For most people, there are few things that are more confusing and frustrating than trying to manage their finances. I can’t tell you how many people I’ve spoken to who agonize over trying to pick the right mutual fund and end up giving up, their money still in a checking account, because the decision was too hard and reliable information was too scarce. If you’re looking for a financial plan, it’s easy to get a broad outline, but very hard to find anyone who will give you specific, detailed advice. But that’s exactly what I’m going to do. Others are more than willing to show you the forest: save money, pay off your credit card debt, contribute to your 401(k), start an IRA. But no one will identify the trees, where the money is actually grown. How should you manage your IRA? What, specifically, should you own in your retirement and discretionary accounts? Which of the most popular mutual funds available in your 401(k) plan is the best place to put your money? I’ll even recommend the best mutual funds, using all the data available as I write this book.
Too many books about money go wrong because they try to offer timeless advice. There’s no such thing as great timeless advice. The really useful financial information is time-sensitive. I don’t know if the people who try to write timeless advice do it to create financial planning books for the ages or to avoid exposing themselves to risk. Nobody will ever get pilloried for telling you that the best long-term investment is a low-cost index fund, like the Vanguard 500, which is the classic cheap Standard & Poor’s 500 index fund. Never mind that unless we’re talking about John Bogle, the man who invented the index fund, no one dispensing this advice is adding even an ounce of value to the conventional wisdom. Timeless advice is the lazy man’s way out, and though I’ve been called almost every unflattering word in the dictionary, I’ve never been called lazy. Instead of regurgitating eternal principles, I’ve rolled up my sleeves, Mad Money–style, and found the best places to put your money right now.
When I select the best actively managed funds, I am choosing the best mutual funds that you should invest in today. It would be nothing short of miraculous if every single mutual fund I highlight in this book beat the market over the next few years, but I have total conviction that most of these funds will be winners. I would rather stick my neck out by giving you specific, timely advice than play it safe with timeless but vague suggestions. I’ll tell you how I go about ranking funds too, but the point isn’t just for you to use my methods, it’s for you to try to make money in the mutual funds I recommend. I was a manager who beat almost every other manager. I know what to look for that others don’t. I grade them the way a professor grades kids in college, except I grade them hard. As I say at the beginning of every Mad Money show, I am not about making friends, I am about making you money, and you must know that when I recommend a fund, it’s not to please anyone but you. Unlike so many others, I have no skin in the game. I don’t get rebates, referrals, kickbacks, percentages, commissions. Nothing. Just the satisfaction of knowing that I am using my twenty-five years of successful money management to help you become wealthy.
Sure, I’ve got plenty of things to say that will still be true a hundred years from now, when these mutual funds likely will no longer even exist. I’ll explain everything you might need to know about creating wealth, from the day you’re born until the day you decide you have enough dough. That means you’ll read some things in this book that you’ve read before. I’m going to tell you to save money, to invest in your company’s 401(k) if it has one, to start an IRA, and all the other boring but good advice. The difference between this book and all the other books that have been written about personal finance is that I don’t stop there. I don’t think it’s helpful to tell people to start an IRA without telling them how to manage it and giving them some specific ideas about what to buy for it—nuts and bolts that will make you more money than the other guys because that’s what I was put on earth to do.
If you’re looking to build your wealth over the long term, to ensure prosperity for yourself and your family, then stick with me and I’ll teach you how to get rich, stay rich, and stay mad for life!
1
GETTING STARTED
Let me get this right out in the open so you know exactly where I’m coming from: I believe that anyone can achieve financial security as long as they work hard, save, and manage their money wisely. All of us have the opportunity to become fabulously wealthy. You just have to know what to do and how to do it, which is something most advisors neglect to discuss. That’s where we hit a snag, or at least where those of us in the United States hit a snag. America may be a nation of limitless opportunity, but it’s also a nation that doesn’t teach its citizens how to harness those opportunities. The vast majority of our children are financially illiterate when they graduate from high school, and no better educated about money after going through college. I’m not talking about anything complicated here; I’m saying that most of us have never been taught the difference between a stock and a bond. That’s a real problem if you’re trying to create a retirement fund, let alone lasting wealth for your family. But once you know what to do, and just as important, why you’re doing it, building self-sustaining wealth is not particularly difficult, nor does it require more than a modest amount of willpower. Everyone knows that saving is supremely important, that it comes first, that without it you can’t invest; and if you can’t invest, your odds of getting rich fall through the floor. If you save merely 5 percent to 10 percent of your annual income every year from the time you start working until your retirement, and you invest that money wisely, or just not foolishly, you won’t have to worry about money for most of your adult life. There’s a good chance that your savings will turn into a sizable sum that keeps growing because of compound interest, snowballing until it becomes not just wealth but a source of wealth.
Here’s an important point to consider, even if it is a cliché: it takes money to make money. Truer words were never spoken. It’s why the rich always seem to get richer, and why it feels like everyone else manages only to tread water. Your paycheck is not enough; you’re not going to earn your fortune, not in the traditional sense. Even for the lucky few who do earn enough to become rich simply by collecting their pay stubs, the possibility of long-term wealth, the type that lasts, is impossible without putting some money to work on the side. Why? As long as you rely on your job alone for income, you’re not really building prosperity. You have to save. If you don’t save some of your income in order to invest it, all bets are off. You can’t count on getting rich or even retiring without savings. But it’s important to view money saved as more than money in the bank. It’s money that you can use to generate wealth. Someone who earns millions of dollars a year and spends it all will be just as broke come retirement as everyone else who didn’t set money aside, no matter how low their salary. If you’re well-paid, that means you have more money to put to work, and if you’re smart you’ll use it. But most people don’t have a great salary or even the opportunity to someday be paid a great deal of money. You need something on the side; you need to make some part of your money start working for you. How do you do that? Generally speaking—we’ll get into the specifics later—you invest your money in stocks, bonds, real estate, or any other asset that tends to increase in value over time. And you take advantage of every possible tax-favored plan that’s available to you, like a 401(k) retirement plan or an individual retirement account (IRA), and you take every tax deduction and exemption you’re eligible for to maximize the amount of money you have working for you.
This is the key to establishing lasting prosperity: save your money and invest it in the right assets at the right times. There’s nothing original about this view, nothing new, but I have many different and, yes, better twists on the old rules that make them understandable and downright enjoyable to apply. I could take a different position, one that might be even more compelling, but it would also be wrong, and wrong loses people money. It would be uninteresting to tell you that compound interest is a great ally, pe
rhaps the greatest, of the individual investor looking to establish long-term prosperity, but it’s true. If you haven’t been introduced to the concept of compound interest, it’s a testament to the idea that little things here and there eventually add up to something substantial.
Here’s how compound interest works: you deposit money in a bank at a 4 percent rate, and every year the interest compounds, meaning you receive your interest payment from the bank, and the bank starts paying interest on what had been its interest payment in addition to the interest it pays on your deposit. Of course, compounding works for you in many more situations than that. For example, from January 1970 to December 2006, the average compounded rate of return (including reinvestment of dividends) for the Standard & Poor’s 500 was 11.5 percent. The S&P 500 is the most representative index of large-cap, American companies, encompassing all the large publicly traded companies in the country, and is frequently used as a stand-in for the market when judging the performance of mutual funds or investors. It’s the benchmark all professional investors measure themselves against. If we assume that for thirty-five years, an investor compounded at only 10 percent annually, behind the S&P 500, we’re looking at someone who made a great deal of money. If you were to begin with merely $2,000, and every year add an additional $2,000, you would have $652,458.48 at the end of thirty-five years. Back in the 1970s, $2,000 was a lot of money, but $652,458.48 is nothing to look down on today, especially on a $72,000 investment. If you went the extra mile and invested $4,000 at the beginning and added another $4,000 every year, you would have $1,304,916.97 after thirty-five years. At that point, you could retire, put your $1,304,916.97 in U.S. Treasury bonds that yield roughly 5 percent annually, and earn close to the median salary among Americans over the age of 44: $66,995. All of that because you used your money to make money, and that was with a conservative rate of return that lagged the S&P 500. If you had simply bought an S&P 500 mutual fund, a fund with very low fees that buys all the stocks in the index and holds them, you would have done even better. And these kinds of funds are easy to find; every mutual fund family has them. This scenario is a bit unrealistic, because as most people get older, they shift their investments away from stocks, which would return about 10 percent annually, and toward bonds, which would have produced a lower but more consistent rate of return. I am a believer that such a switch shouldn’t happen until much later in life than most of the financial planners and so-called wise men out there suggest, but I’ll take that up later in this book. The point is that with time on your side as a long-term investor, it’s not all that difficult to really profit wildly. And I want you in on those profits big-time.
Later, I’ll go into more detail about the appropriate distribution of your capital among stocks, bonds, real estate, and other potential investments. Don’t worry: it sounds scary, but I have traded them all, invented a lot of them, and can tell you—in actual English, not Wall Street gibberish—what they mean and how to use them to make you even richer than you thought you could be. Capital, by the way, is just another way of describing the money you invest; the word actually can refer to any form of wealth that is used to produce more wealth. For everyone who already knows what capital is, please, bear with me. I’m not being patronizing; I just want to make sure that no one is left behind because they don’t happen to know the meaning of a word. I want to help people at every level of skill and education to sustain and increase their wealth.
The strategy I’m going to teach you is a combination of “capital preservation,” which is an investment strategy with which you try to avoid losses above all else, and “capital appreciation,” where your first priority is to increase the value of your assets. Everyone should always have both preservation and appreciation in mind, but at any given time, one will be more important than the other. It’s very important that you pursue capital preservation when times are tough for the stock market, because taking the risk necessary for capital growth will most likely result in capital shrinkage. In a bad market, it’s easier for ordinary investors to lose money than make it, so your goal should be to avoid taking losses. That way, when the market improves and you make capital appreciation your number one priority, you have more capital to work with, and thus will make more money. I really worry that most people who manage their own money don’t do this. I constantly hear people say that preservation of capital is their top priority all the time, or appreciation of capital is always more important. That’s wrong. You might have a bias one way or the other, but there are times when caring more about preservation will mean missing out on big gains, and other times when a strategy focused on appreciation will tend to cause big losses.
That said, when you’re taking a long-term view, the much more boring capital preservation is almost always more important than the exciting capital appreciation, even though most texts focus on the appreciation goal. There are several reasons for this. First, much of the money you will invest should be earmarked for certain necessary expenses: your retirement, or a home, or, if you choose to foot the bill, college tuition for your children. It would be disastrous if you were to lose a large chunk of your retirement savings because you bought riskier assets, like lower-quality stocks that don’t pay good dividends. Even the good stocks can be considered too risky for some. And remember, if your portfolio declines in value by 50 percent, you will need to gain 100 percent to get back to where you started. Sometimes you just cannot afford to take losses. That’s why I always talk and write about two different portfolios: one for retirement that is biased toward capital preservation, and one that I call discretionary and that has a bias toward capital appreciation. In the past, I’ve mostly dealt with growing your discretionary portfolio, but in this book I’ll spend more time discussing retirement.
Devoting your retirement portfolio to capital preservation means taking on less risk and pursuing substantially smaller returns. It can be frustrating to own a bunch of U.S. Treasury bonds that yield only 5 percent annually. To give you some idea of just how frustrating, the consumer price index in the United States rose by 3.2 percent in 2006. The CPI is one of our key measures of inflation, which is the rate at which general price levels increase. In 2006, if you held a bond yielding 5 percent, and you adjusted your return for inflation, you gained only 1.8 percent. This ultraconservative path may seem like an agonizingly slow way to make money, but it’s also an incredibly safe way to make sure your capital at least keeps pace with inflation. Again, you do not want and cannot afford to lose your retirement savings. People who disregard this warning get into serious trouble.
On my old radio show, Real Money Radio, I had a weekly segment when viewers would call in and I would try to fix, or maybe the appropriate term is “resurrect,” their 401(k) plans. A 401(k) plan is an employer-backed retirement savings account that lets employees who contribute defer paying the income tax on their contributions and the earnings generated by those contributions until they withdraw that money after retiring. People would ask me what to do with their 401(k) plans after their assets had been savaged because they had invested in stocks that were too risky or, all too often, because they had poured all of their 401(k) money into the stock of their employer’s company. My point here is not to get into a discussion of diversification, but to shine a light on some of the deficiencies in the conventional approach to long-term wealth building. You can tell people that their retirement funds should be invested more conservatively than nonretirement funds, with an eye toward capital preservation rather than capital appreciation. You can tell them that, but they might not listen if they’ve become frustrated with low returns and crave more risk. Though the conventional wisdom is correct, it doesn’t address the real issue, which is that when we make bad financial decisions, it’s not always out of ignorance. It’s my job to give people who make mistakes despite knowing better a new way to look at their finances, a framework that encourages them to make the decisions they know are right.
If you follow the principles and advice laid
out in this book, you should be able to use your money to create substantially more money, and you’ll have dramatically increased your odds of becoming rich. What, precisely, do I mean when I say “rich”? Because the cost of living varies so much from place to place, it’s not useful to come up with a sum of money and say everyone who has more than that amount is rich. Plus, people with children or other dependents will require quite a bit more money to have the same level of material luxuries as someone who is childless and single. In my view, a person is rich if he or she can stop working and still afford both to cover any child-related expenses like college tuition and to support the level of spending that the person in question is accustomed to for the rest of his or her life—and then some, just to make sure. Really rich people can live off the interest of their nest egg. That’s a tall order, but I will try to get you there. So, though different people will require different amounts of money to be rich, the meaning of the term is essentially the same for everyone. No matter what you’re after—retirement, college tuition for your children, a home, or just a big pile of money—I know how to help. I would love it if I could teach every single person who reads this book how to become rich.
Jim Cramer's Stay Mad for Life Page 2
