It is remarkable how often the names on the rich list change. I often wonder why this is so. Once a fortune has been made, retaining it, and growing it modestly through generations, should be a straightforward affair – with the right advice.

I think of the Packers, investing their fortune in casinos. Goodness why would they do that?

A simple diversified investment in all of the stock market (via an ETF or widely diversified passive fund) would have yielded a much safer and better return. Not to mention how much angst they would have avoided through this far simpler approach.

Did they feel they didn’t have enough money, such that they needed to gamble everything on one small portion of the roulette wheel?  Or was James just bored and in need of a hobby?

But alas, ultra-high net worth families commonly make this mistake . They feel compelled to do something clever, something heroic, something more complex and exclusive. A mainstream passive investment, it seems, will never do.

In this edition of Insights, together with financial journalist Robin Powell, I explore some of the behavioural pitfalls facing the very wealthy.

“Any fool can make a fortune,” the 19th-century rail and shipping tycoon Cornelius “Commodore” Vanderbilt once said,” but it takes a man of brains to hold onto it.” 

When Vanderbilt died in 1877, he was the wealthiest man in the world. Yet he left no instructions to his children on how to invest his fortune. Within seven decades it had largely dissipated. When a family reunion was held in 1973, 120 of the Commodore’s descendants attended, and not one of them was a millionaire.

Sadly, what happened with the Vanderbilts is all too common. All over the world, wealthy families have struggled to retain their wealth. Research has shown that, in the US, only around one in ten families can expect to see their wealth last beyond their grandchildren’s generation. 

The phenomenon spawned a saying in America — “shirtsleeves to shirtsleeves in three generations”, or “rice paddies to “rice paddies” in China. And Australia is no different; look at any list of rich Australians and you’ll struggle to find any examples of so-called “old money”.

Why, then, does it happen? Why do the wealthiest and most successful families find it so difficult to retain, let alone grow, their wealth from one generation to the next? After all, these families can afford the very “best” financial advice available.

A tendency to over-complicate

There are, in fact, several reasons, but I’d like to focus on one that I think is particularly important: it’s that wealthy people often have a tendency to over-complicate matters when it comes to investing. As the legendary investor Warren Buffett once said, “there seems to be some perverse human characteristic that likes to make easy things difficult.”

Buffett has explained repeatedly over the years how the rules of successful investing are actually very simple. The key, he says, is to invest in a low-cost index fund, or a portfolio of index funds, for the very long term, and to avoid the temptation to become either over-excited when stock markets rise, or so fearful when they fall that you’re tempted to bail out. 

That, he says, is the best advice for everyone, regardless of how much or how little they have to invest. And yet, as he explained in his 2016 letter to shareholders in his company Berkshire Hathaway, wealthy investors are less inclined to follow his advice than the less well-off. 

“Over the years,” he wrote, “I’ve often been asked for investment advice, and in the process of answering I’ve learned a good deal about human behaviour. To their credit, my friends who possess only modest means have usually followed my advice.

“I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed that same advice when I’ve given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or… a consultant.”

The “best” advice?

Buffett then went on to explain why, in his view, wealthy people usually ignore his advice. The problem, he says, is that they are used to paying for the best of everything — whether it’s housing, education, healthcare or entertainment. 

“Their money, they feel, should buy them something superior compared to what the masses receive,” he wrote. “In many aspects of life, indeed, wealth does command top-grade products or services.

“For that reason, wealthy individuals… have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars.”

Instead of simple, low-cost strategies, well-off investors tend to prefer complex ones, which are invariably more expensive. So, for example, instead of investing in the whole market, they actively select individual securities, and choose actively managed funds — and often far more funds than they really need — typically these funds give them exposure to specific countries, sectors or themes. And instead of just staying invested, they try to time the market, and to buy and sell the right fund at the right time.

These strategies might seem sophisticated, but, over time, they will almost certainly deliver inferior cost and risk-adjusted returns, relative to low-cost, buy-and-hold indexing.

Using multiple advisers can be counter-productive

Closely related to this tendency to make investing more complicated than it needs to be is the way that many high-net-worth families’ tend to spread their wealth across multiple financial advisers. It’s not unusual for families to have three or even four different advisers managing their money.

Psychologically, you can understand why some families make that choice. They may have worked very hard for their wealth and are determined not to lose it. So, they decide to hedge their bets. They convince themselves that by using multiple advisers they are reducing their risk or making their overall portfolio more diversified.

However, using three or four advisers to manage your money can provide false diversification. This is because when you ‘look through’ to what each adviser is holding in their portfolio basket, there is generally commonality of 70% or more.

Think about it this way….. If each adviser is charged with employing their expertise to take active, tactical positions in stock markets – and you have say four of them doing this for you, all with slightly different views and opinions – then the likely outcome, when you aggregate all four portfolios, will be roughly the market portfolio. The truth is, the more advisers you have, the more likely it is that you will get a combined portfolio that is representative of the market portfolio (ie the market index).

While you can buy the market portfolio very cheaply via an index fund (or a direct indexing approach), paying four gurus to pick stocks and time markets – is expensive. So, you can end up with the market return, less a considerable fee. The whole arrangement can be a waste of time and money.

Remember, too, that when you use more than one adviser, there is often no single authority in charge of your wealth. It’s inevitable that, from time to time, the advisers will disagree and provide you with conflicting advice, and you’ll end up paying one of your advisers to sell stocks that another is buying!

On a personal level, it’s also much easier to maintain a good working relationship with one adviser than with several.

Taking an evidence-based approach requires humility

An often not talked about, but essential element of developing a successful investment strategy, especially in the case of very wealthy &/or successful people, is the requirement for humility.

Very wealthy investors have often made their wealth through a family business, and then upon the sale of their business they believe they can bring the same commercial smarts that helped them succeed before, to the occupation of investing.

However, being an arm’s length investor in businesses (stocks), is altogether a different to running a business of your own. The skills required for the former, are entirely different to the latter.

Succeeding in business requires determination, dynamism, leadership, and energy. And often leaders are required to drive constant change. The more energy they put in, the more success they bring. Sitting still is rarely a good thing.

However, with investing, things are topsy turvy. Often the best thing to do is “nothing at all”. And often the simple, textbook approach, is superior to the instinctive or creative one.

And so, it is natural for these successful people to bring the wrong thought processes to the field of investing. And there are no shortage of investment banks and brokerages ready to feed off these faulty sentiments. They sell the allure of exclusive products, and clever buy/sell advice backed by global research. It all sounds appealing, and consistent with what wealthy people instinctively sense they should be able to access. But alas, the objective evidence finds otherwise. These expensive, and complex products mostly fail to deliver superior returns, and the global research that prompts investors to regularly change tact, is generally wrong.

Warren Buffet’s sage advice, to build long term portfolios comprised of index or passive funds, and then “leave them alone”, is backed by decades of academic research.

But perhaps the piece that Buffet fails to recognise in his counsel, is how hard it is for investors to leave their portfolios alone and not fall victim to the omnipresent allure of other more heroic approaches or ideas.

Most people find it incredibly difficult to stick with a straightforward strategy for the long-term. The temptation to change paths occurs regularly, and investors need educational and emotional support to stay on track.

It is the role of the adviser to guide them through troubled periods when markets and portfolios are not behaving as expected. Through these periods the adviser should be interpreting current events, and educating investors on why it remains appropriate to stick with their strategy. The critical component here is that the adviser themselves must be humble and take an evidence-based approach – rather than a heroic one.

But ultimately to take this pathway, takes humility and discipline on the part of the investor. It requires the strength of character to shun the allure of the latest story, or media piece suggesting a fortune can be made through the pursuit of a particular theme mor stock. It requires an acceptance, that the individual doesn’t have a special skill, that others in markets don’t have. It requires Humility.

So don’t be like the Vanderbilts. Don’t leave yourselves (either you or your loved ones) susceptible to chasing the latest hot investments, and then dumping them when they fail to deliver the returns you were hoping for. 

Instead, keep it simple and evidence based. Have a unified decision-making framework — and one adviser you really trust to manage your family’s wealth.