Tag Archives: millionaire

It's not what you earn that counts …

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I wrote a post a short while ago assessing whether the rich should invest in Index Funds.

I received a few interesting comments, including this one from a reader named Mike, that I thought I should share with you all:

Would you do a post that considers the lifetime earnings of different people? Reason being I read an article that high school graduates earn an average lifetime earnings (from 25 to 64) of $1.2 Million. For people with a college degree this goes up to $2 million, with a Masters it’s up to $2.5 million and a PhD brings in $2.9 million. For people with professional degrees (doctors & lawyers I presume) the number goes up further to $4.4 million. Still not bad, an average of $100K per year for the latter category. For the purpose of this article I’m assuming that all earnings are reconciled to net present values.

So you’ve managed to earn $7 million in 7 years… that’s really impressive and nearly twice that of a doctor’s lifetime earnings. What have you earned throughout your life?

For me I’ve earned $2 Million in my life to date. More than half of this has come in the last 3 years. I’m 35 now and have been working since I was 23. I figure between now and age 65 I should be able to earn a total of about $8 million more with an medium / optimistic case. I will pursue investments but realize high risk brings high reward but potentially devastating losses. For example I’ve taken a large position ($110,000) in a Chinese stock with what I believe to be very strong fundamentals and have researched this company for the last 4 months in detail. In the last 3 weeks the stock is down 30% from where I bought in…! So I don’t put everything into high risk investments for that reason.

I think starting a business has elements of this… if your business crashed you would have lost it all I guess?

Firstly, here is the official government report that I believe Mike is referring to:

http://usgovinfo.about.com/gi/dynamic/offsite.htm?site=http://www.census.gov/prod/2002pubs/p23%2D210.pdf

However, I am totally unconcerned with income or lifetime earning potential … I believe that there is very little correlation between what a person earns today – or over their lifetime – and, how wealthy that they are …

… you see, it’s not what passes through your hands, but what sticks that counts!

I remember reading the book that passes for a ‘bible’ amongst the personal finance community: The Millionaire Next Door (because, to a casual reader, it appears to equate ‘frugality’ with ‘wealth’, which of course is only a small part of the story) and was struck by the story of two doctors:

Both were on super-high incomes, yet one doctor was ‘rich’ and the other ‘poor’ …

… one had saved/invested a good proportion of his ridiculously high earnings, but the other had lived the ‘high life’ and was in debt.

Same income … vastly different outcome.

So, when Mike asks:

So you’ve managed to earn $7 million in 7 years… that’s really impressive and nearly twice that of a doctor’s lifetime earnings. What have you earned throughout your life?

… I say: I didn’t ‘earn’ $7 million in 7 years in the traditional sense; plenty of corporate CEO’s, super-high-flying attorneys, and some medical specialists earn more that that in 7 years (some in 1 year).

In fact, at the time my ‘take home’ and total combined business incomes were less than many professionals earn, and certainly nowhere near the stratospheric heights that I just mentioned …

… no, I ‘earned’ the $7 million by investing my far more modest earnings and my Net Worth grew faster than my earnings ever could.

Keeping the ‘two doctors’ story in mind, do you now see why I don’t care what my lifetime income was? If not, consider Mike’s closing question:

I think starting a business has elements of this… if your business crashed you would have lost it all I guess?

The answer to this question is the key to Making Money 301 (keeping your wealth) and explains why income is so unimportant from a wealth perspective:

For the ‘poor doctor’, when his income stops so does his (financial life); if he loses his ability to earn his ‘paycheck’ through some disaster (he certainly doesn’t have the luxury of retiring, yet) he is just on broke!

But, it’s possible that our ‘rich doctor’ may be O.K. albeit at a lower standard of living … at the very least, he is debt free. At best, he has some passive investments to help sustain him and his family … probably not enough to sustain his current lifestyle, though.

In my case, I ploughed as much income into investments as possible and waived all ‘pay increases’ (I could have ‘paid’ myself a higher proportion of my business profits, but chose not to) …

… in fact, my wife kept working, as she earned more than I took home.

In doing so, we put ourselves in a position where it would not matter if the businesses crashed … we would not have lost it all. In fact, the bulk of the $7 million in 7 years was in passive real-estate … selling the businesses just two years later was the ‘cream on top’.

The Making Money 301 ideal is this:

Earn money, plough 100% of it into investments, live off the income of these investments as though you were already retired … increase your spending only as the portfolio income increases.

Simple and self-sustainable … of course, for most people, the ideal is not achievable, which is why you start with ploughing 10% of you income into investments, and build from there …

BTW: Visit this week’s Carnival of Personal Finance; we have an article published there ,,,

The lament of the middle-class millionaire ….

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I must confess that I understand EXACTLY what this ‘poor woman’ is saying …

http://www.cnbc.com/id/15840232?video=768292103

Ryan (who is one of the Final 15 in my 7 Millionaires … In Training! ‘grand experiment’) sent the link to me saying:

About 6 months ago I did a similar exercise to determine how much I would need to “retire” and live the kind of life I wanted to (travel, philanthropy, golf, bigger house,activities, etc.). Although it seemed like a stretch to even write down, I settled on $10 million in 10 years. After watching a show on cnbc, in particular this clip, http://www.cnbc.com/id/15840232?video=768292103 , I think it’s time to revise my estimate!!! And to think that a couple of years ago I thought if you had a million dollars you could do anything you wanted.

The exercise that Ryan is referring to is the culmination of a series of posts on http://7m7y.com designed for one purpose and one purpose only: to help you find your Number.

This video – I believe – helps explain why I think that your Number should be couched in terms of required living expenses rather than some nebulous lump sum (such as $1 million; $5 million; $10 million; etc.) … although I also show you how to calculate the ‘lump sum’ that you will need.

But, Ryan doesn’t need more than $10 Million (a.k.a. $500,000 per year … indexed for inflation) to live a life that simply involves “travel, philanthropy, golf, bigger house,activities, etc.”; he just needs to realize that on $500k per year:

1. He will not be able to afford ownership (fractional or full) of multiple houses, jets, yachts and the like (although one used Ferrari isn’t out of the question), and

2. He will NOT be rich … rather ‘comfortably off’ – at least, according to Felix Dennis the rather quirky (and exceedingly rich) British/American magazine publisher.

… it’s a tough life 😉

Is this what a transition to Money 201 should look like?

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I received a message from Ethele, a fellow Networth IQ member.

I love this question because it is a chance for me to review all the basics of the 7million7year Philosophy – so new reader, or ‘old hand’, I encourage you to really study this post and all the links that I have included!

Ethele asks:

I was wondering if you can give me some feedback on my plans for moving from Money 101 to Money 201.  At worst, I figure I’ll learn I was silly to ask 🙂  I’m still in the early 101 stages, but want to build a good plan for moving to 201 so I am ready to take advantage of opportunities as they arise.

Our situation:  I only recently got out of debt and bought a house.  Due to the expensive area we live in where the bubble bursting hasn’t been felt very strongly, we spent $370,000 on our home.  We got a 0% down loan, and are paying PMI.  Our NetWorth is currently growing by $1.7K / month, mostly from my J.O.B. I am 25, married to a stay-at-home-parent, with two kids.  Seeking an additional income from my husband isn’t a sensible move right now (he’s anti-J.O.B., has low earning potential, and is not very ambitious), but I am hoping to get him involved in our Money 201 strategy when we get there (and after the kids start kindegarten).

My current plan for getting through 101 is:
1.  Build a small 2 month emergency cushion (by 2009) and invest 6% income into a 401(k) to get the employer match (6 months)
2.  Pre-pay on our mortgage until we have 20% equity in our home (about 4.5 years with current rates of extra income – but will probably be accelerated by raises and bonuses).
3.  Refinance our home, get rid of PMI, lower our payments.
4.  Grow our cushion so we have 6 months expenses (should take about 6 months or less) and can take risks.  Maybe have this additional cushion money do some light work, but nothing too risky.
5.  Start investing our extra income (I’m still fuzzy on how – index funds?  Risk just means we might stay in 101 a little longer – or less long, if we get lucky) and grow until we can invest in a Money 201 strategy – leaning towards rehab / flipping or a rental property, so probably 20% down plus a little more to invest somewhere besides real estate.  This will probably take another three years or so.

Is this what a transition to Money 201 should look like?

Firstly, I responded to Ethele to let her know that I can’t give direct/personal financial advice: (a) it’s not legal – I am not a licensed financial adviser, more importantly (b) how could I possibly have enough information from just one e-mail to know enough about Ethele’s capabilities, hopes, desires, and true financial status to make any reasonable recommendations?

But, I can make some general observations that may assist us all:

Making Money 101 is the basic stage of getting your personal financial house in order … it is the ‘meat and potatoes’ of almost all personal finance blogs that I have read, so why would I bother to even talk about it here?

I agree!

If your plan is to work your entire life; save only via your 401k and buy (then pay down) your own home aiming to retire on $1 – $2 Million when you are 65 then you need read no further.

However, I feel that my audience wants more … they have a ‘big dream’ … they want it now (well, soon’ish) … and it requires fuel – lots of it (money!) – and lots of free time, to boot!

If that’s you, Ethele, then we DO need to revisit Making Money 101 in this blog, because we need to explode some of the myths that will hold you back from your goal of being rich … even before we get to Making Money 201.

Myths like: building a cash emergency fund; paying down our mortgage; diversifying through Index Funds.

So, Ethele, if you are planning to Get Rich Slowly, this isn’t the blog for you … and your plan looks excellent!

However, if you are planning on getting rich(er) quick(er) then you are still on the right track, with a few somewhat controversial tweaks that you may want to consider:

1. Do the math on the 401k + employer match against what you can achieve elsewhere. I have no problem with any answer that you come up with.

2. By all means keep a couple of months of expenses in the bank, but can you find something better to do with 6 months worth of expenses than having it just sit in CD’s: Can you pay down consumer debt? Can you put down a deposit on an investment property? Can you finance renovations to increase rent on something you already own?

3. Can you find a better investment than a diversified Index Fund (by all means use this option over bonds / Mutual Funds, if that’s all that’s available to you inside your 401k)? Maybe Rule # 1 Investing by Pete Town will get you interested in the stock market, or you can consider some of the real-estate options mentioned in #2., above?

4. Does your house fit into the 20% Rule? This is not a measure of % equity that you hold in your own home, rather a measure to ensure that you are always investing at least 75% of your net Worth (as measured by Networth IQ), allowing 5% for other purchases (cars, furniture, etc.).

By doing this, you are indeed transitioning to Making Money 201 … are you sure you need to – and are mentally ready to – make that transition?

So, for all the Etheles out there, food for thought?

Retirement Planning Made Easy!

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Meg, a reader, asks:

My goal has long been to reach $1MM (net worth, not assets) by age 30 – which is under 6 years away for me. I’ve been working actively towards the goal for over a year now, so if I reach it it will have been $1MM in 7yrs. Not nearly as impressive as 7MM in 7 yrs, but that’s if I do it the most conservative way possible with minimal risk and leverage. If all goes according to that plan (which primarily involves utilizing real estate leverage) I will reach $2MM by 35 and then more than double it again by 40…of course that’s almost 2 decades away. Maybe I should look into ramping up my plan with some risk!

[AJC: My response …]

Meg,

Sounds great!

Now, I suggest that you work backwards:

How much income do you need (forget inflation for now, just use today’s dollars) and by when (figure costs of family, college, travel, etc.) … no more work for you OR hubby from then on!

OK, then double that amount for every 20 years until The Date (that accounts for 4% inflation) … and, multiply by 20 (if you want to be really conservtive, multiply by anything up to 40) to get The Number – that’s your Net Worth target (assuming that you also obey the 20% Rule).

Now, do you need to ramp up your plan with some risk, or not?!

Retirement Planning Made Easy! )

Good Luck!

AJC.

Why 99.999% of businesses fail …

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This short (less than 2 minute) poorly made commercial for “Dan’s” product or service (or whatever it is that he is offering) is delivered by a ‘talking’ toy car.

Aside from that, he gives a great summary of what it takes to have a business rather than a glorified job. On that basis alone, it’s worth the effort to try and watch without snickering.

Why retail businesses suck …

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My blogging friend, JD Roth posted a great reader question recently on his super-popular Get Rich Slowly blog:

I’ve been at the same job since I graduated from college nearly ten years ago. Lately I’ve lost the passion for what I do and am aching for something completely different. I want to start a retail shop.

Two problems:

  1. I’m paid well here, so I’m going to have to figure out how to make this transition in a way that won’t hurt the family’s finances.
  2. I don’t have any real business training, and the thought of keeping books for the business gives me stomach pains.  But there are resources out there to help with the logistical side of running a (retail) business, and I know where I need help and will pay for it (accounting, interior decorator, etc.).

Well, this reader is exactly where I was not that long ago … nearly 10 years into a high-flying corporate career – with all the perks that go along with it (cars, travel, expense accounts) – and, I got bitten with the entrepreneurial bug …

… just like getting bitten by a mosquito and catching West Nile (the non-fatal form!), once you get it, it’s almost impossible to shake off.

So, I have a question for this reader … in fact, it’s probably the most important question that he needs to answer before going INTO this (or any) business:

Who are you going to sell it to when you finally decide to get out?

If his answer is: “whoever wants to buy my retail store” …

… then I suggest that he doesn’t even start, because he will effectively be trading his high-paying corporate job (with perks) for a low paying, slave-labor ‘job’ in retail.

Retail sucks because: there are way too many overheads; your balls are tied up in leases and inventory; and, you’ll be working 60 – 80 hr workweeks for the rest of your life.

BUT, if the reader can honestly & passionately answer with something like:

“Well, I have a unique niche/vision, so I’ll be opening my first store in 2008; 3 more in 2010 and 50 across the Eastern seaboard by 2015, then I’ll IPO or sell to Sears”

… he just MAY have an opportunity worth pursuing!

The reader then went on to ask:

The bigger issues, I think, are how to get from where I am now — sitting behind a desk doing the job I’ve been doing for 10 years — and getting the momentum going to really make this happen (and to not fail at it, leaving me jobless and penniless).

No, Little Grasshopper … if you have the passion, and can feel it in your bones … and, if it is REALLY an opportunity worth pursuing … then you are either all wet or all dry …

… you need to have a financial buffer (well, I started even without that … but, then again, I’m one crazy dude!), then get out and Just Do It!

You will NEVER start a retail business like this whilst still working full-time … there are just too many roadblocks in your way: scouting for locations; negotiating leases; sussing out the competition; negotiating with suppliers; hiring your first employees; sucking up to the bank manager; and, so on.

Would I start a retail business … unlikely.

How would I start a business today … exactly the same way that I am now starting two:

Come up with an Internet-based business concept; look for partners who can build the business for equity; put up a little seed money; and, stay in my day job as long as possible (well, this last step doesn’t apply to me … but, you get my point?).

Then I’d cross my fingers, close my eyes, and jump right in 🙂

Flipping / flopping?

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On Wednesday, I pointed out that “if I don’t have direct experience in the specific area of a question, I will say so”.

This was the case with my response to Joshua (coincidentally, another 7 Millionaires … In Training! Final 30 applicant) who used a recent post to ask me a question about ‘flipping’, which I have never done …

… at least not for real-estate (there’s a strong case to be made that a year or two ago I ‘flipped’ a business for a rather large profit … but, that’s another story).

[AJC: Josh, I didn’t mention it then, but I would consider Dave Lindahl an expert in this area – I haven’t met the guy, but I have studied a lot of his material and consider it good-to-great, as is John T Reed’s stuff on real-estate in general … not sure what John has to say specifically about flipping: you should check]

But, Josh, I do have some advice for you:

Treat flipping as a business …

… it’s probably closer to real-estate development, than it is to real-estate (long-term buy-and-hold) investing.

The downfall of many a flipper (or developer) is when the market suddenly turns and you are holding inventory that you can’t afford to cover the holding costs on.

Since we are closer to the bottom of the current cycle than to the the top, this will become less and less of a fear as the market eventually (and, inevitably) starts to rise again … it’s the next ‘correction’ that will catch you out!

Here’s what happens:

You buy your first property – it might be a house that you intend to live in for a while – you fix it up … and, you sell it at a profit. Maybe you pick up $10k – $50k in the process … maybe more.

Wow!

So, you do it again … then you buy two.

Pretty soon, you are earning a nice little side income buying/rehabbing/flipping houses all over the place … you don’t even bother to rent them out – you are purely looking at this equation:

Profit = Selling price – (Buying price + materials used + interest + closing costs + reselling commissions)

The problem with this formula is that you now have a second job!

Your time isn’t factored into this, since you are doing the work yourself … but, your ‘salary’ is actually included in what you call profit. In a great market, you are earning a great salary … in an ‘average’ market, you are probably not really earning all that much.

Here’s what to do:

Treat the rehab. business as exactly that … a business. Go and get a contractor’s estimate or two and add that cost into the formula (don’t forget to inflate the estimate by 20% to cover contingencies) to get:

Estimated Profit = Estimated Selling Price – (estimated Buying price + contractor estimate + interest + closing costs + reselling commissions)

Now, if the ‘profit’ that you estimate makes the project worth while, then you just may have a nice little ‘business deal’ going on here …

… and, it’s then up to you if you decide to hire yourself as the contractor!

But, there is a problem that I see with this ‘business’ … and, it’s a problem that arises out of too much success!

Yes, success makes you more aggressive … makes you do more and bigger deals in order to grow your little business into a bigger and bigger business (buying more/bigger properties to rehab).

That’s when you need to do a couple of things:

1. Move into multi-family properties,

2. Outsource the work,

3. Have a buy-and-hold contingency

The first two are obvious: these are the steps that will pave the way to unlimited growth in your (now, real) business … ALL businesses need to remove obstacles to growth, because a stagnating business is an (eventually) dying business.

The third one will (hopefully) protect you against the inevitable selling problems and market ‘corrections’ that will come up from time to time.

Which brings us to the subject of developers (those developing ‘on spec.’ to then sell ‘in pieces’ to investors and owner-occupiers):

Developers have all of the same issues as flippers, only on a larger scale … many flippers, in fact, end up growing to become developers themselves.

As developers become successful they tend to make two major mistakes:

1. They move into bigger and bigger developments … max’ing out their financial capabilites in one or two large ever growing deals. One market correction can sink them.

2. They start bringing teams of ‘helpers’ in house (architects, designers, builders, etc.) and they have to ‘feed the team’ with a constant stream of projects … it’s very hard to wind back if the market starts to tighten up a little.

So, while I can’t tell you much about the business of flipping or developing, I can tell you that like all businesses you have to be able to handle:

a) Growth, and

b) Contingencies

…. both very hard to do in a business that requires taking huge financial risk for each project.

Here’s what the smartest flippers and developers do: they start off buying to churn …

… this churn (i.e. quick reselling) generates chunks of cash; instead of investing all of this chunk of cash in their next (bigger) project, they divert some to buy-and-hold real-estate.

For example, they might rehab. and reposition an apartment building as condo’s …

… they might then sell most condo’s, but try and keep a couple for themselves as rentals. Do this a few times, and you just might have something left over when the next crash wipes your ‘business’ out (assuming that you have set up your business in the right legal entities so that your ‘hold’ portfolio can’t be touched).

All in all, what can I say?

Some people make huge fortunes (and others lose theirs) in exactly these types of businesses, so who am I to say that this is something that you should/shouldn’t do to start making your own fortune?

Good Luck!

I’m about to find out if you can make money online … Part 4

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Well, it’s been a while since I’ve hunted for the ‘next big thing’ on the internet … as I’m still trying to find a way to make you all rich online …

…. of course, when (if I ever) do, I won’t actually sell you anything – or even refer you to somebody who will pay me a nice big, fat commission – because that’s not how I operate.

But, I think the point is pretty moot if this e-mail that I received from “Brent L” (I won’t tell you his last name) that I will paraphrase for you here, is anything to go by. I have to paraphrase it, because I deleted it before I realized that some of you may actually be tempted to go for it:

AJC [he used my name, sweet],

Here is something that has made me a lot of money and might make your site some money too …

[click affiliate link here]

Brent L.

Well, I pretty much check everything out – I’m a curious fella – and here is what I found … a web ‘sales letter’ that said, in part:

[AJC: unfortunately, the site that hosts my blog forbids links to ‘spam’ sites … so you will have to trust me on some of this … don’t worry, sooner or later somebody will e-mail you a similar breathlessly worded ‘hot tip’ and you will get to see the sales page … just don’t be tempted to sign up unless you really know what you’re doing]

GET FREE GOOGLE PAY PER CLICK ADS

This is an incredible system developed by none other than Dr Jxx Cxxxx, MD (retired) who found a little-known “twist” in how to use the pay-per-click (PPC) and paid-for targeted advertising programs at Google™ and the other search engines.

Say you went to the heads of Google, Yahoo, MSN and 100’s of other TOP Search Engines, and got to be good friends with them, and then they suddenly said to you:

“Don’t worry ever again on paying for  advertising with us – we’ll just let you advertise on our search engines, but we won’t charge you – so feel free to sell whatever you want, using as many keywords as you want, and we’ll even place YOUR ADS at the TOP of every FRONT Page and for EVERY SINGLE KEYWORD you choose!”

So, the promise of free advertising on Google adwords (those little ads that you see on the side of most web-pages … except mine) … you’d be crazy not to take it up to advertise anything that you wanted on the internet! You’d make millions!!

Right?

Until we check out a little bit of semantics … you see, I hunted down the Good Doctor’s own words on this web-page where he defends his product and advertising with a clever example:

I went to a carnival one time as a young man and a fellow was shouting “Buy 1 get 1 FREE!” and I asked him:

“Which one is the free one, and which one is the one I have to pay for?”

He held up one and said “If you buy this one, you get this one here free!”

I told him I would just forego the one that would cost me money, but would surely take the free one for free.

He slapped me on top of my head, and said “Get out’a here, punk!”

[You think I have a deep New England accent! – You should’a heard this guy!]

His point was that in order to get the one for free, I had to buy at least one – which to me I thought meant the “free” one wasn’t really free at all!!

—-> But this is an ACCEPTED advertising practice used by fast foods restaurants, your local businesses, and so many more businesses I can’t even begin to name them all! —->

So, this should give you a clue – the guy (a ‘doctor’ apparently) is hinting that his own product doesn’t really get you free ads on Google … it’s just ‘like getting ads for free’ …

… there’s only one way that I know of to do that:

It’s to bring in as much money (or more) from running your own ads to pay for the ads that you put on Google … so, in a twisted kind of logic, the ads on Google (that you DO have to pay for, by the way … they aren’t free at all! So, of course, Google loves you!) bring you enough customers to your own site to pay for the ads …

… well, isn’t that the purpose of all advertising?!

So, why do I need to pay $67 for an e-book (yep … a $67 e-book) to learn that?

Here’s an exerpt from a UK site that explodes Online Venture Attempt #4:

Ok, so what is in the ebook? Great advice on how to get millions of pounds (dollars) worth of Google Adsense advertising for nothing? No. Here’s the system:

  1. You select as many popular keywords as you like;
  2. You bid the highest possible price for all of them (getting you to number 1 foreach of them);
  3. You fill that website with advertising and affiliate links which will make you money.

That is the “system”.

Forgive my ignorance, but surely that is not free! In fact, that is the whole premise – they aren’t actually FREE, you pay for them, but they are as good as free because of all the lovely cash you’ll be earning. What bollocks. What about all the countless people who click onto your site, and sooner or later, realise that it is just full of shit that they don’t need or want to read. They go elsewhere, yet you’ve spent $2 for them to visit.

Now, you may not understand fully what this is all about, because I can’t give you the link to the web-site (the spam-checkers on my hosting site will send me a cease-and-desist order, thinking that I’m actually promoting the site rather than debunking it! BTW: that’s a pretty good ‘smell test’ right there, isn’t it?) …

… but, I’m pretty sure you will come across this idea soon, if you haven’t already, so bookmark this page.

One final point: I wrote a post a while ago about being able to apply very simple common-sense logic to things that just seem to good to be true.

The test on this one is this:

1. This is the internet … so, news travels fast!

2. So, don’t you think that by the time that you have heard of this, that Google would have, too?

3. And, if by some miracle the Google Ad Execs hadn’t heard of this system already, don’t you think that the Good Doc would want as few people in the know as possible

4. If so, would he risk his self-proclaimed $67 Mill. empire for a few lousy extra million in e-book sales giving the precious ‘secret’ away?

5. And, since #2 is much more likely than #3, don’t you think that Google would have changed the rules by now, if the Doc had really found a way to place top Google Adwords for free?

Hmmm … smells pretty bad to me. Pass!

Anyone else come across this product yet? Anybody try it?

It's a Wonderful Life …

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There was a great black-and-white movie that they show every Christmas, without fail, that starred Jimmy Stewart. The movie is called It’s a Wonderful Life and, if you’ve never seen it, I highly encourage you to find it and watch it.

It’s a particularly great – and relevant – movie for anybody following along (hopefully, actively!) in my 7 Millionaires … In Training! ‘grand experiment’.

Even though the movie was a financial ‘failure’ when it was first released, and failed to win any of the 6 Oscars it was nominated for, it has since been recognized for the tour de force it really is and the film has since been recognized by the American Film Institute as one of the 100 best American films ever made, and placed number one on their list of the most inspirational American films of all time.

The premise is that George (Jimmy Stewart) has a Savings & Loan business that defaults and he feels that he has let his town down and tries to commit suicide. An ‘angel’ then shows George what life in the town would have been like without him – showing him how many people he ‘touched’ in his life and gives him a second chance.

This clip – the final 9 minutes of the film – picks up there …

The financial relevance?

Nothing and everything, as those following here are about to find out … but, it may help to explain why I have asked them (and, you, if you want to follow along actively or passively):

  • To answer 10 ‘soul searching’ life questions.
  • To think deeply about what you really don’t want in your life
  • To think even more deeply about what you what do want in your life

… and more.

I hope that you’ll take the time to look in and see what all the life-changing fuss is about.

Define 'long term'?

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5

That was the challenge set to me by Diane, one of the applicants to my 7 Millionaires … In Training! ‘grand experiment’ in response to a post that I wrote, exploding the myth of diversification that the the 401k jockeys seem to hold on to so dearly … I guess that their financial lives do depend upon it 😉

In that post I said that “diversification is only a mid-term saving strategy ..”.

Why?

As I mentioned in that post: “it automatically limits you to mediocre returns: The Market – Costs = All You Get … period!”

But, Diane is right: a key question is market timing. For example, does diversification help you over shorter time frames? Define short, medium, long … ?

Well, typically financial texts will define short term as anything less than 1 to 5 years; medium as anything between 5 and 10 years; and long-term 10 years+

But, it depends upon who you speak to: Warren Buffett would probably define short-term as anything less than ‘for ever’ … because that’s how long he aims to hold his acquisitions for, and often regrets having sold out of other positions too ‘soon’.

He is also reported as saying that he wouldn’t care if the stock market was only open once every 5 years.

But, I have a different viewpoint, and it begins with a question that I posed to Diane:

Di, the ‘pat’ answer is MINIMUM 10 years. The real answer is: depends why you need to know?

Let’s say that you found an individual stock that you want to buy; when I set out to do this, I set no minimum/maximum time-frame that I would hold the stock for. For me, the holding term is entirely driven by price …

… when I buy the stock, it’s only because I believe that it is well undervalued and the underlying business is one that I understand and love. I’m buying the stock and patiently waiting for the market to catch up with my thinking.

When the market eventually does catch up … I’m outta there!

That process can take months or years … if it takes years, then I am reevaluating how ‘cheap’ the stock still is every time an annual report comes out (if the company’s financials no longer make the current price look cheap, then I am outta there early … whether I need to book a profit or a loss).

So, time-frame is just not an issue here …

But, when I ask this question of others, most people are aiming to ensure that they are building their retirement nest-egg correctly, so for them time-frame seems more important … and it is.

When you plan for retirement, you need to work backwards:

1. How much do I need to ‘earn’ as a replacement-salary from my investments in retirement?

2. How big does my supporting nest egg need to be?

3. How long before I want to stop working?

4. What market return can I bank on getting for that period?

5. Therefore, how much do I need to sock away (in lumps and/or dribs and drabs) to ensure that I get to #2 by #3?

You will most definitely need someone to crunch these numbers for you … just make sure that they crunch the numbers that you provide for #1 thru’ #4, not just the numbers that they will try and ‘sell you’!

Because, ‘they’ will tell you:

… well LONG-TERM the market has RETURNED an AVERAGE of 12% -14% on stocks and only … yada yada …

The problem is that YOU are most certainly not AVERAGE and YOU only get ONE SHOT at this nest-egg-building business. Unless, you can find a way to turn back time and try again 😉

So, you need to choose ‘guaranteed’ numbers for #4 …

Here’s where I like the research that Paul Grangaard did for his excellent book, The Grangaard Strategy, specifically aimed at planning for (Book # 1) and living in (Book # 2) retirement:

Using the research done by Ibbotson Associates (published annually in their authoritative ‘Stocks, Bonds, Bills, and Inflation® Valuation Edition Yearbook’), Grangaard found that over the 75 year period between 1926 and 2000, large cap stocks averaged and annual return of 11% (small cap stocks did a little better at 12.4%), but he also found:

The average annual return [through that 75 period] bounced around all over the place, just like you would expect – between a high of 54% in 1933 and a low of negative 43.3% percent in 1931.

So, clearly planning on holding stocks for just one year has to be counted as extremely short term.

However, if we hold those same stocks for just 5 years, Paul tells us that we get a 6i% reduction in volatility …

… this means that every 5 years period within that time frame (e.g. 1926 to 1931; 1927 to 1932; etc.) still has a chance of being wildly different to the average, but 61% ‘less wildly’ than simply holding a stock for 1 year.

And, it makes sense: wouldn’t your 5 year return have been dramatically different if you bought at the end of 2001 and sold at the end of 2006 than if you bought at the end of 2002 and sold at the end of 2007?

10 year holding periods reduce volatility by 83%; interestingly, we need to move to 30 years before we see another major reduction in volatility (20 years is only few points lower in volatility than 10 years) …

… even so, holding stocks for 30 years means that we should achieve the 11% average return on large cap stocks; but there is still some significant volatility; Paul says:

The best thirty-year holding period delivered a 13.7% average annual rate of return between 1970 and 1999, while the worst thirty-year period delivered an average annual rate of 8.5% between 1929 and 1958.

So, while your “odds” may be high that you will get an average 11% return over 30 years, who do you want to be?

The guy who invested $100,000 and locked it away for 30 years for a ‘safe, secure retirement’ in 1970? 1929? or in an ‘average’ year? Let’s see:

Worst 30 Year Return  $ 1,065,277
Average 30 Year Return  $ 2,062,369
Best 30 Year Return  $ 4,140,507

It’s clear that you would be stupid to ‘bet’ your retirement on ending up with $4 Mill. (BTW: a lovely number … worth about $1.3 Mill. in today’s dollars, if inflation averages just 4% over that period).

But, I equally think that you would be stupid to bank on $2 Mill. either …

… I would use 8.5% in all of my retirement calculations, because 75 years of history  (including buying the day before the biggest crash in Wall Street History, then holding regardless for the next 30 years) says that’s what I will get … not might get, and certainly not hope to get.

And, I will be thankful if I am mildly pleasantly surprised … and ecstatic if I end up winning the Wall Street Lottery!

So, let’s look at time frames in terms of what Wall Street will ‘guarantee’ me:

If I hold for ….. I will get (as a minimum):

10 Years -0.9%
20 Years 4.0%
30 Years 8.5%

So, Di, in terms of being certain of your retirement nest-egg; I’d have to say that 30 years is long-term.

20 years doesn’t even keep up with inflation (4%) and mutual fund fees (1%) … and, anything LESS than 20 years is down-right dangerous!

That’s why gambling on Mr Market for my retirement wasn’t even a consideration for me. How about you?

Now, what number will you be plugging into your #4?