The Best Way to Lose $5 Billion Dollars

I caught an Uber the other night to a function in South Yarra. I was caught in peak hour traffic, so the conversation with my Uber driver went a little deeper. My driver was a young Indian man who migrated (originally) to Sydney (then to Melbourne) with $1,500 to his name. He’s a chef, although, he’s driving Uber until he finds a new job in Melbourne. His wife is a primary school teacher, and he has two young kids. His biggest worry – that his kids won’t value money and the hard work that comes with it.

During my discussions with clients and investors of late, this is a common theme that has recently emerged – generational wealth transfer.

What will my children’s future hold? How do we pass on our values? How can we protect our family’s assets? These are all questions that are being asked by concerned families. While looking into the future is impossible, there are certainly ways we can help our children prepare for it. I think one of the most important aspects of generational wealth transfer is to understand how the attitudes of our children have changed toward family, work, and money.

According to a recent (US) study by UBS, while most Boomers were ‘on their own’ after they finished college, three in four Millennials still receive financial assistance. Rather than viewing their support as a burden, the vast majority (80%) of Boomers feel good about being able to help their children. Only 10% of Boomers withhold support to teach their children financial independence.

Here’s a true story

It was January 4, 1877 and the world’s richest man had just died. Cornelius “The Commodore” Vanderbilt had amassed a fortune of over $100 million over the course of his lifetime as a railroad/transportation pioneer. The Commodore was of the belief that splitting the family fortune would lead to ruin, so he left a majority of his wealth ($95 million) to his son William H. Vanderbilt. At the time of this bequest, $95 million was more money than was held in the entire U.S. Treasury.

The Commodore’s decision not to split his empire proved right. Over the next 9 years, William H. doubled his father’s fortune to nearly $200 million through proper management of the railroad business. After adjusting for inflation, the $200 million Vanderbilt fortune would be worth roughly $5 billion in 2017 dollars.

However, William H.’s death in late 1885 would cultivate the seeds of folly that would lead to the fall of House Vanderbilt. Within 20 years no Vanderbilt would be among the richest people in America, and when 120 of the Commodore’s descendants gathered at Vanderbilt University in 1973 for the first family reunion, there was not a millionaire among them.

This is the story told in ‘Fortune’s Children: The Fall of House Vanderbilt’. Before I finish this story, I want to highlight a saying popularized by the great Charlie Munger, Warren Buffett’s long time business partner:

Invert, always invert.

Originally formulated by the German mathematician Carl Jacobi, the idea was to solve a problem backwards rather than forwards. So rather than asking, “What’s the best way to keep wealth?”, we should ask ourselves, “What’s the best way to lose wealth?” In the Vanderbilt story we have our answer. So without further ado, I present a step-by-step guide on how to lose a fortune:

Spend money like no one else

Have you ever:

  • Dined while on horseback?
  • Owned 9 mansions on Fifth Avenue (some of the most expensive real estate in New York City)?
  • Thrown a party that cost $5 million?
  • Sunk your yacht and then immediately ordered a larger yacht in order to not upset your wife?

These are just a few examples of the Vanderbilts’ spending decisions during the infamous Gilded Age in American history. Extravagance was all the rage during this period and much of it had to do with the vast amounts of wealth created and owned by a small section of society. It has been estimated that before the Civil War (1860s) there were less than a dozen millionaires in the United States, but by 1892 there were over 4,000! New York City was at the heart of this age of opulence, and the Vanderbilts were center stage for much of this time.

As I read the Vanderbilt story it dawned on me that spending money isn’t enough to lose a great fortune. You have to spend money like no one else. The grandchildren and great-grandchildren of the Commodore were no exception to this rule.

Sell your assets at the worst possible time

You may be asking yourself, “How could the Vanderbilts ever become poor? Couldn’t they just sell their mansions?” Your logic is right, but your timing is wrong. They did sell their mansions and many of their other assets, but at some of the worst possible times.

One of the clearest examples of this was the Vanderbilt vacation home known as Marble House in Newport, Rhode Island. Marble House cost $11 million to build in 1892, which is equivalent to roughly $285 million in 2017 dollars:

However, during the heart of the Great Depression in 1932, Marble House was sold for a price of $100,000, or less than 1% of its price to build! A similar fate befell William H. Vanderbilt’s collection of 183 paintings when they were sold in 1945:

“The very best foreign paintings that money could buy,” which he had purchased for more than $2 million — were sold during the evenings of April 18 and 19, 1945 for a total of $323,195.

The fact remains that if you are forced to sell assets in a market with a few number of buyers, you will take large haircuts. This is especially true in markets for luxury items and other esoteric assets (i.e. art, wine, etc.). Here’s how those assets have performed relative to the world stock market since 1900 (click for larger image):

So, how do you prevent this from happening to you? Have ample liquidity (i.e. cash reserves) so that you aren’t forced to sell assets during market turbulence and drawdowns. If you need to spend money and you can’t, that’s risk. Why? There is nothing worse for an investor than selling an asset at rock bottom prices in order to get cash for essential purchases. If it can happen to the Vanderbilts, it can happen to you.

Never buy an income producing asset

Of all the financial sins committed by House Vanderbilt, this one is probably the worst. During their entire fall from grace there is no account of a Vanderbilt purchasing an income producing asset. This is one of the biggest differences between those who grow wealthy and those who don’t — the wealthy buy income producing assets.

While it is true that the Vanderbilts all owned parts of their railroad empire, they never diversified or expanded their holdings, and their wealth slowly faded away as a result.

You Only Need to Get Rich Once

In the financial ashes of the House Vanderbilt we can learn many great lessons. You only need one big break (or many small breaks) to get wealthy. Once you get there, let the words of the late Commodore guide you:

Any fool can make a fortune. It takes a man of brains to hold onto it after it is made.

– Cornelius “The Commodore” Vanderbilt

Let me leave you with a quote from the book, Fortune’s Children, which perfectly illustrates the Commodore’s relationship with his son:

Today, this relationship is very different. Here’s the latest from UBS’ research:

I guess everyone has a very different way of educating their children about money and finances. However you decide to preserve your hard work and wealth, whether and how you choose to distill your values into your children are all personal choices.

Whether you’re driving Uber between jobs and raising two young children, to multi-million dollar businesses and balance sheets with grown children and fiancés, it’s a growing concern that needs to be addressed. Get the conversation going.

This story was originally posted by Nick Maggiullu – Of Dollars & Data with some personal editing.