BLACKWELL: Modern wealth management — Looking at the bigger picture
Anyone who had an investment portfolio five or six years ago understands, at least in a general sense, the nature of market risk. A position that goes up in value can also go down. The factors that create the “up” tend to be anticipated — a company increases its earnings or the economy improves, for example. The significant “downs” tend to come from left field, like the international financial crisis just a few years ago. And it is those unanticipated declines that most of us think of when we consider “risk.” This isn’t a significant consideration for the budding investor, because when you don’t have much invested, you don’t have much to lose. When an investor has achieved significant wealth, however, or as he or she approaches the time that some of those investments will need to be tapped, risk becomes a vital consideration and portfolio management strategies, like asset allocation and diversification, are encouraged to mitigate the risks.
Traditional portfolio management begins with an analysis of the customer’s required return and an evaluation of whether the corresponding portfolio is aligned appropriately to meet the stated need. That approach is good as far as it goes, but it leaves many risk considerations out of the equation. For example, much of the mass affluent population’s wealth isn’t in their traditional portfolio of stocks, bonds and mutual funds. It is in their business, their land, their concentrated stock position, or other wells of significant wealth that are outside the scope of most portfolio reviews, because these sources of value have exposures for both risk and return that are far different than those of more traditional assets.
Building on the latest research into portfolio theory, modern wealth management evaluates assets in three separate risk categories — personal, market and aspirational. Personal assets are those such as cash, CDs and home values. Most savers consider these risk-free, but when taxes and inflation are taken into account, the values of some of these assets may actually be decreasing year after year, and the riskiest investment you own may turn out to be the one that is guaranteed not to provide the return that you need to achieve your goals!
The risk of market assets — stocks, bonds, mutual funds, exchange-traded funds, etc. — are more commonly appreciated by investors. These risks are endured, because these assets provide an opportunity for savings and investments to outperform inflation, thus maintaining or incrementally improving the investor’s standard of living. Aspirational assets — business interests, concentrated stock, etc. — are those, on the other hand, that can provide extraordinary returns to dramatically advance, not just maintain, a person’s lifestyle.
The investor who is managing his investments wisely is the one who understands the risks of each and pursues balance across his entire portfolio, not just traditional assets. As diversification and asset allocation are recommended in the traditional portfolio, they should also be sought in the broader scope of a person’s holdings. The business owner, with an imbalance in the aspirational component due to her business interests, should seek to build up an adequate personal cash reserve and a traditional investment portfolio. The erstwhile investor, who was spooked out of the market five years ago and is still heavily allocated to cash, would be prudent to build up his stock and bond portfolio to, over time, protect the purchasing power of his savings.
The point isn’t to get equal amounts in each category of personal, market and aspirational assets. The objective is to start with a comprehensive risk assessment: To consider an individual investor’s various components of wealth, their unique financial goals, and their risk tolerance. Following that, a customized financial solution is constructed and maintained by a team of subject-matter experts who will prepare and react to the customer’s major life events. This dedicated team — wealth advisors, trust advisors, portfolio managers, lending advisors, insurance specialists and others — working in coordination toward a holistic, customized financial plan, mark the difference between traditional portfolio management and modern wealth management.
» Mark Blackwell is the Area Executive for Regions Private Wealth Executive for Mississippi.
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