by Frazer Rice
“You know what law partners make,” he said, “and on top of that, I have some dough squirreled away from when my father died.”
“Yes,” I said, “but I also know that if you aren’t in the office or on the phone, you’re probably washing your hair in champagne while taking an Uber to the Hamptons!”
“True,” he said.
“I’m less worried about what you’re making now—or even what you cost now,” I said. “I’m worried about what you’ll cost in five, ten, twenty years, and whether you’ll have the assets to cover it. It gets expensive fast around here.”
“I feel like I have things under control,” he said.
“Well, it seems that way, but what do you really want to do with yourself?” I asked.
“Huh?” he said.
“What happens when you get hit by Cupid’s arrow and you’re ready to get married? What about having kids? And if that’s not in the cards, what about retiring early or starting a different business?” I asked.
“Oh God,” he said, realizing he’d never thought about this or had been ignoring the question in his own mind. “I have absolutely no idea.”
“I think the point is that you may know how much you cost now,” I said. “The real question is how much are you going to cost?”
To Begin, Clarify Goals and Resources
Asking someone to answer the question of how much they’ll cost in the future is about as subtle as oncoming sidewalk traffic in New York City. As with many wealth planning issues, the answers to that question rely on both tangible and intangible goals. To help my friend clarify his goals, you’ll notice that I sneakily inserted some additional framing questions before asking the big one:
What are you looking for now and in the next few years?
What experiences do you want to be part of your life?
What are the things you aspire to have?
My friend is handsome, upwardly mobile, funny, and just at the start of his prime earning years. There are lots of people who fit that description but squander the opportunity to enjoy the present while planning for their (or their family’s) future. It is a crying shame when wealth dissolves because people don’t understand their cost structure. The conversation got uncomfortable because I pushed him to think more deeply and imagine exactly what he would be looking for if he were ready to make the break from his swinging bachelor days.
“What do you want—really want—for your life?” I asked.
It was a hard question, and the discomfort was intentional. He gave it some thought, while arching his eyebrows and furrowing his nose. After some hemming and hawing and laughing (along with a drink or two), he started answering the questions.
“I’d love to settle down eventually and have a couple of kids,” he said. “I’d like a couple of houses. And you’re right—this law partnership stuff will wear me out eventually. It’s like a pie-eating contest where the prize is another pie. I should open my own practice and buy some commercial real estate in Fairfield County so I can spend time with my future family in my future homes.”
“My God, the cost of that alone is probably $10 million!” I told him.
He wasn’t finished. “I want to be able to travel. Eventually, I want to take some time to write a book and work on some other real estate projects,” he said.
Travel is an investment of both time and expense. Real estate would be a capital-intensive work commitment. A book is expensive from a time perspective and can cost a lot in terms of research and resources—which I have learned from personal experience!
“You’re talking really big bucks here,” I said.
By the time we were ready to order our dinner, he discovered there was nothing on the menu he could eat because he’s a vegan. That sealed it.
“A vegan partner at a New York law firm? You’ll be withering away in the hospital in no time!” I joked.
Our conversation didn’t make my friend’s graduation to real life any easier, but understanding his goals and their costs revealed a current flaw in his thinking: it didn’t extend beyond his next summer plans. By taking the first step toward developing future goals, he took the first step in answering the question, “What will you cost?”
“How much do you cost?” is one of the most important questions I ask my clients when advising them on the structure and planning of their wealth. In my friend’s case, the determination of his life goals will anchor his future cost structure. That cost structure will impact the definition of success in investments and wealth management.
If you’re on a first date and ask someone what he or she costs, the initial response may be a white dinner glove smacked across your cheek. However, all joking aside, this is a necessary question to ask of yourself and answer honestly. Your advisors need to know this information to give you good counsel.
You may have $10 million parked in the bank but still not feel that it will enable your happiness. The amount of your wealth is irrelevant if you don’t understand your costs. If I do not know how much a client “costs,” it’s difficult for me to provide a good framework and context around the management of their wealth.
Your current and future costs (and the sacrifices they require) are always in play, even for people with extreme wealth. For those of significant wealth, this knowledge serves as the linchpin of legacy wealth management. When you think about wealth decisions through the lens of your costs, you’ll make better-informed decisions and avoid the wanton spending that dilutes the resources needed for your long-term goals.
This perspective is especially important for individuals who have a sudden increase in their wealth. They may spend a crazy amount in the first year without understanding the numbers and effects of their actions. They may not realize their life and legacy extend beyond one year, and excessive spending sets them up for disappointment in the future. If they step back, take a deep breath, and think about the enjoyable life they want in the future, they could embrace a more measured approach to their spending and usage of resources.
The Common Costs to Consider
There is a long list of factors to consider when determining what you cost. Let’s begin with the most impactful factor for most people: real estate.
Real Estate
Real estate is one of the most important components to consider, because real estate has the potential to become your largest unnecessary cost when analyzed against your goals and values.
Real estate is popular with most people, especially the wealthy. Many people make real estate choices based on social mobility, pleasure, convenience, proximity to work, and access to schools. For the wealthy, property ownership can also be a way of keeping score and benchmarking how they measure up against others. For all these reasons and more, real estate can be many people’s largest expenditure.
You can think of a home as an investment that will gain value. That’s terrific, but you won’t be able to see that benefit until you sell the property. There is nothing wrong with the desire to live in one or more attractive and appealing homes. In fact, there are a lot of things that are right about it. However, you can punch a deep hole in your wealth with real estate spending that does not advance your life goals. Excess personal real estate spending should be viewed as a form of consumption, not as an investment. (By the way, consumption, in the proper context, is not a bad thing.)
You may be enraptured by a place you just visited for the first time and, as a result, begin thinking of purchasing a second home there. However, additional homes are a wide Rubicon to cross. The real estate may ultimately rise in value, but it can be a major draw on your assets.
As you climb the ladder of real estate consumption, properties and expenses begin to multiply. The flat in London leads to the house in Southampton, then to the apartment in New York, and the ranch in Montecito. Owning those properties might be fun and open the door to interesting experiences, but each
home needs attention. Each property carries a tax bill, utility costs, and maintenance expenses.
Additional homes rarely produce income to offset their expenses. Because of this, a perceived profit in the sale of real estate can actually be a loss when expenses are factored in. If you purchase a property for $10 million and sell it five years later for $11 million, it’s easy to believe you’ve profited by a million dollars. However, if the expenses of the property were $300,000 per year, or $1.5 million total over five years, you’ve lost half a million dollars. Expenses involved in owning real estate—especially luxury real estate—can rise as fast or faster than inflation. Property taxes alone can rise significantly and unexpectedly.
Even if you rent your property for income, you’ll have to pay for insurance and management. Who will respond if the radiators stop working or if the water main breaks in the middle of the night? What happens if the renters have a big party and wreck the place? What happens if someone drowns in the pool? Also, real estate can be difficult to maneuver in times of trouble. You wouldn’t want to be forced to sell in a down market just because you’ve hit financial difficulty.
If you own three homes, you can’t be in all of them at once. There is only so much time in a year to enjoy each home. Would it be better to tap that same satisfaction in a rental environment where you pay for what you use, rather than owning the property and paying for its maintenance year-round? For instance, if you’re thinking of buying a second home in Aspen, does that come from your desire to ski? If so, that’s a seasonal interest, and it may not be worth the year-round costs of ownership.
If your resources are finite and you overspend on real estate, the tradeoff may require expensive sacrifices in other areas of your life, your kids’ lives, or in the legacies you want to leave. Instead of paying $12 million for a Southampton house, you may find that a $200,000 summer rental could provide the same enjoyment with less commitment and risk to your current and legacy wealth.
Even when you’re dead serious about buying another property, there is another advantage with renting: it can help inform your decision. Let’s say you want a second home near Los Angeles. Do you like Malibu? Do you like the Hollywood Hills? Would you rather go up to Santa Barbara or Montecito, or even Napa Valley? You can rent a property in those places to determine the best match for you. I’m a big believer in living in a new place before taking the plunge into real estate in the area, especially when a large financial commitment is at stake.
It’s important to be honest with yourself about what you like and don’t like and understand what you are trying to achieve when considering the purchase of real estate. Trying to keep up with the Gateses, Musks, and Kardashians is a shabby reason to make a serious financial commitment to an alluring (but illiquid) asset like real estate. If costs aren’t monitored and controlled, high-end residential real estate—even spectacular real estate—can put you on a dangerous treadmill that can run down your long-term wealth.
Education
Education has become a massive expense—even for the well-heeled. Parents today are not only educating their children to age twenty-one but also through graduate school, driving that timeline to age twenty-four and beyond. In addition, the grandchildren’s education is increasingly important for grandparents who want to see their families have the chance to develop and thrive while they’re alive. It can be one of their most rewarding and lasting investments in their legacy.
Education expenses begin well before college. Nanny or childcare expenses come first, followed by lessons in a variety of skills, sports, and vocations. I have a colleague who has his son taking lessons in piano, jiu-jitsu, and golf—all at the age of four. Talk about hedging your bets! Some families view this early indoctrination as a way to distinguish their kids in the hypercompetitive world of school admissions.
At each point in a child’s development, there is pressure for achievement and advancement. This explains the crazy stories of the hoops people jump through to get their kids into the highest-ranked New York preschools. For children as young as two years old—kids whose true abilities are at the level of finger painting—the costs of private tutors and nannies are already explosive. For older children, there might be private lacrosse lessons, figure skating sessions with Katarina Witt, physics tutors, and more.
In most major cities, private day schools run in the $30,000–$40,000 range each year. At the high school level, boarding schools are at least $50,000 annually. Private college today costs as much as $70,000 a year for undergraduate studies. Then, because most people feel a bachelor’s degree is no longer enough in today’s competitive world, the expense of graduate school begins.
The scary part is when one’s college degree is in a rigorous concentration with no traditional occupational track, such as art history. You may have spent a million dollars on the education of someone who cannot support themselves in their chosen vocation. If student loans financed an entire private education, the type of life ahead will be severely limited by the debts. For example, if you graduate with $600,000 in debt, and you’re making only $90,000 a year, you’ll never catch up without help. The loan principal and the interest are just too much. This has other ramifications. It will be a stretch to have enough for a down payment on a house, and starting a family will be difficult financially.
It’s perfectly fine to make one or more of your children happy by bankrolling their educational choices, but you’ll need to understand the immense financial commitment. In developing good financial habits for their children, some wealthy people require their kids to assume responsibility for at least a small part of tuition. I think that’s reasonable once a student finishes high school, and it helps them value the funding of their education. It’s an even better idea to make this a condition of graduate school, because it helps the student avoid mistakes.
I’m a good example. I was extremely lucky to have had my private school educations paid for through college. Rightfully, my parents had had enough and made it clear that graduate school was my responsibility. I financed my law school education with loans, and having that responsibility altered my behavior significantly. Most of my decisions were informed by the need to both support myself and pay down the loan, which I viewed as an investment in myself. When I pivoted away from legal practice into another career, I was able to do that without too much bloodshed because I was aware of the financial responsibility and the consequences of poor decisions. Some heavy metal group may have been deprived of its lead singer, but I was able to get that loan paid down quickly. I moved on into wealth management with a good personal lesson in controlling one’s own debt. Many people can’t do that. They enter graduate school without understanding the ramifications of that choice five years down the road and are buried in debt with a degree they don’t use.
As a wealthy person who may fund the educational aspirations of your children and grandchildren, be clear on the investment you are making and why you’re making it. Make sure that these answers are communicated to your kids and grandkids so they get a sense of your sacrifice and how important this allocation of resources is to you. Don’t expect a quick payback, financially or emotionally. Consider getting your kids involved in the costs of their own education. You can always help them with the debt later, if they need that. Last, assume that the costs of education will continue to rise. Education expenses have exploded in recent years and there is no sign that they will stop—especially at the higher-quality schools. With that in mind and given that spending for education is one of the most tax-efficient ways to transfer wealth to the next generation, planning for this expense should begin shortly after the birth of the child.
Healthcare
As a person ages, other medical expenses and prescription drugs may be needed to lead an active lifestyle. Hip and knee replacements, pacemakers, neck surgeries, eye surgeries, and hair transplants are common costs toward an improved quality of life. The roster of products and services may
grow longer as technology improves, and the accompanying expenses will ramp up in tandem.
When it comes to lifesaving and life-extending expenses such as cancer treatments, grim diagnoses are not commonly built into the budget. They should be, however—even for the wealthy. For the well-heeled, second opinions from the Mayo Clinic or other top-notch medical facilities are almost standard operating procedure today. However, access to that level of healthcare is increasingly exclusive and expensive. It’s safe to assume there will be out-of-pocket expenses for treatments, including the possible costs of medical tourism—treatment in less expensive places such as Europe, South America, or Canada.
It’s still early in the world of concierge medicine, but it will likely become a gigantic industry serving the wealthy. Regardless of what happens with traditional insurance or the Affordable Care Act (better known as Obamacare), people with resources will pay handsomely for the privilege of using the doctors they want and trust. To ignore the personal finance impact of that is folly. It’s worth paying attention to that cost when you can do something about it.
To mitigate the later-stage medical expenses, there is an entire specialty within the legal industry known as elder law. It has developed to operate within the frameworks of governmental systems that determine your access to and costs of late-in-life medical options. Assisted care facilities are a good example of where elder law services come into play. Assisted care facilities are businesses with investors, and they need to grow and generate cash flow. These facilities can receive their revenue from the government or directly from the incoming residents, and the facilities can charge wealthy people more based on their assets.