Key Takeaways
- There are three core considerations that work together for a comprehensive wealth plan when it comes to your assets: Allocation, Location, and Protection (ALP).
- Expectations for the traditional 60/40 asset allocation model may not be met given the evolution of markets and realized returns.
- Compartmentalizing your wealth and a proper protection plan can optimize long-term returns and deliver tax benefits.
- The ALP Principles and Value Investing.
Even the most sophisticated investors have questions about their wealth that keep them up at night. In many cases, it’s because their financial situations are complex, span several generations, and require strategies that are best suited for their unique wealth management needs. Some of the most common questions we hear from clients revolve around both growth and protection of wealth:
- How can I protect my wealth so that I can pass it on to my children and grandchildren?
- How do I ensure that my portfolio will produce the cash flow necessary to fund my retirement spending?
- How do I minimize the impact of taxes on my wealth?
While there is no single answer that fits every situation, there is a comprehensive strategy that is designed to address each client’s overall wealth management needs. Employing such a strategy can go a long way in addressing investors’ concerns about their finances. At Alpine, this strategy is encompassed by our ALP principles: Allocation, Location, and Protection. In this article, we will explain the ALP principles and how the approach benefits clients with growing or long-term established wealth.
A: Why Asset Allocation Matters
There is no right answer when it comes to asset allocation. For many years, advisors used the 60/40 model (60% equities and 40% bonds) as a rule of thumb for investors. Much has been written in recent years about the demise of this model, and it’s one that we believe has never quite been appropriate for sophisticated investors who have accumulated significant wealth.
Alpine’s perspective on asset allocation contains two unique perspectives. First, individual investors should employ an approach similar to the approach of university endowments and non-profit foundations. Instead of thinking of dividends from stocks and interest from bonds providing the necessary cash flow from a portfolio, we believe that investors should define an annual percentage drawdown from their portfolio and be agnostic as to whether that drawdown comes from income or principal. As a result of this perspective, more funds can be allocated to equities, which have historically provided more in total return than bonds thus allowing an investor’s portfolio to grow more than a 60/40 model might deliver.
Second, and following the first point, effective asset allocation requires that an investor view their bond investments as a liquidity bucket from which bonds may be sold for cash flow during down markets when selling equity investments may be imprudent. With proper planning for each client’s cash flow needs, the integrity of an investor’s portfolio can be better protected when equity markets are depressed while still providing the cash flow the investor requires.
L: The Location of Assets and Optimizing Returns
Tax considerations should always be part of the investment conversation. How assets are structured – and where they are located – can have a significant impact on taxes and, thus, the long-term accumulation of wealth. In managing an investor’s overall investable wealth, we evaluate in which type of accounts assets should be held to most efficiently minimize the long-term impact of taxes. This includes taxable, non-taxable, and tax-deferred accounts.
For example, a common mistake is accumulating wealth only in qualified structures like 401(k)s and traditional IRAs. While this can effectively avoid taxes during working years, when the investor must rely solely on their IRA to fund their cash flow needs, they face the unpleasant realization that every withdrawal is shared with the IRS in the form of taxes. This can also result in a double whammy of forcing the investor into a higher tax bracket thus compounding the problem and significantly reducing cash flow in retirement.
Careful planning is required to ensure that an investor’s assets are located in the most tax-efficient structures in not only the present but also in the future. This may entail using Roth IRAs or, at the appropriate time, undertaking a Roth conversion. It also means thoughtful evaluation of the balance between taxable savings and non-taxable savings to ensure that retirement cash flows are not overly burdened by taxes. This is especially true in high-tax states where the total tax bite can approach or exceed 50% on funds withdrawn from large, qualified plans.
Investors should ask their advisor important questions:
- Is my portfolio properly structured to most effectively take advantage of taxable, non-taxable, and tax-deferred structures and investments?
- Should I consider a Roth conversion?
- Do I have a proper balance between taxable and qualified plans to avoid the requirement of ordinary income tax being paid on most or all of my savings withdrawals in retirement?
P: Asset Protection Isn’t Just About Insurance
When most people think about protection as a function of their wealth management, thoughts often center around insurance, and they are correct in that insurance is a key piece of the puzzle. We often advise clients about having umbrella policies and life insurance in place, as well as the appropriate amount and type of policy. Yet another consideration for protection involves how wealth is invested (we believe value investing is a proven strategy for those seeking growth AND protection) and how assets are structured to shield wealth from creditors and estate taxes, among others. This helps to ensure that your wealth serves you in life, and that it is properly transferred through generations. This is a primary concern for many of our clients as they begin to think about how to pass their wealth onto their children while helping to protect them from taxes and other outside pressures that may occur.
Many investors do not know that properly structured trusts can protect an investor’s wealth from creditors and lawsuits. This can be especially critical for families whose wealth is derived from operating businesses or specific real estate holdings. In our litigious society, liability insurance is critical but may not always be adequate. Protecting assets from lawsuits by careful estate planning can add a valuable additional layer of protection.
However, estate planning obviously goes well beyond protection from lawsuits; it also protects heirs from the estate tax which can swallow up as much as 40% of a beneficiary’s inheritance, possibly more for those residing in states which levy an estate tax. This threat will become even more severe when the current lifetime estate tax exclusion of $13,610,000 per person sunsets at the end of 2025 and reverts to a much lower of approximately $7,000,000. For example, a married couple’s substantial estate of $25 million would currently be subject to zero estate tax upon their deaths prior to 2025 if the assets are properly split between the two spouses. However, after 2025, without astute estate planning, the couples’ heirs could face an estate tax bill as high as $4,400,000 and possibly higher as some anticipate a corresponding increase in the estate tax rate.
ALP and Value Investing for Growth and Protection
The Team at Alpine Private Wealth is keenly aware that every situation – and every wealth plan – is unique. That’s why we work with clients and their other advisors (e.g. CPAs, attorneys, insurance brokers, etc.) throughout the year to not only grow their wealth in a steady, deliberate manner but also to protect the wealth they’ve worked hard to build and preserve through the generations. The ALP Principles serve as the foundation for how we approach every client’s wealth, providing the straightforward, comprehensive manner in which we consider how to best structure and protect assets.
We look forward to sharing more about the strategies we’ve described above. Please feel free to contact us with any questions or to learn if any of these fit your financial situation.