Smart Wealth Strategies of the One Percent

Rich people aren’t smart about everything to do with money, but the Millionaire Next Door was right.

The personal wealth statistics supplied by the IRS (which I’ve blogged about in other posts here and here) paint an interesting picture of just who the one percent are and how they operate.

For small business owners, however, the picture gets really interesting because you can see how these individuals operate. And lots of what’s going on with these folks connects to small business and entrepreneurship.

In the paragraphs that follow, therefore, I summarize some of the financial features that jump out…

Lots of Cash

The IRS data, for example, shows the cash holdings by the six tiers of wealth the study uses to break out the top one percent:

As a rough number, then, these one percenters often seem to have ten percent of their net worth available in cash. And that’s thought provoking.

Cash obviously provides two big benefits which are easy to identify—and easy to underrate. First, cash provides cushioning so a personal or business setback or storm is dealt with more easily.

A second big benefit to holding big wads of cash? With big cash balances, a one percenter may be able to exploit unusually excellent opportunities. Hard money loans, distressed real estate properties offered at firesale prices, right-time-right-place business investments, and so on.

Little Debt

The IRS data also show the debts carried on average by each of the six tiers (see table that follows):

Looking at the data in the preceding table, one can see that the great majority of rich people still do borrow money.

But when you look at those mean debt values, one can’t help but think that the richest one-percent may often only have a mortgage on their primary residence. (If you want to compare these debt mean values to the home mean values, here’s link to that post.)

Low borrowing sounds sort of surprising if you’ve ever had someone walk you through the powerful math of using financial leverage to gear up your investment returns. (Oftentimes, this subject receives frenzied attention from get rich quick writers and seminar promoters.)

But what the great majority of the rich actually seem to do is borrow sparingly.

Like holding lots of cash, relatively modest borrowing means that the richest one percent’s finances are much sturdier and able to withstand financial shocks and economic storms.

Management-heavy, High-return Investing

One final smart wealth strategy seems pretty clear from the IRS statistics: A really significant number of these people own either a closely held corporation, or an interest in a noncorporate business (like a professional partnership), or a farm.

Some of these business opportunities produce very high rates of return. All offer the chance not only to boost profits via hard work and clever decisions but also the chance to exercise more control over how long one works.

Here are the ownership percentages and mean values for closely held businesses:

By the way, if you ignore the lowest and top tiers (which contain the weird outliers and so are a little unreliable), you can see what may be a very clear trend: The richer someone is, the more likely he or she owns an interest in a closely held corporation. That’s pretty interesting…

Note: Price-to-seller-cash-flow multiples for small businesses of the size referenced in the first, second, third, fourth and fifth tiers are often very low. A business that’s worth $500,000, for example, might commonly deliver $200.000 in total salary, benefits and return on investment. And, I kid you not, I have seen businesses that produce $2,000,000 of cash flow sell for prices right about $5,000,000.

And, of course, closely held corporations (like Subchapter S corporations and small C corporations) are not the only forms of small business ownership.

Take a peek at the table below which shows ownership percentages and mean values for the rich who own interests in noncorporate business entities like professional service partnerships: law firms, consulting practices, physicians’ groups and so on

The same pattern emerges, right?

Let me give you one other example of this small business focus. Here are the same numbers for one percenters in farming:

Looking at the ownership percentages and mean values for closely held corporations, non-corporate business entities, and farms, one has to acknowledge the reality that many of and perhaps even the majority of these one percent-ers make and store their wealth in small business type ventures.

Obviously, these small business ventures entail much greater risk than something like an generic, low-cost index fund. And success in these ventures over any long period of time (like that required to join the top one percent) demands both management effort and expertise.

But here’s the big interesting takeaway for small business owners and entrepreneurs: For the some small business owners, success leads to membership in the one percent club.