In the post-1982 world, the surest way to make (and lose) a fast fortune was to borrow and speculate. Building sustainable businesses or making real products that improve our world may sound noble. But why bother when you can borrow at 2 percent, buy an asset, and flip it for a quick profit? Why settle for the trickle of an income stream when you can be awash in cash from a liquidity event?
Not all of the rich fell for the allures of high-beta wealth. While they are less visible than the flamboyant strivers such as the Blixseths and Siegels, the low-beta rich offer us lessons in how to build wealth today while avoiding the risks inherent in a post-1982 world. They are allergic to debt. They never buy anything unless they can pay cash. They try to avoid relying on a single stock or a single source of income to fund their lifestyle and retirement. They keep their spending modest. And some low-beta entrepreneurs keep their salaries to a minimum, preferring to live off their liquidity events.
David Gilmour, the multimillionaire founder of Fiji Water, Zinio, and nine other companies, says he hasn’t taken a salary since the 1960s. He lives off the winnings of selling the companies he starts.
“I never take a salary, and never had a company car,” he told me. “It’s a waste. For me, it’s about the best way to create long-term value, for me and my people.”
His philosophy is similar to that of Frank Kavanaugh, another entrepreneur who could serve as a model for the low-beta rich.
Frank Kavanaugh gets nervous when times are good.
Maybe it’s because of the hard knocks he took as a kid, dropping out of high school at seventeen and getting kicked out of his house. Maybe it’s because he watched his dad—a highly respected California psychiatrist—get divorced three times and fall into a deep depression because of his debts.
Frank says it’s because, like most rich people, “I’m just insecure.”
Whatever the reason, by 2007, Frank Kavanaugh—a forty-seven-year-old tech entrepreneur, private equity chief, and former CEO—had no debts and more $100 million to invest. And he was worried.
Everyone around him seemed wildly optimistic about the economy and wealth. Living on the prosperous shores of Laguna Beach, in the heart of California’s real estate boom, Frank had countless friends who were getting hugely rich using borrowed money. They were buying homes and buildings, flipping them for profits, and borrowing even more to do it all over again.
With their easy winnings, they bought new vacation homes, sports cars, boats, and planes. It was no accident that the nation’s largest Lamborghini dealership was in Orange County, California.
Meanwhile, Frank was living in a modest home with his family of five, with no mortgage, no debt, and a five-year-old SUV. Usually dressed in cargo shorts and a T-shirt, with a bright smile and close-cut dark hair, Frank has the look of an amiable corporate executive from the Sun Belt. He is prone to wisecracks and witty one-liners. But his genial façade hides a deep skepticism and an aversion to following crowds.
Frank preferred to stay home and read (mostly science fiction) rather than socialize. He tried joining a wealth club called Tiger 21, which brings together millionaires to give each other financial advice and personal support. But none of them wanted to hang around Frank.
“He wasn’t too popular,” laughs his wife, Susan. “They would all say, ‘If you want to jump off a cliff, go talk to Frank.’ ”
Frank had a name for the Tiger 21 crowd and most of the newly rich in Southern California. He called them the “bubble people.” He didn’t dislike them, blame them, or think he was smarter. He just thought they were wrong. “The bubble people are not bad people. They were all extremely intelligent and successful. They were acting rationally in the system in which they lived.”
There were times—many times, in fact—when Frank envied the bubble people. They made it look so easy. And they were happy. While Frank went around talking about the next financial apocalypse and scrolling through doom-and-gloom blogs on the Web, the bubble people were hosting parties at their newly built mansions and talking about their newest cars, boats, and planes.
“I envied these people, I really did,” he says.
Susan asks, “You did?”
“Sure. I wondered for a while whether I was a complete idiot for not doing what they were doing.”
Yet deep down, Frank couldn’t shake his fear throughout the mid-2000s that things were about to go horribly wrong. His anxiety had its roots in research he had been doing for over a decade on investing, after he sold his second company and had tens of millions of dollars to invest.
He had read investor Harry Dent’s books, including The Next Great Bubble Boom. Dent helped to popularize the “spending wave” theory, which argued that the baby boomers would start spending and investing less as they entered retirement and started downsizing their lives. He argued that the peak for their spending would be between 2007 and 2009. After that, their lower spending and investment would lead to a weaker economy and falling stock markets.
Frank also read a stack of books on value investing, starting with the classic Security Analysis by market legends Benjamin Graham and David D. Dodd. He especially liked Chapter 7, which discussed the difference between speculation and investing based on underlying values.
“A lot of what I saw looked more like speculation than investing,” he notes.
Along with books about the Great Depression, Frank had also started to read bearish blogs by investment gurus such as Michael Shedlock and economist Nouriel Roubini.
By 2007 and 2008, when the debt markets started to falter and housing sales began to slow, Frank felt that the world was poised for a deep financial crisis. So much of the previous decade of growth and wealth creation had been fueled by debt, excess liquidity, and rising asset prices. Now that all three were coming under pressure, Frank believed that the United States was headed for its day of reckoning.
He didn’t hope to make a fortune from the fall. By his own admission, Frank is not a professional investor, or even a sophisticated one. He didn’t have a specific trade idea to express his theory of impending disaster.
“I wasn’t like Michael Burry or John Paulson,” he said, two hedge fund managers who made billions from shorting the housing market in 2008 and 2009. “I didn’t know about shorting subprime mortgages or CDOs or any of that stuff.”
Frank is an engineer and tech geek at heart. His obsession is starting companies, creating jobs, and reinventing industries, from computer software to military vehicles. His talent is in finding a new way to approach a business.
“I see a company or product and I’m always asking myself, ‘How could that be done differently or better?’ ” Frank says.
He also has a knack for peering into the future. Frank calls it “seeing around corners.” But a friend and business colleagues say he has a sixth sense for coming economic trends. What Frank saw in 2008 was the end of the bubble economy and a potential collapse of the U.S. banking system and currency. At the time he was between businesses. He had just left his biggest company—an armored vehicle manufacturer—and had yet to start the next one. So his only goal as an investor headed into the storm was to find a safe place for his cash.
He avoided stocks, hedge funds, real estate, private equity, and all the other fashionable investments. He put his money into U.S. Treasuries, bonds, and cash. He also put on his “apocalypse trade”—opening up a Swiss bank account (fully registered and compliant with U.S. banking laws) and filling it with Swiss francs, Singapore dollars, and euros.
Frank always doubts himself. So he put about 15 percent of his fortune with a highly respected hedge fund manager. He also handed over a small chunk to Credit Suisse to invest.
By 2010, his Treasuries and Swiss bank accounts had maintained their value. The hedge fund investment had plunged by 60 percent. Credit Suisse lost his entire investment in a month.
Thanks to his own trades and pessimism, Frank Kavanaugh emerged from the Great Recession with total losses of about 10 percent or less.
“I don’t want to come off as this brilliant investment guy,” Frank says, sitting on the sofa of his home overlooking the Pacific. “I had brain damage like everyone else. Those losses still drive me crazy. And I’ve had my ass handed to me plenty of times in the past by buying some stupid stock. But I think this time around I just got lucky. Really, I got lucky.”
Frank, who shies away from media attention unless it’s on his companies, insists it’s wrong to hold him out as an example of wealth wisdom during the crisis. “The only reason I didn’t blow up is because I just happened not to be in the real estate business. If I had been in real estate, I would have taken the same hit everyone else did. It’s just by accident, really, that I am where I am.”
Accident and luck may have played roles. But Frank Kavanaugh’s success during the financial crisis, and his ability to accumulate more than $100 million in wealth without becoming a high beta, has deeper roots. It stems from his wayward and unconventional childhood, his family money history, his introverted nature, and the strong partnership and shared frugality with his wife.
When he was seventeen, Frank barged into his house and announced to his stepmom he was quitting school. He was in his senior year of high school in the affluent beach town of La Jolla, California, and after he had decided not to attend a class he hated, the school principal told him he had to go to summer school. Frank told the principal: “I’m not going to summer school. I quit.”
When he got home, he gave his parents the same proclamation. His stepmother, who had endured years of Frank’s truancy and lack of motivation, gave him a simple response.
“She told me, ‘If you’re not going to school, you’re not going to live here anymore,’ ” Frank recalls. “And she was serious. She helped me find an apartment. She gave me three cooking pans and a mattress and wished me luck. She was very sweet about it, but tough. Looking back on it, it was very lovingly done.”
Yet after growing up in the privileged home of a well-known psychiatrist father and a supportive stepmom, Frank was on his own. He had no job, no real skills, and no real friends.
“You can ask what kind of psychological or intellectual stuff was behind all this, but the answer is pretty simple,” Frank says. “I was a stupid seventeen-year-old.”
He also had no real calling or driving passions. School didn’t really interest him. Neither did sports, science, or anything, really, except for girls and cars. He always did the minimum amount required. To get his driver’s license in his junior year, for example, his dad told him he needed to get a B-minus average.
“So that’s exactly what I got, a got a B-minus,” Frank says.
After getting kicked out of his house, he drifted from job to job. He worked as a busboy, carpenter, and bartender. He partied and drank a lot. When I asked him about role models or mentors at that time in his life, he said, “Jose Cuervo?”
On the morning he turned twenty-one, Frank woke up and decided his life needed to change. The drinking, the manual labor, and the low pay had turned him into a listless wanderer. Other friends the same age were graduating from college with degrees and were getting high-paying office jobs. So on his twenty-first birthday, he enrolled in a junior college. He quickly earned an economics degree, then transferred to the University of California at Irvine and got a degree in computer science.
Computers were not an obvious choice for Frank. He wasn’t a childhood programming prodigy like Bill Gates or other successful tech stars. Frank liked technology. But he had never spent much time with computers growing up in the 1980s.
“I chose computer science for two reasons,” Frank says. “Because I thought it would pay well and it was easy.”
In his senior year, he became fascinated by artificial intelligence and dreamed about working on advanced robotics. But after graduating, he decided to take a more practical job as a systems engineer at Hewlett-Packard and later at Microsoft.
At Microsoft, Frank met his wife, Susan, a rising systems engineer who had also grown up in Southern California. Petite, fit, and fiercely intelligent, Susan had gotten two computer degrees from Loyola Marymount University before landing high-ranking jobs at IBM and Microsoft. She had always followed the twin virtues of thrift and hard work: as one of six children of a frugal aerospace engineer, she had worked her way through college and high school serving burgers at McDonald’s and working behind the counter at a rental car company.
As Frank puts it: “She’s the family overachiever.”
In 1988, Frank decided to strike out on his own and start a business. At Microsoft, he spotted a need for a company that could train IT professionals on how to use Microsoft applications. He formed QuickStart Intelligence. The firm quickly grew to become one of the leading Microsoft training companies.
In 1992, Frank sold his stake in QuickStart to a venture capital firm for $1.8 million. For most couples, the payday would have marked the start of the good life. They were, at thirty-four, suddenly millionaires.
“It felt like more money than we would ever need,” Frank says. The typical path would have been to “go out and be wealthy and exchange pictures of dead presidents and suddenly expect my life would get better.”
But Frank and Susan were smarter than that. Both of them had always been careful with money, based on their family histories. At one point, Frank’s dad wound up in the hospital with severe depression because of his finances.
“I said to myself that I would never let that happen to me,” he says.
Frank also had a strange set of personality quirks that helped him avoid getting caught up in bubbles. He is a loner. “I’ve always been an introvert. I have no friends,” he says, only partially kidding. His tendency to pelt people with questions, even in social situations, often leaves him relying on his wife for invitations. “After people meet us, they say, ‘Oh, we loved Susan.…’ ”
He also tends to see the glass as half empty.
“I’m a pessimist about things that I can’t control directly,” he says. “If I’m not involved, I’m less confident in the outcomes.”
It’s not that Frank thinks he’s superior. Quite the opposite. By his own admission, he has what might be considered an inferiority complex. One of his theories about rich people is that they’re motivated in large part by insecurities tracing back to their childhood, parents, or early adulthood. At UC Irvine, when he was among the oldest but least educated in his class, he became used to life as “the dumbest guy in the room.”
“Even today, when I walk into a meeting or conversation, I assume I’m the dumbest one in the room.” This perspective, he says, has helped him enormously.
“Insecurity is a great driver,” he says. “I have friends who are normal, well-balanced people and they do fine, but people with insecurities seem to be willing to work a little bit harder. It’s that extra push.”
Susan, for her part, is far more well adjusted. But she is careful about money, having learned to be a disciplined saver and planner from her father, who would delight in finding pennies on the floor and always drove old cars.
“He was so frugal, and a terrific investor,” she says. “We never did anything flashy growing up. It was all about work and saving.”
Before they got married, Frank and Susan sat down and came up with a detailed financial plan for the rest of their lives, breaking out their targeted spending, incomes, and savings rates. It was all geared toward achieving a specific target: a retirement fund of $8 million.
To meet their goal, they lived in a modest home with their three children. They avoided all debts, including mortgages. And they drove a practical Toyota.
Frank also had an unusual approach to salaries. Large salaries, he believes, are what spoil people and lead them to outsize lifestyles. So at QuickStart, Frank paid himself only $20,000 a year. Most of his compensation came in the form of stock, which would be cashed in if and when the company was sold.
The approach not only helped him keep the family expenses low but also made him more motivated to build the value of the company. His incentives were now long-term rather than short-term. His wealth came from keeping cash in the company, not from taking it out.
“Large salaries are what kills you,” he said. “It’s the most detrimental thing you can have. Your lifestyle just grows to fill the salary, so pretty soon you need $250,000 just to get out of bed in the morning.”
To Frank, a large salary lulls people into thinking that the money will never stop, that they can borrow and spend beyond their current means because they’ll make even more next year. They view their wealth as a never-ending stream, rather than the momentary shower. Sure, they may be overextended on the boat and the plane and the two homes,. But it’s nothing a few years of high salaries can’t fix. Frank is different. He spends only what he has now, and invests for the longer term. In 1993, he helped start a second company, called NewGen Systems, a digital-imaging company. When it was sold five years later, Frank made $5 million. At NewGen, he also took a minimal salary.
After the sale, the Kavanaughs were well past their $8 million. The proceeds from the two companies, along with their savings, investment returns, and Microsoft stock, put them well into the eight figures. Now that they had all the money they thought they’d dreamed of, Frank started dabbling in conspicuous consumption—usually with comical results.
In 1994, shortly after the NewGen sale, Frank and Susan decided to take the family to Ireland. Family travel and education were the two areas where they agreed that spending large amounts of money was actually worth it. Yet when they arrived at the airport, they found themselves stuck on an endless line for check-in on economy class. They were about to miss their flight. Frank went up to the first-class counter—which had no line—and bought first-class tickets for the entire family. They cost $12,000.
“When I was standing on that line, I just thought, ‘Hey, we’re rich, we don’t have to stand on this line,’ ” Frank says.
They boarded the flight and had a memorable trip. But Frank started regretting the expense almost immediately.
“We had just bought a new Toyota Camry for $21,460,” Frank says. “And I remember as soon as I bought the airline tickets, I realized they cost half as much as the Camry. I kept thinking, ‘Half a Camry, for one flight!’ ”
Adds Susan, “I told him not to do it. I thought it was terrible.”
To this day, Frank still refers to the vacation as the “half a Camry” trip.
He also had an awkward flirtation with private jets. When he was younger, Frank promised himself that if he ever made it into the eight figures with wealth, he would fly on private jets. After the NewGen sale, Frank bought a jet card that gave him twenty-five hours of private-jet flight time. Most families would burn through twenty-five hours over Christmas and Easter. It took the Kavanaughs over two years to use the hours because they felt so guilty about the cost. They wound up using most of the flights to visit their son in boarding school, rather than jetting off to Cabo or Aspen for the weekends.
“As soon as you buy it, the rational part of you kicks in and you realize, ‘This is so stupid,’ ” Frank says. “It felt too extravagant.”
For his fortieth birthday, Frank bought a Porsche. It was used and he got a great deal. But after six weeks, he returned it and settled back into his old Lexus 400 LS sedan.
“I just didn’t like the Porsche,” he said. “It wasn’t my thing.”
To be sure, the Kavanaughs live well. They are not the millionaires next door, living in a blue-collar town, driving old Ford Fiestas, and reheating meat loaf for dinner. Their house is a 6,000-square-foot Mediterranean overlooking the Pacific in Dana Point, California—an ultra-wealthy enclave with an average house price of $4 million.
They take exotic vacations to Africa, Asia, and the Caribbean. The day I visited them, they were about to head to the Galapagos Islands. They belong to a destination club in which members pay tens of thousands of dollars to stay in a collection of private mansions or apartments around the world.
The Kavanaughs recently bought their first vacation home—a small house on a quiet island near Seattle. The home has its own airplane hangar, which Frank figured would be a good investment in the long run.
“Our focus has always been to use money to create opportunities for our kids, and on things that bring our family closer together. If we can’t do that, what’s the point of all the money? It’s just money—it doesn’t have anything magical.”
In 2008, Frank cashed out of his biggest company yet—Force Protection, the first U.S. manufacturer of armored vehicles that supplied mine-resistant trucks to the military. Frank had been the CEO and largest shareholder. When he discovered the company in 2001, it was a struggling manufacturer of speedboats. He invested $25,000 and shifted its focus from boats to armored vehicles. By the time he left the company, Force Protection had more than $1 billion in defense contracts, and Frank’s $25,000 stake had grown to more than $60 million.
The stress of running Force Protection took its toll. It was his first public company, so there was the constant pressure of quarterly earnings and shareholders. Worse yet was the anxiety of being responsible for the lives of U.S. soldiers in Iraq. Force Protection vehicles performed well—no Marine had ever died in one as the result of an improvised explosive device.
“But I’d wake up every night worrying about it,” Frank says.
So after leaving the company, he decided to slow down. He founded a group called Prosperitas, which gathered millionaires, entrepreneurs, and great thinkers together for regular meetings at the UC Irvine campus. He caught up on his sleep. He spent more time with his kids.
His semi-retirement lasted for all of a year.
“To me, the excitement comes from finding a new way to do something, and to create jobs. That’s what excites me.”
So in 2010, he founded his next venture, an insurance company. Susan is a little puzzled, since insurance “sounds kind of boring for Frank.” But Frank can talk passionately for a half hour about the “broken business model” of the insurance industry and his ideas to fix it.
“I’m sorry,” he says after finishing his little speech. “Insurance gets me worked up these days.”
What gets him even more worked up is the state of the wealthy. Life as a low-beta millionaire is one of perpetual frustration and disbelief. There is always someone else making more money with less work and discipline. Low betas take comfort in knowing that someday their time will come. They live and work under the assumption that someday America will once again reward people who create lasting companies and jobs.
For Frank and other low betas, the Great Recession was only a partial reckoning. Lots of reckless investors and real estate speculators lost their fortunes. But Wall Street and the entire industry of financial engineering and trading remained largely untouched. The low betas were never really vindicated the way they’d hoped.
“What’s unfortunate is that we continue to reward people for not creating sustainable real value,” he says. “Look at the banking system. It’s reemerged, and even after what these people did, the compensation system remained in place, and they had to be paid bonuses to stay. I know a lot of very smart, very nice people at Goldman Sachs. But they don’t really have expertise in a real business, and I’m not sure they’re creating real lasting value.”
Sitting on his couch overlooking the Pacific Ocean, Frank looks out at a crowd of surfers and the setting sun. He’s the first to argue that he doesn’t deserve his success. He says it’s mostly luck, a result of showing up at the right place at the right time. But he hopes that sometime in the future, America’s wealthy will have to earn and preserve wealth the hard way—by starting companies and filling a need.
“Maybe I’m being naive,” he said. “But we need to reinvent the idea of wealth in this country.”