Financial Mentor http://financialmentor.com Fri, 19 Dec 2014 06:33:52 +0000 en-US hourly 1 http://wordpress.org/?v=4.0.1 How To Retire Early: 6 Essential Strategies You Must Know… http://financialmentor.com/retirement-planning/how-to-retire-early/14486 http://financialmentor.com/retirement-planning/how-to-retire-early/14486#comments Thu, 20 Nov 2014 16:46:56 +0000 http://financialmentor.com/?p=14486

If You Want To Know How To Retire Early, Here Are The 6 Essential Strategies That Can Make Or Break Your Financial Security.

Key Ideas

  1. Discover the three best paths to build wealth for early retirement.
  2. Learn how to tame the inflation monster.
  3. Reveals 3 simple rules to creating perpetual retirement income you can never outlive.

Early retirement planning is identical to conventional retirement planning with one big exception – time.

You have less time to achieve your financial goals, and more time that your money must last after retiring.

What this means is you have a shortened, accelerated financial preparation phase, and an extended, post-retirement spending phase when you retire early.

Changing the time-frame will also change many other aspects of retirement planning – but not everything. It’s important to understand the differences.

In other words, think of how to retire early as conventional retirement planning on steroids.

All of the conventional information about retirement planning throughout this site still applies to early retirement planning. You still need to learn all the other stuff first. It is the foundation on which your financial security stands.

However, certain aspects of retirement planning are magnified by the compressed time-frame, and the purpose of this article is to focus exclusively on those factors affected by accelerating time.

So get the foundational principles of retirement planning right first so that when you step on the accelerator pedal with the ideas in this article you won’t incur excessive risk.

Remember, the unique twist to early retirement is all about time – less time to build wealth, and more time to enjoy it. With that said, let’s begin…

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Early Retirement Requires You To Build Assets Faster

Traditional retirement planning emphasizes traditional financial concepts like saving and passive investment strategies – otherwise known as the slow and secure path to wealth.

It’s the same old stuff you’ve heard repeated ad nauseam: max out your 401(k), and invest the savings in a properly diversified portfolio using buy-and-hold.

This works okay when applied judiciously over a 40 year career to finance a 30+ year retirement, but early retirees have shorter careers and longer retirements. That means they have less time to save and need more money to spend once retired. The traditional approach will only work if you pursue extreme frugality to reduce the savings and retirement income required.

The problem is passive investment portfolios only grow so fast – not nearly fast enough for those seeking early retirement at regular spending levels. Depending on the data and time period analyzed, long-term returns vary from low to middle single digits net of inflation – hardly a rate to grow wealth fast enough for most early retirements.

Additionally, contained within this long-term data are 15 year periods where real returns are actually negative for a diversified, passive portfolio. That’s a mathematical disaster for someone seeking early retirement. (See the buy and hold myth section of this web site for more information on passive investment limitations or here for investment alternatives.)

In other words, if you want to save and passively invest your way to an early retirement at current spending levels, then think again, because there won’t be enough time to compound the growth of the assets in a meaningful way. It’s just math.

Losing compound growth as a wealth building tool due to the shorter time-frame of early retirement requires you to add a non-conventional dimension to your plans. You must apply one or more of the following three principles:

  1. Extreme Frugality: This is defined as being an extraordinary saver with low expenses relative to income. Some people have been known to save more than 70% of their earned income to retire in 7-10 years. It’s possible, but it’s not everyone’s first preference, so let’s look at two other alternatives.
  2. Active Investing: This is defined as adding a skill component to your investment strategies, which creates an additional return stream above and beyond passive returns. The higher investment return amplifies and accelerates the compound return. You can learn more about active investing here.
  3. Leverage: This is defined as expanding your resource base beyond your own limitations. Leverage allows you to replace less time with more resources, thus multiplying what you can achieve in the same amount of time.

“Give me a lever long enough and a place to stand and I will move the entire earth.”- Archimedes

For example, I retired early at age 35 the hard way. I saved the bulk of my earnings (frugality), which I then leveraged with specialized knowledge in investing (see Step 6 – Expectancy Investing), to increase the returns beyond passive buy and hold returns.

This is a rare and difficult path to early retirement that few succeed with. It requires both personal finance and investment skills – something few people with regular careers choose to develop.

A more common path to early retirement is real estate, because it offers financial leverage, business leverage, and tax advantages. The learning curve is also very reasonable. There are many specialized strategies in real estate that shorten the time to build wealth by offering returns greatly in excess of passive investing.

The common formula for these strategies is to find unusual value and/or add value using skill, while magnifying the returns using the financial leverage inherent in mortgage financing.

“When a man tells you that he got rich through hard work, ask him: “Whose?””- Don Marquis

Another common path to early retirement is leveraging other people’s time through business ownership.

Again, business ownership offers several forms of leverage and tax advantages not available to the passive investor. You can either follow your passion by building your own business, or you can become an owner of the company you work for through option and stock bonuses.

In summary, there are three paths to wealth – paper assets, real estate, and business – but only two of these paths offer leverage (real estate and business) suitable to early retirement without extreme frugality.

The conventional retirement planning approach uses the only non-leveraged asset category – paper assets. That’s why it is the slow path. It is also why it is the most popular path – the financial institutions can profit by selling it to you.

If your objective is to build wealth for a secure and prosperous early retirement, then the message is clear: the mathematics of saving and passive investing through paper assets is too slow.

The traditional path requires more time than someone seeking early retirement can afford (unless extreme frugality is your thing). That means you need an accelerated path to financial security using active and leveraged asset accumulation strategies to reach your early retirement goals faster.

And if you are really in a rush, then try combining all three tools – extreme frugality, active investing, and leverage – to really put your early retirement plans into hyper-drive.

Inflation Is The Number One Enemy Of Early Retirees

Once you’ve built your assets, it’s time to examine the issue of protecting your assets.

Inflation is an insidious cancer that eats away at the purchasing power of your savings. It’s a nearly invisible tax on wealth that can destroy your financial security if you don’t plan appropriately. For early retirees, this is particularly important, because inflation has more time to do more damage when you retire early. This makes it your number one enemy.

A mere 4.5% inflation will cut in half the purchasing power of your money every 16 years. That means you must double your money during the same time period just to break even.

A couple retiring in their 40’s (with at least one partner making it to their 90’s), can expect their purchasing power at 4.5% average inflation to get cut in half three times during their retirement. One dollar today would be worth little more than a dime when you are infirm and dependent. That’s a very big deal.

If you think this example is far-fetched and can’t apply to you, then think again. According to Charles Ellis in “Winning the Loser’s Game”, $100 of goods in 1960 would’ve cost $500 in 1995. That’s a 4.8% annual compound inflation rate that destroyed 80% of your purchasing power.

A retiree in 1960 would have to grow his portfolio and retirement income five-fold just to break even. That doesn’t even include making up for the erosive effects of spending principal to support living expenses, while paying taxes on all the capital gains along the way. To learn more about the impact of inflation, try our free inflation calculator here.

Tips on How to Beat Inflation in Early Retirement

If that weren’t bad enough, the unweighted stock market went the opposite direction during part of the same time period (late 1960’s to early 1980’s), and lost roughly 80% of its value when adjusted for inflation. How’s that for passive investment returns?

Or consider how the Dow Jones Industrial Average in 1993 was equal to its inflation adjusted level in 1928 – not exactly a real wealth builder in terms of purchasing power. In short, inflation isn’t just a problemit’s the problem.

Nominal growth in assets deceives. The only growth that counts over the long run is increasing purchasing power. Unfortunately, much of the passive return from investing is little more than asset inflation showing up in higher security prices.

As an early retiree with a long time horizon, you must be very careful. Inflation is a tax on assets and the longer your time frame, the more damage it can do to your real wealth – and “real wealth” is the key here.

Fixed annuities and pensions that don’t adjust adequately to compensate for inflation are a long-term recipe for disaster. Early retirees must structure their portfolio and income sources to grow and offset inflation’s erosive effects.

Examples include income producing rental real estate, equities, and fixed income sources with adequate cost of living adjustment provisions.

The message couldn’t be more serious. Inflation is your number one financial enemy when trying to figure out how to retire early.

Early Retirement Spending Issues

Traditional retirement planning relies on spending to decrease over time as you age. The reason is because studies show spending is proportional to activity level (emergencies and health issues aside), which decreases over time due to diminishing health and energy.

[how-much-money-do-i-need-to-retire]This decrease in spending with age largely offsets the impact of inflation, providing a relatively stable spending picture for traditional retirees.

Early retirement is different.

Studies of early retirees show spending often increases and remains high due to an active lifestyle and greater health. Early retirees can’t rely on decreased spending near the end of life to offset inflation like traditional retirees.

This means early retirees must fit into one of the following categories to achieve financial security:

  1. Begin retirement with excess wealth beyond what’s necessary to support current lifestyle, so that you have an appropriate cushion.
  2. Earn above market investment returns to overcome inflation and lifestyle costs during retirement.
  3. Supplement retirement income with earned income.
  4. Change lifestyle so that expenses decrease.

Most early retirees combine one or more of these four choices to make ends meet.

Early Retirees Must Remain Self-Reliant Until They Qualify For Social Security and Medicare

The traditional retirement three-legged stool for income that included pensions, savings, and Social Security, is often reduced to one or two legs for early retirees. The missing leg, of course, is Social Security and Medicare, as most early retirees are too young to qualify.

Eliminating government retirement programs from the early retiree’s financial picture places an increased burden on savings and other sources of income. Early retirees can’t rely on Uncle Sam to help with their retirement – at least for a few years.

That means you must budget for lower income in the early years until Social Security kicks in, and you must plan on higher expenses to self-insure your health until you qualify for Medicare.

In short, the time gap between early retirement and traditional retirement poses an additional financial burden that must be carried by the early retiree – both in terms of decreased retirement income, and additional health insurance costs.

Early Retirement Requires Perpetual Income Without Spending Principal

Financial planning for early retirement requires a nearly perpetual income stream that you can’t outlive. The reason is simple math.

There’s a good chance a couple retiring in their 40’s will have at least one spouse surviving into their 90’s. That’s 50 years of life to support. Even if you started retirement in your 50’s, you’re going to need to plan for 40+ years. That’s a lot of time.

To understand how this extended time in retirement affects spending investment principal, imagine a traditional 30 year mortgage. The early monthly payments contain very little principal, and the later payments are nearly all principal.

The same thing is true when living off your assets in retirement – the early payments can spend very little principal, but the later payments can spend lots of principal. The only problem is, you never get to know when the last payments will be until it’s too late.

Unlike a mortgage, your longevity is unknown in retirement. You have no choice except to assume an extended life, because the alternative would mean running out of money when you need it most.

Most retirees are more afraid of outliving their money than they are of dying – and rightly so. Nobody wants to end up elderly and indigent. Therefore, your monthly spending for an early retiree should leave principal intact until the end, and by the time you know it’s the end, it’s too late to spend it anyway… so who cares.

What this means is a 30 year time horizon (traditional retirement) allows very little principal to be spent, and a 40 to 50 year time horizon (early retirement) needs to be, for all intents and purposes, a perpetual income stream that can increase over time to offset inflation. But how do you do that? Traditional retirement planning doesn’t offer a solution.

As it turns out, the process for perpetual income planning is even simpler to figure out than traditional retirement planning, although it is harder to accomplish. The various assumptions and estimates required by all the traditional models become unnecessary and pointlessly complicated when planning an early retirement. (For a complete explanation of how much money you need to retire please download this book – below is a brief excerpt…)

“The ability to simplify means to eliminate the unnecessary so that the necessary can speak.”-Hans Hoffman

For example, I’ve been financially “retired” since age 35, in the sense of not earning income to pay living expenses. How can I do this safely when I can’t possibly estimate my investment returns, life expectancy, spending patterns, or inflation, with even the faintest degree of accuracy over a 60+ year future?

It would be an impossible task using the traditional models, but it’s actually rather simple to accomplish using a simple three rule system I developed.

(1) The first rule is you must build an investment portfolio sufficient to throw off residual income in excess of personal expenses. Please note this doesn’t refer to total return, but only to residual income. You can only spend the income thrown off by the assets, but the assets themselves can never be touched. This distinction is critical.

When the cash flow from your portfolio is more than you spend on living expenses, then you are infinitely wealthy. No complicated math required. At this point, your life expectancy is irrelevant because you can never outlive your income, making the expected lifetime assumption irrelevant.

(2) The second rule is you must manage your assets so that growth (total return-income) is greater than the inflation rate. This takes care of the inflation monster.

For example, if your income comes 100% from a laddered bond portfolio, then your growth is zero because total return and income roughly equal each other over time. This means that over the long-term, the inflation monster will likely eat your all-bond portfolio for lunch when you live off the income. Not a good thing.

Alternatively, if your cash comes from appreciating assets like properly valued dividend paying stocks, and positive cash flow rental real estate, then over time, those assets are likely to grow with inflation and your income should likewise grow.

As long as the difference between your total return and the income from your assets exceeds the rate of inflation, you can remove any need to estimate future inflation from your calculations. It becomes a non-issue.

(3) The third and final rule is your residual income must come from multiple, non-correlated sources. A reasonable mixture of dividend paying stocks and income producing real estate would satisfy that requirement.

It’s also possible to mix in some passive business income, fixed annuity income, royalty income, social security income, and pension income.

What you don’t want to do is retire based on one source of income. For example, many airline employees retired solely on their pensions which got decimated when certain airlines went through bankruptcy and restructuring. They had no fall back position and had to cut their lifestyle, and/or go back to work.

“There can be no real individual freedom in the presence of economic insecurity”-Chester Bowles

(4) A fourth bonus rule also exists, but it isn’t necessary. Think of this bonus rule as an insurance policy against the unknown factors in life ruled by Murphy’s Law.

Don’t begin early retirement until your passive investment cash flow exceeds what you spend. This will ensure you have money left over to reinvest.

This provides the last added measure of insurance to cover against unexpected surprises, lost income due to default, catastrophes, excess inflation, etc. Reinvesting excess revenue allows you to compound your way to recovery over time from any adverse circumstance.

There you have it – four simple rules, with no arcane assumptions or calculations, that simplify how perpetual financing for early retirement works. (Again, to get the whole story explaining how much money you need to retire, get the book here.)

It doesn’t matter how early you retire or how long you live. As long as you adhere to these four simple rules, perpetual financial security should be yours throughout retirement.

Money Is The Means To An Early Retirement, But It’s Not The End

What are you going to do with the 2,000+ hours currently spent working each year after you retire?

If you think a fulfilling early retirement is all about the pro-leisure circuit, reading novels, playing golf, and stuffing your face with popcorn while watching daytime television, then think again. For most people, the joy in that lifestyle is short-lived.

Like it or not, humans are goal seeking, social, productive creatures by nature – at least, most of us are. Anyone with enough drive and brains to succeed at building an early retirement will bore quickly with full-time leisure.

The studies prove it, and my personal experience is consistent with that conclusion. It’s a mistake to retire early with only some vague notions around recreation, freedom, flexibility, spending more time with family, and “sticking it to the man.”

When you choose the goal to retire early, it should be motivated by moving toward a new lifestyle that is more compelling than your current lifestyle.

You need a passion or activity that stimulates you. You’ll need to find an interest congruent with your values that is exciting to wake up for, and gets your creative juices flowing.

For example, I’m building a financial mentoring business because I’m passionate about personal finance, investing, and helping others achieve the life of their dreams.

This specialized knowledge has allowed me to retire early, and I enjoy sharing it with others. This business is fulfilling, and it’s the next step in my life’s journey.

“The greatest use of life is to spend it for something that will outlast it.”- William James

What will be the next step in your life’s journey? Some retirees blend part-time work, stint work, volunteering, the arts, launching new businesses, and any number of other occupations to add depth, human connection, and productivity to their day.

Other retirees spend more time at the gym, exercising to improve their health. Still others use the extra time to convert a previously loved hobby like flying, travel, or art, into an occupation.

None of these are mutually exclusive: you can combine them in any way that suits you. Whatever makes you happy is good enough.

There’s no right or wrong answer to a fulfilling early retirement – different strokes for different folks. You just need a compelling reason to wake up each day that is bigger than your personal self-absorption.

You’ll want to participate in the world, be creative, and remain connected. You’ll want an active social network, excellent health, interests, and the money to enjoy it all.

Don’t make the mistake of thinking full time leisure is what retirement should be all about – that’s a myth. Also, don’t make the mistake of thinking money is what retirement planning should be all about – it’s much bigger than that.

Retirement planning must include life planning too, because in the end, retiring early is all about enjoying a fulfilling and complete life experience.

Early Retirement Planning Issues Summary

So there you have it, six critical issues that can dramatically impact your early retirement planning. Below is a quick review:

  1. You can’t rely on passive compound growth to build your assets for early retirement because there is not enough time. You’ll want to apply one of the following three principles to step on the accelerator pedal and grow your assets faster: extreme frugality, active investing, or leverage. Combine all three to supercharge your asset growth and retire even faster.
  2. Inflation is the number one enemy of early retirees because it destroys assets over time – and early retirees have lots of time for the government to devour their savings through inflation. You must design your portfolio so that it’s protected from the ravages of inflation.
  3. Early retirees typically have different spending patterns from traditional retirees because they lead a more active life. You must budget appropriately to compensate for this higher expected spending level.
  4. Early retirees face a period without the base support provided by Social Security and Medicare. They must plan a “bridge budget” to compensate for this time period where income will be lower, and expenses higher.
  5. Early retirement requires you to build a perpetual income stream; your assets must last so long that essentially no principal can be spent – only income.
  6. Early retirement is all about lifestyle – not budgeting, income planning, and investing. Make sure you get a life beyond the pro-leisure circuit, because you are going to be living it for a very long time.

In summary, early retirement is one of my favorite subjects. It was my life dream that I have been living real-time since 1997.

All the lessons shared above are based on my personal experience from walking the talk.

If you share this life dream, then maybe it’s time you consider early retirement coaching with someone who understands the subject intimately. You’ll be able to accelerate your progress and shorten your learning curve in achieving this very desirable goal.

Let me know how I can help…

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The Ten Commandments Of Wealth Building http://financialmentor.com/wealth-building/ten-commandments/13166 http://financialmentor.com/wealth-building/ten-commandments/13166#comments Wed, 27 Aug 2014 23:30:30 +0000 http://financialmentor.com/?p=13166

Discover the Ten Key Principles to Build True Wealth (Surprise! It’s about a lot more than just making money.)

Key Ideas

  1. How you can build wealth automatically with the least amount of effort.
  2. How “environments” and habits can literally pull you toward your wealth goals.
  3. 6 different types of leverage to build your wealth.

True wealth is about a lot more than just growing your net worth.

Yes, it’s true that financial independence is all about money, but living a wealthy life is not. This distinction is critical.

We’ve all seen rich people who are miserable, and poor people who are happy. Research even shows the relationship between money and happiness is small.

Below are the key ten principles that will help you achieve true wealth — both financially and personally.

1st Wealth Building Principle: Get Deeply Motivated

Money is a shallow motivator — too shallow to drive you deep enough to achieve success.

The problem is financial wealth is an external goal with benefits limited to the world outside of you. Money buys things, but money doesn’t buy happiness. It can build you a prettier prison, but it can’t get you out of prison.

The inherent limits of external goals (fancy houses, cars, and big bank accounts) similarly limits how motivated you will be when pursuing them.

To succeed in building wealth, you want to be driven by internal goals deeper than just the external trappings of wealth. You want a cause that will bring transformation to your life and drive you deep enough to overcome all the obstacles that stand between you and financial freedom. 

Internally-driven goals that might focus your attention long enough to succeed include the following:

  1. Freedom: Break loose from the shackles of daily labor so that you have more time to grow, create, and live to your fullest potential.
  2. Charity: The more you have the more you can give. Charitable foundations created by wealthy families often provide the financial muscle to empower great social and environmental causes.
  3. Growth: When you have financial freedom, you also have more time to pursue personal freedom. The wealth in your external world becomes a mirror to the wealth in your internal world. The principles that lead to financial wealth can also lead to true wealth by affecting other areas of your life.
  4. Leadership: Grow your own wealth ethically and joyfully so that you can lead by example for friends and family to rise above the bonds of financial mediocrity and follow in your footsteps.

The reason deeper causes are essential is because building wealth isn’t easy.

You will encounter many problems that must be overcome along your journey to financial freedom. You will pay a price to reach your goal.

To stay the course long enough to succeed, you must be motivated by a commitment that runs deeper than just the lifestyle that money can buy.

2nd Wealth Building Principle: Give More Value Than You Take

Adding value to the world by giving more than you receive makes everyone better off. That is how you build true wealth. You improve other’s lives by improving your own.

Sure, history is replete with people who have amassed financial empires by exploiting others or the environment, but taking value can never lead to happiness or fulfillment. Exploitation may bring riches, but giving value brings happiness and fulfillment as well as riches — and that’s true wealth.

By giving more value than you receive, success becomes a measure of how much you have given. The wealthier you become the more you are giving to others.

It is a rewarding way to live.

“From what we get in life, we make a living. From what we give, we make a life.” - Arthur Ashe

3rd Wealth Building Principle: Live With 100% Integrity

Never do or say anything that wouldn’t make your Mother and Father proud.

Don’t cause harm, encroach on other’s property, violate moral law, or damage the environment. Don’t lie, insult, or cheat in pursuit of financial wealth.

Heck, don’t even stretch the truth. It just isn’t worth it.

The rule is simple: if it doesn’t feel right then it probably isn’t. If you don’t feel comfortable telling your spouse, children, and parents what you are doing, then you probably shouldn’t do it.

Never choose expediency over integrity because no amount of financial wealth can replace a good night’s sleep, a clear conscience, and a peaceful mind.

4th Wealth Building Principle: Be Courageous

Humans are social animals which makes us cautious to venture independently. Yet, wealth doesn’t come from following the crowd. It results from doing what others won’t so you can have what others never will.

It takes courage to be a self-starter and be self-responsible. It takes courage to walk new paths and develop new skills. It takes courage to stand out from the crowd. It takes courage to put out the extra effort when others don’t.

In short, it takes courage to build wealth.

It may be true that the nail that stands up is the nail that gets hammered down, but it is equally true that the nail that never got driven is the nail that didn’t fulfill its purpose.

Live with courage so you can live fully and experience true wealth.

These 10 Commandments of Wealth Building will help you achieve financial success and true wealth.

5th Wealth Building Principle: Be Disciplined

Wealth is the cumulative result of many little things added together and compounded over a lifetime. That means your daily habits will make or break your success.

Saving, investing, reinvesting, and growing your financial and business intelligence are all essential wealth building habits that require persistent and consistent effort.

In other words, wealth building requires discipline.

Without discipline, you risk falling prey to the number one wealth killer: procrastination. You must begin the right habits today without delay. It takes discipline to overcome procrastination by starting today and persisting tomorrow.

Another obstacle to disciplined, daily habits is “magical thinking.” This is the false belief that financial security will magically appear out of thin air without a specific plan or action causing it.

Wealth happens because you do what it takes to make it happen. The appearance of “instant wealth” actually stands on the foundation of years of disciplined, daily habits. Luck comes to those who make their own breaks.

6th Wealth Building Principle: Avoid Conspicuous Consumption

The illusory carrot for building wealth is the attraction of a “more, better, different” lifestyle.

This myth is perpetuated by brokerage ads filled with sailboats, European vacations, and perfectly manicured golf resorts. The problem is consumerism causes your limited resources to be directed toward lifestyle and away from building wealth.

They are competing demands for the same scarce resources – and only one can win the battle.

“Seek freedom and become captive of your desires, seek discipline and find your liberty.” - Frank Herbert

The reality is wealth is a form of delayed gratification. Wealth builders live modestly by spending less than they can afford (in money, time, and energy), so they can invest the difference for greater value in the future. They understand happiness does not result from the material trappings of wealth, because that would only keep them from fulfilling the deeper cause that drives them to success.

Every day you make a choice between consumption today or wealth for tomorrow.

The only way to live delayed gratification as the most fulfilling alternative without any sense of sacrifice is when your motivating cause is a deeper drive than your desire for lifestyle. If lifestyle is your cause then consumption becomes the priority — making wealth eternally elusive.

7th Wealth Building Principle: Build Supportive Environments

[dont-hire-a-financial-coach] If building wealth was easy, then more people would achieve it. Yet few succeed in their pursuit of financial freedom even though anyone can put together a reasonable plan to become wealthy.

The difference is consistent, persistent, focused action. Life provides an endless stream of distractions to sidetrack your plans for wealth. The solution is to create a support system that keeps you focused, on track, and literally draws you toward wealth.

Your family environment, relationships, work environment, financial habits, daily rituals, and more must be pro-actively designed to literally pull you toward wealth by supporting and reinforcing your plans.

You must structure your life to support a wealthy outcome. It’s the path of least resistance.

Financial Mentor’s coaching and educational products can help you re-design your life to achieve financial freedom. You either direct your daily life to achieve your goals, or you can passively allow your days to be filled with alternatives.

You either get the results you choose, or you get the results that are given to you. Which path will you follow?

8th Wealth Building Principle: Apply Leverage To Build Wealth

Leverage is the essential success principle that builds wealth. You won’t get wealthy by trading time for money and you can’t do it all yourself.

Building wealth requires you to work smarter rather than harder by applying the following principles of leverage:

  1. Financial Leverage: Other people’s money so that you are not limited by your own pocketbook.
  2. Time Leverage: Other people’s time so that you are not limited to 24 hours in a day.
  3. Systems and Technology Leverage: Other people’s systems and technology so that you can get more done with less effort.
  4. Marketing Leverage: Other people’s magazines, newsletters, radio shows, and databases so that you can communicate to millions with no more effort than is required to communicate one-on-one.
  5. Network Leverage: Other people’s resources and connections so that you can expand beyond your own.
  6. Knowledge Leverage: Other people’s talents, expertise, and experience so that you can utilize greater knowledge than you will ever possess.

Leverage allows you to build more wealth than you could ever achieve alone by utilizing resources that extend beyond your own. It allows you to grow wealth without being restricted by your personal limitations.

Leverage is the principle that separates those who successfully attain wealth from those who don’t. It’s just that simple.

If you aren’t using leverage then you are working harder than you should to earn less than you deserve — and that isn’t going to make you wealthy.

9th Wealth Building Principle: Treat Your Wealth Like A Business (Because It Is)

[how-much-money-do-i-need-to-retire] You wouldn’t build a business without a business plan. Why should building wealth be any different?

Design your wealth plan based on proven business principles that lead to success. These principles include competitive advantage, leverage, accurate record keeping, and accountability– just to name a few.

Run your money like a business, because that is exactly what it is: a personal financial management business.

Additionally, your personalized wealth building plan should take into account your unique skills, interests, and resources while incorporating the Ten Commandments to Wealth, successful investment principles, and much more. When complete, your wealth plan will be tailor-fitted to your unique life situation, while honoring the proven success principles that no wealth plan is complete without.

Run your money like the business it is. Anything less will slow your journey to wealth.

10th Wealth Building Principle: Steward Your Wealth

“If a man is proud of his wealth, he should not be praised until it is known how he employs it.” - Socrates

Wealth is your servant, and you are a servant to your wealth. Money is little more than a tool that comes with a responsibility to use it wisely.

The rich man is a fool who dies without arranging his affairs to assure that his wealth does good during his lifetime and after his passing.

Through your legacy of wealth, you have the opportunity to bless yourself and your family’s life now and into the future. And you can go beyond that by expanding the circle to include the lives of all who follow you.

As a successful wealth builder you will be in the unique position to organize charities that can do great social good. The fact that you can’t take it with you means wealth is a gift to be given.

Always understand that wealth is not something you possess, but it is a flow which has found a temporary parking place under your stewardship.

Eventually this stewardship will move to others as all things must pass (including you). The wealth builder’s solemn responsibility is to use this temporarily gifted power wisely so that it creates maximum benefit for all those who are touched by what you created in your lifetime.

In Summary…

There are ten key wealth building principles that lead to true wealth, not just monetary wealth. The objective is not just to become rich, but to build a balanced, fulfilling, wealthy life.

These ten key principles will help keep you on track:

  1. Build Wealth For A Deep Cause: Money alone is too shallow a goal to motivate you to overcome all the obstacles that stand between you and wealth. When you find a deeper goal like freedom, growth, creativity, or charity then you will have the internal motivation to persist and succeed.
  2. Give More Value Than You Take: When you give value then your financial success becomes a measure of how much you have given to the world. It is a satisfying way to live.
  3. Live with 100% Integrity: Integrity is non-negotiable because no amount of money can replace a good night’s sleep, a clear conscience, and a peaceful mind.
  4. Be Courageous: Wealth results from doing what others won’t so you can have what others never will.
  5. Be Disciplined: Life will conspire to distract you from achieving your goal so that only the disciplined will stay the course with consistent enough action to get results.
  6. Avoid Conspicuous Consumption: Nobody ever spent their way to financial freedom. Every day you make a choice between consumption today or wealth for tomorrow.
  7. Build Supportive Environments: The path of least resistance to wealth is paved by supportive environments that literally pull you toward the goal.
  8. Apply Leverage: Leverage is what separates those who achieve wealth from those who don’t because you can’t reach the goal by trading time for money and you can’t do it all yourself. You need leverage.
  9. Treat Your Wealth Like A Business: As a wealth builder you are in the personal financial management business and must manage your net worth just like an executive manages a successful business.
  10. Steward Your Wealth: Money is little more than a tool that comes with the responsibility to use it wisely. It is not something you possess, but something that passes through you and must be given back.

Follow these ten success principles and you will be on the path to true wealth.

After all, isn’t life too short to settle for anything less?

“Say what you will about the Ten Commandments, you must always come back to the pleasant fact that there are only ten of them.” - H.L. Mencken

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Are Safe Withdrawal Rates Really Safe? http://financialmentor.com/retirement-planning/how-much-money-do-i-need-to-retire/safe-withdrawal-rate/13192 http://financialmentor.com/retirement-planning/how-much-money-do-i-need-to-retire/safe-withdrawal-rate/13192#comments Tue, 26 Aug 2014 22:47:51 +0000 http://financialmentor.com/?p=13192

Discover The Little-Known, But Highly Dangerous Risks Hiding Behind The 4% Rule, And The Simple Solutions to Correct the Problem

Key Ideas

  1. Reveals the hidden dangers behind the 4% Rule that every future retiree must know.
  2. Learn how supposed “safe” withdrawal rates can allow you to run out of money before you run out of life.
  3. Get the 4 step process that safeguards your retirement savings against potential errors.

What do retirees in 1921, 1966, and 2010 have in common?

Very little… and that’s the problem.

Each faced a different life expectancy and invested in a different economic climate with varying inflation expectations, interest rates, and market valuations.

The truth is these dates weren’t chosen at random: One had the highest safe withdrawal rate in recorded history, the other the lowest, and the third barely survived the ravages of inflation.

Each of these three retirees lived through dramatically different economic times. Yet, according to conventional wisdom they all share the same safe withdrawal rate in retirement – roughly 4%.

It doesn’t make sense.

How can a static, one-size-fits-all solution to a problem as varied and complex as knowing how much money you need to retire be correct?

How could retirees in 1921, 1966, and 2010 share the same safe withdrawal rate when market valuations, interest rates, inflation expectations, and expected lifespans were completely different?

It’s impossible. It’s wrong.

Yet, that is the conventional wisdom in the financial planning profession. It is known as the “4% Rule,” and it is widely considered “the truth” in safe withdrawal rates for retirement.

The problem is it’s not the truth and every day people risk a lifetime of retirement savings on it. There are better solutions.

In this article I will reveal the problems hiding behind the 4% Rule and provide you with practical solutions you can implement for your retirement security.

Are safe withdrawal rates really safe? Learn the truth about the 4% Rule here.

Why Safe Withdrawal Rates Are Critically Important

Retirement income is an inherent conundrum.

How do you convert a volatile pile of assets into a stable income stream you can never outlive?

Every new retiree needs to answer the same critical question: What is the maximum retirement income I can withdraw from savings without running out of money before I run out of life?

It’s the single most important question I get from retirees and near retirees.

The reason is because safe withdrawal rates impact every aspect of retirement planning – from the lifestyle you can afford to the amount of savings needed to fund it.

Small errors in safe withdrawal rates multiply over many years, which causes huge financial impacts. Consider these:

  1. Lifestyle You Can Afford: Few people realize that a mere 1% safe withdrawal rate change makes a big difference in spending during retirement. It seems counter-intuitive because the number is so small. However, a 1% variation from the industry standard 4% assumption will increase (or decrease) your income in retirement by 25%. That can make the difference between a world traveler lifestyle or living at home on hot dogs. In other words, it pays to calculate your safe withdrawal rate as accurately as possible. Small changes in the numbers equal huge changes in the lifestyle you can afford.
  2. Savings Required: The amount you can spend each month from savings and the amount of savings you must build to support your retirement are different sides of the same coin. One implicates the other mathematically. For example, the “4% safe withdrawal rate” is mathematically equal to the “Rule of 25” (you need 25 times your first year spending in savings). Similarly, a 3% safe withdrawal rate equals roughly 33 times your first year retirement spending in savings. Using the two examples above, a mere 1% change in safe withdrawal rate when spending $100,000 per year in retirement is the difference between building a nest equal to $2.5 million vs. $3.3 million – obviously a big deal. Conversely, knowing you can safely spend 6% would knock the savings requirement down to $1.7 million. That’s why it is so important to figure an accurate safe withdrawal rate. It can change the amount you need to save for retirement thus shortening the time it takes for you to reach your financial goals.
  3. Risk To Financial Security: If you withdraw just 1% more than your actual safe withdrawal rate you will go broke before you die. It ‘s a mathematical truth. A mere 1% less would have allowed your nest egg to last a lifetime. That’s why accuracy is critical – because the razor thin margin between 1% too much and getting it right is literally the difference between poverty and financial security.

Like Goldilocks, there’s a sweet spot in retirement spending somewhere between “too much” and “too little” that is “just right.”

In an ideal world, you would exhaust your last penny from retirement savings as you exhaled your last breath. That’s the theoretical objective of safe withdrawal rates.

It’s a high-stakes game where the quality of your life during retirement is dependent on getting the answer right. For that reason, there is probably no question more important in retirement planning.

Unfortunately, the conventional wisdom can be dangerously misleading.

Lesson Learned: Withdrawing the right amount of money from savings is one of the most important retirement planning questions you will confront. Take too much and you blow up: take too little and you leave lifestyle on the table. You need to get as close to the right amount as possible. It’s worth the effort – and it’s worth reading this long article to understand the issues.

A Quick History of Safe Withdrawal Rate Research

[the-four-percent-rule] The state-of-the-art knowledge in safe withdrawal rates has progressed dramatically since the early 1990s. What began as a naïve exercise in simple amortization has progressed to sophisticated regression analysis and Monte-Carlo research.

You may want to skip straight to the results and conclusions instead of learning the research history behind safe withdrawal rates first – but it’s not that simple.

The 4% rule became the sacred cow for a reason, and a new generation of research is teaching important principles that can make big differences to your financial future.

It pays to learn this stuff. It sets the context for the rest of the discussion that follows and is essential to your making smart decisions with your money.

To keep these ideas accessible I’ve organized them into three distinct generations of knowledge:

Generation 1:

The first generation in safe withdrawal rate research was naively based on mortgage amortization – but in reverse. Rather than pay down a mortgage (like your home), you would draw down an asset account (like your retirement savings).

The idea seemed intuitively correct even thought it was fatally flawed (due to volatility and returns sequencing risks as shown below).

Even the venerable Peter Lynch (1995) succumbed to the intuitive appeal of the mortgage-style model when he falsely stated a 7% withdrawal rate would be prudent for an all stock portfolio.

He was forced to retract this obviously incorrect statement when 2nd Generation research proved conclusively how such a withdrawal rate could land you in the poor house.

Generation 2:

Bengen (1994) ushered in the second generation of safe withdrawal research when he published a groundbreaking Journal of Financial Planning article that still sets the basic framework employed by most research to this day.

He used historical simulations of long-term U.S. securities index data to define “Safemax” as the highest withdrawal rate, expressed as a percentage of the account balance on the first day of retirement, and adjusted for inflation annually, that allowed for a minimum of 30 years of withdrawals over all rolling historical periods in the database.

Bengen concluded the maximum safe withdrawal rate was about 4.1% for stock allocations between 37%-67% and later upgraded that amount to 4.5% when small cap stocks were included in subsequent research.

Cooley, Hubbard, and Walz (1998) took the 2nd Generation model to the next level in an effort to overcome the sequencing risk in data (as defined below).

They showed a 95-98% chance you won’t run out of money if you applied a 4% withdrawal rate. This study, dubbed the “Trinity study,” and popularized by Dallas Morning News columnist Scott Burns, was updated in the April 2011 Journal of Financial Planning with similar results.

Other 2nd Generation researchers have come to similar conclusions depending on assumptions applied. Results vary slightly from study to study based on asset allocation, data sources, whether or not fees are deducted, frequency of portfolio rebalancing, and much more.

The key point defining all 2nd Generation research is that each study applies the same basic premises thus producing extraordinarily consistent results.

This consistency caused the 4% Rule to become conventional wisdom and be mistaken as “truth” when it is really just a product of the research premises.

To understand the problems with 2nd Generation research we need look no further than the amazing breadth of dubious assumptions behind the results:

  • Safe withdrawal rate research was based on U.S. securities data history. No foreign market data was included.
  • The research typically assumes a static allocation to stock and bond indexes as the only viable asset classes. Alternative assets are not included.
  • It assumes 30 years of retirement spending regardless of expected longevity.
  • It assumes no investment expenses by using historical index data – obviously not true for any real-world investor.
  • It assumes a fixed spending amount that grows with inflation and does not adjust based on changes in portfolio value or age – not true for most retirees.
  • It seeks to determine the highest beginning spending amount that can be adjusted for inflation without ever running out of money that works across all time periods in the database. It’s sort of a least common denominator concept.
  • All data periods are created equal with no adjustment for valuations or interest rates at the time you retire.
  • You must have 30 years of subsequent data to know if the withdrawal rate was actually safe, meaning retirements beginning after 1985 were unknown and theoretical because they were out of sample.  (This was written in 2014.)

While these assumptions make for expedient research, there’s a clear sacrifice of accuracy when compared to the real-world retirement you will face.

Below, I’ll examine each of these assumptions in detail to show you the implications. Then, you can decide how relevant 2nd Generation research conclusions (The 4% Rule) are to your retirement planning.

Generation 3

3rd Generation safe withdrawal research has attempted to correct the assumption limitations outlined above to provide a more accurate picture of how safe withdrawal rates might apply to real-world retirees like you and me.

In essence, the 3rd Generation models stand on the shoulders of the excellent research that came before it by recognizing the limitations, correcting the flaws, and producing more accurate models. The 4% rule has serious problems and 3rd Generation research seeks to correct those errors.

Rob Bennett was an early pioneer in 3rd Generation modeling by advocating (through various online forums) that withdrawal rates must be adjusted for market valuations consistent with research by Campbell and Shiller (1998).

Also, Wade Pfau (2010 – 2011) broke new ground by applying safe withdrawal rates to international market data with shocking results. He also applied valuation, interest rate, and inflation metrics in regression analysis to form a dynamic and robust safe withdrawal rate model.

The key point illustrated by 3rd Generation research is that a deeper level of complexity underlies the sacred cow “truth” known as the 4% rule. It was the best answer for its day, but those days are gone. It is a 2nd generation model whose shortcomings have been proven well enough that it must be retired.

With that said, the 3rd generation research is in its infancy and has only corrected certain shortcomings from the 2nd Generation model. There are many remaining assumptions you must still individually answer to determine your personal safe withdrawal rate.

For that reason, we’ll examine each of the shortcomings of the 2nd Generation models below and use 3rd Generation research to demonstrate viable solutions where they exist.

In the process, I’ll explain all issues remaining unresolved and point you toward viable answers to consider. The result will be a safer withdrawal rate than the simple rule-of-thumb provided by conventional wisdom.

Lesson Learned: Safe withdrawal rate research has been through 3 generations of growth and sophistication in a very short time. However, the 2nd Generation model, known commonly as the 4% Rule, is unfortunately locked in most expert’s minds as “truth” when 3rd Generation research has already discovered more robust and accurate models. Regardless of the model used some underlying assumption problems remain that must be adjusted for.

Let’s dive into the underlying issues built into 2nd Generation safe withdrawal research so we can see why they pose a problem.

Backcasting – Data Sampling Problem

Data limitations are one of the most obvious problems with all safe withdrawal research.

2nd Generation models have been tested exclusively on U.S. data – sometimes as far back as 1871. While that is a solid long term study it completely ignores international data.

The implied assumption is the future should be no worse than the past as evidenced by U.S. asset price growth.

But is that really true?

The U.S. was the prom queen of the economic world for the last 130 years. She led a privileged life that likely introduces an overoptimistic bias to research based exclusively on her data. Consider the following:

  • U.S. stock market capitalization grew from 22% of world total in 1900 to 54% in 2003.
  • The U.S. stock market grew at 6.3% real compounded and never had a losing 20 year period. This compared to an average growth of 5.4% for other developed countries with only 3 providing all positive 20 year holding periods.
  • U.S. stocks compounded at a higher rate than all but 3 other countries.
  • U.S. stocks had lower volatility of returns than all but 4 other countries.
  • Australia was the only country that had both lower volatility and higher returns than the U.S.
  • U.S. bonds had higher real compound returns than all but 3 other countries and lower bond volatility than all but 2 countries.
  • Only Switzerland had both higher bond returns and lower bond volatility than the U.S.
  • Only 2 countries experienced lower compound annual inflation than the U.S.

Because the U.S. enjoyed the highest returns with lowest volatility for stocks, bonds, bills and inflation, it’s simple math to conclude any research into safe withdrawal rates based on this data would likely provide some of the most optimistic outcomes of any data set.

This isn’t opinion. It is just the way the math works. It’s a fact.

The U.S. led a charmed existence with all the right connections and resources to bubble to the top of the economic heap. Her experience is not representative of the rest of the world, and it’s highly questionable the U.S. will repeat her performance during your retirement for many reasons including the following:

  • Interest rates (as of this writing) are below U.S. historical averages, dividend yields are below historical averages, and P/E ratios are above historical averages. All of these facts imply less than average investment returns (see next section on valuation models).
  • The last 100 years were built on cheap oil and plentiful natural resources. The U.S. used a disproportionate share of those resources to fuel its economic growth and consumption demands. Maybe technology will solve these problems, or maybe natural resource limitations will inhibit overall economic growth.
  • The U.S. also enjoyed a stable political environment with no destructive wars on its soil compared to its developed competitors.
  • The world economy has become more homogenized. The degrees of separation have diminished. U.S. companies sell and manufacturer world-wide while their competitors do the same. It’s truly a global economy in ways that didn’t exist historically.
  • U.S. debt levels have ballooned by every measure compared to economic history placing a serious question mark around the stable inflation assumption of the past.

Are you willing to bet your financial security on the charmed economic stats of the prom queen when she was in her prime compared to how the world is a changed place today? Should you bet on the prom queen returning to the podium or is it more realistic to expect some kind of mean reversion that could lower asset returns to average expectations?

This is more than a cute analogy. Your financial security in retirement depends on it.

Wade Pfau (source for much of the data cited above) was the first to put this idea to the test. He applied a research methodology similar to Bengen but with the critical change of using historical international data instead of U.S. data.

The results were alarmingly different.

In other words, similar methodology as 2nd Generation models + different data = dramatically different conclusions.

Using 109 years of data for each of 17 different developed countries, Pfau determined that a 4% withdrawal rate with a fixed 50/50 asset allocation would have failed in all 17 countries. Yes, a 100% failure rate.

You would have run out of money before you ran out of life using the conventional assumptions on foreign country data.

Ouch!

Lesson Learned: The 2nd Generation models used to prove the 4% Rule showed a surprising failure rate when applied to international data. Basing your retirement expectation on results from U.S. data alone is the economic equivalent of basing your expectations for the High School Prom on the prior 10 years prom queen’s experience. It is overoptimistic. This can be proven either by comparing U.S. economic statistics to the rest of the world or by actually running the models on the actual asset price data. They both point to the same conclusion – if you bet your retirement on becoming the prom queen you stand a good chance of being disappointed.

The Dramatic Impact of Sequencing of Returns on Safe Withdrawal Rates

In the last section, you learned the critical role that data assumptions play in safe withdrawal rates by seeing how international data indicated a potentially lower return expectation than U.S. data.

In this section, you’ll discover how safe withdrawal rates are actually dynamic – not static as commonly taught.

You’ll learn how the sequencing of investment returns and inflation during your early retirement years will make or break your financial security.

The sequencing of returns problem is best illustrated in this example from William Bernstein:

Assume you have a $1,000,000 portfolio with an average return of 10% split evenly between 15 years at +30% and 15 years at -10%. This would give you a compound return of 8.17% (compound is less than average due to volatility effects).

More importantly, when you vary the returns sequences you get something truly shocking:

  • If you are unlucky and start your retirement with 15 straight losing years you can only withdraw 1.86%. Same annual returns, same average return, different sequence of returns, different result.
  • Conversely, if you are lucky enough to start your retirement with 15 straight winning years you can safely withdraw 24.86%.

These are astounding results!

Sequencing risk causes your safe withdrawal rates to vary from a low of 1.86% (in this example) to as high as 24.86%. This variation is solely caused by the exact same returns occurring in a different order.

Nothing else changed. Amazing!

Sequence of Returns 4% Rule & Safe Withdrawal Rate

As shocking as these numbers are, it’s really just common sense when you think about it.

Imagine 15 years of no net investment gain (not hard to do with the stock market’s inflation adjusted performance since 2000), while still withdrawing 4% per year for spending. Even without inflation adjustments, you would wipe out 60% of your account just in spending alone.

When you add inflation and investment losses to the equation, the overall destruction to equity would be the retirement equivalent of death by strangulation.

By the way, this is not some strange statistical mumbo-jumbo that has no bearing on your retirement. This is real-world stuff that is critical to your understanding.

It can make-or-break your financial security. Real people retired in 2000 applying the conventional 4% wisdom and destroyed their nest eggs in the process because of this exact problem. It’s totally real.

Sequencing of returns risk is a huge factor in explaining why actual safe withdrawal rates on U.S. historical data vary from the 3% range at the low end to over 10% at the high end (depending on assumptions and the date chosen to begin retirement).

Sequence of returns is determined by the date you retire, cannot be known in advance, and will be one of the most significant factors affecting your financial security in retirement.

It’s a big deal.

The truth is safe withdrawal rates are all over the map depending on what date you retire and what happens to your investment returns in the early years of your retirement.

Pfau (2010) concludes that retirement success is highly dependent upon early investment returns showing that wealth remaining after 10 years of retirement combined with cumulative inflation during those 10 years explains 80% of the variation in safe withdrawal rates. This is very similar to Bernstein above.

The importance of this issue cannot be overstated.

The problem is your next 10 years investment returns are unknowable. You don’t get to know the sequence of returns until after the fact. The future can’t be predicted with any accuracy (and it certainly isn’t dependent on the last 100+ years of U.S. average historical data!).

Lesson Learned: Your real safe withdrawal rate for 30 years is highly dependent on the first 10 year’s sequence of returns and inflation rate. One size does not fit all. The 4% conventional wisdom is a static, least-common-denominator approximation, but actual safe withdrawal rates are highly variable. It is one reason why retirees in 1921, 1966, and 2010 face such dramatically different safe withdrawal rates.

What’s a near-retiree to do? As it turns out, all is not lost. There are answers provided in the next section below.

(But they are not the same as conventional wisdom would lead you to believe!)

Market Valuations and Safe Withdrawal Rates

2nd Generation research assumed all time periods were equal regardless of market valuations, interest rates, and inflation. According to conventional wisdom a retiree in 1921, 1966, and 2010 should all withdraw the same percentage of savings even though history proves this assertion is patently false (with perfect hindsight, of course).

3rd Generation research concludes differently by attempting to show that safe withdrawal rates vary widely depending on economic conditions on the date of retirement.

Let’s set the stage for this argument with the obvious logic first. Everyone intuitively understands that investment returns are a primary determinant of safe withdrawal rates.

The more your portfolio earns during retirement the more you can afford to spend during retirement. That much is clear.

The argument isn’t whether investment returns affect safe withdrawal rates. Everyone agrees that’s true.

The problem is guesstimating what investment returns will be since you only know in hindsight and your withdrawal rate must be chosen in advance. That’s the problem.

This problem is why 2nd Generation models chose to define the highest withdrawal rate that could survive all historical data periods. The assumption was the best and worst performing periods couldn’t be determined in advance so the only safe choice was the lowest common denominator that survived all time periods.

Fortunately, that assumption is false. Future investment returns are not “luck” or random as many would guess.

As it turns out, market valuations at the time you begin your investment holding period are inversely correlated to the return you can expect over the following 10-15 years.

Notice how this 10-15 year time period is identical to the critical time period identified by Pfau in the research on sequencing of returns risk cited earlier. That’s no coincidence.

Campbell and Shiller (1998), Hussman, Easterling, and many others have documented the effect of valuations on subsequent investment returns. It’s a well known phenomenon that’s valid across data samples and is something you can apply in your own retirement planning.

Is it statistically perfect? No, nothing is. Is it robust enough for me to bet my own retirement on it? Absolutely yes!

The implications are startling. It means the 2nd Generation safe withdrawal rate models were well intentioned but somewhat misguided.

Retirees don’t need to know the historical “least common denominator” withdrawal rate that survived most data samples (as the 2nd Generation models taught). They need to know the forward-looking investment expectation given the actual data that exists on the day their retirement begins (which is what 3rd Generation models teach).

These are completely different questions.

Safe withdrawal rates are based on research that's well intentioned but also misguided.

Michael Kitces considered the valuation effect alone by testing both optimal asset allocations and safe withdrawal rates based on Shiller’s P/E 10. He concluded 4.5% for P/E 10 above 20, 5.0% when P/E 10 is between 12 and 20, and 5.5% when P/E 10 is below 12 were all safe.

These are not revolutionary variations from the conventional 4% Rule, but they point a clear direction: valuations matter.

In other words, the higher the market valuation, the lower the safe withdrawal rate. Rob Arnott (2004) asserted similarly that sustainable withdrawal rates are not a fixed number but evolve with changing market conditions.

Similarly, Rob Bennett provides a safe withdrawal calculator based on regression analysis by John W. Russell that varies output using valuations at the start of your retirement. The key difference between Bennett and Kitces, however, is Bennet’s conclusions are more dramatic with a safe withdrawal rate at the 2000 peak in market valuations using a large allocation to stocks of only 2%.

This is half of what conventional wisdom would claim. Yikes!

More recently, Wade Pfau created a robust model using regression analysis and 3 valuation metrics — PE 10 (price divided by average real earnings for previous 10 years), dividend yield (dividends divided by stock price), and interest rates (on 10 year government bonds) — to explain variation in safe withdrawal rates across time periods reasonably well.

It wasn’t perfect, but most of the results were within 1% of being accurate (which is far more accurate and informative than blindly following historical averages).

For example, our theoretical retiree in 1921 enjoyed an astounding 10.42% safe withdrawal rate largely because of historically low market valuations when he retired. Our 1966 retiree faced a difficult future with high valuations and rising inflation causing a 3.53% safe withdrawal rate. This is a difference of 3 times the spending capacity from the same nest egg simply because of the date you retired!

And if that isn’t shocking enough, our 2010 retiree is looking at a 1.8% safe withdrawal rate according to Pfau’s research.

No, 1.8% isn’t not a misprint. But it sure is far below the conventional wisdom of 4% based on historical research.

It’s caused by the one-two combination punch of persistently overvalued markets and razor thin interest rates that simply don’t exist in the historical data.

What this means is 2010 retirees have serious cause for concern when you consider a healthy couple at 65 has decent odds of one spouse outliving the 30 year lifespan assumption. And don’t forget, none of the models thus far include administrative or transaction fees (both of these issues are explained in detail below, and they both lower the safe withdrawal rate even further).

Suffice it to say, 2010 is a tough year to begin retirement. The conventional “wisdom” could dangerously mislead you to overspend, which would put you at risk of running out of money long before you run out of life.

Lesson Learned: Safe withdrawal rates vary with market valuations, interest rates, and inflation at the time you begin retirement. This connects to the previous lesson because valuations are a strong indicator of subsequent 10-15 year investment performance. When you put these two facts together you have a dynamic model that is more accurate and can be adjusted based on your actual retirement situation.

The safe withdrawal rate you must use is not a fixed number like conventional wisdom claims that can be neatly packaged into a simple rule-of-thumb.

It’s not the same across all time periods in all conditions. One size does not fit all.

It’s a dynamic number dependent on economic conditions and asset valuations prevailing at the time you retire. This is completely contrary to the static 4% rule taught elsewhere.

The Understated Problem with Inflation

In the previous section, we discovered how our 1921 and 2010 retirees faced a more than 5 fold difference in expected safe withdrawal rates because of market valuations and interest rates.

In this section, we look at our 1966 retiree to learn how inflation affects safe withdrawal rates so we can begin assembling a more complete picture.

The key concept to understand about inflation is how it multiplies its pain in two ways through retirement income planning

  1. First off, withdrawal amounts are adjusted annually to reflect cumulative inflation. This forces a progressively larger annual withdrawal from savings to maintain real purchasing power which progressively taxes your savings.
  2. Secondly, periods of high inflation are correlated with lower asset returns (see Unexpected Returns: Understanding Secular Stock Market Cycles).

The combined effect is to increase your annual withdrawals from savings while simultaneously reducing your investment returns. This is a very difficult situation for any retiree to face.

It’s the worst of both worlds all at one time, because your retirement savings are getting squeezed from both ends simultaneously.

The best historical example illustrating the ravages of inflation included the period from 1966-1996. Surprisingly, it was harder on new retirees than the Great Depression.

Inflation caused the annual withdrawal amount to rise from 4% to above 10% of savings within 15 years of retiring. This also coincided with a nominal return on the S&P 500 of 6.81% roughly equaling the inflation rate and putting the real return at roughly zero.

Numbers like these are unsustainable and spell financial destruction.

The only reason these retirees survived was because Paul Volcker wrenched down inflation thus setting off one of the greatest bull markets in history beginning in 1982. The subsequent outsized investment returns offset the outrageously high withdrawal rate that had been caused by inflation in the preceding 15 years, thus bailing out a near-death experience for 1960s retirees.

Consider the 1960s a warning shot over the bow because the next round of inflation may not end so gracefully. Men of Paul Volcker’s caliber seem in short supply these days, and record breaking bull markets, by definition, are extremely rare occurrences and should not be relied upon to repeat.

The other insidious fact about inflation is that it’s not predictable. PhD economists routinely miss their forecasts just one year into the future.

The idea of a 30+ year inflation forecast (the duration of your retirement) is an absurd joke.

In short, inflation is an incredibly dangerous beast: it can’t be forecast accurately and it multiplies your spending while reducing average investment returns.

Lesson Learned: Taking inflation adjusted withdrawals over a 30 year period is only realistic in a stable inflation environment otherwise your withdrawal rate grows to an unsustainably large percentage of savings. The bulk of U.S. economic history has seen stable inflation so there is little historical precedent to judge the seriousness of the problem. Foreign history includes bouts of inflation and the effects indicate safe withdrawal rates below 4%. Given the unprecedented government debt levels you should carefully reconsider any safe withdrawal rate that blindly increases spending during inflation.

How a Long, Healthy Life Is a Financial Problem

Longevity is a key idea when spending principal from savings (as most safe withdrawal research assumes).

Research shows (based on U.S. historical data – see above caveats) that safe withdrawal rates for 10 year retirements approach 10%. 20-25 year retirements push 5% and 30 years or more dip under 4%.

The rule is simple: the longer your money has to last, the lower the percentage you must withdraw. It’s inherent in the mathematics of amortizing a fixed pool of capital — in this case, your savings.

Now that we know the math, let’s look at the problem: people are living longer.

Remember our 1921 retiree? He had a life expectancy of little more than 65 years. When Social Security was created they set the retirement age at average life expectancy. It was never intended to fund 30+ year retirements.

Since that time, average life expectancy has increased by roughly 1/3 of a year for every year thus increasing by 30 years in the last 100.

Our 1921 retiree didn’t need a lot of savings because he could spend a large chunk of principal every year. Our 2010 retiree doesn’t have that luxury.

Today, a healthy couple retiring at 65 has a good probability of at least one spouse living into their 90s. That means today’s retirees must budget for 30+ years and be extremely careful about any strategy that amortizes their savings by spending principal.

Additionally, this average life expectancy is a moving target expected to increase by the time your date with destiny arrives. If history provides any guide, it’s reasonable to expect the average to rise another 10 years over the next 30 moving our 2010 retiree into a 100+ year lifespan.

This may sound extreme, but with developments in biotechnology and nanotechnology, it may actually prove to be a conservative estimate.

Finally, understand that all this discussion is about averages, but half the population outlives the averages. Already the 95% confidence interval life expectancy is over 100 years (and rising).

The risk has never been higher that you could outlive your savings. Extremely long retirements exceeding 30+ years are entirely reasonable to plan for; yet, all safe withdrawal research to date is based on the premise that you spend your assets to zero at 30 years. Yikes!

This could be very dangerous.

For many people this assumption could cause you to run out of money long before you run out of life.

Lesson Learned: Both 2nd and 3rd Generation research into safe withdrawal rates has assumed 30 year retirements as the maximum. Trends in human longevity and developments in medicine make that a dubious assumption at best and dangerous at worst. The longer your life expectancy the lower percentage you can withdraw from savings.

The bottom line is a safe withdrawal rate that spends principal is an oxymoron when longevity expands beyond 30+ years. Any spending of principal is not safe over very long time periods.

You should adjust your investment strategy and withdrawal rate accordingly.

The Zero Fees and Expenses Assumption

How many of you invest with zero fees and expenses?

Not too many hands raised…

Amazing, then, that most safe withdrawal rate research supporting the consensus 4% rule assumes zero fees and expenses.

This is another example of an assumption made for the purpose of expediency in research, but having no real-world application.

Real-world withdrawal rates must be reduced compared to theoretical research to reflect real-world investment management and transaction expenses.

This issue may seem small, but it is not.

Imagine you’ve invested your portfolio with an adviser who charges 1% management fees while investing in mutual finds with 1-2% total expense ratios. That is 2-3% of annual expenses when compared to a 4% withdrawal rate. The difference is huge.

Fortunately, you don’t have to subtract the expenses directly from the theoretical withdrawal rate because the math doesn’t work that way. (It’s a common mistake.)

Instead, you subtract expenses from the investment return first and then calculate the sustainable withdrawal rate. The reduction in withdrawal rate is significantly less than the actual expenses.

For example, Pfau adjusted his 3rd Generation research results for administrative fees of 1.6% for stocks and 1.2% for bonds (similar to recent Morningstar averages). After he did so, he reduced his safe withdrawal rate by only .66 percentage points – far less than the nominal expenses.

Lesson Learned: If you invest in low cost ETF’s without additional advisory fees then you may be able to ignore the investment expense issue since its impact should be limited. However, if you invest with an advisor in expensive mutual funds then this issue is a serious consideration that could reduce the amount you can withdraw each month by 10-20%. It is an important issue to consider that few advisors will explain to you… for obvious reasons. Learn more here…

Humans Are Rational… Sort Of!

The final 2nd Generation research assumption built into the 4% Rule that makes no sense is the idea that you withdraw a fixed percentage of your savings adjusted for inflation (but nothing else) each and every year.

This is nonsense! Nobody lives this way.

In real life we adjust our spending based on the success or failure of our careers and the income they produce. Why should retirement be any different?

If your assets got hammered by inflation and bad investment performance during the first 10 years of retirement, causing the percent withdrawal to rise above 10%, are you going to march like a lemming to the cliff of financial destruction?

Of course not! That would be foolish.

You would reduce your spending based on adverse circumstances in your early years of retirement. It’s the prudent, common-sense thing to do (but it is not included in the research because it’s difficult to model).

Similarly, do retirees consistently spend more each year as they get older? No, quite the opposite occurs. Retirees reduce spending as they age.

Why, then, do safe withdrawal models plan for ever increasing spending? It’s not how real retirees manage their money.

The point is that a 4% withdrawal rate on the first year of retirement that is adjusted every year for inflation has no real world applicability. It’s a fiction of academic research.

Real world retirees increase spending when their assets have a good run and cut back spending when assets get clobbered. They spend more in the early years of their retirement when their health is strong and world travel beckons, and they reduce spending as their energy and health decline with age.

Flexible spending opens up many possibilities not modeled in the 2nd Generation research:

  • You could spend more in your early years and then reduce spending (or forego inflation increases) in later years when you don’t need as much money.
  • You could spend more in the early years and ratchet your spending down if you are unfortunate enough to endure an adverse returns sequence in the first 10 years.
  • You could start at 4% and increase spending if your first 10 years enjoy high investment returns and/or low inflation.

These are just three of many possible variations on how to approach withdrawing money. The bottom line is you don’t have to be a lemming and mindlessly follow the 4% rule into a financial abyss.

Such blind obedience could leave a fortune on the table or risk unnecessary financial ruin. Instead, be smart and adjust your spending based on the actual results you experience.

It’s just common sense.

Lesson Learned: There are many possible spending alternatives that offer real-world practical solutions to the fixed academic model of blindly increasing withdrawals based on inflation each and every year. You can’t determine the risk of ruin for rational retirees from a model based on irrational behavior.

Risk of ruin is just as dependent on retiree behavior as it is on market dynamics – something not considered by the research and certainly ignored by the 4% rule. You must remain flexible during retirement and use your brain.

Correct and adjust your spending based on the growth or decline of your portfolio. Be rational and your risk of running out of money will be reduced.

Putting It All Together

We’ve covered a lot of ground by examining the 3 generations of safe withdrawal rate research and the various problems associated with the 2nd Generation safe withdrawal models.

The reason I focused on the 2nd Generation model is because it has been elevated to the status of “truth” in the financial planning industry. The 4% Rule is quoted regularly in the financial media and used as a benchmark by which all other retirement planning models are compared.

The problem is it’s not really safe. The 4% rule could cause you to leave a fortune on the table or run out of money long before you die. The 4% rule is a static conclusion in a world that is dynamically evolving.

In summary, there are specific assumptions built into the research supporting the 4% model that must be seriously questioned:

  • 4% safe withdrawal rates are based entirely on U.S. investment data covering a time period when the U.S. was the prom queen of the economic world. Research by Pfau on long-term international data shows U.S. results optimistically on the high side of world estimates, and found material risk of failure when the same model was applied to international data.
  • 4% safe withdrawal rates fail to account for rational retiree behavior in response to adverse (or positive) returns sequences.
  • 4% safe withdrawal rates are a least-common-denominator approach to finding a static answer. In other words, the 4% Rule is the highest withdrawal rate that survived most data, but that doesn’t mean it is the highest withdrawal rate that might be safe for your situation. It doesn’t take into account market valuations, interest rates, or inflation at the time you retire. Wade Pfau demonstrated such factors can provide dramatically different safe withdrawal rates (both higher and lower) when compared to the 4% rule.
  • 4% rule cannot account for out of sample data. This was first identified by Wade Pfau using international data and surfaced again in regression analysis on the record breaking market overvaluation and low interest rates of the last 10 years. Both situations produced expected safe withdrawal rates well below 4%. In addition, it can’t possibly account for the potential for out-of-sample inflation that might occur in the future due to government financial mismanagement and excessive debt levels. Don’t believe that 100+ years of U.S. economic history is as bad as it can get. The past isn’t the future.
  • 4% safe withdrawal rates usually exclude investment management fees and transactions costs. This is not a big deal if you self-manage your portfolio using low cost ETF’s but is a very big deal if you use professional advisors and invest in mutual funds. Adjust accordingly.
  • 4% safe withdrawal rates assume 30 year life expectancy. The problem is average life expectancies hold no relevance for your particular date with destiny. You could live much longer. In addition, a 95% confidence interval for a healthy couple at 65 pushes the number beyond 30 years, and increasing longevity combined with medical research breakthroughs can extend this number even further. Budgeting for 30 years may cause you to run out of money before you run out of life.
  • 4% safe withdrawal rates assume conventional asset allocation to U.S. stocks and bonds and cannot be extrapolated to include less conventional investment approaches. Skill based investment strategies (active management), commodities, TIPs, and real estate can imply dramatically different conclusions.
  • 4% safe withdrawal rates assume irrational retiree behavior. A rational retiree who adjusts spending based on actual results can significantly decrease his risk of ruin – even at higher initial withdrawal rates.

[how-much-money-do-i-need-to-retire] The truth is your actual safe withdrawal rate will likely be very different from the 4% rule depending on when you retire, your spending patterns, and your investment strategy.

The 4% rule is promoted as a one-size-fits all answer to the question of “how much can you spend in retirement?” Unfortunately, the exact opposite is true.

The answer is dynamic – not fixed. It is dependent on all the factors discussed above.

One size fits all is naïve and dangerous.

Don’t believe it… even if it is conventional wisdom.

Conclusion…

So what should a retiree do? If the 4% rule isn’t the answer, then what is?

Unfortunately, no simple “plug-and-play” model has surfaced to replace the 4% rule (which probably explains why it has persisted despite inaccuracy).

Below I will provide you with a four step process to serve as a guideline in determining a reasonable approximation for a safe withdrawal rate.

It includes various adjustments you can make to determine a reasonable withdrawal rate for your retirement situation.

Longevity: Decide first how long you need your money to last. I’m personally budgeting for a 100+ year lifespan because anything less is financially risky (see longevity assumption above).

When your retirement time horizon extends to 30+ years then spending principal isn’t safe. As your time horizon shortens (i.e. you get older) then spending principal becomes viable again.

Build these facts into your safe withdrawal rate.

Market Valuations: The next step is to assess market valuations at the time you retire to determine if you are in a high risk or low risk period. (You can reference Wade Pfau’s research or Rob Bennett’s calculator for benchmarks.)

In periods of record high market valuations, the low safe withdrawal rate (under 4%) indicated by 3rd Generation research may make alternative asset mixes to the traditional stock/bond portfolio at least temporarily prudent and allow a higher withdrawal rate.

For example, during periods of high asset valuation you might consider…

  • Limiting your spending to the premium over inflation on Treasury Inflation protected securities.
  • Investing in inflation adjusted fixed annuities and leave the worry to the insurance companies.
  • Limiting your spending to the dividend income from an internationally diversified dividend stock portfolio.
  • Or you can choose to invest in alternative assets that aren’t governed by the same investment return limitations as traditional paper assets. For example, some retirees live off the positive cash flow from directly owned real estate.

Conversely, in periods of low market valuations you may be able to prudently increase your withdrawal rate above the 4% rule and allocate a higher percentage to stocks.

In summary, the second step is to assess the risk level inherent in market valuations so you can decide an appropriate asset mix and withdrawal rate given your longevity expectation and the economic environment.

Refine: Now that you have a benchmark withdrawal rate consider subtracting for other factors discussed above.

For example, if you pay investment adviser fees and invest in high cost mutual funds then, you may want to reduce your withdrawal rate accordingly. The same with other assumptions described above that fit your situation.

Correct And Adjust: Once you’ve picked your investment strategy and withdrawal rate, don’t make the mistake of setting it and forgetting it. Remember that 3rd Generation research by Wade Pfau showed how the bulk of your financial “blow-up” risk is determined by the sequence of returns and inflation during the first 10 years.

You may need to adjust your strategy based on actual results. You certainly shouldn’t blindly increase the amount you spend every year by the inflation rate as the 4% rule would indicate.

Revisit you plan every few years so that you never spend too large a percentage of your savings in any one year regardless of what the research tells you. You may even want to consider employing some alternative spending models:

  • You can replace the “4% rule” with the “3% rule” during times of excessive market valuations thus increasing your safety… but lowering your income.
  • You can eliminate or reduce the annual inflation adjustment factor so that your spending is fixed in nominal terms, but declines in real terms as you age (something most retirees do naturally anyway). One idea to consider is only increasing your spending by inflation during years when your portfolio grows in value.
  • You can change your withdrawal strategy to a fixed percentage of principal which virtually eliminates risk of failure, but causes variability in income based on portfolio fluctuations. As your assets rise you will withdraw more, and as your assets fall you will withdraw less. Whether or not your spending keeps up with inflation would be determined by the growth of your assets.

The key point is to use common sense.

That means use the research and calculators as guidelines only. Don’t apply static models based on blind faith just because they have become conventional wisdom and everyone says they are true.

Your retirement is too important to incur that much risk.

Your retirement will be different from your grandfather’s. Your expected longevity has made any strategy that spends principal in the early years questionable. Financial markets are more volatile and interest rates are at record lows making fixed stock/bond allocations questionable.

In addition, inflation could look completely different from historic norms due to unprecedented government debt levels.

In short, the premise that all 2nd Generation research is based upon – that the future should be no worse than the past 100+ years of U.S. economic history – is extremely dangerous.

Already the last 20 years has produced a period of record market overvaluations and low interest rates not seen in the historical data. This produced a theoretical safe withdrawal rate less than half that indicated by the 4% rule. Never mind the possibility of out of sample inflation in the future making things even worse.

Don’t blindly trust something as important as your retirement security to computer models. No one has a Crystal Ball (least of all economic researchers) and that is why you have to use your brain and not rely on oversimplified rules-of-thumb.

They are useful guidelines to teach important principles, but they aren’t scripture set in stone.

Hopefully the 4 step model outlined here, while admittedly more complex, will help you navigate the journey and find fulfillment and financial security in your retirement.

Please let me know how this article has impacted your thoughts in the comments below.

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7 Key Reasons Why Financial Education Is Your Best Investment http://financialmentor.com/financial-advice/financial-education-best-investment/13173 http://financialmentor.com/financial-advice/financial-education-best-investment/13173#comments Fri, 22 Aug 2014 00:02:11 +0000 http://financialmentor.com/?p=13173

If You Think Investment Education Is Expensive, Just Try Ignorance

Key Ideas

  1. Reveals the only way to make consistently smart investment decisions.
  2. Shows you how to build a wealth plan custom fitted to your unique values, skills, and resources.
  3. Discover why you can never pay an advisor enough to put your interests before his own… and what to do about it.

Do you know the difference between a balance sheet and an income statement?

Do you know the necessary due diligence steps to take before putting capital at risk on a new investment?

Do you know the difference between investing and gambling and how it affects your profits?

Amazingly, the single biggest skill that can make or break your financial success is not taught in school. You can graduate with a four year degree and learn nothing about personal finance or investing.

Doctors and attorneys can open their own practices without any clue how to read a financial statement. Business owners and investors can remain dangerously ignorant of the tax law.

The truth is, financial literacy is the essential skill you must develop if your goal is to build wealth and enjoy financial security. There’s no alternative.

The best investment you can make is in yourself and your financial education. It’s the obvious starting point to building wealth.

Why? Here are seven reasons:

  • Provides dividends for life that nobody can ever take from you.
  • Increases your earning potential.
  • Increases your return on investment.
  • Improves the quality of your life and finances.
  • Secures your retirement.
  • Defends your portfolio from unnecessary losses.
  • Provides peace of mind around money.

That’s a long list of advantages, but what about the disadvantages? Why doesn’t everyone master these essential skills for investing and develop their financial literacy?

Because it requires time and effort — and they’re too busy.

That’s it. There are no other disadvantages.

If you are willing to commit the time, you can have all the advantages that accrue to becoming financially literate. All you have to do is put out the effort and a lifetime of benefits is yours for the taking.

“Invest in yourself, in your education. There’s nothing better.” - Sylvia Porter

It is one of those “duh-obvious” decisions that is easy to understand, but hard to live.

After all, what do you prefer: a little bit of effort now in exchange for a lifetime of financial security, or a little bit of procrastination and avoidance now in exchange for a lifetime of financial mediocrity?

Not a very difficult decision, but surprisingly few people make the wise choice.

Financial education is one of the great bargains in life: it costs little, risks nothing, and returns huge rewards. It is the best investment you can make.

The sooner you get it the more it will be worth to you. The longer you wait, the more it will cost you. Which path will you choose?

Below we’ll examine each of the seven reasons why financial education is your best investment so that you make the a profitable choice.

Why financial education? Because it's the best investment you can make in yourself

Most Investment Advice Is a Dangerous Half-Truth

Aren’t you tired of all the financial and investment experts with their conflicting investment advice?

  • One expert says diversify to reduce risk, and another expert calls it di-worsefying that insures mediocre results.
  • One expert says pay down all your debt because it is bad, and another says leverage up with good debt to build wealth.
  • One expert says the stock market is the key to riches, and another expert tells you more millionaires come from real estate than any other source.

How is a person supposed to learn how to invest money when the supposed experts can’t even agree? It’s enough to make you go bonkers! Who can you trust?

Each authority speaks as if there is one and only one right answer, yet each financial expert offers differing and often conflicting investment advice. It makes no sense! It’s frustrating.

[the-four-percent-rule] It drives me nuts when supposed financial experts speak in over-simplified, dogmatic statements as if they have the one right answer. True experts know that most financial truths are more subtle and complex so they don’t insult your intelligence with over-simplified, sound-bite investment advice.

Even the most basic investment ideas such as buy and hold stocks for the long term are too complex to be adequately explained in a media sound-bite or brief article.

The reality is each item of conflicting investment advice above is partially true and partially false – depending on the situation.

There are times when it makes sense to leverage up with good debt, and there are other situations where it can be equally correct to pay off existing debt. There are times when “buy and hold stocks for the long term” is a sound strategy, and there are other times when the risk isn’t justified by the reward.

Each is a dangerous half-truth.

One reason financial education is necessary is to understand the subtle shades of gray hiding behind all the investment half-truths you hear.

How else are you going to process this information into profitable investment decisions? You must know when a conditional-truth is applicable and when it should be disregarded because it can get you in financial trouble.

For example, do you understand when buy and hold is a smart investment strategy, and when the risk is not justified by the reward? Do you know when to leverage yourself with debt to grow wealth, and when it makes sense to pay off debt? What is the best wealth building vehicle – paper assets, business, or real estate – and why?

Questions like these can make or break your financial future.

Learning the assumptions and reasons behind investment half-truths is one reason why financial education is necessary. It’s the only way you can know who is right, who is wrong, and why in a world of conflicted and contradictory investment advice.

One Size Doesn’t Fit All Investors

Despite what all the investment experts selling seminars and courses want you to believe, there aren’t any secrets to investing. To paraphrase John Bogle of Vanguard Investment fame, “The secret is there are no secrets.”

There are many different ways to invest profitably, and there are many sources where you can learn the information. There’s nothing new under the sun, and no marketer has a corner on teaching any particular type of investment strategy

If you don’t want to pay a high-priced guru thousands for his boot camp or seminar, then you can probably find very similar information for less than a hundred dollars at your local library or online bookstore.

What you can’t get from a bookstore — or most gurus — is the real key to financial security: figuring out which of the many available investment strategies will work for your personal situation.

Their investment advice is generic, but you need it personalized. Not all investment strategies are appropriate for all people, but there is one right solution for you.

Your job is to find it so that you can achieve financial security.

You’re a unique individual with your own skills, background, experiences, and outlook on life. You have a risk tolerance unique to you and preferences, time frames, and goals that are different from everyone else’s.

What are the odds that a weekend investment seminar or week-long boot camp teaching one specific investment technique is going to be the right fit for your unique needs? It makes no sense.

The hidden assumption behind most investor education is “one size fits all.”

It doesn’t work with clothes, relationships, or sunglasses, and it certainly doesn’t work with investment strategy. One size does not fit all.

“If you want to be truly successful invest in yourself to get the knowledge you need to find your unique factor. When you find it and focus on it and persevere your success will blossom.” - Sidney Madwed

Each person has a unique gift to bring to the world and financial success results from an investment plan that capitalizes on that uniqueness. How you retire early and wealthy is going to be different from everyone else you talk to or associate with.

That’s why prepackaged advice, investment seminars, and generic computer solutions that spew static financial “truths” can never measure up to personalized education that helps you find your own truth.

Therefore, the second reason for the necessity of financial education is so that you can learn enough about yourself and the various investment strategies in existence so that you can develop a wealth building solution custom fitted to your unique skills, values, and resources.

If you don’t educate yourself to do it, nobody else will.

How to Overcome the Conflicts of Interest in Investment Advice

The only person 100% committed to your pocketbook is you. Everyone else has a conflict of interest.

No less an authority than Alan Greenspan told Congress that “for an increasingly complex financial system to function effectively, widespread dissemination of timely financial and other relevant information among educated market participants is essential if they are to make the type of informed judgments that promote their own well-being.”

[how-much-money-do-i-need-to-retire] Greenspan also spoke about the need for Americans to better educate themselves about managing their finances and to promote greater financial education for children in the school system. He stated “financial literacy can help prevent younger people from making poor financial decisions that can take years to overcome.”

You must learn how to invest your money because no one will ever care about it as much as you do.

Nobody else is making financial decisions in your life with zero conflict of interest except you. You are the only investment advisor for your portfolio that solely has your best interests at heart.

Everyone else is in business to serve their best interests.

Avoiding conflicts of interest by being skilled enough to sort investment fact from fiction is the third reason why financial education is necessary.

You Can Delegate Authority, But You Can’t Delegate Responsibility

Many people want to believe their advisors will take care of the big financial issues like retirement, college savings, and wealth planning for them.

Just delegate the issues to a professional advisor and don’t bother learning for yourself. They’ll take care of it.

Nonsense!

Whether you hire financial experts or invest independently – you’re still responsible for your investment results. Each choice is a decision you make; therefore, you’re responsible.

You decide which investment expert to hire and you decide which investment to buy. If you don’t like your investment results, there is no-one except you to blame.

You can’t delegate the responsibility, even if you delegate the authority.

“The difference between success and failure in the stock market is education.” - Bill Griffeth, CNBC Anchor

The only way to make consistently smart investment decisions is if you learn what works, what doesn’t, and why.

If your investment decisions aren’t based on knowledge, then what are they based on – salesman’s charisma, speaker’s charm, media sound-bites, trust, or blind faith? None of these are a reliable prescription for investor success.

There’s no substitute for knowledge.

It’s incongruous to own self-responsibility in your mind for your financial future, yet not take action by educating yourself on how to make smart investment decisions. Anything less is irresponsible.

Prioritizing your financial education is how you become self-responsible for your financial future. It is the fourth reason financial education is necessary.

Your Financial Intelligence Compounds Like Money

It’s critically important that your financial intelligence grow at least as fast as your portfolio. Why?

Because there is nothing more financially dangerous than a million dollars worth of investment decisions being made with a thousand dollars worth of financial intelligence.

“Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do, when it ought to be done, whether you like it or not; it is the first lesson that ought to be learned; and however early a man’s training begins, it is probably the last lesson that he learns thoroughly.” - Thomas H. Huxley

Your financial intelligence acts as a ceiling that limits the growth of your wealth. As you raise your financial intelligence, you raise the ceiling on what’s financially possible for you.

Your financial intelligence sets the context for your investment success – or lack thereof.

Your return on investment should improve as you learn how to invest more consistently and control losses when the inevitable mistakes occur. That translates into more dollars in your pocket and greater financial security.

A little known fact about financial intelligence is it grows and compounds just like money. The effect is multiplicative – not additive.

Each new tidbit of information connects to all the other knowledge which multiplies. It doesn’t just add up, but it grows geometrically by multiplying.

Your goal should be to make regular deposits every week into your financial intelligence account just like you make monthly deposits into your investment accounts. When you do this, your financial intelligence will multiply and grow ahead of the growth in your investment accounts to help create a lifetime of financial security.

Financial Intelligence Is the One Investment You Can Never Lose

Financial education is like an annuity. It’s a one-time investment that pays dividends for the rest of your life.

People can steal your money, but nobody can ever take your financial education from you. Once you know it, you can never un-know it.

The sooner you seek investor education, the sooner you can begin reaping the rewards. The longer you enjoy financial literacy, the more value you will get from it.

Every year it compounds profits in your portfolio.

Why not start learning how to invest and manage your personal finances today?

Benjamin Franklin quote on financial education

True Freedom and Independence Requires Financial Intelligence

Needing others to make financial decisions for you is dependence.

Regardless of the amount of money you have, you will never be financially independent or secure as long as you depend on someone else to manage your money.

You can’t experience true freedom if you’re dependent on someone else’s experience and knowledge for your financial well-being.

The world is littered with people who built vast fortunes and lost it all because of their own financial ignorance. Lacking financial intelligence is the opposite of financial security – no matter how much money you have.

Choosing the path of financial intelligence, where you learn to make decisions independent of other people’s advice, leads to investment wisdom. This allows you to independently sort all the divergent opinions with confidence and decide what’s uniquely true for you and your portfolio

The alternative is to remain permanently dependent on all the conflicting and confusing opinions offered up as expertise by others and play a guessing game as to what’s true for you.

Financial education teaches you how to fish so that you never have to be dependent on another person to give you a fish again. Financial education teaches financial independence.

Financial Education Is Your Best Investment

So what should you do now? The answer is simple: commit to growing your financial literacy with a process of continual improvement by beginning to learn today.

Rome wasn’t built in a day and neither is financial intelligence. You have to start somewhere – wherever you are right now – and fortunately, success is a learnable skill.

If you work on yourself and study regularly, the reward for persistence can be financial freedom.

There will never be a better time than now to learn and prepare so that all these benefits can be yours:

  1. Financial education will teach you how to sort all the conflicting investment advice so that you know how to manage your way through a world filled with investment half-truths.
  2. Financial education will help you build a wealth plan custom fitted to your individual needs.
  3. Financial education will help you negotiate the conflicts of interest inherent in investment advice.
  4. Financial education is how you demonstrate self-responsibility for your financial security.
  5. Financial education is how you raise the ceiling on your financial future by raising your financial intelligence.
  6. Financial education is like an annuity – it pays dividends for the rest of your life, and nobody can ever take it from you.
  7. Financial education is the foundation on which true financial independence stands.

Financial education is a long term approach to wealth. It builds success on several levels by growing your knowledge, experience, and portfolio simultaneously so that you can retire early and wealthy with security and peace of mind.

Financial education is your best investment, and the only thing keeping you from enjoying all the benefits of smarter investing is… you.

If you aren’t clear on the tangible dollars and cents value of financial education in your life, then here is a quick and fun exercise to prove it to yourself.

Go to this free retirement calculator and input your financial information as best you know it today and print out the results. Don’t worry about accuracy: just do the best you can.

Then increase your savings rate and investment return by 20% (i.e. from 10% to 12% investment return or from $400 saved per month to $480), and notice the dramatic change in results when compounded over your expected lifetime.

That’s an example of the potential cash value of financial literacy. It’s literally worth a fortune.

It can mean the difference between financial security and flipping burgers in your old age.

So what are you going to do about it? What actions are you going to take today?

If you aren’t motivated to make a change, then all I can say is I walked the talk and it literally made me a fortune. I’m a big believer in financial education because I know the difference it made in my life. I hope you”ll join me and do the same.

Nobody said it better than this:

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10 Commandments of Investment Strategy http://financialmentor.com/investment-advice/10-commandments-of-investment-strategy/13136 http://financialmentor.com/investment-advice/10-commandments-of-investment-strategy/13136#comments Mon, 18 Aug 2014 02:00:18 +0000 http://financialmentor.com/?p=13136

Discover How Your Investment Strategy Measures Up to Proven Success Principles So You Can Improve Your Portfolio

Key Ideas

  1. How to use the “expectancy principle” to stop gambling and profit regularly with confidence.
  2. How to combine offensive and defensive investment strategy for reliable investment performance.
  3. The 3 investment mistakes you never want to make.


Smart investing isn’t as hard as it seems.

You just need to know the right principles, and you need to follow them with discipline.

Unfortunately, much of what is taught about investment strategy is a dangerous half-truth that can be expensive.

Below are ten proven principles to help get you on the path to greater investment success.

1st Investment Strategy Commandment: Thou Shalt Not Gamble

“Expectancy” is what separates investors from gamblers. If you follow hunches, guess, take tips, or “play the market,” then you are a gambler — not an investor.

If you put money at risk on “one-off” investments, special situations, or economic forecasts, then you’re also a gambler because you’re betting on an unknown expectancy.

Expectancy is a formula that shows the average amount of money you can expect to make per dollar risked if you follow your investment strategy consistently enough to achieve statistical validity. It tells you what profits to expect.

Expectancy literally determines the compound growth of your wealth. It is inviolable mathematical rule whether you use it to your advantage, or not.

Gamblers put money at risk on unknown or negative expectancy situations. Investors only put money at risk on known, positive expectancy situations.

Thorough and accurate research is required to know your investment strategy’s expectancy with confidence. You must understand the assumptions underlying the research and know when those assumptions may no longer be valid.

Anything less is gambling.

The principle of expectancy implies a systematic and methodical investment strategy (an investment plan). Otherwise, you cannot have confidence that you will ultimately profit.

Your disciplined investment strategy should include one or more of the following characteristics to create positive expectation:

  • A positive paying attribute: For example, positive expectancy results from certain value-based strategies in the stock market such as Tobin’s Q-ratio and Graham’s intrinsic value. Additionally, well located and properly purchased investment real estate is so well known for it’s positive expectancy under most economic conditions (not all) that a myth about “real estate never going down” resulted (just ask anyone who owned investment real estate beginning in 2008).
  • An exploitable inefficiency: For example, many bond mutual funds are mispriced during rapidly moving interest rate markets because of the infrequent trading of the underlying portfolio of individual bonds and mark-to-market accounting rules.
  • A competitive edge: For example, some people have a competitive edge in real estate foreclosure through their banking network and marketing systems. In paper assets, some firms have a competitive edge in computer systems to exploit option pricing inefficiencies. Competitive edge is usually the result of a business system or specialized knowledge applied to investing.

Most people don’t want the scientific rigor and discipline of mathematical expectancy. They prefer the fun and adventure of “story” stocks, investing by the seat of the pants, or trusting in an advisor.

You must ask yourself, “do I invest for fun, or do I invest for profit?”

Don’t confuse the issues. If you want financial security and consistent profits then expectancy is a required investment discipline. There’s no way around it.

Growing wealth is governed by mathematics. It’s science-based around the core principle of mathematical expectation.

Insurance companies don’t gamble, and neither do casino owners … only their customers do.

Both types of businesses rely on mathematical expectation to profit reliably. You should do the same with your investment strategy.

You either invest scientifically with the odds in your favor based on known, positive, expectation strategies, or you gamble with your financial future. There aren’t any other alternatives.

2nd Investment Strategy Commandment: Thou Shalt Forsaketh the Advice of False Prophets

Never try to outguess the market by following forecasts from the financial media or the latest investment guru. Don’t fall prey to cover story articles about “10 Hot Stocks to Own for 200X“.

Financial forecasts are little more than entertainment, and should never be part of your investment strategy.

“The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.” - Daniel J. Boorstin

Three types of information exist in this world: known, unknown but knowable, and unknowable. Foretelling the future (forecasting) is unknowable. Any investment strategy predicated on any forecast for the future is inherently flawed because the unknowable has no mathematical expectancy.

It’s gambling — not investing.
Abide by these 10 commandments for success with your investment strategy.

3rd Investment Strategy Commandment: Thou Shalt Do Thy Due Diligence

Only invest in what you understand.

If you don’t understand it then don’t invest. One of the best ways to expand your investment knowledge is through the due diligence process.

Never skip due diligence and rush into an investment strategy because of time deadlines, someone’s recommendation, or because you believe you should put your capital to work. Don’t succumb to the temptations of sloth, laziness, or avoiding inconvenience by neglecting due diligence.

What you don’t know will cost you when investing … big time. Due diligence is how you learn what you need to know to make an informed investment decision.

Your first task in due diligence is to determine the mathematical expectation for the investment strategy so that you add only investments that increase the expectation of your portfolio. Understanding expectation includes understanding the source of returns and the assumptions underlying the persistence of returns in the future (see Commandment #1).

Your second task in due diligence is to determine the correlation of the investment strategy so that you can build a portfolio of uncorrelated risk profiles to minimize overall portfolio risk (see Commandment #5).

Your third task in due diligence is to understand what risk management strategies will apply to the investment so that you can accurately assess your risk/reward ratio and know how your capital is protected from permanent loss (see Commandment #6).

There are many other criteria to consider for a complete due diligence process, but mathematical expectation, correlation, and risk management form the foundation by which 95% or more of all potential investments can be eliminated from your portfolio.

4th Investment Strategy Commandment: Thou Shalt Compound Returns

Albert Einstein declared compound growth the eighth wonder of the world … and for good reason. Compound growth is how the average person can attain extraordinary wealth. It is how lots of little things done right can grow into very big results during your lifetime.

To put compound growth to work for you requires just four actions:

  • Begin investing now (not next month or next year). Procrastination is the number one wealth killer. Every day wasted is another day that compound returns won’t work for you.
  • Invest only in known, positive mathematical expectancy investment strategies. Never risk capital on unknown or negative expectancy investments.
  • Reinvest all profits from your portfolio. Don’t spend the profits from your portfolio until after your passive income exceeds your expenses.
  • Accelerate your compound growth by adding to investment principal from earned income.

When you follow these four steps, wealth changes from a question of “if” to the security of “when.”

5th Investment Strategy Commandment: Thou Shalt Diversify, But Not Di-Worse-ify:

Never place all thy eggs in one basket. Similarly, never spread thy eggs among so many baskets that your investment returns become average.

Thou shalt place thy eggs in a carefully selected group of baskets, each with positive mathematical expectation and an uncorrelated risk profile.

For example, don’t attempt to diversify by adding a technology mutual fund to a portfolio already concentrated in NASDAQ listed securities. This will only cause your portfolio to more closely replicate the technology averages. The two assets are highly correlated.

Similarly, don’t add another real estate asset from the same general location to an existing real estate portfolio. Property values are primarily determined by local economies, so each asset will behave similarly.

These are examples of di-worse-ifcation because they don’t meaningfully change the risk profile of the portfolio. They also cause your returns to regress to the mean.

The objective of diversification is to lower the risk profile of your portfolio by adding non-correlated or inversely correlated investment strategies. This allows the performance of each asset to smooth the performance of the other.

When one zigs, the other should zag.

For example, an investment strategy utilizing gold and gold stocks is a natural diversifier for a conventional equity portfolio. They are low or negatively correlated to each other and both can have a positive mathematical expectation when properly managed.

Real estate is another natural diversifier to a bond or equity portfolio for the same reasons.

The point is to never add more of the same risk profile to any investment portfolio. Instead, find other investment strategies with an equal or greater mathematical expectation coupled with a low or negatively correlated risk profile.

The result is lower portfolio risk, more consistent profits, and the ability to rest easier knowing you’re diversified (not di-worse-ified).

Image of Will Rogers with Quote about Investment Strategy

6th Investment Strategy Commandment: Thou Shalt Invest Defensively

Your first objective with any investment strategy should be “return of” capital, and only after that should you concern yourself with “return on” capital.

The hallmark of consistently profitable investors is their focus on controlling permanent loss of capital through risk management disciplines. You’d be wise to do the same.

Carefully examine every investment strategy to determine its maximum downside risk should Murphy’s Law prevail … because eventually, it will.

Your investment strategy must have built in safe-guards that manage risk exposure and control losses to an acceptable level under both normal conditions and worst case scenarios. The alternative is to accept too much risk into your portfolio (which is a bad thing).

7th Investment Strategy Commandment: Thou Shalt Invest Offensively

At first glance, offensive investing might seem contradictory to Commandment #6 . The truth is they work together synergistically to form a complete and balanced investment strategy.

Stated another way, you must invest offensively to seek gains while you invest defensively to manage risk and control losses. Either half of this equation without the other is an incomplete investment strategy.

Your objective as an offensive investor is to maintain and improve purchasing power. You can do this by achieving profits sufficient to overcome the ravages of inflation, currency devaluation, capital losses on other investments, taxes, transactions costs, and more.

History proves this doesn’t happen by stuffing your money under a mattress or in Treasury Bills. An aggressive, offensive strategy is required.

The way you sleep at night investing offensively is by controlling risk through defensive investment strategy (see Commandment 6 above). Isolating the risk exposure to acceptable levels for each strategy and diversifying among non- or low-correlated strategies in one portfolio can provide both strong, positive returns and a controlled, acceptable, risk level.

In fact, offensive and defensive investing are flip-sides of the same coin. No investment strategy is complete without either half of the coin.

8th Investment Strategy Commandment: Thou Shalt Avoid Illiquidity

Liquidity refers to the ease with which an investment can be sold and converted into cash. Certain hedge funds, partnership interests, and real estate are examples of assets that have the potential to become illiquid. Large cap stocks and bonds are examples of highly liquid investments.

The reason liquidity is important is because the risk management tool of last resort (see Commandment #6) is a sell discipline.

If an asset becomes illiquid then you can’t sell it which means you can’t control the losses during adverse market conditions. Loss of liquidity equals loss of flexibility.

Illiquidity places an extra premium on all other risk management tools because it eliminates the possibility of controlling risk by liquidating to cash. Experience has shown most of my worst losses have resulted from illiquidity restricting my ability to manage my risk exposure.

I’ve learned from the school of hard knocks to approach potentially illiquid investments very cautiously. You can learn from this experience and avoid the same mistakes.

“If you have made a mistake, cut your losses as quickly as possible.” - Bernard Baruch

9th Investment Strategy Commandment: Thou Shalt Respect (But Not Obsess About) Expenses

Expenses are a cost of doing business.

The business of investing involves management and transaction expenses such as taxes, brokerage fees, and more.

I have seen people lose fortunes because they refused to pay the taxes and transaction costs necessary to exit a formerly good investment. I have also seen people miss out on great investments because they did not want to pay what appeared to be high management fees.

Neither approach is balanced. The question you must answer is whether the expense adds value in excess of costs.

Does the management company add value (greater return) to your portfolio net of management fees and expenses — or not? Does selling the stock add value to your portfolio by lowering risk and redeploying assets to higher mathematical expectation investments net of transaction fees and taxes — or not?

You must strike a balance. Don’t be a miser on expenses and miss your next great investment. And don’t be wasteful by paying unnecessarily without receiving a value added benefit.

For example, most loaded mutual funds could be avoided by finding a no-load equivalent and investing the fees saved. Rarely do loaded funds justify the fees. Research shows they don’t add value in excess of costs.

Similarly, many high priced hedge funds are now being usurped by specialized mutual funds and ETFs offering a competitive risk/reward profile at a lower cost.

Be smart by willingly paying for value added investment services. Likewise, always seek to get the greatest value from your investment dollar by not paying for services that don’t add value. Again, balance is the key.

10th Investment Strategy Commandment: Thou Shalt Invest in Thyself

[dont-hire-a-financial-coach] Nothing is more financially dangerous than a million dollar portfolio managed with a thousand dollars worth of financial intelligence. Your investment skills and knowledge will be reflected in your investment results.

If you want to improve your return on investment, then you must first improve your financial intelligence. That’s where Financial Mentor can help.

The best investment you can make is in yourself because nobody can ever take it away from you, and it will pay you dividends for the rest of your life. The goal of Financial Mentor’s coaching and educational products is to grow your financial intelligence so you can grow your portfolio.

Let us know how we can help you make your financial dreams come true beginning right now. Whether it is going from zero to wealth or better managing the wealth you’ve already accumulated, Financial Mentor is here to support you.

“An investment in knowledge always pays the best interest.” - Benjamin Franklin

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Andrew Carnegie “The Gospel Of Wealth” http://financialmentor.com/true-wealth/the-gospel-of-wealth/13127 http://financialmentor.com/true-wealth/the-gospel-of-wealth/13127#comments Fri, 15 Aug 2014 05:52:12 +0000 http://financialmentor.com/?p=13127

The Gospel of Wealth, by Andrew Carnegie, Is a Politically Incorrect Assessment of Wealth in America from One of the Greatest Philanthropists and Industrialists of All Time. Learn from His Experience and Uncommon Wisdom.

Key Ideas

  1. The surprising way that wealth inequality is good for society as a whole.
  2. How good wealth management benefits the lower classes more than charity.
  3. 3 ways to distribute wealth — including the shocking method Carnegie thought was best.

Editors Note: Andrew Carnegie was a poor immigrant during the 1800s who became one of the wealthiest men in the America. He built a vast steel conglomerate and became a philanthropist giving away more than $350 million during his lifetime.

Andrew Carnegie was one of the first to publicly assert that building wealth included the responsibility to use it wisely for community benefit. Carnegie saw great value in self-education and built 2,509 public libraries at a time when few existed.

I have taken great pains to provide as complete a version of The Gospel of Wealth as was available; however, I have added some paragraph breaks, punctuation and other details to increase modern day readability. I hope you enjoy Andrew Carnegie’s wisdom.

If you do, please share it with your friends and followers with a tweet:

Andrew Carnegie, The Gospel of Wealth, or Wealth, North American Review (June 1889)

Read the full text of Andrew Carnegie's The Gospel of Wealth.

 

The problem of our age is the proper administration of wealth, so that the ties of brotherhood may still bind together the rich and poor in harmonious relationship. The conditions of human life have not only been changed, but revolutionized, within the past few hundred years. In former days there was little difference between the swelling, dress, food, and environment of the chief and those of his retainers. The Indians are today where civilized man then was. When visiting the Sioux, I was led to the wigwam of the chief. It was just like the others in external appearance, and even within the difference was trifling between it and those of the poorest of his braves. The contrast between the palace of the millionaire and the cottage of the laborer with us today measures the change which has come with civilization.

This change, however, is not to be deplored, but welcomed as highly beneficial. It is well, nay, essential for the progress of the race that the houses of some should be homes for all that is highest and best in literature and the arts, and for all the refinements of civilization, rather than that none should be so. Much better this great irregularity than universal squalor. Without wealth there can be no Maecenas. The “good old times” were not good old times. Neither master nor servant was as well situated then as to-day. A relapse to old conditions would be disastrous to both — not the least so to him who serves — and would sweep away civilization with it. But whether the change be for good or ill, it is upon us, beyond our power to alter, and therefore to be accepted and made the best of. It is a waste of time to criticize the inevitable.

It is easy to see how the change has come. One illustration will serve for almost every phase of the cause. In the manufacture of products we have the whole story. It applies to all combinations of human industry, as stimulated and enlarged by the inventions of this scientific age. Formerly articles were manufactured at the domestic hearth or in small shops which formed part of the household. The master and his apprentices worked side by side, the latter living with the master, and therefore subject to the same conditions. When these apprentices rose to be masters, there was little or no change in their mode of life, and they, in turn, educated in the same routine succeeding apprentices. There was, substantially, social equality, and even political equality, for those engaged in industrial pursuits had then little or no political voice in the State.

But the inevitable result of such a mode of manufacture was crude articles at high prices. Today the world obtains commodities of excellent quality at prices which even the generation preceding this would have deemed incredible. In the commercial world similar causes have produced similar results, and the race is benefited thereby. The poor enjoy what the rich could not before afford. What were the luxuries have become the necessaries of life. The laborer has now more comforts than the farmer had a few generations ago. The farmer has more luxuries than the landlord had, and is more richly clad and better housed. The landlord has books and pictures rarer, and appointments more artistic, than the King could then obtain.

The price we pay for this salutary change is, no doubt, great. We assemble thousands of operatives in the factory, in the mine, and in the counting-house, of whom the employer can know little or nothing, and to whom the employer is little better than a myth. All intercourse between them is at an end. Rigid castes are formed, and, as, usual, mutual ignorance breeds mutual distrust. Each caste is without sympathy for the other, and ready to credit anything disparaging in regard to it. Under the law of competition, the employer of thousands is forced into the strictest economies, among which the rates paid to labor figure prominently, and often there is friction between the employer and the employed, between capital and labor, between rich and poor. Human society loses homogeneity.

The price which society pays for the law of competition, like the price it pays for cheap comforts and luxuries, is also great; but the advantages of this law are also greater still, for it is to this law that we owe our wonderful material development, which brings improved conditions in its train. But, whether the law be benign or not, we must say of it, as we say of the change in the conditions of men to which we have referred: it is here; we cannot evade it; no substitutes for it have been found; and while the law may be sometimes hard for the individual, it is best for the race, because it insures the survival of the fittest in every department.

We accept and welcome, therefore, as conditions to which we must accommodate ourselves, great inequality of environment, the concentration of business, industrial and commercial, in the hands of a few, and the law of competition between these, as being not only beneficial, but essential for the future progress of the race. Having accepted these, it follows that there must be great scope for the exercise of special ability in the merchant and in the manufacturer who has to conduct affairs upon a great scale.

That this talent for organization and management is rare among men is proved by the fact that it invariably secures for its possessor enormous rewards, no matter where or under what laws or conditions. The experienced in affairs always rate the man whose services can be obtained as a partner as not only the first consideration, but such as to render the question of his capital scarcely worth considering, for such men soon create capital; while, without the special talent required, capital soon takes wings. Such men become interested in firms or corporations using millions; and estimating only simple interest to be made upon the capital invested, it is inevitable that their income must exceed their expenditures, and that they must accumulate wealth.

Nor is there any middle ground which such men can occupy, because the great manufacturing or commercial concern which does not earn at least interest upon its capital soon becomes bankrupt. It must either go forward or fall behind: to stand still is impossible. It is a condition essential for its successful operation that it should be thus far profitable, and even that, in addition to interest on capital, it should make profit. It is a law, as certain as any of the others named, that men possessed of this peculiar talent for affairs, under the free play of economic forces, must, of necessity, soon be in receipt of more revenue than can be judiciously expended upon themselves; and this law is as beneficial for the race as the others.

Objections to the foundations upon which society is based are not in order, because the condition of the race is better with these than it has been with any others which have been tried. Of the effect of any new substitutes proposed we cannot be sure. The Socialist or Anarchist who seeks to overturn present conditions is to be regarded as attacking the foundation upon which civilization itself rests, for civilization took its start from the day that the capable, industrious workman said to his incompetent and lazy fellow, “If thou dost not sow, thou shalt no reap,” and thus ended primitive Communism by separating the drones from the bees.

One who studies this subject will soon be brought face to face with the conclusion that upon the sacredness of property civilization itself depends — the right of the laborer to his hundred dollars in the savings bank, and equally the legal right of the millionaire to his millions. To those who propose to substitute Communism for this intense Individualism the answer, therefore, is: the race has tried that. All progress from that barbarous day to the present time has resulted from its displacement.

Not evil, but good, has come to the race from the accumulation of wealth by those who have the ability and energy that produce it. But even if we admit for a moment that it might be better for the race to discard its present foundation, Individualism, — that it is a nobler ideal that man should labor, not for himself alone, but in and for a brotherhood of his fellows, and share with them all in common, realizing Swedenborg’s idea of Heaven, where, as he says, the angels derive their happiness, not from laboring for self, but for each other, — even admit all this, and a sufficient answer is, this is not evolution, but revolution.

It necessitates the changing of human nature itself — a work of eons, even if it were good to change it, which we cannot know. It is not practicable in our day or in our age. Even if desirable theoretically, it belongs to another and long-succeeding sociological stratum. Our duty is with what is practicable now; with the next step possible in our day and generation. It is criminal to waste our energies in endeavoring to uproot, when all we can profitably or possibly accomplish is to bend the universal tree of humanity a little in the direction most favorable to the production of good fruit under existing circumstances.

We might as well urge the destruction of the highest existing type of man because he failed to reach our ideal as to favor the destruction of Individualism, Private Property, the Law of Accumulation of Wealth, and the Law of Competition; for these are the highest results of human experience, the soil in which society so far has produced the best fruit. Unequally or unjustly, perhaps, as these laws sometimes operate, and imperfect as they appear to the Idealist, they are, nevertheless, like the highest type of man, the best and most valuable of all that humanity has yet accomplished.

We start, then, with a condition of affairs under which the best interests of the race are promoted, but which inevitably gives wealth to the few. Thus far, accepting conditions as they exist, the situation can be surveyed and pronounced good. The question then arises, — and, if the foregoing be correct, it is the only question with which we have to deal, — What is the proper mode of administering wealth after the laws upon which civilization is founded have thrown it into the hands of the few? And it is of this great question that I believe I offer the true solution. It will be understood that fortunes are here spoken of, not moderate sums saved by many years of effort, the returns from which are required for the comfortable maintenance and education of families. This is not wealth, but only competence, which it should be the aim of all to acquire.

There are but three modes in which surplus wealth can be disposed of. It can be left to the families of the decedents; or it can be bequeathed for public purposes; or, finally, it can be administered during their lives by its possessors. Under the first and second modes most of the wealth of the world that has reached the few has hitherto been applied. Let us in turn consider each of these modes.

The first is the most injudicious. In monarchical countries the estates and the greatest portion of the wealth are left to the first son, that the vanity of the parent may be gratified by the thought that his name and title are to descend to succeeding generations unimpaired. The condition of this class in Europe to-day teaches the futility of such hopes or ambitions. The successors have become impoverished through their follies or from the fall in the value of land. Even in Great Britain the strict law of entail has been found inadequate to maintain the status of a hereditary class. Its soil is rapidly passing into the hands of the stranger. Under republican institutions the division of property among the children is much fairer, but the question which forces itself upon thoughtful men in all lands is: why should men leave great fortunes to their children? If this is done from affection, is it not misguided affection?

Observation teaches that, generally speaking, it is not well for the children that they should be so burdened. Neither is it well for the state. Beyond providing for the wife and daughters moderate sources of income, and very moderate allowances indeed, if any, for the sons, men may well hesitate, for it is no longer questionable that great sums bequeathed oftener work more for the injury than for the good of the recipients. Wise men will soon conclude that, for the best interests of the members of their families and of the state, such bequests are an improper use of their means.

It is not suggested that men who have failed to educate their sons to earn a livelihood shall cast them adrift in poverty. If any man has seen fit to rear his sons with a view to their living idle lives, or, what is highly commendable, has instilled in them the sentiment that they are in a position to labor for public ends without reference to pecuniary consideration, then, of course, the duty of the parent is to see that such are provided for in moderation. There are instances of millionaires’ sons unspoiled by wealth, who, being rich, still perform great services in the community. Such are the very salt of the earth, as valuable as, unfortunately, they are rare; still it is not the exception, but the rule, that men must regard, and, looking at the usual result of enormous sums conferred upon legatees, the thoughtful man must shortly say, “I would as soon leave to my son a curse as the almighty dollar,” and admit to himself that it is not the welfare of the children, but family pride, which inspires these enormous legacies.

As to the second mode, that of leaving wealth at death for public uses, it may be said that this is only a means for the disposal of wealth, provided a man is content to wait until he is dead before it becomes of much good in the world. Knowledge of the results of legacies bequeathed is not calculated to inspire the brightest hopes of much posthumous good being accomplished. The cases are not few in which the real object sought by the testator is not attained, nor are they few in which his real wishes are thwarted. In many cases the bequests are so used as to become only monuments of his folly.

It is well to remember that it requires the exercise of not less ability than that which acquired the wealth to use it so as to be really beneficial to the community. Besides this, it may fairly be said that no man is to be extolled for doing what he cannot help doing, nor is he to be thanked by the community to which he only leaves wealth at death. Men who leave vast sums in this way may fairly be thought men who would not have left it at all, had they been able to take it with them. The memories of such cannot be held in grateful remembrance, for there is not grace in their gifts. It is not to be wondered that such bequests seems so generally to lack the blessing.

The growing disposition to tax more and more heavily large estates left at death is a cheering indication of the growth of a salutary change in public opinion. The State of Pennsylvania now takes — subject to some exceptions — one-tenth of the property left by its citizens. The budget presented in the British Parliament the other day proposes to increase the death duties; and, most significant of all, the new tax is to be a graduated one. Of all forms of taxation, this seems the wisest. Men who continue hoarding great sums all their lives, the proper use of which for the public ends would work good to the community, should be made to feel that the community, in the form of the state, cannot thus be deprived of its proper share. By taxing estates heavily at death the state marks its condemnation of the selfish millionaire’s unworthy life.

It is desirable that nations should go much further in this direction. Indeed, it is difficult to set bounds to the share of a rich man’s estate which should go at his death to the public through the agency of the state, and by all means such taxes should be graduated, beginning at nothing upon moderate sums to dependents, and increasing rapidly as the amounts swell, until of the millionaire’s hoard, as of Shylock’s, at least ” —- the other half comes to the privy coffer of the state.”

This policy would work powerfully to induce the rich man to attend to the administration of wealth during his life, which is the end that society should always have in view, as being that by far most fruitful for the people. Nor need it be feared that this policy would sap the root of enterprise and render men less anxious to accumulate, for to the class whose ambition it is to leave great fortunes and be talked about after their death, it will attract even more attention, and, indeed, be a somewhat nobler ambition to have enormous sums paid over to the state from their fortunes.

There remains, then, only one mode of using great fortunes; but in this we have the true antidote for the temporary unequal distribution of wealth, the reconciliation of the rich and the poor — a reign of harmony — another ideal, differing, indeed, from that of the Communist in requiring only the further evolution of existing conditions, not the total overthrow of our civilization. It is founded upon the present most intense individualism, and the race is prepared to put it in practice by degrees whenever it pleases. Under its sway we shall have an ideal state, in which the surplus wealth of the few will become, in the best sense, the property of the many, because administered for the common good, and this wealth, passing through the hands of the few, can be made a much more potent force for the elevation of our race than if it had been distributed in small sums to the people themselves. Even the poorest can be made to see this, and to agree that great sums gathered by some of their fellow citizens and spent for public purposes, from which the masses reap the principal benefit, are more valuable to them than if scattered among them through the course of many years in trifling amounts.

If we consider what results flow from the Cooper Institute, for instance, to the best portion of the race in New York not possessed of means, and compare these with those which would have arisen for the good of the masses from an equal sum distributed by Mr. Cooper in his lifetime in the form of wages, which is the highest form of distribution, being for work done and not for charity, we can form some estimate of the possibilities for the improvement of the race which lie embedded in the present law of the accumulation of wealth. Much of this sum, if distributed in small quantities among the people, would have been wasted in the indulgence of appetite, some of it in excess, and it may be doubted whether even the part put to the best use, that of adding to the comforts of the home, would have yielded results for the race, as a race, at all comparable to those which are flowing and are to flow from the Cooper Institute from generation to generation. Let the advocate of violent or radical change ponder well this thought.

We might even go so far as to take another instance, that of Mr. Tilden’s bequest of five millions of dollars for a free library in the city of New York, but in referring to this one cannot help saying involuntarily, how much better if Mr. Tilden had devoted the last years of his own life to the proper administration of this immense sum; in which case neither legal contest nor any other cause of delay could have interfered with his aims. But let us assume that Mr. Tilden’s millions finally become the means of giving to this city a noble public library, where the treasures of the world contained in books will be open to all forever, without money and without price. Considering the good of that part of the race which congregates in and around Manhattan Island, would its permanent benefit have been better promoted had these millions been allowed to circulate in small sums through the hands of the masses? Even the most strenuous advocate of Communism must entertain a doubt upon this subject. Most of those who think will probably entertain no doubt whatever.

Poor and restricted are our opportunities in this life; narrow our horizon; our best work most imperfect; but rich men should be thankful for one inestimable boon. They have it in their power during their lives to busy themselves in organizing benefactions from which the masses of their fellows will derive lasting advantage, and thus dignify their own lives. The highest life is probably to be reached, not by such imitation of the life of Christ as Count Tolstoi gives us, but, while animated by Christ’s spirit, by recognizing the changed conditions of this age, and adopting modes of expressing this spirit suitable to the changed conditions under which we live; still laboring for the good of our fellows, which was the essence of his life and teaching, but laboring in a different manner.

This, then, is held to be the duty of the man of wealth: first, to set an example of modest, unostentatious living, shunning display or extravagance; to provide moderately for the legitimate wants of those dependent upon him; and after doing so to consider all surplus revenues which come to him simply as trust funds, which he is called upon to administer, and strictly bound as a matter of duty to administer in the manner which, in his judgment, is best calculated to produce the most beneficial results for the community — the man of wealth thus becoming the mere agent and trustee for his poorer brethren, bringing to their service his superior wisdom, experience, and ability to administer, doing for them better than they would or could do for themselves.

We are met here with the difficulty of determining what moderate sums are to leave to members of the family; what is modest, unostentatious living; what is the test of extravagance? There must be different standards for different conditions. The answer is that it is as impossible to name exact amounts or actions as it is to define good manners, good taste, or the rules of propriety; but, nevertheless, these are verities, well known although indefinable. Public sentiment is quick to know and to feel what offends these.

So in the case of wealth, the rule in regard to good taste in the dress of men or women applies here. Whatever makes one conspicuous offends the canon. If any family be chiefly known for display, for extravagance in home, table, equipage, for enormous sums ostentatiously spent in any form upon itself, — if these be its chief distinctions, we have no difficulty in estimating its nature or culture. So likewise in regard to the use or abuse of its surplus wealth, or to generous, freehanded cooperation in good public uses, or to unabated efforts to accumulate and hoard to the last, whether they administer or bequeath. The verdict rests with the best and most enlightened public sentiment. The community will surely judge, and its judgments will not often be wrong.

The best uses to which surplus wealth can be put have already been indicated. Those who would administer wisely must, indeed, be wise, for one of the serious obstacles to the improvement of our race is indiscriminate charity. It were better for mankind that the millions of the rich were thrown into the sea than so spent as to encourage the slothful, the drunken, the unworthy. Of every thousand dollars spent in so called charity to-day, it is probable that $950 is unwisely spent; so spent, indeed, as to produce the very evils which it proposes to mitigate or cure.

A well-known writer of philosophic books admitted the other day that he had given a quarter of a dollar to a man who approached him as he was coming to visit the house of his friend. He knew nothing of the habits of this beggar; knew not the use that would be made of this money, although he had every reason to suspect that it would be spent improperly. This man professed to be a disciple of Herbert Spencer; yet the quarter-dollar given that night will probably work more injury than all the money which its thoughtless donor will ever be able to give in true charity will do good. He only gratified his own feelings, saved himself from annoyance, — and this was probably one of the most selfish and very worst actions of his life, for in all respects he is most worthy.

In bestowing charity, the main consideration should be to help those who will help themselves; to provide part of the means by which those who desire to improve may do so; to give those who desire to raise the aids by which they may rise; to assist, but rarely or never to do all. Neither the individual nor the race is improved by alms-giving.

Those worthy of assistance, except in rare cases, seldom require assistance. The really valuable men of the race never do, except in cases of accident or sudden change. Every one has, of course, cases of individuals brought to his knowledge where temporary assistance can do genuine good, and these he will not overlook. But the amount which can be wisely given by the individual for individuals is necessarily limited by his lack of knowledge of the circumstances connected with each. He is the only true reformer who is as careful and as anxious not to aid the unworthy as he is to aid the worthy, and, perhaps, even more so, for in alms-giving more injury is probably done by rewarding vice than by relieving virtue.

The rich man is thus almost restricted to following the examples of Peter Cooper, Enoch Pratt of Baltimore, Mr. Pratt of Brooklyn, Senator Stanford, and others, who know that the best means of benefiting the community is to place within its reach the ladders upon which the aspiring can rise — parks, and means of recreation, by which men are helped in body and minds; works of art, certain to give pleasure and improve the public taste, and public institutions of various kinds, which will improve the general condition of the people; — in this manner returning their surplus wealth to the mass of their fellows in the forms best calculated to do them lasting good.

Thus is the problem of rich and poor to be solved. The laws of accumulation will be left free; the laws of distribution free. Individualism will continue, but the millionaire will be but a trustee for the poor; entrusted for a season with a great part of the increased wealth of the community, but administering it for the community far better than it could or would have done for itself. The best minds will thus have reached a stage in the development of the race in which it is clearly seen that there is no mode of disposing of surplus wealth creditable to thoughtful and earnest men into whose hands it flows save by using it year by year for the general good. This day already dawns.

But a little while, and although, without incurring the pity of their fellows, men may die sharers in great business enterprises from which their capital cannot be or has not been withdrawn, and is left chiefly at death for public uses, yet the man who dies leaving behind him millions of available wealth, which was his to administer during life, will pass away “unwept, unhonored, and unsung,” no matter to what uses he leaves the dross which he cannot take with him. Of such as these the public verdict will then be: “The man who dies thus rich dies disgraced.”

Such, in my opinion, is the true gospel concerning wealth, obedience to which is destined some day to solve the problem of the rich and the poor, and to bring “peace on earth, among men goodwill.”

ANDREW CARNEGIE

The Gospel of Wealth, or Wealth, North American Review (June 1889)

If you enjoyed reading this selection, you might also enjoy learning about why money isn’t the secret to happiness, and how financial freedom is only one part of true wealth.

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Multiple Streams Of Income – Truth Revealed http://financialmentor.com/wealth-building/wealth-program-system/multiple-streams-of-income/13096 http://financialmentor.com/wealth-building/wealth-program-system/multiple-streams-of-income/13096#comments Tue, 12 Aug 2014 04:40:55 +0000 http://financialmentor.com/?p=13096

Multiple Income Streams Is a Wealth Building System Whose Time May Never Come. Uncover the Pitfalls You Must Avoid if Financial Freedom Is Your Goal.

Key Ideas

  1. Why multiple streams of income is not for everyone.
  2. 6 questions to determine if multiple income streams are right for you.
  3. 3 step process to creating multiple streams of income the right way.

Forget everything you’ve read about multiple streams of income.

They haven’t told you the real truth.

The idea is simple enough to understand: diversify your businesses and investments into various, non-correlated sources of residual income so that you are never reliant on any one source.

Unfortunately, this simplicity masks problems that the promoters of this wealth building system don’t talk about.

Just to be fair, the clear benefit of multiple income streams is classic risk diversification. Build a portfolio of non-correlated streams of income and your risk is reduced making your wealth more stable and secure.

This logic is valid because your international bond portfolio should not be affected by what happens to your apartments in St. Louis which should not be affected by your dividend stocks or the income from your business. Each stream of revenue is relatively independent.

The problem rests not in the idea, but in the practical application of the idea.

The key problem is implementation – not theory. Few people ever succeed in building just one stream of income sufficient to achieve financial freedom … let alone several.

It is better to have a permanent income than to be fascinating.
– Oscar Wilde

The idea of diversifying into your personal conglomerate by creating multiple streams of income and successfully competing in all these areas is a task reserved only for the select few. Are you one of them?

Let’s examine this in greater detail…

Multiple Streams of Income Explained

Multiple streams of income image

There are three broad areas in which to create multiple income streams: real estate, paper assets, and your own business. These are the primary asset classes in terms of building wealth and residual income.

You can then subdivide each asset class into specific styles or strategies. For example, real estate can be divided into buy and hold, flipping, foreclosures, single-family, multi-family, and commercial. Business can include many strategies such as infopreneuring, hard goods, retail, and intellectual property, to name just a few.

According to the multiple income streams philosophy your objective would be to build residual income streams in several of these subcategories, each of which is sufficient to live on.

Sounds pretty appealing, eh?

Just imagine all these streams of income flowing into your “Lake Prosperity.” No worries if one of the streams dries up because you have other streams flowing. Your financial future would be secure allowing you to run off and live the high life.

Gee, I can hardly wait to start! But wait…

The Problem Creating Multiple Income Streams

Unfortunately, this simple concept with wide appeal is just another example of a dangerous half-truth.

Deeper issues that could cause great financial and personal problems lie hidden beneath the surface and only appear when applied in the real world. Below are two realities that fly in the face of multiple streams of income.

  • Reality One: We live in a competitive and fast changing world. Business has become highly specialized and niched because knowledge is growing exponentially requiring specialized skills to employ it properly. Successfully competing in many widely varying fields is contradictory to the specialization and complexity required by our current business climate.
  • Reality Two: You have a limited amount of time on this planet to implement your business plans and strategies while also trying to balance the needs of family, health, spirituality, recreation, relationships, and much more. Do you really want to spend your limited time nursing more than one stream of income? Happiness has more to do with balancing life than making tons of money.
  • ResultFinancial success results from focused attention directed to a specific outcome, and happiness results from balancing your personal life with your business life. These are key points, and multiple streams of income is contradictory to both of these realities.

Multiple streams of income diffuse your laser focus from a single point of high probability success into a scattered beam of ineffectual light. It creates multiple demands on your limited time and energy turning your relationships, family, spirituality, business and investing into a difficult juggling act.

Something will likely suffer, and that something will probably be you.

He that is of the opinion money will do everything may well be suspected of doing everything for money.
– Benjamin Franklin

Should Multiple Streams of Passive Income Be Part of Your Wealth Building System? Answer These Questions…

Building multiple streams of income isn’t the right path for everyone. The skills required and the demands on your time grow with each stream you add.

Below are some questions you should consider before embarking on the multiple streams of income journey:

  1. Do you understand the principles of time leverage and technology leverage well enough to manage the complexity of multiples streams of income?
  2. Are you experienced at hiring and managing a staff to run multiple streams of income so that you don’t have to do it yourself?
  3. Do you already have a history of success in business or investing proving that you are ready to graduate to a more advanced, complex strategy?
  4. Do you possess the negotiating skills, business expertise, and street smarts that are required to compete on multiple business and investment fronts simultaneously?
  5. Do you have a team of experts assembled to advise you on the myriad of legal and financial issues involved in managing multiple streams of income?
  6. Are multiple streams of income more important to you than enjoying the freedom that results from successfully building one stream of income?

Think about it. Building multiple streams of income is the equivalent of building your own personal conglomerate. Given the poor track record corporations have demonstrated at this task while employing teams of MBAs, what makes you think you will fare better?

Each stream of income requires its own skills and expertise. Each stream of income has a separate culture and network. Each stream of income makes demands on the most precious and limited resource in your life – time.

In short, there is a price to pay for each stream of income, and only you can decide if multiple streams of income are really worth that price.

Multiple income streams require hard work that can distract you from enjoying your financial freedom.

The Wrong Way to Create Multiple Streams of Income

There are some people who play the money game because they love it. Investment and business strategy is exciting and the process of building wealth is a great adventure.

These people are willing to play the multiple streams of income game because it is the logical next step. It is a challenge.

If you are so inclined then beware because there is a right and wrong way to go about implementing multiple streams of income into your wealth building system.

The wrong way is to get all fired up and launch a new business, begin stock investing, and buy your first piece of rental real estate all in the same few months. This is the financial equivalent of running before you ever learn how to walk. The likely outcome is you will stumble and fall flat on your face.

It’s not smart business strategy to take on risk recklessly, compete in fields without adequate preparation or knowledge, and spread your resources too thin. This is not how you set yourself up to succeed.

I’m not going to tell you it can’t be done because it can. I’m also not going to set you up for disappointment by leading you to believe it is reasonably achievable by anyone – because it isn’t.

It is a tough game to play and you will pay a price whether you succeed or not.

Every approach to wealth building is highly competitive and you will be going head to head with professionals who live and breathe what they do as their sole source of income. Any one person could spend a lifetime developing in-depth knowledge of any one of these money making areas because of the complexity involved.

To begin all three simultaneously is asking for trouble and disappointment.

The Right Way to Create Multiple Streams of Residual Income

If you are going to pursue multiple streams of income then it is important to follow a proven, step-by-step process that will maximize your odds of success. Below is that step-by-step process:

Step 1: Master the First Stream of Income

Begin by picking one stream of income that you are deeply passionate about. For some people it will be real estate and for others it will be owning your own business.

Your first stream of income should be something so personally exciting that you would do it whether you ever made a buck at it or not.

Why? Because the first stream of income will be the toughest.

This is where you will develop your Rolodex of support team members, learn fundamental skills applicable to all streams of income, overcome personal obstacles to success, and create enough cash flow to get out of the rat race.

Your first stream of residual income is where you will get the most bumps and bruises. By choosing an area you are passionate about it will increase the odds that you persist long enough to clear all the hurdles and succeed.

Master your first stream of income and in the process you will develop the necessary foundational skills and abilities that can then be leveraged to develop other streams of income.

Step 2: Systematize the First Stream of Income

Once you have mastered the first stream of income then it is time to systematize that stream so that it no longer requires your limited time and attention.

Systematizing is done through the application of time leverage (human employees) and technology leverage (digital employees). Master the skills of systematizing so that your first success runs on auto-pilot without requiring your time thus earning you residual income and cash flow.

Step 3: Leverage Resources to Create Additional Streams of Residual Income

Once you have systematized the first stream of income to produce residual income without your involvement, then you have the free time and energy to add multiple streams of income. This is done by intelligently adding additional revenue streams that leverage the skills, knowledge, and network you created in the first stream of income so that you aren’t starting from scratch on each additional stream. This is a key point.

For example, I know of highly successful direct marketers who have leveraged their marketing skills, network, and databases to create residual income through offering other product lines with minimal effort.

Another example is Robert Kiyosaki, bestselling author of “Rich Dad Poor Dad,” who got out of the rat race through real estate. Then he added paper assets and leveraged the financial knowledge he gained from his investment business experience into a successful information publishing business.

Similarly, I got out of the rat race through paper assets before leveraging my investing knowledge into real estate and then re-leveraging that same skill set into my information publishing business.

Notice the pattern. Each of the above successful examples developed multiple streams of income by learning the base skills in one stream and leveraging those skills later to create additional streams.

Each successful example learns to walk with one stream before running with multiple streams of residual income.

I challenge you to examine anyone who has succeeded with multiple streams of income and see if they violated my rules of walking before running. Every “multiple streamer” I have met built their success from one stream they were passionate about.

Only after that initial success with one stream of income did they leverage their resources into multiple streams of income.

In fact, to do it any other way is to throw away one of the primary benefits of multiple streams of income: leverage of existing resources.

This concept is known in the corporate merger world as “operating efficiencies.” It takes less effort to operate each additional stream of income because they are all built upon the same foundational resources.

When you attempt to create multiple streams of income simultaneously, you’ll create mayhem instead of leverage because no base resources exist to build upon. It makes no sense. It has no advantage sufficient to justify the problems it creates.

The bottom line is if you are going to build multiple streams of income, then there is a right and wrong way to go about it. Follow this step-by-step process and you will maximize your odds of success.

Should You Even Bother to Create Multiple Streams Of Income?

The primary benefit to multiple streams of income is the consistency and security of your income coming from non-related sources. But there are other ways to achieve this security without all the complication.

[how-much-money-do-i-need-to-retire] After all, how much more financial security do you need than a laddered bond portfolio that throws off more income than you spend so that you can reinvest and continue to grow the income offsetting inflation?

No complication or multiple streams of income here, but lots of financial security.

Another alternative is to own ten free and clear, well located, rental houses. This is something very achievable for most people, not complicated, no multiple streams of income, but extremely secure. What more do you need?

You could easily skip the whole multiple streams of income thing if your goal is time freedom and personal freedom. What do you gain from all the complication created?

These are questions you must consider as you design your wealth building system.

Should you focus your time and resources by really doing one stream right, or should you spread yourself thin by doing multiple streams of income? What is more important: your health and relationships or another stream of income?

What do you gain and what do you lose?

Multiple income streams are complicated, and you can achieve financial freedom without them.

In Summary…

Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game.
– Donald Trump

Creating multiple streams of income is a wealth-building system that has some advantages and disadvantages.

The desirable characteristic of multiple streams of income is it can diversify your passive income into non-correlated streams. When something goes wrong with one stream, your lifestyle and freedom are never at risk.

Also, multiple streams of income allow you to leverage existing resources to create additional revenue — but only when the strategy is implemented properly.

The downside to multiple streams of income is it requires you to juggle all the issues for each stream, which can diffuse your limited resources, create distraction, and lead to confusion. This is the antithesis of success and true wealth.

Similarly, multiple streams of income can divert your attention from deeper sources of happiness such as family, recreation, spirituality and relationships.

[dont-hire-a-financial-coach] My experience after coaching many clients through the process is you are better off succeeding with one stream of income and only leverage into additional streams after you are successful with the first.

I would rather coach you to focus on building one stream very well, creating a high probability of success, than to juggle the distraction and complication of managing several streams simultaneously.

Succeed by building one stream of income first, then use the freedom created from that success to create additional streams if that’s what your heart desires. This path is valid for people who truly love the wealth-building game and desire the creative challenge that comes with building multiple streams of income purely for the fun of it.

Alternatively, you could just decide to skip the whole multiple streams of income idea and learn to enjoy the freedom created by your one successful stream.

Happiness and true wealth are the real goals, and multiple streams of income may just serve as a useless distraction from the reasons you sought financial freedom in the first place.

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The Secret To Happiness… And Why It Has Nothing To Do With Money http://financialmentor.com/true-wealth/secret-to-happiness/13075 http://financialmentor.com/true-wealth/secret-to-happiness/13075#comments Sat, 09 Aug 2014 05:38:55 +0000 http://financialmentor.com/?p=13075

Discover How A Simple Daily Habit Can Create More Happiness Than Achieving Financial Freedom

Key Ideas

  1. The unexpected reason financial freedom causes unhappiness – and how to avoid it.
  2. The best way to enjoy freedom now regardless of your financial situation.
  3. Includes a free, printable checklist to take daily action.

You don’t have to be rich to be happy. Cliche maybe, but also true.

The secret to happiness is well within your reach.

It is a state of mind and completely within your control regardless of your financial situation.

Don’t make the same mistake I made and wait until you gain financial freedom to learn these lessons. You can have happiness right now regardless of your finances or what’s going on in your life because happiness is a choice.

Below I share my personal story explaining the painful process I went through to learn these lessons about money and happiness — and the secret to happiness — so that you can hopefully avoid repeating my mistakes.

Then I will provide you with step-by-step instructions showing you how to achieve personal freedom right now regardless of your financial situation.

Let’s get started…

The secret to happiness has much more to do with your actions than your money.

 

How Financial Freedom Forces You to Learn the Truth About Money and Happiness

There is a seldom spoken, little secret about financial freedom that I will let you in on. It is counter-intuitive and illustrates an essential principle about money and happiness.

Here it is: when you achieve financial freedom your life suddenly changes from pre-determined to self-determined.

The surprising affect of this is you are suddenly stripped of all excuses for why your life might be less than ideal. You instantly become solely responsible for your happiness with no excuses allowed.

To understand how this works and why it’s important, let’s first look at the reality faced by most people living the work-a-day existence.

Their lives are largely pre-determined. They spend the bulk of their time working to earn the money necessary to build a better lifestyle. The little time that remains is quickly swallowed up by family, errands and other personal needs.

Very little free time remains to create your unique life destiny, and very little creative thought is required to live out your lifetime. You work 40 hours (or more) per week for 40 years and try to have a little fun with what little time remains.

It’s pretty straightforward and uncomplicated. Society wrote the script and nearly everyone follows it.

However, once you achieve financial freedom all that changes. Suddenly 2,000 hours a year previously spent on work related issues is yours to do with as you please. Your days have zero pre-determined structure.

Your time becomes an open canvas for you to paint the life of your dreams upon.

Let me repeat this because it is very important: one of the little-discussed aspects of attaining financial freedom is how your life changes from pre-determined to self-determined.

You don’t get to follow the default script imposed by society because financial freedom obliterates the script and leaves a void in its place.

For some people the adventure this situation presents along with the “burden” of responsibility is exciting, but for many others it’s frightening. You become self-responsible for your day, your life, and most importantly… your happiness.

All the excuses are gone.

[how-much-money-do-i-need-to-retire] You no longer have the excuse of a job and a nasty little boss to blame your unhappiness on. You no longer have your days automatically filled with everything to do so that you never have to think for yourself, deal with your personal issues, or constructively plan your life.

With financial freedom all those excuses are gone, many of your day-to-day responsibilities are gone, and you must re-create yourself and your life.

For some people that becomes a tremendous and unexpected burden. It happens to new retirees every day and it  happened to me in 1997 when I sold the hedge fund business and had enough money to retire.

My plan was to marry my long-time girlfriend (currently my long-time wife) and take a six month honeymoon by traveling around Europe and the Middle-East with nothing more than a backpack and a credit card.

Then It Was All Downhill From There Once The Unexpected Reality Struck…

I was on top of the world. I had achieved financial freedom, found love, and was about to embark on the adventure of a lifetime. I was young, healthy, and had my whole life in front of me. It should have been nirvana — and it was for a brief period of time.

Money can’t buy happiness, but neither can poverty.
- Leo Rosten

I made the classic mistake I see so many of my financial coaching clients make — and that you are likely making as well. I projected my value for personal freedom onto money.

I naively labored under the delusion that if I could just attain financial freedom, I would be personally free as well. I falsely believed that once I no longer had to work I would enter the pro-leisure circuit of life where every day would be filled with fun activities, friends, and one continuous holiday.

I was wrong. It doesn’t work that way.

When I achieved financial freedom and quit working, the biggest realization I had was that I was the same guy. I had the same hang-ups and personal issues facing the same life I had before.

The only difference was now I had a lot more time to wallow in it, and no distractions or excuses from the presumed work-a-day life script to distract me from seeing the truth about my life.

What I realized was the goal all along had been personal freedom — not financial freedom — and the one thing I knew for certain was I had not achieved the goal. I was happy with financial freedom because it provided the time, money and flexibility to focus on personal freedom. (No complaints there.)

But I also realized that achieving financial freedom had done little more than lift the mask that hid the deeper issues. It had removed all the distractions and external things, like job and money issues, that I used to project my unhappiness onto.

It forced me to look inward and own full responsibility for my internal state of being because I could no longer project my problems outward on life’s circumstances.

In a nutshell, when you have the financial ability to arrange your life in any way you want, the one thing you lose is any excuse for aspects of your life that don’t measure up.

Financial freedom removes the facade by eliminating the excuses.

Don’t get me wrong; I didn’t slip into depression or anything like that. I just wanted to know how to enjoy each and every day of my life — no excuses allowed — regardless of the circumstances of the day. I didn’t want to have another unhappy day ever again.

This set me on a journey of personal growth in pursuit of that elusive animal known as happiness.

While I’m still a little shy of reaching that lofty objective, I have made significant progress toward the goal and I’ve learned some valuable lessons along the way. One of my discoveries I would like to share with you here. It’s what I call my “Daily Happiness Accountability.”

Secret to Happiness Quote 1 Image

Daily Happiness Accountability

The essence of the daily happiness accountability is that your happiness is a product of your thoughts. Nothing more, nothing less.

This may sound goofy to some of my hard-nosed finance readers, but it’s timeless wisdom that really works. Hang in there while I explain.

The happiness of your life depends upon the quality of your thoughts, therefore guard accordingly; and take care that you entertain no notions unsuitable to virtue, and reasonable nature.
Marcus Aurelius Antoninus

To get myself in the correct frame of mind every day, I created a “cheat sheet” that can be read in less than a minute. This cheat sheet serves as a sort of Cliff Notes version of the greatest wisdom on the subject of personal freedom. You can read it each morning and evening to slowly but surely re-train your mind for happiness.

It doesn’t matter what occurs during your day or how many things go wrong. You can still experience happiness. All it takes is the correct frame of mind.

Your daily practice is to read the following brief list of thoughts at least once per day so that you re-focus your mind on personal happiness. After a month of practice, you should notice tangible results. After 90 days of habitual practice, you should have internalized much of the thinking pattern.

Best of all, it costs you nothing. You risk nothing, and nobody can sell you anything. It isn’t even complicated.

From an investment perspective, that’s a no-brainer proposition. It offers huge potential reward yet costs nothing and has no risk. The only price you pay is the work it takes to put into practice with enough persistence to notice the difference.

Remember, your happiness is a state of mind. You don’t have to be rich, and you don’t have to wait until you reach some level of achievement in the future.

You can have happiness right now.

Learn from my mistake. Don’t wait to become rich to figure this stuff out. Financial freedom is important and worthwhile, but the real game is personal freedom and happiness.

That’s what will make the biggest difference in the quality of your life.

Below are some of my favorite thoughts to re-read each day that redirect my brain toward choosing happiness. I emphasized certain quotes to give a quick mini-reminder when I’m in a rush:

Choose Happiness as The Priority for the Day

  • THE DECISION TO BE HAPPY IS ACTUALLY THE DECISION TO STOP BEING UNHAPPY.
  • Most people seek happiness as a by-product of their achievements, actions and other things they do throughout the day. This makes their happiness dependent upon what happens during their day. I can make happiness a direct choice without any dependency.
  • MY HAPPINESS DOES NOT REQUIRE FAVORABLE EVENTS, INTERACTIONS, OR ANY PARTICULAR STIMULUS. I can just choose happiness at any given moment, no matter what’s going on and for absolutely no other reason than to just be happy.
  • Suffering today in an effort to earn greater success and income for tomorrow so that I can relax and feel secure at some future date is insane. I can embrace the adventure that is my work. I do what I can each day without stress but with creativity and joy, and trust the results will be meaningful.
  • I can pursue all my goals from a happy place today. My internal state of being doesn’t depend on external events that I believe will make me happy at some unknown future.
  • There’s no reason to limit happiness to the dessert in life. It can be the whole meal.
  • Happiness is an option and misery is an option. They are both choices you can apply to the same day’s events. Which option do you choose?

Let Go Of Judgments

  • THE SECRET TO HAPPINESS LIES NOT IN THE EVENTS, BUT IN OUR RESPONSE TO THEM.
  • Adopt an accepting attitude to all things and events in life.
  • Try to go the whole day without blaming, shaming or complaining. No negative thoughts.
  • See everyone as being on their own heroic journey through the trials and tribulations of life. We are all doing the best we can with what we know. If others do you wrong, then have compassion for the pain that motivated them to do wrong.
  • Develop a trust that everything in life is somehow for the best and accept that you will never know why or how.
  • Remember this great quote from Byron Katie: “There are three kinds of business in the world: your business, other people’s business, and God’s business.” I think of it this way: unhappiness always occurs when I stray from my business. I have no right being in God’s business because I don’t know the big picture. Anytime I’m in other people’s business, I’m in judgment which makes me unhappy. My business is where my happiness is. Everything else creates unhappiness.
  • WE CANNOT CHOOSE THE EVENTS AROUND US, BUT WE CAN CHOOSE OUR REACTION TO THEM.

Be Present

  • UNHAPPINESS DOES NOT EXIST IN THE PRESENT MOMENT. IT ONLY EXISTS AS A REGRET ABOUT THE PAST OR WORRY TOWARD THE FUTURE.

Be Grateful

  • MY LIFE IS FILLED WITH ENDLESS WONDERS EVERY HOUR OF EVERY DAY. THE ONLY TIME I AM UNHAPPY IS WHEN I TAKE THESE THINGS FOR GRANTED.
  • Gratitude isn’t just about enjoying and appreciating. It’s a bigger idea about living in the blessing and wonder of an experience.
  • Train yourself to become sensitive and appreciative for all the miracles that occur for daily life to simply go on.
  • Notice how much time today is spent on thoughts of gratitude as opposed to thoughts about problems.
  • Happiness doesn’t mean you have more to be grateful for. It means you spend more time being grateful for what you already have.
  • Say or do something to make your gratitude visible and real.
  • Begin and end each day in active gratitude. As you lay down to sleep think of five things from the day to be grateful for. Before you get out of bed in the morning think of five things to be grateful for.
  • Gratitude is simply a choice to become aware of the good things that are already true in any given situation and become consciously thankful for them.

Create Strong Social Connection

  • The risk we associate with authenticity is illusory. The more we nurture our true selves, remove our masks, and allow uncensored expression, the more our relationships and surroundings will support our true selves.
  • Personal authenticity creates inner-outer harmony and greater connection with others.
  • Simplify your life and greet every person and situation with one face.
  • Quality relationships nurture. Quantity distracts.

Live With Contribution

  • Find at least one way each day to make another person happy. It could be as simple as a kind word, a personal acknowledgement, giving anonymously, or allowing someone in a rush to get ahead.
  • SERVE A PURPOSE GREATER THAN YOURSELF.
  • By giving happiness, you experience happiness.

Secret to Happiness Quote 2 Image

My suggestion is to print the points in this article and review the list daily for at least three months. Try to put these thoughts into practice as you go through your day.

This will force the thoughts into your brain so that you live them rather than just intellectualize them. They will become part of your daily existence.

On days when you don’t have enough time or need a quick refresher just scan for the bold and capitalized items on the list. These are the key principles.

Here’s a link to an MS-Word file containing just the checklist. You can print it, edit it, and tinker with it to suit your needs. No opt-in required or other tricks. Just enjoy.

I know this checklist has made a big difference in my life and hopefully it will do the same for you.

Happiness is found in the journey, not the destination. Don’t make the same mistake I did and wait until you achieve financial freedom to realize the importance and value of these ideas. Learn them now and begin enjoying the benefits today while you work toward financial freedom.

Finally, let me know what quotes or sayings you find particularly valuable in your own practice that I failed to include in this list. Add your favorites to the comments section below. There is always room for more wisdom so please share with us.

Here’s to your happiness!

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12 Tips To Build Wealth For Early Retirement http://financialmentor.com/retirement-planning/early-retirement/12tips-early-retirement-planning/13048 http://financialmentor.com/retirement-planning/early-retirement/12tips-early-retirement-planning/13048#comments Wed, 06 Aug 2014 05:23:43 +0000 http://financialmentor.com/?p=13048

How to Retire Early and Wealthy…

Key Ideas

  1. Reveals the only 3 action steps you need to ensure your early retirement goals.
  2. Uncovers the 2 obstacles that derail most early retirements… and how to avoid them.
  3. Shows you how to put your financial security on auto-pilot.

Believe it or not, building wealth for a secure, early retirement is actually very simple…

in theory.

The equation for financial success is a function of just three easy-to-understand principles:

  1. The amount of money you invest.
  2. The growth rate of your money.
  3. The amount of time it has to grow.

Unfortunately, few people succeed in building wealth because it has little to do with understanding simple principles and everything to do with taking effective action. The challenge isn’t in knowledge, but in translating that knowledge into meaningful results.

Why? Building wealth requires you overcome the following two hurdles:

  1. You must translate the wealth building principles into actionable rules that will take you to your goal.
  2. Then, you must actually live according to those rules. 

You probably already know the three principles for compounding and building wealth. Most people do; yet, few people actually live according to them.

To know and not do is to not know at all.

This is critical. Most people fail to succeed financially because the rules are easy to understand but surprisingly hard to live by. Living them is the key… and also the problem.

For that reason, don’t judge the quality of the following twelve tips by whether they “rock your boat” with originality and genius. That’s not the point.

If early retirement planning via smart wealth building is as straightforward as I claim, then this shouldn’t be rocket science. In fact, you probably already know most of what’s in this article.

But before you yawn and click away from the page, you may want to consider whether or not you are living in congruence with each of the following wealth building tips. That’s the key!

You may think you know this stuff already. But if you aren’t talking the talk and walking the walk, then it requires revisiting.

Either you are living in integrity with what is taking you toward wealth and an early retirement, or you aren’t. It’s just that simple.

As you read this article, ask yourself, “Are my daily habits honoring each and every one of these financial truths?” Judging by results will tell you what you really know, and an honest assessment should be a little uncomfortable for most.

Want to succeed with early retirement planning? Use these 12 tips.

 

Early Retirement Tip #1: Have a Plan

The first mistake most people make is they lack a written plan to build financial security.

You can’t put the formula for financial success to work for you without a plan to accomplish it.

It may be a simple process, but it won’t happen randomly. You make it happen by taking action. A written plan with goals provides the road map and is a necessary first step.

Financial success is a choice. It results from the many small decisions you make each and every day. Without a plan and goals to achieve wealth your life is like a sailboat without a rudder: it just spins in circles without definite direction.

Plans and goals provide the necessary context to focus each and every decision in your life with purpose.

Time spent writing goals and building a step-by-step plan to achieve those goals is an investment in your future. It reduces wasted effort, increases efficiency, produces amazing results, and best of all, costs you nothing.

Every research study on goal setting and planning support the same conclusion: it’s a remarkably effective tool.

For example, a 30-year study by Harvard Business School showed how the 3% of participants with written goals produced 10 times the results when compared to the 83% of participants with no clearly defined goals. A 10-fold improvement is a life-changing difference worth planning for.

[how-much-money-do-i-need-to-retire] To get results like that you must create written savings and cash flow goals, and you must formulate a plan complete with specific action steps to achieve those goals. Your plan can use the investment vehicles of paper assets, business, real estate or any combination thereof.

There is no single right answer to wealth building despite what the latest guru of the day is telling you.

Instead, you must formulate a plan specific to your unique interests, skills, resources and abilities. No two people’s plans should be identical since each person’s situation is unique.

You want to formulate your plan based on three separate financial stages during life:

  1. Aggressive accumulation during career
  2. Continued growth of assets during semi-retirement
  3. Spending down accumulated assets during final retirement when all earned income ceases

How you manage your income and assets will vary with each financial stage of life thus requiring a different plan.

The overall objective of your plan is to utilize your career and semi-retired years to build residual income in business, real estate, and/or paper assets so that your passive income exceeds your living expenses. When you reach that point you are infinitely wealthy as long as you continue to grow your income and assets in excess of inflation. You will always feel abundant and never outlive your income.

Achieving this goal may sound nice, but results like this only occur when you build a plan and take the necessary action steps to achieve the result. Are you doing that?

Ensure you are with the following action steps to financial success.

Early Retirement Planning Quote 2 Image

Early Retirement Tip #2: Lifestyle Lags Income

Most people prefer the trappings and illusion of wealth over the freedom of actual wealth. They want to look wealthy rather than be wealthy.

Don’t believe it?

Just look around you and see how many people are in debt compared to how many people are wealthy. Most people choose lifestyle over financial freedom and violate the first principle in the wealth building equation: accumulate assets.

They spend instead.

The problem is you will never become rich by spending money. You must control your spending so that your lifestyle lags behind your income. This will create available capital for your investment activities.

If you know how to spend less than you get, you have the philosopher’s stone.
– Benjamin Franklin

The life cycle of building wealth dictates the most important factor early in your wealth cycle is your rate of savings or asset accumulation. At some point in the wealth building process, you cross a threshold where the return on your assets is more significant than how much you add to them, but that is much later in the equation.

However, in the early stages you must build the assets so that you have something to grow. For most people that starting point is to save money.

Whether you own your business or work as an employee, you must think of each dollar as a little soldier on the battlefield of your wealth. Every time you spend that dollar on consumption instead of investment, the soldier dies.

But when the soldier is invested he produces new soldiers and creates an ever growing army working for your financial security. The bigger your army the greater your financial security.

According to the The Millionaire Next Door by Stanley and Danko, frugality and disciplined savings is the cornerstone of a financial plan. Self-made millionaires share a common value for thrift and discipline with their finances through budgeting, controlling expenses, and saving a portion of their income.

Judging by results, you would be wise to follow their lead.

Consumer debt is the antithesis of wealth and should be avoided. It causes enslavement to the system in the name of false prosperity.

If financial freedom is your objective then your practice must be to earn interest and compound your assets — not pay interest and compound your debt.

The only debt that is acceptable is to buy productive assets. A home mortgage, positive cash flow real estate, and certain business debt all qualify. Debt for consumption does not qualify.

The rule is simple for principle #1 in our wealth building formula: save money and build assets. The sooner you begin and the more you save each month, the sooner you will retire early and wealthy (see How Anyone Can Retire In 10 Years Or Less).

Every day you are making choices between lifestyle now and wealth accumulation for tomorrow. You can either invest those soldiers for freedom tomorrow or slaughter them for goodies today.

This rule is simple to understand, but hard to live. Are you walking the talk?

All men have an equal right to the free development of their faculties; they have an equal right to the impartial protection of the state; but it is not true, it is against all the laws of reason and equity, it is against the eternal nature of things, that the indolent man and the laborious man, the spendthrift and the economist, the imprudent and the wise, should obtain and enjoy an equal amount of goods.
- Victor Cousin

Early Retirement Tip #3: Invest in Your Financial Education

The second principle in wealth accumulation is the rate at which your capital grows.

This is largely a function of your financial intelligence. You must learn before you can earn.

It is possible to profit from any market condition if you know what you are doing (although, admittedly, some market environments are easier than others).

Every investment in your financial intelligence will pay dividends for a lifetime.

I recommend that clients regularly contribute to their financial intelligence by taking courses, reading, and researching so that their financial intelligence grows faster than their wealth.

This is critically important because financial intelligence cannot be developed overnight any more than wealth can be accumulated overnight. It takes time and disciplined effort.

The earlier you learn your lessons, the less they will cost you. You’ll gain experience on smaller investment decisions, where mistakes can be offset by new savings.

The longer you wait to learn these lessons the more they will cost you. That cost comes in the form of years of missed opportunities and mistakes made with big investment decisions later in life that can’t be offset by savings.

There is nothing more financially dangerous than an investor making a million dollars’ worth of decisions with a thousand dollars worth of financial intelligence.

When it comes to investing, a little knowledge can be a dangerous thing, and a lot of knowledge can be a profitable thing. Get a lot of knowledge.

By growing your financial intelligence every day, you are investing in your financial future. Are you living in integrity with this wealth-building principle and regularly learning about investing and personal finance?

Early Retirement Tip #4: Don’t Procrastinate – Start Today

The third variable in the wealth accumulation equation is the amount of time your wealth compounds and grows.

If you wait just six years to get started and your assets grow at 12% annually, you will have half as much money when you retire compared to starting today (assuming equal contributions over your working lifetime).

If you wait just twelve years you will have only a quarter as much.

That’s a life changing difference in net worth for just a little procrastination.  Just getting this one idea into your bones early enough can change your financial future. It’s that important.

The power of compounding is an invaluable wealth-building tool because money grows geometrically instead of arithmetically — but only when you give it time to work.

Procrastination kills time, and as a result it kills more plans for retirement security than all other culprits combined. It is wealth suicide on the installment plan.

Every day you delay is another day where opportunity is thrown away.

Many people procrastinate because they feel uncomfortable and out of place making financial decisions. They feel ignorant or the subject seems dry and complicated with confusing technical jargon.

Get over it!

Nobody is born a financial genius. Everyone has to start somewhere. Just get started and fumble through it. Silly mistakes are better than doing nothing at all.

Every day you wait puts you at a greater disadvantage. The more time that passes before you start, the harder wealth building will be for you.

According to the Schwab Center for Investment Research, workers who begin saving for retirement in their 20’s can safely save between 10-15% of their income and achieve financial security. If you wait until your 30’s the percentage required rises to 15-25%. Ouch!

If you wait until your 40’s the percentage is an astronomical 25-35%. If you’ve reached your 50’s or 60’s and haven’t yet started to save then the only viable strategies for financial security are non-traditional and outside of the normal “save and compound grow” formula. They require leverage, additional risk, and a totally different skill set.

Clearly, the earlier you start the easier the process is to swallow.

The reality is anyone reading this article will have more than enough money pass through their hands during their lifetime to secure the retirement of their dreams, yet few will succeed at the goal.

Are you letting the procrastination monster stop you from retiring early and wealthy? What are you going to do about it?

Early Retirement Planning Quote 1 Image

Intermission

Up to this point we’ve summarized the tried and proven wealth building formula for most self-made millionaires as follows:

  1. Spend less than you earn and save the difference.
  2. Build your financial intelligence while building your wealth so that you can make wiser, more profitable decisions to grow your assets.
  3. Start early because time is the most important factor in compounding wealth.

Notice how it is the opposite of get-rich-quick: it is the slow and steady path to wealth.

Get-rich-quick uses various principles of leverage which increases the risk and lowers the probability of success. It’s faster, but less likely.

The slow-and-steady method requires more discipline and time but the odds for success are extremely high if you actually do what it takes. It’s a proven formula that just plain works.

But only if you work it.

Our character … is an omen of our destiny, and the more integrity we have and keep, the simpler and nobler that destiny is likely to be.
- George Santayana

The way to work the “save and compound” strategy is to begin the process early enough in your career so that you have lots of time. If you get started late you will either have to save an impossibly large portion of your income or apply a leveraged strategy to make up for lost time.

Regardless of the path you choose, your wealth is always a function of the amount of investments multiplied by their rate of growth and the number of years they grow. The math is always the same regardless of the strategy. It’s inviolable.

Unfortunately, as I’ve said before, it is also difficult for most people to live.

That’s why I am including the following 8 tips as a bonus. You only need the first four to succeed, but the next 8 will help you walk the talk and shorten the learning curve by avoiding some of the more obvious and common mistakes.

These extra tips will help you live according to the principles. Remember, it’s no good having a system to build wealth unless you put it to work for you. Get to work by putting these next 8 principles in practice.

Early Retirement Tip #5: Put Your Wealth Building on Auto-Pilot

The easiest, least painful way to save your way to wealth is automatically.

Arrange you finances so that every month certain actions take place that automatically grow your assets without any decisions or extra effort on your part. This creates an enforced discipline to keep you on track.

Below are a few examples:

  1. Own Your Home: Purchasing your personal residence has several advantages. A portion of each monthly payment pays down debt which builds equity, automatically. Assuming you finance with a fixed interest rate, fully amortizing mortgage, you can expect appreciation from inflation over time; yet, you will repay a fixed amount of debt with depreciating currency. Again, that’s automatic. And you can set your mortgage payoff date to coincide with your expected retirement date . Doing so lowers your cash flow needs when you retire.
  2. Rental Real Estate: If owning your own home is a great idea, then owning even more homes where someone else makes the payments for you is an even greater idea. But be careful: make sure the property has a safety margin of positive cash flow and make sure you’re willing to deal with the potential headaches of being a landlord. It isn’t right for everyone, but owning a rental property can be a great automatic wealth building tool for some.
  3. Tax Deferred Retirement Plans: Maximize your contributions to your tax-deferred retirement plans so that the money comes out of your paycheck automatically before you ever see it. This is a relatively pain-free way to save because you seldom miss what you never had. Additionally, if your employer offers a savings match program make sure to save enough to maximize this free money: it is the easiest savings you will ever put away. These savings cost far less than you might think because Uncle Sam gives you a tax break to boot. For example, let’s assume you earn $50,000 per year, and let’s also assume your company offers a 401(k) with 50 cents on the dollar matched savings up to 6% of your salary (a very common formula). If you contributed just $250 per month ($3,000 per year) you would get an additional $1,500 paid by the company – absolutely free. Assuming a combined federal and state tax bracket of 30%, your take home pay would be reduced by a mere $175 per month; yet, you would be receiving $375 per month in benefits… yes, once again, automatically. This is a no-brainer way to build assets.
  4. Automatic Savings Plans: Another disciplined approach to savings that reduces the temptation to spend your entire paycheck is the automatic savings plan. If your tendency is to spend whatever you have then these programs are a must. The money is deducted from your pay before you ever see it, making the whole process of saving a lot less painful. The key principle is the money is saved automatically. The only decision you have to make is to start the process. After that, it is on auto-pilot.
  5. Join An Investment Club: While group decisions are probably not the smartest way to invest, the social support, regular learning, and forced savings will put your wealth building and financial intelligence on auto-pilot.
  6. Subscribe to Educational Investment Newsletters: The internet is a treasure trove of investment education, and much of it is freely available. Newsletter issues come regularly causing you to grow your financial intelligence over time and automatically. Consider the free investment newsletter from this web site as a good example of this strategy.

These are just six ways you can put the growth of your savings and financial intelligence on auto-pilot. Many more exist.

John Lennon said it best when he sang, “life is what happens when you are busy making other plans” (although I doubt he intended it to be used for building wealth for early retirement).

You must make growing your wealth a habitual part of your daily life so that it happens automatically while the rest of your life runs its normal course. You must build your wealth for early retirement while making other plans.

You can either choose to arrange your life so that growing your wealth and financial intelligence is an automatic habit, or you can let time slip away and allow procrastination to win the day.

Early Retirement Tip #6: Take Responsibility for All Your Investment Results

Unless you are a trust fund baby or win the lottery, the way you will become wealthy is by owning full responsibility for every aspect of your wealth.

This causes you to get into action and correct and adjust your plans until you reach your goal. You must build your wealth like an entrepreneur builds a business: “if it’s got to be, then it is up to me.”

You are solely responsible for organizing your life so that wealth accumulation is a habit. Nobody else will do it for you.

You are the one that determines the priority of your spending habits and whether your lifestyle lags your income or not. You are the one who determines whether you start today or procrastinate until tomorrow.

Liberty means responsibility. That is why most men dread it.
- George Bernard Shaw

When you take the right actions with consistency it will get you the desired result. Financial security becomes a question of “when” – not “if.”

Similarly, you are also responsible for the investment growth you create whether you hire an investment advisor or make the investment decisions yourself. You can’t blame Alan Greenspan, your broker, market conditions, bad luck, or anything else.

You made the decisions therefore the results are yours to own. That is how you learn from your mistakes and make better decisions the next time.

Some people feel intimidated by the idea they are fully responsible for their results, but in fact it is an empowering concept. It means that no matter what your results have been to date, you have the power to turn it around beginning right now.

You are in charge. Nobody else is doing it to you, and nobody else will do it for you. You decide what your financial results will be by the actions you take every day.

Your financial bottom line is you make the decisions: you are responsible. You own the results. That is the only way to achieve true financial security.

Early Retirement Tip #7: Commit What Is Necessary to Succeed

Successful retirement planning requires you to provide the necessary resources to reach the goal. Don’t set yourself up for failure by under-committing.

For example, you don’t want to build a retirement plan around owning and managing rental properties unless you want a part time job. Operating real estate requires effort and can be appropriate for some people and not for others depending on your values, interests and skills.

Don’t commit to real estate as your path to wealth unless you are willing to commit to doing the work required to run a real estate portfolio properly. It isn’t a 100% passive investment. It is part business and part investment for as long as you own it.

Similarly, you don’t want to build your retirement plan around passive investing in paper assets if you’re in your late 50’s, have zero assets, and are just getting started. Someone in that situation will require greater leverage and require active investment strategies to make up for the late start.

A passive strategy can be great when time is on your side, and inappropriate when time is in short supply.

If you are relatively young (40’s or less) and plan to save and compound your way to wealth with paper assets, the good news is that it’s a mathematically viable strategy. The bad news is you must set realistic expectations because much of the apparent return on investment from paper assets is eroded by inflation.

You must use realistic assumptions for long-term return expectations for various asset classes. Don’t set yourself up for failure by committing too little savings to your plan and expecting unrealistic return assumptions to bail you out.

In short, you must set yourself up to win by designing your retirement plan consistent with the time, money, and energy required for success, and you must be willing to commit those resources to the process.

Every person’s situation is different and successful retirement planning must reflect that. One size does not fit all.

Is your wealth plan uniquely fitted to you?

Early Retirement Tip #8: Make Your Money Hard to Reach

A pile of savings that is easy and pain-free to reach is an easy solution to life’s troubles.

And that’s a bad thing.

Your car breaks and you use your savings to buy a new one. You get laid off and use your savings to carry you through until the perfect job arrives. Life throws you curve balls, and savings without barriers to protect them are an easy target for solution.

That is why I love the government-sponsored retirement plans with all the difficult rules and penalties you must overcome to access your money prior to retiring. These obstacles provide a measure of discipline for those who inherently lack this life skill.

Even if you have the discipline of a celibate monk, the rules and penalties provide a formidable barrier for your inevitable moments of human weakness.

The rule is simple: when you build a nest egg, don’t raid it. Never borrow money from it for current lifestyle and don’t spend a dime of it until after you retire.

Just let it grow and grow until you are financially free. This is easy to understand but hard to live by.

Self-discipline is that which, next to virtue, truly and essentially raises one man above another.
- Joseph Addison

That is why many smart investors place their retirement money in hard to access investments like real estate or government-sponsored, tax-deferred retirement plans. This reinforces discipline by making the money just difficult enough to reach that you don’t raid your nest egg when those inevitable “emergencies” arrive.

Additionally, hard-to-reach assets like real estate and retirement plans have another huge advantage: tax savings.

Retirement plans allow you to compound your money while deferring or avoiding taxes altogether (depending on the plan and your circumstances), while real estate provides tax savings and deferral through depreciation deductions and 1031 exchanges.

Building wealth for retirement is not just about how much money you make, but about how much money you keep. That is why tax savings is an essential element of your plan.

Conveniently, both real estate and government-sponsored retirement plans offer both tax savings and barriers to access thus reinforcing discipline while enhancing savings.

You would be wise to put these tools to your advantage. Are you?

early retirement image

Early Retirement Tip #9: Risk Management Is Essential

The mathematics of compounding wealth prove that avoiding large losses is equally as important to growing your wealth as pursuing large gains. They are mathematical flip-sides to the same coin.

For that reason, a smart investment strategy manages risk of loss and volatility risk using a variety of tools. These include diversification, careful asset selection, valuation, and a sell discipline to create a defensive investment plan.

While it is essential to practice defensive investing through risk management it does not mean you should avoid risk altogether by hiding out in Treasury Bills or other so-called “safe assets.”

You must have an aggressive, offensive investment strategy to build wealth because your objective is to grow your assets faster than inflation erodes them so that you increase purchasing power. Hiding out in safe investments won’t achieve that goal.

In other words, you must balance both your defensive and offensive investment strategies to pursue gains in excess of inflation without undue risk of loss.

Are you doing that? Do you know how?

Risk management principles apply equally well to your personal finances as they do to your portfolio finances. For example, the rule with insurance is to insure away all risks that you can’t afford to lose.

The alternative is to put a lifetime of hard work, saving, and investing at risk for one mistake, accident, or health problem that causes a loss large enough to financially destroy you … and that is not acceptable.

Types of insurance to consider include homeowners, health, long-term care, automobile, disability, umbrella, and various other insurance products (Don’t worry, I don’t sell insurance. It is just something to consider).

Whether it is your investment portfolio or your personal finances, risk management is an essential principle. You must manage your investments so that you never lose more than is mathematically acceptable, and you must manage your personal financial risk so that you never lose more than you can afford.

Are you managing both of these risks successfully?

Early Retirement Tip #10: Use Your Common Sense

Common sense is the knack of seeing things as they are, and doing things as they ought to be done.
- C.E. Stowe

Investing is really about business. You can avoid most of the speculative manias and frauds that can rob your retirement plan of valuable principal by following this simple rule: the price you pay for any investment must make economic sense consistent with the earning capacity of the underlying business that you invest in.

In other words, valuation matters – it’s a primary risk management tool.

What this means is when the NASDAQ stock index is selling for more than 200 times earnings as it did in 2000 you should not have your capital at risk in that market.

No businessman in his right mind would ever pay 200 times the earnings capacity for a broad cross-section of technology businesses, and you shouldn’t either. It’s bad business because the valuation built into the price is unsupportable.

Similarly, in 2005 when investment real estate in Southern California was selling for prices so high that the rental income couldn’t cover the mortgage payment even when you assumed no delinquency, no vacancy, no expenses, no insurance, no taxes, no maintenance, and the lowest interest rates in the last 40 years, then you have to step back and question the logic. It makes no business sense and is purely a speculative mania (this was first written two years before the eventual price collapse beginning in 2008). [investment-fraud]

Likewise, if an investment offers you above market yields then you should assume there is a very risky reason that they are forced to pay such high rates to attract capital. Always treat above market yields as a warning sign and perform extensive due diligence before committing retirement funds.

Finally, it’s just good business common sense to only pay for investment services that put more money in your pocket than they take out. They must be value-added.

For example, a broker or money manager’s fees can only be justified when his insights and services add more profit than they cost when compared to a passive index investment strategy that could be easily implemented on your own. You need to get what you pay for.

I have helped clients save many hundreds of thousands of dollars in mistakes by applying simple business common sense to their investing to avoid excessive fees, speculative manias, and blatant frauds. Investing must make business sense.

Do the investments in your retirement plan pass the business-common-sense test?

Early Retirement Tip #11: Basic Estate Planning

It is irresponsible to leave a burden for those you leave behind. The fact is you will die with 100% certainty.

No one likes to think about it, but that’s the reality. Another reality? Your loved ones will be distraught over your passing, busy with their own lives, and not interested in cleaning up a messy financial legacy.

Your estate plan covers your financial assets and also helps set a clear legacyGet your affairs in order and make all the decisions about who gets what now. Depending on your particular circumstances this might include:

  • Powers of Attorney
  • Will
  • Living Trust
  • Life insurance
  • …and much more depending on your circumstances and desires

Many people rationalize avoiding estate planning with thoughts like, “who cares about all that stuff; I’ll be dead anyway,” or “it’s not that important.”

I disagree completely. After all, what would happen if you were incapacitated but still living? What are the guidelines for moving you into a nursing home? What are the rules for pulling the plug on life support or administering controversial and expensive medicines during your final hours? How do you want to die?

In short, there is a lot more to estate planning than just dividing up your assets. It affects your life and the life of your loved ones left behind. You should care — a lot.

Make sure to seek competent legal guidance for estate planning that will customize a program to fit your personal situation and needs. Quality and price will vary so seek referrals and interview several attorneys specializing in this field until you find someone you’re comfortable with.

Have you set up your estate plan yet? Is it up to date?

Early Retirement Tip #12: Get A Life

There’s more to retirement planning than just money.

What about relationships? What about your health? What activities engage your interest?

Money is just a lubricant to life, but it’s not life itself.

I have never been a millionaire. But I have enjoyed a crackling fire, a glorious sunset, a walk with a friend and a hug from a child. There are plenty of life’s tiny delights for all of us.
- Jack Anthony

Happy retirees have fulfilling lives with the health and money to enjoy them. Make sure you have plenty to live for when your work no longer fills your days, and make sure you take care of your health so that you have the energy and vitality to pursue whatever brings you joy.

Protect and enhance your health by investing daily in proper nutrition, regular exercise, and preventative health care to reduce the risk of catastrophic illness. Get adequate sleep, avoid anxiety, and counteract the stress you do incur with proper exercise and recreation.

We never realize the value of our health until we lose it.

Also, invest time now in relationships that sustain and nurture you. Build the connections you desire with family, friends, and business associates. Life without them would be empty.

Avoid retiring simply to get away from your current job. It’s far more fulfilling to retire toward a life that excites you than away from a life you dislike.

Remember, money is just the means, not the end. Family, friends, robust health, and motivating interests are the real tools of a fulfilling retirement while money is just the lubricant.

Once you put in place all the financial tips above so that your financial retirement plan is in order then it is time to consider your life plan as well. One without the other is only half the picture. Both are essential to a fulfilling and happy retirement.

In Summary:

Financial planning for early retirement is simple to understand and hard to live. That is why so few succeed at it.

It all boils down to prudent, routine management of your investments and personal finances. It’s not exactly rocket science. The principles aren’t complex.

The only question now is, “are you walking the talk?” You may know most or even all of these principles, but how many are you actually living right now? 

If your score based solely on results is less than you might have liked, then you have just identified one value of financial coaching. Even though you know the “how-tos,” the reality is that incorporating them into a plan of action that actually gets accomplished is another matter entirely.

That is where Financial Mentor can help. We can help you bridge that gap between knowing something and following through with action that gets results. There is more to financial success than just recognizing the essential principles.

Financial coaching can literally make or break a secure and prosperous retirement for you and the people you love.

Let us know how we can help.

Also, please share your thoughts in the comments section below. What other ideas did we miss that you think are important? What did you think about the ideas we shared?

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Retirement Planning Checklist http://financialmentor.com/retirement-planning/retirement-planning-checklist/13014 http://financialmentor.com/retirement-planning/retirement-planning-checklist/13014#comments Fri, 01 Aug 2014 05:00:13 +0000 http://financialmentor.com/?p=13014

How to Plan Your Retirement Whether You’re 20 or 80: Get Started with this Simple Retirement Checklist for Each Stage of Life

Key Ideas

  1. Discover the no-brainer first step everyone must do – starting today!
  2. Find out which advanced strategy is seldom used but amazingly powerful.
  3. Learn why formal retirement planning too early is actually a bad idea.
  4. Uncover the exact action steps required in the years immediately before retirement.


Retirement planning doesn’t have to be complicated.

You don’t need a degree in finance and you don’t have to read a bunch of books to understand the important action steps.

For the bulk of your working years, there are just a few important and very simple actions that need to be done right. The rest can be figured out in the years immediately preceding the day you retire.

That is why we created this retirement planning checklist: to demystify the vagueness around retirement planning, simplify the process where appropriate, and provide a step-by-step guide so that you can do those few important things right at each stage of your life.

The retirement planning checklist is an easy-to-use reference for people who have other things to do besides get a degree in financial planning.

Retirement Planning Checklist in Your 20s: Save Money & Build Assets

You’re out of school and you’ve begun working at your first job. You’re finally on the path to independence after relying on your parents or other adults all your life. The future is in your hands, and so is your financial security.

Let’s face it: at age 25, your priorities don’t include reading books on retirement planning. Yet, if you don’t begin the process of saving for retirement now it will only get harder with each passing year.

You stand at a crossroads. You can choose between good money habits or financial ignorance.

You can take the easy and secure path to financial security by saving from each paycheck… or you can follow the more common path of consumerism and financial mediocrity by putting it off until later.

Which path you choose will largely determine your financial outcome in life.

Admittedly, saving for retirement is easier said than done for most in their twenties because old age seems impossibly far away. Why save for it now?

The Importance of Starting Now

There’s plenty of time so it’s not a priority. Right?

Not really. Every 60 year old that started building their assets later in life wishes they started earlier.

The math is simple, compelling and undeniable. And that’s good news: there is no need to get complicated at this stage.

You don’t have to read investment books, get a masters degree in finance, or build some fancy plan because that would only cause you to put off doing what is important at this stage.

Trying to immerse yourself in complicated materials doesn’t do anything to help you. Instead, it serves as a great excuse to not get started because you feel overwhelmed.

But that’s the only thing to do right now: just get started.

“Sometimes the questions are complicated and the answers are simple.” - Dr. Seuss

How to Begin

One simple action is sufficient. Here’s what you can try to just get started today:

  • Max out your government sponsored, tax-deferred retirement plans. Your employee benefits department, accountant or any mutual fund company can show you how.
  • If your company offers a 401(k) or similar plan, contribute the maximum.
  • Fund either a traditional IRA or Roth IRA to the maximum amount allowed by law. (Self-employed? Try the SEP IRA.)

Put as much money into tax deferred savings as you can. Few things are black-and-white clear in financial planning. If you’re in your 20s or 30s, you’re in luck: you just found one of them. Just do it and get started.

Want Retirement Planning Extra Credit?

For those that are savvy wealth builders, an additional smart strategy at this stage in life is to buy real estate with a fully amortizing, fixed-rate mortgage that can produce income and provide positive cash flow.

Notice the details of that last sentence: positive cash flow, fully amortizing fixed-rate mortgage. These are important details. Don’t gloss over them.

Rather than rent an apartment, buy a starter home or a small apartment building that you can live in now and use as a rental unit later. The fully amortizing loan will be paid off by the time you are ready to retire and you will have inflation-adjusted income you can never outlive.

This is also a very good strategy for people who choose lower paying careers thus making it harder to save large amounts of money in retirement plans. Skilled deal-makers, handymen, and construction workers with specialized talents can also benefit from this investment approach.

These two strategies may sound aggressive, but anyone in their 20s or 30s today must own up to the idea that the Baby Boomers will either bankrupt Social Security or change it beyond recognition.

You can’t depend on Uncle Sam to pay for your retirement. If you are going to retire in style, then it is up to you to make it happen. You’re on your own. Sorry, but that’s reality.

To sum up, here’s all you need to worry about right now:

  1. Max out your tax deferred retirement plan contributions. This is the no-brainer first step that everyone should do. It requires no education or financial experience so you can start immediately. It’s as simple and direct as anything gets in the financial world.
  2. Acquire positive cash flow rental property: This strategy is for more aggressive wealth builders with the skills and inclination to go one step beyond the basics. It’s not necessary and isn’t for everyone, but it has the unique advantage of providing inflation-adjusted income during retirement that you can never outlive.
  3. Oh yeah, and don’t forget to have fun! You’re only young once.

Don’t worry about creating a highly-detailed plan at this stage of life. Complicating your situation will only serve as an excuse for procrastination.

You don’t need to learn about retirement planning or hire a financial planner. Just follow these two simple action steps designed to put you in the asset accumulation mode and never touch the savings that accumulate.

If you keep it simple and get started accumulating assets, you’ll complete all the retirement planning that is necessary at this stage of life.

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Retirement Planning For Mid-Career: Grow Your Assets and Financial Intelligence

Mid-career is defined as the period following your 20’s and 30’s but ends 5-10 years before your retirement.

The length of “mid-career” retirement planning varies widely from person to person: some will retire in their 30’s and others won’t retire until their 70’s. Some will have very long “mid-careers” and others will have very short “mid-careers”.

Your retirement planning objectives for mid-career are twofold:

  1. Grow a nest egg large enough to support retirement.
  2. Grow your financial intelligence to make smarter, more profitable, financial decisions

Your twenties were about getting started building assets. Your mid-career years are about turning up the volume on asset growth and your financial skills. It is the beginning point of real retirement planning but is still too far away from your actual retirement date to benefit from formality and over-planning.

“Our life is frittered away by detail. Simplify, simplify.” –Henry David Thoreau

The reason you don’t want to get into formal retirement planning yet is because too many factors will change between now and when you actually retire. Much of the planning you would do now would just be invalidated by the time you reach actual retirement.

Instead, focus the available resources you do have where they can make a difference. Emphasize your investment skills to grow your assets by developing your financial intelligence. It is a skill that will pay you for a lifetime, and by now your assets should be large enough to justify the time and effort required.

Below are the mid-career action steps that you can add to the savings process you already put in place during your 20s:

  • Build Your Financial Intelligence: Now is the time to begin learning more about investing and personal finance. Read books, listen to audio courses, and study the investment masters. You need to learn what works and what doesn’t with investing so that you can hire smart money managers and make wise investment decisions.The reason this is important is because the return on your assets will be a far greater determinant of your financial security than your savings abilities, and the return on your assets is a function of your investment knowledge and decision making. By contributing to your investment education regularly you are compounding your financial intelligence just like regular contributions to your savings compound your wealth. It is essential to a secure retirement and true financial independence.

“Employ your time in improving yourself by other men’s writing so that you shall come easily by what others have labored hard for.” —Socrates

  • Keep Accurate Records: Another habit to develop in mid-career is good record keeping. You want to run your finances like a business. That’s exactly what it is: a financial management business. Maintain expense records showing how much you spend and where it all goes so that you know how much income you need to retire securely. Keep your investment records efficiently organized and monitor the progress of your assets. Treat your money with the respect it deserves and it will respect you back by sticking around and growing in your accounts.
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  • Create Your First Ballpark Estimate: Make your first attempt at figuring out how much money you will need to retire comfortably. Don’t worry about doing it perfectly because so much will change between now and retirement that perfection and accuracy are impossible at this stage.All you want to do is create a ballpark estimate so that you can get your head around the size of the goal and whether or not you are on track. Determine the low end range of acceptable savings required using optimistic assumptions then determine the high end range using pessimistic assumptions. Reality will likely be somewhere in between. This task is easily completed using our free retirement calculators.
  • Never Raid Your Retirement Accounts: This should go without saying, but just in case there was any vagary – you can never, ever raid your retirement accounts to support current lifestyle. If you lost your job and can’t find a suitable position then take an unsuitable position but don’t use retirement savings as an easy solution. If the car is broken then fix it but don’t buy a new car with your retirement money.Whatever problem you face in life must be solved as if the retirement accounts don’t exist. They will always appear as the easy solution to life’s economic difficulties, but that will only create bigger problems for you in the future and defeat the whole purpose of saving for retirement.The truth is you would find a solution if you didn’t have the retirement plans, so just assume they don’t exist and find that solution anyway. Never raid your retirement accounts – never. Did I say never? Yes, never…ever.
  • Think Long-Term: Your habits will determine your success. Every day you make a choice between consuming today and delaying gratification by saving and investing for consumption tomorrow. You can enjoy a BMW or Lexus today or you can invest that money so that you can enjoy a lifetime of BMW’s and Lexus’s. Similarly, you make a choice every day between the mindless rot of television or growing your financial intelligence with good investment books and seminars on CD or DVD. The habitual way you spend your limited resources of time and money during mid-career will determine your long-term financial success. It’s not how much money you make that determines your financial success, but what you do with what you make. Your habits will determine your success.

Checklist For 5 To 10 Years Before Retirement

Up to this point the retirement planning process has been intentionally oversimplified so that you don’t get distracted by unnecessary information that might divert or delay accomplishing the most important tasks. Your responsibility so far has been to build a solid foundation of good financial habits so that you can grow your assets and grow your financial intelligence.

Now it is time to up the ante because retirement is within sight. You have a limited number of years remaining to adjust for any errors or shortfalls.

“We think in generalities, but we live in detail.” - Alfred North Whitehead

It’s time to take retirement planning seriously and dig into the details. You’re getting close enough that time is running short.

Any critical adjustments must be made now while there is still sufficient time to change course. In order to know what adjustments to make you will have to get more detailed.

Below are some actions steps to consider now that you can see light at the end of the retirement tunnel:

  • Build Your Dream: Grab a favorite bottle of wine, relax with your spouse and share your dreams for retirement. You want to answer the “what, where, and when” questions.Where do you want to live? What do you want to do? When do you want to do it?Answering these questions is essential because they determine “how much” your retirement will cost. You must know the “what”, “where” and “when” of retirement planning to go to the next step and figure out “how much”. Think in stages because the early period of retirement when you are active and traveling will be very different from late stage retirement. Build a vision that both of you are excited to live.For the whole story on how to complete this step please see Five Essential Questions For Pre-Retirement Planning on this site.
  • Create A More Accurate Ballpark Estimate: Once your dream for retirement starts taking shape you can then sharpen your pencil when estimating “how much” assets and income you will need to retire securely. Your dream for retirement determines the cost. Five-star travel is more expensive than camping, and playing golf costs more than playing bridge. Where you live and what you choose to do will determine your financial needs. It is time to tighten up your budget estimate and determine if your assets are on track or lagging behind. With just a few years to go you have precious little time to make adjustments. For the whole story on how to complete this step please see How Much Do I Need To Retire and 27 Retirement Savings Catch-Up Strategies For Late Starters on this site.
  • Consider Paying Down The Mortgage: If your savings is on track and there is still more money than month then consider paying down your mortgage. There are many advantages to living mortgage-free in retirement: not only does it lower your monthly income needs but your home is a uniquely protected asset against certain debts and financial obligations. Many retirees feel more secure and sleep better at night when they own their home free and clear.
  • No More Consumer Debt: Consumer debt including auto loans and credit card debt are a no-no at this stage of the retirement planning game. Debt is antithetical to wealth building and financial security. You should only spend what you can afford because retirees need to earn interest – not pay it. Eliminate debt and learn to live within your means now before it is too late.
  • Take Care Of Your Health: There’s not a lot of value in spending your working years building a robust nest egg only to die of a heart attack before you get to enjoy it. As youth fades, your body becomes less tolerant of poor health habits. It may be a cliché but now is the time to build the habit of exercising and eating right so that you can add more years to your life and more life to your years. Get regular checkups and screenings so that any problems can get caught early enough to do something about them. Take care of your health now so that you can live a long, full retirement.
  • Encourage Independence For Dependents: You may be at a tough stage in life where aging parents need help and adult children are just getting started. When you get squeezed at both ends like this it is hard to take care of your own retirement planning needs at the same time. If your kids are out of school and not disabled, encourage their independence. Empower instead of enable. It is important to respect your financial needs as much as everyone else’s.
  • Review Your Insurance Coverage: Life insurance that was appropriate when your savings and kids were both small may be a wasteful expense now. Alternatively, it may be appropriate to raise the liability limits on your home and auto insurance policies and consider an umbrella policy as your assets grow. You should also understand long-term care insurance and how it fits into your overall financial plan. You’re entering a different phase of life and your insurance needs should change to mirror life’s changes.
  • Get Defined Benefit Plan Estimates: Contact Social Security and your company’s human resource department to get a benefits estimate based on possible retirement dates. How are your benefits affected by your expected retirement age? Are any special severance packages being offered? What career changes can increase or decrease benefits? What about health care insurance? Learn the arcane rules and intricacies for both the public and private pension systems so that you can plot a strategy to maximize the benefits you will receive. This knowledge can make a significant difference.
  • Get Health Insurance Estimates: It’s time to determine what Medicare supplemental insurance will cost and get estimates for self-insuring the time period between when you retire and when you qualify for Medicare. Fidelity Investments estimates that a couple retiring at age 65 with no employer health coverage will need close to $200,000 just to fund out of pocket medical expenses in retirement. These numbers are significant and must be built into your budget.
  • Get A Second And Third Opinion: Get referrals for at least two fee-only financial planners who specialize in retirement planning. Have them look over your portfolio, budget, and investment allocations and provide additional opinions. You want to make sure you haven’t overlooked something important or completely misjudged the situation. Fee-only financial planners can help you sort out some of the more technical questions like taking Social Security early or waiting until later for bigger benefits. Should you take a lump-sum retirement plan distribution or monthly payments? What is the best order of liquidating assets to support spending in retirement? What is their recommended asset allocation and investment structure?

These questions are complicated and vary with individual circumstances. The fee charged for the personal advice is cheap insurance for the value provided by having an educated, second set of eyes look over your retirement plan. Just don’t let them sell you any investments or insurance. You want impartial advice – not a sales pitch.

[dont-hire-a-financial-coach] I would be remiss if I didn’t mention that a retirement planning coach such as myself can be very valuable as well. See our page contrasting financial advice with financial coaching do decide which is best for you.

If you and your hired experts agree that you are on track for a secure retirement then congratulations: you are a retirement planning genius. On the other hand, if it looks like you are lagging behind then now is the time to do something about it. (Again, you can check out 27 Retirement Savings Catch-Up Strategies For Late Starters to learn how to correct the problem.)

Also, because this stage of retirement planning is about detail it is important to understand the limits to what can realistically be accomplished here.

The scientific appearance of the retirement planning process paints a deceptively detailed picture about what is essentially an artistic and inherently imprecise process. Don’t be deceived by the mathematical precision of it all. Retirement planning deals with the vagaries of life – not the precision of science.

For these reasons it is wise to use a range of assumptions from pessimistic to optimistic to determine how secure your retirement plan is.

Try inflation at 7% rather than the customary 3% and watch the impact. Throw a bear market, cancer, and Parkinson’s disease at your plan and see how it holds up.

Ultimately, no retirement plan is ever complete no matter how accurate it appears today. This is just the unfortunate reality of making a long-term bet on an unknowable and unpredictable future. Do the best you can and build a safety cushion just in case one of your assumptions proves to be too optimistic.

The problem with retirement planning is the necessity of making a bet on an unknowable future. You must make assumptions about the future to build your plan, but the assumptions could be wrong. Inflation might be higher than expected, you might live longer than expected, or your assets might grow slower than expected.

Worst of all, you could experience catastrophic and expensive health problems. Each of these risk factors is potentially large enough to undermine the best planned retirements.

This may not be a pleasant or comforting way to approach retirement planning, but reality is reality whether we like it or not.

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Checklist For 1 To 3 Years Before Retirement

Up to this point you have been progressively adding more and more detail to your retirement plan.

You began in early career with simple asset accumulation strategies then added growing your financial intelligence to the picture during mid-career. In recent years you formalized the process with more concrete retirement plans. At this stage your retirement plan should be fairly complete.

If it is not, then please review the previous sections of this article for any missing pieces.

Using a home building analogy you have laid the foundation, raised the walls, and capped it off with a roof. The structure should be more or less complete so the only tasks remaining at this stage are to paint and decorate as a final preparation for moving in.

In other words, with just a couple of years to go it is time to put the finishing touches on your retirement plan.

  • Color in The Dream: By now the “when”, “where”, “what” and “how much” of your retirement plan should be very detailed. Your budget should be based on real numbers rather than generalized assumptions. Your future lifestyle should be estimated, and your expected income from investments and retirement plan benefits should be known. If you don’t have these in place then there is no time like the present. Retirement is right around the corner.
  • Test Drive the Dream: If you are thinking of spending your retirement in Panama then schedule your next few vacations for different times of year in different locations throughout the country. Also, brush up on your Spanish lessons and begin building your network so that you are ready to go. Similarly, if you plan on retiring at home with only 50% of your current income try living on that budget now while you still have earned income to bail you out if it proves unworkable. Or if you plan on building a second career then begin laying the groundwork. In short, start test driving your dream today so that you can correct and adjust any incomplete plans and move toward your new future with confidence. Getting started now will smooth the transition.
  • Review Social Security and Pension Benefits: Rules can change and data can be entered incorrectly. Go through your benefits statements with a fine tooth comb to check for errors and correct as necessary. Make sure the benefits you were expecting to receive match the current rules.
  • Long-term Care Insurance: Examine the risks and benefits of long-term care insurance so that you can make an informed decision. Get cost estimates and learn the various alternatives when purchasing this insurance product.
  • Financial Planning: Are you going to take a lump sum payout or monthly payments? Are you going to leave your 401(k)s where they are or roll them over into an individual retirement account? Are you going to take Social Security as early as possible or delay for a bigger monthly benefit? What is your investment strategy? What will be your asset allocation during retirement? Are you going to purchase fixed annuities or accept the risks of fluctuating investments in hope of a higher return? You are entering the window where these decisions must be made. It is time to begin finalizing these plans. A fee-only financial planner and a retirement planning coach can help.

Checklist For Less Than 12 Months To Retirement

You’re in the home stretch now. You should be complete on everything listed in this article up to this point.

The golf clubs are dusted off and you can almost taste that fancy drink with the little pink umbrella in it.

But don’t make the mistake of celebrating too early because you still have a few important details to tend to. Below are some final actions steps:

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  • Get Organized: If you are like most people you have retirement accounts and savings scattered in various places. Find a service where you can consolidate your accounts and view them as just one source. Automate as many of your financial transactions as possible including routine bill paying and monthly deposits so that you have the flexibility to run your financial affairs on the road or in a foreign country. You want to simplify so that you are free during retirement to do as you please without being bogged down by disorganized financial problems.
  • File for Defined Benefits: If you will be filing for pension and Social Security benefits get the paperwork prepared and finalize any last minute questions. Plan on Social Security and Medicare requiring a three month lead time to process so don’t wait until the last minute or you could be throwing away some benefits. Consider requesting direct deposit to reduce your paperwork while also eliminating delays in processing checks while away from home traveling.
  • Finalize Your Withdrawal Strategy: When the time comes to replace your paycheck by withdrawing assets, where will the money come from? How much income will you need each month? What are your sources of income? If you are liquidating savings to fund current living expenses what accounts will you liquidate first and why? You want to have the answers to these questions before your paycheck ends.
  • Finalize Health Insurance Coverage: Get up to date quotes for any supplemental coverage to Medicare or transitional coverage until Medicare kicks in. Complete and file the applications once you have decided the plan that best fits your needs.
  • Finalize Your Long-Term Care Insurance Strategy: Learn the facts about long-term care insurance and decide if and when it is appropriate for your retirement plan.
  • Complete Any Rollovers: Rolling over a workplace retirement plan to an individual retirement account can take anywhere from several weeks to a couple of months. If you are relying on that money you will have to begin the process well in advance of when you need to make your first withdrawal.
  • Give Notice to Your Employer: Find out from your employer what is required to begin receiving the benefits your have earned and to end employment. Most employers appreciate receiving more than two weeks notice. Determine the timelines and complete the required paperwork.

A Checklist For After Retirement

Congratulations! You did it. You are now retired and hopefully living the fulfilling life you always dreamed was possible.

But even though you are now retired, it doesn’t mean retirement planning is finished. There are still a few financial matters requiring your ongoing attention beyond just deposit and spend. Think of these actions as your long-term maintenance plan.

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  • Annual Budget, Asset and Cash Flow Review: Just because you put a retirement plan in motion doesn’t mean it necessarily worked according to plan. Sometimes your finances do better than planned and sometimes they do worse. For that reason, you must review your assets, budget and cash flow each year so that you can correct and adjust. This includes reallocating assets, reviewing investment performance, adjusting withdrawal rates, and anything else necessary to make sure your money lives as long as you do.
  • Healthy Habits: Multiple studies show the human body has a remarkable ability to recover from a lifetime of abuse with just a few short years of healthy habits. Now is the time. You may have used the excuse of being too busy working and raising kids to rationalize not preparing healthy food and exercising regularly, but you don’t have that excuse any more. It is hard to imagine a more important and worthwhile way to spend your new-found extra time than taking care of your health. After all, what is the point in spending a lifetime building a secure retirement only to die early and never enjoy it all?
  • Don’t Forget Required Minimum Distributions: Traditional IRAs require minimum distributions beginning at age 70 ½. Check with your accountant or financial advisor as the rules may change and exact details may vary depending on your situation.
  • Beware of Fraud: Retirees are unfortunately a favorite target for con-artists because they usually have more assets to be conned out of than the average citizen. See our extensive list of articles on How To Avoid Becoming A Victim of Investment Fraud to assure you aren’t next in line.
  • Update Your Estate Plan Periodically: Check with your attorney to make sure your estate plan includes such items as powers of attorney, gifting, account titling, and all beneficiary designations are accurate and current.

Finally, go out and enjoy yourself. You’ve earned it. Live all those forgotten dreams that got buried in the busy-ness of working life and have a great time doing it.

It is time to live your dream retirement. You deserve it.

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