High net worth (HNW) individuals are defined as those with liquid assets of $1 million or more. Ever wonder how high net worth retirement planning works or how HNW folks keep that much money? To some degree, they follow sensible investing principles that all investors should follow, such as not spending above their (elevated) means and following a long-term plan.
But they also use their net worth to take advantage of strategies not available to more modest portfolios, such as pursuing a greater range of investment opportunities. Let’s look at the strategies HNW individuals follow.
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What They Have in Common With Other Investors…
They manage annual spending
HNW individuals manage annual spending so that it is well within annual income, from whatever source.
This seems like a very ordinary strategy, right? Everyone should keep an eye on spending to make sure they stay within their means, whatever their income source. But it’s a crucial building block. Simply put, if annual spending is allowed to exceed annual income, it will erode net worth, no matter how large the income is.
They invest according to a long-term plan
HNW individuals invest (and spend) according to long-term plans and goals. They don’t, in other words, suddenly switch investment strategies to follow a hot new stock (or any other hot new investment).
They don’t react suddenly to market moves, such as stock market declines, with precipitous withdrawal of funds. Withdrawing your money to preserve cash after the market drops simply ensures your money won’t be around to increase when the market goes up again. It results in an opportunity loss. HNW individuals manage for opportunity gain, not opportunity loss.
They take the time to articulate long-term personal goals. Whatever their long-term goals are, they are worked toward steadily.
Where They Begin To Diverge From Other Investors…
They have multiple means of managing investment risk
All investors need to manage risk in their investment portfolios, regardless of its size. The most common method is via asset allocation, with a prudent mix of bonds/cash instruments (to manage the risk of stock volatility) and stocks (to manage the relatively low current return of bonds).
Asset allocation typically varies with age, with a higher percentage devoted to bonds and cash as investors age, so their retirement plans are not derailed by stock market declines.
However, HNW individuals add more methods to risk management. If their annual spending as a percentage of net worth is low, for example, they may take more risk, as they are comparatively less exposed to profit erosion. If their net worth comes from a business, they may diversify investments outside of similar businesses, its sector and even the location.
They rebalance portfolios often
Rebalancing refers to the analysis of asset allocation and taking steps to maintain it as market moves result in changes. An asset allocation of 70 percent stocks and 30 percent bonds, for example, will change over time.
If the stock market rises 25 percent over the year, the stock portion will be greater than 70 percent. If the stock market falls, it will be less. Rebalancing is the buying and selling of assets to restore the desired allocation.
All investors should rebalance, but smaller net worth individuals may do so once a year. But large amounts of money can result in a more frequent need for rebalancing.
They manage taxes aggressively
HNW individuals manage taxes aggressively, with an eye to leaving as much as possible for their heirs and/or charitable passions. All investors should manage taxes, but the opportunity for taxes to erode the profits of a business or high net worth portfolios is greater.
HNW people may structure trusts or employ other strategies to shield their wealth from taxes as much as possible.
They manage fees for the long term
Portfolio and wealth management services charge legitimate fees, but it’s important to keep an eye on what the fees are and what advisors provide for the fees.
The difference between a 1 percent and 2 percent fee, in a $1 million portfolio, adds up to $10,000 per year. All factors being equal, the HNW families choose the lower fee.
If you think $10,000 is small change to the HNW group, think again. Over 25 years, that’s a quarter of a million dollars, lost to high fees. A quarter of million is money to fund a business or bequeath to heirs.
The Most Common Strategy Used by HNW Individuals: Diversification on Many Fronts
The most common strategy HNW investors use to grow their wealth is portfolio diversification. Here, too, this strategy is not unknown to investors with lower net worth. Diversification is a common tactic to manage risk and maximize performance.
But smaller investors may stick to just a few asset classes – and within those classes, sector diversification or mutual fund diversification. HNW individuals, by contrast, turn to a much wider range of potential investments. These might include:
- Real estate
- Precious metals, such as gold
- Collectibles, such as art
- Hedge funds
- High-yield debt
HNW individuals also tend to turn to private market investment, such as private equity funds. They may invest in start-up companies, either through venture capital or other means. These companies are private.
They may become listed on the stock market at some point (often an occasion for profit realization on the part of early-stage investors) or remain private. (HNW investors may also take an active role in managing these companies, such as serving on the board of directors.)
When HNW investors do turn to private market or venture capital investment, they may make multiple investments, in different companies. This, too, is a risk diversification method. Statistically, most small companies and start-ups fail within the first several years. The higher the number of companies invested in, the greater the likelihood of one or more becoming successful.
The final diversification move is to think globally. HNW investors are more likely to think outside of the United States, the United Kingdom, and the European Union for investment opportunities. Emerging markets can offer significant profit opportunities.
Managing HNW portfolios presents both opportunities and challenges. At Financial Freedom Fee-Only Wealth Management, we have over 30 years of experience working with high-net-worth individuals and couples. We are a fee-only, fiduciary, wealth management firm dedicated to helping our clients protect, grow, and maximize their wealth.
Contact us today for a complimentary consultation, and find out if we are the right fit for your needs.