Investing, Broken Down to its Ridiculously Simple Core

simple investing lessons
Myth: Wealth and freedom come exclusively from living below your means.

Fact: Frugality is the first step … not the last.

There’s a couple that I’ve known for more than a decade.

When we met, they were apartment-dwellers, and I don’t mean the New York City variety. Their dark and musty apartment existed in an area where land is plentiful and square footage is cheap, where the only reason you’d live in an apartment is because you have nothing to your name.

I’m not quite sure when their tables turned, or how long they toiled quietly behind-the-scenes building their family empire; I can’t pinpoint the year their net worth climbed into seven digits. Their newfound wealth isn’t the obvious flashy kind. They still drive modest cars and wear nameless brands, though admittedly they’ve upgraded into a large and lavish home.
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The Next Financial Challenge: 20 Contenders in a Fight to the Top

2015 Grow Your Dough investing competition

My hobbies include reading, hiking, and … wagering cold, hard cash on financial experiments for the sake of your amusement.

Last year I blindfolded myself, threw darts at a list of stocks, bought the first 10 that I hit, let them ride for a year and showed you the results.

This year I’m embarking on a ploy that’s a tad less crazy, but far more heated: I’m competing against 19 financial writers in a tournament to see who can rock the hottest investment gains.
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Why My 77% Savings Rate … Means Nothing

Why My 77% Savings Rate ... Means Nothing

Finance nerds have strange habits.

Here’s one of mine:

Once a year, I lock myself in a room with nothing but a laptop, spreadsheet, and boatloads of determination.

The mission: Decipher my savings rate.

Am I saving 30 percent of my income? 40 percent? 60 percent?

As longtime readers might recall, Will and I saved half of our income in 2012. We did it by following one simple rule: Pretend we’re a one-income couple. Live entirely on one partners’ salary, and invest 100 percent of the others’.

Since we earned roughly the same amount, we ended up investing about 50 percent of our income in 2012.

In 2013, we didn’t follow any strict rules about spending from one bank account or the other. But both of our earnings escalated, and I suspected this might translate into a turbocharged savings rate.

(After all, the best way to fast-track your savings is by earning more, and saving every dime of that extra income.)

I crunched the numbers, and made two shocking discoveries:

  • We have a 77% savings rate
  • That statistic is meaningless

Here’s why that factoid is crap – and how to find the metric that really matters.

Measure the Metric That Matters

I don’t want to wax philosophical – at least, not too much.

But before this conversation can continue, we need to discuss an important question: What are “savings?”

Is saving the absence of spending? Is it the money that’s left over at the end of the month?

— Or —

Is it cash that’s set aside for a specific goal?

If so — Does the timeline of that goal matter? Does it qualify as “savings” if the goal is five years away? Five months? Five days? What’s the cutoff?

Furthermore, does the content of the goal matter? Are certain goals, like retirement, more worthwhile? What about world travel – is this a worthy goal, or a frivolous expense?

You can see where the definition of “savings” gets hazy.

Here’s the crux of the problem:

“Savings” is money that you’re setting aside for the future. Which means that “savings” is deferred spending. When you save money, you’re saying: “I’ll spend this later.”

But spending later won’t get you closer to financial freedom. There’s a better metric that we can track — one that’s even more important than savings. (We’ll come back to that metric in a moment.)

But first:

Back to my meaningless savings rate.


This issue arose during a conversation with a friend who happens to work as a financial planner. We were chatting about income (yeah, I’m a fun conversationalist) and he asked how much I had saved in the past year.

I took out my laptop, showed him the spreadsheet … and drew a blank.

Because here’s what it says:

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Look at that second line-item: “Pay Cash for 2 Cars.”

Last year, Will and I both paid cash for our cars. I bought a 5-year-old Honda Civic; he bought a 7-year-old Acura.

So …

Is this “savings,” because we saved enough money to buy cars in cash? Or is this “spending,” because we spent the money on cars?

“It’s savings,” my financial planner friend remarked. “‘Spending’ is month-to-month.”

I contemplated that remark for a long time. I’m not sure if I agree — but then, it doesn’t matter.

Because within those reflections, I realized: We’re discussing the wrong metric. Savings won’t bring you financial freedom. Investing will.

That’s the metric we should track.

Savings Are Awesome … But Investing is the Real Mack Daddy

Savings are great. They help you pay for big-ticket items like cars, graduate school, medical bills, world travel and a wedding. But savings – alone – won’t help you achieve the nexus of all freedoms.

“Savings” is a feel-good word that means, “I’ll spend this money later.” While that’s great for buying big-ticket stuff, it won’t move the needle on creating your life’s freedom. It won’t help you reach the 4 Types of Retirement.

“Investing,” on the other hand, allows you to grow your assets and passive income. This creates freedom.

So …

If my mission is to track my progress towards Financial Freedom, I need to throw away my so-called savings rate, and focus on my investing rate.

I tightened those line-items into a more condensed version. Here’s the breakdown:

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Let’s attack this.

“Cash” represents money that will morph into refrigerators, washing machines and other junk that doesn’t command a return. Sure, these purchases are important — I need a fridge to keep my food cold — but it won’t move the needle.

Let’s throw it out.

Next, let’s look at the “Health Savings” line.

Prior to a few months ago, I would have thrown out that line for the same reason – this money will get spent on wisdom tooth extractions and blood tests. (Those are important expenses, for sure, but our mission is to track financial freedom.)

But then I read an awesome article from the Mad FIentist on How to Hack Your HSA. He advised leaving your money inside your HSA, so that it can continue to grow tax-deferred. Pay out-of-pocket for medical costs. Conceptualize the HSA an a “bonus” retirement account.

Brilliant idea. I can’t believe I didn’t think of that.

So my total retirement investing rate is:


Next come the extra mortgage payments. I’m paying down my rental properties (so that they’ll produce even stronger passive income.) Extra principal payments comprised 14 percent of my income last year.

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What happens when we add these figures?

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Now we’re reading the metric that matters.

We’re focused on investing, not savings.

And that’s what moves the needle.

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One TERRIBLE Piece of Financial Advice You Should Never, Ever Listen To

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Bad Financial AdviceLaunch into any money-related conversation and you’ll inevitably hear the following bad financial advice:

“But it worked for me!”

Those insidious five little words have been used to justify all types of terrible ideas, from buying lottery tickets to over-leveraging your investments to investing every last dime into Apple stock.

Let’s try this one on for size:

Common Sense: “Even if you find an awesome investment, spread your risk by picking a few other investments, as well. Rental properties are awesome, but even if you could make 20 percent cap rates, you should still keep a solid chunk of money in stock market index funds.”

Retort: “But I put 150 percent of my savings in gold in the year 2007 and it totally worked for me. Put every dime in gold! Nothing else! Why bother diversifying when you get the best returns in this arena?!”

Common Sense: “Hold on, you invested 150 percent of your savings?”

Retort: “Yeah, I can take a cash advance from my credit card at 14.9 percent and invest it for 170 percent gold returns! I’d be stupid NOT to!”

Common Sense: “Uh, don’t you think that’s a bit risky?”

Retort: “Hey scardey-cat, if you’re so terrified of risk, why don’t you sew your money into a mattress and leave REAL investing for us tough guys?”

Uh-huh. Right.

Tip: When your opponent has to justify their investing strategy with ad hominem attacks, they’re grasping for straws.

Alright, that was an easy example. Afford Anything readers are an intelligent group. I don’t need to explain this example. You can see why it’s an insane argument.

But let’s look at a subtler example of the “it worked for me” phenomenon. Let’s check out an example in which the counter is uncommon sense.

“But I Sold my Home for $20,000 More Than I Paid!”

UnCommon Sense: “Don’t tie up a huge chunk of your net worth in your home. Your home is NOT an income-producing asset. It won’t stick cash in your pocket each month.

Your money should make money. So live in a cheap home while you deploy your cash into rental properties, stock index funds or other income-producing investments. Reinvest. Lather, rinse, repeat.

“Better yet, buy a small apartment building (like a duplex, triplex, 4-plex) as your first home. Live in one unit and rent out the others. If your neighborhood doesn’t have multi-units, live with roommates until you either have a baby or your mortgage is paid off.”

Retort: “But I sold my home for $20,000 more than I paid for it! So my house IS an investment! It worked for me!”

This is precisely the type of argument you’ll hear from someone who hasn’t crunched the numbers. The people who say it often conflate gross gains with net gains.

The average person doesn’t make very strong net gains on their home value, after adjusting for insurance, taxes, loan interest, repairs, maintenance, Realtor commissions and closing costs. If they’re lucky, most of their net gains can be explained as “inflation plus 2 percent.”

Most people would be better off living in tight quarters and putting the excess money into stocks.

Are there exceptions? Sure. Just ask the people who bought houses in Southern California in the 1970s. But this is the tail end of the bell curve. People have also made millions winning the lottery.

Furthermore, most of the people who happened to buy in 1970’s Southern California shot themselves in the foot by “trading up” continually until the market burst. Many people thought they were different, that they were the exception to the rule, but then they became scared that they’d be “priced out in five years.” So they bought a big home, then lost all their gains.

The best antidote to getting “priced out in five years” isn’t to pay an overinflated price today. It’s to create more wealth. Build your net worth at a rate that’s faster than housing growth. It’s not that tough.

Let’s try another example.

College is Good, Grad School is Better

UnCommon Sense: “You’re not a zombie. So don’t blindly repeat the mantra that college is good and graduate school is better.

“Do the friggin’ math.”

“If you want to be a neurologist, awesome. Take out a six-figure student loan to go to medical school, because you’ll have a rare, high-demand skill that will command you a $225,000+ income.

“But if you want to be a social worker earning $30,000 a year with a master’s degree, think twice before burying yourself with debt.”

Retort: “But I did it and it wasn’t so bad! My student loan payments are only $180 a month. That’s nothing. That’s less than my car payment! And I think the government will forgive my loan in 20 years, anyway.

Plus, I got this job that pays $42,000 a year, and there’s a chance I could get enough in bonuses to make as much as $50,000. There’s no way I could have gotten that without my master’s degree.”

Ouch. This is one of the most common “it worked for me” arguments that I hear. And what’s befuddling is that the underlying message is that it really didn’t work.

$180 per month for 20 years is $43,200. That’s a decent chunk of cash, but it’s not horrifying. People have lost more by buying a house at the wrong price.

What’s worse is the missed opportunity. $180 invested monthly over 20 years is $106,730. That’s a horrifying amount.

But that’s still not the worst part. The real sad news comes from other missed opportunities. Want to start your own business after a few years? Good luck! The rest of us can move into grandma’s basement, mow lawns on the weekends to pay for groceries, and spend the rest of the week building our own graphic design enterprise. Your extra $180 monthly loan payment means you’ll need to mow many more lawns.

“That’s true of a mortgage, too.”

Yes, but you can sell a house.

That’s not the only hang up. You’ll be far less inclined to change careers if you decide your current path isn’t fulfilling. What would you do – go back for a second master’s degree in a different field, racking up even more debt?

You’ll have a rougher time quitting your job to travel the globe. You’ll lose the flexibility to change jobs and take risks. You’ll probably delay buying your first rental property or maxing out your Roth IRA by a few years.

“It worked for me” isn’t always the best path. At best, it’s an isolated data point. At worst, it’s bad advice.

Myth: Only Rich People Invest

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Myth: Only rich people invest.
Fact: WTF?!?! Do people really think this??

Myth: Only Rich People Invest

The scary truth is that many people do. “Investing” conjures images of rich fat guys wearing Armani suits, sipping fine brandy and smoking cigars while they sit at the country club, deciding which stocks to buy and sell.

AA readers know better, of course, but you’re the special few. We surround ourselves — online and in person — with like-minded people committed to growing and preserving wealth.

But don’t get complacent — PLENTY of people in this world fall prey to the myth that “investing” is something old rich people do.

The media spoons-feeds us images of miserly rich people who casually buy companies and count their coins while scoffing at the “ordinary people” who work hard. What a bunch of baloney.

Being rich is the result of, not the prerequite to, investing.

If you’re not savvy enough to recognize that this depiction of investors is nothing more than a cartoonish stereotype, you’ll set yourself up for a lot of financial stress and heartache.

Fortunately, you read financial blogs and books. Then you act on what you read. That’s what sets you apart.

Being rich is not a prerequisite to investing. Rich is the result of investing.

I have to thank one of my AA readers for busting through this myth recently.

“I used to think I wasn’t rich enough to invest,” she told me, “until I began reading your blog.”

Dude. EVERYONE is rich enough to invest. Got $20 bucks? You can buy one single share of a Schwab or Vanguard exchange-traded fund. You can make the trade commission-free.

“But that’s just one share!”

It starts with one.

Book Review: The Millionaire Real Estate Investor

Is investing risky?

millionaire real estate investor

Maybe. The less you understand the investment, the riskier it is. Knowledge is the antidote to blind risk.

Unfortunately, many people write off investing altogether. They assume all investing is dangerous, and they don’t realize they can lower their risk by developing a strict set of criteria that guides their investing choices.

This notion – investing is risky, so I should avoid it – is one of five “MythUnderstandings” (myths + misunderstandings) that author Gary Keller, the founder of Keller Williams, describes in his book, The Millionaire Real Estate Investor.

Other MythUnderstandings?

Myth #1: Investing is Complicated
Truth: Investing is only as complicated as you make it. The more you learn about it, the less complex it seems.

To a kindergartener, fractions seem impossible. But they grasp numbers through increasingly complex stages – counting, adding, subtracting – until they’re ready for fractions.

Investing, Keller says, is the same. Jump straight into the advanced topics and you’ll quickly feel overwhelmed. Focus your time, learn the concepts that apply to your goals (and dismiss the ones that don’t), and you’ll be solid.

Myth #2: The Best Investments Demand Specialized Knowledge
Truth: The Best Investments Are in Whatever Arenas You Understand Most

There is no “best” industry to invest in. It doesn’t matter how great the past returns have been in widget-making. If you don’t understand widgets, avoid it. Stick to what you know.

Myth #3: Investing is Risky
Truth: Investing Isn’t Risky if You Buy Right

You win or lose the game when you buy, Keller says. Investing isn’t risky if you buy such a steal that there’s nearly no way you could lose.

Risk happens when you over-pay for an investment and then pray that the market will save you from your mistake.

Myth #4: Great Investors Time the Market
Truth: Great Investors Make the Best of All Times

If you’re constantly in the game, you’ll spot the hot deals. But those deals won’t tap you on the shoulder – you have to constantly be searching.

“It doesn’t matter what the market’s doing,” says Bill O’Kane, an investor interviewed in the book. “You’re going to buy what the market gives you.”

Myth #5: All the Good Investments Are Taken
Truth: Every Market, in Every Time, Has Opportunity

“Rest assured, all the good investments will be taken,” Keller says. “The only question is by whom … those who take them are those who best understand the conditions that create them.”

Should I Read It?

The first half of The Millionaire Real Estate Investor reads like a motivational book. Keller explains the path of money (turning capital into cash flow) and walks through ideas like the “Three D’s:” investments that are tax deductible, depreciable and deferrable.

The concepts he explains in the first half apply to all types of investing, not just real estate, and the tone feels a little bit like Rich Dad, Poor Dad.

The second half of the book more specifically focuses on real estate investing. He offers worksheets and “sample problems” that guide you through learning how to analyze a house, either for rental income or flipping potential.

This Book is For You If: You’re looking for a broad, conceptual overview about how to think about money and investing. You’re a real estate novice who wants to learn more. (I certainly consider myself a novice, even after a handful of rentals).

This Book is NOT For You If: You’re an advanced real estate investor.

Check out more reviews of The Millionaire Real Estate Investor.

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Investing 100 Percent of My Income: May Edition

investing 100 percent of my incomeTime for the next edition of Investing 100 Percent of My Income, and I have just one question:

How is it June already?!

For those of you who are new readers: Will and I are a couple who have pledged to live on one income and invest the other. He gets a steady paycheck, while my income fluctuates because I’m self-employed. So we’ve decided that in 2012, we’ll live on his income and invest 100 percent of mine. (This makes financial planning a heckuva lot easier!)

By the end of last month’s update, I maxed out my Roth IRA, renovated a rental house with a 14.8 percent cap rate, and paid quarterly taxes.

That was the easy part. Those were no-brainer moves.

Now comes the hard part. It’s time to make strategic decisions about how to invest the rest of my income for the next 7 months of the year. Here are a few lessons I’ve gathered:

#1: Spending Money is a Full-Time Job

Spending money requires hundreds of hours. I have to brainstorm ideas. Research options. Gather quotes. Run spreadsheets. It makes me wonder: How does anyone have the time to earn AND spend?

This website’s maxim says you can afford anything, but not everything. If I want to grow this website, I can redesign the site OR hire assistants OR start podcasting.

Alternately, I can focus on real estate. I can save up to pay cash for another rental house OR hire a bookkeeper OR upgrade my triplex building.

Every dollar I spend on X is one less dollar I can spend on Y, so I need to compare the options. Emotion says, “I want it all!” Reality says, “Make a spreadsheet.”

#2: Avoid Too Many Irons in the Fire

Last week I reconnected with a friend from college whom I haven’t seen in years. I described my various projects: building websites, buying real estate, running a freelance business.

“Sounds like you have too many irons in the fire, none of them are getting hot fast enough, and you’re sweating,” she replied.

Wow. She hit the nail on the head.

Diversification is a central investing tenet for good reasons. It’s prudent, up to a degree.

But it also carries the risk that you’ll throw money at an investment you don’t understand. You can’t be an expert at everything.

That’s why I mostly avoid buying individual stocks: I don’t have time to read balance sheets and trade journals. I buy a few broad-market index funds and move on with my day.

The same thing needs to happen the rest of my investments. There are a zillion possible directions I could take. I can’t pursue them all. I need to narrow my options, make a decision, and roll with it.

So What Did I Do Last Month?

Last month, I did a lot of thinking, a lot of reading, and a lot of tinkering with spreadsheets. I spent time with several potential contractors in both the real estate and website world. I started a few negotiations.

And I didn’t spend a penny.

“You mean you’re just sitting on one month’s pay?”


I know, I know: this doesn’t make for riveting reading. You’re probably yawning as we speak.

But I assure you, there’s a ton of activity in my tiny little brain. Lots of thoughts being processed. Options considered. Numbers crunched.

Stay tuned.

Thanks to ShedBoy for today’s photo.

We Bought a Third Rental House!

I can’t believe I’m saying this: Dear Readers, I’d like to introduce you to Rental House #3.

“But Paula, didn’t you just buy a house? A couple months ago?”

Yep, it feels fast to me, too.

Check out the pics, and meet me below the photos to hear the details.
(If you’re reading by email, click “display images” to see the photos.)

bought rental house - making repairs

We removed the 1970’s wood paneling from this room …

bought rental house - repair wall

We removed a closet to add more space to a bedroom …

bought rental house - repair kitchen

The kitchen is decent, but not amazing …

bought rental house - repair man

… so we’re adding a skylight to the kitchen. Hooray for natural light!

bought rental house - repair stairs

These used to be the steps to the front porch.

bought rental house - repair porch steps

These are the new steps to the front porch! Much better!

The LowDown

The basic stats are normal: 3 bedrooms, 1.5 baths, built in 1965, neglected and needs repair. Up to this point, the description sounds remarkably similar to House #2.
repairing the home
Its location sets it apart. Will and I have “stuck to our core competence” by only buying rental properties that cash-flow. We’ve diversified pretty heavily, though, when it comes to location.

As background: the Atlanta metropolitan area is encircled by a highway, 285, which we call “the Perimeter.” City lovers look for homes “inside the Perimeter,” while suburban-dwellers live “outside the Perimeter.”

Generally speaking (there are many exceptions), the suburbs north of Atlanta are more educated and moneyed; the suburbs south of Atlanta are less.

House #1, the triplex, is in the urban heart of the city, with a view of the skyline. House #2, a single-family home, is “outside the Perimeter” in the faraway suburbs to the south of Atlanta. (That’s why it only cost $21,000.)

House #3 is in a location that Atlantans would call “AT the Perimeter” — in that grey zone where urban meets suburban, within a mile of the 285 highway. It borders the suburbs to the north of Atlanta, in an area with good school districts.

Sorry if I’ve bored you with too much detail, but location is the most important aspect of this project. Many real estate investors decide to specialize in ONE location — sometimes limiting their search to only a few blocks — and there’s a ton of merit to that strategy. If I start flipping houses, I’ll most likely follow that approach.

Will and I are taking the opposite tactic for our rentals, because we’re buying-and-holding for the long run. Neighborhoods will fluctuate in unpredictable ways over the span of the next 40 years. By diversifying our buy-and-hold locations, we’ll defray the risk of holding a bunch of houses in an area that might experience a collapse. (Of course, if ALL of metropolitan Atlanta plummets, we’re screwed.)

C’mon, Get Talkin’ Numbers, Already

rental property - repairThis house went on the market in August 2011 with an asking price of $175,000. If that sounds like a lot of money for a home in disrepair — in a city where you can pick up houses for $21,000 — you can thank the location. This property sits on one acre of land, which is a rarity inside the Perimeter.

The asking price was a little high. The next-door neighbor’s house is currently on the market with an asking price of $155,000, and it doesn’t need repair.

So one month later, in September 2011, the owners dropped the asking price to $148,000. That’s in line with homes on that street that are in good condition, but this place needed a deeper discount to compensate for the work that needs to be put into it.

So in October 2011, the owners dropped the price again, down to $125,000, and that’s where the price remained when we stumbled upon the house in February 2012.

Negotiation Time

We toyed with our offer for a long time. We had a very strong sense that the owners would accept $115,000, and we were ready to pay that. But we wanted to make a smaller offer, so that we could “negotiate up.”
bathroom renovation
Will wanted to offer $105,000. I argued that we should offer $95,000. We volleyed the idea back and forth. We both worried that the “reverse sticker shock” of a less-than-six-figure-offer would cause the seller to dismiss us.

We consulted Mom and Dad. My dad, a tough negotiator, liked Will’s idea. My mom, an even tougher negotiator, agreed with mine.

Mom knows best: we submitted an offer of $95,000 and waited for the seller to retort with a counter-offer. To our amazement, the seller accepted it!

You know, real estate just blows my mind. You can “save” $10,000 just by asking for it. I don’t know any other area of life in which that’s possible, unless you’re running a major business.

We bought the house for $94,000, after getting another $1,000 concession when the inspector found mold in the basement. (It’ll cost $1,000 to treat the mold, so we’ll “break even.”)

The “REAL purchase price” is the purchase PLUS initial repairs. Our repairs are going to cost about $6,000, so the “actual cost” of the house is $100,000.

According to the One Percent Rule of Thumb, this house would be a good deal if we collect $1,000 per month in gross rent. ($100,000 x .01 = $1,000).

I estimate that this house can rent for $1,000 – $1,200 per month, thanks mostly to its zoning and its school district. The return on investment isn’t as hot as the $21,000 house, but the quality of tenant is likely to be much higher.

What’s Next?

rental house team sportThank goodness we’ve started delegating out the repair work: instead of sanding cabinets and hammering nails in House #2, we outsourced that work and used the extra time to search for House #3.

Plus, we forged great relationships with the contractors who worked on House #2, so we knew exactly who to call for quotes on House #3. This streamlined the process immensely, allowing us to coordinate the repairs much faster.

If there’s one lesson that Houses #2 and #3 have taught me, it’s that you’re only as strong as the team around you. Business is a team sport. My focus from this point forward is to build that team.

UPDATE, NOV. 2012: We rented out the house! Check out the final numbers.