When I started in wealth management, I thought that entrepreneurs, being risk takers, would want risky, high-octane investment portfolios. I realized the opposite is true: one of the top priorities for them is preserving the wealth they have created. As they built their business, they knew they could lose everything. As they take money out, they want to make sure they keep it.
Reid Hoffman is a partner at the venture capital firm Greylock Partners and the founder of PayPal and LinkedIn. At a conference I attended years ago, he was asked if his experience with PayPal led Greylock to invest in payment companies. He replied that Greylock had not made any investment in payment companies since becoming a partner because it had vetoed them. Hoffman knew how difficult PayPal was to create and how lucky they had been, so he was well aware of the barriers payments companies face. Hoffman knows that whatever it takes to earn his first $ 100 million can work against him when he tries to keep it.
Generating great wealth
While there are exceptions, if you want to build significant wealth, you must own part of a successful business. High-income people like doctors and lawyers make a good living, but people who number in the tens of millions or more are business owners with remarkably similar strategies. They:
- It concentrates its assets, generally in a single company. This increases your chances of winning big if your single big bet is worth it.
- Tolerate a high level of risk – Your success or failure depends on your business. If it takes off, they are rich; If it fails or fails, they are not.
- They are obsessed – they invest almost all of their time and talent in your business. Building the business is their singular focus and it occupies much of their lives.
And luck also plays a role. Looking back, successful business owners can identify how everything seemed to fit together “that’s right.” If some things had happened a little differently, your business would not have been as successful. On the other hand, bad luck kills many promising companies.
Preserving great wealth
The strategies for preserving wealth are the opposite of those for generating it.
- Instead of concentrating, diversify. Spreading wealth among many investments eliminates the chances of losing everything.
- Reduce the overall level of risk by reducing leverage and creating a margin of safety by allocating to bonds and cash
- Participation goes from active to passive. Being an investor means investing in someone else’s company. Investors generally don’t influence the success of the companies they invest in, so let the money do the work.
- Mitigate the effects of luck by following a disciplined investment process. Establishing portfolio strategy and rebalancing are essential tools for long-term success.
Preserving wealth requires a mindset and discipline that avoid great losses. I recently spoke with a client about investing half of his estate in a new business venture. If the business failed and she lost that money, it would affect her lifestyle and financial security. On the other hand, if the startup business took off and doubled or tripled your wealth, very little would change – you already had enough to accomplish all your financial and lifestyle goals. Consequently, he invested 20% of his money in the new business and found other investors to make up the difference.
Keep in mind that preserving wealth does not preclude excellent returns; Over the past decade, the value of a 70/30 portfolio of globally diversified stocks and bonds more than doubled. Compound returns on a diversified portfolio can turn great wealth into even greater wealth. But if you start with a modest investment, doubling in value in a decade is a far cry from the colossal returns needed to turn it into tens or hundreds of millions of dollars.
Think of two cubes
After a successful business is sold, it is important to consider the wealth-building versus preservation paradigm when deciding how much to invest in another new business. Previous success does not guarantee that you will catch lightning in a bottle a second time.
I advise my clients to imagine two buckets and decide how much of their equity should be in each one. Taking this bucket view helps in a number of ways.
First, thinking in terms of two categories helps set expectations. The money in the wealth-building cube can generate large returns or go to zero; 20% of startups fail in the first year, half survive five years, and only a third make it to ten years. Money in the preservation bucket increases wealth less spectacularly, but reliably in the long run.
Second, as a company’s value grows, it may make sense to shift value from the creation segment to the preservation segment. As William H. Vanderbilt once said: “Any fool can make a fortune. It takes a smart man to hold onto it. “Or a person with two buckets.