Before Reaching a Financial Settlement, Consider Investment Sophistication

By: Rob Clarfeld
Last Update: February 28, 2018

The financial and investment sophistication required to successfully manage post-divorce settlement assets is often overlooked by a divorcing couple and their advisors.

There are many factors that a divorcing couple and their advisors take into consideration when structuring a financial settlement, including: current and anticipated living expenses, future earnings potential, taxes, and the pool of assets to be divvied up. An additional consideration that often is overlooked is the financial and investment sophistication that will be required to successfully manage post-settlement assets.

For someone who is not investment savvy, converting a cash settlement into a diversified investment portfolio that will fund all or part of their future lifestyle engenders tremendous anxiety. Further, the investment returns achieved by an unsophisticated investor often fall short of what the market is otherwise delivering. This can happen even when using professional investment management, for reasons that are not necessarily intuitive.

Investment Sophistication: Can You Assess (and Accept) Portfolio Risk?

Successful investing is difficult. This is because portfolio returns need to be evaluated in connection with the underlying asset allocation – the risks the investor is willing to take in order to achieve them. Developing an asset allocation appropriate to one’s unique circumstances requires both considerable skill from the investment manager, and an educated client. That is, in addition to accepting the myriad of systemic investment risks, those who are relatively new to investing face a steep learning curve, which can be especially precarious when lost principal cannot easily be replaced. They need to develop both knowledge and experience – knowledge of how investing in various differing asset classes work together to reduce overall portfolio volatility, and the experience that comes with surviving down markets when no strategy seems to be working well.

Those new to investing need to learn how to add portfolio risk gradually as they develop a level of comfort that will serve them well over time. A quality advisor can help unsophisticated clients achieve the knowledge and experience required to avoid pulling out of the market at the worst possible times. Watching the portfolio that you depend on decline is extremely difficult, even for experienced investors.

New investors also need to develop an understanding of fees, taxes and the impact of inflation on their future purchasing power, as well as learn how to fairly evaluate an investment manager’s approach and performance. All this takes time.

Investment Sophistication: Should the Savvy Spouse Keep the Portfolio?

When we provide financial advice to matrimonial clients who are relatively unsophisticated financially, we often are asked to weigh in on the tradeoffs between receiving spousal maintenance verses lump-sum payments. Generally, our experience is that the more financially sophisticated spouse is in a position to earn better portfolio returns, especially if he or she is able to replace lost principal.

So will both parties be better off with the more sophisticated partner retaining more investable assets, and providing the spouse with higher ongoing maintenance? From a pure investment prospective, probably yes. But this tradeoff has major non-investment considerations including taxes, remarriage, and the assurance that ongoing maintenance payments will continue – pretty big considerations.

5 Investment "Truths" for Divorcing Individuals

To summarize, here are five general “truths” that I've learned over the years both as a wealth manager and from working with matrimonial clients:

  1. Investments are a necessary aspect of one’s financial life. 
  2. Very few investors are completely comfortable with the responsibilities of investment management, especially those who are new to the process.
  3. Investors who lack financial acumen, experience, and are unable to replace lost principal, are less likely to obtain expected market returns than their more experienced counterparts.  
  4. Employing professional investment professionals is important, but not a substitute for directly acquiring knowledge and experience.
  5. There are no easy answers to the tradeoffs between maintenance payments and lump sum settlements. Keep in mind that there is a lot to be said for “a bird in hand….”

The intended outcome of settlement negotiations is to arrive at the most favorable aggregate outcome for both parties. So among the many related considerations in a matrimonial dissolution, consider the relative investment abilities of both parties.

By:Rob Clarfeld | February 07, 2018 | Financial Issues | (0) Comments

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