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Three Types of Investors

JScott

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I recently wrote a blog post, and a few days later, I realized that (at least in my mind), it went a long way towards defining what we've been referring to "fastlane" and "slowlane".

Basically my take is that every investor fits into one of three investor categories/types: Passive Investor, Active Investor, or Focused Investor.

A Passive Investor is essentially what we refer to as "slowlane". And a Focused Investor is generally what I think a lot of us refer to as "fastlane." But I think there is another class of investor, what I refer to as an Active Investor who is somewhere in-between -- he wants to be "fastlane," but ultimately ends up failing.

Here is how I've defined the three types of investors, and would love any feedback or thoughts (sorry if it sounds formal, but I cut and paste from my blog post):

Passive Investors

Passive investors are those people who spend the majority of their life slowly growing their “nest egg†in order to ensure a comfortable retirement. Passive Investors explicitly choose not to focus their time on investing or investment strategy; they either entrust others to dictate their investments (money managers or financial planners) or they simply diversify their investments across a number of different asset classes (they create “a diversified portfolioâ€). For those who create a diversified portfolio, their primary investing strategy is to hedge each of their investments with other “non-correlated†investments, and ultimately generate a consistent annual return in the range of 3-8% (after adjusting for inflation). Those who entrust their money to professional money managers generally get the same level of diversification, and the same 3-8% returns (minus the management fees).

The Passive Investor seeks low-risk growth of their capital, and in return, is willing to accept a relatively low rate of return. While there is certainly nothing wrong with striving for consistent returns, what the Passive Investor is doing is really no different than putting their money in a savings account or CD, albeit with slightly higher returns. The bulk of Passive Investors are investing for long-term financial security and retirement. They start saving in their 20’s and 30’s by putting money in 401(k) accounts, mutual funds, and other diversified investments, and in 30 or 40 years, they have enough to retire on.

The Passive Investor relies in a single force to grow their capital: time. Because their rate of return is generally consistent, a passive investor’s primary mechanism to achieve wealth is to invest and wait. In fact, passive investors often use The Rule of 72 to calculate long-term investment growth and plan their retirement. While passive investing is an almost surefire path to a comfortable retirement, it also generally means 30-50 years of work to get to that point.


Active Investors

Unlike Passive Investors, Active Investors choose to take control of their investments, and not rely solely on “time†to get to the point of financial independence. Active Investors are happy to forgo the relatively low returns of a diversified portfolio in order to try to achieve the much higher returns of targeted investments. Instead of just spreading their money across stock funds, bonds, real estate funds, and a variety of other asset categories, Active Investors are always looking for an investing edge. Perhaps they get a hot stock tip and try to cash in on the next Google. Or perhaps they hear about all the real estate investors who have made a bundle flipping houses, so they go out and buy the first run-down house they see.

Active Investors recognize that they can have higher returns than Passive Investors, and are willing to do or try anything to get those returns. They’re not scared to throw some money in an Options account and try their hand at derivatives trading; or run out and buy a bunch of inventory from a wholesaler they know and open up an eBay selling account. Active Investors are always looking for the next great investment; for them, it’s all about being in the right place at the right time, and taking a chance on getting rich. If today’s investment doesn’t work out, there will always be another one tomorrow.

While the Active Investor recognizes the potential gains from smart investing, he doesn’t always invest smart. He is very much a gambler, and while sometimes those gambles pay off, often times they don’t. And just like a gambler, the Active Investor’s biggest rival is the “vigorish,†the commissions and fees he pays to enter and exit all his investments. While the active investor may have enough luck and skill to be a successful investor, he may show little or no profit after paying brokerage commissions, and other investing fees.


Focused Investors

The third type of investor is the Focused Investor. Like the Active Investor, the Focused Investor realizes that there is a more powerful investing strategy than just diversifying across a range of asset classes. But, unlike the Active Investor, the Focused Investor understands that the key to successful investing isn’t luck, “hot tipsâ€, or “being in the right place at the right timeâ€; it’s education and experience. The Focused Investor recognizes that investing is no different than any other competitive endeavor — there will be winners and there will be losers, and the winners will generally be those who are most prepared.

The Focused Investor generally picks a single investing area, and becomes an expert in that area. Some Focused Investors deal in paper assets, some deal in real estate, and some start businesses. Unlike the Active Investor who looks for the next “hot†investing area and the next hot market, the Focused Investor can make money in his chosen investment area during any market — hot, cold, or in-between. The Focused Investor knows his investment area inside and out, and instead of just entering and exiting investments, the Focused Investor has a plan.

In fact, having a plan is the key difference between the Focused Investor and either the Passive or Active Investor. The plan is the blueprint for achieve investment success, and with it, the Focused Investor can achieve huge returns with relatively low risk.
 

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kimberland

Bronze Contributor
Jul 25, 2007
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JScott,

I think this outline is solid.

However, have you thought about putting different titles to the classifications?
There's so much baggage attached to, for example,
the phrase passive investor,
putting a new spin on it would be challenging.
Best to come up with a phrase that you can more own
and have control over its meaning.
(I'd suggest alternatives but then, you wouldn't own those either).
 

Diane Kennedy

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Aug 31, 2007
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JScott: I agree with Kimber that new names would be great. There gets to be too much confusion otherwise.

Your analysis is interesting, though, because there is a fundamental difference in "how to get rich" that I see on this board than I personally believe. You've clearly brought it up.

I believe that there are three primary assets we can bring to a deal (biz or RE or stock): expertise & abilities, time and/or money. You need to have one of them in the deal to make money. If you put money or talent into a deal, you can put little time in with your investments and still make a lot or money. And, at some point, as was pointed out somewhere else, if the amount of money you have to invest is big enough, it doesn't matter how low your return is....the key element is not putting your time into it. $10 mill at 6% is a lot of money. I don't think there is any disagreement so far.

But, I also believe you must understand the fundamentals FIRST otherwise it doesn't matter how much money you have or make. You're going to lose it unless you stay on the treadmill. And it doesn't matter who owns the treadmill. If you have to keep running to keep the cash flowing in because you don't know what to do once you've got it or how to create reliable and reportable systems within a business, you're just like a hamster on a wheel.

I don't have all the answers, of course, no one person does. But I do have the advantage of seeing first hand thousands and thousands of clients who have succeeded and failed. And by first hand, I get to see their tax returns and financial statements to see what the truth really is. There is a common thread between long-term success and failure. It has to do with whether you understand the (shudder - go ahead hit me with a slow lane comment again) fundamentals of interest, time value of money, ROI, COCR, gross profit, gross margin, direct and indirect expenses and the wide world of taxes.
 

nomadjanet

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Aug 28, 2007
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I like the active & focused terms but I think the passive is a little misleading. People who have been told the key to wealth is passive income may associate the two catagories. What would be another term for a passive, conservative investor as you have described? What about the people whoes tendencies run to a little of passive, a little active? At different times in a person's life they may tend toward acive or focused investment then pull back to a more passive postition. Good start to your hypothesis.
Janet
 
Last edited:

gofalls

Contributor
Oct 7, 2007
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Some new name suggestions.

Passive – Participating Investor
Active – Progressive Investor
Focused – Particular Investor

And I’ll ad one

Non-Investor – Paralyzed Investor
 

Bilgefisher

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Aug 29, 2007
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I found your analysis pretty good. Ive been a passive investor for the better part of 8 years. Roth IRA, stock funds etc. I want to become a focused investor and I fear being an active investor (aka gambler). Your analysis is a good way to stand back and look at it for me.
 
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JScott

JScott

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I found your analysis pretty good. Ive been a passive investor for the better part of 8 years. Roth IRA, stock funds etc. I want to become a focused investor and I fear being an active investor (aka gambler). Your analysis is a good way to stand back and look at it for me.
Appreciate the feedback.

And agreed with a lot of people that didn't like the labels I assigned to each of the categories. While I haven't come up with anything I really like, I think better designations would be:

- Savers
- Speculators
- Specialists

For those looking for the post, I moved it here...
 

BeingChewsie

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Appreciate the feedback.

And agreed with a lot of people that didn't like the labels I assigned to each of the categories. While I haven't come up with anything I really like, I think better designations would be:

- Savers
- Speculators
- Specialists

For those looking for the post, I moved it here...
Great site! I really enjoyed(and needed to read) when focus beats diversification...thank you!

Sue
 

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