One of the main reasons people fail at retirement is they give too much money to their children.
Let’s say you’re in your 60’s when you retire or even early 70’s. At this time in your life, your children are adults, yet they’re still hitting up Mom & Dad for cash. What’s up with that? And how can or more likely, will that impact your financial security? Although every parent wants to see their children succeed, giving too much money away can cause a severe drain on a couples retirement resources and jeopardize their own financial security.
Here’s just one common scenario I’ve seen play out with clients:
Mom & Dad, I’m going to start my own business!
One of the kids who has been struggling financially all their life suddenly decides they want to start a business, so they go to Mom and Dad for funding. It's usually not a small amount of money and it definitely could put a crimp in Mom and Dad's parents budget.
As you might imagine, this brings up a lot of issues in the family dynamic - both emotionally and financially. Of course parents want to help their children, but how do they find the right balance between helping without putting their financial future at risk?
As with most financial life decisions, particularly investment decisions, it's best to not let your emotions sway your decision. As an investment advisor, that means walking clients through the process of deciding whether or not to give their child the money to start the business.
The first thing to say about the above scenario is that it’s not always a bad thing to help your kid(s) start a business. People do start businesses in this country all the time and many do very well. So for the record, I’m not necessarily going into the conversation with my clients absolutely trying to talk them out of it. Rather, I want to talk them through a decision making process where everybody can feel good about the risk the child is going to take with the parents money.
The first thing I want to know is do they have a business plan? Most of the time, they don’t, but like most people, they have an idea of a business. They want to start a business, but they really haven’t taken the time and effort to go through a business planning process. Other times we discover they actually do have a business plan but it’s not a very good one, which is the reason the banks wouldn’t loan them any money, which is why they turn to Mom & Dad.
From a rational, investment perspective, if this is truly a loan to start a business, the parents should be compensated fairly for making the loan. For example, they should have proper loan documents, and they should charge an appropriate rate of interest. Remember, if the banks were not willing to make a loan, there’s a good amount of risk there.
Usually by this point in the discussion the parents consider the risk involved and conclude that it is indeed a pretty risky endeavor. With that realization, they start to expect a little more about the validity of the business. Oftentimes the child reacts very favorably to this, they do their due diligence and spend quality time putting together a business plan that seems more viable and everyone seems a little more comfortable making that loan.
But it’s when the child does not agree with this course of action that I have to be absolutely frank with clients about their situation. I truly understand their desire to want to help their child. That makes perfect sense to me - yet I work for my clients, not for their kids. Because I am intimately aware of the parents financial situation, if warranted, I let them know that what I see is a very risky situation. I remind them that they are about to give (not lend) money away to start a business, to their child who perhaps has not been able to hold a steady job for ten years. That’s why the business sounds so attractive to them - now he or she is self-employed and they can’t get fired.
Fortunately, each time this has happened, either Mom, Dad or most times both will open up to me and share some of the challenges their son or daughter has had in life. They know this loan is risky, but they also feel deep in their hearts that this would be a way to help them. It’s a heartbreaking decision to say no to their child.
Making the Leap – Moving Forward
So let’s say the child does their due diligence, gets their act together and Mom & Dad decides to loan them the money, what happens when they need more money? Invariably, even with the best business plan in place, unforeseen situations call for more money. If only that heating system hadn’t failed, or the flood hadn’t happened and the store was closed for business for 2 months. They’re so close in succeeding, just one more loan will see them through...
This all goes back to the critical importance of having a good business plan. Who are they selling to? What are they selling? What’s their cost structure? What are their employee costs and their benefits costs? How are they going to market their business? Do they have sufficient insurance coverage? A surplus for emergency funds?
And most importantly of all questions - when are they going to pull the plug? If it becomes necessary, at what point are they willing to cut their losses? Without these decisions made in advance, it’s a bottomless pit with the potential to be an extreme drain on the resources of the Bank of Mom & Dad.
Most of the time, once you tell either your son or daughter that they need to present you with a detailed business plan that includes cash flow projections as well as profit and loss projections before you make the loan, that ends the discussion all together. With no real plan you discover your child hasn’t thought it through. Yes, there was a great idea, but when they actually started to do the work, all the old habits that created the financial struggles in his or her life all come back.
Simply Put –
A financial advisor that works in a fiduciary capacity is looking out for your financial best interests. That’s what a client really wants and needs from their advisor. With such an emotionally charged issue, they want someone to help them weigh the pros and cons, the tradeoffs involved with this financial decision, and ultimately to do what’s best for their future.