Feeling Wealthy vs. Being Wealthy

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The Wall Street Journal has a nice little piece today on tech entrepreneurs, and what they should do with their newfound wealth.  The advice: as little as possible.  Don't spend it, and don't leave all of it parked in your company's stock.  This is sound advice for anyone who has come into money, whether it's an inheritance or a squintillion worth of IPO capital.  People need to diversify their nest egg (your income and your savings should never be tied to the same firm), and more broadly, they need to minimize their risk.  So t-bills won't give you the same returns as a tech stock--who cares?  If you've got a lot of money, you can afford to accept lower returns.


The best piece of advice is also the simplest, and the one we'd all do best to take to heart:

If it's not cash, don't spend it.Mr. Hoffman may be a paper billionaire, but he sold only about $5 million of stock in the IPO. He is still rich, of course. But advisers are telling the instantly wealthy to limit their lifestyles to their cash rather than their paper wealth, which can vanish in a heartbeat.

While LinkedIn, Groupon and the other companies have enjoyed steadily higher valuations in the private market, they are likely to endure a more volatile ride in the public markets.

"There's a temptation to start spending the money right away," Mr. Sheldon says. "But the lesson from recent history is that your stock doesn't always have the same value in six months that it does today."

Economists call it the "wealth effect": people become more willing to spend when they feel like they have a lot of assets.  When those assets are things that can go up as well as down, this can get people in big trouble.  And when it happens to large groups--as it did during both the stock and housing booms--it can lead to an economy-wide consumption binge that leaves capital malinvestment and financial ruin in its wake.

I was reading Daniel McGinn's House Lust this weekend.  It was clearly sold as a chronicle of the housing bubble, but the bubble inconveniently collapsed while he was reporting the book, leaving him with a slightly odd book (it was published in 2007) about the early stages of the decline.

Now, four years later, it's an extraordinary artifact.  It's hard to believe that people pulled $350,000 in equity out of a home they paid $350,000 for in order to fund lavish renovations that they told themselves were only making the property more valuable.  Hard to believe that people really thought that buying a house was a good way to save for retirement.  Nearly impossible to believe that we once thought a nationwide decline in home prices was the next best thing to impossible.

We just reluctantly decided to not to redo our horrible backyard, which is an unsightly patch of broken concrete, remarkably hardy weeds, and sagging fences; the only thing it needs to complete the look is a car up on blocks.  It's pretty appalling--but when we called in our trusted handyman for a quote, he informed us that it would also be pretty expensive to fix.  And while we have the money in cash, it's more important right now to build up our savings after an expensive year of weddings and house down-payments.  Having such a terrible yard is a little limiting, but you know what?  Our friends are still willing to come over to grill, sit in our motley assortment of folding chairs, and drink beer--which means that for now, it is good enough.  Even though I've been looking forward to ripping out that yard for almost a year now, I felt immensely peaceful as soon as we decided to delay.

Five years ago, we'd probably have taken out a home equity loan and done it, maybe along with the wretchedly renovated upstairs bathroom or the kitchen--and we'd have told ourselves that we were saving, increasing the value of our biggest asset.  You don't hear that so much any more.  I wonder if it's because we're actually wiser--or simply because we have less wealth to fool ourselves with.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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