A recent study performed by the investment research firm, Openfolio, found that the wealthiest 1 percent of American investors had higher returns, or less of a loss, than the rest of investors, year over year. Of course, we all know that wealthier people make more money than those with less money, given the same rate of return. (Five percent of $1 million is a lot more than 5 percent of $100,000.) That's to be expected, but it has been found that the return is not even the same, not even close really, according to Openfolio.
The analysis performed by Openfolio has shown historically about a 7 percent difference between the two groups of investors each year, in favor of the wealthy. Now, the market isn't simply handing out better returns to the wealthy because they put more money in.
The difference in their returns is due to the investment behavior of the wealthy, a behavior that all investors would be wise to replicate.
So, what is it that they are doing differently? The main difference is that ever-important investment strategy: diversification. You see, if a portfolio is focused on very few stocks or sectors, any movement in those few stocks or sectors can lead to dangerous volatility. The rich, however, are much less likely to put their money into single stocks like Apple or General Electric; they tend to be much more diversified in many different stocks in a variety of sectors.
Openfolio broke it down into specifics. The bottom 5 percent of investors have positioned the vast majority (over 70 percent) of their portfolios into single stocks, creating a very volatile portfolio, with volatility within the portfolio of over 33.23 percent. The rich guys, on the other hand, have much less volatility just 14.9 percent (less than half) because they have less of their holdings focused on single stocks. Essentially, they are heavily diversified, have less volatility, giving them a higher probability of success. The report further suggests that wealthier investors tend to take on less risk, while other investors are chasing returns resulting in more risk. Of course, some of these riskier bets pay off. However, over time, the data overwhelmingly says that this type of strategy does not work.
As an advisor, I believe a strategy focused on managing volatility and downside risk is the key to long-term investment success.
An annual study of investors conducted by DALBAR, the nation's leading financial market research firm, found one of the primary reasons why small investors fail is due to their investment process, or lack thereof. The DALBAR study also found that most small investors make investment decisions based on their emotions, perceptions, or instincts about the market. We find that it is this lack of process that often leads individual investors to fall into the all-familiar cycle of buying high, and selling low.
Having a diversified portfolio, backed by strategies that use facts and logic to help manage downside risk, take advantage of gains and minimize losses, that might not earn you the lifestyle of the rich and the famous, but can give you the consistency that makes a successful investment strategy.
This content created by Rick Durkee in conjunction with Fusion Capital Management.