high investor risk

What Makes an Investor Sophisticated?

The first five investor controls for maximum investment success

Rich dad often spoke of the sophisticated investor. “A sophisticated investor is an investor who understands each of the ten investor controls,” he said. These ten controls were the key to making huge sums of money in the markets.

This week I’m going to share the first five investor controls my Rich Dad taught me, and I’ll finish up with the next five in next week’s post.

Investor control #1: Control over yourself

“The most important control you must have as an investor is control over yourself,” said rich dad.

Most of us were taught in school to become employees. There was only one right answer, and making mistakes was horrible. We were not taught financial literacy in school. Once you leave school, it takes a lot of work and time to change your thinking and to become financially literate.

A sophisticated investor knows that there are multiple right answers to any given situation, that the best learning comes through making mistakes, and that financial literacy is essential to be successful. They do not become flustered when they make a mistake. Rather they have control over themselves to learn from and get better from mistakes. They know their own financial statement, and they understand how each financial decision they make will ultimately impact their financial statement.

Investor control #2: Control over income/expense ratios and asset/liability ratios

This control is developed through financial literacy. My rich dad taught me the three cash flow patterns of the poor, middle class, and the rich.

The poor spend every penny they make and own no assets. It is simply money in and money out.

The middle class accumulates more debt as they become more successful. A pay raise qualifies them to borrow more money from the bank so that they can buy things like cars, vacations, boats, and more. As their income increases, so does their personal debt. That is what we call the rat race.

The rich have assets that work for them. They have gained control over their expenses and focus on acquiring or building assets. Their businesses pay most of their expenses, and they have a few, if any, personal liabilities.

Sophisticated investors focus their time and energy on buying assets that put money in their pockets—not chasing liabilities that take money out. It’s just that simple.

Investor control #3: Control over the management of an investment

An inside investor who owns enough of an interest in the investment to control the management decisions has this type of investor control. The investor can be a sole owner or own enough of an interest that he or she is involved in the decision-making process.

The skills learned through building a successful business using the B-I Triangle are essential to this investor.

Once the sophisticated investor possesses these skills, he or she is better able to analyze the effectiveness of the management of other potential investments. If the management appears competent and successful, the investor is more comfortable investing funds.

Investor control #4: Control over taxes

The sophisticated investor has learned about the tax laws, either through formal study or by asking questions and listening to good advisors. The right side of the CASHFLOW Quadrant provides certain tax advantages that the sophisticated investor uses thoughtfully to minimize taxes paid and to increase tax deferrals wherever possible.

For instance, in the United States, people on the B (business) and I (investor) side of the quadrant enjoy many tax advantages that those on the E (employee) and S (self-employed) side do not.

Much of the sophisticated investor’s income is in the form of passive and portfolio income, so they do not have to pay social insurance taxes like social security and Medicare on that money.

They can use tax laws to defer tax payments, sometimes indefinitely.

They can pay for expenses with pre-tax dollars and be taxed only on the net income.

These and many other advantages give the sophisticated investor a huge head start over those investing in the E and S quadrants.

Investor control #5: Control over when you buy and when you sell

The sophisticated investor knows how to make money in an up market as well as a down one. In building a business, he or she has great patience. I sometimes refer to this patience as “delayed gratification.” A sophisticated investor understands that the true financial reward is after the investment or business becomes profitable and can be sold or taken public.

Next week, I’ll cover the last five investor controls that make an investor sophisticated. So be sure to catch that post.

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