Plan Models and Asset Allocation Issues

By George Chamberlin

One of the five major levers in a client’s Wealthcare plan is the client’s asset allocation. When we put together a plan with its cash flows and the dates and amounts specific to each of the major and minor goals it is critical to not overlook the role asset allocation plays in the calculation of the plan results and determination of the reasonably expected confidence level for our clients.

The act of selecting a particular asset allocation to apply in our evaluation of that assortment of cash flows, assets and assumptions called a plan might be easy to think of as just another data entry point to be used in the calculations. However, it is not that simple and the allocation we’ve chosen to apply is much more important to the plan results than the simple act of selecting an allocation we’ve developed or have chosen from a list provided with the software might suggest. That allocation, made up of different percentages of various asset classes, is guiding the software in the many simulations it runs to test our plan against the capital market assumptions for those asset classes and the various types and timing of markets the client could encounter over time. If the client’s actual asset allocation – where the assets are invested when we run the simulations – is different from the allocation we input for use in the plan, then the results do not relate to the client’s actual situation and may in fact be misleading.

“Now wait just a minute,” you might say, “the allocation we are testing is the one we will recommend and the client will be using in the future. Those plan results and the related confidence level are therefore the right ones to use for this client.” Now that might be true in some cases, but in the vast majority of client plans – even when we have been working with the client for some time – there is a disconnect between the allocation we are testing and the actual investments the client holds and often this disconnect is a major one.
We will come back to this point in a moment, but first let us consider the client’s actual allocation and holdings. An advisor working with a new client will often benefit by testing the client’s goals against the current allocation. Just because it may not be an allocation you would typically recommend does not mean that it is not working for the client and the goals you’ve discussed. Often, though, it is not working well and you will see a direct value add to the client coming from your investment recommendations. However, it is important to remember that your value to the client is much more aligned with understanding and valuing the client’s goals and their attainment than it is with your prowess as an investment picker or allocation chooser.

Returning to the idea of there being a potential disconnect between the allocation being tested by the software in your plan model and the client’s actual real-time allocation, consider the variety of points where things may go awry. First, there are the unmanaged assets – client accounts we know of but do not trade or control for investment allocation purposes (i.e., a 401(k) plan). In the best case we will know what is in those accounts based the client providing us access to statements. But have we appropriately modeled those items and properly reflected them in our recommended allocation? And if we have directed the client to make some changes in the holdings in the account, will the client do so in a timely manner and communicate that fact to us?

Second, there are the client accounts where we want to sell certain legacy positions and acquire new holdings to better reflect the components of the desired allocation as well as to improve diversity and lower risk. Can we effect these changes without encountering significant tax liability as where low basis stock, for example, would need to be sold in a taxable account? Will the client balk at selling some or all of a particular position in which the client has some emotional attachment? Are there restrictions on client activity in a particular holding such as sale of an employer’s stock? If we are barred from selling a legacy position, how are we doing in terms of meeting our burden of accurately modeling around these holdings so the allocation we use in testing the plan reflects what is actually owned and not simply what we wish it was?

Then there are the alternative assets and holdings which some clients pursue. How about the client who holds business interests in his or her IRA but apparently is unaware of the dangers of unrelated business taxable income or the prohibited transaction rules? Or the client who was sold a number of MLP investments as a tax shelter? What about the client who bought bullion, perhaps in his IRA or maybe just to keep on hand? Also prevalent are annuities and variable life insurance products that carry aspects of other investments. These and similar holdings present significant issues in valuation as well as properly representing them as part of an allocation recommended for the financial plan.

Finally, there are the client holdings that we are not told about or are asked to omit from the plan. That these items may have an impact on the client’s financial plan is fairly certain but how we are to allow for them in our planning is not. One cannot “model around” the unknown and of course a plan which excludes any significant client assets will not be an accurate model of the situation and the advisor may not even know that fact. It is difficult to put one’s professional advice on the line when one does not have all the relevant information.

As you can see by these various examples – all points that you likely have encountered in working with clients, along with issues other than those listed here – there may well be client holdings that are not well handled in the allocation you would recommend for the client. Being prepared to address these items, whether by changing the model allocation or by changing the holdings themselves will go far in making the advice you are giving and the confidence of the client on point and reliable.


George Chamberlin has been working in the legal and financial industry for over thirty years, including working at Wealthcare Capital Management from 2002-2009. George practiced law for several years before focusing on writing, planning and software development in the estate planning and financial planning areas. During his time at Wealthcare, George wrote weekly e-mails for advisors and their clients, engaged in basic and advanced financial planning and estate planning as well as working on a variety of other Wealthcare projects. Since 2009, George has worked as a registered investment adviser representative in his own firm, meeting and planning with clients, and more recently as a consultant to financial advisors, including Wealthcare advisors, on a variety of matters including advanced financial and estate planning.

George Chamberlin & Mentor RIA Consulting © 2015