Thursday, June 19, 2014

How to Invest Like A Rich Guy

by Paul Merriman

From time to time over the years I've been invited to talk to high-school students about financial matters. I always enjoy this opportunity to learn from them and - I hope - teach them some important things.
One question I often ask is:
"Would you rather invest like a rich person or a poor person?"
Of course they always choose the first option.
I use this question to introduce a couple of important concepts: Mutual funds versus individual stocks and index funds versus actively managed ones. High-school students, most of whom have little or no exposure to investments, have no trouble comprehending that a wealthy investor will own thousands of stocks, while a poor one might own only a few.
My point: Buy a handful of individual stocks, and you will be following the poor person's example. On the other hand, if you buy mutual funds - especially index funds - you will be investing like the rich investor.
As it turns out, the divide between poor investors and rich ones is deeper than I had thought.
A recent article published at summed it up this way: "Rich people prefer productive companies while the poor prefer gold. That's bad news."
The article was based on a Gallup poll that found upper-income Americans are most likely to gravitate to stocks and real estate (and 87% of them own their own homes), while those in households with $30,000 or less annual income are more likely to choose gold as the best long-term investment. (Only 18% of wealthy Americans made that choice.)

There's plenty of data from the past 200 years to support wealthy Americans' choice of stocks and real estate. I don't have to bore you with the reminder that stocks have far outstripped bonds, metals and other commodities, bonds, cash and real estate.
Public companies often pay dividends and grow by producing things that people want, while gold just sits idle waiting for somebody who's willing to pay more for it than the last investor.
Barry Ritholtz, a columnist at Bloomberg View, noted that the study indicates lower-income people and higher-income people seem to have quite different expectations from life. Consequently, the two groups place their trust in different places.
Even though lots of high-income people remain wary of stocks and real estate because of the 2008 debacle, by and large there's a big difference in attitudes between the wealthy and the not-so-wealthy.
Investing in real estate requires more than the ability to make a down payment and pay the mortgage. It requires faith in the legitimacy of property laws and the legal system. It requires faith that your property won't be taken from you illegally.
Likewise, when you invest in stocks you need faith that the country's financial system and economy will continue to function so that productive uses of capital are rewarded.
Stated another way, when you invest in stocks and real estate, you are being an optimist.
But as Ritholtz sees it, when you invest in gold you are more of a pessimist: "Gold is more or less portable; it often can be traded extra-legally. It is a disaster currency that will have value even in a Mad Max era when society breaks down. Gold reflects a hedge against the potential collapse of the existing order."
In other words, even though gold is seen by many people as a glamorous commodity associated with wealth, it is actually an investment for pessimists.
Obviously, well-to-do individuals are more likely to have confidence in the system than those who struggle to get by.
Perhaps not quite so obviously, people on the lower rungs of the economic ladder are less likely to know and understand the rudiments of what it takes to be a successful investor.

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