Build wealth like the pros!

If you’re on a slower path to wealth than you would like, this is the post for you. No wealth whatsoever? Even better. Let’s get you started. There are the special hacks that will help a lot: marrying into money, inheriting a bundle, lottery winnings or working somewhere with a juicy stock option plan. If none of those are in the cards, not to worry. Turns out, there are just 4 factors to tweak to build wealth like the pros. Which one is the biggest issue for you? Read on and let’s find out!

Factor 1 – Rate of return

As you save money and invest those funds will grow. How much? That depends on the rate of return. If you want to build wealth like the pros, that is the first place to look. For a quick perspective, the Rule of 72 is a handy way to understand the impact. If you divide your percentage return into 72, the result is the number of years it will take to double your money. As an example, at 7% return, it would take about 10 years to double your money. At 2%, it would take 36 years. Ouch! That’s a big difference. No Lamborghini for you. And if inflation was running at 2%, you would be getting exactly…nowhere. Now you know why having all of your money invested in savings accounts, treasury bills and GICs won’t work.

Compare to the Indexes

How are you doing on your rate of return? Go back and take a look. For business, the rate of return should be quite clear from the business statements. For savings with an investment firm, your rate of return should be available on your statements or online. In the case of equity investments (stocks) the question is whether, after all fees, they exceeded the overall stock index. For the US market the index is usually viewed as the S&P 500. It has averaged about 8% over time. If your investments are trailing that, it’s time for a review with your investment advisor. Investing on your own, maybe it’s time to invest in the overall index. By definition, if you are investing in the index, you can’t be underperforming it. Also, maybe act on fewer “hot” stock tips from your Uber driver.

It’s important to compare like for like investments to the indexes. That is to say, compare your US stock portfolio to the US stock index. Likewise with bonds, European stocks etc. Here are the common indexes to use as benchmarks:

• US Stocks – S&P index
• European Stocks – STOXX Europe 600
• Canadian Stocks – S&P TSX index
• Global Bonds – Merrill Lynch Global Bond Index

These are just examples of some indexes for comparison. Find one that works and compare your investment returns.

Factor 2 – time

Assuming you are getting a great rate of return, the next big factor is time. Compound interest is the 8th wonder of the world, but time is the magic that really sets it ablaze. To illustrate, let’s go back to the Rule of 72. As we said earlier, at 7%, money doubles every 10 years or so. Cool. But it doesn’t stop there. It keeps doubling every 10 years. Let’s say that you had $100,000 invested at 7%. After 10 years it would double to $200,000. So 10 years later it would be $400,000, then $600,000 and $800,000 after a total of 40 years. Wow! that is a pile of money. OK, now let’s see who was napping during that math! It actually doubles every 10 years. So the real math is $200,000, then $400,000, then $800,000. After 40 years, it hits an astonishing $1,600.000!

Enjoy now or save for later?

Well that is a big pile of money, but who wants to wait 40 years to get rich? Great question. There are three parts to this. First, if you are 20 right now, 40 years from now you will be 60. Which isn’t all that old. Trust me, I’m almost there. I can still run, ski, play the guitar, and bike. And the mortality tables tell me that I still have another 30 years or so to go. So I’m glad that I followed my own advice and earned a good return and let that money grow over time. Second, you aren’t waiting for all of your money to grow like that, just the part that you are saving. The rest you can spend and enjoy through all of those years. Third, let’s go back to that $1,600,000. That means that every dollar you set aside and invest at 7% becomes $16 in 40 years. That is a big difference vs spending that $1 now.

But how much should you save and how much should you spend? That leads us to our next factor in how to build wealth like the pros.

Factor 3 – Savings Rate

Savings rate is just the percentage of your gross income (before deductions for taxes and other things) that you set aside to build wealth. So if you earned, say $100,000 and saved $10,000, your savings rate is 10%. If you saved $15,000 on that same income, your savings rate would be 15%. But how much difference does the savings rate really make? Is it really worth it to increase your savings rate from 10% to, say, 15% or 20%? Let’s take a look:

In the graph above, we see the difference that savings rate makes. To provide context, the graph is based on a household income of $150,000 with the savings earning 7% annually. Saving 5% of that would be $7,500 a year, or $625 a month. At a 5% savings rate, after 30 years, we would accumulate $762,000. Not bad! But saving 10%, we would accumulate $1,526,000. Quite the difference. After 40 years, the 5% saver would have $1,640,000 while the 10% saver would have $3,281,000. Of course, someone who enjoyed all of their income and saved nothing would have, well, nothing. Not a great retirement. Or maybe working longer than you had hoped. So savings rate is a key to build wealth like the pros.

And there are other ways to look at this chart. As an example, let’s say you wanted to retire early. At a 5% savings rate, you would accumulate $1,126,000 after 35 years. But with a 10% savings rate, you could gather the same amount after just 27 years. That’s 8 years to whack white balls across the countryside, build a school in Kenya, or just bask in a hammock sampling Pina Coladas.

What counts in savings rate?

Another good question. It’s anything that builds wealth. For instance, contributing to a registered education plan is a great thing to do, since the government helps you save more effectively. But it doesn’t contribute to your long term wealth. Joining the company pension plan does count. If you want a 10% savings rate and your pension plan contribution is 6% of your gross, then you would need to save another 4% elsewhere. If you had a high interest mortgage or other debt, applying accelerated payments would count since the “return” is guaranteed and eliminating that debt would help build your long term wealth. Just make sure that you aren’t living beyond your means, continuously racking up debt, then paying it off. That doesn’t count! Nice try though!

What if you can’t scrape together a decent savings rate?

There are tons of ways to save on just about every category of spend. I spent 2 years finding the best ideas, in fact, $13,000 of monthly savings ideas. Check it out here. And be sure to subscribe to this blog so you don’t miss anything. No spam, no passing your information to foreign hackers. Just you and me building your wealth!

One more trick to build wealth like the pros

Saving any amount might seem daunting. But 4% is better than 2% and 2% is better than nothing. Build the savings habit, establish some sort of automatic savings plan that snatches the money before you can. A company stock purchase plan, an automatic monthly  transfer to an investment account or a government registered plan. Start with a small percentage and step it up a bit at a time. If you do it just as you get a raise, you literally won’t notice the difference. Maybe enjoy half the raise and use the rest to crank your savings rate up an extra 2 or 3%. Then do it again next raise. It’s worth it.

And there is one more way to build wealth like the pros:

Factor 4 – Income

On the one hand, this is a bit obvious. Doesn’t everyone who earns a lot end up rich? Well, actually not. Ask Mike Tyson, MC Hammer, Nicolas Cage, Toni Braxton, 50 Cent, Kim Basinger, Michael Jackson or Burt Reynolds. If you spend as much as you earn, or more, you will go broke no matter how much you earn.

But what happens if we keep everything else the same, but increase our household income from, say, $150,000 to $200,000? Let’s take a look at the chart with the new numbers:

No surprise. All of the numbers get bigger. As an example, a 20% saver earning $150,000 would accumulate $3,049,000 over 30 years, while the 20% saver earning $200,000 would pile up $4,066,000. Whoa! An extra millski. And it shows that increasing your earnings is another key to build wealth like the pros.

What did I miss? What aha’s did you have? Let me know in the comments. If you enjoyed this, please share it with the social buttons.

Why your investments aren’t growing

What an awesome year for investors! The Dow Jones Index is up 58% in the last year. Rank amateurs are striking it rich. Your Uber driver, plumber and urologist are all making zillions! Investing has become a way better fad than the Macarena, the Ice Bucket Challenge and even fidget spinners. And everyone is crushing it except, maybe, you. Let’s look at the 5 reasons why your investments aren’t growing and everyone else’s are:

1. Everyone else’s aren’t growing

It’s a bit like Facebook. Remember Ronnie’s post about getting demoted at work? No? How about the one about Tom getting dumped by his girlfriend? Or maybe the one showing Tammy watching Netflix all alone since she wasn’t invited to the virtual wine and cheese Zoom party? Investing is a lot like that. People do plenty of bragging about their winners. Everyone stays silent about their losers. In other words, don’t listen to the hype, its likely not showing you a clear picture. Maybe you are doing ok and everyone else is just exagerating.  On the other hand, maybe your results really do suck. Let’s fix that. Read on.

2. You are watching your stocks like, well, a watched pot

No wonder they aren’t boiling. Warren Buffett often paints the picture of someone building or buying a business. Do they call in a business valuator every day to get an update on the value of the business? How about 4 times a day? Unlikely. Give your stocks some time. As a stockholder you own a piece of a business, give it time to grow.

For example, look at this stinker of a stock:

Whoa! A drop of almost 37% and this chart was taken over just 2 1/2 months. Should I sell?

Why can’t it be more like stock Number 2 below?

This one went up almost 10X in just 2 years. Love that. And the great news is that the first stock IS a lot like the second stock. In fact they are the same stock. They are both Apple stock (AAPL). Here is a longer term chart:

If you play around with stock charts, you will find that any stock can look like a winner or a loser by just changing the time frame. In conclusion: Buy quality stocks and hold them for the long haul. Don’t buy or sell based on the ups and downs of their charts. Stop watching them at every commercial break, they will do just fine without you. Too much trading could be why your investments aren’t growing.

3. Don’t buy and sell based on news headlines, boredom or tips

The news is there to sell more news. It’s not intended as investment advice. Let’s look at a few headlines that might have made you sell your stocks:

• North Korea is going to flatten us with their missiles.
  Didn’t happen. The stock market continues to grow. If it does happen, our investment returns won’t be our biggest worry.
• We are running out of oil, the world is doomed!
  Lots still available! In fact oil prices were negative just a few months back. Couldn’t give the stuff away.
• The 2008 Financial Crisis will decimate stocks.
  It did for a while. Since then they have grown 292%. Thankfully you didn’t sell and miss all of that. Did you?
• The volcano in Eyjafjallajökull Iceland will wipe out airline stocks!
  Hard to spell and it did suspend flights, but planes are back and flying.
• Financial expert says get out of the markets now!
  This is a permanent-headline. Like the sign at a bar that says free beer tomorrow. Ignore it.
• If Trump gets in, the stock market will implode.
  Actually markets rose 9.6% in his first 4 months.
• If Biden gets in, the stock market will implode.
  Actually markets rose 13.6% in his first 4 months.

In other words, headlines don’t have a great track record of predicting stock markets. Even if you get out at the right time, how will you know to get back in at the right time? Build a quality portfolio and then let it grow.

Warren Buffett’s quote tells the story

“The stock market is a device to transfer money from the impatient to the patient”. Print this off, cut it down to size and Scotch tape it to the screen of wherever it is that you buy and sell stocks. It’s like taping a picture of either your fat self, or the movie star you want to become, to your fridge door.

A Dalbar Inc study showed that for the twenty years ending in 2015, the S&P 500 averaged growth of 9.85% a year, while the average equity investor earned a market return of just 5.19%. The reason is human emotion. Greed. Fear. The fun of hitting the buy and sell button. The craving to lock in wins. The panic to avoid tragic losses. Resist! Keep a qualified financial advisor in between you and your investments. Or develop the discipline to buy and hold. It works.

If you have dividend stocks with a dividend reinvestment program in place, you may learn to love the dips in stock prices. Sound weird? I wrote about that here.

The conclusion – buy and hold for the long term. Think of that old adage that your investments are like a bar of soap. The more you handle them the smaller they get. It could be a big reason why your investments aren’t growing.

4. Stay properly diversified

Some companies do better when interest rates rise. Others are happier when they fall. Sometimes bonds do better than stocks, other times the reverse is true. The US markets might outperform Europe. or it may be the other way around for a period of time. The same is true of small company stocks vs large company stocks. Returns vary by industry as well.

All of this makes it very hard to consistently pick winners. And even if you pick a great stock in a growing industry in a booming economy with rising productivity and a powerful product advantage and great Super Bowl ads, it may all come crashing down when the CEO gets caught licking quarts of ice cream at the supermarket.

How to prosper? Invest with proper diversification by:

• Asset classes – stocks, bonds and cash. Maybe some real estate.
• Geography – exposure to the major economies
• Duration in the case of bonds. Short, medium and long term
• Company size – so called large caps and small cap companies
• Industry type – tech, resources, consumer goods, financials etc

As an example of the first point, many people are terrified of the stock market and instead hold only cash, treasury bills, short term bonds and their wallet. As a result, they see terrible returns of under 1%. After tax they earn well less than inflation. That means that their money buys less every year. They lose by not investing. Here is a post about how to solve that one.

If this sounds complicated, get some help from a qualified financial advisor, or use Exchange Traded Funds to simplify diversification. As an example, part of my holdings are in Vanguard’s VTI Exchange Traded Fund. It holds over 3,600 companies in every industry. Well diversified. It has averaged over 8% annual growth since its inception and even pays a dividend. Combine that with a bond fund and you can build a solid portfolio. This is just an example, readers should do their own research prior to investing.

In short, if you are wondering why your investments aren’t growing, it could be that you aren’t properly diversified.

5. Don’t overpay for investment advice.

Many studies have been done about the ability of investment pros and fund managers ability to consistently outperform the market. The answer is that about 90% don’t. And you might be paying 1.5%, 2% or even more in fees for the privilege of trailing the market. The fees could be a combination of advisor fees, fund fees, commissions and other expenses. It can be a big reason why your investments aren’t growing.

How much does this matter? A lot. Those fees come right out of your returns and the effect compounds over time. Let’s take an example of an investor who invests $100,000, pays 1.75% in total fees and the investments earn 5% per year. Over 25 years, the investment would grow $238,635, but investment fees would add up to $116,176 and the investor would keep $122,460 or about half of the total return. Try some different scenarios on the excellent simulator at Larry Bates’ site here.

While that tool might whip you into a frenzy about investment fees, remember that for many people, an investment advisor can save them from blunders 1 through 4 above. The key is to ensure that you are getting more in value than you are paying in fees. Maybe that financial advisor stops you from selling during the start of the Covid crisis, thus keeping you in the market as it rebounded more than 50% in a year.

In summary, know how much you are paying in investment fees of all kinds and know your investment returns for each year. Compare your after fee returns to the benchmarks for each of your investment types – stocks, bonds etc.

Why your investments aren’t growing – the summary

Saving 10% or more of your income is a powerful step to wealth building. But the magic really happens when you have those savings invested and the results compound over time. If you are saving less than 10% look for ways to save more. There are lots of ideas in my blog on how to do that with minimal effort and sacrifice.

But it is just as important to make those savings grow. Select quality stocks and bonds (or funds) and then give them time to grow. Diversify your portfolio and align it with your risk tolerance. Then track your investment returns and fees for the last several years. If you aren’t growing as fast as the market, take the time to understand why not.

Which of these issues are hampering your investment growth? What are you looking to change? Please let me know in the comments.

Photo credit Pixabay.

Reduce bill anxiety!

Ugh. There it is. That gnawing feeling that there is something not so good in your finances. Maybe you have a sense that you missed a past due bill? Perhaps a fear that those last few purchases put you into overdraft? Or maybe there is a masked money monster on your desk, lurking under a jumble of bills, bank statements, cat toys, tax receipts, charging cables and lint. Whatever the situation, let’s permanently reduce bill anxiety in your household.

Let’s start by setting up your money into 3 pots:

Your Savings Pot

Your Savings Pot(s) are anywhere you send money to decrease debt or increase your investments. It might include registered accounts, work pensions, investment accounts or aggressive mortgage pay downs.

• Ideally, get your savings money payroll deducted and straight into your Savings Pot. If that isn’t possible then set up an automatic monthly transfer from your Fun Pot where your income gets deposited each month.
• Your Savings Pot is a priority. It sets you up for financial freedom. Do some quick math and see how much of your gross income you are saving.
• Add up how much you save each month. Include what goes into your registered accounts like your IRA, 401(k) (or TFSAs and RSPs for Canadians) as well as what you are saving in cash accounts and divide that by your monthly gross income.
• If the result is less than 10%, you need to free up some cash to increase your savings rate. Are you saving 10-20%? You are well on your way to financial freedom. Crushing it with a savings rate of 20-50%? Please reach out to me and let’s do a case study on you!
• If you are overwhelmed by bills, and can’t save anything at all, you may end up working longer than you would like.  Find ways to grind down your monthly bills and/or your fun expenditures. Check out my blog posts or some of the ideas in Cashflow Cookbook.

Some savings come with extra sauce

• If your company offers company pension plans, company sponsored 401(k) plans or company stock plans it is their way of trying to give you free money! Don’t say no!. Look for ways to free up cash and participate.
• The government wants to help too! Tax advantaged plans like IRAs, 401(k) and 529 education savings plans (TFSAs, RSPs and RESPs in Canada) also provide free money by reducing the taxes you would otherwise pay. When your government offers free money, don’t say no to that either.
• Sometimes debt repayment can be the best place to ‘save’. As an example, say you are carrying $30,000 in credit card debt at 22%. If your tax rate is 40%, paying that off is like investing in a government bond that pays 36%  interest! Bit of a no brainer. *

Boom! Savings are covered. Just let that pot simmer. Nothing to worry about, you are on track for financial freedom. As you earn more, be sure to generously top up your Savings Pot. On to the Fun Pot.

Your Fun Pot

Your Fun Pot is just a checking account where your paychecks or other income get deposited each month. An automatic monthly transfer pours bill payment money to your Bill Pot each month. The rest is yours to enjoy.

• You may want to do all your spending on a rewards credit card to pick up some cash or travel points, then pay off the card every month from your Fun Pot. I like the reward credit card finder from SmartAsset (or the rates.ca credit card  finder for Canadians)
• If you share your finances with someone else, be sure to have regular communications about this account. What  larger expenses are planned for this month? Where do we stand now and what trips, dinners and things are left to buy?
• With the bills out of the way in the Bill Pot, it is much easier to manage your fun money. No surprise bills coming out that kick you into overdraft hell. Less arguing about money. A way to reduce bill anxiety.
• Look for ways to get more for your fun money spend. Clever ways to share things vs buying your own? Better ways to buy things? Or even ways to save on vodka?

Your Bill Pot

Automating and streamlining your bills is a great way to reduce bill anxiety. Here are some steps to get things under control:

1. Pull out each of your recurring bills (cell phone, internet, gas, electricity, insurance etc) and calculate the average monthly spend for each and total them up. Add 10% for good measure.
2. Set up a separate “Bill Pot” account that is only used to pay your recurring monthly bills. This account will have 6-12 bills a month drizzling out and one monthly payment coming in. Find the lowest cost account that can do that.
3. Set up an automated transfer for the amount in step 1, coming from your Fun pot into your Bill Pot once a month.
4. Set up a browser favorites folder on your computer called “Household Bills”. Create accounts with each of your service providers with automatic bill payments coming from your Bill Pot Account. Bookmark each of them into your Household Bills folder. Lovely! While you are at it, select the paperless billing option. Add each of your bill accounts to your Household Bill folder on your computer and use a password manager so you don’t have to remember dozens of passwords like Ye$EyElike2Golf.
5. Double check that everything gets paid as you transition between manual bill payment and this automated approach.
6. Enjoy bill freedom. Throw out all of that paper. Let those companies do the filing for you. Want to retrieve an old bill? Have a sudden hankering to review last May’s gas bill? Go to Household Bills and peruse away. No hassles, no overdue bills, no paper, no stress.

The fine tune

Once you get everything in place and your bills pay themselves, you have managed to reduce bill anxiety, eliminate a lot of paper and automate your savings, it’s time to fine tune things:

• Call each of your providers each year and make sure that you are on the best plan, getting the best rate and enjoying all of the discounts. They would love to hear from you. An example script for speaking with your cell phone provider is here. Some gentle mention of the competition or actual shopping of the competition never hurts. Once optimized, reduce the money flowing into the Bill Pot and increase your Savings Pot if you can. Set a reminder to call each provider every year or use online comparison tools like Zebra (For US car insurance) or rates.ca (Canadian car and home insurance, credit cards, life insurance and more).
• As you reduce these boring and painful bills, use the freed up cash to reduce the monthly transfers into your Bill Pot and increase your automated monthly Savings Pot contributions.  If you are already saving 10-20%, then splurge with a higher Fun Pot.
• Not a bad idea to set up an emergency account or have access to a credit line to cover unforeseen emergencies like broken dishwashers, dog operations or car crash deductibles.

At Retirement

In retirement, keep going with your Fun Pot and your Bill Pot.

Your Savings Pot now replaces your income and just pours cash into the other two every month. Keep seasoning your Bill Pot by optimizing your expenses. Monitor your Savings Pot to make sure that you don’t outlast it. And enjoy yourself! You’ve earned it!

*If you want an explanation of this 36% government bond, leave a comment below and I will respond.

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How do you set up your accounts? What did I miss? Please let me know in the comments.