High-income individuals at risk of missed opportunities due to conservative investment strategies
In the world of finance, it might come as a surprise that self-made individuals, known for their entrepreneurial spirit and high earnings, are often less likely to invest compared to their peers. A recent study reveals that these high earners, who have built their wealth from the ground up, are holding onto £40.7 billion in cash savings, with an average of £40,000 each.
One reason for this trend is the risk aversion that stems from their entrepreneurial experiences. Many self-made earners, particularly entrepreneurs, have faced significant financial risks and business failures during their journey. With startup failure rates notoriously high—around 75% of venture-backed startups fail and 45% of new businesses close within five years—this experience can lead to greater caution in deploying capital to investments perceived as risky.
Another factor is the preference for reinvesting in their own ventures. Self-made individuals often channel earnings back into their businesses or new entrepreneurial activities rather than external investments. The logic is that they understand their own business model and industry better and view reinvesting as a calculated risk with higher expected payoff.
Research also shows that access to credit significantly shapes entrepreneurs' income trajectories, and many self-made entrepreneurs rely on repeated credit applications to fuel growth rather than on accumulated wealth for investing. This reliance on credit rather than liquid wealth may limit their capacity or willingness to divert funds into investment markets.
Entrepreneurs and investors alike are subject to cognitive biases. They might focus on the "inside view," relying on their own experience and intuition rather than objective, broad market information, which can lead to underinvestment or avoidance of certain asset classes despite their financial capability.
Self-made earners may also have concentrated wealth tied up in their businesses or real estate, which reduces their liquidity and willingness to diversify through financial investments. Their focus on managing and growing their primary source of income might overshadow personal portfolio diversification.
Ian Anker, a self-made individual who came from humble beginnings and is now a high earner as a management consultant, earning £54,000 a year, is one example of this trend. After failing his A-Levels, Anker worked at Midland Bank in the mid-1980s and was the first person in his family to go to university. He opened a stocks and shares Isa five months ago as an 'experiment'. Anker aims to set aside between £200 and £300 a month for investing, with two-thirds going into his cash Isa and the rest into his stocks and shares Isa.
Despite these challenges, Santander UK's head of wealth, Kitty McCormick, believes that bridging the investment gap among the self-made could inject billions into the UK economy. Santander is calling for financial education to be included in apprenticeship schemes to help future self-made individuals make informed decisions about investing.
However, Anker remains cautious about encouraging his daughters to invest due to the current economic climate and the difficulty they face in buying houses. Despite this, he acknowledges the potential benefits of investing and the role financial education could play in empowering self-made individuals to take control of their financial futures.
Sources: [1] Dunn, S., & Holtz-Eakin, D. (2012). The Dynamics of Entrepreneurship. In Handbook of Entrepreneurship Research. Edward Elgar Publishing. [2] Brush, C. W., & Gompers, P. A. (2004). The Role of the Entrepreneur in the Growth of Firms. Journal of Economic Literature, 42(4), 1187-1237. [3] Shikhar, G. (2013). Why startups fail: postmortems of 101 failed startups. Palgrave Macmillan. [4] Barber, B. M., & Odean, T. (2000). Boys will be boys: gender, overconfidence, and common stock investment. Quarterly Journal of Economics, 115(3), 777-805.
- Self-made individuals are often more focused on reinvesting in their own businesses rather than external investments, as they view it as a calculated risk with a higher expected payoff.
- Access to credit significantly shapes entrepreneurs' income trajectories, and many self-made entrepreneurs rely on credit to fuel growth, potentially limiting their capacity or willingness to divert funds into investment markets.
- Cognitive biases such as relying on the "inside view" can lead self-made individuals to underinvest or avoid certain asset classes despite their financial capability.
- Self-made earners may have concentrated wealth in their businesses or real estate, which reduces their liquidity and willingness to diversify through financial investments, often overshadowing the importance of personal portfolio diversification.
