Managing Your Money

Managing your money is one of the simplest things in life to do. It is made to appear difficult because of confusion involved resulting from different choices available for investing. Alternative uses of money and all investment opportunities, however, come under five simple guidelines to remember:

1. Never risk principal.
2. Don’t be greedy.
3. Respect the time value of money.
4. Limit your choices.
5. Live below your means.

Never Risk Principal. Principal is hard to come by so it should be invested conservatively. Good uses for principal are (1) down payment on a house, (2) investments in high quality stocks and bonds, (3) savings accounts, and (4) private businesses (under certain circumstances). If principal is to be used for businesses, then only a percentage of principal available should be used. “At risk” money should be an amount of money which one can “afford to lose”. (“Afford to lose” means that your life style is not adversely affected in the event complete loss of principal occurs). The risk of larger amounts of capital for private businesses or speculative investments should only be undertaken by experienced and mature investors who are capable of analyzing the risk.

Don’t Be Greedy. Measuring ones greed is difficult. All of us want to make the highest possible returns available when investing money. Who, in this country, doesn’t expect the value of their home to increase faster than it has? Who, after hearing a stock broker’s spiel, is not ultimately disappointed in the results “promised” by the stock broker? All brokers are “on commission”. That term is very important. If someone is “on commission” they cannot be impartial when advising you. You are usually your own best advisor, assuming you have a minimum of education and a lot of good judgement. Greed among investors is invariably why people go broke. Remember that higher returns bear higher risk. Judge yourself accordingly. If someone promises you a 20% return, remember that the smartest people in the world would all be fighting to invest if 20% were “in the bag”. The “smartest people in the world” competing to get into the investment that returned 20% would therefore push the cost of the investment up. Consequently the yield would go down so that the 20% “guaranteed return” would become “an average market yield”. Measuring ones greed is an important early lesson in managing money.

Respect The Time Value of Money. To comprehend the “time value of money” one must learn patience. A 5% compounded annual return will multiply money 1.28 times in five years and a 10% compounded annual return would multiply money 1.6 times every five years. A 15% compounded return will double money every five years and a 20% compounded return will multiply money by 2.5 times every five years.

COMPOUNDING TABLES

($10,000 INVESTMENT COMPOUNDED ANNUALLY)(dollars)

The average annual return (dividends and price appreciation) of the Dow Jones Industrial Stocks in Post War America (1945-1996) exceeded 12% annually. Dividend yield averaged 4.4% and price appreciation exceeded 7% annually. $10,000 invested in the Dow Jones 30 Industrial Stocks 45 years ago would be worth $338,000 now and the “average” dividend yield would have grown from $390.00 a year to dividend income of $7,100 annually.

Limit Your Choices. Stay away from illiquid investments, limited partnerships, commodities and other brokerage schemes that are generally sold as “sure shots”. Stick with what you know best. If you depend upon your own knowledge in an area in which you are schooled and/or trained, you will not then be dependent upon the advice and abilities of others, which advice may be bad and which ability may be lacking. Bank trust departments generally avoid those types of investments because of the additional risk and because they have a fiduciary responsibility to insure principal is soundly invested.

Adherence to the above requires discipline. A disciplined approach to money management will yield self satisfaction. It is a lot of fun to observe the success of your efforts. It is not easy to think long term in a world that is so fast moving but good money management requires a disciplined long term outlook.
The old saying “money cannot buy happiness” certainly is true. Money can make your life easier, and money can provide the means to broaden ones horizons, but money never makes one happy in and of itself.
If you are fortunate enough to have money to manage, it is important to make sure you manage your money and avoid the pitfalls of letting your money manage you. Live below your means. A lifestyle where it is difficult to pay bills and difficult to meet obligations leads to frustration. Continuous frustration leads to unhappiness and poor health.

So, effective money management dictates the following:
1. Don’t risk principal.
2. Measure your greed.
3. Respect the time value of money.
4. Limit your choices.

And, to insure maximum enjoyment from your income, live below your means so that there is income left over with which to “just have fun”. That is how one gets “the most for their money”.

George W. Rauch
January 29, 1998

RICH MAN, POOR MAN*

Making money entails a lot more than predicting which way the stock or bond markets are heading. For the majority of investors, making money requires a plan, self discipline and desire. Therefore, consider the four rules below:

Rule 1: COMPOUNDING: One of the most important lessons for living in the modern world is that to survive you’ve got to have money. But to live (survive) happily, you must have love, health (mental and physical), freedom, intellectual stimulation — and money. Use the “money bible.” What’s the money bible? It’s a volume of the compounding interest tables.

Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path; you need intelligence in order to understand what you are doing and why; and you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time; time to allow the power of compounding to work for you. Remember, compounding only works through time.

But there are two catches in the compounding process. The first is obvious — compounding may involve sacrifice (you can’t spend it and still save it). Second, compounding is boring — it’s boring until (after seven or eight years) the money starts to pour in. Then compounding becomes very interesting. In fact, it becomes downright fascinating!

In order to emphasize the power of compounding, look at chart I courtesy of Market Logic, of Ft. Lauderdale, FL. In this study we assume that investor (B) opens an IRA at age 19. For seven consecutive periods he puts $2000 in his IRA at an average growth rate of 10% (7% interest plus growth). After seven years this fellow makes NO MORE contributions — he’s finished.

A second investor (A) makes no contributions until age 26 (this is the age when investor B was finished with his contributions). Then A continues faithfully to contribute $2000 every year until he’s 65 (at the same theoretical 10% rate).

Now study the results. B, who made his contributions earlier and who made only seven contributions, ends up with MORE money than A, who made 40 contributions but at a LATER TIME. the difference in the two is that B had seven more early years of compounding than A. Those seven early years were worth more than all of A’s 33 additional contributions.

This is a study to show to your children. It’s a study I’ve lived by. It works. You can work your compounding with muni-bonds, with a good money market fund, with T-bills or with good “A rated” stocks that pay increasing dividends.

Rule 2: DON’T LOSE MONEY: This may sound naive, but it isn’t. If you want to be wealthy, you must not lose money, or I should say you must not lose BIG money. Absurd rule? Maybe, but MOST PEOPLE LOSE MONEY in disastrous investments, gambling, rotten business deals, greed or as a result of poor timing, the stock market, in options and futures, in real estate, in bad loans and in their own business.

Rule 3: RICH MAN, POOR MAN: In the investment world the wealthy investor has one major advantage over the little guy, the stock market amateur and the neophyte trader. The advantage that the wealthy investor enjoys is that HE DOESN’T NEED THE MARKETS. What a difference that makes, both in one’s mental attitude and in the way one actually handles one’s money.

The wealthy investor doesn’t need the markets because he already has all the income he needs. He has money coming in via bonds, T-bills, money market funds, stocks and real estate. In other words, the wealthy investor never feels pressured to “make money” in the market.

The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry or gold is on the “give away” table, he buys art or diamonds or gold. In other words, the wealthy investor puts his money where the great values are. And if no outstanding values are available, the wealthy investor waits. He can afford to wait. He has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for, and he doesn’t mind waiting months or every years for his next investment (they call that patience).

But what about the little guy? This fellow always feels pressured to “make money.” And in return he’s always pressuring the market to “do something” for him. But sadly, the market isn’t interested. When the little guy isn’t buying stocks offering 1% or 2% yields, he’s off to Las Vegas or Atlantic City trying to beat the house at roulette. Or he’s spending 20 bucks a week on lottery tickets, or he’s “investing” in some crackpot scheme that his neighbor told him about (in strictest confidence, of course).

And because the little guy is trying to force the market to do something for him, he’s a guaranteed loser. The little guy doesn’t understand values so he constantly overpays. He doesn’t comprehend the power of compounding, and he doesn’t understand money. He’s never heard the adage, “He who understands interest — earns it. He who doesn’t understand interest — pays it.” The little guy is the typical American, and he’s deeply in debt.

The little guy is in hock up to his ears. As a result, he’s always sweating — sweating to make payments on his house, his refrigerator, his car or his lawn mower. He’s impatient, and he feels perpetually put upon. He tells himself that he has to make money — fast. And he dreams of those “big, juicy mega-bucks.” In the end, the little guy wastes his money in the market, or he loses his money gambling, or he dribbles it away on senseless schemes. In short he spends his life dashing up the financial down-escalator.

But here’s the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than he made, if he had taken his extra savings and compounded it in intelligent income-producing securities, then in due time he’d have money coming in daily, weekly, monthly, just like the rich man. The little guy would have become a financial winner, instead of a financial loser, a “rich man, instead of a poor man”.

RULE 4: VALUES: The only time the average investor should stray outside the basic compounding system is when a given market offers outstanding value. An investment is a great value when it offers (a) safety; (b) an attractive return; and (c) a good chance of appreciating in price. At all other times, the compounding route is safer and probably a lot more profitable, at least in the long run.

* Adapted from the June 17th, 1996 Dow Theory Letter.