Mike is a divisional CEO for JP Morgan (runs a whole country for them!), and he earns $250,000 in a bad year and $350,000 in a good year. He’s running fast and aiming high.
But, is Mike aiming high enough?
If you weren’t following the comments on this post, then you were missing out on more than 50% of the benefit of that post … I think that also holds true for most of my posts; our readers rock!
Anyhow, Mike said:
I’m 36 and have already got up to the savings level of someone who is 50 or 55… question is when do I want to take it easy and stop working for a while- or at least working make myself rich instead of JP Morgan, who owns the company I’m running!
Aspiring to the savings level of someone who is 50 or 55 is no great shakes; it’s where Mike goes from here that will dictate his future, so I asked Mike a few questions:
Disclaimer: We know next to NOTHING about Mike’s true situation, so nothing here constitutes financial advice* … it’s best if you – and, Mike – treat this as a hypothetical, merely illustrating how to apply 7m7y ‘rules’ to somebody on an income rather than working their own business/investments. On with the questions …
1. What’s your Number?
2. What’s your Date?
3. Why?
4. What’s your Current Net Worth?
It may be that Mike’s presumably super-high salary (after all, he is running JP Morgan in his neck of the woods!) combined with an aggressive savings / investment strategy will do the trick …
Mike’s response:
Salary isn’t super high – only $260K USD a year (base salary & guaranteed bonus) – max variable bonus on top of this is another $100K so it’s comfortable but not huge.
My number is abour 10 million – would like to hit it in the next 14 years or sooner.
Current net worth is 1.7M USD with $1.3 M in very liquid assets (cash…) Residence is fully owned and monthly burn rate is pretty low.
Given that Mike’s Prime Financial Objective should be to reach his Number by his Date, his financial strategy should be the one that he is most comfortable with that seems most likely to achieve that target …
… IMHO, he (or anybody) should only choose a more ‘active’ (read: risky) strategy if it’s a by-product of the strategy that he truly resonates with …. for example, I would start a business even if plonking my money in CD’s would have been enough – that’s just me [AJC: but, it wouldn’t have been all of my money – or even a lot – going into starting that business].
What does this mean for Mike … I mean, Hypothetical Mike? 😉
Well, let’s go through the steps:
STEP 1 – What is Your Number / Date?
Mike’s Number is $10 Million and his date is circa 2023.
STEP 2 – What is your Required Annual compound Growth Rate?
Starting with his $1.7 million Net Worth [AJC: reading between the lines, Mike’s paid off house may not even ‘break’ the 20% Rule – and if it does, not by much, so I don’t see a problem here] our faithful online calculator shows me that Mike ‘only’ needs a 13.5% Required Annual Compound Growth Rate on his Net Worth.
[Tip: If you haven’t used this calculator before, it’s simple: Mike’s ‘ending value’ is his $10 million Number; his ‘starting value’ is his current $1.7 million Net Worth – although, I would be tempted to subtract cars/furniture and any other personal ‘stuff’ that can’t be easily turned into cash and/or loses value … house is probably OK to include here – and, ‘the number of periods’ is just his 14 year Date]
STEP 3 – Select your Growth Engine
This is where it gets fun … Mike simply needs to take a look at Michael Masterson’s table of ‘money making strategies’ – handily reproduced for you in this post – to see that any number of strategies will be enough to propel him from $1.7 million to $10 million in 14 years: anything from stocks to real-estate to small business.
But, not CD’s … this calculator shows that Mike’s biggest risk is actually the low-risk ‘investment’ option that he has so far chosen: cash …
… if he keeps ‘investing’ in cash, Mike’s Number will be struggling to reach $3 million in 14 years, rather than the $10 million that he needs 🙁
Rather than being the ‘safe haven’ that it appears, keeping his assets overly-liquid is actually stopping Mike from reaching his financial objectives … worse still, it’s forcing Mike to think about chasing more income, when it’s the exact opposite strategy that Mike should be following!
That’s why, I recommend that Hypothetical Mike choose stocks and/or real-estate in whatever mixture of either / both that suits his temperment.
Now, we are talking Value Stocks when we suggest a 15% compound growth rate, and reasonably well-geared (i.e. no more than 25% – 30% starting equity) commercial real-estate – mixed with stocks – when we suggest a 30% compound growth rate.
But, here is the key …
… for Mike, and anybody else whose primary Making Money 201 ‘accelerate your income’ tool has been climbing the corporate totem pole to a position where (a) income is [relatively] high, (b) expenses are reasonably low, so (c) saving rates are high, their net worth will most likely grow even if they merely plonk their money in their 401k and/or Low Cost Index Funds…
You see, Mike will continue feeding his Net Worth with both Investment Returns AND additional salary contributions.
This means that Mike will most likely reach his Number simply sticking his money into low cost index funds:
Mike should follow the advice that Warren Buffett gives to all the Hypothetical Mikes of this world … in fact, it was virtually tailor made for his situation:
If you are not a professional investor, if your goal is not to manage money in such a way that you get a significantly better return than world, then I believe in extreme diversification. I believe that 98 or 99 percent — maybe more than 99 percent — of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs.
Given that Mike’s current salary / job makes reaching his Number a virtual gimme – with such a variety of relatively low impact [AJC: certainly in the context of amassing a $10 million fortune!] Index Fund, Value Stock, and/or Real-Estate investment strategies available to him, what would you advise him when he says:
Right now my best option is to continue to get a successful track record (already turned around the business and changed it from major losses to modest profits) and maybe I can find a better gig.
What advice would you give to Mike?
I know what I would say 😉
* [Insert: ‘Not qualified financial advisor; not financial advice; seek qualified advice before investing; take two Tylenol and call me in the morning; yadayadayada’ disclaimer message of choice]
Adrian,
Thanks for doing a post on (the hypothetical) me…
Since I posted earlier my NW is up to $1.8 million and the company is in a position where we can sell it to another investor and depending on the price of the sale I can get anywhere from a few hundred K to about a million. So that will be a nice compound annual growth that equate a few years of 15% growth per year :-), if and when this happens.
I’m still sitting on a lot of cash, the ‘speculative stocks’ I’m in with 15% of my NW are moving sideways.
Appreciate the advice and will let you know when I pull the trigger and change my strategies.
My aunt was trying to get me to think about buying a condo in downtown Brisbane but the financial are terrible (purchase price of $900K AUD, monthly rent of $2200, annual fees & taxes of $9K and worst of all, Australian non-residents have to pay 29% minimum tax on the first bracket of income…. seems like a no brainer- to walk away from this, that is.
-Mike
Mike – Nice job! I agree that unless you have some big purchase in mind, you shouldn’t be holding so much cash. Esp, with a non-trivial risk of substantial inflation kicking in. We are similar in age and goals, and my portfolio is roughly:
40% US Stocks
10% REITs
14% EU & Pacific Stocks
6% Emering Mkt Stocks
30% Treasuries & TIPS
If you are living outside of Australia or where ever you hope to retire, you should think about a currency hedging strategy, e.g. buying laddered options of FXA etc.
Let us know what you figure out!
@Mike
I have to agree with Adrian that cash won’t do the trick for you. Inflation is NOT your friend! I also agree that you should be using index funds- you don’t need to speculate to reach your goals!
-Rick Francis
Sounds like you have already done this, but if you are successful at running this business (you said you turned it profitable) then you should be in a position to negotiate larger and larger bonuses or equity ownership. Seems like THAT is what you are talented in. Don’t feel like you need to start investing in real estate or small biz because that is how OTHER people might have gotten rich.
I do agree that you should keep some cash positions if that makes you feel secure, but also to keep the bulk of your invest-able assets in at least an S&P500 index fund.
What are Hypothetical Mike”s Talents and hobbies? Based on what he likes to do in his spare time. I might recommend starting a business, that could bring in an income and later be sold for a nice return. This could help him reach that goal quite well. It would be less like running a business cause it would be something he enjoys anyway.
14 years is a long time. OK, it’s short in the context of the number Mike is trying to achieve, but in the context of a strategy that is partly dependant on salaried income in an industry as volatile as banking the greatest risk to his target may be job loss. (Given what I know about bankers generally, lifestyle inflation could be an issue as well.)
I would be very tempted to look for some slightly higher risk/higher return investments to try and shorten the time horizon and/or provide a buffer against the possibility of disruption to the job related income stream.
I agree that cash and cash equivalents just won’t do the job.
Disclaimer: anyone who takes advice from an unqualified, anonymous stranger over the internet should put all of his/her money in this great time share scam I have going.
Thanks for the good comments, keep em coming. I realize cash is a terrible strategy in the long term. However buy and hold isn’t so good either, at least in the last 10 years where the S&P has basically gone sideways.
I do plan to put my money to work, I’m just biding my time as I don’t think deflation / deleveraging is done playing out. Since I’m not too old my investing life only started in the late 90’s and let’s say that in spite of all my investing I’m still claiming a capital gains loss of $3000 USD every year, the maximum amount!
Hypothetical hobbies: hiking & mountain climbing (climbed Kilimanjaro and a dozen 14000′ / 4000 meter peaks in North America), adventure races and exploring, music- can write some music and play a handful of instruments, languages (besides English can speak 2 others pretty well), general interest to learn new things. I spend a lot of free time on the internet checking out what is going on around the world economically and with new technologies / trends.
On job loss, I am aware that the future is very uncertain. I’m not in banking, actually run a business for the shareholders without going into too much detail. The business is doing very well now.
I do agree with the majority that I need to move out for cash, I’m just waiting for a good entry point and for the timing to ‘feel’ right.
-Mike
Last sentence should read move out of cash…
Mike, If you are going to sell your share in the business, then doesn’t that mean you *won’t* have that income stream anymore, and are not guaranteed to have $260K/year coming in? That does change things a lot.
” I need to move out [of] cash, I’m just waiting for a good entry point and for the timing to ‘feel’ right. ”
@ Mike – Here’s an article that I ‘feel’ you should read until YOU ‘feel’ very differently about trying to time the market
http://7million7years.com/2008/10/16/the-time-of-your-life/ 🙂
Neil,
Most likely, I’d still be employed – most of the new partners are looking to retain the mgmt team.
-Mike
@Adrian,
The link to the Dalbar study in you old post is broken :-(.
@Mike,
I wouldn’t try to time the market- no one can reliably do it. If you could time the market wouldn’t you have gotten back in Mar of 2009?
If you keep waiting for it to feel “right” you will likely have missed a LOT of appreciation as it is unlikely to feel right until well into a bull market.
The Dalbar study looks at how investors get sub market returns rates. The reason is due to their behavior- actions like chasing hot funds- just before they turn cold. Attempting to time the market- but failing. There are some good posts on investor mistakes at http://www.behaviorgap.com/
Instead of investing according to feelings, why not make plan – choose some asset allocation plan and rebalance periodically?
-Rick Francis
Rick Francis says:Instead of investing according to feelings, why not make plan – choose some asset allocation plan and re balance periodically?
Actually, I don’t like this re balancing thing everyone talks about. I think it takes you out of your best stocks and puts you into your second or third choice(which might not do as well.
Better to find 3 to 6 really good stocks(based on due diligence) invest in those, and have a get out point in mid in case you were wrong. then let those winners ride (to full valuation) whatever that might be,before getting out. This re balances you anyway.As long as a stock looks good fundamentally, and is making progress, no need to re balance.Remember to use stop losses to protect in case of a bad choice or some other occurrence.
Indeed, I should have invested closest to the business I’m working in… but hindsight is 20/20. I’m happy what where I am thus far, it seems like my path is making money this way- 10 years ago I had a net worth of about $120K.
I’ll still try and invest- really gamble- as my track record from 2000 – 2010 is pretty bad, averages to be not too much above zero % (but I didn’t reinvest the dividends, kept them).
-Mike
@ Steve – I agree with your points re ‘rebalancing’ … I hate the concept 🙁
@ Mike – I just don’t see it as ‘gambling’ if you put, say, $1 mill. of your $1.7 into some sort of investment (index funds, conservatively leveraged RE, etc.); then you can just ‘average’ into the Index Funds with the savings portion of your future pay packets; think about it, you won’t be buying into today’s market … you’ll be buying into EVERY market over the next 14 years 😉
Mike Hunt says:I’ll still try and invest- really gamble- as my track record from 2000 – 2010 is pretty bad
Investing is not really a gamble (unless you have no entry and exit strategy. You need to know what your investing in first . Also need to know the value of that stock,bond or whatever. Then is it undervalued? By how much ? Then plan entry point, and wait for it to become fully valued(or in case of error)at which point you can get out and begin again with another investment. Have stop loss in place to minimize loss so you can try again later.Sounds like your taking profits too soon and not letting winners run. Also ,those dividends need to be reinvested(perhaps in another quality stock). But at least in something of quality.
You can be right in your stocks only 50 % of the time , and still do well, if you have stop losses in place, do your due diligence, and have and exist strategy, and let those winners run .
Mike, thanks for sharing your story here, there’s no learning like learning from an example.
What do you think about taking a nice portion of that cash (the max you feel comfortable with) and actually buying a larger stake in the business you manage and currently own a piece of? Seems to me that this is your edge, not equities or RE…plus its sounds like it could have a nice return, 50% plus maybe.
Kinda goes along with Steves advice, your taking profits too early (your thinking of selling out, i think , right?) and not letting your profits run. Don’t only let this baby run, double down.
Steve,
You are probably right- I need to re-look at my strategy. Certainly I’ve not put in stop losses as I should have.
Josh,
Currently I don’t have to option to buy equity – I may have that chance after a change in ownership though. Good thinking.
-Mike
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