Looking at 3 stock market investment strategies and which of them can make you rich
When it comes to investing, there are four major asset classes: real estate, commodities, business, and paper (with cryptocurrencies as an emerging fifth asset class).
One of the most important things to being a successful investor is to decide which asset class you’re most interested in and to become an expert in that asset class.
For many people, paper assets like the stock market make the most sense, but if you want to get rich investing in the stock market, you have to have different investment strategies than the average—read amatuer—investors.
The interesting thing is that most people only know of one way to invest in the stock market, so they never ask the question of how they should do it.
But the reality is that there are three main ways to go about stock investing. The trick to getting rich investing in the stock markets is to match your investing goals with the right investment strategies.
The three stock market investment strategies
As a stock investor, there are three ways you can use the stock market to accomplish your goals:
Capital gain: buy a stock share at a low price and sell it at a higher price — the difference between your buy and sell price is your gross profit
Cash flow: have a stock portfolio that pay out dividends or buy a stock share and option it to earn income for ongoing cash flow
Hedge: buy insurance (options) on your stock share to protect it
All three of these are valid actions. It’s important that you know about these different strategies so you can make smart decisions.
What is your goal for investing in stocks?
Before you begin investing in stocks, or any asset class for that matter, it’s important to establish why you want to invest in the first place.
Ask, “What are my investing goals? Is one of them to increase my net worth? Is it to play it safe and lose as much as possible? Is it to dramatically change my day-to-day experience? If so, what investments should I buy to accomplish this?”
The answers to these questions will help you define your stock market investing strategies.
Investing in the stock market for capital gains
If stock investors want to increase their net worth with stocks, they can buy shares and hold them in their portfolio, hoping they increase in value. Many people are already doing this through retirement plans such as a 401(k), an IRA, and mutual funds.
We’ll talk about it later, but this is the most common way to invest in the stock market. It’s what most people have in mind when you talk about how to invest in the stock market. And it’s also the worst way to do it.
Investing in the stock market for cash flow
If your goal is to generate cash flow, you may want to use the strategy of selling options to meet your cash flow goal. Cash flow is valuable to you because it’s how you are able to feed your family and pay your bills.
Simply having an asset that increases your net worth does nothing to improve your cash flow situation. There are many people who are rich on paper but poor in cash. Lots of people found that out the hard way when the dot com bubble popped in the early 2000s. Thousands of “millionaires”, people who had stock options in high-flying tech companies, became “poor” overnight. That’s why Rich Dad encourages people around the world to think differently and seek assets that give them cash flow.
When you have assets that generate cash flow for you, it can help you now and through retirement. Remember: Net worth doesn’t help you retire; cash flow does. Your net worth doesn’t pay the bills; the cash that comes into your bank account each month does.
That’s an important distinction to make. If you are selling options on your stocks, that is cash flow that goes into your income statement. It’s an important addition to your income statement that can transform your life.
If you want to learn more about how to use options in stock investing, you should read my Rich Dad Advisor, Andy Tanner.
Investing in the stock market for hedging
Your third investing strategy is hedging, which is essentially buying insurance on investments. When you buy an investment such as a house, you certainly don’t want to lose that investment. No matter the reason behind your purchase, it’s important to protect it. If the house burns down, the insurance you bought guarantees that your investment will be safe.
Hedging is simply a purchase that protects you if something bad happens to your primary investment. So, if your goal is to protect what you have, then hedging is the strategy you’ll want to deploy.
Buying insurance doesn’t put money in your pocket. It’s an expense. But smart investors protect their investments with insurance.
Many people don’t realize that you can buy insurance on your stock investments, but you can. Just as you can use stock options to gain cash flow, you can also use them to protect against lose in your stock portfolio.
To learn more about this exciting approach on how to invest in the stock market, read Rich Dad Advisor Andy Tanner’s book, “The Stock Market Cash Flow: Four Pillars of Investing for Thriving in Today’s Markets.”
What does it mean to be rich?
Before we move on, I want to briefly discuss what it means to be rich because it ties in with what we’re talking about here with net worth vs. cash flow.
Many people will say they are rich, but what they really mean is they are rich on paper. The way I define being rich is to be financially free. By this I mean that I do not have to work in order to pay my bills and enjoy myself.
Unfortunately, as I mentioned before, net worth, while nice, does not pay the bills. Cash flow, on the other hand, does.
Let me ask you a question. Who is richer? Some who has a net worth of $1 million and makes $75,000 per year via cash-flowing assets and covers all her living expenses or someone who has a net worth of $1 million and makes $100,000 per year in salary?
The way you answer that question will tell me your level of financial intelligence. More on this later in this article.
How professionals vs. amateurs invest in the stock market
The two biggest differences between professional and amateur stock investor are:
Amateurs are always going for the capital gain, and professionals go for cash flow.
Amateurs are always trying to hedge or protect themselves with diversification, but professionals use option contracts like insurance.
Capital gains vs. cash flow in stock market investing
Let’s take a look at the difference between investing in the stock market for capital gains vs. cash flow.
Maybe you want to buy stock in Acme and you buy it at $100 a share. Let’s say that after a while Acme is now worth $200. Now your net worth has gone up. You have more wealth than you did before—but you are not wealthy. Your “assets” have grown, but Acme has not given you any income; there’s no cash flow from it.
While it’s nice to have an asset worth more than when you bought it, it could very easily go down again. If you need help to pay your bills or mortgage, it will make no difference if your asset is worth more. The only way it can help you is if you sell it… and then you no longer have an asset, just cash.
But suppose you buy a stock that pays you a regular dividend. Now you own an asset that is also adding to your cash flow without you having to do a thing for it. With enough assets like this, you can eventually have the income to do whatever you like right—now or in retirement. In my opinion, that should be the overall goal of investing: freedom of choice and lifestyle.
Most common retirement plans are based on capital gains
Today’s typical retirement plans, such as the 401(k), don’t provide you with cash flow. Instead, the focus is usually trying to build a net worth that is large enough to support retirement—and that is very hard to do. Many people are concerned that their money will run out before their time on earth does. Most mutual funds are not created to provide you with cash flow. Instead, they simply add—or sometimes subtract—from your net worth. But they are not giving you income.
For some new investors, this is a difficult concept to understand. We are trained by the media and Wall Street to equate net worth growth with investing success. But let’s look at a familiar situation that illustrates why net worth may not be the best investing goal.
To be rich is to be free
Suppose you have monthly bills of $4,000. Well, having your net worth go up and down isn’t really going to matter. You need to cover these expenses every month. You need income-producing assets to produce cash that helps crack this nut. If you can get $4,000 in cash flow coming from assets, you can be independent of a job. Now, that’s a goal! That is wealth. That is being rich. Wealth is when you have passive income to cover your $4,000 in expenses. Cash flow is the key to wealth.
This is why in the example I used above, the person who makes less per year in cash flow but still covers her expenses is rich and the person with a higher salary is not. If that job is lost, the bills have to be paid still. That is not rich. That is risk.
If you have a high net worth, you may be rich but you may still have to work. You can be rich in net worth and not be able to pay your bills. You can have a million dollars in a 401K and not be able to cover your monthly-expenses for the rest of your life.
But if you have passive income that exceeds expenses, then you’ve become independently wealthy. In other words, you have enough wealth to be independent from having to work.
So if you want to get rich from investing in the stock market, then learn to invest for cash flow and to hedge against your losses with option contracts. This takes a level of financial education, but investing in growing your financial knowledge will be well worth it. It’s the only way to get rich after all.
This content was originally published here.