At Wanger OmniWealth, we work at the intersection of life and wealth. That intersection falls within the individualized family offices we provide to our high-net-worth clients. On one hand, that means coordinating with CPAs in connection with tax re­turns, helping reduce estate taxes and managing related mat­ters, and about 100 other things. Our objective is to simplify our clients’ lives and enable them to spend their time the way they want. We seek to optimize our families’ lives, financially and otherwise.

We also serve as our clients’ investment consultant. We are responsible for developing and implementing strategy for them. This is where asset allocation theories, access to the right resources, economic and market views, and individual client needs and behaviors all come together.

Each new family that comes to us has their particular sets of circumstances and concerns. These are perhaps more chal­lenging than ever before. Many of these concerns, as interpret­ed through our decades of experience and current views of the world, are summarized below.

•   2008 through March 2009 eroded many personal balance sheets by around 35%. The scariest part was that we didn’t really know when or how it was going to end.

•   2009 through the first part of 2010 went up like a rocket. Investors gained a false sense of optimism very quickly.

•   May and June 2010 came along and caused us all to realize that we have a long, difficult road ahead.

•   Many investors are concerned about their ability to maintain their lifestyles and level of wealth, in real terms, over a long period of time. They expect to live a long time and would like to leave more behind to their heirs and charities than they currently have.

•   Very wealthy individuals are routinely selling vacation homes and cutting back. Most of what we have seen isn’t dramatic and it’s not always absolutely necessary. One might argue it is curtailing prior ex­cesses to some degree. However, these actions speak directly to their feelings about the future.

•   Investors really don’t know what to do. Most of the non-clients we meet are pretty much invested as they have always been. Query: How has that worked out over the last 10 years? Further, many investors sold out either partially or in total when the market crashed. The ma­jority of those don’t know how, when, or if to get back in the game.

With that in mind, here are a number of considerations. Let’s call this re-engineering your future. Unfortunately, we’re all forced to address this reality in one of the most difficult times we’ve ever seen.

1. Start at the beginning: People tend to do things backwards. I’d start with a good balance sheet and ask myself, “what is all of this for? What do I need to accomplish with it over the next X number of years?”
2. Focus on cash needs: How much do you need to spend each year? There are a few problems here. Some people tend to underestimate. They don’t consider that they buy a new $80,000 car every year or two, make annual gifts, give to charity, remodel their homes, etc. and they don’t leave enough cushion. The second challenge is that many families spend more than they should.
3. Think again about spending: My experience is that it doesn’t matter how much money one has, you can always out-spend your capital base. I have worked with clients that spent $100,000 per month - pick a number. I am sug­gesting that for many this is the time to do a little soul searching and to make minor sacrifices. In this context, sacrifice is nothing more than choosing one priority over another.
4. Time to understand risk: Most people don’t really under­stand risk until a portfolio depreciates by 40%. It is really important to understand what would happen to your net worth if the Dow went to 8,000, for example. I don’t think that will happen, but it certainly could.
5. Be realistic about return: There was a time when everyone seemed to expect 10% annual returns from their blended portfolios. Most portfolios don’t have a chance at deliver­ing those returns without carrying way too much risk. The tooth fairy died.
6. Who are we investing for? Should the objectives be centered on the senior generation, children, grandchildren, family foundation, or some combination thereof? There are probably pockets for each group that all necessitate different strategies. However, the answers to these questions are not always self-evident and not always properly analyzed.
7. Liquidity: How much of the portfolio needs to be liq­uid? How concerning is it if certain components of the investment strategy cannot be turned into cash imme­diately? How much excess return should one expect for that illiquidity?
8. Cash Flow: There was a time when this meant having enough in muni bonds to provide interest income to cover annual living expense needs. Nowadays, most investors tend to embrace a total return philosophy. That is, the risk and return characteristics should primarily drive the investment strategy as opposed to the cash flows associated with particular investments.
9. Focus on risk first and return second: This requires a great deal of discussion, modeling, and analysis. Both are im­portant. However, for most investors the key is to not give up too much in the down markets. You can’t figure that out once you are in a down market - it is too late. You have to prepare for this scenario when you think it is unlikely to happen. (And certainly if you think it is likely to happen.)
10. Understand that you can reduce risk disproportionately to reducing return: In the old days, if you were 30% muni bonds and 70% stocks you had a particular risk/return ex­pectation. If you changed it to 40% munis and 60% stocks, or 50/50, risk decreased along with return. Today, we have a wide array of investment choices that blend into a port­folio designed to reduce risk substantially while reducing return potential much less.
11. Manage risk and make money: We are asked all the time, “How can you make money in these sorts of markets?” True, it is very difficult to generate positive returns in a year like 2008. However, over a cycle, even one like the last two and a half years, it is certainly possible to manage risk and earn a positive return. In fact, managing risk for severe downturns is a key driver of positive returns over the cycle.
12. Get out of the box: This doesn’t mean take inappropriate risks. Quite the opposite. The old fashioned “retail portfo­lios” that we see are typically the ones carrying excess risk. By getting out of the box I mean to say that most high-net-worth investors need to rethink what they have been doing. The institutional world has been at least ten years ahead of the retail investors. It's time for high-net-worth investors to catch up.

I thought about calling this article, “Let’s Start at the Be­ginning.” We could have talked about particular investments or how you might build a portfolio. However, that’s the middle, or perhaps the end. I wanted to share a few thoughts on how to work up to the portfolio construction process. Most im­portantly, perhaps, are things like knowing what your wealth needs to accomplish for you and why. It is extremely impor­tant that you are clear on the possible outcomes associated with building a strategy to accomplish your objectives. It’s a lot tougher than in 1997. Avoiding failure becomes all the more critical. Creating success is always possible. It may just mean rethinking things from the beginning.

Don E. Scott, Chief Executive Officer,
Wanger OmniWealth, LLC