No two wealthy individuals are the same, but our research has shown consistently that differences between wealthy individuals can be observed depending on how they have acquired their wealth. Additionally, as the global pattern of wealth creation shifts, these differences have significant implications for how the wealthy spend, save and share their money.
Residents of the United States, please read this important information before proceeding
Please read this important information before proceeding.
Living in a high-beta world
In financial market parlance, a high-beta stock is one that tends to outperform the market on the way up, but falls further when it drops. In his recent book, High-Beta Rich, Robert Frank argues that the wealth of high net worth individuals bears similar characteristics, rising faster than the wealth of the overall population during boom times, and falling more quickly in a downturn. “There is no question that many of the rapid wealth creators live in a high-beta world but that is often because you do not get rich quickly without taking risks,” says Stuart Lucas, Chairman of
Wealth Strategist Partners.
This is particularly true of entrepreneurs who, by definition, have had to take risks in order to become successful. Compared with wealthy individuals who have earned their wealth through inheritance or savings over time, those that became wealthy through the sale of a business do indeed have a higher risk tolerance (see chart 5).
As a result, entrepreneurs need to embrace volatility and recognise that fortunes can be lost as quickly as they were made. Among our sample, wealthy entrepreneurs are more likely than those who have inherited or acquired wealth through savings or bonuses to say that their wealth accumulation has been a rapid process. Wealthy entrepreneurs have also, however, experienced greater fluctuation in their wealth over time (see chart 6).
By contrast, inheritors are less likely to have experienced these fluctuations and have, on average, a lower tolerance for risk. Part of this can be explained by the fact that, unlike entrepreneurs, inheritors do not need to possess a built-in tolerance for risk and, indeed, their willingness to accept risk is likely to be similar to that of the population as a whole. Inheritors may also see themselves as temporary custodians of wealth, which leads them to adopt a lower-risk approach to wealth protection and preservation.
According to Mr. Lucas, it is common for risk appetite to decline as individuals make the transition from the concentrated risk of business ownership to the more diversified risk of financial management, particularly across generations. “A first-generation entrepreneur might not have started out with very much, so in the early stages they view themselves as having not much to lose,” he says. “Whereas if you’re an inheritor of wealth then your attitude toward risk is different because there’s a lot of perceived downside associated with losing what you’ve received or inherited.”
This declining risk appetite can have severe consequences. “If you’re highly risk averse, I would argue that you’re guaranteed to see your wealth decline over time,” he says. “It’s only if you’re willing to maintain a reasonable level of risk, and to try to reinvent yourself and recreate the family’s wealth, that you have a chance of preserving it and growing it, particularly if that wealth needs to be divided among many children in each generation.”
A different type of market engagement
Entrepreneurs and business owners are frequently comfortable living in a high-beta world when it relates to their own business, but can find it challenging to shift their focus from building wealth — often through entrepreneurial endeavours — to sustaining it through financial investment. “Wealthy individuals have often become rich through the management and growth of their business,” says Mr. Lucas. “It’s transferring those instincts from the high-beta business world to the high-beta financial world that tends to trip people up a lot.”
In an entrepreneurial context, individuals are rewarded for a very focused approach to their business. “Business owners are typically used to backing their winners,” says Mr. Lucas. “So, if they have a product that is performing well, they continue to support that product. If they have employees that are doing a great job, they tend to give those employees more and more responsibility.”
If you were to say to a business owner that they should fire all their top-performing employees and give their responsibilities to underperforming ones, they would look at you like you’re mad. But it is exactly that buy-low, sell-high mindset that tends to be successful in the financial world rather than the reverse. Stuart Lucas, Chairman of Wealth Strategist Partners
But this same approach can be disastrous when it comes to financial investment because of the concept of mean reversion, a theory that states that prices always return back to the mean, or average. “In the financial world, mean reversion tends to be a highly prevalent phenomenon, so the natural instinct of backing your winners actually works against you in many cases,” says Mr. Lucas. “If you were to say to a business owner that they should fire all their top-performing employees and give their responsibilities to underperforming ones, they would look at you like you’re mad. But it is exactly that buy-low, sell-high mindset that tends to be successful in the financial world rather than the reverse.”
Entrepreneurs frequently demonstrate hesitancy to jump into the financial markets. “Entrepreneurs tend to value control almost above everything else and, while they might be prepared to jump into risky enterprises where they buy into the story, they will be reluctant to do so if they think it means relinquishing control. They need to be personally engaged and convinced,” says Greg Davies, Head of Behavioural Finance at Barclays.
From a financial investment perspective, this desire for control means that entrepreneurs will very often take a very concentrated approach to risk-taking. “A combination of high risk tolerance and self-confidence means that entrepreneurs tend to take risks with their investment portfolio in a fairly concentrated way,” says Mr. Davies. “They will pick assets in areas where they feel most comfortable or knowledgeable, and they won’t invest where they don’t have conviction. This doesn’t necessarily mean that their portfolio is high-risk overall, because they may have a high proportion of their wealth in cash, but it does mean that the risk can be concentrated in a small number of positions.”
Compared with entrepreneurs, those who have inherited or come into wealth have lower levels of market engagement (see chart 7). This may reflect a relative lack of knowledge and experience with financial investments, but also perhaps a more passive relationship with wealth because they have not created it themselves. “Individuals who come into wealth through inheritance or other relationship ties can sometimes be reluctant to play an active role in preserving or growing it, whereas those who have earned their wealth are more cognisant of what has been required to earn it,” says Mr. Davies.
Leapfrogging to greater affluence
Individuals who acquire wealth during their lifetime can face massive changes in their lives, which some may find difficult to assimilate. In essence, they must cross a socioeconomic divide and become accustomed to a very different set of values, cultural cues and even language. It is no wonder that acquirers of wealth have been described as “immigrants… travelling to a more affluent country from their homeland.”6 “Leapfrogging from one socioeconomic status to another is like moving to a new country and culture,” agrees Dr. Jamie Traeger-Muney, Founder and Director of the Wealth Legacy Group. “The quicker you make that money, the faster the leapfrogging and the more sudden the transition to a new set of values, rules and often community of friends.”
At its most extreme, the newly wealthy may suffer from “sudden wealth syndrome,” a term coined by Psychologist Stephen Goldbart in the dotcom era to refer to the mixed feelings that can often accompany the experience of becoming rich very quickly. These can include anxiety, guilt, identity confusion, overspending and difficulties making decisions. “The quicker you acquire wealth without really educating yourself and getting a sound team in place, the more likely the chances that you are not going to hold onto it,” says Dr. Traeger-Muney.
The challenges of new wealth that are experienced by both entrepreneurs and inheritors, emphasises the importance of why both groups need to receive the right preparation to deal with this newly found wealth. “The financial awareness of the next generation is a hot topic for the current generation of entrepreneurs,” says Catherine Grum, Head of U.K.-International and EMEA Wealth Advisers at Barclays. “A good succession plan covers not just who you want to inherit, but also how you wish to educate them about their wealth.”
Equally, individuals or families who acquire wealth must think about how they will spend the rest of their lives and what purpose and values they would like to impart to their immediate and extended family. As Psychologists and Authors Dennis Jaffe and James Grubman observe7: “Life’s choices are broader when one is rich, but the criteria for what a person should do, and what will motivate one’s actions, are more elusive.”
6 Acquirers’ and inheritors’ dilemma: Discovering life purpose and building personal identity in the presence of wealth: Dennis T. Jaffe and James Grubman, Journal of Wealth Management (2007)