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Tuesday, 1 November 2011

Generational Finance NOT Personal Finance

Just do a google search for Personal Finance, and you will see tons of websites, blogs, articles, marketing pitches etc, all doling out advice on personal finance and how to go about achieving the various goals, investment decisions, savings rates etc associated with it.  It is amazing how much information and guidance gets dished out and consumed relating to this topic.  I guess, Personal Finance gets down to the core of who we are, what we do, and how we do it, and touches every aspect of our lives, which is why it is so hotly discussed, debated, talked about, and basically flogged to death on every financial TV channel, news media, or personal finance blog that you come across.

Now typically, when it comes to the savings and investments part of personal finance, every single financial planner and wealth management guru seems to approach it in the same structured manner.  The first step is to collect data about the person (or nuclear family) in terms of his/her current financial situation.  This could be in the form of  assets, liabilities, income sources, expenses, investments, insurance, etc.  The next step is to document all the financial goals, and try to assign a timeline and a Rupee (or Dollar) amount to it.  Then, typically the financial Yoda (Star Wars reference) will pull out a bunch of assumptions based on historical data and future projections, regarding risk and returns for different asset classes, and suggest a quantum of money for savings/investments and the asset class mix, to attain each separate financial goal.  This overall summary is called the Personal Finance Plan, that is handed out to the client with a hefty charge for the service.  I have seen this pattern repeated over and over ad nauseam, with only minor variations in the overall storyline. 

Pictorially you could think of a Personal Finance Life Cycle to look like this. 


The actual age at which you target these goals, or even the goals themselves may vary from person to person, but the concept is basically the same.  For each financial goal, the planner will suggest a quantum of investment and an asset strategy that starts with an aggressive allocation plan, and then subsequently moves to safer and lower risk allocations as the goal gets nearer and nearer.  This is the time honored method of PERSONAL financial planning.

I propose that this method has become dated and a new thought process is required to redefine financial planning.  The key change in thinking is to plan in terms of GENERATIONAL finance, and not PERSONAL finance.  Lets do a thought experiment for a minute wherein the same financial planner as before, is providing financial advice to the person above, and at the same time also to his father and son.  To explain simply, lets assume that the planner is providing financial guidance to 3 generations of the family across their entire lifetimes, all in a synchronized manner, rather than looking at each persons financial plan in isolation.  In this new scenario the planner will observe that major financial goals will typically come up in every 5year cycle (either for the grandfather, father or son; forgive the patriarchal assumption here, but I need to work with something and a matriarchal lineage would work just as well for this thought experiment) Basically every 5year cycle or thereabouts, major financial goals will mature, need to be funded and retired.  So I hypothesize that a simple asset allocation of 90% aggressive investments (high return, high risk; be it equity, real estate, or whatever if the flavor of the day) and 10% safe investments (low return, low risk; be it CDs, FDs, debt or whatever works at that time) should be sufficient for the GENERATIONAL planner to meet all the Generational goals.  At any point in time, there will be 1 goal that will be nearing maturity, and which will need funding, and all other goals will be at a longer timeline. 

Fundamentally, I do not believe this is a new concept at all.  In India, all large corporations (except the more recent ones) have been built up over generations and are tightly owned by a single family (Tata's, Birla's, Ambani's, Wipro, Mallya's, etc).  This is also true, maybe to a smaller extent in the US (Walton's, Hilton's etc) Typically multiple generations of the family are involved in building up and maintaining the scale and size of the corporation and in turn the family wealth.  Even in historical times, kingdoms were ruled by dynasties that held power for multiple generations (Mughals, Guptas, Mauryas, Peshwas etc).  For that matter even today the Indian political system is dominated by one family, and I could argue the same for the US a few decades earlier (the Kennedy's)  Taking a holistic view of generational wealth building, can help you develop plans that are better suited and optimized to help you meet all your generational goals and not just your personal financial goals.  Also the longer timelines associated with generational wealth building, can significantly increase the power of compounding, and mitigate the probability of high risk asset strategies failing on you. 

And the amazing part is that there are live running examples of this concept that you can look at right now!  Trusts are fundamentally formal structures that enable generational wealth management.  Trusts are able to look at long term trends and benefit from a longer timeline that allows them to make the right investment calls.  For example the Harvard Management Company (HMC) maintains and manages the Harvard University Endowment Trust.  The trust forms the backbone of the university funding, and all new grants and withdrawals are managed around the core endowment fund.  You can think of your generational wealth also in similar terms, with core assets that keep growing form generation to generation, and your own personal income and withdrawal needs to be managed around the generational core.  In fact in India we have the concept of HUF (Hindu Undivided Family) which is a legal financial entity, that can own and invest in assets, is a taxable entity and can be managed separately from your own personal financial entity, even while you are a partner in the HUF. 

So in summary, I posit that taking a holistic view at Generational Finance is the secret of all the large wealth (or power) building efforts that you see in history, which take advantage of the compounding effects of decade and even centuries in generations rather than just years within a single generation.  I also propose that there are already legal avenues like Trusts and HUFs where you can see this in action today.  All you need is a paradigm shift in thinking from Personal Finance to Generational Finance, to open up new methods and avenues of investment thoughts and actions. 

Let me know if you agree with my thought process on this.

2 comments:

  1. When it comes to finances, I think I am very low in IQ.
    Personal Finance

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