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Douglas P. McCormick
Douglas P. McCormick
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Americans are constantly bombarded with financial advice from well-intentioned organizations attempting to educate them on how to achieve financial security.
Unfortunately, such attempts regularly fall short. Most of this advice will not bring people any closer to financial security. While well-intentioned, most personal finance advice is ineffective because of three common shortcomings: it is too narrowly focused on financial assets; it is too simplistic to address the complex financial challenges most families face; and it is too tactical at the expense of holistic strategic planning.
Too narrow: Today’s financial education focuses exclusively on the narrow definition of managing money such as budgeting, saving, borrowing and investing. While these are critical skills required for financial security, they neglect the largest and most important asset owned by most families — their labor assets. Depending on skills and career choices, an individual can reasonably expect to generate between $1 and $3 million dollars in today’s purchasing power throughout a professional lifetime. Choices regarding education, industry, job selection and entrepreneurship impact a family’s financial health and security as much as any other decision they make. Financial literacy education must include labor management skills as a key pillar to achieving financial independence.
Too simplistic: Almost all of today’s financial literacy training is aimed at our least-educated and most financially-at-risk demographic, which means the material and content is appropriately basic. While this at-risk demographic is in dire need of appropriate advice, the rest of the population also needs sound advice as they navigate complex financial choices. Financial planning has become more complicated over the past several decades as individuals assume more risk and responsibility for their education, employment, health care and retirement. It’s time our financial literacy initiatives address such needs as we navigate this new reality.
Tactics without strategy: Today’s financial education offers tactical advice without a holistic framework for making financial decisions that are consistent with an overall customized strategy. Advice for budgeting, saving, managing debts and risk and retirement should be considered suspect if not offered in the context of a strategic financial plan that specifically acknowledges a family’s objectives, all of their assets (including labor), risks and time horizon.
Narrow, oversimplified personal finance advice without an overall strategy might make for catchy sound bites, but it does not leave Americans equipped to manage their real-world finances. True financial literacy is the result of identifying the key decisions that impact your family’s financial security, seeing how those choices are related and ensuring that they are part of an overall strategy that is customized to the family’s unique circumstances. To achieve this, I recommend viewing your family as a business — what I call Family Inc. — and, as the Family CFO, managing it the way a CFO manages a business.
The Family CFO is responsible for managing two primary assets: labor and financial capital. The labor business involves “selling” family members’ skills and energy for money, while the asset management business involves growing that money to support your spending needs today and in the future, long after you retire. This new paradigm allows the Family CFO to use many of the time-tested tools of the world of business to identify life’s important decisions, understand how to customize your financial plan to your unique circumstances and monitor your progress on the way to winning the financial game of life. This personal finance framework results in eight principles that will help the Family CFO manage and grow their family’s wealth:
1) Play defense before offense: Given that your labor is your largest asset, the first and most important investment is to protect this asset through insurance. Disability insurance, life insurance and liability insurance protects the family from the “going out of business” scenario.
2) Long-term planning starts with short-term contingency funds: Before you can evaluate investments for your long term financial security, you must have a cash reserve to buffer your family from unexpected setbacks. This is the most important role of your financial assets.
3) Maximize the value of your largest asset: There is greater opportunity to create significant wealth from investments in your labor than investments in financial assets. Your labor must be actively managed, and the principles of investing can be applied to your career choices to increase your expected lifetime compensation.
4) Adopt a real-world asset allocation program: Your asset allocation program must consider labor, Social Security and real estate assets — not just the value of your investments.
5) Adopt a risk profile consistent with your time horizon: With the exception of contingency funds or expected near-term large purchases such as a house, your time horizon for selling your investments is likely very long. Given this, you should be heavily invested in stocks versus bonds. In the long run, stocks are likely to deliver greater expected purchasing power with less risk than bonds.
6) Don’t confuse debt with consumption: Basic financial education often advises to avoid all debt. High-cost debt incurred to fund discretionary consumption — i.e. shopping and vacations — is best avoided, but not all debt is bad! Debt can be an important tool for the CFO to finance investments in labor development or appreciating assets.
7) Understand your risks in retirement: Volatility of investment returns is a significant risk for retirees. However, outliving your money, high costs of health care and inflation are often more problematic. These competing risks are best managed through an equity heavy portfolio complemented by insurance and annuities.
8) Family Inc. is only as secure as your succession plan: Your family’s financial security depends on someone at the helm who is knowledgeable and competent — don’t make the mistake of putting your family at risk because you haven’t trained your replacement.
While well-intentioned, the current tools and framework for financial advice are inadequate. Financial security is not achieved through simplistic saving tricks and stock picks, but through a holistic perspective of the financial game of life — Family Inc. — that promotes strategic and rigorous decision making about the major factors that impact long-term financial security such as education, career, spending, investing, insurance and retirement.
Douglas P. McCormick is the author of "Family Inc.: Using Business Principles to Maximize Your Family's Wealth." Currently Managing Partner at HCI Equity, McCormick has spent two decades managing money for institutional clients such as insurance companies, pension funds, entrepreneurs and high net-worth families, helping them grow their businesses to create sustainable long-term value. McCormick holds a Master of Business Administration from Harvard Business School and a Bachelor of Science in Economics from the U.S. Military Academy at West Point.
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