Published December 19, 2007

COMMENTARY

Investing tricks of the wealthy

Average investors can apply the same techniques to their own investments, no matter the size of their portfolio

By BEN FOK

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RECENTLY, I asked a wealth manager whether an average investor can make more money by mimicking the investment strategies of the rich. He answered: not really. Later he explained that the rich invest differently because, well, they’re different. They can take more risks because they have more money to lose. Furthermore, they can speculate and have a short-term view because losing money is not a problem for them.

Well, I do not totally agree with his opinion. For the past few years, I have been advising wealthy people on their financial well-being. As a financial adviser, my job is to help these rich clients search for financial services who meet their needs. Throughout my interaction with them, I have gained an insight into how they accumulate wealth.

I can tell that the rich don’t necessarily have any special insights into which stocks or assets are going to soar. But what they do have is the confidence to apply a disciplined and systematic approach to managing their money. They have the habit of applying common sense to each investment opportunity facing them. Even though the interests of wealthy investors are not always necessarily aligned with those of the average investor, there are a number of principles and strategies employed by wealthy investors that do apply to virtually anyone who seeks to invest for the future.

It is a common fact that most financial textbooks teach us that in order to build wealth we need diversification, wealth preservation and strategic growth. To me, this not an accurate statement in itself because two of those strategies - diversification and preservation - don’t help to build wealth. Perhaps the rich use these two strategies to maintain wealth.

After they have accumulated great wealth, they didn’t use the strategies during the accumulation phase and they tend to preserve the wealth they have built. Yet average investors have not yet reached the ranks of the financially independent, so they are generally more concerned about investment growth and losses. The wealthy, as a general rule, do not have this concern. At the same time, they also learn how to avoid taxes legally so that they can keep their money working for them and learn how to pass their assets on to the future generations without the government taking a huge part of what they spent their lives building.

Another common perception is that the rich take more risk, therefore they accumulate wealth faster. However, the truth is that the majority of rich people do not build their fortunes by speculating on high-risk investments as is commonly believed. My experience tells me that the rich do not heavily rely on high-risk investment vehicles like hedge funds or venture capital funds but are moderate risk takers who put more than half of their money into listed securities and keep a large amount as cash. The reason for this is that they have so much money that even if they do not meet their goals for investment growth, it would not be bad news to them; however losing their financial independence would be devastating.

So how do the rich invest? Unlike the average investor, the rich think long term in most of their investment strategies. They believe that there is power in long-term thinking and many of them make it habit of doing so. Great investors like Warren Buffett - his successes in investment include Washington Post Co, where Berkshire invested US$11 million in 1973 and which investment was worth US$1.3 billion at the end of 2006. That is 33 years of holding power which demonstrates his investment philosophy - always invest for the long term. Hence, most rich do not engage in short-term speculation but have a long-term goal in mind.

However, the rich make use of risk by taking advantage of risk. They often build fortunes using volatile assets and investments but that does not mean they were engaging in risky behaviour. They understand the risk and embrace risk because they know it always brings an opportunity for growth; however, the average investor is fearful of risk. Nevertheless, taking risk for the rich does not mean taking a shot in the dark. The rich take calculated risk that means to gain knowledge first and to consider the consequences of failing before taking action. The rich overcome fear with knowledge as knowledge can cause fear to fade away.

The rich also demand value for their money. Otherwise, how do you think they got to be rich in the first place? Value to them is buying assets at a discount to its intrinsic value. So for them the right time to buy is when there is weakness in the market. They buy when others are despondently selling and sell when others are greedily buying. This requires the greatest fortitude but also has the greatest rewards. This bargain-hunting approach to buying value will enable them to buy quality assets at reasonable prices. So they buy when there is bad news and sell on good news. For instance, some of the wealthy invest because they understand that the weakness is only temporary, and the stock price had fully priced in negative news and it was time for them to hunt for bargains again.

If we look back at the Singapore stock market, there are many opportunities for investors to bargain hunt and buy on bad news, e.g. the Asian financial crisis in 1997/98, the Sept 11 terrorist attack and SARS. The rich take advantage of these negative events to buy assets, whether in real estate or stocks and that’s where value can be found. However, the average investor will seek to sell and get out of a bear market fearing that the asset will fall in value.

To the rich, probably now is the best time to sell and get out of the market, where all assets prices have gone up in value. Over the past years, we have very good reports about our economic growth and all the good news are now factored into the stock price, so for the rich it’s time to sell.

Another investing secret of the rich is that they approach investing like a business. They set up a business plan, establish annual targets, then analyse the results and they have reasonable expectation. At the end of the day what they want to achieve is increasing their net worth and not their income. The rich truly understand the meaning of working smart not working hard: to focus on growing your net worth is working smart but working for an income is working hard. As their net worth grows, they do not increase their spending, instead they increase their investment. By repeating this over the years, once their net worth is built to a certain level, they are free to do what they want. Hence, to increase your net worth you need patience, knowledge, and wisdom.

Often they are not willing to pay more for investment services simply because they find a particular adviser to be charming or knowledgeable. Nor do they chase after the hottest manager or the most publicised fund. Instead, they go shopping for the best combination of reasonable fees and consistently good performance. However, they will pay for advice from people who have specialised knowledge in a field they need to learn about. They don’t believe in free advice as it can often be the most expensive advice.

As you can see, most investing secrets of the rich are nothing more than a combination of basic common sense and knowledge. The difference between the rich and the average investor is that they have the self-confidence to stick to the basics and to find out what they need to know. They don’t get caught up in the theory of the week or the trend of the month. It’s an approach that’s easy to articulate but difficult to follow.

However, average investors can learn important lessons from the wealthy, specifically the need to manage both risk and their own investment expectations. The failure to match expectations to the risk an investor is willing to take can result in frequent switching among investments, or even worse. Now the good news for the average investor is that you can apply many of the same techniques to your own investments, no matter how big or small your portfolio is.