It takes money to make money.
That's the easy conclusion to draw when looking at the actions of the nation's top hedge fund managers. Many of them have amassed their wealth by putting tens of millions into play on any given investment, as they identify 50% or even 100% potential gains.
Take corporate raider Carl Icahn. He can buy a huge chunk of a company and then rattle some cages until the company is forced to make value-unlocking moves such as an asset sale or a big stock buyback. Or look at George Soros. He earned more than 1 billion British pounds in 1992, simply by wagering that the pound would soon lose value.
Yet a number of other hedge fund billionaires have earned their fortune the old-fashioned way: through savvy stock picking. Even mainstream investors like us can profit by learning from their approaches. Here's a look at four unique approaches they've employed to build their stock market riches.
We've written about the 'Oracle of Omaha' quite extensively for one simple reason. He's built a remarkable track record. Buffett has outperformed the S&P 500 in 24 out of the past 30 years, racking up 18% average annual gains in the process.
Buffett's winning strategy is remarkably simple: Focus on companies that generate robust annual cash flow, and make sure those companies are not at risk of technological obsolescence. Insurance companies best exemplify the perfect Buffett stock, which is why he spent the early part of his career mostly buying insurers.
These days, Buffett is venturing further afield. He's been buying stock in companies as diverse as DirecTV (NYSE: DTV) and dialysis services provider DaVita HealthCare (NYSE: DVA). Their common trait: robust annual cash flow.
Still, it's been said that Buffett's favorite length of time to hold a stock is 'forever.' Buffett tends to stick with his best investment ideas for the long haul, making him a true buy-and-hold investor. More than half of his firm's portfolio remains invested in Wells Fargo (NYSE: WFC), Coca-Cola (NYSE: KO), IBM (NYSE: IBM) and American Express (NYSE: AXP). He started buying these stocks years ago and has rarely sold a share since.
And Buffett's definitely not alone in his love of 'Forever Stocks.' My colleague Elliott Gue -- editor of StreetAuthority's Top 10 Stocks newsletter -- is such a believer that he spent six months and $1.3 milllion worth of research trying to find the best stocks to buy and hold forever. Click here to see his 10 favorites that he found.
2. Seth Klarman
You may not know billionaire hedge fund manager Seth Klarman, but you should. He's considered a guru among value investors, thanks to two key traits: great stock-picking and remarkable amounts of patience. Klarman, who runs the Boston-based Baupost Group, is perfectly content to wait years for the right investments to come along. In fact, in any given year, up to half his portfolio may simply be parked in cash.
Klarman often speaks about a concept that few investors think about: 'margin of error.' He only buys companies that are unlikely to drop in value, even if his basic investment premise is wrong. After all, he hates losing money just as much as he likes making money.
Klarman loves to go against the tide, seeking companies that are deeply out of favor. Here are two recent examples. In the aftermath of the oil spill crisis in the Gulf of Mexico, energy firm BP (NYSE: BP) was widely reviled. Some investors mistakenly assumed that BP would be put out of business by the countless number of lawsuits it faced. Klarman was one of the first to realize that BP could absorb legal blows and emerge in solid financial shape.
In a another case, Klarman aggressively bought shares of beleaguered insurance company American International (NYSE: AIG) after it became apparent that the company would not be forced into bankruptcy. AIG is now on the mend and has generated vast profits for Klarman and other gutsy investors.
3. Ray Dalio
Dalio's Bridgewater Associates isn't a household name like Warren Buffett's Berkshire Hathaway -- and Dalio prefers it that way. Even as his firm manages $120 billion in assets, making it the largest hedge fund on the planet, Dalio maintains a decidedly low profile on Wall Street.
It's not because Dalio is shy. Instead, he wants to make sure that he -- and his legion of analysts -- steers very clear of the groupthink that can overtake Wall Street. Dalio's success is based on his desire to formulate his own view of the macro-economic forces driving the stock, bond and commodity markets. He then seeks investment opportunities that are tailored to his conclusions.
This may sound like too much for an individual investor, but the basic concept is one we should all follow. Turn off the TV, ignore the pundits, pursue your own line of thinking about how the world -- and the global economy -- is changing, and develop your own set of investment choices.
4. Paul Tudor Jones
The first three men profiled here are considered to be savvy investors. Paul Tudor Jones is a legend among folks who would rather trade than invest. His idea of a profitable opportunity may only be in place for a matter of days, weeks and months, and certainly not the many years that folks like Warren Buffett tend to focus upon.
Like many traders, Jones likes to profit from major 'events,' whether it's a market-shaking economic report or a change in Federal Reserve policy. Even in the absence of any major events, Jones will watch any of his trading positions like a hawk. If the trade isn't working, he's quick to cut his losses.
Jones also believes that average investors mistakenly focus on stocks, ignoring other opportunities such as options contracts. That's why he has worked with the Futures Trading Association to launch an educational effort to help individual investors trade like the pros. These days, like many hedge fund billionaires, Paul Tudor Jones is better known for his philanthropic efforts, primarily in the field of education.
The Investing Answer: Investors have a lot to learn from these and many other top fund managers. It's also worthwhile to examine the secrets behind the success of other hedge fund billionaires such as: T. Boone Pickens, David Tepper, Carl Icahn, Leon Cooperman and William Ackman.
Each one of these fund managers pursued a distinct path, and combining the best traits of many of them can bolster your chances of success.