Secrets of the rich

Kelly Rodgers, MoneySense February 2002

As a consultant to nonprofit organizations and high-net-worth individuals, I'm often asked how the rich manage their money. The answer may surprise you. Rather than employing complex investment strategies, most wealthy investors stick to simple ideas. Some of their strategies are not much more than common sense. Others are less obvious and sometimes contrary to the advice given by many financial advisers. If you'd like a glimpse into the financial doings of the toniest Canadians, check out these four easy-to-apply ideas:

- THE RICH MANAGE THEIR RISK Well-heeled clients never put the bulk of their wealth at risk. They split their portfolios between "core" money and "fun" money. The core money is the sum that a client is saving for retirement or other vital needs. It represents 75% to 80% of his or her total portfolio, and it's handed over to a professional money manager to invest conservatively. The rest of the portfolio is the client's fun money. He or she can take some risks with this cash because a loss isn't devastating. If the client wants to take a flyer on a junior mining company or a start-up database developer, he or she can do so without betting the house.

Small investors should follow a similar strategy. Build a solid base, then tiptoe into chancier areas as you see fit. If you're just beginning to invest, took for a solid, low-fee balanced mutual fund. As you grow wealthier, you may want to add a diversified equity fund. But until you've built a base, steer clear of most sector and specialty funds. They're too volatile for most small or even medium-sized investors. And they should never make up more than 20% of your portfolio.

- THE RICH KEEP IT SIMPLE Wealthy Canadians ensure their investments are well diversified. But they make sure their investments aren't overdiversified. Most of us can get all the diversification we want with no more than five mutual funds. Anything more and I begin to suspect that an adviser is looking for opportunities to create artificial complexity and, hence, charge higher fees.

This problem is widespread. A nonprofit organization recently came to me with a multimillion-dollar portfolio. Its financial adviser had divided the portfolio among 31 different mutual funds -- a horrifically large number. The overlap in the underlying Canadian equity holdings was an astounding 66%, which means that the portfolio was not diversified at all. It was actually more volatile than the average balanced fund. This client has since fired the adviser.

My advice is to keep it simple. If you're just starting out, a good balanced fund will provide you with all the diversification you need. Even wealthy investors don't need anything more than a bond fund, a Canadian equity fund, a U.S. equity fund, a global equity fund and a small-cap fund.

- THE RICH DON'T BORROW TO INVEST Financial advisers often sell their clients on the virtues of using leverage, or borrovving money, to invest. The reason for the adviser's enthusiasm is easy to explain. If you have $100,000 in your portfolio and you borrow another $100,000, your adviser's revenue from investing the expanded portfolio has just doubled. Wealthy Canadians know that while leveraging can magnify your gains when your investments soar, it can also magnify your losses when investments turn sour. The wealthy don't appreciate this additional risk.

- THE RICH PICK MANAGERS WISELY The wealthy measure any potential money-management firm on the five Ps. Philosophy: does it have a well-defined approach to investing? People: is the investing team stable and successful? Price: are fees competitive? Process: does it actually implement the strategy it espouses? And performance: how do its results compare with its peers and to the index?

The same approach can be applied to hunting for good mutual funds. Look for a stable firm with a good performance record and low fees. You should never pay an MER above 2%.

Any mutual fund investor should begin by looking at the excellent no-load offerings from Phillips, Hager & North, McLean Budden, and Mawer. If you don't mind paying a front-end load, consider companies such as AIM, Trimark and AGF. But never -- I repeat, never -- lock yourself in with back-end-load funds. You'll have to pay a steep charge if you want to withdraw your money before several years have passed. And that's not the way, to join the ranks of the rich.