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 »

Spend less than you make - 2nd of top 14 things you should start doing immediately to get rich

Note: This is the second 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

Spending less than you make is a principle that a lot of people in the States and in the world have trouble with. An average American today spends 108 dollars for every 100 dollars that he makes. We are spending 8% more than we make and since this is the average there must be people who spend 2, 3 or four times more than they make.

Guess, where does most of the money we don’t have, come from? Credit cards!

In comparison the average person in China spends about 50% of what he makes. This means that in China an average person spends 50 dollars for every 100 dollars(or yuan/renminbi) they make and saves the second 50 dollars.

 From the view point of finance and specially personal finance what China is doing(saving) is good and what the US is doing(spending the money we don’t have) is bad.

The problem with debt is that it has to be paid back. For an average American who spends 8% more than they make this means that when repaying your debts you will get to keep 92 dollars for every 100 dollars you make. But since we also have to take into account interests that almost every loan in the world comes with - it will more likely be that you are left with 70 dollars. And remember - you have to use these 70 dollars to buy all the stuff you used to by for 108 dollars. There is just no way you can do this without lowering your standard of living. Check out my article What’s wrong with most „Get out of Credit Card debt” tutorials? for some pointers about getting rid of credit card debt.

The spend less than you make principle is actually a derivative from the “pay yourself first” rule, which in my opinion is the most important principle of getting rich. If you are paying yourself first then you are also spending less than you make (unless you are paying yourself first and then living on credit cards which is a very stupid thing to do and I have no idea why anyone would do something like this).

Spending less than you make is psychologically difficult to do. When one achieves a higher position at work he automatically wants to show his success to the world - and what better way than buying new shiny things, right? Wrong! While shiny things are good for showing off they will almost always loose value over time - this means that instead of making you richer they are making you poorer. For instance after driving a new car out of the car dealer, it’s value drops more than 20%. In order to increase your net value one would need to buy things that go up in value or invest money.

Spending less than you make is the prerequisite for being able to invest your money. The money that you will not spend will make you rich because it will generate you interest.

Thanks to the way compound interest works the money that you saved by not spending it will after some years make you more money than the actual amount that you saved in the first place. Compound interest is also the reason Why Warren Buffet doesn’t like to spend money.

How to spend less than you make

Spending less than one makes is tricky because of the natural law of money - our spending habits will expand by the additional amount we have available. This is a golden rule and will work always unless one starts to think about his spending habits and patterns. The good news is that you only need to start thinking about the way you spend your money and the spell of the natural law of money gets broken.

Good practical advice is that every time you get a raise or an extra income you should take half of this money and spend it as you like. After all, you have earned it with your hard work and are worth to loosen it up a bit! The second half of the extra money you should keep - and by keeping I mean pay it to yourself. If you follow this advice, it means that every time you get more money you will be able to spend more but at the same time you will also save more. - you get the benefits of both!

Shawn at Watson Inc put it this way: Financial intelligence is not measured by how much you make but rather by how much you keep.

Posted in Investment principles, Saving money, getting started | 2 Comments »

How the falling dollar hurts bloggers and web based businesses outside the US

Lately there has been a lot of talk about the US economy coming to a recession. Some analysts are saying that the US is in a recession but others don’t agree. The only agreeable thing is that the dollar is falling.

In some aspects the falling dollar is a good thing for the US - it means that products made in US are cheaper compared to the things made in other countries. This in turn enables the US companies to sell their goods with better prices as compared to their competitors. On the other hand it also means that for people living in the states it is more expensive to buy foreign products. This can make everything starting from bananas and finishing with foreign cars more expensive for the US consumer.

In the long run the falling dollar is a bad thing. Nobody wants to use a currency which simply put vaporizes.

Lets imagine for a moment that you are the Central Bank of China and you decide to put 1 billion dollars in a safe. When you open the safe 3 years later you have only 700 million dollars left(no smartass, nobody took the 300 million - it just vanished).
This is what is happening with the for at least three years dollar - the longer you keep it the less it will be worth. This is why countries like Iran don’t want to use the dollar for selling oil.

But what about the bloggers?

Bloggers and online businesses are relatively safe - as far as they make and spend their money inside the US. The same is actually true for online businesses that make their money on markets that have no direct link with the dollar. Markets like this could be the European Union, Asia, Australia and basically any market which allows for a web based business to operate without buying or selling any product that has anything to do with the dollar. So that is the good news - most online businesses are relatively safe.

The bad news

The bad news is that there is a group of bloggers and web businesses that are hurt daily because of the falling dollar. This is the group that make their money in dollars and spend it in other currency. If you live in England and have a website that makes money selling products or services to people in the US you are actually losing money every day.

The easiest way to understand this is by imagining a blog such as the one you are currently reading. What I do is write articles about the things that interest me and hope that people with similar taste will find them. Each time somebody visiting my blog decides to click on an ad I make a small amount of money.

Most of the people on my blog are from the US and the advertising program I use pays me in dollars which is the case with all advertising programs that I am aware of. The problem is that I live in Estonia - a small country in the European Union. Our money is directly tied to the euro. Within the last 3 years the dollar has fallen more than 30% compared to the euro. This means that while you make the same amount of dollars with your online business you can buy 30% less stuff for it in the EU. So basically just to stay even you would have to increase your income 30% to keep the same living standard.

The falling dollar is actually improving some businesses who operate from the US but make their money elsewhere - the amount of euros(or other currency) they get their income in translates day after day to a larger amount of dollars.

While it is difficult to say if there are more US companies getting their income abroad or more foreign companies who get their income from US it is definite that the falling dollar is hurting bloggers around the world. The reason is simple - most advertising programs are based on dollars. The only way to stop hurting bloggers is to use another currency.

Posted in Currency, Investment principles | No Comments »

What is risk?

Risk comes from not knowing what you are doing

Warren Buffett

The average investment advisor’s recommended portfolio will vary depending on his client’s “appetite for risk”. If the client wants to avoid risk he will be offered a well-diversified portfolio of “safe” stocks and bonds that theoretically won’t lose money - or make much, either.

If a client is willing to take risks he is probably advised to invest in so-called growth stocks which all have great promise but no guarantees.
This idea makes sense to the advisor and the client who both believe it’s impossible to make above-average profits without exposing yourself to the risk of loss.

But this is not the case.

A great investor understands that risk is contextual, measurable and manageable or even avoidable.

What is risky for me might not be risky for you

Is the experienced rock climber, whose fingers are the only things holding him a hundred feet up a vertical cliff taking a risk?

Or is the expert skier who zooms down the almost vertical double black diamond slope at sixty miles an hour taking a risk?

You would probably answer “Yes!” But what you actually mean is “Yes, if it was me doing it”.

Risk is related to knowledge, understanding, experience and competence. Risk is contextual.

While we can’t be sure that the rock climber or the skier are taking no risk we intuitively understand that they are taking less risk than we would in the same situation.

Even when we observe something that feels very high risk we can assume that for somebody else it might not be risky at all.

To even better understand the concept, think about driving a car. Chances are that you are an experienced driver and you have the ability to make instant judgments while driving - You can even listen to the radio and switch lanes at the same time.

When you first started driving it was not as easy as it is now. When switching a lane you actually have to consider several things:
Is my speed OK compared to the speed of the other cars to switch lanes?

What’s the speed of the cars in front and behind me?

Will the drivers in the other lane let me in?

…and so on.

The more you practice driving the better you get at it - to the point that you will be able to do it unconsciously leaving your conscious mind to be able to listen to the radio.

The more you practice something the better you get at it - until at one point it becomes a habit where you do what you do unconsciously.

This is the case with the death defying rock climber and the skier but it is also the case with professional investors.

There is a story of George Soros interrupting a meeting to place orders worth hundreds of millions of dollars. A person who was attending the meeting told later:

“I would shake in my boots, I wouldn’t sleep. He was playing with such high stakes. You had to have nerves of steel for that”

For this person it looked like George Soros was taking a huge risk but in fact he didn’t. In order to be able to make fast decisions concerning hundreds of millions of dollars like this we would have to know what Soros knows and it would not look like such a huge risk any more. We would simply have to learn to drive the “trading car” as well as George Soros is doing it.

Remember:

Risk declines with experience

How can we embrace risk as a winning investment habit?

Restrict your investments to the areas of life where you can make competent decisions. If you don’t know anything about computer chip makers don’t invest in them even if a stock has an attractive price. If you know about construction find a company that does just that. It will be so much easier for you to understand what they are doing.

Warren Buffett:

It’s not risky to buy securities at a fraction of what they are worth.

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

Posted in Books, Investment principles, Philosophy, Uncategorized, Warren Buffet | No Comments »

What Happens To Investors Who Dont Make Preservation of Capital Their Primary Aim?

They are very often wiped out!

Here’s an example about two companies:

Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether who was a former vice-chairman and head of bond trading at Salomon Brothers.
Long-Term Capital Management had developed complex mathematical models to take advantage of arbitrage opportunities on the bond market. Because of the enormous profit they made on the first years they had more money to invest than they knew how to invest. In other words they had too much money to use with their successful model. Because of the pressure to keep making the amount of money they did in the first years they took very risky positions outside their know-how and burned badly.

Victor Niederhoffer is a well known fund manager and a professor of finance in University of Berkley (1967-1972). After having an average annual return of 35% Victor Niederhoffer had made so much money that he gave most of it back to the investors but he took the 130 million dollars and invested it in Thai bank stocks after they had fallen heavily because of the Asian financial crisis. On October 27, 1997, losses resulting from this investment, combined with a 554 point (7.2%) single day decline in the Dow Jones Industrial Average (the second largest point decline to date in index history) forced Niederhoffer Investments to close its doors.

That’s what happens to companies who don’t make preservation of capital their primary aim - they lose their money.

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

Posted in Investment principles, Philosophy, Uncategorized | No Comments »

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 »

“I am responsible”

Excellent investors always take responsibility for their results.

When a good investor takes a loss he doesn’t say „The market was against me” or „My stock broker gave me bad advice”.

After a mistake an excellent investor always admits „I made a mistake”.

A winning investor accepts the result without recrimination and always analyses what they did or didn’t do so that they won’t repeat the mistake.

A true investor acknowledges that the best lessons are always the ones that you get from your own mistakes.

By taking responsibility for your actions – both profits and losses - a good investor stays in command of himself.

It’s exactly like the expert surfer dude hitting the waves. He doesn’t believe that he controls the waves but because of his experience he knows when to ride a wave and when to avoid it. He is in control of his own actions. If he falls – it’s his fault.

Posted in Investment principles, Philosophy, Uncategorized, getting started | 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 »