Mail Bag: How Would You Convert a Pile of Money Into Passive Income?
Here’s a good question for beginners about how one might think about converting an asset base, or pile of cash, into a stream of passive income.
Hi Mr. Kennon,
I’ve been a reader of your blog for quite a few years now, and i’ve learnt a lot from you. Thank you for continually sharing your knowledge.
My question is, if a person who sets up an internet company, and later sells it for millions, how could he invest so that he would still live be able to live on enough passive income a year?
Thanks.
jclifesuc
Whether it was selling a business, receiving an inheritance, or winning the lottery, a person who suddenly found themselves sitting on a large pile of cash, and who did it without slowly amassing that cash through investing, would need to begin putting the money to work in assets that produced passive income. To understand what this means, I wrote a very basic explanation of passive income over at my Investing for Beginners site at About.com.
In layman’s terms, it comes down to needing to convert a pile of money into assets that produce a stream of money. If you manage your risk well, and operate conservatively, a pile of money can run out whereas a stream of money can last much longer. Do it right and your children and grandchildren could still living off it when you’ve left this world for the sweet by and by. Just look at Quincy, Florida – a big chunk of the town is still living off the secret Coca-Cola fortunes their grandparents and great-grandparents amassed.
There are only so many places you can execute this conversion process of turning a pile of capital into a stream of earnings. We call these asset classes. A few of the major asset classes are:
- Business equity (you own private companies or stocks),
- Fixed income (you lend money to institutions or people in the form of bonds, certificates of deposit, direct loans, etc.),
- Cash and cash equivalents (meant to be stable and safe, such as FDIC-insured checking deposits on Treasury bills),
- Real estate (apartment buildings, storage units, office buildings, townhomes, rental houses, industrial warehouses), and
- Commodities (gold, silver, wheat, soybeans).
There are lots more, but most people keep almost all of their net worth in those major categories. Each asset class has its own risks, rewards, dangers, traditions, laws, and economics. Some securities, such as mutual funds, are not really an asset class themselves (some people mistakenly refer to them as such), but more of a mechanism through which you own one of the big asset classes.
If it were me, I would want a mix of my assets coming from all of the asset classes, with a heavy emphasis on business ownership and real estate.
Let me walk you through what I mean. Please understand that none of this is intended to be, nor should be taken as, investment advice. I’m solely interested in sharing a high-level view of what the primary mechanics might look like to help better illustrate the task at hand; to clarify and focus what it is I want to accomplish as I set about structuring my holdings. In that sense, the question I am going to answer is not, “How would you convert a pile of money into passive income?” but, rather, “How would you think about converting a pile of money into passive income?”.
With that said, imagine that you had $10,000,000 (throughout my response, I’m going to use “you” to refer to the royal “you”, as in everyone or our hypothetical investor, not you, specifically). You started some business, sold it, and have no idea what to do with this money. You decide to take $2,750,000 and build apartment units such as this, paying all cash and using no debt:
(On a side note: If you were an experienced real estate operator with a good history of understanding risk and protecting your downside, it might be perfectly reasonable to choose a conservative capitalization structure and, instead, build $5,500,000 worth of property using $2,750,000 in equity and $2,750,000 in debt. If you were particularly sophisticated, you might even do something like create a real estate partnership, contribute your $2,750,000 in equity, raise more equity from passive investors, take on debt financing that was non-recourse, earning management fees of some sort for your role in structuring the entire operation, effectively providing leverage and economics of scale on your equity capital in a way that, properly done, can involve less risk than trying to handle the project entirely with your own wealth. That is far beyond the scope of the simplified, theoretical academic exercise in which we are engaging but, frankly, the latter would probably be my approach given my comfort with starting companies and handling day-to-day operations.)
You hire a real estate management company to take care of everything for you. On a pre-tax cash basis, you should demand at least $22,500 per month in rents after paying expenses. As long as you maintain the property, and it is located in a healthy market, you now have a money machine. While you sleep, vacation, read, or play video games, this money machine is pumping out fresh cash for you to save, spend, reinvest, or give.
Now, you are left with $7,250,000 of your $10,000,000. You may decide you want to buy 30 blue chip stocks, and invest $100,000 in each of them, just like the case studies we did of McDonald’s, Procter & Gamble, Clorox, Hershey’s, Nestle, Tiffany & Company, Coca-Cola, Colgate-Palmolive, General Mills, Chevron, etc.
This will cost you $3,000,000 in total. At current earnings yields, you might expect your share of the net profits to be around $200,000 per year, but only $81,000 of this is going to be distributed as cash dividends, with the rest of it reinvested for future growth (the reason, historically, stocks have crushed every other asset class over the long-term though there is no guarantee the future will look like the past). As your money is reinvested for you by the various management team, you still get to add $6,750 per month in cash income from dividends generated by your companies selling everything from chocolate bars, cheeseburgers, ice cream sundaes, laundry detergent, dish washing soap, bleach, toothpaste, infant formula, carbonated beverages, breakfast cereal, oil, natural gas, diamonds, emeralds, and more. Twenty, thirty plus years from now, these shares should be worth far more than your real estate investment.
Now, you’re left with $4,250,000. If we were in an ordinary interest rate environment – we are not, this is a once-in-a-few generation low-rate anomaly – you might take $2,500,000 and park it in tax-free municipal bonds which, under ordinary conditions, would be paying you 4% or more per year. That would have added $100,000 per year to your income, and there are no Federal or state taxes owed under most conditions (there are always exceptions, which is why it is so important each investor speak with a qualified CPA or other tax professional). That would have been another $8,333 in cash per month. Unfortunately, this isn’t an option right now, but throughout most of history it was, and I believe it will be again, someday. It might take years, maybe even decades, but we will revert to the mean.
Now you are left with $1,750,000. You might take $500,000 and keep it in the bank as emergency cash reserves. Again, in an ordinary interest rate environment, you would have been earning 3% on this money, which would have added $15,000 per year to your income, which works out to $1,250 in extra cash each month. That isn’t an option at this moment, but as before, I think it will be, again, at some point in the future.
This would leave you with $1,250,000. You might decide that you want to actually have a career and not sit around all day and do nothing. You decide to join the McDonald’s corporation. You setup a limited liability company – for the purpose of our hypothetical illustration, we’ll call it Consolidated Hamburger Holdings, LLC – and use it to buy a franchise in your hometown. As per McDonald’s requirements, you make it your full time job. You have a place to show up every day, help create jobs, generate tax revenue. Unlike other McDonald’s franchisees just starting out, you get to jump in with a much larger-than-average chunk of equity and would only need to borrow a small amount of the purchase price, which would be paid off within a few years (or, if you wanted to take your other investment income and redeploy it to debt reduction, barely more than 12 months). All else equal, in a decent sized town with a fairly normal location, you might expect to make around $21,000 per month in profit between your combined salary and operating profits. This isn’t “passive” income, obviously, since you are involved and have set hours, but who wants all of their income to be passive? There is a reason a lot of people die or give up on life when they retire and no longer have a purpose. Most people want to work; to feel productive.
You buy a McDonald’s franchise as part of your private business holdings …
Now, in an ordinary interest rate environment, you would have been earning as much as $59,833 per month in cash; real, liquid greenbacks that flood into your checking account. Remember, though, that you’d be making much more in actuality because your stocks are retaining a big portion of their net profits for future expansion. Your weighted average tax rate it is going to be fairly low because you will be able to use depreciation to shield your real estate income, your tax-free municipal bond income doesn’t require any payments to the Federal, state, or local government if you did it correctly, and your dividend income is taxed at a low rate of 15%. If you were to put things like SEP-IRAs in place and you were married, you could shave even more off your tax bill by sheltering the money through these special pension plans.
This means that your $10,000,000 has been converted into a collection of assets that pumps out as much as $59,833 per month in cash – a figure that, assuming normal economic conditions and wise management – should grow at a rate slightly faster than inflation in the future.
(Right now, given that we are in such a massive bond bubble where investors are not adequately demanding interest rates that are likely to result in real, long-term purchasing power maintenance on an after-tax, after-expense basis, I would have adapted, and been earning more, because the cash that would have been allocated to municipal bonds in this scenario would have been, instead, put to work in a secondary real estate project. If and when rates return to normal, I’d have a period of couple of years where I lived well below my means and built the bond component. At present prices, real estate is much cheaper than bonds.)
That’s it. The situation would change based upon your own skill set, abilities, risk tolerances, and preferences. I know some people that would never want to own a fast food restaurant or who would be terrible operators so they would invest more in real estate with no private businesses, for example. Still, it gives you a general idea of how the thought process behind the task might work. It’s about putting together cogs for your compounding machine. The big thing is to never invest in something you don’t understand because a poor decision can destroy a lot of wealth very quickly. Personally, I have people in my own life that if they were to ever try and run so much as a lemonade stand, they’d go bankrupt, yet I could find a way to franchise it and be collecting lemonade fees without having to work myself. Everyone has different abilities. You have to know your limits and be aware of that when putting together your portfolio. Do not try to structure your affairs based on what other people are doing. It has to work for you. Your individual situation, circumstances, risk tolerances, preferences, skills, abilities, time considerations, and much, much more all matter.
A major consideration in designing a portfolio is that it should be able to survive a recession. Consider the hypothetical example I structured in this illustration. Under present conditions, and assuming a talented operator, the portfolio owner would have very little debt, all of which could be paid off in under a year. The portfolio should be able to survive a 90% drop in the stock market – the owner isn’t relying on the stock price to fund cash flow, the equity component consists of a diversified collection of blue chip companies, and there are no outstanding margin balances that can be called by the broker-dealer. It should be able to survive a spike in interest rates – at worst, the fixed-income component holds intermediate term bonds. A reasonable person should not lose sleep if he or she did it right. For example, the real estate should be insured against risks such as earthquakes, floods, fires, tornadoes, etc. Stated plainly, an event bad enough to take down a portfolio like this likely indicates a situation so horrific that there probably isn’t much of a national economy left, anyway, so there’s no use being upset about it.
Update: Due to requests from the blog community, I restored this post on 05/18/2019 as part of a project that involved bringing back some of the past articles and essays from the private archives. It required making a few minor edits along with adapting it to the new blog template by adding higher resolution images. In addition, several of the conversation threads in the comments were deleted as they involved discussing different scenarios. Although neither the post nor conversations were intended as investment advice, and clearly all of it was general and academic in nature, I was not comfortable with it being published on my personal blog now that, all these years later, Aaron and I are the founders of a fiduciary asset management firm, Kennon-Green & Co., and we manage wealth for other individuals and families alongside our own. This compromise was the only solution in which I found myself willing to restore the piece so those of you who found the core lessons valuable could have access to it.
Reader Comments (24)
Comments are presented chronologically, with replies indented beneath the comments to which they respond.
Tyler Phillips
May 24, 2013
Interesting article.
You said: "As per McDonald’s requirements, you make it your full time job"
What does that mean exactly? Is there a punch clock? What kind of activities would an owner be expected to complete?
Joshua Kennon
May 24, 2013
Replying to Tyler Phillips
McDonald's expects their franchisees to be primarily focused on their restaurant business. You can't start an LLC, contribute the money, then be a passive partner. They won't permit it. They want good operators who know exactly how profitable each item is, how to cut waste, how to hire talented managers. That's why you'll never see McDonald's on "Kitchen Nightmares". It's a self-selected system that drives out failure fairly fast and doesn't tolerate those who aren't actively involved in improving profits. There's not a punch card or anything, but you can't treat it like a weekend hobby.
The trade-off is a fair one, in my opinion. You do well and get to where you own 2-3 locations, paying them off from profits, you are instantly a member of the top 1% of wealth and income in the United States.
Nick Pape
May 26, 2013
Replying to Joshua Kennon
Can you describe for us what makes a 'talented operator'? What kinds of characteristics does this person need?
JD Arney
May 24, 2013
Is building an apartment complex really so simple that it wouldn't be a full time job (at least during the construction phase? I understand after completion you'd be having it managed.)
Joshua Kennon
May 24, 2013
Replying to JD Arney
I'm assuming that if you've just sold your business and have a huge pile of money, you don't have a job anymore and would take a year or so to put all of this in place. That isn't always the case, but yeah, if you wanted that return, you'd have to be involved a lot in the beginning. There would definitely be a 'ramp up' phase to put all of the money to work. It would only become passive once you had fully employed all of the capital.
FratMan
May 24, 2013
Replying to JD Arney
JD, you bet it would be a full time job! And then some, because no construction project in the past 5,000+ years has been done in time or come in under cost.
I'm assuming when Joshua writes a sentence like that, he would expect you to relate it to your own situation in one of two ways:
(1) Treat the deployment of the $10,000,000 capital as a series of projects. i.e. in year one and two, you build your own apartment complex. Once you finish that, you can get a McDonalds franchise. Then, you could take the money from the apartment, McDonalds, and blue-chip stocks to buy a car wash. I think it is a string or series of projects to keep you busy during your life that Joshua has in mind here. Plus, it comes with the enermous psychic reward of knowing that you built something on this earth that would not otherwise exist if not for you, and Joshua's illustration taps into that energy.
(2) If you didn't want to put in the time or energy to construct an apartment complex, you could just find one for sale for $3,000,000 and that would cut the time out considerably.
Joshua can correct me if I'm wrong, but I think these articles provide templates to jog your mind and get you thinking, as opposed to defining a path you should take literally.
JD Arney
May 24, 2013
Replying to FratMan
Good comment and good points.
Joshua Kennon
May 24, 2013
Replying to FratMan
Perfect analysis.
Scott McCarthy
May 24, 2013
Looks like you made a couple of math typos.
$10m - $3m =/= $7.25m
$7.25m -$3m =/= $5.75m
Joshua Kennon
May 24, 2013
Replying to Scott McCarthy
Thanks for catching that; it looks like I accidentally cut and pasted the draft version in ... I just deleted it and replaced it with the correct text (I had changed the asset allocation halfway through writing the draft and forgot to go back and correct the beginning of the article).
JD Arney
May 24, 2013
Josh, any chance you could walk through this scenario but for $1 million?
Joshua Kennon
May 24, 2013
Replying to JD Arney
For me, it would depend on 1.) my age, and 2.) what I was trying to accomplish.
Scenario A: If I were 21 years old, ambitious, and wanted to amass as much money as possible, I'd kick the funds into a new LLC or LP and raise money from other investors to join me in exchange for a 25% cut of the profits, managing it full time. I could earn enormous rates on my capital between the underlying returns and my share of the managerial fee.
Scenario B: If I were 21 years old, just wanted freedom over my time, desired to be left alone, and wanted to play all day or focus on other things, I'd probably setup something like Kennon Real Estate Group, LLC, kick in $500,000, and then use that money as collateral on an HUD FHA 223(f) loan to buy a $1,600,000 to $1,700,000 apartment building in a town where there was very little competition, very attractive, sustainable economics (e.g., no single employer or industry supporting the town, historically in-line with rental rates relative to median family income, not a lot of inventory in the pipeline from other units about to open, preferably population growth, etc.). That sub-section 223(f) program would let me lock in the interest rate and amortization table for 35 years. I doubt interest rates will ever be this low for a generation or two, so it could be extremely attractive once things return to normal in that I could raise the rents every year, but still have the same fixed payment. I'd then live in the building myself, so I didn't have a house payment, and now I've set it up so the equity grows over the years, my income keeps pace with inflation, and I can shelter most of my cash from taxes using the depreciation and amortization charges.
I'd then use the other $500,000 to keep a $100,000 emergency reserve in the bank, and buy $400,000 worth of high quality blue chip stocks and master limited partnerships with the target of adding at least $16,000 per year in pre-tax income, or $1,333 per month.
It might be messy in the short-term - think of the Great Recession in 2009 - with asset values fluctuating all over the place, but if I just stayed the course and had chosen the assets well, with sufficient conservatism, I'd have a very nice standard of living and end up much richer by retirement as I used the surplus to buy more properties or stocks.
I could spend my days figuring out what career I wanted, or how I wanted to make more money. I'd have my life, my shelter, my income, and a recurring source of capital to fund new investments.
Scenario C: If I were a 65 year old retiree who needed absolute income, and didn't care about compounding my money long-term (just wanted the stream of cash), I'd stick $100,000 in the bank for emergencies, and then take $900,000 and, through a newly established LLC, buy up very inexpensive real estate assets in suburbs that could get me a 12% cap rate, using no debt, so I'd be earning $108,000 per year pre-tax. The $9,000 per month before tax adjustments and shelters, coupled with Social Security, would let me live very well. If a few of the renters weren't paying, the overall portfolio would still be doing well, so it wouldn't matter in terms of my day-to-day standard of living.
Scenario D: If I were a 45 year old doctor, with a high income, who wanted as much money as possible in 25+ years and didn't require any income now, I'd buy baskets of blue chip stocks and stick them in a vault, with the dividends left to compound on themselves, ignoring the stock market entirely. I'd be stuffed with things like Coca-Cola, Colgate-Palmolive, Clorox, Johnson & Johnson, McDonald's, Exxon Mobil, Chevron, etc.
Scenario E: If I were a successful 30-year old operator who could compound money at attractive rates of return by putting it to work in a business, I'd start a company of some sort with the $1,000,000. This would be the highest returning out of all, but if you didn't know what you are doing, it could be the fastest way to lose it.
I know this is not satisfactory, but the answer: It depends.
JD Arney
May 24, 2013
Replying to Joshua Kennon
Great answer, thank you.
Donald Pato
May 24, 2013
Replying to Joshua Kennon
Could you please elaborate or maybe provide some tangible examples, like you've done in the past for home prices, of how a 12% cap rate is realistic for suburban rental properties?
Joshua Kennon
May 24, 2013
Replying to Donald Pato
If you are referencing the 65 year old scenario: I don't think it would be possible in places like, say, Mercer County, New Jersey, but for most of the country, I'd be looking through foreclosure listings, courthouse auctions, and short sales, setup an LLC and get contractor pricing with home supply companies so I could pay near wholesale, and then upgrade it to increase the rental value.
The other day, I was on my way to the grocery store and there was a house that was being auctioned. It wasn't listed anywhere else, just a sign stuck in the yard. I followed it up just out of curiosity. It was more trouble than it was worth, but someone could have made money doing it.
I have an older relative who lives on real estate investments. She recently bought a distressed house for $30,000 that was just falling apart - there were parts of it literally held up with chicken wire that you'd use on a farm. She put $10,000 or $15,000 into it, made it look much better, and collects somewhere around $8,000 a year in rent. She now generates a lot of money nobody knows about, with seven figures of property sitting on her balance sheet as well as some first mortgages she's underwritten herself when a tenant asks if they can buy the house from her (most of these people don't have credit, so she charges 13% to get them a payment history and then works with them to have the bank refinance them into a traditional mortgage once they have equity in the property). She'd drive around in a specific radius of her home and work areas, then stalk the listings, or in some cases, buy up houses across several blocks to upgrade the entire neighborhood at once. It started as a way to keep her busy but she's been very successful at it.
My father knows a guy who made a ton of money in real estate. One of his ways to increase his cap rate was to work with a bank and put about 60% of a home's value in an escrow account. He knocked on people's door in lower and lower middle class neighborhoods, told them that they could walk away with the money today if they would sell him the house, but they had exactly 1 hour to make a decision at which point the offer expired forever. People sold him their homes at these crazy prices all the time for reasons you wouldn't believe - some wanted to get away from their family and friends, some wanted to move out of state and start over, some just hated the house and never bothered to put it on the market. Offers that you would think would make people throw you off their lawn for even suggesting, he'd get. He had the audacity to ask and to tilt the incentive system.
WIth a $1 million portfolio, I'd be looking at places like this. Very little work, landscaping, new flooring, a few other upgrades and you can juice the cap rate.
I've never bothered with this sort of thing because my personality doesn't lend itself to small projects like that. It would drive me mad, even though the returns could be very good if you were selecting about your buying, if someone were calling me in the middle of the night about plumbing or if there turned out to be a meth lab in one of the houses I owned. If I ever dip into real estate in any meaningful way to put it on par with my other activities, I'll buy a hotel or build an apartment building or something. When it happens, it will be entirely happenstance. There is a terrible low-price brand name motel that I pass all the time near Kansas City that, if it were to suddenly come up for auction, I might make a bid to own. It would require a lot of capital but the neighborhood is so good it's just mismanagement. It's a wasted opportunity just sitting there.
TL;DR: You'd have to Ben Graham it, only the value investing approach would be for real estate not stocks. Look for low liquidity situations (auctions, foreclosures, short sales), be armed with a lot of cash so you can make a quick offer with a firm time limit to get people to accept, have access to below-wholesale level renovation and construction sources so you can upgrade the properties, and be patient enough to wait until something intelligent comes across your radar. You wouldn't get those kind of cap rates looking at a Marriott listed for sale in The Wall Street Journal by a national broker.
Donald Pato
May 25, 2013
Replying to Joshua Kennon
Thanks!
al
November 15, 2013
Replying to Joshua Kennon
Joshua,
I was just reading through your older articles again and came upon this comment. Can you explain your thought process on finding the Omaha, Nebraska house as a good rental given that you live in Kansas?
Thanks, Al
Gilvus
May 24, 2013
Joshua, you often write about how some people are terrible operators (e.g. Warren Buffett, some of your friends/family), while some others have the Midas touch. From your extensive experience, is there a set of characteristics or temperaments that great or terrible operators consistently display?
Odai
May 26, 2013
I'm wondering if the writer of this letter was inspired after reading the book, "The Millionaire Fastlane" - despite the corny title, it's good advice (for someone new to wealth creation), although a gross over-simplification. That book is what got me into investing and lead to me finding your website.
The author was the founder of Limos.com, and so he heavily advocates founding a web-based business, selling it, and using the money to buy passive wealth-generating assets - the "Fastlane" to wealth. While that definitely appeals to my personality, your writing has made me realize that people with different priorities, personalities, or skill sets might prefer different strategies.
...
I've had the luxury/curse before of having no school, no work, and sitting on a considerable amount of cash - basically, having the freedom to goof off all day. Much to my surprise, I discovered that being non-productive feels just awful. I felt like I was wasting my life, and while I fully intend to achieve financial independence, I never want to return to that non-productive retired lifestyle.
Great article.
jacob
May 27, 2013
Great article. Thanks!
Odai
June 6, 2013
Joshua,
In another post you said that we shouldn't have more than the FDIC insurance limit in a bank account. As far as I can find, the limit seems to be $250,000 for a single person's account.
In this hypothetical, we have $500,000 in the bank. Is this considered an acceptable risk, given the large monthly income this person makes anyway? Or would you split the balance into two accounts, or possibly use treasury bills? Or is there a way to increase the FDIC insurance that I'm not aware of?
FratMan
July 2, 2013
Not that long ago, you mentioned that you fired your broker (I think). Other than something obvious (he's stealing from you, lying to you, etc.), what are the kinds of things that would make you want to leave a broker? Is it something you'd do quickly without hesitation if you're not in love with the guy/gal, or is it something you treat as a "sticky" relationship in which it would take something substantial to get you to leave?
Joshua Kennon
July 3, 2013
Replying to FratMan
The reason we parted ways? The first few trade confirmations were not issued; when they were, they had the wrong address (I do not now, nor have I ever, lived in Alabama); the trade settlement fund instructions were ignored; the online tools weren't working; customer service was limited to a small range of hours; the list is endless. This was not a small operation - it is very large, very famous, and has billions of dollars in assets. It was part of a much larger bank with whom I have some personal and business relationships and was being done for convenience. It was shameful how poorly run the brokerage division was.
As for your question, if you are talking about a broker, as in someone who solely executes trades, I would be focused on cost, execution speed, ability to not move markets, hours and rapidity of customer service response, online tools, security, etc.
Look at the Disney Foundation post I did the other day - the family just shoved $20+ million worth of Walt Disney Company shares in a Charles Schwab brokerage account. If they wanted to move the money tomorrow to Merrill Lynch, it wouldn't be hard. They don't need anything more than the ability to have something bought or sold. There is no compelling reason for them to have to stay with Schwab, even though they are among the best discount brokers in the world in my opinion. Schwab is just there to take orders. That's it. It's a simple relationships. And Schwab is good at it.
If you are talking about a wealth manager, who makes investing decisions and manages the portfolio, I'm not now nor have I ever been interested in such services, though this is what the typical American thinks of when they hear the term "stock broker" - a guy who opens an account at a local branch office, manages your money, and buys and sells shares for you. For the average person who doesn't know what they are doing but have been successful enough to amass a nice size portfolio, I would be looking for someone I trusted, who was part of a larger institution that would prevent fraud or theft, who charged a reasonable fee (e.g., 1% or less per year for most situations), whom I liked, and who listened. I can see the appeal of the rich old farmer who went down to the local bank trust office each morning to have a cup of coffee, read the newspaper, and talk to his broker about what shares he planned on buying that quarter or how large the dividends were last month.
In a case like that, I'd be looking for a personality match, someone who had a good track record that could be independently verified, someone who listened to me and was interested in meeting my requirements based on my own personality and risk profile, and someone that was part of a larger institution that could meet my other needs (taxes, insurance, etc.) so it was a one-stop operation. I would absolutely separate custody from asset management.
For a lot people, in the wealth management arena, personality match matters, even though it probably shouldn't on an intellectual level. It's because people want to feel like the folks watching over their money identify and care about them. It's such a powerful truism that one of the greatest wealth management companies and private banks in the world, Northern Trust, runs specialized divisions focusing on different demographics. They have a practice group focused on business owners, another focused on corporate executives, another focused on successful lawyers, another focused on rich gay families, another focused on wealthy doctors, and yet another focused on professional athletes.
In a case like that, I would think the relationship should be stable and long-term so you have people who know your needs and understand your family. I also think that investment strategies take time to play out, especially value investing. You have to give a good value investor at least 3-5 years of uninterrupted runway to see a difference in your portfolio.
In the end, I'm of the school that private banking, wealth management, accountants, and lawyers should be mostly sticky once you've found the right match, while trade execution is less so, unless you are dealing with vast, institutional level sums (e.g., Warren Buffett), in which case you find the best institutional equity desk you can and stick with them for as long as they are performing and have had no major ethical lapse. But I form relationships with people, not institutions. If I were using an accountant and they left to go to another firm, I'd probably follow them.
FratMan
July 3, 2013
Replying to Joshua Kennon
Thanks for that, Joshua. That was a useful response. I've been unimpressed by most in the financial industry that I have encountered, and I can't tell if it is because I'm being profiled based on my age and told simplistic things that they think I want/need to hear, or if that reflects their true thought process. I dunno, it's hard to explain. Maybe you had to deal with stuff like that along the way.