/ 9 May 2011

What do rich people know that we don’t?

South Africa is one of Africa’s richest nations and we are seeing an increase in wealthy families. These families generally have one aim in mind — to grow wealth and, where possible, pass it on to future generations. Leaving a legacy is something we’d all like to do for our children.

When most of us are sitting puzzling over how to make our books balance, wealthy families seem to come from another planet. In fact, they’re a fairly rare phenomenon — South Africa has perhaps 1% of the world market cap when it comes to wealthy families. But there’s no doubt we’re seeing more of them. Why is this?

Andrew Ratcliffe of Private Client Holdings, a Family Office specialising in generational wealth management, says that over the past decade wealth has been unlocked by new listings on the stock exchange and the All Share Index (ALSI) has delivered in terms of outperformance, giving a number of South Africans a leg up. Entrepreneurs have also made their mark, particularly in hedge funds, retail and construction.

Wealthy families seem to have it all, but we’re forgetting that some may not hold on to their wealth. In fact, many are prone to financial mismanagement, mistakes, over-confidence and over-spending. Sometimes wealth is eroded because families don’t know how to prepare the next generation to manage money, leaving them at the mercy of unscrupulous advisors (or Uncle John may step in as a tax expert and make a spectacular mess). In fact, there are statistically rather few families who have managed to hold on to their wealth from one generation to the next, never mind grow it.

There is, of course, a school of thought that holds that it’s not a good idea to bequeath vast sums to the young and flighty — Paris Hilton being a case in point. The mega-wealthy are in the habit of squandering hard-earned cash handed down to them and there’s a growing trend to “dissave” — that is, offload one’s wealth as one gets older, perhaps giving to charity or bequeathing to an institution rather than an individual. There’s a lot to admire about philanthropy.

Ask Warren Buffet’s kids Susan, Howard and Peter. When Buffet said he was giving away most of his fortune to charity (including the Gates Foundation), he didn’t forget about his kids. He said they’d each get $1-billion for their own charitable foundations.

When Peter was 19 he got Berkshire stock worth $90 000 from his father (the stock’s current valuation is $70-million), but he bought musical equipment with it and continued to live quite frugally. He’s an Emmy-winning musician who scores films. He’s also adamant that money doesn’t buy happiness.

“The perfect amount of money to leave children is enough money so that they would feel they could do anything, but not so much that they could do nothing,” his famous father once quipped.

So what unique challenges do wealthy families face — and what can we learn from them?

What are wealthy families afraid of?
The adage “Where there’s a Will there’s a relative” suggests that financial claims are common when it comes to vast wealth or whatever legacy has been left behind. Who benefits from the wealth? Who constitutes “family”? Grasping step-mothers and feckless cousins needing financial bail-outs may be stereotypes, but they do exist.

Family feuds can derail the best-laid financial plans, leaving some members out in the cold and others more interested in their own bank accounts than in trusts for grandchildren.

Families are afraid of being ruined, but being torn apart is also legitimate fear. The idea is to manage the family affairs so that they benefit everyone — which is why the Family Office has become popular — with a bevy of impartial advisors having family members sit down and discuss their overall welfare. Ratcliffe says everything from estate planning and investment strategies to family dynamics and paying the bills are taken into account.

Another pressing issue is divorce. According to the United States Journal of Sociology, US data from the National Longitudinal Survey of Youth (which tracks people in their 20s, 30s and early 40s) shows that divorced respondents’ wealth typically starts falling about four years before divorce and they experience an average wealth drop of 77%. Divorced people find it easier to lose money than to make it.

Divorce itself costs money, family savings are lost and some assets are not that easily divided. You can sell assets and grab cash, sure, but if market conditions don’t favour you then it’s unlikely you’ll get the full value of that asset. And we all know that two homes are far more expensive to run than one — even if you do have pots of money.

Remember too that insurance policies, mutual funds, investment portfolios and so could also be included in the list of marital assets and don’t forget that child support will take into account a lot more than food, clothing and housing.

How can a family preserve and grow wealth?
Cheryl Howard, of Cheryl Howard & Associates and executive member of the Fiduciary Institute of South Africa, says that wealthy families have to take a few steps to ensure their wealth will be in safe hands. First, families need to examine their own internal dynamics and adopt the view that there is no “dysfunctional” family — only a recognition that different dynamics need to be well managed, preferably by a trusted advisor who can be sufficiently objective about a family’s wealth-creation goals.

Families should also be open to a “fair versus equal” approach. “Family members with special needs should be considered on a proportional basis when a divisional of assets occurs,” says Howard.

Communication is vital and families need to have access to information to assist members to make decisions that in the interests of the family as a whole. An advisor may be needed here too.

Ratcliffe says that the Family Office has become popular because a team of qualified advisors can step in — investment advisors, private bankers, tax advisors, estate planning attorneys. Ratcliffe says that generational wealth management is a complex affair and although the services of a Family Office don’t come cheap, inter-generational wealth planning is pretty much assured.

Howard recommends that a family should create an inter vivos trust to manage family wealth. When it comes to drafting Wills, she says that the most common mistake is “ruling from the grave” and dictating when income should be drawn or how much capital can be drawn. The timing of receiving an inheritance can be a delicate matter.

The family as a business
Even a less-than-wealthy family can benefit from some key strategies that wealthy families seek to adopt.

“Every family needs to view itself as a business,” says Howard. “Assess your income, expenditure and budget. What are your income and capital needs? What are your investment strategies? What’s your appetite for risk?”

Howard also recommends that families don’t let the joint ownership of assets become “a poisoned chalice”. You simply have to set up rules that will apply to how these assets are shared. Different needs and agendas can cause family feuds that may never really heal, so you have to be very clear about which procedures should be followed.”

It doesn’t matter how grand the scale of assets, it’s the principle that is important here. Even if you have a small family business, partners can disagree and family members can opt for different business strategies. The idea is to be firm about what’s required to make the business a success.

Tips to follow on the road to wealth creation

  • No journey starts without a road map, and to this extent, no matter the size of the family’s wealth, it needs to have a defined destination and a clear map on how to get there.
  • Teach the value of compounding interest to your children as early as possible.
  • Teach children about pocket money: 10% tithing, 20% saving, and the balance for discretionary spending.
  • Don’t spend more than you earn. “My other piece of advice, Copperfield,” said Charles Dickens’ Mr Micawber, “you know — annual income £20, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”
  • Spread investment risk and understand the importance of a well diversified portfolio.
  • To put away as much as possible, for as long as possible, it stands to reason that one needs to earn an income for as many years as you can to secure a financially independent retirement.

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