.

What it means for financial advisors. You don’t have agree with Patterson’s advice (or ours), but these are issues you would be well advised to discuss with your clients. Remember, as a trusted advisor, you provide more than financial advice, you provide life advice.