CHAPTER 1


WEALTH BUILDING
THE FIRST PEARL OF FINANCIAL WISDOM: A Woman Must Build Her Own Wealth


THE FIRST PEARL OF WISDOM we want to offer you is that a woman must build her own wealth. Traditionally, we have been raised to think that somehow, magically, our financial well-being will be taken care of by others, either by family inheritance or, more likely, by marrying a man who earns a lot of money.
It is understandable that most of us have never really considered the idea of building our own wealth; only in the last few years has it even been a realistic possibility. Women couldn't get a business loan on their own until the 1970s in America. As Ana Harvey, the assistant administrator for women's business ownership at the U.S. Small Business Administration (SBA) explains,
Congress passed the Equal Credit Opportunity Act in 1974, which, among other things, made it illegal for creditors to discriminate against anyone on the basis of race, color, religion, national origin, sex, marital status, age, or whether or not a person is receiving public assistance. Suddenly women, who had always been required to have a male cosigner, could secure loans on their own, at least in theory. In fact, women continued to face significant discrimination for a number of years.
It wasn't until 1988 and the passage of the Women's Business Ownership Act that the needs of women in business—such as access to resources and the elimination of discriminatory lending practices by banks that favored male business owners—were addressed. It was a move that Julie Weeks, the head of Womenable, a research, program, and policy-development consultancy whose mission is to improve the environment for women-owned businesses worldwide, calls "the big bang in women's entrepreneurship." According to the American Express OPEN State of Women-Owned Businesses report, in 2011 there were an estimated 8.1 million women-owned businesses in the United States, generating $1.3 trillion in revenues and employing nearly 7.7 million people.1
Here is the grain of sand that first enters our snug shell—the unfortunate reality of what happens to a woman who does not assume responsibility for building her own wealth: She develops an unspoken terror that one day she will be the little old homeless bag lady she sees on the street. A report from the Center for Progress called Straight Facts on Women and Poverty reveals that 13.8 percent of women are poor in the United States versus 11.1 percent of men. Over the age of seventy-five, 13 percent of women are poor versus 6 percent of men. This gap is bigger here than in any other developed country in the world.2 Three quarters of the women with incomes below the poverty line are single women. We say a woman "must" build her own wealth to avoid becoming an unfortunate statistic. We really must take care of ourselves!
THE GRAIN OF SAND IN THE OYSTER SHELL
Do you know a woman who …
• Works in a low-paying, service-oriented job?
• Has a great corporate job but still earns less than the men in her field?
• Has been divorced and has had to lower her standard of living?
• Has been divorced and has to pay alimony to her husband?
• Has to shoulder the entire burden of child support because of an ex-husband who won't pay?
• Has a wonderful husband who lost his job and can't find another one?
• Has a husband who became ill and can no longer work?
• Has been widowed and whose late husband left insufficient funds for her retirement years?
• Has no money saved for retirement and no idea what she will do to support herself in her old age?
• Is one of the 13 percent of American women who are poor in their old age (versus only 6 percent of men)?
If you do know any women like this—or if any of these situations apply to you—then it's a perfect opportunity to turn a grain of sand into a pearl of great price. The good news is that today, by following our first pearl of wisdom and by realizing that you must build your own wealth—for your own sake and for the sake of your family—you can avoid the heartbreak of poverty in your later years. When you have money, you have security, you have choices, and you can make plans. Whether you are a mother planning your children's education, a new wife discussing money plans with your husband, a new college graduate considering your first career, or a retiree considering helping a family member, remember that your own financial security is paramount.
How do we build our own wealth? There are many ways to go about it; below, we will cut through the bewildering number of possibilities and help you get focused on the most effective strategies.
START YOUR OWN BUSINESS
Why Investing in Your Own Company Delivers the Biggest Return by Far
Starting a business is by far the best way to build your own wealth today. When you are trying to build wealth, you need to recognize that the world still offers obstructions as well as opportunities. If you are a highly educated woman, chances are good that you have pursued a corporate career. Working for a large company may make sense in the early years, so that you can develop great experience in a field. However, in the corporate world, women are still earning seventy-seven cents on the dollar compared to men. The glass ceiling is very much alive, and the ranks of women at the most senior levels are thin. Many women leave the corporate life to start their own business precisely because they realize that they will never earn as much as their male counterparts, particularly at the senior level. They then take their excellent skills and put them to work in a small business.
Between 1997 and 2011, when the number of businesses increased in the United States by 34 percent, the number of women-owned businesses increased by 50 percent—a rate one and a half times the national average.3 When you own your own company, you have a chance to level the playing field in terms of your salary, bonus, and even preferred insurance rates. "The great equalizer for women in my mind is entrepreneurship," says Marsha Firestone, Ph.D., the founder of Women Presidents' Organization (WPO), a nonprofit membership organization for women who serve as presidents of multimillion-dollar companies.
Today, two out of every three new businesses are started by women.4 "Many [women business owners] come from the corporate world, where they've hit the glass ceiling or the level of flexibility they seek is not available. They know they can do just as well—or better—on their own, and so they go into business for themselves," explains Ana Harvey of the U.S. SBA.
Although the prevailing view is that women are running mom-and-pop-style operations, Marsha Firestone says research shows that "the fastest-growing segment of women-led companies are those that have more than a million dollars in annual revenue."
The World Wealth Report, published each year by Merrill Lynch and Capgemini, reveals that the majority of all global wealth is created by family-owned businesses. Business-owner data also reveals the potential for greater earnings for business owners rather than employees. In the top 25 percent of earners, entrepreneurs make more money than those who work for employers. The average small-business-owning family earned $185,350 in 2007, compared to $64,207 earned by non-business-owning households.5
If owning your own business becomes your sole vocation, you'll be able to set your work schedule and get excellent tax breaks. If it's a secondary interest, you will gain more financial security in the new freelance economy. This is the era when your business vision can come true at any age, and there's a lot to consider when starting your own business. As Oprah Winfrey says on her website, "What I know for sure is that if you want success, you can't make success your goal … the key is not to worry about being successful; but to instead work toward being significant—and the success will naturally follow."
We realize there are many excellent resources available to help women start businesses. In this section, we want to dispel some of the myths surrounding this path to wealth building and help you focus on the most important things to know before you get started.
To Succeed in Your Own Business, Start with a Good Idea
We want to dispute the widely held belief that you must only start a business that reflects your deepest passion. Although that would be ideal, this daunting preconception can stop you from pursuing the best way to build your wealth. According to Marsha Firestone, the single most important characteristic of the women who have created businesses that earn more than $1 million per year is that they focus on some type of innovation. That means that the idea for your own business might be found in something simple—improving the way you do an everyday task, inventing a better version of an existing product, or coming up with a less expensive way to deliver a product to market, thereby drastically reducing costs. There are also many success stories of women who started a business based on a beloved hobby like working with pets or gardening.
Understand the Limitations of a Service Business
Many people decide to start a business based on providing a service. If the service is something that is provided by you, the growth of your business will be limited by the number of hours in your day. A good example of this is a massage therapist who works at a gym and decides to leave the gym to take only private clients. The growth of her business will be limited to the number of hours in a day in which she can give massages. Service businesses do not have property, manufacturing plants, or equipment, which means that they do not have assets that could be used as collateral for a business loan. Eventually, in order to expand a service business beyond what you can personally do, you will have to hire employees who do what you do, and these employees may or may not be able to provide the same level of excellence you provide in giving the service.
On the other hand, people who are excellent at providing a service can translate this excellence into a products-based business. For example, a Pilates instructor can consider writing a book on Pilates, creating DVDs to sell, and marketing a line of clothing to wear during Pilates classes.
Products do not require you to personally interact with each potential customer. You write a book once, and it can be read by millions, for example. You can standardize excellence much more easily in a product than in a service. Many products take equipment to produce, and these assets can be financed through business loans. There are tax incentives and subsidies available from the federal and state governments to businesses that hire employees. In the long run, a products-based business generally provides you with more personal flexibility than a service-based business. As your business becomes more successful, you can hire others to run it while you sit back and enjoy the benefits of ownership.
Start Your Business in Twenty-four Hours
If you're feeling overwhelmed by the task of starting your own business, don't be. Getting started now takes only a few strokes of the keyboard, thanks to technology. Jane Applegate, America's leading small-business expert and the author of 201 Great Ideas for Your Small Business, declares to reluctant entrepreneurs: "Only in America can you wake up in the morning with a great idea and start a business by nightfall. Anyone can do it in a day. It really is the American dream." You used to need between ten thousand and twenty thousand dollars to set up a business. Now you can accomplish it with less than five thousand dollars, and do most of the work on your computer.
SMALL BUSINESS TIPS
These helpful tips come from author and small-business management expert Jane Applegate.
• Set up your preferred business structure—a corporation, partnership, or limited liability company (LLC)—and register it with your city, county, or state online through websites like Rocket Lawyer or LegalZoom.
• Open a business bank account online.
• Surf your way to a Web domain registration site (examples include Go Daddy and Network Solutions) and register a name for your website.
• Set up Web hosting, fill in a design template, and have a website online before bedtime.
• Hire outsourced talent to service your business from sites like ELance.com. They handle all the tax forms and arrange payments between you and your freelancers or employees.
• If you need marketing help, go to a website like growyourbusinessnetwork.com.
• Set up a cloud-based telephone system on RingCentral.com, or go to Google Voice and set up a "follow me" phone number.
• Take a step into social media for your new business by setting up a Facebook fan page, a Twitter account, and a LinkedIn page.
• Order your promotional materials on sites like 4over4.com, Zazzle.com, and 1800postcards.com.
• Finally, before you rest your head on your pillow, you can announce your new venture through PR Newswire or EnFlyer.com.
Do Your Research and Write a Business Plan
The most important investment you can make is taking the time to write a business plan. It is absolutely critical to figure out if there is a market for your business idea and to figure out how much money it will cost to get started. There are a number of great online resources and software programs you can purchase to help you write a business plan. You must get very clear on the costs of running your own business and understand how you will pay for these costs. The high failure rate of new businesses can be overcome by smart planning. If you are new to working with numbers, hire a good accountant to help you develop a business plan, and bounce your ideas off people with experience in the field you want to enter if you are not highly experienced. Take advantage of the wisdom of retired executives available through SCORE (www.score.org), which provides free small-business training and mentoring. The more research you do in advance, the more likely your business is to thrive.
Be Able to Cover Your Living Expenses Before Quitting Your Day Job
There are conflicting ideas on how much money you need to set aside when leaving a job to start your own business. Conservatively, you need to have two to three years of living expenses put aside—because that's how long it's going to take for a new business to start generating cash. It's always a good idea to keep your day job as long as possible. Use your spare time to write your business plan and source materials, and when you absolutely can't move forward unless you quit your job, then it's time take the plunge.
Fund Your New Business Sensibly
You can fund your new business from savings or by obtaining financing. Often, the cash used to start a business comes from an unexpected source. For example, some women have launched businesses by using a divorce settlement or a lump-sum payment received after they have been laid off. If you intend to fund your business from savings, you should fund it from personal savings, not your 401(k) plan. You can withdraw funds from your 401(k), but this is a very unwise thing to do. First, if you are younger than fifty-nine and a half, you must pay a withdrawal penalty and taxes, which means that you are receiving only forty cents of every dollar you have put away. Second, you are potentially devastating your retirement. Your business may or may not work, but you will certainly grow older and need those funds in the future, regardless of how the business does.
Although it may be tempting, also avoid using the excess value in your home as collateral for a home-equity loan to start your business. If the business does not take off, you may not be able to cover the second mortgage payments and may, tragically, lose your home as well as your new company. If you do not have enough personal savings to fund a new business, and many people don't, then you will need to look for financing.
• Borrow against your 401(k): To finance your start-up costs, you might consider borrowing against your 401(k), but this can happen only while you are still employed and working on your new business on the side; once you leave your corporate job, you must repay the loan, so this is a very short-term solution.
• Check out SBA programs: You can investigate loan-guarantee programs available from the Small Business Administration, which has many good options for women looking to start their own businesses. The SBA does not make loans but does provide loan guarantees to encourage banks to lend money to you. Again, you are more likely to get funds for a product-based business—one that has equipment, a plant, or property that can be used as collateral for a loan. It is much more difficult to get a loan for a service business, and almost impossible to get a bank loan for a service business without years of demonstrated cash flow from multiple clients.
• Don't place high hopes on the banks unless you have other collateral: It is extremely rare for banks to give noncollateralized loans to start up a business. The bank may give you a loan if you have other assets to pledge, such as a personal portfolio of securities. It may make sense to pledge a personal securities portfolio in order to get the funds to start your company; your securities can continue to grow while you launch your business. In this case, negotiate for long repayment terms, or an interest-only loan, to give yourself two or three years before you have to start repayment. Make sure the securities are conservatively invested so that you don't face a margin call if the markets go through a bad period. (A margin call means that the value of your collateral has fallen and the bank wants to sell the securities to pay back the loan.)
• Take a personal loan from friends and family: Many people turn to friends and family for personal loans to start a business. In this case, share your business plan, draw up a promissory note, and make sure family members have reasonable expectations of when you can repay the loan. Offer to pay interest and take out a life-insurance policy that would repay your family member should you die unexpectedly. These policies are usually very inexpensive if the benefit amounts are small.
• Take a part-time job or a second job: You may find it necessary in the beginning to take a part-time job or a second job to fund your living expenses while working on your business. This is not as bad as it seems—as long as you can cover your overhead, you can give your business the extra time it needs to become self-supporting.
• Live on your partner's salary while starting the business: If you are in a relationship, you may be able to join forces with your partner to support you and your family while you are starting your business. This can be an exciting family decision, and if the business takes off, your partner may be able to quit the nine-to-five routine and join you in working on the business. It is critical to share the business plan with your partner and to have regular financial meetings so he or she understands the progress you're making and setbacks you may be experiencing.
• Max out your credit cards as a last resort: Some famous businesses were started by maxing out credit cards; this is a much less likely scenario today due to tighter credit standards and smaller credit lines.
Beware the Dangers of Angel Investors and Venture Capital
If you have a terrific idea, you may be able to attract the attention of angel investors or venture capitalists. These are individuals who are looking to invest their capital in start-up businesses. Although this route may be appealing, angels can be distinctly devilish to new business owners.
First of all, angels and VCs expect you to give up a huge percentage of the equity in your business in exchange for their funds. Often, you end up owning less than 20 percent of your own company if you seek funding from these sources.
Also, angels and VCs want a quick, high return on their investment. They often want to see growth rates of 30 percent per year or more. This may be anathema to your idea—they may force you to sacrifice quality in order to obtain steep growth rates, as opposed to letting the business grow more organically.
In addition, these investors want an "exit strategy." They want to sell the company and realize a high return on their funds. You may want to create a business that could stay in your family for generations—therefore, you may have a very different time frame in mind. Make sure you agree with the strategy that the VCs or angels envision before you sign up.
Flexible Hours Do Not Exist
Women have been in search of flexible hours for decades in an effort to balance their personal lives and professional lives. However, do not start a business if you think it will mean having all kinds of glorious flextime. Running your own business only means that you now control your hours, not your boss. Let us be clear: If you want to succeed, you must not sacrifice work hours in favor of outside activities. Author and business expert Jane Applegate says, "There's certainly advantages to being self-employed, including lots of personal flexibility, but you'll definitely be working twice as many hours overall."
Choose a Legal Entity for Your Business
There are several different choices available when it comes to choosing a legal entity for your business. We strongly urge you to consult with a good business lawyer to discuss the pros and cons of each. In general, if you are going to be the sole owner of a small company, you might want to start as a single-member limited liability company, or LLC. This type of entity provides you with legal protection in case you are sued, but it taxes your income only once. By contrast, if you set up a corporation, the company pays taxes—usually quarterly—and then you pay taxes again on money the company distributes to you as a dividend. This often doesn't make sense for small companies. You may find that you wish to set up your LLC in a state other than the state in which you live. Many LLCs are registered in Delaware, for example, because Delaware has favorable LLC laws.
If you are starting a business with one or more partners, you should compare the advantages of an LLC to a partnership or an S corporation. A good business lawyer can help you make the choice. And it is critical that you have a very thorough legal agreement with your partner or partners before the business starts, so that you agree on how to split profits, make decisions, and most important, how to dissolve the partnership if things don't work out.
TAX BENEFITS AND BURDENS
When you are launching your business, it's absolutely imperative that you are aware of your tax benefits and burdens and keep on top of them. To understand the tax issues better, we consulted with Barbara Taibi, a director in the Personal Wealth Advisors Group of EisnerAmper LLP, a New York–based tax and consulting group. She has more than twenty years of public accounting experience and more than fifteen years of experience in income tax planning and tax return preparation. Barbara explains, "I see a lot of women and men in businesses that could have worked, but then they always say, ‘I can't stand all of these tax rules and additional forms; I can't deal with this and I don't want to do it anymore.' Unfortunately, it is some of these additional forms that have the worst penalties for noncompliance. If they had assigned this responsibility to someone else, it might have been different."
With Barbara's expertise, we have laid out key tax and planning measures for you to pursue with the assistance of an accountant that will make you rich and keep you happy.
Take Advantage of Greater Business Expenses
When you are a salaried employee, there are very few expenses that you can deduct to lower your tax burden due to limitations on deductible amounts. One of the great benefits to owning your own business is the ability to offset a large number of your expenses against your business income, thereby lowering your taxable income. It is absolutely key to keep excellent expense records now that you are no longer a salaried employee.
Time Your Income
When you are a self-employed person, you have some flexibility on how much income to declare each year for tax purposes. Income, for tax purposes, is defined as business revenue (which is generally sales of goods or services) minus business expenses. By timing your cash receipts and the payment of expenses, you may be able to take advantage of the graduated tax rates and fall into a lower tax bracket. It is crucial that you work with a good accountant to take advantage of all the ways you can time income, expenses, and depreciation on plant and equipment.
Choose to Account for Your Business on a Cash or Accrual Basis
There are two ways to legally account for your income as a business owner: a cash basis or an accrual basis. A cash basis means that the income and expenses are declared when they are received or made; an accrual basis means that income is declared as the service is given. For example, a spa may sell a series of five facials at one time for a discounted price. On a cash basis, the income would be declared when the five facials are purchased. On an accrual basis, the income would be declared as each facial is given over the entire year. As a cash-basis business owner, you can manage your cash flow by managing how you make purchases and pay company expenses. For example, if you pay expenses on a corporate credit card, you can declare those expenses in the year that you purchased the items on your card, even if you pay back those card balances in the following year. This would allow you to lower your income for tax purposes while preserving your cash.
Take Advantage of the Home Office Tax Deduction
If you are starting your business in your home rather than renting an office, your home office can create a significant tax deduction. Your home office space must pass two important tests. It must be used exclusively for the office and no other activities, and it must be your principal place of business. Many people convert their garage for this purpose. A legitimate home office allows you to deduct the percentage of your housing expenses equal to the percentage of the home used as the office. For example, if you are using 30 percent of your total home space as an office, you can deduct 30 percent of the costs of your home as business expenses, including depreciation on the house, rental payments, electricity, mortgage interest, utilities, and even repairs. Make sure to keep scrupulous records, as the IRS loves to audit for home-office expenses. It is never a good idea to deduct a significant percentage of your home as a home-office expense—the IRS will insist that you document this and may visit to verify that you are not exaggerating the square footage used for the business. The exception here may be a small apartment, but then it is hard to declare that the space is being used "exclusively" for the business.
Use the Health Insurance Deduction
If you're self-employed, you can deduct 100 percent of the health insurance premiums you pay for yourself, for your spouse, and for your children. If you are a sole proprietor without employees, you may be able to get more reasonably priced health insurance through the Freelancers Union, which operates in most states.
Take Advantage of a SEP
When you're self-employed, you have some interesting opportunities to plan your retirement by creating a Simplified Employee Pension, also known as a SEP. Contributions to a SEP are tax deductible and your business pays no taxes on the earnings of the investments. You are not locked into making contributions every year; each year, you can decide whether, and how much, to contribute to the SEP. There are no filing requirements with the government for your SEP. There are a number of specialized rules that need to be followed, so it is best to discuss a SEP with your accountant or financial advisor.
Catch Up on Retirement Savings with a Defined Benefit Plan
A qualified defined benefit pension is the traditional pension plan in which the employer bears the risk of providing the promised level of retirement benefits to participants. The defined benefit plan limit is based on the benefit to be received at retirement, not on the annual contribution. Each year the plan's actuary determines the required annual contribution based on several factors, such as age, salary level, and years of service, as well as interest rate assumptions. The maximum annual benefit for which a plan may fund is the lesser of 100 percent of the participant's compensation up to $195,000 (indexed for 2010). For participants closer to retirement, contributions to a defined benefit plan may exceed the 100 percent, or forty-nine-thousand-dollar, limit imposed by defined contribution plans. This may be advantageous if you are a business owner who is approaching retirement age, has never started a retirement plan, and wishes to put away as much money as quickly as possible. Keep in mind the administration of this plan is more expensive and complex than a 401(k) or a SEP, and that you should consult a pension benefits expert to see what is right for your company.6
Deduct the Interest Expense of Borrowing Money
You may be taking on debt to purchase equipment or grow the company. The interest expense is a business deduction to you, and that could be a fairly significant number. By contrast, the only interest expense you can deduct without a business is your home mortgage interest and investment interest on money borrowed to buy investment property (i.e., a margin loan).
Choose the Right State for Your Business
"Residency issues are a huge deal," says EisnerAmper accountant Barbara Taibi. "We're seeing a lot of business planning and a lot of retirement planning based on how the state treats business income or how the state treats you as the owner because eventually this is all flowing to you anyway."
When you set up a new business, it's critical to look at states that are friendly to small businesses and have fewer filing requirements. For example, Florida, Texas, and Nevada have no state income tax. If you're an Internet-based business and you don't need to live in a high tax bracket state, consider moving to a tax-friendly environment. Since state regulations are constantly changing, consult Internet resources like the Small Business Council's ranking of best and worst states for small businesses. Keep in mind that taxes are only one aspect to consider when launching your small business; a trained workforce and your own preferred lifestyle may cause you to trade off taxes for other factors.
Tax Burdens
Many entrepreneurs throw in the towel too early because they never figure out how to work the system. When you are successful in a corporation, you have applied yourself to navigating the company and engaging with departments to make your life easier and your work more effective. Use these skills and apply them to your own business. Whenever possible, your efforts should be focused on growing the business and not on paperwork. Here we're going to outline the headaches of the self-employed and the solutions that work for the experts.
Outsource the Administration of Payroll and Payroll Taxes
One of the burdens of owning your own business is payroll. Bottom line: Payroll tax is a nightmare, and there is no difference between having one part-time employee and five thousand full-time employees when it comes to dealing with the IRS. You have the same payroll reporting requirements, and they're very strict. They're voluminous both on the state level and federal level. One of your best investments is to hire a payroll company, such as ADP or Paychex, to handle payroll for you. Alternatively, consider using a service like Elance, which offers a virtual workforce and handles virtual employee paychecks through an escrow account for you. These options are inexpensive and eliminate the time-consuming payroll issues that distract you when you'd rather be growing your business.
Outsource Bookkeeping
Bookkeeping is extremely frustrating and overwhelming for the new business owner. For women who are fastidious about the bills, it is easy to get bogged down in accounting and have little time left to concentrate on growing the business. On the other side of the curve, many new business owners don't even attempt to keep track of the books until they come to the end of their first year and need to file their taxes. They are then left with the gargantuan task of re-creating the previous year.
Get a bookkeeper who has Quicken skills, and keep your books up to date. Alternatively, buy the Quicken software, set it up under the direction of your accountant, and commit to spending an hour each week inputting data on your business schedule.
Make Estimated Tax Payments
When you are an employee, tax is automatically withheld from your paycheck, leaving you with very little to worry about. As a self-employed individual, however, it is critical to file estimated tax payments every quarter. It is much easier to come up with quarterly payments than to be hit with a large amount of unexpected cost on April 15 each year. If you do run into trouble, however, the IRS will often be willing to accept a payment plan that allows you to pay off taxes over time. Keep in mind they may only do this if you make a good faith effort to pay estimated taxes going forward.
Keep a Separate Checking Account for the Business
It is critical to apply for a separate tax ID number for your business and to set up a separate checking account in the name of your business. You must keep all business expenses separate from personal expenses. Ideally, take a lump sum and transfer it to your personal checking each month for your personal use.
Understand the Tax Payments Due for a Partnership or S Corporation
Sometimes owners are unaware that if the business is a partnership or an S corporation, you pay tax on the income that's earned every year versus the cash distributed to you. This may present a challenge to find the cash to pay taxes if there has been no distribution. On the positive side, if you've built up accumulated income and paid taxes, those distributions are tax free when they finally come to you.
CHOOSE A FEMALE INVESTMENT ADVISER
Even if you don't elect to start your own business, you may be accumulating money through the investments in your 401(k) plan at work, a rollover IRA if you have changed jobs, or a personal portfolio of liquid assets that you have either earned, received in a divorce settlement, or inherited. You will need to decide how to invest these assets. Although some studies have shown that we women don't particularly like to talk about investing or spend time thinking about the subject, we, as a group, are starting to accumulate a good deal of financial wealth. In fact, according to data released by the IRS, nearly 1.2 million women in the United States have more than $1.5 million in assets, and these numbers are growing.7 The good news is that we women are actually very good at investing money. You have every reason to feel confident that you can take charge of your own investments.
You may be surprised to learn that one strategy for increasing your odds of building real wealth is to choose a female investment adviser to work with you. Although men dominate the ranks of financial professionals, and for that reason you may think a man can better help you manage your assets, consider the research findings in this section before you make a decision. There are several important characteristics you need in a good financial adviser: great skill at investing, a good ability to carefully manage risk, and the discipline to avoid too much trading, which—because investors are taxed on a per-trade basis—tends to erode your fortune. Women investors have been exhibiting great strength in the above areas, which means you may have a better ally in a female investment adviser than you would in a male adviser. In addition, there is a less numbers-driven reason to consider a female investment adviser: Women tend to adopt a holistic view of their money, and a female adviser will understand that your money constitutes just one part of your very full life.
Female Hedge Fund Managers Earn Better Returns than Male Managers
In 2009, the National Council for Research on Women published a comprehensive report, Women in Fund Management, which takes a look at how female fund managers performed versus their male counterparts during the financial crisis of 2008, among other issues. We highly recommend that you read this report, which is available for free on the Internet. The report was spearheaded by Jacki Zehner, who was the first female trader to be made a partner at Goldman Sachs and who is now a top philanthropist and advocate for women in finance. The report highlights the fact that women hedge fund managers performed better during the financial crisis. "We focused on data from hedge fund managers because they are unconstrained in their trading," Jacki notes.
For the study, Hedge Fund Research, Inc. (HFRI), a company that tracks statistics about hedge funds, created a composite index of twenty-two female-owned hedge funds and compared their returns to those of the broader HFRI Fund Weighted Composite Index, which tracks more than two thousand individual hedge funds. The data is quite startling. The report looks at the fact that female managers outperformed male managers significantly during 2008. The women-manager index was down 5.41 percent that year, whereas the hedge fund composite index was down 19.03 percent during the same period.
This was not a fluke; during the period between January of 2000 and May of 2009, the female-managed funds had an annualized return of 9.06 percent, versus only 5.81 percent for the composite index. The female-managed funds had more consistent returns as well; the standard deviation was half that of the male-managed funds. The biggest one time loss in a month, called the maximum drawdown in hedge fund speak, was -10.86 percent for the female-managed funds but a whopping -21.42 percent for the composite index. This led the female-managed funds to generate a much higher Sharpe ratio, or return per amount of risk taken—1.06 versus 0.43 for the composite index. In plain terms, the female-led funds vastly outperformed the composite index by every measure of professional money management!8
Men Are Driven by Testosterone to Trade
One of the foremost reasons women did better in the fund-management study is that women are more cautious than men about overtrading. Experiments by scientists in the U.K., published in 2007 by the University of Cambridge, show that when men trade and their trading produces positive results, they experience a surge of testosterone, which feels good and leads them to trade even more. This testosterone surge leads to competition with other male traders for dominance as well as excessive risk taking. Women are not affected in the same way by testosterone, so we don't tend to overreact and overtrade.9
A study conducted in 2001 by Brad M. Barber of the University of California–Davis and Terrance Odean of the University of California–Berkeley, titled Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment, analyzed the investment behavior of more than thirty-five thousand households. All else being equal, men traded stocks nearly 50 percent more often than women. This added trading drove up men's costs and lowered their returns. This tendency was observed again in a 2010 survey conducted by Vanguard Investments. Of the 2.7 million people with IRAs at the company, 10 percent more men than women abandoned their investments at the low point of the 2008–2009 financial crisis, which means they missed the rally that followed.10
Women Make Fewer Investment Mistakes
A 2005 report by Merrill Lynch surveyed five hundred men and five hundred women on their experience with investing. All investors had investable assets of at least seventy-five thousand dollars. According to the report, "while all investors make mistakes, women make fewer mistakes than men." Women are far less likely to hold an investment too long (35 percent of women versus 47 percent of men) or wait too long to sell a winning investment (28 percent of women versus 43 percent of men). Men were also more likely than women to allocate too much to one investment (32 percent of men versus 23 percent of women), buy a hot investment without doing any research (24 percent versus 13 percent), and trade securities too often (12 percent versus 5 percent). More troubling, the men were much more likely to repeat the same mistakes and not learn from their experiences.11
In addition, a 2005 study at the University of Cologne, which studied U.S. mutual funds run by female and male portfolio managers from 1994 to 2005, found that the female managers took fewer risks, had more consistent investment styles, and avoided overtrading when compared to the male managers. These are exactly the types of characteristics women want from their managers and advisers, and are the types of characteristics that allow portfolios to survive in times of financial turmoil.12
Women Excel at Complex Investment Decision Making
One of the salient facts about today's investment world is that investment products are getting more complicated. Performing intricate and unemotional analysis is something that women excel at, given what many studies have identified as our superior ability to handle detail and to revise our initial hypothesis. As noted in the fund-management report, "Women … tend to take into account more decision-making detail. They consider information that does not confirm their initial decision, where men tend to ignore this new information … therefore women's decisions tend to be better when complexity increases, whereas men's outcomes tend to be less positive as the complexity increases."13
We see this in the HFRI fund data, which show that men had much more volatile performance and much higher one-time monthly losses, to a maximum of 21 percent per month. Women's maximum loss was 10 percent per month, less than half. This means if women saw that a trade was going against them, they were willing to admit their mistakes and sell the holding rather than hang on, adhering to their initial reason for buying and incurring bigger losses, as the men did.
Women Look at Investing Differently
We have found that women adopt a holistic view when it comes to money. We women look at money in terms of how we are going to use it for ourselves and our families, and a female investment adviser tends to understand this motivation. A woman will think twice about making a risky investment, since she is considering the ultimate use of her funds—whether for retirement or as a legacy for her children. She is much less likely to make a decision without considering all the ramifications. Jacki Zehner, who worked closely with some of the top men on Wall Street, has chosen to work with a female investment adviser for her own funds. She says, "There are huge reasons why I choose to use a female investment manager, including all of the issues around risk taking. In general, women have a different sort of attitude around money, in that money is a means to an end rather than an end in itself. Women tend to think of money and say, ‘My goal is not to have a lot of money; my goal is to have a great life.'"
When you consider all the evidence above, you have to conclude that women certainly possess better investment skills than many people realize. Of course, sex is not the only criterion you should examine when choosing an adviser, and there are vast differences in the quality of female advisers just as there are in the quality of male advisers. But perhaps now you are convinced that being female gives you an advantage as you approach investing, and it might be an advantage in the adviser you select as well.
BUY A VACATION HOME
In the United States, most people buy their primary residences first and invest in a vacation home later. In this new economy, however, it is time to take a second look at this conventional approach. There are some amazing opportunities out there: a vacation home can pay for itself, provide secondary income, and become an oasis for your future retirement.
Cora Bett Thomas is the founder and CEO of Cora Bett Thomas Realty and a member of the Who's Who in Luxury Real Estate. Her business covers an area that runs all the way from the South Carolina Low Country to the Florida border. Thomas brokered the sale of the 2,300-acre luxury waterfront community Hampton Island in 2003: it was one of the largest East Coast land deals on record. With a thirty-plus-year history in the business, Bett agrees that renting your primary residence while buying a vacation home works to enhance your quality of life as well as your personal wealth.
She also notes that buying a vacation home is a growing trend among women.
I have been in the real estate business since 1975. Each and every year, I've noted women taking charge of the investments for their families as well as investing wisely with long-term goals in mind. The woman who travels is often more versed in the advantage of second-home investments and will act on her knowledge and thus reap great rewards later in time. Her choices are made with two main factors in mind: those factors are the potential for appreciation plus an opportunity to experience firsthand the community and make a better decision as to the appropriateness of the community for her family retirement later on. Is it the right fit? That is wise thinking and planning. Climate, lifestyle, community involvement, and of course, resale value (appreciation) are all considerations. After all, you make your money when you purchase.
Thomas adds,
Women should listen closely to their intuition when shopping for a vacation home—or any property, for that matter. Women have an advantage; it's often called a gut instinct. It speaks to them the moment they step inside a property. Additionally, women are in touch with their feelings and emotions, therefore better understanding that intuitive message being sent to them. I find the most evidence of that kicking in when it comes to the reaction to location—the key to real estate!
Listen to your intuition, review the facts, and take it all into account.
Why Your Great Escape Is a Wonderful Nest Egg
Imagine owning a dream beach house off the coast of Santa Barbara or in the Hamptons, a ski home in Vail or a lake house in Vermont. It is managed by a professional management company (not you) while the property shelters your income and earns a few extra thousand dollars a year. While you're paying down the mortgage, the property is appreciating (adding value to your portfolio). Long after the mortgage is paid, it continues to pay you by continuing to appreciate. Think of the pleasure you'll experience visiting this beautiful location each year with friends and family.
For example, a woman of our acquaintance bought a small, furnished one-bedroom condo on the beach in Dauphin, Alabama, for $183,000 in 2004. She put 20 percent down and worked with a local bank to arrange the mortgage. The mortgage payment was $909 per month. The insurance was $900 per year and the condo-association fee was $176 per month, which also included hurricane insurance. During the peak season between May and August, our friend was able to rent out the property for $2,000 per week. In the off-season, she was able to rent it out at a lower price. She used a management company to arrange all the bookings, feature the house on its website, and maintain the property. For its services, the management company charged a fee of 20 percent of the monthly rent. Our friend's real estate play, which fed both her financial and emotional needs, carried a fairly low risk because of her careful planning.
Paying rent on your main residence may also save you thousands of dollars in the long term, particularly if you are likely to experience multiple relocations. According to the 2010 Census, the average American moves 11.7 times in his or her lifetime. If you are continually selling and buying your main residence as you relocate over and over again, you put yourself at risk of losing money, especially in an unstable economy. Renting your primary residence can sometimes save you money, particularly if you are likely to experience multiple primary-residence relocations. "When you're moving from one place to another, you may take a twenty percent hit on selling your own home, and you may have to pay a lot more for the next place you're going to, even if it's offered at a distressed price," explains Thomas. Purchase a property that you keep in your investment portfolio for long-term appreciation. If you are subject to moving frequently, this plan allows you to invest in your retirement home and have it paid in full when the time arrives.
Mortgages
You have two ways to finance the purchase of your vacation home. The most common way is to use a mortgage lender and borrow against the value of the property. You will most likely find that a lender in the area will give you the best loan because they are in the best position to get you a fair appraisal on the value of the house. It's essential to go after a fixed-rate mortgage while interest rates are at historic lows, even if an adjustable-rate mortgage initially looks enticing. You want to stay in charge of your payments and not suddenly find yourself at the mercy of the local bank.
Alternatively, if you have a large portfolio of personal securities, you could take a secured loan against that portfolio rather than a loan against the house. However, you may not be able to enjoy as large a tax deduction if you take this route. The total interest that you can deduct for up to two mortgages is $1.1 million: the interest you can deduct on a secured personal loan is limited to the total interest you earn on that portfolio, which is usually less than $1.1 million.
Factors to Consider
Among the most important factors to consider when buying your vacation home are the location, the condition of the property, and the price you can charge for the property as a rental. "At the end of the day, what's on the ocean is going to rent for more money than what's on the next block," explains Thomas. "Your goal should be to buy the best property you can in the best neighborhood you can afford."
It's also critical to research the best property managers in the location, understand their fee structure, and make sure they will manage the property properly and maintain it well. When you're busy in another location, your management company is the only one that's taking care of the home, and you don't want your vacancy rate to suddenly increase because of a disgruntled renter's bad review online.
When buying a property, make sure you do additional research on top of what the broker shares with you. Look at what people have said on the Internet about the property, or ask local residents. A number of things can be deceiving to a buyer who doesn't check independently. For example, a broker may position a property as being "within walking distance" of a beach when it's actually a six-block walk to the beach—farther than is comfortable for some people.
When you are shopping for a vacation home, you can put yourself in a particularly strong financial position if the property can serve as a year-round rental as well as a seasonal vacation residence. If the vacation-rental market crashes, it's still a desirable place to rent full-time. An example would be a rental property that is both near the ocean and near a college town, which would have a steady supply of student renters. You will get a higher rental income and you will have a better chance of selling the property, whatever the economic environment is.
Other factors to consider include
• Insurance costs: Vacation rentals are one of the places insurance companies are redlining. Shop for your insurance carefully and choose a company that will stand by you in an emergency. Review the insurance protection against hurricanes and flooding.
• Green is not necessarily better: Although green living is a growing trend in primary residences, it may not make you any "greener" (i.e., richer) when it comes to your rental property. Cora Bett has found that people go for convenience rather than environmental responsibility when they're choosing a vacation spot, especially if they have children.
• Beware of foreclosures: If you buy a foreclosed property, know that you may not be able to resell it. Avoid foreclosed properties in heavily foreclosed areas. Buy your foreclosure in a neighborhood where, no matter what, the property will resell because the neighborhood is strong.
• Beware of new subdivisions: According to Cora Bett, people who buy in brand-new subdivisions usually want to sell in five years. One of the reasons for this is that, as a landlord, you may be competing for tenants against another new local development with even better amenities.
• Put together a great team: Enlist the help of trusted professionals, including an insurance broker, a financial adviser, a CPA, and a tax attorney. You may also want to create strong relationships with a cleaning crew, a gardener, a handyman service, and a local council member.
• Become a property magnate: If you own a successful rental property that has greatly increased in value, you may have an opportunity to keep your money working for you by buying additional vacation-rental properties and not paying taxes on the purchase. With an IRS 1031 exchange, you may acquire, for example, two properties of lesser value in exchange for your current property without paying capital gains tax. You may want to consider using the equity in your current vacation rental to refinance the property and buy something in a comparable area to expand your real estate empire.
INVEST LIKE A BILLIONAIRE
There are millions of articles on the Web encouraging investors to buy the same stocks as Bill Gates, Warren Buffet, or Carlos Slim, the world's wealthiest billionaires. This advice seems at best confusing and at worst irrelevant, since most people don't have the same diversification strategy that these mega-investors have. However, there is one thing that many of the world's billionaires, including Oprah, do have: a private company that is staffed by people who do nothing but select and watch after their boss's investments. This company is called a family office.
We believe that you can learn to think like a billionaire's family office, and that this is the best approach to take with your money. A family office offers the Rolls Royce of wealth-management services—integrated advice on investment management, tax planning, estate planning, philanthropy, and financial education for future generations. According to the 2010 Multifamily Office Study, conducted by the Family Wealth Alliance,14 the top seventy-two multifamily offices currently manage a staggering $357.3 billion in the United States; the average amount of assets under management for each client is $49.6 million. Carol has been running a family office on behalf of a number of clients for the last ten years; prior to that she worked for the Rockefeller family office. Carol is hired by billionaires to create family offices for them, so she is an expert in this area.
Develop an Investment Philosophy
One of the principal jobs of a family office is to help families develop an investment philosophy. The vast majority of families working with the firms surveyed by the Family Wealth Alliance use the family office to create an asset allocation, to select and monitor investment managers, and to select alternative investments, such as hedge funds or private-equity investments.
We all know that the financial markets fluctuate every day, often to an alarming degree. Turn on any financial news program, and you can hear how much the Dow is up or down for the day, hear about the latest interest-rate move, or about the trading patterns of the day's hot stock. There is tons of information out there but very little useful guidance—and almost no sense of long-term strategy. Family offices receive the same conflicting information, but are savvy in the ways of Wall Street and the brokerage community. They know that a broker selling you products is a salesperson and cannot deliver completely objective advice. Investors working with brokers are expected to look out for their own interests, according to the standards set by the SEC. Registered Investment Advisers are held to a higher standard, but that does not necessarily completely protect your money. That is why family offices develop an investment philosophy and write an investment policy statement for their clients before they begin investing.
One assumption that underlies all family-office investment philosophies is long-term thinking. Family offices consider investments in light of generations, not weeks or months or even a year. Of course, the family office makes sure that a family's short-term cash needs are met and that there is always sufficient money available to meet expenses. But long-term thinking is critical to investment success, and can be practiced by everyone. For example, it is much better to start saving for a child's college education when she is born rather than when she becomes a teenager; the power of compound interest means that you can start with a smaller initial investment than you would otherwise. Thinking for the long term can also mean having the patience to wait for the right time to sell an investment. For example, waiting to sell a valuable piece of art until its style is popular again, even it if means waiting a couple of years, might be a better decision than selling it at a fire sale price today.
Like a family office, you need to develop an investment philosophy and policy before you approach the markets. Some elements of your investment philosophy are going to be universal—good practices that all investors should follow, regardless of their personal preferences—and some are going to be unique to your own situation. We'll explore the universal elements first.
Adopt the Universal Keys to Good Investing
The first key to investing is to realize that the only reason to make an investment is to achieve a return on it. The fact that you like the broker, like to attend events sponsored by a particular bank, or that your friends are making the same investment are not good reasons to invest your money. The only reason to invest is that you think you will receive all your money back, plus an appropriate return. So the first universal principle of your investment philosophy should be, "I am going to invest my money only where I think I can make a return; that is, I have conviction when I invest."
The second key to investing relates to the question, Why do you believe that this particular investment will give you a return? This is one of the principles followed by Warren Buffet. He is famous for investing only in companies and businesses that he understands. Certainly, in the post-Madoff world, this is an important tenet. Not understanding how an investment proposes to give you a return is a big mistake. So the second key is, "I invest only where I have an understanding of how it will make money for me."
This leads us to the third universal key: It is critical to have the information necessary to monitor investments so that you can determine whether your original conviction and understanding prove to be correct. Unless you get detailed monthly information, you can't tell how the investment is doing. You should choose only investments that give very detailed disclosure of how they are performing and how fees are being charged. So the third universal key is, "I invest only where there is transparency on an investment's performance and fees."
We now have the first three universal keys of our investment philosophy: conviction, understanding, and transparency—or CUT. With these, we can "cut" through a great deal of hype and focus in on only the most suitable investments. Any investments that don't pass muster, that don't meet the criteria of these first three keys, won't make the "cut"!
Customize Your Philosophy to Reflect Your Preferences
After you adopt the universal principles of good investing, you need to take your own fundamental inclinations and preferences into account. If you like bargains and hate to overpay, you are probably going to be happier following the value-investing path. If you love looking for the next great success, then growth investing will be more appealing to you. The good news is that growth investments sometimes outperform value investments, and value investments sometimes outperform growth investments, so your natural inclination will be most successful at least some of the time. Understanding whether you are a growth or a value investor by preference is critical to investment happiness. It is impossible to get a value investor excited about high-priced, high-growth investments, just as it is impossible to get a growth investor excited about a company that to her looks half dead but to a value investor reveals hidden potential. The key is to adopt the principle, "I invest primarily in my favorite style."
How much risk are you really comfortable taking? How did you feel when your portfolio swooned during the crisis? Understand that this could happen again in your lifetime, and invest accordingly. Be honest with yourself about how well you handle market volatility. The principle here is, "I accept only an appropriate level of risk." Your financial adviser should spend a great deal of time with you to make sure that he or she understands your risk tolerance, and it is crucial that you are honest about this subject. Don't let an adviser talk you into taking more risk than you are comfortable assuming.
How much time do you have to devote to understanding the markets and participating in them? For example, we know a woman named Julie who no longer trades stocks, because she doesn't have enough time to watch the market closely every day. It is part of her investment philosophy that if she can't devote the amount of attention required for trading individual stocks, then she would rather invest in well-managed funds. Here the tenet is, "I invest in a way that makes sense given the amount of time I have to devote to it."
How strongly do you feel about funding guns, tobacco, or alcohol? For some investors this is a big problem, and they will be happier if they avoid making money on these types of investments. How strongly do you feel about funding community banks, alternative energy, or organic farming? There are investments that fall in the "socially responsible" or "sustainable" categories that will help you fund the things that are important to you. If you want to make these kinds of investments, you should seek out experts who are familiar with the growing number of options in these areas—many traditional advisers simply don't know where to find the best socially responsible or sustainable funds. The tenet here is, "I invest in a way that comfortably reflects my values."
In summary, your investment philosophy should reflect three universal investment best practices—conviction, understanding, and transparency—which will help you "cut" through the noise in the market. You should then consider your style, risk tolerance, time commitments, and values as you decide where to focus your energy. Armed with this personalized investment philosophy, you can now map out a strategy. You can even write up a simple document to share with your financial adviser that reflects your investment principles. This will be the beginning of your investment policy statement.
Develop an Asset Allocation for Each Portfolio
The first step in turning your investment philosophy into a smoothly functioning portfolio is to develop an asset allocation for each pool of money. Your financial adviser will help you with this task. An asset allocation is the mix of cash, stocks, bonds, and other investments that you choose to have in your portfolio. The appropriate mix will depend on the amount of time you have available for investing, your risk tolerance, and the purpose to which you want to put each pool of money. You may have one particular asset allocation for your long-term retirement plan and quite a different asset allocation for investments that will eventually be used to buy a home. Before you start picking funds or individual investments, make sure that you and your adviser have crafted the correct asset allocation first. You might like to see what the world's wealthiest individuals are doing in terms of asset allocation by consulting the World Wealth Report, published each year by Merrill Lynch Global Wealth Management and Capgemini, and available for download on the Internet. The 2010 report stated that wealthy individuals around the world kept 17 percent of their assets in cash and 41 percent in fixed-income securities—a much more conservative asset allocation than is normally promoted by many financial advisers.15 Don't be afraid to insist upon the level of cash and fixed-income securities that will make you feel comfortable.
Insist on Quality Guidelines for Selecting Investments
It is not enough to create an asset allocation, however; you should also create quality guidelines for your financial adviser and make sure they are adhered to. In all cases, you want to have the highest-quality investments, managed by the most experienced team possible. If you are considering funds or portfolios, you want to see the longest track record possible, with good performance during difficult markets. Although all financial investments come with the disclaimer that "past performance is no guarantee of future results," the truth is that a fund with good past performance is a safer bet than a fund with no past performance to evaluate. Each type of investment has its own particular set of criteria—for example, investors judge corporate bonds differently from high-yield bonds, small-capitalization stocks differently from large-capitalization stocks. If this is new territory, ask your adviser to help you develop a set of criteria to judge the quality of your investments.
Use Online Tools to Assess Mutual Fund Quality
When selecting investments, it is helpful to use ratings agencies to help you assess the quality of any mutual funds you are considering. Most online brokerage websites will give you mutual fund ratings from a company called Morningstar. If you are investing in mutual funds, you can set minimum standards by insisting on funds that are highly rated by Morningstar. There is very little reason to invest in a mutual fund with fewer than three stars. Another good rule of thumb is to look for investment management teams with at least ten years of experience working together. You can also assess the track record of a fund by comparing its performance to that of its corresponding investment index. Your adviser can provide this information for you. You can also look up mutual fund performance information on free websites like Yahoo! Finance, which offers a great deal of detail on mutual funds. You can also set up an online tracker for your funds so you can see their performance every day.
It is also important to look at the size of the fund. Beware of mutual funds or ETFs (exchange-traded funds) below $200 million in size—they are just too small to operate efficiently. Don't let your adviser put you into a brand-new fund with no track record—many brokers get paid higher commissions for selling new funds. This helps them, not you!
Separately Managed Accounts
If you have a large amount of cash to invest, your financial adviser may suggest that he or she set up separately managed accounts for your money rather than mutual funds. Separately managed accounts, which are created for you and have a personal portfolio manager, offer the advantage of allowing the portfolio manager to more carefully manage the realized gains and losses in your portfolio by deciding when to buy and sell securities. It is very important to investigate the track record of any adviser who is proposing a separately managed account. If the account is going to hold different types of assets—for example, stocks and bonds in the same account—ask the manager to create subaccounts for each asset class. The manager should also give you performance information for each asset class separately, as well as for the account as a whole. There should be a ratings number for the performance of bonds as compared to the appropriate bond index, and a number for the stocks compared to the appropriate stock index. Otherwise, it is very difficult to judge whether the account is performing well for you.
Pay Attention to Cash and Liquidity
There are two key tenets to consider when constructing your portfolios: the amount of liquidity, or cash, in the portfolio, and the degree of liquidity of the securities in your portfolio. The need for liquidity—or, more simply stated, the need to have cash—was painfully brought home during the crash of 2008 and 2009. Investors who had enough cash to feel comfortable were not so likely to panic and sell at the bottom. The degree of liquidity of your securities refers to how long it takes to sell an investment and receive your return in cash. On one end of the spectrum, most mutual funds and ETFs have daily liquidity. On the other end, private-equity-fund investments cannot usually be sold for ten to fifteen years, making them highly illiquid. Although there may be a secondary market for illiquid investments—that is, someone willing to buy them from you—you typically receive only 10 to 30 percent of the amount you invested back, so they are a very poor choice and a last resort when you absolutely must get some cash.
Make Sure to Diversify
It is critical that you specify to your adviser that you don't want to take too much risk by concentrating investments in just a few stocks or bonds. Most mutual funds hold more than thirty stocks, the minimum considered necessary to diversify a fund appropriately. Make sure that if you have a separately managed account, the manager is limited to the size of the positions he can take, which means that there should be a limit on the percentage of the total portfolio invested in any one stock or bond. A good rule of thumb is that there should be no more than 5 percent of the total value of the portfolio invested in any one fund, and within a fund or portfolio, there should be no more than 2 to 3 percent invested in any one stock or bond. This rule does not apply to smaller accounts, with a value of, say, five thousand dollars or less—in cases like this, you may have to invest in just one or two funds until your assets grow.
If You Are Considered a Sophisticated Investor
Depending on your income and net worth, you may be classified by the SEC and your brokerage firm as a sophisticated investor. A sophisticated investor must have either a net worth of $2.5 million or have earned more than $250,000 in the past two years to qualify. Once you are classified this way, you can be shown investments that have a higher risk, or less detailed financial disclosure, than investments shown to non-sophisticated investors. The assumption is that you can afford to lose 100 percent of the investment, that you have a high degree of knowledge of markets, and you can make decisions about complex investment products. All these assumptions may be false, however, even if you have the required net worth and income. Do not invest in products for which you are not given enough information to thoroughly understand the risks you are taking. Don't rely on the fact that the investment carries the name brand of a top firm—insist on understanding where your money is going.
Hedge Funds and Alternative Investments
If you are a woman with a large portfolio, the chances are good that you will be offered the opportunity to invest in hedge funds, private placements, or other so-called alternative investments. These investments are usually not regulated by the SEC or any other governmental body, so they are inherently riskier. Hedge funds, for example, often have lockup periods—it can take months to get your money back. In the wake of the latest financial crisis, many hedge funds have imposed gates, which means that if all the investors want to get out of a fund at once, a "gate" is slammed shut and an orderly liquidation takes place, sometimes over a couple of years.
The prevailing wisdom used to be that you were compensated for the lack of liquidity and additional risk in hedge funds by much higher returns. However, the performance of many hedge funds was dismal during the crisis, and they did no better protecting investor wealth than traditional investments, which have significantly lower fees. If you plan to invest in any alternative or hedge fund investments, you must have a clear understanding that you are most likely paying much higher fees and getting less transparency, less regulatory oversight, and less ability to redeem your cash. The returns you earn should compensate for all these negative characteristics—if they don't, then stick to traditional investments. According to the 2010 World Wealth Report, wealthy investors with more than $1 million in investable assets put, on average, only 6 percent of their total worth in alternatives16—so don't be pressured to overinvest in illiquid alternative investments.
Ask for a Blended Benchmark
Your financial adviser should be able to help you accurately measure the performance of your assets against an appropriate benchmark. Remember, you are paying the manager a fee to manage your assets, so the fund should make more money using an active money manager than you would make using a passive index account.
In order to assess how your manager is doing, each type of investment should be measured against an appropriate benchmark. Your large-capitalization U.S. stock investments should be measured against the S&P 500 index, for example. To make matters more confusing, there are actually several versions of the S&P index, including those with dividends and those without dividends, among other variations. Work with your adviser to make sure you are using the right benchmark. It is also possible for many advisers to create a "blended benchmark" that reflects that same percentage allocation as your portfolio. For example, if your portfolio has 60 percent U.S. large-capitalization equities and 40 percent municipal bonds, you can have a blended benchmark of two indices in the same ratio and use that to judge the performance of your account. This is easier to do if you have separately managed accounts than if you have mutual funds. If you are investing in mutual funds, each will be measured against an index; your job will be to measure the performance of your total portfolio correctly. Ask your adviser for options.
Your Investment Policy Statement
Once you have set your investment philosophy, asset allocation, and quality standards, you can put all these elements together into an investment policy statement that you can give to your financial adviser. Most family offices and most institutions, like pension funds, provide their own policy statements to their investment advisers. There is no standard form for these statements, but there are certain elements common to all of them. Creating a written document that contains all these elements will make your intentions clear and will ensure that there are no misunderstandings between you and the people who manage your money.
To give you an idea of what an investment policy statement might look like, let's create a hypothetical example for a woman we'll call Susan Smith, a forty-five-year-old professional who works as a corporate marketing executive and lives in California. After taking care of her liquidity needs and fully funding her retirement accounts, Susan wants to grow her wealth, so she has decided to create an investment portfolio that she plans to leave untouched until retirement. She has seventy-five thousand dollars to invest today and, based on her budget, can contribute a good chunk of her bonus each year, so she plans to add another twenty thousand dollars annually. Susan cares deeply about environmental causes and travels frequently, so she is interested both in socially responsible investments and in international stocks, particularly those from Asian countries. She realizes that she does not have a very high risk tolerance, however, so she wants a fairly stable and conservative portfolio. Her investment policy statement might look something like the one below.
INVESTMENT POLICY STATEMENT FOR SUSAN SMITH
This document describes the investment policy for my personal investment portfolio.
Initial investment amount: $75,000.
Tax status: This is a taxable account.
State tax: I am a California resident.
Structure: This portfolio is part of my revocable living trust. [See here.]
Purpose: The purpose of this portfolio is to create wealth that I can live on in retirement.
Percentage of my liquid assets: This portfolio is 50 percent of my liquid assets.
Percentage of my total assets: The portfolio is 30 percent of my total assets.
Ultimate distribution: I plan to pass on any money I don't use to my sister's children and my alma mater.
Time horizon: I expect to invest this portfolio for the next fifteen years, or until retirement, whichever is later.
Liquidity requirements: I do not require any current income from this portfolio. I will use this money in retirement. I am keeping cash in other portfolios.
Liquidation of investments: I want only investments that can be sold every day. I don't want locked-up investments.
Diversification: No one fund should be more than 5 percent of the portfolio.
Risk tolerance: I am a low-risk investor. I would like to limit the possibility of investment losses. However, I want some equities and commodities so the portfolio will grow.
Style preference: Although I know my investments should comprise a variety of styles, I am a growth investor and I prefer to invest 60 percent of my U.S. equities allocation in growth companies and 40 percent in value-oriented companies.
Values: I do not want this portfolio invested in the traditional "sin" stocks. Do not invest in alcohol, tobacco, gaming, or military contractors.
Interests: I am interested in socially responsible investments, international investing—especially Asian equities—and clean technology. I like commodities, including gold.
Avoid: I don't want real estate funds, as I own two buildings and have enough real estate in my net worth. I don't want hedge funds.
Asset allocation:
Rebalancing: I would like to rebalance the account at least once a year to maintain the asset allocation, unless we discuss otherwise.
Investment vehicles: Use mutual funds and ETFs for the investments.
Quality standards: No mutual fund should have fewer than three stars from Morningstar unless I give specific written permission to the adviser for an exception. I want funds to have a ten-year track record with the same team of investment professionals. I do not want to invest in any fund or ETF that has less than $500 million in assets, unless I give specific written permission to the adviser for an exception.
Position size: No one fund should comprise more than 5 percent of the portfolio.
Duplication: Please analyze funds to the best of your ability to make sure that there is not a great deal of duplication in the underlying securities.
Performance reporting: I want to see each fund or ETF compared to the appropriate benchmark. I also want a blended benchmark that I can use to monitor the results of the total portfolio.
Information access: I want online access to my portfolio, as well as statements in PDF format emailed to me each month.
Communication with adviser: I expect to speak to my adviser at least once a month. During a crisis, I want to be able to reach my adviser every day if necessary. I will be the one communicating with my adviser.
These instructions shall remain in effect until I submit written modification of them.
Structures to Hold Investments
In addition to choosing investments, family offices make sure that the right legal structures are used to hold assets, given the family's tax and estate planning situation. Sometimes an LLC is the right answer; other times, a family limited partnership makes better sense. Even if you are single, it is still critical to hold your assets in the right form, which may be a Revocable Living Trust, which we explain next. The key point is this: don't assume that having investment accounts in your own name is the best way to hold your assets. The choice of vehicle and which state to hold the vehicle are critical. Some states, such as Alaska, Delaware, and South Dakota, have progressive trust laws. You do not need to be a resident of these states to have a trust that is domiciled in the state. Consult a good trust and estate planning attorney and consider your options.
THE ADVANTAGES OF A REVOCABLE LIVING TRUST
A revocable living trust can hold all your assets during your lifetime and distribute them to your heirs after you die without the assets having to go through the probate process. It is called "living" because you create it during your lifetime, and "revocable" because you can change it at any time. Once the trust is created, moving money into it is as simple as opening an account in the name of the trust and transferring the funds into the account.
The trust must be drafted by a good estate-planning attorney, who will help you include all the right provisions, such as the following:

• You are the trustee of your trust, and you can change the terms any time.
• All your accounts and assets are in the trust's name (e.g., the Susan Smith Revocable Living Trust).
• A revocable trust names a successor trustee should you no longer be able to act on your own behalf. This means that if you are in a car accident and go into a coma, there is already a designated person in place who can legally take over and manage your affairs.
When you die, assets in the revocable trust do not go through probate court. This means that your estate is kept a private matter—in contrast to assets in probate, which are a matter of public record. Any assets held in your own name are subject to probate and public scrutiny.
You still need a will with a revocable living trust. If you so choose, you can have a special "pour over" will drawn up, which names the trust as the beneficiary of any assets held in your own name that you have not specifically put into the trust. These assets are then distributed according to the wishes of the trust. This is especially useful if you should suddenly die without having time to put assets in the trust. You also still need a will to designate a guardian for your children, which cannot be done with a revocable living trust.
Here are some other advantages of a revocable living trust:
• Your beneficiaries will receive distributions much faster from the trust than from your estate, which can take years to be settled in court.
• If you own a business, the revocable living trust's designated trustee can carry on quickly after your death under the instructions in the trust.
• You can name more than one person to act as trustees after your death: for example, you can have one trustee make decisions on behalf of your business and another manage trust distributions to your beneficiaries.
Get on Top of Your Budget
You may be surprised to learn that many very wealthy people work with monthly budgets to manage their spending. The Family Wealth Alliance's 2010 Multifamily Office Study showed that 97 percent of family offices offer financial-planning services and that 77 percent of their clients take advantage of them.17 Clients of family offices usually have meetings with a personal accountant, who goes over all their past and projected spending needs to make sure that their investments are correctly positioned to meet those needs. Many more wealthy individuals started working with a budget after the latest market crash, when they discovered to their dismay that they did not have sufficient liquid assets to meet their ongoing lifestyle requirements—because, for example, too many assets were tied up in illiquid partnerships, hedge funds, and private-equity investments. Individuals who have inherited money also know that if they want the money to last, they need to live on their investment income rather than draining the principal. Otherwise, even a sizable inheritance can disappear rapidly through overspending.
If you plan to think like a family office, you should have a budget for your spending. A 2007 survey by MSN Money revealed that only 40 percent of Americans use a household budget.18 Contrast this with the whopping 77 percent of wealthy families who use their family office's financial-planning services, and you, like them, may come to recognize the value of this powerful tool.
A simple way to keep track of all the money you spend is to use a debit card for all purchases rather than cash. You will always have to spend some cash, but by reducing this amount, you can monitor the majority of your expenses. In addition, financial-planning software like QuickBooks can help you understand exactly how much you are spending. You can open a personal "company" on QuickBooks and use the excellent features of the program to categorize every expense. If you have online access to your bank account, you can download your monthly debit card expenses to QuickBooks and then add in your monthly credit card expenses (also by accessing your credit card accounts online) to get a full picture of your personal spending. Each expense should be categorized—restaurant meals, personal grooming, clothing, medical, household expenses, and so on. If you decide to create a dating budget, as we suggest in the next chapter, you can create a dating category and capture all dating expenses easily.
If the task seems too overwhelming, you should consider hiring a part-time bookkeeper to create a personal QuickBooks company on your behalf; you may be able to have that person come to your home only one day a month and get the entire job done. We also recommend that while you are entering expenses into QuickBooks, you or your bookkeeper scan all business and personal receipts and put them into electronic folders, organized by vendor, that mimic the categories you are using in QuickBooks. You can keep the paper receipts as well, but it will be much easier to find copies of receipts once they are scanned. Once all receipts are scanned and all expenses entered into QuickBooks, enter in your monthly income. You can then see whether or not you are living within your means. You will also understand the extent to which you are using your credit cards—remember that you are spending this money even if it doesn't feel like you are. Knowledge is power—you can decide what you need to adjust only once you see what you are really doing. Then, you have choices.
Take a look at your expenses by category for each month—ideally, take a look at two or three months at a time. Now you can see where the cash is going, and decide if your long-term goals are being met by these spending habits. If you want to save for a vacation-home down payment, for example, you may need to cut back in some other area, or you might want to start a small part-time business to increase your income. No matter what you would like to achieve, the first step is understanding where you are today so that you can have choices about how to move forward toward manifesting your vision and making your dreams come true.
Thinking like a family office involves thinking strategically, staying calm, and planning rather than reacting. Once you adopt these habits, your chances of increasing your wealth by investing in the financial markets will rise dramatically, and the first pearl of wisdom will be yours.


Copyright © 2012 by Carol Pepper and Camilla Webster