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For the last several years, I’ve been studying the world’s ultra-wealthy. I’ve studied not only their habits, but also their investments. Where do they invest? What do they invest in? How do they decide what is a good investment and what is not? Risk, returns—the whole enchilada. The one thing that I have found is that most of their investments are non-liquid, and are heavily concentrated in private investments.
Before I go on, you must understand two things: 1) liquidity and 2) private investments.
1) Liquidity – This is the ability to easily sell your investment and receive cash for it. The faster you’re able to sell and receive cash, the more liquid the investment.
2) Private Investment – This is any investment that isn’t publicly traded on an exchange. Think about decent-sized companies that do not trade on a stock exchange.
In the past, I have always viewed private, non-liquid investments as things to avoid. I was always taught that a lack of liquidity is a bad thing. I was working for a brokerage at the time who, of course, preached the importance of high liquidity. That’s how they make money: people buying and selling stocks frequently. But the more I researched the wealthy, the more I found that they use non-liquid investments as an opportunity to make great money.
Let me share an example. Let’s say that a company that is producing $10 million of annual revenue wants to grow. They need a loan from a bank to build a new factory that will enable them to double their revenue in five years. Because their revenues aren’t high enough, the big banks don’t want to waste time with them. Enter in private investors. If a private investor, or in this case a group of private investors, agrees to terms to loan this company money, the terms are normally very good to the investors. This is because the company has nowhere else to go. The lack of liquidity provides the opportunity for a great return on a great investment.
The next relevant question regarding investing in the private market is how much liquidity one needs. Most people do not need 100% liquidity in their investment accounts. These accounts are built for the next 20, 30, 40 years. I have found that people can get by with having a portfolio of 80% liquidity, meaning that they can convert 80% of their entire account into cash if they need to. It’s unlikely that one would ever need to liquidate that much of their entire portfolio—and we certainly hope that would never happen—but liquidating such a portion is possible.
The other 20%, however, could be used to invest in some private companies. This can provide a potentially good investment and can diversify a portfolio in a unique way that is usually otherwise unattainable.
Now, for those of you thinking about the risk: there certainly is. The amount of liquidity holds most of the risk, but also holds most of the benefit. If for some reason you need your portfolio to be 100% liquid, you may not be able to get out of the private investment immediately. It may take time. The other main risk is the risk of default. Any time you loan any company money, there is a risk of default. The key is making sure you loan the right companies money to keep this as low as possible.
Although the private market holds marginal risks, it’s been my experience that embracing these risks is not only a path to wealth, but is also one of the fundamental tools of the ultra-wealthy. Liquidity needs must be evaluated on a case-by-case basis, but for my clients who have lower liquidity needs, I always pay the private market due consideration as an effective investment.
To learn more about this type of investment, please join us on January 31st at 6:30pm ET for a special webcast. We will talk about the risks, rewards, structure, and how anyone can invest in these private investments.
Here’s to wise investing,
Brett Pattison
Disclosure: Private investments like the one discussed in this article are not meant for everyone. Please talk with a licensed professional to see if this type of investment is suitable for you. Please understand the risks before investing.
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