Why Some Rich Folks Are Complete Idiots

Earners,

In the world of high finance, complexity is often mistaken for sophistication. High-net-worth individuals (HNWIs) are bombarded with pitches for private equity, venture capital, and private lending as the golden tickets to wealth accumulation.

These options promise exclusivity, the thrill of high stakes, and the allure of outsized returns. But do they deliver? The truth is, you don't need a seat at the table of high-stakes deals to secure financial prosperity. In fact, a simpler, more disciplined approach can’t only match but often exceed the returns of these complex investments.

The Illusion of Complexity

Complexity sells. The finance industry is a master of creating investment vehicles that sound impressive but are often opaque, costly, and risky. Private equity and venture capital funds tout the potential for exponential returns, but these come with significant drawbacks: long lock-up periods, high fees, and the very real possibility of losing everything. Private lending offers the promise of steady income, but it's fraught with risks that can turn steady cash flow into a trickle or worse, a loss.

The appeal of these investments lies in their exclusivity. Being offered a chance to invest in a private equity fund or a hot startup is like being invited into a secret club. But this sense of exclusivity often blinds investors to the realities of these investments. According to the Cambridge Associates U.S. Private Equity Index, the average annual return for U.S. private equity funds over the past 10 years has been around 13.6%. Not bad, but not the windfall many investors expect when they fork over millions.

Data from Cambridge Associates also shows that private equity likely does edge out public investments from a top-line return perspective. Their comparison is between the returns of roughly 1,500 private equity funds and the Russell 3000, which is an index made up of the 3,000 largest U.S. public companies.

During the 25-year period ending December 31, 2022, private equity saw an average annual return of 13.33%, while the Russell 3000 saw an average return of 8.16%. Now, the S&P 500 returned just over 9% per year over a similar time frame (period ending June 2022), but the historical return is anywhere from 9-10% across a number of different time frames for the U.S. public equity market.

But those returns don’t tell you everything you need to know. First, private equity is considered a high-risk investment. Yes, you have a chance of getting a return that’s higher than the stock market. However, you also have a greater chance of losing your money, given that private equity often invests in startups. Private equity funds also tend to have significantly higher fees (the classic 2% MER plus 20% of the profits versus the insignificant 0.03% of something like VOO, the Vanguard S&P 500 ETF), which slashes returns so much that they tend to come close to, if not lag, public markets.

Additionally, private equity funds are highly illiquid. When you invest in one of these funds, you’re often committing your money for many years before you can expect a return. The ridiculous lack of liquidity needs to be factored into people's decisions. You’re stuck with the opportunity cost of the returns or the use of that money you could have invested elsewhere.

The Power of the Index Fund

Now, let’s contrast that with something simple, boring even: the index fund. The S&P 500, for instance, has returned an average of 12.2% annually over the past decade. What’s more, it does this with lower fees, no lock-up periods, and full transparency. You know exactly what you’re getting—a slice of the 500 largest companies in the United States.

If you’re a high-net-worth individual, do you really need to pay 2% management fees and 20% of the profits to private equity managers when there are options like an S&P 500 ETF out there? Again, Vanguard’s S&P 500 ETF (VOO) has an expense ratio of just 0.03%. Let’s do some simple math: On a $10 million investment, that’s $3,000 a year versus the $200,000 in fees you’d pay to a private equity fund. Over 10 years, that’s nearly $2 million saved in fees alone.

For Canadian investors, BMO offers a range of ETFs that deliver similar benefits. Take, for instance, the BMO S&P 500 Index ETF (ZSP). It provides exposure to the U.S. market with an expense ratio of just 0.09%, allowing you to capture the same market returns with minimal costs. Over the past decade, ZSP has delivered solid returns, making it a compelling option for those looking to simplify their portfolios while still achieving growth.

The Case for Real Estate

Then there's real estate—another so-called "boring" investment. Yet, according to the Federal Reserve's Survey of Consumer Finances, real estate remains one of the most reliable sources of wealth accumulation for HNWIs. Over the past 20 years, the average annual return on residential real estate has been about 5.4%, according to the Federal Housing Finance Agency. While that’s lower than the stock market, real estate offers something stocks don’t: sustainable leverage.

With a 20% down payment, you can control a $1 million property with $200,000. If that property appreciates by 5% in a year, your return on the $200,000 you invested isn’t 5%—it’s 25%. Add in rental income, tax advantages, and the fact that real estate tends to be less volatile than stocks, and you have a compelling case for including real estate in a high-net-worth portfolio.

The ETF Revolution

Exchange-traded funds (ETFs) have revolutionized investing by making it easy and cheap to diversify across a wide range of asset classes. Whether you’re interested in bonds, commodities, international stocks, or niche sectors like healthcare and technology, there’s likely an ETF for that. And just like index funds, ETFs come with low fees and high transparency.

Consider the iShares MSCI ACWI ETF (ACWI), which gives you exposure to over 2,000 stocks across developed and emerging markets. Over the past 10 years, this ETF has delivered an average annual return of 8.5%, all for an expense ratio of just 0.32%. For HNWIs looking to diversify globally without the headaches of managing individual stocks or the illiquidity of private investments, ETFs offer a simple, elegant solution.

For Canadian investors seeking global exposure, the BMO MSCI All Country World High Quality Index ETF (ZGQ) offers a similar opportunity. With an expense ratio of 0.50% and healthy compounded annual returns of 16.07% over the past 5 years, ZGQ provides exposure to a broad range of global equities, allowing investors to participate in international growth without the complexity or costs associated with private investments.

The Risks of Private Investments

Let’s be clear: There’s nothing inherently wrong with private equity, venture capital, or private lending. These investments have their place, particularly for those who are well-versed in their complexities and can afford to take the risks. But the key word here is "risk." A study by the Kauffman Foundation found that only about 20% of venture capital investments generate 95% of the industry’s returns. That means the other 80% either break even or lose money.

For private equity, the story isn’t much better. A study by McKinsey found that while top-quartile private equity funds outperform public markets, median and bottom-quartile funds do not. In other words, unless you have access to the best managers—and even then, there’s no guarantee—your returns could be subpar or worse.

The Simplicity Advantage

Simplicity offers not just peace of mind, but also robust returns. When you invest in broad-based index funds, ETFs, and real estate, you’re essentially betting on the long-term growth of the economy. And history has shown that this bet is a pretty good one.

High-net-worth individuals are often the targets of complex investment schemes because they have the means to invest in them. But just because you can, doesn’t mean you should. The data is clear: Broad-based index funds, ETFs, and real estate can deliver returns that rival or even exceed those of private equity, venture capital, and private lending, all while offering lower costs, greater liquidity, and less risk. That’s not to say you shouldn’t invest in those other asset classes—it just means you need to go in with eyes wide open.

In the end, wealth management isn’t about finding the next big thing; it’s about securing your financial future. And sometimes, the best way to do that is to keep it simple.

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Earn more,

Nate

As always folks, I am not an investment advisor and none of this is financial advice. All of this is for educational purposes only and the reason I am mentioning specific ETFs is simply for example purposes and is NOT recommendation from me to buy them. Please do your own research and invest your hard earned dollars at your own risk!