Not Keeping Up with the Joneses

I am going to cover a couple of topics today – expanding on a great post by Michael Kitces on lifetime earnings and savings and how to serve the Millennial client and still stay in business. Let’s start with Michael Kitces. If you are not familiar with Kitces, he is a partner and Director of Planning Research at a firm in Columbia, MD, along with a couple of my friends, Dwight and Ken. I follow Kitces on Twitter and he recently had a great post about earnings and lifestyle, which you can find here.

In this post, he discusses how establishing good savings and spending habits early in one’s career can lead to long-lasting results. Studies have shown that while the average real growth rate of earnings from age 25 to age 55 is about 3%, the fastest rise occurred before age 40 and began to slow or level off at that point. This is not to say that everyone will have this lifetime earnings path; there are still many individuals who will not reach “peak” earnings until in their 50’s or 60’s. The people fortunate enough to be in this position may still salvage a decent retirement with accelerated savings near the end of their careers, but for most others, the future is already written.

The culprit can sometimes be “lifestyle creep”, as Kitces calls it. This results in a larger house, a more expensive car, better vacations and outsourcing chores such as housecleaning and lawn care. We don’t notice this sometimes glacial movement in spending, however, diverting funds from savings to these increases leaves you ill-prepared to attempt to replicate your current lifestyle in retirement, particularly if much of this spending creep is fixed in nature, in the form of debt service or excess real estate. I often use the “ball of yarn” analogy to explain savings and withdrawals, the ball being your savings. In the early years, it is easy to see the ball of yarn get bigger as you wrap new yarn around it, but when it gets to a certain size, it is hard to notice the increase. However, when you begin to unwind it, it can shrink quickly after a certain threshold is crossed. The point here is that trying to boost savings in the decade or so before retirement is not as impactful as a strong savings ethic early on.  

Now that we have established that a program of disciplined early savings is one of the keys to a successful retirement (or financial independence, if you prefer), let’s address the generation that will benefit from such a program – the Millennials, or Generation Y. Generally, these are people born from the early 1980s to the early 2000s, i.e., 1984 to 2002. (Full disclosure – I have two in my household.) This is currently the largest generation in America, slightly eclipsing the Baby Boomers, the oldest of which will turn 70 in 2016. The Millennials have either been in the workforce for a few years already, or are about to enter the workforce. For them, this Kitces post is particularly relevant. A plan to save for retirement seems almost too far in the future to be of importance, but a long-term viewpoint is critical here. There are two potential roadblocks here; (1) how do you get Millennials interested in retaining a financial advisor when other needs are more pressing and (2) how does an advisor stay in business servicing this cohort?

The traditional fee-only advisor pricing structure has been a percentage of assets under management (AUM). This works fine for someone who has accumulated a portfolio of investments and has ongoing questions requiring a financial advisor, but certainly does not work for someone who is just beginning to save, yet still has some questions that need answers. A recent article in an industry publication suggested the following fee schedule for a Millennial with $50,000 of investments.

  • $1,000 up-front planning fee
  • $150 monthly retainer
  • 1% AUM, which translates to $500 the first year

Under this scenario, by my calculations, the advisory firm gets to break-even at about 30-40 clients, assuming the infrastructure at the firm is already in place and this revenue is incremental. That would be acceptable if you could accomplish this in a one-year time frame, but beyond that I wonder how much traction that program would have. Additionally, the fees themselves seem a little high to me (and to the Millennial in our office), unless the clients in question have fairly high incomes. Of course some of the motivation for me here is to be profitable as that is why I am in business, but there is also an altruistic motive. All the statistics point to a hugely under-prepared group of pre-retirees, with many having no retirement savings at all. I do not think society is prepared for this level of poverty among retirees and I want a hand in trying to make sure the Millennials are not in the same situation when their retirement approaches. For many of you Boomers who may be reading this right now, I am sure you do not want this situation for your Millennial children, either.  

So, the question for you, Millennial reader, is what price are you willing to pay, either in delayed gratification, a higher savings rate, or to a financial advisor? Is the above fee schedule acceptable? Does an annual plan with scheduled quarterly updates (and fees) around certain events, such as year-end planning or tax time sound better?