When we work with clients to design a customized portfolio, we need to understand their most fundamental goals.

Goals lead us beyond the simple mix prescribed by a risk profile—conservative, moderate, aggressive—and help us understand how wealth fits into our clients’ lives and what they want to achieve with the assets they have accumulated. This may include providing education for children and grandchildren, having more flexibility in retirement spending or fulfilling specific charitable wishes.

Taking a page from institutional investors

The trend of goals-based allocation first took hold in the institutional world. Think of a company preparing for future pension outlays or a university endowment planning for a specific investment like a new campus building. Because institutional portfolio designers know the particular goal and the exact time horizon, they can design an allocation geared toward that outcome. This is known as liability-driven investing (LDI), and the process has become a standard practice for many institutions.

While a duration-targeted LDI portfolio may not suit the typical family, we can use the same concept to identify specific goals and timelines for clients, which then guide asset allocation proposals and portfolio construction. Here we share a few examples to bring the concept to life.

Sample Allocation Example 1: Spending in retirement

One of the most common client scenarios we face is tackling the allocation for a couple that is spending in retirement. For many families, the entire pool of their wealth is intended to be their support in retirement. In this case, the goal for the entire portfolio is the same—achieving a level of income to support regular expenses, without dipping substantially into the principal balance.

Given today’s low level of interest rates, however, we find that many families are often allocated in too risky a mix of assets. Indeed, if you look at a typical target date fund, the prevailing approach is to hold a majority of assets in stocks even in retirement. The other challenge is that the yield on traditional fixed income, like Treasury bonds, is currently too low to support a majority allocation to traditional fixed income and still provide sufficient yield.

Sample Allocation 1: Spending In Retirement

This single portfolio may include a diversified mix of assets that balance growth and income generation to help meet spending needs through the retirement years.

There are ways to construct a creative and diversifying mix of income-generating investments. For investors that are comfortable moving further out on the risk-return spectrum, a solution could include income-oriented equity (which tends to include higher-quality dividend-paying stocks) alongside higher-yielding fixed income asset classes in both taxable and municipal bond strategies. Another possible option might be an allocation to an absolute return or long-short equity strategy, with the goal of diversifying traditional equities and bonds.

Sample Allocation Example 2: Accommodating lifestyle spending as income changes

Sometimes a family has seemingly conflicting goals for a portfolio, like wanting to spend out of savings in the short term while maintaining long-term growth potential through illiquid investments. For example, let’s assume a married couple with a high level of annual income, about $5 million a year, substantial savings of approximately $6 million and high lifestyle spending: three houses, frequent travel and two children in college. They both expect to scale back on working in the near future to a state of semi-retirement and want to rely on their savings as they adjust. They have a moderate risk profile, but are qualified for alternative assets and interested in incorporating private equity and other less-liquid alternative investments in their portfolio.

In this case our approach might be to propose an overall portfolio that involves segmenting it into two halves and allocating the two portions separately. The first half, which we call “core capital,” would be allocated to liquid and moderately conservative investments— primarily investment grade bonds and some high-quality dividend stocks. The other half of their assets, which we would call “opportunistic capital,” would be allocated to private equity and other alternative assets with higher growth potential. This approach could give the couple a level of comfort in maintaining their allocations during periods of volatility as the “core capital” half would be available for short-term needs.

Sample Allocation 2: Core Capital + Opportunistic Capital

This clearly segmented portfolio could include a lower-volatility, income-focused component and a more-aggressive, less-liquid growth component.

Sample Allocation Example 3: Earmarking investments for charitable giving

Families may also have specific charitable giving goals. Let’s assume a couple has about $5 million in assets for the family’s personal investments, and another $3 million in assets for charitable goals. The couple has a conservative risk profile for their personal portfolio and a more aggressive profile for their charitable portfolio, driven in part by their charitable commitments.

Another sample approach to constructing their portfolio might first involve suggesting that they consult with a trust and estate planning attorney to consider setting up a charitable trust for the assets earmarked for giving, as this may provide some tax benefits. The timeline for the charitable commitment is long—approximately 20 years. Given the long time horizon, a low need for liquidity and an aggressive risk profile, we might design an allocation for the charitable assets that includes a mix of traditional equity and alternative assets. In the personal portfolio, the assets could be allocated to a conservative mix of municipal and taxable bond holdings.

Sample Allocation 3: Separate Portfolios for Personal and Charitable Use

Creating separate portfolios delineates assets by goals. If the charitable assets are located in a charitable trust, there could also be certain tax advantages.

Starting with the end in mind

Individuals and families may not have an exact timeline and specific goals for assets the way that institutions do. Still, incorporating an institutional approach of identifying goals to the extent possible offers us a more nuanced picture of our private wealth clients than we can obtain from risk profile alone. The truth of the matter is that there are many ways to assemble a moderate or conservative portfolio. With goals as the guide, we can tailor a mix of investments to clients’ intended time horizons or liquidity levels, and thereby help them achieve their long-term objectives.

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