Sep 13 2011
Seven Steps to Building Wealth - Part 2 of 2
Written by Dave Young, President of Paragon Wealth Management
Step 4 - Avoid Unnecessary Debt
Debt can be useful if used properly. A few years ago I went to Africa. While I was on the trip I noticed buildings that were half built everywhere. Projects were at different levels of completion and then abandoned. When I asked my guide why the structures were halfway done, he responded, there is no banking system. There is no way for the common man to borrow money. People can only complete part of the building because they lack the funds to pay for building supplies right away. They build what they can pay for now, and then come back and build more next year when they have more money.
If debt is used sparingly, for assets that appreciate or allow you to make more money, then debt makes sense. For example, a house, a car, or an education all make sense.
Using debts for consumables or things that go down in value makes no sense. Impulse buying or buying on emotion are a recipe for financial disaster. Before you make any major purchase, it is important to decide whether it is a “need” or a “want”. It is amazing how few purchases actually fall into the “need” category. If it is a “want” then a conscious decision should be made as to whether or not you can afford it. Generally, there is no reason to go into debt for “wants”.
For example, most credit card debt is for things that hurt rather than help your financial situation. My definition of a credit card is, “A means of buying something unneeded, at a price you can’t afford, with funds you don’t have.”
Set a goal to live debt free. Put a plan in place to reduce and then eliminate your debts. With 1.5 billion credit cards in circulation, an average household credit card balance of $8,562 and an average interest rate of 19%, it’s no wonder that one out of every 50 households filed for bankruptcy in 2005.
Accumulating debt is the exact opposite of accumulating wealth. If you are paying debts, you are helping someone else accumulate wealth. With the few exceptions mentioned above, avoid debt like the plague.
Step 5 - Follow a Sound, Long-Term Strategy
Research has shown that most investors do not follow a strategy. In other words, they do not have a disciplined, systematic process they follow to make investments. Their portfolio of investments often represents a patchwork of uncorrelated ideas that were sold to them by various salesmen over their lifetime.
The first step to an effective strategy is to properly select your risk tolerance. This means that you identify in advance how much risk or volatility you are willing to subject your account to. For some investors that means taking no risk at all and being willing to accept low returns in exchange for zero volatility. For others, it means to attempt to generate returns in excess of twenty percent and be willing to endure the necessary roller coaster ride to get them. Most investors end up somewhere in between those two extremes.
Identifying your individual risk tolerance is the single most important step to achieving long term investment success. If it is set too low, you won’t generate the returns you should. If it is set too high, should market conditions become difficult, you will likely change strategies at just the wrong time and miss out on superior long-term returns.
Once your risk tolerance is set then you must follow a proven investment strategy that doesn’t simply involve “gut feelings.” Emotional investing is a recipe for failure.
What makes investing so difficult is that it is counter-intuitive. Usually, doing what “feels good”, doesn’t work. This is why you must have a systematic investment process that you follow.
At Paragon, we follow an investment discipline that is designed to remove emotion from the investment process. For example, one of the models that we use is based on investor sentiment. This model measures how what percentage of investors are optimistic versus pessimistic at any point in time. Interestingly, when most investors are optimistic and think the market is going to go up….it goes down. Likewise, when most investors think the market is going to go down… it goes up. We measure this statistically and the model is extremely accurate. The market usually does the opposite of what most investors hope, think or feel that it is going to do. I have always said that once you begin to “hope” an investment will move in your favor, you are usually in trouble.
Our strategies are driven by quantitative models that seek to proactively position our accounts for the most benefit in ever-changing market environments. For the past twenty years, we have developed and relied on rigid models to point us to the areas of the market to invest in. These models identify the sectors of the market that rank in the top twenty percent over the past three, six, nine and twelve months. Our portfolios are constantly adjusted as positions move in or out of the top twenty percent.
We use five other models to determine how conservative or aggressive we should be positioned at any point in time. These models measure an array of fundamental and technical data that constantly compare what is happening in the market today to what has happened historically. Following these systems and processes does not guarantee that we will always be positioned perfectly. Historically, we expect to be wrong 20% to 30% of the time. Even still, following this methodology has enabled us to significantly reduce risk and generate excess returns for our clients. (See our ten year track record at www.paragonwealth.com )
When comparing investment alternatives we believe that you should measure whether or not the strategy you are considering meets the following, time tested criteria. Your strategy should:
- ¨ Work over different time frames
- ¨ Provide effective rather than traditional diversification
- ¨ Work in both bull and bear markets
- ¨ Be disciplined yet flexible and evolving
- ¨ Reduce risk and provide downside protection
- ¨ Generate better returns than traditional stock indexes
- ¨ Have a proven long-term track record
Step 6 - Avoid Large Losses
Unfortunately, it has always been much easier to lose money than to make it. In my business, I am constantly presented opportunities to invest in. For every twenty proposals I see, I may invest in one. Even with complete due diligence, some of the investments are losers. My experience is that there are ten ways to lose money for each way there is to make it. Money is slippery and hard to hold on to.
It’s not uncommon for money to come in large lump sums-in the form of a retirement plan distribution, an inheritance or a life insurance settlement. People are expected to manage these large chunks of cash wisely, but there is no real training available on how to manage or invest large sums of money. To make matters worse, most people simply don’t have the time, resources, expertise or desire to manage their assets, and there are plenty of incompetent advisors, relatives requesting loans and scam artists ready to step in and take advantage. It’s no surprise, then, that most recipients of life insurance settlements in the United States completely lose their money within three years.
Some investment losses are unavoidable. They come with the territory. The key is to minimize large losses that can quickly reverse the benefits of compound interest. Even though it can be time consuming, you should research thoroughly before turning over your money to someone else. This will increase your odds of avoiding investment scams and subpar money managers.
For example, if you lose 25% of your account, you need to make 33% to get back to even, which is workable. If you lose 50% of your portfolio, you have to make 100% to get back to even, obviously a much more difficult task. A loss of 90% of your portfolio requires a gain of 900% to get back to even. Forget about it. A much better scenario is to follow a sound investment strategy that seeks to avoid those big, dramatic losses in the first place.
Step 7 - Be Patient
“A man watches his pear tree day after day, impatient for the ripening of the fruit. Let him attempt to force the process, and he may spoil both the fruit and the tree. But let him patiently wait, and the ripe fruit at length falls into his lap.” -Abraham Lincoln
It has been said that patience is the greatest of all the virtues. We live in a world where it seems that patience has been forgotten. In our instant everything world people want it all and they want it now. They don’t think in terms of paying the price or investing for the long term. They act on a whim rather than follow a long term plan.
Mountain View High School has a very successful track team with several runners being nationally ranked. I asked their coach why his runners are so successful. He told me that much of their success comes because they are taught to have the patience to pace themselves and wait for the right time to make their move to win the race. Even with runners, exercising patience is one of the keys to success.
In the fall I spend some of my spare time hunting for big game. I focus my efforts on finding animals that have record book potential. In order to locate them I have to backpack into places that rarely traveled and often I come back empty handed. In my quest to find trophies I have traveled to some very dangerous parts of the world. In order to succeed I have had to hunt in ways that differ from the traditional. While there are several factors that contribute to my success, I believe that extreme patience has been the most significant.
Patience is a key attribute for successful investors, but it can only work if you adopt the kind of smart investment strategy that we previously discussed. Without the right strategy, all the patience in the world is essentially worthless. As soon as you put a solid strategy in place, it’s all about patience, self-control, patience and of course more patience.
This is one of the most difficult steps for most investors, and it’s an issue we have to constantly reinforce with our clients. Patience goes against human nature, and a lack of patience has ruined many sound investment plans.
We are constantly positioning our funds to take advantage of whatever the markets will give us. We never know in advance when we’re going to be rewarded. Sometimes, we spend months waiting. But we do know that following this process in the past has yielded tremendous rewards.
The portfolios we manage, Managed Income and Top Flight, have both tested our patience during periods of underperformance. By exercising patience and staying invested, Managed Income has met its conservative objectives since its inception in 2001. Paragon’s growth portfolio, Top Flight has also generated outstanding returns and met its performance objectives since its inception in 1998. (See www.paragonwealth.com for more details regarding our performance).
Clients who exercised patience during periods when our portfolios returns went flat or negative still received outstanding returns over time. It seems like the market does its best to make investors give up at the worst possible time. For example, when you review our track record you see that our best returns almost always follow the years we have lackluster performance. Unfortunately, the investors that did not exercise patience and stay invested missed out on those returns, even though the overall strategy was good. As you can see, patience keeps you focused on the long term. Patience is critical to long term investment success.
These seven rules apply whether you have a large or small amount of money. Building wealth is possible-if you follow the rules.
About the Author
Dave Young started his career as an entrepreneur. He successfully started 12 businesses in the early 1980s. In 1986, he decided to sell his businesses and invest the proceeds, but he was unable to find an investment company that met his needs. As a result, later that year he began managing his own portfolios.
Dave continued to research to find the best methods to invest that would produce most profitable returns. He believed in his methods so much that he invested his life savings and started Paragon Wealth Management. Over 20 years later, Dave continues to invest and research ways he can improve his business to serve his clients better. His methods have attracted national and local attention. He has been interviewed by BusinessWeek, CNBC, the Wall Street Journal, the Deseret Morning News and other national and local media. Visit www.paragonwealth.com to learn more about Dave Young and Paragon.
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.
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