Posts Tagged index funds

This is Part 4 of my review and chapter summary of Getting Rich in America: 8 Simple Rules for Building a Fortune and a Satisfying Life by Dwight R. Lee and Richard B. McKenzie.

You can read the first three parts of this review by clicking the following links:

Getting Rich in America Book Review and Summary, Part 1

Getting Rich in America Book Review and Summary, Part 2

Getting Rich in America Book Review and Summary, Part 3

Rule #7. Take Prudent Risks

When considering an investment program, being willing to accept some risks can increase the return on your investment enough to add hundreds of thousands of dollars to your retirement wealth.  The key is to take prudent risks - meaning only those risks that have a real potential to increase your return.

You don’t need a lot of specialized knowledge to become a successful investor.  The phrase “A little knowledge can be a dangerous thing” applies here:

• Information on taxation can save you lots of money by deferring or avoiding taxes, but keeping up with tax code changes is a full-time job better left to tax accountants;
• Insurance is an important supplement to an investment program, but few people have the time or interest to become well informed about insurance, which means they must rely on experts;
• Wills and trust agreements are important for protecting one’s net worth, and a lawyer is the right person to help with this process.

For an investment strategy that doesn’t require any special knowledge, you can buy the market by investing in a mutual fund that tracks to the S&P 500 Index.  A broad based index fund will almost surely do better over the long run than an individual stock or a managed mutual fund.  Here are five advantages of index funds:

1. Investing in index funds is easy to do, requiring no special knowledge or insights;
2. Such funds provide a high degree of diversification that eliminates almost all the risks that you are not getting paid for;
3. The risks that remain with investing in index funds are not very troubling, especially for young investors;
4. The long-run return from index funds is higher than you can expect from almost any other investment;
5. Management fees associated with index funds won’t eat up much of your return because an index fund requires very little managing.

U.S. Bonds are often referred to as risk-free investments, because the federal government guarantees the return.  Over the long run, the real guarantee you get from investing in anything guaranteed by the government is that you will end up with thousands of dollars less than you could have had.  A financial instrument that promises a fixed rate of return with little risk of default will pay a much lower return over the long run than will stocks whose return fluctuates.

A good rule, especially for young people, is never invest in anything that provides a guaranteed yield - it’s simply too risky.  Government bonds are risky because their interest rate remains constant, making them vulnerable to inflation.  Young people have time to wait for the market to recover from down swings.

One way to beat the market is to start your own business.  This is a riskier strategy than investing in index funds, but it can lead to very high rates of return.  A high percentage of those who become millionaires do so by starting and running a business:

1. The potential for high profit from business ownership is partly explained as a return to the considerable risk involved.
2. Researchers tend to focus on business owners who’ve “made it” and often ignore those who’ve failed.
   
3. Not all potential return from business ownership is explained by risk, but from the payoff of putting in the long hours necessary to make it successful.  The income is similar to someone who takes on a second job.
4. Business owners often do well because they save a much higher percentage of their income than most people do.
5. Those who start their own business ignore the diversification adage of “putting all your eggs in one basket”, and focus their energies on making the business a success.

My Take

I’ve got a ways to go before retirement, and I’m invested primarily in stocks and mutual funds.  I do like index funds, especially their low expenses.  While many will look at my portfolio and exclaim that I’m not as diversified as I should be, I’ve taken some advice from Robert Kiyosaki and focused on several companies that provide a cash flow through dividends rather than just capital appreciation.  Still, for someone not as savvy in regards to investing, an index fund is the way to go if you want to track to the market.

Rule #8. Strive for Balance

Rule #8 is a recap of the first seven rules, but also hits upon some broad topics.  Being principled means living a life guided by constraints that have been tested through the ages.  It’s a tough assignment, given the temptations that we face every day.  These rules guide you toward becoming a moral person.

Self-discipline stems from having a never-quit attitude, something that people who have “made it” all share.  Jesse Owens had a coach who laid out a “ladder to his dream”:

• 1st rung is DETERMINATION
• 2nd rung is DEDICATION
• 3rd rung is DISCIPLINE
• 4th rung is ATTITUDE

The first three rungs are important, but the 4th rung is vital.

My Take

Rule #8 seemed to be a summary of the previous rules, and not as well-defined as Rules #1-#7.  I would have presented 7 Simple Rules instead of 8.  Nonetheless, the authors did a good job laying out their philosophy.

The authors also provide a primer on stocks and bonds that is worthwhile reading for the novice.

Rating: 4 axes out of 5

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