Would you take financial advice from this man?

Here’s an article about some guy who’s lost his house: http://www.consumerismcommentary.com/the-financial-planner-who-lost-his-house/

Sad, yes, you say … but, not to be rude, you also say … so have hundreds of thousands of others during this global financial crisis

But, if you look closely, you’ll see a small difference between this guy and the rest: this guy should have known better.

You see, he’s a financial advisor …

… and, not just any financial advisor, he’s a New York Times financial columnist/blogger!

What’s even more interesting is that he’s prepared to use his own tale of woe (as is Consumerism Commentary in his follow up piece to the original NYT article):

to explain how people continue to behave irrationally about money even when they know better. It’s a good indication of why a healthy approach to your finances requires much more than knowing, “spend less than you earn.” We’d like to think that building wealth is as simple as that, but if that were true, anyone who could do simple arithmetic would be financially secure over time.

Hello?!

Doesn’t anybody see what’s really wrong with this picture?

Consumerism Commentary tells us:

Carl Richards is one of today’s best writers focusing on personal finance

This is after Carl admitted to the world that he lost his house because he “behaved irrationally about money” …

If the BEST financial advisors can lose their houses … how have the average ones mismanaged their’s … and, how badly can the worst ones screw up your life?

And, would you have known about Carl’s screw-up if he didn’t come forward and tell us?

Who are you seeking financial advice from? And, how can you really be sure … ?

Did I fail the Ultimate Money Test?

Financial ‘personality tests’ are fun. I like doing them; you should try this one.

Unfortunately, the results don’t always speak for themselves:

[AJC: the star is my score; very average, as I am in (almost) all things in life. The $7m7y logo to the top-right is how my financial performance probably compares to 99%+ of the population]

Whilst this is a pretty good test – much better than many others that I have seen – it will only identify average performance and sub-/super-performance perhaps to one standard deviation (for those statisticians amongst you) …

… however, these tests can’t identify the factors that produce the outliers i.e. the ones (like me) who can make $7 million in 7 years.

If you want to produce (slightly) better than average financial performance over your lifetime, use this test – and others like it – to identify areas of weakness, typically:

- Not saving enough,

- Overspending,

- Credit Card Debt,

… and so on.

All valid reasons why you may be in financial trouble today, but certainly not highly relevant to your chances of retiring rich and retiring soon.

If you do want extraordinary financial performance, keep reading read this blog

Before you can find the answer …

Yes. Before you can find the right answer, you need to know the right question.

So it is with personal finance: most pf bloggers will answer a whole variety of questions:

- How can I become debt free?

- How can I pay off my credit cards?

- How can I save for retirement?

- How can I be more frugal?

BUT, these are not the questions that you need to be asking … at least, not at first.

No, there are only TWO questions that you need to ask. The first is in two parts, and it simply asks:

a) How much money do I need to support the life that I truly want to live? And, b) when do I want to begin?

I have a hypothesis about the typical answer to these questions, but the truth is that for every human being on this planet there is a different answer:

For some, it may be that they are happy doing what they are doing today, and are happy to keep doing it until they drop. For, them personal finance begins with maintaining their current lifestyle (which probably revolves around maintaining their employment) and staying healthy.

It probably also means learning all the lessons about personal finance that the blogosphere has to share: living below your means, eliminating debt, cutting up your credit cards, paying off your home, setting aside an emergency fund …

My second question – which I’ll come to in a moment – is moot for these lucky, satisfied, job-secure, working-class few.

But, my hypothesis is that most people are not satisfied with their current lifestyle … that you are not satisfied with your current lifestyle … that you:

- Want more time with your family,

- Want to indulge your hobbies and interests,

- Want to travel more,

- Want to be more relaxed and healthier,

… and, the list goes on.

And, I’ll wager that the limiting factor for you, right now, is money.

But, I’ll also bet that with a little thinking, you could come up with a salary that if a rich uncle were to pay it to you, would allow you to stop working full-time (or, altogether) and fund your ideal lifestyle.

I’ll also take a stab that ‘salary’ would bear little resemblance to your current salary.

But, if you can take an educated guess at what that ‘salary’ would need to be, I can tell you what your Number is (the answer to the first half of my first question) simply by telling you to multiply that amount by 20.

Let’s now assume that you have no rich uncle and have to amass this amount yourself …

How long will you give yourself to reach your goal so that you can begin to live the life you really want to live before you are too old to enjoy it?

I gave myself just 5 years to reach my Number of $5 million; in the end, I made $7 million in 7 years, starting $30k in debt.

[AJC: keep in mind that the longer you allow to reach your Number, the larger it will need to be because of the effects of inflation. For example, whatever Number you come up with today, you will need to add 50% if you aim to reach it in 10 years, and you will need to double it if you are prepared to wait 20 years ... just to keep up with inflation.]

Which brings us to the second most important question in personal finance:

How am I going to get there?

For example, in order for me to reach a $5 million target in 5 years from a virtual standing start:

- I had to learn how to invest (I had no investments and no idea HOW to invest or WHAT to invest in)

- I had to turn my business around (it was breaking even, at best)

- I (more importantly, my family) had to sacrifice our existing life: we had to move overseas, my wife gave up her career, my children their friends, we all gave up our families for the 5 years we were away from home.

But, we all agreed that it would be worth it, because we had already answered the first question (both parts).

How about you?

Are polar bears left-handed?

Here’s some interesting ’information’ that I picked up:

Apparently, all Polar Bears are left-handed.

Well, it seems that there are two types of people in this world: those who will now run off and propagate this ‘fact’ at trivia and pub nights, and those who will go and check their sources.

I’m in the latter … now, I’m not obsessive about it, so this information ‘seems’ right, but I’ll let a polarbearophile prove me right or wrong with these Polar Bear Myths:

- A hunting bear will cover its black nose while lying in wait for a seal.

Canadian biologist Ian Stirling has spent several thousand hours watching polar bears hunt. He has never seen one hide its nose, nor have other scientists.

- The great white bears are left-pawed.

Scientists observing the animals haven’t noticed a preference. In fact, polar bears seem to use their right and left paws equally.

- Polar bears use tools, including blocks of ice to kill their prey.

Scientist Ian Stirling believes that this assertion can be traced to unsuccessful hunts. After failing to catch a seal, a frustrated and angry polar bear may kick the snow, slap the ground — or hurl chunks of ice.

- A polar bear’s hollow hairs conduct ultraviolet light to its black skin, thus capturing energy.

This theory was tested—and disproved—by physicist Daniel Koon.

- The polar bear has a symbiotic relationship with the arctic fox, sharing its food in exchange for the fox’s warning system.

Not only is the bear-fox relationship not symbiotic, the little foxes often annoy the bears. An arctic fox will sometimes tease a bear by darting in to nip at its heels and will sometimes try to drive a bear off its prey.

- Orca whales prey on polar bears.

This has never been observed.

- Polar bears live at both poles.

Polar bears, of course, live only in the circumpolar North. They never encounter penguins, which do not live in the same regions as polar bears.

[AJC: Polar bears = Arctic and Greenland; Penguins = Antarctic, Australia and New Zealand. Get it??!!]

Source: http://www.polarbearsinternational.org/bear-facts/myths-and-misconceptions/

So?

Well, if this is how many myths polar bears can generate, imagine how many there are about our favorite subject: personal finance?!

Here are just some that I have tried to dispel on this site:

- The myth that entrepreneurs are driven by greed

- The myth that a high income equates to wealth

- The myth that diversification is one of the most important personal finance tools around

- The myth that retirement planning centers around replacing your income

… and, I have written many, many more (just type the word ‘myth’ into the search box at the top of this page).

What myths (personal finance or otherwise) have you recently had cause to question?

… another man’s poison!

To some people, it seems that I promote high-risk strategies. For example, long-time reader, Josh says:

I wondered over to your blog to see what’s new and after reading a few posts I realized why I don’t visit anymore, and it’s because your articles are drenched in pro-debt/leveraged strategies. This is something I don’t agree with and don’t practice. I do understand the mathematical ramifications of using debt to leverage yourself, it’s just something I plan to do without.

Firstly, what Josh is saying isn’t quite true …

… in fact, I don’t recommend debt to anybody. What I have said is that I don’t believe in the anti-debt lobby.

There’s nothing evil about debt per se, it’s if/how/when you apply it that counts.

For example, I have variously had:

a) a little debt: on my various buy/hold properties

b) a lot of debt: in my finance company (for a finance company, cash is like stock … you need as much of it on hand as possible)

c) no debt: all of my other businesses were ‘bootstrapped’ and self-funded

I should point out that Josh is a stock investor; he has made a small fortune (turned a couple of $k into one $m or so while still at college) buying pharmaceutical ‘penny stocks’ … I wonder how many people would consider that risky?

One man’s ‘sensible investment strategy’ is surely another man’s poison

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 Bankrate.com’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 - http://www.bls.gov/news.release/pdf/cpi.pdf. 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 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%,

For new readers ….

Every so often I like to do a post for new readers, because this isn’t your ordinary personal finance blog.

How so?

Well, the first thing you’ll notice is that there’s no advertising. In fact, no obvious way of monetizing the blog at all …

That’s an important clue. It either means: (a) I have no readers to bother monetizing, (b) I have no idea how to monetize a blog, (c) or I don’t need to monetize.

Given the title, it should be obvious that (c) is the correct answer.

In fact, the lack of monetization is one way that I try and ‘prove’ the basic premise of this blog … and, therein lies its greatest differentiator:

I am one of the vey few self-made multimillionaires to write about finance … and, one of a tiny group that actually made their money before they started writing.

For example, in one of Robert Kiyosaki’s books he states that his passive income from real-estate was about $100k per year when he wrote Rich Dad, Poor Dad (or, produced his game “cashflow quadrant”, whichever came first: book or game).

To be fair, let’s just take that to mean ‘net income’ … assuming that his net-income was between 5% and 10% of his real-estate portfolio, that made him a millionaire once – perhaps twice. Certainly impressive, but hardly enough to retire on.

On the other hand, I started $30k in debt and made $7 million in 7 years.

In fact, the highest cash balance that I had in my bank account before I started to write this blog was $10 million. And, that was on top of the other assets that I owned.

This makes my perspective very different to most personal finance bloggers who are all about frugality, debt reduction, paying yourself first …

… all admirable, even necessary, but none will make you rich.

And, herein lies the unique nature of this blog: I believe that you need to become relatively rich in order to retire reasonably well (and, early) these days. I believe that you need to build up a nest-egg of $x million in y years, where x > 2 and y < 10.

I filter my readers by the title of this blog: How To Make $7 Million In 7 Years.

So, when new readers, like Emily tell me:

Some people really don’t care about riches. Our neighbor and handyman loves being able to work at his own pace and not deal with employees. He will occasionally have a nephew or brother help him with a job, but he has no desire to rack up a ton of money and looks forward to continuing his trade until he dies.

I say:

True.

But, pushing aside obvious issues such as what does he do if he gets too sick to work (or, simply too sick OF work), my blog is aimed solely at those who DO want riches. 

A formula for investing in real-estate …

People are always looking for “magic formulas” to get rich. Even I’ve had a go at sharing mine …

But, when it comes to real-estate, the formula is simple: buy/hold/reinvest.

That means:

1. Buy positive cashflow ’20% down’ real-estate in an area that can appreciate

2. Hold on to it until it does appreciate

3. Refinance using the extra equity plus any accumulated rental profits to create your next deposit

4. Goto 1.

Here is a guy who has a very conservative (and, sensible I might add) real-estate investing strategy [AJC: for those who take the trouble to read the whole post, they will find the 'magic formula' they are looking for]:

I went from zero to more than one hundred units between 1977 and the early eighties by seeking tired rental property owners with free and clear buildings who were willing to finance the sales.

The early eighties was a financial climate not too unlike that today in there was really no mainstream lending occurring. It was the savings and loan crisis, Jimmy Carter and 18%+ FHA mortgages.

At the time I paid a bit more than the properties were “worth” in cash. But I operated with a buy and hold strategy so the properties became free and clear off the rents while providing me an above average income. We still own almost every property we purchased in the past 33 years.

In the early 2000′s every kid entering the business had Excel spreadsheets with estimated returns that would have them richer than Bill Gates in a decade. Every waiter, barber and auto mechanic you ran into was on their way to be the next Donald Trump or so it seemed.

Even buddies of mine called me a “dirt farmer” because I wasn’t taking advantage of easy lending and apparent ever expanding market, rather I stuck with the hard work of landlording. But the prices were unsustainable compared to rent. So I kept with what I knew worked and withdrew from buying. Between 2002 and 2010 I bought just three properties, two of which were commercial units for our own businesses. I’m still here and they all went belly up.

Usually you can’t go wrong if you are headed in the opposite direction of the majority. So that means today, with everyone shunning real estate it is probably a good time to buy, just as it was in 1982.

This year I reentered the market , but only on limited basis as there are some good deals, but for the most part the market still is in somewhat of a free fall.

My math in the beginning, which remains so today is: Assuming that you financed the whole purchase at 12% for 15 years, even if you paid cash, the property had to net $100 per month per unit after all expenses including at least $100/unit/month for maintenance. Did I get every deal? No, but why own if ownership will not help you reach a financial goal.

[AJC: 12% is very conservative; if you used 8% in the USA and 10% in Australia you would still have plenty of margin for error; remember, this guy was investing in an era with 18%+ interest rates]

It may not be ‘get rich quick’, but it is sensible

You don’t need to become a barber to become rich …

Darwin’s Money shares a story about his barber that shows how anybody can become rich; here’s a trimmed down version of Darwin’s assessment of how his barber became rich:

• Real Estate Mogul – He owns multiple rental properties.  He started off small and kept rolling his profits into more and larger properties.
• Business Savvy… and Patient – He knows the real estate market very well and he waits for deals to come around.  He’s patient.
• Frugal – Just through some casual observations, it’s evident he’s a frugal guy.  He dresses modestly, he doesn’t take extravagant vacations, and he doesn’t drive a fancy car.  The combination of multiple streams of income and frugality make for a huge net worth in your later years.
• Small Business Owner– Like all smart business owners, he gets other people to work for him and generate income and offset his costs.  Rather than just running a one man barbershop, he has a couple other barbers working there.

This looks likes an great observational report … I’m not certain that Darwin actually asked his barber how much money he has or how he made it?

I’ll do the reverse; I’ll tell you how I made my money … it’s much the same as the barber, but I think it’s the order that’s critical:

Business Savvy, Impatient, Small Business Owner – I started by becoming a small business owner, then trying to become business savvy. But, it was a slow path. When I finally hit rock bottom (business-wise) and found my Life’s Purpose, hence my Number, I suddenly became impatient. In fact, this was the turning point for me: as I accelerated my business growth, I accelerated my income, which is the first key to becoming rich.

Frugal – Now, this is where most high income earners go wrong: as their income increases, they become looser with their money. It should be quite the reverse: in dollar terms it’s OK to (in fact, you should) reward yourself by increasing your expenditure [slightly] in $ terms. But, and this is the secret, you should be decreasing your expenditure in % terms. While it’s fine and dandy to be frugal while you are still on a low and/or fixed income (i.e. job), it’s actually critical to become more frugal in relative terms as your income increases.

… and Patient Real-Estate Mogul - What to do with the rapidly increasing bank balance? Well, you could put it in mutual funds (but the fees are too high and/or the returns are too slow), stocks (but, they are not leveraged enough), or other businesses (but, you run the risk of spreading yourself too thin). For me, the best compromise between the leverage of a true business and a passive investment is – and remains – investment-grade real-estate. This is where being patient finally kicks in, because buy/hold real-estate is subject to the vagaries of the market. But, I had a primary source of growing income, so I didn’t need to touch my real-estate investment income until I finally began Life After Work.

So, my assessment is that Darwin is right, but the order is wrong.

Oh, I also think that you can substitute small business ownership for any high income potential (e.g. highly-paid professional; CxO-level employee; consultant; etc.) with the only catch being that you miss out on the potential capital gains that owning a business may offer – on the other hand, you may be able to negotiate yourself a nice golden parachute …

How well do you think this simple strategy could work for you?