Avoid wiggly-line investments!

UPDATE: We have a winner in my $700 in 7 Days Giveaway … yep, ‘barbaramontgom’ (with 6 points) was chosen by random drawing (see below) and wins the entire $700 Cash!!!!!! Barbara just needs to send me an e-mail ajc [at] 7million7years [dot] com to claim her $700 cash prize (less any PayPal fees)!

Bet you wished that you had entered ūüėČ

Special thanks to Steve and Trisha who tied at the top of the leader board … if you send me an e-mail with your name/mailing address I will send each of you a $60 Apple Gift Card! Thanks to all of the others who entered and promoted the contest like crazy!

LAST CHANCE¬†to enter my free contest: CONTEST OVER: in just ONE more¬†today, I am giving away $700 cash to one lucky reader (drawn at random) as part of my $700 in 7 Days No Strings Attached promotion. It’s free to enter simply by clicking here.


CNNMoney fields a question from a reader who’s scared that her money will run out before she does:

Question: I recently had to take early retirement at age 57 because of back problems. I’m now looking for a safe place to invest my retirement money where I’ll have no risk losing it. Any suggestions? — Donald H., Morris, Alabama

Yes, I have a suggestion: don’t post your questions to a financial ‘expert’ who still works for a living!

If you do, you’ll get answers like:

Answer: If the threat of losing principal were the only financial risk you had to protect yourself against in retirement, then finding a safe haven for your money would be pretty simple. You could plow your entire nest egg into Treasury bills or spread it among FDIC-insured savings accounts and CDs (taking care to stay within the FDIC coverage limits).

But while doing this would insure that you would never lose a cent of your money, it would also insure that your retirement stash earned a pretty measly return.

Good, so far … so, no cash. Got it!

What should she do instead (?):

If you want to have a decent shot at your retirement savings lasting as long as you do, you also want to invest in a way that has at least some potential for long-term growth.

[Keep some in cash and the] rest of your savings you want to keep in a diversified portfolio of stock and bond funds. Again, there’s no single correct mix. Typically, though, someone just entering retirement might have 50% or so of his or her portfolio in stocks and the rest in bonds.


Question: If you are aiming to retire, why do you want long-term growth?!

Answer: Because, you expect to lose some significant proportion of your capital to:

– Spending too much,

– Inflation,

– Market downturns.

In other words, the expert recommends to invest in a ‘wiggly line’ investment, hoping that the upswings outweigh all the downswings + spending after inflation is taken into account.

How well has that been working out for the past, oh, 20 years?

So, can you think of an investment that tends to grow with inflation, and provides income that also tends to grow with inflation?

Well those treasury-protected bonds certainly have principal that keeps up with inflation, but the returns are so low that income will become a real problem.

But, what about real-estate?

It’s where ‘the rich’ have kept the bulk of their retirement savings since time immemorial … I wonder why? ūüėČ

It's all about the curve …

The secret to making money can actually be most easily explained visually; at least I’m going to have a go at trying to explain it visually in this three-part series:

The Straight Line Curve


A straight line is actually a ‘curve’ mathematically / graphically-speaking …

… but, financially-speaking it describes a situation where you may have a lump sum just sitting in CD’s and earning you 2.5% and you withdraw the interest to spend. This describes a basic Making Money 301 situation where you may have already reached your Number, want to keep it in the bank (safe, right?), and can afford to just live off the interest.

[AJC: This would be OK, if it were not for the effects of inflation; in reality, your Net Worth would be decreasing as inflation erodes the buying power of your lump sum savings]

This ‘curve’ also describes what happens when you earn money primarily from your own labor: you have a ‘lump sum’ (i.e. the total number of hours that you can apply to your job/profession), which provides a ‘fixed return’ (i.e. the hourly rate that you are paid or charge) that you spend / live off: nice, while lasts ūüôā

Given that none of my readers are interested in ‘straight-lining’ their way to certain financial ‘death’, in the next two parts of this series, we will examine ways to accelerate your returns …

The lesser of two evils?


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:

¬†‚ÄúShould I invest in CDs or a Roth IRA?‚ÄĚ

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 ūüėČ

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).


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/

Business for sale?

As you know, I’m a member of Networth IQ – and quite an active member, at that! I love reading and answering questions …¬†

[AJC: you’ve probably already seen that from the detailed responses that I try and give commenters on my posts on this blog … try me, if you have a question … I just won’t give direct personal advice, because I am not a qualified professional,¬†but I will give general advice if I think it will benefit all of our readers]

… and this unique site provides a great platform (as does Tickerhound, which provides a great Q&A forum on everything from stocks to real-estate).

For those of you who aren’t members of Networth IQ, here¬†is an exerpt of a great question:

I found a business for sale that has generated the following free cash flows since 1998.

1998 – $3,426.0 Mil
1999 – $3,949.0 Mil
2000 – $4,917.0 Mil
2001 – $7,133.0 Mil
2002 – $6,077.0 Mil
2003 – $8,333.0 Mil
2004 – $8,956.0 Mil
2005 – $9,245.0 Mil
2006 – $11,582.0 Mil
2007 – $12,307.0 Mil

The current owners are asking $183.49 Bil, …. I don’t have $183.49 Bil, but they said that they would sell me a smaller portion of the business if I wanted … Should I buy?

I like this question on two levels:

1. It’s a neat reminder that when we buy stocks, we’re not just buying ‘bits of paper’ … we’re buying a small piece of a real, live business!


2. It gives me an opportunity to show you the sorts of questions that I would ask – and the types of information that I would be looking at before buying into this – or any – business.

According to Warren Buffet (or sources who purport to know how he works) the intrinsic value of a business is in its discounted cashflow.

That is, a business is – or should be – a cash machine … what’s the reason for owning it, if not to get some cash out?

So, in the above example, we should be able to decide if the business is worth¬†$183.49 Billion (not knowing the company in the above excerpt, I am assuming that this number represents the entire current market capitalization of the business) by discounting the cash-flows shown above …

… a quick look at the most recent cash-flow figure shows that it is currently producing $12 Bill. cash per year (probably growing, if history is any guide); that would mean about 15 years to get our money back … yuk.

Now you know why the stock market is generally a fool’s game …¬†I would by far prefer to invest in my own business, or buy a private one at ‘only’ 3 to 5 years free cash-flow (better yet, Net Income), and grow it …¬†then float it myself!

Or, at least sell it to a public company who can immediately ‘claim’ 15 times my Net Profit (hence, give me 7 to 12 times my Net Profit).

But, if we are going to play ‘the stock market’ game, what would we need to know before we can make an informed decision about ‘investing’ in this stock?

Hmmm …
As I pointed out, the free cash-flows on their own say nothing …
For example, I recently¬†sold two similar businesses: one had been going for many years and generated ‘free cash flows’ [now that’s an oxymoron!] of $1 mill. and the other was less than 2 years old and had yet to make a dime.
Yet, I sold them both (separately) for about the same price! So, there must be more to the valuation of a business than Free Cash-flows, right? Absolutely!Let’s start with Return on Invested Capital:
I’d like to know what it has been¬†for this company (and, the industry) over the past 5 years? I’d like to see an improving trend in excess of 15%,¬†please.
Then, is the company growing?
Cash Flow is just one measure¬†(but, what about operating cash-flow … have they made any strategic purchases / major capital expenditures /etc.),¬†so what about the 10 years trends in: Earnings? Book Value? And, what about plain, old Sales?
I’d like to see a history of growth (min. 10%) in all of these …Now, how is there debt situation?
How long will it take them to cover their long-term liabilities from ‘Free Cash Flow’?
I’d like to see no more than 2 to 3 years.
Do the people who run the company own stock? Are they buying or selling?
Tell me about the company: do they have a ‘sustainable competitive advantage’ (what Warren Buffet calls a ‘Moat’ … but, that’s too much water for me!).

Do I believe this company will be around for the next 100 years … do I really want to buy THIS business in THIS industry?

Lastly, if I like¬†the answers to all of the above (unlikely … so far I’ve only liked the answers to similar questions for 7 companies out of the 5,000+ that I can currently buy a ‘piece’ of) …

…. then how CHEAP can I get this thing!?
PS I made the ‘other’ category … waaaayyyyyy down at the bottom of the 150th Carnival of Personal Finance … whoo hoo!

How much interest do you earn on one million dollars?

Welcome new readers!

Here are three of my favorite posts to get you started; if you want to find out:

1. If $1 million will be enough to retire with, then click here, or

2. How much house you can afford, then click here, or

3. Why buying a new car is such a losing proposition, then click here.

Otherwise, please enjoy this article, then bookmark my home page (click here) and come back often …


How much interest do you earn on one million dollars?

This was the question that Clint at Accumulating Money asked in a ‘classic’ post – I commented on it earlier this year and still receive click-through’s two or three months later. It must be a very popular question!

I’m not sure why, because it implies that people are happy to just have their life savings ‘sit’ in CD’s …

… but, here’s the answer to the “million dollar” question¬†courtesty of Accumulating Money anyway:

So, to answer the question, how much interest do you earn on One Million Dollars (assuming a 4% interest rate, compounded monthly)?

One Day – $109.59

One Month – $3,333.33

One Year – $40,741.54

Five Years – $220,996.59

Ten Years – $490,832.68

Twenty Years – $1,222,582.09

I think this related question asked by Afroblanco at Ask Metafilter Рrepeated on Get Rich Slowly (which is where I picked it up) Рreally goes to show how The Savers (as opposed to The Investors) think:

‚ÄúWhat‚Äôs the safest possible thing that I can do with my money?‚ÄĚ :

I take bearishness to an extreme. Having witnessed the 2000 tech crash, I have no faith in the stock market or the US economy. I keep all of my money (USD) in a savings account. However, with the recent financial turmoil, I have a few questions:

  1. Is it conceivable for the FDIC to fail?
  2. If so, is there a place where I can put my money that will be safer than a savings account?
  3. What’s the safest, most risk-free way for me to save money and not get killed by inflation and the tanking US dollar?
  4. If there is a safe way for me to save money and not be punished by inflation and the depreciating dollar, is there a way that I can do this without having to stress out and micromanage my finances? I don’t want to be checking the finance page and making adjustments every day.

Even though I follow finance news, I’ve never done any investing or money management other than socking money away in my savings account. I’m a n00b, I admit it.

OK …¬†I confess …. I am like our friend, Afroblanco¬†… very risk-averse; yet I have become rich by understanding that it is actually¬†safer to invest than not.

The GREATEST RISK that our friend can take is NOT TO INVEST … inflation will just eat up any bank deposit/CD strategy.

Take Accumulating Money’s example above:

One million dollars approximately doubles in 20 years … but, inflation¬†will halve¬†its buying power!

Think about it, if the average bank interest rate is 4% (pushing the value of your savings UP) and inflation averages 4% (pushing the buying power or value of your savings DOWN), what have you gained in 20 years?

Nothing …

Now, if you just push your savings into a low cost Index Fund that averages, say, an¬†8% return over the 20 years, then the same 4% inflation means that you should effectively DOUBLE the value¬†(or ‘buying power’) of your million dollars over 20 years.

But, Afroblanco¬†is even better off BUYING The Bank [i.e. investing in the Bank’s stock] than putting his money in The Bank. The risk of failure is about the same (if the bank fails you will lose the money that you have IN the bank’s vault¬†as well as the money IN the bank’s stock), yet, as long as he has a long-term view (minimum 20 to 30 years), the former strategy will make him rich and the latter broke.

If the bank stock averages just 12% average growth over 20 years –¬†as any well-picked Value Stock, can easily do – then Afroblanco won’t just double the buying power of his money ONCE, he will get to double it TWICE … that’s $4 million AFTER the effect of inflation (or, the $1 million grows to $10 million in ‘raw’ dollars).

What about risk? Aren’t bank deposits FDIC Insured?

[AJC: Well, yeah … up to a paltry $100kof course, you could open up¬†4 bank accounts at 4 different banks ¬†… but,¬†$400k is hardly what I hope my readers are aiming at!]

But, inflation is a much bigger risk:¬†100%¬†certain to¬†eat up your money … and, would the Federal Government (the same entity backing the FDIC) allow a Major US Retail Bank to fail?

I guess we’ll find out in the next few months!

If you don’t believe that’s likely, then isn’t your money just as safe in The Bank as it is in the bank?

[AJC: think about it ūüėČ ]

And, doesn’t The Bank’s stock at least meet the overall market returns which averaged 8% p.a. for the past 100 years … what have bank deposits averaged in that time? 3%? 5%?

The point here is not necessarily to buy stock in¬†The Bank … rather it’s to think about Investing rather than Saving …

Before suggesting WHAT to invest in, we need to know HOW long is our friend is expecting his money to last? Assuming that our friend is a hands-off investor, here’s what I suggest as the lowest-risk strategies possible:

If less than 30 years, then TIPS are a an option РPROVIDED that he can live off the inflation-adjusted interest (unfortunately, very unlikely in the current low interest environment Рbut, in 5/10 years, who knows?).

If 30 years or more, then a low-cost Index Fund is ideal for a hands-off investor. There has been NO 30 year period since the recording of the stock market indices where the market has not produced a positive return well above inflation.

If he is more hands on and/or more knowledgeable, then I would recommend no more than 4 or 5 well-selected individual stocks and direct investment in real-estate, for any time period 10 years or greater.

Inflation forces us to invest … because of this, inflation is our friend!