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The following is a research abstract from The Cerulli ReportTM NavigatingtheEmergingAffluentMarketplace.
INVESTOR SEGMENTATION
Key Points
Effective segmentation methodologies are not a one-and-done exercise.
We use a multifactor analysis to identify seven investor segments within the emerging afflu
These segments represent a combination of economic, demographic, behavioral, and
psychographic factors.
These segments are: business owners, established retirees, real estate wealthy, spenders,
up-and-coming professionals, inheritors, and the suddenly affluent. Some investors may fall
more than one of the following segments.
Economic factors are used by many firms as a first cut at segmentation, which is very us
However, it should not be the only cut.
Macro factors such as the privatization of Social Security; real estate busts; the repeal of ca
gains taxes; or changes in estate, gift, and income taxes may affect the segmentation process
Research Abstract The Cerulli ReNavigating the Emerging Affluent Marketplace M
CERULLI ASSOCIATES
ONE EXETER PLAZA
BOSTON, MA 02116
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WWW.CERULLI.COM
RESEARCH ABSTRACTFrom the Cerulli Report
TM
TARGETING THE AFFLUENT AND EMERGING AFFLUENT
C e r u l l i
A s s o c i a t e s
CA
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The investors who comprise the emerging affluent segment of the market are very diversein
terms of their net worth, risk tolerance, financial goals, and a myriad of other characteristics. Because of
this diversity, in order for firms and advisors to effectively service this market they must perform some
level of segmentation. There are many ways to segment any group, and this is especially true of this
market. The methods employed by players in this market will depend on the firm and their advisorforce,
as well as on the construct of their existing and desired client base.
Though differences will exist between factors considered, weightings applied, and techniques
employed, there are some commonalities that persist among effective segmentation strategies. Foremost,
investor segmentation is a strategynot just an occurrence. The investor segmentation methodology
must be defined, constructed, deployed, and promoted via a top-down initiative. If a methodology is
employed by only one group, the question arises as to who services all other investors who fall outside
of this group. Thus, most methods dictate what segment the firm or individual groups will pursue and
determine what is to be done with the leftovers. Second, effective segmentation methodologies are
revisited periodicallyit is not a one-and-done exercise. The financial services industry is not stagnant,
and the segmentation methods employed by firms cannot be. Markets change, firms redirect their efforts,and advisor migration patterns alter. Thus, segmentation methods must respond to these dynamics.
In this chapter, we discuss some of the basics of constructing a segmentation methodology
highlighting how to use different segmentation factors in conjunction with each other. We then detail
some of the generic factors that can be used to construct a segmentation methodology, such as econom-
ic, demographic, behavioral, and psychographic factors. From there, we delineate the seven segments we
believe are the most noteworthy in the emerging affluent marketplace as a whole. These segments will
not necessarily be ideal for every firm or advisor, as they are segments of the entire emerging affluent
population instead of smaller segments being targeted by different firms or advisors. Thus, though these
segments may not be the ideal for all in the industry, they give some guidance to those creating a seg-
mentation methodology and some possible outcomes of the application of that methodology. Finally, we
conclude this chapter with a discussion of some influential factors that may cause these segments to flour-
ish, or not, and be more or less of an opportunity than they currently present.
Basic Segmentation Methodology
In creating a segmentation methodology, there are two key pieces that must be considered: whatfactor or factors should be considered, and how should they be used separately or together. As stated, the
exact factors employed and how they are utilized will depend upon the individual firm or advisor, but
below are detailed some of the generic factors and methods to consider employing when creating a cus-
tomized segmentation model.
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Segmentation Factors
In many instances, the only segmentation factor considered is a clients investable assetsoften
not the total amount of those assets, but just the amount capable of being invested with the firm or advi-
sor. However, utilizing just this one economic factor is very short-sighted and relatively uninformative
about the true needs of the client. Thus, a variety of factors should be thrown in the hat when consider-
ing what factors are appropriate for usage within a firm or advisors segmentation method. There are four
basic categories into which generic segmentation factors fall.
EXHIBIT 18GENERIC SEGMENTATION FACTORS
Source: Cerulli Associates
Each of these four categories attempts to categorize a different aspect of human nature. The pos-
sible variables that comprise each factor are potentially limitless. In order to cite some of these variables
and give examples of firms that have employed these factors in their business, we expound upon each of
these four categories in the following subsection.
Economic Variables
The variables used most often are economic variables, such as investable assets, net worth,
income, and expenses. Many firms and advisors use this segmentation factor as the beginning and the
end of the process, or as the first step in it, for several reasons. First, it is a useful segmentation factor
because firms and advisors can quickly have an idea about the investors potential advice and product
needs, and their ability and willingness to pay for them. Second, this is a variable that is fairly easy to
plug into a profitability model to measure the potential revenue and profit generated from an investor who
falls into a particular economic category. Finally, when dealing with new clients, there is some informa-
tion they are willing to give from the outset and other information they are not. Many economic figures
especially investable assetsare ones that an investor approaching a firm or advisor for financial assis-
tance is prepared and willing to give, which is not necessarily the case with other segmentation factors.Though this information is helpful, it does not reveal some of the other nuances about an
investors needs, wants, and actions that may be more significant drivers of the nature and profitability
of the ongoing firm-client or advisor-client relationship. However, every process needs a starting point
and our analysts believe this is a good one.
Most firms utilize economic variables in the segmentation models. However, when you think of
the firm that personifies the usage of economic variables, it is Merrill Lynch that jumps to mind.
Economic Demographic Behavioral Psychographic
Investable assets Age Event-driven Self-directed
Net worth Race Strategic Validator
Liabilities Sexual orientation Opportunistic Delegator
Income Marital status Investment style Apathetic
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EXHIBIT 19MERRILL LYNCH SEGMENTATION PYRAMID
Sources: Merrill Lynch, Cerulli Associates
Merrill Lynch segments clients into four distinct groups based upon their investable assets, whichdictates the group that will service the investor. Those investors with less than $100,000 in investable
assets are serviced by the call center, and are offered a wide array of advice and products by the individ-
uals who staff this center. As investors investable assets increase, the sophistication of the advisor serv-
icing them, array of products offered to them off of the platform, and fee arrangements from which they
have to choose continues to increase. Though Merrill does take other factors into consideration when
servicing these four different investor groups, the initial cut is purely economic in nature.
Demographic Variables
Demographic variables are another example of a segmentation factor about which it is relatively
easy to gather information. Some examples of these variables include sex, age, race, and marital status.
Though this information is relatively simple to collect, it does not as readily generate actionable infor-
mation as do economic variables. Whereas economic information can dictate needs and be plugged into
a profitability model fairly easily, demographic information typically only means something when seen
through the lens of the past.
With some historical information about typical needs and wants about other investors who have
fallen into a particular demographic category, firms and advisors can target their product and service
offerings to these clients. Using this information, firms and advisors can lead with more appropriate sug-
gestions or offerings to their current client basemaking the client feel as though they are a relatively
important client of the advisors. A firm well known for utilizing this information is Fidelity Investments.
Fidelity has created its Retirement Income Advantage Program to position product and service offerings
based upon the age or lifestage of its clientas investors nearing or entering the retirement phase of their
lives, at around the age of 60 or 65, need assistance in the retirement income planning process.
In addition to being of assistance in servicing existing clients, many firms use this information to
position special offers or advertising to different groups with whom they want to make a connection in
Advisory Division
(
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order to broaden their client bases and draw in new business from outside of their conventional markets.
Examples of firms with recent forays into multicultural markets are ING, Bank of America, and Allstate.
ING hired personnel in an attempt to better service certain minority groups from whom they have not tra-
ditionally attracted a lot of business. Through this group, ING hopes that the right type of advisor with
the appropriate service offering will be able to take advantage of the untapped opportunities presented by
certain minority groups. Bank of America is investing millions in multicultural media and considers the
cultivation of multicultural markets a key component of its growth strategy. At Allstate, the allocation for
multicultural marketing has doubled from 4% in 2000 to 8% in 2005. Allstate also entered into internet
advertising this year (lifting its share to 5% from nearly nothing) and plans to spend only 40% of its budg-
et on mass-market TV commercials (down from 70% in 2000). In the next few years, firms that build
successful programs based upon demographic differences and differentiate themselves will have an
advantage in capturing and retaining the increasing assets of these communities.
Behavioral Variables
Behavioral variables categorize investors actions or reactions under or caused by certain circum-stances. However, it does not take a Ph.D. in psychology to know that it is very difficult to predict indi-
vidual human behavioreven under exact circumstances, investors reactions can be very diverse. Yet,
there are identifiable patternsthough it is difficult to know which investor will exhibit which ones.
Additionally, though these variables are helpful in giving firms and advisors some insight as to how a
specific investor may react to a particular offering or their willingness to purchase a particular product or
service, their implications are only known when viewed in a historical, scientific context. In order to
make sense of a certain behavioral variable, firms and advisors must have some type of background infor-
mation from which to draw in order to correlate predictive behavioral hypothesis with business initiatives
and profitability.
Some variables that fall into this category are whether an investor is strategic, opportunistic, or
event-driven, among others. Bank of America is a firm that uses behavioral variablesoutside of invest-
ment style detailed belowto segment their customers. The firm is placing smarter ATM machines in
certain geographic regions. These ATMs will be keeping track of certain behaviors that a user demon-
strates and using that information for future use and product or service promotions. For instance, the
machine will be able to remember that a user has never selected Spanish as the language in which their
transaction should be conducted; that they always attempt to withdraw an amount that is not one of the
preset amounts and will make that unique amount one of that users preset amounts (as opposed to hav-ing to select Other Amount and keying in the exact amount); or, because they have a mortgage with
Bank of America, the user will receive information telling them it appears to be time for them to refi-
nance.
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One of the most well-known behavioral variables is an investors investment style: aggressive,
moderate, conservative, or risk-averse. These variables describe an investors investment outlook and rel-
ative tolerance to investment risk and are typically learned through an advisor- or self-administered
investment-style test, which is a basic questionnaire for evaluating investors views regarding investing
and planning.
Once armed with this information, firms and advisors use them in a variety of ways. First, firms
and advisors use this information to recommend a generic group or type of investments to investors
fixed income for a conservative investor and individual equities for more aggressive investors, for exam-
ple. Additionally, firms use this information to construct packaged products, ideally with embedded
advice, that can make the sales process easier for advisors or a direct sale. An example of this is the con-
struction of lifecycle funds. Funds in this category can either be lifestyle or target date funds. Target date
funds constructions are more affected by a demographic variable: an investors age relative to their pre-
determined retirement date. However, lifestyle funds are created for any investor simply based upon their
predetermined risk tolerancea behavioral variable.
Psychographic Variables
Psychographic variables classify investors based upon their psychological profiles. Though
everyone is unique, there are four segments into which experts attempts to bucket individual investors
based upon their measure of participation and mindset regarding finances and their ability and desire to
manage them. The four segments are each a bit different: self-directed (independent investors); valida-
tors (investors who only desire limited guidance or advice); delegators (investors who want ongoing
advice or discretionary management services); or apathetic (investors who do not know what they want
or do not take steps toward attaining what they want). Each of these segments helps better define
investors based upon their specific approach to investing.
Psychographic variables do give some insight into the choices that investors may make regarding
the actual product or advice offering. However, more often, this variable provides information regarding
the best way to service a particular clientwhether they are more hands-on or hands-off. Charles Schwab
is an example of a firm that uses this variable in developing packaged advice programs and better prod-
ucts. This firm also uses psychographic variables to determine the best method and frequency of deliv-
ery of information regarding these products and services.
Factor Usage
Determining the best variables to measure the different factors is just the beginning of the cre-
ation of an investor segmentation methodology. In general, best-practice firms do not rely solely on one
or two factors in their segmentation modelsthey employ a totality of factors in their segmentation
process. However, there are many firms and advisors who simply rely on investors investable assets
when determining if they represent a future client. When advisors almost sole function was to facilitate
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product transactions for clients, this may have been sufficientinvestors investable assets were all that
really mattered in measuring profitability and success in that market. Though this may have been suffi-
cient in the past, in the current times with buzzwords such as advice, financial planning, and fee-based
pricing on almost everyones mind, there needs to be more investigation into other investor factors. Thus,
we contend that this should be just the first step in the process.
In constructing this process, which will contain a variety of factors, firms and advisors can use
either a multileveled or multifactor process. A multileveled analysis would comprise multiple screens
through which an investor would pass in a step-by-step processin order to be considered in the third
screen, the investor must pass both the first and second. A multifactor process would have all factors con-
sidered in making a decision about an investor. Thus, all factors would be considered at once, potential-
ly in different weightings of importance. Though there are valid reasons for using either technique, we
have found that a multifactor analysis tends to be the better method, and is therefore the method we
employed in creating the seven investor segments detailed below. Some factors, almost completely on
their own, dictate that an investor falls into a certain segment while other segments fall out of a combi-
nation of factors. By using a multifactor analysis, this can be taken into consideration more easily.
Methodology Outcome
Once a segmentation methodology is created and applied to existing and potential clients, sever-
al key takeaways will ideally fall out of it. Some of the information that should be learned is related to
the most appropriate services, products, and delivery mechanisms for a particular investor segment.
However, this is just the beginning of the information-gathering process for a particular investor. Firms
and advisors should use the basic information garnered from an investor falling into a particular segment
as an in to the beginning of the relationship with the client. By having some quality knowledge about
how to or what to approach an individual with, the firm or advisor has demonstrated they have done some
level of homework about the individual and should use this information as a springboard into perpetuat-
ing a stronger relationship with the client. Thus, segmentation should be viewed as a way of making the
relationship with a client better or easiernot the end-all in terms of servicing. Throughout the remain-
der of this chapter, we detail the seven investor segments that we believe comprise the emerging affluent
marketplace. Though there are more possibilities, these are the outcomes of the employment of our seg-
mentation methodology.
Cerulli Emerging AffluentInvestor Segmentation
We segment investors into three basic categories: lower net worth, emerging affluent, and higher
net worth. We segment the emerging affluent market into seven subsegments. In this section of the report,
we highlight differences between the wealth tiers, and also between the seven segments within the emerg-
ing affluent market itself.
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Comparisons to Other Wealth Tiers
The services investors need in the emerging affluent marketplace are rarely different in kind from
those needed in the higher and lower wealth tiers, but there is a significant difference of degree and fre-
quency of delivery. Emerging affluent investors have considerable need for estate planning advice and
wealth transfer products, services rarely considered for the vast majority of mass-market investors. High-
net-worth investors, however, find estate planning and wealth transfer advice to be a primary service,
sometimes even requiring advice for passing on their wealth to subsequent generations beyond just their
children and grandchildren. Conversely, one of the biggest concerns for mass-market investors is the
need for retirement savings advice, another service important to emerging affluent investors. And while
the middle and bottom wealth tiers view retirement savings as a primary concern, it is far less important
to high-net-worth investors, who are often able to retire at any time and fund a high quality of life.
It is often difficult for advisors to serve the emerging affluent marketplace because they require
different advice and services than their high-net-worth and low-net-worth counterparts. Serving these
investors is not as easy as splitting the difference, and offering a wide selection of services that the
diverse group of emerging affluent investors may need. Emerging affluent investors need to be brokeninto smaller segments, made up of advisors with various similarities who often desire similar types of
advice. We explore a method for segmenting the emerging affluent market into more easily targeted
groups in the following section.
Emerging Affluent Segments
Firms and advisors will undoubtedly have their own methods of segmentation and their segments
will often differ from ours, or they will have additional subsections. However, Cerulli Associates is con-
fident that our wealth tiers can serve as a template, or guidelines, for firms and advisors targeting the
emerging affluent market. Some investors may fall into more than one of the following segments, but
Cerulli Associates believes that the needs and goals of investors in each segment are similar, regardless
of whether they fall into more than one segment. Our seven segments are: business owners, established
retirees, real estate wealthy, spenders, up-and-coming professionals, inheritors, and the suddenly
affluent.
Business Owners
As can be expected, a major portion of the emerging affluent market is business owners: those
investors with a significant portion of their assets tied to business interests. Some of these may be typi-
cal entrepreneurs who started and run their own small company; others may act more like venture capi-
talists, investing a large portion of their assets in a business they do not operate themselves; others may
have inherited a family business, while some worked their way up in a firm to become part or sole owner.
Using data gathered by the Federal Reserve in its Survey of Consumer Finances, Cerulli
Associates estimates that 30.8% of emerging affluent households, when viewed by investable asset tier,
are business owners, and 48.7% of households by net worth tier are business owners. The large differ-
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ence between segmenting by the two methods exposes the large number of potential clients that an advi-
sor may overlook if solely focused on a potential clients investable assets, as business interest is a non-
investable asset and only captured in that net worth total. The importance of analyzing an investors net
worth in addition to their investable assets when deciding to take them on as a client cannot be
understated.
EXHIBIT 20BREAKDOWN OF BUSINESS OWNERS BY INVESTABLE ASSET TIER
Sources: Federal Reserve, Cerulli Associates
Some business owners may have almost all of their assets in a business interest (i.e., the mom and
pop pizza parlor), while others may have a much smaller stake (i.e., a partner at a law firm). While the
percentage of their assets may vary greatly, the services they need are often similar, varying in degree
rather than kind.
Whether self-made or a business owner through inheritance, of primary importance to business
owners is a financial advisor who can offer them business planning and transition services. The need for
business planning advice goes without saying and is the most critical service that a business owner will
seek out. Transitioning the business into other hands creates the need for services such as wealth trans-
fer and estate planning advice, and may call for the creation of a family limited partnership or a stock
optimization strategy to protect assets and avoid the myriad tax concerns. Various types of business insur-
ance may also be required.
Business owners do not have the luxury of having their employer contribute to a 401(k) plan, so
they need financial advice on individual retirement. A popular product is a solo 401(k), which is ideal for
sole proprietorships with only owner and spouse employees, but others may opt for the tax advantages
of other retirement plans.
Business owners may also need help establishing an employer-sponsored retirement plan. Some
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
Net worth tierInvestable asset tier
Tier VITier VTier IVTier IIITier IITier I
62.0%
86.4%
45.4%
69.4%
59.5%
71.5%
26.9%
47.5%
18.0%22.2%
8.2%5.3%
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of the more common vehicles for employer retirement, especially for small businesses, include SEP IRA,
SIMPLE IRA, various defined benefit plans, and numerous 401(k) plans (normal, Safe Harbor, and SIM-
PLE). Some of these plans are more appropriate than others. Depending on how the company is legally
structured (sole proprietorship, LLC, corporation, or partnership) and the size of the company, a business
owner will have varying needs for their companys retirement plans. The employer-sponsored retirement
planning can take the form of total benefits outsourcing, which includes insurance products, health and
welfare, and other benefits offered to employees in addition to retirement plans.
Investment planning is important for almost every investor, but is critical for business owners
after the sale or transition of their business. The large amount of assets they will have after the sale of the
business is often more than they know what to do withsound investment advice is a must for these
investors. Linked with the sale of the business comes a variety of tax issues; good tax planning is an
absolute necessity. Without the proper tax advice after the sale of the business, an investor stands to
squander much of what they worked so hard to create.
The above is not an exhaustive list of what services a business owner needs; they need much of
the more generic product offerings and advice that every investor, regardless of occupation or financialstatus, also needs. The same can be said for all of the following market segments. The services mentioned
are just the ones that these investors will be seeking because of their background, and is not a full list of
the services that these investors require.
Established Retirees
Regardless of how they overlap with other segments, whether they are business owners or have
significant real estate wealth, established retirees are those investors who have entered retirement some
time ago and now have specific needs. We consider established retirees to be any investor 68 years of age
or older. Few investors in the emerging affluent marketplace remain in the workforce after this age, with
many having retired years earlier.
As with all wealth tiers, the wealthiest investors also tend to be the oldest: 26.8% of emerging
affluent households by investable asset tier, and 25.9% by net worth tier.
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EXHIBIT 21BREAKDOWN OF HOUSEHOLDS OVER AGE 68
Sources: Federal Reserve, Cerulli Associates
Established retirees do not need any retirement savings planning, but may have some concerns
for retirement income planning depending on how far they are into retirement. Insurance is needed as
these investors age as a safeguard for their spouses and estates. Elder-care planning and cash flow man-
agement are a concern for many established retirees to provide assistance later in life and to avoid run-
ning down their savings too quickly.
Unlike similarly aged investors in the middle market and mass-market wealth tiers, these
investors need help with wealth transfer. They have enough assets that they will not use them all upbefore they die; many wish to pass on some of their wealth to their heirs.
Related to the need for wealth transfer planning, established retirees also look for advice on edu-
cation planning. Often this education planning is not for themselves or their children, but for grandchil-
dren and, in some instances, subsequent generations. Many may create or contribute to their grandchil-
drens 529 planpossibly using the Five-Time Rule (see Glossary).
Additionally, trust services may be needed because many of these investors want to take care of
their children and grandchildren while avoiding some of the negative tax implications of other forms of
inheritance.
Real Estate Wealthy
Some investors in the emerging affluent market would only be included if looking at their net
worth, as their investable assets are often not great enough to put them in that wealth segment. These are
the investors that have most of their assets in real estate, which is somewhat surprising given their income
and the rest of their financial status.
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
Net worth tierInvestable asset tier
Tier VITier VTier IVTier IIITier IITier I
49.0%47.2%
35.8%
18.9%
22.6%
28.0% 27.4%25.7%
21.5%
26.1%
15.7%14.5%
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If these investors decide to liquidate some of their real estate assets, they will remain in the emerg-
ing affluent marketplace, and often then have enough investable assets to put them in the emerging afflu-
ent marketplace when measured by investable asset tier.
The real estate wealthy are often overlooked by financial advisors who only see their compara-
tively low investable assets, without thinking about the investors future after the sale of their real estate.
Overall, 6.82% of emerging affluent households by investable asset tier are real estate wealthy, and
15.6% of emerging affluent households by net worth tier are real estate wealthy.
EXHIBIT 22BREAKDOWN OF REAL ESTATE WEALTHY HOUSEHOLDS
Sources: Federal Reserve, Cerulli Associates
Many of the services these investors need after the sale of the real estate closely mirror those
required by a business owner after the sale of the business, including investment planning, budgeting,
income planning, trust planning, and estate planning.
Because these investors often lack the high salary or significant amount of investable assets that
many investors of the emerging affluent have, retirement planning and insurance needs are relatively
more of a concern.
Spenders
The group most in need of discipline is those who act like most Americans, living beyond their
means. They borrow and borrow until they are heavily in debt and in a potentially risky financial situa-
tion. However, these are not the investors in dire straits, with one foot in bankruptcythose investors are
in need of a good lawyer rather than a good financial advisor. We define these investors as those house-
holds with a debt-to-income ratio of greater than 50%. This is considerably higher than the recommend-
ed debt load and is enough to put these investors on the path to a less-than-exciting financial future.
With a national savings rate close to zero, it is no surprise that many Americans would be consid-
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
Net worth tierInvestable asset tier
Tier VITier VTier IVTier IIITier IITier I
1.1%
4.9%
0.4%3.3%
2.0%
10.0%7.5%
15.9%
32.1%
40.8%
50.9%
47.6%
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ered overleveraged. This is not just a problem of those Americans with low incomes and a high cost of
living, but it is a way of life for many investors at all levels of wealth. In the emerging affluent market-
place, 40.9% of investors are overleveraged according to investable asset tier, and 41.0% by net worth
tier.
EXHIBIT 23DEBT-TO-INCOME RATIO OF GREATER THAN 50%
Sources: Federal Reserve, Cerulli Associates
They need debt help. If their debt was under control, their amount of assets would put them in a
position to potentially jump into an even higher wealth tier. Unfortunately, some of these investors would
be passed over by advisors who are looking at investors by investable assets. If they delved deeper and
looked at the investors net worth, they would realize that they might actually make great clients.
Their greatest need is debt consolidation. Without reducing their level of debt, their financial
future is uncertain. Hand in hand with debt consolidation is budgeting and cash flow planning. Although
they are often one of the hardest types of financial plans to implement, they are also one of the most
important pieces of advice for these investors. In addition to getting their spending under control, they
need advice on saving, especially plans that include automatic savings, to counteract any increase in debt.
These investors tend to be reactive: they look for financial help only because they really need it,
rather than anticipating that it would help and being proactive about their financial future. If these
investors can be found before they are in a somewhat dire situation, the upside for a financial advisor canbe incredible.
Up-and-Coming Professionals
The group of investors in one of the rosier financial situations is the up-and-coming profession-
als. These are the investors under the age of 40 who earn more than $100,000 per year. Given their age
and income level, these investors are somewhat more likely to move up wealth tiers than some of the
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
Net worth tierInvestable asset tier
Tier VITier VTier IVTier IIITier IITier I
23.3%
26.7%
11.3%
19.5%
35.8%
32.2%
41.6% 41.4%
51.6%49.3%
44.4%44.8%
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other emerging affluent investors. Up-and-coming professionals make up a small, but potentially advan-
tageous group of the emerging affluent marketplace, 6.00% of emerging affluent households by
investable asset tier are up-and-coming professionals, and 6.71% of households by net worth tier also fall
into this category.
EXHIBIT 24BELOW AGE 40, INCOME GREATER THAN $100,000
Sources: Federal Reserve, Cerulli Associates
Retirement savings and investment planning are the two most important services for these
investors. They want to have their retirement squared away, and early, but also look to grow their wealth
for any future plans, such as buying a house or providing for their children.
Along with the desire to take care of their family is the need for education planning. Advice on
a 529 plan will allow them to finance their childrens education and not have them going into debt later
in life. Their children are not the only ones in need of education planning, however, as some of these
investors are very young and may still go to school to earn a graduate degree or enroll in a professional
program. The majority of these investors have already completed their formal education, which makes
debt consolidation a widely shared need among this group of investors. Many of them have significant
debt from education, whether it was undergraduate, graduate, or professional school, and these investors
can carry upwards of $200,000 worth of debt. Charitable giving, especially for its tax advantages is
another desired service.
A common characteristic of these investors is their proactive nature: they are seeking help
because they want to be in a better financial situation, not because they are in desperate financial shape.
This attitude contrasts with the overleveraged investors who often seek out financial advice after realiz-
ing (somewhat late) that they are in poor financial condition and need some advice to keep from falling
further.
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Net worth tierInvestable asset tier
Tier VITier VTier IVTier IIITier IITier I
4.2%
5.7%
1.1%
3.0%
4.6%
4.0%
6.2%
6.9%
6.2%
5.6%
2.4% 2.4%
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Inheritors
Unfortunately, gauging the number of inheritors in the emerging affluent marketplace is incredi-
bly difficult. For the purposes of our research, it is impossible to tell how many investors received their
wealth through inheritance.
While there are many inheritors in this marketplace, they are one of the more diverse groups of
investors. They represent all age groups, and their wealth may be divided into a broad number of sources.
Some of these investors may have been in a favorable financial situation, as an inheritance was some-
thing for which they had been planning. However, there are those who enter this marketplace more swift-
ly, by receiving an unexpected inheritance, or one larger than expected.
Estate planning, trust, private banking, and business or real estate advice are all necessary, and are
often the vehicles by which the inheritor received their wealth. Depending on the age of the inheritor, the
services they require vary greatly. An 18-year-old in this group will need education planning more than
a Baby Boomer who may be looking for retirement planning advice and may possibly be in need of retire-
ment income assistance.
Suddenly Affluent
The suddenly affluent segment encompasses that group of people who were suddenly thrown into
the affluent marketplace. They include lottery winners, athletes entering professional sports, instant
entertainment stars, inventors, IPO millionaires, those who received a completely unexpected inheri-
tance, people receiving settlements in lawsuits and, on the flip side, those who lost a large portion of their
wealth and now find themselves in a lower wealth tier.
Sudden InflowAlong with the dramatic change in their wealth comes a lot of baggage. These investors are rarely
ready for the new wealth they have, and sometimes the result is disastrous. All too often we hear stories
about lottery winners spending all of their money, ruining their lives, losing their families, and sometimes
losing their lives. Without a hand to hold, many of these investors are consumed by their new psycholog-
ical state, and their wealth can disappear.
These investors also need an advisor with experience in charitable giving. An important aspect of
newfound wealth is a sense (whether real or imagined) by the investor that their wealth was not earned,
and they are under more pressure to give some of that money away. Cash flow planning is needed because
much of the newfound wealth comes all at once and without proper cash flow planning and budgeting,
an investor could go through their wealth in a short period.
These investors need advice in trust planning, and some suddenly affluent investors may even
need a specialized product like a special needs trust for their disabled children. These special needs trusts
allow a disabled child to receive money without ending their public medical care. If the child received
the value of the special needs trust immediately, they would lose out on their ability to receive public
funding for their medical care: a special needs trust allows them to maintain this funding while also
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keeping money safe for them in later life.
Insurance and elder care planning also remain a concern, as many of these investors, especially
those who earned money through a lawsuit or through the lottery, tend to be older and have not adequate-
ly prepared for later life.
Case Study: Starcare
Lawsuits with rewards between $2 million and $5 million have become increasingly common in
the last several years. The increase in settlements from these lawsuits has led to one category of sudden-
ly affluent investors, who overnight become part of the emerging affluent segment. However, only a few
advisors actually specialize in providing planning services to this niche market.
One such firm, Starcare, created by Richard Hearn, a full-service, independent financial planning
firm affiliated with LPL Financial, specializes in providing sudden wealth advisory services. He
believes that serving this client base can be challenging, as advisors are not only providing investment
advice and cash flow management services, they are, in many cases, acting as personal counselors to their
clients.Hearn recommends that advisors genuinely interested in serving the sudden wealth segment must
first acquire a strong understanding of the unique issues and challenges typically faced by individuals
who become suddenly wealthy through settlements. Sudden wealth advisors must garner a thorough
knowledge of the overall legal process, expertise in relevant legal issues, and a strong understanding of
the investment vehicles designed to protect settlements, such as special needs trusts. Understanding set-
tlement proceduressuch as those that dictate whether or not individuals can receive certain settlements
and remain on certain government-funded programsare required to effectively manage assets for sud-
den wealth clients. Moreover, comprehending the inner workings of the court system to protect the client,
their families, and their settlement are essential to perform the job effectively.
Next, it would be well advised for sudden wealth advisors to create partnerships with personal
injury attorneys, trust accountants, NAELAa nonprofit association that assists lawyers, bar organiza-
tions, and others who work with older clients and their familiesand counselors as a means of generat-
ing new client referrals. The most important of these is likely the personal injury attorney. Finally, advi-
sors must make sure to design cash flow budgets geared toward protecting assets from uncertain medical
costs, from individuals who do not have the clients best interests in mind, and on occasion from the client
themselves.
Ultimately, advisors who are successful in this market are those who provide emotional supportand counseling during their clients most stressful timesby sitting with their client in court or visiting
them in the hospital. They are the ones who develop a great deal of mutual trust and respect with their
clients, so that being their financial advisor is a natural extension of their relationship.
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Sudden Outflow
Not all investors in the sudden affluent segment received an inflow of wealth, however. Many
actually lose money and end up in a lower wealth tier. These investors include the former IPO million-
aires who lost a significant portion of their wealth after the downturn in the tech market. They are sud-
denly in the emerging affluent market having recently been in a higher wealth tier. An advisor specializ-
ing in high-net-worth clients may be unwilling to retain a client in a significantly lower wealth tier who
may need vastly different financial advice than the rest of the advisors clients. These investors, like those
with a sudden inflow of wealth, may need some psychological help in addition to a financial plan as they
deal with the loss of so many of their assets.
Not all firms have clients who fall into each of these segments, not all investors fall exclusively
within one of our aforementioned categories, and not all have the same needs. However, in order to wrap
up this section, we present a matrix that delineates the service needs of each of the preceding segments.
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Though this matrix just gives some ideas of investor needs, when used in conjunction with the
Cerulli Emerging Affluent Advisor Matrix in the following chapter, a firm attempting to match investor
and advisor segments will find some guidance.
Influencing Factors
Though we have segmented emerging affluent investors into seven distinct categories, each
investor is unique. Additionally, though some of the needs of the emerging affluent segment are distinct,
they share some characteristics and issues with other wealth tiers. Consequently, there are some factors
that will have some influence on all investors in the different wealth tiers. However, there are four that
we believe will have a greater amount of influence upon emerging affluent investorsin terms of influ-
ence relative to that exerted on other wealth tiers and relative to other factors exerting influence on the
emerging affluent segment. These factors have the potential to increase or decrease the opportunities pre-
sented by the emerging affluent wealth tier in general and potentially by some investor segments in par-
ticular. The four influencing factors to which we pay special attention are: the potential privatization of
Social Security; the possible downturn of the real estate market; the proposed permanent repeal of capi-
tal gains taxes; and shifting focus from estate to income and gift taxes. Throughout the remainder of this
section, we go into detail about these factors and their influence on opportunities.
Privatization of Social Security
Privatizing Social Security is being floated around Capitol Hill as one of a combination of meas-
ures to shore up the Social Security trust fund. By allowing Americans to divert a portion of their Social
Security taxes into private accounts that invest in bonds and equities, proponents hope that Americans
will be able to supplement their retirement income at a level that is equal to or larger than what the gov-
ernment could provide. If privatizing Social Security is approved by Congress, it will impact every work-
ing American. For the emerging affluent, it introduces a degree of uncertainty into their overall portfolio
construction, which will facilitate discussions with their financial advisor.
The Privatization Proposal
There are a number of variations on the structure of privatized Social Security accounts. The most
popular proposals only offer privatized accounts to individuals younger than 55. The reasons behind this
are as political as they are economic. Workers within 10 to 15 years of retirement are counting on SocialSecurity as their main source of income during retirement. In 2004, Social Security provided at least half
the income for 75% of retirees. Such a high dependency on Social Security means that politicians are
unwilling to create an abrupt change to current and near retirees primary source of income.
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EXHIBIT 26SOURCES OF INCOME FOR THE POPULATION AGE 65 AND OVER BY INCOMEQUARTILE, 2004
Sources: CRS Analysis of March 2005 Current Population Survey, Cerulli Associates
Offering near retirees a private account also puts additional strain on the Social Security Trust
Funds. Instead of paying into private accounts, near retirees would receive a lump sum equal to the pres-
ent value of a future stream of income. The government would need to carve these lump-sum payments
out of the current trust funds, thus depleting the funds at a faster rate than if they had been paid over time.
Most proposals call for the structure of privatized accounts to mirror the Federal Thrift Savings
Plan (TSP)the DC plan for Federal and Military employees. The TSP is comprised solely of five index
funds and five lifecycle funds that utilize the index funds on its platform. It also offers five basic types
of income annuities to participants. Thus, privatized accounts will likely feature a limited number of
index funds with the option to annuitize the accounts for life at retirement.
Only 4% to 6% of an employees pay, or a little less than half of a workers Social Security taxes,
would be diverted into a privatized Social Security account. The vote is still out as to whether it would
be optional or mandatory to divert the funds into privatized accounts. Thus, workers would still have a
portion of their pay directed into the general trust fund and will still receive a small stream of govern-
ment-provided guaranteed income during retirement. The goal is that American workers will accumulate
enough in their privatized accounts to offset any decreases in Social Security benefits.
General Impact
Privatizing Social Security will benefit the emerging affluent more than the average American on
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0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
Other
Public assistance
Earnings
Pensions
Asset income
Social Security
Fourth (lowest) quartileThird quartileSecond quartileFirst (highest) quartile
21%
58%
82%86%
17%
9%
6%5%
25%
21%
7%2%
35%
9%
3%1%0.1% 0.3%
2%5%
2% 2% 1% 0%
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a dollar basis. Collectively, emerging affluent investors seek professional advice more often than low- to
middle-income Americans. Thus, when questions arise on how privatized accounts fit into the overarch-
ing asset allocation strategy, they will seek professional advice. Conversely, the average American han-
dles accumulation on their own. They are more likely to invest in one asset class, chase performance, or
stick with conservative investments. Emerging affluent investors will have diversified private accounts
that are better equipped to handle market volatility.
On a percentage basis, privatization will hardly make a dent in emerging affluent investors
retirement income. Contributions to Social Security are currently capped at $94,200 in 2006 and annual-
ly indexed to inflation. Workers only pay into Social Security up to $94,200; anything above $94,200 is
not hit with Social Security tax. On the other hand, this entails that the maximum Social Security bene-
fit anyone can receive is based on the cap. Most emerging affluent investors, who typically have higher
wages, will receive a smaller portion of their retirement income from Social Security. Studies estimate
that retirees in the top decile of retirement income attribute less than 10% of their income to Social
Security. Factor in that workers will divert less than half of their Social Security taxes to private accounts,
and the emerging affluent segment ends up with an even lower percentage of their retirement incomeattributable to private accountseven after higher asset accumulation potential is accounted for.
Specific Impact
Each emerging affluent segment has its own unique attributes that dictate how privatization
affects them. The only groups that wont be affected by privatization are current and near retirees because
they will continue to receive promised Social Security benefits under the present systems design.
EXHIBIT 27PROS AND CONS OF PRIVATIZING SOCIAL SECURITY
Source: Cerulli Associates
The business owners will be more impacted by how privatization affects their businesses than
how it affects their personal retirement goals. Privatization will increase their administrative cost and bur-
den, as they will likely assume some of the responsibility of data collection and account administration.
How privatization affects business owners future retirement income, and thus their current savings, will
be based on a variety of factors. If the business owner plans on using the sale of his business as the pri-
mary source of his retirement income, then Social Security may only supplement their retirement income,
and they are unaffected by privatization. The same would be true for business owners who continue to
receive income from their business during retirement. However, if the business did not generate sufficient
Issue Pros Cons
Individual Control
Clients will be able to accumulate a
larger nest egg at retirement and
learn the basics of investing.
The majority of Americans don't
understand the fundamentals of
investing.
Recordkeeping and
Administration
The success of the Thrift Savings
Plan for federal employees shows
that the government can implement
a streamlined tracking system.
Tracking and administering
millions of small accounts is an
arduous undertaking and
increases administrative burden
on the employer.
Social Security
Future Benefits
Higher returns from investing in the
market leads to higher retirement
benefits.
Reduces guaranteed income
source.
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income either before or during retirement and there were limited outside savings, then the emerging afflu-
ent business owner could be hurt by the loss of a guaranteed source of income.
Privatization could affect the real estate wealthy segment of emerging affluent investors to vary-
ing degrees. For those who have their money tied up in a large residential estate, privatization means a
loss of steady, supplemental income. For those who use real estate as an investment or rental income, pri-
vatization creates the potential to accumulate a larger market portfolio.
Privatization could negatively affect the overspenders. This group needs structure and limits on
how much they can spend. They are not equipped to control their spending, and they run the risk of quick-
ly depleting their Social Security assets at the onset of retirement. During the accumulation phase, the
privatized account may cannibalize other retirement savings. Overspenders may view privatized accounts
as another another savings vehicle dedicated to retirement, and thus save less in traditional retirement
accounts. This segment of emerging affluent investors needs advisors who can control their spending
either through product selection or portfolio construction.
The up-and-coming professionals will benefit most from privatization. With the help of their advi-
sors, they will allocate the private account investment options to maximize their overall portfolio strate-gy. They also have time on their side, which allows them to accumulate a large nest egg.
The inheritors fall into two camps that would be affected differently by privatization. For those
who hope to create a legacy for future generations, privatization is a way to supplement their assets and
leave a larger legacy. However, if an inheritor is an overspender who plans to spendor inadvertently
squandersall of their inheritance, losing a source of secured income is a detriment for them. Advisors
to this group of inheritors would need to find alternative products that provide a steady, predictable, and
untouchable stream of income
Privatization could affect the suddenly wealthy in any number of ways. Age, assets previously
amassed, prior level of income, and future spending needs will all dictate how privatization would affect
this cohort. For this group, the role of an advisor is especially important, and the effect that privatization
has on them will be determined by the financial advisor.
Privatization will affect each group of emerging affluent in different ways. Although private
accounts represent only a small percentage of their retirement income, it creates a degree of future
income uncertainty and raises questions on its impact on the overall portfolio strategy. Thus, privatiza-
tion opens the door to discussion with financial advisors to ensure that retirement savings and spending
goals will be met, whether or not Social Security is privatized.
Real Estate Bust
The real estate boom is a hot topic for the media and for many individuals looking to buy their
first home. For the past several years, home prices have continued to rise overall and soar in urban areas
such as New York, Boston, and San Francisco. Some individuals bought their homes cheaply, and have
stayed there because it is their home and they have no desire to sellthey are comfortable there or may
want to keep the house in the family. Other individuals viewed this real estate boom as an opportunity to
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make quick profits by flipping property.
However, the boom appears to be slowing downthe market in many metropolitan areas is show-
ing signs of softening. One cause: between five and seven years ago, there were many individuals who
bought propertythey could get a mortgage cheap because of the low interest rates, and they believed
that real estate was going to continue to appreciate and they could sell it at a higher price in a couple of
years. Many of these individuals took out large mortgages on their homes, many a five- or seven-year
adjustable rate mortgage (ARM) that may have been interest-only. Some of these individuals may have
gone even further and proceeded to take out home-equity loans on this propertywith some additional
renovations like hardwood floors, stainless steel appliances, and a granite countertop so that they could
sell the property for an even higher price. Now, these individuals have to pay more than just interest-only,
and they are struggling. Refinancing is not an option as rates have risennot dramatically, but enough
to exclude refinancing as an avenue to pursue.
Thus, between the individuals or developers who bought property to flip and are now selling and
those individuals who must sell because they cannot pay their mortgage, the market is beginning to be
flooded with property. Basic economics tell us when supply exceeds demand, prices must fall.For many individuals in the lower wealth tiers, their homes account for the majority of their
assets. Though the situation in the emerging affluent segment is not as extreme, on average 27.8% of
emerging affluent investors assets are accounted for by their homes. There are some individuals, partic-
ularly those who fall in the Real Estate Wealthy segment, whose homes account for a much greater per-
centage of their total assets. As home values drop, some of these individuals who are included in the
emerging affluent market simply because of their valuable homes may no longer fall into this category,
which will reduce the potential opportunity for advisors and firms. For some, the short-term sale of their
home may allow them to remain in the emerging affluent. However, for some who are going to wait it
out, there is a good chance that some of them will fall into a lower wealth tier.
Repeal of Capital Gains Taxes
Legislation passed in 2003the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA)
lowered capital gains tax rates, in addition to affecting the taxation of both dividends and estates. Prior
to JGTRRA, capital gains were subject to tax rates ranging from 8% to 20%, depending upon the type
and term of the capital gain. Under JGTRRA, the tax rates of capital gains for 2003 through 2007 would
drop to a range of between 5% and 15%, and, for 2008, to a range of 0% to 15%. Under several provi-
sions of President Bushs proposed 2006 budget, the capital gains being taxed at a range of 0% to 15%would not expire at year-end 2008, but instead would be extended indefinitely.
For emerging affluent investors who have an average of $954,468 tied up in brokerage accounts
and $907,955 in real estate, the reductionand occasional nullificationof capital gains tax rates could
have a rather large impact on their ability and willingness to increase their invested assets. Because of
the currently temporary nature of these tax rate reductions, many individual investors and businesses
have been hesitant to make decisions that are more long-term in nature. However, a permanent imple-
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mentation of these capital gains rate reductions will spur more immediate investment as well as future
ongoing investment in capital goods.
If these rate changes become permanent, we believe the opportunities presented by the emerging
affluent market for advisors and firms will increase in two manners. First, investors will need some assis-
tance sorting out the implications of the change in tax policy. Second, these investors will also have more
disposable assets, because those assets are not being paid in taxes, which could lead to more investment
opportunitiesthat can be implemented via a firm or facilitated by an advisor.
Estate, Gift, and Income Taxes
Much has been made in recent years regarding the federal estate tax, as exemption amounts con-
tinue to rise and tax rates continue to decline through 2010 when there is a permanent repeal of the estate
tax. For investors falling into the emerging affluent wealth tier, who have net worth totaling between $1
million and $25 million, the estate tax is potentially an issue with which they and their advisors need to
be concerned. However, as of 2003 when the exempt amount was $1 million, only 1% of all decedent
estates required the payment of any amount of federal estate tax. Granted, assets currently held by estatesshould appreciate in future years before they are transferred, but the appreciation will not necessarily
exceed the increase in the federal estate tax exemption amount, which increases to $3.5 million in 2009
just before its impending repeal in 2010. Thus, the number of decedent estates and amount of assets sub-
ject to the tax, which is assessed at a lower rate in totality, will lead to less of a concern about the feder-
al estate tax being levied on the emerging affluent investors estates.
Of course, when we need to worry less about one form of taxation, there must be other forms that
are there to fill the void and to which our attention must be turned. These other forms are state-level estate
taxes and federal- and state-level income taxes. In a nutshell, though attention still needs to be paid to the
federal-level estate tax for some emerging affluent clients estates, most often the concern now needs to
be focused on the state-level estate tax and income taxesa new perspective needs to be taken on an old
problem.
In the past, most statesestate tax rates were significantly lower than federal rates, and most states
took advantage of the state death tax credit. Under this regime, the state would take the maximum amount
that would be deducted directly from the federal tax total so that decedents estates did not have to pay
anything above and beyond the amount paid to the federal governmentthe amount paid was simply
divided between the state and federal governments without hassling the decedents estate. However, the
state death tax credit has been reduced in the past several years and was completely repealed in 2005.Consequently, states are not getting paid anything directly from the federal government, and many are
looking to fill this revenue gap by imposing state-level estate taxes at higher rates than they currently are
imposingif they are imposing any at all. One way around the imposition of the state-level estate tax
could be to gift assets, as very few states have a gift tax. However, most states that are looking to impose
a state-level estate tax will most likely see the lack of gift tax as a loophole and close that by imposing
both an estate and gift tax. An additional consideration if these state-level taxes are imposed: if part of a
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decedent estates assets are in another state in which the decedent does not reside, the tax regime of that
other state will come into play as well.
On the income tax side of the equation, when estate taxes, at least at the federal level, become less
of a concern, income taxes become a greater one. Income taxes have always been around. But, when less
time needs to be taken worrying about shielding assets from the estate tax, more attention can be paid to
ensuring that the maximum amount of income taxes are avoided. Advisors can take the time to ensure
that income is allocated to beneficiaries who fall into lower income tax bracketsmost likely benefici-
aries who fall in the wealth tiers below the emerging affluent. Additionally, there is less of a concern
about asset values from an estate tax perspective and more of a concern with regard to paying income
taxesespecially capital gains taxes. In the past, a focus has been on discounting the transferred assets
value in order to reduce the value of the estate. However, now the focus in some instances is on increas-
ing the transferred assetsvalue in order to reduce the amount of taxes that must be paid upon the sale of
that asset.
Because investors who fall into the emerging affluent category are on the line of total estate assets
exceeding those exempt under the federal estate tax, some of these tricky tax maneuvers may be in order.Thus, those emerging affluent investors who know enough to be concerned about federal- and estate-
level estate, gift, and income taxes will most likely seek out the assistance of an advisor to help them nav-
igate through these issues. Therefore, the continued confusion brought about by the current and potential
future tax issues could lead to the emerging affluent presenting an increased opportunityespecially for
those advisors who have strong tax planning skills.
As mentioned previously, these four noteworthy issues that may impact the opportunity present-
ed by the emerging affluent are not unique to this investor group. However, they are relatively more influ-
ential in this group and could expand or contract the opportunity presented by this market for different
advisors and firmsdepending upon their forte. Therefore, they are issues that should be considered
when determining if and how to service the emerging affluent market. Taking the different investor seg-
ments and these issues into consideration, we now turn to our next chapter in which we discuss the dif-
ferent service models which can be employed to service the emerging affluent.
Key Implications
Employ segmentation of the client base as a top-down initiative.
Decide what factors should be considered in your methodology, then decide whether they should be
considered separately or together.
Assess macro factors that may affect segmentation, and revisit the methodology yearly.