Know Why You Need Money
To remedy – or minimize – dilution of returns the first step is to clearly divide one’s wealth according to its objectives, and sticking to that division. This will help the investor focus on what is really needed from each of the different pools of capital. There are typically three reasons for having money: to live, to build and bequeath, and – perhaps – to have fun.
This portion of an investor’s wealth should cover living expenses in the broadest sense of the definition (not just “essentials”). Its size depends on one’s style of life. It is replenished with the flows generated by the current business/work activity, and/or excess cash flow from Permanent and Fun Capital, if any. It should be invested exclusively in cash instruments or bonds (for the portion of outflows with a known deadline).
This is the portion of an investor’s wealth which is dedicated to more lasting long-term objectives. It is the portion of the capital which will never be “redeemed”, unless severe unexpected circumstances occur. It will be bequeathed to future generations, and it is topped-up by excess cash generated from current business/work activity or from fun capital. It is the most important part of the overall wealth of any individual.
This “keep-your-broker-happy” portion of the capital is not mandatory. It can be invested in a more esoteric and active fashion. In this category of capital the investor can indulge in specific bets or ad hoc trading strategies, perhaps following the advice or ideas from any number of sources. It should be by far the smallest of the three types of capital.