Most high-net-worth (HNW) individuals haven’t built their wealth through the stock market. In fact, the vast majority (more than 80 per cent, in my experience) are current or former business owners. After a liquidity event like a business sale, a lot of times they become “reluctant” public market investors at first.
Nevertheless, most of them prove to be fairly skillful investors. No, they don’t get it right all the time. But their “batting average” is consistently higher than investors of more modest means.
That’s a little surprising, because there are important differences between being a successful business owner and a successful investor. In business, the goal is generally to build wealth by concentrating assets. In investing, the goal is generally to preserve wealth by diversifying assets. While both disciplines revolve around the allocation of capital, the required skill sets are quite distinct.
So where do the wealthy get their investment “edge”? What makes them so good at investing? What are they doing differently – and better?
I recently posed these questions to Robert Stammers of the U.S.-based CFA Institute. As the director of education for the Institute, Mr. Stammers regularly speaks with advisers and managers who work with some of the wealthiest families in the United States. Before that, Mr. Stammers was a private equity manager. This experience has given him a good idea of where high-net-worth individuals get their investment edge.
“A lot of HNW investors are business people,” Mr. Stammers says. This experience leads them to take an unemotional, business-like approach to investing, which helps them avoid some of the errors or pitfalls that can happen when greed or fear guide the investment process. “A lot of that mentality is part of it.”
Perhaps more significantly, the business mindset makes such investors very goal-oriented. “They know really what it is they’re investing for, and those goals are what really drive everything else,” Mr. Stammers says. “A lot of the average investors, they’re investing because they feel they need to be investing, as opposed to, investing for [a] particular reason.”
“[Average investors] think ‘I want to get rich. I want to make as much money as possible.’ That tends to force people to make some of the other common mistakes, which are trading too often, or chasing yield, or just trying to maximize return.”
What else do the wealthy do better? Here are some of Mr. Stammers’ insights, supplemented with my own observations. Taken together, they’re a good “action list” of investment-related issues that every investor can get better at.
They have clear investment goals: High-net-worth individuals are obsessive goal setters. They always know why they’re investing (beyond “to make money”). They reverse-engineer their return objectives to meet both long- and short-term goals. That’s not necessarily different from what other investors do. But their business background helps them execute on those goals better, and gives them discipline to stick to them.
They know when to delegate: High-net-worth investors are not “do-it-yourself” investors. While they view investing as necessary for supporting the lifestyle they want, quite frankly, most of them aren’t passionate about it. So they tend to delegate most of the job to talented professionals who are. They don’t feel bad about this delegation – it’s much the same approach they used with their operating business.
They think risk first: High-net-worth individuals are generally focused on wealth protection as much as wealth generation. This focus on risk has profound implications on portfolio allocations and investment selection. When your focus is capital preservation, you tend to avoid unnecessary risks. You tend to be well-diversified, and you tend to pay a lot of attention to your holdings. These habits help protect their portfolios, and lead to more stable returns over time. It’s not that they’re hitting home runs over and over again. They’re better at avoiding strikeouts.
It’s business: In general, high-net-worth investors tend to be good at “segregating” their emotions from their investment decisions. Their investment decisions tend to be based on facts rather than “gut feel.” They’re less inclined to fall in love with investment ideas, and more inclined to move on when those ideas don’t work out. However, we’re all human, and there are situations when money can’t help but be emotional. But even in these situations, such individuals tend to be more aware of their “emotional limit” – that is, the point at which a buy or sell decision might become emotional, and they are careful to avoid those situations where emotions might come into play.
They keep the news in perspective: Most wealthy individuals are news junkies. Of course they listen to, digest, and consider a lot of financial news. But the focus of their attention is on long-term trends, not necessarily up-to-the-minute financial data. And they think very, very carefully before making any decision based on news.
They seize the opportunity in crisis: Most high-net-worth individuals are born contrarians. Most of them have made their money by going against the crowd, trusting their own smarts rather than conventional wisdom, and taking business ideas to market when everyone else said it wouldn’t succeed. This is a particularly important point right now. Unlike most investors, the wealthy are generally not looking to “ride out” volatility – they’re looking to profit from it. They’re actively seeking money-making opportunities. They’re not “long only”— they’re hedging, shorting, and using other strategies. And they’re also picking up assets on the cheap.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances. Insurance services are offered through Richardson GMP Insurance Services Limited in BC, AB, SK, MB, NWT, ON, QC, NB, NS, PEI and NL. Additional administrative support and policy management are provided by PPI Partners. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.