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Guest Comment: The Benefits Of Household Balance Sheets for High Net Worth Clients
Neal Ringquist
19 September 2012
Editor’s Note: Neal Ringquist, president and chief operating officer of Advisor Software, discusses why the use of household balance sheets is gaining traction among US HNW clients. Opinions expressed are the author's but this publication is grateful for the right to publish them. Financial advisors are increasingly turning to new technologies to improve efficiency, stand out in a crowded field and, above all, provide customized solutions for their clients. The financial planning tools that are available range from simple online calculators to programs that incorporate tremendous amounts of data and produce extensive reports. The more comprehensive tools are often appropriate for high net worth clients with complex financial lives that include estate planning and risk mitigation or multiple trusts with multiple tax rates. However, many HNW households have relatively straightforward financial realities that call for more than a calculator but less than a full-blown 50-page financial report. These clients may have considerable assets in 401 accounts, with perhaps some holdings in mutual funds or individual stocks, but no trust accounts holding alternative investments or SMAs with complex tax planning considerations. For them, a household balance sheet focused on their long-range goals can be the ideal construct, providing a clear and holistic approach to financial planning. The household balance sheet allows an advisor to collect and interpret household financial data within the context of helping the client meet specific goals. The household balance sheet also enables advisors to clearly demonstrate the purchasing power of different account types and future benefit cash flows. Compare and contrast The role of the household balance sheet becomes clear when looking at the portfolios of two hypothetical HNW investors. Let’s say both are single, 65 years old and in the 40 per cent tax rate category. They both need $10,000 per month to live on at retirement and both have $2 million in liquid assets. However, Jim has his assets in an after-tax brokerage account with no capital gains liability, whereas John has his in a 401. Their household balance sheets reveal that because of the 401’s deferred tax liability, John’s goal is only 85 per cent funded, with a total deficit of $206,392. Jim’s goal, on the other hand, is shown to be 142 per cent funded, with a total surplus of $593,608. The need for John’s expenses to be reduced by $1,190 per month is represented with graphs and numbers within the household balance sheet to help both the advisor and John better understand his financial picture. “What ifs” The advisor can also use the household balance sheet to quickly model different “what if” scenarios. HNW individuals might be interested in seeing the tax implications of living in Nevada versus California, or Texas versus New York. They might want to factor in future charitable giving and bequest goals, or they may have more nuanced retirement expense priorities. Whereas mass affluent clients may be primarily focused on funding daily expenses in retirement, HNW clients may want to look at a broader range of goals. The objective of using a household balance sheet is to provide a quick analysis of goal plan affordability. The advisor begins by determining a client’s assets that are available to support future goals and liabilities; this data represents the client’s resources. The resource side contains both controllable and fixed assets, including employment income, Social Security payments, rent or capital gains from real property, interest from fixed investments and current income and capital gains from managed investments. On the commitments or liability side are the client’s goals: these are future expenditures against their financial resources. These could include mortgage payments, college tuition and retirement living expenses. Some of these may be unavoidable and fixed, while others may be obligations with lower payment priorities that can be postponed. Under ideal circumstances, net resources should be positive; that is, the total cost of the household’s commitments should be less than the total resources that are available. This will enable the client to meet his or her goals with certainty. At the very least, resources must balance against future costs and present liabilities. Ideally, the advisor would break the goals section into three areas: "Necessary Goals" , "Target Goals" , and "Aspirational Goals" . Everything defined as essential should be immunized from an investment standpoint, whereas aspirational goals are subject to more uncertainty as to whether they can be achieved. Using a household balance sheet allows advisors to create highly flexible and customized investment and planning models that take into account a multitude of goals. This is especially valuable when working with a broad range of clients. After all, the Aspen getaway that may be an aspirational goal for a mass affluent client could be an entirely necessary goal for a HNW individual.