The Investment Hierarchy
Are you an "expert" investor or a "novice?" Maybe you're not even an investor. Why not? Perhaps you don't feel competent or confident. If that's you, don't be ashamed. Most American's could use a little more investing knowledge.
Today, I'm going to talk a little about what I call the Investment Hierarchy. As I've been thinking more about all of the different financial teachings by people like Dave Ramsey, Jim Cramer, David Bach, Robert Kiyosaki, and the many different investing and financial philosophies they teach, I'm left to ponder how does someone make sense of it all?
Every financial teacher has an angle, and honestly, I believe they all have their place. But for the average person, how do you cut through the clutter and create a path forward for your financial future?
I'm a firm believer that anyone can become a millionaire...if they make the right life and financial choices. So how do you make the right financial choices in a cluttered landscape of financial teaching? Let me try to help you.
The Investment Hierarchy
When it comes to investing your money, there are literally dozens of directions you could go. And depending on who you are listening to and the advice you receive, you could be making a good choice or a bad choice.
There is some generally accepted wisdom when it comes to investing. Things like...
Buy low. Sell high.
High risk, high reward vs. lower risk, lower reward.
As you get older and near retirement age, lower your risk.
Use other people's money.
Diversifying your investments lowers your risk.
There are literally dozens of these nuggets of investing wisdom from seasoned investors, but how do all of these little nuggets help you develop your own investing strategy? Where do you start and where can you get the best returns?
If you're investing through a 401K or IRA, then the chances are you have invested through a mutual fund. These tools are the #1 form of investing for the majority of Americans since they are offered through the workplace. Unfortunately, that also makes them the only form of investing for many Americans.
If you want to build real wealth, then you should expand your investing strategies beyond 401ks, IRAs, and mutual funds. That's why the investment hierarchy is so important.
As I talk with people about their finances, I encourage them to think about their 401k, IRAs and mutual funds as part of their "financial foundation." The foundation is stable and fairly predictable. Once you have your foundation in place, I encourage them to expand their investment portfolio by exploring other investment options that carry more risk with the potential for greater returns.
The problem with exploring these higher risk-return options is that you stand a higher chance of losing all your money. However, you also stand the chance of seeing much larger growth than what a mutual fund will deliver. Let me share an example.
The best investment advice I've ever received was from my wife. She told me to invest in Apple in 2003. However, due to circumstances in our lives at the time I chose not to invest in Apple. I did, however, invest in mutual funds through my 401k. Over the next 17 years, S&P Index mutual funds returned 360%. Apple returned 45,000%...that's 450x your money.
The risk in 2003 of me investing in Apple was much greater than the S&P, but so were the chances of returns. I'll regret my decision to "play it safe" for the rest of my life. :)
Now that doesn't mean every stock you pick will be a winner. That's impossible. But some will be winners. In reality, some will be big winners, some will win on par with mutual funds, and some will be losers. However, the big winners can far outweigh the losers.
When you lose money, the losses are "finite." That means they are limited to what you've invested. However, with the big winners, the gains are much greater. For example:
If you make 10 investments of $1,000, what's the most money you can lose? $10,000. Now if just one of those investments creates Apple like gains, what's could you gain? $450,000. The gains you get from one investment erase all the losses from the other nine investments.
Of course, this is all just an investment theory. Or is it? People say playing the stock market is like gambling. In some ways it is, but in some ways, it isn't. With gambling, you truly are at the mercy of chance and luck. With investments, you can lower your risk through education and study. You can look at the health of a company, it's leadership, the market opportunity and many other dimensions to help you determine if a company is a good investment.
Now I'm not telling you to go out and start making a bunch of risky investments. What I am saying is to educate yourself on the possibilities. Expand the way you think about money and investing. Millionaire Key #3, Get Money Smart. Always keep learning about money and how to use it. It's just good stewardship of the resources you've been given.