As investors gather more assets and develop more sophistication, their investment style with often evolve. Sometimes, however, we’ll still see investors who have accumulated large investment accounts and maintain the same investments in mutual funds that they owned years ago. On the other hand, it’s possible for investors who develop sophistication quicker than they can accumulate assets. For these people, it might make sense to invest like the rich.

Mutual funds serve a very useful purpose for a beginning investor. They allow the investor to make regular, small deposits for no cost (generally) and they provide built-in diversification. It just wouldn’t make sense to dollar-cost average into an ETF if the dollar amount is very small. (As an example, $10 is 2% of $500, so paying a $10 commission on a $500 trade costs the same as owning a mutual fund with an MER of 2% for a year.)

As the dollar amounts increase, it might make sense to shift from mutual funds to ETFs and eventually to a collection of individual stocks or bonds in order to minimize the cost. In theory, it costs nothing to own a portfolio of stocks for a year if the investor places no trades. In practice, most investors place a number of trades, especially those who are still saving (in the “accumulation phase”.)

Once an investor has a portfolio of ETFs or individual stocks and bonds, how else can the portfolio become more sophisticated? Remaining in the realm of liquid, stock/bond-market-based investments, hedge funds and leveraged 130/30 funds come to mind. A hedge fund has fewer restrictions than a mutual fund and is restricted to “accredited investors”. They can leverage and go short, and they can invest more of their assets in a single company. In short, they are able to increase risk for a chance at increased returns, or they can implement an “alternative” investment strategy to try and reduce volatility of returns.

However, hedge funds will still react to the pressures and vagaries of the market. To avoid that, and for other reasons, many wealthy investors own private holdings. The most common seem to be a private business (such as an incorporated professional or a small business owner) or real estate. These usually produce a return in the form of a stream of income as well as an eventual increase in value, but they have a market value that is difficult to determine. In this way, it doesn’t appear to react to market forces. At the same time, it often requires time and attention from the investor/owner.

Another possibility is to add a stream of royalty income such as timberland, oil and gas or patent or copyright. This can be owned directly or through an income trust or limited partnership. Some serious effort should be directed to understanding what you own. There may be legal requirements, regular negotiations or other complications that apply.

In order to invest like the rich, an investor should consider expanding their expertise and the type of asset they are willing to own in order to produce income or increased value. These “alternative” assets might increase risk or require additional commitment and effort and should not be acquired lightly. The rewards, however, are likely to include an improved return and a reduced reliance on the fickle stock and bond markets.

Invest Like the Rich

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