Think big picture: Understanding real wealth management

Doug Nelson, a family business specialist, and a speaker at the Knowledge Bureau’s Distinguished Advisor Conference this year, says determining wealth involves more than just adding up numbers — advisors must also take into account things like taxes, fees and inflation. If these factors are considered in a financial plan, then you’re not just determining wealth, you’re calculating real wealth.

“When we define real wealth, we need to take into account taxes, inflation and fees,” says Nelson. “We have to examine all aspects of things we do as advisors so we can achieve the long-term objectives of our clients. That’s very contrary to what you hear most people recommending.”

Nelson says without taking extra costs into consideration, it’s impossible to determine how much money a client actually has.

“If we’re paying attention to accumulation of real wealth and to all the things that can detract from accumulating wealth, then the result is that people ultimately won’t need to invest as much in order to accumulate the same or more,” he says. “That leaves more money in their pocket.”

Of all the hurdles that could bring down a person’s real wealth, taxes are the biggest drain. Nelson determines that 28% of a client’s worth is related to tax efficiency. So, if the client’s forking over a lot of tax money, then his or her portfolio will be significantly affected.

Softening tax implications for your client shouldn’t be too difficult, says Nelson. The first step, he explains, is understanding the tax system. “Advisors are pretty good in seeking out and improving their tax knowledge, but you can never have enough,” he says.

The second step is looking at a client’s tax return. “The tax return tells you a lot about where different sources of income come from, what their top marginal rate is, or how that’s divided between spouses,” says Nelson. “It raises the question ‘Are there ways in which you can get money into a lower-taxed person’s name?'”

Clearly, there are ways to reduce taxes, but getting fees down for a client is an entirely different story. Nelson says decreasing fees requires the industry to stop looking at advisors as salespeople and more like professionals who are offering a service. Then advisors can charge professional fees, instead of packaging them within a product.

“Right now, there’s imbedded compensation in a lot of products,” he says. “Advisors will often give away advice on retirement planning, estate planning and more. They’ll say that’s part of the trailer fees. In fact, if you separated the two, we could reduce the fees for the clients on the portfolio, which will help accumulate long-term wealth.”

Getting fees down — even 1% — will save an investor a ton of cash. If a client invests $100,000 and sees a 10% gross return with a 2% management fee — for a net return of 8% — the value of the investment in 25 years will be about $684,847.

Drop the fee to 1%, which then gives the investor a 9% net return, and the value of that investment will be 26% more, or $862,307.

“Nobody has a problem paying a professional fee if they’re getting a good value for it,” says Nelson, “but the challenge for investors today is they’re paying high management fees, and they’re not sure if they’re getting additional value. That’s stunting the growth of their long-term wealth accumulation.”

Once fees, taxes and inflation are reduced and taken into account, the real wealth management process can really begin. Basically, the advisor needs to take into account everything a person owns or owes. Nelson calls this the net worth statement.

“We need to look at the whole picture,” he says. “When putting your money to work, sometimes you can get a better bang for your buck by reducing debt, rather than investing.”

In terms of investing, he cites an example of a business-owner client who wants to get into the stock market. The real wealth advisor will say to the client, “You’re taking a lot of risk in your business. Do you want to take the same type of risk in investments?” Nelson says the client will likely say no.

“He wants his investments to be his safe money and his business to be his home-run money.” With that knowledge in hand, the advisor will then tread conservatively when investing the client’s capital — something he might not have considered if the client’s non-investment assets were not taken into account.

When the real wealth management approach is implemented, not only does the way one determines wealth change, but portfolio construction can be seen in a new light too.

Richard Croft, an investment advisor specializing in portfolio construction, and a speaker at the DAC conference, likens real wealth portfolio construction to a trip to the grocery store. He says if he were an investment manager, he’d buy the leanest deli meat at the best value he could find. Then he’d buy a loaf of bread. However, he’d look at these two items individually, instead of trying to create a sandwich.

A portfolio manager would buy the meat and bread, and then make the sandwich. “Clients need to get away from looking at individual securities and focus on the whole picture,” he says.

He says a client could have a portfolio with 10 stocks, two that are up and eight that are down. An investor who looked at the stocks individually would probably question the advisor’s ability to govern his or her money. But if the advisor points out that two stocks performed so well that the whole portfolio had a positive return, the client might actually be pleased. “It’s important to get the client to focus on the bottom line, and that’s the entire portfolio value,” says Croft.

When it comes to portfolio construction, advisors can’t just look at investing in individual stocks for the clients. If they can get the client’s head around the total portfolio concept, then the client will be less likely to follow individual stock prices or panic when a sector underperforms.

“If I have 10 securities in a portfolio, I have to make 10 decisions and justify them to my client,” explains Croft. “But if we look at the big picture, there’s only a single decision. Portfolio management is all about the interaction of the components in it.”

Croft agrees with Nelson that tax can be the greatest impairment on real wealth. But asset mix isn’t far behind, accounting for 21% of net wealth, he says. The actual security selection accounts for only minimal, single-digit exposure to wealth.

Therefore, single-stock-minded advisors or planners who don’t see the big picture will find themselves making less for their clients than real wealth managers.

“As an advice giver, we’re challenged to provide people with the right advice to sell certain products,” says Nelson. “The damage can occur when you provide advice in a vacuum. In other words, when you don’t have all the information.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(11/14/07)

Bryan Borzykowski

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(November 2007) In today’s financial landscape, determining wealth is tricky. You can tally up the value of investment assets, cash on hand and real estate, but is number crunching really the best way to figure out a client’s worth?

Doug Nelson, a family business specialist, and a speaker at the Knowledge Bureau’s Distinguished Advisor Conference this year, says determining wealth involves more than just adding up numbers — advisors must also take into account things like taxes, fees and inflation. If these factors are considered in a financial plan, then you’re not just determining wealth, you’re calculating real wealth.

“When we define real wealth, we need to take into account taxes, inflation and fees,” says Nelson. “We have to examine all aspects of things we do as advisors so we can achieve the long-term objectives of our clients. That’s very contrary to what you hear most people recommending.”

Nelson says without taking extra costs into consideration, it’s impossible to determine how much money a client actually has.

“If we’re paying attention to accumulation of real wealth and to all the things that can detract from accumulating wealth, then the result is that people ultimately won’t need to invest as much in order to accumulate the same or more,” he says. “That leaves more money in their pocket.”

Of all the hurdles that could bring down a person’s real wealth, taxes are the biggest drain. Nelson determines that 28% of a client’s worth is related to tax efficiency. So, if the client’s forking over a lot of tax money, then his or her portfolio will be significantly affected.

Softening tax implications for your client shouldn’t be too difficult, says Nelson. The first step, he explains, is understanding the tax system. “Advisors are pretty good in seeking out and improving their tax knowledge, but you can never have enough,” he says.

The second step is looking at a client’s tax return. “The tax return tells you a lot about where different sources of income come from, what their top marginal rate is, or how that’s divided between spouses,” says Nelson. “It raises the question ‘Are there ways in which you can get money into a lower-taxed person’s name?'”

Clearly, there are ways to reduce taxes, but getting fees down for a client is an entirely different story. Nelson says decreasing fees requires the industry to stop looking at advisors as salespeople and more like professionals who are offering a service. Then advisors can charge professional fees, instead of packaging them within a product.

“Right now, there’s imbedded compensation in a lot of products,” he says. “Advisors will often give away advice on retirement planning, estate planning and more. They’ll say that’s part of the trailer fees. In fact, if you separated the two, we could reduce the fees for the clients on the portfolio, which will help accumulate long-term wealth.”

Getting fees down — even 1% — will save an investor a ton of cash. If a client invests $100,000 and sees a 10% gross return with a 2% management fee — for a net return of 8% — the value of the investment in 25 years will be about $684,847.

Drop the fee to 1%, which then gives the investor a 9% net return, and the value of that investment will be 26% more, or $862,307.

“Nobody has a problem paying a professional fee if they’re getting a good value for it,” says Nelson, “but the challenge for investors today is they’re paying high management fees, and they’re not sure if they’re getting additional value. That’s stunting the growth of their long-term wealth accumulation.”

Once fees, taxes and inflation are reduced and taken into account, the real wealth management process can really begin. Basically, the advisor needs to take into account everything a person owns or owes. Nelson calls this the net worth statement.

“We need to look at the whole picture,” he says. “When putting your money to work, sometimes you can get a better bang for your buck by reducing debt, rather than investing.”

In terms of investing, he cites an example of a business-owner client who wants to get into the stock market. The real wealth advisor will say to the client, “You’re taking a lot of risk in your business. Do you want to take the same type of risk in investments?” Nelson says the client will likely say no.

“He wants his investments to be his safe money and his business to be his home-run money.” With that knowledge in hand, the advisor will then tread conservatively when investing the client’s capital — something he might not have considered if the client’s non-investment assets were not taken into account.

When the real wealth management approach is implemented, not only does the way one determines wealth change, but portfolio construction can be seen in a new light too.

Richard Croft, an investment advisor specializing in portfolio construction, and a speaker at the DAC conference, likens real wealth portfolio construction to a trip to the grocery store. He says if he were an investment manager, he’d buy the leanest deli meat at the best value he could find. Then he’d buy a loaf of bread. However, he’d look at these two items individually, instead of trying to create a sandwich.

A portfolio manager would buy the meat and bread, and then make the sandwich. “Clients need to get away from looking at individual securities and focus on the whole picture,” he says.

He says a client could have a portfolio with 10 stocks, two that are up and eight that are down. An investor who looked at the stocks individually would probably question the advisor’s ability to govern his or her money. But if the advisor points out that two stocks performed so well that the whole portfolio had a positive return, the client might actually be pleased. “It’s important to get the client to focus on the bottom line, and that’s the entire portfolio value,” says Croft.

When it comes to portfolio construction, advisors can’t just look at investing in individual stocks for the clients. If they can get the client’s head around the total portfolio concept, then the client will be less likely to follow individual stock prices or panic when a sector underperforms.

“If I have 10 securities in a portfolio, I have to make 10 decisions and justify them to my client,” explains Croft. “But if we look at the big picture, there’s only a single decision. Portfolio management is all about the interaction of the components in it.”

Croft agrees with Nelson that tax can be the greatest impairment on real wealth. But asset mix isn’t far behind, accounting for 21% of net wealth, he says. The actual security selection accounts for only minimal, single-digit exposure to wealth.

Therefore, single-stock-minded advisors or planners who don’t see the big picture will find themselves making less for their clients than real wealth managers.

“As an advice giver, we’re challenged to provide people with the right advice to sell certain products,” says Nelson. “The damage can occur when you provide advice in a vacuum. In other words, when you don’t have all the information.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(11/14/07)

Bryan Borzykowski

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