Luck or Skill?
In investing and in other situations in which you are making an evaluation, it is important to remember this: Sometimes a manager does well because he or she is talented and perfectly executes a certain kind of investing style again and again. But sometimes this person just gets lucky. And 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.
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; the shareholders of the company. However, the people who buy the shares in their mutual funds they sell to the public don’t do nearly as well. As for the average investor, you need to exert critical self-discipline.
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 athletes/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 and New Jersey.
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 about to receive a lot of money, don’t accept it until you have consulted with a CPA or a qualified tax adviser—possibly also a certified financial planner—before you start spending it. (By the way, having an advisor can be very useful for some MoneySense investors. Later on in this book, we’ll discuss how to find one).
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.
It Can Be Done
How do you accumulate significant assets, the slow patient way, when you’re not a big earner?
You make a commitment to saving and investing, despite all the pressures to consume that come from almost everywhere every day. These pressures 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!
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 the neighborhood, good for everyone. 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. 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. In fact, I can remember in my early 30s making $20,000 a year—I had one full-time and two part-time jobs—and thinking I was finally starting to make some money.
One reason 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 the best kinds of long-term investments? More in the next chapter.