Journal of Financial Planning; July 2011
Rick Adkins, CFP®, ChFC, CLU, is president and CEO of The Arkansas Financial Group Inc. in Little Rock, Arkansas. He served as the 2003 chair of the Board of Governors of Certified Financial Planner Board of Standards. You can write to Rick at RickA@ARfinancial.com.
Over the years, I’ve observed clients who started out with very little, controlled their spending, saved regularly, and now have portfolios in excess of $5 million. I’ve watched other clients with similar incomes start with little and still have little today. I’ve observed clients receive large sums of money through inheritance, sale of a business, divorce, or the death of a relative. Some now have substantially less than others—and not because of market losses.
I must confess my curiosity about the implications of divergent money behavior with respect to human nature and our relationship with money. I’ve found myself wishing I could give certain clients a pill that would cure their self-destructive tendencies with money, but, alas, none exists.
While my personal observations are anecdotal, research conducted by Hoekstra, Hankins, and Skiba on 35,000 winners of the Florida Fantasy 5 lottery game found that 5.5 percent were bankrupt within five years. Further, big winners were just as likely to file for bankruptcy as small-time winners. The bad behavior transcended the amount of money. How could this be? Why do some folks handle money well, no matter how much or how little, while others don’t? This plight isn’t unique to lottery winners—think of the actors, professional athletes, and other entertainers who have gone from great wealth to destitution.
Here are my thoughts on three sources of challenge for humans in building and keeping wealth: guilt, ego, and a “monthly paycheck” mentality. This is one of those times I would love to have dialogue with other planners who have thoughts on this subject, because as a profession we can have the best investment processes in the world and yet fail clients who need help beyond determining where they should be on the efficient frontier!
With apologies to all great mothers highly adept at wielding guilt to manage the behavior of their offspring, the “money guilt” I’ve observed seems to be either situationally cultural or event-driven. Here are a few of the possible drivers that can derail wealth building:
Misguided Religious Teaching. Some of our clients come from families that were very poor and coped with their poverty by holding onto the thought that “While we may suffer now (because we aren’t rich like the Johnsons), we’ll be just fine when we die and go to heaven. They might not be so happy then because rich folks will have a harder time making it to heaven than a camel going through the eye of a needle.” Were you to buy into this thinking, how could you cope with making more money in a year than your parents did in their lifetime? The idea of accumulating wealth can leave you certain that you’re headed straight to hell like the rich man in the story of Lazarus! The resulting behavior can be totally bizarre, unpredictable, and self-destructive.
Blood Money. One of our tougher challenges can be serving a surviving spouse who receives a large insurance payout or legal settlement because of the death of a spouse. Some have great difficulty hanging onto the wealth because it is a constant reminder that the money exists only because the spouse no longer does. They can also become greater prey to relatives who feel the spouse doesn’t deserve such good fortune as a result of the death of their relative.
While I’m not suggesting that financial planners should all become great therapists, I do wish I had a better way to help clients so burdened by guilt that they are challenged to ever accumulate adequate wealth to achieve reasonable long-term goals. How do we help them?
You would think that the first decade of this century would have been a wakeup call regarding risk and loss. Yet our relative affluence during the 1980s and 1990s gave many of us the false illusion that we control our environment and destiny. I well remember clients who would blow off sound financial principles like having an adequate emergency fund or owning appropriate insurance by saying, “I can just borrow the money if I need it” or “She’ll be okay; she’ll get Social Security if I die.”
While this sense of control has been shaken by recent tornadoes and flooding, it’s still persistent. Weather is just one aspect of life we don’t control; office closings, stock market crashes, job elimination, divorce, health surprises, or death of a loved one tend to diminish our sense of control.
The high income/modest wealth syndrome can become a huge trap in thinking. You see this most routinely with professional athletes. They earn huge incomes for a relatively short time. The pressure of conspicuous consumption is massive. They live as if the income will last forever, but the career lifespan of an NFL running back or MLB pitcher is usually short. As a result, what Texans refer to as “big hat, no cattle” can affect professional athletes, entertainers, and even doctors. My real concern is what is going to happen to physicians’ salaries over the next 10 years. I’ve watched “sector rotation” happen with specialty incomes over the past 30 years. My fear isn’t that rotation will continue but that the entire pie will be diminished. The illusion of control from high incomes may be a great hurdle for many of our clients. How do we help them?
Monthly Paycheck Thinking
For Americans above the poverty level, “Give us this day our monthly paycheck” might be an appropriate prayer today. While the original Daily Bread prayer was appropriate in Palestine 2,000 years ago (and still is today for many around the world and even in our own country), our culture and relative affluence no longer leave us wondering about the source of tomorrow’s food. Yet therein, on multiple levels, is the problem.
In my experience counseling clients in financial matters, I have observed that the perspective for humans within an affluent environment has evolved our point of reference for financial decisions. We have become “monthly cash-flow centric.” As a result, we are usually “wealth challenged,” and have trouble emotionally coping with large sums of money. I suspect there are three culprits of illusion that contribute to this problem:
Illusion of Time. With each passing year I become humbled by my changing perception of the passage of time. The song “100 Years” popular a couple years ago illustrates human time perspective from age 15 to 99, beginning each stage with, “I’m ____ years for a moment.” My, how the passing of those moments seems to accelerate with age!
As a result it’s difficult to capture the interest of a 26-year-old with retirement planning; yet, it’s at that point $100,000 invested at 6 percent would grow to become $970,351 by normal retirement age. Waiting 10 years to invest lowers the end value to $541,839; 10 more years it’s $302,560. And $100,000 invested at 56 will end up at only $168,948.
Because most of us don’t have large sums lying around when we’re 26, we lose much of the benefit of compound interest. Raising families is expensive and, as a result, most retirement savings capacity blossoms in the 10 years leading up to retirement. Most of us don’t have a “return” problem, we have a savings rate problem caused by a consumption problem.
Illusion of the Retirement Plan Solution. Some clients come to us presuming that if they just fully fund their retirement plan each year, they’ll magically have enough to retire. My colleague Dr. Broadwater counsels young physicians with the perspective that while they might soon have high incomes, they’ll probably never be wealthy unless they find ways to limit the expansion of their lifestyle and save for future consumption. Just using modest earnings and inflation assumptions, a physician might earn $23,710,251 over a career. After taxes, that converts to $12,625,708. After-tax income in the last year of employment would be $564,947. If nothing is being saved, the portfolio required to support that standard of living would be $14,123,685. If all the client has saved for retirement is $30,000 per year into the clinic’s retirement plan, that might have grown to $3,818,044. There’s an obvious gap. If consumption is constrained so that half of the income is being saved, not spent, only $7 million of capital is needed to fund retirement (that would imply that there’s about as much outside the retirement plan as has been saved inside the retirement plan).
Illusion That Capital Is the Same as Income. Back before perpetuities became illegal to establish, families like the Kennedys and Rockefellers funded legal structures that ensured the wealth of their heirs for all time. They accomplished this by giving their heirs no access to the principal, only the income generated by the principal. Foundations operate on the same theory today; the withdrawal rate is commensurate with the income generated by the foundation. Spending down principal is either limited or isn’t an option. The beneficiaries never confuse “the tree” (corpus) with “the fruit” (income).
Lottery winners usually have the option of taking a lifetime income or a smaller lump sum. Most take the latter; they would all be better off taking the former. Yet, because corpus is not mentally differentiated from income, they are doomed to eventually have neither.
This issue makes thoughtful estate planning so critical. How much corpus should you leave your children and at what ages? How much access to corpus should they have and for what reasons? How much protection of the corpus should you impose? These aren’t easy questions to answer, but the typical answer of one-third at 25, one-third at 35, and one-third at 45 is a formula for disaster if the heirs don’t understand the importance of living on income, not spending principal.
Whether you call yourself a financial adviser, a financial planner, or a wealth manager, your challenge is presenting facts and risks as accurately as possible so that clients can make rational, smart decisions. I’m convinced that because of our human nature, the deck is stacked against clients to succeed by actually doing what can easily be rationalized. Retirement planning gets more challenging each year, but I believe this profession holds the keys to help clients manage wealth and build decision frameworks that will help them achieve their goals.