Why do families lose their wealth in three generations?

I often write on Quora.com, where I am the most viewed writer on financial matters, with over 415.7 million views in recent years.

In the answers below I focused on the following topics and issues:

• Why do families lose their wealth in three generations?
• Which celebrity lost a lot of money for investing foolishly in Wall Street?
• Why do people lose their health later in life for the sake of making money?

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Why do families lose their wealth in three generations?

Firstly, we have to consider the maths of inheritance tax and numerous siblings.

Let’s say parents who have three children have $11m, but only $9m after inheritance taxes are paid, that means $3m per child after taxes.

Now let’s say they both have two kids each, and the money hasn’t grown or declined, since they inherited it. Now each child has $1.5m.

$1.5m sounds like a lot of money to most people, but it isn’t enough to live a life of luxury forever. It will run out for many people if it isn’t invested well.

According to the 4% rule of retirement, which holds that you can only withdraw 4% of an investment portfolio over 30 years, that is $60,000 of inflation-adjusted income per year.

Few people who inherit $1.5m think in those terms, so they overspend and underinvest.

There are some other reasons for the issue you refer to including:

1. Typically the founder is a self-made person and comes from the first generation. That generation knows how to make, manage and spend money. Sometimes, the third generation is less resilient and just knows how to spend it!
2. Even if the third generation has excellent business skills, they take too few, or too many risks, unlike the first generation who are more likely to manage risk properly.
3. An unexpected event, such as a war or pandemic, affects the family fortune, although this is linked to the point of not managing risk properly. These events tend to affect those in one, illiquid, asset class, like a business. If the majority of your family fortune is based on a business, that is very risky.
4. Bad individual decisions, such as multiple divorces, affect the inherited wealth.

Sensible wealthy people have created trusts for this reason, to make sure that the money can’t be squandered easily.

That is one reason royal families tend to not go broke because they can’t manage and spend all the money themselves.

Most fourth-generation rich have that structure in place:

Which celebrity lost a lot of money for investing foolishly in Wall Street?

There was an investment scheme called Eclipse.

Many prominent people in the UK sports and entertainment industry, such as Sir Alex Ferguson, invested in it.

Other notable investors included Glenn Hoddle

The scheme was complex and worked through buying and renting back Hollywood blockbuster movies to studios.

Eventually, the UK tax authorities, HMRC, approached the investors with a settlement, so it could have been worse.

My understanding is that the investment itself wasn’t the issue, but its complex nature of it gave rise to tax issues.

It just goes to show that sometimes simple schemes work better than complexity.

Why do people lose their health later in life for the sake of making money?

There used to be an expression which was popular amongst Marxists at one point, which went something like this:

“People sacrifice their health for wealth, and then use their wealth to fix their health”.

It has been repeated by non-Marxists as well, as per the quote below:

That is now an outdated concept.

These days the evidence is clear:

1. Wealthier people (note not always high-income people) live longer on average, and have longer health spans than poorer people.
2. Wealthier people tend to spend more on health-related products and services, and less on luxury goods, than the media, implies. In other words, they prioritize their health.

These days even, most people, including Marxists, complain about “wealth inequality causing health inequality”, so the outdated quote above is no longer applicable.

It probably was applicable during the days when most royal families lived for fewer years than their servants, due to extravagant lifestyles, and being very fat was a sign of wealth hundreds of years ago.

With that being said, some people sacrifice their health for wealth, on all ends of the wealth and income ladder.

The main reasons are:

1. Some people have to. If you are struggling, and have three kids, you need to work harder to put food on the table
2. When you are in your teens or 20s, it is very hard to imagine your 70s or 80s. Giving up pleasures now, when you are young, doesn’t seem worth it for some.
3. The second point is about delayed gratification. Plenty of people see no point in having a longer life and health span, in return for fewer pleasures when young. By the same token, the easiest, and most tried and tested, way for middle-income people to get wealthy is via the “get rich slowly” route of compounded returns. This doesn’t require loads of hard work either. It doesn’t require that you sacrifice your health. However, it requires patience, which many people don’t have.
4. Habits built up from a young age, which are difficult to break.
5. Some just love what they do. The average freedom fighter, football coach, or CEO of a start-up wouldn’t want to live an “ordinary life” in return for living healthily until 105. If you love what you do, that has to count for something, as it is life satisfaction.

Also, let’s not forget something else. There are no guarantees in life. That demotivates many people.

You could make all the healthy decisions in the world but be struck down with illness at a young age.

You can make all the right decisions when it comes to money, but still not succeed, and even if you do succeed, it might take a decade or two because success isn’t linear.

All we can do is give ourselves the best chance and increase the odds in our favour, but the lack of guaranteed results makes many people feel demotivated.