Make Your Own Snowball of Money
My goal is financial independence, so I don't have to worry about money.
The best money is the money that helps me sleep at night free from anxiety and not needing to work even if I continue to do so.
Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.
So the first step is increasing your savings rate (the percent of money you save each month after expenses) so that you'll have money to add to your snowball that will over time compound into an avalanche of cash.
So first let's look at books that will motivate you and help save more of your hard earned cash each month.
Most millionaires don't drive Ferraris
"The Millionaire Next Door" by Stanley & Danko First order of business on our agenda is popping the consumerist bubble of illusion that millionaires are big spenders.
If your savings rate is close to zero it doesn't matter that you're making an obscene amount of money like as an example 700,000 USD a year. You can have less wealth (net worth) than someone making 40,000 USD a year but saving and investing a significant amout each year.
There's an example with two actual doctors in the book making 700K a year where one is consuming everything on cars, boats, a mansion, family etc. He ends up with less wealth than a fireman's family at the same age.
An interesting statistic from the book is that over 60 % of people driving a luxury car with a cost of 70,000 USD are not millionaires (in net worth). In fact the average amount of USD paid for a car in cash is 25,000 USD by actual dollar millionaires.
So the vast majority of people driving around in luxury cars are not wealthy and probably either leased the car or borrowed money to buy it. So trying to appear wealthy can be completely detrimental to building your wealth.
Keeping Up with the Joneses and the Hedonic Treadmill
So if you want to be rich don't give in to the consumerist treadmill and your ego. Save and invest money each month. "Keeping up with the Joneses" is a recipe for financial disaster.
You need to live well below your means to save and invest nomatter what you earn. For inspiration you can check out this blog about early retirement even if that is not your personal goal. You can also check out the classic "The Richest Man In Babylon" by George Clason.
"The Snowball" by Alice Schroeder This is an autobiography of Warren Buffett and it'll show you that even the best investor in the world started out by living well below his means and saving up his first 100,000 USD from menial jobs very early in his young life.
If you read "Titan" by Ron Chernow about Rockefeller, you'll see the same pattern. Both books are excellent inspiration for increasing your savings rate and also for investing in general.
If you need more inspiration as to why owning expensive shit will not increase your happiness in life anyway, you can refer to new reasearch on the "hedonic treadmill" or any number of classical philosophers such as Seneca. The book "Stumbling on Happiness" by Daniel Gilbert is also excellent.
Alright, so now we sold all of our expensive cars, paid off all our debt except the mortgage and we're saving lots of after tax income each month out of our paycheck after our family's spending. So now it's time to look at investing.
There are many routes to take here. All other routes than passive investment through index funds will require you to do lots of reading, independent thinking and possibly a lot of work.
The most common investments are rental properties (real estate), publicly traded stocks and bonds.
Real estate will be riskier for most people as it is a geared investment unless you can pay for the entire property in cash (no mortgage). Real estate is also subject to local area supply and demand as well as entails actual work with getting tenants, fixing stuff and perhaps chasing payments.
I have no passion for rental properties or real estate as an investment vehicle, so I have no experience with owning them and have no advice to impart.
I have always chosen to invest in stocks as it has historically been the best return and they're less vulnerable to inflation as opposed to fixed returns on bonds.
If you want to invest in stocks there are two roads that you need to consider:
- Passive investment in index funds = no knowledge required and no time spent on your part
- Active investment in stocks = lots of research required and a lot of work on your part
I'll cover both types of investments here.
Passive investing in Index Funds
If you choose this road (which pretty much everyone should as your chances to beat the market are slim and your chances to underperform the market are excellent), then you can skip all of the books below and stop worrying about investments now.
I'll even save you the time trying to figure out what index fund to invest in. You'll just invest in the one Warren Buffett picked for his 1,000,000 bet that an index fund would beat any hedge fund over a 10 year period of time (he already won the bet)
This table is from Berkshire-Hathaways annual letter to shareholder 2016 page 22 this also contains Buffett's reasoning behind the bet. So invest your savings in Buffett's pick here every month or quarter at regular intervals (invest regularly so you get the average not a skewed result based on whether or not the stock market was low or high when you put in the most money).
That's it you're done. Let the power of annual compunding interest take over and expect a realistic 6-7 percent minus inflation and trading costs. Use this calculator to see how much money your savings will make you in 20 years. Congratulations now you own a small share of all of the companies making big money in America.
Active investing in selected stocks
So you decided to swim with the sharks and test your investing skills in the marketplace. If you're new to this and haven't invested before I urge you to only put 10-20 % into stocks you pick yourself and the rest into index funds and then slowly over 10-15 years allocating more money to your actively invested funds.
Why this split? Because it takes a lot of experience to have any chance at all to beat the market. You'll need to have experienced recessions and how you emotionally react to recessions and you'll need to make a lot of mistakes to get smarter that will cost you money and make you either underperform the market or experience permanent loss of capital (a publicly traded company that never recovers).
To help you understand this point read "A Short History of Financial Euphoria" by John Kenneth Galbraith. Investing is in large part pshychological, even Isaac Newton lost most of his money in the stock market despite being one of the smartest people to ever walk the planet.
I can calculate the motion of heavenly bodies, but not the madness of people.
But active investing is a lot of fun if it's a genuine interest for you. I do 50/50 investing. My tax deductible pension portfolio just passively follows the market but my after taxes savings I invest in stocks that I pick myself.
I only do any active investing at all because I have a strong interest in stock investing, enjoy the proces and have 20+ years of investing experience (I owned stocks during two recessions (dot-com bubble and 2008 financial bubble). I know how I react to these situations and I've made many mistakes over the years. Most of my big mistakes were made long before I had any significant cash to invest and were invaluable experiences.So if reading annual reports, researching business, trying to figure out the strength of brands and company market positions and reading tons of investing and other books sounds like your idea of fun then let's roll up our sleeves and look at some of the best books out there:
Daytrading is gambling
Don't daytrade or do high frequency trading it's a fools game - You might get lucky until you don't. "What I learned loosing a million dollars" Jim Paul. You might make a ton of money for awhile and think that you're making it because of your incredible investment skill but you're really just gambling and eventually you'll loose all of your money. For the theory behind this see "Fooled by randomness" and "Black Swan" by Nicholas Nassim Taleb.Take the long view
So now we're long term investors. If you want to make money in the stock market you need to view yourself as part owner of a business. What matters is not the stock quote but the intrinsic value and future projected value of the business based on a lot of factors like competitive edge, competitors, earning potential etc.
Markets are not efficient and there will be opportunities. Take Benjamin Graham's Mr. Market allegory to heart. Imagine that you are one of the two owners of a business, along with a partner called Mr. Stock Market. The partner frequently offers to sell his share of the business or to buy your share. This partner is what today would be called manic-depressive, with his estimate of the business's value going from very pessimistic to wildly optimistic. You are always free to decline the partner's offer, since he will soon come back with an entirely different offer.
Rockefeller was also known for being extremely calm and always offering to buy out his partners when they were panicking about the future prospects of Standard Oil, got angry about something or needed money for their expensive consumption habits. "Meet me in the morning, I'll bring my checkbook and buy you out" he would say (it's pretty much part of what Buffett does today as he bought up stocks and made great deals during the latest recession of 2008 and those before that).
Be fearful when others are greedy and greedy when others are fearful
Great books for creating your own investing philosophy
So let's look at some good books on the nitty gritty of selecting stocks. "The Intelligent Investor" and "Security Analysis" by Benjamin Graham. These are the origins of value investing which is looking for underpriced stocks. This is how Warren Buffett got his start but he was later influenced by Charlie Munger and his own experience to adopt the maxim: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." which runs somewhat counter to the original value investing ideas.
"Poor Charlie's Alamnack" by Charlie Munger because we need to understand that we're making a bet on the probability of a future return and you need to make the right bets. Investing is all about making an intelligent guess about a company's future earning power. So you need to figure out if a stock has a fair or even undervalued price in the current market compared to your own valuation of the company's future prospects.
Maynard Keynes called this degrees of belief in a future outcome. You can't say anything for certain but you can try to estimate the probabilities that you might be right and factor in what Buffett calls a "margin of safety" before you'll accept the bet (buy the stock at the current price and hold on to it until its prospects change). Reading Peter Bernstein's "Against the Gods - The Remarkable Story of Risk" is also great.
More books on the proces of picking stocks. "Common Stocks and Uncommon Profits" Philip Fisher this is a very hands on approach with good thougths in it. "The Most Important Thing Illuminated" by Howard Marks a great introduction to both the psychological factors involved and the economics of stocks. "The Warren Buffett Portfolio" by Robert Hagstrom if you want to beat the market you need a fairly focused portfolio otherwise you end up with your own version of an inefficient index fund. Peter Lynch "Beating the Street" and "One Up On Wall Street" here's another hands on take on investing, it's good to get other sources of inspiration.
"The Essays of Warren Buffett - Lessons for Investors and Managers" by Lawrence Cunningham this is a compilation of the most relevant parts of the letters to shareholders that Buffett has been writing during his lifetime. There's invaluable hints at his investment strategy here.
"Zero to One" by Peter Thiel because there's a lot of advice here on how inefficient markets can be great for business (like Google is almost a monopoly on search without actually getting busted by the anti trust authorities). "Only The Paranoid Survive" by Andrew Grove to understand the constant threat of extinction by technology that every company needs to deal with (don't get stuck holding Kodak or Blockbuster stocks when digital cameras and streaming take over).
"The Outsiders" by William Thorndike This book looks at all of the most successful CEO capital allocators in the world, so try to understand their method and the principles behind it. "More Than You Know - Finding financial Wisdom in Unconventional Places" by Michael Mauboussin here's a lot essays on different economics and investing related topics.
Let your capital work for you
Read "Capital in the Twenty-First Century" by Thomas Piketty and you'll understand why having capital is always better than earning a wage provided you know what to do with the capital.
Your capital (your money) can compound faster into more money than you can work and increase your salary. It's extremely powerful in the long run!
Also read "23 things They Don't Tell You About Capitalism" and "Economics: The User's Guide" by Ha-Joon Chang so you know that Economists and everyone else is making intelligent (sometimes stupid) guesses just like you about the macro and micro of markets and companies.
"The Magic of Thinking Big" by David Schwartz because you need to believe that you can actually beat the market so you'll start thinking "how will I do it" and create a plan for it based on research. If you don't believe that you can actually do it, you'll never come up with a good plan and will certainly underperform the market and loose lots of money.
And finally one of the most important books on investing which isn't an investing book: "Thinking, fast and slow" by Daniel Kahneman so that you understand the concept of "loss aversion" and why your brain is prone to making numerous mistakes (such as jumping to conclusions) in your decision making. Then you can try to counter act all of these mental biases in your investing decisions.
Your investing career will be a life long journey made up almost entirely of reading books on all kinds of subjects (not just investing books), annual reports, news papers and a little bit of rare actual buying or selling of stocks. Also, don't listen to experts or talking heads on TV and their short term crap - Maynard Keynes will tell you why with his Beauty Contest allegory.
My coffee is completely cold now, so I'll just end the post here. Good luck!
Let me know if I missed any great books in the comments, so that we can all benefit