With Douglas McCormick, Author of Family Inc.: Using Business Principles to Maximize Your Family’s Wealth, Managing Partner and Co-Founder of HCI Equity Partners
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Managing Family Finances Entails Much More than Balancing a Checkbook
After years of experience in the investment world and corporate boardrooms, Douglas McCormick developed a formula to manage your finances and ensure family financial security which he explains in his new book, Family Inc.: Using Business Principles to Maximize Your Family’s Wealth. The main argument of Family Inc. is that just as any business must be actively managed to be successful, so should a family operate within an organized framework to ensure stability and wealth. “A company CFO not only manages the income statement and the balance sheets,” McCormick says, “They do financial planning to forecast how that company is going to do, and they spend a lot of time ensuring that the company has adequate cash flow or access to capital to execute its business plan.” While the specific actions and processes are different in business, the main concepts are applicable to how people “navigate the financial game of life.” The game is converting labor into money as quickly and efficiently as possible to ensure that you have ample funds for retirement.
Family CFO As Active Manager Of Family Assets
The designated CFO of a family can utilize these same tried-and-tested tools and principles as does the CFO of a major corporation. McCormick refers to this as active management and has developed a chart to highlight the concept he calls “Family Inc.” The three assets every family has are labor, savings (which hopefully will grow over time), and social security benefits. Taking these assets into consideration, McCormick outlines a strategic plan to carry a family through life’s major risks and unexpected circumstances. Some of the key factors in managing household finances include:
* Having short-term liquidity in case of a downturn in income or catastrophic expenses in the form of savings or disability and life insurance.
* Assessing the value of labor as capital combined with a pension, 401ks, and social security to calculate retirement needs.
* Determining the value of large financial decisions such as education based on potential returns and opportunities.
Labor As A Long-Term Asset To Be Maximized
One of McCormick’s core concepts is that labor should be looked at as an asset, or—if put in terms of your investment portfolio—like a bond or fixed-income asset. If you think of it as one of the long-term assets of your family business, you want to see it gain in value over a long span of time. This perspective will encourage you to make decisions that maximize your labor’s long-term value such as investing in education. McCormick argues that despite its increasing cost, education still provides the highest ROI of any asset class. Steve points out that this probably depends on which degree a student chooses to pursue and McCormick agrees, noting that math and science degrees and other quantitative fields lead to much better earnings outcomes.
Family Savings And Investment Risks
Steve asks about financial risk-taking within the Family Inc. construct, pointing out that McCormick’s model for a savings retirement portfolio treats, as we’ve seen, labor as well as social security and pension income as if they were fixed income assets. His response is that people should be more willing to take on more “return risk” through greater equities exposure, which is the risk that market volatility will hurt the value of stocks you own, to offset “longevity risk,” which is the risk that you will outlive your retirement savings.
Steve agrees that investors should hold a greater percentage of equities for a longer period of time than has traditionally been recommended by financial advisors, adding that while short-term risks seem very real to investors, long-term risks are “ethereal” and “uncertain.” McCormick observes that financial news keeps people’s attention locked on daily or annual results, an irrelevant time frame for investors whose main goal should be long-term appreciation
McCormick encourages people “to think about themselves like a business owner with their investment portfolio, not an investor.” He says it’s easy to succumb to feeling as though you own a certain fund such as, for instance, a Vanguard mutual fund, when, in effect, you don’t. What you own when you buy these funds are the individual companies that comprise the underlying fund portfolio. Understanding which companies are in the funds or ETFs you own and their financial profiles can go a long way towards mitigating anxiety about price volatility.
Liquidity Is Crucial To Managing Household Risks
Wrapping up their conversation, Steve asks McCormick for his take on a hypothetical scenario: someone in their early 30s working in a cyclically sensitive business and has been putting as much money as allowed into his 401(k) account, finds himself suddenly out of work and needing to draw down from his savings accounts. McCormick believes that the number one priority for our financial assets is to offer short-term liquidity when needed to handle a crisis or unexpected expense or just to keep its regular level of consumption going. As much as he advocates for equities investments, he thinks that life and disability insurance and a savings cushion of 3 to 12 months of income—what McCormick calls “playing defense”—have to take priority when resources are threatened or getting depleted. It’s crucial to play defense to keep yourself out of “financial distress,” defined as defaulting on a loan or declaring bankruptcy.
Steve talks about how many years ago during a rough patch in the economy when many of his peers were declaring bankruptcy, he considered the possibility for himself. Ultimately, he decided against it and, instead, stood behind all his promises and obligations. He’s very glad he made that choice as it later allowed him to borrow money to start his investment advisory business, an opportunity that would have been impossible had he filed bankruptcy. McCormick brings this back around to his idea of labor as an asset and, taking it a bit further, the idea that your labor is part of your personal brand, along with your credit score, your history of business dealings and relationships, and your skills. These are all parts of a more holistic personal brand that can have tremendous long-term value.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: Douglas McCormick has gone from active duty army officer with a young family to the Harvard Business School to employee at a Wall Street investment bank to private equity investor and entrepreneur. Douglas answers the question: Is financial security achieved through savings, tricks, and stock picks, or through your key decisions about education, career, and even the lifetime value of your hard-earned labor. He takes a somewhat unconventional but entirely rational view of the vital decisions we face as we guide our lives toward financial success. Welcome, Douglas McCormick.
Douglas McCormick: Thanks very much, happy to be here.
Steve Pomeranz: Douglas, as I said, you have figured out a somewhat unconventional approach to building financial security using the idea of acting as your family’s CFO. What is the role of a CFO in a company, and what is the role, as you see it, for the family?
Douglas McCormick: A little bit of background, I graduated from business school, I was about 30 years old, and I was avidly reading, trying to understand how to make good financial decisions myself. One of the things I struggled with most was a lack of a framework to help me think through the trade-offs between investments in myself through education or entrepreneurship versus investments in the market and how those things influenced my need for savings or insurance. I think the key thing that the book offers is a framework to help to connect all of these different disparate decisions. It’s a framework that’s been tried and tested in the business world. If you look to a company CFO, they often do things like manage the income statement and the balance sheets of the company. They do financial planning to forecast how that company is going to do, and they spend a lot of time ensuring that the company has adequate cash flow or access to capital to execute its business plan. In many ways, the specific actions are different, but all of those concepts are very applicable to how people navigate the financial game of life.
Steve Pomeranz: Okay, those are some very good points and a very good description of what a CFO does for a company. Let’s take it right down to the family level, what you call Family Inc.: Using Business Principles to Maximize Your Family’s Wealth. Give us some specific examples of how that would work.
Douglas McCormick: First of all, the reason that I call the book Family Inc. is, the analogy is that all of us are business owners, and we own our labor, and we own our financial capital. The game is to convert labor into money as quickly and efficiently as possible so when it becomes time to retire you can rely on that money. That’s the business, if you will. None of us believe that businesses manage themselves, they must be actively managed, and a CFO in the family does things like manage the budget. They do things like manage how people are spending their labor, so choices around education, career choices, risk management through insurance, and, of course, investing, and then retirement planning.
Steve Pomeranz: I want to get into this idea of labor as an asset. Why is labor …we don’t think of labor, we think that you work, you use that money to pay for your life, if you have extra, you try to save. You may try to invest. We don’t actually think of labor conventionally as an asset like a stock, a bond, or a piece of real estate. Why do you?
Douglas McCormick: Well, first of all, I believe intellectually it should be, and my best analogy is I think labor is like food, and that if you sell it at the right time it can be very valuable, but if you don’t take care of it and you let it spoil it just goes to waste. I think it really changes the philosophy about how you spend your time professionally. I think when you think about it as an asset where you’re going to gain value from it over many years, it forces you to make decisions that maximize the long-term value of that labor as opposed to decisions that may be a bit in the short term.
Steve Pomeranz: Give me an example of that.
Douglas McCormick: I think education is the best example. There’s lots of conversation today about how education’s too expensive, it’s not a good investment, and I would argue it’s certainly gotten more expensive—and there are a lot of reasons that are not great about why that is—having said that, it’s still an exceptional investment for someone who has the aptitude to finish and who uses those skills to pursue professional opportunities that require an education. If you look at it from the investment perspective, education has a better-expected return than any asset class out there right now.
Steve Pomeranz: I guess that would depend on the kind of degree you’re getting and the kind of career you’re going for because not all degrees have the same value.
Douglas McCormick: No doubt. You know, one of the things I always point out when people talk to me about the book, I am not saying that every decision you make should be financially driven, and, when it comes to things like career choice, that’s a great example where you’ve got to overlap your values and your passions with the financial implications. I think we’re doing our young people a huge disservice as they go to pursue college. Arguably it’s the largest investment they will make in their lifetime, and we’re not giving them good tools to evaluate the financial impact of those choices. Just to comment on the impact of those choices, you know, the data’s pretty clear. People that pursue educations around math and sciences and more quantitative-oriented fields garnish significantly better compensation in the workforce.
Steve Pomeranz: I like some of the charts that you used in the book. The book is Family Inc., by the way, my guest is Douglas McCormick, the author. Where you plot it out, you said, you know, the beginning of your career, if you look at the value of your future earnings, it comes out to a pretty large number. If you’re making $50,000 a year, let’s say, or $100,000 over a year over a 30-year period or a 35-year period, that could be worth $3.5 million dollars or something of that nature. You’ve actually plotted that and, really, you also plot a termination point or a terminal point. Let’s say at age 67 where you’re just not …where the value of labor diminishes because you’re going to stop working, and now you need your assets to make up the difference. Can you talk to us a little bit about that?
Douglas McCormick: Yeah, I think that chart is the best way to convey this concept that I call Family Inc. It highlights the three assets that a family has over a lifetime: your labor, your savings which grow over time, hopefully, and then social security benefits, which you could argue not everybody gets, but a very high percentage of us do get, and I think it’s an important asset to consider. I think for people to see that graphically and be able to see the trade-offs between how to convert that $3.5 million dollars (which is a good estimate for many people) into savings that support them when their business kind of changes. You know, when it comes time to retirement, you have a lot less flexibility on how you’re going to achieve financial security because as long as you’re working, in my mind, you still have lots of flexibility to overcome bad things in your life whether they be market returns or divorces because you can always choose to work longer and save more. Once you get to that retirement point, you have a lot less latitude in how you manage your risk.
Steve Pomeranz: Let’s talk about risk for a second. Many of my listeners have built up investment portfolios and savings over time. Let’s say they’re approaching retirement or they’re at retirement, and they go to a financial planner, and a financial planner recommends an asset allocation. This asset allocation is generally decided upon as to what kind of rate of return is needed versus what kind of volatility risk a person can stomach which I think is a very elemental way of looking at it. We look at things more complicated than that. My question is that if you take in the type of job you have, the type of income sources that you have at retirement—for example, if you have a pension or even using social security—that should be included in your total asset allocation because those sources of income act like an asset, like a fixed income or a bond asset. Do you want to expand on that a little bit?
Douglas McCormick: Yeah, and I would actually take it back a little bit further in that chart that we’re talking about. One of the things I think is relatively different about my approach is when you include your labor assets and your expected social security assets, both of those, in my mind, behave like fixed income. It really implies that we should all have much great equity exposures both while working and even while retired than most people recommend. I think we’re all conditioned to perceive risk in different ways. Obviously, investment return risk or volatility in that return is one that you read about a lot. I think the two scarier risks are often inflation—and that’s arguably not a big risk in today’s environment, but over history, it has been—and longevity risk. We all hope to live a very long, full life but financially that creates incremental consumption needs, and I believe, in general, if you ask me which one I’m more comfortable assuming, volatility and return risk or longevity risk, I would much rather take more return risk because I think we’re all going to live longer than we often expect. Even when you’re retired, when you lay out when you’re actually going to consume this money, it’s much longer of a period than most people estimate or appreciate. I generally recommend more equity exposure than I guess convention.
Steve Pomeranz: Yeah, which I thought was really quite interesting and to a very large degree very accurate. I think it’s also a …there’s a disconnection. We can see what’s in front of us, so we can easily understand short-term risk as measured—let’s say the S&P goes up and down, has it gone down a lot—it’s perceived as a risk. These long-term risks are really very hard to grasp, very hard to get your arms around. There’s so much uncertainty. It’s so ethereal in its nature. There’s this tension between this short-term focus that we all have and really the long-term needs. Do you want to talk about that a little bit?
Douglas McCormick: I think, first of all, it’s interesting to me that a lot of the way we consume information is simply to make it easily understandable. We look at returns on a daily basis. We look at annual returns and we measure volatility on an annual basis. Arguably from a practical perspective of how that influences the investor, it’s really irrelevant. You know, if your timeline to consume these assets is more than a year or two out, you should be looking at volatility on multiple year basis and returns on multiple year basis. Also, I think, returns are, in terms of how it impacts a person, should really be measured on after tax, after inflation, basically, your ability to consume. When you think about it in that way, I think it’s still hard, it’s hard to ignore what’s happening on a day-to-day basis, but I think through education, we can get people focused on the important risks and teach people to endure the short-term volatility for the benefits of what I expect to be longer-term appreciation. I guess one more comment here.
Steve Pomeranz: Sure.
Douglas McCormick: I encourage folks to think about themselves like a business owner with their investment portfolio, not an investor. What I mean by that is, you know, it’s easy to get to fall into the trap of feeling like you own the S&P, but you don’t own the S&P, you own Walmart, you own Berkshire Hathaway, you own Amazon. If you look at those businesses in collection, I mean their performance, in terms of actual earnings growth or earnings stability, is really quite good.
Steve Pomeranz: We often do this in our office. We open up these index funds, and we show what’s inside. You know, you may have a Vanguard growth fund or Vanguard value fund or something of that name, and it goes up and down up and down. You look at your statement, you go, “What is this thing, it’s going up and down? Oh, it went down a lot, I don’t feel so good about this.” When you open it up and you see Disney, and you see Home Depot, Berkshire Hathaway, Johnson and Johnson, Proctor and Gamble—the list is long—it helps to ground in exactly what it is that you own, and also this fact that these companies are worth more today than in aggregate, on average, than they were worth 5 years ago, 10, 20, 30 years ago, and, as a shareholder, you are really participating in that wealth creation. Put those all together in a package, put a name on it, and call it an index fund, Vanguard does this, Fidelity does this, I-Shares does all of this, and so many other funds. You have this product that seems to bounce up and down every day, but inside that product is something real. That’s what you really have to count on.
My guest is Douglas McCormick, and the book is Family Inc.: Using Business Principles to Maximize Your Family’s Wealth. You can go to his website too at FamilyInc.com. I wanted to talk about one other aspect here, we have a few minutes left. People work, and you say this labor has value, this labor has capital, and they put their money in their 401K’s, and, let’s say, they put it all in equities because they’re 28 years old, they’re 35 years old. Here’s one issue that’s come up that I think needs to be addressed. In my view, if your job is very economically sensitive—let’s say you’re in a cyclical industry, right, versus being a doctor or something that’s kind of a steady income—and your savings are cyclically sensitive, too, Douglas, what happens when you lose your job and you need to go into your savings at the same time in order to survive? Both are going to be depressed.
Douglas McCormick: Yeah, so I think we often get confused about the priorities of our financial assets. In my view, the number one priority for our financial assets is short-term liquidity to support the family’s consumption when your labor business underperforms, if you will. While I’m a big proponent of equity investments, I think the number one thing you’ve got to do is play defense, and the way you play defense is you ensure you have appropriate insurance around disability and life insurance, and that you have a savings cushion. I think that, depending on how high your income is, how much you spend, and how hard it will be to replace that income, that savings cushion could be anywhere between 3 and 12 months in my mind. I think you’ve got to buy yourself peace of mind and give yourself enough liquidity to make sure that you don’t find yourself in financial distress.
I said earlier, there are a lot of things we can overcome by working longer, saving more. Financial distress defined is having to default on a loan or have bankruptcy. It’s a real tough time overcoming that kind of financial challenge.
Steve Pomeranz: You never know what a bankruptcy can do to your future. Years and years ago when I went through my own difficult times, a lot of those people around me were declaring bankruptcy. I decided not to. I just thought it was the wrong thing to do. I stood up to the plate. I kept my promises and paid my obligations. Then years later, when I decided to start my own fee-only investment advisory business, and I went to get my license for it, one of the disqualifying criteria was bankruptcy. Now, little did I know years before that that was going to affect me in my future life. That would have changed the whole direction of my life. Interesting.
Douglas McCormick: I think it highlights—to go back to labor being an asset—I think you can think about that more holistically. It’s really your brand, right, and your brand is your credit quality, the way you behave, and your business dealings, and your skills, and all those go together, and I think more and more in this kind of gig economy, people are selling their personal brands.
Steve Pomeranz: Yeah, I agree. My guest, Douglas McCormick. It’s a very good book, especially if you want an organized way of thinking about your investments in the totality. Hate to use the word holistic, but it is a holistic approach. The book is Family Inc.: Using Business Principles to Maximize Your Family’s Wealth and the website is FamilyInc.com. Douglas, thank you so much for joining us.
Douglas McCormick: Appreciate it, Steve, lots of fun. Thank you.
Steve Pomeranz: Bye.
