| FAMILY CROSSED WIRES: WHY MOST GENERATIONAL WEALTH TRANSFERS FAIL Better communication is the key to wealth preservation By G. Scott Clemons, CFA BBH Chief Investment Strategist 1 | Women & Wealth Magazine n his landmark treatise, An Inquiry into the Nature The Causes of Failed Wealth Transfer and Causes of the Wealth of Nations, the Scottish economist Adam Smith observed how difficult it was for families to transition wealth from one Igeneration to the next. He noted, “In commercial countries, therefore, riches, in spite of the most vio- 25% lent regulations of law to prevent their dissipation, very seldom remain long in the same family.” The year was 1776, and in an effort to maintain social order, the British monarchy preferred that wealth 60% remain concentrated in the hands of relatively few aristocratic families, and therefore promulgated a 12% legal structure to encourage that stability of wealth. 3% Today, of course, the “most violent regulations of law” are designed to achieve the opposite outcome – to ensure that wealth does not remain in the same hands, at least not for long. Unless detailed plan- Breakdown of family communication and trust ning takes place at every step, wealth is taxed upon Inadequately prepared heirs its creation, distribution and ultimate dispensation. Failure to establish family mission Poor legal/tax/investment advice It is easy to attribute the failure of wealth transfer Source: The Williams Group to today’s ever-changing legal landscape and the complexities that it poses to families with substan- Williams attributed only 3% of the failed wealth tial wealth, whether in the form of financial assets, transitions to poor technical advice. There are real estate or a family business. But things were plenty of moving parts in tax and estate law, and seemingly no easier 240 years ago. Then, just as ambiguities abound as to their interpretation now, very few families succeeded in transitioning and implementation. And so the legal, insurance, wealth beyond a generation or two. It appears that, accounting and investing professions spend a in addition to mastering the legal and financial great deal of time and money on accreditation complexities of wealth transfers, other elements and continuing education in order to keep up with are at play that influence whether or not a family those changes and stay current on best practices. can preserve its wealth across multiple generations. Although change is certain to remain a constant when it comes to the right trust structures and A Failure to Communicate transition plans, the “how” of wealth transfer is a In 2002, Roy Williams of The Williams Group pub- relatively settled science – and one that advisors lished the results of a 25-year survey of 3,250 rarely get wrong. instances of generational wealth transfer. He con- cluded that 70% of those transitions failed, where Ninety-seven percent of the failures were attrib- failure was defined as involuntary loss of control utable to the family itself: due to a lack of a family of the assets. That finding underscores and even mission (12%), the inadequate preparation of heirs quantifies the observation that Smith made cen- (25%) or a breakdown of family communication turies ago, but Williams took the analysis a step and trust (60%). The common thread in each of further and explored the reasons for those failures. these causes of failure is a lack of communication. Therefore, better communication is the common Quarter 1 2016 | 2 | FAMILY Conversations about mission are an oppor- “tunity to align values with cure. Families typically spend more time planning and dad (or grandma and granddad) take? How a vacation or researching the purchase of a new did they succeed along the way, and to what do wealth, and appliance than they do discussing the legacy they they attribute that success? What would they have wish to leave to future generations and how best done differently? more often than to realize those wishes. We all need to speak more about the “why” of wealth – not just the “how” of We had the privilege a few years ago of visiting a not take the transferring it to our children. new client of Brown Brothers Harriman who was on the verge of selling a company for several hundred simple form of Providing Roots and Wings to Future million dollars and worried that his family of young Generations adult children would be influenced adversely by the storytelling. Wealth is power, and like any power, is easily sudden arrival of such wealth. We spent a snowy ” abused when easily obtained. A firearm in the afternoon with the family members, saying very hands of someone who doesn’t know how to use little, but listening to their stories about working in it is a terribly dangerous thing, whereas training the family business when they were young, sweep- and respect mitigate that danger dramatically. Sim- ing factory floors on Saturday afternoons, scraping ilarly, an automobile also represents a great deal of together money to take an annual family vacation power, which, if taken lightly, can be life-threaten- in an old VW van, and sharing together in the prog- ing. That’s why we teach teenagers to drive defen- ress and occasional setbacks of the business. By sively and safely, why we require licensing and why the end of the afternoon, we were all exhausted we require relicensing from time to time. from laughing at stories, and my colleagues and I left feeling confident that the family’s second gen- Driving a portfolio is no different. Unless we teach eration was well protected against the negative our children why the wealth exists, how to respect implications of wealth. Their challenge will be to and use it wisely and act as good stewards, all the do the same for their own children one day. best estate planning advice in the world won’t be enough to escape the old adage that families go If that seems soft and subjective, it is – but that from shirtsleeves to shirtsleeves in three genera- doesn’t make it any less important. What about tions. The first generation strives to build wealth, the 25% of failures in Williams’ study that were due the second enjoys the fruits of that labor, and the to inadequately prepared heirs? We all want our third has to start all over again with nothing. children to be “good with money,” which requires a balanced approach to earning, saving, spending, Families who transfer wealth successfully from investing and giving money away, but how is this generation to generation understand the family best accomplished? Families with wealth should mission. That needn’t be a formal document, but ensure that the next generation has a working at very least should be an ongoing conversation knowledge of the fundamentals of investing – not about why the wealth exists beyond the family’s necessarily to turn the children into investment needs and comfort. This is not an attempt to dictate professionals, but to make them informed consum- to future family members how they should think ers of the guidance they will receive from advisors. about wealth, what careers they should pursue or what they can and can’t do with the money. Man- When it comes to educating heirs, all children are aging from beyond the grave leads to resentment home-schooled. The examples that mom and dad at best – and absolute dysfunction at worst. This is, set are the best lessons for the next generation, instead, an attempt to provide future generations but advisors are a valuable resource in this effort with both roots and wings. as well. Beyond having the technical knowledge of asset allocation, portfolio construction, invest- Conversations about mission are an opportunity ment selection, trust structures, tax planning and to align values with wealth, and more often than so forth, advisors have the vicarious experience of not take the simple form of storytelling. What is the working with multiple families and seeing firsthand genesis story of the wealth? What risks did mom how wealth transitions succeed or fail. 3 | Women & Wealth Magazine Philanthropy plays a powerful role in this exercise. Many families rely on a trusted advisor from time to Not only does it provide a tangible expression of a time to facilitate family interaction. That may be the family’s mission and values, it also offers an oppor- formal role of an attorney or wealth planner, but tunity for the next generation to learn the techni- also may be the informal engagement of a minister, cals of wealth management through interaction neighbor, teacher or more distant family member. with advisors and real-time scenarios. Children who A third party who cares deeply about the family engage in their family’s philanthropic efforts learn can often provide an independent perspective, about how portfolios work, what form returns can provoke conversations that the family should have take, how to acknowledge and manage for risk and and simply offer a caring insight into family dynam- how to ensure that philanthropies are good stew- ics. Reliance on such an individual is not a sign of ards of the funds with which they are entrusted. weakness – if anything, it’s a sign of strength and This benefit is obvious when philanthropy takes the a demonstration of the seriousness with which the form of a family foundation, but even the far sim- family approaches the importance of open, honest pler exercise of making donations from a donor-ad- communication. vised fund creates an occasion for families to have these sorts of conversations together. Many families are tempted to ignore these issues. And yet ignorance – at least in this case – is not The largest cause of failure in Williams’ study was bliss.The benefits associated with taking the time a breakdown of family communication and trust, to define your wealth can not be overstated.