21 TMND : Case Studies

A TEACHER AND AN ATTORNEY: A CASE STUDY

Henry and Josh are brothers, but having the same parents does not mean that these two people are similar. Henry is forty-eight years of age; Josh is forty-six. Henry is a high school math teacher; Josh is an attorney and a partner in a modest-sized law firm.

The brothers are two of six children born to millionaires Berl and Susan, who accumulated their money by operating a successful contracting firm. The couple has always been generous with their children. Each year they have given Henry and Josh and their other son and daughters approximately $10,000 in cash. This gift giving did not stop when their sons and daughters became adults. Berl and Susan felt that such gifts would help reduce the size of their estate and thus reduce the inheritance tax their children would have to pay someday.

Berl and Susan also wanted to help their adult children get a good start in life. They felt that financial gifts would help their children ultimately become financially independent. Berl and Susan were always democratic about distributing their wealth to their children. Each adult child received the same size cash gift each year. In addition, each child was given approximately the same amount of money to help purchase a first home.

One might expect that the children in such families would become financially independent. Certainly, Berl and Susan felt this way. They always assumed that they themselves would have been even more successful if they had attended college and subsequently received cash gifts from their parents. But their parents on both sides were poor. Berl and Susan were successful because their parents gave them something other than money. Each was the product of a disciplined home life. Berl and Susan were not only well disciplined; they also taught themselves how to deal with adversity, and adversity made them what they are today—successful millionaires. Tough times in the contracting business drive out the weak and unproductive. Berl and Susan were never weak of heart and always ran a highly productive, low-cost operation. This applied to both their business and their household.

Even today this couple has never owned a luxury automobile. They have never been on skis, never traveled abroad. Nor have they ever joined a country club. But somehow they assumed that if their adult children could be exposed to the wisdom gained from college, travel abroad, and associating with higher- status people in general that they would outperform their parents economically.

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Berl and Susan were wrong in making such assumptions. The children of affluent parents don’t automatically perform as well as their parents in terms of accumulating wealth. This is not to say that the Henrys and Joshes of America will never outpace their parents. Some do. But they are a minority among all the children of the affluent. It’s important to note that the children of affluent parents have (in today’s dollars) about a one-in-five chance of accumulating wealth in the seven figures during their lifetimes, while the average child in this country whose parents are not millionaires has about a one-in-thirty chance.

Are any of the children of Berl and Susan millionaires today? No! But one is more likely to become a member of the seven-figure (net worth) club soon. Will it be Henry or Josh or one of the other children? Berl and Susan’s other children are considerably younger than Henry and Josh. Certainly age is a correlate of wealth accumulation. Young adults are not likely to have accumulated considerable wealth on their own. Also, the other four children have not been receiving economic outpatient care (EOC) from their parents for the same length of time as their older brothers.

Many observers might predict that Josh would more likely accumulate a seven-figure level of net worth before his brother. It is certainly understandable that they would feel this way. Attorneys typically generate significantly higher incomes than high school teachers. Once again, income is highly correlated with wealth accumulation. Last year Henry’s total household income (not including the gift of cash from Berl and Susan) was $71,000; Josh’s Was $123,000. One would assume just from these figures that Josh would be much more likely to accumulate wealth. After all, his income is nearly twice that of his brother’s. But observers who make such predictions overlooked the fundamental rule regarding wealth building.

Whatever your income, always live below your means.

Henry, in spite of his smaller salary, lives below his means. Josh, on the other hand, lives substantially above his income. In fact, Josh “really counts on that $10,000 from Dad and Mom to keep in balance.” The $10,000 added to his $123,000 income places him in the top 4 percent of all income-producing households in America. Remember that approximately 3.5 percent of the households in America have a net worth of $1 million or more. But Josh has a net worth that even optimistically estimated is well beneath that figure. His total net worth, including the equity in his home, law partnership, pension, and other assets is $553,000.

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How about Henry? In spite of his much smaller income, Henry has accumulated significantly more wealth. Stated conservatively, his net worth is $834,000. How is it possible for a teacher to have so much more wealth than an attorney with nearly twice the income?

Stated simply, Henry and his wife are frugal; Josh and his wife are heavy consumers. Much of this difference is related to their respective positions. We find that, as a group, teachers are frugal. Additionally, attorneys who receive cash gifts from their parents spend more and save and invest less than do attorneys who are comparable in age but receive no gifts. As stated earlier, attorneys who receive cash gifts from their parents have only 62 percent of the wealth and 77 percent of the income of attorneys in the same age bracket who receive no gifts (see ‘Table 5-2).

Where do teachers who receive gifts rank along the dimensions of wealth accumulation and income? Households headed by teachers who receive cash gifts from their parents have, on average, 185 percent of the net worth and 92 percent of the annual household income of those in the same occupational and age category who do not receive cash gifts.

Teachers who receive gifts are more likely than nonreceivers to teach in private schools, which generally pay their faculty lower salaries than do public schools. Perhaps unknowingly, many of the Berls and Susans in America are subsidizing private schools by giving cash gifts to their adult children. This, in turn, may encourage people like Henry to be willing to work for less money in a private school. Henry may figure that since he receives economic outpatient care (EOC), he does not need to earn a few thousand dollars more teaching in a public school. And although he teaches at a private school, Henry is quite comfortable driving his four-year-old Honda Accord or his wife’s minivan.

By contrast, Josh is in a completely different environment. In fact, the office complex where he parks his car is filled with imported luxury sedans and sports cars. Josh is responsible in part for new-business development for his firm. So even if he would like to drive a four-year-old Honda, his clients and prospective clients might not wish to ride along with him. They might get the wrong impression.

Josh and his wife have three late-model automobiles. These include a 7 Series BMW and a seven-passenger Volvo, both leased, and a Toyota Supra. His consumption habits regarding motor vehicles are similar to those of other consumers who have significantly higher incomes. Josh spends three times more on average than Henry for motor vehicles.

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Josh also spends nearly twice as much as Henry in mortgage payments. Josh lives in a larger, more luxurious home, in a so-called prestigious subdivision. Henry lives in a much more modest home in a middle-class neighborhood. Henry’s neighbors are teachers, middle managers, civil servants, and store managers. Henry and his family blend in nicely in this neighborhood. The consumption habits they display are very middle class. This is true even though Henry’s household has four to five times more accumulated wealth than its typical neighbor.

What about Josh’s neighborhood? His primary residence (he also has a time- share in ski country) is in an upscale neighborhood. His neighbors are high- income-producing physicians, senior corporate executives, top-earning sales and marketing professionals, attorneys, and affluent entrepreneurs. Josh feels comfortable in this environment, and it is ideal for entertaining clients as well as associates. But there is something Josh does not realize: Although his income is in the third quartile compared with that of his neighbors, he is near the bottom in terms of his household net worth.

Josh and his family are playing the role of those with two, three, and even more times the net worth they have. Josh, you are not alone. At least one in five households in your neighborhood is playing the same role. They, too, are on outpatient care. They, too, spend more and invest less than others in their area.

How does Josh’s budgeting system operate? How does it accommodate his propensity to spend? Josh is like many other under accumulators of wealth (UAWs). He spends first. He saves and invests what is left over. What this actually means is that he saves and invests nothing beyond what happens to be injected into his pension and profit-sharing plan. More than two-thirds of his wealth is the equity in his home, his partnership, and his pension. In essence, Josh and his family invest zero dollars from their personal income. But perhaps they feel affluent anyway. Josh does receive $10,000 in cash each year. And he anticipates inheriting much more someday.

But what about Josh’s children? Are they likely to receive substantial cash gifts from their father? It is very unlikely. Yet these children are growing up in a high-consumption environment. They will likely attempt to imitate their father’s consumption behavior. This is a difficult act to follow, especially without the help of substantial outpatient care.

Henry’s children, in contrast, may be surprised to learn that their father has accumulated a small fortune. Henry and his wife have never overextended themselves. Henry looks like a teacher, drives what teachers drive, dresses like a teacher, shops where teachers shop. He has none of the designer artifacts his brother owns. Henry has no pool, no sauna, no hot tub, no sailboat, no country club membership. He owns two suits and three sports jackets.

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Henry’s activities are much simpler, cost much less, and are much less status- oriented. He exercises by jogging every other day. He and his family are avid hikers and campers. They do own two tents, several sleeping bags, and two canoes (one used). Henry reads a great deal and is active in his church and its affiliated youth group.

His simpler lifestyle translates into surplus dollars, which are saved and invested. During Henry’s first year as a teacher, a senior member of the faculty advised him to enhance his investments by contributing to a 403b deferred annuity program. Henry has contributed to this program each year since he has been employed as a teacher. He has also invested most of the cash gifts his parents have given him each year.

Who will be more likely to retire in comfort someday—Henry or Josh? Their parents are now distributing their capital not only to their children but also to their grandchildren. Thus, Henry and Josh may inherit very little. At the rate Josh is consuming, he may never be able to retire in comfort. Henry will likely retire with ease. Projections are that his combined pension, deferred annuity package, and investment portfolio will be substantial by the time he reaches the age of sixty-five.

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