Investing, Reduced to Its Core (2024)

Myth:Wealth comes from living below your means.

Fact:Frugality is thefirststep,not the last.

I’d like to tell you about one of the most interesting couples I know.

Theywere apartment-dwellers when we met, and Idon’tmean the New York City variety. Their dark, mustyapartment festered inan areawhere land is plentiful and square footage is cheap, where apartments are synonymous with squalor.

I’m not sure when their tables turned, or how long they toiled behind-the-scenes building their family empire; I can’t pinpoint the yeartheir net worth climbed into seven digits.

Their newfound wealth isn’t flashy. They drive modest cars and wear nameless brands, though they’ve upgraded into a nicerhome.

The main hint that they’re moneyed, though, isn’t reflected in their purchases. It shows inhow they spend their time.

Neither have jobs outside the home (anymore), nor do they have any sense of urgency about getting one.They travel regularly, ski often, kayakon occasion, and hike like it’s going out of style.

Occasionally I’ll spend a weekend with them. When we’re togetherat the grocery store, I see them scanning their receipt carefully, checking for errors: Did the milkring up twice?

For a moment, I’mtempted to believe that their wealth came from penny-pinching.

“See?,” I tell myself,because I want to believe it.“They’re frugal; they pay attention to sales and check receipts. And they’re millionaires. I bet that’s how they did it.”

Then I slap myself.

“College students and low-wageworkers check their grocery receipts for accuracy,” I remind myself, “and they’re notmillionaires.”

“Yet.”

Here’s a lesson I wastedyearsfiguring out —

Paying attention to sales, scrutinizing receipts, negotiating bills — these aresymptomsof attentiveness to money.But they’re not thecauseof wealth.

You don’t grow wealth by clipping coupons and turning down the thermostat; you grow wealth by starting businesses and investing.

Frugality is the first step, not the last.

Why Investing Doesn’t Get Enough Credit

Most personal finance adviceemphasizes saving, saving, saving — oftento the exclusion of the limitless potential found inearning more.

Earning more (while maintaining current spending) is the most effective wayto build your net worth. It’s also the most overlooked.

I have a few theorieswhy:

#1: Low-Hanging Fruit:Chopping a $35 monthly cable TV bill is easier than starting aside businessor buying a rental property that brings in an extra $800 per month.

If you’re new to the personal finance scene or if you’re prone to overspending,frugality provides the “quick win,” the low-hanging fruit.

#2: Simplicity:Avoiding packaged foods and dining at homeon Fridaynight is easy to understand; these articles require minimal research.

Understanding how a mortgage amortization schedule works, knowing the difference between an appraisal and an assessment — these topics are complex, and therefore less discussed on the distracted Internet.

#3: Accessibility:You need confidence to believe you can launch a business, quit your job, and travel to Italy with a one-way ticket. You don’t need (as much) confidence to believe you can shop at T.J. Maxx instead of Banana Republic. Frugality feels accessible. There’s less risk of rejection; less fear of failure.

#4: Instant Gratification:Buying a sweater on clearance, scoring a great deal on shoes— these cost-cutting measures provide us with instant gratification.“Sweet!I saved $12 on groceries!”

Buying your first rental property takesmonths.It’s no surprise that people aredrawn to instant results — even if these doesn’t move the needle as much.

The take-away, however, isnottoabandon frugality altogether. It’s to recognizefrugality as astepping stonethat createsthe initial seed money for your businesses and investments. Those businesses and investments create sustainable, freedom-inducingwealth.

Three Types of Investments

There are three types of investments:

1. Owner— Stocks, businesses, real estate. You’re the owner. You profit fromperformance.
2. Lender— Bonds, peer-to-peer lending, owner-financing. You’re the lender.You profit fromspread.
3. Holder— CDs, money market accounts, savings accounts. You don’t profit. You hope to break even with inflation, but you probably won’t.

We’ll focus this article on investments in which you’re the owner.

Here are four strategies for investing in assets you own:

#1: Three-Fund Portfolio

First, a short vocabulary lesson:

• Broad market is a fancy way of saying “gigantic market” — like the entire U.S., or every big company in Europe.
• Index fundsare baskets of stocks that mirror an underlying trading index, like the Dow Jones.

Broad-market index funds, represent a huge cross-sectionof the market.

Okay, a few more definitions.Equities (stock) markets are classified in three ways:

• Size:Large, mid-size and small companies.
• Style:Value, growth, and blend.
• Geography:As Americans, we divide the world into U.S. and International. We break down international as:
  • Developed markets like Western and Northern Europe, Australia, New Zealand, Canada, and some parts ofAsia (Japan, Hong Kong, Singapore),
  • Emerging markets like Brazil, Russia, China,India, South Africa, Thailand and the U.A.E.
  • Frontier markets like Ghana, Serbia, Croatia, Jamaica, Ukraine and Botswana

This elaborate setup leads to the following idea:

Invest 1/3 of your portfolio in each of three broad markets:

• U.S. stocks
• U.S. bonds
• International stocks

Keep a one-third proportion in each.

Funds will rise and fall over time, which means you won’t hold one-third forever. Rebalance annually to return to one-third.

Repeatuntil you’re 55-60, then switch to a 50/50 split between U.S. stocks and bonds. (I’m aiming this specifically at U.S.-based readers.)

“Is this the most-optimized portfolio?”

No, it’s the easiest. Done is better than perfect.

Extra Credit:

If you want something that’s slightlymore sophisticated, try this:110 Minus Your Age= the proportion in stocks, with the rest in bonds.

Of the proportion that goes into stocks, 70% goes to the U.S. and 30% goes to International funds.

If you’re 30, for example:

• 80 percent stocks (56% U.S. stocks, 24% International stocks)
• 20 percent bonds

If you enjoy a bit more risk, modify the equation to 120 minus Your Age; if you lean conservative, modify it to 100 minus Your Age.

#2: Five-Fund Portfolio

Here’s a modifiedversion of the strategy above. It uses five types of indexfunds:

• 20% U.S. large caps
• 20% U.S. small caps
• 20% International emerging markets
• 20% International developed markets
• 20% U.S. bonds

If you like to place tiny betson the market, try a modified version that lets you stick 10 percent of your portfolio into anotheralternative.

• 10% Random wild fun investing
• 18% U.S. large caps
• 18% U.S. small caps
• 18% International emerging markets
• 18% International developed markets
• 18% U.S. bonds

UsePersonal Capital to track your investments When you login, you’ll see your allocationat a glance:

You can also use this totrack your net worth.(It’s free, although that’s an affiliate link.)

#3: Real Estate

Don’t spread yourself too thin. If you want to become a real estate investor, chooseone niche and one strategy.

• Niches:Residential; Retail; Apartments; Office; Notes; REITs; etc.
• Strategy:Rentals; Flipping; Wholesaling; etc.

Start with the end in mind. My goalispassive income, so I prefer rental properties thanks to their cash flow.

My strategy is straightforward: buy, rehab, put my property manager in charge, and collect payments. Dump the profitsinto massacring the mortgage and/or buying more houses in cash.

#4: Launch a Business

Many entrepreneurs don’t think of themselves as investors. But having your own business is the ultimate investment, for reasons that are obvious if you think about it.

There are two types of businesses:

• Lifestyle —Your goal isa lifestyle that creates freedom and flexibility. You’re happy as anindependent solo-preneur. If you hire employees/contractors, you’ll limit your growth to a tiny team.You don’t want scale; you want lifestyle.

• Growth Businesses— You’re building a company that could be an acquisition target or that you can take public. Youharbor huge ideas: you want to expand to 40 employees by December.You want to scale up, then cash out(or keep scaling.)

So … What Should You Choose?

What does this mean in yourlife?

Here’s my challenge to you:

#1: Pickone methodthat we’ve discussed.Rebalance your portfolio. Buy a broad-market index fund. Choose areal estate niche.

#2: Writethe smallest step required to get started. Start a website for your lifestyle business. Learn more about rental properties.

#3: Createa deadline for thatsmall step. Two days? Five days?

#4: Start.