From the July 2007 issue of Boomer Market Advisor • Subscribe!

Just because we can doesn't mean we should

These are the best of times, at least in this market cycle. Since 1980, Americans have experienced one of the greatest periods of income and wealth accumulation in history (notwithstanding a few speed bumps along the way). Demographic trends, a long-term decline in inflation and interest rates, and substantial gains in national income have paved the way for real wealth and financial security.

Wall Street has responded with increasingly creative solutions for handling this newfound wealth. But sorting through the solutions is a mind-boggling task -- stocks, bonds, commodities, options, variable annuities, actively managed mutual funds, index funds, ETFs, hedge funds and private equity vehicles. The list goes on and on.

With so many options, it's increasingly difficult to match client needs with investment vehicles appropriate for their individual circumstances. With choice, we get answers, but we also create more questions. Should they be put in a managed account or individual investments? Considering their wealth, account size and tax sensitivity, is one vehicle in question more appropriate than another? There's no single answer; each client is different. And there's no single standard to help us decide.

We know how to sell product, but today's solutions require improvements in the methods used when applying these products to complicated wealth-planning situations. It's likely the future of product development will focus on improving these methods.

It's commonly believed that clients can assume more investment risk in the early stages of wealth accumulation. However, a strong argument can be made that clients do the opposite; that they opt for simple and safe investments for their limited capital base. For these clients, investment choice should carefully balance the need for asset growth while keeping a keen eye on preserving the small nest eggs they've acquired. A diversified portfolio of mutual funds and/or ETFs with exposure to multiple asset classes is adequate.

As investors grow their asset base, their needs change and they have the ability to assume more risk. Advisors should delve deep into an individual's balance sheet. It's critical to gain a comprehensive understanding of the individual's total asset picture, as well as the liabilities he has assumed to date. The investor might seek more risk if enough of a cushion is in place once liabilities are accounted for. Understanding whether clients can "afford" to take risks will help to identify the appropriate investment vehicle.

Determining the investment preference for wealthy clients can be a challenge, too.

Because these clients have a significant amount of assets and income, issues pertaining to current liabilities are not as important. However, their objectives often vacillate between preservation of capital and maximum growth. Their preference for either is usually dependent on long-term tax and estate planning objectives, as well as their willingness to assume risk. Investors with plans to bequeath wealth to heirs and charitable organizations are as likely to seek asset growth as they are a capital preservation strategy.

There is always demand for more complicated and risky investment alternatives (especially in times of market growth), which Wall Street engineers are happy to create.

But just because we can offer these products doesn't mean we should. Determining a suitable investment recommendation for clients at a particular stage of the wealth accumulation process requires it be based on how well the advisor knows the client. To effectively help clients, the only true solution is to ask lots of questions.

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