Simple Path to Wealth 1 – Rules, Debt & Millionaires

Today’s post is our first visit to a new book – The Simple Path To Wealth.

Simple Path to Wealth

Many years ago, JL (Jim) Collins wrote a famous series of blog posts (the stock series), aimed at educating his daughter about investing.

Then not so many years ago (in 2016), he wrote a book (based on the blog posts) called The Simple Path to Wealth.

• The foreword is by Pete Adeney, better known as Mr Money Mustache – one of the earliest FIRE bloggers.

I got a review copy and wrote a review here on the blog.

• But I never got around to writing a book summary, until now.

Foreword

Pete correctly points out that most books about investing are boring.

• I would go further and say that most of investing is boring.

Occasionally you come across an idea you haven’t seen before.

• But most of the time it’s just one foot in front of another, trying hard not to let your human failings get in the way of your plan.

Pete says that Jim’s book is different because it’s folksy.

He lights up the campfire and just starts telling stories.

Which is fine if you like folksy, but in my experience to date, I don’t.

• I like new and value-added, and actionable – so I’m setting a pretty high bar.

Pete thinks that Jim’s book will easily clear such a bar.

• But his own blog is more about frugality than investing (which is fine).

He concludes:

Although very few people actually follow it, I have found that the road to a wealthy life really is simple and quite enjoyable to follow.

I agree, apart from the simple bit.

• I would say that it’s simpler than people think but still too complicated for some people.

And as we know, simple is not the same thing as easy.

Introduction

Jim explains how the book grew out of a series of letters about investing that he wrote to his then-teenage daughter, which later became blog posts.

Since money is the single most powerful tool we have for navigating this complex world we’ve created, understanding it is critical.

Yet most people – including Jim’s daughter – can’t be bothered with money.

• So he needed to keep it simple.

Jim thinks that most people in the financial world make things complicated so that they can sell us complicated solutions to complex problems.

They are certainly self-interested, they are certainly more expensive than a DIY approach, and they don’t have any secret sauce.

• But I think that financial advisors and fund managers and platforms would like to make it simple, and in many cases think that they are making it simple.

But as Einstein said:

• Things should be made as simple as possible – but no simpler.

Money is one of those things where “as simple as possible” is not simple enough for everyone.

In fact, you might even say that Jim and those like him who write books explaining that investing is so simple that anyone can do it are guilty of the same crime in reverse.

• Making money seem so simple that we buy their book.

Guidelines

Jim ends his introduction with a few guidelines:

1. Spend less than you earn (ie. save) – if your lifestyle matches your income, you are no more than a gilded slave.
2. Invest the surplus (rather than keep cash)
3. Avoid debt
4. Avoid fiscally irresponsible people.
5. Avoid investment advisors – by the time you know enough to pick a good one, you know enough to handle your finances yourself.
6. The things you own in turn own you.
7. Always be clear about the financial impact of the choices you make.
8. The greater the percentage of your income you save and invest, the sooner you’ll have F-You Money – he suggests saving 50% (which will train you to be frugal).
9. The market and the value of your shares will sometimes drop dramatically – this is absolutely normal and to be expected.

I like all of these.

• But there are four others that I don’t agree with.

First up – and the theme of this series of articles – is:

• Sound investing is not complicated.

It needn’t start out that way, but unfortunately, it’s likely to end up that way if you stick at it long enough.

• Once you make more money from your investments than from your job – or once you’ve quit your job and live entirely from your investments – sticking it all in a single Vanguard fund won’t cut it.

Second is:

• When you can live on 4% of your investments per year, you are financially independent.

The 4% rule is largely discredited.

• The maximum safe withdrawal rate from a retirement pot designed to last forever is closer to 3%.
• And that requires holding a large proportion of risky growth assets (ideally 75% stocks) in your retirement portfolio – something that many retirees are unwilling to do.

Third:

• When the market drops, buy more shares. This will be much, much harder than you think.

You bet it will be.

• Even experienced investors find it hard not to sell in a crash.

Apart from that, to keep on buying (or buy more than usual) you need to have spare cash (which will have been a drag while markets were rising) or to be so early in your investment journey that your salary throws off enough spare cash to make a difference to your portfolio.

• What are the retirees supposed to do in a crash?

Fourth, and most controversial is:

• Nobody can predict when these drops will happen, even though the media is filled with those who claim they can. They are delusional, trying to sell you something or both.

I think that most drops can be predicted (not precisely, in timing or magnitude), since they are usually related to a looming recession, and are often triggered by conditions in the US economy.

I’m not suggesting that investors quit the market at the first sign of trouble.

• But dynamic asset allocation and techniques like trend-following can help you to outperform in a crisis.

And using these approaches feels better than the “rabbit-in-the headlights

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So I like nine, and question four of Jim’s rules.

• But 9 out of 13 isn’t bad.

A parable

Chapter ii is the parable of the monk and the minister:

The minister says “You know, if you could learn to cater to the king, you wouldn’t have to live on rice and beans.” “The monk replies: “If you could learn to live on rice and beans, you wouldn’t have to cater to the king.”

Jim is closer to the monk, as am I.

Jim’s story

Chapter iii is a potted bio of Jim’s life.

It has never been about retirement for me. I like working. It’s been about being able to say “no.”

This is the Fuck-You Money school of FIRE – FI without the RE.

I never enjoyed work, and by the end, I didn’t like the people I had to work with too much, either.

• I quit as soon as I was sure that I had enough cash, and I’ve never regretted it (it doesn’t sound like the average workplace has improved much in recent years).

After a series of career breaks, Jim quit for good in 2011 – a year before me.

• He’s probably a bit older than me since he started investing in 1975 – nine years before me.

Jim is not a fan of the “multiple income streams” school of investing (though he does have his blog, which I hope is more successful than mine, and the royalties from his book).

What is striking to me is how many mistakes I’ve made along the way. Yet those three simple things [50% savings, no debt, index investing] got us to where we wanted to be. That should be encouraging to anyone out there who has also made poor choices along the way and who is ready to change.

The older I get the more I hold each day precious. I’ve become steadily more relentless in purging from my life things, activities and people who no longer add value – while seeking out and adding those that do.

That’s what financial independence is all about.

Notes

The keynote of importance is the timescale used by Jim is most of the projections and calculations in the book.

He uses the period from 1975 to 2015 – basically his investing career at the time of writing the book – for that and two other reasons:

1. It is a nice, solid 40-year period and this book advocates investing for the long term.
2. 1975 is the year Jack Bogle launched the world’s first index fund and this book advocates investing in index funds.

Gross returns over that 40-year period for the US stock market were 11.9% pa (dividends reinvested).

After inflation, that’s a real return of 7.8% pa.

These are very good returns, and Jim uses the 11.9% figure a lot in the book.

Nobody should rely on this number.

• From where we are today, it’s hard enough to construct portfolios to return 3% to 4% pa real (5% to 6% including inflation).

Debt

We’re now into the book proper.

• Chapter 1 is about debt.

Debt is a bad thing – it makes you think that you have money that you don’t.

• But it’s not bad for everyone.

For marketers, it is a powerful tool. It allows them to sell their products and services far more easily, and for far more money, than if it didn’t exist.

The acceptance of debt is the reason that most people don’t achieve FI.

• Servicing debt is an addictive lifestyle, with all the stress, shame, guilt loneliness and helplessness that other addicts feel.

Debt also forces you to focus on your past decisions rather than the future.

• These days, we get people off to a bad start with student loans (which are actually a graduate tax but feel like debt).

Paying off debt

There’s no magic bullet to paying off debt.

1. Spend less, until you have a reliable monthly surplus.
2. Pay down the most expensive debt first, paying only the monthly minimum on everything else.

There’s no need to pay a service to help you or even to consolidate loans.

• The lower rate might save you money, but it might also make you think you’ve solved the problem, which you haven’t done until the last debt has been paid.

Jim also advises against paying off the smallest loans first, for the psychological boost.

• He’s not a fan of crutches (and neither am I).

Of course, all this is another thing that is simple, but not easy.

• Discipline is required, and time.

Good debt

The only good debt is that taken out to buy an appreciating asset, which for most people is a mortgage on a property.

But even here, Jim is not so sure:

The easy availability of mortgage loans tempts far too many into buying houses they don’t need or that are far more expensive than prudent. Seek the least house to meet your needs rather than the most house you can technically afford.

This is of course great advice.

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Jim is not a fan of property in general:

More house also means more stuff to maintain and fill it. The more and greater things you allow in your life, the more of your time, money and life energy they demand. Houses are an expensive indulgence, not an investment.

I would say that depends.

1. In the UK, buying a house is the tax-advantaged pre-payment of your future costs of shelter.
2. As such, it reduces your sequencing risk (sensitivity to market crashes) in retirement.

I would say buy a house, but only buy one that you are prepared to own for 20 years.

• In general, owning more than one house is not a great plan, even if some of them are rented out.

Millionaires

It is possible for every middle-class wage earner to retire a millionaire. Though it’s never going to happen.

Using his massive 11.9% pa compounding, Jim notes that $12K in stocks in 1975 would be worth $1M in 2015.

• Alternatively, $130 per month from January 1975 ($1.6K pa) would get you very close.

He also shows that IF someone earns $25K pa, saves 50% of that into a stock-market index fund, and their retirement pot safely earns 4% pa:

• THEN they are financially independent in 11.5 years (assuming they can still live off the $12.5K they have been saving each year).

I think Jim’s compounding rate is too high and his withdrawal rate is unsafe.

• Getting to $1M – and living off it – would be much more difficult for someone starting today.

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But $1M is worth around £800K as I write, so that’s not as stupid a target as it sounds.

The average house in the UK costs £232K, leaving £768K for your retirement pot.

• At 3% pa, that would generate £23K pa to live on.

Which might be enough for you or not – it might even be more than you need.

Being independently wealthy is every bit as much about limiting needs as it is about how much money you have.

Income is not the key – plenty of high-income people go bust.

• Income minus spending is what counts.

You don’t have to go far to meet someone who will tell you about all the things they can’t live without. But if you want to be wealthy, it pays to reexamine and question those beliefs.

Money

Stop thinking about what your money can buy. Start thinking about what your money can earn. And then think about what the money it earns can earn.

Once you spend it, money is gone.

• And so is the money it might have earned.

Jim explains that the $20K used to buy a car would earn 8% (real) in the market.

• Which is another $1.6K pa in each of the 10 years you own the car.

Or a total of $36K, not $20K.

• It’s even worse if you finance the car and pay interest on the debt.

With a more realistic rate of return, the numbers are less scary, but the principle is the same.

Investments

Jim notes that Warren Buffett doesn’t try to time the market.

• And he regards his investments as part-shares in the business (sometimes, he actually buys the whole business).

When the share price of one of his businesses drops, what he knows on a deep emotional level is that he still owns precisely the same amount of that company. As long as the company is sound, the fluctuations in its stock price are fairly inconsequential.

They will rise and fall in the short term, but good companies earn real money along the way and in doing so their value rises relentlessly over time.

In other words, buy and hold.

Bull and bear markets

In Chapter 5, Jim runs through some of his core investing principles:

1. It is simply not possible to time the market.
2. The market is the most powerful wealth-building tool of all time.
3. The market always goes up and it is always a wild and rocky ride along the way. We need to toughen up mentally and ride out [the swings].
4. I want my money working as hard as possible, as soon as possible.

As before, I’m not so black and white on market timing.

• Lots of things – some that are forced, some that are choices – amount to market timing.

You have to deal with portfolio cash flows, and with simple things like rebalancing.

• And there are times when the vast majority of the risk is to the downside.

Sticking everything in the S&P 500 forever really isn’t the optimal investment strategy.

• And you would have to be prepared for 50% drawdowns, which I am not.

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That said, Jim makes the good point that it rarely feels like a good time to put money into the market.

• Twenty years later, it’s much harder to find a time that would have been bad.

Jim reports some of the questions he is asked:

Is NOW a good time to invest, right before a possible stock market crash? My fear had held me off for months, but I feel because I’m holding off I’m losing out. Maybe I should wait until after the crash so I don’t lose a chunk of money.

This is all about fear and greed, the two major emotions that drive investors. Inevitably, there is a major market crash coming, and another after that. Learning to live with this reality is critical to successful investing.

The question is not “Should I invest in stocks now?” Rather it is “Should you invest in stocks at all?” Until you can be absolutely certain that you can watch your wealth get cut in half and still stay the course, the answer is no.

Market timing again

To play this market timing game well, you need to be right twice: First you need to call the high. Then you need to call the low.

Jim is right about this.

• Since most timing is about selling before a crash, getting back in after the crash has happened is more difficult than you might expect.

It always feels like there is another leg down to come.

Jim’s argument that market timing can’t work is that if it did, the best market timer would be richer and more famous than Buffett.

• I find this argument pretty weak, since (1) Buffett is not a buy and hold index investor and (2) the only guy who got rich off index funds was Bogle, who invented them.

In contrast, there are dozens of billionaires and hundreds of multi-millionaire investors who used active techniques to get there (usually trend and macro, but sometimes even stock-picking).

Conclusions

I haven’t re-read Jim’s book since I wrote my review five years ago.

• In fact, I don’t plan even to re-read that review until I reach the end of the book once more.

We’re off to a good start today, with plenty of useful stuff and just enough to disagree with for it to be interesting.

• I’ve covered a quarter of the book today, so there will be three more articles in this series, plus a summary.

Until next time.