As the Investing for Beginners guide, one of the things that I've seen frequently over the past decade is the tendency for investors to delude themselves. Sometimes, they delude themselves into thinking that their financial situation isn't as bad as it is. Other times, they delude themselves into thinking they can spend today, ignore their retirement, and make up for it later. When it comes to managing an investment portfolio, one of the most common delusions I see is when an individual investor passionately argues that a stock is "undervalued" at 100x earnings or that the reason they are losing money is because of the "crooks" on Wall Street.
Making Money Isn't Difficult
As we have discussed countless times in the past, making money isn't difficult. I talked about this in a special called How to Get Rich. This morning, I wrote an essay on my personal blog explaining how during the early part of my career, Aaron and I were earning between $80,000 and $100,000 a year as college students without having full-time jobs by simply doing intelligent things in an intelligent way. Our entire setup consisted of a couple of computers and an Internet connection. We were making money in between attending classes by using our ideas, a couple of computers and an Internet connection.
The 4 Keys to Making MoneyThere were four keys we used during those early days that aided us in our quest to make money. If you remember each, I believe you have a much better prospect of achieving your financial goals than you would going it alone. These keys are:
- Never forget that making money consists of one simple formula: Revenue (sales or gross pay) minus cost (expenses) = profit. To make more money, you must either increase your revenue, decrease your expenses, or both. There is no other way. It really is that simple. How you do that involves tradeoffs in terms of time, relationships, and quality of living. Some people try to make money by going to law school and earning a higher salary, even though it means years of study and lots of debt. Others try to make money by starting a successful business.
- Focus obsessively on controlling your risk. You should never be willing to take on wipe-out risk just for the chance at making money. Don't start speculating with options in the hopes of striking it rich. Don't recklessly borrow money in an attempt to leverage yourself to the hilt and have one big score. Never rely on a single household income to pay all of your bills (I much prefer the Berkshire Hathaway model).
- Treat your money like an employee. In the past, I've written about a technique I used to help me understand how compounding works when I started studying finance in childhood. I thought of each dollar as a potential employee that could earn more dollars for me if I protected them and put them to work. A decent employee, in my mind, was able to earn at least 10% per year, or 10¢, without using any debt. My job was to collect as many employees, and get them to churn out as much additional money, as I possibly could, while still enjoying my life and living according to my morals. At some point, my dollars (workers) would be earning enough for me to live off the passive income. Looking back now, it is kind of funny because I don't want to retire - I'll be one of those guys who is so passionate about his job that he continues to work his entire life. But it is important because I don't have to work; I have a choice.
- Making money is impossible if you delude yourself. In a 1982 speech to the British Parliament during an international visit, then-President Ronald Reagan said, "If history teaches anything, it teaches self-delusion in the face of unpleasant facts is folly." While Reagan was discussing political science, the same is true in economics. The first step to making progress is to confront reality, face it boldly, and recognize the situation in which you find yourself. Only then can you develop a plan to improve your life. It may not be pleasant, but it is necessary.
In short, making money and building wealth is easy if you stay the course, keep costs low, and put your cash to work in good investments for long periods of time. Compounding will do all of the heavy lifting. An 18 year old saving $500 per month throughout his or her career would retire at 65 with nearly $2,000,000 in wealth at a 7% rate of return. Add another decade and the fortune grows to nearly $4,000,000. Increase the return to 10% and the portfolio swells to $13,665,700. This is the nature of money and making money.