I read The Wealthy Barber (which I recommend) recently and it changed (or reinforced) my thinking in a few key areas:
For most people, investing success is dependent on strong personal finance habits
The potentially more valuable point here is a broader one - choosing what you focus on is critically important. You won’t receive your desired outcome if you don’t understand the true drivers (inputs) of your desired outcome. If investing success is your desired outcome, but you don’t get the personal finance piece right (you have a negative savings rate) or you don’t control your emotions (you buy speculative “hot stocks”) you won’t achieve investing success.
You should be able to save more than $300k by implementing the tips in the book (with common sense investing)
Mr. Chilton recommends setting aside 10% of your salary for savings. Once you have set aside a decent amount (possibly enough to cover 3 to 6 months of expenses) in a standard savings account as an emergency fund, he recommends investing your 10% in low-cost equities (Wealthfront or Betterment are great options). This insight has the potential to be a game changer for your average family. When you run the numbers you see that a mid-career, middle-income family could expect their savings account to be worth well over $300k by the time they retire (in addition to their retirement accounts).
A dollar saved is two dollars earned
We have all heard “a penny saved is a penny earned” but that turns out to be incorrect. If you grab your most recent itemized paycheck you should be able to quickly prove this point. For each $100 you are paid, how much goes to Federal Taxes, State Taxes, Medicare, Retirement, Health Insurance Premiums, etc. It’s likely that somewhere between $30 and $50 of each $100 you make disappears with taxes and other deductions. So, each time you decide to spend a dollar think about how much you have to “earn” to pay for that expenditure… it’s close to two dollars. Understanding this helps to reframe the true cost of purchases.
I want to briefly focus on the first point because it can be applied broadly. In order to determine success, one has to define a successful outcome. We frequently talk about investing here, so let’s start by considering investing success as our ideal outcome. If investing success is your goal what is the first thing you should focus on to achieve your goal? It’s certainly not asset allocation and it’s probably not even taxes or fees (this assumes you aren’t already independently wealthy). In order to achieve investing success, you are going to have to create money to invest… which is dependent on your personal finance habits. To farther illustrate this point, I’ve leveraged the USDA original food pyramid (which was used from 1992 - 2005). I remember this vividly from my childhood; it seemed to strongly imply that “bread, cereal, rice, and pasta” were good and the foundation of a healthy diet. While fats and oils were bad (there is significant controversy about how these recommendations were made by the USDA and what role the wealthy companies in the food industry played in crafting these recommendations). For our purposes, let’s disregard if the food pyramid is right and focus on the story it tells. If we tried to make a “food pyramid” for investing success it might look like the second image below.
The USDA's original food pyramid, from 1992 to 2005.
Simple “investing pyramid”
I hope our “investing pyramid” illustrates the appropriate story. Your natural tendency is first to seek advice on your asset allocation strategies, but when you do that you are focusing on the wrong thing. Before you worry about asset allocations, set your foundation with strong personal finance strategies that enable you to invest more money, minimize your taxes and fees, etc.
When we apply this idea broadly, to areas where our focus may be misguided, I think of the following:
We often focus on: Investing (especially Asset Allocation & “Hot Stocks”), but we should focus on Personal Finance and Savings
We often focus on Money, but we should focus on Happiness, Well-being
We often focus on Tasks, but we should focus on Relationships
We often focus on Caffeine, but we should focus on Sleep
We often focus on Ourselves, but we should focus on Family and Friends
We often focus on Possessions, but we should focus on Experiences
We often focus on Our wants, but we should focus on Our neighbor’s needs that aren’t being met (by volunteering or giving back)
Regardless, you should read The Wealthy Barber, it’s enjoyable and it will reduce your stress levels.