Oh man, the Hotshot loved to hear himself talk.
“I own a couple restaurants, and I own a couple beach houses I rent out…”
He kept talking. People around me were hanging on his every word.
But I tuned out. I know chances are GREAT this guy won’t keep the fortune he’s made.
Why? It all comes down to my theory about the “Natural Rate of Return.”
Today, I’ll explain how this little “mental model” works… and show you how to use it to increase the return on your money.
[ad#Google Adsense]This’ll take a few paragraphs. So bear with me. Here we go…
This theory starts with the idea that there’s a “natural” interest rate for money. And there’s a “natural” rate of return on your money.
The natural interest rate is where lenders and borrowers meet in a free market. (Let’s call it 6% for now, but it doesn’t have to be 6%.) I believe that, over the long run, the natural rate of return on money EQUALS the natural interest rate.
Some investors will earn much higher than 6%, and some will earn much lower. But balancing it all out, the natural return on money equals the natural interest rate. (It’s just a theory here… But stick with me a little longer and I’ll show you how it works with your money.)
Only a few things tilt this equation. One of the most important is the “Enjoyment Factor”…
For example, most people don’t own a beach home for the rental income alone. There’s a certain Enjoyment Factor (bragging rights… a great vacation spot… whatever) that doesn’t have a monetary value.
Once all is said and done – after property taxes, insurance, damage, maintenance, and so on – a beach house rental might actually be a money-losing business. But a lot of people are willing to sacrifice investment return for the Enjoyment Factor of owning a beach rental.
The same might be true of a restaurant…
To some people, there’s no greater thrill. They’re hosting their friends, and they’re the toast of the town. The Enjoyment Factor of owning a restaurant can be so great, people are willing to sacrifice investment return. But like the beach house, once all the bills are paid, a restaurant might just be a money-losing business.
The actual rate of return on a beach house or a restaurant is the natural interest rate (our hypothetical 6%) MINUS the Enjoyment Factor. So the return can be very low… or even negative. It’s the price of the enjoyment.
So if you don’t own a beach house or a restaurant, what does this have to do with you? How do you use my Natural Rate of Return theory to maximize your gains?
Well, the theory works on the flip side, too. Guys dealing in things perceived to be unsavory (like toxic waste disposal, for example) will earn the natural rate of return PLUS a reward for managing something nobody else wants to.
Let me show you with an example…
I’ve written about gold coins for about eight years – but I’ve been too embarrassed to talk about ’em. At cocktail parties, they didn’t turn heads like the latest beach house “knockdown.”
But who is better off today? The guy who bought my recommended gold coins? Or the property flipper?
Now, gold coins were hardly toxic waste. But they sure weren’t popular when I first started writing about them. And they absolutely made a higher return than real estate.
In short, if you want to be like the Hotshot above… if you want investments you can brag about at a cocktail party… go ahead. But realize you’re swimming upstream – you’re on the losing side of the “Natural Rate of Return.”
If you actually want to make money, invest in things you’re embarrassed to talk about… The more you have to “hold your nose” to make an investment – the more the “Enjoyment Factor” is negative – the more money you’ll likely make.
In my career, “holding my nose” to buy has worked out fantastically better than buying what was hip. I didn’t have to subtract the Enjoyment Factor out of my returns.
This is just a little “mental model” I use to help increase the rate of return on my money. Keep it in the back of your mind the next time you’re stuck talking to the Hotshot.
Good investing,
— Steve Sjuggerud
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Source: Daily Wealth