How Wealth Ratios can help you understand your client’s outcomes

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For financial professionals only

Last week we hosted a special Let's Talk Financial Planning and Wellbeing webinar where we discussed the link between financial adviser, financial planning, and financial wellbeing. One topic we discussed in particular was the use of Wealth Ratios.

The increased use of cash flow modelling gives advisers the data to assess the relative levels of wealth across their client base, by looking at individuals’ Wealth Ratios.

What is a Wealth Ratio?

Your client’s Wealth Ratio is shown by comparing their:

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Present value is assessed by discounting future cashflows into today’s worth by using interest rate, inflation and investment growth factors.

Why’s this useful for financial planning?

The Wealth Ratio indicates the degree of ‘capacity for loss’ that exists within a financial plan.

It also provides a shorthand, relative comparison of different individuals’ circumstances. Someone with assets of £1million may not have as high a wealth ratio as someone with a more modest lifestyle but less capital.

The Wealth Ratio, including the value of residential property, is likely to need to exceed 1.5 before someone considers retirement, reflecting the general relationship between lifestyle spending and choice of home.

Once a Wealth Ratio rises well above 1, a whole field of subjectivity opens up. In simple terms: What is the point of owning excess money? The answers will vary widely, leading into wider and important discussions around ‘financial wellbeing’.

At a Wealth Ratio around 1, advice can have a huge bearing on the client’s outcome, for good and bad.

With a Wealth Ratio below 1, something needs to change, to reduce spending or increase saving or putting more at risk when investing. It’s an indication you are going to run out of money at some point in the future.

The Wealth Ratio can also be a helpful guide for you to consider your firm’s commercial viability and risk of your client relationships. Defining your target market is now central from a regulatory perspective.

It’s also an easy way to explain to clients where they stand, relative to their goals, and gives a simple summary of your analysis of their financial situation.

Things to remember

Like cash flow modelling, assessing the Wealth Ratio depends on a set of assumptions, subjectivities and forecasting decisions, including expenditure budgets, selected level of investment risk and consequent returns, longevity, levels of taxation, structure of the family or planning unit and more. Sourcing assumptions for investment returns, inflation and longevity needs care.

Talking points

Is there any other basis for establishing ‘capacity for loss’ as required by COBS than financial analysis? An ability to manage at a reduced level of income might be relevant.

What are the average levels of Wealth Ratio of salaried professionals versus owner managers at point of peak wealth, such as at retirement or on sale of business?

Excess wealth allows an individual to select more certain outcomes through taking less investment risk, holding more cash, and/or insured solutions. What are the sensible limits to that drift away from risk, especially when care and legacy are potential liabilities and hard to quantify?

Have you seen our ‘Planning for Financial Wellbeing’ webinar?

You can hear me discuss all of this and more with Ruth Sturkey, Chair of the Institute for Financial Wellbeing, in our ‘Planning for Financial Wellbeing’ webinar. Watch it here

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.  

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