Generational wealth refers to assets that are in excess of that which is needed to fund one’s retirement needs and can therefore be passed down from one generation to the next.
Many people dream of creating generational wealth, but few achieve it. Most people are living paycheque to paycheque, with little or nothing to hand over to their children.
Renier de Bruyn, senior investment analyst at Sanlam Private Wealth, explains what separates those who are able to create this kind of wealth from those who aren’t.
“Building generational wealth can be used to provide your children or grandchildren with a relative advantage, if they use it astutely, to buy property, fund education, start a new business or for the benefit of any social cause,” says De Bruyn.
“You’re not going to get wealthy putting your cash under the mattress. If you’re risk-averse, you won’t build wealth. You must be prepared to take reasonable risk.
“Looking at the ultra-high-net-wealth people among our clients, there are five broad types: successful business owners who sold their businesses for large sums of money; those who earned stock compensation and the share price subsequently performed well; people who made money out of property; and people with a large position in a single stock that performed extremely well over the long term, such as the early investors in the Rembrandt group or Naspers.
“There is a fifth source of generational wealth, and that is inheritance, but this only works if your parents or grandparents did any of the above.”
Does creating generational wealth require a different investment strategy?
De Bruyn says three factors differentiate generational wealth from conventional investing:
- Adopting a longer-term investment horizon, with less attention on short-term fluctuations in the market.
- Beating inflation becomes a bigger concern than short-term market volatility.
- Ensuring you have the correct estate planning structures in place to minimise tax leakage and ensure your assets are protected and managed prudently after your death.
What are some of the lessons that can be learned from the ultra-wealthy?
The power of compounding. One of the key lessons to learn is that few people get and retain wealth through get-rich-quick schemes, says De Bruyn.
“A far better lesson to learn is the power of compounding. Investing early, and regularly, is the first step. Build wealth over the long term through consistent compounding and don’t let greed suck you into ventures promising quick returns, which are not backed up by fundamentals.
“Warren Buffett once said that over the short term the market is a voting machine, but over the long term it is a weighing machine. In other words, over the long term an investment will revert towards its intrinsic value which is a function of the future cash flow that it can generate while over-hyped investments are sure to come back to earth.”
Building wealth requires actual and responsible risk taking. You will not build wealth by hiding your cash under your mattress, says De Bruyn.
“It is a common practice to define risk as the volatility of returns. So from this perspective cash and fixed interest investments are ‘safer’ than stocks because their returns are more stable and predictable than stocks. However, over the long term the greater risk to your wealth comes from inflation, which erodes wealth, and investing in underperforming assets. Viewed in this light, stocks and property are less risky than cash.”
To avoid exposure to underperforming assets, make sure you are buying assets below their intrinsic value, which reduces downside risk and increases prospective returns. Some of the best opportunities occur during market crashes, he adds.
“So make sure you have fire power, whether in the form of cash or credit, for these events and that you have the conviction to act when it seems as though the world is falling apart.”
Invest in things you understand well, and within your area of expertise. Successful business owners clearly understand and operate within their specific industries better than others. For the vast majority of private investors in the public markets it is better to use a professional money manager or passive index trackers, says De Bruyn.
How does one start on this journey of creating generational wealth?
Build good savings practices into your routine, such as automatically setting aside 10% of all income as reserves.
“Improve your financial literacy, and of course, live well within your means,” says De Bruyn.
“See how much of your monthly cash outflow can go towards businesses or assets that will grow in value.
“Understand the difference between good debt, which is debt used to build income-earning assets, and bad debt, which is debt used for consumption.”
De Bruyn advises setting up an emergency fund as a priority, invested in short-term investments such as money market funds, and building additional income streams, which helps to avoid falling into bad debt.
Those who already have sizeable discretionary funds and are ready to build a portfolio should start by purchasing quality companies – particularly those with healthy balance sheets, predictable cash flows, and high, sustainable return on capital.
“Don’t pay too much for these companies,” he says, adding that one way to evaluate them is to look for those with high free cash flow yields.
“Also, diversify properly across industries and geographies, so that some of those companies will perform well while others take a dip.”
How does Sanlam Private Wealth go about structuring a client portfolio?
“We do in-depth and proprietary research on the companies in our investment universe with the aim of understanding the various drivers and market position of the business and calculating their intrinsic value based on expected future free cash flow,” says De Bruyn.
“We construct a well-diversified portfolio based on finding good quality, but undervalued companies and our understanding of the macro investment cycle, which should dictate which industries are expected to outperform. In other words, we marry a top- and bottom-up investment process.”
In a volatile environment battered by high and rising inflation, how does one protect one’s wealth?
The investment risks have certainly increased during the course of 2022, with heightened geopolitical risks, high inflation and rising interest rates. This differs from the disinflationary environment experienced in recent decades, when inflation was contained and asset prices increased in value.
This cycle is different from what we have experienced in past cycles, says De Bruyn.
“Until inflation can successfully and sustainably be brought under the central bank target ranges, we are likely to see above-average volatility and high risk for policy error given the lagged impact of policy changes on economic activity.
“Given these risks, we would argue for more diversification, and some exposure to alternative assets, such as gold, which will likely perform when the interest rate cycle tops out.
“In previous times we didn’t have to look further than equities and bonds, but both are now coming down in value.
“Investing in the right equities and property at this time will give you the war chest you need to build wealth for the future.”
You can watch Renier de Bruyn speaking at the Moneyweb Better Investor Conference on Tuesday, 29 November, at 09h00.
Brought to you by Sanlam Private Wealth.
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