Read? Rich Man, Poor Man
MAKING MONEY: The most
popular piece I've published in 40 years of writing these Letters was
entitled, "Rich Man, Poor Man." I have had dozens of requests to run
this piece again or for permission to reprint it for various business
organizations.
Making money entails a lot more than
predicting which way the stock or bond markets are heading or trying to
figure which stock or fund will double over the next few years. For the
great majority of investors, making money requires a plan,
self-discipline and desire.
I say, "for the great majority of people"
because if you're a Steven Spielberg or a Bill Gates you don't have to
know about the Dow or the markets or about yields or price/earnings
ratios. You're a phenomenon in your own field, and you're going to make
big money as a by-product of your talent and ability. But this kind of
genius is rare.
For the average investor, you and me,
we're not geniuses so we have to have a financial plan. (CW8888: Ants can continue reading. Grasshoppers can stop here!) In view of this,
I offer below a few items that we must be aware of if we are serious
about making money.
Rule 1: Compounding:
One of the most important lessons for living in the modern world is that
to survive you've got to have money. But to live (survive) happily, you
must have love, health (mental and physical), freedom, intellectual
stimulation -- and money. When I taught my kids about money, the first
thing I taught them was the use of the "money bible." What's the money
bible? Simple, it's a volume of the compounding interest tables.
Compounding is the royal road to riches.
Compounding is the safe road, the sure road, and fortunately, anybody
can do it. To compound successfully you need the following:perseverance
in order to keep you firmly on the savings path. You need intelligence
in order to understand what you are doing and why. And you need a
knowledge of the mathematics tables in order to comprehend the amazing
rewards that will come to you if you faithfully follow the compounding
road. And, of course, you need time, time to allow the power of
compounding to work for you. Remember, compounding only works through
time.
But there are two catches in the
compounding process. The first is obvious -- compounding may involve
sacrifice (you can't spend it and still save it). Second, compounding is
boring -- b-o-r-i-n-g. Or I should say it's boring until (after seven or
eight years) the money starts to pour in. Then, believe me, compounding
becomes very interesting. In fact, it becomes downright fascinating!
In order to emphasize the power of
compounding, I am including this extraordinary study, courtesy of Market
Logic, of Ft. Lauderdale, FL 33306. In this study we assume that
investor (B) opens an IRA at age 19. For seven consecutive periods he
puts $2,000 in his IRA at an average growth rate of 10% (7% interest
plus growth). After seven years this fellow makes NO MORE contributions
-- he's finished.
A second investor (A) makes no
contributions until age 26 (this is the age when investor B was finished
with his contributions). Then A continues faithfully to contribute
$2,000 every year until he's 65 (at the same theoretical 10% rate).
Now study the incredible results. B, who
made his contributions earlier and who made only seven contributions,
ends up with MORE money than A, who made 40 contributions but at a LATER
TIME. The difference in the two is that B had seven more early years of
compounding than A. Those seven early years were worth more than all of
A's 33 additional contributions.
This is a study that I suggest you show
to your kids. It's a study I've lived by, and I can tell you, "It
works." You can work your compounding with muni-bonds, with a good money
market fund, with T-bills or say with five-year T-notes.
Rule 2: DON'T LOSE MONEY:
This may sound naive, but believe me it isn't. If you want to be
wealthy, you must not lose money, or I should say must not lose BIG
money. Absurd rule, silly rule? Maybe, but MOST PEOPLE LOSE MONEY in
disastrous investments, gambling, rotten business deals, greed, poor
timing.
Yes, after almost five decades of investing and talking to
investors, I can tell you that most people definitely DO lose money,
lose big time -- in the stock market, in options and futures, in real
estate, in bad loans, in mindless gambling, and in their own business.
RULE 3: RICH MAN, POOR MAN: In
the investment world the wealthy investor has one major advantage over
the little guy, the stock market amateur and the neophyte trader. The
advantage that the wealthy investor enjoys is that HE DOESN'T NEED THE
MARKETS. I can't begin to tell you what a difference that makes, both in
one's mental attitude and in the way one actually handles one's money.
The wealthy investor doesn't need the markets, because he already has all the income he needs. He has money coming in via bonds, T-bills, money market funds, stocks and real estate. In other words, the wealthy investor never feels pressured to "make money" in the market.
The wealthy investor tends to be an expert on values.
When bonds are cheap and bond yields are irresistibly high, he buys
bonds.
When stocks are on the bargain table and stock yields are
attractive, he buys stocks. When real estate is a great value, he buys
real estate. When great art or fine jewelry or gold is on the "give
away" table, he buys art or diamonds or gold. In other words, the
wealthy investor puts his money where the great values are.
And if no outstanding values are
available, the wealthy investors waits. He can afford to wait. He has
money coming in daily, weekly, monthly. The wealthy investor knows what
he is looking for, and he doesn't mind waiting months or even years for
his next investment (they call that patience).
But what about the little guy? This
fellow always feels pressured to "make money." And in return he's always
pressuring the market to "do something" for him. But sadly, the market
isn't interested.
When the little guy isn't buying stocks offering 1% or
2% yields, he's off to Las Vegas or Atlantic City trying to beat the
house at roulette. Or he's spending 20 bucks a week on lottery tickets,
or he's "investing" in some crackpot scheme that his neighbor told him
about (in strictest confidence, of course).
And because the little guy is trying to
force the market to do something for him, he's a guaranteed loser. The
little guy doesn't understand values so he constantly overpays. He
doesn't comprehend the power of compounding, and he doesn't understand
money. He's never heard the adage, "He who understands interest -- earns it. He who doesn't understand interest -- pays it."The little guy is the typical American, and he's deeply in debt.
The little guy is in hock up to his
ears. As a result, he's always sweating -- sweating to make payments on
his house, his refrigerator, his car or his lawn mower. He's impatient,
and he feels perpetually put upon. He tells himself that he has to make
money -- fast. And he dreams of those "big, juicy mega-bucks." In the
end, the little guy wastes his money in the market, or he loses his
money gambling, or he dribbles it away on senseless schemes. In short,
this "money-nerd" spends his life dashing up the financial
down-escalator.
But here's the ironic part of it. If,
from the beginning, the little guy had adopted a strict policy of never
spending more than he made, if he had taken his extra savings and
compounded it in intelligent, income-producing securities, then in due
time he'd have money coming in daily, weekly, monthly, just like the
rich man. The little guy would have become a financial winner, instead
of a pathetic loser.
RULE 4: VALUES: The
only time the average investor should stray outside the basic
compounding system is when a given market offers outstanding value. I
judge an investment to be a great value when it offers (a) safety; (b)
an attractive return; and (c) a good chance of appreciating in price. At
all other times, the compounding route is safer and probably a lot more
profitable, at least in the long run.