How Patience Is the Key to Long-Term Wealth Creation
Fast-moving investments are sexy.
High-frequency traders are among the more glamorous figures in the world of finance, with their high risk, high reward strategies.
But the most reliable path to wealth doesn’t lie in these fast-moving investments.
It comes in long-term investments, those that take years to provide a return. It lies with illiquid assets.
The Power of Illiquidity
This might sound like a counter-intuitive way to invest. After all, doesn’t illiquidity limit your options?
Doesn’t it mean that you can be forced to sell assets at the wrong time, losing out on the potential they represent?
In reality, there’s strong evidence that illiquid assets are the path to success.
This doesn’t mean that all your money should go into them. They need to be accompanied by the cash to get you through emergencies so that you don’t make those forced sales.
But to grow your substantial wealth, patient, long-term investment is the way forward.
The Evidence for the Power of Long-Term Investments
The evidence for the power of illiquid assets lies in the behaviour of the rich.
An analysis of personal assets based on net worth (https://www.visualcapitalist.com/chart-assets-make-wealth/) carried out using data from the US federal reserve (https://www.federalreserve.gov/econres/scfindex.htm), shows that the more wealth someone has, the more of it is tied up in the illiquid assets of property and business interests.
This is a strong sign of the power of these assets.
Either they’re how these people got rich, or, having attained their wealth and with it access to the best financial advice, this is how they’re protecting and increasing that wealth.
Similar patterns can be seen with large institutions.
Given a choice between investing in stocks or illiquid assets, they’ll predominantly go for the latter.
It can be property, investment in the business, or putting the money in funds that require a long-term commitment.
Whichever way it’s done, these are long-term choices.
Why Illiquid Investments?
So why do these investments pay off best? One reason is the behaviour of the investor.
If you can get your money out quickly, then it’s tempting to do so when things go wrong. This leads to panic decisions, with assets being sold off during downturns, with a loss in the profits they could have made.
By forcing your hand, illiquid investments force you to hold out for the long-term profit, removing the temptation of foolish short-term decisions.
Locking up capital in long-term investments removes another temptation – to spend it.
This might sound petty, but when you’re making your first efforts to save real wealth, this can be critical.
Long-term investments benefit hugely from compound profits. If the returns on your investment stay invested then they, in turn, will create more profit.
Beyond this, there’s the nature of the specific assets that fall into this group. The wealth-enhancing power of property is widely recognised.
Limits on land and the effort of construction ensure that property if properly managed, will grow in value while providing steady returns.
The opportunity to invest in a private company, whether that’s your own business or someone else’s, has many advantages over a public company.
Public companies suffer from a built-in conflict of interest between the shareholders, who bear the risk, and the executives, who manage it. Private companies generally give greater equity ownership to managers, aligning these interests.
The result is that private companies retain around half the cash that public ones do. Instead of keeping that money around, they leverage it to increase their returns.
Getting into Illiquid Assets
If you want to get into the sort of illiquid assets that the rich benefit from, how can you get started?
If you own your own business, reinvesting in that is a good way forward.
Whether it’s a one-man freelancing service or something more substantial, this is an excellent way to improve your long-term prospects.
Property is another accessible starting place.
It will get you into the habit of paying off debt through mortgage payments, and the profits will rise as rent goes up with inflation.
If you don’t want the commitment of buying a rental place for yourself, or you can’t yet afford to, then real estate finance marketplaces can provide a way into this sector.
Hedge funds with longer “lockups” provide an indirect route to long-term investment.
These are funds that let managers invest in less liquid holdings. In keeping with the benefits of patient investment, they tend to earn higher long-term returns.
Analysis by Barclays Strategic Consulting has shown that funds with a 2-3 year holding period tend to earn nearly three times as much as those with lockups of less than a financial quarter. So investing in high lockup funds can improve your earnings.
The idea of illiquid assets scares some people.
But if you’re willing to think long term, they can provide the best path to secure wealth.
Paul Connolly
Paul Connolly has been a journalist for more than 20 years, as a reporter and editor for Argus Media, Reuters, The Times, Associated Newspapers and The Guardian. He has covered Islamic Finance for Reuters in the 1990s. Paul has since helped launch three newspapers, as well as reported from Tokyo, Los Angeles and Stockholm.
