Goals-Based Wealth Management. Jean L. P. Brunel

friends who neatly fell in two categories: several of them believed in the concept of goals-based wealth management, but others were openly skeptical. They all, however, provided very insightful and useful comments without which the text would be less interesting, quite a bit poorer, and much harder to read and follow. So thank you, in alphabetical order, to Thierry Brunel, Mark Cirilli, Vera Cvijetic-Petrovic Boissier, Kevin Irwin, Jean Karoubi, Mel Lagomasino, Jack Parham, Todd Pines, Kevin Prinsen, Vincent Worms, and Michael Zeuner.

      I should obviously thank Wiley for their willingness to support and publish this text. Laura Gachko, senior editor, Digital Business Development, Professional Development, stands as the first person I should thank, as she was the one who negotiated the contract that led to this book. Judy Howarth, senior development editor, helped me manage the writing schedule, gave crucial feedback along the way, and captained the team as the book went from manuscript to published book. Finally, Tula Batanchiev, associate editor, Professional Development, was always there to make sure that everything ran smoothly, from designing and selecting a cover to setting up the website. I could not imagine working with a more professional and helpful team.

      Last but not least, I must thank my wife of forty years and business partner of almost fifteen, Debbie. She went through numerous iterations of the manuscript with an eagle eye for typographical or grammatical errors, but, more importantly, for flow and even contents as well. She tolerated my “mental absence” while we were entertaining friends in our home in the south of France last summer, as I would only appear at meal time and spend the rest of the day holed up in my office working at the keyboard. Without her patience and understanding, I surely would not have met the deadline we had agreed to meet with Wiley & Sons.

      Preface

      I have spent the last thirty-eight years in the world of investment management and the last twenty-three dealing with the people we all call “the affluent.” Although I do not want to cast aspersions on anyone, I feel that we – as an industry – have not done the best job serving them, in part because we have not sufficiently adapted our processes to their specific needs and in part because the affluent have not always taken the time to discern what they really needed. My point in this Preface is to take our readers through the evolution of our industry and its market over the last forty odd years, to describe the way our industry is currently structured and operating, and to identify the mission I feel it needs to fulfill. I also want to discuss the three areas of focus that should help me achieve my goal of contributing to the further growth of the industry: (1) recognize the need for humility, (2) promote a sharper focus on the definition of the goals of our clients, and (3) discuss the potential for a restructuration of the typical advisory firm so that it can better serve its target market. But, first, we must define what we mean by “the affluent.”

      There are about as many definitions of that group of people as there are people trying to serve them. They can be described by the financial assets they possess, but this can be misleading, as assets can be income-producing or not; they can be owned or in some form of generational wealth transfer structure; they can be liquid or illiquid; they can even cost more to maintain than they produce in terms of income! Think of the aristocratic European families, for instance, who conduct guided tours of what is left of their castles or estates because that is the only income they have to live on and maintain these massive structures!

      I define the affluent as a group of people who have liquid assets of at least $5 million and who could maintain their lifestyles drawing income and principal from these assets, even if they do not earn material outside revenue. Thus, a family with $5 million, where both husband and wife are in their early sixties and semi-retired and spend $250,000 a year would qualify. By contrast, a single individual – a young man, for instance – with $10 million who spends the same $250,000 a year and is in his thirties would not be affluent, by my definition. Our semi-retired couple does not have to change their lifestyle to enjoy a high likelihood of not running out of money in the next twenty-five or thirty years, which corresponds to their current life expectancy, if they have taken the precaution to buy appropriate catastrophic insurance.1 By contrast, the young man in his thirties has a sixty-odd-year life expectancy; unless he is an excellent investor, he could well run out of money spending about 2.5 percent of his assets each year, particularly if inflation was to play dirty tricks on him. He could run out of money in two different ways. First, he could run out of money by taking too much risk that does not pan out into higher returns if he simultaneously tries to grow the assets while being unwilling to cut his spending. Conversely, he might run out of money by being too conservative in his investments, which would then not earn enough of a return to carry him through the balance of his life, let alone the possibility that his spending might change as and when he decides to marry, start a family, and raise children! In short, you have to look at assets, running spending rates, and required horizons before labeling someone – a family or an individual – affluent in my definition.

      Over the last twenty plus years, I have had the luxury to follow the evolution of this industry with a serious dose of fascination coupled with cynicism. When I first started to work with the affluent, as the chief investment officer of J.P. Morgan's (JPM) Global Private Bank, the vast bulk of the industry's assets, at least in the United States, were comprised of inherited money. JPM at the time had to be one of the largest players in the industry globally, and probably the largest in the United States; we used to figure that 80 percent of the financial assets entrusted to us were either in trust or inherited. Our clients trusted their portfolio managers and trust officers, and these people truly tried to do what was best for their clients, rather than for themselves or their employer. In fact, I vividly remember our “big boss” reminding us at every opportunity that “clients pay your salaries, not the bank!”2 Fiduciary responsibility – putting client interests ahead of our own, duty of care and loyalty, avoiding conflicts of interest, and managing costs and expenses for the benefit of the client – was our sole guiding light. In truth, the processes we used were, with the benefit of hindsight, somewhat simplistic, but some of that was driven by the law. Would you believe that we were told then that hedging currency risk in foreign equities, for instance – which required us to buy foreign exchange contracts – was a speculative activity?

      Back in the late 1960s, the industry experienced a first important change, which affected both private and institutional wealth management, although it is fair to suspect that private clients might not have totally accepted or even understood it. The advent of modern portfolio theory that resulted from the work of Nobel Economics Prize laureates Harry Markowitz and Bill Sharpe led us and many others to begin to view the investment “space” as a two-dimensional affair that comprised both return and risk. Hitherto, the principal focus had been on return.

      Then two other changes impacted directly the private wealth management industry. First, the make-up of the clientele began to change. With the substantial equity market rally that followed the success experienced by Fed Chairman Paul Volker fighting inflation and with investment bankers much more diligent looking for mergers and acquisitions or initial public offerings, self-made money was becoming a much more important source of clientele for investment managers. These clients were different from inheritors in several ways. The two main differences were that they were less educated in the behavior of financial markets – their experiences were with creating and running businesses – and much more demanding of their financial advisors – they had achieved their status of financial wealth through and with the help of advisors and were not afraid of being tough with them. They quickly found trust officers too sleepy – little did they know that those officers were by and large simply doing their jobs and following the rules that were laid down for them. In addition, having dealt with investment bankers and brokers when selling their businesses, they were more inclined to hire them rather than those bank trust departments when it came to choosing a wealth advisor!

      The second change was the growing recognition, which JPM pioneered in the United States, that individuals were very different from institutions in that they had to pay taxes. The phrase was coined: “It's not what you get, but what you get to keep that counts!” This moved us from our two-dimensional space to one that had a third dimension, tax-efficiency. It would prove to be an important source of innovation starting in the second half of the 1990s. Although that focus has

1

This is needed because some catastrophic event, such as a major health crisis, can quickly and irreversibly eat up their savings and make it impossible for them to sustain their lifestyle to the end of their lives.

2

Note that he was only echoing the famous quote by Henry Ford: “It's not the employer who pays the wages. Employers only handle the money. It's the customer who pays the wages.”