The Wealth Anchor


Last week I popped the big question — What would you do with $10 Million Dollars?  I got a ton of great responses from readers in the comments.

(Apparently having a lot of money is very a popular idea.  Go figure!)

Even though you can spend $10 million dollars in a million different of ways, I found many reader responses had similarities —  Many people wanted to pay-off their mortgages, and travel more.  Some people thought they’d send their kids to private school, and only increase consumption “by a little”.

Others suggested that they wouldn’t change a thing about their life.

Those were all were great answers… and it got me thinking about an even more important question

How would I invest that $10 Million Dollars?

 

A Small Population

Unfortunately, I can’t just ask someone with $10 million dollars how they invest it… I don’t know anyone with $10 million dollars!

For good reason too — there’s not a lot of people in the world that actually achieved this kind of immense wealth.

According to Credit Suisse’s 2017 Global Wealth Databook there are 14,387,156 individuals in the United States with more than $1 million but less than $10 million in assets.

Those High Net Worth Individuals are surprisingly common!  Roughly 4.4% of the U.S. population.

(Note:  If you curious, the 2017 Global Wealth Databook contains data for other countries too)

The next group of people (those with more than $10 million) is a much much smaller party — a mere 969,281 people.

This trend continues as we climb the wealth pyramid.  Fewer and fewer people achieve those heights….

wealth pyramid
The Wealth Pyramid — The higher you climb the lonelier it gets.

Looking into this data got me thinking… Is there something different about how the people in the top wealth tiers invest?

Do they have access to different investments?  Do they achieve higher returns?  Do they have higher job income?

Or, can they simply hire better investors than the rest of us?

 

Do The Wealthy Have Access To Better Investments?

For those of us not in the $10 million+ camp, we might make the assumption that the wealthy have access to “special” investments that the rest of us don’t.  We read (or hear) all the time about fancy hedge funds that use leverage, options, derivatives and other financial products to “juice” returns.

At first blush, the idea that the wealthy can realize better returns than lower net worth individuals seems like a compelling argument.  But what does the data say?

Well, the data might just agree…  I found a 2016 paper on “Household Wealth Trends” from the National Bureau of Economic Research which shows the upper 1% does see substantially higher rates of return than the middle class.

Check out the annual rates of return by wealth class:

average annual rate of return by net worth
Average Annual Rates of Return by Net Worth, from Household Wealth Trends In the United States.

For the moment, let’s only look at gross assets in Table 11 above  (we’ll discuss net worth later).  It looks like the Top 1% simply outperforms the middle class… but these numbers are very misleading.  It’s not because they have “better” assets.

The “Household Wealth Trends” paper cites four different studies which found different asset classes actually return the same regardless of net worth.

In other words, it doesn’t matter if you have access to high net-worth investments or not.  Stocks are going to return pretty much the same at all wealth levels.  The same goes for bonds, real estate, and other financial assets.

Anecdotally, we can see the truth of this idea in Warren Buffett’s recent bet that a simple S&P 500 index fund would outperform a selection of hedge funds after fees and taxes.

Technically that bet doesn’t end until December 31st of this year, but hedge fund manager Ted Seides has already conceded.  The S&P 500 index outperformed his hedge funds.

In other words, fancy investing “help” means big investing fees… not bigger returns.

 

The Asset Mix

So if asset types return the same, what’s the secret sauce to those higher returns the Top 1% earn?  What allows very high net worth individuals to outperform the middle class?

It boils down to different asset ‘mixes’ held at different wealth levels:

household wealth by class
Household Wealth By Asset Class, from Household Wealth Trends In the United States.

The top 1% (those with more than $10 million) hold a disproportionately large percentage of their net worth in financial assets (31.4% of gross assets), and business equity/rental real estate (49% of gross assets).

While the wealthy are busy buying stocks, and owning businesses, the middle class have a HUGE portion of their net worth (62%) tied up in residential real estate.

Is this a good way to invest?

Long term return data shows that residential real estate provides lower returns than that of financial assets…

nominal rates of return
Average Annual Nominal Rates of Return, , from Household Wealth Trends In the United States.

This is why the rate of return by net worth in the earlier figure (Table 11) sometimes shows the middle class beating the Top 1%.   Net worth takes into account leverage used (aka debt) and the middle class typically borrows large sums to buy a home.

In periods of rising real estate prices,  additional leverage can cause temporary outperformance.

The “leverage factor” can also reverse itself, causing underperformance as it did in the 2007 to 2010 time period (The Great Recession) when housing prices fell.

All that debt and interest due creates a drag on wealth building.  While a middle class family continues to pay interest every month on their mortgage, the wealthy top 1% households have relatively little debt.  They’re using excess cash to buy stocks and other financial assets.

 

Lessons Learned

This “leverage factor” is probably the biggest differentiator I found between wealthy and middle-class households.

While the middle-class make interest payments on debt, a wealthy household grows wealth at a faster rate because they have excess income to purchase higher returning assets (stocks and other financial assets).  The wealthy aren’t “house poor”.

Allocation of assets is the key.  While the advantage for the wealthy is small at first, over time the wealth disparity between the two groups grows.

Wealth inequality is now at the highest it’s been in the last 50 years. and I see no reason why this would change.

The middle classes continue to purchase way too much home with too much debt.  They save too little (to their detriment).  On top of that, a home is a lower returning asset class.  All that debt is an anchor on building wealth.

While it sounds simplistic to say so, perhaps a better path to building wealth is to emulate the wealthy — seek to ‘live simply’ and spend far less on one’s shelter.

Now it’s time to pass the question to the readers — How would you invest that $10 million dollars?

 

[Image Credit: Flickr1, Flickr2]

42 thoughts on “The Wealth Anchor

  • December 9, 2017 at 3:31 AM
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    I don’t think the wealthy have access to better investments. It’s more likely they can afford to wait for better investments. The average Joe has the urge to always put his money to work, but that’s not true for the wealthy.

    Reply
    • December 9, 2017 at 1:01 PM
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      If the top 1% do have access to better investments, the data seems to indicate these investments don’t outperform the stock market.

      You brought up patience in investing and that’s definitely important… just not something I can see in a data set.

      Reply
  • December 9, 2017 at 4:19 AM
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    Awesome post and thanks for digging up those charts! You just summed up why I refuse to pay off my mortgage. The interest is a paltry 3.25%, and my money is better utilized pro-creating like rabbits in the stock market!

    I realize I won’t always beat that 3.25% in the market, I’ve been doing this for along time and have seen my share of downturns. But overall the upside gains have already beaten any “loss years” many times over.

    Reply
    • December 9, 2017 at 1:03 PM
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      I’m with you. I won’t pay off my mortgage either. Instead, I allocate my resources to assets with higher returns. Yes, there’s volatility, but in my experience it’s worth it.

      Reply
  • December 9, 2017 at 4:22 AM
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    This is a great article, Mr. Tako! And a very thoughtful analysis. It struck me that the top 1% had 49% of their wealth in unincorporated business equity. What does that mean? Businesses that aren’t S- or C-Corps? So would this be small businesses? I think you’re absolutely right–one’s primary residence bring a fairly average or even mediocre return on investment over the years, and that’s if you’re not leveraged up to the hilt.

    How would I invest $10 million? I’m tempted to say I would invest the lot in index funds, but I would probably take a small percentage (10%) and buy a piece of commercial real estate, and actively manage it as my day job. Or, I might take a similarly small percentage and start a company. And that might be in Chile, so we could relocate our family there. Basically, I would give myself permission to take the financial risks with my investments that I’m currently too conservative to take. 🙂

    Reply
    • December 9, 2017 at 1:07 PM
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      Thanks Laurie. The best explanation the paper provides for those unincorporated businesses is the following:
      “Net equity in unincorporated farm and non-farm businesses and closely-held corporations”.

      My guess is that means sole-proprietorships, partnerships, and LLC’s.

      Reply
  • December 9, 2017 at 4:33 AM
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    Nice charts and summary of the data. The unincorporated business equity and other real estate is probably the thing that separates the top 10 from the top 1%. The top 1% tend to own a business or have equity in a non-public business they have worked many years and built up.

    My grandfather was an example. He was a primary care physician for 5 decades. But his real wealth came because he was on of the founders of a local bank lending to oil field service companies and home owners. Now that bank stock is worth 10 times as much as his net worth from 50 years of non- government influenced Medicine.

    But it’s all academic anyway right? As a top 4.4%er i don’t really care if i break into the top 1%. Law of diminishing returns on that extra wealth.

    Reply
    • December 9, 2017 at 1:09 PM
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      True. I don’t really to be in the top 1% either, but it’s nice to understand the asset allocation model that got the 4.4%ers into the 1% crowd.

      Reply
  • December 9, 2017 at 4:52 AM
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    Wow this is a super interesting analysis!

    “While the wealthy are busy buying stocks, and owning businesses, the middle class have a HUGE portion of their net worth (62%) tied up in residential real estate.”

    As you mentioned, the wealthy have more excess cash and invest in more stocks and financial excess. I think owning businesses is also key since they can scale up and generate continuing and growing revenue. Owning one home alone definitely can’t make one wealthy.

    Reply
    • December 9, 2017 at 1:13 PM
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      The Millionaire Next Door had a similar analysis (although that data set it starting to get a little long in the tooth). Many of the millionaires they surveyed were small business owners.

      This newer analysis of real tax data seems to echo that great book. The top 1%ers just take that excess cash engine and keep building it to generate even more excess cash.

      Reply
  • December 9, 2017 at 6:13 AM
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    Cool post, Mr. Tako.

    I’d take my $10M of investable cash and dump it all into bitcoin!

    Haha, yeah right…

    I’d likely invest a third into commercial assets like multi family units and/or apartments, a third into the stock market, and leave another third for my entrepreneurial projects (I’ve always wanted to own my own restaurant!).

    Reply
    • December 9, 2017 at 1:16 PM
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      Apparently the Winkelvoss twins did dump a huge fortune into bitcoin… a perfect example of the crazy risks the ultra wealthy can take.

      I really like your asset allocation model Michael. It’s a good mix of market based and non market based assets, as well as a few more speculative gambles.

      Reply
  • December 9, 2017 at 6:35 AM
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    Good post. I’m not a fan of hedge funds or options. It’s hard to beat the market. In the Bernie Madoff’s Ponzi scheme case, many rich people became the victims. I only go for no load and low cost index funds. For the top 1%, probably they invest a lot on 2 things: stock market and business ventures. They have the skills and stomach to take more risks.

    If I had $10M, I would put:
    – 20% into the banks, FDIC insured. In this way, I have a peace of mind for any market volatility.
    – 79.5% into the no load, low cost index funds. US market will be 45%, and International market will be 34.5% .
    – For the rest 0.5%? I’ll play the stocks, and trade them daily, as I can afford to lose all. I like that excitement, and it’s good for my brain.

    Reply
  • December 9, 2017 at 7:32 AM
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    I’m not sure it counts as investing but I would like to think that with 10m I would have enough to start a charitable foundation of some sort and use running that as my day job.

    Reply
  • December 9, 2017 at 8:45 AM
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    Nice analysis and breakdown! What you’ve discovered here is what blew my mind when I read “Rich Dad, Poor Dad”. As Robert K says “Poor people buy things, middle class buy houses, and rich people buy investments/assets.” He talks a lot about how people think residential real-estate is an asset, but it’s not since it doesn’t produce cashflow. Only if it’s turned into a rental property does it become an asset.

    And only the rich understand this concept so they continue getting richer while poor and middle class fall behind.

    As for how to invest 10 million, I’d probably put it into low cost index funds, go 90/10 and donate most of the passive income it throws off. Or maybe use the passive income to start a non-profit.

    Reply
    • December 9, 2017 at 3:20 PM
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      Yes, it’s similar to some of what’s written in the Rich Dad, Poor Dad stories. Except he wrote emotional stories, which I always take with a grain of salt.

      I prefer this ‘real data’ version. 😉

      Reply
  • December 9, 2017 at 9:03 AM
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    I think is agree with most folks. I feel like at this point we’d invest most of it in low cost passive funds. Eventually we’d probably look to buy a modest house in an area we like, just to lock it in and continue life much as it is today.

    I’d love to take a bit and do some angel investing in small businesses. But that would have to be throw away money.

    Reply
  • December 9, 2017 at 10:15 AM
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    Great post and comments! I would probably step away from residential and multi-family investing to a large commercial property where I can hire a PM to take care of the day to day tasks. I’m already exercising plenty and eat healthy, so very little change there. Just travel more, perhaps learn yoga, listen to Eckhart Tolle more frequently, meet some of you (my fellow FIRE peeps). We only get one life and one body. Might as well live well now in preparation for a long and prosperous life. Reminds me of that quote by Ralph Waldo Emerson: “We’re always getting ready to live, but not actually living”. @buyrentsell

    Reply
  • December 9, 2017 at 3:04 PM
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    Great post, Mr. Tako – very interesting data! I think you’re definitely right that the middle class tend to over-buy and over-leverage themselves on their own homes. That bad debt tends to become their own sort of prison.

    When I get receive my $10 million from you for this test, I plan to use it to buy mostly commercial real estate and then invest in some businesses. Let me know if you want me to email you my address for you to send the check to. 😉

    — Jim

    Reply
  • December 9, 2017 at 8:49 PM
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    I agree with your thesis. The allocation of assets make it such that the net asset growth rate up by another 1% relative to the other groups, and that with compounding, is enough to create greater inequality over time.

    If I received the $10M, I’d be holding a lot of cash until valuations come down and sentiment becomes a lot more fearful then it is right now.

    My company has just reorganized and I was impacted by this. Come the start of next year will get a lump sum payout but need to find another job or go into early retirement mode. So having a war chest would be very handy right now.

    -Mike

    Reply
    • December 10, 2017 at 4:21 PM
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      Sorry to hear about the company re-organization. These things happen, but I’m certain you’ll become a stronger person because of it. Best of luck!

      Reply
  • December 10, 2017 at 7:40 PM
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    I know a lot of people worth over $10 million. Most got there from starting businesses, and investing in real estate, including primary home. Real estate in my area has increased in value faster than equity markets for the past 50+ years, so with leverage the values are turbo-charged.

    I also think people worth over $10 million are risk-takers, and comfortable with risk. I had the opportunity to make $250 million but ended up with only $15 million because I am not a risk-taker. Your example of the Winklevoss twins is a good one – they “invested” a significant portion of their assets into a very risky bet, only risk-takers could ride the bet to $1+ billion, weaker hands would have taken profits much earlier. Same for many (most?) other rich people who still hold 50%+ of their wealth in a single asset such as their business or stock equity. Other examples are the founders of just about any publicly traded company; they are able to take a lot of risk because just 1% of their wealth is enough to live very well on.

    Ultra high net worth individual profiles are affected by survivorship bias. There are plenty of people who held all their net worth in their company and then lost it all. It’s not easy getting to the UHNW category and definitely involves a lot of luck.

    Reply
    • December 10, 2017 at 8:58 PM
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      Interesting thoughts Joe. Unfortunately data like this is anecdotal. In your area real estate was a good road to wealth, but many areas did not see that same real estate appreciation.

      The same goes for starting businesses or investing in “special” investment vehicles only for accredited investors. It could be true in some small pockets of the world that these things worked-out, but if we look at the data broadly those assets actually underperform equities.

      Love your point about survivorship bias. The data can’t tell us the stories of those who “lost it all” when a big gamble didn’t pan out.

      That said, it looks like the middle class are taking the biggest gamble with most of their net worth in a lower return leveraged asset.

      Reply
  • December 11, 2017 at 12:39 AM
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    Wow your analysis is so detailed. That’s interesting that less than 1,000,000 people in the U.S. are ultra high net worth individuals (>$10 million). Also interesting that the middle class mainly has homes instead of businesses.

    If I had 10 million I think I would have it invested in whatever got me to $10 million (likely businesses, starting and buying businesses like they do in Shark Tank). If I was handed over $10 million, I would invest it in the index and also buy real estate and develop it, a la how Charlie Munger got his first million.

    Reply
    • December 12, 2017 at 10:20 PM
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      Thanks GYM! Munger hit a unique sweet spot in California. Real estate appreciation has been superb there for decades. The same can’t be said in other locations around the country.

      Reply
  • December 11, 2017 at 3:53 AM
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    Interesting statistics! Some trends match with what we have here in the Netherlands. Of the about of 110.000 millionaires (wealth over EUR 1M), about 100.000 of them became so by having their own businesses (incorporated or not). You see similar investment effects in your post too.
    Guess the best way to become a millionaire is by starting a business. Very few people (the FIRE crowd is an exception) become millionaires by saving and investing.

    Reply
    • December 12, 2017 at 10:24 PM
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      Thanks Cheesy! Do you happen to know how many EUR 10M+ individuals there are in the Netherlands?

      Reply
      • December 14, 2017 at 1:11 AM
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        Based on stats from 2013, about 3500 people (3.5% of the total number of millionaires according to the article).

        Reply
  • December 11, 2017 at 8:38 AM
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    Interesting read Mr. Tako and thanks for digging up the data for us. I too like how this is a “modern” look at some of the info The Millionaire Next Door presented. That book was a game changer for me.

    To answer your question, I would feel pretty comfortable 10M would more than suffice for the remainder of my days. After setting aside enough to live off of, I’d invest the remainder in changing the world for the better.

    “F you money,” is fun to say, but I’d rather have it be, “help others money.”

    Reply
    • December 12, 2017 at 10:25 PM
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      Awesome way to think about it Mr. Fired & Free!

      Reply
  • December 11, 2017 at 9:11 AM
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    Great question.
    I would invest a lot more conservatively if I have $10 million. Some stocks, but probably more bonds.
    At that point, it’d be more about conserving and security rather than growth.
    Why keep playing the game when you’ve already won it?

    Reply
    • December 12, 2017 at 10:26 PM
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      Indeed! I see many older retirees go this route. They’d rather have security rather than “more”.

      Reply
  • December 11, 2017 at 2:11 PM
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    With 10m $ i would probably invest 20% in indexfunds, 20% in growth funds and 50% in commercial realestate and leverage that at a comfertable rate. The remaining 10% i would use on friends and family.

    Reply
  • December 11, 2017 at 10:30 PM
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    The wealthy may not have better access to different investments. However, what you do have with 10+ mil is being so financially secure that you can take bigger risks with a smaller amount of your overall portfolio. Likewise you can send your kids to the best schools in the world and the connections may help them excel. I do not think it is black and white but I do think that being a deca millionaire comes with its own set of advantages.

    Reply
  • December 12, 2017 at 6:37 AM
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    Maybe I’m cynical, I used to agree with the idea that the 1% don’t have access to better investment options then I came across Renaissance Technologies LLC (they are a top holder of one of my investments). You should read the Wikipedia article. There are also companies that can use sophisticated ‘front running’ strategies and make essentially risk-free money off of being fractions of a second faster than the market trade… I’m sure there are many other games Team 1% play that the 99% don’t know (or understand), but if you don’t have access to these vehicles to juice risk-adjusted returns, then I agree that index funds are the next best thing.

    Reply
    • December 12, 2017 at 10:31 PM
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      Interesting Steve. I’m not convinced… it just sounds like another LTCM. Which, as I’m sure you know eventually imploded.

      Reply
  • December 12, 2017 at 7:49 PM
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    I love that question.
    If I had 10 millions dollars (assuming “after tax”, although it probably doesn’t matter that much at that level):
    1) I would quit my job since FI would be reached
    2) I would buy a house in cash instead of dealing with a mortgage (waste of money: yes. But because most banks here in Japan won’t lend to someone who doesn’t have a job, this is the reason I have to keep my job right now, so see #1 above), and would probably spend twice as much on it as what I plan to spend in reality. (Our current house goal is reasonable financially, but will have many compromises compared to what I’d consider a “reasonable” housing situation from a day-to-day life perspective)
    3) I would hire an accountant to do my taxes (sounds funny to wait to have 10 million dollars to do that, but I have a tax situation that requires someone who can handle taxes in the US, France, and Japan. A single entity with these skills is rare and very expensive)
    4) I would consider sending my kids to international school
    5) Donate a significant amount (somewhere between $100’000 and $1MM maybe?) to an organization fighting against global warming and the destruction of the planet
    6) I would remove advertising from my website since I wouldn’t need the side income anymore.
    7) Whatever remains would be invested in ETFs, following the same plan I have right now.

    Reply
    • December 12, 2017 at 10:32 PM
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      Great plan Stockbeard! (Also, welcome back!)

      Reply

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