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Written by: Christopher Crawford | Buffalo Funds
What does it mean to be a high-net-worth (HNW) individual? If you have investable financial assets between $1 and $30 million, excluding the value of your primary residence, then congratulations, you’ve made it into the HNW club. According to data firm Wealth-X, in their 2019 Global HNW Analysis, the highest population of HNW individuals resides in the U.S., with the highest number of these individuals living in New York.
At the same time, Asia is projected to have the greatest growth in the number of HNW individuals, with its high-net-worth population expected to increase over the next five years at a compound annual growth rate of 7.6%.When considering a successful wealth management plan, it could be beneficial for HNW individuals to start thinking like an institutional investor. Institutional investors include foundations and endowments, non-profits, plan-sponsors, insurance companies, Taft-Hartley Plans, and public and corporate investors.At first glance, HNW individuals may not seem to have many similarities with institutional investors. However, a closer look reveals that they actually have many qualities in common. These similarities highlight precisely why HNW individuals should also share the same investment strategies as financial institutions.
What HNW Individuals and Institutional Investors Have in Common
Long-Term Financial Stability
High-net-worth individuals and institutional investors share an exclusive space where they have similar financial goals. One of those goals is to ensure long-term financial stability. In the case of a HNW person, he or she must consider multigenerational needs. Preparing the next generation and setting their children up for success later in life is a major concern, but what happens beyond the second generation? According to a recent report by the Williams Group wealth consultancy, an estimated 70% of families will lose their wealth by the 2nd generation, while 90% will lose it by the 3rd.
There are several reasons why this happens, such as the effects of taxes, inflation, bad investments and the dilution of assets, but perhaps one of the keys to understanding why there is such a loss in wealth over several generations is the fact that the 3rd generation is often unprepared to manage what is handed to them. Their grandparents put in the work to build and nurture the family’s assets, while their parents grew up with the struggles of not having a lot of money. Having experienced none of the work and hardships of their grandparents and parents, the third generation grows up with very little preparation for what it takes to manage their wealth.Similarly, the backbone of any successful institutional investor is financial longevity. For larger institutions that have been established for a long period of time, there is a specific aim to implement financial strategies that ensure revenue growth. Just as families must consider the best plan to ensure wealth for future generations, so must older, more established institutions think ahead to how they can maintain the financial health of their organizations.
Risk Mitigation
HNW investors also have a broad perspective when it comes to risk. Unlike ordinary investors, HNW individuals have a greater ability to accept financial losses, particularly in the short term. What may seem like a staggering sum to most could be a mere fraction of liquidity for someone with a comfortable nest egg. For example, the short-term market volatility in December 2018 to early January 2019 had little or no effect on HNW investors and institutional investors alike, due to their long glide paths.
While tempting to react to the latest headlines about imposed tariffs, HNW individuals can afford to stick with what works for their financial goals, whether that includes balancing their assets in equities, fixed income and alternative investments. Much in the same way, investment strategies for institutional investors are designed with a long glide path to weather short-term losses. Depending on their mandates and investment guidelines, institutional investors execute investment strategies that balance risk tolerance with a variety of asset classes.With a wide-ranging perspective on risk, both HNW individuals and institutional investors require complex investment strategies that can factor in short-term losses and gains while remaining focused overall financial growth.
Wealth Stature
A distinctive financial profile and access to investment managers are two additional qualities that HNW individuals and institutional investors share. What makes a person stand out as a HNW individual is the value of their investable assets. Similarly, an institution that has been established for 50 years or more has amassed assets that far surpass the average organization. Both occupy a status that is outside of the financial norm because of their collected wealth. It is this wealth that allows them unique access to investment managers and investment products that are not typically available to retail investors.
Building Portfolios That Suit HNW Investors’ Needs
What is the best approach to take then when constructing portfolios for high-net-worth individuals? On the client relations side, having a low and transparent cost structure and generating a return to cover management expenses are basic attributes of HNW portfolios. This builds trust and a good foundation for the advisor-investor relationship. On top of that foundation, a portfolio that is designed to outpace inflation is critical to its longevity. Inflation increases the cost of everyday goods and services, with long-term effects on withdrawal rates, especially when maintaining a certain lifestyle. In the same way, if a portfolio does not address a HNW individual’s lifestyle needs by meeting or exceeding current income requirements, it will run out of funds. Finally, protecting and growing assets for beneficiaries is a long-term goal that all advisors should aim for when building HNW investment portfolios.
Related: The Evolution of the Advisor with Christopher Crawford