An Explanation of Holistic Financial Wellness
My 83 year old father doesn’t like debt. Not one little bit. Growing up I was told many times – “Neither a borrower nor a lender be” and that is the way he has lived his life. He tried to pay cash for everything and made sure that other than the house mortgage, our family was never “burdened” with debt. Now, deep into retirement, he is doing just fine; his house is owned free and clear, his disciplined and committed savings behavior throughout his career as a theoretical mathematician has provided him a guaranteed lifetime annuity from TIAA-CREFF which along with Social Security and Medicare, provides him and my mother a modest but reasonably comfortable (and low stress) lifestyle. They don’t travel much, but they have all of what they need and much of what they want. They even have a bit of savings set aside in case of emergencies. In short, his retirement plan was just right – for him.
For many years up until his retirement and then for some time after, my father would ask me my opinion on the financial decisions he was making. Being a pension actuary, with access to all the theoretical knowledge there is about how one “should” plan for retirement, I gave him plenty of advice, almost none of which he took. But those conversations, along with hundreds of others I’ve had with colleagues, clients and friends about their financial situations were critical to the evolution of my ideas about Holistic Financial Wellness. I eventually came to the conclusion that most of the advice and “conventional wisdom” around retirement planning and financial wellness in general is not only often wrong, but more importantly, even when correct, is rarely fully applicable to a given individual’s situation. We are all just too idiosyncratic in our circumstances, inclinations and objectives for “rules of thumb” to work. Beyond that, almost all financial wellness principles are based on serious oversimplifications and overly compartmentalized views of key financial decisions; whether they are as seemingly straightforward as “how much should I put aside in my 401(k)?” or fraught and complicated like “do I have enough to retire next year?”
About a year and a half ago I put up a blog post on “Holistic Financial Health” and how without looking at the totality of our financial situations – i.e. all of our assets and liabilities (including known future income and expenses as well as hard to quantify assets like our education, skills and future earnings potential) along with our individual goals, plans, hopes, fears and dreams — we will never make the right choices and attain the financial health we all seek. For a while if you did a google search on “Holistic Financial Wellness” or “Holistic Financial Health” my blog post as well as a few of the actuarial presentations I have given on the subject were at the top of the list. Now the field has become more crowded and many others are using those terms. I’m sure that’s a good thing because it is important for more brains and voices to enter the debate as the result will undoubtedly be better answers and insights. However, I also worry that my voice is now getting lost in the noise, and so today I want to talk about what I mean by “Holistic Financial Wellness” and how I believe an individual (with some help) should start to think about it.
For me, Holistic Financial Wellness means ensuring financial wellness over a lifetime and doing so in a way that is congruent with one’s objectives, constraints (i.e. life circumstances) and values. When I say “values” I mean both what is most important to you now (e.g. having an emergency cash reserve vs a new car) and how you balance the present known financial aspects of your life with the future unknown (and often unknowable) contingencies that we all must face (i.e. how important is meeting current needs relative to future needs or leaving a legacy behind after you die). In order to begin to get at this concept, it might be helpful to look at the chart below that I presented at the Enrolled Actuaries Meeting earlier this year and shows generally the concerns we all face as we move through life.
As useful a roadmap as the above chart is, you also need, at each stage of life, to consider what is coming; what money you will be receiving from all sources (earnings, investments, etc.) and what money you will need to pay out (expenses, debt repayment, necessary asset acquisition, insurance etc.). In short you need to think about your personal holistic balance sheet.
Below is a simplified version of this kind of balance sheet. A deeper dive into Holistic Financial Wellness would entail breaking each of the assets and liabilities listed into their component parts and then considering the connections between those components as you approach the key decisions you need to make to manage that balance sheet holistically. Specifically, you need to recognize that each decision that you make with respect to one asset or liability will affect the totality of the picture. So for example, you might have a potential future earnings stream from your current job and potential promotions that is dependent on your current level of education. One decision you might consider is to take on some more debt (e.g. via a student loan) to increase that “education/skills” asset which will in turn have an impact on the “future income” asset. That’s what I mean by thinking holistically.
The discussion above may seem a little too conceptual and abstract to be useful, but in fact taking some time to look at your financial picture in this way can give you insights that will allow you to consider approaches to improving your financial wellness that you would not have considered had you not looked holistically at your situation.
Specifically, in addition to the “invest in your education” decision noted above, there are many other examples of Holistic Financial Wellness decisions that we make all the time, but rarely call them that. For example, when you choose where to live, you of course consider emotional/lifestyle issues, but you also consider many interrelated financial issues; e.g. what is the cost of housing ( a pure liability if you rent, an asset and a liability if you buy) in the neighborhoods you are considering and what is the quality of the public school system (an asset) in each. If you choose to live in a low cost neighborhood with a poor school system you may then decide to pay for private school (an asset and a liability). These are just two interrelated (mostly financial) aspects of your choice of residence, but there are many other interrelated financial factors (e.g. length of commute, local job opportunities, other cost of living factors etc.) that almost everyone needs to think about before they make a move. In short, choosing where to live is a holistic decision where all the interrelated factors need to be considered together.
The key here is that many of our most important decisions have many interconnected financial and emotional aspects and we have a tendency to either “go with our gut” or focus on one or two of the factors in isolation. What I am suggesting is that while it is hard to consider everything together, in many cases it is possible to separate out the financial from the emotional factors, and then to deal with the financial factors (which are amenable to analysis) together in a holistic manner.
To show you what I mean, I want to describe in some detail how using the Holistic Financial Wellness framework can assist individuals with one of the most critical financial wellness issues anyone will face — that is how to provide for a secure and stable retirement with enough income to live comfortably during the period after you retire but without risking outliving your assets later in your retirement years. To do this in a holistic way it is important that you consider your house (an asset), your mortgage (a liability) and your future retirement income needs (a liability and part of “future expenses” above) together. To me the use of home equity as a means to generate retirement income is a great demonstration the effectiveness of thinking about your financial decisions holistically.
You will never hear it from your financial planner, but home equity is the elephant in the room when it comes to retirement planning. For many, if not most of you, your house is the biggest asset on your personal balance sheet and your mortgage could easily be your biggest liability. In total the value of all the residential real estate in the US is far greater than the value of all the 401(k) balances held by all employees throughout the country.
To put it in context, total 401(k) assets in 2015 were a little less than $5 trillion. The total value of all houses owned by Americans is now about $18 trillion or more than 3 times the amount of all 401(k) account balances. And while outstanding mortgage debt is slightly higher than $8 trillion, the amount of net home equity that Americans have is still more than $10 trillion and is significantly more than all the retirement savings that individuals have set aside for their retirement years.
So how can this valuable asset be used to generate retirement income? The answer is through the use of a Home Equity Conversion Reverse Mortgage (HECM) line of credit. Because so few individuals and advisors look at retirement planning holistically, Reverse Mortgages have been an under-utilized tool for enhancing the financial wellness of large numbers of retirees.
Despite its rarity, a HECM is actually nothing more than a credit line from which you can borrow against the value of your home. It operates just like a traditional home equity line of credit (HELOC) except, first of all, unlike a HELOC the amount you can draw on from a HECM credit line grows every year by a fixed amount and secondly, even after you draw from the credit line, you don’t have to pay back the HECM until you sell or move out of your house, and you will never have to pay back more than the residual value of your house REGARDLESS of what the real estate market does. As a result even if you fully utilize a HECM you will still be able to leave your house to your children when you die, a legacy objective that is very important to many of us as we consider our financial situation.
Because of the above, a HECM credit Line can be a powerful retirement income generation tool that, when part of a sophisticated and highly effective decumulation strategy, can take you from a situation of having to worry about outliving your assets to a situation where you can comfortably draw down 6%, 7% or even 8% of your savings every year and still be confident that you have very little chance of running out of money before you die.
A technical discussion of why this is so is beyond the scope of this piece, but for those interested you can read Barry Sacks’ excellent paper ( “Reversing Conventional Wisdom: Using Home Equity to Supplement Retirement Income,” Journal of Financial Planning February 2012) where the strategy is explained in detail. In essence, setting up a HECM credit line enables you to draw money from two sources, which can be coordinated (again an example of holistic thinking). That is, instead of drawing money every year from your 401(k), IRA or other retirement savings account, you draw from your retirement savings account only if the investment returns (in the prior year) on that account were positive, and draw from the HECM credit line if the account’s investment returns (in the prior year) on were negative. This coordinated strategy minimizes what is called the “sequence of returns” risk, associated with market volatility. In short, using this strategy allows you to draw on the account at a higher rate, for a longer time, than you otherwise might.
So why isn’t the use of Reverse Mortgages more prevalent and talked about? Well one obvious reason is that financial planners generally make their money by selling you investment products (e.g. Mutual Funds) and Reverse Mortgages not only don’t generate any income for them, but their use may reduce the amount of other products they can sell you. But there is another reason that goes back to what I mentioned earlier. To consider home equity as a source of retirement income requires you to think holistically about your financial life, and as of today, very few people do.
About a year ago, I raised the possibility of a Reverse Mortgage with my father as a means to make his retirement years a bit more comfortable. Given what I said about him at the outset, it should come as no surprise that he rejected the idea immediately. I should have known better because he does consider his financial wellness holistically and for him the idea made no sense because the psychic value he places on being debt free is far more than the incremental monetary value of additional retirement income. In short, he used the framework of Holistic Financial Wellness to make the right choice for himself. So please don’t think I am recommending a Reverse Mortgage for everyone. Rather it is just one example (of many) where thinking holistically can give you approaches to your financial health that can make a real difference.
My mission is to help others fully understand and incorporate the idea of Holistic Financial Wellness into the decisions they make. For better or for worse, I am not looking to make any money selling “holistic financial wellness funds” or other kinds of products. Rather I just want to spread the idea that thinking about your financial situation in a holistic fashion will lead to better financial health. If you want more information on Holistic Financial Wellness or how I think about it, please look around my website.