Secrets of extreme wealth investing

Classic investment choices for liquid funds include stocks (equities), bonds, and cash (usually money market or short-term CDs).Most investments involve an asset allocation among these three asset classes and hopefully a long, disciplined commitment to them. Historically, equities provide the highest long term return, followed by bonds and then cash. Especially in equity investments, choices are divided between active and passive funds (usually mutual funds or ETFs). Active funds employ managers and analysts to try to discern the best performing stocks (or bonds) and to make a higher return than just buying a large number of stocks/bonds in the pool selected. So, an active fund manager picking stocks in large American companies is trying to usually find the best company stocks in an index like the S&P 500 instead of just buying almost all of the stocks in the index (passive). Since markets are volatile, good investors in these asset classes should plan on a long-term view.Trying to move in and out of the investments based on hunches or other perceived information is almost always a losing strategy, other than maybe buying and selling at marked extremes of valuations (such as buying in 2008-9, selling tech stocks in 1999). We know that very few active investors exceed the returns of just buying the inexpensive passive index funds — but sometimes hope springs eternal.

You may not be aware that there are an array of “investments” offered to very wealthy families and individuals that I’ll discuss here. You might see these called “alternatives.” In the past, most of these investments required that one be an “accredited investor” and an AI search for the definition of an accredited investor finds:

An accredited investor is an individual or entity that the Securities and Exchange Commission (SEC) deems sophisticated enough to invest in private securities offerings, due to their financial sophistication and ability to handle the risks involved. These investors are generally permitted to participate in investments not registered with the SEC, such as private placements, hedge funds, and venture capital.

Individual Accredited Investor Criteria:

Earned income exceeding $200,000 (or $300,000 jointly with a spouse) in each of the past two years, with a reasonable expectation of the same for the current year.

A net worth exceeding $1 million, either individually or jointly with a spouse, excluding the value of their primary residence.

But many new products are being rolled out to allow participation in similar investments by almost anyone.

Let’s examine some of these investment types and consider if they are advisable.

Hedge Funds: These funds can invest in almost any assets globally, but usually focus on betting on some stocks and betting against other stocks simultaneously. They seek to profit on both sides. Some hedge funds have had spectacular success (whether luck, timing or skill), but most do not. They tend to be very expensive and very illiquid (you get your money back when they decide and that is often many years later). They also lack transparency, as you have no idea what they are doing with your money. Unless you have particular access to the very best managers (unlikely if you are not already very wealthy), I’d stay away.

Venture Capital: These funds invest in early start up type companies and supply the financing to help them grow and succeed.They then sell their interest to bigger VC funds and or the company goes public (goes on the stock market) which allows the fund to receive money back for their investors. They are also expensive and illiquid and you should have access only to top firms if you hope to do well.

Private Equity: These funds often buy companies and either strip them of assets or try to improve and sell the better product. A flood of money has come into the funds over the last decade and we see regular reports that private equity funds are finding it difficult to exit and get their money back. They are also expensive and illiquid.

Private Credit: These are funds that lend to private enterprises (including often Private Equity funds) at high rates of interest. These funds are getting a lot of current publicity as Wall Street seeks to move money out to smaller investors.

These funds are also expensive and illiquid (no surprise) and only very sophisticated investors should look at them.

Real Estate: We are not talking about widely traded Real Estate Investment Trusts (REITs) here which are actively traded on public markets and monitored by the SEC. Here we’d be wary of “private real estate,” “non-traded REITs” and real estate “syndications.” Again, expensive and illiquid and unlikely to reward you enough for all the downsides.

Interval Funds: These are funds that can technically invest in almost any of the above type funds. They are listed on the stock exchanges and look just like mutual funds that are valued and can be sold any business day. However, interval funds will limit redemptions (getting your money back), usually only available quarterly and with severe limits on investors ability to get access to their funds. Typically, the sponsoring fund will limit total redemptions to 5% a quarter.You should be aware of these expensive, illiquid vehicles if you are having a non-fiduciary advisor making investment recommendations.

Commodities represent a different asset class and are therefore attractive in diversifying one’s portfolio. However, the reality of investing in commodities is that they are often in third world countries with their less than transparent regulation and accounting. In addition, which commodities—oil, copper, gold? This asset class has been a mostly disappointing place to put one’s money.

David Swenson was the highly successful chief manager of the Yale endowment fund for many years. His record was spectacular, and he pioneered investing in many of these alternative products. But he did this early and wrote a book for more typical investors (you and me) in which he strongly cautioned against trying to invest like an endowment. He related that most of us have no access to the “best” alternative funds, and therefore would be unlikely to mirror his success. He recommended the tried-and-true stocks and bonds investing for a best outcome. I strongly agree!

Steven Podnos MD CFP practiced pulmonary and critical care medicine in both private practice and in the Air Force reserve for forty years.He is the founder and CEO of Wealth Care LLC, a fiduciary fee-only financial planning practice and can be reached at [email protected].