The Messed Up Thing About Stock Investing
Financial advisors all say the same thing. Every last one of them. “Invest for the long term in a well-diversified portfolio of stocks, bonds, and mutual funds.”
I believe it’s the worst financial advice of all.
It’s not the asset class that makes a person rich or poor. For example, when a person asks, “Is real estate a good investment?” I reply, “I don’t know. Are you a good investor?” Or if they ask, “Are stocks a good investment?” again my answer is the same, “I don’t know. Are you a good investor?”
If you are like most people and not interested in your financial education, then do as the experts tell you to do, which is to turn your money over to them.
Remember, gold is not a good investment if you are a bad investor. Nothing is a good investment if you are a bad investor.
My point is that it’s never the investment or asset class that is important. Success or failure, wealth or poverty, depends solely on how smart the investor is. A smart investor will make millions in the stock market. An amateur will lose millions.
So then, you have to ask yourself, are you a smart investor, or an amateur? Here’s how you know…
Amateurs vs Professionals
Tragically, most people do not think learning to invest is important. This is why most people believe investing is risky and turn their money over to “experts,” most of whom are not investors, but salespeople who make money whether the investor makes money or loses money.
Amateur investors are easy to spot. They usually buy low and sell high or buy low and pray.
They try to time the market with very little training and experience and believe they are diversifying their stock portfolios by acquiring stocks from different sectors of the market.
Crashes, like the one in 2008 devastate amateur investors.
Professional investors, on the other hand, exploit the stock market to earn profits. With their solid understanding of how the market works, and the knowledge that they can’t control where the market heads, they typically use investing methods with a built-in safety net.
The most commonly-used strategy for them is to use the stock market in conjunction with the options market. Stocks become their main investment, while options are like the insurance they buy for that investment. It’s very similar to real estate — you buy the property as the main investment, and then you purchase insurance to protect it.
That’s why top stock market investors know how to do the same thing with stocks and options. It’s not difficult at all, but it takes a basic understanding of how it works and how to use it for yourself.
When it comes to paper assets, the biggest differences between amateur investors and professional investors are how they seek to generate income and how they manage risk.
Too many people begin investing without a plan or any financial education. Below are six basic rules for investing that my rich dad taught his son and me.
6 basic rules for investing, regardless of the asset class
#1 Always know what kind of income you are working for
There are three different kinds of income: Ordinary earned, portfolio, and passive.
Ordinary earned income is generally derived from a job or some form of labor. In its most common form, it is income from a paycheck. It is also the highest-taxed income, so it is the hardest income with which to build wealth. When you say to a child, “Get a good job,” you are advising the child to work for ordinary earned income.
Portfolio income is generally derived from paper assets such as stocks, bonds, and mutual funds. Portfolio income is by far the most popular form of investment income, simply because paper assets are easier to manage and maintain.
Passive income is generally derived from real estate. It can also be derived from royalties from patents or license agreements. Yet approximately 80 percent of the time, passive income is from real estate. There are many tax advantages available for real estate.
#2 Convert ordinary earned income into portfolio income or passive income
Rich dad said, “That converting ordinary income into passive income, in a nutshell, is all an investor is supposed to do.”
#3 Keep your ordinary earned income secure by purchasing a security you hope converts your earned income into passive income or portfolio income.
A security is something you hope will keep your money secure. And generally, these securities are bound up tightly by government regulations. Stock or a piece of real estate is a security.
#4 It is the investor who is really the asset or the liability
You often hear people say, ‘Investing is risky.’ But it is the investor who is risky. I have seen many so-called investors lose money when everyone else is making money. I have sold businesses to many so-called businesspeople and watched the businesses soon go bust. I have seen people take a perfectly good piece of real estate, real estate that is making a lot of money, and in a few years, that same piece of real estate is running at a loss and falling apart. And then I hear people say that investing is risky. It’s the investor who is risky, not the investment.
#5 A true investor is prepared for whatever happens. A non-investor tries to predict what and when things will happen
Have you ever heard someone say, “I could have bought that land for $500 an acre 20 years ago. And look at it now. Someone built a shopping center right next to it, and now that same land is $500,000 an acre”? When you hear someone say this, you are hearing someone who wasn’t prepared.
Most investments that will make you rich are available for only a narrow window of time—a few moments in the world of trading or a window of opportunity that is open for years, as it is in real estate. But regardless of how long the window of opportunity is open, if you are not prepared with education and experience or extra cash, a good opportunity will pass.
#6 If you are prepared, which means you have education and experience, and you find a good deal, the money will find you or you will find the money
Good deals seem to bring out the greed in people. So when a person finds a good deal, the deal — because it promises great rewards — attracts the cash. If the deal is bad and doesn’t promise great rewards, then it is really hard to raise the cash.
As rich dad said, “Investing is a subject you can learn the basics of for the rest of your life.” What he meant was that it sounds complex at the start, and then it gets simple. The simpler you can make this subject or the more basics you learn, the richer you can become while reducing risk. But the challenge for most people is to invest the time.
I have found that too many people want to invest in the investments of the rich without first having a strong financial foundation under them. All too often, people want to invest at the rich person’s level because they are hurting financially and often need money desperately. Obviously, I do not recommend investing when you are desperate.
Editor, Rich Dad Poor Dad Daily