How the Wealthy Really Invest — It’s More Than Just the S&P 500

So how do the ultra-wealthy invest? I can tell you this, their strategy encompasses more than just a S&P 500 index fund.

In fact, many of these high-net-worth types are investing in more than just stocks and bonds. And when they do hold these traditional assets, they often employ strategies far more sophisticated than standard ETFs or mutual funds.

Traditional stock and bond strategies have long served as the cornerstone of most investor portfolios—and for good reason. Over the long term, stocks have delivered attractive returns, particularly for those willing to take on higher equity exposure. However, this approach comes with challenges: stocks bring significant volatility, while bonds have struggled to generate meaningful returns over the past decade and a half due to persistently low interest rates. In this environment, high-net-worth and ultra high-net-worth investors are increasingly turning to alternative strategies to enhance returns and manage risk.

So, what are alternative investments? Alternative investments are assets outside the realm of traditional stocks, bonds, and cash, often exhibiting lower correlation to broader equity markets. Examples include private equity, private credit, real estate, hedge funds, private real assets, collectibles, commodities, infrastructure, digital assets (e.g., NFTs and cryptocurrencies), and structured products.

Today, I’ll highlight a few of these strategies that are gaining significant momentum in the private wealth management space.

There has been a significant influx of funds into private credit strategies. In the private markets, private credit serves a similar role to what bonds represent in the public markets. It is an alternative form of lending provided by non-bank entities, offering the dual advantages of low volatility and high return potential.

The average return for direct lending—the most common type of private credit—was 9.4% from 2004 to 2023, according to the Cliffwater Direct Lending Index (CDLI). These higher returns come with lower volatility compared to equity markets. Research from the investment firm Blue Owl indicates that the standard deviation—a measure of volatility—of direct lending is comparable to the U.S. Bond Aggregate. However, volatility is just one measure of risk. Despite this, the combination of low volatility and high return potential has made direct lending an increasingly attractive option, drawing billions of fresh investment dollars.

That said, investors should carefully consider the risks. Private credit consists of higher-risk floating-rate notes, which means there is a greater likelihood of default compared to investment-grade bonds. Additionally, since this form of lending operates in the private market, it involves opacity, illiquidity, and a lack of daily pricing.

I am also noticing a trend toward private equity exposure, particularly because fewer companies are choosing to IPO. Private equity funds invest in non-publicly traded companies that often have significant upside potential. Like private credit, private equity is often opaque, illiquid, and pricing is infrequent.

Once reserved for the ultra-wealthy and saddled with 7 to 10 year lock-up periods, private equity has democratized and is now available to investors with a liquid net-worth as low as $2.2 Million through what are known as “Evergreen” strategies. These strategies provide much greater diversification, potential for quarterly liquidity, and much lower investment minimums.

While the opacity and illiquidity of both private equity and credit are viewed as a negative, there is one large advantage — investor discipline. Unlike the public markets that are subject to emotional knee-jerk millisecond trading, private market fund managers are less likely to be distracted by the latest market scare which allows them to see an investment through a stormy period which can lead to better risk adjusted returns.

Also, private equity has outperformed the S&P 500 in all time frames greater than three years during the 25 year period ending in December of 2023 according to research from Cambridge Associates. Over that 25 year period, private equity had an average annual return of 13.1% while the S&P 500 averaged 8.4%. And with fewer companies going public, one has to wonder if the return potential on PE widens compared to the public markets. Time will tell.

Investors are also putting more money into equity-based investments that utilize options as a way to hedge. One example is the covered-call ETF which sells call options on an ETF that an investor owns in order to generate additional income. In exchange for this income, you give up some potential upside if the stock’s price rises significantly. It’s a way to earn additional cash flow from your investments, especially in flat or slightly rising markets. Some of these instruments have yields in excess of 10% and the investor can participate in some market growth.

Investors are increasingly seeking greater diversification through buffered ETFs and structured notes. These instruments provide market participation with partial, and in some cases full, downside protection.

In short, alternatives are becoming the third leg of the stool for high-net-worth investors. While it was once typical to invest in a mix of stocks and bonds, investors are now increasingly incorporating alternatives alongside these traditional asset classes.

Certain alternatives often exhibit low or no correlation to broader public markets. For example, when both the stock and bond markets experienced double-digit declines in 2022, private credit delivered a positive rate of return. This level of diversification deserves greater attention.

To be clear, this type of diversification does not necessarily reduce overall portfolio risk but instead shifts the nature of risk by incorporating non-correlating assets.

In addition to alternative investments, wealthy investors are increasingly demanding greater tax efficiency, which is often lacking in traditional mutual funds and ETFs. The rise of direct indexing is transforming the landscape for these investors, offering enhanced opportunities for tax-loss harvesting.

A direct index allows investors to own a portfolio of individual securities that replicate the performance of an index, such as the Russell 2000, rather than investing in the index as a single fund. Because the investor holds individual securities, the portfolio manager can strategically harvest losses from specific underperforming stocks, even if the overall index gains value in a given year. This approach enables investors to capture the broader index’s returns while benefiting from tax-loss harvesting opportunities. Additionally, in the event of a significant index drawdown, managers can act quickly to realize losses as they occur, further enhancing the portfolio’s tax efficiency.

Investors are not only seeking greater access to alternative investments but are also demanding enhanced tax efficiency in their traditional long-equity strategies. Recent financial innovations have transformed the wealth management landscape, reshaping how we invest for our clients and providing more tailored, tax-optimized solutions.

Moreover, during periods of market turmoil, such as 2008-2009, 2020 or 2022, when public markets experienced widespread declines, having exposure to alternative investments and tactical tax strategies can provide valuable resilience. If your advisor isn’t offering access to these tools, it may be time to reassess your options and ensure your portfolio is equipped for both growth and stability in any market environment.

If you’re an advisor without access to these tools, it might be time to ask yourself: is the grass greener on the other side of the fence? Chances are, it is.

Disclosures:
The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index. Raymond James and its advisors do not offer tax or legal advice.
You should discuss any tax or legal matters with the appropriate professional. Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice.