Financial Planning for Attorneys in Manhattan - Part Three
By using a Total Wealth perspective, large Company Town Risks become obvious.
In my previous blog posts in this series, I identified how AmLaw 100 attorneys in Manhattan are exposed to pervasive (and hidden) Company Town Risks® (“CTRs”). Those posts can be found here and here.In my work, I have found that almost all investors, including ultra-high net worth investors, are exposed to CTRs that are rarely addressed in traditional financial planning , let alone identified.Many CTRs cannot be eliminated, however some can be reduced. In this post, I will explore how our representative AmLaw 100 partner could reduce her exposures using methods that are available to most investors.
Attorneys in Manhattan - Reducing Company Town Risks®
The key to eliminating CTRs (and the most practical path) is to treat an investor’s financial assets as a completion portfolio. This means the assessment of CTRs is done first and the allocation of financial investments is done last. This method allows the financial assets, which are the easiest to adjust, to be invested away from the risks that are impractical to adjust and/or non-diversifiable.
Human capital is typically the most difficult to diversify, especially as an investor becomes older. Efforts to diversify human capital tend to have high costs, such as reducing the time available to work, which reduces the present value of the individual’s existing human capital. Also, as an investor becomes older, their number of working years is necessarily reduced.
Our attorney could take an in-service distribution from the firm, provided the plan allows for it and she is at the “normal retirement age”, both of which will vary by firm. The trend appears to be for earlier mandatory retirements of AmLaw 100 partners, so this is possible at earlier ages.For the purposes of my example, I am assuming our representative partner can take an in-service distribution for the full amount of her pension’s cash value.
Most people are unwilling to move merely to diversify their real estate exposures. Additionally, those exposures would most likely exist to some degree wherever our lawyer lived because her house would have to be within commuting distance of Manhattan. Home prices in Westchester and other areas within easy commute of Manhattan are highly correlated to those in New York City. These typical facts make real estate a CTR that is hard to diversify
The financial assets are the easiest to adjust and to diversify away from the other exposures. As we will see, our attorney could significantly reduce her risk by some simple changes to her investment allocations.First, the equity allocation should be skewed towards international securities, which will diversify our attorney away from the U.S. capital markets.Second, with the human capital exposure to the healthcare industry and the additional private equity fund investment, there should be no other investments in healthcare stocks or bonds, or healthcare focused private equity funds.Third, the New York City bonds should be reallocated to a diversified portfolio of high quality national municipal bonds. While this would reduce their tax-efficiency somewhat, it would significantly reduce the Manhattan risk exposure, which is critical. This is an easy flipping of asymmetric risks from the existing low upside, high downside exposure, to a low downside, higher upside exposure.Many of the New York State bonds will be highly correlated to the fate of New York City. While they are a secondary priority, they could also be reallocated nationally. This could be accomplished without any adverse tax consequences by letting the New York State bonds roll off as they are called or mature, and diversifying the proceeds nationally.Table 2: Company Town Risk® Comparison
As can be seen, these portfolios are significantly different. However, in the case of the Total Wealth Diversified portfolio, our attorney has significantly reduced her Company Town Risks to the U.S. capital markets, the firm, and Manhattan.Should a negative event affect the U.S. capital markets, the firm, or Manhattan, or all three, her financial assets have been diversified away from them and should be less affected, while her human capital and firm exposures could simultaneously explode.
By looking at our attorney’s balance sheet from a Total Wealth perspective, her large Company Town Risks® become obvious. These exposures would not be obvious from a traditional financial asset perspective and makes clear the superiority of the Total Wealth approach.Once identified, the CTRs can be diversified using a variety of techniques, including treating the financial assets as a completion portfolio to be invested last.
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