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How to make 7 million in 7 years …

What are the most important lessons to learn about personal finance?

Screenshot 2014-05-21 13.38.29Everybody has an opinion about the most important financial lessons that you can learn about personal finance. Just look at how many personal finance blogs there are [Hint: over 7,000 are listed] … and, here I am adding one more blog to that long list.

What do these blogs suggest? What do they say are the most important lessons that their authors have learned along the way?

Is it to avoid debt? Probably [here are 50 blogs just focussed on debt reduction].

Perhaps, you need an emergency fund? Of course [Googling "emergency fund" brings up 1,050,000 results].

How about spending less than you earn? Naturally [Googling "spend less than you earn" brings up 844,000 results]!

Sure, each of these can be important …

… equally, each of these can actually hurt you!

It all depends on what your ultimate goal is. For me, it’s to live my Life’s Purpose, but let’s just wind that back a little to a more generic goal – one that doesn’t require a degree in philosophy to understand:

The most important financial goals are:

1. Satisfaction – having sufficient money on hand to satisfy your most important needs, and

2. Security – having sufficient surety that your most important financial needs will always be met.

Think about these carefully, as they appear to be similar … but, they are not the same:

One (satisfaction) points to understanding your true needs (physical, environmental, emotional, etc.) and ensuring that you have sufficient income to provide for them, whilst the other (security) points to forward planning of the cash-flow required now, whilst you are working, and in the future, when you are not.

And, financial satisfaction & security is only really achieved when you have:

1. Sufficient money invested to safely fund your required lifestyle (not to be confused with your current lifestyle) – by a date of your choosing and for the rest of your life – without needing to work, and

2. Sufficient cash buffer to ensure that you can maintain that lifestyle for a reasonable period should something go wrong (market corrections; real-estate vacancies; etc).

EVERYTHING else that you do (financially-speaking) has to take you closer to achieving the above.

To illustrate the importance of this, let me give you three examples:

1. If you are young (say 25), happy to work in your current profession for the next 40 years, and living a frugal lifestyle is sufficient to satisfy your needs for the rest of your life, then financial security can be easily achieved for you simply by saving the equivalent of half your current after-tax salary (indexed for inflation) until you retire.

Of course, it would help if you avoid piling up debt, and put in place the necessary insurance (incl. an emergency fund), in case of any glitches along the way; in any event, most such issues will likely be nothing that another 4 or 5 years of hard work can’t resolve.

2. If you are in your 30’s or 40’s, entrepreneurial, and have desires in life that only early retirement can satisfy (e.g. you want to be a full-time artist; writer; traveller; and, so on), then you simply won’t be able to save enough to maintain the security of your lifestyle when you stop work in 5, 10, or even 20 years (even if you somehow manage to save 25% – 50% of your salary, accumulate no debt, and build up a huge emergency fund).

So, you will need to take my path: focussing on growing income first, then saving second (e.g. simple math shows that investing 25% of $250k a year will get you much further than saving 50% of $50k a year). Starting a business and actively investing as much of the proceeds as possible into real-estate, stocks, and bonds (rather than in your own lifestyle) has a better chance of taking you to an early, self-sustainable retirement [a.k.a. Life After Work] than any amount of debt reduction, emergency fund building, and so on.

3. If you have retired early (or late; it doesn’t matter), you are pretty much stuck with whatever level of lifestyle you have been able to satisfy from the retirement nest egg that you have built up … now, the main financial goal you need to focus on is security.

My recommendation is to now focus purely on capital protection and income:

Purchase real-estate outright and live from 75% of the net proceeds, and keep 2 years cash as an emergency fund, or purchase inflation-protected federal treasuries. Forget stocks; you will put too much strain on your heart and psyche as you watch your net worth double and halve every 7 to 10 years. That’s pretty much it.

So, when people tell you their ‘Top 10 Strategies for Financial Health’, ignore them …

… any such set of strategies is meaningless unless you can first put them into context:

How do they help you achieve your desired level of financial satisfaction and security?

I am 21 and clueless …

Screenshot 2014-05-21 12.37.01This is quite typical of the types of questions that I receive from time to time:

I’m 21, and am clueless about finance. I want to start up a business at my mid 20s. Should I opt for endowment plans or unit trust?

The first thing you’ll notice is that there are no further details, as though there’s a ‘pat’ answer for every clueless 21 year old.

Still, let me suggest the following if you are 21 years old and also want to start a business ‘one day':

1. If you consider yourself clueless about personal finance, start by reading everything you can.

Since you are young, start with I Will Teach You to Be Rich – I was weaned on a diet of Rich Dad Poor Dad, The Richest Man in Babylon, and so on …

Warning: The important thing to note is that these books are only to whet your appetite, they will  NOT make you rich … once you reach a certain point, much of the advice will have to be discarded.

2. If you want to start a business in your mid-20’s the best way to prepare is by starting one now:

It doesn’t matter if the business is successful or not, the idea is to learn by doing.

While you are studying, you can easily start an online business: become an eBay seller; start a drop-shipping business; write a blog about your passion (or, perhaps about your financial journey) and package up some of the posts into a series of information products that you can sell.

3. If you are worried about company structures, don’t!

Just get started … and with your first $1,000 in savings (from 1.) and/or earnings (from 2.) see an accountant and do what they suggest … this isn’t the place for such technical advice.

If you do these simple things, you will be financially better off than 99% of your peers within years, if not months, and should remain so for the rest of your life.

Why?

Because they will remain clueless, whilst you will not ;)

Advice for a new multimillionaire …

shoppingI realized that I’ve been talking a lot on this post how to become a multimillionaire, but I haven’t talked a lot about what to do when you get there!

Let me rectify that right now: for my first example, take this young (and, new) multimillionaire:

What advice can you give me, as a new 32-year-old multimillionaire, that you wish you had known at that age?

Firstly, I told her, don’t overestimate your wealth …

Spectrum (a Chicago-based consultancy that specializes in understanding the High Net Worth individual and family) surveyed a number of people whose net worth was in the $1m, $5mill, and $25m+ ranges about how much money that they would need in order to feel wealthy.

Almost invariably, the answer was: “about double”.

Having lived through the ups and downs of wealth, I think I understand the reason: wealthy people spend capital. What they should be spending is income.

That’s another way of saying that it’s very easy to live beyond your means no matter how much money you have.

Here’s how to control your wealth:

1. Take your capital and divide it by 20. That’s roughly how much you have a year to live off (if you’re going to live on bonds and savings, well, divide by 40 instead).

2. Invest 95% of the capital as though it’s the last money that you will ever see (because, it most likely is).

3. Be Rent Wealthy, not Buy Wealthy. Rent Wealthy means that you rent what you need: want to holiday in Aspen? Rent a villa … but do not, under any circumstances, buy one. Want to travel? Go First Class but do no buy the plane!

[Note my rule on personal 'capital purchases' (eg houses, cars, boats, etc.): only buy something when it makes absolutely no sense not to]

4. How you invest your money during Life After Work (a.k.a. early retirement) is VERY different to how you might invest your money while you’re still trying to build your fortune:

– Pre-retirement investments include: businesses, francises, property development, share trading, and so on.

– Post-retirement investments include: TIPS (inflation-protected bonds); dividend stocks; 100% owned commercial real-estate, and so on.

Not many people can make the mental switch from high-flying entrepreneur/investor/big-wig to conservative investor … in order to survive post ‘Your Big Windfall Event’ you’re going to have to make the switch.

Debt free or financially free?

A recently-graduated student asks:

What would be a better investment than paying off $30K of subsidized low-interest student loans?

Money available: 30k
Interest on subsidized student loans: 3-4%
Principle: 30k

Do I pay them off, or look for a better investment, and keep the spread? What would be a better investment?

If you’re also trying to decide whether you should pay off debt or start investing, here’s what you need to decide right now:

Do you want to live debt free or do you want to live financially free?

If you choose the former (debt free), you may make some GREAT investments: eg paying off your 19% credit cards (probably the best investment you will ever make in your life; avoiding this kind of debt will be your second best investment).

But, if you blindly pay off ALL of your debt, you will also make some TERRIBLE investments: eg paying off your student loans will only ‘return’ 3% – 4%.

So, let’s list all of the debt (and their interest rates) that you may have on one sheet of paper, and all of the investments that you may like to make – with their likely (historical) returns – on another.

Now, on a third sheet of paper, put the items from BOTH other lists into one new list, strictly in descending order of interest rate and/or return.

THAT’S where you should allocate your money … from the top down.

Here’s a practical example for you:

Your current student loans are costing you 3% – 4%, and I presume you have no other debt (or, I assume you would have mentioned it).

The Dow Jones (i.e. the top end of the US stock market) has NEVER had a 30 year period where it has returned less than 8%.

So, provided that you are in this for the long term …

Put your money into a low-cost index fund, until you learn the skills to reliably invest at even greater long-term returns than 8%.

What do you do with the student loans? Pay them down slowly (safest) or let them sit until you have to pay them off (more risky).

Now, that’s how to start the process of becoming financially free.

How lucky are you?

luckyMy son and I had a great time in Washington (where he was competing in a student entrepreneurship competition); the life of an entrepreneur can often be a lonely one, so it was good for my son to meet others following the same ‘student entrepreneur’ path.

The trip got me thinking about the interrelationship between ‘luck’ and ‘success’ …

It’s clear to me that the most successful – and, wealthy – people of all ages are indeed lucky … certain things had to go ‘just so’ in order for that big breakthrough to be made.

BUT, I think the luck factor is a rear view mirror effect

… that is, if you position yourself for success, the luck will come but you won’t know exactly when or how.

Richard Wiseman a researcher in the field of luck (he wrote a series of books on the subject) says that lucky people generate good fortune via four basic principles:

1. They are skilled at creating and noticing chance opportunities

2. They make lucky decisions by listening to their intuition

3. They create self-fulfilling prophesies via positive expectations

4. They adopt a resilient attitude that transforms bad luck into good

I’m not sure that this is the same as visualization techniques (a la The Secret), I just think it’s a difference in attitude.

In this context, Richard gives some advice on how to turn your luck for the better:

Unlucky people often fail to follow their intuition when making a choice, whereas lucky people tend to respect hunches. Lucky people are interested in how they both think and feel about the various options, rather than simply looking at the rational side of the situation. I think this helps them because gut feelings act as an alarm bell – a reason to consider a decision carefully.

Unlucky people tend to be creatures of routine. They tend to take the same route to and from work and talk to the same types of people at parties. In contrast, many lucky people try to introduce variety into their lives. For example, one person described how he thought of a colour before arriving at a party and then introduced himself to people wearing that colour. This kind of behaviour boosts the likelihood of chance opportunities by introducing variety.

Lucky people tend to see the positive side of their ill fortune. They imagine how things could have been worse. In one interview, a lucky volunteer arrived with his leg in a plaster cast and described how he had fallen down a flight of stairs. I asked him whether he still felt lucky and he cheerfully explained that he felt luckier than before. As he pointed out, he could have broken his neck.

Hopefully, reading this blog is one giant step along the path to making you a lucky person, too :)

Speculating on stocks; how much is OK?

Twitter IPOAs I mentioned in my last post, my 19 y.o. son’s online business is doing quite well …

… well enough for him to start thinking about investing in stocks. Or, real-estate.

But, right now, he’s thinking mainly about stocks.

Unfortunately, his thoughts are more towards Tesla and Twitter than GE and Unilever.

At least, he knows they (TSLA and TWTR) are speculative ;)

So, this is how the conversation went:

AJC Jr: I want to invest in Twitter. How much should I invest? I have quite a bit set aside …

Me: How much you have to invest is the least important part of your decision-making process.

AJC Jr: Oh! What’s the most important part, then?

Me: Well, son, you’re considering speculating in a technology stock that could go in any direction. How much to invest actually depends mostly on how much you’re prepared to lose?

AJC Jr: Hmmm. In that case, I think I’m prepared to lose $10k.

Me: OK. Now, how far do you think the stock is likely to fall.

AJC Jr: I think it’s going to go up!

Me: Of course you do ;) BUT, if it does fall, how far do you think it will go … worst case?

AJC Jr: If I wait for a while – for all the IPO hype to die down – and buy Twitter at more reasonable $30 a share, then I think the most it will go down is $10.

Me: In that case, if you are prepared to lose $10k and you only think the stock will drop by 1/3 worst case, then you could invest up to $30,000.

AJC Jr: But, I could afford to invest a lot more in stocks!

Me: Sure! Just not in risky stocks … and, not more than $30k in Twitter. Now, take look at this stock chart for a nice, safe, boring trash dumping company I’m considering investing in …

When investing, decide if you’re in it for the long-term, or if you are simply blindly following some boom/bust tech trend; if the latter, look at how much you’re prepared to lose and make your decision on how much to invest based on that.

 

The New-Age Lemonade Stand …

Lemonade StandPeople think my son is following in his father’s footsteps …

… but, I didn’t even think about beginning my entrepreneurial journey until I was 26 (and, didn’t actually start until I turned 30).

My son, on the other hand, started his entrepreneurial journey when he was 12.

Whereas most children begin by starting a newspaper delivery round, or opening a lemonade stand – although, at age 10, he wanted to start a cake shop outside his grandmother’s house (naturally, she would bake, he would sell) – my son was a little different:

At 12 years old, AJC Jr came to me and asked for $50 to start his new business on eBay. He offered me 49%. I accepted, just to see what would happen.

And, something did happen: a week later a package from China arrived at our front door, and over the next week a few smaller packages left the same way.

Two weeks later, my son came to me and said “here’s your $50 back” … he bought me back out!

[I didn't have the heart to tell him that it doesn't work like that. That's probably the only non-commercial assistance that I've given his business in the last 6 years].

Since then, after growing his eBay store for 3 or 4 years, my son ‘graduated’ to an online service-based business that nets him in excess of $60k p.a. (turning over $100k++ p.a.) and has bought him a car whilst still in high school.

He contracts programmers in India and has 2 full-time customer service contractors in Manila. One of them just sent him a Christmas present and a card thanking him, saying that – because of my son – he can now fulfil his life ambition of opening up his own coffee shop.

Not only is my son setting up his own life, he’s changing other people’s lives already … and, he’s just finished high school.

With luck, and your encouragement and support (but, NEVER, EVER push) your children may embark on a similar journey … after all, the barriers to starting a business (i.e. by going online) have been lifted.

Why should your entrepreneurial child start a mere lemonade stand, when any child can now start an online marketplace for anybody who wants lemonade and anybody who can make it (or supply the ingredients and know-how)? ;)

How to catch a monkey …

Screen Shot 2013-11-06 at 8.59.32 AMI’m always amazed by people who think that they can make ‘quick bucks’ (or, its sister currency: ‘easy bucks’) just by fiddling with paper …

… if trading stocks, options, FOREX, or commodities is something that you really want to do, I should at least teach you all that you really need to know before you begin.

And, it all has to do with catching monkeys …

But, rather than hearing it from me, far better to learn from the masters at Goldman Sachs, whom – or, so I am told by a very unreliable source – share this story with every new hire on their very first day of training:

Once upon a time in a village, a man announced to the villagers that he would buy monkeys for $10 each. The villagers, seeing that there were many monkeys around, went out to the forest and started catching them.

The man bought thousands at $10 and as supply started to diminish, the villagers stopped their effort.

He further announced that he would now buy at $20 each. This renewed the efforts of the villagers and they started catching monkeys again.

Soon the supply diminished even further and people started going back to their farms. The offer rate increased to $25 for each monkey captured and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!

The man now announced that he would buy monkeys at $50!

However, since he had to go to the city on some business, his assistant would now buy on behalf of him.

In the absence of the man, the assistant told the villagers, “Look at all these monkeys in the big cage that the man has collected. I will sell them to you at $35 apiece and when the man returns from the city, you can sell each monkey back to to him for $50 each. He’ll be none the wiser and we’ll all have made some easy money!”

The villagers squeezed together all their savings and bought all the monkeys.

Then they never saw the man nor his assistant again … of course, now there were monkeys everywhere!?!

That’s how trading really works; welcome to ‘Goldman Sachs’!

[Source: http://www.quora.com/Jokes/Which-are-some-of-the-most-profound-jokes-ever/answers/1170178]

So, before you begin trading, consider this:

EVERY trade is two-sided.

This means that if you WIN some other shmuck has to LOSE. Sounds a bit like a poker game, doesn’t it?

If you agree, it would be wise to remember a very important saying in the world of professional poker:

If you can’t see who the shmuck is at the table … it’s you!

So it goes with trading: for every trade there is a counter-trade, and it’s probably being made by somebody with more experience than you …

… since so much institutional money passes through the various markets each day your ‘adversary’ is most likely a professional investor.

Now, let me ask you:

Would you play heads up poker with a professional poker player for anything other than the learning experience or fun?

Or, do you  really think you can turn a long-term profit catching monkeys? ;)

Investment logic gone askew …

Whilst I was traveling, I hope that you had a little time to reflect on some of the advice that I’ve been dishing out over the last few years?

It’s important that you don’t just follow my (or anybody’s) advice blindly, else you may end up making some fatal logic errors like this poor bloke:

Suppose I have 100K in an index fund that has a ten year return of 7.4%, a five year return of 8.2%, a 3 year return of 17.5%, and a 1 year return of 24.76%.  That is a pretty dependable return over the last few years, but it will probably not keep up with the 24.76% return, but will probably maintain at least a 7% return over the next year.  So I assume that 7% return.

I want to buy a car for 100K.  I can take money out of the index fund to buy the car, and give up $7000 over the next year.  I can borrow money at 2% and pay $2000 in interest over the next year.  If I choose to pay cash, I lose $7K, but if I borrow and leave my own $100K in the mutual fund, I pay $2K and earn $7K, for a net gain of $5K.

So my logic says that paying cash for anything when the investment return is higher than the interest rate is a mistake.  Suze Orman won’t give me advice on this, so if my logic is off, I hope someone will show me better logic.

Have you spotted the flaws?

Well …

The principle of taking a 2% loan on the car so that he can invest at 7% elsewhere is sound, BUT his assumptions are wrong:

1. A low-interest car loan is generally subsidized by price.

Check the true rate, if it’s more than 2% then he is probably better off negotiating the cash price lower THEN doing his cash v finance analysis.

Screen Shot 2013-09-10 at 11.08.38 PM

[Source: http://www.bankrate.com/]

2. Unless he’s planning on a 7+ year auto loan, the correct comparison is the finance rate on the loan against a CD for the same term.

This is because the stock market is way too volatile and he needs an investing horizon of at least 7 – 10 years before returns even approach ‘normal’.

Screen Shot 2013-09-10 at 11.00.27 PM

In fact, even though this chart doesn’t show that time period, he needs at least 30 years (based on nearly 100 years of data) to ‘guarantee’ at least an 8% return (the worst thirty-year period delivered an average annual rate of 8.5% between 1929 and 1958).

3. Your past returns are NO predictor of future performance:

His ~25% of last year could just as easily be a LOSS of 48% next year. Look what happened in 2008:

crash_of_2008

But, he redeems himself, somewhat:

The same logic applies to my mortgage: I pay 2.62% on my house.  I could pay it off, but taking the money out of an international fund with a one year return of 22.85% would result in a net loss of $100k over the next year (moving $500K from an investment at 22.85% to pay off a $500K balance at 2.62%).

4. On the other hand, his mortgage comparison is ideal:

If you can lock in a 3o year mortgage, fixed at today’s ridiculously low rates, and lock that money into a low-cost index fund for the same period then, yes, you are almost assured of a 3%+ net return, compounded for 30 years (which means that he should almost return 1.5 x his initial investment PLUS whatever profit he makes on your property).

That’s why real-estate is such a great long-term investment, and why the stock market is a terrible short-term gamble.

What advice would you give?

 

A 10 minute primer on how to get rich?

primerOn Quora, somebody asked for “something I can learn in 10 minutes that will make me rich?”

The obvious answer is: “not much”.

But …

… this is my blog, and I’m up for a challenge.

In fact, I think you can learn pretty much everything that you need to learn about getting rich in just 10 minutes.

Unfortunately for me, if I’m right, you’ll know everything you need to know in just this one post, so you’ll have no need to keep reading …

… and, if I’m wrong then you’ll simply delete your bookmark to this blog, as it will prove I can no longer deliver.

It appears that I lose either way ;)

Even if this puts this blog out of business, I’m willing to take the 10 Minute Challenge because it also puts every other best-selling ‘get rich’ spruiker – and, let’s face it, most of them are crooks – out of business, as well.

And, that’s worth the sacrifice …

So, here goes:

I think the number one thing that you can learn in 10 minutes is: “what is your Number?” … in other words, how much is ‘rich’ for you?

For example, think about how much annual income you would need (start with $250k p.a. and work your way upwards) and multiply that number by 20.

[AJC: the question was about "rich", so the answer needs to be $5m to $10m++ ... but, this exercise is still valid even if your Number is based on 20 times $50k or $100k]

Once you have that Number in your head, think about how long you are prepared to wait before becoming ‘rich’ (if you are prepared to wait more than 5 to 10 years, surely you can give this exercise longer than 10 minutes)?

Once you have those two numbers, a few minutes playing with this Compound Annual Growth Rate calculator will tell you what % return you need on your investments each year, over that time frame.

Finally, 30 seconds with this chart will tell you everything that you need to know about how you can get rich, which was your original question:

[Source: Seven Years to Seven Figures: The Fast-Track Plan to Becoming a Millionaire (Agora Series): Michael Masterson: 9780471786757: Amazon.com: Books]

Now, as promised, this really is everything you need to know in order to become rich …

… but, I’m not worried about losing readers, because – now that you know what to do – you’ll want to bookmark this page so that you can keep reading to learn how to do it ;)

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