Preserving family wealth
8 lessons drawn from JP Morgan to safeguard what you have worked for
IN 1982, Forbes Magazine in the US published its now renowned list of the 400 wealthiest Americans for the first time, ranked by their net worth, says Riëtte Coetzee, an advisory partner at Citadel Wealth Management.
Twenty-one years later, JP Morgan conducted a study to examine the list and determine which families remained among the country’s wealthiest. The result was astonishing: less than 15% of people, or 54 of the original names, remained on the list.
The most common reasons for dropping out included an over-concentration in a particular asset and too much leverage, followed by excessive spending and tax.
Below is a brief discussion of the key risks for families to safeguard against in the quest to stay wealthy, drawing on JP Morgan’s 2004 paper “Beating the Odds and Staying Wealthy”:
Concentration.
“Most wealthy 1
families have, at some point, channelled their resources into one area – whether a company, an industry, real estate, or an art collection – which has become the primary source of their increased financial wealth.” (JP Morgan)
However, not all assets maintain their value over time. Trends change, prime property locations lose their attraction, technology disrupts established industries and companies fail. Diversifying your asset base can be challenging, especially as it may involve selling an asset to which you have a strong emotional attachment.
But spreading investment risk is crucial to preserving wealth, ensuring that your investment strategy remains uncorrelated to specific asset classes, companies, industries and locations.
Spending.
“It comes as a surprise 2
to many that to sustain wealth, they can spend no more than 4% annually of their investable assets.” (JP Morgan)
This highlights the importance of adjusting your income expectations as a percentage of your overall wealth rather than a simple rand amount.
If the value of your investable assets decline as a result of poor investment returns, your consumption as a percentage of your assets will increase, potentially eroding your capital base.
Also, no sound investment strategy can save you from bad spending habits. Taking on more investment risk to address the shortfall between income and spending needs is not likely to be sustainable.
Leverage/gearing.
“Leverage is 3 a double-edged sword. It provides an opportunity to enhance returns but it also increases risk.” (JP Morgan) Borrowing money to make money can be extremely productive, but the key is to understand the risks and how best to mitigate your exposure.
Taxes.
“Tax poses a significant 4
risk to families that do not implement effective strategies on a timely basis.” (JP Morgan)
Effective tax and estate planning are crucial to understanding the impact that taxes will have on a family’s wealth, especially in a world where governments are increasingly raising revenue through various forms of wealth taxes.
Consider that taxes on the transfer of assets in an estate from one generation to the next can even be as high as 50% in some jurisdictions.
Simultaneously, fiscal authorities have tightened the rules on “tax havens” and formalised the sharing of information between jurisdictions.
As a consequence, it is more important than ever to carefully weigh up the risks you may be taking in order to reduce your tax liability.
Attempting to minimise tax through implementing a complex ownership structure means you risk having the entire structure disallowed by a tax authority. It would be wiser to consider simple strategies that make economic sense.
Family dynamics.
“Many fortunes 5 do not survive to the third generation, often because the relatives find it hard to manage their assets together effectively.” (JP Morgan)
Solutions for addressing the risk of family dynamics include drawing up a memorandum of understanding to express a convergence of intent between parties, flexible structures and appropriate insurance cover. Also avoid leaving all financial decisions to a single family member: should this person be unable to attend to the family finances for any reason, the family fortune could be placed at risk.
Liability.
“In our increasingly 6 litigious world, the wealthy are vulnerable to risks such as class action suits for employee discrimination, malpractice, insider trading or negligence – justifiably or not. Theft remains an equally strong concern.” (JP Morgan)
Manage these risks by taking out appropriate insurance against liability suits, and instituting good controls such as restricting access to your personal or financial information.
Currency.
“Currency risk comes 7 into play when there is a mismatch between a family’s assets and its financial goals.” (JP Morgan) The steady depreciation of a vulnerable currency owing to higher local inflation will gradually erode the wealth of a family, and make no mistake that the value of currencies can drop rapidly and unexpectedly.
Government action.
“Throughout 8 history, the actions of governments have caused the destruction of wealth owned by individuals.” (JP Morgan)
In South Africa, we have already experienced the risks of government action on wealth, and seen first-hand the effects on investment and growth.
Radical tax increases or the expropriation of private assets can also have a significant impact on the wealth of families, while reckless monetary and fiscal policy can lead to hyper-inflation, as we’ve witnessed in Zimbabwe.