Tag Archives: millionaire

Risk is in the eye of the beholder …

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Our Philip Brewer Confest is almost over, and it’s time to thank him for his articles and inspiration for a series of posts exploring the concepts of safe withdrawal rates [AJC: which has more to do with financial planning than family planning 😉 ], however I did want to wind up by exploring one of his comments:

I think your step 1 is the most important: Decide what you want to do with your life.

I wanted to write fiction. That doesn’t take much money, but it does require time (and high-quality time at that). So, for me, getting free of a regular job as soon as possible was a much higher priority than accumulating a vast amount of wealth.

For me, too, the turning point for my financial life – indeed my whole life – came in Step 1: finding my Life’s Purpose then using that to calculate my Number. For me, though, it happened to turn up a Large Number / Soon Date … that may not be the case for everybody.

Just remember that Time = Money and if you are desperate to achieve that financial freedom (e.g. in Phil’s case, so that he can write that book) you may need a lot of both …

… IF so, then I have a hypothesis [AJC: tested on a subject of one i.e. me] that goes like this:

When you find your Life’s Purpose, you will most likely find that you will come up with a Large Number / Soon Date [AJC: remember, this is just my hypothesis albeit, now, supported by a little research] and you will not stop until you get it …

… your priorities (including your financial priorities) will drastically change.

 But, what about Philip’s thoughts about risk?

I would like to suggest, though, that your ideas on which assets are secure and which aren’t could use some fine tuning.

It’s true that you may not be able to work during your retirement, but most people will be able to earn at least some money if they need to. It’s also true that government pensions can be taken away—but so can anything else.

And don’t forget all the other ways that things can be lost or taken away—declining market can sap your portfolio, a lawsuit can seize your assets, a natural disaster can destroy your house.

My point is not that it’s hopeless, but rather that while racking up assets may increase your standard of living, at a certain point it no longer increases your security. (A flood can destroy a house worth $1 million as completely as it can destroy a house worth $100,000.).

At some point—and to my mind the point is well before you have $7 million—you don’t get as much security from adding another million to your portfolio.

I beg to differ: until I made my $7 million Number, my thoughts were EXACTLY about ” adding another million to my portfolio” … but, that’s only because I calculated that I needed it – not want, not desire, but need – to live my Life’s Purpose.

But, that may not be you; like Phil, you might just need a little extra time to write your book or to support huminitarian projects like backpacking to hotspots like Haiti, so your Number may be $100k, $1 mill., or … ?

And, unlike me, your assessment of your Number may include allowances for earning extra income through part time work, income producing projects, pensions, inheritences, or even handouts.

In that case, I challenge you to substiute your Number where, in my blog, I use the $7m7y illustration … the principles won’t change much.

[AJC: unless, you have a “<$1 million in >20 years”-type Number, in which case this blog is NOT for you 🙂 ]

So, substituting your Number for mine, here is the second part of my hypothesis:

– While you are trying to reach [insert your Number] so that you can achieve your Life’s Purpose, ‘hold back’ concepts such as risk take a backfoot to ‘push forward’ concepts such as REWARD, suddenly opening your eyes to the ‘benefits’ of burning the candle at both ends, starting a business or three, trying to become a stock market and/or real-estate mogul, etc.

BUT

– Once you reach [insert your Number], somehow your brain resets such that RISK (i.e. protecting your nest-egg) seems to become much more important than reward (i.e. growing the nest-egg) and all of a sudden CD’s, bond laddering, (dare I say it!?), index funds, 100%-paid-for-by-cash real-estate, etc. becomes much more attractive.

At least, that’s how it happened for me …

This doesn’t mean that risk isn’t important (after all, we spend a lot of time on this blog covering strategies to manage risk), it’s just that in some respects, it’s in the eye of the beholder 🙂

The Ideal Perpetual Money Machine …

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So,  it seems that creating a mix of bonds and stocks and then picking some magic withdrawal rate (e.g. 4%) is not the ideal way to plan our retirement (a.k.a. life after work) after all …

… instead, it seems that we need to create our own Perpetual Money Machine: a renewable resource of cash 😉

The ideal Perpetual Money Machine – at least, according to my liking – is Real-Estate (more wealthy people build their own Perpetual Money Machines using real-estate that any other investment, even more so than cash, CD’s, bonds, mutual funds, or stocks):

1. Real-Estate (particularly commercial real-estate, when purchased well) protects your capital and keeps pace with inflation; it will last as long as you do, and then some!

2. Real-Estate (when managed well -and, this is something that you CAN confidently outsource) protects your income (i.e. net rents; they will grow with inflation).

3. The bumps in your real-estate road can be managed with insurance and provisions: you can insure against most catastrophic losses (and, you can spead your RE investments to minimize even those risks), and you can keep a % of your rents (and, starting capital) aside to help smooth your income stream (against vacancies, repairs and maintenance, etc.).

For example, with $7 million (aiming for a $350k per year gross income – indexed for inflation – which should net $200k – $250k after tax), you could:

1. Keep $500,000 as a two years of living expenses cash buffer (one year to allow for the rents to start coming in, another year “just in case”),

2. Invest $6.5 million CASH into 5 x $1.0 million to $1.25 million dollar properties (allowing for closing costs, etc.),

3. Which should provide 5 x 7.5% x $1.0 million to $1.25 million = $400,000 gross rental income

4. Of which you would pay tax of 30% (say) and divert another 25% of the remainder to your ’emergency / provision fund’ leaving $215k (PLUS, tax benefits such as depreciation, tax deductions of cars, certain travel and other business expenses etc.).

After every few ‘good years’, you can trim your provision fund back to two years of living expenses, allowing you to buy some more real-estate (therefore, providing the basis for another future pay rise!).

If you don’t like real-estate, then you can always lower your spending expectations and dust off your bond-laddering books 🙂

The fundamental rule of money?

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Here’s the difference between conventional personal financial advice and 7m7y thinking in one slide; according to Brian Taylor the fundamental rule of money is to:

Either earn more than you spend or spend less than you earn.

Simple … and, much better than the alternative (spending more than you earn) …

… but, wrong!

There is only one fundamental rule of money:

Earn more than you spend

Can you see why? Your financial future depends upon it 🙂

The Myth of the Safe Withdrawal Rate …

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I have noticed an unusual phenonemom: I write a post on one theme and your (i.e. our readers’) comments explore another one entirely!

This is a GOOD thing … it means – I hope – that we are building an online community dedicated to the idea of linking our finances to our life, rather than simply attempting to fit within society financial ‘norms’.

Case in point: I wrote a post exploring various windfalls, and the comments lead us down the path of exploring so-called ‘safe withrawal rates’, which is the idea that there is a Magic Percentage of your Number that is ‘safe’ to withdraw to live off each year.

The problem is, what % do you choose?

For example, I have proposed the ‘Rule of 20’ for calculating your Number, which seems the same as proposing a 5% ‘safe withdrawal rate’, but Jake disagrees:

A 5% drawn-down rate on the pot of gold is a little on the risky side if you want the money to last.

After looking at a bunch of data, I feel that a draw-down rate of 2-3% is too conservative, but 5-6% to aggressive. 4% or so seems right. I know, only 1% off from your value but over time it makes a huge difference.

So, Jake has highlighted one problem with selecting a ‘safe’ withdrawal rate … if you are out by even 1% your spending can be over (or under) the ideal by 20%. I don’t know about you, but a 20% payrise (or paycut) is a pretty big deal … people quit their jobs over less!

So, what do the experts recommend?

Believe it or not, there is support out there for just about any annual % of your nest egg that you may choose to spend, for example:

7% – Not so long ago, the financial services industry proposed spending as much as 7% of your portfolio each year in retirement.

6% – More recently, Paul Graangard wrote two books proposing a bond-laddering and stocks strategy that supported a spending rate as high as 6.6% of your portfolio each year.

5% – Investment funds routinely allow spending of 5% of the portion of their investment portfolios dedicated to simply keeping up with inflation. Indeed, my Rule of 20 appears to support this withdrawal rate, too.

4% – A large number of studies – probably, the most famous of which is the so-called Trinity Study – advocate spending up to 4% of your initial portfolio (ideally, 50% stocks and 50% bonds, rebalanced each year), which provides somewhere between a 90% and 100% certainty that your money will last at least 35 years.

3% –  A whole slew of new retirement planning tools (generally using a Monte Carlo approach to modelling tens, hundreds, or even thousands of potential economic scenarios) have been released over the last 4 or 5 years by the financial services industry, purporting to analyse hundreds of alternative economic scenarios to try and model what would happen to your retirement portfolio (i.e. simulating changes in interest rates, market booms and busts, etc.) to find the ideal ‘safe’ withdrawal rate. The trouble is that a lot of these advocate very low withdrawal rates, typically in the 2.5% – 3.5% range. 

2% – Some even advocate a totally ‘risk-free’ approach to retirement savings by investing close to 100% of your retirement portfolio in inflation-protected bonds (i.e. TIPS); historically, these have provided a 2% return, after inflation and with total protection of your starting capital.

So, which is right?

None, as TraineeInvestor explains in his comment to my post:

I’m not fan of draw down models either. If you have to spend your capital to avoid eating cat food (or the cat) or are working with a very limited time period fair enough. But with a sufficiently long time horizon, my view is that any draw down rate is dangerous – in fact I would be uncomofortable if my nest egg was not growing at at least the rate of inflation (after taxes and spending).

Another way of looking at it is that if you are relying on draw down of capital for living expenses you are very vulnerable to adverse events. No thanks – I’d rather sleep soundly at night.

Me too! 🙂

Three feet from gold …

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This video summarizes a book hailed as the successor to Napoleon Hill’s classic: Think and Grow Rich. I’m not sure that you can just think your way to $7 million in 7 years … but, having a burning reason why you might need that much / that soon sure seemed to help me.

But, I can’t help feeling: did I think, therefore attract … or did I happen to think and happen to attract? I guess we’ll never know for sure, as we are all an Experiment of One 🙂

Reader Poll: Manifesting Millions?

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IMPORTANT: Please read this post in full, THEN choose the FIRST answer that applies.

How much money have you manifested in the last 18 months?

View Results

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There are two groups of people in this world:

– those who believe that there are two groups of people in this world, and

– those who don’t 😛

At the risk of parodying myself, I think there are two groups of people in this world:

– those who believe in The Secret, and

– those who don’t.

I want to conduct an experiment, right here / right now, to see if The Secret works …

First though, in case you’ve been living in a cave for these past few years (in which case, you have probably already developed powers far beyond those of The Secret), you will already know that The Secret is the most recent in a long series of books, blogs, and banter about the ‘power’ of creative visualization …

… see it in your mind and you will manifest it into reality.

Believe it, and it will be so.

I don’t know how The Universe works, so I can’t tell you whether I manifested my millions (perhaps by concentrating on my Life’s Purpose and the Number required to get me there) or was merely driven to make it at all costs … you could certainly mount an argument either way.

Also, I am an experiment of one …

Fortunately, we have Steve Pavlina who is an expert in these matters, and  is also the creator of a very interesting project, aptly called the Million Dollar Experiment:

The goal of this experiment is to attempt to use the power of intention to manifest $1 million for each person who chooses to participate.

From what I can see, the experiment ran from November 2005 until July 2007 … just over 18 months. Here’s what happened:

In that 18 month period, nearly 1,600 participants reported ‘manifesting’ anywhere from $504,873.56 (in just one day; if you choose to believe him) down to just one cent.

The average was closer to $3,500 in less than a year, with the median being just $180.

I’m not sure what you would count as a worthy ‘manifestation’ amount (I mean, would you dream of anything less than $10k in a year?), but 120 people – just 7.5% of those participating – ‘manifested’ $10k or more in that period.

Cast your mind back 18 months: how much have you manifested in that timeframe? I guess by ‘manifested’, I mean by following Steve Pavlina’s instructions to his own readers:

Only count the new money you feel has come into your life as a result of your participation in this experiment (i.e. the manifestation of this intention), not your regular income. Obviously your interpretation of that will be subjective, but this is a subjective experiment. Just do your best, and trust your intuition.

Just pretend that you signed up to Steve’s experiment 18 months ago … what money (if any) that came into your life since then would you have reported on Steve’s blog?

Oh, and feel free to tell me what you think about the power of The Secret, Steve’s Million Dollar Experiment, and/or this post … but, don’t forget to scroll back up to the top and make your poll choice first 🙂

Popular in Finland …

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I seem to be popular in Finland these days, with my blogging friend over at Kohti taloudellista riippumattomuutta still sending me the most new visitors daily [AJC: reciprocating may be a little hard as I am guessing that more of his readers are fluent in English, than my readers are in Finnish].

I also receive referrals from my other Finnish blogging friend Tarkan markan blogi, who asks (thanks to Google Translate) Million Not Enough For Any:

And, The Economist does raise a valid point:

How much money do you need to count as wealthy in the first place? Merrill Lynch’s wealth-management report starts counting at $1m in “investible assets”. That excludes people’s main homes, which may seem reasonable. But it means that a Londoner who sells his home and decides to rent can suddenly find himself “rich”.

After all, a portfolio of $1m these days would generate an income of only $30,000 if invested in Treasury bonds, which does not leave much scope for the playboy lifestyle.

I’m not sure what amount that you need to be ‘rich’ – I define it in terms of having enough to live your Life’s Purpose – but, I certainly agree that $1 mill. (even if it doesn’t include your own home) simply doesn’t cut the mustard 🙂

Is he really a clever dude?

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[Disclaimer: Artist’s rendering of AJC … any resemblance to other bloggers living or dead is purely coincidental]

Have you noticed that I don’t have a category for debt on this blog?

[AJC: you can click on any of the keyword/categories in the orange header-banner above to see a list of blog posts focusing on that subject]

It’s not because we don’t talk about debt, as we clearly do …

…. it’s because, to me, creating or paying off debt is just the same as investing (after adjusting for tax: a dollar saved in interest, is the same as a dollar earned in interest or investment income, right?).

That’s why I was genuinely interested in finding out what was going through fellow-blogger Clever Dude’s mind when he loudly proclaimed:

We’re Free of Consumer Debt!!!!!!

As of today, we have paid off all $113,000 of our student loans, auto loans and credit card debt.

We are debt free!!!

My fellow blogger is right to be proud of his achievement … but, does that make it the right investment choice?

Check it out:

He paid off $113k … now, this is no small achievement, some people don’t even save that in their entire lifetime! Still I couldn’t resist asking Clever Dude for some details:

The rate on the student loans was 6.25%. The 2nd mortgage is 7.875%. First was 5.25%.

I chose to pay off the student loan because it was more manageable and I could get it off the books faster than the 2nd mortgage. Mathematically, the 2nd mortgage makes more sense until you factor in the tax deduction which brings them down to about equal.

I also wanted to know a little about his current net worth (after the mammoth debt-payoff feat) – nosey, aren’t I?! Anyhow, Clever Dude was happy to share:

Don’t mind the math as I rounded:

Cash: 17%
Investments: 37%
Home Equity: 6%
Autos: 17%
Personal Property: 12% (if I could sell it all right now)
Whole Life Insurance: 5% (yep, I got it, it’s expensive, but I’m not giving it up!)

So, Clever Dude has ‘invested’:

-> $113k in loans returning (by avoiding having to pay) around 6.25% after tax

-> 17% of his net worth in cash returning (I’m guessing here) 2%?

-> 6% of his net worth in his home returning some unknowable amount in future (potential) capital gains

-> 5% of his net worth in insurance ‘investments’ of dubious value after (often) exorbitant fees

-> 29% in (presumably) depreciating ‘assets’ such as autos and personal property

Now that he is debt-free, what  will drive Clever Dude’s investment strategy from here on in? He says:

Investing and savings are next up in our planning. Honestly, we’ve spent so much time just thinking about debt, we haven’t spent much time on the future. Now is the time.

Now, I’m not here to pick holes in Clever Dude’s investment strategy as he had a strategy and moved mountains to achieve it – not to mention, that we know so little about Cleve Dude’s true financial situation that we are in no position to advise / criticize …

…. but, I do want to use this example to show why following a blind – and, in my mind totally arbitrary – investment goal such as “reducing debt” is not always the best idea:

Clever Dude has only 37% of his net worth in investments right now (OK, he is working on his Master’s Degree, so he has had other things on his mind) and has limited the bulk of his net worth’s returns to only 2% to 6% (or so) by almost-totally focusing on paying debt.

Why?

So, that he can start “investing and saving”!

Now, does that make sense to you?

Even more on the debt-free fallacy …

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I’m not a Ramsey fan, and I am equally not a fan of pithy statements that are supposed to make us financially secure, both for the simple reason that they are unlikely to help me – or, you – achieve a Number (i.e. retirement nestegg) amount that is large enough to live my – or, your – Life’s Purpose.

Now, if you don’t have a lot of travel and free time associated with your own Life’s Purpose, then you may be able to live nicely off $50k a year indexed (assuming that you have a $1 mill. nest-egg, in today’s dollars)  … but not me!

I aimed for – and, achieved – a $7 million in 7 year target (starting $30k in debt) because that’s what I decided that I needed (actually, calculated) … and, this blog is written primarily for those who want to achieve the same.

So, it shouldn’t come as a great surprise that I both agree and disagree with Jesse – the Debt Go To Guy– who says:

Risking $1,000 a month on a possible 8% return instead of a guaranteed after-tax ROI of 5% by paying down mortgage debt is NOT such a “Duh” decision. If you do get 8% you must pay taxes, and if you live in a state like CA, then after taxes you’re about even. Plus you have slippage… transactional fees etc for the investment / trade. So risking your $1,000 a month on 8% instead of a guaranteed after tax return of 5% is not always so smart, and a bad example.

People with double-digit interest rates on credit card debt, especially the many folks paying 20-30%+ interest, are not likely to find a better investment opportunity in their entire life than inside their own liability column. Every dollar in debt paid off is a guaranteed after tax ROI of 20-30%. Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time. What makes you think someone in debt could pull off such a stunt?

OK, that’s sound commonsense advice and hard to argue with:

– Sort your debts into high interest and low interest, and have a good crack at the high interest ones first, because the money that you save on interest is probably way higher than you could earn elsewhere. A dollar saved is a dollar earned, right?

– Now, when comparing the lower interest debts and investments, you really need to look at all the factors, such as risk, taxes, costs, etc. Often, it will be paying down the debt that wins, although I would be surprised if paying down a 5% mortgage ‘wins’ over any sensible RE, value stock, or business strategy in terms of serious wealth building.

But, I don’t really think that “Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time”. I know that Warren Buffett has produced 20%+ compound returns, and George Soros didn’t become a billionaire on less than 20% – 30% compounded returns.

That doesn’t detract from Jesse’s statement that “every dollar in [credit card] debt paid off is a guaranteed after tax ROI of 20-30%” and I do agree that it would be almost impossible for anybody except [insert: Forbes Rich 1,000] 😉

But, here’s where I disagree with Jesse:

I think Dave Ramsey provides sound advice for most people, and while I think it’s better to expand your means and increase your income instead of living like a popper, his advice has proven to help many hundreds of thousands of people to stop paying interest and start earning interest, and that’s the key.

– readers attracted to this blog are not in the same position (at least, no longer wish to be in the same position) as the ” hundreds of thousands of people” that Dave Ramsey has helped, and

– “stop paying interest and start earning interest” is not the key to reaching a large Number by a soon Date.

Look, there is nothing intrinsically right or wrong about paying interest, it’s merely a by-product of a loan that you have taken out. Just make sure that the loan produces more income than the interest expense that you paying, by a wide enough margin to account for the risk, taxes, and costs that may be involved.

This is a ‘no brainer’ when you realize that a rental property can produce income (assuming that your calc’s prove that it is all worth while … by no means the case on all – or even many – properties), and it is equally a ‘no brainer’ when you realize that borrowing money on your credit card to buy an LCD TV produces NO income, so why would you do it?

But, it takes a giant leap to suddenly realize that – for any existing debt that you may already have – paying down debt on a mortgage that costs you 5%, or a student loan at 2% may not be such a brilliant idea when an investment that can produce 15% compounded comes along and you now need to decide where to put your cash: into paying off those loans (to blindly achieve a ‘no interest’ outcome) or into the investment (hopefully, to produce an income-producing asset with excellent cashflows).

Of course, we’re making an assumption that reasonable people can achieve reasonable investment returns … but, if you think those kinds of investments are almost impossible to come by, take another look at:

– Value stocks (read Rule # 1 Investing by Phil Town),

– Real-estate (read Multifamily Millions by Dave Lindahl),

– Business (read The E-Myth Revisited by Michael Gerber).

[AJC: and, if these all sound too scary for you, just remember that over a 20 to 30 year period a low-cost index fund that tracks, say, the S&P500 will return circa 11% to 12% (yes, before taxes and ultra-low fees), and – if you are worried about risk – has NEVER produced less than an 8% return over 30 years]

I didn’t become a multi-millionaire by blindly entering into debt, but neither could I have become a multi-millionaire by blindly avoiding it … debt, for me, was a tool that I used sparingly, yet wisely.

I recommend that you do the same 🙂