CHAPTER 1

Why Do I Need a CFO? I Don't Even Own a Business

Growing up, my brother, Dave, and I developed different attitudes and behavior about money. Dave's nickname was Spendsworth, given to him by our grandfather because, as Grandpa said, "He spends what he is worth." Dave supported his carefree spending because he always seemed to have some sort of job. Making money wasn't the hard part for him; holding on to it seemed to be. Like any good younger brother, I took the opposite tack. I, too, had many jobs-newspaper deliverer, farmhand, babysitter, Christmas tree trimmer, and stationery salesman, to name a few. But I saved almost everything I earned, made some investments with my father's help and even loaned some of it out to poor Spendsworth at usurious interest rates.

While most of these youthful habits have stood me in good stead, they haven't exempted me from the sometimes scary financial decisions and challenges that come with becoming an adult. In my twenties, I resigned an Army commission to go to Harvard Business School just as my wife, Michele, became pregnant with our first child. While the opportunity to attend Harvard was exciting, it came at a high cost. Boston was much more expensive than we anticipated, and the job Michele got at Harvard barely covered child care and housing. Because I had some modest savings, I wasn't eligible for financial aid. For the next two years, we depleted my savings and borrowed heavily to pay for school, fund living expenses, and carry a monthly mortgage on our previous house, which we ultimately sold for a $50,000 loss. As my savings dwindled, so did much of my confidence, replaced by the humility and sense of helplessness that many families experience in the face of financial hardship.

Even when I was a newly minted MBA, the financial losses continued. We had to borrow money from a family friend to move to New York, where we spent our first night sleeping on the floor, sweating with no air conditioning in the city's summer heat. Lying there, feeling more than a little defeated, I realized that in spite of a lot of effort and hard work, bad financial decision making had put us in this precarious situation. I was still managing our finances as I had as a young single man. It would take another decade of more learning and more mistakes to make sense of how my everyday life decisions fit together financially into the precepts for success on which this book is based.

Many of us go to great pains to separate our work life from our family life, and to leave "business" out of the family equation. But doing so diminishes our ability to make sound decisions about our financial future-and the financial future of each of our family members. What I'll introduce in this chapter, and elaborate on in the chapters that follow, is how to apply the business principles of corporate finance to your own personal wealth management decisions.

Asset and liability management, practical financial statements, control of risks, asset allocation, tax planning-all are tools in the world of corporate finance that help companies achieve their goals. And there's no reason these techniques can't be adopted for your personal use. Every business has a CFO-a chief financial officer-and every family needs one.

Though few people think about it this way, everybody owns not just one but two distinct businesses: a temporary labor business and an asset management business, which together comprise Family Inc.

1. Your temporary labor business. Each of us is born with a finite amount of labor potential to be harvested over a lifetime. Regardless of whether you are an employee in a large company, a soldier in the Army, or a small business owner, in all cases you are in the same basic business-converting your labor into money. Like natural resources such as coal, natural gas, or gold, your labor potential is finite and is depleted over time. As part of a family, it's not just your own labor you need to consider, but that of your family members as well. The financial objective of your temporary labor business is to convert your labor into financial assets as efficiently as possible. In any job, your temporary labor business sells your skills and energy.
2. Your asset management business. The second business is an asset management business that manages the assets you have acquired through your temporary labor business or by other means, such as inheritance. These assets might include your home, your savings, your 401(k), and more. Your objective in your asset management business is twofold: (1) manage and enlarge your portfolio of assets; and (2) produce adequate cash flow to support both your consumption needs-everything from groceries, clothes, and car expenses to recreation-and investments to further your labor business, such as my return to graduate school for further education that enhanced my earning power.

These businesses are complementary and interdependent, and they must be managed in a coordinated manner. Your objectives as CFO in managing these two businesses can be simplified into three basic goals:

1. Provide adequate cash flow to support your spending, now and in the future, while allowing necessary investments to enhance those two businesses of yours: labor and asset management.
2. Maximize your "Family Inc. Net Worth"-the sum of your labor and financial assets after taxes.
3. Manage your legacy by maximizing what you can leave to family members (and their ability to manage these assets) or to worthy causes. While this goal is worthwhile, it is a distant third in priority. You can't do number 3 without first accomplishing both 1 and 2.

To illustrate the interaction between these businesses over time, let's take a simplified snapshot of one young man's current financial situation, encompassing all the assets he has to work with, which include estimates of future compensation for his work, future returns on his investments, and future Social Security payments, based on assumptions that are reasonable today.1 Throughout this book we present examples like this one that illustrate key concepts by representing common circumstances. Tools to personalize the examples to fit you and your family can be found at familyinc.com.

These assumptions allow us to generate the holistic view in Figure 1.1 of the young man's projected Family Inc. Net Worth over his lifetime, including the value in today's money (that is, 2016 dollars) of the expected future assets generated by both of his businesses after all of his spending. For example, Figure 1.1 shows that at age 25 he estimates his expected lifetime labor value (compensation for his work, shown in green) at about $2 million. (For details on how to calculate expected lifetime labor value, see the Appendix.) By age 40, as the chart indicates, he will have received almost $500,000 of that value, so his remaining labor value has shrunk to $1.5 million. However, that $500,000 of used-up labor has funded his living expenses for the past 15 years while also allowing him to accumulate over $75,000 in savings and other financial assets (shown in red). By age 40 he has also paid enough into Social Security to earn some $95,000 in expected future Social Security payments (shown in purple). By age 67, he will have retired, so he'll have no remaining earnings-he depleted the $1.5 million of potential earnings over the 27 years since he was 40-but his financial assets have increased to about $570,000 and his expected Social Security payments to more than $250,000. At 67, he will have to use these assets to support his spending for the rest of his life.

FIGURE 1.1 The Three Parts of Family Inc. Net Worth and How They Evolve Over Time

As Figure 1.1 demonstrates, Family Inc. Net Worth embodies three key components: (1) the value in today's money of expected after-tax labor income; (2) the value in today's money of after-tax future Social Security benefits; and (3) net financial assets (financial assets minus financial liabilities). In summary, the family converts labor into money and future Social Security payments during working years so it can use these assets to fund consumption during retirement.

This graphic is oversimplified, and the assumptions, based on today's realities, are certain to be off base because circumstances will change. Yet the concepts, insights, and planning tools that it facilitates remain powerful. First and foremost, this 25-year-old has an estimate of what his future financial life might look like if he doesn't go back to school. If, however, he were thinking of leaving his job to go to law school, he could modify these assumptions to reflect the impact of becoming a lawyer and compare the two scenarios. Figure 1.1 highlights several concepts that we will explore in greater depth throughout the book.

Family Inc. Net Worth is an expanded definition of net worth (all your financial assets minus all your liabilities) that includes as assets the value today of anticipated lifetime after-tax income and Social Security benefits. Including these as assets highlights several critical principles:

• For most people, future earnings from work are the largest asset, so the greatest net worth is achieved at a time when...