I’m going to make a fortune, effective immediately!

Screen Shot 2013-03-22 at 9.21.59 PMAs catchy as the title is of today’s post, it has very little (but not, nothing) to do with the image on the left …

… which image simply serves to illustrate my preferred – or, should I say ‘accepted’ – approach to investing.

But, wait, you say!

Surely, the quadrant to the bottom-right (where the combination of profit and risk is optimized) is the most efficient?


So, why would I want my arrow to hit the target in ‘no mans land’?!

Well, that’s the exact question that I threw to my readers in my last post

There were a lot of amazing comments (and, you should go back and read them all), but Dustin wins a signed copy of my book for his comment, which summarizes my views nicely:

there are significant gains to be made with a moderate increase to your risk … however the long term of the investment should moderate that for the endgame result. Technically it is a less “efficient” investment, but only statisticians care about that, not real world investors.

And, JD earns an ‘honorable mention’ (and, also wins a signed copy of my book) for his comment, which adds a crucial caveat to my views:

I worry less about potential losses for incremental investments. I may be biased since I am young enough to earn it back (I’m in my late 20s)

Whilst I would argue (as would Warren Graham who provided the source chart and much valuable commentary to my original post), that learning about the efficient frontier is valuable to investors, not just statisticians, Dustin has hit the nail on the head by focussing on the “endgame result” …

… for me, your overall investment objective drives everything.

The aim, in my opinion, isn’t to find the optimal investment where ‘optimal’ is defined as sitting on some curve, it’s to find the investment from the limited range typically available to you in the real world that delivers the result that you need.

If you’ve been following this blog for a while, you’ll realize that – in order to pin down that ‘result that you need’ – I advocate a Top Down Approach To Investing:

This means, knowing how much money you need; when you need it; and, using those answers to derive your required annual compound growth rate.

It’s this growth rate, as indicated by the horizontal line on the chart below (the positioning of this line will be different for everybody) that should dictate what investment choices you go after:

Screen Shot 2013-03-22 at 9.41.46 PM

Each of these investment choices (and, in my experience, there will be very few to choose from, since you need access, education, and aptitude in each type of investment in order to proceed) will bring with them their own risk profile …

… and, you will be amazingly lucky, if one of those choices (e.g. as represented by the black squares on the chart above) happen to fall on the intersection of the horizontal line and the ‘efficient frontier’ curve.

If not, and if you want to achieve your Number by your chosen Date [AJC: you do, don’t you?], you will go ahead and make that investment, anyway, even if it doesn’t fit neatly in the quadrant on the bottom-right of the image at the top of this post.

Because, as JD says, even if your investment fails, hopefully, you will still be “young enough to earn it back”.

We get one opportunity to live our Life’s Purpose; we get many opportunities to make investments to help us get there, but only if we have the mettle to choose the ones that have the potential to meet your minimum required annual compound growth rate.

To me, the investment choices that can help us reach our Number are the most effective of investments …

… they just may not be the most efficient 😉




Surfing the efficient frontier …

Screen Shot 2013-03-22 at 9.21.31 PMOne of my Finnish blogging friends shared this interesting graphic on one of their most recent posts …

The implication is clear:

The best investments …

… in fact, the ideal investment is one that maximizes profit at the lowest possible risk.

Whilst that is ideal, the real world – at least in my opinion – doesn’t work that way.


– You may not understand the investments that maximize profit at the lowest possible risk

– You may not have access to the investments that maximize profit at the lowest possible risk

In fact, the operative word here is ‘you’ …

… unless you are professional investor, who has access to – and understands fully – all of the investment choices available, you will not be able to surf the ‘efficient frontier’:

Screen Shot 2013-03-22 at 9.41.46 PM

Because of access and education you may only be able to select from a few investments that, if you are lucky and choose well, approximate the efficient frontier, as represented by the four dots in the chart, below:

Screen Shot 2013-03-22 at 9.43.26 PM

In this case, you have lucked out!

Two of your investments have hit the efficient curve smack on, and one is optimal (i.e. best combination of risk/reward), whilst the other will suit the most risk-averse amongst you, as it is efficient, yet carries the least risk (of course, it also produces the lowest return of all the ‘efficient’ choices available to you).

Screen Shot 2013-03-22 at 9.21.59 PMMaths aside, here (diagram to the left) is where I like to position my investments …

… and, where I think most (but not all) of you should like to position yours, as well.

It’s not optimal (higher reward, more risk); probably not even efficient; but, ideal … at least, for my (our?) purposes!

Any idea why?

Why do you think I actually like to assume more risk?

I’ll do a follow up post; in the meantime, I’d like to hear what you think my reasoning will be?

I might even send a signed copy of my book to the person with the best (not necessarily correct) answer 🙂

The myth of asset allocation …

pie 2There’s a Rule of Thumb that says that you should keep 100% – Your Current Age in stocks (and, the rest in bonds).

For example, if you are currently 27 years old, you should keep 27% of your current investments in bonds and the remainder (73%) in stocks e.g. an Index Fund that mirrors the S&P500.

There’s also a new school of thought that says the numbers should be ‘upped’ to 110% or even 120%, to ensure that you keep a larger percentage of your net worth in stocks at a young age, whilst you can still stand the volatility of the stock market (c’mon, you haven’t forgotten 2008 already?) and allow for a larger upside to help find your longer lifespan.

But, there’s a problem:

Let’s say that you want to retire at age 65, and you are currently 60; the original ‘rule’ says that you should still have 40% of your (hopefully, now considerable) net worth in stocks; the question is:

If you plan to retire in 5 years, what % of your net worth should you put in stocks?

Well, the answer is none.

5 years is too short an investment horizon to invest in stocks!

In fact, we’ve already established that the best place to keep your savings is in CD’s:

Screen Shot 2013-01-29 at 2.38.40 PM

Over 5 years, based on past performance, there’s simply too much chance that you will lose money on the stock portion of your portfolio.

But, that’s not the major problem that I have with this – or any – theory of asset allocation …

… my issue is that asset allocation theory only works in long timeframes (again, because we can’t afford risk of loss), say > 10 years, and probably greater than 20.

And 10 to 20 years didn’t work for me, because my plan was to make $7 million in 7 years.

To have any hope of emulating my outcome, you need to focus on three things:

1. Building up the largest ‘starting bank’ that you can,

2. Not spending more than you absolutely have to help build that starting capital in the shortest space of time possible, and

3. (this is the most critical of the three), investing to obtain the highest possible compound growth rate.

Sitting on a basket of stocks and bonds – no matter what the mix – probably won’t cut it.

Short time frames put a LOT of pressure on modern asset allocation and portfolio theories …

… way too much pressure, if you ask me.


How to see the future …

A Get Rich Slowly reader shared his financial advisor’s advice when asked whether he should go with mutual funds or index funds:

“..in 2008, as banks stocks were dropping rapidly, if they were a part of an index like the S & P 500, they were still held by the fund,  while a  manager of a fund could lower the funds exposure to this sector, thus attempting to limit the downside risk to the portfolio.”

This, of course, is a classic case of trying to time the market … and, we know what happens when anybody (except for Warren Buffett and a select few others who aren’t giving you their advice) try and time the market …

… for example, the famous Dalbar Study shows that people who attempt this reduce their returns from 11.9% to only 3.9%.

In their latest report, Dalbar says:

The unprecedented ups and downs of 2011 drove up the aversion to risk and investors succumbed to their fears. They decided to take their losses instead of risking further declines. Unfortunately, as is so often the case, this occurred just before the markets started on a steady trek to recovery.

So, the idea of ‘taking bank stocks’ out of your portfolio just as they are crashing is very enticing, but simply means that you also need to work out how to put them back in when they are climbing …

… and, if you really could pick when stocks are climbing or falling, you’d be off living the high-life in Monaco.

You certainly wouldn’t be selling your advice to us ordinary folk, now, would you? 😉

Poor little rich doctor …

A couple of weeks ago, I responded to a reader request from a young doctor who is on what can only be described as an OMG level of income:

I am a young physician (early 30s) making approximately 800k per year. After expenses and taxes, I am left with ~300k to save/invest.

Never mind the fact that he is losing approximately $500k a year in “expenses and taxes”, a $300k take home is still pretty good in anybody’s language!

There was plenty of well-considered reader debate and advice for the young doctor, including this highly-reasoned argument from traineeinvestor:

I’d suggest he continue to focus most of his energy on maintaining or growing his professional income. Time spent on side ventures and investments should be limited so that it does not interfere with the $800K professional income.

In terms of investments, given his time constraints, I’d go with a Boglehead approach, possibly supplemented with some geared cash flow positive real estate (especially if he lives in the US and can take advantage of depressed prices and long term fixed borrowing costs).

I agree on both counts:

a) When you are earning a super-high level of salary, your primary goal should be to protect that source of income. It’s a river of money: you should do everything in your power to keep it flowing!

b) However, you shouldn’t just let the money flow into the taxman’s pocket, then into yours, and then out again by increasing your spending. Instead (and in keeping with our ‘river’ analogy) you should also build a downstream dam.

And, you should only open the sluice-gates to let off a much smaller amount than is going into the dam …


Because that’s the only way that the dam gets to fill up!

This way, when the river stops flowing (ideally, at a time of your choosing i.e. early retirement, but it could be forced upon you even earlier for a variety of reasons), you can keep the sluice gates open, knowing that there’s still enough water in the dam to keep the flow running for the rest of your life.

In other words: you don’t want the dam to run dry before you do 😉

But, this is much harder to achieve than you may think, so here’s where I differ – but, only slightly – starting by reversing the order of traineeinvestor’s otherwise excellent investment strategy:

I’d go with a geared cash flow positive real estate approach (especially if he lives in the US and can take advantage of depressed prices and long term fixed borrowing costs), possibly supplemented with some Boglehead-type investments.

The reasons are two-fold:

Firstly, I’m not accepting that 62.5% (i.e. $500k) of our doctor’s $800k earning capacity can simply be wiped off in “expenses and taxes” …

… professionals are just sitting ducks when it comes to taxes.

But, by implementing a nicely geared (and, maybe even cashflow negative after depreciation allowances) real-estate strategy, there may be deductions that can legitimately increase his super-high professional’s take-home income, without falling afoul of the tax man.

This is a clear-cut case of where a professional’s advice can add huge value [AJC: not in asking “is real-estate a good investment for me” but in asking “is real-estate a good tax-advantaged but highly legitimate investment vehicle for me?”], and our doctor should not take another step without seeking such professional advice.

Secondly, he should go through every single expense with his accountant and see what he can reduce or better manage. Nobody can afford to burn $500k worth of dollar bills …

… not even a super-high-income doctor.

Secondly, real-estate (especially when prices are depressed) is just a great long-term investment.

With his $300k (and, hopefully much more once he implements some of his accountant’s tax and cost-management advice) cashflow plus any income that he receives from his tenants, the doctor can afford to leverage quite a large portfolio of such high-quality, long-term, income-producing investments.

And, it is this large portfolio that becomes his growing ‘dam’ of cash, trickling out at perhaps a $100k – $150k sustainable annual spending rate … one that he should be able to index with inflation and maintain for his whole life, whether he (one day, perhaps quite soon) chooses to work full-time, part-time, or not at all.

And, isn’t that the whole (financial) point of it all?

Would you take financial advice from this man?

Here’s an article about some guy who’s lost his house: http://www.consumerismcommentary.com/the-financial-planner-who-lost-his-house/

Sad, yes, you say … but, not to be rude, you also say … so have hundreds of thousands of others during this global financial crisis 🙁

But, if you look closely, you’ll see a small difference between this guy and the rest: this guy should have known better.

You see, he’s a financial advisor …

… and, not just any financial advisor, he’s a New York Times financial columnist/blogger!

What’s even more interesting is that he’s prepared to use his own tale of woe (as is Consumerism Commentary in his follow up piece to the original NYT article):

to explain how people continue to behave irrationally about money even when they know better. It’s a good indication of why a healthy approach to your finances requires much more than knowing, “spend less than you earn.” We’d like to think that building wealth is as simple as that, but if that were true, anyone who could do simple arithmetic would be financially secure over time.


Doesn’t anybody see what’s really wrong with this picture?

Consumerism Commentary tells us:

Carl Richards is one of today’s best writers focusing on personal finance

This is after Carl admitted to the world that he lost his house because he “behaved irrationally about money” …

If the BEST financial advisors can lose their houses … how have the average ones mismanaged their’s … and, how badly can the worst ones screw up your life?

And, would you have known about Carl’s screw-up if he didn’t come forward and tell us?

Who are you seeking financial advice from? And, how can you really be sure … ? 😉

Make money when you buy!

There’s an old saying that you may have heard. It’s used particularly in relation to real-estate, but it can be applied to many forms of investment. It’s:

You make money when you buy, not sell.

One of my new readers asked me to explain what it means:

Could you expend on this statement a little or maybe you have some related blogs about this on your site? “…buy at the right price you make money when you BUY not when you sell.”

I don’t think I’ve ever written explicitly about this age-old investment adage, because it’s almost a tautologogy …

… after all, an investment is something that you should never need to sell!

To me, a true investment is something that generates ongoing income. So why would you ever sell it?

Any ‘asset’ that you buy, specifically to sell to (hopefully!) generate a profit, is in reality a SPECULATION, not a true investment.

Business makes these kinds of speculations all the time: buying trading stock (or labor) with the expectation [read: hope] of selling it at a sufficient price to generate a healthy profit.

Businesses take a calculated risk in doing so, hoping that the potential profits justify the risk, but …

90% of business owners are wrong!

They say that 9 out of 10 businesses fail within their first 5 to 10 years. They fail for lots of reasons, but one of the main ones is that these simply cannot make enough money when they sell due to competitive pressures, new products, outdated manufacturing techniques, low volumes, etc., etc.

As investors, we cannot afford to make the same mistake, otherwise we are just gamblers – gambling that: red will hit more times than black; we will roll a natural 7; AAPL stock will go long this month; Las Vegas house prices will continue to climb.

On the other hand, as true investors, we have to buy well, then hold on for the long run.

It is the income from our investments that makes us rich (by funding our dream lifestyle), not the amount that we could sell the investment for.

How about you? Are you an investor or gambler? Do you see the difference?

… another man’s poison!

To some people, it seems that I promote high-risk strategies. For example, long-time reader, Josh says:

I wondered over to your blog to see what’s new and after reading a few posts I realized why I don’t visit anymore, and it’s because your articles are drenched in pro-debt/leveraged strategies. This is something I don’t agree with and don’t practice. I do understand the mathematical ramifications of using debt to leverage yourself, it’s just something I plan to do without.

Firstly, what Josh is saying isn’t quite true …

… in fact, I don’t recommend debt to anybody. What I have said is that I don’t believe in the anti-debt lobby.

There’s nothing evil about debt per se, it’s if/how/when you apply it that counts.

For example, I have variously had:

a) a little debt: on my various buy/hold properties

b) a lot of debt: in my finance company (for a finance company, cash is like stock … you need as much of it on hand as possible)

c) no debt: all of my other businesses were ‘bootstrapped’ and self-funded

I should point out that Josh is a stock investor; he has made a small fortune (turned a couple of $k into one $m or so while still at college) buying pharmaceutical ‘penny stocks’ … I wonder how many people would consider that risky?

One man’s ‘sensible investment strategy’ is surely another man’s poison 😉

The problem with financial advice – Part I

Now, I’m just some semi-anonymous blogger, so what do I know, right?

So, sometimes it’s nice if I can point you to others who share my opinions on controversial financial matters [AJC: I write almost exclusively about controversial financial matters … why write something that’s already in 5,000 other blogs, therefore, has a 99.9999% chance of being wrong?!].

For example, my opinion on financial advisors is that they are a waste of money.

But, Dan Ariely, a behavioral economist and author of two best-sellers, including Predictably Irrational, agrees:

From a behavioral economics point of view, the field of financial advice is quite strange and not very useful. For the most part, professional financial services rely on clients’ answers to two questions:

  • How much of your current salary will you need in retirement?
  • What is your risk attitude on a seven-point scale?

From my perspective, these are remarkably useless questions — but we’ll get to that in a minute. First, let’s think about the financial advisor’s business model. An advisor will optimize your portfolio based on the answers to these two questions. For this service, the advisor typically will take one percent of assets under management – and he will get this every year!

I agree with Dan when he says:

Not to be offensive, but I think that a simple algorithm can do this, and probably with fewer errors. Moving money around from stocks to bonds or vice versa is just not something for which we should pay one percent of assets under management.

Now, this is targeted at funds managers (both retail and institutional) as well as those who charge fees and/or commissions to prepare similar financial advice.

Remember, funds tend to fall short of the market in performance over time, by about how much they charge in fees …

Lesson: if you really want to short-change your financial future by investing in funds and over-diversifying (two sure ways to die broke), do what Warren Buffett suggests and invest in super-low cost Index Funds:

A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.

In the next part of this special three part series, I will show you how most people short-change their retirement by 60%,


The right time to speak to a professional …

I have previously gone out on a limb to say that it’s very difficult (actually, I said impossible) to pay to get good commercial / investing advice.


Unlike a doctor, accountant, or attorney who can only give themselves so much self-help [AJC: unless the doctor’s a hypochondriac; the accountant’s an embezzler; or, the attorney’s a criminal]  …

… any “investment / business advisor” really worth listening to is probably making too much money for themselves to waste their time advising you on how to make money.

On the other hand, on rare occasions, you can find such high-quality advice:

– You can find a mentor; somebody who’s been there / done that and is willing to counsel you one-on-one

– You can buy stock in a company owned by such a person e.g. Berkshire Hathaway; by investing in BH (for example) you are ‘paying’ Warren Buffett to look after your wealth as a by-product of looking after his own.

WARNING: if you ever receive a bill from either of these types of people … run for the hills! They are not whom they seem 😉

But, there is a time when you DO need to seek – and, pay for – financial advice; to illustrate, here is an e-mail that I recently received:

Heh Adrian, do you think you can help and ole lady, who has been swindled more time that you can count, now unemployed (forced retirement), drowning in debt with but 1.1 million in property assets and 80K in bank that I am using to live off but it will only last 11 months with what I am paying out? I am 66 my husband (also retired) is 68.

It was our two financial advisors that got us into some of this trouble. We Lost our retirement investment through their recommendations. Even our other real estate investment (2 raw land and 1 condo) are now worth less than the remaining mortgages.

[My last] $80k is not just spending money; it is also supporting those mortgages, which I can’t sell due to the market.

You see, the time to pay for GOOD financial advice is when you think you might be in financial trouble (even if it was BAD financial advice that got you there, in the first place).

That’s why I don’t like to seek advice about WHERE to put my money.

But, this reader DEFINITELY needs to seek urgent professional financial advice!

She should get a recommendation from a friend to a fee-based advisor and/or accountant and just ask them to help her make some immediate decisions about her current structure: e.g. should she (can she) walk away from her mortgages? How much can she budget for the next 12 months in living expenses, and so on?

Then she’ll need to start learning (reading this blog is a good start) how to make real money, all over again …

What would you do in her situation?