Wealth Management

University of St.Gallen (HSG)

International- and Corporate Finance Doctoral Seminar 10.101 Winter Term 1999/2000 4-5 February 2000

Wealth Management – Financial Planning, Methods and Concepts

Prof. Dr. Klaus Spremann

Carmen Eckmann Urbanski Wartensteinstr. 30, 9008 St.Gallen and Oliver Müller Johannisbergstr. 17, 8645 Jona

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Contents

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Contents
Contents.....................................................................................................i Figures and Tables .................................................................................iii 1 Introduction .......................................................................................1 2 Wealth Management .........................................................................2
2.1 Customer Segmentation .................................................................................2 2.2 Financial Planning..........................................................................................3 2.3 An Integrated and Systematic Wealth Management Process.........................6 2.4 Life Cycle of Wealth ......................................................................................8 2.4.1 Time Horizon versus Life Cycle.........................................................10 2.4.2 Lunch Money and Smart Money ........................................................11 2.4.3 Life Cycle Products and Live Events..................................................11 2.5 Financial & Human Capital..........................................................................12

3 Life Cycle and Life Style Theories and Models – a Survey.........13
3.1 Introduction ..................................................................................................13 3.2 Relative Income Hypothesis by James Duesenberry ...................................15 3.3 Life Cycle Hypothesis by Franco Modigliani ..............................................16 3.4 Permanent Income Hypothesis by Milton Friedman....................................17 3.5 Consumption over the Life Cycle by Gourinchas/Parker ............................18 3.6 Conclusions of the New Saving Theories ....................................................19 3.7 The Portfolio Approach by Robert C. Merton .............................................20 3.8 Asset Allocation over the Life Cycle and Vintage Model by Klaus Spremann ......................................................................................21 3.9 Survey...........................................................................................................22

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4 Wealth Management in Practice....................................................25
4.1 Information Technology Changes Decisively the Field of Wealth Management and Financial Services ...............................................25 4.1.1 Strategies to Meet the Challenge of Information Technology............26 4.1.2 Information Portals to Control the Port of Entry ................................28 4.2 Concepts and Tools in Financial Consulting – Status Quo and Trends .......28 4.2.1 Structured Wealth Planning Process in Practice.................................28 4.2.2 VermögensZentrum (VZ) – the Motivation of an Independent Consultant ......................................................................29 4.2.3 Internet Solutions for Wealth Management........................................32 4.3 New Measures of Professional Financial Consulting...................................34

5 Conclusion........................................................................................36 Partners of Interviews...........................................................................38 Bibliography...........................................................................................39

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Figures and Tables
List of Figures
Figure 2-1: Return for a Financial Services Institution Depending on the Customer Segment Environment of Wealth Management and its influence on the complexity of Wealth Management The Four Dimensions of Financial Planning An Integrated approach to the Wealth Management Process Example of a Life Cycle Concept Human Capital and Financial Capital = Total Wealth Life Cycle and Buffer Savings Overview of Different Analytical Approaches to Wealth Management Trend in Asset Management Arrangements of Financial Services Provider to Clients Requirements Personal Wealth Plan Basic Structure of a Consulting Process with VZ Consulting Areas of the VermögensZentrum The Motivation of an independent Financial Consultant Through E-Commerce supported Products and Services

Figure 2-2:

Figure 2-3: Figure 2-4: Figure 2-5: Figure 3-1: Figure 3-2: Figure 3-3: Figure 4-1: Figure 4-2: Figure 4-3: Figure 4-4: Figure 4-5: Figure 4-6: Figure 4-7:

Introduction

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1

Introduction

In modern western society, the determinants of wealth management changed dramatically during the last decades. Up to now, the market demonstrated its reliability concerning the conservation of wealth and prosperity. Today’s generations in the western world seem not to have to worry themselves about complete break-downs of financial markets, as it was the case during the first half of the last century. Nowadays, to save gold for emergencies and hiding it at home as our grandparents did, seems unnecessarily. The sustainability of the economy and the law offers the opportunity to save and invest efficiently. In this paper we want to focus on systematic approaches to optimal wealth management. In chapter 2, we introduce some up-to-date concepts and develop an integrated view of a wealth management process. Later on we will refer to the life cycle philosophy in financial planning and present some applications currently discussed in academic literature. In the practice are rather intuitive approaches in use, that take into consideration life cycle and life style aspects. Therefore chapter 3 discusses life cycle models and theories in literature. The focus lies on three main streams of research. All approaches take into account the impact of the personal situation of an investor on his asset allocation. Chapter 4 gives a brief survey of wealth management and the use of concepts in practice. The focus lies on the implications of information technology. The recent structural changes have uncovered, that the radical changes in the world of wealth management are mainly technology driven. The paper finishes with Chapter 5 – a brief retrospective view of modern wealth management and an outlook on current trends and developments.

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2

Wealth Management

‘A man who seeks advice about his actions will not be grateful for the suggestion that he maximize expected utility’.1 The statement above confirms that a Financial Planner not only has to analyze a set of economic factors, such as expected return, risk and correlation, but also has to be able to communicate to the customer efficiently. Above all, he has to scent the client's risk aversion for optimal decision making. The importance of such a behavior still is being underestimated.2

2.1 Customer Segmentation
‘Understanding market segmentation is as important as understanding the market itself. Institutions that ignore market segmentation stand to lose market share, even though they may have had the first product into the market, and may have the best one currently.’ 3 Basically, market segmentation is a marketing tool which tries to subdivide the market into homogeneous customer groups concerning needs and reactions.4 The importance of market segmentation is not limited in the marketing context. Not only does this tool help to understand the market environment – threats and opportunities – as well it enables a financial services institution to focus on its business. In other words: It helps to save costs and supports the production process.

1 2 3 4

Roy (1952), P.433 Interwiew with (VZ) Bollenbacher (1992), P.104 Verwilghen (1997), P.6

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Affluent Banking

Retail Banking

Figure 2-1:

Return for a Financial Services Institution Depending on the Customer Segment Source: Own presentation

As shown in Figure 2-1 the bigger the wealth of a customer the more return will be earned by the financial services institution. This is the consequence of the extensive production costs in the retail business and the small margin the institution can earn in this segment, compared to the Affluent or Private Banking. A result of the time intensive and costly financial consulting process financial advisors mainly focus on High-Net-WorthIndividuals (HNWI). According to the lack of professional consulting a lot of customers in the retail banking segment loose time (and money) making sub-optimal investments over a long period of time. The solution to this problem is to build a package – a product – which includes the time effort of a Financial Planner. In the field of portfolio management this challenge has been solved. Investment strategies and stock exchange orders have long been bundled in the ‘ready to use’ wrap of a wide range mutual funds. Idiosyncratic risk is diversified by the ‘pooling’ effect of the fund. Transaction costs can be minimized by the creation of a special vehicle, which is managed and organized professionally. As a result of the professionalism a lot of unnecessary losses can be avoided.

2.2 Financial Planning
Currently, the range of financial services is increasing dramatically. The technology advancements are driving the opportunities in an overwhelming speed. The globalization and new international agreements force the legal environment to change. Barriers of entry are decreasing and speeding up the competence. The condition for growth and

Increasing Volume

Return for the Financial Services Institution (Fees)

Private Banking

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consolidation in the Financial Services industries are ideal. Mergers, alliances and new financial networks are borne. The Financial Services industry is in a process of redefinition. In the middle of this environment it is getting more and more difficult to obtain an overview of the vast increase in the number of products and the constantly changing regulatory framework. As a result of this increasing options, the complexity of customer needs are augmenting simultaneously, as showed in Figure 2-2.

E

al Leg ment ron nvi

Te

ch

no

log

y

Increasing Complexity of Wealth Management
Fi N e w n Se anc Pr rvic ial ov es id er

ct du Pro riety Va

Competition Prices, Globalization

Figure 2-2:

Environment of Wealth Management and its influence on the complexity of Wealth Management Source: Own presentation

More and more specialists have to be visited. Thus, they loose the necessary overview over the various problems, which makes the whole decision making process increasingly difficult without doing justice to the existing complexity. In addition the risk of making the wrong decisions increases the more interfaces there are. Moreover, the single consultants are biased by the industry or the organization they are working for. Representatives of a bank favor banking products as representatives of an insurance company insurance products. Apart of the new regulations and the increasing variety of products, a customer also has to take a whole diversity of different dimensions of determinants into consideration, such as:

Wealth Management • • • • • • • • • • • Life cycle of earnings Influence of past behavior Growth of economy and productivity Social security and quality of pension scheme Uncertainty of future income Liquidity constraints Tax effects Duration of lifetime Length of working and retired life Unconventional consumption habits Needs, requirements and life events

5

The desire for an integrated approach is increasing. This approach will depend on adequate analysis, methods and instruments. Techniques have to be developed to systematically analyze and value complex problems and decompose them into their single parts.

Eventualities

Investment Philosophy

Four Dimensions of Financial Planning

Goals & Preferences

Financial Situation

Figure 2-3:

The Four Dimensions of Financial Planning Source: Spremann (1999), p. 285

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Spremann (1999) describes four dimensions determining a financial plan. The necessary integration of all sub-systems is guaranteed by the Investment Philosophy. This philosophy is the main idea and embodies the major direction of the financial planning process. Every decision has to be projected to this philosophy and inevitably needs to reflect these key ideas of the financial plan. The philosophy is somewhat like the ‘glue’ between the single parts of the plan. The second dimension of financial planning is called the Financial Situation. As the words indicate we have to consider the current existence of wealth. First of all, it’s the static picture in the sense of a balance sheet, second the volume and directions of cash flows, such as labor income and liabilities. Another important question is how much risk can be taken by the investor to avoid a financial distress. This complex problematic also depends on current wealth and the current and expected cash flows. The more wealth there is and the more cash inflow we expect the more risk can be beared. The preferences embody the risk awareness and the individual utility function of the investor. The utility function should reflect the ‘wishes’ and ‘desires’ of the single customer - it is a ‘technical’ description of the investor’s interests and his specific value system. How does he feel in a certain situation, what kind of decisions does he take? The risk awareness is the measure of the amount of risk a customer is willing to take. It is a major determinant of the financial planning process and the resulting asset allocation, which will be steering risk and expected return in the portfolio. The last dimension, the eventualities take unexpected incidents into account. It is an external and arbitrary noise to the development of the resulting portfolio, such as unanticipated returns or losses. A financial plan always has to take all dimensions into consideration to fulfill its task.

2.3 An Integrated and Systematic Wealth Management Process
Above, we showed that a person who wants to invest faces a complex and dynamic situation. To manage the variety of a complex system, we need an integrated approach, which takes all subsystems – and their interactions – into account. The following steps propose such an integrated and systematic approach to wealth management: (1) Definition of needs & goal setting: In this first step, we have to understand and define the core objectives. It is very important to understand the whole complexity of the situation that is being analyzed instead of focusing on single, insulated parts of the situation.

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Example: Someone owns two houses and faces a liquidity constraint. Now he seeks advice concerning this shortfall. Superficially, one would try to solve the question how he can finance his house – but according to (1) we have to define the problem in a bigger frame. Our definition has to look for the cause of the problem. Why is there a liquidity constraint? Does our customer really need a second house? Maybe not and if that is so he can sell the house and a liquidity constraint can be avoided. (2) Analysis of the customer’s financial situation: What is the structure of his wealth? How much is he earning? What are the future prospects? How do the single parts of his assets and the cash flows interact? Did we seize the whole wealth or are there any imponderables left? Are there any non-financial values or expected changes we forgot about? (3) Diagnosis of the financial situation: The output of (2) will be the input of (3). Here, we will compare the current financial situation with the ‘ideal’ situation and possible planning approaches, while taking the existing constraints into considering, as well. Where are the weaknesses in the current financial structure? Where are the strengths, opportunities and threats? (4) Design of financial plan: First of all, we have to develop the optimal financial plan in detail. Did we consider the investment philosophy? In a second step the differences between the current and the optimal situation have to be worked out. Which changes do we have to execute? (5) Implementing & controlling the financial plan: Up to now, we just had a plan. No action, no real changes have been made. In this step we will realize the developed financial plan. Always, after implementing a financial plan, we have to control the process. Are we still in the expected range – will we meet the target? Do we still meet the customer’s investment philosophy? If not, interventions have to be carried out. The whole process is portrayed in Figure 2-4. The design shows a cycle of the five steps on purpose. A sound financial plan has to be revolving. After every change in one of the four dimensions (Figure 2-3) the procedure of wealth management has to be repeated. The process is set together of a revolutionary and an evolutionary part. In the beginning we (probably) have to radically redesign the current financial situation as we put the financial plan into action. Afterwards, after each cycle of the process there should just be small changes in the financial plan itself, unless there appear major changes in the customer’s environment.

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Implementing & Controlling the Financial Plan

Definition of Needs & Goal Setting

Maximize the Customer‘s Utility
Design of Financial Plan

Analysis of the Customer‘s Financial Situation

Diagnosis of the Financial Situation

Figure 2-4:

An Integrated approach to the Wealth Management Process Source: Own description following Gomez, Peter/ Zimmermann, Tim (1997)

2.4 Life Cycle of Wealth
In modern wealth management risk capability, liquidity constraints and the specific tax situation of the investor determine the asset allocation. Though, the fact that individual liquidity requirements and the investment horizon determine the risk capability changes in the life cycle of the investor has long been ignored. Consequently, the asset allocation has to be adjusted to life cycle of the investor, to take the differences of the life situation into account, as well. Every ‘normal’ human being passes more or less the same stages of development in life. Each stage has its specific characteristics. A possible life cycle is described in Figure 2-5.

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Saving & Investment Financing & Consume

Time

Education

Start of Career

Family

Pre-Retirement

Retirement

Figure 2-5:

Example of a Life Cycle Concept Source: Own presentation

Education: Normally, this ‘first’ step of life does not have a major influence on the saving plan of a person. Possibly, there will be the opportunity to save a little. The grand parents or the parents might collect some money on a savings account. Though, while (co)financing ones education, major dissaving (debts) can occur. Start of Career: Usually, a person finishes his education between 20 and 30 years and enters a career. Starting with a low salary he will be able to save a little money as the needs are still restricted. Though, major investments and purchases occur during this step of life. Family: Starting his career, the individual gathered job experience. The salary increased and a little more money could be saved. Now, the person founds a family and does some key investment, like buying his own apartment or house. The saved money will not reach to these investment and some financing (like mortgages) will be essential. Later, the children start their education. Further liquidity or specific funding has to be available. Pre-Retirement: This part of life is probably the most successful period concerning the accumulation of wealth. Even if the growth of the salary may stagnate or even decrease in a late stage of the pre-retirement, it is still significantly high. All major investments and expenditures have been made. There is no costly education any more. The consume will decline, as well. The mortgage of the house is amortized. Wealth is even increasing as a result of earlier investment decisions. The living standard can easily be kept with labor income, only.

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Retirement: At the beginning of this last phase of life there will be major changes as no cash inflow of labor income will exist any more. On the contrary, the individual continuously starts dissaving to maintain the usual living standard. These five characteristic stages have to be considerate by every investment strategy. As a consequence, the asset allocation has to be adjusted during every major change in the environment of the investor.

2.4.1 Time Horizon versus Life Cycle
What is the consequence of the life cycle (Figure 2-5) concerning the traditional time horizon perspective? The return of a portfolio will depend on the holding period. This holding period return equals income earned over a period as a percentage of the bond price at the start of the period. The holding period return can be calculated for any holding period based on the income generated over that period.5 Supposed the possibility of an increase equals the possibility of a decrease, the volatility grows with the square root of the period. Yet, the average rent ability increases proportionally to the time interval. How does the time horizon influence the shortfall-risk of the return of shares? If we assume a standardized return6 (z-value) there will be a zValue after T periods of [zT = zt+1 ∗ ROOT(T)]. Hence, the z-value and the volatility grows with the square root of the time horizon. Usually, the z-value is negative. As a result it decreases in the time horizon – consequently the probability of a shortfall declines, in respect of a given return with increasing time horizon.7 This fact implicates that a young person with a long time horizon can ‘reduce’ risk while maintaining the expected return or alternatively can bear more risk (put more weight on risky assets) with a higher expected return, supposing the investment is done for a long period. Now, taking the life cycle concept into consideration as well, we have to notice that the young person will probably need all his money to do some unavoidable investments – short term. If he invests all his money in risky assets short term, the findings of the shortfall-risk (above) will have an effect on the shortfall-risk. With a short time horizon, the shortfallrisk increases and the contrary ‘time horizon effect’ will occur.
5 6 7

Bodie, Zvi/ Kane, Alex/ Marcus, Alan J. (1996), p. 408 Standardized z-value of a Normal Distribution (Statistics). Rudolf, Markus (1996), p. 115

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Avoiding a loss in capital, we have to give the advice of investing in fixed income (safe assets) to ensure an immediate withdrawal of money – as soon as the investment takes place.

2.4.2 Lunch Money and Smart Money
A pragmatic approach to solve the problem above (2.4.1) can be a partition of the whole financial portfolio into two parts, one being smart money the other lunch money. The basic idea is the question ‘what the money will be used for’. What does lunch and smart money stand for? Lunch money is the part of financial wealth that is saved to serve some basic needs and liabilities, which will occur at a later stage of life, such as maintenance, food, education of children and renovation of the house. This part of wealth should be invested passively and safely, because it could be a major problem not being able to supply critical actions with sufficient liquidity. Hence, the residual wealth called smart money is not needed for a particular purpose and therefore can be used to follow a more aggressive strategy.

2.4.3 Life Cycle Products and Live Events
Following the statement of 2.1 that the intense consulting costs (time and money) of wealth management should be transformed into commodities, we need something that embodies this approach. It has to be a product in the sense of a problem solving ‘package’. Instead of just using the risk awareness as a criteria we should focus on the objectives or the purpose of saving. Ideally, it correlates with some events in a man's lifetime.8 Consequently, a customer analyses the purpose he wants to save for and compares some products for best suitability. Possible purposes could be marriages or education of children. Anyway, the most powerful purpose will still be the retirement. As stated in Figure 2-5 in the fist half of lifetime (education, start of career and family) high expenditures will play a key role. Hence, the motivation for investments might start in the late stage of family or latest in the pre-retirement stage. Consequently, there still are about three decades of time to invest. Thus, the issue of time horizon gets more important. Spremann (1996) suggests a program, which adjusts the individual asset allocation for each investor over the whole life cycle. Such a ‘Vintage Program’ could be a success in the market, as the target market segment – retail customers – will not be considered by Private Banking institutions, as these customers are not attractive in the first phases of their life

8

Spremann (1997)

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cycle. The intense consulting process will not pay off, as the customer volumes are low in the retail business. Probably, these individuals invest into mutual funds during their youth. Though, later on they are not consulted well concerning their specific situation. During the pre-retirement or retirement stage these customers will not seek consultancy by a professional, even if they earned a fair amount of money in the meantime. On the other hand, mis-investment over decades cannot be corrected in a later stage. Therefore will this group for Spremann (1997) be the main target of such a ‘life cycle product’ lunch. The argument that an individual advisement might be too expensive is not fair. On the other hand, intensive consulting might not be useful, neither. Therefore would such a ‘dynamic’ life cycle product for this segment be appropriate. The production costs are small, even if the life cycle of a customer will be taken into consideration. The main driver of the sequential strategy of the program will be the age of the individual. There will be an automatized adjustment of the asset allocation to the age of the investor. As in a mutual fund, there will be the benefit of a pooling effect. On the customer level of the program there will be a whole variety of different individual portfolios – on the management part of the program decisions will be based on traditional methods and measures of investments. As a result, the customer will profit from an individual asset allocation – depending on the stage of life he is in – at lower production costs.

2.5 Financial & Human Capital
Up to now, we only considered financial capital. Looking at a young individual we have to admit that at the current point of time there is only little financial wealth. On the other hand the individual disposes of a whole variety of valuable skills, which allow him to generate income. Hence, to really seize the ‘wealth’ of an individual, the technical term ‘financial capital’ has to be completed by another term , called human capital. Human capital is the discounted value of the whole future income of the individual. The development of human capital obeys it’s own rules. In the beginning of life the remaining time of working life is long, which supports the value of human capital. Though, a smaller wage is a contra-effect. As time passes the wage rises. As the value of human capital depends on the length of the remaining ‘income’ life and the ‘market value’ of the individual a culmination in the pre-retirement part might take place, very likely.

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3

Life Cycle and Life Style Theories and Models – a Survey

In this section some basic approaches will be discussed, which take into account the impact of the personal situation of an investor on the asset allocation. While models such as a the ALM-approach for private investors or CAPM and APT mainly concentrate on the definition of risk and the modelling of risk aversion the following approaches focus on the life style and life cycle profiles of an investor and their implications for the asset allocation. This implies that on the one hand information is needed about the amount and the characteristics of the non-tradable human capital, which can change over time, on the other hand the liabilities need to be estimated. It is evident, that life cycle and life style have a different impact on the asset allocation for e.g. a young single, a middle aged employee with family or a business man short before retirement. In practice the requirement of considering the personal situation for the optimal asset allocation is increasing. With the single-dimensional concepts, these requirements can not be met sufficiently. Up to now, in practice there are applied less model- as intuition-approaches providing life cycle and –style aspects for the asset allocation. Especially in USA are instruments such as Lifestyle-, Lifecycle-, Lifepath- or Generation-Funds well introduced.9 Intuitive approaches therefore, as these concepts are considering basically factors such as e.g. age, income, marital status for the asset allocation. For this reason this section will give a brief overview of different research results. The following selection on literature is not representative and raises no claim to completeness as life cycle related consumption and saving models are topics treated broadly.

3.1 Introduction
Life cycle and life style models try to answer the question, how a private investor should divide his assets into risky (e.g. equities and options) and riskless assets (e.g. treasury bonds) and how he should modify his asset allocation in the process of the life cycle. The focus lies on an optimal asset allocation in the individual life stages and its modifications in time. Therefore portfolio selection under the aspects of life style and life cycle requires in the first place the consideration of additional deposits and withdrawals in the life cycle

9

See Verwilghen (1997), p. 50

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as well as the consideration of risk qualities of the assets and the individual risk aversion of a private investor. The evolution of the total wealth of a private investor passes frequently in such a way that considerable savings in the course of work life are accumulated in order to consume a part of it in the last life stage and to pass the rest on to the following generation. In this case, two categories of wealth are economically important: The human capital (labor income) and the financial capital (increasing through savings and capital profits).10 Figure 3-1 shows the course of human and financial capital of a private investor, who at the beginning of the life cycle is not wealthy but has a higher-than-average income in the following years.

4 3.5 3
CHF Mio

2.5 2 1.5 1 0.5 0 30 35 40 45
Age Human Capital Financial Capital Total Wealth

50

55

60

65

Figure 3-1:

Human Capital and Financial Capital = Total Wealth Source: Spremann (1995), p. 121

This course of the income profile across a working life is called hump-shaped.11 During a working life, wealth is first intensely increasing and in the latter phases of a life cycle decreasing. The term ‘human capital’ describes human, non tradable resources, that enable

10 11

Spremann (1995), p. 118 See Verwilghen (1997), p.50f. who refers to the founder of the term ‘hump saving’.

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an investor generating labor income due to his education and skills.12 Therefore the development of the human capital follows other rules than the principles of financial markets. The influence of life cycle and life style aspects on the development of the wealth situation of a private investor can not be assigned clearly, as these two aspects form each other. While life cycle aspects are suitable to explain changes in the risk allocation of the financial capital over life periods, life style aspects are of use explaining different portfolio selections of investors with similar life stage and risk aversion.13 These findings indicate to the personal financial planning, that a life cycle analysis enables a consultant to ascertain the human capital of an investor and his power to accumulate wealth. And the life style analysis determines the liabilities to be met with the human capital and their risks. The study of the intertemporal allocation of resources and thus the study of saving and consumption behavior of individuals over the life cycle has long been central to economics. There is an extensive research activity about finding the optimal saving and consumption path over a life cycle. Other models are considering in addition the optimal portfolio selection under uncertainty. Another group of research concentrates on the implication of the non tradable human capital over a life cycle.

3.2 Relative Income Hypothesis by James Duesenberry
From findings, that an increasing income on a long term basis has no impact on the saving rate, Duesenberry provided 1949 the relative income hypothesis (RIH).14 He postulates that subjective saving is primarily determined from the outside through the social integration of the individual into its social environment. A private investor does not decide on his individual guidelines more or less isolated as his saving decisions are influenced by his social environment. In the long term the social position of a household defines its saving behavior. So the saving rate keeps constant if the incomes of the other households are increasing too. In addition Duesenberry is postulating that current consumption is not only determined by current income – beside its relative position compared to other social classes – but also by its highest previous peak (ratchet effect).15 Therefore income modifications affect consumption behavior only with a temporal delay. With this, Duesenberry can provide an explanation for the long run stability of the saving ratio and its

12 13 14 15

Verwilghen (1997), p. 51 Verwilghen (1997), p. 51 Wiek (1993), p. 10 Modigliani (1986), p. 298

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cyclical variations. Duesenberry’s relative income hypothesis is one of the fundamental contributions to Modigliani‘s life cycle hypothesis.

3.3 Life Cycle Hypothesis by Franco Modigliani
With the life cycle hypothesis (LCH) Modigliani set together with Richard Brumberg in the fifties and with Ando 1963 an important basis for the intertemporal allocation of resources.16 The theory gives fundamental statements about the intertemporal split of income between saving and consumption. But LCH does not provide a solution for the optimal portfolio selection because investment decisions under uncertainty are not part of this model. LCH has the purpose to show that rational, utility maximising consumers allocate optimally their resources to consumption over their life (in the spirit of Irving Fisher 1930).17 Thus ‘[..]the resources that a representative consumer allocates to consumption at any age, depends only on his life resources (the present value of labor income plus bequests received, if any) and not at all on income accruing currently’.18 A consumer chooses to smoothen its consumption path over his life. This consumption smoothing leads to a hump shaped age path of wealth holding, as it has been discussed earlier in this section. Therefore variations in income do not lead to fluctuations of consumption but they imply a process of saving and dissaving . The solution of the utility maximising consumption defines the optimal savings. By explicitly recognising the finite life of households, in the basic version of the LCH following simplifying assumptions concerning the life cycle path of household opportunities and tastes are applied:

1. Opportunities income constant until retirement, zero thereafter zero interest rate

2. Preferences: constant consumption over life no bequests

-

16 17 18

Modigliani (1986), p. 297ff. Modigliani (1986), p. 299 Modigliani (1986), p. 299

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This basic version of the LCH predicts many aspects of individual and aggregate saving and wealth holding behavior. But as some of the assumptions turned out to be counterfactual, Modigliani demonstrates, that the replacement of the simplifying assumptions by more realistic ones does not change the basic nature of the results. Especially the absence of bequest in the basic LCH which implies that, with retirement, savings should become negative and thus assets decline at a fairly constant rate to zero at death, needs to be modified under the empirical evidence. Modigliani argues, that the wealth left reflects risk aversion and the cost of running out of wealth rather than any bequest motives.19 Although there are some studies proving households to behave myopic, LCH can not be rejected in its basic findings with empirical tests. Modigliani refers to the result of a study in the USA saying that ‘the assets held at the peak of the life cycle are found to represent a substantial multiple of average income (in the order of 5 [...] and an even larger multiple of permanent income which, in a growing economy, is less than current income.’20

3.4 Permanent Income Hypothesis by Milton Friedman
Around the same time Milton Friedman has developed the permanent income hypothesis (PIH) which is quite similar to LCH.21 Basis of the PIH is a rational, utility maximizing individual trying to smoothen the consumption path over life. The central focus of this theory lies in the question, how individuals build up their estimations about future income. According to Friedman decisions about the level of consumption are not defined through the actual income but through the expectations of income over a certain period. During this period, the individual expects a constant income, called permanent income. Due to cyclical events, a change of job or modifications in wealth, the actual income differs from the permanent income. This difference, which can be positive or negative, is called transitory income. Thus saving and dissaving are kind of a ‘bumper function’ smoothening the income in the context of intertemporal planning.22

19 20 21 22

Modigliani (1986), p. 307, 310 Modigliani (1986), p. 305 Friedman (1957) Wiek (1993), p. 12

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3.5 Consumption over the Life Cycle by Gourinchas/Parker
Gourinchas and Parker use individual-level data to estimate a dynamic stochastic model of intertemporal consumption choice with realistic levels of income uncertainty.23 Their structural estimation of consumption function incorporates precautionary savings. The model contributes to the debate on the determinants of wealth accumulation, as the relative movements of the consumption and income profiles reveal information about the relative roles of precautionary and retirement motives for accumulating liquid assets. Gourinchas/Parker show why, despite a low discount rate, individuals do not accumulate assets for retirement early in life. According to the life cycle saving, a private investor, expecting his income to grow significantly from age 25 to 50, is to consume out of lifetime resources and so to borrow when young to smooth consumption. Gourinchas and Parker prove ‘however, households are smoothing marginal utility and they instead save in response to the uncertainty about their future income.’24 The following Figure depicts these findings.

20 15 10
TUSD

5

Buffer Stock
0 25 -5 -10
Age Buffer Stock Life Cycle (liquid)

Life Cycle
35 40 45 50 55 60 65

30

Life Cycle (total)

Figure 3-2:

Life Cycle and Buffer Savings Source: Own presentation according to Gourinchas/Parker, p. 30

23 24

Gourinchas/Parker (1999), p. 1-47 Gourinchas/Parker (1999), p. 31

Life Cycle and Life Style Theories and Models – a Survey

19

Given the estimated discount rate, life cycle consumers would like to borrow early in life. But as it is shown in Figure 3-2 precautionary saving motives cause them to hold a positive buffer stock of wealth. The model proves that around age 38, life cycle savings becomes larger than precautionary savings – the need to build retirement sets in. Gourinchas/Parker postulate that as asset levels increase, the expected variance of consumption declines, decreasing the precautionary saving motive. Thus an individual can decrease the buffer and as a result the total saving rate is smaller in latter life phases than under the certainty equivalent framework.

3.6 Conclusions of the New Saving Theories
In contrast to Keynes’s assumption of a rigid connection between actual and absolute income and saving behavior, the new saving and consumption theories have developed income terms of a more complex and more differentiated structure.25 In particular do the new theories take into account individual courses of action. The models are considering the importance of subjective willingness for saving beside objective, economical factors. RIH as well as LCH, PIH and the model of Gourinchas/Parker provide realistic explanations for today’s saving behavior over a life time, especially in their extended studies, allowing additional factors influencing the life path of saving. While RIH determines the subjective saving mainly through someone‘s social environment, LCH and PIH define the rational decisions about saving through someone’s expectations over the long run income. Besides numerous critics regarding the – partly quite rigid – assumptions (e.g. Duesenberry’s social dependence, Modigliani’s long planning horizon or Friedman’s rational behavior), several empirical tests have proven the new dimensions of saving of households, as stated in the models. Individuals act more and more actively when it comes to decisions of asset allocation. This change of saving behavior claims a change of financial services as well. Besides micro-economical factors macro-economical factors have to be considered too. LCH and PIH neglect portfolio selection under uncertainty. This research gap can be closed with models considering intertemporal consumption decisions including risky assets.

25

Wiek (1993), p. 13

Life Cycle and Life Style Theories and Models – a Survey

20

3.7 The Portfolio Approach by Robert C. Merton
While approaches like the Life Cycle Hypothesis of Modigliani (1986) and the Permanent Income Hypothesis of Friedman (1957) focus on savings and income, Merton (1969, 1971) bases his approach on investments and the portfolio theory. The new approach is the basic model of the intertemporal saving and investment decisions. Income is exclusively generated trough returns on investments.26 Traditionally, in the portfolio theory there is a discrete or one-period view. In the framework of life cycles this restriction turns out to be a major handicap. Thereafter, it would not be possible to take different life events and constraints into consideration, while advising a wealth management customer. Income is only generated through returns of investments – labor income is not applicable by Merton’s model. ‘Most models of portfolio selection have been one-period models. I examine the combined problem of optimal portfolio selection and consumption rules for an individual in an continuous-time model where his income is generated by returns on assets and these returns or instantaneous ‘growth rates’ are stochastic.’27 To describe the asset prices, Merton decided to choose a Brownian Motion. This stochastic process implicates a log-normal distribution of asset prices. Another assumption is an exogenous utility function. The individual is risk averse without changing his preferences over time.28 Hence, the weight in risky assets is constant over time. The weight only

26 27 28

As an assumption all investments can be traded without restrictions. Merton (1971), p. 70 Merton supposes a time additive utility function. This implicates a total utility being equal with the net present value of all future utilities. The current utility only depends on the current amount of consume. If such a time additive utility function is assumed, changes (reductions) in the current consume behavior can be balanced without any difficulties by changes (increases) in the future consume behavior. Assuming such a utility function it is very likely that individuals will invest riskier, even taking budet restrictions into account. Modelling a utility function supposing low substainability of consume, a reduction in consume will end up in a decrease of total utility because total utilty cannot easily be corrected through an ‘over-consume’ at a future point of time. Consequently, individuals with less opportunities of substitution will invest less riskily. For more information follow Spremann (1995).

Life Cycle and Life Style Theories and Models – a Survey

21

depends on the individual risk awareness, the expected return and the variance of this expected return.29 The validity of the Tobin-Separation was proved by Merton. As a result, the structure of the risky portfolio does not depend on the total size of the risky portfolio and is therefore independent of the development of income and consume over time. Appreciating Merton’s effort concerning the problem of continuous-time portfolio decisions it has to be emphasized the major contribution to expanding the portfolio theory and making it useful for a wide range of problems in the field of financial planning. In his essay ‘Optimum Consumption and Portfolio Rules in a Continuous-Time Model’, Merton (1971) overcomes the restriction of the first essay, which concentrates on returns of investments, only. He expands his model by considering income generated also from noncapital gains sources. Furthermore, he extends the results of the essay ‘Lifetime Portfolio Selection Under Uncertainty: The Continuous-Time Case’ for more general utility functions and price behavior assumptions.30 The human capital of an individual can hardly be recorded in assets being traded on perfect capital markets without any restrictions. Furthermore, changes in the value of human capital can barely be described by conventional price-designs. Merton generally presents a high net worth individual who mainly lives from capital income – compared to a common household living from labor income.

3.8 Asset Allocation over the Life Cycle and Vintage Model by Klaus Spremann
This approach of intertemporal portfolio selection considering human capital can be assigned to a third research stream, as Spremann’s main intention is not to enlarge the existing literature of simultaneous consumption and allocation decisions.31 Under the focus of a private investor (at the beginning of his career he is not wealthy, his wealth path is hump shaped), Spremann makes the assumption, that the split of income between consumption and saving is exogenously given whereas the risk aversion is endogenously.
29

The implication of assuming a constant risk aversion is an unporoportional relation between consume or the weight of risky assets and total wealth. The weight of risky assets is constant over time. Consequently, the weight in risky assets declines as wealth grows. Assuming an additional change in the preferences of the individual, the results discussed above will not be valid any more. For further discussion follow Spremann (1995). Merton (1971), p. 121 Spremann (1995), p. 139

30 31

Life Cycle and Life Style Theories and Models – a Survey

22

Furthermore Spremann shows, that the aggregation of individual investment decisions is suitable for reducing transaction costs individuals facing when restructuring their portfolio over the life cycle. The model is suitable for a group of investors being not wealthy at the beginning of their career but expecting a hump shaped path of wealth development, as their career is promising. It is shown, that young investors should choose preferably riskier assets, due to three main reasons:32 1. Human Capital Young people face considerable human capital (see course over the life cycle in Figure 3-1). 2. Time Horizon Effects The longer the asset horizon, the more assets can be allocated in equities, as the shortfall risk is decreasing. 3. Intertemporal Diversification It implies that the asset allocation should be riskier at the beginning of the life cycle. In particular, the model explains the decreasing risk tolerance with increasing age, which is often empirically observed, but the argumentation is different. For the translation of the model into practice, Spremann suggests a ‘Vintage Program’33 which adjusts permanently the optimal asset allocation during a life cycle. The vintage program could be realised with a two tier system: funds management and individual allocation of the collective results of the funds management. This model leads us to the question, what is the actual practical state.

3.9 Survey
In this part we aim to give a brief overview of section three. The main goal is to compare the single models and approaches with each another. There is no claim of completeness in the following Figures.

32 33

Spremann/Winhart (1998), p. 151ff. Spremann (1995), p. 130ff.

Life Cycle and Life Style Theories and Models – a Survey

23

Different models and approaches for wealth management under the aspects of life cycle Permanent Income Hypothesis

Determinants and assumptions of the different approaches

Lifetime Portfolio Selection The Continous-Time Case X X X O O O O O

Life Cycle Hypothesis

Intertemporal allocation of income to saving and consumption optimal portfolio selection Planning horizon: - a whole life - a certain period
(several years, month or cycles)

X O

X O

X O

O X

investment decisions under uncertainty

O

O

Duration of lifetime: - life is indefinitely long - finite life of household Income: - constant income until retirement - zero income after retirement - uncertainty of future incomes - social security - tax effects

O X

X O

X X O O O

X X O O O

Explanation of signs: taken into consideration by the model not considered in the model not applicable or not analysed by the authors

X O -

Vintage X X X O X O X O O O O O

Life Cycle and Life Style Theories and Models – a Survey

24

Different models and approaches for wealth management under the aspects of life cycle Permanent Income Hypothesis

Determinants and assumptions of the different approaches

Lifetime Portfolio Selection The Continous-Time Case O X O X O O X

Life Cycle Hypothesis

constant consumption over life bequests (motives) Behavior: - myopia - households behave rational and selfcontrolled Consideration life events: - education - start of career - family (children) - divorce - retirement

X O

X O

O X

O X

O X O O X

O X O O X

Explanation of signs: taken into consideration by the model not considered in the model not applicable or not analysed by the authors

X O -

Figure 3-3:

Overview of Different Analytical Approaches to Wealth Management Source: Own description

Vintage O X O X O X O O X

Wealth Management in Practice

25

4

Wealth Management in Practice

The business of financial consulting is booming. It wasn’t until recently, that wealth management focused just on High-Net-Worth-Individuals (HNWI). Nowadays, the target of clients is widening. It is the often cited globalisation and internationalisation that revolutionised financial consulting and financial planning. In the past, institutions were limited to a defined geographical area and could not offer their products over a country’s border. But time has changed. Today’s private investors are much more professional and independent and act on their own initiative. Private clients are tired of customer focused concepts, that turn out to be pure concepts of distribution. Wealth management and financial planning can no longer be driven by products instead of processes. Today it is not only the HNWI that seek competent wealth management which takes into account individual, long-term goals and needs. As it has been outlined in section three, less wealthier clients need a thoroughly financial planning as well, especially with regard to financially secure individual retirement. The reason for the former concentration on HNWI is a problem of costs. Personal wealth management claims high specialised consultants and up to now only wealthier clients had the corresponding optimisation potential guaranteeing the consultants a good return on their investments. An overall personal wealth management comes up to several thousand Swiss Francs for a client and it is questionable whether such an investment pays out for an individual client. Thus financial consulting for less wealthier clients has to be performed with fewer personal resources. A standardised advisory service is desirable meeting the clients needs in the field of optimal asset allocation, insurance-, tax-, retirement-, inheritance-planning etc. A solution of such a standardised form of financial planning can be offered by new information technology enabling attractive sales channels such as telebanking, mobile banking, Internet or interactive television (iTV).

4.1 Information Technology Changes Decisively the Field of Wealth Management and Financial Services
Information technology performs a great influence on the financial business’ structure. In particular the technological possibilities of e-services intensify decisively the competition among financial services. Information technology is no longer just a tool for supporting a provider of financial services in satisfying customers needs, it also wakes new customers needs. Today’s clients expect to have access to a large product and services offer at any time and through different channels. Therefore financial services, i.e. products with a high

Wealth Management in Practice

26

level of actual information, are just predestined for the distribution channel Internet. Thus the traditional banking sector will face more and more competition, especially from nearand non-banks. The following Figure depicts for the USA the trend in wealth management, that households choose increasingly asset manager acting through electronic media.

70 60 50

in %

40 30 20 10 0 1976 1977 1983 1986 1987 1989 1992 1995 1996 1997

Banks

Asset Manager

Figure 4-1:

Trend in Asset Management Source: Ringli/Ebnet (1998), p.6634

4.1.1 Strategies to Meet the Challenge of Information Technology
It will be the traditional banks in particular loosing clients. But the banks the chances are promising to be successful on the global market. E-commerce enables a provider of financial services to take care of the clients worldwide. As the new technologies and their control are in the upper cost segment, in the financial sector, a lot of banks co-operate with partners such as insurances, credit card centres, postal services and others. Thus – out of one source – they can provide a client with a full range of financial products and services over multiple sales channels. Clients obtain information of current prices, investment recommendations, competitor comparisons from the Internet at any time and at low cost.

34

The statements of Ringli/Ebnet are based on the Ernst & Young E-Commerce-Study 1998

Wealth Management in Practice

27

And that’s exactly what a customer requires: Multiple product offerings and relationships at different points in time.

Style of Interaction

Partner

Technical Advisor

R M elat an io ag ns em hip en t

s on as ati M iz l m na sto tio ce ra en Cu pe ll O xce E

Transaction

Single

Bundles

Themes

Product Approach

Figure 4-2:

Arrangements of Financial Services Provider to Clients Requirements Source: Ringli/Ebnet (1998), p.67

In order to meet these clients requirements, financial institutes will increasingly concentrate on their core competences but enlarged with bundles of services or combinations of products and services from other providers. They seek strategic alliances. This strategy of concentration on core competences leads to market segmentation in such a way as companies concentrate either on perfect operational excellence, on mass customising or client relationship management. Among other facts, these strategic alliances are one reason, why even big companies use increasingly standardised IT-solutions instead of proprietary self-made solutions.35

35

For example offers UBS with UBS Quicken the Swiss version of the world’s leading software for personal financial planning and portfolio management produced by Intuit. UBS Quicken is the first financial software with on-line updating of all accounts of a UBS client. This software allows general bill payment services (account management, budget planning, display of liquidity flows etc.) and investment and asset management (evaluations in graphic form thanks to on-line stock exchange link, retirement planning etc.)

Wealth Management in Practice

28

4.1.2 Information Portals to Control the Port of Entry
In the intensified competition of wealth management the client relationship is changing too. It is the client who uses increasingly electronic distribution channels and thus he decides, when, where and how he likes to get into touch with a bank or any other financial services provider, worldwide. Therefore a decisive factor of competition will be the point of entry of a client into the virtual world. Those who control such a portal have direct contact to clients and can deepen clients relationship. A study from Merrill Lynch gives the market of enterprise information portals (EIP) an annual grow of 35% of a total volume of USD 14 billion until 2002.36

4.2 Concepts and Tools in Financial Consulting – Status Quo and Trends
Along with the change in client needs regarding comprehensive financial planning and wealth management financial services and products have been improved permanently and extended strongly by its providers. Larger banks usually have established a financial consulting organisation of their own and built up an international network of financial planners who work together with specialists from all divisions. Thus these banks are able to meet a client’s financial needs and to provide him with comprehensive advice of his total financial and wealth situation. Their comprehensive financial advice covers areas such as risk, wealth planning, tax planning, inheritance planning, insurance planning, art banking, trusts and foundation, accounting and reporting services etc. The state of the service providers in Switzerland of comprehensive financial advice is quite different. While some banks have their own financial consulting departments are other banks still at the beginning of developing specialised teams.

4.2.1 Structured Wealth Planning Process in Practice
In practice the process of personal strategic wealth planning is structured similarly with every provider. Fundamental to effective financial planning is an in-depth analysis of someone’s personal financial situation. The next step is the identification of the client’s goals and needs at every stage of his life. A consultant compares the status quo with the objectives identifying gaps and problems that need to be solved. The next step is the development of constructive solutions that preserve and enhance the wealth of a client and ensure that his personal goals can be realised. At the end of the process, a client gets his tailor-made personal wealth plan ready to implement. It is up to a client to determine the

36

Bosshard (2000), p. 62

Wealth Management in Practice

29

extent and manner of the implementation. The consultant usually undertakes periodic reviews. The personal wealth plan has to be changed when significant changes occur in a client’s personal or family circumstances. Figure 4-3 shows the course of a wealth planning process in six steps.

Figure 4-3:

Personal Wealth Plan Source: UBS AG Wealth Planning, http://www.ubs.com/g/pb/fp_wm/fp_international/ fp_wealthplan.html (11.1.2000). The first two steps are for clients who just want some limited financial advice.

Structured processes instead of banking or insurance products lead to the optimal all-in solution. The process, the optimisation propositions, financial calculations, simulations etc. are supported by modern software programs. The level of detail and rendering of a personal plan and the process can be determined by the client. A financial plan can consist of some charts and tables without any explanations or it can be very detailed, full of valuable comments and explanations. This explains the wide spread of the price for a personal wealth planning.

4.2.2 VermögensZentrum (VZ) – the Motivation of an Independent Consultant
VermögensZentrum is a domestic provider of integrated financial services solutions. The consultants emphasize the neutrality of their advisement. In the Swiss market the VZconcept appears unique as VZ acts as an intermediary between the investors and the financial services product suppliers.

Wealth Management in Practice The consulting process is mainly spread into three parts:

30

First Customer Contact: This first step of the consulting process contains the idea of a diagnosis and is completely free. There is the goal to offer the customer a first overview and discuss the value added of a possible ongoing contact for both parts of the process. Following the contact an offer will be made.

First Customer Contact Concept Design

Implementation

Figure 4-4:

Basic Structure of a Consulting Process with VZ Source: Corporate Information, VermögensZentrum, 1999

Concept Design: The concept design offers a treatment on the diagnosis. The outcomes will be the basis of a directional decision. Afterwards, the detailed concept will be approved. Implementation: The last step is the realization of the concept.
VermögensZentrum

Wealth Management & Investment Consulting Insurance Consulting & Legal Advice Beqest Planning

Mortgage & Debt Consulting Tax Consulting

Retirement Planning

Corporate Consulting

Figure 4-5:

Consulting Areas of the VermögensZentrum Source: Corporate Presentation, VermögensZentrum, 1999

Wealth Management in Practice

31

Currently, VZ does not work with an elaborate theoretical model. A representative of the firm37 emphasizes the strong individual character of the business. Every analysis of a customer’s situation (see Figure 4-4) will take all ‘consulting areas’ into consideration. These areas are shown in Figure 4-5. Depending on the individual situation, different experts will join the advisement. It is VZ’s goal to realize a 360°-consulting process. What is the difference between an independent consultant and a bank or an insurance company? • As the payment takes place on a fee-bases, a certain neutrality will be credible and guaranteed. The consultant’s income will mainly be based on the quality of his advice – while a dependent consultant (with a firm-own product range) might try to sell ‘his’ products as his personal income depends on the volume he sells. As a consequence of the independence the independent consultant enters into different contracts with Financial Services product providers to be able to offer a wide range of products to his customers. Very individual combinations of different producers can be freely combined – to achieve the customer’s best value added.

•

Market Structure without Financial Consultant as Intermediary

Market Structure with Independent Financial Consultant

Market Structure with an Dependent Financial Consultant

Investor

Investor

Investor

Investor

Investor

Investor

Investor

Investor

Investor

Investor

Investor

Investor

Independent Financial Consultant

Financial Services Provider Financial Services Provider

Financial Services Provider Financial Services Provider

Financial Services Provider Financial Services Provider

Figure 4-6:

The Motivation of an independent Financial Consultant Source: Own presentation

37

Interview with Thomas Wyrsch, Financial Planner, VermögensZentrum, 21.12.1999

Wealth Management in Practice

32

In Figure 4-6, a non-coordinated market structure is visualized by the bigger amount of ‘contract connections’ between the investors and the financial services provider. As more contracts have to be signed it is very likely that the whole financial planning process will be more costly and more complex. The main problem will be the integration of the different products into one investment philosophy. Under or even double coverage may occur. The advantage of an intermediary appears intuitively clear. Every intermediary will be based on two element possibilities: the dependent and the independent financial consultant. While the dependent financial consultant sells his own products the independent acts as a ‘turntable’ between the financial services product provider and the investor. A word to neutrality and independence: We have to mention that an ‘absolute’ neutrality is very hard to achieve, as there is a network with product suppliers which also implicates some political argumentation within the network. Further more, VZ tries to reduce the consulting fees of the customers (during the design and implementation process), especially for insurance products. Therefore, they get paid with the sales representatives premium when mediating an insurance contract. This fact stands in contrast to the feemodel and significantly increases the dependency of a financial product supplier, as the consultant has a clear incentive to sell the products with the highest premium. à VermögensZentrum is an almost independent financial consultant. Though, there are still a few elements corresponding the model of the dependent financial consultant, such as the ‘service representative premium’.

4.2.3 Internet Solutions for Wealth Management
In addition to products enabling the settlement, clients put a lot of pressure on banks to provide Internet solutions in the field of wealth management. Therefore it is not amazing that the number of financial services offered on Internet is growing quickly. The field of financial planning is expected to grow from 24% in 1997 up to 69% in 2001, as depicted in Figure 4-7.

Wealth Management in Practice
90 80 70 60 50 40 30 20 10 0 82 64 46 31 24 28 67 69 72 62 60 57 53 28 15 67 63 59 69 54 47 27 22 68 74 73

33

in %

s

es nc ro B ke

d

Pr

nc

Fi

na

1997

D

ep

Figure 4-7:

Through E-Commerce supported Products and Services Source: Ringli/Ebnet (1998), p.68

Different Internet solutions recently appeared on the market. Examples: • The VP-Bank-Group in Liechtenstein could no longer keep off from providing esolutions for its clients. Together with VP Link the bank has introduced a e-commerce solution for its professional clients of attorneys and trustees. In an interview with ‘Schweizer Bank’ the CEO of VP-Bank confirms, that they had to create this new solution, as in the last two years the need for such a product was increasing rapidly.38 The management of the VP-Bank is aware that further e-solutions for other clients have to follow. • In October last year Bank Leu launched ‘Leu Portfolio Expert’, an investment advisory services tool for the Internet.39 This tool guides an investor to his optimal asset strategy, according to his long-term wealth development. It enables the simulation of wealth forecast, liquidity planning and investment strategies. An important focus lies on the definition of the risk profile. The definition of an optimal asset strategy is supported through comprehensive Figures. The strategy can be implemented directly with a mouse click.

38 39

Strebel (2000), p. 18 ‘Leu Portfolio Expert’ can be found under the internet adress http://www.leu-portfolioexpert.ch/. The access of this simulation tool is for everybody free.

g ym e ot e E nts xc A e cc ou rpt nt s D A cc ata ou Se ntin tt le g m en t
2001

ar

di

in

nf

te

ag

es

ts

g

o

nn

re

tI

tc

uo

di

la

uc

C

Q

or

su

ra

tg

lP

od

M

at

C

iv

Pr

ia

In

Pa

re

e

ra

Wealth Management in Practice

34

• Credit Suisse Private Banking launched new interactive on-line services for free, too. After directnet.ch, youtrade.ch and fundlab.ch a private investor finds under ‘cspb.com’ new Internet solutions. One innovation is the ‘Investment Proposal Online’. A client can construct his own asset allocation profile and determine his risk behavior. The analysis program bases on adequate questions as they are common in a professional consultation. The result is an individual asset allocation proposition basing on CSPB title recommendation. Those who wish can send their profile with mouse click to CSPB in order to get into touch with a consultant. Other two innovations are that one can ask a structured overview of derivatives, IPOs and bond issues and one gets actual market data from Reuters about all important stock exchanges and markets. This three examples of online tools mark an important step, as these new financial services are not product-focused but process- and customer-oriented. Most of the Internet tools are free. This leads to the question, if the Internet is able to soften the boundaries between the fields of retail and private banking. Edward Horowitz, executive vice president of Citigroup, is convinced that exactly this will happen.40 Clients who want a private banking service will have to tribute a charge. Everybody chooses service he wants. By Citigroup the range leads from Internet banking to full service. The development of Internet products and tools in the field of financial services is still at its beginning. The traditional world of banking will keep on changing radically.

4.3 New Measures of Professional Financial Consulting
Up to recently, client relationship was provided by well educated consultants. Today’s technologies have the potential to optimise the state of the art on a scientific basis. Makes the Internet a private banking consultant unnecessary? The services of wealth management and financial planning effectively add value for a client, as the suggested investment and saving strategies optimise a clients situation related to his individual life cycle. This active advisory service can not be done without a professional consultant who leads good, well structured conversations with his clients and keeps in any phase of the process a comprehensive survey and accompanies a client over the long term.41 A consultant can share more time for a private investor, as new technologies free him from administrative jobs. As subjects such as taxes make advisory services much more complex, one individual consultant needs a team of specialists
40 41

Edward Horowitz has been interviewed by Brigitte Strebel in Schweizer Bank (1999), p. 32-34 Interview with Jost Peter (UBS Private Banking), 11.1.2000

Wealth Management in Practice

35

supporting him. It is this personal top service that gives banks an enormous potential of differentiation in the competition with other financial services providers. Internet can not offer this advantage because the quantity of information is overwhelming. An integrated advisory service makes high demands on a personal consultant. A consultant needs a broad horizon. He must be able to feel and create a client’s needs. The combination of areas such as tax planning, optimal asset allocation, inheritance planning etc. makes it necessary that consultants develop themselves permanently. Therefore, banks and other suppliers intensely educate their individual consultants and expert teams in internal and external courses. The Certified Financial Planners Board (CFP board) 1985 has been founded with the aim to define standards for effective financial planning and to certify the training. The Swiss Financial Planners Organisation (SFPO) got its licence 1998. The licence is internationally bound at four rules: Education, Examination, Experience and Ethics. In Switzerland, provider of financial services such as e.g. Rentenanstalt/Swiss Life have taken the CFP training program into its education program and are planning to provide professional financial planning not only to HNWI. Donald Bills, Director of International Operations CFP, characterises the situation in Switzerland in such a way that Switzerland does not lie behind for years, but Switzerland has missed building up an organisation such as CFP, in due time.42 As in the future top educated consultants are a key element in the increasing competition, those who are able to provide professional wealth management and financial planning on a very high level, will be the winners. Banks which can respond to these demands will not have to worry, as only experienced professionals are able to organise and utilise this information overload, provided in Internet and other media.

42

Donald O. Bills is cited by Musio Marcello in: Schweizer Bank (1999), p. 57

Conclusion

36

5

Conclusion

This paper shows that wealth management as a part of life cycle planning, has become a complex task. The need for personal financial consulting is increasing throughout all levels of private investors. Wealth management continues to be an attractive business in the future but demands will increase dramatically as clients are better informed. In the second part of the paper we introduced some basic concepts concerning wealth management. The emphasis was put on the dimensions of financial planning, as well as on a systematic and integrated wealth management process, to deal with the increasing complexity in this field. As an outlook the life cycle concept was established and some conclusions, such as the difference between time horizon and life cycle, smart money and lunch money and the idea of life cycle products, have been made. Finally, the human capital concept was presented. Most of the mentioned points were discussed in further detail at a later stage of the paper. The discussion of life cycle models and theory in literature showed that human needs and thus their demands for financial services may change from one life phase to another. Therefore a supplier of financial services can increase decisively added value in offering life cycle adjusted products. Of course there are needs that can be met with classical, standardised products. But when it comes to life events such as inheritance, retirement or tax planning, the complexity rises dramatically. In the USA, approaches such as investment throughout a life cycle or saving for a life event, have made way for risk management which combines the advantages of a savings book with the risk/reward characteristics of stocks and bonds, while taking into account individual risk aversion and the time horizon. Thus the optimal mix of investments over a period of time is determined. A brief discussion of the status quo of wealth management in practice shows a fast and revolutionary development of the financial services supplier’s structure in short time. Information technology is a central driver for these changes. In particular the Internet offers a bunch of online financial solutions to the clients. Thus the clients are better informed, more performance-oriented, more price sensitive due to competitor comparisons and the supplier are forced to seek new fields for branding and maintaining margins. One example has been given with the information portals. But beside creativity and fast responding to new trends, supplier of financial services have another potential for differentiation: Personalised financial consulting offers. Apart from the benefits generated by e-media, many clients consider active, personalised advisory services more successful over the long term than the services offered to a client to consult himself. To realise the

Conclusion

37

advantage in active advisory services, providers need well educated consultants and teams of specialists. The complexity of products and clients’ needs are still increasing. It will be interesting to watch the future development. How will wealth management and financial planning services develop? How will clients needs change and influence the market? Will life cycle-oriented products become key products? Will the trend of comprehensive, tailor-made financial consulting last or do clients overtake more initiative or do they fear to rely upon one consultant? How will the change of financial structure develop – will further alliances follow? And how will regulations meet the new challenges?43 Financial consulting will characterise financial markets significantly. The evolution of this segment is still at its beginning.

43

The recently passing of the Gramm-Leach-Act in USA opens the US-banks wide possibilities in the field of comprehensive financial services.

Partners of Interviews

38

Partners of Interviews

Jost, Peter Leonhard

Director, UBS Private Banking, Financial Planning Domestic Switzerland, 11.1.2000 VermögensZentrum Financial Planner and Asset Management, 21.12.1999

Wyrsch, Thomas

Bibliography

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