Five Rules of Wealth Accumulation

Is there more to life than money? Of course there is, but money is still important. For society, money (or currency) provides a medium for exchange that eliminates the need for barter and therefore avoids the inefficiencies of barter. For the individual, money gives you the means to buy essentials for life, that is, food, clothing, and shelter. Of course, if you have enough money to provide you with food, clothing, and shelter for the rest of your life, money is a luxury rather than a necessity. Regardless, below are important rules for accumulating wealth. Although some of these rules may be repeated in other posts, I think if an idea is important, it needs to be repeated.

1. Pay yourself first, automatically

I was made aware of this piece of advice from the book The Automatic Millionaire. The basic idea is that, rather than spending your income and investing what remains, it is better to invest a fixed amount as soon as you receive your pay and then spending whatever remains.

There are two ways to achieve this. One involves simply talking to someone in HR to put a specific amount from your pay into a separate savings account or fund. If you are a salaried worker who received a fixed amount every fortnight, another way to pay yourself first involves having two different bank accounts. You set your bank accounts up so that your pay goes into one bank account and then automatically, a few days after, a fixed amount goes into another bank account. You carry around a card for access to only the bank account you use for spending.

Regardless of the details on how you achieve this, you are fundamentally trying to make saving automatic. Life throws things at you. You don't want to have to think too much or bother with transferring money here and there in order to reach your savings goals. By making savings automatic, you don't have to do anything other than keeping yourself employed.

How much do you save? That is going to be different for different people, but I suggest that you start with an amount that is challenging and sticking to it. When I started working full-time out of university, I was only earning $40,000 a year before tax ($1538 a fortnight), and I automatically saved $1000 per fortnight simply because it was a nice-looking number. After a few years, I increased this to $1300 per fortnight.


2. Diversify

"Divide your investments among many places, for you do not know what risks might lie ahead."

~Ecclesiastes 11:2 NLT

It's one thing to automatically save your money but it's another thing entirely to make sure your money is safe. Personal finance experts often tell people to minimise risk by researching and doing your due diligence, but investments can be incredibly complex. Warren Buffet, the world's greatest investor, advises people to only invest in what you know. However, I believe that even if you think you know an investment, you may not. For example, if you buy shares in a company, you may know the business model, the products being sold, and so forth, but will you know every decision the managers make or what strategies they have to make the company profitable. You cannot possibly know all the conversations that go on behind closed door among the directors and executives. The problem of asymmetric information that exists between investors and managers is to an extent fixed with financial reporting and accountancy but there are limits to the accuracy and usefulness of this information.

In my opinion, when choosing investments, it is wise to research your investments but don't be afraid to go with your gut and, most importantly, regardless of what your gut says, you must diversify. In other words, do not keep your money in one place. Spread it across different types of investments in different financial institutions.

Diversification is hard work. It's not easy opening multiple funds or accounts in multiple financial institutions. The paperwork can get overwhelming and during tax time it can be difficult to account for the different tax treatments that different investments require (if this is the case be sure to use a qualified accounting at tax time). However, diversification is important, and if you have any doubts about this, do some research into Bernard Madoff. No matter what your research tells you, no matter what your gut tells you, and no matter what the financial statements say, all investments have risk, and the only way to mitigate risk is to diversify.



3. Invest for income

Whenever I invest, I like to invest in assets that produce income. The main appeal of these investments come from the idea that I can have money automatically dropped into my bank account without me doing any work at all. We all have expenses. We need to eat, buy clothes, and put a roof over our heads. If the income from your investments can cover the cost of these necessities, you do not need to work ever in your life and you may find that you enjoy your work a lot more because the pressure is off. You can take risks and be yourself rather than kowtowing to your manager. If your employer won't pay you, your investments will.

Positive cashflow is freedom and negative cashflow is slavery. It's as simple as that.

Of course, when investing for income, don't forget to diversify because high-income investments are risky. The higher the yield from an investment, the riskier it is. Some companies have high yields because their prices are going down because investors foresee future problems. Sometimes dividends are paid not from earning but from borrowings, which puts into question the sustainability of these dividends. You should invest for income but also remember to diversify.



4. Avoid debt, obligations, or commitment as much as possible

"The rich rule over the poor, and the borrower is slave to the lender."

~Proverbs 22:7

Debt is slavery. Try to stay out of debt as much as possible. Debt occurs when you borrow money from someone and have an obligation to pay back at a later date. The problem lies in the uncertainty of the future. Can you know for sure that you will earn the money to pay the money back?

But I will go so far as to say that it is not just debt you should avoid but all future obligations or commitment. This means, for example, avoiding phone plans that obligate you to pay a fixed amount (say $60 per month for 24 months) and getting a cheap but good phone and using a pre-paid SIM card.

Don't get a car loan. Save up money and pay cash for a second-hand car. Some people think a new car must be more reliable and that, when you buy a second-hand car, you are buying someone else's problems. Before you buy a second-hand car, you can easily get it independently checked for defects. Buying second-hand means you avoid the massive depreciation associated with new cars. When you drive a new $30,000 car from the dealer, automatically about $5,000 in value is wiped away. If you buy a $7,000 second-hand car, there will still be depreciation, but not as much.

You should also be extremely careful with intimate relationships with others as this creates commitment or obligation. One of the weirdest observations I have made is how society labels men who are cautious with commitment as "commitment phobes" who need to "man up" quickly. They talk about commitment phobia as if it were negative. If anyone tries to manshame me by labelling me a "commitment phobe" I will simply tell them that yes I am cautious about signing up to something that would bind me and that I am proud of it. If a car salesman tried to sell you a Ferrari and wanted you to go on a car loan and you hesitate, that is commitment phobia. You're expressing reluctance to commit to a long-term arrangement. It is a prudent thing to look before you leap. 

If you sign a marriage contract, you are entering into a serious commitment of your time and cash and there are extreme risks associated. Everyone needs intimacy but too many people rush into securing themselves what they believe is an infinite supply of intimacy without fully considering cost and risk. As a man, how I handle this issue involves treating female intimacy as a product that you buy. You pay a female money in the form of gifts, dinner, lunch, and events and in return she provides you with the intimacy, and you can alter how much you spend on her depending on the quantity and quality of the intimacy she supplies. Do not have the mindset that your girlfriend is the monopoly supplier of female intimacy because otherwise she will charge monopoly prices. Always have the attitude that whatever your girlfriend is supplying, you can get it somewhere else, and this will keep prices competitive.

Of course, there are some obligations you cannot avoid, for example, you need to eat, so you are obligated to spend money to buy food to eat in order to keep yourself alive (unless you grow your own food, but then you are obligated to harvest that food). There are also those necessities that you just must have that only come in contracts that involve future payments, e.g. broadband internet, private health insurance, utility bills, rent, and so forth.



5. Play the pauper

Once I have a fixed amount of my pay automatically invested in multiple investments, I don't keep track of how much money I have saved up. Many people track their net worth every month and proudly boast about it to the world. I don't because I know that I already have enough money saved up to fly off to Asia and retire if I need to. If I save up more than what I need to save up, why do I need to bother keeping track of how much I have? Being ignorant of my wealth helps because, if someone asks me how much money I have, I can, with all honesty, tell them I have no idea. It is genuine and plausible ignorance.

Why is it important to be ignorant of your wealth and be very vague about how much money you have? One word: theft. If other people think you're a pauper, they will leave you alone. If other people think you are rich, you have a target on your back. People will come up with all sorts of manipulations and cons to get to your money. This is especially true of people who are close to you, for example, relatives, parents, children, and spouses.

I would even go so far as to say that you should both conceal your wealth and also play the pauper. In other words, pretend to be poor. This goes against human instinct. Normally people purchase status symbols in order to show off wealth, but I do the opposite because the pride I would get from showing off wealth is nothing compared to the fear and anxiety I get from thinking about theft. This means you should dress modestly (but nearly, not like a bum) and avoid prestigious brand-name products. Constantly talking about how little money you have because of rising costs and try to convince others that you don't earn much money.

By playing the ignorant pauper, you avoid yourself a lot of heartache. Gone are the begging relatives or friends who want to borrow money off you or get you to invest in their coffee shop venture. People will leave you alone and theft risk is greatly reduced.

One potential problem with looking poor is that people who think they are richer than you may put you down. Class warfare is as old as human history. It will never go away, and if someone thinks he or she is richer than you then it is likely they will ridicule you. You can fix this problem by not looking too poor. You can also fix this problem by trying to ignore the bully. If that is not possible, my strategy is to act like a psycho mobster. When someone ridicules you, simply shout back at them and make vague allusions to your connections with organized crime. Constantly read true crime fiction and constantly talk about death and killing and murder. Your friends should become wary and scared of you over time and will be fearful of provoking you. You need to be careful that you act psycho only and that you don't actually kill someone or even threaten to kill someone, as these acts are likely illegal. I only go crazy this when it is clear that someone is a snob and continues to ridicule me and I cannot ignore them or distance myself from them easily.

APN AREIT Fund Yields 9%

As of 16 July 2011, the APN AREIT Fund gives a distribution yield of 9.12 per cent, paid monthly. I have been invested in the APN AREIT Fund for a little over half a year now, and I am very happy with not only the high distribution yield but also the monthly income as well as the stability of the investment income. The payout from the APN AREIT Fund is so stable and predictable that I can make plans for various spending and can reasonably rely on future APN payouts to pay off the liabilities (e.g. if I use a credit card). This predictability, high performance, and stability created by what is seemingly highly compentent active management makes me question the value of unpreditable index funds that pay quarterly distributions that are highly variable.

My hope is that as the income from my APN fund increases, I can devote more of my salary income to investments and rely on the income produced by APN to fund all my living expenses. This means that ultimately I will be able to live without working, which for me is very appealing!

Estimated Yield of iShares S&P Global 100

I am keen on producing high yields from my investments. Due to the strong Australian dollar, I have recently purchased on iShares S&P Global 100 ETFs (ASX: IOO). According to the iShares website, this ETF's distribution yield is estimated to be around 9.5 per cent, which seems very high. However, when I actually did the numbers myself using data on the ETF's actual distribution history, I noticed that the yield is more like 2 to 3 per cent. I am not saying iShares has misled anyone. On their site they clearly state that their figure is an estimate with various assumptions. Clearly iShares's assumptions were different to mine. I suspect that the main difference is that I took all the historical distributions from about three years back and then divided it by the current price. Perhaps iShares took the historical distributions and then divided it by a weighted average. Perhaps they also accounted for exchange rate fluctuations between the US dollar and the Australian dollar. It would make sense that this ETF would give low yields if you consider that currently the Australian dollar is strong and has been appreciating against the US dollar for a while now. If the Australian dollar were to suddenly pull back for whatever reason (e.g. American money printing actually turns out to be a valid plan that strengthens corporate America and and the US dollar with it) then I should expect yields on IOO to increase.

I am in a little bit of a dilemma because on one hand I want high yields but on the other hand I want to hedge against a collapse of the Australian dollar. I can hedge against a collapse of the Australian dollar if I buy US dollar denominated assets, but the problem is that as the US dollar weakens then my income from dividends gradually falls because the dividends are originally paid in US dollars and then is converted to Australian dollars. As the US dollar gets weaker, so too does the value of these dividends.

Living Off Dividends

Living off dividends is one of the best goals you can aim for, and it is certainly something I aim to do.

Dividends are payments companies make to shareholders. If you own shares, every so often the company will will drop money into your bank account as dividends. By owning shares, you can provide income for yourself without actually doing any work. Income from work requires time and effort, but you can earn income from shares by sitting back and doing nothing. This passive nature of earning income is why dividends are a form of passive income.

It is important to understand that ownership of shares is not the only way you can earn money from doing nothing. You can receive passive income from savings accounts, term deposits, real estate, bonds, royalties from book sales, and so on. When I say that living off dividends ia a worthwhile goal, I am referring to living off passive income. I talk about dividends because I personally use stock ownership almost exclusively to earn passive income. For the average person, I think it is probably not a good idea to exclusively rely on stocks for passive income. Do as I say, not as I do. You should diversify into less risky income-producing inverstments like term deposits. There are some term deposits out there now that give you 7 per cent per year. I have not invested in these mainly because you need to save up a whopping $25,000 to invest in them.

The main benefit of living off dividends is the freedom it gives you. When you live off interest, rent, and dividends, you live off the fruits of other people's labour, not your own. You don't work for others. They work for you. This gives you incredible independence. Many people who are dependent on work income to fund their mortgage, car payments, etc are essentially slaves to their bosses. If the boss tells you to lick the toilets clean, if you depend on your job to pay for your food, mortage, car payments, etc then you have to lick the toilets clean in order to survive. There is no dignity in being a slave to your boss. However, if you had passive income, you don't need to lick the toilets clean if your boss tells you to do so because you can quit and still comfortably live off dividends. While you are unemployed you can find another job but even if you take a long time finding a job or even if you never find another job, it doesn't matter because you don't need to work for yourself. Others work for you.

Many people say that debt is dangerous. Just to be clear, I am not anti-debt. I think debt can be used as an effective tool to build wealth. If you borrow money and invest in an asset that goes up in value significantly, you can build yourself massive profits. The problem is that there is no asset that is guaranteed to go up significantly all the time. (If such an asset exists, why would anyone bother working. Just borrow money, buy that asset, and then retire.) For the average person, I recommend you stay out of debt. This not only means staying away from the debts that almost everyone thinks are bad such as car loans and credit cards but also the so-called good debts like home loans. I recommend you try to buy a second-hand car and to live with parents if you can. I am different to most people in that I broaden the definition of debt. Most people think of debt as obligations to pay money placed upon them because of some bill that appears in the mail, e.g. credit card bill. My definition of a monetary debt is as follows: "a future obligation to pay." Hence a credit card debt is a debt since you are obligated to pay X dollars by a certain date. The same applies to home loans and car loans. However, using this definition, it becomes logical that hunger and shelter are also debts. All humans have a need to eat food for energy and a need to cover himself for shelter from cold and heat. In order to eat and in order to cover himself, he need to pay. Hence eating and sheltering are future obligations to pay and hence by definition they are debts. We all are born with debts because we all need food and shelter. They are necesities for life. The best way I think you can eliminate these debts is to produce passive income. The more passive income you produce, the less indebted you are and the less indebted you are, the further away you move from a state of slavery. The greater your passive income, the greater your freedom.

If the need to feed and cover yourself is a debt, then image how much more debt you'd be in if you had a child. If you produced a baby, not only do you have to feed yourself but you are also legally obligated to feed your child (if you don't, you will go to prison). Hence having a child is one way of going into immense debt. The problem is worse because if you have a child without being able to pay the debt then you harm not just yourself but you also harm an innocent child.

CNN Money is a critic of living off passive income. In their article Living Off the Interest? Good Luck, they say that living off passive income is a poor strategy because "few people will amass a big enough nest egg to live without touching principal." The problem with many of these analyses is that they assume that your investments will not provide enough income for your lavish lifestyle. The way to live off dividends then is to keep your expenses low and to invest in high-yielding investments.

If you are an Australian resident who wants to produce passive income, I recommend you invest in the Vanguard High Yield Australian Shares Fund (High Yield Fund). The management fees of 0.90% are a little high, but given that this mutual fund gives you monthly distributions (most of the time) and franking credits, I think it's worth it. The High Yield Fund doesn't really track any existing index and so it cannot really be called an index fund but an actively managed fund or maybe a mixture of both. Rather, it takes the ASX200 index, strips AREITS out, and then invests in the companies in the index that pay the highest dividends. Another investment that I think shows good passive income potential is the SPDR S&P/ASX 200 Listed Property Fund (SLF), which in an ETF you can buy on the ASX. As of Christmas 2009, SLF has a 8.03 per cent dividend yield.

Ultimately, dividend investing is an inexact science as it is difficult to predict how dividends will change over time, so it is up to you to select the best investments. The two products I recommend above are just recommendations for those who don't know where to start. They are products that I use myself.

I have about 20,000 units in the High Yield Fund. The graph below shows the historical distribution payments from High Yield Fund if you had 20,000 units in it. The horizontal axis shows the date, the vertical axis is in Australian dollars, the blue line shows the distribution payment, and the red line shows the 12-month moving average of distribution payment.

As you can see, about 30% of the time the fund does not pay a distribution. The 12-month moving average suggests that on average the distirbutions are fairly stable. It would seem reasonable to live off this income stream. There are a few spikes, suggesting that some years there are windfall profits to companies.

According to my estimates, my passive income at the moment is about $254 per month, so I am about halfway to being able to live off passive income. At the moment I am investing 80% of my pay, which I think is the most I can handle without suffering immense pain. I think an individual should save up at least 50 per cent of his pay initially and, when he is comfortable, be more ambitious and slowly increase that savings rate higher if he can till it is, say, 70 or 80 per cent. This way you can most quickly get yourself into a position where you can live off dividends. If you are not living off dividends, you are a slave, and what is the best thing for a slave to do? Escape.