My biggest mistake?

A new tool to drive traffic to your page: if you haven’t seen Pinyo‘s new site, yet, click here now … I am predicting that it will become THE place to see what late breaking personal finance stories and blogs are hot right now!

I’m not really sure how it works, so I just submitted 3 or 4 of my posts to see what happens … I hope that you will visit PF Buzz, find them, and give each post the rating that it deserves 😉 It’s just an experiment … we’ll see how well it works … in the meantime, here’s today’s post …

I’m often asked what my biggest semi-financial mistakes were … and, I can point to some doozies:

1. I was offered the opportunity to head up a regional business unit promoting one of the first ever PC’s in the market … I said “no thanks … the future’s in mainframes!”

2. I sold 5 ounces of gold (losing money on the transaction) about a week before the 1980’s boom that took gold from $350 and oz. to over $1,800 an oz.!

3. I constantly choose to enter the markets just at the end of a major bull-run … because that’s when I happen to be cashed up.

But, my biggest financial mistake? That’s easy … not getting ‘religion’ early …

Explanation: we all know the benefit of SAVING early:

The following graph shows three investors, each of whom invests $1,000 a year until age 65. However, one begins at age 25, investing a total of $40,000; one at age 35, investing a total of $30,000; and one at age 45, investing a total of $20,000. Each earns 7 percent per year and, for purposes of this illustration, the effects of taxes and inflation are ignored.

The Power of Compounding

Source: Investment Company Institute

And, you already know my view on this: big deal … for each $1,000 invested the start-early guy saves $215k by the time he is 65 … or $2.15m if he can scrape up $10k each year from the age of 25.

That will provide the equivalent of about $30k a year (today) in retirement living (then) …. big deal.

No, I’m talking about the equivalent compounding power of starting to boost your income early … so that you can pump far more than $10k a year into your ‘retirement investments’ …

… imagine what you would get OUT if you could pump $100k a year IN?

The key is to get religion early … the ‘religion’ that I am talking about is the massive why that leads to the massive action that leads to massive amounts of money.

I can easily divide my financial life into two distinct parts:

1. Pre-Why: Until 1998 I plodded along with my little business slowly trying to grow it. I worked hard, but had no particular goal other than to try and eke out a living. My results were unspectacular, to say the least.

2. Post-Why: In 1998, I read the E-Myth Revisited by Michael Gerber; in it he recommended thinking about what I wanted my life to be like when I was ‘done’ and to think about how much money that would take (and by when).

I now had a massive ‘why’ and an ‘oh shit’ amount of money required to support it!

That’s what kicked off my $7 Million Dollar Journey.

So, what was my ‘big mistake’???

There was NOTHING that I did in that 7 years that I COULDN’T have done in the preceding 7 years, or in the 7 years before then!

If I had ‘got religion’ early, I may have reached my goal early … that little ‘financial mistake’ makes every other financial mistake that I could have made, did make, and probably will still make … pale into insignificance.

Which brings me to a comment made by Blogrdoc to a recent post, in which he says:

I seek business success primarily as a challenge and because I want more in life. Not more money, but more impact on others and being able to have fun.

When you’re a 9-5 corporate stiff like me, it’s so easy to just let life ‘happen’. For me, the motivation to get off my ass and try something different from my 9-5 is the tough part.

That was me, pre-1998 … but, 7 years post-1998, I went from there ($30k in debt) to $7 million cash in the bank … fully retired a couple of years later at the age of 49.

Mistake? Hell, yeah …

… I could have just as easily have retired in the same financial position at age 39 or 29!

At the very least, I would have had a helluva buffer against failure: Shoot for 29 … missed? Oh, well … shoot for 39 …

So, when you are still in your 20’s or even 30’s, I suggest that you try and ‘get religion’ early. Here’s how Blogrdoc might do it:

1. He could look for the real meaning in “I want more in life. Not more money, but more impact on others and being able to have fun”.

What would it mean to Blogrdoc … his FAMILY … hell, the WORLD ! … for him to have this?

What about your WHY?

Would it mean enough to you to really need it?

Would it mean enough to you that you would feel that your life was a failure if you didn’t have it? Would it be enough of a need to carry you through the 1st, 2nd, and 100th obstacle that will get in your way?

If not, stop now!

You will never have the emotional strength to crash you through the invetiable HUGE obstacles that will get in the way of you and (say) $7 million: you won’t get rich and you will ‘die’ trying …

But, If so … great … you have the WHY!!!

2. The, you should  think about HOW MUCH in today’s income (as if you did it today) you will need to live the life that gives you your WHY (think about costs like travel, housing, cars, donations, etc.); also, decide if you need to quit work entirely to do it … the difference is how much PASSIVE INCOME that you need.

Remember: even if you do decide that you can still work, you may need to rerun these numbers for when you stop work entirely as well … sort of a pre-quit and post-quit plan.

3. Think about WHEN you need this to all happen by (not want it to happen by, NEED it to happen by); DOUBLE the amount of income that you calculated in Step 2. for every 20 years until the WHEN (you can prorate, eg add 50% for 10 years and so on … it wll be close enough).

Multiply by 20, 25 or 40 depening on how conservative you are and how much of a buffer you need (remember, once you stop ‘earning’, what you have in savings and investments has to last your whole life, therefore, I use 40 .. perhaps, excessively conservative) … that’s your Number.

3. Oh shit?


Now, you have the WHY that leads to the WHEREFORE that leads to the MONEY  …

… and, you just may get there 10 or 20 years before I did 🙂

What the Quality of Life Index means to you …

First LIVE show aired last night … thanks to all of those who joined us (!) … a few technical glitches … the host wasn’t exactly Jay Leno [I don’t have as many cars as Jay, either] … some great question and fantastic chatting. Same time next week, all?

Now, for today’s post

Today, I am reviewing – and adding to – an important concept recently introduced by mymoneyblog … a way of comparing wealth without resorting to meaningless concepts like Net Worth.

It’s a ratio that mymoneyblog has dubbed the Financial Freedom Ratio:

If someone tells you that they have a net worth of $1,000,000, you might be impressed. But what if they spent $150,000 per year? If they stopped working, the money wouldn’t last very long. However, if they only spent $15,000 per year, they might already be set for life. In other words, your income doesn’t matter. Your expenses do. It may be assumed that the two are related, but that is not necessarily true. We all have the power to disconnect the two.

I’m sure somebody somewhere has already coined this term, but until told otherwise I will call it the Financial Freedom Ratio (FFR):

Liquid Net Worth divided by Annual Expenses

By liquid, I simply mean you can sell it for cash while not affecting your expenses. (Don’t count your car if you need it for work).

I like the FFR because it is a way to compare two people who may be on different financial paths; I mean, who is better off?

The doctor who earns $250k per year (net) but spends $260k a year on mortgages, cars, vacations?


The veterinarian who earns $150k per year (net) but spends $110K and has paid off their house?

But, there is a problem, as mymoneyblog also points out:

For example, if you had $200,000 but only spent $20,000 per year you would have the FFR value of 10 as someone with $1,000,000 but spent $100,000 per year. This also calls into focus how important spending patterns are when talking about financial freedom.

You see, Ratios are dimensionless … they lose scale. Therefore, with the FFR a ‘hobo’ COULD conceivably have a better FFR than a multimillionaire!

For example: my FFR is 40 (purely based upon cash in the bank) – but, that doesn’t mean anything to you, until I also tell you one of the Scaling Numbers (either ‘liquid net worth’ OR ‘annual spending’ will do).

If we want to keep these numbers secret (the great benefit of the FFR), then we simply need to add some sort of Quality of Life Index:

Quality of LIfe Index

As long as the QLI is greater than 1, then I agree that the FFR is a great way to share ‘financial positions’ WITHOUT disclosing how much we actually have in the bank!

It is also a great way to determine if your are on track to your ideal retirement, rather than just settling for the personal finance blogger’s curse: you will save, and save, and save until you can retire on your current paltry salary …

… the QLI forces you to assess what you really need to be able to spend in retirement and then it, together with the FFR, doesn’t let you retire until you can get there!

The only problem?

It doesn’t tell you how to do it! So, you tell me … how will you do it??? 

What does it mean to be wealthy?

7million7years live tomorrow (!) and 7million7years in the press:

Two of my favorite sites are TickerHound (the Investment Q&A Community) and the Tycoon Report (Daily Investing Newsletter); and, they’re both free! 

Also, 7million7years got two mentions when these sites got together here 🙂

Now for today’s post …

Trent at the Simple Dollar rekindled this debate  by asking “How Much Money Is ‘Walk Away From It All’ Money?”

I’ll let you read Trent’s post yourself, but, what often interests me most are some of the questions and comments left by readers to my posts and those on other blogs.

For example, I am often asked what my definition of wealth is; I can tell you what it ISN’T:

I DON’T like the simple numerical definitions of wealth that researchers and academics like to trot out e.g. $170,000 income per year; or $1,000,000 in assets not including primary residence; or even the often quoted Millionaire Next Door formula:

Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be.

To me, these are just meaningless numbers.

Then there are the passive-income-covers-current-income approaches to wealth [AJC: you may recall that Robert Kiyosaki  claimed $100k p.a. passive income as = wealth for him in Rich Dad, Poor Dad]; “KC” left this example in her comment to Trent’s post:

I’ve always said “wealthy” people are folks who don’t have to work and can live off their savings, pension, social security check, dividends, and any other non-work related payments. That is an age dependant term. My 90 year old grandmother is wealthy by those standards – but I’d hardly call her style of living wealthy – but she is able to live comfortably off her savings cause her budget is so small – no car, paid for house, minimal food & utility needs.

I disagree with this definition of wealth, because of exactly that scenario: the ‘cash poor’ person who accepts a certain level of lifestyle because that is what they can afford. They have one benefit: they can maintain this lifestyle WITHOUT WORKING therefore some would consider them wealthy. But, to me, they are still just getting by …

… which is interesting, because KC then when on to show the contrast:

My in-laws are wealthy – they both have pensions and health benefits, but retired early (55’ish) due to a sizable inheritance and wisely saving money when they were younger despite knowing they’d come into an inheritance. I would describe their lifestyle as wealthy – European travel, upscale cars, very nice paid-for home.

 This lifestyle has all the trappings of wealth … but, to me ‘trappings’ do NOT equal wealth. So, KC what would I consider wealthy?

Simple, it’s the definition that you provided, with an additional – but critical- twist:

It’s having the regular passive income to cover your ideal lifestyle not just your current lifestyle!

Your ideal lifestyle is the one that you measure by what you DO not what you HAVE …

… the DO part is about legacy: what, if anything, do you want to be remembered for?

The financial part of this is then simple. Just ask yourself: how much will it COST (time and/or money) and by WHEN do you need it?

When KC did the numbers she came up with the following:

But for me (a 35 yr old) to be wealthy by the no work standard would easily take 3 million. I arrived at that number by saying what amount times 8% would allow me to maintain my lifestyle on the principal generated? I chose $3 million cause in a few years I’d need that extra money due to inflation. At $3 million I could very easily pay off my home and live VERY comfortably off the 8% interest. That would make me and my husband independently wealthy. Oh well, I’m only about 2.8 million away from my goal – sigh…

Firstly, good on KC for ‘getting’ that you need a hell of a lot more than $3,000,000 AND for figuring inflation into the equation. But, here are some things that she needs to correct:

1. Firstly, she needs to work out her annual passive income requirements – it looks like she’s counting on $3 Million LESS ‘inflation allowance’ LESS Paying off current home.

2. I’m guessing that amounts to something like $150,000 a year that she’s aiming at – a healthy income, but nowhere near ‘reasonably rich’ (that would take about $350,000 – $500,000 a year income: big house, First Class flights, 5 Star Hotels, a couple of fancy cars, private schools). But, let’s assume that she has modest retirement spending requirements: she doesn’t say WHY she needs it, or HOW much … but, we do know that she needs to replace 100% of her time with money as she doesn’t intend to work at all.

3. Before retirement, KC may be able to count on a 12%+ annual compound return (over a 20 – 30 year period) on her ACTIVE investments (forget 401k’s, managed funds, index funds, etc. … to get 12+% she’ll need real-estate and direct investments in stocks), but in retirement, she will want to wind that back to, say 8% on her PASSIVE investments (now she can buy those Index Funds, if she likes).

Why 8%: because that’s the largest return that the stock market has ‘guaranteed’ over any 30 year period, in the last 100 years (the figure drops to just 4% over any 20 year period, and 0% over any 10 year period). And, then we really should deduct mutual fund and middle-man fees …

4. But, to counter for inflation and up/down market swings, KC will need to wind back her withdrawals to somewhere between 2.5% and 5% of her portfolio … 8% is right out of the question! Why? You have to reinvest at least the expected amount of inflation; KC will need a payrise if she wants to keep up with rising prices …

5. That means somewhere between $3 Mill. and $6 Mill. is the ‘Number’ for KC, or she’ll have to be content with taking ‘just’ $75,000 a year in retirement (at least, it will be indexed for inflation) … just remember, if she takes 20 years to get to that $3 Mill. it will be just like retiring on $35,000 a year today. Whilst $75k seems like a lot to most, it ain’t ‘rich’.

Maybe KC was a little optimistic in saying: “At $3 million I could very easily pay off my home and live VERY comfortably off the 8% interest”?

Do you need to shift your financial goalposts a little, as well?

Is Money's only 7 Investments that you need wrong?

ANNOUNCEMENT: To kick off the final stages of the 7 Millionaires … In Training! project selection process, AJC is going LIVE – this Thursday @ 8pm CST !!!


Last month Money Magazine published an article listing the only 7 investments you need – and Kevin at No Debt Plan wrote a follow-up piece that summarized the options nicely:

That’s right, this Thursday @ 8pm CST 7million7years is coming to a web-cam near you! All you need to participate is a PC with sound and broadband connection – AJC has the web-cam!!

Click here for more details: be a ton of fun!

Now, for today’s post …



CNN Money thinks you only need 7 investments:

  1. A blue chip US-stock fund (track the S&P 500 index) (Fidelity Spartan 500 Index, FSMKX)
  2. A blue chip foreign-stock fund (track the international stock index) (Vanguard Total International Stock Index, VGTSX)
  3. A small company fund (T. Rowe Price New Horizons, PRNHX)
  4. A value fund (Vanguard Value Index, VIVAX)
  5. A high-quality bond fund (Vanguard Total Bond Market, VBMFX)
  6. An inflation-protected bond fund (Vanguard Inflation Protected Securities, VIPSX)
  7. A money-market fund (Fidelity Cash Reserves, FDRXX)

And, I was happy when I saw that Kevin’s article disagreed, saying:

I think that is four to six too many for the average investor … I think Money’s intentions were good here and I don’t have anything personal against the funds they mentioned. (Well, except the Fidelity S&P 500 fund. $10,000 minimum investment? Are you kidding?) I sincerely think seven funds is too much. You end up sharing a lot of the same stocks in many instances.

But, I disagreed for a totally different reason … Money is trying to have you invest in EVERYTHING … and, trying to invest in everything simply doesn’t work for all the reasons that Kevin of No Debt Plan mentions in his post (go read it!).

But, I disagree with Money on this one simply because I hate, hate, hate funds … any, but mostly the ones with fees e.g. Target Funds … which, No Debt Plan tells me can also be bought quite cheaply, if you shop wisely, so maybe I hate them not just for the fees 😉

I mainly hate them, because investing directly in a few select investments is a strategy of the rich and those who want to BECOME rich. Of course, diversifying a little may be a better way to stay rich … I’m still deciding on this one, and will let you know when I pop up for air.

So far, I’m still on the side of not diversifying …

Of course, not everybody wants to be rich (and, I recently found out that some of them still read this blog!), so for them I agree with Money strategy – but, drop the bonds and most of the other funds … just Funds #1 and #2 will do.

I’ve mentioned on this site before that Warren Buffett agrees 100%:

In fact, I was just at his Annual General Meeting in Omaha where he said that IF you don’t want to take the time to learn about investing directly then you should just dollar-cost-average into a broad piece of “American Business” … which he went on to clarify as meaning Fund # 1 (except he specifically named Vanguard for its very low costs, but I know that Fidelity fund is pretty cheap, too).

Here is what Kevin had to say (via e-mail) when he saw my comments on his post:

I believe in diversification for the average joe out there. I just think the 7 funds they picked was stupid especially because it takes more than $24,000 to get started with all of the minimum investments (if you wanted an equally weighted portfolio).

The target fund expense ratio is not bad at all 0.21% for the 2050 fund by Vanguard. Sure it isn’t 0.07% but it also isn’t 1%. For instant diversification starting out… I’ll take it.

I’ve read Buffet’s comments as well. Thinks the average investor should be indexing and I agree. Kind of a set it and forget it deal.

That’s where Kevin’s view and mine part company … we’re on the same page except that I think the ‘average joe’ should aim to get rich and not be indexing/diversifying at all … 

In fact, I was surprised to hear at his Annual General Meeting that Warren Buffett (and Charlie Munger, his partner also agreed) said that he would put 80% of his wealth into ONE investment – surprised because Warren owns 76 businesses and lots of other investments!
But, the reason he later said is that he grew bigger than his investments, so he had to keep buying more.
So, it’s very simple:
1. If you want to be poor, but slightly less poor than you otherwise might be: diversify into American Business a.k.a. buy one, two, or even all seven of Money’s recommendations (just choose the ones with the lowest fees) and wait 20 or 30 years. Actually, not all seven … if you can wait 2 decades, why buy bonds?
2. If you want to get rich, don’t diversify … choose a very few investment, choose them very wisely, and manage them very well! If you can do that you just may very well end up rich … 
Let me leave you with the words of a very wise man, business man, inventor, and famous author:

Behold, the fool saith, `Put not all thine eggs in the one basket’–which is but a manner of saying, `Scatter your money and your attention’; but the wise man saith, `Put all your eggs in the one basket and–watch that basket!

The Tragedy of Pudd’nhead Wilson, Chapter 15.
Mark Twain(Samuel Langhorne Clemens) [1835-1910].

PS Keep this post handy, you’ll need Mark Twain’s real name (including middle name for extra bonus points) to win at Trivial Pursuit … after all, you’ll have lots of spare time to play when you’re retired 7 years from now 😉

Give me the skinny on MLMs

Disclaimer: 7million7years does NOT participate in any MLM either as owner, member, participant, or promoter … so there!

I wrote a post last month about a rumor that Warren Buffett had bought half a dozen Multi-Level Marketing (MLM) companies. He didn’t … I’m almost, absolutely positive about that. He may have bought one (at least, according to one of our commenters) but I couldn’t even find any independent verification of that.

But, if he did …

… why MLM‘s?

Well, they are one of the many ways that people use to try and build additional income streams … and building additional income streams are one of the key Making Money 201 steps to building wealth (since, you can’t just save your way to wealth).

Now, before I tell you more about MLM’s let me share the following:

MLM’s don’t work for me … I don’t have the personality for them: you need to be able to ‘mine’ from within your circle of friends and acquaintances; you need to be able to also ‘cold call’; but, most importantly you need to be really, really persistent.

I’m none of those things (though, I have learned to cold call … yuk … and, am a little more persistent than I used to be), but …

… it’s this third characteristic that (if well controlled) can help you in ANY endeavor!

Having said that, MLM can be an astoundingly good business model for the operators.

And, if you join because you use and love the product (not just because you can propogate membership), for the members, as well. [AJC: if you choose a highly reputable one]

Think about it this way:

i) If you love the products and will use them anyway, then you get to buy at ‘wholesale’ prices.

Well, not quite … and you usually have membership fees and ‘starter kits’ to buy. But, if you have compared prices and believe that you will buy enough to justify any ‘upfront fees’ then why not buy in?

ii) If you love the products, some of your friends might as well.

Why shouldn’t you subtly recommend them to your friends? If you used a product that you loved but didn’t sell it, wouldn’t you still recommend that product to your friends and family without hesitation? And, if you owned a store in the local mall, wouldn’t you want your friends and family – and wouldn’t they be happy to – shop there?

So, why not sell to your friends – how convenient for them!

Just don’t commit the sin of trying to cajole your friends and family into either buying more or joining just so that you can make more money … keep the attitude of trying to serve them, not have them serve you and your interests –  even if they appear to be happy to do so [AJC: I assure you, they are just being polite].

iii) Now, here is where it gets tricky: if you love the product and it makes you money, why shouldn’t you introduce other people – even your friends and family – to the same opportunity?

In principle, no reason not to: just remember that your friends and family will be ‘expecting’ this move from you [AJC: with rolled eyes … and a sigh or two].

Here is where I failed: I just can’t bring myself to involve friends or family in my ‘deals’ … I don’t like the idea of anybody thinking that I am profiting from them.

But, that’s just me. In truth, most people are looking for an opportunity to ‘get ahead’, just like you … and MAY respond well to an offer to “find out more”.

Just don’t commit the Three Great MLM Sins:

1. Don’t drag your friends/family along to some ‘secret meeting’ – “I can’t tell you what I’m involved in, but if you just come along I think you will thank me later”. That’s just plain tacky … be upfront.

2. Don’t plead/cajole/cry to get your friends/family ‘into’ your meeting/s – MLM’s are a direct-selling business pure and simple; don’t confuse the motivational stuff that goes on [AJC: necessary, because MLM can be a HARD business to grow fast] with how YOU should act.

3. Don’t be persistent with your friends/family – Now doesn’t this conflict with what I just said: “most importantly you need to be really, really persistent”?!

Yes, be really, really persistent with anything you truly believe in – including your beloved MLM – just don’t expect your friends/family to be the same … be persistent with the business, not the person.

In other words, it MAY be OK to politely, subtly ask a friend/family member who has expressed: (a) some liking for the product, and/or (b) some desire for a new opportunity … ONCE.

Anything more is simply out of bounds!

To me, the same rules apply to anybody that you meet: ask them once (OK, if not a friend or family member, go ahead and ask them twice … after all, you don’t want your new MLM Family to laugh at you, right?) … but, twice is enough!

Oh, and don’t do what my multi-millionaire friend does (who joined an MLM after becoming rich) …

4. Don’t plaster your brand new BMW with tacky vinyl stickers that say: “Want to lose weight now? Ask me how!” …. just … don’t 🙂

Why do we need middle-men?

I read an interesting article in the Tycoon Report yesterday … one that I would normally gloss over because it was not their usual meaty, financial “how to” type of article, but it said:

By now must know where I stand on capitalism.  I told you then and I will tell you again that unfettered capitalism is NOT a good thing … the problem with capitalism is that, by design, it rewards deviant behavior.

For example, let’s say that you are a conventional doctor with his/her own practice and you take insurance.  You get rewarded based on how many patients you see, how many drugs you prescribe, and how many procedures (e.g. surgeries) that you do.

Does this make sense to you?
Wouldn’t it be better if the doctor were compensated based on how healthy you were?  Or if he got you to stop smoking or to exercise more?  In other words, shouldn’t he be compensated based on making you healthier or keeping you from being unhealthy?  Shouldn’t both of your interests be aligned so that there is no conflict?

An extremist view perhaps, but it was ‘food for thought’ and actually reminded me of something that Warren Buffett said … so I went through my files and dug it up!

In his 2006 letter to shareholders, Warren Buffett was scathing of what he calls “helpers”, that is stockbrokers, investment managers, financial planners and so on”

A record portion of the earnings that would go in their entirety to owners, if they all just stayed in their rocking chairs, is now going to a swelling army of helpers.

Of all places, this was first picked up as a major issue in Australia, because one of Buffett’s targets was the financial planning industry, which has been under the spotlight down-under, resulting in major new controlling legislation for this ‘industry’.

Helen Dent, a director of the Australian Shareholders’ Association, says that she “personally” agrees with Buffett’s scepticism of financial advisers:

Look, let’s face it, most people when they start thinking about investing, they ask their friends and they ask their neighbours and workmates what they’re doing before they get anywhere near an adviser.

The commissions that are paid to financial advisers, that you actually pay, is effectively coming from the producers of the financial products. That’s, on the whole, where the financial advisers are getting the bulk of their income from.

Most financial advisers are tied to financial institutions. That means that the range of products that they suggest to you is often bounded by what the financial institution says they can offer. It’s not bounded by what’s in your best interests.

So, what do you think?

Will you ever put a penny in your 401k again?

I stuck my neck out, and made a candid admission; as expected, I copped a little flak – after all, I admitted to the world that I don’t even know how much is in my own Retirement Accounts 😉 Whoo boy!

What surprised me is that I didn’t lose readers … I even gained some; Josh pointed to the reason why in his comment to that post:

Controversial? This article was absolutely controversial and that’s why I come here. If you want extraordinary results you need to make controversial moves, a.k.a “taking risk”.

Thanks, Josh. Here’s how I see it:

I’m not a risk-taker, far from it … to me, the so-called controversial move is usually not “a.k.a. taking risk” …

… blindly following Conventional Wisdom can be the riskiest move of all because you may unwittingly be risking a good proportion of your financial future!

To prove my point, and (hopefully) change the way that you look at investing in your 401k forever, let’s take this example from another comment to that same post, by Alex:

This strikes me, in a good way. I am about to be eligible for the 401k at my company. Normal people who cannot think of anything else better (and safer) than sticking their money in the funds.

Correct me if I’m wrong, what you are really saying is: instead of saving diligently and sticking $30,000 into a fund, maybe that same $30,000 can be used as a down payment for a rental property that will both appreciate and generate cash flow.

Now, I cannot advise Alex – or anybody else – on what to do with their money … that’s the job of financial advisers.

But, isn’t it Rule # 1 of Personal Finance to FIRST PUT YOUR MONEY IN THE 401K TO GET THE COMPANY MATCH?

After all, isn’t that FREE MONEY?

If the employer matches your entire contribution, aren’t you getting a 100+% return on your investment … impossible to match anywhere else?

Absolutely, which is why almost every personal finance writer (be it books, magazines, or blogs) recommends to at least invest to the limit of your employer’s matching contribution …

…. except for one problem, this thinking doesn’t hold up to scrutiny!

You see, your money is in the 401K for the long-run (isn’t it?) … your contribution – and your employer’s match is only a Year One issue; over the long run, your Contribution (with the employer’s match) will tend to a much, much lower return.

Alex’s question is: will that $30,000 be better off in the 401k or in a rental property?

The only way to find out is to run some numbers over the expected life of your ‘plan’ to see what happens … fortunately, just like a cooking show, I have prepared the numbers for you and here are some very interesting results:

SCENARIO # 1 – Assumptions

A. Let’s simply take Alex’s question ‘as is’ i.e. make a one-off $30,000 contribution to the employer’s 401k:

We will assume that the employer is VERY GENEROUS and match 100% of the entire $30,000; and we will assume that the markets are equally generous and compound an 8% return for us – tax free – for 30 years.

B. Alternatively, we can put that entire $30,000 as a 20% deposit against a $150,000 house; and we will assume that it’s value increases by a more conservative 6% (also compound) each year. We will also assume that Capital Gains Tax (15%) is payable.

SCENARIO # 1 – Results

1. We know that in Year 1, the employer’s 100% match provides a 100% return on the 401k; but, in year two that return drops to 58% (the employer’s $30,000 ‘match’ effectively becomes a $15,000 ‘return’ over each of the two years … then add the 8% Net Managed Fund Return).

This rate drops each year – because we are looking for the equivalent compound return, it drops fast – so that it only takes 9 years for the overall compound return to drop below 20% and by Year 18 through to Year 30, it averages a compound return of ‘just’ 11% – 12%; still almost twice real-estate, though!

2. The total amount available to cash out of the 401k at the end of the 30 years is $559,000

3. However, if the entire $30,000 was used as a deposit on real-estate, even with a 15% Capital Gains tax on any increase, the total 30 year Capital Return will be $713,000.

That’s a 28% advantage by putting the $30,000 into real-estate instead of the 401K …

… a greater overall $ return even though the % growth was half that of the 401k!

How can this be so?

The power of leverage (we borrowed 80% on the real-estate and nothing on the 401K except for the employer’s Year 1 ‘match’).

But, wait, there’s more!

The property is an investment property (if you choose to live in it, simply figure that you pay yourself a ‘market rent’ and these conclusions still hold true) … so, we can assume:

That we fix the mortgage at 5.25% (that’s $8,000 a month), and average a 5% rental return based on current market value (means that our ending-rent grows to nearly $36,000 a year!), and assume that 25% of rents will go towards expenses (other than the mortgage) and vacancies (a useful Rule of Thumb).

4. The net income (with any ‘surplus’ over mortgage and expenses being held on CD at a 30 year average of just 5%) is an additional $217,000 for the real-estate option.

Taken together, here’s how it looks:

 Total Return:       
 401k   $    559,036  CGT+Income   CGT Only  
 Real-Estate   $    930,476 66% 28%

So Alex, by (a) forgoing the exceedingly generous employer match in your 401k and (b) putting that $30,000 into a pretty tame residential real-estate investment instead, your overall 30 year return increases by 66%

Now, this is not how the ‘real-world’ usually works:

We don’t usually invest in one lump sum … we usually make annual contributions to our 401k of 10% – 20% of our salary. So, how does The Alex Plan work under this ‘real world’ scenario?

Let’s see …

 SCENARIO # 2 – Assumptions

A. Let’s adjust Alex’s question to instead make an annual contribution of 10% of an assumed annual salary of $50,000 (4% inflation-adjusted, so that the contributions also increase by 4% each year)  to the employer’s 401k:

We will assume that the employer will remain generous and 100% match the employee’s contribution each year; and we will assume that the markets are very generous and compund an 8% return for us – tax free – for 30 years.

B. Alternatively, we can simply put each year’s contribution in a bank account (earning a paltry average of 5% over the entire 30 year period):

When we save around $30,000 [Year 6] , we take that money out of the bank as use it as a 20% deposit against a $150,000 house; and we will assume that it’s value increases by 6% (also compound) each year. We will also assume that Capital Gains Tax is payable.

Once be buy the house, out bank account is depleted, but we are still saving 10% of the employee’s salary, so we start to build the bank account up again … of course, similar properties get more expensive, so we wait until we have saved around $38,000 [Year 11] as 20% deposit and buy our SECOND property … then we repeat: saving around $46,000 [Year 16] for property THREE, and around $56,000 [Year 21] for property FOUR and final.

Why final? Well, we are within 10 years of retirement, so the BEST PLACE for our final 9 year’s worth of annual contributions is probably the 401k … 9 years is simply not long enough to chance the property market (for this reason, we could even be really conservative and also forgo the purchase of the 4th property).

SCENARIO # 2 – Results

1. The numbers are too complicated to measure the effect of the employer’s match on the hypothetical return … but, the overall numbers are far more important.

2. The total amount available to cash out of the 401k at the end of the 30 years is now $1.8 Million (now, you know why you want to make annual contributions to your investment plan!).

3. With the purchase/s of the 4 properties (the last of which we hold for just 10 years), even with a 15% Capital Gains tax on any increase, the total 30 year Capital Return on the FOUR properties (plus the final 9 years of 401k savings) PLUS the net income for each of the FOUR properties, will be $2.4 Million.

That’s a 32% advantage by putting 10% of your salary into real-estate instead of the 401K …

 Total Return:   
 401k   $  1,833,746  CGT+Income 
 Real-Estate   $  2,412,898 32%

Before you say, well 32% is just too much work to worry about … you’re not thinking like a millionaire. Over the 20 years, you will have built up enough equity in properties #1, #2, and probably #3 to also purchase properties #5, # 6 and possibly #7. And, so it goes until rich …

So, Alex, will you invest in your 401k? If you have a lump sum … I’d guess definitely not?

But, for your long-term savings plan: the 401k is certainly more convenient … but, is that convenience ‘worth’ $600,000 (or – a lot – more!) to you?

That’s only a choice that you – and, aspiring followers of The Alex Plan – can make 🙂

Should you buy Berkshire Hathaway instead of an Index Fund?

After yesterday’s post which was aimed squarely at my readers who want to get rich – I hope all of you 😉 – I thought that I should write a follow-up piece aimed at the window-shoppers who are stopping to look at my Get Rich(er) Quick(er) wealth creation ‘catalog’ but have no intention of ‘buying’ …

This question arose as a result of a recent article on Get Rich Slowly  which references the same Warren Buffett quote that that I posted yesterday:

What advice would you give to someone who is not a professional investor? Where should they put their money?
Well, if they’re not going to be an active investor — and very few should try to do that — then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time.

Get Rich Slowly then went on to say something very interesting:

Buffett has said this time and time again, which is why I’m baffled when people use Buffett as a reason to not diversify. I am not Warren Buffett. Neither are you. Unless you have Buffett’s combination of patience and intense research, you’re better off putting your money in an index fund. (As one reader recently noted, if you can afford to buy a share of Buffett’s company, Berkshire Hathaway, you’re getting the best of both worlds: a diversified portfolio picked by Warren Buffett!)

… which I also commented on yesterday, but it’s the “one reader” comment at the end, that grabbed me.

If Warren Buffett is indeed the World’s Greatest Investor (he is, without a doubt!), and you want to diversify as he recommends, why not forget about the “low cost index fund” option altogether, and jump straight to the top i.e. into Berkshire Hathaway (the company that Warren controls)?


Because, Warren didn’t recommend it … he’s too ethical to recommend it … in fact, he even says openly that an investor with $1,000,000 can achieve far better returns than he can nowadays, because Berkshire is just too darn big to move quickly and must invest in such large sums that the number of opportunities out there are much smaller for them than for us ‘little guys’.

Of course, the occasional ‘big opportunity’ opens up for Berkshire Hathaway, because of their $60 Billion ‘war chest’ … in the meantime, that $60 Bill. just sits in the bank barely beating inflation.

Even if Warren were still at his ‘smaller, more nimble’ peak, he still would NOT recommend that you do as “one reader” suggests because:

1. You would be buying just ONE stock … admittedly one that has performed well in the PAST and MAY (or may not) perform well in the future, and

2. You would be buying into only a partially-diversified conglomerate … a ‘piece of Warren’ rather than a ‘piece of [the whole of] America’.

So, if you are on the path to saving rather than investing, do what Warren Buffet himself suggests: stick to low-cost index funds …

… only buy any individual stock – including Berkshire Hathaway – if you are in the business of investing and really know what you are doing.

Are you in the habit of saving or are you in the business of investing?

If you’re in Colorado, tune your dial to KRYD FM tomorrow morning (that’s May 22) @ 7.15 am when 7 Millionaires … In Training! hits the airwaves!!

If you listen in, you’ll find out that I have a face for radio and a voice to match … c’est la vie …

Take note that I said OR … I didn’t say AND …

In fact, most financial writers/bloggers/commentators take it as a ‘given’ that you will do exactly that: save a certain % of your salary and plonk it into your 401k to get the company match and have it invested in the restricted group of managed funds offered by your employer and/or 401k provider.

They’ll recommend that you dollar-cost-average your way into, say, a low-cost Index fund … and, you’ll be surprised to know that I agree and so does Warren Buffett:

What advice would you give to someone who is not a professional investor? Where should they put their money?

Well, if they’re not going to be an active investor – and very few should try to do that – then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time.

Now, I agree that this is indeed an elegant and simple long-term SAVING strategy for the Average Joe who thinks that they can save their way to wealth … $1 million by 65 … whoohoo!

But, if you want more (and, you probably should), then you have to move to Part B i.e. get “in the business of investing” …

That usually means one – or, for the rare genius, a combination of – four things:

1. Get in the business of running a business (that’s what Warren Buffett does … contrary to popular belief, he is primarily a business owner … he owns or controls 76 major businesses!)

2. Get in the business of learning about and selecting a FEW individual stocks (that’s what Warren Buffett does … he owns / has owned stock in Coca Cola, Kraft and many others)

3. Get in the business of learning about and actively investing in real-estate (that’s what the rehabbers, flippers, foreclosure experts, etc. do)

4. Get in the business of climbing/clawing/backstabbing your way to the very top of the corporate ladder (that’s what America’s Fortune 500 CEO’s do)

Usually, it means choosing just ONE of these as your main Making Money 201 path to income – at least, that’s what I did – then choosing a SAVING strategy to convert that income to passive assets to keep your wealth growing and fund your eventual retirement:

I was in a corporate job for nearly 10 years … after about 6 years, even though I was doing ‘very well’ (for my age, position, seniority, etc.) I realized that Option 4. wasn’t for me – I would never become a CEO of somebody else’s company.

I didn’t know much at all about either 2. or 3. but I did have a sudden urge for Option 1. – so that’s what I chose!

My first business was a bit of a ‘sleeper’ – it started its life as a very small (and new … I joined one year after inception) family business and grew fairly slowly. Because it was barely breaking even, I bought the family out and managed to get it to grow rapidly and substantially. I still keep it 15 years later, although, it has run very well without me for a number of years now.

I used the profits from that business (the nice little cash-cow that I turned it into) to fund a few start-ups, most of which I subsequently sold.

But, when all of these business were running, I SAVED a good proportion of the profits in various ‘savings’ vehicles: mainly real-estate and a little (at that time) in stocks … none in funds.

Why do I say ‘saved’?

Because I didn’t ‘actively invest’ in them … I wasn’t in the business of investing … I was simply in the habit of saving. I happened to select a non-standard mix of savings vehicles to put my money into (e.g. real-estate and stocks, rather than CD’s and Funds) … then I held on to them … and let time (and the markets) take care of the rest. Because I could put so much in, I eventually got so much out.

It was a Making Money 101 strategy.

My % returns from the businesses were spectacular … my % returns from my ‘savings’ were ordinary … yet, each played a critical part in my current financial success. Interestingly, my overall $ returns from both were excellent!

In the last few years, as I geared up for my ‘retirement’, I have revisited these options and moved away from business and to investing … because I gave myself so much exposure to both real-estate and stocks over the years, I have built up the skills in both to allow me (for some time, now) to actively (as well as passively) invest in both as a Making Money 301 wealth protection strategy.

But, if you want to become financially free, at a relatively young age, with a relatively decent passive income (you’ll have to plug in your own numbers), then you will need to find one of these four options that interests you, and hope that it delivers spectacular returns for you …

… for most people, Warren Buffet and I also agree that it’s unlikely that it will be in stocks, at least according to this little exerpt as reported by Soul Shelter (whose brother, Charles,  attends Berkshire Hathaway events in Omaha each year) who relayed this anecdote from Buffett’s 2006 shareholders’ meeting”:

One shareholder asked a question along the lines of ‘how should I study investing in order to build wealth in my spare time?’

Buffett replied that, for most people, the bulk of their income is going to come from earning power in their chosen profession. Therefore, from the standpoint of building wealth, free time is better spent sharpening one’s professional skills rather than studying investing.

This statement applies directly to my Option 4.; it equally applies with a little modification to any of the other options (e.g. Option 1: … for some people, the bulk of their income is going to come from earning power in their chosen business. Therefore, from the standpoint of building wealth, free time is better spent sharpening one’s business skills rather than studying investing).

In other words, select where you will make your money, and focus all of your energy, research, and attention into that … focus!

Of course, if you’ve decided that your financial future lies in the business of investing then here’s what you should do:

Do not as Warren says … do as Warren does! 

PS We were featured in the Q&A for the latest Carnival of Finance; visit it here: