Investing is scary business. It is intimidating for those of us who have never done it. Investment can be a tricky thing. Especially if you have no knowledge of how to secure your hard-earned money from inflation. Besides that, having a specialist who works in your interest is probably one of the smartest things to do if you want to accumulate wealth. We all know it’s better to invest rather than having the money sitting in a savings account losing its value and earning a low return.
But what if you don’t have ready access to a specialist? Some of them can be really expensive. And maybe you don’t know where to go or who to ask about where you can put your money. Perhaps you don’t trust banks because of previous cases of fraud or bankruptcy.
DIY investing
Then you will need to do it yourself. Fortunately, if you’ve been following my articles you now have all the knowledge you need to get started. But perhaps, since you haven’t done it before, you are finding it difficult to take that first step. You always reach out to me. I will personally guide you through the process.
Or you can take inspiration from people I have helped in the past. They have implemented the Investment Framework. And not they are drawing confidence from their successful investments. And you can too.
Feel certain about your choice
Many of these people felt the same way as you. They wanted to feel as certain as possible they’ve made a good choice. The key to this is to follow the steps that I have laid out in previous articles. As a reminder, the Investment Framework is:
- Define your goals and how much they will cost
- Calculate what return you need
- Determine what your risk tolerance is
- Figure out what your constraints are (time horizon, liquidity needs, taxes, legal and regulatory, unique circumstances)
- Choose the assets you want to invest in.
- And calculate how much you want to or can contribute.
Case Study: Mark
I went through this process with Mark. Mark is a spare car parts salesman in Springfield, Virginia. I really admire him because he has been really disciplined with his money. He is not a high-flying banker or management consultant at PricewaterhouseCoopers. Yet he probably has a higher net worth than the average banker.
This is because he has no debt. Mark bought a house with a mortgage 20 years ago. He repaid the mortgage last year. Mark has no credit cards. He doesn’t spend frivolously on fancy clothes or buying everyone drinks at the bar. Instead he has dutifully saved his money in the bank.
I actually envy Mark’s discipline a lot. I wish I could be like him in fact. Unfortunately, I have wasted a lot of money on useless stuff in the past. This leaves me with a lot of work to retire at the level of wealth I would like to. So, no, we cannot all be like Mark.
Where to invest for a higher return?
But we do have the same problem as Mark. Where to invest our money. And regardless of our specific situation, we can use the same framework to achieve our goals.
Mark’s basic problem was that he had his life’s savings in one bank account. And he also had some cash in a shoe box under the bed! In my previous article, I spoke about the significant risks of bank savings accounts. In the current environment, having your money in a savings account means guaranteed losses. Heavy losses in fact.
It is a shame because responsible people like Mark are being punished. This is while irresponsible people are being rewarded. How so?
Printing money robs you and me
The mainstream press reported that the big banks were saved through quantitative easing. This is a complicated way of saying “printing money”. Now if you were to print off dollar bills in your basement you would be accused of counterfeiting. You would go to jail.
But when the Fed does it, it’s called expansionary monetary policy. Or quantitative easing. Effectively the Fed (in coordination with the major central banks of the World) printed money and used it to buy the failing loans from the banks.
This causes inflation. How much and where depends on where the central bank puts the money. If it uses the money to buy financial assets from banks, then the prices of those assets will increase. Typically, people think of inflation as affecting consumer prices only. This is not always the case. It can affect the prices of financial assets. In this case, you might see increases in stock and bond prices. This is exactly what we have seen.
Also, it drives down interest rates. At the same time that prices of consumer goods are increasing. Interest rates might be thought of as the price of money. If there is more money (quantitative easing) then its price will be lower.
The Fed robs you and pays the banks
So, if the Fed is producing more money, at the same time that you are depositing money at the bank, what do you think will happen? The interest rate is lower on your savings.
Effectively, these bailouts keep bad banks in business. Above all, it amounts to a massive subsidy. A subsidy from you, the good saver. And it goes right to the bankers who lent unwisely. And at the same put your savings at risk. Because banks lend your savings on risky investments.
Does this make you mad? It should.
But you don’t have to sit and take it. And neither did Mark.
What investment funds can you buy?
Frustrated with losing money continuously at the bank Mark came to me. He explained what he had tried. At first, he tried asking the bank for help. He wanted to know what higher return investments they could offer him. Were there investment funds that he could buy?
Mark was not impressed with what he was offered. First of all, the bank’s “financial advisor” did not seem to know any more about investing than Mark did. He presented Mark with half a dozen funds, none of which were appealing. They had returns ranging from 2% to 6% and had fees of up to 2%. So, Mark probably wouldn’t do much better than keeping his money in savings.
It’s my view that banks are the greatest scam artists around. They offer rock bottom interest rates on savings accounts. And then they lend that money at a much higher rate. They also take risks with your money that you are not compensated for. And then when you ask for investment advice, they take their pound of flesh.
Go straight to the source
I suggested that Mark go straight to the source for his investments. Companies like Vanguard, Blackrock, State Street and others. You can find index funds from these companies via your bank. However, they will probably charge you a fee on top.
But first, I taught him the Investment Framework. In this way he would know what return he needed and how much he needed to put aside. However, first we needed to know what Mark’s goals were.
Mark’s goals
For Mark this was easy. He was 40 years old and he wanted to retire at 45. Mark was married but had no children. He also owned his home free and clear. All he needed to do was figure out how much he needed to live on.
We figured out that his current living expenses were $50,000 per year (including taxes). He also had a savings balance of $850,000. I like to use a “rule of thumb” that you can conservatively earn about 6.5% on an investment portfolio (in a portfolio that is 80% bonds and 20% stocks. We should probably also adjust that for inflation. So, we are talking an inflation adjusted return of 3%.
$50,000 in 5 years is $58,000. Or about $60,000. To determine what size portfolio Mark needed we divided $60,000 by the return of 3%. To earn $60,000 per year from his portfolio Mark needed a portfolio of $2m. Could Mark save this much by age 45?
Were Mark’s goals realistic?
Mark could afford to save about 30% of his salary. Like I said, Mark is very good at saving. This worked out to be about to about $21,000 per year. We found that to meet his goal, Mark would need to earn a return of 17% per year. The S&P 500 has earned a 13% average return per year for the past 5 years. So, Mark retiring at 45 is unlikely. He would have to take on some significant risk to get a 17% return. It’s probably not worth it.
So, Mark decided that retiring at 45 was probably a bit optimistic. Instead, he explored retiring at 50. In this case, we found that he would only need a return of about 7%. This is certainly achievable with a portfolio that is 40% stocks and 60% bonds. In other words, fairly conservative.
Pick an achievable goal
In this scenario, Mark has a very good chance of retiring at 50 and possibly sooner if he takes on a little more risk. If Mark is in good health and decided to carry on work until 65 if required, he could afford a little more risk. In other words, if Mark invested in 60% stocks and 40% bonds he would have $2m by age 49. Not too bad.
So now Mark had completed the Investment Framework criteria:
- His goal was to retire at 50 years old. It would cost $60,000 per year
- The required return was 7%
- Given he could be flexible about when he retired and he had a good size portfolio, Mark had an average tolerance to risk
- His primary constraint was his time horizon. In this case, 10 years.
- He was going to have a portfolio of 40% stocks and 60% bonds
- He could contribute $21,000 per year.
Take action!
Finally, all Mark had to do now was open his investment accounts. However, when I spoke to him a few weeks later he still hadn’t done it. When I asked why he told me that his wife and parents didn’t think that it made sense. They asked him why, if things were going well up until now, would he change?
To answer these questions, we need to go back to Mark’s goal. The goal was to retire at age 50. If he kept his money in a savings account he would not meet his goal. By age 50 Mark would only have a portfolio of $1m. This is half of what he needs. In this case, things would not be going well.
Don’t let fear stop you
Another issue Mark was having was just making the investment. There were residual fears about things going wrong. It was hard for him to commit all of his money in one go. I suggested that he take micro-steps. Start with about 10% of his savings. Then add more as he grows in confidence.
Get used to the idea of being an investor. Read the company reports. Also, read the statements you get from the fund provider. As you get used to making investment decisions the idea of investing more money gets easier. I have nearly all of my portfolio in investment funds. It has been there through the financial crisis of 2008 and beyond.
So, Mark finally began investing. And his portfolio began growing. As a result, every day he moves closer to his goal. On the other hand, if he had kept his money in savings accounts he would be moving in the opposite direction.
There is no reason you cannot do the same. So, reach out to me and we can do it together!
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