Germany is a wealthy nation. Of the Forbes list of the world’s 500 richest people, 44 carry German passports.
In 2015, the number of millionaires in the country grew by five percent to 1.2 million people, a number surpassed only by the United States and Japan, according to the consulting firm Cap Gemini.
About 20 kilometers south of the financial center Frankfurt, in the small town of Bad Homburg, 450 family offices manage the fortunes of some of Germany’s wealthiest names. They include the Quandt family, who have amassed a fortune in the billions.
In the nearly half century since Harald Quandt passed away, his four daughters have grown their inheritance – through good times and bad – to an estimated €4.5 billion ($5 billion).
What’s their secret? The millionaires of Bad Homburg will tell you that the Quandt family fortune has grown due to the steady hands and foresight of their financial advisers. Small investors interested in joining the world’s growing millionaire class would do well to take note of their strategy.
So what’s the strategy? According to Reinhard Panse, chief investment officer at the Harald Quandt Trust, one of the biggest mistakes that small investors make is losing their nerve in a crisis.
“You can't get scared when you see on the evening news that the DAX has lost 100 points.”
“We have never exited the stock market during a crash, even if we didn’t see it coming like in 2008,” Mr. Panse told Handelsblatt. “In times of crisis, we have always increased our quota of stocks.”
Mr. Panse pointed to the past to make his case: During the stock market’s golden era in the United States, for example, a small investor could have become a millionaire in just 16 years, if only they had held their nerve.
From 1986 until 2000, the S&P 500 was growing by 16.3 percent annually. An investor who put $100,000 in an exchanged-traded fund based on the S&P would have ended up with $1.1 million.
But very few smaller investors actually made their million. Most saw an annual return of only 5 percent because they bailed at the first sign of trouble. As a result, their $100,000 investment grew on average to only $230,000.
“You can’t get scared when you see on the evening news that the DAX has lost 100 points,” Christian von Bechtolsheim, board spokesman at the multi-family office Folcam, told Handelsblatt.
“If you invest only at home, you'll miss too many opportunities for returns in the rest of the world. ”
Mr. Bechtolsheim is a direct descendant of the Fuggers, the richest and most powerful family in 16th-century Europe. The biggest difference between normal investors and the rich, he said, is that the latter develop a strategy to generate wealth over the course of generations – just like the Fuggers.
Historically, stock markets recover relatively quickly after a crash, Mr. Bechtolsheim said. The one exception was the crash of 1929. It took until the early 1940s for the markets to fully recover.
To make it through the bad times, it’s important to have a diversified portfolio, a strategy long followed by family offices like that of Harald Quandt Trust.
Take the example of Hans-Adam II, the prince of Lichtenstein. As one of the wealthiest monarchs in Europe, he’s tasked with maintaining a fortune of €7 billion inherited from the Habsburg royal family.
Private investors can participate in the prince’s investment strategy through LGT Bank, which is owned by Lichtenstein’s royals. The goal of LGT’s fund manager, Stephan Kind, is to achieve “returns that are similar to stocks but are exposed to less price fluctuation.”
Mr. Kind has achieved a 6-percent annual return for the past 17 years by investing in a mix of stocks, bonds, hedge funds, private equity, raw materials and real estate. An annual return of 3.5 percent is the minimum to keep up with inflation, according to Kaspar von Schönfels of the journal Elite Report.
For the most part, Mr. Kind invests in actively-managed funds, which have bigger returns than indexed ones. There are a couple of exceptions, though. When it comes to raw materials, he buys indexed products and in the case of bonds he mixes actively managed funds with passive exchange-traded funds.
In terms of real estate, Gerit Heinz of the Swiss bank UBS recommends broadly investing across both real estate funds and investment trusts, known by their acronym as REITs. That way, no one investment is too large and the risk of a major loss is reduced.
In this broad portfolio of securities, however, bonds should take a back seat to stocks. That’s largely due to the European Central Bank’s decision to reduce benchmark interest rates to zero and push the rate it charges banks for their deposits into negative territory, forcing some banks to charge customers to hold large sums of money. All this has has made many bonds worthless or even worse – dangerous.
In the old days, the 10-year German bond, or “Bund” offered investors both a safe haven and a respectable return. No longer. Today, many investors are buying 15 or 30-year Bunds just to see a return.
“That’s not enough,” Mr. Kind said. And when interest rates eventually rise again, the longer term bonds will take the biggest hit, he said.
One alternative is to buy bonds from governments with lower credit ratings. These bonds offer higher returns, but investors also run the risk of losing their money in the event of a default.
Current conditions aside, the Harald Quandt Trust found that bonds have a poor historical record. In an analysis of how bonds from 19 industrial states performed during 30 year intervals beginning in 1900, there were 33 cases in which they had a negative return.
There was only one period, on the other hand, where stocks performed poorly. From 1917 through 1947, they suffered a loss of 0.1 percent.
This is bad news for Germany’s cautious investment culture, where people prefer to park their money in savings accounts and bonds. Only a tenth of all Germans, about 9 million people, bought stocks in the past year, according to Christine Bortenlänger, head of the German Stock Institute.
Those who aren’t prepared to risk a short-term loss don’t have a chance of seeing a return anymore, said Mr. Heinz with UBS bank. The only option left is to buy stocks, he said.
But choosing the right stocks is a game for professionals. Legendary investor Warren Buffett has warned small investors against buying individual stocks on their own, advising them instead to purchase exchange-traded funds that track an index.
And as Mr. Buffett can attest, there’s literally a world of stock opportunities out there. But many small investors still choose to park their money mostly at home when they should be diversifying globally.
“If you invest only at home, you’ll miss too many opportunities for returns in the rest of the world,” Tom Friess, head of the Munich consulting firm VZ Vermögenszentrum, told Handelsblatt.
According to a survey by Castell Bank, 44 percent of millionaires said they've had a sleepless night over an investment decision.
When investing abroad – whether in real estate in Asia and North America, or in gold bars in Switzerland and Australia – it’s important to take precautions. Returns, for example, should cover the cost of exchange-rate fluctuations.
And small investors should also make sure that they’re making quality investments. Mr. Panse of the Harald Quandt Trust has three criteria for choosing stocks: minimal price fluctuation, products that are in demand during times of crisis and a good long-term dividend outlook.
When it comes to dividends, Mr. Panse looks for companies that have a low payout ratio because it’s unlikely that dividends will be cut.
Avoiding bubbles is also key to a successful investment strategy. Bubbles don’t come out of nowhere; they develop over years and can be identified. What’s difficult to know is when exactly they will burst.
The Harald Quandt Trust has developed criteria to identity when financial bubbles are on the verge of bursting. One indicator is a low return on the financial instrument in question.
Before the sub-prime mortgage bubble burst, for example, investors were driving up the price of junk mortgages while the return was falling.
Based on this criteria, many analysts see a bubble waiting to burst in the bond market. Central banks have pumped tens of billions into bonds, driving prices up and returns down – even into the negative as with the German Bund.
Developing a diverse portfolio with a 10- to 15-year strategy that’s regularly reviewed can help investors survive crises in one particular investment area by using the rest of their assets to balance the loss.
But even the big-time investors and wealth managers are only human, and many struggle with anxiety. According to a survey by Castell Bank, 44 percent of millionaires said they’ve had a sleepless night over an investment decision.
Still, taking a certain amount of risk is the only way to yield returns. It’s just that the wealthy have learned how to strategically choose when and where to take these risks.
Robert Landgraf is Handelsblatt’s deputy finance editor and chief correspondent for the financial markets. Peter Köhler covers finance and banking. Anke Rezmer covers the investment fund industry. To contact the authors: firstname.lastname@example.org, email@example.com and firstname.lastname@example.org