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The Recipe for Wealth

Editor's Note: This column was originally published Sept. 30 as part of Arne Alsin's Turnaround Report, a premium subscription service. We hope you enjoy this special bonus issue of The Turnaround Report. To subscribe, please click here for more information.

Did you learn anything from the recent publication of the Forbes 400 wealthiest Americans? You should have. Just look at the top 10:

1) Bill Gates
2) Warren Buffett
3) Paul Allen
4) Helen Walton
5) S. Robson Walton
6) John Walton
7) Jim Walton
8) Alice Walton
9) Larry Ellison
10) Michael Dell

Each one's fortune is derived from owning shares in one of five different businesses: Microsoft (MSFT), Berkshire Hathaway (BRKA), Wal-Mart (WMT), Oracle (ORCL) and Dell (DELL).

There are common ingredients to these people's success in building wealth, and these ingredients should be part of your wealth-building portfolio strategy.

  • Long-term ownership of equity. None of the top 10 changed their investment strategy because they were worried about the advent of a bear market, for example, or the level of interest rates. They didn't change their investment posture because of who was in the White House, or because of wars or outbreaks of a deadly virus in Asia.

  • Lack of trading. Where are the hyperactive daytraders on the Forbes list? They aren't there, and they will never be there. You can't ante up for commissions, slippage (a much bigger cost than most investors realize) and taxes without creating considerable drag to your wealth-building effort.

  • Concentration. The vast majority of investors overdiversify. Big wealth isn't made by investors who widely diversify. Now, these 10 wealthiest Americans placed most of their chips on a single stock, but that doesn't mean every investor should do the same. However, you'll never convince me that the typical equity-fund manager earns his keep when he buys 100 to 150 companies. There is not enough time in the day to know intimately such a large number of companies -- not when there are quarterly conference calls, 10-Qs, 10-Ks, proxies and annual reports to review, and not just for these companies, but for peer companies as well.

    Ask yourself what buying 150 companies accomplishes. I say that it provides a screen for the inept money manager to hide behind. Under the aegis of diversification, the manager says he is doing his job. I say that overdiversification reflects a lack of skill. I don't want my capital allocated to a money manager's 150th best idea.

  • Buy early in the game. You don't need to buy the IPO, certainly, to invest like the Forbes 400, but you do need to get in early in the game. I've consistently urged my readers, here and on RealMoney, to focus on smaller companies. It's a lot easier for a $1 billion company to become a $20 billion company than it is for a company as large as Cisco (CSCO), with a $145 billion market capitalization, to grow a like amount, which would take its market cap to near $3 trillion.

  • Buy "great" companies. The Forbes wealthiest made their money by owning great companies. That means investors should take a pass on cheap companies that lack the ability to scale their model onward and upward.

The wealth-building strategy of America's wealthiest is not unlike the formula I spelled out in a RealMoney column early in 2001, Give Me an Edge, Or I Won't Play:

Great investing is not about taking advantage of each opportunity ... it's about picking your spots. It's not about frequent bets (commissions and slippage). It's about betting infrequently ... and loading up when the odds are heavily in your favor. (To read that column, click here).

A word of warning: Just because three of the five companies mentioned above are tech companies, don't make the mistake of looking for history to repeat itself on this score. This same list was dominated by oil money in the early '80s. There is nary an oil baron on the list now.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. At time of publication, Alsin held no positions in stocks mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to arne@alsincapital.com. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.

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