Do you believe in Dragons? No, I didn’t think so.
Whilst I don’t believe in dragons as exact, living beings I do believe that they exist as three dangerous things that may take your wealth.
Just like the King Arthur tales of old, these dragons will steal your wealth. Yet evolution has taught these dragons to be more subtle and sneaky and take from you without you even knowing it.
Like a Knight of the Round Table you must challenge these beasts to guard your financial dominion.
Meeting the Dragons
1. The first is understood as “The Dragon of Taxes”,
2) The second dragon is known as “The Dragon of Inflation”, and
3) The third and most important dragon is known as “The Dragon of Poor Performance”
Why is the third dragon the most important?
You see, the first two dragons are beasts you can’t defeat and are immortal. The Dragon of Taxes and the Dragon of Inflation are immune to all weapons. They are so powerful; no single investor can predict what they will do.
The Dragon of Taxes is in reality the various levels of Government who love to take your money to spend it on various programs. This dragon is always hungry and has an endless appetite.
The Dragon of Inflation represents the demand of the marketplace for money and the interest policy of governments. Inflation may be high in some years and low in others, but it will always erode your spending power and your wealth. You cannot slay the Dragon of Inflation.
The third dragon known as The Dragon of Poor Performance is the only dragon that you can tame. The good news is that if you manage to tame this dragon, it will help you fight the effects of the other two dragons!
Battling the Dragons
Let’s pretend that you are a brave knight and you set out to defeat the Dragon of Poor Performance. You attack but barely escape with your life because you misjudged the dragon’s ability. You decide that it’s best of lay low and lick your wounds.
Doing this seems like a wise move except that while you are resting the other two dragons come along and gobble you up!
You see, when you get poor performance in your investments either by picking too conservatively or not picking right, the returns you do get are eaten up by taxes and inflation. Ouch!
If you invest your money into something that is certain to generate five percent a year, you have just made sure that you aren’t making the cash you might have. There are investments out there that have solidly earned 8% a year and though they could be riskier, they shouldn’t be evaded.
Should you take increased risk for just a 3 point difference in the return? Yes! A 3 point difference does not seem like much, but when you factor in the magical effect of compounding returns, it is critical to get the better return.
Let us assume you wanted to invest $1,000 for your brand new child for him/her to have as a graduating gift when they turn 18. You invest it, forget about it, and never contribute another penny. You choose an investment that gives you a return of 5%.
Scenario 1 @ 5% Starting amount – $1,000 Years – 18 Additional contributions – $0 per month Rate of return – 5.00% compounded daily Total amount you will have contributed – $1,000 Total at end of investment – $2,459
Total amount you’ll have given – $1,000 and you get back $2,459. Not too tacky, but we have not figured in inflation and taxes. Let’s check the second scenario:
Scenario 2 @ 8% Starting amount – $1,000 Years – 18 Additional contributions – $0 per month Rate of return – 8.00% compounded daily Total amount you will have contributed – $1,000 Total at end of investment – $4,220
Not surprising you would earn more money, but who would have known that the 3 point difference was worth $1,761 more! Taking the greater risk does pay off. Still, we can’t forget the first two dragons, the Dragons of Taxes and Inflation. Look out, because they always take their share of the pie.
Avoiding Investment Risk is Risky To Your Financial Health
Avoiding risk is impossible. There is no such thing as risk free, because low-return and low-risk investments are subject to tax and inflation risk.
Face it. Taxes and inflation is here to stay. They will wear away your wealth. Since you can’t fight them, you must learn the way to manage them. The solution is to get good returns and to tame the Dragon of Poor Performance.
Let us assume the state taxes you at 25%, for each buck you earn; you give twenty-five cents to the Dragon of Taxes.
Scenario 1: A 5% return x 25% tax rate = 1.25 points off your 5% return = 3.75% actual return after taxes. That is just barely keeping above inflation which has typically run between 2% and 4% a year.
Scenario 2: A 8% return x 25% tax rate = 2.00 points off your 8% return = 6% actual return after taxes. Now this is a much better spread over inflation.
Do you see what I mean when I say that the Dragons of Taxes and Inflation will gobble you up when you invest poorly? The solution comes in taming the only dragon that can help us fight the other two.
Taming the Dragon of Poor Performance
One of the simplest techniques of taming the Dragon of Poor Performance is to stop making only investments in assured investments (CDs In America and GICs in Canada).
Use them as a place to store money for short term periods whilst you understand where to invest your money, but never use it’s your main investing method, unless you are about to retire! Get the best interest rate you can for your short term money. It is always better to get three percent than two percent for the explanations mentioned above, but since it’s a place to just park your money, you must get your cash working better for you.
To find better investments, you want to directly invest into companies on the stock exchange. Unlike interest based investments like bonds and CDs/GICs, the stock market provides a much higher rate of return.
You may think that investing in the stock market is like gambling. And it is gambling for those who do not understand the rules. But just like a knight needs to use a sword and shield properly to fight a dragon, you need to learn how to invest to get your best returns.
Consider at the minimum Exchange Traded Funds which are wonderful instruments that capture all of the returns found in the stock market. They do better than Mutual Funds and should be the shield in every knight’s armor.
But easily, the Excalibur sword of the investing world can be found in stocks and options investing. If you want to not just tame but slay the Dragon of Poor Performance, you want to start doing some research through websites, electronic courses, and books on “Stocks and Options”.
Its important to remember that those willing to manage the greatest risks, receive the greatest rewards!
May you successfully win your battle with the Dragons.