The Great Wealth Transfer. We discuss the 5+ living generations, how their wildly different macro experiences have led to divergent wealth, and how the wealth-inheriting generations invest and spend differently than the older generations. But not all are set to see an inheritance. We analyze how the tax structure facilitates dynastic wealth and explore a future with significant intragenerational wealth divides. We wrap up on a high note looking at the new opportunities available who service both the haves and have-nots in the $68T wealth transfer.
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In this week's letter:
Total read time: 12 minutes, 46 seconds.
The Great Wealth Transfer. $68 trillion will supposedly be transferred from 45 million US families to heirs and charities over the next 25 years.
That's a lot of wealth. More than twice the value of the housing stock in the US. That raises some important questions:
To understand what's going on, we have to first look at the current generational and societal wealth divisions, both atypical for the past hundred years. From there, we can start to look at what may happen as this wealth starts to move, how taxes may change the story, and who might be the winners and losers. This will be a truly massive societal shift.
Let's dive in!
We have 6 generations alive today. Spread across 90 years, each generation was born into a different set of circumstances and experienced different defining events. The Silent Generation lived through The Great Depression and World War II while their children experienced tremendous growth and the "American Dream." Fast forward to Millennials who include the first digital natives and came of age during September 11th and The Great Recession.
These divergent experiences can facilitate - or hinder - wealth creation for entire generations. As the Silent Generation passes away and the Boomers retire, we're now starting to experience what happens when accumulated wealth is passed between those generations. In this case, from generations that are tremendously wealthy to ones that have struggled.
Core to the American Dream is the expectation that your children will make a better life for themselves than you did, and that their children an even better life still. For many of the past generations that vision has played out as intended, but the engine stalled with the millennials.
Despite being the most populous of the working-age generations, millennials share own just 10% of the wealth of the boomers. This is not just a function of age that "all generations go through" and "will change as they get older." The Federal Reserve's data backs this up:
Wealth in 2016 of the median family headed by someone born in the 1980s remained 34 percent below the level we predicted based on the experience of earlier generations at the same age... Alone among the six decadal cohorts we studied, the typical 1980s family lost ground between 2010 and 2016, falling even further behind the typical wealth life cycle.
Take the just-prior Generation X for a direct comparison. They went from 0.4% of household wealth in 1989 to above 5% nine years later just as the youngest Gen X'ers turned 18 years old. The youngest millennials are now 25 and the generation is just crossing the 5% threshold. That's a full 7 years behind schedule compared to Gen X. The story gets worse if we then compare back to the boomers. Generation X got their wealth by taking a lot more risk than previous generations.
Generation X developed significant wealth but did so with significant leveraged. Millennials have no wealth and still have debt. They are unique among current generations in actually having more average debt than wealth, much of it made up of loans for education. Lots of debt with little wealth is not exactly a recipe for success.
We see a different version of the high-debt-low-wealth profile in the asset class makeup of millennial wealth. Whereas older generations are overweight stocks and underweight real estate, the reverse is true for the youngest generations. Why real estate? The US regulatory and tax regimes highly incentivize real estate investment versus alternatives like public company equity. This is likely to further exacerbate the wealth divide - average investment returns on public companies have significantly outperformed real estate over long time horizons.
Against the backdrop of a wealth divide, note also that millennials are the first digital natives. Many came of age during the 90s internet boom and some likely cannot remember life before cell phones. The trend has accelerated with Gen Z. These generations engage with applications many times a day that are often entirely foreign to older generations.
Novel experiences like this can and do often lead to different tastes and preferences. In the words of Morgan Housel:
The most important driver of anything tied to money is the stories people tell themselves and the preferences they have for goods & services. Those things don’t tend to sit still. They change with culture and generation.
Keep that in mind as we turn our attention to a wealth transfer. With a high probability, boomers will not live forever. The generation has accumulated tremendous wealth, much of which it appears will be transferred to millennials and Gen Z. What happens when the wealthiest generation transfers 3x annual GDP to the poor generation in just 25 years?
The reality is that much of the wealth won't be transferred at all and instead be consumed by healthcare. The average different-sex couple who retire at 65 can expect about $300,000 of out-of-pocket healthcare expenses over their remaining life. That's almost 20% of average boomer wealth before we even consider long-term nursing care and rehabilitation, costs that are not included in the $300,000 estimate and which can be large.
For those fortunate to transfer wealth to future generations, there is no guarantee that it will happen successfully. In a 25-year survey, 70% of wealth transfers resulted in some involuntary loss of control of assets with a breakdown of family trust and communication identified as the leading cause. This is increasingly reflected in litigation as the number of contested estates in New York more than doubled in the three years leading up to the pandemic. These trends are expected to continue as more estates are transferred and the average size increases.
For those fortunate to receive an inheritance, the average size increased 45% from inflation-adjusted $146,844 in 1998 to $212,854 in 2019. But the averages don't tell the whole story.
Most inheritances are much smaller than the average. And many will receive no inheritance at all.
It's tautological - if you don't have wealth, you won't transfer wealth.
For those in the bottom 50% by wealth, very little will be transferred between generations. Most of the press and financial advice regarding The Great Wealth Transfer focuses on those who will inherit wealth. It's equally important that we consider those who will not and the potential long-term structural challenges that may arise.
What we find is that wealthy families are more likely to have inheritances and those inheritances are proportionally bigger. The result is a perpetuation of wealth concentration among those who already have it. We even have a colloquial term for it - dynastic wealth. In theory, our tax code is set up to guard against such perpetual concentration, in part out of a sense of fairness that all can obtain the American Dream and in part out of practicality to incentivize greater consumption today. In reality, the tax code leaves a lot wanting.
On paper, the US has federal estate taxes for wealth at the time of death that exceeds $11.7 million. Some states also have estate taxes and others have inheritance taxes. The difference is who pays the bill, the estate or the recipient, respectively. These efforts are half-hearted - trusts and sophisticated tax planning can materially reduce and even eliminate the taxes that would otherwise help prevent dynastic wealth accumulation.
Among the provisions that perpetuate wealth disparity is the stepped-up basis. A person who accumulates assets over the years without paying tax on them, such as the equity value of a small business or a stock portfolio, can pass those assets along to heirs and the cost basis is reset at the higher valuation. For example, imagine if I purchased shares of Apple today for $150 per share and the value rose to $300 per share by the time I passed away. If I sold those shares moments before I passed, I would owe capital gains taxes on the $150 per share difference in value. But, if my estate passed the shares onto heirs and they sold the shares at $300, they would owe no taxes. The starting point for taxes would be stepped-up to the price at which the asset was inherited.
Eliminating the stepped-up basis would be a straightforward mechanism to limit dynastic wealth. In the words of Cliff Asness, a hedge fund manager:
I don’t see why on earth they don’t just get rid of the step up basis and not jump through hoops. Fixes a ton, is relatively straightforward, and it’s existence has never made any sense. I wouldn’t make it due on death but just carry the basis forward. So no forced liquidations. But when you do eventually sell, even if way down the road, you pay the same way whoever passed it on would’ve paid. Just seems right and can replace a ton of stupid.
But don't hold your breath. Eliminating the stepped-up basis was dropped from the recent Congressional tax legislation.
As a result of both our tax code and the wealth accumulation by the Silent Generation and boomers, many will inherit significant wealth, especially compared to their current situation. Their tastes and experiences are different. What might they do with their newfound wealth?
Millennials and Gen Z think and act fundamentally differently with their money than previous generations. These digital natives who experienced The Great Recession firsthand and who remain debt-burdened and wealth-poor have had a profoundly different experience than those generations priors from whom they are inheriting their wealth.
First and foremost, they are a self-service generation. Why talk to someone when you can Google the answer? Why ask an "expert" when can determine the right answer for yourself? Robo advisors are built to serve exactly this type of buyer.
Millennials are far more likely to use robo advisors than any of the previous generations. These "advisors" are in fact algorithms that can take in the preferences of the investor - I want to invest in large, environmentally friendly US companies with at least 50% female representation on the board of directors - and allocate the investor's money accordingly. Like most software, there are few-to-no marginal costs to service the Nth user which allows the robo advisors to be cost-competitive versus traditional financial advisors.
Betterment is one of the earliest and remains among the largest standalone robo advisor companies. There is no minimum investment amount and fees start at just 0.25%. Fees are even lower for larger portfolios. For those investors who want to engage a Certified Financial Planner alongside their robo advised portfolio, fees start at 0.40%, much lower than the industry averages for financial advisors. Investors - many of them millennials - have entrusted Betterment with over $29 billion of their wealth. They're by no means alone - competitor Wealthfront manages $27 billion.
Such innovations have forced the incumbents to offer new services. Vanguard, Charles Schwab, and Fidelity all now offer robo advisor services. While cost-competitive with the startups, the incumbents are mostly playing catch up with the digital-first, iPhone-like user experience that is the default for startups but a new design paradigm for electronic trading systems built in the 90s. It'll be an important hill to conquer as more wealth is allocated by generations for whom the user experience is a meaningful differentiator.
The dramatic up-and-down economic experiences of younger generations underpin a broader investment horizon. In a world where seemingly safe investments like real estate and regulated markets like stocks can come crashing down, why not expand investment horizons to other asset classes? While they may be riskier, the apparent returns can offer upside that more than compensates for the risk. All the better if the investment apps are iPhone native and gamified.
Invest like the richer generations in alternative assets. With Masterworks, you can take fractional ownership of the $1.7 trillion art market. With SeedInvest and StartEngine, you can invest directly in startups. Invest in the games and comic books from your childhood through Otis. If you're looking for steady income, get access to higher interest rates with Yieldstreet. Buck the traditional assets entirely and invest in Bitcoin and Ether through Coinbase.
For generations that are materially less wealthy than the ones that came before, there's a willingness to take greater risk to "make it." As they take hold of and internalize their newfound inheritance and become wealthy in their own right, time will tell if the game continues with bigger stakes or if the risk appetite diminishes.
If the latter, we may be in for interesting economic dynamics.
Millennials in particular are wildly in debt relative to wealth. What would it mean if all 72 million of them decided to eliminate their per-person average debt of $87,000? It'd be almost $6.5 trillion in debt directly removed from the economy, an amount that could multiply significantly as the effects reverberate through the financial system. Perhaps with newfound wealth, millennials become more like the Silent Generation who, having seen the potentially disastrous effects of debt in the Great Depression, remained debt-adverse for the rest of their lives.
Such a shift could have significant follow-on effects. If it extends to mortgages, we may see a return to renting rather than buying. If it extends to education, we may see waning interest in large student debt loads currently necessary to attend most colleges. Housing and education may become "good enough" purchases with wealth spent on experiences instead. That would bring about dramatic change.
The Great Wealth Transfer will bring about significant change as $68 trillion moves from older generations to digital natives. Much of the societal shift will be an often silent, ever-present force that shapes the experiences of the upcoming generations. While the future will always be difficult to predict, two key themes are a near certainty.
Millennials and Gen Z generations will be forced to reckon with intra-generational wealth divides that they have not had to face to date. Our system perpetuates wealth and members of these generations will come into it for the very first time while many of their generational peers do not. That will lead to political and socioeconomic tensions as factions debate if a wealth divide is something society should strive to reduce and, if so, how.
While society attempts to determine the future wealth divide, companies and individuals servicing the newly-wealth individuals will generate significant fees. The tastes, preferences, and desired user experiences of the heirs to wealth are different than those of their predecessors. Those who can tap into this new demand will benefit from a rising tide, much like those healthcare providers who service the ever-increasing wallet size of the aging generations today. We're likely to see even more startups challenge the now-entrenched incumbents who, just a few decades ago, were the darlings of the 90s as electronic trading and ".com" became all the rage.
These changes will be massive and bring with them challenges never before managed by the generations involved. For those willing to participate - politically, financially, and more broadly - the opportunities will be equally massive, a chance to shape the societal fabric of tomorrow.
A fall-appropriate punch, courtesy of Death & Co.
2.0oz Laird's Bonded Apple Brandy
1.0oz Cinnamon Orange Tea-Infused Sweet Vermouth
1.0oz Lemon Juice
1.0oz Simple Syrup
2.0oz Club Soda
Cinnamon stick
Apple slices
Pour the brandy, vermouth, lemon juice, and simple syrup into a mixing glass. Add ice until it comes up over the top of the liquid. Stir for 20 seconds (~50 stirs) until the outside of the glass is frosted. Strain the cocktail into a glass of your choice, no ice. Top with club soda and add the cinnamon stick and apple slices for garnish.
This is designed as a large-format punch, but I scaled it down to try it first. It's just awesome. The apple from the brandy comes through beautifully, the way a crisp Macintosh is just a bit too sweet and it hits you in the back of the jaw. The lemon keeps it in check alongside the cinnamon and orange to create a flavor that's unmistakably reminiscent of fall. I'm very much looking forward to making this as intended by creator Phil Ward - properly scaled up, passed around among a bunch of friends.
Cheers,
Jared
