Passive Investing for HNW Investors

​The gig is up. Main Street investors are finally wising up to Wall Street's dirty little secret - that financial advisors and professional managers offer little value. The result? 

More and more money is being pulled from money managers. According to a new CNBC "Invest in You" survey released Monday, only 1% of those polled said they use a financial advisor.

Over the past decade, there's been a tremendous rise in passive investing - the so-called buy-and-hold investing of index funds. 

Investors are embracing the do-it-yourself ethos because financial advisors can't beat the market - 92.25% of them do no better than the S&P 500. In other words, you can invest in an S&P 500 index fund and do better than 92.25% of all financial advisors. 

But what about professionally managed mutual funds? 

The statistics are even worse. 96% of mutual funds have failed to beat the market over the past 15 years.

The consequence of this Main Street shift to passive investing? Layoffs. They are occurring mostly in the financial advisory sector, as well as in trading-desk operations.

Banks like Deutsche Bank, Citigroup and Societe Generale used to make money from trading-desk operations when buying and selling stocks or bonds that used to happen on the phone, in person or on packed trading floors in Chicago, New York, and London. 

You've seen the images - middle-aged traders in colored vests frantically waving slips of buy and sell offers on behalf of their clients. 

These banks used to operate trading desks the size of football fields, but with the move by Main Street investors to passive investing, these big financial firms are now announcing significant trading-desk layoffs.

While middle-class Main Street investors eschew Wall Street advisors and professional managers for passive investing in index funds, high-net-worth (HNW) investors continue to rely on "passive income investing" to generate wealth non-correlated to Wall Street. 

Unlike the Main Street investors, they've known Wall Street's dirty little secrets for years. And unlike Main Street investors, they're not merely content to beat financial advisor returns with index funds; they want to do much better with another type of passive investing - investing for passive income.

Passive investing in the middle class is relying on the Wall Street machine. Passive investing to the HNW investor is about leveraging the expertise of others and placing their money with diversified funds that generate cash flow.

They understand that passive investing in index funds will not make them rich. They realized early in their investing careers that unless they created a stream of income that made them money while they slept, they would never be wealthy. 

The wealthy seek out tangible assets that cash flow. Cash flowing businesses, real assets, agriculture, and commodities can all provide passive income essential for building wealth.

For example, passive investment in commercial real estate through a private equity/debt fund allows an investor to participate in an asset class offering high risk-adjusted returns without the huge capital outlay and time demands required for direct investment.

This passive investing in commercial real estate through a credible fund can generate high returns running 7-13% per year based on historical data. Investing in a private fund offers investors the opportunity to reap the income, appreciation, and security benefits of commercial real estate investing without the headaches—no need to come up with a substantial down payment.

Passive income investing requires patience and discipline, which typical HNW investors have in spades. They play the long game. They understand cash flowing investments need time to gestate and mature to cash flow and are willing to defer to competent and skilled management to execute the fund's investment strategy and reach the fund's financial milestones.  

Private funds have accreditation and qualification requirements and are illiquid withhold periods typically ranging 2-7 years. The qualification restrictions and hold periods save investors from themselves. It prevents the volatility inherent in a liquid market where investors can bail on investment at the slightest tremor.  

HNW investors are willing to invest for the long-term, but they will never put all their eggs in one basket. They'll invest in various funds across a variety of geographic locations, asset classes, compensation structures, and hold periods. 

They understand that if they invest in only one property in one location, they'll be exposed to risk associated with that property in that location. If an acute economic disaster strikes in that location affecting that one property, they won't have investments in other parts of the country to spread their losses. 

That's why HNW investors embrace the diversity offered by the variety of passive income investment opportunities and will actively diversify their portfolio - so the money will continue to flow even if one asset underperforms.

To the HNW investor, passive investing means something completely different than what it means to the Main Street investor. 

To them, it's not about putting their assets in an index fund and letting it ride on the fortunes of Wall Street. 

Passive investing to the HNW investor is about investing for passive income by entrusting their capital to credible fund managers invested in cash flowing, tangible assets uncorrelated to Wall Street.

Scott