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The Atrophy of Family Wealth – Demystifying the Shirtsleeves Proverb – Part 1

Family Wealth like Ruins?
Photo by Raph Howald on Unsplash

The proverb is “Shirtsleeves to Shirtsleeves in 3 generations,” and as many are quick to say, the proverb is universal.  All major global cultural groups have some version of it.  A common extension of the sentiment is expressed as “The first generation makes it, the second generation spends it, and the third generation blows it.”

Today, I want to ask a controversial question – does the blame for the proverb fall solely on the third generation?  In many rooms I have been in with advisors to the wealthy, there is often a universal dismissiveness of the ‘perceived hardships’ of the third generation in inheriting wealth. And as such, almost no surprise that the wealth is quickly blown.

Today, instead, I would like to postulate instead, that each generation contributes its own unique dysfunction to the toxic cocktail that ultimately brings down the family.

“Dammit, don’t spend it like that,” Conrad Hilton [once] admonished his sons. ‘I’ve worked to hard for it.”  One day, Nicky [Hilton] answered his father by saying, ‘What can I tell you, Dad?  You never had a rich father like we do.”  

Be My Guest by Conrad Hilton

So first, yes, profligate spending is the ultimate cause of death for a family fortune.   By the third generation, wealth has been reduced and become dispersed enough, that one generation’s spending can prove the death knell. But is profligacy a moral failure or are there other drivers? 

I recently was modeling out the path of family wealth over a 100 year period taking into account estate taxes and some common estate planning measures.  What becomes quite clear is that if the family loses its ability to take risk and grow its wealth at attractive rates (more here), a sinister dynamic begins to take hold.  Namely that each subsequent generation must increase the amount of distributions it takes relative to the prior generation.

So, if the first-generation wealth creator took a 3% distribution, the second generation, may take 4.25%, and the third generation will be in the 5.5-6% range, leaving very little by the 4th generation.

Why does this increase occur? 

For the simple reason that the standard of living we enjoy and observe growing up becomes the ‘lens’ by which we determine what is normal for spending.  For the second generation to live like their parents, they have to spend more because of the growth of the family and the bite of taxes.  For the third generation to live like their G2 parents, the same dynamic is true.  (More thoughts on this dynamic here)

The frog in the kettle is not wrong, what becomes normal happens over long periods of time, in gradual ways.  If you take this natural tendency and layer on top of it a degree of profligacy, the outcome is predictable.  This is not meant to excuse poor behavior, but to offer a view that there may be other underlying factors driving human behavior. In my experience, human behavior is generally almost always rational, even if not always reasonable.

So let’s not entirely let the third generation off the hook, but maybe let’s consider reapportioning the blame a bit.

Next week, we will look at G2’s role in the shirtsleeves proverb.

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