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When we mean to build,
All right, you've read Step 1 --
The Rule Maker Philosophy -- and you're intrigued. Maybe you haven't been
happy with your approach to money and investing. You now recognize how shocking
it is that so few of us got any financial education in our schools. You may
even accept that our nation's ignorance about money is fueling some
misbehavior in the financial industry. Finally, you just might be
saying to yourself: "Hey, this is as good a time as any for me to take charge
of investing my savings."
Excellent. The place to start, though, isn't with stocks. Nor with bonds.
And definitely not with commodities or options or gold coins -- all pitched
at you in low-grade advertisements in the newspaper and on the radio. Nope,
to tackle your financial circumstance with the panache of a Fool, you'll
need to begin at the beginning... with your personal finances.
After all, if you have a heavy load of credit-card
debt or a demanding 15-year mortgage to manage or tuition payments due
in the next twelve months, you shouldn't be investing in stocks. You have
other fish to fry.
Truth to be told, though, we'll only talk in very general terms here about
personal finances because the subject is already thoroughly covered in
The Fool's School as well as in
Step 2 of the
13 Steps to Foolish Investing. Some of
it does bear repeating, though... so voila:
1. Develop a plan for regular savings.
Set aside and save a portion of each of your paychecks. For most Fools, this
should be around 10 percent of your annual income. As your salary rises from
$25,000 to $50,000, you should begin putting away more than 10 percent each
year. To get there, you might have to cut down a bit on the $325 spent on
new compact disks, the $250 on cheap beer, and the $650 on swank new clothing,
but think of this as paying now for your future endeavors. The savings of
your todays, compounded at 10-15% annually, will dramatically expand in the
decades ahead. Did you know that $1 of savings per day invested in a stock-market
index will grow into $575,000 in fifty years, if the market performs as it
has this century? No worse, and no better, just average performance from
stocks and a buck of savings a day.
You can save more than a dollar a day, can't you?
Now when you're saving this money, Fool, the best way to do it is through
some type of direct deposit into a savings account. Keep it out of your checking
account. Put the funds out of sight and outta mind. Oh, and, recognize that
if you have a disproportionate amount of personal debt, then you should
concentrate on paying that down now, rather than setting it aside as savings.
2. Erase all credit card debt.
Yep, just like we said. Get rid of that credit-card debt. The rate of interest
paid on most credit cards is in the area of 18 percent -- and the unfortunate
truth in America is that right now the average adult is carrying $5,800 in
credit-card debt from one month to the next. Worse still, the interest on
that debt isn't tax deductible -- whereas, for example, your mortgage payments
are.
Given all that, we see no logical defense for investing in stocks when you
have unpaid, high-rate debt. You would have to consistently earn something
in the range of 20 to 24 percent per year in the stock market just to break
even on the credit payments. Remember that you'd have to pay capital-gains
taxes on any investment profits before transferring the money to pay down
debt. Ya can't beat your credit-card debt with investments in stocks -- pure
and simple. Pay the debt down, methodically and relentlessly. In fact, encourage
your kids, your colleagues, your fellow Fools, encourage everyone but your
mortal enemies to pay down their credit-card debt.
And here's one way to get started today: contact your credit-card company
and attempt to restructure this debt, bringing the interest rate lower. You
can often get your card provider to drop rates from, say, 18% to 12% in just
five minutes of chatting them up. Threaten to take your business to another
card provider, if they hesitate. And if this fails, go ahead and consolidate
your debt at lower rates via some of those new card offers from other banks.
Be aware that the bank often drives up rates from, say, 7% to 20% after six
months, though. So, you'll really want to pay down your debt, if you
have to flit from card to card.
That really is the point here -- use the card-switching alternatives only
as justification for eliminating your debt load... not preserving or extending
it. In your quest to pay down loans, order the debts from highest to lowest
interest rate, and begin at the top of the list. Fool, remember:
The best investment out there has a guaranteed annual return of at least
15-20%, which is free from all local, state and federal taxes. It doesn't
make sense to put a dime into the stock market until you've maxed out on
this particular gold mine. The name of this greatest of all investment techniques
is 'paying off your credit cards'.
3. Get the rest of your debts in order.
We know this stuff is getting boring, "Debt this... blah blah... debt that."
You came here for investment ideas! And many of you have already cleared
out your debt. Very Foolish. So particularly for those of you with $2,000
or $10,000 or $500,000 saved and waiting to find its way into cash-rich
companies, we're going to race to the end of this, Step 2. There are only
a few, but important, short lessons that remain before we get into stocks.
Onward!
When setting up your savings plan, make sure that you are properly insured
(not overinsured) with long-term disability coverage. Then ensure that you
can meet all of your payment obligations on your home mortgage, your car,
your student loans and/or tuition. Get ready for a controversial point!
When paying your mortgage, we think you should aim to exceed the minimum
payment whenever possible. Our bias here is toward getting rid of your mortgage
sooner rather than later, and we think the discipline of paying down the
house quicker will have you looking to buy a little less house upfront. Real
estate has not been the best investment of the 20th century; common stock
has. We expect that to continue into the next century, and so we'd recommend
buying a little less house than needed, paying it down quickly simultaneous
to moving savings into the stock market.
Now, we do recognize the benefits of investing alongside tax-deductible mortgage
bills. Once all deductions are included, many are paying less than 5-6% on
their mortgage debt -- a rate that has historically been walloped by the
stock market. So why are we recommending increasing the amount you pay of
your mortgage? To protect you against the extreme downsides -- the loss of
a job, the death of your family's main income provider, the ten-year collapse
of the stock market. The more debt you have, the more vulnerable you are
to the extremes. And, unfortunately, all of us will be visited by extreme
negatives at some point in our lives.
To close, are we saying pay all of your mortgage down before investing in
a 401k plan or directly into common stocks? No. But we are suggesting that
you buy a little less than a mansion, that you abide a discipline of paying
slightly more than the minimum on your mortgage payments, and that you only
invest into stocks what you can afford to put away for more than five years.
Hey, these ideas are controversial, and as we said in Step 1 -- we don't
think you should blindly follow what we're doing or proposing here. Ask questions
on our message boards, ask others what they're doing with mortgage and other
low-rated debts, and steer your ship on the course that makes most sense
to you.
All right. That was simple. You're ready to save, or you've already been
saving. On to stocks? Well, before we get to discussing the allocation of
your savings into investments, we want to address what sort of money we think
should be invested in the stock market -- and what shouldn't. Because the
Rule Maker approach to the stock market demands making long-term investments
in businesses -- not looking for a gimmicky, quick profit on trading - we
hereby challenge you not to invest into stocks any money that you'll need
in the next five years.
Do you need capital for a downpayment on a house in two years? Need some
cash for your son's bar mitzvah next year? Need moola to cover an outstanding
loan from your Great Uncle Bjorn? You shouldn't invest into the market any
money that you've earmarked for oncoming bills. Just remember that while
the stock market has grown at an average yearly rate of 11% this century,
it has also been nearly cut in half a handful of times along the way. You
don't want to be stuck having to sell a holding at the worst possible time
just to cover bills!
Step 3: Allocating Your Savings Money »
We first survey the plot, then draw the model;
And when we see the figure of the house,
Then must we rate the cost of the erection.
-- Henry IV, Shakespeare