In finance, there is an interesting mathematical quirk that arises which investors can take advantage of in their calculations. It's called the Rule of 72. By using it, you can estimate how long it will take to double your money, or the rate of return you need to earn to reach a target savings goal, all in a few seconds without any difficult math. It's definitely one of those things you should have in your back pocket at all times, so be sure to read an explanation of how to do the calculation ...
The composition of family income, which is the dry powder that makes funding an investment portfolio possible, differs significant from the middle class to the upper class. In 2010, the most recent year data was available from the nation's central bank, it showed some interesting characteristics.
A family in the 50th-74.9th percentile distribution of household income generated money as follows:
- 76.3% wages
- 0.4% interest or dividends
- 4.8% Business, farm, self-employment income
- 0.1% capital gains
- 15.9% Social Security or retirement plans
- 2.5% transfers of societal benefits
Meanwhile, a family in the 90th-100th percentile distribution of household income generated its money as follows:
- 55.8%% wages
- 8.7% interest or dividends
- 23.9% Business, farm, self-employment income
- 2.3% capital gains
- 7.8% Social Security or retirement plans
- 1.5% transfers of societal benefits
That means the richer families - those making a median income of $238,000 per year - are generating vastly higher proportions of annual household income from combination of dividends, interest income, capital gains, and small business profits. The rich are much less likely to sell their time for a paycheck and, instead, own equity in a firm of some sort.
Still plowing through economic data as part of my day-to-day work at the office, I am now examining the household income of various demographic groups. Median household income in 2010 (the latest data available) based on educational attainment was as follows:
- No high school diploma = $23,000 per annum
- High school diploma = $36,600 per annum
- Some college = $42,900 per annum
- College degree= $73,800 per annum
That amount is where half of the people in your category make more than you and half make less. Over a lifetime, the cumulative dividend from a college degree is in the millions of dollars. Value investing works in this area, too, because the key is not to overpay for the degree by taking on too much student loan debt or picking a discipline that doesn't monetize well unless you can afford such a luxury.
Across all demographics in the United States, 52% of families reported running a surplus and saving at least some money in the past twelve months looking at the Federal Reserve data. As expected, this scales with income and retirement, college, and emergency savings rank supreme on the list of priorities.
The highest income bracket - those in the 90th - 100th percentiles - reported 80.9% of households saving money, while those in the bottom 20% of society reported 32.3% of households saving money. Young people under 35 years old are the most likely demographic to save as are childless couples and those who have a college degree.
If you've ever wondered if your savings are enough, check out an article called How Much Money Should I Be Saving? to get a rough estimate of whether you're on track.
Why do people invest their money? The answer may seem obvious, but when you get to the heart of the matter, it can change how you allocate your funds. Typically, there are four primary sources of increase or utility that cause an outlay to produce a better life for you and your family. Arranging your portfolio so that you can maximize each of them can make the process of investing a lot less stressful, a lot more enjoyable, and, in the end, much simpler, too. To learn more, check out The 4 Sources of Wealth That Make an Investment Valuable ...
The biggest advantage of owning a business is that a really good company has the power to raise prices at or higher than the inflation rate so that, over time, the owners enjoy bigger dividend checks. While you can never be certain how a single investment will work out in the end, a well-diversified collection of high quality holdings can shower you with ever-increasing piles of money that keep growing larger over time. It's a mistake to focus on the stock price itself too much; the focus should be on the cash income. To see some real world examples from my own portfolio, check out my newest article ...
Going through more economic data, an interesting trend appears in the holdings of the typical American family. While most own stocks indirectly through retirement plans such as a Roth IRA, Traditional IRA, or 401(k) plan, or through mutual funds or index funds that are invested in things such as the S&P 500, only 1 out of every 8 or so households actually makes a point to buy shares of common stock outright, directly, to take advantage of the long-term compounding power and live off the dividends. Of those who do, more than a third of them buy shares of their employer, meaning if they were to lose their job due to a bankruptcy or downturn in the industry that puts food on their table, their portfolio would get hit at the same time!
Take a moment to go through the figures with me in a new article I wrote breaking down the numbers ...
Cross referencing data from a handful of sources and a picture emerges that is interesting to those of us who look at investment portfolios and assets all day. It turns out that one of the biggest demographic indicators for how you manage your money, and how much money you have to manage, is whether or not you own a business. Business owners, as a class, have more money, more investment capital, and are more aggressive with how they put their funds to work, while remaining more rational during down turns and panics.
There might be a chicken-and-the-egg problem here. Are business owners like this because they have to be (otherwise they'd lose their business). That is, is it a skill that evolves over time as a by-product from running a company so that every penny of surplus benefits your own family and every penny of loss comes out of your own pocket? Or, are people with this temperament and personality naturally drawn to business ownership? It could be a little bit of both.
To see some specific numbers and walk through a breakdown compared to the general population, read Business Owners Appear To Be Better Investors.
Whenever you are making an investment in a family business or small business with friends, often in the form of a limited liability company, there are only two predominate ways you can put up capital. To walk you through each, along with a brief explanation, I wrote The Two Types of Investments You Can Make In a Small Business. It will cover a majority of most scenarios, even though exceptions do exist that are beyond the scope of the beginner (e.g., leasing a productive asset or intellectual property at certain rates of return to the company with the right to take possession in the future).
When it comes to investing, there are three ways you can make money from owning a share of common stock.
- The initial dividend yield you collect
- The growth in intrinsic value per share, which will fund dividend increases and capital gains
- The change in valuation applied to the firm's earnings (i.e., how much every $1 in profit is valued)
When it comes to owning a bond, there are also three ways you might be able to make money.
- The interest income you receive on the money you loaned the bond issuer.
- The capital gains generated by buying a bond prior to a drop in interest rates or following an increase in the credit quality of the bond itself.
- Special operations from unique circumstances, like conversion privileges being attached to a bond allowing you to swap it for common stock under certain scenarios.
When making a new commitment with your hard-earned money, it's often best to identify, clearly and specifically, how you think you are going to make your profit. This one disciplined practice can help you avoid major bubbles as others get washed away by over enthusiasm, paying too much for their holdings.