ABOUT POVERTY

Those not familiar with my personal history may have the perception that I am unsympathetic to those who may have personal struggles with money. Nothing could be further from the truth.

I was a runaway from age 15.  As a runaway, I have eaten out of dumpsters, slept in parks, and have stolen food to survive.  As a young adult I’ve failed at business, been fired from jobs, and been evicted from my apartment.  I know what it is like to have money problems of just about every type.  I’ve had to choose between food and rent.

It is because of these past failures that I became obsessed with educating myself regarding finance.  Because of the experience gained through my past failures and my unquenchable thirst for knowledge, I’ve brought myself out of poverty and created quite a comfortable life for myself.  Here are a few of the things I’ve learned along the way regarding poverty and escaping its clutches:

1.  TAKE RESPONSIBILITY

The biggest difference between those who succeed and those who fail is the DESIRE to take responsibility.  Those who fail always blame somebody else.  They blame the corporations, the government, the IRS, the deadbeat dads, and the weather for their woes.  Those who succeed will always blame themselves for their problems, and then work on finding a solution.  If you are blaming somebody else (ANYBODY ELSE!) for your problems, then you are giving control of your life away.  If you accept blame then you accept control, and when you control for something then you have the power to change it.

2.  LONG TERM VS. SHORT TERM THINKING

Thinking in the short-term creates money problems.  You buy toys, see concerts, and eat out instead of paying bills because it creates a sense of immediate satisfaction. When you switch to thinking long term, you will start saving money, investing, and paying bills first, then spending for pleasure with whatever is left over.  You start seeing how such actions will create a fortune for you in the future and you would RATHER do these things than see that concert or buy that toy.  There is no struggle because you stop seeing it as a struggle between saving $30 and seeing that concert.  You see it as having a fortune vs. seeing a concert.  The choice becomes a no brainer. 

3.  SCARED MONEY NEVER WINS

The more worried you are about money, the less chances you should take with it.  As in dating, desperation leads to terrible decisions.  If you are broke, you need to build a foundation of financial security before you take chances.  Be teaching yourself to walk away from high risk situations now, you will also be training yourself to better evaluate risk in the future.

4.  FIND MORE INCOME

Most self-finance books focus on saving and cutting spending.  Though these things are important, they are secondary to raising income.  Before you even consider saving or cutting expenses, you have to have income.  And you need to do whatever you can to make sure that your income is high enough to cover your expenses.  To do this you need to evaluate your skills and education and then search for a job you qualify for that pays well enough to accomplish you needs.

This is where I often hear things like, “well, I don’t have much of an education or many job skills”, or “the job market sucks right now,” or “whine, bitch, cry, and moan.”  If something along these lines popped into your head when reading this, I’d like to refer you back to point #1.  The fact is, there are well paying jobs that require very little education and very little skill.  Furthermore, if you know the job you want requires a higher education or specific skills, the GO GET THEM!  And if none of that works, then create a product and sell it.  In short, if you do not have an income that is high enough to meet your expenses, then your sole priority should be doing whatever is required to do so.

5.  PUT YOUR MONEY OUT OF REACH

Investment accounts not only allow you to (drum roll here) invest money, but they also have the advantage of taking about two weeks between withdrawing money from them and actually receiving it so you can spend it.  If accessible money tends to burn a hole in your pocket (as it does to my pockets), then make it inaccessible!  I never think about spending my savings or investment money because it takes too much time and too much effort for me to get to it.  In short, I simply don’t allow myself to make stupid decisions with my money.  I’ve found this system is wonderful for circumnavigating the short circuits found in our human psychology. 

There are of course a number of other things I’ve learned about investing and personal finance that I will likely share over the months and years to come.  But these five simple things will by far produce the greatest results. 

KNOW THE ENEMY

And now for some really bad news.

In a system that creates money from nothing, there is a slow but extremely destructive side effect. This side effect is your #1 enemy in all things financial. Almost everybody knows it exist, but few take it into consideration when making financial decisions. Understanding what this side effect and your ability to counteract its devastating deteriorative effects will make or brake you financially.

And no, its not debt.

The answer: INFLATION

Most people know what inflation is, but for those who don't, here is a quick explanation. Inflation is the reason why an ice cream cone that used to cost a nickel now cost $1.25. It is the slow but inevitable devaluation of money. YOUR MONEY!

With our current monetary system, more money MUST be created so governments can pay interest to the central banks. So more money is printed and the government has to pay back the banks PLUS interest. The only way this interest can ever possibly be realized is to.... print more money. And thus the cycle continues indefinitely, with the result being money typically loses a little bit of it's value every year. Here in the United States money loses roughly 2-4% of its value annually. That means the dollar you have in your wallet will only be capable of purchasing 96¢-98¢ worth of goods a year from now.

In other words, (assuming 3% inflation) if you have $10,000 sitting under your mattress earning 0% interest, in ten years it will only have the power to purchase $7374.24 of goods.

This means your money MUST be earning a MINIMUM of 2-4% interest annually JUST TO KEEP UP WITH INFLATION. If your money is not growing at the rate of inflation, then you are losing money every year in a slow, devastating, and almost invisible manner.

This is the first and primary reason why you should be investing if your not already.

SOME INVESTING FUNDAMENTALS

The entire purpose of investing is to spend money now so that you will receive more money in the future.  Typically, the two ways of doing this is through the receipt of future payments such as coupons from a bond, or dividends payed out through the ownership of stock.  The other way is through capital gains, which is what I will be addressing today.  

The golden rule of capital gains is buy low and sell high.  What you buy is a matter of preference. Some people buy commodities such as corn, or gold, or oil.  Others buy stocks.  If you choose to buy stocks I think it is important to remember that when you buy stock, you are BUYING SHARES OF OWNERSHIP in a company. Think of it as purchasing a little piece of a giant corporate pie.  If you are buying shares of stock for anything other than this purpose, then you are speculating or trading, NOT investing.  There is nothing wrong with that, but it is important to know the difference.

Many people throughout history have felt that corporate interest have been at odds with the interest of the people and that these two opposing forces are forever engaged in some type of perpetual war. Your typical "rich vs. poor" argument. What people fail to realize is that even the poor can easily align their own interest with that of the big corporations by purchasing shares of stock in those corporations. Next time you feel (or hear about) "big oil," or "big pharma," or any other such "big," might be taking advantage of the little guy for profit, you may wish to consider purchasing some of their stock, and with modern investing tools you can even purchase fractions of shares (in case you can't afford a full one).  Now, I don't encourage people to invest in things they feel are unethical, but I do encourage people to take the necessary actions to ensure that it is YOUR pockets that are getting fat and not just "evil big business." The best way to do this is through ownership.

When purchasing stocks for the purpose of capital gains, the golden rule is "buy low, sell high." This being the case, I would ask you if the stock represented in this chart, priced roughly at $92 a share, would be a good buy or not?

If you answered yes or no, then you answered incorrectly. The reason this is so is because you do not have enough information yet!  Charts only provide you with a PRICE, but they tell you nothing of VALUE.

A huge part of investing is understanding group psychology. Though individuals can be intelligent, you need to understand that people tend to do what other people are doing, and this tendency leads to some pretty stupid behavior.  It is this tendency that creates the boom/bust cycles that we see. The key to successful investing is taking advantage of this tendency by realizing it causes other investors to sell shares far below their actual value and buy shares for far more than they are worth.  In order to take advantage of this, you MUST be able to approximate a companies value!

 If I told you that you could buy a 'thingy' for $92, would that be a good price?   Obviously, you don't know until you know what the 'thingy' is!  The same applies to stocks. You need to determine if you are buying a yacht or a loaf of bread before you an determine what a fair price is.

Now if I told you the above stock earned $6.78 per share over the last year and typically traded at 28 times earnings per share (EPS)?  Would this stock price then be considered  "low" ($6.78x28=$189.84)? 

Truthfully, you still don't have enough information, because EPS share numbers are very easy for companies to manipulate.  But you certainly have a better idea than you did with just the chart.

Now what if I told you this company had $24.89 per share worth of cash lying around?  What if they had no debt? What if this company had been growing it's annual earnings at a rate of over 70% for over five years?  And what if I told you that they were producing some of the most popular products around (you probably own one of their products)?

Hopefully by now you can see this stock might be worth purchasing! And though actual stock valuation is a bit more complicated than this, sometimes companies are priced at such screaming bargains that they are hard to miss for those who know how to look. It is for these reasons that I emphasize the importance of being able to determine a stocks approximate value (valuation is more art than science) when investing.

If you are interested in learning valuation, I highly recommend the following books:

Value Investing by Bruce C. N. Greenwald, The Intelligent Investor by Benjamin Graham, and Security Analysis by Benjamin Graham and David Dodd

The last book is boring, dry, and over 900 pgs., but the other two aren't that bad, and they are definitely required reading if you intend on doing this stuff on your own.  If your head has already exploded all over your computer screen and you have absolutely zero desire to read a bunch of books so you can figure out what companies are actually worth... then scoop your brains back into your head and fear not! There are multiple ways to invest, and many of them require much less work.  But value investing (what this method is referred to) is one method that has achieved rather consistent results since at least 1934.

In case you are wondering, the stock used in this example was Apple from December, 2008.   

Lessons from the Panic of 2008

The "Panic of 2008" is now old news. Though employment numbers are lagging (they always lag), the stock market has since recovered a great deal of it's losses. But what have we learned?

Unfortunately, most people haven't learned anything. They didn't know what they were invested in to begin with because they left their investing to the brokerage firms that ran their 401Ks and pensions. If they were among the few people that did know what they were invested in, they probably didn't know why. They chose where to invest their hard earned money based upon social proof, groupthink, and because "everybody else was doing it." And off the cliff the lemmings went.

Here are a few lessons you should have learned:

1) Markets Crash Unpredictably, and Rise Unpredictably

You would think this is common sense, but few people I know had a plan on what to do when the market began to tank. Uncertainty and fear were the prevailing themes. What is your plan if the markets crash again? They WILL crash again. I don't know if it will be this year, 10 years from now, or 30 years from now. And I don't know if they will fall by 20%, 50%, or 80%, but they WILL fall at some point. What will you do? If your relying on the money managers that run your 401K, by default your plan is to let other people take charge of your financial future. Is this a good idea? If you intend on selling, what will you sell and when? If you intend on buying, what will you buy and when (and how?)? Develop your plan now for bull and bear markets and there will be no surprises.

2) Remember the Fundamentals

Buy low, sell high. Sounds easy right? Then how come (almost) nobody was doing it? The answer to that question is that in addition to the fact that most people don't know when the price of a stock is high or low, there is a very strong psychological pull to do what everybody around you is doing (PANIC!). In my opinion you MUST learn how to value a business if you intend on investing, and you MUST be capable of rejecting herd mentality. If honest self assessment leads you to think you are incapable of either of these skills and you decide that it is best to let others invest your money for you, you MUST make sure they possess these skills. Otherwise you are gambling.

In the 25 days of panic following the collapse of Lehman Brothers in 2008, Warren Buffett's Berkshire Hathaway invested $15.6 billion dollars when everybody else was selling off their investments as fast as they could. He did this because he was able to determine prices were low, because he didn't follow the crowds, and because he had a plan that involved having enough cash around to take advantage of such a situation. You don't need to be Warren Buffett, have $15 billion, or even follow the same strategy as he does in order to be successful with investing. But you do need a plan.

3) Derivatives are Toxic

Most people still aren't sure what a derivative is. They certainly can't tell if the fund manager running their 401K or pensions are loading up on them (many were and still are, in case you haven't figured that out). And even if they did, the sure as Hell didn't know what they were worth. Which brings me to my next point...

4) Know What You Own and Why

Stocks are shares of ownership in a business. Bonds are ownership of debt. These the two basic units of investing and everything else is just more complicated versions of these two basic units. Ask yourself what is in that mutual fund or index fund that you own. Then ask yourself why you own it. I couldn't tell you how many people have told me "I was invested in all blue chips." But nobody was able to tell me why. Safety? How delusional...

5) Don't Trust the Media

Most financial news is about as useful as hitting yourself with a hammer. Very, very few people predicted what was going to occur in 2008 until it was happening. Fewer offered useful advise about what to do when it happened. Even fewer predicted the rebound the stock market has a seen since then. Listening to the predictions now is like watching headless chickens. Nobody seems to know which way we're going. If they tell you they do, take it with a grain of salt. Because they CAN'T KNOW. Go back to #1 to find out why.

6) You Must Be Financially Aware

The George Soros', Warren Buffet's, and bank CEO's came out just fine in this crisis. Its the "average Joe" that has suffered the most. Why? Is it because "wall street fat cats" are simply horrible people who derive sadistic pleasure from feeding of the weak? Not likely. Sure they are greedy, but so are you. They just ended up on the better end of the equation and the primary reason why they did so is because they were prepared and aware of what was going on.

The past is behind us and unchangeable. We have choices regarding the future. You can remain ignorant of the financial "goings on" of the world and thus subject yourself to eventual victimization of the "fat cats," or you can educate yourself, gain awareness, and prepare yourself for the various scenarios that are likely to play out in our economic future. If your new to all of this, it will seem like rocket surgery. And sometimes it's best to hire a good rocket surgeon. If that's your plan, make sure you know how to tell a good rocket surgeon from a bad one. To do that effectively you will at least have to learn the basics. Remember, everything is difficult until you learn how to do it!

If you haven't already, START LEARNING!!!

WHEN TO START INVESTING?

Most people realize that if they don't invest their money, at some point they will grow old, be broke, and be screwed.  The question that I am most often asked by younger people (20s and 30s) is, "when should I start investing?" The question is almost always immediately followed by, "how much money do I need to get started?"

The answer to the first question is the easiest: You should have started investing years ago!  The magic of compound interest is one of the great wonders of the world.  Once you understand its magic, you will have wished you invest the very first birthday check you got from grandma vs. buying that GI Joe.  Let's take a look at what I mean:

Let's pretend you are 25 years old and only have $1000 saved up that you would like to invest. Let us also assume that you are going to earn 10% average interest on an annual basis. Here is what you your money would earn over the next ten years;

Today - $1000

Year 1 - $1100

        2 - $1210

        3 - $1331

        4 - $1464

        5 - $1610

        6 - $1771

        7 - $1948

        8 - $2143

        9 - $2357

      10 - $2594

Not bad. In ten years time you have more than doubled your money. But had you started just five years earlier, you would now have $4178, four times the amount you started with!

In reality, you would want to make a couple of adjustments. First, you would want to regularly contribute to your investments.  Second, you would ideally want to achieve returns grater than 10%.

Another thing to keep in mind about the real world is that many investors lose money as well.  And if you haven't started investing yet, it is likely for one very real and very valid reason: you know that you don't know what your doing, and thus you understand you are likely to lose money!

Unfortunately, many people never make it past this point because they are seized by what I like to call "financial paralysis." They realize they should be investing, they look at a financial page on the Internet, and after about 20 minutes they decide the whole thing is insanely complicated and beyond their comprehension. The smarter of those with financial paralysis then set aside an amount of money from every check to invest in a 401k or Roth IRA so somebody else can do their investing for them.

There is absolutely nothing wrong with this approach... until the market crashes (as it did in 2008). Then you realize half your retirement is gone and you have nobody to blame but yourself.

So, in response to the second half of the question, my reply is, "start small."

"Small" means different things to different people. But you should only start investing with an amount that you can afford to lose.  But with the free stock tracking software found on nearly every financial page on the internet, that amount can be as little as $0 through the use of "play money."

I recommend using real money, preferably an insignificant amount.  Just understand that when you are starting, you are likely to make mistakes.  By using real money, no matter how small of an amount, you can feel the pain of these mistakes.  The point when you begin is to learn.  Making money with your investments will come later.  Just like when you learned to swim you started by holding on to the edge of the pool, or when you started riding a bike you had training wheels, when you begin investing you should begin with a small amount of capital.

Then, after you begin learning what you are doing and begin to feel more confident, you can start to wander away from the edge of the pool and gradually into deeper waters.

Whether you go on to become the investing equivalent of a deep sea diver or the person who stays in the shallow end of the pool is dependent upon a number of factors that I'll get into another time, but the point is that everybody should learn to swim. Otherwise, you are bound to eventually drown in this ocean we call life.