Monthly Archives: May 2016

Book review: The Millionaire Next Door by Dr. Thomas J. Stanley


Book cover. The Millionaire Next DoorBooks at great bargain

I bought this book at a second hand store for only $2. The regular price was $10.99. That’s an 80% discount for a book which is just as valuable today as when it was written in 1996. One of the millionaire’s habits is to constantly be on the lookout for good value.

The irony of Dr. Stanley’s death

Unfortunately Dr. Thomas J. Stanley (1943-2015) left us last year after a fatal car accident. He was a fantastic writer of business books. He wrote many New York Times’ best sellers including The Millionaire Next Door and The Millionaire Mind. The ironic thing about his death is that after a lifetime of pontificating abstinence and frugality, he died while driving his brand new, luxurious Corvette.

Having a beer with a few friends
Having a beer with a few friends

Are you a PAW or a UAW?

Dr. Stanley divides people in two categories: Prodigious Accumulators of Wealth (PAW) and Under Accumulators of Wealth (UAW). He creates this division by using a formula. He multiplies the person’s age, times their annual income, times 10%. If your net worth is above that number, you are a PAW. If your net worth is below that number, you are a UAW.

Let’s experiment, let’s see if I am a PAW or a UAW.

I’m 49 years old.
My income is about $18,000 per year.

49 old X $18,000 X 0.10 = $88,200

My net worth is about $150,000, so according to this formula, I am a Prodigious Accumulator of Wealth (PAW.) Yeeeaaahhh.

Try it! Are you a PAW or UAW?

The book goes on to describe the habits of millionaires and of people with high incomes who are not millionaires.

Dr. Stanley doesn’t tell us exactly the sample size, nor how he managed to have so much face time to interview all the subjects of his study.

I really enjoyed the book and I think everyone who wishes to be a millionaire should read it. It shares many of the principles and ideas that I am implementing to become a millionaire.

At the same time, I think that the book is highly deceiving favoring the romantic idea of a person who starts from a humble background and who through decades of self sacrifice, deprivation and hard work, becomes a millionaire.

Almost all the subjects covered in the book were self employed, white male, blue collar workers. In his samples, there were no females, no movie actors, no sport celebrities, no CEOs from big companies, no rich traders from Wall Street, no programmers from Silicon Valley or the equivalent from that time. Where were all those millionaires? They were nowhere because they don’t fit the ideal character which Mr. Stanley portrays in his book. Although I loved the book, it’s credibility is highly questionable.

Although I don’t believe the research, I believe that the lessons shared are of great value to anyone who wants to increase their wealth. Here are some of those lessons:

Spend less than you earn

According to the book, all the millionaires had frugal wives and they owe their wealth, in part, to the wife’s ability to cut coupons.

I am a deep believer in the “spend less than you earn” philosophy, but I think he could have found better examples than frugal wives.

Avoid buying status objects or leading a status lifestyle

There is a lot to say about this subject and there are many anecdotes to support it, but it boils down to spending less than you earn.

Willing to take a risk

Since most of the millionaires were business owners, they all took the risk of starting their own businesses. It’s hare to become rich when you depend on a salary.

Inter generational lessons

Dr. Stanley claims that sons of high consumers become high consumers and sons of frugal people become frugal. In short, your destiny is predetermined by the habits of your household. It is ironic that most of these millionaires were self-made millionaires from humble families. Yes, your family habits and background can influence your future, but all of the alleged millionaires overcame those odds.

Conclusion

Although the book is portrayed as  serious research, I see it more as a depiction of the fictional character that Dr. Stanley had of the ideal millionaire. All the millionaires of the book became millionaires for the sake of becoming millionaires. They deprived themselves from their own money during their whole life.

Here’s the story of Mr. Ronald Read a Vermont gas station attendant and janitor, who had a portfolio of $8 million dollars by the time he died at 92. He accumulated that much wealth by saving, investing wisely, and being frugal. Mr. Ronald Read never enjoyed any of his own money. This is The Millionaire Next Door.

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Dragon boat with friends

Save by taking money off the top

Dragon boat with friends
Dragon Boat with friends

Money can’t buy you happiness but it can eliminate a lot of unhappiness

Most of us have dreams and ambitions. Realizing those dreams and ambitions could be so much easier if we have some financial comfort. For example, if you want to spend a vacation in the Caribbean, you need money. If you want to help less privileged people, you need money. Money is the medium of exchange which can help you realize your dreams and ambitions. Money does not guarantee happiness but it can eliminate a lot of unhappiness. It’s a great relief when you don’t have to worry about money for essential needs such as food, shelter and medicine.

How do we make sure we have enough money to cover our essential needs and to achieve financial security?

It’s my belief that anyone in North America (and in most industrialized countries) has an opportunity to make money. Since the arrival of the sharing economy, anyone with an extra room can create extra income ( affiliate link ) and anyone who knows how to drive can start earning some money with Uber ( affiliate link). For the first time in North American history, women have an equal opportunity to earn money as drivers (See this article by the National Post). And there are so many other ways in which a person can start earning money almost immediately. You can earn money by walking dogs. You can earn money by putting together Ikea furniture. The idea is to start earning money today while you build a medium-term and a long-term plan to continue earning money in the future.

Money is a tool with great leverage capabilities. For example, if you want to buy a $200,000 house and you have good credit, you can give a down payment of only 5% ($10,000). If your house goes up in value 5% in two years ($210,000), you would have made 100% return on your investment.

But, in order to acquire this fantastic tool that you can use as leverage to realize some of your goals, you need to start saving today.

OK, so how do you save money?

Most personal-finance books and/or websites advocate the use of budgets. Budgets to track your spending habits and to make sure that you don’t spend too much in consumer items such as lattes, restaurants, and designer clothes.  Hopefully you will notice all the ways in which your money is being mismanaged and you will fix it. The problem with creating a budget is that no one likes to budget.

I don’t like to budget either, that’s why I suggest to save by taking money off the top, to pay yourself first, even before the government takes its cut. Talk to your employer or to your bank and ask them to automatically take a percentage of your paycheck and to deposit it into your registered retirement account.

Reduce your tax bill by saving for your retirement

When you take money off the top and put it into your registered retirement account, you are also reducing your taxable income.

Here is a quick example: Let’s say you earn $40,000 per year. If you take $10,000 and put it into your registered retirement account, your taxable income is only $30,000. You pay less taxes because you’re in a lower tax bracket.

Unfortunately, ours is a progressive tax system ( I prefer to call it “oppressive” ), which means that if you earn more, you are taxed at a higher rate. In Canada, at the upper scale, people are taxed way in excess of 50%. Can you imagine? More than 50% of your work is taxed away from you.

Start saving today, even if you save a small percentage

My suggestion is to start saving 10% of your income. For many this is a big move. If saving 10% is too much, then start saving 5% or even 2%. The important thing is to get started. Once you get started, once saving money becomes a habit, then you can gradually  increase the percentage of your savings year after year.

My saving habits

Once you have decided to save a percentage of your earnings, then you need to figure out how to live with what is left over. Life is made of a thousand small decisions. This is how I go through the process of spending less so that I can save more.

  1. I don’t have cable. When I want to watch a movie I use Netflix. A great movie which was released two years ago, is still a great movie today. Movies don’t go bad after two years.
  2. I buy my clothes at Walmart. I am not endorsing Walmart, but I think it is dumb to spend $80 for a pair of designers jeans when I can pay $20 for normal jeans. Also, I only buy new clothes when my old clothes begin to tear.
  3. I cut my own hair. One day I was frustrated because my favorite barber (the one who only charges $15) was too busy. I went across the street to his competitor who charged me $35 for a haircut that wasn’t any better. I was so upset with the price that I went to buy my own hair cutting machine. It took me half an hour to learn how to cut my own hair and now I have become an expert. I spend 5 minutes cutting my own hair every Tuesday and the cost is $0.00. I believe Mr. Money Mustache also cuts his own hair.
  4. For transportation, I prefer my bicycle, then public transportation and finally Uber. Taxis are too expensive.
  5. Recently a friend of mine invited me to celebrate her birthday at an expensive restaurant. In spite of liking this friend very much, I decided not to go. My budget for restaurants is $20 or less.
  6. For wine, I try to stay below the $10 price range.
  7. I have a thing against Apple products. I think they are too expensive. My Android phone does just as good a job sending texts for a lot less money.

How about you? What are your money saving strategies? What are your consumer habits? In which ways are your frugal? In which ways do you spend too much?

I know many of you don’t agree with me in one way or another, please feel free to speak your mind.

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The case against the “Buy and Hold” strategy


f2Enticing Investment Headlines

We’ve heard it all over the news, on TV, in the papers, on the radio, the internet and every communication medium there is. Here’s the typical headline:

  • Hot stocks to own for 2016
  • Undervalue stocks you must buy NOW
  • Stocks with amazing growth potential
  • Here is the new Apple

Every reporter has a story to sell, a reason to pitch a company. Your financial advisor has some recommendations of his own. Even your Uber driver will tell you to buy.

However, no one tells you to sell.

When to Sell a Stock

It is my belief that knowing when to sell is as important, or even more important than knowing when to buy.

According to Hewitt Heiserman author of the book “It’s Earnings That Count,” only 25% of the stocks in the US stock market accounted for 100% of its gains. The other 75% broke even or lost money. He also claims that 1 out 5 stocks has gains in excess of 300%. Conversely, 1 out of 5 had losses of over 75%.

If you look at the NASDAQ for example, most of its gains have been driven by a few stocks such as Apple, Google, FaceBook, and Amazon.

The way I see it, there is one way to significantly tilt the chances of winning  in your favor: to sell the stocks which are draining your resources and of course, keep those who continue reaching new highs.

Create systems to buy and sell stocks

I believe that every investor should have systems. There are many systems which can work as long as the person sticks to it and creates some selling rules.

For example:

  • Invest dividend paying stocks. And sell as soon as the stock stop paying dividends.
  • Invest in companies with net profits. And sell as soon as there is a loss.
  • Invest in companies with increasing earnings. And sell when earnings stop increasing.

There is one thing for sure. Even the best companies will eventually go down. Backberry has gone down from $148 in  June’08 to $6 May ’16? If you don’t know when to get out, if you don’t have selling rules, you might end up with a net loss.

You might say: Well, the Dow Jones and the S&P 500 are great indexes to invest over the long term.

That is completely right. But even major indexes like the Dow Jones and the S&P 500, they don’t just buy and hold. They have a system. They have a set of requirements for companies to be part of those indexes. Once a company doesn’t meet those requirements, that company is kicked out of the index.

A word from legendary stock traders

Here is a great quote from legendary trader Nicolas Darvas from his book “How I Made $2,000,000 in the Stock Market

“I have no ego in the stock market. If I make a mistake I admit it immediately and get out fast. If you could play roulette with the assurance that whenever you bet $100 you could get out for $98 if you lost your bet, wouldn’t you call that good odds?”

In the stock market we have this opportunity to get out of a position and to limit our losses.

Here are some lessons from trader and entrepreneur William O’Neil author of the book “How to Make Money in Stocks.”

“I make it a rule to never lose more than 7 percent on any stock I buy. If a stock drops 7 percent below my purchase price, I will automatically sell it at the market – no second-guessing, no hesitation”

“The whole secret to winning in the stock market is to lose the least amount possible when you’re not right.”

 

Here is another lesson from legendary trader Bernard Baruch:

“If a speculator is correct half of the time, he is hitting a good average. Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong.”

Conclusion

Learning when to sell is more important than knowing when to buy. For example, let’s say that you buy  100 companies at random. If you believe Mr. Hewitt Heiserman, 1 out 5 of the stocks will have gains in excess of 300% and 1 out of 5 will have losses in excess of 75%.

If you follow William O’Neil’s advice to sell when a stock trades below 7% of your purchase price, you can eliminate all the big losers and you can let your winners ride. If your winners start going down, let’s say 10% to 15% from its top price, you sell them  and lock-in those gains.

Do you have a buying strategy? Do you have a selling strategy? Share it with the rest of us.

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“Buy And Hold,” Money managers don’t follow their own advice

Spending time with friends
Spending time with friends

Practically every financial adviser in North America gives the same piece of advice to their clients:  “buy and hold”. Of course financial advisers have a strong economic incentive to keep your account in their books, they don’t want you to sell because they get a trailer fee of 1.5%. This fee is paid to the adviser for as long as the client stays invested. .

A common meeting between financial adviser and client
  1. You meet your financial adviser. Either you choose someone at random at your local bank or one arrives at your kitchen table because a friend or a family member referred him.
  2. The adviser asks a few questions to determine your risk tolerance so that they can classify you in one of five investment risk tolerance categories. These categories are: Conservative, Moderate Conservative, Moderate, Moderate Aggressive, and Aggressive.
  3. Once your risk tolerance has been identified, the adviser chooses one of their company’s mutual funds and buys it for you.

If at any time the value of the mutual fund goes down in value and you call in order to inquire about your account, you are told in firm terms. “Our strategy is to buy and hold.” You are told to hold until you need the money, and if you cannot handle the volatility, you are advised to switch to a more conservative category.

Given this piece of advice, “to buy and hold,” do you think that mutual fund managers follow it themselves?

Of course not.

While investors are told to buy and hold, many mutual fund companies have a portfolio turnover of over 100%. This means that 100% of the securities within the fund are replaced over the span of one year. It is not uncommon to see portfolio turnover as high as 500%. This is not the buy and hold strategy which is pushed down your throat.

Side note: The turnover of Index Fund is close to zero, but a financial adviser would never recommend and Index Fund because Index Funds don’t pay any trailer fees.

How is a portfolio with a high turnover a detriment to a mutual fund’s performance?

Lots of commission. The more turnover, the more buying and selling. The more buying and selling, the higher the commission expense. The higher the commission expense, the less money for you the shareholder of the mutual fund. .

Bid and ask spread. Stocks always have a price spread. For example, someone might be willing to sell shares of Royal bank for $21 and someone might be willing to buy shares of Royal back for $20. The difference of $1, between the bid and the ask is called the spread. When a mutual fund wants to buy, they buy at the “Ask” price and when they want to sell, they sell at the “Bid” price, therefore they are always losing on the spread.

Market impact. The size of a big order to buy stocks can influence their price. Imagine that a mutual fund wants to buy one million shares of Royal Bank which is trading at $20. The mutual fund buys all the available shares which are selling at $20 and in order to buy more they have to offer more money, let’s say $21, and if they buy all the shares available at $21, then they have offer to buy at $22 in order to be able to buy more shares. The bigger the quantity of shares a fund buys, they bugger the impact they create in the market and the more they end up paying for the shares they want.

Taxes. When a mutual fund buys and sells stocks, some of them are sold at a profit. When stocks are sold at a profit it triggers a capital gain. When there are capital gains, there are taxes to be paid. Unfortunately, it is owner of the mutual fund, you, the individual investor who ends up paying those taxes.

Why do mutual fund companies have high turnovers?

There are two main reasons.

Seeking for Alpha: Mutual fund managers are always trying to outperform their peers and their benchmark. If they outperform their peers and the benchmark, they will want to use that outperformance for marketing purposes. In order to outperform, they are constantly buying companies they think will outperform.

Window dressing: Every quarter, mutual fund companies disclose to their clients the names of the companies they are holding. Right before the disclosure, they get rid of all their losing stocks and they purchase the most popular stocks of the quarter. This activity give the impression that the fund always has the best stocks in their portfolio.

Conclusion:

Statistic research shows that buying and holding good companies is a long term profitable strategy. If investment advisers want their clients to follow that strategy, maybe they should make sure the mutual funds they recommend also follow the same strategy.
What should an individual investor do? If you have a financial adviser, tell him that you like a buy and hold strategy and for that reason, you want to invest in mutual funds company which follow this philosophy. To be more precise, you want to invest exclusively in Index Funds and/or ETFs.

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