“The essence of strategy is choosing what not to do.” – Michael Porter
How to Make More Money Than Wall Street Wants You to Make
The investment “advisory” business in America is a huge, multibillion-dollar industry populated with smart, sophisticated, and ambitious people. It’s a world in itself, supported by computerized systems and algorithms equal to or better than NASA. But it’s at least partly based on one widely accepted and respected lie.
The lie is that you can grow wealthy safely and surely by investing in some sensible combination of stocks and bonds.
It’s not a big, black lie. Because it’s sort of true… can be true… has been true… at certain times, in certain circumstances, for certain people.
The truth is that limiting your wealth-building strategy to stocks and bonds is a mistake. In most cases, a big mistake.
When you limit your investing to stocks and bonds, the best you can hope for over the long term is to make an average return for stocks and bonds. That’s about 5.5% for non-taxable government bonds and 10% for taxable stocks. Most financial advisors recommend, depending on your age and net worth, a split between stocks and bonds of 60/40 to 40/60. That would give you an average return of about 7% to 8%.
The easiest and cheapest way to achieve a long-term return of 7% to 8% would be to buy one no-load stock fund (like the Vanguard 500 Index Fund) and one bond fund (like the Fidelity Total Bond Fund). Index stock funds and total bond funds are designed to track the markets – i.e., give you returns equal to the stock and bond markets. Limiting yourself to one reliable stock fund and one reliable bond fund is the simplest and easiest way to achieve that sort of 7% to 8% long-term result.
And that’s not bad. You can, indeed, become wealthy that way if…
* You start with a sizeable one-time investment of, say, $100,000, or…
* You contribute a sizeable amount of, say, $10,000+ each and every year, and…
* You have 30 or 40 years ahead of you before you retire.
Or you can try to beat the averages by doing your own research and/or getting advice from a broker and creating a portfolio of individual stocks/bonds of your choosing. If you are going to do that, be prepared to work hard and be very disciplined. Most individual investors that take this route end up achieving average returns that are actually much lower than stock and bond market averages. Instead of getting the 50+% returns they are hoping for, they actually earn, on average, less than half the 7% to 8% they could get by investing in index funds.
If you opt for putting all your investment dollars into conservative stock and bond funds, you have to be satisfied with the 7% to 8% returns you will probably achieve. But if you’d like to earn more than that safely, there are ways. I am going to tell you about one of them. One that I know very well… because I developed it myself.
A Different Approach to Building Wealth
This is not some theoretical strategy I learned from reading books on investing or talking to financial advisors. It’s the result of making and losing money over the course of many years.
Like any strategy, it has don’ts and dos. The don’ts are those investment schemes that looked great when I first tried them, but failed me in practice. The dos are the few that worked for me consistently over time.
One of the reasons this strategy worked for me – and may not for you – is that it was calibrated to my own particular wealth-building mentality. (See Monday’s blog.)
For one thing, I am not much interested in the game of investing. I find it tedious, even boring. I don’t believe it actually is tedious and boring. The best investment analysts are not just smart but also immensely interested in the subject matter of investment. I’m not. So that’s something to keep in mind.
Second, I am deeply and purposefully lazy. I am always looking to get the best result from the least amount of work. I shouldn’t say the best result. I should say a satisfactory result. If I can score a 90 on a test by studying one hour and a 100 by studying 5 hours, I am satisfied with the 90.
Third, I am a fast but not a careful thinker. I like gathering what seem to be the important facts, and then coming to quick conclusions about them. I don’t like reviewing details. And I definitely don’t like reviewing my decisions, if I don’t have to.
And finally, although I am not, by nature, a patient person, I have learned to be patient about building wealth. That means my approach is appropriate for you if you have at least 10 years to let it do its magic.
These characteristics rule out my involvement in a few perfectly good investment strategies. Strategies that some of my more industrious, punctilious, and thoughtful colleagues in the investment advisory industry embrace. That’s fine with me. We have to work with who we are.
In short, you can think of what follows as…
A Quick and Lazy but Safe and Sure Way to Grow Rich
- Stocks – I have three stock portfolios. One (which I call The Legacy Portfolio) contains about a dozen big and reliable Warren Buffett-type companies like Nestle and Coca-Cola. A second (Legacy Two) contains half a dozen companies like Amazon, Apple, and Alphabet. And a third (Junior Legacy) is a smaller portfolio of mid-cap stocks. Stocks currently represent about 15% of my net investible wealth. (My net worth minus my residence and possessions I would never sell.)
- Options – Although my cardinal rule is to not invest in something I don’t understand, I found a way to trade options that I actually do understand. Like real estate and insurance products, many options strategies are essentially leveraged speculations. So, I steer clear of them. But the way I do options – selling puts on high-quality stocks that I want to own – has so far worked well for me. Still, I’ve limited my activity to only about 3% to 4% of my net investible wealth.
- Direct Investments in Entrepreneurial Businesses – I’ve been an investor in private, start-up companies for more than 30 years. I learned early that when I put money into businesses about which I know nothing, I get back nothing. (As in: I lose all my money.) Today, all the money that I have in private businesses are in companies that sell information via direct marketing. A business I know very well. I have only two rules that I follow for private placement deals: (1) I have to know the business inside and out, and (2) I have to have a controlling interest in it, which means the ability to approve key decisions. My initial investments in private businesses were almost all shockingly small, but they now represent about 32% of my net investible wealth.
- Pre-IPO Deals – This is where I violate my rule about not investing in things I don’t understand. A friend of mine has made a successful career out of investing in private businesses that are on the verge of going public. He is very good at this sort of thing. He is smart. He is careful. And he does his homework. (He is actually an advisor to one of the celebrity investors on “Shark Tank.”) So when he started his own recommendation service, I joined it. But although I have great faith in his abilities and expertise in making the individual buy and sell decisions, I consider this activity to be a form of gambling and I’ve limited my exposure to less than 1% of my net investible wealth. To be clear, I’m not recommending this as a safe way to build wealth. If you like this game, consider it like you would backing an expert player in a game of poker. It’s not as risky as roulette, but it’s better than playing yourself.
- Fixed-Income Bonds – At one time, bonds (AAA-rated municipal bonds) represented as much as 40% of my net investible worth. Today, they are less than 4%. My strategy was always to buy them in “ladders” and hold them until maturity. But I haven’t bought them since the rates dropped below 4%. When rates hit 6% again, I’ll probably start buying again.
- Private Debt – I’ve been lending money privately for about 30 years. About half of these loans are mortgages, secured by the property. The other half are business and personal loans. I made some bad investments doing this early on – some to friends and family members, which was awkward and embarrassing. Nowadays, I make only collateralized loans and I demand interest payments to start immediately. My private debt investments are about 5% of my net investible wealth.
- Rental Real Estate – Next to direct investments in start-up companies, investments in income-producing real estate have been the largest contributor to the growth of my wealth. I follow a strict rule about how much I will pay for a property that is based on the income the property is currently producing. I expect immediate cash flow of 6% to 8%, plus long-term appreciation of 4%. Whenever possible, I buy properties whose value can be increased by making inexpensive improvements. The formula is simple: Fix them up. Raise the rents. And then leverage my position with bank financing. (Because rental real estate is local and simple, leveraging properties with bank financing is usually a very safe proposition.) Rental real estate represents about 25% of my net investible wealth.
- Land Banking – Although my preference is to invest in current income rather than future appreciation, I have bought about a dozen parcels of land over the years in the US, Canada, Central America, and Europe. Since my bet here is that these assets will appreciate in the future, I consider them to be speculations, not investments. Land banking represents about 5% of my net investible wealth.
- Gold and Silver – I bought a bunch of gold coins some years back, when gold was selling for about $400 an ounce. I also bought some silver and platinum coins. These have appreciated more than four times, as you know. But I didn’t buy them to increase my wealth. I bought them as insurance against the remote chance that there will one day be a collapse of the dollar and a subsequent deep, inflationary depression. If that happens, these coins will be very valuable. In the meantime, they make me feel like I have the threat of financial Armageddon covered. Gold and silver coins represent about 4% of my net investible wealth.
- Crypto Currencies – About a year ago, I bought a small basket of five crypto currencies – bitcoin and Ethereum and three of the other usual suspects. I bought them not because I believe they will replace the dollar, but because I wanted to be able to say I did if they eventually do. Like the money I put into pre-IPO deals, I consider this activity to be a form of gambling. And since I think of gambling as spending, not investing, I limit my total exposure to an amount I wouldn’t mind losing. Thus, my investment in cryptos is less than 1% of my net investible wealth.
- Collectibles – I’m a big fan of investment-grade collectibles because they are tangible, portable, non-reportable, and provide the pleasure of looking at them while they appreciate. My preferred collectible is investment-grade art. But I also have modest collections of first-edition books, vintage cigarette lighters, watches, and rare coins. Since I have experience and some expertise in the markets I deal in, I consider these to be smart speculations. Altogether, my collectibles represent about 10% of my net investible wealth.
- Cash – The amount of cash that I have at any time depends on the state of the economy (precarious now), the stock market (overvalued but with room to rise), the bond market (rates are unattractive), and any opportunities in business and real estate that present themselves. Right now, my cash holdings represent about 5% of my net investible wealth.
As I said above, my strategy isn’t the ideal strategy for everyone. I don’t think it’s the best possible example of diversification for people that are younger or older than I am, richer or poorer, or have different emotional and intellectual inclinations. But the overall approach has done well over the years, and its diversity and balance are just right for me.
Most importantly, it reflects my strongest belief about building wealth: To get the best result, you have to go beyond stocks and bonds.
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