Shirtsleeves to Shirtsleeves in Three Generations
In case you haven’t noticed, I’m fascinated by the psychology that drives money behaviors and financial outcomes. As a reformed tax attorney with formal accounting and finance education, I appreciate the fact that knowledge in these technical areas absolutely aids in the process of wealth accumulation. But I’ve seen enough examples of technically knowledgeable individuals that didn’t have clue as to how to manage money to know for certain that basic psychology and resulting money behaviors are the real drivers of success or failure in the wealth-building game. Nowhere is this principle more evident than in the area of inter-generational family wealth transfer—quite possibly the most interesting field of research in the personal finance space. Two articles recently appeared in the mainstream financial media that were deliciously interesting. The first is a blog post from Money-ish (published at Marketwatch.com) that summarizes a research study showing that 90% of wealthy families will ultimately squander their financial resources by the third generation. The second is a case-study of this phenomenon describing how the Stroh family managed to build and then lose a fortune of a billion dollars over three generations (in the beer industry no less! Remember Stroh’s Beer?). How is this possible? Why don’t these people take their inherited millions and just live an only-slightly exorbitant lifestyle and continue on happily ever after for generations?
Shirtsleeves to Shirtsleeves
The basic psychology and behavioral pattern goes like this: (1) the first generation is hungry and poor so they work hard and ultimately achieve great financial success. (2) The second generation isn’t as hungry because they came of age during a period when the parents were making progress, but they still remember seeing what hunger looked like and therefore have a working knowledge of the connection between work, frugality, and money. The family wealth plateaus as the second generation preserves the wealth earned by the parents but fails to properly educate the third generation (their own kids). (3) The third generation is then born into a life of privilege and easy money and is never forced to develop an appreciation of the value of hard work or money, and ultimately consumes all the family wealth. This psychological-behavioral cycle is so common and pervasive that it spans disparate languages and cultures—the quip (true or not I don’t know … probably not) is that the Chinese refer to the “rice paddy to rice paddy” progression; in India it’s “from peasant shoes to peasant shoes.”
The data highlighted in the Money-ish blog comes from a study by The Williams Group of more than 3,200 high-net-worth families. The study reports that 7 out of 10 wealthy families will lose their fortune by the second generation, and 90% will lose it by the third. The awareness of this predictable cycle is not new—once a phenomenon is the subject of a colloquialism (“from shirtsleeves to shirtsleeves”) it’s been around a while. Indeed, as best I can tell from their website, it appears that The Williams Group focuses their business strictly on consulting with high-net-worth families to avoid these financially disastrous inter-generational consequences. But if this undesirable result is so predictable, why don’t more families act decisively to avoid it?
I lay the bulk of the blame on the second generation for neglecting their duty to educate their kids on the value of work and money. In the course of enjoying their wealth, managing their own inherited fortune, and spoiling their kids, they fail to impart this critical life skill of learning to respect money as a valuable and limited resource. But the third generation is not blameless since they have what the law refers to as the “last clear chance” to avert disaster. At some point in the third-generation heir’s life someone somewhere will put them on notice that money does not grow on trees and that their pile—while significant—will not last forever if not managed properly. And upon hearing such a warning it seems implausible that such a person wouldn’t at least trip over one of the many “shirtsleeves to shirtsleeves” stories that pops up on a Google search. Upon reading such an account, wouldn’t you be moved to change your behaviors to preserve your family’s wealth?
Alas, the same faulty short-term thinking that prevents people from saving modest sums of money today likely plagues the third-generation heirs: in both cases the actors are unable to visualize the long-term consequences of today’s behaviors. The moderate-means individual that doesn’t save today loses out on the time-value of compounding, which was his most potent weapon in the fight to build meaningful wealth. For the third-generation heir it works in reverse—he sees a huge pile of money that generates income today and he can’t appreciate how spending it faster than it can re-generate itself will marginally reduce that capital base and resulting income, eventually killing the goose that lays the golden eggs. In the Stroh Family piece the third-generation beer heiress Frances Stroh describes the family’s financial collapse using a quote from Hemingway in The Sun Also Rises: “How did you go bankrupt? Gradually and then suddenly.”
The destructive “shirtsleeves to shirtsleeves” cycle holds lessons for us—the FI community—to apply in our own lives and in our own families, even though we may not be heirs to billion-dollar fortunes. If all goes according to plan and we follow a safe withdrawal rate, the Monte Carlo analysis indicates that we have a very good chance of finishing the game with more money than we began with. In many scenarios a lot more. And that wealth will be either a blessing or a curse for our kids and downstream heirs depending on how we instruct and guide the generations that come after us, starting with our kids.
Prepare Kids to Manage Money. Individuals need to be prepared to successfully manage wealth. That preparation can take different forms, but the end objective is the same: the development of a healthy respect for money as a valuable and limited resource. Many people—including a lot of us in the FI community—are prepared to manage wealth by years of hard work in earning it. When you spend years (or decades) of your life at hard labor to earn money, you are not likely to quickly forget the value of that money. But if wealth is suddenly foisted upon an individual before he has had an opportunity to learn this lesson, he will have to learn on the job or else face likely financial ruin.
Talk to Your Kids About Money. After modeling good financial behaviors for your kids, the first and most basic step to preparing children to be prepared to manage their own money is to discuss it with them. At length. I have been talking to our three daughters about financial management and our family values related to money since they were old enough to receive crisp $5 bills from grandma on their birthdays. We discuss the value of money and the stuff that it can buy; the mechanics of money administration like balancing a bank statement; the unstoppable force which is compound interest; and how we value money in comparison to other aspects of our lives (hint: it’s not at the top of the priority list, but it is important in determining what kind of life you will lead). We explain that money is a tool that lets us do things we want to do, like travel and help others that are less fortunate. It also (now) lets us NOT have to spend our lives commuting to and fro a trap-cube where we edit TPS reports. We explain that people that engage in ostentatious displays of wealth like fancy cars and big houses are, according to the data, most likely NOT wealthy. As a side-benefit, more often than not these conversations are a great source of entertainment for me. (Example: we pass a fancy-dressed lady in a fancy car and I note: “Poor thing. She spent all her money and then some on that car and now she doesn’t have any money left! She’s poor!” Daughter No. 1: “How do you know!? She could be rich!” Response: “True, it’s not impossible, but the data shows that it’s highly unlikely. Roughly 86% of owners of prestige/luxury automobiles in America have a net worth of less than $1 million! Go see the data for yourself at p. 181 of Stop Acting Rich … And Start Living Like a Real Millionaire.)
In many families the discussion of money is taboo—whether among the adults or with the children. This is terribly confusing to me. I’ll admit a personal character defect here (I have lots of them): almost no subject is off-limits for me—maybe that’s another reason I lose a lot of friends—but this one should not be debatable as an appropriate topic for in-depth discussion between parents and kids (at almost any age, as long as the depth of the discussion is adjusted to be age appropriate). Money management and respect is a critical life-skill, and failing to discuss it with your kids because it’s uncomfortable would be just as bad (maybe worse) than failing to have THE TALK (you know what I mean; and apparently a lot of parents are neglecting this obligation too). If you don’t talk to your kids about money with a clear message and viewpoint, an implied message will ultimately be conveyed through your behaviors and it may not be the one you want. In the Stroh Family article the daughter recounts the “mixed messages” she received from her father regarding money: on the one hand they lived in an expensive house with countless antique artifacts of high value (or at least high cost) that she was not permitted to touch, but was also told that she had to be vigilant to avoid potential kidnapping because “they could not afford the ransom!” Whoa. That’s confusing. And scary.
Preserve Family History—Generally, and Specifically Related to Money. Recounting the story of how the family earned its money can help to create a derivative understanding of value for the subsequent-generation beneficiaries of that wealth. Studies have shown that a general familiarity with family history can provide a sense of belonging to children that serves to enhance happiness in life, so cultivating an environment where family history is told and appreciated is a good idea. And focusing specifically on details related to the hard work and sacrifices that went into producing wealth has the potential to bolster the perception and understanding of the value of that wealth by the beneficiaries. (I came across this outfit that produces “family documentaries” to aid in this process! I think I’ll wait on that.)
Give Them Real Experience In Managing Money While the Stakes Are Low. This week I took my 9-year-old daughter to a local toy store to buy a few birthday gifts for her friends (and make part of our monthly payment on our Stealth Lifestyle Debt). While we were there she decided to drop $20 on one of these (a trendy spinner-fidget device). She has her own money in her own high-yield savings account and can generally do as she pleases with it. I took one shot at convincing her that in a few months (I put the over-under at 6) this thing would be at the bottom of a drawer somewhere and her net worth would be forever diminished. She held firm, and I concluded that it would be much more efficient to learn this lesson with a $20 piece of junk than a $50k piece of junk (e.g., a BMW). So as much as it hurt, I winced and stood down.
Each of our girls—even the 6-year-old—has her own bank account and gets monthly statements showing interest accrual, inflows, outflows, net change, etc. I magnify the 90 bps interest rate in order to highlight the power of compound interest and the principle that capital can earn money for you while you sleep. Each month I sit and go through it with them, and this seems to assist in the understanding that money is a finite resource that needs to be thoughtfully managed.
I go back and forth on the question of whether frugality and a respect for money is a trait hard-coded into our genetic make-up or not, but the shocking data regarding wealth atrophy over inter-generational transfer is strong evidence supporting the view that environmental factors are the more critical variable. It doesn’t seem possible that upward of 90% of third-generation heirs are born spend-thrifts. So the environment that we create for our kids matters. A lot. We don’t tell our kids that we are wealthy or that according to the data we are likely in the top 1% for our age cohort in terms of household net worth—even though it is tempting sometimes when they contest our explanation for why we don’t buy certain things—but they undoubtedly have or will eventually figure out that we have resources. But they will never have any reason to believe that anything other than their own hard work and effort will be required to sustain them in their adult lives. Between us girls, I’m cautiously optimistic that by the time we turn out the lights we will be on that favorable end of the Monte Carlo analysis that calculates a net worth much greater than where we started our (approximate) 4% draw-down decades earlier. And if/when that happens I hope and expect that our kids (and their kids) will view the windfall as a not-so-surprising blessing that they are fully equipped to manage.
Post-script note 1: Here is the definition of “shirtsleeve.” (The adjective form was more instructional than the noun form.) For the record: I am a strong proponent of shirtsleeves in both of the usages below, irrespective of how much wealth one has.