Building a Family Focused Investment Plan | AWM Insights #125

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Episode Summary

Where do you start when building an investment plan? What are the first steps and what’s most important? Should we maximize returns and let our investments run our lives or should we let our needs, wants, and wishes drive how we invest? Where do taxes fit in?

You have only one net worth and one effective tax rate. Thinking about your investments separate from taxes is never optimal. You will end up paying higher taxes than is otherwise necessary. When you are wealthy and you ignore the tax implications of investments, you leave money on the table that could have been used for greater impact. It’s that simple and it’s still missed by many in the ultra-high net worth space.

Aligning your financial resources to the things most important to you is vital before even thinking about what type of investments to make. Matching your investments with desired outcomes brings a better and more customized experience to the individual.

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Episode Highlights

  • (0:57) Where do we start when building an investment plan?

  • (1:17) How to optimize for your one net worth and your one effective tax rate.

  • (1:35) Your financial structure is your net worth but it additionally incorporates the future. Human capital is valuing and accounting for future earnings.

  • (2:30) Your financial asset stack is all your available resources which include cash, publicly traded stocks, public trades bonds, illiquid private investments, human capital, pensions, social security, and homes. 

  • (3:15) Aligning your asset stack to what you want to accomplish in life is the key to a successful investing experience.

  • (4:11) Give money a job. Use your assets in the most effective way possible to achieve the priorities you want to accomplish.

  • (4:25) If you want to pay for your newborn daughter’s wedding 30 years out, you don’t need those dollars now. This gives you the opportunity to invest in private equity and capture an illiquidity premium.  

  • (5:30) Having the full picture of your financial stack and matching it to your priorities allows you to be specific and deliberate in how you are invested.

  • (6:46) Time and duration is important in investing but so is tax efficiency. Optimizing where and how you hold assets avoids leaving money on the table.

  • (7:56) We want tax-efficient assets to be in taxable accounts.

  • (8:09) Higher taxable income investments can be put in Roth accounts which takes full advantage of their tax-free qualities.

  • (8:45) Be careful of someone selling you outperformance in the public markets like stock picking or sector rotation. The real value comes from the planning aspect of investments, not from beating the market.

  • (9:18) If you’re in illiquid investments like private equity, venture capital, or real estate you should be getting an illiquid premium. A return above what you could get in the public markets.

  • (9:58) How do we think about the private side?

  • (10:30) Illiquidity planning is not given enough attention and must be planned for.

  • (11:15) Private investment data does support active management and average returns are actually not very good.   

  • (11:32) We love the top-tier managers in venture. Getting access is the critical aspect. It is a relationship-based game.

  • (12:11) You can really get hurt going down the path of venture or private equity.

  • (12:30) If you strike out when selecting investments or managers you can end up way worse off than just investing in a tax efficient low cost way in the public market.

  • (12:58) More access to private investments is getting easier but it is potentially going to hurt people too.

  • (14:00) You should be putting money where you are rewarded for the type of risk. A careful approach and intentional selection can be very rewarding.

Stay Connected

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Justin Dyer: LinkedIn
Brandon Averill: LinkedIn

+ Read the Transcript

Brandon Averill (00:05): All right, Justin, we're back and we're talking wealth, that ultra-high net worth wealth. Last episode we really tackled some of the big reasons why we focus so much on tax planning within our practice and why it's so applicable to the client. And today we left that episode really talking about the translation of that tax planning into our investment portfolio and why that's so important. And so we're going to continue along that train of thought today. We're going to talk a little bit more about certainly the tax efficiency of your portfolio, we'll double down on that a little bit, but also just how do you actually go about constructing a really well thought out financial structure and ultimately the implementation into an investment portfolio? So maybe just pick it up there for me, Justin. Talk a little bit about some of the considerations as we start to think about building this investment plan for some of our ultra-high net worth clients. Where do we even start? What's important? Where do we place assets?

Justin Dyer (01:08): We start with the financial structure, like you said, and if you listen to the last episode you heard me say we always like to say you have one net worth, one effective tax rate. And that's a similar concept to financial structure, right? We want to optimize those two things in everything that we do. We're going to start with the financial structure, because that is that first layer, and financial structure is simply your net worth. But it's a little bit more nuanced than that. Often people go to just net worth and look at the current value of everything. Well, total financial structure incorporates the future a little bit more than just a point-in-time type measurement. And really the biggest asset that it incorporates is human capital, or unrealized human capital. There is a true value to that. There are other things like social securities and pensions that generally don't show up on a net worth statement, and for good reason, but thinking about those is important, because they're powerful. They're meaningful, even for the ultra-high net worth. There's a pretty substantial value if you take that stream of income and bring it back to the present value, but you put all these things together and you get your... We call it your financial stack. You have your cash, you have your portfolio, your liquid assets, public stock, public bonds, maybe some illiquid investments, human capital, pension, social security, homes, et cetera, et cetera. That is your total financial structure. And starting there is critical, because then you also get a liquidity profile. That is very, very important, especially when you start to talk about the ultra high net worth, we'll get into more of around why. But then we know what your financial stack looks like and we can compare it to your priorities, to your unique priorities, and make sure that there is an alignment of your assets from both a liquidity and a risk standpoint with what's truly important to you as an individual. Do you need to spend money in the short term? Is it super important that you spend money in the short term? Or do you have some really long term, much more, "Hey, if everything works out, we want to do X, Y, Z," type goals? And, again, those are so unique to each and every person, but being able to systematize this and capture them, bring them to a present value, compare them to your financial structure is really, really powerful. Really, really robust is the term I like to use. It's a stronger starting place to think about managing wealth.

Brandon Averill (03:54): Yeah, I think it's so important because when you start to think about this financial structure and really what the purpose of those assets are, I think Eric, one of our partners, he talks about this a lot, but give money a job, right? And that's the simple way of putting it, but let's say you've got a priority that's 30 years out. You want to pay for your newborn's wedding. 30 years might be a little long, but all of us parents hope it's 30 years out, but let's say that it's 30 years out. Well, you put yourself in a really unique position, right? You don't need that money. Let's assume that you've met your other priorities, you have enough assets to meet your other priorities, but that's 30 years away. So let's go capture what we actually deserve there. We don't need to have liquidity from those investments from those dollars. And when you invest money privately, you pick up something called a liquidity premium, or you should, this is obviously making everything very simplistic, but you have the opportunity to be compensated for tying up money, which is totally fine because you don't need this for 30 years. So as we start to think about that, and then conversely, like you said, just a lot of times we'll see other families that will come in and maybe they had a big exit and they have a ton of money, and so they think, "Okay, I made my money building a private business. I've exited, let me continue to reinvest in private businesses." And that can get you into trouble. But I think, at the end of the day, what we're saying here is by having that full picture of your financial stack and then aligning that with your priorities, it allows you to be very specific on what those assets are doing. And it's not like every other shop that's going to come in and say like, "Well, you sound aggressive. You got a lot of money. Let's go with the 70, 30 portfolio, we'll put 70% in stocks and 30% in bonds. And we'll sprinkle in some private equity deal that the wire house picked up for you." And there's just very little strategy to it. We see it all the time, right?

Justin Dyer (06:00): Yeah. Well, not only is there very little strategy to it, and we think very strongly, clearly, that looking at it in a total financial structure way is way, way better. There's another layer to what we're talking about or what we've introduced as well. So it gets more specific, more fine-tuned and it really dovetails with our last conversation around tax planning, right? Well, so we have your financial structure, we have your priorities, well then let's go a layer deeper and make sure we're putting, not only assets from a length of time or a duration standpoint to match your priorities, but also from a tax efficiency standpoint. So a perfect example, especially in the ultra-high net worth arena, is municipal bonds. Phenomenal place to be for shorter term, more conservative or important or essential type priorities, where the general nature of municipal bonds are that they're just highly, highly tax efficient. Not every single state treats them the same way, and it depends on where you live, et cetera, et cetera. But overall, it's an incredibly tax efficient place for the ultra-high net worth to allocate assets to, again, for more your essential, important-type things. And again, it goes back to maximizing your after tax rate of return. It's very easy for somebody to say, "Oh, this particular bond is yielding X," and then forget about the tax treatment of that particular bond or where it's held, even. And, again, just leaving money on the table. So there's more to this. And even beyond just using municipals as an example, right, it's this concept of asset location. Again, we touched on it in the last conversation where we want the most tax efficient assets to be exposed to taxable accounts. If we have the option or the opportunity to put assets that generate higher taxable income, current income, you can't avoid it necessarily all the time, we're going to put those in tax deferred accounts or a Roth account where, hey, it's tax-free for essentially the rest of your life. And so thinking through it in a multi-dimensional way goes to optimizing your overall rate of return net worth and minimizing your tax rate.

Brandon Averill (08:26): And I think the other thing that I think, hopefully, people are starting to realize is we haven't brought up a stock picking strategy yet. We haven't started to bring up that we have some keen insight on the public markets or anything like that. And that's because, frankly it just doesn't matter. If that's what you're being sold, especially as an ultra-high net worth person, they're definitely selling you a bag of goods. You know, really where the value in planning on an investment portfolio comes from is this planning aspect, right? It's putting the right financial structure in place, making sure that you're getting the full return that you deserve from market access, you know, when you do need liquidity, and then flipping over to the illiquid side, I had mentioned this, hopefully you're getting an illiquid premium, unfortunately, that doesn't always happen, but it all turns to access. And so I do want to spend a couple minutes there at least, Justin, talking about once you find yourself in this position and you have the ability, not everything's created equal on this private side, right? It's so much access that's going to drive your return, your risk profile, you getting what you deserve, and you're going to be in inundated with all kinds of different opportunities. So maybe spend a couple seconds here, Justin, just talking about if I'm this ultra-high net worth family, I've got all my priorities dialed in, I can take some illiquidity risk here, should I just be picking the product off the platform? Should I be involved in pre IPO stuff? How do we think about the private side and actually helping families get what they deserve on this side?

Justin Dyer (10:03): Yeah. I mean, short answer is let's go to the data first and foremost. And I also, before I go there, I want to hit on what you said earlier around the liquidity or illiquidity planning as well. We're talking about a hypothetical example where we've sat down, we're like, "Yes, you deserve some illiquidity. You can get exposure." It's really important to think about that, illiquidity or liquidity planning. We've seen it, like you said, time and time again, where the illiquid nature of someone's financial stack, they have plenty of wealth, but it doesn't actually line up with what they want to do. And so there's a planning opportunity that's been missed in the past, and we're trying to correct it. But to your question specifically around the private market side, we talk about this a lot. We go to the data. We are a data driven organization. And in the private markets, the general thesis is completely different than what exists or what we have in the public market side. We don't pick active managers. We don't pick individual stocks, because the data just doesn't support it. You alluded to it on the private side, the data does support some form of what you would call active management. Now, it doesn't support just blindly going and taking any fund or product off the shelf that is a venture capital fund or a private equity fund, it's a lot more nuanced. The top tier managers and venture, we love that space quite a bit, is the best performing asset class in general, the best performing managers tend to outperform persistently. That's great, but getting access is critical. Building that network. It's such a relationship game and building that network takes time. It takes the right value ad relationships or opportunities. And so those are all things to think about. Just because there's a big check that can be written doesn't automatically grant access. It's very, very, like I said, very much a relationship game. So that's one way to think about it. And then also the dispersions of return, right? You can really get hurt trying to go down this path. It's not just this, "Hey, this is a great asset class that's the highest performing. I think we can get access to it." If you strike out, let's just say, you're going to likely end up with worse returns than you could have very easily had in a tax efficient, low cost way in the public markets. And so really being cautious and having the background, the understanding, the relationships within the venture capital and private equity space, it really, really matters. And what's happening in this industry just... This could be a full podcast on its own, is like there's a lot of product and platforms that are being created just to provide a little bit more access to the private markets. It's great because the private markets are a phenomenal place to deploy capital. There is such a substantial number of opportunities. I think we've hit on it in this podcast. I mean, something like 90 plus percent of companies are privately held businesses. So there's a big opportunity set there. However, all the data still rings true. And just deploying money in the private markets, because access is now easier, you know, I worry about that. It's good that access is easier, but it's also, I think, potentially going to hurt people at the end of the day, which often happens within our industry, unfortunately.

Brandon Averill (13:36): Yeah, definitely. I think it goes back to first principles, right? Running businesses is hard. Anybody that's ran a business or started a business knows that it's very, very difficult, and to stay in business and to generate returns is even more difficult, right? And so, as you're evaluating these opportunities, you need to make sure that you're at least putting your money where it has the opportunity to reward you for that type of risk. And there are people that are really successful at doing those things. And then when times like we've gone through recently happen, markets have been phenomenal, especially in the private side, money has flown in like crazy, it becomes a lot more difficult. Sure, during that period of time it's the monkey throwing at the dart board, a lot of people super successful. You got to go through a period of difficulty that, a lot of times, washes those things out. So you want to just be really careful and make sure you have the access to the right managers, the right people, that are in these different spaces. And like you said, Justin, that takes time. It takes a lot of intention. We've certainly learned it. We've spent over a decade developing these relationships. We've seen the good, the bad, the ugly, and it just really does matter where you go on this private side, but if you have the opportunity, it can be pretty darn rewarding. So hopefully we gave you some nuggets to think about as a family, how you're thinking about your investment portfolio. We want to hear more from you. As always, we'd love to tackle some more of this. You can shoot us a text. It's (602)704-5574. And, until next time, own your wealth, make an impact, and always be a pro.