Tag Archives: Making Money 101

… the fallacy of dividend paying stocks!

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When I’m not writing posts here, I’m hanging around the Share Your Number Community Site, talking to the other members.We launched this site in 2008, and in 2009 we are planning a major expansion so please join now … it’s FREE and easy!

Remember, helping others get to their Number is the best way to get to yours …

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I have been itching to write this post for some time now, and yesterday’s post about investing in income-producing real-estate v speculating in (hopefully) appreciating RE should have provided the necessary comments/questions …

… but, it didn’t 🙁

However, Steve chose this particular day to finally complete his comment on a post that goes back 6 months … a comment that is right ‘on topic’ for me … and, is a question that all of us should be asking … so, thanks Steve!

Here’s what Steve had to say:

I don’t purport that he is write [sic] in his article but would really love to hear your views on [this] story…

http://seekingalpha.com/article/84850-investing-in-dividend-paying-companies?source=d_email

what i liked about it is the dividend paying stock situation. certainly i wouldn’t consider as an only avenue to wealth, but do you feel dividend paying stocks are a better choice than non dividend paying stocks?

The article promotes a method of investing that the author claims returns “a little over 8.68% annually … while not earth shattering by any means, compare[s] very favorably with the market’s performance over the same period. From July 1988 to now, the S&P 500 has advanced … around 7.86% annually.”

The ‘now’ is actually July 2008, so only reflects some of the recent stock market losses, but the principle is clear, at least according to the author: invest in dividend-paying stocks …

… and, this is certainly ONE (of many) Making Money 301 tactics that I recommend when you have made your Number and are trying to preserve your wealth. However, it is just that – a tactic – and, certainly not the best one there is.

Given this, and my strong recommendation that you invest in RE for income, you might be a little surprised to hear me say:

As a Making Money 101 or 201 strategy, seeking out dividend-paying stocks is almost irrelevent!

Why?

Well, let’s take a look:

Stocks return in TWO main ways, just like real-estate:

1. Capital Appreciation

2. Dividends

Capital Appreciation

Just like real-estate, the price of a stock tends to go up according to the profits of the company. When I say “just like real-estate”, I mean just like commercial real-estate … residential real-estate has other, less tangible drivers of future value. So commercial real-estate tends to rise in value as rents rise, and stocks tend to rise in value as the company’s profits rise.

Naturally, inflation is a key driver (forcing rents/profits up, hence the price of the real-estate/stock) but there are plenty of other ‘micro’ and ‘macro’ factors as well e.g. for real-estate it could be job growth, for companies it could be competitive pressures, etc.

This is what I would call the Investment Factor that tends to drive up the value of such investments, and you can generally be confident that prices will increase according to this factor – over the long-haul.

An equally important factor is ‘market demand’ for that type of investment, which is reflected in ‘capitalization rates’ for real-estate and ‘Price-Earning (PE) Ratios’ for stocks … this is essentially a measure of how long somebody who buys that investment is willing to wait to get their money back via future rents/profits.

This is what I would call the Speculation Factor that tends to drive up or down the value of such investments, and you can never be sure which way this will drive prices – over the short-haul.

Unfortunately, as recent market events in both real-estate and then stocks have very clearly shown – the Speculation Factor has a much greater effect on pricing than the Investment Factor … unless your time horizon is very long, indeed.

This is why it is much better to look for the underlying investment returns, unfortunately often mistakenly confused with …

Dividends

Because Real-estate produces rents – and, hopefully positive cashflow after mortgage and holding costs are taken into account (which, should be your main criteria for investing ), people often confuse dividends paid on stocks with returns on real-estate investments.

This is not the case:

Whereas real-estate returns are simply the rents that you receive less the costs (e.g. mortgage, repairs and maintenance, etc.), stock dividends do NOT directly reflect the profits of the underlying business.

Commercial real-estate usually provides an investment return set by a ‘free market’ (for things like competitive rents, competitive interest rates, etc.) …

… but, the dividends on most stocks are simply set by a board of directors according to whatever criteria makes sense to them at the time.

People who invest in dividend-paying stocks are confusing dividends with company profits … but they are NOT directly aligned: a company may make super profits and not pay a dividend at all (for example, Warren Buffett’s own Berkshire Hathaway has NEVER paid a dividend).

A company that makes NO profit may still choose to pay a dividend (perhaps from cash or even borrowings) … just to keep their shareholders happy (for example, in 2004 Regal Cinemas paid a $5 per share dividend; “to make the $718 million payout, Regal first had to borrow from its banks”).

Is it a sound financial strategy TO invest in Regal Cinemas because they DO pay a dividend, or NOT TO invest in Berkshire Hathaway because they DON’T?

I’d love to hear your views …

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You can also find us at the latest Money Hacks Carnival, hosted this week by Money Beagle …

Rich Rat, Poor Rat

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This video is essentially an ad for Robert Kiyosaki’s (Rich Dad, Poor Dad author) board game … a game that I own but have NEVER played. But, the video is also a snapshot of how you can use assets to buy consumer goods. Watch the (visually OK, but aurally uninspiring) video, then read on as I have some comments …

[AJC: Finished watching? Good …. now read on ….]

1. The assumption is that you are smart enough NOT to finance a depreciating ‘asset’ (actually, liability) and save up enough money to pay CASH for your boat: GOOD

2. Can you see how Robert Kiyosaki then suggests that you buy a cashflow positive property, using the cash that you saved for the boat as a deposit on the property instead? Robert implies that the property produces enough cash to then pay for the loan repayments on the boat: BETTER

But, Robert is suggesting that we BREAK a key making Money 101 Rule: that we should borrow to by a consumer item (this is BAD debt); Robert also suggests that ‘delayed gratifiction’ is good. So, let’s make use of this to see if we can come up with a better outcome.

Using a very simple loan calculator, I find that the $16,000 boat will actually cost us $21,600 over 4 years (assuming 10.5% interest, and $343 / month payments) …

… but, if we instead SAVE the full $750 / month that the property spins off as money in our pocket (after mortgage, etc.), we will have SAVED up enough to pay CASH for the boat in just under 2 years (21 months)! What’s more, over the four years that we have NOT been paying the boat loan, our money has been earning us approx. an extra $100 – $400 in bank interest.

OK, so the $100 – $400 extra interest we earn (if the money just sits in CD’s) is not exciting, but also SAVING $5,600 … a total of nearly $6k … surely is? So waiting less than 2 years, then paying cash for the boat, thus saving ourselves nearly $6,000: BEST

There is an exception: where the expense is a business expense it may be OK to finance … Robert gives the example in one of his books about how he was going to buy a Ferrari, but his wife (who’s obviously smarter – as well as better looking – than him) told him to buy a self-storage business instead, and use that to fund the payments on the Ferrari.

Smart … but, I’m sure the IRS would have some words about the deductibility of a Ferrari as ‘company car’ for a self-storage business 😉

Making Money 101? What to do today!

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I write about advanced financial strategies; these are designed in three stages: Making Money 101 – Get on your feet, financially speaking; Making Money 201 – Build your wealth; and, Making Money 301 – Keep your wealth.

Another way to look at it is that my blogs are all about getting you to your Number, then keeping you there!

Since we are dealing in time-frames of years (at least 7 years to go from ‘zero to financial hero’) we have to expect to deal in all phases of market cycles – both the up’s and the down’s – so I avoid talking about specific ‘today’ strategies in favor of the longer-term.

However, my son has said that I need to help people through the current financial ‘crisis’, so that’s what I am going to do over the next 3 days:

Today, advice for all those Making Money 101 …

Wherever your money is right now, keep it there!

That’s it, thanks for reading 😉

Oh, you want details?!

OK, here it comes:

– If you are currently in cash, stay in cash.

– If you are currently in stocks or mutual funds, stay in stocks/mutual funds.

– If you are currently in real-estate AND can afford the payments and are not ridiculously in credit card and other consumer debt, stay in real-estate.

Why?

Well, as this post explained, over the long run, you will achieve the market averages for all of these investment choices … only if you stick with them through thick and thin.

Right now qualifies as being about as ‘thin’ as anything in the last 100+ years 😉

If you run away during the bad times (now) and only buy in the good times (2006) you will be buying high and selling low: the exact opposite of what you should be doing …

… then, you will be lucky to make 3% or 4% annual returns – the same (or less) than if you had kept your money in cash!

So, for those MM101’ers out there, what are you doing with your assets while the financial world seems to be crumbling around you?

Hitting Suze Orman out of the ball park …

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… with a fly ball that even Dave Ramsey won’t be able to catch!

As expected, my recent post “Contrary to popular opinion, paying off your mortgage is the dumbest move you can make …” drew a number of comments – but, not as many deep criticisms as I was expecting (hoping for) … I would’ve liked some issues out in the open so that we can really bang them around.

After all, my view is diametrically opposite to the ‘pay off ALL debt INCLUDING your mortgage’ view espoused by the likes of Suze Orman and Dave Ramsey!

With some suitable flaming of the “you’re just another Make Millions In Real Estate Like I [wished] I Did guru” or “Robert Kiyosaki knows what he’s talking about compared to YOU” kind, I’d at least be able to dig in and show you why my view is correct for MOST people.

I’d also be able to explain why, perhaps counter-intuitively, it’s actually the more conservative option.

Instead, let me make do with the much more polite, and more thoughtful, comments that one reader – Chris – did leave on that post:

AJC – I completely understand and agree with your concept. I think the reason why you and Suze Orman differ is because you target a different group, or have a different approach.

You talk much more about leverage. Suze Orman wants to get people to stop buying frivolous things and instead pay down debt (because most people are buying junk and creating more of it).

While anybody can start a business, a rental, etc. There are people who don’t have the ambition or the stomach for it. The concept of leverage and more involved ways of wealth appreciation get lost on those people.

The point that needs to be made is, if you aren’t going to leverage that debt properly to grow wealth, then paying it off is better than buying useless things. Perhaps for some people we need to focus on getting them to be frugal spenders first, and then wealth builders later.

I would also note that I think paying off mortgage debt should rank much lower than other investments in reducing higher cost debt, a business (including rentals) or retirement accounts. But for some people, putting an extra $100 towards a mortgage is a great way for them to start being more financial considerate.

The assumption is that my approach is different to Suze’s and Dave’s because:

1. I aim at a different audience

2. Their approach is a more sure way to a comfortable retirement

3. They focus on ‘frugal living / debt free’ which comes before wealth building

It seems logical, safe, and conventional … and, I agree on one point, my approach isn’t for everybody …

… it’s just for anybody who doesn’t want to retire on the poverty line!

By that, I mean that I am targeting anybody who wants to retire with a nest-egg of MORE than $1 Million in LESS than 20 years.

Now, that is almost everybody that I have ever known or met– and, I’ve known and worked with a LOT of people from call-center people to CEO’s – because $1 Mill. in 20 years (the typical target for the ‘save your way to wealth’ crowd) simply gives you the equivalent of $15k per year in today’s spending-dollars!

For every extra million dollars, you only get an additional $15k per year to live off … and, for every 10 years that you will retire sooner, you get another $7,500 per year ‘pay rise’.

So: how much do you need to live off now? How much do you need to live off when you ‘retire’ and by when?

I don’t know the answers to these questions, so you do the math …

I can tell you this: if all you do is live frugally and become debt free you will be poor, with a roof over your head … if you don’t, you will be poor without a roof over your head.

Neither seems like a great option … so, you can understand when I say that the Suze Orman / Dave Ramsey ‘save and pay off all debt’ approach still seems a tad ‘risky’ to me, and a sure approach to a fairly uncomfortable retirement.

Given that Door 1 and Door 2 pretty much suck [AJC: OK so one door sucks more than the other … are we here to measure degrees of ‘suckiness” or what?!] what’s left is Door 3 …

If you live on the same planet that I come from (Planet Save a Little, Spend a Little … Enjoy a Lot), then we simply have to aim for more … a lot more!

That’s where leverage comes in … and, it has to come in WHEN saving, WHEN learning to be frugal, WHEN paying off all debt (and, probably BEFORE paying off some debt) …

… and, if you are aiming to retire somewhere above the poverty-line, then you are simply going to have to find the ‘ambition or the stomach’ for something.

I never had the ambition or stomach for work … I simply had to do it or starve. Don’t you?

I never had the ambition or stomach for investing … I simply had to do it or figure on retiring near-broke. Won’t you?

If the government takes away your social security safety net … if your employer takes away your pension … if your rich relatives die and forget to leave you anything … it’s going to be that simple: do it or retire broke.

OK, if that hasn’t turned you on, then nothing I ever write will … otherwise, here are some options, in decreasing order of risk and difficulty – but, also decreasing order of financial outcome:

1. Start a business

2. Buy a business

3. Invest in real-estate

4. Buy your own home

5. Leverage into Stocks

6. Leverage into Index Funds

In every one of these cases, you borrow as much as the banks, convention, your gut, your advisers tell you to … then you hold – preferably for ever.

[AJC: Speculative ‘investment’s such as: rehabbing/flipping real-estate; trading stocks/options etc. all belong in Category 1. Start a business]

Now, go do it …

The one question that you should always ask when it seems too good to be true

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I’m only 4 months into this blogging thing, but it has already broadened my horizons.

For example, here’s a blog that may not normally have made it to my ‘must read list’, but the guy is quite funny. I found him because he left a comment on one of my posts (it’s the one with the Mad Magazine, Alfred E Neuman avatar) … seems this is the way that blogs work.

[AJC: Leads me to wonder if the only people who read/comment on blogs are other bloggers?]

…. there is a [admittedly, small] finance point to this, so stick with me.

I saw this post on his blog: Why Don’t Psychics Win The Lottery? 

Here’s an “oh, so true” snippet from his post:

Being able to tell the future and predict events should give all Psychics the ability to become rich beyond their wildest dreams. So why aren’t they?

They should be able to win the lottery, predict stock market gains and losses, predict business trends, and win in Vegas–big time. With this knowledge, they should be able to run circles around experienced financial advisers.

This caught my eye, because about a month ago, my wife and I went to a charity event (my wife was one of the organizers, so I had to go … damn, hate those events), an event that just happened to have a semi-well-known ‘mind magician’ (a.k.a. a mentalist or psychic).

Apparently, he’d been on TV …

He was quite good and managed to guess a friend’s chosen number (it was 99) as well as a bunch of other, non-numeric stuff. Now, we all know that these types of shows are all staged and the people on the stage are all ‘stooges’, right?

Well, that’s what I assumed until … wouldn’t you know it, he called my wife up to the stage.

Now, my wife is nobody’s stooge and I have the bruises to prove it 🙂

Apparently, she does have a ‘thing’ for George Clooney … the psychic guessed that – but, I didn’t know it (time for that face-and-body-lift for me … pronto!). He also guessed her ‘number’ (it was  63).

Does that make him a psychic … perhaps. Are my wife and her friends ‘new believers’ … absolutely!

But, not me; I like to apply the ‘common sense’ test to these things … the questions that I ask are simple:

1. How many digits can this guy correctly ‘read’ in one night?

Looks like 4 digits per night at 100% accuracy, from what I saw.

2. How much did he get paid for this extraordinary feat?

Not sure, but it was a local charity event (it wasn’t Vegas), so I’m guessing a few hundred bucks.

3. What would I do if I were this guy?

Now isn’t this the Litmus Test question; the one that we should always ask when confronted with a seemingly ‘too good to be true’ situation?

If I were this guy, I guess I would go to Switzerland, and stand outside a bank for a few days … waiting for one of those mysterious looking men going into their equally mysterious looking bank to access their really, really mysterious ‘secret bank’ account using only their 10 digit access code, conveniently committed to memory.

If I could guess 4 digits per day at close to 100% accuracy, then I’m pretty sure that I could guess 10 digits, if I stood outside the bank for, say, a week and made at least 3 or 4 attempts … I might need a couple of different fake moustaches

I wouldn’t net a few hundred dollars in a night, I would net the $1 Bill. or $2 Bill. sitting in some chump’s secret bank account in a week.

So, our psychic … real or not?

Your answer probably dictates whether you have any chance of making some serious money in your life … because so much of financial success [AJC: see, I promised a ‘financial’ point] depends on being able to apply simple, perhaps ‘uncommon’ sense to sort out the ‘too good to be true’ from the ‘thank god it’s true’.

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Applying the 20% Rule – Part I ( Your House)

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Since my early post How Much To Spend On A House is still one of the most visited posts on this site, I thought that I should write a little follow-up piece that gives some examples on how to apply this important ‘rule’.

First a recap:

You should have no more than 20% of your Net Worth ‘invested’ in your house at any one time; you should also have no more than 5% of your Net Worth invested in other non-income-producing possessions (e.g. car/s, furniture, ‘stuff’). Why?

This ‘forces’ you to keep the bulk of your Net Worth in investments i.e. real assets (stuff that puts money into your pocket … not stuff that drains your finances)!

Warning: most people think of their house as an asset, but by this definition, it most definitely is not … let this be a warning to all those ‘house rich … asset poor’ people out there who think they can retire just from their house.

For those mathematically minded, as a formula, this can easily be represented as:

20% (max.) for your house + 5% (max.) for all the other stuff that you own = 75% (min.) of your Net Worth always in Investments! Simple, huh?

Also, for those who have been tracking my posts, the difference between your Notional Net Worth and your Investment Net Worth will be the Current Market Value of Your House + the Current Market Value of Your Possessions; if you’ve been following my advice this should be no more than 25% of your Notional Net Worth.

Now, you may have noticed something interesting:

The Current Market Value of Your House will usually go up over time (current market conditions aside!)

The Current Market Value of Your Possessions will usually go down over time (collectibles aside!).

Houses generally appreciate … possessions generally depreciate.

This sets up some interesting situations that we should discuss … by no means an exhaustive list:

1. Aspiring Home Owner – The chances are that you have debt (particularly if you were recently a student), little income, some possessions, virtually no savings or investments. You will probably never be able to buy a house at all – or, if you can it may never be bigger than a cardboard box – if you follow the 20% Rule …

… My advice is to buy the house anyway IF you can afford a decent down payment (ideally 20+%) and can afford the monthly payments (lock in the interest rates for the max. period that your bank will allow, ideally 30+ years).

A lot of financial mumbo-jumbo has been written in the press, books, and blogosphere about this … ignore what you may have read: for most people, it’s the only way you will ever get financially free.

2. Already A Home Owner – Revalue your home (be conservative … don’t wear ‘rose-colored glasses’ … check what other houses around you have actually sold for … don’t rely on any realtor’s advice – they may ‘talk’ up the price to convince you to sell – we don’t want to do that, yet!). Do this every 3 – 5 years (yearly is better).

If the conservative value of your house puts the equity in your home (Your Equity = What the Home is Conservatively Worth – Today’s Payout Figure On Your Home Loan) at greater than 20% of your Current Net Worth (you will need to redo this calculation at the same time as you revalue your house), then it is time to extract that ‘excess equity’.

What to do with this excess equity? Invest it of course! For example, you could buy a long-term, buy-and-hold, income-producing (get the picture!) rental property … or you could buy stocks … or you could take some risk and buy / start a business … or it’s up to you!

But, if you locked in your home mortgage at a cheap interest rate, you probably don’t want to refinance it, so be sure to ask a professional about suitable options for you (second mortgage; use your home’s equity to ‘guarantee’ the loan on another, etc.) … just be sure that you can afford the loans on both your house and your investment/s … make sure you have a cash [AJC: better yet, a Line of Credit] buffer against emergencies (loss of job, loss of tenant, etc.).

 3. Right-Sizing Home Owner – Again, revalue your home … but, of course you can down-grade (let’s say that you are retiring or the kids have moved out) – but just because you have freed up some equity and can easily fit into the 20% Rule doesn’t mean that you can slack off on your Investments.

ADD the freed up amount of equity to your Investment Plan … it will help you retire earlier and/or better!

Remember, your Investments should be a minimum of 75% of your Net Worth … you can and should invest more wherever and whenever possible! 

Again, if your original house is rent-able, and you have locked in a cheap interest rate (like I told you), you may want to keep it as an investment … consider doing so!

Now, buying houses isn’t always about making the right investment choice; there will be times in your life when you have to consider changing houses whether it fits within the 20% Rule or not (one obvious example was our First Home Purchase) …

… most likely, this will be at major life changes (marriage, divorce, babies). So be it!

Remember our Prime Directive: Our Money is there to support Our Life … Our Life isn’t there to support our Money (that would be just plain sick)!

Just make sure to revalue every year at first, then every 3 – 5 years min. and try not to get off-track, but if you do, simply realize if you are off-track financially and that you just have to get on-track at the first opportunity …

AJC.

PS You may want to bookmark this post (using the convenient links below) and review at every major ‘house change’ decision!

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Celebrating Spending Week!

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For the remainder of this week I want to do something that I believe has never been done in the history of Personal Finance: encourage spending!

Why would I do a ‘heathen’ thing like that:

1. Well spending is good for the economy … it’s how we got things going after WW2 … go ahead be a Patriot!

2. Money has NO PURPOSE until you spend it

3. Money SPENT NOW is worth more than MONEY SPENT later (due to a little thing called Inflation)

4. Learning when/how to spend is AS IMPORTANT as learning how to save … after all, you WILL spend b/w 50% and 90% of your weekly paycheck!

5. If you don’t SPEND when you CAN and SHOULD, society has a word for you: Miser and we don’t want to confuse being SENSIBLE with being STUPID, do we?

But, there is a why and a wherefore that I will be exploring for the rest of this week … enjoy!

And, don’t forget to let me know what you think … we want to be on the cutting-edge of Personal Finance thinking, not the BLEEDING EDGE … your feedback will help us determine where we stand.

AJC.

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Why do personal finance bloggers blog … what's in it for me?

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I must admit that whenever I read a personal finance book I ask myself the question: was this guy rich before he wrote this book or because he wrote this book?

Sadly, for many, writing the book is a way to wealth for the author … not a way to express wealth to the reader.

For personal finance blogging, I feel that it is different, simply because there isn’t enough money in it to justify the time … even for those who do accept advertising on their blogs.

So, why do personal finance bloggers blog?

For the answer to that question, I turned to a blogger who is clearly so successful that he can’t possibly be in it just ‘for the money’ – or the fame – Guy Kawasaki … he already had plenty of both!

If you don’t know Guy and his blog, I suggest that you open a new tab in your browser and get acquainted with him now.

In a recent post, Guy talks about a a three-part study from C-NET, appropriately called “The Influencer Study from CNET Networks: Challenging Perceptions.”

Guy says that the study “explored the structure of social networks, the motivations for giving advice, and methods of acquiring information.”

The part that interested me was this comment about influencers: 

Influencers aren’t driven to share information for the sake of appearing knowledgeable or to demonstrate their expertise. They’re primarily motivated by a basic desire to help others. They develop a stronger sense of self-confidence when it’s well-received, further motivating them to help and advise others.

Now, I can relate to this …

I write this blog because I want to share what I learned the hard way … there was no clear roadmap for me to follow when I was struggling financially, so I want to create one for others to follow.

The many books –  and blogs – that are out there dealing with the subject of money seem to mainly focus on how to save and get debt free, or how to retire on plus/minus 20% of your current salary …

… while important, none addressed my need to be totally financially free, at a (relatively) young age and with enough ‘play money’ to do the things that I needed to do.

And, none showed me how to do that quicker than ‘get rich slow’, but more safely than ‘get rich quick’.

I  guess I had to write my own ‘manual’ on how to get rich – by trial (many) and error (many) as I went along … this blog is the result.

I hope that it works to make your path to wealth a little quicker and easier for you than it was for me!

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Measuring my performance against the Edelman 'secrets' …

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Ric Edelman book 

I’m going to do TWO things today that I don’t normally do …

1. I’m going to review a book, and

2. I’m going to do it by using a review of that book on another blog (The Simple Dollar, a Personal Finance blog that I happen to like … a lot)!

Why?

The book review outlines some of the ‘secrets’ suggested in the book … and I would like to give you some insight into how I think …

… so, here goes (everything in italics is from the blog post): 

Ordinary People, Extraordinary Wealth pledges to contain “the eight secrets of how 5,000 ordinary Americans became successful investors – and how you can too.” Intriguing subtitle. I can’t wait to dig in, so let’s get started. Looking Into Ordinary People, Extraordinary Wealth:

Secret #1
They carry a mortgage on their homes even though they can afford to pay it off.
Edelman basically argues that the concept of a mortgage being a bad thing is a relic of the 1930s, where banks would foreclose on a house on a whim, and the negativity associated with mortgages has hung around this long even though there are a lot of protections for the borrower today.

I bought my most recent house without a mortgage … I had plenty of cash, but I simply plonked it down. But, I have two rules around this:

1. The 20% Rule – never have more than 20% of your net worth invested into your house at any one time; for MOST people this means that you will HAVE to take out some sort of mortgage, and

2. Even if you meet # 1. (I do … most people don’t) don’t be afraid to use up to 50% of your home’s equity to support other buy-and-hold investments.

So, recently I took a $1 mill. line of credit on my home (about 50%) to plonk into my Scottrade account (I use margin lending in there, as well, so I am really taking some additional risk with my home equity that I shouldn’t be taking).

Secret #2
They don’t diversify the money they put into their employer retirement plans.
The subtitle struck me as quite odd at first, as it seems to fly in the face of common sense. Edelman’s advice, though, is actually pretty common – put your retirement money into a diversity of stocks. In other words, select an index fund or two of stocks in your retirement plan and just dump all of your savings into it.

Firstly, 401K’s are a tool of the poor: if you are young, you want to invest as much as you can outside of your 401k so that you can exert some control (a self-directed fund is another matter entirely – PROVIDED that you borrow money against your invested equity to leverage into investments).

And, if you are old, you should have so much money in outside investments that your 401k is just icing on the cake (I confess that I have NO IDEA how much is currently in my 401k-equivalent).

Secondly, diversification is also a tool of the poor and uneducated; even Warren Buffet recommends low-cost Index Funds over other forms of investing for the uneducated … but Warren doesn’t diversify. Neither do I.

Secret #3
Most of their wealth came from investments that were purchased for less than $1,000.
Basically, Edelman states that people who became wealthy did it not by having a ton of money right off the bat. Instead, they just invested a little bit at a time – less than $1,000 a pop. They just did it regularly.

Hmmm … this is a hit-or-miss one for me; a LOT of my money came from businesses that I started with No Money Down. But, a lot came from other investments, as well … most recently an office building that I bought for $1.4 million (25% down) that sold for $2.4 million less than 5 years later.

Secret #4
They rarely move from one investment to another.
The question then becomes what should one invest in? Edelman doesn’t offer a direct answer here, but does suggest that the only clear way to lose is by rapidly shuffling your money around from investment to investment. The route to success is to buy and hold, not to move like a jackrabbit from investment to investment, losing most of your gains to brokerage fees and taxes.

Another strange one …. you see, to me the VERY DEFINITION of INVESTMENT is something that you buy-and-hold … that’s the strategy that I use in two different ways:

1. To Get Rich Slowly (but surely), and

2. To KEEP my money, once I’ve made it.

But, you can’t just save your way to the sorts of investments that will make you rich; you need to find the money to make those Buy-and-Hold investments by INCREASING YOUR INCOME.

Other than getting a pay rise, working overtime, or holding down 2 or 3 jobs (all of which suck, if you ask me … especially the pay rise if it requires grovelling for 18 months to get it), ONE WAY that I can think of to increase your income is to TRADE …

… that means rapidly moving in/out of ‘investments’ such as stocks (trading stocks or options) or real-estate (flipping). It’s not really INVESTMENT … if it’s RISKY, it’s BUSINESS … but you have to take some chances along the way IF you want to get rich.

Secret #5
They don’t measure their success against the Dow or the S&P 500
Instead of using various metrics like the NASDAQ to judge their investment success, they look instead at whether or not their investments are actually achieving the results they need in their life. So what if the S&P 500 has an up or a down day? What’s actually important is that your investments are giving you the returns you need.

Couldn’t agree more; I have more than $1 million invested (or trading in/out) in the market at any point in time and I don’t track the indexes other than to assess the MOVEMENT of money in/out of the market AFTER the fundamentals tell me that I am ready to buy (or sell).

Secret #6
They devote less than three hours per month to their personal finances.
I think this concept relates very well to the “training wheel” conceptI talked about a while back. Basically, Edelman is correct in stating that the people he’s talking about do spend three hours or less a month on their personal finances, but these are people who already have a firm grip on their financial state.

I’m a terrible budgeter …. I’m probably the only multi-millionaire who ever had their American Express card taken away from them for forgetting to pay the bills (really!) … not highly recommended, but if you increase your income and invest well, personal finances actually take a back seat (and, my wife now controls the houshold accounts!).

Even when I was starting out, I only ever did one budget … actually, I tracked EVERY SINGLE EXPENSE for just one month … that was enough to tell me where I was and I already knew where  I needed to go. 

Secret #7
Money management is a family affair involving their kids as well as their parents.
If there’s one point that Edelman really hits out of the park in this book, it’s this one. You’re doing nothing but hindering your children’s financial education by keeping them oblivious to money.

 My wife and I started teaching our children about money very early and I’m happy to say that they both understand the basics, saving 50% of their pocket-money and only spending what they need to.

My 13 y.o. son seems to have an entrepreneurial-flair having his own successful eBay business (he earns more from this than his pocket-money brings in) and even runs his own books and accounts (using Quickbooks). He researched this and set it all up himself … other than gentle encouragement, I can lay no claim to his success 🙂

Both our children know that they will need to find their own way in the world … we will nurture and educate, and that’s about it (financially).

Secret #8
They differ from other investors in the attention they pay to the media.
In other words, they ignore the talking heads on CNBC or the thousands of stock tips floating around out there for the most part. Why? Because it’s information overload and it’s not particularly useful to most of the people Edelman interviewed for this book.

I don’t read the financial press … too boring.

Anyway, to make money, you need to be contrarian (BUY when stuff is cheap … ) … you can only do that if you have the guts to buy when everybody else is lining the windows to jump off the ledge.

How do you match up against the Edelman ‘secrets’?

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Dumb Money!

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I take issue with the seemingly interchangeable use of the words ‘saving’ and ‘investing’ …

Let’s not confuse buying Index Funds or typical diversified ordinay stock Mutual Funds with INVESTING …

… when you buy a Fund you are SAVING – consider it a long-term savings vehicle, no different to ordinary bank savings accounts, CD’s, and Bonds.

The difference? Effort.

 Buying a packaged financial product is no different to buying any other product: you send away for some information; if you like what you see you fill in the appropriate sales form; you pay your money and receive your ‘product’.

 Hopefully, when it comes to Funds, you make some money when you eventually cash out.

Contrast that with INVESTING:

 You do your research; you look for an underpriced item (in this case, a stock); you purchase the item; you watch the market carefully … and, when the price goes back up … you sell (this could be sooner = trading; or later = long-term-buy-and-hold).

Of course, you could just keep holding for dividends. In either case, you are aiming to MANAGE your holding to MAXIMIZE your RETURN.

Some people call the former Passive Investing and the latter Active Investing … but, if it walks like a duck …

… it is a duck!

BTW: there’s nothing wrong with SAVING … go ahead and buy some Index Funds if you’re not up to the task of INVESTING, even Warren says it’s OK …

“Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”W. E. Buffett – 1993