Sales Insight - July, 2007

The United States is suffering an economic crisis and there is little that the President, Congress or the Federal Reserve can do to fix it. The only people who can solve it are your clients – and you.

This problem is the inability of U.S. households to save money systematically. Having officially begun in April of 2005, this crisis has grown worse for 26 straight months. If it continues much longer, American prosperity will be threatened, now and perhaps for generations to come.

It’s my observation that perhaps less than 10 percent of all financial advisors are successful in motivating disciplined savings among their clients through consistently applied techniques.

Don’t answer too fast. Due to changes in the ways Americans spend and save, traditional definitions of savings may no longer be useful.

I have developed a household savings tracking service that meets four requirements: 1) easy to use; 2) totally objective; 3) precisely measurable; and 4) systematic in motivating savings habits.

Offering such a service will help you become a successful motivator of personal savings – not by cheerleading but by driving a disciplined process that becomes ingrained in clients’ habits. Your clients will gain control over their long-term financial goals, regardless of future rates of asset appreciation, and you will capture more assets and referrals.

Here, I will explain how to implement it. If you are currently using a software system to track clients’ savings, this article will help you evaluate whether your system is adequate for the task.

To become a disciplined motivator of savings, you should first understand the problem of negative personal savings in the United States, which has become an infectious epidemic. Three charts tell the story.

Personal savings is defined as personal income from all sources (wages, dividends, interest and government benefits) less personal expenditures, according to the BEA. Until about a decade ago, Americans consistently saved about 5 to 10 percent of their incomes. In the late 90s, savings began to erode and, in 2005, the Personal Savings Rate turned negative for the first multi-month period since the BEA began keeping score in 1959. (Prior to April 2005, the U.S. had experienced negative personal savings just once – in the month after 9/11 – over more than a half century.)

Over the past 26 months, Americans have lost a cumulative $2.2 trillion of personal savings – roughly $21,000 per U.S. household. But, as everyone knows, Americans have been adding billions of dollars to their bank deposits and retirement plan balances. So, what is really happening?

Americans have built bank and retirement plan balances, while also losing personal savings, because their personal debts have soared. “Total Household Credit Market Debt Outstanding” – a measure of consumer credit plus home mortgage balances – increased from about $5 trillion a decade ago to $13 trillion today, according to the Federal Reserve. This data cuts through the illusion of rising U.S. wealth by showing that much of the “wealth” produced over the last decade actually has been borrowed.

Home equity is an important source of personal wealth because it generally has increased over time, and monthly mortgage payments are a form of enforced savings. It has always represented the largest pool of American wealth, but that may not be the case much longer.

Over a decade (1996-2005), millions of Americans put too much faith in the appreciation potential of their own homes by taking out equity loans or lines of credit. Now, in a prolonged national housing slump, a portion of those gains have vanished while the debts remain.

The blue line in the chart shows the ratio of homeowner equity to value for all U.S. homeowners. An estimated 30 percent of homeowners – mostly older people – have paid off 100 percent of their mortgages. When they are eliminated, the red line shows that this ratio for homeowners with mortgages has declined to 35 percent, the lowest level in history. If national home prices decline by another 10 percent over the next two or three years, as some analysts predict, the ratio (red line) will drop below 30 percent.

Many Americans have become confused about how personal wealth is created. They can’t easily separate the sure-fire wealth creation that they control (personal savings) from the speculative wealth that they hope will be created by asset appreciation. BEA’s official definition of Personal Savings excludes appreciation altogether, in part, because it can be illusory.

The graphic below shows an equation for producing household personal wealth in the New Debt Economy.

There are three basic components of personal wealth: 1) Net Assets already accumulated; 2) New Net Savings added annually; and 3) Net Asset Appreciation on investments and real estate.

Most Americans, and many financial advisors, have focused long-range planning on the third component based on a belief that stocks and real estate will grow enough wealth to meet future goals. But rates of asset appreciation are not predictable, and for a variety of reasons (including low rates of personal savings) they may be lower in the future than they have been in the past. As the bear stock market of 2000-02 and the bear housing market of the present have shown, apparent wealth created in the up-leg of an appreciation cycle can be destroyed in the down-leg that follows.

The advisor’s focus should be to work with each client to set an annual goal for New Net Savings, the second component of personal wealth in the graphic above. Each year, the advisor tracks progress toward the goal and reports the rate of success. (i.e., “Your New Net Savings for the year totaled $7,439, which was 10 percent below your goal.”)

Some financial advisors view “appreciation creation” as an important part of their professional service, which links their personal earnings and wealth to the future success of the stock market. When advisors systematically motivate New Net Savings, they clear up the confusion (about how wealth is created) for clients and reduce stock market risk for themselves.

The grandparents of today’s generations knew that the surest path to prosperity was to save for it. But those grandparents didn’t carry a half dozen credit cards and $100,000 home equity lines of credit. With easy credit always in arm’s reach, today’s households must be reminded that most new debt incurred equals negative savings.

For this reason, financial advisors who wish to motivate systematic savings should monitor not only clients’ savings but also their personal debts. In the New Debt Economy, unless you are in touch with the liabilities side of your clients’ balance sheets, you can’t effectively track savings progress. The Savings Tracker is designed with this purpose in mind.

New Savings

Once per year, clients should provide you with the following information:

Once per year, the client should total the current principal balance of all personal loans, credit card debt, consumer debt, installment debt and student loans. If this total is greater than the year before, it is New Debt that subtracts from annual savings. If it is lower, it adds to savings progress.

For simplicity, eliminate from this calculation the loan or lease balance on vehicles and the mortgage balance on real estate. For most households, the annual cost of operating vehicles (including loans and leases) is relatively constant and does not greatly impact personal savings. Real estate is a complex area that the advisor may want to examine more closely depending on each client’s circumstances. For example, tapping a home equity line of credit to make home improvements doesn’t increase New Debt, because the home’s value should increase by the amount borrowed. On the other hand, tapping home equity to pay monthly bills does increase debt and erode savings.

New Savings
	Start of Year	End of Year	Difference
Bank checking balance	$13,437	$11,245	($2,192)
CDs balance	$32,410	$34,011	$1,601
Transfer from checking to brokerage account		$4,500	$4,500
Personal contribution to 401(k)		$5,500	$5,500
Employer matching contribution to 401(k)		$2,750	$2,750
IRA contribution		$4,000	$4,000
Home mortgage principal pay-down		$1,470	$1,470
Total New Savings			$17,629
New Debt
Credit card principal balance	$16,260	$19,450	$3,190
Installment loan balance	$0	$8,500	$8,500
Student loan balance	$9,750	$9,435	($315)
Total New Debt			$11,375
Annual New Net Savings			$6,254
Annual New Net Savings goal			$10,000
percent of goal achieved			62.5 percent

A hypothetical client works with a financial advisor to set a New Net Savings goal of $10,000 annually. The table below summarizes their situation at the start and end of the year.

This service can be integrated with an annual investment review and help clients understand what part of wealth accumulation was created by New Net Savings, as opposed to Net Asset Appreciation. Perhaps most importantly, as the service becomes ingrained into daily activities, clients will become more aware of the impact of new debts on personal savings progress.

It should be clear that the U.S. negative personal savings debacle of 2005-07 has been driven by undisciplined increases on the debt side of the ledger. Offering this service gives advisors a clear window into clients’ debts on a high level. By capturing a few pieces of debt information once per year, advisors can see clients’ financial obstacles and opportunities and show them how each swipe of a credit card has an impact on annual savings. Hopefully, this understanding can help your clients become more disciplined in their spending.

Additionally, this service will promote systematic or enforced savings programs including regular retirement plan contributions, accelerated mortgage principal payments, over-funding of permanent life insurance programs, and dollar cost averaging investment programs. When you can convince clients to put these programs to work, their ability to meet annual New Net Savings goals will increase.

Clients who consistently set and reach annual New Net Savings goals will become more successful and loyal to you, in part because of the discipline of the annual goal-setting process. They also will feel more in control of their debts and accumulate more assets under management in long-term investment accounts.

Finally, clients who systematically save more money can take aim at long-range investment goals without having to take excessive or uncomfortable investment risks in search of asset appreciation.

Because of the widespread nature of this crisis, this service will prove useful to a wide range of clientele. More notably, it will have great appeal to a particularly attractive market segment – affluent pre-retirees. Statistical evidence suggests that millionaires are having as much trouble saving money as people of modest means, largely due to heavy borrowing. Most affluent people want to enter retirement nearly debt-free, and this service will help them see that every dollar of debt paid down works to build savings. If interest rates rise, paying down debt will be an even more efficient way to increase savings progress.

Regardless of the exact market you’re targeting, these points suggest how to discuss this service with clients:

“Most people don’t have a clear idea how much New Net Savings they achieved last year. Do you? This is the most important driver of personal wealth that you control. I can help you set a New Net Savings goal for this year, and then help you measure achievement year after year.”

“Each time you borrow money, you reduce your personal savings. For 26 straight months, higher debts have caused the U.S. Personal Savings rate to be negative, and this poses big potential problems for the future. We can’t fix national problems, but we can make sure your personal savings are high enough to meet your long-term goals.”

“If you would like to set a systematic goal for new savings and achieve that goal year after year, I can help you. This service will require us to meet once per year and review information such as your savings account and credit balances, retirement plan contributions, and mortgage principal pay-down. It will add discipline and confidence to your long-range planning, and it only requires about 30 minutes of your time.”

The negative Personal Savings rate that the U.S. has experienced for the last 26 months is unsustainable. If the trend were to continue for another decade, America would become impoverished.

The blame for bad borrowing and spending habits doesn’t belong to the Chinese, Japanese, credit card companies, home equity lenders or Wal-Mart. It belongs to each and every consumer who lacks savings discipline. This problem comes at a time when, according to an analysis by USA Today, the United States as a nation has public debts and obligations totaling $59 trillion.

Americans can no longer count on a strong dollar, Social Security, rising home prices, or stock market appreciation for true financial security. The only real security that they totally control is their own savings. You can help America solve its savings problem and avert financial calamity – one client at a time. In doing so, you will make your own future more secure, too.