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Jean-Luc Bourdon
Jean-Luc Bourdon
Lessons From the Financial Crisis

How has the financial crisis changed financial planning and estate planning? And how can we adapt to it?

July 23, 2009
by Jean-Luc Bourdon, CPA, PFS

Reverberating from the stunning string of events that gave rise to this economic crisis, far-reaching effects are deeply felt. For instance, Federal Reserve Bank data shows U.S. households lost $11.2 trillion of wealth last year. Consequently, many individuals turn to CPA wealth managers to understand the impact on their lives and their families.

What Changed?

Clients and prospects also want to understand whether the world upon which we build our financial assumptions has fundamentally changed. Fortunately, the resources available to CPA wealth managers through the AICPA PFP section (guidelines, surveys, newsletters, webinars, conferences, etc.) equipped us well to navigate an uncertain world. So, for the diligent practitioner, the world isn't fundamentally different. The last 18 months presented us with the same old uncertainty — just a whole lot more of it!

Financial leverage risk exploded into a global economic crisis on a scale that past data did not lead us to anticipate. Looking back at historical information in our rear-view mirror, a warning now points out: Risks May Be Greater Than They Appear. Simply put, what has truly changed is our perception of risk.

What Now?

Looking at the road ahead, other important personal finance risks have been growing for some time as well: low retirement savings, lower job security and benefits, inflation, increasing longevity and medical spending, solvency of pensions and Social Security.

Worse yet, many of these risks are amplified by current economic conditions. For example, many older households — perhaps one-third — will be less secure in retirement because of the burst housing bubble, according to a brief from the Center for Retirement Research at Boston College. Growing personal finance risks are well presented by research from University of Pennsylvania's The Pension Research Council, books such as The Great Risk Shift by Jacob S. Hacker and documentaries such as I.O.U.S.A.

When the road gets slippery, it makes senses to slow down and buckle up. As such, U.S. consumers shifted from maximizing spending (and save nothing) to seeking safety through increased saving. In fact, the savings rate went from near zero in recent years to an impressive 6.9 percent last May. This eagerness to re-evaluate spending and saving gives us the opportunity to go over client goals to better pave the way for very uncertain times.

What to Do?
With need and opportunity facing us, how do we bring about pragmatic solutions? Logically, uncertainty can be reduced with security and mitigated with flexibility. Here are a few ideas to find both:

Move from the bottom up. Rather than planning with clients' preferred financial goals first and reducing them if circumstances (often a crisis) dictate, it helps to define client needs and wants separately, and then establishes a minimum amount and a desired amount for each. The minimum amounts for needs become the fallback or baseline position. That position should be secured as well as possible. Ultimately, clients build up from the baseline to their desired plan according to priorities and desired amounts.

This approach has clear advantages. First, it challenges clients to consider what they need and how to best secure it. Having that fallback position can provide peace of mind when a crisis tosses many other goals up in the air. Second, future adjustments to the plan are more easily embraced with an initial understanding that the plan is scalable — rather than felt as a failure to meet a particular target. It also contains a structure (ranges and priorities) to guide future adjustments.

Stretch assumptions. Assumptions should be stretched beyond usual historical data to show that, hopefully, the baseline plan can sustain a variety of scenarios (high inflation, low investment returns, and/or high taxation, etc.). A wide combination of assumptions should also be used to show the limitations of the target plan. This may be useful for client to understand their risk exposure and better determine their risk tolerance.

For example, instead of maximizing a mortgage and decreasing the odds of success of the overall plan, a family may want to lower their housing costs (such as downsizing) to increase financial security and gain the flexibility to reach easily scalable goals (such as education and travel). Demonstrating such options is particularly useful as consumers are considering what they are willing to trade off for increased financial security.

Be creative. More uncertainty brings more complexity which requires more creativity. Fortunately, the new willingness to save could open the door for creative solutions and substitutions still considered unconventional: for example, online education, overseas medical care, and overseas retirement. Baby boomers have already been challenging the conventional notion of retirement with a more creative approach (more active, more work). Clearly, alternative solutions may be better accepted than we generally anticipate.

Estate Planning

Of course, wealthy clients often look beyond meeting their ideal personal goals and are concerned about legacy planning. Before diving into the alphabet soup of estate planning possibilities (ILITs, CRUTs, GRATs, QTIPs, QPRTs, CRTs and more) to reduce the size of a taxable estate, let's make sure there is enough security and/or flexibility in establishing the capital needed to accommodate the senior generation's goals under wide assumptions (possibly far from historical). Even in such situations, flexibility is almost never, ever overrated.

Conclusion

A fast changing world is bringing us more uncertainty than past decades might have indicated. The current crisis provides both the need and the opportunity to prepare for greater personal finance risks by encouraging clients to build plans which can easily be scaled back to a safety zone. This may sound like the old "plan for the worse and hope for the best" advice, advocating flexibility and caution. Indeed it is — just a whole lot more of it!

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Jean-Luc Bourdon, CPA, PFS is an advisor with Walpole Financial Advisors, LLC in Goleta, CA. Bourdon volunteers as financial literacy advocate. He also currently serves on the UW-Platteville's Distance Learning Alumni Advisory Board. Visit the personal financial planning resources at AICPA's PFP Section. Join the PFP section or to apply to become a PFS Credential holder.