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How to Add Real Value as a Wealth Manager

Wealth author Stuart Lucas says advisors need to translate a family's values into their financial goals.

Helen Modly, 05/31/2007

Would you be comfortable advising an enormously wealthy client who happened to hold an M.B.A. from Harvard as well as being a Chartered Financial Analyst? What if I told you he previously had managed the ultrawealthy private client group of a large bank, managed the European operations of a large investment company, and ran the portfolio of a successful mutual fund? Well, if you wouldn't know where to begin, take heart. Stuart Lucas will be sharing his unique insights into the wealth management process from both the perspective of a wealthy client and an experienced wealth advisor.

Lucas has been living this double live for 25 years, both as a fourth-generation heir to the Carnation fortune and as an accomplished wealth manager to other investors. He understands the complex needs of the wealthy client as well as having a thorough knowledge of the industry issues with which many wealth advisors must contend. He is the author of Wealth: Grow It, Protect It, Spend It, and Share It, published last year by Wharton School Publishing. He will be addressing the 2007 Morningstar Advisor User Forum on June 27, and his message may surprise you.

Helen Modly: Stuart, you will be talking to a room full of advisors who are, or who aim to become, wealth managers. Will you be concentrating on a particular investment strategy or is there something else you think is more important for these advisors to hear?

Stuart Lucas: Financial advisors assume an enormous responsibility when they establish a client relationship. It is important for them to understand that what they do, and don't do, will profoundly affect their clients' lives, perhaps for generations. They have a responsibility to thoroughly explore more than just the client's investments; it is the values that a particular family holds that should direct how their wealth is managed, and more importantly, spent.

Modly: Can you give an example of how advisors can learn to translate values into financial goals?

Lucas: There are 10 values-based discussion points that advisors can use to guide their clients through this exploration. Advisors can help their clients learn to translate their important values into financial terms that they and their advisors can act upon and be held accountable for.

Modly: We all accept that advisors must be held accountable to their clients. Are you suggesting that clients should be held accountable to some degree also?

Lucas: Absolutely. The two greatest variables affecting the long-term success of any wealth-management strategy are the level of client spending and how well taxes and fees are controlled. Both of these items are largely in the client's control. Many advisors fail to adequately educate their clients as to how damaging this "leakage" can be to their long-term goals.

Modly: What are some of the flaws you see in terms of advisor accountability to their clients?

Lucas: Many advisors view accountability as a necessary evil to gain and keep the trust of their clients. They are missing a valuable opportunity to use accountability as a client-education and decision-making tool.

Modly: Can you give us an example?

Lucas: Sure. Advisors are quick to deliver comprehensive investment performance reports on a regular basis. These reports usually provide a summary of assets, net periodic performance net of fees, but gross of taxes. They will provide detailed transactional information and tax-basis information on the security level, and often will show the allocation of accounts on an asset class or industry sector basis. Rarely do advisors deliver an annual consumption report showing what client's have spent from their portfolios, including taxes and fees.

An important comparison for clients would be the 10-year growth in their assets compared to their 10-year spending rate. If clients are allowed to think only of the rosy investment return they received over the past year without focusing on the fact that their withdrawals actually caused their account balance to be less than it was at the beginning of the year, they will surely miss the warning signal that something needs to change.

Modly: Many advisors are constrained by their employers as to what information they can provide to their clients. How can they influence their firms to allow them to provide more of this relevant information to their clients?

Lucas: They need to engage their clients in the wealth-management process. This is not something advisors do to their clients or even for their clients; this is something that advisors and clients need to do together. Advisors need to educate their clients to ask the right questions and then empower their clients to insist upon change. Financial firms are quick to deliver any service that the market requests, and advisors should begin to show clients what to demand.

Modly: You mention taxes often, yet you indicate that you and your family are not so tax adverse that you seek to minimize your tax liability without regard to your after-tax return. You also have an interesting way of thinking of the IRS as an investment partner, and in your book, you talk about incentives built into the tax code that investors should take advantage of. Are these concepts that would be useful for wealth advisors to use in educating their clients?

Lucas: Understanding how taxes can be an investor's ally will enable your clients to realize that the IRS is really their silent partner in sharing downside investment risk. This sharing of risk is a phenomenon that is rarely discussed, but it can have a significant impact on portfolio design.

For example, when the price of appreciated stock shares drop, the embedded capital gain drops as well. Since the embedded gain is taxed by the IRS, the IRS loses some of its "share" in the security. If you calculate the investors share of the gain and the IRS' share of the gain before the price drop and again after the price drop, you'll see that the investor's "loss" and the government's "loss" are disproportionate. The investor keeps a larger percentage of his gain than the government does. This makes holding appreciated stock more attractive than most investors realize.

Modly: Let's talk about investment strategies for a moment. Three strategies that you support as effective are indexing investing, barbell investing, and active alpha investing. All three of these have a valid underlying premise, but differ significantly from each other in terms of both philosophy and execution. You suggest that the selection of an overall strategy is probably the single most important decision that clients and their advisors can make. How should advisors match the appropriate strategy to their clients?

Lucas: This has as much to do with the personalities and temperament of your clients as it does with their financial goals. There is no right or wrong answer, but one of these three strategies should suit almost everyone. Advisors need to be able to assess where and how they can add the most value to a particular client relationship.

Modly: Many advisors want to expand their client relationships beyond pure portfolio management or financial planning. My impression is that you intend to give the advisors at the Morningstar conference some concrete "take-aways" that they can use to transform themselves and their firms into effective wealth managers.

Lucas: I'm not here to replace the academics, but to offer some real-world insight into what works and what doesn't.

Modly: Thank you for your time, Stuart. It has been very interesting to talk with you today and I'm sure those advisors who have the opportunity to hear your presentation will take home some valuable and actionable ideas!

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