From the December 2003 issue of Investment Advisor • Subscribe!

December 1, 2003

The Total Picture

If you're focusing only on your clients' assets and ignoring their liabilities, you're missing an important part of the picture.

James Brown was elated. He had finally reached a level of financial security where he felt he could afford a vacation home. After receiving a promotion, he and wife Karen decided it was time to act on their dream vacation house. They found a nice place, got a financing quote, then went to their advisor to liquidate $200,000 in assets that was tied up in bonds for a down payment on their dream.

The advisor could have easily sold those bonds and gotten the cash the couple needed, but instead he made a smarter move. Since he had just begun offering liability management services, he guided the couple through an analysis of their liability holdings and presented them with several options, based on their risk tolerance and other preferences. Upon restructuring those liabilities, James and Karen wound up with $700 per month in cash and tax savings that could be applied to buying their new home.

Moreover, they could purchase the property by liquidating only half of what they thought they needed ($100,000) and keeping the rest of their money in the interest-bearing bonds. James and Karen gained a much better understanding of their options for managing their liabilities, while contributing to the growth of their net worth. The advisor began the process online and assisted the couple throughout until the financing was completed.

Clearly, liability management provided an optimized solution for the young couple's financial need. But what is liability management? It is the process of analyzing, planning, and executing all forms of a client's liabilities, including real estate loans, home equity loans, and consumer loans, with the objective of improving the client's overall financial picture. It is, in fact, a form of wealth management that considers liabilities rather than just assets. Wealth management focuses on building wealth by managing assets. The same is true for liability management, except that the wealth is built through careful management of liabilities.

As the scenario above shows, the key is to use liability management in tandem with asset management. An advisor who offers liability management to his clients can also identify cash and tax savings for them that can then be reallocated to asset products she offers.

Why Now?

Providing a holistic service for clients that manages assets and liabilities has always been a good idea. But our society's complacency with debt has magnified the need to offer liability management services with asset services. Debt and liabilities are on the rise throughout America and are at their highest levels in years.

Household debt (according to the Bureau of Public Debt) stood at $6.7 trillion in the fiscal year ending September 2003. That debt is mostly in the form of mortgages, but also includes personal and equity liabilities.

Liabilities are especially high for the mass-affluent and high-net-worth individuals. According to the Federal Reserve Board's calculations, the debt burden for households, based on a percentage of disposable income, rose faster in early 2002 for higher-income than lower-income Americans. In fact, last year the debt burden was 20% greater for higher-income than lower-income Americans than in 1995. Furthermore, high-net-worth clients tend to refinance their mortgages and other loans more often to benefit from refinancing's greater cash flows and tax benefits.

The financial industry today typically focuses solely on assets because, historically, the industry has rewarded asset allocation with little regard for liabilities. In fact, an advisor's success is often judged by the amount of assets they have under management and they generally are compensated by charging basis points for managing those assets. The industry has grown partly because of the earnings potential of asset management.

Liability management, on the other hand, has never been monetized. But what if there was a meter put in place that tracked liabilities under management and basis points earned for liability management transactions? Is it possible to earn 20 basis points a year on liabilities under management?

It absolutely is possible. The key is to use the right liability management services and tools that enable financial advisors to analyze and restructure an individual's debt portfolio with immediate execution capability.

Technology Is Crucial

Liability management is not yet a standard service offered by advisors; it is at the same stage where asset management was a decade ago. Ten years ago, financial advisors did not have standardized financial tools, technologies, or the Internet access needed to assist their clients with financial planning. The rapid growth of those tools and technologies over the past decade has made asset management more accessible to more advisors and more clients.

Over the last decade asset management has evolved from an exclusive service for the wealthy, provided by experts with years of experience, into a mature business that, with the aid of technology and the Internet, now offers a broad spectrum of consumers deep, analytical, and active asset management services.

Technological breakthroughs have also enabled consumers to connect with their financial advisors and transform rigid desktop applications to adaptive Web-based tools with execution capabilities.

Deregulation was another element that made it easier for the asset management sector to become more efficient in monetizing the industry: The Internet and other technologies brought consumers closer to sellers of financial products via online trading applications. For example, most trades placed today are executed online versus a decade ago, when not a single person traded securities over the Internet.

Over time, technology began to usurp the advisor by going directly to the consumer. But this business model (B2C) proved unsuccessful after the long bull market of the 1990s, when customer-driven online trading resulted in millions of disappointed investors and revealed their unwise investment decisions. This lesson highlights the significance and relevance of the financial advisor's role in the financial planning process.

Liability management is now emerging as an integrated service offered by financial advisors. The quality of advice does still rely heavily on the advisor's knowledge and experience, as asset management did 10 years ago. But we have learned a lot from the evolution of asset management, and those lessons applied to liability management can flatten the learning curve. In fact, the technologies and processes are in place for advisors to quickly begin offering liability management services.

A Liability Management Practice

Helping individuals manage their liabilities requires building a practice that considers the whole financial picture. Whether partnering with a liability management solutions provider or building his own liability management practice, an advisor should remember the following points:

o Liability management is more than mortgages. An understanding of the mortgage industry is important since it is typically the biggest liability, but a liability management service must analyze the entire liability picture.

o Relationships with many lenders offering various products will increase the likelihood of success. It is critical to have easy access to lending criteria, guidelines, and rates. Access to rates and products from many lenders will allow the advisor to offer better savings scenarios for clients.

o A client's liability portfolio changes with important factors such as risk tolerance, age, life cycle, and economic cycle. A professional skilled in liability management must take all factors into consideration. It is helpful to have a strong understanding of the suitability of various debt products, as well as tax consequences and cash flow issues relating to liability transactions.

o Liability management products require timely execution. It is critical to analyze a client's data in a timely fashion and--more important--to execute quickly. That requires quick access to clients and to the products available. Technology is a key element of a strong liability management practice.

Working with an independent liability management provider can ease the transition into liability management by providing easy access to multiple liability products; education on when and how to offer the services to clients; knowledgeable and experienced support personnel; and the technological means to analyze and execute quickly.

Untapped Opportunities

Liability management is an untapped opportunity that offers new ways to approach financial planning for clients. Financial professionals will be able not only to offer quality financial advice, but also optimize cash flow for their clients and enable them to purchase other products.

Liability management services can also be an efficient prospecting tool for advisors. A financial advisor can show prospects various ways to afford an asset accumulation product. With current clients, liability management services can improve client retention and promote deeper relationships. It can be used as well to cross-sell other asset services.

Finally, liability management is a win-win for the advisor and the client. The financial professional gains an opportunity to generate revenues, expand his business, set himself apart from the competition, and gain customers for life. At the same time, clients are offered ways to analyze and restructure their liabilities, optimizing their cash flow and tax savings.

Financial advisors with the foresight to help their clients with their liabilities will build their businesses through client retention, deeper relationships, and the ability to cross-sell asset products. Deregulation and advancements in technology enable financial advisors to quickly and easily assist their clients with the liability side of their portfolios. In order to take a more holistic approach and gain a better understanding of their clients' finances, financial planners must incorporate liability management into the financial planning process.

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