Steve Lytle, a family shareholder of The Agnew Company, is committed to investing with family members via the collective family portfolio. But that portfolio is not exactly what he would choose if investing on his own.
“I have my own portfolio that I use to balance where my family’s investment portfolio isn’t perfectly aligned with how I would otherwise invest. It provides me diversification,” Lytle says.
Lytle’s strategy is one possible solution to a common challenge faced by families who invest together via a family office: How can all family members agree on what level of risk is acceptable — and what happens if they can’t?
Risk tolerance is a measure of how much volatility and potential loss an investor is willing to accept — and when family members are investing together, their collective risk tolerance needs to be acceptable to all of them.
Some differences in risk tolerance may be generational: Younger people tend to be more likely to take risks in general, and they may also have longer time horizons for their investments. Previous investing experience and life circumstances are also factors. A serial entrepreneur may be reluctant to invest in stocks and bonds, for example, but a family member who is sending children to college may want a reliable source of income.
A lot can depend on family members’ cash flow needs.
“When people are asked about their ‘risk tolerance,’ what family shareholders often tend to mean — whether they say it or not — is their tolerance for periods of reduced liquidity,” Lytle says.
“Liquidity becomes a huge issue,” says Andy Busser, president, Family Office for Pitcairn. “If someone feels that they can’t buy a house because their brother is investing in a risky commercial real estate deal, that’s not a recipe for family harmony.”
Getting to consensus
As families grow larger, having an organized process for discussing and agreeing on investment goals, including the appetite for risk, is crucial.
“You’re trying to understand the risk tolerance of each family shareholder and find the middle of the ‘fairway’ for all,” Lytle says. “The more people you have, the more difference in risk tolerances you have, and the greater the likelihood that there are people further from that middle. That’s why as the family becomes bigger, you need greater governance.”
Getting everyone together is a good place to start.
“Typically, with a family office, we like to have initial meetings getting the key beneficiaries of the assets and/or the donors together to discuss the goals of the assets and to understand their appetite for risk,” says Donald N. Hoffman, partner at Eisner Advisory Group, LLC. “We like these to be annual meetings to keep the key donors or beneficiaries informed.”
Ultimately, the family’s approach to risk should be written down and used as a guide.
“We have an investment policy statement that frames our risk tolerance for our portfolio of investments,” says Nancy P. Bruns, chairman of the board of the Dickinson Group. “It is on our radar daily, as we make decisions for the future of the family assets.”
Exploring solutions
If the family is relatively small — or its members have similar appetites for risk — it may be that some family discussions, perhaps led by an investment advisor, will lead to an agreement about what types of investments to make. But what happens when the family members’ goals do not align?
There are several options:
* Compromise. “We look at the donors of the assets and the beneficiaries and review each one’s risk tolerance and average these out,” Hoffman says. “This actually works out well.”
* Separate assets. For some families, it may be possible — even desirable — to not hold assets in common, even if they make some investments together. “Some family members are naturally savers and some are naturally spenders,” Busser says. “If you force them to do everything the same way, it will just breed resentment.”
* More conversation. If the disagreement centers on one particular investment, especially a direct investment, it could be that talking through the risks will make family members more comfortable. “It’s an opportunity to talk about what the risks are associated with any direct investment, and who is doing the due diligence,” says Susan Wells Jenevein, managing director of philanthropy and family engagement for Tolleson Wealth Management. “Then we find ourselves in conversation: ‘This investment is interesting, and it happens to have more risk associated with it. Tell me how much you understand about the risk.’”
* A combination of compromise and separate assets. In Lytle’s case, making some investments collectively with the family and others on his own allowed him to create a portfolio that overall matches his own risk profile, even if the family portfolio is not a perfect fit. This approach can work well in families where members have money to invest outside the family.
This can also be a good solution in situations where a younger generation wants to take more risks than the older one. Jenevein suggests creating a separate investment pool with a higher tolerance for risk and loss, to allow the rising generation to “understand and operate the levers to experience risk.”
“It’s one thing to know that 90% of all startups will fail,” Jenevein says. “But to hear the first pitch of a startup is very exciting. By the time you have heard 27 of them, you know that everything sounds like a miracle, and you have to be discerning.”