01:07 What is the Hierarchy Of Wealth?
Patrick Donohoe: For about ten years, I had the privilege of being a faculty member on this investment cruise. We traveled mostly around the Caribbean. For six of those years, Robert Kiyosaki, the author of “Rich Dad, Poor Dad,” was also a faculty member. He would hold these late-night study groups, but they were limited to a select number of attendees. If you didn’t adhere to his strict rules, he wouldn’t hesitate to call you out. It was quite entertaining, to be honest. I distinctly remember one study group where we discussed the hierarchy of needs. He was referencing Maslow’s hierarchy of needs, which starts with physiological needs and progresses to safety, relationship, self-esteem, and finally, self-actualization needs.
Before that cruise, I had listened to Cameron Herald, whom I’ve interviewed a few times on the Perpetual Wealth Standard podcast. He spoke about the hierarchy of needs. Tom Wheelwright was also on that cruise. Tom has a unique investment philosophy: risk lies in the investor, not the investment. To reduce risk, you must increase control, and to do that, you need to enhance your financial education. That’s when it all clicked for me. I thought, “Hierarchy Of Wealth.” We can use our training as financial advisors, which is still heavily influenced by the modern portfolio theory, to help clients understand their assets. This theory is essentially a balance of risk assets and non-risk assets.
For almost a decade, we’ve used the Hierarchy Of Wealth to help clients understand their assets, whether it’s equity in their house, business, cash assets, high-risk assets, or real estate assets. It provides a snapshot within a four-tier hierarchy, showing the level of risk you’re taking and the return you’re getting. What’s crucial is not just the return of one investment but the aggregate return. It’s about the return on wealth, not just a specific investment.
Wade Reed: I really appreciate that perspective. Many of us tend to focus on the performance of a single investment and assume that’s representative of all our money. We think if one investment is doing well, then all our money should or could be doing the same. But that’s not the reality. Different investments come with different levels of risk and potential return. There’s a hierarchy to the level of return that can be achieved at various risk levels.
04:53 Does high risk equal high reward?
Wade Reed: There’s this common mantra out there that many of us have heard: high risk equals high return. But is that truly accurate?
Patrick Donohoe: When you break it down, risk is essentially the probability of loss. So, if we’re saying higher risk, are we implying a higher probability of loss equates to a higher reward or gain? It feels conflicting and somewhat counterintuitive.
Wade Reed: It’s confusing because, as a society, we’ve largely accepted this notion without questioning it. But in reality, they’re opposites. High risk means there’s a high probability of loss, with a low probability of achieving a high return. When you frame it in this truthful context, it starts to make more sense. Yes, you can take on high risk and have a low chance of getting a high return. But if that’s the case, and the probability is low, then how much of my wealth should I actually allocate to such an investment? And, that’s really the question we want you guys to be asking: what’s the appropriate allocation for that level of risk compared to other types of risks?
05:54 Which free tool lets you visualize your financial risk clearly?
Patrick Donohoe: I believe that once you can visualize your financial situation, it becomes clearer. Now, with our technology platform for clients, we’ve incorporated a digital Hierarchy Of Wealth. This allows clients to place all their assets within this hierarchy, helping them visualize the amount of risk they’re taking in relation to the returns they’re achieving. What’s more, it highlights areas where they can seek better opportunities for returns with less risk. The goal is to increase financial education, which in turn increases control and minimizes risk.
Wade Reed: Absolutely. Our educational platform is designed to provide visual representations of one’s financial life. This way, when seeking investment opportunities, individuals can approach them more strategically. We’ve discussed cash flow in other episodes and the importance of protection. Here’s where they come together: you need surplus cash flow to create a pool for investments. Additionally, you need protection to ensure your basic uncertainties are covered, giving you peace of mind. It’s like having reliable brakes in a car; you can speed up knowing you can stop when needed. When we talk about wealth creation and use the Hierarchy Of Wealth to measure risk, it’s about balancing where within the tiers we can take on risks. Most of us store money in Tier one, getting used to having a cash reserve. This way, we don’t feel pressured to always have it invested and can be more judicious about our education. Listening to this podcast, attending trainings, and reading books on these topics will help in recognizing risks within investment opportunities. This leads to Tier two investments, like employment or business ownership, and then Tiers three and four, where the highest risks and returns exist. These tiers often attract the most attention because of the allure of high returns, but it’s crucial to approach them with caution.
08:38 Why are investors drawn to high-return investments, regardless of risk?
Patrick Donohoe: I’ve seen some really intelligent and seasoned investors make poor decisions when it comes to risk.
Wade Reed: Right
Patrick Donohoe: And, we’ve had some great conversations. On our podcast, as part of the Paradigm ecosystem, we’ve discussed the nature of risk. We all have a natural propensity for uncertainty. If everything in life was calculated and certain, it would be incredibly boring. There’s a thrill in novelty and excitement. I recall the era around 2013-15 when there was this buzz about the Iraqi dinar. The narrative was that if you bought these seemingly valueless dinars, once the U.S. government intervened, their value would skyrocket. Smart people were investing heavily in this. There were other instances too, like the Ponzi schemes that promised to double your money daily. Now, there’s a similar sentiment around cryptocurrency. While blockchain has its merits, the euphoria around crypto is reminiscent of past investment frenzies. Instead of focusing on the specific investments, let’s discuss what makes these opportunities so compelling. Why do people get so caught up in the promise of high returns?
Wade Reed: It’s fascinating because our financial behaviors often stem from deep-rooted traditions. We might be following practices that were relevant a generation or two ago but might not be as effective today. For instance, consider the family tradition of cutting off the end of a ham before cooking. One might do it without knowing the reason, only to find out it was because the family’s pot was too small decades ago. Similarly, in finance, we might be following outdated practices without questioning their relevance today. Our behaviors are driven by a desire for a better future. If someone is willing to take a speculative risk, they believe it might lead to a better life, perhaps a dream vacation or escaping an unfulfilling job. This hope, combined with the allure of becoming, say, a ‘crypto billionaire’, can sometimes lead us to make poor decisions.
Patrick Donohoe: It’s the allure of getting something for nothing. I feel that our progressive society, with its abundance, has reduced the perception of risk and uncertainty, even though they still exist.
14:29 How do certainty and uncertainty affect our outlook on investments
Patrick Donohoe: The principle of uncertainty is fundamentally a human need. Tony Robbins frequently discusses the six human needs: certainty, uncertainty, significance, love, growth, and contribution. We desire certainty in various aspects of our lives, but not in everything. We crave the excitement, novelty, and the unknown of life. That thrill, like the potential of a windfall without the associated stress, can be likened to the allure of the lottery. Investments, too, play a role in this dynamic. And what often happens is that people relinquish control. They lack influence and expertise, so they entrust their hard-earned money to someone else. This delegation of responsibility for growing and managing their wealth doesn’t always end well. History has shown that it can lead to catastrophes, Ponzi schemes, or market crashes. The outcome is often the opposite of the investor’s intention.
Wade Reed: For instance, during the recent pandemic, we’ve observed our clients, who have 401k and IRA investments, experience reductions in value by as much as 50% to 70%. While this isn’t necessarily a “loss” but a temporary reduction in valuation, the emotional toll is significant. The language we use matters. It’s distressing to see the value of our investments decrease, making us feel out of control and fearful. Our brains, in their protective nature, equate this fear with potential threats, even death or despair.
It’s fascinating when you delve into neurology and neuroscience. We realize that our brain’s primitive function to protect us is still very active, even though our frontal cortex allows for more advanced reasoning than in our more primitive days.
Today’s risks are numerous and diverse, but they can be managed, especially with a structured approach like the Perpetual Wealth Strategy and the Hierarchy Of Wealth. It’s not about avoiding risks entirely. I love the thrill of a roller coaster, but I’d only ride one that I’m 99.99% certain is safe. It’s that 0.01% uncertainty, the slight possibility of danger, that makes it exhilarating. But we trust in the thorough evaluations, the braking systems, and the harnesses. All the certainty is in place, allowing us to enjoy that tiny bit of uncertainty, bringing joy and excitement.
Patrick Donohoe: That’s a great example.
17:49 How does Paradigm Life empower you to take control of your financial risk?
Patrick Donohoe: Tools of self-evaluation are crucial. For instance, having all of your assets visible on one page can be enlightening. Our tool, Wealth View 360, available in our portal for clients, provides this consolidated view. It allows individuals to assess their current financial standing and align it with their financial goals. The Hierarchy Of Wealth is particularly valuable in this context.
Wade Reed: Absolutely.
Patrick Donohoe: The Hierarchy Of Wealth tool lets you assess the risks associated with all your investments on a single page. It prompts you to ask: “What risk am I taking for the return I’m getting, and how can I optimize my returns while being conscious of the risks?” Our primary goal is to guide clients towards a strategy that protects their quality of life and fosters a mindset of certainty. When you bring a certain mindset to uncertain situations, the possibilities are limitless.
However, when you’re exposed to risks in investments over which you have no control, it can negatively impact other areas of life that might have led to financial growth. Our focus is to help clients get their cash flow under control. Once you’re saving at least 20% of what you earn, you can then focus on areas where you have influence and can invest to potentially earn more. This could mean hiring someone in your business, investing in a role, or even pursuing further training or certification in your profession to boost your earnings. Right, and the potential benefits of such investments in oneself are significant. By making these strategic moves, you could increase your earnings by five, six, or even 10% per year. When we’ve done the math, the potential for wealth and gains from such personal and professional growth is profound. It’s a multiple of trying to earn ten, 15, or 20% from a traditional investment.
The Hierarchy Of Wealth helps you see and understand the risks you’re taking. The goal is to minimize those risks through education and gaining more influence and control. Repositioning your money to bring more certainty into your life can empower you to pursue new avenues of income production, especially in areas you’re passionate about and have expertise in.
20:48 How personal growth and wealth are interlinked
Wade Reed: As you mentioned earlier, Tom emphasized that risk is in the investor. Wealth truly lies within the individual. It’s about understanding how to create wealth, which is fundamentally about solving problems. If we can address issues and create value in society, that’s where true wealth generation occurs. Why are individuals like Jeff Bezos and Elon Musk so wealthy? It’s because they’ve addressed significant societal problems. The bigger the problem you solve, the larger the payout.
Exactly. If we’re addressing substantial issues for our employers, clients, or customers, we’ll be compensated in proportion to the problems we’re solving. Think about it: if you want to create more wealth, the area where you have the most control is in your ability to generate it. This can be achieved by being a better version of yourself, by seeking further training, or by looking for better employment opportunities that pay more for the same work. Or, within your current employment, you could seek promotions by addressing the challenges of those above you, making them look good, and thus increasing your income.
One thing many people undervalue is the compounding nature of our income. I’ve assisted clients who, over just two or three years, have seen their incomes rise from $60-70,000 a year to $150,000. If you compound that growth over time, it’s a significant increase.
Patrick Donohoe: We’re talking about potentially doubling or tripling what most people get as a standard 3-4% cost of living increase per year. The key is investing in yourself, but specifically in areas where you have genuine interest and passion. Everyone has a unique drive. Many don’t see themselves as assets, but we are the ultimate asset. The wealth you’ve created, the investments you have, the equity positions, and financial products—all of that money came from you. It’s a result of your production. But your capacity to produce income is infinite.
Wade Reed: That’s right. It’s Tier Two in the Hierarchy Of Wealth. As you go through this self-evaluation tool, inputting your financial data into Wealth View 360 and then populating the Hierarchy Of Wealth, you can begin to identify where you’re most effective and where the highest risks lie. This allows you to make necessary adjustments to better position yourself. For many, it might mean shifting from one employer to another, having the confidence to make that move without feeling trapped by funds locked in a 401k, for instance.
Liquidity is essential. If you have cash reserves, it’s easier to make decisions without the fear of what might happen if a new job doesn’t pan out or if unexpected medical bills arise. Having cash on hand provides a safety net. If you respect yourself, you’ll respect your money. And if you value your money, you’ll ensure it’s available for these critical decisions. As you said, we are our most valuable asset. That’s Tier Two. Recycling money between Tier One and Tier Two, storing it in Tier One, ensures that when we’ve maximized our earning capacity, either in our businesses or employment, we can then seek out new knowledge, mentors, and opportunities in other people’s businesses. But it’s crucial to do so judiciously, investing only a portion of our money in line with our overall asset allocation.
25:18 How does whole life insurance enable you to invest in yourself
Patrick Donohoe: One of the things we often discuss, and I’ll use this example, is the Wealth Maximization Account, which is high cash value whole life insurance. It’s truly in a class of its own. It plays so many different roles, which is why it’s sometimes challenging to compare it to a standard investment or savings vehicle. When you’re comparing, you’re often just looking at one characteristic. In the Hierarchy Of Wealth, we consider the cash value of whole life as a Tier One asset because of the multiple roles it plays. It also offers a degree of certainty that’s unparalleled for the return you’re getting.
One of the standout components of this is the ability to have a guaranteed policy loan against that cash value. This can essentially be a funding mechanism for personal or professional development. What’s remarkable is that this loan not only offers low interest but also carries the accountability associated with taking money, investing it, and then replenishing the source, rather than just spending or consuming it.
It’s a profound idea. We’re discussing the high-level fundamental principles of the Perpetual Wealth Strategy without delving deep into the strategy itself. But this gives you an idea of the potential of using this specific vehicle to invest in yourself and potentially other assets that you have influence and control over.
26:47 How does the Hierarchy Of Wealth assist you in minimizing the risk of your returns?
Patrick Donohoe: Wade, the Hierarchy Of Wealth is such a valuable tool. It’s essentially a self-evaluation. When you can see all your assets in one centralized place, it allows for a different perspective.
Wade Reed: Absolutely.
Patrick Donohoe: I’ve had numerous clients who have assets scattered across various accounts, often organized on a spreadsheet. This can be challenging to interpret. The Hierarchy Of Wealth provides a framework where you can categorize your assets in a very protected space. This allows you to see the risks you’re taking for the returns you’re getting. It helps you evaluate opportunities to achieve better returns for less risk or to simply take less risk. The goal is to invest with a mindset of certainty, so you can operate at a higher level and produce more value for the world.
Wade Reed: It seems we often overlook one component when evaluating investment returns: the blended return. This looks at the overall return among all assets in different risk classifications, rather than focusing on one particular high-returning asset. If you consider the blended return, you can ask: “Overall, am I achieving at least X amount?” My observation from my undergraduate days was that larger corporations had about 5 to 10% of their total assets that they could invest in higher-risk funds with higher potential returns. But it wasn’t their entire portfolio. When we structured the Hierarchy Of Wealth, we based it on practices of the wealthiest and most well-run organizations.
Patrick Donohoe: Tier One, for instance, is a measurement of capital that banks have. It’s the healthy area to seek out asymmetric risk-reward. Meaning, you’re not risking much of your overall wealth, but there’s potential for high reward. If it doesn’t pan out, you still have 90% to 95% of your wealth protected.
Wade Reed: Exactly. When evaluating opportunities, I often ask three key questions: What’s the upside? What’s the downside? And can I live with that downside? If you can evaluate based on these questions, you can live with the downside of a 5 to 10% loss. But the upside might be doubling your asset base. This approach, when you look at the overall blended return, supports why we’re willing to accept smaller returns with safer money. A higher return, even with a small percentage, can have a significant effect on the overall portfolio.
Patrick Donohoe: That’s a very valid point. The Hierarchy Of Wealth tool is available to clients of Paradigm Life. If you’re already a client, these new tools are available to you on our portal. To register, click the link above this transcript. For those who aren’t clients yet, you can request a free consultation by clicking the link above this transcript. You will meet with one of our wealth strategists to get introduced to our strategies, especially the Perpetual Wealth Strategy, and see if it’s a good fit for you.