The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life

by J.L. Collins

While the mantra here is “avoid debt at all costs,” if you already have it, it is worth considering if paying it off ahead of schedule is the best use of your capital. In today’s environment, here’s my rough guideline: If your interest rate is... Less than 3%, pay it off slowly and route the money to your investments instead. Between 3-5%, do whatever feels most comfortable: Either put the money to debt payment or investments. More than 5%, pay it off ASAP.

Mortgage loans Taking on a mortgage to buy a house is the classic definition of “good debt.” But don’t be 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. Shamefully, this overspending is often encouraged by real estate agents and mortgage brokers. If your goal is financial independence, it is also to hold as little debt as possible. This means you’ll seek the least house to meet your needs rather than the most house you can technically afford.

Remember, the more house you buy, the greater its cost. Not just in higher mortgage payments, but also in higher real estate taxes, insurance, utilities, maintenance and repairs, landscaping, remodeling, furnishing and opportunity costs on all the money tied up as you build equity. To name a few. 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. That’s OK if and when the time for such an indulgence comes. I’ve owned them myself. But don’t let yourself be blinded by the idea that owning one is necessary, always financially sound and automatically justifies taking on this “good debt.”

Letting an index work its magic over the years isn’t very exciting. It is only very profitable.

Let me take a moment to be absolutely clear. I don’t favor indexing just because it is easier, although it is. Or because it is simpler, although it is that too. I favor it because it is more effective and more powerful in building wealth than the alternatives.

Bonds are in our portfolio to provide a deflation hedge. Deflation is one of the two big macro risks to your money. Inflation is the other and we hedge against that with our stocks.

VBTLX—Vanguard’s Total Bond Index Fund—most

When interest rates rise, bond prices fall. When interest rates fall, bond prices rise. In either case, if you hold a bond to the end of its term you will, barring default, get exactly what you paid for it.

As an aside, there are studies that indicate holding a 10-25% position in bonds with 75-90% stocks will actually very slightly outperform a position holding 100% stocks.

You might also want to rebalance any time the market makes a major move (20%+) up or down.

The first three are for us individual investors: Admiral Shares: VTSAX .05%/$10,000 Investor Shares: VTSMX .17%/$3,000 ETF: VTI .05% (ETF=exchange traded fund)

The great irony of successful investing is that simple is cheaper and more profitable. Complicated investments only benefit the people and companies that sell them.

The basic concept behind Vanguard is that an investment firm’s interests should be aligned with those of its shareholders. This was a stunning idea at the time and to this day it is the only firm that is, and as such is the only firm I recommend.

Second, we have all our dividends, interest and capital gains distributions in our tax-advantaged accounts reinvested. I am not captivated by the idea of “living only off the income” (that is, dividends and interest) as many are. Rather, I look toward drawing the ~4% the research has shown a portfolio like mine can support. Third, we have the dividend and capital gains distributions from VTSAX in our taxable account sent directly to our checking account. Since the payment of these is a taxable event, it makes no sense to reinvest them only to turn around and withdraw the equivalent amount of money shortly thereafter. Fourth, I want to let my tax-advantaged investments grow tax-deferred as long as possible.

Once 4% of your assets can cover your expenses, consider yourself financially independent. Put another way, financial independence = 25x your annual expenses. That is, if you are living on $20,000 you have reached financial independence with $500,000 invested.

As you can see, being financially independent is every bit as much about controlling your needs as it is about building your assets.

Once you decide you are done working, diversify into bonds. The more bonds you add, the smoother the ride but the lower the growth.

To consider buying a house, if you are so inclined. But don’t be in a hurry. Houses are not investments, they are expensive indulgences. Buy one only when you can easily afford it and if it provides the lifestyle change you want.