Building Wealth vs Getting Rich : A distinction of Risk and Return

Disclaimer : I am a glorified monkey with a keyboard and not some fancy advisor.

Introduction

In the past year, I’ve witnessed people around me slowly growing accustomed to the “get rich” mindset. With the cryptocurency and stock market seeing abnormally high returns relative to the norm and 20/30/40% returns becoming progressively more common it seems that everybody is a finance expert. I mean, look at me I started a whole blog about it! But reality is much more punishing and gritty when it comes to finance. This post hopes to provide the reader a framework to evaluate their current investing mindset and evaluate when taking returns is important and the distinction between “building wealth” and “getting rich”

YOU CAN’T PREDICT THE FUTURE

Back to the Future 2' Is a Sham - The Ringer
Me, finding the solution to all of my problems (Courtesy : Back to the Future)

Wall Street can’t predict the future, there is absolutely zero people on the planet who can predict the future to my understanding. Yet still, Influencers who claim to be the next oracle of Omaha (but who most definitely have limited finance knowledge) function on a luck engine. This engine runs on a limited resource, called luck. Getting in at the right time without actually understanding the underlying fundamentals of the financial instruments they are using. It is important to maintain the perspective that no person or group of people can accurately predict the future. So, does this mean that there is no adequate way to evaluate the stock market? How does Wall Street do it then? Do they know something we don’t? Well, let’s visit one important evaluation for gamblers, wallstreetbetters, and finance enthusiasts alike. Risk vs Return

Risk vs Return

To understand everything from stock investing to grocery shopping we must consider the effects of risk and return.

Risk is defined as : the possibility that something unpleasant or unwelcome will happen.

Return is defined as : a profit from an investment.

So, if I were to ask you which one of these was most important for investing many would likely answer return. Return controls how much money you make, how good you feel about yourself, and how much dopamine you get. However, if you evaluate the actions of people who have amassed a large amount of money you will begin to see a common occurrence. The most consistent returns are made through consistent evaluation of the risk in relation to the reward. You ALWAYS want to consider the downside risk BEFORE you consider the upside return.

Now, a short anecdote. I have recently become a bonafide chess addict, despite my apparent Attention Deficit handicap. I have noticed that when I am focusing on attacking the enemy king, I have lost focus of the true goal. When I am focusing on evaluating each possibility systematically, I am being patient and considering the risk and return of each situation.

Back to finance, what is the goal of finance? Is it to make everybody rich? Is it to make the rich richer? Is it to create frustration amongst the masses? I would call the answers : No, yes, and yes. So, now that we know that the finance is designed to make the rich richer, and inverse robinhood the lower class (take from the poor and give to the rich). Let’s see if we can figure out how poor people like us can profit off of the system.

Finance is not designed to make you rich

The title of this section really says it all. Finance is designed to make the rich richer. So your dreams of 2 da moon I want lamborghini while not completely impossible are HIGHLY unlikely without careful consideration of finance. Now, I propose a question to you. How do the rich get richer? Well, the simplest example of how this system is stacked against the poor is to evaluate what being rich gives you to start out.

When you start out wealthy, you can leverage this wealth to make more wealth, so if you have say a small loan of a million dollars. A 3% return now becomes $30000 per year which is enough to live on for many people in the lower middle class. However, if your life savings from your day job is $1000 then that same 3% return becomes a grand total OF $30 per year. That’s pretty trash. But just wait, it gets worse. Let’s say that I have $1,000,000 worth of stocks and I want to buy something for $1000000, in the case that I sell my stocks then capital gains will kill me so instead I choose to use my stature to borrow a secured loan of 2.4% on my $1,000,000 in stocks so now I have $1,000,000 to put wherever I please and I have $1,000,000 in low risk stocks averaging out at 3% a year. I AM MAKING MORE MONEY THAN THE LOAN I HAVE TAKEN OUT COSTS. When you are rich, you can literally get free money by leveraging secure loans and the stock market. This makes it significantly more simple to make consistent money and build your riches in the stock market.

So, awesome. Only one problem, I am a graduate student who has $5 and a blog that nobody reads to his name. I can not leverage this 2% loan system and make the money machine go brrr. My loan interest even on a secured loan would sit more in the realm of ~5% which is MUCH harder to use to leverage money to make more money.

So, this is how the system is stacked against the poor. But….

How do we game the system?

Well, as described above, the system is designed to take money from the impatient who have $1000 and need it to grow quickly to make any significant amount of money and give that money to the patient, who need to make a cool 3% to make a significant amount of money. The past year, if anything shows me just how irrational the former group gets when they are given A CHANCE of getting rich through 20% returns. But guess what, PARABOLAS DO NOT RESOLVE SIDEWAYS (Thanks Michael Burry)

r/Superstonk - Burry On Twitter: Parabolas don't resolve SIDEWAYS

in no way, shape, or form, is the current market growth sustainable. Remember, the goal of the rich whom the system is designed to help is not to make 20% it’s to make a LOW RISK 3-8%.

As the system is designed to make a consistent low risk 3-8% in order to take on these stocks which are making 20%+ you are also accepting a significant downside risk. Nobel prize winner Harry Markowitz is quoted in saying “Diversification is the only free lunch” this is because diversification is the method used to create a portfolio focused around making a cool and steady 3-8% on your portfolio.

In order to game the finance system all you need to do is evaluate the downside risk rather than fantasizing over the upside return. Shoot for a 3-8% consistent return and continually place money in the market EVERY SINGLE MONTH. Time in the market always beats timing the market. Always considering the risk over the return gives you a more levelheaded and less emotional (remember, emotions are the enemy for investors). You can also reduce your emotional swings by isolating yourself from market conditions and cultivating a low information diet on which you trust a well researched portfolio to give you adequate but not significant returns. If you do this, your money will not continue to feed the rich get richer / smart get richer system.

3-8% Annually is not a good return

Not true. 3-8% anually gives a consistent and meaningful growth to your money assuming you’ve correctly evaluated the downside risk of your portfolio. Does this mean it’s impossible to do more than this? No, of course not, there are thousands and thousands of blogs, books, and videos showing you exactly how quantitative analysts intend to evaluate the market to make the most consistently correct investing predictions, however, this is only applicable to people who TRULY understand finance and financial instruments. NEVER take your advice from the shoeshine boy who claims you can get 50% returns. If you can get 30/40/50% returns CONSISTENTLY for more than a year without already being rich, then you are either:

A : A prophet

B : The worlds greatest quantitative analyst (in which case please contact me)

C : Me, in my dreams

D : A liar

V : An Idiot

This is because, quant firms who are geniuses whose literal job it is is to create the best computer programs to predict the market average only 11% if you could really beat them consistently in a way that is reproducible then contact me, and we’ll make something happen.

Conclusion

In this post, I had a short overview of how the rich get richer. Destroyed your dreams of getting rich. And invited the worlds greatest quantitative analyst to give me advice.

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