I Will Teach You To Be Rich: No guilt, no excuses - just a 6-week programme that works

by Ramit Sethi

Yes, in theory it’s possible for you to lose all your money, but if you’ve bought different investments to create a balanced (or “diversified”) portfolio, you won’t.

Ask your friends what the average return of the S&P 500 has been for the past seventy years. How much money would they have if they invested $10,000 today and didn’t touch it for ten years — or fifty years? They won’t know, because they don’t even know the basic return rate to assume (try 8%). When people say investing is too risky, it’s because they don’t know what they don’t know.

It takes strength to know that you’re basically getting shares on sale – and, if you’re investing for the long term, the best time to make money is when everyone else is getting out of the market.

Imagine one day you woke up and you had enough money in your accounts to never work again. In other words, your investments were generating so much money that your money was actually producing more money than your salary. That’s the Crossover Point, first described by Vicki Robin and Joe Dominguez in their book Your Money or Your Life. It’s an incredibly influential idea in personal finance: money makes money and, at a certain point, your money is generating so much new money that all of your expenses are covered. This is also known as being “financially independent” (FI). What can you do once you hit the Crossover Point? At a minimum, you can do nothing. Wake up, spend three hours at brunch, go work out, see friends and practise your hobby. You can choose to work, or not – after all, you could spend the rest of your life spending down your investments. Many call this “retiring early” (RE); together, they’re Financial Independence + Retiring Early = FIRE. There’s “LeanFire”, which is people who’ve decided they can live on a “lean” amount of money – often £30,000 to £50,000 a year in perpetuity. They reject materialism and embrace simplicity, often in an extreme way. “FatFire” is for people who want to live an extravagant life at the highest levels of spending. Ever wonder how celebrities can spend £250,000 on a single party? That’s because their money is earning so much money that they actually have to work to spend it all.

Anyway, the little-known fact is that the major predictor of your portfolio’s volatility doesn’t stem from the individual stocks you pick, as most people think, but instead from your mix of stocks and bonds. In 1986, researchers Gary Brinson, Randolph Hood, and Gilbert Beebower published a study in Financial Analysts Journal that rocked the financial world. They demonstrated that more than 90% of your portfolio’s volatility is a result of your asset allocation. I know “asset allocation” sounds like a BS phrase – like “mission statement” or “strategic alliance”. But it’s not. Asset allocation is your plan for investing, the way you distribute the investments in your portfolio between stocks, bonds and cash. In other words, by diversifying your investments across different asset classes (like stocks and bonds or, better yet, stock funds and bond funds), you can control the risk in your portfolio – and therefore control how much money, on average, you’ll lose due to volatility. It turns out that the way you allocate your portfolio – whether it’s 100% stocks or 90% stocks and 10% bonds – makes a profound difference on your returns. (Later, other researchers tried to measure how closely volatility and returns were correlated, but the answer ends up being pretty complicated.) Suffice it to say that asset allocation is the most significant part of your portfolio that you can control.

If you’re older – especially if you’re in your sixties or older, for god’s sake – a sizable portion of your portfolio should be in stable bonds. Bonds act as a counterweight to stocks, generally rising when stocks fall and reducing the overall risk of your portfolio.

But in your thirties and older, you’ll want to begin balancing your portfolio with bonds to reduce risk. And what if stocks as a whole don’t perform well for a long time? That’s when you need to own bonds to offset the bad times.

“Once you’ve won the game, there’s no reason to take unnecessary risk.”

target date funds.

You don’t want to own only US small-cap stocks, for example, or funds that own only small- cap stocks. If they didn’t perform well for ten years, that would really suck. If, however, you own small-cap stocks, plus large-cap stocks, plus international stocks and more, you’re effectively insured against any one area dragging you down.

“I believe that 98% or 99% — maybe more than 99% — of people who invest should extensively diversify and not trade. That leads them to an index fund with very low costs.” —WARREN BUFFETT, ONE OF AMERICA’S GREATEST INVESTORS

“When you realise how few advisers have beaten the market over the last several decades, you may acquire the discipline to do something even better: become a long-term index fund investor.” —MARK HULBERT, FORMER EDITOR OF HULBERT FINANCIAL DIGEST

“The media focuses on the temporarily winning active funds that score the more spectacular bull’s eyes, not index funds that score every year and accumulate less flashy, but ultimately winning, scores.” —W. SCOTT SIMON, AUTHOR O...

Over the long term, the stock market has always gone up. As a bonus for using index funds, you’ll anger your friends in finance because you’ll be sticking up your middle finger to their entire industry – and you’ll keep their fees for yourself.

Disadvantages: When you’re investing in index funds, you typically have to invest in multiple funds to create a comprehensive asset allocation (although owning just one is better than doing nothing). If you do purchase multiple index funds, you’ll have to rebalance (or adjust your investments to maintain your target asset allocation) regularly, usually every twelve to eighteen months. Each fund typically requires a minimum investment, although this is often waived with automatic monthly investments.

Anyway, Swensen suggests allocating your money in the following way: 30% – Domestic equities: UK stock funds, including small-, mid- and large-cap stocks 15% – Developed-world international equities: funds from developed foreign countries, including the United States, Germany and France 5% – Emerging-market equities: funds from developing foreign countries, such as China, India and Brazil. These are riskier than developed-world equities, so don’t go off buying these to fill 95% of your portfolio. 20% – Real estate investment trusts: also known as REITs. REITs invest in mortgages and residential and commercial real estate, both domestically and internationally. 15% – Government bonds: fixed-interest UK securities, which provide predictable income and balance risk in your portfolio. As an asset class, bonds generally return less than stocks. 15% – index-linked gilts: these bonds protect against inflation. Eventually you’ll want to own these, but they’d be the last ones I’d get after investing in all the better-returning options first. A significant amount of maths went into Swensen’s allocation, but the most important takeaway is that no single choice represents an overwhelming part of the portfolio.

Q: HOW MANY FUNDS SHOULD I INVEST IN? A: If you’re wondering how many funds you should own, I’d encourage you to keep it simple. Ideally you should have just one (a target date fund). But if you’re picking your own index funds, as a general guideline, you can create a great asset allocation using anywhere from three to seven funds. That would cover domestic equities, international equities, real estate investment trusts and perhaps a small allocation to bonds or gilts. Remember, the goal isn’t to be exhaustive and to own every single aspect of the market. It’s to create an effective asset allocation and move on with your life.

The first thing you want to do when picking index funds is to minimise fees. Look for the management fees (“expense ratios”) to be low: around 0.2% and you’ll be fine. Most of the index funds at Vanguard, Hargreaves Lansdown and Fidelity offer excellent value. Remember: expense ratios are one of the few things you can control, and higher fees cost you dearly – and they just put money in the City’s pocket.

Anyway, “pound-cost averaging” is a phrase that refers to investing regular amounts over time, rather than investing all your money in a fund at once. Why would you do this? Imagine if you invest £10,000 tomorrow and the stock drops 20%. At £8,000, it will need to increase 25% (not 20%) to get back to £10,000. By investing at regular intervals over time, you hedge against any drops in the price — and if your fund does drop, you’ll pick up shares at a discount price. In other words, by investing over time, you don’t try to time the market. You use time to your advantage. This is the essence of automatic investing, which lets you consistently invest in a fund so you don’t have to guess when the market is up or down.

But here’s a question: If you have a big pile of money to invest, what’s the better option: pound-cost averaging it or investing the entire lump sum all at once? The answer might surprise you. Vanguard research found that lump-sum investing actually beats pound-cost averaging two-thirds of the time. Because the market tends to go up and stocks and bonds tend to outperform cash, investing all at once produces higher returns in most situations. But — and there are several buts — this isn’t true if the market is going down. (Of course, nobody can predict where the market will go, especially in the short term.) And investing isn’t just about maths, but about the very real effects of your emotions on your investing behaviour. In short, most of us already pound-cost average since we take part of our monthly salary and invest it. But if you have a lump sum of money, most of the time you’ll get better returns by investing it all at once.

I bought stock in a company called JDS Uniphase (JDSU), an optical communications company. The stock effectively went to zero. I bought stock in a company called Excite, an early search engine, which was renamed Excite@Home after being acquired. It went bankrupt. And then I bought roughly $11,000 in a little company called Amazon .com. My investment of a few thousand bucks turned into $297,754. I should be proud of myself, right? WRONG. It might seem like I won, but you can learn a lot of counterintuitive lessons from this example. What are the lessons here? THE SUPERFICIAL LESSON: “You’re so smart for picking Amazon!” THE REAL LESSON: That is exactly the wrong lesson to take away. If that’s your reaction, please read carefully: It’s very important to know WHY you win and why you lose. I won with this Amazon investment, but it wasn’t because I was a good investor. It was, purely and simply, luck — a freakish once-in-a-generation winner. THE SUPERFICIAL LESSON: If you pick the next Amazon, you’ll be rich.

The best way to rebalance is to plough more money into the other areas until your asset allocation is back on track. How? Assuming your domestic equities now represent 45% of your asset allocation – but should actually be only 30% – stop sending money there temporarily and redistribute that 30% of your investment contribution evenly over the rest of your investment categories. You can do this by “pausing” your automatic investment to particular funds from within your investment account.

Note: There is another way to rebalance, but I don’t like doing it. You can rebalance by selling the outperforming equities and ploughing the money into other areas to bring the allocation back under control. I hate selling, because it involves trading fees, paperwork and “thinking,” so I don’t recommend this.

If, on the other hand, one of your funds has lost money, that will also knock your asset allocation out of whack. In this case, you can pause the other funds and add money to the loser until it returns to where it should be in your portfolio.

When you’re young, there are only three reasons to sell an investment: You need the money for an emergency, you made a terrible investment and it’s consistently underperforming the market, or you’ve achieved your specific goal for investing.

You Need the Money for an Emergency If you suddenly need money for an emergency, here’s your hierarchy of where to get it. 1. Use your savings account, which you established in Chapter 2. 2. Earn additional money. Drive for Uber, sell old clothes, pick up tutoring. You might not be able to earn a huge amount in a short time, but selling some of your own goods is an important psychological step – it will let you prove how serious you are both to yourself and to your family (which will be useful if you’re asking them for help). 3. Ask your family if you can borrow the money from them. Note: This doesn’t work if your family is crazy. 4. Use the money in your retirement accounts. You can always withdraw money you contributed to your ISA penalty-free, although you’ll be severely retarding your money’s ability to compound over time. With a pension, you can take money out for “hardship withdrawals” (mainly if you are terminally ill), but you will be hit with a punishing 55% tax otherwise – possibly more. If it comes to this, consult your HR representative. But I urge you to avoid cashing out your retirement accounts because of the penalties and taxes involved. 5. Use your credit card only as a last resort. I can’t emphasise this enough: The chances are very good that your credit card will gouge you as you’re repaying it, so don’t do this unless you’re truly desperate.

1. CREATE AN EMERGENCY FUND. An emergency fund is simply another savings goal that is a way to protect against job loss, disability, or simple bad luck. Especially if you have a mortgage or you need to provide for your family, an emergency fund is a critical piece of being financially secure. To create one, just set up an extra savings goal and then funnel money to it in the same way you would your other goals. Eventually, your emergency fund should contain six to twelve months of spending money (which includes everything: your mortgage, payments on other loans, food, transportation, taxes, gifts and anything else you would conceivably spend on).

2. INSURANCE. As you get older and more crotchety, you’ll want more and more types of insurance to protect yourself from loss. This includes homeowner insurance (contents and/or building) and life insurance. If you own a home, you do need insurance, but young, single people don’t need life insurance. First of all, statistically, we hardly ever die, and the insurance payout is useful only for people who depend on your livelihood, like your spouse and kids. Beyond that, insurance is really out of the scope of this book, but if you’re truly interested, I encourage you talk to your parents and their friends and search for “life insurance” online to research the various options. You likely don’t need to buy a bunch of insurance options right now, but you can certainly set up a savings goal so that when you do need them, you’ll have money to use. One last thing: Insurance is almost never a good investment, despite what financial salespeople (or clueless parents) will tell you. So use it as protection from downside risk — like for fires or accidental death when you have a family — but don’t think of it as a growth investment.

3. CHILDREN’S EDUCATION. Whether or not you have children yet, your first goal should be to excel financially for yourself. I’m always confused when I see people online who are in debt yet want to save for their children’s education. What the hell? First, get out of debt and save for your own retirement. Then you can worry about your kids. That said, the cost of university fees and living expenses can total as much as £50,000 over four years. If you’ve got kids (or know that one day y...

You Made a Terrible Investment That’s Consistently Underperforming This point is largely moot if you invested in an index fund or series of index funds, because they reflect the entire index’s performance. To oversimplify it, if your “total market index fund” is going down, that means the entire market is down. If you believe the market will recover, that means investments are on sale for cheaper prices than before, meaning not only should you not sell, but you should keep investing and pick up shares at a cheaper price.

But let’s talk about this conceptually to understand when to sell an investment for poor performance. If you discovered that the share price of a stock you own is down by 35%, what would you do? “Ramit,” you might say frantically, “this stock sucks! I need to sell it before I lose all my money!” Not so fast. You have to look at the context before you decide what to do. For instance, if the example is a consumer goods stock, how is the rest of the consumer goods industry doing? By looking at the stock and the surrounding industry, you see that the entire industry is in decline. It’s not your particular investment. They’re all doing poorly. Now, this raises questions about the industry, but it also gives you a context to explain your stock’s plunging returns. And just because they’re plunging doesn’t mean that you should sell immediately. All industries experience declines at one time or another. Find out what’s happening with the industry. Is it still viable? Are there competitors replacing it? (For example, if you own shares in a company that’s producing CD players, chances are that business is not coming back.) If you think the industry or investment is simply going through a cyclical downturn, then hang on to the investment and continue regular purchases of shares. If, however, you think the industry won’t recover, you may want to sell the investment. Now, if your stock’s share price has plummeted, but the share prices of other companies in the industry are high, then co...

You Achieved Your Specific Goal Buying and holding is a great strategy for ultra-long-term investments, but lots of people invest in the medium to short term to make money for specific goals. For example: “I’m going to invest for a dream vacation to Thailand . . . I don’t need to take the trip anytime soon, so I’ll just put £100/month into my investment account.” Remember, if your goal is less than five years away, you should set up a savings goal in your savings account. But if you’ve invested money for a longer-term goal that you’ve achieved, sell and don’t think twice. That’s a great investing success, and you should use the money for whatever your original goal was.

Investing vs Paying Off Student Loans It can be difficult to hear the drumbeat of “Invest early!” when you’re faced with student loan statements that look increasingly scary and interest rates that seem to add more to your debt than you can pay. When it comes to choosing between paying down your loans or investing, you typically have three choices: ▪ Pay the minimum monthly payment on your student loans and invest the rest. ▪ Pay as much as possible toward your student loans and, then, once they are paid off, start investing. ▪ Do a hybrid 50/50 approach, where you pay half toward your student loans (always paying at least the minimum) and send the other half into your investment accounts. Technically, your decision comes down to interest rates – so if your student loan has a super-low interest rate of, say, 2%, you’d want to pursue option one, given you can make an average of 8% by investing in low-cost funds. However, this reasoning doesn’t quite apply to UK readers because your student loan system is very different from ours – for a start, your interest rate doesn’t vary as much and is tied to current inflation, based on the Retail Price Index (RPI). You also don’t have to begin repayment until you meet a certain income threshold (due to go up to £26,575/year in April 2020, unless you’re in Scotland) and the amount you repay is based on how much you earn above that threshold, rather than how much you actually owe – in other words, it doesn’t matter whether you owe £10,0...

Be mindful of how you discuss money and who you discuss it with.) By mastering your money, you’re disrupting the normal relationship pattern you’ve had with others, which makes them uncomfortable and causes them to react in odd ways. Don’t take it personally. Smile and say: “Thank you.” As the people around you get more comfortable with the new you, the comments will gradually fade away.

Chris was right. He taught me that my intention was right, but I didn’t have to get into exact dollar figures to communicate that I was secure. In reality, my parents don’t care about the number in my bank account – they just want to know that I’m happy

The next time I spoke to my parents and they asked how things were going, I took extra time to thank them for everything they’d taught me and told them that, thanks to them, I was fortunate enough to have a dream business that let me live an incredible life.

▪ As you become more financially successful, your relationships with others might change. Be aware of it. (For example, I’m hyperconscious about different people’s ability to spend on a dinner or vacation. If I’m meeting a group of friends for dinner, I’ll always pick a restaurant that we can all easily afford. My nightmare is choosing a place that makes them feel financially pressured.)

▪ You might be tempted to share specific numbers. If it’s with your spouse or a very close friend or family member, okay. But beyond those people, ask yourself why. Is it to communicate that you’re doing well? Or is it to subtly show off? Are there other ways of communicating this? Remember, sharing numbers without context is a bad move. Your intention might be good, but to someone who earns £60,000, telling them you’re on track to have a £1 million portfolio (or much more) doesn’t communicate safety and security. It communicates arrogance.

When One Person Earns More Than the Other Once you and your significant other start sharing expenses, questions will invariably come up about how to handle money on a daily basis, especially if one of you has a higher income than the other. When it comes to splitting bills, there are a few options. The first, and most intuitive, choice is to split all the bills fifty-fifty. But is that really fair to the person who earns less? They’re spending disproportionately more, which can lead to resentment and, often, bad money situations. As an alternative, how about this idea from Suze Orman? She encourages dividing expenses based proportionately on income. For example, if your monthly rent is £3,000 and you earn more than your partner, here’s how you might split it up: DIVIDING EXPENSES BASED ON INCOME You Your partner Monthly income £5,000 £4,000 Rental payment £1,680 £1,320 (5,000/9,000 = 56%) (4,000/9,000 = 44%) There are lots of other options. You can each contribute a proportional amount into a joint household account and pay bills out of that. Or one person can cover certain expenses, like groceries, while the other handles rent. The key takeaway here is to discuss it, come to an agreement that feels fair (remember, fifty-fifty is not the only definition of “fair”), and then check in every six to twelve months to make sure your agreement is still working for both of you.