The late Dr. Thomas Stanley’s research in The Millionaire Next Door offered the statistics that 92% of millionaire households in the United States were first-generation wealthy. There are three primary factors that explain why wealth is not stagnant in America: an extensive spirit of philanthropy (American millionaires are more likely to donate half their estates to charitable causes than the wealthy in any other country); general mismanagement by the heirs (there seems to be something in human nature that suggests people who do not directly earn wealth from their own labor cannot maintain it as well as those who did); and an increasing divisor of heirs makes it difficult for idle wealth to perpetuate.
Few very investment articles discuss the mechanics of this third element. To conduct a case study into how this plays out in real life, let’s take a look at what we know from the trust of the richest American that this country has ever produced: John Davison Rockefeller, Sr.
Rockefeller was so rich that he, at one time, controlled over 90% of the oil market and represented over 1.5% of the entire United States economy. That was in terms of revenues. When the United States generated $88 billion in 1920, approximately $1.3 billion of that economic activity flew under the umbrella of something Rockefeller owned. On an inflation-adjusted basis, he died with a $340 billion net worth in 1937. Rockefeller earmarked over half of his wealth to set aside in trusts that would support the lifestyles of his progeny.
Based on this information, you would assume that every Rockefeller heir would be sitting on $100+ million estates from the work of the elder Rockefeller alone. But that is not the case.
The book “The Rockefellers: An American Dynasty” chronicles the slow process of receiving wealth for the fourth and fifth generation Rockefeller. The general terms of receiving the trust are this. Starting at age 21, each Rockefeller begins receiving $10,000 per year from a trust created by John Sr. At age 24, the annual income doubles to $20,000. It increases by $10,000 per year until age 30, at which time a Rockefeller heir can receive $130,000 per year. At age 30, or upon getting married, a Rockefeller may begin receiving all income generated from the trust, generally between $400,000 and $600,000 depending on the market conditions.
Of course, none of this takes into account the trusts set up by subsequent Rockefellers for their kids, and no information has been publicly been disclosed on the topic. But we can see what the individual efforts of the richest American have been to produce. This is meaningful wealth–certainly enough income to put someone in the top 1% of Americans based on annual household income–but it is not the sort of wealth you would expect to be generated from a man who could have purchased every NFL, MLB, NBA, and NHL team combined. And still have $100+ billion leftover.
This can be explained by an increasing divisor. If each Rockefeller got married, had one kid, and then had one kid, the maintenance of the same standard of living could be achieved. But if you have three kids, and each of them has three kids, and each of them has three kids, you suddenly have 39 people. Thinks really bust up the generation after that, as you would have 81 new entrants if the three kid status quo is maintained.
That is why it is very difficult to preserve wealth over extended periods of time, because the beneficial effects of money compounding is offset by a rapidly increasing divisor as each generation creates more people to lay claim to the trust assets.
None of these figures take into account an unusually high generation–what if one beneficiary early in the family tree has six or seven kids?–and nor does it adjust for the probability of squandering the trust over time due to poor investment selection (it assumes ordinary market rates of return.)
The debate matters because it often has a strong influence on policy matters relating to taxation for intergenerational wealth transfers. The idea of what the 1% in America really looks like is quite different from general media depictions on the topic. Going back, again, to Dr. Stanley’s research, the average American family that reaches millionaire status enjoys it for 9.7 years. It is not something that lasts forever. That is because it takes years of diligent delayed gratification, and the time necessary for compounded returns to do its work. The public sentiment in the United States regarding the wealthy would shift if people thoroughly understood Dr. Stanley’s data: Over 90% of American millionaires did not come from millionaire households, and they tend to enjoy millionaire-status for 9.7 years towards the Back Nine of life.
Originally posted 2015-08-16 22:20:27.