Andy: In Search of the "First Principle" of Family Wealth Management

In doing anything, you must get clear on its “first principle.” And the “first principle” of family wealth management is the enduring succession of family wealth and the happiness of family members.

This is how Andy, founding partner of Flourishing Tree Family Office, understands the work of a family office—the fruit of reflection over many years in the field.

Without thinking through the “first principle” of family-office service, one ends up treating the head when the head aches and the foot when the foot hurts. Whether it is designing a family trust or planning an asset allocation, none of it addresses the family’s most fundamental problems.

Protagoras, a leading figure of the ancient Greek Sophists, held that man is the measure of all things. And starting from the “first principle” of family members’ happiness, many matters in family wealth management find their basis for judgment and their measuring rod.

Andy says that to ensure wealth serves the goal of family members’ happiness, wealth must be made the family’s servant; the family must not become the slave of its wealth.

In his latest conversation with Chinese Family Wealth, Andy shared, from the standpoint of financial capital, his thoughts on how to make wealth truly “serve the family.”

He introduced the concept of family accounts, breaking it down further into five accounts—foundation, security, investment, legacy, and philanthropy—each corresponding to a level of Maslow’s hierarchy of human needs. The following is a transcript of the conversation.

The “First Principle”

Q: Now that you work in family-office service, how do you view the core elements of that service?

Andy: This industry has only just begun to take shape and develop. Clients and practitioners alike start from single, isolated needs—treating the head when the head aches, the foot when the foot hurts—so that when they consider a family trust or an investment, they think only, in isolation, about protecting assets and growing wealth. In truth, family clients have not yet developed a systematic sense of framework for how to carry out their own succession or manage their wealth as a whole.

Our recent reflection is that in doing anything, one must find the “first principle.” One must get clear: what is the “first principle” behind doing these things? The “first principle” on Earth, for example, is gravity. Why do we all sit on the sofa? Because of gravity. Without gravity, we would all be floating in the air. It is a force we cannot see or touch, yet it governs the laws of our world. I believe that whether it is family wealth management, succession, or protection, at its core there is a “first principle.”

Our thinking is that the “first principle” of family wealth management is the enduring succession of family wealth and the happiness of family members. On this basis, everything I do must be measured against whether it lets family wealth pass on for the long term and whether it makes family members happier. If what I am doing embodies long-termism and brings greater happiness—if I can trace it to this root—then the thing is done right. If it cannot be tied to any of this, then perhaps I should think again and slow down.

Being the Master of Wealth

Q: Once the “first principle” of family wealth management is clear, what comes next?

Andy: After recognizing the “first principle” of family wealth management—the enduring succession of wealth and the happiness of people—the second thing is to ensure that wealth obeys this goal. That is to say, wealth must become your servant; wealth must not become your master. If you keep your head down and toil day and night, working solely for money, then you are the slave of wealth. You should ask the reverse question: how can wealth serve me and make my life better? You must join the uses of money to the goals of the person; only then can wealth serve you and become your servant.

Here we come to the concept of family accounts. A family account is a broad metaphor—not a matter of opening a bank account, but a systematically designed “basket” for holding family assets. Human needs can be understood by reference to Maslow’s five-level hierarchy: physiological, safety, social, esteem, and self-actualization. The higher one climbs, the happier one is.

The Theory of Family Accounts

Q: This concept of family accounts corresponds to the family’s various needs. What levels, specifically, does it comprise?

Andy: Within the family accounts, the first account is the foundation account, used to meet basic living needs. This money mainly covers the household’s daily expenses, and the funds in it typically come from salary income, corporate dividends, returns on liquid investments, property rents, and the like. The core requirement of this account is liquidity.

The second account is the security account. It differs from the foundation account: this money is not to be spent now but in the future. Retirement, medical treatment, children’s education—these must be prepared for in advance, and backed up both at home and overseas, because you do not know where you will live later, where you will seek medical care, or where your children will study, and so you must prepare for a rainy day. The funds in this account typically come from a portfolio of assets with long-term positive cash flow, such as real estate in core locations, insurance-policy portfolios, index investments, and quasi-fixed-income products. The core requirement of this account is certainty.

The third account is the investment account. The investment account means that once the money for present use in the foundation account is in place, and the money for future use in the security account is in place, the remaining funds can be used to pursue better returns. In the first two accounts, you cannot allow any permanent loss of principal, and the drawdown requirement is low; the investment account can tolerate the possibility of a loss of principal. Because you want a higher rate of return, and return corresponds to risk, this is a reasonable psychological expectation. The funds in this account typically come from equity investments and trading opportunities in the primary market, the secondary market, and special situations. The core of the investment account is a return commensurate with one’s understanding of risk.

In fact, for many entrepreneurial families, the family business sits in this account, because the family business continually generates cash flow—and high-growth cash flow at that. If the second generation wants to start a venture, the innovative enterprise of the “second curve” also sits in this account. So this is the creative account, the one that pursues future growth and returns. If the foundation and security accounts are the accounts of preserving wealth, the investment account faces more toward the future.

The fourth account is the legacy account. The legacy account means that once everything else is arranged and you have decided to give something to your children—say, a trust, or a large residence—you place it in this account. The expectation for this account is that it be passed down, not that it make more money or be sold and cashed out. Many European families, for instance, stipulate that a certain house may never be sold, writing it into the family charter as something reserved for future descendants.

The fifth account is the philanthropy account. More and more clients now ask to do public-benefit and charitable work. Some may think they do it for their children or for their personal reputation, but not necessarily. Some clients we meet do it simply because, having acquired wealth, they want to do something for society and hope to use that wealth to help those around them. One client, for example, hopes that after retirement he can devote himself to charitable work together with his partners, and bring his children along, making charity part of the family’s spiritual inheritance. Another client, because his own child is a little girl, wanted to find projects dedicated to the care of young girls—covering matters of self-protection and education—entirely out of genuine personal feeling.

So, from the five accounts—foundation, security, investment, legacy, and philanthropy—we have linked to Maslow’s five levels of need, which I find quite fascinating. This is our own original thinking.

Of course, what we have discussed here is the family’s financial capital. In the future we might also talk about the family’s human capital, which can be considered in three categories: body, mind, and spirit.

The Lesson of Misaligned Expectations

Q: Is there a case that could help us better understand the system of the five accounts?

Andy: There was a client who, fairly early on, suffered a rather large investment loss that made up a fairly high share of his total assets. He said to me that he had finally figured it out: in truth, at the very beginning, the need behind that investment was a security-account goal—he was seeking certainty. But in the actual investing, he had placed that money in the investment account. This was a misalignment of expectations.

The reason for the misalignment was that at the outset he had not thought clearly about the purpose of that money. If, in his heart, that money was money he could not accept losing, he should have placed it in the security account, choosing an investment direction among assets with long-term, certain growth. Instead, he later invested it in equity.

Of course, there are also people who put their money in the security account but then, seeing the market doing well, pull it back out to chase returns. At that point, your mindset should be one of allowing for loss. You cannot say that you want to reach for returns yet refuse to accept loss and feel wretched about it—that will not do; it shows you still have a problem. You are using security-account money to do investment-account work, and that is a misalignment of expectations.

This, too, is the point we keep reminding ourselves and our clients: one must not look at returns alone, but at returns commensurate with one’s understanding of risk.

Buffett once said, do not use money that belongs to you—and that you also need—to earn money that does not belong to you and that you do not need. It is foolish; risking something important to you to win something unimportant to you is simply beyond reason—even if your ratio of success to failure is 100 to 1, or 1,000 to 1.

Closing Remarks

In fact, if a family does not achieve a breakthrough on the enterprise’s second curve, then a family’s period of rapid wealth growth may last only a brief ten or twenty years. This is positively correlated with the ability curve of the family’s leader, and the growth curve of the investment account that ultimately emerges is really a normal-distribution, bell-shaped curve. During this period, the growth of the investment account is also the core source from which the security account is able to grow. The two accounts require coordinated management and rebalancing. Mapped onto Maslow’s hierarchy of needs, the five accounts, as they are built up, are established in order—beginning with the foundation account and ending with the philanthropy account. But once all five accounts are in place, they enter the same tier, interlinked and dynamically adjusted among themselves.