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Building wealth is simple really, it’s mathematical, but it is the emotions that come with finances that is the challenge. Enter the term “Risk Tolerance”, you hear about it all the time but what is it? How can I build up my Risk Tolerance?

Investopedia states “Risk tolerance is the degree of variability in investment returns that an investor is willing to withstand.” But first let’s look at the simple steps to growing wealth.

1. Save

2. Invest

3. Speculate

I will focus on item 1 first and in future articles we will delve into item 2 and 3.

Saving is difficult for everyone, but those that master the habit of saving are well on their way to emotional stability when building wealth. The reason saving or preserving principle is important is we are human and humans are emotional. Savings provide emotional stability to us humans during volatile financial times. Savings is also a way to measure your Risk tolerance.

Side track to the Brain :

The way I understand the brain is there is a lower brain and a higher brain. The lower brain (amygdala) controls the “flight or flight” reaction and is good for possibly saving your life. But it is also the part of the brain that controls your defensive or aggressive behavior. The lower brain gets input faster than the higher brain (cerebral cortex) and gets hit with fear and doubt. The cerebral cortex controls the higher-level thinking skills like logical or analytical thinking.

Think about it this way, if you were worried about making rent or mortgage payment every month how could you be a good investor or speculator? The fear would overcome your higher-level thinking and “fight or flight” responses would not be out of the question. I think this is called “weak hands”, sound familiar?

OK so what, you are talking about saving and risk tolerance!

If you can save and have an emergency fund available, then fear, doubt and volatility would not bother you as much. I hate the term “emergency fund”, I prefer to call it my “emotional stability fund”. And sometimes I think about it as “cash for the crash”.

Building a base that you can feel safe with will provide this emotional stability and help you to think from the cerebral cortex with logic and analytical reasoning. Many of the top companies (Apple, Microsoft, Google, Coca-Cola etc…) have between 6 months to 1 years’ worth of liquid capital (cash), so if something happens, they can still operate with no income. Berkshire Hathaway (Warren Buffet) has $100+ Billion is cash set aside. This stabilizes company executive’s emotions during fluctuations in the market and as a bonus provides opportunities to buy and grow assets in times of market crashes. Now if only we could do this as individuals! Well we can.

Let’s save

It’s not about how much you save; what matters is the habit of saving! Even if you are in debt saving just a dollar is a start. I do suggest not getting into debt and make a plan to pay that debt off, but there are different types of debt (maybe a topic for another time).

Always be saving and always be increasing your savings amount. That is the only way to increase your risk tolerance and start the path to higher-level investing and then later speculating.

Photo by Jeremy Dorrough on Unsplash

I’ve been thinking about leaving my daughter a message for some time. You always think you will live forever and be a good mentor/teacher of your children, but if an unfortunate event occurs, how will I pass on what I believe to be so important for my child?

I could give a list of poems and books I have fallen in love with, hoping my emotional attachment would be transferred and influence her thoughts. However, everyone is unique, brilliant and insightful. My takeaways from these poems and book are drastically different than the next person and this does not exclude my own daughter.

My favorite poem is “The Road not Taken” by Robert Frost. The opening sentence is a attention grabber …

TWO roads diverged in a yellow wood,

And sorry I could not travel both

And be one traveler, long I stood

And looked down one as far as I could

To where it bent in the undergrowth;

I suggest reading this poem if you have not read before.

The poem goes on to describe the struggle to make a simple decision. … What road to take? Most likely every day, for everyone, they encounter a simple choice of which road to take. Within seconds, without pondering the future result, we start heading down that road. The last sentence is the most quoted and by far the hardest choice to make for so many.

Two roads diverged in a wood, and I—

I took the one less traveled by,

And that has made all the difference.

So instead of a poem or a book, I want to describe my advise to my daughter in very simple statements on independence and the road less traveled that I suggest. For when you are truly independent, choices you make are not out of necessity but out of what you truly want to do, be and experience.

The path I suggest for my daughter:

- Avoid debt: “what you do when you run in debt you give to another power over your liberty” Benjamin Franklin

- Surround yourself with friends you aspire to be like and avoid the ones that drain your energy especially fiscally irresponsible people.

- Read often and diverse books, it expands your minds reach.

- Hard Work and Diligence (consistent and persistent work or effort) will pay you back 10-fold, just not when you want it to or expect it to.

- Save as much money as possible in your early years and invest it in stocks (like index of S&P 500), save preferably 50% or more of what you make and invest it.

- Learn the tax code and fund your retirement accounts appropriately (max out your contributions)

- Don’t get caught up in an ever-expanding lifestyle, you want your money to work for you not for you to trade your time/energy for money.

- Every dollar bill you have is your little employee, be careful giving away your little employees

- While you are young and accumulating stock investments, every time the stock market drops, be grateful. (Wait what?) Yes, be grateful, for every dollar you invest now buys more shares

- After your investment start earning dividends (always reinvest dividends while accumulating) and capital appreciation is to a level that can support your lifestyle with the 4% withdrawal rule, consider yourself one of the lucky few on our planet that can choose to work where, when and how you want. (Or not work at all)

- Be charitable after you have gained this financial independence, you will be more engaged/genuine and happy to contribute your time, money or insights to those in need.

One last quote to think about to end this letter.

“There are two ways of being happy: We may either diminish our wants or augment our means- either will do- the result is the same. But if you are wise, you will do both at the same time; and if you are very wise you will do both in such a way as to augment the general happiness of society.”

Benjamin Franklin

Photo by Samantha Hentosh on Unsplash

Let’s say you wanted to be privileged enough to get a free lunch for life. Don’t laugh; this is entirely possible.

So the main theory of Financial Independence is that if you Invest in Stocks/Bonds and withdraw only 4% per year, the invested principle amount (over time) would not only be maintained but grow indefinitely. In a 1998 paper, titled “Retirement Savings: Choosing a Withdrawal Rate that is Sustainable”, which is colloquially known as the Trinity Study, this paper considered a retirement length of 30 years. The conclusion was even after inflation adjustment if you withdrew 4% you had a 95% chance of the money lasting 30 years. There are always 2 sides to a story and there are both extremes in opinion higher and lower for this 4% withdrawal rate. Lets just stick with the 4% rule for this topic.

Sure there are ups and downs in the stock market, but over time this 4% rule is generally accepted by Financial Experts and proven through back analysis of the stock market since its inception (even with the depression, recession and bear markets).

Ok you say, so how do I get a “free lunch for life then”… well its simple math.

Let’s say you want a $10 lunch every day of the year. ($10x365 days) equates to $3,650 annually.

Simple math shows that if you were to save 25x the amount ($3,650) which equals $91,250, you could have a $10 lunch every day for the rest of your life if you saved $91,250 and put it into a simple inexpensive index fund like the S&P 500.

Why would I invest in the S&P 500 instead of Cryptocurrency, that’s the hottest thing today?

Well, if you think about it, investing in the S&P 500 means you own a market cap adjusted piece of the top 500 US traded companies. These companies answer to shareholders, HEY thats you!, and every person from the janitor to the CEO is working everyday to make you money (in the form of dividends or stock value appreciation). Now your money is making its own money. Your income is produced from capital, rather than your own labor.

Drop the mic, your done and you have a “free lunch for life”.

Oh, of course that’s if you put the work up front and saved/invested $91,250.

So all those people out there with $100k in their savings, don’t tell me there is no free lunch, you are living it. (even after adjusting for inflation over time).

Free lunches exist …. End of story.

[Photo by Brandon Morgan on Unsplash]