How many times have you assumed that rich people invest in hedge funds, offshore investments and other opportunities only available to those with means? I’ve had the same assumption many times myself. It wasn’t until I began working as a stockbroker that I saw how rich people invest.
In many cases, it’s not that complicated. Many times it’s simply following a sound strategy that seeks to grow their wealth over time. A recent study from Openfolio bears that out showing that those considered in the top one percent enjoyed gains of close to four percent while those in the bottom one percent saw losses of over three percent.
For those not doing the math, that’s a difference of 7 percent. The study has some drawbacks, in my opinion, mainly only surveying their clients over the past 12 months, but it still brings out some interesting points to consider with investing. If you’ve ever wondered ‘how do the rich invest?’ here are three relatively simple practices many follow and why they aren’t that difficult for anyone to implement.
The Rich Avoid Paying too Much
This is probably the most common characteristic I saw when speaking with rich clients. They did all they could to avoid paying too much in investing fees. They don’t give into the investing lie that paying more for their investments means they’re getting better service.
This makes sense on multiple levels. First, it took time to amass their wealth (especially if it came as a result of their work) so why would they want to spend it foolishly on needless fees?
Secondly, they know that fees make a huge difference when it comes to returns. As I’ve written before, the SEC reports that a .75 percent difference in fees results in a loss of $30,000 over the course of 20 years on an initial investment of $100,000. Most rich people will be investing significantly more than $100,000 so their loss will only be greater.
So, how do the wealthy invest if they want to avoid fees?
- They avoid actively managed funds.
- They make portfolios that have low turnover.
- They don’t invest a large portion of their investments in single stocks.
Instead, they keep a pretty straightforward portfolio – generally speaking of course.
The Rich Are Properly Diversified
I used to believe diversification meant owning stocks of several different companies, or owning several different mutual funds. While it is possible to be diversified with such a portfolio; it’s rarely the case for many investors. True diversification, on the other hand, owns not only different types of investments but also different types of companies.
This is something many rich investors understand and implement. That’s for one key reason, as the Openfolio study shows, it drags down volatility and makes a portfolio less prone to wild and crazy swings. This doesn’t mean they will never experience crazy swings, but it protects them from unnecessary volatility.
If you want to invest like the rich, that means to avoid the “hot tip.” Hot tips on a specific stock can be fun to follow, and in some cases may result in a huge upswing, but it can often lead to significant losses.
This isn’t to say the rich don’t own individual stocks because they do, it just means they may have less of their portfolio, on a proportionate basis, in individual stocks. They also realize diversification requires rebalancing their portfolio on a regular basis and not ignoring it completely.
The Rich Don’t Give in to Panic Selling
It’s easy to want to sell everything when the market is going crazy. Investing can be an emotional exercise, and it sucks to see losses. However, one of the worst things to do when investing in the stock market is to sell in a panic as you only lock in your losses. In fact, SigFig reports that wealthy investors turnover their portfolio one-quarter of the time than less wealthy investors do – largely due to panic selling or trying to time the market.
Rich investors understand that risk is a part of investing, and that opportunity is born out of those losses that help them build their portfolios. Many, like Warren Buffett, will even use it as an opportunity to get investments at a value and ride them back up to higher levels than before.
At the heart of this sentiment is emotions and knowing how to control them with investing. It’s not always easy to separate your emotions, but doing so and thinking logically helps rich investors grow their portfolios because they stay in the market instead of avoiding it for one fear-based reason or another.
Investing Doesn’t Have to Be Difficult
Many believe the stock market is only for the wealthy. I’ve regularly heard that sentiment for years and used to be guilty of it myself. Many also believe there is some sort of special code or expertise to beat the market. Both of those beliefs are wrong and only hold you back from growing your wealth.
You can invest like the rich, albeit it in a reduced capacity and within your means. The key to doing so is education. According to research from the University of Maryland, education and sophistication of knowledge are the keys to being a better investor.
I know that in certain circumstances it may be difficult to get the education needed to invest comfortably. There are also some who honestly don’t have the funds to invest in the stock market. For many others, however, that’s not the case, and they simply need to start either educating themselves or actually investing in the stock market.
If you want to invest like the rich, implementing the three above tips can be quite simple. You can accomplish both tips #1 and #2 together. There are many options to do this, from Vanguard or Fidelity or Betterment if you want someone to manage your investments for you.
I commonly hear that only rich people can get access to an advisor. Thanks to options like Betterment or Wealthfront, that’s available even if you’re investing with little money. Both also offer good diversification opportunities, so you know you’re managing risk appropriately. If you’re investing through a 401(k), you can also get similar help through many Target-Date Funds. This isn’t to say you shouldn’t invest in individual stocks and only invest in passive index funds, but to seek balance in being diversified.
The final tip to invest like the rich isn’t always as easy to conquer but is very possible. The best way to avoid panic selling is keeping a long-term mindset, even when the stock market is having heart palpitations. It’s not always easy to do when you’re watching your retirement account lose money, but the last thing you want to do is lose out on the resulting upswing.
What are some ways you invest like the wealthy? Do you own individual stocks – how many? How do you avoid selling when the market is going down?