Asset Allocation and High Net Worth Retirement Planning

Asset allocation decisions are among the most important choices about investment and retirement portfolios facing high net worth (HNW) individuals. (HNW is generally defined as $1 million or more in assets, excluding real estate.) Why? Because asset allocation decisions, performed correctly, both drive robust returns and protect your capital against erosion. 

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Studies have shown that up to 90 percent of an investment portfolio’s performance variability can be traced to asset allocation decisions.

Asset Allocation Is Designed To Maximize Capital Returns and Protect Capital from Declines

Those two tasks – driving robust returns and protecting capital – are key to all asset allocation decisions for investors of all wealth levels. Generally, asset allocation divides portfolios into two broad classes: stocks and bonds. 

Stocks typically generate the highest returns, but stock market returns are also risky because stock markets move up and down. Severe stock market declines can erase a substantial portion of investor capital.

Allocations of bonds and cash instruments (such as money market funds) counterbalance the risk of stocks by providing more stable investments whose values likely fluctuate less. But the risk of bonds and cash, especially now, is that returns are very low – as little as 1 percent or less. Therefore, while the stability function is important, bonds and cash currently don’t keep up with inflation, which runs between 2 percent and 3 percent annually. 

As a result, portfolio allocation decisions in a standard stock and bond/cash portfolio generally hold proportionally more stocks and fewer bonds, to maximize returns (stocks) and minimize risk (bonds). Other factors, such as age, goals, and risk tolerance, are factored in. As investors age and draw nearer to retirement it’s prudent to rebalance asset allocations to more heavily feature bonds, while still retaining enough proportion of stocks to help maximize returns.

Asset Allocation and the HNW Investor: More Options, More Flexibility

How does having higher net worth affect asset allocation? 

First, the stock asset allocation can be far more diversified. The more diversified a portfolio is, the more it can maximize capital and minimize risk. 

Financial advisors often advise that HNW investors diversify their holdings within the stock asset class. If one part of the stock market falters, such as small-cap stocks, other parts of the market may remain robust. Diverse holdings should be maintained among the small-cap, mid-cap, large-cap and international stock market areas. 

Second, HNW individuals can invest in many more asset classes than just stocks and bonds/cash. Many financial advisors recommend investments in real estate and energy/natural resources for further diversification. 

Other potential asset classes include:

• Precious metals, such as gold
• Commodities
• Currencies
• Agriculture
• Collectibles, such as art
• Hedge funds
• Private market offerings
• High-yield debt

Third, HNW individuals can invest in businesses if they wish (their own or other people’s). Key business segments like health care, technology, and financial services can power a portfolio.

Diversification of assets and business investment especially are the key ways in which the rich do things differently. HNW individuals possess sufficient wealth to purchase real estate investment properties and other alternatives, while investors of average means may not. Private market offerings and strategic business investment may only be open to people with a specific (high) net worth. The relatively smaller investment pool means that there is less competition to enter these areas. 

It is also relatively more common for HWN investors to have made their money in business or to be actively in business. If that’s true for you, the advisors at Financial Freedom Fee-Only Wealth Management can discuss various asset allocation strategies with you. Your asset allocation strategies need to be made with the state of your business, sector, and broad economic outlook in mind. 

Among the factors to discuss: whether it’s prudent to invest in the same sector in which your business operates, and if so, how much of an allocation should be made. If your sector and business do well, it can enhance your net worth. 

But if businesses in the sector encounter adverse conditions, both your business and net worth can be impacted negatively. Remember, diversification ensures that investors don’t place too many eggs in the same basket.

Asset Allocation, Financial Planning, and Your Goals

Finally, asset allocation decisions are crucially affected by your goals. This is true of all investors, but higher net worth may make goals slightly different.

A comprehensive financial plan includes the following:

• Cash flow statements of income and expenses
• Investments and a well diversified portfolio
• Retirement planning
• Educational savings for children and grandchildren
• Risk management (insurance for your assets)
• Estate plan (wills, trusts, powers of attorney)
• Executive compensation strategies (stock options, RSUs, deferred comp, etc)

Review these categories and assess them vis-à-vis your goals. At what point, for example, do you plan to retire? Do you have (or want to purchase) homes in multiple geographic areas? Do you want to travel extensively? Might you want to set up a charitable foundation or contribute to an existing one? Do you want to pass a business on to your heirs?

For high net worth individuals, asset allocation strategies can be harnessed to other goals. If you have or plan to purchase homes in multiple geographic areas, for example, your real estate assets can be linked to these areas. If you want to leave artworks to a museum, art may be a smart portfolio allocation choice. Purchasing an apartment building in a town where your children or grandchildren attend college can be part of your real estate allocation as well as educational savings planning.

Don’t Forget About Taxes

Don’t forget tax planning as part of your financial planning. HNW folks (or their heirs) may be subject to estate taxes in some states. The cut in allowable deductions for interest on mortgage payments stemming from the 2018 tax cuts lowered the amount to $750,000 from $1 million of loan indebtedness, which disproportionately affects HNW individuals. They may also be proportionately more affected by the cap on allowable deductions for state and local taxes, especially in states with relatively high taxes. 

Taxes are a potential drain on capital; the more they can be minimized, the more your asset allocations are protected from risk.

Managing HNW portfolios and asset allocation presents both opportunities and challenges. At Financial Freedom Fee-Only Wealth Management, we have over 30 years of experience working with high-net-worth individuals and couples. We are a fee-only, fiduciary, wealth management firm dedicated to helping our clients protect, grow, and maximize their wealth.

Contact us today for a complimentary consultation, and find out if we are the right fit for your needs.