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Patrick S. O’Connor: Plant your inheritance within your portfolio

Published: Saturday, Aug. 30, 2014 5:30 a.m. CDT

Money can, after all, grow on trees – family trees.

And judging by the $8.4 trillion baby boomers are expected to inherit from older generations in coming years, we’re not talking chump change. In fact, about two-thirds of boomer households will receive an inheritance, and the average value of those inheritances is just under $300,000. That is according to a research report titled, “How Important Are Intergenerational Transfers for Baby Boomers?” from the Center for Retirement Research at Boston College.

A $300,000 inheritance has the potential to grow over 30 years into nearly $3 million, assuming a 7 percent annual return.

Most people who leave an inheritance want it to improve their heirs’ financial security. Growing the money over time is usually the best way to fulfill that intention. 

If you expect to receive a sizable inheritance, it’s smart to consider how you’ll integrate it into your overall investment plan.

As you develop an investment strategy for your new wealth, consider the following factors:

Asset allocation: Your existing portfolio is probably divided among stocks, bonds and cash investments. Adding new assets in just one of these classes could throw your strategy off-kilter. For example, holding your inheritance in stocks alone would boost your overall stock exposure and introduce more risk to your portfolio.

That can require making the sometimes difficult decision to sell. Heirs can feel as if they’re betraying the memory of the person who left them, say, a concentrated position in a blue-chip stock. Yet they need to look at the larger picture of the intent behind the inheritance – and at good portfolio construction practices. The key is to develop a strategy to invest these new funds while maintaining an appropriate asset allocation strategy for your circumstances. 

Alternative assets: Conversely, an inheritance may present opportunities to diversify your investment portfolio beyond traditional asset classes such as stocks and bonds. For instance, you may choose to invest a portion of your new wealth in alternative investments like real estate, private equity or a hedge fund. 

Such assets typically have low correlation with the broader stock market and may provide valuable diversification and help smooth out your portfolio’s potential returns over time. But because these investments tend to be less liquid than traditional asset classes, most investors should allocate just a small portion of their portfolios – no more than 10 percent – to them. 

Alternative investments carry specific investor qualifications which can include high income and net-worth requirements as well as relatively high investment minimums. Please carefully review the Private Placement Memorandum or other offering documents for complete information regarding terms, including all applicable fees, as well as risks and other factors you should consider before investing.

Tax-advantaged accounts: You can help maximize the growth potential of new assets by placing them in a qualified account, such as a 529 college savings plan. Or you could maximize your contributions to a retirement plan such as an IRA or other type of tax-advantaged account by using the inheritance to fund living expenses.

Since taxes won’t whittle growth on assets in these types of accounts, the assets are likely to accumulate more than if invested in an ordinary taxable account. Tax rules can be complicated for placing inherited assets into a qualified account, so be sure to discuss such a plan with a financial adviser and tax adviser.

• Patrick S. O’Connor, CRPC, is the managing principal, senior financial adviser and PIM portfolio manager at Wells Fargo Advisors Financial Network in Algonquin. He can be reached at 847-458-0142, p.oconnor@wfafinet.com or via www.algonquin.wfadv.com.

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