The Essence of Asset Protection: Risk Management
Asset protection planning is closely related to financial planning. Both asset protection and wealth preservation strategies are about managing risk, which requires careful planning and appropriate asset allocations.
Asset Protection Works in a Similiar Way to Premium Insurance
In the insurance industry, underwriters charge fees (“premiums”) to undertake risks. Individuals and businesses pay those premiums in order to limit their exposure to financial losses. In other words, premiums represent known, fixed costs that are paid in exchange for a release from future liabilities, the extent of which are unknown. Traditionally, asset protection has worked in a similar way. The transaction fees required to set up wealth preservation strategies and asset protection plans are fixed, up-front costs similar to insurance premiums.
In the aggregate, people are more likely to lose money due to poor financial planning–a lack of proper asset allocation, biased advisors, and a bad economy or poor investment choices–than they are to lose money in a lawsuit. But each individual situation is unique, and some people are in riskier, more lawsuit prone businesses than others. In the case of high net worth individuals with significant exposure to risk (e.g. physicians like OBGYNs), certain wealth preservation strategies (in addition to insurance) absolutely must be pursued.
Wealth Preservation Through Asset Management
The least expensive form of wealth preservation comes from shifting at-risk assets to exempt assets. The only cost from such a reallocation of assets (other than transaction fees) is a possible reduction in liquidity. As an example, one could sell a certain portion of their stock or bond portfolio and purchase a cash-value life insurance policy. While stocks and bonds are highly vulnerable in a lawsuit by creditors, the cash value of life insurance is protected from the claims of creditors in many states. The practice of economics is the shifting of assets from areas of low yield to areas of high yield. Thus, if one can achieve her or his required rate of return via one of two investment vehicles, it makes economic sense to choose the less risky vehicle–the vehicle with less exposure to a suit by creditors.
Preservation of Assets
Where the goal is preservation of assets, timing is another consideration. The structure of any asset protection plan should match the investments made within the plan. It would make little sense to implement a wealth preservation strategy intended to last 30 years only to lose the principal in risky, short-term investments. In the very near future, however, it may be possible to earn growth portfolio type gains while only taking wealth preservation risks. We will write much more on this topic in the weeks and months to come, but the purpose of this post is simply to explain how significant protection can be achieved through meticulous planning, asset allocation, and risk management.