Few subjects are as rich as rich people. The mystique of how they think, how they behave, and what time they wake up everyday has produced more podcasts, books, magazine articles, and blog posts than arguably any other subject. We all want to know their “secret.”
A new study in the National Bureau of Economic Research has now made its own attempt to demystify the rich, using survey data to find answers about how millionaires make financial decisions and how these are different from regular people.
In a survey of thousands of people with over $1 million in investable assets (this discounts home worth) that were in a UBS database, researchers representing Insurance company GuidWell, UBS, Yale School of Management, and University of Toronto took a hard look at how these wealthy people behave financially.
When it comes to the stock portion of their net worth, millionaires cited professional advice, retirement horizon, personal experience, and disaster risk as the most important factors determining their investing choices.
A few things that were not so important? Loss aversion, peer advice, what the media says, and "a desire to become wealthier than other rich people."
Regular non-millionaires, on the other hand, are more motivated by retirement (having enough and timing it right) and cash needs – including routine cash-flow needs and emergency funds.
Surprising conservatism in big portfolios
One especially interesting finding in the survey was the conservatism in portfolio allocations. Millionaires kept on average 20.1% of their wealth in cash instruments (cash/CDs/money market) and another 4.1% in government bonds. Stocks made up 53.3% and real estate, excluding their own homes, made up 5.9%.
Nicholas Colas, co-founder of DataTrek Research, pointed out in a note that the "average asset mix in high net worth respondents' portfolios is more risk averse than we expected,” adding that the dates predate the coronavirus market volatility.
Looking at the reasons for equity allocations, however, “really caught our eye,” Colas wrote. In a way, it appears that somewhat of a barbell strategy — a good chunk in ultra-safe assets like cash and another chunk in something with a lot of potential upside — is favored by the wealthy.
An important differentiating factor of wealthy investors’ portfolios is that they have their near-term needs and rainy day fund taken care of. When you’re not worried about paying for a new car if yours breaks down or feeding your family if you lose your job next month, your investment behavior pivots dramatically to other factors.
“It is a remarkable if entirely understandable difference and explains the rising popularity of tech-enabled/automated budgeting and wealth management tools,” wrote Colas. “This is a largely untapped addressable market in real need of sensible long-term financial planning to replace the ‘how much money might I need this month’ approach.”
A lot of money and a lot of confidence
Despite a conservative allocation the survey found that many millionaire investors did in fact have large holdings in single stocks. The survey found that 15% of respondents reported having 10% of their net worth in a single company’s stock, with 46% of them saying it would have better returns than other options, and 33% saying they viewed it as less risky – contrary to standard views about the importance of diversification in portfolios.
“A unifying theme,” the study’s authors write, “is that many wealthy investors believe that they can identify superior investment opportunities.”
Collectively, the study found, millionaires don't believe that higher expected returns are always associated with higher risk, something that does "not match historical experience."
Millionaires also reported they were not on board with momentum investing, the investing model that buys winners and sells losers based on the thesis that the "momentum" will continue.
"Our respondents see high-momentum stocks as having lower expected returns and higher risk than low-momentum stocks,” the authors wrote.