- Dominik von Eynern
An Introduction to Behavioural Risks
Let's assume your world is perfect: you have got nothing to worry about and more money than you can spend. What would you do then? Would you gorge yourself on any want, need and lust any individual can muster? Or would you build something to have a purpose and try to make more of what you were given? Whatever it is, money changes these parameters. So imagine one day all the money being gone. Whether by chance or the spending of subsequent generations, someday that money will be gone. What then?
There is a commonly held notion that family wealth is lost within three generations: the first generation builds it, the second generation manages it, and the third generation spends it. According to recent studies, empirical evidence confirmed this notion, this is the case in 70%* of families.
What is surprising though, is that the most common reason (95%* of cases) for this erosion is not bad investments or taxes, but behavioural issues. There are risks that these behavioural issues will result in inefficient decisions which will eventually destroy the wealth. Examples of these behavioural risks include:
Family conflicts – interpersonal or generational
High dependency ratio – too many indolent people to feed
Feelings of entitlement – e.g. Rich Kids of Instagram
Reputational issues – scandals or drawing too much unwanted attention
Adultery – additional costs and consequences
Crime – legal fees (at the very least)
Addiction – drug abuse, alcohol misuse, gambling
Boredom – idle hands lead to bad decisions
It certainly seems a lot easier to analyse and control financial risks by looking at this list. Certainly, you cannot apply standardised methodologies to behavioural risks as each situation is different and so is the extent of the impact and consequence.
So, if there are no straight answers to mitigating behavioural risks, what can one do as the family grows over generations and the risk of incurring detrimental effects on one’s wealth multiplies exponentially? Understanding the trigger points of behaviour and the consequences of our actions is a good start and, in turn, families must appropriately plan as it is in their best interest if they are to have any chance of preserving mutigenerational wealth.
In the following weeks, we shall explore several types of behavioural risks (risk identification), consider the reasons for manifestations (risk analysis) and shall attempt to measure the impact of behavioural risks. Finally, we will produce ideas of how to mitigate behavioural risks, including:
Instilling a sense of accountability by all family members
Creating a common vision to be held by the family
Eliminating mistrust and improving communication between family members
Implementing effective corporate governance
Assigning roles and responsibility for all family members
Starting education early for the next generation
*(Vic Preisser, Preparing Heirs: Five Steps to a successful Transition of Family Wealth and Values)