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.
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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.
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.