Federal Securities Law in the United States defines a ‘Sophisticated Investor’ as someone who has either a net worth of $2.5 million or has earned more than $250,000 annually for the past two years to qualify. An ‘Accredited Investor’ is defined as someone who has a net worth of $1 million dollars and an annual income of $200k for the last two years. However, don’t let those numbers scare you, read on to discover an alternative definition of a truly “sophisticated” investor and how you can become one.
Almost every financial advisor or institution considers this ‘Sophisticated Investor’ the big fish they are baiting their hook to catch. Many so-called sophisticated investors are charmed by the bright lights and shiny objects dangled in front of them by investment brokers and institutions. Oftentimes, the Sophisticated Investor is merely dropping sizeable chunks of cash into Hedge Funds and getting ripped-off in the fees (usually 2% of assets under management and 20% of returns) for the so-called privilege.
Here, we’re going to park the standard definition of the sophisticated investor as purveyed by high-rollers on Wall Street. By my definition you have become a sophisticated investor when the majority of your required income is being generated in the Investor Quadrant described earlier in this book.
Learning the ropes of building and owning a business will kind of pre-qualify you to become a sophisticated investor. It’s not absolutely necessary to have been a business owner before you graduate to becoming a professional investor but it certainly does help. Flexing your business acumen muscle in the cut and trust world of business will have taught you some valuable lessons about:
1. Yourself - how you think, your capabilities, strengths, and weaknesses.
2. Risk - the levels of risk-taking you are comfortab e with.
3. Financial Statements - income & cash flow statements, balance sheets etc.
4. Managing Resources – people, systems, technology etc.
5. Capital - raising it, borrowing it, utilizing it.
6. Sales and Marketing - strategies, tactics, plans etc.
7. Negotiating - learning the art of win-win.
Investing: Divesting from Average, Becoming Sophisticated
Nobody likes to consider themselves as average…even in the financial world of investing and wealth creation. However, making the transformation from being an average investor to a sophisticated investor requires the development of a whole new mindset, and set of financial and business skills, not to mention attitude to risk. It requires you to sidestep Mr. Average and step-up another level. The following table helps makes some clear distinctions between how average and sophisticated investors think, operate and invest. I would encourage you to really study this table and think before you act on your next investment.
The Average Investor
The Sophisticated Investor
|Invests directly in their own name.||Invests through corporate structures.|
|Has wealth largely invested in one or two levels of the investment pyramid e.g. cash and paper assets.||Has wealth allocated prudently across the different levels in the investment pyramid – includes paper assets and hard assets like real estate and precious metals.|
|Is heavily influenced by emotions, what their broker or friends/colleagues say.||Invests unemotionally – thinks in financial gray!|
|Calls his broker first seeking investment tips and advice. Doesn’t have a written plan. Invests alone.||Has his own plan and then a team of financial and legal advisors. Calls broker last!|
|Buys when asset prices rising, sells when the asset price is falling.||Buys when asset prices falling/have fallen, sells when they are rising.|
|Only makes money when the market goes up.||Makes money in both upward and downward cycles.|
|Seeks external security from job and government and overvalues so-called professionalism and endorsements. Focus is on avoiding mistakes and appearing successful.||Values independence and financial freedom. Seeks internal, self-generated security. Focus is on managing risk. Understands failure is the mother of success.|
|Invests with post-tax dollars.||Invests with pre-tax dollars.|
|Has a heavy focus on professional education i.e. decreed education.||Has a heavy focus on financial and self-education i.e. achieved education.|
|Is usually under-insured or only uses insurance as an investment product.||Uses insurance as an investment product mainly to hedge against exposed investment risk.|
Note: Credit/Inspiration for this table must be given to Rich Dad’s ‘Guide to Investing’ book
Creating real wealth requires you to quit average-Joe investing style and mindset and transform yourself gradually into a sophisticated investor. That said, it’s important to know yourself and your risk-tolerance level and only make investments you are in the main comfortable with (whilst stretching your comfort zone where it’s counter-productive to your wealth creation)
For many brand-new entrepreneurs who dream of creating wealth but have never started a business before or invested, stepping outside their normal comfort zone can be difficult. However, creating wealth will require an investment on your part. It’s the idea that you have to invest money in order to make money.
Investing carries a certain level of risk and you need to decide upon your risk tolerance depending on your personality type and your stage in life. You can choose to invest in low-risk assets that yield less but at least you can sleep easy at night!
You absolutely must acquire the knowledge about investing in these asset classes in order to build wealth. Work within your own boundaries. Only acquire assets you can afford to pay for or learn how to use Other People’s Money.
About Keelan Cunningham
Keelan Cunningham is an entrepreneur, multiple business owner, author, and personal finance/wealth building specialist. Keelan’s passion is helping people improve their business acumen and personal wealth creation strategies, so they can lead a truly wealthy life in all aspects and with any luck similarly transform the lives of others.
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