I’m a big fan of professional poker. Doyle Brunson, Phil Hellmuth, etc. are iconic figures who’ve made a TON of money from gambling. When you watch them play, it seems so easy, as if anyone can do it. However, there’s a ton of mathematical calculations from various hands these players must be able to intuitively understand in order to compete at a high level. For every poker player who makes money, there’s probably a thousand (or more) who go broke. Unless you’re a genius poker player (and you’d know pretty quickly if you are) it’s best to play just small stakes for fun, otherwise you’re in for a world of hurt. As they say, if you look around and don’t know who the sucker is…it’s YOU!
Investing in individual stocks or any other investment is quite similar to poker. There’s a small percentage of investors who make a ton of money, but the vast majority flounder. If you’re looking to build wealth, your best bet is sticking to index funds and real estate, as I’ve outlined above. Leave gambling to the professionals.
It’s interesting how even professional managers feel the same. In one of his newsletters, famous (and extremely successful) debt investor Howard Marks talks about how much he likes a book written by famous poker player Annie Duke called Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts. He cites several excerpts of the books, with the basic idea that a good investor will get comfortable with making a bet on an uncertain outcome, and the quality of those bets is made when the bet is placed, not based on the outcome. In gambling, Marks writes, you’re trying to make the best guess as to where the outcome is headed, without knowing all the facts. It’s telling that one of the world’s foremost investors is so drawn to ideas consistent with the strategies of gamblers. Certainly Mr. Marks puts in a lot of time researching and working on his bets, and he also has developed an uncanny knack for getting in front of successful investment trends. I’d also be willing to bet that he has an amazing natural talent for investing that can’t be taught.
The point is there are a lot of investors who invest in alternative assets that make returns well above what you can make in index funds and real estate, using the methods I’ve described above. There are however, far more investors who lose everything trying to imitate professional investors. There are also people who earn far less than the S&P 500 because they insist on investing with investment gurus who promise outsized returns, and fail.
I want to discuss the assets that make some people rich, but that you should stay away from as an investment. In doing so, I’m opening myself up to the criticism that I may be advising you against investing in something that could make you a ton of money. That’s true. But it’s far more likely I’m helping you make good steady returns, instead of losing your money and winding up bitter.
The first type of investment I want you to stay away from is trying to pick individual stocks (or bonds for that matter). For the vast majority of people, this is a losing battle that will cause you to make less than you otherwise would have made had you followed my advice above.
Most people who invest in individual stocks believe that by studying various companies, they can get insight that can allow them to pick winners, avoid losers, and then generate outsized profits. Yet the vast majority of people severely underperform the S&P 500 while employing this strategy. Why is that? There are several reasons.
First of all, people tend to focus on strong companies that have performed well in the past. While logically this is a good idea, those are also the companies that have had their strong performance already priced into the stock, as all investors see the stock has performed well and anticipate it will perform well in the future. The risk is there’s not much upside, but a ton of downside if the company falters.
The other problem is focusing on winners makes you miss the stocks that have not done great, and have a ton of upside. On the whole, it’s going to be the smaller companies that are still growing that have the most room to run (in terms of generating returns). You’ll miss those if you focus on the winners. Investing in the whole market (S&P 500, Mid-Caps, Small-Caps, etc.) will give you exposure to ALL stocks, and you’ll find over time a good portion of your returns are generated by outsized performance by a relatively small number of companies. The chances of you picking these companies on your own (and avoiding the bad performers) is small.
In addition, I don’t feel like you can truly know the condition of a public company nowadays unless you have inside information (which is illegal). With publicly traded companies, you have no idea what’s truly going on at a company by reading its financial reports. First of all, there’s things going on in terms of market shifts, competition, regulation, etc. that are hard for even the top executives in companies to see as they are happening. In addition, the way numbers are reported may be the executives attempt to show a story to investors that’s not 100% true. Accounting is as much art as science, and CFOs will often use tricks to report the story that investors want to hear, while (hopefully) staying within the parameters of the law.
In order to know the true state of a company, you’d need to do a TON of investigation in order to get down to the true financial condition of that company. Professional investors (most of whom don’t outperform the S&P 500) will look into many different items in order to try to verify the reported numbers of companies. For instance, I’ve heard that professional money managers will scour job postings online to see how much hiring a company is doing, in order to see how much growth they are anticipating. My point is that’s what it takes to even have a shot at gathering the information needed to get outsized investment returns. Do you really have the time (and desire) to do that? Doubtful, especially if you are working a full-time job. It’s a much better idea to invest in the manner I’ve described above, using index funds.
I want to turn now to the myriad of other types of investments that are marketed as alternatives to stocks (and by extension real estate). These investment ideas play on the notion that the stock market is “risky” and purport to be alternatives.
The list of alternative investments is large, and seems to grow every year. While I’ll list a bunch here, a good rule of thumb is that you should not invest in anything that’s heavily marketed during stock market downturns. Whenever there’s a stock market correction (the stock market goes down 10% or more) or a bear market (stock market goes down 20% or more), there are a number of investments put forth as a “safe” alternative to stocks. For the bulk of investors, they’re not safe. In general, these are trash investments that will cost you in the long run. Stick with stocks and good quality real estate.
Before we list these investments, I want to start by saying there are investors who will absolutely make a TON of money in the investments listed below. However, they are generally experts in the asset in questions, and have knowledge about the marketplace that you do not, or have access to investments to which you will never have access. Their results are not representative of the VAST majority of people who invest in these areas.
These successful investors could easily criticize what I’m about to say, and I’ll admit they’re right, as it applies to them. If you’re one of those successful investors, worth tens of millions of dollars, you don’t need my book. But for the vast majority of people, the following investments will lose money, so it’s best to stay away.
If you’re willing to put in the work to become an expert at these investments (and are prepared to lose some money in the process) then by all means, try them out. Maybe you’ll be a natural, and make a ton of money with these. But probably not, most of us are better off to avoid these.
Here’s the investments YOU Should Avoid:
GOLD
The most common alternative asset people invest in is gold. The theory is that gold retains its value in any market, and will protect you against inflations and a stock downturn.
In some short-term situations, this is true. When a bear market happens, gold often (though not always) increases. In addition, because gold is a commodity that has an alternate use (jewelry), it will often protect you against inflation.
However, in the long run, stocks perform much better. Any information you’ve read to the contrary usually is cherry-picking time periods when the stock market is down temporarily. Over the long term, while gold has had some huge run-ups (like the 1970’s), it has performed poorly relative to stocks.
I’ve noticed that gold sales, gold stocks, and even gold index funds surge in popularity each time there’s a recession. Generally, this is the result of huge marketing efforts aimed at people who are worried about the temporary dip in stock prices. This is designed to play to people’s fears about the collapse of the US dollar, as inevitably happens when times are bad.
While I’m sensitive to people’s concerns about the devaluation of the US dollar, I must stress that gold is not the answer. Usually people end up buying gold after a significant runup in price, which inevitably reverses once the economy recovers.
If you’re investing in gold because you’re worried that the USA is going under, and we’re going to live in an anarchy environment, can I suggest bullets instead? Small, easily divisible, useful for personal protection, it’s likely that 9mm rounds would perform much better than gold in the event of the end of the world. Just saying!
CRYPTOCURRENCIES (BITCOIN)
One of the hottest investments over the past few years has been cryptocurrencies, led by bitcoin. Based on blockchain technology, crypto has been touted as a game changer, leading to everything from the end of fiat currency to even the end of borders as we know them.
Cryptocurrency is an online form of money, generally tied to the blockchain, which is an independent, decentralized method of virtually verifying transactions. I’m no expert in the tech side, and an explanation is way beyond the scope of this book, but suffice to say that it purports to emerge as an alternative to fiat money, meaning governments printing their own currency for use in financial transactions.
This is an idea I really want to believe in. It serves as an alternative to fiat currency, which is essentially a government monopoly on the idea of money. It would prevent the government from printing money to fund silly ideas, and avoid the inevitable comeuppance of inflation when the world loses faith in the US dollar as the world’s reserve currency.
It also can send transactions without reference to borders, which would prevent much of the manipulation that goes on around the world by restricting currency use and trading by citizens. An example would be South Africa, which limits the exchange by its citizens of the rand into other forms of currency. This government control limits the freedom of citizens, and allows the government the power to manipulate currency (by printing more) without allowing productive citizens the power to opt out by converting that currency into a stable alternative. Cryptocurrency cannot be easily controlled by the government, and restrictions on conversion are much more difficult (if not impossible) to control.
There’s also nothing to say that an alternative to government money couldn’t emerge. In the 1800’s banks would print their own form of money, albeit backed by gold in their institutions. I would suspect that an alternative will emerge eventually. The likely candidate, as I write this, is Bitcoin, which is the most popular form of cryptocurrency in use today. Is Bitcoin going to replace the US Dollar and other currencies?
The reality is much less exciting than the hype. The reality is that Bitcoin, and other cryptocurrencies aren’t a usable form of “money” for a variety of reasons. Rather, as we sit today, they are simply a speculative investment, where people are betting that a certain cryptocurrency will emerge as an alternative. I’m all for using crypto once it actually becomes a currency, but I’m totally against speculative investments, so can’t recommend it in its current state.
Why do I say it’s not currency? First, you can’t buy anything with it. Try to buy a steak at the store with Bitcoin, or anything else. It won’t work. A currency must be usable to be considered an actual currency, and even Bitcoin doesn’t fit that bill. Until some form of crypto is accepted as payment for a wide variety of goods and services, it’s not really money.
Next, it’s too volatile to be considered a currency. Money is often referred to as a “store of value”. This means you can earn it one day, and put it aside until a future time for spending. As long as that future time is not TOO far out into the future, where you could lose value due to inflation, you’ll be able to purchase the same amount of goods as the day you earned it. That’s not the case with any crypto, as the values fluctuate rapidly. A unit of Bitcoin earned or purchased today will likely be worth a significantly different amount one month from now.
Whatever you do, please stay away from Initial Coin Offerings (“ICOs”). These are (as we write) not highly regulated by the SEC, but are similar to Initial Public Offerings (“IPOs”), and involve investment into a particular cryptocurrency. These are marked with fraud, and millions are getting swindled by hucksters as we’re writing this.
Here’s the rub with what I’ve said thus far. Some people are going to make a ton of money from crypto. But unless you have unusual insight into the industry, that’s not going to be you. What you’re essentially doing, when you invest in crypto, is placing a bet on which version (or versions) will eventually become an actual currency. I can’t recommend making bets. As such, it’s best you stay away. Once crypto is actually currency, I’m all for it, but currently it’s not there.
CANNABIS
Cannabis is the latest hot investment de jour, and these things seem to come along every few years. Whether it’s medicinal marijuana, hemp, or CBD oil, pot is hot! But what often happens with these trendy ideas is a few people get in early, get rich, and the average investor gets scammed.
I’m not sure of the health benefits of weed, and I don’t care to debate, but I’m confident that much of the interest and investment dollars flowing into this industry is a trend, probably caused by the allure of a forbidden substance.
What I’m really concerned about is all the people opening CBD stores or trying to sell hemp clothes, who are going to be wiped out when this trend ends. There’s going to be others down the road just like it, don’t get fooled.
OPTIONS
In late February 2020, billionaire hedge fund manager and brilliant investor Bill Ackman invested $27 million to “short” the stock market. This means he purchased an “option”, which would pay off big if the stock market declined in value. When the Coronavirus hit, the stock market fell sharply, and his $27 million bet paid off with a $2.6 billion profit.
Wow! Why don’t we all buy options? The reality is that odds were that the Coronavirus was a non-event, and the market wouldn’t have gone down much at all. That option would have turned out to be an expensive, non-paying off bet on Ackman’s part. But Bill Ackman is an amazing intuitive investor who seems to time these things perfectly. Maybe it’s brilliance, and maybe it’s luck, but it’s definitely not something you and I are likely to profit from.
Options are priced according to what millions of option traders are pricing them at. This mass of traders, some of whom are smarter than others, as a whole, will tend to price options to match the risk involved. This means that if a bad (or good) event is likely to happen, the option to benefit from it will be priced so high that you won’t make much money from it.
A lot of investment professionals like to recommend options to hedge against stock market declines. Please don’t do this! It’s expensive “insurance”, and you’ll lose compared to just riding out stock market declines.
There’s no denying that certain people are great at options trading. If that’s you, hats off. But most people who get involved with options end up losing a lot of money. This is another investment category to stay away from if you want to get rich.
DAY TRADING
Day trading came into vogue when online trading first came around in the 90’s. Places like eTrade, TD Ameritrade, etc. allowed every investor to trade to their heart’s delight, for $10 or so a share (less nowadays). A few people got rich (or said they got rich) buying and selling stocks quickly. These investors were trading on trends, trying to spot the direction that markets or individual stocks were going, and profiting from those short-term trends. Sometimes these investors would hold onto their stocks for less than a day, earning the name “day traders”.
Successful day traders began selling their “programs” often on infomercials, claiming they could teach the secrets of instant riches to anyone. Thousands bought these programs, and lost untold amounts of dollars trying to put them into practice.
Why? Again, with certain investments, some people have the knack for success. Most people don’t. You can’t teach day trading. I’ll admit that some people can be highly successful at this, but it’s because they’re naturally talented, lucky, or both. Again, just like options, you and I will not be successful here, so it’s best to just stay away.
DIRECT LENDING
Direct Lending is another one that a lot of people make great money doing. Direct lending is lending money directly to borrowers, rather than having borrowers go through a bank. Generally, these are for real estate deals, like bridge loans or house flippers, but occasionally these are done for businesses as well.
One challenge with direct lending is making sure you’ve got adequate security, meaning an actual asset, like real estate or business equipment, to back up the loan if the borrower defaults. A lender should never make a loan without an actual asset to secure the money being lent. No matter what anyone tells you, there’s always a risk of default.
Direct Lending is also ripe for fraud. There are countless stories of lenders being duped by crooked borrowers giving security interests in phony real estate or bank accounts. If you’re going to involved in this type of investing, you’d better be able to perform “due diligence”, which is a fancy way of saying know what you’re getting into, and you’d better have an attorney who can help you draft the legal documents to protect yourself (and get those attorney fees paid for by the borrower).
There are some online lending sites like Peerstreet that aggregate lending and due diligence into one place, allowing lenders and borrowers with a ready market place to lend and borrow. The theory is that this will reduce transaction costs and allow creditworthy borrowers the opportunity to get funds for investment deals.
I have invested a little into Peerstreet deals in the aftermath of the COVID financial crisis, but that was simply because yields were over 10% for a brief period of time. At that rate of interest, it makes sense to me to have the loans as a diversified part of my portfolio. But they’ve already fallen short of that 10% mark, so my thought is that I’d rather invest in real estate or stocks, where I’m confident that I’ll get a return higher than 10%.
Direct lending can be a successful source of revenue for many people, however, absent using a commercial source like Peerstreet, which candidly is still a bit risky, this is an area that most people should not venture into.
LIFE INSURANCE
Life insurance, when purchased properly, is an essential tool you can use to protect your family in the event of your death for a very small sum of money. Life insurance, as sold as in “investment” by the life insurance industry for high commissions, is a waste of money.
I want to start by making it clear that until you are liquid, meaning your assets are enough to cover your living expenses, you need life insurance. The appropriate life insurance is a term policy. This is a policy where you pay premiums for a term of years, and if you die within that time period, your insurance pays out.
If you’re at the beginning of your wealth journey, with no assets and in debt, you need to multiply your income by 15 and purchase that dollar amount in a 20-year policy. It’s that simple. Even if you’re out of debt, as long as you’re fairly young and healthy, this type of policy is the way to go. It’ll be cheap and you can set it up on autopay and forget about it.
The only issue comes if you’re older and in ill health. The term policy will become more expensive at that point, and you may need to limit the amount of the policy to 10 times your income in order to make it affordable. But you really need to shoot for at least 10 times your income to make the policy something that can take care of your family. It needs to be able to pay off your mortgage and provide income to your spouse to replace yours, especially until your kids are out of the house.
With a term policy, an insurance company will send an examiner to do a general medical checkup involving height, weight, medical history, and blood tests. Once those come back, you’ll receive an offer for your insurance and can move forward. Generally, you want to deal with an insurance broker who can shop the insurance among multiple companies, to get the best deal for you.
The reason the 20-year term policy makes sense is that’s the time period you should need to grow your wealth to the point where your assets will provide for your spouse and kids’ income needs should something happen to you. Once that time period is up, your spouse will be able to use your assets to cover your wages, and your kids will likely be out of the house. There’s no more need for insurance.
Because you’re limiting the time period of your insurance to 20 years, in all likelihood, it’ll never pay out. Therefore, the insurance company can afford to charge a price much lower than the dollar amount being paid out. If you need $2 million of insurance to cover 15 times your salary, the amount of the premiums, added up over 20 years will be pennies on the dollar. Why? Because the goal of both you and the insurance company is that the money is never paid out!
Contrast term insurance with so-called permanent life insurance, which is by definition designed to be around at your death. That means it’s definitely going to (in theory) pay out at your death. As a result, it’s going to be much more expensive than term insurance, because the insurance company has to make enough money, over time to pay the death benefit.
On one hand, it might seem like a plus that the insurance pays out. After all, with term insurance, odds are you and your family will never get anything from all the premiums you pay in. However, you need to look at the difference in the premium costs of term insurance (small) with permanent insurance (high). By purchasing permanent insurance, you’re forgoing the opportunity to invest the large cost difference between the two premiums into investments described in this book, which is a huge loss. Those thousands of dollars in extra premiums you pay into the policy could otherwise be used to purchase stocks or real estate that will help you earn income while you’re alive, rather than ensure a payout at your death.
The insurance industry has tried to hide this problem by referring to their insurance policies as “investments”. These policies are designed so that you pay much more in premiums in the early years of the policy. A small part of this payment goes to providing the actual insurance. This amount would be similar to what you’d pay each year for a term policy. The remainder of the premium is called the “cash value”, and is held within the policy as an investment to pay for insurance in future years. The cash value is actually invested for you into a variety of investment options, often mutual funds, that should grow over time. The idea here is that if the cash value grows enough through the course of your life, you will have enough money in your policy for the insurance company to withdraw premiums each year during your life, ensuring that the agreed upon death benefit will be paid upon your death.
These policies go a step further, by allowing you, through (a) premium payments and (b) the investment growth of those payments as cash value, to actually accumulate more in the policy than will be necessary to make those premium payments over the course of your life. By a quirk of tax law, you can borrow this excess cash value in your policy tax free. Why? Since you will need to pay back these amounts at your death (plus interest), it’s not really like you’re receiving actual earnings, like with a stock portfolio. It’s more like getting a loan to purchase your house, you would not pay tax on those loan proceeds. The idea here is that you would fund your retirement through borrowing money from your insurance policy, and never pay taxes. Sounds great right?
There are several problems with these cash value insurance policies. First, the cost of setting up these policies is staggering. The insurance agents involved make a TON of money from the commissions on the policies they sell, often equal to ½ or all of the first year’s premiums. When your insurance company starts that far in the hole, you can imagine how they’ll need to recoup that over time from your premiums and policy. Also, the agent is really disincentivized to care whether this is the best thing for you. If they sell you this policy, they’ll make a ton of money immediately. If they recommend the investment advice outlined in this book, they’ll make a lot less. It’s really that simple, and that conflict of interest alone should steer you away from this market.
Another problem with these cash value policies is the investment returns are often poor, compared to what you’d get in index funds. Generally, your cash value is invested into mutual funds. These often are owned by the insurance company (or the insurance company is compensated for directing cash value of policies to the mutual fund) and charge high fees. While disclosed (meaning buried) in the paperwork, these fees are not something the insurance company wants you to see, because they’re often as high as 2% of the invested amount. Even if they were invested as I’ve outlined above, your stock market returns would be 2% lower. If your portfolio made 10% over time, you’d actually be collecting 8%, because 2% went to the fund manager. It’s also important to note that if the policy cash value does not perform as expected, you won’t have enough cash value to cover premiums at some point. You’ll be faced with the choice of funding the policy with more premiums, or letting the policy lapse.
Also, the cash value disappears at your death. One of the selling points of this type of policy is that you can borrow the cash value to support your living needs in retirement, but the reality is that the cash value is not yours, it belongs to the insurance company. Once you die, all that passes to your family is the death benefit, not the actual cash value. To make matters worse, many policies require you to pay interest, to borrow your own money.
Furthermore, loans put the policy at risk. The cash value, which you are able to borrow to support your retirement needs, is needed to fund future premiums. Again, you’re paying significant premiums upfront in order to make the policy permanent. These premiums form the cash value, and that cash value needs to grow in order to continue to pay the premiums as you grow older. It needs to grow significantly, because the premiums are going to increase as you get older, because the older you are, the more likely the policy is to pay out.
What tends to happen as people grow older with these policies is due to (a) lower than expected investment performance and/or (b) policy loans, policies get into trouble and the cash value is insufficient to cover future premiums. The policyholder is often asked to put in more premium dollars than expected, lowering returns to much less than initially advertised. Think about it this way. If your S&P 500 index fund performs at 6%, rather than 10%, you have less money. If your cash value insurance policy performs less than expected, you could end up losing everything! Not a good deal.
Are you confused enough at this point? Cash value life insurance policies are one of the most confusing types of investments that exist. There’s so many catches and provisions designed to protect the insurance company. Unlike stock or real estate, which are true assets, all you really own is a contractual obligation with the insurance company. Over the years, I’ve seen so many of these policies go wrong that it’s impossible for me to recommend them to the average person.
I do want to caveat this by saying that I have seen these types of policies be beneficial, in certain circumstances, for the ultra-wealthy and certain highly compensated corporate executives. I want to also say there are some insurance advisors who are very honest and are able to design these policies to meet the needs of their customers. However, these policies are being done for very sophisticated investors who have (or should have) their attorneys, CPAs, and independent insurance consultants review the arrangements to make sure they’re done properly. Unless that describes your situation, it’s best to stay away and stick to term policies. This is another example of how most investors should not mimic the investments of the ultra-wealthy.
ANNUITIES
Annuities have been traditionally marketed to old folks to provide guaranteed income in exchange for a fixed sum of money. The idea is that the purchaser of the annuity is giving up the prospect of a higher return (in the stock market for instance) in exchange for a guaranteed payment for life.
In theory this is all right for older people who don’t want to worry about investing and are willing to trade certainty for a low return. As one gets older, the short-term fluctuations in the stock market can become more unnerving, and an annuity was designed to avoid that stress.
An annuity factors in the amount of money the buyer puts in, called the principal, as well as the buyer’s age and the interest rate the annuity company (usually a life insurance company) is willing to pay. This interest rate is dependent on market conditions, so right now, rates (and annuity payments) are extremely low.
Let’s say an 80-year-old wants to pay $500,000 for an annuity. How much will it pay him per month for his life? According to a simple annuity calculator, the estimate is $4,253 per month, for life.
That seems like a ton of money, $51,036 per year! Why wouldn’t everybody do that? The answer is that the annuity company can pay out so much because 80-year-old men don’t live very long, on average. According to an actuarial table from the company Annuity Advantage, an 80-year-old can be expected to live 8.34 years. 8.34 year of $51,036 per year would be $425,640, which is less than the buyer put into the annuity.
Now, again, annuities are designed for certainty, so maybe that’s alright. In addition, if the 80-year-old buyer lives to age 100, he’d get $1,020,720 of payments for his annuity. Unfortunately, that’s only about a 4.26% return, so not great. But again, certain.
The real problem with annuities comes from the various esoteric varieties that claim to “give you the upside of the stock market without the downside”, where you can “lock in your returns”. Please run whenever you hear this. In reality these are marketing gimmicks that will give you ultra-low returns. Just invest in the stock market, and keep cash on hand to deal with short term needs so you don’t have to sell stocks when the market turns temporarily.
You’ll notice that annuities are heavily advertised in recessions, when people have just seen tremendous short-term volatility in their stock market portfolios. The sad part is that many people will sell their stock portfolio when it’s down, and then invest the cash in annuities. What they do is lock in their losses and give themselves no change to bounce back. Selling while the stock market is down is the only way you can lose money in the stock market. Don’t fall victim to this trap!
You should especially not fall victim to the sales pitch that annuities are “tax protected vehicles”. Yes, you don’t pay tax on growth in an annuity until you take it out. But the growth is so low that you’re much better off in a traditional stock portfolio just paying the taxes as they come. It’s not a good deal to be paying no tax on an annuity with no return.