What are the two key rules for accumulating personal wealth?

In this blog I will list some of my top Quora answers for the last few days. 

If you want me to answer any questions on Quora or Youtube, don’t hesitate to contact me.

What are the two key rules for accumulating personal wealth?

Source: Quora

Let me give you some incredible stats:

  1. David earns $60,000 after tax and invests $15,000 a year for 15 years. He gets an average of 8% per year, which is 1%-2% less than the long-term average US stock market performance. His wealth after 15 years = $439,000
  2. Sarah also earns $60,000 a year. She also invests $15,000 a year, getting 8% per year, but does it for 40 years. Her wealth = $4.2million!
  3. Jim is a high earner, who earns $500,000 a year after tax. He has multiple divorces and overspends. So on average he only manages to invest $5,000 a year for 30 years, but he gets 10% per year, either due to luck, or any number of reasons. His wealth at the end of 30 years? $1.6m
  4. James earns $1m a year after net but spends $1.1m. He has negative net worth and is in debt like countless celebrities, such as the estimated 78% of basketball stars that are bankrupt or “in distress” after retirement – Money lessons learned from pro athletes’ financial fouls.

What’s the point here? Jim is earning a great, after tax, wage or income from a business.

Most people don’t make $500,000 net. Even less people manage it for 30 years in this pure example. He is also getting a much superior investment return than the other two.

And yet, Sarah is about 2.5x wealthier than him for one simple reason…..she has invested more, and for a longer period of time, than Jim.

I know several people in my own network that are wealthy but have never had a big pay cheque, and others that have inherited or made millions, and done nothing with it.

Countless people have responded to my Quora answers in the comments section by admitting they did the same thing.

Various studies have also shown that how much you invest, and for how long, impacts on your wealth more than mere percentage returns and your income.

Wealth is a simple equation. Your net income – spending will equal your surplus. How much your surplus grows will depend on your compounded investment returns.

So yes, how much you have in your hand, minus taxes, every month is important. If you don’t have any job, or income, it will be impossible to build up wealth unless you inherit it, or marry into it.

However, it isn’t as important as living below your means and investing well for a long period of time.

Any other decisions that helps with this “equation”, for example changing your residency to a lower tax country, which therefore can improve your net income but maybe not gross income, can be important.

And yet, most people are obsessed with status.

So countless people would prefer, deep down, to:

  1. Have fancy goods like an expensive cars, and “looking” rich in the eyes of others, rather than being wealthier by being more frugal
  2. Many inexperienced businesspeople prefer to look like a “big shot” with a fancy office, rather than being online with no fixed costs
  3. Many of these same people love to boast about their success, if they start getting it. If you think about it though, in at least 80% of situations, boasting about business success isn’t rational. If you boast, your competitors might take more notice of your methods.
  4. Boast that they have “doubled their money” in a tech stock in 2 years, then gotten rich slowly.

So the biggest two tips would be:

  • Focus on your net income, spending and investing habits, and not just one component. Within those three categories you think mention many tips and tricks about how to improve your income, lower spending without affecting your quality of life and improving investment results
  • Don’t care about status or the views of others. If you do, your decisions will become silly.

That doesn’t mean that you should take it to the extreme. A bit of balance is fine.

Living a little is great. Boasting once in a while won’t do you any harm. Do these things too much, and you might regret it.

If everyone knows that the stock market will perform better in the long term, why do people sell in panic and not hold their investments?

Source: Quora

There are a number of reasons. Firstly, it just isn’t true, unfortunately, that “most people” know that the markets will eventually perform better.

Many people don’t know basic facts like:

  • Most major stock markets, especially American ones, have outperformed all other investments long-term. That includes bonds, cash, gold, commodities and property.
  • How often markets hit record highs. Sometimes they hit records highs as much as 30–80 times a year. Take the S&P500 as an example – Closing milestones of the S&P 500 – Wikipedia. Now sure, there are various periods where stocks can take 1, 3, 5 or even over 10 years to recover. But markets have been hitting record highs for over 200 years. The Dow has been hitting record highs since it started in 1896, and so did Stock Markets which existed before then.
  • Many people believe they can beat the market by market timing, when the evidence suggests less than 0.1% of people manage this long-term.
  • The dead outperform the living in investing, including most of the living who consider themselves professionals. The reason is simple enough. They don’t have emotions like greed, fear, over-confidence etc. They buy and hold by definition. How about when it comes to the living – who does the best? PHDs in portfolio theory? No. How about people working at banks? No. Or millionaires? No. The answer is people who never login to their investment accounts, either because they have forgotten about it or they are relaxed.

Apart from that you have the following facts

  1. Countless people don’t understand the difference between a loss and a decline. If markets fall 50% next year, you haven’t lost any money unless you sell.
  2. Emotions. Fear is a far bigger, and stronger, emotion than greed. You will therefore notice a trend. Even though markets go up big time long-term, the falls are big and fast. Most major stock markets fell 20%-25% in a very short period of time in late 2018/early 2019. They fell much harder this year. This is called “loss aversion”. Look at Quora. Whenever markets hit record highs, there are few questions on here. There are more questions about people panicking (fear) about a crash. Whenever there is a huge crash, questions increase 10x!

3. The media. Whatever bleeds, leads. The media always leads with fear-mongering headlines. This of course exists beyond money. The media are more likely to report on negative news, than positive news. So whenever markets crash, it is usually the number 1 news headline. When markets hit record highs, it is barely mentioned.

4. People don’t understand that falling, or stagnating markets, bring about an opportunity. I mentioned in this answer how somebody could have made a great profit investing during the Great Depression – even if they had invested a big lump sum at the peak in 1929! Adam Fayed’s answer to How should I invest my money during the coronavirus crisis?. Rationally speaking, people should want markets to go down in their 20s, 30s and 40s, and spike higher before retirement. One of the best podcasts I watched was with a guy who became a multi-millionaire by tracking the markets from age 18 until 45. He mentioned how he would, quote,. “be dancing in the streets if markets crashed tomorrow”. That is logical, but emotions often act differently. This is especially the case when you consider that the media always say “this time is different”. They say that in every single market crash, and will do during every single one in the future I am sure!

5. There isn’t a sound understanding about how bonds and stocks, asset allocation, can reduce your risks. So if stocks fall, and short-term bonds rise, this is a great rebalancing opportunity.

In March-May, some of the major DIY firms reported that up to 35% of people over 65 panic sold.

There can be no rational reason for that. Most of the people who sold were retired, or close to retirement, at that age. So it was just blind fear.

Vanguard reported the same thing. Net inflows into Vanguard funds were highest during 1999, at the end of 18 years of strong stock market performance.

They were at their lowest in 2008–2009. I am sure a percentage of those people lost their jobs and needed to sell, but many of the orders came in days after Lehman Brothers went bust.

So it was mainly due to emotions. A so-so investor that can control their emotions, will beat an PHD in portfolio theory, if he/she can’t control their emotions during the highs and lows of the market.

Why do so many people still believe real estate investing is a better investment than stocks when data does not support that argument?

Source: Quora

There are many reasons. Some are understandable and some aren’t.

The main reasons are

  1. The media bang on and on about property. Compare the way they report on property vs the stock market. Whenever stocks fall hard, it is the biggest news story on the BBC, CNN etc. When they hit record highs, there is barley a word! You have to check the business sections as it isn’t on the headlines. There are also many expressions which are simply not true, like “you can’t lose with property”, renting is dead money etc. Seldom do the media actually compare the returns of property and stocks. They also don’t report on long-term trends. I will give you a great example. If you asked the average person in the UK “have UK house prices gone up in real terms in the last 13 years” they would say yes, but that is factually incorrect. UK house prices have indeed hit nominal records, but not inflation adjusted records. As per the graph from House Price Crash, UK housing has never recovered from 2007–2008. They are higher than in 2010 and 2015 though. You can see the difference between nominal and real here – Graphs > Nationwide average house prices adjusted for inflation

Moreover, even wages have outstripped house prices from 2007–2020 (but again not from 2015–2020)

2. Localism. Many Londoners would be even more surprised by the nationwide picture than a person living in the Midlands or North. The reason? London is one of the few places in the UK where prices have indeed recovered, in fact more than recovered, in real terms. I am sure the same thing will exist in the US and other countries. If people have seen their local housing market outperform, they are more likely to think the whole country (or even world) is facing the same trend. The same is true in stocks. If people live in an area with weak stock market growth, like some parts of Europe or the Emerging Markets, they are likely to think housing beats stocks. They are less likely to consider owning a diversified portfolio, with access to better performing regions.

3. If they are a truly professional real estate investor. Most people ask “do you want to invest in property”. Few people ask “do you want to start your own business in property”. But in reality owning properties is essentially running your own business. Many tax authorities globally, including HMRC in the UK, consider it as such. The reason is simple. You have cashflow management to consider – in other words money coming in and out. You have time pressures unless you outsource it to a property management company. You also need to consider how to use leverage/debt well. So it is much more complex and time consuming than a passive investment like a REITs, ETF or index fund. For that reason, I have seldom seem amateur landlords do well long-term vs the markets, unless they get in at the right time, or have done a lot of research. I have seen some professionals do it, in the same way I have seen countless people do very well in other business areas.

4. Familiarity. Before the 1980s and 1990s, only the rich really bought stocks and index funds, apart from maybe the US. Over 50% of the US population owns stocks, but perhaps one reason for that is it became popular in the 1920s and after WW2 as well. In many countries, investing in markets was an elitist thing until relatively recently.

5. Taxes. In some countries, real estate is taxed less aggressively than stocks, ETFs and funds. Usually that isn’t the case though. In most countries, the tax-free options governments have created for self-invested pensions, aren’t available for property, and tax rates on property are huge. Again let’s take the UK as an example. The buying tax (stamp duty) can be between 0%-12%, with overseas buyers (including British expats) charged between 3%-15%. Capital gains tax is at a higher marginal rate than stocks as well. In comparison, you can invest tax-free, at least up to a certain amount, yearly in an ISA.

6. Property does beat stocks over countless periods of time. You are right about the long-term trends of stocks vs property, but property can beat stocks over many 5 and even 10–15 year periods. This can result in people have “recency bias”.

People don’t always factor in dividends as well. This is a huge reason contributor towards stock market gains long-term.

So you are right in what you are saying, apart from those people who get lucky (right place right time) or are professionals in the real estate area.

As a final comment, people are also not told about the risks with property either.

The media doesn’t make any distinction between holding individual stocks vs the whole market (index funds), in the same way they seem to make no distinction between being long-term and short-term.

So they seldom mention facts like nobody has been down over a 25 year period if they just bought and held the S&P500 index.

In comparison, with property developments, and even “ready made real estate”, you can lose 100% of your money, which can never happen with a collective investment like the S&P500.

I remember a few years ago, many people couldn’t sell their homes because of fears about being too close to radiation via telephone mass.

Now many people can’t sell due to cladding – Cladding red tape ‘stops people selling homes’.

These aren’t extremes either. I have ran out of the number of people who just can’t find a buyer or tenant for their property. With something like a REIT you don’t face that risk.

That is one reason why most professional property developers focus on having a diversified portfolios of properties, rather than thinking just having 1–2 will pay for their retirement.

What are some common examples of high risk investments?

Source: Quora

Many people below have made excellent observations about risky investments.

I could go on and mention some investments which are high risk and more like speculations.

Examples include many forms of binary options and other things which really aren’t investments and are more pure speculations.

That is an obvious point. What isn’t obvious to many people though is that one high-risk investment which hardly anybody mentions is……..cash in the bank!

As Ray Dalio says below, cash is arguably the riskiest investment of them all:

His comments have been echoed by Buffett and Vanguard Founder John Bogle.

The main reasons are:

  1. Ruin risk. If you own the whole stock market (index funds or ETFs) your money won’t go to 0 if you hold onto it for a long-term. That is unless there is nuclear war and everything is worthless of course! Moreover, they have always risen long-term, but they have been volatile short-term. Want even less risk? Hold stocks and bonds for decades. With cash though, your money can go to 0. It has happened notoriously in places like Zimbabwe and Germany in the 1930s. Less extreme, and recent examples, would be places in Latin America like Brazil, Venezuela and Chile. Historically this 90%-100% lose has happened in most countries. There are very few countries relative to the 190+ in the UN that have had stable inflation for 70 years+ without a major currency crisis
  2. Inflation and devaluation risk. You might that “ruin risk” is less likely if you are from the US, UK, Japan and other developed countries, or invest in those currencies. That is true. However, you are guaranteed to lose to inflation now, and have done since 2008. Inflation compounds. If you are getting 0% in the bank and inflation is 2%-3% for 10 years, that is an approximate 30% lose to inflation. Over 25 years? Your money could be close to worthless just from those small yearly erosions. Previously it was only old ladies that faced that risk with their money in jars under the sofa. Now it is everybody that puts money in a 0%-1% per year account. Likewise with a currency devaluation. Many Brits living overseas saw the USD:pound exchange rate go from 2:1 to 1:30 in 10–13 years. So if a British expat living in America or the Eurozone had left their money in the bank for 13 years from 2007 until now, they would have lost over 50% of their capital in real terms in Euro or USD terms.
  3. Little or no upside potential – If you start your own business, you could face ruin risk, lose 100% of your money and your house if the bank asks for that in return for giving you a loan. However, you do face an upside as well. With cash in the bank, the best case is that inflation falls to 0% and your currency gets stronger, reducing the costs of imported goods. So you break even with inflation at best in most cases. Not much of an upside!

I am not saying there are never uses for cash. Having an emergency amount of cash is great.

Likewise, some businesspeople hold cash long-term, waiting for opportunities.

I am merely saying that cash in the bank isn’t a low risk move if it is held there long-term.

It is merely low-volatility.

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