Poor little rich doctor …

Posted on May 11, 2012 by Adrian

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

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

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

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

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

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

I agree on both counts:

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

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

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

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?

Why are professional athletes so horrible with money?

Posted on May 6, 2012 by Adrian

In 2009, Sports Illustrated observed:

78% of NFL players and 60% of NBA players are bankrupt within two years of leaving the game.

From this Get Rich Slowly concluded:

Many professional athletes are horrible with money.

Why does this occur?

Investopedia in a recent article stated the obvious:

Athletes have a unique problem that many other professions don’t: the earnings window is small. While the more traditional careers may allow a person to work 30 to 50 years, a professional athlete will work only a fraction of that time. This leaves the retired athlete with the job of managing what they have to last for the rest of their life with only a fraction of their old salary being earned.

Whilst I agree with GRS that many sports players are horrible with money, this is simply an undistributed middle fallacy of the type:

All students carry backpacks.

My grandfather carries a backpack.

Therefore, my grandfather is a student.

In other words, this problem is not isolated to athletes … they are just one class of people who have highly skewed earnings.

Others include anybody with what I call “Found Money”, which is my term for any one-off (or otherwise time-limited) sudden influx of cash. For example:

– Anybody who signs a major contract (athletes, musicians, actors, celebrities, even sales people or small business owners who “land that once in a lifetime deal”)

– Anybody who wins a substantial sum

– Anybody who inherits a substantial sum

… and, so on.

The Horrible Money Management Syndrome, that Get Rich Slowly incorrectly attributes to athletes, actually comes with the sudden influx of money i.e. it’s a problem with the source, not the recipient.

For example, there are lottery winners from all walks of life, yet the operators of the UK Lottery found that, on average, lottery winners had spent 44% of their winnings after just 2.5 years, which supports the anecdotal evidence that 80% will be entirely broke in just 5 years after winning a major lottery!

Whilst some sharp wits may observe that this is “because the qualifications for playing the lottery are being ignorant of the principles of mathematics” [AJC: for example, as one blogger recently observed, you are more likely to die from melting underwear than winning the lottery], my theory is that …

… you need to learn the lessons slowly on the way up, in order to stop yourself learning them the hard way on the way down.

In case any of you are planning to make a lot of money quite suddenly [AJC: even faster than $7 million in 7 years ‘suddenly’], you would be wise to heed the lessons that I taught my children when they were still very young (and, follow to this day):

When they get money [AJC: Any money: an allowance, a gift, find it on the street, etc.] half goes into Spending and the other half into Savings.

So, too, does it go for you: anytime that you get any additional money [insert ‘found money’ methods of choice: you’re a professional athlete; you win the lottery; you get a pay increase; a second job; loose change that you save out of your pockets; a gift; a manufacturer’s cash rebate; tax refund check; etc.; etc.] you Spend half and you Save half.

At least, this is advice that will tide you over until I share my Found Money System with you …

… next time 😉

How to start with next to nothing in cash and build up from there?

Posted on April 28, 2012 by Adrian

Ken H asks:

I am just starting my journey to the concept of making money when you buy. Can I get more examples of what can be bought to use this concept? Where do I learn a strategy that I can start with next to nothing in cash and build up?

Great question, Ken!

The short answer is that you need a source of cashflow.

The long answer:

A high-paying job is ideal (but, only if you invest 30% to 50% of it after tax) …

… if not a high-paying job, then a second source of income.

I like the idea of starting an online business ‘on the side’ and reinvesting 100% of the profits (a) back into the business to help it grow and, whatever’s left over, (b) in income-producing investments.

The ideal investments, of course, are ones where you can get a silent partner to put up 75% – 90% of the money required. That way you can get more investments quicker.

Also, when the bank puts in 80% of the funds required to fund a real-estate acquisition, and it goes up in price by 20%, you have just doubled your money (less the bank’s interest).

And, the best ‘silent partner’ that I know is The Bank. But, the investments that The Bank likes the most – hence, they will lend by far the most on these – is good old-fashioned real-estate.

So, I would reinvest as much of my savings as possible into real-estate, and then wait 10 to 20 years (unless my business grows really fast, in which case I might wait 5 to 10 years.

Sure beats ‘working for The Man‘ for 40+ years, doesn’t it?

How to become a wealthy doctor?

Posted on April 21, 2012 by Adrian

We all have this image of doctors. We believe that that they are all-knowing and well … rich.

But, is that really the case? Let’s check out what this young doctor (a new reader), David, has to say:

I am a young physician (early 30s) making approximately 800k per year. After expenses and taxes, I am left with ~300k to save/invest. However, I have been making ~40k for the majority of my working life and am completely overwhelmed as to how to handle this chunk of change (unfortunately I received no financial education in medical school…). Do you have any advice as to how and where I should allocate this money? I am worried about investing too much money in one source and would like to be fairly diversified.

You see, right here is where doctors go wrong!

Firstly, $120k – $250k net spending money p.a. [AJC: my estimate, depending on how the taxes and other expenses work out] is, indeed, quite a large “chunk of change” …

… especially when jumping from $40k starting salary.

So, the first mistake that most people in this situation make is to immediately increase their standard of living. Now, a conservative person won’t increase their living standard to $120k less 10% (because that’s what the books tell you that you should ‘pay yourself first’), but the chances are that they will raise their living standard quite dramatically.

The $40k quickly becomes $60k as they equip themselves with a new car and some extra furniture and a larger TV or two … then $85k as they move into a bigger apartment (with a view) … then $120k as they step into a more committed relationship and buy the house, school the kids, and so on.

In other words, the treadmill has a way of increasing its speed until you forget that you are supposed to be ‘rich’.

You see, David’s sudden increase in income comes under the heading of ‘found money’; I’ll post on it soon …

In the meantime, I recommended that David (and, you!) read this: http://7million7years.com/2012/03/22/installing-an-atm-in-your-business/ and this: http://7million7years.com/2008/09/22/why-most-doctors-arent-rich/

… actually, read it in reverse order (i.e. read the second article first).

Then, you can tell me what you think David should do?

Would you take financial advice from this man?

Posted on April 16, 2012 by Adrian

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

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

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

You see, he’s a financial advisor …

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

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

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

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 … ? 😉

Life’s tough at $250k a year …

Posted on April 10, 2012 by Adrian

I was chatting to a friend last night and was amazed at his reaction to what I had to say.

The conversation went something like this:

Me: Did you see that article about the guy who can’t live on $350k a year?

Him: What guy?

Me: Oh, some guy written up in the Wall Street Journal the other day.

Him: I didn’t see the article. What about him?

Me: He’s a lawyer or law professor or something who earns $350k a year and can’t make ends meet.

Him: Yeah, I know people like that. Remember Elton John nearly went broke?

Me: Yeah [laughs]. But, that’s not what I’m talking about. He says he can’t even afford to own a house because he lives in New York … in Queens or Brooklyn or somewhere like that … and between his taxes … I think he pays nearly half in taxes … and his rent, he is really struggling.

Him: Poor him [laughs]

Me: [laughs]. Yeah I guess it seems funny. But, I actually know where he’s coming from. I own my house and my cars outright. OK, I have two kids in private school, so that’s expensive. But, we struggle to stick to our $250k a year spending budget.

Now, here’s the weird part: my friend didn’t seem surprised at all …

… like NOT being able to live on $250k a year (before taxes) when you have NO mortgage, NO car payments – in fact, NO debt at all – is nothing unusual.

I made $7 million in 7 years so, for me, spending ‘only’ $250k a year is probably being frugal.

What’s his excuse?

And, how much annual expenditure are you banking on your Number being able to produce?

Make money when you buy!

Posted on March 31, 2012 by Adrian

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

You make money when you buy, not sell.

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

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

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

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

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

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

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

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

… 90% of business owners are wrong!

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

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

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

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

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

Installing an ATM in your business …

Posted on March 22, 2012 by Adrian

I met a small business owner a few weeks ago …

He was a smart young guy [AJC: aren’t they all?] who was setting up his own Internet design studio, building Internet-based software projects for other business owners.

His business is essentially a professional service business, and my advice to him was pretty much the same as I give to all professional service business owners (consultants, accountants, attorneys, doctors, etc.):

Except in rare circumstances, you don’t have a business, you have a high-paying job … with perks!

[AJC: the perks are around the tax benefits that attribute to business owners but not to paid employees; ask an accountant for examples.]

Most of these kinds of businesses don’t scale very well i.e. they can’t grow very large; they rely on the owners’ personal exertion (sometimes called ‘partners’); and, either can’t be sold, or can only be sold for small multiples of annual profit or turnover.

In short: you can’t rely on selling these businesses to fund your retirement.

But, what they do generally provide is income …

Because they are professional services, the owners are able to sell their own labor – and, those of their employees – at high multiples, usually generating excellent recurring revenue.

And, because they often take years of hard work and relationship building over many, many clients they can be quite “bullet-proof” (if well managed) in terms of providing that income reliably.

This was certainly the case for the young guy that I met.

Even though his agency was still quite young/small, it was already generating a nice income and showing signs of growing well.

My advice for him was to grow his personal income very slowly (this is advice that I would give to any business owner), and to pull as much money out of the business as possible (this is not advice that I would give to other business owners) …

… my advice was to treat the business as his personal ATM

[AJC: but not to the detriment of the business, or his partners, employees, clients, backers, etc.]

But, my advice was not to spend that ATM-cash on personal lifestyle building (homes, cars, vacations, etc.), but on passive investments.

I recommended that he use that cashflow to fund an aggressive investment portfolio, outside of his business: one that would one day grow to replace his personal income as generated by the business.

When the day comes that his passive income surpasses his personal business income, he becomes free.

What would you advise?

Are wealthy people more unethical?

Posted on March 13, 2012 by Adrian

It’s nice to see science magazines writing about money 🙂

This time , it’s trying to find a link between wealth and (a lack of) ethics.

This is not a new notion, just check out Charles Dickens’ “A Christmas Carol” and it’s offshoot – and my favorite cartoon character – Scrooge McDuck and you need look no further.

But, I think that these scientists – and authors and cartoonists – miss the point:

You do not have to be unethical to make money …

… and, I think that it actually harms your chances as people often can spot unethical tendencies and will take that (correctly) as a sign that they cannot trust you.

However, if the study is correct, I think one explanation may simply be that wealthy people have been exposed to more opportunities to make the “should I be ethical or unethical in this situation?” decision.

More exposure simply means more unethical behavior evidenced.

For example, working on a production line may not produce wealth …

… but, it also may not produce many opportunities to take unethical action during the 8 hours a day that you are at work.

[AJC: although, you may have plenty of opportunity to indulge in unethical behavior after hours if that is your bent]

However, being in business or running around making real-estate investments may give you plenty of extra opportunities to (a) become wealthy and (b) exhibit unethical behavior both during and after hours, thereby giving you twice the exposure to both potential outcomes.

So, I think it is a case of increased exposure rather than cause and effect …

What do you think? Do you need to be unethical to make money? If so, is that a ‘cost’ you are willing to carry?

Another reader question …

Posted on March 6, 2012 by Adrian

Eddy asks:

I am 21 years old living in Los Angeles CA. I dropped out of [college] after 2 years of studying because of lack of stimulation. I’ve had a job since I was 15 and have been in sales since I was 18. I currently work as an account manager at an IT outsourcing company. Oh, and I forgot to mention one small detail, I am also $40,000 in college debt.

My only plan right now is to gain enough experience and a set of skills in sales to make six-figures. After that I will begin investing. I know its to early to doubt myself, but I am constantly reminding myself where I am and where I am going to make sure I am on the right path.

My question is this, am I on the right path? A lot of my colleagues do a great job reminding me about the glass ceiling above me because I don’t have a college degree. Also, once I start making six-figures, how do I learn how to invest?

I told Eddy that I don’t/can’t give personal financial advice (laws aside, I simply don’t know enough about him … or any other reader).

BUT, I can make some general observations about the e-mailed question:

To succeed in life requires tenacity … and, to make any sort of large Number (e.g. $7 million) in any sort of soon Date (e.g. 7 years) requires super tenacity; if it didn’t, everybody would be rich!

7million7years

How to make 7 million in 7 years …

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