Tuesday, October 19, 2010

Beating the Odds in Wealth Preservation

My boss Jay Henderson passed along an interesting article to me last week.

Titled "Creating a Goal Based Wealth Allocation Process", the piece is written by Ashvin Chhabra, Ravindra Koneru and Lex Zaharoff.

The article discusses strategies that advisors can follow in helping their clients achieve their goals. I have posted a link to the complete article below, but I thought I would highlight just a few thoughts.

Long term wealth preservation is harder than it seems. The most interesting paragraph, in my opinion, was about halfway through (I have highlighted a couple of lines, as well as adding a paragraph break):

In researching how wealthy families created their wealth and then how some were able to sustain it while others lost the wealth, we came across the following insight. To create wealth required concentrated risk taking, often magnified through leverage. To sustain it, the better strategy was to diversify and take a diverse portfolio of risks.

This was highlighted through a study of the Forbes 400 ( a list of the wealthiest individuals in the U.S.) over a 23 year period. Of the 400 on the list at the beginning of the 23 year period, only 50 remained on the list. The principal factor in dropping off the list was that they did not change their approach to risk taking and their concentrated wealth did not keep up with increases in the market. The interesting insight from this study was that any of the original 400 who would have sold their concentrated asset at the beginning, paid taxes and simply invested in the S&P 500 index, would still be on the list today.

The authors go on to discuss the steps that wealthy families should consider in their investment strategy.

In their opinion, there are seven factors that should be considered in a successful strategy:
  1. Taxes
  2. Cash Flows
  3. Asset Location
  4. Minimum Wealth Level
  5. Understanding Multiple Risks
  6. Keeping it Simple
  7. Factoring in Emotions
In the end, all successful investment strategies should have three broad objectives: Protecting one's minimum wealth level; maximize the probability of maintaining one's standard of living; and provide an opportunity to reach for "aspirational" goals.

I won't go through all the details of the article here, but if you're interested I would suggest either buying the article at the link below or using Google to get the full text.