Building a Fortress Balance Sheet: Insights From Our CIO

On a recent podcast, I mentioned in passing the idea of building a “Fortress Balance Sheet,” and I wanted to take a minute to expand on this idea because it speaks to the very core of how we ought to think about wealth management – whether we’re investors or advisors.

Kendrick Mercer, the founder of Mercer Advisors, said it best: “We are unconditionally committed to work with our clients to create the best context possible for their Economic FreedomTM, so that they don’t have to worry about money.”  

Yet it’s common for most investors to focus on important but narrow topics. Things like investing in the “right” stock or fund, setting up fancy estate planning structures or attention-grabbing tax strategies, or owning complex life insurance or annuity products, but it is important to understand the risks and complexities involved.   

While these are important discussions, on their own, they’re all far too narrow to achieve or maintain true Economic Freedom. Instead, we need to think about finances more holistically, as I’ve outlined below: 

A balance sheet for real families

Wealth management should be about far more than just managing a portfolio of ETFs or stocks, doing a simple estate plan, or filing a 1040. It should be about building and managing entire balance sheets for families — taking an expansive view of both assets and liabilities. It should be about building, managing, and integrating these balance sheets with the aim of maximizing wealth and, in effect, preserving economic optionality for the family. 

A balance sheet for real families takes a comprehensive view of assets, one that includes not just public stocks and bonds, but also private investments, home equity, private real estate, cash, closely held business interests, employee benefit plans, insurance policies, annuities, deferred tax assets (e.g., capital loss carryforwards), and (arguably) even one’s human capital. 

Additionally, it fully and accurately captures the families’ liabilities. While things like mortgages and credit card debt (long-term liabilities) are obvious, a realistic, economically-accurate balance sheet would include current liabilities (planned spending over the next 12 months), future expected liabilities (longer term spending on things such as retirement income, education for kids, heath care for elderly parents, etc.), and deferred tax liabilities such as the tax liabilities inherent in large estates and 401(k) plans. 

A family-centered, economically accurate balance sheet — a balance sheet for real families — would account for all these things. And a well-managed balance sheet can help mitigate, maintain, and protect our Economic Freedom against things like over-consumption (running out of money), market risk, inflation, growth shocks, adverse tax changes, lawsuits, natural catastrophes, and more. 

What we need is a Fortress Balance Sheet. 

The Fortress Balance Sheet

A Fortress Balance Sheet provides five things: 

1. Growth: A Fortress Balance Sheet aims to provide for real, inflation-adjusted growth by delivering the after-tax expected returns necessary for the family to achieve its long-term goals. This should not be where wealth management conversations begin and end. While building a balance sheet that’s well-positioned to deliver inflation-beating after-tax returns is a critically important dimension of a Fortress Balance Sheet, in isolation, it’s insufficient to achieve and maintain Economic Freedom.
   
2. Income: A Fortress Balance Sheet can provide the real-time, after-tax income that families need to maintain their lifestyles. Income differs from growth in that income represents the liquid financial returns that we need to earn today, in the here and now, and not the lumpy, unrealized, often illiquid, and typically untaxed returns characteristic of long-term growth assets.
   
   This income can come from any combination of financial and human capital. And herein lays a key implication of the Fortress Balance Sheet framework — it requires an expanded, economically accurate approach to balance sheet measurement and management, one that accounts for the family’s total assets and liabilities.
   
   Things like human capital (e.g., education, special skills, health, etc.), deferred tax liabilities (e.g., the potential taxation of unrealized capital gains and the income taxation of withdrawals from qualified plans), and deferred tax assets (e.g., capital loss carryforwards) are classic examples of things that are almost always ignored on net worth statements but that can have a significant impact on our ability to achieve and maintain Economic Freedom.
3. Liquidity: Balance sheet liquidity is important for any number of reasons, but mostly to meet liabilities (e.g., unreimbursed hurricane damage to coastal property) or to capitalize on opportunities (e.g., capital calls or opportunistic co-investments).
   
   We typically think of liquidity in terms of cash and cash equivalents (e.g., money market funds), but it’s bigger than that. Liquidity is ultimately a measure of how easily, cost-effectively, and quickly we can convert an asset to cash at its fair market value. Short-term investment grade bond ETFs, for example, are typically far more liquid than high-yield individual corporate bonds or even A-rated bonds issued by most municipalities. Liquidity is a spectrum.
   
   The Fortress Balance Sheet aims for liquidity to meet current and future liabilities, whether expected or unexpected, without having to borrow at needlessly high interest rates, incur significant transaction costs, or sell assets at fire sale prices to raise cash.
4. Protection: A well-managed fortress balance sheet — through a combination of asset allocation, liability management, insurance, and entities — protects families against a wide range of economic threats. We often think of economic threats in terms of market declines, inflation, taxes, and recession. But many other dangers are far more threatening to our Economic Freedom, which are often left out of an investing conversation. Shifting tax laws, litigation, premature death, disability, cognitive decline, fraud, and identity theft, to name only a few, pose a clear and present danger.
   
   Fortress Balance Sheets address these threats through a combination of life, disability, property and casualty, and liability insurance; effective estate planning; broad global diversification, both across and within public and private asset classes; and proper asset titling and location across different tax environments.
5. Flexibility: Last but not least, a Fortress Balance Sheet provides flexibility to change our minds, reallocate resources as needed or desired, and respond to the inevitable curve balls life throws our way.
   
   I think of flexibility in terms of having options. The best financial decisions are, in theory, always revocable with no switching costs. However, this is obviously easier said than done; many decisions — for example, setting up an Irrevocable Life Insurance Trust (ILIT) or investing in a venture capital fund — aren’t so easily reversed without incurring potentially significant costs. The same can be said for allocating capital to permanent life insurance or annuity products with high upfront costs and years-long surrender periods. There are important trade-offs between financial strategy and flexibility that need to be carefully considered — and revisited as circumstances change. 

Key takeaways

The Fortress Balance Sheet is ultimately about helping families achieve and maintain true Economic Freedom. A few final closing thoughts on this: 

• Wealth management is about far more than any single stock, mutual fund, asset class, or investment account. The building and maintenance of wealth across balance sheets, generations, time, and space — a balance sheet that immunizes families against economic threats and delivers Economic Freedom — requires a multidimensional view of wealth. 

• At Mercer Advisors, we’re built to help families construct and maintain Fortress Balance Sheets. Building and maintaining a Fortress Balance Sheet requires a specialized team with a shared understanding of the mission. It involves complex areas — finance, taxation, law, insurance, and more. No single person is an expert in everything and none of us are smarter than all of us. Only by working together can we hope to build a strong Fortress Balance Sheet and achieve true Economic Freedom. 

• A Fortress Balance Sheed requires a comprehensive approach. This approach requires looking across one’s entire financial life. The Fortress Balance Sheet is a reminder that we can do a far better job managing wealth with a full picture of assets, liabilities, tax situation, liquidity needs, insurance protection, and more. 

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