Context Key to Sound Decision Making

Like most of you, I’ve been inundated with news and analyses of what’s going on in the markets (see Market Events, page 4) and what we should do about it. I’m particularly struck by the flurry of David Letterman-like lists that have cropped up: the top ten things that you should not do in this market environment, the top three things that you should do, the top six places to go to learn what’s going on. One pundit gives you three reasons to liquidate; another lists the bargains you should snatch up. One article I saw recommended a list of what the author believed were recession-proof investments. Addictions, like tobacco, were high on his list for the obvious reasons.

People love lists; they boil complicated situations down into neat recipes for success. But aside from the fact that many of the lists contradict each other, I doubt the solutions to everyone’s dilemmas can really be that simple.

I often say that wealth creates opportunity and complexity in equal measures. Few navigate its intricacies with ease and confidence, even in the best of times. I believe that’s because people tend to face issues as they arise and make decisions out of context. But context—interrelated elements that give a situation meaning—is the key to sound decision-making.

The importance of context

Let me give you an example. The value of your portfolio has very likely dropped in recent weeks, and that is naturally upsetting. For some, it’s so upsetting that they’ve started moving things around—selling this and buying that. But is that the right strategy? It’s impossible to answer that question without asking a host of other questions first. Are you clear about what your investments are intended to fund? Maintaining your lifestyle? Starting a new business? Buying a new property? Do you know if your investments are well aligned with those goals? When will you need that money?

It may be that changes to the investment strategy are indeed warranted, but you won’t know that without evaluating them in the proper context. Trying to ask and answer all the right questions is difficult, especially in the midst of a crisis. To help our clients organize their thoughts, we developed a framework that focuses on what they want and need for themselves, their families and their communities, both now and over the course of their lives. We have these discussions at the very beginning of the relationship and revisit them regularly. In the process, clients also recognize differences in urgency, priority and comfort with risk from goal to goal. Clarity around life goals is the first of those interrelated elements that establish the proper context for decision-making.

The second element is a very current and complete picture of a client’s total wealth—an inventory of resources, including assets, ownership and anticipated cash flows. The important point here is that the picture has to be complete and it has to be current. In the parlance of a corporation, we mean having access to current balance sheet and cash flow statements.

The last element is an understanding of how a client’s wealth is being used to achieve specific life goals. By this I mean which strategies and tools are being used to serve which goals. With this perspective, a client can see how they are progressing toward each goal as well as how a proposed change might affect the likelihood of achieving one or more of their goals.

How does the proper context make a difference?

While no one could have predicted the extent of the drama that’s been playing out in the markets, my colleagues and I have been paying attention and considering possible outcomes. It’s been clear to us that the economic and market struggles could be prolonged and, as a result, the value of assets could decline. Wealth managers who are armed with the proper context can identify a variety of highly-personalized options for their clients to consider, along with the tradeoffs inherent in each, allowing clients to make timely, well-informed decisions—under any circumstances.

Was this your experience?

 Let’s look at some of the actions we took as far back as eighteen months ago, when we started talking with clients about the economic situation. As you read through these examples, think of your experiences with your wealth manager.

Our clients’ first concerns tended to be around lifestyle—maintaining the way they live now and/or ensuring they’ll be able to live as planned down the road. Through our planning, we already had a clear picture of what each particular family spends in a year and whether they expect those expenses to change in the short-term. But we revisited the data just to be sure. We find that most people underestimate what they spend now. They also underestimate what they’ll spend later, after transitioning into retirement, for example. It’s likely that spending levels will actually increase as couples find they have time for travel and other pastimes they’d put off while raising their families and building their wealth.

We also reviewed the resources we had allocated to meeting the lifestyle goals, as well as the investment strategy we developed to support them. We had to consider how the market volatility might affect our assumptions about resources and strategy. For example, income sources like bonuses, stock options and real estate income may be reduced in a recession. A realistic assessment of income sources over the next two to five years is important to ensure the family has enough liquidity to meet cash flow needs.

Adding to that mix of data and our clients’ emotional responses to potential market volatility, the actions we ended up taking for specific clients were quite diverse.

• Some clients needed greater peace of mind with respect to covering their lifestyle costs for the next zero to five years, and we increased the amount of cash allocated to that goal to offset the potentially negative impact of market volatility. However, we kept their longer-term assets fully invested to be ready in the event of a swift market recovery.
• Other clients chose a different recommendation. We added an allocation to a diversified hedge fund strategy to the investment strategy that supports their current lifestyle. Hedge fund managers target absolute returns during both up and down markets, and tend not to move in synch with equity and bond markets. While there is no guarantee of this, it’s another way for accredited investors to diversify.
• Some clients were comfortable with the resources and strategy we’d set up to support their lifestyle and had excess resources, which they wanted to use to take advantage of the opportunities created by the depressed markets. There are many wealth transfer techniques that can be funded now to take advantage of depreciated assets and low government rates that may both optimize the value of your gift and help minimize the tax impact. A GRAT or CRAT for example, allows a client to transfer assets earmarked for family members or the community. For some clients, we added or increased an allocation to a depressed asset class, using cash they didn’t need to keep liquid to buy undervalued assets.
• Other clients were confident that they could weather short-term market fluctuations without any negative impact to their lifestyle. These clients take a total-return approach to spending—spending income and principal rather than income only—and we did not need to make any changes for them.

These examples illustrate actions we took for individual clients, but they are just examples and do not guarantee any specific outcome. Unlike the one-size-fits-all lists appearing in the media, the process of revisiting each client’s goals, priorities, urgency, resources, investment strategies and concerns—both emotional and practical—yielded a wide variety of actions.

Acting and reacting

What I’ve been talking about is the difference between acting and reacting. Certainly situations change and we can’t always predict them. But with the proper context—the knowledge of what is most important to each client, a current and complete picture of the resources they have at their disposal and a large toolkit of products from which to draw—I can help my clients anticipate the potential impact of new issues that arise and make rational, well-informed decisions rather than reacting emotionally. I continue to track and manage success (often measured in fewer sleepless nights) based on feedback from my clients. Meanwhile, be wary of lists.

The SEI Wealth Network is an “umbrella” name for various life and wealth advisory services provided by your personal business manager and SEI Investments Management Corp. (SIMC).

This material represents an assessment of the market environment and your personal situation at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results. The examples provided are based on individual situations and goals and should not be construed as investment and/or tax advice.

SIMC is a wholly owned subsidiary of SEI Investments Company.