Financial planning challenges in an unequal society

The topic of inequality has been a hot topic lately, I have been writing off and on about its effects for some time. There is no question that inequality has been growing for the last few decades in the United States. The debate is over whether the economic and social policies surrounding this change. Here is an informative if somewhat wonkish chart from Chart Book of Economic Inequality:

In Thomas Piketty's latest book, his thesis explaining inequality can be summarized as:

Whenever the rate of return on capital is significantly and durably higher than the growth rate of the economy, it is all but inevitable that inheritance (of fortunes accumulated in the past) predominates over saving (wealth accumulated in the present).... Wealth originating in the past automatically grows more rapidly, even without labour, than wealth stemming from work, which can be saved.

Today, we seem to be seeing those kinds of conditions. The returns to capital are durably higher than the returns to labor and they are "durably higher" than the economy's growth rate. It's no wonder inequality has grown.


The Downton Abbey asset management challenge
Regardless, this presents a whole new set of challenges for those working in the wealth management business. The New York Times had an interesting article about the intersection of growing inequality, Baby Boomer demographics and inheritances:

Rich families today are holding onto a big piece of the pie. The top 1 percent of households owns about 35 percent of American wealth, more than the entire bottom 90 percent does. But at least at the moment, growing inequality has not resulted in a big boom in inheritances. Since the 1980s, the value of inherited wealth has only drifted upward slightly. In fact, wealth transfers as a proportion of net worth have fallen, to 19 percent in 2007 from 29 percent in 1989.

But the baby boomers are only now retiring. Once that process accelerates and reaches its inevitable conclusion, get ready for a flood of princelings — and some potentially worrisome consequences for social mobility in the United States, as the immense earnings of an already stratified economy are entrusted to a new generation. The inheritance boom will come, eventually. What’s unclear is what the country will look like afterward.

The money will go to the children of Boomers, otherwise known as Generation X and Generation Y:

That money will flow into the bank accounts of the by-then-over-the-hill members of Generation X and Generation Y, and the United States might look a little more like aristocratic Europe, with its Downton Abbeys and super-hyphenated names — maybe with a few more tattoos. Lists like the Forbes 400 might be filled less with financiers and technology entrepreneurs and more with third-generation Waltons and second-generation Zuckerbergs and Bezoses or, perhaps, first-generation Walton-Zuckerberg von Bezoses.

Running a dynasty vs. retirement planning
This expected transfer of wealth presents a challenge for people who are in the wealth management business. Much of the discussion in the current low interest rate environment revolves around the right withdrawal rate from savings for retirees. For the super-wealthy, the withdrawal rate question is not relevant - and therefore financial planners and wealth managers need to deal with a paradigm shift in their business.

The current underlying model for retirement planning goes something like this. When you are young, you save for retirement, aided by tax-deferred vehicles like 401ks, IRAs, etc. When you cannot work anymore and retire, you draw down on those savings to fund your living expenses. Upon death, those savings are exhausted or nearly exhausted and the residual goes to the heirs.

While that model of retirement remains relevant for the mass affluent market, it's less relevant for the super-wealthy. This demographic will not need to draw down their savings to retire. The income generated by their wealth far outstrips their spending needs. After all, if you have $100 million, does it matter that much if your withdrawal rate is 2% or 4%? How much could you possibly spend? For this group, their savings will outlive them and the financial planning framework shifts from "will I outlive my savings" to "how do I maintain my wealth for my heirs after I die" . In other words, how do I sustain my dynasty?

If you are a financial planner and wealth manager, you have to be aware of these trends. America has been getting more unequal and the wealth distribution is getting more skewed. If you get caught with a business model that caters the to common man by on the idea that the American Dream is still relevant, then be aware that the size of your market is stagnant or shrinking. The growth market is serving the super-wealthy, which presents its own sets of challenges, massive changes in the infrastructure of your services and business model.

The NY Times article indicated that these clients often focused on philanthropy, so you need to have the financial planning infrastructure to service those needs.

For one, the wealthy tend to give away a big chunk of their money, leaving less for their heirs, Wolff says. Bill Gates, Warren Buffett, Mark Zuckerberg and many others, for instance, have signed onto the “giving pledge,” promising the bulk of their estates to charity.

For clients who look to maintain wealth in a dynastic framework, then the financial planning challenge shifts from attracting 401k and IRA savings to sustaining wealth for generations in a tax efficient fashion. Do you have the legal and tax planning resources to do that? Do you have the resources to diversify into other asset classes, such real estate development and management, for clients with such long time horizons? No longer are you dealing with the plain vanilla bonds and equity asset classes for the mass affluent market.

This Reuters article offers the example of one firm that is re-orienting itself towards new business model:

Baltimore financial adviser Lyle Benson describes his work as that of "Personal CFO" or chief financial officer.

His boutique financial planning firm manages money, but it also does everything from bill paying to estate planning, even assisting clients' adult children negotiate terms for their first automobile purchase or mortgage.

"We coordinate and work with all of our clients' advisers" including attorneys, accountants and insurance agents, says Benson. "We make sure everyone is on the same page and working together."

The services necessary to quarterback a client's complete financial life, often referred to as family office services, are not just for the ultra-rich. Benson says anyone with investable assets of more than $2 million can benefit from such comprehensive oversight. At his firm, those services are used by more than 30 percent of clients.

However, advisors should be aware of the business challenges of chasing after such accounts. A separate Reuters article outlines the issues and it is well worth reading in its entirety:

High-net-worth clients, especially those with $30 million or more, are different from garden-variety millionaires. They do not sweat the small stuff, like planning for their kids' education or retiring comfortably, so they do not value basic financial planning services as much as less-affluent clients.

Very wealthy clients often expect investment services and products beyond those offered by smaller wealth managers. They may require income- and estate-tax strategies that are more complex than the adviser can deliver.

This mismatch of client expectations and adviser services can actually hurt a wealth management practice that is not set up to manage all that money.

Regardless, the super-wealthy is an enormous growth market in an unequal America. The size of the market is exemplified by the CNBC report that American billionaires gained nearly $1 trillion in the bull market. The private banking divisions of a number of get it, even though the term "dynasty" is distinctly un-American and is far more reminiscent of Old Europe, it is a growth business that deserves to be addressed.




Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

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