On Wall Street, there’s a strategy investors often use to lock in investment gains by incorporating a type of stop-loss measure called a trailing stop order.
A trailing stop is an order you place with your brokerage to sell off your stock once the price goes down a predetermined percentage from a high point.
You invest $100,000 in stock and make a $50,000 gain (50%) over ten years. You want to lock in a percentage of that gain so you put in a trailing stop order that directs the sale of the stock if it loses 10% of its value from a high. With that trailing stop order, you would sell if the value of the stock dropped to $135,000 from the current high of $150,000, ensuring a profit of 35% from the original price.
This would lock in no less than a 35% gain. It’s called a trailing stop because if the stock market continues to rise without a correction, your 10% stop rises along with it, and so does your guaranteed profits.
However, if the stock price immediately drops after you put in the trailing stop order, triggering a liquidation of your stock, you sacrifice any future gains once the stock rebounds.
With a trailing stop order, you will always be left wondering: What if the stock rebounds to astronomical levels after triggering a sale order? You’ll never know.
The only thing a trailing stop order guarantees is that you will never realize your maximum profit potential. It’s a defensive mechanism, not an offensive one.
Wall Street’s idea of locking in investment gains is a loss mitigation strategy, not a profit-maximizing one. The affluent don’t play this profit minimizing game, they prefer to lock in investment giants to maximize profits by avoiding Wall Street.
Locking in gains for the affluent is an entirely different concept than it is for stock investors. It’s not a stop-loss strategy. It’s about locking in their investments for the long-term to maximize investment gains. I’ll explain how.
The affluent as a whole are high-income earners and most have been around the block and made their money from high paying careers or have successfully started and operated their businesses.
- For most of these investors, success didn’t come overnight.
- They understand it takes time to execute a business plan.
- They understand that the investments that are allowed to incubate and grow will be the most profitable in the long-run.
So how do the affluent lock in investment gains?
The affluent lock in investment gains by locking up their capital long-term in investments with long-term windows.
What types of investments fit this bill? Real estate and private equity are two of the affluent’s favorite asset classes.
Just look at the asset allocations of the members of Tiger 21 – an exclusive peer-to-peer networking investment club whose members are required to show $50 million in investable assets. Each quarter, Tiger 21 publishes an asset allocation report summarizing how its members invested for the quarter – by asset class.
In the latest report for Q2 of 2020, the members of Tiger 21 reported allocations of 26% and 29% to private equity and real estate respectively. That’s a combined allocation of 55% towards private equity and real estate.
Why the preference?
Because private equity and real estate both offer unique short-term and long-term benefits that appeal to affluent investors.
Although both asset classes require unique sacrifices on the part of the investor, because they offer affluent investors the chance to lock in gains through consistent short-term income coupled with reliable long-term growth, there is no lack of affluent investors willing to give up certain rights in exchange for significant upside.
Here are the attributes found in assets like private equity and real estate that affluent investors seek out to lock in investment gains:
Alternative Investments: They seek out alternative investments that are uncorrelated to Wall Street and the broader markets. This allows them to ignore short-term market volatility while keeping an eye on the long-term prize.
Intrinsic Value: They invest in assets with intrinsic value – value that is independent of the price. Assets with no intrinsic value derive their value solely from what the investing public is willing to pay and not from anything else.
Crypto and gold may go up and down in value due to public sentiment, but other than offering gains from the rise and fall of their market prices, crypto and gold do nothing else to put money in their investors’ pockets. They just sit there.
Private equity and real estate are different. They have intrinsic value because they put money in their investors’ pockets independent of their prices. An office building generating monthly income from rents and a private equity business that offers goods or services generating monthly cash flow are both examples of assets with intrinsic value.
Currently Profitable. They invest in companies that are currently profitable or in assets like real assets that have been historically profitable. They don’t invest in pies in the sky that may or may not be profitable one day. They seek out companies that offer immediate or almost immediate cash flow – entrusting their capital to management that is confident in the performance and profitability of their chosen asset class and their business plan.
Only from profitable companies can consistent, reliable income is generated – income necessary for building wealth through reinvestment, and that is shielded from market downturns.
Investing in assets that lock in gains from short-term income and long-term growth requires discipline and sacrifices.
It requires sticking to principles and fundamentals for what makes companies successful and it requires investors to sacrifice liquidity and give up control of their capital for a minimum of 5-7 years.
It also requires giving up control of any decision making by deferring to the expertise of others with specialized experience in specific asset classes and markets.
Investors who can commit their money to experts for several years can lock in investment gains just like the affluent do. And for locking in investment gains, no asset classes are more ideal for accomplishing this than private equity and real estate – as evidenced by the asset allocation of the ultra-wealthy like the members of Tiger 21.