A lot of our clients have built portfolios worth millions of pounds, thanks to many successful years of work.
Most are perfectly content to continue with the scientifically proven strategy of investing in a diversified, low-cost portfolio of the great companies of the world.
They know the story of the tortoise and the hare.
A boring, 'high-end vanilla,' sensible way of growing and/or protecting their wealth always wins the race.
However, now and again, some clients express interest in exploring more 'exciting' investment opportunities...
These 'shiny' opportunities are typically private-equity, venture capital, 'pre-IPO' stocks, or hedge funds.
Rich people are typically aware of these, because money-hungry private banks and smooth-talking brokers stroke their egos with 'privileged' access, whilst promising 'extraordinary' returns.
But I believe the real agenda is something quite different (the vendors' personal financial interest, not yours)…
You can keep your investments simple and straightforward, regardless of whether you have £500,000 or £25 million to invest. Sure, you can afford to take some bets and lose some money, but it’s not necessary.
The problem with shiny investments
So, what’s the issue with investing in any of these 'fancier' options?
On paper, private fund performance sounds good - some people grow their wealth this way.
But here are some points to consider, which may make them less thrilling:
1. Your money is not easily accessible (illiquidity)
You can’t quickly convert the investment into cash for everyday expenses. Unlike owning the great companies of the world, which you could sell if needed.
Private equity, hedge funds, and other venture investments can lock your money away for months, or even years. Either you won’t be able to access your funds when you need them, or you’ll have to pay hefty fees to do so.
It's also extremely hard to borrow against illiquid investments which can act like carbon monoxide on your wealth, given leverage (on stocks or property) can be a tremendous wealth multiplier.
Many people are just unaware of this drawback when they opt for the 'excitement' that comes with owning them.
It's also often difficult to determine the true value of illiquid investments.
2. Your money is not diversified
One of the key benefits of investing in the stock market (the great companies of the world) is that it gives you exposure to thousands of publicly traded companies globally. If one company or country underperforms, it’s balanced out by many others. You're so well diversified, you really don't need to worry or think about what's happening in the daily news.
Compare this with being reliant upon a single company, a narrow fund, or a lump of gold.
3. Your investments are less transparent
In the public stock market, companies are required to share their financial details with shareholders every quarter, adhering to strict accounting standards.
This ensures a high level of transparency and accurate valuation.
Private markets and companies operate under different regulations, meaning the information available is often limited and can sometimes be difficult to understand. Governance and due diligence are typically thrown to the wind.
These investments are commonly not available to retail investors for good reason (a lot can go wrong). Don't sign your rights and protections away by allowing yourself to be categorised as a professional investor, if you're not.
4. You pay much more
Buying and selling globally diversified index funds and ETFs on the open market is usually extremely low-cost, but in the private equity market/pre-IPO market, you're often looking at hefty introducer commissions of 5 or 6%, and more.
The hidden incentives potentially create a conflict of interest between your best interest and the person recommending them. If you remove these incentives (by opting for a fee-only financial planner) - it's fascinating to see how few of these opportunities get recommended.
5. Your investments could lack intrinsic value
When you own a stock, you're essentially holding a portion of a company that generates revenue, entitling you to a share of its future earnings. The discounted future cashflow expectations of the company (and the market’s view of this) dictate the value of its share price at any time.
Similarly, holding a bond means you've lent money to a company or government with the promise that your principal will be repaid with interest at a pre-determined point in the future.
But then take something shiny, like a pre-IPO hot stock or start-up.
It's extremely speculative and highly dependent on luck, unless you have deep knowledge.
If the music stops playing - you don't want to be the individual investor who's left without a chair.
6. You're competing with professionals
Another consideration is the level of expertise needed.
Investing in traditional markets is challenging enough, but a DIY investor competing in niche markets against seasoned professionals can be a losing battle.
Professionals who specialise in these areas spend their entire careers analysing opportunities and risks, and even they can struggle to consistently outperform the market.
As a 'regular' investor, your chances of outsmarting these experts are slim, and the stakes are high.
The reality of risk and return
Not all the challenges above apply to all the investment choices. But hopefully it gives you an idea of the issues they present.
Perhaps most obviously, investors are also drawn to alternative investments by the promise of higher returns.
But remember, with the potential for higher returns comes higher risk and volatility. The historical data on the returns of public investments, like the MSCI World, is well-documented and tends to be a good place to start. By contrast, the returns on alternative investments are sometimes murky and inconsistent at best, and disastrous at worst.
Private equity and venture capital, while having the potential for massive gains, are also prone to massive losses, and their inherent value is still a matter of interesting debate. This risk-reward profile is perhaps suitable for large institutions, but typically one you should avoid when considering how best to invest your future nest egg.
Before diving into any of these investments, ask yourself: do you really need to take on this additional risk? If you’ve already accumulated enough wealth to meet your needs, why gamble it on something uncertain?
An experienced financial life manager can help you to build a Life Strategy, specific to your circumstances and help work out what return you need on your money to enjoy the lifestyle you want, without fear of money running out.
We call this 'your number'; and can assist in building a portfolio that has the greatest chance of achieving this over the timeframe you have available (before retirement, for example).
A simple strategy for success
The truth is, you don’t need fancy investments to build or maintain wealth. A straightforward, low-cost, globally diversified portfolio of stocks and bonds is often the best strategy, and the long-term evidence backs this up.
It’s easier to manage, more predictable, and gives you peace of mind by knowing you’re invested in the global economy’s growth.
There’s a reason why many wealthy individuals and institutional investors stick to simple, diversified portfolios.
And why Warren Buffet, arguably the world’s most successful and well-known investor, also recommends this sage approach.
It’s not because they lack 'privileged' access to more complex options, but because they recognise the best way to achieve long-term financial success is to keep things simple, and do what's always worked.
