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

but if I am wrong, I must honestly admit that it will not be the first time I was wrong!

      I wanted to write this book because I feel that a lot more is needed to help individuals manage their wealth. I think that a crucial first step is to help individuals understand the relationship between their wealth and what it does for them, and this may well be the most important failing I noticed in our industry over the last twenty-five years or so. The next step relates to creating a process that allows that relationship to prosper and develop, with all the necessary feedback loops so that individuals can avoid the pitfalls that await them at each turn in the road. Finally, I strongly believe that this will likely lead to changes in the way the industry structures itself so that clients can be effectively served while other stakeholders can earn the rewards they deserve.

      I therefore invite you, each reader, to make up your own mind. A lot of considerably more academic literature has been written on a number of these issues. Not all of it is unilaterally in agreement with my views. It takes more than one to make a market. Thus, read the book, ponder the insights, consider how they apply to your own circumstances, and then decide whether and, if so, how much of them make sense and should be integrated into whatever part of the integrated wealth management process most directly concerns you.

Jean L.P. Brunel, CFANovember 2014

      Introduction

      The first book I wrote on the topic of Integrated Wealth Management was published in 2002, with a revised edition in 2006.4 In truth, it was a textbook whose audience turned out to be chiefly comprised of students of the industry. One day, I actually told a friend who had asked me to sign a copy he had just bought that the best use I could think of for the book was as a means of propping up a table that had one leg shorter than the other three. Another joke I probably overused was that it should be prescribed to people who had trouble sleeping!

      Clearly, I only half meant those jokes, as it had taken me quite a bit more than a year to write the book and I had poured everything I knew – or knew of – into the effort. I was quite pleased (and proud) of the end product. I saw it at the time as a bit of a reference book to which one could go to see not only what one person (me) thought about a particular issue, but, probably more importantly, what the current leading thinkers in the industry thought. I received some praise for it, and it was mentioned as a reason behind an award I received from the CFA Institute in 2011, which is quite close to my heart. Therefore, I still look back on the effort as both useful and quite worthwhile. With the second edition nearly nine years old, I could simply have endeavored to bring the text up-to-date, called it a third edition, and left it at that.

      Yet, I decided to take a completely different route. I decided that the experience – quite a bit of it practical – gained over the last fifteen years or so required me to take a different tack. In truth, the theory behind our industry and its day-to-day activities has evolved somewhat, but the change has not been radical. Even something as “big” as goals-based wealth management, which was pioneered in 2002, has really not caused massive change in the last few years; we have seen slow evolution, at best. Goals-based policy formulation itself has only seen modest refinements, arguably in large measure because it has yet to be broadly adopted. We first need to see what really causes practical implementation challenges and what works well as is before we can finalize the full specification of the approach. In short, you could argue that the baby has been born, but that it still needs to go through many of its normal growth phases.

      This book is, therefore, about sharing that experience, with the main focus being on what I see as the cornerstone: goals-based wealth management. The vast majority of people who know something about managing assets or wealth agree with the simple statement that the key to long-term success resides in having the right strategy. This truth has often been phrased in ways that obscure rather than clarify the point: “Asset allocation is the main contributor to long-term returns.” In fact, the statement is only partially true and, more importantly, is missing a key word. The correct formulation5 is that one's “asset allocation is the main contributor to long-term risk.” In fact, I take this one step further; I add the word “strategic” so that the phrase becomes: “Strategic asset allocation is the main contributor to long-term risk.” This allows one to distinguish between the long-term investment policy and tactical portfolio rebalancing or tilting. The former is what drives the long-term performance expectations for the portfolio in terms of both return and risk. The latter involves the activities associated with shorter-term portfolio moves either to bring a portfolio that has drifted away from policy – as a result of market performance – back to it or to take advantage of occasional, perceived market opportunities. These rarely generate more than a minute portion of total return and, if properly managed and executed, return volatility; in fact, rebalancing or tactical tilting often fails to generate extra returns when it is executed in a tax-oblivious manner and taxes are taken into consideration. So, in short, the fundamental element of our thinking should be that strategic asset allocation drives long-term expected risk and, thus, returns.

      Experience has taught me that goals-based wealth management is the best way to deal with the formulation of that strategic asset allocation, at least when it comes to individuals with more financial than human capital. Clearly, the experience I want to share does not exist in a vacuum. I will have to recall certain facets of theory from time to time; if only to stay grounded. Yet, I will refrain from detailed exposition of theory and will rather strive to keep linking it to what it means to the affluent and their advisors alike, in a very practical way. In fact, the conceptual framework used in each of the four parts of the book will involve setting out the issue with a sufficient recall of theory to provide the base on which and the principles with which we can build. I will then translate this base and these principles into day-to-day language, illustrating one of the most important lessons I have learned in the last fifteen years: clients do not ask advisors how to make a watch; they ask them what time it is! To wit, they ask us to translate for them the stuff we learn in our jargon, which I have come to dub “financialese.” Being a client certainly does not absolve any affluent individual from his or her share of responsibility in the joint enterprise in which we cooperate: the management of their wealth. However, these responsibilities do not extend to the need to learn a foreign language. Clients should feel able to rely on advisors to translate their needs into the realities of capital markets and to explain to them what is possible and what is not, how one can proceed and what to expect.

      The goal here is to focus on the most important issue affecting the affluent: how their various goals, constraints, and preferences should drive the strategic – or policy – allocation of their financial assets and how the process has to take into account the very natural fact that we are all subject to a variety of emotions. Will these always help us? The effort must, therefore, reflect all of the client's personal circumstances to allow the advisor to feel safe that he or she does understand what he or she needs to do before actually doing anything. It should also allows the client to feel equally safe so that he or she can accept that there are emotional elements at play and that he or she has to learn how to deal with and control them. Last century, at J.P. Morgan, one of our standard lines was that we would not touch a penny of our clients' assets until we knew exactly what the client needed. This was not a principle limited to the Trust and Investment Division; the classic JPM advertisement, which displayed a blank mirror and stated that “Some time, the best thing to do is to do nothing,” illustrates that it applied to the institution as a whole. The main message there and in what we told clients is that we would not start work and charge a fee if we did not think that the client's goals were feasible. And before we could tell whether these goals were feasible, we had to understand them. In the Preface, I mentioned the case of a young man with $10 million in assets who spent $250,000 a year. I stated that I would not consider him affluent because he could not maintain that level of spending unless he quickly got a job to add wages to investment income. I am sure that more than one family patriarch or matriarch will immediately think of this or that descendant who needs to adjust their lifestyle to be sure that some of the capital that the individual inherited is left for his or her own descendants; similarly, I am sure that a few of our readers within the wealth management industry will recognize real-life circumstances when they had clients who were trying to achieve

4

Brunel, Jean L.P. Integrated Wealth Management: The New Direction for Portfolio Managers. Institutional Investor Books, a Division of Euromoney Institutional Investors PLC, 2002. (2nd ed., 2006.)

5

Brinson, Gary P., L. Randolf Hood, and Gilbert L. Beebower. “Determinants of Portfolio Performance.” Financial Analysts Journal, 42(4), July/August 1986 or, Brinson, Gary P., Brian D. Singer, and Gilbert L. Beebower. “Determinants of Portfolio Performance II: An Update.” Financial Analysts Journal, 47(3), May/June 1991, pp. 40–48.