wealth management for hni’s

Wealth Management for HNI’s

WHAT DOES HIGH NET WORTH INDIVIDUAL - HNWI MEAN?

A classification used by the financial services industry to denote an individual or a family with

high net worth. Although there is no precise definition of how rich somebody must be to fit into

this category, high net worth is generally quoted in terms of liquid assets over a certain figure.

The exact amount differs by financial institution and region. The categorization is relevant

because high net worth individuals generally qualify for separately managed investment accounts

instead of regular mutual funds.

The most commonly quoted figure for membership in the high net worth "club" is $1 million in

liquid financial assets. An investor with less than $1 million but more than $100,000 is

considered to be "affluent", or perhaps even "sub-HNWI". The upper end of HNWI is around $5

million, at which point the client is then referred to as "very HNWI". More than $50 million in

wealth classifies a person as "ultra HNWI".

HNWIs are in high demand by private wealth managers. The more money a person has, the more

work it takes to maintain and preserve those assets. These individuals generally demand (and can

justify) personalized services in investment management, estate planning, tax planning, and so

on.

WEALTH MANAGEMENT SEGMENTATION

The Indian market has been segmented by Wealth management service providers into five

categories, namely:

Ultra-high net worth, or Ultra-HNW (in excess of US$30 million), will have a total

population of 10,500 households by 2012.

Super high net worth (between US$10 and $30 million) will have a total population of

42,000 households by 2012.

High net worth (between US$1 million and $10 million) will have a total population of

320,000 by 2012.

Super affluent (between US$125,000 and $1 million) will have a total population of

350,000 households by 2012.

Mass affluent (between US$25,000 and $125,000) will have a total population of 1.8

million households by 2012.

1


Mass market (between US$5,000 and $25,000) will have a total population of 39 million

households by 2012.

WEALTH MANAGEMENT SERVICES COMPRISES:

Financial Planning

Portfolio Strategy Definition/ Asset Allocation / Strategy

Portfolio Management –Administration, Performance Evaluation and Analytics

Strategy Review and Modification.

KEY CHALLENGING AREA:

While immense business potentiality of this emerging sector is a driving point for most of the

firms, they face many challenges in formulating winning services offering meeting the client

needs. In the following section, we would briefly take a look on the key challenges area in the

present context.

1. Highly Personalized and Customized Services: Unlike other stream of financial services,

mostly being transactional / commoditized in nature, wealth management services require client

specific solution and service offering. No one solution exactly meets the needs of other client. In

a situation of highly personalized and customized nature of service offering, developing any

form of generic service model does not support growth of the business.

2. Personal relationship driving the business: To meet client expectation of personal attention,

mode of communication in wealth management services tends to be highly personalized. Thus,

the conventional grids of communication, such as call centre, data centre does not fit well.

Success of wealth management services heavily draws on personal interaction with the dedicated

relationship manager, who takes care of whole investment management lifecycle for bunch of

clients on one-to-one basis. This essentially requires service firm to invest heavily in human

processes to groom and retain a team on competent relationship managers with cross functional

skills.

3. Evolving Client Profile: The biggest challenge in providing wealth management service

offering is to factor and reckon the evolving nature of client profile, in terms of investment

objective, time horizon, risk appetite and so on. Thus, a service model developed for a particular

2


client cannot remain static over a period of time. Any service model has to be flexible enough to

consider the dynamic nature of client profile and expectations arising out of it.

4. Client Involvement Level: The conventional adage – the more money you have, more effort

is needed to manage it – proves to be otherwise in case of HNWIs. Generally, client involvement

in managing the finance remains on the lower side. This brings onus of managing the whole

gamut of investment and due performance single-handedly on the shoulders of investment

manager.

5. Passion Investment (Philanthropy and Social Responsibility): In the recent years a trend

has been observed that bulk of investments by HNWIs has been directed towards passion

investments (art, antique, jewellery, coins, unique assets, luxury), philanthropy and

social/community causes. As per World Wealth report, 11% of HNW investors worldwide

contributed to philanthropic causes with a contribution over 7% of their wealth in year 2006.

Ultra-HNWIs contribution was even more - 17% of Ultra-HNW investors that gave to

philanthropy contributed over 10% of their wealth. In total, this equates to more than US$285

billion globally. Against this backdrop, new breed of HNWIs expect to strategically manage the

wealth and personal resources allocated to philanthropy purpose, in order to maximize its impact.

This demands a relationship manager not just to be a passive financial advisor rather a passionate

partner sharing interest and inclination of the associated client.

6. Limited Leveraging Capabilities of Technology (as an enabler): In the recent times, we

have witnessed technology a key enabler to help business to expand its market reach with

reduced cost of services offering. Online banking and online trading/brokerage services are the

best examples in this regard. Technology leveraging has helped services firm to achieve

universal proliferation of market with substantially reducing transaction cost. As business rules

and service definitions to guide the applications tends to be quite composite in wealth

management services, leveraging the capabilities of technology to meet the business requirement

may not be highly feasible in the initial years.

7. Technical Architecture and Technology Investment: As business architecture is still

evolving, a proven basis of resilient technical architecture and framework to support the

emerging business greatly remains missing. In absence of this framework, any investment

3


commitment towards application development / system implementation would be fraught with

severe risk.

8. Intricate Knowledge of Cross-functional Domain: By very nature of wealth management, it

not just involves matters of plain vanilla finance but has intricate relationship with many

elements of domestic / international law, taxation and regulatory norms. In order to provide

sound investment guidance, a relationship manager is required to have intricate knowledge of

domestic/cross-border finance, accounting, legal and taxation subjects.

4


SOLUTION FRAME WORK

A HNWI client expects exclusiveness in services and key to success for a firm lies in offering

exclusiveness in services delivery (high quality services on most personalized basis), going

beyond client expectations.

A solution framework with considered inclusion of following key elements would help firms in

meeting and exceeding client needs towards sustainable business growth:

1. Quality of service level provided by the service provider firm would the key determinant of

growth and success in client acquisition, client satisfaction and client retention aspects.

In a sense, service offering could be developed in the form of partnership with the client based

on trust and integrity, where the relationship manager remains highly responsive to client

sensitivities and expectations. Without over-emphasizing, a satisfied client would provide

multitude of opportunities of growth of business – through deepening the relationship, direct /

indirect referencing as well as cross selling of products. In the other situation of deficiency in

service level, he would not hesitate to move the business to another firm. This keeps strong

emphasis on continued engagement with the client on the aspects of client expectation and

servicing, rather than showing extra attention only during the period of client acquisition.

Focused around client needs, a broad framework of service offering during whole lifecycle of

client investment management would be revolving around: Anticipate, Analyze, Advice, Act and

Monitor cycle.

2. Universal Service Offering: To meet the client needs in holistic manner, product and service

offering range of the firm should be wide enough to cover the investment spectrum across its

lifecycle. In an ideal situation, a client would expect to deal with a single firm to get complete

range of investment management services. However, for various business considerations of the

service provider firm, in many situations it may not be a viable proposition to offer those

services. While universal service offering with assortment of services under single umbrella is

not attainable in house, it could be achieved through active partnership and affiliation. But, due

consideration is required that quality of service level provided by partners/affiliates does not get

compromised in any manner. Any shortcoming in service quality, even if caused by

partner/affiliate’s services, would be ultimately impairing client satisfaction towards the firm.

5


3. Investment in People Processes: As relationship manager remains the face of the firm to a

client, success of the firm would be greatly dependent on the skills, drive and enthusiasm of

relationship managers (to take an extra mile), while bonding and dealing with any of client

issues. This aspect is more challenging than as it appears. This necessitates transformation of

organizational philosophy towards its people and people processes contributing to business

success. Firms would be required to invest heavily in human processes to attract, groom and

retain a motivated team of relationship managers, who will make the real difference between

winning and losing the game.

4. Price not a True Differentiator: Pricing as a key differentiator to distinct the service offering

from one firm to other may not be highly relevant in case of wealth management services.

Focused on performance and quality of service, pricing in isolation will not make much meaning

to service seeking clients. Client would always value the pricing from the quality of services

received. He will certainly not mind paying extra, if he finds services offered to him meeting and

exceeding his expectations.

5. Unconventional Delivery Channel and Communication: Delivery channel for service

content and mode of communication has to be greatly customized – aligned with the client-

desired vehicles. This would require a process of continuous re-inventing and re-defining the

grid of delivery and communication channels to meet client expectations. Impact of

technological advancements and its interplay on service delivery and communication method

would certainly be an equally challenging aspect to be factored in, while designing such

strategies.

6. Flexibility of Technical Architecture:

Against the background of lack of clarity on business model and involved process, A

loosely oriented technical architecture with optionality and mix of Build – Buy –

Integrate components would be considered as a good beginning point.

To meet the information technology requirements, a firm has several alternatives (or

combination of alternatives) to consider:

Integrated solution approach: Developing in-house applications to meet end-to-end new

business requirements.

6


Service Bureau /ASP Model: Information technology service providers offering

integrated end-to-end processing infrastructure and services including core of business

processes of wealth management.

Stand-alone commercial software product/solutions: Pre-packaged solutions that can be

focused to specific part of services or provide comprehensive end-to-end processing.

7. To provide enough resilience and high business relevance, any of the considered option

and associated technical structure should keep due provisions for the following key

elements:

Rule based processing to manage complex business rules and service definitions.

Client profile / data management to cater a profile driven solution offering.

Complex decision support and client oriented analytics.

Flexibility to incorporate manual processing interfaces in applications.

7


CORE ELEMENTS OF WEALTH MANAGEMENT

Services

In most basic sense, wealth management services involve fiduciary responsibilities in providing

professional investment advice and investment management services to Institutions, funds

(Pension/mutual/Hedge), corporations, trusts as well as HNWIs. In the present context of our

discussion,we would keep our focus limited to HNWIs. Some of analogous terms used for wealth

management could be considered as Portfolio Management, Investment Management and many

times Fund Management or Asset Management. Depending on the mandate of the services given

to the Wealth Manager, wealth management services could be packaged at various levels:

a) Advisory

Wealth manger’s role is limited to the extent of providing guidance on investment / financial

planning and tax advisory, based on client profile. Investment decisions are solely taken by the

client, as per his /her own judgment.

b) Investment Processing (transaction oriented)

Client engages wealth manager to execute specific transaction or set of transactions. Investment

planning, decision and further management remain vested with the client.

c) Custody, Safekeeping and Asset Servicing

Client is responsible for investment planning, decision and execution. Wealth manager is

entrusted with management, administration and oversight of investment process.

d) End-to-end Investment Lifecycle Management

Wealth manager owns the whole gamut of investment planning, decision, execution and

management, on behalf of the client. He is mandated to make financial planning, implement

investment decisions and manage the investment throughout its life.

Wealth management services comprises of following key function areas:

a) Financial Planning:

Client Profiling

Client profiling takes in account multitude of behavioural, demographic and investment

characteristics of a client, that would determine each client’s wealth management requirements.

Some of key characteristics to be evaluated for defining client’s investment objective are:

8


Current and future Income level

Family and life events

Risk appetite / tolerance

Taxability status

Investment horizon

Asset Preference /restriction

Cash flow expectations

Religious belief (non investment in sin sector like - alcohol, tobacco,

gambling firms, or compliant with Sharia laws)

Behavioural History (Pattern of past investment decisions)

Level of client’s engagement in investment management (active / passive)

Present investment holding and asset mix

b) Portfolio Strategy Definition / Asset Allocation

Defining Portfolio Strategies and Portfolio Modeling

After establishing investment objectives, a broad framework for harnessing possible investment

opportunities is formulated. This framework would factor for risk-return tradeoff of considered

options, investment horizon and provide a clear blueprint for investment direction.

Investment strategy helps in forming broad level envisioning of asset class (Securities, Forex,

Commodity, Real State, Reference and Indices, Art/Antique and Lifestyle Assets (Car, Boat,

Aircraft), market, geography, sector and industry. Each of these asset classes is to be

comprehensively evaluated for inclusion in portfolio model, in view of defined investment

objectives. While defining the strategy, consideration of client preference or avoidance for

specific asset class, risk tolerance, religious beliefs is the key element, which would come into

picture. Thus, for a client with a belief of avoidance of investment in sin industries (alcohol,

tobacco, gambling etc.) is to be duly taken care of.

c) Strategy Implementation

Having decided the portfolio constituents and its composition, transactions to acquire specific

instruments and identified asset class is initiated. As acquisition cost would be having bearing on

overall performance of the portfolio, many times process of asset acquisition may be spread over

a period of time to take care of market movement and acquire the asset at favourable price range.

9


d) Portfolio Management

Portfolio Administration involves handling of investment processes and asset servicing. This

would also require tax management, portfolio accounting, fee administration, client reporting,

document management and general administration relating with portfolio and client. This

function would involve back office administration and custodial services to manage transaction

processes (trading and settlement) – interfacing with brokers/dealers/agents, Fund managers,

Custodians, Cash Agent and many other market intermediaries.

e) Strategy Review and Alignment

Recalibration of Portfolio Strategy based on performance evaluation and future outlook of the

investment, portfolio strategy is evaluated on periodic basis. To keep it aligned with the defined

investment objectives, portfolio strategy is suitably re-calibrated from time to time. Many times,

review of portfolio strategy would be necessitated due to change in client profile or expectations.

Rebalancing, Reallocation and Divestment of Assets Any re-calibration of strategy and consequent

change in portfolio model would require rebalancing of the assets in portfolio. This would be

achieved through rebalancing the asset (divesting over-allocated part and acquiring under

allocated), relocation (from one sector the other or from one instrument to other instrument in the

same class) or complete divestment.

10


ATTRIBUTES OF HIGH NET WORTH INDIVIDUALS

1. They live well below their means:

They may make a large income, but they don’t live like it. They are, as Stanley says,

“Frugal, Frugal, Frugal”. They live in an older house, drive an older car and don’t spend

a lot of money on life’s luxuries (often because they don’t enjoy them). At an interview

they did of millionaires, one deca-millionaire when asked if he would like an expensive

glass of wine responded that he drinks only two things, scotch and two kinds of beer –

Bud and Free. For those wealthy that were married, they almost always found that the

spouses were also frugal. If one spouse is a hyper-consumer, it is extremely difficult to

end up with a high net worth.

2. They allocate their time, money and energy efficiently in ways conducive to building

wealth:

Wealth accumulators spend more of their time in doing things that are conducive to

creating wealth – budgeting, planning and setting goals for their future. They work hard

towards their goals, and are more likely to be spending time planning their goals. Those

who are high income earners but that do not have a high net worth do not spend as much

time in these activities. In fact they found that PAWs (prodigious accumulators of

wealth) spent almost twice as much time every month in planning their investments as

did UAWs (underachieving accumulators of wealth).

3. They believe that financial independence is more important than displaying high

social status:

They don’t care about living in the right neighborhood, having a big house, driving the

newest cars or shopping at the trendiest stores. These high net worth individuals care

more about providing for their own financial independence and work towards that goal.

11


4. Their parents did not provide economic outpatient care:

The parents of these high net worth individuals did not subsidize their lifestyle, or give

them a bunch of money. They made their own way, working hard and succeeding on their

own terms. Children who receive economic outpatient care (EOC) often are stripped of

their motivation to work hard and achieve, and as a result often do not become PAWs.

5. Their adult children are economically self sufficient:

The children of high net worth individuals have been taught how to live a frugal lifestyle,

how to accumulate wealth, and often have been taught how to succeed on their own

without help from their parents. Because they don’t receive EOC, and in general are self-

sufficient, it allows their parents to accumulate more and be better off later on.

6. They are proficient in targeting market opportunities:

The high net worth individuals are good at seeing opportunities and taking advantage of

them. They aren’t immune to the fear of failing that all of us have at times, but they

overcome their fear and act upon good opportunities when they see them.

7. They chose the right occupation:

Those who have a high net worth almost always are doing something that they enjoy –

and they work hard at their chosen career. Just because you’re not an entrepreneur or a

business owner doesn’t mean you can’t be wealthy. You just have to choose a career that

will provide a reasonably decent income, and live in a way that is conducive to building

wealth. Find a career that you enjoy, work hard at it, and live frugally – and you can

build a large net worth.

These 7 attributes of high net worth individuals really expose the framework for living a life

based on sound financial principles. The attributes prove that it is possible to live well on much

12


less than you make, and have plenty left over to save, invest and give. It can even be done by

individuals who don’t make a lot of money, as long as they are disciplined.

The attributes speak to the power of educating yourself and your children about money, and

practicing sound money management through the use of budgets and financial plans. They

show that displaying high social status often means that you won’t be financially secure. The

attributes show how money is a tool to be used, and should not be an end in itself. Those who

understand that are often happier, and in the long run, wealthier.

13


QUALITATIVE CHARACTERISTICS OF HIGH NET WORTH

INDIVIDUALS

High net worth individuals have the following characteristics:

A) Complexity

Prince states, .The worlds the Ultra-Affluent move in are especially complex. The personal and

financial situations of the Ultra-Affluent tend to be more intricate due to their wealth. External

Macro-environmental factors (e.g., tax and estate laws, as well as other regulations affecting

their sphere of action) weigh in. The Ultra-Affluent are not unconstrained in their control over

their capital. The very policies that constrain them also create significant complexity..

This characteristic of complexity describes the financial affairs of the Ultra-Affluent. Their

financial affairs are much more involved because they need to structure assets to maximize their

value and ensure their preservation. The Ultra-Affluent confront more intricate financial issues

from embedded capital gains to effective tax management. Among the ultra-affluent, advisor

referrals dominate. Therefore, the answer to sourcing ultra affluent clients is building bridges to

advisors who have such wealthy clients.

B) Control

Another core characteristic of the Ultra-Affluent is control. The Ultra-Affluent characteristically

seek to exercise dominance in various spheres of life including family, community and work.

Often due to strength born from demonstrable success, the Ultra-Affluent tend to see their views

on any subject as the best ones. Due to the complexities they face, there is a strong tendency to

exercise their will. Prince also states, .When the objective is the perpetuation of the founding

fortune, the strategies and tactics that are employed do more than just ensure the tax-efficient

transfer and perpetuation of vast wealth. They create an emotional and cognitive framework in

which the benefactors must live. There is a psychological, if not legal, hold on the benefactors

that (paradoxically) makes many of them actually quite ambivalent about the situation.

14


C) Capital

Prince outlines, .The Ultra-Affluent tend to define themselves more in terms of the application of

Wealth than in terms of their actual wealth. For the Ultra-Affluent, capital--another core

characteristic--is very often their measure of personal value. In general, the Ultra-Affluent

measure themselves by capital and not in terms of net worth.. Money is not the gauge by which

they generally rate themselves--it is capital because capital is the ability to deploy resources to

make things happen. This is why most of the Ultra-Affluent merge their business empires into

their self-image. And, that is why advisors need to be attentive to the interplay of money and

self-image among their Ultra-Affluent clients.

D) Charity

Public policy in the United States since the early 20th century has been to create tax incentives

for charitable actions. The tax incentives coupled with the Ultra-Affluents’ desire to be

Philanthropists translate into tremendous benefit to the nonprofit sector. What is critical to

recognize is that the Ultra-Affluent are indeed philanthropic. They are looking for ways to "make

the world a better place." Admittedly, because of the government’s decision to use tax policy to

affect social policy, charitable gifting can concurrently financially benefit the Ultra-Affluent as

well as the nonprofit organizations they support. Nevertheless, the Ultra-Affluent like the sense

of purpose charitable gifting gives them. Indeed, quite a few aspire to be major philanthropists.

The trend is for the Ultra-Affluent to gift, but taxes come into play in defining the strategies and

tactics that are used to enable the charitable gifts.

15


HOW HIGH NET-WORTH INDIVIDUALS DIVERSIFY RISK

Managing money for high net-worth individuals is a complex task that needs access to various

resources, asset classes and constant monitoring.

As wealth increases, the needs evolve; from plain vanilla reactive investment strategies to active

oversight and scientific planning.

Historical data indicates clearly that no one asset class tends to perform consistently over a long

period of time. Therefore, to curb volatility and achieve targeted returns, an individual must

spread his wealth not just across asset classes, but also across management styles.

Unique Requirements

Today, sophisticated investors have access to various asset classes like equity, debt, private

equity, real estate, structured products, insurance, commodities etc. Investments can be done in a

variety of styles such as discretionary and non-discretionary equity, concentrated portfolios,

diversified portfolios, long only, conservative, hedged, arbitrage, growth, value, etc .Every

individual has unique requirements based on appetite for risk, ability to tolerate volatility and

cash flows. Additional needs of asset preservation and handover to the following generations

adds a layer of customization and complexity to the process.

While attempts have been made to broadly classify investors according to their financial

planning needs, the market has been evolving constantly.

The growing maturity of the players and evolving regulations are giving birth to newer

opportunities. Let us look at some of the newer developments in the product space.

Today a substantial part of the investors’ portfolio is on Indian shores. As regulations permit and

structures develop, we will increasingly see investors demanding geographical diversification to

minimize country risks. This will not only mean geographical access to global markets but also

access to more cutting-edge structures that fulfill possible risk-reward gaps in the portfolio.

While a few years back Indians had restricted access to global markets, today regulations permit

investors to route large amounts through global access mutual funds and limited amounts

directly. 16


Investment strategy

These products offer investors geographical diversification, access to emerging markets across

the world or could also offer asset class diversification for example; a global gold fund. These

enable the investor either to reduce volatility or simply attempt to outperform.

Sometimes existing products may or may not be enough to meet every gap in the portfolio.

At such times, the smart manager needs to access sophisticated products that are structured

specifically for the individual needs.

A structured product is generally a pre-packaged investment strategy, which is based on

derivatives, such as a single security, a basket of securities, options, indices, commodities, debt

issuances and foreign currencies.

A unique feature of some structured products is a ‘principal guarantee’ function, which offers

protection of the principal, if held to maturity. Structured products can be used as an alternative

to direct investments, as part of the asset allocation process is to reduce risk exposure of a

portfolio or to capitalize on the current market trend.

For example, today’s HNIs have access to structures that outperform the benchmark on the

upside and protect capital on the downside.

Private Equity

The last but amongst the most interesting opportunities that HNIs can benefit from is the

alternate space; this is predominantly in the form of private equity.

These opportunities may be in broad sector agnostic funds or in targeted verticals such as real

estate and infrastructure.

While these alternates hold the promise of larger returns, they come along with their share of risk

and long lock-ins ranging from 7 to 12 years.

At the same time, the funds try to achieve higher IRR through structured draw downs and profit

bookings that are paid to investors on realization before the final wrapping up of the fund. These

options are definitely for the larger investors and smaller investors may well be advised to

exercise caution. Thus, we see that, as wealth increases, the complexity only increases.

Managing money is a fulltime activity that requires trained professionals, who understand both:

17


the high net-worth individual as well as his wealth management need, to achieve a fine balance.

After all it takes all ingredients to make a perfect recipe.

Far too many high net worth individuals suffer the consequences of pathetic advice and live to

regret it. A combination of time constraints, financial ignorance, and quite possibly egos often

impede a wealthy individual’s ability to make rational economic decisions. And let’s face it, not

all of Wall Street’s ‘finest’ have your best interest at heart.

Having extensive experience working with wealthy families, I have seen the financial carnage

that

occurs first hand. The symptoms are always the same: inappropriate strategies, excessive costs,

exaggerated risk, portfolio churning, liability exposures, lack of integrated planning and failure

to meet reasonable goals.

If you are tired of fattening up other people’s wallets at the expense of your financial growth,

empower yourself to make better financial decisions.

Wealthy professionals, because of their high incomes and high visibility, are often easy targets

for bad advice. When hiring an advisor, a considerable amount of thought and research should be

dedicated to the process. After all, it’s only your money. Here are some things you should ask

when engaging a financial professional:

• How are you paid?

• Are your recommendations in any way influenced by compensation?

• Do you have a clean regulatory record?

• What are your credentials?

• How much experience do you have?

• How much authority will you exert over my accounts?

The Certified Financial Planner Board of Standards offers some great (free) online guides on

18


how to choose a planner. Check out their site at http://www.cfp.net/learn/library.asp.

In your quest for an advisor, the more informed you become, the better your outcome should be.

Here are the underlying factors that often jeopardize a sound financial plan.

Inappropriate strategies

Wealthy individuals are often successful business owners or professionals exercising a high

degree of rationalization. The same practice should be executed with your money.

Successful portfolios are based on research and reasonable expectations, not intuition. Illogical

investors attempt to guess which manager, stock or asset class will have tomorrow’s best

performance. That’s why so many have consistently failed. Successful, rational investors excel

because of a clear methodology and, of course, discipline. What type of investor are you? What

type of investor do you want to be?

For the past fifty years, modern finance has been exploring the most efficient methods of

achieving

global market returns. The findings have been a boon for individual investors who have put forth

the effort to learn about them.

The single largest driving force behind investment results is the policy decision allocating

between stocks, bonds and cash. Roughly 94% of the variations in returns are explained by asset

allocation. The factors that most investors assume contribute the most to investment returns, like

individual stock selection and market timing, contribute less than 6% to the result.

Also, by mixing risky asset classes with low correlations together, the resulting portfolio will

have higher rates of return, but with lower risk than the average of the individual parts.

19


Excessive costs

Here’s a quiz. Besides inappropriate diversification, what is an investor’s worst enemy? Answer:

excessive costs. Costs are mainly comprised of the following categories: commissions, taxes, and

fees

Commissions

Many financial advisors are nothing more than glorified salespeople. The investments they sell

have a direct correlation with the compensation they receive. Given those dynamics, what are the

odds that you will receive objective advice?

Commission based advice serves only the broker and the brokerage firm. Stay away from

investments that charge your front end or back end loads or surrender charges. Commission

based compensation includes “fee-based” compensation which is a particularly evil label

referring to both fees and commissions. Don’t be fooled.

Fee-only compensation (non commission driven) eliminates the exploitation of investors, where

quality objective financial advice is the product, and the advisor sits on the same side of the table

with the client.

Taxes

I don’t know of one high net worth investor who is not burdened by hefty income taxes. Add to

that the additional drag of investment related taxes and your problem is further augmented.

A rational investor should not necessarily seek tax avoidance, but it makes sense to pursue the

highest after tax return possible. The excess turnover of actively managed funds, will no doubt 20


lead to higher tax bills (whether or not your have a gain in the position). One of the most

effective ways to manage this problem is through tax efficient investment vehicles like index

funds. Tax managed funds that harvest fund gains against fund losses may also be a suitable

alternative. Also, consider allocating positions with higher turnover and distributions in tax-

deferred accounts where possible.

Fees

It doesn’t take a neurosurgeon to understand that fees are a dead drag on performance. The

more it costs to run your portfolio, the less you’ll see in your pocket. Risk reward studies

indicate that investors are paying too much for what they’re getting. On average, investors in

funds with lower fees earn better returns than investors in fund with higher fees, due to the fact

that lower fees are being deducted from gross returns

Exaggerated risk

Investors get paid for accepting market risks, that’s true. But taking calculated risks is a far more

effective way to achieve your desired returns.

Investors that hold concentrated portfolios are bearing far more risk than justified by the

expected return. Concentrated issues include individual stocks, industry, sector and geographic

concentrations. There is no separately priced risk element for any of these oncentration issues,

and no additional return to be anticipated by bearing these risks.Investors should attempt to

spread the risk across various asset classes that include: Large, Large

Value, Small, Small Value, International Large, International Large Value, International Small,

International Small Value, Emerging Markets and Short Term Bonds. Employing these asset

classes in your account will result in true global diversification and tilting toward small and

value should enhance returns over time.

21


Portfolio churning

Whether you or your broker creates the churning, stop it! Technology has made it awfully

tempting and so easy to shoot ourselves in the foot, hasn’t it? Hey, at the click of a button we can

move thousands, even millions from one account, fund, or stock to another.

But, excessive trading has a consequence: transactions fees, taxes (in some cases) and missed

opportunities. Do yourselves a favor; get your finger off the trigger. Trading for the sake of

trading is expensive. Develop a long-term strategy and stick to it. Portfolio turnover should really

be limited to rebalancing, distribution requirements and tax planning. Remember, if you want to

be a long-term investor, act like one!

Liability exposures

Asset protection planning is an integral part of a comprehensive financial plan. While the level of

exposure varies by profession all high net worth individuals risk being sued. Malpractice, and

errors/omissions may be the most obvious threats for certain professions (ie. Doctors, attorneys,

securities professionals). But, if you think it’s your only exposure, think again.

If you are self-employed and your business sponsors a retirement plan you are exposed to

fiduciary liability as well. Plan sponsors (that would be you) retain a fiduciary responsibility to

act with loyalty and prudence, to diversify plan assets, and act in accordance with plan

documents. After Enron (et al) the Department of Labor has been hammering down on

employers that are not in compliance, or fail to offer appropriate choices and participant

education.

Solution: find a competent, objective advisor to oversee the management, education and

administration of the plan. The plan must be comprised of funds with low expenses, a broad

selection of asset classes, and benchmark performance standards. It’s important that the advisor

assume partial fiduciary liability with you. Otherwise, the responsibility falls squarely on your 22


shoulders, and you’re right back to where you started.

23


Lack of integrated planning

Individuals often make the mistake of having a single motive when designing their financial

plan. A comprehensive financial plan is a complex structure that should consist of multiple

planning challenges. Retirement planning, estate planning, marital planning, tax planning, asset

protection, education funding and investment management are among the many factors to

consider. If you want a successful result, no individual component of this plan should be

mutually exclusive.

There is no one-size-fits-all solution. And many of these strategies can be downright expensive,

inappropriate, embedded with commissions or hidden costs, may be lousy investments or lack

integration with your overall plan.

Let’s use in example using annuities, since many states allow them as creditor exempt assets.

Doctor A buys an annuity with a 5% upfront commission, 1.30 % annual administrative fees, and

inside the product holds mutual funds with an average annual expense ratio of 1.19%. Doctor B

buys an annuity with no load (commission), annual administrative fees of 0.60%, and holds

index funds with an average expense ratio of 0.30% annually. Presumably, both doctor’s annuity

assets are protected. But, assuming identical market performance (unlikely), which doctor do you

think will have accumulated more after 20 years?

The asset protection tail should never wag the dog or exist in a vacuum. Asset protection

planning should not come at the expense of the most optimal strategy. Your planning should be

cohesive and integrated. The goal, after all, is to preserve AND maximize wealth.

Don’t be a sitting duck. Armed with this wealth of information, you can empower yourself to

make better financial decisions and avoid financial predatory practices. Now that you have a

better idea of what to look for, who to look for and what to do, your chances of success should

dramatically improve.

24


25


26

wealth management for hni’s

Documents