In part one of this series, we explored whether the common business concern for financial planners over their aging client base is overstated, when we consider the long term survival of the clients’ assets if they are withdrawn at the ‘safe’ 4% level.
Another classic concern of the AUM model with retirees is that as they age, clients will ultimately pass away, and most firms struggle greatly to retain assets (one study estimates that advisors will lose as much as 90% of the assets that pass to the next generation).
Yet again, a critical look at mortality statistics suggests that this client attrition through death is more likely to be a decades-distant challenge than a near-term one. For instance, the chart below shows the survival rate for males, females, and couples, based on the Social Security Administration’s mortality tables.
As the figures show, while the mortality rate does rise as retirees move into their 60s and 70s, the joint life expectancy — i.e., the probability that at least one member of the couple remains alive — remains extremely modest in the first half of retirement. It takes 15 years, from age 65 to age 80, for just the first 10 percent of client couples to pass away, at a rate of less than 1 percent per year. Only as the couple enters into their 80s does the joint mortality rate begin to accelerate, where 25 percent of couples have passed away by age 85, and only at age 90 does the joint survival line finally move below the 50 percent threshold.
Of course, some criticize the Social Security mortality tables as unrealistically conservative for financial planners in the first place, as clients of planners tend to be more affluent with better life expectancies than the broad population assumption from Social Security. Some suggest the Social Security tables fail to sufficiently adjust to anticipate a continued trend towards medical improvements that may further enhance life expectancies between now and when today’s baby boomers actually do reach their 80s and beyond. For planners, that means in practice that client survival rates may even be slightly better than the chart above indicates.
Losing a tailwind is still a headwind
The asset losses due to retirees taking withdrawals and eventually passing away may not be an avalanche of outflows anytime soon, given that the very oldest baby boomers are “only” in their late 60s and the youngest are only just turning 50 this year. The reality is that relative to businesses that were built on the basis of working with accumulators, the fact that clients aren’t adding assets is a lost tailwind that will no longer aid the growth of business revenues. Also, clients tend to have more conservative portfolios at retirement that reduces the portfolio’s contribution to the growth rate. So while the actual headwind of client withdrawals and attrition may be modest, the ‘net’ headwind of shifting from net savers to net spenders and reducing the anticipated portfolio growth rate is a bit more dramatic.
Nonetheless, the results here suggest that ongoing retirement withdrawals (at a ‘mere’ 4% withdrawal rate) and attrition from clients passing away (even at today’s mortality rates) is not likely to hit baby-boomer-centric advisory firms any time soon.
I’d argue that the greatest impact doesn’t really begin until clients approach their 80s, which is a decade away for even the oldest boomers and not until the 2030s(!) and beyond for most. That also assumes that medical advances don’t push out client life expectancies even further, which would both reduce client attrition from death and also likely lead clients to moderate their spending further in anticipation of longer life.
So which clients should you focus on?
In turn, these statistics suggest that advisors should be cautious about how aggressively they adjust their business strategies to account for an aging client base. For instance, while much has been made of the importance of building relationships with the children of clients in an effort to retain assets, these statistics suggest it may be far more important to simply focus on establishing a relationship with the prospective surviving spouse of a couple, rather than their children.
This is especially true given that asset/client retention for most advisors is also poor with widows (and the odds of one spouse dying and leaving assets to the survivor is far higher than both passing away and leaving assets to children). In addition, the irony is that dissipating assets to the next generation could even result in unprofitable clients that the firm wouldn’t want to retain anyway. For instance, consider that a retired couple with $1 million in assets may turn into three $333,333 son-and-daughter clients at the next generation, tripling the required work and turning one profitable client into three unprofitable ones.
Similarly, advisors who are selling a practice should be cautious not to discount the value of the practice too much just because it has a large base of retiring/baby-boomer clients. While it is crucial to recognize that most clients will be in net outflow and not contributing — which does impact the growth trajectory of the firm and therefore its value — the reality is that the bulk of spending outflows and attrition due to death is still 15 to 20+ years out. Given a typical 20%-25% discount rate used in the valuation of advisory firm cash flows, changes in the assumptions for asset retention that far out have almost no impact anyway.
For instance, a projection of losing a whopping $1 million of revenue in 20 years due to client withdrawals/deaths would only reduce the price of the business by a mere $11,500 in today's dollars at a 25% discount rate.
The bottom line is that building an AUM-based practice around retirees is likely to grow more slowly than a similar business built around accumulators due to more conservative portfolios, lack of ongoing contributions, a shift to spending withdrawals, and the ever-greater risk of client attrition due to death as the years advance. The reality, however, is that the impact on most planning firms is likely to be modest in the coming decade.
Though the trend will eventually accelerate in the 2020s and especially the 2030s, that point is far enough out that in the near term, planners might be better focused on simply retaining and growing new (retired) clients, and building relationships with spouses to ensure that the couple together remains a client for the decades to come.
Yes, building a practice with younger clients who are still in the accumulation phase and adding assets can ultimately benefit the firm’s long-term growth and value. Yes, a client with $X who is still a net accumulator is more valuable as a client than one with the same assets who is retired and withdrawing. However, pursuing such clients may be best suited for those firms that are truly seeking to serve those clients profitably, or are deeply concerned about the valuation of the business 10-20 years out, and not necessarily those who wish to wind down or sell their practice in the near term anyway.
See part one of this series on the business implications for advisors of an aging clientele.