In a stunning memoir (Beer Money), Frances Stroh, the great-great-granddaughter of beer magnate Bernard Stroh, catalogs the collapse of the family business and family wealth in less than one generation. The Stroh’s were one of the richest families in America as recently as the 1980s, worth $700 million according to Forbes Magazine. Refusing to bring in outside talent to run the business, Bernard’s great-grandchildren managed to run it into the ground, taking on huge debt to finance multiple unsuccessful acquisitions. The business was owned through a series of trusts that paid large dividends to family members, even as the business declined.
Frances recalls accompanying father Eric as he traveled to auction houses and paid top dollar to acquire innumerable antiques and art works. During the 1990s, according to an article in Forbes Magazine, Eric received annual dividends from the company of $800,000, in addition to his substantial salary as head of marketing for the brewery. Unfortunately, he lived long enough to see dividends reduced to zero just before his death in 2009. Although she seems to have turned her life around, Frances was a massively spoiled child and, like each of her three brothers, was thrown out of prep school for drug abuse. One of the brothers became an addict and died trying to climb off a hotel balcony using bedsheets.
This sad story seems a counterweight to my belief that creating family money is a good thing. In my definition, “family money” is a pot of assets that tends to grow over time and over the generations. The Stroh family could have achieved this result, but failed because they ran their company into the ground and spent too much along the way.
The keys to growing your portfolio over time are twofold: diversify and withdraw only a small percentage of the assets each year. My specific recommendation for family money is to spend no more than 1% per year. Extensive simulations have convinced me that a one percent spending rule is consistent with portfolio growth over an indefinite period. Some of the people I have shared this result with have responded negatively “who can live on 1% of their portfolio?”
While that is a reasonable question, it is beside the point. Of course it is true that few families can live on 1% of their financial wealth. Median family spending in the U.S. today is about $50,000; this is 1% of $5 million and only 1% of households have financial net worth greater than $5 million. I argue that is not relevant because you don’t need to designate your entire portfolio as family money. The first responsibility is to utilize your resources to achieve your consumption goals. Total resources include your future earning power (human capital) and your financial portfolio (including pensions or other retirement plans). Human capital is a very large proportion of total resources for young people, and a small proportion for old people. As you build your financial capital, you may choose to designate a small portion of this as “family money.” Suppose the initial designation is just $1,000. If spending out of this portfolio is <=1%, it will grow to be quite large after a few generations. For example, suppose you invest family money in the equity market and it earns the average real historical return of 8% per year. The portfolio will double every nine years if you spend 0% of the portfolio, and will double in 10 years if you spend 1%. Once you double ten times (ninety years or one hundred years, respectively, for our two cases), family money will have increased by 1000 times, $1,000 becomes $1 million. In another hundred years (I’m assuming by this time your heirs are spending 1% per year), it will be $1 billion (in today’s dollars). Naturally, you will have to get your heirs on board the program. The numbers are proportionately greater as you contribute more than $1,000 to start.
So, in principle, given enough time and perseverance, most anybody can create substantial family wealth. Quite a few people have already done so. In his book The Givers, philanthropy expert David Callahan reports that today there are approximately 70,000 families with liquid net worth of $30 million or more, and 5,000 households with $100 million or more. Of course, at the top of the wealth distribution, there are a few families with tens of billions.
Callahan notes that people are both creating wealth and turning to philanthropy at earlier ages than in prior generations. A prominent example is Bill Gates who stepped down from his position as CEO of Microsoft in his early 50s to focus full-time on usefully giving away his $100 billion fortune through the Bill and Melinda Gates Foundation. Gates also teamed up with Warren Buffett to promote the “giving pledge” by which billionaires pledge to give away a large proportion of their wealth during their lifetimes. Another example is a much younger (than Gates or Buffett) Mark Zuckerberg who, while retaining the CEO position as Facebook, pledges along with wife Lily Chan to give away 99% of their wealth during their lifetimes.
Callahan’s book is an examination of the effects of philanthropic giving. On the surface, it seems like a good thing. At least, it would be if the givers were as smart about giving as they were in acquiring their wealth in the first place. Callahan seems positive about some of the initiatives, like the Gates Foundation effort to eradicate malaria world-wide. But he is concerned about the power of foundations to impact public policy. For example, one of the favorite targets of charitable giving by people on the political right is the promotion of school choice. Callahan, apparently a man of the left, finds this problematic.
Perhaps Callahan is correct. Why should people be able to obtain a charitable tax deduction for activities designed to achieve political ends? Another approach that could be followed by affluent families is to provide financial support to entrepreneurial activities in areas of interest, like private education, or green energy, or drug research, etc. Instead of setting up a charitable foundation, the family would set up a “venture capital fund.” This fund would sponsor a wide range of promising initiatives. If all the ventures failed, then at least we would know more about what does not work. If a decent fraction of the ventures succeeded, the fund might well grow over time, enabling yet more promising ideas to be funded.
Despite the Stroh family debacle, I don’t believe that accumulation of family wealth necessarily results in kids that are losers. However, it does take some thought and planning to avoid that outcome.