Part 1
Taking Responsibility for Your Financial Success
âThe investors chief problemâand even his worst enemyâis likely to be himself.â
Benjamin Graham, Wall Street legend and proponent of value investing
Tip 1
Recognize the Real Obstacles to Your Financial Security
You will never be financially secure until you understand that the real problems holding you back are probably your own attitudes and misconceptions.
The obstacles that keep us from enjoying financial security are usually not low salaries, too much income tax, stock market crashes, or our own less-than-perfect financial advisors. They are more likely to stem from wrong attitudes and wrong thinking. Some of the obstacles may include
- not taking responsibility for our own financial success;
- not making financial security one of our main goals;
- not knowing what rate of return is needed to achieve our goals;
- not having a financial plan that shows what we must do to achieve our goals;
- getting all our financial advice from salespeople;
- thinking that finances are too complicated to understand;
- not having, and sticking to, an investment strategy; or
- focusing on investment products rather than on the investment process.
Financial security comes to those who want it more than the pleasure they may receive from spur-of-the moment, feel-good purchases. It comes to those who can visualize its benefits and are willing to spend and live within the level of their current income. It comes to those who spend less than they earn and save the difference. Financial security rarely comes to those who try to become wealthy through speculation. You donât have to be lucky or brilliant or earn a high income to become financially secure. You just need to save regularly and avoid the most common investment mistakes.
Financial security and financial independence are not the same thing. Financial security is being on the path that will lead to financial independence. Financial security is a state of mind that gives you a confidence that pays psychological as well as financial dividends. You can have financial security by avoiding simple mistakes and committing to saving 10% of what you earn. Financial independence is having enough income from your pension or your capital to pay your living expenses with no more need to work for a living. Obviously, the more income necessary to support your lifestyle, the more capital you will need and the longer it will take to reach financial independence.
You will achieve financial independence when you take responsibility for your finances and manage your money wisely. If you stick to a sensible plan, financial independence in your old age is virtually certain. To make it happen, however, you must take charge. If you are not on the road to this independence and you are close to retirement, then more drastic measures will be needed. The specific steps required will become clear when you prepare a comprehensive financial plan.
BOTTOM LINE: You can overcome financial difficulties and accumulate enough capital to retire in comfort. The key is to have specific goals and a keen desire to achieve them. When you have goals and they are sufficiently important that you put money aside to achieve them, then the magic of compounding interest will do the rest.
WHAT YOU CAN DO NOW: Start taking control of your own financial security by getting a financial plan that shows what you need to do to become financially independent. When you have a financial plan, you must also want the goals badly enough to continue following the plan. You have to know your goals, take charge, and take action.
Tip 2
Take Responsibility for Your Own Investment Success
You will reach financial independence only if you realize that you are in control and that financial security depends on your commitment to the process.
When it comes to personal finances, we frequently act as if things are beyond our control. In cases where we do not save enough put aside to build financial independence, we may blame our employer for a low salary, the government for taking too much in tax, or the economy for high inflation and interest rates. We may consider it unfair that rent and daycare are so expensive, making it impossible for us to pay for all our day-today expenses, let alone have money left over to save.
Similarly, when we experience bad investing results, we blame the markets, the economy, management fees, or income tax. We fault our financial advisor for not picking stocks that always increase in value. We blame our accountant for not helping us avoid more income tax, and our financial planner not giving us a financial plan that keeps us on track.
The point is, however, that we should expect these problems. All of them can be overcome or avoided, however, when we take responsibility for our financial security.
Albert Ellis, the renowned psychotherapist, has said, âYour financial health is a function of the attitudes you have learned and taught yourself about money over the years.â We have created our financial situation and we have the power to change it. Just as improving our health requires personal commitment, improving our finances requires that we make financial security one of our priorities.
You must first take responsibility for setting your financial goals. You, or you and your spouse, should sit down and decide what you really want out of life. You almost certainly will not be able to get everything you want. But you are likely to get more of what you want if you agree on what you are aiming for and are willing to work toward it.
If you donât have the knowledge to do this yourself, work with a financial planner to create a financial plan that shows what you must do to achieve your most important goals. When you know the amount you must save, you can adjust your spending to reach that target. Then you can budget for the things you want most: a nice home, education for your children, early retirement, or the ability to help others by leaving a valuable estate.
If you already have a financial advisor, you should still go through this goal-setting exercise with him or her. It is amazing how few advisors actually know their clientsâ financial history or goals. This is where you can start to work more effectively with your advisor.
Take the time to choose your priorities before spending on things of lesser importance. To get the things that are really important to you, you may have to make some difficult choices. These choices might mean moving to a smaller home, getting by with one car, reducing vacation costs, cutting up your credit cards, buying nothing until you have the cash available, or avoiding expensive restaurants. If you say, âBut this is impossibleâI donât want to give up any of these things,â then your only alternative is to stay in debt, work until you die, and never experience the freedom of money in the bank and the feeling of financial security.
You canât have it both ways. It is impossible to spend more than you earn and still create financial security. Delaying decisions too long will mean even tougher choices in the future. After you have committed yourself to a regular savings program, the next step is to monitor results and ask questions when your investments are not performing as expected. Obtain a basic understanding of how the stock market works. Finish reading this book to get a better grasp of how you can avoid the mistakes that most investors make.
Almost anyone, regardless of investment expertise, present income, and financial circumstances, can become financially secure by following the simple steps listed below. You donât need to be an expert on financial matters to gain financial security. Whatâs needed is the recognition that you are the master of your own destiny.
Do not assume that hiring an advisor frees you from making decisions, setting goals, and monitoring the results. Be involved in the process. Your input is essential. Just as you cannot turn all responsibility for your health and fitness over to a personal fitness trainer, so you cannot turn all of your financial decisions over to your financial advisor. A fitness trainer can show you the exercise, but you still have to do it. Itâs the same with your finances. Unless your pension plan is generous enough to provide for all your needs and wants in retirement, you will need to save regularly, have a plan that shows the required rate of return, and follow the plan. You must ask questions, make decisions, and monitor the results.
At a minimum, you must
- itemize your major financial goals.
- prioritize your major financial goals.
- get a financial plan that shows how much you need to save to achieve your goals.
- ask your financial advisor for something called an investment policy statement (IPS). An IPS is an agreement between you and your advisor that explains how things are expected to work. (See Tip 9 on pages 21-26 for an in-depth description of this agreement.)
- stick to a simple but sensible investment strategy.
- commit to saving each month the amount your plan calls for.
- spend the time necessary to monitor your investment portfolio.
If the recommendation to live within your present income seems like tough medicine, consider the benefits. Once you turn things around and have a positive cash flow, you can enjoy more material things and spend more on other pursuits than you would be able to if you were to stay in debt.
BOTTOM LINE: Take charge. Donât think of yourself as a victim of circumstances. A change in behaviour will bring a change in results. The process is easier than you think and will bring more pleasure than you can now imagine.
WHAT YOU CAN DO NOW: Finish reading this book to get a basic understanding of what you have to do to achieve financial security.
Tip 3
Donât Think a Higher Income in the Future Will Make Up for a Late Start
If you think that eventually you will make up for a late start by saving more when your income is higher, you are fooling yourself. It will not be any easier to save in the future when you have a higher income. You can save only when you spend less than you earn. In the absence of a commitment to save, a higher income may only mean higher spending.
Many examples show us that the surest way to become financially independent is to start saving at an early age. Ten years of compound interest is a surer route to riches than a plan to invest later in investments that will produce an exceptionally high rate of return.
Typically, the young say that they donât earn enough to start saving. They think that the amount they save is not enough to invest. Thus, many young people tend to forget about accumulating any savings.
Compare the progress of someone who starts to save at 20 with that of someone who starts at 35. After the late starter begins to save, he or she will have to save about four times as much each year to arrive at the same total as the early saver.
Most young people will tell you how difficult it is to save because it costs so much to maintain their lifestyle. Those just beginning family life with children find it especially difficult. Yet it isnât all about the scarcity of money. Many young couples live at a standard just above the limit of what they can afford.
Consider the couple who make a combined income of $80,000 and spend about $81,000 during the year. Chances are that if their combined income were to rise to $100,000, they would spend $102,000, or if it were to go up to $120,000, their spending would increase to $125,000. As soon as this coupleâs income goes up, their standard of living goes up. They move to a nicer apartment, buy a better car, and take more expensive vacations.
Saving is something this couple plan to do in the future, when their income is higher. They are forgetting one important fact: The key to higher savings is not a higher income; it is the decision to spend less than you earn. Savings can be generated only when there is a commitment to save. Individuals who truly feel the need to save can do so even with very low incomes. Saving is easy if you make the commitment to live within your means.
Young people who do save will find that they have much more to spend in future years, for two reasons: (1) they will not have to spend a large portion of their income on interest on debt, and (2) the interest earned on their savings will be available to spend.
It is possible for almost everyone to live happily on much less. This should be especially encouraging to those who think they just canât save because they need all of their income to live on. Sometimes people have to lose a job or take a lower-paying job before they really learn this lesson.
I once took a 50% cut in my income after leaving a secure position as a manager with a major accounting firm to take up a new position as a commission salesperson. While at the accounting firm, I would never have believed it possible for my wife and I to cut back so drastically. But we did, and we now look back on those belt-tightening years as some of the most enjoyable years of our marriage.
Many excellent books point the way to a lifestyle of good saving habits. By reading just a few of them, you should have as much fun saving money and watching your capital grow as you now are spending money.
To inspire you on the way to savings, here are three good sources: The Richest Man in Babylon by George S. Clason, Your Money or Your Life by Joe Dominguez and Vicki Robin, and The Automatic Investor by David Bach, a state-of-the-art savings guide.
BOTTOM LINE: Many people think that a higher income will make it easier to save more in the future. However, they will find that there will never be surplus money because expenses, if unchecked, will always grow faster than income.
WHAT YOU CAN DO NOW: Decide what changes you have to make to your lifestyle so that you can save 10% of what you earn.
Tip 4
Know Your Target Rate of Return
If you do not know the rate of return that you should be aiming for, you may be taking either too much risk or too little.
To become financially secure, you need to be clear about your goals. When your goals are clear, the financial-planning process will show the rate of return you need to earn on your investments in order to meet your objectives. This rate of return becomes the target against which to measure success or failure.
If you donât have any goals, it doesnât matter what you do with your finances. However, most people do have some idea of what they want. To have meaning, goals must be clear, quantified, and tied to a specific time period. For example, if the plan is based on retirement goals, the first step is to set the retirement date and the amount of money you expect to spend in your retirement years.
Assume, for example, that you want to retire in 20 years. At that time, you want to spend $40,000 per year in todayâs dollars. Assume that you have $100,000 saved today and you are saving $1,000 per month. Assume also that in retirement you will earn $1,000 per month in pension income. Given reasonable assumptions for inflation, life expectancy, and income tax, you will need a rate of return of about 8% to achieve these goals.
On the other hand, ...