10 Controls Of A Sophisticated Investor
I believe that people say that investing is risky for three reasons.
First, and the most obvious is that they have not been trained to be investors. Most people are trained to go to school and get good grades so they can get a high-paying job.
Second, most investors lack control or are out of control. As an example, my rich dad would say, “There is some risk just driving a car, but driving the car with your hands off the steering wheel is really risky.” He then said, “When it comes to investing, most people are driving with their hands off the steering wheel.”
Third, people say investing is risky because most people invest from the outside, rather than from the inside.
Most of us know intuitively that if you want a real deal, you have to be on the inside. You often hear someone say, “I have a friend in the business.” It does not matter what the business is. It could be to buy a car, tickets to a play, or a new dress. We all know that “on the inside” is where the deals are made.
My rich dad often said, “Investing is not risky. Not being in control is risky.” Many people find investing risky because they are not in control of one or more of what rich dad called the “ten investor controls of a sophisticated investor.”
In recent weeks, there has been a ton of crazy moves in the market that is causing a lot of people to make some pretty amateur moves.
Take, for example, GameStop. Before January 27th, its price bounced around $20 a share. On January 27th it reached $347 a share before dropping to $54 a week later.
Now, I’ve talked in the past about what caused this to happen, but a lot of people who bought in during the frenzy have been burned. And I think it’s because the amateur investors don’t possess the 10 investor controls.
So, before jumping into the fray and making a quick buck on what’s happening in the market, I’d encourage you to really contend with these 10 controls and ask yourself if you really want to be a gambler, or if you’d rather commit yourself to master these ten controls and become a sophisticated investor who intelligently builds wealth over time.
Sophisticated investor control #1: Control over yourself
A sophisticated investor knows when to hold back from jumping into a volatile and unpredictable market like we’ve been seeing. The mind of a sophisticated investor knows there are multiple right answers to any given situation, that the best learning comes through making mistakes, and that financial literacy is essential to be successful. They do not become flustered when they make a mistake. Rather they have control over themselves to learn from and get better from mistakes.
They know their own financial statement, and they understand how each financial decision they make will ultimately impact their financial statement.
If you are not mentally prepared and committed to becoming a successful investor, it may be better to turn your money over to a professional financial advisor trained to help you choose your investments.
Sophisticated investor control #2: Control over income/expense ratios and asset/liability ratios
This control is developed through financial literacy. My rich dad taught me the three cash flow patterns of the poor, middle class, and the rich.
The poor spend every penny they make and own no assets. It is simply money in and money out.
The middle class accumulates more debt as they become more successful. A pay raise qualifies them to borrow more money from the bank so that they can buy things like cars, vacations, boats, and more. As their income increases, so does their personal debt. That is what we call the Rat Race.
The rich have assets that work for them. They have gained control over their expenses and focus on acquiring or building assets. Their businesses pay most of their expenses, and they have a few, if any, personal liabilities.
Sophisticated investors focus their time and energy on buying assets that put money in their pockets—not chasing liabilities that take money out. It’s just that simple.
Sophisticated investor control #3: Control over the management of an investment
An inside investor who owns enough interest in the investment to control the management decisions has this type of investor control. The investor can be a sole owner or own enough of an interest that he or she is involved in the decision-making process.
The skills learned through building a successful business using the B-I Triangle are essential to this investor.
Once the sophisticated investor possesses these skills, he or she is better able to analyze the effectiveness of the management of other potential investments. If the management appears competent and successful, the investor is more comfortable investing funds.
A sophisticated investor would know they have no control over the management of GameStop and that the gains in the stock price are not related to the business performance of the company, which has poor performance.
Sophisticated investor control #4: Control over taxes
The sophisticated investor has learned about the tax laws, either through formal study or by asking questions and listening to good advisors. The right side of the CASHFLOW Quadrant provides certain tax advantages that the sophisticated investor uses thoughtfully to minimize taxes paid and to increase tax deferrals wherever possible.
For instance, in the United States, people on the B (business) and I (investor) side of the quadrant enjoy many tax advantages that those on the E (employee) and S (self-employed) side do not.
A sophisticated investor would know that getting mixed up in the GameStop frenzy for short-term gains would be taxed at some of the highest tax rates because it would be considered capital gains.
Sophisticated investor control #5: Control over when you buy and when you sell
The sophisticated investor knows how to make money in an upmarket as well as a down one. In building a business, he or she has great patience. I sometimes refer to this patience as “delayed gratification.” A sophisticated investor understands that the true financial reward is after the investment or business becomes profitable and can be sold or taken public.
Sophisticated investor control #6: Control over brokerage transactions
Sophisticated investors who have inside influence can direct how the investment is sold or expanded. As outside investors in other companies, sophisticated investors carefully track the performance of their investments and direct their broker to buy or sell appropriately.
Many investors today rely on their brokers to know when to buy and sell. That is not sophisticated. It’s foolish. Amateurs learned this the hard way when the popular trading app, Robinhood, stopped allowing trades of GameStop.
Sophisticated investor control #7: Control over the E-T-C (Entity, Timing, Characteristics)
“Next to control over yourself, the control over the E-T-C is the most important control,” said rich dad. To have control over the entity, timing, and characteristics of your income, you need to understand corporate, security, and tax law.
Rich dad truly understood the benefits offered through choosing the right entity with the right year-end and converting as much ordinary income into passive and portfolio income as possible. This strategy combined with the ability to read financial statements helped rich dad build his financial empire more quickly.
A sophisticated investor would understand that retail trading is capital gains and is done on the left side of the CASHFLOW Quadrant where entities and the law are not built to maximize gains.
Sophisticated investor control #8: Control over the terms and conditions agreement
The sophisticated investor is in control of the terms and conditions of the agreements he or she makes when on the inside of the investment. For instance, when I rolled over the sale of several of my small houses into a small apartment building, I used a Section 1031 exchange (U.S. law), which allowed me to roll over the gain. I didn’t have to pay taxes on the sale because I controlled the terms and conditions of the agreement.
A sophisticated investor would know that the GameStop situation doesn’t allow for this type of control and would put them at risk for serious tax liabilities and losses.
Sophisticated investor Control #9: Control over access to information
As an inside investor, the sophisticated investor again has control over access to information. This is where the investor needs to understand the legal requirements of insiders imposed by the SEC in the United States (other countries have similar oversight organizations).
A sophisticated investor would understand that the price of GameStop’s stock had nothing to do with what was happening inside the company and that there would be no way to have control over the access to information that influenced the stock price.
Sophisticated investor control #10: Control over giving it back
The sophisticated investor recognizes the social responsibility that comes with wealth and gives back to society. This may be through charitable giving and philanthropy. Some of it will be through capitalism, by creating jobs and expanding the economy.
A sophisticated investor would also weigh the cost of short-term gains betting on crazy price fluctuations with the human impact that has on the people inside a company.
You could jump onto the GameStop crazy train, I can’t stop you, but I would encourage you to consider the risk and the cost. I think your time could be better spent mastering the ten controls of sophisticated investing.
Editor, Rich Dad Poor Dad Daily