From the July 2006 issue of Wealth Manager Web • Subscribe!

The Debt Trap

One of the toughest areas for financial planners is dealing with clients who overextend their means, put too many purchases on credit cards or dip heavily into home equity for things like new cars and vacations. It doesn't matter how wealthy someone is: The more money a client has, the more opportunity there is for easy credit and getting in over his head. It takes both financial and psychological skills for an advisor to help such a client get back on budget.

Usually, there isn't just one cause. For example, some clients have recently received a monetary windfall and rather than invest wisely, they prefer to spend, spend and spend. For some, the overzealous spending is more of a temporary insanity brought on by the joy of receiving unexpected financial gain. For others, compulsive spending is a long-ingrained habit, and changing that behavior does not happen overnight, advisors say.

"Money problems are often not rooted in finances," says Ric Edelman, chairman, Edelman Financial Services LLC in Fairfax, Va. "For most, financial problems begin psychologically and are symptoms of other issues--whether emotional, marital, medical or job-related. Their problems are about what's going on in their lives."

Sometimes overspending simply is a result of inattention or laziness, Edelman says, and it happens to people in the same way that five or 10 pounds of extra weight might creep up on them.

"We become counselors, and this is not the training of most financial advisors," he adds. "We have to be careful to know when to refer them to a trained professional therapist or psychological counselor. Compulsive spending is one of the main symptoms of clinical depression, as well as other emotional problems."

This may be a particular problem with Baby Boomers, as this generation attained more financial success than any other generation, advisors say, and people who become accustomed to that success will commit themselves to car payments, mortgages, student loans and other lifestyle purchases like big-screen TVs or furniture. If the income disappears for some reason--such as job loss or medical problems--they still have the obligation to pay.

"When the problems arise, it can be difficult to extricate yourself," says Edelman. "We have to determine what the problem really is and then tackle it. Or do we have to focus on behavior modification? Lack of education sometimes is the real issue."

Edelman bases his guidance on solutions outlined in his book The Truth About Money. Specifically, he tries to help clients realize how they are spending their money, which sounds easy, he says, but sometimes is not. "Most people have no idea how much they spend on a monthly basis," he points out. "We work with clients over a period of time to identify the actual spending."

Clients are asked either to go backwards--and check expenses for the previous six months, recording expenditures from their check books and credit card statements and then categorizing them--or to go forward and keep track of all expenditures during the upcoming six months.

"When I say every expense, I mean every expense--from 25 cents for a newspaper to $4 for a latte to 75 cents for a Hershey bar from the snack machine at work," he adds. "This paints an accurate picture of where your money goes, and for most clients, this works and it's enough. It is enlightening, and once they see they're spending $400 a month on coffee, they stop."

However, tracking expenditures does not work for all clients. Some are simply irrational about money and require aggressive counseling and behavioral changes before their financial problems can be repaired.

"Overspending happens to all age groups and all income levels," Edelman says. "People in general have a habit of spending up to their income levels. Clients can be just as broke with $300,000 in income as with a $50,000 income."

Furthermore, most clients cannot go "cold turkey" on spending, says Michael Kitces, director of financial planning at Pinnacle Advisory Group in Columbia, Md. "This is such a tough area, and classically, financial planners do not work with this unless their clients have a lot of money to invest and then begin the overspending," he said. "People dealing with severe debt, however, usually have a fairly limited scope of interaction with financial advisors."

More commonly, advisors see clients who have inherited large sums of money and may or may not have problematic spending habits.

"One of the problems with people inheriting a million dollars, for example, is that they have no idea how far that money will go," Kitces explains. "It doesn't really go that far, and when sudden money comes to the table, spending habits can become a real problem. Ultimately, we help clients understand the consequences of their actions and help them plan for the future."

The first step Kitces suggests is assisting clients to understand how their actions affect their finances. "We don't order them not to spend money or tell them not to, because they will do as they please, anyway," says Kitces. "We can't be antagonistic or they may stop using an advisor altogether. So to some extent we try to address the underlying behavior. We can't practice psychology, but we do try to understand the issues they are struggling with."

Spending for many people relates to selfworth or self-esteem, Kitces says. "They buy things to make themselves feel better or to make someone else happy or to try to patch up a relationship. Debt problems are not about people knowing that they spend, but about changing the behaviors."

And because in most cases the debt did not build up overnight, changing those behaviors happens in small incremental steps, he says.

"We usually get them started by working on paying down the debt," says Kitces. "They can pay down the credit card with the smallest balance first to help them develop the habit of paying off cards. We help them move forward and work out of their debt. It's often about looking at ways to help people [develop] good habits, like paying off the smaller cards and then tackling the bigger ones. Success is key. It is very much about behavior modification much more than simply saying here's what you should do: Go do it."

From a mathematical perspective, paying off the credit card with the highest interest rate is the most practical option, Kitces notes, but clients with poor spending habits need to realize the success of paying off something, so the card with the smallest balance is the fastest, easiest choice.

Why do Americans spend like there is no tomorrow? Edelman and other advisors say it is because we live in a consumptive and materialistic society, and we are constantly bombarded with advertising messages encouraging us to consume.

"People in our country think they are measured by what they have, more so than what they have accomplished," says Edelman. "We look around and see that everyone else does it or everyone else has it, so we say, 'Why not?'"

Another contributing factor is the lack of education about personal finance in our school systems. Students can graduate college without ever having taken a basic financial planning course, Edelman adds. "There is no alternative message of resistance. We are encouraged to consume."

CFP and Certified Divorce Financial Analyst (CDFA) Randy Gerard of the Bank of Blue Valley in Leawood, Kan., agrees with that assessment, adding, "We have such an instant gratification society, that we have totally separated payment from consumption. We don't even stop to think, 'When am I going to pay for that?' Credit is easy, interest rates are low and most people are making fairly good income. The debt just sneaks up on people."

Gerard says there is so much misunderstanding about how to make the best use of money in one's life. "So many people just go off the deep end, and as a financial planner, I try to make them understand that first and foremost, what happened in the past is now the past, and it is time to move on. They have to agree not to wallow in self pity because they made some dumb money mistakes. They also have to agree to make an effort to get out of this hole they've dug for themselves."

From a behavioral standpoint, money is all about choices, Gerard continues. "I ask my clients, do you want to give up future freedoms to spend now? If so, they have to know that they won't really enjoy life on the other end of that spectrum. I try to help them become more aware of how they spend their money, and we talk about those conscious choices they make on a daily basis."

For example, if every day, the client is buying a bagel and a latte at the corner coffee shop and spending $7, over time that could add up to half the amount of money needed to open an IRA. "We talk about spending habits and spending patterns, and I try to help them break those bad patterns that have developed over time," Gerard says. However long it took to build up the debt, he adds, that is just about how long it will take to pay it down or eliminate it--if not longer.

"I actually like to talk to people about handling their money better," says Gerard. "I try to help them change the way they look at things. I tell my clients [to] look at this as an opportunity to improve yourself and say, 'That was a lesson I learned well, and I improved myself.' I take a positive approach to debt management. It does no good to lay guilt trips on good clients who have made some poor choices. We just make it factual and help them get back on track again."

Marian Chang is a freelance business journalist and feature writer based in Reno, Nev. She may be contacted at

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