Beating the odds and staying wealthy

Riëtte Coetzee, Advisory Partner, Citadel Wealth Management

In 1982, Forbes Magazine in the United States published its now renowned list of the 400 wealthiest Americans for the first time, ranked by their net worth. Twenty-one years later, JP Morgan conducted a study to examine the list and determine which families remained amongst the country’s wealthiest.

The result was astonishing: less than 15% of people, or just 54 of the original names remained on the list. The most common reasons for dropping out included an over-concentration in a particular asset and too much leverage, followed by excessive spending and tax.

A more recent 2012 study from JP Morgan found that only 36 of the original names were still on the list – in other words, just 9% of people had managed to keep their wealthy status over a 20-year period.

These studies demonstrate that not only does it take considerable work and aspiration to build wealth, but preserving wealth equally demands hard work and attention.

Below follows a brief discussion of the key risks for families to safeguard against in the quest to stay wealthy, drawing on JP Morgan’s 2004 paper “Beating the Odds and Staying Wealthy”:

  1. Concentration

“Most wealthy families have, at some point, channelled their resources into one area – whether a company, an industry, real estate, or even an art collection – which has become the primary source of their increased financial wealth.” (JP Morgan, 2004)

However, it’s important to remember that not all assets maintain their value over time.

Trends change, prime property locations lose their attraction, technology disrupts established industries and companies fail – just consider the example of Steinhoff, or the recent slide in share prices of the companies in the Resilient Group.

Diversifying your asset base can be challenging, especially as it may involve selling an asset to which you have a strong emotional attachment. But spreading your investment risk is essential to preserving your wealth, ensuring that your investment strategy remains uncorrelated to specific asset classes, companies, industries and geographical locations.

  1. Spending

“It comes as a surprise to many people that to sustain wealth, they can spend no more than 4% annually of their investable assets.” (JP Morgan, 2004)

This sage advice highlights the importance of adjusting your income expectations as a percentage of your overall wealth rather than a simple rand amount.

Studies have shown that overspending is common even among the affluent, as families get used to a certain lifestyle and struggle to adjust their spending habits relative to the size of their investable assets.

It’s important to remember that if the value of your investable assets decline as a result of poor investment returns, your consumption as a percentage of your assets will increase, potentially eroding your capital base.

The reality is also that no sound investment strategy can save you from bad spending habits. Taing on more investment risk to address the shortfall between income and spending needs is not likely to be sustainable.

  1. Leverage/Gearing

“Leverage is a double-edged sword. It provides an opportunity to enhance returns but it also increases risk.” (JP Morgan, 2004)

Borrowing money to make money can be extremely productive, but the key is to understand the risks and how best to mitigate your risk exposure.

We don’t need to look much further than our own market to demonstrate these risks – just consider the collapse of Steinhoff’s share price at the end of 2017.

Also remember that when share prices collapse, not only does the investment value disappear, but a leveraged position would cause banks to call on the collateral provided, making the owner of the shares a forced seller in the market.

  1. Taxes

“Tax poses a significant risk to families that do not implement effective strategies on a timely basis.” (JP Morgan, 2004)

Effective tax and estate planning are crucial to understanding the impact that taxes will have on a family’s wealth, especially in a world where governments are increasingly raising revenue through various forms of wealth taxes.

Consider, for instance, that taxes on the transfer of assets in an estate from one generation to the next can even be as high as 50% in some jurisdictions.

Simultaneously, fiscal authorities have also tightened the rules on “tax havens” and formalised the sharing of information between jurisdictions. As a consequence, it is more important than ever to carefully weigh up the risks that you may be taking in order to reduce your tax liability.

Attempting to minimise tax through implementing a complex ownership structure means that you risk having the entire structure disallowed by a tax authority. Rather, it would be wiser to consider simple strategies that make economic sense.

  1. Family dynamics

“Many fortunes do not survive to the third generation, often because the relatives find it hard to manage their assets together effectively.” (JP Morgan, 2004)

Solutions for addressing the risk of family dynamics include drawing up a memorandum of understanding to express a convergence of intent between parties, flexible structures and appropriate insurance cover.

Also avoid leaving all financial decisions to a single family member: should this person be unable to attend to the family finances for any reason, the family fortune could be placed at unnecessary risk.

  1. Liability

“In our increasingly litigious world, the wealthy are vulnerable to risks such as class action suits for employee discrimination, malpractice, insider trading or negligence – justifiably or not. Theft remains an equally strong concern.” (JP Morgan, 2004)

Manage these risks by taking out appropriate insurance against liability suits, and instituting good controls such as restricting access to your personal or financial information.

  1. Currency

“Currency risk comes into play when there is a mismatch between a family’s assets and its financial goals.” (JP Morgan, 2004)

The steady depreciation of a vulnerable currency owing to higher local inflation will gradually erode the wealth of a family, and make no mistake that the value of currencies can drop rapidly and unexpectedly.

Events in emerging markets come to mind – just consider the recent freefall of the Argentinian peso, which has lost 30% against the US dollar so far this year. The South African rand is no different, and ranks amongst the most volatile emerging market currencies.

  1. Government action

“Throughout history, the actions of governments have caused the destruction of wealth owned by individuals.” (JP Morgan, 2004)

In South Africa we have already experienced the risks of government action on wealth, and seen first-hand the effects on investment and growth.

Radical tax increases or the expropriation of private assets can also have a significant impact on the wealth of families, while reckless monetary and fiscal policy can lead to hyper-inflation, as we’ve witnessed in neighbouring Zimbabwe.

Meanwhile, as demonstrated in the US and China, the implementation of exchange controls and ideology shifts can occur suddenly, catching families by surprise.

Preserving your wealth

The many risks to wealth are significant, and the only way to safeguard against misfortune is through a considered investment strategy that emphasises diversification, safety and security.

Protecting your wealth requires constant vigilance, so having a dedicated wealth partner who understands the nature of your business, family and country’s dynamics is essential.

Having a sound financial framework might just save you from disaster, helping you to beat the odds and stay wealthy.

By Riëtte Coetzee, Advisory Partner, Citadel Wealth Management



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