The powerful, undeniable truth is that making a lot of money doesn’t require a high IQ, either in the market or in business. It takes ruthless cost control, disciplined routine, and a focus on doing what is right for the long-term. Whether you are running a McDonald’s franchise or managing your 401k from your home office, perhaps Nobel prize-winning economic Paul Samuelson said it best: “Investing should be like watching paint dry … If you want excitement, take $800 and go to Las Vegas.” I detailed the nature of this by giving readers a glimpse into my personal dividend portfolio and showing how my own accounts have prospered over the past three years, despite horrific market fluctuations, through a collection of well-capitalized and well-operated common stocks.
- Buy shares of good businesses that generate real profits, attractive returns on equity, have low to moderate debt to equity ratios, improving gross profit margins, a shareholder-friendly management, and at least some franchise value.
- Dollar cost average into and out of your positions, buying and selling at fixed rates, set amounts of money. This will allow you to avoid buying it at a peak or selling out at a bottom.
- Reinvest your dividends because it will supercharge your dollar cost averaging program. The work of renowned finance professor Jeremy Siegel has shown time and time again that reinvested dividends are a huge component of the overall wealth of those who made their fortune investing in the market.
- Keep your costs low. Think there isn’t a difference between earning 7% and 8.25% on your money? Think again! For a 25 year old investing $5,000 per month into a Roth IRA with hopes of retiring at 65, the 7% rate of return will get him around $998,175 by retirement. The 8.25% return will result in $1,383,610 in wealth. That’s 38.6% more money, or $385,435! Place the difference into municipal bonds and you get an extra $17,000+ in after-tax income each and every year without touching your principal.
Think about that – the same investment, with only slightly higher returns, is going to get you an extra $1,400+ per month in after-tax retirement income without ever having to touch your portfolio. Before taxes, that’s about $2,300 in gross pay when you were working nine to five at the day job. Put another way, getting that extra 1.25% return over 40 years is like receiving a $27,600 pay raise during your working years. The big difference is that you won’t have to deal with scheduled hours, a boss, coworkers, or a commute to collect your municipal bond interest.
Why talk about a 1.25% difference? That’s the management fee charged by most actively managed mutual funds. An index fund just buys and holds a basket of stocks established to mirror an index – most often, the S&P 500 or the Dow Jones Industrial Average. With almost no maintenance expenses, the fund costs are a mere 0.12% of assets per year, or $120 for every $100,000 you have put to work! The two most popular of the index funds are offered by Vanguard and Fidelity (check the prospectus for the current expense ratios).
I’ve seen one major wealth management firm offer an S&P 500 index fund, that requires virtually no work, but charge a 1%+ expense fee each year. That’s 10x the cost of the Fidelity and Vanguard funds for a virtually identical product! You’ve already seen what the implications can be to your pocket book over a few decades. Most investors don’t realize the importance of fees because the money is automatically deducted from the mutual fund itself. In other words, they don’t have to write a check so it is a case of “out of sight, out of mind”. (For more information, read All About Mutual Funds.)
- Finally, the last secret to building your fortune when Wall Street is in a storm is to create backup cash generators and income sources. This is one of the single most important things you can do to cut your risk. Even if you are an attorney earning $300,000 per year, or an actor making $2,000,000 per film, you are going to have a much more enjoyable life if you know that you aren't dependent upon your next paycheck to maintain your standard of living.
My personal favorite utilization of this method is the Berkshire Hathaway Model. This is the way my own life and finances are structured, and it can make it far easier to amass the first few million dollars in net worth. In essence, you live off your day job, funding your retirement out of your regular salary. Then, you build other cash generators (e.g., car washes, retail stores, newspaper routes, a lifeguard job during the summer, patents, royalties, rental houses, etc.) that you use to build your investment portfolio. That way, while you are doing your regular thing - going to work, picking up the kids, having staff meetings, and putting gas in the car - your cash generators are pouring money into your brokerage, retirement, and other investment accounts. This can shave decades off your quest to financial independence, not to mention protect you if you happened to lose your job (in which case, you could temporarily pull the money out of the cash generators to pay your living expenses until you could find work again). Think about Warren Buffett. If Dairy Queen were to go bankrupt, he would still be rich from GEICO. If it were to go down, he still has Nebraska Furniture Mart. If it were destroyed, there's always Benjamin Moore Paints. If it were wiped away, he could always fall back on Coca-Cola. If it ceased to exist, there's always American Express. And the Washington Post. And Wells Fargo. And U.S. Bancorp. And Johnson & Johnson. And Borsheim's. And MidAmerican Power. Plus, he makes millions sitting on various Board of Directors. All of this was built out of a paper route that provided his initial capital more than sixty years ago. Learn from it!