Monthly Archives: June 2016

The Liquidity Trap – Or How to Lose $4.5 Billion

Liquidity is defined in the Dictionary of Finance and Investment Terms as “the ability to buy or sell an asset quickly and in large volume without substantially affecting the asset’s price.”

In layman’s terms it means being able to get to your money quickly and without a major loss.  Liquid assets are things like checking accounts and money market funds.  They can also include mutual funds and stocks in large companies that trade on a major stock exchange, although in times of severe financial stress even these may see major price swings.

But there are lots of things people own that are not liquid.  The typical family’s home is a large part of their wealth.  Homes are not liquid; they can’t be sold quickly and converted to cash in times of need.  What a home can be sold for is a guess; something that millions of people learned when the housing bubble burst in 2008.  Families found that the value of their home was tens, even hundreds of thousands of dollars less than their mortgage.

Besides a home, many stocks are not liquid.  Shares in small companies with a few shares outstanding may not be liquid.  Even the very wealthy are finding out that the liquidity trap can turn them from billionaires to paupers in short order.  Forbes Magazine listed Elizabeth Holmes, the founder of Theranos,  as America’s richest self-made woman last year with a fortune estimated at $4.5 billion.  The most recent listing gave her net worth at zero.  The reason for this is fairly simple.  Her net worth was based on the value of one stock: Theranos.  The stock was not publicly traded and if she had tried to sell some of it the share price would have plummeted because it would show a lack of confidence in the future of the company.

So when Theranos ran into serious problems Holmes could not get out and her fortune literally disappeared into thin air.

The average person can avoid the liquidity trap by following a few simple rules.

  1. Do not put too much of your personal wealth in things – like homes – that can’t be easily sold.
  2. Do not put too much of your personal wealth in one stock. You do not want your net worth to evaporate because of poor decisions by corporate management.
  3. Smart investors spread their financial assets widely.  Realizing that they cannot accurately predict the future, they own stocks and bonds, domestic and foreign.  If they don’t have the means to diversify using individual stocks and bonds they use mutual funds or ETFs.
  4. Get an advisor. Most smart people use professionals when they need medical, legal or financial advice.

For more information, contact us.

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Keeping the Family Together With a Private Foundation

A private foundation has many advantages for the high net worth (HNW) individual. Along with the tax benefits, the foundation also provides a way of keeping families together.

Private foundations sound like they are only appropriate for the ultra-rich; but that’s not the case.  There are over 90,000 private foundations in the U.S. and 98% are under $50 million.  In fact you can start a private foundation with as little as $250,000 according to Foundation Source.

Of course the immediate advantage of a private foundation is the tax benefit you get from funding it.  It sets you apart in the world of philanthropy and allows you to leave a legacy that can outlive you.  It also provides protection from unsolicited requests for donations; you can always tell people that it’s a wonderful cause but you’ll have to check with your board.

But one of the major benefits of a family foundation is that it can act in many ways like a family business.  It can create the glue to keeps a dispersed family together working toward a common purpose.  It creates a way of instilling family values and transmitting those to a younger generation.

A large proportion of family foundations have two or more generations on the board.  Most are set up as family affairs with membership limited to immediate members of the family.

Contact us for more information.

 

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Slow and steady wins the race

Tortoise-and-the-Hare

 

We have all heard Aesop’s Fable about the race between the tortoise and the hare.  The hare, convinced that he was much faster than the tortoise, took time out for a meal and a nap.   When he woke up he realized his mistake but the tortoise crossed the finish line first.

It seems that this fable is especially true about how people grow rich when investing.   There are some spectacularly wealth people who got that way virtually over night – we have all read about them – but the vast majority of the “High Net Worth” (HNW) people –  those with at least $3 million in investable assets – did it the tortoise way.

The interesting thing about these HNW people is that they rose from the poor and the middle class; they did not inherit their wealth.

A study by Bank of America and U.S. Trust found that 77% – more than three quarters – of their clients grew their wealth slowly.  83% said that they grew rich by making small wins rather than taking large risks.  They grew their wealth by careful investing and avoiding major losses.

In our practice we have met quite a few people who managed to turn modest incomes into multi-million dollar portfolios.  We have also spoken with people who took big investment risks only to fail, and have to continue to work long after they planned to retire.

It’s up to each one of us to decide what race we wish to run.  But keep in mind that the odds favor the tortoise over the hare.  And if you have a problem with the slow-but-steady approach to wealth, get a good RIA who will guide you.

 

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