How to Build a Billionaire-Grade Portfolio with One Million Dollars

Welcome back, future billionaires, to another episode of the Invest Like a Billionaire podcast. I'm your moderator today, Ellis Hammond, and joined with Bob and Ben Fraser, host of this show and managing principals of Aspen Funds. And today, guys, I want to answer a common question that we get from listeners and even investors of Aspen Funds is how to build a billionaire grade portfolio if I'm starting with a million dollars? And so Bob, I'll start with you. If someone handed you a million dollars today and said, build me a billionaire-style portfolio, what's your first instinct?

My first instinct would be congratulations. That's an intelligent question and intelligent approach. Let's go figure that out. And yeah, start going through the process.

Ben, I'll ask you the same question. What would be a rookie mistake someone might also make with $1 million?

Yeah, well, I think the first question I hear a lot is, well, I can't, right? The billionaires have a much bigger advantage than I do, both from just the size of their portfolios and then access to opportunities. I think one, it's important to understand that you can, but I also would say you want to, you don't want to, do exactly what the billionaires are doing because there are additional risks that you gotta consider at a smaller level. But I think some of the biggest pitfalls that we can get into here in the conversation to me would be overallocation into a single deal or a single sponsor that substantially puts that million dollars in this case at risk.

Well, and you know, we all start there. So, so I actually did this exercise, okay? And I actually went through and started doing my own allocations to the billionaire portfolio allocation. Allocation and realized that, wow, what a pile of random things I have, and really obtuse, hard to get my head around. And so, but it was really a great exercise to actually realize how I'm really allocated in reality. But it was kind of shocking to realize that, you know, how concentrated I was in one sector, and then, you know, how much I had in my own personal direct real estate, which was, you know, overshadows some of my alternatives. And just, you know, you're going to find you have all your investments in your 401 401. So navigating that is going to be a big challenge.

I think it's such a good point because this is so common with people that start to get into private equity investing, real estate investing, is it's very haphazard, right? It is the first few deals that you see, you invest in, and maybe it's your, your cousin that's doing some real estate, and then you have another friend that's doing a startup, and you kind of just invest in onesies-twosies, and all of a sudden take a step back and look at what you've invested in, there's no rhyme or reason, there's no strategy, there's no consideration for concentrations. It's easy to not realize the allocations you have. And so we've kind of put together a resource for investors in the Invest Like a Billionaire book of here's the percentages that are the averages of these billionaire models and where are you at in comparison.

So let's back up a little bit, guys, for, you know, listeners or new listeners and maybe folks who haven't read the book. By the way, Invest Like a Billionaire book, You can find it on Amazon, you know, Barnes Noble, wherever. Number 3 bestselling book. Congrats guys. So in, in the book though, you guys talk about how billionaires invest 50 to 60% into private alternatives, which is a major difference when the average retail investor only has 2% into alternatives. Let's start there on why is that and how do we maybe replicate that on a smaller scale since we're talking about $1 million here.

Yeah, absolutely. And I talk in the book about the guy who pioneered this model. His name is David Swensen, who ran the Yale Endowment starting in 1985. And in 1985, the billionaires did what the little guys were doing. They was all in public stock market, stocks and bonds, okay? And he was a very smart mathematician who studied finance theory. And he says you can get higher returns with less risk. And the idea is that having things that zig when other things zag, in your portfolio so you do not take losses. And I pointed out in the book, the, the mathematics of losses are far more impactful to your portfolio than the mathematics of gains. And so you want to maximize gains, but not at the risk of taking losses. And the key to that is private alternatives, which are highly uncorrelated. And I, I go through the book and point out how unrelated these assets are. And uncorrelated means they zig when it— when the public markets sag, and they zig and zag from one another. So everything is uncorrelated to everything else. And mathematically, this was a Nobel Prize-winning guy, uh, who, who won the Nobel Prize in 1990 for this. It's called Modern Portfolio Theory. And very few Private investors put this math to work for them. Okay, it's magic. It's what, it's so powerful. It's what Swensen called a free lunch. And of course, we know there's no such thing as a free lunch. He said, yeah, we all know that except this, this is a free lunch.

I think the other big thought that you go into in the book in that section is the public markets have become way more correlated over the past decade than they have in the past. And historically, you know, the 60/40 portfolio, we were 60% stocks, 40% bonds, that was the idea of diversification, right? When stocks go, go up, bonds are down. When stocks are down, bonds are up. And so you create some of that diversification in non-correlation that you're talking about. But the problem is, Over the past, you know, several decades, correlations have all gone up, meaning as one thing moves up, everything else moves up. As one thing moves down, everything else moves down. And so the only real way to get true diversification, which is you talk about in that part of the book, means non-correlation— there's, there's a, a very key distinction there— the only way to do that is to go outside the public markets. And that's why it's so important to adopt this framework as the billionaire model and billionaire portfolio, because that's the only way to get the free lunch.

Yeah, that's exactly right. So, and I, I said that the little guy can't take, can't take advantage of this math. And the reason is because if you're only in the public markets, well, every stock is correlated to every other stock, highly correlated. And I show a bunch of data again in the book that shows how correlated they are. Those correlations have been steadily increasing since 2000. And since the great financial crisis, most stocks are 90% correlated to other stocks. So you can buy a whole, you know, diversified portfolio of stocks and you are not diversified mathematically because they're still correlated. So let's, let's make a distinction between diversification, which is kind of a myth, or it's a fuzzy concept, versus non-correlation, which is a mathematical concept. And if you buy 100 stocks in the stock market at random, you are not diversified. They are highly correlated.

So let's kind of start to construct this million-dollar portfolio. I mean, how many individual investments is optimal to maintain, you know, diversification, or maybe a better word is non-correlation, uh, and oversight?

Well, the answer is more is better. So at a million-dollar portfolio, you're going to be hitting investor limits. So if your sponsors have a $50,000 limit, that's going to be your driving factors. There.

And let me ask you this too. What has been your philosophy over the years in terms of investing in what you understand and don't understand, right? I mean, you can't be an expert in private credit, oil and gas, industrials. I mean, you are an expert because you do this for a living, but what about the passive investor? How important is that to this equation in investing in multiple type of deals?

You know, I think it's kind of ridiculous, to be honest. You know, how many people that own Apple stock understand Apple business, you know, and the iPhone consumer electronics businesses and the challenges of manufacturing in China. And, you know, and then how many Apple investors can even tell me what is the breakdown between income from Apple TV and from iPhones and iPads? It's kind of ridiculous, right? You just, you know, you find good sponsors and you, you know, and you place capital. I mean, the billionaires, that are, you know, investing in hedge funds and venture capital and private equity, they're not necessarily experts in those things. David Swensen, as I've read all of his material, and what he would say he is an expert in is sponsor selection. They spend a lot of effort, time and effort in sponsor selection. And he said people that are successful in investing in the space are very good and spend a lot of time and energy in sponsor selection.

Yeah, I think as a passive investor, you're never going to be the expert in what you're investing in. If you were, you probably wouldn't be doing it passively, right? So I do think there is kind of a misnomer of, you know, I think Warren Buffett popularized that idea of don't invest in something you don't understand. I would kind of push back a little bit and say there's, there is a certain level of understanding how, at the most basic level, right, if you can explain it what you're investing into a 5th grader or something to where here's just how it works and, you know, how you make money, then you at least have a base level understanding of this is a legitimate opportunity. Because the other side of it is, and I think this is, we get this farther in the book, not really relevant to this conversation, but avoiding Ponzi schemes. A lot of times these are very elaborate, complicated structures with, you know, a big black box and that can be a yellow or red flag. And if you can't understand and explain it, then, you know, I wouldn't touch it. But, you know, I think the way I would answer that question of how do you take $1 million and start to slice it up, I do think at $1 million you have a few constraints, right? So one of the charts we have in the book is what we call the alternative investment continuum. And it's this kind of simple chart that shows your investable assets and how much allocation you put into private equity or private alternatives. And the more investable assets, the more your net worth and your portfolio grows, the easier it is to allocate a higher percentage into alternatives. And, and some of the natural constraints are— Bob Fraser mentioned one— there might be minimums that you have to invest in to get into certain assets. Many times it's at least $50,000, but usually more than that. So if it's $100,000 and you only want to invest 50% of your portfolio, that's only really 5 investments. So you're not getting the same level of correlation benefit as you would as, you know, with 20, say. I think the other kind of constraint that you're going to have aside from minimum investments and at $1 million is also liquidity, right? But we have all these calculators in, in the book and these resources at our website that can help you estimate what your liquidity is, right? Because is at a million dollars, your liquidity as a percentage of your net worth will likely be larger than at $10 million. And so that's gonna be another constraint.

Well, pause there because let's talk about liquidity, 'cause I do think that's another question I have for later, but you're hitting it, might as well talk about it now. I mean, people, Bob, you say in the book, people overestimate their need for liquidity in a lot of cases.

We've kind of just talked about allocation, but in the book we talk about exactly what's our process, what's our process for determining our allocation. And the step one is, to determine your liquidity need. So a lot of people don't invest in alternatives because they think about, you've got $1 million, you think about, I'm gonna write $100,000 check, it's gonna be illiquid, what if I need more? And they never do the math. Do the math of what your liquidity need is. So I've got a super little spreadsheet that is available on our website for free at investlikeabillionaire.org, and it's called the iLab Allocator. What you'll do is you actually calculate your liquidity needs. So let's go through the next 3 to 5 years, things you might need cash for, and you add 'em all up. And then you look at, okay, what is the sources of your liquidity? So what is any lines of credit you have, any bonds that you have can also help meet your liquidity needs. And generally, as I went through this and I went through the process myself, I realized I didn't have a lot of liquidity need because I had one line of credit and two, I've got some bond portfolios. So there's my liquidity need that's being met right there. But you determine it for yourself, right? And for your family, what is your personal liquidity need? And that's step one is kind of that becomes a block that you put in your allocator that is immovable. That's the first step. And maybe you find your cash need is, your liquidity need is $100,000. So there, now you're investing $900,000 in everything else.

Yeah, Bob, that was actually after I read your book. Even though, you know, I do this for a living too, I think I also overestimated my need for liquidity and didn't also realize like the other liquidity options I have. Like I have a line of credit on my insurance policy, right, that charges me 5%. Now, is it free money? No, but 5% is not expensive. So like I realized like, oh, I have a lot more liquidity options, right, at my disposal if needed.

So you look at your liquidity need, you look at your liquidity sources and you determine, well, how much of those things, if your liquidity need is really just, you know, kind of contingent things like, hey, what if I need an emergency loan for this or that or the other? Then certainly having a line of credit at 5% would meet that. But it could be your liquidity needs. Well, I want to save up for my kids' college. So you may— you got to decide whether you're comfortable borrowing on your insurance policy for college or not. So again, it's personal. You have to decide whether you want to— how you want to meet that liquidity need. So the first thing is determine your liquidity need, which is your cash need. The second thing is, you know, determining your bonds. And in the book, we have a billionaire portfolio allocation with a million-dollar kind of— we have a $1 million, $10 million, or $100 million recommended portfolio or starting point. And that would be 10% cash at a $1 million portfolio. 15% in bonds, so $150,000 in bonds, then 35% public equities. So, you know, just because that's where we figure most people probably are, and that's really fine. And then 30% private real estate and 5% private credit. So $300,000 would go into private real estate and $50,000 into private credit. Now, I would say if you are— now, the first two, these first two private investments, private credit and private real estate, have the advantage of being two very different strategies with different risk profiles and different income profiles. So private credit is an income, high income, low risk strategy, and private real estate is a growth strategy primarily. So it does have the advantage of if you're like closer to retirement and you want to take less risk and you want to have more secondary liquidity than private, I would probably change that allocation and be more heavily into private credit.

That was a great breakdown, by the way, Bob Fraser. Uh, by the way, if you, if you didn't catch that, rewind this episode 2 minutes and listen to that breakdown again. I think that was super helpful. Let's talk about access, you know, as we start to wrap up this show. I mean, one of the biggest differences for billionaires is, is deal flow. Right. So how should a $1 million investor approach this?

Yeah, find one or two sponsors would be my hope or thought, you know, and maybe three. But, you know, as we pointed out here, you're only investing maybe $350,000, $400,000 into the private space if you've got a million-dollar portfolio. So find a sponsor you like or two, and that would be my recommendation.

I would totally agree with that. I think at that stage, at $1 million, you need to be more concerned with finding the best sponsors versus getting into as many deals as possible. All right, because the biggest thing you gotta be thinking about at $1 million is, you know, minimizing your downside. And as Bob Fraser mentioned at the very beginning, sponsor selection is the number one driver of, you know, outperformance or underperformance. We have another chart in the book that shows in private alternatives, the variance of return is really, really, really wide depending on who's the one operating the deal. And so sponsor selection is the most important, I agree. One, maybe two. And I think another thing to think about is just go slow, right? This is a target that you can set and aim for, for, you know, a period of time. It doesn't have to be all at once. In fact, we recommend if you come into a liquidity event where you have a big chunk of capital all of a sudden, you should be very disciplined and slow in how you're allocating that because the most important thing at that size is minimizing your risk, working with really good quality sponsors. You want to emphasize quality over quantity and go slow.

I think those are great principles. And that was kind of my last question is, so if someone is listening, has a million bucks or on the path there, what is the single most most principal they should take away from How Billionaires Invest? Ben, you said sponsor selection, I'm hearing go slow. Anything else you guys would add to that question?

You know, I'll add there, and we haven't talked about this, is chasing the moonshot or the return. You know, I find new investors are typically looking, you know, what, this guy, you know, Sponsor A said 50% returns and sure thing, and I'm gonna put all my money on that one. And I talked to him and boy, he's smart and super believable and everybody's doing this. And, uh, Do not do that. Don't put all your money in one deal. Don't just listen to what salesmen are gonna tell you. And focus on risk, not returns. Or at least focus primarily on risk and secondarily on returns. That's probably a better way to say that. So most investors, when they get started, are just enamored with returns. And the higher, the better, right? And you do a little spreadsheet. Oh, if I can make 35% returns, look at, you know, this money's gonna turn out. It's going to turn out in 30 years. And, and yeah, that's great as long as they do that, but they don't. So the most important thing is to not lose money and to, and to get deals that are high quality deals and that are, that are, you know, the returns are definitely secondary to the risks. So pay more attention to the risks.

All right, everyone, that's a wrap for this week's episode of Invest Like a Billionaire. Hey, if you want to dive more into this topic, Uh, this is actually in the book, chapter 15, titled Building a Smart Portfolio, where you can really get full detail of what Bob and Ben chatted about today, kind of a list of their dos and don'ts. And again, if you are interested in really diving deep into this with a community of other investors, we are building a free online community for alternative investors. Go to investlikeabillionaire.org to learn more. Cheers.