The Golden Rule of personal finance …

golden ruleIf you find yourself asking a personal finance question like this one, this post will give you all the tools that you need to answer it for yourself:

I am in my early 20s, earning between $110-180k/yr depending on my bonus. Would it be inappropriate for me to drive a $50k Mercedes Benz?

Most people would deal with this by saying things like:

– Can you pay cash for the car?

– If you buy a Merc now, what will you buy next year?

– Save for your own home

– And, so on …

Which are all valid concerns …

… but there is one important question that nobody thinks to ask:

What is your current net financial position (i.e. net worth)?

Yet, this is the most important question to ask!


Because it’s your Net Worth that sustains you in retirement:

– Before your retire, you earn income

– You save and invest as much of your income as possible to build up your ‘nest egg’ (this is your net Worth on the day that you retire)

– After you retire, you live off the income (e.g. interest, dividends, investment income, etc.) generated by your Net Worth and/or deplete it over time

And, this takes you directly to The Golden Rule of personal finance …

… because, it’s the one financial rule to live by; the one above all others; the one that – if you follow it – will answer all of your financial questions and guarantee your financial future:

Always have 75% of your net worth in investments.

This means: at least until you retire at a time and place of YOUR choosing, that you should always have no more than the remaining 25% of your current net worth (tested yearly) as equity in your own home, car, possessions, etc..

These rules of thumb then follow:

– Have no more than 20% of your current net worth as equity in your own home

– Have no more than the remaining 5% of your current net worth in your other possessions. It is typical to split this 50/50 between your car and your other ‘stuff’.

– This means that you should have no more than 2.5% of your current net worth in your car. I suspect that the reader’s proposed Mercedes would break this rule.

There are a few important things to note, if you’re going to obey The Golden Rule:

1. You can – in fact, should -break the 20% Equity rule for your first house (otherwise, you will never be able to afford to buy one), but don’t upgrade for as long as you will be breaking this rule.

2. You will probably need to borrow money to buy your house (first and/or future home), but don’t spend more than 30% of your take home pay on the mortgage repayments, except – again – for your first house (but, only if you absolutely have to).

3. Never borrow money to buy a depreciating asset (e.g. car) UNLESS it’s required to earn income AND you have no other way of buying one. Even then, obviously buy the cheapest that will do the job, borrow the least, and pay it off early.

4. For a pleasant surprise, test these numbers annually: because your Net Worth will go up each year, yet your car and other ‘stuff’ will depreciate (check eBay). This means, you can actually afford to buy more ‘stuff’ every year or so, if you like, or just save up your ‘spare net worth’ for a couple of years to upgrade your car, etc. when ready.

So, are you following The Golden Rule?

If not, what do you have to change in your life so that you do?

Which would make you feel richer?

Last week I asked my readers what would make them feel richer: more income? Or, more net worth?

This was prompted by a Twitter Trail (my term for a thread on Twitter) that started with this:

@NoDebtPlan articulates the classic fallacy: income makes you feel richer because it can be turned into net worth.

But, that is illusory: if your net worth is invested wisely, it’s pretty hard to lose all of it.

On the other hand, ask the millions of people who are ‘down-sized’, get injured, relocated, become under-skilled, out-voted and so on just how easy it is to lose your entire income … and, as soon as your income stops, you begin to feel very poor indeed 🙁

Of course, what’s the use of net worth if not to create income?

So, while it is certainly true that income can create net worth … that’s the beginning of the chain, not the end.

The whole point of net worth is to (a) live in / drive in / enjoy and (b) to create an alternate (passive) source of income so that you can eventually stop work, should you so choose (or be forced into).

Now I’m not talking from some book that I read: I created my $7 million in 7 years simply by exchanging income (from my business) into assets (income-producing real-estate and stocks) … and, you should do the same:

Remember that Rule of 75% … without it you, too, will always be a slave to earning an income 😉

Applying the Formula for Wealth – Part II

The first part of the $7million7year Formula For Wealth is pretty simple, therefore so is its application:

Where (W)ealth is a function of (C)apital and (T)ime

It’s pretty useful for teaching your children to save part of their allowance; other than that, you need more help than I can give you if you still don’t know that you should be investing at least some of your money (i.e. capital) 😉

But, what about a more difficult questions? Like deciding whether or not you should pay off your mortgage early?

Dave Ramsey would suggest that you pay off your mortgage NOW and INVEST (presumably, once those funds are no longer required in order to pay off your mortgage) LATER.

According to the base formula, you are still putting your money into an asset (hence, creating Capital), and allowing that to sit for a long time, which has to be a good thing, right?

Of course it’s better than spending the money – perhaps literally eating your capital (fine dining, anyone?) …

… but, is it optimal from a wealth-building perspective? For that, you need to turn to the third part of the formula – the X-Factor:

The two sub-sections of this part of the equation simply suggest that (Re)ward is offset by (Ri)sk; you have to rely on other studies (or common sense) to realize that Risk and Reward are related: as you increase Reward, so – to a greater/lesser degree, depending where you are on the Risk/Reward curve – so do you increase Risk.

In other words, Risk is a dampener for Reward – otherwise, we’d be traveling to work by jumping out of planes and playing the options market, as a matter of course!

But, the same cannot be said for (L)everage and (D)rag …

Leverage is the ‘big secret’ of building wealth: increase leverage and you MULTIPLY your wealth.

Using other people’s money is one way to increase leverage … but, by paying off your home mortgage, you are DECREASING leverage!

According to the formula, that’s bad 😉

Interestingly, Peer to Peer lending also fails the leverage test.

You see, peer to peer lending, mortgage ‘wraps’, and other products where you are financing other people, reduces your Capital and increases their Leverage … the polar opposite of what you should be doing!

So, why do banks lend money, potentially reducing their leverage?


They’re not lending their money; they are borrowing money as well. They are leveraged to the full extent allowed by their law and their board of directors.

Which brings us back to risk:

As the banks proved before the financial crisis, applying too much leverage can be bad for your financial health.

What about risk and your home mortgage?

The argument often cited for paying down your home mortgage is one of decreasing risk. Yet, if you intend to live in the house for some extended period of time how is your risk increased / decreased by paying down debt?

How have you applied leverage to improve your wealth?


Applying the Formula for Wealth – Part I

There’s no point in having a formula – no matter how simple it may seem – if you don’t know how to APPLY it.

So it is with the $7million7year Formula For Wealth:

The beautiful thing about a formula like this – and, why I am so excited every time I get to share it with you – is that you don’t need to know anything about personal finance in order to answer the typical personal finance questions that arise … the formula makes the answers obvious.

Let’s take a really simple example, you earn money … so, you’re entitled to spend it right?

Well, what you do with your money is your own concern. But, if part of your plans include building wealth, what should you do?

Maslow’s Hierarchy puts physiological needs (food, water, warmth, etc.) right at the bottom, so you had better take care of all of the basic household expenses first. Then comes safety and security so you also had better take care of those brakes!

But, then come the ‘soft’ areas that cover the gamut of love and self-esteem, all the way to self-actualization and self-sufficiency. Which means that you have to take care of your future physiological needs etc. – but, that probably accounts for your basic spending and your 401k contributions.

Then you have to decide the tough issues: do you have more fun now (spend more now) or hold some back – better yet, invest – so that you can also have some fun later?

That’s a personal choice, but one that finding your Life’s Purpose will make much easier.

Which brings us back to the point where you’ve made the decision to build some wealth (e.g. your Number). And, that’s were the Formula For Wealth comes in really handy:

The formula for wealth merely says that (W)ealth is a function of (C)apital and (T)ime.

So, you need to start building capital – the earlier the better to also increase time – which means you shouldn’t spend that excess cash on going out and having (too much) fun, nor should you buy depreciating assets such as cars, furniture, and accessories (other than to satisfy the Maslow-needs for basic transport, protection and comfort).

And, the formula makes it pretty clear that the more your capital increases over time, the better. So, simply sticking your cash under the mattress probably won’t cut the mustard … you’ll need to start thinking about investments that grow your capital over (sufficient) time e.g. CD’s, bonds, stocks, or real-estate.

Nothing earth-shattering, so far. So, next time, let’s use the second part of the formula to answer one of the most commonly-debated questions in personal finance: should you pay off the mortgage on your home loan early, or just let it ride?

How Much House Can You Really Afford?

Jaime from Eventual Millionaire interviewed me. Check out the interview (you can even download the podcast) here!



I have two house-related rules of thumb:

1. never have more than 20% of your Net Worth tied up as equity in your house (i.e. borrow the rest)

2. Don’t let your mortgage payments be more than 25% of your Net Income (i.e. after tax)

Ryan questions the first of these:

Regarding the first tip, I”m assuming you are referring to not using more than 20% of your net worth as a down payment, correct? Because as time goes by, your equity should grow, and it wouldn’t make sense for most people to withdraw equity from their home value.

As I explained to Ryan, I think it makes great sense for “most people” to withdraw equity from their homes … but, only for the purposes of investing ;)

My overarching rule of thumb is to always have 75% of your net worth in investments.

The remaining 25% can typically be:

20% in your house

2.5% in your car

2.5% in your other possessions

[AJC: by “in” your house/car/possessions, I mean “in the current value of the equity that you hold”; so it’s a good idea to reevaluate yearly e.g. using tools like Zillow or an MLS search tool to check the current value of your house and Kelly’s Blue Book to check the current value of your car and a finger in the wind – or eBay / Craig’s List – for your possessions, etc.]

Since you can only buy a shoebox (literally) for 20% of Net Worth, if you’re a typical person just entering the workforce … don’t sweat it: just apply these rules AFTER you have bought your first house/car/TV/etc.

Then, if you abide by these simple rules, they will stop you from buying more too soon AND from over-investing your hard-come-by Net Worth in ‘stuff’ 🙂

None of my friends know that I blog ;)

It’s true, I am the ultimate Secret Blogger …

… only two of my closest friends even know that I do blog – about personal finance – but, I won’t even tell them the name of my blog or my ‘pen name’!

[AJC: By now, you probably know that Adrian John Cartwood isn’t my real name – only the Adrian part is. For no reason that I can understand, my daughter started calling me ‘Adrian John Cartwood” when she was 7 … well, when the idea to write this blog sprang to mind in 2008, AJC was the natural choice!]

It’s not comfortable to talk about money: but, I resolved from Day 1 that this blog would need to be authentic and I would have to share the most gruesome details of my financial life.

So, when Bob asked:

From your “I’m a money hacker” post:

What is some financial advice you could give our readers?

Most people don’t really know how much house they can afford, so let me give your readers some very specific advice that will help them through every stage of their own financial journey: never have more than 20% of your Net Worth invested in your own house…

Do I understand from this post that $5M of your $7M net worth is in your own house?

… I can, from a position ‘protected’ by semi-anonymity, remind our readers that my $7 million journey represents a 7 year ‘slice’ of my financial life from when I started $30k in debt in 1998 and ended up with $7 million in the bank in 2004.

My recent ‘bad beat‘ post talks about what happened between 2008 and now 🙁

But, the years in-between (i.e. 2004 to 2008) were very kind to me: dominated by a series of sales of my Australian, New Zealand, and US businesses to a UK public company … it was almost literally raining money for those years.

But, this is a personal finance blog, not a business blog, so I concentrate on the $7m7y because I believe that is repeatable by almost any of my readers.

Even so, my $5 million (cash) house certainly breaks the 20% Rule (my net worth would need to be $25m+) but, it doesn’t matter!

You see, the 20% Rule only applies when you are still chasing your Number!

When you have reached your Number (Making Money 301), THE RULES CHANGE:

Remember when you calculated your Number?


1. Took your required annual living expenses (of course, adjusted for future inflation until your chose ‘retirement’ Date) and multiplied that by 20, and

2. ADDED in the value of your house (plus any additional cash required to pay off the mortgage), initial cars, and any other one-time purchases.

Once you reach your Number, you no longer require 75% of your Net Worth to be in investments: you ‘only’ require the amount that you came up with in Step 1.

So, you can buy as much ‘stuff’ (houses, vacation homes, cars, etc.) as you like with any extra cash that you happen to have!

For me, it doesn’t really matter how much house I bought, as long as I still have >$5m in investments, generating my annual living requirements.

So, Bob, you don’t have to worry about me … yet … I just like to complain 🙂

Who wants to be a billionaire?

Do you want $1 Billion? If so, I can’t help you much, but maybe this video can help …

For the rest of us, what will YOU spend your money on when your reach YOUR Number (list in the comments)? Even if it is only a paltry $7 Million in 7 years 🙂

To get you started, here’s my list:

House ($6 million; later ‘downsize’ to apartment worth ‘only’ $2 million)

Cars ($500k + $50k p.a. towards buying newer ones every few years)

Travel x 2 to 4 trips per year ($50k p.a.)

Startups ($500k) – Maybe these will pay off, maybe not 😉

Speaking Tours (incl. in travel + $25k marketing budget) – as above!

Charitable Donations (at least $25k p.a.) + time: my wife’s 🙂

… then, there’s all the ‘living’ type stuff: house/parties/clothes/restaurants/sports/etc./etc. ($200k p.a.)

How about you?

I’m diversified …

Applications for the new $7 Million 7 Year Wealth System Guided Learning Experience are now closed. Thanks to all of those who applied … and, congratulations to those 30 who made it!

I’m not going to encourage my other readers to join, as I can’t see the point of paying $97/year for something that you could have got for free (well, for $1 a year). Anyhow, no advertising allowed on this blog … and, that even applies to me!

Instead, I hope that you will keep reading this blog, and that it will inspire and help you to make millions the good, ol’ fashioned way 🙂


Yes, I am well and truly diversified …

… and, it sucks!

Here are my current holdings, roughly:

$5.0 million – House in Australia

$1.5 million – House in USA (soon to be a rental)

$2.5 million – Cash in Bank/s

$1.0 Stock in UK (actually, 70% has just been converted to cash)

$1.0 million – Equity in 5 condos

$1.0 million – Equity in two development sites (could be up to $3 million – $6 million once permits are issued)

$1.0 million – Value of business (I still have a finance company running on ‘auto-pilot’)

… aside from the fact that I’ve over-invested in my Aussie house [AJC: see this post for the problem and how I intend to fix it], you can see why I am not happy:

– Too much in cash,

– Too much overseas, in chunks too small to be meaningful

– Too many ‘small’ chunks of $1 million

Ideally, I would like to bring some of those small chunks together, merge them with my cash (like so many drops of mercury) and do something useful with them …

…. by ‘useful’, I mean plonk as much as the bank requires into my two development projects, then use the proceeds to buy as many investment properties in the $1 million to $3 million price range that I can find, as long as the net result is free cashflow of $500k+ p.a.

Nowhere here do you see me saying:

– 30% in cash,

– 30% in real-estate,

– 30% in stocks

– 10% in venture capital

Mine will look more like:

– 80% – 90% real-estate (albeit, over a number of properties, rather than just one big’un),

– 5% – 10% cash for contingencies (up to approx. 2 year’s living expenses or $500k to $1 million, whichever is the lesser)

– 5% – 10% for ‘fun projects’ (e.g. venture capital investments).

Why so much in RE?

[AJC: It doesn’t have to be RE; how I invest my money is not how you should invest yours … but, the principle of NON-diversification is what’s important, here. And, I should clarify that, too: for you, non-diversification could be 95% in TIPS; 80% in AN index fund; 90% in just 4 or 5 stocks … in other words: it means, avoiding spreading across asset classes]

I can’t find the online reference, but Warren Buffett was asked at the 2008 Berkshire Hathaway AGM (which I attended, so I am paraphrasing exactly what I heard, here) how much of his net worth he would place into one position (Berkshire Hathaway doesn’t count, because it’s really a conglomerate).

Warren said that his biggest problem right now is that his investment war chest is so large that he is forced to buy many investments, however, he did point out that he was very happy in days long gone, when his investment in AMEX comprised nearly 60% of his net worth.

Charlie Munger (Warren’s long-time business partner) said that he would be equally happy to have close to 100% of his net worth in just one outstanding investment.

BTW: Charlie is a real ‘character’; short on words … long on wisdom!

Having sat on both sides, I can tell you that – right now – I am NOT happy being so ‘diversified’ … it annoys me, and I feel hamstrung in that I can’t bring my full financial weight to bear on any project.

But, each to their own … it’s just that certain rich peoples’ “own” = non-diversification 🙂


Adrian J Cartwood is on FaceBook … come and be friends!


Paying down debt … an instant Net Worth fix?

I think we’ve covered this in brief before, but it’s a common – and, easy to make – mistake, so I thought that I should cover it again, here …

… Diane asks:

I’m withdrawing the funds in the IRA to pay [some of my] debt. So, is my Net Worth actually decreasing?

Unfortunately, that’s not the case; simply moving money between accounts (such as using some spare cash to pay down your home mortgage) doesn’t do anything to change your Net Worth, at least not on its own …

… it seems counter-intuitive, so try updating your NWiQ profile by, say, taking $10k from your retirement account and reducing one of your debts by the same amount … you’ll quickly see that your Net Worth does not change.

Here’s an example:


Let’s assume that Diane currently has a Net Worth of $66k because she has some assets (including a $93k ‘retirement account’) totaling $259,500 but she has to pay debts (liabilities) of $193,000 (including a $33k credit card debt).

Now, let’s see what happens if she takes $10k out of her Retirement Account to help knock a hole in her expensive credit card debt (let’s also assume there are no taxes or other penalties involved):


All that’s happened – from a purely Net Worth perspective – is that the Retirement Account has gone down $10k (to $83,000), but so has the credit card debt (from $33,000 down to ‘only’ $22,000). Do the math and it’s clear:

Diane’s Net Worth hasn’t changed … it’s still $66,000!

What will change is that Diane will earn less in her retirement account, but she will save more interest on her debts. I’m betting that paying the debt down (thus saving, what, 10% – 20% interest p.a.?) will put more money into her pocket than the 6% – 10% that she is ‘losing’ in long-term mutual fund returns (after fees and charges) …

… and, it’s what Diane does with THAT ‘found money’ that will dictate what happens to her future Net Worth 🙂