Making the Big Bet - Investing for Wealth

by Shri V. Srikanth

Published on this site: March 24th, 2006 - See more articles from this month

• Diversify your investments
• Invest for the long term

One cannot fault that advice, for it takes care of the two big issues with investing:

1. Risk - which is reduced by diversifying your investments, and
   
   
2. Time for serious growth - which the long term horizon provides

Betting Big

Wealth oriented investors, such as Warren Buffett, however, are of the opinion that you should put all your eggs in one basket, and "watch that basket carefully".

Now, that may be possible for a full-time investor like Warren, but what about the rest of us who have other things to worry about, like our careers and perhaps a second-income business? Is there anything that we can learn from the advice?

There is an essential truth about investing that Warren Buffett points to, and that other wealth oriented investors have indicated, and that is:

"In order to become seriously rich through investing, you have to bet big".

For example, if you invest $10,000 in a single investment that grows 10 X (i.e. multiplies in value by 10), you will have $100,000 at the end of the stock's bull run. If you however, spread that investment across 5 stocks at $2000 each, your
portfolio may end up looking something like:

• Investment 1 (The Star Investment) : $2000 X 10 = $20,000
  
  
• Investment 2 (Good Investment) : $2000 X 2 = $4000
  
  
• Investment 3 (Barely There) : $2000 X 1.05 = $2100
  
  
• Investment 4 (Small Loss) : $2000 X .95 = $1900
  
  
• Investment 5 (large loss/cut early) : $2000 X 0.8 = $1600
  
  Total Value: $29,600
  
  The difference - a whopping $81,400!

All this is assuming of course that you employ good discipline and keep your losses small and let your winners run.

At the end of this run, you are now operating either from a base of $100,000 or a base of $29,600. The difference is obvious and will only compound over time. The million dollar mark is well within the reach of the $100,000 net-worth person, while the $29,600 person has to find several solid investments to get there.

But hasn't the risk for the single investment person increased dramatically?

Truth is, risk increases in proportion to the investor's level of ignorance about an investment, as opposed to the nature of the investment. True wealth investors are far more conservative, and build in a far larger margin of safety into their investments than those who invest without understanding.

"Watching the nest egg carefully" implies knowing your investment very well - and knowing when to hold and when to fold. In such circumstances, the single investment is not risky anymore.

Finding the Great Investments - With Help

There is help out there for finding great investments - use it.

One of the best forms of help is with expert investment newsletters, where the editors help you find investments that are frequently likely to double or more, and in some cases, have the "home-run" quality of multiplying by a factor of ten.

Sure, no one is right all the time, but if you follow the careful discipline of cutting your losses and letting your winners run, then overall, you will be far ahead of the field. And what's more, solid ideas will be fed to you in a steady stream on an
ongoing basis - pointing you towards one bull market after the next - often getting you in on the ground floor.

A second fertile source is solid financial advisors. Note that any financial advisor can put you in ordinary mutual funds (especially into those from where they get their commission), but it is the rare advisor (and they are out there) who will put you into areas where your returns are much higher and which they themselves understand very well.

Both of these sources are a short-cut to getting great investment ideas to allow you to invest for wealth.

Maximizing Returns

Two simple concepts will help you maximize your returns through these great investment ideas:

• Set Target Allocation for each of your investments, building towards your target as the stock story begins to work in your favor
  
  
• Cut your losses, and let your winners run
  
  The first concept simply says that before you buy any stock, you should know how much money you want to actually allocate to that investment. Then begin purchasing shares with 25% to 50% of that final target amount. As the stock begins to rise in value in accordance with your expectations (this is called market validation - and is the only validation that counts), you buy more shares and build to your final position.
  
  The second concept says that if a stock is not working in your favor, cut it loose. You can always purchase it later if it seems like the original story will eventually work out - but more than likely, you missed something that the market is seeing. On the flip side, when a stock is performing well, it means your story is working out. Let it run - this is where the big money will be made.

A final third concept that can be added to the above is:

• Sell all the way to the top
  
  That is, as the stock doubles, and triples - begin pulling your initial investment out, and then some of the profits, and then some more. Once your initial investment has been recovered, you are only playing with "house money". Continue following the stock and on further rise, start taking some of the profits off the table.
  
  Of course, make sure that you have some investment in that stock remaining as it enters its final run. This is where a lot of the profit is actually made - but the markets are always tricky and you may not have that final blow off. Consider yourself lucky if you can get out of an investment within 20% of its eventual peak (known only in hindsight). But well before your investment reaches its final run, you should have gotten substantial profits off of the table and into your kitty.
  
  With this stock run complete, look for a new one, now with your larger asset base - and repeat!

Done properly, you only need 3-4 good bull runs in different areas of the economy to build you serious wealth!



Shri V. Srikanth is co-founder and editor at Character & Wealth, an online community of career professionals working towards totalfinancial freedom in under ten years. Get your free membership to this community at http://www.characterandwealth.com