A remnant from the Great Recession is ongoing financial anxiety about the future. The recent global market turmoil highlighted how this anxiety sits as a strong influencer across generations and wealth strata. Consider the following from recent studies:
- Millennials, who witnessed parents suffer with financial stress, save at extraordinary rates compared to older generations (Source: LinkedIn Affluent Investor Study 2015)
- Clients’ top three “biggest concerns” relating to an insecure financial future in the coming 12 months are funding retirement, protecting assets and outliving their savings (Source: Jefferson National/Harris Poll; July 2015)
- 83 percent of investors say it’s important or critical their adviser helps them stay calm when the market drops (Source: IMCA 2014)
- 65 percent of 40- to 59-year old investors with average household assets of $18 million fear running out of money (Source: SEI/Scorpio 2015)
- 72 percent of investors have a primary investing goal to “maintain my current lifestyle later in life,” and these same investors spend a total of 475 hours a year worrying about money (Source: Legg Mason Investor Study 2015)
Overemphasizing Market Volatility
The Jefferson National/Harris study identified market volatility as the No. 1 issue for both the macro environment and investment execution (noting the concern is actually downside volatility; investors are fine with volatility in rising markets). Volatility’s prominence in investor consciousness speaks to an important truth: when markets decline, wealth is lost; and, when wealth is lost, anxiety increases.
However, market declines are an overemphasized contributor to financial anxiety since any dollar lost has the same wealth affect. Dollars are also lost due to overspending, changed priorities, financial mistakes, unprotected property, tax inefficiency and excessive investment product fees.
Each time a dollar is lost unnecessarily, its compounding value is lost too. Wealth preservation must minimize the loss of dollars from any source, and each dollar not lost allows the remaining wealth to compound from a higher floor.
A Plan’s Wealth-Protecting Actions
Beyond a diversified portfolio to minimize the impact from market downturns, a comprehensive wealth plan protects against many other losses such as:
- Reducing taxes through tax-loss harvesting, gains management, income shifting, and asset location
- Lowering expenses for core asset classes with ETFs or passive mutual funds.
- Avoiding waste by setting spending priorities and budgets
- Eliminating financial mistakes by using an adviser’s expertise
- Protecting property with new appraisals and resetting coverage
- Avoiding probate using a Revocable Living Trust
Something is Clearly Missing
After the wealth plan is executed, attention shifts to the portfolio’s investment performance, thereby excluding the important value secured from the other wealth-protecting actions.
Whereas market declines are infrequent and unpredictable, overspending, taxes and high fees degrade wealth day after day. Preventing these other wealth leakages have absolute monetary value that, in total, can exceed the value generated through portfolio design.
Consider if the S&P 500 declined 50 percent over a few weeks, wealth would clearly be impacted at that moment; paper losses would result with clients’ anxiety spiking. The above IMCA data point highlights that clients value an adviser who keeps them calm in a downturn and prevents paper losses from being realized in a panic. Over time as markets rebound, the paper losses would be washed away by a new bull market—i.e. bull markets last much longer than bear markets.
What’s missed in the reporting task is a high-income client’s largest single expense every year is taxes, at a marginal rate exceeding 50 percent in high-tax states. This annual wealth erosion can far exceed the impact from a single, even severe market decline.
At the typical client meeting, the adviser’s tax alpha production—increased after-tax returns resulting from tax management tactics—is nowhere to be found in the report package.
Not Just Performance Reporting, but Value Reporting
In a performance report, a low-basis investment is shown with a large unrealized gain; a paper profit that may not be realized for years to come. The client’s financial anxiety is reduced knowing this asset exists should it be needed.
In the same vein, the adviser’s wealth-protecting actions have value even though some remain unrealized at a particular time—like a property loss or probate.
An adviser’s value is accentuated when all wealth-protecting actions are illustrated side by side in the performance report package. Seeing the wealth plan’s total value—not just related to portfolio returns—reduces anxiety from headline-grabbing market declines. When anxiety is reduced, a good portion of those 475 hours spent worrying are left to more inspiring thoughts. How could an adviser’s value to this client be more evident?
Wealth Planning Consulting Inc.
Princeton Junction, NJ