Do you believe in Dragons?
No, I didn’t think so.
While I do not believe in dragons as actual, living beings I do believe that they exist as three harmful things that can steal your financial wealth.
Just like the King Arthur tales of old, these dragons will steal your wealth. Yet evolution has taught these dragons to be more subtle and sneaky and take from you without you even knowing it.
Like a Knight of the Round Table you need to challenge these beasts to protect your financial kingdom. The purpose of this article is to tell you about these dragons and how you can fight them.
Meeting the Dragons
1) The first is known as The Dragon of Taxes,
2) The second dragon is known as The Dragon of Inflation, and
3) The third and most important dragon is known as The Dragon of Poor Performance.
Why is the third dragon the most important?
Well, the first two dragons you cannot defeat. The Dragon of Taxes and the Dragon of Inflation are immortal!
You see, the Dragon of Taxes represents the government’s ability to levy taxes on your earnings and wealth. Governments are always hungry for more revenue and will happily find ways to spend your money. You may elect somebody who will reduce your taxes, but you will always pay some kind of taxes. You cannot slay the Dragon of Taxes.
The Dragon of Inflation represents the demand of the marketplace for money and the interest policy of governments. Inflation may be high in some years and low in others, but it will always erode your spending power and your wealth. You cannot slay the Dragon of Inflation.
The third dragon known as The Dragon of Poor Performance is the only dragon that you can tame. The good news is that if you manage to tame this dragon, it will help you fight the effects of the other two dragons!
Fighting the Dragons
Let’s pretend that you are a brave knight and you set out to defeat the Dragon of Poor Performance. You attack but barely escape with your life because you misjudged the dragon’s strength. You decide that it’s best of lay low and lick your wounds.
Doing this seems like a wise move except that while you are resting the other two dragons come along and gobble you up!
You see, when you get poor performance in your investments either by picking too conservatively or not picking right, the returns you do get are eaten up by taxes and inflation. Ouch!
If you invest your money into something that is guaranteed to generate 5% a year, you have just ensured that you are not making the money you could have. There are investments out there that have consistently earned 8% a year and though they may be riskier, they should not be avoided.
Should you take increased risk for just a 3 point difference in the return? Yes! A 3 point difference does not seem like much, but when you factor in the magical effect of compounding returns, it is critical to get the better return.
Let us assume you wanted to invest $1,000 for your brand new child for him/her to have as a graduating gift when they turn 18. You invest it, forget about it, and never contribute another penny. You choose an investment that gives you a return of 5%.
Scenario 1 @ 5%
Starting amount – $1,000
Years – 18
Additional contributions – $0 per month
Rate of return – 5.00% compounded daily
Total amount you will have contributed – $1,000
Total at end of investment – $2,459
Not too shabby, but we still have not figured in inflation and taxes. Before we talk about those two, let us compare the result if you had picked an investment that generated 8% a year.
Scenario 2 @ 8%
Starting amount – $1,000
Years – 18
Additional contributions – $0 per month
Rate of return – 8.00% compounded daily
Total amount you will have contributed – $1,000
Total at end of investment – $4,220
Not surprising you would earn more money, but who would have known that the 3 point difference was worth $1,761 more! Taking the greater risk does pay off.
Avoiding Investment Risk is Risky To Your Financial Health
Risk is not a bad thing. You should learn how to manage risk, not avoid it.
Taxes and Inflation are facts of life and will always erode your wealth. Since you cannot avoid them, you need to learn how to manage them just like you need to manage risk. That only way you can do this by choosing investments that generate a higher return.
Want proof?
Using the two scenarios again lets assume that the government taxes you at 25%, for every dollar you earn; you give 25 cents to the Dragon of Taxes.
Scenario 1: A 5% return x 25% tax rate = 1.25 points off your 5% return = 3.75% actual return after taxes. That is just barely keeping above inflation which has typically run between 2% and 4% a year.
Scenario 2: A 8% return x 25% tax rate = 2.00 points off your 8% return = 6% actual return after taxes. Now this is a much better spread over inflation.
Do you see what I mean when I say that the Dragons of Taxes and Inflation will gobble you up when you invest poorly? The solution comes in taming the only dragon that can help us fight the other two.
Taming the Dragon of Poor Performance
One of the simplest ways of taming this dragon is to stop investing in guaranteed investments (CDs in the US and GICs in Canada). Use them as a place to store money for short term periods while you are figuring out where to invest your money, but never use it has your main investing strategy.
Get the best interest rate you can for your short term money. It is always better to get 3% than 2% for the reasons mentioned above, but since it is a place to just park your money, you need to get your money working harder for you.
To find better investments, you want to directly invest into companies on the stock exchange. Unlike interest based investments like bonds and CDs/GICs, the stock market provides a much higher rate of return.
You may think that investing in the stock market is like gambling. And it is gambling for those who do not understand the rules. But just like a knight needs to use a sword and shield properly to fight a dragon, you need to learn how to invest to get your best returns.
Consider at the minimum Exchange Traded Funds which are wonderful instruments that capture all of the returns found in the stock market. They do better than Mutual Funds and should be the shield in every knight?s armor.
But easily, the Excalibur sword of the investing world can be found in stocks and options investing. If you want to not just tame but slay the Dragon of Poor Performance, you want to start doing some research through websites, electronic courses, and books on Stocks and Options.
Remember that the greatest rewards come to those willing to manage the greatest risks!
Good luck in your quest to tame the dragons!
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