Risk Taking: Intelligent vs Non-Intelligent

When we told select family and friends that we were going to purchase this website, we got some stunned looks and some other words of support. The interesting part about that varied reaction is the fact that we intentionally haven’t told many people. For example, we agreed to tell our parents about the business venture after we had earned enough from our web properties and freelance work to pay the loan back in full. The reason for this is that we have grown accustomed to having our eardrums intact and would rather not have them burst by hearing, “Are you insane” shouted at glass-shattering decibels. You see, many people (including banks) just don’t understand the idea of buying a blog. The business model is not well-known, and there is only very tentative precedent currently available. Seeing as how a web property is something you can’t touch, it makes it very difficult to quantify to most people, and even harder to support taking out a loan in order to buy such an entity. Interestingly enough, I am almost certain that if either my partner or I had took out a fairly large loan to buy a new vehicle that was above what we needed, we might have gotten a slight smirk at our perceived slight overspending, but overall the reaction would have been to enjoy yourself and your new toy (we probably “earned it” according to every advertiser out there).

Intelligent Risk

You’re Buying A What?!

Why is this? It is socially acceptable to purchase luxury goods and enter into contracts paying relatively high interest rates for them, but yet buying an income-producing asset is met with such disbelief? If we had purchased a rental property, there would have been some words of caution no doubt, but probably far less of a reaction than purchasing a website. Again, this is interesting to me. From what I can tell, the average perception of risk is quite different than the one I have. So either I am completely wrong and will end up biting off way more than I can chew or, many of us are little mixed up in regards to how money and risk are used.

I Deserve It, Just Ask Visa

Purchasing luxury goods is not an intelligent risk, yet is generally accepted in society. Going into debt to pay for these luxury goods is also fairly common. For transactions that appear to be straight capital-for-pleasure trades, the marketing industry appears to have convinced us that we can never have too much, and that we deserve everything we can get our hands on. This of course leads to that weird lifestyle inflation phenomenon we all know and love. I must be wired differently, because I get way more of a jolt out of buying an asset than I do from buying something to wear, or drive, etc. This is not to say I’m overly cheap (although I may be). I like to pay for experiences, trips, going out with friends etc., but going into debt for luxury goods is not my thing.

My Best Investment Is My Home *gulp*

Many people who believe they know their way through day-to-day personal finance would strongly agree that going into large amounts of debt for a home mortgage (500% leverage anyone?) or for a rental property is a good investment. You can touch a home, feel a home, and the business model is very common. This is obviously intelligent risk right? I mean home rates always go up, renting property is totally passive since home maintenance is almost non-existent, what could go wrong? Paying the carrying costs on mortgages is an intelligent risk, while the carrying costs on a relatively small investment loan is insane if it’s used to buy a blog right? See where I am going here?

The Difference Between Good Risk and Bad Risk

Many of the things we believe are good risks such buying a “luxury toy” like a boat, or a new vehicle aren’t risks at all, they are merely buying something that has no way to generate cash (and will just leak value forever). Other things we believe that are considered intelligent risks include certain types of investment loans to buy real estate, or to purchase a piece of equipment for your business to make use of. To me, the bottom line on intelligent vs non-intelligent risk of your money/capital is: do you understand how your risk will pay off and do you understand the size of your risk?

If you understand the industry, you have a solid grasp on how profits are made and what “best practice” is within the field, then you can be confident that you continue to operate the asset your buying in an efficient fashion. If you believe that your risk-reward ratio carries a return on investment that is greater than 15%, then you are also in good company (the stock market by comparison has historically returned around 10%, and lately, much less than that). Finally, if you understand just how much money you are borrowing, relative to the expected income of your purchase, then you are well on your way to determining the difference between intelligent and non-intelligent risk in my opinion. If we step back a look objectively at mortgages, they are often just a socially acceptable way of leveraging your money in a massive way. There are plenty of lenders out there willing to hand out mortgages with 5% down if you have a decent credit history. That is 20-1 leverage, or 2000%!! If the housing market dips at all, you can lose massive amounts of net worth in a very short time. Yet five years ago a mortgage would have been considered a very smart risk if any risk at all.

Common Sense Makes You Average By Definition

Try not to let “common sense” money practices cloud your impression of what good and bad risk is. I find common sense a great guide in most aspects of life, but in terms of money and capital management, it has led many astray. People rarely go wrong investing in things that produce income, and are also assets that they understand. On the other hand, plenty of people go wrong when debt is used to fund luxurious tastes and overextending ourselves through social acceptable means.

 

 

19 Comments

  1. Christine Wilson on May 3, 2012 at 9:33 am

    So where did you find websites for sale? What are some trusted sources?



  2. John @ Married (with Debt) on May 3, 2012 at 11:17 am

    I think it’s clear by now that the right people can invest in online real estate as well as physical real estate, with similar results. The only difference is that if your online tenants disappear, it might not be so easy renting out again.



  3. Joe @ Retire By 40 on May 3, 2012 at 12:29 pm

    It is an investment and you’ll need to see if it pans out. I think it’s a much better investment than buying a new car. Good luck!



  4. From Shopping to Saving on May 3, 2012 at 3:06 pm

    I think people are just ignorant when it comes to investing (or any financial matter it seems) that they are quick to jump the gun and voice their opinions, which are usually based on something that they have just been hearing or what they have been told. People are brainwashed to think that buying expensive cars and a nice big house are symbols of success….and while I think that’s true if you are able to pay it off, then kudos, but if not…it’s not worth it. So you’re being smart about it, and when you’re rolling in the dough – THAT’S when people will look into it!



  5. Teacher Man on May 3, 2012 at 4:46 pm

    Even when you can afford the expensive car or big house, wouldn’t you rather own assets so that you can build wealth that transcends material possessions? I guess it is always nice to enjoy the fruit of your labour as well.



  6. Teacher Man on May 3, 2012 at 4:53 pm

    The tenants comment is an interesting consideration because unlike people renting out a house – who have to rely on a few tenants (maybe as few as one) – we’d have to have bad luck with a whole bevy of tenants before it really hurt us to the same degree. Also, online real estate is still a much smaller initial capital requirement, so that is nice for us young’ins.



  7. Teacher Man on May 3, 2012 at 4:54 pm

    Hey Christine, most website sales I have seen are private (as this one was). If you want to see a public auction setting I recommend checking out Flippa. Some people swear by it, but I prefer to buy something I know extremely well instead.



  8. Nunzio Bruno on May 3, 2012 at 9:46 pm

    One of my favorite lines in your post was about asking Visa that you are worth it. That is such a big behavioral hurdle to get people over because we all want to feel special. It’s mostly rationalization but it’s still an emotional pull. I loved the comments so far because I actually have a few domains I’m looking to offload lol. Anything you allocate resources to should provide you with some kind of utility and we hope (most of the time) that the return ends up being worth it. I loved the points about the real costs though because people don’t give enough credit to the interest they pay – that’s opportunity cost.



  9. femmefrugality on May 3, 2012 at 9:57 pm

    I think you pinned the nail on the head: it’s an industry that’s newer and therefore not well-known, and it’s an intangible investment. It’s so funny that something that can generate such large income is considered foolish.



  10. young on May 3, 2012 at 10:05 pm

    Actually you make an excellent point- we had the option of buying a duplex for 100K less than what we paid for our current house.. but the duplex didn’t have a basement suite to rent out.

    It’s been great having a basement suite to rent out- but yeah, I agree that investments are a good idea.

    Initially as the psycho girlfriend waiting to be proposed to (haha psycho alter ego comes out) I balked at the idea of my boyfriend wanting to invest in a start up business etc. etc. but now I understand.



  11. Christine on May 4, 2012 at 7:25 am

    How do you get to know about private sales? Sorry newbie here! I will check out Flippa, thanks. 🙂



  12. Teacher Man on May 4, 2012 at 7:55 am

    Hopefully we are able to set a new precedent going forward.



  13. Teacher Man on May 4, 2012 at 7:57 am

    Do you make a living dealing in online properties Nunzio? Is there any way that you don’t see web properties becoming more valuable (the general market I mean)? I can’t help but think as more of the world gets connected to the net, and more advertisers look online, web properties have to continue to rise in value.



  14. Teacher Man on May 4, 2012 at 8:01 am

    I think my gf could sympathize with you greatly Young! The basement suite is a great overall deal, because it be an income-producer, and as your financial standing grows, it will give you a lot of cool renovation (every PF bloggers favourite word) options to build a great home.



  15. Miss T @ Prairie Eco-Thrifter on May 4, 2012 at 8:33 am

    I would agree. I think websites hold value longer than cars these days. Give it your all and see where it takes you. If you work hard it should pay off. Having a solid growth strategy in place is important though. You can’t just wing these kinds of things and expect good results.



  16. Nunzio Bruno on May 4, 2012 at 9:50 am

    I honestly don’t lol. I am a professor, consultant, and a blogger and that’s where my living comes from. I just happen to have a few domains that I’m looking to offload myself. As for value I think you’re on to it – web properties are going to continue to get more valuable. Not only are businesses acquiring their desired domains but are also related ones to catch visitors.



  17. Teacher Man on May 4, 2012 at 5:13 pm

    I didn’t even think about the fact that businesses are boosting the market as they try to acquire the .com properties for their own use. I’m glad to hear that you believe the market will continue to climb!



  18. Teacher Man on May 4, 2012 at 5:17 pm

    Basically private sales will filter in if you build up a network in any field right? For us, it was through our guest posting.



  19. Christine on May 5, 2012 at 3:08 pm

    Thanks that gives me a starting point 🙂



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