When I glanced at the incoming stats to this blog this morning, I happened to see that a number of people had come to this site because they had typed the following search into Google: “should the rich invest in Index Funds”?
It’s a great question to which the answer is: it depends! 🙂
If you want to BECOME rich: No
If you have a high salary and can save a lot of it (see yesterday’s post) … and are happy to keep doing this for 30 years (to ‘guarantee’ the return), then plonking your money into an Index Fund (preferably via a series of 401k’s, ROTH’s, etc. etc. to get the tax benefits) may be all that you need to do.
But, even with some employer matching and tax benefits, for many salary earners the low returns (and, the costs built in) to such funds might not be enough to get you to where you need to go …
If you are ALREADY rich: Yes
Here the rules change … you are more concerned about wealth-preservation than wealth-building. Therefore, ‘saving’ in a way that ‘guarantees’ your principle and living standards can be a suitable alternative to ‘investing’ for high returns in retirement (or close to it .. i.e. within 10 years).
The typical choices here are:
1. CD’s: Just keep your money in the bank – but, inflation will kill you.
2. Bonds: Preferably inflation-protected – and, low returns will probably put a damper on your long-term spending habits.
3. Real-Estate: Using low-or-no borrowings (opposite to our wealth-building real-estate strategies!) – reasonable (and, reasonably safe returns) provided that you invest wisely, manage the property well (using an expert and reputable property manager, of course!), have a suitable cash buffer for expenses and loss of tenants, etc. You live off the rents and you may have the added benefit of a larger estate to leave to the rug-rats and/or donate.
4. Index Funds – you may need to be prepared to sell down 2.5% to 4% of your holding every year (that becomes your ‘replacement salary’), but – over a 30 year period – that should be enough to self-sustain (i.e. keep up with inflation and your annual salary). The lower the % that you withraw, the greater the chance that your money won’t run out before you do (and, if the market goes well, you COULD even have the added benefit of a larger estate to leave to the rug-rats and/or donate).
But, when planning for retirement, don’t make this mistake: the market has returned an average of 12% – 14% p.a. for the last 100 years …
… but, if the market crashes just before – or in the early stages of – retirement, it can have a major impact on the longevity of your portfolio … in other words, you are screwed!
So, do what I do and plan for the worst: plan to have the bulk of your money in the Index Fund for 30 years, because that’s how far out you need to go to ensure an 8% return … then take off another 1% for fees … another 3% or 4% (5%?) for inflation …
If you only plan for 20 years, the ‘guaranteed’ return drops to a measly 4% and inflation will just say “thanks for the snack” and leave you with nothing!
So, are Index Funds for you?
Hi AJC,
Would you do a post that considers the lifetime earnings of different people? Reason being I read an article that high school graduates earn an average lifetime earnings (from 25 to 64) of $1.2 Million. For people with a college degree this goes up to $2 million, with a Masters it’s up to $2.5 million and a PhD brings in $2.9 million. For people with professional degrees (doctors & lawyers I presume) the number goes up further to $4.4 million. Still not bad, an average of $100K per year for the latter category. For the purpose of this article I’m assuming that all earnings are reconciled to net present values.
So you’ve managed to earn $7 million in 7 years… that’s really impressive and nearly twice that of a doctor’s lifetime earnings. What have you earned throughout your life?
For me I’ve earned $2 Million in my life to date. More than half of this has come in the last 3 years. I’m 35 now and have been working since I was 23. I figure between now and age 65 I should be able to earn a total of about $8 million more with an medium / optimistic case. I will pursue investments but realize high risk brings high reward but potentially devastating losses. For example I’ve taken a large position ($110,000) in a Chinese stock with what I believe to be very strong fundamentals and have researched this company for the last 4 months in detail. In the last 3 weeks the stock is down 30% from where I bought in…! So I don’t put everything into high risk investments for that reason.
I think starting a business has elements of this… if your business crashed you would have lost it all I guess?
-Mike
@ Mike – thanks for the comment, Mike. Yes, I will post on this; in the meantime keep in mind that it’s not what passes through your hands that matters … it’s what ‘sticks’ that counts!
can you elaborate on the best inflation protected bond investments?
Thanks AJC,
I look forward to your perspective on this in a future post.
Regards,
Mike
@ Creeping – if a TIPS-based retirement strategy is one that you are interested in, then I highly recommend that you ‘invest’ in a copy of the highly qualified/respected Zvi Bodie’s book: Worry Free Investing.
The only problem with the strategy that he outlines that I can see relates to the potential tax implications unless you are investing via a ROTH etc. An alternative that you may want to explore with a suitably qualified financial adviser might be selected inlfation-protected Municipal Bonds (MUNI’s).
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Wealth building is a very interesting job. everyone want to have some financial freedom.:.~
wealth building should be the priority of most people not just leisure and playing some online games and stuffs like that-.*