Dear Lauren & Rachel,
As you guys get a bit older I thought it would be a good time to start putting some thoughts together on a very important subject...money. (I'll let your Mom handle the letter on boys!)
You see, there is an old saying, "A fool and his money are soon parted." My job, as a dad, is to make sure that you are not the fool.
There is another saying made famous in a great movie, "Wall Street" (we'll have to watch it soon), "A fool and his money are lucky enough to have gotten together in the first place." Unfortunately this saying is practiced by far too many so called financial "professionals".
Money can be a very emotional and complicated subject ... it doesn't have to be. Hopefully with some simple rules, and some education, we can start you down that road of enlightenment (the opposite of fool).
- Money (also known as investment capital) is a perishable commodity if not handled carefully. Be serious. Pay attention to your own financial affairs, don't count on anyone else to have your best interests at heart. I know this may sound harsh, but if you count only on yourself you'll rarely be disappointed by others, and you may even be positively surprised on occasion.
- Another word for money is capital. There are two types of capital, financial (money) and intellectual (education). It is important to remember that capital will always flow to where it is welcome, and stay where it is well treated. Think of this whenever you are investing or looking for work. Is the investment or potential employer attracting capital? And why? Investing is a lot like working, you want to work for a place that attracts the best and brightest. You want to invest in the company or country that is going to treat your capital the most favorably.
- Think of your Net Worth (assets minus liabilities), not your paycheck. Divide your assets into three baskets. 1) Your education and career, how you make money. This is where most of your focus should be. 2) Your savings, your liquid assets, they should cover at least six months of your living expenses. Protect and preserve them. 3) Your long-term investments. This is your diversified investment portfolio. It is higher risk, and more speculative, so be prepared for volatility.
- Be frugal/cheap. If you can't afford it don't buy it. Watch this video clip Saturday Night Live: Don't Buy Stuff . Save as much as you can. Especially in employer sponsored savings plans, like 401-K's. However, invest minimally in your employers stock. You are already reliant on your employer for your income, if something were to go wrong and the company no longer exists, than you would lose your job and your savings. Don't over do the frugality, life is way too short to worry about every dollar. Focus on getting the big things right; education, house, car, investments. But allow yourself to enjoy life's simple pleasures; dinner with friends, travel, etc.
- Credit cards should only be used as a cash substitute and paid off every month. This is very important. Do not fall into the credit card debt spiral.
- Be ethical in all of your endeavors, even if the world may not be. So much of finance is based on trust, you have to hold yourself and everyone that handles your money to the highest possible ethical standards.
- KISS. Not the kind you're thinking, the other KISS, as in Keep It Simple Stupid. Investing doesn't have to be complicated. In fact, the harder an investment is to understand the more strenuously you should avoid it. Complexity is a wonderful way for the financial industry to hide fees, expenses, and risk.
- Understand the Financial Services Industry. While they serve a purpose in helping people save and financing homes, etc, that is not their primary objective. Their primary objective is to make money for themselves and their shareholders (especially at the larger institutions). They do this by gathering assets and skimming a little from every investment or transaction. There is nothing wrong with this, it is how they make money. You need to realize that you will be paying for everything, you just want to make sure you don't overpay. See "Fool" quote above.
- Insurance is not an investment, it is an expense. Until you have a family, life insurance is a waste of money. Even with a family don't over do it. Health insurance and property insurance are pure expenses, necessary evils. You want to carry the largest deductibles as possible, thereby lowering your monthly expenses.
- There is no free lunch (unless of course your Dad is buying, and even then you'll probably have to endure my lame preaching). What this means is that for every investment return you expect, there is a risk associated. Risk and return go hand-in-hand. There is no such thing as risk free. The higher the expected return, the more risk you are taking. Even if you don't invest you take the risk of your money losing value, because of inflation. Again, there is no free lunch.
- Don't put all your eggs in one basket. Diversify. When you think of diversifying, think about diversifying your risks, not your returns. The big risks are economic (think globally), inflation/deflation (choose assets that do well in either environment), and currency (currencies can lose value rapidly, diversify globally, and use hard assets like gold or collectibles).
- Never borrow money to invest. Leverage cuts both ways, and while leverage may enhance your returns it also magnifies your losses.
- You cannot eat relative performance. It doesn't matter how you performed against some benchmark like the S&P 500, what matters is how you performed against your own objectives. You need to think of absolute performance not relative. You probably won't be very happy if the S&P 500 is down 30% and you are only down 25%.
- What type of return should you expect? Unfortunately, this is not a pretty number. You need to think of real returns, not nominal returns. Real returns are what you get to eat, after inflation, taxes, and fees. If stocks have returned about 9% annually on a nominal basis the real return is closer to 2% (9% - 3% inflation - 2.5% taxes - 1.5% fees = 2%). Historically you've done really well to earn a real return of 2% -3%.
- Since we are talking about real returns, it should be obvious that there are two areas where you can quickly increase your returns. First, lower the tax bite by maxing out your IRA's and 401-K's. I know it's only tax deferred, but the long-term tax-deferred compounding adds up. Second, watch your fees. There is no way to invest for free, believe me I've tried, but you can lower the bite the investment industry takes. If you invest on your own, using index funds or ETF's, you can get your fees and trading costs down to the 0.25% range. If you hire someone to help you the best you could hope for is about 1% - 1.25% in fees and expenses. Remember to add all the fees in. If you use an investment advisor find out exactly how they are getting paid, also add in all the investment management fees in any mutual fund or ETF, and add in trading costs. Unfortunately way too many people end up paying 2% or more every year.
- Speaking of investment advisors, if for some reason I am no longer able to act as your advisor (you know, senile), then you may need to hire one. First try and do it on your own for as long as you can, but I realize that you have a life and following global financial markets may not be at the top of your list of fun things to do in your spare time. OK, if you have to hire an advisor, what should you look for? Since there are ten's-of-thousands of so called investment advisors out there the first thing to do is narrow down the universe. The easiest way to do that is to focus on CFA's (Chartered Financial Analysts) only. Why CFA's and none of the other alphabet soup designations? Well, because your Dad's a CFA and he's biased. Seriously though, the CFA designation is by far the hardest most grueling designation to earn. It shows a level of commitment to the profession that no other designation can match. It requires a candidate to pass three successive exams given over three years (less than 10% of those who sit for Level I pass in three years), and requires four years of "acceptable professional work experience". The level of ethical studies in the CFA program is also unmatched. Just because an advisor is a CFA doesn't mean they are great, you'll still need to review their track record, talk to existing clients, and see if there is a good emotional fit. Emotional fit is very important. You need an advisor who can talk to you and explain to you why he has lost you money. Yes, there will be times when no matter how good your advisor, they will lose you money, it is in those dark days that he will need to be able to explain his strategy and why it didn't work. This isn't a marriage. Give them a few years, but if it isn't working out don't hesitate in leaving.
- Spend your interest, never your principal. If at all possible, take out less than comes in, in the form of dividends and interest. If you never have to tap into your principal your portfolio should continue to grow.
- Don't be afraid to take losses, they happen. Admit to your mistake and move on.
- Act. Be decisive and make decisions. We live in the information age, but no amount of information can remove all uncertainty. Have confidence in your moves, but be willing to change course if the information changes.
- Prepare for the worst, while enjoying the good times. Expect the unexpected. Even though the world may say that it won't/can't happen prepare for it. You should never be surprised by an economic calamity, they can and will happen. The key to survival is being prepared and willing to act. For every loser there is a winner, find out who the winner is and join them.
- No one can predict the future. The investment industry is full of prognosticators, but none of them know what will happen in the future, they are just opinions. The collective intelligence of the market is much greater than that of any individual. You should strive to be in harmony with the market, don't fight it. If a segment of the market is bullish than you should be bullish, if a segment is bearish than you should be bearish. Don't try and force your opinions or beliefs onto the market. "Those who have knowledge, don't predict. Those who predict, don't have knowledge." - Lao Tzu
- "Read, every day, something no one else is reading. Think, every day, something no one else is thinking. Do, every day, something no one else would be silly enough to do. It is bad for the mind to be always part of unanimity." - Christopher Morley
Well, I know that there's a lot of information here, but hopefully over the next several years we'll be able to work through some of these in real time. My goal is to get you girls to a point where you won't have to worry about money, you'll understand it for what it is...a means to an end.
Love always,
Dad
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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