Creating the Family Fortune Trust

What if you could make it so that every one of your descendants had money to attend college?  What if each member of your family received money when they were born that they could invest and use to pay for their retirement?  How about each of your descendents receiving a generous sum of money when they became an adult (or maybe when they became 25 and had developed some sense) to start them out in their new life.  Maybe each of your family members gets an initial emergency fund so that they would never need to go into credit card debt.  Maybe you pay for the weddings of all of your descendents.  Or their funerals.  Or their honeymoons.  Or a world trip when they turn 20.

Does this sound like something only a rich person could do?  Believe it or not, it can be done for less than most people spend on drinks in restaurants each year.

Here is a simple idea that could allow you to accomplish all of this for just a modest amount of money.  Unfortunately, unless you have a less-than-modest amount of money you won’t be able to do these things for your children, but you could starting with your grandchildren and all of your descendants after that.  Here is the plan:

1.  Around the time your children are born, or maybe when you’re starting your first job and don’t have a lot of expenses, make an investment of $2000-$5000 in a growth mutual fund. 

2.  As time goes on this sum will grow.  Assuming an average return of 10%, the amount in the mutual fund should double about every 7 years.  This means by the time your children are out of the house the value should be $8000 to $20,000.   At that point, begin to spread it out into one or two other mutual funds.  For example, in addition to your growth fund, you might purchase a growth and income fund and a value fund.  If you started with a small cap fund, you might buy into a mid cap fund and a large cap fund.

3.  By the time your children are having children (assuming they are in their early thirties), the value of the funds should have doubled one or two more times, making the value between $32,000 and $80,000.  At this point, spread the money further into five different mutual funds by adding an international fund and some sort of aggressive growth fund.  By this point your trust should have enough diversification to weather any market events that should occur.

4.  18-21 years pass and your grandchildren are entering or through college or early in their careers.  At this point the funds should have doubled three more times, making the account balances between $256,000 and $640,000.  At this point they would receive a distribution from the account.  For example, you could give each 5% of the trust, or between $12,300 and $21,300.  This is a nice gift, emough to start an emergency fund, but certainly not life changing (except perhaps allowing them to avoid credit card debt).

5.   Sometime after the distributions to your grandchildren, you’ll need to set up a formal trust with specifications of how the money is the be distributed (since you’ll be growing quite old).  At that point you’d need to create a line of trustees and specify exactly how the money is to be given out.

6.  When you great-grandchildren are ready to enter adulthood, another 35 years will have passed since the time your grandchildren got their distribution.  At that point, the trust will probably contain between $27 and $112 million dollars (depending on whether you started with $2000 or $5000).  At that point,  1% distribution could be made to each heir at the appropriate time, resulting in payments of $270,000 to $1 million each.  Wouldn’t that be a great way to start out in life?  As long as the payments were kept below a certain percentage of the trust (between 5 and 8% per year), the value should never drop.

In summary, using a little creative planning, the returns of stocks,  the power of compounding, and taking advantage of time, anyone can create a trust that would change your family for generations to come.  There isn’t much that can be done for your children.  The amounts received by your grandchildren would be appreciated but modest.  By the time your great-grandchildren were ready, however, your could dramatically change their futures.  As long as no one gets greedy along the way and the trust is not eaten up by lawyer fees, your legacy could last indefinitely.

Why High Beta Stocks have Higher Returns

Over long periods of time, a basket of stocks with a high beta will do better than a basket of stocks with a low beta.  Put another way, a basket of stocks with predictable earnings will do worse than a basket of stocks with uncertain earnings.  So what is a beta and why would a high best stock outperform a low beta stock?

Beta is a measure of relative volatility of a stock versus the market.  If the market goes up 10%, a stock with a beta of 1.0 should also go up 10%, on average.  If the market goes down 20%, a stock with a beta of 2 would go down 40%, while one with a beta of 0.5 would go down 10%.  Betas are determined by looking at the volatility of a stock (the amount and extent of deviations in price) and comparing it to that of the market in general.  In general, the reason for a high volatility is uncertainty in earnings.

Let’s say there are two companies, Sally Steamer and Roger Rollercoaster.   Sally Steamer has very predictable earnings – one can look out ten years and predict the earnings growth rate with fairly good certainty.  Roger Rollercoaster on the other hand is growing rapidly but is just as likely to lose money than make money.  You have no idea what earnings will be in ten years.  Both companies are expected to have a 7.1% growth rate, but one has much more confidence that Sally Steamer will double earnings in ten years than Roger Rollercoaster.

In making an investment and looking to lock in for a long period of time one considers the choice between Sally Steamer and a bank CD paying 4% per year.  Looking at expected earnings, one could figure out what the future dividend payment from Sally Steamer would likely be.  Let’s say that Sally Steamer is expected to be earning $1.20 per share in ten years and paying an $1.00 per share dividend.  At a price of $20, one would be earning a 5% yield plus the retained earnings of $0.20 per share would be used to increase the value of the company, further adding value. 

If one were almost certain of the company making the expected earnings, one would be likely to pay $18 per share or more now to lock in an effective yield of 6% or more on one’s money (including future dividends and perhaps a small capital gain as earning s are realized) ten years from now since one would be doing better doing that than investing in the bank CD.  Note that if earnings were absolutely certain, one would determine how much one would earn from a bank CD over the next ten years and pay the price for the stock that would result in the same return.  If the price were lower more people would come in bidding up the price until the returns were identical.  Because there is some level of uncertainty, the price paid is slightly lower to provide a little extra gain to justify the risk taken.

In looking at an investment in Roger Rollercoaster vs. a bank CD paying 4%, one would also look at the expected earnings, but also understand that the company may very well not make those earnings.  If the stock were expected to make $1.20 and pay a $1.00 dividend in ten years, but the chances of the company actually making those numbers was 50-50, one might only pay $10 per share for the company, locking in a yield of 10% if the company actually makes the future earnings numbers, plus leaving plenty of room for price appreciation should the company start performing as expected.

Because investors require the potential return be higher for more risky (less predictable) stocks, the prices will necessarily be lower, thereby increasing the potential return.  For this reason, baskets of higher beta (less predictable) stocks will return more than those of low beta (predictable) stocks over long periods of time.  Note that a basket of stocks is required however.  There is a reason that higher beta stocks require a greater potential return: Compared to the less volatile stocks, fewer picks will pan out. 

Buying a single biotech start-up can result in tremendous fortunes, but is most likely to result in a large loss.  Buying a large, established company is more likely to provide a modest but steady return.  The more risk one takes on in terms of earnings predictability and price volatility, the more diversification is needed to ameliorate the effects of those picks that do go South.

Another Reason to Not Use Credit Cards

Any regular reader to this blog knows that I discourage carrying debt, particularly loans for depreciating assets such as cars.  Most of all I discourage credit card debt.  There is simply no way to make enough from investments to fight a 25% credit card interest rate.  Anyone who wants to become wealthy should only use a debit card, and even then using cash should be prefered (since you’ll spend less).

From the Wall Street Journal (Thursday, March 17th) comes another good reason to avoid debt.  It seems that some debtors, particularly credit card companies, debt collection agencies, and auto loan companies are actually putting debtors in jail!  See the full article at the Journal’s online edition:

In some cases the debtors don’t even know that there has been a warrant sworn out on them until the sheriff’s deputy shows up at the door.  Ironically, the article mentions one individual who was put in jail for two days by a unit of AIG due to a debt of $4024.88 on an auto loan.  (Remember AIG, the company that shared a large share of the responsibility for imploding the financial markets a couple of years ago with their collateralized debt obligation writing business, accepted a multi-billion dollar loan from the US Government (which is not expected to be repaid anywhere close to in full), and then had executives go for an elaborate spa treatment a few days later?  Think maybe the government will put a few of their executives in jail when they don’t pay their loans?)  Apparently the debtor in that case was treated to a strip search and delousing.  He says he didn’t even know he was being sued and therefore didn’t show up to the trial (resulting in the arrest warrant).

The take-away from this is that by taking on debt you are setting yourself up to be at the mercy of various entities, many of whom care little about whether you can keep your lights on or stay in your home if you pay their bill.  You set yourself up for harassment, having your bank account cleared out, or even spending some time in jail. 

Each time that you use that shiny gold (or platinum) card you are putting a set of shackles around your wrists that you can’t release until you pay off your balance.  Even if you pay every month, if you mess up just one time (write a check wrong, forget to mail it on time, or are on vacation when the bill comes) you can end up paying all sorts of fees.  If you are paying the minimums and lose your income due to a job loss or medical emergency, you may get to meet the other side of your credit card company.  Suddenly names like “Chase” and WatchOvaYa” will then take on a whole new meaning.  Now ask yourself, “Are those airline miles you’re collecting that you will probably never end up using really worth the risk?”

Your investing questions are wanted.  Please send to or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.