The New “Alpha” in Wealth Management: It’s Not Just About Beating the Market
In January of this year, as the calendar turned to this new decade, I shared with our clients an insight from Microsoft founder Bill Gates: We tend to overestimate the change that will occur in the next two years, and underestimate the change that will occur in the next 10.
Few of us foresaw the changes the pandemic would bring to our lives within months. However, based on my years of working with institutional and individual investors, I believe that many in the wealth management industry have also underestimated the impact of two gradual but significant developments over the past two decades. The first is the shift in retirement benefits from company-provided pension plans to employee-funded savings plans. The second is the aging of the populations in the world’s largest economies (Europe, China, Japan and the United States), which is leading to incrementally lower economic growth and market returns.
Taken together, these developments have profound implications for successful wealth management. For many years, wealth management was viewed as “the icing”—personal savings and investments in addition to “the cake” of a company-provided pension plan. Today wealth management is “the iced cake”—because in the absence of traditional corporate pension plans, most investors have become primarily responsible for their own retirements and long-term financial success.
This means that wealthy investors need to redefine success. Traditional “alpha,” or the excess return above an investment benchmark, is not sufficient in isolation to assure long-term financial sustainability. Investors today need to broaden their definition of success from beating a benchmark to achieving long-term goals.
At BNY Mellon, we have not just decades but centuries of experience in advising wealthy families in achieving their goals. Recently, our team has harnessed that experience to devise a framework to help clients sustain success over this new decade and beyond. We call it “Active Wealth.” And we know that it works. It encompasses five essential disciplines: Invest, borrow, spend, manage and protect. We also have worked with our team of technologists to build a proprietary planning tool that measures the impact of choices in each discipline and helps clients chart their courses to achieving their goals.
The premise of Active Wealth is simple: Good advice makes a difference. Our research shows that prudent decisions across the five disciplines, systematically executed over years, can add 2.5 percent to 5 percent in annualized after-tax wealth.
The events of 2020 underscore the value of a goals-based approach across the five Active Wealth disciplines. On the one hand, investors could have fallen asleep in February, awakened six months later and missed the bear market in the S&P 500 index. On the other hand, the Federal Reserve’s dramatic drop in interest rates will have ongoing impact on investing, borrowing, spending, managing taxes and costs and protecting legacy.
Here are some examples highlighting the positives and negatives of low rates on wealth:
- Introduce borrowing opportunities with mortgages and other forms of credit available below 3 percent—lifetime lows.
- Create exceptional opportunities to protect legacy through estate planning with the lowest rates ever for split interest gifts such as GRATS and intra-family loans.
- Reduce the returns of a traditional 60/40 portfolio by roughly a percent a year due to lower bond yields.
- Invest for total return versus yield, as bond yields impact spending budgets.
- Impact after tax returns, as investors weigh the choices between tax-free municipal bond yields at all-time lows versus higher taxable yields.
Regardless of the path of recovery from the pandemic, we expect that the ongoing shift toward employee-funded savings plans and the synchronized aging of the world’s largest economies will continue. We also think it’s possible that the darkness of the pandemic could give way to an illuminating era of new technology, consumer goods and infrastructure, just as we saw in the Roaring Twenties, which followed the pandemic of 1918.
Whatever the future brings, we know that clients can attain roaring success in achieving their goals if they take a broad view of their wealth beyond their investment portfolios and see the importance of borrowing, spending, managing taxes and costs and protecting family legacy. Indeed, in wealth management today, “alpha” means much more than beating the market. It means achieving long-term goals. It requires strong advisors and good tools. It is not easy, but successful wealth management never has been easy. This new decade necessitates a new approach: Active Wealth.
Catherine Keating is the CEO of BNY Mellon Wealth Management.
The views expressed within this article are those of the author only and not those of BNY Mellon or any of its subsidiaries or affiliates.