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An individual’s approach to managing their personal finances is shaped by a myriad of influences. These may include their upbringing, community, social circles, and religious beliefs. A lifetime of experiences, and the manifestation of all these influences, impacts one’s relationship with, and attitude towards, money.
Another, often overlooked, factor that impacts the way individuals handle their finances is their level of wealth. Financial planning techniques necessarily differ based on how much money one has. Interestingly, the financial misconceptions held, and missteps made, by individuals can also vary based on wealth levels. High-net-worth (HNW) individuals’ money mistakes are typically the result of an overconfidence developed through years of success in their professional life. While a healthy dose of self-assurance will undoubtedly help in achieving initial financial success, it can also be a hindrance to effectively preserving and managing that wealth in retirement. The ability to understand and avoid the below pitfalls is crucial for ensuring HNW investors achieve their financial, philanthropic, and legacy objectives.
1. Achieving success in one area of life does not necessarily translate to success in personal finance: If you are financially successful, it may seem like a forgone conclusion that you will also be proficient at managing your personal finances. Unfortunately, this couldn’t be further from the truth. Building and running a successful company involves many skills, including industry knowledge, understanding your market, and perfecting your craft. However, none of those areas of expertise automatically translate into success with one’s personal finances.
This is particularly clear when it comes to investing in the market. The daily gyrations of stocks can seem like a mystery to many outside the investment world. There are not always simple explanations for market swings or why, over a short time period, some industries, sectors, or companies thrive while others remain stagnant. Stock prices may be equally driven by investor emotions as they are by company fundamentals. For example, if the CEO of a particular company is a savvy marketer, their company’s stock price may keep rising despite poor sales. This is counter to the way many businessmen and professionals view the world. Accepting these realities may be demoralizing to many successful people who can’t understand why the markets are so irrational. However, embracing the uncertainty and incorporating it into your planning is imperative. Hiring someone to help you navigate this strange world of investing may save a lot of stress and money over the long run.
2. Concentrated investments can make you rich but may not keep you rich: Many HNW individuals’ wealth is locked up in their business. A concentrated capital investment and the simultaneous dedication of reinvesting cash flow back into the company is how many affluent folks accumulated their fortune. However, the approach that made them wealthy is not the optimal approach to keep them wealthy.
A high-profile example of this concept is Patricia Kluge, the ex-wife of late billionaire media mogul, John Kluge. While her ex-husband created his fortune with concentrated investments in media companies, Patricia invested most of her divorce settlement money into her own vineyard. When the housing market crashed, she lost everything and had to sell her jewelry at auction just to make ends meet. Unfortunately, there is no shortage of similar stories of wealthy people who blew their fortune on a few bad investments.
In order to maintain one’s affluence, one should focus on preservation of capital. That is accomplished through prudent diversification, a strategy that most people don’t get excited about. It is, admittedly, quite boring and sometimes frustrating since there will always be an underperforming asset within your portfolio and overall returns will lag at least some areas of the market. That being said, this strategy also helps minimize the likelihood that your portfolio will implode. In retirement, the name of the game is to live off the fruit of your labor. Searching for the next hot investment idea to triple the value of your assets can lead to financial ruin.
3. Having more control does not necessarily lead to better performance: Based on years of experience, I’ve noticed that my least successful clients are generally the ones that are always adjusting their strategy. This can be frequently modifying their allocation, tactically rebalancing, actively trading, and more. Just leaving things alone is not in everyone’s DNA, especially for investors who implemented a hands-on approach in their professional life.
Unfortunately, constantly tweaking one’s investment portfolio is almost always the wrong decision. A far better approach is to clearly define your financial goals, outline the parameters for how you want your assets managed, and then let professionals handle the day-to-day management. This will help minimize the urge to tinker with your investments, an action that may derail you from achieving your financial objectives.
4. Underestimating the required annual income to maintain your lifestyle: It always impresses me how quickly people can spend their money. This is true regardless of asset levels. While this may be a compliment to the marketing skills of our nation’s retailers, it is also an insight into human nature. People tend to spend the money they have, especially if they are accustomed to maintaining a certain lifestyle.
In order to maintain one’s lifestyle in retirement it’s important to properly evaluate income needs and modify plans as necessary. During one’s working years, there is always the potential of making more money to replenish one’s spending. However, in retirement, the ability to earn more income decreases. It is, therefore, imperative to define one’s cash flow numbers from the onset of retirement. This cash flow analysis should serve as the cornerstone of one’s financial plan to increase the probability of achieving financial objectives.
5. Not factoring in tax planning: It’s surprising how many wealthy families completely neglect tax planning within their financial strategy. If you’ve been fortunate to have accumulated a large sum of assets, ensuring that you can pass that money tax efficiently to your beneficiaries should be a top consideration. There is really no reason for Uncle Sam to take more than necessary upon your passing. That is why it’s important to explore various estate planning techniques, including gifting, utilizing trusts, and proper structuring of assets, with your advisors.
Additionally, many HNW clients don’t consider taxes when it comes to day-to-day investing. They seem to be more focused on hot investment ideas or gaining access to boutique alternative investment strategies that they can discuss with their friends on the golf course. While none of those strategies are guaranteed to live up their potential, one sure way to provide value for them is proper “asset location.”
Asset location is the process of allocating tax inefficient investments to tax deferred accounts, like IRAs or 401(k)s, and tax efficient investments to taxable accounts. Investors should carefully examine their investment vehicles. If a particular strategy involves a high level of trading, generates non-qualified dividends or income payments, it may be tax inefficient and should be held in the appropriate account. There are no free lunches in the markets; proper tax planning is as close as you can get.
6. Getting caught up in relative performance: Relative performance is the measurement of one’s investment performance against a suitable benchmark. The problem is agreeing on what is suitable. Theoretically, the optimal comparison would be a blend of indexes that correspond to your portfolio’s holdings. However, investors like to use a familiar standard index, such as the S&P 500. The issue is that if your portfolio is not exclusively made up of the largest US companies and includes international equities, small companies, and fixed income, then it really doesn’t make for an apt comparison.
There is also what I like to call the “keeping up with the Joneses benchmark.” If friends from your social circles mention their stellar investment returns, it often leads to jealousy and frustration as to why your portfolio’s performance doesn’t measure up. Unfortunately, people often cherry pick information to create an appealing narrative to impress their friends. They boast about the returns of their big winners and neglect to mention all their losers. Hearing about others’ success, whether accurate or inflated, can cause emotional distress and make investors question their overall strategy.
Frankly, the only performance metric that should matter is whether you are on track to achieve your personal financial goals. Seeing your investment performance through that lens is much more relevant than the performance of an arbitrary index or the unverified claims of your friends.
7. Failure to teach your kids about money: Unfortunately, money doesn’t come with an instruction manual. If it did, there would be far fewer stories of families with generational levels of wealth who squander it all. One prominent example is the Vanderbilts, who were at one time the wealthiest family in America. Their fortune was gone within a few generations as the family spent all their money on expensive luxuries.
Ideally, an inheritance should empower future generations to create, build, and pursue their own goals. Achieving that result requires that children receive a solid fiscal education. Parents can teach their children, starting from a young age, through demonstration and being cognizant of how they speak about their finances in front of their children. Kids are very perceptive. Observing the way these conversations are handled at home will serve as the foundation for how they handle money in the future. As children enter adulthood, the focus should shift, and they should be actively included in discussions related to finances, investments, and philanthropy. Imparting the values, knowledge, and expectations of how your children should handle their inheritance is essential in cementing one’s own legacy. Over time they will form their own opinions and thoughts about how to handle their wealth responsibly.
I’ve noticed that the single characteristic that’s common to the wealthy people who succeed in business and also at managing their wealth is the ability to acknowledge what they don’t know. Taking the time to evaluate one’s limitations, and then surround oneself with the right team of tax, legal, and financial professionals, can help avoid many of the aforementioned misconceptions. This approach will help position affluent investors to better preserve the wealth that they spent their lifetime creating.
Disclaimer: This article authored by Jonathan Shenkman a financial advisor at Oppenheimer & Co. Inc. The information set forth herein has been derived from sources believed to be reliable and does not purport to be a complete analysis of market segments discussed. Opinions expressed herein are subject to change without notice. Oppenheimer & Co. Inc. does not provide legal or tax advice. Opinions expressed are not intended to be a forecast of future events, a guarantee of future results, and investment advice. Adtrax #: 3239095.1