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Investing Strategies for the High-Net-Worth Investor

By Matthew Frankel, CFP® - Jul 22, 2017 at 9:33AM

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Here are some smart ways to reduce taxes, protect your savings, and boost returns.

When you're a high-net-worth investor, proper investment-management strategies are even more important -- but that doesn't mean that you need to do anything out of the ordinary. With that in mind, here are some investing strategies that could save you money, protect your portfolio, and boost your investment returns whether you're a high-net-worth investor, or aspire to become one in the future.

Know the fees you're paying

Investment fees can really add up, especially if you have a lot of money invested. If you have $5 million invested in mutual funds at an average expense ratio of 1%, you're paying $50,000 per year in investment fees alone.

Now, I'm not saying that fees are never worth paying. In fact, I'll happily pay relatively high fees for mutual funds that consistently deliver strong performance. Rather, I'm saying that it should be a part of all high-net-worth investors' strategies to know the investment fees they're paying and compare them with other investment options that might accomplish the same objective. For example, if you're invested in an S&P 500 index fund with a 0.4% expense ratio and switch to a fund that tracks the same index, but charges just 0.05%, it can make a big difference in your long-term returns.

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Take advantage of tax-free investments

Many traditional tax-reducing strategies don't apply to high-net-worth investors, or are not quite as effective as they are for the average person. For instance, traditional IRA contributions are limited to $5,500 per year -- $6,500 if you're 50 or older -- no matter how much you earn. In addition, high-net-worth investors are generally in higher tax brackets, which makes it extra important to minimize tax exposure. Tax-free municipals are a good example of an investment type that can be far more effective for high-net-worth investors than the general investing population.

As a simplified example, let's say that you have the choice between two fixed-income investments: a taxable bond paying 5% interest, or a tax-free municipal bond paying 3%. At first glance, it may seem like a no-brainer to take the 5%. However, if you're in the top tax bracket, you'll pay 39.6% in federal income tax plus an additional 3.8% in net investment income tax if you meet the criteria. All of a sudden, that 5% yield is effectively reduced to just 2.83%.

Diversify, diversify, diversify

Diversification is important for all investors, but is especially important for investors with lots of assets. And I don't just mean creating a diverse stock portfolio and practicing appropriate asset allocation. In fact, the average asset allocation of the superrich is:

  • 18% in U.S. equities
  • 18% in hedge funds
  • 14% in global equities
  • 10% in private equity
  • 10% in taxable bonds
  • 7% in cash
  • 7% in municipal bonds
  • 6% in real estate
  • 5% in commodities
  • 5% in other assets

Generally speaking, more diversification translates to lower portfolio risk. And high-net-worth investors have a wider variety of investment opportunities available to them, such as hedge funds and certain private equity opportunities.

Rebalance regularly

One important strategy high-net-worth investors should incorporate is to regularly rebalance your portfolio. Here's why this is so important.

Let's say that you set up your portfolio in January 2010 and allocated 70% of your holdings to stocks and 30% to bonds. Since that time, a low-cost S&P 500 index fund would have returned about 156%, including dividends, while the Vanguard Total Bond Market Index Fund has produced a total return of just 30%. If you hadn't rebalanced your investments, and your stock and bond investments matched these indices' returns, your portfolio would now be 82% in stocks and just 18% in bonds, thanks to the stock market's high return of the past seven years.

While this is a simplified example, the point is that it's important to rebalance regularly -- or make sure that whoever is managing your investments does it -- to ensure that your asset allocations don't get too far from where you want them to be.

Keep some cash

As you can see from the average asset allocation of the superrich that I listed earlier, the average person in this group keeps 7% of their assets in cash. When we're talking about people with eight- and nine-figure net worths, this translates to quite a bit of cash sitting on the sidelines.

Many wealthy people keep significantly more cash than this. About 3 in 5 keep over 10% of their investable assets in cash, and 1 in 5 keeps 25% or more in cash.

This isn't purely for diversification purposes, or because these people are afraid to be fully invested. Rather, the top reason given when a high-net-worth individual is asked why they keep so much cash is to be able to take advantage of opportunities, such as a sudden market drop. As Warren Buffett says, "Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold." However, if you don't have any cash on the sidelines, you won't be able to take advantage of these situations.

Ask for help

Finally, it's important for high-net-worth individuals to ask for help, unless they consider themselves to be investment experts. Do-it-yourself investing can be risky, especially if you don't have the time, knowledge, and desire to do it right. It shouldn't come as a surprise that the wealthy are the most likely group to seek out help from investment professionals.

These strategies aren't just for the rich

You may have noticed that these strategies aren't all specific to the wealthy, and you're right. Of course, average investors don't get quite as much benefit from investing in tax-free bonds, nor can they invest in hedge funds, but the principles behind these -- tax reduction and portfolio diversification -- apply to all of us.

Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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