Ten Rules of Financial Sophistication

"I don’t want a nation of thinkers. I want a nation of workers." 

—John D. Rockefeller

Written by Ingemar Anderson with the help of GPT-3, an artificial intelligence model.

I have developed ten rules to remind myself to stick to my investment strategy. Of course, the list is not complete, but it is a start. Please feel free to add your own rules at the end of this chapter that you feel should be used to manage any of the five asset classes money, securities, commodities, real estate, and businesses.  

1. Never buy an asset above market price

This first rule seems to be an obvious statement. However, I have seen too many times that investors end up paying too much for an asset. I do intensive research before I buy, I do my due diligence and always try to understand the seller to get a better deal. Paying cash will always be an incentive for the seller to sell quicker.

2. Focus on assets that create income

By following only these first two rules, buying primarily assets that produce income for a reasonable market price can be a game-changer. You can minimize the investment risk and increase financial returns. 

There are some exceptions, however. If the asset is a highly secure and liquid asset, which you can use to trade for other assets in the future, the immediate income may not be of importance. Some people say “cash is king” and “gold never gets old.” So, instead of buying an income-producing asset today, it might be smarter to keep the cash or buy a non-producing asset to be able to obtain an income-producing asset later. 

3. Do not keep Dead Cows

Everybody who owned a Dead Cow asset like an underwater real estate property knows how dangerous a dead cow in a portfolio can be. That asset drains money continuously from the investor. Such an asset is worth less than I owe to the bank, and I have to pay every month to keep the asset. I will not even be able to sell the property without putting a lot of cash into it. So, I will never hold a dead cow. I will sell it, let it go, or pay it off, so I get it out of your liability column. Sophisticated investors never lose money!

4. Never over-leverage

When you leverage your investment, you should consider two questions: 

First question: is your annual income (annual return) from an asset you have purchased higher than the yearly rate you must pay for debt services related to this asset? You can read more about this principle in the chapter on liabilities and assets.

Second questions: did you include a buffer to contain the remaining investment risk? You have often heard the advice: you should buy a condo in a good location, put down a small down payment, and take a bank loan to finance the rest. Many people suggest that it is wise to leverage as high as possible. That might work out great for your return on investment, of course. However, you will take the full risk when the condo depreciates over time or your rental income decreases. Your loan payments might start to exceed the rental income, or the apartment might lose value and be worth less than you bought for.

5. Monthly Asset Statement 

Create an asset statement every month showing income and current net asset value of all your assets.

6. Stay in the Cash Cow Quadrant

Aim to move all assets into the cash cow quadrant. It seems logical and even easy to accomplish. However, you can read it every day: businesses ran out of money, many real estate properties are in the red, and many money market accounts are just stumbling along, drawing money out of people’s pockets. Concentrating on the cash cow quadrant can help to keep assets productive. 

7. Put your assets first

If you lose sight of your assets, they can turn sour sooner or later. I recommend paying close attention to the financial performance of your investments. A safe and most successful investing method is to contribute money from your disposable income to specific assets weekly or monthly using automated transactions over a longer time. The accumulating value and the compounding interest from these investments can be significant. However, as a sophisticated investor, it is critical to be educated about the investment vehicle and align it with one’s own strategic goals and expectations. 

8. Don’t be just a trader! 

Do not trade your assets for capital gain purposes only. Trading is a profession and has little to do with investing. Think about the 2-bucket investing approach of level 5 and 6 investors. They make money by realizing their business ideas. They understand how to convert ideas into businesses and profits.

9. Put Income before Capital Gains 

Remove yourself from the community of speculators and return to the community of sophisticated investors. A regular and reliable income stream from all your assets should be your goal.

10. Have an Asset Development Strategy

If you buy a young cow, you should have an excellent plan to develop it into a cash cow. Preferably, you can take personal control of the asset’s development. If you purchase an old cow, you should create a concrete plan to convert it into a cash cow eventually. If you plan to buy a dead cow (underwater asset) from someone, you should structure the deal so that this new acquisition will be in the young cow or cash cow quadrant. And finally, you should always have at least a rough idea about how you plan to exit the investment. My general suggestion is to buy assets below the current market price and leverage as little as possible. 

11. Please add your own rules 

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