In this article, I have summed up the essence of 80/20 investing. It all leads back to operating from a position of financial strength and making the right decisions. Through some core rules of intelligent investing, you can find out the quickest and least risky way to wealth that will set you on the path of becoming an 80/20 Investor.
#1 80/20 Investing is about doing your homework
There are a couple of tasks you need to do to make the right financial decisions for yourself. You can read up on these simple tasks in any self-help book on home budgeting and financial management, but here are the basics:
Take an inventory of all your assets. Assessing your earning power and taking an inventory of all your personal assets is vital when it comes to investing. You won’t be able to avoid unnecessary risk, if you are not sure about your income situation and the financial reserves you have at your disposal. The old adage “nothing ventured, nothing gained” may be true, but doesn’t imply that you should be taking dumb risks. Get your financial house in order by measuring and assessing it. Periodically go over these numbers. It will train you to take charge of your financial affairs, which is, ultimately, the single most important step in creating an investment plan.
Check your current and potential earning power, and keep track of expenses. Equally important is the matter of saving to accumulate assets and to build a strong financial base for future investing. Saving works. If there is not enough money for future financial needs such as retirement, you either save more money, work more, work longer, or you create additional earnings opportunities over time, so that you can save more in the future.
Once you have done your homework, you can start contemplating on index fund investing, crypto coins or any other esoteric asset classes in more detail. It starts with the all-important question: how much money are you willing to lose?
#2 Before you invest in other people’s businesses, open a business
Warren Buffett, with his usual sagacity, once said, “I am a better investor, because I am a businessman, and a better businessman because I am an investor.”
If you study Warren Buffett’s early life, you will see how he started out by delivering newspapers, then investing his savings in a pinball machine and a beaten down Rolls Royce that he rented out. He even bought farmland. He created his own business platform based on income-producing assets that would finance all his future endeavors. He admitted that his early experiences of going into his own business taught him valuable lessons for his future career in money management and stock market investing.
Before you even consider buying other people’s assets, create your own assets, like Buffett did. Invest in yourself or create a business from scratch. By far the most important income-producing asset will be yourself. Get an education, training and work experience – it will be the best investment you can ever make.
Needless to say, you need to monetize skills and passions. Today, with the diversity of digital platforms, and the reach of the digital world, anyone can bootstrap simple income-producing assets. Your first platform might not turn a profit quickly, but managed well, it will never financially bankrupt you.
It would also teach you valuable lessons about business investing, and that can be projected onto financial markets. You would learn the basic concepts of economics firsthand – input and output, as well price determination depending on demand and supply. You would learn the impact of economic cycles in your own business, and how to make it less prone to downturns. You would truly understand the magic of compounding returns that so many financial gurus rave about. You’d experience a crash course in basic accounting and budgeting where you will see money going out, but, initially, little coming in.
Automatically, you would learn to control your spending – a vital skill for financial success. You would also understand the difference between real cash flows (i.e. cash hitting your bank accounts vs accounting earnings).
You would also learn everything about modern marketing and promotional techniques in order to generate sales – how to encourage potential customers to open their wallets for you- from limited time offers to buy one get one free or those dreaded pressure-sales techniques expedia.com is famous for (‘50 customers have booked this hotel in the last hour!’). At the very least, you will become aware of these elaborate techniques when they’re used on you.
#3 Always assess the odds of success or keep your wallet zipped
Having gone through your personal MBA course, and having your own income-producing assets, you will know how difficult it is to establish and maintain profitable businesses. You will be aware that whenever you open your wallet, by passing your money to someone else, you take substantial risks. Having your own assets will have taught you the skill of assessing the odds of success of each financial transaction. This alone will prevent you from gambling and taking stupid bets in financial markets. You will most likely end up keeping your wallet zipped most of the time.
#4 Compare possible returns in the securities markets with your personal cost of capital
If you established your own cash engine first, and you have your own income-producing assets, you would soon realize that it would be foolish to put the money into the stock markets or any type of mutual fund all the time. The reason is you usually get much higher and better returns from the assets you control. Always compare potential returns with the returns you can achieve yourself – at much less risk.
Buying index funds, that might make you 5%, but could cost you 50%, will be far less attractive a prospect than investing in your own business where you could make double-digit returns. Ever wondered why top traders and investment managers are so eager to share their tips through expensive research and educational courses (present company included) or why they are so eager to manage your money?
Well, they know that doing this is a very profitable business model in itself that can generate generous returns with less risk and more predictable cash flows.
#5 Avoid overpaying for other people’s assets
The biggest risk in investing in financial markets is not price volatility but overpayment risk. Overpayment risk is simply to pay too much for the value you receive in return, i.e. you get much less than previously anticipated. It’s common sense to ask for at least equal value for the price you paid. Having your own income-generating asset would train you for this. Overpaying happens in public markets day in and day out. You always pay the price for popularity, and the result is mediocre returns or losses.
#6 Let diversification come naturally
Risk management involves assessing the odds of success with each financial transaction. Today, there is an overemphasis on diversification: people arguing the need to hold 500 stocks, or thousands of stocks, with hundreds of bonds and several funds spread over several asset classes at all times.
This is what I like to call “dumb diversification,” and it has its limitations. What you end up with is excessive diversification and meager returns at high fees. Any form of risk management costs money, even if you use cheap index funds.
Investing by definition means taking chances on the future. We cannot completely eliminate this through diversification. If you are worried about portfolio volatility, you shouldn’t invest in financial market instruments, but put your money in high quality fixed income securities.
Alternatively, with establishing your primary cash engine comes the understanding of natural diversification. All future cash flows must come from your primary income stream. Hence, efficient diversification means building several income streams over time that will allow you to withstand any financial shock.
You will never be forced to sell any of your assets at subpar prices. Keeping liquid assets, such as cash and gold, is your default diversification plan.
#7 Follow the 80/20 way to investing
Financial success relies on only a few decisions. We are our best cash generators. So, we should take care of ourselves first and our own business endeavors. Aim to simplify and streamline your investment strategy and portfolios.
By focusing only on the tasks and decisions that count in your life, you would naturally become more selective with your investments and how you spend time on them. A consequence of this attitude would be only to occasionally invest in financial markets; in other words, when you are getting offered unbelievable odds of winning and true value that make all your efforts worthwhile.
Ask yourself if you want to spend countless hours sitting in front of the screen and listening to the BS of so-called experts when you could be investing in your own business platform or simply leading a more balanced life.
# 8 Never forget Rule #1
All the rules mentioned lead back to the mother of all investment rules: Never lose money. By establishing your own income producing assets first, you will inherently appreciate this rule right from the start, instead of betting on price differentials and rising markets.
With creating your own assets comes education and awareness. It would teach you how to take calculated risks while demanding appropriate compensation. You will instantly understand that the prerequisite for financial success is having high standards while creating value for yourself.
For those already in business, and with plenty of cash, I would like to remind you how and why you got into the comfortable position you’re now in. It was certainly not through speculating wildly in stock markets and other esoteric financial products or hoping that index fund portfolios grow at 7% perpetually into the future. I would like to refer you to Benjamin Graham’s observation:
“Investment is most intelligent when it is most businesslike. It is amazing to see how many capable businessmen try to operate in Wall Street with complete disregard of all the sound principles through which they have gained success in their own undertakings.”
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The 80/20 Investing Strategy Conclusion
There you have it. The 80/20 investing strategy is all about improving the odds of your investment success by bundling your strength and resources. Ultimately, this will help you develop a strong mindset that will give you a psychological edge when financial markets go haywire.
80/20 investing is intelligent investing and 80/20 Investors are Superinvestors, because they strive for high returns by following just a few rules and avoiding mass deception and exuberance.
80/20 investing is ideal for individual investors with an enterprising mindset because they can do what’s right in investing without following institutional imperatives or conventional thinking.
