After reviewing this post a year after writing it, I realized two things: (1) it is the most popular post on my site and (2) it was too long. I’ve updated and split this post into a three-part series. Here in Part 1 we cover four principles to avoid wealth-destruction, in Part 2 we discuss how to make more money, and in Part 3 we talk about why a philosophy of zero debt makes sense.
At 29 years old, I bought a 10,000 square foot mansion for $3.1 million dollars.
Six months later, I wanted to sell it. (Two and half years later, we finally sold it.)
We had this amazing house with two pools, a gym, and a movie theater only 15 minutes from downtown Austin.
But, I wasn’t any happier. The house cost $20,000 per month including the mortgage, interest, pool maintenance, “landscaping team” (you can’t just get the lawn mowed on a 10,000 square foot house apparently), and never-ending repairs of our seven air conditioning units.
(We did have incredible pool parties though.)
What we think will make us happier often doesn’t (like buying a huge house). But, the financial consequences can be massive.
Here are four principles to avoid destroying the wealth you build I’ve learned by making A LOT of bad financial decisions:
Don’t Buy Bitcoin or GameStop Stock
Most of the time when broke people say they’re “investing” they’re actually gambling.
Recently, GameStop’s stock shot up from around $10-$20 per share to $325. (January 25th, 2022 update: It’s now at about $99.)
Millions of people received stimulus checks due to the COVID-19 pandemic, had access to easy trading platforms like Robinhood, and jumped the bandwagon with other gamblers reading online trading forums.
I read about one low-paid service industry worker who took out a $20,000 loan to buy GameStop at $234 only to see 80% of the value wiped out within a few weeks. Now he’s stuck paying the $300 per month payments on that loan out of his low-paying day job’s wages.
To me, Bitcoin speculation is no different. People with zero knowledge of financial management or investing buy Bitcoin and lose their small life savings during inevitable price swings.
What’s going to happen with GameStop or Bitcoin prices in the future? I have no clue.
I do know that 99.9% of us shouldn’t touch either unless we know, for sure, based on past investing history, we have the right temperament to ride out the volatility.
This likely means we’re already worth at least a few million dollars and our speculation in those assets are less than 10% of our total net worth. (My preference is 0%.)
We’d still be gambling, but at least doing so with less risk.
Don’t Invest in Real Estate
Real estate is a bad idea for most people, but for a different reason.
Proponents of real estate investing love to talk about the cash flow benefits.
“It’s mailbox money! You get real cash coming your way every month!”
This is sometimes true.
If we buy a property in which the cost to pay for the mortgage principal, mortgage interest, property taxes, and maintenance costs are less than what we receive in rent, we can receive positive cash flow.
There are also special tax advantages to real estate such as the depreciation deduction which can further improve our financial returns.
We also own a property with the potential for price appreciation.
On the other hand, the most irrational argument in my opinion is it’s a “real” asset you can “see, touch, and feel”. This implies that owning a share of a company such as Amazon is less real, even though we can (and do) touch, feel, and see the Amazon packages arriving at our doorsteps every day…
After we factor in the costs, time, and hassle of maintaining investment properties, the returns of real estate don’t seem so great. Maybe we earn a few hundred dollars a month on a highly leveraged property (see the section on zero debt below). Or, if we pay cash to avoid debt, we’re lucky to earn 10% on a highly concentrated investment (not worth it to me).
Typical real estate investing also offers little diversification. If our total net worth is $1,000,000 and we buy three investment properties in our hometown, which is exactly what I did early on, our entire net worth is tied up in one asset type, one city, one state, and one market.
If the city experiences a downswing, schools are rezoned making our property less valuable (like what happened to our multi-million dollar home), or something else, we can experience a significant, permanent reduction in the value of those investments.
We also have to deal with renters, homeowner’s associations, and a physical structure that breaks down over time.
This is why almost every personal finance real estate proponent eventually sells their investment properties to “simplify” their lives.
The biggest reason I don’t like real estate investing is the lack of liquidity. If I want out of the investment, I have to get rid of the renters (hard to do), hire a real estate agent to sell the house (expensive), list the house for sale (time-consuming), and sell the house, paying all the associated costs (also expensive).
Unless we want to build a real estate investing business and spend a significant amount of our time managing it like a real business, then I say we avoid investing in real estate.
Use the 4% Rule
There’s a concept in personal finance popularized years ago called the 4% rule. If you spend an amount equal to less than 4% of your investments in a 50/50 stock/bond portfolio annually, you can likely live off that fixed pool of money for a long time (30+ years, if not indefinitely).
For example, if you have a million dollars saved, half in stocks, half in Treasury bonds, as long as you don’t spend more than $40,000 per year (4%) you never have to make another dime for likely the rest of your life.
While the details are debated, the message is clear: If you save enough money and live off a conservative amount relative to your savings, you can be financially free for life.
Warren Buffet advocates a 90% stock, 10% short-term government bonds portfolio for people who aren’t full-time investors (nearly all of us).
Almost anyone trying to convince us of something wildly different is likely trying to sell us something.
My personal belief is to make my investments as stable as possible because my income (small business ownership) is already “exciting” (aka, risky). So I invest a significant portion of my savings into S&P 500 index funds such as Vanguard’s VOO and VFIAX.
Recently, however, I’ve read about 5,000 pages on value investing including the top twenty books or so Warren Buffett has recommended on the subject. Because of this study, I’ve started investing in a few cash-producing companies I’ve calculated to be selling at least 30-40% below their intrinsic value (“margin of safety”). (I wouldn’t recommend investing in individual stocks unless you’ve done the same reading on value investing and have run your own intrinsic value calculations. There’s still a big chance I might be wrong and will just go back to index fund investing in a couple years.)
There is one caveat to investing in index funds and even attempting to buy undervalued stocks…
Don’t Try to Time the Stock Market (You’ll Lose)
Nobody knows what’s going to happen to the stock market tomorrow, next week, next month, or next year. The long-term trend is up, but there have been periods of ten or more years with little overall progress and lots of down periods.
Most people lose money trying to time the stock market. It’s next to impossible to pick the highest point to sell or the lowest point to buy. This means, inevitably, we will buy at a price in which we’ll experience significant downturns.
If we buy an index fund, we’re doing so knowing the positive, consistent long-term returns. If we buy an undervalued company, we are (hopefully) confident we’re buying a dollar for 60 cents. In either case, eventually the value of our assets should rise. We just don’t know when or how bumpy the ride will be along the way.
Whatever we do, if we have our money in basic index funds or good companies with 10+ years of good track records, we MUST leave our money invested regardless of what the market does.
If the stock market tanks by 30%, don’t do anything.
If your friend doubles her money on a high-flying speculative stock, don’t touch it. Stick with the plan.
In the long-term, everything will work out OK. In the short-term, we can permanently wipe out a significant portion of our life savings with the click of a button.
“But, I Don’t Want to Wait 40 Years to Be Wealthy!” Neither Did I.
If you don’t make a lot of money now (at least multiple six-figures), it will take decades to build significant wealth to increase your lifestyle freedom.
Some people live off 20-40% of their income, build a nest egg of $1-2 million dollars, and retire.
That wasn’t my path.
No way was I going to wait decades to become a millionaire, travel first class, go on nice vacations, and buy the stuff I thought would make me happier.
So what do we do? We need to figure out how to make more money now.