There’s good and bad advice in mostly every industry. Something that successful high net worth investors know is that they need a team of advisors in their corner with specializations in many areas. You might have heard it said: more money, more problems.
As a high earner or someone that has amassed wealth, you face a number of challenges with one common issue being a constant amongst those I work with: How do I preserve my wealth? You work hard for your money and it’s heartbreaking to see wealth depleted by market loss, taxes, inflation, or other asset eating factors. There are tried and tested techniques that can be used in order to preserve wealth from a market drop or from the tax bite. Here are some of the top time-tested and most effectives techniques. I broke this article down into three sections: one about stress testing your portfolio, one regarding critically important financial planning aspects, and one section specifically for business owners and partners of firms.
STRESS TESTING YOUR PORTFOLIO
If you are a high net worth investor, it is critical that you are stress-testing your portfolios. As we say in our office, stress test to be stress less. I won’t go down to the molecular level in this article (I’ll be publishing a future article where we'll dissect the stress test procedure), but it’s important to understand how critical stress testing is to a portfolio.
Stress testing is a process in which a portfolio is analyzed and scenarios are run against the portfolio to see how they hold up during a variety of market conditions. We are officially in the longest bull-run (a period when markets go up) in the history of the stock market. Many analysts have been calling for a recession for some time, others are simply calling for a correction. If you followed the markets late last year, you probably saw the bloodbath in late 2018. Equity markets were down nearly 20%, taking portfolios with them1. We’ve since recovered from that and appear to still be strong. Bear markets (when markets go down) don’t happen “just because”, but lest we forget that gravity still exists. There will be a market correction and your portfolio needs to be allocated appropriately and ready for when the time comes.
CONSIDERING MORE THAN JUST THE INVESTMENTS
While stress testing your portfolio is important, high earners and affluent investors would be making a mistake to simply consider their investments2 and neglect all of the other aspects of their financial health. We could get deep into the philosophies of financial planning here, but I’d like for you to have a few quick takeaways from this section.
Tax Minimization Strategies: Taxes are a big problem for high earners. Too many times, people commit what I like to call “Capital Gain Sins”.
- The big one is realizing Short-Term capital gains instead of Long-Term. Any short-term capital gains are taxed at your ordinary income rate. What’s worse is that this costly mistake is often caused because their financial advisor isn’t working closely with their client’s accountant.
- Another big mistake is not utilizing tax-efficient investments. IRAs are taxed differently than Individual or Joint accounts. The types of investments matter. Rebalancing can cause high earners huge tax bills. You need intelligent management, not auto-rebalancing that a software is doing on your behalf.
- Finally, not having a proper distribution plan. Believe it or not, I’ve seen accountants make this mistake before. Taking money first from your Individual accounts and then your IRAs or Retirement Accounts isn’t always the right answer. Imagine that you have only IRA or Retirement assets left, and you need to purchase a new car. A $35,000 car is actually going to cost you more like $48,000 since you’ll need to take an additional $13,000 out of your account to pay the taxes on the $35,000 that you need for your car. Not good.
Utilizing Trusts and Insurance properly: Passing on your wealth to the next generation is a big priority for affluent families. Probate is a public process, it’s expensive, and time consuming. Then to add, the Courts get to decide who are the proper heirs. Trusts help to eliminate this. You get to set parameters on how your money is going to be used by the heirs, it avoids probate, it’s a private engagement and never makes it to public eyes. Think about some famous people that have passed and didn’t have this planned out properly – all of their business was in the news for everyone to see. Insurance is another great tool that can be used to pass on wealth tax-free, especially if you structure the ownership of the policy properly.
Managing Risk: Your wealth needs protecting. A “diversified or asset allocated” portfolio simply isn’t enough. You’ve amassed wealth that needs to continue growing but in a very specialized way that participates in growth but also helps to protect your wealth from volatile markets2.
Cashflow Management: Have you ever heard the stories about professional athletes that went broke 10 years after they retire? Proper cashflow management and use of a financial plan to project possible future net worth and cashflow will help you stay on track and make sure you never end up on the “Wall of Shame”.
Utilizing Financial Plans: Just like a successfully run company benefits from a business plan and implementation, so does a well-run portfolio benefit from a financial plan and implementation. Too often, we’ve seen great financial plans be executed improperly and cause harm to the investor.
BUSINESS OWNERS, PARTNERS AND ENTREPRENEURS
You have an office manager to run your business, but do you have a manager that’s dealing with all things that revolve around a dollar sign? Your business or partnership is a major investment and should be considered a part of your portfolio and must be included within your financial plan. As a stake-holder, your investments need to be crafted differently and specifically taking considerations around your industry. Other things you need to consider are as follows:
New Tax Law Changes: Recent tax law changes allows for massive deductions for certain business owners and partnerships. You might be eligible for a 20% deduction, and other changes include being able to depreciate your equipment 100% in the first year (or in a highly profitable year so you can reduce your taxes), as opposed to past tax code that only allowed a small depreciation at a time.
Utilizing the full features available in retirement plans like 401Ks and SEP IRAs: This is the most under-utilized tool by business owners and partners. You can reduce your taxable income by as much as $56,000 with a SEP IRA3. With 401Ks, you can put away hundreds of thousands of tax deferred assets into the plan, with those assets allocated directly to you and not other plan participants. You can even use these assets to buy yourself out when you’re ready to retire.
Liquidity event: You’re ready to cash out your chips and now you need these assets to last you for your lifetime and beyond. There is a lifestyle that you want your money to support and your investments should be crafted in a manner that supports your lifestyle and financial plan.
Disability Insurance (Pay Attention, Doctors!): This can apply to most everyone with a craft but I’ve seen this be a problem with doctors and surgeons. Most of your ability to produce an income is based on your ability to perform procedures and surgeries. If you are in an accident or have some type of injury to your hands, that can put you out of commission for quite some time, and your value to a medical practice may be diminished. You are the single most important aspect of generating an income and you need to protect yourself and your family in case the worst happens.
If this resonates with you, let us know. If you have questions about any of this stuff, give us a call. We'd be happy to chat with you about these financial planning topics and how you can help set your economic trajectory toward success. After all, it's not just your money, it's your future.
1 - www.finance.yahoo.com
2 - There are risks involved with investing, including possible loss of principal. Investments will fluctuate and may be worth more or less than when original purchased.
3 - www.irs.gov