Are rich people better investors?
Are rich people better investors?
Here is an interesting factoid: If you perform a regression analysis of the returns of investors portfolios with all kinds of variables, one thing tends to be a significant driver of higher returns. Investors who are wealthier at the beginning tend to have systematically higher returns than poorer investors.
One may say that this is because wealthy investors have access to better performing investment products like hedge funds, but if you believe this, then I have a bridge (or hedge fund) to sell you. As Javier Estrada has recently pointed out once again, the average performance of hedge funds was pretty poor, not just over the last couple of years, but basically over the last two decades. Investors could have easily outperformed hedge funds with a simple portfolio of stocks and bonds (and saved themselves a ton of fees in the process).
Annual performance of hedge funds vs. S&P 500 and 60/40 portfolio
Source: Estrada (2021).
And lest you argue that hedge funds are not designed to outperform stocks but to provide high risk-adjusted returns, yadayadayada… Here is the same chart showing risk-adjusted returns.
Annual risk-adjusted returns of hedge funds vs. S&P 500 and 60/40 portfolio
Source: Estrada (2021).
The higher returns of wealthier investors are not due to access to superior investment vehicles. Even if you just look at their equity portfolios, wealthier investors achieve higher returns than poorer investors. And Yosef Bonaparte has an explanation. He finds that wealthier investors simply put more effort into selecting their investments. They use more professional advice than poorer investors and take more time to do their research and select the right stocks or funds to invest in. The result is that compared to poorer investors they tend to have more diversified and better performing investments.
But why would richer people put more effort into their investment research? Here, I can only speculate, but one factor may be that wealthier people tend to have a bit more time on their hands (they tend to be older, so on average a higher share of them will be retired, for example). Also, many of the wealthier investment cohort will have a background in business and management and that will create some basic interest in investments. Plus, of course, for wealthier people, more money may be at stake and as a result, they simply may choose to invest more time to make sure they don’t invest their money in any stock but only into high-quality stocks.
Whatever the reason, the lesson for all of us should be clear. Investing is not something you can do in five minutes. It takes time and effort to create a good investment portfolio. If you don’t have the time to invest or don’t want to make that effort, then, please, at least ask an independent professional adviser for help. It may cost a fee for advisory, but it will be well worth it in higher future returns.
I think another factor is also that wealthier investors tend to have a much larger cushion (more cash in bank and ability to cut down on optional expenses) in drawdown scenarios and hence are much more risk tolerant, which allows them to have a longer-term view when it comes to investing or take on riskier assets. Paradoxically, the ability to take risk is lower for less wealthy investors even though financial theory says that they should take on more risk to increase their level of wealth.
1. I agree with @Justin Yang. On the sequence of return risk alone, the poorer investors who have no recourse but to liquidate investment during the worst points e.g. 2008 plus they cannot deploy capital at the bottom e.g. March 2009 or say, May 2020 makes their return worse. But those who can hold (or at least not be paper hands), can follow DCA and heed Buffet to buy an SP500 ETF would have kicked ass for the time interval chosen.
2. The wealthier investors actually are more financially educated. Formally or otherwise, e.g. by mimicking their parents that accumulated wealth and wisdom.
The school system does not educate ordinary citizens about money and investments. Poorer people also put their time to get educated on vocational or white-collar employable skills, rather than putting time into learning about investing. They need to get employed so they can waste more of their time working for a mindless task so they can pay off their student loans (which by the way, the rich do not have and so they can choose carefully employment opportunities and maybe select those that will enhance their knowledge rather than get a grunt job).
So much so a substantial portion of the poorer investor class ends up more like gambling and speculating, rather than investing.
3. Really, it is hard to dream when you are trying to survive.
I grew up dirt poor. So I know this first hand. The fortunate thing is I have a healthy skeptical, curious scientific mind. So I never believed half the tales that other people fed me when I was growing up...unless I can check it out for myself. I thought I will engineer my escape velocity out of poverty and I kinda did. (Eh...still doing it). But I have been at least free enough to make my choices for many years now.
4. Lastly, certain life-changing opportunities are only given to "accredited investors" and otherwise inaccessible to ordinary, poor people. PPM would account for some much higher ROI for affluent investors. This nonsense should be democratized as well. Crowd investing is trying but we are still in the infancy stage overall.
But to be fair, there are wealthy people that actually crashed and burned. Especially 3rd generation inheritors that only understood how to burn money but never bothered to learn how to invest and behave prudently, just like their elders.