It seems that each day we get to read comments from political leaders — whether Obama in the US, or Zapatero in Spain — arguing for increased taxes on those who have earned or saved more, with justification that it’s “fair”; that this segment of society should do more to help those in need.
Moral issues aside, the problem is that the reality is far less straightforward than one segment of society helping another.
How to best organize a society is certainly an area in which I’m hardly qualified to offer opinions. That said, having studied economics for a couple of years, what I’ve heard that makes most sense to me are the free-market, small government ideas of Milton Friedman. For that reason, I tend to gravitate towards conservative political candidates like Ron Paul.
The thing that most bothers me about the conservatives, however, is that they seem to assume their “market” is composed of uneducated dimwits, and as such, the best communications strategy is to speak to them as simpletons attending a Saturday-night Baptist revival.
The Big Short, by Michael Lewis, is an amazing book about the banking crisis of 2008. Having watched the events unfold over the course of about a year, and not really understanding everything involved, the tragedy of situation wasn’t quite as impressive to me at the time, as it is having read Lewis’ concise, clear and compressed explanation of it.
While I’d encourage everyone interested to read the book, I’m going to try to summarize the story here.
According to Milton Friedman, the problem with socialism isn’t its intentions; the notions of government helping those in need, and protecting the disadvantaged are honorable. The problem is that when implemented, public funds inevitably end up in the wrong hands, and far more people exploit protection than benefit from it.
Although people often state financial independence as a personal goal, few with whom I’ve spoken can articulate what that means. (And even fewer know precisely how to get there.) It’s a lot easier to work towards an objective, when that objective is precisely defined.
For me, financial independence would require having an invested amount of capital, capable of providing a sufficient annual income, for as long as I live.
So how much is required to achieve financial independence?
There’s a general rule of thumb which states that if you withdraw no more than 3% of your invested capital every year (assuming it’s sensibly invested), then it’s very unlikely you’ll ever exhaust your invested capital.
According to William Bernstein, in “The Investor’s Manifesto”:
My rule of thumb is that if you spend 2 percent of your nest egg per year, adjusted upward for the cost of living, you are secure as possible; at 3 percent, you are probably safe; at 4 percent, you are taking real risks; and at 5 percent, you had better like cat food and vacations very close to home.
For example, if you could live comfortably today, on $100,000 per year, then you would need about $3.3 million dollars of invested capital in order to achieve financial independence. The invested capital should grow sufficiently to cover inflation, such that each year, for as long as you live, you can withdraw enough to preserve the purchasing power of $100,000 today, and never have to worry about exhausting your capital.
So how do you get there?
Given the power of compounding returns, the importance of starting a savings/investment plan early can not be emphasized enough.
Consider two people who begin with no savings — one at age 20, and one at age 30. Both wish to be financially independent with an annual income (in today’s dollars) of $70,000 by age 50. Let’s assume 4% inflation, an 8% annual return on investment, and contributions adjusted annually for inflation. How much would each have to save, annually (and adjusted upward for inflation) to reach that goal?
Looked at another way, if the 20 year old defers starting his savings/investment plan only 5 years, his required annual contribution (in today’s dollars!) jumps 37% to $55,000.
Again, the power of time (compounding return) is so, so important. If you are young, you need to start saving now.
Dr. Burton Malkiel, professor at Princeton university, is one of my favorite authors on the subject of investing. His book, A Random Walk Down Wall Street, is considered one of the cornerstones of personal investing literature. In 2008, Dr. Malkiel published another book, From Wall Street to the Great Wall, in which he makes the case for investing in China. Having read both books, I was puzzled by the apparent conflicts between the two.
Continue reading →In this article, I’m going to compress a lot of study, experience and opinion about personal investing, into a single essay to which I can refer others. It covers the power of compound returns, definition of asset classes, importance of diversification, role of asset allocation in the setting of risk, and introduces the Exchange Traded Fund (ETF). Continue reading →
“The budget should be balanced, the Treasury should be refilled, public debt should be reduced, the arrogance of officialdom should be tempered and controlled, and the assistance to foreign lands should be curtailed lest Rome become bankrupt. People must again learn to work, instead of living on public assistance.” Marcus Tullius Cicero, 55 BC
Obviously not a perfect analogy, but I found it cute nonetheless. A simplified exercise in Socialism, translated from http://tinyurl.com/kl7fuz
Although I’ll probably do a disservice to the topic, I’m going to try to compress a lot of study, experience and opinion into a brief blog article about personal investing. I’m very interested in the subject of investment, and enjoy chatting with others about it. So I decided that, rather than having to always repeat myself, I’d attempt to write down some things I’ve learned over time into a single article I can point people to. Continue reading →
