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Wealth Management Principles

Wednesday, May 21, 2014

Robert J. Wassel, Jr. MBA, CPA/PFS

Who Are You?

Wealth means different things to different people, but most agree that being wealthy equates to financial independence.  Wealth is highly variable when measured across different time intervals or when viewed from different perspectives.  A mentor of mine frequently reminded me that even a person of modest means in today’s world lives better than kings of 100 years ago.  Our job is to help you identify your current position as either among the truly wealthy, accumulating wealth or both.

A simple definition of wealth is that your investable assets are sufficient to support your lifestyle for the remainder of your life while leaving some, or all, of the principal to your heirs or charity.  This definition requires a regular income stream from your portfolio based on your expenses less non-portfolio income sources, such as pensions or Social Security.  Portfolio income is comprised of interest, dividends and realized capital gains.  Thus, a typical wealth management portfolio may be weighted heavily towards investments that pay regular interest and dividends, such as bonds and large company stock.  Disregarding outside income sources, a person with annual expenses of $50,000 requires a smaller investment income stream than someone with $200,000 in annual expenses.  Being a millionaire doesn’t necessarily mean you are wealthy!.

For those fortunate enough to be among the truly wealthy, maintaining wealth requires managing risk.  All types of risk, not just what we find in the portfolio.  Focusing on portfolio risk, the key issue is whether or not your portfolio can safely navigate the inevitable ups and downs of the world economy and still provide the needed income.  True wealth, coupled with proper wealth management, reduces risk by limiting the downside effect on portfolio value during market downturns while allowing sufficient growth when markets prosper.  Managing wealth effectively does not entail trying to capture the peak of every bubble or anticipate every trend.  Thus, extremely wealthy individuals will pay a billion dollars for a company with 6% after tax income and be satisfied with consistent, albeit flat, profits.  They can live off the $60 million per year!  Trinity Wealth Management uses the term “Stay Rich Pocket” to describe one method we use to manage portfolio risk and keep our clients among those deemed wealthy.

Many high income clients spend years acquiring education, job skills and paying their “dues” in the corporate ranks, yet they never build true wealth.  If they recognize this fact and commit sufficient current resources to building financial wealth, most of these clients have enough time to accumulate the assets required to be included among the truly wealthy.  If this is your situation, you are a wealth accumulator and the proper approach to investing is significantly different.  While everyone needs a certain degree of capital preservation, accumulators need to invest more aggressively to achieve their goal of financial independence.  Thus, accumulators view periodic market declines as a buying opportunity.

Where Are You?

When you begin working with Trinity Wealth Management, one of our first tasks is to identify your assets, income and expenses.  We then determine your goals and objectives and calculate your progress in achieving them.  The outcome of this analysis drives the strategy we recommend.  If you are financially independent, we chart a course for wealth preservation and income.  If you need to accumulate additional wealth to achieve your goals, we chart a course to make that happen.  We believe no situation is without hope.  We live in a great country with a great deal of benefits that are often overlooked and undervalued.  Let’s start by reviewing the principals of wealth accumulation.

Wealth Accumulation

Periodic Investment

Often called dollar-cost-averaging, this is a strategy that mathematically buys more shares when prices are down and less shares when prices are up.  Don’t confuse this strategy with investing a windfall or lump sum.  This strategy is designed to maximize the value of your discretionary income invested each month.  Look at this real life example of the American Mutual Fund, a large value mutual fund, over 10 years.

There is a $12,000 difference in the amount invested between the buy-and-hold and the monthly purchase strategies, yet almost a $30,000 difference in value after 10 years.  The point is you should not wait for a rainy day to start saving to achieve financial goals nor should you wait until you have a large sum to invest to get started.

Riding the Wave

In the accumulation phase of Wealth Management, you can and should take more risk as defined by larger swings in value.  In the example above, periodic investments increase ownership percentage at a faster rate when the value of the asset purchased decreases.  Subsequent price increases then amplify the gain.  I’m reminded of the Andrea True Connection song that went, “more, more, more! How do you like it?  How do you like it?”  We like it very much, thank you.

But what about those times when we hear everything is changing and the world is coming to an end?  In my lifetime, I recall talk of the end as we know it at least a half dozen times.  I can only imagine what the people of the Great Depression, World War II, and the Cold War thought.  There is a powerful message here for all of us: we must be open to make changes, but remain focused on fundamental laws of economics.  One of these fundamentals is long term growth.

There are many ways of looking at investment results. When results are as bad as they’ve been recently, try to keep a long-term perspective, rather than focus on short-term fluctuations.  To gain some perspective, take a look at the S&P 500 results by 10-year rolling returns shown in the table below.

In calculating “rolling returns,” analysts look at the total returns of the S&P 500 in each of the decades that have elapsed since the inception of the index in 1926, the first being 1926–1935, the second 1927–1936 and so on until the latest decade, 1999–2008.

Of these 74 periods, just four decades had negative returns: 1928–1937, 1929–1938, 1930–1939 and 1999–2008. It’s important to keep in mind that past results are not predictive of future results.

The S&P 500: 10-year rolling returns, 1926-2008

Number of rolling decades with positive returns


Number of rolling decades with negative returns


Results are based on the unmanaged S&P 500 calculated with dividends reinvested for the period December 31, 1925, through December 31, 2008. Note that two of the four decades (1928–1937 and 1930–1939) had negative annualized results of just –0.00% and –0.08% respectively.

The Fine Print

One caveat: the S&P 500 is actively managed insofar as the index components are periodically reviewed by a committee and, just as an active manager buys and sells stocks for his or her portfolio, the components of the index may be changed.  This fact creates a survivor bias and the S&P 500 would look very different, and probably not as good, if it still held Enron, Worldcom, General Motors, Washington Mutual, and Chrysler, just to name a few recent examples!.

Don’t Kill the Goose

Lastly, wealth accumulation requires an almost sacrosanct treatment of your long-term savings.  In an emergency all bets are off, but the annual Mercedes Benz Holiday event is not an emergency.  This is really a mental approach to wealth.  These assets are for a particular purpose, typically retirement funding, and for that purpose alone.  In many cases, even in bankruptcy, retirement account assets are protected.  If the government is going to treat it that way, you should too.

Wealth Preservation Principles

Two Pockets Approach

One of the hedge fund managers we like is fond of saying the approach to wealth management is simple: you need to have two pockets, your stay rich pocket and your get rich pocket.  The idea being you take more risks in the hope of getting rich but take limited risks with the funds identified as your wealth.  The ratio is not important since it is dependent on your situation.  One of the benefits of working with Trinity Wealth Management is we take a client centered approach.  Your needs and situation dictate the strategy instead of the other way around.

Matching Income with Expenses

While this may not sound like the appropriate heading, it is exactly what you are doing when you manage risk in a portfolio.  Stocks have returned about 10% per year over the past 80 years.  I’ve been in meetings where the advisor discussed stock returns going back 200 years, but we believe those are inappropriate comparisons for several reasons; let’s focus on just two.  First, when you have a mortgage, does the mortgage company say, ‘we want you to pay an average of 6% plus principal over the next 30 years’?  Or, do they tell you the exact amount down to the penny they expect each month?  The latter is obviously the case as your mortgage is an example of a fixed, or locked-in, expense.  We believe that fixed expenses should be matched with a fixed income source.  Otherwise, in a bear market, you may find it hard to pay these expenses.  We consider this an unacceptable and avoidable risk.

Another scenario is when retirement is still 20 or more years away.  You can and should accept more fluctuation given the historical returns of stocks and bonds.  It is almost guaranteed that short term fixed income investments will not keep up with inflation nor will they grow in principal value.  Keep your investments in instruments that will move with the uncertainties of time like inflation, technology advances, and taxes.

Finally, realize that your retirement time horizon is actually a relatively short period of time and your point of entry is vital to your success.  For example, if you retire at age 60 and start drawing from your portfolio at the beginning of a 15-year secular bear market, you will withdraw a constantly increasing percentage of your portfolio.  The result is you need constantly rising rates of return just to keep even!.

“That Large Sucking Sound”

Who can forget Ross Perot’s comment made during the 1992 Presidential campaign?  We use it here to illustrate another significant difference between wealth accumulation and wealth management.  Down markets are devastating to a portfolio when there are withdrawals and the portfolio is not positioned appropriately.  Since withdrawals are made during market lows, the portfolio likely never recovers.  Let’s review two scenarios illustrating the effects of point-of-entry on the portfolio.

Assume $100,000 is invested in the S&P 500 and $5,000 per year is withdrawn over a 20-year period.  Assuming return matches the S&P 500 return over the last 30 years, the portfolio value grows slightly.  There were some very good years during this 30-year period with negative returns occurring later in the period.  However, if we reverse the returns so that the worst years occur first, the portfolio runs out of money prior to the end of the 20-year retirement period.  Same returns, same average, but different timing of returns. Volatility is the enemy when you are taking withdrawals.

Know When Enough is Enough

Kurt Vonnegut (Slaughterhouse 5) and his neighbor, Joseph Heller (Catch 22) were at a party being held at the estate of a wealthy Wall Street tycoon on Long Island.  Vonnegut purportedly looked around and asked Heller, ‘wouldn’t you like to have all this guy has?’ to which Heller replied, “I got one thing this guy doesn’t have.  I know when enough is enough!”  The reason we mention this point is not to present some moral lesson on wealth, but to help you realize that once your goals are achieved you should shift to wealth preservation.  You no longer need to, nor should you accept, the higher risk associated with wealth accumulation.  If you still wish to accept higher risk, then we need to discuss modifying your goals.  Otherwise, we don’t want you taking unnecessary risks once reaching your objective.