You can read about the interview with Andrew Hallam here.
This book talked about nine rules of wealth.
Rule 1: Spend Like You Want to Grow Rich
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Andrew defined wealth as having the financial ability to stop working; and having passive income that is twice the national median household income.
He believes that not having a car would give you a financial headstart in life. In fact, he researched that the median price paid for a car by U.S. millionaires in 2009 was US$31,367.
When buying a home, he suggests a rule of thumb is to double the interest rate to figure out if you could still afford the mortgage payments.
Do not spoil your kids! He quoted Thomas Stanley’s book, The Millionaire Next Door, that people who received stocks, cash, real estate or other forms of financial gifts tend to be in a lower level of wealth than those in the same income bracket who did not receive any help at all.
Rule 2: Use the Greatest Investment Ally You Have
Make compounding effect work for you so start to invest as early as possible. “The odds are high that you’ll slowly grow very wealthy.”
“[T]he U.S. stock market has averaged 9.96 percent annually from 1920 to 2010.” With $10,000 growing at 9.96 percent annually, you will have $1.1 million in 50 years.
Rule 3: Small Percentages Pack Big Punches
He is a firm believer of index funds and he reckoned that by spreading your investment in three index funds, you can beat majority of the investment professionals.
Fund 1: Tracks your domestic stock index
Fund 2: Tracks an international stock index
Fund 3: Tracks a government bond index
There were many instances where actively managed funds cannot beat the stock index overtime.
“It was the top-ranked fund [44 Wall Street Fund] of the 1970s – outperforming every diversified fund in the industry and beating the S&P 500 index for 11 years in a row. Its success was temporary, however, and it went from being the best-performing fund in one decade to being the worst-performing fund in the next, losing 73 percent of its value in the 1980s.”
“Then there was the Lindner Large-Cap Fund, another stellar performer that attracted a huge following of investors as it beat the S&P 500 index for each of the 11 years from 1974 to 1984. But your won’t find it today. Over the next 18 years (from 1984 to 2002) it made its investors just 4.1% annually, compared with the 12.6% annual gain for investors in the S&P 500 index.”
There are five reasons why actively managed funds perform worse than the index
- Expense Ratio – Need to pay for the staff, office lease, etc. “A fund holding a collective $30 billion would cost its investors (the average Joe) about $450 million every year”.
- 12B1 Fees – Marketing expenses in a nutshell. “They can cost up to 0.25 percent, or a further $75 million a year for a $30 billion fund.”
- Trading Costs – “… the average actively managed stock market mutual fund accrues trading costs of 0.2 percent annually, or $60 million a year on a $30 billion fund.”
- Sales Commissions – Some funds charge fees when you buy or sell the fund. This goes to the pockets of the “investment advisors” or salesman in layman terms.
- Taxes – Mutual funds in U.S. pay taxes for capital gains. Hence, the more they trade and make gains through buying and selling, the more taxes they incur.
Rule 4: Conquer the Enemy in the Mirror
Although the path to investment success seems easy, it is very hard to put into practice. Humans have a tendency to buy when the stock market is rising and sell when the stock prices are crashing.
There is a price for missing out the great market movements when you do not stay invested. From 1982 to 2005, the stock market averaged 10.6 percent returns annually. “But if you missed the best 50 trading days, your average return would have been just 1.8 percent annually.”
Contrary to many who fear stock market crashes, Andrew turns greedy. “After 9/11, I wanted the markets to stay down. I was hoping to keep buying into the stock markets for many years at a discounted rate.”
Rule 5: Build Mountains of Money with a Responsible Portfolio
Andrew suggests to own a percentage of bonds in your portfolio that is almost equivalent to your age. For example, if you are 30 years old, you should have 30% or less of your portfolio in bonds.
Comparing short term and long term bonds, Andrew prefers the former. “… buying bonds with shorter maturities (such as one- to three-year bonds) is wiser than buying longer term bonds (such as 10-year bonds). If inflation rears its head, you won’t be saddled with a 10-year commitment to a certain interest rate.”
The true value of bonds is not the interest payment. It is for the purpose of knowing when stocks are cheap or expensive. Over the long run, bond price and stock price are inversely related. Hence, when the percentage of bonds go up and percentage of stocks drop, you have to rebalance the portfolio by selling bonds dear and buying stocks cheap. It works vice versa. By rebalancing the portfolio, you will always buy low and sell high.
The other advantage is that bonds cushion your portfolio during stock market crash. If your drawdown is too big, you may end up in fear and sell your stock holding. A full stock portfolio would have dropped 20.15 percent in a 31-year period (1973-2004) while a 40 percent bond and 60 percent stocks would have a drawdown of only 9.15%. The difference in performance was just 0.7% (average annual return of 11.19% vs 10.49%).
Rule 6: Sample a “Round-the-World” Ticket to Indexing
In this chapter, Andrew talks about people practising index investing in different countries. Read this chapter for the detailed accounts of the portfolio performance.
A couple had families in Singapore and Canada and they set up a portfolio comprising securities form both countries:
- 20% – ABF Singapore Bond Index Fund
- 20% – SPDR STI ETF
- 20% – Canada’s Short-Term Bond Index
- 20% – Canada’s Stock Market Index
- 20% Vanguard World Stock Market Index
Rule 7: Peek Inside A Pilferer’s Playbook
This chapter exposes the agenda and motivation in the fund industry to grow their business.
For example, instead of taking care of the client’s interest first, one Canadian bank trained her staff to sell the highest fee fund if the client does not know much about investing.
Even large pension funds are moving away from active management and onto the index bandwagon. “… the Washington state pension fund, for example, has 100 percent of its stock market assets in indexes, California has 86 percent indexed, New York has 75 percent indexed, and Connecticut has 84 percent of its stock market money in indexes.”
Rule 8: Avoid Seduction
There are many investment scams out there and we have to resist the temptation of easy money. Also, he also suggest avoiding things like investment newsletters, high-yielding bonds, fast growing markets, gold, investment, investment magazines, and hedge funds.
Rule 9: The 10% Stock-Picking Solution… If You Really Can’t Help Yourself
He suggests that if you are not able to resist picking stocks, limit it to no more than 10% of your portfolio. This would not affect your overall financial success as long as you are disciplined by indexing 90% of your portfolio.
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