Review & Outlook: Setting a Foundation: Goals-Based Investment and Wealth Planning

October 5th, 2017

 

  • Goals-based investment and wealth planning is the foundation for successful personal wealth management.
  • Investment and wealth plans should reflect an investor’s goals and objectives and define the strategies to achieve these goals.
  • The techniques and technology used to make planning and investment decisions have improved dramatically, providing investors with greater insight and confidence that they can achieve their spending, gift and estate, and philanthropic goals.
  • These techniques and technology can also be used to evaluate alternate investment and planning strategies and in the process, investors may realize they can set bolder and more ambitious goals.

Goals-based investing and wealth planning is hardly a new concept. Growing up in West Hartford, Connecticut, I remember the signs outside the local saving banks advertising “Christmas Club” accounts with special bonus rates. Participants would set aside monies each week in order to have enough to buy Christmas gifts by the beginning of December.1 From a child’s perspective, I believed there was no more admirable and worthwhile investment goal.

Modern life is a little more complex. Goals for wealth multiply, shift in importance and tend to morph over time. Without a structured framework, it is easy to make one of two mistakes: First, it is possible to let the issue become overwhelming, do minimal planning and hope for the best. This can work but luck may be an unintentionally large influence.

Alternatively, an investor could resort to squirreling away little money pots, one for retirement, another for a big vacation and so forth. While the squirreling method can have the benefit of taking advantage of different tax and trust laws, haphazardly fragmenting assets can leave an investor little flexibility to handle changing circumstances and shackled with an overly risk- controlled portfolio of assets.

Glenmede recommends taking a step back and once a year walking through a Goals-Based Wealth Review with your Relationship team to:

1. Create or update the goals for your wealth, including future spending needs, the assets you intend to leave for loved ones and those intended for charitable interests. Specific amounts are helpful, but you can start with educated guesses.

2. Create a personal balance sheet of assets and liabilities. If this is being done for the first time, it need not be exact. Your Glenmede team can help.

3. Assess the probability of meeting your goals.

4. If projections indicate a lower than comfortable probability level, consider alternate investment, spending and wealth planning strategies to shore up potential shortfalls.

5. If projections indicate a high probability you will meet your goals, consider more—or more ambitious—goals for your wealth.

STEP 1: SETTING WEALTH GOALS AND OBJECTIVES

Setting your goals may be the most challenging part of the planning process. Most of us don’t plan decades in advance, tending to focus instead on life’s immediate opportunities and challenges. We recommend a steady and iterative process where your Glenmede team can be an instrumental part of recording and helping you think through your goals. We often start by writing a short summary of your goals for personal spending, legacy gifts and charitable causes. This memorializes your intentions in a document that is reviewed and edited annually or as circumstances and goals change.

We recommend focusing first on your personal goals and estimated spending needs. The latter is particularly important in retirement when expenses are no longer covered by annual compensation. You may also want to factor in expenses such as the purchase of a second home, college tuition or a new business venture.

A second goal worth documenting is your plan for passing wealth to children, grandchildren and other loved ones. Plans can be as simple as allocating remaining funds through an estate. If you are feeling ambitious, you could target minimum and maximum amounts per beneficiary. Finally, you may have significant charitable interests that would require specialized planning.

To better illustrate the annual Goals-Based Wealth Review process, the example below documents the experience of a fictional client, the Rostov family.

CLIENT WEALTH OBJECTIVES   Prepared for Sofia and Alexander Rostov2

Sofia and Alexander live in Austin, Texas. Sofia owns outright $6 million in her company stock, Moonshot Corp. Both Sofia and Alexander have retirement assets and a joint investment account of $5 million. The couple owns a home valued at $1 million with a $250,000 mortgage. Their two adult children, Nina and Emile, have graduated from college and live in Denver and Utah, respectively.

Personal Objectives

Sofia and Alexander wish to retire when they are 61 and 59, respectively. They want to maintain their current lifestyle and estimate in retirement they will need $300,000 per year, indexed to inflation. They would like to purchase a second home in the Texas Hill Country, which they think should cost $600,000. This purchase will increase their annual spending needs by $25,000 per year, indexed to inflation.

Legacy Objectives

The Rostovs’ first priority is to ensure ample provisions remain for the surviving spouse. The second priority is to responsibly and thoughtfully transfer their wealth to their children and future grandchildren. The couple’s most recent wills were drafted in 2016 and mirror each other. They would also like to gift $1,000,000 now to each child, removing these assets from their estate and lowering their eventual estate tax bill.

Charitable Objectives

The Rostovs are actively involved in Austin University of the Arts and would like to make a $1,000,000 gift to the college endowment.

STEP 2: CREATE A PERSONAL BALANCE SHEET

Like many couples, the Rostovs’ financial position is equivalent to that of a small business, but their approach to their wealth has been decidedly personal. While businesses depend on financial statements to operate with checks and balances, individuals have a tendency to rely on memory or an unsorted pile of papers in a file cabinet. It makes tremendous sense for individuals to also operate from a balance sheet, the second step in a Goals-Based Wealth Review.

As a Glenmede client, the Rostovs could create their personal balance sheet by partnering with their Relationship team or by going online and using Glenmede’s WealthView technology. WealthView provides access to a balance sheet which can accommodate all types of assets, including those managed outside of Glenmede such as savings plans, deferred compensation, private company equity, checking accounts, real estate and other asset accounts. This software can dynamically update prices and amounts through online connections. It can also estimate the liabilities, including home mortgages and future taxes on deferred compensation.

The example below shows the WealthView-generated balance sheet for our friends, the Rostovs, from their Annual Wealth Review.

STEP 3: ASSESS THE PROBABILITY OF  OUTCOMES

At this point, the Rostovs have documented their goals and estimated their personal balance sheet. The question, now, becomes whether their current assets and future income will sufficiently meet their personal spending, legacy and philanthropy goals.

There are two ways to assess the probability of achieving success: One assumes “normal’ future market returns; the other assumes a range of below- and above-normal market returns. Glenmede incorporates both sets of projections in its planning to generate the most complete and realistic picture of a client’s future income and asset sufficiency.

In the Rostovs’ case, we first projected their future spending using the assumptions from their Client Wealth Objectives and Glenmede’s estimates for future asset returns and inflation, which assume normal (median) market returns. Our models allow us to gauge approximately how much money should remain when a client reaches the age of 95.

From the data, we determined the Rostovs’ net worth should grow from $13.7 million today to $36.1 million in 2057, when the younger spouse turns 95, after spending and taxes. Adjusted for inflation, their net worth is forecasted to be about $13.1 million in today’s dollars.

Unfortunately, markets don’t travel in straight lines, and even with a long-term time horizon the Rostovs may earn more or less than our long-run median forecasted returns. Hence, we perform the second analysis, where we seek to forecast for good markets, bad markets   and everything in between. The probability of success is derived from this analysis and is an estimate of the likelihood of having enough money to meet all defined goals and not run out of money by age 95.3 Generally, we like to see a probability of success of 85 percent or higher when devising plans.

As it turns out, when we run the second simulations for the Rostovs, the probability they will meet their goals becomes approximately 77 percent. Put another way, there is a 23 percent chance that they will run out of money before age 95 if we go through sufficiently bearish long-term markets.

STEP 4: EVALUATING ALTERNATE PLANNING OPTIONS

The 77 percent probability level is below our comfort level. We would suggest the Rostovs either reassess their goals or evaluate alternate investing or wealth planning options. We have outlined below different strategies the Rostovs could use to raise their probability of success above 85 percent. These include changing their spending plans, altering their investment strategy, modifying their philanthropic strategy and making use of different legacy planning techniques.

a) Change their Spending Plans: This is the “eat your spinach” option. The Rostovs could commit to spending less in retirement. For example, if they were to forego buying a second home, they could still make gifts to their children and charity, increasing their probability of success to 85 percent, well within the comfort zone. Or, they could defer making gifts to their children and charity and put the monies toward their retirement spending and second home purchase. The probability of success with this option is 91 percent.

b) Change their Investment Strategy (Part 1): A good amount of the Rostovs’ wealth is in Moonshot stock. While an individual stock holding can provide tremendous growth, it can also prove far more volatile than a diversified portfolio of stocks. If the Rostovs sell their Moonshot stock, they will very likely incur a large tax bill. Their forecasted wealth level, assuming normal market returns for Moonshot, would drop from $36 million to $25 million. However, by eliminating a very volatile holding, the probability of success rises from 77 in the base case to 81 percent.

c) Change the Investment Strategy (Part 2a): The Rostovs could also reconsider their investment strategy following the sale of their Moonshot stock, by taking more risk in their portfolio. In this scenario, the Rostovs could increase their expected assets to $28.5 million at age 95 in a normal (median) market environment, making up some of the loss incurred by taxes. This move, though, would not change their probability of success.

Change the Investment Strategy (Part 2b): Alternatively, the Rostovs could allocate a portion of their portfolio (10 percent) to private equity and other partnerships. Given private equity historically earned a return premium over typical stocks, the expected median value of assets at age 95 becomes $30.5 million and the probability of success rises to 86 percent.

d) Modify their Philanthropic Plans: Rather than make an outright gift of $1 million to their alma mater, the Rostovs could create a charitable remainder trust with $1 million of Moonshot stock.4 The Rostovs will receive ongoing income from the trust and a taxable deduction. The beneficiary of the charitable trust will receive the trust principal upon the Rostovs’ passing or by a pre-set date. While this does defer their gift, it allows them   to live off the future appreciation. The probability of success associated with this option is 88 percent.

e) Utilize Alternative Legacy Planning Techniques: Another means the Rostovs might consider is the creation of a Spousal Lifetime Access Trust. Using this technique, two $1 million trusts would be created, removing the assets from their estate. The assets can now grow without being subject to future estate taxes. Further, under certain circumstances, the Rostovs could access the money in their lifetime if truly necessary. As a result, their probability of success rises to 88 percent. Another virtue of this approach, the Rostovs will pay half  as much in estate taxes and will leave approximately 20 percent more to their heirs. Of course, with all trust structures there are other implications to this approach.

It should be noted we have shared a hypothetical case study based on specific assumptions tied to the Rostov family. Would these techniques and suggestions work in other cases? That depends very much on a family’s particular facts and circumstances. In the world of goals-based investment and wealth planning, one size does not fit all. Appropriate strategies will vary greatly for different people, and they will change over time as a family’s goals and circumstances change.

STEP 5: CONSIDER MORE AMBITIOUS GOALS

It is quite possible that when we compute your analysis, the projections will show a 95 percent or greater probability of goal achievement. In that case, you could afford to set higher goals. This might include spending more money on personal interests during your lifetime, moving assets from your estate at an earlier age or making more sizable gifts to a charity within your lifetime. Even if you decide not to commit to any particular goal, it is worth running the numbers to know the attainability of these goals and in the process, potentially realize a more fulfilling set of dreams.

Regardless of the path you choose, your Glenmede Relationship team is prepared to help you navigate the different choices and alternatives. Goals-based investing and wealth planning provides an extremely useful framework for evaluating the probability of achieving current goals and knowing the choices and outcomes of alternate planning solutions.

1According to Wikipedia, the first Christmas Club account was started in Pennsylvania by the treasurer of the Carlisle Trust Company in 1909.

2Sofia and Alexander Rostov are two of the main characters from “A Gentleman in Moscow” by Amor Towles. Set in post-revolutionary Moscow, this fictional work is a delight to read, particularly if you enjoy humor at the expense of Bolsheviks.

3Clearly, if you are reading this footnote, you want to know more about how we calculate this number. In this analysis, we simulate out 1,000 different portfolio return scenarios based upon our capital market assumptions. This is known as a Monte Carlo simulation. We then feed these portfolio returns into a simulation of your wealth after taxes and all other cash flows to you, your family or other gift recipients. The probability of success figure is based on the percentage of the portfolio return scenarios in which you don’t run out of money before the end of the projection period. Of course, no probability calculation can be conclusive: due to any number of circumstances, results may not be achieved.

4Using trusts as philanthropic or legacy planning tools can be complex, and should only be done in consultation with a qualified trusts and estates attorney. Nothing in our example should be relied on as definitive tax advice.

Review&Outlook is intended to be an unconstrained review of matters of possible interest to Glenmede Trust Company clients and friends and is not intended as personalized investment advice. Advice is provided in light of a client’s applicable circumstances and may differ substantially from this presentation. Opinions or projections herein are based on information available at the time of publication and may change thereafter. Information gathered from other sources is assumed to be reliable, but accuracy is not guaranteed. Outcomes (including performance) may differ materially from expectations herein due to various risks and uncertainties. Any reference to risk management or risk control does not imply that risk can be eliminated. All investments have risk. Clients are encouraged to discuss the applicability of any matter discussed herein with their Glenmede representative.