Affluent investors often suffer wealth management pitfalls that are distinctive to their higher financial status. These challenges do not get addressed in the general financial advice. Although these High Net-Worth Individuals (HNWI) can use the fundamental rules of investing, they should keep in mind the nuances which are typical of significant wealth.
Excessive Fear of Losing Hard-earned Wealth
Wealthy investors have worked hard to accumulate their wealth and love it with their dear lives. We have all heard the story of Uncle Scrooge, who couldn’t part with a penny in spite of having the world’s biggest pile of gold. Excessive fear of losing wealth makes these investors extremely risk averse and they often make investments which are too conservative. This reduces the total investment pool that they could have enjoyed in the future. Moreover, it also impacts the next generation which would inherit their wealth in the future. Affluent investors should keep in mind that your returns directly depend on the risk you take. No risk implies no returns.
Paying a Significant Amount of Income As Taxes
HNWI are heavily taxed by the government and thereby have a greater need for tax protection. In fact, HMRC created a separate division in 2009 to target HNIs specifically and raised extra £500 million tax from that department only. There are a variety of methods that could be used to cut your taxes:
- Non-cash Benefits - Reduce your taxable income with your employer by asking for more non-cash benefits – like transportation allowance, driver allowance, club membership, car leasing, medical insurance, etc.
- Pension Payments - Increase contribution to pension payments to your employer. All contributions up to £40,000 are tax-deductible
- Charitable Trusts - Contribution to charitable trusts is non-taxable and reduces your taxable income
- Spouse Benefit –They can move their savings in the name of their spouse if he/she is in the lower tax bracket
- Other Complex Methods - Joint ownership advantage, Reduce inheritance tax bills (gift tax), tax-efficient investment – EIS (Enterprise Investment Schemes) and VCT(Venture Capital Trust), Tax relief on Mortgage interest for Buy-to-Let property, Offshore tax havens (Cayman Islands, Luxembourg, Liechtenstein)
Extreme Self-reliance for Investments
Investors, who have accumulated significant wealth due to their hard work, passion and self-confidence, often hesitate to ask someone else for advice. They are smart, intelligent and have been excellent in their professional career. This leads them to believe that they can carry their success in the field of investment as well. However, they should realize that it took them years of practice to meet that success in their career. Moreover, there were times when they had to suffer failures in their field. They can’t afford to take such chances with their hard-earned wealth. It would be prudent to take the help of an expert professional.
Investing in Illiquid Alternative Investments
Wealthy investors usually develop a taste for collector items like fine wines, art, antiques, etc. Investment in these collectibles is referred to as Alternative Investment. Some of these asset classes have provided good returns in the long run and cut the overall risk of the investment portfolio through diversification. For example, from 2005 to 2013 the value of the Classic Cars Index rose 275%. Similarly, investment grade stamps provided 11.7% return over the last 10 years. But one must exercise caution while investing in these asset classes as their market can turn illiquid very soon. Moreover, they are not regulated, have associated storage and maintenance costs, and do not give a regular income (make money only on sale). However, if they really want to invest in their passion, up-to-date appraisals are required to keep a track of estate liquidity and taxes.
Too Many Advisers Spoil the Broth
Sometimes wealthy investors hire multiple advisers in their enthusiasm for great financial returns. These advisers look at a part of the portfolio and do not have access to the entire investment pool. At face value, the idea looks great, but it has an inherent drawback. Access to the entire portfolio is required for risk management and tax planning. In the above scenario, as no investor has access to the entire portfolio, the uncoordinated actions may lead to sub- optimal outcomes. A better approach would be to get investment advice from a wealth manager who has access to the entire portfolio. And then confirm it by taking a second opinion from one or two advisers. They can then choose the adviser who offers the best return within their risk appetite.
Putting All Your Eggs in Your Company's Basket
The above problem is typical of corporate executives in CXO role who have stayed with one company for a considerable period. These executives accumulate large positions in their company stocks in the form of Employee Stock Options or ESOPs. Such a large position in the stock of one company exposes them to concentration risk. Stock investments are subject to market risk and the executive can lose his hard-earned wealth if the company stock declines significantly. Moreover, there can also be a situation where the executive loses his job due to worsening economic scenario for the company. Such a situation would have a double impact, and can cause considerable financial damage. Therefore, Diversification 101 suggests you should have the least investment in the company you work for.
These are just a few of the pitfalls that are faced by HNWIs. As they accumulate more wealth, unique challenges would arise like investment in tax havens, diversification by investment in other countries, inheritance tax plans, tax planning through trust and charitable institutions, elusive real returns on investment, net of fees, inter-generational family feuds, etc. Investors should be wary of the above pitfalls while making their investment decisions.