September 2002

“Managing Expectations”: The Key to Wealth Management

By Gloria J. Higgins

Wealth management has become a critical issue for the high-net-worth individual as a result of several years of stock market appreciation, followed by a significant decline in value. In addition, demographics and the challenges of transferring wealth between generations have created the need for a new approach to financial services.

Large financial institutions define wealth-management services broadly, covering everything from serving as the “financial quarterback” to providing “buy/sell” investment decisions and stock picking. Although some CPAs have transitioned to the buy/sell professional, the financial quarterback is a more natural position. Defining this position from both sides and managing expectations are critical to a successful relationship.

Managing Investor Expectations

Investors’ expectations vary with their portfolio’s values and growth, their technical skills, and the CPA’s perspective. Although most Americans are familiar with investments and the related terminology, few people understand the nuances of successful investing, and many take unnecessary financial risks. Because most CPAs’ professional training has focused on historical financial information, giving advice predicated on future events is difficult at best.

The wealth manager must also develop tools for understanding an individual’s tolerance for market volatility. For example, September 2001 differentiated wealth managers; although, from a financial perspective, the sky was falling, this didn’t mean that portfolios should be liquidated. The financial quarterback’s primary responsibility is to work with clients on positioning their portfolio so they have peace of mind during times of great uncertainty and anxiety. This “soft” issue—the psychology of investing—can be as important as the assets in the portfolio.

Setting financial goals is another soft area of wealth management. In some cases, goal setting begins with debt management and lifestyle. An investor’s lifestyle issues are expressed through the portfolio when it is used to fund living expenses or as a vehicle for passing wealth to future generations. A clear understanding of lifestyle issues allows for more structured management and better monitoring of investments.

Managing CPA Expectations

Managing the expectations of the CPA–wealth manager is as important as managing those of the investor. Wealth management is less codified than GAAP or the IRC, and no governing authority exists from which to build planning alternatives. Several schools of thought can guide wealth management recommendations, and asset allocation modeling can be presented to the client as support for specific recommendations. But the primary basis for decision making is the wealth manager’s professional judgment and knowledge of the investor.

The investment axiom “past performance should not be used as an indicator of future performance” is very important. Resisting the influence of historical performance is difficult. The CPA–wealth manager must develop mechanisms such as trend analysis in order to constantly monitor investment products with an eye toward their expected performance. Although diversification should minimize portfolio volatility, the wealth manager and investor must recognize the risk of loss as an integral part of portfolio management.

The concept of errors and omissions within an investment advisory practice is also critical. In addition to facing professional liability for incorrect or negligent advice, wealth managers may be responsible for transactional mistakes. Processes and checks and balances are necessary to ensure the proper execution of each intended transaction.

Developing a Practice

Managing expectations is the foundation of a successful wealth-management practice. A firm without wealth-management experience should explore three areas in the development process: education, strategic partners, and profitability.

The CPA–wealth manager should consider building strategic relationships with other investment professionals, especially those with a strong commitment to clients rather than investment products. Investment consultants are also good strategic partners in dealing with clients and their portfolios, and some consultants will work with the CPA–wealth manager on a retainer basis, making themselves available for professional advice on a consistent basis.

Creating portfolio reports on a fair market value basis can be accomplished through a custodial bank relationship, a broker that holds the securities with the ability to report noncustodied assets, or a data aggregation firm.

Managing the firm’s expectations generally revolves around profitability. The pricing model for wealth management ranges from a percentage of assets under management to an hourly fee. After evaluating the additional costs required to start up and run a wealth-management division, the firm can determine an appropriate profit margin and set a pricing model.