Sometimes, one must go backward to go forward.
Unless financial advisors charge a retainer or hourly fee, they are in the asset-gathering business. Usually, that puts advisors on the same side of the table as clients, and advisors who help clients save diligently and invest intelligently will help them grow richer and collect more in fees and commissions.
But advisors who are truly putting clients first should occasionally find themselves advocating strategies that will shrink clients’ portfolio and cut their own income.
Yet these are the opportunities that can propel an advisory firm’s long-run success. Advisors who make it clear to clients that they are acting in their best interest will build trust and reap the reward in increased referrals.
Here are five ways to do just that:
1. Paying down debt. Most of us aren’t nearly as creditworthy as, say, the U.S. government or Coca-Cola. As a result, institutions borrow at lower rates than you or me, so we typically pay more on our debts than we can earn by buying their bonds.
Yes, there are exceptions. For instance, after factoring in the mortgage-interest tax deduction, clients might earn more from bonds held in a Roth individual retirement account than they pay on their mortgage, so keeping the mortgage and owning the bonds can make sense.
But often, clients will be better off selling bonds and using the proceeds to pay down debt. That, of course, will hurt an advisor’s income, but it will leave clients better off.
2. Delaying Social Security. Two decades ago, the conventional wisdom was that seniors should claim Social Security retirement benefits as soon as they quit the workforce, so they spent down their savings more slowly. This was also good for advisors because it left them with more client dollars to manage, at least in their early retirement years.
But the thinking has shifted as the financial community has come to appreciate the value of Social Security’s inflation-adjusted income stream. By drawing more heavily on savings during the early retirement years while delaying Social Security to get a larger monthly check, clients not only buy themselves extra insurance against the risk that they outlive their assets but can also ensure a larger survivor benefit for their spouses.
In the short run, advisors who encourage clients to delay Social Security will hurt their own income. But most of the time, it will pay off in the long run, both for clients and for advisors.
If clients live until at least their early 80s, delaying Social Security will usually leave them with greater wealth. That means that advisors will also benefit, assuming that they retain them as clients.
An added bonus: Thanks to their fatter Social Security check, aging clients are less likely to end up destitute. No matter how good a talker an advisor is, that is always an awkward conversation.
3. Converting to Roth IRAs. Advisors can add significant value by helping their clients manage their investment tax bills.
A good strategy is use low-income years to convert traditional IRAs to Roth IRAs. The problem, of course, is Roth IRA conversions can trigger a big tax bill, which is often paid by pulling money out of the portfolio.
That means less money for an advisor to manage. But it usually makes sense for clients.
By converting during low-income years, clients shrink their traditional IRAs. That can mean big tax savings once clients get into their 70s and have to start taking required minimum distributions from retirement accounts.
Converting can also trim the client’s taxable estate, thus reducing the hit from federal and state estate taxes.
Meanwhile, the Roth IRA itself can make a great bequest. Under current law, beneficiaries can draw down a Roth IRA over their lifetime, thus enjoying decades of tax-free growth and tax-free income.
What if Congress kills the so-called stretch IRA and instead forces most beneficiaries to empty inherited IRAs within five years? In that scenario, Roth conversions may make even more sense because if clients bequeath a large traditional IRA, their beneficiaries could be pushed into a much higher income tax bracket as the withdrawals are added to regular income.
By contrast, with an inherited Roth IRA, the beneficiaries wouldn’t be caught in this nasty tax trap, no matter how quickly they have to empty the account. The result is that by encouraging Roth IRA conversions, an advisor can be a hero to clients and to their children, who may also want to hire the advisor.
4. Pushing to spend. During my time at The Wall Street Journal and at Citigroup, I met or corresponded with thousands of ordinary investors who had amassed seven-figure portfolios. Many had surprisingly modest incomes.
Most were mediocre investors. But almost all shared one attribute: They were extremely frugal, otherwise known as cheap.
This, of course, was the key to their financial success. They lived far beneath their means and thus were able to save gobs of money every month.
Yet many of these “millionaires next door” find it hard to abandon their thrifty habits once they are retired. This is another opportunity for advisors to improve their lives.
By encouraging frugal clients to spend their wealth, advisor will put a dent in their assets under management. But imagine the word-of-mouth publicity that can result when clients tell their friends about the great trips they have taken and the new car or summer home they bought.
All this was made possible by their advisor who reassured them that, even if financial markets generated lackluster returns and even if they lived to 95, they could spend thousands more every month and still be in good financial shape.
5. Making gifts. Despite encouragement, some clients will never make the switch from saver to spender. But an advisor could help them go from saver to giver.
Clients who won’t spend money on themselves often get a lot of pleasure from giving to charity or helping their family financially.
Giving during their lifetime also makes a heap of financial sense. If clients make regular annual gifts to their children and other family members, they can shrink the size of their taxable estate, potentially reducing the sum lost to federal and state estate taxes.
Clients can give up to $14,000 to as many people as they wish this year without worrying about the gift tax.
If clients give to charity while they are alive, they can garner an income tax deduction while also trimming the size of their taxable estates. There is no income tax deduction for those who make charitable gifts when they die, though such gifts can potentially reduce the hit from estate taxes.
The bottom line: It makes more financial sense to give to charity and to family during their lifetimes. Although an advisor may have less money to manage, clients will enjoy bringing pleasure to others and might have a few nice things to say about their advisor, too.
Jonathan Clements, a Financial Planning columnist in New York, is a former personal finance columnist for The Wall Street Journal. He is the author of Jonathan Clements Money Guide 2015 as well as the forthcoming How to Think About Money. He is also the former director of financial education at Citi Personal Wealth Management. Follow him on Twitter at @ClementsMoney.
This story is part of a 30-day series on how to generate the best referrals. It was originally published on Sept. 25, 2015.
