A man and a woman hugging side by side, while both looking at a house
Investors should think in terms of their ‘total financial portfolio’, of which property is a key part © PeopleImages/Getty Images

We all make mistakes in investing, even the wealthy. Hopefully, they are small, little harm is done, and we can recognise our mistakes and learn how to do better — much better.

But one mistake is made by almost all investors almost all the time — and, because it is not recognised, they make it over and over again: taking decisions on securities in the wrong context, leading to an over-reliance on bonds. Their “framing” is not right, giving them little chance of choosing an appropriate strategy. And the long-term result of this self-inflicted blunder can do serious financial harm to wealth, particularly later in life.

When accumulating and investing in assets to assure retirement security many decades hence, or to pass on to the next generation, people worry far too much about price fluctuations in the near future. And so their portfolios are more “conservative”, and more heavily invested in bonds, than is optimal.

When I was working for one of the world’s wealthiest families, I asked the manager of a small trust for a young child why it was conservatively invested, with 40 per cent in ultra-safe bonds and 40 per cent in utility stocks. He had given no thought to the reality that the child would also be a beneficiary of other, quite enormous, trusts. So the small trust could have been much more adventurously invested.

This is to wrongly define the problem to be solved, and to ignore the value of the long-term investor’s greatest asset — time. That — the period between now and when assets will be converted into spending — is the Archimedes lever of investing. (He said: “Give me a lever long enough and I can move the world.”)

That is also why asset-mix policy is so powerfully important for long-term success in investing. The well-known differences in rates of return — particularly after adjusting for inflation — between stocks and bonds compound relentlessly over time. In the long run, the consequences are substantial.

So, what does this mean for the typical wealthy investor? The first step is to recognise that a securities portfolio is only part — even if it can be quite a large part — of what we should consider when making long-term decisions about investing.

Recognising those other parts of our total financial portfolio (TFP) can be quite a happy surprise, and they can be an important or even dominant factor in how we go about structuring our securities investments. Aside from inherited wealth, those parts are our real estate as well as the net present value of future earnings, savings and social security.

Investors often do not even estimate the total value of their future earnings and savings — partly because they are unfamiliar with looking at these streams of money over the years in a different way, as a lump-sum asset.

For high earners, the present value of future earnings and savings will be substantial, even enormous. Investors would be wise to develop reasonable estimates of the value of all their major financial interests (or have this done for them). Real estate and social security are both relatively stable in value, more like bonds than stocks, which brings us to an important reality. While the typical investor focuses only on securities and believes he or she holds the majority in equities, the reality in terms of their TFP is actually far lower.

Take someone with $1mn in securities, split 60:40 between stocks and bonds, as well as $1mn in home equity and $500,000 in present value of future savings and social security. While this person might think they are 60 per cent invested in equities, the reality is closer to 25 per cent when they take into account these other elements of their TFP. Seen this way, the person should invest much more of their wealth in equities.

Those with sufficient wealth to be comfortable living on the income from investments would be wise to consider separating their thinking about capital and income.

Dividend payouts are remarkably persistent in their gradual, uninterrupted increases. While share prices can fluctuate by distressing magnitudes, those who live within their incomes need not be concerned. They can, and likely should, commit substantially to equities. Personally, with my earnings and required distributions from retirement funds covering all expenses, I am, at the age of 85, really investing for my children and grandchildren. Given their rather long horizons, my securities investments are entirely in shares.

However, all too many of us — in the race to achieve financial security in retirement or to pass on to heirs a handsome inheritance — start out with wrong maps and keep our vehicles in the lower gear. Would that each of us could see the whole picture and make investment decisions based on our total financial portfolio. 

Charley Ellis is founder of Greenwich Associates, a former board member of Vanguard and author of 19 books, including the recently published ‘Inside Vanguard’

This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment

Copyright The Financial Times Limited 2023. All rights reserved.
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