Why The Rich Keep Getting Richer

The ultra rich do not follow the traditional investing strategy of buying when the market is already rising and selling when the market is falling. According to legend, F. Scott Fitzgerald and Ernest Hemingway had a disagreement over the wealthy.

Fitzgerald allegedly said, “The rich are distinct from the rest of us,” while he had stars in his eyes.

Hemingway, who didn’t, answered, “Yes.” They are wealthier.

It’s possible that conversation never truly happened, at least not in person. The plot may just be based on something the two independently stated and wrote.

However: Who was correct?

According to recent studies, it may be a little of both. The wealthy may actually differ from the rest of us in terms of their financial portfolios, retirement plans, and estates. And by that I don’t just mean that they are wealthier.

Five economists from Harvard, Princeton, and the University of Chicago examined comprehensive monthly portfolio data from Addepar, an investment advisers’ wealth-management platform. This provided them with details on up to 139,000 household portfolios with assets worth up to $1.8 trillion. Or, a respectable-sized sample.

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They examined the activities of such investors month by month between January 2016 and August 2021. Despite being a shorter period of time than six years, it was plenty of excitement, including the unrest around the 2016 presidential election, the abrupt market decline in late 2018, the COVID crash in March 2020, and two major booms.

The ability of the economists to categorize the portfolios by size was crucial. Nearly 1,000 “ultrahigh-net-worth” households with an average wealth of more than $100 million were included in the sample.
They also discovered something significant and quite interesting.

Those who the researchers termed the UHNW don’t typically buy when the market is already up and sell when the market is down.

According to the researchers, “we assess how the flow to liquid risky assets responds to aggregate stock returns throughout the wealth distribution.” “Quite remarkably, we see that the sensitivity drops off rapidly with affluence. In actuality, the number of households with assets over $100 million is mostly unaffected by stock returns.

In other words, “UHNW families buy shares during downturns, but less wealthy households act pro-cyclically.” (Buying after the market rises and selling when it falls is known as pro-cyclically.)

In fact, UHNW households are so countercyclical that they contribute to market stabilization during recessions. When others are selling, they are the ones who are purchasing.

This naturally brings up the age-old contradiction that the wealthy only get richer.

We already know, however, that common mom and pop investors enter and exit the market at the incorrect periods. They exit after a market decline and enter after a market recovery.

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Why is this important?

If you are considering selling the stock funds in your 401(k) now that the market has already dropped by a fifth, keep this in mind.

The next time the market is flourishing and you are tempted to get in head first, keep that in mind as well.
Rich people, it seems, often plan ahead of time what their ratio of “safe” to “risky” assets will be, and they try to maintain it constantly, rebalancing one way when things are booming and the other way when they are crashing.

It also brings up a fascinating query regarding the current market. According to some market analysts, the market lows won’t occur until private individuals have sold their holdings. For instance, they reference private-client information from BofA Securities.

Perhaps they are correct. But how much of that belongs to the wealthy and how much to the general public?

Consider looking at the most recent data from the Investment Company Institute, the industry trade group for the mutual fund sector. It’s a highly accurate representation of how individual investors will act, at least for those who have 401(k), IRA, or similar accounts.

In accordance with the ICI, individual investors left the stock market in 2020. (when, of course, they should have been buying). They then began to make purchases in anticipation of 2021. (when, of course, they should have been selling, especially near the end). Since April, they have been running away. The third quarter saw strong net selling.

Naturally, none of this establishes that the market has reached a bottom, is getting close to one, or is even close. A market bottom can only be seen in the rearview mirror, and it’s typically a very far way back, as any market veteran will tell you.
Furthermore, the wealthy do not own a miraculous crystal ball. After the initial Wall Street crisis of 1929, John D. Rockefeller, who was at the time the richest man in the world, is credited for purchasing the market. He openly stated, “There is nothing in the business scenario to excuse the destruction of values that has occurred on the exchanges over the past week. “My kid and I have been buying sound common stocks for a few days.”

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Of course, everything worked out in the end. Unfortunately, he was around three years early. Before the market reached its bottom, it would decline another 80%. (To be fair, he couldn’t have predicted that the Federal Reserve, the U.S. Treasury, and the U.S. Congress would adopt irrational measures in response to the crash that sparked the worst depression in recorded history.)

But the next time you feel the want to freak out over the market, you should consider: “What would a really, really affluent person do?”