sophisticated investor

The Three Advantages of a Sophisticated Investor

Understanding the law and making it work for you

Most people are average investors. They count their chickens before they’re hatched, have no control over their investments or income, and play the averages when it comes to the markets.

If you want to be successful as an investor, you must move from average to sophisticated.

Rich dad defined a sophisticated investor as someone who understands how money works, the nuances of the markets, how to size up a company, and is familiar with the following specialties of law:

  • Tax law
  • Corporate law
  • Securities law

While not lawyers, sophisticated investors may base much of their investment strategy on the law as they do on the investment product and potential returns.

By knowing the basics of the law, the sophisticated investor is able to employ the advantages of E-T-C, which stand for:

  • Entity
  • Timing
  • Character

Sophisticated Investor Advantage #1: Entity

Sophisticated investors have control over the entity of their investment, which means the choice of business structure. Employees, for instance, do not usually have such control, while a self-employed person can choose from the following entities: sole proprietorships, a partnership, an S corporation, a limited liability company (LLC), a limited liability partnership (LLP), or a C corporation.

More than just having a choice, however, the sophisticated investor knows how to work these entities to his or her favor.

For instance, in the United States, if you are an attorney, doctor, architect, dentist, etc., and you choose the C corporation as your entity, your minimum tax rate is much higher than it would be for someone like me, since my business is a non-licensed, professional-service business.

By understanding and choosing the right entity, a sophisticated investor can save 20% or more in taxes. That adds up to a lot of money.

Want to learn more about entities and their advantages? Read Rich Dad Advisor Garret Sutton’s book, Start Your Own Corporation . And, of course, consult with your tax advisor for what works best for you.

Sophisticated Investor Advantage #2: Timing

Rich dad said, “Timing is important, because ultimately we all need to pay taxes. Paying taxes is an expense of living in a civilized society. The rich want to control how much they pay in taxes, as well as when they have to pay them.”

Understanding the law helps in controlling the timing of paying taxes. For instance, Section 1031 of the U.S. Tax Code allows you to “roll over” your gain in investment real estate if you buy another property at a greater price. This allows you to defer paying taxes. You can do this indefinitely if you’d like.

Another example is that C corporations can choose a different year end than December 31, unlike individuals, partnerships, S corporations, and LLCs. The advantage? A different year-end date allows for certain strategic planning as to the timing of distributions between corporations to individuals.

Again, it is best to consult your tax advisor on what the best strategy is for you.

Sophisticated Investor Advantage #3: Character

Rich dad said, “Investors control. Everyone else gambles. The rich are rich because they have more control over their money than the poor and middle class. The moment you understand that the game of money is a game of control, you can focus on what is important in life, which is not making money but gaining more financial control.”

The character of money was important to Rich Dad. He taught that there are different characteristics of income:

  • Ordinary earned income
  • Passive income
  • Portfolio income

He said, “The poor and the middle class focus on ordinary earned income, also called wages or paycheck income—the highest taxed income. The rich focus on passive and portfolio income—the lowest taxed income. That is the fundamental difference between the rich and the middle class. That is why it’s important to focus on the character of the income you receive, not just how much money you make.”

Start being more sophisticated today!

If you want to move from being average to sophisticated when it comes to your investments, you have to start with an investment in your financial education—and you have to start today.

Rich Dad has a number of workshops to get you started, as well as coaches that will help you reach your financial goals.

Original publish date: November 04, 2014