When I first started in wealth management, I thought that entrepreneurs, being risk takers, would want risky, high octane investment portfolios. I realized the opposite is true – a top priority for them is to preserve the wealth they have created. As they built their business, they knew they could lose everything. When they take money out, they want to be sure they’re keeping it.
Reid Hoffman is a partner at venture capital firm Greylock Partners and founder of PayPal and LinkedIn. At a conference I attended years ago, he was asked if his PayPal experience led Greylock to invest in payment companies. He replied that Greylock had not made any investments in payment companies since becoming a partner because he had vetoed them. Hoffman knew how difficult it was to start PayPal and how lucky they had been, so he was keenly aware of the hurdles payment companies face. Hoffman knows that whatever it takes to win your first $ 100 million can work against you when you try to keep it.
Generate great wealth
Although there are exceptions, if you want to generate significant wealth, you must own a part of a successful business. High-income people – like doctors and lawyers – make a good living, but people in the tens of millions or more are business owners with remarkably similar strategies. They:
- Concentrate their assets, usually in a single company. This increases the chances of winning big if their only big bet pays off.
- Tolerate a high level of risk: their success or failure depends on their business. If it takes off, they’re rich; if it flounders or fails, it does not.
- Are obsessed: They invest almost all of their time and talent in their business. Building the business is their singular goal and occupies a large part of their life.
And luck also plays a role. In hindsight, successful business owners can identify how it all seemed to fit “just like this”. If some things had turned out a little differently, their business wouldn’t have been so successful. On the other hand, bad luck is killing many otherwise promising companies.
Preserving great wealth
The strategies for preserving wealth are the opposite of those for generating it.
- Instead of focusing, diversify. Distributing wealth among many investments eliminates the risk of losing everything.
- Lower the overall level of risk by reducing leverage and creating a safety margin by allocating bonds and cash
- The involvement changes from active to passive. Being an investor is investing in someone else’s business. Investors typically 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. Defining the portfolio strategy and rebalancing are essential tools for long-term success.
Preserving wealth requires a mindset and discipline that avoids huge losses. I recently spoke with a client about the opportunity to put half of her fortune into a new business. If the business failed and she lost that money, it would affect her lifestyle and financial security. On the other hand, if the start-up company took off and doubled or tripled its wealth, very little would change – it already had enough to meet all of its lifestyle and financial goals. As a result, she invested 20% of her money in the new business and found other investors to make up the difference.
Note that the preservation of wealth does not exclude excellent returns; Over the past decade, a 70/30 portfolio of globally diversified stocks and bonds has more than doubled in value. Compound returns from 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 nowhere near the disproportionate returns needed to turn it into tens or hundreds of millions of dollars.
Think of two buckets
After selling a successful business, it’s important to keep the wealth creation and preservation paradigm in mind when deciding how much to invest in another new business. Past success doesn’t guarantee you’ll catch Lightning in a Bottle a second time.
I advise my clients to imagine two compartments and to decide the share of their heritage in each of them. Taking this compartment view helps in several ways.
First, thinking in terms of two buckets helps set expectations. The money in the Wealth Generating Compartment can generate excellent returns or go to zero; 20% of new businesses fail in their first year, half survive five years, and only a third make it ten. The money in the preservation bucket increases wealth less dramatically, but reliably in the long run.
Second, as the value of a business increases, it may make sense to shift value from the creative compartment to the preservation compartment. As William H. Vanderbilt once said: âAny fool can make a fortune. It takes a smart man to hang on to it. Or a person with two buckets.