It's common if you're wealthy to worry about losing your fortune due to forces beyond your control, like market meltdowns or economic stagnation. But what many don't realize is that their own behavior may be the root of significant losses. Here are 7 wealth-draining behaviors to avoid:
1. Chasing top-performing money managers and markets - Although every presentation of investment returns has to include the warning that "past performance does not predict future results," the reality of investor psychology is that this is very hard for people to believe. It goes against one of the fundamental tenets of how humans typically make decisions – if it looks like a duck and quacks like a duck, it will continue performing like a duck, right? A top performing duck! Who expects the duck to turn into an elephant, or a lemon, for that matter, since that is what most top performers turn into thanks to a nasty reality called "mean reversion." So, if you want to devise a strategy to predictably underperform the market, switch often from top performer to top performer and repeatedly incur the resulting transaction and tax costs. If you want to do better than that, consider investment options like index funds that reliably capture market returns and do it at a low cost (another sure way to lose wealth – pay high fees to investment managers who underperform!
2. Putting more money into the asset that made you wealthy - This same "it-will-continue-to-perform-like-a-duck" thinking is what leads people to double down on the company stock or other single investment that has made them wealthy. It's true that many who are wealthy got that way as a result of a concentrated investment, but the converse does not hold (all concentrated investments do not make you fabulously wealthy; in fact, just the opposite is true.) And the concentrated investment that made you wealthy yesterday may be nearing it's time to revert to the mean. So, if you've been lucky enough that your concentrated investment has done well, now is the time to take money off the table and diversify away from the asset that made you all your money
3. Overspending – If you're wealthy, it can be difficult to fathom the possibility that you could spend too much. But everything is relative. No matter how much money you have, it's always possible to spend it faster than is sustainable, particularly in our world of $100 million penthouses, yachts and flights into space. If you want to make sure that your spending doesn't cut into your wealth, set a sustainable withdrawal rate (say 3% per year of your investment portfolio) and stick to that. This also applies to how much you spend on your children – see #7.
4. Focusing only on pre-tax investment returns - Investment marketers sell pre-tax returns, but when you look under the hood to figure out how much you actually get to keep after you pay taxes (especially in our current higher tax environment), it's not unusual to discover you keep 50% or less of the marketed number. Now that new hedge fund's numbers don't look so good, and the risks they're taking to achieve those returns seem alarming when you realize you'll keep only half.
5. Failing to manage the risks in your financial situation beyond your investment portfolio – The money you can lose outside your investment portfolio can dwarf the returns of even the best-performing investment. Families have come to me after having lost over 50% of their wealth because of an inadequate estate planning strategy or having spent millions in litigation to unwind a poorly drafted buy-sell agreement for their business. Do yourself a favor and have in your court a comprehensive wealth advisor whose job it is uncover and stay on top of these issues.
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