Financial Freedom: Investing 101

Money makes money, and the money money makes makes more money.

– Benjamin Franklin


DISCLAIMER: I am not a registered investment, legal, or tax advisor, or a broker/dealer. All investment and financial opinions expressed in this blog are from my personal research and experience and are intended as educational material. Investing money is a personal decision that you should only make after doing your own thorough research and/or consulting with a financial professional.


The following is an excerpt from the financial section of my latest book, Strong & Happy. In this chapter, I discuss how to achieve financial freedom by investing what I call seed money. In the preceding chapter, I describe how to generate seed money, which is disposable capital above and beyond your salary and the money you save for a safety net.

Five years ago, I was living paycheck to paycheck, had a net worth of zero, and I owed $65,000 for my son’s college education. This put my household at the bottom 2% of Americans, meaning 98% of my fellow Americans had more wealth than did I. Five years later, I have zero debt, and the wealth of my household falls within the top 10% of Americans. If you look at liquidity, which is the amount of cold hard cash that I can get at a moments notice, then my household falls within the top 2% of Americans. The advice that follows is part three of the five-part financial plan described in Strong & Happy.


In five years, my five-step financial plan took the net worth of my household from being less than 98% of all Americans to more than 90% of all Americans.

Maybe you see them on television. Maybe you see them at Starbucks. Maybe you see them in fancy restaurants, clubs, or at exclusive gatherings. Or maybe you heard of them from your disgruntled college professor who claims they stole the wealth that is rightfully yours. I am, of course, referring to wealthy people. When we see them, most of us aspire to be like them. We wish we were born with money and the easy life, or we wish we knew the secret of their wealth. As for them stealing wealth that is rightfully ours, that may be the case with some of the super rich, but it is not the case with most people who simply worked to have enough wealth for a comfortable and relatively worry free life. As for their secret, well, there is none. Believe it or not making enough money to achieve financial freedom is easy. You read that last sentence correctly – achieving financial freedom is easy, regardless of your current situation or who you are. ”If it were so easy, then why aren’t I doing it?” you may ask. If you are not doing it, then it is because you were never told how, or because you never tried. I can help you with the first reason, but the second reason is on you. Most of us do not take time to learn and participate in building wealth because we believe it is harder than it really is.


Most of us do not take the time to learn and participate in building wealth because we believe it is harder than it really is.

The bookstores are full of get rich quick books. These books are written by people who happened to be in the right place at the right time and hit it big. Then, before their lucky break ended, they parleyed their profits into other ventures. They will tell you that the secret to getting rich is to take large risks until you are lucky enough to be in the right place at the right time. Following this advice will not get you rich because everyone has jumped on the bandwagon that made these authors rich in the first place. Consequently, following their advice is more likely to have you lose your job, your house, and your spouse. For the majority of us, there is no way to get rich quick. You can, however, get wealthy in a relatively short period of time.


There is no way to get rich quick. You can, however, get wealthy in a relatively short period of time.

As previously stated, there is no secret to becoming wealthy. There is, however, a formula. It is a formula of sacrificing a few years to reap the benefits of financial freedom for the rest of your life. I am often amazed by the majority of people who accept a life of worry and living paycheck to paycheck instead of sacrificing only a few years for financial independence. If you are ready to make that sacrifice, then read on. Better yet, get my latest book, Strong & Happy to see how you can build wealth beyond your investments.

The investment step toward financial freedom entails:

1. Opening a savings account to use as your financial staging ground.

2. Generating seed money to invest. The seed money can be as little as a five hundred dollars.

3. Grow an investment portfolio of bank savings, funds, and precious metals.

STEP 1: OPEN A SAVINGS ACCOUNT

You will not get wealthy from a savings account. That being said, do not discount the power of compound interest. The first purpose of a savings account is to have a safe place to keep your money. The second is to have a staging area from which to move funds in and out of investments.

Most people open savings accounts at their local banks and receive a ridiculously low return on their money. The supposed rationale is that brick and mortar banks have higher costs and, therefore, they cannot afford to offer decent interest rates on savings. This is nonsense. Banks provide low interest because it is far more profitable to collect interest on loans than to give it out. For most banks, savings accounts are simply a necessary evil.


The difference between the poor and the wealthy is that the poor pay interest and the wealthy collect it. - Richard Paul Evans -

At the time of this writing, a Chase savings account offers a scant interest rate of only 0.02%. At 0.01%, Wells Fargo is even worse. For this reason, you should consider a high-yield savings account through an on-line bank. Personally, I keep my savings with Marcus by Goldman Sachs. A Marcus account is covered by the FDIC, it is easy to manage, and no minimum deposit is required. Best of all, at the time of this writing, Marcus provides an interest rate of 0.8%, which is 40 times higher than an average brick and mortar savings account. The chart below shows the interest you would gain based on an investment of $1000.

A year ago, interest rates were significantly higher with Marcus coming in at 2.25%. At that time, the yields would have been as follows:

It is easy to see that those who are not wealthy keep their savings in a local bank, and those who are wealthy keep their savings in a Marcus by Goldman Sachs account. People living paycheck to paycheck may see twenty-two dollars and seventy-three cents as nothing. That is not how the wealthy see it. To them, it is twenty-two dollars and seventy-three cents more than they had before. This is the mindset that you must take if you wish to acquire wealth.


Marcus provides an interest rate 40 times higher than the average brick and mortar savings account.

STEP 2: GENERATING SEED MONEY

Generating seed money is a subject that falls beyond the scope of this blog, which is why an entire chapter of my book, Strong and Happy, describes how to generate seed money regardless of your current financial situation.

STEP 3: YOUR INVESTMENT PORTFOLIO

The Economic Cycle

Maximizing your portfolio is merely a matter of keeping your finger on the pulse of the economy, which is primarily affected by the principle of supply and demand. The principle of supply and demand states that the worth of a product increases when the demand is larger than the supply. Conversely, a product’s worth decreases when the supply is larger than the demand. This applies to money as well. If too much money is being spent in the economy (as is the case in a booming economy with high consumer spending), then the worth of that money goes down. As a result, prices will increase to make up for the loss of value. What you bought yesterday for $1.00 could cost $1.05 today – or it could cost $5.00 in the case of hyper-inflation. On the flip side, if everyone is socking their money away in the bank instead of spending it, then there is less money being spent in the economy and the value of money goes up. This may sound like a good thing, but if no one is spending money, then the economy will stagnate. This is known as depression. Lesser versions of these conditions are termed recovery, which is a lesser version of inflation; and recession, which is a lesser version of depression. Contrary to what you are told, inflation and depression did not happen with great severity or regularity until reserve banks were instituted in countries throughout the world. Reserve banks are large private banks, which are given government sounding names and the power to manage a county’s monetary system in order to avoid financial crisis.

In 1913, the United States of America put in place the Federal Reserve Bank (a.k.a. the Fed), which it justified by siting numerous runs on banks six-years prior. The primary charter of the Fed is to enforce responsible banking and control the money supply in order to avoid inflation and depression. This is accomplished by adjusting interest rates. If there is too much money circulating in the economy, then the Fed will increase interest rates to encourage people to save - hence avoiding inflation. If there is not enough money circulating in the economy, then the Fed will decrease interest rates to encourage people spend - hence avoiding depression. Oddly enough, in 1929, only 16-years after establishing the Fed, the United States was hit with the Great Depression. Instead of repealing the Federal Reserve Act, politicians used the crisis to give the Fed even more power. The same is true of the Great Recession in 2007. Ever since the Great Depression, the Fed has regulated the economy to create what is known as the economic cycle, (see below).


Generally, the Fed raises interest rates when the economic cycle peaks (recovery) and when money has lower value. Conversely, the Fed lowers interest rates when the economic cycle troughs (recession) and when money has higher value. As goes money, so goes the world. Therefore, watching the economic cycle will help determine when to invest and where your money should be invested. Doing so does not have to be overly complicated. It is a simple matter of calculating where we are in the economic cycle and putting our money where it has the best chance to grow.

The Three Golden Rules to Grow Your Money

1. If the economy shows signs of picking up, then invest more seed money in stock market funds – see below.

2. If interest rates rise above the consumer price index, then invest another portion of your seed money into your savings account.

3. If the economy shows signs of dipping, then invest some seed money in gold.

If you follow the three rules above, then you can take advantage of the economic cycle regardless of where it falls. Some people spend inordinate amounts of time tracking markets in order to buy low and sell high. I am going to assume that, like me, you are not one of those people. Therefore, you will want to play the long game. Generally, stocks and gold continue to appreciate with each cycle, so buy low and hold on to your stocks for long term growth (see the comparison charts below). The same is true of gold, but if you can cash out gold within a year, then you should do so. That being said, never sell your gold when it is at a low.

How to Determine Where We Are in the Economic Cycle

Finding agreement across the three websites shown below can serve as a good indicator of where we fall in the economic cycle.

Federal Reserve Bank

The Fed website helps indicate where we are headed with regard to interest rates.

Gross Domestic Product

The Gross Domestic Product (GDP) data from the Bureau of Economic Analysis website is a good indicator of whether the economy is growing (trending towards recovery on the economic cycle) or shrinking (dropping towards recession on the economic cycle).

Consumer Price Index

The consumer price index (CPI) as shown on the U.S. Bureau of Labor Statistics website helps reflect rates of inflation and recession. Increases in CPI indicate that the economic cycle is moving up towards recovery. Decreases in the CPI indicate that the economic cycle is moving down towards recession. The following chart displays drops in the CPI as a result of the housing crisis in 2008 and the economic crisis in 2020 (dotted boxes). Also, take notice of the blue line on the chart. Do you see the economic cycle?

If you prefer to skip the work and trust someone else, then go to the economy.com website and click the country in which you live to see where it falls in the economic cycle.

Diversification

There are some stocks that will not recover after a dip. This risk is mitigated by diversifying your portfolio. You diversify by not putting all your investment eggs in one basket but by spreading them out among many baskets. Amateur investors, like me, accomplish this by investing in mutual funds and Exchange Traded Funds (EFTs). Later, further diversification is accomplished with investments in gold and commercial real estate.

At this juncture, you may be thinking, I have always wanted to take advantage of higher yield investments like stocks, but I do not have enough money to get started. This perception is a myth. In today’s modern era, people do not need a lot of seed money to take advantage of the stock market. Case in point, a single share of a common EFT is $50. Admittedly, the brokerage fees may eat into a low dollar investment, but it does show that a lot of money is not required to get into the game. The myth of needing more money is still perpetuated today by brokers who attempt to maximize their commissions. Just recently, I was contacted by an investment advisor after I opened a new checking account. He espoused a ridiculously high number for the minimum investment required. Coincidentally, it was half my entire net worth, which the bank knew when I opened the account.

YOUR INVESTMENT OPTIONS

In the spirit of diversification, the options shown below do not include common and preferred stocks. It is true that you can buy stocks individually and diversify your own portfolio. However, I find this requires too much work for an average person like me. Instead, there is plenty of money to be made with mutual funds, ETFs, REITs, and precious metals.

Mutual and Exchange Traded Funds

A fund company pools money from many investors and invests that money into a widely diversified portfolio of stocks. Instead of buying individual shares of each stock, investors buy shares of the entire fund. The idea here is that there is strength in numbers. Furthermore, the fund managers will often change up the portfolio (add new stocks and drop old ones) for the best return. The value of the fund is based on the total performance of all the stocks. So, if 100 stocks in the fund fall and 400 other stocks gain, then you still make a profit. A great benefit of mutual funds is that you can often invest with as little as $50. Primarily, there are two types of funds, mutual funds, and exchange traded funds (EFTs). Mutual funds are purchased though a fund manager, and EFTs are purchased through a broker. Unlike bonds, fund investments are liquid. You can cash out a mutual fund in under a week, and you can cash out an EFT immediately. My overall investment strategy is to invest in both mutual funds and EFTs. Two popular fund types are growth and dividend. Growth funds focus on stocks likely to increase in value, whereas dividend funds, which pay out dividends to investors, are less focused on growth.


Mutual Funds

A mutual fund is managed by an investment company that charges fees for the management of the fund. Overall, mutual funds are structured to outperform the market. At the time of this writing, the average return on a mutual fund is 13%. That is a return of $113 for every $1,000 invested in the fund. If you compare this with the $22.50 you would make in a high-yield savings account, then you can see why mutual funds are so attractive. It is for this reason that mutual funds are the primary engine behind your 401K. Keep in mind, however, that the fund’s fees will eat into your profits and no-load funds (no fee) may not be as profitable. Be sure to get a prospectus and a detailed list of all the fees before choosing a mutual fund in which to invest. It is also important to determine when a mutual fund will pay out distributions and invest in the fund immediately after the distribution. If you invest prior to the distribution, then you will be taxed as if you had invested in the fund for the entire year.

Exchange Traded Funds

ETFs resemble mutual funds in that you are still pooling your money with other investors to own shares in a widely diversified portfolio of stocks. The primary difference is that the fund is traded in the stock exchange. Therefore, the fund is more like buying stocks - in that you can buy and sell in the same day. This is an advantage with regard to liquidity and having fewer fees and fewer taxable events. Keep in mind, however, that you will incur brokerage fees when you buy and sell. If you choose to hold multiple funds, then ETFs offer an advantage to avoid stock overlap by allowing you to see which stocks are in the fund. Conversely, you can see the stocks in the portfolio of a mutual fund only twice a year. Overall, ETFs are structured to keep up with the market. At the time of this writing, the average return on an ETF is 11%. That is a return of $111 for every $1,000 invested in the fund.

Real Estate Investment Trust (REIT)

REITs offer people a way to invest in property without the headaches of actually owning property. Instead, the investor owns shares of commercial properties and benefits from both the gains and dividend payouts. The annual return on REITs can range from 4%-10%.

Why go with a REIT? REITS rarely perform in lock step with the stock market, so they serve as an excellent investment for diversification. I feel that REITs for residential rental properties hold a certain allure in that people will always need a place to live regardless of how the economy is doing.

Gold

There is good reason to invest in gold. For one thing, gold keeps its value and it is immune to inflation. Ten years ago, one ounce of gold sold for $1,200. At the time of this writing, one ounce of gold sells for $2,034. Even so, the value of gold has not changed. Two thousand years ago, a Roman soldier could buy a fine tunic for a half ounce of gold. Ten years ago, a man could buy a fine suit for around $500 (half an ounce of gold). Today, a man can buy a fine suit for $1,000 (half an ounce of gold). As you see, the price of gold may change but the buying power does not. When it comes to precious metals, I strongly advise buying gold and not silver. Silver has a far more turbulent track record and it is far more difficult to predict. Additionally, the average annual return for gold over the past twenty-years is 27%. This equates to a return of $270 for every $1,000 invested, which far exceeds the return of most investments today.

There are a number of ways to invest in gold. If you want a tangible asset (something you can touch), then gold coins and bullion will do the trick. You can also buy gold and have it stored for you. In other words, you never touch it unless you cash it out. There are also paper investments, like ETFs for gold. The negative aspect of physical gold is that it is at risk of theft. To that end, I suggest dedicating no more than 5% of your portfolio to physical gold.

Based on the last 100 years, gold prices are lowest during economic booms, when the economic cycle is highest; and they are highest during economic downturns, when the economic cycle is lowest (see chart below). Hence, you should buy gold when the economy is strong and expect it to appreciate during the next dip in the economic cycle. Since the long-term capital gains tax for gold is 28%, compared to the 20% of stocks, if the appreciation does not eclipse the tax savings, then you will want to treat investments of physical gold (other than what may be in your safe at home) as short-term investments to sell when the value appreciates at the next economic downturn.

Your Wealth Building Algorithm

1. Generate seed money (see my book Strong & Happy).

2. Open a savings account as a staging area for your investments.

a. Sock your seed money away into the savings account until you have a six-month cushion. In other words, you should save at least six months of living expenses as a cushion in case you lose your primary mode of income.

3. Once you have a six-month cushion, start investing new seed money into mutual funds or EFTs, based on the three golden rules shown above. Keep investing, until the amount in your funds match that in your savings account.

4. Once your investments match your savings account, increase your savings account for an additional three month cushion.

5. Repeat steps 3 and 4 until your savings account can cushion you for at least a year.

6. Continue putting your seed money into funds and start diversifying (as per the three golden rules above) with REITS and gold while continuing to feed your savings account.

Where to Invest

Investing money is a personal decision that you should only make after thorough research. The guidance shown above should put you on the right path. That being said, I am often frustrated with informational articles in which the authors become vague when it comes to specifics. To that end, I have listed my personal choices for investment below.

My Advice for Research

1. Choose the investment to research based on the principals given in this blog.

2. Evaluate the performance of the fund for the last 1, 5, and 10-years. This is easy to do via the Yahoo! Finance website or with one of the many stock apps for smart phones.

3. Make note of how many dips took place in the 1,5, and 10 year history.

4. Evaluate if the dips coincided with the economic cycle.

5. Evaluate how well the fund recovered from those dips vs. other funds.

6. Invest in the fund with which you feel most comfortable.

An additional way to research an investment is to simulate it. In other words, research your portfolio as per the steps shown above, choose a realistic sum to invest, and pretend that you made an investment. Once you have made your pretend investments, set a future date when you will cash it out. You can do this for a few months or for as long as it takes to save and generate your seed money. When done, see how much money your faux investments earned or lost. When my lady saw how much one of our potential investments had grown, she commented, “Too bad we didn’t invest a year ago.”

MY INVESTMENT CHOICES

Vanguard

If you are new to investing, then Vanguard is the way to go. Vanguard boasts of having a robust portfolio of no-load mutual funds, EFTs, and REITS with the lowest fees in the industry. Furthermore, the Vanguard website is not overwhelming but it remains highly educational.

a. Vanguard Dividend Growth Fund (VDIGX): This dividend generating mutual fund has performed on par with growth funds, giving you the best of both worlds. According to Vanguard, this fund has a ten-year average rate of return of around 13%.

Chart courtesy of Yahoo! Finance

b. Vanguard U.S. Growth Fund Admiral Shares (VWUAX): This mutual fund ranks among the highest for return on investment, with a ten-year average rate of return of nearly 18%. Furthermore, it is said that Vanguard focuses this fund on holdings that are likely to hold up during times of economic uncertainty. Furthermore, this fund is recommended by Warren Buffet, who is one of the most successful traders of our time.


c. Vanguard Real Estate ETF (VNQ): This REIT should prove profitable with average risk. You may notice in the chart shown below that this fund is hurting in July 2020. However, the 10-year history shows consistent growth. Therefore, chances are excellent that the fund will recover. I see this drop as an excellent opportunity to get into this fund at a low buying price.


d. Diversyfund

The Diversyfund is a private REIT (not publicly traded) that essentially flips properties. This is an excellent way to invest in commercial real estate without the headaches of actually buying and flipping the property yourself. The good news is that you can invest with as little as $500 and the potential returns can run as high as 20%. The bad news is that the risk can be high, and profits must wait for the properties to be purchased, renovated, and flipped. As a result, you will not have access to your money during the investment minimum term of 5-years.


e. Physical Gold in Your Possession: I suggest purchasing bullion since it reflects the pure value of gold. Start by finding the current value for an ounce of gold, which is known as the spot price. Next, find a reputable dealer in your state by going to the U.S. Mint Website. Try to find a dealer who sells gold at no more than a 5% markup from the day’s spot price, keeping in mind that there will be a minimum purchase requirement.

f. Vaulted Gold: Vaulted gold is gold that you buy, but of which you do not take possession. Instead, the holding company stores the gold for you in their vaults. This can be an excellent way to buy gold without having to deal with the physical limitations of storing it. Keep in mind, however, that to avoid money laundering, access to your funds requires verification, which can be both frustrating and time consuming. Bullionvault is one of the better rated holding companies from whom you can buy vaulted gold.

g. Gold ETFs: SPDR is one of the oldest and best performing gold ETFs on the market and my personal choice when it comes to gold.

Closing Thoughts

If you follow the advice of this blog, along with the other advice in my book Strong & Happy, then you can amass a large net worth in about five-years, at which point you should have few financial worries. The magic number that you want to shoot for, however, is one million dollars. Once you have one million dollars, then you can keep $400,000 in your savings account as guaranteed security, while keeping $600,000 in the market to grow. It is not unreasonable to assume at least a 10% return from your investments. As such, $600,000 will bring a return of $60,000 a year, which is almost enough to live on. Better yet, the following year will bring a return of $66,000 and a return of $73,26 in the year after that. Do you see where this is going? Eventually, you can live off the returns of the money you invested, while still having that money at your beckon call. The trick is not to be spooked when stocks take a downturn. As long as you are diversified in a good fund, then the returns will eventually come back stronger than before, and you still have the $400,000 in your savings as a safety net.

Should You Leave Your job? Absolutely not. Why in the world would you want to walk away from a steady stream of income when the income from your job can continue to feed your investments? Besides, if everyone left their jobs, then the economy would most certainly crash, and your wealth would evaporate.


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