It's a dilemma almost every high net worth financial advisor has faced — being blindsided by a client's big-ticket purchase so large that it limits their investable funds.
To provide the best counsel, advisors need full visibility into their client's spending habits. Lack of clarity across all financial accounts, not just investments, means you don't have a complete view into client liquidity, cash flow and/or asset risk, which can inhibit your ability to manage their portfolios effectively.
In a complex world, however, such information is not always at hand. Having worked with high net worth clients and their advisors for more than three decades, we've seen how detrimental the lack of a 360-degree perspective can be. Below are ways to boost visibility into your clients' spending habits, a goal that all advisors should prioritize.
Connect the dots
You can't make investments on a client's behalf if you don't know what can actually be invested. Make sure clients share updates on their cash flow and personal priorities. We've seen scenarios where advisors look at their client's portfolio, determine they can invest, say, $1 million into a certain asset class, and then find out the client bought a new house in the previous month. This leaves the client with no cash to make investments the advisor thinks are in their best interests.
Issues can also arise when there are gaps in insurance coverage. We've seen clients pay cash for a $15 million home in Manhattan and place their $10 million art collection in it. But because they paid cash and didn't have a mortgage, insurance was not required at settlement and so it was forgotten. If a client is uninsured for property & casualty, they are likely uninsured for liability. That's a dangerous situation, particularly if an injury takes place on the property, a scenario we've seen play out many times. An automobile domiciled at the property may also be deemed uninsured, which creates a mobile risk in the event of an at-fault injury to another party.
How liquid?
High net worth clients typically have various investment entities involving complex liquidity requirements. Let's say a client commits $1.5 million to a private equity investment and not all of the money is required upfront. If there is an initial capital call for one-third of the investment and if, as their advisor, that is all you see, you may not realize there is another $1 million still committed over the next 12 to 24 months.
This affects the client's liquidity, and of course, their future financial needs. Another example is
Who else are they seeing?
The reality of working with wealthy clients is that there are often multiple wealth advisors involved. They may look to one trusted wealth advisor — you — for guidance, long-term planning and financial allocation but they likely have assets custodied with other advisors as well. If you are the primary advisor, you need to know who the other parties are in order to make recommendations that are the best fit for the client.
You may, for instance, look at a particular stock and determine it has a strong upside. What you don't realize is that through another entity, your client already owns 1,000 shares of that same stock. In such a case the discretionary power you possess can actually be a detriment to the client's interests.
Flag fraud
Understanding where and how your clients spend money becomes particularly crucial when a client is a victim of fraud. Should a scammer get hold of client credit cards and bank accounts, for instance, there is a time limit in which such
Minimize waste and redundancy
But even in the absence of fraud, such understanding makes for better financial planning and helps the advisor suggest ways that a client can effectively redirect cash toward asset-enhancing spends versus asset depletion spends. Such knowledge also comes in handy in counseling the client on waste minimization. We've seen clients maintain multiple insurance policies, for example through different brokers, which create inefficiencies and overlap — therefore increasing the cost of coverage. We've also seen instances in medical costs where bills are sent multiple times, and if not carefully reviewed, are often paid more than once.
Variable vs. fixed costs
Finally, a consistent issue we've seen arise from lack of insight into client spending concerns variable versus fixed costs. For instance, a client may look at their mortgage, insurance, and taxes and think they are spending a total of $3 million a year on their properties without taking into account the ancillary, more variable, costs of maintenance, upkeep, landscaping and utilities, which bring that figure closer to $6 million. We've seen clients spend six figures along on gardening and landscaping among their multiple properties. It adds up to real money that a financial planner has to be aware to avoid a cash crunch.
It's also important to note that discretionary spending can be fixed or variable, for instance a car lease payment is fixed but the amount owed depends greatly on the make and model. Owning a car may be nondiscretionary but owning a Bentley isn't. Likewise, clothing is a necessary variable cost but the amount spent creates the distinction between discretionary and nondiscretionary.
Returning to real estate, a knowledge of variable expenses is important for tracking the cost basis and potential return of an investment. If a client purchases a house for $2 million and later sells it for $5 million, that's great, but if they also put in another $2 million for improvements during that time, the gain is actually lower — which reduces the tax on the gain. Variable costs that count as capital improvements need to be part of the basis and the ensuing capital gain calculations. When the gain is realized is not the time to scramble to determine actual capital costs — which unfortunately is often the case.
