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….
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:
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:
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…
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.
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?