Goals-Based Wealth Management

By M. Isi Eromosele

Goals-based wealth management has attracted a lot of attention over the last few years as the global financial crisis that started in 2008 changed the way many families look at how their wealth is managed.

While significant losses in market value have occurred at other times in history and did not necessarily modify investors’ attitudes, this global crisis was different in one major way. It challenged a number of expectations as to what could or could not happen in investments.

The simultaneous substantial price declines and liquidity losses that affected several alternative strategies forced investors to rethink significantly the way in which their portfolios were allocated.

Integrated Wealth Planning

Strategic asset allocation, the process by which families work with their investment advisors to set long-term strategic targets for various asset classes, cannot occur in a vacuum.

Among other factors, families must look at financial planning, estate planning, philanthropic planning, investment planning and tax planning when creating an overarching wealth management strategy.

Other than investment planning, however, each factor requires a distinct focus on the specific goals of each client and a willingness to consider several discrete goals. Keep in mind that this may include tradeoffs if certain goals prove to be incompatible.

Financial advisors should help families perform some capital adequacy analysis to help the members of the family understand whether they have enough assets to maintain their current lifestyle, to extend it to incorporate their dreams, to protect them against risks and nightmares and to deal with any form of additional contingency.

Yet, such an exercise is often disconnected from the work of the investment advisor who may not incorporate all these important data points into his or her strategic asset allocation analysis.

A discussion centered on the family’s goals need to be fully integrated into the overall advisory process. It should start with financial planning and then naturally extend into investment, estate, tax, and philanthropic considerations. Other important considerations are the need to harmonize tax and estate planning and strategic asset location.

Goals-Based Asset Allocation in Practice

The goals-based strategic asset allocation process can best be explained as a decision pyramid with three critical components.

Asset Division

The first step in goals-based asset allocation requires the family to divide assets into two categories: internally managed (where any value added is generated by the activities of the family) versus externally managed (where any value added can be traced to external managers).

While this may seem to be a simple step, it is important for several reasons. It provides a framework for families to view their own entrepreneurial activities, divide these activities between those that involve a high degree of risk and those that do not and account for different liquidity levels.

It allows the family to consider assets which, though valuable, are not expected to be traded, such as homes, collections, and the like.

It also allows the family to specify those areas where it feels able and willing to create value, and those where it recognizes that it needs external help. Finally, it makes it possible to postulate the almost obvious: wealth is typically created through internal, often entrepreneurial ventures, while it is only dynamically preserved in the public markets.

This last element is important in that it can serve as the pillar on which rational expectations are anchored.

Asset Identification

The second key branch in goals-based asset allocation relates to the need to separate the assets necessary to support the family’s lifestyle from those that are surplus to this requirement: separating assets into lifestyle and non-lifestyle buckets.

Families spending a very small portion of their capital to maintain their lifestyles are often tempted to create a form of an endowment portfolio whose income can be used to fund annual expenditures.

The major problem with the endowment approach is that assets must be “located” in a structure that belongs to the people who are spending the money. This can create estate transfer or gifting issues in that it may effectively freeze some share of the overall assets in the hands of a generation that might not wish to keep them, unless the goal is for whatever remains of the portfolio be passed on to charity.

The importance of taking a long enough time horizon is simple: assuming that one has a life expectancy that is longer than the time horizon chosen, one will need to replenish the lifestyle bucket over time. This is obviously more difficult when markets are not performing as expected.

Thus, the longer the time horizon, the more time for markets to perform in line with expectations. Yet, given the path dependency of the behavior of this lifestyle portfolio, one needs to assess the circumstances in which this strategy would or would not work.

Strategic Goals Determination

The third and final branch of goals-based asset allocation relates to the strategic determination of the family’s goals beyond lifestyle maintenance. While the range of such goals is practically limitless, goals can generally be classified into one of three categories: personal, dynastic or philanthropic. Importantly, these goals can involve an equally varied range of implied risk profiles.

While some families do not need much prodding to create a list of goals, others need a bit more guidance. It is not uncommon for a family to initially assume that discretionary wealth should automatically be allocated to a growth objective.

This may not necessarily be the best approach for two reasons: (1) growth has its limits and (2) what constitutes discretionary wealth varies based on individual needs and desires.

A Practical Framework

The starting point for the goals-based framework is to help a family translate goals and objectives expressed in non-financial language into financial realities. The framework comprises two dimensions.

First, the list of family goals is open-ended; second, the investment universe should be  divided into modules, which are designed to work with the family’s internal and external assets.

While there is plenty of room for customization, the framework need to be sufficiently flexible to allow for all but the most unusual circumstances and need to be properly structured to provide a measure of operational efficiency.

The framework is an extension of the typical wealth planning dialogue. While the questions leading to the discovery of the key inputs into the model might appear to be deterministic, they are intended to help a family understand the various trade-offs they may need to make.

Once family goals have been identified, classified and analyzed, the next step is to create the policy portfolio. To the extent that each family portfolio will have totally customized allocations to each investment module, the resulting overall portfolio will clearly be different from one family to the next based on individual goals.

However, within each module, the guiding force is not the family’s goals, but the

realities of capital markets. The ultimate goal is to help them achieve some economies of scale beyond personal family goals.

Depending on the needs of the families, the investment modules should have different incarnations. These options should reflect both tax status and the family’s investment preferences.

While no one framework can ever hope to meet every challenge associated with the real world, the foregoing process is designed to meet the needs of a large cross-section of wealthy families, both domestically and internationally in a way that integrates the investment activity into the broader wealth management process.

The goals-based allocation can be viewed as a bottom-up exercise designed to elicit the family’s risk profile given the different and possibly competing goals it is trying to achieve.

Families will most likely view the process as successful once they have discovered and identified their goals, quantified the capital required to meet each goal and created complimentary sub-portfolios that meet each goal in a comfortable manner.

In the post-2008 global financial environment, families need to be able to clearly map their assets to their goals with more clarity and definition. The clarity fostered by a more direct link between portfolio composition and the nature of the goal each portfolio seeks to achieve provides at least one more level of protection against emotionally-driven missteps.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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