Money Management

How To Build Generational Wealth from Scratch [5 Must-Know Strategies]

Generational Wealth
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Generational wealth is a concept that more and more individuals and families are thinking about. The largest wealth transfer in history is taking place right now, with an estimated $30 trillion being passed on from Baby Boomers to their children. Plus, the tech and crypto boom has helped many in their 30s and 40s explore the concept.

In this article we’ll look at:

  • What generational wealth is.
  • How people are building generational wealth from scratch today.
  • Strategies to pass wealth from one generation to the next.
  • The downsides of generational wealth

What Is Generational Wealth?

When most people think of generational wealth, they think of passing down assets like stocks and real estate from one generation to the next.

While this is no question a big part of what comprises generational wealth, there’s another much more complex side to the topic: making sure your heirs do things like use their money wisely and are able to live a fulfilling life, and ensuring that future generations can continue to benefit from the wealth you’re building today.

How Is Generational Wealth Created From Scratch?

More than 88% of millionaires today are first-generation. In our article on how to get rich, we looked at the most realistic ways to build substantial wealth in your lifetime, focusing on the core idea of increasing the gap between your income and your expenses (as illustrated in the graphic below). 

Graph showing the gap between income and expenses

In short, you’re looking to maximize the gap between your income and expenses while investing everything within that gap in a way that builds sustainable wealth. 

Ideally, you’re able to take advantage of compound interest for as long as possible. After all, while Warren Buffet has a great track record of picking investments, his overall success is largely due to the fact that he’s been steadily investing over a 70-year time horizon

While real estate — including homeownership and real estate entrepreneurship — are touted as the best ways to build wealth, research shows that the majority of today’s millionaires got rich from investment appreciation, employee compensation and stock options/profit sharing.

To me, what these things have in common is that they require a long-term commitment.

A million-dollar portfolio only comes after decades of staying in the market. Highly-paid employees are able to bring the most value to an organization, which comes from taking the time to develop high-value skills. The most lucrative stock market and profit sharing agreements go to the longest-tenured employees at the most senior levels. 

As much as I love entrepreneurship, building a company that’s going to last decades and allow you to continuously have a large gap between your income and expenses for decades is hard. And with real estate, since leverage is used, all it takes is one market crash over your lifetime to wipe you out. 

So building generational wealth requires — in lieu of just getting lucky — a very long-term timeline. In a fascinating article titled “Meet the Money Whisperer to the Super-Rich NBA Elite,” one financial adviser even uses a 100-year timeline with his clients. 

Getting rich and staying rich over one’s lifetime isn’t easy. But staying rich over a 100-year period is even harder, and requires a different set of strategies. 

Strategies to Build Generational Wealth

If you’re looking to create generational wealth — whether you’re someone who has already accumulated the assets or someone who wants to put themselves on the right trajectory — here are five strategies to consider.

#1. Prepare a Family Money Mission Statement

A family money mission statement is a document that gives family members, including yourself, a clear sense of purpose and values when it comes to money.

The idea of a family money mission statement is similar to why a business goes about creating its own mission statement: it’s not about the tactical strategies, but about the principles and values that you want to carry through the generations.

In the business world, thanks to Jim Collins (author of business classics like Good to Great and Built to Last) there’s been extensive research into what leads to enduringly great companies

What he found was:

“Companies that enjoy enduring success have a core purpose and core values that remain fixed while their strategies and practices endlessly adapt to a changing world. The rare ability to balance continuity and change–requiring a consciously practiced discipline–is closely linked to the ability to develop a vision. Vision provides guidance about what to preserve and what to change.”

If you’ve already accumulated wealth over your lifetime — and I can’t emphasize this enough — your heirs should be a part of the process of creating a family money mission statement! It’s your heirs that are going to be the ones seeing out the mission and vision of this document. You want them as involved as possible.

If you’re in the early stages of your life, this process is beneficial for helping you make career and investment decisions over the decades to come. 

Learn more: In an article designed for financial advisers, the well-respected blog Kitces.com has an excellent and thorough rundown of things to consider when creating a family money mission statement. I’d also recommend Jim Collins’ work on creating a vision statement for a company, mainly his books Built to Last and Good to Great. There’s a lot of overlap between building a company’s vision statement and a personal one, and his research in the field is second to none.

#2. Invest in the Right Assets

A different mindset and strategy is needed when you’re looking to invest in a way that’s going to be sustainable for multiple generations. Your goal becomes not only to have enough money to last throughout your lifetime, but also to maximize and preserve your assets for future generations. 

Warren Buffett plans to put 90% of his estate into the S&P 500 after he passes. He’s confident, and obviously has proven, that he can invest wisely on his own. Yet this skill isn’t something that’s guaranteed to be passed on from generation to generation.

Just as important, when considering what assets to invest in, you must take into account the wide range of capabilities and needs of your heirs. 

For example, if you have the risk tolerance to stomach the wild swings in the crypto market, that’s great. But there’s no guarantee your heirs will, and when prices hit an all-time low, they may sell at the absolute worst possible time.

Family businesses are something that you might want to pass on as well. Yet only 40% of family businesses survive through the second generation, and just 13% the third.

It’s for these reasons that index funds that track the S&P 500 and total stock market are a great starting point to design your asset allocation around. You’ll need to adjust your asset allocation based on your (and your family’s) goals, but overall, a bet on index funds is a bet that the world’s economic engine will continue to run.

It’s worth asking, however, whether you can really accumulate wealth for future generations with just index funds. 

Let’s say that at 60 years of age, you’ve built up a million-dollar portfolio. You’ll need to withdraw $30,000 annually over the next 30-years to cover your own living expenses. Once you pass away, an additional $30,000 is withdrawn every year. How would this portfolio fair after about 60 years?

Using FIREclac, which runs simulations based on historical market performance, the average balance using this strategy would be $34,442,773 after inflation (with dividends reinvested). 

We’re often taught to think of the power of compound interest in short time frames, such as 10 or 20 years. But when we can extend our timeline to 50 or 60 years, we get very interesting results that are hard for us to comprehend — like turning $1 million into $34 million.

Morgan Housel, the best selling author of The Psychology of Money, once wrote

“There are over 2,000 books picking apart how Warren Buffett built his fortune. But none are called ‘This Guy Has Been Investing Consistently for Three-Quarters of a Century’. But we know that’s the key to the majority of his success; it’s just hard to wrap your head around that math because it’s not intuitive. There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called ‘Shut Up And Wait’. It’s just one page with a long-term chart of economic growth. Physicist Albert Bartlett put it: ‘The greatest shortcoming of the human race is our inability to understand the exponential function’.”

While your ideal withdrawal rate may be more aggressive, what’s important to realize is:

  1. When you’re dealing with long-term time horizons, a massive sum of money isn’t needed upfront to create wealth for future generations. 
  2. You need to invest in a way that allows you to stay in the market for decades.

#3. Optimize Asset Location and Tax Strategy

Billions of dollars are spent every year trying to out-gain the stock market. Some of the smartest people in the world work full-time to win an extra percent or two.

In terms of picking fruit, aiming to beat the market each year is like climbing to the top of a 100-foot apple tree (no, these don’t exist) when perfect-quality apples are hanging from the lowest branches.

Outperforming the market is fun. Tax planning is not. Yet in terms of impact, you’ll be far better off focusing on proper tax planning rather than designing an optimal asset allocation.

Consider this fact: if you pass on a Roth IRA to your heirs, they’ll be able to make tax-free withdrawals for a five-year period.

Another interesting strategy is opening up a Custodial Roth IRA for your child once they start earning income. There are no age limits for having an IRA — the only requirement is that they earn income. 

Overall, Roth IRAs are just one of the many strategies you can use to make sure your investments are able to compound longer and are less likely to be liquidated at a bad time. The bigger point is there’s a lot you can control when it comes to taxes, and working with a professional will pay for itself many times over when you look at the impact over decades.

#4. Create an Estate Plan

A good estate planning attorney can help you properly plan to minimize taxes. But most importantly, they can also help you put in writing and design the strategies to have your family money mission statement play out.

At its fullest expression, estate planning includes wills, trusts, powers-of-attorney for financial affairs and healthcare, and more depending on your situation and goals.

It’s not something that can or should be done on your own. It’s important to work with a financial adviser or wealth management team who understands the complexities of family dynamics, generational wealth building and tax law. 

#5. Plan Ahead for Liquidity

Over your lifetime, as well as the lifetime of your heirs, assets in your estate will need to be sold. Whether it’s to pay debts, to pay taxes, or even to provide payments to your heirs, these events, as much as possible, need to be planned for ahead of time.

When estates don’t plan for liquidity, they often have to sell more illiquid assets, like real estate or business interests, at an inopportune time.

Proper life insurance planning can help here as well.

I’d familiarize myself with the Buy, Borrow, Die strategy to reduce taxes over your lifetime. With this strategy, you borrow against your assets now to give yourself income, instead of selling assets and paying capital gains tax.

Whatever your liquidity needs are, having a plan in place for future generations is important. If your heirs have to sell to create liquidity when the market is at a low point, plus pay taxes on those investments (meaning they’ll have to sell more than what’s needed), the chances of your estate spanning multiple generations diminish.

Final Thoughts on Building Generational Wealth

Paying for your kids’ and grandkids’ education, making sure nobody in your family has to take on medical debt, or even helping future generations buy a home is empowering.

No matter where you’re at today, the process has to start with taking control over your own financial situation. Setting a vision for your own future, based on the core values and principles you want to live by. Getting your own finances and investments organized. Finding a career that you love (that’s going to maximize your income). 

So, whether you’re in debt or have seven figures in the bank, there are steps you can take today to help future generations have a better quality of life. 

That’s powerful.

R.J. Weiss
R.J. Weiss is the founder and editor of The Ways To Wealth, a Certified Financial Planner™, husband and father of three. He's spent the last 10+ years writing about personal finance and has been featured in Forbes, Bloomberg, MSN Money, and other publications.

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