Tag Archives: Rich

Define 'long term'?

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That was the challenge set to me by Diane, one of the applicants to my 7 Millionaires … In Training! ‘grand experiment’ in response to a post that I wrote, exploding the myth of diversification that the the 401k jockeys seem to hold on to so dearly … I guess that their financial lives do depend upon it 😉

In that post I said that “diversification is only a mid-term saving strategy ..”.

Why?

As I mentioned in that post: “it automatically limits you to mediocre returns: The Market – Costs = All You Get … period!”

But, Diane is right: a key question is market timing. For example, does diversification help you over shorter time frames? Define short, medium, long … ?

Well, typically financial texts will define short term as anything less than 1 to 5 years; medium as anything between 5 and 10 years; and long-term 10 years+

But, it depends upon who you speak to: Warren Buffett would probably define short-term as anything less than ‘for ever’ … because that’s how long he aims to hold his acquisitions for, and often regrets having sold out of other positions too ‘soon’.

He is also reported as saying that he wouldn’t care if the stock market was only open once every 5 years.

But, I have a different viewpoint, and it begins with a question that I posed to Diane:

Di, the ‘pat’ answer is MINIMUM 10 years. The real answer is: depends why you need to know?

Let’s say that you found an individual stock that you want to buy; when I set out to do this, I set no minimum/maximum time-frame that I would hold the stock for. For me, the holding term is entirely driven by price …

… when I buy the stock, it’s only because I believe that it is well undervalued and the underlying business is one that I understand and love. I’m buying the stock and patiently waiting for the market to catch up with my thinking.

When the market eventually does catch up … I’m outta there!

That process can take months or years … if it takes years, then I am reevaluating how ‘cheap’ the stock still is every time an annual report comes out (if the company’s financials no longer make the current price look cheap, then I am outta there early … whether I need to book a profit or a loss).

So, time-frame is just not an issue here …

But, when I ask this question of others, most people are aiming to ensure that they are building their retirement nest-egg correctly, so for them time-frame seems more important … and it is.

When you plan for retirement, you need to work backwards:

1. How much do I need to ‘earn’ as a replacement-salary from my investments in retirement?

2. How big does my supporting nest egg need to be?

3. How long before I want to stop working?

4. What market return can I bank on getting for that period?

5. Therefore, how much do I need to sock away (in lumps and/or dribs and drabs) to ensure that I get to #2 by #3?

You will most definitely need someone to crunch these numbers for you … just make sure that they crunch the numbers that you provide for #1 thru’ #4, not just the numbers that they will try and ‘sell you’!

Because, ‘they’ will tell you:

… well LONG-TERM the market has RETURNED an AVERAGE of 12% -14% on stocks and only … yada yada …

The problem is that YOU are most certainly not AVERAGE and YOU only get ONE SHOT at this nest-egg-building business. Unless, you can find a way to turn back time and try again 😉

So, you need to choose ‘guaranteed’ numbers for #4 …

Here’s where I like the research that Paul Grangaard did for his excellent book, The Grangaard Strategy, specifically aimed at planning for (Book # 1) and living in (Book # 2) retirement:

Using the research done by Ibbotson Associates (published annually in their authoritative ‘Stocks, Bonds, Bills, and Inflation® Valuation Edition Yearbook’), Grangaard found that over the 75 year period between 1926 and 2000, large cap stocks averaged and annual return of 11% (small cap stocks did a little better at 12.4%), but he also found:

The average annual return [through that 75 period] bounced around all over the place, just like you would expect – between a high of 54% in 1933 and a low of negative 43.3% percent in 1931.

So, clearly planning on holding stocks for just one year has to be counted as extremely short term.

However, if we hold those same stocks for just 5 years, Paul tells us that we get a 6i% reduction in volatility …

… this means that every 5 years period within that time frame (e.g. 1926 to 1931; 1927 to 1932; etc.) still has a chance of being wildly different to the average, but 61% ‘less wildly’ than simply holding a stock for 1 year.

And, it makes sense: wouldn’t your 5 year return have been dramatically different if you bought at the end of 2001 and sold at the end of 2006 than if you bought at the end of 2002 and sold at the end of 2007?

10 year holding periods reduce volatility by 83%; interestingly, we need to move to 30 years before we see another major reduction in volatility (20 years is only few points lower in volatility than 10 years) …

… even so, holding stocks for 30 years means that we should achieve the 11% average return on large cap stocks; but there is still some significant volatility; Paul says:

The best thirty-year holding period delivered a 13.7% average annual rate of return between 1970 and 1999, while the worst thirty-year period delivered an average annual rate of 8.5% between 1929 and 1958.

So, while your “odds” may be high that you will get an average 11% return over 30 years, who do you want to be?

The guy who invested $100,000 and locked it away for 30 years for a ‘safe, secure retirement’ in 1970? 1929? or in an ‘average’ year? Let’s see:

Worst 30 Year Return  $ 1,065,277
Average 30 Year Return  $ 2,062,369
Best 30 Year Return  $ 4,140,507

It’s clear that you would be stupid to ‘bet’ your retirement on ending up with $4 Mill. (BTW: a lovely number … worth about $1.3 Mill. in today’s dollars, if inflation averages just 4% over that period).

But, I equally think that you would be stupid to bank on $2 Mill. either …

… I would use 8.5% in all of my retirement calculations, because 75 years of history  (including buying the day before the biggest crash in Wall Street History, then holding regardless for the next 30 years) says that’s what I will get … not might get, and certainly not hope to get.

And, I will be thankful if I am mildly pleasantly surprised … and ecstatic if I end up winning the Wall Street Lottery!

So, let’s look at time frames in terms of what Wall Street will ‘guarantee’ me:

If I hold for ….. I will get (as a minimum):

10 Years -0.9%
20 Years 4.0%
30 Years 8.5%

So, Di, in terms of being certain of your retirement nest-egg; I’d have to say that 30 years is long-term.

20 years doesn’t even keep up with inflation (4%) and mutual fund fees (1%) … and, anything LESS than 20 years is down-right dangerous!

That’s why gambling on Mr Market for my retirement wasn’t even a consideration for me. How about you?

Now, what number will you be plugging into your #4?

Scam, bam … thankyou, Sam …

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I received a call today from a very legitimate sounding “XXX Futures” … I took the call wondering if they were associated with a prestigious Bank of the same name – who, through a very circuitous route actually owned a minority position in one of my businesses.

They weren’t … it turns out that they are just a well and conveniently named independent company selling ‘investments’ in Futures, options and the like.

I have no direct experience with the company, but trading Futures and Options just aren’t my style, so I respectfully declined and asked to be removed from their list … [click] was the response. Professional!

Now, I’m sorry that I didn’t invest 😉

But, my day was soon made brighter when I opened my in-box and found that I had ‘won’ a Spanish Lottery!

EURO MILLIONNATIONAL LOTTERY ONLINE PROMO

Batch Number: 074/05/ZYxxx
Ticket Number: 5877600545 xxx

We are pleased to inform you today  2008 of the result of the winners of the EURO MILLIONNATIONAL LOTTERY ONLINE PROMO PROGRAMME, held 2008.

($1,500,000.00) (One Million, Five Hundred Thousand Dollars)
Names, Contact Telephone Numbers (Home, Office and Mobile Number and
also Fax Number)and also with your winning informations via email.
CONTACT PERSON:MR ANDREW WOOLLEY
Bank Name:LA CAIXA BANK MADRID

Email:    mlacaixxxxx88@aol.com
           Tel:+34-693-518-xxx
           Fax:+34-91-181-xxxx
 Provide him with the information below:
1.Full Name:        2.Full Address:
3.Occupation:       4.Nationality:
Yours Truly,
Anna Maria(Mrs)

The days are not so long-gone since the mere sight of $1.5 Mill in writing gave me a blip of adrenalin; even so, it didn’t take me more than a micro-second to assess that it belongs in the Scam basket.

Not sure why I blanked out the last digits; which of my readers would actually call them? Still people get ‘stung’ by these and the so-called Nigerian Scams all the time.

I have a question: what would happen if you called, it was legitimate, and you actually won?!

Here’s what I think: if you don’t work hard to grow your wealth (through whatever legitimate means can get you there) and learn the rules of money on the way up … the statistics would say that you have an 80% chance of blowing it all – and, then some – within the next 5 years …

… and, believe me, it’s a lot more devastating to slip back down than it is to suffer some setbacks on the way up, in the first place.

Get Rich(er) Quick(er) … it’s much better than getting there too quickly … or, not at all 🙂

The way wealth is built …

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Damn, I had just finally trashed (and, I mean that in the nicest possible way) the Tycoon Report article that I had excerpted yesterday and the say before … after all, there is such a concept as “too much of a good thing” …

But, I wanted to cover the basics of making money today – hence, my digging the Tycoon Report Article out of my trash (a third time!) because the author, Jason Jovine, just happened to have summarized it really nicely in that same article:

Let’s start off today with a very short, simple lesson on the basics of money.  The way wealth is built is based on just a few things …

1.  How much you make (your income).

2.  What your expenses are.

3.  How you invest your money.

(I am of course not factoring in any inheritance or gifts that you may receive; they are just icing on the cake.)

The key here is to focus on the words “the way wealth is built” … here, we are talking about making money.

And, to make lots of money, if boils down to a ‘simple’ formula:

fn{a($Income – $Expenses)} x fn{b(%Returns – %Expenses)}

Now, I haven’t done maths in 20+ years, so the formula (mathematically speaking) is cr*p, but the principle is this:

Your wealth is some function of how much you earn (less what you spend each year living, etc.) together with some function of how and how much you invest (less any expenses involved in ‘investing’).

This means that there is more than one way to skin the ‘get rich’ cat; for example:

1. You can earn a sh*tload every year on your job (say, $250k p.a.), save a huge % of it (say 35% pre-tax), and invest in a bunch of off-the shelf products (e.g. mutual funds, ETF’s, etc.), taking into account that you will only get circa-market returns (stats say, usually less) and carry some costs (averages 1% – 2% of funds under management, hopefully all tax advantaged at least until withdrawal).

2. You can earn an average salary every year (say $50k p.a.), save a reasonable proportion of it (say 15%, preferably pre-tax) and amp up the returns on your investments (carrying some additional risk in order to do so) … I say ‘some function’ because you can (and should, IF getting rich on a small salary is your prime concern) borrow as much money as you believe that you can handle to increase the upside (of course, you again increase your risk).

3. You can increase your income (e.g. start a full or part-time business, with all the attendant risks) and then invest per 1. or you can amp it up (again) and invest per 2.

There are many combinations, hence strategies, available – obviously increasing your income and increasing investment returns greatly increases your chances of getting rich(er) quick(er)! As does lowering both your personal and investment expenses.

Now, the article’s finally toast!

One more time …

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You can check out 7million7years and other great personal finance blogs at Money Talks … in the meantime, here is today’s post …

I’ve written a whole series of posts just focused on one thing: understanding whether you are in the BUSINESS of the stock market, or are you in some other profession/business just looking to save a little or invest a lot … and, have chosen the stock market as your vehicle (instead of, or as well as, real-estate, etc.)?

If you are in the BUSINESS of the stock market, and very few of us are (I’m not), then you treat it as a Making Money 201 BUSINESS i.e. to create income (either through dividends, profits on trades, or capital appreciation).

“You puts your money and you takes your chances”, as the old fair-ground spruiker once said.

If you are NOT in the BUSINESS of the market, then what should you do? Well, go back and read those posts, starting with this one …. they are designed to STOP you wasting your time chasing the impossible so that you can INVEST more time in the activities that will actually stand the best chance of making YOU money.

I received a couple of important comments from Moom to that post (and the one the day before):

I’m not sure there’s much difference between option 2 and being a speculator/trader. Most people aren’t going to beat the stock indices doing this on a risk adjusted basis. As I said yesterday, you’ve got to ask yourself: “do I have an “edge” that can beat the market” and if you do can it earn enough in above market returns to make your time invested worthwhile. If you only earn 1% above the market and only have $100,000 to invest it’s not worth spending much time on investing except in order to learn to be better.

It might make sense for someone with say $100-200k at least to invest to build a portfolio of just individual stocks they like. On the other hand ETFs/index funds in the US have very low management costs and so it might not make much sense unless they have an edge of some sort or just enjoy owning these different companies and their “stories”.

Another option is to select good managers. But that might be as tough for most people to determine as selecting good stocks.

My comments yesterday were that there are ways to earn equity like returns with lower volatility without trading (except rebalancing) or much in the way of security selection. You need to include lots of asset classes and use cheap leverage (mortgages and levered funds like SSO) where possible so that you can get an equity like return while including some stuff in your portfolio that earns less than equities (like bonds).

The point here is to understand which side of the fence that you lie; it’s a Binary Choice:

1. Dollar-cost-average into low-cost Index Funds over a 20+ year period, OR

2. Spend the time and effort to identify 4 to 5 undervalued companies that you understand, love, and believe have a strong reason for being able to stick around for, say, 100 years (try Coke … except it’s not undervalued) and buy those to hold for 20+ years or until the market ‘wakes up’ to their true value (I have nothing against you trading/in out of these stocks on the way up … equally, I have nothing against you just holding them).

The SAVER is looking for market returns over 20 years by dollar-cost-averaging into safe Index Funds: $100k becomes $400k+ (the reality is that they will be topping up regularly for an even bigger nest-egg circa $1 Mill.)

The INVESTOR is looking for circa DOUBLE market returns over 10 – years by investing in the stocks of a few well-chosen undervalued businesses: $100k becomes $1.4 Mill.!

To me, there are NO other [stock market-related] choices for the non-gambler (who is in the ‘business’ of trading/speculating a la Soros and a select few).

The 7million7years Binary Stock Strategy Selector 🙂 is designed to STOP you from wasting YOUR precious time and money chasing funds, managers, the market, etc …

… and, concentrate on building YOUR core skills (e.g. your profession; your business; your talents; etc.) and maximising YOUR return from THOSE.

This is not just me saying this; it’s Warren Buffett as well … but, we’re just two conservative rich guys (one ultra … Hint: his initials are WB … the other so/so) … what do we know 😉

But, here’s where I differ from Warren: IF your core skill is ‘speculating’ [AJC: and, this might be you, Moom?] … then, go for it … but, treat it as your BUSINESS …

…. and make sure you invest the proceeds in one of the other, safer ways available, just in case you ever get it wrong!

But, Buffett doesn't use Stop Losses …

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On my first Live Chat Show, in response to a viewer question, I discussed the theory of Stop Losses (I just posted on this, so I won’t go into the details here).

Andrew saw the show and asked:

Your webcast today prompted me to look up some more of Warren Buffet’s letters to shareholders and general advice, I wanted to get your take on something I came across that seemed potentially contrary to what you mentioned about your use of stop losses in your webcast today.

Warren said he believes that when you invest in a company you should be able to see it go down in value by as much as 50% and not sell off because you know that you already bought it at a steep value. I know this is potentially different than what you mentioned because you were talking about protecting gains, but if you have the time let me know what you think.

I’m amazed that my web-casts can prompt anybody to do anything! Well done, Andrew!

The way that I see it …

… there are two ways to invest: (a) buy and hold through thick and thin, (b) trade in/out on market swings.
 
Warren does (a) and I do (b) hence, Warren is (much, much, much) richer than me 😉
Warren’s method takes excellent understanding of the market fundamentals, a stock that provides strong underlying cash-flow, and a business model that will stand the test of time. It also takes an awful lot of faith …
Trading in/out seeks to avoid staying in a falling stock … those choosing this path, generally are trying to move with the ‘Big Boys’ (the institutional ‘insiders’ who might have caught wind of some negative news that may put a short-term dent in the company stock) or are trying to avoid getting caught up in a dog that looked like a show-pony.
(b) is also trying to time the market, and we know where that can go …
But, Warren and I agree on the underlying principle: we are both buying a stock that we believe is currently well-underpriced by the market, and one that we would be prepared to hold on to for a very long time.
 
I just trade in/out of the inevitable (and, hopefully, relatively small) up/down swings in what I hope is a generally upward trend … once the stock gets back to market price, I’m out’a there, Baby!
Who’s method works better over the long-term: Warren’s, without a doubt!
Remember, always go with the money 🙂

The Mighty 401k Fights Back!

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A short while ago I wrote a post challenging the notion that you should automatically plonk your money in your 401k, because:

1. It’s ‘forced savings’

2. It’s pre-tax savings

3. You get free money from your employer!

Yesterday I wrote a follow-up saying acknowledging that these are all good things to have in an investment.

But, not the only things … in fact, there’s only ONE THING that I want from an investment: that it gives me a return that supports My Life.

Not, the life that the investment is capable of supporting … not the life that I have … not even the life that I want … but, nothing less than the life that I need.

But, I expected to cop some flak, and here is some of it …

Traciatim said:

Historically real estate tracks inflation, not 6% annually. You’re also forgetting maintenance and property tax, water/sewage, heat, etc. When you want to retire you’re also forgetting the cost of selling the properties.

In fact, this is a really common theme amongst the detractors (there were a lot of positive comments, too) … but, who ever said that you should invest in ordinary residential real-estate in ordinary locations?

Also, those who ‘remembered’ the costs of these direct investments (which I did allow for) , we tend to forget the hidden management costs and fees of the funds that your 401k invests in (which I did not allow for).

Curt said:

If you wait three years, real estate ‘good deals’ will be everywhere and you won’t have to invest the time to find them. That will likely be a better time to move money back into real estate.

This is the mistake of trying to time the market; this affects both the 401k ‘option’ and the alternatives, and probably requires a whole post in itself … if you are interested in the real-estate option (and, it is just one of many non-401k options that you could take) and you can find something that ‘works’ now, go for it!

Paul said:

One major flaw in your analysis…and I’m sure I could find others if I look hard enough:

You’re not accurately accounting for taxes here at all. The contributions to the 401(k) Plan are on a pre-tax basis. If you’re saving money in a bank account to buy real estate, that’s on an after-tax basis. To save $5k in a 401(k) Plan, you have to earn $5k. To save $5k in a bank account, you’ll need to earn $6,667 assuming a 25% tax rate.

I didn’t even talk about the risk inherent in real estate versus a diversified portfolio, or how your analysis of the return on the employer match is a bit off.

While it is good to think in unconventional ways at times, you better make sure you are accurately looking at these scenarios before you risk your entire future on them. While it could pan out, it could also blow up in your face.

Wise words, Paul. Of all the criticisms of my post that I read, Paul’s is most valid: I did not do an after-tax treatment (although, I did mention Capital Gains Tax); it’s just too damn complicated to run the numbers for a post like this … and, doesn’t change the relative outcome.

In fact, why do you think so many wealthy people invest in businesses and real-estate? It’s partly FOR the tax breaks! How much tax do you think that they legitimately pay per dollar earned compared to you, even WITH your 401k?

And, it appears that Pinyo of Moolanomey actually reran the numbers:

AJC – Interesting post, but I have to agree with the naysayers. Your analysis in scenario 1 didn’t include mortgage and other expenses. In part 2 of scenario one where you actually account for expenses and deposit everything into CD, the true advantage is only $63,000 over 30 years and this is before tax — after tax it’s virtually wiped out.

Sorry, Pinyo, on this one we’ll have to agree to disagree … unless you want to share your numbers? Then, I’m happy to do [yet another] followup.

BTW: real-estate is not the only viable alternative to saving in your 401k; my arguments apply to any investment that has the following four characteristics: leverage, depreciation, other tax deduction/s, and inflation protection.

Guys, the critical difference is this one – hardly mentioned in the comments at all: Real-estate has an apparent risk … but, the 401k option has a hidden risk.

I think we all understand the apparent risks of alternate investments v the nice, safe 401k (if you were set to retire at the end of 2007 and you ‘forgot’ to shift the bulk of your funds to the bond market, you may have a slightly different view on this) …

I’ll leave you with one thought: when was the last time that you read this headline:

‘Multimillionaire thanks the tax system for favoring his 401k … says” “without it, I would not be sitting in my beach house in Maui sipping Pina Coladas today” ;)

The Hidden Risk of your 401k …

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Recently I wrote a post that challenged the ‘Set It And Forget It 401k Brigade’ to at least rethink their strategy instead of just automatically maxing out their 401k …

… in doing so, I mentioned that there was a ‘hidden risk’ in your 401k.

Whilst the 401k proponents put forth all the wonderful, low risk arguments in favor of 401k’s (quoting long-term market averages of 12%+) they conveniently forget:

1. Fees: Figure around 0.5% – 1.5% in fees set by the funds that your 401k invests in and the fees associated with managing the 401k and the underlying funds (but, only the ones that your employer doesn’t pay). Most of these are conveniently hidden in your returns.

2. Market Dips: Did you know that while  the ‘market’ averages 12%+returns, you can only count on 8% as your 30 year return, 4% as your 20 year return, and 0% as your 10 year return from the market. My rule of thumb is: when planning your retirement, count on less … enjoy the possible upside when you are wrong!

3. Inflation: It takes time to get to the nest-egg that your 401k will give you … 20 – 40 years when you are starting out … so $1 Million just ain’t all that much money (now, let alone 20 – 40 years time!).

But, that’s not the hidden risk that I was talking about … it’s much, much more dangerous than those …

… the hidden risk of your 401k is that you may not get enough out of it to retire well.

Almost as bad, you may not care enough now to plan for what may happen then; after all, for you ‘retirement’ may be still 10 – 20 – 40 years away! Although, it need not be …

So, what do I mean?

As I said yesterday, the arguments that the 401k proponents put forth center around: it’s ‘forced savings’; it’s pre-tax savings; and, the possibility that you get free money from your employer!

All good things to have in an investment. But, not the only things …

… in fact, there’s only ONE THING that I want from an investment: that it gives me a return that supports My Life.

Not, the life that the investment is capable of supporting … not the life that I have … not even the life that I want … but, nothing less than the life that I need.

Just remember this: there’s nothing holy about a 401k.

The purpose of your 401k investment is NOT to get a tax break, not to put aside 15% of your gross salary a month, and not to get any employer match … they are just (important) features …

Just like any other investment, your 401k’s purpose is to help you get you to Your Number so that you can live Your Dream!

Anything less is just settling for less. So, let’s consider the binary options here:

1. Your 401k will get you to your Number

You know your Number, right? And, you know when you need it?

If not, either read this and do this … or, you’ve just wasted a valuable 3.5 minutes beer drinking, relaxing time that would have had a far more beneficial effect on your life than what you have just read … or, will ever read … on this blog!

And, you know what your 401k can deliver by then, right? Not when your employer says that you retire, but by when you need The Number!

If you haven’t done the calculation yet, ask a Financial Adviser to help you (or follow along with our 7 Millionaires … In Training! at http://7m7y.com starting with this article) …

… you think knowing this might be just a tad important?

Now compare what your 401k is likely to be able to produce (now, I would not be using ‘average returns from the stock market’ for this life-critical calculation … I’d want a buffer … but, that’s really up to you and your bean-counter) with Your Number …

… if they are much the same, stick with your 401k (after all, it is ‘set it and forget it simple’). Then concentrate on keeping your job and, getting bigger and bigger pay-rises, because you’ll need ’em!

2. Your 401k will NOT get you to your Number

If your 401k will not get you to your Number, what choice do you have but to at least consider alternates, be they instead of –  or in addition to – your 401k savings plan …

… be they real-estate, stocks, 2nd/3rd/4th jobs, marrying into money, winning the lottery, businesses … 

…. be they whatever …?

Of course, you could just give up and settle for your lot in life; who am to tell you not to give up on your dreams?

I’ll leave that little job up to Frankie 😉

Should the rich invest in Index Funds?

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When I glanced at the incoming stats to this blog this morning, I happened to see that a number of people had come to this site because they had typed the following search into Google: “should the rich invest in Index Funds”?

It’s a great question to which the answer is: it depends! 🙂

If you want to BECOME rich: No

If you have a high salary and can save a lot of it (see yesterday’s post) … and are happy to keep doing this for 30 years (to ‘guarantee’ the return), then plonking your money into an Index Fund (preferably via a series of 401k’s, ROTH’s, etc. etc. to get the tax benefits) may be all that you need to do.

But, even with some employer matching and tax benefits, for many salary earners the low returns (and, the costs built in) to such funds might not be enough to get you to where you need to go …

If you are ALREADY rich: Yes

Here the rules change … you are more concerned about wealth-preservation than wealth-building. Therefore, ‘saving’ in a way that ‘guarantees’ your principle and living standards can be a suitable alternative to ‘investing’ for high returns in retirement (or close to it .. i.e. within 10 years).

The typical choices here are:

1. CD’s: Just keep your money in the bank – but, inflation will kill you.

2. Bonds: Preferably inflation-protected – and, low returns will probably put a damper on your long-term spending habits.

3. Real-Estate: Using low-or-no borrowings (opposite to our wealth-building real-estate strategies!)  – reasonable (and, reasonably safe returns) provided that you invest wisely, manage the property well (using an expert and reputable property manager, of course!), have a suitable cash buffer for expenses and loss of tenants, etc. You live off the rents and you may have the added benefit of a larger estate to leave to the rug-rats and/or donate.

4. Index Funds – you may need to be prepared to sell down 2.5% to 4% of your holding every year (that becomes your ‘replacement salary’), but – over a 30 year period – that should be enough to self-sustain (i.e. keep up with inflation and your annual salary). The lower the % that you withraw, the greater the chance that your money won’t run out before you do (and, if the market goes well, you COULD even have the added benefit of a larger estate to leave to the rug-rats and/or donate).

But, when planning for retirement, don’t make this mistake: the market has returned an average of 12% – 14% p.a. for the last 100 years …

… but, if the market crashes just before – or in the early stages of – retirement, it can have a major impact on the longevity of your portfolio … in other words, you are screwed!

So, do what I do and plan for the worst: plan to have the bulk of your money in the Index Fund for 30 years, because that’s how far out you need to go to ensure an 8% return … then take off another 1% for fees … another 3% or 4% (5%?) for inflation …

If you only plan for 20 years, the ‘guaranteed’ return drops to a measly 4% and inflation will just say “thanks for the snack” and leave you with nothing!

So, are Index Funds for you?

That little pup called inflation …

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If you’ve been sticking around to see how the 7 Millionaire … In Training! ‘grand experiment’ can pay off your you … 
… your patience is about to be rewarded – at least, that is my sincere hope. 
Starting today are a series of special weekly posts at http://7m7y.com designed to help you find your Number.  
This is perhaps the most important financial exercise that you will ever undertake in your enitre life … at least, it was for me! Whether you intend to be an active participant in my second site or not – this is my gift to you: 
All you need to do is read the posts, starting today and continuing (once or twice a week) for the next 3 weeks, and follow along with the simple – but critically important – exercises that I will be providing. Like everything here, this information is provided free, without any catches, for your benefit. Make good use of the opportunity … it won’t come around again. 
Good Luck and I hope that it is as profound an exercise for you as it was for me! AJC. 
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Sometimes you can’t see further than the back of your own hand until somebody points the way …

… then it just seems so damn obvious that you wonder why all of those other dopes out there are still staring at the backs of their hands!

I was preparing for a radio interview the other day and I happened to pull up an old e-mail (that I mentioned in a previous post) from Fidelity – a fine investment management company – that proudly proclaimed:

Did you know that weekly contributions of $34 could potentially grow to over $76,000 in 20 years?

At the time, I just wrote my little counter-piece and laughed it off because that $76,000 probably won’t even buy you a car in 20 years time!

But in thinking about it – and, this is what I said on air – it’s actually much worse than that …

You go without lunch every day for the next 20 years, and you don’t even get a new car?!

How the hell are you ever going to retire!

Think about it, if $34 a week gets you $76,000 in 20 years … then, you would need to save $340 a week for the next 20 years just to get $760,000 !

Now, even if you could figure a way to save $340 a week (starting right now!) $760,000 a year in 20 years is NOT the same as having $760,000 today …

$760,000 today will get you a reasonably ‘safe’ income of $30,000 a year (indexed for inflation) if you invest the capital wisely, if you don’t suffer any major losses, and if you don’t spend any of it up-front or along the way.

In other words, the equivalent of $30,000 a year has to buy you everything you need and want for the rest of your life!

But …

That’s only if you have the $760,000 today!

If you’re like the rest of the world, to get there you’ll need to put aside that $340 a week for the next 20 years, but that little pup called inflation will be nipping at your heels the whole way …

… and, that $760,000 in 20 years will only be ‘worth’ $350,000 if inflation is just 4%. I can’t even begin to think about what would happen if inflation rises to 5%+, as predicted.

That means that you get to live on $14,000 (in today’s dollars) a year!

So, how much did you expect to save?

By when?

But, wait, Fidelity is offering a 7% annualized return … aren’t you going to invest that money in the stock market (an ultra-low-cost Index Fund, of course) that averages 13% a year?

Sure.

Because the day that YOU invest the market is going to crash, WWIII is going to break out, the sub-prime crisis will just be getting into full swing (again … will they never learn?), or worse.

YOU, my friend, will need to plan for numbers that you can rely on because you only get one shot at this …

… and, the money has to last you for the rest of your life  – unless your backup plan is (a) still checking out groceries at the local supermarket when you’re 75, (b) eating dog food, or (c) let me hear it [leave a comment].

And, the number that you can rely on is this: 8%

Because, you can put your money in an ultra-low-cost Index Fund (we’ll forget about minimums and entry/exit fees for now) and rely on the fact that the market has never had a 30 year period where the returns have been less than 8% (that includes periods of war and pestilence and pure market stupidity).

… but, now you have to wait 30 years; because if you only wait 20 years, you can only be sure of getting a 4% annualized return, and that just sucks.

The good news is that if you can wait 30 years so that you can get a ‘guaranteed’ 8% return and you can keep socking that $340 away, week in week out for 30 years, well that’s over $200,000 a year (at a 4% ‘safe’ withdrawal rate)!

Unfortunately, we still have that little pup (a.k.a. inflation) dragging at us via his leash, which means that you can really only comfortably rely on an annual income of $25,000 in today’s dollars.

But …

You will do (much) better if you can start socking away, without fail, $340 a week and indexing that with inflation as well (in 15 years you’ll be putting away $588 a week and in 30 years $1,060 a week).

In fact, if you can maintain that regimen for 30 years, you’ll deserve a medal as well as your annual income of $37,000 in today’s dollars!

$14,000 … $25,000 … or even $37,000 a year in 30 years: is that really what you had in mind?

I suspect not, or you wouldn’t be reading this blog 😉

The true cost of 'helpers' …

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The best way to give up your ‘day job’ is to watch my Live Show this Thursday @ 8pm CST (9pm EST / 6pm PST) at http://ajcfeed.com ….

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Last month, I wrote a post that was a little scathing about what I call ‘middle-men’ and Warren Buffett calls ‘helpers’ … all of those people inserted between us and those fantastic “little pieces of American Business” [another Buffett quote … he means ‘stocks’] that we want to buy.

The problem is they cost us …

and, for every 1% in fees that they cost us, and our returns on $100,000 invested for 20 years goes down as follows:

1% 2% 3% 4%
 $17,383.14  $31,876.74  $43,938.73  $53,958.08

That’s how much you LOSE from what you COULD have earned on that $100,000; scroll to the bottom [better yet, keep reading] to see what Warren Buffett actually estimates all of these middlemen (agents, brokers, advisers) to cost American Business – hence us!

In the meantime, let me cast my views on these two important topics:

Financial Advisers

I will lay it right out on the table for you: I don’t like ’em, don’t trust ’em … but, sometimes you can’t live without ’em. In fact, I usually advise people to see a financial adviser and, I have NEVER told people not to.

I’m just telling you my opinion 😉

I see four problems:

1. Commissions – in the USA, most advisers are tied in some way or another to selected funds and/or providers … they will not or can not, provide you with truly independent advice. Sure, they may be honorable and educated and ethical (of course, they all are) but would you go to an honorable and educated and ethical Lexus salesman and expect her to advise you to buy a Maserati?

2. Fees – I love them! Truly … if I pay a fee I know I should be getting what I need, not what some ‘freebie’ guy is selling me. Unfortunately, in the financial planning industry even fee-only advisers can have affiliations to selected providers via agency, equity, or simply because they only have experience with a limited product set.

3. Results – How rich is your financial adviser? How rich do you want to become? They should be as rich as you want to become x 10 [AJC: OK, as rich as you want to become x 1 or 2 for right now is OK … but, when you get half-way whomever you ask for financial/commercial advice should be as rich as you want to become x 5]. And, if they are stinking rich already, did they get there because they invested in the same way as they are advising you or because they run a damn good financial planning business (which requires more selling talent than investing skill)?

4. Product – When was the last time that a financial adviser – particularly a financial planner – said, “Look Bud, I’d love to sell you this really great financial product, but [takes you aside, puts his arm around you and whispers conspiratorially] what you really need to do is [insert sensible alternate investment of choice: invest in real-estate; buy your own home; put the money towards starting a new business; look for 4 or 5 undervalued businesses and buy their stocks]” ?

Personally, I’ve never been to a financial planner [AJC: actually once, nice guy – I went because I kind’a know him socially – but, as soon as he started talking ‘business’ I felt my skin crawl and couldn’t wait to get out of there!], I would rather look for a business/investment savvy accountant to run the numbers for me.

Invisible Middle-Men

These are the guys researching, packaging, distributing, and managing investments for you. The most ‘typical’ product that we are talking about here are Managed Funds, which all carry fees – most hefty, some miniscule – to cover the costs associated with all of these ‘invisible’ middle-men, as well as the financial planner’s commission (if you decided to go with Option 1., above after all).

The problem is that, even if you wanted to diversify [you shouldn’t!] you wouldn’t buy one of these funds through an adviser/salesman … you would go direct to, say, Vanguard’s web-site and sign up for their lowest-cost broadest-based Index Fund and start contributing … and, you wouldn’t need to come up for air for another 30 years!

Warren Buffett talks a lot about other middle-men; what he laughingly calls the “Helpers” (as in “I’m from the Government and I’m here to help you”) e.g. the stockbrokers, the hedge fund managers) and if you want to read his beautifully laid out reasoning from his 2005 Letter to Shareholders, check out this article.

In the meantime, I lead you to Warren’s stunning conclusion:

The burden of paying Helpers may cause American equity investors, overall, to earn only 80% or so of what they would earn if they just sat still and listened to no one.

Try compounding a 20% ‘loss’ over 10 years and see what you end up with!