The Half-Life of Extraordinary Wealth

Partner content by Bob Casey, Founder & CEO of Santa Barbara Management.

I’ve now met with hundreds of builders who have experienced life-changing financial events: the sale of their business, an IPO, a substantial carried interest distribution, and other wealth creation milestones. They’ve built real wealth and they’ve crossed whatever threshold they’d once set as “enough.”

And then, almost without fail, the question shifts from “how do I build this?” to “how do I preserve this?”

Most people assume the second question is the easy one. There’s a version of the same idea that goes viral on X every few months: just live off 3% of your multi-million dollar portfolio a year, and you’ll never work again or run out of money!

The idea is clearly alluring. Reddit’s “FIRE” (Financial Independence, Retire Early) forums count more than three quarters of a million subscribers! And I get it. In fact, many financial planners cite the “4% Rule” as a rule of thumb for a “safe” spending rate. For most of the families that we serve at SBM - with net worths well into nine figures - 3% or 4% is many millions of dollars a year, and is a far higher magnitude of expenditures than most of them had ever imagined. And yet this logic falls apart in practice.

For the vast majority of wealthy families I’ve gotten to know, spending scales almost linearly with wealth. Some of the growth is certainly driven by fancier houses, private aviation, and luxury personal consumption, but plenty of the incremental spending comes in the form of supporting family members and friends, passion projects, or philanthropy. But it scales all the same. Preserving and growing wealth turns out to be just as hard as creating it in the first place.

In a world awash with money, capital itself loses value over time. It’s shockingly hard to preserve wealth across many decades. Inflation, spending, taxes, and ultimately division among heirs erode even the largest fortunes.

In The Missing Billionaires, Victor Haghani and James White do a great job of bringing to life the reality of how wealth dissipates across generations with both data and real world examples. They share:

“To get a rough count of these “missing billionaires,” let’s turn back the clock to 1900. At that time, the US census recorded about four thousand American millionaires, with the very richest counting their wealth in the hundreds of millions. If a family with five million dollars back then had invested their wealth in the US stock market and spent from it at a reasonable rate, that single family would have generated about 16 billionaire households today. If even a quarter of those millionaires in 1900 started with at least five million dollars, their descendants alone should include close to 16,000 old‐money billionaires alive today. If we include the private wealth created throughout the twentieth century as well, rather than just a snapshot in 1900, we believe the tally of potential billionaires is vastly greater.

But as of 2022, Forbes estimated there were just over 700 billionaires in the United States, and you’ll struggle to find a single one who traces his or her wealth back to a millionaire ancestor from 1900. We needn’t go so far back in the past to find this pattern. Fewer than 10% of today’s US billionaires are descended from members of the first Forbes 400 Rich List published in 1982. Even the least wealthy family on that 1982 list, with “just” $100 million, should have spawned four billionaire families today. We recognize that some wealthy families purposefully chose to give away or consume virtually all of their wealth in their lifetimes, but we believe these cases were relatively rare and do not account for the near‐complete absence of “old‐money” billionaires we see today.”

Ray Kroc liked to say “when you’re green you’re growing, when you’re ripe you rot.” It’s true of most things in life. And growth doesn’t just happen. It requires effort and ambition. It requires a builder actively working at it.

Let’s say your portfolio does what a good diversified portfolio is supposed to do and grows nicely over time. For the purposes of this example, we’ll assume returns of 8% a year over the very long run. The reality is that this is harder than it sounds considering that most wealthy families keep a meaningful portion of their wealth in low-productivity assets like cash or personal real estate, but we will use it here.

Now start subtracting what actually happens to that 8% before it ever gets the chance to compound. We can assume 3-4% a year in expenditures, and that Uncle Sam takes another 2-3% a year in income and capital gains taxes on the portfolio itself.

Add it up and you’re left with perhaps 1-3% of nominal growth per year before inflation. After accounting for inflation, most families are flat in real terms in a good year, and losing ground in a bad one.

Over the course of decades, exogenous events can have substantial negative effects. Spending tends to be “sticky,” and during substantial market drawdowns, household expenditures rarely fall at the same rate. For families with significant concentrations in their balance sheets, exogenous shocks can be much larger than a broad market drawdown.

The largest resets happen intergenerationally. Estate and transfer taxes often claim 25-40%+ of the estate at death, depending on a family’s level of planning. Whatever is left gets divided among children, grandchildren, and often some philanthropic causes.

To illustrate the impact, let’s look at the numbers on a $200 million family fortune. First, we can assume that it holds flat for thirty years in real terms, which is a generous assumption given everything discussed above. We’ll assume that due to some planning and use of lifetime exemptions, the estate tax for this family falls at a 35% effective rate, reducing the fortune to $130 million. Split three ways, each kid ends up with about $43 million. Now do it again with their kids: flat for another thirty years, another 35% effective tax, split three ways again. Each grandchild ends up with about $9 million.

While that’s certainly real money, across two generations and 60 years of compounding, nine grandkids each receive less than 5% on the dollar in real terms of what their grandparents built. Nobody wants to imagine their grandchildren with a significantly lower standard of living than they have themselves, but that’s the mathematical reality for most of the ultra-wealthy.

The above example may even understate the erosion of wealth in real terms. Over the past 30 years, CPI has averaged between 2.5-3% a year. But CPI, which measures what an average household buys, is the wrong yardstick for a wealthy family. CPI measures groceries, gas, a used car, a flat-panel TV, and other common goods. In that basket, prices have been remarkably tame, because innovation keeps creating abundance. A 65-inch TV costs a fraction today of what it did fifteen years ago - for a much better product.

But wealthy families experience a different type of inflation. Their largest expenditures are typically on scarce assets: a house in a place like Aspen or Palm Beach, tuition at Stanford, a holiday week at the right hotel, or a one-of-a-kind piece of art. Scarce assets get bid up as capital becomes more abundant.

The Forbes Cost of Living Extremely Well Index has shown luxury goods inflating at 5.1% over the last four decades, almost exactly double the inflation rate of CPI, with true ultra-luxury assets such as private jets and yachts running north of 10% in some years - or nearly four times regular inflation. Elite college tuition has outpaced CPI by nearly 2x over the past two decades. Even the cost of an Hermes Birkin bag has compounded at over 6% a year going back to its 1984 launch.

When families ask me how to combat the long-term erosion of family wealth, there’s a core idea I try to communicate: you can’t assume that the fix here is to just design a better portfolio - although that is part of it. The families who actually grow real wealth across many decades and multiple generations do something that looks almost contradictory. They keep a big chunk of their money in a steady, boring, 8%-a-year portfolio, and they leave it alone. That portfolio funds their spending and covers the downside.

But they never stop building.

Alongside that steady portfolio, they pour time and energy into something that can generate meaningful alpha.

The same way it’s impossible to outsource alpha when building wealth, it’s also impossible to outsource alpha when maintaining wealth.

This is where many families go wrong after a liquidity event. The instinct is to look for alpha at arm’s length: commit to funds, make co-investments, invest via SPVs, and invest through layers of managers. Some of these investments may work out, but ultimately this approach tends to be a significant investment of time and resources in the outsourcing of a family’s alpha.

The most successful multi-generational families focus their energy and attention in two buckets. The first is working hard to grow and build operating businesses that they control and where they have a direct impact. Sometimes this is a multi-generational business that was the original source of wealth; in other instances these are businesses that the family has come to own over time - but with an active, rather than passive approach to stewardship of the business.

The second area is in new opportunities that they can start, incubate, and grow directly. This is also counterintuitive in that those new opportunities may represent less than 1% of their net worth on day one, yet they get the lion’s share of time and focus. That feels backwards, but it’s the same lesson the best-run companies have already learned: if you spend all your energy protecting the cash cow, you will never build the next wave of growth.

Meanwhile, their large portfolio is managed simply, almost boringly. It is this observation that underpins much of our approach at SBM - from the client profile we focus on to our investment philosophy.

Jeff Bezos famously introduced the idea of “Day 1” thinking to the world in his first shareholder letter in 1997. He named the building he works in after it, and has carried the name with him every time Amazon has moved offices. In his 2016 letter, Bezos expanded on the idea and laid out a simple but sharp distinction:

“Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.”

A company is either in Day 1 and still building, or it is in Day 2. Families are no different. Wealth has its own version of Day 2: a quiet, comfortable stasis that sets in once a family decides the hard part of building wealth is behind them. Nothing dramatic marks the transition. Rarely does a family lose a fortune overnight - much more typical is a slow erosion over time.

The families who actually grow real wealth across generations are the ones who never let themselves settle into Day 2. They stay builders. They work on the next thing, long after “enough” has come and gone.

The FIRE movement, which I mentioned earlier in this email, is predicated on a finish line. Its purpose is to identify the point at which an individual no longer needs to work, which is a perfectly reasonable goal for an individual. For a family that hopes to build and grow wealth across generations, there is no finish line.

If the goal is to create a family enterprise, that requires a culture of building that perpetuates for generations after the original family wealth creators have passed.

This kind of culture and these values rarely persist on their own. The drive that created the wealth in one generation doesn’t automatically pass to children and grandchildren who grew up with generational wealth as part of their day-to-day reality. Families that sustain it successfully are intentional about a few things: what the family’s wealth is for, how the family’s structures reward effort and ambition, and, most importantly, how it fosters a culture of building.

Family councils, charters, and offsites can also be useful, but governance for its own sake is rarely the answer. Ultimately, what matters most is whether the family’s culture leads to continued building.

This is one of the hardest problems a successful family faces. I don’t think anyone has it fully figured out, including us!

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Bob Casey is the Founder & CEO of Santa Barbara Management, a fractional family office built to serve the world's most exceptional builders, and their families, with an integrated advisory model that incorporates tax, trust and estate, investment advisory and financial operations under one roof. You can follow more of his thinking here.