Asset Protected Investing (Part 2)

In my first post on this subject (Asset Protected Investing?) I indicated that I had been exposed to a way to see the markets that I had not known even existed before a couple of years ago.  In this post I am going to expand.  Let me start with the way that I, and I think 99% of us, understood investing.

Basically, to invest in something I would take the money I had earned and then saved and “buy” a certain asset which I felt would increase in value, or pay some type of interest or dividend during the time I was holding that asset.  That was “Investing”.  And this applied whether it was a stock, a bond, a certificate of deposit, a piece of real estate, or a loan I made to my cousin.  Basically they are all the same thing.  Take my cash and give it to someone for something I think will return me a profit.

If I was correct in my assessment of the asset I purchased, then I would in fact get the return I expected.  If not, then I wouldn’t.  And if I was really wrong I might even lose the money I put up in the first place to buy the asset.  Just ask anyone who bought real estate in 2007!

Risks of Retail Investing

Now this is all well and good, and as far as I knew this was about the only way to do it.  But there are a two critical features to this way that almost always go virtually unnoticed:

• Feature #1:  You are risking 100% of the capital used to purchase the “Investment”
• Feature #2: It is extremely difficult to assess the amount of actual risk being taken on any given “Investment”

In other words, in the world of retail investing, you are risking it all and don’t understand, or get adequately paid for, the risk you are actually taking.

When this was actually pointed out to me I literally felt my gut give a confirming twinge.  I knew this was correct.  Not just from my own experience, but from the thousands of clients I have spoken to over the past 20 years who time after time said “I just didn’t fully understand what I was doing.”

Professional Investing Protects Your Assets

And I can tell you that in that moment of getting it, all I could think was:

“Is there another way?”

Of course, since the distinction had been made, then the answer is YES there is. The question is WHAT is it? And to answer that my neighbor patiently began to explain to me the world of professional investing.  Here is what I learned

Professional Investors do 2 things differently.  And I bet you can guess what 2 things they are:

1. They DO NOT risk 100% of their capital
2. They precisely understand the RISK they are taking, and more importantly, they get PAID to take it.

This may not make total sense to you yet, but these differences are critical.  By taking an incremental amount of greater risk, and doing so in a managed way, the professional investor can get paid a dramatically greater return, while risking only a fraction of his capital.   You may want to think of it this way.

Which would you rather have, 5% per year taking a 1% risk of losing all your capital, or 10% a year and take a 2% risk of losing all BEWARE: This is a Trick Question!

Now think of it this way: which would you rather earn 5% a year with a 1% risk of losing it all, or 5% a year with a 2% risk of losing only half your money?

The professional investor sees risk as opportunity precisely  because they manage WHAT they put at risk.  The retail investor sees risk as a threat because they fail to  see that they are free to not risk everything!

I hope this is beginning to make some sense, and if not, don’t worry.  I am working on Asset Protected Investing (Part 3) already. 🙂

Doug