Investing in stocks has traditionally been seen as a key part of building long-term wealth, but that may no longer be the case. A recent Bank of America Private Bank study of high-net-worth individuals found that the majority (75%) of investors between the ages of 21 and 42 do not think it’s possible to achieve above-average returns solely with traditional stocks and bonds.
The Future of Finances: Gen Z & How They Relate to Money
See: 5 Things You Must Do When Your Savings Reach $50,000
Young Investors Are Shifting Their Priorities
Ken Shepard, CFA, head of investments at Bank of America Private Bank, believes there are a couple of reasons why wealthy Gen Z and millennial investors no longer believe traditional stocks and bonds are key components to building wealth. One is that they are quicker to adapt to change within the industry.
“When you look at these younger generations and you look at the time that they’ve been raised, they’ve been raised during a time of incredible advancements when new innovations are coming out on an almost monthly basis and old innovations are very quickly discarded,” he said. “They’ve been brought up online, and what works today is great, but then tomorrow there may be something new and better. I think they’re much quicker to embrace advancements than the older generations.”
He also notes that these generations have lived through some major market swings that may lead to some hesitation to count on the market to build up their wealth.
“They’ve experienced the tech bubble, they’ve experienced currency crisis, they’ve experienced the Great Recession, they’ve experienced the economic turmoil created by COVID, and then, of course, the volatility that we’ve seen this year with high inflation and the crisis in Ukraine,” Shepard said. “I think those experiences have created a degree of skepticism on the equity markets that the older generations may not have.”
Where Are Young, Wealthy Investors Putting Their Money Now?
The Bank of America survey found that 80% of young investors are now looking to alternative investments, such as private equity, commodities, real estate and other tangible assets. Shepard notes that these assets are best utilized by younger investors who have a longer time horizon to build wealth, versus those who want to cash in in the short term.
“These investments generally have limited liquidity compared to more traditional assets,” he said. “In the case of private equity, you’re talking about an investment that is a 10- to 12-year commitment. So if you’re an investor that has a shorter time horizon, then I think that time would disqualify a portfolio favoring these types of assets and relying more heavily on traditional investments.”
If you do have a long time horizon, illiquidity can be a benefit.
“It gives them the opportunity to capture an illiquidity premium, where they’re committing their capital for a longer period of time,” Shepard said. “In addition, the illiquidity and longer time horizon for these investments gives that private equity manager more opportunity to improve the operations of the company they’ve invested in, and therefore, hopefully, create more value.”
Investing in alternative assets rather than traditional stocks and bonds can also be beneficial to the long-term investor because it enables them to get exposure to a much broader range of markets and securities than they would be able to get through traditional investments, Shepard said.
As for which nontraditional assets are now the most popular among these young high-net-worth individuals, Shepard said he has seen a recent shift from private equity to hedge funds.
“I think the reason is prior to the pandemic, hedge funds were being overshadowed by such a strong bond and equity bull market, and as we started 2022, we’ve really seen clients embracing hedge funds a lot more — not at the expense of private equity, but we’ve seen much more use of hedge funds,” he said.
“The reason is it’s a different market cycle and what worked in the past, I think will work going forward but maybe not quite as well. When you look at 2022 and you look at the performance of the different asset classes, we are seeing for the first time in quite a while hedge funds and hedgeable assets being very additive to a portfolio. Overall, we think that trend is going to continue for the foreseeable future.”
What the Average Investor Can Learn From What the Wealthy Are Doing
Unfortunately, some of the assets favored by the wealthy may not be accessible to the everyday investor.
“Depending upon the structure of the actual vehicle, the investor may need to qualify in order to purchase the hedge fund or private equity fund, and the qualification could be based on a number of factors, but most commonly it’s net worth and/or income,” Shepard said.
And even if you can afford a particular investment, it may not be the best choice if it will cost you too much of your wealth.
“One consideration when you’re talking about real assets, like farmland, timber, commercial real estate or ranches, what we often see with high-net-worth clients is that they’re owning a property directly. Because of the cost of these properties, these are often reserved for clients that have much larger net worths,” Shepard said. “If you have $3 million and a farm is going to cost you $2 million, generally, for diversification reasons, you don’t want to tie up two-thirds of your net worth in just one solution.”
However, there are still ways to utilize the strategies the wealthy are using to diversify your own portfolio.
“For example, in the case of real estate, there are publicly traded REITs that clients can invest in,” Shepard said. “You maybe don’t get the exact same benefit you would if you owned real estate directly, but it does give you a way to at least get some exposure to real estate.
“In the case of hedge funds, there are what we call non-traditional mutual funds that are publicly traded mutual funds that employ strategies that are a little bit more like a hedge fund than a simple an equities strategy,” he continued. “Again, you don’t get the same benefits that you would with a hedge fund, but it is a way for investors that don’t qualify to be able to achieve some of the benefits.”
More From GOBankingRates