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1 February 2014 CFA Institute Journal Review

Rich Make Same Investment Errors as Rest (Digest Summary)

  1. Marc L. Ross, CFA

Research indicates that wealthy investors tend to make the same investing mistakes that ordinary investors make.

What’s Inside?

The wealthy and ultra-wealthy are often susceptible to the same behavioral biases as those of the wider investing public. The author investigates this phenomenon and also highlights differences between the two groups.

How Is This Article Useful to Practitioners?

In general, wealthy investors engage in the same investment decision-making process as those investors who are less wealthy. Prone to investment fads, wealthy investors have also displayed particularly poor timing. The author cites their investment in hedge funds just prior to a time of lackluster performance and their investment in credit derivatives shortly before the onset of the Great Recession. In 2008, many wealthy investors also abandoned the best practice of rebalancing and instead frequently sold investments at inopportune moments. Finally, their asset allocation has about 50% of their wealth in public equities, 30% in fixed income, and 20% in alternatives. The allocation to alternatives is smaller than popularly believed.

But there are some noteworthy differences between the two types of investors. The wealthy in the United States tend to hold more municipal bonds, which have tax advantages, to minimize their higher tax liability. Additionally, they tend to hold equities directly rather than in mutual or exchange-traded funds. They also retain a greater number of financial advisers than average, which is probably related to the number of taxable entities that hold their wealth. In this sense, they pay for active management just as the average investor does who entrusts his or her money to a mutual fund manager. Finally, the top decile of wealthy investors correctly anticipated the recent market upheaval and exited investments in the middle of 2007.

Wealth managers, particularly those who serve the high- and ultra-high-net-worth investor, as well as behavioral economists, would find the author’s conclusions to be sobering. The accredited investor label on an investor often does not also mean he or she is a sophisticated investor.

Abstractor’s Viewpoint

Most people believe that wealthy investors are different. But sifting through research on their investment decision making, the author discovers that their thought processes are very similar to the average investor’s. A small group of the ultra-wealthy has managed to eschew conventional wisdom, as evidenced by their shift to cash in the middle of 2007 just as things were beginning to unravel. Wealthy or average, investors need guidance more often than not. The findings would appear to validate the whole purpose of the investment advisory profession.

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