As wealth advisors, it’s critical that we understand our clients and their lives. After all, we need to understand long-term goals to make sound recommendations today.
Asking the right questions is an important part of gaining that understanding, but that is only the starting point. To provide truly tailored guidance that meets the unique needs of each individual client, we need to understand the family’s cash flows.
Why? Because there is no clearer or more objective way to determine a family’s interests and priorities than by looking at how they make and spend money.
Cash Flow Planning vs. Budgeting
Many high-net-worth investors are understandably a bit hesitant to review their cash flow. This is likely due to the fact that traditionally, the terms “cash flow planning” and “budgeting” have often been used interchangeably. In reality, these two concepts have overlapping principles but are fundamentally different things.
- Budgeting involves defining an expense threshold that should not be exceeded. Implied in this concept, is the idea that money will “run out” if the spending threshold is repeatedly exceeded. Running out of money (in the conventional sense) is a low-probability event for many high-net-worth investors.
- The primary objective of a cash flow analysis is to understand inflows, understand outflows, and then define a plan of action that enables a family to be most effective with their wealth.
The benefits of cash flow planning are numerous and far-reaching: more efficient philanthropic gifting, strategic account drawdowns during retirement, and even fraud prevention, to name a few. The most common benefit we see, however, is in estate planning. Through a cash flow analysis, we can help people determine how much of their wealth should be removed from their estate and how much wealth should be retained.
Considerations for Estate Planning
High-net-worth investors’ feelings about estate planning typically falls somewhere on a spectrum. At one end of the spectrum are those who are concerned about giving away too much wealth during their lifetimes. These individuals may forego estate planning opportunities and “overpay” from a tax standpoint. At the other end of the spectrum are those who are highly focused on minimizing their taxable estate — these families may be very efficient with their tax planning, but often run the risk of “overgiving” while they are still alive. (Remember, the risk to high-net-worth families is not that they will run out of money, but that they are giving to the point of inefficiency.)
Looking at a family’s cash flows allows us to model both of these paths and answer two key questions:
- What will your estate and taxation look like if you do nothing?
- What will your estate and taxation look like if you give away a significant portion of your assets while you are still alive?
Through a comprehensive analysis of inflows and outflows, we can determine the right path forward. For most of our clients, that means a blended approach: taking several strategic steps that provide the most value from a tax perspective while retaining significant wealth within the estate.
We begin the cash flow planning process by mapping out all of the family’s cash inflows: pensions, Social Security, portfolio income, rental income, RMDs, etc. For any inflows that might vary with market performance and account drawdowns, we model these variables into the future.
Our team can do the majority of the work on the income side of the equation, but we heavily rely on clients to identify cash outflows. We recommend that families start by identifying their big-ticket items: mortgages, income taxes, property taxes, defined charitable giving, etc. Once those have been identified, the next step is to use credit and checking account statements to fill in the rest of the picture. This can be a painful process, and one many of us have mental blocks with doing it, but determining your expenses with a reasonable level of accuracy alone is often a worthwhile task.
It is important to note that projecting cash outflows does not mean accounting for every last dollar spent — our goal is to be within 10% of the actual spend. In other words, if your projected cash outflow is $800,000 and your actual spend is $825,000, that’s okay. Finally, we take the inflows and the outflows, and we model this out over an individual’s lifetime. At a minimum, this should be to age 90, but we typically build the model to age 95 or 100 to provide an additional margin of safety.
Creating this model benefits the families with whom we work, as having a clearer understanding of their monthly cash flows makes it easier for families to adjust and re-prioritize their spending if necessary. It also enables our team to provide more customized tax and estate planning recommendations, as well as build investment portfolios that match our clients’ current lives and longer-term financial goals.
High-net-worth investors and families may not have to worry about running out of money, but cash flow planning is a valuable tool that can help ensure the family wealth is utilized efficiently. We hope this article has shed light on why we make cash flow planning a priority in our work — if you are interested in this approach, we invite you to connect with our team.
ABOUT THE AUTHOR: JEFFREY FOSSELMAN, CFP®, CPA/PFS, JD
As Senior Wealth Advisor for Relative Value Partners, Jeff provides comprehensive advisory services in estate planning, income tax planning, cash flows, asset allocation and other financial planning areas. With more than a decade of experience in the industry, Jeff is instrumental in delivering financial planning strategies and counsel to high-net-worth individuals.
Jeff is also an attorney and has provided basic legal services in the areas of business consultation, formation of legal entities and drafting of estate planning documents.
After graduating with a Bachelor of Science from the University of Illinois in 2000, Jeff continued his studies and earned his Juris Doctor from the University of Illinois College of Law in 2003, and a Master of Science in Taxation from DePaul University’s Charles H. Kellstadt Graduate School of Business in 2010. He is also a member of the American Institute of CPAs – Personal Financial Planning Section and holds a CPA license with a Personal Financial Specialist designation. Finally, Jeff also holds the Certified Financial Planner (CFP®) designation.
Information contained in this article is obtained from a variety of sources which are believed though not guaranteed to be accurate. Past performance does not indicate future performance. This article does not represent a specific investment recommendation.
No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from Relative Value Partners, LLC which can only be provided through a formal advisory relationship. Clients of the firm who have specific questions should contact their Relative Value Partners counselor. All other inquiries, including a potential advisory relationship with Relative Value Partners, can be directed here.