I have talked to you about ways to you can use trust funds to build wealth, and even talked to you about some of the interesting trust funds we saw in college. I recently encountered a young man who, upon turning 18 this year, found himself with a trust fund. The fund contains between $1,500,000 and $2,000,000 in assets, including real estate, marketable securities, and cash. The circumstances leading to the creation of this trust are really interesting, but it is too long of a story to get into here. In any event, since the man was very young, a series of trustees have diligently and prudently watched over the capital, protecting it from his family. Given the terms of the trust, and the restrictions placed on them, they have done a very good job.
Unfortunately, this young man isn’t very wise. Now that he is of legal age, he is demanding the trust dissolve because he wants the money. With the money in the trust, especially with the spend-thrift provision that makes it nearly impossible for creditors to seize in the event of a bankruptcy, he could have a source of wealth that was beyond the reach of banks and credit card companies if he ever experienced a personal catastrophe. It’s an absolute dream solution if you are interested in long-term financial security.
The Smart Thing Would Be to Take Dividend Distributions or Reinvest for Future Growth
He could switch to high quality dividend stocks and take distributions of between $53,000 and $80,000 every year.
Think about that: Without working a single hour, for the rest of his life, he could walk into the trust department every Christmas until he died and walk out with a check for between $53,000 and $80,000. That figure would grow with inflation, keeping his purchasing power intact.
[mainbodyad]If he ignored the trust fund entirely, and let it compound at average rates of return, by the time he was Warren Buffett‘s age, the trust would have $670 million and $891 million in it (adjusting for inflation at a 4% long-term rate, this would be the equivalent of between $55 million and $73 million in today’s money). His children, and their children, would be set for life. He could live well in the meantime, building a life as if he didn’t have the money, always knowing that the capital was silently compounding for him in the background; an unknown secret to which he, and a few other people, were privy. That is what happens when you start life with a lot of capital and have a 60+ year time frame.
Either of those situation is a fantastic way to start life. Whether he spent the dividends or reinvested them, it doesn’t matter. He’s won. It’s all icing on the cake from here, provided he is intelligent.
Instead, He Is Going to Dissolve the Trust Fund and Take the Principal
But no. He won’t do that. He is going to dissolve the trust, take the capital, pay the taxes, and then spend the money.
It is so frustrating to me. I know how this story ends. I’ve seen it before. In a few years, he will struggle to make more than $15,000 or $30,000 annually, working minimum wage jobs in a poor community. It doesn’t have to be this way but he just can’t help himself.
The good news: This is why capitalism works.
Most of you were born with nothing. You didn’t get a trust fund early in life, and you had to make your money through hard work and discipline. You may own a business, or be a doctor, or come up with an idea that changes the world. When you give society something it wants, whether that is a place to sleep (by owning hotels) or a hot cup of coffee (by running a coffeeshop), the more value you give society, the more cash flows into your coffers.
This young man isn’t giving society any value. His trust fund was giving value, by providing capital to productive businesses, but he is going to dig out those financial trees and consume it all. When it’s gone, it will have flowed through to more productive uses and some of you reading this may just end up with a small part of it.
As horrible as it sounds, this is the triumph of the capitalistic system. People vote with their dollars. They don’t always vote in ways we like (as Jon Stewart pointed out, there is a market for cocaine and hookers), but it is the only fair way to run a society; giving people individual freedom to live how they want, even if we don’t think it is rational. Steve Jobs gave us iPads and he became a billionaire. Walt Disney entertained us and he became a billionaire. Ray Kroc fed us cheeseburgers and he became a billionaire. As long as society is mostly just (no kickbacks from Congress or bribes in bidding processes), it works out well in the end.
It can be messy in the interim, but the overall product is so much more attractive than what our ancestors suffered through, working far longer hours to avoid starvation and dying at an average age of 35. There is still work to be done to make the system fairer, especially with the regressive taxation that has begun to crush the lower and middle classes, but when all is said and done, I have faith we’ll get it right.
I have no hope of convincing the young man he is making a mistake. Neither do the trustees, who remain very gracious and political but you can tell they are exasperated and don’t expect this to turn out with a happy ending. The players may change, but the story remains the same.