The ASI Balance Sheet Approach

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The ASI Balance Sheet Approach

  1. 1. A Single View of the Household Financial Picture The ASI Balance Sheet Approach sm A More Holistic Alternative to Traditional Financial Planning 1 Beyond Traditional Financial Planning Analyzing the Totality of a Household’s Resources, Liabilities and Goals 2 Bringing It All Together Unifying the Distinct Aspects of an Investor’s Financial Life 3 The Bigger Picture Goal Directed Investment Management 4 Case Study The Gorham Family’s Household Balance Sheet
  2. 2. M ost investors do not have a clear understanding of how they can achieve their financial goals and dreams. At the same time, they are hesitant to put their complete trust in the solutions currently available from financial advisors. These solutions are just not personalized enough to address all of the components of an individual investor’s unique financial life. But while this clearly represents a deficiency 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 financial planning and investment management decisions can be made with confidence. These decisions are an important first step in developing a realistic strategy for meeting an investor’s lifelong financial goals. 1 Beyond Traditional Financial Planning Analyzing the Totality of a Household’s Resources, Liabilities and Goals Like a traditional financial planning analysis, the ASI Balance Sheet Approach begins with an examination of a client’s circumstances. But instead of limiting the focus to cash flows 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-fifty’s and have significant 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. ASI BALANCE SHEET APPROACH | © 2 0 0 8 | 2
  3. 3. Clearly, the ASI Balance Sheet Approach reveals a number of insights that go beyond traditional financial analysis and are critical to the planning process. Traditional Financial Planning The ASI Balance Sheet Approach Accounts and products are managed All resources (including, real estate, human independently; human capital and real capital, and social security), liabilities and estate are not considered. goals are considered together. Financial planning is tightly integrated with Financial planning is not well connected investment management in order to achieve to investment management. an investor’s goals. Risk is measured through a quantitative Risk is measured via a questionnaire or asset/liability framework that addresses how other qualitative means. much risk a household can afford to take without adversely affecting its goals. Resulting strategies are qualitative, Resulting strategies are more personalized inconsistent and do not give the investor and relevant, based on goals defined by the the best chance of meeting her goals. investor. Analyzing the Family’s Goals In using the ASI Balance Sheet Approach, the family’s resources serve one purpose -- 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 financial 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 Household Before 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 sufficient 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. ASI BALANCE SHEET APPROACH | © 2 0 0 8 | 3
  4. 4. “Unlike a traditional asset alloca- 2 Bringing It All Together tion model that lumps assets into Unifying the Distinct Aspects of an Investor’s Financial Life rigid classifications, like long term or One of the key benefits of the ASI Balance Sheet Approach is its ability to bring all of the short term, the ASI Balance Sheet disparate parts of the investor’s financial life together in a single view. As a result, the investor is Approach considers that some able to gain deep insights into potential issues that may be lurking beneath the surface. assets, which may appear similar, are really not all the same. What Margin of Safety for Better Risk Assessment if one person’s wealth is in liquid instruments while another’s is in an 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 illiquid business or real estate? that are available. If this is the case, in a deterministic environment, the household will be able The ASI Balance Sheet Approach to meet their goals with certainty. But in the real world, the investor must also consider their considers all of an investor’s “margin of safety,” which is the net resources as a percentage of total resources. resources, appropriately quantifies them and adjusts for risk.” In the case of an affluent 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 Andrew Rudd, founder, chairman and CEO of Advisor Software 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 financial management. Identifying Liquidity Challenges While a household may have the wealth to fulfill 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 flow needs, identify potential liquidity traps and determine how they can finance their expenses during those critical years. 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 ASI BALANCE SHEET APPROACH | © 2 0 0 8 | 4
  5. 5. Dynamic Asset/Liability Management for the Household It is important to realize that the balance sheet will shift significantly 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 financial 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 financial 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 Benefits: • Improves Asset Allocation and Asset Selection. • More Accurately Reflects an Investor’s Financial Circumstances. • More Effectively Addresses the Asset/Liability Problem. • Enables Better Control over Diversification. • 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. ASI BALANCE SHEET APPROACH | © 2 0 0 8 | 5
  6. 6. 3 The Bigger Picture Goal Directed Investment Management The ASI Balance Sheet Approach allows financial institutions and their advisors to deliver a holistic, goal-directed wealth plan. By considering a household’s entire financial 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 first 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. 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 ASI BALANCE SHEET APPROACH | © 2 0 0 8 | 6
  7. 7. 4 Case Study The Gorham Family’s Household Balance Sheet A lexander Gorham is a 49-year old mid-level financial 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 firms. 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 financial 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. The Gorham Family Balance Sheet Resources Cl a i ms Liquid Accounts † Liabilities † First Republic Bank: Joint $24,067 Mortgage $586,247 Joint Brokerage $370,000 Total Liabilities $586,247 Custodial $354,344 Goal Costs † Total Liquid Accounts $748,411 Adam’s Education $346,981 Illiquid † Erich’s Education $342,989 Real Estate $1,480,500 Sally’s Education $351,019 Total Illiquid $1,480,500 Expenses [Pre-Retirement] $2,498,591 Restricted Accounts † Expenses [Partial-Retirement] $646,646 Alexander’s 401(k) $140,851 Expenses [Retirement] $4,106,793 Alexander’s IRA $783,350 Home Remodel $739,601 Amy’s 401(k) $52,737 Bequest $338,695 Amy’s IRA $547,005 Total Goal Costs $9,371,315 529 $144,659 TOTAL CLAIMS $9,957,562 Total Restricted Accounts $1,668,602 Social Security † Alexander’s Social Security $197,567 Amy’s Social Security $215,428 Total Social Security $412,995 Pension† Alexander’s Pension $503,807 Total Pension $503,807 Employment † Alexander’s Employment $1,649,937 Amy’s Employment $1,929,508 Total Employment $4,083,252 TOTAL RESOURCES $8,393,760 † Calculated in Present Value Comparison of Resources vs. Claims ASI BALANCE SHEET APPROACH | © 2 0 0 8 | 7

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