14TMND : TAXES, GOVERNMENT, AND GOVERNMENT

 TAXES, GOVERNMENT, AND GOVERNMENT

Many high-income earners in America—both PAWs and UAWs—are greatly concerned about the actions of the federal government. These actions are external forces—those over which an individual has no control. Dr. South indicated that he feared four external forces that are government-related. Interestingly, these issues are not of major concern to Dr. North. Let’s look at these four concerns:

1: Paying increasingly high federal income taxes

Both physicians think that the federal government is likely to require high- income producers to pay more in taxes. But tax increases are more the concern of Dr. South than of Dr. North. Why is Dr. South concerned about this issue? Because he needs to maximize his realized income to support his hyperconsumption lifestyle. If the government requires Dr. South to pay a higher share of his income, his lifestyle will be threatened.

What about Dr. North? He told us that he had a low level of concern over the prospects of the federal government increasing the share of his realized income that he must pay in taxes. Last year Dr. North paid approximately $277,000 in income taxes (see Table 3-3). This may seem like a big bite. But look at it through the eyes of Dr. North. He looks at income tax more as a portion of his total wealth than a portion of his realized income.

What if the government doubled the tax rate on high incomes? This is very unlikely, but just as an example, Dr. North would then have to pay the equivalent of 8 percent of his wealth each year. By comparison, Dr. South would be at a “wealth rate” of 150 percent! Is it any wonder Dr. North is much less concerned about paying increasingly higher federal income taxes than Dr. South is?

TABLE 3-3 INCOME AND WEALTH CONTRASTS

Households ; Total Annual Realized Income ; Total Income Tax ; Tax As % of Realized Income ; Total Net Worth ; Tax As % of Net Worth. 

THE NORTHS ; $730,000 ; $277,000 ; 38% ; $7,500,000 ; 4 %.

THE SOUTHS ; $715,000 ; $300,000 ; 42% ; $400,000 ; 1%.

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2: Increased government spending and the federal deficit

Dr. South is very concerned about this issue. He believes that increased spending on the part of the government will translate into higher taxes on his income. Dr. North is not overly concerned for the reasons stated above.

3: A high rate of inflation

Dr. South is also concerned that such government action as increased spending and an increase in the deficit will precipitate a significant increase in the inflation rate. Dr. South has a moderate level of concern about this issue because he, like many UAWSs, keeps trading up to more and more expensive homes, cars, clothes, and so on. On the other hand, Dr. North feels that inflation will significantly increase the value of at least part of his investment portfolio!

4: Increased government regulation of business and industry

Most physicians feel that this type of government action is targeted at them. They interpret increases in government regulation as preceding the advent of socialized medicine. Both physicians feel that this would have a dampening effect on the fees they generate for their professional services. Dr. South indicated that this issue is of significant concern to him, while Dr. North viewed such action as only a minor concern.

Why do these two respondents perceive things so differently?

The actions of the government are often a threat to high-income earners who use most of their incomes to support their lifestyles. This is especially true when there is political gain for those in power in targeting the “wealthy.” Actually, the people the politicians are targeting are high-income earners. Most politicians don’t understand the difference between having a high income and having high levels of wealth. They have a more difficult time targeting people with high levels of net worth.

Most millionaires who are PAWs are self-employed. Being self-employed gives one much more control over one’s economic future than does working for others. Conversely, employees today, even high-income-producing executives,

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have less control over their livelihoods than ever before. Downsizing, for example, is taking its toll, even among the most productive employees. More often than not, even high-income-producing employees are not likely to be millionaires.

UAWs who are employees (not self-employed) are particularly vulnerable to external forces that threaten their ability to earn a living. We found that only 19 percent of PAWs versus 36 percent of high-income-producing nonmillionaires (UAWS) were concerned about having their jobs eliminated (see Table 3-4). But in spite of the “handwriting” that is often “on the wall,” even most high-income- earning employees are consumption-oriented.

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FINANCIAL GOALS: WORDS VERSUS DEEDS

Many high-income-producing PAWs and UAWSs share similarly stated goals concerning wealth accumulation. For example, more than three-fourths of both groups indicated they had the following goals:

◆ To become wealthy by the time they retire

◆ To increase their wealth

◆ To become wealthy through capital appreciation

◆ To build their capital while conserving the value of their assets

But having a set of stated goals does not necessarily mean that one is committed to achieving them. Most of us want to be wealthy, but most of us do not spend the time, energy, and money required to enhance our chances of realizing this goal.

TIME ALLOCATION

Most PAWs agree with the following statements, while most UAWs disagree:

◆ I spend a lot of time planning my financial future.

◆ Usually, I have sufficient time to handle my investments properly.

◆ When it comes to the allocation of my time, I place the management of my

own assets before my other activities.

TABLE 3-4 CONCERNS, FEARS, AND WORRIES: PAWS VS. UAWS

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% with High or Moderate Concern, Fear, and/or Worry: PAW¹= N155 ; UAW²=N=205 ; Significant Difference³.

 I. YOUR ECONOMIC WELL-BEING 

Not being wealthy enough to retire in comfort: 43 ; 60 ; Yes.

Not having an income high enough to satisfy your family’s purchasing habits : 31 ; 37 ; No.

 Having to retire : 20 ; 18 ; No.

 Having your job/occupational position eliminated : 19 ; 36 ; Yes.

 Experiencing a significant reduction in your standard of living : 44 ; 44 ; No.

 Never accumulating significant wealth 32 ; 42 ; Yes.

 Having your own business fail : 38 ; 32 ; No.

 Not being able to protect your family financially in case of premature death : 22 ; 32 ; Yes.

II. YOUR CHILDREN 

Having to support your adult children financially : 23 ; 17 ; No.

Having adult children who spend more than they eam : 39 ; 25 ; Yes.

Having children who are underachievers : 34 ; 30 ; No.

Finding that your adult children have moved back home :13 ; 11; No.

Finding out that your son/daughter married an unfit spouse : 36 ; 34 ; No.

Having adult children who think that your wealth is their income : 20 ; 18 ; No.

 IIl. YOUR PHYSICAL WELL-BEING 

Having cancer and/or heart disease : 61 ; 58 ; No.

Having visual or hearing problems: 47 ; 40 ; No.

Being mugged, raped, robbed, or burglarized : 38 ; 45 ; No. 

Contracting AIDS : 13 ; 11 ; No. 

IV. YOUR GOVERNMENT 

Increased government spending/federal deficit : 88 ; 78 ; Yes. 

Increased government regulation of business /industry : 82 ; 16 ; No. 

Paying increasingly high federal income taxes : 80 ; 79 ; No. 

A high rate of inflation :  64 ; 52 ; No. 

Having your famity pay high taxes on your estate : 65 ; 41 ; Yes. 

V. YOUR DOMESTIC TRANQUILITY Having your children feud over your wealth : 10 , 11 , No. 

Having your family fight over your estate: 17 ; 11 ; No. 

Being accused of financially favoring one adult child over the other(s) : 7 ; 8 ; No.

 VI. YOUR FINANCIAL ADVISOR 

Being swindled by a financial advisor: 26, 29, No.

Not receiving high-quality investment advice : 40 ; 33 ; No.

 VII. YOUR PARENTS, CHILDREN, AND GRANDCHILDREN 

Having your children exposed to drugs: 47; 59; Yes, 

Having your parent(s) /inlaw(s) move into your home : 12 ; 19 ; Yes. 

Having too little time to devote to your children / grandchildren : 44 ; 56 ; Yes.

¹The 155 PAWS in this sample had an average realized annual income of $151,656 and average net worth of $2.35 million, Their average age was 52.

²UAWS in this sample had an average realized annual income of $167,348 and a net worth of $448,618. Their average age was 48.

³Probability at less than 0.05 level.

Conversely, UAWs tend to agree with the following statements:

◆ I can’t devote enough time to my investment decisions.

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◆ I’m just too busy to spend much time with my own financial affairs.

PAWS and UAWS also differ in the amount of time they actually allocate to planning their investments.

Planning is typically found to be a strong habit among people who have a demonstrated propensity to accumulate wealth. Planning and wealth accumulation are significant correlates even among investors with modest incomes. In our survey of 854 middle-income respondents (see Table 3-5), for example, a strong positive correlation was found between investment planning and wealth accumulation.

One of the more interesting findings in our studies of the affluent relates to why many people spend so little time planning their investments. Many people who do little or no investment planning often feel the way these respondents did:

It’s hopeless....

I never have the time needed to make it pay off.

We never have made so much.... But the more we earn, the less we seem to accumulate.

Our careers take up all our time.

I don’t have twenty hours a week to fool with investing my money.

But PAWs do not spend anywhere near twenty hours a week in this way. If you study Table 3-5, you will notice that, on average, even prodigious accumulators of wealth do not need to devote a large proportion of their time to planning their investment strategies.

TABLE 3-5 INVESTMENT PLANNING AND DEMOGRAPHIC CONTRASTS: MIDDLE-INCOME PAWS VS. UAWS

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Planning for Investment Decisions (Average Number of Hours Allocated) : Wealth Accumulator: PAW  N=205 ; UAW N=215 .

Per Month : 8.4 hrs ; 4.6 hrs .

Per Year : 100.8.hrs ; 55.2 hrs .

Demographic Characteristics 

Age (Average Years) : 54.4 ; 56.0.

Annual Realized Household Income (Average/$000’s) : 51.5 ; 48.9 .

Net Worth (Average/$000’s) : 629.4 ; 105.7 .

Net Worth of $1 Million or More (%): 59.6 ; 0.0 .

Expected Net Worth! (Average/$000’s) : 280.2 ; 273.8  .

Realized Income As a Percent of Net Worth : 8.2 ; 46.3 .

Percent Self-Employed : 59.1; 24.7 .

¹ Expected net worth was computed via the wealth equation: expected net worth =1/10 age x annual realized household income.

We found that these middle-income PAWs spend an average of only 8.4 hours per month planning their investments. This translates to about 100.8 hours per year. Given that there are 8,760 hours in a year, PAWs allocate approximately 1.2 percent of their time planning their investments.

UAWS, on average, spend 4.6 hours per month planning their investments, or about 55.2 hours per year. In other words, PAWs spend an average of 83 percent more hours (100.8 versus 55.2) planning per month than do UAWs. UAWs allocate only 1 in 160 hours of their total available time to planning their investments. PAWS allocate 1 in 87 hours.

Will UAWs automatically become PAWS simply by doubling the number of hours they devote to planning their investments? Not likely. Planning is only one of many key ingredients in building wealth. Most PAWs have a regimented planning schedule. Each week, each month, each year, they plan their investments. They also start planning at a much earlier age than do UAWs.

UAWs, on the other hand, are much like some overweight people who occasionally starve themselves to reach their ideal weight. But more often than not, they regain all the weight they lost and more. UAWs may start the new year with a plan that outlines a variety of investment goals. 

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These goals may be the product of a couple of days of aggressive planning that specifies the number of dollars allocated to investments. Also included in the plan may be a significant “cold-turkey” reduction in the consumption of goods and services. More often than not, this “shock planning” and corresponding radical change in lifestyle are so severe that they do not work. The typical UAW, in this case, quickly becomes disenchanted with his new model for wealth building. Soon he “falls off the wagon,” once again breaking his promise of planning, investing more, and consuming less.

Many UAWs think that a professionally prepared plan will make them PAWs overnight, but even the best financial plans are ineffective if you don’t follow them. All too often UAWs think that others “can lose weight” for them.

The UAWs in such cases would greatly benefit from understanding how PAWS operate. PAWs do a little planning each and every month. Again, only about eight hours a month. UAWs might do more planning if they knew that it would not require them to “quit their day jobs”! PAWs build wealth slowly. They do not live a spartan existence, but they do have a regimen when it comes to balancing working, planning, investing, and consuming.

YOUR TIME IS YOUR OWN

The work factor is an important part of understanding the differences between PAWs and UAWs. Note in our study of middle-income respondents the percentage (59.1 versus 24.7) of PAWs versus UAWs who are self-employed (see Table 3-5). In this study, self-employment correlated significantly with planning investments. Overall, the self-employed spend more time planning their investment strategies than those who work for others. The self-employed, even those with middle incomes, typically integrate investment planning into their work lives. Most employees, in sharp contrast, have a set of job-related tasks that are independent of planning their investment strategies. Why is this so?

Those who succeed among the ranks of the self-employed never take their economic position for granted. Most middle-aged people who are self-employed have seen good as well as bad economic times. They tend to offset the inevitable changes in their revenue by planning and investing. They must build and manage their pension plans by themselves. They have to rely on themselves for their current and future financial situations. More often than not, only the well-disciplined self-employed survive economically over the long run.

But, you may ask, don’t these people work long and hard? 

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Yes, most successful people who are self-employed work ten to fourteen hours per day. In fact, this is why many employees shy away from even considering “going out on their own.” They want something less demanding. They want to be employees. But most workers, even those with middle-level incomes, also work long and hard. As for employees who earn annual incomes in the upper five or lower six digits, much of their time and energy is allocated to their jobs. They usually don’t have the benefit of writing their own job descriptions. And their occupational tasks typically don’t include setting aside a few hours per week to plan their investments. In contrast, the self-employed, especially in the high-income category, have a different set of occupational goals; one of them is to become financially independent. Conversely, employees are too often fully dependent on their employers. Thus they tend to be less self-reliant when it comes to planning their investments in a way that will facilitate accumulating wealth.

There is another issue to consider in the planning equation: UAWs spend less time planning their investments than do PAWs, in part because of the nature of their investments. UAWs consider cash/near cash and equivalents, such as savings accounts, money market funds, and short-term treasury bills, to be investments. UAWs are nearly twice as likely as PAWs to hold at least 20 percent of their total wealth in cash/near cash. Most of these cash categories are federally insured. Most are easily accessed when consumption needs arise. And, of course, it takes less time to plan cash-related investments than it does to allocate wealth the way PAWS tend to do.

PAWS are more likely to invest in categories that usually appreciate in value but do not produce realized income. They tend to have a greater percentage of their wealth invested in privately held/closely held businesses, commercial real estate, publicly traded equities, and their pension plans/annuities and other tax-deferred categories. These types of investments require planning. They are also the foundation for wealth. UAWs hold a larger percentage of their wealth in motor vehicles and other assets that tend to depreciate.

ACTIVE OR INACTIVE TRADER?

Nearly all (95 percent) of the millionaires we surveyed own stocks; most have 20 percent or more of their wealth in publicly traded stocks. Yet you would be wrong to assume that these millionaires actively trade their stocks. Most don’t follow the ups and downs of the market day by day.

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Most don’t call their stock brokers each morning to ask how the London market did. Most don’t trade stocks in response to daily headlines in the financial media.

Do you define active investors as people who, on average, keep an investment for days? Of the millionaires we interviewed, fewer than 1 percent of those who own stock are in this league. How about weeks? Another 1 percent. Let’s move up to those who, on average, hold on for months but less than a year. Fewer than 7 percent are “monthly” investors. Overall, only about 9 percent of the millionaires we have interviewed hold their investments for less than one year. In other words, fewer than one in ten millionaires are “active investors.” One in five (20 percent) hold, on average, for a year or two; one in four (25 percent) hold for between two and four years. About 13 percent are in the four-to-six-year category. More than three in ten (32 percent) hold their investments ĺlĺĺĺĺr more than six years. In fact, 42 percent of the millionaires we interviewed for our latest survey had made no trades whatsoever in their stock portfolios in the year prior to the interview.

The so-called active investor is one of the more difficult types of millionaires to find for interview purposes. He may be an ideal target market for stock brokers. He certainly spends considerable amounts for brokerage fees related to his trading. But he represents a very small minority of the millionaire population. In fact, we have encountered more non millionaire active traders than millionaires who actively trade. How can this be possible? Because it is very expensive to buy and sell, buy and sell, buy and sell one’s equity holdings each day or week or month.

Often, active investors spend more time trading than studying and planning their investments. Conversely, millionaires spend more time studying far fewer offerings. Thus, they can focus their time and energy—the resources needed to master their understanding of a much smaller variety of offerings in the market.

We have always been interested in studying the wealth accumulation habits of stock brokers. Compared with the members of other industries, stock brokers earn high incomes. They have access to large amounts of research data. Also, they pay less than other people when they trade securities because they earn their own commissions. Are all these high-income-producing investment advisors wealthy? Not by a long shot.

We have asked many stock brokers about this issue. Perhaps one individual stock broker stated it best when he told us:

I'd be rich if I would just keep ... [my stocks, but I] can’t help but make trades in my own portfolio. I’m looking at the screen every day.

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Keep in mind that this broker’s net annual income is in excess of $200,000. But because he’s a very active investor, he rarely allows the investment seeds he sows to grow. Any short-term realized gains he enjoys are taxed immediately. He is not the type of broker a millionaire prefers to patronize. Then what type do they prefer? Far less active investors. They prefer to deal with those who believe in buying based on considerable studying and then holding.

Let’s return to our case studies, Drs. North and South, to see financial planning in action.

COMPARING TIMES

Dr. North allocates about ten hours in a typical month, or 120 hours a year, to studying and planning his future investment decisions (see Table 3-6). In contrast, Dr. South allocates three hours a month, or fewer than forty hours a year.

TABLE 3-6 HOURS ALLOCATED: DR. NORTH VS. DR. SOUTH CONTRASTED WITH SAMPLES OF PAWS AND UAWS

HOURS SPENT IN AN AVERAGE MONTH FOR: Dr. North ; (PAW)N=155 ; Dr. South ; (UAW) N=205 . 

Studying planning future investment decisions :10.0 ; (10.0) ; 3.0 ; (5.5) .

Managing current investments : 20.0 ; (8.1) ; 1.0 ; (4.2) .

Exercising : 30.0 ; (16.3) ; 10.0 ; (16.7).

Who spends more time managing his current investments? Again, the answer is predictable. Dr. North, on average, allocates about twenty hours a month, or 240 hours in a typical year, for this purpose, while his counterpart reported spending only one hour per month managing his current investments. Certainly, this is a contributing factor to Dr. South’s low net worth.

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Dr. North is a focused investor. He has two favorite investment categories, agricultural land and stocks from the medical industry:

First, a fellow I attended medical school with ... He saved the life of a patient who believed in investing in grade A agriculture/orchards. My colleague invested and told me about it. He told me that these people were very honest. I met them and agreed. I have been investing ever since ... still investing regularly today.

I have made most in the stock market from the medical industry.... Drug companies and medical instrument companies ... I know this area. I do research on the medical... drug field.... That’s what Warren Buffett does ... invests in companies that he knows and understands. But you must have seed money [savings to invest] in areas you have knowledge. I have over $2 million in my profit-sharing plan.

Dr. South is responsible for making the major investment decisions in his family. It was his decision to have accounts at four different full-service brokerage firms. But surprisingly, Dr. South has less than $200,000 in securities. Then why does he have four different financial advisors? Because he believes, incorrectly, that he does not need to spend time making his own investment decisions. He admitted to us that he would be “really” affluent if he did not take advice from these so-called experts. But even bad advice does not come cheap. We estimated that Dr. South spent over $35,000 in a single year for advice and trades related to his poorly performing $200,000 portfolio. What about Dr. North? During the same period he spent zero dollars for transaction fees and zero dollars for financial advice. He is his own financial advisor. He rarely sells stocks. Also, there are no transaction fees for his direct investing in farmland and its products.

Dr. South, in traditional UAW fashion, has been burned by financial advisors. Too often people in his position respond to cold calls from brokers who are touting the stock of the week. Too often Dr. South is late entering the up market and exits it too early. In sharp contrast, most of the PAWs we have interviewed make their own investment decisions. They take the time and energy to study investment opportunities. They consult with financial advisors, but ultimately their investment decisions are their own.

Dr. South has a history of trading rapidly among his brokers’ “flavors of the  month.” He spends many dollars for these trades. If these “flavors” appreciate in value, they precipitate capital gains taxes. On the other hand, when stocks in a pension plan are traded, they are not subject to capital gains taxes. Unfortunately, Dr. South is not a big fan of pension plans. We estimated that he had less than $40,000 in his plan at the time of our interview with him!

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WHO ARE YOUR SUPPLIERS?

How did you hire your household’s financial advisor? Did you list the position in the help-wanted section of your local newspaper? Did you evaluate the stacks of resumes your advertisement generated? Or did you ask your accountant, attorney, or minister to help you find a quality advisor? Many people tell us that such methods are just too much work.

This is unfortunate. The more intellect, time, and energy you spend in hiring a financial advisor, the more likely you will be to find a suitable one. Perhaps you’re not convinced about the need to exert yourself in this task. Look at it another way.

How much time and effort did it take you to find your most recent employment position? What are the chances that you could call General Motors, IBM, or Microsoft and obtain a job today by phone? What theme would you use?

Hi, I’m a red-hot potential employee. I can greatly enhance the productivity of any department in which I’m placed. I’m smart, efficient, positive, personable, well groomed, resourceful, and have empathy for the needs of others. When do you want me to start?

Your chances of being hired by placing a telephone call, especially a cold call, are near zero. Then why do so many people hire their financial advisor after he or she made a cold call to them? Because they are not experienced in hiring employees.

Why aren’t you as wealthy as you should be? It may be because of the way you operate your household. Would a business, especially a very productive one, ever hire a key employee without doing a serious background check and an in-depth interview? No! Yet most people, even those with high incomes, hire

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