This post is a reminder to myself and to all of you that we can and will lose money if we invest in risk assets for a long enough period of time. The only way to never lose money again is if we never make any investments.
However, to build great wealth over time, it’s important to take calculated risks and continuously invest for the long term. Over time, stocks, real estate, and bonds have shown to beat inflation and provide a real rate of return. With the power of compounding, it’s only a matter of time before investors build a healthy nest egg.
A Cautionary Tale To Start
To show the dangers of investing and getting caught up in the hype, let’s take a look at the rise and fall of cryptocurrencies.
There is this one guy who boasted making minimum wage a year ago and is now a cryptocurrency millionaire. He shows his electronic wallet on social media for all to see in order to create FOMO in his followers. He succeeds.
He began aggressively promoting Bitconnect in 2H2017, a bitcoin based lending platform where they take your cash or Bitcoin and give you a GUARANTEED interest of between 0.25% – 1% a DAY with Bitconnect currency. They said they have a “proprietary bitcoin trading bot” that produces such returns.
In other words, if you invested $1,000, after 3 years of 1% daily compounding interest, you would have something like $53,000,000! Come on! Check out this chart from Bitconnect highlighting their promised returns and capital back time table.
When the Bitconnect platform realized they were running out of money to pay their new users, they decided to shut down their exchange, leaving all those who gave them cash or Bitcoin stranded. Their Bitconnect currency proceeded to plummet 90% overnight and its fate remains to be seen. Where did all the cash and Bitcoin they collected go? Who knows!
Once I saw the price plunge and learned about the promoters and how Bitconnect worked, I thought to myself there’s no way anybody could have been so gullible and fall for this scam. Here’s a comment after the plunge that parodies an Eminem song.
OK, people must be joking. Nobody could have given Bitconnect money right? Then I saw more serious comments from people who claim to have lost a lot of money in Bitconnect. Here’s one from a guy who supposedly invested $500,000 in Bitconnect and wants to take out a $5,000,000 loan to invest more in cryptocurrency!
Still unconvinced about the seriousness of these comments, I kept on reading the feedback and stumbled across this Youtube video of a guy who lost $30,000 in loans in Bitconnect. After watching this video, I’m now convinced there were actually people who did fall for Bitconnect’s wild promises. It does not look like he’s acting.
Let me share some exercises I go through before making ANY investment. Hopefully these exercises will help keep you grounded as you seek to build your fortune.
Steps To Take Before Making Any Investment Decision
1) Calculate how many hours, days, weeks, or months you need to work to make up for a loss. Let’s say you make a $10,000 investment in anything that has risk. You earn $20/hour. If you lose all your money, you will have to work at least 500 hours to get all your money back. Since you have to pay taxes, you have to work more like 650 hours. Given you’re only making $20/hour, the job probably isn’t something you love to do. Knowing the “pain of recovery period” will help keep your FOMO in check and help you make more risk appropriate investment decisions.
2) Look for keywords such as “can’t lose,” “guarantee,” and “get rich quick” in the marketing material. If you find any of these keywords, run the other way. There is NO GUARANTEE to any investment except for an FDIC insured savings account up to $250,000 per person or holding a US Treasury bond until maturity. Even then, the US economy could blow up.
3) Ask yourself whether you truly understand the business model. If you cannot easily explain the business model with a straight face to a loved one, you do not understand what you are investing in. If you don’t understand what you are investing in, you should not invest in the product. For example, I had one guy ask me why he hadn’t received any returns three months after making a $25,000 equity investment in a three year real estate crowdfunding deal. He’d confused an equity investment with a debt investment and obviously hadn’t understood the literature about the deal discussing their strategy of selling the property in three years for a target profit.
4) Calculate your net worth composition to understand risk. You must understand your net worth composition in order to understand how much risk exposure you have or are comfortably able to take. Losing $30,000 in Bitconnect is survivable if you’re worth at least $300,000 and have a steady job making at least $60,000. But it doesn’t sound like the guy in the video has much more than $30,000 to his name since he said he “lost his life’s savings.” There’s a reason why professional money managers diversify client holdings.
5) Limit all alternative investments to no more than 10% of your net worth. I define alternative investments as any investment other than publicly traded stocks, bonds, CDs, and physical real estate. Investing in stocks, bonds, and physical real estate is good enough to build enough wealth for financial independence. There is NO NEED to invest in anything else. Alternative investments do have the ability to generate higher returns or diversified returns than non-alternative investments, but they are often illiquid, more difficult to understand, carry higher fees, and may carry much higher risk. You are not the ~$27B Yale endowment with ~55% of their fund in alternative investments because you don’t have the same amount of access, power, and team of investment professionals tracking the fund full-time. BTW, they returned 11.3% between June 2016 – June 2017 with venture capital (17% allocation) leading the way +106%.
6) For goodness sake, please don’t take out a loan to invest in alternative investments. The people who get into real trouble during a correction are those who not only invest too much of their net worth in the investment, but also take out a loan. Yes, margin investing in the stock market is at all-time highs, which is scary because the stock market is also at all time highs. Yes, taking out a mortgage you can’t afford when real estate prices are at all-time highs is also a terrible idea as we saw in the 2008-2010 financial crisis. If you lose 100% of 10% of your net worth, you will be pissed off, but survive. If you lose 100% of 100% of your net worth, you will be devastated and perpetually depressed, but will likely survive if you have a job. But if you lose 100% of 200% of your net worth due to debt, you will be ruined and likely stay poor forever.
7) Please understand the background and history of the person trying to sell you something. If the person is a broke fella who was packing boxes for minimum wage a year ago and is now telling you how to get rich, be wary. If the person is a high school student teaching you about the fundamentals of investing, be wary. If the person only highlights his wins and never his losses, be wary. The person should have a multi-year track record before you listen to their advice. And even still, be wary. There’s a reason why institutions wait until a fund has at least a 3-year investment track record before investing any money. There’s a reason why funds that have a 10-year or longer track record tend to have the most assets under management.
“Hey, hey, heyyyyyy!” Long live Carlos Matta and his Bitconnect promotional video! It’s no longer available, but was such a classic.
8) Get feedback from at least three people before making an investment. It is easy for us to get excited about an investment that could make us rich. We start fantasizing about what we would buy with our profits, where we would travel, or how we would quit our jobs. Yes, money makes us go crazy. Therefore, you must share your investment thesis with at least three people: a parent, a sibling or best friend, and the smartest person you know. Listen to all their criticism. I get someone telling me I’m an idiot every week for my investment decisions, and I appreciate it because there is no guarantee! It’s when everybody agrees with what I’m doing when I start getting worried. If you have truly listened and still believe in your investment thesis, then go ahead and take a risk with no more than 10% of your net worth.
Invest Responsibly Please
One of the reasons why I’m so much happier just being a personal finance blogger than working in investment banking is because I’m not calling or e-mailing anybody to buy anything. If people want to read my writing by bookmarking this site, subscribing to my e-mail feed or private newsletter, or listening to my iTunes channel, or join the FS Forum for free. You’re not going to get your face ripped off by learning about one guy’s perspective on money.
Please invest responsibly folks. Don’t ever give your money to someone you don’t know or invest in something you don’t thoroughly understand. Be wary of folks who are saying you just can’t lose. Please try and tame your desire for getting rich quickly. If you can avoid stepping on financial land mines, you will be able to reach financial independence more easily.
As for me, I’m back to building up a large cash hoard. I’ll still invest in risk assets when I see some opportunity. It’s just that the amount I’ll be investing will be much lower than usual. The Bitconnect implosion has really reminded me about risk. I’ve already gone beyond my comfort zone and plan to get back to my safe place.
If you think about it, every investment except for hard assets like real estate or your 1952 Mickey Mantle rookie card are just digital numbers on the screen. Your screen might show a fortune one day and a big fat ZERO the next. It’s the reason why I’m so much more comfortable investing in physical real estate than any other investment.
Finally, I leave you with this final investing thought. You can never lose if you lock in a gain. Yes, you might sell something too soon and kick yourself for not holding on for more gains. But selling early is much better than selling too late. The floor drops out from under you when everybody starts to panic. I experienced this firsthand when I tried to sell my house in 2012.
Recommendation To Build Wealth
Manage Your Money In One Place: Once you make an investment, your money is at risk. Therefore, it is imperative that you stay on top of your wealth. Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. In addition to better money oversight, run your investments through their award-winning Investment Checkup tool to see exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing. I’ve been using Personal Capital since 2012 and have seen my net worth skyrocket during this time thanks to better money management.