An Overview and Comparison of How Multimillionaires and the Super Rich Invest Their Money
While the phrase “invest like a multimillionaire” may evoke connotations of get-rich-quick schemes, investing like a multimillionaire and becoming one are usually two distinct processes – the majority of multimillionaires earned their fortunes through business endeavors, before they started picking stocks and bonds to add to their portfolios.
In this guide we're not going to show you how to become a multimillionaire through investing. Instead, we're going to cover the investment habits and practices commonly employed by people who have already obtained their millions, and point you towards the information you need to get started investing like a multimillionaire. But before we do that, let's look into…
The Mindset and Perspective of the Average Multimillionaire Investor
Even in today's relatively inflated economy, a couple million dollars is still viewed as a small fortune in most circles. However, poor investing decisions and profligate spending habits can easily dwindle a multi-million dollar fortune in less than a decade.
Wise money managers are aware of this unfortunate reality and are therefore often more cautious about their investing decisions than people who have not yet earned a fortune, which makes sense because the ‘fortuneless' are trying to create a fortune, whereas the ‘already fortunate' are mostly trying to protect one, while also building wealth of course.
Statistics from a Fidelity Millionaire Outlook report, based on a survey of more than 500 multimillionaire investors:
|Multimillionaire Investor Survey Results|
|30% mostly concerned with preserving their wealth|
|20% mostly concerned with growing their fortune|
|92% of Gen X/Y millionaires rely on financial advisors for long-term planning|
|68% of older investors rely on financial advisors for long-term planning|
|25% feel they need an average of $5 million in investable assets to “feel wealthy”|
Here's a generalized rundown of the thought process that drives the decision-making rationale of many multimillionaire investors:
“I've already earned a small fortune. As long as my spending habits are conservative it should last me a while. If I have $3 million and I take out a $100,000 salary each year, I can live comfortably, but not lavishly, for about three decades. But of course I want more – more for retirement, more the future generation? Who doesn't? So I'm going to make this money grow, but my top priority is to protect it.”
So the multimillionaire has this inevitable epiphany and decides to become investment-savvy, leading them to countless hours of internet research, in-depth consultations with financial advisors, and late nights hovered over finance-related books and magazines.
After assimilating all of that advice and wisdom, they devise their own unique portfolio to accommodate their particular goals, but regardless of their specific investment decisions, most are instructed or intuitively inclined to utilize the 4 principles and tactics listed below:
1. Practice Selective Diversification
You've probably read in a dozen different places that your investment portfolio should be “diversified” to minimize risk. Here's the thing though, a portfolio packed a with a diverse range of failing stocks is still a failing portfolio – there's no way around it. The two factors that are going to primarily determine the success of your portfolio are:
a) your ability to choose low-risk, moderate-return investments that are likely to perform well
b) the subsequent performance of each individual instrument or asset
A portfolio of only 5 consistently well-performing investments is preferable over a portfolio of 20 high-risk investments that could cause significant loss. So contrary to popular misconception, sheer diversity is not nearly as important as scrutinous selectivity.
Many multimillionaires don't have the time or willingness to independently manage their own portfolios, so they commit to a fund and let a professional choose their investments for them. Others dive straight into managing their own investments. For the sake of diversity, why not try both at the same time and see which one provides better results? You could cross reference to see how well your custom-built portfolio performs against a popular mutual fund, and then make adjustments accordingly.
When selecting your own investments, consider the following tips:
- Don't rely solely on historical data – the way a stock or other instrument has performed in the past does not indicate how well it will do in the future.
- Aggregate information continually – the best way to make well-informed decisions is to scout recommendations and speculation from a variety of sources. Subscribe to newsletters, follow blogs and TV shows, and stay-up-to-date on the latest events in the financial sector.
- Avoid high-risk investments – opting for a safer yet less profitable return is always preferable over taking a risk on an investment that could go either way.
- Consider opposing arguments – when you get a stock recommendation or other investment suggestion from a pundit or advisor, don't immediately take their word for it; they could have vested interests or they could be plain wrong. Consider the opposing side of the argument in every instance and make your conclusion based on the results of your own fact-finding and discretion.
- Diversify after diversifying – diversification is more than just utilizing a broad range of instruments and assets (i.e. – stocks, bonds, ETFs, mutual funds, etc.), it means taking it a step further and diversifying within each investment type. For example, if you've already invested in Home Depot stock and you're looking to invest another company's stock as well, it may be wiser to purchase the stocks of a grocery or department store (i.e. – Walmart) rather than purchasing the stocks of a competing hardware store like Lowes – if your stocks are in direct competition with each other you could wind up offsetting your profits when one does well but the other does poorly.
- Don't be afraid to go outside the norm – Benjamin Graham, one of Warren Buffet's teachers, was referred to as the father of value trading. If you were to look into his portfolio you would see that he had a lot of uncommon stocks. He excelled in taking a creative approach and made significant profits on stocks that the general public seemed to have overlooked. When a relatively rare stock suddenly achieves success it can be much more profitable than a popularly held stock that gradually increases in value.
- Analyze risk first, then return – This is a key differentiator in how wealthy investors think vs. how retail level investors think. Retail level investors tend to chase the highest returns and are okay with moderate risks as long as the potential return justifies the risk. Instead, selecting low-risk investments should be the highest priority. From a multimillionaire's perspective, an investment that is low-risk with moderate return potential should always be preferred over a moderate-risk investment with higher return potential.
- Pay attention to industry insight – Some of the best investors in the world make their decisions not based on trackers, tickers, graphs, charts, and other statistical data, but rather on current and upcoming events highlighted in the news and industry reports. Upcoming product releases, mergers/acquisitions, scandals/lawsuits, and other events that could shape the progression and growth of a company are all points to pay attention to while in search of your next big move.
If you haven't become a reader of the Investopedia online university, you might want to start today – no self-respecting internet-savvy investor can say that they've never relied on it for information at one point or another. Obviously, discussing everything about selecting the right investments goes beyond the scope of this article, so here are some good starting resources:
2. Comparing the Average Portfolios of Multimillionaire and Mega-MIllionaire Investors
Once you're confident in your ability to start selectively diversifying your own portfolio with the help of a financial adviser, an auxiliary step you can take to gain insight and inspiration is to examine the portfolios of other successful multimillionaire investors. Here are a few examples of portfolio structures that are similar to those used by multimillionaires:
According to data given to Forbes by IPI, the average asset allocation of the super-rich looks something like this:
Hover mouse over slices for easier viewing:
However, according to investment specialist Phil DeMuth, the above portfolio structure only netted investors an average of a 10% return for 2012, which is much lower than you would expect, and certainly nothing to aim for. Does this show that the majority of the super-rich aren't such great investors after all, or does it imply that they're less focused on profits and more focused on security? Either way, we're sure most of them aren't managing their own portfolios, so their portfolio managers are almost certainly leaning towards lower risk investments, which again is actually a wiser move than going for higher profits.
Note: You'll notice that in the above portfolio representation we've made the lone deviation of specifying that precious metals typically account for a portion of a prudent investor's cash/commodity holdings. Most governments consider precious metals the same as cash because they can be easily liquidated around the globe, and precious metals are also a commodity as well because of their use in various industries.
David Kaufman of Westcourt Capital characterizes the average asset allocation structure for the less wealthy multimillionaires, which you'll see differs significantly from the super-rich portfolio:
Although this appears to be a slightly less diverse portfolio on the surface, it provides a good point for the average multimillionaire (or aspiring multimillionaire) to start from. Even investors who have just hit their first million could theoretically use this asset allocation structure to begin investing funds in a more institutional and professional manner.
It should also be noted that the above portfolio comparisons are not intended to represent typical investor behavior in a pre-recession environment, in which many affluent investors would most likely be transferring a larger percentage of their savings into precious metals that are more stable in value than fiat currencies.
3. Gain Understanding and Confidence in Every Investment
Ironically, people with millions of dollars at their disposal are usually more cautious and conservative than people with less money to spend. Even with a multi-million dollar investment budget, there's no sense in risking even a single dollar on an investment that you don't fully understand and have confidence in. Committing funds to any asset or business without conducting the necessary due diligence beforehand is a common mistake made by the overzealous.
Here are some of the things you should understand about an investment before committing to it:
- How will the investment earn you money?
- What is the expected annual rate of return?
- What are the risks involved?
- How will the investment be managed and what are the terms governing trades, sales, and other dispositions of the assets/instruments that are being invested in.
- What are the laws and regulations pertaining to this particular investment type?
- What does the historical data for this investment show?
- If it is a business you're investing in, does it have a solid track record of being profitable? If not, is there reasonable evidence to suggest that it might become profitable in the future?
- What are some risk mitigation and management tactics that can be used to hedge against potential losses?
- What does your financial advisor think of this investment?
- What is being said about this investment in the news and online?
Warren Buffet has been quoted as saying: “never invest in a business you cannot understand.” Before investing a penny in a company you first must know how the business is making a profit, or why it is likely to become profitable in the future. If you've covered all of the basic points above you should have a thorough enough understanding to make a well-informed decision under almost any circumstance.
4. Protect a Portion of Your Wealth with Commodities and Precious Metals
Finally, all successful investors know the importance of devoting at least 5-20% of their investment portfolio to commodities and precious metals. Doing this gives you a backup plan that will ensure you don't lose everything even if all of your other investments fail, the stock market crashes, and the dollar implodes. Even in the worst economic scenario, precious metals like gold, silver, platinum and palladium will still carry value.
As a result, while other currencies are devalued due to inflation and other factors, the demand for precious metals increases, thereby driving the price up – so dedicating a portion of your portfolio to precious metals not only protects value, it also provides the opportunity to profit in the event that prices skyrocket during economic turmoil – although it would be wiser to hold onto your precious metals instead of selling them for a profit.
The primary reason for investing in precious metals is not to gain wealth but to preserve it.
Every multimillionaire should have a diversified portfolio that is specifically reserved for the retirement savings. One of the best ways to invest in precious metals while also saving for retirement is to open up a precious metals individual retirement account (IRA). To invest in gold within an IRA you'll need to choose a Gold IRA custodian. In the UK there is a similar alternative called a Self-Invested Pension Plan (SIPP). Both of these accounts let you use your retirement savings to invest in gold while taking advantage of numerous tax benefits.