Think back to the first investment decision you ever made. You were probably just investing a small portion of your salary in some basic large-cap stocks like AAPL or in a well-known index like the S&P 500. You were nervous of losing your money, but excited about getting returns.
What about now? If you have more wealth, you’re probably less nervous now and have started experimenting with your investments.
When your wealth grows, so does the amount of investable capital you have. This change in capital prompts a change in investment decisions and options too. Let’s explore how having different amounts of capital can open/close you to certain investment options and what’s the best portfolio allocation you can have based on your capital.
How Capital Influences Investment Decisions
The relationship between capital and investment preferences is simple: the more money you have to invest, the less you worry about losing a part of it. When you have a smaller dollar size portfolio, your risk tolerance and need for liquidity differ from when you have a larger portfolio. Here’s how this plays out for an investor:
- An investor with lesser capital can tolerate lesser risk than an investor with a more capital. By risk here, we simply mean the portfolio volatility an investor is comfortable with.
- Investors with a smaller dollar size portfolio also demand a higher degree of liquidity. Since these investors have less extra money, they need it easily accessible for financial, medical, or other emergencies.
What is risk?
Investors look for long-term returns that will help them build their wealth and achieve financial freedom. In exchange for those returns, investors bear some risk. All investing involves risk, but its level differs depending on multiple factors.
Risk influenced by two factors: liquidity and volatility.
Liquidity refers to the ease with which an investor can sell a given asset. The more liquid an asset is, the more easily the investor will be able to cash it out.
You anticipate a higher return if you forego the ability to cash out your investment quickly. As a result, highly liquid investments can command a higher price than less liquid investments. However, the price is usually relatively stable, as demand is consistent for highly liquid assets. So liquid investments also typically generate lower returns.
As a retail investor, you can control the liquidity of your portfolio by choosing to invest in either private or public markets (more on this below). Public markets are more liquid than private markets.
Volatility refers to how much an investment tends to fluctuate in value over time. If you’re looking for a high-return investments, you’ll need to give up some liquidity in exchange for increased volatility. More volatile asset classes are usually less liquid and provide better returns. For example, stocks are inherently more volatile than bonds but also provide better returns.
Best Asset Allocation According to Portfolio Size: What Are Your Options?
Depending on how much investable wealth you have, the asset classes and markets you can and should invest in vary. Some markets/assets are simply inaccessible to investors with a capital below a certain threshold because of U.S. Government rules. These rules prevent financial harm to less wealthy investors who don’t have the resources to mitigate the risk associated with highly volatile and less liquid markets and asset classes.
Many asset classes are both public and private. However, some can be strictly private or public. Here’s the key difference between the two.
Public Market Investments
Public market investments include assets like stocks, bonds, credit, mutual funds, etc. In public markets, any investor can buy securities without a minimum portfolio size requirement. Public markets are highly liquid. They are traded most days a week, with a wide variety of investors entering and exiting throughout the day.
Public market investments require investors to have a brokerage account and an understanding of the underlying investment product. They are typically easier to buy and sell and are more transparent in terms of pricing and available information. They’re also easier to manage and regulated by financial authorities like the SEC.
A good example of public market investments are stocks traded on a stock exchange like the NYSE or NASDAQ. Examples include AAPL and MSFT, or ETFs like VOO. All the information about the price of the equities and the financials of the company is available to everyone.
Similarly, exchange-traded commodities (ETCs) and US Treasury bonds are some other examples of publicly traded investments. Alternative assets like gold ETFs, crypto, and inflation bonds are also publicly-traded.
Generally, an investor with a portfolio size of less than $1 million should have a portfolio with a diverse asset allocation to public asset classes. This is because such investors’ liquidity goals and volatility appetite is better served by the nature of publicly-traded securities.
Private Market Investments
Private market investments are those that aren’t publicly traded and are accessible to only a select group of individuals. These people have privileged access because they satisfy at least one requirement regarding their income, net worth, asset size, governance status or professional experience—and they’re called accredited investors.
Accredited investors include high-net-worth individuals (HNWIs), banks, insurance companies, brokers and trusts; anyone with an average yearly income over $200,000 or who works in the financial industry also qualifies for these privileges.
For example, private equity (PE) is a form of alternative investing that involves purchasing shares in private companies pre-IPO. This means that the company is not publicly traded, and its shares are not available on an exchange like the New York Stock Exchange or Nasdaq.
Examples of private investment sectors include private credit, real estate, natural resources, private equity, art, infrastructure. Private market investments are generally less liquid and carry more risk than publicly traded options.
Private market investments are riskier than public market investments because authorities like the SEC do not vet them. They are also not as transparently regulated as public investments.
The risk in a public market investment is lower because the investor can rely on an authority like the SEC or FINRA to ensure that the company/ follows best practices and complies with regulations. If the company fails, there will likely be some sort of compensation offered by the government or other entity overseeing these matters.
In private markets, however, there is no such oversight. The investor must rely on their own due diligence before making an investment decision.
How Different Retail Investors Should Allocate Capital
Here’s an example to help you understand the relationship between capital and asset allocation:
Most people with under $10,000 in investable capital should not invest in anything that bears risk and are much better off keeping the funds as cash. This is because you might need these funds for emergencies and you will want them fully liquid.
At $25,000, investors begin making low-risk public investments in bonds, high-yield savings accounts, money market funds, and stocks. Investing in ETFs and stock and bond indices to have enough diversification is also a good idea for investors with a similar dollar size portfolio. Investors on the higher end of this spectrum should also consider allocating a small portion of their portfolio to alternative public assets like crypto, inflation, and gold.
At $100,000, you should continue investing in public and liquid assets while diversifying, but this is where you need to start to considering return optimization.
Alternative public asset classes like gold, inflation, crypto, and commodities should be a significant part of your portfolio. Assets like commodities and inflation bonds can also hedge your portfolio against inflation, which is important when you’re making significant returns. Emerging market credit and foreign developing bonds are some other good additions to consider for a portfolio this size.
As you stack these alternatives onto your portfolio, you will encounter complex documentation and regulations. Typically, investors with more wealth choose a wealth management service to effectively manage alternative investments. But many investors cannot afford such services or institutions, and that’s where comprehensive wealth management apps like Hedgeful come in.
Hedgeful helps retail investors build highly diverse, multi-asset class portfolios made of public market investments. We also use sophisticated investment strategies and advanced financial engineering to hedge your portfolio against sudden market downturns.
With a $1M size portfolio, you can invest in private markets, write angel checks, and invest in real estate. While you should still continue to invest primarily in public markets even at this stage, venturing into the private sector can make your returns more impressive and help you build your wealth quicker.
As your investable wealth increases beyond a million dollars, stacking on more private investments onto your largely public market portfolio is preferable. At $10M, investors can start putting their money towards less common and more risky investments like art or other collectibles. Investing fractionally in art, private real estate, privately-traded commodities, is all recommended.
Keep in mind that investing in private markets is more complex and will require some institutional support or wealth management service. You will also take on more risk and enter a loosely regulated market.
Building A Diverse Portfolio the Hedgeful Way
If you’re an individual with a portfolio size over $25,000, using a wealth management app like Hedgeful can ease your investment decisions.
Hedgeful invests your wealth in a diverse range of public asset classes like stocks, bonds, credit, inflation, commodities, gold, real estate, and crypto. We allocate your capital to some or each of these asset classes such that you have a diversified portfolio protected from sudden market downturns.
While we do not invest in private market instruments, our investment strategies in the public market are similar to that of hedge funds and institutional investors. We focus on helping you build long-term wealth with both main and alternative public asset classes.
The amount of investable capital you have does play a critical role when it comes to your investment options and strategies. The key is to recognize how much volatility you are willing to take on and how liquid you want your capital to be depending on how much you have. When you’re starting with a smaller portfolio, stick to basic public asset classes like stocks and bonds. As your wealth grows, stack on both public and private alternative assets gradually.