Here's how to get rich quick (and stay poor forever)

Buying speculative stocks like Innate Immunotherapeutics Ltd (ASX:IIL) and Resapp Health Ltd (ASX:RAP) is not a reliable way to grow your wealth over the long term.

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With people that come late to investing, it can be common to try to 'make up for lost time' by swinging for the fences on speculative companies like biotech Innate Immunotherapeutics Ltd (ASX: IIL), technology company Resapp Health Ltd (ASX: RAP), or pot stocks like Auscann Group Holdings Ltd (ASX: AC8).

Getting rich quick

The idea is that, by supercharging their returns, these investors can make up for lost time and enjoy a wealthier retirement. Unfortunately, by trying to get rich quick in this type of company, most investors will fail to get rich at all.

This approach can be tolerable if you're a younger person trying to make up for all those holidays and smashed avocado toast. You will lose money, learn the hard way, and it will suck – a lot – but it can be outright disastrous if you're an older investor putting larger amounts of money into risky companies.

The problem with the 'speculative investing' approach is that it has binary outcomes. Either you make a lot of money – maybe, and if you're lucky – or you lose most of your investment. The most likely outcome is that you trap yourself for years into a company that is 'gunna' do awesome stuff – someday. In the meantime, these companies are burning a lot of cash for an outcome that, in the end, may not even occur. You can find an illustration of this phenomenon here.

Getting rich slow

A blue-chip company like Wesfarmers Ltd (ASX: WES) might not sound exciting or worthwhile, but at least it is profitable and you're earning a 5% return per annum (dividends) instead of going backwards like you are with unprofitable spec companies. Bottom line; trying to make up for lost time will only lead you to take great risks.

I have three suggestions for all investors who might be looking at speculative companies:

  • If a company doesn't have a proven track record selling its product (if it isn't earning meaningful and growing sales) don't buy it. They could have the greatest treatment/device/thingamajig in the world, but they still have to sell it to people, which is harder than it looks.
  • You can still make a lot of money in a company with a proven business model, as this example shows
  • If you must own speculative stocks, keep them to a small part of your portfolio, say 5% or less of your total investable funds
  • Try a common-sense approach to valuing the speculative stocks. If a company's market capitalisation (the total value of all its shares) is $200 million, it has less than $1m in sales, and is losing $10m in cash every year for example, there is a very good chance it's not worth $180 million – i.e., it is likely overpriced or perfectly priced, and you could lose money.

It is a sad irony that many investors would see much better returns overall by targeting lower returns.

Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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