Advisors Embrace Rules of Thumb To Educate Clients About Money

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 | 2/15/2019

The best advisors take complex concepts and make them easy to understand. Clients come away more engaged and empowered as a result.

Explaining complicated financial products often falls on deaf ears. And trying to teach the value of Monte Carlo simulations or calculate the opportunity cost that accompanies certain investment decisions can prove exhausting.

Fortunately, there are simple rules of thumb that advisors can cite to help clients grasp the complexities of personal finance. While these rules may not apply precisely to every situation, they provide general guidance and enable lay investors to proceed with more confidence and knowledge.

The downside is that some rules are overly broad. They stoke confusion and lead clients astray, so advisors must sift through these popular, oft-repeated principles and jettison the less accurate ones.

When purchasing life insurance, for example, some people believe they need a policy that covers 10 times their annual income. But relying on any multiple — even 20 times yearly income — is not sufficient to determine an appropriate amount of coverage. Many other factors enter the mix, including one’s reasons for buying life insurance in the first place and other features of the policy.

Yet the most instructive rules of thumb come in handy. If they’re memorable, they can stick with a client and guide spending and saving behavior.

Julia Pham, a certified financial planner in Long Beach, Calif., favors the 50/30/20 rule to help clients fine-tune their budgeting. It states that 50% of your earnings go toward your needs (such as housing and utility bills), 30% covers your wants (such as dining out and other lifestyle expenses) and 20% gets set aside for savings and debt payment.

Age And Assets

Because budgeting can stymie some clients, the 50/30/20 rule provides a tidy construct to influence their actions. It’s also appealing to those who like to label their activities, assigning their spending to different categories.

“I’m a big fan of that rule,” Pham said. “I like to use it with my client’s children in their 20s and early 30s who may need help with budgeting. Typically, I emphasize that 20% and the importance of socking it away in a 401(k).”

Another axiom Pham likes to share with clients is the 120-minus-your-age rule for asset allocation. Subtract your age from 120 and that’s the percentage you should invest in equities. The rest gets invested in fixed income.

“It used to be 100,” Pham said. “But with longevity and medical advances, the rule has changed.”

Advisors often underscore the power of compounding over time, especially for younger investors. That’s where the rule of 72 enters the picture.

Rich Rosa, an advisor in Hunt Valley, Md., cites the rule to estimate how many years it will take a given investment to double based on a set interest rate. It involves dividing 72 by the expected annual rate of return.

“We’re pretty conservative so we stick to the basic parameters of the rule of 72,” Rosa said. “We like to keep it simple. We’ll put up all the numbers on a whiteboard and have our client do the math. Visualization is important.”

Now, Soon, Later

Tracking advances in behavioral finance, many advisors help clients grapple with the psychology of money. Giving them a handy way to organize their savings can breed discipline and improve their attitude about wealth accumulation.

The three-bucket system often works well, in which advisors instruct clients to divvy up their funds into threes. While there are variations on this approach, it usually boils down to “now, soon and later” buckets.

The “now” category covers living expenses and emergencies that arise, the “soon” bucket represents investments with a limited time horizon (perhaps less than 10 years) and the rest is set aside for the final chapters of retirement.

Other rules translate into dictums that advisors frequently share with clients. For instance, Rosa works with many professional athletes who earn sudden wealth at a young age. He often tells them, “Don’t rent a lifestyle.”

“When a young athlete gets a large contract, we preach planning and budgeting,” Rosa said. He cautions them against rushing headlong into overspending on fancy cars and other luxuries.

At the same time, he’s careful not to overstep his bounds. If someone was raised without wealth, Rosa knows it can be jarring to come into a quick fortune.

“You may be 22 and earning $2 million this year after not having much growing up,” he said. “As an advisor, you don’t want to tell the client how to spend their money. You want to approach it like, ‘I’m just educating you.'”

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For more information or questions, please contact Halbert Hargrove at hhteam@halberthargrove.com.