Why Do Some Families Get Richer With Each Generation, And Others Get Poorer?

There was a write about a half-century ago named John O’Hara. He was a cranky guy with a wide variety of interests, and although he had a large number of critics, he was good enough to persuade fellow writer Fran Lebowitz to dub him “the real F. Scott Fitzgerald.”

One of his caricatures that he liked to create in his writings were hypothetical dialogues between characters that represent “Old Money” interacting with young men that were on a quest to get rich in a hurry. It would be hard for a writer like O’Hara to become generally mainstream today, because O’Hara relied on a mixture of strong moral condemnation mixed with relentless stereotyping, and that would create a strong mismatch with the rising sensitivities and general tendency to take abstract insults personally that generally typifies the current socio-political climate.

Why, then, do I bring O’Hara up? Because one of his female caricatures of “Old Money” frequently repeated the line, “Dahhhhhhhling, don’t touch the principal.” It was a commandment. It was in the DNA these fictional characters breathed. Anyone suggesting anything else was quickly labelled an enemy trying to pry them from their accumulated wealth.

Personally, if wealth that is truly built to last for the long haul is your goal, then “don’t spend the principal” needs to be one of your three commandments. The other two are “diversify” and “own high-quality assets.” That’s the holy trinity of wealth preservation: principal retention + diversification + quality. From there, it’s just a matter of structuring a life that meets that formula.

Every now and then, when I write about excellent companies like Colgate-Palmolive or General Mills, I’m tempted to include a line that says, “All bets about their dividends are off if another Great Depression or World War II hits.” But then, I realized that wouldn’t be fair to their corporate histories to include that line, because both of those companies did manage to make cash dividend payments throughout the 1930s and 1940s, with records dating back to the 1890s.

To preserve wealth, you need to avoid wipeout risk. That’s not as tautological as it sounds. The simplest way to accomplish that is to own several hundred thousand dollars worth of US Treasury notes, a collection of 20-30 highest-quality stocks (Exxon, Chevron, Pepsi, Coca-Cola, Colgate, General Mills, Nestle, you know the drill), and two or three pieces of rental property real estate (if you really want to do it right, you will pay cash and own the property outright, and wrap each company in an LLC. Opening up an LLC sounds harder than it is in reality—I remember being intimidated by the notion when I was 18, and then I visited a place called “Birds, Birds, Birds” and after meeting the people there, I concluded that if they could do it, so could I. Essentially, you just fill out some paperwork with your Secretary of State’s office, get a number, and open a bank account. This will protect you from having problems with one property reach in to your other assets, although you may not be fully protected if you open a single-member LLC and then seem to be using the LLC front as a sham. Courts have been increasingly willing to disregard single-member LLCs, depending on the state in which you live).

To avoid wipeout risk, and become one of those people who gets more affluent through each ebb and flow of the economy, you have to effectively combine three things that have a particular purpose. You diversify, and this lowers the risk of one bad decision affecting your cash flow. You don’t touch the principal, so that you’re not self-destructing by depleting your assets. And lastly, you own high-quality assets so that the probability of failure is minimal. Quality. Diversification. Principal Preservation. Combining those three things is the secret—there you have it.





Originally posted 2014-02-16 01:28:47.

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One thought on “Why Do Some Families Get Richer With Each Generation, And Others Get Poorer?

  1. scchan_2009 says:

    I think a prudential way to save and invest is to save, avoid leverage unless necessary (I can understand people need loans to buy a house), and only invest in high quality securities. Heck, if one is uncomfortable with stocks, at least go buy Treasuries saving bonds and TIPS. They are still better than 1) buying rubbish (your choice of useless items at home) from Walmart/Target/Sears (your choice of retailer) that would end up in garage or basement, 2) buying high yield junk bonds or the next hot .com and biotech (your choice of junk in financials). People spend too much, borrow too much, speculate too much, and don’t save enough.
    Leverage/Gearing is great for wipe outs in financials. Your call/put options can go worthless, and one’s potential loss in shorting, future contracts, leveraged buys are infinite!

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