Why Spending Should Be Discussed by Financial Advisers

As a financial adviser – whether you work through Western International or as an independent securities broker – how much time do you spend talking with your clients about their spending habits? According to one prominent expert, spending is something advisers do not spend enough time talking about. He makes the case that things need to change.

Morgan Stanley’s Ben Huneke recently told the assembled group at the annual conference of the Investment Company Institute that spending among clients is a more pressing issue than the performance of their portfolios. At first, his comments seem counterintuitive to what financial advisors and brokers are trying to accomplish. And perhaps it is, if their primary motivation is to maximize their own profits. However, advisers and brokers genuinely concerned with protecting their clients’ financial futures should also be concerned about spending.

Huneke’s comments focused mainly on investing for retirement. He outlined how the best investment plan that provides maximum retirement income will still fall short if said retirees spend more than they earn. As financial advisors, we tend to focus only on return without working with clients to help them understand spend. We give them the financial tools for retirement but we do not help them learn how to use those tools.

Ever Dwindling Value

We can take Huneke’s comments and expand them beyond just the retirement arena. The principles he sets forth actually pertain to all sorts of investors whose sole concentration is growth. A growth-only focus leads to two problems, starting with the ever-dwindling value of investments.

The easiest way to understand dwindling value is to look at something as basic as an individual retirement account (IRA). Financial advisors and independent securities brokers recommend these all the time to people without pensions or 401(k) plans. That’s great. But what happens when a client starts withdrawing from his or her IRA?

That account loses value with every withdrawal. As the account loses value, there is also less cash in it to create future returns. So along with less money in real terms, there is also less future value as the balance of the account gets smaller. This is a two-edged sword. It is a sword that cuts into all sorts of investments.

Reduce the amount of cash in your stockbroker account and you will have less money to put into stocks. Cash out some of your gold and silver and you will have less value whether prices rise or fall.

Making up the Shortfall

The second problem created by the growth-only mindset is felt mainly by retirees: having to make up the shortfall. In other words, spending more than an investor earns puts that investor in negative territory. There will come a point when returns no longer meet the client’s needs, forcing the individual to make up the shortfall elsewhere.

There is a reason why so many of today’s retirees are working part-time jobs even though they have retirement investments to fall back on. They have consistently spent more than they earned, substantially negating the benefits of investing in their younger years. They now have insufficient income to pay the bills at a time of life when they should not have to worry about working.

Both the independent securities broker and the employed financial adviser owe it to their clients to help them create strong portfolios capable of maximum growth and returns. But they also owe them the courtesy of at least talking about spending and how it might outpace earnings. Clients need to understand that how they spend will ultimately influence the true value of their various investments.

 

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