Managing CEO wealth: why do so many otherwise-capable executives make mistakes with their own personal finances?

Chief executives are charged with growing wealth for thousands of stakeholders, and personally sign their names to just about every major company decision. It seems only natural that they would transfer a little of that expertise to their own personal financial domain. Compared with billions of dollars of market cap, how complicated could one's individual portfolio be?

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Very, as it turns out--and as some have learned the hard way. By the time a CEO reaches the corner office, his or her portfolio has likely already grown to proportions that make managing it a full-time occupation. As salaries rise, compensation packages grow in complexity and stock options pile up, that portfolio becomes an unwieldy mass of diversified holdings, offshore accounts and steep tax traps lurking on every page.

Yet many CEOs have trouble recognizing that managing that complexity may be beyond the scope of their time, interest or expertise. "They often don't see it as a discipline, like being CEO of a company is a discipline, requiring a certain set of skills," says Robert C. Elliot, senior managing director at Bessemer Trust, a New York-based wealth management and investment advisory firm.

One technology company CEO, for example, saw his personal bottom line soar in 1999 as the company stock ballooned. But over the next year and a half, as the stock continued its decline, he refused to sell any shares, both reluctant to send the wrong message to Wall Street and convinced that the stock would rebound. Despite the fact that the company holdings represented 95 percent of his net worth, the CEO made no effort to diversify--until the shares were down 30 percent off their high. "That was a wake-up call," recalls Elliot, who worked with the CEO to develop a plan to offset some of the damage. It's a common enough example of CEOs missing the big picture. "The business of wealth management is really just as complex as running a Fortune 500 company because you have a totally different set of dynamics," he adds.

For one thing, creating millions of dollars of wealth over, say, a five-year period, doesn't necessarily use the same set of skills, or mind-set, as the task of preserving it across three or four generations. "CEOs tend to be short-term oriented by necessity," Elliot says. "If you're used to having to worry about quarterly results, it's hard to think in longer terms and ask, 'What's my wealth supposed to do every 10, 20 or 30 years?'"

CEOs also have trouble taking the critical eye they use on the job, and applying it to their own personal situations. They develop a soft spot for the family accountant, attorney or local broker who may have served them well early on in their careers, Elliot notes, but who might not be appropriate to help manage, say, a $70 million portfolio.

Moreover, top executives tend to put too much stock in their own ability to play the market, some experts say. Their narrowly focused expertise in their own industry can blind them to other key opportunities. "CEOs tend to invest in what they know well, but don't necessarily diversify," says Meloni Hallock, CEO of Acacia Wealth Advisors based in Los Angeles, who counts about half her clients as chief executives. "They've been very successful in one area or industry, so they have sort of an inside angle as to what's going on in that industry." The kinds of investments necessary to complement their portfolios often get short shrift, leaving them vulnerable to huge losses, adds Stephen Craffen, owner/principal and senior wealth manager with Baron Financial Group in Fair Lawn, N.J. "They may not understand that they need to have 5 to 8 percent in natural resources or 8 to 10 percent in real estate. They only understand one aspect of the picture."

For many CEOs, a preference for concentration in one-off investments comes naturally. It is, after all, through concentrated investments in a single stock or two that many of them made their fortunes. To take those positions and cash them in for a sedate, diversified portfolio that promises, at best, a 7 to 10 percent yield sounds, if not unwise, then boring as heck. It certainly doesn't have the same thrill as rolling the dice on a hedge fund that could jump 50 percent in one year. "The game is different and they may not enjoy that game as much," Elliot says.

Concentration in a single stock is an occupational hazard of the sitting public company CEO, who may receive restricted stock and can't liquidate positions on either a whim or well-reasoned strategy. If they cash out of a position too early or too quickly, they risk running afoul of Securities and Exchange Commission rules. And even when they can sell, corporate leaders are often loathe to send a signal to Wall Street that the company's top cheerleader is taking skin out of the game. "They feel a responsibility to continue holding the position," says Timothy Speiss, practice leader of Eisner LLP's Personal Wealth Advisory Group in New York.

The problem is particularly chronic among company founders and CEOs who've spent years turning around troubled companies. To them, diversifying out of their company stock undercuts their own message to investors: that the company will continue to outperform and the stock will rise. "That's where third-party objectivity comes into play," says Tim Kochis, CEO of Kochis Fitz, a wealth management firm in San Francisco. "It's very difficult, if not impossible, to be dispassionate about your own financial affairs."

Sometimes CEOs only gain that objectivity once they've left their companies. One of Kochis' clients, the CEO of a Fortune 500 company, had for years resisted his advisor's efforts to diversify out of a company stock and insisted on making his own investments with whatever liquid cash was available. About 18 months into an early retirement, the company stock was down, and the CEO discovered he had a passion for private equity investment and art, and wanted to have money to pursue them. "It's amazing what a little distance from the company and the stock market downturn did for his views on owning so much stock," says Kochis.

For the sitting CEO, the job of the third-party financial advisor is to understand the importance of CEO passion and of keeping money on the table, but at the same time be a foil to that emotional investment. The basic reality Kochis starts with is that no company can continue to outperform all other market alternatives. "In fact, the better it did perform in the past, from a probabilistic standpoint, the less likely it is to continue to outperform in the future," says Kochis. "There has to be some balance between looking after your own interests and looking after the interests of the company."

Kochis insists that truly sophisticated investors and analysts understand that CEOs have to take care of their own assets and their own families, just like everyone else. And they should understand that when senior executives are too highly concentrated, it leads to a short-term mentality, which inspires not only the creative accounting but also the kind of risk aversion that leads to company paralysis and stagnation. "That's an issue that doesn't get enough attention," says Kochis. "If the personal wealth of the CEOs and all the senior executives is concentrated in the stock of the company, they run the risk of being unwilling to take appropriate business risks for the long term, because they're afraid it's going to affect their wealth in the short term."

Assuming the CEO is fairly diversified outside company holdings, there is room for a few strategic, localized bets, says Kochis, author of Managing Concentrated Stock Wealth: An Adviser's Guide to Building Customized Solutions (Bloomberg Press, 2005). "Concentration is not necessarily a bad thing," he says. "You just have to know if you can afford it."

The right advisor can help you analyze your total wealth and determine just how much money you can afford to play with, and having that on the side can satisfy the itch to gamble a bit on hunches, while leaving the bulk in a diversified basket of stocks. Elliot will often recommend that a CEO who wants to actively choose individual stocks carve out 5 or 10 percent of a total investment pool "and dabble in an area you know well."

When her CEO clients want to invest in a risky venture, Hallock sits down with them and calculates how much of their net worth the investment represents and what would happen if the investment goes bust. "You walk through the what-if scenario and you help them put parameters around it, before they become too emotionally invested," she says, adding that it's important for the advisor to give honest advice and to push back when necessary. "If they wanted a 'yes person,' they could hire anybody," she says.

In the end, most good advisors will defer to their clients' knowledge of a particular company or industry, as long as the CEO understands the risk. When Eisner's Speiss recently advised a former oil company chairman to begin diversifying out of his mammoth position in company stock, the client refused, arguing that he believed prices were going up. "He ended up being right and I ended up being wrong. The stock went up," says Speiss.

Even those CEOs who feel they're up to the task of managing their personal portfolios might find it worthwhile to delegate some of the job so they can preserve their most valuable asset--time. "It's just like washing your car," says Hallock. "Could you wash your own car? Yeah. But how many CEOs do?"

RELATED ARTICLE: What to Look For in Financial Advisors

THEY SHOULD have at least 10 years of experience, operate on the basis of fees rather than commissions and offer great referrals. Here are a few other key attributes:

* Experience working with CEOs. Look for an advisor who manages not only portfolios of comparable size but who also works with other chief executives. CEO wealth comes with its own unique challenges, such as restrictions regarding company stock ownership.

* A "big picture" communicator. You won't have time for all the nitty-gritty details, so find someone skilled at giving the executive summary, says Meloni Hallock of Acacia Wealth Advisors. "CEOs don't need to know the 43 things that went into how an investment is built. They need to know the three things that will make them decide whether it's for them."

* A bevy of well-researched options. Unlike other high net worth individuals who may want to be told what to do, "CEOs want alternatives," says Richard Joyner, of Tolleson Wealth Management in Dallas. Find a planner who is willing to research the options, give you the pros and cons, and let you make the call.

* Someone you trust. You must feel the right chemistry with your advisor and know you can ask any question and share any secret. Rely on the intuition that has served you well in the boardroom.

Source: Chief Executive