I Cannot Do This!

The idea of investing means different things to different people.  As a social scientist, I find economics fascinating and market behavior intriguing.  My first goal in writing this book was to make that wonderfully fascinating world approachable to everyone.  It took me a long time to realize that many people don’t have the time or interest to set investment mastery as a goal.  Young people have social networks to maintain, careers to kick start, and families to begin.  These folks may not have the time to make this material a priority.  Some may find it terribly annoying and not have the patience to read this entire volume.  Some may be too scared to attempt managing their own portfolio.

Much of what these pages contain going forward has to do with convincing you that you are not Warren Buffett and you cannot beat the market.  I cannot accept that idea, and I will be reading papers and books about the subject on my deathbed.  (I am still trying to fix the crime problem as well, but that is another book).  I must force myself to realize that I’m a geek, and you may not be.  If you just cannot bring yourself to study the subject and learn about trends and tilts and other controversial things, you can still retire in comfort.  You may not have quite as much profit as someone who obsesses over returns, but you will likely beat most of them.

In addition to reading the classic book The Millionaire Next Door, you should have a look at the results of Fidelity Investment’s  Millionaire Outlook.  What the Fidelity study shows is that the behavioral characteristics of the emerging wealthy have in common doesn’t change much over time.  Women and minorities have joined the ranks of the wealthy in ever-increasing numbers, but the way that all wealthy people view money is very similar.  Here is what Fidelity says of investing styles:

“Similar to deca-millionaires, the emerging affluent display a willingness to invest aggressively to help maximize returns, as well as a willingness to set aside a significant portion of their portfolio for riskier investments that promise a bigger payoff.  The emerging affluent and deca-millionaires were also most likely to describe themselves as “self-directed” investors, seeking hands-on involvement with their investments.

That is a bold statement coming from an investment first that provides wealth management advice.  Perhaps the inescapable logic is that if you want to have a lot of money, you have to understand how money works.  Another thing that Fidelity found was that millionaires started young, made above average pay in their careers, and invested huge chunks of their earnings.  Most did not, however, make vast sums of money.  On average, they are professionals that make around $100,000 per year.  In many areas of the country, this would be the equivalent of a combined income of a teacher and a police officer (assuming that neither are rookies).

Two other important considerations are worthy of note.  Most of the future millionaires of America have a long-term outlook on wealth, and they have a plan.  I considered methods of increasing income in the first book in this series, and I will not belabor those points here.  Just remember that saving is usually done as a percentage of revenue, so in your income matters.  Not all decisions in life should be financially motivated, but you should understand the financial impact of all decisions.  The idea of needing a financial plan is an important one and is well worth exploring.  I’ll say more about that subject in later sections, but for now, let’s establish some fundamental factors to consider.  The first is your goal.  For most of us, the ultimate goal of investing is to retire without a noticeable decrease in our standard of living.

The first thing to consider, then, is your ultimate goal.  If you want to set a minimum level of success that you must achieve, I suggest targeting your annual household income multiplied by 25.  Therefore, if you make $40,000 per year, you need a $1 Million retirement account.  If you make $100,000 per year, you need a $2.5 Million retirement account.  Those numbers seem staggering, but with the magic of compounding, you can achieve it if you begin early and don’t do anything stupid.  The beautiful thing about finance is that most often, doing something stupid means doing anything.

Most often, the best thing to do in any market is nothing.  This is a dirty secret that financial advisors and brokers do not want you to know.  There are many complicated investment options on Wall Street, but these are usually distractions from the real engines of wealth building.  Complex investments are designed to make the creators and sellers of those instruments rich, not you.  All you really need to get rich are a species of investment known as indexed mutual funds (which are available with every retirement plan on the planet), and their cousins Exchange Traded Funds (ETFs).  You can use a “hands off” strategy known as indexing and beat 85% of the players on Wall Street.

If you really hate this stuff and just want to retire wealthy and do not really care what happens to your money in the meantime, here is what you can do:

  1. Go to your human resources office and ask for a retirement allocation change form. Explain that you want to contribute the maximum allowable under the plan.  Ask what the match is.  If she says that there is no match, resign and look for a job that has one.  If the maximum is less than 15% of your salary, you will need to do something else on the side, such as an IRA.
  2. Scan the form for a list of investments that are available to you.  Find a column that lists expense ratios. Scan down that column until you see numbers less than one.  These will be the index funds.  Find one that has “Total Stock Market” in the name (if there are more than one option, look for the name Vanguard).  If you cannot find that, look again and find something with “500” and “Index” in the name.  Put 100% of your contributions into that fund.
  3. Completely ignore the performance of your account until you are about 10 years away from retirement.
  4. When you are 10 years from retirement, buy a broad index bond fund with 3% of your account value.  Each year after that, move an additional 3% from the stock fund into the bond fund.
  5. After you retire, you should be holding a mix of 30% bonds and 70% stocks in two mutual funds.  Rebalance at the end of each year so that the percentage stays at that ratio. Most of the time, this means selling stock and buying bonds.  When the stock market is having a bad time, you will sell some bonds and buy some shares.

I would call this style of investing “stock market indexing with rebalancing,” and it is a potent investment tool that can beat the vast majority of investors out here.  The success of this plan hinges on you being able to do Step 3.  Human psychology does not work that way for most of us, and we can’t help but look and see how things are going.  If we see that things are going badly, we will panic and sell at the bottom, which is a financial disaster.

Index investing is only successful when you can take a very long-term approach and completely ignore the short-term vicissitudes of the market.  Professional money managers care very much about the short-term performance because this year’s performance determines who enters the fund and who leaves it.  A single bad year can decimate a managed fund.  Indexing requires that you not care about the short term.  If you want to understand why indexing works, why the downturns in the market do not matter, and why you would want to add those bonds before you retire, you must read the rest of the book.  Without the conviction that only understanding can bring, you will fail to stand fast, and you will lose a ton of money.

Last Modified: 07/11/2018

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