The Simple Path to Wealth: Is It Really That Simple?
Today’s Classic is republished from Physician On Fire You can see the original here.
The moderator, Dr. Jim Dahle, posed a question. “Is a 100% stock allocation foolish for someone in their 20s or 30s?” In other words, would that be a simple path to wealth or a dangerous one?
I had my answer, but I was curious to see what the other more accomplished and known personalities on the stage would say. First up was Harry Sit, The Finance Buff, author of My Financial Toolbox. He said “no.” That would be perfectly acceptable.
Next, it was Rick Ferri’s turn. He’s the host of the Bogleheads podcast and the author of about 10 books on investing, including The Power of Passive Investing: More Wealth with Less Work. He also said “no.” Another vote for 100% stocks.
You can probably guess what Phil DeMuth, the author of The Overtaxed Investor and a bunch of investing books co-authored with Ben Stein had to say. Not foolish.
With those three in agreement, I was not going to look foolish when I stated the same. What a relief!
By the way, you can watch the whole thing and our answers to several dozen other questions in one of 34 presentations in the online CME course, Continuing Financial Education 2020. $100 off with code CFEINTRO.
Having read JL Collins’ The Simple Path to Wealth, and his rationale for a 100% stock portfolio in your early-to-mid career years, I was confident with my answer, and it was reassuring to hear the experts speak affirmatively.
My dentist friend from Debt Free Dr has also read the book, and today he shares his review and overview. This was written in January of 2020, so any mention of all-time highs is not quite valid at the time of publication, but the principles hold true. Enjoy!
The Simple Path to Wealth: Is It Really That Simple?
I recently came across a doctor that asked a question in the White Coat Investors Facebook Group that reminded me of just how many well-educated people there are that need financial help.
He’s in his early 40s and was terrified of the thought of investing. He never learned how to invest money (like many of us), and claims that he was money-deprived growing up. It seems that he didn’t learn anything about money from his parents nor in school. Sound familiar?
He was debt-free but confessed to being a huge procrastinator when it came to investing money.
He claimed he was good at saving money, but not investing it for compound growth. He was confused on how to proceed as he was once burned by a financial advisor and now does not trust them.
He feels bad that he missed out on the large gains that the market saw in 2019 (around 30%).
Now he’s worried that if he puts money into the market, it will fall (because it’s at all time highs) and doesn’t know what to do regarding his serious emotional aspect he has about losing money.
Sometimes people think that difficult problems involve difficult answers.
Fortunately for him and many others that have this same problem, there’s a simple solution…..The Simple Path To Wealth.
The book’s author, JL Collins, states that the idea for his book, The Simple Path To Wealth, actually started out as letters that he’d written to his teenage daughter.
He wanted to teach her about financial responsibility and thought what better way to do so than with a series of personal letters. His mains goals were to help her not only avoid the money mistakes he’d had but also to keep things, you guessed it, simple.
How To Think About Money
Mr. Collins is big on getting people how to think about money just like Jonathan Clements is too.
He gives an example about debt and how former boxer Mike Tyson who had earned $300,000,000 ended up bankrupt as he was spending $400,000 a month. I don’t believe my wife could even spend that much a month!
Like Tyson, other high-income professionals such as doctors, lawyers, and athletes are showered with money and lose it all as they too never learn how to think about money.
Collins, like many other personal finance gurus, states it all starts with having a mindset shift. He recommends something that I think is so profound, if you make this shift, it could save you millions over your career:
“Stop thinking about what your money can buy. Instead, start thinking about what it can EARN. And then think about what the money it earns can earn. As you do this, you’ll start to see that when you spend money, no only is that money gone forever, the money it might have earned is gone as well.”
In this same chapter, he highlighted how Warren Buffett thought about his money:
- Rule #1: NEVER lost money.
- Rule #2: NEVER forget rule #1.
Collins recalls a time when his daughter was eight years old and she asked him if they were poor after watching the news showing people standing in a bread line.
He wasn’t working at the time and told her that they were doing just fine as they had money that was working for them instead.
This so-called money that was working for him and his family was something he calls “F-You Money.”
This is when you have saved enough money to stop working for a few months or even permanently. (You can tell your boss: “F-You.”)
Collins stated how he saved up F-You Money early in his working career to give him the freedom to work whenever he chose to.
He then used his wealth to retire early as a financially independent writer, speaker, and blogger.
Why Invest in Stocks?
I recently had a conversation with my youngest son about why his Roth IRA was invested in stocks (index funds). I told him the same reason that Collins tells his readers is that over time, the stock market always goes up.
Don’t believe me?
Here’s a chart of how the market has performed over time courtesy of Macro Trends:
Here’s the last ten years:
Not only does Collins state that the market always goes up, he also claims that it’s “the single best performing investment class over time, bar none.”
How To Invest Your Money
To go along with the book’s title, The Simple Path To Wealth recommends that we keep our investing strategy…simple. Collins states that simple is good. Simple is easier. Simple is MORE profitable.
The more complex an investment is, the less likely it is to be profitable. Index funds outperform actively managed funds in large part simply because actively managed funds require expensive active managers. So the fees are notably higher.
Collins really does keep it simple by providing what he calls the 3 Tools To Wealth:
1) Stocks: VTSAX (Vanguard Total Stock Market Index Fund). He claims that stocks provide the best returns over time and serve as our inflation hedge. This is the core wealth-building tool.
2) Bonds: VBLTX (Vanguard Total Bond Market Index Fund). Bonds provide income, tend to smooth out the rough ride of stocks and serve as our deflation hedge.
3) Cash: Cash is good to cover routine expenses and for any unforeseen emergencies. You do have an emergency fund, right?
As a side note, we keep the majority of our cash in VMMXX (Vanguard Prime Money Market Fund.) We have one account for emergencies, one for travel and one for investing in passive real estate.
The Simple Path To Wealth spends most of its time discussing stocks – mainly index funds but includes an entire chapter on bonds.
He likes to add bonds to the mix to smooth out any bumpy rides in the market, provide income when needed and help with deflation hedge as bonds are more steady and reliable than stocks.
Honestly, up until the point of reading this book, I didn’t know too much about bonds. But that changed after reading this chapter.
Collins reiterates why they’re in his family’s portfolio:
Here’s a few key features about bonds:
Bonds are in his portfolio to provide a deflation hedge. Deflation occurs when the price of goods spirals downward and inflation occurs when they soar.
Bonds pay interest which provide him with income. An example would be Municipal bonds which their interest is exempt from federal income tax and the income tax of the state in which they’re issued.
Collins answers the question how bonds differ from stocks. He states that when we buy stocks, we’re buying a part ownership in a company. When you buy bonds you’re loaning money to a company or government agency.
Since deflation occurs when the price of stuff falls, when the money you’ve lent is paid back, it has MORE purchasing power.
This increase in value helps to offset the losses deflation will bring to your other assets.
In times of inflation, prices rise and money owed to you loses value. When you get paid back your cash buys less stuff. It’s better to own assets, like stocks, that rise in value with inflation.
He decreases most of the risk of owning individual bonds by investing in Vanguard’s Total Bond Index Fund – VBTLX.
The fund holds close to 8,000 bonds at this time.
The two key elements of bonds are the interest rate and the term. The interest rate is what the bond issuer (borrower) has agreed to pay the bond buyer. The term is the length of time the money is being lent.
One of the things you must consider is the possibility of the bond issuer defaulting and not paying you back. Default is the first risk associated with bonds.
Interest rate is the second risk factor associated with bonds and it’s tied to the term of the bond. This risk only comes into play if you decide to sell your bond before the maturity date at the end of its term. When interest rates rise, bond prices fall.
Last year, I ended up selling some bonds that I had purchased over seven years ago before its maturity rate. I was able to sell them very close to what the interest rate was stated and then invested in a multifamily syndication paying 5x what the bonds were paying.
The length of the term of a bond is the third risk factor and it also helps determine the interest rate paid.
The longer the bond’s term, the more likely interest rates will change significantly before it matures, and that means greater risk.
- Bills – Short-term bonds of 1-5 year terms
- Notes – Mid-term bonds of 6-12 year terms.
- Bonds – Long-term bonds of 12+ year terms.
Usually short-term bonds pay less interest as they are seen as having less risk whereas long-term bonds pay more as they are seen as having higher risk.
He ends the chapter by stating that inflation is the biggest risk to having bonds. The eight short pages of the chapter are a great primer if you’re interested in learning more about bonds put in simplistic terms with examples.
Why Invest In VTSAX?
Here are the three main reasons that Collins lists for why most of us in the “accumulation phase” should simply put all money into VTSAX (Vanguard Total Stock Market Index Fund).
- VTSAX historically beats 82% of actively managed funds
- VTSAX is much cheaper to own than actively managed funds – very low expense ratio 0.04%
- VTSAX is “self-cleansing”
- Companies may rise in value 1000%, but the most they can ever lose is 100%
- Companies that fail are “cleansed” out of the index
Self-cleaning? I liked his explanation about how both the market and VTSAX are self-cleansing. The market is not stagnant. Companies routinely fade away and are replaced with new ones.
Take a look at the 30 stocks in the Dow. Guess how many of the original are still in it. Only one. General Electric.
Here’s the original 12:
- American Cotton Oil
- American Sugar
- American Tobacco
- Chicago Gas
- Distilling & Cattle Feeding
- General Electric
- Laclede Gas
- National Lead
- North American
- Tennessee Coal Iron and RR
- U.S. Leather
- United States Rubber
VTSAX holds almost every publicly traded company in the U.S. stock market. The worse performance a bad stock can deliver is that it can lose 100% of its value and its stock price drop to zero.
It then drops out never to be seen again. But on the flip side, what’s the BEST performance it can deliver? 100%? 300%? How about 10,000% or more? There’s no upside limit!
This process of the new replacing the old and dying is what makes the market (and VTSAX) self-cleansing.
The Health Savings Account (HSA) Strategy
We’ve discussed the Health Savings Account in the past and why it’s also known to having a triple tax advantage.
An HSA is a tax-advantaged savings accounts for medical expenses. In 2005, President Bush put this into place as part of a plan for reducing the nation’s spiraling health care costs.
We personally funded an HSA for years using our high deductible health insurance plan but once our premiums tripled, it was time to look for other options.
Luckily we found out about Medishare and were able to drop our health insurance.
HSAs are like an IRA for your medical bills as as of 2020, you can set aside up to $3,550 for an individual and $7,100 for a family each year. If you’re 55 or older, you can add another $1,000 to each of those.
Like an IRA, you can fund this account with pre-tax money as your contribution is tax-deductible.
Here’s a few key points that you may not know:
As long as you save your medical receipts, you can withdraw money from your HSA tax and penalty free anytime to cover them. Even years later. (SAVE your receipts!!)
Once you reach the age of 65, you can withdraw your HSA for any purpose penalty free, although you will owe taxes on the withdrawal unless it’s for medical expenses.
Here’s a unique option that The Simple Path To Wealth suggests by turning an HSA into an IRA type account:
Collins recommends fully funding our HSA and investing in low-cost index funds. Next, pay any medical expenses out-of-pocket, save receipts while letting the HSA grow and compound tax-free.
He states that in effect, we’d have a Roth IRA in the sense that withdrawals are tax-free and a regular IRA in the sense that we get to deduct our contributions. We get the best of both worlds.
How Much Can I Withdraw in Retirement?
For most people that stay on top of investing, one of the questions that comes up rather frequently is the amount of money that can be taken out during retirement. (This is another reason I like passive real estate investing. You simply create multiple flows of income paying your expenses.)
Collins saves the last part of the book to go over the withdrawal rates that can help with a smooth retirement.
He recommends that we:
- Hold a 75% stocks / 25% bonds asset mix by retirement
- Withdraw between 3-4% a year
By doing this, he feels that we will have almost a 100% chance of dying with much more money than you started with.
There are too many high-income professionals that feel investing is too complicated which causes confusion and overwhelm.
The Simple Path To Wealth is one of those books that can help deliver a simple strategy for long term investing success.
It’s actually one of the first recommendations I make to those that are interesting in learning where to put their money with little to no investment experience.
[PoF: Thank you, Debt Free Dr., for the excellent review and overview. For more from JL Collins, see my wide-ranging and comical interview with : Christopher Guest Post: J.L. Collins. Jim was one of the first bloggers I met in real life, and he was kind enough to give me this interview back in 2016.]