Many words have been spent on Israel’s new tech millionaires, most of them focused on sociological aspects of this group: how they dress (T-shirts), to what extent they are likely to change their lifestyles (probably not much), where they want to live (apartment in Tel Aviv), and so forth. Yet, there has been very little discussion about the enormous questions facing those who have suddenly run into significant wealth. These are a few important points for consideration for newly minted tech millionaires:
1. Wealth concentration can be hazardous
Many tech millionaires continue to hold shares in the company they started, or in which they work, and that has made them rich. Often, this holding still constitutes a significant part of their overall wealth. Whether they continue to hold the shares due to their belief in the company or for pure sentimental reasons, they find it difficult to let go.
History teaches us that even the most established companies can suffer from sudden, sharp drops in their value. There are a few notable examples from the world: companies such as General Electric, Nokia and Lloyds Bank. We could have also added Teva, the Israeli pharmaceutical company, which for many years seemed invincible. When it comes to tech companies whose product can turn uncompetitive (or perhaps completely unrequired) with the appearance of a new and improved technology, the risk of an unexpected sharp fall in a stock’s price is so much greater.
To preserve wealth for the next generations, it is wise to diversify it. This does not necessary mean selling the entire position in the company’s stock. It is possible to reduce it or hedge it to varying degrees. By doing so, one is obviously giving up on some of the additional upside, but at the same time, they are also reducing the risk of a full or partial loss of the wealth that has already been achieved through much hard work.
It is important not only what return is achieved on investments made, but also how much of it remains in your pocket after tax. Minimizing the tax impact has an important role in building wealth over time. To be clear, we are not talking about tax evasion, but rather about using legitimate knowledge and tools to improve one’s after-tax returns. A few examples:
A) Investing for the long-term, as opposed to trading short-term, is more tax efficient. It enables one to compound wealth more effectively by deferring tax events into the distant future. In the case of American taxpayers, the focus on long-term investing also means paying capital gains tax at lower rates.
B) Making maximum use of tax-efficient savings and investment schemes, such as IRAs, can greatly reduce tax paid.
C) When investing globally, it is crucial to minimize exposure to estate tax in foreign countries. An investor is exposed, for example, to estate tax on US assets – such as stocks, real estate, and more – even if the investor is not a US citizen or taxpayer, and even if these assets are held through a bank account outside the US, including in Israeli bank accounts. Maximum US estate tax rate is 40% and is charged on capital, not only on investment gains!
3. High spending can hurt wealth preservation
It is important not only how much money is made, but also how much of it is spent. Wealth advisers always emphasize the fact that risk and return go hand-in-hand, and that taking more investment risk should generally lead to higher investment returns over time. However, a point that is less frequently discussed is that from a capital preservation perspective, the wealth-owner’s spending rate (as a percentage of assets) could have just as much impact as the investment return achieved on the real level of wealth. What is clear is that the spending rate (3%, 5% or 7%) has an influence that is just as great, if not greater, than the portfolio’s risk profile on the probability of such a loss of wealth
To conclude, studies show that 70% of wealthy families lose their wealth by the second generation, and 90% by the third. To preserve wealth over many years, and even generations, one needs to act wisely and responsibly. After all the hard work that had been put into generating the newly created wealth, it would be a shame to find yourself on the wrong side of these statistics.
The writer is chief investment officer, Clarity Capital. The content of this publication does not replace and should not serve as substitution for investment advice services that take into account the special characteristics and needs of each investor.