Once you’ve maxed out your 401K, you should open an account at a financial institution, and buy stocks with the remainder of your savings. In the previous section on 401Ks, I was more focused on the mechanics of the 401K, and the employer match, rather than discussing how to actually invest the money. I want you to invest those funds in the manner discussed in this chapter. Generally speaking, your 401K will have an easy online investment portal that will allow you to choose your investments. Just go ahead and invest as described below.
If you absolutely hate stocks, go ahead and skip to the real estate section. But let me say before you go that you’re missing the boat, and should investigate this further. It’s a great way to easily build long term wealth, without any effort on your part.
I also think the stock market is a good place to invest funds while you’re saving up for a down payment for real estate. With investment real estate, as we’ll discuss, you’ll need to assume you’re going to need at least a 25% down payment on your properties. You’ll also need more cash than that to cover repairs, vacancies, etc. You may even decide that you want to put down 100% on your properties in order to eliminate the risk of not being able to pay your mortgage completely.
What I’m getting at is there’s likely to be a long time between when you start saving to buy a property, and when you actually purchase the property. In the meantime, if you stick the money in the stock market, it will have a better chance of growing, and you’ll reach your goals faster.
Now, I say that with a huge caveat. The stock market goes up, but it goes down as well. There’s been periods in fact where it’s gone down in value for a LONG period of time. For instance, in times of a recession, when real estate prices are likely attractive, your portfolio will have likely declined significantly in value, leaving you unable to buy anything. If you’re not comfortable with that risk go ahead and just save cash for real estate, but understand that your money won’t be earning ANYTHING in the meantime. My personal belief is that it’s worth the risk, as your money will likely appreciate in the interim, and you can wait it out if stocks go down in value.
The great thing about stocks is that they are a quick and easy way to build wealth. Money will automatically go from your paycheck to your 401K and your non-qualified (non-401K) stock account. You can have your account automatically invest in the stock market for you. You can do all this without any research or effort, and you’ll become wealthy over time. It’s a great deal in that respect.
Don’t listen to people who say “the stock market is risky” or “you can lose everything in stocks”. They’re wrong. If you invest correctly in the stock market, by following the instructions outlined later in this book, then over time you’ll make a ton of money in the stock market.
When I say the “Stock Market”, I mean investing in a large pool of stocks in one or more index funds, like the S&P 500. When “people” say the “Stock Market” in order to put it down, they usually mean investing in individual stocks. Yes, if you invest in individual stocks, and they go down, and you sell, you can lose money in the stock market. Whenever you hear that someone lost everything in the stock market, they were betting on individual stocks. But if you invest in index funds, like I’m telling you to do, and don’t ever sell until you retire, you won’t lose money over time.
Since 1926, the S&P 500, which is the largest 500 companies in the US, has earned about 10% per year. That’s probably going to be about what it’ll make in the future. That means if you invest your $19,500 into your 401K for 30 years, at the end of it you’ll have around $3,673,292. Want to check that for yourself? Go to google, and type “Compound Interest Calculator”. You’ll understand why Einstein called compound interest the 8th Wonder of the World.
Stocks can go down, temporarily. For instance, from October 10, 2007 to March 9, 2009, the S&P 500 went down in value 56.8%. That’s a huge downturn! You know how much you would have lost had you owned stocks but not sold during that period? Nothing! However, had you continued to invest in stocks and buy more during that period, you’d have bought a ton of stocks at lower prices. Downturns in the stock market are really just sales, that allow you to buy more stocks cheaply.
That brings us to “Dollar Cost Averaging”. According to investopedia.com, the definition is “an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase”. That’s a fancy way of saying as the stock market goes up, you make more, and as it goes down, you’re able to buy more. If you invest a portion of your paycheck each month in your 401K, and the excess into a regular stock account, then you are dollar cost averaging.
When you eventually retire, the great thing about stocks is that they pay a dividend. This means that the individual companies in your stock portfolio will pay cash to shareholders, including you, each quarter. For the S&P 500, this amount should be about 2%. While you’re working, you’ll reinvest this stream of income into your portfolio, using it to buy more stocks and grow your wealth fast. Once you retire, you’ll live off this stream of income. Simple.
OK, so what do you actually invest in? If you want to keep things ULTRA simple, and don’t want to research about investing any further, you can go ahead and invest in any reputable S&P 500 index fund. That represents the largest 500 American companies by market capitalization (value of all the stock owned by all their shareholders). Since there’s 500 companies in such a fund, you’re well diversified, meaning if one company does poorly you won’t be out of luck, because you’ll have other companies that are likely doing well.
What kind of a return can you expect? Historically, the S&P 500 has returned around 10%, and that’s probably about what you can expect over any 20 to 30-year period. There’s going to be ups and downs of course, but over the long run you’ll earn a solid return with an S&P 500 index fund, without having to put much thought into it.
Companies like Vanguard, Fidelity, and others have very well-known S&P 500 Index Funds they sell, and these are great investments, even if you owned nothing else. In fact, Warren Buffet himself has said “In my view, for most people, the best thing to do is to own the S&P 500 index fund.” It’s really that simple.
If you did NOTHING but invest in an S&P 500 Index Fund, you’d earn around 10% over time, and that’d be more than enough to make you wealthy over the course of your life. Of course, there are ways to make a little more, with a little less volatility. That being said, you shouldn’t expect gigantic benefits out of spreading your investments far beyond the S&P 500. Still, if you’re interested, it might be worth the effort.
There are several other classes of index funds that offer the stocks of companies outside of the S&P 500. Theoretically, you’d want to spread your investment dollars over every single company in the world, in parts equal to the size of those companies. You’d want to be earning money off the hot dog vendor in New York City and the shoemaker in India, as much as the largest companies in Silicon Valley and Wall Street. The successes would far outweigh the failures, and the smaller companies would actually grow faster than the large ones (because they have more room to grow faster). That’s obviously impossible, but it makes sense to at least look at opportunities beyond the largest 500 companies in the US.
You can start by looking at large companies around the world. A global ex-US (excluding the US) index fund is a great way to invest in the world at large, and makes a great compliment to the S&P 500 index fund. There are gigantic companies around the world that are great businesses, making great products and offering great services, and you should invest in those as well.
There are also other types of business classes in the US that are worth looking at, Mid-Cap and Small Cap companies. Cap, or Capitalization, refers to the total market size of all the stock in a company. Mid-Cap and Small-Cap Index funds allow you to invest in thousands of companies which are not as large as S&P 500 companies, but are still large enough to be public and warrant consideration for investment.
Theoretically, you’d expect Small-Cap companies to grow faster (and offer a higher return) than Mid-Cap, and Mid-Cap to grow faster to Large-Cap stocks on the S&P 500. Why? They have more runway. While certainly there’s more risk in individual Small-Cap stocks, after all they could go out of business, there’s room for some of them to grow and eventually become Large Cap stocks. Companies like Google, Facebook, and Amazon, all started out as small companies.
Emerging Markets are a unique type of stock as well. They reflect all the less developed nations out there, what we used to call the Third World, back in the Cold War days. Now, as globalization has spread, and people are investing in poorer economies, companies within those countries have begun to flourish, and your opportunity to invest in them comes in the form of Emerging Market Index Funds. The most prevalent Emerging Market countries are the “BRICs”, meaning Brazil, Russia, India, and China. Not exactly small economies, but they earn their emerging market status from being less developed relative to Europe, Japan, etc. in terms of financial markets. Note that there’s a TON of risk with any individual Emerging Market stock. Accounting laws are looser, legal systems are not as developed, and governments are corrupt. However, by investing in all emerging market companies through an Index Fund you can avoid the isolated disasters, and take advantage of the market as a whole.
HOW TO CREATE A STOCK PORTFOLIO
Now that I’ve laid out the various types of stock index funds you should consider buying, how do you “build” a portfolio. If you listen to financial institutions, you need to have a well-diversified portfolio. What the heck does this mean? Well, it’s the idea that you need a lot of variety in your investments, so that some zig while others zag, smoothing out your returns over time.
As you read above, I’m a big fan of the S&P 500. It’s made up of the 500 largest companies in the US, so it’s already diversified. The fact that those companies are in the US gives them the protection of the greatest financial powerhouse the world has ever known. It also gives them the rule of law, less corruption than other countries, and accounting rules that give you comfort that most of those 500 companies will report their true condition.
Again, I’m fine if the ONLY investment you choose is an S&P 500 Index Fund. It’s well diversified already, and it’s always a good idea to bet on America. How better to do that then bet on the largest 500 companies in America? The largest part of any portfolio should be this S&P 500 Index fund, and I’d never recommend less than a 60% allocation.
However, I also said above that there is some benefit to expanding into these other types of index funds. Because these indexes contain (on the whole) companies that are smaller than the US S&P 500 companies, they have more runway for growth. However, I would limit the ex-US global index fund to 25%, and the other types (Small-Cap, Mid-Cap, and Emerging Markets) to 5% each.
This would mean that that a good portfolio might look like this:
- 60% S&P 500
- 25% Global ex-US
- 5% Mid-Cap
- 5% Small-Cap
- 5% Emerging Market
It’s that simple to create a well-diversified portfolio that will serve you well over the long term.
WHAT ABOUT BONDS?
Bonds are a debt obligation owed to you by the government or companies. They pay you a rate of interest each month, and you get your principal back at the end. The problem with bonds is that all you get is the interest. The principal doesn’t grow. That means the total return, or growth plus income, is always going to be lower for bonds, compared to stocks, in the long run. While there are short periods of time when bonds outperform stocks, this is usually during a bear market recession when interest rates are going down, in the long run you’ll lose with bonds.
Even during retirement, you’ll fare better with stocks than bonds, as long as you commit to never selling. While the dividend yield, 2% for the S&P 500 for instance, is lower than bonds, your income will grow over time, because that yield is based on the total value of your portfolio.
Bonds will pay out more up front, probably even double, although that’s not true as of the time we’re writing this book. However, the principal never grows, so the overall income payment won’t increase much over time. This is getting confusing, so let’s do an example. Let’s say you’re 60 when you retire. You’ve saved your 30 years’ worth of $19,500 401K contributions and have the $3,673,292 from my earlier example, because you followed our advice and got a 10% return.
If you keep it in stocks, you’ll get a growth component plus an income component, that will equal that 10% total return. Your income component, historically, should be about 2%, so let’s use that in our example. That means your growth should be about 8% a year. It might be a little more or a little less, depending on the market’s performance, but over a full market cycle of about 20 years, that should be about what you get. Also note that growth is not linear, meaning that you might have a lot of growth one year, and no growth, or even negative growth the following. However, even when the market goes down, your dividend amount should hold pretty true, because companies usually try not to cut their dividends, even when the market goes down.
So, in year one, you’ll get dividend income of about $73,465.84, along with growth of about $293,863.36. That growth is important, because it means your net dividend payment should increase by about 8% a year. By year 10, your dividend will be $146,858.55, and by year 20, your income will skyrocket to $317,056.60. All along, your principal will have increased significantly as well, ending the 20-year period at $15,852,830. Again, the wonders of compound interest.
Here’s a chart that shows this in action:
| Year | Principal | Growth | Principal Growth | Income Yield | Income |
| 1 | $3,673,292.00 | 8% | $293,863.36 | 2% | $73,465.84 |
| 2 | $3,967,155.36 | 8% | $317,372.43 | 2% | $79,343.11 |
| 3 | $4,284,527.79 | 8% | $342,762.22 | 2% | $85,690.56 |
| 4 | $4,627,290.01 | 8% | $370,183.20 | 2% | $92,545.80 |
| 5 | $4,997,473.21 | 8% | $399,797.86 | 2% | $99,949.46 |
| 6 | $5,397,271.07 | 8% | $431,781.69 | 2% | $107,945.42 |
| 7 | $5,829,052.76 | 8% | $466,324.22 | 2% | $116,581.06 |
| 8 | $6,295,376.98 | 8% | $503,630.16 | 2% | $125,907.54 |
| 9 | $6,799,007.13 | 8% | $543,920.57 | 2% | $135,980.14 |
| 10 | $7,342,927.70 | 8% | $587,434.22 | 2% | $146,858.55 |
| 11 | $7,930,361.92 | 8% | $634,428.95 | 2% | $158,607.24 |
| 12 | $8,564,790.87 | 8% | $685,183.27 | 2% | $171,295.82 |
| 13 | $9,249,974.14 | 8% | $739,997.93 | 2% | $184,999.48 |
| 14 | $9,989,972.08 | 8% | $799,197.77 | 2% | $199,799.44 |
| 15 | $10,789,169.84 | 8% | $863,133.59 | 2% | $215,783.40 |
| 16 | $11,652,303.43 | 8% | $932,184.27 | 2% | $233,046.07 |
| 17 | $12,584,487.70 | 8% | $1,006,759.02 | 2% | $251,689.75 |
| 18 | $13,591,246.72 | 8% | $1,087,299.74 | 2% | $271,824.93 |
| 19 | $14,678,546.46 | 8% | $1,174,283.72 | 2% | $293,570.93 |
| 20 | $15,852,830.17 | 8% | $1,268,226.41 | 2% | $317,056.60 |
Now let’s talk about bonds. If you invest in bonds, you shouldn’t really see any growth. Again, with a bond, you’re loaning money in exchange for an interest payment, and getting back your principal when the bond matures. However, due to things like (a) bond prices temporarily rising when interest rates drop and (b) bonds being sold and discounts and premiums, you should see slight appreciation over time in practice. Those concepts are beyond the scope of this book, but let’s assume you should see 1% growth in your bonds over the course of a 20-year period.
You also should see higher income yield with bonds over dividends as well. While interest rates are extremely low right now, it’s a good bet that over a 20-year period your income yield should be around 4% (hopefully).
Let’s return to our example of your nest egg of $3,673,292, but now let’s assume you sell all your stocks and convert to bonds. First of all, note that if this happens in a 401K or IRA, there’d be no tax, because those accounts are tax sheltered until actual distributions are made.
In your first year, your 4% income yield would give you $146,931.68 of income, which is double the dividends you’d get with your stock portfolio. So why wouldn’t you just do that??? Well, there’s also the growth component. Your bond portfolio is only growing at about 1% per year, compared to the stock portfolio’s 8% growth. This means that your income yield with the bonds is growing slower as well.
In fact, the stock portfolio dividend payment overtakes the bond portfolio payment in year 12. By year 20, your stock portfolio is paying $317,056.60, but the bonds are paying only $177,509.48. Worse, your principal in the bond portfolio has grown to only $4,437,736.94, compared to the stock portfolio at $15,852,830.17.
Here’s the chart showing bond performance:
| Year | Principal | Growth | Principal Growth | Income Yield | Income |
| 1 | $3,673,292.00 | 1% | $36,732.92 | 4% | $146,931.68 |
| 2 | $3,710,024.92 | 1% | $37,100.25 | 4% | $148,401.00 |
| 3 | $3,747,125.17 | 1% | $37,471.25 | 4% | $149,885.01 |
| 4 | $3,784,596.42 | 1% | $37,845.96 | 4% | $151,383.86 |
| 5 | $3,822,442.39 | 1% | $38,224.42 | 4% | $152,897.70 |
| 6 | $3,860,666.81 | 1% | $38,606.67 | 4% | $154,426.67 |
| 7 | $3,899,273.48 | 1% | $38,992.73 | 4% | $155,970.94 |
| 8 | $3,938,266.21 | 1% | $39,382.66 | 4% | $157,530.65 |
| 9 | $3,977,648.87 | 1% | $39,776.49 | 4% | $159,105.95 |
| 10 | $4,017,425.36 | 1% | $40,174.25 | 4% | $160,697.01 |
| 11 | $4,057,599.62 | 1% | $40,576.00 | 4% | $162,303.98 |
| 12 | $4,098,175.61 | 1% | $40,981.76 | 4% | $163,927.02 |
| 13 | $4,139,157.37 | 1% | $41,391.57 | 4% | $165,566.29 |
| 14 | $4,180,548.94 | 1% | $41,805.49 | 4% | $167,221.96 |
| 15 | $4,222,354.43 | 1% | $42,223.54 | 4% | $168,894.18 |
| 16 | $4,264,577.98 | 1% | $42,645.78 | 4% | $170,583.12 |
| 17 | $4,307,223.76 | 1% | $43,072.24 | 4% | $172,288.95 |
| 18 | $4,350,295.99 | 1% | $43,502.96 | 4% | $174,011.84 |
| 19 | $4,393,798.95 | 1% | $43,937.99 | 4% | $175,751.96 |
| 20 | $4,437,736.94 | 1% | $44,377.37 | 4% | $177,509.48 |
This means that with a bond portfolio, you’ll generate more income in the short run, but you’ll lose out in the long run. In addition, when you eventually pass away, you’ll be leaving a lot less to your family.
The (theoretical) advantage of bonds is that they are a lot less volatile than stocks. So, if you absolutely can’t stand volatility and sell every time the market goes down, maybe bonds are the only thing you’ll be able to handle investing in. In addition, if you started saving late, and don’t have enough dividend income coming in to live off, you may be forced to generate more income through bonds. However, in the long run, you’ll lose out.
VOLATILITY
A constant question in investing is how to deal with volatility. We are told constantly that one needs to be worried about volatility, theories about how to combat volatility. My personal opinion is that the current approach used, hedging, is all wrong. These common techniques will lead you to accept lower returns over time in exchange for less fluctuation in the short term.
The first thing many experts advise when faced with volatility is to hedge your investments with assets that will zig when the market zags in order to reduce volatility. Bonds are a good example. When the economy dips, and the stock market inevitably goes down, the thought process is that bonds will benefit from The Federal Reserve (‘the Fed’) action to cut interest rates. This is because your bonds would then offer a higher interest rate than newly issued bonds (the lower rate set by the Fed). Thus, your portfolio doesn’t go down as much as it otherwise would.
The problem with this theory is that bonds will never earn as much as stocks in the first place, and will hold back your returns the whole time you have them in the portfolio. Especially today, why would you have a bond in your portfolio earning 2%-4% over the next 10 years? Sure, when the market tanks, then bonds will go up a little, because their interest rate will be more attractive than newly issued bonds. But why deal with the constant underperformance over the life of the portfolio?
Financial advisors sell all sorts of investments based on this premise that are absolute crap. Hedge investments are a great example. A hedge investment is designed to invest in assets that don’t correlate to the stock market (I’ll distinguish high return hedge funds in a future chapter). That means these assets won’t go down (at least to the same extent) when the stock market declines. The problem is that most of them won’t go up as much as the stock market in the long term, especially when weighed down by heavy fees charged by the investment managers. These hedges are extremely trendy, but are terrible for the average investor.
The solution to dealing with volatility is realizing that it is temporary in nature, and waiting for stocks to inevitably come back when market corrections happen. For instance, as I’m writing this, in 2020, we had a HUGE market meltdown due to COVID-19 shutting down America. The S&P 500 reached a high on February 19, 2020,of 3,386. Just a few weeks later, on March 23rd, it bottomed out at 2,238, representing a decline of 33%. However, as I write this, it’s currently almost back to it’s high, just a few months later. That’s a quick recovery, but it’s the same recovery that inevitably happens in every market downturn. Sure, maybe by hedging your portfolio you’d only go down 25%, instead of 33%. But given the strong likelihood of a recovery, which spend the remainder of the time getting less than the 10% return you’re going to get over time by investing in the portfolio I described above.
Another advantage of volatility, if you’re investing only in stocks I’ve described, is the effects of dollar cost averaging. In the current downturn, if you were investing in index funds with each paycheck, you’d be buying the stock market on the cheap during the downturn, allowing your portfolio to rocket upwards as the market recovers. Don’t sell yourself short by hedging with low performing investments!
DO I NEED A FINANCIAL ADVISOR?
A question I’m constantly asked, particularly since I used to be in the wealth management business, is whether it’s a good idea to hire a financial advisor. For most people, the answer is no. For people who have less than $5M to invest, you won’t be able to find an advisor who will be able to give you outsized returns in relation to their fee. You will be much better off following the advice above.
Furthermore, the investment industry is in many ways set up in a manner that is actually designed to limit your success. Stated another way, if you get involved with most financial advisors, the way they’re compensated will ensure your returns will be less according to the method I’ve outlined above. It’s very difficult for financial advisors to justify their fee by following the advice listed above, and they’ll often insert lower return, expensive products into a portfolio in order to justify the fee their charging clients. In addition, the fees associated with “investments” like cash value life insurance, annuities, hedge funds, etc., are where the real money is made in the industry. It’s hard for financial advisors not to convince themselves these items are good investments, because the commissions are so high! The incentives are all wrong!
First of all, many financial advisors fancy themselves as stock pickers. They think they can get returns above the S&P 500 by picking individual stocks they think have great odds of success going forward. I think this is a fallacy, and I further think that if they were so good, they’d be working for a large hedge fund, rather than advising individual investors. Time after time, I’ve seen stock pickers in this vein blow up their clients’ portfolios.
The reason is companies nowadays have become so complex, it’s impossible to know their true state without insider information (which is illegal). There are things going on at companies every day that would seriously affect the way market experts look at the company. However, these material items don’t make their way into the news at large, except in quarterly reports and other special announcements. Even accounting is manipulated, to some extent, to deal with timing and recognition issues that, while perfectly legal, allow companies to massage their numbers to meet the short-term predictions of Wall Street analysts.
A common role model for financial advisors is Warren Buffett. They’ll fancy themselves value investors, in the Benjamin Graham model. Indeed, I’ve read Graham’s “Intelligent Investor” and it’s really been insightful, especially as to the valuation of companies. The problem with this approach is that it ignores Buffett’s intuitive genius about the management of companies, which almost every other advisor lacks. I’d also argue that Berkshire Hathaway is much more like a Private Equity company (discussed in a subsequent chapter) than a simple stock picker, and their deals with buying stock are often extra-market transactions that you and I would not be able to execute. Furthermore, early in his career, when his capital was lower, and he was much more of a traditional stock picker, Mr. Buffett was privy to information (by attending shareholder meetings, speaking to executives with companies, etc.) that while legal at the time, would be considered inside information today.
There’s no doubt that there are investors able to generate outsized returns. Warren Buffett is the best example, but there’s a ton of others out there. Howard Marks, Stanley Drunkenmiller, Paul Tudor Jones, these are all famous names that have made their clients lots of money. Often, they invest in asset classes outside of equities and still earn extremely high returns. But they’re investing for institutional investors, like pension funds, family offices, etc. You can’t invest smaller sums with them. Furthermore, if you invest with someone who says they’re going to get your returns higher than the S&P 500, how do you know that’s true? The VAST majority of stock pickers earn returns much lower than the S&P 500, so it’s not a good bet. In all likelihood, if you go with someone trying to out earn the investments I’ve described above, you’ll earn less, and pay a hefty fee for the “privilege” of poor performance.
HERE’S WHEN YOU DO NEED A FINANCIAL ADVISOR
So, I’ve just spent some time outlining why most financial advisors are a waste of money. Now I’m going to discuss when a financial advisor might make sense for you. If you are unable to invest in the manner I’ve described previously without selling out when the market goes down in value, you may need a financial advisor. Let me give some examples.
As I mentioned before, when the market dropped 33% between February and March of 2020, due to COVID-19 concerns, many investors sold all their stocks and went to cash. If this was you, you locked in your losses and killed any investment returns you might have gotten. That’s a huge mistake, and you don’t have the temperament (or discipline) to invest in the stock market on your own. In that case, it would be a good idea for you to hire a financial advisor to invest in substantially the same manner I’ve described above. The 1% of your portfolio value to pay each year for outsourcing your investment management will be well worth the fee. In essence, instead of the 10%-12% returns I’ve described above, your returns will be more like 9%-11%.
In essence, this type of a financial advisor is more like a coach or therapist than a stock picker, and that’s just fine. Instead of trying to beat the market or time the market, they’re just trying to keep you in the market. When the market tanks, it’s very helpful for fearful stock investors not to have the nuclear option of selling and going to cash in their own hands, on an online brokerage platform. It’s MUCH better to be forced to call your financial advisor, who would then have the opportunity to act as your voice of reason and keep you from making a HUGE mistake.
Let me give you a funny example. When it became apparent that Donald Trump had been elected president (a huge surprise in 2016), the overnight futures for equities tanked big time. This overnight futures market essentially lets people bet on how they think the market is going to do the next day, and obviously investors (speculators really) were betting it would do terribly. I started getting texts from a client around 7pm telling me to sell his entire portfolio and go to cash. Luckily for him, the markets were not even open at the time, so I couldn’t sell even if I was willing to follow his bad instincts. We kept texting back and forth, and finally I called him and told him that this was a huge mistake, and we’d talk in the morning. I called him at 6:30am Pacific Standard Time, but couldn’t get a hold of him. Meanwhile, the stock market, which had opened by that time, started going up. Then it kept going up, and up, and up! Finally, my client emailed me around 10am. It turned out he was so distraught by the news of the futures market that he’d drank until he fell asleep and now had a huge hangover. Good thing the only pain he was feeling was a headache and not losing money with foolishness! That’s the advantage a financial advisor can plan, talking you out of a bad decision.
Myself, I don’t really need a financial advisor because I’m immune to worrying about stock market fluctuations. When it goes down, I look to buy more. When it goes up, I leave it alone and don’t think too much about it. I know that over the long run, I’ll get around a 10-12% return, and that’s fine by me. I also know that I’m no stock picking guru, and I don’t try to beat the market, I just try to be the market. I will admit that I have a little side account with about $5,000 that I play around with for speculating. I’m currently reading about merger arbitrage and want to place a few bets in that area for fun. I’m under no illusion that I’ll do well, and the reality is that I’m pretty confident I’ll severely underperform my normal portfolio with that account!
FINANCIAL ADVISORS FOR WEALTHY PEOPLE
Financial advisors for very wealthy people, who have more than $5,000,000 in investable assets, are a bit different than I’ve described above. I want to go over their utility not because I think you necessarily need to find one who offers these benefits. If you have less than $5,000,000 to invest, you won’t be able to get access to the types of advisors I’m speaking about. However, if you follow the general investments principals I’ve outlined, there is a likelihood that, at some point in your life, you’ll qualify for access, and I want you to understand what these financial advisors do.
Generally good financial advisors at the $5,000,000 plus level are referred to as “Wealth Managers” or “Wealth Advisors” to denote that their advice goes far beyond simple investments. In fact, at this level there’s a combination of investments, banking service and estate planning advice that becomes crucial, and the banking and estate planning becomes more and more important as net worth increases.
Very wealthy people typically have a myriad of banking transactions that get more complex. First of all, they often have lines of credit, secured by real estate or investments. Wealthy people will often use these lines for opportunistic investing. Opportunistic investing just means investing in things when they’re temporarily cheap.
Often, an investment opportunity will come about when the stock market is down or there’s otherwise temporary drama about in the financial markets. Well, if the market’s down, you won’t do yourself any good by selling your depreciated assets (locking in those losses) to invest in others. Those assets you already own will eventually come back, and you’ll miss those gains. Waiting for stock market index fund assets to come back is one of the surest returns you’ll ever get, and you don’t want to screw that up.
Instead, wealthy people will borrow for a short period on their line of credit, paying a low amount of interest to the bank, and then settling their debt when the market comes back to life. They not only get the benefit of their original portfolio roaring back, but they’ll benefit from their new investment even more.
Wealthy people will also use lines of credit for opportunistic real estate acquisitions. Often, if you pay cash (a line of credit gives you access to cash) you can close quickly on an undervalued piece of real estate which is worth much less than it would be if it were fixed up. Wealthy people will buy the property with their line of credit, fix it up with their line of credit, and then put permanent financing on the property once they’re all done. Oftentimes, the benefit of doing this is that you’ll be able to pay off the line of credit completely with the permanent financing, or at least have to come into the deal with very little cash. If you are able to pull off having no cash in the deal, you’ve generated an infinite return. More on that later in the real estate section.
Financial Advisors to the wealthy will also offer their clients access to more assets than you will have access. Wait, didn’t I just say above that you don’t need more investments than index funds? Well, yes that’s true, but there’s also other types of assets, like private equity, private real estate, and even private debt, that have high minimums, but offer higher returns than even the stock market.
In addition, wealthy clients who already have their income needs met by their investments are often looking more for safety than additional growth. You NEED growth if you’re ever going to have your investments pay for your living expenses. People who are already wealthy don’t. They have a much more vested interest in protecting their wealth, than enhancing it. They are willing to give up potential returns in exchange for safety, which is something you cannot afford to do if you’re not yet wealthy.
It’s important to note that not all wealthy people choose good advisors, and many get ripped off. Vast fortunes have been lost by advisors who’ve invested their clients’ money in risky investments. Often advisors choose to put their clients into investments that pay the highest commissions, rather than offer the greatest returns. Some advisors outright steal from their wealthy clients, a la Bernie Madoff.
Both wealthy individuals and yourself should understand that the foundation of a good investment plan is similar to what I’ve outlined above. Cash to weather storms and equity index funds will always be the way to go in order to make your assets grow over time. Wealthy people would be wise not to stray too far from that path, and make sure their advisors don’t pull them in the wrong direction.