WhyDon’t the Rich Invest in Index Funds?
Barbara Friedberg
Warren Buffett might be the world’smost famous investor, and he frequently touts the benefits of investing inlow-cost index funds. In fact, he’s instructed the trustee of his estate toinvest in index funds.
“My advice to the trustee couldn’tbe more simple: Put 10% of the cash in short-term government bonds and 90% in avery low-cost S&P 500 index fund,” he noted in Berkshire Hathaway’s 2013annual letter to shareholders.
Yet, despite Buffett’s advice, thewealthy typically don’t invest in the simple, low fee, market-matching indexfunds. Instead they invest in individual businesses, plus art, real estate,hedge funds, and other types of investments with high entrance costs. Theserisky investments generally require large buy-in costs and carry high fees,while promising the opportunity for outsized rewards.
Howthe Wealthy Invest
Steve Ballmer, former CEO ofMicrosoft, reports a net worth in the range of $32 billion. After leavingMicrosoft, Ballmer bought the LA Clippers for a record $2 billion. Despiteleaving Microsoft, he owns 330 million shares of company stock, a 4% share ofthe firm as of 2014. At today’s $69.94 price tag, that’s a whopping $23.08billion investment.
But Microsoft’s largest shareholderhas other investments as well. Ballmer owns approximately $450 million inTwitter shares, plus real estate investments in Hunts Point, Washington andWhidbey Island. That means his wealth is concentrated in a few investments – a far cry from the “invest in low fee index funds” touted byBuffett and most personal finance experts.
Thomas J. Stanley, author of The Millionaire Next Door, notes thatmost millionaires are business owners. So, it’s no surprise that theseentrepreneurs favor investing in businesses, their own and others.
The wealthy also have the cash tobuy what they love and watch it appreciate. From rare art to real estate tocollectibles, the wealthy enjoy their investments while they grow in value.
Hedge funds are likewise popularwith the wealthy. These funds of the rich require investors to demonstrate$1,000,000 or more in net worth, and use sophisticated strategies intended tobeat the market. But hedge funds charge approximately 2% of fees and 20% ofprofits. Investors need to get huge returns to support those high fees!
The wealthy also own traditionalstocks, bond, and fund investments. Yet, their riches and interests open doorsto other types of exciting and exclusive investments that aren’t typicallyavailable to the average person.
WhyDon’t the Wealthy Invest in Low-Fee Index Funds?
Over the past 90 years, the S&P500 averaged a 9.53% annualized return. You’d think the rich would be satisfiedwith that type of return on their investments. For example, $10,038.47 investedin the S&P 500 in 1955 is worth $3,286,458.70 at the end of 2016. Investingin the whole market with index funds offers consistent returns, whileminimizing the risks associated with individual stocks and other investments.
But the wealthy can afford to takesome risks in the service of multiplying their millions (or billions). To takeone example, look at world-famous investor and speculator George Soros, whoonce made $1.5 billion in one month by betting that the British pound andseveral other European currencies were overvalued against the German Deutschemark.
Hedge funds promise extraordinarygains, although in recent years have failed to outperform the stock marketindices. But they can also pay off in a big way for their rich clients. Lastyear, James Simons of Renaissance Technology earned his investors 21.5% net offees. And Simons himself earned a handsome $1.5 billion. The wealthy arewilling to risk hefty buy-in fees of $100,000 to $25 million for theopportunity to reap great returns.
The one-percent’s investing habitsalso tend to reflect their interests. As most wealthy people earned theirmillions (or billions) from business, they see this path as a way to continuemaximizing their finances. They also enjoy art, cars, homes and collectibles;buying those luxuries enhances their lifestyles, and the future appreciation isa nice bonus.
The wealthy are different than youand me, with massive incomes, net worth, and opportunities. Although they seekout unique investments in the hopes of spectacular returns, not all theirventures pay off with returns greater than a low-fee index fund. A simpleinvestment strategy in low-fee index funds is good enough for Warren Buffett,and it’s good enough for the average investor.
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