Even the rich and famous have trouble keeping their finances hassle-free, even though most might think that they have figured out exactly what works in business and their own financial life.
But you’d be very wrong. Billionaires make money mistakes all the time and even admit to doing so. Some even claim their errors were learning points for them, helping them become better at money management.
However, the majority of them commit financial blunders which would be points of reference for when we come into big bucks.
Here are some money mishaps of the rich and famous we can learn from:
Several rich and famous people have tried to circumvent paying their taxes only to get burned by Uncle Sam who always collects.
Wesley Snipes, Ja Rule, Martha Stewart, and Nicholas Cage are some of the celebrities that owed their taxes. When you owe taxes, you incur penalties and interests which means more money is taken out of your pocket. Not to forget the emotional and mental stress that you would undergo when the IRS comes calling.
The rich and famous are known for living extravagant lifestyles…well, most of them.
The limits of celebrity conspicuous consumption continue to be pushed. Some of the rich and famous have distinguished themselves by the sheer quantities of cash spent on quirky luxury items.
Yet it's not only the rich and famous that live extravagantly.
Ordinary people also engaged in this lifestyle, sometimes in emulation of the celebrities whom they see as idols. But wealth cannot be built by engaging in frivolous spending. Money has to be put to work to generate more money.
While it's good to treat yourself to the finer things of life, like every other thing, this should be done in moderation. When you have money, the question that should guide your actions is how best can I put this money to good use?
Like Charlie Munger says: "Money invested saves you a day from work."
A lot of celebrities have made bad investment decisions that would make you cringe.
This is not surprising considering that many celebrities come from fairly humble beginnings with no more finance training than the average public school kid. This in turn affected their investment decisions when they came into money more than they ever dreamed of.
MC Hammer bought a mansion and spent $500,000 a month paying servants to attend to his home, treating his entourage to a lavish party lifestyle.
Model turned actress Kim Basinger purchased the town (Bank of Braselton, Georgia) for $20 million. Her idea was to turn the town into a tourist destination with its film studios and movie festival. However, she sold the property for $1m five years later after she could not bring the project to reality.
While no one is immune to failed investments or making bad business decisions, Even the Oracle of Omaha made a $200bn mistake.
However, it underscores the need for due diligence and risk management. When faced with an investment decision, do not go all in. Weigh your risks appropriately and invest only what you can afford to lose.
If you are unsure, you can spread your investment over time and see how it pans out. This allows you to understudy the investment while risking less capital.
You would think that the rich and famous with all the money and connections at their disposal would be privy to the best financial advisors.
However, history shows us that they can be victims of bad financial advice from these so-called professionals.
Rihanna fired her accountants in 2010 after the Barbadian singer was left 'effectively bankrupt' at the end of 2009 due to bad financial advice which saw her lose $9m in one year. Her accountant advised her to buy a Beverly Hills mansion for 7.5m, which turned out to be moldy and leaking.
In 2010, Nicholas Cage sued former business manager Samuel J. Levin and his firm for $20 million, saying they gave him bad financial advice and mismanaged his money. Former NFL star, Terell Owens' financial advisor put his money into bad investments, including a casino that went bust.
While you may depend on experts on the best ways to use your money, the financial misfortune that befell some of these celebrities shows that all investment advice is not good advice.
This is where self-education comes into play. Rather than depending on others, take the pain to educate yourself. This way you can consult due diligence on investment options.
Besides, its costs less to educate yourself on money management than to depend on others.
Some celebrities failed to negotiate their true worth and got underpaid for it. For example, Jennifer Lawrence (star of Divergence) disclosed that she was paid less for the movie "American Hustle" than her male co-stars, Bradley Cooper, Christian Bale, and Jeremy Renner.
Lawrence initially did not know about the wage gap between her and her male co-stars, until the Sony hack of 2014, which leaked confidential emails.
This shows that you should never underestimate your value, and always negotiate what you deem is your worth. If it can happen to stars, then most probably it can happen to you.
The celebrity lifestyle is all about showmanship.
This means they do things to get validation from the public. One area where this is noticeable is their quest for instant gratification. Splurging on liabilities like cars, jewelry, clothes, or even real estate they can't manage to send them down the rabbit hole of fiscal irresponsibility.
Some famous people also forget that you can only hold the public's attention for so long. There would come a time your fame would wither away, and public attention will be diverted to the next biggest star.
Rather than splurging on liabilities, why not invest your money in assets to create generational wealth? Just like celebrities whose fame may wither at some point, opportunities to create and multiply wealth may be few and far coming.
The only way to ensure that you constantly create income is how you use the resources presently available to you. Always have a plan to maximize your cash before it even hits your account.
All the worms of your past life seem to crawl out of the woodwork when you get rich and famous.
Some celebrities, because of their humble beginnings, feel the need to help out family members and friends who are in financial trouble. While this is a commendable act, it has also led some of them to financial ruins.
MC Hammer famously reported having a staff of 200 with a monthly payroll of $500,000 for friends and family who did nothing for the money. Former NFL star Terrell Owens also reportedly doled out a lot of cash to help friends and family.
On a much smaller scale, this can happen to everyday people as well. You may find yourself in situations paying for family members’ bills, for example. Although small amounts at first, they can add up quickly and put you in a bad financial situation.
Apple founder Steve Jobs defined focus as learning to say no to too many good ideas. The same goes for financial discipline. There are many ways you can empathize and support loved ones other than becoming a human ATM.
When approached for money, draw up a loan agreement and agree on repayment plans.
Also, ask them about their financial plans and what they intend to use the money for. This would give you insight into if the person will use the money for a worthwhile venture or if they just want to take their share of your largesse.
Stories of rich and famous people going bust are a clear indication that without financial education and sound money management skills, it would be impossible to keep your money, let alone grow it.
While too many people prioritize chasing riches, more important is knowing when and how to invest them. This is why people who earn less but have sound financial knowledge can grow their wealth through diligent investment.
One of the stark differences between the rich and the poor is the way they view debt.
For the former, debt is a footstool to climb up the wealth ladder. For the latter, debt is a weight that can weigh their finances down and keep them in perpetual poverty. One way the rich use debt to enrich themselves is the Buy, borrow, die strategy.
You may be thinking: How come they borrow money when they have a lot?
The answer to that question is Buy, Borrow and Die.
This is a fascinating technique that the wealthy use to control their wealth and pass it down to future generations.
The wealthy have also become masters at buying, borrowing, and dying while paying minimal taxes or no taxes at all.
A report published on ProPublica showed that the 25 richest Americans (by Forbes’ ranking) paid a “true tax rate” of just 3.4% on wealth growth of $401 billion between 2014 and 2018.
Jeff Bezos — one-time richest man in the world — paid a true tax rate of 0.98% of his wealth from 2016 to 2018. Tesla founder Elon Musk paid 3.27% of his wealth as federal income taxes within that period.
Billionaire investor Warren Buffett, who saw his wealth grow by more than $24 billion within the same period paid a true tax rate of 0.10%
Some may scoff at the tax system saying that it only favors the rich, but the reality is far from that. Fortunately, this technique applies to anyone willing to learn and put it to use. You do not need to be rich to make a profit from knowing this information.
Let's look at how you can use buy, borrow and die to protect you and transfer your wealth with minimal tax costs.
First, you buy an asset that you can borrow against.
This could be an asset that appreciates but the two most popular assets are stocks and real estate, with the latter being the more preferred by lenders. This is because real estate prices tend to go up in the long term, and are less volatile than stocks. You can also depreciate real estate and reduce your income tax.
Next, you borrow against your asset.
The common logic is selling your assets to raise money if you are asset rich and cash poor. But when you do, it triggers capital gains that are taxed.
To avoid this, you don’t sell your assets to get cash. Rather you collateralize your asset, this implies using your assets as collateral to obtain loans. Since loans are not considered income, they are not taxable. But you do have to pay interest to the bank.
If you have stocks as assets, you can borrow against your securities through SBLOCs. This is an easy and inexpensive way to access extra cash by borrowing against the assets in your investment portfolio without having to liquidate these securities.
However, in most cases, real estate is used and seems to be the preferred choice for the wealthy.
Every good plan needs a decent exit strategy, and this one depends on the best one of all: death.
Your estate belongs to your heirs once you pass away. The assets are used to pay off the debts, and when the assets are passed on to your heirs, their (cost) basis is increased.
Your beneficiaries' current cost basis in those assets when they inherit them is equal to the asset's current market value (at the time of your death). Your heirs might pay much less in taxes thanks to that step-up.
For example, if I bought shares of Apple for $145 and it appreciates 4 times higher than at the time when I passed on ($580), my beneficiaries get the step-up in cost basis.
If they sell those shares today at $580 each, they will pay no capital gains tax because they had no gains. (They may have to pay estate taxes as a result of getting those shares.)
The strategy works because of the step up in cost basis of the asset. I paid $145 per share and if I sold it, I’d owe taxes on the gains. Because they got the shares after I died, they “paid” the higher price and if they sold it that day, they owe $0 because they had no gains. The loan can also be paid off with the proceeds of the sale.
This strategy is an effective way of ensuring your dependents are well taken care of after you have passed on.
Because your assets are collateralized and never touched, they continue to appreciate value (see why real estate is the preferred choice for the wealthy?).
A hidden benefit is that your asset's appreciation can offset the interest rates paid on the loan. As your asset increases in value, its increment may surpass accumulated interest paid on the loan, which technically is a profit for you.
Debt is not taxed. When people borrow against vast amounts of valuable assets, they don’t pay tax, because the tax code does not count debt as income.
When you borrow money from the bank instead of selling an asset for cash, you pay the bank some interest and the government doesn’t get its capital gains tax. This is unlike taking a loan from your 401(k) whereby the value of your contribution is reduced.
You can compound using this strategy.
The loan obtained against your asset can be used to acquire another investment with cash flow that you can borrow against again. This cycle of borrowing and investing in assets that generate cash flow stacks up assets for you and increases your net worth over time.
This strategy works more efficiently if your asset is real estate. Unlike stocks where you may have to pay for the full price, you can lock real estate with down payment.
One demerit of this strategy as a way to accumulate wealth is that it might not be the most efficient way of acquiring an asset in the first place.
You can typically own real estate by paying a fraction of the cost of buying it. A 20% down payment (sometimes less) can get you a piece of property.
You also need a huge amount of money to benefit from this strategy. It may take time to build your assets and portfolio to a level where you can benefit from this strategy.
Since you are borrowing against your assets, interest rates would affect the total cost of your loan.
As such, you need interest rates on that loan to be relatively low. If interest rates creep up, it makes this strategy less effective and unprofitable. Your best bet is using a fixed-rate loan as this accommodates periods when the interest rate would be higher, and also allows you to plan your repayments.
A variable rate loan may not be appealing, since it would be adjusted according to benchmark rates set by the Fed.
Although it appears that the wealthy are the only ones who may benefit from many of these tax avoidance techniques, practically everyone with assets can do so.
Even if you aren't a billionaire yet, you may probably benefit from simple tax planning techniques like making contributions to tax-advantaged accounts (like IRAs and 401ks), taking out loans against taxable assets (such as stocks and real estate), and making sure your estate is properly planned.
You can purchase, borrow, and pass away without paying taxes if you put these fundamental tactics in place.