“Money is not the most important thing in the world. Love is. Fortunately, I love money.” – Jackie Mason
A recent Business Insider article discusses the differences in investment style between the wealthy and non-wealthy from the perspective of a Wall Street insider. Let’s just say it wasn’t too kind to the little guy.
Investment strategist Richard Russell seems to think that wealthy people have a huge advantage when it comes to investing:
The advantage wealthy investors possess is they DON’T NEED THE MARKETS. I can’t begin to tell you what a huge difference that makes, both in one’s mental attitude and in the actual handling of one’s account. The wealthy investor doesn’t need the market because he already has all the income he needs.[…] And if there are no outstanding values, the wealthy investor waits. He can afford to wait. He has money coming in daily, weekly, monthly.”
Russell then moves on to those that aren’t considered wealthy:
When this fellow isn’t buying stocks at 3% yields, he’s off to Vegas or Atlantic City trying to win at craps or he’s spending ten bucks a week on lottery tickets or he’s ‘investing’ in some crackpot real estate scheme with an outfit that his bowling buddy told him about. And because the little guy is forcing the market to do something for him, he’s a consistent and constant loser. The little guy doesn’t understand values so he always overpays. He loves to gamble, so he always has the odds against him. He doesn’t understand compounding and he doesn’t understand money. He’s the typical American and he’s perpetually in debt.
This extreme over-generalization is funny to me considering the wealthiest 20% own something like 85% of all financial assets. Do you really think its mom and pop that are making all of the irrational short-term decisions in the markets these days?
What Russell fails to realize is that there’s no monopoly on behavioral biases. We all succumb to human nature at times. It’s just that different circumstances can dictate which biases can affect us the most.
You could make the case that the wealthy are much more overconfident in their investment approach while those that aren’t as wealthy fall prey to loss aversion much more often and fail to take enough risks because they’re afraid to lose money.
Rick Ferri had an interesting take on the pitfalls of overconfidence in those with an abundance in any one area:
I define the “entitlement effect” as the belief that obtaining superiority in one aspect of life entitles a person to superior investment returns in the public markets. This belief could have been formed from having extraordinary success in business, graduating summa cum laude from an Ivy League college, completing medical school early, hitting a baseball better than anyone else, or just being born into the right family. Whatever the reason for the belief, the “entitlement effect” is an attitude that often leads people into shark-infested waters where they are sold the wrong investments for the wrong reason.
Having a higher income is an obvious advantage but having more money doesn’t always translate into becoming a better investor. I know from experience that wealthy investors aren’t all that different from the non-wealthy investors. They just have more money to abuse.
John Kenneth Galbraith explained this line of thinking nicely:
Accordingly, possession must be associated with some special genius. This view is then reinforced by the air of self-confidence and self-approval that is commonly assumed by the affluent. On no matter is the mental inferiority of the ordinary layman so rudely and abruptly stated: “I’m afraid that you simply don’t understand financial matters.” In fact, such reverence for the possession of money again indicates the shortness of memory, the ignorance of history, and the consequent capacity for self- and popular delusion just mentioned.
In other words, having more money can often times lead to a lack of self-awareness. This is the line of thinking that can build up an air of overconfidence.
Of course, not everyone on Wall Street agrees with Russell’s conclusion, but you get the sense that many still share his sentiments.
Part of the problem is the fact that Wall Street plays up this stereotype to their wealthy clients to sell them services.
You have more money. Of course you’re smarter. Let’s get you in some highly complex strategies with outrageous fees. You have to pay up for quality, right?
While the wealthy have more means to pay for higher quality financial services, it doesn’t necessarily mean that’s what they’ll get.
For some reason people feel much more comfortable being surrounded by complexity to solve their problems. The thought process is that if something is complicated, then it must be better than the simple alternative.
And if it costs a lot of money to turn that complexity into an investment strategy, all the better. Complex strategies are much easier to sell and for some they’re much easier for investors to buy. The clients feel like they are making intelligent choices with their capital.
These types of investments can lead to a misunderstanding of the risks, fees and liquidity involved which can cause headaches down the road.
No one wants to believe there is a simple solution to complex problems. The wealthy often feel much more secure in paying more for financial services because it feels like they are doing something.
The term “sophisticated investor” gets thrown around fairly loosely in financial circles as an excuse to push complex products and make people feel safer about their portfolios.
Unfortunately, most of the time in the financial markets, as the great John Bogle has pointed out on many occasions, “You get what you don’t pay for.”
This is true of the wealthy and non-wealthy alike.
Every investor is different, but the best ones share some similar attributes.
The really good ones have the ability to control their emotions and learn from past mistakes. A healthy dose of self-awareness, humility and a little luck now and then doesn’t hurt either.
These characteristics have nothing to do with the size of your current net worth, but do correlate strongly with having a large amounts of common sense.
Sources:
Wealthy Investors Have One Gigantic Advantage Over The Little Guy (Business Insider)
Don’t become shark bait (Rick Ferri)
A Short History of Financial Euphoria
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