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How do you manage real estate risks?

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My most recent post – of a long series – on 401k’s v real-estate (which is a dumb comparison: like comparing the container with the drink that you might put into it … when, what we are really trying to compare is Mutual Funds v Real-Estate) sparked a long series of detailed comments about the risks and rewards of real-estate …

… I encourage you to read that post and the associated comments here. The discussion culminated in a great series of comments/questions by Jeff who also asked:

I agree, the “technical risks” need be manageable. But, how much does the management of these risks (infusion of cash when necessary) reduce your return?
For instance, do you keep a safety net for possible negative cash flows (high-yield savings account, CD)? Do you then bundle the two investments (investment property return plus safety net return) to determine the actual return of the investment property?
Do you pull cash out-of-pocket to cover short falls? Since you don’t receive any additional growth from this new cash and the new cash is added to your capital investment amount, it drastically reduces your present and future return from the investment.
Do you borrow more money to cover the cash flows? Since this borrowed money provides no additional return it puts you in severe negative leverage situation. Further, that loan has to be paid back with future cash flows from the investment property that you were expecting to give you the return your initially expected–for lack of a better term–compounding the damage of the negative cash flow.
Do you use a cash flows from another property to cover the short falls? This seems to be the best solution for the property receiving the infusion of cash, but to what extent doe sit reduce the return of the other investment property–by reinvesting its cash flows in an investment that provides no additional return? Put differently, it is a loss of opportunity to invest those cash flows in something that will bring additional return–rather than saving your RE investment from foreclosure.

When you experience short falls in RE investing, which one of these options is best? What did you do when you experienced cash short falls, and why? …and what effect did/does it have on your annualized return?

As I said, great questions, but the first comment that I would make (actually, did make) is:

I would caution you to remember the phrase: “paralysis by analysis” … in a practical sense, once I satisfy myself that (a) a certain type of investment is within my skill/interest level, AND (b) is LIKELY to meet my investment targets, AND (c) I can cover the risks – usually through a ‘reserve’ which may or may not be sitting in a shoebox with the word ‘RESERVE’ etched in the side, then … shoot … I’ll close my eyes and just go for it!

In other words, if you are going to be a success in real-estate investing – indeed, any endeavor where you expect to achieve more than the average person expects/can achieve – then you need to have a bias for action.

Often, we have to proceed in a world of imperfect information …

… magically, once we jump in a lot of these types of questions just seem to fall away!

But, to try and answer Jeff’s question:

Technically, YES the ‘reserve’ is part of the investment and lowers the returns e.g. if you are earning 20% on the investment and only 4% on the CD’s sitting in ‘reserve’ then obviously the actual return lies somewhere between the two.

BUT pulling ‘free cashflow’ out of one property to help service another, doesn’t actually reduce the return of the first … but, the amount of cash that you put IN to the second property affects ITS return.

But, at the end of the day, it’s the COMBINATION of all of these returns that counts: will you, or will you not make your Number, or whatever target you set?

The only real benefit of analyzing the return on each individual investment once you have made it is if you then intend to do something about it e.g. trade it for something better …

… a forced flight away from stocks!

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I wrote a post a while ago about the Myth of Diversification – just another piece of financial ‘wisdom’ almost designed to keep you form retiring early / retiring rich …

Yet, despite the current melt-down that should prove that there is no real safety in diversification, the principles remain as mainstream as this comment from Francis illustrates:

That’s the idea behind diversification and re-balancing. If you invest in multiple things and periodically adjust the balance between them you are forced to buy low and sell high.

It really doesn’t take a genius to make a few million if you can just buy low and sell high …

… but, it takes genius to know when to buy low and when to sell high!

Who knows where ‘high’ and ‘low’ really sit: they are relative, which serves (partially) to explain why market timing doesn’t work!

As the Dalbar Study shows:  mere mortals should not be in the business of trading stocks / timing the market; people who attempt this reduce their returns from 11.9% to only 3.9% … !!

No, we are simply investing for the long term, that’s why I asked Francis:

I agree with the “buy low” part … but, why “sell high”? Warren Buffett got rich by not selling his winners … he holds on to them.

Quite rightly Francis responded by pointing out that we aren’t Warren Buffett, saying:

Another reason to sell is that there are bubbles where the valuation of particular resources is out of whack. Wouldn’t it be a good idea to sell off at some amount before the peak of the bubble then repurchase after the crash? If you could reliably time the market you would sell it all at the peak and buy at the trough. I don’t have a crystal ball and I’m terrible at market timing. I’ve accepted rebalancing as a reasonable compromise.

As for Warren I know his favorite holding period is forever, but he is buying individual companies and is really good at valuing companies. He avoided the internet bubble like the plague, but I suspect that if he had stocks that became wildly valued he would sell them off.

But, if we really aren’t Warren Buffett, how do we KNOW when “the valuation of particular resources is out of whack”? Well, according to Francis, that’s when ‘rebalancing’ comes into play …

But, how does re-balancing provide a ‘reasonable compromise’ to the fact that we are all (WB aside) “terrible at market timing”:

Let’s say that you have $100,000 invested: 50% of your money invested in stocks and 50% invested in bonds.

Let’s then say that stocks ‘devalue’ by 50% overnight (a huge market crash) … in the case of an Index Fund, this could simply be a cyclic response to the market that has occurred many times in history.

Suddenly, your portfolio has shrunk by $25,000, so now you have $25,000 worth of stocks at post-crash prices and $50,000 worth of bonds (their price/value hasn’t shifted in this hypothetical crash). That is, you have 33% in stocks and 67% in bonds … so what do you do?

Well, you buy $25,000 more stocks … or, do you sell $25,000 of bonds?

The reality is that most people don’t have the $25,000 in ‘loose change’ to rebalance by topping up their portfolio, so they shift money FROM bonds INTO stocks.

Yippee … except, what happens when stocks recover and/or bonds dip?

In that case, you’d be taking yourself OUT of the stock market (a 9.2% – 11.9% annualized return, depending on who/how is doing the measuring) into the Bond market (a 4% annualized return?) …

… a forced flight away from stocks!

Would Warren Buffet do this?

Heck no! Warren Buffett doesn’t worry about market dips; he knows the market always recovers, as long as the underlying businesses keep making money. In fact, he looks at market dips as a buying opportunity (didn’t he load up on Kraft, while we were all bailing out of the market).

He identifies quality when he buys (bet he didn’t own any Enron), but, he recommends that you buy a little piece of all of America’s finest companies (a.k.a. an Index Fund, so even if you do happen to buy Enron, it’s only a tiny sliver of what you own), if you don’t know how to do what he does.

Warren doesn’t ‘rebalance’ his portfolio into cash (no dividends even, because cash/bonds doesn’t produce as high a return as his investments can) … and, he certainly buys more when the market dips and NEVER sells.

Here’s what to do:

If stocks are the asset class that you like and if you think that the stock market (as represented by an Index Fund or one or a few individual stocks, if you prefer) represents acceptable value:

1. Buy stocks … as many as you can afford; and,

2. Keep buying whenever you can afford more; and,

3. When the market dips, it’s ‘on sale’ … buy even more; and,

4. Never sell.

That’s it … now you are Warren Buffett.

A random walk in the financial park …

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I’ve looked high and low and I’ve finally found it!

‘It’ is the source document for all of the commentators who have (rightly) suggested that Index Funds outperform actively managed Mutual Funds.

And, it is produced by Standard & Poors who publish the major Indices themselves:

The Standard & Poor’s Index Versus Active (SPIVA) methodology is designed to provide an accurate and objective apples-to-apples comparison of funds’ performance versus their appropriate style indices, correcting for factors that have skewed results in previous index-versus-active analyses in the industry.

And, here are their most recent findings (they are in the process of rebuilding their databases for 2008):

Indices continue to exceed a majority of active funds. Over the past three years (and five years), the S&P 500 has beaten 65.7%   (72.2%) of large-cap funds, the S&P MidCap 400 has outperformed 68.6% (77.4%) of mid-cap funds, and the S&P SmallCap 600 has outpaced 80.2% (77.7%) of small-cap funds.

The solution is simple: don’t buy any of the funds in the bottom 65.7% 🙂

Great! But how?

Well, Mutual Funds are rated by Morningstar as 5-Star (best performance) to 1-Star (worst performance) so, we should simply buy 5-Star funds, right?

Wrong … because Morningstar – even though it is the best / most highly regarded of all the Mutual Fund ratings services – is only based upon past performance, which is NO guide to how any rated fund will perform in the future as this independent research review found:

They find, for example, that five-star US equity funds significantly outperform one-star funds only 37.5% of the time; at the same time, these same funds significantly outperform three star-funds 18.75% of the time. It is clear then that—compared to a random walk–Morningstar’s ratings system offers no added value in terms of predicting mutual fund returns.

If the best can’t do it, do you think you can?

And, do you want to leave your financial future to a ‘random walk’ in the financial park?!

So, why do funds tend to fall short of the ‘market’?

Well, partly because of a tendency to trade stocks too much (the fund managers like to ‘look busy’) and partly because of fees … Mutual Funds tend to fall short of the market by the amount of the fees that they charge!

The ‘small moral’ of the story: invest in the Indices …

… find a low cost Index Fund that will do the job; by as much of it as you want and hold it for the long term.

Of course, the ‘large moral’ of the story is: who the hell is content with 11.9% maximum long-term stock market index returns, anyway 😉

Who are 'the rich', really?

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“The rich are different from you and me.” — F. Scott Fitzgerald

“Yes, they have more money.” — Ernest Hemingway

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I received a pretty strong reaction from some readers to a post – largely tongue in cheek – that had a ‘social moral’ …

… that ‘rich people’ are actually just ‘people’ who happen to have a few more zeros in their bank account.

For a start, let’s look at how they got there: inheritance; marriage; luck; hard work [AJC: although, ‘marriage’ could also be included in this last one 🙂 ]

It’s a stretch then to say that ‘The Rich’ can be genetically or socially any different to the ‘The Not Rich’: what are the common traits required for each of the above methods? None obvious to me …

So, if anybody can get rich, why should ‘The Rich’ be any better or worse on any human scale (e.g. being socially responsible; giving to charity; etc; etc) than anybody else?

On the other hand, they may have the means to display their characteristics more obviously – for better or worse 😉

But, let’s not generalize, let’s turn to Prof. Thomas J. Stanley, former professor of marketing at Georgia State University (author of The Millionaire Next Door and The Millionaire Mind); I found a summary of the latter book by noted economist Prof. Mark Skousen who says:

Here are the results of his (Prof. Stanley’s] survey of over 1,000 super-millionaires (people who earn $1,000,000 a year or more):

  • They live far below their means, and have little or no debt. Most pay off their credit cards every month; 40% have no home mortgage at all.
  • Millionaires are frugal; they prepare shopping lists, resole their shoes, and save a lot of money; but they are not misers; they live balanced lives.
  • 97% are homeowners; they tend to live in fine homes in older neighborhoods. (Only 27% have ever built their “dreamhome.”)
  • 92% are married; only 2% are currently divorced. Millionaire couples have less than one-third the divorce rate of non-millionaire couples. The typical couple in the millionaire group has been married for 28 years, and has three children. Nearly 50% of the wives of the super-rich do not work outside the home.
  • Most are one-generation millionaires who became wealthy as business owners or executives; most did not inherit their wealth.
  • Almost all are well educated; 90% are college graduates, and 52% hold advanced degrees; however, few graduated top of their class — most were “B” students. They learned two lessons from college: discipline and tenacity.
  • Most live balanced lives; they are not workaholics; 93% listed socialiazing with family members as their #1 activity; 45% play golf. (Stanley didn’t survey whether they were avid book readers — too bad.)
  • 52% attend church at least once a month; 37% consider themselves very religious.
  • They share five basic ingredients to success: integrity, discipline, social skills, a supportive spouse, and hard work.
  • They contribute heavily to charity, church and community activities (64%).
  • Their #1 worry: taxes! Their average annual federal tax bill: $300,000. The top 1/10 of 1% of U.S. income earners pays 14.7% of all income taxes collected!
  • “Not one millionaire had anything nice to say about gambling.” Okay, but his survey also showed that 33% played the lottery at least once during the year!

Thus, we see how the super upper-income families of this nation are not the ones contributing to crime, welfare, divorce, child abuse, and a spendthrift society. But they are playing a lot of taxes and making a lot of contributions to solve these social problems.

But one still wonders, why are any of the ‘Rich = Bad’ believers reading a blog titled:  How to Make $7 Million in 7 years?

Horses are not for courses …

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You can find this post in this weeks Carnival of Personal Finance ….

As I mentioned yesterday, I drafted yesterday’s and today’s series of two posts before the latest round of stock market crashes … it seems that with all the money LEAVING the market at exactly the wrong time – i.e. the market bottom (or, close to!) – everybody is suddenly ‘anti-stocks’ … of course, as soon as we get towards the top of the next bull market all the pro stock / anti-real-estate people will come out of the woodwork again … and, the cycle repeats 😉

There is a great argument for investing in stocks and businesses: Warren Buffett has done it successfully for 40+ years turning himself into either the #1, #2, or #3 richest man in the world (depending upon what’s happening with Bill Gates and Carlos Slim on any given day).

Warren has shepherded his company, Berkshire Hathaway to compounded returns averaging 21% for the past 20+ years doing the one thing that us ‘mere mortals’ have difficulty doing: picking ONE horse and riding it all the way home.

What we seem to prefer to do is invest in Mutual Funds, the stock market equivalent to following all the advice of a ‘top tipster’ in the Saturday Racing Guide for either the horses or the dogs (how many of these newspaper ‘tipsters’ are rich, anyway? If not, how good are their tips, really?) …

… or, we plonk our money into Index Funds, which is the stock market equivalent to betting on every horse in the damn race!

By betting on every horse or – in this case – stock, we are aiming exactly for the average result … for the time frame that we manage to stick it out.

But, wouldn’t we get better results if we simply bought all the stocks in the Index Fund that are above average and ignored all the others? 😉

Simple and powerful strategy, no?

No!

We know that the logic is there: by simply NOT buying the dogs, and concentrating on the (even slight) favorites, we push the odds markedly in our favor.

But, when it comes to stocks – or horses and dogs for that matter – the form guide, tips, and other sources of ‘best buy’ information have proven to be highly unreliable.

The past is simply NO guide to the future, so we are left with either relying on others to pick some winners for us (they will lose us money, relatively speaking, because of the fees they charge, but at least we’ll feel good about having an ‘expert’ doing our guessing for us) or ‘playing the whole card’ i.e. buying the Index Funds …

… the net result is that we tend towards the average (returns) or worse … never better.

So, quite rightly, we talk about the stock market in terms of aiming towards (but, never quite getting there) long-term average returns.

Yet, the total opposite applies to real-estate:

The pro-stock / anti-real-estate movement [AJC: I am neither; I am simply pro-profit 😉 ] points to the average return from real-estate and compares it to the average return from stocks and says “aha … stocks are better!”

Putting aside the leverage, tax, income and other benefits of real-estate, the problem is that nobody buys the whole card when it comes to real-estate …

… there is no Index Fund for real-estate!

[AJC: well, there might be an artificial ‘index tracking’ ETF that does this … but do you know ANYBODY who’s ever bought it? 🙂 ]

You either buy a Mutual Fund (technically, called a REIT) that buys a selection of real-estate for you, based upon what some inside ‘expert’ predicts will do well (after fees, fees, fees) …

… or, you buy one or more properties yourself.

You see, unlike stocks, you NEVER buy the market, so comparing average returns is just plain dumb.

There is also one other key difference:

You DO know how to pick real-estate … you have at least some experience: you bought your own house, didn’t you?

You chose a ‘nice area’, close to schools, transport, in a nice neighborhood, didn’t you? And, if you still live with Mommy and Daddy, well, they bought a nice house, etc., etc. … right?

Gotcha!

Right there, you bought in the top half of the market in terms of growth … you just beat the (real-estate) market average!

When it comes to stocks, not one of us is Warren Buffett, so we ‘gamble’ on the performance of some market index that we don’t really understand …

… but, when it comes to real-estate, we are all like Warren Buffett – we all have the capability to pick the horse … oops, house … that will perform better than average.

And, even if we only get ‘the average’ return on our real-estate investment … we are going to do two things that we are never going to do with stocks:

1. We are going to leverage our investment – we will almost always take a mortgage on real-estate, but we will hardly ever borrow to buy an Index Fund

2. We are going to invest for the long-term – we will most likely stay in the real-estate investment for at least 7+ years, but we will most likely try and time the market (i.e. get scared and sell at the first sniff of a ‘down market’) if we buy stocks or Mutual Funds, thus absolutely killing our potential returns.

Still don’t believe me?

Then why is that conservative old banker prepared to back your real-estate acquisition with a couple of hundred grand?!

[AJC: at least until a couple of months ago … and, again in a couple of months time]

See if he’ll do the same when you want to go and visit your bookie … or stock broker 🙂

The time of your life?

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It’s interesting that I drafted this post 3 or 4 weeks ago, just before the current wave of stock market crashes hit us; now, of course, I am ‘preaching to the converted’ …

We spoke about getting – or beating – average returns from either stocks or real-estate, but David points out: what is an average financial return?

I agree with you about the number. However, think you should use real rates of returns not some theoretical possibility. For example your number on mutual funds is 9.5%. Well actual rates of returns for individuals investing in mutual funds averaged 4.4% over the last 20 years (Dalbar, Inc. Vanguard, etc.).

So, what are the average returns for the stock market?

First, define the ‘stock market’:

Do you mean the US market? International (if so, which country or countries)?

If US, do you mean large cap (the stocks with the largest total stock market value or ‘capitalization’)? Or, small cap? Or, do you mean stocks listed one one of the alternative exchanges such as NASDAQ?

Or, do you simply mean ‘all’ stocks listed on the New York stock exchange (NY Composite), or ‘only’ 5,000 stocks (Wilshire 5000) or perhaps ‘just’ 2,000 of the listed stocks (Russell 2000)?

If ‘large cap’ do you mean the top 500 stocks listed on the NY stock exchange (S&P 500) or perhaps the just the largest 30 (DJIA)?

The point here being that there is no such thing as an ‘average return for the stock market’ … you have to decide how you want to slice ‘n dice it first!

Semantics aside, let’s pick an Index – say, the S&P 500 – how has it performed?

Pick a Number!

Here is data taken from Econstats.com and summarized here into the average returns of the S&P 500 for various 10 years periods from 1989 – 1998 through to 1998 – 2007:

10 years too short?

OK, let’s find an online calculator and see how the S&P 500 performs over various 25 year periods:

In case you can’t read the diagram:

The best 25 year return (since 1871) for the S&P 500 was 17.6%, but the worst was 3.1% .. yah think that might make a difference if you your whole damn retirement strategy was hinging on achieving ‘average’ returns?!

BTW: If, you were ‘lucky’ enough to get the average, it was 9.4% …

… but, here’s the problem:

In ‘real life’ people don’t get the average!

Firstly, they rarely choose the S&P 500 … they usually gamble on just one or just a few Mutual Funds that used to perform better than the market (but, rarely ever do again).

Secondly, they pay fees that knock down returns by an average of 1.5%.

Thirdly, even if they do buy into a low cost Index Fund that tracks (say) the S&P 500, they actually rarely stay the course for the full 25 years (take another look at even the 10 year chart, above, if you want to see what that can do to the reliability of your returns).

Don’t believe me?

Check out the Dalbar Study

… then, scroll all the way back to the graph at the very top of this post:

Pictures really do tell more than a 1,000 words 🙂

Passion before money …

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I’m about to find out if you can make money online: click here to read the latest installment in my new online money-making adventure!

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I talk a lot on this site (and, on http://7m7y.com) about money being there to serve your Life …

… yet, we slave our lives away to the pursuit of money. Go figure!

So, when working out your Number – that ‘magic number’ that tells you if/when/how you will retire – it is my contention that you first need to start by understanding your Life’s Purpose.

It’s nice to see that somebody on the finance community agrees with me: George Kinder, author of The Seven Stages of Money Maturity!

In fact, George is a financial planner who is one of the early pioneers / practitioners of a form of financial planning called ‘Life Planning’ … where your financial plan is designed to support the life you want, not necessarily the life that you have.

I have provided some exercises to help you understand your Life’s Purpose, hence your Number; similarly, George Kinder poses three questions that he considers important in achieving a similar result (you may have seen these on Oprah):

1. “Assume you’ve got all the money you need – enough for the rest of your life. Maybe you’re not as rich as Warren Buffet, but you never have to worry about money for any reason. The question is, what would you do with it? How would you live? Feel free to let your imagination roam. What would you do with it all? Think for a moment, then write down the answer … ”

2. “You go to the doctor. The doctor discovers you have a rare illness. He says you’re going to feel perfectly fine for the rest of your life. But, he says the illness will prove fatal. The sorry outcome will occur sometime within five and ten years. It will be sudden. The question is, now that you know that your life will be over in five years, how would you live it? What would you do?”

3. “This question will sound a bit like the previous question, but it’s different: It starts the same way. You go to the doctor. You’re feeling perfectly healthy. And again the doctor says you have a serious illness. But then the doctor says, ‘You only have 24 hours to live.’ So, what did you miss? Who did you not get to be? What did you not get to do?”

Of all these questions, obviously the last is the key … and it is the purpose of the Rear Deck Speech – designed to make you think past ‘things’ and to the more deep/meaningful aspects of your ideal life.

These questions, however, will help you if you’ve been struggling with the Finding Your Life’s Purpose exercises that I provided …

The fractal market …

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What does this fern leaf and the stock market have in common?

Surprisingly, a lot!

For a start, this is not a drawing or photo of a real leaf … it’s a actually a computer-generated image derived from just a few short lines of computer code.

It’s a ‘fractal image’ – a branch of mathematics that uses randomness (with many similarities to ‘chaos theory’) to describe natural objects so that they look ‘real’ to the naked eye … again, using only a very simple mathematical formula!

The two most interesting things about fractals:

1. They are easy to generate – they are based upon replication of a very simple formula, over and over again. Order-in-Randomness takes care of the rest

2. As you scale up or down the picture looks remarkably similar ….. take the leaf to the bottom right and blow it up to full-size and you will see something very similar to this original image

What does this have to do with the stock market? Well take a look at the following two graphs:

These both indicate movements in the Dow Jones Industrial Average; what’s interesting isn’t the direction … it’s the shape …. they both indicate a random series of up/down movements in a general direction (that, too, seems to change randomly).

The interesting thing about these charts is that they are the same chart (almost)!

One is a 1 year view of the Dow Jones, the other a 3 year view (it should be easy to work out which is which!) …

… you see, as the IBM scientist who ‘founded’ fractal geometry (well, actually revived … it was ‘discovered’ in the late 19th century by a scientist named Julia) in the 80’s discovered, the stock market is fractal.

While the movement is seemingly random, each piece of market movement when enlarged looks very similar to the larger scale movements … so we have up/down movement in the stock market at every scale: daily, weekly, monthly, annually that actually behave quite similarly.

The frustrating thing is this: chaos theory abounds.

Chaos theory says that when systems become complex, a very small apparent change in one variable (i.e. number) can suddenly have a HUGE change on the whole.

It’s why they say that a butterfly flapping its wings in Japan can cause a hurricane in Louisiana …

You can’t think of a system (except in Nature) more complex than the stock market: thousands of stocks make up a market … each one is a real-live business generating revenue, controlling costs, dealing with market/economic/government changes on a daily, or even minute-by-minute basis.

The whole shebang can move up … down … or sideways. But, within each movement is the movement of each company’s stock. The price of each individual stock is fixed by the investors: are they net buyers or sellers in this micro-second (that’s how fast the stock exchange moves)?

Suddenly, one mutual fund executes it’s order to sell Company A and the effect is minimal, either on that company’s stock or on the market. But, on another day a ‘perfect storm’ arises (an announcement by the feds of a change in interest-rates; a war in the Gulf erupts; etc.) and that same sell-off triggers a panic.

Who can predict it?

Nobody … and, that’s the point … look at the charts: do you see anything that looks remotely predictable in that lot?

Do you want to bet your financial future on where the stock market is heading, even for the next 3 years?

I don’t … but, I do know that while the market can (and, does) move dramatically & randomly, there is an underlying force driving it relentlessly upwards:

The companies that make up the market are producing widgets, and inflation is always making the price of widgets go up/up/up (with an occasional, but only short-term pull-back) inevitably pushing their profits (hence stock price) along with it … where inflation goes, the stock market will surely follow … eventually.

But, who can say exactly when?!

So always be a buyer and holder … never a seller be.

Your Number

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Nowadays, somebody only need to write “The” and “Number” next to each other and we automatically know what it means: the amount that you need in your nest-egg so that you can finally throw off those corporate shackles and ‘retire’ …

… well, do anything other than ‘work’ for your daily crust.

The only problem is that nobody tells you how to find The Number!

I should know, I read books on the subject and they all focus on rubbish like: “multiply 75% of your pre-retirement’ salary by 13”.

Which has some obvious problems:

1. How do I know what my pre-retirement salary will be?

2. What if I spend more/less in retirement than when I was working?

3. How will I know my money will last?

The reality is that – for most people – there is (and should be) a total disconnect between how you make your fortune and how you spend it!

In other words, just because you earn $x before you retire, it doesn’t mean that you will spend 75% of $x to 125% of $x (as most financial authors assume) in retirement.

So, I came with my own method – and, it worked for me!

Here’s how:

1. Complete a simple spreadsheet of your major (non-investment) personal purchases, income, and living expenses now and over the next 1, 5, 10, and 20 years. Don’t forget to apply the Inflation Adjustment Factors!

2. To help I have listed the typical expenditures of a $100,000 a year lifestyle, a $250,000 a year lifestyle, and a $550,000 a year lifestyle. These should provide some reference points to calculate your own future living expenses.

3. Use the spreadsheet to calculate Your Number and Your Date.

That’s it!

… and, I’m betting that it won’t even resemble your expected final salary – in fact, I’m betting that the number is so damn big’n’scary that you won’t even get there just on any typical salary – even with your 401k maxed 😉

A new look at our 7 Millionaires … In Training!

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I’m hoping, but not sure if you are staying in touch with the goings on at our ‘sister site’ http://7m7y.com – the home of what I still call our ‘grand experiment’ to make a lot of people rich by applying the principles that I write about here …

Jeff asks:

I have a question about how your readers now fit into the conversation on 7m7y.com as the site’s focus changes. Since you have named your 7 MIT the posts and comments have naturally shifted focus toward those individuals. As I review the discussions, it appears to me that the conversations and comments have become almost exclusively between you and the seven with little engagement from outside.

Do you see a place here still for the team of benchwarmers who have been to practice but didn’t make the team? I have learned a lot about myself and my desires through the series of exercises that led up to the 7MIT selection. Will there be more “try this at home” exercises moving forward or will 7m7y.com become increasingly tailored to the seven?

You see, I don’t just want to create 7 Millionaires … In Training! I want to create 70, or 700, or even 7,000 Millionaires … In Training!

So, there are no ‘bench warmers’ in our 7m7y Community – don’t be a wallflower (!) – but, you do get to choose your level of involvement:

1. You could just passively read along and pick up a lot of valuable information that isn’t in this blog, and

2. You could comment/criticize/congratulate, and

3. You could ask/answer questions of anybody (including the 7MITs and me), and

4. You could participate in the same exercises that I purposely post online, and

5. You could even share your own progress by e-mail/comment/feedback.

If you do want to participate – and I sincerely hope that thousands of readers like Jeff will – I suggest that you hop over to that site and bookmark it because it is an unusual blog … by it’s nature: http://7m7y.com is fluid, not static!

That’s also why I have come up with some additional navigation options for that site … let me know what you think!

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