Subj: Where Do Millionaires Invest Their Cash to Keep It Safe?
03/27/2013
Where Do Millionaires
Invest Their Cash to Keep It Safe?
By Joshua Kennon
I’ve been having a conversion about investing and money with the reader “Frat
Man” in the comments section of another post. He asked:
I also had one other question I have always wondered. Where do millionaires
keep their money? In the sense that FDIC insurance only covers $250,000 at the
bank and SIPC only covers $500,000 at the brokerage. I mean, I can’t see Bill
Gates putting $250,000 at thousands of banks across the country, nor can I
imagine Lou Simpson’s net worth getting wiped down to half a million because of
a bankrupt Scottrade. Ha! So when people accumulate millions, what becomes the
“safe spot” to keep it?
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When I went to hit “reply” in the comments section, I realized that it was
nearly 1,500 words so I thought it might be better to just post it as its own
in the event some of you were interested in where billionaires and millionaires
like Bill Gates or Lou Simpson invest their cash. It really has nothing to do
with beginners, otherwise I could have gotten an About.com article out of it,
but it might still interest those of you who are curious about these sorts of
things.
Here is my answer …
Where Do Millionaires Park Their Cash?
First, you have to realize that “money” in one sense doesn’t exist. It is an
idea. If you are talking about the green pieces of paper the Treasury
department prints, there is only about $575 billion in circulation yet
household assets in the United States are valued at more than $50 trillion.
Think
about that. If you owned every single United States dollar bill in the entire
world, you would only have 1/100th of the estimated household net worth in the
United States. The reason: Those greenbacks are merely an exchange mechanism.
They represent something that people can trade to signify a claim check on
society. In and of themselves they have no value. We could have just as easily
chosen sea shells or jars of strawberry jam. The reason societies have
preferred gold and silver over time is they are difficult to mine, so it is
very hard for governments, politicians, kings and presidents to make the
currency worthless by printing more paper.
The result is that most wealth isn’t held in the form of cash. In fact, I think
of money as being held in seven distinct forms (there are more but these are
the major ones):
Business ownership (stocks). If you own a chain of dry
cleaners that makes $1 million a year in profit, you could probably sell the
company for between $10 million and $15 million. You don’t have that money “sitting”
anywhere, but it is yours nonetheless.
Money they have loaned and must be repaid to them in the
future such as bonds, certificates of deposit, money parked in bank accounts,
and money invested in money market funds.
Real estate, such as hotels, apartments, stadiums, homes,
storage units, bridges, etc.
Commodities such as gold, silver, platinum, corn, cattle,
mineral rights, oil, natural gas, sugar, coffee, etc.
Nominal currencies, such as United States dollars, Euros,
Yen, and British Pound Sterling stuffed in envelopes or briefcases.
Intellectual property, such as ownership rights to famous
songs, books, movies, and photographs. If you owned the rights to Star Wars,
you could have no money in the bank but the truth is, you are probably a
billionaire because you could sell those rights to a lot of interested
investors; they, in turn, could create new merchandise and products and make
money from it, which is why they are willing to pay you. Brand names are a huge
source of intellectual property value, such as Coca-Cola, Clorox, Wrigley,
Hershey’s, and Folgers.
Tangible property, such as famous paintings, historical
artifacts, rare books, etc. If you owned an original, signed copy of the
Declaration of Independence, you could convert it into any other form of wealth
you wanted, such as nominal currency, which you could then use to transfer your
wealth into real estate, or commodities, or any of the other categories.
That means that most of the time, someone with substantial net worth doesn’t
need to park their money in a checking account. You couldn’t steal Bill Gates’
$50+ billion from him because it isn’t money in a briefcase; it is office
buildings, shares of stock, railroads, book copyrights, personal real estate,
private jets, rare art … the list is endless.
Don’t Think of “Money” As Being Cash
This may help explain the perspective of an investor…
It is estimated that there are 1,348,528,420,000 barrels of oil in the ground
that have a 90% or greater probability of being drilled and recovered by humans
(called “proven reserves”). The current spot price of crude oil is roughly $73.
That means that all of the oil in the ground is worth an estimated
$98,442,574,660,000. Let’s round up and call it $100 trillion.
(For now, let’s ignore the obvious fact that if this oil was harvested at once,
oil would be worth about 50 cents a barrel because the supply would grossly
exceed the demand. At current consumption rates, that is enough oil to meet
world demand for 54 years. )
That means if you were to suddenly inherit 100,000 barrels of oil, you would be
worth $7,300,000 at today’s market prices (100,000 barrels x $73 per barrel =
$7.3 million).
If oil rose to $100 per barrel, your assets would rise to $10,000,000. You are
now worth an extra $2.7 million! Where did it come from and where is it parked?
Nowhere. It is the estimated liquidation value of your oil if you choose to
sell right now and the market has enough demand to fill your order without the
price falling. You are quoting the value in dollars because, as a United States
citizen, those dollars mean something to you. You inherently understand the
value of $5 and what it will buy you compared to $20.
If the United States
government began to print money so it became worthless, and a loaf of bread
that originally cost $5 is now $10,000, your oil may be trading at $146,000 per
barrel even though you have gained nothing in purchasing power, giving you an
asset value of $14.6 billion. The thing is, your purchasing power would be the
same because:
$14,600,000,000 would buy 1,460,000 loaves of bread if each loaf was $10,000
just like
$7,300,000 would buy 1,460,000 loaves of bread if each loaf was $5
That means that, measured in bread as an exchange, the government printing
money didn’t have an influence on your actual purchasing power. You can still
buy the same loaves of bread as you could before hyper-inflation. This is one
of the reasons famous investor Warren Buffett talks about the importance of
measuring gains in your net worth in “how many cheeseburgers you can buy”.
Purchasing power counts. Not dollars.
What Do The Rich Do With Their Cash?
If you are specifically interested in what the rich do with their short-term
cash, comparable to the middle class putting money in a checking or savings
account, there are several popular alternatives to those with at least a few
million dollars:
Establishing a so-called zero-balance account. The rich investor has his or her
money in bonds, certificates of deposit, commercial paper and other highly
liquid debt instruments. They write checks out of the account, which has $0 in
it, and at the end of the business day, the private bank sells off enough of
the highly stable, liquid investments to wipe out the negative balance in the
account, bringing it back to $0. That way, if the bank fails, it doesn’t hurt
the investor because the underlying assets are held in his or her name, not the
name of the institution. (This service is known as custody or, in some cases,
global custody. The banks will charge a small fee for it as a percentage of
assets in most cases.) Almost every intelligent rich person on the planet uses
some form of global custody because you don’t want to worry about losing your
shirt because a broker failed.
Parking the money directly with the United States Treasury in an account backed
by the taxing power of the United States government. They can buy short-term
Treasury bills and keep rolling them over until they need the money. Unless the
United States goes bankrupt by hyper-inflating, they are safe. Buffett
literally has tens of billions of dollars of Berkshire Hathaway’s money parked
in Treasury bills, bonds and notes at times. There is no risk of default or
bankruptcy unless the entire nation goes bust!
Physically holding cash in multiple currencies in safe deposit boxes throughout
the world. These aren’t insured, though, so there is that risk.
I hope that helps you understand how a lot of private banks such as Northern
Trust think about parking money for millionaires and other rich investors.
