Fundamental rules for investing
The process to go from employee or self-employed to entrepreneur or investor is essential to get out of the rat race. It’s about moving from the left side to the right side of the CASHFLOW quadrant, but to do it right you need to know some fundamental rules of investing.
Because you have to put whatever extra money you can get your hands on to work, investing it in income-producing assets. And the complicated thing is that this process requires a change of mentality that not all people are capable of carrying out.
An ideal situation to do this would be when you find yourself with more money than usual from an inheritance or winning the lottery. Average people on the left side of the quadrant will follow more traditional advice like putting that money into a pension plan or a time deposit. In the worst case, they spend it on liabilities like a car or a trip.
If you find yourself in this situation, it is the ideal time to invest that money in assets that make cash flow.
But remember that you need to understand well the following fundamental rules to invest.
Go from a poor mentality to a rich mentality
As Robert Kiyosaki has always said, the poor and middle class in most parts of the world teach their children from an early age that all they have to do is go to school, get a good job, work hard, and save money.
However, the rich tell their children: “ learn how money works, start working not to earn money but to learn, make your money start working for you and invest in assets that create cash flow”
It is very difficult to get rich working for a salary. Basically because of how taxes work. The government gets a big chunk of those taxes we pay before we even get paid.
However, business owners can invest their money on a pre-tax basis. In this way, they get more money to work with while reducing the total income on which taxes are applied. This means that they end up paying less in taxes than the middle class.
The problem is not the rich but the mentality of the poor and the middle class. And that is in our power to change it. If you want to be rich you must go from the poor mentality to the rich mentality.
Learn to distinguish the different types of income
Average people only think about having a good job to earn money. Few realize that there are different types of income :
- Work income – This is the type of income that most people think of when they talk about making money. It is an hourly job. So many hours you work, so much you earn. It is the income with the highest taxes which are also taken from you before receiving your salary. Therefore it is the type of income with which it is more difficult to become rich. To earn more money you have to work more hours even look for a second job or wait for your boss to raise your salary. But your boss can also fire you, so this is also the type of income you have the least control over.
- Portfolio Income – Many high-salary employees also have some portfolio income. Usually investment funds and/or a pension plan. Many times this is left in the hands of a financial adviser who administers it. This income is also highly penalized by taxes and it is very difficult to generate wealth with it. As with income from work, you have little control over this income.
- Capital Gain Income – This income occurs when you buy something for security and sell it for more at a profit on that transaction. There are many examples of different products or goods. One of them may be to buy a house for 110,000 euros, spend 20,000 to improve it, and sell it for 160,000 euros. The profit that you have obtained after discounting the expenses associated with the purchase-sale operation is the capital gain. Although they are also harmed by taxes, it is possible to generate wealth with them. The problem is that to make a capital gain you need the market you are trading in to rise after the purchase and you have no control over that.
- Passive income: you have this type of income when you manage to generate a periodic and constant flow of income. Let’s use the same example above to fully understand passive income. You buy a house for 45,000 euros and rent it for X euros per month. Those 45,000 euros are not all put by you. You ask the bank for 80% of the appraisal value and with the amount you collect you pay the mortgage, the expenses of the property to which you are obligated and you end up with 100 euros left over. Those 100 euros are passive income that will come to you every month. You can also obtain them with stock dividends, royalties for the copyright of a book, benefits distributed by a company in which you have invested, rental of machinery or tools, etc. In summary, It is income that comes to you whether you work or not. You have a lot of control over them and they are also taxed lower. It is the best way to generate wealth.
Turn your earned income into a passive income
Since most people start (and continue) working for someone else as an employee, it is best to understand the fundamental rules of investing as soon as possible and with them discover and understand that there are other types of income. With that idea in mind, it’s all about taking advantage of any opportunity to convert part of the salary into the best types of income efficiently.
If you get a raise, don’t put it in a pension plan, don’t put it in a savings account. Pay yourself and invest that money in assets that generate cash flow. Turn that raise into passive income.
Treat the investment as if it were an expense and gradually increase it until it becomes your most important expense. That’s what “pay yourself first” means. You have to treat yourself as an expense to be paid first and invested in assets. And go increasing that payment as you receive more income.
Invest in financial education
Many people may think that this investment involves too much risk. But the reality is that investing is not a risk. The investor is the one who can be a dangerous investor.
Some investors lose money even when everyone else is making it. Many good investors closely follow these “risky” investors because they can find real investment bargains there.
An investor’s financial knowledge can be an asset or a liability to him. With a low financial IQ, you can make big investment mistakes that other higher IQ investors can take advantage of.
In order not to be a “risky” investor, you must invest in financial education. And also as part of that same financial education, you should start investing little by little, learning from the mistakes that you will surely make, to increase your investments over time.
Getting money to invest is the easy part
When you are a beginning investor, one of the main concerns is how to get the money to invest in a good business.
However, this should not worry you. This is the easy part. The key is to focus on seeing the opportunities and be prepared to take advantage of them. And being prepared means having a good financial education and experience. With this, when necessary, money will find you or you will find money.
Focus on finding a good investment opportunity that will attract money.
Learn to manage the risk/reward ratio
Over time you must learn to distinguish the relationship between the risk you assume and the reward you expect in the investment opportunities you find.
For example, investing 30,000 euros in the idea of a friend’s cousin to create a bookstore does not seem like a good investment. Too much risk for little expected reward.
However, if you tell us that this cousin of our friend has been working for the largest bookstore chain in the world for 15 years, has been vice president of that chain, has been the promoter of that chain’s most successful ideas, and is prepared to create your own chain of bookstores worldwide, and that with those 30,000 euros, we are going to acquire 10% of the company, doesn’t it now seem like a good investment?
The reward now seems much greater relative to the risk we seem to be taking.
Remember to invest in your financial education and know and apply the fundamental rules of investing to have a better chance of getting out of the rat race.
