Tag Archives: Starting Out

Is Mike aiming high enough?

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Mike is a divisional CEO for JP Morgan (runs a whole country for them!), and he earns $250,000 in a bad year and $350,000 in a good year. He’s running fast and aiming high.

But, is Mike aiming high enough?

If you weren’t following the comments on this post, then you were missing out on more than 50% of the benefit of that post … I think that also holds true for most of my posts; our readers rock!

Anyhow, Mike said:

I’m 36 and have already got up to the savings level of someone who is 50 or 55… question is when do I want to take it easy and stop working for a while- or at least working make myself rich instead of JP Morgan, who owns the company I’m running!

Aspiring to the savings level of someone who is 50 or 55 is no great shakes; it’s where Mike goes from here that will dictate his future, so I asked Mike a few questions:

Disclaimer: We know next to NOTHING about Mike’s true situation, so nothing here constitutes financial advice* … it’s best if you – and, Mike – treat this as a hypothetical, merely illustrating how to apply 7m7y ‘rules’ to somebody on an income rather than working their own business/investments. On with the questions …

1. What’s your Number?

2. What’s your Date?

3. Why?

4. What’s your Current Net Worth?

It may be that Mike’s presumably super-high salary (after all, he is running JP Morgan in his neck of the woods!) combined with an aggressive savings / investment strategy will do the trick …

Mike’s response:

Salary isn’t super high – only $260K USD a year (base salary & guaranteed bonus) – max variable bonus on top of this is another $100K so it’s comfortable but not huge.

My number is abour 10 million – would like to hit it in the next 14 years or sooner.

Current net worth is 1.7M USD with $1.3 M in very liquid assets (cash…) Residence is fully owned and monthly burn rate is pretty low.

Given that Mike’s Prime Financial Objective should be to reach his Number by his Date, his financial strategy should be the one that he is most comfortable with that seems most likely to achieve that target …

… IMHO, he (or anybody) should only choose a more ‘active’ (read: risky) strategy if it’s a by-product of the strategy that he truly resonates with …. for example, I would start a business even if plonking my money in CD’s would have been enough – that’s just me [AJC: but, it wouldn’t have been all of my money – or even a lot – going into starting that business].

What does this mean for Mike … I mean, Hypothetical Mike? 😉

Well, let’s go through the steps:

STEP 1 – What is Your Number / Date?

Mike’s Number is $10 Million and his date is circa 2023.

STEP 2 – What is your Required Annual compound Growth Rate?

Starting with his $1.7 million Net Worth [AJC: reading between the lines, Mike’s paid off house may not even ‘break’ the 20% Rule – and if it does, not by much, so I don’t see a problem here] our faithful online calculator shows me that Mike ‘only’ needs a 13.5% Required Annual Compound Growth Rate on his Net Worth.

[Tip: If you haven’t used this calculator before, it’s simple: Mike’s ‘ending value’ is his $10 million Number; his ‘starting value’ is his current $1.7 million Net Worth – although, I would be tempted to subtract cars/furniture and any other personal ‘stuff’ that can’t be easily turned into cash and/or loses value … house is probably OK to include here – and, ‘the number of periods’ is just his 14 year Date] 

STEP 3 – Select your Growth Engine

This is where it gets fun … Mike simply needs to take a look at Michael Masterson’s table of ‘money making strategies’ – handily reproduced for you in this post – to see that any number of strategies will be enough to propel him from $1.7 million to $10 million in 14 years: anything from stocks to real-estate to small business.

But, not CD’s … this calculator shows that Mike’s biggest risk is actually the low-risk ‘investment’ option that he has so far chosen: cash …

… if he keeps ‘investing’ in cash, Mike’s Number will be struggling to reach $3 million in 14 years, rather than the $10 million that he needs 🙁

Rather than being the ‘safe haven’ that it appears, keeping his assets overly-liquid is actually stopping Mike from reaching his financial objectives … worse still, it’s forcing Mike to think about chasing more income, when it’s the exact opposite strategy that Mike should be following!

That’s why, I recommend that Hypothetical Mike choose stocks and/or real-estate in whatever mixture of either / both that suits his temperment.

Now, we are talking Value Stocks when we suggest a 15% compound growth rate, and reasonably well-geared (i.e. no more than 25% – 30% starting equity) commercial real-estate – mixed with stocks – when we suggest a 30% compound growth rate.

But, here is the key …

… for Mike, and anybody else whose primary Making Money 201 ‘accelerate your income’ tool has been climbing the corporate totem pole to a position where (a) income is [relatively] high, (b) expenses are reasonably low, so (c) saving rates are high, their net worth will most likely grow even if they merely plonk their money in their 401k and/or Low Cost Index Funds…

You see, Mike will continue feeding his Net Worth with both Investment Returns AND additional salary contributions.

This means that Mike will most likely reach his Number simply sticking his money into low cost index funds:

Mike should follow the advice that Warren Buffett gives to all the Hypothetical Mikes of this world … in fact, it was virtually tailor made for his situation:

If you are not a professional investor, if your goal is not to manage money in such a way that you get a significantly better return than world, then I believe in extreme diversification. I believe that 98 or 99 percent — maybe more than 99 percent — of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs.

Given that Mike’s current salary / job makes reaching his Number a virtual gimme – with such a variety of relatively low impact [AJC: certainly in the context of amassing a $10 million fortune!] Index Fund, Value Stock, and/or Real-Estate investment strategies available to him, what would you advise him when he says:

Right now my best option is to continue to get a successful track record (already turned around the business and changed it from major losses to modest profits) and maybe I can find a better gig.

What advice would you give to Mike?

I know what I would say 😉

* [Insert: ‘Not qualified financial advisor; not financial advice; seek qualified advice before investing; take two Tylenol and call me in the morning; yadayadayada’ disclaimer message of choice]

Stuck for a new business idea?

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I’m not sure why anybody would be stuck for a business idea?! We get at least one million-dollar idea a day [AJC: you may not think so, but it’s anytime that you are dissatisfied … inside every problem is a million dollar solution just waiting to break out], but we either fail to recognize it or – more likely – act on it.

I have two solutions:

1. Carry a small pen and a notepad (yes, an iPhone or PDA is a great substitute) and …. use it!

Write down every idea that you get, then make sure that you act on each: do something to verify that your first idea has / hasn’t merit and … act further: do some research, talk to somebody in the industry, etc., etc. If you feel, at any stage, that it isn’t for you, put a line through it and REPEAT for Idea # 2 and so on.

2. Or, if you are The Vacant Parking Lot Of Business Ideas, don’t fret … just buy this book (Hint: buy the .pdf from his web-site at half the price that Amazon charges).

Disclaimer: I haven’t read the book, but that’s not the point … as far as I am concerned, it only needs to give you a list of ideas to explore – any additional valuable content is a bonus.

Still not sure that you want to spend the ten bucks on helping you reach your Number? Shame on you … but, here’s an excerpt, anyway:

Retiring with enough …

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Philip Brewer has written a couple of articles for Wise Bread exploring the question: “Can You Buy Your Way Out of the Rat Race?”.

He says:

If you’re tracking your spending, you know how much money it takes to live on. If you’re tracking your investments, you know about how much return you’re getting from your capital. With those two numbers, you can get a pretty good estimate of how much money it takes to buy your way out of the rat race.

In its simplest form, the cost to buy your way out is just your annual spending divided by the return on your investments. I used to do that calculation a lot. When I got my first job interest rates were in double digits, so I could imagine getting $30,000 or even $40,000 a year — plenty of money to live on — from an investment as small as $300,000.

This is good advice if you want to retire on “$30,000 or even $40,000 a year” … I don’t 😉

The problem with these types of retirement articles is that they usually start from the assumption that your current salary +/- 30% is what you want to live off.

When my salary was $250k, this probably also held true for me … but, just a year or two earlier (when I was actually planning my own retirement) my salary was only $50k – plus my wife’s $60k, making our total household income less than half my ‘required retirement salary’.

So, I describe the retirement calculation process much as Philip describes it, with an extra step:

1. Decide what you want to do with your Life

2. Decide how much annual income you require (probably, without needing to work … but, that’s up to you)

3. Convert that amount to the capital that you need.

Now, Philip would say that you should subtract any income and/or pensions that you expect to receive along the way …

… I recommend that you don’t.

You see, you may not want to – or be able to – continue work through your ‘retirement’ – and, government pensions can always be taken away.

Rather, I recommend that you assume neither of these while you are ‘retired’, and reinvest any such ‘windfall income until you have enough accumulated to effectively increase your Number, hence your standard of living.

Huh?!

Well, Philip suggests:

Among people who invest for large institutions, there’s a rule of thumb that you can spend 5% of your endowment each year, and then expect to have a bit more to spend next year than you spent this year.

Of course, they can’t expect that 5% to be more every single year. Some years the investment portfolio does poorly–and after one of those years, the 5% that’s available for spending will be less than the previous year. Maybe much less.

For households, therefore, the rule of thumb is 4%.

We have a similar rule: The Rule of 20, which seems effectively the same as Phil’s 5% Rule [AJC: we’ll explain why it’s actually a VERY different concept, in a series of MM301 posts, coming up soon] … this is probably enough because you will probably:

– Earn some additional money in retirement (remember those part-time income and pensions that we mentioned?)

– Spend a little less as you get older (unless you feel that health care will outweigh all of those Learjet trips?)

– Overshoot your Number, if you wait until reaching your Number (on paper) before actually trying to sell your business / real-estate, etc.

BUT, don’t let me stop you from building in an additional buffer by modifying my ‘rule’ to anywhere between the Rule of 20 to the Rule of 40.

Hint: I wouldn’t bother … the Rule of 20 is plenty to aim for; but, don’t let me stop you from aiming for more …

…. just don’t try and make it LESS 🙂

What is your Number?

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Well, it certainly took me a long time to ask the question (see Reader Poll: What Is Your Number?) and, it took me almost as long to answer it.

Why?

I’d like to say it was because I was forensically and actuarialy analyzing the results … I’d like to say it was, but that wouldn’t be the truth, which is much more mundane: it was mainly because I forgot all about it after our ridiculously long Australian summer holiday season (Aussie summer = USA winter) 🙂

So without further ado, here are the results:

Now, the first thing that you may notice is that the answers aren’t in any sort of obvious order; traineeinvestor was the first to notice:

The order … is not sequential. I fully expect to be awake all night trying to figure out whether this is really a cover from some experiment in behavioral finance.

Actually, the reason is equally mundane: I was trying to copy the following poll from GenerationX Finance, but when you compare them, you’ll find out that I even got that wrong (!?!):

I presume that GenX ‘randomized’ the ranges to make his readers think through all the options before merely selecting the first one that looked OK; at least, that’s what I would have done had I not tried to copy him 😉

But, to help us analyze the results, I have graphed them side -by-side and in logical order:

OK, that tells me that we are on the right track:

– either I am attracting the ‘right’ audience for this blog (which is nice), or

– my readers have altered their perceptions of “how much is enough” based upon some of my preachings (which would be really nice).

Given that GenX’ers are born in the 60’s and 70’s (I was born in the – late! – 50’s … scary, huh?), I can understand why some may be aiming for only $1 mill. to $3 mill., but to my mind, it’s still too low; and for Gen Y and so on, inflation will decimate your living standard by the time you reach ‘standard’ retirement age, so you have no choice but to aim higher.

But given that so many of our readers have lofty targets – and, I just may be responsible at least in small part for at least a few – let me ask you, what would you like to see from this blog in 2010 that you haven’t seen (enough of) yet?

Are you saving enough for retirement?

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This video asks an important question, one that we asked our readers some time ago (and, will answer tomorrow).

It also seems to indicate that roughly 8% is a safe withdrawal rate, at least for men who choose to retire at the standard retirement age in the USA … we’ll explore this further, through a series of posts beginning later on this week.

For now, what do you think is a ‘safe’ % of your Number to live off each year?

What would you do if you won the 2010 World Series of Poker – Part II?

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Last week I gave some unsolicited advice to those who may have finished 6th, 7th, 8th, or 9th in last years’s World Series of Poker – Main Event – pocketing a tidy sum in the range of $1.2 to $1.5 million.

Sounds like a lot, but not if you are aiming to retire on a helluva lot more than $57k a year (plus a $60k ‘one off’ spending spree’) …

… so, what if you finish 5th, where the prize money jumps to a tidy $1.9 million?

Well, where this poker-listings article suggests that you could buy a 1977 Learjet 36A, it’s probably not a smart idea if you want to use it more than once or twice 😉

Well, you now have a $95,000 spending spree on your hands (of course, you don’t have to spend it all), and you could just retire and live off $90k a year.

Job done!

But, if you are still chasing that $7 million in 7 years, then you still need to follow the advice from last week’s post … but, I would tend towards investing more in real-estate (commercial RE with a good spread of tenancies) and, I would not risk too much of such a ‘once in a lifetime’ windfall in my new/existing business (it’s best to start/stay lean ‘n mean, anyway).

But, if you come 4th (picking up a tidy $2.5 million, in the process) then you can afford to live this $100k lifestyle (and, still have $125,000 – once off – to splash around to help you celebrate). Similarly, if you make it all the way to the final 3 before busting out with $3 mill. jangling in your pocket …

Next week, I’ll tell you what to do if you come 1st 🙂

So, who’s missed the point?

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Philip Brewer, a freelance writer for Wisebread (I presume, amongst others) has had a couple of mentions here, lately; this one for a comment that he made on his review of the book: Your Money Or Your Life [AJC: snappy title]:

The book has a very simple investment program that many people have taken issue with. The authors want you to invest your surplus money (a growing amount, once you make some progress on maximizing income and minimizing expenses) in long-term treasury bonds. More than a few people have criticized the program on the grounds that a diversified stock portfolio would produce higher returns. These people have missed the point: The goal of the investment portfolio is to produce a very secure stream of income. Long-term treasurys are a perfect choice.

Since I haven’t yet read the book, I can only say that I disagree if the authors – hence Philip – were talking about investing for retirement; after retirement – Making Money 301 – I wholeheartedly agree that the “goal of the investment portfolio is to produce a very secure stream of income.”

I also agree that “Long-term treasurys [sic] are a perfect choice”, especially if they are inflation-protected (e.g. TIPS in the USA), and perhaps laddered in some way; alternatively, you could try:

– income producing real-estate purchased in whole or in large part for CASH,

– index funds (although, you open yourself up to a certain volatility),

– Covered calls, perhaps protected by PUTS (if the option pricing allows).

But, not when you are still trying to build up your nest-egg unless you have such a low required annual compound growth rate (which probably means that you came by the page accidentally and are about to click off, never to return) that bonds / treasuries will do the job.

Until you do get within a few years of retirement, the goal of your investment portfolio is simple: it should be to produce your Number 🙂

Pay yourself first or last?

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Adam (a staff writer at Get Rich Slowly) wants you to “challenge yourself” by replacing the the standard ‘pay yourself first’ advice with:

Only pay yourself first if you deserve it.

Now, Adam isn’t suggesting that you stop saving that 10% to 15% of your gross income that the bulk of the personal finance blogosphere recommends …

… what Adam is really asking is:

Should You Stop Funding Retirement to Focus on Debt?

[This] is one of the most heavily debated dilemmas in personal finance. Unlike “spend less than you earn” or “track every penny you spend”, there’s no cookie-cutter answer to this question. Variables such as age, career, risk tolerance, and even personality type make each individual situation unique.

This is a good line of questioning – and I encourage you to read his article – but, unlike Adam, I think there is a “cookie-cutter answer to this question”:

You should always ‘pay yourself first’ …

… but, where you place that money depends on where you earn the greatest after-tax return.

Keeping in mind that a “dollar saved is a dollar earned”, it could be in:

– Your 401k, potentially earning 8% plus the value of any employer matches (in an earlier post, we calculated this as providing another % point or two to your long term return),

– Your debts, potentially saving 10% to 30% interest on high-interest car, credit card, and consumer loans,

– Your real-estate investment strategy, potentially earning 15% to 25% in long-term rental increases and capital appreciation,

– Your seed capital for your new business, potentially earning 50%+ in future profits and windfall gains on the sale of the business,

– etc.

But, is unlikely to be found in paying off low interest student loans (saving 0% to 5%) or mortgages (saving 4% to 6%) or in investing in low interest savings such as bank accounts, bonds, or CD’s (earning 1% – 5%).

Blindly plonking your money into your 401k, or paying off debt, or paying down your mortgage is not the way to get rich(er) quick(er) … 7m7y readers always look at their options in terms of greatest contribution to reaching their Number.

Business for Cash Flow and Real Estate For Wealth

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I don’t know these guys, but I do like what they have to say: “our philosophy on creating and sustaining income without a job: Business for Cash Flow and Real Estate For Wealth” …

… it pretty much sums up how I achieved my $7 million in 7 years; maybe it’s how you’ll also make yours? 🙂

Free money at last!

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Once my honeymooner guests agreed that purchasing a home would be a good investing goal, the question became how much equity to maintain?

I explained that if you have an empty glass, worth $100 (let’s say it’s a collectors’ item) representing your house then it makes no difference how much fine wine (also a collector’s item at $100 a glass) you have poured into it as to the future value of the glass …

… the glass can be full or empty, but if collectors’ glasses double in value every decade, it will still be worth $200 in 10 year’s time.

Of course, after consuming a few glasses of that fine wine, another question arises:

What happens if I put less money into the house (or other real-estate)?

Simple, you have to borrow the rest: less deposit, more borrowings/mortgage … more deposit, less borrowings/mortgage.

Then, in deciding exactly how much wine to pour into your glass, you think of the next logical question:

What’s the ideal amount (or %) to borrow against the property i.e. how much deposit should I put in?

Given the current ‘crisis’ in domestic RE values, it’s popular to imagine a high number: 20%? 50%? 100%?

But, it’s not so long ago (and, I wager it won’t be more than a decade before it comes around again) that it was popular to imagine a low number: 10%? 0%? Even negative 10% (as people borrowed 100% of the property PLUS closing costs)?

But, what’s the right number?!

Surprisingly, at least to me, there’s no magic ‘right’ number …

… once you realize that it matters not what equity you have in the house as to how your future wealth increases – based on the appreciation of such fine real-estate.

So, another question forms instead:

What does it cost/save me if I put in more/less money into the RE purchase?

Well, we know it does not cost you future capital appreciation, but it does cost/save you exactly what the bank would charge in you in mortgage interest and ancillary charges … circa 4% – 5% these days.

So, let me ask you two closing questions:

1. Do you think that you can do better than getting ‘free money’ by owning real-estate that appreciates, perhaps even doubling every 7 to 18 years (depending upon whom you believe), leaving you with virtually ALL the excess over the original purchase price?

2. Do you think that you can invest money that would otherwise cost/earn you only 4% – 5% for more than that [Hint: how about some more of that yummy real-estate? Failing that: stocks; business; P2P lending; etc; etc; etc? But, we covered this question last week ]?

… at least those are the questions that I put to our house guests 🙂

What do you think?