Friday, March 26, 2010

The path to becoming rich is already known.

When reading all those books on becoming rich there is one common thread. Unless you are the big aggressive ‘Donald Trump’ type who gambles big time, getting rich is a pretty boring undertaking that takes a long time view of things. You live below your means, you save and invest at 8 to 15% per year on average and when you reach retirement age or somewhat earlier when you reach ‘freedom’ 55 then you have hopefully scraped enough together to retire and call yourself wealthy. You may win the lottery or suddenly become a star, but chances are that in that case you do not have the skills to keep your fortune together. There are so many stories of lottery winners who were broke again within a few years.
So, really, it is not only about earnings power, it is a lot about managing your resources and gradually becoming rich while building your investment skills along with it. That was the difference between Rich Dad and Poor Dad. Although poor Dad had lots of earnings power, he did not have investment savvy and spend all his income. Rich Dad had a modest income but through excellent investment skills he builds up a fortune over the years.
It is no accident that only 3 to 5% of Canada’s population can call themselves millionaire. Not that it takes a genius to have a million, but it takes patience and backbone. How many people have not traded away their wealth by continuously selling their residence and buying yet another dream home? All profits were lost in paying commissions and lawyers and movers. It is not that real estate commissions are too high. Realtors work really hard to earn them. My estimate is that the top 20% of realtors, many with 20 years or more experience, make on average $125,000 per year. Not bad, but not great either and it took a lot of shoe leather for them to get there.

Why do we prefer ETFs over Mutual funds? Because, the administrative expenses of continuously buying and selling stocks (”active management”) is cutting in your returns big time. That is why the ‘buy and hold’ strategy is so efficient: you don’t pay commissions and you don’t pay capital gains taxes and you only pay a bit of taxes on your dividends. That is why guys like Warren Buffett state that if possible they like to keep a stock for ever.
So investing is not exciting, in fact it should be boring and you need the backbone to stick with your plans and strategies. That is easy to do when everything is hunky-dory, but in tough times, you may have to hold on to your stocks while you’re sick in the stomach. Even worse, you need a stomach strong enough to buy good companies while everybody around you runs like a chicken without a head.

Buy low and sell high is something nearly impossible to achieve consistently. You may luck out a couple of times, and then you may suddenly get hit by setbacks (to say it nicely). My earlier post on Godfried’s Ten Rules of investing is not coming out of the blue. These rules are the result of many runs to the washroom.

Although 2007-2010 was my 8th or 9th major downturn, it was still difficult to keep my cool and it was even more difficult to have sufficient cash for buying those ‘once-in-a-lifetime’ opportunities while seeing your net worth running south at an alarming rate. Every downturn though I handle a bit better. You may have read my numerous comparisons between real estate and stock market investing, and here again nearly all my observations in this post are applicable to both asset classes.

There is a bit of a market timing trick you may want to keep in mind. As you know, I don’t time markets but this may work. The real estate market ‘lags’ the stock market by several months if not up to half a year. If you were considering taking profits and felt that you should have cash ready for future opportunities, when you see the stock market tank you might use that as an additional argument for selling that fully valued real estate property. Because you know that real estate prices are soon to follow the stock market. Visa versa, if you see that the stock market has improved significantly and the real estate market hasn’t yet, you know that this might be a good time to expand your real estate portfolio. Not fire-proof, but if you are ready to do a buy or sell transaction it is something to keep in mind.

I don’t invest based on technical market analysis, I invest based on fundamentals. But if the fundamentals are right, I don’t mind trying to use some technical trends to see if I can buy at an even better price. I don’t depend entirely on the technical stuff. I may buy first a bit at the 'right price', and then at the next try I buy it bit more on technical reasons, and then when the fundamentals are still good I buy again a bit using the technical analysis as guideline. Thus you can combine fundamentals and market trends to get something for an optimum price.

When all is said and done, with investing you want to keep things simple. If you don’t understand how an investment works don’t use it. So, KISS (keep it simple stupid), save, live below your means, build investment skills, a strong stomach, buy on fundamentals while not forgetting that the ‘trend is your friend’ are the elements of becoming wealthy. Not at all difficult to understand; if you truly want to become a millionaire though you have also to handle that what so few can do in real life: “Stick with It”.

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