In Message #1240, I told you about a man I met at the ETR Wealth-Building Bootcamp who wanted more advice on investing in individual stocks and options. When I discovered that his personal net worth was only about $18,000 (not counting the value of his home), I was shocked. Why would anyone with so little in savings take so much risk?
I found out later that night (by way of a registration survey) that he wasn’t the only one. At least a third of the conference attendees were small-fry investors. Interestingly, when asked to rate their interest in various types of investments, there seemed to be an inverse relationship between net worth and the stock market. The wealthier attendees were very interested in real estate, side businesses, and alternative forms of investing, while the beginners wanted to make their fortunes by buying and selling stocks.
As I pointed out to the conference attendees the next day (and to you in Message #1240), unless you have at least $50,000 to invest in stocks — and $100,000 is better — you probably shouldn’t be investing in individual stocks. And you definitely shouldn’t be trading options and futures. At this first wealth-building stage, your primary focus should be on earning more income by developing a financially valued skill. (We’ve talked about this in many past ETR messages.) The more you earn, the easier it will be for you to save. And the more you save, the faster you’ll build up a substantial amount of money that you can invest.
But what should you be doing with your savings now? What can you do with $25,000? Or $18,000, for that matter?
There is only one answer: Start a business.
You can’t start a capital-intensive business with $18,000. You can’t, for example, open a restaurant or create a new line of pharmaceuticals. But you can start a small direct mail business by investing a few thousand dollars (and a lot of hard work) and see it grow into a business that’s worth a million. I’ve done it many times.
I’ve coached people who have done it. Stories are published in magazines every month about people who have done it. We’ve even developed a program to help you do it. When you reach the second wealth-building stage — when you have between $25,000 and $100,000 to invest — you can take a multi-layered approach to your investing.
Here’s the portfolio I’m recommending for stage-two investors in the book I’m writing for John Wiley & Sons (“Automatic Wealth: 6 Steps to Financial Independence”):
The first money you save should be marked for emergencies. This needs to be put somewhere safe but easy to access, like a home safe or a safety deposit box. The amount you should keep for emergencies depends on your personal situation: how much you typically spend, how reliable your income is, etc. As a rule of thumb, though, I’d recommend about 10% of your net worth. If you have a net worth of $100,000, that would be $10,000.
* Equity-Building Real Estate
After you’ve taken care of your family’s emergency needs, start to develop a portfolio of equity-building real estate. What is equity-building real estate? It’s any property (other than your home) that is likely to go up in value. It can be a piece of land that costs you very little to maintain, or a rental property that brings in enough income to meet or exceed its expenses. How much equity-building real estate should you have? If you have a net worth of $100,000, I’d recommend a bit more than half. Let’s say $60,000.
* Fixed-Income Instruments
Other than cash and real estate, your money should be in Treasuries, municipal bonds, or quality corporate paper. Fixed-income investments like these don’t provide a high return, but they are safe. You’ll notice that in this second wealth-building stage, there are no stocks, options, futures, rare coins, or derivatives in the portfolio. And there’s a good reason for that. When you have less than $100,000 to invest, your main goal should be to ensure your capital, not to grow it at an accelerated rate. As Will Rogers is reported to have said, “Be more concerned with the return OF your investment than the return ON your investment.” You will make nothing on your cash and only about 4% on your tax-free bonds (which will probably be worth about 6% on a taxable basis). But if you invest reasonably in real estate, financing 80% of your investments with bank loans, that larger (60%) part of your portfolio should appreciate at 15% to 25%. That will give you an overall return of between 12% and 15%.
While you are going through your, pre-$100,000-net-worth stages of wealth building, a return of 12% to 15% on your hard-core savings is plenty. But what do you do with your money when you pass these first two plateaus? When you have between $100,000 and $1,000,000 to invest? That’s what we’ll talk about tomorrow.[Ed. Note. Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]