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The Northwood Perspective

Chairman’s Message: How to Really Weather Market Downturns

Tom McCullough

Two friends are out camping. They hear a cry for help and rush into a fast-flowing stream to save a drowning child… only to see another struggling child drift by… and then another, and another. As one of the campers starts to run to shore, his incredulous friend demands to know where he is going. Over his shoulder he yells “I’m going upstream to tackle the guy who is throwing all these kids in the water.”

I read this story in Upstream: The Quest to Solve Problems before they Happen by Dan Heath (one of my favorite business writers). I highly recommend the book, by the way.

But it also made me think about what makes for successful wealth holders (like our clients) in a market downdraft like the one we currently find ourselves in. The answer is to focus on prevention vs. reaction. Here is how to do that.

Quantify your goals

It doesn’t make sense to launch out on a trip without thinking about your desired destination. Investing is the same. You need to know where you are headed and what you want.

Unfortunately, most people invest without knowing or quantifying their goals. One of my favorite cocktail party questions is — “What rate of return do you need on your investments to meet all of your objectives?” Virtually no one knows the answer to this question, mostly because they don’t know what their goals are and have certainly not quantified how much they will cost.

One of the causes of stress in families is not knowing if their wealth will last, how much they can spend, and how much they will leave for their children — even for people with a lot of money.

Families who are able to weather the inevitable storms can identify their goals and can answer these five questions: What is the money for? Who is it for? When will it be needed? How high a priority are each of their goals? And how much will they cost?

Create a family balance sheet

Just like a company, every family needs a balance sheet. On the left-hand side of the ledger, you can start by listing all family assets including cash, securities, real estate, operating companies and the estimated present value of future employment income, business cash flow and inheritances to be received.

On the right-hand side of the balance sheet, you list the family liabilities. For many families of wealth, this may not be debt. Liabilities are often self-imposed and are more commonly known as family goals. These liabilities must be funded, either by income or by assets.

They typically include (the present value of) expected lifetime spending, potential one-off cash flow requirements, planned gifts to future generations, and charitable donations. The difference between assets and liabilities is family net worth.

But different liabilities or goals have different priority, urgency, and certainty levels attached to them. It’s like air travel (– remember when people used to do that?). The goal of safe arrival requires extremely high certainty; arriving on-time, while important, is a lower priority, and; in-flight comfort is a nice-to-have, not a need-to-have, at least relative to the other goals.

Similarly, in the management of wealth, some goals are so important or imminent (such as near-term monthly family expenses, or funding kids at universities over the next four years) that you can’t risk not meeting them if your portfolio drops or you don’t have the required cash flow. For these goals, you’ll need to invest in assets that offer certainty and usually not much return, like cash, short-term bonds and conservative equities.

Other goals that have long time horizons often need higher rates of return (usually associated with riskier assets like equities and other growth assets) to make sure capital lasts a long time and stays ahead of inflation. Examples might include funding long term family expenses, inheritances for children and bequests to charities. The long-time horizon also allows the portfolio to handle the inevitable volatility that will occur in risky assets.

Here’s the key. When markets drop, families who have taken this planning-oriented approach know that they have non-risky assets to fund near term goals and can wait for a recovery to ensure that long term goals are met.

It always reminds me of the mountain climber I once heard say: “When you get to the top of the mountain, you are only halfway there”. Why? Because you have to “get back”. Life is a movie, not a snapshot. The absolute dollar value of your portfolio at the market peak isn’t especially relevant, nor is the amount of your net worth at the market low. What is relevant is how much cash flow it will produce over your lifetime to meet all of your goals.

Build a bridge and stress test it

“Wealth management isn’t really an art or a science, but a matter of engineering.” This is a great quote from long-time investor Charley Ellis. Many people approach investing as a game of forecasting, timing, outsmarting, and hoping. In fact, it is a lot more like a problem of engineering.

Picture yourself on one side of a river (i.e., “the present”, from an investing standpoint) and you need to get to the other side (i.e., some future state, like retirement, end of a long life, or over multiple generations). And you need to do it safely, with a high degree of certainty and with as few negative surprises as possible.

One of the ways to get from ‘here’ to ‘there’ across an actual river is to build a bridge. To do that you need to take a myriad of factors into account such as:

Similarly, if you are building a financial ‘bridge’, you need to assess questions like:

Families who are set up to manage effectively through a crisis will have planned out the construction of their financial ‘bridge’ and stress tested the risks.

But, how do you make this kind of thing happen in a world that seems to be so uncontrollable? Is there anything that can actually be controlled or predicted?

As it turns out, there is. Successful families know that tough times are inevitable. They don’t know when they will happen, what will cause them, how severe they will be, or how long they will last. So, they take specific steps ahead of time.

Not every family has the resources to do all of these things and it’s not easy to do. But after 40 years of working with families, I have found that these are the most common indicators of success in a crisis. It’s not quite as sexy as trying to catch the bottom of oil prices, shorting pricy tech stocks at the top, or catching tomorrow’s next wave – but it is more successful!

In calm seas, every ship has a good captain

There is an old Swedish expression that says: “In calm seas, every ship has a good captain.” And that is certainly true. Everything’s easy when it is clear sailing. Everybody looks like they know what they are doing and are very confident in their own abilities.

But when the storms come (as they always do), you can see who the good captains are. They are the ones who are prepared. They are not the ones searching around for bailing buckets when the waves start coming over the gunwales. Or in the financial world, they are not the ones who are switching horses, chasing what’s moving, or throwing in the towel. If fact, there is often surprisingly little activity.

Families who were well prepared for this crisis (and for other crises to come) have taken the time to prepare with clear goals, the right assets lined up to fund the right liabilities, and a sound, integrated, stress-tested plan that boosts the probability of success on all fronts.

I’ve also found that just knowing you have a sound plan in place gives you the confidence and wherewithal to keep your head and make good decisions when others are losing theirs. As Warren Buffett says: “A little bit of planning can go a very long way.”


Tom McCullough

Tom McCullough is Chairman and CEO of Northwood Family Office. The combination of his background, along with his own family’s desire for a truly ‘comprehensive, customized and confidential service, led him on a search for a multi-family office. Tom is a frequent speaker on issues relevant to families of wealth and is the co-author of Wealth of Wisdom: The Top 50 Questions Wealthy Families Ask and Family Wealth Management: Imperatives for Successful Investing in the New World Order and the soon-to-be-released Wealth of Wisdom: Top Practices for Wealthy Families and Their Advisors. He is an adjunct professor and Executive-in-Residence at the University of Toronto’s Rotman School of Management MBA program. He is an Entrepreneur-in-Residence at Western University’s Ivey School of Business and a member of the Editorial Board of the Journal of Wealth Management. He was recently awarded ‘Best Individual Contribution to Thought Leadership in the Wealth Management Industry’ by the 2020 Family Wealth Report Awards.

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