Installing an ATM in your business …

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?

A new kind of slum dog millionaire …

KC points me to an article in Yahoo Finance:

A new AP-CNBC poll finds nearly one-third (31 percent) of U.S. residents believe they would need a minimum savings of $100,000 to $500,000 if retiring this year in order to be confident of living comfortably in retirement, and 22 percent believe the minimum is $1 million or more to retire comfortably.

I’ve just conducted my own survey and I’ve found:

– Nearly one-third (31 percent) of U.S. residents are totally deluded if they think that they can retire on $100,000 to $500,000 today.

– 22% are only slightly less blinded to the obvious to think that even $1 million will be enough to sustain them in retirement.

Let’s say that you can withdraw 4% of your portfolio ‘safely’ each year (a figure commonly promoted by the financial planning industry): then, you can give yourself a salary of:

– $4,000 per year if you retire today on $100,000

– $20,000 per year if you retire today on $500,000

– a whopping $40,000 per year if you retire on $1 million

Now, there’s be a whole bunch of people reading this who’ll say: “$40k a year, indexed for inflation … for life … without working. Now I can live with that!”

So, let’s see what it will take to get to $1 million in retirement savings; the same article says:

If you start with an initial $10,000 investment and your portfolio grows by 5 percent every year, here’s how much you need to save each month to reach your $1 million goal by age 70, according to’s calculator.

• 25-year-olds have to save $450 a month. That’s just $15 a day for the rest of your working years.

• 35-year-olds have to save $850 a month.

• 45-year-olds have to save $1,700 a month.

• 55-year-olds have to save $4,000 a month. (Of course, with an average inflation rate of 3 percent, that $1,000,000 nest egg will only be worth $642,000 in today’s dollars. So that means you’ll likely wind up having to save even more.)

Did you check out that last point? Even if you could save these amounts, your $1 million is whittled down by inflation by the time you get there, so $40k expected retirement salary is only worth (in today’s dollars):

– $30,000 p.a., if you’re 55 and have 10 years to retirement

– $20,000 p.a., if you’re 45 and have 20 years to retirement

– $10,000 p.a. if you’re 35 and have 30 years to retirement

… or, to put it another way – because of inflation (even at only 3%), if you want to retire at age 65 on the equivalent of today’s $40,000 salary, you need to:

– Quadruple the above suggested monthly savings rates if you’re 25

– Double the above suggested monthly savings rates if you’re 45

– Add 50% to the above suggested monthly savings rates if you’re 55

… Oh, and did I mention that these numbers are after tax?

And, just when you were kidding yourself that you really can save yourself to a decent retirement: current CD rates are 1% and inflation is still running close to 0.5%, meaning that even a 4% withdrawal rate – previously described as ‘safe’ according to the financial planning industry – is committing financial suicide.

On current returns, to safely pay yourself $40,000 p.a. (indexed for just 0.5% inflation) you would need to retire with a nest egg of not just $1,000,000 …

… but, $8,000,000.

Or, you could just keep reading this blog and find a whole new way to look at your financial future 😉

[AJC: Try and find consensus on inflation; it’s hard! One article that I saw in researching this post suggested that inflation is currently running at just 0.5%, another says 4%, as suggested by Steve in the comments below – Since nobody really knows what inflation will be over a long enough period, I always use 3% – 4% just because it makes forward planning easy: just double your estimate for how much money you need to retire with for every 20 years until retirement]

The problem with financial advice – Part II

Why do you see a financial advisor?

ONE reason that people go, is because they expect that the financial advisor has great modeling tools, so they should be able to calculate your financial position and future needs with great accuracy.

What if I told you that doing your own financial planning using the simplest possible online tools and financial spreadsheets would get you closer – much closer – to your real financial needs than any ‘typical’ financial advisor can? What if I told you that is exactly the reason why I do my own financial planning using those exact same simple online tools and financial spreadsheets?

But, what if I told you that most financial advisors routinely underestimate your retirement needs by ~80%?

Would you even pay for such ‘professional’ financial advice again?

Need proof?

Well, a week ago I covered the first of best selling author, Dan Ariely’s comments about financial advisors, but he then goes on to say:

In one study, we asked people the same question that financial advisors ask: How much of your final salary will you need in retirement? The common answer was 75 percent. When we … asked where they got this advice, we found that most people heard this from the financial industry. You see the circularity and the inanity: Financial advisors are asking a question that their customers rely on them for the answer. So what’s the point of the question?!

In our study, we then took a different approach and instead asked people: How do you want to live in retirement? Where do you want to live? What activities you want to engage in? And similar questions geared to assess the quality of life that people expected in retirement. We then took these answers and itemized them, pricing out their retirement based on the things that people said they’d want to do and have in their retirement. Using these calculations, we found that these people (who told us that they will need 75% of their salary) would actually need 135 percent of their final income to live in the way that they want to in retirement.

This is a really important point; let’s say that your expected final salary is $100,000 in today’s dollars.

Then at 75%, you would need a nest-egg of $75,000 x 20 = $1,500,000

But at 135%, you would need a nest-egg of $135,000 x 20 = $2,700,000

[AJC: the ’20’ in the above calculations comes from my Rule of 20; see this early post]

That’s a shortfall in your retirement of $1,200,000 … more, if your expected ending salary is over $100k.

Now, what if I told you that I think your shortfall is not likely to be $1.2 million, but closer to $2mill – $3mill or even more?

I’ll let you know how I think you should calculate your true retirement needs in the next – and, final – post in this short series, because knowing what you’re aiming for now will stop a LOT of disappointment later 😉

The problem with financial advice – Part I

Now, I’m just some semi-anonymous blogger, so what do I know, right?

So, sometimes it’s nice if I can point you to others who share my opinions on controversial financial matters [AJC: I write almost exclusively about controversial financial matters … why write something that’s already in 5,000 other blogs, therefore, has a 99.9999% chance of being wrong?!].

For example, my opinion on financial advisors is that they are a waste of money.

But, Dan Ariely, a behavioral economist and author of two best-sellers, including Predictably Irrational, agrees:

From a behavioral economics point of view, the field of financial advice is quite strange and not very useful. For the most part, professional financial services rely on clients’ answers to two questions:

  • How much of your current salary will you need in retirement?
  • What is your risk attitude on a seven-point scale?

From my perspective, these are remarkably useless questions — but we’ll get to that in a minute. First, let’s think about the financial advisor’s business model. An advisor will optimize your portfolio based on the answers to these two questions. For this service, the advisor typically will take one percent of assets under management – and he will get this every year!

I agree with Dan when he says:

Not to be offensive, but I think that a simple algorithm can do this, and probably with fewer errors. Moving money around from stocks to bonds or vice versa is just not something for which we should pay one percent of assets under management.

Now, this is targeted at funds managers (both retail and institutional) as well as those who charge fees and/or commissions to prepare similar financial advice.

Remember, funds tend to fall short of the market in performance over time, by about how much they charge in fees …

Lesson: if you really want to short-change your financial future by investing in funds and over-diversifying (two sure ways to die broke), do what Warren Buffett suggests and invest in super-low cost Index Funds:

A very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money.

In the next part of this special three part series, I will show you how most people short-change their retirement by 60%,


How to change your life!

I’m reviewing the final draft (actually, the pre-publication draft) of my new book.

But, I’m not happy with the current intro: it talks about the Roadmap To Riches, but that’s not really what this book is about. My next one, certainly, but not this one.

I just added an epilogue based on this post (almost word for word), and I want to do something similar for the introduction.

You see, I feel that while the subject of personal finance – a.k.a. money – is supposed to be entirely rational …

… it’s actually totally the opposite.

I believe that all discussions of money are entirely rooted in emotion, then our point of view is justified rationally.

The reason for this is that our lives and our money have become so intertwined that it’s hard … nay, impossible … to separate one from the other.

Don’t believe me?

Well, do you think you’re totally rational on the subject of money? Do you think that your life comes first, and money is only a tool?

Then let’s test that, right here, right now: you have 24 hours in an ‘average working day’, how do you spend it?

If you are anything like the average US worker, you spend an ‘average work day’ (that’s around 2/3 of the average year) sleeping, eating, and maintaining your house and your family.

You spend the bulk of what’s left (8.7 hours: the largest chunk of your day) earning money. Leaving a sliver of ‘life’ for you.

Now, think about how much of that tiny slice of life you then spend thinking, worrying, arguing, balancing and maintaining your money?

And, you’ll do this through the entire 40+ years of your working life 🙁

I rest my case.

So, the angle that I want to take with my book’s intro is this:

If you were to script your life, would you choose:

– Study hard so that you can get a great job, and

– Work hard at the job – eking out the occasional high point (landing a big account, making the boss happy, bringing a new product to market, etc.) – just to earn money, and

– Spend what you have to just to support your family, saving the bulk of what’s left over just so you can retire at 60+ to do … what?

OR, would you script for yourself something like:

– Travel the world, and

– Live large on the world’s stage, and

– Give back to others,

… and, so on?

The restriction on the latter probably being money and time (and, if you had the money, you could create the time, right?).

My point?

Doesn’t it seem as though we live our lives according to money’s script …

… rather than putting money in it’s proper place, which is simply as a tool to support our Life’s Script?

What do you think? Am I on the right track?

A brilliant 94 y.o. investor?

Edward Zajac is an amazing man: at 94 he is still alive, sprightly (or so it would appear from his photo), and actively investing his own $2.5 million share portfolio …

… and, is still sharp enough to describe himself as an opportunist.

Wealthy Matters shares Ed’s financial success with his readers (you should read the whole article to learn more about Ed’s ‘EZ’ investing system):

Stick with stocks, says investor Edward Zajac. He should know. The 94-year-old has been trading for 72 years and said he’s made about $2.5 million.

So, should we all aspire – strictly from an investing standpoint (after all, who doesn’t want live to 94 and still be so ‘with it’) – to be like Ed?


According to my calculations, Ed (assuming he started on or around the average salary for college educated technicians “installing computer systems” of $1,900 in 1939) would had to save 50% of his salary until he retired young (at the age of 51) and receive Warren Buffett level stock investing returns (21% compounded) for the entire period!

What I can’t model, because the numbers simply fall short, is how Ed managed to draw enough salary to “travel the US in a recreational vehicle with his wife” after he retired in 1968, yet still manage to double his portfolio again in the 42 years since he retired.

Good on you, Ed, we have a lot to learn from you 🙂

Premature Retireration …

Don’t get me wrong, early retirement is great …

… not for everybody, mind you.

Many go back to ‘work’ because post-retirement life can become pretty boring, if you haven’t properly planned your time and your money.

I don’t include in ‘work’ anything where you are earning money because you want to, except where the commitment / stress / boredom rises to sustained uncomfortable levels and you feel that you can’t just walk away, in which case it’s probably ‘work’ just the same.

No, the real problem is that people don’t know when ‘retirement’ really begins:

They think it begins when they receive the huge card signed by 50 people they have hated for 40+ hours a week, or when the gold watch that they expected to receive turns into a Parker pen (in a nice box!), or when they get a nice speech from the boss who says: “Gee, we’ll really miss you, Bob” when your name’s John.

But, it really begins much, much later.

Ashton Fourie puts it best when he says:

This reminds me of a conversation I had with a friend after we sold our first business.

His comment then was, that having a pile of money, is not useful, because expenses continue to be a regular occurence. So we realized that one can only really “retire” when you have enough secure, passive income. Many people make the mistake to think you can retire on a pile of money.

Until you’ve figured out how to turn the pile of money into secure, long term passive income, you’re going to have to keep “working” – even if that “work” is the process of moving that money into income generating, secure, instruments.

This is really a very important observation and realization!

I remember being insanely jealous [AJC: slight exaggeration] of my friends who cashed out while I was still trying to earn a quid. Now, I am insanely jealous [AJC: this one is probably a huge exaggeration for dramatic effect] of those who still have a job or a business because they can spend pretty much whatever that want, knowing that next week the magic pot of honey will be refilled.

You see, it really is all about cashflow …

… when you have a pile of cash, you can only deplete it. Sooner of later it has to run out, no matter how much you started with, right?

Just ask [Insert big spending celebrity who’s financially crashed at least once in their lives: Elton John; MC Hammer; Willie Nelson; etc; etc] 😉

So, think about the early days of your retirement as a “transition phase” while you busily reassign your financial jackpot into income-producing investments then think about how much income those investments produce (after tax, various buffers for contingency, and reinvestment to keep up with inflation) and retire on that!

The Pay Yourself Twice Wealth Strategy!

As you have no doubt worked out for yourself paying yourself twice is in itself just a stepping stone to financial success.

Let’s just quickly recap for new readers:

The likes of David Bach (The Automatic Millionaire) like to tell you that you needn’t do much more than ‘pay yourself first’ (i.e. save) 10% – 12.5% of your gross salary in order to live an idyllic life (well, at least retire well) … going so far as to call this “A Powerful One-Step Plan to Live and Finish Rich”.

The reality is that this is actually a dangerous financial strategy to pin your financial future on.

Whilst the idea of saving money is to be commended – in fact, saving is absolutely necessary – the sad reality is that you would need to pay yourself first 75% of your gross income, starting now and continuing for the next 20 years, just to maintain your current standard of living in retirement.

Clearly, my solution – which is to Pay Yourself Twice 15% of your gross salary – does little to bridge the gap.

Of course, it’s what you do with the money that counts:

I assume that your current ‘pay yourself first’ savings are going into some sort of employer sponsored, tax-advanatged retirement plan …

… which we already know cannot possibly be enough to support your current lifestyle in retirement, let alone set you up for that hammock in the Bahamas with free flowing Pina Coladas that you crave 😉

However, I do want you to keep your retirement fund going – and growing – because it is insurance, if all else fails.

But, it’s the “all else’s” that will make the difference between an austere retirement in 20 – 40 years or a certainly more memorable (and, very early) retirement with $7 million in 7 years … or a happy medium, if that’s more your speed.

And, that’s why you need to Pay Yourself Twice:

– Once to maintain this insurance policy, and

– The second time to build your investing war-chest.

If the power of compounding at bank to mutual fund rates of return (i.e. 4% – 10%) is not sufficient, then it stands to reason that you need to start investing at (much) higher compound returns.

This means building up a modest starting capital amount and ‘rolling the dice’ with higher risk / higher reward investments e.g.

A few minutes with a good compound growth rate calculator will (a) confirm how well your current strategy is doing against your desired retirement needs, and (b) tell you how deep into the above table you need to dive to bridge the gap.

It goes without saying – so, I’ll say it anyway (!) – that I hope that you all succeed with your investments, be they in stocks, real-estate and/or businesses. However, if you should fail … well, by continuing to Pay Yourself Twice, it won’t take too long to build up enough starting capital to have another go.

And, it might take one, two, five times before you are successful …

All the while, you have a 20 year backup plan (by also continuing to pay yourself first) just in case 😉

Pay Yourself Twice!

It is commonly taught that in order to build wealth, you first need to save; and, the best way to save – so common financial wisdom says – is to pay yourself first.

Investopedia (the online investment dictionary) explains Pay Yourself First:

This simple system is touted by many personal finance professionals and retirement planners as a very effective way of ensuring that individuals continue to make their chosen savings contributions month after month. It removes the temptation to skip a given month’s contribution and the risk that funds will be spent before the contribution has been made.

Regular, consistent savings contributions go a long way toward building a long-term nest egg, and some financial professionals even go so far as to call “pay yourself first” the golden rule of personal finance.

Whilst certainly better than the other 99% of the population who don’t even bother saving anything, paying yourself first doesn’t go far enough:

Never mind underestimating what it costs to live a reasonable lifestyle, realize that the old “retire a millionaire’ ideal is no longer adequate; this is largely because of inflation i.e. over 40 years, you will suffer roughly two doublings in the cost of living.

Another handy way to think about this is to think of your retirement date & financial target:

Think of a ‘number’ … the amount that you think is reasonable to aim for in retirement, given the financial strategies that you feel that you can employ. Can you save $1,000,000 by your expected retirement date? Less? More?

Don’t guess; there are plenty of retirement saving calculators around to help you with this task …

1. If 20 years out, ask yourself: “would I be happy with living off no more than 2% of that number, each year?”

2. If 40 years out, ask yourself: “would I be happy with living off no more than 1% of that number, each year?”

If your answer is a resounding ‘yes’ then you are done … it looks like your retirement savings strategy will work.


Now, stop reading this $%@@# blog, it will make your head spin 😉

But, I’m guessing that the answer will be ‘no’ … then what?

Then, you have to face some realities about your current “pay yourself nothing” and “pay yourself first” and “no debt in my life” strategies:

– A million dollars in 20 years (= approx. $500k today) to 40 years (= approx. $250k today), is too low a target,

– 10% isn’t enough to save,

– 20 – 40 years is too long to wait,

– Your 401k – more importantly, the underlying investments – isn’t the right place for your money,

– And, you are probably under-leveraged.

Today, we’ll deal with the first issue:

If you have two reasons to save money (1. to pay down debt, and 2. to build your investment war chest), then it stands to reason that you should pay yourself twice!

But, most people pay themselves second, if at all.

From now on, I want you to concentrate on paying yourself twicebefore you spend money on anything else (other than taxes and social security); here’s how:

1. Pay Yourself Once: If you currently participate in an employer-sponsored retirement plan, then you should continue to do so, and

2. Pay Yourself Twice: You should save an additional 10% of your take-home pay – for now, this can be in an ordinary savings account clearly separated from your other funds.

If you do not currently participate in an employer-sponsored retirement plan or if you and/or your employer are currently contributing less than 5% of your gross pay into your retirement account, then you need to increase your pay yourself twice target to 15% of your take-home pay.

Of course, this is easier said than done: if you had 10% of your take home pay just lying around, by definition you would already be saving it …

… in other words, you are already paying yourself twice; if not, all of your take home pay is currently spoken for!

So, let’s start slow:

Step 1 – Could you save just 1%?

Take a close look at where your money is going: do you think you could find any spending areas where you can cut back enough to allow you to save just 1% of your take home pay?

If you are already saving – but less than the 10% / 15% Pay Yourself Second target – do you think you could find any spending areas where you can cut back enough to allow you to save another 1% of your take home pay?

[AJC: No need to start at 1% if you can find ways to save more; start at (or, adding) 2% or even more, but make sure that once you start that you never turn back … be realistically aggressive in setting your Pay Yourself Second target]

Step 2 – Wait 3 months and double it!

Over the next three months, perhaps by scouring the personal finance blogs on the internet, dedicate yourself to finding ways to double your savings rate i.e. if you started at 1%, after three months you should be saving at least 2% of your take home pay. If you started at 2%, don’t take your foot off the gas … double your savings to 4% of your take home pay.

Step 3 – Repeat

Keep doubling every three months until you reach 8% of your take home pay; three months later, save that 8% plus an additional 2% of your take home pay.

Step 4 – Almost there

What you do next depends on your Pay Yourself Second target:

– if you are already saving at least 5% of your gross pay in an employer-sponsored retirement plan (or similar), then you are done! Keep saving that 10% of your take-home pay.

– if you don’t participate in a retirement plan, or if you contribute less than 5% of your gross pay (including employer contributions), then you should keep saving 8% of your take-home pay plus you should concentrate on doubling the additional 2% every 3 months (i.e. 2% to 4% to another 8%) until you reach your combined target of 15%.

Step 5 – NEVER give up

Start today and never stop!

Unfortunately, as I’ve already pointed out, saving alone won’t get you to Your Number … it won’t even replace your current salary!

So, next time, I’ll help you decide what to do with your Pay Yourself Twice savings …

Brick Wall Retirement

[pro-player width=’530′ height=’253′ type=’video’][/pro-player]

Late last year we had some discussion about so-called “safe withdrawal rates” i.e. what is the ‘magic percentage’ that you can withdraw from your bank account (or other investments) each year, once you are retired, so that you don’t risk running out of money?

Jacob from Early Retirement Extreme said:

It’s fairly well-established (by the original Monte Carlo paper) that the 4% rule is only good for 30 years. Also it only pertains to a broad market total return portfolio. For shorter periods I’ve seen people quoting up to 7%. For longer periods, 3% or less seems to be in order.

He also suggested for a “more extensive discussions see Bob Clyatt’s book”, which we started discussing last week.

Bob undertakes a reasonably good strawman-analysis of some of the existing thinking on Safe Withdrawal Rates then uses some of his own analysis to come up with three rules:

1. It’s OK to withdraw between 4% and 4.5% of your portfolio each year, but

2. You only need reduce the $ figure of the previous year by 5% to cushion the effects of a down-market, as long as you

3. Follow his recommendations for a highly diversified portfolio of stocks, bonds, bicycles, and sausages.

[AJC: OK, I made up the bicycles and sausages bit ;)]

If you follow these rules, here’s your chances of NOT running out of money, depending on your time horizon:

Now, a few things bother me about this, indeed most discussions on this and other so-called Safe Withdrawal Strategies:

1. Here’s a bunch of people who generally advocate NOT to try and time the stock market, yet, in most cases (including Bob’s strategy, if you take the 5% option) you are trying to TIME the worst possible market of all: how long you expect to live!

2. There’s always a chance that your money will run out before you do – including  in 7 of Bob’s 8 (recommended as ‘safe’ and ‘sustainable’) categories; and, in the one ‘safe’category, you still have to run the gauntlet of a nearly 20% chance of perhaps losing your money for 2 whole decades.

3. Even if you wind down your % to Jacob’s suggested 3% withdrawal strategy, Bob’s numbers [AJC: you’ll have to see the book for this one] still show an almost 15% chance of losing your money in the first decade.

Now, there are other Monte Carlo studies that show that withdrawal rates on 3% to 3.5% are pretty damn ‘safe’ … BUT:

a) Personally, I expect to live forever and expect my money to do the same, and

b) How close to ZERO (but never quite reaching it, according to the statistical analysis of 3% – 3.5% withdrawal rates) do I allow myself to get before I panic?

I can’t help thinking that you need to substitute the words “safe withdrawal %” for “the right length and strength of vines” in the video, above, to really understand what it would mean to suffer a prolonged market downturn in retirement 😉

I’ve said it before, and I’ll say it again: unless you have a perpetual money machine set up, there ain’t no safety in withdrawal rates!