So what am I talking about then? How can you become rich? Ok well if you really want to know, I am talking about INVESTMENTS. And no I am not pitching any of the other messages that stockbrokers and financial managers are throwing your way. I am talking about a methodical, well thought out investment strategy that will beat anything your mutual fund managers are pitching. I am also talking about an investment strategy that will make good use of the magic of compound. Compound interest, by the way, has been called the 8th wonder of the world by Albert Einstein. And for good reason, Einstein knew the magic of compound interest and how by saving a portion of your money and allowing it to compound, you can increase your net worth tremendously. So let’s begin talking about the investment strategies that can be your golden ticket to wealth.
Important note: Remember, the tortoise not the hare wins the race. Slow and steady. Life is a marathon not a sprint (ok I think I that’s enough with the coined phrases).
The first thing we have to learn is that in order to accumulate wealth we have to take a portion out of our income and put it away for investments. Think of it as paying your future self. You pay your creditors, you pay your mortgage, you pay your bills, you pay just about everyone else but yourself. It’s time to shift that mentality. You have to look at this as paying yourself before you pay anyone else. So first you have to decide how much you are comfortable putting away for your future self. If you can put away 10% then that’s a great start but ultimately you want to get to a point where you are putting away 20%-30% of your earnings to pay your future self.
The best way to go about this is to automatically have it deducted from your check or account before you even have a chance to look at it. The old saying, out of sight out of mind, holds true here. If you don’t see it at first then you wont miss it. However if you see it deducted from your paycheck and had a chance to see how much was there initially, it will hurt you much more. So go to your bank or stock broker and have them automatically deduct the portion you want to set aside, each time you get paid.
The next thing you must know is that you should never invest in a MUTUAL FUNDS (as Bobby Boucher’s mother in Waterboy would say, “Mutual Funds are the devil bobby!”). Ok maybe not all of them are bad but the vast majority are. So why is that? Because they have a conflict of interest, on the one side it’s their job to make you money by investing money into their stock portfolio and on the other side it’s their job to make money through the money you invest in their stock portfolio. So they are in direct conflict with themselves. Yet people continue to pour money into the funds year after year. Not only is it their job to make money off of you but they are also only showing you the portfolios that does well, they don’t show you the portfolios of stock that have failed. Of course they wouldn’t, they know you would run out the door! So how do they make money off of you? They do so by charging you fees, lots and lots of fees. They say they are only charging you 1% or 2% but in reality they are charging you much much more. They are able to get away with this because the fees are disguised as crazy financial jargon that no one understands. You literally need a PhD in Finance to understand what the contract/agreement says. Oh and just like we said earlier that compound interest is magic and we can get wealthy through compounding, well the same holds true for compound fees. Fees compound as well and take up a large portion of your nest egg.
Wait, it gets even worse. Not only do mutual fund managers charge you an arm and a leg for investing in their portfolios, the mutual funds themselves are horrible. The stocks in the mutual fund portfolio hardly beat the market.
This brings us to the next thing you must learn, INVEST IN INDEXES. Indexes, if you don’t know, are investment funds that aim to replicate the movement of a specific financial market (sorry for getting too technical). Indexes like the S&P 500 already does the grunt work for us by choosing the top 500 US Stocks. And the mutual fund managers, 96% of the time, wont beat the index. So why put your money in a mutual fund when you can put your money into an index? That’s the question everyone should be asking themselves! Not only do indexes beat fund managers by far but they also don’t charge you crazy fees. So you are winning two folds, by decreased fees and a higher return on your investment.
If you shouldn’t invest in Mutual Funds and need to invest in Indexes then how should you put your money away? You know you have to put money in a retirement account that also provides you the ability to save on taxes. Most people are lured by Mutual Funds because they are tax deferred. They think that by putting off taxes, that they can accumulate wealth because their accounts look large (whenever they take the time out to look at it). However this is another area where the general public is completely fooled. The reason this is such a bad strategy to pursue is because when you defer taxes, you end up paying such a large amount when it’s time to pull the money out. Think about it, if you put off taxes until it’s time to pull it out and your retirement account grows and grows; by the time Uncle Sam collects on the money owed from the retirement account, it’s a huge amount! It’s in their best interest to collect after it amasses such a large amount then when it’s a small amount.
Your best bet it to invest in ROTH IRA’s or ROTH 401K’s. Why is that? Because you pay taxes on the front end, when it is going in instead of coming out (and also when it’s a much smaller amount). Compare that to when the money has grown into a large amount, you have to give away a much larger portion. You are better off paying taxes while the amount is small than paying taxes when it has grown to a large amount. Also, once you pay taxes as they go in, the money now grows interest free! So whenever you look at your account, you will actually know how much money you have in there instead of thinking you know; and in reality half of it is going away to Uncle Sam and to your Mutual Fund Manager. Most people think that whatever amount they see in their Mutual Fund is what they are actually retiring with, yet they haven’t factored in the Fund Manager’s portion and Uncle Sam’s portion. So you can kiss almost half your retirement fund goodbye!
Interestingly, it is easier than ever to open a ROTH 401K or ROTH IRA. All you have to do is go online to sites like TD Ameritrade, Charles Swab, Fidelity and so many more. By going this route you circumvent 2 disasters; having to pay your mutual fund manager’s fees and having to pay all the money you have compounded over the years to Uncle Sam. Take my advice and pay your taxes while the money is a small amount than when it’s a large one. Another way to look at this is, would you rather pay taxes on the seed or on the harvest? I think you’re better off paying on the seed.
Now onto one of the most important investment tips to remember, ASSET ALLOCATION or DIVERSIFICATION. Diversification is extremely important because the markets will go up and also down eventually, no matter how well they have been performing (which we’ve learned all too well in 2008). Nothing continues to go up forever, what goes up must come down! So to begin with lets look at the different investment vehicles you can choose from:
Indexes / Stocks
Asset allocation is essential to investing because it provides you with a safety net should one of your investment vehicles go down the tube. For example, in 2008 when all the stocks crashed, if your investment were spread out through stocks, bonds, commodities and so forth, you stood a better chance to weather the storm than those who had all of their money invested in mutual funds. Most people simply saw their savings vanish into thin air. So it’s extremely important to diversify your investments.
An example of a good portfolio can look something like this:
This would consist of indexes like the S&P 500, NYSE Composite, Dow Jones Industrial Average, etc. However a smaller portion can also be allocated to International indexes such as Europe & Asia and an even smaller portions in Emerging Stock Markets like in Africa, Vietnam & Brazil. The reason to invest very small portions in foreign indexes is due to higher rates of return, but with higher returns come higher risks. The US are considered to be the safest.
BONDS – 45% (15% in short term and 30% in long term)
Now this might come to a shock to most people that we would suggest such a large amount in bonds but Bonds, especially US Bonds, tend to be one of the safest investment vehicles. The only way this would backfire is if the US government collapses, but that isn’t likely to happen any time soon. For short-term bonds you should look into 7-10 year treasuries and for the long-term bonds 20-25 year treasures. Remember, we’re in it for the long haul so don’t be afraid to invest in such a long term strategy.
COMMODITIES / GOLD – 15% (7.5% each)
Commodities & Gold stand the test of time and when all else fails it’s good to have small portions of your investment in these vehicles.
OK so I know what some of you are thinking, “I’m going to die before I am able to enjoy my money!” I understand your concern on such a long-term strategy but bare with me.
Another way to be financially free is to put your money into ANNUTIES. Not VARIABLE ANNUITIES either! They are the worst; I won’t go in to too much detail here but just know that you should never invest in them. You want to invest in either TRADITIONAL ANNUITIES or FIXED INDEX ANNUITIES. The way annuities works is simple, you give the insurance company your money, decide when you want to start receiving a monthly income (the longer you wait, the more you receive) and in return they provide you with a fixed income for the rest of your life. Traditionally this was for older folks, 55yrs+, but today there are some new annuity plans for younger people. This is great because you now have a fixed income for life and don’t have to worry about whether you will outlive your retirement fund, which with advances in technology, is becoming more and more commonplace.
Well there you have it, How to Become Rich! (albeit a slow avenue) I hope you learned the foundations to a good investment strategy that can get you to where you want to be financially. Of course there is plenty more to learn but this is a good foundation to start. So let’s quickly recap.
· Invest in your self and automatically draft money into an investment/retirement account so you don’t see it get drafted and learn to make due.
· Invest in indexes (there are plenty of indexes to choose from) and not in mutual funds. This way you don’t have to pay crazy fees and invest in a Mutual Fund that wont beat the market.
· Invest in ROTH (either IRA or 401K) so you can pay taxes while your money is small and don’t pay when your investment balloons into a large amount.
· Diversify your Investment! Asset Allocation is KING. Make sure your investments are spread out; this is your safety net.
· Invest in income insurance or ANNUITIES so you can have an income for life.
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