Wealthy Investors Found To Be Over Optimistic About Portfolio Returns

by Phillip Morton, Investors Offshore.com

28 April 2005

Amid rising interest rates and single digit market returns, a new survey of affluent investors by Northern Trust revealed that a substantial number of millionaires have overly optimistic expectations about the performance of their investment portfolios.

According to Northern Trust, more than half are inadequately diversified across asset classes, and most don't plan on making any changes to their current asset allocations in 2005.

The survey of US investors, entitled "Millionaires' Views of Investing and the Stock Market," canvassed more than 1,200 investors with over $1 million of investable assets, representing $7.3 billion in total investable assets.

The survey found that:

Two-in-five (40%) affluent investors expect the performance of their investment portfolios will be two percentage points or greater than a realistic return for that portfolio based upon its underlying asset allocation and respondents' expectations for the equity market.

Further, nearly one in six (16%) respondents expects the performance of their investment portfolios will be a full five percentage points greater than its realistic return.

“Surprisingly, there seems to be a disconnect between what successful people think their portfolio will return and what their portfolio can deliver given its current asset allocation," Orie Dudley, Northern Trust Chief Investment Officer observed.

Expectations of investment performance varied somewhat by occupation, but not by age or amount of investable assets.

For example, surveyed business owners are the most likely to be overly-optimistic about investment performance, as nearly half (47%) expect the performance of their portfolios will be two percentage points or above what is realistic, given the analysis. Of these respondents, 26 percent said they expect returns will be five percentage points or greater than what is realistic.

By comparison, surveyed corporate executives are least likely to be overly-optimistic about the performance of their portfolios. Thirty-three percent said they expect investment performance will be two percentage points or more than a realistic return, while 19% of these respondents expect investment performance will be five percentage points or greater, given the analysis.

The survey went on to reveal that more than half (59%) of millionaire investors surveyed are inadequately diversified across four broad asset classes: equities, fixed income, cash and alternative investments, which includes real estate, hedge funds and private equity. Among this group, investors with no exposure to alternative investments accounted for 78% of the total. Yet, just 16% of inadequately diversified millionaires plan to change their asset allocations in 2005.

"Even the most sophisticated, experienced investors don't always appreciate the impact of asset allocation on investment performance," said Dudley, adding:

"We encourage all investors to re-balance their portfolios periodically to maintain a well-diversified portfolio. The ultimate goal of an asset allocation strategy should be to build an efficient portfolio—one that will provide investors with the greatest possible return for the lowest risk based on their goals, timeframe and comfort level as well as the tax implications of various investment strategies."

"Of course, adding alternative investments, including hedge funds and private equity, may not be appropriate for all millionaire investors and they should seek the advice of investment experts. Often investors can diversify their portfolios by changing the line up of equities, perhaps adding different investment styles and classes of equities appropriate to their investment parameters," explained Dudley.

While the majority (69%) of surveyed affluent investors consult with their principal advisor when making decisions about investing, Northern's survey found that more than a third (34%) of millionaires view themselves rather than a financial professional as their "principal advisor". Of those, nearly half (46%) of investors with more than $10 million of investable assets are more likely than other groups surveyed to rely on themselves rather than use a financial professional as their principal advisor.

"We're seeing a defection among investors from traditional investment advisors perhaps because of reported improprieties, lower than expected returns in the last few years and skepticism that advisors' interests aren't aligned with clients' interests. It's key to choose a principal advisor who is independent, and provides unbiased and objective investment advice," Dudley noted.

Nearly half (49%) of those surveyed said they conduct personal research when making investment decisions. In particular, younger affluent investors, under age 55, rely less on professional advisors than other age groups surveyed and more on information sources such as newspapers/magazines (53%), and investment newsletters (37%).

"We are seeing some generational differences when it comes to making investment decisions, as this younger age group is accustomed to searching the Web. Close to half (42%) of those under 55 rely on financial and investment websites and online services for information," observed Dudley.

Surveyed millionaires with more than $10 million of investable assets are the group most likely to use personal research (51%) and least likely to consult with friends or relatives (7%) when making decisions about investing. More than half (53%) favour newspapers and magazines and 41% cited investment newsletters as information sources for investing.

According to the survey, in order of importance, the three primary goals for investing cited by the millionaires is to fund retirement (73%), grow their estate to pass on to heirs (46%) and provide for their families (43%). Additionally, 21% said they give to charity, while 29% cited personal hobbies, including travel, art and recreation, as goals for investing.

There were distinct differences in survey responses among millionaires with more than $10 million in assets to invest. A vast majority (71%) of these investors said their primary goal for saving and investing is to grow their estate and pass it on to heirs, indicating that they have already accumulated sufficient funds for retirement. In addition, many of those surveyed are philanthropic-minded, as close to half (41%) said they employ various charitable giving strategies.

Also, wealthy investors are worried that external factors will have a negative effect on stock market returns. For instance, of most concern to slightly more than half of millionaires (51%) is a spike in the price of oil. Nearly as concerning to 47% of respondents is the possibility of a major terrorist attack. Affluent investors were less concerned about corporate scandals (10%) or other world events (15%).

The Northern Trust survey was conducted in November 2004 among 1,235 millionaire investors, clients and non-clients. The margin of error is plus or minus three percent.

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