Sustainable Distributions: How to Make Wealth Last and Grow
The United Nations has promulgated 17 Sustainable Development Goals. Broadly speaking, these inter-related goals address global issues such as poverty, inequality, climate change, environmental degradation, peace, and justice. This is a model for other human endeavors including trusts or charitable organizations intended to last a long time.
Something is “sustainable” when it keeps living and growing over time. Something is not sustainable when it is used up, depleted and dies. Obviously, sustainable is good and desirable, while depletion, death and decay are bad and unwanted.
Nowhere is this more obvious than with money. When a bank, government, dynasty trust, or charity distributes its funds, if there is always an increasing amount of money available to distribute, the distributions are sustainable. If the money shrinks and eventually runs out, it is not sustainable. So, . . . how can we keep the flow of money going and growing indefinitely? How do we make distributions sustainable?
The Unsustainable Model
Sustainable distributions are important because when the money stops, it’s game over. The institution or economy is dead, and so are the people. And yet, people and institutions overwhelmingly behave as if there will always be money without understanding what makes the flow of money go or stop. Most charities, businesses, governments, and otherwise really smart hard working people just live hand to mouth. They spend everything they bring in, and often more. Too often, we don’t have a plan or even a working model for developing sustainable distributions.
The absence of sustainable distributions is a chronic condition. The world and our nation is facing the largest transfer of wealth from one generation to the next in its history. And yet, only about 57% of that wealth held by generation one will make it generation two, and only about 10% will make it to generation three. This is the fate of inherited wealth in every nation, culture, and form of government in recorded history. No race, religion, gender, or political philosophy is exempt. Inherited wealth declines over time every time. Inherited wealth can function as poison that kills incentives or fertilizer that fosters growth for future generations.
So much money and so little sustainability. Why?
The Physics Connection
Money is like water. It runs down. Wealth typifies the Second Law of Thermodynamics. According to this “law” of physics, everything degrades or flows downhill. Entropy continually increases. The universe is ever approaching an equilibrium where complete chaos will be the ultimate end. In other words, death, decay and the decline of wealth are inexorable physical processes that can perhaps be delayed, but never completely avoided. Long term, sustainability is impossible.
This is terrible news for any kind of long term financial or investment plan.
This so-called fact of science is wholly unsatisfying. We want sustainability. That is our goal. What do we know of that seems to escape entropy and is sustainable contrary to the creeping encroachment of chaos? Is there anything that is sustainable in defiance of the inexorable downhill flow of the universe?
The Living Distribution Model
The key to developing sustainable distributions is found in life. Life defies entropy and chaos. It is an enigma. Living things grow. Life self perpetuates. It self replicates. Life is the archetype of sustainability. Even when a particular living organism dies, other living things and thus life itself keep going. Life is a yet unexplained part of the universe that is both subject to entropy (all living things die), and yet springs into existence and persists in spite of that. Things that are not living are inert. They just sit there. They do not act. Living things act. Life animates. How is that? Can we do the same thing with money? Can we invest long term in a manner that escapes entropy? Can we make are wealth grow and be sustainable like life?
There are certain fundamental characteristics of life which, when applied to money and investments, can make distributions infinitely sustainable.
Living organisms are open systems.
First, life is an open system, not a closed system. In a closed system, the only available resources are inside the system. Nothing comes in from the outside. When the resources are consumed in a closed system, the system fails, and death occurs. When living things stop eating, drinking, and breathing, they die. Every time. Life ends when the system closes.
In an open system, resources flow in from the outside. In fact, for any organism to live, and be sustainable, it must have an inflow of energy and resources. The same applies to wealth and investments. If the only money you have is the money you have, and there is no inflow from the outside, the money is going to run out. When resources are finite, the system is closed, and death is unavoidable.
Stunningly, although this idea may seem obvious, a great many people with a whole lot of wealth don’t understand this concept. It is hard to conceptualize wealth over time as an open system. The closed system of the money in my pocket right now is a simple idea. It is the answer to the question “how much can I spend?” Treating wealth as a closed system is one of the many reasons why wealth rarely makes it to generation three. Seeing and treating wealth as an open system requires something few are willing to give: delayed gratification.
How can I deploy wealth now, instead of spending it today, so that there is more wealth available to spend in the future?
Life produces more than it consumes.
Here is a simple idea. Spend less than you earn. Reinvest the difference. Wow! That’s really all it takes. We have a good example of this.
The Nobel Prize was created by Alfred Nobel, the inventor of the explosive Nitroglycerin. He set up the prize in his Will. The Nobel Prize has gone to a great many incredibly bright people, including a number of economists who claim to have a better way of managing money. The investments that pay for the Nobel Prize are managed by the Nobel Prize Foundation. The Nobel Prize Foundation’s goal is to make a 3.5 percent real return on assets AFTER INFLATION. This is correlated with its spending policy of a 3-4 percent annual target BEFORE INFLATION.
What is the practical consequence of these tandem return and spending goals?
It means that the principal is not only preserved, but grows over time with inflation. It also means that in general spending is able to go up as the principal grows even though it is throttled to prevent depleting the principal. One consequence is that sometimes we spend nothing. There have been some years where a Nobel Prize was NOT awarded. No spending in the down years is embraced in order to protect the corpus and enjoy the benefit of increased spending in other years.
The Sustainable Distribution Hack
Obviously, the mechanics and calculus to determine actual rates of return and rates of spending adjusted for inflation is a complex and sophisticated process. Most dynasty trusts and charitable organizations do not have a budget to engage a Chartered Financial Analyst to make such calculations. I have worked with a number of organizations that have adopted a quick and simple formula that gets close enough to get the job done. This is it:
Cap spending at 3/5 of the net return after taxes and cost of administration. In talking with clients and charitable organizations about this concept, I call it the “Nobel Prize Model” for sustainable distributions.
While this is greatly oversimplified, it gets the job done in most instances for some simple reasons. Spending never exceeds net income. Each year, a portion of income is contributed to principal. So the corpus grows. Over time, funds available to spend go up. The distributions are sustainable.
It’s that simple. It works. That is the best evidence.
Sustainable Distribution Applications
When establishing a Dynasty Trust or a Family Foundation intended to last and grow over multiple generations, and potentially indefinitely, a deliberate sustainable distribution plan is essential for survival. The structure blows up without one. For those who lack the resources to engage in sophisticated data analysis, the simple hack of spending less than you earn in a predetermined ratio does the trick. The principal grows. Spending grows. Distributions are sustainable. Mission accomplished.
We help people establish long lasting multi-generational structures. One of the key elements to long term success is sustainable distributions. We can help you.