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Fiduciary Responsibility: Risk from the Client's Perspective | Part 3 - Financing the Goals

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Fiduciary Responsibility: Risk from the Client's Perspective | Part 3 - Financing the Goals

Alex Serman • February 08, 2024



Fiduciary Responsibility: Risk from the Client's Perspective (Part 3)

“How are we going to pay for all this?” When it comes to providing financial support over several generations, every organization needs a long-term strategy.

In our last segment, we looked at client types in terms of their mission and the beneficiaries they support. We focused on making ongoing monetary payments to help their beneficiaries “pay the bills.” Payments from these organizations often provides a significant source of the funds these beneficiaries need; sometimes, it is their only means of support. Whether these payments are fixed legal obligations (as with pensions) or they are voluntary and flexible (as for endowments and foundations) organizations have a goal of maintaining this level of monetary support over the long term, regardless of any distress in the financial markets. This is a significant challenge that requires three well-coordinated components:

  • Adequate capital
  • Sustainable spending policy
  • Investment strategy matched to spending discipline


Our client-centered, goals-based approach to investing requires a different perspective from the traditional view that focuses on investment products and competitive results. In simple terms, we define success as delivering the money that beneficiaries need, while preserving the value of the investment portfolio for future generations.

This goals-based approach involves all the rigor of traditional investing, while also considering risk from a variety of additional sources. This requires examining all of the traditional statistics, along with considering monetary outcomes. After all, there is little comfort in beating a benchmark or a peer group if we fail to provide the funding our beneficiaries need, or if we cannot maintain this support going forward.

We will explain the process for providing this inter-generational support, while preparing for the various circumstances, challenges and risks we are likely to face. While the future is uncertain and unknown, we are called to make decisions under the guidance of a rigorous approach that is thorough, thoughtful and diligently applied. Future events may be unknown and even unexpected, but they should never be “unplanned for” within a fiduciary framework. While the timing and severity of these challenges cannot be known, we can be prepared for them when they do occur. This paper outlines that process.


Withdrawals from the investment portfolio flow to the beneficiaries, and these are the most visible effect of the organization’s good work. We intend to have “fair dealing” across generations, and so the ideal spending amount is one that can increase with inflation, while preserving enough portfolio value to continue this process forever. Accomplishing this goal means aligning the organization’s capital with an investment strategy that allows the withdrawal of increasing amounts, regardless of the “ups and downs” of market volatility. The proof statement of success is in the remaining portfolio value, which should also increase with inflation over the long term. This is the source of the sustainability of these payments to future beneficiaries.

Let’s examine a hypothetical case study of goals-based spending, using a common withdrawal rate of five percent. (This amount is mandated for private foundations, and is often found in public foundations and endowments.)

Our portfolio has $1 million in capital and it is invested with a goal of earning a long-term return of about 7.5% (which should support 5% withdrawals plus 2.5% inflation growth in the remaining investments.) Intuitively, it seems reasonable that we can sustain these withdrawals, since we are simply spending the gains from investments.

There’s another way to confirm our intuition, using a simple valuation metric that’s taught to every first-year student in their investment classes. To calculate the value of a perpetuity of growing payments, we simply divide the withdrawal amount by the difference between the investment return (7.5%) and the growth of the payments (2.5% inflation.) Here is the calculation:

Capital needed for a $50,000 withdrawal = $50,000/(7.5% - 2.5%) or $50,000/5%

The answer is $1 million in capital. We may think of this as needing $20 in portfolio assets for every $1 we intend to withdraw from the portfolio. That’s because $1/5% (or 0.05) equals a factor of 20x.


Our plan works perfectly – as long as we always earn the return we expect, and inflation remains within our estimate! But we know that nothing is guaranteed, and so we might earn more or less than we expected. We must evaluate the likelihood that our long-term return results may not preserve the portfolio value for the next generation. We must also evaluate the severity of potential portfolio loss, which would cause the next generation to receive a lower level of support. We call this the “Risk of Mission Failure” and it is THE essential risk we face.

To evaluate the potential for mission failure, we must determine our own sense of how severe a loss is tolerable. This is the client’s true risk tolerance, since it represents the level of deterioration in support that they could accept. Once we have defined what “failure” means in measurable terms, we can then find the likelihood of its occurrence. By seeing both the probability and severity of failure, we can take steps to align our investment strategy and its return and volatility risk to our spending goals.

We evaluated our current approach by running a set of potential outcomes and then ranking the results. By generating 3,000 random scenarios we determine the extent of failure that we might encounter. If the results are outside our true risk tolerance, then we could adjust our strategy, or our spending rate, or both.


Using a set of capital markets returns, risks and correlations between the pairs of assets, we created a strategy that is expected to earn the expected compound return of 7.5% per year with a minimum of volatility of return. We developed a well-diversified allocation that includes both global stocks and bonds plus alternative investments.

The specific allocations within each sector:

Expected Results from 3,000 simulated return scenarios (spending $50K per year, growing with inflation)

  • We expect to spend 1.4x of the portfolio’s real value over the next 30 years
  • We expect to grow the portfolio’s real ending value, net of spending, however…
  • Our median result reflects a loss of about 4% in portfolio value.

How do we reconcile the second and third results? The answer lies in the shape of the set of outcomes. The portfolio’s upside results are very strong, and when these are included in calculating our overall expected outcome, our average portfolio value (across 3,000 scenarios) reflects substantial portfolio growth.

Our expectation of meeting our goal of retaining the portfolio’s value comes with some risk of mission failure. Our simulations evaluate the likelihood of loss at increasing levels of severity. By bringing severity and likelihood of mission failure together, we capture the client’s unique risk tolerance in meaningful terms. For those who see a 15% loss as failure, the risk is 1-in-6, while for those who define failure as a loss of 25% of the portfolio, the risk is only 1-in-10.


What if this set of downside outcomes is just too risky for the client?

There are three things we may do differently to reduce risk of mission failure:

  • Spend Less
  • Use a more aggressive strategy to earn a higher return on our investments
  • Use a different spending methodology (more on this in upcoming articles.)

Let’s try lowering our spending rate.

If we lower our spending rate to 4%, we create a safety cushion of return (relative to spending) that provides protection for the portfolio value. This “return cushion” should be visualized as “unspent money” that accumulates during “good years” while earning higher returns on that money, creating a surplus in portfolio value. This surplus sustains spending during years of low or even negative market returns.

With the return cushion and surplus in place, our expectation is now to grow the portfolio by 60% over the next 30 years. Of course, cumulative spending declined from 1.4x to 1.2x of the portfolio’s initial value; however, our primary fiduciary responsibility (preserving portfolio value) was at less risk. We can see this in a lower likelihood for significant losses to occur:

  • Likelihood of a 15% loss was reduced from 1-in-6 to 1-in-8
  • Risk of 25% loss was reduced from 1-in-10 to 1-in 18
  • Chance of 30% loss was nearly cut in half, from 1-in-13 to only 1-in-24


Establishing realistic goals within a fiduciary approach should be a rigorous process that aligns an organization’s capital and its investment strategy with the monetary support it provides to its beneficiaries. In this context, risk is defined in terms of the mission: to continue to support the work of the organization across generations. This is a challenging set of tasks, especially when we consider the uncertainties of the investment markets.

With this in mind, we provided an approach rooted in good stewardship of the organization’s assets. This includes investing its assets prudently and effectively, and then spending for beneficiaries in amounts that can be sustained across generations. The goal is to provide as much as we can for the current generation, while preserving enough to treat the next generation equally well. The key to accomplishing these goals is adequate risk management.

It’s not enough to set reasonable expectations. We must also understand the risk of unexpected outcomes that could cause a loss of value in the organization’s assets. Its leaders must establish the “guard rails” around potential losses, so that the degree of loss and its likelihood are both within acceptable limits. This requires a partnership between the organization’s board, its investment committee and its investment providers.


Our upcoming articles will provide more in-depth insights into the processes of asset allocation and spending policy, as well as the implementation of the strategy through the selection of specific investments.

Written in partnership with Stephen Campisi