Investments

Ever wondered why the affluent are drawn to investments in hedge funds, venture capital, venture debt, private equity, and specialty funds, despite many of them historically underperforming the S&P 500? Billions of dollars flow into these actively managed funds annually.

These active funds often comprise alternative assets, which are typically less efficiently priced than standard marketable securities. This inefficiency provides a chance to take advantage of market anomalies through skillful management. Alternative assets encompass areas like venture capital, leveraged buyouts, and commodities like oil, gas, timber, and real estate.

Since 1999, I’ve allocated some of my wealth into various actively managed funds. Reflecting on a recent reader’s question, I’ve realized that my rationale for doing so has evolved over the years.

The Motivation Behind Investing in Active Funds at Different Life Stages

As we age, our perceptions and attitudes towards money undergo changes. Understanding these changes can lead to wiser investment choices.

1. In Your 20s: Curiosity, Inexperience, and Opportunity I started my investment journey in 1999 by investing in a hedge fund through Goldman Sachs’ 401(k). Back then, as a rookie financial analyst, the chance to invest in such a fund intrigued me, despite the high fees.For a young investor, the thrill of belonging to an exclusive club – having access to something not ordinarily available – can be alluring. Andor Capital, where I initially invested, performed exceptionally well during the Dotcom bust.As a newcomer in the finance world, these early impressions were influential, leading me to regard hedge funds positively and even aspire to manage one someday.
2. In Your 30s: Aspirations and Ambitions As you accumulate wealth, you begin to dream big, inspired by stories of fund managers like John Paulson, who made billions in shorting mortgage-backed securities in 2008.This phase of life fuels the desire to emulate those who acquired vast wealth not by playing safe with index funds, but by making daring, concentrated bets. Active investing can be a roller coaster, with both impressive gains and disappointing losses. For those who succeed more often than fail, the enthusiasm remains.The pursuit of wealth becomes a driving force, aligning with the active investment strategy in an attempt to make a big splash.
3. In Your 40s and Beyond: Stability and Safeguarding Wealth Decades of investing bring the realization that active investments often lag behind passive index investments. Yet, investing in active funds still makes sense as it harmonizes with reality.The advantage of active funds at this stage is the wisdom and resources you’ve gathered. You become more strategic in your allocations and seek fund managers with expertise and proven track records.As financial security becomes the focus, rather than chasing lofty returns, the flexibility of active fund managers to shield investors adds to their appeal.

Hedging and Diversifying: Safeguarding Against Financial Crisis

Wealth preservation becomes a priority for many as they grow richer. The quest for more remains, but protecting what’s already achieved takes precedence. Active funds offer potential protection, but true security lies in diversification.

For instance, a hypothetical scenario with $10 million in assets might see a distribution of 40% in real estate, 30% in public equities, 20% in active funds, and 10% in risk-free investments.

The combination of these elements could generate a consistent 5% yearly return with reduced volatility. When you’re at a financial level where a significant market drop could mean a loss of nearly $2 million, stability becomes vital.

Pursuit of Peace and Serenity

Ultimately, the essence of investing and life is not merely about returns. One Thursday, as I enjoyed a day at the zoo with my daughter, I experienced a sense of peace, love, and tranquility far surpassing the thrill of a profitable investment.

Trust in active management to better safeguard my assets offers comfort, even if I don’t expect them to consistently beat the S&P 500. During market downturns, not losing as much becomes its own reward.

These insights are shaped by experience, understanding of markets, and recognition of the human factors influencing investment decisions. The blend of financial pragmatism with life’s intangible values illustrates the multifaceted approach to investing in active funds across different life stages.

We’ve been discussing different ways I would put money to work, whether it’s $100,000 or $250,000. Now, let’s tackle the big one: how I’d invest a cool million today.

Putting a million dollars into investments is a different ball game from dealing with $100,000 or $250,000. Losing that smaller chunk might sting, but it’s bearable. But if a million dollars were to vanish, it could send you spiraling into despair!

Once you’re sitting on a million bucks in investments and your house is all paid off, the game changes. You don’t have to gamble on risky ventures. You can settle into a comfortable groove with low-risk options and enjoy life.

But we all know that more is often better, so let’s explore how to make that million grow without being reckless.

Investing a Million Bucks Isn’t One-Size-Fits-All

There’s no single way to invest a million dollars because it depends on your personal situation. How did you earn that money? If it took blood, sweat, and tears, you’ll probably be more cautious with it, and rightly so.

Your age factors in, too. If you’re already comfortably off in your later years, losing a significant sum would be a gut punch. So you’ll probably be conservative there as well.

How big is that million in the grand scheme of your wealth? If it’s just a small part of your net worth, you might be more daring with it.

And don’t forget your income. Someone raking in a million a year can afford to be bolder than someone living on $50,000.

In this article, let’s assume this million came from over a decade of hard graft and maybe some luck – like striking gold with a startup, selling a longtime home, or landing a windfall from a divorce or accident.

Most people don’t save up a million dollars and then throw it all into investments at once. Usually, it’s a sudden windfall that prompts such a move.

Hitting the Million-Dollar Mark Feels Like Winning

Reaching that seven-figure net worth is an awesome achievement. You’ll probably bask in the glory for a while before setting your sights on the next financial goal, such as investing that million.

Investing or spending a million bucks opens up a world of options. Want to spend your days on a Hawaiian beach? You could do that for a while or invest to earn even more. The dream is having money that works for you, providing a never-ending stream of income.

A Glimpse Into My Recent Million-Dollar Moves

In 2020, I stumbled upon my dream home and made a bold move. I didn’t have a million in cash, but I scraped together over a million by selling off some municipal bonds. I used that to make a down payment, borrowing the rest at a decent interest rate.

Today, that down payment has turned into about $1.7 million, including a 57% gain thanks in part to some clever leveraging.

A Trip Down What-If Lane

Had I known what I know now, I might have played things differently back in 2020. Maybe a smaller down payment and investing the rest in the S&P 500. That move could have netted me around $750,000 today, with gains elsewhere totaling around $850,000.

But hindsight is 20/20, and I was dealing with competition for the house and a very uncertain world at the time.

Fear Factor and 2020’s Challenges

Back in 2020, the uncertainty was real. I was more comfortable buying something tangible like a home rather than risking it on volatile stocks. I still invested in stocks, but real estate felt like the safer bet then.

Now, with interest rates up, I can see that my decision to offload those municipal bonds was a smart one, despite the market fluctuations over the past years.

Investing a Million Today: What I’d Do

So, now that I’ve walked you through my recent million-dollar investment adventure, let’s talk about what I’d do if I were in those shoes today.

For someone like me, who’s more concerned with control over time rather than maximizing wealth, my advice on investing one million dollars might be different from someone who’s trying to grow their financial foundation aggressively.

But, hey, if you’re young and find yourself with a million-dollar windfall, congratulations! Investing that money wisely can set you up nicely for the future. And I hope my experience can give you some guidance.

Why Everyone Should Consider Stock Investments

While stock investments don’t have an immediate tangible value like real estate or artwork, they can offer dividends and opportunities for capital gains. Historically, the S&P 500 has given approximately 10% returns annually since 1926.

Moreover, once you’ve achieved sufficient returns, it’s wise to cash out some stocks to fund your desires. After all, the primary purpose of investments is to aid in achieving our life goals.

To illustrate, stocks aren’t something you can physically use like a house, piece of art, or wine. Their value only materializes when you decide to cash them in. They’re essentially a tool to achieve financial milestones.

Key Purchases After Cashing Out Stocks

People have various motivations for selling their stocks. Setting aside the speculative approach of predicting market movements, here’s an insight into what returns from the S&P 500 have looked like since 1980: despite an average 14% drop intra-year, 76% of these years showed positive annual returns.

Here’s a glimpse of potential reasons to sell stocks:

1. Buying a Vehicle: If your stock investments have flourished enough to buy a car outright, it might be the right time to sell. However, ensure you’re not overspending, especially given that stock markets generally rise. When buying a car, consider its true necessity and aim for value for money.Example: Want a $38,000 car? Ideally, have that amount or more in stock gains. Paying outright is ideal, but financing options exist if they align with your monthly income. Personally, the thought of liquidating stocks for a car was unsettling; I kept a modest car for 14 years due to this.
2. Funding Higher Education: Parents ideally begin saving for their child’s college right from birth. 529 plans and Roth IRAs are effective vehicles for this purpose. Moreover, ensure the value of the degree is worth its cost. Remember, when you use stocks for tuition, you’re essentially reallocating your assets.A significant challenge might be the temptation to not fully utilize the 529 funds, perhaps hoping for scholarships or cheaper colleges. Unused 529 money can be transferred to Roth IRAs or to a different beneficiary.
3. Purchasing a Home: This is a primary reason many liquidate stocks. Historically, real estate has grown around inflation rates plus 1-2% annually. This means trading stocks for property often entails moving from high to relatively lower returns. However, real estate has its unique perks and stability.Fear of property devaluation? Opt for homes with inspection contingencies. If remodelling, prioritize expansion and essential areas like kitchens and bathrooms.A personal anecdote: A once-desired home became available for 14% less than its earlier asking price. The catch? It required selling substantial stock holdings.
4. Managing Emergencies: Everyone should ideally have a six-month living expense buffer. For emergencies surpassing this, selling stocks can bridge the gap.
5. Sustaining Retirement: One core reason we invest in stocks is to ensure a comfortable retirement. Over time, it can be challenging to sell stocks, hence many lean towards dividend-earning stocks. In retirement, diversifying income sources is crucial. Stock sales might be a primary or supplemental source, but it’s essential to be aware of tax implications.Selling stocks at a younger age can feel like a missed opportunity. Personal experience suggests younger retirees might explore alternative income streams. However, as age advances, it becomes relatively easier to cash out.

Which Stocks to Sell: Winners or Losers?

Active investors often grapple with this. Generally, successful stocks continue their upward trajectory, while underperforming ones might continue to dip. It might be wise to offload underperforming stocks first, benefiting from tax deductions. If that’s not sufficient, some profitable stocks might need to be sold, ideally balancing out capital gains and losses.

For those invested in indices like the S&P 500, remember that selling might mean missing out on future gains about 76% of the time. Diversifying and not keeping all your eggs in one basket, especially company stocks, is also advisable.

An Alternative: SBLOC

If selling stocks feels premature, consider a Security-Based Line of Credit (SBLOC). This allows you to borrow against your stocks, akin to a home equity line of credit.

Silver Linings Despite Economic Disruptions

Economic downturns, like bear markets and bank panics, don’t usually benefit the masses. But let’s find the silver lining in the potential impact of the Federal Reserve on the middle class. By looking at extremes, we gain clarity and can make informed choices.

A few points for context:

1. The Federal Reserve seems more driven by its reputation than the welfare of the middle class. Given that the decision-makers at the Fed are wealthy, their perspective on economic downturns might be from a numbers standpoint, rather than its impact on the general populace.
2. Alarms have sounded about economic impacts if the terminal Fed Funds rate consistently exceeds 5% with slowing inflation. Nevertheless, the rate was increased by 0.25% on May 3, 2023, setting it between 5% and 5.25%.
3. Often, there’s an increased appreciation for a problem-solver who first creates the problem. It’s about recent contributions being valued the most.

In 2007, the last instance when the Fed Funds rate was set at 5%-5.25%, the global financial crash of 2008 followed. While the crisis was devastating, it paved the way for some good, like the inception of Financial Samurai in 2009.

Though we can’t always dictate our circumstances, our responses remain within our control. So, in the spirit of optimism, let’s consider the potential advantages of another economic downturn.

Advantages of Federal Reserve’s Policies on the Middle Class

1. Re-prioritizing Life’s Desires: With economic stress, aspirations for prestige and wealth might become secondary. Financial struggles often shift our focus from materialism to essential needs and genuine happiness.
2. Tackling the Student Loan Crisis: Economic stress may encourage more judicious college choices, spurring students to pursue more cost-effective education and universities to offer better financial aids.
3. Promotion of Financial Prudence: Financial downturns force a reevaluation of spending habits, fostering greater financial discipline and resilience.
4. Eco-Friendly Lifestyle: Reduced disposable income might translate to fewer cars, contributing to environmental protection. It might also be a good time for low-budget travel and cultural immersion.
5. New Career Opportunities: Economic challenges might push many out of unsatisfying jobs, opening doors to new, more fulfilling careers.
6. Improved Education Systems: An economic decline may lead to less crowding in schools, better teacher-to-student ratios, and more time for parents to engage with their children’s education.
7. Deepening Relationships: Financial woes often bring people together, fostering stronger bonds with family and friends.
8. Health First: Financial constraints can lead to a more focused approach to mental and physical health, as job-related stress diminishes.
9. Political Re-evaluation: Economic challenges might pave the way for political change, prompting fresh solutions to pressing issues.
10. Reduced Borrowing Costs: In the wake of economic decline, interest rates might decrease, providing relief to borrowers.
11. Inflation Control: A financial decline might lead to reduced inflation, potentially making essentials more affordable.
12. Boosting Passive Income: Higher interest rates could enable better returns on savings, helping individuals achieve financial security and maybe even early retirement.

Though potential benefits exist, it’s essential to remember that a thriving middle class is integral to any nation’s health. Finding balance and sustainable solutions should always be a priority.

I’m not one to jump on new tech bandwagons quickly; I prefer others to iron out the issues before I adopt. This mindset made me somewhat indifferent to artificial intelligence (AI).

One weekend at a children’s party, a father from the finance sector approached me, curious about the progress of my book. Casually, I mentioned its decent performance and that I’d likely publish another next year.

He was taken aback, admitting he wasn’t aware of my second book. His surprise led to a peculiar comment: “Why write another? Aren’t you concerned about AI’s impact on writing?” He quickly realized how unusual his remark was.

Usually, such news is met with encouragement. However, he suggested I was squandering my time and talents, given the challenges writers already face.

His life was a stark contrast, filled with Hawaiian vacations and financial successes. These encounters have made me question if my current path is truly best for my family. Maybe the traditional work structure is more beneficial.

Safeguarding Against AI’s Impact Considering our conversation, it’s apt to discuss how we might shield ourselves from AI’s potential pitfalls. Many believe that AI could threaten job security, especially for knowledge workers.

A simplistic but challenging solution is accumulating substantial wealth, ensuring future generations don’t rely on traditional employment.

Although we might have a decade before AI begins significantly replacing jobs, it’s imperative to financially prepare.

Leveraging Artificial Intelligence for Wealth Accumulation To safeguard our careers, it’s essential to recognize which jobs AI might soon make redundant. Research from esteemed professors has provided a list ranking jobs by vulnerability.

It’s disheartening that many educational roles seem jeopardized. Though online learning platforms have made strides, nothing replaces the adaptability and nuance of a physical educator. However, AI’s role in education, particularly in higher studies, remains ambiguous.

For those considering higher education, it’s wise to select fields less likely to be affected by AI, or those that leverage AI’s capabilities. This might mean prioritizing STEM over liberal arts, though both have their merits.

The authoring profession seems safe from AI’s imminent takeover, but the investment landscape might soon see AI’s influence.

Harnessing AI for Career Enhancement For those in high-risk sectors, it’s advisable to integrate AI to enhance professional services or output.

Simultaneously, professions rooted in tangible services, like home improvements, seem less threatened. Yet, AI can assist in designing or planning such tasks.

Investing in AI-Driven Ventures Allying with AI could also involve financially backing corporations capitalizing on its potential. Several global conglomerates are leading the AI frontier. Investing in such firms or associated index funds offers an indirect way to benefit from AI’s expansion.

Additionally, participating in private AI ventures, preferably through reputable venture capital firms, can be a strategic move.

Real Estate and AI: The Nexus Investing in property located in AI hubs offers another strategic move. Several global cities house the headquarters of major AI-invested corporations. Their presence ensures steady job creation, leading to sustained demand for housing and, subsequently, real estate appreciation. Owning property in these regions could be profitable in the AI era.

Planning for the AI Era To prosper in the upcoming AI-driven world, aligning with long-term trends is crucial. While the journey may have its pitfalls, consistent alignment with strong sectors will likely yield substantial returns.

AI undeniably holds the potential to reshape the world. Although entering the AI workforce may be challenging for many, everyone can still leverage this revolution through wise investments.

Our offspring can strategically chart their academic and professional journeys, ensuring they’re equipped for an AI-dominated future.

Furthermore, tools like ChatGPT can streamline and improve our daily lives. In this rapidly evolving landscape, personal branding is pivotal.