Wealth Management in the New Economy

Investor Strategies for Growing, Protecting and Transferring Wealth

Norbert M. Mindel, Sarah E. Sleight

• Publisher: Wiley
• Year: 2009
• ISBN:
  9780470590102
• Edition: 1
• Topic: Commerce
• Subtopic: Gestion de patrimoine

A practical guide to managing wealth in modern times

Wealth Management in the New Economy addresses a wide array of wealth management topics and established financial theories. Author Norbert Mindel has successfully advised his clients for more than three decades in the business. Now, with this new book, he shares the wisdom he has acquired and offers valuable insights into successful wealth management in an economy that has changed dramatically over the past year. Along the way, Mindel explores the essential aspects of this discipline, including the keys to wealth creation, properly managing risk, asset protection, planning for a prosperous retirement, and many other issues that you need to understand in order to survive and flourish in today's economy. While market forces are far too complex to be fully predicted or exploited, it is still possible to protect and grow your-or your client's-wealth. Wealth Management in the New Economy will show you how to achieve this important goal.

• Reveals how you can reduce market risk by using proven theories of portfolio management
• Written by accomplished financial advisor, attorney, and CPA Norbert Mindel
• Lays out strategies wealth managers and investors both can use to protect and grow wealth in the new economy

For practical financial guidance you can count on, look no further than Wealth Management in the New Economy.

PART I

Evolution of a Wealth Manager: My History, World, Experience, Clients, and Company

CHAPTER 1

Starting Out

In this chapter, I explain the first origins of the investment philosophy that now guides the way I advise my clients. Since investment philosophy in itself can be not only dry but abstract, I want to breathe life into that philosophy by offering it in the most personal way possible, as the story of my own education as a wealth manager. My story in this chapter and the next one will introduce the main concepts that I spend the rest of this book discussing. I hope that the personal context will make the concepts more easily understandable.

Inflation, Stagflation, and High Interest Rates

Before I begin this discussion, I think it is important for me to provide the briefest macroeconomic context for the period 1978-1982, when this story begins. In 1971, President Richard Nixon slapped wage and price controls on the economy in response to what was termed raging inflation (4.5 percent). That worked well enough in the very short term and backfired massively in the longer term, arguably resulting in both stagflation at the end of the 1970s and the inflationary cycle of the early 1980s. Remember stagflation? It is a macroeconomic term for a period of inflation combined with stagnation or slow economic growth and possibly even recession. Inflation was now really raging in a way it had not been previously—11.2 percent in 1979. Under President Jimmy Carter, the Federal Reserve enacted monetary policies to combat inflation, including raising interest rates significantly. The first effect was more pain, as inflation hit 13.6 percent in 1980. Meanwhile, economic growth had mostly ground to a standstill, and unemployment hit a high of 9.7 percent in 1982. Then the world economic system got a big jolt when OPEC first flexed its economic muscles and raised crude oil prices fourfold in 1973. We experienced some of the worst down markets in recent history in 1973 and 1974, with a mini cycle that ended in 1975.

Interest rates in the bond market tracked the rising inflation rate. The long bond yield hit a high of 15 percent in October 1982. Mortgage rates touched 18 percent in 1981. The housing market came to almost a complete standstill. There was little technology and no technology boom in those days; the Internet and electronic trading were still far in the future. The highest marginal tax rates were 70 percent or more and did not come down until the start of the Reagan administration. Those rates led to many investments that made little economic sense but sheltered income taxes. For affluent individuals, tax planning and investing were driven above all by this high tax bracket and trying to avoid taxes. It was a strange time.

Finding Partners

At the beginning of my career as a financial adviser, I never thought I was smart enough by myself to know how to invest for my clients, and I spent years looking for the Really Smart Guys who were going to teach me how to invest. I learned over time that, in fact, those guys were not really that smart—although they were certainly greedy—and never had the best interests of my clients at heart. They got paid their billions—some of them—and I did not. I don’t know what happened to all of them, but I am still here.

I know that lives have turning points. You get up in the morning and have breakfast and walk out the door without knowing that, by the end of the day, the entire direction of your life will have changed. My life changed in that way at a lunch my partner Joe Hudetz and I had with Dave Reedy in 1979. I walked into the restaurant as a young attorney without a real direction, and when I left, I had found one of the individuals I would spend most of my business career in partnership with.

In the Introduction to this book, I mentioned the law business Joe and I had established in 1978. We specialized in networking lunches in our first year in business, as we struggled to get a toehold on enough business to sustain us. Joe knew Dave Reedy from high school and we solicited him and his partner Tom King for business.

The year 1979 was a bad year for us to start out in business; it was a terrible year for real estate businesses like Reedy-King. Stagflation and high interest rates were strangling the real estate market and traditional real estate firms were forced to reconsider how to stay in business. Dave and Tom had decided to branch out.

Dave and Tom asked if we had experience in real estate syndications and tax-deferred exchanges, both of which required a high degree of expertise in securities and income tax law. Dave hired me to write the offering memorandum for the first apartment building that he was going to offer as part of a limited partnership. Of course we assured him that I had the expertise this job required, and then spent weeks learning everything I could about real estate and securities law. The three of us quickly became fast friends.

As it turned out, this new business worked so well for them that they had to diversify beyond selling only their own deals, and this required a fundamental change in their business organization. You can sell your own limited partnerships privately but you have to get a securities license and belong to a broker-dealer to sell deals that you did not originate. In effect, at that point you are selling securities and you have become part of the highly regulated securities industry.

Dave and Tom also wanted to try financial planning. They believed the new fledgling industry called financial planning would become important. We all saw the limitations of focusing solely on real estate, and they wanted to expand their expertise and offer more services. Dave and Tom were already dealing with a wealthy, sophisticated client base that could use these services, although the International Association of Financial Planning (IAFP) had only just come into existence. No one really knew what a financial planning firm was, although I, too, was intrigued by the idea and imagined it could be a great business to meet successful people with vision and drive and be paid for one’s expertise.

Founding Terra

For all these reasons, we decided to form a company. Dave and Tom founded Terra in 1981 and I soon joined as partner: Dave, Tom, and I were the original three partners. Dave used his Catholic education to come up with the name of Terra Securities, from the Latin word for earth or ground—a good name for a firm that began with real estate and was transitioning to securities.

At the beginning, we only wanted to find a larger broker-dealer with which to affiliate. Therefore, we attended the second conference of the IAFP held, ironically, in Las Vegas. There would be 20 or 30 brokerage firms at the convention and we thought they would all be interested in talking to us about our financial planning business and real estate partnerships.

Tax Shelter

Put simply, a tax shelter is a method to reduce taxes; taxpayers in general will always have more money left after taxes if they can increase the amount of tax deductions. In investment terms, a tax shelter makes money for the investor more from producing income tax deductions than from producing profit from the deal. If your income tax rate is approximately 35 percent—as it is likely to be at the time I write this book—then $1,000 of tax deductions will put approximately $300 in your pocket. If you look at the highest marginal tax rates at the time we are talking about—the late 1970s and early 1980s—then you can see that $1,000 of tax deductions could put on the order of $700 or more in your pocket (some deals gave $2 of losses for every $1 of investment). Then consider that it might be much easier to structure some investment so it can generate losses rather than profits. Now you have a tax shelter.

At that time, broker-dealers in our channel sold only tax shelters in the form of real estate limited partnerships, which basically consist of at least two persons: a general partner, who has unlimited liability, and a limited partner, whose liability is limited to the amount invested in the company. Limited partnerships are often used as a vehicle for raising capital, due to the limited liability for the limited partner. A real estate limited partnership would of course have been created for the purpose of investing in real estate.

The limited partnerships we saw at this conference went beyond real estate to include wacky tax shelters like gems, Christmas trees, oil, and lithographs. There were oil and gas drilling limited partnerships, movie deals, leasing deals, guns; I remember seeing the racks of guns. They were raising money for anything you could think of and creating big tax losses. It was one great sleazy group of people—way too sleazy for us. There was no way we would be able to join any of those organizations. As it turned out, most of those broker-dealers were eventually driven out of business for all the usual reasons, mostly bankruptcy. Even some of the financial planning on display was like something from an alien universe. No one was thinking about mutual funds or the stock market. There were just a few, barely perceptible signs of the first credible vendors and mutual funds that would play a significant role in building this industry.

It had not yet occurred to us that we should form our own introducing broker-dealer. At that time, you could form an introducing broker-dealer with only $5,000 in capital, but there would then be restrictions on the kind of business you could do. It turns out to have been an extremely fortuitous decision, but in fact we started it only so we could legally get into the financial planning business.

And yet, as we started up with Terra, our small group was captivated by the notion of changing clients’ lives in a positive way. We were young; we thought we were smart; and we wanted to establish a good business and embrace the new world of financial planning so that we could help our clients in ways that had not been possible for us before.

As it turned out, founding our own company was exactly the right thing to do, but we did not realize then what a good decision it would turn out to be.

Creating a New Business Model

Acquiring new clients one by one is one way to establish a new business, but you get more leverage when you use centers of influence. From the inception of Terra Securities, Dave Reedy, Tom King and I were aware of the advantages of marketing through centers of influence such as tax professionals and other lawyers. The idea, obviously, is to woo them so they refer business to you. Accountants are preferable even to lawyers because they have a regular client base and are highly respected. Furthermore, they are perfectly placed to see when an individual has cash to invest or has made a bad investment or could use some investment advice. (I use the term tax professional rather than accountant or CPA because not every accountant is a CPA, but I am afraid that when using these terms casually, I—like most people—tend to use them interchangeably.)

So at first, Dave took referrals from accountants but he did not have a way to pay them aside from an annual bottle of J&B every Christmas. The securities laws made it illegal to pay them (because you had to be securities licensed to share in the commission), so it was not a lucrative arrangement for an accountant.

The governing body for accountants is the American Institute of Certified Public Accountants (AICPA). When Terra was first formed, the AICPA had a rule that its members could not be in the financial services business. Fortunately for us, just at the time we were getting started with that idea of working with accountants, the Federal Trade Commission (FTC) sued the AICPA and the latter had to change its rule. This was a transformative change.

Finally it occurred to us that we would still do the sale but the accountants we worked with should acquire the necessary licenses so they could get paid a portion of the commission or fee from securities transactions completed with their clients. It was not a matter of getting accountants to try to sell securities themselves; the central issue was our being able to share commissions legally with them. We thought we had really discovered a new business model! It was a novel idea to have them get licensed so that they could not only provide advice but also get paid if we provided the advice.

Building the Business Model

While we were figuring out the business model that was to carry us forward, my friend Brian Savage joined us in 1984. Brian was a CPA with a practice based mostly on tax preparation. We bought his business by making him a co-owner/partner of Terra Securities and moved him into the office with us. Since Terra had a value of basically zero, it was a good buy for us to trade part of our practice for his.

Like many accountants and tax professionals, Brian’s tax business required him to work from 8:00 A.M. to 8:00 P.M. during tax time, and people just rolled through his office. Brian would finish his tax appointment, then walk that client into an adjoining office and say, “Talk to Dave.” Dave would try to sell the client a mutual fund for an IRA or something. It was the easiest way to get new clients that we had ever experienced. Our epiphany was the realization that by affiliating more closely with more tax professionals, we could revolutionize the whole way we prospected and did business.

Although at the time tax professionals saw commissions as a huge conflict of interest, in1984 we brought in the very first outside accountant that we did not make a partner in the business. Our idea was so revolutionary that we then stopped looking for new clients and started looking for tax professionals who had 300 to 400 clients so that we could leverage their business. I could spend all my time building a book of business with my own 300 to 400 clients, or I could find one individual who already had those 300 to 400 clients and work with him on the securities business and split everything with him. That was the basic concept.

We realized that we had discovered a great business model because accountants were already in a position of trust with their clients and wanted to broaden and diversify those relationships. As time went on, we developed ways of talking to, educating, and serving our customer base.

Accountants are both risk-averse and analytical, which fit extremely well with our risk-averse, asset-allocation approach. The greatest risk an accountant faces is losing his or her clients. We found accountants to be a tough constituency: they wanted the right product at the right price for their clients, and that became a driving force in how we looked at money and investments.

Accountants are just not motivated by money: Their client is their most important asset, so they will not do anything to abuse that trust. Furthermore, an accountant already has a way of earning a living and generally will not push product sales to clients just to get some income.

Evolution of the Business Model

Working with a few of the pioneers was one thing. At some point, we realized that our doing the presentations for every accountant was not creating a scalable model for our business. It was just impossible for us to visit every accountant for every $2,000 IRA investment.

We decided that instead of trying to send out Terra principals for every sale, we would develop very robust marketing, training, and compliance so these accountants could do it on their own; that was what the model eventually evolved to. Here was our value proposition to accountants: You be the adviser, and we will give you everything you need to advise your clients about investments; we will give you the entire support structure. We will provide you with asset allocation models; we will do the due diligence; we will provide you with all the training and the compliance. You maintain the client relationship and provide your clients with investment recommendations that are truly in their best interests. We thus had two clients, both the accountant and the clients of the accountant.

Marcus Heinrich joined the firm as we were beginning to develop this business model and took the lead in recruiting accountants much more systematically than we had in the past, and then developing the Terra program to support and teach our accoun...