At first glance, it’s not obvious why business principles would be helpful in informing a long-term wealth management strategy. Yet, the world of business provides useful concepts and a broad financial perspective, which are valuable to anyone planning for their financial future. Perhaps even more surprising is that Doug McCormick, a former knuckle-dragging infantry officer, is the man to deliver this important message.
Doug is an intriguing and impressive character, sporting a Harvard MBA, a BS from West Point (#1 ranked cadet!), and several decades of experience in industry. Oh, let’s not forget he was also the Captain of the West Point wrestling team, an Airborne Ranger Infantry Officer, and a runner-up in the 1995 All Army Best Ranger Competition. So in addition to being really smart, Doug can also kick all of our butts!
Doug recently wrote a book, “Family, Inc.,” which we recently reviewed. The book argues that we should apply a business-like approach to family wealth creation. After writing the book review and learning more about Doug’s background, we decided to reach out to Doug for some follow on discussion.
Below are some thoughts from Doug.
AA: We loved your idea that people should look at the value of an overlooked asset: human capital. Yet, one’s lifetime income is often highly correlated with lifetime expenses: the more we make, the more we spend. Should we discount our expected value of lifetime labor based on our individual marginal propensity to consume?
Doug: I agree with your assertion that lifetime expenditures are highly correlated with lifetime income, because over a lifetime people generally tend to maximize their consumption. However, that doesn’t mean we should discount our labor value. Your lifetime labor is just like any other asset—stocks, bonds, real estate, etc. People who have more financial assets are also likely to spend more but we don’t discount those asset values based on this expectation.
AA: You described how, despite that you and your brother had become financially sophisticated, your father had a difficult time sharing a leadership role with you when discussing family finances. He struggled to create an environment in which the family could openly discuss finances, which complicated the family’s ability to plan over multiple generations. This seems like a common dynamic within families. What do you think accounts for this tendency within families, and how should they respond to it?
Doug: There are numerous reasons why this is a challenging conversation for many families: it can be embarrassing to share mistakes; it’s hard for family members to abandon their traditional roles (i.e. parent, child, etc.); and parents have legitimate concerns that sharing information about family wealth can create unhealthy expectations among heirs and perhaps even negative behaviors. While not always easy, I recommend three core principles when navigating these delicate conversations:
- Clearly establish expectations among younger generations that the first priority of family assets is supporting consumption of the owners, NOT accumulating inheritance;
- Promote two-way conversations that allow all family members to participate, share successes and failures and learn from one another;
- Be Patient! Becoming a good family CFO and navigating these complicated topics effectively can take a very long time. Conversation and learning does not have to lead to immediate action; a conversation that promotes learning and socializes important key values is still time well spent. Remember the financial game of life, “Family Inc.” is a marathon not a sprint.
AA: You mention that for employees joining a company with a high P/E, “time trumps P/Es.” If the company’s earnings grow at a high rate, workers can make strong returns over time even if the P/E contracts. This contradicts value investing, i.e., buy cheap stocks. What are your thoughts on the employee who joins a company with lower growth rates and a low P/E on the basis that it is undervalued?
Doug: One of my core tenants for managing Family Inc. is to act like a “growth investor” with my labor assets and a “value investor” with my financial assets. I recommend this approach because of the asymmetry of risk in these different scenarios. As an equity investor, I can experience both gain and loss equally and significant growth usually comes with increased financial risk often in the form of higher valuations. On the contrary, being an employee possesses a payout much more like an option. If the company is financially successful, you will likely accumulate significant wealth and experience good career progression as your responsibilities and skills grow with the organization. However, if the company is not as successful as expected, you can take your experiences and lessons learned in an early stage growth company and benefit from those battle scars by re-deploying your labor in a new rapidly growing, dynamic opportunity. This is not to suggest, that slow-growth, value-oriented companies can’t offer attractive employment opportunities, but I think these situations are usually most interesting for senior managers who can financially benefit both as an employee and owner in some capacity through direct investment or options. In these leadership positions, managers often get very concentrated ownership positions that make their risk profile more aligned with that of an investor.
AA: You recommend against investing in commodities. Others agree. Harvard’s endowment reduced its public commodity exposure from 8% in 2008 to 0% in 2014. Yet investors have relied on the diversification benefits provided by commodities for many years, and some academics maintain that there is still a commodity risk premium received for bearing future spot price risk, as expressed in this paper, and which is a subject we discussed here. Do you think you think commodities an asset class are dead?
Doug: In a word, NO. I suspect that Harvard’s reduced exposure is based on its view of inflation and the composition of the rest of its portfolio which includes private real assets such as real estate, natural resources and commodities. Given this rationale, I view Harvard’s asset allocation to be a tactical move, not a commentary on the viability of commodities as an asset class in general. As the paper points out, commodities do offer a risk premium for bearing future spot price risk and more importantly, have proven to be uncorrelated with stocks and bonds over the long term. These attributes can make commodities an attractive asset class for businesses that have real hedging needs and money managers. With all that said, I still don’t recommend commodities for the individual investor. As individuals, we have other assets that insulate us from inflation risk; principally, our expected labor value, social security benefits and real estate holdings. Given that these asset values are likely to increase with inflation over the long term, most families are relatively well positioned to endure inflation. If you accumulate enough wealth such that these assets are an insignificant portion of your net worth, then exposure to commodities can make sense.
AA: You mention you set aside 5%-10% of your portfolio for your own investment ideas (in public markets). You add that it’s hard to benchmark your own performance to determine whether you have skill. You also have a day job in private equity. Why do you continue to pick stocks?
Doug: The honest answer is probably because I can’t help myself……. Throughout the book I advise that most investors should stick to passive equity investing. I recommend this, not because I think the markets are efficient, but because few public market investors are good enough to compensate for the drag resulting from fees, expenses and taxes. Furthermore, few individuals have the expertise to identify these exceptional money managers. Occasionally, because of the resources I have through my professional endeavors, I find opportunities that are compelling enough to justify these extra costs and take advantage of them. When I do select individual stocks, they generally possess three attributes: a) business models that are relatively easy to understand; b) valuations that make the risk of being wrong relatively low; and c) long-term growth prospects that allow me to hold for a very long time.
AA: Thanks very much Doug. I’m sure readers will appreciate the insights.
Doug: My pleasure.