My latest quarterly ramblings to my Financial Professionals list are out: Financial Professionals Fall 2022

When asked, we refer to ourselves as “wealth managers” and this month I thought I would explain that term and a few related things.

Wikipedia defines Wealth Management as:

[S]ervices to a wide array of clients ranging from affluent to high-net-worth (HNW) and ultra-high-net-worth (UHNW) individuals and families. It is a discipline which incorporates structuring and planning wealth to assist in growing, preserving, and protecting wealth, whilst passing it onto the family in a tax-efficient manner and in accordance with their wishes. Wealth management brings together tax planning, wealth protection, estate planning, succession planning, and family governance.

I want to explain it in a slightly different way. You may remember Maslow’s Hierarchy of Needs (probably from an Introduction to Psychology class in college). In Maslow’s Hierarchy, each need must be satisfied before the next one is relevant (though there is frequently some overlap). In other words, if you are in immediate physical danger you don’t really worry that much about whether you are loved and respected. I believe there is a similar paradigm that I call the “Financial Planning Hierarchy of Needs” which proceeds from a focus on the individual’s immediate personal finances to a focus on needs that are more distant both temporally (i.e. much later) and relationally (i.e. for more distant people):

1. Desire to be okay financially in the short run. This is the most pressing need. If an individual can’t pay their current bills, the next items aren’t really a concern. (This typically isn’t an issue for our clients, but it is for much of the population.)
2. Desire to be okay financially in the long run. Once the current bills are paid it is time to be concerned about the future. This is a focus on the individual still, but incorporates a longer time period – including retirement.
3. Desire to help your descendants. The next goal is usually to help the children (or grandchildren, and possibly even more distant descendants). Frequently this starts with education expenses, but also potentially includes other gifts or bequests.
4. Desire to help others. This usually takes the form of charitable giving or bequests.

Generally these are funded in order. Item one is generally funded (or is on track to be so) before two, two before three, etc. Financial planning focuses more on the top of the list compared to wealth management.

Over time most people start with a lot of human capital and little financial capital. In other words, in your 20’s you typically don’t have much money but you have a lot of future wages expected. In your 70’s (hopefully) the reverse is true as you have converted wages to financial capital over time by working and saving. Thus, there are two categories of obstacles to achieving the goals mentioned previously that are of varying importance depending on the specific situation:

1. Human capital impairment
   1. Disability
   2. Premature death
   3. Job loss
2. Financial capital impairment
   1. Expropriation (primarily through inflation and taxes)
   2. Divorce
   3. Personal liability (e.g. you cause a car accident)
   4. Unexpected health costs (including long-term care)
   5. Low returns
   6. Casualty (e.g. your house burns down)

Generally financial planning can address most of those risks and at least mitigate if not eliminate them by using appropriate insurance, portfolio construction, legal documents, legal entities, etc. As noted earlier, as compared with financial planning, wealth management addresses these issues in a more integrated and comprehensive manner, and typically for people with somewhat higher net worth.

To summarize, as the wealth of the individual or family increases, the focus typically includes more distant descendants (in time) and more distant people (in space). In other words:

• If you don’t have a particularly high net worth you may just be trying to pay for your children’s college. (financial planning)
• If you have a significant net worth you may be trying to make sure there are trust funds that will provide for your family for generations, or that your gifts to local charities are made as efficient as possible. (wealth management)
• If you have enormous net worth you may move to another whole level and try to end malaria in Africa! (large-scale philanthropy)

There seems to be view (particularly on the left) that some wealth distributions are grossly unfair (and government should do something about it), but they have not thought through the implications of their beliefs.

Take whatever distribution you think is the outer limit of fair, for example suppose you think no one should have more than $1 billion dollars net worth or less than $100,000 of net worth. Or (equivalently) no one should have a net worth in excess of 10,000 times someone else’s. The actual distribution doesn’t matter. It could be that everyone should have exactly the same amount, whatever. As long as you think there should be some limit on either end (I’ll use the $X for the top end and $Y for the bottom end) then:

• If you are at $X maximum you are (functionally) not allowed to work or invest. If you do so you would go over the limit.
• If you are at the $Y minimum you are not allowed to spend any of your money because then you would be under the minimum. So you really don’t have $Y since you aren’t allowed to spend it!
• Suppose the $X person is an entertainer and wants to do a show, and suppose the $Y person wants to pay to go to the show. The tickets are $1. They are not allowed to transact! Even though both would like to, it would be illegal if you really believe that no one should have more than $X or less than $Y.
• If “everyone” gets $Y net worth regardless of what they do then they should spend extravagantly and the government will give them back what they spend because they would be below the minimum “fair” amount.
• Alternatively, if “everyone” gets $Y net worth regardless of what they do then they could take that $Y and buy deep out of the money options (or lottery tickets, or whatever). If they win, then they are rich, but if they lose the government gives them the money back!

This is insanity!

My latest quarterly ramblings to my Financial Professionals list are out: Financial Professionals Summer 2022

Below are some strategies for coping with market downturns. Before getting to that though, it is fundamental to have an appropriate portfolio before the downturn occurs. That means not only properly diversified, but also one with a risk level that you will be comfortable with when the inevitable downturns come.

One very popular strategy is to simply don’t look at your portfolio. Most people, when they look at their portfolios, are happy when the value has increased and are unhappy when it has decreased. The magnitude of the change seems less important than the direction in determining how they feel. Therefore, to maximize happiness, most people should probably look at their portfolios less often. Here’s why:

From the beginning of 1988 (I don’t have daily total return data prior to 1988) through 6/28/22, the U.S. stock market (using the S&P 500 total return index still) has had an average annual return of about 10.5%. In other words, ignoring transaction costs and taxes, $10,000 invested at the end of 1987 in U.S. stocks with dividends reinvested would have grown to about $315,000 today. If you looked at your portfolio daily during this period you would have been unhappy about half the time, while if you looked annually, you would have been happy about 4 out of 5 times. Here are numbers:

Frequency of Looking	Happy	Sad
Daily	54%	46%
Weekly	58%	42%
Monthly	66%	34%
Annually	79%	21%

Ideally you could be both happy and informed, but in this case, there is a trade-off; knowing the current value of your portfolio frequently is likely to make you less happy.

Another key strategy is to have a significant margin of safety. In other words, spending significantly below your resources (relative to income pre-retirement, and relative to portfolio size post-retirement) gives comfort that in virtually all situations that you will be just fine. We probably don’t need to spend as much as we do. I’m going to make some book recommendations below so here I’ll mention Walden; Or, Life in the Woods (1854) by Thoreau or The Quest of the Simple Life (1907) by William Dawson for perspective on how much we need.

You can also rebalance your portfolio. (We take care of this for you if you are a client.) This means trimming portfolio holdings that have been doing better and purchasing more of relative losers. This is important in good times as well, and is difficult for people to do in both scenarios.

You might also add to your portfolio when the market is down. We wouldn’t recommend holding cash waiting for a downturn, but if you find you have excess cash it’s always a good time to invest (because expected returns on investments are always higher than cash, though realized returns may turn out not to be).

If you have holdings in a taxable (i.e., non-retirement) account you may also be able to tax-loss harvest. (Again, we take care of this for you if you are a client.) This means selling positions that have losses to reduce your taxes. There are nuances to this (e.g., wash sale rules) but it can be a good opportunity.

It can also be helpful to maintain a long-term perspective and be aware of market history – plus ça change, plus c’est la même chose! This is harder if you aren’t a financial professional as the time investment is probably unreasonable for an individual, but I would recommend you read The Rational Optimist (2010) for a much-needed counterpoint to the fear and panic that seem to feature in our society.

Finally, and this may be the very best recommendation, you could read books such as Man’s Search for Meaning by Viktor Frankl. It is difficult (and perhaps impossible) to read a first-hand account of the Holocaust and simultaneously worry about your portfolio size!