The mistakes of the wealthy can happen to anyone. But why do the wealthy often become poor investors? In this article, we will explore the lessons we can learn from their failures.
Why Do the Wealthy Fail in Investments?
In the 1900s, there were about 4,000 millionaires in the United States. If a family with $5 million had invested this money in the U.S. stock market and consumed only 2% annually, they could have had $16 billion today. However, currently, there are only about 730 billionaires in the U.S., and very few families have maintained their wealth over generations.
Victor Haghani, co-founder of the asset management firm Elm Partners, and his colleague James White explored this phenomenon in their book The Missing Billionaires. They explain that people focus too much on which stocks to buy and sell without giving enough consideration to how much to invest.
The LTCM Lesson: How Much to Invest?
In the 1990s, Victor Haghani co-founded Long-Term Capital Management (LTCM), which achieved an annual return of 30%. However, when the Russian crisis struck in 1998, LTCM lost $4.6 billion in just four months. Despite intervention from the Federal Reserve, the fund was eventually liquidated.
The lesson here is that in investment, it’s not just about what you buy and sell, but also about making well-informed decisions on how much to invest.
The Mistakes of Wealthy Families: The Vanderbilt Example
Cornelius Vanderbilt left $100 million at his death in 1877. Yet by the 1950s, there was not a single millionaire left among his descendants. This is a prime example of poor investment decisions. Wealthy families often take on significant risks because they fail to allocate their investments properly and do not diversify their portfolios adequately.
The Importance of Investment Allocation
Let’s assume that investors achieve an annual return of 5%. While this might seem substantial, in reality, volatility reduces the compound return. For example, if you invest $100 and gain 50% only to lose 50% later, your average return is 0%, but your actual assets are reduced to $75.
The Sustainability of Spending
Additionally, investors need to consider the sustainability of their spending. If a sustainable spending policy is established at one point but later becomes unsustainable due to market fluctuations, the assets can quickly deplete.
Determining the Level of Risk
When investing, it is crucial to set basic goals and maximize risk-adjusted outcomes. Investors should calculate the level at which they can sustain their spending throughout their lives while considering their risk tolerance.
Wealth Redistribution and Social Benefit
Ultimately, the only ways to use wealth are to consume or give it away. Over time, wealth redistribution has positive effects on society.
The failures of the wealthy provide us with important lessons. The key to successful investing is to carefully decide how much to invest and how much to spend. By following these lessons, we too can become successful investors.
Reference: CNN, “The very rich are often bad investors. Here’s why”