Where Are the Customers’ Yachts?
Why Does Wall Street Keep Selling Costly Products That Don’t Deliver?
by Chris Brown, Ph.D., MBA, CFP® and Ron A. Rhoades, JD, CFP®
The Invitation that Changes Everything
Imagine Sarah. She is sixty-four years old, a successful regional manager who has spent forty years diligently saving. She is about to retire and roll over her $1.2 million 401(k) – the lifeblood of her future security.
Last week, Sarah walked into a plush office in a downtown high-rise to meet with a Senior Vice President of a major brokerage firm. The advisor, dressed in a bespoke suit, slid a glossy, leather-bound proposal across the mahogany table.
“Sarah,” he said, his voice dropping to a confidential whisper, “standard mutual funds are for the average investor. But you’ve reached a level of wealth where you need institutional sophistication. We have access to exclusive vehicles – Private Equity, a Private Credit fund, and a specialized Interval Fund. These are the tools the endowments use. They provide downside protection and non-correlated returns.”
He showed her charts of smooth, upward-sloping lines. He mentioned terms like “illiquidity premiums” and “absolute returns.” The fee disclosure was buried in the appendix: a 1.5% management fee plus an “incentive allocation” of 20% of profits, on top of the underlying fund expenses.
Sarah left feeling flattered. She felt she was finally being invited into the “inner circle” of investing.
But here are the questions we must ask: Is Sarah being offered a financial lifeline, or is she being sold a product designed to transfer her wealth to the firm? Do these exclusive products actually deliver superior returns? And if not, why do so many intelligent people keep buying them?
A View from the 60th Floor
To answer these questions, let Ron share a story from a decade or so ago.
Ron took a group of finance students to New York City for a field trip. We visited a prominent global investment bank and were ushered into a boardroom on the 60th floor. The view was breathtaking, overlooking the Hudson River and the bustling harbor below.
The firm’s Vice President was hosting us. As he walked toward the floor-to-ceiling windows, he gestured enthusiastically toward a yacht basin far below.
“Look down there,” he said with pride. “See that 80-footer? That belongs to our Head of Fixed Income. The one next to it? That’s the CEO’s.”
He proceeded to point out several other luxury vessels owned by the firm’s senior executives.
The students were mesmerized. But Ron was reminded of a famous anecdote from 1940 by Fred Schwed, Jr. In his classic book, Where Are the Customers’ Yachts? or, A Good Hard Look at Wall Street, he recounts a visitor to New York who was shown the bankers’ and brokers’ yachts. The visitor naively asked, “Where are the customers’ yachts?”[1]
The answer, of course, was that there were no customers’ yachts. The customers had paid for the bankers’ yachts through fees, commissions, and trading costs.
Today, the yachts are bigger, the products are more complex, but the fundamental dynamic remains unchanged.
The Machinery of High Costs
Wall Street firms – investment banks, broker-dealers, and asset managers – are manufacturing businesses. Their “products” are investment vehicles like hedge funds, private equity (PE), business development companies (BDCs), and interval funds.
The pricing structure of these “exclusive” products is often exorbitant. A common structure is “2 and 20” – a 2% annual management fee on assets, plus 20% of any profits generated.[2]
Why do these products exist?
The Profit Imperative
They exist because they are incredibly profitable for the issuers. As Nobel Laureate William Sharpe explained in “The Arithmetic of Active Management,” the average active dollar must equal the market return minus costs.[3] High costs are a mathematical certainty of underperformance for the aggregate investor, but they are a guarantee of revenue for the firm.
Recent research from the National Bureau of Economic Research quantifies this stark reality: data on 5,917 hedge funds over 22 years shows that after incentive fees and management fees are assessed, investors received only 36 cents of every dollar earned on invested capital.[4] In other words, fund managers kept 64 cents.
The Sales Incentive
Brokers and “advisors” at non-fiduciary firms are often incentivized to sell these products. The commissions and revenue-sharing agreements attached to private placements and complex funds are significantly higher than those for low-cost index funds. When the salesperson earns more by selling you one product over another, whose interest are they truly serving?
The Allure: Why Do Investors Fall for It?
If the math is so bad, why do high-net-worth investors like Sarah buy them?
The Psychology of Exclusivity
Robert Cialdini, one of the world’s foremost researchers on the psychology of persuasion, identifies “Scarcity” as a key principle of influence.[5] Wall Street markets these funds as “limited capacity” or “invitation only.” This triggers a fear of missing out and an ego-gratification response. Investors believe that by paying higher fees, they are buying “alpha” (skill) that isn’t available to the general public.
The language itself is designed to flatter: “institutional-quality,” “sophisticated,” “accredited.” Who wouldn’t want to be part of that club?
The “Volatility Laundering” Illusion
Investors often fear public market volatility – the stomach-churning daily swings visible in any brokerage statement. Private assets (like PE or private real estate) are not traded on public exchanges. Their prices are based on appraisals or models, often updated only quarterly. This results in an artificially smooth return profile.
Cliff Asness, founder of AQR Capital Management, coined the term “volatility laundering” to describe this phenomenon.[6] As he explains, the illiquidity and infrequent pricing that came with private investments used to be acknowledged as a drawback – a “bug.” Today, this same bug is sold as a feature.[7] The risk is still there; it is simply hidden from your statement.
Research suggests that when private equity returns are “unsmoothed” to reflect their true economic volatility, the standard deviation of returns can increase by 50% or more.[8] That smooth line on the marketing brochure? It’s an illusion.
The Reality: Do These Products Earn Higher Returns?
Let’s examine what academic research actually tells us about these costly vehicles.
Hedge Funds: The Emperor’s New Clothes
While some legendary managers exist, the aggregate data is sobering. Research by Ibbotson, Chen, and Zhu decomposed hedge fund returns from 1995 to 2009 into three components: fees (3.43% annually), alpha or genuine skill (3.00%), and market beta or what you could have gotten from the market anyway (4.70%).[9][10] The result? The index fund returned an average of 8.5% annually, more than doubling the best-performing hedge fund in the bet, which averaged only 6.5%. The five fund-of-funds that took the other side of the bet earned their managers rich fees every year – even as their investors lagged far behind the market.[11]
Private Equity: The Billionaire Factory
Private equity is often touted as the holy grail of high returns. However, Ludovic Phalippou, Professor of Financial Economics at Oxford’s Saïd Business School, published groundbreaking research that challenges this narrative.
In his study “An Inconvenient Fact: Private Equity Returns & The Billionaire Factory,” Phalippou analyzed PE fund performance using multiple large datasets. He found that net of fees, private equity funds have returned about the same as public equity indices since at least 2006.[12] Large public pension funds received a net multiple of money (MoM) within a narrow 1.51 to 1.54 range – roughly equivalent to what they would have earned in the stock market.
But here’s the striking finding: the estimated total performance fees (“carry”) collected by PE funds raised from 2006 to 2015 totaled approximately $230 billion – most of which went to a relatively small number of individuals. The number of PE multibillionaires rose from 3 in 2005 to 22 in 2020.[13]
The difference? The PE managers became billionaires, while the investors took on illiquidity and leverage risk for no distinct advantage.
It is worth noting that more recent industry data from sources like McKinsey and Cambridge Associates suggests private equity has outperformed public markets over certain longer time horizons.[14] However, these findings must be interpreted carefully: performance varies dramatically across vintages and managers, with top-quartile funds delivering substantially better results than median performers. Large institutional investors – with hundreds of millions or billions to invest – can often negotiate with private equity and hedge fund managers for lower fees. For the average investor without access to top-tier managers, the picture is considerably less rosy.
Are They Good Diversifiers?
The final sales pitch Sarah heard was that these assets are “non-correlated” – meaning they zig when the stock market zags, providing protection during downturns.
History suggests otherwise. During periods of extreme market stress, such as the 2008 Global Financial Crisis, correlations across almost all risky asset classes – including hedge funds, private credit, and private equity – converged toward one.[15] The Lehman Brothers collapse resulted in significant increases in correlations across global stock markets.[16] In other words, when you needed diversification most, these expensive products fell in lockstep with everything else.
Research from the European Central Bank documented a “build-up of connectedness” in the hedge fund sector leading into the financial crisis, finding that funds with high commonality were strongly affected by liquidity shocks and negative returns precisely when investors needed protection most.[17]
Furthermore, “Private Credit” and BDCs often involve lending to companies that are too risky for traditional bank loans. In a recession, these are often the first loans to default. That is not diversification; that is amplified credit risk.
Sarah’s Choice: The Prudent Path
Let’s return to Sarah. If she signs that proposal, she is likely locking up a portion of her money for years, paying 2.5% or more in annual fees, and funding the next yacht in the harbor.
The alternative? The Prudent Investor Rule.
Sarah needs to reject the sales pitch and demand a portfolio managed under the Prudent Investor Rule. This legal standard, adopted in some form by virtually every U.S. state, requires a fiduciary to:
- focus on the total portfolio risk and return;
- diversify across broad asset classes; and
- to avoid high-cost investment products.
This tough standard of care is voluntarily adhered to by only a small minority of investment advisers today – but you should require it (and have it placed in writing).
Academic research overwhelmingly supports that a low-cost, globally diversified portfolio of public securities (stocks and bonds) offers the highest probability of capturing the market’s long-term returns.[18] Nobel Prize-winning research has demonstrated that most actively managed funds fail to beat their benchmarks after accounting for fees – and those that do rarely persist in their outperformance.
What You Can Do
The financial industry is filled with brilliant marketing designed to separate you from your wealth. To protect your retirement:
Ignore the “Exclusive” Hype. If a product requires a 40-page explanation and a “lock-up” period, it is likely designed to benefit the seller, not you. Complexity is often the enemy of the investor and the friend of the financial firm.
Seek a Fee-Only Fiduciary. Ensure your advisor is compensated only by you, never by commissions from the products they sell. Ask directly: “Are you a fiduciary at all times, and how are you compensated?”
Ask the Right Questions. We have prepared a document, “10 Questions to Ask Any Financial Advisor,” to help you uncover conflicts of interest. Read it as a blog here or download the PDF version here (and accompanying worksheet here).
Understand the Math. Remember William Sharpe’s arithmetic: before costs, the return earned by the average investor will equal the market return. After costs, the return earned by the average investor will be less than the market return. The higher the costs, the greater the shortfall.
The Choice Is Yours
Sarah decided to walk away from the 60th-floor view and the high-fee products. She found an independent fiduciary who built her a transparent, liquid, low-cost portfolio. She kept her wealth compounding for her own retirement, not for an executive’s yacht.
The questions we posed at the beginning now have clear answers: Sarah was being sold a product designed to transfer her wealth to the firm. These exclusive products, in aggregate, do not deliver superior returns after fees. And intelligent people keep buying them because of powerful psychological biases that Wall Street has learned to exploit masterfully.
Will you make the same choice Sarah did?
Does your financial advisor truly represent you – and will they protect you from Wall Street’s hype for high-cost products? Or does your financial advisor sell products – that benefit their firm, rather than you?
The customers’ yachts are waiting to be built – the question is whether they will belong to you, or to the people selling you financial products.
About the Authors
Ron A. Rhoades, JD, CFP®
Ron Rhoades is an Associate Professor of Finance at the Gordon Ford College of Business, Western Kentucky University. He also serves as a financial advisor at Scholar Financial, a practice within XY Investment Solutions LLC. With a background as both an attorney and a CERTIFIED FINANCIAL PLANNER™ professional, Ron is a nationally recognized authority on the fiduciary duties of financial advisors.
Chris Brown, Ph.D., CFP®
Chris Brown is a faculty member in the Department of Finance at the Gordon Ford College of Business, Western Kentucky University, and a financial advisor at Scholar Financial, a practice within XY Investment Solutions, LLC. He holds the CERTIFIED FINANCIAL PLANNER™ designation and a Ph.D. in Finance. His research and teaching focus is on behavioral finance, retirement planning, and evidence-based investment strategies.
Endnotes
- Schwed, 1940
- Picardo, 2024.
- Sharpe, 1991
- Ben-David et al., 2020
- Cialdini, 2007
- Asness, 2022
- Asness, 2022
- Geltner, 1993; Rabener, 2020
- Ibbotson, Chen, and Zhu, 2011.
- Hayes, 2025.
- Buffett, 2017
- Phalippou, 2020
- Phalippou, 2020
- McKinsey, 2025
- Syllignakis & Kouretas, 2011
- Kenourgios et al., 2013
- ECB, 2014
- Fama & French, 2010
Sources
Asness, C. (2022). Volatility laundering. AQR Capital Management Perspectives. https://www.aqr.com/Insights/Perspectives/Volatility-Laundering
Ben-David, I., Birru, J., & Rossi, A. (2020). The performance of hedge fund performance fees (NBER Working Paper 27454). National Bureau of Economic Research. https://www.nber.org/papers/w27454
Buffett, W. (2017). 2016 Annual letter to shareholders. Berkshire Hathaway Inc.
Cialdini, R. B. (2007). Influence: The psychology of persuasion (Revised ed.). HarperCollins.
European Central Bank. (2014). Commonality in hedge fund returns (ECB Working Paper No. 1658). https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1658.pdf
Fama, E. F., & French, K. R. (2010). Luck versus skill in the cross-section of mutual fund returns. The Journal of Finance, 65(5), 1915–1947.
Geltner, D. (1993). Estimating market values from appraised values without assuming an efficient market. Journal of Real Estate Research, 8(3), 325–345.
Hayes, Adam. (2025). How Warren Buffett Won a $1 Million Bet Against the Hedge Fund Industry: What It Means for Investors. Investopedia. https://www.investopedia.com/warren-buffett-usd1-million-bet-8779290
Ibbotson, R. G., Chen, P., & Zhu, K. X. (2011). The ABCs of hedge funds: Alphas, betas, and costs. Financial Analysts Journal, 67(1), 15–25.
Kenourgios, D., Samitas, A., & Paltalidis, N. (2013). Stock market correlations during the financial crisis of 2008. Journal of International Financial Markets, Institutions and Money, 21(5), 662–680.
McKinsey & Company. (2025). Global private markets report 2025: Braced for shifting weather. https://www.mckinsey.com/industries/private-capital/our-insights/global-private-markets-report
Phalippou, L. (2020). An inconvenient fact: Private equity returns and the billionaire factory. The Journal of Investing, 29(5), 10–27.
Picardo, Elvis. (November 25, 2024). Two and Twenty: Explanation of the Hedge Fund Fee Structure. Investopedia. https://www.investopedia.com/terms/t/two_and_twenty.asp
Rabener, N. (2020). Private equity is still equity, nothing special here. The Journal of Investing, 29(7), 66–79.
Schwed, F., Jr. (1940). Where are the customers’ yachts?: or, A good hard look at Wall Street. Simon and Schuster.
Sharpe, W. F. (1991). The arithmetic of active management. Financial Analysts Journal, 47(1), 7–9.
Syllignakis, M. N., & Kouretas, G. P. (2011). Dynamic correlation analysis of financial contagion: Evidence from the Central and Eastern European markets. International Review of Economics & Finance, 20(4), 717–732.
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