The FT had a video today interviewing Columbia Business School professor Enrichetta Ravina who showed the difference between techniques used by rich investors (with an average net worth of $90 million) versus middle class people. The wealthy used many different advisors, presumably specialists in different areas, and they moved to almost double their position in risk–off assets such as bonds and cash on the eve of the crash of 2008-09 and at the same time reduced their holdings of equities. Investors should seek independent financial advice from finance professionals in order to avoid being manipulated by the naïve prejudices of the masses of people.
My opinion is that one of the key differences between being rich versus middle class is that middle class people may be tempted to feel they have to take on excessive investment risk in hopes of making a higher rate of return to reach their goals. If someone is too stubborn about taking on too much risk then they may ignore bubble top warnings and end up buying at the top of the cycle. It takes courage to sell stocks at the top of the market because one’s emotions may tell an investor that since stocks recently went up that they will continue to go up. However, when the market has gone up too much it is time to rebalance by selling off excessively appreciated assets and buying undervalued assets. (Of course during a world manipulated by Quantitative Easing this may be very difficult since all assets may be overpriced.) The actions of the rich in 2008 clearly show they are different from middle class people because they were willing to bravely give up their treasured appreciated equities and invest in cash. The inflation-adjusted real return on cash or “near cash” at most times in history is roughly close to zero, so at most times it is very hard emotionally to exit a popular risk-on investment asset and move to cash. But it is precisely this counter-intuitive, unpleasant thing of selling treasured assets and going to cash and high quality bonds that must be done at bubble tops. And that is what the rich excelled in doing and they did it with the help of a team of advisors.

   Perhaps the rich simply feel satiated with their assets and see no need to pursue a high rate of return and feel that risk avoidance is more important than beating the market. But ironically by not trying to seek excessive returns they end up doing better than middle class people. The key is that one must avoid investment losses. The problem with losses is that they are asymmetric compared to gains because if you lose 50% then you need to make 100% to break even.

   The cost of investment and financial advice as a percentage of assets goes down as asset size increases and the ability to attract top advisory talent increases as asset sizes increase, which also helped rich people. Being rich may allow access to hedge funds and Private Equity ventures that middle class people can’t access. However a very important point that I see from the charts published in the study was that the rich made a dramatic switch into large amounts of low risk assets like cash and bonds in 2008 before the crash. That didn’t require a hedge fund or Private Equity venture, instead even a modest sized RIA advisor could direct clients to invest in risk-off assets such as cash and bonds. Thus the single most important concept is that an investor needs to feel a sense of being satiated rather than frustrated so that he will be at peace with himself and not engage in reckless gambling when he should be taking risk off the table and going to a higher cash allocation. This sets the stage for careful, thoughtful investing instead of getting emotional and making excessively risky investments.

   There were plenty of advisors who were bearish or neutral and cautious in 2008. Being a good listener to those advisors and seeking to avoid excessive risk is what helped the rich to get out of risk assets before the crash. Of course taking risks after the crash helped too. In the future the more sophisticated investments like hedge funds and private equity may be available to people with an upper-middle class profile with a minimum net worth of $1,000,000 which may reduce the competitive advantage that rich people have during bull markets. In addition the returns for hedge funds in recent years have slumped to match those of publicly available investments. But simply buying those won’t be enough to really succeed if one can’t get the courage to do the unpopular thing and move out of risk assets when they are overpriced at the top of a bubble driven cycle.

   Investors should seek independent financial advice about how to protect their investments from the risk of QE bubble.

   Investors should seek independent financial advice. I wrote an article about taking risk off the table with cash “What’s the most daring way to make a big investment return?”

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