Understand The Risk Management Or Pay The Price Later
130: The importance of understanding risk.
Welcome reader! It took us over 90 posts to write about maximizing efficiency and ensuring you are in a better position than those around you. It would only be fair if it took us 40 more to write the guide on positioning yourself and understanding. Better said, to give you an overview of risk management and how to approach it. Prepare yourself… This is a long post that everyone can benefit from.
Risk And Why It Matters
Why would you care? Risk is a topic that will start to make sense after you get out of "survival mode." When you are in a position to have time to think about what you want to get more out of your life instead of living paycheck to paycheck—once you stop being satisfied with the minimum. Since most of our readers are not living paycheck to paycheck and are out of survival mode. It is essential to realize what managing risk is all about. People think they are in a unique situation (human nature) and purposely avoid reading things such as this one. That is not true. However, if you had a side business making 6 figures one year and the next year you are in 4 digits or that same business doesn't exist anymore… we can all agree that you took a series of wrong steps. You didn’t take the risk presented seriously enough. The same logic can be applied to investments, careers, and relationships. It is impossible to stay on top without experiencing pullbacks—no one can deny it. But experiencing drastic pullbacks and going from "hero to zero" should not be something you want. Solution? Risk management.
Making things easier for us: To get our point across, we split the readers into 4 categories based on their total assets. As with topics such as this one, it is hard to give one answer that will fit all. We are sure there are outliers in this case as well, but that is something we cannot cover, and most of those reading this post will fit into one of these groups. We did not consider age, as it would complicate things. Net worth is more than a good enough metric and should allow everyone to understand where we are going with this.
1) Learning to avoid disaster—Mostly young people with $0 assets to their name. Yet to set themselves up with a predictable income (career), invest, or start a side business.
2) Living comfortably—Those with over $300k in assets and a predictable income have a high chance of running a side business and investing in stocks and crypto. Some may still have a debt that is managed with minimal effort.
3) Impossible to lose—Anyone with over $1-1.5 million, no debt and investments, predictable income, and side business. All those from previous categories.
4) Not worth bothering with—If you are here, there is a good chance you have already hired someone to take care of your risks while focusing on other things. Congrats.
This doesn’t mean you should not follow the principles of the other groups. Let's say you are in group 1 and can invest in a stock you know will 3x. The choice is easy. The game is about playing all the fields and moving up. It is never linear or black and white.
Important to mention
We would argue this is still one of the best takes from legendary WSP regarding RE.
Real Estate: One of those topics we stay away from for a good reason. Over the last year, we have talked with multiple people (mainly from Europe and the US) who have said their housing expenses have increased. This can mean only two things: living expenses (rent, bills) have increased, or their income has decreased. The second one is rarely the correct answer. We all know what has been happening for the last couple of years with everything else, not just real estate. This leaves you with the WSP approach and how to look at it. We don’t recommend getting into a long-term mortgage (debt) just to buy a place. If you are 100% sure that buying living space is right for you, ensure you have enough cash to minimize interest and not waste unnecessary money. Owning a place does not necessarily mean it will improve your life. If you haven't been in a good position before purchasing, it will decrease your quality of life—a common case. Before anyone comments, "Real estate prices always go up" that is not necessarily true. We leave this one up to you to decide what is worth it. Our last piece of advice regarding real estate? Avoid buying or getting into unnecessary debt before entering the last category. If you don’t believe us, look at yourself in the table below.
Example of a house costing $1.5 million and what you are looking at if you set yourself up for a 40-year plan. More than 2x the original price… Avoid.
Debt: Another topic we don’t want to touch in detail, as there are too many specific cases, and it is impossible to give proper advice without knowing the background. Neither our goal is to turn this post into a personal finance one. A big difference exists between having student debt with a 2% interest rate and a car payment with 8%. One way to look at the debt and how to minimize the risk is from the outperforming perspective as long as you outperform the debt with your investments. You are good at paying the minimum—this way, you minimize the risk, as you know you will always be able to cover the debt. This approach has nothing wrong with it as long as you can get more with your investment on the other side. It is better said that there is not much to worry about if you are in low digits up to 1-3%, and things get tricky when discussing higher single-digit numbers 6%+. To make things more practical. Let’s say your investment portfolio brings you 7% yearly post-inflation. Your interest on the debt payment is 4%. This means you would be better off investing your money and paying the minimum debt as you go—the inflow of money is higher than the outflow. That is all the science there is when it comes to debt. Unfortunately, most do not invest in the first place, so they do not beat the debt anyway. Result? The majority realize they are better off getting out of debt.
Steps To Minimizing Risk
Minimizing risk: long-term winning framework for those starting from zero.
Get predictable income (high-paying career)
Make sure you have at least 3 to 6 months of savings in case things go south
Start investing your money in a side business to get it off the ground (multiple income streams should be your goal)
Any money left after taking care of the side business → invest in stocks/crypto
Focus on building multiple income streams
Exit once side business income exceeds predictable income—when you are in a comfortable enough position
Learning To Avoid Disaster - Basics ($0 To Your Name)
Reality check: We have all been there. What separates those who make it from those who don’t? A strategy that revolves around minimizing risk-maximizing odds.
Living expenses: There is a reason why we are putting this first on the list. If you don’t have at least 3 to 6 months (depending on your position) of monthly expenses saved… You are doing something wrong. Not just wrong. Dangerous—something we have discussed multiple times on this website. If you are exposed to a risk that directly impacts your basics, it leads to short-term decisions. The short-term decisions? They lead to long-term losses. It is one big loop. One that once you notice, you won't be able to unnotice. This is a boomer type of advice worth listening to. The minimum you want is to not worry about a roof over your head or afford a healthy diet.
Predictable income (W2-career): If you have nothing going on and are without any cash flow. Starting the business or trying to hit it big could be a mistake. To start a business, you need money. Suppose you want to drive traffic to sell the products you are offering. You need money. Working for someone else in the same industry for 2 years while trying to start your side business? Underrated. It is one of those things that don’t get as much attention. That is the proper way to find mentors and exponentially speed up your learning process. Since we want to avoid getting away from the main idea of this post—keep it simple. What you should do is aim for a high-paying career in a growing industry, such as tech. This will allow you multiple options and ensure you are in a favorable position that brings you enough money. This advice is no longer popular, and there is a good reason… Most careers are not worth it. But if you follow our advice and know what you are doing, there is not much to worry about. All it takes is a few years of effort in your early life that will set you up for the future.
Side business: Essential piece of the puzzle. Side business. Why? Because the side business will bring you more than anything else regarding scalability. This means that all the money you have left from your predictable income after you take care of your basic needs should go into a side business. Luckily, 80% of the online side business can be started for less than $150—which no one thought was possible years ago. Meaning? You have one less excuse not to start. You want to understand basics such as those presented in practical advice for business owners and start as soon as possible. The bigger problem is the sacrifices you must make along the way. The first few years are brutal, and you should put maximum effort into getting things off the ground. Remember that all the money you have left after taking care of your expenses should be prioritized for spending to start your business.
Company—pension match: This should be self-explanatory. Whenever you are presented with the opportunity to receive an employer contribution—pension match on your investment. You already know what to do… We won’t discuss any specifics, as each country has a different approach. Overall, the system works on the same principles. You put $100 into the S&P 500, and your company or pension fund does the same. Without a doubt, it has the lowest risk with the highest reward.
Investing: We are leaving investing for last because it can be distracting for many. It is not just a distraction but can also help develop a coping mechanism. Something along the lines of: "By buying this, I will be able to take it easier and just sell it once it grows big enough." Everyone can do that, but it often leads to poor long-term performance. The reality is that if you do not have good cash flow (predictable + side business) and are putting significant amounts of money into it. Investing will not make you comfortable enough in the long run—your energy could be better spent elsewhere. Does that mean you should not invest? No. You should focus on the earlier aspects to get more out of it. If you cover all expenses, pay off your debt, fund your business, and still have some money left to invest. That money should be put in index funds (S&P500/QQQ) and big crypto coins (BTC/ETH). One could argue that it is risky enough to bring you some returns while not being risky enough to go to zero.
Living Comfortably - Intermediate ($300K+)
Reality check: We argue that at least 30% of regular readers reading our content is in this category. A well-off position with multiple things going on. This is a solid position to be in, but at the same time, it's tricky. Why? Most get stuck in this range as the requirements to move things up become harder, or there is a missing piece of the puzzle. On top of that, add a feeling of comfort and the belief that you always have it—or at least that’s how most individuals think. Your mindset and approach should shift once you are over $300K in net worth (out of survival mode). Result of that shift? Understanding how to use your money on anything that positively impacts your life. ROI+ is one way to look at it.
Predictable income (W2-career): If you have played your cards correctly or followed our earlier advice. Your daily tasks should be automated. Meaning you are only spending your time on things that will move you forward and ensure you are in a better position. Extra points if you are already in a decision-making role that will make it harder for your employer to replace you. Results? More time to focus on what matters. The whole point of your work should be to put in the bare minimum necessary to get the most out—in case your goal is to 100% focus on building your business.