The Means To The Ends
A client’s portfolio is the means to an end. It’s how their wealth grows over time and how they achieve their desired outcomes. Adopting a goals-based approach does not mean that wealth advisors should ignore performance, but rather change the utility function to solve for a family’s objectives. HNW families obviously want and expect access to the best investment strategies. However, if the top-performing strategies come with high volatility and high turnover, then their value may be negated on an after-tax basis.
If assembled correctly, portfolios can solve for specific goals, and if you properly understand the role of each investment, you can measure its effectiveness in the overall portfolio. As covered throughout my book Goals-Based Investing, I tend to think of asset classes as puzzle pieces. If they fit together well, they provide a clear picture of what the portfolio is designed to do. If they are put together in a haphazard fashion, the portfolio’s purpose will not be clear. (See figure 1.)
To help clients understand the role of various investments in their portfolio, I like to use puzzle pieces to illustrate the individual role of each investment, and how they need to come together. This puzzle piece analogy works well with clients because it helps demystify the individual investments and establish their role in a diversified portfolio. It is more intuitive for clients if we frame the investments in terms that they understand, such as growth, income, defense, and inflation hedging.
This framework establishes a more effective way of measuring each investment’s success and failure. Commodities like gold are not in a portfolio to outperform the S&P 500. They are a defensive asset, included in a portfolio to provide safety and stability in the face of market shocks and help hedge the impact of inflation. Fixed income, as the name suggests, is designed to generate income in portfolios, and equity-oriented strategies are focused on generating growth.
This framework also makes it easier to include complex investments like alternative investments. Alternatives are valuable and versatile tools, but they can be confusing for investors to understand. Using this framework simplifies the discussion considerably by putting the investment into terms investors understand.
By framing the asset class discussion like this, advisors can move investors from benchmarking everything to the S&P 500 in rising markets and to cash in falling markets. HNW families may own many of the same asset classes across account types but may weight the accounts differently to achieve the various goals. A trust established for grandchildren may be more growth-oriented because of their long time horizon. The patriarch’s retirement account may be geared toward generating income, and the personal account may be more defensive, based on their views of the prevailing market environment.
Family Goals
Wealthy families are typically solving for multiple goals simultaneously and are not focused solely on maximizing returns. Their objectives may include preserving wealth, transferring wealth efficiently, and funding causes that matter to the family. A family’s wealth may determine priorities, and it may be instructive to review the hierarchy of financial needs.
Cash-flow needs. Meeting the basic needs for food and shelter.
Financial safety. The ability to create a financial cushion for unforeseen events.
Accumulating wealth. Building wealth, saving for retirement, and paying down debt.
Financial freedom. Adequate savings for retirement, children’s educations, and vacations.
Legacy. Focused on estate planning, tax planning, charitable giving, and instilling value in children and grandchildren.
A family may be solving for various needs simultaneously. A family’s personal account may be focused on accumulating wealth, their retirement accounts focused on financial freedom, and their trusts established for legacy purposes.