“Wealth in Equities is supposed to function as does a river, widening and deepening as it falls down through the generations“
– Nick Murray
In last month’s article, we explored the impact of investor psychology on equity market behavior. This month we explain how true wealth can behave like a River.
Money vs. True Wealth
Over a 30-year career spent working with families to invest and grow their financial capital, I believe there is a significant difference between having a lot of money and being wealthy. This difference is difficult to pin down, but it may be best said that people in the former group are more concerned with how investing money tends to cause a much shorter term perspective on success. Those in the latter group are much more concerned with why and for whom they are investing their capital, which tends to bring forth a much longer term view of planning the stewardship of their family’s wealth over time.
My favorite metaphor for describing this difference is that true wealth, when it is properly managed, should behave similarly to a river. If you think about it, a river flows from high up in the mountains down to the ocean, and as it flows, it constantly grows deeper and wider. You can stand by the side of the river with a bucket to draw out the water you need to drink or cook with, but even as you do, the river inevitably keeps getting wider and deeper.
In our philosophy of advice here at Concentus, we define true wealth as an asset base that will afford you a growing stream of income to live on which you cannot outlive, combined with an increasing capital base, which you can leave behind to future generations of your family or the causes you care about. When thought of in this way, wealth becomes more about the long-term stewardship of your capital than it does the day-to-day vagaries of stock market volatility.
A Growing Stream of Income You Cannot Outlive
Most of the wealth saved and invested in America is set aside in retirement savings accounts to prepare for achieving financial security in the investor’s later years. In fact, most of the clients who hire a firm like Concentus typically do so in order to design and implement a plan to help them achieve a lifetime income stream, which will sustain their lifestyle no matter how long they live in retirement or how badly inflation erodes the purchasing power of their wealth. Nobody wants to run out of money in their old age, so American investors have dedicated vast financial resources to preparing for retirement to secure an income stream for life. And rightly so.
As we have emphasized in this article series many times, long-term equity investing is the primary key to achieving this kind of long-term financial security for those investors who have the temperament to weather the inevitable crashes and corrections that equities periodically experience. As we have explored in the past, over the last 75 years, the S&P 500 has experienced almost 20 episodes in which equities temporarily declined by 20% or worse. However, despite those scary moments, the S&P 500 has also managed to produce a compound annual return of just about 10% per year over that same time period.
Thus, the goal of retirement preparation can be fairly simple for an investor who achieves an annual return of about 10%. She should be able to easily sustain an annual withdrawal rate of 4% or 5% of her portfolio assets to live on, even after adding in an additional 3% for inflation and still leave some return leftover for the long-term appreciation of her capital base. In other words, historical equity returns have enabled investors to meet our definition of true wealth – a growing stream of income, which one cannot outlive, no matter how long she lives or how badly inflation erodes her purchasing power. And to never fear running out of money along the way.
Of course, this is in no way a prediction or a guarantee that the S&P 500 will continue to produce a compound return of 10% per year into the future as it has in the past. However, today, 10-year Treasury bonds yield about 1.46%, so the alternative to equities is to invest in an asset class with almost no chance of even keeping up with a 3% inflation rate, much less producing a meaningful income stream after inflation. It is a wealth dissipation plan as opposed to a wealth accumulation plan. To us, it seems better to take our chances with equities.
An Increasing Base of Capital to Leave Behind
For most people, their pre-retirement years and first few years of retirement focus on the first part of our definition of true wealth – securing a comfortable lifestyle with no risk of running out of money.
However, for many people, a couple of interesting things happen as they grow older. First, with the proper plan in place, one’s wealth accumulation plan will likely succeed beyond our expectations, as equity returns have a way of growing capital even despite ongoing retirement withdrawals. And second, the pursuit of not using up one’s money before using up one’s heartbeats begins to seem like a limited and almost self-centered goal. As children and grandchildren grow, or as we think about the good done by the charitable causes dear to us, we begin to think about what our wealth might mean to them.
For a couple in their 70’s who began investing about 50 years ago, the S&P 500 has risen by about 50 times. (It halved three times during this period, but those were blips, as indeed all equity market declines are blips in the context of lifetime and multigenerational investing.) Fifty years from now, their grandchildren will also be in their late 60’s, at which time the Index may be up another 50 times from where it is now. From this perspective, regardless of age, everyone’s investing time horizon is, or certainly should be, forever.
And so, as investors advance through their 60’s, into their 70’s and beyond, those who have a mindset of true wealth do not think of investing their capital as a short-term proposition but often begin to see themselves as the stewards of their children’s and grandchildren’s future fortune.
We all have to be careful not to let our affluence – and even more, our good intentions – weaken our children. And the best of us are, just as the best of our children are careful to stand on their own two feet and make their way in the world. But as we begin to see what a significant legacy might accomplish in our children’s successful lives, we come to regard wealth in a new way.
Rather than looking at money as a finite resource, we begin thinking of wealth as a river, capable of growing deeper and wider as it flows downstream to the next generation of our children, and then our grandchildren – and we start thinking of wealth not merely as transgenerational but multi-generational.
At this point, we become our family’s “Riverkeepers.” We try not to worry too much about whether technology stocks are completely in a bubble, or about the vagaries of emerging-market investing today, or about the challenges of the supply chain, or how many more Americans will fall prey to COVID before this pandemic is over.
We don’t own the river; we are merely its stewards. Although we’ll draw water from the river as we grow older, we’ll preserve it with an eye toward the days when our grandkids – and their brothers and sisters and cousins yet to be – are our age and are tending it for their grandchildren.
Investors who like numbers more than they like people always think that money is money, and regard estate planning primarily as a method of saving taxes. But truly wealthy people who possess the values and skills of the Riverkeeper know that money is love. They see estate planning as a process of widening and deepening – thereby extending the life of – the river.
Having a Plan
It may be worth restating our overall principle of investment advice. It is goal-focused and planning-driven, as sharply distinguished from an approach that is market-focused and current-events-driven. Long-term investment success comes from continuously acting on a plan. Investment failure comes from continually reacting to current events in the economy and the markets.
We are long-term equity investors, working steadily toward the achievement of your most cherished life goals. We make no attempt to forecast the equity market; since we accept that the equity market cannot be consistently timed by us or anyone, we believe that the only way to be sure of capturing the full premium return of equities is to ride out their frequent, but ultimately temporary, declines. We do this because, at least historically, the permanent advance has triumphed over the temporary declines.
Our essential principles of goal-focused portfolio management remain unchanged. The only benchmark we should care about is whether we are on track to accomplish our financial goals. Risk should be measured as the probability that we won’t achieve our goals, and investing should have the exclusive goal of minimizing that risk.
The very best investors have a disciplined approach to making portfolio decisions and always stick to their plan, no matter what the rest of the world is doing. They are able to live through the peaks of euphoria, as well as the depths of terror, with a healthy understanding that a well-designed, written investment and financial plan will get them through both.