By Brian G. Bissell, Senior Vice President and Client Advisor for Whittier Trust
Wealth preservation is always a critical concern for individuals, families, and businesses, but it is especially a focus during economic downturns. When the economy contracts, businesses are distressed, the broad market declines, jobs are lost and investment portfolios experience reduced valuations. In this environment, it is essential to be strategic, calculated and prepared to protect the family assets and take full advantage of the opportunities available. Here are four smart, practical strategies that have helped families weather economic instability for generations.
Recessions don’t last forever. In fact, the average length of a recession is only about 10 months. Maintaining an adequate cash reserve can help you persevere through challenging economic environments that impact your business or investment portfolio. Liquidity can help cover expenses while income levels are temporarily depressed. The biggest consideration is trying to avoid the forced sale of an asset that has substantially decreased in value. We are essentially buying some time for the markets to recover and the economy to rebound. A good rule of thumb is to keep six months of business or household operating expenses in cash or cash equivalents.
We have been reminded with the current banking crisis that cash reserves shouldn’t all be held in deposits at a single bank if they are well above the insured limits. With 3- and 6-month Treasuries yielding around 5% right now, it is probably safest to keep deposits at any single bank near the $250K FDIC insured limits and position the rest in either short-term treasuries or Treasury-backed money market funds.
Having liquidity and dry powder during an economic downturn is a major step toward peace of mind, but it is more than just a security blanket. It provides ammunition to be opportunistic and gives you the ability to buy while others might be forced sellers.
Diversification is an essential strategy that has been a difference-maker in wealth preservation for centuries. Oftentimes real wealth is generated by concentrations and leverage, but while concentrated or leveraged investments have the propensity to create wealth, they have the same ability to take it away. Once a family or business has achieved a level of success or generational wealth, one surefire way of limiting the risk of total loss is diversification.
A common storyline with wealthy individuals stems from them or one of their ancestors being an early founder or high-level executive of a successful business, leading to a large concentration in the company stock. They may struggle to overcome the psychological hurdle of the sentimental value they place on those shares. Sometimes this nostalgia spans generations. But all it takes is a technological advancement, shift in consumer behavior or black swan event within an industry to take a blue-chip large-cap stock and make it worthless or severely reduced in value (i.e., Kodak, Gannett, First Republic, Blockbuster, etc.). Diversification is the antidote to putting too much into one investment vehicle. For an individual’s investment portfolio, this means spreading risk across many different industries, businesses, and asset classes. For a family business, this means investing capital in other business lines that may provide exposure to a broader set of potential customers.
Tax Loss Harvesting
While economic downturns can be stressful and unnerving, they also present us with several opportunities to make some great strategic estate and tax planning moves. Tax loss harvesting is the low hanging fruit during challenging economic environments. There could be some low-cost basis stock positions you have been holding onto more so to avoid having to pay capital gains tax than your true belief in the prospects of the company. Harvesting losses allows you to offset other gains and reposition the portfolio with minimal tax ramifications.
Many wealthy families and family business owners have estates that will exceed the lifetime exemption. All assets above the lifetime exemption amount for gift/estate taxes will be subject to a 40% tax when transferred to the next generation. If you are planning to give assets to future generations, an economic downturn might be the perfect time to accomplish the transfer. With values down, getting an appraisal done on the family business or any other asset you plan to transfer allows you to pass along more due to the temporary reduction in valuation. While it can be painful to see valuations fall, don’t miss your opportunity to use this time to maximize your planning. When the transfer is complete, and valuations have normalized, the true benefits will be realized.
Economic downturns and recessions can be scary for even the most optimistic among us. However, such seasons don’t have to be anxiety-filled. With the right guidance and plan in place, you can use such economic cycles to your long-term advantage.