The perils of an aging book


The financial advisory industry is at a generational crossroads. According to a 2012 study, 44% of advisors are over age 55 – and so are many of their clients.1 On the one hand, this trend represents a great concentration of wisdom, life experience and wealth. On the other hand, it represents a risk: at a certain point, the firm’s future profitability and growth potential is hampered by older clients impacting the revenue that the advisor may eventually be able to generate.

Connecting age and enterprise value

As pictured below, a typical investor usually goes through three wealth phases over the course of their life:

  • the “accumulation” phase, during which investors contribute to their retirement assets and wealth grows at an increasing rate (the power of compounding at its best);
  • the “wealth maximization” phase, during which the portfolio returns outpace any withdrawals being made from the portfolio. Depending on return and spending assumptions, this typically occurs at, or right after, retirement and can last for about ten years.
  • the “decumulation” phase, during which income distributions begin to exceed investment returns and wealth decumulates at an increasing clip.

Pattern of wealth accumulation, maximization and decumulation for a typical investor2

Wealth accumulation and decumulation

Viewed from an advisor’s perspective, investors in the “wealth maximization” phase are usually their most profitable clients – the sheer size of the assets often provides a disproportional amount of revenues to the firm compared to clients in other age cohorts. However, what’s often overlooked is the fact that these clients are also on the cusp of introducing risks to the business that jeopardize the future growth potential of the firm.

Chief risks of having clients in wealth maximization or decumulation phase include:

  • “decumulation risk” (the risk that clients will draw down their account to support their lifestyle in retirement at a faster rate than investment returns are able to keep growing the account value)
  • “asset flight risk” (while high net worth clients may not be subject to decumulation risk, they may be tempted to pursue private investment opportunities outside of their primary advisor’s purview)
  • “generational risk” (the risk that the primary advisor may not retain the assets after an “estate event” – i.e. when the assets transfer to the next generation)

Of course, not all investor experiences will be identical. Some investors may be so wealthy that they never eat into their principal. And obviously market returns, which can’t be accurately forecasted, are a significant determinant of wealth patterns. That being said, the average investor depicted in the graph above reaches his or her peak wealth somewhere between age 65 and 75. The current low market return environment compounds these risks – advisors can no longer rely as much on the market for asset growth as they could when markets were stronger.

Either way, this dynamic matters from an enterprise valuation perspective because future growth potential of the firm is one of the three primary drivers of value for wealth management firms (profitability and sustainability are the other two drivers). The more clients an advisor has that are in the decumulation phase, the more the firm’s value is likely to suffer because such a significant amount of the firm’s revenue is derived from a declining asset base.

What can you do about this for your own firm?

So, what can advisors do about this? As a starting point, conduct a demographic analysis of your current book of business. What percentage of your revenue comes from different age cohorts? In particular, what percent of your revenues come from clients who are over age 70? Be aware of the relationship between age, future growth potential and enterprise valuation. Look at your book and identify clients who may already, or in the near future, present decumulation, asset flight or generational risk to your book. Then, devise strategies to attempt to mitigate those risks. These may include ensuring these clients have sustainable income goals, talking to them about consolidating assets that are currently outside of your purview, engaging the next generation of investors or diversifying the age distribution of your client base.

Those advisors who are able to address these risks head-on – by analyzing their client base and where their revenue stream is coming from – have a higher likelihood of being able to rectify the situation before it becomes a problem.

1 Thomas Coyle, “Colony gets funds for growth, succession,” Financial Advisor Blog of the Dow Jones Newswires.  (accessed 2/6/13)

2 Based on the median outcome of a Monte Carlo simulation of an investor who

  • begins investing at age 25
  • increases their retirement contributions over time based on a salary that initially grows at 4% annually and eventually grows at 2% annually as retirement approaches
  • relies on social security payments and their investment portfolio for their retirement income, which equals 85% of their final salary (increasing 2% annually until death)
  • invests their investment portfolio more conservatively as retirement approaches.

A Monte Carlo simulation is a sophisticated mathematical approach used within the financial industry to model possible outcomes of investment scenarios by substituting a range of values – a probability distribution – for any factor that has inherent uncertainty. It then calculates results over and over, each time using a different set of random values from the probability functions. The projections or other information generated by the Monte Carlo simulation regarding are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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