Each year, the Federal Reserve and the UN publish data on the wealth distribution among the richest and poorest. To perhaps no one’s surprise, their data confirms that the rich have gotten richer (at the relative expense of the poorest). Investing like a wealthy person just seems to… work.
What are the wealthy doing that drives this growth? And how can the rest of us use their techniques when managing our own personal finance to boost our own net worth? Read on to learn more about how to invest like a wealthy person.
Please be aware that this article is not financial advice. I hope it will provoke some inspiration when you are planning for the future.
How to invest like a wealthy person
Here are my principles for investing like a wealthy person:
- Wealth is the goal, not a means to an end
- Avoid tax at all costs
- Become fully invested
- Consider less diversification
- Take high risks with a portion of your capital
Wealth is the goal, not a means to an end
The first principle is about the mindset. Wealthy people don’t generally become wealthy by accident. Any economics textbook will explain that the sheer competition between businesses, investors and even workers means that money doesn’t come easily to anyone, no matter how effortless some may make it appear.
Consider some of the wealthiest tech billionaires such as Mark Zuckerberg, Elon Musk and Jeff Bezos. We can fall into a trap of reducing their journey to wealth to a two-step process:
- Have a great idea
- Successfully execute the idea
- Attain billionaire status
But this summary skips a crucial hurdle that all of these entrepreneurs cleared along the way: they turned down offer after offer to buy their businesses at staggering valuations as the business grew.
£100 million is arguably more money than anyone needs to live a blissful existence. And yet each of these tech moguls will have repeatedly turned down similar dream hauls in the pursuit of more growth at their company.
Only when you can put yourself in the shoes of someone who has said ‘no’ to the offer of risk-free piles of cash, can you appreciate that wealth does not just accrue to the lucky few. It accrues to those who don’t see wealth simply as a means to buy goods & services. It accrues to those who pursue it almost as an objective in its own right.
Wealth creation is an intentional pursuit that requires perseverance, risk tolerance and a very long term mindset. We’ll touch upon these points in later principles.
Avoid tax at all costs
If payslips are the engine that propels your net worth vehicle forward, then it would be accurate to describe tax as the brakes.
Tax is a necessary evil in any modern civil society. We want to enjoy good public services and we also want the less fortunate to have equal access to basic goods as well. This tenet costs a small fortune to make a reality, and therefore governments must raise substantial tax revenues to balance the books.
In the 21/22 tax year, the UK Treasury collected £718.2 billion in tax, mostly through VAT and income taxes.
We recognise the necessity of tax and that’s why we encourage everyone to embrace the lawful obligation to pay taxes and comply with the letter and spirit of the rules when managing their personal finances.
However, the tax rules offer discounts or tax-free opportunities if you know where to look. By leveraging those opportunities and accepting the consequences, the wealthy significantly reduce the amount of tax they pay.
Progressive tax systems levy higher rates of tax on higher incomes and wealth. This means that for many wealthy people, tax rather than underlying returns becomes the largest single driver of investment success. A modest (but untaxed) investment profit can be more valuable than a sizeable taxable profit.
While the specific schemes or reliefs used by the super-wealthy may not apply to the average household, you can still apply this mindset when avoiding tax. Here is a simple idea on how to legally avoid tax to boost your net worth:
Take advantage of the generous tax relief available through salary sacrifice schemes.
If you avoid 42% of tax, are you 42% better off? The answer is no – you are actually 72% better off.
If you are a higher-rate taxpayer, every £1.00 of income above the higher rate threshold is subject to £0.40 of income tax. It will also attract £0.02 of employees’ national insurance if it’s above the NIC upper earnings limit. Check the latest rates on the HMRC website here. Tax may vary depending on your personal circumstances.
If you pay £1.00 into a workplace pension scheme through salary sacrifice, it would escape all income taxes.
From a net worth perspective, you now have £1.00 of assets in your pension scheme, instead of the £0.58 of net pay that would have otherwise been paid into your bank account.
Having £1.00 instead of £0.58 isn’t a 42% better outcome – it’s a 72% better outcome. And that’s before we include any employer matching contributions or NIC savings being passed on.
Therefore every £1.00 sacrificed will result in a 72% boost to its impact on your net worth.
How will you use this information? If you leverage this opportunity to its extreme, you could sacrifice your entire salary above the higher rate threshold, contributing several hundred pounds per month into your net worth.
For the sake of completeness, I should highlight that income taxes may have to be paid on pension pots when you finally draw down an income from the scheme. However, this can be done in a tax-efficient way that could see you pay anywhere from 0% – 20% on the income rather than 42% currently. Be aware that 25% of a pension pot can also be withdrawn at your retirement date as a tax-free lump sum.
You may have noticed that this section is called ‘avoid tax at all costs’ which hints at the trade-offs the wealthy need to accept to use tax relief to boost their net worth.
In our example, the downside of paying into a pension is that you cannot access the money until your retirement date. Currently, the retirement date for private pensions is 55 although this will soon increase to 57 and may rise further in the future.
The wealthy recognise that they need a pension of a certain size and they cannot retire until they meet their target pension pot level, so it’s smarter to grow the pot quickly in a tax-free environment and retire earlier than pay in slowly over a career, while losing tens or hundreds of thousands to income tax along the way.
Be fully invested
The wealthy appreciate that after years of saving and investing, the main source of future wealth will be their investments, not their labour.
Our careers are a source of pride, and intellectual nourishment (as well as stress), but they’re not the only way to build wealth.
With an investment portfolio of £750,000, a well-off investor could enjoy dividend income of up to £35,000 when invested in the best investments for equity income.
That income windfall didn’t require any effort on the part of its owner, almost like a ‘shadow salary’. If those dividends are immediately reinvested, this drives an accelerating compound interest cycle that could see the same investor holding £1.3m of investments (and receiving £78,000 in dividend income) after ten years, without depositing any further money from other sources.
The act of being fully invested is why the wealthy get richer almost every year – the value of capital will grow over the long term and is completely independent of the value of your skills or the number of hours you can spend working in a week.
This is the secret that explains why some people appear to have wealth in such abundance. You want your investments to snowball and begin to become a financial powerhouse in their own right. But this will only be noticeable relative to your salary if you reach a critical level of savings & investments.
A 6% return on a £1,000 investment account is worth £60 – barely enough for a restaurant meal for two. At this initial phase of saving money, the sacrifice may not feel like it’s baring enough fruit to justify the £1,000 of sacrifices made to invest that money.
That’s why I view each £1,000 invested as its own small scale battle of willpower. Winning one battle won’t change your life, but winning that battle every month and investing that money regardless of the latest stock market outlook should show incredible results after ten years. It’s a matter of perseverance. Perseverance that the wealthy have demonstrated they have. Do you?
Consider less diversification
When you learn how to create an investment portfolio, you will be taught about diversification. Diversification could mean buying lots of assets within an asset class (like lots of different company stocks) or spreading your money across different asset classes altogether (like adding corporate bonds and REITs into the mix).
Portfolios that label themselves as ‘diversified’ tend to include bonds. Including bonds within a portfolio should reduce the overall volatility of your account value. That’s great for your mental health, perhaps, but not great for your overall wealth. It’s certainly now how to invest like a wealthy person.
That’s because bonds have a significantly lower expected return than equities. So why would we include them in a long term portfolio designed to build wealth over decades?
This is another form of trade-off that you will need to come to terms with. Investments that we choose for temporary comfort and stability may work against our long term goals of maximising absolute growth.
We don’t recommend creating a portfolio that exceeds your risk tolerance, so your own decision on this matter must be one that you are comfortable with. But simple mathematics will prove to you that allocating 50% of your portfolio to bonds will reduce the expected return of your assets.
Take high risks with a portion of your capital
Most equity investments made by retail investors are in large cap companies. This the term given to mature, established businesses that represent some of the most valuable companies on the stock market.
It’s natural that the companies representing most of the market cap of an index will attract the most investment. However, the wealthiest investors don’t settle for this type of equity because they appreciate that higher returns can be made elsewhere: the private markets.
Private market investments are investments in the shares or debt of private companies. If you’ve wondered how to invest in venture capital or how to invest in private equity, you are already asking about how to access private markets.
These investments are high risk for a myriad of reasons:
- Private securities can’t be easily sold and investors may be locked in
- Private companies are often smaller and more reliant on fewer customers & products and therefore experience failure at a higher rate than mature listed groups
- Private companies have fewer avenues to raise capital if they suffer financial distress
This extreme level of risk makes these investments unsuitable for frankly most retail investors. As a result, financial intermediaries may actively prevent retail investors from contributing to the best VCT funds at launch. Of those that do accept retail investor cash, the high minimum investments (which sometimes exceed £20,000) practically keep the door firmly closed to most.
Nevertheless, the wealthy understand that allocating a small element of their wealth to high-risk investments such as venture capital and private equity is like buying a lottery ticket they can afford to lose in the hope of striking it rich.
Summary: how to invest like a wealthy person
I hope you enjoyed this article, which offers a different perspective on approaching investment.
Above all else, the reason why wealthy people invest differently is that they have security of income and therefore can afford to take risks with most of their capital.
In your pursuit of wealth, you should not take risks that could impact your quality of life. To the extent this prevents you from designing an ‘optimal’ portfolio, I hope you accept this as a necessary constraint.
Holding high-risk investments can be a difficult experience. It is one thing to accept risk on paper, but to experience investment loss is another thing entirely. Beyond the financial loss, you must also learn to accept the mistakes you have made, as the feeling of regret and embarrassment is also a significant component of the pain of seeing an investment plummet in value.
Here is a summary of how to invest like a wealthy person:
Recognise that building wealth is an uphill battle against the laws of economics, and that it will require dedication. You may only succeed if you pursue of wealth as an objective in its own right.
Accept that some trade-offs may be necessary to avoid taxes slamming the brakes on your net worth growth.
Remain as invested in the stock market as your personal finances allow, with the objective of never exiting the markets, and reinvesting dividend income immediately. This will enable you to leverage the independent growth that capital can provide.
Consider the expected returns of asset classes carefully before adding them to your portfolio. If you can stomach high volatility then including bonds in your holdings will actively hold back your returns over the long term.
Explore high-risk investment opportunities but diversify across them and only allocate a small percentage of your total net worth.
This is how to invest like a wealthy person, and could offer the quickest way to become a millionaire without starting your own business or earning an impressive salary.