Do you have a “play money” allocation in your investment portfolio?
These are effective ways to build wealth over time via continual additions and compounding. They’re also rather boring, and there’s absolutely nothing wrong with that.
Some people crave a little excitement or a chance to make outsized gains, however, and that’s where the concept of play money comes into play. Who knew investing could be fun?
What is Play Money?
I view play money as investments you make that deviate significantly from what you own in the bulk of your portfolio. Ideally, it’s a fairly small allocation, although I feel it’s reasonable to increase the percentage as your net worth increases, particularly when you’re financially independent and then some.
What constitutes play money will vary from one investor to another.
If you’re invested 100% in index funds, you might consider your first passive real estate investment to be made with play money.
If you invest primarily in real estate, your play money might buy a handful of individual stocks.
You might put some play money into starting up a small business for yourself or to help a friend or family member realize their dream of becoming a business owner.
When a physician-turned-blogger invests (speculates, actually) in a pre-seed round for a digital token associated with a foreign social media app, that is most definitely done with play money.
There’s no one correct answer here. What feels like a safe play to one person might represent a risky departure from the norm for another.
Benefits of Play Money Investments
In the examples above, a unifying theme is that play money tends to be invested into assets that carry more risk.
As an investor, why would you take on additional risk? For the potential of additional rewards, of course. If the small business takes off, your stock picks are stellar, or your farmland is fruitful, you can expect to earn higher returns with your play money than you do in the rest of your portfolio.
Risk is a double-edged sword, though, and there’s a reason play money should represent a small fraction of your overall investments. One should accept the fact that any play money investment could go to zero. If you can’t afford to lose the money, you shouldn’t be playing around with it in the first place!
When your play money bets do pay off, though, they can pay off handsomely. With stock index funds, you hope to continue the past performance of about 10% nominal returns going forward. With leveraged real estate, low double digit annual returns are solid.
Investing in a small business, a more mature startup, or the right digital asset can lead to 10x or 100x returns in a matter of months or a few short years. You have to enter and exit at the right time, and luck and chance play a role here, but there truly is the opportunity to strike it rich if your money is in the right place at the right time and you make a successful exit.
Is play money just gambling with higher stakes? That depends. Generally, gambling is a little worse than a zero-sum game. The average player has to lose money for the house to profit.
That’s not exactly the case with most play money investments, as new businesses can flourish as new markets are created and new use cases are discovered. On the other hand, some of these segments are rife with scams, and Ponzi schemes haven’t gone away.
There’s obviously a range of risk here. Choosing a half-dozen individual stocks or investing in a pre-vetted real estate syndication are not as risky as going all in on a $hitcoin and hoping to sell all after the pump but before the dump.
Again, when taking a chance on a risky asset class, always invest with money you can afford to lose.
How Much Play Money is OK?
The more money you have, the more money you can afford to lose. Along those lines, the younger you are, the better able you’ll be to recover from financial loss.
A good starting point is to limit play money to no more than about 5%. The riskier the assets you seek, the smaller that allocation should be. The bulk of your portfolio should be in tried and true investments with decades or centuries with a solid track record (stocks, bonds, real estate).
Want to bump that up to 10%? I don’t think that’s an unreasonable number. Factors that favor a higher play money allocation:
- High risk tolerance
- Lower-risk play money investments
- High Salary
- Competitive Advantage (knowledge, experience)
If your tolerance for risk is high, losses should faze you less. If you’re young and/or earning a great income, you’ve got the time and ability to recover.
If you’re relatively wealthy, you’ll probably still consider yourself wealthy with 10% less. A competitive advantage in the space you’re investing in can increase your likelihood of making successful investments with your play money.
Play Money and Financial Independence
Once you’re beyond financially independent (FI), that is, you have all the money you and your family will need to last a lifetime, I grant you permission to increase your play money even higher.
You don’t want to lose your FI card, so don’t play with the money that’s earmarked to provide for the rest of your lifetime. Based on safe withdrawal rate studies from ERN, Dr. Bill Bengen, Trinity College, and others, I’d say it’s advisable to have 25x to 33x your anticipated annual spending invested in 60% to 80% stocks with 20% to 40% bonds. Plus or minus real estate, adjusting the other percentages accordingly.
Any portion of what’s left over after setting aside your 25x to 33x, up to 100% of the additional money if you love to play the game, could be considered play money. If we accept the definition of play money to be money that you can afford to lose invested in assets with a higher risk/reward profile, you could choose to have a whole lot of play money.
For example, if you accumulate a portfolio worth 100x what you spend in a normal year, with a 1% withdrawal rate, you could consider 50% of your portfolio to be play money while ensuring an ultra-low 2% withdrawal rate even if you were to lose every last drop of play money to woeful investments. As much as 75% of your portfolio could be considered play money in this scenario.
Ideally, you wouldn’t risk half or three-quarters of your wealth in a way that it could realistically drop to zero. I believe there’s definitely a role for diversification even within your play money allocation. An angel investor might invest in ten startups, and if one or two do really, really well and the other eight tank, she could be a very happy gal.
Dangers of Play Money
Perhaps the worst thing that could happen with your first play money investment is that it works out extremely well. If you get a 10-bagger or 100-bagger ( meaning you 10x or 100x your initial investment), you might think you’ve got the Midas touch.
This hubris could lead to bigger bets with more at stake. You might find yourself in a position with unlimited downside. You can lose a lot more than 100% of your money with a naked call option, for example.
Some people invest far too much money in what I would consider to be “play money.” Some small businesses may sound like a sure thing, but that doesn’t mean you should invest the bulk of your retirement money in one. Yet, that’s exactly what some people do, including the father of a friend of mine. The business failed.
It’s important to limit your play money allocation, especially when you’re older and have fewer years to make up for mistakes. It’s equally important to recognize when a potential investment is a high-risk play money investment. Investing too much while underestimating the risk is a great way to torpedo what could otherwise be a comfortable retirement.
My Play Money Allocation and Investments
When I learned what financial independence was in late 2014, I realized that my family and I were already FI based on our spending at the time. In the interim years, I’ve continued to earn a good living and our investments have performed quite well.
If we were withdrawing from our portfolio rather than adding to it, our withdrawal rate would be under 2%. In other words, we could use half of our portfolio for play money without violating the 4% rule of thumb for a secure retirement.
Now, I’m not actually investing 50% of our money in high-risk assets. I got to where I am today by investing in diversified funds holding primarily U.S. stocks, and that’s what makes up the bulk of our portfolio today.
When I made my first investment in private passive real estate, I considered that to be play money. It was a significant departure from the way I had been investing.
Now that I’ve had a half-dozen or so deals go full circle, with no capital losses and primarily strong returns (with a range of 2.5% to 54%), I no longer consider that asset class to be play money. It’s about 10% of my portfolio and I plan to increase that to 20% over time.
I’ve invested play money into two startup breweries. One gave me equity and that deal has gone full circle. The other investment was a loan which remains outstanding, and I’ve been collecting dividend payments in the form of 15.5 gallons of beer per year. These investments gave me a taste of the fun one can have with play money (and the taste of hoppy deliciousness).
Adding up the “play money” investments I’ve made over the past couple of years, the amount I’ve invested adds up to about 10% of our overall portfolio, although if I were to mark up a couple of the following investments to current valuations, the percentage would be much higher.
Until 2021, I had no real skin in the cryptocurrency game, but I wanted to profit from its success. Rather than picking a coin, I picked an exchange, investing in one of the world’s largest crypto exchanges.
The reference I made to the digital currency? Yes, I recently made a small speculative investment in a token, a digital currency used in a booming Asian social media app. I’ve also invested directly in the company that produced the app.
You could call me a space cadet, too, as I’ve got my head in the clouds with two investments in aerospace companies. Both will be in the news with launches in the coming weeks.
These investments were all made in private companies that are not yet (and may never be) publicly traded. Remember, this is play money. If one or more of these mature startups do go public, I will likely receive a nice multiple on these play money investments, even if one or more fail.
I own three of the four in a self-directed Roth IRA, set up via Rocket Dollar. If you choose to work with Rocket Dollar, you can save $50 on the setup fee using promo code Physician.
I made each of these investments on the Republic.com platform, a company in which I have some equity (another play money investment of mine). Most were made via Republic Capital, which is for accredited investors only, and I’ve also made a small investment in a canned cocktail company on Republic.com, where accredited investor status is not required to invest in newer startups at much smaller minimums (typically $100 to $1,000).
I’ve taken some chances, had a little fun, and I’m hoping one or two of these will pay off big time. That’s the idea behind play money!
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Do you invest with play money? How much money do you allocate to these types of investments?