The Good, The Bad, and The Ugly for Investors
Moving from an average investor to a sophisticated one
Last week, I wrote on the three advantages of a sophisticated investor . This week, I want to write about something else that distinguishes a sophisticated investor from an average one. That is, knowing the difference between the good and the bad.
A sophisticated investor knows the value of:
Good debt versus bad debt
Good expenses versus bad expenses
Good losses versus bad losses
As a general rule, good debt, good expenses, and good losses all generate additional cash flow for you.
For instance, debt taken to acquire a rental property that has a positive cash flow each month would be an example of good debt.
Paying for legal and tax advice that save you thousands of dollars in reduced taxes is an example of good expenses.
And an example of a good loss is the loss generated by depreciation in real estate, often called phantom loss, because it is a paper loss and does not require an actual outlay of cash. The end result is that this phantom loss becomes a gain on the tax side.
Conversely, bad debt, bad expenses, and bad losses all take money out of your pocket.
Average investors hear the words, “debt, expense, and loss,” and react negatively. Their experience does not allow for thinking of these terms in a positive way. Generally, their experiences with debt, expenses, and losses result in additional cash flowing out of their pockets, instead of into their pockets.
When they hear the word debt, they think of things like credit cards, which are used to buy liabilities like new clothes or TVs, and that have very high interest rates. That indeed is bad debt.
When they hear expenses, they think of monthly bills, which they have to work hard to pay month to month, as well as the rising cost of things like medical care. Those indeed are bad expenses.
And when they think of losses, they think of things like their 401k taking a beating in the stock market and watching their retirement funds dwindle. That indeed is a bad loss.
The ugly part of this all is that it becomes very difficult for the average investor to make the shift to see debt, expenses, and losses in a positive light—which makes it very difficult for them to invest in a way that makes them truly rich.
So, for instance, when it comes to buying investment real estate, they say things like, “Wouldn’t it be better to pay all cash?” Their fear of debt makes it hard for them to see that using all their own cash is an average way of investing because the return is so much lower. They don’t realize that by leveraging good debt, the Rich Dad fundamental of Other People’s Money (OPM), they have the possibility of a near infinite return.
When it comes to expenses like legal advice and tax accounting consulting, they decide to go the cheap way or do it themselves. They don’t have the ability to see that the potential savings of using quality services and experts can actually make them more than the initial cost.
And because they don’t know enough about the law, they can’t even imagine how a loss could actually be a gain.
Educate yourself financially
If you want to move from average to sophisticated investing, all it takes is financial education and the desire to open your mind to new possibilities. That’s why we created Rich Dad Insiders for folks just like you.
The good news (for you) is most people won’t put in the effort required. So, just by taking the next step towards a higher financial IQ, you’ll be light-years ahead of the average investor.