Super-rich investors are better diversified than most.
How do ultra-wealthy people get rich, and then become even richer? Certainly stocks like the ones you probably already own help — but not as much as you might think. As it turns out, the wealthier people are, the less likely it is that their investments will mostly consist of conventional stocks. They’re more likely to own real estate and stakes in privately owned companies.
The problem? These private investments are (by definition) not readily accessible to the average investor.
But they’re more accessible than you might think. You can own these very same kinds of investments for less than $1,000, letting you mirror the returns that many high-net-worth households achieve.
Actually, private equity isn’t overwhelmingly private
They go by a few different names, but you’ll most often hear these investments referred to as private equity, or PE for short. As the name implies, these are companies that aren’t publicly traded. There’s also a related category of private investments called private credit, which are just structured loans made to private (non-publicly traded) companies that tend to be ignored by traditional commercial banks. These loans tend to be made at above-average interest rates, reflecting their above-average risk.
Wealthy, high-net-worth families love them. The Motley Fool’s in-house research team finds that while these investors allocate about 31% of their investable assets to ordinary listed stocks, they allocate an average of 27% of their portfolios to private equity investments. Another 4% of this money is put to work in the private credit market.
Great. But how do you put some of your money into these investments?
Image source: Getty Images.
It’s not as difficult as you might imagine. Although you would struggle to own a direct stake in most privately held corporations, you can easily own a piece of a private equity firm specifically built from the ground up to hold such companies.
Ares Capital (ARCC -0.59%) is one of these organizations.
It’s officially structured as a business development company, or BDC. That doesn’t dramatically change the nature of its business, though. Ares is primarily a lender to about 500 mid-sized companies ranging from athletic uniform maker Badger and auto parts maker Eckler to insurance middleman High Street and dentistry supply outfit JDC, just to name a few. The average interest rate on its loans is in the ballpark of 12%, with most of that being passed along to Ares shareholders in the form of dividends. Ares stock’s current dividend yield stands at 9.4%.
While the nature of the business can occasionally mean some of its borrowers struggle to make loan payments, by and large Ares collects as expected. Underscoring this claim is the fact that since Ares Capital was launched in 2004, between its dividend payments and its price gains it’s outperformed its peers as well as the S&P 500 (^GSPC -1.23%)
Oh, and by the way…. Ares is publicly traded, just like the stocks you likely already own.
Plenty of other accessible private equity choices
Ares isn’t your only publicly traded private equity option, of course. Consider a stake in Rithm Capital (RITM -0.74%) as well.
It was launched in 2013 as a mortgage-servicing rights outfit, but it’s since grown into so much more. The company operates as a real estate investment trust (REIT) and now manages a wide range of real estate businesses, including ownership of commercial and single-family rental properties.
Similar to Ares Capital, Rithm is built to turn rent payments into income for shareholders. REITs, like BDCs, must by law pay out at least 90% of their taxable income as dividends. These day Rithm’s dividend yield is a healthy 8.8%.
Blackstone (BX -0.44%) is still another private equity holding company that any investor can plug into. It’s less like Rithm and Ares, by virtue of taking on more true equity stakes among 126 of the companies it backs. These companies include dating app Bumble, genealogy platform Ancestry, vacation resort chain Great Wolf Lodge, and others.
Being more equity-oriented, Blackstone shares also tend to be more volatile… like the overall stock market. The chief goal here is long-term capital appreciation rather than immediate income, though, and Blackstone shares consistently achieve this goal.
Or if you’re still looking for something a bit more familiar, consider this: Warren Buffett’s Berkshire Hathaway (BRK.A -0.86%) (BRK.B -1.17%) is more private than not. Although you certainly hear a great deal about the publicly traded stocks it holds, these only account for about 40% of Berkshire Hathaway’s total market cap. The rest of the fund’s value comes from its privately held companies like Geico Insurance, Duracell batteries, Pilot Travel Centers, Fruit of the Loom, and several others. These privately held businesses generated about two-thirds of Berkshire’s 2023 operating income, all of which was retained to deploy if and when Buffett finally sees an opportunity worth diving into.
Why ultra-wealthy people love PE (and you should too)
So why do rich people prefer these relatively boring investment options?
If your gut tells you alternative investments like private equity tend to perform better in the long run, you’re correct. As the Motley Fool’s analysis points out, the Cambridge Associates U.S. Private Equity Index has outperformed the S&P 500 for the past three-, five-, and 10-year timeframes.
It’s also worth adding that the average hedge fund — once considered ultra-wealthy investors’ best chance at outperforming the stock market — actually underperformed the S&P 500 for this same timeframe.
Even beyond the performance-based aspect, however, PE investments generally require less ongoing monitoring. They also tend to be less erratic than conventional, company-specific stocks. In other words, rich investors may be sleeping better at night than you are simply because they’re not regularly picking and choosing stocks.
The irony? Private equity’s built-in buy-and-hold approach is a key reason these people often end up faring better than more active investors.