This happens for multiple reasons now. Usually it's due to the poor spending habits of the subsequent generations who didn't have to make it. There are plenty of sayings to explain this. "From shirtsleeves to shirtsleeves in 3 generations." "The first generation makes it, the second generation spends it, the third generation makes it back." You can find these phrases around the world, whether it be England, India, Japan, or Africa it involves human nature more so than money.
So how does one avoid this and insure a financial dynasty for generations to come? Well it involves math, law, and education. Let's get started!
1. The first thing that you need to do it make the money. This sounds simple and it actually is if you learn to live below your means. Your goal should be to strive to save 50% of your after tax income. The good news is that you don't have to do it immediately or in one generation. Actually the slower you do it the more likely it's going to last. It's like losing weight. The people that go on crash diets always end up gaining the weight back. Those lose the weight slowly through lifestyle changes end up keeping it off. Compare this to the people in the book The Millionaire Next Door and lottery winners. Lottery winners are almost always in the poor house within a decade.
2. Let the wealth grow via compounding interest. The money that you save should be put to use to maximize your return. This won't make much of a difference at first, but will make a huge difference decades later. Let's say you live in a two income household making a combined income of $70,000 per year with 2 kids. This puts you in the middle class. You're able to save $25,000 a year from that $70k and you invest it wisely making an after inflation adjusted return of 7%. This is by no means extraordinary, actually it's very average. If you start doing this at the age of 25 and retire at the age of 65, you will have built a nest egg of $5,000,000 that can then grow and be passed onto your heirs. If your children continue to do the same thing as you, then they will have a net worth of $28,668,879 in today's dollars. What about the third generation? If they continue than they will have a net worth of $157,179,635. If you're able to keep this going for another 3 generations you're looking at around $25 billion. That's $25,000,000,000!
3. Keep the tax man from taking it. Unless all of your heirs become estate lawyers and tax CPA's you're going to need to get their help. Setting up these large amounts of money into trusts help keep the fortunes intact and reduce your taxes at the same time. By giving away control of the money you can avoid a lot of taxes. This creates a philosophical problem though as we'll talk about later.
4. How do you keep future generations from blowing it like a kilo of cocaine? So now you've made the money and then sheltered it from the tax man, thus preserving as much as you can. Education and lifestyle is the key. Teach them from a young age how to control spending habits and also to keep track of their money. I had a checking account when I was in 1st grade. The more you learn as a child the more you can learn as you grow older.
5. Teach your children that they're simply the stewards of the family fortune rather than the owners. Never touch the principle! Only spend a small fraction of the yearly income that that principle generates.
Now it's a big "if" as to whether you should even do this at all. That's the topic for a separate discussion. In the mean time, don't feel bad about saving money...