富不过三代 (fu bu guo san dai) Literally: Wealth does not pass three generations

Meaning: It's rare the wealth of a family can last for three generations (the 2nd may see the value of hard work, the 3rd, forget it).

It's difficult enough for a family to accumulate wealth in the first place. If however, the above Chinese proverb is indeed true, we suspect that in order for the family to remain wealthy past the third generation mark will require a robust investment plan which would include the characteristics of discipline, patience and probably a bit of luck too.
 
Let's take a look at history (Jan 1960 to present) and we see what the All Share Index has dished out by way of wealth creation. The annualised total return has been 17.3% vs an annualised inflation rate over the same period of 8.8% which means an annualised real return of 8.5%. This translates into any sum of capital which was invested in the ALSI back then increasing by a multiple of about 50 times in real terms. Now we're on the right track.
Let's look back to 1960...
 
Year zero: First generation: Wealth creation

Starting capital:  Zero. The family income generators (2 parents) are hard-working and manage to invest 10% of their after-tax income equating to R30/month into the South African stock market. (Yes, this was pre-Union, but we did say "equating to"). Remember this is the sixties and an income of R300 is a very decent monthly wage.
 
The family maintains this savings plan, stepping up their savings amount in-line with inflation. The parents have three lovely kids. Stepping the combined after-tax family income up in line with inflation has resulted in a present day monthly debit order of R1,850 into the market via an equity unit trust. The family is now sitting on R10.5m after the capital reached a high of R17m in previous months.
 
Year 45: Second generation: Wealth preservation
 
The parents ensured that their three children didn't have to experience hard times. The children attended decent enough schools and were fortunate enough to mix with similarly privileged friends. There is general unease in the family however, as the second generation gain independence. 

The pressures of wanting to keep up with the lifestyles of their wealthier friends, coupled with an unfortunate down-turn in the economy, results in a halt in savings and as a result the R10.5m family wealth no longer enjoys any debit order increases. In addition, the capital base is required to maintain an income for the folks who have now retired.
 
This is not too much of a problem because the dividends yielded by their equity investments equate to about R45,000/month which is more than enough to cover the cost of living for the first generation despite having to be stepped-up in-line with inflation.
 
The after-dividends capital base grows very well over time despite the market volatility, 30 years later amounts to a sum of R330m.
 
Year 75: Third generation: Wealth destruction
 
The second generation finally inherit the family wealth and it is split three ways. By this time the R45,000/month comfortable family living has ballooned to R600,000/month as a result of inflation. Each family now only enjoys income from a capital base of R110m and, because they themselves are approaching retirement they opt to de-risk their portfolios, which results in the capital invested unfortunately realising a more sedate 3% real rate of return.
 
The third generation children are in the throes of getting a higher education, however the transition to independence has been difficult and they fail to contribute any income or savings. As a result, each family unit is having to depend on their R110m capital base to derive a monthly income of R700,000. Each of the family capital bases grows in value (at 3% per year) reaching a peak of R155m in year 90, however the strains of an 11% annual income withdrawal (R1.3m/month) reduces the capital to zero over the closing years.

Year 97: No Capital


After a torturous revelation later on in life, one of the 3rd generation children decided to carve out a career as a financial advisor. She made the following insightful observations:

1. Her grandparents did a fantastic job of consistently placing 10% of their monthly income into an equity investment over a 45 year period. 

2. As they had generated sufficient capital to live off the dividend income therefrom, her grandparents had stuck with their equity investment throughout their retirement. 

3. Unfortunately, her parents had failed to adopt a savings ethic and they hadrelied optimistically on their inheritances to generate their own retirement income. 

4. The 3rd generation children (herself included) failed to comprehend the importance of generating an income and as a result were unable to adopt a savings plan or meet their own costs. 

Time to start again.
 
The moral of the story: Draw up a savings plan (regardless of how small) and start saving.  Enjoy your weekend.

* Mark Seymour
 Head of Multi-Management at Alphen and is also responsibe for quantitative analysis. Mark joined the market in 2001 and was employed by Appleton in a quantitative role in late 2002.  Since this date he has been managing Alphen's three multi-managed funds.

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