Category Archives: Investing

Should the rich invest in Index Funds?

Posted on by
8

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?

The true cost of 'helpers' …

Posted on by
2

The best way to give up your ‘day job’ is to watch my Live Show this Thursday @ 8pm CST (9pm EST / 6pm PST) at http://ajcfeed.com ….

__________________________

Last month, I wrote a post that was a little scathing about what I call ‘middle-men’ and Warren Buffett calls ‘helpers’ … all of those people inserted between us and those fantastic “little pieces of American Business” [another Buffett quote … he means ‘stocks’] that we want to buy.

The problem is they cost us …

and, for every 1% in fees that they cost us, and our returns on $100,000 invested for 20 years goes down as follows:

1% 2% 3% 4%
 $17,383.14  $31,876.74  $43,938.73  $53,958.08

That’s how much you LOSE from what you COULD have earned on that $100,000; scroll to the bottom [better yet, keep reading] to see what Warren Buffett actually estimates all of these middlemen (agents, brokers, advisers) to cost American Business – hence us!

In the meantime, let me cast my views on these two important topics:

Financial Advisers

I will lay it right out on the table for you: I don’t like ’em, don’t trust ’em … but, sometimes you can’t live without ’em. In fact, I usually advise people to see a financial adviser and, I have NEVER told people not to.

I’m just telling you my opinion 😉

I see four problems:

1. Commissions – in the USA, most advisers are tied in some way or another to selected funds and/or providers … they will not or can not, provide you with truly independent advice. Sure, they may be honorable and educated and ethical (of course, they all are) but would you go to an honorable and educated and ethical Lexus salesman and expect her to advise you to buy a Maserati?

2. Fees – I love them! Truly … if I pay a fee I know I should be getting what I need, not what some ‘freebie’ guy is selling me. Unfortunately, in the financial planning industry even fee-only advisers can have affiliations to selected providers via agency, equity, or simply because they only have experience with a limited product set.

3. Results – How rich is your financial adviser? How rich do you want to become? They should be as rich as you want to become x 10 [AJC: OK, as rich as you want to become x 1 or 2 for right now is OK … but, when you get half-way whomever you ask for financial/commercial advice should be as rich as you want to become x 5]. And, if they are stinking rich already, did they get there because they invested in the same way as they are advising you or because they run a damn good financial planning business (which requires more selling talent than investing skill)?

4. Product – When was the last time that a financial adviser – particularly a financial planner – said, “Look Bud, I’d love to sell you this really great financial product, but [takes you aside, puts his arm around you and whispers conspiratorially] what you really need to do is [insert sensible alternate investment of choice: invest in real-estate; buy your own home; put the money towards starting a new business; look for 4 or 5 undervalued businesses and buy their stocks]” ?

Personally, I’ve never been to a financial planner [AJC: actually once, nice guy – I went because I kind’a know him socially – but, as soon as he started talking ‘business’ I felt my skin crawl and couldn’t wait to get out of there!], I would rather look for a business/investment savvy accountant to run the numbers for me.

Invisible Middle-Men

These are the guys researching, packaging, distributing, and managing investments for you. The most ‘typical’ product that we are talking about here are Managed Funds, which all carry fees – most hefty, some miniscule – to cover the costs associated with all of these ‘invisible’ middle-men, as well as the financial planner’s commission (if you decided to go with Option 1., above after all).

The problem is that, even if you wanted to diversify [you shouldn’t!] you wouldn’t buy one of these funds through an adviser/salesman … you would go direct to, say, Vanguard’s web-site and sign up for their lowest-cost broadest-based Index Fund and start contributing … and, you wouldn’t need to come up for air for another 30 years!

Warren Buffett talks a lot about other middle-men; what he laughingly calls the “Helpers” (as in “I’m from the Government and I’m here to help you”) e.g. the stockbrokers, the hedge fund managers) and if you want to read his beautifully laid out reasoning from his 2005 Letter to Shareholders, check out this article.

In the meantime, I lead you to Warren’s stunning conclusion:

The burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of what they would earn if they just sat still and listened to no one.

Try compounding a 20% ‘loss’ over 10 years and see what you end up with!

ETF's as a hedging tool?

Posted on by
2

A while a go I wrote a post that discussed the difference between ETF’s and and Index Funds for diversification purposes … and, you know what I think about diversification.

But, for those who are just passing by the blog and thought you’d like to drop in [AJC: my regular readers will skip over this post because they wouldn’t be interested in diversification either 😉 ] here is an interesting article from the Tycoon Report:

If you haven’t already, you should start moving your money out of mutual funds and into ETFs (Exchange Traded Funds).  In my opinion, they are tailor made for the “Average Joe” investor to get the benefits of a mutual fund without their crazy fees.

For a detailed listing of all of the fees, etc. that come with mutual funds, you can visit http://www.sec.gov/investor/pubs/inwsmf.htm#how.

In my opinion, the only downside (for some people) with respect to ETFs may be that you can buy and sell them as easily as you can.  The reason that I say that this may be a downside for some people is because, if you are impatient or have an addictive personality,etc., then you may know yourself well enough to stay away from investments that you can easily get in and out of.

In other words, if your personality is such that you are tempted to trade without a logical reason to do so, then perhaps the difficulties (such as fees) that come with a mutual fund will prevent you from trading needlessly.  An ETF, on the other hand, may (because of their ease) encourage certain types of people to trade.  If you do not have this type of issue, then you should certainly choose ETFs over mutual funds.

I like ETFs personally because they are less risky than individual stocks.  As you may know, you can never totally eliminate risk, but you can reduce it.  You can reduce risk by hedging, diversification, and insurance.  ETFs reduce risk through diversification, as you’re not assuming the risk that your investment will go to zero based on the demise of one single company.

Nice summary. Here’s where I sit … if you’re using the ETF for:

1. Speculation– Using an ETF (or any other ‘broad-based’ investment) as a hedge against short-term risk is fraught with danger … you are speculating. Yes, you are ‘hedging’ against the risk of any particular stock tanking (conversely, spiking) but you are really just betting with/against the whole market – if people knew where the market was going, they would be richer than Buffett. On the rare occasions that I do speculate (anything less than a 5 – 10 year outlook going in is speculating to me), I prefer to speculate with options and/or just a select handfull of the underlying stocks.

2. Investment– Now, if I am going to invest with a 5 – 10+ year outlook going in, then I am less likely to be speculating and more likely to be ‘saving’ or ‘investing’. It’s important to realize that I may not actually hold the investment for that long ( who knows what the future will bring?), but I certainly have the expectation of holding, going in. I don’t like to ‘invest’ in a broad-based ETF/Index because then I am truly ‘investing’ in paper, and market sentiment/emotions. I would not be investing with the understanding of the fundamentals of the underlying business, which is the only way that I expect to ‘beat the market’ in the long-term: buy under-valued businesses that I would be prepared to hold forever, and wait for the market to ‘catch up’ to my way of thinking … this is pretty much what Buffett does (actually, did … when he was a little smaller and could make smaller investments) with the stock investment part of his portfolio. If I get it wrong, but I llike the business and it makes good profits (else, I wouldn’t have bought it … then, I don’t mind holding. If I get it right, and the price spikes up to ‘fair market value’, I may end up selling early.

3. Saving– I don’t have ‘saving’ strategies – my speculation (20%) and investment (80%) strategies seem to cover me pretty well. But, if you just want to plonk your money away … either as a one-off (Uncle Harry left you some money) or on a more regular basis (you have a 401k or just want to regularly save) … AND you have a 20+ year outlook, then this is where ETF’s or Index Funds finally come into play! Plonking your money into a Spider ETF or broad-based Index Fund can be better options than CD’s or Bonds. Just don’t get fancy here … the good news is that Warren Buffett also recommends this strategy for the “know nothing investor” as he calls them … he also calls it “dumb money“, but he means that in a nice way 🙂

Now, as to selecting an ETF v a broad-based Index Fund, it’s a close call.

Finally, I was a little amused this little ‘teaser’ on the very same page as this very nice Tycoon Report article exhorting you to ‘invest’ in ETF’s; it said:

Most ETF Traders Will Lose … And Lose BIG

ETFs are the hottest new investment around, and for good reason. But many everyday investors who jump into ETFs without a proven system to guide them will lose their shirts.

Then [of course] it went on to the ‘solution’: On Thursday, June 12th, Teeka Tiwari will reveal the secrets of using ETFs to generate enormous wealth. But, there’s nothing wrong with a little good marketing …

My advice? Keep your shirt buttoned!

What are the pro's and con's of value investing?

Posted on by
7

I answered a great question at TickerHound posted by the staff (as they do from time to time to stimulate discussion) that I thought I should simply repeat here:

What are the pro’s and con’s of value investing? Do you think it’s a worthwhile strategy or are you more of a “efficient market” proponent?

Well, I consider myself a Value Investor in everything that I do … stocks, real-estate, etc. The only exception is in the case of businesses, I’m generally a Growth Investor or a Value Investor.

Value Investing simply means “buying something worth $2 for $1” … well, not exactly, but you get my point: buying something for less than it is WORTH.

Now, this is a critical distinction: just because something was selling for $2 last week, and is selling for $1 this week, doesn’t mean that it is a VALUE Stock … it may only be ‘worth’ $0.50 and the market may simply be driving the price down to that … and, beyond!

In fact, that same stock (really ‘worth’ only $0.50) may BECOME a Value Stock if/when the market overshoots and sends the price down to $0.25.

The problem with Value Stocks is then one of KNOWING what they are truly worth at any point in time, and only buying when they are selling for a price less than that (preferably, with a large Margin of Safety … which simply means, buying it for MUCH LESS than what you THINK it is worth “just in case” …).

Now that we have covered the basics, what is the PRO of Value Investing?

Exactly that … being able to buy something ‘worth’ $2 for only $1. I can’t think of a better, more sure way of making money than that!

Then, what is the CON of value Investing … after all, there must be some or we’d ALL be doing it?

Simple: as I said before, it’s all about KNOWING which stock that is currently selling for $1 is actually worth $2 (and, avoiding the ones that are only worth $0.50!!). And, that takes some knowledge and skill. Warren Buffett has that knowledge and skill … so do many others, to a greater or lesser extent.

One other CON – one that is, ironically enough, addressed by another TickerHound question: “Is technical analysis still applicable in a “news driven” market like the one we’re in now?”:

If a stock that you KNOW is worth $2 is currently selling for $1, is it an automatic BUY?

Well NO … you see, you KNOW it is worth $2, but the rest of the market may not!

Or, it may have BEEN worth $2 but there is something happening (maybe a pending lawsuit around a key patent, or the loss of a major contract, or … ) that YOU don’t know about because it hasn’t hit the “news” (or TickerHound) yet, but those ‘in the know’ are selling off the stock by the truckload.

So, that’s where technical analysis is not just applicable in a “news driven” market like the one we’re in now, but absolutely CRITICAL for buying Value Stocks …

… it will tell you WHEN to buy (or sell off) that stock holding, based upon what the “insiders” are doing.

If you want to learn more about Value Investing, and using Technical Analysis to know when to get in/out of a Value position, I recommend picking up a copy of Phil Town’s excellent primer: Rule 1 Investing …

… and, Good Luck!

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz

The lesser of two evils?

Posted on by
5

 

Ramit Seth of I Will Teach You To Be Rich recently arose from his bunker – where he has been holed up, busy polishing the manuscript to his latest book [publishers please!] to pose the question:

 “Should I invest in CDs or a Roth IRA?”

The post was brief, and to the point:

Sherene writes:

“I am a recent college graduate and I want to put the little money I have saved (approx $3,000) into something that will give me good returns over the years. Would you suggest I get CDs or a Roth IRA?”

The two are very different.

A Roth IRA is an investment account, but once you get it, you have to put money in it and invest. You can read all about it on my article The World’s Easiest Guide to Retirement Accounts.

A CD is a type of investment, which you can buy inside (or outside) of any investment account. And if you’re wondering what I think about CDs/bonds…

It was the last line that triggered the most comments … and, of course those comments were split into four camps:

1. Pro-CD’s

2. Pro-Bonds

3. A little of both

4. Ramit, why don’t you write more 😉

But, these miss the point …

Are you an ACTIVE investor or a PASSIVE investor?

Active Investor

You will have realized that you can’t retire on $1,000,000 in 15 to 20 years. And, inflation will serve to ensure that investing greatly in either Bonds or CD’s will keep you poor.

Therefore, you will be looking for direct (maybe leveraged through margin borrowing, if you have the ‘appetite’) investments in a very few stocks that you understand and love, a business here or there if you have the aptitude and interest, and/or a few well-chosen real-estate investments.

You will manage these for growth and hold until they no longer make sense to keep, or you retire (and, want to adjust your investment strategy).

I don’t see any room in this portfolio for either CD’s or Bonds, except as short-term vehicles for parking cash while you gear up for the ‘next big thing’ do you?

Passive Investor

OK, so we don’t all want to be rich … and some of you are just window-shopping this blog (or, seeing how the ‘other half’ lives?).

Let’s say that you DO subscribe to the $1,000,000 (or even $2,000,000) in 15 – 20 year philosophy (yes, I even had some applicants for my 7 Millionaires … In Training! ‘experiment’ with that outlook … they don’t need my training; they just need Valium!) … what then?

Firstly, you will be looking to max out your 401k/ROTH certainly enough for the full employer-match; this will probably mean selecting from the list of funds available … unlikely to include Bonds (although, there may be a Bond Fund in there, somewhere) and certainly CD’s won’t be an option. So, it’s a moot point.

Secondly, you will probably be looking to invest in buying a home … saving a deposit, making payments, etc. then trading up as soon as the sun starts to shine (now, there’s a financial treadmill for you!). So, it’s a moot point.

But, Uncle Harry might die and leave you with $20,000 and you are suddenly faced with the decision: CD’s or Bonds …

…. hah, you think you got me? No way!

I would be immediately looking at becoming an Active Investor ($20k might just be enough for a deposit on that nice little rental ‘fixer upper’ down the street).

But, let’s say that you still are determined to retire late and poor … but, don’t want to be quite so poor … where would I go for advice on conservatively investing that nice little chunk of change?

Hmmm … when I look for investing advice, I usually look to the best in the business. That’s why I went to Warren Buffett’s Annual General Meeting in Omaha a few weeks ago.

At the meeting, Warren suggested that IF you don’t really know what you’re doing, you should dollar-cost average (that means put a little bit over time) into little pieces of all of “American Business” … he later clarified that to mean a low-cost Index Fund (in fact, he named Vanguard).

Why?

Well inflation will keep your CD’s and Bonds worthless … by buying and holding Index Funds (LOW-COST ones) for a VERY LONG time, the market will go up (there hasn’t been a SINGLE 30-year period where the market hasn’t averaged an 8% return) and you will stand a better chance to beat inflation …

Of course, none of these PASSIVE investment strategies will make you rich (or even financially free at a young age), but Warren’s strategy at least has a better chance of keeping you out of the poor house, and giving you a chance of retiring at 55 or 65 … IF you start young enough, and maintain the course for 20+ years!

But, what if you don’t want to invest in stocks at all … even via an ultra-low-cost Index Fund? Is it thenOK to invest in Bonds or CD’s?

Maybe, but I would much rather plonk that $20k into my mortgage!

I know that I said that it’s a dumb strategy, but it’s sure better than the CD/Bond alternative (better after-tax returns, but check with your financial adviser before doing anything!).

In fact, the only time that I would invest in:

1. CD’s – when I need to ‘park’ some money for a while … waiting for the next ideal investment to come along.

2. Bonds – when I am already rich and retired: Bonds can play an important part in maintaining wealth as part of a Making Money 301 strategy. As Ramit mentions in his comments, Bonds can be laddered (that means bought with a variety of expiry/cash-out dates).

For two great Bonds-in-Retirement strategies, read: Worry Free Investing by Zvi Bodie and The Grangaard Strategy by Paul Grangaard.

Now, let’s go and get rich!

PS For more Personal Finance articles visit: http://ptmoney.com/2008/06/09/the-156th-carnival-of-personal-finance-songs-of-summer/

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz

The Myth of Diversification

Posted on by
34

Important Announcement: Applications for my 7 Millionaires … In Training! ‘grand experiment’ CLOSE TONIGHT (June 2) at Midnight CST !!! This is your last chance to throw your hat in the ring …

I have been just itching to write this post … it falls straight into the category of ‘uncommon wisdom’ and will probably be jumped on by every Personal Finance author and self-appointed ‘finance guru’ out there.

All I can say is …

… bring it on, baby!

If you’ve read my posts on the only three ways to invest in stocks and the follow-up post that quoted some of Warren Buffet’s views on Index Funds vs direct stock investments, you’ll have some idea where this is heading.

But, if you’re just reading 7million7years for the first time, here it is in a nutshell:

1. Diversification is only suitable as a mid-term saving strategy – it automatically limits you to mediocre returns: The Market – Costs = All You Get … period!

Now, saving money this way, and compounding over time (a loooooonnnnnngggggg time) will put you way ahead of the typical American Spend-All-You-Earn-Then-Some Consumer ….

Just don’t confuse it with investing or wealth-building: it simply can’t, won’t, will never make you rich … nor will it make you wealthy …. nor will it even make you well-off ….

… because as long as you run, the dog of inflation is nipping at your heels!

However, it WILL stop you from being poor, broke and you may even be able to retire before 70, on the equivalent of $30k or $40k a year – not in today’s dollars, but in the inflation-ravaged dollars of the day that you retire!

But, if that’s all you need, then relax, that’s all that you need to do 🙂 But, if you need more then …

2. Concentration puts all of your eggs into one (well, a very few) baskets – it automatically gets you above average returns … if you get it right!

Investing implies taking some risk … it means choosing a vehicle (stocks, business, real-estate) … it means selecting one or a very few, well-chosen targets … it means putting your all into those well-selected targets and actively managing them for above-average market returns … until you get close to retirement.

Now, I could wax lyrical on this subject all day, every day … but, why trust me when you hardly know me and you can simply go to a source that everybody knows and can respect … Warren Buffet, who says:

I have 2 views on diversification. If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. The economy will do fine over time. Make sure you don’t buy at the wrong price or the wrong time. That’s what most people should do, buy a cheap index fund and slowly dollar cost average into it. If you try to be just a little bit smart, spending an hour a week investing, you’re liable to be really dumb.

If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice. “Lebron James” analogy. If you have Lebron James on your team, don’t take him out of the game just to make room for someone else. If you have a harem of 40 women, you never really get to know any of them well.

Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. Later in 1998, LTCM was in trouble. With the spread between the on-the-run versus off-the-run 30 year Treasury bonds, I would have been willing to put 75% of my portfolio into it. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up.

Over the past 50-60 years, Charlie and I have never permanently lost more than 2% of our personal worth on a position. We’ve suffered quotational loss, 50% movements. That’s why you should never borrow money. We don’t want to get into situations where anyone can pull the rug out from under our feet.

In stocks, it’s the only place where when things go on sale, people get unhappy. If I like a business, then it makes sense to buy more at 20 than at 30. If McDonalds reduces the price of hamburgers, I think it’s great. [W. E. B. 2/15/08 ]

So Warren Buffett seems to be suggesting that the average investor should be diversifying … not true. He is saying that unless you educate yourself, you should be ‘saving’ not ‘investing’ … but, here is what the difference between the two strategies means to you financially:

 i) Warren Buffet-style Portfolio Concentrationhas produced 21% returns compounded annually since warren Buffett took the reins of Berkshire-Hathaway 44 years ago. This is how he became the world’s richest man, and created many other multi-millionaires in his wake.

ii) Common Wisdom Portfolio Diversificationas measured by an index such as the Dow Jones Industrial Average (DJIA) averages out to just 5.3% compounded annually, even though the DJIA appeared to “surge” from 66 to 11,497 during the 20th century.

When you subtract 4% average inflation from each of these sets of returns, which do you think has ANY CHANCE of making you rich? 

But, it’s true that it is far better to be earning $30k – $40k (albeit in ‘future dollars’) in retirement than being flat-broke … so you need to build a safety net before you take on the additional risk that concentration implies.

Here’s how:

1. Create two buckets of money: your long-term savings, and your risk-capital.

You should first create your long-term savings bucket, as your fall-back … this means, max’ing your 401k; being consumer-debt-free; buying your own home and building up sufficient equity to satisfy the 20% Rule; and holding some money in reserve (this could be a 3 – 6 month emergency fund, or extra equity in your home that you are prepared to release in an emergency).

2. Maintain your long-term savings with the first 10% of your current gross salary, but using excess savings (i.e. any additional money no longer required to pay off debt now that you are debt-free); 50% of future pay-rises or other ‘found money’;  50% of any second income (e.g. from a part-time business) all to fund your risk-capital account.

3. Educate yourself on the investments that you will specialize in … then do your homework on the specific investments that you want to make and seek professional advice before stepping (not jumping) in.

4. If you fail … fall back to Step 2. then try and learn from your mistakes … but do try again/smarter.

Which path will you take?

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz

Is Money's only 7 Investments that you need wrong?

Posted on by
13

ANNOUNCEMENT: To kick off the final stages of the 7 Millionaires … In Training! project selection process, AJC is going LIVE – this Thursday @ 8pm CST !!!

___________________________________________________________

Last month Money Magazine published an article listing the only 7 investments you need – and Kevin at No Debt Plan wrote a follow-up piece that summarized the options nicely:

That’s right, this Thursday @ 8pm CST 7million7years is coming to a web-cam near you! All you need to participate is a PC with sound and broadband connection – AJC has the web-cam!!

Click here for more details: http://7million7years.com/live … should be a ton of fun!

Now, for today’s post …

 

 

CNN Money thinks you only need 7 investments:

  1. A blue chip US-stock fund (track the S&P 500 index) (Fidelity Spartan 500 Index, FSMKX)
  2. A blue chip foreign-stock fund (track the international stock index) (Vanguard Total International Stock Index, VGTSX)
  3. A small company fund (T. Rowe Price New Horizons, PRNHX)
  4. A value fund (Vanguard Value Index, VIVAX)
  5. A high-quality bond fund (Vanguard Total Bond Market, VBMFX)
  6. An inflation-protected bond fund (Vanguard Inflation Protected Securities, VIPSX)
  7. A money-market fund (Fidelity Cash Reserves, FDRXX)

And, I was happy when I saw that Kevin’s article disagreed, saying:

I think that is four to six too many for the average investor … I think Money’s intentions were good here and I don’t have anything personal against the funds they mentioned. (Well, except the Fidelity S&P 500 fund. $10,000 minimum investment? Are you kidding?) I sincerely think seven funds is too much. You end up sharing a lot of the same stocks in many instances.

But, I disagreed for a totally different reason … Money is trying to have you invest in EVERYTHING … and, trying to invest in everything simply doesn’t work for all the reasons that Kevin of No Debt Plan mentions in his post (go read it!).

But, I disagree with Money on this one simply because I hate, hate, hate funds … any, but mostly the ones with fees e.g. Target Funds … which, No Debt Plan tells me can also be bought quite cheaply, if you shop wisely, so maybe I hate them not just for the fees 😉

I mainly hate them, because investing directly in a few select investments is a strategy of the rich and those who want to BECOME rich. Of course, diversifying a little may be a better way to stay rich … I’m still deciding on this one, and will let you know when I pop up for air.

So far, I’m still on the side of not diversifying …

Of course, not everybody wants to be rich (and, I recently found out that some of them still read this blog!), so for them I agree with Money strategy – but, drop the bonds and most of the other funds … just Funds #1 and #2 will do.

I’ve mentioned on this site before that Warren Buffett agrees 100%:

In fact, I was just at his Annual General Meeting in Omaha where he said that IF you don’t want to take the time to learn about investing directly then you should just dollar-cost-average into a broad piece of “American Business” … which he went on to clarify as meaning Fund # 1 (except he specifically named Vanguard for its very low costs, but I know that Fidelity fund is pretty cheap, too).

Here is what Kevin had to say (via e-mail) when he saw my comments on his post:

I believe in diversification for the average joe out there. I just think the 7 funds they picked was stupid especially because it takes more than $24,000 to get started with all of the minimum investments (if you wanted an equally weighted portfolio).

The target fund expense ratio is not bad at all 0.21% for the 2050 fund by Vanguard. Sure it isn’t 0.07% but it also isn’t 1%. For instant diversification starting out… I’ll take it.

I’ve read Buffet’s comments as well. Thinks the average investor should be indexing and I agree. Kind of a set it and forget it deal.

That’s where Kevin’s view and mine part company … we’re on the same page except that I think the ‘average joe’ should aim to get rich and not be indexing/diversifying at all … 

In fact, I was surprised to hear at his Annual General Meeting that Warren Buffett (and Charlie Munger, his partner also agreed) said that he would put 80% of his wealth into ONE investment – surprised because Warren owns 76 businesses and lots of other investments!
But, the reason he later said is that he grew bigger than his investments, so he had to keep buying more.
So, it’s very simple:
1. If you want to be poor, but slightly less poor than you otherwise might be: diversify into American Business a.k.a. buy one, two, or even all seven of Money’s recommendations (just choose the ones with the lowest fees) and wait 20 or 30 years. Actually, not all seven … if you can wait 2 decades, why buy bonds?
2. If you want to get rich, don’t diversify … choose a very few investment, choose them very wisely, and manage them very well! If you can do that you just may very well end up rich … 
Let me leave you with the words of a very wise man, business man, inventor, and famous author:

Behold, the fool saith, `Put not all thine eggs in the one basket’–which is but a manner of saying, `Scatter your money and your attention’; but the wise man saith, `Put all your eggs in the one basket and–watch that basket!‘

The Tragedy of Pudd’nhead Wilson, Chapter 15.
Mark Twain(Samuel Langhorne Clemens) [1835-1910].

PS Keep this post handy, you’ll need Mark Twain’s real name (including middle name for extra bonus points) to win at Trivial Pursuit … after all, you’ll have lots of spare time to play when you’re retired 7 years from now 😉
 

Why do we need middle-men?

Posted on by
11

I read an interesting article in the Tycoon Report yesterday … one that I would normally gloss over because it was not their usual meaty, financial “how to” type of article, but it said:

By now must know where I stand on capitalism.  I told you then and I will tell you again that unfettered capitalism is NOT a good thing … the problem with capitalism is that, by design, it rewards deviant behavior.

For example, let’s say that you are a conventional doctor with his/her own practice and you take insurance.  You get rewarded based on how many patients you see, how many drugs you prescribe, and how many procedures (e.g. surgeries) that you do.

Does this make sense to you?
 
Wouldn’t it be better if the doctor were compensated based on how healthy you were?  Or if he got you to stop smoking or to exercise more?  In other words, shouldn’t he be compensated based on making you healthier or keeping you from being unhealthy?  Shouldn’t both of your interests be aligned so that there is no conflict?

An extremist view perhaps, but it was ‘food for thought’ and actually reminded me of something that Warren Buffett said … so I went through my files and dug it up!

In his 2006 letter to shareholders, Warren Buffett was scathing of what he calls “helpers”, that is stockbrokers, investment managers, financial planners and so on”

A record portion of the earnings that would go in their entirety to owners, if they all just stayed in their rocking chairs, is now going to a swelling army of helpers.

Of all places, this was first picked up as a major issue in Australia, because one of Buffett’s targets was the financial planning industry, which has been under the spotlight down-under, resulting in major new controlling legislation for this ‘industry’.

Helen Dent, a director of the Australian Shareholders’ Association, says that she “personally” agrees with Buffett’s scepticism of financial advisers:

Look, let’s face it, most people when they start thinking about investing, they ask their friends and they ask their neighbours and workmates what they’re doing before they get anywhere near an adviser.

The commissions that are paid to financial advisers, that you actually pay, is effectively coming from the producers of the financial products. That’s, on the whole, where the financial advisers are getting the bulk of their income from.

Most financial advisers are tied to financial institutions. That means that the range of products that they suggest to you is often bounded by what the financial institution says they can offer. It’s not bounded by what’s in your best interests.

So, what do you think?

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz

Should you buy Berkshire Hathaway instead of an Index Fund?

Posted on by
5

After yesterday’s post which was aimed squarely at my readers who want to get rich – I hope all of you 😉 – I thought that I should write a follow-up piece aimed at the window-shoppers who are stopping to look at my Get Rich(er) Quick(er) wealth creation ‘catalog’ but have no intention of ‘buying’ …

This question arose as a result of a recent article on Get Rich Slowly  which references the same Warren Buffett quote that that I posted yesterday:

What advice would you give to someone who is not a professional investor? Where should they put their money?
Well, if they’re not going to be an active investor — and very few should try to do that — then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time.

Get Rich Slowly then went on to say something very interesting:

Buffett has said this time and time again, which is why I’m baffled when people use Buffett as a reason to not diversify. I am not Warren Buffett. Neither are you. Unless you have Buffett’s combination of patience and intense research, you’re better off putting your money in an index fund. (As one reader recently noted, if you can afford to buy a share of Buffett’s company, Berkshire Hathaway, you’re getting the best of both worlds: a diversified portfolio picked by Warren Buffett!)

… which I also commented on yesterday, but it’s the “one reader” comment at the end, that grabbed me.

If Warren Buffett is indeed the World’s Greatest Investor (he is, without a doubt!), and you want to diversify as he recommends, why not forget about the “low cost index fund” option altogether, and jump straight to the top i.e. into Berkshire Hathaway (the company that Warren controls)?

Why?

Because, Warren didn’t recommend it … he’s too ethical to recommend it … in fact, he even says openly that an investor with $1,000,000 can achieve far better returns than he can nowadays, because Berkshire is just too darn big to move quickly and must invest in such large sums that the number of opportunities out there are much smaller for them than for us ‘little guys’.

Of course, the occasional ‘big opportunity’ opens up for Berkshire Hathaway, because of their $60 Billion ‘war chest’ … in the meantime, that $60 Bill. just sits in the bank barely beating inflation.

Even if Warren were still at his ‘smaller, more nimble’ peak, he still would NOT recommend that you do as “one reader” suggests because:

1. You would be buying just ONE stock … admittedly one that has performed well in the PAST and MAY (or may not) perform well in the future, and

2. You would be buying into only a partially-diversified conglomerate … a ‘piece of Warren’ rather than a ‘piece of [the whole of] America’.

So, if you are on the path to saving rather than investing, do what Warren Buffet himself suggests: stick to low-cost index funds …

… only buy any individual stock – including Berkshire Hathaway – if you are in the business of investing and really know what you are doing.

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz

Are you in the habit of saving or are you in the business of investing?

Posted on by
14

If you’re in Colorado, tune your dial to KRYD FM tomorrow morning (that’s May 22) @ 7.15 am when 7 Millionaires … In Training! hits the airwaves!!

If you listen in, you’ll find out that I have a face for radio and a voice to match … c’est la vie …

Take note that I said OR … I didn’t say AND …

In fact, most financial writers/bloggers/commentators take it as a ‘given’ that you will do exactly that: save a certain % of your salary and plonk it into your 401k to get the company match and have it invested in the restricted group of managed funds offered by your employer and/or 401k provider.

They’ll recommend that you dollar-cost-average your way into, say, a low-cost Index fund … and, you’ll be surprised to know that I agree and so does Warren Buffett:

What advice would you give to someone who is not a professional investor? Where should they put their money?

Well, if they’re not going to be an active investor – and very few should try to do that – then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time.

Now, I agree that this is indeed an elegant and simple long-term SAVING strategy for the Average Joe who thinks that they can save their way to wealth … $1 million by 65 … whoohoo!

But, if you want more (and, you probably should), then you have to move to Part B i.e. get “in the business of investing” …

That usually means one – or, for the rare genius, a combination of – four things:

1. Get in the business of running a business (that’s what Warren Buffett does … contrary to popular belief, he is primarily a business owner … he owns or controls 76 major businesses!)

2. Get in the business of learning about and selecting a FEW individual stocks (that’s what Warren Buffett does … he owns / has owned stock in Coca Cola, Kraft and many others)

3. Get in the business of learning about and actively investing in real-estate (that’s what the rehabbers, flippers, foreclosure experts, etc. do)

4. Get in the business of climbing/clawing/backstabbing your way to the very top of the corporate ladder (that’s what America’s Fortune 500 CEO’s do)

Usually, it means choosing just ONE of these as your main Making Money 201 path to income – at least, that’s what I did – then choosing a SAVING strategy to convert that income to passive assets to keep your wealth growing and fund your eventual retirement:

I was in a corporate job for nearly 10 years … after about 6 years, even though I was doing ‘very well’ (for my age, position, seniority, etc.) I realized that Option 4. wasn’t for me – I would never become a CEO of somebody else’s company.

I didn’t know much at all about either 2. or 3. but I did have a sudden urge for Option 1. – so that’s what I chose!

My first business was a bit of a ‘sleeper’ – it started its life as a very small (and new … I joined one year after inception) family business and grew fairly slowly. Because it was barely breaking even, I bought the family out and managed to get it to grow rapidly and substantially. I still keep it 15 years later, although, it has run very well without me for a number of years now.

I used the profits from that business (the nice little cash-cow that I turned it into) to fund a few start-ups, most of which I subsequently sold.

But, when all of these business were running, I SAVED a good proportion of the profits in various ‘savings’ vehicles: mainly real-estate and a little (at that time) in stocks … none in funds.

Why do I say ‘saved’?

Because I didn’t ‘actively invest’ in them … I wasn’t in the business of investing … I was simply in the habit of saving. I happened to select a non-standard mix of savings vehicles to put my money into (e.g. real-estate and stocks, rather than CD’s and Funds) … then I held on to them … and let time (and the markets) take care of the rest. Because I could put so much in, I eventually got so much out.

It was a Making Money 101 strategy.

My % returns from the businesses were spectacular … my % returns from my ‘savings’ were ordinary … yet, each played a critical part in my current financial success. Interestingly, my overall $ returns from both were excellent!

In the last few years, as I geared up for my ‘retirement’, I have revisited these options and moved away from business and to investing … because I gave myself so much exposure to both real-estate and stocks over the years, I have built up the skills in both to allow me (for some time, now) to actively (as well as passively) invest in both as a Making Money 301 wealth protection strategy.

But, if you want to become financially free, at a relatively young age, with a relatively decent passive income (you’ll have to plug in your own numbers), then you will need to find one of these four options that interests you, and hope that it delivers spectacular returns for you …

… for most people, Warren Buffet and I also agree that it’s unlikely that it will be in stocks, at least according to this little exerpt as reported by Soul Shelter (whose brother, Charles,  attends Berkshire Hathaway events in Omaha each year) who relayed this anecdote from Buffett’s 2006 shareholders’ meeting”:

One shareholder asked a question along the lines of ‘how should I study investing in order to build wealth in my spare time?’

Buffett replied that, for most people, the bulk of their income is going to come from earning power in their chosen profession. Therefore, from the standpoint of building wealth, free time is better spent sharpening one’s professional skills rather than studying investing.

This statement applies directly to my Option 4.; it equally applies with a little modification to any of the other options (e.g. Option 1: … for some people, the bulk of their income is going to come from earning power in their chosen business. Therefore, from the standpoint of building wealth, free time is better spent sharpening one’s business skills rather than studying investing).

In other words, select where you will make your money, and focus all of your energy, research, and attention into that … focus!

Of course, if you’ve decided that your financial future lies in the business of investing then here’s what you should do:

Do not as Warren says … do as Warren does! 

PS We were featured in the Q&A for the latest Carnival of Finance; visit it here: http://moneyandvalues.blogspot.com/2008/05/carnival-of-personal-finance-153-q.html

Add to: | blinklist | del.cio.us | digg | yahoo! | furl | rawsugar | shadows | netvouz