Inflation erosion - a real and present danger to generational wealth

Successful generational wealth transfer can be difficult for many reasons.

Often, significant wealth is created in a single generation. The vast majority of examples of such wealth creation is through enterprise building.  Corporations are recognised cornerstones of economies and communities. They can put families on the map.

Great wealth creation in and of itself is very difficult to accomplish, and most entrepreneurs take risks to accomplish outsized success and returns.  Many will fail -- some for taking too much risk; others for taking too little risk. Others will become leaders in their business endeavours and find tremendous success. They create wealth for their shareholders, their families, and their communities.

While wealth creation remains difficult, maintaining and growing family wealth from generation to generation presents many challenges as well. It is rare to have dynastic wealth. There are different reasons for why this is but, in our opinion, three jump out as most heavily influencing the success or destruction of family wealth.

  1. Family dynamics
    We have written articles in the past on the challenges that family disharmony can cause (most recently: Avoid a family feud when it comes to generational wealth transfers. As we wrote in that article, “Too often generational planning is done with a singular focus on family wealth. While it’s true that this is a really important element, it also brings other aspects to the forefront: tax-planning, legal considerations, corporate and trust structures, insurance and investments. Ensuring maximum wealth transfer requires the right team of professionals and a strong plan. But we’d be foolish to ignore the anchor of the family wealth triangle: family cohesion and family compass, which are both commonly overlooked or ignored in planning. This triangle was developed at Tall Oak Private Wealth to deepen conversations with families and ensure that wealth is grown and preserved for generations to come.”

  1. Division, by definition, means less
    When families successfully transfer assets through multiple generations, they most often divide assets between a greater number of descendants. A grandparent may build $300 million of family wealth and choose to pass it on to the next generations, but inevitably each successive descendant will end up with a smaller share of the pie. Even if none of the wealth was spent or lost along the way, if there were three children, and each of those children had two children, the grandchildren’s share of the family wealth would be calculated at $50 million.
  1. Failure to protect and grow assets
    In order for generational wealth to become dynastic wealth, wealth has to grow.  We define dynastic wealth as wealth that is not only transferred from generation to generation but also grows as it transfers.

The first tenet of ensuring that wealth is categorized as dynastic is to transition the often-ingrained belief that wealthy families have of focusing solely on capital preservation. This focus on preservation only works in situations where there is no division of assets (point 2 above) and where inflation is non-existent. We have lived in a low inflationary environment for decades and so have gotten used to forgetting how detrimental inflation can be to long-term wealth.

In March 2022, rising post-pandemic consumer demand, coupled with supply chain bottlenecks and labour shortages, led to a significant rise in the price of almost everything. Inflation reared its ugly head, rising to 4.8% in 2021 (its fastest pace since 1991), and so far in 2022, annualized inflation has risen to 6.7% in March. Attempting to rein it in, the Bank of Canada raised interest rates by 0.25% in March, and 0.50% in April 2022. Some analysts anticipate another half-percent increase in June, and possibly more in the latter half of the year.

Inflation erosion is a real and present danger to generational wealth. At 3.4% over 20 years, the real value of wealth is cut in half. Said differently, if the family above kept $300 million in cash in a trust for 20 years with the intention of dispersing the funds at that time to the beneficiaries, and inflation averaged 3.4% during those 20 years, the real – inflation-adjusted – value of that $300 million in 20 years would be $150 million. Simply by doing nothing and holding cash, this family would lose half their true wealth in 20 years. 

We often discuss the relationship between risk and investment opportunities with our clients. When asked if “risk” means “opportunity”, many would agree. Turning that around, the following statement rings true: “no risk” means “no opportunity”. In investments, without taking risk, you can expect no investment opportunity or returns. This is especially true when taking into consideration the negative effect of inflation on the true value of investments. However, “risk” certainly does not guarantee “opportunity” or returns.

The dilemma that many families face is how much risk to take. If not enough is taken, assets are subject to inflation erosion. If too much risk is taken, losses can destroy wealth. The responsibility of balancing risk and reward to, at a minimum, maintain the real value of generational wealth for the future is daunting for many families. We have worked with many to understand the landscape of opportunities and to build diversified wealth portfolios that include many asset classes. Our lens in assisting families in building these portfolios remains tied to our stated investment objective of achieving long-term capital appreciation with a focus on diversification and downside protection by investing across multiple asset classes.

At Tall Oak Private Wealth, we have had the privilege of working with many wealthy families to transfer, preserve and grow their wealth successfully for generations to come.

If you, or anyone you know, could benefit from our expertise, we would be more than happy to assist. Please click here to schedule a complimentary discovery call.

Your Tall Oak Private Wealth Team (Written by Mehendi Kamani, Portfolio Manager)

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Information in this article is from sources believed to be reliable, however, we cannot represent that it is accurate or complete. It is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell securities. The views are those of the author, Tall Oak Private Wealth and not necessarily those of Raymond James Ltd. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decision. Raymond James Ltd. is a Member - Canadian Investor Protection Fund.

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