Lessons Learned During My Forty Years as a Wealth Manager

Forty years ago, I started advising families on investing their financial wealth. Four decades have provided plenty of opportunities to make mistakes and observe others do the same. I share some below, and six lessons learned:

  1. Creating wealth and staying wealthy require different strategies.
  2. Adjust spending and goals to the level of wealth.
  3. Control emotions when markets rally or drop.
  4. Small losses are better than big ones.
  5. We can’t time when we will die.
  6. Too good to be true always is.

Creating wealth and staying wealthy require different strategies

A client, who created a lot of wealth during the technology boom of the late 1990s, had one passion: baseball. Great financial success enabled him to have the winning bid to buy a major league baseball team. Unfortunately, he did not sell or hedge his concentrated stock position. The stock’s price dropped, and he failed to raise sufficient cash to close the purchase.

Interesting insights can come from unexpected sources.  Since 1982, Forbes Magazine has published an annual list of the 400 wealthiest individuals in the U.S. After twenty years, only 15% of the original 400 were still on the list and even fewer are there today. In researching why, we discovered that all too often what got them onto the list, a leveraged concentrated investment, was the same factor that led to slowing wealth accumulation. Concentrated risk can equally create and destroy wealth; a portfolio of diversified risks maintains it.

Adjust spending and goals to wealth level

Another client started a private elementary school. A building was purchased, teachers were hired, and a curriculum was developed. The client desired to create an opulent environment for the students and teachers. Only the best furniture, rugs and curtains would do. The overspending on the facilities limited the size of the endowment to support ongoing operations. After a few years, the school had to reach out to parents for donations to avoid closing.

While having a lot of money can support a lot of spending, even the very wealthy cannot buy everything or help everyone.  I met with an entrepreneur who had just sold his frozen food company to a large consumer goods corporation and was in the process of setting up a foundation to support his charitable causes. Until the sale, he never had much liquidity. After the sale closed, he donated $100 million to his foundation, looking forward to funding a wide array of initiatives in perpetuity. He was surprised to learn that the endowment would be limited to $4 million of annual grants if he wished them to continue indefinitely. Realizing the constraints, he adjusted his expectations accordingly.

Irrespective of the level of wealth, I learned that a realistic spending plan is critical – either for a family or a foundation. Without it, near-term spending depletes the pool of assets needed to support longer-term goals. Over the past forty years, the rapidly declining cost of computer power has enabled better estimates of the probabilities of achieving multiple goals over time. In the 1990s, when developing the analytics for my patent, each portfolio simulation took 45 minutes. Now the same projection takes 45 seconds.

Control emotions when markets rally or drop.

I was five years into my first position at Morgan Guaranty Trust Company when the stock market crashed on Monday, October 19, 1987. That morning, I went to the conference room for our weekly investment committee meeting. The U.S. stock market had started to drop the previous Friday and was in a free fall by 10 am on Monday. Companies lost market value by the minute. As I entered the room, I expected to see pandemonium with portfolio managers on phones rapidly calling in sell orders. What I saw were donuts and coffee being passed around. Were these experienced portfolio managers in denial, lazy, or frozen by indecision? In listening to their discussion, I learned the importance of understanding a situation before acting. Choosing not to sell is OK if based on thoughtful analysis.

Small losses are better than big ones

From January 2007 to March 2009, Citigroup stock lost 97% of its value, dropping in price twice as fast as the overall stock market. I worked with colleagues who hesitated to sell their employer’s stock in the hope that it would recover. While the U.S. stock market regained its value four years after The Great Recession, Citi stock still has not, wiping out most of the savings of many who had worked there. Their unwillingness to take small losses as prices declined caused a material loss of wealth. The lesson learned was that any individual company’s stock can go to zero, but established equity markets do not.

We can’t time when we will die

A mistake early in my career was assuming an energetic, fifty-year-old British client had many years to enjoy life. We discussed that his U.S.- based investment account, in his individual name, could avoid estate taxes if he established an irrevocable trust – a perfectly legal strategy. As he was in good health, he saw no rush to complete the trust. I failed to push him to sign the documents and learned an important lesson when I received the news that he had passed away suddenly. The delay unnecessarily cost his estate millions in taxes.

A colleague shared the story of a U.S. client who had recently concluded an acrimonious divorce. He planned to sign his new will the following week after a short trip in his private jet. The jet crashed and he died with the new will unsigned. The existing will left all his assets to his ex-wife. Some may say that was appropriate, but it was certainly not his intention. Since we can’t time death, these stories are valuable lessons on the importance of an updated estate plan and a properly executed will.

Too good to be true always is

Over lunch at a private club in Palm Beach, I was explaining the investment capabilities of the firm I worked for to a couple of members. Halfway through I was politely stopped. “Lex, we are simply not interested. We invest with Bernie Madoff and receive a steady 10% return, each year, with no risk.”

I knew at the time that since riskless U.S. Treasuries yielded 2%, it was impossible to generate 10% returns without risk. The mistake I made was not researching Bernie’s alchemy in greater detail upon my return to the office. A few years later we all found out that it was a Ponzi scheme.

There has been no shortage of “too good to be true” products over the past forty years.

  • U.S.-based clients bought high-yielding CDs denominated in Mexican Pesos under the belief that the U.S. Dollar to Peso exchange rate would never change. That was true until the Mexican Government decided to devalue the Peso, eliminating the additional yield those U.S. investors had counted on.
  • In the early 2000s, brokers promoted auction-rate preferred securities as “just like cash” but with a higher rate of interest. That was true until no broker would redeem these securities for real cash due to credit concerns.

It may be premature, but Bitcoin has always looked to me as a product owned by many who are blinded by the opportunity for attractive returns without an appreciation for the risk. It has been promoted as “just like cash” but real cash does not fluctuate in value in the short term. Bitcoin is also not an inflation hedge “just like gold” since its value dropped when inflation returned.

Investing well requires both quantitative analysis and avoiding behavioral biases

I am a better investment advisor now than I was in 1982. I have learned that taking the time to apply quantitative techniques can help avoid unsustainable spending or investing in “too good to be true” opportunities. I also learned the importance of managing our biases, since we:

  • Gravitate to what is familiar,
  • Filter out data inconsistent with our beliefs, and
  • Are overconfident in our conclusions.

While I will likely learn from future mistakes, I hope that most are in my past.

Lex Zaharoff, CFA

Lex joined HTG in 2014. With over 40 years of experience advising wealthy families at four major private banks, Lex provides clients with a unique perspective on the art and the science of investing to achieve one’s financial goals.

As Adjunct Professor of Finance at NYU’s Stern School of Business, Lex teaches the MBA course on wealth management. He has a BSE from Princeton University and an MBA from Harvard Business School.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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