High Net Worth Strategies – What Are They? (Backtest)

Frequently used in the financial industry to denote a person or a household with a substantial amount of wealth, the term high-net-worth individual (HWNI) seems to be the new buzz phrase for wealth in today’s world. But what does it mean?

While there is no official definition for high net worth, a high-net-worth individual (HNWI) generally refers to a person who owns liquid assets valued at $1 million or more. Liquid assets here include money held in bank or brokerage accounts, with the exclusion of assets like a primary residence, collectibles, and durable goods.

In this post, we take a look at high-net worth individuals and how they manage their assets. Do high-net worth individuals use other strategies than “normal” people?

Who are high net-worth individuals?

There is no official definition of high net worth.

However, in the financial world, a high-net-worth individual (HNWI) generally refers to a person who owns liquid assets valued at $1 million or more. Liquid assets here include money held in bank or brokerage accounts and other investible assets, with the exclusion of assets like a primary residence, collectibles, and durable goods.

Classifying the type of investor varies from one financial institution to another and from one country to another. While there may not be set-in-stone figures, financial professionals have some general guidelines for classifying wealth, and they group them as follows:

• Mass affluent individuals: This refers to individuals with less than $1,000,000 but more than $100,000 in liquid assets.
• High-net-worth individuals: This refers to individuals whose liquid assets are valued between $1 million and $5 million.
• Very-high-net-worth individuals (VHNWIs): This refers to individuals whose liquid assets are valued between $5 million and $30 million.
• Ultra-high-net-worth individuals (UHNWIs): This refers to individuals who own more than $30 million in liquid assets.

According to CapGemini’s World Wealth Report, the U.S., Japan, Germany, China, and France were the top five countries by total HNWIs, as of 2019, with the U.S. having the most. In 2020, Spectrem Group estimated that about 11.6 million American households held a net worth between $1 million and $5 million in liquid assets, while about 1.8 million households own between $5 million and $25 million in liquid assets.

How net worth is calculated

The formula for calculating net worth is quite easy. It is simply the total value of an individual’s assets minus all of their liabilities.

Net Worth = Total Assets – Total Liabilities

Let’s give an example. Let’s say an individual’s total assets sum up to $2 million, including home equity, vehicles, bank account balances, collectibles, and investment accounts. At the same time, the person’s liabilities, including unpaid mortgage balance, outstanding vehicle loan balances, student loan debt, credit card debt, and alimony sums up to $500,000. The fellow’s net worth would be:

$2 million — $0.5 million = $1.5 million.

However, this does not mean that the person belongs to the HNWI category, as only the liquid assets (bank and brokerage account balances) are considered when determining if someone is a high-net-worth individual.

The benefits of high net worth

There are many benefits of being wealthy (not considering the obvious material benefits). These are some of them:

1. Financial professionals and advisors give you special attention. HNWIs are normally treated like royalties by financial advisors and money management firms because of the amount of wealth they command. Although the perks vary, financial management firms may offer HNWIs a dedicated wealth advisor, reduced fees, access to conferences and events, and tickets to sporting, theatrical, and entertainment events, in addition to other benefits.
2. High net worth opens doors. Apart from the attention, HNWI individuals also have access to many opportunities that are not available to other investors. Such opportunities include private placements and some other opportunities that require huge investments.

High net worth investing strategies

In addition to the usual investing strategies that apply to everyone regardless of how big their portfolio is, such as holding a diversified set of assets (investing in a broad market index fund) and focusing on long-term investments, some investing strategies are more suitable for high-net-worth individuals. Some of the HNWI strategies include these:

Investing with hedge funds

HNWI are best suited to invest in hedge funds, which are alternative investment approaches that often require minimum investments of at least $1 million. Hedge funds pool make complex investments, including investing in various derivatives. They include long-short funds, market-neutral funds, and event-driven funds.

Hedge funds are usually structured to hedge risks, so they are perfect for high-net-worth investors who are already rich. Despite the ‘hedge’ in their names, hedge funds come with some risks, as the complex derivative products they invest in have some significant risks. But with their huge net worth, HNWIs can stomach the risks.

Investing in tax-free municipal bonds

Keeping tax bills under control is very important to HNWIs, which is why tax-free municipal bonds are often attractive to them. While municipal bonds might not have as high of yields as a riskier investment, they provide a high-net-worth investor with steady growth that isn’t subject to taxes.

Private investing

Private investing or private placement is often exclusively reserved for high-net-worth individuals. They are the key investors behind most big firms in the world today. Imagine investing in Uber, Facebook, and Google in their early days before they came public. Spotting good companies in their early days is how many HNWIs make their money. But it takes a bit of work and more than a bit of luck to find an entrepreneur who has a product or service you think can make it big. There’s also a significant risk here — not all promising companies end up becoming worldwide successes. But when they hit it big, they make a whole lot of money after the company goes public.

Traditional Investments

Of course, HNWIs also invest in traditional asset classes, such as stocks and bonds. In fact, many of them made their wealth from such assets. Usually, high-net-worth investors use their money to build a broadly diversified portfolio of choice based on their investment styles. Their portfolios often consist of dividend stocks, growth stocks, and myriad bond classes.

While they mostly focus on long-term investments, they can also have a mix of long-term and short-term investments. But most HNWIs are known for employing the buy and hold strategy, which allows them to take advantage of economic growth.

Charity foundations

Many HNWIs set up their own charity foundations. Giving back to society in the form of charity benefits them in multiple ways. Apart from the good feeling of giving out some of their money to help people in need, giving to charity is a form of investment strategy for them too.

Charitable donations are tax-deductible, so it can help them lower the taxes they pay each year. However, there are specific rules for how charity can be used to reduce taxes. Their financial advisors often help them with that.

Asset protection strategy for high-net asset individuals

In general, HNWIs are more interested in preserving their capital than getting rich, as they are rich already. There are many different techniques they use to protect their assets, but the common ones are as follows:

• Deposit insurance: The most basic asset protection for cash in the bank is deposit insurance on bank accounts. In the US, the Federal Deposit Insurance Corporation (FDIC) covers money in member banks for up to $250,000 per depositor, per bank, and per ownership category. So, even within the same bank, one can increase the total coverage by having different account categories.
• Security insurance: Similar to deposit insurance for cash in the bank, the Securities Investor Protection Corporation (SIPC) insures your cash and securities held with member brokerage houses for up to $500,000 in the event that the brokerage firm becomes insolvent.
• Personal insurance: Apart from the risk of a bank or brokerage failure, investors often want to protect their assets and businesses from costly lawsuits. They achieve that through various personal insurance products, such as liability coverage, umbrella insurance, professional liability insurance, business liability insurance, and so on.
• Trusts: Investors also put some of their assets in a trust to shield them from creditors. A properly written trust can be used to protect assets but only if it’s set up before anything bad happens that could lead to a claim against the investor. It is important to know that if a trust is established after something bad has happened, even if the individual hasn’t actually been sued yet, it may be considered a fraudulent transfer to avoid paying creditors, which would create a whole new set of legal problems.
• Other legal options: Another option is transferring assets to a spouse or children, but both moves have significant risks of their own — for example, divorce in the case of a spouse and loss of control of the money in the case of children. There is also the issue of gift taxes in the case of children if the gift is up to a certain amount in any year. In the US, the limit is $15,000 for 2019 through 2021, but the spouse can also give a like amount, which increases the limit to $30,000.

High Net Worth Strategies – What Are They? (Backtest)

A high-net individual is looking for other strategies than most retail investors.

Why?

Because a high-net individual wants to protect what he or she has, and is less likely to take risks to increase his wealth. They want to invest conservatively. Why should they take risks when they already have money?

An example of how they look at risk is to look at volatility. Some argue volatility is not the best proxy for risk, but in our opinion, it is because high volatility increases the risk of letting emotions and impulses interfere with your investments.

Let us give you an example of this from the real world by looking at the graph below:

The red line is the performance of Brummer Multi Strategy – a hedge fund managed by the Swedish money managers Brummer & Partners. The grey line is the Swedish total return index.

As you can see, the paths traversed for the two different strategies are pretty different. While the Multi Strategy has a smooth line, stocks have experienced a much more bumpy ride.

Which return of the two above would you prefer?

Many would probably pick the grey line because it has the best returns, but we are pretty sure high net worth individuals would pick the red line, or at least their advisers would.

That said, we believe the most important concept for high net worth strategies is to diversify into assets that correlate as little as possible. The main point is to be diversified. The reason why the red line in the chart above is so smooth is that the fund consists of several different hedge funds with their own different investment style. Not only do they have different investment styles, but they also invest in different asset classes.

We have in previous articles written about the crucial element of being diversified:

• What does correlation mean in trading?
• Uncorrelated assets and strategies – benefits and advantages (examples and backtests)

Other relevant high net worth strategies might be Ray Dalio’s All Weather Portfolio or how to hedge against tail risk.

High net worth strategies – ending remarks

Because high net worth trading strategies with backtested trading rules and settings require a great deal of work (and not to mention investment aims), it’s pretty difficult to make a specific high net worth strategy. The aim of an individual that has a high net worth should be to diversify as much as possible.