What’s your idea of what it is to become wealthy? Is it retiring at age 40? Is it buying a vacation home on Maui? Or maybe it’s buying a 50-foot sloop and spending three months a year cruising the Caribbean?
While we all have some idea of what to become wealthy would mean the majority of Americans have no idea as to how to get there. They have a vague idea that it’s important to save and invest but very few people really understand the stock market except the fact that it seems to go way up and way down practically weekly. As an example of this the Dow Jones average dropped more than 3% when it was announced that Great Britain would be leaving the European Union but now, less than a week later it’s regained almost all of what it lost.
Becoming wealthy is not that complicated
If your goal is to truly become wealthy then, according to author JL Collins, it’s not that complicated.
- Stay out of debt
- Save half your income
- Invest in low-cost index funds
- Ignore all news about the stock market and anything your friends tell you
For many people, that’s easier said than done. In fact, most Americans are already in debt. If you’re part of that small minority that has no debt, congratulations. If not, you need to begin paying off your debts. If you need help getting out of debt, there are two well-tested plans for doing this – the snowball method and the avalanche method. Both have their pros and cons but the important thing is to choose one and started.
Saving half of your income
This might seem sort of like a mission impossible but is fairly easy to do if you have no debt. You will need to do a thorough analysis of your spending and then organize it into two categories – discretionary and non-discretionary spending. Your non-discretionary spending would include categories such as utilities, housing, insurance and transportation. Discretionary expenses typically include entertainment, clothing, eating out, cable and your cell phone bill.
Since there’s not much you can do about your non-discretionary expenses you will need to get to work on the discretionary ones. If you truly want to save half of your income, you may need to make some deep cuts in some of them. Just remember your long-term goal, which is to become wealthy.
Buy low-cost index funds
If you’re not familiar with index funds, the free, online encyclopedia, Investopedia, defines them as follows: “An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover”. In addition, as Investopedia also notes, most mutual funds cannot beat broad index funds such as the S&P 500.
If you’d like to know more about Index Funds, here’s a short video with some good information …
Ignore all news about the stock market
Once you’re invested in low-cost index funds, stop paying any attention to news about the stock market and ignore any stock tips you get from friends. As noted above, not even mutual funds much less individual stocks, can beat low-cost index funds. Your battle cry should be, “stay the course,” Just continue to invest in low-cost index funds and leave alone the investments you’ve already made in them.
The best metaphor for the stock market ever
I recently read what I thought was the best metaphor ever for investing in the stock market. It was created by author JL Collins. What he wrote is try to visualize someone pouring you a beer but it’s out of sight in a dark brown mug that you can’t see through. As a result, Collins wrote, there’s no way to know how much of the glass is beer and how much is foam. In his metaphor, the beer is the businesses of which we can own a part. At the top, the foam, is all those pieces of paper that fall and rise in price from minute to minute. As he notes, this is the market of CNBC with its daily stock market report. He goes on to note that this is the daily, weekly, monthly and yearly volatility that causes the average investor to go out on a window ledge in desperation.
How much is beer and how much is foam?
As he further notes, when you look at a given stock and its daily price it’s hard to know how much of it is beer and how much of it is foam and this is why a company can increase dramatically in value one day and then suffer a very sharp drop the next. If you ever watch CNBC you’ll see a parade of experts, each of whom has impressive credentials, confidently predicting where the market will go next – while at the same time they often contradict one another.
It makes for great TV but …
All of this news and all of the experts make for great television but it’s important to understand that this is the foam and the only thing that matters is the beer – the company’s real operating money – which is what over time drives the value of the market even higher. In fact, according to Collins the more attention you put on the stock market the poorer your investments are likely to perform. And, again according to Collins, this is not just an opinion. It’s a well-documented fact.
What a novice investor should do
Collins suggests that if you’re a novice investor you should go to the library and check out some books on smart investing. Spend some time learning about bonds and stocks and how the markets work. Read especially about index funds since this is where you’ll be investing your money.
You will become wealthy
If you stay on the simple path you will eventually become wealthy – regardless of how you define the word. But do understand this will not happen in the short term. It will take time and self-discipline but stay on this simple path you’ll ultimately get there.