How To Avoid Becoming Rich

How To Avoid Becoming Rich

We’ve all heard the stories about the Silicon Valley barber who became a millionaire by listening to and investing in the companies of the executives whose hair he cut.  Or about the thousands of employees during the early days at Microsoft who became millionaires simply by accumulating their stock options as the company’s stock price grew and grew.  Although starting your own company remains one of the best ways to amass a large amount of wealth, not everybody has the temperament to be an entrepreneur.  And not everybody has the skills or opportunity to work for a high-flying startup.  But anybody today has the ability to invest his/her savings in the newest publicly-traded tech company to try to strike it rich.

So why shouldn’t we all do just that?  Because for every millionaire who succeeds, there are dozens who tried and failed.  Some lost everything.

Remember Enron?  The default choice in the company’s retirement plan was Enron stock.  And employees were perfectly happy to collect more and more shares as the price soared. Sound familiar?  That’s exactly what all those Microsoft employees did.  With one big difference: Microsoft succeeded as a company and the employees got to keep their gains.  Enron did not.  You might argue that Enron failed because management was corrupt and committed fraud.  Regardless, its employees (who were all insiders at the company) apparently were unable to recognize the situation. They all believed, as did Microsoft employees, that their company would be a long-term success.  Those that bet big on company stock at Microsoft reaped big rewards, while those who did the same thing at Enron crashed and burned.

When it comes to investing, the higher the return you strive for, the more extreme the possible outcomes are.  And at the end of the day, only one will play out.  If you’re lucky you may hit the jackpot.  If not, depending on how much of your savings you invest, you could end up on welfare.  The problem is you can’t know in advance.  Could you have known in 2016 that the stock of a long-term successful company such as GE would lose almost half its value in 2017, the same year that stocks in general had their best performance in over a decade?  Can you know today which company’s stock will turn out to be the 2018 winner?

I contend that there is a better investment strategy to follow than trying to become rich.  I call it “growing your savings adequately.”  How much is adequate?  It’s the growth needed to maximize the likelihood that you will be able to do everything you want to do for the rest of your life.  And for most people, that’s way less than the growth needed to become rich.  It’s also much easier to achieve by properly diversifying your investments.  Diversification effectively narrows the possible outcomes of your investment returns.  How much diversification to apply to your investment portfolio is a function of your future goals and your comfort with losses.  What’s great about investing today is that you have so many different investment asset classes from which to choose.  Which means you can tweak the scope of diversification very specifically to meet your needs.

The problem with diversification is that it will limit your ability to become rich.  The benefit is that it will prevent you from becoming poor.

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