Never spend all your money - 6th of top 14 things you should start doing immediately to get rich

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Note: This is the fifth of 14 consecutive posts from 2nd to 15th of April about the principles of how to get rich. Check back daily or subscribe to the RSS feed

Credit card debt is an increasingly bigger problem in the US, Europe and parts of Asia. It seems that the convenience of buying something and paying for it afterwards in small payments is a luxury that is difficult to give a way.

In spite of hundreds of millions of credit card users there is however a substantial part of population who don’t use credit cards. If we take a closer look we will see, that these people mainly fall into 3 groups:

1. People who have been in major credit card or other debt that have faced the difficulties of paying back their enormous debts. These people have promised themselves that they will never use a credit card or take a loan again. Most people who have managed to come out of tens of thousands of dollars of debt usually end up by cutting their cards.
2. People who don’t trust banks or anybody but themselves to keep track of their money. A lot of Hispanics but also a good number of black and white people do the same. These people only use cash. For them cash truly is king,
3. People who are determined to go through life without debt.

(more…)

Posted in Cutting costs, Future value of money, Investment principles, Saving money, getting started | 7 Comments »

Save at least 10% of what you make - 3rd of top 14 things you should start doing immediately to get rich

Note: This is the third of 14 consecutive posts from 2nd to 15th of April about the principles of how to get rich. Check back daily or subscribe to the RSS feed

You can become an entrepreneur and build a company that will generate positive cash flow or you can do it the simple way - by saving a portion of your paycheck.The concept of saving is a simple one, but saving money is in no way simple. I would rather say that

Saving money is simple but it’s not easy

If you are too comfortable to change your spending habits, let me tell you this

Saving money is the only conventional way of getting rich

Other principles of getting rich that are not directly connected with saving money are more difficult to master and require a bigger effort!

Saving is also a universal principle for getting rich - you can save money when running a company, being an employee or still getting money from your parents. The only prerequisite to saving money is that you have an income. However small it might be - there is at least a 99% probability that you can save at least 1 dollar(it’s better than nothing and it kick-starts the habit of saving).

What are the reasons for saving at least 10% of your income?

Keep in mind that 10% is the absolute minimum that you should save. I recommend to set a goal to eventually save 50% of everything you make.

Jim and Chuck

Let me tell you a story about my imaginary friend Jim. Jim is a steel mill worker who gets paid 15 dollars an hour and usually works on average about 10 hours a day.

This makes him 750 dollars per week, 3000 a month and 36 000 dollars a year.

Since Jim is an avid reader of the blog Psychology of Money he took my advice and saves 10% of what he makes. This is  exactly 300 dollars every month. By the time he has saved for 10 months he has 3000 dollars - the same as his monthly salary. Let’s also assume that Jim is a bit of a fruitcake and decides to stack all his saved money inside a box under his bed. At this rate it takes Jim exactly 10 years to collect 36 000 dollars - his yearly salary.

If Jim were to double his savings and put aside 20% of his income or 600 dollars a month it would take him 5 years to save 36 000 dollars.

Now let’s take a look at Chuck.

Chuck is Jim’s co-worker and makes exactly as much. In addition to being extremely good with roundhouse kicks he took a personal finance class during his sophomore year at highschool.

Just like Jim, Chuck saves 10% of his income but instead of putting the money in a box under his bed he invests it. The interest rate on his savings is also 10%.

At this rate it takes Chuck a bit less than 7 years to get 36 000 dollars. That’s a 3 years win over holding the money under your bed.
If Chuck were to double his savings and put aside 20% of his income a month it would take him just under 4 years to save as much as his yearly salary.

Since Jim and Chuck are both in their twenties this means that over a course of 30 years and saving 10% of their income they end up with the following:

• Jim who stacks the money under his bed ends up with 108 000 dollars

• Chuck who invests the money he saves ends up with $ 651 396 dollars.

Get this - they both saved the same amount over the same time but one ends up with over half a million dollars more. This money is living proof of compound interest at work. Chuck’s extra 500 000 dollars is interest that the 108 000 dollars that he saved from his paycheck generated over time.
If Chuck would have been able to invest his money with an average return of 20% a year as the famous investor Warren Buffett has done for over 30 years he would have ended up with 5 105 728 dollars.

The average return of the US stock market is about 12%. Getting a return of 12% instead of 10% would automatically make Chuck 973 053 dollars instead of 651 396. That’s a pretty big jump if you ask me.

When saving at least 10% and investing it for the long run you will end up with many times more money than you can save.

It is possible that money that you save ends up being 10 or 20 times more than you make during your lifetime from working.

Tips for saving money

Since saving 10% of your income will be unnoticed by most people it is an idea that I can not recommend enough. The 10% savings mark should be took as a starting point - over the course of a lifetime you should try to increase this to 20%, 30%, 40% and eventually as high as 50%. In countries like China, saving half of everything you make is the norm. Financially it is the best advice one could get.

The best way to start would be to make saving money as effortless as possible. Use the information that you already know from my previous tips about getting rich. If you have access to internet banking it should be possible to set up your account so that the 10% gets wired to a different account that you use for saving and investing.
Never keep the money you have saved on the same account with your everyday money. This gives you a false sense of wealth and makes it easy for you to spend the money that you should actually be saving.

Also keep in mind that saving money should always be done as the first thing after getting your paycheck - always pay yourself first.

When for some reason you should skip a month of saving as you have planned, always make the extra effort to get this money back. By paying back the money that you spent instead of saving you will tell yourself on a subconscious level that it is not OK to be spending this money in the future.

When deciding whether to save or not to save money one should keep in mind that because of the way compound interest works:

A dollar saved can eventually be 100 dollars gained

Posted in Future value of money, Investment principles, Saving money, getting started | 1 Comment »

The biggest difference in the thought patterns of amateur investors and professionals.

Seems that a lot of people agree that professional investors are better in investing than you and me or the so called amateur investors.

While this might often be the case there is literally tons of information out there about exactly the opposite being true. If you would like to know how an ordinary person can beat the professionals in their own game I would recommend to start from reading the classic One Up On Wall Street by Peter Lynch.

But that’s not what this post was supposed to be about.

While there is no doubt that an amateur can beat a professional there is also no doubt that there are people (usually professionals) who have an amazing track record. Peter Lynch and Warren Buffett are the first to come in mind. These are the people who have shown year after year that they can beat the market. For example Warren Buffet’s portfolio has grown an average of more than 20% per year.

With a rate like that it takes a little less than 4 years to double your money. The average return of the markets is widely believed to be about 12% . With a return of 12% you would double your money in a little less than 7 years.

The key point to agree upon here is

There are people who constantly outperform the markets.

The Average Joe

Let me ask you this. Have you ever lost money in the markets? Chances are that when you have done at least a few investments in your life you have lost money.

Now let me ask you another thing – Have you ever made back what you lost – in the markets?

I bet that the answer is NO. It is no for the majority of people.

For the average investor, investing is a sideline. When he takes a loss, he usually subsidizes his portfolio from his salary, pension fund, or other assets. If the average Joe has 1000 dollars less than his goal he will simply put a little more money aside each month to get back to the desired level.

The Master Investor

For the Master Investor investing is not a sideline – it is his life. So when you take a hit and lose a portion of your portfolio – you can’t subsidize it from your salary (because you only get paid when you make money). The only way to get the money back is to make it back in the markets.

I already mentioned the fact that if you lose 50% of your portfolio you will need to get a return of 100% on the rest in order to get the money that you lost back in my post about The winning investment habit number 1 – preserve your capital.

Consider this - if you lose 50% of your investment capital and you manage to achieve the average 12 percent a year return – it will take you a little less than 7 years to get back to where you were before the loss.

With Buffett’s average return of 24.4 percent it would take 3 years and 2 months and for George Soros with an average yearly return of 28.3% it would take 2 years and 9 months.

What a waste of time!

Isn’t it simpler to just avoid the loss in the first place?

So there you have it:

The biggest difference in the thinking patterns of highly successful investors and the not so successful ones is that for professional investors losing is not an option. If you lose then it will take a lot of time to get the lost money back. So you only invest when you are absolutely certain that you won’t lose it.

If you can’t subsidize your losses then your thinking shifts from “Make profit” to “Keep what you have and after that if possible make a profit”

So here you go – Only invest when you are certain that YOU WILL NOT LOSE YOUR MONEY.

The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.

Posted in Books, Future value of money, Goals, Investment principles, Uncategorized, Warren Buffet | No Comments »

What is the difference between a 10% loss for Warren Buffett and an ordinary investor

When we lose money, we count the dollars we actually lost. Not Warren Buffet. His loss is what those dollars could have been. For him losing money is a gross violation of his underlying aim, which is to “watch money grow”.

Preservation of capital is an investment rule propounded by many but practiced by few.

When asking investors how it would feel to make preservation of capital, most report a sense of paralysis or a feeling that you can’t do anything because you might lose your money.

Here is a graph how most investors think about investing and risks. The conventional thinking goes like this – in order to make a 1000 dollars I need to risk to lose the 1000 dollars I already have.

Here is another graph showing the thinking behind the best investors of the world.

There are a couple of reason why the graph for the best investors in the world looks a lot better to anyone even remotely acquainted with the principles of risk versus potential profit. The second graph illustrates a proportionally smaller amount of risk with better profit.

Here is why the second graph is the right way to think about risk and reward.

1) While investing money the most you can lose is all of it but the most you can win is unlimited. If you bought the stock of Microsoft in the early 80’s you would have made more than 100 times the money you put in on your investment.

2) The second reason for this graph to look like it does is even more important. Because of the compound interest every dollar that you make on your investmet further increases the amount that you are going to make. For instance if you manage to buy a stock with a dividend yield of 10% then after the first year your 100 dollars would be 110, after the second year 121, after the third year 133,1 and so on. As you can see the first year you made 10 dollars, the second year 11 dollars and on the third year 12 dollars and 10 cents. When you have a stock that keeps rising 10% a year that doesn’t pay any dividends it is essentially the same thing – the first year your stock price will rise 10 dollars, the second year 11 dollars and the third year 12 dollars and 10 cents.

The investors that consider the second graph to tell the truth are more often focused on the investment process. They don’t view each investment to be a discrete, individual event because they know that even if you only invest for a relatively short term and make 10 per cent on your investment – it will give you 10% more to invest the next time.

Thanks to the compound interest you will potentially make more money with every passing year. Thus the longer your investment period the lower is the risk to lose all your money compared to what you can make.

The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.

Posted in Books, Future value of money, Investment principles, Natural law of money, Philosophy, Uncategorized, Warren Buffet | No Comments »

Winning Investment Habit No 1 – KEEP WHAT YOU HAVE. Preserve your capital

Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1

Warren Buffet

„Survive first and make money afterward.”

George Soros

„If you don’t bet, you can’t win. If you lose all your chips, you can’t bet”

Larry Hite

What’s the difference between a Winning Investor and a Loosing Investor?

The winning investor – Believes that his first priority is always the preservation of capital, which is the most important cornerstone of his investment strategy.

The loosing investor – Has only one investment aim – „to make a lot of money”. As a result he often fails to keep the money he already has.

Did you know that if you have a stock that drops 20% then you would need it to grow 25% in order to get back to the same price level before the price drop. (Example: If you start with 100 dollars and lose 20% you will end up with 80 dollars. In order to go from 80$ to 100$ you need a gain of 25%).

If you lose 50% of 100 dollars you will end up with 50 dollars. But in order to get from that 50 dollars back to 100$ you need to double the 50 bucks. This means you need a growth of 100% .

It might not seem like a big deal – 50 dollars to lose is nothing catastrophic. But consider the same on a larger scale.

Let’s say that you have a pension fund that holds 1 million dollars. Because of problems in the subprime market your fund loses half of its value – now you only have 500 000 dollars left. What do you think how much time would it take to get back to the initial 1 million?

Well no one can tell for sure but the only thing that is known for sure is that it will take a lot more effort (and time) to get the money back.

Here is a chart that on the left give you the initial loss in % and on the right it shows how much you need to make afterwards in order to get the initial sum back.

This is exactly why Preservation of capital is ALWAYS the number 1 priority of any half decent investor. If you have a loss of 1 per cent you need a growth of more than 1 per cent to get the money back. The more you lose the bigger the gap between what you lost and how much you need to make to get it back will grow.

The ideas from this post are derived from the book „The Winning Investment Habits of Warren Buffet & George Soros”.

Posted in Books, Future value of money, Investment principles, Natural law of money, Saving money, Uncategorized, Warren Buffet | 1 Comment »

Why Warren Buffet doesn’t like to spend money

So you spent a 100 dollars today without even thinking twice?

We’ve all spent money that we shouldn’t have without thinking much about it. The reason is that money is relative - if you have a lot of it you tend to spend more. If you only have a little you spend little or nothing. There is a huge difference in the perceived value of 100 dollars if you only have the 100 dollars for the whole week or if you have 10 000.

The worlds wealthiest investor Warren Buffet has a secret about the way he thinks of money.

When we think about a 100 dollars we usually give value to it by thinking what we could have or do with that money. While it’s the most common way to think about money, it is also something that holds back a lot of people from becoming rich.

When Warren Buffet thinks about 100$ he doesn’t think what will he get when spending it today but he thinks what will he get from it in the future - while gaining 20% interest on the money annually.

If you decide to save 100 dollars and INVEST it with an expected annual payoff of 20%, in 5 years you would have 248 dollars and in 10 years you would have 619$. After 20 years your initial 100 bucks would be 3833 dollars.

It’s pretty tough to spend 100$ when you know that by doing that you will loose 3833$

This is an excerpt from “The Winning Investment Habits of Warren Buffet & George Soros”:

[Buffet’s wife] Susie… was a virtuoso shopper. She dropped $15,000 on a home refurnishing which “just about killed Warren,” according to Bob Billig, one of his golfing pals. Buffett griped to Billig, “Do you know how much that is if you compound it over twenty years?”

Well - it’s 575 064 dollars. (compounded with 20% which is the average pay-off of Warren Buffet’s stock portfolio)

Posted in Books, Future value of money, Saving money, Warren Buffet, getting started | 2 Comments »