I’m going to do TWO things today that I don’t normally do …
1. I’m going to review a book, and
2. I’m going to do it by using a review of that book on another blog (The Simple Dollar, a Personal Finance blog that I happen to like … a lot)!
Why?
The book review outlines some of the ‘secrets’ suggested in the book … and I would like to give you some insight into how I think …
… so, here goes (everything in italics is from the blog post):
Ordinary People, Extraordinary Wealth pledges to contain “the eight secrets of how 5,000 ordinary Americans became successful investors – and how you can too.” Intriguing subtitle. I can’t wait to dig in, so let’s get started. Looking Into Ordinary People, Extraordinary Wealth:
Secret #1
They carry a mortgage on their homes even though they can afford to pay it off.
Edelman basically argues that the concept of a mortgage being a bad thing is a relic of the 1930s, where banks would foreclose on a house on a whim, and the negativity associated with mortgages has hung around this long even though there are a lot of protections for the borrower today.
I bought my most recent house without a mortgage … I had plenty of cash, but I simply plonked it down. But, I have two rules around this:
1. The 20% Rule – never have more than 20% of your net worth invested into your house at any one time; for MOST people this means that you will HAVE to take out some sort of mortgage, and
2. Even if you meet # 1. (I do … most people don’t) don’t be afraid to use up to 50% of your home’s equity to support other buy-and-hold investments.
So, recently I took a $1 mill. line of credit on my home (about 50%) to plonk into my Scottrade account (I use margin lending in there, as well, so I am really taking some additional risk with my home equity that I shouldn’t be taking).
Secret #2
They don’t diversify the money they put into their employer retirement plans.
The subtitle struck me as quite odd at first, as it seems to fly in the face of common sense. Edelman’s advice, though, is actually pretty common – put your retirement money into a diversity of stocks. In other words, select an index fund or two of stocks in your retirement plan and just dump all of your savings into it.
Firstly, 401K’s are a tool of the poor: if you are young, you want to invest as much as you can outside of your 401k so that you can exert some control (a self-directed fund is another matter entirely – PROVIDED that you borrow money against your invested equity to leverage into investments).
And, if you are old, you should have so much money in outside investments that your 401k is just icing on the cake (I confess that I have NO IDEA how much is currently in my 401k-equivalent).
Secondly, diversification is also a tool of the poor and uneducated; even Warren Buffet recommends low-cost Index Funds over other forms of investing for the uneducated … but Warren doesn’t diversify. Neither do I.
Secret #3
Most of their wealth came from investments that were purchased for less than $1,000.
Basically, Edelman states that people who became wealthy did it not by having a ton of money right off the bat. Instead, they just invested a little bit at a time – less than $1,000 a pop. They just did it regularly.
Hmmm … this is a hit-or-miss one for me; a LOT of my money came from businesses that I started with No Money Down. But, a lot came from other investments, as well … most recently an office building that I bought for $1.4 million (25% down) that sold for $2.4 million less than 5 years later.
Secret #4
They rarely move from one investment to another.
The question then becomes what should one invest in? Edelman doesn’t offer a direct answer here, but does suggest that the only clear way to lose is by rapidly shuffling your money around from investment to investment. The route to success is to buy and hold, not to move like a jackrabbit from investment to investment, losing most of your gains to brokerage fees and taxes.
Another strange one …. you see, to me the VERY DEFINITION of INVESTMENT is something that you buy-and-hold … that’s the strategy that I use in two different ways:
1. To Get Rich Slowly (but surely), and
2. To KEEP my money, once I’ve made it.
But, you can’t just save your way to the sorts of investments that will make you rich; you need to find the money to make those Buy-and-Hold investments by INCREASING YOUR INCOME.
Other than getting a pay rise, working overtime, or holding down 2 or 3 jobs (all of which suck, if you ask me … especially the pay rise if it requires grovelling for 18 months to get it), ONE WAY that I can think of to increase your income is to TRADE …
… that means rapidly moving in/out of ‘investments’ such as stocks (trading stocks or options) or real-estate (flipping). It’s not really INVESTMENT … if it’s RISKY, it’s BUSINESS … but you have to take some chances along the way IF you want to get rich.
Secret #5
They don’t measure their success against the Dow or the S&P 500
Instead of using various metrics like the NASDAQ to judge their investment success, they look instead at whether or not their investments are actually achieving the results they need in their life. So what if the S&P 500 has an up or a down day? What’s actually important is that your investments are giving you the returns you need.
Couldn’t agree more; I have more than $1 million invested (or trading in/out) in the market at any point in time and I don’t track the indexes other than to assess the MOVEMENT of money in/out of the market AFTER the fundamentals tell me that I am ready to buy (or sell).
Secret #6
They devote less than three hours per month to their personal finances.
I think this concept relates very well to the “training wheel” conceptI talked about a while back. Basically, Edelman is correct in stating that the people he’s talking about do spend three hours or less a month on their personal finances, but these are people who already have a firm grip on their financial state.
I’m a terrible budgeter …. I’m probably the only multi-millionaire who ever had their American Express card taken away from them for forgetting to pay the bills (really!) … not highly recommended, but if you increase your income and invest well, personal finances actually take a back seat (and, my wife now controls the houshold accounts!).
Even when I was starting out, I only ever did one budget … actually, I tracked EVERY SINGLE EXPENSE for just one month … that was enough to tell me where I was and I already knew where I needed to go.
Secret #7
Money management is a family affair involving their kids as well as their parents.
If there’s one point that Edelman really hits out of the park in this book, it’s this one. You’re doing nothing but hindering your children’s financial education by keeping them oblivious to money.
My wife and I started teaching our children about money very early and I’m happy to say that they both understand the basics, saving 50% of their pocket-money and only spending what they need to.
My 13 y.o. son seems to have an entrepreneurial-flair having his own successful eBay business (he earns more from this than his pocket-money brings in) and even runs his own books and accounts (using Quickbooks). He researched this and set it all up himself … other than gentle encouragement, I can lay no claim to his success 🙂
Both our children know that they will need to find their own way in the world … we will nurture and educate, and that’s about it (financially).
Secret #8
They differ from other investors in the attention they pay to the media.
In other words, they ignore the talking heads on CNBC or the thousands of stock tips floating around out there for the most part. Why? Because it’s information overload and it’s not particularly useful to most of the people Edelman interviewed for this book.
I don’t read the financial press … too boring.
Anyway, to make money, you need to be contrarian (BUY when stuff is cheap … ) … you can only do that if you have the guts to buy when everybody else is lining the windows to jump off the ledge.
How do you match up against the Edelman ‘secrets’?
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I am digging the 20% of your net worth rule…and as a result eager to invest the remaining 80%. I obviously have not followed this rule with previous purchases of my primary residences in the past but realize that I am indavertantly at that point. I often flirted with the concept of continually rolling over all of my net worth, from proceeds of a home I sold, into a new home but this rule has been an eye opener, puts it in prospective, and one I have not found in previous readings. However, having said that, you indicated that your house is paid for in cash and you chose to use 50% of your equity, via a line of credit, to invest. What are the advantages of using a HELOC as opposed to a 30 year fixed to accomplish the same goals?
love “the simple dollar” too, great blog but I read this one because I understand you have to take risks.
really enjoyed the post, couldn’t agree more.
Thanks, RDiN. If you are in the Making Money 301 (i.e. keeping your wealth) stage and can (a) afford to pay cash for your house and (b) still fit into the overal 20% Rule then, apply this advanced rule: borrow at least 50% of the equity of your house for investments.
I read the 20% rule recently in an obscure book, found I was meeting it, then found it matched up with the Benchmark in the new book about the wealthy called ‘Get Rich, Stay Rich, pass It On’.
The 50% Rule is my own ‘twist’ …
… it avoids having ‘dead money’ tied up in your house … as to how to borrow LOC or Fixed 30 years: depends upon age and liquidity req’s (I use a floating LOC for my home but try to ‘fix’ all my other real-estate investments).
… and, thanks for your comments, too, Joshua.
A very provocative post. I like your take on Edelman whom, admittedly, I have only glanced at. I like the comments on all except 2. On this I just wanted to nuance some of your language a bit and ask for further elaboration. You write:
“Firstly, 401K’s are a tool of the poor: if you are young, you want to invest as much as you can outside of your 401k so that you can exert some control (a self-directed fund is another matter entirely – PROVIDED that you borrow money against your invested equity to leverage into investments).
And, if you are old, you should have so much money in outside investments that your 401k is just icing on the cake (I confess that I have NO IDEA how much is currently in my 401k-equivalent).
Secondly, diversification is also a tool of the poor and uneducated; even Warren Buffet recommends low-cost Index Funds over other forms of investing for the uneducated … but Warren doesn’t diversify. Neither do I.”
I am not so sure this is as clear cut as you put it and wanted to ask for further clarification.
First, I tend to react a bit to the language of 401ks for the poor. The poor do not have 401Ks (I am sure they wish they had them); 401Ks are utilized by middle class folks (like myself!). Now middle class people may seem poor to those with seven million, but there is a big difference between the way middle class people live their lives and the grinding stressers of people who are poor. Middle class people are people that are very busy doing other things important for society but who may not have the time to start a business, the knowledge, nor the interest. They may not be the engine to riches; but they are the avenue through which middle class people (if they use them rather then spend their money on needless consumables) can store up significant amounts of money, benefit by the markets inevitable growth (despite ups and downs), get matching funds from their employer, etc. The usual story we get and we buy into as middle class people and benefit to a certain extent from.
What I think you are after is something I am curious to know more about. I believe your argument is that people should take their little extra money they squirrel away in their 401K when they are young, and sink it into starting a side business, investment property, etc. Furthermore, you seem to suggest that people should borrow money out of their 401ks for investment purposes. I think this is intriguing but risky….and again is dependent upon one’s knowledge and comfort.
Should people take money out for:
1) investing in the stock market?
2) their own business?
3) investment properties?
4) others?
Of these I feel the most comfort with #3. For #1, 401ks are usually investing in this already so one must be very confident to beat the professionals. I still believe that low cost Index funds…not just for the uneducated, but also for those with real money (see THE DICK DAVIS DIVIDEND: STRAIGHT TAK ON MAKING MONEY FROM 40 YEARS on Wall STREET) is not a bad way to go. You allude to this being only for the uneducated but many of the best recommend it. Is this wrong?
If you take the money out for #2 or #3, I think that makes sense. I think #2 is riskier…but not for the person who is confident and knowledgeable in a particular area. It sounds like your son is already off and running thinking like an entrepreneur…it is that kind of mind that perhaps does best with #2.
Again, for me #3 makes the most sense for various reasons. (mainly because I am not a #2 kind of guy nor have the time nor believe I am smart enough to be a #1 time of guy). #3 allows me to continue to do work I love (my regular salaried job) but do not make as much money at while building wealth and communities (via investment properties).
Thanks for your post and I appreciate you and/others feedback.
I enjoy being enlightened by those who have made the big bucks!
Nothing wrong with using 401k as a long-term SAVINGs vehicle, Tim. But, there’s a problem with just trying to SAVE your way to wealth:
http://7million7years.com/2008/02/21/do-you-really-care-that-weekly-contributions-of-34-could-potentially-grow-to-over-76000-in-20-years/
If you understand the leverage = wealth equation, then real-estate is the obvious choice … you can apply maximum leverage into a long-term (20 – 30 year) ‘safe’ investment.
As indicated in a previous post, I concur with the no more than 20% of your net worth rule in your primary residence. But this leads me to my next question: do I qualify to pay off my personal residence using the 20% rule. I have a Police & Firemen pension that some say is worth approximately a millions dollars, no debt, other than my mortgage of $200,000, and $160,000 in a taxable account. I make approximatley $115,000 year and at the ripe old age of 53 get to walk away with 65% of my base pay, which if I was to leave now would be about 65% of approximatelely $90,000, not to mention full benefits. It would appear that I qualify to pay off my house using the 20% rule?
Hi RDiN. It sounds to me like you are asking “does the 20% rule work in retirement?” If so, I will address in an upcoming post, because it is an important distinction. The simple answer for now is that the 20% Rule is REALLY saying: “Always have at least 75% – 80% of your Net Worth in INVESTMENTS”.
But, when you retire, you are (generally) no longer concerned with GROWING your portfolio, but SAFELY WITHDRAWING from your portfolio.
Therefore, you really need to see a properly-qualified fee-based financial planner to help you make these decisions.
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Sorry for the confusion, I am just having trouble trying to quantify my pension so I can include it in my net worth. In the previous post I used money in a taxable account and equity in my home to come up with my net worth. This new number will have an impact on how I allocate the money in my taxable account. For e.g., possibly pay of my home. The trouble is I don’t receive a lump sum, but rather 65% of my base upon retirement, every year, which includes increases for cost of living every year. Hence, my confusion. My base is approximately $90,000 and if I were to retire now I would receive 65% of said number for life, which is about $58,500 per annum.
@ RDiN – You bring up a good point that I will cover in an upcoming post … in the meantime, for your specific situation, I recommend seeing a qualified fee-based planner. AJC
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I fail on all of those 🙂 Though I don’t own a house. Under US conditions if I did I would carry a mortgage. Under Australian conditions – 9.5% no tax deductions – it’s more a borderline case… Houses are too expensive here, especially with the market beginning to weaken. I don’t have children either. But on #7 I think I benefitted from interaction with my parents about finances and today I help look after my Mom’s money.
@ Moom – even at 9.5% after tax return, why would you REDUCE LEVERAGE by paying down your mortgage, when to grow your wealth you need to INCREASE LEVERAGE?
401K’s are a tool of the poor—whoa that is sooo harsh, but true
401k’s were design as a supplement to retirement not THE retirement
I found this page while searching for a review on Ric Edelman. Having read this initial article, I have no desire to go further. Your massive EGO is very distracting.