| Becoming intelligent with money requires more than just getting out of debt. It also means making your money work for you instead of you working for it. It means earning interest instead of paying interest. It means buying assets instead of liabilities. All of these things are true even if you are not out of debt yet. Even if you are diligently repaying your debts, it is still time to begin to think and act like the rich do; not because being rich is the goal (it may or may not be), but because rich people understand money. Beginning with this chapter, and for the next few chapters, we will show you how money works for the wealthy and how you can begin to make more of it. Not only will this enable you to get out of debt more quickly, it just makes life easier. As John Lennon once said, "I'd rather be rich and unhappy than poor and unhappy." Start Now It is easy to say that you can't begin to invest until you are out of debt. That is commendable. It is also wrong. If we are looking at how wealthy people treat money, do you think that they don't have debts or that they don't have bills to pay? Of course, they do. Their bills would dwarf yours by comparison because their overhead is so much higher than yours. But that does not stop them from using their money wisely. Money Talks In 1963, John Lennon and Paul McCartney formed Northern Songs, a corporation that would own the rights to Beatles songs. The company was formed with assets of a little more than $200. In the late 1980s, Michael Jackson gained control of the company, paying more than $60 million for it. They buy cattle ranches, collect art, invest in businesses, dabble in the stock market, and gobble up real estate because they know that money invested is money returned. Despite mortgages, credit card bills, family members needing help, and huge tax liabilities, most wealthy people make sure to invest at least 10 percent of their income. Investing is how rich people stay ahead. Money Talks The World Bank Atlas estimates that the total value of all assets owned by individuals in the world is between $500 trillion and $1 quadrillion. (That's 1,000,000,000,000,000.) This amount does not include assets owned by governments or religions. It doesn't matter what type of investment you pick; you could choose to start your own business or buy some mutual funds. The important thing is to shift your thinking from just getting out of debt to getting ahead. We are not saying that you have to get rich. You don't. What we are saying is that if you are in debt, then maybe there are a few things you could learn about money, and rich people are the best role models. Take Jill, for example. A writer and producer for the television show Cheers, she made a lot of money and now lives the good life. But she does not just have her money sitting in the bank. Jill owns six in-and-out auto lube franchises. Her money makes money. You need to begin to do the same. Sure, money is tight, but there are ways for you to create investment capital without changing your life. We explain how to do so at the end of the chapter, so read on. Assets and Liabilities In the movie The Edge, Anthony Hopkins and Alec Baldwin played two men stranded in the Alaskan outback. Armed with only a few knives, a book about survival in the wilderness, and their wits, the two had to find a way to live and make it out. At one point a grizzly bear began to stalk them. The survival book had a chapter on how to kill a bear. Baldwin was convinced they could not do it without a gun. Hopkins thought otherwise. His motto was, "What one man can do another can do." He read the book, learned how to kill a bear, believed that what one man could do another could do, and made Baldwin believe it, too. It was not easy, but they killed the bear. Money Talks Alec Baldwin's wife, Kim Basinger, made so much money that she bought an entire town in Georgia in the 1980s. In 1993, she was sued for breach of contract for backing out of a movie. She lost and was ordered to pay a judgment of $713,522.05. On May 28, 1993, Basinger and the corporations she ran filed for protection under Chapter 11 of the bankruptcy code. Only a movie, yes, but it's a powerful lesson nonetheless. What one man can do, another can do. If those men can slay a movie bear, you can slay the money bear. What the financially literate can do, you can do, too-if you learn how they do it. Do you want to know how the wealthy became rich in the first place? They bought assets. Liabilities Are Not Assets We all think we know the difference between an asset and a liability, but sometimes the most obvious thing is the most difficult. The problem for most people who fall into debt is that they buy liabilities, but think they are assets. The first thing to understand then is the difference between an asset and a liability and how they affect your bottom line. There are many ways to define what assets and liabilities are. Accountants have definitions, as do business people and investors, but let's keep it simple: 1. An asset makes you money. 2. A liability costs you money. If you want to get rich, or out of debt, you will buy assets instead of liabilities. Let's say that you and your sister Sydney both just inherited $5,000. What would you do with that money? If you are like most people, you would buy a liability. Maybe you would use it as a down payment on a new car or use it to take your mate on a nice trip. Those are fine things, but they just don't make you money. They cost you money. Look at the facts. If you put that $5,000 down on a new car, you would be creating more debt in the form of monthly payments. Sure the car would be an "asset" in the conventional sense of the word, but a car and a car loan don't make you any money. They cost you money. The same is true for a trip. These things look like assets, but they are liabilities insofar as money goes, see? (This is not to say that you shouldn't buy a new car when you need one.) Let's also assume Sydney is a bit more financially literate than you and that she decides to do something different with her $5,000. She wants to buy an asset. She might buy some stocks or mutual funds, or she might invest it in some real estate. Maybe she will decide to expand her business with it. She would use the money in such a way that it would make her more money instead of cost her money. Consider the difference. Even if you got a low interest rate, your new car would end up costing you maybe another $20,000. Five years from today, you would be another $25,000 in the hole (with a five-year-old car to show for it). Conversely, $5,000 put in a mutual fund might make Sydney another $3,000. Five years later, she would be $8,000 ahead. There's a big difference between $25,000 down versus $8,000 ahead. This, then, creates a cycle. With $8,000 to use, Sydney might be able to purchase a small rental property and thereby create even more income for herself. You would have an older car with probably 75,000 miles on it that is worth one third of what it cost you and no way to create more money. Multiply this time and again, and you will begin to see why the rich do indeed get richer. Assets make money; liabilities cost money. Wealthy people buy assets. The poor and middle class buy liabilities thinking they are assets. Types of Assets Of course, you need a new car sometimes (well, maybe you don't need a new car; maybe a used car would do, and you could pocket the difference). The point is, if you are going to get out of debt, get ahead, and make more money, you need to buy some assets; you need to invest some money. Consider the following investments: 1. The stock market: You can buy stocks, bonds, or mutual funds. 2. Real estate: Someone owns all of those rentals people live in. With federally guaranteed loan programs, qualifying for a loan is not so far-fetched. 3. A new business: We all know the economy is changing. Home-based businesses and other entrepreneurial activities are the jobs of the future. Investing 101 So just what is investing? It is putting something of value into something else with the expectation that the end result will be bigger and better. You can invest your time in a good cause, you can invest your energy in your job, or you can invest yourself in a relationship. When you invest in these things, you expect that something good will come of your effort. Likewise, when you invest your money in stocks, mutual funds, real estate, or a business, you do so because you think your money will grow over time. The magic in investing is in something called compounding. As you earn investment returns, your returns begin to gain returns as well, allowing you to turn a measly dollar into thousands of dollars if you leave it invested long enough. You saw this concept in action with the example of Sydney earlier. Her $5,000 became $8,000. If she continued to invest the $8,000, it would soon be worth $12,000, and so on. The more money you save and invest today, the more you'll have in the future. Real wealth is created almost miraculously? through investing and the most mundane and commonplace principles of time, patience, and the power of compounding. Compounding is so magical that you can fairly easily double and triple your money over long periods of time. When you hear someone brag about doubling his money in 10 years, you should know that you only need a 7.1 percent annual return to double your money in 10 years. If the Standard and Poor's 500 (a widely used barometer of the stock market) had gone up 10.6 percent a year, the poor fellow who doubled his money in 10 years underperformed compared to the market. Investing Is Not Speculating With compounding, you have to wait patiently for years for your riches to accumulate. But why put your money in slow-and-steady investment vehicles that merely promise double-digit returns when (according to some infomercials) you could have nearinstant riches? What if you want it all now? Then speculating is for you. Speculating is the art of taking your hard-earned money and putting it in a scheme that promises potential amazing returns. The key word is potential. What are the odds of winning the lottery? Probably something like one in seven million. What about Vegas? Your odds of walking out a winner are less than 50-50. These are extreme examples of speculating. Speculating is like gambling. According to the dictionary, a speculative investment is a "transaction or venture the profits of which are conjectural or subject to chance; to buy or sell with the hope of profiting by fluctuations in price." To invest, though, is to "commit capital in business in order to earn a financial return; the outlay of money for income or profit." Understanding the difference between speculating and investing is simple once you focus on the difference between two words in the definitions of these concepts. The key word in the definition of speculation is hope. The key word in the definition of invest is earn. Let's say that you hear your dentist telling a patient about a company that is "going to go through the roof in the next few months." If you call your broker the first thing the next morning and place an order for 100 shares, you've just speculated. Do you know anything about the company? Are you familiar with its competition? What were its earnings last quarter? Are you not just hoping that your dentist knows what he is talking about? That's speculation. Money Talks Tulips were introduced in the Netherlands in 1593. In 1636, trading in tulips rapidly increased, and more and more people started speculating. Bulbs of one or two guilders could be worth a hundred a few months later. Fortunes were being made, and people from all walks of life who knew nothing of tulips became swept up in the gamble. "Tulipomania" was in full bloom. In 1637, prices spiraled to a ridiculous level. The market finally collapsed in 1637, leaving many people bankrupt. Investing, on the other hand, requires research, expertise, and patience on your part. If you do your homework and learn about where and how to invest your money, the chances that you will lose it are quite small. Yes, all investing requires some element of risk. The difference is, real investing takes a lot of the risk out of the equation (but even with investing, there's always at least a little risk, except when you invest in a federally insured bank account). Setting Your Investment Goals Deciding how you are going to become an investor and what types of investments you will make requires planning. You need to answer these sorts of questions: 1. What do you want to accomplish by investing? Is this money to get you out of debt? A down payment on a house? Your child's education? A home? Income to live on in retirement? 2. What is your investment time frame? Five years? Ten, twenty? 3. How much money will you need to reach your goals? Don't let yourself get away with nonspecific answers, either. In the end, investing is about numbers, and you need to get used to that. That is a good thing. Real numbers let you see exactly what you need in order to get to your financial destination. How much do you need to get out of debt? How much will college cost when your child needs to go? How much yearly income is reasonable for your retirement? After you have a rough idea of how much money you will need, you can start to think about what investment vehicles might be right for you and what kind of returns you can reasonably expect to make from them. Take a look at how various types of investments have performed historically: 1. Putting your money into cash reserves, such as U.S. Treasury bills or money market funds, has yielded roughly 4.2 percent per year during this century. 2. Long-term government bonds have returned around 4.0 percent per year since 1900. 3. Overall, stocks have returned an average of 9.8 percent per year since 1900. Investing in real estate can be profitable as well, but it is very complex Money Talks The best decades for stocks have been the 1950s, when stocks increased by 18.23 percent annually; the 1980s, when stocks increased by 16.64 percent annually; and the 1990s, during which stocks have increased by 17.3 percent annually. Taking the Plunge The two major variables in figuring out your investment plan are your risk tolerance and the amount of time you can dedicate to investing. In our capitalistic society, the biggest rewards are given to those who take the biggest risks-the entrepreneurs. Rather than being risk takers, most of us have gotten into the habit of putting in eight hours a day working for someone else. At the end of the week, we cash our paycheck and do it all over again. It's called the rat race. But think about the guy who owns the company you work for. He's not hurting for money, is he? He knows something you are just figuring out: Working for someone else doesn't make you rich. Being the employee just makes you the employee. Being the boss is more risky, but it can also make you rich. You need to become the boss of your own financial world. It need not be a full-time position, and you certainly do not have to quit your job tomorrow because you have decided to become an investor today. What it will require is learning the entrepreneurial skills necessary to take back control of your financial house. It is going to require taking chances with both your time and money and possibly being told by your loved ones that it cannot be done. But it can. So what kind of financial investment is right for you? Here are the pros and cons of each possible investment option: 1. Stocks are fairly risky, but they can easily be done on a part-time basis and have historically given good returns. 2. Bonds are much less risky than stocks and can also be done part-time, but they give smaller returns. 3. Real estate can be risky if you buy the wrong piece of property or buy at the wrong time, but generally speaking, it can be a great way to make extra money part-time. For some people, however, the hassles of dealing with tenants are not worth the possible return. 4. Starting your own business is probably a full-time venture, and both the risks and rewards are high. The 10 Percent Solution You are probably thinking that this all sounds well and good, but where will you find any extra money to invest? We are here to tell you that you can create it, but we warn you: It will not be easy. Of course, you have lots of bills; that's why you bought this book. You have a list of things and people you need to pay: rent, mortgages, car payments, dad, credit cards, and household goods. Pay them. But you need to add one more category to that list: you. We are not advising you to be irresponsible. Pay your bills. Get out of debt. But as you do, pay yourself first. First? Yes, first. You need to take a fixed amount of your income every month, put it in savings, and not touch it. Saving 10 percent of your income would be great, but 5 percent would do for starters. Do it every month. As we said, this will not be easy. It will take self-discipline. But it's the best way to be sure you have money to invest. Say that you bring home $2,000 a month. Of that amount, $600 is paid toward rent, $300 goes for the car payment, food takes up another $500, and utilities take another $300. You have $300 left over for everything else. Now, take a percentage of the total, say 5 percent ($100), and stick it in the bank. Besides getting into the habit of saving, you will begin to create a nest egg. At the end of a year, how much would you have? $1,200? Nope. You would have more. Why? Because you would have begun to act like the rich do and you would have been compounding your money and earning interest instead of paying interest. That $1,200 might be worth $1,300 at the end of the year. It would be a small, but very significant, milestone. You don't need a lot to get started in the world of investing. You can buy plenty of mutual funds for $1,000. A total of $3,000 can be the down payment on a duplex. You could live in half, rent out the other half, and begin a real estate investment career. The secret, and the hard part, is to put away money every month and to pay yourself before all others. There will be months where you are sure you cannot do it, but who is more important to pay than you? If you don't prioritize your finances, who will? Pay yourself first, and you will thank yourself later. If you do this, you will begin to act like the rich. You will be creating the means to buy some real assets instead of frittering a measly $100 away on liabilities. You will earn interest instead of pay interest. You will be acting like the financially literate. Remember: What one man can do, another can do. The Least You Need to Know 1. Liabilities are not assets if they cost you money. 2. Compounding your money is the secret to getting ahead. 3. Investing and speculating are very different. 4. Saving money every month is how you can get started. provide basic education about money management and information to help you avoid financial problems in the future. provide credit repair information and free credit reports for debt consolidation and debt management counseling. |
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