This special Family Lawyer Magazine Podcast features Christy Watkins – Senior Investment Advisor at Wilmington Trust – discussing the types of financial information family lawyers need in order to negotiate the best deal possible for their clients with Diana Shepherd – Editorial Director of Family Lawyer Magazine.
My name is Diana Shepherd, and I’m the Editorial Director of Family Lawyer Magazine. My guest today is Christy Watkins, who is here to discuss “The Financial Information Family Lawyers Need to Negotiate the Best Deal for Their Clients”. Christy is a Senior Investment Advisor at Wilmington Trust where she manages the investment portfolios for wealthy individuals, multi-generational trusts, and institutions. She is also a member of the company’s Matrimonial Advisory Practice Group guiding divorce attorneys and their clients. Thank you for joining us today, Christy!
Christy Watkins: Thanks for having me.
As divorce attorneys go to the negotiation table, what financial advice and perhaps data would you provide to help them get the best settlement for their clients?
Divorce attorneys have a unique opportunity during the divorce process to set up their clients for future financial independence and success. Getting the right settlement is crucial as to whether or not their clients will be able to maintain their expected lifestyle. The question is, how do attorneys build confidence that the settlement they’re requesting is going to be enough?
As they approach negotiations, a powerful tool that they can use and that they have at their disposal is the use of data. In this case, when I’m talking about data, I’m suggesting a financial projection that would be based upon the requested settlement and accounting for their clients’ anticipated cash flow needs. Having that kind of data to put on the table can empower an attorney to ask for a settlement that maybe they hadn’t previously considered. Having that data can also make it very difficult for their counterparts to dispute the amount that they’re requesting; having those figures in black and white is very powerful. When using this data to support the request, the only way that they can ensure the settlement will be truly successful is to make sure there’s an understanding of the client’s holistic financial picture, and not just thinking about the settlement amount in isolation.
What is at risk if the divorce attorney does not have full financial information at the negotiation table?
If they’re missing a deep understanding of the full financial picture for their client, there’s a chance that the requested settlement won’t end up being enough to meet their client’s expected lifestyle. This would be extremely disappointing after going through the whole negotiation process only to find out that they have to adjust their lifestyle. Issues related to that could be as simple as not properly accounting for property taxes or any other type of tax, or maybe they missed considering outstanding debt that they have. It’s important to understand that once the negotiations are complete and the settlement is reached, it’s very hard to go back and negotiate for a higher amount. In that case, it’s crucial to have a full picture in advance and when you’re going through the negotiation process in order to make sure that you’re able to win an appropriate settlement for clients.
If a divorce attorney models the asset values and cash flows in a spreadsheet, what are some areas that a spreadsheet can’t account for?
Spreadsheets are a fantastic tool and have any number of uses. I probably use Excel every day. However, it’s not sophisticated enough to model more complex or real-life-type situations. A couple of examples here would be helpful.
The first is that our tax code is not simple. Different types of income carry very different tax rates and consequences, and it’s difficult to get a spreadsheet to account for a realistic estimate of what tax consequences might be over time, especially as an investment portfolio grows and changes. The spreadsheet has a difficult time capturing something like that. Also, investment returns do not happen in an even and consistent manner. Anyone that was investing during March 2020 can certainly vouch for that. We can see some very wild swings in the market, and it’s unrealistic to apply a single rate of return year after year. Unfortunately, that’s what we often see when we’re reviewing spreadsheet models that have been put together to try and estimate the growth of a portfolio.
Keeping on the topic of returns, one of the key components in determining whether a settlement will be enough is estimating the growth rate of the portfolio. Spreadsheets aren’t going to provide this data point, so the attorneys are probably estimating that based upon historical information. A question I would ask is whether the historical 10-year environment that we just experienced is likely to repeat in the future. Divorce attorneys are probably not well-positioned to answer that question. Forecasted returns must be used instead of historical information because those forecasted returns are likely more based on realistic expectations for future economic growth and future interest rates. In order to handle all of these variables and pull them together in a way that’s more consistent with real life, a more sophisticated type of tool than a spreadsheet is required.
You just mentioned sophisticated tools. What kind of information goes into a more sophisticated financial analysis – especially considering the current financial uncertainty?
The first thing we would suggest starting with would be looking at the full financial picture of the individual, which would entail putting together a global list of assets and any liabilities to understand their full financial picture. This would incorporate banking accounts, any marketable securities they own, any real estate they have, any mortgages, etc. We want to make sure that we are getting a full financial picture of their situation, obviously post-settlement, post-divorce, what they are anticipating.
Next, we would want to account for estimated cash flows. Considering inflows, we will be looking at any type of income or cash payments the individual would expect receiving. This could incorporate alimony or salary amount, or any social security down the line. Any type of inflow or inheritance could be one as well. We’d want to try to estimate all of those figures together. Then we would want to look at estimated outflows. Incorporated in this would be any kind of expenses they anticipate in the future, which could include living expenses or education costs, or perhaps they’re looking to travel. In doing so, we want to make sure that we’re accounting for a realistic level of inflation, as those expenses are likely to increase over time. In particular, education costs and medical costs tend to increase at a faster rate than a lot of the other living expenses, so we want to make sure to get a more realistic picture to increase those types of expenses at a much faster rate than some of the others. Also, their tax situation may be changing post-divorce, so we want to understand what their anticipated tax rates could be in the future.
Last but not least, we’d like to develop an understanding of the individual goals and their comfort level with taking risks. These two components together would determine what the anticipated growth rate or return for any assets they anticipate receiving during divorce would be, which in turn would impact whether or not they would be successful in meeting their expected lifestyle. However, figuring out what an appropriate level of risk would be can be difficult and would often involve incorporating an investment professional in the discussion. Those conversations are best had talking about shocks to the portfolio – which a sophisticated analysis would incorporate—looking at what would happen to the portfolio in a really tough market environment to gauge whether the client would feel comfortable staying invested through rough market times given that level of risk. This will help determine if that’s appropriate for them or not.
What are the results of a sophisticated financial analysis?
After taking all of the information from the analysis into consideration, the output would likely be a series of reports that provide a forecast into the future. The results would incorporate all of this information together in one. Returns do not happen in an even and consistent manner, so the sophisticated analysis will project thousands of possible scenarios that could happen, where the order of the returns that you receive are different.
The order of the returns can have a big impact on the future outcome of the portfolio. As an example, if at the beginning of the timeframe, there’s a big decline in the value of the portfolio, that can have long-term consequences as to the amount of growth that’s potentially possible for that portfolio. Therefore it could potentially put at risk the plan or the ability to meet those lifestyle needs. So this range of expected outcomes after running these thousands of scenarios is very helpful, versus a single expected outcome that you would get from a spreadsheet. With this range of potential outcomes, the analysis can also provide a probability that those assets will last and cover all of the anticipated expenses. This can help provide a much higher level of confidence, so even if we anticipate or experience a difficult economic or market situation, the individual will be able to maintain their lifestyle. We then want to use the flexibility of the analysis to run a variety of different scenarios in order to increase that confidence that under different circumstances they will be in a good place post-divorce with the settlement. We can do that by adjusting the amount of the settlement, incorporating different spending levels, and also looking at what would happen if they took different levels of risk in investing and what impact that would have on the outcome.
How can these analytics help the family lawyer and their client during divorce negotiations?
A spreadsheet can provide a forecast and provide some basic assumptions and also serve as a starting point. However, sophisticated analytics take into consideration a broader set of outcomes and potential market shocks that better model real-life situations. This could lead the attorney to the conclusion that more is needed from the settlement than they originally anticipated using their spreadsheet model. Therefore, it’s very important to use this analysis when negotiations are still underway versus waiting until the settlement has already been determined and it’s too late to make a change. Using these analytics, the attorney can have a higher degree of confidence that assets or payments they’re arguing for will be enough, and it also provides that data during the negotiations to support the amount that they’re requesting at the negotiation table.
Once the financial settlement has been determined, what else needs to be considered?
So much hard work goes into the negotiation process. Once that’s complete, there’s still work to be done. As the assets are being split amongst the two parties, there are a number of factors that should be taken into consideration, the first of which is the titling of the assets. How will those assets be owned? Will they be owned directly, or will they be owned in trust? That’s important to understand, and it ensures that your client is being treated fairly. When the assets –marketable securities in particular – are being split, it’s important not to just focus on the value and that there’s equal value in the split, but to also understand the characteristics of the various investment holdings to make sure that your client is being treated fairly.
A municipal bond and a share of Berkshire Hathaway Class A shares may have the same value, but their characteristics are incredibly different. One thing to focus on is income production. Are the assets that your client is receiving able to produce regular cash flow or income to help provide for the spending needs that they may have? The second is, how liquid are those assets? Are they able to be converted to cash and sold easily at a reasonable value to meet some cash flow needs? Finally, thinking about tax implications is important as well. What is the cost basis of the securities that they’re receiving, and is it equivalent or fair as they’re being split? If the assets need to be sold for either covering cash flow needs or to reposition a portfolio, there is a real expense associated with unrealized gains and taxes associated that they may need to pay and that may impact the value of their portfolio. Pulling that all together, just make sure that you’re considering these characteristics as assets are split.
What guidance do you have for family lawyers who wish to help their newly divorced clients find good financial advisors? What are some of the must-have qualities in an advisor?
As a settlement is reached and a newly divorced individual is finding their path forward, they may be drained from the divorce process and could use guidance from their attorney to help them find their way forward. In searching for a financial partner for your clients, I think one of the most important characteristics or things that a financial partner can help provide is peace of mind. Given everything that they’ve gone through it is important that they have a partner, and not just an advisor, who’s there to help see them through and plan for their future and the next stage of their life. They need to have confidence that the financial provider will set them on the right path and is a partner that they can trust that will help provide guidance specific to their situation and not just general advice.
In particular, a financial partner that will be working in your client’s best interests is a must, so someone held to a fiduciary standard versus just a suitability standard is incredibly important. Finally, a financial partner that has deep resources to handle any variety of situations that may come up or life challenges that your clients will be facing in the future is incredibly helpful to help guide them through any variety of situations that could occur.
How do you educate a divorced individual to manage their financial affairs if they’ve never done that before?
In a marriage, one spouse tends to be responsible for all financial matters in the household. Upon divorce, oftentimes one person is now picking up that responsibility on their own behalf and they haven’t been involved in the past. It may be very daunting to pick that up. We would suggest some foundational education for those individuals, and in particular with investing some basic concepts to understand the impact of inflation on your investments, how helpful the compounding of returns or interest might be, developing an understanding of what different asset types are, understanding risks associated with those assets, and understanding the importance of diversification. Receiving some training on those basic financial concepts is certainly important. That can be something that can be done through reading books, online training, or one-on-one with the financial partner they’re working with.
My best advice would be to be curious and ask a lot of questions. Now that you’re in control of your financial future, getting involved is incredibly important, and taking those steps to be educated is incredibly helpful.
Diana Shepherd: Thank you, Christy, for joining us today, and thanks to our audience for listening in. My guest for this informative podcast has been Christy Watkins, a Senior Investment Advisor from Wilmington Trust. For more information about the services Christy and the Matrimonial Advisory Practice Group at Wilmington Trust offer to family lawyers, please visit their website at www.wilmingtontrust.com/divorce.
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