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The man who knows and knows he knows is wise.
Follow him.
The man who knows and knows not he knows is asleep.
Wake him.
The man who knows not and knows he knows not is a student.
Teach him.
The man who knows not he knows not is a fool.
Shun him.
After calculating my net worth once a month for a bit more than a year I saw that sitting down once a month and thinking about finances can be very rewarding.
Before I started, my net worth was about minus 5000 dollars. That’s right – minus, negative 5000.
That means that if you were to take everything I owned in this world and sold it – you would still be about 5000 dollars short of having anything.
After calculating my net worth for the first time I come to the somewhat startling conclusion that I have a lot less than I thought.
I started to think if there is a way to grow my net worth.
There is.
With 1 year I got from the negative part of the scale to the positive and even some more.
But then I stopped calculating my net worth. Looking back at it – stopping was a bad idea. You should never stop.
This website – Psychology of money – is one thing that will hopefully keep me calculating my net worth each month for the rest of my life.
But why you ask?
Simple! I want my Net Worth to grow.
I believe that it is interesting for everyone to know how much they are worth if you only take into account the things you have and don’t consider what you know that can make you a lot of money in the future. At least we all like to think that we will make a lot of money some day in the future…
Calculating your Net Worth consists of 2 main parts. First you will have to add together the value of everything you own and secondly you will need to add together all your debt.
Your Net Worth is positive when you take everything that you have and after selling it you can pay off your debts and even have some extra money left.
However your net worth will be negative if the total amount of debt that you have is greater than the total value of the things you own.
That much for the theory, but now to the fun part.
My Net Worth (yes, this is for real)
Assets
Ownership in companies – $ 946
Pension funds – $ 895
Real estate – 0 $
Cars – 0 $
Stocks – $ 551
Cash on hand at the moment – $ 378
Things I own -
Mobile phone – $ 946
Camcorder – $ 189
Digital camera – $ 47
Laptop – $ 662
IPod – $ 47
All assets combined – $ 4 662
Debts
Student loan – $ 4490
Credit card – $ 115
Laptop payment - $ 606
All debts combined - $ 5211
Net Worth = Assets – Debts
My Net Worth = $ 4 662 - $ 5211 = -549 dollars
My Net Worth is MINUS 549 dollars.
As you can see I don’t like buying expensive stuff just for showing off. And I don’t like borrowing. I only take a loan when there is absolutely no other way.
That being said I am not satisfied with my net worth at all because I feel I should be worth more. But that is just the emotions talking, not the facts.
The facts are that I own very little and at the same time I owe very little. My assets and debts pretty much cancel each other out.
I am more than certain that there are people reading all this that have a lot more assets but at the same time there total net worth is lower than mine (this means that they also have a lot more debt than I have).
Tips on how to calculate net worth
Different people like to calculate their net worth differently. As you can see I have included the things I own all the way down to my digital camera that I estimate to be worth about 47 dollars today. Some people don’t include things that are worth less than 500 or 1000 dollars. It would just end up being too complicated and take too much time to complete. The reason I included my cameras and iPod is I don’t have too many things and it is not very complicated to do. Of course I have a lot of other things that are not listed on my net worth statement but the ones that I have included are the ones that are worth the most and at the same time are easy to sell.
Coming up with the values of your assets
Coming up with the price of your assets can be tricky. What I do is take the things that I have and have an educated guess – For how much could I sell this in two weeks?
The time period is something that you would have to come up with yourself. If you own a house you should probably put down the price you would get when selling it in 1 or 2 months. Whatever you choose – stick to it.
Check the prices of similar things
Look at your local ads magazine. Is anybody selling the same thing? If yes take the price and list it in your net worth with a 10% to 20% lower value.
For example if you want to know the value of your car, check the web for similar cars selling in your area and list it on your net worth a little cheaper. Use your common sense – for how much could you sell it in a few weeks?
The reason it is a good idea to list some of your assets as a bit cheaper than they really are is because you want to be sure that you can sell it in the timeframe you have in mind. Listing your car or your house as more expensive than it really is might look good on paper but in reality it would more likely harm than benefit you. It might give a false sense of security and thus do you more harm when you are suddenly in need of selling your assets.
Should you include the money in your pension plan or a 401K?
Yes you should. While this money might not be accessible to you at the moment it is still YOUR money and on some occasions you can use this money to secure a loan.
I have a house and a mortgage. Do I need to put them on my net worth?
Yes. The way you should do it is list the full price of your house under assets. And by price I mean the amount of money that you would get from selling the house before paying off your mortgage.
Under debt you should list the amount you still need to pay for the mortgage.
When you do all this you can actually see if your home is financially worth something for you.
If the price of the house is less than the mortgage then it means that after selling your house you would need to come up with extra money to pay for your mortgage.
If you take a close look of my net worth above you will see that I did exactly the same thing with my computer that I recommended you do with your house.
I still need to make 606 dollars worth of payments for my laptop (as seen under debt) and I estimate my computer to be worth about 662 dollars when I would need to sell it right away. That means that after selling my laptop and paying back the debt I would end up with 56 dollars.
Bringing you down to earth
Calculating your net worth is a good method to bring you down to earth. When first calculating their net worth most people are startled to find out that they are worth a lot less than they thought.
Make calculating your net worth a habit – you can only benefit from it. It does magic on making you think about your finances. It is exactly as I wrote in my post about the Natural Law of Money
If you start thinking about your net worth your chances of multiplying what you already have grow exponentially
The first step makes all the difference
Risk comes from not knowing what you are doing
Warren Buffett
The average investment advisor’s recommended portfolio will vary depending on his client’s “appetite for risk”. If the client wants to avoid risk he will be offered a well-diversified portfolio of “safe” stocks and bonds that theoretically won’t lose money - or make much, either.
If a client is willing to take risks he is probably advised to invest in so-called growth stocks which all have great promise but no guarantees.
This idea makes sense to the advisor and the client who both believe it’s impossible to make above-average profits without exposing yourself to the risk of loss.
But this is not the case.
A great investor understands that risk is contextual, measurable and manageable or even avoidable.
What is risky for me might not be risky for you
Is the experienced rock climber, whose fingers are the only things holding him a hundred feet up a vertical cliff taking a risk?
Or is the expert skier who zooms down the almost vertical double black diamond slope at sixty miles an hour taking a risk?
You would probably answer “Yes!” But what you actually mean is “Yes, if it was me doing it”.
Risk is related to knowledge, understanding, experience and competence. Risk is contextual.
While we can’t be sure that the rock climber or the skier are taking no risk we intuitively understand that they are taking less risk than we would in the same situation.
Even when we observe something that feels very high risk we can assume that for somebody else it might not be risky at all.
To even better understand the concept, think about driving a car. Chances are that you are an experienced driver and you have the ability to make instant judgments while driving - You can even listen to the radio and switch lanes at the same time.
When you first started driving it was not as easy as it is now. When switching a lane you actually have to consider several things:
Is my speed OK compared to the speed of the other cars to switch lanes?
What’s the speed of the cars in front and behind me?
Will the drivers in the other lane let me in?
…and so on.
The more you practice driving the better you get at it - to the point that you will be able to do it unconsciously leaving your conscious mind to be able to listen to the radio.
The more you practice something the better you get at it - until at one point it becomes a habit where you do what you do unconsciously.
This is the case with the death defying rock climber and the skier but it is also the case with professional investors.
There is a story of George Soros interrupting a meeting to place orders worth hundreds of millions of dollars. A person who was attending the meeting told later:
“I would shake in my boots, I wouldn’t sleep. He was playing with such high stakes. You had to have nerves of steel for that”
For this person it looked like George Soros was taking a huge risk but in fact he didn’t. In order to be able to make fast decisions concerning hundreds of millions of dollars like this we would have to know what Soros knows and it would not look like such a huge risk any more. We would simply have to learn to drive the “trading car” as well as George Soros is doing it.
Remember:
Risk declines with experience
How can we embrace risk as a winning investment habit?
Restrict your investments to the areas of life where you can make competent decisions. If you don’t know anything about computer chip makers don’t invest in them even if a stock has an attractive price. If you know about construction find a company that does just that. It will be so much easier for you to understand what they are doing.
Warren Buffett:
It’s not risky to buy securities at a fraction of what they are worth.
The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.
They are very often wiped out!
Here’s an example about two companies:
|
|
Long-Term Capital Management |
Victor Niederhoffer |
|
Time to make the money |
4 years |
20 years |
|
Amount of money made |
5 billion dollars |
130 million dollars |
|
Beginning of collapse |
April 1998 |
October 27, 1997 |
|
End of collapse |
October 1998 |
October 27, 1997 |
|
Amount lost |
4.6 billion dollars |
130 million |
|
Amount left |
$400 million |
Nothing |
Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether who was a former vice-chairman and head of bond trading at Salomon Brothers.
Long-Term Capital Management had developed complex mathematical models to take advantage of arbitrage opportunities on the bond market. Because of the enormous profit they made on the first years they had more money to invest than they knew how to invest. In other words they had too much money to use with their successful model. Because of the pressure to keep making the amount of money they did in the first years they took very risky positions outside their know-how and burned badly.
Victor Niederhoffer is a well known fund manager and a professor of finance in University of Berkley (1967-1972). After having an average annual return of 35% Victor Niederhoffer had made so much money that he gave most of it back to the investors but he took the 130 million dollars and invested it in Thai bank stocks after they had fallen heavily because of the Asian financial crisis. On October 27, 1997, losses resulting from this investment, combined with a 554 point (7.2%) single day decline in the Dow Jones Industrial Average (the second largest point decline to date in index history) forced Niederhoffer Investments to close its doors.
That’s what happens to companies who don’t make preservation of capital their primary aim - they lose their money.
The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.
Seems that a lot of people agree that professional investors are better in investing than you and me or the so called amateur investors.
While this might often be the case there is literally tons of information out there about exactly the opposite being true. If you would like to know how an ordinary person can beat the professionals in their own game I would recommend to start from reading the classic One Up On Wall Street
But that’s not what this post was supposed to be about.
While there is no doubt that an amateur can beat a professional there is also no doubt that there are people (usually professionals) who have an amazing track record. Peter Lynch and Warren Buffett are the first to come in mind. These are the people who have shown year after year that they can beat the market. For example Warren Buffet’s portfolio has grown an average of more than 20% per year.
With a rate like that it takes a little less than 4 years to double your money. The average return of the markets is widely believed to be about 12% . With a return of 12% you would double your money in a little less than 7 years.
The key point to agree upon here is
There are people who constantly outperform the markets.
The Average Joe
Let me ask you this. Have you ever lost money in the markets? Chances are that when you have done at least a few investments in your life you have lost money.
Now let me ask you another thing – Have you ever made back what you lost – in the markets?
I bet that the answer is NO. It is no for the majority of people.
For the average investor, investing is a sideline. When he takes a loss, he usually subsidizes his portfolio from his salary, pension fund, or other assets. If the average Joe has 1000 dollars less than his goal he will simply put a little more money aside each month to get back to the desired level.
The Master Investor
For the Master Investor investing is not a sideline – it is his life. So when you take a hit and lose a portion of your portfolio – you can’t subsidize it from your salary (because you only get paid when you make money). The only way to get the money back is to make it back in the markets.
I already mentioned the fact that if you lose 50% of your portfolio you will need to get a return of 100% on the rest in order to get the money that you lost back in my post about The winning investment habit number 1 – preserve your capital.
Consider this - if you lose 50% of your investment capital and you manage to achieve the average 12 percent a year return – it will take you a little less than 7 years to get back to where you were before the loss.
With Buffett’s average return of 24.4 percent it would take 3 years and 2 months and for George Soros with an average yearly return of 28.3% it would take 2 years and 9 months.
What a waste of time!
Isn’t it simpler to just avoid the loss in the first place?
So there you have it:
The biggest difference in the thinking patterns of highly successful investors and the not so successful ones is that for professional investors losing is not an option. If you lose then it will take a lot of time to get the lost money back. So you only invest when you are absolutely certain that you won’t lose it.
If you can’t subsidize your losses then your thinking shifts from “Make profit” to “Keep what you have and after that if possible make a profit”
So here you go – Only invest when you are certain that YOU WILL NOT LOSE YOUR MONEY.
The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.
Excellent investors always take responsibility for their results.
When a good investor takes a loss he doesn’t say „The market was against me” or „My stock broker gave me bad advice”.
After a mistake an excellent investor always admits „I made a mistake”.
A winning investor accepts the result without recrimination and always analyses what they did or didn’t do so that they won’t repeat the mistake.
A true investor acknowledges that the best lessons are always the ones that you get from your own mistakes.
By taking responsibility for your actions – both profits and losses - a good investor stays in command of himself.
It’s exactly like the expert surfer dude hitting the waves. He doesn’t believe that he controls the waves but because of his experience he knows when to ride a wave and when to avoid it. He is in control of his own actions. If he falls – it’s his fault.
When we lose money, we count the dollars we actually lost. Not Warren Buffet. His loss is what those dollars could have been. For him losing money is a gross violation of his underlying aim, which is to “watch money grow”.
Preservation of capital is an investment rule propounded by many but practiced by few.
When asking investors how it would feel to make preservation of capital, most report a sense of paralysis or a feeling that you can’t do anything because you might lose your money.
Here is a graph how most investors think about investing and risks. The conventional thinking goes like this – in order to make a 1000 dollars I need to risk to lose the 1000 dollars I already have.
Here is another graph showing the thinking behind the best investors of the world.
There are a couple of reason why the graph for the best investors in the world looks a lot better to anyone even remotely acquainted with the principles of risk versus potential profit. The second graph illustrates a proportionally smaller amount of risk with better profit.
Here is why the second graph is the right way to think about risk and reward.
1) While investing money the most you can lose is all of it but the most you can win is unlimited. If you bought the stock of Microsoft in the early 80’s you would have made more than 100 times the money you put in on your investment.
2) The second reason for this graph to look like it does is even more important. Because of the compound interest every dollar that you make on your investmet further increases the amount that you are going to make. For instance if you manage to buy a stock with a dividend yield of 10% then after the first year your 100 dollars would be 110, after the second year 121, after the third year 133,1 and so on. As you can see the first year you made 10 dollars, the second year 11 dollars and on the third year 12 dollars and 10 cents. When you have a stock that keeps rising 10% a year that doesn’t pay any dividends it is essentially the same thing – the first year your stock price will rise 10 dollars, the second year 11 dollars and the third year 12 dollars and 10 cents.
The investors that consider the second graph to tell the truth are more often focused on the investment process. They don’t view each investment to be a discrete, individual event because they know that even if you only invest for a relatively short term and make 10 per cent on your investment – it will give you 10% more to invest the next time.
Thanks to the compound interest you will potentially make more money with every passing year. Thus the longer your investment period the lower is the risk to lose all your money compared to what you can make.
The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.
Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1Warren Buffet
„Survive first and make money afterward.”
George Soros
„If you don’t bet, you can’t win. If you lose all your chips, you can’t bet”
What’s the difference between a Winning Investor and a Loosing Investor?
The winning investor – Believes that his first priority is always the preservation of capital, which is the most important cornerstone of his investment strategy.
The loosing investor – Has only one investment aim – „to make a lot of money”. As a result he often fails to keep the money he already has.
Did you know that if you have a stock that drops 20% then you would need it to grow 25% in order to get back to the same price level before the price drop. (Example: If you start with 100 dollars and lose 20% you will end up with 80 dollars. In order to go from 80$ to 100$ you need a gain of 25%).
If you lose 50% of 100 dollars you will end up with 50 dollars. But in order to get from that 50 dollars back to 100$ you need to double the 50 bucks. This means you need a growth of 100% .
It might not seem like a big deal – 50 dollars to lose is nothing catastrophic. But consider the same on a larger scale.
Let’s say that you have a pension fund that holds 1 million dollars. Because of problems in the subprime market your fund loses half of its value – now you only have 500 000 dollars left. What do you think how much time would it take to get back to the initial 1 million?
Well no one can tell for sure but the only thing that is known for sure is that it will take a lot more effort (and time) to get the money back.
Here is a chart that on the left give you the initial loss in % and on the right it shows how much you need to make afterwards in order to get the initial sum back.
| % of loss of initial investment | % that your investment must grow to get even |
| 1% | 1,02% |
| 5% | 5,3% |
| 10% | 11,1% |
| 15% | 17,8% |
| 20% | 25% |
| 25% | 33,4% |
| 30% | 42,9% |
| 40% | 66,7% |
| 50% | 100% |
| 75% | 300% |
| 80% | 400% |
| 90% | 900% |
| 95% | 1900% |
| 99% | 9900% |
This is exactly why Preservation of capital is ALWAYS the number 1 priority of any half decent investor. If you have a loss of 1 per cent you need a growth of more than 1 per cent to get the money back. The more you lose the bigger the gap between what you lost and how much you need to make to get it back will grow.
The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.
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