When investing, it often hurts to think of what might be possible if only you started with even more money. Those already wealthy have far more opportunities to use investment to make themselves wealthier. They can afford to take more risk, they can tie up money in more illiquid products, they can afford the high minimum investments for alternative asset classes and they can even afford to pay for the best advisers.
It is wholly to be expected, therefore, that the very wealthy will ram home their advantage when they invest. In this light, it is not clear whether it is alarming, amusing, or reassuring that the latest exhaustive research shows they are prone to almost exactly the same mistakes as everyone else. Indeed, they even handled the crisis of 2008 somewhat worse than the average investor.
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That is the message from a study of the portfolios of 115 wealthy US households, with an average net worth of $90m, from 2000 to 2009, carried out by a group of academics including Enrichetta Ravina of Columbia Business School, Luis Viceira of Harvard University and Ingo Walter of New York University's Stern School of Business. The data came from a research file that aggregates and consolidates information from wealthy households. Including data for families who were not in the sample for all the 10 years, the academics could look at 260 households, who between them used 450 different wealth managers and invested in 29,000 different securities.
What did this exercise reveal? It turns out the wealthy manage their money in much the same way as everyone else.
Their typical asset allocation involves illiquid asset classes with high minimum investments, but not that much. The norm is 30 per cent in fixed income and 50 per cent in public equities (not so different from those far less wealthy), with 10 per cent in hedge funds and 10 per cent in private equity and venture capital.
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Investment fads
They are just as keen as their poorer brethren to follow investment fads. The families sampled only began investing in hedge funds in a big way in 2005, after several years of strong outperformance in the wake of the dot-com bubble – and on the eve of several years of rather poor performance in the wake of the credit crisis. And they also started dabbling in mortgage-backed bonds just as the crisis was about to start – a bad idea that was not open to those with fewer resources.
There are differences. Asset allocations remained so steady over time that the researchers were convinced that the wealthy were indeed rebalancing their portfolios regularly. This is arguably the cheapest and most effective form of market-timing, involving selling assets that have risen, and buying more of assets that have fallen.
Wealthy families are more likely to hold muni bonds, presumably because they have a higher tax bill to attempt to minimise. They also tend to hold their stocks directly, rather than own mutual funds or exchange traded funds. So they avoid paying fees to fund managers for active management. However, they make up for this by retaining a number of wealth advisers – six on average – whom they seldom or never fire. This is in part because the families had an average of 9.5 different tax entities to hold their wealth.
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By and large, their behavior is less different than might be expected, then. They do take advantage of the illiquid asset classes that are open to them, but not in a big way, and they tend to enter them once the best opportunities for outperformance have passed.
The fascinating question, however, is how they behaved under the extreme stress of the 2008 financial crisis. And they did not show up well. This was one time when rebalancing would have been a great strategy, because it would have forced them to buy stocks near their bottom in the dark months after the Lehman bankruptcy.
But on average, the stock in wealthy investors' portfolios tended to fall by more than the market during the crisis, meaning they had suspended their regular rebalancings and had instead sold even more stock. Some may have been forced to do this by calls from private equity funds for more money, which their investors were obliged to provide during the worst of the crisis.
The median wealthy investor had just as much in cash in mid-2009 as in mid-2007. There was no great move to take evasive action in the months before the disaster unfolded.
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Richest are different
There is an exception to these rules, however, and an important one. The richest of the rich steadily expanded their advantage over other wealthy people as the decade continued.
It turned out that while others froze or lost their heads during the crisis, the top decile of Ms Ravina's sample, the 10 per cent of families with the most wealth, responded to it with steely resolve. Unlike other samples, they started liquidating their portfolios and slugging money into cash as early as the summer of 2007.
Why did this happen? It might be that the super wealthy are luckier than the rest, or smarter. Conceivably they are more conservative.
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The suspicion has to remain that the very wealthiest escaped into cash because they, almost uniquely, understood the gravity of the situation. And that was because their insider knowledge gave them a grasp of what lay ahead. Conspiracy theorists can make of this what they will.
The research, as yet unpublished, is fascinating and can doubtless be mined for many lessons. Broad lessons appear to be that the wealthy could probably be doing more to maximize their advantages – or alternatively that the less wealthy need not feel too aggrieved about missing out on hedge funds and private equity.
And as the wealthy seem keen to pay for advice, even if it does not help them keep their heads while all others around them lose theirs, perhaps the most useful lesson to be gleaned is that there is money to be made as a wealth manager.
