Many people believe that accumulating wealth is a random event or that pure luck determines who is wealthy and who isn’t.
In order to build wealth you must follow certain rules. In order to keep wealth you must follow those same rules. If you never learn the rules or don’t have the discipline to follow them, you will never build or sustain wealth.
“The most powerful force in the universe is compound interest.” — Albert Einstein
For compound interest to be truly powerful, it must have the benefit of time. The more time the better. Think of it like a snowball rolling down a hill. It starts out small and then gets bigger and bigger the longer it rolls.
For example, compare two investors who each put away $2,000 a year and earn 10% annually. The first investor starts at age 19 and puts away $2,000 per year for eight years in a row and then holds it there. The second investor waits eight years before investing $2,000 per year for 38 years. At the end of the 38 years, the first investor’s account will have grown to $941,054. The second investor’s account will be at $800,896. The first investor invested $60,000 less but ended up with $140,158 more.
The other factor affecting compound interest is the rate of return. Everyone knows that a higher rate is better than a lower one. What most people don’t realize is that the benefit is exponential. A 15 percent rate of return is not merely three times more than a 5 percent rate of return. It can actually be anywhere from seven times to 70 times more depending on how long you invest. Small increases in rates of return make enormous differences over time.
There are always plenty of reasons not to save. In your youth, you don’t believe you will ever reach retirement. Between the ages of 20 and 60, with kids, a house, cars, college, taxes, etc., there is never an ideal time to start saving.
Saving requires discipline. You must “pay yourself first” by putting aside at least 10 percent of your income. After paying yourself then pay the rest of your bills. The sooner you implement this habit the sooner you will see your savings begin to grow. Otherwise it will become one of those great ideas that never turn into reality. Start now! Don’t just think about it. There will never be a good time to start. The sooner you start, the greater the effect of compound interest.
“Too many of us are spending money we haven’t earned to buy things we don’t need to impress people we don’t like.” — Unkown
“Spend less than you earn” seems like obvious advice, but it is often ignored. According to an article in Smart Money, Americans collectively spend more than they earned after taxes the past two years in a row. This bad habit afflicts people at all income levels–those with less may feel as if the extra expenses are a necessary evil, while those with more may assume their high income protects them from any future financial trouble. This mentality must be changed in order to build wealth.
I’ve known individuals who earn $40,000 a year but have the discipline to save $5,000 for the future. Although it may seem like a small annual amount, that money, over time, adds up to future wealth and security. In contrast, I have met others who earn $200,000 a year and spend $220,000. This lack of discipline is a quick way to become broke, even if you have a very good income.
Often, people assume that if you drive an expensive car or live in a luxurious neighborhood, you must be doing well financially. From my experience, this assumption is only accurate about half the time. The rest of the time people are living beyond their means. They have no savings and their net worth is actually negative. This group spends money faster than they earn it. They appear to be successful but eventually crash financially and are forced into reality.
On the extreme side, I know people who earn over $4,000,000 a year but still regularly spend more. Over the years they have destroyed their net worth. This makes the point that a successful savings plan isn’t the result of earnings more money. The critical element is having the discipline to spend less than you earn, regardless of how much you make.
“You wouldn’t consult an electrician about heart surgery, a dentist to do your taxes, or a plumber for legal advice. Since the investment decisions you make today critically affect your future, wouldn’t it make sense to work with an experienced investment specialist?” — Dave Young>
For some reason, it has always been easier to lose money than it is to make it and keep it. According to the Utah Division of Securities, during 2007 alone, they filed enforcement action on 63 cases. Within those cases, 727 investors lost over $77 million dollars.
Managing your own investments can be done successfully, but it is not easy. First, it requires a time commitment to research and track your investments. Second, it requires a time commitment to research and track your investments. Second, it requires discipline to stick with your strategy through challenging times. Third, and most difficult, it requires you to remove emotion from your investment process.
Most successful people recognize the need for a relationship with an accountant and a lawyer. Many have not yet discovered the benefits of working with a financial adviser. Based on the variety of investment options and the myriad of people that call themselves financial advisers, it is easy to understand why. Often figuring out who to work with is so confusing that people give up and opt to manage their money themselves.
Studies have shown that most investors would be better off with the help of a financial adviser. Unfortunately, finding the “right” adviser is much more difficult than most people realize. Most investors hire someone they “trust.” However, “trust” is very intangible and difficult to quantify. Also, contrary to popular belief, the size of the firm or familiarity of the brand name does not indicate the quality of the advice provided.
Part of the problem is that titles for financial sales reps are completely unregulated. This means that brokers, annuity salesman and insurance agents are all free to call themselves advisers, financial consultants, financial planners or whatever else they prefer.
To make sure you don’t get stuck with a salesperson when you are really looking for an adviser, make sure you ask these five questions:
As I mentioned at the beginning, it has always been easier to lose money than it is to make money. Implementing these tips will help you keep your money and find a great adviser.
“Creditors have better memories than debtors.” — Benjamin Franklin
Debt can be useful if used properly. A few years ago I went to Africa. While I was there I noticed half-built buildings everywhere. Projects were at different levels of completion and then abandoned. When I asked my guide why the structures were half finished, he told me they do not have a banking system. There is no way for the common man to borrow money there. People can only complete part of the building because they lack the funds to pay for building supplies right away. They build what they can pay for now, and then come back and build more next year when they have more money.
If debt is used sparingly, for assets that appreciate or allow you to make more money, it makes sense to take out a loan. For example, a house, a car, or an education all make sense.
Using debts for consumables or things that go down in value does not make sense. Impulse buying or buying on emotion are recipes for financial disaster. Before you make any major purchase, it is important to decide whether it is a “need” or a “want”. It is amazing how few purchases actually fall into the “need” category. If it is a “want” than a conscious decision should be made as to whether or not you can afford it. Generally, there is no reason to go into debt for “wants”.
For example, most credit card debt is for things that hurt rather than help your financial situation. My definition of a credit card is, “A means of buying something unneeded, at a price you can’t afford, with funds you don’t have.”
Set a goal to live debt free. Put a plan in place to reduce and then eliminate your debts. With 1.5 billion credit cards in circulation, an average household credit card balance of $8,562 and an average interest rate of 19%, it’s no wonder that so many households file for bankruptcy.
Accumulating debt is the exact opposite of accumulating wealth. If you are paying debts, you are hurting yourself and helping someone else accumulate wealth. With the few exceptions mentioned above, avoid debt like the plague.
“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” – Warren Buffet
In my business, I am constantly presented with investment opportunities. For every 20 proposals I see, I may invest in one. Even with complete due diligence, some of the investments are still losers. From my experience, there are 10 ways to lose money for each way there is to make it.
It’s not uncommon for money to come in large lump sums—in the form of a retirement plan distribution, an inheritance or a life insurance settlement. People are expected to manage these large chunks of cash wisely, but there is no real training available on how to manage or invest large sums of money.
To make matters worse, most people simply don’t have the time, resources, expertise or desire to manage their assets. There are plenty of incompetent advisers or relatives requesting loans or scam artists ready to step in and take advantage. It’s no surprise, then, that most recipients of life insurance settlements in the United States completely lose their money within three years.
Some investment losses are unavoidable. They come with the territory. The key is to minimize large losses that can quickly reverse the benefits of compound interest. Even though it can be time consuming, you should research thoroughly before turning over your money to someone else. This will increase your odds of avoiding investment scams and subpar money managers.
For example, if you lose 25% of your account, you need to make 33% to get back to even, which is workable. If you lose 50% of your portfolio, you have to make 100% to get back to even, obviously a much more difficult task. A loss of 90% of your portfolio requires a gain of 900% to get back to even. Forget about it. A much better scenario is to follow a sound investment strategy that seeks to avoid those big, dramatic losses in the first place.
“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” – Sir John
Research has shown that most investors do not follow a strategy. In other words, they do not have a disciplined, systematic process they follow to make investment decisions. Their portfolio of investments often represents a patchwork of uncorrelated ideas that were sold to them by various salesmen over their lifetime.
There are two steps to follow when making a long-term strategy:
Properly select your risk tolerance.
Decide in advance how much risk or volatility you can subject your account to. For some investors this means taking no risk at all and being willing to accept low returns in exchange for zero volatility. For others, it means an attempt to generate returns in excess of 20 percent and be willing to endure the necessary roller coaster ride to get them there. Most investors end up somewhere in between these two extremes.
Identifying your risk tolerance is the single most important step to achieving long- term investment success. If it is set too low, you won’t generate the returns you should. If it is set too high, should market conditions become difficult, you will likely change strategies at just the wrong time and miss out on superior long-term returns.
Follow a proven investment strategy that doesn’t simply involve “gut feelings.”
Emotional investing is a recipe for failure. Investing is very difficult because it is counter-intuitive. Usually, doing what “feels good”, doesn’t work. This is why you must have a systematic investment process and follow it.
There are many investment strategies you can follow. The important thing is that you pick one and follow it. Even following a bad strategy is better than having no strategy at all.
For example, our investment discipline at Paragon is designed to remove emotion from the investment process. The market usually does the opposite of what most investors hope, think or feel it should do. My experience has been that once you begin to “hope” an investment will move in your favor, you are usually in trouble.
One of the models we use tracks investor sentiment. This model measures what percentage of investors are optimistic versus pessimistic at any point in time. Interestingly, when most investors are optimistic and think the market will go up, it goes down. Likewise, when most investors think the market will go down, it goes up. We measure this statistically and the model is extremely accurate. This helps us increase or decrease our investment exposure when needed.
Our strategies are driven by quantitative models that seek to proactively position our accounts for the most benefit in ever-changing market environments. For over 20 years, we have developed and relied on rigid models to point us to the areas of the market to invest in. Our portfolios are constantly adjusted as market conditions change.
Our various models measure an array of fundamental and technical data that constantly compare what is happening in the market today to what has happened historically. Following these systems and processes does not guarantee that we will always be positioned perfectly. Historically, we are wrong 20 to 30 percent of the time. Even still, following this methodology has enabled us to significantly reduce risk and generate excess returns for our clients. (Visit our website for more information www.paragonwealth.com.)
Review and compare your current investment strategy to make sure that it incorporates the following time tested criteria:
• Works over different time frames
• Provides effective rather than traditional diversification • Works in both bull and bear markets
• Is disciplined yet flexible and evolving
• Reduces risk and provide downside protection
• Generates better returns than traditional stock indexes • Has a proven long-term track record
“A man watches his pear tree day after day, impatient for the ripening of the fruit. Let him attempt to force the process, and he may spoil both the fruit and the tree. But let him patiently wait, and the ripe fruit at length falls into his lap.” –Abraham Lincoln
It has been said that patience is the greatest virtue. We live in a world where it seems that patience has been forgotten. In our “instant everything” world people want it all, and they want it now. They don’t think in terms of paying the price or investing for the long-term. They act on a whim rather than follow a long-term plan.
Mountain View High School in Utah has a very successful track team with several runners nationally ranked. I asked their coach why his runners are so successful. I thought he would tell me strategies that help make his athletes stronger and faster. Instead, he shared with me his secret that was completely different than I expected. He said that much of their success comes from learning to pace themselves. They must have the patience to wait for the perfect time to make their final move to win the race. Counter intuitively, even in running, a sport that is built around speed, exercising patience is critical to success.
Every autumn I spend some of my spare time hunting for big game animals. I focus my efforts on finding animals that have “record book” potential. In order to locate them I backpack into places rarely traveled. Often I come back empty handed. In my quest to find trophies I have traveled to some very dangerous parts of the world. In order to succeed I often hunt differently than traditional hunters. While there are several factors that contribute to my success, I believe that extreme patience has been the most significant.
Patience is also a key attribute for successful investors, but it can only work if you adopt the kind of smart investment strategy we previously discussed. Without the right strategy, all the patience in the world is essentially worthless. As soon as you put a solid strategy in place, it’s all about patience, self-control, patience and of course more patience.
This is one of the most difficult steps for investors, and it’s something we constantly reinforce with our clients. Patience goes against human nature, and a lack of patience has ruined many sound investment plans.
We are constantly positioning our funds to take advantage of whatever the markets will give us. We never know in advance when we are going to be rewarded. Sometimes, we spend months waiting. Following this process in the past has yielded tremendous rewards.
The portfolios we manage at Paragon have tested our patience during periods of underperformance. By exercising patience and staying invested, our conservative portfolio has met its objectives since its inception in 2001. Paragon’s growth portfolio has also generated outstanding returns and met its performance objectives since its inception in 1998.
Our clients who exercised patience during periods when our portfolios’ returns went flat or negative still received outstanding returns over time. The market does its best to make investors give up at the worst possible time. For example, when you review our track record you see that our best returns almost always follow the years we have lackluster performance. Unfortunately, the investors who did not exercise patience and stay invested during the rough times missed out on those returns, even though the overall strategy was solid. As you can see, patience keeps you focused on the big picture and is critical to long-term investment success.
These seven rules apply whether you have a large or small amount of money. Building wealth is possible—if you follow the rules.
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