Step 2: Diversify your portfolio
Risk management through diversification is important in both maintaining and building wealth, but many investors think they're diversified just because they own a dozen different mutual funds. However, if most of the funds invest in the same asset class, such as large-cap stocks, the investor is exposed to risk.
"Since the financial crisis, we have seen many asset classes move in higher correlations with each other that differ from their historical norm," says Matthew Tanner, financial adviser in private wealth management for UBS Financial Services. Assets are considered correlated when they move together in relation to the mean. So if all asset classes are moving in the same direction, such as those made up primarily of stocks, your portfolio is not diversified.
"You need some assets to be zigging while others are zagging," says Nixon, who counsels clients to include assets across all capital markets in their portfolios. In addition to stocks, those could include some publicly traded real estate, commodities, high-yield bonds -- all of which can be bought through funds and will decrease the portfolio's overall risk. "For example, one of the biggest risks is long-term inflation risk," she says. "(Treasury inflation-protected securities) and commodities provide explicit inflation protection."
Nixon cautions that when investors are building a diversified portfolio, they should beware of the three factors that take away from nominal return: taxes, fees and inflation. "The first piece of advice I would give the 99 percent is to manage your fees."
Just because the 1 percent invest in hedge funds, for instance, doesn't mean average investors should look for funds that mimic that strategy, says Nixon. "If you want risk management, there are cheaper ways to get it than by adding a mutual fund that replicates a hedge fund. For example, adding high-yielding, dividend-paying stocks or certain fixed-income products."
Depending on individual risk tolerance, Fykes suggests an investor with a traditional portfolio made up of stocks, bonds and cash consider adding a possible allocation of 5 percent to 10 percent in commodities such as gold; 5 percent in a real estate investment trust, or REIT; 20 percent to 30 percent in long/short, market-neutral or arbitrage funds; and 20 percent to 25 percent fixed-income that goes beyond Treasuries and traditional bonds, such as global, emerging market debt, high-yield and TIPS.
The 1 percent don't necessarily have any secrets that the 99 percent can't copy, according to Fykes. Once you understand diversification and your risk tolerance, take the time for research, pay close attention to the U.S. and global economies, don't chase returns, and pay attention to more than just past performance.