In his book the Aspirational Investor, Ashvin B. Chhabra provides insightful analysis on investing. The book is a great read and provides some thought-provoking ideas about making smarter investment choices that are aligned with our life’s financial goals. More specifically, the Aspirational Investor has a chapter on How Do People Become (Very) Wealthy? – which is a fantastic journey into the sources of wealth of the very wealthy in America. I claim no originality of thought here, but I believe Mr. Chhabra’s ideas in this chapter have nuggets of wisdom for all of us to soak in – and hence this blog.
Mr. Chhabra states that the path to extreme wealth is invariably built upon very specific undiversified risky business undertakings, which involves monetizing a skill through concentration and leverage. He argues that the super rich do not earn their wealth by sticking to conventional asset allocation and diversification strategies – the lynchpins of modern portfolio theory. In fact he goes on to say that nearly all wealth creation amongst the Forbes 400 was based on specific 'idiosyncratic' undiversified risk - the kind of risk rational investors should avoid (as per modern portfolio theory). This is a fascinating insight.
The corollary to this is that while we see only the positive effects of monetizing skill through concentration and leverage, the path to extreme wealth is also littered with many causalities who have fallen prey to the downside of these undiversified, leveraged and risky business undertakings. In fact this pans out in the fact that the Forbes 400 list experiences extreme churn in its constituents. To justify his insight, Mr. Chhabra quotes a study by his colleague Lex Zaharoff, which analyzed the cause of exit of each of the dropouts from the Forbes 400 list. Not surprisingly concentration and leverage formed two of the major factors that caused dropouts from the Forbes 400 list – the very two factors which were the cause of the wealth in the first case!!
To me, the first and foremost lesson from this is that the sources of wealth for an individual is his specific skill or vocation. It is a focus on and build up of this skill that generates wealth for an individual. No amount of smart portfolio construction by any investment adviser or portfolio manager can substitute this. In fact if it is indeed attempted to make extreme wealth through investment strategies alone, these strategies would invariably lead down the path of high leverage and concentration, thus exposing oneself to 'idiosyncratic' risk and hence to extreme loss.
So, as investment advisers our primary role is wealth preservation and hopefully a little extra, not much more – for if we strive for much more, we are likely to expose our clients’ assets to concentration and/or leverage a path ridden with potholes. Clients on the other hand must focus upon their chosen vocations/skills and invest in themselves and their vocations as opposed to expecting a portfolio manager/investment adviser to exponentially grow their wealth.