Abraham Maslow, who developed the theory of a Hierarchy of Needs, believed that our basic needs must be satisfied before we satisfy higher needs. Once we actually meet all the steps (physiological, safety, belongingness and love, esteem and finally self-actualizing) we would then become Self Actualizing. Maslow’s theory can be applied to Wealth Management. At the base of the pyramid is Financial Independence. Until we are comfortable with the notion that our Assets can support both current and future Liabilities (living expenses, children’s education, home purchase, retirement, et al) our ascent to Family and Social Legacy is intimidating.

At Nelson Roberts Investment Advisors, Wealth Management is working with clients to establish for them a definition of Financial Independence, illustrating the levers necessary to reach or maintain that goal, then strategically implementing a plan to navigate the ascent through Family and Social Legacy.

Planning Your Financial Future

The Responsibility of Wealth

Wealth arrives in many fashions. Perhaps you excel in your profession and are enjoying its financial rewards. Perhaps you have inherited wealth or enjoyed a windfall – or you know one is coming. Whichever way wealth comes to you, it brings you new responsibility. Managed well, your assets can form the base of a secure and prosperous future. Unmanaged, your wealth could dwindle away.

It may be time to hire an investment management professional. It is important to research your options prior to making a decision. You want to understand the fundamental tenets of investment planning, and see how investment managers approach the discipline.

The Investment Plan: A Roadmap to Success

Your financial goals and objectives and your tolerances for risk are as unique as your personality. That is why every investment plan needs to begin with a thorough assessment of these personal factors. Based on these variables, your investment plan will map out goals, strategy, and discipline while clearly defining how to monitor performance.

The first step, setting goals, allows you to make intelligent trade-offs between risk and return. In your present circumstances, you may need to maintain adequate financial cushion while preparing for the next stage of your career. Or your profession may subject you to unpredictable income levels. You also need to manage tax liabilities and generate enough capital growth to fund long-term needs like retirement.

The second critical step is to construct a suitable strategy to reach your long-term goals while accommodating your short-term needs. An effective strategy does not look to maximize returns, but instead, aims to achieve the returns you seek without taking on unnecessary risk. A prudent investment plan results in managing risk rather than avoiding it; generally, you can’t expect to earn a significant return without taking some investment risk.

There are many factors that determine how much risk is appropriate for you. Age, current assets and liabilities, as well as future liabilities and income should all be considered. An asset allocation plan can be developed after a thorough assessment of your risk tolerance in combination with articulated financial objectives.

Discipline keeps your investment program on track so that you attain the long-term results you want. Investors who allow interim market swings to distract them or to send them off course can fall short of their goals.

Communication and performance monitoring is the key ongoing element to any successful investment advisory relationship. It allows you to manage your investment program and make the necessary adjustments. The growth progress of your investments should be measured against both your individual objectives and against independent benchmarks. A periodic rebalancing of your portfolio and reevaluation of your financial objectives – yearly or more often – to keep your asset allocations in line with your plan is essential.

Academic research on investment management has resulted in great insights into the nature of risk and ways to manage it. Two economists, Harry Markowitz and William Sharpe, won the Nobel Prize for their work in this area.

Markowitz’s work sought to show how a diversified portfolio can accommodate a certain amount of “risky” investments, and actually produce higher potential returns with a lower potential risk than a portfolio that attempts to avoid risk altogether.

Sharpe sought to establish ways to quantify the level of risk for different investment vehicles. This enabled him to show how particular portfolio mixes might be expected to perform and at what level of volatility, or risk.

The economists’ pioneering work led to the development of the “efficient frontier” concept. Simply put, the concept states that for any particular level of risk an investor might accept, there are many possible portfolios of stocks, bonds and other investments. However, one optimal portfolio would have the highest expected rate of return for that level of risk (measured in standard deviation). These optimal portfolios, viewed collectively, are the efficient frontier (see Exhibit 1).

Exhibit 1: Efficient Frontier

According to these theorists, an investor whose portfolio is on the efficient frontier cannot obtain a higher return without accepting additional risk. In the real world, virtually no portfolio is actually on the efficient frontier. Good investment management, however, means moving your portfolio closer to the efficient frontier so that you receive close to the maximum return for your level of risk. This exercise will affect the types of investments that are appropriate to your portfolio.

Remember, what can be one of the most important risks for an investor is the risk of not achieving your investment objectives. Every investment vehicle has some risk attached to it. The type of risk we are most familiar with is market risk – booms, corrections, bears and bulls – but there are many types of risk. The accompanying chart lists some of the major risks most often associated with various instruments.


Type Of Risk Investment Most Prone to the Risk Common Risk Management Techniques
Inflation Treasury bills (6-month maturity and under),bank deposits, money market funds, other short-term fixed income instruments Use equity and longer-term fixed income investments for part of the portfolio to provide greater after-tax return.
Interest Rate Long-term fixed-income investment User shorter-term fixed income securities which provide most of the yield of longer-term instruments with less prices fluctuation.
Market Equity investments (primarily stocks, but also real estate, precious metals, others) Diversify among types of equity holdings and among markets (e.g., U.S. and foreign); limit share of portfolio devoted to equities.
Company Equity and fixed-income investments, except obligations issued or guaranteed by the U.S. Treasury Diversify among companies within a particular industry or stock market sector; focus on issuers with high credit ratings and good prospects; limit investment exposure to smaller enterprises.
Currency International equity and fixed-income investments denominated or traded in currencies other than the U.S. dollar Limit exposure to international equities; diversify international investments among countries; use various financial techniques to “hedge” currency fluctuations.


Asset Allocation

Once you have determined your financial goals and tolerance for risk, the next step in investment management is to decide how much to invest in stocks (for growth), bonds (for income and relative stability) and cash equivalents (for liquidity purposes). This is the fundamental process of strategic asset allocation. Your asset allocation will be the biggest factor controlling the risk and return characteristics of your portfolio.
The basic premise of asset allocation is to diversify your holdings. You’ll increase your chances of getting good results because, generally, different parts of the market do well at different times, for different reasons- and for unpredictable amounts of time.

Asset allocation helps quantify the returns you can reasonably expect from different mixtures of stocks, bonds and cash. It also shows you the varying degrees of risk that accompany those mixtures.

Exhibit 2 illustrates this. Nelson Roberts Investment Advisors studied market returns for the period 1939 through 2003, comparing the performance of various allocation mixes. The analysis shows the range of average annual returns over five-year time periods since 1939. This covers many variations in market conditions and is a relatively good indicator of the range of returns you might experience with these various allocations of percentages. Of course, past performance is no guarantee of future results.

The chart illustrates there are 5-year time periods, most notably the most recent 5 year period (1999-2003), when portfolio returns can be meager. However the reverse is also true, the average annual returns can be quite attractive and there have been periods of exemplary performance. It is also interesting to observe that with an increase in allocation to stocks (Portfolio A has the highest, Portfolio E the lowest) the average return is higher and the worst 5-year period is lower.

Diversification is Critical

When establishing an asset allocation plan, it’s important to consider diversification within asset classes. In the equity portion of your portfolio, for example, you may want to gain exposure to different size companies (i.e., large-, medium-, and small-capitalization), investing styles (i.e., growth and value), and possibly industry sectors. An international component to your portfolio also should be considered. In general, each asset class performs differently in any given economic environment, therefore, it is prudent to diversify to smooth the fluctuations in the value of your portfolio.

In the fixed income portion of your portfolio, you have many different types of bonds to choose from, including taxable (U.S. Treasuries, corporate, high yield), tax-exempt (municipals) and international. For bonds, maturity and credit quality provide a useful measure of risk and reward. Maturity is the length of time until the bond expires and the issuer repays your principal. Generally, the longer the maturity, the higher the yield will be. Credit quality indicates the level of certainty that the interest and principal of the debt will be repaid. The higher the credit quality, the lower the yield. U.S. Treasuries, for example, have the highest credit quality and consequently a lower yield.

For investors in the highest tax brackets, tax-exempt municipal bonds often offer more attractive yields than other fixed income securities with comparable maturities. This is because tax-exempt municipal bonds pay interest that is often not subject to federal income tax and is also free of state and local taxes if investors live in the state where the bond is issued. The value of tax-exempt income increases with your tax rate.

Portfolio Review, Rebalancing

The review and rebalancing of your portfolio is a critical part of asset allocation. On a regular basis – at least once a year – you should review your portfolio. Are the allocations still aligned with your original plan? Have your needs and goals changed? Whenever specific goals are reached – such as your achievement of a new level in your career or the financing of a child’s higher education – you should review your portfolio and adjust it in accordance with where you are.

Portfolios need periodic rebalancing. For example, if one sector of your portfolio has done especially well, your allocation to that sector may then be too large to meet your risk comfort levels. That’s why we review your goals and your holdings on a regular basis: if your goals change, then your risk tolerance and other parts of your investor profile may also have changed.

Looking Ahead

Investing is not the only challenge of wealth. Once you have substantial assets, it becomes important to think about ways to protect them from unnecessary taxes, and what will happen to your assets after you die. As you plan your financial future, estate planning – including the use of trust structures – should go hand-in-hand with your investment program.

A well-constructed estate plan can minimize the impact of taxes on your assets and smooth the way for your family, loved ones, or worthy causes to benefit from your achievements in life.

Investment success doesn’t happen overnight or by chance. It takes planning and discipline. The more wealth you have earned- the more important it becomes to seek expert advice in managing it.

Incorporating decades of experience and a philosophy of partnership, Nelson Roberts Investment Advisors offers an efficient blend of wealth and asset management services for clients with net investable assets of one million to twenty million dollars.

We would welcome the opportunity to answer any questions or discuss whether our services are appropriate for you.