The divergence between the haves and the have-nots has never been greater. The rich get richer and the poor get poorer. A very difficult market environment will only deepen the gap.
There are many reasons for the dichotomy, both social and cultural, but one of the biggest reasons has to do with the simple power of compound interest. The bigger your portfolio, the larger it grows over time—assuming positive returns.
Most investors understand this concept, but there are many that don’t. And they should. Compounding is one of the easiest financial ideas to understand. The only requirement is that investors generate a return on their portfolio. Time does the rest.
What many individual investors fail to realize is that the marketplace for investments that can be used to generate a compounded return is artificially restricted by rules promulgated by the Securities and Exchange Commission (SEC).
In its effort to supposedly protect the small guy, the SEC does not allow non-accredited investors to buy placements of equity in private, non-publicly trading companies. That means only accredited investors, otherwise known as high net worth investors, can participate.
The rule eliminates a very significant tool for generating returns in the market. Private investments, although risky, can offer very large returns. Used properly and within a diversified portfolio, successful investing in private placements of equity can greatly increase performance.
Add in the compounding effect, and you see that the rich do indeed get richer.
I can appreciate the intent of the rule. In the Wild West days before the rules were put in place, swindlers would coerce unsuspecting investors to part with their money into private transactions that ultimately crashed and burned.
Lots of fraud and craziness took place in the private equity market causing losses by Mom and Pop investors that could least afford to lose. Suckered in by the promise of riches, the little guy was easy prey.
The SEC stepped in to say that only accredited investors are allowed to buy these highly speculative securities. The thought was that accredited investors by their very nature were sophisticated in a way that allowed them to better understand the risk of owning a privately offered security.
That’s good news for the accredited investor and tough luck for the small guy.
Why does this matter?
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It matters a great deal in that one of the residual effects of the current market malaise is that there are very few attractive investment alternatives today. Other than buying gold, there are few places to turn.
As I peruse this landscape today, I find myself more and more interested in private equity opportunities. Investing in a portfolio of private companies makes a ton of sense. With small businesses having more and more difficulty obtaining capital, it will be the accredited investor that fills the vacuum.
For example, I recently heard a story about an olive farming business that was funded with an initial capital of $1 million. The business grows its own olives and then processes and sells olive-based products from its own store and the Internet.
They are doing well, but they would like to grow. Doing so requires capital. The first stop was the bank to see if they could obtain a loan. Not in this market. Even with great credit, a great story and a great plan, the bank is not even returning their calls.
Where will they turn? If they want to grow their business, their only option is to sell private equity to accredited investors. Knowing that they are the only option, the accredited investor can extract a higher price for parting with its very desirable capital.
This is a story that will take place over and over again many times during this current economic downturn. That’s why I say owning private companies is one of the most attractive, if not the most attractive, alternatives available to accredited investors today.
Of course, the big problem with investments in private companies is that the market for those opportunities is very inefficient. By definition there is no public market where an investor interested in these deals can turn for potential opportunities.
Finding the deals then is a very difficult proposition. In that regard, I have assisted some of my high net worth clients in identifying these private transactions that they may not have been able to find on their own.
In fact, I’ll be doing more work in this area in the near future with an exciting service for accredited investors only. If you are an accredited investor and would like more information, drop me an e-mail at jamie@investorplaceblogs.com.
Yes there is a high degree of risk involved in buying private equity, but the time may be right for doing this type of investing. If you are an accredited investor, I would encourage you to seriously consider doing just that.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com and check out:
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