Investment secrets of the wealthy

Sept. 1, 2006
“Tell me the investment secrets of the wealthiest dentists.

“Tell me the investment secrets of the wealthiest dentists.”

This request has always guided my professional activities to the extent that, every year, we conduct research on what causes dentists to succeed or fail.

First, let me share the mythic version of a wealthy doctor’s investing. While at a speaking engagement, a participant shared with me that he had accumulated $12 million by the age of 60. Somewhat startled, I asked what his secret was. He had heard Microsoft chairman Bill Gates speak in the early 1980s, and was so impressed that he purchased $11,000 of Microsoft stock. He said his current accumulation was $12 million. When I asked about his investment secrets, he said he would continue to hold Microsoft.

So the secret of this doctor has been to pick one stock, based upon a gut instinct, and hold it through thick or thin. This breaks all the rules of diversification and risk management. Sounds like investing in the late 1990s. Perhaps this secret cannot be easily replicated. I think I have about as much chance of starting at quarterback for the Indianapolis Colts in place of Peyton Manning as I do picking a stock like Microsoft in the early 1980s!

Recently, I discussed investment management with an advisor who was constructing a portfolio for an individual with $300 million to invest. Before sharing a Vanguard portfolio with a similar construction, let me share with you five rules that guide the wealthiest investors.

Rule 1: The wealthiest manage risk while the poorest chase returns.

Have you changed your portfolio construction dramatically during the past five years? Most investors have. The poorest were weighted in aggressive technology stocks in 1999. Now they own real estate. The wealthiest have maintained the same portfolio construction they have always held.

• Rule 2: The wealthiest act on objective analysis while the poorest trade on emotions.

Does the latest news change your investment philosophy? The poorest investors change portfolio construction based upon world events. The wealthiest invest strategically and maintain overall principles.

• Rule 3: The wealthiest invest long term while the poorest buy and sell short term.

What has your portfolio return been for the past 10 years? The poorest investors seem bound to short-term trends that always sabotage results. They can’t change behavior even when experiencing failure again and again. The wealthiest have maintained a diversified blend of asset classes.

• Rule 4: The wealthiest use science to invest while the poorest use instinct.

Do you know there is a science of investing that is maintained in publications like The Journal of Finance? The poorest read popular investing publications, listen to tips from relatives or friends, and invest on gut feelings. The wealthiest use the same scientific process that they have always used.

• Rule 5: The wealthiest follow a process while the poorest act haphazardly.

Do you follow a written investment policy statement? The poorest investors don’t follow a consistent process. The wealthiest follow the process they originally outlined.

Wealthy investors possess a sophisticated process of portfolio construction that uses the latest science of investing, is driven by controlling risk, and serves them in all kinds of investment markets. You can learn from wealthy investors.

A sample portfolio of Vanguard funds* that has similar investment principles (equity component only) might be: Vanguard 500 - 15%, Vanguard Value - 20%, Vanguard Small Cap Value - 20%, Vanguard REIT - 15%, Vanguard European - 10%, Vanguard Pacific - 5%, Vanguard Emerging Market - 5%, Vanguard International Value - 10%.

This equity portfolio has the following one-year, three-year, and five-year returns compared to the S&P 500 Index as of June 30, 2006: Vanguard portfolio (17.99%, 20.70%, and 10.07%) vs. S&P 500 (6.65%, 9.25%, and 0.75%)

*This portfolio is for illustration purposes only and is not intended as investment advice. Past performance is no guarantee of future performance or that losses will not occur. Some mutual funds contain redemption and other fees that could affect performance. Some funds may not be open to investors at the current time. Always read a mutual fund’s prospectus before investing. Performance calculations are from the Steele Mutual Fund Expert, copyright Steele Systems, Inc.

Brian Hufford, CPA, CFP®, is president of Hufford Financial Advisors, an independent, fee-only planning firm dedicated to helping dentists achieve financial peace of mind. Many dentists attend Hufford Financial Advisors’ Financial Breakthrough Workshops. Upcoming workshop dates and locations are listed at www.huffordfinancial.com. Contact him at (888) 470-3064, or at [email protected].

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