This is one of the most important questions for senior international professionals, when it comes to the management of their family’s financial assets.
Historically, asset allocation was determined by first defining sufficient boundaries and second by risk mapping.
Often resulting in clients being pigeonholed into whatever portfolio was available…
It's common for our clients (say, managing partners in law firms) to receive a bonus around this time, prompting a 'top up' into their portfolio.
These 'top ups' are of course factored into the financial plan we have already created together.
These plans don't generally revolve around one single goal, or one single time horizon.
They contain several goals, with differing time horizons and different degrees of urgency.
Although certain goals can be viewed as needs which must be achieved, others can be classed as wants, wishes, and dreams which are desirable, but not necessary.
I would argue that risk, in the context of individuals or families, should not be measured in terms of volatility of return, but in relation to the degree of urgency associated with reaching (or not reaching) the goal.
Each goal needs to be provided for independently…
Think sub-portfolios, each dedicated to meet a goal, over the required time horizon and with the required degree of urgency.
Once created, they can be grouped into a single family asset allocation, built to allow wealth transfers; asset protection; or other personal motives.
I believe the process involves 4 steps:
- Create a list of all the goals you have as a family.
- Identify the constraints that naturally apply to each portfolio designed to meet each specific goal.
- Determine the amount of assets that should be dedicated to meet each goal, by selecting the portfolio with the highest return possible, given both the time horizon and the required urgency.
- Combine all the individual portfolios into an overall investment policy to manage the assets on a continuing basis.
The ultimate end goal of this 4-step process is to help families “marry their financial assets.”
Because it’s still a fact that many affluent families know they’re wealthy, but don’t know how their wealth is helping them achieve their life’s goals.
Being able to identify the amount of assets needed to reach any goal is great for two reasons:
- It allows the family – and individuals within it – to appreciate the amount of their wealth needed to achieve a particular goal; think, say, how much is needed to maintain some lifestyle over some defined period.
- It allows the family to be in control when goals may need to be changed or amended (pushed out further in time or their urgency reduced) when they see conflicts. The above 4-step process must be repeated at regular intervals, such as yearly, allowing the family or individual to “stay current.”
Budgets are created with the best of intentions, but spending may be higher – or lower – than anticipated.
Similarly, capital markets may not produce the returns that were expected, and goals and preferences change with time, as certain “needs” change…
This goals-based approach speaks more directly to the wealth holder with observations like:
“I do not have enough left to meet my goal because I am spending more than anticipated”
“Capital markets have proven riskier or less generous than I expected.”
For families with substantial non-financial assets, this process can help with the eventual disposal of certain assets.
It may well appreciate in value over time, but, in the short-term at least, it requires maintenance or insurance that adds to the family’s spending needs without contributing any direct financial return.
A liability that families will often find difficult to divest.
It’s now possible for families to develop truly customised investment policies based on their specific goals and preferences.
There are, however, practical limits.
I work with a lot of keen cyclists, so let’s use an analogy.
Although it’s feasible for a racing bike to be built based on the specifics of each individual, it’s usually not necessary to create new parts.
The frame can reflect the exact physical measurements of the racer, but the elements that create the frame can be cut from standard tubes.
The pedals can have various lengths but don’t need to be manufactured specifically.
A racing bike is more a case of mass customisation than ultimate bespoke manufacturing.
The same is true for most families.
A good financial planner can act as an interpreter who is working to translate the goals and constraints of the family into the realities of capital markets.
Though the realities of capital markets can’t be changed, they can be accommodated in a way that allows the family or individual to reach as many goals as desired, over the horizons chosen and with the appropriate urgency.
What should your asset allocation be?