When markets are rising, risk management seems easy—invest, sit back, and watch your investments grow. Things get a bit trickier when the markets experience volatility and decline. These are the times when you need to understand the amount of risk your investments are subject to and how that risk relates to your financial plan.
The first and least tangible measure of risk is qualitative in nature: how much risk are you willing to take? How would you feel, for example, if the markets declined more than 20%? What if the markets fell by more than 40%? Generally, what is the level of decline that you are comfortable with that will encourage you to stay invested and allow for your plan to thrive? Take some time to think about it. While it is easy to come up with a threshold or a hypothetical number, it is different in real time (consider the financial crisis or the markets’ initial response to the COVID outbreak, for example).
Once we have a handle on your subjective feelings around risk, there are a variety of tools we use here at Merriman Wealth Management to help our clients manage the quantitative measures of risk.
First and most important is answering this question: what is the amount of risk my portfolio can take within the context of my financial plan? This is a super important question. Too often, folks will bifurcate their investment and financial plans. This does not typically lead to successful outcomes. We manage this for clients by calculating statistically valid risk and return measures for our clients’ portfolios—i.e., we expect an all-equity portfolio to return 9.52% net of fees per year with a standard deviation of 20.49. A more moderate 60% equity portfolio would return at 7.95% and 13.06, respectively. Understanding these figures within the context of your accumulation and distribution plans is what matters. The typical recipe is for folks in their early years to take on more risk, as they have time for the markets to recover from declines. In contrast, folks later in life have less time to recover, and a more moderate portfolio is conducive to their plan.
The next risk management tool to understand centers around the sequence of returns. While one can craft statistically valid long-term expectations for portfolio risk and return, it is extremely difficult to predict returns in any given year. Consider 2020: who would have thought the markets would have rebounded so swiftly?
One thing to keep in mind with respect to sequence risk is what we call “bad timing.” What happens if you retire (switch from accumulating to decumulating) and the markets have two successive bad years? This is a good stress test for your portfolio. Pass this test, and your plan is likely in good shape.
The next measure to consider is the longer-term variability of returns. We measure this by running 1,000 different return trials for our clients (Monte Carlo analysis), effectively looking at everything from years of sustained above-average performance to years of sustained below-average performance and everything in between. The results are considered a success if greater than approximately 80% of the trials result in money remaining at the “end” of your plan.
In conclusion, consider the list of questions below as you evaluate the risk metrics of your plan:
What are the risk dynamics of my current portfolio, and how do these relate to my financial plan?
What is the outcome of my financial plan if I retire and the markets have two successive bad years?
How am I accounting for the sequence of returns? What is my plan’s probability of success—will I have money left at the end of my plan?
Here at Merriman Wealth Management, we live by our tagline of “Invest Wisely. Live Fully.” If you are a Merriman client, we’ve got you covered. If you are not a Merriman client and would like a holistic review of your financial plan and corresponding risk metrics, let us know, and we would be happy to take you through our complimentary Discovery process.
Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Nothing in this presentation in intended to serve as personalized investment, tax, or insurance advice, as such advice depends on your individual facts and circumstances. Past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.
At Merriman, we partner with our clients to ensure no stone goes unturned with respect to their complete Wealth Management plan. One of the more complicated issues clients face is crafting and updating their estate plans.
This is not surprising as estate planning preparation and upkeep come with difficult questions—both qualitative and quantitative. The burden of these questions can often drive folks to put off the discussion and leave their plan vulnerable. The purpose of this brief post is to let you know that it does not have to be so difficult.
This article serves as a starting point to initiate the estate planning discussion. It is a discussion of the various estate planning roles you need to fulfill. Like most things, having a process and a plan will lead to peace of mind and planned success.
Let’s start with the various roles that need to be filled:
Financial Power of Attorney (POA)
One commonality for all these roles is proximity. If you can find someone close, that is a prudent solution. For example, in selecting a guardian for your children, it is best they are local to avoid changing schools, establishing new friends, etc. Similarly, if there is property to sell in your estate, it is best to have a local executor, as opposed to having someone across the country who is unfamiliar with the local scene and would have to travel extensively to manage the estate.
A Guardian is someone who looks after and is legally responsible for your children until they are adults. This person should embody all the traits you would want in someone who will take care of your kids in the event you are no longer around. Often, this is a family member with close proximity (as outlined above). Keeping your kids in their current environment is so important, especially when they are already trying to deal with your absence.
A Trustee is the person who has control or powers of administration over the trust assets in your estate. The trust assets do NOT belong to the Trustee. Rather, the Trustee is safeguarding the assets per the terms of the trust and for the trust benefactors.
The role of Executor “triggers” if one or both spouses pass away. This person’s job is to fulfill all of the requests and wishes as outlined in your will. This person should have high financial competence and a good understanding of what you own and how you want your assets distributed. Technically, they will follow the wishes as outlined in your estate plan. However, we advise clients to draft a less formal letter of instruction to confirm your wishes are carried out as precisely as possible.
The next two items are in effect during your lifetime. A Financial POA grants that person the ability to make financial decisions on your behalf if/when you no longer have the ability to do so of your own accord. A Medical POA functions the same but is related to medical decisions. Both of these roles should be set up with your initial estate plan.
If you have already crafted your estate plan, take a few minutes to consider who is currently filling these roles. Are they still the right person for the job? If not, who is better suited? If changes are required, let your estate planning attorney know and get to work on updating your documents. If you have yet to complete your estate plan, consider who would best serve in the aforementioned roles. If you already have an estate planning attorney, get to work on crafting your plan. If not, let us know, and we can connect you with one.
Another tool you can use to begin to formulate your plan is our “After Death Occurs” checklist. While this outlines a post-mortem list, it also serves as a great tool to get you thinking about the roles described above.
At Merriman, our goal is to ensure clients’ plans are buttoned up from top to bottom. While we emphasize financial planning and investment portfolio management, we also partner with our clients to ensure they are covered in the areas of estate planning, taxes, and insurance. Ensuring your estate plan is taken care of will provide peace of mind on your journey to Investing Wisely to Live Fully.
For additional reading on this topic, check out our ebook The Transparent Legacy for advice on conversations you must have with your loved ones before it’s too late.
Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.”
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This post was co-authored by Wealth Advisor Lowell Parker, CFP® and Information Systems Manager Rodney Gonzales.
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Physicians with at least one retirement account (for example, an IRA, Roth IRA or 401k) and one taxable account will benefit from higher returns with comprehensive asset location. In asset location, all accounts supporting the same financial objectives (for example, providing income in retirement) are viewed collectively as a single portfolio. Asset classes (for example, U.S. stocks or government bonds) are preferentially placed in either retirement or taxable accounts.
In taxable accounts, high-yielding assets have a higher tax burden than in retirement accounts. These assets are prioritized for placement in retirement accounts. In contrast, tax-free municipal bonds bear no tax burden, so they are preferentially placed in a taxable account. The result is the risk-adjusted expected return from the sum of all accounts increases. This is particularly important for physicians who, by virtue of being in high tax brackets, pay a lot of taxes.
Consider what happens if you place a high-yielding investment in a non-tax sheltered account. You must pay 39.6% (top tax rate) on non-qualified distributions from that investment, as opposed to sheltering that high-yielding asset in a tax-deferred account. Clearly, your net returns are dependent upon more than just appreciation. Smart asset location matters, especially for high income earning physicians.
Think of it like a hospital – a complex entity separated into different wings and departments to maximize efficiency. Each department houses doctors and staff who are best equipped for their roles. Emergency room doctors are going to be dealing with people needing the most immediate and intense level of care. An ER doctor wouldn’t treat a patient with a sprained finger while someone who was just in a traumatic car accident sits in the waiting room. In much the same way, your aggregate investment portfolio can be separated into different accounts and investment vehicles. Inside each of those vehicles are investments and holdings that are suited for the particular account type.
A more efficient hospital will lead to greater outcomes and profitability. The same is true for your portfolio. Strategic asset location maximizes efficiency and leads to better outcomes and portfolio growth.