For all the innovation in modern finance, one fact has been strangely overlooked: Most wealth management today is too narrow to deliver what families really need.
We have a passion for excellence the right Confronted with stocks, asset allocation or significant tax drives, we routinely ignore the broader economic reality in which real families live. What advisors and their clients need is a different approach and framework called the Fortress Balance Sheet. The driving idea behind the strategy is what families are looking for when they move into our industry and that is to keep their wealth in the whole financial picture, their whole balance sheet. This helps them become immune to economic threats and reduces their need to worry about money.
However, this is a commitment that fundamentally cannot be delivered through portfolio building alone. The full range of risks that a household’s finances face is vast: market risks and inflation, yes, but also overspending (depreciation), growth shocks, negative tax changes, laws, natural disasters, and more.
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A comprehensive balance sheet approach begins with a comprehensive view of assets, including public stocks and bonds, but also private investments, home equity, personal real estate, cash, closely held business interests, employee benefit plans, insurance policies, annuities, deferred tax assets (eg, capital losses) and even human capital losses).
In addition, it fully and accurately takes care of family responsibilities. While things like mortgages and credit card debt (long-term liabilities) are obvious, a true, economically accurate balance sheet will include current liabilities (planned expenses over the next 12 months), future expected liabilities (long-term expenses such as retirement income, education for children, health care for elderly parents, etc.), and major liabilities such as major taxes. 401(k) plans.
With this thorough understanding in place, building and maintaining a fortress balance sheet requires an expert team with a shared understanding of the mission. The full complexity of family finances includes not only financial matters, but also taxation, law, insurance, and more.
Imagine an investor who chooses an attractive investment, but neglects their tax strategy, and loses their profits by paying unnecessary taxes. Imagine an investor who gets their tax strategy right, but doesn’t update their estate plan to match their needs. Imagine an investor who carefully plans their finances and assets, but finds themselves on the wrong end of a lawsuit, or someone who doesn’t realize after a disaster that their home is underinsured.
It is only when all parts of a family’s finances are arranged in concert that their balance sheet can be considered safe. Once it’s created, the balance sheet has five goals:
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Growth: The strategy provides real, inflation-adjusted growth for households to achieve their long-term goals. This should not be the beginning and end of the wealth management conversation.
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Income: It should also provide real-time after-tax income that families need to maintain their lifestyle. Income is different from growth in that income represents the liquid financial income we need to receive today, here and now, and not the long-term growth characteristic of assets, with unrealistic, often illegal, and typically tax-free returns.
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Liquidity: Balance sheet liquidity is important for meeting liabilities (for example, uncompensated storm damage to coastal property) or for capitalizing on opportunities (for example, investment requests or opportunistic co-investments). We typically think of liquidity in terms of cash and cash equivalents, but it’s bigger than that. Liquidity is ultimately a measure of how easily, cost-effectively and quickly we can convert an asset into cash at a fair market price. A strong balance sheet aims for liquidity to meet current and future obligations, whether expected or unexpected, without borrowing at unnecessarily high interest rates, incurring significant carrying costs, or selling assets at fire sale prices to raise cash.
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Maintenance: Through a combination of a well-managed balance sheet, asset allocation, liability management, insurance and institutions, households are protected against a wide range of economic threats. Changing tax laws, lawsuits, premature death, disability, cognitive decline, fraud and identity theft, just to name a few, pose a clear and present risk.
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Flexibility: Last, but not least, this approach provides the flexibility to change our minds, reallocate resources as needed or desired, and respond to life’s inevitable curveballs that are thrown our way. Protecting your finances is not a task that you do once, then put in place automatically. Not only must dispatchers (ie, your consulting team) always be on the job, they must be ready to constantly review the plan and adjust it as circumstances dictate.
Flying Castle. As wealth advisors, our fiduciary responsibility to our clients is both a legal standard and a sacred duty. We can only truly live up to this mandate when we operate under a framework that protects every aspect of our clients’ finances.
When we focus too little on investing, we’re not only failing to fully fulfill our mission, we’re simply not giving clients the advice they really want and need.
Dan Kilcagni is the Chief Investment Officer at Mercer Advisors, a CFP Professional, and has earned the Certified Investment Fiduciary designation.
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