My investing philosophy in 2020 boils down to this: set specific goals, purchase assets, manage spending, and use the power of leverage!
Let’s get into it.
I used to think the hardest part of achieving something was figuring out how to do it.
In some ways I still believe that’s true, but what I’ve realized is that the creation of goals is actually more important than knowing how to reach them.
The combination of setting goals and working towards those goals day in and day out for long periods of time are what allow people to do amazing things.
The Bigger Pockets podcast asks every guest this question, “What separates successful investors from those who fail, give up, or never get started?”
My answer is that successful investors do two things.
1. They know what they’re trying to achieve
- They know how much money they want
- They know when they want it
- And they know how they plan to get there
So a successful investor has a goal written down that looks like this:
I will have a $5 million net worth and $25,000 per month of income by my 40th birthday, and I will achieve that through buying and renting out real estate, purchasing dividend paying stocks and owning online businesses.
An unsuccessful investor has a goal to become wealthy, but they don’t really know when it will happen and they don’t know how they will get there.
2. They work towards those goals every day
You can have a well thought out goal, but the other ingredient to success is that you consistently take action towards achieving that goal.
The primary method I use is through daily affirmations. I have a list of sentences to reinforce the behavior I need to be successful, and I read them out loud every day.
So if I read “I will create $25,000 of monthly cash flow by my 40th birthday” out loud every day, then my mind does two things.
- It starts to believe that I will achieve that goal
- It is constantly searching for opportunities and solutions to that problem
Creating the mindset of a successful person naturally changes your behavior into that of a successful person.
How To Create Wealth
I believe there is only one way to create wealth, and it is to pair investing with healthy spending habits.
But what is investing, really?
My personal definition of investing is the purchase of assets. And to me an asset is anything that makes you more wealthy over time.
- A 401k is an asset because it will grow in value over time and it has no expenses.
- A home that you live in is usually not an asset. It costs you money through utilities, taxes and insurance payments, and probably interest on a mortgage.
- A rental property with positive cash flow is an investment. It covers all expenses and makes you money every month.
- A car, a TV, furniture, a computer, and pretty much every expensive thing in your home is not an asset. Those things don’t make your richer.
The house I live in is an asset, but it’s not a very good asset. Since Kate and I run an AirBnb out of our basement, we are able to pay for utilities, insurance, taxes and the interest on our loan. But the only part about our house that is actually making us wealthier is the appreciation of our home, which is about 2-3% per year, and is not a very good return.
What are good spending habits?
Good spending habits are different from person to person.
My rule is that your spending should allow your cash flow to increase over time.
The more your cash flow grows over time, the more disposable income you have to purchase more assets, and the faster you can increase your wealth.
In general your spending should increase at the same percentage rate as your income.
So if your income is currently $1000/month and your spending is $500/month, then your cash flow is $500/month.
If your income increases by 10% to $1100, then it’s reasonable to also increase your spending by 10% up to $550. Your cash flow also went up 10% to $550 allowing you more money to invest.
The best way I know to ensure healthy spending habits is to track them. And this can be done by creating a budget and using budgeting software or some personal system.
Some Assets Are Better Than Others
I think the baseline metric for whether an investment is a good one or a bad one is the average growth of the stock market.
The average return of the stock market over long periods of time is around 10% when you ignore inflation.
When I look at purchasing an asset I have three main considerations.
- What type of net worth return will I get on this investment?
- How will my cash flow be affected?
- How much of my time will be required?
If my expected net worth return isn’t greater than 10% then the asset should be not be purchased. In fact I usually expect at least a 25% return of net worth on the money I put in to the investment.
If my cash flow doesn’t improve, then I will pass on the investment.
And I’m willing to put more time into an investment with greater expected returns. If I can get a 10% return in the stock market with basically no time investment, then why would I want an investment with 15% return that requires hours of my time every day?
My experience so far has me ranking real estate and purchasing of online businesses as the best investments for me. You can find opportunities for 25% returns and often much better, and both of these improve your cash flow situation while requiring some time, but usually not obscene amounts of time.
Net Worth vs. Cash Flow
At this point in time I put much more weight on improving my cash flow than I do on increasing my net worth.
This is because I still have a full time job, and in order to quit my job I need more cash flow to support my normal living expenses.
In general I think focusing on cash flow is what leads to financial freedom, and your net worth will grow plenty if you prioritize cash flow.
I’ve mostly avoided stock for this reason. The type of cash flow returns you can get with dividend paying stocks are embarrassingly low compared to real estate and online business.
The Power of Leverage
Debt is the most powerful tool at an investor’s disposal. It allows your wealth to grow much, much faster.
While the conservative investor considers debt to be a risk, the unbound investor uses debt to his or her advantage.
Consider a simple case.
You have $10,000 to invest and you want to invest it in the stock market. This should give you a 10% return.
If you just buy $10,000 of the stock, then after 10 years your stock value would be $25,937.
Let’s assume you were able to get a $10,000 loan at 5% interest and you bought $20,000 of stock ($10,000 of your own money and the $10,000 loan money).
Your $20,000 investment would be worth $51,875 after 10 years, and assuming a 10 year loan term, you would have paid $12,728 total on the loan.
This would put the value of your portfolio at $39,147 after 10 years.
Using the debt money to invest resulted in an extra $13,210 added to your net worth. That’s 50% more!
The power of leverage has led me to use this rule when I purchase assets:
Purchase assets worth significantly more than the amount of money you have to invest.
That means if I have $20,000 to invest, then I’m looking for assets currently worth $50,000 or $80,000 or $100,000. I can buy a $100,000 home for only $20,000 of your own money.
But don’t take leverage for granted! When you take on debt to purchase an asset, you must verify that this is a great investment with rigorous due diligence using your most conservative numbers.
Always assume there will be unexpected expenses with the purchase of an asset!
My investment philosophy is always evolving, and the best investing opportunities are often dependent on each individual situation.
I’ll be back next year to see how my philosophy has changed.