Advising Clients With Diminished Capacity

Advising Clients With Diminished Capacity

Dealing with a client with diminished financial capacity is an inevitability for most financial advisors. But it’s sometimes done in an unstructured or ‘seat-of-the-pants’ way, which can leave both advisor and client exposed to risks. 

One of the best protections, for both sides, is the client’s stated goals, values, and financial plan. These provide a touchstone for what should be happening, and an early warning system should inappropriate things start to occur.

There are more older clients

The average age client of a US financial advisor is 62 years old. But, of course, many are much older — and able to afford the care required to become even older still. Meanwhile, an increasing number are running more sophisticated investment plans into retirement, rather than converting everything to cash in their mid-sixties.

As a result, most financial advisors’ working lives are being touched by clients who are suffering a decline in their cognitive abilities.

It’s easy to automatically blame conditions like Alzheimer’s or dementia as the primary causes of diminished financial capacity. But research shows that capacity diminishes, for most people, with age. It can be present even when the more debilitating conditions are not present — and when there is a formal diagnosis of those diseases, the diminished capacity has often been noticed for a year or more prior.

The AARP (formerly the American Association of Retired Persons) says financial capacity is:

“The capacity to manage money and financial assets in ways that meet a person’s needs, and which are consistent with his/her values and self-interest.”

Consequences of diminished capacity

Understanding complex investments or retirement plans are one part of financial capacity, which can pose several challenges, and questions, for advisors:

  1. Are these the right financial products for this client currently?
  2. How can the critical points be communicated effectively to a person with intellectual or physical problems?
  3. How can the advisor be assured that the client has the capacity necessary to make decisions and execute transactions?
  4. What is the potential for financial abuse by the client’s family, friends, or associates?

These are critical questions for advisors and compliance departments to confront — and they can be very complex, and difficult, questions to answer.

Most firms do have some sort of process in place to deal with diminished capacity which is often focused around ensuring a Power of Attorney is in place for when it might be needed. But this alone may not be enough to address all four of those concerns in sufficient detail to ensure both client and advisor are protected.

Financial advisors are often the first people to notice when a client is starting to have irregularities or problems in their financial capacity.

Diminished capacity can manifest at some very basic levels:

  • Problems in identifying and counting money
  • Not keeping bill-paying organised
  • Losing understanding of debt and loans
  • Not acting prudently with good judgement
  • Becoming vulnerable to financial exploitation

These problems could start very small and slow. It might be just a longer-than-usual pause or difficulty in understanding what was once easy that alerts an advisor that their client could be struggling.

But sometimes the problems arise with a big bang that sets alarm bells ringing. The trigger could be when the advisor receives a withdrawal request that is unusual or out of character.

Is it financial abuse?

Usually, a client’s withdrawals and spending will align with their goals or values and they’ll often be very happy to tell you about where the money is going. So, behavior that is unexpected or unexplained warrants further consideration.

This is how it could happen. One day, out of nowhere, a big withdrawal request appears from a client. It seems at odds with the plans they have in place and out of character for the client. There is no explanation of what the money is to be spent on.

It is, of course, the client’s money to spend as they wish — and to not act on their instruction could leave the advisor liable. But, at the same time, the advisor could open themselves to liability by acting on an instruction that the client does not have capacity to give.

Elder financial abuse is a real and growing problem, which is often perpetrated by trusted friends and family. The American SEC warns it is chronically under-reported, estimating that for every case documented 44 went unreported. Losses are estimated to be as high as US$30 billion.

The advisor is placed in an uncomfortable position. Their shared understanding of the client’s goals, values and financial plans is their best protection.

It’s okay to ask, ‘Are you sure?’

An advisor who truly knows their client will have discussed with them what their financial lives should look like — and will be keeping up to date with changes in the client’s lives, through their regular reviews.

So, when something arises that is not consistent with that picture it makes sense that the advisor would get in touch with the client to check that everything is as it should be. The simple question ‘This doesn’t fit in what you’ve previously told me – are you sure about this’ could reveal that everything is just fine. But it could also help uncover something that should not be happening.

Several research studies have revealed an interesting paradox. Financial capacity tends to decline with age — but confidence in financial decision-making increases with age! Taken together, this paradox might explain why the elderly are at higher risk of being scammed or financially abused.

It is also helpful for the advisor to have solid relationships in place with advocates, caregivers and family as unusual behavior can potentially be discussed with them. But these arrangements and introductions need to be made in advance to ensure all privacy concerns are addressed.

Managing the business risks

Advice businesses need to have procedures in place to deal with diminished capacity.

There are several business issues and risks presented by clients with cognitive decline:

  • How does the business satisfy itself that the client has capacity to give instructions and authorize transactions?
  • What happens if the business acts on instruction in an action that is detrimental to the client?
  • How will the validity of powers of attorney be checked and managed?
  • How will the business protect against legal actions by heirs alleging the client lacked capacity?
  • What role does the business play in protecting the client from elder financial abuse?

Each advice business must find its own answers to these questions — there is no easy ‘tick-a-box’ checklist that everyone can follow.

I have been using FinaMetrica for over 17 years for onboarding new clients. They like the extensive value of the reports; but what we appreciate is the innovations in technology, the value of the client-facing materials and the development of the life-long client relationships as I get to really know their behavioral tendencies. FinaMetrica has assisted me in building a very successful practice and we highly recommend it for any advisor who wants to enhance the overall value of their client relationships.

Ron Wilkinson - Portland, Oregon, USA
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