Passing Down Your Wealth

Charlie Bowers Income Planning, Insight Investing Articles, Kids & Young Adults, Life Events, Retirement, Retirement Plans

You have done well in life.  You’ve saved enough money to last you the rest of your life and then some.  That was your first goal.

You love your children and want nothing but the best for them, and you plan on leaving some of your nest egg to them.  That is your next goal.  And it is easy to believe that many retirees want to leave an inheritance of some kind for their children and grandchildren as well.

According to a New Retirement survey, the average American retiree expects to leave behind approximately $177,000 to their heirs.1 After all, leaving behind an inheritance for the next generation is a special gift that can help provide a financial advantage for your descendants.

Unfortunately, the skills that it takes to build and maintain a growing investment portfolio are typically not transferred along with the inheritance. It is estimated that 70% of families lose their wealth by the second generation, and 90% by the third generation, according to Money Magazine.2

In other words, beneficiaries may not know how to prudently manage their inheritance.  Many have not done an adequate job passing on their wisdom before passing on their wealth, and further, haven’t done an adequate job passing on their very own  values.

Let’s look at four key points to include when discussing investing with potential beneficiaries for creating inter-generational wealth.

Just for fun, before we get to those points, let’s see what would happen if a family were able to compound that $177,000 they intend to pass on, at 9% annually (the approximate historical average of the U.S. stock market) over various periods of time:

$177,000 compounded at 9% per year grows to the following amounts over the time frames below:

  • $419,023 after 10 years
  • $2,348,379 after 30 years – the rest of your life (30 years)
  • $31,157,538 after 30 more years –the rest of your children’s lives (60 years)
  • $413,388,205 after 30 more years – the rest of your grandchildren’s lives (90 years)
  • $5,484,701,788 after 30 more years – the rest of your great-grandchildren’s lives (120 years)

As you can see, the payoff of passing down the knowledge of how to save, invest, and compound wealth to future generations can be absolutely enormous.

So let’s look at the four key points you may want to discuss with your potential beneficiaries:

Key Point #1: Have A Long-Term Mindset

When you focus on long-term returns, you set yourself apart from all the “financial experts” and talking heads that are scouring the market and crunching numbers in order to speculate on what stocks will perform the best in the next 3 months or so. You just can’t win at that game.  But you don’t have to play that game, either.

Having a long-term perspective means investing in:

  • Great companies
  • With strong and durable competitive advantages
  • That have attractive total return potentials

When one develops a long-term mindset, it makes sense to invest money where it's likely to grow the fastest over long periods of time, instead of looking at what asset class might be the 'hottest' next month or next year.

Key Point #2: Invest in Stocks for The Long Run

Investing in stocks can feel strange.  It’s not really what we’ve been taught or what we’ve been marketed.  To many people, the stock market is little more than a place for 'financial gamblers' to congregate.  Broad-based index funds can intensify the 'casino feel,' because one doesn't have a connection to what they are investing in. But market exposure can be wonderful because the stock market has greatly outperformed gold and other commodities, short-term debt, long-term debt, and cash over the long term.3

Investing in the stock market means you are investing in real companies.  Every share of stock is a tiny fractional ownership claim on that business.  I believe equities have outperformed other asset classes by wide margins over long periods of time because businesses exist primarily to make money for their owners.  And the people who run those businesses work hard to make that happen. 

Income paying stocks pay out a portion, and sometimes virtually all, of their earnings or cash flows to shareholders, the owners of the business.  And this can be key to long term success.

Key Point #3: It is Easier to Prevent Panic Selling With Income Investing

While building wealth over very long periods of time is nice, you may need to cover your expenses today (or be prepared when you do retire) with income from your investments.

If your various income streams plus your portfolio income covers your expenses, then you have reached a special investing state; you are no longer forced to sell.  You get to pick when you sell.

If the stock market collapses 50% and your high-quality income stocks keep paying steadily and/or even increasing your income, then your quality of life is not diminished. In fact, you can take advantage of lower prices by reinvesting any excess dividends into the undervalued securities. 

This makes market declines “almost” enjoyable as they create sales on great businesses instead of becoming permanent wealth destroying events.

I believe that panic selling during market downturns is likely the single biggest threat to most investors.  Avoiding this one, fear-driven mistake will likely do more for your retirement portfolio than anything else.

And finally,

Key Point #4: Minimize Costs

People would rather think more about the fun it is to make money than worrying about the costs of investing.  But minimizing costs is critically important.  Think about how hard we try to capture the lowest mortgage interest rate available.  We recognize even the smallest difference in interest rate, over a long period of time, is some serious money.

Without going into great detail, when looking at investment options, consider the following potential costs of holding that investment4:

  • Adviser Fees
  • Commissionable Sales
  • Expense Ratios
  • Transaction Frequency Costs
  • Cash Drag
  • Tax Costs
  • Mistakes and/or Poor Choices
  • Early Surrender Costs
  • Special Management Fees
  • Optional Benefit Charges
  • Etc.
Implementing Inter-generational Investing

In the final analysis, you can't force your children and grandchildren to invest the way you wish, unless possibly if a complex trust is involved.

But you can make sure they understand these key concepts:

  • Compounding
  • Long-term investing
  • Investing in businesses / stocks / equities
  • Avoiding panic selling
  • Minimizing costs

Understanding these points makes it more likely that your investments will continue to compound for the benefit of future generations; and be sure to pass down your wisdom and your values before passing down your wealth to the next generation.

Sources

1 Average Inheritance: How Much Are Retirees Leaving to Heirs? - Editorial Team - May 22, 2017
https://www.newretirement.com/retirement/average-inheritance-how-much-are-retirees-leaving-to-heirs/?mc_cid=f25b10efa1&mc_eid=83e817c8cb

2 70% of Rich Families Lose Their Wealth by the Second Generation - Chris Taylor / Reuters - June 17, 2015
http://money.com/money/3925308/rich-families-lose-wealth/?mc_cid=f25b10efa1&mc_eid=83e817c8cb

3 Invest In Stocks For The Long Run  February 24, 2019
http://valueandprices.com/invest-in-stocks-for-the-long-run/

4 The Real Cost Of Owning A Mutual Fund – Ty A. Bernicke - April 4, 2011
https://www.forbes.com/2011/04/04/real-cost-mutual-fund-taxes-fees-retirement-bernicke.html#6b966c743244