Great question! Most wealthy individuals own a significant portion of index funds. But then they think they need to do more. It's difficult for people to accept that a simpler approach might often yield better results.
Why Not 100% Index Funds?
Hubris. We all think we are smarter than we are. We believe we are the exceptional few who can outperform the market consistently. Index funds are for the less savvy, we tell ourselves. We think we have figured out the key to timing the market and are invincible.
In reality, many rich people do not put their entire net worth into index funds. Some are so rich that they no longer need to invest actively or are drawn to real estate opportunities instead. Millions of dollars allow for some luxurious house flips.
The Rich Don't Invest Everything in Index Funds
The rich understand that diversification is key. Putting all of your eggs in one basket would be foolish and risky, and the rich didn't get rich by making such foolish decisions.
Index funds work because they average out a lot of diverse businesses, some of which will have good years and some will have bad, without the need for in-depth knowledge of any particular company. Rich individuals can afford to pay large sums to financial advisors or take the time themselves to become experts in which specific companies are likely to do well in the next time period. Sometimes, this approach results in a better return, but many more people think they know more than they actually do.
Moreover, some wealthy individuals may have the financial means to own a controlling interest in a business or get representatives elected to the board of directors, giving them the power to make changes that might be even more profitable. This is something that index funds cannot provide.
Sure, Some Rich Invest in Alpha
While it's true that not all of the rich invest exclusively in index funds, a significant portion does seek to capture alpha, or excess returns over market benchmarks. These individuals also diversify their portfolio across different asset classes, seeking to earn returns that differ from those of index funds.
As a result, we are witnessing tremendous growth in private market strategies such as Pension Defined Contribution (PDC) and Defined Benefit (PDB), private equity, structured products, hedge funds, and other alternative investments. These investments allow wealthy individuals to further diversify their portfolios and potentially achieve higher returns.
Conclusion
In conclusion, while index funds are a smart and simple way to invest, many wealthy individuals prefer more complex strategies to maximize their returns. Understanding the benefits of both index funds and alternative investments is key to creating a well-rounded and diversified investment portfolio.