Affluent investors should carefully consider their liquidity needs, privacy concerns and diversification strategy.
Along with identifying your goals and time horizon, assessing risk is a key part of building a holistic financial plan. And while affluent investors generally have higher risk tolerances, determining their individual risk profiles isn’t straightforward.
For those with large and varied investment portfolios, it can be difficult to visualize how a major market decline or sudden interest rate shift would impact your overall financial situation. And if you’re more easily able to absorb losses, it’s not always simple to distinguish what level of volatility in your investments’ value would be tolerable versus intolerable.
Despite these challenges, it’s crucial for wealthy families and individuals to actively assess their risk profile. They may have exposure to additional forms of risk than other investors, and they also may have heightened concerns about preserving their financial legacy for future generations and their preferred charitable causes.
The renowned American economist Benjamin Graham once said, “The essence of investment management is the management or risks, not the management of returns.” Let’s take a look at a few risk topics that may be of particular relevance for affluent families.
Financial liquidity refers to your ability to meet immediate expenditure obligations with cash. This is a notable consideration for investors who many have a significant portion of their net worth tied up in illiquid assets, such as real estate, businesses or an executive compensation package.
It’s also important to address if you derive your income from multiple sources and at irregular intervals over the year, rather than receiving a steady cash paycheck. It’s prudent to assess your liquidity needs and, if appropriate, consider flexible lending solutions to help prevent disruption of your investments via inopportune liquidations (and the tax implications that can accompany them).
Affluent families in particular may need to evaluate their exposure to various forms of legal risk. For example, if someone brought action against your business, could they come after your personal assets as well? Be sure to approach your personal and business insurance coverage – as well as your company’s legal structure – thoughtfully, and distance your assets from your business’ when possible, by reviewing asset protection strategies which could include asset titling, insurance and trusts.
When it comes to privacy, bear in mind that deliberate titling of assets and accounts can affect what appears in public records. In addition, if you value confidentiality around your philanthropy, certain vehicles such as donor advised funds can allow for greater anonymity than others when it comes to personal tax returns.
While portfolio diversification doesn't guarantee investment returns or eliminate risk of loss, there may be certain assets appropriate to incorporate in higher-value portfolios to reduce correlation with the direction of the markets. These can include a range of vehicles such as hedge funds, managed futures, funds of funds, private equity, private real estate and other alternative investments.
The opportunity for growth and supplemental diversification is key, however, keep in mind that alternative investments should only comprise a small percentage of an overall portfolio due to high potential losses. Your advisor can carefully consider the choices that complement your existing financial objectives before moving forward.
Another valuable tool your advisor may offer is the ability to run simulations of different macroeconomic changes to show you how your investments would respond. This can be especially helpful for affluent investors with a large portfolio and wide range of holdings. Visualizing what a broad-based equity decline or sudden increase in interest rates would look like for your unique portfolio can be a valuable tool in assessing risk.
Your advisor can help narrow in on exactly what level of loss you are financially and emotionally comfortable with sustaining, and then adjust the target risk level of your portfolio accordingly.
Risk management isn’t a one-and-done task – it’s an ongoing consideration that should be revisited over time as your needs and goals shift. Your advisor can work with you and other risk management professionals to assess your situation and implement strategies to mitigate the risks most applicable to you and your family.
Alternative investments involve specific risks that may be greater than those associated with traditional investments and may be offered only to clients who meet specific suitability requirements, including minimum net worth tests. You should consider the special risks with alternative investments, including limited liquidity, tax considerations, incentive fee structures, potentially speculative investment strategies, and different regulatory and reporting requirements. You should only invest in alternative investments if you do not require a liquid investment and can bear the risk of substantial losses.
Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. There is no assurance that any investment will meet its investment objectives or that substantial losses will be avoided. Diversification and asset allocation do not ensure a profit or protect against a loss.
