David’s Articles

David has been writing and publishing since 2006.  

This post was written and published prior to September 2023 when David and his prior firm, Family Capital Strategy, merged with Greycourt.  Views expressed reflected David’s personal views at the time and do not necessarily reflect the views of Greycourt.  Posts and information may be out of date and should not be relied upon for investment advice.

Distribution Rate – The Only Variable a Family Can Control in Investing

Feb 6, 2020 | Family Wealth

Photo by Pepi Stojanovski on Unsplash

Several weeks ago we considered how fast a family’s assets must grow to compound in line with the family’s growth over time.  Article here. We looked at a number of different elements that factor into the calculation of a target return, and concluded the following:

  • Family Growth – 3.4% target per year
  • Inflation – 2.5%
  • Distributions – 2%
  • Fees – 0.5%
  • Taxes – 1%

 Compounding these four together means a starting target rate of return of 9.8%. Needless to say, this rate of return is substantially higher than most long-term pools of capital. For example, the target long-term returns for most pension plans right now hovers between 7-8%.  

The challenging thing about this reality is that most of these variables are outside the control of the family. Inflation, taxes, fees, and growth are just facts of life. While families may choose to have few or more children, even assuming a replacement rate for each parent (i.e. 2 children), the family continues to double in size every 20 – 25 years.

That leaves us with only one variable that is controllable – distributions. We want to consider today how you go about determining the correct amount for distributions to the family.

The natural tendency in considering a distribution rate is to immediately jump to the quantitative. And certainly there are very real quantitative considerations that matter. How sizable the distributions are tie into the overall risk the portfolio can bear. If those cash flows have to remain constant over time – that will affect how well the portfolio can be managed during and coming out of downturns. The potential return environment will guide whether or not the distribution level can be funded via portfolio cash flows (i.e. dividends / interest payments), or if is some level of principal spend is required to reach the funding target. All of these are all highly important to take into consideration. 

But I can say conclusively with years of experience in the markets and managing portfolios that despite their importance, they are ultimately secondary considerations. They are helpful data to consider, but are by no means the only or most important source of data.

So where to begin instead?

First, let’s begin with a warning. The process of setting a distribution rate cannot be driven by fear. Too often, attitudes towards liquidity are driven by fears of running out of funds and / or losing the fortune once it has been created. It has been remarked that the greatest of all tragedies is having to make a second fortune. 

A study produced in 2011 by Boston College’s Center on Wealth and Philanthropy surveyed a group of ultra-high net worth individuals.  Respondents reported an average net worth of $78MM (with 2 billionaires among the 120 surveyed). Yet despite being firmly in the 0.10% of net worth in the United States, the majority did not consider themselves financially secure – and would only feel so with 25% more wealth than currently possessed. There are many possible conclusions to draw from this – but one I think important to highlight is that a feeling of security (an emotional response) is not a given from a quantitative reality (a certain figure on a balance sheet).

As well, fear can be expressed in worries about the potential negative consequences of having excessive annual liquidity – i.e. how will the family behave if resources of a certain level are available and restricting liquidity ipso facto. Treating wealth and liquidity in such a fashion is like a beach ball held beneath the water. It can remain submerged, but only as long as there is a strong force to keep it down. Eventually it will burst forth to the surface once that force is removed – often times when a parent leaves the stage or the change of a trustee or long-tenured advisor. 

So if fear is an inadequate place to begin, where should distribution considerations begin? 

The answer is straight forward – extensive education and regular and comprehensive communication. Financial literacy for the average person is a slowly acquired skill. I have had countless conversations with individuals over the years who say that when they are in the room with their financial advisor they understand and can explain what is going on. But 24-48 hours later, the clarity quickly dissolves. For the wealthy, the level of complexity can be so high that a master degree can feel like a prerequisite for even a basic understanding.

Distribution decisions can only be made thoughtfully when the individual / family thoroughly understands their financial picture and what the impact of potential distributions are relative to their goals around consumption, investment, philanthropy and their own legacy planning. Crafting these goals is part of drafting what we at FCS call a wealth strategy. Yet even something as comprehensive as a wealth strategy is contingent upon an individual’s own life plan, and the work a person has known to craft the well-examined life. 

Of course, the way the family’s assets are structured play an important role in the mechanics of distribution. Whether the assets are pooled collectively with a single distribution rate or assets are in a separate trusts with current and future beneficiaries, each structure has an important dictate to the amount of liquidity possible. As is common with larger families, varying levels of ownership may also impact the magnitude of the distribution size, with certain family members potentially receiving more liquidity than is needed.  

Correspondingly, the family itself needs to work to develop consensus about the purpose of the family’s wealth. Is a distribution meant to be sizable enough for someone to live off entirely or is it meant to be merely a lifestyle enhancer, but still require each family member to have employment?  Are certain professions considered ‘off-limits’ because they of their lower income potential? Or is each person / generation able to pursue their own professional dreams regardless of the financial considerations?

These are sensitive conversations with many different views. First generation wealth creators likely have very different views from subsequent generations. Of course, this is not a new tension for families to manage. As John Quincy Adams noted in 1780, “I must study politics and war, that our sons may have liberty to study . . . commerce and agriculture, in order to give their children a right to study . . . poetry . . .”

Helping the family understand the line of ‘enough,’ as well as developing appropriate pathways for potential excess liquidity are of vital import. The question of ‘enough’ I always find helpful to ground with a bit of data.  Studies on happiness point to the $75,000 level as an important level for overall life happiness. Those with incomes materially over this level are not appreciably more happy. Keep in mind that figure needs to be adjusted for geography and family size.  

The point is while there are many wonderful and exciting ways to spend greater and greater amounts of cash flow – it simply does not follow that those pursuits result in greater happiness.  In fact, those purchases often result in a phenomena I call consumption surplus – i.e. a level of consumption materially beyond what any one person is able to enjoy. 

For example, a UCLA study of homes showed via heat map that the average couple regularly inhabits only 3 rooms of their home – the kitchen, the bedroom, and the small den. With that in mind, footage beyond those spaces is used so infrequently that its purpose and presence should be carefully considered – the vast majority of many super large homes are often simply unlived in.  Socrates remarked that the unexamined life is not worth living – this even more so true for those with means. Ever increasing dollars do not correspond with greater happiness. Instead, those dollars must be aligned with the core priorities and purposes of the person. 

In conclusion, what we see is that while determining a level of distribution appears to be a quantitative consideration at the outset – the reality is that at its core, it is a highly qualitative consideration. Helping build a life plan and a corresponding wealth strategy requires time, careful consideration, and arguably an outside advisor to push and test your thinking. Jumping the gun and moving immediately to specific dollar figures often furthers levels of anxiety about wealth within the family. 


About David

David is the Founder and CEO of Family Capital Strategy, a strategy consultancy for family offices and family businesses based in Nashville, TN. We help families stay invested together through the design of the family office and the thoughtful development of the family’s investment program. We provide objective, conflict free advice in a strategic, customized and multi-generational manner.

Disclaimer: This does not constitute investment advice or an offer to buy or sell any securities. It is provided for informational purposes only and represents the author’s own opinions


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