The investment “advisory” industry is a huge multibillion-dollar business based on hard work, clever thinking and sophisticated algorithms. But it’s also based on one teensy-weensy lie.
The lie is that you can grow wealthy by investing in a combination of stocks and bonds.
It’s not a big black lie. Because it’s sort of true… can be true… has been true… in certain circumstances.
But the truth is that there are many ways to grow your wealth – including some that will give you better returns with equal or even less risk.
When you limit your investing to stocks and bonds, the best you can hope for over any length of time is the average long-term return for stocks and bonds: about 5.5% for government bonds and 10% for taxable stocks. Most financial advisors recommend a 60-40 split between stocks and bonds, which would give you an average return of about 8%.
The easiest and cheapest way to do that would be to buy one no-load stock fund (like a Vanguard index fund) and one bond fund (like the Fidelity Total Bond Fund). Index funds are designed to track the markets and will give you the best chance of doing as well as the markets do during your investing years.
Or you can try to beat the averages by doing your own research and/or getting advice from brokers and creating a portfolio of individual stocks of your choosing. If you are going to do that, be prepared to work hard and be very disciplined. Most individual investors who take this route end up making considerably less than they would get in index funds.
So if you limit your investing to stocks and bonds, you are looking at two possible outcomes:
- Play it conservatively and invest in index funds and be happy with 8% over the long haul.
- Take the risk of beating the market by buying and selling stocks and bonds yourself and accept the chance that your average earnings over time may be half of that 8% or lower. (One study showed average returns for individual investors of 2.5%.)
But if you are willing to look beyond stocks and bonds, you can do better than 8% – and safely.
There Are Lots of Good and Safe Ways to Build Wealth in America
I’m talking about expanding your investment horizon beyond stocks and bonds. I’m talking about investing in other asset classes, some of which can give you potentially higher returns than the stock market, and with relative safety.
What I’m about to show you is a bit of my own strategy for building wealth. It is the result of making and losing all of my money on my first investment 40 years ago and becoming, overnight, a super-cautious investor committed to diversification.
Diversification gives you the possibility of making great returns. But to reduce your risk, you need to employ a sensible strategy of asset allocation.
(You might think that something so dull as asset allocation could not possibly be that important in acquiring wealth, but numerous studies have shown that it may be the most important factor. These studies can be found here.)
What I’m about to show you is my current diversification strategy.
I have added three pieces to it in the last 10 years: a nominal stash of five cryptocurrencies, a fairly good-sized portfolio of Amazon/Apple-type stocks and a small portfolio of about a dozen fun pre-IPO stocks. All those have done very well, as you would expect.
The core portfolio has also worked well since I started adding to it almost 40 years ago. It has helped me increase my net worth a good deal more than 8% per annum, and without a single negative year.
Here’s the point though: The success of this portfolio was not due to any particular knowledge I have of stocks and bonds, or to any individual buy/sell decisions I’ve made. It was due to the decision to invest in a half-dozen asset classes besides stocks and bonds.
- Stocks: I have three stock portfolios. One, which I call the Legacy Portfolio, contains about a dozen big and reliable Warren Buffett-type companies like Nestlé and Coca-Cola. A second, which I call Legacy Two, contains a half-dozen companies like Amazon, Apple and Alphabet. And I have a third, smaller portfolio of midcap stocks, which I call the Junior Legacy Portfolio. Today, stocks represent about 15% of my investible net worth (my net worth minus my residence and possessions I would never sell).
- Options: Although my cardinal rule is not to invest in something I don’t understand, I found a way to trade options that I understand and also believe in. Like real estate and insurance products, most options strategies are speculations. I’d advise against them. But the way I do it – selling puts on high-quality stocks – has worked very well for me. Although I enjoy options trading the way I do it, I’ve never had more than 3% of my net investible worth in them at any one time.
- Direct investments in entrepreneurial businesses: I’ve been an investor in private startup companies for more than 30 years. I learned early that when I put money into businesses that I know nothing about, I get back nothing – as in: I lose all my money. Today, 100% of the money I have in private businesses is in companies that sell information and advice via direct marketing. These investments have given me, by far, the best returns – like thousands that turned into millions.I have only two rules I follow for private placement deals: (1) I have to know the business inside and out, and (2) I have to have a controlling interest, which means the ability to approve of or deny key decisions. My initial investments in private businesses were shockingly small, but they now represent about 32% of my net investible wealth.
- Pre-IPO deals: About two years ago, I began investing money into startups whose intention was to eventually go public. These are long-shot deals whose odds are shortened, I believe, because of the expertise of the man who vets them. I invest the same amount in every deal he recommends, which eliminates the chore of studying them and making buy and sell decisions. This is an investment in the manager’s expertise. The total I’ve invested to date in this sector is less than 1% of my net investible wealth.
- Fixed-income bonds: Historically, bonds make up this asset class. At one time, bonds (AAA-rated municipal bonds) represented as much as 40% of my net worth. My strategy was always to hold until maturity and buy them in “ladders,” replacing them when they matured. But I haven’t bought them since the rates dropped below 4.5%. When rates hit 6% again, I’ll probably start buying again. At one time municipal bonds represented nearly 40% of my assets. Today they are about 4%.
- Private debt: I’ve been lending money privately for about 30 years. About half of these are mortgages, secured by the property. The other half is composed of business and personal loans. I made some bad investments early on – some to friends, which was troubling. Nowadays I make only collateralized loans and I demand interest payments to start immediately. My private debt investments are about 5% of my net investible wealth.
- Rental real estate: Next to direct investments in startup companies, income-producing property investments have been the largest contributor to the growth of my wealth these past 30-plus years. I follow a strict rule about how much I will pay for a property that is based on the income the property is currently producing. I expect immediate cash flow of at least 8%, plus long-term appreciation of 4%, plus the ability to add value and thus increase rents (by marketing and physical improvements), plus the leverage I can get from financing them after the rent rolls increase. Because rental real estate is local and simple, leveraging properties with bank financing is usually a very safe proposition. Rental real estate represents about 15% of my net investible wealth.
- Land banking: Although my investment philosophy is to invest in current income rather than future appreciation, I have bought about a dozen parcels of land over the years in the U.S., Canada, Central America and Europe. I have no rationale for doing so. I just like the idea of having these plots of earth here and there. I’m guessing that land banking represents about 5% of my net investible wealth.
- Gold and silver: I bought a bunch of gold coins some years back, when gold was selling for about $400 an ounce. I also bought some silver and platinum coins. These have appreciated more than four times, as you know. But I didn’t buy them to increase my wealth. I bought them as an insurance policy against the remote chance that there will one day be a collapse of the dollar and a subsequent deep, inflationary depression. If that happens, these coins will be very valuable. In the meantime, they make me feel like I have the threat of financial Armageddon covered. Gold and silver coins represent about 4% of my net investible wealth.
- Cryptocurrencies: About a year ago I bought a small basket of five cryptocurrencies – Bitcoin and Ethereum and three of the other usual suspects. I bought them not because I believe they will replace the dollar, but because I wanted to be able to say I did if they eventually do. My investment here is less than 1% of my net investible wealth.
- Collectibles: I’m a big fan of investment-grade collectibles because they are tangible, portable, nonreportable and provide me with the pleasure of looking at them while they appreciate. My preferred collectibles are investment-grade art, but I also have a modest collection of first-edition books, vintage cigarette lighters, watches and rare coins. Altogether my collectibles represent about 10% of my investible net worth.
- Cash: The amount of cash I have at any time depends on the state of the economy (precarious now), the stock market (overvalued but with room to rise), the bond market (rates are unattractive), and whatever opportunities in business and real estate deals present themselves. Right now, my cash holdings represent about 5% of my net worth.
I don’t think my portfolio is the ideal portfolio for everyone. I don’t think it’s the best possible example of diversification for people who are younger or older than me, richer or poorer than me, or have more or less tolerance for risk. But it has done well over the years and the new additions are doing well, and I think its diversity and balance are just right for me.
Most importantly, it reflects my strongest belief about building wealth: That to have the best result in building wealth, you have to go beyond stocks and bonds.
Are you diversified outside of stocks and bonds? Tell us about it at email@example.com.