the asi balance sheet approach
TRANSCRIPT
The ASI Balance Sheet Approachsm
A More Holistic Alternative to Traditional Financial Planning
Beyond Traditional Financial PlanningAnalyzing the Totality of a Household’s Resources, Liabilities and Goals
Bringing It All TogetherUnifying the Distinct Aspects of an Investor’s Financial Life
The Bigger PictureGoal Directed Investment Management
Case StudyThe Gorham Family’s Household Balance Sheet
A Single View of the Household Financial Picture
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Most investors do not have a clear understanding of how they can achieve their fi nancial goals and dreams. At the same time, they are hesitant to put their complete trust in the solutions currently available
from fi nancial advisors. These solutions are just not personalized enough to address all of the components of an individual investor’s unique fi nancial life.
But while this clearly represents a defi ciency in today’s advice market, an even bigger gap exists. Traditional advice delivery still fails to make a relevant connection to the investor’s goals.
The solution to this problem is a comprehensive view of the household balance sheet – one that encompasses the full range of a household’s re-sources, goals, and liabilities as well as its portfolio of investments. Leveraging this holistic balance sheet framework ensures that critical fi nancial planning and investment management decisions can be made with confi dence. These decisions are an important fi rst step in developing a realistic strategy for meeting an investor’s lifelong fi nancial goals.
Beyond Traditional Financial PlanningAnalyzing the Totality of a Household’s Resources, Liabilities and Goals
Like a traditional fi nancial planning analysis, the ASI Balance Sheet Approach begins with an examination of a client’s circumstances. But instead of limiting the focus to cash fl ows generated from the client’s taxable and tax-deferred accounts, this innovative approach considers the totality of the resources that can be used to support future goals and liabilities. This could include, among other items:
• the value of household taxable accounts, net of taxes and transaction costs;
• the value of household retirement accounts, net of deferred taxes, transaction costs, and any early withdrawal penalties;
• the equity in the family home, as well as investment properties;
• and the present value of anticipated social security payments, pensions and human capital (future earnings).
Analyzing the household’s resources in this way provides unique insights that facilitate decisions about liquidity, taxes, insurance and other considerations.
For example, using the ASI Balance Sheet Approach to analyze the resources of a young family might demonstrate that achieving their goals will depend heavily on income from their employment. Perhaps they might want to secure this income with disability and life insur-ance. For a boomer family, whose principals are in their mid-fi fty’s and have signifi cant equity in their home, the value of their real estate is of primary importance. As a result, hedging their exposure with the appropriate investments may be appropriate.
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Clearly, the ASI Balance Sheet Approach reveals a number of insights that go beyond traditional fi nancial analysis and are critical to the planning process.
Analyzing the Family’s GoalsIn using the ASI Balance Sheet Approach, the family’s resources serve onepurpose -- funding goals
Most investors will be able to express essential goals that must be met even under dire circumstances. These include, for example, minimal living standards along with personal life objectives that they are unwilling to compromise. But under normal circumstances, investors expect that they should be able to satisfy more than their minimum requirements. Finally, almost all investors have aspirations that they would like to achieve if things turn out better than expected.
Unlike traditional fi nancial planning analysis, which does not consider nuances of the typical investor’s thought process, the ASI Balance Sheet Approach helps investors systematically categorize their goals into priority classes. This goal structure can then be used to drive strategic investment decisions.
Considering the Impact of Liabilities on the HouseholdBefore the family’s goals can be achieved, the family must carefully consider its liabilities or legal obligations. For most households, these liabilities may include a mortgage on the primary residence, a home equity line-of-credit or revolving debt from use of a credit card. The ASI Balance Sheet Approach helps investors understand whether their household has suffi cient liquidity to service their debt as well as the resources to eventually pay it off. Too much debt on the balance sheet may ultimately hinder goal achievement.
Traditional Financial Planning
Accounts and products are managed independently; human capital and real estate are not considered.
The ASI Balance Sheet Approach
Financial planning is not well connected to investment management.
Risk is measured via a questionnaire or other qualitative means.
Resulting strategies are qualitative, inconsistent and do not give the investor the best chance of meeting her goals.
All resources (including, real estate, human capital, and social security), liabilities and goals are considered together.
Financial planning is tightly integrated with investment management in order to achieve an investor’s goals.
Risk is measured through a quantitative asset/liability framework that addresses how much risk a household can afford to take without adversely affecting its goals.
Resulting strategies are more personalized and relevant, based on goals defi ned by the investor.
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Bringing It All TogetherUnifying the Distinct Aspects of an Investor’s Financial LifeOne of the key benefi ts of the ASI Balance Sheet Approach is its ability to bring all of the disparate parts of the investor’s fi nancial life together in a single view. As a result, the investor is able to gain deep insights into potential issues that may be lurking beneath the surface.
Margin of Safety for Better Risk Assessment
Under ideal circumstances, net resources should be positive. In other words, the total cost (in present value) of the household’s liabilities and goals should be less than the total resources that are available. If this is the case, in a deterministic environment, the household will be able to meet their goals with certainty. But in the real world, the investor must also consider their “margin of safety,” which is the net resources as a percentage of total resources.
In the case of an affl uent family, whereby the margin of safety in achieving essential goals is high (greater than 10 percent), the chance of success is fairly secure. In contrast, a low margin of safety (under ten percent) in funding aspirational goals reveals that the chance of reaching these is somewhat slim. While this family can likely afford their dreams, they cannot afford any sloppiness in their fi nancial management.
Identifying Liquidity Challenges
While a household may have the wealth to fulfi ll all of their goals (in present value terms), they may not have the necessary liquidity to meet their liabilities and goals in a timely manner. For many families, there will be a time when the principals are near retirement, the children are entering college, and elderly parents may need additional support. All of these events may come together in a period of a few years, posing potential liquidity challenges for the household.
Clearly, the ASI Balance Sheet Approach enables investors to better understand their cash fl ow needs, identify potential liquidity traps and determine how they can fi nance their expenses during those critical years.
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Timeline of Goals Liquidity Challenges for a Household
Principal 1 Retirement
Principal 2 Retirement
Home Remodel
Child 1 College
Child 2 College
Child 3 College
Parent Long Term Care
2008 2013 2018 2023 2028
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“Unlike a traditional asset alloca-
tion model that lumps assets into
rigid classifi cations, like long term or
short term, the ASI Balance Sheet
Approach considers that some
assets, which may appear similar,
are really not all the same. What
if one person’s wealth is in liquid
instruments while another’s is in an
illiquid business or real estate?
The ASI Balance Sheet Approach
considers all of an investor’s
resources, appropriately quantifi es
them and adjusts for risk.”
Andrew Rudd, founder, chairman and CEO of Advisor Software
Dynamic Asset/Liability Management for the Household
It is important to realize that the balance sheet will shift signifi cantly over time and that the portfolio will need to adapt as personal circumstances and market conditions change. One of the hallmarks of the ASI Balance Sheet Approach is that the investment process is dynamic.
While a family’s fi nancial situation will change over time due to various factors, these changes are largely evolutionary and fairly predictable. For example, over the long term, the net value of the family home is likely to dramatically increase as a result of move-ment in the overall real estate market and from the reduction in the mortgage obligation as it gets paid down.
As the various aspects of an investor’s fi nancial life evolve over time, the ASI Balance Sheet Approach offers the ideal framework for dealing with the asset/liability matching problem. In doing so, this framework leverages an investment strategy for ensuring risk appropriateness in matching portfolios with goal priorities. This ensures that essential goals can be met with relative certainty while taking the appropriate amount of risk nec-essary to reach aspirational goals.
ASI Balance Sheet Approach Key Benefi ts:
• Improves Asset Allocation and Asset Selection.
• More Accurately Refl ects an Investor’s Financial Circumstances.
• More Effectively Addresses the Asset/Liability Problem.
• Enables Better Control over Diversifi cation.
• Ensures More Relevant, Goal-Driven Risk Management.
ASI Balance Sheet Approach Key Features:
• A Single View of the Household Financial Picture.
• A Platform for Prioritizing Multiple Goals and Making Trade Off Decisions.
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The Bigger PictureGoal Directed Investment Management
The ASI Balance Sheet Approach allows fi nancial institutions and their advisors to deliver a holistic, goal-directed wealth plan. By considering a household’s entire fi nancial picture, the ASI Balance Sheet Approach provides unique insights into how to make the most of a household’s net assets to support future goals. Using this more sensible wealth planning and risk management methodology, advisors can give clients the best chance of achieving their hopes and dreams.
The ASI Balance Sheet Approach is an integral part of ASI Wealth Manager®, the industry’s fi rst end-to-end application for goal-directed investment management. Leveraging the ASI Balance Sheet Approach and Advisor Software’s patent-pending process for creating a dynamic wealth plan, ASI Wealth Manager:
• Integrates Financial Planning, Investment Management and Trade Execution.
• Offers a Single, Comprehensive View of the Household Financial Picture that Considers All Resources, Liabilities and Goals.
• Utilizes Cash Flow and Scenario Analysis to Facilitate Important Liquidity Decisions.
• Supports Dynamic Asset Allocation and Asset Location Strategies.
• Delivers Tax-Aware Trade Recommendations across Accounts.
• Optimizes Investment Advice to Fund Investors’ Goals.
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For more information about the
ASI Balance Sheet Approach
and Advisor Software’s Intelligent
Wealth Management Solutions,
visit us at:
www.advisorsoftware.com
or contact ASI sales at:
(925) 299-7782
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The Gorham Family Balance Sheet
†Calculated in Present Value
Claims
†
†
†
†
Resources
Liquid Accounts
First Republic Bank: Joint
Joint Brokerage
Custodial
Total Liquid Accounts
Illiquid
Real Estate
Total Illiquid
Restricted Accounts
Alexander’s 401(k)
Alexander’s IRA
Amy’s 401(k)
Amy’s IRA
529
Total Restricted Accounts
Social Security
Alexander’s Social Security
Amy’s Social Security
Total Social Security
Pension
Alexander’s Pension
Total Pension
Employment
Alexander’s Employment
Amy’s Employment
Total Employment
TOTAL RESOURCES
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†
$748,411
$1,480,500
$1,668,602
$412,995
$503,807
$4,083,252
$8,393,760
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†
$586,247
$346,981
$342,989
$351,019
$2,498,591
$646,646
$4,106,793
$739,601
$338,695
Liabilities
Mortgage
Total Liabilities
Goal Costs
Adam’s Education
Erich’s Education
Sally’s Education
Expenses [Pre-Retirement]
Expenses [Partial-Retirement]
Expenses [Retirement]
Home Remodel
Bequest
Total Goal Costs
TOTAL CLAIMS
$586,247
$9,371,315
$9,957,562
$24,067
$370,000
$354,344
$1,480,500
$140,851
$783,350
$52,737
$547,005
$144,659
$197,567
$215,428
$503,807
$1,649,937
$1,929,508
Comparison of Resources vs. Claims
Case StudyThe Gorham Family’s Household Balance Sheet
A lexander Gorham is a 49-year old mid-level fi nancial services executive. His wife, Amy, is a 45-year old computer software sales professional. They have half-a-dozen taxable and tax-deferred accounts across their bank and two brokerage fi rms. They also
expect to receive a pension from Alexander’s company when he retires.
The Gorhams want to make it possible for each of their three kids, Sally, Adam and Erich, to attend their alma mater, Stanford University. In the next couple of years, they would also like to remodel their home. And when they retire, which they hope happens by their 60th birthdays, they expect to maintain their current lifestyle. Finally, they would like to leave something to the children.
With investable assets at close to $2.5 million, their fi nancial outlook over the past year has been generally healthy. But recent mar-ket upheaval has affected some of their accounts and caused a slight dip in their home equity. As a result, they are wondering if they will be able to achieve all of their goals.