Just glance at today’s world and it’s easy to see how things are rapidly changing – technology, the average life expectancy, the shifting economic paradigm.
I. A World in Motion
Our world is in flux and so the way we invest and grow our wealth is no exception. Today’s clients must adapt in order to protect, preserve and increase their assets.
In this changing economy, the approach that wealthy families take must be multidimensional and extend beyond a “one-size-fits-all” methodology. What we know is that each client is unique, with differing assets, fears and aspirations. Making decisions around a more holistic view of your financial picture can help protect, maintain and enhance your lifestyle. This comprehensive view of your portfolio is called the wealth allocation framework.
II. Before the Picture
The conventional approach to wealth through asset diversification has been to focus on Market risk. With this, only one dimension of risk was considered, therefore leaving out key components of a client’s wealth framework that were not invested in the market – including real estate, business ownership and liquid accounts.
Our new method gives a more comprehensive view of your overall wealth or asset allocation and risk. This new, all-encompassing framework is tailored to better service your needs and help you retain control of your assets. Regions Private Wealth Management is applying the principles of this theory through a tool called the Regions Wealth Assessment.® The Regions Wealth Assessment (RWA) helps you allocate your wealth in a way that protects your current lifestyle while also allowing flexibility to potentially enhance your lifestyle by taking measured risks.
III. Looking Beyond the Numbers
Every client’s needs are unique, and using the RWA, a Regions Wealth Advisor can evaluate your financial needs and goals in a more personal way, customizing a plan that reflects your objectives. The three aspects or “buckets” of risk in the Regions Wealth Assessment framework:
- Personal risk
- Market risk
- Aspirational risk
Personal Risk
Personal risk is a dimension that focuses primarily on protecting your standard of living for your most basic needs, keeping the very foundation of wealth in a solid and reliable place. The assets that fall under personal risk can be your primary residence; cash and near cash investments; insurance on home, property and life; and even the human capital that determines individual earning power.
In short, the goals of analyzing the personal risk bucket are to minimize downside risk and provide safety and liquidity. Protection of assets is the foundation of this effort. Assets in the personal risk bucket have low return expectations because they carry lower risk. Returns should be benchmarked to inflation.
The following factors are considered when looking at Personal risk:
Cash flow – Are you annually a net-saver or a net-spender? Will you need to withdraw money at any point or perhaps regularly?
Lifecycle stage – At the peak of your earning capacity you may be able to take on more risk than someone approaching retirement. Or maybe you want to gift and create a legacy at some point for family or friends.
Ability to weather shortfalls – As average life expectancy increases, how can you protect against outliving your assets?
Event risk – Are you able to protect against a variety of unforeseeable events such as job loss, health concerns, disability, the need to support another family member, lawsuits or shifts in political and economic climates?
Market Risk
Market risk concentrates on market investments such as stocks and bonds. The goal is to maintain the lifestyle that you’ve worked so hard to achieve. Its elements can include fixed income, stocks, bonds, funds, equities and IRAs. Most securities fall into the Market risk category.
The primary goal of the Market risk bucket is to balance risk and return in order to attain market-level performance from a broadly diversified portfolio. Allocations to the Market risk bucket should provide risk-adjusted market returns, with the objective of achieving a steady way to preserve your wealth so that your lifestyle can be maintained after retirement.
It is clear, though, that both the Personal risk and Market risk buckets deal solely with securing and sustaining your assets. But what about the future? Assets in these buckets generally do not increase your wealth standing. In order to truly grow your wealth, you must acquire substantially, not incrementally, more wealth. You cannot meet such a goal without taking on substantial risk. This brings us to the third category, the Aspirational risk bucket.
Aspirational Risk
Aspirational risk is focused on specifically enhancing your lifestyle, building what you have into what it can be. Its primary goals are to maximize the upside and take measured risk to achieve significant returns.
Its elements can include executive stock options, concentrated stock positions, single-manager hedge funds, leveraged investment real estate and call options. A family-owned business that forms significant part of your wealth would also be included in this bucket. The Aspirational risk bucket provides the boldness of risk you need to advance your wealth standing. Return characteristics for this bucket are high risk, high return.
As you can see, Personal, Market and Aspirational risks hold different positions along the risk/return spectrum and encompass different types of assets, but all are essential to achieving the type of balanced portfolio that ultimately increases wealth.
IV. Applying the New Framework
Analyzing your personal financial statement and your personalized view of wealth and risk begins by completing a Regions Personal Financial Statement with your Wealth Advisor.
The assets on your statement are then wrapped into the risk buckets and analyzed by your Wealth Advisor. Hedge funds, private equity, real estate, futures, commodities and FX have become an integral part of the investment portfolios of the wealthy. The wealth allocation framework looks at all of these investments closely in terms of both their particular risk-return characteristics and the role they play in your portfolio.
Real Estate
A primary home along with its mortgage fits in the Personal risk bucket. An investment property such as a condominium for rental purposes belongs in the Aspirational risk bucket.
Executive Stock Options and Company Stock
Stock options belong in the Aspirational risk bucket. However, if any of the stock or stock options can be hedged, then depending on the structure of the hedge, the hedged portion would move to the Personal or Market risk bucket to focus on protecting and maintaining your lifestyle.
V. Summing It All Up
Using the RWA to allocate and analyze risk can help clients reduce the impact of bubbles and crashes. Where is the next bubble? Is it gold, the U.S. dollar, municipal fixed income? Knowing that your wealth is managed to protect, preserve and enhance your lifestyle gives you the confidence to invest wisely, taking into account a wider spectrum of key factors. Understanding risk and controlling risk are two different issues. This is why bucketing risk helps you protect on the downside and maximize on the upside. By using the Regions Wealth Assessment, we can incorporate all of your assets and liabilities, including home, mortgage and human capital, as opposed to solely concentrating on financial assets. With a close eye on all three dimensions – Personal, Market and Aspirational – today’s approach to wealth management is tailored to you, with optimum allocation of risk, careful consideration toward your own goals and preferences, and a well-planned strategy cultivating your wealth to grow and prosper.
We hope that this overview has been informative. If you have any questions at all, a Regions Wealth Advisor would be glad to sit down with you to perform a Regions Wealth Assessment based on the principles outlined here.
