From the October 2008 issue of Investment Advisor • Subscribe!

Even Affluent Clients Feel the Chill

Some have their confidence tested, while others feel the true impact

The affluent may have significant assets, but that doesn't make them immune to economic chills. Even if retirement savings are in the multiple millions, affluent retirees and near-retirees will at least feel the shrinkage in their portfolios emotionally when they see a one-third drop in asset levels in a single year. And while they remain far more secure than those middle-class homeowners rocked by the mortgage crisis, the affluent might adjust their habits relative to their expenses and spending habits in the face of such shaken confidence. Advisors with high-net-worth clients know that they need to remain responsive to the advanced-planning needs of families undergoing a true economic transition, as well as those with an exaggerated concern given the relative stability and size of their net worth.

Feeling the Impact

Some high-net-worth families have felt the very real impact of a change in fortune. A former hedge-fund manager who made the transition to commercial real estate, for example, is feeling the pinch of harder times in a soft real estate market. He's currently trying to sell his 9,000-sq. ft., six bedroom home in one of Long Island's plushest towns for $7 million. He's cut the price twice in the 12 months the house has been on the market. He's also thinking about buying a hybrid to drive instead of choosing one of his two Mercedes in the four-car garage.

During an economic slowdown, even wealthy clients can feel less confident about their near-term financial condition and longer-term retirement standard of living. Studies show that even the wealthy who can easily write checks for coverage are concerned about the cost of medical care during their senior years.

On their own, many clients take a fresh look at their formal financial plans in search of reassurance. Tough economic times can also cause some clients to rethink their relationships with their advisors--and whether they're getting value for the fees they pay. This is the time to show your value and the value of an advanced planning team. It's an opportune moment to strengthen your relationships with clients by reviewing plans and adjusting them as needed. According to research from Prince & Associates, Inc., investment advisors who maintain regular contact with their clients fare better in terms of client retention and new assets than those who avoided communicating bad news.

Lowered Optimism

The recent 2008 Phoenix Wealth Survey tracked a clear difference in the attitudes of affluent investors between 2007 and 2008. This year, 50% of the survey respondents expressed pessimism about the nation's economy, the highest level since 2001 when the question was first asked. The survey found that respondents (more than $1 million net worth minus primary residence) are feeling less financially secure this year than last (see table on next page).

Interestingly, the study also showed that HNW investors with a net worth of $5 million or more felt estate planning was much more important now for someone at their level of wealth than in the past. With the still surprisingly low number of the affluent who have current, comprehensive financial plans, this finding would indicate a potential opportunity for advanced planning teams to provide necessary services. Given the national debt and the political climate, a complete, permanent repeal of the estate tax appears unlikely. If Congress doesn't act before 2011, the estate tax exemption reverts to $1 million and the maximum estate tax rate becomes 60%.

The HNW Take a Tougher Look at Investing

The wealthy thought about their investment strategies differently, too. Last August marked the beginning of a slowdown for all for high-net-worth and ultra-high-net-worth investors, according to the 2008 World Wealth Report by Merrill Lynch and Capgemini. According to the report, HNW investors worldwide in 2007-2008 moved to less risky and more familiar investments:

  • HNW investors moved to safer investment categories, with cash/deposits and fixed-income securities accounting for 44% of HNW investor financial assets, up nine percentage points from 2006;
  • Fixed-income securities saw a 6 percentage-point increase in asset allocation, accounting for 27% of holdings, up from 21% in 2006. North American HNW investors allocated 29% of their holdings to fixed-income securities;
  • Globally, HNW investors continued to decrease their holdings in North America;
  • HNW investors showed greater interest in domestic market investments, preferring more familiar grounds amid heightened levels of economic uncertainty.

Beyond the appropriate asset allocation to withstand some stormy economic weather, preparing clients emotionally for reasonable expectations is the key to reducing the number of frantic phone calls. A very robust spending habit supported by a few years of 10%-plus portfolio growth can prove a hard addiction to break.

A new book from Merrill Lynch and Capegemini, Wealth: How the World's High-Net-Worth Grow, Sustain, and Manage Their Fortunes, examines the data the team collected and analyzed about the global wealth management market, clients, and prospects.

A number of investment behavior trends and habits of the wealthy are listed below.

  • International Investing Emerging markets hold greater interest and opportunity at the same time as they help to globalize portfolios to better withstand regional downturns.
  • Wealth Transfer The old etiquette of silently transferring wealth to children while offering few details--and the avoidance of any discussions of money at all, has faded with the need to educate the children of the wealthy to become better managers of their inherited assets.
  • Philanthropy Donations by HNW investors rose to $285 billion dollars in 2007, as did the degree of personal involvement (not just check writing) and the expectation of recipients to report on results in greater detail.
  • The Internet, Technology, and Self-Education Affluent clients are increasingly using the Internet and technology to manage investments and research on their own. The result is a more demanding, informed client than seen in previous generations.

Changing Luxury Spending

The biggest challenge for some retailers and manufacturers of high-end luxury goods is self-image in a time of economic difficulty for many U.S. citizens, according to an article in the Wall Street Journal ("Luxury Goods Weathering Economic Woes in U.S", July 28). Marc Cohen, director at Ledbury Research, a London-based luxury consulting firm, notes that wealthy Americans in particular are now more cautious about projecting conspicuous consumption, even if they have the potential for big budget shopping. "We're seeing more comments about, 'I feel bad about spending,' when there is so much negative economic news," he observed.

Growth in sales of luxury goods in North America slowed to 2% last year, according to consulting firm Bain & Co. And investors responded with caution as luxury stocks fell 13% between the end of May and the beginning of July, according to Savigny Partners LLP, a luxury-goods advisory firm based in London.

Where the affluent are spending their discretionary dollars is shifting in response to local economic conditions around the world. While Ferrari, for example, reported high growth in the emerging markets of Asia and the Middle East, the U.S. and German markets--which historically consumed the largest portions of the auto maker's output--showed much more modest single digit growth, according to the 2007 annual report.

By contrast those high-ticket items with an investment dimension, such as art and collectables, have remained steady or have grown in the U.S. American art collectors have actively participated in important auctions. At Christie's November 2007 auction of post-war and contemporary paintings, Americans bought 50.8% of the art, while at previous-year event they bought 48.5%, as noted in the 2008 World Wealth Report. While a lower end luxury watch costs about as much as a Toyota Prius, affluent collectors have pursued the exclusive and limited edition models from Patek Phillippe and other makers. Patek Phillippe, in fact, expects to sell out of its entire inventory for the year in the U.S., reports the Wall Street Journal article.

"We used to think in terms of hedge funds when targeting new customers," says David Norman, worldwide co-chair of Sotheby's Impressionist and Modern Art Department in the Wall Street Journal. "Now, we look for barrels of oil."

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