Warren Buffett is probably the most famous investor in the world and he often emphasizes the benefits of investing incheap index funds. In fact, he instructed the executor to invest in index funds.
“My advice to the trustee couldn't be simpler: Put 10% of the cash in short-term Treasury bonds and 90% in a very low-cost S&P 500 index fund,” he noted in Berkshire Hathaway's 2013 annual letter to shareholders. .
Yet,despite Buffett's advicethe rich generally do not invest in simple, market-based index funds with low costs. Instead, they invest in individual companies, art, real estate,hedge fundsand other types of investments with high entry costs. These risky investments generally require high buy-in fees and incur high fees while promising the possibility of large returns.
Key learning points
- Wealthy investors can afford investments that average investors cannot.
- These investments offer a higher return than indices because there is more risk involved.
- Wealthy investors can absorb the high risk that comes with high returns.
How the rich invest
As an example, let's look at Steve Ballmer, the former CEO of Microsoft, who reports a net worth of approximately $70 billion.Despite leaving Microsoft, he owns more than 300 million shares in the company, a multi-billion dollar investment.
Some of the other ways Ballmer chose to invest his money included a roughly 4% stake in Twitter (before selling his shares in 2018), plus real estate investments in Hunts Point, Washington and Whidbey Island.He bought the LA Clippers basketball team for $2 billion.His wealth is concentrated in a handful of investments – a far cry from the hundreds of investments that accompany Buffett's (and many personal finance experts') low-cost loan proposal.index funds.
Hedge funds are also popular among the wealthy. These wealthy funds require investors to demonstrate a net worth of $1 million or more and use sophisticated strategies aimed at beating the market.But hedge funds typically charge about 2% of costs and 20% of profits.Investors need huge returns to be able to bear these high costs!
This is not to say that the wealthy don't own traditional stocks, bonds and sharesfinance investments-they do. Yet their wealth and interests open doors to other types of exciting and exclusive investments that are typically unavailable to the average person.
Why don't the rich invest in low-cost index funds?
Over the past 90 years, the S&P 500 has achieved an average annual return of 9.5%.You'd think the rich would be happy with that kind of return on their investments. For example, the $10,038.47 invested in the S&P 500 in 1955 was worth $3,286,458.70 at the end of 2016. Investing across the market with index funds delivers consistent returns while minimizing the risks associated with individual stocks and other investments.
But the rich can afford to take risks in the service of multiplying their millions (or billions). For another example, look at the world-famous investor andspeculant George Soros. He once made $1.5 billion in a month by betting that the British pound and several other European currencies were overvalued against the German mark.
Hedge funds seek these kinds of extraordinary profits, even though history is littered with examples of years in which many hedge funds underperformed stock indexes. But they can also yield a lot for their wealthy customers. That's why the wealthy are willing to risk large buy-in fees of $100,000 to $25 million for the opportunity to earn big returns.
The investment habits of the one percent also tend to reflect their interests. Because most wealthy people made their millions (or billions) in business, they see this path as a way to continue maximizing their finances while sticking to what they know best: business structure and market performance. They also like art, cars, houses and collectibles. By purchasing these luxury goods, the wealthy improve their lifestyle and, as a nice bonus, enjoy the increase in the value of these luxury goods.
In short
The rich have enormous incomes, assets and opportunities. While they seek out unique investments in the hopes of making spectacular returns, not all of their bets pay off with returns greater than those of a low-fee index fund. But because they have more than enough cash on hand to survive, they are less dependent on stable returns. A simple investment strategy in index funds with low costs is good enough for Warren Buffett, and good enough for the average investor.
Frequently Asked Questions (Frequently Asked Questions)
How do index funds work?
Index funds are generally set up to trackMarket performancewhich specific index they follow (e.g. the S&P 500). Investors in an index fund can expect similar returns to the index itself, making it a fairly reliable, low-risk investment. They usually arepassive boardThis means that managers do not actively buy and sell much to keep costs low.
How much return does index funds have?
The return of an index fund depends on the index on which it is modeled. Aindex fund will generate a different return than, for example, a real estate market index fund.
What are the disadvantages of index funds?
Although index funds are generally a reliable way to invest, no investment is without risk. Some index funds may underperform the market they index, and some may be too rigid for an investor who wants flexibility and the ability to adapt as the market changes. In general,passively managed fundsalso offers fewer opportunities for higher returns.
