Just because you’re rich doesn’t mean you’re smart

By Felix Salmon
August 18, 2009
tweet from Joe Weisenthal yesterday, on the subject of Annie Leibovitz, is I think revealing of a particularly American mindset: call it the Wealth Corollary of the Efficient Market Hypothesis. In a nutshell, it says that if you've made lots of money, you must be pretty smart.

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A tweet from Joe Weisenthal yesterday, on the subject of Annie Leibovitz, is I think revealing of a particularly American mindset: call it the Wealth Corollary of the Efficient Market Hypothesis. In a nutshell, it says that if you’ve made lots of money, you must be pretty smart.

I think there’s a pretty good case to be made that the EMH(WC) is responsible for a lot of the rules surrounding the limitations on who is and who is not allowed to invest in hedge funds, and also for many of the obsequious interviews with rich individuals frequently featured in the financial media.

“If she’s rich, smart and has access to good advisers,” said Joe, “it’s on her to take such a huge decision [borrowing $24 million from Art Capital Group] seriously.”

That’s fair, as far as it goes, but the only evidence that Joe had of Leibovitz being a smart person with access to good advisers was that she had lots of money. The problem is that it’s far too easy for people to simply assume, on the grounds of wealth alone, that therefore there must also be some degree of financial sophistication.

The annals of finance are full of people taking advantage of the financially-illiterate, and while it’s certainly possible to take advantage of the financially-illiterate poor (lotteries, numbers games, payday lending, overdraft fees, etc) it’s equally lucrative to take advantage of the financially-illiterate rich, both through outright fraud and through hidden and/or excessive money-management fees. Or, in the case of Art Capital Group, getting Leibovitz to take out a loan with punitive default provisions, in the full and certain knowledge that she would be forced to default.

The fallacy embedded in the EMH(WC) can be hard for financial journalists to grok, because we have such a high financial-sophistication-to-wealth ratio. (More thanks to a low denominator than to a high numerator, it must be said.) If a financial journalist became wealthy, there’s a good chance they would be qualified to look after their money reasonably well. But that doesn’t mean for a minute that the same is true of photographers, say, or baseball stars like Lenny Dykstra, or pop stars like Michael Jackson, or any number of other people who have struck it rich in the sports/media/entertainment business. Annie Leibovitz was ill-advised for many years, and would have been much better off taking simple off-the-peg advice from her client American Express. But they were smart enough not to go down that road:

Because of her credit issues, Leibovitz was forced to deal almost exclusively in cash. In 1987, American Express offered her a plum ad campaign. Ironically, Leibovitz’s application for a card had been denied many times.

The American Dream is fundamentally meritocratic: if you’re smart and work hard, you can be massively successful. But the reality is different: some people are massively successful, and some non-negligible proportion of those people is not smart at all, especially not when it comes to finances. Having lots of money, sometimes, just makes it that much easier not to ever worry or think about matters financial. And that, in turn, makes it much more likely that you’ll end up being taken advantage of.

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Comments
11 comments so far

Your example of Lenny Dykstra is a poor one. Dykstra didn’t make it rich in baseball. He made it rich after baseball with investments. He then made it very poor after that by making very stupid decisions in investments and in the publishing industry.

Whenever we’ve gone back and forth on topics like this, for years now, you often omit the concept of risk. The American Dream is NOT terribly ‘meritocratic’. People who achieve wealth and success without exploiting other people usually do so by exploiting opportunities and taking significant risks. Sometimes risk pays off, sometimes it doesn’t.

Financial journalists watch speculators all day long and often fail to see the legions of income investors quietly sitting on their blue chips and utility stocks for decades between sales.

Or just like on the golf course…it’s good to be lucky.

One could surmise as much about Mavs owner Mark Cuban…his business acumen in owning the NBA team has served him well (absent a NBA ring, of course). And yet, the dude also was incredibly lucky on market timing, selling his company to Yahoo prior to Nasdaq topping out and then once his agreements are in the clear, using options in a strategy to short Yahoo shares as they tumbled down.

Posted by Griff | Report as abusive

correction: just because you have a CFA and a HBS MBA does not mean you are rich

Posted by dvictr | Report as abusive

I don’t feel terribly sorry for Mrs. Leibowitz. She certainly worked very hard to earn her money, but if she was unwilling to apply one of the most basic principles in life (save for the rainy days) and instead went to Art Capital to pay for her expensive lifestyle, well, she had that coming.

Sorry for the social darwinist comment, but it really grinds my gears to see so much coverage of Mrs. Leibowitz’s (self-inflicted) travails. It reminds me of those NBA players who, during the 1998 strike, were really worried that they had to sell one of their Ferraris to keep their lifestyles. Please….

Posted by Lgg | Report as abusive

You say: “[W]hile it’s certainly possible to take advantage of the financially-illiterate poor (lotteries, numbers games, payday lending, overdraft fees, etc) it’s equally lucrative to take advantage of the financially-illiterate rich…”

Instead of “it’s equally lucrative” I’d say “it’s FAR MORE lucrative.”

Bernie Madoff wasn’t swindling the homeless.

Posted by AndrewBW | Report as abusive

” People who achieve wealth and success without exploiting other people usually do so by exploiting opportunities and taking significant risks.”

And then you have the Gary Colemans of the world.

Posted by Jon H | Report as abusive

Congratulations on blowing down a strawman. Joe’s point is not that all rich people are smart. His point is that a rich person can hire an adviser or lawyer to review a proposed deal or document, and should do so when $24 million is on the line. If the rich person fails to do so, he has only himself to blame. For the poor, on the other hand, hiring an adviser is not always an available option.

Kapish?

Posted by Dan Daoust | Report as abusive

This has nothing to do with efficient markets.. this is a stupid argument.

Posted by Kint | Report as abusive

Matt Stevens – So, Dykstra example wasn’t so bad after all…

Posted by Jonathan | Report as abusive

I believe this was best expressed in Fiddler on the Roof: “When you’re really rich they think you know.”

If I read this correctly, I would argue that there’s a bit of a logical fallacy with regard to how you’re defining the corollary to the EMH.

In the terms you’ve laid out here, the EMH effectively says “If the market is efficient, smart doesn’t equal rich.” Your description of the corollary is essentially, “Rich does equal smart, if market is efficient.”

But that’s actually the converse of the original EMH statement in these terms, which is not logically equivalent. The only statement that would be logically equivalent to the original EMH statement in this form is the contra-positive, which would be “If smart equals rich, then market is not efficient.”

Posted by Observer | Report as abusive
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