When and How to Invest
We began by using a low-cost balanced fund, the Vanguard Star Fund. That’s because a balanced fund is an all-purpose fund that gave us a mix of both stocks and bonds. It is a good idea for those who can’t afford to buy both a stock and a bond fund. This balanced fund was a diverse investment that would never shoot the lights out in bull markets but would avoid self-destruction in bad markets because it wasn’t as risky as the all-stock approach.
Over more than 25 years of holding and adding to the fund, it has provided what we wanted, about nine to ten percent a year long-term. We still have some money in that fund because it is a sensible, conservative fund. Here is a true “Tacano” fund. It is a fund that has some of the lowest costs in the investment industry. And one must always be wary of the latter. It is an industry that sometimes piggy; it abuses the small investor as I will detail later.
As we earned more and as I took on extra work, we put more into our investments. We raised it to $200 a month and eventually, over about a decade as we both earned more because we were in our prime earning years, we increased it to as much as $1,500 as a month spread over five funds.
This was besides contributing to our retirement plans at work. It was a lot but no, we never starved ourselves or stopped taking occasional vacations to reach the $1,500 figure.
These investments included stock, bond and cash funds. They also included paying off our variable rate mortgage early. This was important because we lived through some of the lowest mortgage rates in history. But remember, with a variable mortgage, the only one our bank would offer, it can come back to bite you if interest rates suddenly spike. We also increased our investments gradually so it didn’t result in a decline in our standard of living.
We had several different kinds of mutual funds. We also had some stocks and bonds. Besides our retirement plans at work, we each opened individual retirement accounts (IRAs). We saved for retirement through these qualified—qualified as in special, reduced tax, treatment—accounts for several reasons: One, in our early years of marriage, when we had relatively low incomes, they gave us immediate tax breaks by reducing our current tax liability. That’s always a big issue when you live in a taxing place like New York. Two, as these accounts built up, we paid no taxes on investment gains, which would not be taxable until between the ages of 59.5 and 70.
Tip: Wait until age 70 or whatever is the latest age you must start withdrawing if you don’t immediately need these retirement funds. The longer tax-deferred compounding takes place, the better. Remember how we have shown, time and again, that even just a few extra years of compounding can make a huge difference. And by the way, as per the advice of numerous financial professionals I have interviewed over the years, don’t expect Social Security to be a big part of your retirement income.
I will discuss these issues as well as the woes of Social Security with an official of the program in chapters at the end of the book. He concedes that changes must be made in the program. Don’t wait for them happen because the changes—if they are like previous changes—won’t be good. Yet changes are inevitable because the system is running in the red. Prepare for them now.
And second, keep adding to your qualified retirement accounts in your 60s if you are still a part-time worker as I am. If you have a Roth IRA, you can continue to contribute forever as long as you have earned income, up to $7,000 currently. It could be increased owing to inflation. You never have to take assets out of a Roth IRA and when they come out there are no taxes. That’s because, unlike a traditional IRA, you never received tax deductions.
Still, although this book is primarily about how to start with little or nothing and accumulate enough to make you financially independent, I also have a chapter for those who have already accumulated a nice amount and are close to or in retirement. It’s important to understand how to protect these assets in retirement, which were built up by you and your significant other over decades.
Look Out! Someone Leers at Your Money
One caveat of using these qualified retirement fund assets: My wife and I have a lot in our retirement accounts. I would say 60 percent of our total assets are in these retirement accounts. Millions of Americans are in the same position. Yet, as I write this, there are various pols who are coming up with schemes that would grab some of these retirement assets.
Be on guard for these money grabs. That’s because the government is increasingly becoming hard up for cash. When people or institutions are hard up for money—whether they are advanced welfare states with aging populations or crack addicts desperate for the next fix—they will do outrageous things they normally would never would do. Desperate governments—the same as desperate drug addicts—could hurt all of us who have systemically saved over the decades.
A final point on our investment plan, these various saving and investment accounts would help us arrive at our goal: financial independence.
How did we do?
We had triumphs—fat markets in the 1990s when we often made 20 percent or more a year—and we had some disasters, the first decade of this century when markets crashed and some people told us we were idiots for investing.
Overall, we made a little more than nine percent a year over the long term. That is what I set out to do; earn the long-term market return. I wasn’t trying to get outrageously high returns—say 20 percent a year—because the risks one would take to achieve it would sometimes mean you end up losing 20 percent. I haven’t tried to hit home runs every time at bat because home run hitters often strike out. I’m happy to hit a lot of singles.
However, it was still a rocky ride, one in which were sometimes tempted to turn back. Luckily, at the outset, we realized a truth: the sensible investor doesn’t expect to become rich overnight. That’s for those poor souls who plan on winning big in Vegas, or at any of the thousands of casinos that are sprouting up everywhere like venereal diseases that can’t be contained.
These casinos are actually supported by many pols as a form of economic development. That idea would be comical if it wasn’t tragic. And remember, the casino scam is a place where the house has every advantage and no one advertises your odds against winning big.
Once, when I was doing a story on the low profit rates of many New York casinos—they raise a lot of money but net relatively little for the state after they have paid all the expenses of this system—I asked a state official about the social problems caused by the government becoming some prominently involved in gambling. This official, who I interviewed for the story I was doing on state gambling businesses, explained to me the state’s ultimate, and pathetic, justification: “Look at all the jobs they provide.”
Yes, but they also lead some people to think that a trip to Vegas or Atlantic City will solve all their money problems forever.
Avoid the get rich mentality of the casino. A long-term investment plan means patience. The MoneySense investor is putting money into good investments on a systematic basis—every month, every pay period or every week. And the MoneySense investor is ready to do this for 10, 20 or perhaps 30 years. That depends on how much he or she needs to achieve financial independence.
Still, the MoneySense investor is the tortoise, not the hare. The MoneySense investor is happy to make steady progress. This person understands that it is better to light a candle than curse the darkness. That’s because the latter screams and hollers, but accomplishes nothing. The former starts one toward the achievement of a long-term goal, even if it is only the first steps.
So focus on regularly putting money into good investments. We’ll see later these include low-cost index funds. And it doesn’t matter that you start with small amounts. What matters is that you start as soon as possible—tomorrow or, better yet, today or yesterday if you have a time machine handy—and that one sticks to a long-term strategy.
That means put money into funds in good times and bad times, especially the latter. That’s when one can buy shares of some excellent stocks or bonds at bargain prices. These are shares that will likely later become profitable when markets recover.
And sign up for automatic investing with a mutual fund company—a good one that has low expense funds that consistently do well, but never shoot the lights out. Vanguard is one. There are other fund companies that can help. Don’t look for a fund that has just had the best performing fund numbers because the next year it will often be a dog.
In sports terms, it’s almost the same as signing a player to a long-term contract just after he or she has had the greatest year in a career. You’re paying for a performance level the player or the fund will likely never duplicate.
Look for a fund or fund family that consistently does well, not fabulously, over a five year or a ten-year period. Fabulous returns frequently are the result of luck or a fund manager taking a big chance one year and hitting a home-run (For more on this, please see a later chapter on how this year’s big mutual fund winner often becomes next year’s dog). Often those factors will reverse the next year and the fund will go from best to worst.
Want an example?
Look up the history of the roller-coaster American Heritage fund run by manager Heiko Thieme. I once met him at a conference. Thieme was an electrifying speaker, but I’m glad I looked beyond his considerable charisma in investing my own money.
Indeed, the fund hooked lots of investors who did poorly because they bought the fund just after it had a fabulous year. His fund was incredibly volatile. He would have a great year every once in a while—maybe up close to 100 percent. Then he would advertise these numbers to the hilt and bring in lots of new investors. They thought they were also going to get 100 percent. Then the next three years the fund was egregious. Investors wondered what happened. He was the free agent in sports who sells himself just after he has a fabulous year and everyone starts bidding on him. He gets a long-term contract. He never reaches those peaks again.
In investing and in other situations in which you are making an evaluation, it is important to remember: Sometimes a manager does well because he or she is talented and perfectly executes a certain kind of investing style. But sometimes this manager’s perfect storm is unlikely to ever happen again.
However, other times a person who has a big year was just lucky. The manager is unlikely to ever turn in outstanding numbers ever again. Some fund companies don’t care about the latter scenario. Like most pols, they just care about getting your money. They want to accrue as much in assets as they can. That’s how they, and often not you, make a lot of money.
Why Don’t the Customers Do Well?
For example, I can remember the complaint of John Bogle of Vanguard, one of the greatest money managers and investment thinkers. In a kind of “where are the customers yachts” comment, he said that many investment companies do very well for the people who own them. However, the people who buy the shares in their mutual funds they sell to the public don’t do nearly as well.
In following a systematic investing plan, don’t count on yourself to take the money out of an account each month or pay period and put it into investments. Have the money automatically deducted from your checking account and put into the funds.
If you have to mail in money each month, it is amazing how funds can often end up spent on other things.
The Patient Investor
Why do I emphasize a long-term view of investing, the idea of getting rich slowly?
First, expecting to get rich quickly, through some lucky break, is dangerous. It usually doesn’t happen. In fact, the opposite usually does.
Second, another reason to be patient is one rarely appreciates fast wealth and what it represents. Consequently, it is very easy to lose that kind of wealth. How many times have you read about sports stars and one-time superstar entertainers who made a lot of money in a short period—such as people who won a lottery or sports stars who received huge signing bonuses—and, a few years later, had gone through all their money and were broke? It happens.
Sometimes they had no tax reduction strategy and much of their income in their prime earning years was eaten up by Uncle Whiskers and his merry band of publicans. The quick overnight wealth made these aathletes/entertainment figures reckless with their money. They had no system for maintaining wealth.
By the way, ever notice that a lot of sports stars live in Florida even though they weren’t born there? It’s because, once they come into the big bucks, their financial advisers/lawyers tell them to move there. State taxes are incredibly low there compared to states like New York, California and New Jersey.
Fighting Off Uncle Whiskers
Over the course of a long-term contract, Florida residency can save huge amounts of money. That’s money they may someday need when they are no longer making big bucks.
Coming into huge pools of money in a short period can trigger a tax problem. All of a sudden, in most advanced western welfare democracies, one can be paying a high tax rate if one suddenly receives a lot of money.
Warning: If you are going to come into a huge pool of money unexpectedly, don’t accept it until you have consulted with a CPA and or a qualified tax adviser—possibly also a certified financial planner—before you start spending or investing it.
Human nature can also be the friend or the enemy of your wealth. Your money will get eaten up much faster than if you slowly accumulated assets. But what if you make it and lose it fast? It is unlikely that, in a lifetime, one will repeat the big earning patterns. You usually get one chance for your prime earning years.
So one must remember to get the most out of these prime earning years. They are unlikely to happen again. But one simple key is this: Just automatically put aside a healthy percentage of one’s earnings year by year. Ten percent is a nice way to begin.
Slow Cooking Is Better
How do you accumulate significant assets, the slow patient way, when you’re not a big earner?
You make a serious commitment to saving and investing, despite all the pressures to consume that come from all quarters every day. These are pressures that come from mass media. Here are some examples of them that come bursting out at you when you turn on the tube: “But you must act now. Call now! Operators are standing by. If you don‘t buy now, you will die tomorrow so act immediately.”
O.K., the last one was an exaggeration, but not by much.
So if you’re an average earner, there is that wretched thing that exists in every country. It will likely be your biggest expense. So be warned: Governments’ misguided spending and taxing policies often destroy would be wealth. Here’s an irony: In the long run governments are actually hurting themselves. That’s because, with less wealth generated, there is much less to tax!
You Want More in Taxes? Tax Less
If the government really wants to generate a lot in tax revenue, it would keep tax rates as low as possible, giving people an incentive to work harder because they would get to take home more of their hard-earned geld. That may seem counterintuitive. But nevertheless, it is true as I detail at the end of the book.
Indeed, supply side economist Arthur Laffer sums up this philosophy perfectly when he says, “We want more, not fewer, billionaires.”
To which I would add: We want more Americans to be millionaires or at least to be well off. More and more people getting wealthy is good; good for the economy, good for individuals, good for everyone, even good for the government. The more, the better, because high net worth are often paying a lot in taxes compared to the rest of us.
Still, governments persistently tax savings and investments. Especially in Western countries, in the advanced democratic-welfare states, they treat savings and investments as though they were plagues instead of the building blocks of every healthy, growing society that the world has ever known. This was an idea brilliantly explained in the great economic tome “Human Action.” The latter is a classic work by Ludwig von Mises. Mises used to write that all of us who benefit from a prosperous economy are standing on the shoulders of our parents and grandparents who saved and invested.
How do you benefit from their wisdom?
Small Amounts Can Become Big Amounts
It doesn’t take a lot to get started on the MoneySense road to financial independence. It should be as much a mental as well as monetary commitment. Tell yourself that, no matter what, you will make a commitment to save and invest starting now, even if it is just a few dollars a month at first. One can start modestly, but by all means start now. There is no time like the present.
Try to designate ten percent of your income as a starting point. If you don’t make a lot of money—say you make $30,000 a year so you are saving/investing $3,000 a year—it doesn’t matter that you start modestly. It matters that you start with something as soon as possible.
Is $3,000 a year, or $250 a month, really so much? For most people, especially young and middle-aged employed people with lots of prime earning years ahead of them, I don’t think so. And I say it as someone who used to make less than $30,000 a year for a lot of years. (By the way, $250 a month over 30 years at a nine percent rate of return adds up to $431,912.08).
That’s because one of the biggest reasons why some people achieve financial independence and others don’t is a factor that has nothing to do with being rich or poor or smart or not or even which investments you choose. It is something that equally affects the humble and the well-heeled—time.
Over time the compounding effect, the ability of money to create money, becomes more and more powerful. The sooner one starts money compounding, the more years one has, the more likely one is to end up with large assets. That’s the sentiment of one of the smartest money people I have ever come across.
“One of the most important concepts to accumulate wealth and becoming financially independent is understanding the time value of money”, writes Staten Island, New York CPA John J. Vento.
“By far the most valuable asset we have is time, but unfortunately it is usually something we take for granted and then do not fully appreciate until later in life.” [That’s from Vento’s excellent book “Financial Independence: Getting to Point X.,” p 285, (John Wiley & Sons, New York, 1985)]
Fine, you say, I’m ready to invest on a regular basis. What are some other good long-term investments? More in the next chapter.
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