Recently, Wall Street Journal personal finance columnist Jason Zweig made this observation: Getting rich isn’t the hard part, he said. “Staying rich is the hard part.”
On the surface, staying rich might actually seem like the easy part. After all, you simply need to build a balanced portfolio then withdraw from it at a reasonable rate. Sure, there are stories about lottery winners and professional athletes going broke. But you might assume that phenomenon—of having a hard time staying rich—is limited to extreme cases like that.
In my experience, though, this is a challenge for everyone. That, I think, is because the skills and strategies required to retain wealth are different from those required to build it.
What to do? Here are some of the approaches that I’ve seen work well in retaining wealth:
Your Portfolio, Part 1. When it comes to building a portfolio, most people think first about risk. That makes sense, and I do too. But it’s important to recognize that there’s such a thing as being too conservative. You might, for example, feel that the ultimate “safe” portfolio would be one invested entirely in U.S. Treasury bonds. While that would certainly offer safety in one respect, it would also be enormously risky—because of the exposure to inflation. Consider that in just the past twenty years, the dollar has lost about a third of its purchasing power. And that’s despite inflation being historically low. Counterintuitive as it may seem, a key ingredient in maintaining wealth is to take sufficient risk.
Your Portfolio, Part 2. Back in the fall of 2008, when the financial crisis hit, Harvard University found itself in a difficult position. With a large part of its endowment tied up in illiquid private equity and hedge funds, the university faced a cash crunch. It had to lay off hundreds of employees. And to raise cash in a hurry, the school began selling investments at fire-sale prices. It was a disaster. None of us should make the same mistake. Even if it feels inefficient, maintain plenty of cash and bonds so you can weather a rainy day.
Budgeting. Mention the word “budgeting,” and a lot of people have a Pavlovian response. But if your goal is to preserve wealth, especially after you’ve stopped working, I do recommend a form of budgeting. The approach I recommend is to set annual allocations for each of three major spending categories: (1) general household expenses; (2) charitable giving; and (3) gifts to family. Then, for your household expenses, set up automated transfers from your investment account to your checking account. That will ensure that you stay on budget. Or at least, it will highlight when you go over. For charitable giving, I often recommend donor-advised funds. That’s because of their tax benefits. But they provide another benefit, which is that they make it easy to track contributions and donations on a year-to-date basis. And for gifts to family, simply complete the allotted gifts all at once, once a year. In combination, those three processes should help you stay on budget without the pain of a traditional budget.
Spending. The expression “penny wise, pound foolish” sounds elementary. But in recent decades, certain categories of expenses have dramatically exceeded others. Foremost among them: college tuition, which has risen at an egregious rate. As I’ve noted before, tuition represents the single biggest obstacle to many families’ financial security. Fortunately, it’s not mandatory to pay $80,000 per year. And there is now more data with which to make informed college choices. If you can contain big expenses like this, that might pack more punch than a lifetime penny-pinching on everything else.
Creative solutions. Economists like to talk about the twenty-dollar-bill theorem. It says that you’d never find money simply lying on the ground because someone would have already picked it up. By the same token, it may not seem worth the effort to look for ways to substantially cut your budget or increase your income. But both exist. Consider my friend—let’s call him Jim—who has two children a year apart in age. Recognizing the way the college aid formula works, Jim convinced his older child to take a gap year after high school. The result: Instead of being offset by a year, both children went through college in the same four years, yielding Jim tens of thousands of dollars of additional aid.
Taxes, Part 1. In retirement, taxes represent a double-edged sword. On the one hand, retirees have much more control over their tax rate. But on the other, it requires a fair amount of diligence on an annual basis to exercise that control. What to do? Work with your accountant or advisor—or both—to develop a tax-smart “de-cumulation” plan for annual withdrawals from your savings.
Taxes, Part 2. If you’re still working and have charitable intentions, a useful tax strategy is to front-load a donor-advised fund. Suppose your annual giving totals $5,000 per year. You could continue to give at that rate into retirement, but then the value of the tax deduction would likely fall—and might even be eliminated. Instead, you might consider making one big contribution—say, $100,000—to a donor-advised fund in your last year on the job. Then you’d get a huge deduction at a high tax rate. You could then dole that out in $5,000 increments over the course of your retirement.
Insurance. Most of us understand the importance of life and disability insurance, but it’s good to review these periodically. During the first half of your career, you might need to bump up coverage levels periodically. And in the second half, your accumulated savings might allow you to decrease coverage again. Another insurance recommendation: Secure plenty of umbrella coverage.
Plan B (and C). In making a financial plan, I always find it useful to ask what levers would be available if things didn’t go according to plan. Could you downsize or sell a second home? Liquidate a life insurance policy? Request financial aid from the bursar’s office? Secure a reverse mortgage? None of these are pleasant to think about, but I’ve found it’s easier to sleep at night after identifying these levers.