Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
The great wealth transfer is underway, with about $85 trillion expected to be inherited by the next generation by 2045, according to a report released by Cerulli Associates. That is a massive amount of capital by any reckoning, but many of the recipients may not have the wherewithal to properly manage those bequests.
Like many advisory firms, we work with many multi-generational families and use a team approach that matches our younger advisors with clients in the same demographic to help them prepare to be good stewards of assets they earn and inherit. These tend to be hard-working, intelligent individuals who have graduated from the finest colleges and universities but lack a thorough financial education.
To help our young clients build a strong financial future, we initially focus on three important areas. The fact that our advisors are in the same age group as them builds rapport and a deeper level of trust for these next-gen clients to develop good financial habits that will last a lifetime.
- Budgeting
The cornerstone of any financial plan is establishing a budget and sticking to it. It is very common in the early stages of one’s career to live from paycheck to paycheck and to run up credit card debt or for new inheritors to spend the majority of their newfound wealth without thinking about the long-term implications.
To counter that, we urge our young clients to live within or below their means. We tell them, “If you can’t pay for it, don’t buy it.” That is the only way to build savings in case of an emergency and toward long-term goals, as well as to have money for investments that can help them begin growing their own wealth.
- Preparing for the future
You are never too young to start planning for retirement and we explain the advantages of saving early and creating a financial plan.
We always encourage our next-generation clients to make sure they enroll in their employer’s 401(k) plan as soon as they are eligible, contributing at least to the level where they get the maximum company match. Employee stock option plans, if they are offered, are a good way to save since they often offer shares at a discount. Employer-matching funds and discounted stock options are basically free money that can build substantial value by the time retirement rolls around.
In addition to what is offered by their employers, starting an individual retirement account (IRA) is also a good idea, even if at this point in their lives they can’t put all that much into it. Through the magic of compounding and re-investing interest and dividends, where gains build on previous gains, a small monthly contribution can grow to a significant nest egg by the time retirement age rolls around.
We also discuss the pros and cons of traditional versus Roth 401(k)s and IRAs. We don’t have a strong preference one way or the other; it depends on the individual’s tax situation. But generally, younger people have less income, which means a lower tax bill, so paying the tax now at a lower rate very often makes the most sense, but that may reverse in later years.
- Prudent investing
The previously mentioned IRA is a great place for young clients to begin long-term investing. Our approach starts with the very basics – the difference between a stock and a bond, or a mutual fund and an ETF – and goes on from there.
We explain that for someone who invested $5,000 in the stock market and earned 8% a year, and reinvested earnings and dividends, in 30 years, that initial $5,000 would have grown more than 10 times to over $50,000. And that’s without any additional investment. When we tell them that if that person added $100 a month into that account, earning that same average of 8% annually, the portfolio would likely be worth more than $186,000, they begin to get the picture. And with an annual return of only 1% more, which is closer to historical averages, that portfolio would be worth well over $225,000. That won’t be enough money to retire on, but it would certainly help.
For young people new to investing, prudent investing in stable, well-run companies that are likely to be in business for the long haul is essential. In the last few years, there have been a lot of investing fads like cryptocurrencies, NFTs, and meme stocks that have captured the imaginations of young people looking to make a quick killing.
While some people have made a lot of money on those types of assets, they are highly volatile and carry a tremendous level of risk. Some people also make money day trading and gambling in casinos, but those are not recommended investment strategies either.
Those three items are a great place to start when counseling younger clients who are inheriting wealth or just finding their financial footing. As the relationship deepens, we will go into more detail and cover a wide range of subjects, such as the benefits of buying versus leasing, the right way to pay down debt, or even their parents’ estate plan, and how to handle an inheritance.
A holistic advisor needs to provide more than financial planning and investment management, and be a comprehensive resource of financial knowledge. For younger clients, that entails providing the financial education that will set them up for long-term success.
Grace Salvino and Charles Lesser are wealth managers at Performance Wealth, an independent Registered Investment Advisor with offices in the Chicago suburb of Hinsdale, IL, Naples, FL, and San Diego, CA.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent white papers.
Read more articles by Grace Salvino, Charles Lesser
