What is the purpose of building wealth?

The other day, I found myself reflecting on what exactly is the goal of wealth building. To answer that, we must dig deeper into the definition of wealth. Wealth includes:

  • the means to sustain ourselves, such as buying food, paying for shelter, and providing transportation and clothing
  • the money to buy other goods like cameras we can take pictures of our family or gasoline to travel and visit family
  • the ability to spend days visiting friends and family without worrying about work
Can you think of other key reasons you need to build up a storehouse of wealth in order to retire? If you haven’t, then you need to set aside some time and think about this. Why do you want to retire? Can you put it into words, or is it just some nebulous concept you are pursuing simply because everyone else is?
You see, wealth isn’t a means unto itself. There is an age old adage that says “family is more important than money.” But there is a twist, because it requires a certain amount of money to have the means to visit your family. My long term goal is to acquire enough wealth to comfortably enjoy retirement with my wife and be able to visit our family as often as possible. Now that last statement isn’t too complicated, but it provides an overall guidance on my plans to build wealth.
To accomplish my goal, I have already realized that putting money away in a 401K isn’t good enough. There is too much volatility. My own analysis of the last 60 years of market data shows that for any 20-year period of retirement, things swing too widely. It is possible to hit a big boom, but it is also possible to get passed up by inflation, which would halt any family time and instead force me to resume work. It really is a luck-of-the-draw on whether you hit a major downturn close to retirement or not. In fact, we are quite likely to hit a major downturn somewhere within five years before or after retiring. That is not good! Factor in things like taxes, and the returns of a 401K falls into dismal performance. 
My cash value life insurance policy will provide a nice chunk of tax free money. My dividend paying stock portfolio should also pay a nice chunk of money, partially tax free. Hopefully the rest will be at a better tax rate than my 401K could have produced. But, there is no way to tell. Tax laws are always the subject of election campaigning. But since I also plan to reduce my total tax exposure, I won’t be stressed about this when it’s time to retire. Instead of shouting at the TV set, I can instead be boating with my family on a pleasant day.
We have friends in Florida that we visit rather frequently when we travel to our town home in Florida. Just last week, they happened to be traveling up north, and stopped to stay with us for a couple days. It was fun! To fully enjoy it, I took off for a couple of days. My long term goal is to be able to enjoy those times without having to take any time off. When we travel to Florida, I work from my laptop, but in the long run, my plan is to retire so we can travel any time of the year and not worry about working.
That is what wealth building is all about. Building up enough wealth that you can go the places you wish without worrying whether you have enough vacation or holiday time. At least that is what it is for me. What is it for you? If you can’t say it in a couple of sentences, then try setting aside some time to  think about your long term plan. Don’t just drop some money into an account that you never think about. That isn’t a plan at all, and it can be the most expensive thing you never thought about! Remember, failing to plan is planning to fail.

Paul Graham discusses how to make wealth

I recently was pointed to a wonderful essay by technologist and start up founder Paul Graham. For those of you running in software circles, Paul Graham pursued LISP and even tried to build his own dialect of it, “Arc”. He has been involved in startup companies, which are a bit of a rage amongst software geeks, especially in the Bay Area.

In his essay, How To Make Wealth, Paul discusses some core points developers should understand before they dive into a startup company. While coming to grips with joining a technological startup, he sprinkles this essay with key elements of wealth building that stretch to any business. If you are reading this blog and are not a software developer, every word of this essay is still of high value for you to read.

Let’s visit some of the highlights.

Leverage

Paul discusses how a fresh, young software developer working for a big corporation could probably average $80,000/year in salary. If you worked at a startup, it is not unreasonable to assume your work would be better valued at around $3 million. This may sound ridiculous, but when you move into a startup environment, a lot of barriers are removed, empowering you to build a lot more wealth than you ever imagined was possible.

But the demands rise as well. As I mentioned before, when you trade up for higher performance, it’s possible to move a bigger load. That is the nature of leverage. And no lever is of any value if it’s not used. So don’t expect that you can join a startup and not be expected to carry much more than a typical corporate job. The other half of that coin that Paul points out is that no one expects you to work at that rate forever. The idea is to generate enough value and growth that your company is either acquired, goes IPO, or some other aspect where you ultimately get paid off and possibly catapulted into better prospects.

Money is not wealth

Moving beyond the subject of software startup companies, Paul makes several powerful points. One of the biggest is the fact that money is not wealth. Money is simply a medium we use to exchange with other people. Wealth is what you build. There are strong opinions on what is and isn’t wealth. If you dig deep into the arguments that are out there, many of these boil down to two opposing viewpoints: either there is a fixed amount of money/wealth in the world, or there is a variable amount.

Would you would like to be the richest person in the 1600s or a relatively poor person in today’s age? Most people quickly answer they would prefer what we have now. The reason is that we have more now than people have ever had before. This is the result of generations of people building new wealth, not simply moving existing wealth around between different people.

There is a great inertial force at work. Each person that is born will work a certain amount of time, generating a certain amount of wealth for society. One big criticism from fixed wealth believers is that a new invention, like the cotton gin, is invented, it puts existing laborers out of work, essentially rerouting the wealth they were generating. But these people don’t simply go home and stop working forever. Instead, they find new jobs, new pursuits, and redirect their existing energy into other places, continuing to create wealth in other places.

Work smarter, not harder

It’s really interesting that every now and then, I pick up some amazing insights from my daughter’s favorite cartoon: Duck Tales. In one episode, Scrooge McDuck is explaining to his nephews how he got wealthy. He repeats several times, “worker smarter, not harder.” There is no harm in working hard, but spinning your wheels and not creating much isn’t going to be effective in your wealth building plan. A critical factor in growing wealth is building something people actually want and working strategically to get that product into as many hands as will buy it with as much efficiency as possible. Your first instinct may be to double your hours of assembling your product, but it may be better leverage to automate some or all of the process. There is risk in that you may need a loan or entertain bringing on board an investor. But if you can succeed at building more without burning more hours, your time may better serve at visiting more stores to develop more sales.

Another type of leverage are the tools you use, and the means you employ to reach as far as possible. One of the reasons Facebook was so successful is because it a) provided something people wanted (socializing with current friend and finding past ones), b) it was free, c) ran on any computer with no effort, and d) sold ads to companies that wanted to get inserted into all this networking we as humans enjoyed. We already mentioned that more physical labor may not the best step to take. Technological leverage like developing a web site to market and sell your business is of undeniable benefit in today’s society.

Wrapping it up

One of the most interesting things I found in Paul’s essay towards the end was comparing small businesses with big ones. Paul compares this to a big person chasing a small one. When you reach a decision on what to add to your business, consider it as a choice to either run downstairs (easier) or upstairs (harder). In all likelihood, the small guy can run faster than the big guy upstairs. This creates a bigger lead for the little guy, which can materialize as wealth your business creates that your big competitors can’t keep up with.

Yes, this essay may be long, but it is definitely worth a read if you are thinking about running your own business or joining a new, small startup. If you are working on your wealth building plan, consider this essay a valuable lesson plan as well. Perhaps it will inspire you start your own business.

Go anywhere funds that really go nowhere

I chuckled as I saw an article today posted on Fidelity.com titled “5 funds that ‘go anywhere’ for a smoother return.” It involves a new “type” of mutual fund. They are called ‘go anywhere’ funds, meaning the fund manager isn’t constrained to the usual set of restrictions, like only investing in certain types of asset classes, or adhering to a certain proportion of stocks vs. bonds. Some of the quotes are really quite telling.

“The so-called Lost Decade proved that we don’t need to rely on large equity allocations to seek meaningful returns,” says Rob Arnott, chairman and founder of Research Affiliates and manager of the PIMCO All Asset fund (PASDX), noting many investments, including high-yield bonds, emerging market debt and commodities, offer equity-like returns. Yet, because of the complexities of these assets, there’s value in having an expert calling the shots on when to move in and out of these alternatives.

Is it just me, or is this manager now telling us that asset allocation doesn’t work? Not wanting to put words in his mouth, let’s see what another manager quoted in that article says:

Because the funds potentially can go anywhere, they may throw a wrench in your overall asset allocation but “that’s not always the worst thing,” says Waddell, explaining there are times when it pays to have a good manager making big-picture calls on your behalf. Still, it’s not a bad idea to see how such a fund will mesh with your other holdings by taking a look at the manager’s track record and current holdings.

It seems both Arnott and Waddell are telling us that it wouldn’t be the worst thing if the fund manager was able to go out and simply pick what is best and had the best deal. From 10,000 feet, it sounds like the same approach taken by Warren Buffet. He seeks out companies that are different sectors, ranging from insurance to jewelry stores, to shoe makers, to brick manufacturers, to carpet makers (and that ain’t the half of it!) But people none-the-less keep throwing stones at Warren Buffet even though he consistently beats the S&P 500.

Looking towards the bottom of the article, I notice a matrix showing the performance of five such funds. Strangely, they didn’t list all the ones actually mentioned in the article. I guess it is only the “go anywhere” funds that are sold by Fidelity. Though they mentioned 10-year returns in the article, I only see 1, 3, and 5-year annualized returns in this matrix. Why is that? Is the 10-year performance not too hot? Well the best one only sports an 8.23% 5-year return. With a 0.76% expense ratio, it would appear that my total gain (before taxes) would be 7.47%! Subtract 30% in taxes (5.23%) followed by by 4% inflation, and all you get is 1.23% gain. Not too good for long term wealth building in my opinion! Not to rub salt into your wound, but the article touts that these funds are doing better than 85-95% of the other mutual funds. Yikes!

And why are they coming up with these new strategies? Because the other ones crashed and burned over the last decade! People jump ship when mutual funds nose dive, so the Wall Street salesforce needs to offer something “new and exciting” that people are willing to buy, causing a reaffirmation of our human nature to sell to stop losses, i.e. sell low, and then buy on the upswing, hitting the high point, and killing our overal wealth building performance.

Bottom line: if 1.23% gain is what I have to look forward to, then you can count me out of trying use mutual funds to build my retirement wealth. But let’s at least adhere to the tail end of the second quote: “it’s not a bad idea to see how such a fund will mesh with your holdings by taking a look at the manager’s track record and current holdings.” Indeed, let’s check what the managers track record looks like over a 20 year period. Because that is the traditional time window we really have.

Cross posted from http://blog.greglturnquist.com/2012/05/go-anywhere-funds-that-really-go.html.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Your 401k won’t create wealth

If you are paying income tax on your cash flow that is too high in your opinion, then there are many strategies that could lighten that road not using an 401K investment strategy. The real issue is would you rather pay taxes on input or output? So you input $100,000 and have a $250,000 output. Which would you rather pay taxes on? Personally, I have learned there are many options to deal with the tax issue on my income/cash flow. But when you are retired and are FORCED to take cash flow from your 401K and incur income tax there are much fewer options. The popular one for most financial planners is to be so poor as to not have to pay a high income tax rate. There are some real reasons why I think most 401K plans are a fools paradise (low rate of returns, loss of control, penalties for access, more net tax obligations, etc.) but for most folks who are employees I think the biggest one is the con job Wall Street has done convincing them that this retirement strategy can become one’s primary retirement income. Nothing wrong with funding a 401K if your company is matching you up to the match, but if that is all you got you are in trouble. That is why I show people how to build real wealth in other vehicles and then suggest they have a EIUL to protect them from premature death and the tax man. I think that the 401K/EIUL comparision is a straw man argument because both are poor wealth creators. Better put that $15K/year into investment real estate and have some real time tax protection, build wealth, and then protect it with a EIUL. You see it is the plan that is important and how each strategy fits into the plan. I just don’t think buying mutual funds is much of a wealth building plan whether you get a tax break from it or not. You don’t think that the government designed the 401K to decrease tax revenue do you? –David Shafer, http://www.bloodhoundrealty.com/BloodhoundBlog/?p=3203 

 That comment is one big nugget of wisdom when it comes to investing for the future.

You especially can’t escape the simplicity of David’s closing sentence, “You don’t think the government designed the 401k to decrease tax revenue do you?” We BOTH know the answer to that!

Cross posted from http://blog.greglturnquist.com/2012/05/your-401k-wont-create-wealth.html.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.