Over the years I have found that many people have an improper view of risk, what it is, and how to minimize and handle it. They also don’t have the right view on savings, investing, income, and how to overcome challenges and crisis. Many investors believe in commonly held myths and as a result don’t make the best financial decisions that can cost them quite a bit of money in the long-run.
While the definitions are the same wherever you go, how you view them is key. Here are the commonly held definitions and the proper view you should have of them.
RISK – The possibility that an investment will lose, or not gain, value. All investments involve some degree of risk. In finance, risk refers to the degree of uncertainty and/or potential financial loss inherent in an investment decision. In general, as investment risks rise, investors seek higher returns to compensate themselves for taking such risks.
- Many people either take too much risk, or don’t take enough risk. In order to become financially independent and financially free, you have to take risks. You cannot do it without it. When some people try to avoid risk altogether, that alone is a significant risk because the value of that money will decrease in value (losing purchasing power) over time due to inflation. Generally speaking, the higher the risk, the greater the potential return, and the lower the risk, the lower the potential return. The goal is to maximize your returns while minimizing your risks. Being proactive means taking risks and accepting the fact that you may be wrong. A SMART Mentality understands that mistakes happen. It means you took a risk and ventured into new territory. Our school system penalizes us for making mistakes. But in the real world, you won’t know what the best way or plan is until you try. Making mistakes and failing is part of the learning process. The best way to learn is by doing. Regardless of the situation, actions, not plans, teach the best lessons. The wealthy and most successful people learn to take SMART risks. Instead of avoiding risk, taking SMART risks give you a competitive edge and help you find opportunities others may miss. Some of the wealthiest people I know are the ones that snatched up properties and stocks in spring of 2009, when the market was an all-time low. It was a risk because the market could have continued to fall, but it was a SMART risk since the valuations were high and sooner or later the market would rebound. Doing this isn’t easy, it requires resiliency, the ability to spot trends, and learning to fail forward. That is why the wealthy are not afraid to be proactive, take action and SMART risks. What does it mean to take SMART risks? We talk about this in greater detail in the next steps when we address the concept of Diversification and Asset Allocation.
- Improper View of Risk: I will do whatever I can to avoid risk
- Proper View of Savings: I will take SMART Risks that minimize the downside and maximize the upside
SAVINGS – In finance, the amount of money that is not spent or used. It is the excess of income over buying things. It is also lower costs and expenditures.
- Benjamin Franklin said “A penny saved is a penny earned.” Today I am sure Franklin would say “A penny saved is two pennies earned” since there were little taxes in his day. In order to save $100 dollars, you have to earn over $200 dollars. Why is that? You have to pay federal income taxes, state and local income taxes, Social Security and Medicaid, fuel/gasoline taxes, property taxes, and others on the $200 dollars you earned. The average US citizen in 2013 paid close to 60% of their income in total taxes! So in order to save $100, you have to earn more than double that. Another way to look at it is not spending money is the same as making money. If you save $2,000 a year by switching to more inexpensive lattes, that is the same as someone paying you over $4,000! This is why the wealthy view protecting their money as very important. If you lose 50% of it in the stock market, in order to break even, you need to gain 100%!
- Improper View of Savings: Saving a certain amount is equal to earning the same amount in today’s economy
- Proper View of Savings: Saving a certain amount is almost double the earned amount in today’s economy
INVESTING – In finance, it means to commit money in order to earn a financial return. It is use to money for future benefits and advantages.
- As I mentioned in the “What is Financial Independence?” section, in order to achieve financial independence and freedom, you have to invest and create a SMART Money System where you trade money for more money, not time for money. Whatever you are investing in, stocks, bonds, alternative investments, real estate, etc., you are investing so that you can earn more money than what you put in. You want to invest for growth and income so in the end you can have income for life without working. Many people see investing as a chore, some see it as a get-rich quick scheme, and some others see it as not necessary. The most critical component to investing is not the money you put in or the interest you get, but it is the TIME. Why is TIME so critical to investing? It is because of what they call the 9th Wonder of the World: COMPOUND INTEREST. This is basically your interest and gains earning more interest and capital gains. You are making money on the money you made before. The longer your money has to grow, the faster and more it will grow. It is just like a snowball where it grows at a faster rate over time. If you are new to investing or haven’t put as much as before, the best time to start investing may have been in the past, but the second best time to invest is now!
- Improper View of Investing: I can wait later to invest when I have more money. I don’t need to invest because I plan on making more money instead. I will trade time for more money. I will invest only for growth.
- Proper View of Savings: I will start investing now, even if it is a little bit. I need to invest for financial independence and freedom. I will trade money for more money. I will invest for growth and income.
INCOME & EARNINGS – The amount of money and income you make at your job, from your investments, from your business over a period of time.
- We talked about how important it is to save and invest, and the proper view to have on them. While spending less is important, it is more important to focus on earning more. If the average person makes $40,000 a year, saving 10% is $4,000. However if you can focus on earning more (I talk about this in the SMART Strategy section under SMART Ways to Make More Money) and are able to receive $200,000 a year, saving 10% is now $20,000. Big difference! Earning more is playing offense, spending less is playing defense. You need to do both. If you focus on bringing in more money, saving more, and investing the difference, you can achieve financial independence and freedom in very little time!
- Improper View of Income and Earnings: Saving more is more important than earning more. I should focus on only finding ways to save more.
- Proper View of Savings: Earning more is more important than saving more. I should focus on finding ways to make more and also save more.
OVERCOMING CRISIS – We all will face obstacles and challenges throughout our lives. How you overcome them will determine your personal and professional growth.
- When I was in high school, I heard a speaker say that the secret to success was by failing. At the time I thought this guy didn’t know what he was talking about! After graduating from West Point, serving on Active Duty and the National Guard, starting multiple businesses, and leading a state political party, it turns out he was absolutely right. I have learned much more from failure than success. Success actually can be a very poor teacher, especially if done through bad habits. Bill Gates stated, “Success is a lousy teacher. It seduces smart people into thinking they can’t lose.” On the one hand, when people believe they can’t lose, they become complacent. Complacency forces people to be reactive, playing not to lose instead of being proactive and playing to win. Failure, on the other hand, can teach more about success than success itself. Failure is a process and an event toward success. Seeing failure as the end is quitting, but seeing failure as a means to success is “true success.”
- Improper View of Overcoming Crisis: Failure is to be avoided at all costs and if I do fail, I am a failure and will never recover
- Proper View of Savings: Failure is a stepping stone to success, it is a part of life and when I do fail, I will fail forward and try again!
For more information on having the right view of things, read the “Secrets of the Wealthy” ebook!
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