The secrets of wealthy people

Three basic truths can help you make and preserve wealth, says David C Stevenson.

I’ve just finished writing a book about the secrets of wealthy people, which involved talking to a lot of investors, wealth managers, and entrepreneurs. My findings? The sad fact is that there is no single secret. But there do seem to be three basic truths about making and preserving wealth.

The first is that most wealthy people don’t make their money from investing: they just work bloody hard, and invest wisely. Secondly, they are willing to take lots of risk, as long as they have a clear understanding of what they are investing in and the risk/return trade-off. This leads to a third truth, which is that we all face too much noise when investing.

If we’re to succeed, we have two main options. Focus on a small group of ideas on which you have expert-level knowledge, and take very concentrated risks. For everything else, keep costs down and don’t over-complicate things.

Keeping track of what’s hot and what’s not is exhausting. Most investors should stick with an easy-to-implement plan, ignore the likes of the equities versus bonds debate, and focus on earning more money by being better at their job or business.

How do you keep things simple? One option is to use ‘multi-asset-class passive funds’: a single fund giving access to several asset classes: equities, bonds, and maybe some alternatives. In short, it’s a ready-made, fully diversified portfolio.

You just decide a) the level of risk you are comfortable with; b) how much you want to pay; and c) how much active management of the asset classes (ie, bonds versus equities) is appropriate.

Every investor will have a different take on these questions. This is why I am a bit nervous about the millions of investors being shoved by financial advisers into ‘target risk’ or ‘target date’ portfolios (where risk levels are based on how long you have until you retire).

These usually follow a simple three-part structure: low-risk portfolios aimed at capital preservation, balanced approaches that mix bonds and equities, and growth portfolios for risk-friendly types. This is a million times better than most of what came before, but it does risk shepherding us all towards the same bunch of assets.

That said, these multi-asset-class funds are a brilliant way to invest for the long term without too much hassle. Find your risk level, get a good manager and sit back and watch the fund grow in value (hopefully). So how do you choose the right one for you?

Options include fettered fund of funds (the same manager offering different funds from their own stable in a single portfolio); unfettered fund of funds (different underlying managers from different providers in one portfolio); or low-cost passive structures.

But the key question really is: should you buy a portfolio that invests largely in actively managed funds, or one that buys passive funds?

I have a lot of time for active managers. If you find a consistently successful one, I think they are (mostly) worth the extra money you pay for them. But it’s also true that there aren’t that many consistently successful managers – and even the most persistent have bad years.

So, if you buy a fund of active funds, you are asking for double trouble – not only does your portfolio manager have to pick the best fund managers, they also have to be great at asset allocation. I think managing both is probably beyond most financial professionals.

And once you factor in all the extra layers of costs (at least 1% a year in extra fees), it’s just not worth it.

That leaves managers who use passive funds to access their chosen mix of asset classes. You still run the risk that your manager will make useless asset class calls, but you’ve removed two risks – excessive costs and the chance of picking duff active fund managers for the portfolio.

In the US, this approach is huge, but so far the choice of funds in the UK is far smaller. There are almost no exchange-traded funds (ETFs) doing this (I can think of just one from DB-X trackers, involving specialist managers SCM). I’d rather buy a multi-asset-class ETF because of the flexibility it gives me. But I suspect I might have to wait another year or so for a decent choice to emerge.

On the unit trust side, there’s more choice. There are two main approaches, based around cost and the asset allocation process for selecting the funds. On one side, Vanguard and, to a lesser degree, companies such as HSBC and Architas, offer cheap, simple portfolios, costing less than 0.5% a year. Their asset mix won’t change much – perhaps annually.

On the other, a growing army of specialist managers such as Charles Stanley’s new business Evercore, TCF, 7IM and SCM offer more complex solutions where the cost is usually 0.5%-1% a year. These focus more on ‘tactical’ or ‘dynamic’ asset allocation, with frequent decisions taken about the attractiveness of different asset classes as the economy ebbs and flows.

There’s no right or wrong approach – but next time I’ll look at what you need to understand about asset allocation, the underlying funds, and calculating costs of ownership, in order to choose the right one for you.

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