June 7, 2016
June 7, 2016
Ah, to be young and rich. While it may sound like an idyllic, carefree existence, that certainly isn’t the case for all of today’s young high-earners. Let’s not shed too many tears for these folks, but young people are particularly prone to make mistakes with their money. Having excess funds alleviates many day-to-day struggles, but it also creates its own set of choices and challenges. With age comes experience. If you’re old enough to have lived through numerous market cycles, you’re more likely aware of the risks of being overly greedy or overly fearful. Young people, on the other hand, lack the wisdom that only comes with that experience and are often overconfident and overoptimistic. These attitudes result in behaviors that can be devastating to wealth accumulation. These are what I’ve noted as being the five most common mistakes made by the young and rich.
Real estate prices in the Bay Area, where I live, have been on a tear the last several years due to limited supply and a surge of tech and foreign buyers. Many young, wealthy families were not able to buy homes before the boom started, so they’re only just now entering the market as prices reach all-time highs. Just because prices are high doesn’t necessarily mean that everyone should postpone their plans to buy homes, but it does mean folks probably shouldn’t stretch themselves too far. A primary residence is not an investment asset. It’s a consumption asset. Since people need to live somewhere, they’re unlikely to realize the full value of all the appreciation on their homes. For this reason, buying too much house is a real risk. Even if prices continue to rise, buyers with “too much house” still feel the pinch in the monthly budget. And if prices go down, they’ll end up upside down on their mortgages. Not only does this devastate a balance sheet, but it can also have real implications for someone’s ability ever to move out of their home. If you need to write a big check to the bank upon the sale of your home, you’re unlikely to move, even if your job or family would really benefit from doing so. It can be a real problem.
Many tech industry employees have earned a good chunk of their wealth from company stock. Facebook, LinkedIn, Google and many other Bay Area companies have seen their stock prices rise consistently since their IPOs but the technology sector is not immune to broad market downturns. I see lots of tech workers with underwater options and RSUs who continue to hold out for a big run up in the stock price before they intend to diversify. The problem with this plan is that your company’s stock price may never rise. Just as is the case for workers in traditional companies, techies are wise to avoid excessive portfolio concentrations and should sell company stock at regular intervals. Indeed, when your employer’s stock falls, your future employment and promotional opportunity are also more at risk.
The tax code is written in a way that provides incentives and penalties for different financial choices. Not all gains and losses are taxed at the same rate. High earning, young professionals and business owners often miss opportunities to lower their tax bills by simply not paying attention to or not taking the time to learn important details. This all but transfers excessive money directly from their checking accounts to IRS coffers every year. Not taking advantage of special tax-advantaged accounts is a common mistake I see young people make all the time. Putting college savings in a 529 plan and maximizing retirement plan contributions can save thousands in taxes every year. Our government has created provisions that provide tax incentives for using these types of accounts and that means real dollars, especially over decades.
No one wants to talk about the possibility of bad things happening to them or their families. But avoiding those uncomfortable conversations can be costly. Young people should consider having a plan for the two “Big Ds”-disability and death- and in that order in terms of importance. Someone in their 30s is at a much higher risk of disability than premature death. If one spouse is disabled, it can be financially ruinous to a family. Not only does disability result in loss of income, but it may also mean expensive care for the disabled. Many professionals at larger companies have group disability insurance plans but those who are not covered through their employer are smart to buy individual plans. Similarly, life insurance is important, especially for young families with children or big mortgages. Affording child care, tuition and mortgage payments may be difficult even for wealthy families if one spouse is not around to take care of the kids or earn an income.
Portfolio management and financial planning aren’t rocket science. Smart, disciplined people with sufficient interest and time can do a good job on their own. The problem is that many young people cannot dedicate the time required to do it well, and are therefore more at risk of making financial decisions today in a hurried fashion. Hiring a pro is of course more expensive than doing-it-yourself, but good professionals can earn back their fees, and these fees can pale in comparison to the cost of mistakes and the value of missed opportunities. I’d compare it to painting my house or mowing my lawn: cheaper for me to do it myself, but I probably wouldn’t do it quite as well and I’d rather spend that time with my friends and family. If you can’t dedicate the time to necessary to manage your money, hire someone who can.