Kitces: When clients cheat

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As advisors, we never want to see a client run out of money on our watch. This makes working with people who appear to be spending at unsustainable levels especially challenging. Yet the problem may not be that the client has a spending problem, but rather that they haven’t been up front about all their assets. That’s really a trust problem.

Learning about unaccounted-for assets can shock many advisors. And it may lead to some unpleasant reckonings. On the one hand, we may learn they actually had another advisor we didn’t know about. On another, we learn they had other assets we didn’t know about — and in sufficient quantities that they weren’t actually overspending at all.

As more of the advisory industry shifts to the AUM model and packages together planning and investment management, this problem is only going to get worse before it gets better. Luckily, there are some sound strategies that we can use to not only strengthen client trust, but also strengthen our bottom lines.

One client came on board our firm back in 2004 wanting to roll over a $1 million retirement account. We executed a plan that projected the impact of the client’s Social Security and portfolio withdrawals to ensure they could afford to retire, created an appropriate investment allocation and then managed their portfolio on an ongoing basis.

However, this client was spending at a dangerously high level. They were receiving about $4,000 a month in Social Security benefits as a married couple and commanded good salaries over their working years, but they were spending about $100,000 annually.

So here they were taking almost $60,000 a year plus their taxes from a $1 million portfolio, which represents a 6% withdrawal rate. Technically, this works more than half the time, as the median historical safe withdrawal rate is fairly close to 6.5%. But most advisors don’t sleep well at night when we do a Monte Carlo projection for a client and it shows up at 60%, let alone 70%. Theirs was just over 70%.

Despite all of our warnings, they wouldn’t change their spending behavior. After about three years of this, they announced they were terminating our relationship and consolidating their retirement account with another advisor. Essentially, they were afraid that if they told us about held-away assets we would have pushed them to consolidate all of it with us — which in retrospect is probably true because that’s what we tend to do when we’re on the AUM model.

But the problem that I didn’t appreciate at the time was the conflict that crops up when clients don’t necessarily want to be solicited about other assets to be managed. Consequently, they may not be fully up front with us, which then leads to a dysfunctional planning relationship.

Looking back, 2004 to 2007 was a good cycle in the markets, and we gave them good service. But they grew tired of our constantly calling out their irresponsible spending — which of course was predicated on an incomplete picture of their finances.

The reason I’m highlighting this problem is that as more of the advisory industry shifts to the AUM model and packages together planning and investment management, this problem will only deepen and broaden.

According to Spectrum research there are about 115 million households in the U.S., roughly one-third of which have at least $100,000 of investable assets outside their primary residence. This is the segment we call the mass affluent. Meanwhile, about 10% of these have at least $1 million, and about 1% are ultra-high-net-worth, with $5 million or more in investable assets.

Not every U.S. household that looks like a good prospect is one. Some are going to be do-it-yourselfers who won’t hire an advisor, while some may just want advisors for occasional or incremental advice. Forrester Research estimates that only about one-quarter to one-third of all consumers want to fully delegate the investment management process to an advisor in the first place. We tend to call these good clients because they’re easy to work with and they like to delegate to us.

So about one-third of the households are at least mass affluent, but only half of those have money available outside of retirement plans, and only about one-third of those are likely to hire an advisor. We net out with roughly seven or eight million households that we can work with.

According to Cerulli there are about 300,000 advisors in the U.S., which translates to about 21 clients per advisor in that AUM model — and only five of these are millionaires.

Ironically, that means that if all clients consolidated their assets with just one advisor, a whole bunch of us would go out of business. Perhaps the only reason we can have 300,000 advisors chasing the same seven or eight million households is that clients cheat on us. They split assets across multiple advisors and they don’t necessarily tell us about it. Their duplicity keeps more of us employed, but it undermines the planning relationship.

It’s probably not quite as bad as I’m making it out, primarily because not all advisors have adopted the AUM model. Some just sell various products, like life insurance or annuities, and don’t compete for managed accounts — meaning they don’t compete for that same pool of assets.

And some advisors do hourly planning or charge retainer fees, which frees them to take on clients who may not have assets to manage but who will pay for planning.

So the pie may be bigger than then numbers suggest. That’s actually why I’m so upbeat about opportunities to adopt other models, such as monthly retainers that are structured in such a way as to not compete with the AUM model or for AUM clients. Rather, advisors using this billing structure would be reaching clients that the AUM model doesn’t serve.

Nonetheless, as more of us converge on the AUM model and approach planning and investment management with a 1% fee structure in mind, the more we’re likely to have clients not disclose their full financial profiles with us, for fear of being solicited. There are ways to cope with that.

My early, sour experience with that particular client turned out to have a silver lining. It led me to be even more focused on leading with planning first, but to be less aggressive about trying to encourage clients to consolidate with us. I realized that ultimately, if we did good planning work, gave good advice and had a good investment processes, we’d win and retain business in the long run.

Admittedly, this was difficult because of how much I value holistic planning and management of the portfolio. But now, with a few more years of experience, I’m much more comfortable letting clients engage us with just a portion of assets. That’s our opportunity to build trust and have them open up to us.

And frankly, we as advisors have earned some built-in protections over the years. To ensure we don’t lose money in the upfront planning work, we have investment minimums that we put in place. That’s just a necessary business reality to ensure that we have enough revenue per client to cover the overhead and the cost of doing business.

Still, it helps to be humble. Just when we think everything’s out on the table, it may not be. And the process of winning clients’ trust never ends. We of course want to be holistic in the planning we do, but we don’t have to do everything in the portfolios all at once. As I learned the hard way, not pushing for consolidation right out of the gates can improve the long-term advisor-client relationship, which in turn can get us to the point where we end up doing all their business anyway.

So what do you think? Have you ever had a client you thought had a spending problem but was really just hiding assets from you? Does the AUM model lead clients to want to hide assets from advisors? How can advisors better gain the trust of clients so that they don’t hide assets? Please share your thoughts in the comments below.

This article originally appeared in Michael Kitces
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