Our Responsibility

Income and estate taxes have an insidious effect on the creation and accumulation of wealth. However, the greatest menace to the transmission of wealth is not estate taxes but the lack of communication between generations. This often results in poorly conceived transmission mechanisms, deep resentment, or the waste of inheritance by ill-prepared heirs. We consider it our responsibility, not only to understand the basics of estate and financial planning and to invest family funds wisely, but also to maintain an abiding interest in the intricacies of our clients' lives and family relationships.

People seldom lose their fortunes due to money managers. More often, they either waste it due to a lack of foresight while creating a plan or to inconsistencies between intent and behavior. Exacerbating this is the difficulty some parents have in "letting go" of control, or their failure to prepare succeeding generations for the responsibilities of holding wealth.

This doesn't assume that family members don't talk to each other, but it is necessary to reconcile two views of life. Over the years, working as part of a team of experts that we periodically help assemble, we have successfully assisted clients in planning and implementing intergenerational wealth transfers while also advising families on interpersonal issues. Inheritors confront a different set of challenges than entrepreneurs. Entrepreneurs believe they can build (or rebuild) the family fortune faster than it can be eroded by unforeseen challenges. They often need strong prodding to start thinking about the dynastic aspects of their new wealth. Inheritors, on the other hand, tend to view their wealth as a precious legacy that cannot be replicated and are often threatened by forces beyond their control, such as taxes, volatile markets, and greedy outsiders. We have seen this manifested in inheritors as a strange, contradictory combination of extreme risk aversion mixed with a naive susceptibility to "pie-in-the-sky" schemes. As a result, a persistent underlying paranoia prohibits them from enjoying themselves and their money as they might, and their financial plan tends to be fraught with problematic inconsistencies and obstacles. This is often related to a compelling but not always realistic sense of duty toward future generations.

For example, the stated objective we hear most often is the desire to afford multiple heirs the same standard of living the inheritors have themselves been enjoying. But this is a more challenging task than most people realize, to wit:

• The total return earned on U.S. common stocks - including dividends and capital appreciation - has averaged approximately 11% per annum over the last 75 years, while different asset classes (bonds, real estate, etc.) have generally fared worse. Some money managers achieve superior returns for a number of years, but most fail to match the market's growth over the long term. Let's assume, however, that a very good manager generates long-term total returns of 12% per annum.
• The families who have been with us for the past thirty years are domiciled in countries throughout the world. Despite these and other lifestyle differences, they have in general demonstrated reasonable fiscal discipline. Using them as a benchmark, we can assume living expenses will require 3% - 5% of capital annually, so the family fortune can grow at a rate of 7% - 9% annually.
• We then assume that exceptional tax advisors help keep overall taxes at 3% of capital per annum. People living in major industrial countries where tax rates on income alone hover around fifty percent coupled with further erosion from capital gains and inheritance taxes, will likely pay much more. As such, it is generous to assume that after taxes (or the tax-avoiding expenses of going offshore), the remaining capital will grow by 4% - 6% annually.
• Finally, purchasing power is further eroded by inflation. So even if the cost of living increases by only 3% per annum, the purchasing power of capital will only grow by 1% - 3% each year given these favorable assumptions.

Since most families inevitably divide their assets among multiple heirs, it is extremely difficult - even under ideal circumstances - to maintain the parents' standard of living for each child over time. Which is all the more reason to prepare children of wealth to the realities of their future condition.

Both entrepreneur and inheritor parents want to make sure their children are mature enough to recognize the responsibility that comes with wealth before discussing long-term financial plans with them. As a result, they often put off the necessary discussion and implementation of family financial planning until it is too late. Meanwhile, a tight rein on the fortune becomes an instrument of control that ensures compliant behavior but hides the problems simmering below the surface. Thus, even when future inheritors live well on generous allowances or trusts, they still live in dependency; their only responsibility is to spend the money made available. There are few surer ways to prevent a child - or even an adult for that matter - from fully growing up.

Families are complicated regardless of size or history, and these days they are more complicated than ever. With two or more generations, in-laws, divorces, stepchildren, and all the other possible permutations, the potential for conflict is significant. Having a trusted advisor outside the family who acts as an advocate to facilitate communications between the various family constituencies can be invaluable.

Helping to facilitate this process is a central part of what we consider to be our responsibility. We liken ourselves to the old-fashioned family doctor that becomes a "friend of the family." To perform well the doctor needs to know your family background and understand your lifestyle. So do we. In time, clients develop a sufficient comfort level to call on us with problems that extend beyond the purely financial, confident that we will take the time necessary for such matters.

In addition, to help educate children about their future responsibilities, Tocqueville encourages the parents to gift a very small portion to them as they enter adulthood. It is important that the children be free to do what they wish with the money, no strings attached. We also emphasize that mistakes will be made, which is how one learns that money is about responsibility and risk as well as freedom.

In many cases, we manage all or most of our clients' money, which implies a high degree of trust. It also invests us with a greater fiduciary responsibility, one that emphasizes absolute rather than relative performance. This affects our culture and the way we look at investing, which can be summed up in a set of basic investment principles:

1. Investing in companies that are out of favor and undervalued relative to their assets, earning power, or growth rate, has the highest potential for generating consistently superior long-term returns. Typically, this approach reduces portfolio volatility, meaning that gains will be less dramatic in advancing markets and losses less devastating in declining markets.
2. We invest for the long term and choose to view stock market volatility as primarily a short-term phenomenon - a price that long-term investors should be willing to pay for the promise of superior long-term performance. Superior returns come with commensurately greater risk, but when a significant portion of that risk is short-term volatility that does not affect our long-term goals, it becomes much more acceptable.
3. To us a client is a person, not a portfolio. Since most of our clients rely on our investing to fund their lifestyles, we try to maintain higher cash reserves than most managers to insure our ability to meet their needs. This also tends to reduce a portfolio's vulnerability in a declining market.
4. We avoid speculation and resist fads. Sometimes the urge to speculate on the latest investment trend becomes overwhelming, even among otherwise conservative family members. The lure of easy money is very powerful. We consider it our responsibility to stand against these tides when they arise because we know how rapidly and devastatingly they can turn.

To maximize clients' comfort with our mostly contrarian perspective, we devote considerable effort to communicating our thinking. Portfolio managers regularly post comments on our website, see Articles (also distributed in printed format), and are readily available to clients for meetings by phone or face-to-face.