Wealth, Actually Read online

  If you don’t have any sense of what goals you want to achieve, advisors’ well-intentioned advice can end up coming in a piecemeal and painfully uncoordinated approach. Without a good overall strategy based on your goals, it’s possible to build structures (and investment portfolios) that overcomplicate your life and create problems in the future.

  Answering the Late-Night Email

  Now that I’ve laid the groundwork for the rest of this book, let’s answer the questions asked in the late-night email from earlier:

  Frazer,

  I’ll be coming into a large sum of money soon. It’s an inheritance from my grandmother. I’ve known about this inheritance for a while, but this money is not something I relied on or even thought about. Unfortunately, my mummum recently passed away, and now this inheritance is coming. I don’t feel prepared for it. I’ve got a lot of things going on in my mind. Can I retire off this? Should I retire? How do I tell my husband? Should I tell my husband? How do I broach the subject to my kids? I don’t want them to turn into monsters. Yikes! I don’t even know what to ask or where to start. What should I do?

  My answer?

  You’ve already thought about the issues keeping you up at night, and you’ve written down those issues. That is a great start. Now is the time to sit down and read this book. It will lead you through a thought process to understand what you have and what your assets will allow you to do.

  As you go through the chapters, absorb the experiences laid out here and apply them to your family’s situation. It will help you spot the issues that can threaten your wealth and give you the tools you will need to protect and maintain your legacy. After reading this, I am confident you will be able to make a huge dent in planning for the next phase of your life.

  Chapter One

  1. Am I Rich?

  I had a client who wanted me to help his nineteen-year-old son (let’s call him Jimmy) learn about wealth. The father inherited a major sum of wealth but wasn’t sophisticated beyond his taste in cruising yachts and high-end real estate. He was also uncomfortable discussing money, probably because he knew where his expertise started and stopped. His solution to teaching his son about wealth was to have the son call me to discuss it.

  “Umm…Hey, Mr. Rice,” Jimmy said on the other end of the line.

  [Side note: It’s always nice to hear respect for one’s elders!]

  “Hi, Jimmy,” I replied. “Your father said you might be calling. How’s school?”

  “It’s pretty good,” Jimmy said. “I’m still trying to figure out my major, and with parties and so on, it’s tough to keep on top of studying.”

  [Some things never change!]

  “Understandable on all counts,” I told him. “Majors are tough to choose. Anything lined up for the summer?”

  “Not really. I have some friends who want to kick it down in St. Barts for a couple of weeks in June­­­­­ and I think my dad’s boat may be down there, which is cool, but I’d kinda like to be in Nantucket for the summer. I haven’t figured it out yet,” Jimmy said.

  “Well, both of those sound pretty good. Any job or study programs lined up?” I asked.

  “Not really. I’m just playing it by ear for the moment. I may try to do something with my dad’s company,” Jimmy said.

  [Uh-oh! I know the truth on this one: his dad doesn’t really have a company. His boating lifestyle is funded by a bunch of trusts.]

  “That doesn’t sound too bad,” I said, knowing the father would come up with something for Jimmy to do. “What’s on your mind, Jimmy?”

  “Well, Mr. Rice, my dad wanted me to call you to start to learn more about our finances,” Jimmy said.

  “Sure, Jimmy, I’m happy to help. Where would you like to start?”

  “Well…am I rich?” Jimmy said.

  My Initial Answer

  Jimmy is probably rich. He’s enjoying a lot of activities wealthy people enjoy. However, the word rich means different things to different people. This results in different types of questions:

  Do I have enough money so I don’t have to work anymore?

  Do we have enough money to have a building at Harvard named after us?

  Do my spouse and I have enough money to send the kids to private school?

  Do my kids (and my heirs) have enough in resources to get the chance to pursue the careers and lifestyles that they want?

  Can I go on that dream trip around the world with my spouse? (Or also: Can I go on that dream trip around the world without my spouse?)

  Will people remember my legacy when I’m gone?

  To determine whether you’re rich by your standards, we’ll need to do a bit more analysis.

  What Is Wealth?

  Wealth, in many ways, is just a number. But arriving at that number is no easy task. It begins with this question: How much income do you need to do what you want?

  The answer is different for each person. Some people could live happily on $50,000 a year. For others, $50,000 would be an insulting clothing budget for the month of August. So how do people calculate their number?

  Among the first questions I ask clients is what income level they’re accustomed to. I’m not asking clients how much they cost (yet), but that’s ultimately what I’m ascertaining. If you’re accustomed to $400,000 in earnings, is $400,000 a year going forward enough to support what you want to do?

  The answer to that question informs how I ascertain the amount of assets they have and whether their expectations of their future lifestyle can be supported by their asset base. Some people may be retiring after making $600,000 a year at their job but haven’t saved enough. Therefore, they don’t have the right types of saved assets to generate the $600,000 a year they’re accustomed to earning. They’re going to have to take a substantial reduction in the way they live their life, or they’re going to have to return to work to supplement what their assets are able to generate.

  By the same token, some people might have $10 million in liquid assets and have $500,000 of yearly expenses they need to pay for. In that scenario, I would look at what type of return is needed (5 percent on the $10 million, in this case) and then determine if the current asset allocation will get them to that rate of return, keeping in mind the need for wiggle room.

  In both scenarios, the income number helps to instruct how to meet the client’s spending and income needs. That’s what I call the “How Much Do You Cost” component. Again, this number is going to be different for each person. However, the analysis doesn’t stop there. To determine the type of wealth each person truly has, I need to draw the distinction between liquid and illiquid wealth.

  What Is Liquid Wealth?

  Liquid wealth is any wealth comprised of assets that can be sold or exchanged quickly, easily, and for their fair market value. At a basic level, the most liquid form of wealth is cash. It’s already “liquidated” and doesn’t need to be sold to use it. Almost anyone will exchange something of value for cash. If you want to buy a car, you can’t do that by bringing shares of Pepsi to the auto dealership. You’ll need cash in one of its various forms.

  Stocks and bonds, especially the popular, heavily traded ones, are also fairly liquid. You can normally sell them quickly and turn them into cash. There are exceptions to that, but converting the asset to cash is what I mean when I’m defining liquidity.

  What Type of Wealth Is Illiquid?

  Illiquid wealth can encompass many types of assets that are more difficult to convert into usable cash. Examples can include a house that needs to go through a selling and closing process, or a business that needs to go through a strenuous process of identifying a buyer, negotiating price and other terms, and closing the transaction.

  Private equity or hedge fund investments can also be considered illiquid, as they can require notice and lead time to be able to collect on the investment. If you’re invested in a private e
quity deal, it’s possible your wealth is inside a series of small businesses. This type of investment tends to require money to be committed for a long time—standard private equity deals last at least ten years—making it extremely painful to pull out your money if you need it in the short term, if you can at all. Therefore, that’s not a very liquid asset.

  Hedge funds don’t have the long lock-ups that private equity investments do. They tend to be invested in more liquid assets and buy and sell their assets much more rapidly in the face of changing economic conditions. However, that doesn’t mean you have ATM-like access to your funds. As people discovered in 2008 in the financial crisis, you can’t just call up a hedge fund and have them wire over your money. There is a process involved in getting your money, and it tends to involve timely notice to the firm, with payments to be arranged quarterly or yearly. There is also a holdback period while they settle their accounts to get your money to you. Finally, the hedge fund can also put up “gates” if it feels like the fund is in some sort of trouble or at risk of dealing with reckless selling in order to meet liquidity needs.

  For all those reasons and more, hedge fund assets are not the type of wealth that is readily available and liquid.

  Beyond the Balance Sheet

  By considering whether an investment is easily salable or not, one can see how a balance sheet is more complicated than the number describing the net worth. That’s why being “land rich but cash poor” is a different kind of wealth compared to having $10 million in the bank and a rented apartment.

  Lack of liquidity is the reason you can be wealthy on paper but unable to meet your needs. This issue comes to the forefront often in the wealth management industry. A common example of this would be someone who lives in a $20 million house and grew up relying on trust funds for income. He has $500,000 in the bank and a trust fund that kicks out $100,000 of income for his needs, but no income from a job or a business (and no work experience). This person is living the type of existence that has the trappings of wealth. It may look like he’s rich, but in reality, his options are limited.

  Having a $20 million house with $500,000 in the bank and no job is a different form of wealth than earning a million dollars a year from a job or business. The house could be sold to augment the $500,000 he has in the bank, but with no income, it’s still a situation that requires a different strategy than someone who makes a million dollars a year from a job or business.

  Now, that’s not to say that the person making a million dollars a year is without risk—far from it! They could lose their job, become disabled, not save enough for their retirement, and encounter other risks to their work and wealth.

  Balancing the Liquid and Illiquid

  When structuring your wealth to pay for your desired future, you need to know how much you cost, and how liquid your wealth is (or isn’t). You’ll need to make sure you haven’t skewed the characterization of your wealth too far one way or the other in terms of liquidity.

  By and large, illiquid assets are expected to increase in value more than liquid ones. (Why invest in things that you can’t sell if you don’t expect them to grow?) The downside of illiquid assets is that you’ll need to find a buyer when you’re ready to sell those assets, and the timing of the sale may not be convenient or ideal. For this reason, I believe there is value to having a certain level of liquid assets in your profile at all times.

  The balance between liquid and illiquid assets is necessary because you need cash flow to pay for life’s expenses along the way, but you need your assets to grow as the costs increase over time. And expenses not only go up, but they can also spring out of nowhere.

  Current Wealth and Legacy Wealth

  I draw a distinction between current wealth and legacy wealth. Current wealth is the wealth required for you and your family, in your lifetime, to take care of your needs. Legacy wealth is the wealth you don’t spend in your lifetime and is earmarked for your children, charities, and anything else you’d like to support when you’re no longer alive.

  Another way to think about it: retirement planning is for current wealth and estate planning is for legacy wealth. If you’re charting your current wealth, you’re charting the wealth required to retire in the way you desire. Most families emphasize liquidity in that bucket of wealth because it will be needed to cover expenses. That planning is quite different from the type of planning needed for the wealth you’re not going to spend, that you’re earmarking for your kids and your causes. Legacy wealth structures are a good bucket to hold illiquid assets because they are being tasked with growing wealth for use by future generations, not funding current cash needs.

  Putting forethought into your goals for both current and legacy wealth is important. It will help you and your advisors make good decisions about what investments are made and why, and how they fit into the broader vision for the family and its future. This enables the structuring of the investments to perform their function most efficiently.

  Another Type of Wealth: Time

  Time is another important aspect of wealth I help my clients consider. I view true wealth as having enough money to be able to do what you want, when you want, without much interference from the outside world.

  Do you need to go to work, or can you devote your time to things you care about, without having to worry about the financial ramifications of those decisions? Those questions are scalable, and their answers are unique to each person. For example, Bill Gates probably wishes he had several more billions of dollars, not because he needs it to enjoy a nicer hamburger, but because he’d like to do even more impactful things for the betterment of society.

  A person’s control of their time and circumstances can have an interesting correlation with their happiness, and it’s another aspect of considering what can be enabled by a person’s wealth.

  Health and Wealth

  The final component of wealth to consider is your health. If you have an infinite amount of resources and riches, but you’re not healthy enough to use them for your enjoyment, are you truly wealthy?

  Some of the least happy people I’ve met have substantial wealth but little ability to do anything with it due to their poor health or deteriorated relationships. They’ll likely end up going to their graves with a lot of regrets. Retirements shouldn’t be spent trying to answer what-if questions.

  If you built a business but worked so hard that you destroyed your health and relationships, and sold it with an uncertain path or purpose to your life, have you truly made a great wealth decision? This isn’t considered as often as it should be, and it’s an important part of analyzing where wealth and money fit within your life and worldview. To acquire wealth at the expense of health is a huge mistake, in my opinion.

  At What Dollar Amount Is One Considered Wealthy?

  There is no specific dollar amount that universally defines being wealthy. Many advisors think that “wealthy” is the point where you have amassed enough in assets to think less about current wealth requirements and more about legacy wealth issues. These legacy wealth issues and goals might be focused on your children’s and grandchildren’s circumstances, your philanthropy, or any other usage of your wealth beyond your lifetime. Some in the industry define “wealthy” as arriving at the point where you need to pay estate taxes.

  The estate tax was put in place as a means to raise additional funds from the wealthy as money passed from a descendent to his or her heirs. It was also established to frustrate a permanent upper class. As a rule of thumb, when you’ve crossed the threshold of wealth that requires the payment of estate taxes, you’ve got an amount of wealth that can generate a yearly cash flow that is adequate for most people’s current wealth needs.

  For example, assume the federal estate tax threshold (as of 2017) for a married couple is approximately $11.2 million. That $11.2 million could generate a yearly cash flow of $448,000 (at a 4 percent rate of return). Most people—even New Yorkers—w
ould say $448,000 would be a nice yearly income.

  For many people, the definition of wealth would require much less than $11.2 million. It’s possible that a million dollars could generate enough cash flow for a person to live on comfortably, and do everything they want to do in life.

  To put a number on what it is to be the American version of wealthy, and considered to be truly rich, would be a net worth in the range of $20 million. That number may seem pretty high to most. If that level of assets generated a 4 percent return and we exclude taxes (which I rarely do but will for this point), the family would be able to see $800,000 of income each year. That’s enough money to cover most families’ lifestyles with plenty left over for future generations. However, not all families fit this analysis. If your measure of success is being on the board of the Getty Museum in Los Angeles, then $20 million is not going to be your definition of wealthy or rich—you’ll need more than that. However, if you’re in Fort Dodge, Iowa, and you have $20 million, you probably own a big swath of town with full control of your time and access to the best resources for health, education, and leisure.

  The Source of Wealth Is Important

  How a person acquires their wealth sets the context for the situations we’ll talk about in this book, and it also frames the experience for the wealth holder. A person who grew up being a major heir of the DuPont estate, for example, may be indoctrinated in all the different societal norms associated with wealth. At the same time, you hope they’ve also been indoctrinated with some sense of where that wealth came from, and how it’s managed, and what the value of a dollar is as it relates to taking care of their costs.