If you are young and have no money, how to start building wealth, my answer is learn to take risks. Many people wonder why I emphasize so much on risk taking while everyone else is telling you to play safe and not to lose money. Well, I don’t deny those are wise words, but maybe it suits in a different situation than the one you are in right now. If you don’t take enough risks when you are young, then I am sorry to say that you will not be able to take more risks when you grow older.
You see, I want to outline two distinctive phases of your life here, one is you are building wealth and the other is enjoying your wealth.
When you are in the phase of building wealth, that’s when most risks should be taken. And when you are in the phase of enjoyment, then the risk should be mitigated. Most people don’t know how to play in these two phases, in fact, they play safe their whole life and get stuck in phase one. Or they think retirement is the flipping point where you change from building wealth to enjoy wealth. But in fact, your flipping point is when you reach your financial goal, some people may reach earlier than others, but nevertheless, you should always use your financial goal as a guidance.
And people don’t tell you that in these two different phases, your investing strategies should also be different.
In the building phase, You should put more focus on growing your money, your net worth, and very little focus on earning dividends and passive income, you may wonder, is not earning passive income the ultimate goal to be financially free, Yes, that’s right. But that is in the enjoyment phase, you see, if I don’t have much money, I will not have much dividend payout either, so the point here is to have a lot of money first through building.
And after you reach your flipping point, then you have a lot of money to generate passive income for you and the dividends payouts on those money will be huge.
Let me give you some example of what I consider is building wealth versus earning passive income.
So let’s say you are into real estate investing, many people are tempted with the idea of owning second property for rental income, well this is a typical passive income focused strategy, if you do not have money, you probably need to have huge loans for your second property and your real income from your second property is the rental income minus loan and interest payment, also the maintenance fee for that property.
And after all those expenses, you may have a couple of hundred bucks passive income from your second property every month, and that can create an illusion of you getting rich because of all those extra income you get every month, and in turn you may start to raise your monthly expenses because you think you can afford it. And this is totally normal and natural that we behave this way, when the income rises, our expense raises too.
In this way, you are not really increasing your net worth dramatically. You may say, but I do own a second property, and the property value goes up, my net worth goes up too.
Yeah, first of all, you do not own the property if you take out a loan, the bank owns the property.
And secondly, the potential money that’s generated from the property value appreciation is locked in the property and you can only take it out by either selling the property or remortgage it. And either way, it will impact your passive income negatively.
So what is a building wealth strategy then?
In my opinion, if you could find an undervalued old outdated property and you buy it with a loan, but then you renovate it yourself and resell it to a much higher price. Then all the profit you get from doing this is an increase in your net worth. You can start with a small one bedroom apartment and climb all the way up through the property ladder.
But it is much more risky and needs a lot more effort, and not many of us have the time nor the skills to do it. But if you have the time and the skill, then I think it is a good strategy for you to build your wealth fast.
Now, if you are not into real estate, then putting focus on investing in high risk assets like growth stocks and cryptocurrencies can be a good way to build wealth. It is a lot more risky than investing in a index fund or a dividend stock, and you definitely need to know what you are doing so that you are not gambling your money on those assets.
Taking high risk doesn’t mean you should blindly invest in whatever people say is high risk, you should understand by yourself the fundamentals of the investment and always believe in what you are investing in.
For example, if you invested in Tesla stock, ask yourself, why I invested in it? Is it because everyone else is buying it and saying it will go up, or is it because you believe in Tesla’s fundamentals and its promising financial outlook in the near future?
If your answer is the first one, then I am sorry to say that you are a gambler in this space, I would highly recommend you to start study Tesla, maybe you will truly believe in Tesla’s future potential once you studied by yourself, and by then you also have turned yourself from a gambler to an investor.
Many people say, well, I am just not born a risk taker, guess what, neither am I. I have been playing safe for as long as I can remember, and most of us too, that’s because our parents told us so and schools teach us so. But no one teaches us how to take risk, and I believe risk taking is a skill that can be learned, not a personality if you think of a gambler. And in order to take proper risk, you need to educate yourself first, that’s how you will be transformed from a gambler to an investor.
First, you need to learn to calculate the risk.
How? By looking at everything in the lens of scenarios and probabilities.
What are scenarios? Scenarios are the possible events that could have occurred.
For example, there is a possibility that the earth gets hit by a giant comet, but is it likely? Probably not, so the probability of this happening is maybe lower than 0.1%. And because it is only 0.1%, we basically can disregard it in our risk management. But if it has a 10% percent probability, then we should weigh this much heavier in our risk management. Meaning that if there is a 10% chance of a giant comet hitting earth, then we should put more focus on developing the defense system that can protect us when that happens.
So the probabilities are the likelihood of certain scenarios playing out. And it is the same when it comes to evaluate any investment opportunities, you of course need to understand its fundamentals first, because then you are able to outline all the possible scenarios that could potentially happen, and analyze the probability of each scenario happening.
If a scenario has a 60% probability or higher, then it’s a good probability for me. Now this is subjective though, it depends on how bullish or bearish you are with that investment, but I believe the more you understand the fundamentals of the investment, the less subjective you will be. But nevertheless, this is how I calculate if the investment is worth it for you to take the risk or not.
If this sounds too complicated for you, don’t worry, your takeaway from this is nothing is 100% in the market, it’s all probabilities. and Our decision making should use the probabilities.
And next time if someone tells you he is 100% sure of an investment going up or going down, then you should definitely ask him if he has a crystal ball, because if he does, then I want his contact number.
Just kidding…
So a quick recap, we have two phases in our life, building wealth and enjoying being wealthy. During building wealth you should take more risk, risk taking is a skill that can be learnt, learn to analyze things with potential scenarios and probabilities. And use them as input for your decision making.
And in the next article, I will show you some concrete examples of how I invest by using the probability of scenarios to calculate the risk reward ratio.
