I spend my days helping my clients think through and make good decisions regarding their wealth. Often these decisions are based on what they want their wealth to do for their lives, their futures and their loved ones. Most of my clients have built or hope to build multi-generational wealth that will last.
To achieve this goal, they have to make informed decisions, especially at critical moments in the wealth-building process. A big part of my role is helping clients focus on those things they can control and make good decisions.
In my last article I outlined 7 impediments to wealth creation that are beyond your control. In this article, I want to discuss 7 impediments to wealth building that you do control. I have discovered that when you focus on those areas where you can change outcomes, you greatly increase the likelihood of achieving your goals.
Impediments caused by personal choices
Here are seven common areas that drain wealth that affluent individuals can control:
- Not saving enough
- Excessive spending on non-essential items
- Panicking during a stock market crash
- Caring for loved ones
- Poor tax planning
- Not recognizing the underlying costs of investments
- Relocating to another state.
Let’s look at each of these individually.
Not saving enough
I find that many families do not save enough. This is the number one most controllable factor in wealth building. Affluent individuals are especially susceptible to the notion that they are ahead of the game on savings when in fact they may be well behind.
Just because a family has a high household income, this does not mean that they will build multi-generational wealth. Building wealth is not so much about how much you earn as it is about how much you retain.
Your savings plan should be in line with your wealth building goals. This means some families may need to save far more than others. No matter where you are on your journey, I recommend an annual review of your spending habits.
There are those who have enough resources and wealth that they do not have to be disciplined about how much they spend. For most of the rest of us, adhering to a well-conceived savings plan is necessary to achieve one’s goals.
Excessive spending on non-essential items
Those who are building wealth need to keep a close eye on expenditures on non-essential items. Many people who work hard also want to play hard. This can lead to drainages on wealth that may not be obvious at first. But once you perform an analysis of your choices and the other options that you didn’t choose, you might be surprised at the long-term impact.
The most common forms of non-essential spending include lavish vacations, expensive automobiles, high-end second homes or vacation homes and excessive spending on creature comforts. Often these visible statements that suggest success can actually inhibit wealth-building over time.
Generally, people do not take into account the long-term carrying costs of some of these items, such as a second home with high real estate taxes, insurance and maintenance.
We all want to enjoy our lives and taste the fruits of our labors. Yet all choices have benefits and consequences. Learning to live within your means could be the difference between having enough wealth to last your lifetime or having enough to last several generations.
Panicking during a stock market crash
This is one of the biggest mistakes that individuals make. Most investors want to buy low and sell high and this philosophy works until the pressure of a crash. Then we see the opposite behavior – buy high and sell low. Studies have shown that this is exactly what the majority of investors do. This is a major source of how wealth is drained from affluent individuals.
If you live within your means, save, invest and balance your portfolio effectively, a stock market crash may be an excellent opportunity to buy, not sell. If you take a long-term perspective on investing, you know that crashes have occurred many times. But they have always been followed by recoveries.
A disciplined approach to rebalancing your portfolio to your strategic goals is a very effective way to ensure success. But “rebalancing” may mean selling what performed well and buying what did not perform well. Most investors struggle with making these decisions during a crash.
Investors who do not take advantage of crashes may be missing out on opportunities that only come around every generation or so. This is why it’s so important to have a financial partner with you for the long haul. Every investor will feel the pressure to sell in a down market. But if you don’t panic and instead realize the opportunity, your wealth could grow substantially from these events.
Caring for loved ones, particularly children and grandchildren
There is a “new normal” relating to paying the expenses for children and grandchildren. Numerous baby boomers have to delay retirement because they co-signed for a portion of the trillion dollar student loan debt.
But, parents helping children has gone beyond that. The financial Armageddon of 2008 drained billions of dollars of value out of home values. Many parents have had to stretch their financial resources to help their children avoid foreclosure and eviction from their homes. In some cases parents co-signed mortgage loans and have been stuck with having to subsidize the debt.
All too often plans for educational funding start when children are in high school. There are numerous ways in which tax subsidies can help to mitigate the educational cost burden, such as a 529 plan or a Coverdell account or even a prepaid tuition program. These all work much better when they are started while the children are in grammar school or even preschool.
Parents want the best for their children. When deciding on which college to attend care should be given to looking at how the 4 year, or in many cases 5 year, cost will impact the financial future of the child and the parent. Just because a child is accepted into an ivy league school does not mean that is the right answer for the family. I have seen parents delay saving for their own future as they are funding annual costs of $80,000 or more for their child to attend an elite school.
Poor tax planning
Tax planning is a critical component to building wealth. This is especially true for affluent individuals and families who end up paying as much as 50% of their household income to taxes in any given year. I often see these individuals making costly mistakes that are completely controllable.
For instance, I see people buying investments that are very tax efficient inside their IRA or 401k account. However, these same individuals sometimes buy investments that are very tax inefficient in their taxable account. The result is lower economic returns simply because the assets were bought in the wrong pocket.
Very few mutual funds or investment banks show their results on an after-tax basis. With significant new and higher taxes on investment income, I believe it is a mistake not to take taxes into account when evaluating your investment portfolio.
A tax-efficient retirement plan, investment strategy, estate plan and charitable contributions plan should all work toward reducing your tax burden. This is an area where I feel a particular responsibility to help clients realize their goals.
Not recognizing the underlying costs of investments
While investments should help you build multi-generational wealth, they can also be a source of wealth drainage. How so?
Many investors do not take the time to investigate the fees associated with their portfolios. If you are working with a traditional stock broker, you might be surprised at how much you are paying in commissions and fees that may not be completely visible on your statements. If you add up these fees over a ten-year period, it can be shocking how much wealth leaves your hands and transfers to others.
This is where working with a fee-only investment advisor is a better option. Fees are completely transparent. There are no commissions on trades.
Relocating to another state
People who relocate to another state can also lose wealth through the process. This is especially true for those who live in states with tax codes favorable to wealth-building who then move to states with higher tax codes.
States like California offer a good economy and lovely weather. But the tax codes… Well let’s just say they aren’t pretty. Before you make a choice about moving to a new state, be sure to look at the tax implications of the move.
When planning a move, it may be advantageous to implement “pre-move” tax strategies prior to changing your state of residence. An example of this would be to convert all or a portion of your IRA account to a Roth account, especially if the state you are leaving does not impose a tax on the conversion.
Steps you can take
All of the situations I outlined in this article are very controllable… If you know what to look for. I encourage you to think carefully about the choices you’ve made in each of these areas. If you believe you’ve missed opportunities to build your wealth, let’s have a conversation to help you get on an even better track.
The information contained in this article is provided for informational purposes only. No illustration or content in it should be construed as a substitute for informed professional tax, legal, and/or financial advice.