If you are young, investing in index funds and focusing on a high savings rate – I have bad news for you.
Wrong! You are doing it wrong.
Do not get me wrong, regularly investing in a low-cost index fund and saving a crap ton of your income will build wealth gradually over time.
This path has become so commonplace that it’s like going to a restaurant, not looking at the menu and ordering #3 because of everyone else orders #3.
Sure, #3 has great reviews, makes people happy and brings customers back. But there is a new chef running the kitchen with world-renowned talent and he’s adding items to the menu.
Some of the chef’s new items are worse than #3. Some of his items are just as good as #3. A few of his new additions to the menu are a bazillion times better than #3.
However, if you never look at the entire menu, you may never discover there are options other than #3.
Menu item #3 is the ‘save a ton and invest in low-cost index fund’ path to FI. It’s a solid option and many people would be happy with this order.
Many would argue #3 is infallible. Others would yell blasphemy at the recommendation of ordering another item on the menu.
Well, I am here to tell you that is just plain WRONG. There are many noteworthy paths to financial independence and there is no one size (or menu item) that fits all.
Let me reiterate something for you. You – are – YOUNG. That means you have the greatest asset on your side – TIME.
The best part about being young is time. When you are in your 20s or 30s you have an abundance of time. The older we get the less time we have. But what does this have to do with risk taking?
When you are young, you have time to lose all of your money and make it back again. Having time provides a chance to recover. Someone who is 65 and entering retirement should not take significant risk. Sorry, grandma – you aren’t invited to this party.
You are young and
should need to be taking risks. To be clear, I am not encouraging you to go to Vegas and place everything you own on black. Only a fool does that.
Risk should not be taking all willy-nilly, on a whim or because others are doing it. More importantly, focus on taking calculated risks (more on that later).
Sure, the generic advice of saving a ton of your income and invest it in VTSAX will yield (good) results over time. This is the slow and steady path to financial independence and possibly the most risk adverse path too.
According to CNN Money, only 52% of Americans own stocks. Many do not own stocks because of perceived risk and are fearful of their own shadows.
It’s a case of chicken little. The sky is falling! The sky is falling! But things are rarely as bad as people think.
Others simply do not have the means to invest.
Too often in the financial independence community, many are unwilling to take any risk outside of a low-cost index fund. This path limits their downside but also significantly caps their upside.
A slight increase in risk can reduce the time to financial independence by months or even years. That is right, there are faster paths to financial independence but they do require taking a bit more risk.
Taking a few calculated risks provides more of a diversified path to building wealth and generating passive income. Failing to look at other options, like failing to look at the entire menu, could lead to missing out on great opportunities.
What is Calculated Risk
A calculated risk is an educated guess. A few examples of calculated risks worth taking may include investing in cash-flow real estate, creating a business, buying the next Amazon or Google before they take off. Buying cryptocurrencies or investing in a startup are also good examples of calculated risks.
How much risk should you take
Like I mentioned earlier, I do not want you flying to Vegas and betting everything you own on black. I also do not want you putting 100% of your net worth into risky investments.
All investors should consider earmarking 1-10% of their portfolio for riskier or speculative investments. Limiting riskier investments to 10% or less will reduce the investor’s downside. If these investments end up worthless (unlikely), the investor will not be crippled. Investors should not use money they need for speculative investments; they should assume they may never see these funds again.
Buying real estate may require more than 10% of an investor’s portfolio. This asset class would be the one exception. Investors should only consider buying real estate that meets the 1% rule or where rents are well above the mortgage.
However, if the speculative portion of the portfolio takes off, these investments have the ability to be life-changing. For example, imagine if you invested $1,000 in Google, Amazon, Netflix, Starbucks or Apple 10 years ago.
The chart below compares the returns of Google and the S&P 500. The chart dates back to August 2004 when Google became a publicly traded company.
If you Invested $1,000 in the S&P 500 in 2004, you would have a profit of $1,415.50. If you had invested $1,000 in Google in 2004, you would have a profit of $19,052.60. That is a difference of $17,637.10 – big difference, right?
If you bought bitcoin 5 years ago, you would be a millionaire today.
Investing in Real Estate
You are young, maybe do not have a lot of assets and want to take some calculated risks. Real estate is a great way to take start building wealth.
Buy a single family home or 2-4 unit building with an FHA loan. This type of loan only requires a 3.5% down payment. Live at the property and rent out the extra space. This is known as house hacking. I did this at my first property and my second property.
Other types of risk worth considering
Start a business or invest in a startup are great examples of risks to take when you are younger. One of my biggest regrets was not investing in a friend’s start-up.
Four years ago, I had the opportunity to get in on the ground floor of a 3-D printing company my friend founded. Being young and fearful, I passed on this investment because I thought it was too risky.
His company generated over $500,000 in revenue last month alone. A $1,000 investment four years ago would be worth way more today. Needless to say, I missed out on a great opportunity.
Selecting your path forward
Taking calculated risks properly can set yourself up for life. For some, this may be investing in a stock. For others, it may be creating a business.
Buying real estate and house hacking allowed me to go from a negative net worth to over $500,000 in 4 years. I am 27 and will reach financial independence before I turn 30. The willingness to take risk easily saved me 5-10 years.
The biggest risk of being young is simply not taking risks. If things do not pan out, you are young and still have time to recover. A small amount of risk belongs in every portfolio.
There is no right or wrong path to financial independence. Everyone must choose the path that best fits their needs and risk profile.
Heck, people can take multiple paths or switch paths at any time as well.
Are you going to still order #3? That is great.
Or will you consider taking calculated risks, investing in a speculative stock or cash flow real estate and reduce your time to financial independence? That’s cool too.