Here’s the difference between conventional personal financial advice and 7m7y thinking in one slide; according to Brian Taylor the fundamental rule of money is to:
Either earn more than you spend or spend less than you earn.
Simple … and, much better than the alternative (spending more than you earn) …
… but, wrong!
There is only one fundamental rule of money:
Earn more than you spend
Can you see why? Your financial future depends upon it 🙂
The real problem with any of the so-called ‘safe withrawal rates’ that we explored yesterday – with 4% currently being perhaps the most popular amount advocated – is that they all assume a fixed annual spending amount, but are actually generated by a totally volatile (some would say random) portfolio.
We’re trying to fit a square peg (fixed annual spending) into a round hole ( a ‘random walk down Wall Street’) 😉
But 7m7y readers have an even more fundamental problem with planning our ‘retirement’ based on this type of common industry wisdom: we are planning on retiring early, hopefully, with a very large Number and a soon Date!
Most retirement models assume a 30 to 35 year retirement lifespan …
… I don’t know about you, but I retired at 49 and intend to live AT LEAST another 40 years 🙂
Many of my readers will be aiming to reach their Numbers even sooner .. and, may expect to live even longer!
The bottom-line: traditional retirement planning models don’t work, because we need money that will last as long as we do … we need a Perpetual Money Machine, because we don’t know how long we will live once we stop working.
A Perpetual Money Machine is anything that:
a) Protects your capital over the long-run, even allowing for the ravages of market changes and inflation, and
b) Produces a reasonably reliable stream of income, that also (at least) keeps pace with inflation.
Neither stocks nor bonds – the traditional tools of retirement investing – fit the bill for us:
1. Stocks are too volatile, and the income tends to be artificial (e.g. so-called dividend stocks attempt to fix the level of dividend provided even as the company’s profits fluctuate).
[AJC: Raiding marketing, R&D, and other seemingly non-essential budgets in lean years in order to protect the dividend stream is – to my mind – the mark of a poorly run company]
2. Bonds provide a very safe return, but the % returned each year is too low, meaning – at least, to me – an unnecessarily reduced lifestyle, especially after allowing for reinvestment to try and keep up with inflation.
That’s why my Rule of 20 is exactly that: a planning rule, NOT a 5% spending rule!
[AJC: Otherwise, I would have called it the 5% Rule, d’oh!].
In other words, my advice for PLANNING your Number, is to decide what initial income you want and multiply that by 20 in order to find your Number …
… but, my advice for LIVING your Number is to turn on your Perpetual Money Machine and live off whatever it happens to produce, after allowing for taxes and provisions against inflation and contingencies.
I have noticed an unusual phenonemom: I write a post on one theme and your (i.e. our readers’) comments explore another one entirely!
This is a GOOD thing … it means – I hope – that we are building an online community dedicated to the idea of linking our finances to our life, rather than simply attempting to fit within society financial ‘norms’.
Case in point: I wrote a post exploring various windfalls, and the comments lead us down the path of exploring so-called ‘safe withrawal rates’, which is the idea that there is a Magic Percentage of your Number that is ‘safe’ to withdraw to live off each year.
The problem is, what % do you choose?
For example, I have proposed the ‘Rule of 20’ for calculating your Number, which seems the same as proposing a 5% ‘safe withdrawal rate’, but Jake disagrees:
A 5% drawn-down rate on the pot of gold is a little on the risky side if you want the money to last.
After looking at a bunch of data, I feel that a draw-down rate of 2-3% is too conservative, but 5-6% to aggressive. 4% or so seems right. I know, only 1% off from your value but over time it makes a huge difference.
So, Jake has highlighted one problem with selecting a ‘safe’ withdrawal rate … if you are out by even 1% your spending can be over (or under) the ideal by 20%. I don’t know about you, but a 20% payrise (or paycut) is a pretty big deal … people quit their jobs over less!
So, what do the experts recommend?
Believe it or not, there is support out there for just about any annual % of your nest egg that you may choose to spend, for example:
7% – Not so long ago, the financial services industry proposed spending as much as 7% of your portfolio each year in retirement.
6% – More recently, Paul Graangard wrote two books proposing a bond-laddering and stocks strategy that supported a spending rate as high as 6.6% of your portfolio each year.
5% – Investment funds routinely allow spending of 5% of the portion of their investment portfolios dedicated to simply keeping up with inflation. Indeed, my Rule of 20 appears to support this withdrawal rate, too.
4% – A large number of studies – probably, the most famous of which is the so-called Trinity Study – advocate spending up to 4% of your initial portfolio (ideally, 50% stocks and 50% bonds, rebalanced each year), which provides somewhere between a 90% and 100% certainty that your money will last at least 35 years.
3% – A whole slew of new retirement planning tools (generally using a Monte Carlo approach to modelling tens, hundreds, or even thousands of potential economic scenarios) have been released over the last 4 or 5 years by the financial services industry, purporting to analyse hundreds of alternative economic scenarios to try and model what would happen to your retirement portfolio (i.e. simulating changes in interest rates, market booms and busts, etc.) to find the ideal ‘safe’ withdrawal rate. The trouble is that a lot of these advocate very low withdrawal rates, typically in the 2.5% – 3.5% range.
2% – Some even advocate a totally ‘risk-free’ approach to retirement savings by investing close to 100% of your retirement portfolio in inflation-protected bonds (i.e. TIPS); historically, these have provided a 2% return, after inflation and with total protection of your starting capital.
So, which is right?
None, as TraineeInvestor explains in his comment to my post:
I’m not fan of draw down models either. If you have to spend your capital to avoid eating cat food (or the cat) or are working with a very limited time period fair enough. But with a sufficiently long time horizon, my view is that any draw down rate is dangerous – in fact I would be uncomofortable if my nest egg was not growing at at least the rate of inflation (after taxes and spending).
Another way of looking at it is that if you are relying on draw down of capital for living expenses you are very vulnerable to adverse events. No thanks – I’d rather sleep soundly at night.
Me too! 🙂
This video summarizes a book hailed as the successor to Napoleon Hill’s classic: Think and Grow Rich. I’m not sure that you can just think your way to $7 million in 7 years … but, having a burning reason why you might need that much / that soon sure seemed to help me.
But, I can’t help feeling: did I think, therefore attract … or did I happen to think and happen to attract? I guess we’ll never know for sure, as we are all an Experiment of One 🙂
IMPORTANT: Please read this post in full, THEN choose the FIRST answer that applies.
Loading ...There are two groups of people in this world:
– those who believe that there are two groups of people in this world, and
– those who don’t 😛
At the risk of parodying myself, I think there are two groups of people in this world:
– those who believe in The Secret, and
– those who don’t.
I want to conduct an experiment, right here / right now, to see if The Secret works …
First though, in case you’ve been living in a cave for these past few years (in which case, you have probably already developed powers far beyond those of The Secret), you will already know that The Secret is the most recent in a long series of books, blogs, and banter about the ‘power’ of creative visualization …
… see it in your mind and you will manifest it into reality.
Believe it, and it will be so.
I don’t know how The Universe works, so I can’t tell you whether I manifested my millions (perhaps by concentrating on my Life’s Purpose and the Number required to get me there) or was merely driven to make it at all costs … you could certainly mount an argument either way.
Also, I am an experiment of one …
Fortunately, we have Steve Pavlina who is an expert in these matters, and is also the creator of a very interesting project, aptly called the Million Dollar Experiment:
The goal of this experiment is to attempt to use the power of intention to manifest $1 million for each person who chooses to participate.
From what I can see, the experiment ran from November 2005 until July 2007 … just over 18 months. Here’s what happened:
In that 18 month period, nearly 1,600 participants reported ‘manifesting’ anywhere from $504,873.56 (in just one day; if you choose to believe him) down to just one cent.
The average was closer to $3,500 in less than a year, with the median being just $180.
I’m not sure what you would count as a worthy ‘manifestation’ amount (I mean, would you dream of anything less than $10k in a year?), but 120 people – just 7.5% of those participating – ‘manifested’ $10k or more in that period.
Cast your mind back 18 months: how much have you manifested in that timeframe? I guess by ‘manifested’, I mean by following Steve Pavlina’s instructions to his own readers:
Only count the new money you feel has come into your life as a result of your participation in this experiment (i.e. the manifestation of this intention), not your regular income. Obviously your interpretation of that will be subjective, but this is a subjective experiment. Just do your best, and trust your intuition.
Just pretend that you signed up to Steve’s experiment 18 months ago … what money (if any) that came into your life since then would you have reported on Steve’s blog?
Oh, and feel free to tell me what you think about the power of The Secret, Steve’s Million Dollar Experiment, and/or this post … but, don’t forget to scroll back up to the top and make your poll choice first 🙂
I seem to be popular in Finland these days, with my blogging friend over at Kohti taloudellista riippumattomuutta still sending me the most new visitors daily [AJC: reciprocating may be a little hard as I am guessing that more of his readers are fluent in English, than my readers are in Finnish].
I also receive referrals from my other Finnish blogging friend Tarkan markan blogi, who asks (thanks to Google Translate) Million Not Enough For Any:
And, The Economist does raise a valid point:
How much money do you need to count as wealthy in the first place? Merrill Lynch’s wealth-management report starts counting at $1m in “investible assets”. That excludes people’s main homes, which may seem reasonable. But it means that a Londoner who sells his home and decides to rent can suddenly find himself “rich”.
After all, a portfolio of $1m these days would generate an income of only $30,000 if invested in Treasury bonds, which does not leave much scope for the playboy lifestyle.
I’m not sure what amount that you need to be ‘rich’ – I define it in terms of having enough to live your Life’s Purpose – but, I certainly agree that $1 mill. (even if it doesn’t include your own home) simply doesn’t cut the mustard 🙂
[Disclaimer: Artist’s rendering of AJC … any resemblance to other bloggers living or dead is purely coincidental]
Have you noticed that I don’t have a category for debt on this blog?
[AJC: you can click on any of the keyword/categories in the orange header-banner above to see a list of blog posts focusing on that subject]
It’s not because we don’t talk about debt, as we clearly do …
…. it’s because, to me, creating or paying off debt is just the same as investing (after adjusting for tax: a dollar saved in interest, is the same as a dollar earned in interest or investment income, right?).
That’s why I was genuinely interested in finding out what was going through fellow-blogger Clever Dude’s mind when he loudly proclaimed:
We’re Free of Consumer Debt!!!!!!
As of today, we have paid off all $113,000 of our student loans, auto loans and credit card debt.
We are debt free!!!
My fellow blogger is right to be proud of his achievement … but, does that make it the right investment choice?
Check it out:
He paid off $113k … now, this is no small achievement, some people don’t even save that in their entire lifetime! Still I couldn’t resist asking Clever Dude for some details:
The rate on the student loans was 6.25%. The 2nd mortgage is 7.875%. First was 5.25%.
I chose to pay off the student loan because it was more manageable and I could get it off the books faster than the 2nd mortgage. Mathematically, the 2nd mortgage makes more sense until you factor in the tax deduction which brings them down to about equal.
I also wanted to know a little about his current net worth (after the mammoth debt-payoff feat) – nosey, aren’t I?! Anyhow, Clever Dude was happy to share:
Don’t mind the math as I rounded:
Cash: 17%
Investments: 37%
Home Equity: 6%
Autos: 17%
Personal Property: 12% (if I could sell it all right now)
Whole Life Insurance: 5% (yep, I got it, it’s expensive, but I’m not giving it up!)
So, Clever Dude has ‘invested’:
-> $113k in loans returning (by avoiding having to pay) around 6.25% after tax
-> 17% of his net worth in cash returning (I’m guessing here) 2%?
-> 6% of his net worth in his home returning some unknowable amount in future (potential) capital gains
-> 5% of his net worth in insurance ‘investments’ of dubious value after (often) exorbitant fees
-> 29% in (presumably) depreciating ‘assets’ such as autos and personal property
Now that he is debt-free, what will drive Clever Dude’s investment strategy from here on in? He says:
Investing and savings are next up in our planning. Honestly, we’ve spent so much time just thinking about debt, we haven’t spent much time on the future. Now is the time.
Now, I’m not here to pick holes in Clever Dude’s investment strategy as he had a strategy and moved mountains to achieve it – not to mention, that we know so little about Cleve Dude’s true financial situation that we are in no position to advise / criticize …
…. but, I do want to use this example to show why following a blind – and, in my mind totally arbitrary – investment goal such as “reducing debt” is not always the best idea:
Clever Dude has only 37% of his net worth in investments right now (OK, he is working on his Master’s Degree, so he has had other things on his mind) and has limited the bulk of his net worth’s returns to only 2% to 6% (or so) by almost-totally focusing on paying debt.
Why?
So, that he can start “investing and saving”!
Now, does that make sense to you?
This very funny video is a great argument for NOT having life insurance …
… you never want to be worth more dead than alive 😉
In fact, I canceled my policies, but not until I already had my $7 million sitting in the bank.
How about you?
I’m not a Ramsey fan, and I am equally not a fan of pithy statements that are supposed to make us financially secure, both for the simple reason that they are unlikely to help me – or, you – achieve a Number (i.e. retirement nestegg) amount that is large enough to live my – or, your – Life’s Purpose.
Now, if you don’t have a lot of travel and free time associated with your own Life’s Purpose, then you may be able to live nicely off $50k a year indexed (assuming that you have a $1 mill. nest-egg, in today’s dollars) … but not me!
I aimed for – and, achieved – a $7 million in 7 year target (starting $30k in debt) because that’s what I decided that I needed (actually, calculated) … and, this blog is written primarily for those who want to achieve the same.
So, it shouldn’t come as a great surprise that I both agree and disagree with Jesse – the Debt Go To Guy– who says:
Risking $1,000 a month on a possible 8% return instead of a guaranteed after-tax ROI of 5% by paying down mortgage debt is NOT such a “Duh” decision. If you do get 8% you must pay taxes, and if you live in a state like CA, then after taxes you’re about even. Plus you have slippage… transactional fees etc for the investment / trade. So risking your $1,000 a month on 8% instead of a guaranteed after tax return of 5% is not always so smart, and a bad example.
People with double-digit interest rates on credit card debt, especially the many folks paying 20-30%+ interest, are not likely to find a better investment opportunity in their entire life than inside their own liability column. Every dollar in debt paid off is a guaranteed after tax ROI of 20-30%. Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time. What makes you think someone in debt could pull off such a stunt?
OK, that’s sound commonsense advice and hard to argue with:
– Sort your debts into high interest and low interest, and have a good crack at the high interest ones first, because the money that you save on interest is probably way higher than you could earn elsewhere. A dollar saved is a dollar earned, right?
– Now, when comparing the lower interest debts and investments, you really need to look at all the factors, such as risk, taxes, costs, etc. Often, it will be paying down the debt that wins, although I would be surprised if paying down a 5% mortgage ‘wins’ over any sensible RE, value stock, or business strategy in terms of serious wealth building.
But, I don’t really think that “Warren Buffet, Peter Lynch and Sir John Templeton would all agree and even George Soros couldn’t produce a better ROI over time”. I know that Warren Buffett has produced 20%+ compound returns, and George Soros didn’t become a billionaire on less than 20% – 30% compounded returns.
That doesn’t detract from Jesse’s statement that “every dollar in [credit card] debt paid off is a guaranteed after tax ROI of 20-30%” and I do agree that it would be almost impossible for anybody except [insert: Forbes Rich 1,000] 😉
But, here’s where I disagree with Jesse:
I think Dave Ramsey provides sound advice for most people, and while I think it’s better to expand your means and increase your income instead of living like a popper, his advice has proven to help many hundreds of thousands of people to stop paying interest and start earning interest, and that’s the key.
– readers attracted to this blog are not in the same position (at least, no longer wish to be in the same position) as the ” hundreds of thousands of people” that Dave Ramsey has helped, and
– “stop paying interest and start earning interest” is not the key to reaching a large Number by a soon Date.
Look, there is nothing intrinsically right or wrong about paying interest, it’s merely a by-product of a loan that you have taken out. Just make sure that the loan produces more income than the interest expense that you paying, by a wide enough margin to account for the risk, taxes, and costs that may be involved.
This is a ‘no brainer’ when you realize that a rental property can produce income (assuming that your calc’s prove that it is all worth while … by no means the case on all – or even many – properties), and it is equally a ‘no brainer’ when you realize that borrowing money on your credit card to buy an LCD TV produces NO income, so why would you do it?
But, it takes a giant leap to suddenly realize that – for any existing debt that you may already have – paying down debt on a mortgage that costs you 5%, or a student loan at 2% may not be such a brilliant idea when an investment that can produce 15% compounded comes along and you now need to decide where to put your cash: into paying off those loans (to blindly achieve a ‘no interest’ outcome) or into the investment (hopefully, to produce an income-producing asset with excellent cashflows).
Of course, we’re making an assumption that reasonable people can achieve reasonable investment returns … but, if you think those kinds of investments are almost impossible to come by, take another look at:
– Value stocks (read Rule # 1 Investing by Phil Town),
– Real-estate (read Multifamily Millions by Dave Lindahl),
– Business (read The E-Myth Revisited by Michael Gerber).
[AJC: and, if these all sound too scary for you, just remember that over a 20 to 30 year period a low-cost index fund that tracks, say, the S&P500 will return circa 11% to 12% (yes, before taxes and ultra-low fees), and – if you are worried about risk – has NEVER produced less than an 8% return over 30 years]
I didn’t become a multi-millionaire by blindly entering into debt, but neither could I have become a multi-millionaire by blindly avoiding it … debt, for me, was a tool that I used sparingly, yet wisely.
I recommend that you do the same 🙂
This is a loaded question, obviously, because I just revisited the subject of buying your first home (of which I am now an avid fan) a week or so ago; Rick suggested:
Since equities also have a good long term investment record, why not scale back on the primary residence somewhat and invest in both real estate and equities?
At the time, I responded by saying: “The effect of the 20% Equity Rule and 25% Income Rule is to ensure that you are always investing AT LEAST 75% of your networth elsewhere (could be business, RE, equities, etc., etc.).”
Of course, that doesn’t address the question, as I have also said that these rules are up for grabs – meaning, you can just ignore them – when considering buying your first home.
Now, I am clearly a fan of buying your first home – you just need to go back to one of my very first posts to see that – but, it wasn’t always that way …
… I started by believing that there were other investments out there that performed better than your first home.
And, that still holds true; after all, as my Grandfather once told my Grannie when they had the same decision to make soon after immigrating to Australia:
You can’t always buy a business from your home … but, you can always buy a home from [the profits produced by] your business.
This still holds true … as does the 20% Equity Rule. In other words, if you are absolutely committed to using the funds to start a business, or are ABSOLUTELY committed to ALWAYS investing at least 75% of your Net Worth, then by all means keep renting.
It’s just that 99% of people will – sooner or later – fall off the investing wagon. It’s human nature.
Then they’ll end up with no investments, little net worth, and no home. Buying your first home, and using that as a springboard into other investments, is a great way to go; just remember what I said, way back in the beginning of 2008:
If you are ready, willing and able to buy your first house, or you are thinking of trading up (or, down) …. here’s my advice:
Put aside the emotional decisions and just consider the financial impact, and that is: your house is the ONLY way that most people will ever get off the launching pad to financial success …
Why? Because, you are building up equity over time (even a flat or falling real estate market eventually climbs back up again) …
… but – and here is the key – ONLY if you are prepared to put the equity in your house to work for you … that means, borrowing against the equity in your house to INVEST.
