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It’s hard to resist a good deal, and today’s high interest rates on short-term Treasurys
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and CDs are luring in even wealthy investors who have financial advisers handling their affairs.
You might think that paying a professional to manage your money would involve all sorts of private deals, hedge funds or business opportunities, and often it does. But that is usually only a small portion of a wealthy person’s asset allocation. The majority involves the same nuts and bolts as in most people’s portfolios, making them look very familiar, just with larger numbers.
“We go out and purchase CDs, some people have money-market funds, even something as basic as a high-yield savings account. We help with bond ladders, Treasury bills, things like that,” said Nicole Sullivan, a certified financial planner who is a co-founder and director of financial planning at Prism Planning Partners in Libertyville, Ill.
The financial-planning industry sets a level of $1 million or more in investable assets to be considered in the high-net-worth category – that’s money beyond the value of a house. Sullivan says her clients typically have between $2 million and $10 million to invest, and some of that comes in lump sums from the sale of a business or an inheritance.
The big focus for clients like this is having many different kinds of investments and making sure the different streams are optimized for growth and tax efficiency. That means basic investment diversification — having a mix of stocks, bonds and cash-like investments that are placed in accounts that are tax-deferred, tax-free and taxable now.
“No matter who you are, the basic structure is the same,” Susan Hirshman, director of Wealth Management at Schwab Wealth Advisory, told MarketWatch. “We believe in having an asset allocation based on your specific risk tolerance and goals. It’s all very similar, just at different scales.”
The difference for high-net-worth investors is what advisers call risk capacity. That’s the amount of strain your portfolio can take without losses impacting your lifestyle. On the other hand, risk tolerance is how much you feel comfortable investing based on your psychology.
When you’re very wealthy, you obviously have the ability to take more risk than the average person. It may seem counterintuitive, but a high level of assets will also allow you to be less risky. “The wealthier can maintain more cash,” said Lisa Kirchenbauer, a financial adviser who is a founding partner at Omega Wealth Management in Arlington, Va. This is because high-net-worth investors have enough invested otherwise to risk inflation outstripping the growth of their cash. So they can actually be much more conservative in that respect.
Another advantage for the wealthy is that they can keep more cash on hand for their yearly spending so they don’t have to sell assets at inopportune times, Hirshman said. And of course, they can hold onto excess cash for “dry powder,” waiting for a specific investment opportunity, like a new business or real estate.
“Because they may have more liquidity, they can invest in less liquid assets, because they might not need those assets for cash flow. That’s where the portfolios tend to look different,” Hirshman said. Another thing she noted was that corporate executives who have a lot of company stocks will do something like a covered options strategy, —selling options on stock they already own — to create income from their assets.
Where to keep large sums of cash
It’s actually not that easy to keep lots of cash on hand. The limit for FDIC insurance on cash is $250,000 for each account type, so keeping it safe from bank failures is one concern. “I’ve had clients hold multiple hundreds of thousands in cash, way over the FDIC limit, so they spread it over multiple banks, or in CDs,” Kirchenbauer said.
When it comes to cash and most cash-like securities, there aren’t special deals for high-net-worth individuals. The price is the price.
That goes especially for U.S. Treasury products, which you buy at auction directly from the government. Currently, you can get a 12-month Treasury bill at auction from the government for around 5.4%, depending on your purchase date, and there are no limits on how much you can purchase. Yet Kirchenbauer’s wealthy clients tend not to favor this type of investment for their cash. “One thing that’s not great for wealthy families is that you can’t do Treasurys in a trust,” she said.
Another drawback is that building a ladder of Treasury products with overlapping maturities is time-intensive and a lot of people don’t have the patience to deal with Treasurydirect.gov, which has a difficult interface.
At high balance tiers, you can sometimes get better interest rates on brokered CDs and high-yield savings accounts or money-market funds. So if you’re buying $20,000 in brokered CDs through the custodian where you keep most of your funds, you might get a slightly higher interest rate than if you were buying $2,000, which could make it the best deal on the market currently.
But that leads to the major downside to consider in holding a significant amount of cash: taxes. Interest income is taxed as ordinary income, which would be 37% for the top tax bracket. If you have, say, $200,000 in cash at 5%, you’re adding $10,000 to your income for the year, which could add something like $3,700 to your tax bill.
“We try to educate on the pros and cons of holding that much cash,” Kirchenbauer said. “Cash is making decent money right now, but what happens when yield drops? And when you hold multiple hundreds of thousands in cash at 5% interest, that can start to mess with your tax planning. That’s not good.”
If clients are holding too much cash, some financial advisers will steer them into municipal bonds instead.
“A number of our clients have been out shopping for high rates, but they need to be more concerned about taxes,” Hirshman said. “CDs are attractive at 5% or more, but it might not be the greatest move, because of the taxes.”
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