I am flabbergasted by how many seemingly smart people are inept at handling newly acquired wealth or how some can create a fortune exceeding $1 billion in a few years and then blow it all up faster than they acquired it.
This goes for professional athletes, entrepreneurs, actors, rock stars and lottery winners. Even those kids of baby boomers who find themselves with a minor inheritance can find lessons to learn in here.
The key is recognizing that your new found wealth is not an ongoing revenue stream, but more typically reflects a onetime windfall.
Why is that? Because you never know what the future holds no matter how much you plan… and because most importantly it’s real hard to replicate being in the right place at the right time.
One of the more interesting aspects of the whole sudden wealth riff is that monetary magnitudes outside of an individual’s experience become divorced from reality.
On the one hand, you have an individual with a modest or a more successful lifestyle who can more or less successfully budget their existence. Put a seemingly large amount of money in their hands and it becomes inexhaustible.
It was an interesting gambit recently when Obama threw out the cap on total 401k and IRA dollars. What was even more interesting was the rational for the $3 million amount. They converted it to an annuity worth $205,000 per year and that was the basis for the $3 million. I don’t think many people were paying attention to how much money it takes to generate $205k per year, but they should. Using income rates of about 2% to 6% (range of living off dividends-interest only to complete conversion to annuities), gives a much more realistic valuation of retirement savings than focusing on the big lump sum sitting in the bank account.
I have had repeated conversations with extremely intelligent and accomplished regular people who often assume they can do well in the financial markets.
What I try to explain to these highly educated, smart people is that they absolutely can achieve the same success in markets that they have as their own respective professions — They just have to put the requisite time in, immersing themselves in finance for a decade or so. It is usually around this moment that the light bulb goes off, and the cause of prior mediocre performance becomes understood.
As a personal example, a public company acquired one of the companies I founded. While I experienced a windfall it wasn’t without a couple hiccups. As a major shareholder I was in lockup when a major TV financial commentator took a shine to the acquiring company (featured the CEO on his show a couple quarters) and ran the stock from low single digits to just shy of $10. That looked great on paper but by the time I could divest my shares it had round-tripped. There was ample opportunity to use those paper gains as leverage but I didn’t which was lucky. In transactions of this type there is holdback of a certain % of stock in escrow to ensure there are no o/s claims against the acquired company. In our case there was. So another chunk of stock was tied up for two years after the acquisition and only about 60% was eventually released to the shareholders after a settlement. Then there was an issue with options accounting. I was granted options with a 10-yr window to exercise and I had done so in a cashless exercise well before the companies entered into M&A talks. The catch for me, however, was I hadn’t been operationally involved in the company for several years which means the common stock I converted into was taxed at the ordinary income rate rather than capital gains which is how I reported it so I had to pay the offset in addition to taxes on disposition of the shares. That was a chunk of change that came as a bit of a surprise.
Bottom Line: There is no handbook for negotiating some of these things. It was very frustrating not being able to settle on one figure (the gross worth) for several years. The point of this missive is it is hard work to handle a windfall …. which leads us directly to a few rules about dealing with sudden wealth:
1. You must avoid the hubris and arrogance that often accompanies sudden wealth. (Becoming wealthier does not equal acquiring more expertise);
2. Debt is a dangerous tool, especially in the hands of the naive;
3. Assets are not the same as income; wealth is not the same as cash flow; Spending is not the same as investing;
4. You best understand your own strengths and weaknesses; this includes emotional, intellectual as well as behavioral.
5. Experience teaches us that the belief “I’m rich, therefore I must be very smart” is a recipe for disaster when not backed up with actual knowledge in relevant fields.
There are many more rules we can derive from the experience of rags to riches or vice versa, but perhaps the single most important one is the importance of living within your means. This is true whether you have $500 in the bank or $500 million.
Insolvency occurs when your liabilities exceed your assets and cash flow, regardless of how many zeros are on either side of the balance sheet . . .
Share your thoughts…
By : Ziad K Abdelnour
Ziad is also the author of the best selling book Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics (Wiley, 2011),
Mr. Ziad Abdelnour continues to be featured in hundreds of media channels and publications every year and is widely seen as one of the top business leaders by millions around the world.
He was also featured as one of the 500 Most Influential CEOs in the World.
