Friday, September 28, 2007

Buy "Assets That Grow By Themselves"

During our working lives, most of us earn $1.5 to $2.5 million before taxes. By using 10 percent of that income to buy “assets that grow by themselves,” we can accumulate another $1.5 million to accomplish all that we want to do in life. We can be free of money worries!

The “food” that makes “assets grow by themselves” is TIME. The best investor, Warren Buffett said, “We continue to make more money when snoring than when active.”

Assets that “grow by themselves” are the assets that increase in value without you doing a thing. Smart investors buy and hold a silent stake in great businesses—companies they use everyday. They buy stocks through mutual funds. They watch their money make money on top of dividends the businesses pay as they grow. The earnings compound over time.

The value of the businesses increases over time too. In 10 years, your purchase of $500 of assets per month ($60,000) grows to over $115,000, $250,000 in 15 years, $1 million in 25 years. From this Wealth Reserve, you can buy those things you have planned for—a luxury car, a starter home, a college fund, a retirement nest egg. If you start buying “assets that grow by themselves” early, you can accumulate a tidy sum--$1.5 million.

You have to let “assets grow by themselves!” Assets that grow by themselves grow faster inside your retirement plan at work, your rental real estate, and your securities inside IRA mutual funds. Mutual funds can own almost any asset. Some grow at a rate that is higher than inflation—about 3%. Risk free savings accounts can’t do that. Over the long run, stocks are less risky than savings because 12%-3% is greater than 3%-3%. It is the amount you keep not the yield that matters.

Most of your private property—checking, savings, CDs, vehicles, appliances, furniture, and house--are NOT assets that grow. They loose value or don’t grow in value over time. They don’t pay dividends or earnings. They don’t help you accomplish your financial goals. Most of them eat up your hard-earned paycheck. Between inflation, bank fees and taxes, most “safe” accounts lose money.

Financially independent people own different kinds of assets that grow. They never put “all their eggs in one basket.” Even when they run a business full-time, they typically have only 25% of their wealth in the business. They own many types of assets--tax-favored retirement accounts, real estate, and securities taxed at low rates are the most popular. They avoid hedge funds and commodities.

Financially independent people are independent because they use their income to buy more “assets that grow by themselves,” NOT more things. Typically their assets allow them to feel comfortable because they never use credit to pay for what they need. They spend less than they make. If their income were to be cut for five years, they would be able to survive—keeping their family and home intact. They don’t borrow money except to buy assets that earn more than the cost of the loan. Usually a mortgage or business loan is all they owe.

Most people buy mutual funds through their retirement plan. Typically they started early in their working life and consistently increased the proportion of their income designated for investments. By maximizing their retirement plan contributions, they reduced their taxable income and pay less tax now. Some obtain FREE contribution matches from their employer. Their asset growth is SUPERCHARGED.

Stock mutual funds usually grow at the highest rates over time. You can easily buy a well-rounded bunch of stocks by owning them through a mutual fund. Using one with few expenses and fees leaves more earnings for you. Some funds grow quickly but not at a steady pace. However, over time stock market index funds average 12% per year. You can estimate how much your assets can grow by themselves with the chart.

You can use the chart (or to estimate how long it will take you to buy a starter home, college fund, start a business and build a large nest egg for retirement or any other reason. The stock market returns are not guaranteed, but over time—in most 15 year periods—they are within our estimate.

Your investment portfolio should hold only assets that grow by themselves. The long term rates of growth will vary so that your TOTAL portfolio can grow no matter what type of economic situation you are in. This may allow you hold higher growth stocks as well as rental real estate and non-U.S. and emerging market stocks. By holding assets of different types, you can earn high returns with less than market risk.

One of our members, Bill, holds these asset classes at low-cost Vanguard. Bill’s portfolio had 5-year total returns of 13.66% as of 12/31/06:

Asset Class (symbol) Annual Return Volatility
500 Index (VFINX) 6.07 1.00
Selected Value (VASVX) 14.12 0.83
REIT Index (VGSIX) 22.70 1.00
Strategic Equity (VSEQX) 13.43 1.05
Small Value (VISVX) 12.96 1.00
Small Index (NAESX) 11.63 1.00
Int’l Value (VTRIX) 17.21 1.03
Emerging Mkts (VEIEX) 25.51 0.99
IT Hi Yd Bond (VWEHX) 7.55 0.82
IT Bond Index (VBIIX) 5.43 1.00

Total portfolio return 13.66 0.97

Some members like to keep it simple. They hold the Total Stock Market Index, Total International Stock Index and Total Bond Market Index funds. (U.S. stock market represents just 35% of the world's stock value.) Each year they shift assets from one to the other depending on how well each is growing. Because the largest U.S. corporations have earnings from foreign operations, some members hold just the S&P 500 Index fund. In every 15 year period, this index has averaged over 12% per year. These members added $2,000 per year, $5.56 per day, to achieve $1.3 million since 1970, $412,000 since 1980 and $90,000 since 1990. All are on track to meet their goals.

Buy “assets that grow by themselves” and relax. Let your money do the work. It is TIME not timing or stock picking that wins.