Wealth preservation takes an entirely separate frame of mind compared to someone accumulating wealth. At this point, managing your family becomes as important as managing your finances. Family topics can be sensitive topics. Still, I want to write about it. Your ability to avoid problems here will likely make you substantially wealthier. I’ll divide this blog into three sections.
Divorce: If it happens, how do you limit the financial damage?
Why is Divorce so Financially Damaging?
Passing wealth-building values down to your children
Financial issues are often cited as a top reason for divorce. That’s pretty intuitive; money conflict can cause divorce. I want to go beyond that. We’re talking about the other side of the situation–divorce causes serious money issues.
The Financial Impact of Divorce
Oddly enough, divorce is dropping among the younger generations. What’s increasing is “gray divorces”–divorce over the age of 45.
Bloomberg ran a story last year covering the research from Bowling Green University and the National Center for Family and Marriage Research. Here are some of the findings:
Wealth drops by 50% (this is pretty obvious)
Incomes also substantially drop post-divorce
Standard of living has a stark decrease
One decade later, wealth and standard of living do not recover–we’ll go into why this is later.
If Divorce Happens, How Do You Limit the Damage
I realize I’m writing about something that virtually every person has to deal with–whether personally or through someone close to them. Here are some things to help limit the financial impact.
Don’t disinherit your kids. The most common or infamous estate planning mistake is accidentally disinheriting your children. This can happen quite easily after a divorce if you get remarried. How? Most estate planning laws at the state level favor your spouse–if legal documents aren’t clear, laws typically favor the spouse. In addition, it’s common to list your new spouse as a beneficiary (in fact, some retirement plans require a spousal signature with a notary if you’re NOT listing your spouse). Lots of people assume they can list their children either in their will or as contingent beneficiaries. Nope. Whoever is listed as the primary beneficiary on your retirement accounts is getting that entire account. It will trump your will. Furthermore, contingent beneficiaries mean nothing after you’re gone. If you don’t want to disinherit your kids, include them as a primary beneficiary on your account and review your will/trust.
Take a step back with your lifestyle. I’ll dive into this in the next section, but your assets take a steep hit in divorce. This isn’t easy to adjust to, because your lifestyle has probably been getting more expensive consistently over the last few decades. Common sense might suggest that it’s a non-issue. After all, your assets can cut in half because your expenses will cut in half after divorce. Except, that never happens. It’s more likely that your expenses are closer to what they were pre-divorce than cutting them in half. But cutting back lifestyle expenses will greatly help limit the damage.
Increase your income. You have to keep your foot on the gas, especially if you’re not yet at retirement age. The timeframe from age 45 to age 65 is critical. If you’re spending assets instead of letting them grow (or at least keeping them at the same level), you ensure future problems.
Why is Divorce so Damaging to Your Assets?
Compound Interest Gone Awry. Age 50-60 is arguably the most critical decade in your financial life. Large Oil & Gas companies produce more retirees with substantial 7 figure retirement accounts than other industries. Getting to $5M in assets is extremely rare. Very few Americans do it. Oddly enough, the path to getting there is boring and very simple.
Let’s pretend you’re approaching 50, and you have $1Million in your 401k. How does that situation turn into $5M by age 60? If we go back to 2010, you likely did this by simply keeping your job and continuing to invest. Since then, the S&P 500 has just about quadrupled. So, if you stayed aggressive (note: most of you in your 50’s should stay aggressive if you have a pension), you likely saw your portfolio jump from $1M to $3-4M in that decade. Add a pension and any amount of after-tax savings, and you probably reached the rare $5M mark.
That’s how compound interest works. It takes you almost 30 years to save your first million. And then, growth can happen very fast. In fact, it’s so simple at this stage, even if you stop contributing to retirement plans yourself, you would have been fine. A target-date fund from 2010-2020 would have more than doubled.
But, divorce disrupts the above scenario. Instead of continued growth, your nest egg gets cut in half. This is a problem in and of itself, but it gets worse—statistically, you’re very likely to see your income drop post-divorce. So, this means you’re saving less over the next ten years.
Let’s revisit the 50-year-old with $1M in a 401k. Well, it’s now $500,000. Future contributions to investment plans will likely be less. And the pension was also cut in half. So, instead of reaching the $5M mark, somewhere around $1.5M is far more likely.
It can get a lot worse, though. In many of the “gray divorce” situations from the Bowling Green study, families are forced to start spending that $500,000 nest egg instead of letting it grow.
To recap, the path to $5M over the past decade required this:
Stay invested (don’t ever sell when the market fluctuates)
A ton of research shows that the human mind does not comprehend compound interest. George Washington University research says 2/3 of Americans mathematically do not understand compound interest. That’s just the math part. Of the 1/3 that understand the math part, there’s still a disconnect.
I bring this up to say divorce almost never leaves you with half of your assets. Because of compound interest, it’s common to miss out on way more than 50%. In our above examples, $5M dropped to $1.5M or even $500,000 in some scenarios.
It’s tough to lower your expenses as you get older. Lifestyle creep is real. Once you experience a luxury, it becomes part of your daily life. Then, it becomes a necessity.
After we bought our first house, I noticed a mowing crew mowing both of my neighbors’ yards. Out of curiosity, I asked them how much it would cost to cut mine.
I think you can guess what happened next. I haven’t used a lawnmower in years! And let me tell you, I have no interest in changing that.
The tough thing about divorcing in your mid 40’s & 50’s is that you’ve had decades of lifestyle creep. So for most people, a drastic drop in expenses does happen alongside their drastic drop in assets. It’s not uncommon for both people to find a way to spend what they were spending together even though they’re now apart.
It’s common for both of these reasons to see a bleak financial picture 10-20 years after a divorce. The Bowling Green study makes a lot of sense. Not only do your assets drop, but your income may also decrease, and your expenses don’t drop much.
Passing Wealth Building Values Down to Your Children.
A well-covered familial topic with money is how often inherited wealth gets squandered.
One of the most impressive stats about millionaires is that almost none of them inherit wealth! Around 80% of millionaires are first-generation wealth. Part of this is a testament to America’s free-market opportunity. Another aspect of this is the 2nd and 3rd generation doing poorly with their inherited wealth.
One of the craziest examples of passing down wealth is the Frescobaldi family in Italy. Lamberto Frescobaldi currently runs the family wine business. A wealthy vineyard owner outside of Florence isn’t necessarily something to write home about. But when the family business has now been successfully passed down for 700 years, it is truly unique.
This quote from Lamberto is incredible, “You have to feel that what you have inherited, you actually do not own,” he said, seated on a wine cask. “You only have to run it properly, and to carry on to something else.” Talk about mastering the art of wealth preservation.
Throughout Europe, it’s common not just to pass down wealth, but also to pass down occupations. What can we learn from their stories about how to instill culture into our families?
Think long-term. I don’t mean decades, either. It’s clear that families who have wealth last for hundreds of years were building something they would never see for generations coming after. There’s something special about this.
Instill actual skills into children. I’m fascinated by the trend of families staying in one occupation. I think there’s something powerful to it, and it’s likely connected to my next point. Wealth preservation is a team sport.
Building a culture of making the family (and world) better than you received it. The quote from Frescobaldi above says it all. Instead of thinking he owns all of his assets (which he does), he views himself as a steward, passing them down to the next generation. I think there’s also likely a charitable component to this. The Fugger family in Germany has managed ultra-low-cost housing for the poor for 400 years.
These families don’t have to work. But they choose to. This is an important lesson. We don’t work because it gives us a paycheck. We work because it is sacred to create value and serve others.