Wednesday, May 25, 2016

Dangers of Using the Rich as Role Models

A recent story at Market Watch discussed the fact that rich people often diversify their investments poorly. Not mentioned is the fact that many people get rich through concentrated bets. But that’s a bad reason to do the same.

There are good reasons to look to successful people to see what they do well. However, using successful people as role models isn’t always a good idea.

A common way for investors to get rich is to make an extremely risky concentrated bet and get very lucky. However, for each person who takes a wild chance and gets rich, there have to be many more who take wild chances and lose almost everything.

It’s hardly surprising that people who get rich taking big chances would have a tendency to continue to take big chances. Others who try to copy this behaviour are likely to lose badly. If the rich role model was simply lucky, the next person probably won’t be lucky. If the rich role model succeeded through genuine skill, the next person probably doesn’t have the necessary skills.

I’m not saying we shouldn’t pay attention to what successful people do. What I am saying is the we have to examine whether copying a successful person’s actions is likely to work for us.


  1. For every penny-stock millionaire from the 50's or 60's or Internet Millionaire from the 90's there are countless thousands that made the wrong "Big Bet" and are paying for it now.

    Given most of my great decisions were blind luck based, I would never espouse my life methods, unless I could make money doing it. Not sure if anyone would buy a book that espouses getting laid off, and then get a job in the government and manage to transfer your pension over, but you never know?!?

    1. @Alan: If a book is entertaining enough, the subject matter doesn't matter much.

  2. Replies
    1. @aB: This is an extreme form of survivorship bias. We might be focusing on only 1 person in 1000 or more who happened to become wealthy with a particular strategy. The remaining 999 are less interesting.

  3. And it's not a good idea to mimic the lavish lifestyle of the riches, at least, before to be really rich. Anyway, a big proportion of the millionaires are people "next door" in the real life. My boss as an example is a multi-millionaire and his car is almost the least expensive in the job's car lot. He is not an exeption...

    1. @Le Barbu: You identify the problem of identifying who is really rich. It may not be a good idea to blindly follow those who are rich, but as you say it's even worse to follow those who seem rich but are actually just spending themselves into debt.

  4. (this may be the nth repost of this comment!)

    I've stated numerous time that the non-wealthy should NOT try to duplicate the investments of the wealthy. For starters, they are wealthy and you are not, two different worlds. The wealthy have access to a multitude of investments and strategies that the non-wealthy do not.

    Not only that, but most wealthy people achieved as much through prolonged very high income and/or successful business ownership -- not via the stock market. It's easy to buy an index fund, it's very difficult to attain the previously mentioned states.

    As MJ said, extreme survivorship bias. Less than 1% of Canadians have $1 million in investable assets, and most of those are in the $1-5 million range. Not to mention the replacement rate of the lower rung wealthy.

    But, we live in a Capitalist society, money is THE measuring stick for success. What sells is marketing money even though we would learn much more studying the failures. Paraphrasing Munger, figure out how to avoid what you do not want (non-wealth) and you'll probably end up with what you want (wealth).


  5. This phenomenon reminds me of how dangerous it is to misinterpret a market forecaster's correct prediction that a particular stock would soar. How many false predictions did that forecaster make, and how much money would people have lost if they had concentrated in those positions instead?

    Similarly, we can misinterpet the situation when a person became rich by making a concentrated bet. How many people also lost money by making concentrated bets?

    To properly evaluate a strategy, we need to consider *all* the people who followed that strategy. Not just the winners.

  6. Reminds me of an analysis of "sucessful" restaurants I read years ago. As we all know, failure of food establishments is very high within the first five years. The analysis concluded that it wasn't always the best restaurants which survived (e.g. best food), but those which had a strong influence of other factors (e.g. location, deeper pockets, etc). Thus trying to emulate the winners would probably result in losing simply because the other factors, both known and unknown, could not be replicated.

    For example, a couple of rich lawyers in the U.S. opened a cereal bar chain in the 00s. They sued-until-closure every other person in the greater vicinity (including Canada) who attempted to operate a cereal bar. It was the unrelated wealth and legal expertise which made their food company a success, not the food company itself.

  7. @Brad and @SST: You both make excellent points. A person's success may be nothing more than luck and have nothing to do with the traits visible to us.