Affluent Investors Do Not Invest In Index Funds

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It should be very clear to everyone by now that the wealthy invest very differently from the Main Street investor.

They zig when everybody else zags. That’s why they’re wealthy. Take for instance Main Street’s fascination with index funds. The wealthy couldn’t be bothered with them.

Main Street investors gravitate to index funds for their convenience and – compared to mutual funds – their relative inexpensiveness. For investors who don’t have the time or disposition to research and track individual stocks, index funds are appealing.

Index funds track the market fairly consistently and consistently beat actively managed funds like mutual funds and hedge funds. Why pay 9x the cost for expertise when the so-called experts rarely even beat the market?

So why do the wealthy ignore index funds?

They ignore index funds for the same reason they ignore most Wall Street investments: they’re not content to make “average” returns, they want to beat the market.

That’s why they’re willing to look outside the box and venture into asset classes Main Street investors are hesitant to indulge in; specifically, alternative assets available through private markets.

Private investments tend to be tagged “high risk” because higher-risk alternatives such as hedge funds and venture capital tend to get lumped with lower risk, less market-correlated assets like private debt and commercial real estate. However, the wealthy have learned to reduce alternative asset risk through various mitigating strategies to generate above-market risk-adjusted returns.

One of the mitigating strategies adopted by the wealthy is an allocation to income-producing assets. Income-producing investments backed by hard assets don’t fit the traditional risk-reward paradigm.

High returns don’t necessarily translate to high risk with these types of assets. Because of the cash flow factor that increases returns over time from the compounding effect, it is actually possible to achieve high returns at a reduced risk because of the security offered by the underlying asset. This is particularly true for assets that thrive in a downturn.

Another mitigating strategy the wealthy use is multi-tiered diversification. The problem with public equities is while diversification is achieved through acquiring multiple stocks across multiple industries to minimize risk in good times, no amount of diversification will save your portfolio in a market crash.

While diversification on Wall Street typically comes at the cost of returns as risk is reduced, diversification in the world of income-producing alternatives doesn’t necessarily mean reduced returns.

Multi-tiered diversification of alternative assets is less about lowering risk at the expense of returns and is more closely associated with creating multiple streams of income to preserve cash flow and appreciation.

The wealthy gravitate to income-producing alternatives because these assets lend themselves to diversification across a variety of variables including:

  • Alternative Asset Class
  • Stage of Development
  • Investment Vehicle
  • Type of Return
  • Holding Period
  • Geographic Location

All of these factors serve to preserve one thing – income – essential for growing and maintaining wealth even in the midst of turbulent times.

To achieve those above-market returns, wealthy investors are willing to give up liquidy. In fact, they welcome illiquidity because it prevents the type of volatility that destroys wealth on Wall Street.

That’s why 33% drops in the Dow like in the early days of the pandemic didn’t faze them. Not being heavily allocated to public equities means continued cash flow from insulated assets – assets found only in the private markets.

Wealthy investors willingly give up liquidity to achieve:

  • Above-Market Returns
  • Non-Correlation to Wall Street
  • Consistent Income Stream
  • Management Transparency
  • Long-Term Growth
  • Expert and Efficient Management

Are you satisfied with average returns?

Why settle with index funds?

The wealthy ignore index funds because they’re not satisfied with average returns.

That’s why they’re constantly in pursuit of above-market returns – the type of high risk-adjusted returns found only with income-producing alternative assets in the private markets.

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