From time to time over the years, I’ve been invited to talk to high-school students about financial matters. I always enjoy these opportunities to learn from them and — I hope — teach them some important things.
One question I often ask is:
“Would you rather invest like a rich person or a poor person?”
Of course, they always choose the first option.
I use this question to introduce two important concepts: mutual funds versus individual stocks, and index funds versus actively managed ones.
High-school students, most of whom have little or no exposure to investing, quickly grasp that wealthy investors tend to own thousands of stocks, while poorer investors might own only a handful.
My point is simple: Buy a few individual stocks, and you’ll be following the poor investor’s example. Buy mutual funds — especially index funds — and you’ll be investing like the rich.
A deeper divide than expected
As it turns out, the divide between poor investors and rich ones runs deeper than I had realized.
A recent article published at TheWeek.com summed it up this way: “Rich people prefer productive companies while the poor prefer shiny lumps of metal. That’s bad news.”
The article was based on a Gallup poll showing that upper-income Americans are far more likely to favor stocks and real estate, while households earning $30,000 or less per year are more likely to choose gold as the best long-term investment.
Only 18% of wealthy Americans chose gold, while a much higher percentage of lower-income respondents did.
There’s plenty of data from the past 200 years to support the wealthy investors’ preference for stocks and real estate. Stocks, in particular, have dramatically outperformed bonds, metals, cash, and most commodities.
Optimism versus pessimism
Public companies grow by producing goods and services people want. They often pay dividends and reinvest profits to create more value.
Gold, by contrast, just sits idle, waiting for someone willing to pay more for it than the previous owner.
Barry Ritholtz, a columnist at BloombergView , noted that the poll suggests higher-income and lower-income people have fundamentally different expectations about life — and therefore place their trust in different assets.
Even after the 2008 financial crisis, wealthy investors tend to maintain greater faith in stocks and real estate than lower-income investors do.
Investing in real estate requires confidence in property rights, the legal system, and the rule of law. Likewise, investing in stocks requires faith that the economy will continue to function and reward productive use of capital.
Put another way: when you invest in stocks and real estate, you are acting as an optimist.
As Ritholtz puts it, gold investors tend to be pessimists. Gold is portable, often tradable outside formal systems, and retains value even in extreme societal breakdowns.
Gold, despite its glamorous image, is essentially a “disaster currency.”
The role of knowledge and education
It’s not surprising that people who struggle economically may have less faith in institutions and the future. Nor is it surprising that they may lack access to basic financial education.
If this analysis is correct — and I think it has merit — investment success depends heavily on attitude, outlook, and understanding.
This isn’t good news for lower-income investors. Much of the dramatic improvement in living standards over the past two centuries has come from betting on progress — technological, economic, and social.
Wealthy investors tend to make that bet. Investing heavily in gold is, in many ways, a bet against progress.
What this means for investors
An essential ingredient for long-term investment success is faith in the future — another word for optimism.
That optimism may not come naturally to people whose life experiences have been difficult. But it can be supported by education.
When people understand how investing works, they may be able to act optimistically — even if they still harbor doubts.
Unfortunately, many in the investment industry are happy to sell investors whatever they want to buy, whether it’s good for them or not.
Until that changes, the best defense is learning from the overwhelming evidence about which asset classes have historically been most productive.
We should also examine our own attitudes from time to time. Pessimism is tempting because it lets us blame others or “the system.”
But pessimism, as we’ve seen, can be very costly.
Final thought
My advice in a nutshell: Trust the future — while you watch your back.
The best way to do that is to learn as much as you can and put that knowledge to work, whatever your starting point may be.
Richard Buck contributed to this article.