Wealth Longevity

Wealth is an accumulation of value in the form of real assets and financial assets. Very simply put, if your bank account balance is $1.00 ($1 billion) your wealth is very small (large).

For one to be wealthy there must first be an accumulation of real assets and or financial assets. Once the accumulation has been accomplished, the next step, if one chooses to protect that wealth over the long-term, is to manage it to prevent a reduction in wealth from occurring.

Longevity, in the context of a portfolio’s performance, is stability and growth in perpetuity. It requires full knowledge of fundamentals - concepts that remain true throughout time - so that a portfolio is capable of surviving any market environment as it occurs. This type of performance allows wealth to last over the long-term.

Now that the major elements are defined, let’s start with an examination of wealth. If the generative determining characteristic of wealth is the accumulation process, there must be some sort of flow of money to the individual so that an accumulation is possible. Commonly, this is called income. Income has many forms and can be anything from a salary to dividends to rents, but in general it is money that is received on a regular basis.

For one to be able to accumulate wealth, though, there must be an excess, or some amount left over, after all expenses are met. This is called savings. So, the portion of income that is left after expenses are considered can be saved and then accumulated over time to create wealth for the individual. This is all very straightforward and well-known. Unfortunately, there is often a mismatch between income and expenses such that savings is low or non-existent and accumulation can never occur, or the rate of accumulation is too little to allow for wealth to truly occur. (As an aside, this is something that can be corrected with some help, which we are happy to advise on).

In the alternative case, where savings is a large enough to be able to accumulate wealth over time, the next step is to ensure that wealth is protected over the long-term. This is wealth longevity, and it essentially means the management of wealth such that it is sustained over a long period of time, and even in perpetuity if desired. How this is accomplished relies primarily on how the wealth is invested. Let’s now review the options available.

As mentioned earlier, there are real assets and financial assets that can be used to store wealth. Real assets are all physical, or tangible, assets and include things like real estate. Most retail finance clients are not able to invest directly in many real assets (outside of real estate) so they rely more on financial assets. Financial assets are essentially contracts examples of which include bonds, private ownership in a company, etc. Financial assets also include all securities, which are defined as being tradable. Think of anything from stock, shares of mutual funds, exchange-traded funds (ETFs), etc. Financial assets are intangible and are more easily accessed by retail clients because the barrier to entry (ownership) is less than it is for real assets typically.

Given that retail investors are primarily restricted to using financial assets to accomplish their wealth longevity goals the portfolios that are created for this will hold financial assets. This is how we arrive at the beginning of determining the composition of the portfolio, through real-life parameters. From here, the problem now moves to the composition itself. What collection and proportion of financial assets will allow for a portfolio to achieve longevity and by extension wealth longevity? The answer to this question is also based on real-life parameters.

The portfolio must be able to weather a variety of economic environments and their effects on the price of financial assets. This constraint to the construction of the portfolio does not apply in only the negative (when prices are decreasing), it also applies in the positive (when prices are increasing). This is because when prices are decreasing the goal will always be to minimize the effect of the decrease in prices, but when prices are increasing the goal will always be to ensure that the portfolio benefits from the increase in prices that is going on. The reason for this is that if a portfolio’s value is stagnant and not increasing, as prices are increasing, the portfolio itself is not keeping up with increase in prices, which translates to a loss of purchasing power of the portfolio, and a decrease in wealth. This has the same effect as what would happen if prices were not moving up or down, but the portfolio owner destroyed a portion of the wealth held in the portfolio; the portfolio would hold less wealth and have less purchasing power.

So, the composition of the portfolio must translate to performance that is positive during times when prices are increasing, and limited in negative performance when prices are decreasing. Ultimately, we end up with same composition as that of a portfolio with a convex performance payoff structure (a payoff structure that does well in positive markets and reduces losses in negative markets), or a convex portfolio.