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 …

Why?

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?

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.

Hello?!

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 … ?

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?

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

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%,

Why?

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?

I have a 2009 BMW M3 Convertible. It chews through a tank of gas at least once a week. At Aus prices of $5.30 a gallon, it’s not cheap.

But, it is a heck of a lot of fun

My wife counterbalances: she owns a 2009 Lexus 400 Hybrid. She grudgingly refills about once per month … sometimes I think that she must push the car up hills just to avoid having to refill early.

But, she also thinks playing Gas Roulette is a heck of a lot of fun.

My first car (actually second) in the US was a Mustang GT convertible. It had a monster V8 engine, sounded great with the roof down. Needed a gas station on every corner. Drove like a tank.

It was also a heck of a lot of fun.

But, it was the dumbest car I ever owned …

There was an air-scoop on the hood of the car. The idea of an air-scoop is to suck in extra air to the carburetors on the car to keep the engine happy.

An air-scoop is supposed to be a performance enhancement …

… except, it sticks up out of the hood, so it destroys some of the air-flow, increasing drag, actually decreasing performance and fuel economy.

But, the engineers are made to make the hard design choices: do the increases in performance (extra efficiencies in the carbies) offset the losses (extra drag)?

Naturally, the engineers are experts at what they do so we can trust them to make the right decision. Right?

Well, I would have thought so … until I bought my Mustang. You see, I’m a layman, but even I can tell that:

1. The Mustang has NO carburetors (neither does any modern car), nor does it have any turbo-chargers or anything else that required the injection of air that a hood air-scoop would provide.

2. Now, here’s the killer (just in case we have any engineers out there to dispute my point 1.): the scoop has no air-holes in it.

That’s right, it’s simply an imitation airscoop. A fashion accessory.

As a marketing device, simply designed to make me buy the car, it worked brilliantly!

In other words, it reduces the performance of the vehicle!

Now, don’t get me wrong, the Mustang performed well, and was fun to drive, but didn’t perform better than ‘advertised’. It’s (partially) a marketing con.

My wife’s hybrid is also (partially) a con.

She paid a lot of money to have a hybrid that clearly does save money. But, just like the Mustang, it is designed to perform less than optimally, I believe just to build a marketing story to help sell the product.

The Lexus Hybrid includes a dynamic dash that shows the power flow between the gas engine, the wheels, and the electric motors.

If you don’t understand how a hybrid works check out this video:

In essence, it’s a closed system that uses electric motors (and batteries) to augment the traditional 6 cylinder gasoline engine:

- The gas motor drives the vehicle at all times except when the car’s at rest

- It saves gas simply by ‘switching off’ the engine whenever the vehicle stops.

- The electric motors then restart the engine as the car begins to move (like ‘jump starting’ a car by pushing it downhill … you can even feel a very slight ‘jump’ as the engine kicks in)

- The gas engine then takes over again when the car is moving at a mile or two an hour

- The electric motor’s batteries never need recharging: they are simply charged by an alternator and whenever the car is coasting or braking (it’s called ‘regenerative braking’)

Now, just like the Mustang’s air-scoop, the problem is in the ‘performance enhancement’ of the recharging system. For example, let’s take a closer look at regenerative braking:

Whenever the car is coasting down a hill, it needs to be able to retain as much momentum as possible to help carry it up the next hill, otherwise you have to hit the gas pedal that tiny bit earlier.

The regenerative braking takes a bit of the car’s energy and turns it into electricity, creating additional friction which slows down the car. So you do have to hit the gas pedal that tinier bit earlier.

If you know your physics, introducing this extra step MUST reduce overall efficiency hence increase gas usage.

So, the hybrid works (because when you have to come to a complete stop, such as at a traffic light then you might as well put some energy into the batteries rather than simply heating up the brake pads), but it would work BETTER by turning OFF its regenerative braking ‘performance feature’ when coasting.

But, then that pretty display (image at top of post) wouldn’t be nearly so pretty

What does this have to do with finance?

Well, your 401k is pretty much like my wife’s hybrid!

Sure, it helps to save money. Sure, it’s employer matched. Sure, it’s tax-protected.

But, it could be a lot BETTER simply by turning OFF some of the ‘performance enhancements’ that they’ve added to make the products SEEM more attractive to both employers and employees e.g.:

1. Choices of funds: it has been shown time and time again that long-term buy/hold investors would be better off either selecting their own stocks (if they have the necessary desire and aptitude) or simply putting their money into an ultra-low-cost Index Fund (e.g. S&P500).

All those other high-fee fund choices perform more poorly over the long run. So, why not eliminate them from the fund choices offered? Simple: marketing!

2. Additional services: Fund managers, and the guys that put together benefits plans for employers, offer all sorts of freebies & incentives to the employer to encourage them to buy THEIR funds and services; the problem is, these help the employer – not you. Worst of all, they cost you money. So, why not eliminate them? Simple: marketing!

So, a 401k performs a lot worse than it should, just so the marketing guys can pitch a better story.

Forget the Lexus Hybrid – and, your 401k – they don’t deliver on their promise.

Instead, hop into a BMW M3 – or, direct stocks, real-estate, or business investments – and, supercharge your life.

Unlike my wife’s Lexus Hybrid, or your 401k, their promise – living a little on the edge, but being thrilled with the results – is delivered in spades!

Marketing and performance, for once, are totally aligned

Since the sale was to a public company, the details of the sales (there was more than one) are equally public …

… which is one reason why I choose to remain ‘semi-anonymous’ here.

What my friends don’t realize is that well before selling my businesses even became an option, I had been quietly building up a real-estate and stock investment portfolio instead of paying myself a decent salary.

In fact, my self-paid salary never exceeded $50k a year (plus cars) until I moved to the USA, at a time when my professional friends were all earning at least double or triple my salary.

At one stage, I owned 5 condos and a commercial office building (now, I still own the five condos, but sold the building, adding an extra house, a small, downtown retail shopfront, plus two high-rise condo development sites in its place, not to mention various business and venture investments).

I did this because I didn’t know that I ever would be able to sell my business …

In fact, I wouldn’t be writing this blog if my first $7 million (that I made in just 7 years) relied on either selling my business, or drawing a huge salary as that wouldn’t be repeatable for most of you.

You see, only a minority of people (a) are really driven (as opposed to simply want) to be entrepreneurs, and (b) only a minority of those ever succeed, and (c) only a minority of those ever succeed in spectacular fashion.

So, for me to write a personal finance blog about my (later) business success would be about as useful as a lottery winner writing about their lottery success: interesting, but hardly a key learning experience

So, you do NOT need to be an entrepreneur to make your own $7 million in 7 years …

… but, you do need to be entrepreneurial.

You don’t need to start a business, but you have to make investing your business.

And, that takes a particular mindset; I’m not sure if it can be learned, either. That’s because I believe that entrepreneurialism is an instinct.

How can you tell if you have the entrepreneurial instinct?

Well, I can think of at least three ways:

1. There’s an old joke that asks: “how you can tell who the psychologists are at the movies?”

Answer: instead of watching the movie, they’re the ones in the audience watching everybody else!

Well, my twist is to ask: “how can you tell who are the entrepreneurs at the movies?”

Answer: they are the ones counting the number of seats that are occupied v unoccupied and mentally calculating the ticket price of each to try an work out how much money the theater is making!

Are you that guy? If so, you probably have the entrepreneurial instinct to try and find the ‘deal’ in eveything that you do.

2. Do you play poker? If so, what kind of player are you?

Are you a ‘rock’ or ‘grinder’ who plays tight and patiently waits for the ‘nuts’ (think a pair of Aces or Kings, if you don’t play poker and you’ll get the idea)? Then you’re probably more suited to frugal ‘save and wait’ personal finance philosophy … forget making $7 million in 7 years: it’ll never happen.

Are you a ‘fish’ who just plays the two cards in your own hand without considering what the other guy may have, do, or represent? If so, you should probably quit poker now; equally, you probably don’t have the creativity and imagination to succeed in ‘serious investing’ either.

Or, are you a creative player who knows when to flat call (with the occasional raise, just to be cagey) with a speculative hand (such as a pair of 3′s, or a small suited connector like a 7 or hearts together with a 6 of hearts) knowing that you will either throw the hand away pretty quickly or you will take a lot of money from the ‘rocks’, if you hit your third 3 or make two pair, a straight, or a flush with your 6 and 7 of hearts.

This is the kind of thinking that will help you test an investment, then follow through if it proves to be working for you.

3. You can try a psychological test.

I distinctly remember making the mental ‘click’ from thinking like an employee who wanted to rise up the corporate ladder to an entrepreneur who wanted to be in his own business …

… but, even though I ended up in my own business/es, I didn’t realize that I had true entrepreurial instincts until I signed up to do a Kolbe A-Test.

Not surprisingly – in hindsight (!) – I came up as an entrepreneur … by instinct!

That gave me even more confidence to proceed at ‘full steam’ with my investing (and, business) plans; maybe one (or more) of these methods might do the same for you?

As a personal finance blogger we thought you might have interest in Prosper (www.prosper.com) and peer-to-peer lending.  You may know that Prosper was the first peer-to-peer lending marketplace in the US.  In 5 years, we have originated over $215 million in loans on our site.

In fact, here’s what I said in my reply:

Oops!
http://7million7years.com/2010/01/13/peer-to-peer-lending-a-7m7y-tool/

My argument in that post was about risk; Glen responded with a link to the following:

The basic argument being that Prosper manages loss/risk better than competing P2P sites through their proprietary rating system which “allows [Prosper] to maintain consistency when giving each listing a score. Prosper Ratings allow you to easily analyze a listing’s level of risk because the rating represents an estimated average annualized loss rate range.”

Which is all well and good until it is YOU that suffers the statistical loss/es (you can get unlucky and lose on a number of your loans); I don’t know about you, but I don’t like any system where I play statistical roulette without at least some measure (OK, illusion) of control.

The only control that you can really apply here is diversification: take out lots of small loans in your risk/reward categories:

In fact, if this risk-rating-system is so good, why doesn’t Prosper simply knock out the competition by adjusting the interest rate earned by the rating-weighted loss-rate and carry the risk themselves?!

But, what’s your for/against reasons?

I would like to hear both from readers who swear by P2P, and those who wouldn’t touch it with a 10 foot pole …

_________________________

I didn’t expect that one of my most argued series of posts would be about dividends; I thought it would be around my vehemently anti-anti-debt stance (see if you can work THAT out).

So, I’d like to wrap up that discussion with a point-by-point review of a really interesting comment left by Deek:

I see where you are coming from and disagree to a point. It depends on what your outlook is. 7 mil in 7 years of course dividends aren’t going to get you their.

But my grandfather who was a coal miner who cannot work into his 70s because of the type of job. He was able to be a dividend millionaire. When he did retire the income from dividends, his pension and social security was more than enough for him to live comfortable into his 90s and leave money for his children.

At 90 years old he isn’t going to work,build a business or mess around with real estate. He wanted to check he dividend paying stocks once a month and enjoy retirement, drink a few beers and his biggest worry was cutting the grass.

I also find it interesting you mention Berkshire Hathaway. Depending on when you look at BRK holdings they do invest a significant amount of money into dividend paying stocks even though they do not themselves pay a dividend.

This really summarizes a lot of the for/against arguments around dividend stocks, at least as raised by the many reader comments to my earlier posts, so I thought I should run my readers through it:

1. Yes, this blog is specifically aimed at those who want to make what I call a Large Number / Soon Date (eg $7m7y or $2m5y, etc.); however, in this case, I don’t think it makes any difference: investing in stocks just because they happen to produce dividends is dumb.

In my businesses, I am free to create a dividend whether the business is performing well or otherwise. So can the boards of public companies. If that simple point doesn’t win the pro-dividend lobby over, nothing will.

2. It seems like Deek’s grandfather did an amazing job! Investing in a bunch of “dividend stocks” – and, holding for long periods – is certainly a lot better than many other strategies, certainly for non-$7m7y’ers.

But, he may – probably (certainly!) – have done even better by following a Value Investing approach (e.g. such as that proposed by Rule # 1 Investing author, Phil Town). Buying and holding great stocks – ones that produce a steadily growing profit stream – is an even better way to make long-term money than buying and holding stocks just because they happen to pay a steady dividend stream. The two should be synonymous, sadly that’s not always the case.

3. I’m not suggesting that you (or Deek’s grandfather) should invest in business or real-estate etc. Although, I strongly argue that in retirement RE, in particular, provides a much more secure retirement, again for $7m7y’ers.

4. Deek’s point about Warren Buffett (“BRK holdings they do invest a significant amount of money into dividend paying stocks even though they do not themselves pay a dividend”) neatly summarizes my key point:

Like Warren Buffett, I am not against investing in stocks that pay a dividend; I am simply for investing in great businesses – or, the stocks of great businesses – regardless of whether or not they pay a dividend.

Get it?