​​High Risk vs. Low Risk Investing (The Reality)

Life isn’t just about target date funds and index funds. Lots of people understand that, logically, they should create a well-diversified portfolio of low-cost funds. But they also want to have fun investing. If you feel this way, sure, use a small part of your portfolio for “high risk” investing—but treat it as fun money, not as money you need.

“Fun Money” Allocation

I set aside about 10 percent of my portfolio for fun money, which includes particular stocks I like, know, and use. Companies like Amazon that focus on customer service, sector funds that let me focus on particular industries, and even angel investing, which is personal investing for private ultra-early-stage companies. All of these are very-high-risk investments, and they’re funded by just-for-fun money that I can afford to lose. Still, there is the potential for great returns. If you have the rest of your portfolio set up and still have money left over, be smart about it, but invest a little in whatever you want.

Young Ramit’s $297,754 Lesson

When you were fifteen, a lot of your dads were teaching you how to drive, showing you how to use a razor, or throwing you a quinceañera. My dad told me to open a Roth IRA.

A fifteen-year-old is too young to open a Roth IRA, so my dad and I opened a “custodial” account together at E-Trade. I had a few thousand bucks from a few high school jobs I worked—pizza maker, soccer referee, and sales guy for an internet company—so I started looking for what to invest in.

For lil’ gangster Ramit, this was about as exciting as it got! So I started doing my research, which consisted of:

  • Looking up which stocks went really high and really low (because I thought “Higher risk = higher reward, and I’m young, so I can stand high risk so I get high reward!!” God, I hate myself.)
  • Restricting it to tech (“Because I understand technology!”)
  • Reading magazines like the Industry Standard, which breathlessly hyped different companies as they swelled to hundreds of pages of ads during the dot-com boom. Back then, I thought investing meant picking individual stocks, so I ended up buying three stocks.

I bought stock in a company called JDS Uniphase (JDSU), an optical communications company. The stock effectively went to zero.

I bought stock in a company called Excite, an early search engine, which was renamed [email protected] after being acquired. It went bankrupt. And then I bought roughly $11,000 in a little company called Amazon.com.

My investment of a few thousand bucks turned into $297,754. I should be proud of myself, right?WRONG. It might seem like I won, but you can learn a lot of counterintuitive lessons from this example.

Top 3 Investment Lessons I have Learned


1.) THE SUPERFICIAL LESSON:
“You’re so smart for picking Amazon!”

THE REAL LESSON: That is exactly the wrong lesson to take away. If that’s your reaction, please read carefully: It’s very important to know WHY you win and why you lose. I won with this Amazon investment, but it wasn’t because I was a good investor. It was, purely and simply, luck—a freakish once-in-a-generation winner.

2.)THE SUPERFICIAL LESSON: If you pick the next Amazon, you’ll be rich.

THE REAL LESSON: Investing isn’t about picking individual stocks. Research shows that even veteran portfolio managers will, on average, fail to beat the market. I could have picked another one hundred stocks, and statistically, I would not have even beaten the market. It was pure luck. I’ve actually made much more money on long-term, low-cost investing.

3.) THE SUPERFICIAL LESSON: Getting the right stock matters a lot.

THE REAL LESSON: Getting started early mattered a lot. I was extremely lucky to have a dad who pushed me to start investing early. If you had the same, awesome. But let’s say you didn’t grow up with parents who knew a lot about money. Or, until recently, you thought the only way to invest was to “pick stocks.” I hear you—we all start from different places in life. Hey, my dad didn’t teach me about the importance of engaging my core when deadlifting. We all start with the cards we’re dealt.

What About Crypto?

I thought you only found mindless, roving hordes in zombie movies—until I met crypto “investors.” I use that term loosely, since the majority of cryptocurrency fanboys have no other investments. They are “investors” in the same way that I am a mermaid because I can swim.

The next time you hear someone ranting and raving about why crypto is the future, ask them this simple, devastating question: “Besides crypto, what does the rest of your portfolio look like?”

Their answer will instantly reveal that they are speculators, not investors, because they almost never have a diversified portfolio.

Here are the three answers you will get:

  • “LOL. I don’t invest in fiat currency.”
  • “Traditional investments are so boring.”
  • “You don’t understand blockchain.”

These answers are contrarian, that’s for sure. The only catch with being a contrarian is you have to actually be right.

When you get one contrarian, they just sound a little crazy. Put two of them in the same room, though, and you’re suddenly witnessing a convention of people with all the hallmarks of brain-dead speculators. These people are almost always young, libertarian, and disaffected. You’re not seeing a lot of people with successful careers spending four hours a day posting “HODL” (crypto investors’ take on the word “hold” from “buy and hold”) on social media. See for yourself at bitcoin.reddit.com. It gets a little quiet when crypto investments drop 80 percent though.

I have no problem with alternative investments when they are part of an overall portfolio. I have a real problem with mob mentalities around money-making ideas that then get rationalized and twisted from “currency” to “investments” to scathing (and shortsighted) criticisms of worldwide currency.

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Ramit’s Guide to Understanding Crypto as an Investment

  1. THEY SAY: Cryptocurrency is a form of currency that you can use to pay for various goods.

REALITY: Very few merchants accept cryptocurrency. Also, one thing people seem to like is their currency being stable, meaning one dollar is worth one dollar. What happens when your cryptocurrency swings over 25 percent in one week? That’s right, people tend to not spend it, because your TV might be 25 percent cheaper next week.

  1. THEY SAY: Cryptocurrency allows people to use cryptography and decentralization to remain anonymous.

REALITY: This is true, and there are some valid reasons for people to purchase anonymously. However, for now crypto largely gets used to buy drugs.

  1. THEY SAY: It is better than fiat currency.

REALITY: If you spend more than three minutes talking about crypto with a fanatic—excuse me, fan—they will surely bring up the argument of fiat money. This quickly progresses to referencing Nixon’s 1971 decoupling from the gold standard, followed by “Money isn’t real.” I just stare at them, blinking.

  1. THEY SAY: It’s not about Bitcoin, it’s about blockchain.

REALITY: Bitcoin is one example of a cryptocurrency using “blockchain” technology, which uses cryptography and a decentralized architecture. The technology is legitimately impressive. It is also used by fans to distract from the constant failings of the actual usage, like Bitcoin and the thousands of applications. In one study, 80 percent of ICOs (initial coin offerings) were, and I quote, “identified as scams.” Fans ignore these and instead point to the blockchain as the panacea for all of societal ills: Hungry? Blockchain will solve that. Need to walk your dog? What about using blockchain? Hey, I need to change my underwear. Got blockchain?

  1. THEY SAY: Well, crypto is an amazing investment.

REALITY: Investment returns in Bitcoin increased hugely in 2017. From January to June, it had increased by 240 percent compared to 9 percent for the S&P 500. Hard to argue against that. But irregular returns are a larger problem than most people realize. In just three months, Bitcoin soared over 340 percent, then dropped like a rock. Just like in any other type of high-risk gambling, you get addicted to the highs, but when it goes down, you begin hiding your losses and not talking about them. True to form, that’s exactly what we saw. The number of people who searched for Bitcoin soared at the same time its price did—and, of course, once the price dropped, people stopped talking about Bitcoin as an investment.

Conclusion

If you want to invest in cryptocurrency, be my guest. As I said, once you have a solid portfolio in place, I encourage you to invest 5 to 10 percent in something fun! Just make sure you have a fully functioning portfolio first, meaning you’ve completed the Ladder of Investing, you have six months of emergency funds, and you limit your exposure by periodically rebalancing.

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