The management of liquid wealth in the United States, and indeed, in the world, is a well-established industry with many players.  Americans are accustomed to having their wealth managed by others in one of a number of fashions.  As I was thinking about liquid wealth management, I reflected on my own personal experiences and those of many clients and friends.

A Few Questions

Let me ask you to reflect with me as I ask a few questions about liquid wealth management.

What do the very wealthy in America do to manage their wealth?

The very wealthy quite often establish what are called “family offices” through which investments are handled and a variety of personal or family planning activities are administered.  By and large, these family offices hire staffs responsible for allocating assets among a variety of investment funds and strategies, seeking diversification, satisfactory (or superior) returns, and reduction in volatility, or risk. They also monitor investment performance in order to be able to recommend shifts in strategies or allocations over time.

But family offices are more than wealth managers. Family offices are described by Todd Ganos of Integrated Wealth Counsel, LLC, and writing for Forbes.com, as follows:

Perhaps the simplest definition of a family office is an organization that assumes the day-to-day administration and management of a family’s affairs.  To that end, to honestly call itself a family office, an organization needs to provide more that just the standard wealth management functions. Most people in the industry would agree that a family office should be able to provide for tax compliance work, access to private banking and private trust services, document management and recordkeeping services, expense management, bill paying, bookkeeping services (look over here for the Best Toronto accounting services), family member financial education, family support services, and family governance.

My “family office” is my desk at home, so I try to relate.

Let’s focus on investing.  The very wealthy, through their family offices, place their assets across a variety of investment classes, ranging from Treasuries, to fixed income securities, to market portfolios bearing numerous names representing their “strategies,” to private equity funds, and even to hedge funds. Then, there are investments in land, timber and developed real estate, either through REITs or more directly, through proprietary funds, and even direct investments.

In addition, the very wealthy are continually investigating tax-efficient ways in which to preserve their wealth and to pass it to subsequent generations, or, increasingly, to give it away (like Bill and Melinda Gates, Warren Buffet, and many others).

What do the merely wealthy in America do with their money?

In many respects, the merely wealthy do the same thing as the very wealthy, except they may outsource the investment decisions to a trust department of a bank or to a variety of “multi-family offices” or investment managers.

Quite often, the merely wealthy will spend considerable time and money seeking tax and legal advice to accomplish their objectives of intergenerational wealth transfers as well as their charitable objectives.

What do the affluent in America do with their money?

Most affluent Americans place all, or at least large portions of their liquid assets, into a variety of mutual funds, or place their assets with other investment intermediaries who, in turn, place collective assets into some of the same funds used by the very wealthy or make direct investments on their behalf.

There are some who attempt to manage their money on their own.  That’s good for people with training or experience and the discipline to actively manage.  However, based on conversations with many business owners, we tend to lack the time or the interest in managing our liquid wealth personally.  Life and business gets in the way, so many of us tend to rely on others.

What do the rest of Americans do with their money?

Many Americans who may have virtually no liquid assets nevertheless have assets invested on their behalf through their retirement plans at work.

The fiduciaries of these plans who deal with growing pools of assets over time are charged with the duty to invest retirement funds.  They do so through the same vehicles as do the very wealthy or merely wealthy.

Like many other businesses in America, Mercer Capital has a profit-sharing plan with an accompanying 401-k plan for our employees.  We have had the plan for more than 25 years.  Our plans are invested with a trust company that handles the ongoing investment management.  We employ a separate administration firm to handle the administrative and reporting requirements of the plan.

Our employees know about the plan, of course, but their vested benefits are managed indirectly through the plans trustees and the trust company they selected.  They get regular reports and can make certain personal investment decisions in the context of their 401-k plan benefits.

I make this example because it is illustrative of the funds that are managed for many millions of Americans through similar processes.

One More Question

What do the management practices for liquid wealth by the very wealthy, the merely wealthy, the affluent, and the rest of us in America have in common?  There are at least two common threads tying liquid wealth management for all together.

1. Investment Treatment.  The first common denominator of the investing habits of most Americans is that our accumulated liquid assets are treated like investments.  They are placed in the custody of capable investment managers who handle the direct investment activities and periodic changes to our portfolios.  In many instances, the managers will advise their clients regarding asset allocation and portfolio strategy.  In other words, there are structures in place to facilitate decisions regarding asset allocation, diversification, risk profiles, return monitoring, and in many cases, with wealth preservation and transfer activities.
2. Management Fees.  The payment of management fees to asset or wealth managers is the second common denominator. These fees are frequently based on a percentage of assets under management and are paid monthly or quarterly, often in advance. Returns are provided net of these asset management fees, so most people never even think about them.  While a family office may not seem like a management fee, the costs associated with running a family’s office are akin to investment fees, as well.

Earlier, we talked about the principles of diversification and asset allocation.  It is now time to think about how those principles are employed by wealth managers.

Liquid Wealth Management Process

If you Google “wealth management process,” you will see many pages of results.  The process is discussed on the websites of financial planners, money managers, insurance professionals and others.  All of the descriptions of the process involve common elements:

• Learning about a client’s needs and objectives
• Understanding the client’s personal situation
• Determining strategies to meet client goals and objectives
• Implementing those strategies
• Monitoring the progress of the strategies in order to determine when changes or adjustments need to be made, which takes the process back to the beginning.

This process is described as a four-step, five-step, or sometimes, even six-steps or more, depending on how particular firms combine the common elements.

My own take of the circular planning process involves least six discrete steps in the process.

1. Sett overall objectives.  A wise man once said, “If you don’t know where you are going, any road will do.”  Managing wealth is too important not to consider in the context of circumstances in existence at any point in time.
2. Make asset allocation decisions.  Asset allocation decisions are important.  If you invest, you have to decide in what sector or sectors you will invest in and then, what specific securities you will acquire. There is an often-mentioned thought that asset allocation decisions determine some 90% of long-term returns from investing.  The actual study actually concluded that asset allocation decisions account for 90% of the variability  of returns across managers. See this academic paper for more discussion. I don’t know what portion of investment returns asset allocation provides, but allocation decisions are clearly important, if only as a means of diversifying the risks associated with particular markets.  One quick takeaway at this point: If you own a closely held business that represents a significant portion of your wealth, you should be focused on your asset allocation and risk profile.
3. Establish strategies for achieving allocation and objectives.  Where will you invest and with whom?  Will you use a single manager, multiple managers, or a fund-of-funds concept?  Who will help you evaluate performance and progress toward objectives.  If you own a closely held business, this principle is especially important.
4. Monitor Regularly.  Many, if not most investment managers report summary performance on a monthly basis (or even daily in some cases).  Virtually all managers provide detailed performance reports on a quarterly basis. As one example of monitoring, we receive monthly notices of fund performance from the trust company that manages Mercer Capital’s profit sharing plan funds.  And we receive detailed reports on a quarterly basis.  In addition, we meet a couple of times per year in person with our account manager and have other conversations during each year.  We talk about performance and asset allocation and make occasional adjustments to our asset allocation decisions based on these conversations.  The point is, there is regular monitoring. Many people work with financial planners or other wealth managers.  There tends to be a relatively high degree of ongoing communication regarding portfolio performance.  It just makes sense from common sense and client service viewpoints.  There is too much at state to ignore what’s going on. Let me ask this question: If you own a closely held or family business, what do you do to monitor its value in relation to the rest of your wealth?  If you are like many business owners, the answer is either not much or nothing at all.  Like I just said, there is too much at state to ignore what’s going on.
5. Review and reallocate..  Performance over time will cause asset allocations to change as one sector outperforms another.  It may be necessary to reallocate funds from one investment sector, say large capitalization stocks after a period of robust growth, to other sectors to maintain overall asset allocations.  If you own a closely held business, reallocation does not occur automatically or even easily.  We will discuss reallocation strategies later.
6. Revise objectives, when appropriate.  As circumstances change, it may be appropriate to revise investment objectives, and so the process begins anew.

Liquid Wealth Management Process Summary

Wealth managers who work with liquid assets are intimately familiar with these steps, or investment principles, and work with their clients through an ongoing process of setting objectives, deciding on asset allocations and establishing strategies.

Once these are set, there is regular monitoring of liquid asset portfolios, and consistent efforts to enhance performance through manager selection and other techniques.  Then, given varying performance in the various segments of the portfolio, reallocations of assets are made as appropriate to remain consistent with the initial objectives.

Finally, the objectives are periodically reviewed over time and adjusted as necessary to meet the changing needs of clients.