What qualifies a person as ultra-wealthy? Also known as ultra-high-net-worth individuals (UHNWIs), the ultra-wealthy are individuals with investable assets of at least $30 million.
Despite the Dow and Bitcoin trading at record highs, the ultra-wealthy know better. They know the underlying economic fundamentals don’t justify the levels at which stocks and crypto are trading. GDP is still stagnant – down 2.3% for 2020 – and unemployment is still above 6%. The ultra-wealthy don’t trust the current markets. They view the rise in stock and bitcoin prices as more a product of emotion – fueled by FOMO and herd mentality – than any sound economic principles. That’s why they’re avoiding swimming in the public pool (i.e., the public markets)
So what are the ultra-wealthy doing to protect themselves in uncertain times? Before I answer that question, let me first dispel a few myths about the ultra-wealthy.
- Myth #1. Most UHNWIs inherited their wealth. The fact is most UHNWIs are self-made – successful in a chosen profession, field, or business before they started investing.
- Myth #2. UHNWIs got wealthy by getting lucky. UHNWIs don’t gamble. They didn’t make their money from the lottery or high-risk investments.
- Myth #3. UHNWIs live lavish lives of luxury surrounded by mansions, yachts, and Ferraris. Most UHNWIs, in fact, don’t spend conspicuously. They’d rather not flaunt their wealth to be seen by others.
- Myth #4. UHNWIs don’t pay their share. According to the most recent IRS data, the top 10% of earners pay more than 70% of the taxes in the U.S.
Against this backdrop, let’s delve into how UHNWIs protect their portfolios. In times of turmoil and economic distress, the ultra-wealthy may make subtle reallocations, but in any economic client, they live by a few simple investment rules:
1. They invest for income. The ultra-wealthy invest for income for two reasons: 1) cash flow can compound and grow wealth through reinvestment and 2) for security during economic downturns. Multiple streams of passive income from assets resistant to market volatility are ideal for hedging against recessions – by ensuring a constant cash flow stream. Even if some assets falter, the performing ones can pick up the slack until the markets stabilize.
2. They invest in the future. The ultra-wealthy not only invest with an eye on today, but they invest with an eye on the future – the distant future. They invest with the goal of creating generational wealth – wealth that will span multiple generations. That’s why most UHNWIs don’t spend for show. They don’t care what the neighbors think. Their concern is for future generations and, believe it or not – charities. Contrary to popular belief, the rich are not only paying their fair share in taxes, but they also give more to charities. According to a report by the Economist, the wealthier people are, the more they tend to give to charity—both in absolute and relative terms
That’s why they gravitate towards long-term assets – assets that – over time – reliably cash flow and appreciate. Long-term investments may falter during stretches, but any dips will likely be ironed out over time because of the long investment window. Long-term assets offering the twin benefits of income and appreciation accelerate wealth like no other assets – while protecting it over the long-term.
3. They avoid intangible assets. Intangible assets such as public equities and cryptocurrency – where prices are determined purely by what investors are willing to pay for them – are susceptible to market volatility. The market for intangible assets is driven by emotions and behavioral biases such as the Availability Bias. Investors make investment decisions based on what most recently heard or saw on the news, social media, the water cooler, etc.
Investing in uncertainty is no way to protect a portfolio. That’s why the ultra-wealthy prefer tangible assets – especially ones that cash flow and appreciate. Additionally, tangible assets provide an additional layer of protection if an investment goes south. With stocks and cryptocurrency, in a crash, there is no hard asset to fall back on to prevent your portfolio from being wiped out.
4. They invest in private placements instead of IPOs. Securities offered through private placements are insulated from market volatility, the madness of the crowds, and group behavioral biases because the long lockup periods common among private offerings prevent investors from acting on emotion. They’re handcuffed. They can’t liquidate their holdings with a simple swipe or click of their phones like in the public markets.
How the ultra-wealthy protect their portfolios in uncertain times. During economic downturns, the ultra-wealthy never betray their core investing principles, but they may make subtle reallocations to adjust to more difficult times. And one of the assets the ultra-wealthy reallocate towards is private debt secured by a hard asset like real estate. Private debt is desirable during uncertain times because there is nothing more certain than a fixed income backed by a hard asset. And if something goes wrong, debt holders are first in line in a liquidation. The ultra-wealthy go for an added level of certainty by investing in private debt with even longer investment horizons than usual – ensuring a fixed cash flow for an extended time into the future.
To understand how the ultra-wealthy protect their portfolios, you only have to look at their core investment principles. They stay true to these principles in good time and bad, and it’s through these principles that they can protect their portfolios.