Illustration by Kotryna Zukauskaite

There’s not a client today who isn’t concerned about wealth preservation, and astute financial advisors are nimbly helping investors meet this critical need. Indeed, since the global financial meltdown, clients have shown greater awareness and sensitivity to protecting their assets.

“I’ve yet to meet any family, regardless of portfolio size, that isn’t focused on preserving wealth,” says Michael Swenson, managing director, Swenson Jones Associates, in private banking at Merrill Lynch. His group, based in Wayzata, Minnesota, works with an ultra-high-net-worth clientele.

But asset preservation isn’t a simple matter in the face of current and projected stepped-up market volatility, rising interest rates (finally) and clients’ conflict over the pressing need to fund their own retirement versus wanting to leave money to succeeding generations. Among advisors, there seems to be little consensus as to which objective is the top priority.

On one hand: “Preserving wealth for your own retirement has definitely gained precedence. In 2008–2009, a lot of clients were very focused on leaving money to their kids and grandkids. All of a sudden, they got very focused on: ‘I need to make sure our own needs are taken care of first’,” says Carol Schleif, chief investment officer of the Midwest region at Abbot Downing, a Wells Fargo business serving ultra-high-net-worth clients.

On the other hand: “In most family structures that I’ve dealt with, transferring assets to family members in the future has a higher focus that it did 15 or 20 years ago,” Swenson says.

Whatever the prevailing chief goal, wealth preservation is clearly a top-of-mind issue; and to address this, it’s essential for risk management to be at the core of each strategy.

“If you don’t plan for things that can blow up your finances, it doesn’t matter if you’re beating the S&P 500,” says Mary Brooks, managing director of Integr Wealth Management of Raymond James, in Walnut Creek, California.

Alternative Methods

The most effective strategies require tough tradeoffs. The prevalent approaches that FAs are putting into play include alternative investments, annuities, life insurance, long-term care insurance and increased use of liquid assets.

“We’ve created a new set of investment objectives that are predicated on all-liquid assets,” shares Schleif, based in Minneapolis. “We have clients who don’t want any hedge funds or private equity — they want to be able to get money when they need it.”

For clients with a large exposure to the equity markets, paying attention to upside-downside capture is key.

“We look at outside managers who’ll participate on the upside but who are much more protected on the downside. We’re willing to give up some upside to make sure that swings are smoothed out,” says Mark Donohue, managing director, wealth management, the Donohue Group at Morgan Stanley in New York City and managing assets of about $1.2 billion.

Employing alternative investments as a third asset class can work well. They help to diversify and protect against volatility, and can also be used as replacements for bonds.

One such alternative is a global macro strategy, which seeks to capitalize on the impact of movements in various asset classes or segments. It looks at stock, bond, currency, real estate and commodity markets worldwide, going long or short and utilizing futures and options, according to Anthony Valeri, investment strategist with LPL Financial in San Diego.

“We’ve been using global macro strategies in some portfolios for just over a year now [instead of] bonds to provide diversification and potential downside protection,” Valeri notes.

“Investors need to be aware, however that [such] alternatives reduce potential upside. They’re designed for risk mitigation, not capital appreciation. So if you’re in a really strong equity market, these strategies likely won’t keep pace with stocks by themselves.”

Investing in alternatives that are non-correlated to the stock and bond markets is “a big part of wealth preservation. You need to [structure investments] so there’s a yin to the yang,” Donohue stresses.

Some advisors are recommending alternative strategies that institutions have long provided to pension and endowment funds. They can be a savvy choice in light of the expected drop in bond values resulting from rising interest rates anticipated over the next few years.

Seeking Stability

To generate income in retirement, some advisors are moving to utility stocks and master limited partnerships (MLPs), while at the same time, being selective in bonds.

“There’s a big transition of baby boomers from the equity markets to fixed income based on the need for income to support their [accustomed] lifestyle in retirement,” Donohue says. That transition is occurring partly because they “don’t want to maintain the risks in the equity positions they had in the companies they worked for.”

Last year, MLPs were beaten up by plummeting oil prices. Why does Donohue, for one, like them today?

“Whether MLPs are a good investment now depends on whether you believe that energy has bottomed,” he says. “Morgan Stanley is projecting crude to be in the mid-to-high $60s by the end of [this] year. So [MPLs] would be a reasonable thing [to buy].”

Though yields will be dragged by rising interest rates, bonds will nevertheless remain a primary source of income for many retirees and thus integral to the wealth preservation scenario.

“Bonds should not be abandoned even though they offer low yield. They work as important diversification [tools] and help protect against equity decline,” Valeri notes.

Further, bonds provide stability in the short term.

“We still believe in owning fixed income assets, but the type and structure of what we own has changed,” says Tom Sedoric, managing director-investments, the Sedoric Group of Wells Fargo Advisors, in Portsmouth, New Hampshire.

Sedoric is using a number of adjustable-rate bonds that “protect somewhat against rising interest rates,” he says. “Today we need to hedge both inflationary pressures in certain segments of the economy and deflationary pressures in others.”

One trend that’s on the increase with investors is buying annuities instead of bonds.

“Some of the highest quality [insurance] companies will give a 5% guarantee on your balance if you keep [your money] in for 12 years — and they have lots of different investments,” Brooks says. “Then, when it’s time to start using the money, it becomes [substantial] cash flow for your retirement.”

Time Horizons

A combination of high-dividend stocks in top-performing sectors, bonds and annuities is the combination on which Brooks is focused. However, in the last year, she has invested only in bonds with no more than a 10-year maturity.

“If you own a 30-year bond, you’ll get killed in the pricing. But using bonds with a 10-year maturity, your ladder is set up; and with rates going up, you’ll be able to invest the money that comes due at a high interest rate.”

Preserving wealth for one’s retirement is foremost in clients’ plans, according to Scott Grenier, senior vice president and senior estate planner with Robert W. Baird, in Milwaukee. “The most important aspect is assuring that you take care of yourself and your own retirement,” he says.

Purchasing a life insurance vehicle is one possible solution for clients who want to transfer assets to their heirs but whose overriding priority is funding their retirement.

“Oftentimes clients will buy life insurance in a trust to replenish the money they plan on spending when they retire,” Grenier notes.

Long-term care insurance can be another way to mitigate portfolio risk — plus, pass along wealth to children and grandchildren.

“There are some wonderful programs now with a life insurance rider that provide for leaving money to your kids or a charity,” Brooks says.

Life insurance can also be a means for ultra-high-net-worth clients to pay estate taxes.

“When we do a retirement plan and figure out that there’ll be a $25 million tax liability in the client’s estate when both spouses pass, we’ll buy second-to-die insurance in the trust to fund a portion of it,” says Gordon Sommer, vice president and financial advisor with the Donohue Group.

Speaking of taxes: They’re “our biggest lifetime expense — but clients tend to gloss over them when you talk about building tax efficiency into a family’s portfolio,” Sedoric says. “We make sure that retirement accounts [address] the annual gifting tax exclusion.” In 2016, as in 2015, folks can give away $14,000 tax-free, according to the IRS.

Investors who choose to pass assets to their heirs while they’re still alive have the opportunity to see — for better or worse — how the funds will be used. These days, though, many clients are opting to gift to charity instead.

“I’m seeing a huge surge in donor-advised funds, with people giving their money to charities more often than to their children,” Brooks says. “You can put in as much as you need to offset your taxes; but you don’t have to give the money away immediately.”

It’s always important to bear in mind, however, not to let taxes drive goals and investment strategy.

“Even if a plan may not make sense from an income tax perspective, “Grenier says, “You may still want to follow through with that plan.”

Though in the past, most investors’ primary wealth preservation strategy was to shield assets from estate taxes, the American Taxpayer Relief Act of 2012 reduced the number of families who are subject to theses taxes. For 2016, the exemption increased to $5.45 million for individuals.

Moreover, with the advantage of portability — also effective with the 2012 Act — a deceased spouse’s unused estate tax exemption is transferred to the surviving spouse.

Hence, there is now greater emphasis on “the qualitative side of asset protection,” Grenier notes.

When it comes to income tax, conversion from a traditional IRA to a Roth IRA can spell meaningful tax benefits for clients’ children, grandchildren or other heirs.

“The Roth would go to the next generation tax free, and they can draw on it tax free,” Sedoric notes.

Another strategy employed now more than previously is the beneficiary-controlled trust. This provides greater asset protection for the primary of its two beneficiaries; for example, maintaining assets separately from a spouse as part of a prenuptial agreement.

Structuring a financial plan around life priorities is a potent strategy for Merrill Lynch advisors. They break the large category of “Finances” into subsets: Family, Health, Home, Work, Leisure and Giving.

“We’re prioritizing the investable assets of the family and making sure that [the top ones] are properly financed in the portfolio. Once those are covered, then the secondary priorities receive assets,” Swenson explains.

Not surprisingly, the road to wealth preservation isn’t without pitfalls. These include “reaching for yield and ignoring the creditworthiness or an investment’s risk,” according to Donohue. Another is trying so hard to focus on preserving assets that investors fail to include a growth component in their portfolios. In addition, being too concentrated in an employer’s stock can pose a huge risk in the event of job loss or damage to the firm itself.

To put it plainly: wealth preservation is paramount with clients because most fear outliving their money.

“I don’t hear very much talk of ‘I want to preserve my wealth for future generations’,” says Brooks, with a clientele mainly in the $1 million to $20 million range. “Clients in their 50s and 60s have taken care of their parents and have seen what it costs to be in a health-care facility. People are worried about running out of money — even people with plenty of money.”