Few investment areas are more fraught with peril then when an investor receives a sudden influx of wealth.

Such is the plight of the surviving family members of the September 11th tragedies. Many are about to receive compensation packages equal to ten -- or even twenty -- years' salaries. Few people have the requisite skillset to competently manage this sum of money.

When instant riches are added to a recent loss, an ill-fated combination is born. The survivor may still be emotionally vulnerable; Grief can cloud better judgement. While most people would welcome an instant fortune, it can be a bit overwhelming.

Together, money and grief are a recipe for poor long term financial planning.

Case in point: Some unsavory financial advisors have been capitalizing upon the widows of New York City Firemen who perished in the World Trade Center disaster. The New York Times published a front page article ("Firm That Advises Firefighter Widows Has Tarnished Past") detailing the situation.

The Times details how these advisors are referring the NYFD widows to a law firm which is charging them a 10% fee for prosecuting their compensation claims. ("Legal Representation and a 10 Percent Fee") This is utterly irresponsible behavior on the part of these financial advisors. The NYC Fire Department Union, as well as the Trial Lawyers Association (Trial Lawyers Care/Volunteer Lawyers Resource Page), have arranged for high quality legal representation for surviving family members -- at no charge.

As a market professional, I find it impossible to imagine a situation where I would ever give up 10% of my clients' capital for no benefit whatsoever. Anyone who would do so, in my opinion, could not have their clients' best interests at heart. Either that, or they are grossly incompetent.

I would advise any recipient of sudden wealth to carefully consider a number of issues before committing funds to a financial advisor:

1. Take Your Time in Making Major Planning Decisions

Whenever I have dealt with people who received a windfall, there is always some urgency to make a fast decision. This is a huge mistake.

Quick decision making is not the hallmark of a good investment strategy; Rather, it is a sales tactic.

To the holder of newfound wealth, there is simply no advantage to an accelerated decision. I promise that the Stock Market will still be there in a month (or six) from now. You will not miss the "investment of a lifetime" by delaying your decision while you think it over.

Many experienced fund managers will tell you that its not the "winners" that makes for superior returns -- its the lack of disasters. That's never been more true then lately.

You have gone your entire life without a big pile of cash. There is no advantage -- and many potential disadvantages -- in making an impulse decision. You should be thoughtful, contemplative and unhurried. Do not allow sales pressure to coerce you into an ill thought out determination.

2. Focus on Wealth Preservation as Opposed to Growth

Several factors underpin good financial planning. Traditionally, an investors' goals, annual income and assets are the keys to putting together a suitable plan.

That may seem obvious; But to the windfall recipient, it requires a radical change in perspective. Suddenly, their situation has changed dramatically -- especially in the case of their assets and goals.

A formerly middle class investor may have spent much of their life pursuing financial security -- working, investing, saving for retirement. With a sudden influx of capital, all of their prior financial goals might no longer apply.

The crucial difference is this: Before the windfall, the investor's focus was on increasing their capital; Growth was their primary goal. Now, they are primarily concerned with preserving their capital and the potential lifelong income stream it can produce.

This change defines the construction of their portfolio. The emphasis now shifts from growth to income, capital preservation and risk reduction.

Specifically, they are more suited to a higher percentage of bonds (only high quality corporates and munis) than before; Their stock exposure will likely be reduced. Even within the equity portion of their portfolio, a larger emphasis may be placed on yield producing preferred issues, rather than ordinary common stock.

This is a 180 degree reversal from their prior perspectives. Many newly wealthy find it difficult to make this mental adjustment. Its hard, after all, to break a lifetime of financial habits.

3. Review past performance

When a windfall recipient finds an advisor they like -- preferable one who is not pressuring them, and who understands their new wealth preservation needs -- they should review his/her past performance. (Performance reviews should also be a continual part of their ongoing asset management strategy).

There are a variety of ways to do this. Some managers maintain a "model portfolio;" Others emphasize sector or index funds. You can find out what they hold, and when they recommended those positions (just ask). A note of caution: Most models are unaudited, and should be viewed merely as examples, and not true performance measures.

You can also see actual portfolios (with the clients' name and account numbers excised, of course). These accounts will be closer to the asset management you would be getting, versus the model portfolios.

Try to get a "feel" for other performance related issues. What are the manager's goals for growth and for income? Look for targets that are realistic, given current market conditions. Highly "aggressive" growth targets may be a sign of inappropriate or impractical investment strategies.

Ask about "drawdowns" -- how has their portfolios have fared when the market has sold off? How did they handle the post September 11th swoon? What are they doing to adapt to the current turbulent conditions?

Ask about what risk management tools do they employ. Are they willing to take a loss when an investment strategy or stock selection doesn't work out? Don't be afraid to ask about their biggest "losers." You want to avoid those managers who go down with the ship -- who ride down stocks to the single digits, because of their "long term" buy and hold strategy. Investors in Lucent (LU), Enron (ENRNQ) and Global Crossing (GX) also used the same tactic -- and look where it got them.

Finally, ask about their overall experience in the market. What areas have they focused on? What is their expertise? You should get enough information to be comfortable entrusting your assets to this person.

4. Ask for References

Any money manager with the commensurate experience, skill set and acumen should be able to provide you with a short list of satisfied clients. Despite the desire for privacy, I have found that many clients are willing to discuss their experiences with you.

Speak to these references at their convenience. Find out how long they have known the manager; Ask general, open-ended questions (avoid "yes or no" questions). Give the reference an opportunity to tell you the thing they like the least about the advisor (Don't be afraid to ask).

You should also inquire how much the reference has invested with them. This is a delicate question, but there is a discrete and indirect way to handle it: Inform the reference of how much you are considering putting under the advisor's management; Ask them if they would be comfortable if the advisor was a handling a similar amount for them.

Lastly, ask the reference for their next best choice in advisors. Many people spread their holdings amongst several managers; It never hurts to seek out another opinion or perspective. I would assume that a person without a second choice has little experience in finance.

5. Discuss fees explicitly

Discussing what advisors charge for services is uncomfortable for many investors. There is a fear of appearing "nouveau riche." Some people simply find it unseemly.

Get over it -- all savvy business people negotiate fees, terms and conditions. The mark of an unsophisticated investor is being intimidated when discussing so crucial an aspect of your financial well being.

No one of character will object to your desire to understand what traditional fees are. You are free to negotiate what you think is a fair deal. This doesn't mean that the asset manager has to accept your lowest offer, but you should be comfortable at least discussing what their price range and sliding scale is.

The typical wrap fee for money management ranges between 2 and 3% on the equity portions of the account (Bonds are often excluded from wrap fees in exchange for small commissions when purchased). If your windfall is larger than the typical client, ask for a better rate. Many firm's fee structures are on a sliding scale that decreases as the amount of money under management increases. If your account is over 10 million dollars, you may pay a percentage as little as 50 to 100 basis points (0.5 - 1.0%).

The cliche is true -- you get what you pay for; That doesn't mean, however, you need to overpay. Especially if yours is going to be an extremely large account.

6. Be Comfortable with what is Being Discussed

Lastly, listen not just to what your potential money manager discusses, but to the way they explain things to you. A superior advisor should be able to discuss your planning in simple, jargon free language. There should be no "talking down" to you.

Being able to clearly communicate complex issues to the layperson is the most difficult part of my job. Everyone tends to use their profession's lingo and shorthand -- that's as true for mechanics and lawyers and scientists as it is for Wall Streeters.

The challenge is to get past the jargon barrier so everyone understands what's at issue.

Be wary of an advisor that doesn't take the time to explain the details; "Its complicated / You wouldn't understand / Don't worry about that" are all red flags. Avoid any money manager who takes that approach.

Conclusion

Wealth has been described by some as both a blessing and a curse. A sudden influx of money can be an awesome and overwhelming responsibility. Hasty, careless planning, compounded with rash, emotional decision making could lead to a financial disaster.

With a little forethought and intelligence, you can ensure a newfound bounty does not become an undue burden.

Barry Ritholtz is the Market Strategist for Ehrenkrantz King Nussbaum Securities. Ritholtz appreciates your feedback and invites you to send it to ritholtz@aol.com.

April 8, 2002

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