To Invest as Individuals or as a Family?
Pooling the family's resources can lead to higher earnings, and fewer resentments.
Owners of family businesses tend to focus much of their time and energy on just that—running a successful business. There are, however, strong pressures on families to properly invest their capital and asset base. Given the vagaries of business cycles, many times families see greater returns from the management of their assets than from their businesses.
Money managers who invest for families often face difficult issues that are not present in managing the assets of individuals. Emotions, rivalries, and complicated relationships can poison the chances for successfully preserving family wealth.
To maximize the chances for successful investing, families must address several critical issues, such as whether to pool individual funds, and whether to use a money manager. A discussion of the following points will help guide families through these issues, and provide unity as investments are made.
The first question that must be addressed is whether the assets of individual family members should be kept separate or together. Investment managers at my firm have found that it is much more profitable to pool resources than to split them into individual accounts. By combining resources, the family profits as a whole. Single, pooled accounts lead to higher interest earnings, more collective investment power, and lower fees and commissions.
Individual accounts can also lead to jealousies between family members who have smaller portfolios or have not invested as successfully as others. With a pooled account, each family member succeeds at the same rate, proportionate to his or her stake in the account. In addition, a pooled account demands consensus in investment decisions, which tends to promote cooperation and moderate rivalries and blaming.
Managing a Diversity of Goals
Even when a family pools its resources, it must still consider the different future financial interests of each member. A father at age 70 will have a different investment goal than his 40-year-old daughter. For this reason, the emphasis of a pooled account should be directed toward three goals: preserving capital, generating income, and providing for the security of parents and children.
These goals can be accomplished by dividing the family account into subgroups. One subgroup might focus on long-term growth, another on safety of principal with increased income, and a third on a balance between the two. This diversification would allow a daughter, with her eye on the future, to choose a subaccount with the greatest long-term growth potential. At the same time, older family members—those looking for a secure income—could take the safety option or a balance between the two.
The subgroups differ from individual accounts because the money remains pooled. The three- prong ed approach still saves on commissions and retains the clout of a unified account, while permitting investment flexibility.
Borrowing from the Family Account
There are times when it may be wise for the family business to borrow from the family account. On the positive side, the family account is usually the cheapest source of money, because it gives the lender first-class collateral—namely, the business. Because the family account is the lender, the loan can be offered at a very low rate.
There are, however, risks involved. When the business is part of the collateral for a loan, whoever is managing the account must apply standard criteria in periodically reviewing the loan; the manager may even call for repayment when it seems advisable from the family’s investment point of view. In effect, the manager might try to influence the business. For many families, this shift in control can be traumatic.
Another option is to use the available cash in the family account for a cash loan to the business. The drawback here is that taking cash out of the account may result in missed investment opportunities. The same risks of collateral and outside control apply in this situation as well.
Hiring a Money Manager and Granting Discretion
Since family members may have very different investment philosophies and points of view, many families hire an outside investment specialist to set up and manage the family account. Often, as well, a money manager is hired because he has much greater investment knowledge than anyone in or close to the family business.
It is important for the manager of a pooled account to have wide discretion in making investment decisions. Without this power, the manager might be forced to consult with each family member before taking action, an arrangement that is obviously impractical. With discretionary power, the manager has the ability to make decisions quickly and efficiently, and the client does not have to spend time doing the research that is needed to make informed decisions himself. Pooled, managed accounts are not for clients who want to manage their own money and use the manager solely in an advisory capacity.
Working With the Investment Manager
Most families designate a single family member to work with an investment manager. This not only cuts down on potential confusion, but allows for a relatively unencumbered flow of valuable investment information; it is much easier for the manager to develop one strong relationship rather than 20. It is up to the family to designate an individual whom they trust to represent their best interests and to communicate with them, when necessary, about crucial investment decisions.
Once the modus operandi for making decisions is in place, it is vital that the family meet at least once a year to discuss common goals. Twice a year would be preferable, but may not be feasible. These meetings give the family representative the opportunity to update everyone on the status of the account and get feedback on how others feel the account is being handled. Money is an extremely emotional subject—especially in families—and this meeting can help to clear the air of disagreements.
It is almost impossible to accurately assess the performance of an investment strategy on a year-to-year basis. The true test is profitability over a period of market cycles. By drawing a trend line from one “down market” to another, you should get an accurate portrait. If over five years a friend’s portfolio has averaged a 14 percent return compounded, while yours has averaged only 5 percent com pound ed, it may be time to consider other options.
Just as performance must be viewed through a long lens, you should choose and judge a money manager based on the long term. It takes time for a trusting relationship to develop and for the manager to fully appreciate your family’s needs and goals. A good manager, moreover, should be more than a “stock picker.” He can become an advisor who can be consulted on many questions unrelated to investments, such as where to go for the best advice on insurance, wills, and estate planning.
Gerald Cramer is chairman of Cramer Rosenthal McGlynn, a New York investment management firm that specializes in family investments.