Not all investors are created equal. There are different levels of investors. I see that in their approach to investing and more importantly, in their results. Some investors try to be more than their education has prepared them for and others let themselves plateau.
If you can understand the different levels of investors, you will know what type of investor you are or will be. You will see what your goals will require of you. I have people asking me for advice on investments, but I can tell from the questions they ask their experience level doesn’t match the investment they are pursuing. It’s like they’re trying to race in the Tour De France but still have training wheels on their bike
Level One: The “Lottery Winner”
Level One investors are the “lottery winners.” These are the unconscious incompetent who don’t know what they don’t know. This level of investor has spent very little time, if any, understanding money and investing. They rely on the advice of others—often bad advice.
I call the level one investor the “lottery winner” because nearly 70% of lottery winners end up broke within seven years, and nearly a third of lottery winners declare bankruptcy—meaning they are worse off than before they hit the “jackpot.” They’ve found themselves with a large sum of money and because they lack financial education they fall victim to financial advisors who care more about making money than a client’s financial well-being.
Level Two: The Borrowers
Level Two investors are the borrowers. Instead of investing, these people solve their financial problems by borrowing more money. These are the people that fall prey to the financial advice of solving their credit card bills by refinancing their home. They roll their high interest short-term debt into low interest long-term debt. They think this makes sense because they tell themselves the government will give them a tax break if it’s debt on their house. That’s how a borrower solves their money problems. These individuals also use credit cards or they spread their debt.
What people are doing today is taking all of their credit card debt from one credit card company and moving it to another credit card company. These people are the compulsive shoppers. They always have debt. They don’t know how to stop. Borrowers are the people that look rich. They have the biggest house, the nice Mercedes, the SUVs, and take expensive vacations. They look good, but if you actually pulled out their financial statement, what you’ll see is financial cancer.
Level Three: The Saver
Level Three is the person I call, the saver. What these people do is, they save a small amount of money, each month, instead of investing it. They think by putting their money in a 401k that they are investing it, but a 401k is actually a savings plan more than an investment plan. That’s why a 401k is very appealing to them. It provides them the feeling of investing, but feels safe like saving. But savvy investors really know a 401k is a savings plan. A savvy investor looks for higher returns while still preserving the equity or their capital. Savers are also people who work really hard at saving money. I’m afraid my mother fell into this category. She would travel from supermarket to supermarket, spending dollars to save pennies. Not only did she spend dollars in gas, she wasted a lot of time trying to save money.
Level Four: The Smart Investor
Level Four is a smart investor. The smart investor is a person who is aware of the need to invest. They participate fully in a 401k or mutual funds. They have a solid education. They’re often very middle class, but unfortunately, have very little financial literacy. They have good allocation and budgeting abilities. They put the money in the “safe” places. They take a long-term view on the subject of investing and they’re very
For most people, becoming a Level Four investor would be a high ideal. Unfortunately, at least 50% of the population is below that and that’s what concerns me. The smart investor is a person who does not gamble. They don’t speculate. They don’t jump into IPOs. They don’t buy derivatives, day trade, or do things like that. They’re very solid. The Millionaire Next Door is really about the level four or the smart investor.
Level Five: The Long-Term Investor
Level Five is the long-term investor. From Level Five on, we’re talking about professional investors. They’re what I would call insiders. When somebody asks, “How do you become an inside investor?” I say, “Start with real estate.” The reason for that is if they buy a share of IBM or Microsoft they’ll never be an insider. They’re so far away from the decision making process of IBM or Microsoft. But with a piece of real estate, you need to become financially literate. You need to understand financial statements, pro formas, due diligence reports, and you become a little bit more sophisticated.
They actively invest. They cut their own deals. A Level Five investor is becoming more sophisticated. They’re doing their own deals. They negotiate, so when people say, “Well how do you find these good deals,” a major part of it is being able to read a financial statement and negotiating the buy/sell price. A Level 5 investor is somebody who is fairly sophisticated and invests on his or her own.
Level Six: The Sophisticated Investor
We’re now into Level Six. Level Six is the sophisticated investor. A sophisticated investor can afford to seek more aggressive investment strategies. They can do this because they have good cash flow management skills. A sophisticated investor does not diversify. He or she is very focused. A sophisticated investor is very aware of tax laws, corporate laws, and business laws. What many people fail to realize is that most of your money is made in what the lay person calls the “loophole.”
The sophisticated investor knows the way that real money is made. They have the ability to read financials as well as a very good team of accountants and attorneys. They know how to structure the deal so they maximize their returns. A lot of times the average investor says, “I’m going to buy a stock at $50 and it’s going to go to a $100, so I’ll make $50.” A sophisticated investor is not concerned with the capital gains. They are concerned with the cash flow and how much of that money can flow from the investment into his or her pocket with the least interference with taxes as possible. Those are some of the things a sophisticated investor knows that other
Level Seven: The Capitalist
The seventh and last level of investors is called the capitalist and I love this level the most. My rich dad pushed me so I could ultimately become a capitalist. What’s the difference between a capitalist and everybody else? Very simply, a capitalist is so good at what he or she does that people give them money to do what he or she does. In other words, Warren Buffet is such a great investor that people will gladly give their money to him to invest. So that’s why I scoff when somebody says it takes money to make money. That has not been my experience. When somebody has a hot-hand, they don’t need any money. People will throw money at them to do their deals with them.
The ultimate goal of becoming financially literate is to get to the point where you don’t need to use your own money. In fact, all you need to do is create and think and people will give you money to do things. For example, when I announce that I’m about to start another company, people literally line up to give me money because I have a track record. Now it doesn’t mean that we always make money. The same can be said when I write a book. Many authors ask, “What is your secret to becoming a great author?” I tell them, “I’m a capitalist. I don’t look at writing a book as an author. I look at writing a book as a business owner.”