Tuesday, June 7, 2011

Lessons from the wealthy

By Dan Danford, Founder and CEO of Family Investment Center

We often hear that “the rich keep getting richer,” and that’s a common refrain in America. I usually enter this fray by noting that the “educated” keep getting richer; and that the best economic solution seems to be further education.

This is particularly true of financial education. I’ve been managing money since 1984, and I’ve noticed some important gaps in the typical family’s financial knowledge. Simply, wealthy people behave differently, and we can learn some important lessons from them:

The stock market isn’t a casino. Many middle-class people think it is. It’s true, buying a stock is risky. Buying many stocks, though, is prudent. Millionaires own stocks, but they aren’t frequent traders. When Drs. Tom Stanley and Phil Danko wrote The Millionaire Next Door (Longstreet Press, 1996), they discovered that fewer than one percent of interviewed millionaires traded stocks on a daily basis. Another one percent traded on a weekly basis. In fact, over forty percent hadn’t traded a single stock in the year prior to interview! Clearly, millionaires were investors, not gamblers.

The heart of wealth management is the idea of thoughtful diversification. This scientific basis for portfolio theory won a 1990 Nobel Prize in Economics (several, actually). In essence, risk is reduced and performance enhanced by owning a wide variety of investments. There’s a lot more to it, but that’s the basic concept.

Many so-called “safe” options collapse to genuine evaluation. Low interest rates, inflation, and taxes eat much of the gain from bank deposits or government bonds. Comfort comes at a very high price, and a bit of education about stocks and diversification can put your mind at ease.

Not all debt is bad. “Neither a borrower or lender be,” Shakespeare advised. And it’s become a sort of holy middle-class mantra. Despite that timeless advice, there are different kinds of debt, and not all debt is bad. Borrowing for consumer goods is almost always bad. Borrowing to buy a nice house in a nice neighborhood is almost always good.

Many quality advisors recommend against paying off a mortgage early, and there is solid evidence supporting this approach. Nevertheless, many middle class folks want to “pay off the house” as quickly as possible.

They think they’re doing the right thing, but money for paying down a mortgage comes from somewhere, and it’s no longer available to invest. That can be counterproductive. Our wealthy friends understand the difference between good and bad debt and they aren’t in a big hurry to pay off the mortgage.

There’s a distinction between price and value. In The Millionaire Mind (2000, Andrews-McNeel Publishing, his follow-up to The Millionaire Next Door), Dr. Tom Stanley discovered that millionaires tend to look at products on a long-term basis. They bought shoes or furniture based on the lifetime costs of ownership. Quality shoes or furniture cost more, but last much longer. Briefly, millionaires tend to focus on value instead of price.

I once worked with a fellow who proved this folly every three years. We were on the same purchase cycle with new automobiles. I’d carefully research various options, then choose my car with an eye towards resale value. He ignored this methodical approach, looking instead for the “cheapest” deal. We’d spend similar amounts when we finally reached a decision.

Three years later, I always got more money for my used car. And he never understood why. Instead, he’d launch right back into the very same pathetic cycle. Destructive buying habits are everywhere. In creating wealth, price is important, but value is more important.

Time is money. I used to be Moderator of our local church. Meetings just drove me crazy. I’d create agendas, monitor the time, and cancel unnecessary meetings. For me, a meeting is an avenue towards reaching some goal. Get together, have discussion, accomplish some objective, adjourn.

Well. It turns out that other people see church meetings in a different light. They’re social gatherings. The point of the meeting is – well, to meet. They get satisfaction from the activity, not necessarily the accomplishments.

Many people get similar satisfaction from investment chores. They drive to or telephone various banks about new rates on CDs. They study stocks, bonds, and mutual funds. They spend hours assembling, then computing annual tax information. A lot of very satisfying activity.

But, not necessarily productive activity. Who says that hours of amateur study generate better investment returns? Can a computer really replace a qualified and knowledgeable accountant? Will an extra quarter percent at the bank justify a tankful of gas or hour of time?

Do-it-yourself isn’t the best choice. “No one cares about my money as much as I do.” How many times have you heard that? It’s true, no one does care as much about your money.

But caring about your money isn’t always good enough. With rare exceptions, a good advisor knows more about your money than you do. I’ve spent a career studying financial issues and helping people manage investments. I’ve passed licensing exams and met professional credentialing standards. I have a graduate degree in business and I’ve started two successful investment companies. Modestly, I have insights and understandings my clients can’t have.

Further, caring about something isn’t always the best way to face decisions. It can be very hard to press a loved one to do a necessary, but painful, thing. We know how difficult it can be to use self-discipline – even when our own health is involved. The fact is, caring too much can be every bit as bad as caring too little.

Wealthy people hire advisors because it’s good business. It helps to have a knowledgeable, objective professional by your side. The cost is far less than the value. By definition, that’s a wise family choice. Plain and simple.

No comments:

Post a Comment