Average investors consistently earn below-average market returns. Why? Mainly because they don’t know how to build wealth.
Instead of a long-term view, they focus on the short-term, chasing performance without an understanding of how to diversify their risks appropriately. They don’t take an active role in managing their assets or think about how to generate operational alpha. And as a result, they end up with less resilient portfolios with poorer long-term returns.
Not only that, but the investment landscape has become more challenging in recent years. Flat to negative yields, rampant inflation, and the likelihood of a 60/40 portfolio returning just 3% means that average investors have to become savvier about building wealth.
Fortunately, there are some tried and tested ways individuals can build wealth, even in these challenging times. The CAIA Association has outlined five marks of effective investing:
- Diversification
- Focus on private assets
- Active engagement
- Fiduciary mindset
- Operational alpha
More diversified portfolios
Diversifying your portfolio across different asset classes, geographies, sectors, and purposes is one of the best ways to mitigate risk and build wealth over the long term. Investing in a diversified mix of assets can weather market volatility and shocks better than if you had all your eggs in one basket.
And with the current low-interest-rate environment, there are plenty of opportunities for diversification outside traditional investments like stocks and bonds. For example, you could consider investing in alternative assets such as private equity, venture capital, and commodities.
Some alternative asset classes, like venture capital, have low or even negative correlations with public markets, which can help diversify your portfolio and smooth out returns. Private markets have outperformed public markets in the long run, with 90% of LPs saying that private equity will continue to outperform public markets in the coming years.
This is of particular importance given the current state of the economy. We’re amidst a long bull market, and many experts predict a recession in the next few years. If that happens, private equity will likely outperform public markets again, as it did during the last two recessions.
As a Cliffwater examination of PE investments in 16 years (encompassing two bear and two bull markets) shows, PE outperformed public equities by 440 basis points annually on average. And another analysis of median net IRRs of U.S. buyout funds confirms private equity’s outperformance during economic downturns.
So if you’re looking to protect and grow your wealth in the future, investing in private equity is smart.
A more heavily invested private markets portfolio
It’s important to remember that not all asset classes are created equal. In recent years, private markets have outperformed public markets and become an increasingly attractive option for long-term wealth building.
The numbers show tremendous potential in private equity. A recent study by Hamilton Lane found that private equity funds generated an extra 83 cents on average per dollar invested since 2017. That’s a significant outperformance compared to the public markets. Not only that, but the study found that over the past 12 years, the majority of private equity funds have outperformed their public market equivalents.
This is another reason to consider allocating a portion of your investment portfolio to private equity. With its ability to generate solid returns and provide downside protection, private equity can be a powerful tool for long-term wealth creation.
One reason is that private companies are typically less exposed to market volatility than public companies. They also offer the potential for higher returns since you get a piece of the company’s growth instead of just the dividends or interest payments on its debt.
Of course, investing in private companies is generally more illiquid than investing in public companies. That means you must be prepared to commit your capital for the long term – at least five to seven years – to see any real return on your investment. But if you’re patient and can stomach short-term volatility, a heavier weighting towards private markets can pay off handsomely over time.
A fiduciary mindset
When it comes to wealth building, having a fiduciary mindset is essential. That means always putting your financial interests first and making decisions based on what’s best for you, not what’s best for the person selling you an investment product.
A lot of so-called “financial advisors” are salespeople in disguise. They’re more interested in making a commission off you than in helping you build wealth. So be sure to find a fee-only financial advisor legally bound to act in your best interest. This way, you can rest assured that the advice you’re getting is genuinely in your best interest – not theirs.
Take an active role in engagement with assets
In today’s world, investing your money and hoping for the best is not enough. You need to actively manage your assets and engage with the companies you invest in.
This is especially important regarding sustainability factors like carbon footprint and progress on diversity, equity, and inclusion (DEI). More and more institutional investors are starting to integrate sustainability considerations into their investment decision-making process, and as an individual investor, you should too.
Amidst more significant concerns around climate change and social inequality, investors are increasingly looking for opportunities to invest in companies making a positive impact on the world. A recent study by Gartner found that 85% of institutional investors consider ESG factors when making investment decisions.
According to Reuters, this trend is borne out in the numbers: inflows into ESG funds reached a record $649 billion in 2021 (excluding December). And there’s a good reason for this – companies with firm ESG profiles are more competitive than their peers.
Don’t fall behind – integrate sustainability considerations into your investment process today. It’s not only the right thing to do but will also put you ahead of the curve in terms of identifying leading companies that are primed for success in the years to come.
Focusing on generating operational alpha
One of the best ways to generate wealth is to focus on generating operational alpha. That means using big data and cutting-edge technology to support functions like risk management and operations.
By taking an active role in managing your assets and using data-driven insights to improve your investment strategy, you can add real value to your portfolio. And that value will compound over time, helping you build substantial wealth over the long term.
Suppose you’re looking for an efficient way to gain diversified exposure to non-public assets with low capital minimums, lower fees, and greater liquidity. In that case, Gridline is a digital wealth platform that’s worth considering. Gridline provides access to a curated selection of professionally managed alternative investment funds, letting investors and advisors build diversified portfolios of private market assets.