Your Investor Type Reveals How You Can Advance Your Investment Strategy To The Next Level
Investor Type 1: Pre-Investor
Unless you were born with a silver spoon in your mouth and a trust fund to match, then you likely began life as most of us do: a pre-investor. A pre-investor is simply someone who isn’t investing. Pre-investors are characterized by minimal financial consciousness or awareness. There’s little thought of investing, and there are correspondingly little savings or investments to show for that minimal thought.
Some pre-investors have a company retirement plan, but that wouldn’t exist had the personnel department not set it up for them. The pre-investors financial world is primarily about consumption, which takes precedence over savings and investment. As wage-earners, they typically live paycheck to paycheck believing their financial difficulties will be solved by the next pay increase. When pre-investors earn more, they spend more, because lifestyle is more important than financial security. For whatever reason, pre-investors haven’t woken up to the necessity of owning financial responsibility for their lives and their future.
This isn’t to judge all pre-investors harshly because it’s perfectly acceptable for a seven-year-old to live in this reality. It’s another thing for a 40-year-old to never graduate beyond it.
Are you a pre-investor? How is your savings and investment plan progressing? Is your financial consciousness ruled by consumption needs, or are you prioritizing savings and investment? What are you going to do to take the next step and begin passively investing so that you can move beyond financial dependence and get on the road to financial independence?
Investor Type 2: Passive Investment Strategy
As we mature and gain responsibility, most people graduate from pre-investor status and enter the investment world through the window of passive investing. It’s the most common starting point on the road to financial security. Most financial institutions, educational services, and web sites support passive investing as the proven, accepted solution. Most of what you can learn from the information available in your local bookstore or on the internet is the conventional wisdom of passive investment strategies.
Passive investing is where the retail world of investing lives. While there are no hard statistics to support my claim, I believe well over 90% of all investors fall into the passive investor category.
The passive investor type usually employs all the basics of sound personal financial planning: own your own home, fund tax-deferred retirement plans, asset allocation, and save at least 10% of earnings. If you follow these foundational principles and begin early enough in life, then passive investing is likely all you’ll ever need to attain financial security.
The passive investment strategy is good for people with busy lives, families, jobs, outside interests, or entrepreneurs building businesses.
Let’s face it: most people’s lives are already full, leaving little time for developing investment skills. It’s difficult to make investing a top priority despite its financial importance.
A common result of having limited time is passive investors often delegate the responsibility and authority for their investment decisions to “experts” such as financial planners, brokers, money managers, or even newsletter writers. Rather than become their own expert on investing, passive investors typically rely on other people’s expertise for their investment strategy. The defining characteristic of passive investment strategies is their simplicity. They require less knowledge and skill making them accessible to the general populace.
“Buy and hold” with mutual funds or stocks, fixed asset allocation, averaging down, and buying real estate at retail prices are all examples of passive investment strategies. There’s nothing wrong with any of these strategies, but they can have negative consequences.
Sure, it’s possible to become acceptably wealthy, but the downside is it usually requires a working lifetime combined with discipline and regular savings contributions to achieving financial independence using the passive investment style. The one exception is extreme frugality because of the high savings rates and low spending rates that accelerate the timeline.
The other downside to the passive investment strategy is you’ll take a lot more risk and can expect lower returns than investors who have reached the next level of investing. That’s because passive investors have no “value-added” or skill component to their expected return stream so they’re dependent on the opportunity in the market for investment return. Rising markets provide great returns, and declining markets provide miserable returns.
The passive investor submissively rides the market roller coaster up and down into the future and willfully bets his financial security on the hope that the roller coaster will end higher than when he started. You can learn more about the buy and hold investment approach here.
Investor Type 3: Active Investor
Active investors build on the foundation of the passive investor. They take the process to the next level by running their wealth like a business. The primary difference between active and passive investors is the active investor not only receives market-based passive returns but also gains a value-added return stream based on skill; two sources of return in one investment.
This allows the active investor to make money regardless of market conditions or direction and to reduce losses during periods of adversity. This holds the potential to increase returns and lower risk. A primary distinction between passive and active investment strategies is passive investors work hard to acquire and save money, but spend far less energy making their money work for them.
Active investors work just as hard at making their money work for them as they ever did earn it in the first place. In other words, active investing is more work, and that’s why it is not for everyone. The reason active investors are willing to spend that extra effort is that they understand the wealth-building game is about return on capital. Small differences in growth rates over long periods of time make huge differences in wealth – far bigger differences than could ever be realized by working toward the next pay raise.
Which Investment Strategy is Right For You?
There is no such thing as the “best investment strategy”. Each type of investing has its trade-offs and there’s no single answer that will be right for everyone.
For example, some people have successful businesses and need to focus their energy on growing their business. They shouldn’t be distracted by the time commitment necessary for active investing. Other people with lower incomes or who begin investing later in life have little hope for a secure retirement without the benefit of an active investment strategy. Active investing can become almost a necessity if your time horizon to retirement is only ten to fifteen years away and you’re just getting started. Each person is unique and has an appropriate investment style at an appropriate time for them. Many people naturally progress through each of the three types of investing as their skills, experience, and portfolio grow. Sometimes successful entrepreneurs choose to become active investors as a second career later in life to enhance and secure their nest egg. The point being there’s no single “right” answer to investment strategy, but there is a right answer for you.
In Summary: Three Types of Investment Strategy
There are three types of investors: pre-investor, passive investor, and active investor. Each level builds on the skills of the previous level below it. Each level represents a progressive increase in responsibility toward your financial security requiring a similarly higher commitment of effort. The advantage is each level offers a similarly higher level of potential reward and reduced risk for the effort expended.
Below are five questions to help you decide what type of investment strategy is best for your personal situation.
- Do I have the time and desire to learn the skills necessary to become an active investor?
- Do I have the stomach to tolerate the roller-coaster ride and potentially lower returns that come with the convenience of passive investing?
- What’s my primary goal from investing: to enjoy the financial freedom I already attained, or compound my savings to reach financial freedom ASAP?
- Do I have enough years prior to retirement and sufficient savings already put away to rely on passive investment returns for a secure retirement, or do I require a higher level of return to meet my retirement goals?
- What difference would it make in my financial future if I could create higher returns with less risk, thus compounding my wealth much more rapidly? What would that be worth to me and how should I prioritize it as a goal?
- (This course will show you how to match the right investment strategy and asset class to your personal skills, resources, and goals.)
The choice is yours. What type of investor are you going to be?