If you care about helping your clients minimize their tax costs, you should care just as much about helping them reduce interest costs. Debt management can sometimes be seen as something that’s only for clients who are struggling, or for younger households. But plenty of people carry debt for various reasons, and would benefit from seeing the cost of those debts as low as possible. Just like taxes, interest costs eat into wealth creation. If you start incorporating debt strategies into your regular client process, you can more easily spot additional wealth-building opportunities. And, you might be surprised at how many of your clients have debt you didn’t know about.
Debt is a four letter word, but it isn’t necessarily a bad thing. Debt is just a financial power tool that can help your clients accomplish many of their financial goals more easily. Think about the other things we use power tools for, and how difficult those tasks would be if we didn’t. Can you imagine every home being built only with hand tools now? Of course not! It would take forever. But, like any power tool, if your client doesn’t know how to use it safely, they can easily hurt themselves. Clients can do damage to their wealth with debt that isn’t severe or obvious, but it’s damage just the same. A client doesn’t need to be over-indebted to be wasting unnecessary dollars on interest.
Too often, when people (including financial professionals) consider what debt options are best for them, they place too much emphasis on the interest rate. Interest, of course, is only one variable that determines how much debt repayment will actually cost your client. The total principal and amortization also have significant effects on how much a debt costs to pay back. But it’s much easier for people to quickly assess that 4% interest is lower than 6% interest. That doesn’t mean that 4% costs less than 6%. It’s far more difficult to figure out how much the total cost of a debt is when accounting for all of the variables.
In the above example, you can see that 4% interest actually costs nearly 50% more than 6%. In this case, we’ve changed both the loan amount and the amortization. You could say that’s not really apples to apples, but how many people will borrow more because they can get a lower rate? The point here isn’t that interest rate doesn’t matter; it’s that the real impact on your client’s wealth is the total cost of debt, not the rate alone. Most clients could use your help to see what their debt is really costing them in the long run.
The other issue with focusing on the interest rate of bigger debts is that it’s easy to lose track of the total interest cost across all debts. If your client has a few different kinds of debts, they may be mostly focused on their mortgage rate because it’s generally their largest debt. However, if your client also carries a line of credit and a credit card, their total interest cost across those debts is probably much higher than they realize.
Watch our webinar: Debt Management for wealth advisors
Below are just a few ways debt management can help your clients build more wealth.
1. Borrowing for growth 🏘️
Even when your client borrows to invest in a rental property, for example, the total cost of repayment (and not just interest) should be considered. It’s true that this type of debt is considered good debt, and that interest on it is tax deductible. But your client’s wealth-building efforts will still be best served by ensuring the cost is as low as possible. After all, spending a dollar to save even as much as 50 cents in taxes still costs you 50 cents!
2. Balancing debt management and wealth creation ⚖️
We’re often asked if it’s better to pay off debt before saving or investing. Prioritizing debt over wealth creation only makes sense when a client’s debt is so extreme that they can’t qualify for refinancing, and their minimum debt obligations make it impossible to save anything.
In most cases, it’s best for the client to invest, save and pay down debt simultaneously. Some will argue that mathematically, especially with higher interest debt (which is paid with after-tax dollars) that it often makes sense to pay down that debt first. That would be true if clients were calculators and not humans. You have to consider how strategies will affect your client’s behaviour, not just the math.
Behaviourally, it’s dangerous to pay down debt before saving or investing. One reason is that the second the client has an emergency, if they have no savings, their only choice will be to use debt. When they’ve been working hard and focused only on paying down debt, and suddenly they have borrowed more, it can be disheartening. This is very hard on the client’s motivation, and leaves them more susceptible to making financial mistakes. Also, only focusing on debt repayment limits the time value of money that is lost when the client delays regular investment contributions. So with rare exceptions, you’ll want them to balance savings and investing with debt repayment, rather than put them in any sort of priority order and tackling them sequentially.
This is why cash flow planning is so important. It creates a much easier and more effective path to find the money needed to fund debt repayment, savings, investing and other needs, like insurance, all at once.
3. Prevent asset erosion in retirement 🌬️
Credit card debt is becoming increasingly common, even among retirees. Do not underestimate the possibility of client debt eating away at their assets during retirement. It is much more common than you think.
It’s likely that some of those great clients you assume don't have any debt issues because they’ve done a great job of saving for retirement are carrying debt you don’t know about. You may wonder why they didn’t tell you. But think back to how you engaged with them. Did you ever talk to them about your debt management strategies? Did you actively try to reduce the chances of making them feel judged or afraid to tell you about their debt? Can they tell that sharing the complete debt picture with you would result in them saving interest? If it’s not an ingrained part of your process, and the benefit isn’t obvious to your client, they are unlikely to tell you everything about their debts.
In particular, clients are far less likely to tell you about credit card debt or lines of credit. There is a general sense in our society that carrying consumer debt is bad, and makes the debtor stupid or irresponsible. You and your clients can't afford to have hidden debt erode the retirement plans you’ve all worked so hard to build.
In the current economic climate, strains on the cash flow of even your best clients can often result in the creation of new debt. Wealth advisors can no longer afford to keep their hands off the other side of the balance sheet. The easiest way to build effective and profitable debt management into your process is to embrace cash flow planning. And it doesn’t have to be you that does the debt management work for your clients. With a Certified Cash Flow Specialist (CCS) certificate, your associate advisors or even assistants can handle the bulk of this work.
CacheFlo is a financial education company that builds eLearning and tools to help financial professionals and individuals make behaviour-based changes, which allow them to get more life from their money. We want to make it easier for people to predict the impact of their financial choices before they make them.
About the Certified Cash Flow Specialist (CCS) program
CCS professionals go through enhanced cash flow-based training to develop the skill set to deliver behaviour-based cash flow advice. They start the financial planning process with a cash flow plan to genuinely help their clients get more life from their money.
About the Financial Capability Program (FCP)
The FCP combines quick and practical lessons with tools, including Winton, which helps people make financial changes they can stick to. Users can apply what they've learned to their financial situation, thus bridging the knowing-doing gap. The goal of the FCP is to help people get more life from their money.