How Being a Boring Investor Can Make You Rich
Most millionaires don't rely on complicated strategies to attain wealth. More than three-quarters of a typical millionaire's portfolio is held in a basic mix of stocks, bonds, and cash—with some real estate and annuities mixed in, according to Phoenix Marketing. As for exotic fare such as private equity or art, only 5% to 7% of the average affluent person's wealth is tied up in those investments. And just one in eight high-net-worth households even owns a hedge fund, according to a survey by U.S. Trust.
That sure sounds a lot like the strategies regular investors use. So why do millionaires do so much better? Well, for one, they actually stick with their plain-vanilla strategy and don't let market swings or hot performance sway them. And they pay greater attention to the small stuff that can nick returns over time.
That will be particularly important going forward. "Given today's stock valuations and low interest rates, it would be safer to assume returns that are 1.5 to four percentage points lower than historical averages," says Hal Ratner, head of research for Morningstar Investment Management. For a balanced 60% stock/40% bond portfolio, you're looking at returns closer to 5% rather than the historic 8.6%. Here are ways to boost that result:
Your Millionaire Moves
• Embrace your passive side. Nearly a third of those with ultra-high net worth—folks with $5 million or more—are interested in investing in low-cost ETFs this year, Spectrem found. Among those worth less than $1 million, it's just 14%.
What do the wealthy know? That passively managed index funds and ETFs outpace actively managed funds over the long term, thanks to their lower costs. In the 10 years ending in December 2014, the S&P 500 returned an annualized 7.7%, while the typical actively managed blue-chip fund gained 6.6%. A $100,000 investment will hit $1 million in 37 years at 6.6% rate. But at 7.7%, you'll get there five years sooner.
The Oracle of Omaha gets this. In his will, Buffett left instructions for the trustee managing his wife's estate to go with index funds, preferably Vanguard's. "I believe the trust's long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions, or individuals—who employ high-fee managers," he wrote.
• Fend off Uncle Sam. Four in five millionaires say taxes are a major factor in their investment decisions, according to Spectrem. For good reason. Research by Vanguard and T. Rowe Price shows you can lose as much as two percentage points annually to taxes. Yet there are plenty of ways to make some of that up.
How? Here again, index funds help. Over the past 15 years stock index funds have lost 0.8 percentage point less a year to taxes than actively managed portfolios.
Next, be mindful of where you keep your investments. Buy-and-hold equity index funds, because of their inherent tax efficiency, can be held in taxable accounts. But funds that throw off short-term capital gains or interest income, such as actively managed growth funds or bond funds, should be stashed in tax-advantaged plans like 401(k)s and individual retirement accounts.
Yet an analysis of Vanguard IRA customers found that only two in five are keeping their active equity funds in IRAs and only 18% own their bond funds there. That's a costly mistake. Vanguard found proper "asset location" can boost the value of a balanced portfolio by up to 11% over a decade.
If you must hold stock funds in a brokerage account, go with a tax-managed option. T. Rowe Price Tax-Efficient Equity (PREFX) minimizes taxes through various means, including selling losing shares to offset gains. That has helped it beat the S&P 500 by an average of nearly one point a year for the past decade.
• Curb your enthusiasm. It's hard to resist the temptation to chase a highflier. But ultra-high-net-worth investors, Spectrem found, consider past performance far less than risk, diversification, taxes, and reputation when it comes to picking an asset or security.
That approach helps preserve gains. Morning-star found that investors lost 2.5 points a year on average over the past decade by chasing what's hot and getting in too late, rather than buying and holding.
Focus instead on strategies that can help you manage your own behavior. A study last year at Goethe University Frankfurt found that households that successfully built wealth had better self-control as measured by their ability to set goals, monitor their portfolio, and commit to their objectives.
To improve your self-control, automate your investing as much as possible, says Ben Carlson, a money manager and author of A Wealth of Common Sense. For instance, 60% of 401(k)s offer auto-rebalancing. Set it up and you won't balk at making the tough decision to buy low and sell high.
• Don't swing for the fences. Millionaires are actually quite risk-conscious. U.S. Trust found that only a third of high-net-worth investors are willing to take more risk to earn higher returns. That explains why about two-thirds of the group stash 10% or more of their portfolios in cash.
This isn't entirely about fear. Millionaires worry about valuations. And the price/earnings ratio for stocks—based on 10 years of averaged profits—is at a level not seen since the financial crisis and dotcom bubble. Like them, you shouldn't feel compelled to use every last dime to buy stocks if you fear prices are too high.
Adapted from “How to Get to $1 Million,” by Kara Brandeisky, Elaine Pofeldt, Penelope Wang, and Jackie Zimmermann, which appeared in the August 2015 issue of Money magazine.