“Get what you can and keep what you have; that’s the way to get rich.”
Scottish Proverb

In a series of earlier posts, I discussed the three planning areas that I believe constitute real wealth management – wealth accumulation, wealth preservation, and wealth distribution. Of those three, I would suggest that wealth preservation is the most important.  As the Scottish saying goes, “make as much as possible and keep as much as possible.  That’s the secret to becoming wealthy.”

Studies are consistently showing that the public wants more information about asset protection and wealth preservation techniques. Estate planning is being replaced by integrated estate planning, which combines estate planning with asset protection strategies.  There are those in the legal community who now suggest that an attorney’s failure to assess a client’s need for asset protection and to discuss asset protection strategies with a client may constitute malpractice.

When I tell people that I am a wealth preservation attorney, I usually get the quizzical look that begs for further explanation.  In my practice, wealth preservation focuses on protecting one’s wealth from loss due to common problems such as unsuitable investments and/or improper portfolio management, taxes and litigation/risk management.

“Don’t confuse brains with a bull market” is a well-known saying on Wall Street. It is very easy to make money in a bull market, as research shows that three out of four stocks follows the general trend of the stock market.  Unfortunately, investors are often lulled into a false sense of security during bull markets, as their advisers point to increased values as evidence of their investment acumen.

A study by the Schwab Institute concluded that 75 percent of the investor portfolios that they studied were unsuitable for the investors based on the investor’s financial goals, need and personal parameters. My experience would suggest that the actual number may be higher than 75 percent, especially when investment fees and adviser fees are considered.

I have written articles and posts on the Active Management Value Ratio (AMVR), a proprietary metric that allows investors to assess the cost efficiency of actively managed mutual funds.  In most cases we find that the cost of the active management component  of actively managed mutual funds far outweighs the incremental return, if any, that the active management component of actively managed mutual funds, often by as much as 300 to 400 percent, or more.

Charles D. Ellis, a highly respected investment professional, has recently suggested that advisory fees are high, very high, in relation to the benefit provided.  Mr. Ellis suggests that the most commonly used fee by investment advisers, a fee based on a client’s assets under management (AUM), is extremely misleading.  By focusing on fees as a percent of actual benefit produced by an adviser, Mr. Ellis suggests that the 1 percent AUM fee is actually more along the lines of 50 percent or more.

Many investors may dismiss a 1 percent AUM fee as trivial, as just 1 percent.  When analyzed in terms of the AMVR and Mr. Ellis’ methodology, the true cost of such fees and expenses becomes clear. The Department of Labor has estimated that over a period of twenty years, each additional 1 percent of investment fees and expenses reduces an investor’s end wealth by 17 percent. Wealth preservation analysis alerts investors to such cost issues and allows them to make changes as needed to prevent loss of wealth due to unnecessarily high investment fees and expenses.

High fees and expenses are not the only wealth preservation issues that investors need to address.  Two common wealth preservation threats are ineffective, or “pseudo,” diversification and a failure to hedge one’s investments against significant losses.  Too many investors think, or are told, that diversification simply involves owning a lot of different types of investments.  That simply is not true.

True, or effective, diversification depends not on the number of investments one owns, but rather how the investments interact with each other in different market conditions.  The idea is to own a combination of investments that react differently in certain circumstances, or, technically speaking, have a low correlation of returns, so that when some investments are down, other investments will help balance out any losses in order to protect against significant losses to the overall investment portfolios.

Effective diversification is one form of hedging, or using techniques to prevent against significant portfolio losses. Other forms of hedging may include the use of options, inverse index funds and other strategies in order to protect against significant losses. Hedging is simply another example of approaching successful wealth management as the management of risk instead of the management of returns.

Taxes are another major issue with regard to wealth preservation.  The Supreme Court has stated that there is nothing legally wrong with arranging one’s affairs so as to minimize the amount of taxes.  Tax planning as it relates to wealth preservation may involve making inter vivos, or living, gifts to others, in order to reduce one’s taxable estate. Other commonly used techniques include creating wills and trusts to address both inter vivos or post-mortem wealth preservation issues.

Litigation/risk management involves proactively addressing potential litigation/risk concerns and planning appropriately, with the stress on proactively. Far too many times I get a call from someone telling me something unfortunate has happened and they need to protect their assets.  Asset protection and wealth preservation cannot be used to defraud others.  Once a potential cause of action has arisen, the courts will strike down and attempt to shelter or hide assets from the injured party.

In some cases, the easiest risk management tool, insurance, may be sufficient to provide the needed protection against losses due to litigation. In some cases, the cost of insurance requires the consideration of other wealth preservation techniques.

Trusts are a common litigation/risk management tool.  The effectiveness of using trusts as a wealth management tool depends on a number of factors, including the proactive establishment of the trust and the extent of control retained by the creator of the trust.

As mentioned before, trusts are basically ineffective as wealth preservation tools if the event creating liability has already occurred.  With regard to retained control over a trust, the rule is basically that the more control that the creator of a trust retains over a trust, the less protection the trust provides. Likewise, the more that the trust provides in terms of personal benefits to the trust creator, the less protection the trust provides.

One common misperception is trusts have to be expensive.  If you want an offshore asset protection trust based in the Cook Islands with all the trust protector provisions and a collapsing bridge trust as an additional level of protection, then yes, that trust is going to be expensive to establish and maintain.  The good news is that most people do not require that level of protection.  In many cases, common trusts such as an intentionally defective grantor trust, an income only trust or family trust provide the needed protection at a much lower initial and annual fee.

Wealth preservation involves a number of interrelated legal areas.  Wealth preservation can provide valuable benefits without being cost prohibitive.  While the benefits of wealth preservation can be significant, it is important that anyone interested in maximizing the potential benefits act proactively by contacting a professional with experience and knowledge in such services.

© 2013 InvestSense, LLC. All rights reserved.

This article is neither designed nor intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.