Satisfying Portfolio Claims Prudently
Recall that I said that claims against the portfolio must be satisfied on a prudent basis. What I am thinking about is that the path of a portfolio's returns matters a great deal. Imagine a six-foot tall nonswimmer who is determined to cross a pond he knows to have an average depth of three feet. The critical question for our nonswimmer isn't the average depth of the pool, but the deepest depth. If the pond is 100 feet across, and there is a 30-foot stretch that is 15 feet deep, our nonswimmer is doomed.27
A family can also be doomed even if the long-term average return on its portfolio is satisfactory, because there could be a very bad stretch in the markets that drives the portfolio value and the family's income below critical limits. Thus, a portfolio can end up, many years in the future, achieving the family's long-term return objectives, but the family (or the portfolio) won't be around to see it. The portfolio ultimately achieved its goal, but it was a failed portfolio because along the way it allowed the family's wealth to fall below the minimum level that enabled the family to live the way it wishes to live.
Asset allocation isn't the sexiest part of an advisor's job, and as a result it's easy to give it short shrift. Especially for advisors who have been in the business for a very long time, it's easy to imagine that we know better than the client how best to structure the portfolio. But in fact there is no one best way to design an investment portfolio for a family—everything depends on the family itself.
It's important to get the family talking about the nature of the risks it faces with its capital, to ask the right questions, and, especially, to listen to the answers.