Intergenerational wealth planning is a strategic approach to managing family wealth across multiple generations. It’s a process that’s crucial to sustain a family’s future wealth, especially as 70% of high-net-worth families are expected to lose their wealth by only the second generation and 90% by the third.
Indeed, it is becoming increasingly important in an era where people are living longer and the family dynamic continues to evolve. It involves creating a comprehensive plan that ensures the financial well-being and preservation of wealth for both current and future generations, considering factors such as longevity, inflation and security, as well as the specific needs of different family members.
The greatest wealth transfer of assets is anticipated to occur over the next 25 years, with an estimated $100tn projected to transition from the baby boomer generation to their heirs and charities. It’s becoming increasingly vital to be prepared with a functioning succession plan, whilst maintaining the fundamental underlying philosophy that comes with family wealth preservation.
The core philosophy supporting family wealth focuses on the idea of unity and collective strength. When it comes to effective planning, family members need to move away from an individualistic mindset. Embracing the concept of long-term financial planning assumes the responsibility of safeguarding assets for the benefit of future generations.
Building wealth as a collective through joint and synchronized family owned investment structures gives wider reach to the appropriate investments, more bargaining powers with counterparts and better access to the right advisors.
A strong place to start from, is to ensure that all family members involved are aware of their family’s background and the values that have been passed down through generations. Sharing stories and experiences has been an effective way to communicate across generations, while also binding the family together and establishing a long-term vision that guides financial decision-making.
By thinking intergenerationally and enhancing family ties, this allows family members to better manage their spending habits and expectations, for the benefit of future generations. Indeed, from an Islamic perspective, when creating wealth, it’s important to actively provide for your family, both in the present and for the future; starting with those closest to you, the benefits will naturally extend further afield and to the greater good of humanity.
For a multigenerational portfolio to effectively cater to the anticipated increase in the number of family members, significant growth is expected. As the family grows, the portfolio must not only sustain the lifestyle of its current members, but also provide for and adapt to the evolving needs of future generations.
Spending habits will directly impact the well-being of all generations, and capital preservation should be the primary focus. As a rule of thumb, it is prudent for a family to spend less than 3% of its consolidated wealth per year; the lower the current spending the more resources are conserved for the future.
While the portfolio is unlikely to take major risks, the growth required implies that it will need to have significant equity exposure to cover for future expenses, whilst also taking account of inflation. This aligns with Shariah-compliant investment strategies, which lean more towards risk sharing investment models rather than lower guaranteed returns.
Indeed, for investors mindful of Shariah values, assets are better invested in activities that promote the economy and production with strict consideration of social and environmental wellbeing.
With the investment horizon focused on the long term, the liquidity of such portfolios is less important, as long as spending needs are adequately covered. This allows investing in private alternatives, such as private equity and private financing, which have historically shown a return premium over public markets.
To effectively manage intergenerational wealth, it’s important to establish a detailed investment policy statement (IPS). Setting and reviewing an IPS is an exercise that helps family members understand the family’s investment goals and objectives and establishes a framework for current and future decision-making. Given higher levels of volatility witnessed over recent market cycles, a well thought out and crafted IPS is likely to be even more valuable today than ever before. Seeking the guidance of advisors in setting up a suitable IPS is essential, as they can provide insights into the consequences of uncalculated actions such as overspending, in addition to making investments that do not align with the portfolio’s objectives.
To ensure proper governance and objective decision-making, it is beneficial to include independent members in the Board of Directors. It is important that independent members understand the family dynamics from the outset, this will help to rectify fundamental challenges, if they were to emerge. How many essential decisions were avoided to prevent conflicts? A third party plays a vital role in ensuring that such decisions are made objectively, bringing impartiality and clarity to the decision-making process.
There needs to be a greater focus on preserving wealth than taking on unnecessary risks. Younger generations are often less cautious in managing inherited wealth and may require education and guidance on financial matters. This is also where independent Board of Directors and committee members can help.
Diversification plays a vital role in preserving intergenerational wealth. It reduces the risk of one investment by allocating a small proportion of the wealth into it. This also helps to reduce the impact of one asset’s performance on the overall portfolio return, as it could be counterbalanced by another's.
To ensure the ongoing successful implementation of diversification strategies, families are highly encouraged to resist the temptation to abandon their asset allocation during extreme market conditions. Retaining quality assets during market downturns prevents crystallizing losses in case of sale, fostering a long-term investment approach across the different market cycles and its unavoidable corrections. Furthermore, holding sufficient cash to cover potential expenses without liquidating investment positions is important for maintaining a consistent asset allocation.
Budgeting for spending needs over the upcoming four years is considered prudent, with around 50% held in high-quality liquid investments and the remainder funded through portfolio cash returns.
It’s also wise to avoid excessive leverage for both portfolio stability, especially in economic downturns, and in adherence to the Shariah principle of limiting the use of interest-bearing debt.
Last but not least, any conflicts that materialize between shareholders has to be managed timely and effectively. Having conflict resolution protocols put in place outside courts and public domains is extremely important. Also, allowing family members to exit and liquidate their investments without jeopardizing the other’s interests is equally significant and needs to be outlined in family charters or trust documents. Such flexibility provides family members the psychological comfort and assurance that staying together is an encouraged choice rather than an obligation.
Intergenerational wealth planning is crucial to building a lasting legacy. Setting the right strategy, establishing proper governance structures and managing investment risks effectively are key factors that enable families to navigate the challenges of wealth transfer across generations. By embracing long-term financial planning, whilst ensuring that older and younger generations continue to effectively communicate with each other, families can create a solid foundation for intergenerational wealth.
It will require a well-thought-out plan, but with it, families can ensure the preservation and growth of their wealth across generations and at the same time build a legacy that continues to extend to the wider community.
Saad Adada, CFA
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