Our extensive interactions with affluent families and their advisors repeatedly reveal that they benefit from a regular, formal review and planning process.
The idea of undertaking such a process might seem overwhelming, so we thought we would share what we have found to be an efficient and constructive approach.
To ensure a good foundation, we recommend the following best practices:
• Solicit the participation of all relevant stakeholders in this process—such as family members, financial advisors, legal counsel, tax professionals, and investment staff. It is especially important that family members fully participate in this process and fully understand each aspect of it.
• Separate the analysis into three discrete but interrelated topics: investment, governance, and family circumstances.
• Codify/memorialize and share the results, action items, and conclusions.
Rather than take a prescriptive approach (e.g., to always seek maximum diversification), we believe the Socratic method yields the best results. Thus, we challenge you to answer the following fundamental questions.
Assessment
1\. What is our investment objective?
Common investment objectives can include funding lifestyle needs during retirement, supporting family members, funding philanthropic activities, and ensuring multi-generational transference of wealth.
2\. What is our investment policy?
This should include, at a minimum, the investment time horizon, the family’s ability and willingness to withstand portfolio volatility, asset class preference and limitations, other investment preferences like liquidity and ESG, rebalancing rules, level of discretion over tactical positioning, and other implementation requirements (use of third-party money managers, investments in mutual funds, exchange-traded funds, or individual securities).
3\. What are our investment beliefs?
Draft an investment belief statement that articulates the fundamental perceptions of investors and their intermediaries regarding the nature of financial markets and the role these individuals play within these markets. For example, “We believe that public equity markets are generally efficient and are best accessed through low-cost passive products,” “We would like the portfolio to be a mix of active and passive products,” or “We are long-term investors and are comfortable with a sizeable portion of the portfolio being in illiquid instruments.”
4\. How do we make investment decisions?
Could we categorize our process as rigorous? Systematic? Scientific? Discretionary? Ad hoc? Can we evaluate the efficacy of our decisions over time? Have we identified appropriate benchmarks at the asset-class and instrument levels? We have also found that much can be learned by revisiting investment decisions, both acted upon and not; for example, we hired manager X but not manager Y: was this the right decision? Did these decisions add or subtract value? What can these actions tell us about our decision-making process? How could they be improved (e.g., with more or different data, or better assessment tools)?
5\. Can we demonstrate that our current portfolio supports our current needs and complies with our investment policy and investment beliefs?
Are our strategic asset allocations within the stated ranges? Have we monitored and reviewed our managers to ensure that their activities will continue to comply with the terms of the investment-management agreements? It is also important to identify which processes, methodologies, and metrics will be used for monitoring.
Planning
6\. What are our anticipated financial and familial needs for the next ten years (and beyond)?
Think broadly, and include continuous lifestyle needs and one-time spending (a second home, a boat, etc.). Think in terms of liquidity, safety, growth, resiliency, transparency, succession, and inheritance, for example.
7\. What exogenous macro-level risks do we foresee over the next ten years and what investment opportunities do we foresee over the next ten years?
Geopolitical (e.g., the trade war, fading US hegemony)? Environmental risks? New technology developments and market-disruption opportunities such as artificial intelligence, cryptocurrencies, blockchain, decarbonization technology, and water rights.
8\. What changes could we make to the portfolio to increase the likelihood of managing these risks, capitalizing on these opportunities, and achieving our investment objective in general. Even if affluent families are long-term investors, they may be understating the true risk of capital losses in a world in which forward expected returns can decline without commensurate declines in spending rates. This situation suggests the need to reexamine risk tolerance and volatility targets.
9\. Does our current investment policy support these potential changes?
Are the constraints and limitations too restrictive to capitalize on opportunities? Is the asset-allocation minimum and maximum range aligned with future expected returns?
10\. Do we have the proper tools to identify, Are we using common risk measures such as volatility and value-at-risk (which are calculated at the end of the investment horizon), or are we evaluating risk in a continuous way (i.e., by asking what can happen to our portfolio at any point in time)?
While it is certainly easier to focus on quarterly investment performance than answering the fundamental questions we pose, last quarter’s performance is not something that you can affect. What you can affect are your future investment decisions.
An honest assessment of your current investment situation and rigorous, contextual estimation of your future financial needs and expectations would certainly prove more valuable for all stakeholders. Indeed, we believe that performing such rigorous reflection and discussion is one of the best pieces of advice we can provide in order for families and investors to improve their long-term financial performance.
