Investment Products Formerly Available Only to the Ultra-Rich? I'll Pass

Posted by Alex Frey (@alexhfrey )
Not the best person to invest like

Unless you've had blinders on for the last decade, it should be pretty obvious that there is scope to improve the outcomes that the financial system delivers to regular people.

Many middle and upper-middle-class people (the unfortunate reality is only the top 50% of wage-earners really have money to invest) like to believe that this is because the rich have some kind of exclusive access to world-beating investment products and strategies that just aren't available to them.

New wealth management companies are usually quite happy to feed this story, promising to "democratize wealth management" by enabling anyone to access and use "products that were once only available to the ultra-wealthy."

At the bottom of this all is the narrative that the "rich get richer," which is a compelling story that a lot of people would like to believe, and that probably really is true in lots of areas of life (education comes to mind, for instance). But investing is not one of them.

The "exclusive" products that rich people invest in -- like hedge funds -- like to bill themselves as exclusive partly so that they can charge very high fees. Once you subtract those fees from their performance, they mostly underperform very simple strategies that are available to anyone.

Some simple math goes a long way. Over very long periods of time (like a century), the compounded annual growth rate of the US stock market has hovered around 10% a year. With a Vanguard ETF (VTI), you can effectively own the US stock market for an all-in expense of .05% a year, so assuming the market returns 10%, you will get 9.95%. Hedge funds charge a typical fee of 2% of assets and 20% of profits. In order to "beat" what you could get historically from investing in VTI, a hedge fund would have to return around 15% a year, beating the market by a full five percentage points (do the math). And even then the hedge fund manager would capture substantially all of that outperformance.

Sure, there are a handful of people like Soros, Buffett, Dalio, and Druckenmiller that are probably really capable of this. But you're more likely not to end up in one of their funds then you are to end up in it. There is just no evidence in the data to suggest that you should be confident that any manager you are able to get an allocation to is going to be able to consistently beat the market by more than 5% a year -- and that's true even if you have $20 million to invest.

So if the strategies of the rich seem built largely to make money managers richer, what about those available to investors with less means?

Exaggerated jeremiads on high frequency trading aside, the reality is that we have never been in a better age to be a small-time individual investor. With a click of a button, you can now build a diversified portfolio of 10,000 bonds and stocks from around the world for fractions of a cent on the dollar, completely bypassing most of the money management establishment in the process.

Nor does it take heaps of financial sophistication in order to execute such a strategy. Let me take my own service out of this for the moment1 . If you want nothing to do with investing, here is my totally free and independent advice that you can immediately act on, and that will set you up to outperform 90% of rich people, and that you don't need to be rich at all to follow: Buy a Vanguard or T. Rowe Price Retirement Date 20xx fund, contribute 10% or more of your paycheck every month to it, and forget about it2 .

Here's how that strategy would have performed over the last seven years, versus investing in an aggregate basket of "rich people" investments (hedge funds).


Why don't more people just do this then? Part of the answer is that they are starting to - Vanguard is killing it, and their retirement-date products are leading the way 3 .

Still, a surprising number of otherwise intelligent people for some reason think they "shouldn't" do the simple thing with their money. And it's an interesting question why this is.

My guess is that is at least partly because buying a single retirement-date fund does not fit the "image" that people have in their minds about what investing "should" look like.

  1. Following this strategy is boring, while people think investing should be something that is glamorous and fun.
  2. Following this strategy is relatively easy4 , while people think investing should be something that is hard.
  3. Following this strategy takes very little "financial literacy" (mostly just requires the ability to operate a computer), whereas people think investing is something that should require a large amount of financial sophistication.

In the end, the "we are enabling anyone to access products previously only available to the ultra-wealthy" story will likely continue to work, because enough people want to believe it, and because it fits with the image a lot of people have in their head about investing. But the data is pretty clear: when it comes to growing your money, there are plenty of good products available to anyone with more than about $3,000. Your enemy is not a corrupt system that favors the ultra-rich, your enemies are:

  1. Yourself 
  2. High fees

Luckily, both are pretty easily defeated:

  1. Take emotions out of investing by using a system5  
  2. Don't pay high fees

  1. Here's the part that you'll have to assume may be biased (in fact, it happens to be what I actually believe, but I don't know how you could know that unless you inherently trust me for some reason): If you are willing to spend a bit more time on your investments (and I'm talking a few hours a year there) and you want to try to improve your returns over the course of a cycle and avoid the chance of falling over the cliff if and when the next bubble bursts and the next bear market starts, then you should check out the IvyVest strategy. Subscriptions are as low as $49.97 a year, the all-in management fees on your ETFs will come to less than .2% a year, and you'll avoid paying any trading commissions on 70-100% of your portfolio if you house it at Vanguard, TD Ameritrade, Schwab, or Fidelity. We can't be sure if you'll come out ahead of where you would be if you just bought that retirement-date fund, but if you believe in behavioral finance and think that stocks are a better buy when they are cheap then when they are expensive, there is a good chance.  

  2. For identity theft purposes, you should not actually forget about it 

  3. I have somewhat mixed feelings about this. Passive retirement-date funds are certainly an improvement over what people are currently doing (because the costs are lower and there is less room to screw up), but neither the doctrine of passive management nor the doctrine of asset allocation glidepaths (future blog post idea...) have ever totally made sense to me.  

  4. This is true from a purely mechanical point of view. There are other things, like massive bear markets, that can make it actually quite difficult to stick to this strategy from a psychological point of view (which investors who have not yet experienced a 50% reduction in their wealth tend not to appreciate), and that's one reason why I think our dynamic asset allocation approach at least deserves your attention.  

  5. Of course this only works if you will actually follow that system, so make sure you have at least some idea of why it should work first. Otherwise you will get frustrated when you go through the inevitable period where it isn't working, and you'll switch systems at the exact wrong time. So it's perhaps more accurate to say that you need a consistent system. 

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By Alex Frey