Squandering the family fortune: Why rich families are losing money

June 25, 2014: 10:51 AM ET
vanderbilt estate
In 90% of cases, the family fortune is squandered by the third generation. Here, New York City mansions built by the Vanderbilt family -- a classic example of wealth made and lost.
NEW YORK (CNNMoney)

Rags to riches is a familiar narrative, but when it comes to preserving family fortunes, more often it's rags to riches to rags.

Nearly 60% of the time a family's money is exhausted by the children of the person who created the wealth, according to Roy Williams, president of wealth consultancy The Williams Group. In 90% of the cases it's gone by the time the grandchildren die.

"It goes back to the Biblical story of the Prodigal Son," said Williams, referring to the free spending child who blows his father's inheritance yet is welcomed back anyway. "We haven't changed in 2,000 years, and that same unprepared heir issue is now worldwide."

Profligate spending by heirs -- the type chronicled on sites like Rich Kids of Instagram -- is often a reason for a loss of wealth, as is a simple lack of ambition.

"The people who created the wealth were often obsessive," said Russ Prince, president of the wealth research and consulting firm Prince and Associates. "But their kids were not hungry."

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Perhaps the most famous example is the Vanderbilt family. Cornelius, the patriarch, built a fortune on railroads and shipping during the mid-1800s. Adjusted for the size of the economy, he was the second richest American ever, worth over $200 billion -- well above Bill Gates.

Yet his children -- and especially, his grandchildren -- lived lavishly, building huge mansions in New York City, Newport, R.I., and elsewhere, and did little to preserve the fortune. By the 1970s, the family held a reunion with 120 members attending, and there wasn't a millionaire among them, wrote Michael Klepper and Robert Gunther in their book The Wealthy 100.

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Yet the biggest reason family fortunes are squandered, experts say, is because the people who built the wealth do not pass along clear instructions on how to handle the money after they're gone. That often leads to bitter infighting among surviving family members, and an eventual loss of fortune.

"The intent is good, but there's a communications gap," said Michael Liersch, director of behavioral finance at Merrill Lynch Wealth Management. "People can have a different take on what the wealth creator wanted, and that creates dispute."

Avoiding that might seem simple enough -- just divide up the money equally. But in practice, preserving a fortune requires communication and collaboration that's hard to achieve in any organization, let alone a family.

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Large bequests should come with detailed instructions like whether the money will be used to pay for the education of all family members, how much will go to charity, whether money be available for entrepreneurial endeavors, and more.

"Families need to take their time to shape their attitudes toward wealth," said Nathan Dungan, who runs the family wealth consultancy Share Save Spend. "It needs to go beyond maximizing returns and reducing taxes."

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One of the best ways to do this is to set up a philanthropic organization, experts say. That helps the family develop effective tools for communication and decision making, yet no one has a personal interest in the cash at stake. Those tools can then be used to better administer the family's personal wealth.

"They create family banks, seed capital, and go into businesses together," said Tom Livergood, head of the Family Wealth Alliance. "If you pool your resources, you get scalability."

A good example of this, said Livergood, is the Rockefeller family. They have a prominent foundation, and are still living quite comfortably seven generations after the fortune was made.

"It's not that [John D.] Rockefeller was one of the richest guys in the world," said Livergood. "It's what the family did after."

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