Aurora Borealis
1 May 2012 CFA Institute Journal Review

Goal-Based Wealth Management in Practice (Digest Summary)

  1. Gregory G. Gocek, CFA

The author advocates for a broader definition of the investment function of wealth management in order to align it more effectively with the reality of client objectives. He offers a practical methodology for making that adjustment.

Catalyzed by the 2008 financial market meltdown as well as an increased understanding of investor behavior, which reinterprets perceived risk as the probability of failing to achieve an investment goal as opposed to the volatility of returns, financial advisers are modifying their processes accordingly. With strategic asset allocation increasingly driven by a mixture of client goals, a new framework of wealth management operations spanning the totality of financial, estate, and investment planning needs can have practical value for practitioners.

The author argues that within the complexity of multidimensional family wealth planning, the investment decision-making component has traditionally focused too simplistically on searching for an appropriate risk–return utility function. It is more effective to translate allocation techniques in terms of the reality of client imperatives, such as maintaining a desired lifestyle over an intergenerational planning horizon.

Illustrating the implementation of a dynamic goals-based asset allocation process, the author explains that its key initial distinction is between internal and external assets, with a family dividing its assets into the two buckets to split those it will manage itself, such as a family business, from those assigned to external managers. Although superficially simplistic, this split compels a fundamental division of labor through which all parties (asset owners and their agents) can concentrate on their most suitable means to create value.

The bulk of the discussion examines the external branch of this division, which is handled by investment advisers. First, practitioners help by identifying assets needed to support clients’ lifestyles in the short and long term. The author notes that a “declining-balance portfolio” (in contrast to an endowment approach) that funds a discrete spending period with a 15-year planning horizon is a common choice.

Once fundamental consumption objectives are addressed, attention can be directed at nonlifestyle goals. Although possibilities can be infinite, ultimately clients’ aims fall within three generic categories: personal, dynastic, and philanthropic. Each has its associated implied risk profile, and all must reconcile the trade-off between capital preservation and growth. Questions related to growth involve the five issues of unexpected inflation, protection against generational fragmentation of assets, potential lifestyle changes, transparency of future needs, and investment performance measurement.

To make these concepts concrete, the author presents a detailed practical model that illustrates how family goals can be pursued when they are matched with the specific policy portfolio and investment instruments to attain them. The model uses nine modules across the lifestyle versus nonlifestyle goals, covering all major subobjectives of income generation, capital preservation, growth, and an “opportunistic” category to capture potentially attractive but unknown possibilities. Asset amounts/shares are denominated for each category. The allied policy portfolio designed to deliver these results is presented and summarized in terms of both related-dollar amounts and percentage allocations. Although the model of goals is tailored to particular family circumstances, the policy portfolio can, in principle, conform to “mass customization” across the nine modules and thus provide a multiclient practice with some economies of scale. The policy portfolio also has the flexibility to adjust to both the tax statuses of clients and their preferences for traditional versus alternative investment vehicles.

This process is described as synthesizing the independent dynamics of family goals and capital market realities. It deals with the complexity of the former, which can entail associated diverse asset mixes, concentrated (sometimes low basis) positions, and ingrained investment preferences, by using a simple, standardized portfolio structuring. Although he acknowledges it is not an all-purpose, universal solution to the wealth management challenge, the author stresses that the process’s “bottom-up” appeal may provide real hope for mapping assets to goals with more transparency and may reduce the chance of emotionally driven missteps.

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