Are the rich different?

This is the text of my 4 December feature for the Financial Times

There is an apocryphal tale about an exchange between two of America’s most famous novelists on the nature of wealthy individuals. F Scott Fitzgerald, author of The Great Gatsby, is reputed to have said: “The rich are different from you and me.” In reply, Ernest Hemingway is quoted as saying: “Yes, they have more money.”

As it happens, the quote attributed to Fitzgerald seems to be a corruption of a line in The Rich Boy, his 1926 short story: “Let me tell you about the very rich. They are different from you and me.” Either way, Fitzgerald raises an important question: are the very rich different from everyone else besides the fact that, by definition, they have a lot more money?

Thanks to advances in behavioural finance it has become possible to answer whether the wealthy do indeed think differently from the rest of us.

A rich source of information on the topic is the behavioural finance team at Barclays. It conducts an extensive survey – its Financial Personality Assessment – on 40,000 of the bank’s wealthy clients around the world. The survey goes way beyond the risk tolerance questionnaires that have become commonplace among wealth managers. Instead it questions investors on three dimensions related to attitude to risk – risk tolerance, composure and market engagement – and three on decision style – perceived financial expertise, desire for delegation and belief in skill.

Of course, Barclays conducts the survey in a bid to better serve its clients, rather than out of purely intellectual curiosity. Nevertheless, it provides an interesting peek at how the rich think about risk and investment. In this respect it is particularly fortuitous that it covers the periods of extreme market volatility of recent years.

The survey yields some results that do not conform to the traditional depictions of the wealthy. Greg Davies, head of behavioural finance at Barclays, says that, controlling for other variables such as age, the wealthy only exhibit a slightly higher risk tolerance than the general population.

Entrepreneurs, however, stand out from the rest of the wealthy, he says. “Among entrepreneurs we definitely observe higher risk tolerance and higher levels of engagement with the markets,” Davies says.

Entrepreneurs also display a marked reluctance to hand over the management of their wealth to others. “We observe lower delegation scores,” Davies adds. “These people like to have control over it themselves and are less willing to hand it over to an adviser.”

But although entrepreneurs are willing to take risks to expand their businesses, it does not necessarily follow they are risk-takers in other areas. “We know from academic research that someone’s financial risk attitude may be entirely different from their attitude towards taking risks in terms of health behaviours or participating in dangerous sports,” says Davies.

Perhaps more surprisingly, many entrepreneurs hesitate before investing in the markets because of the perceived risks involved. Davies draws the analogy with a mountaineer. Although climbing a mountain appears risky to laymen, the experts often deny it because of the amount of planning and training they engage in beforehand. Similarly, entrepreneurs often feel they can understand and control risk within their businesses but are less confident about the markets overall.

When such people invest, they often need to create what Davies calls “stories” to provide them with emotional comfort. This could be that they perhaps have a personal connection with a particular firm or they prefer companies from their home country. Often they are reluctant to embrace the conventional view that the best strategy is to have a broadly diversified portfolio.

Hersh Shefrin, a professor of finance at Santa Clara University, draws similar conclusions to Davies about the preferences of the newly wealthy. From his base in Silicon Valley he observes the behaviour of one of the world’s largest concentrations of super-rich entrepreneurs. He has also worked with many ultra-high-net-worth families.

“Wealth acquirers are typically entrepreneurial,” Shefrin says. “That means they set ambitions that are high and they also attach a very high importance to configuring their environment to maximise the likelihood of achieving those aspirations.”

In addition to their strong desire for control, the super-rich tend to exhibit “dispositional optimism” or what a layman might call a rosy outlook. They also typically have good social skills, larger than average families and lower divorce rates.

In psychological terms they tend to emphasise what is often called “system two thinking” rather than “system one”. That means they prefer to ponder difficult decisions slowly, rather than come up with quick answers.

Both Shefrin and Davies agree that what are often perceived as national or cultural differences among the rich tend to reflect this division between old and new wealth. Western Europe and Japan have a higher proportion of inherited wealth, while the US, particularly in Silicon Valley, has more new wealth. Russia, which did not even exist as a market economy until a generation ago, has a particularly high proportion of ostentatious new wealth.

If F Scott Fitzgerald were alive today he might no longer declare that the rich are different from you and me. Instead, he might claim, in terms of behavioural psychology at least, that it is the new generation of wealthy entrepreneurs who are different.