A dollar saved is a $100 earned …

A Dollar Saved

If you read this blog often enough, you may be forgiven if you leave with the impression that saving is not important.

Of course, you would be wrong!

It’s just that enough is written elsewhere about saving – too much – that little is left for me to say here.

So much, in fact, is written about saving, that you would also be forgiven for thinking that it’s the Holy Grail of Personal Finance.

It isn’t …

But, if your aim is to begin Life After Work (a.k.a. early full/part-retirement) as soon as possible, then every dollar that you save now has a far greater meaning than you may, at first think.

Firstly, though, you have to eradicate from your mind the idea that each dollar that you save is to be closeted in the warm confines of your bank, perhaps sitting shoulder to shoulder with your other dollars in a 5 year CD, locked up like sardines in a tin can waiting for the day that the lid will slowly curl back, only to be quickly consumed.

Equally, you have to eradicate from your mind that the “invisible dollars” scraped from the top of your paycheck and secreted in the mysterious 401k will somehow pop up just when needed to save your retirement, like an airbag in a crash …


It’s clear – at least to me and my long-time readers – that if you need a Large Number / Soon Date (that means, retiring early with a large enough bankroll to happily sustain you until your family finally decides to park you in some nursing home for the remainder of your drool-filled days), then you need to actively manage your money.

Perhaps you need to start a business? Or, you should start rehabbing some houses to build your rental portfolio? Maybe, it’s time to plunge head-first back into that Blue Chip Lottery called the stock market?

Whatever your ‘investing poison’, it should be clear (perhaps with the aid of a few minutes and a simple online compound growth rate calculator) that you need to actively work to gain Very Large Compound Growth on your Net Worth.

So, the value of each dollar saved now is not the paltry 5% to 8% return that others expect, passively watching their CD’s and Index Funds match-racing with Inflation …

… rather, it’s the value of using those dollars to build a small war-chest (OK, a modest level of seed-capital, may be more apt for most of us) that allows you to get started on your business / real-estate / stock-based plan.

And, it is every dollar that you add, or reinvest instead of spending, that helps to fuel the flames of growth.

Once you start to see the value of saving though the spectacle of building a modest pool of funds-for-investing, you begin to realize that every dollar that you save today is really the same as $100 in a mere 10 years timeif invested in a business.

If you don’t believe me, here it is in black (well, blue) and white:

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So, slash those Coke Zero’s from your diet and start drinking tap water and, before you know it, you (too) will be a semi-retired multimillionaire, sitting on a beach in Maui …

Now, how do you feel about saving?


The myth of asset allocation …

pie 2There’s a Rule of Thumb that says that you should keep 100% – Your Current Age in stocks (and, the rest in bonds).

For example, if you are currently 27 years old, you should keep 27% of your current investments in bonds and the remainder (73%) in stocks e.g. an Index Fund that mirrors the S&P500.

There’s also a new school of thought that says the numbers should be ‘upped’ to 110% or even 120%, to ensure that you keep a larger percentage of your net worth in stocks at a young age, whilst you can still stand the volatility of the stock market (c’mon, you haven’t forgotten 2008 already?) and allow for a larger upside to help find your longer lifespan.

But, there’s a problem:

Let’s say that you want to retire at age 65, and you are currently 60; the original ‘rule’ says that you should still have 40% of your (hopefully, now considerable) net worth in stocks; the question is:

If you plan to retire in 5 years, what % of your net worth should you put in stocks?

Well, the answer is none.

5 years is too short an investment horizon to invest in stocks!

In fact, we’ve already established that the best place to keep your savings is in CD’s:

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Over 5 years, based on past performance, there’s simply too much chance that you will lose money on the stock portion of your portfolio.

But, that’s not the major problem that I have with this – or any – theory of asset allocation …

… my issue is that asset allocation theory only works in long timeframes (again, because we can’t afford risk of loss), say > 10 years, and probably greater than 20.

And 10 to 20 years didn’t work for me, because my plan was to make $7 million in 7 years.

To have any hope of emulating my outcome, you need to focus on three things:

1. Building up the largest ‘starting bank’ that you can,

2. Not spending more than you absolutely have to help build that starting capital in the shortest space of time possible, and

3. (this is the most critical of the three), investing to obtain the highest possible compound growth rate.

Sitting on a basket of stocks and bonds – no matter what the mix – probably won’t cut it.

Short time frames put a LOT of pressure on modern asset allocation and portfolio theories …

… way too much pressure, if you ask me.


How much do you really need?

2013-02-14 17.05.10My soon-to-be-nephew is having his wedding at our house; he’s an event organizer (amongst other things) so this is his opportunity to create his (and my niece’s) ideal wedding …

… we were, of course, delighted to be able to lend our house.

As he was supervising the erection of the marquee over our tennis court and false flooring over the pool, we were chatting about wealth.

During the course of discussion, the subject came up of how much do you really … and, ideally … need?

What is the Perfect Number?

If you’ve been following my blog for a while, you will know that I’ve said that you need as much passive income as you need to live your Life’s Purpose.

Even without knowing your Life’s Purpose, though, I can still tell you roughly what your Perfect Number should be:

You should aim to live no better than your closest group of friends.

Let me explain with a personal example …

We have a long-standing group of friends.

We eat often eat together. We party together. We travel together.

Not always. Not only. But, often enough.

Now, how would you feel if you travel coach, most of your other friends travel coach, but one of your friends is always at the front of the plane?

How would you feel if you like to eat out at a mid-priced restaurant once every couple of weeks with your friends, but one of your friends is always trying to arrange 5-star dining? And, 5-star hotel’ing?

I think your friend would eventually price herself out of your group of friends.

Well, I am in danger of becoming that friend.

Our friends are all quite well-off, because they are all professionals (both husbands and wives) drawing great incomes for many years. All of our children privately school together, and vacations are now flying coach (with kids) or business class (without kids), staying at international 4-star resorts at least once, and probably twice, most years.

But, our house is clearly the best in the group. Our cars are the best (and, could be better, but I’m starting to realize that I should hold back a little). And, we could be flying business class (sometimes even international first class), and easily stay in 5-star hotels.

In short, we have to be careful not to make the difference obvious.

That’s why I told my nephew (to be) – as I am telling you now: aim to live no better (but, no worse) than your closest group of friends, assuming that you wish them to remain your friends.

I can add a little more:

– Aim to be towards the top of your circle in terms of sustainable annual income.

– Aim to have a buffer, so that you can maintain that standard even if something goes wrong.

[AJC: This is not the same as an emergency fund: this means, for example living on the same $50k p.a. as your friends, but actually earning $70k p.a.]

– Aim to be able to maintain that standard of living (with buffer) when you begin to live Life After Work.

– Make sure that your Life After Work (i.e. very early retirement) makes you still ‘look’ busy

[AJC: Sitting on a beach all day while your friends still 9-to-5 it 50 weeks a year will just as quickly put you in the ‘former friend’ category as flashing your cash]

So, how much money do you really need?

Step 1: Take what your friends are earning and add 20% buffer

Step 2: Multiply that by 20

Step 3: Add the amount remaining on your mortgage (or, what your mortgage would be if you bought one of the better houses owned by your friends)

Step 4: Add any additional ‘crazy money’ that you need for some of your ‘keep busy’ Life’s Purpose activities.

Step 5: Double your final total for every 20 years until you expect to be able to accumulate that amount of money (or, add 50% for every 10 years), to account for inflation.

That should give you a very practical Number … you might even say your Perfect Number 😉

Now, you just need to go out and get it.

When should you take a loan instead of saving?

debt v savingsHere’s a commonly asked question:

In which cases should you take credit or a loan instead of saving up?

Len correctly answers:

When the price of whatever you are looking to buy is rising faster than the interest on the loan.

But, the answer that I want to focus on is that by popular financial blogger, Pinyo who says:

Buying a house at today’s interest rates is a good example of where taking a loan could be more beneficial than saving up.  You’re amortizing over 30 years and inflation would counter the interest expenses you paid over the life of the loan. In the mean time, you get to enjoy the house much sooner.

Whilst what Pinyo suggests is correct: real-estate is a great hedge against inflation; and, borrowing to purchase your home is probably the only way that most people will ever get to buy one …

… his comment actually fails to mention that it’s also a pretty good investment. Even your own home.

Let’s take a look at a simplified case of somebody purchasing their own first home (house or condo) for $100k, including closing costs. They put in a 20% deposit and take out a 30 year fixed loan, locking in at 3% interest.

Let’s also take Pinyo’s line that the interest rate just happens to offset 30 years of inflation (i.e. inflation also averages 3%), which is almost spot-on, based on the past 30 years’ average inflation rate.

Whereas Pinyo suggests that you are (a) offsetting inflation, and (b) enjoying your house …

… I think you are also making a great investment.

Here’s why:

– Over the 30 years, at just 3% inflation, your $100,000 home would have grown in value to $237,000

– Of course, in that same 30 year period, you would have also paid your bank $52,000 interest on that $80k loan

– Don’t forget that you put in a $20k deposit, which could have been earning interest elsewhere; let’s say that you would have averaged a 5% return on this investment, so your $20k could have grown to $86k.

The bottom line is that you will make an additional $17k profit, if you buy the house instead of just ‘saving’ the $20,000.

To me, this is a clear and tangible case where borrowing (to buy your first home) is better than merely saving …

What about the repairs and maintenance cost, you ask? And, the insurance, and the land tax?

My feeling is that these would be a lot less than the rent that you no longer need to pay …

… after all, you did just buy your own first home didn’t you? 😉


The best place to keep your savings …

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Where do you keep your money if you want to buy a house in, say, 7 years?

If you keep it in the bank, you’ll find rates up around 5% if you can commit to a 5 year term.

Given that inflation is currently running around 1.7%, you’re heading for a very small gain.

That’s why many choose to put their money into mutual funds

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Despite the crash, returns from investing in a low-cost Index Fund (say, one that mirrors the S&P500) have been up to 28.6% for any 5 year period that you care to nominate in the past 85+ years.

Now, that’s certainly a lot better than CD’s (long-term bank deposits).

But, there’s a catch … and, it’s a big one!

Whilst’s CD’s virtually guarantee their admittedly paltry return, there’s no guarantees in the stock market …

… and, there has been at least one 5 year period where the S&P500 has lost 12.5%.

But, let’s look at the downside v the upside: that’s a potential 12.5% loss each year for the 5 years … compounded (meaning your savings will halve in a little less than 7 years) … but, you may gain up to 28.6% annual return (meaning you may double your savings every 2 years).

Compare that to the measly 5% return (before inflation) from CD’s and it seems like no contest, which is why many Americans are opting to use mutual funds as a mid-term savings vehicle, but …

It’s a huge mistake.

You see, it might be fine if you already had the deposit for the house saved up, and you were just setting it aside for 7 years. If so, and if this were me, I might very well elect to buy units in a low cost Index Fund rather than scraping by with a CD.

But, if I had the deposit already, I would more likely just go ahead and buy the house now, and rent it out if I wasn’t yet ready to live in it.

But, the reality is that most people need that 7 years to save for their deposit. And, that’s a whole different ballgame, because now you are putting aside a little every month and, over that 7 year period, slowly building up your deposit.

This means, your money is really only going to sit in your investment or savings account on average just for 3 years.

Now, your risk of loss is up to 27%, almost as much as your potential gain of up to 31%, and that means you are gambling, not saving.

This is one of very few cases that I have found where common financial wisdom is correct …

… the minimum period for committing your funds to the stock market should be 5 to 10 years, assuming you are not prepared to gamble with your starting capital.

And, if you are prepared to play the market, well, that’s a subject for a whole other post

So – and, unfortunately – the best place (indeed, the only sensible place) to keep your money safely parked for up to 7 years is in CD’s 🙁