The recovery in asset values since the global financial crisis has propelled household wealth to all-time record levels. At the same time, the ageing of populations throughout the western world indicates that this unprecedented store of wealth will be transitioned to future generations over the next few decades (see Fig. 1). Successfully passing this wealth on to the next generation poses both opportunities and threats to investors and their advisors.

The good news is that the mechanics of wealth transfer are well established. Although laws and tax codes change from time to time and from jurisdiction to jurisdiction, the legal, accounting and financial communities are sufficiently trained and continually educated to make sure that the advice they deliver is appropriate and effective.

The bad news is that even with good advice, wealth transfers often fail. An old adage holds that families usually go ‘from shirtsleeves to shirtsleeves’ in three generations. The first generation takes risks, makes sacrifices and builds wealth. The second generation, having witnessed the blood, sweat and tears that went into creating that wealth, typically holds onto to it, or even enhances it. Yet the third generation, who rarely experiences the initial wealth creation firsthand, loses the appreciation for the work that went to create it, and therefore presides over its dissipation and returns to shirtsleeves once again.

Hope is not a good wealth transition strategy. If you don’t define your wealth, it will define you

Wealth transfers almost always fail for reasons outside the control of third-party advisors. Roy Williams of the Williams Group conducted a study of failed wealth transitions, and found that only three percent of them were due to bad advice. A further 12 percent of failures were due to the lack of a family mission, 25 percent to inadequately prepared heirs, and 60 percent to a breakdown of family communication and trust.

There is a lesson here for wealthy families as well as their advisors: good technical advice is a necessary, but not sufficient, condition to a successful transfer of wealth. Addressing these more intangible issues is of paramount importance for families who wish to transfer wisdom as well as wealth to the next generation of owners.

Although these seem like issues that families need to deal with on their own, the challenge is that individuals only go through a generational wealth transition process once or twice during their lives. Professional advisors, on the other hand, see these transitions taking place almost daily throughout their practices, and can therefore draw on a wealth of vicarious experience to guide their clients. If advisors are genuinely interested in helping their clients preserve and grow wealth across generations they should embrace this opportunity, while clients should take advantage of that resource as they work through the softer issues of wealth transfer.

Brown Brothers Harriman has been in the wealth management business for close to a century, and has had the privilege of guiding many families through these transitions. Additionally, as a private partnership the firm itself has transitioned its wealth and values across generations of owners. A combination of research and experience has led us to three high-level observations that can help families to transfer both wealth and wisdom to the next generation.

Starting early
For most families this starts with an allowance in exchange for basic responsibilities such as cleaning up a room or making a bed. Even at an early age children can learn that money comes from work, and that money can be traded for things. By encouraging children to allocate their earnings to spending, saving and giving, parents introduce the basic concepts of budgeting, the value of patience and the role of philanthropy.

The concept of inherited money can be introduced to older children. A family we work with conducts a ‘practice inheritance run’ by giving each of their children $5,000 on his or her 15th birthday. This is not an allowance earned in exchange for work, but an amount ‘inherited’ merely by virtue of being part of the family. The funds are given without restriction, and are substantial enough that the possibilities for using the windfall are quite broad. Children can spend it, save for a car, invest it, put it aside for college, give some away, or a combination of all these things. These practice decisions build valuable skills for that day when the sums in question are significantly larger.

The key in these brief examples is that the young person is allowed to learn through his or her own experience, but with sums that are modest enough that the cost of error is not prohibitive. At the same time, the older generation is there to provide guidance and insight, but not to the extent of subverting the powerful lessons learned through trial and error. Experience is, indeed, the best teacher.

More than money
Studies show that families who are successful in preserving wealth across multiple generations understand and appreciate that financial capital is only one measure of a family’s wealth. A family also has human capital – the health, happiness and well-being of each family member, along with the ethics, morality and character that define the family. Intellectual capital consists of what the family ‘knows’, both in a formal sense of education and training, as well as the more subjective elements of experience, heritage, tradition and faith. Finally, a family’s social capital is defined by its engagement with the community and others – how it embraces philanthropy and a responsibility to the greater good.

These are admittedly subjective definitions of wealth. Yet families who subjugate their financial capital to the service of these broader categories of wealth are far more successful in preserving and growing all these forms of wealth. This is particularly important when the family’s primary store of financial capital is a business. If some relatives work to grow the value of the family business while others simply benefit from that work, friction can ensue. Yet if the entire family appreciates and works to enhance all of these forms of capital – financial, human, intellectual and social – that friction can be avoided.

Understanding and discussing these various forms of capital leads to some good and deep conversations between generations. What do we want our family’s wealth to do for us and future generations? What difference will this make in our lives, and will it be beneficial or harmful? How do we want to impact the community in which we live? What are the core values that we live by, and how does our financial wealth support that? Asking and discussing these questions facilitates the transfer of both wealth and wisdom.

Engaging in philanthropy
In addition to aligning values with wealth, engaging in philanthropy provides an ideal training ground for younger generations to develop a familiarity with financial concepts. More knowledgeable family members can help the younger generation read the financial statements of charities to which the family has given money. Children can see how funds are used, and discern between effective and ineffective stewardship.

If a family uses a donor advised fund to implement their charitable giving, younger family members can see how those funds are invested, learn what risks are taken, what returns are generated, and how decisions to give funds are made. If the family’s philanthropic pursuits rise to a level that warrants a family foundation, younger family members can be provided the opportunity to interact with financial advisors, to advocate for grant requests, to sit on the boards of local charities and see how they operate from the inside.

Philanthropy provides multiple opportunities for an engaged and committed older generation to instil values and skills in a younger generation.

None of this is easy, which is precisely why most families don’t do it. It is tempting to hire the right attorneys, accountants and financial advisors to put the right vehicles, trusts and documents in place and then simply hope for the best. But hope is not a good wealth transition strategy. If you don’t define your wealth, it will define you.

In order to transition both wealth and wisdom, families should embrace the challenge and opportunity as soon as possible. It is never too early to start engaging the next generation in the topics outlined above, while at the same time it is never too late. Avoiding the curse of going from shirtsleeves to shirtsleeves in three generations requires commitment, communication and constant attention. These precepts are important regardless of the size of a family’s balance sheet. The tactics may change as zeroes mount up at the end of an account statement, but the underlying concepts are universal.

Returns on financial investments are always and forever unpredictable. But the return on the investment of time and energy in educating the next generation is the best investment a family will ever make.