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THE NATIONAL LAMENT
Everyone Is Getting Rich but Me
Extraordinary Popular Delusions
and the Madness of Crowds
If it weren't so sad, it would be easy to say that some greedy people got what they deserved. In the latest mania that consumed investors at the dawn of the third millennium, people learned the hard way that dumping their life savings into risky stocks--and going into debt to do it--was not the sure road to riches. Some ended up worse off than others. Those who mortgaged their homes and maxed out their credit cards to buy stocks on margin not only lost everything they had, but they also wound up deep in debt with little to show for it except a tax write-off and a lesson they will never forget. (Fortunately these were not my clients but people I've met in various travels.) Those who took my advice and risked just a small portion of their money came crawling back, deeply appreciative of my warnings and thankful that the rest of their portfolio was doing fine.
I never say "I told you so," because I understand how easy it can be to succumb to the temptations of the markets. After 20 years as a financial advisor I know as well as anyone that the lure of the markets and the prospect of extraordinary riches can be enormously compelling, especially when it all seems so easy. You don't have to work very hard. You don't have to be especially smart. You don't have to be born into the right family or have superhuman gifts. All you have to do is pay attention to the markets, pick the right stocks, and voila! You're rich. It happened to the thousands of people who invested early in Microsoft or Dell Computer and held on to their stock throughout the 1990s. It happened to the lucky people who got in and out of stocks like Qualcomm or Amazon. com at just the right time in these stocks' recent, but extraordinarily volatile, trading histories. It happened to people who went to work for brand-new companies with funny-sounding names like Yahoo! and who took stock options in lieu of high salaries because they believed the company was onto something big--and who cashed in early, before the stock fell 90 percent from its high.
As the 20th century came to a close, everyone seemed to be saying, "If all these people can get rich the quick and easy way, why can't I?" And so we saw investors doing some very strange things in their quest for extraordinary wealth. One client who had known me since childhood and who had been investing with me for 5 years transferred her account to another broker because her returns "weren't high enough." Over the 5 years she'd been with me, she had earned average annual returns in the high 20s. In 1999 alone, her mutual funds were up 58 percent, 32 percent, and 12 percent, respectively. But a broker she met at a wedding convinced her he could quadruple her money within a year, so she decided to transfer her account to him. That was in March of 2000, the month that now marks (in hindsight, of course) the beginning of the tech-stock crumble. I haven't talked to her since, but I'll bet she wishes she were back in her boring old mutual funds.
Another client, husband and wife, conveniently forgot our entire risk-reward discussion that took place when we first started investing their small-business retirement plan assets in 1994. When they complained to me in 1999 of their 29.5 percent return, I pulled out their original investment policy guidelines, which called for anticipated returns of 8 percent to 10 percent-- established at that level because they said they didn't want to assume too much risk. In the ensuing years, when their actual returns averaged 14 percent, they were very pleased. But in 1999, when the Nasdaq was up 86 percent, their 29.5 percent return suddenly seemed like peanuts. I pointed out that the vast majority of the Nasdaq's stellar gains that year were due to only a handful of stocks and that half of all Nasdaq stocks were actually down for the year. They admitted they hadn't heard that side of the story.
One of the saddest stories was told by the owner of a clothing store where my husband and I do business. One day in April 2000, this normally upbeat guy was uncharacteristically irritable and cantankerous. When we asked if everything was okay, he confided that he had taken out a second mortgage on his house, borrowed money from his in-laws, taken a cash advance on his credit cards, and put it all into a margin account at a brokerage firm. He lost everything, more than $200,000. Now all his savings were gone and he had to pay back the margin loan, the credit card companies, the in-laws, and the mortgage. No one should have to suffer like this. But the markets can be ruthless if you're not careful, and anyone who takes such huge risks unfortunately has no one but themselves to blame.
FEAR OF MISSING THE BOAT
What causes normally rational people to do irrational things with their money? Why would an otherwise sensible client fall for a sucker pitch by a broker who promised to quadruple her money in a year? Why would my risk-averse clients, who know that high returns and high risks usually go hand in hand, suddenly want to abandon a well thought out strategy and consider subjecting their (and their employees') retirement money to high risk? Why would a successful businessman take huge risks with his personal funds, going so far into debt that it will take years to recover?
The answer lies in the fact that these are unusual times. Like the tulip mania of the 1600s and the California gold rush of the 1800s, the technology boom of the late 1990s was a chance for ordinary people to acquire extraordinary wealth. Everyone seemed to be cashing in. People were afraid of missing the boat. So they assumed a "land grab" mentality and almost went into an altered state of consciousness, forgetting--or rather, repudiating-- all the conventional wisdom about diversification and risk management in a desperate attempt to claim the wealth they felt they deserved, before it went away. Never in my career have I had such a difficult time convincing people that the only sure road to riches is through working, saving, and sensible investing. With everyone around them getting rich, they simply didn't want to hear it. And in some ways I don't blame them. Other people were doing it, so why not them?
Now that the boom is over and the greed that once consumed Wall Street has been balanced with a healthy dose of fear, it's back to reality. To all of you who didn't strike it rich in the technology boom of the late 1990s--which is most people--I'm sorry that you did indeed miss the boat. It's unlikely we will ever see market conditions like that again, where companies that are actually losing money carry market valuations higher than some of our best blue-chip stocks. Those were crazy times, and personally I'm glad they didn't last. They were an aberration and a distraction, and they kept people from doing what they need to do to get rich the old-fashioned way, which is what this book is all about.
WHY WE WANT TO BE RICH
There is a national obsession with being rich. It pervades our culture, from the popularity of the TV show Who Wants to Be a Millionaire to the fact that gambling is now legal in 47 states. This obsession comes at a time when our standard of living has never been higher, when modern conveniences like videocassette recorders and microwave ovens are so affordable that nearly everyone has at least one. When I was growing up, these things didn't even exist. Today we take them for granted and still they're not enough. We want more. We want to be rich. And we want it now. Why?
One reason is that the media has exposed us to much greater wealth than we would otherwise be aware of if our world were limited to our own neighborhoods and social circles. We read about, and see pictures of, Bill Gates's 45,000-square-foot mansion and Larry Ellison's private jet. And because they are both self-made men (Ellison is the founder and chief executive of Oracle Corp.), we believe it's within our power to have those things too--or something close to it. By flipping the channels on our TV, we can see beautiful people in designer gowns, exquisitely decorated homes in Aspen and Palm Beach, and relaxed people enjoying lavish vacations in exotic parts of the world. We see all these trappings of wealth and we want them too.
Although none of us would care to admit it, keeping up with the Joneses is still prevalent in our culture. We want a bigger house, a newer car, a fancier vacation than the people on our block. But since flashy, conspicuous consumption is no longer chic, bragging rights these days often go to the one who takes the more rugged adventure vacation or has the most sturdy sport utility vehicle. What we're really after is social acceptance. As much as we all abhor the idea of keeping up with our neighbors this way, it's endemic in our culture, especially among upwardly mobile people who can't help showing off to their friends the evidence of their success. Once the cycle has been set in motion, it's very hard to break.
Some would say that our focus on wealth and materialism reflects a spiritual void that we are desperately trying to fill. It's not money we want, but love, community, and a sense of peace and well-being. But, not knowing how to get those things, we go after money instead, in the misguided belief that wealth will make us happy. Never mind that survey after survey shows that people value relationships and good health over money, or that many people think having a lot of money makes people greedy and insensitive. In today's fast-paced world it's hard to lead a truly spiritual life, so we fill the void with BMWs and designer handbags.
Or maybe we want to be rich because we just want not to have to worry about money. By amassing enough cash to last the rest of our lives, we could be free to work at something we really enjoy, to not work if we didn't want to, to pursue humanitarian activities like volunteerism or teaching, to live where we want to live, to send our kids to good colleges, and to be able to buy things without pinching every penny. We think that if we could just get a quick hit of about $10 million or $100 million, we could say goodbye to bills and bosses and create the life we really want. Furthermore, we think there's nothing unhealthy or unusual about this attitude. Indeed, we would be less materialistic and moneygrubbing if we had enough of a stash that we wouldn't have to worry about money ever again.
Why We Want It Now
It's not good enough to acquire wealth over time. We want it now. Let's face it. We're not used to waiting for things. Our society used to be a lot more patient than we are now, but microwave ovens, TV sound bites, and e-mail have trained us to expect instant gratification. Do you remember when TVs and radios had to "warm up" before they came on? Have you ever seen a replay of an old commercial? It seems to take forever to get its message across. Perhaps some law of physics explains why time seems to pass faster now, but the fact is that we want what we want when we want it. We don't want to wait.
So when we see game show contestants and lottery winners and dot-com executives walk away with millions, we think that's for us. Give it to us in one fell swoop with no work and no waiting. Same with stock market riches: Why sit in a mutual fund and earn mediocre returns year after year when we could simply pick the right stock and strike it rich overnight?
The rise of easy credit has also made us impatient when it comes to money. In the past, people had to save up for major purchases. Today, we use a credit card and start enjoying our purchases immediately. Then we want those pesky credit card balances to disappear as rapidly as they appeared. We're used to instant credit. Why not instant debt elimination?
What It's Costing Us
This drive to get rich--quickly--is taking a toll on our lives. The most extreme example of money-induced stress was the nationally reported story of Mark O. Barton, a day trader who walked into an Atlanta brokerage firm one day in July 1999 and opened fire on several people before turning the gun on himself. Clearly, he was a disturbed man, but were it not for the stresses of day trading, the incident might not have happened.
Gambling is on the rise, and problem gambling--where the compulsion to win causes psychological, financial, emotional, marital, legal, and other difficulties--is also up. The 1999 National Gambling Impact Study Commission estimates that of the 125 million Americans who gamble at least once a year, approximately 7.5 million have some form of gambling problem, with another 15 million at risk of developing a gambling problem. As problem gamblers move from the winning stage to the losing stage to the desperation stage, their view of money begins to change. It loses its traditional value as a means to buy needed things or provide financial security and becomes a necessary tool to keep the gambler in action. Like alcoholics and drug addicts, extreme problem gamblers lose jobs, families, their health, and sometimes their lives in their desperate attempt to win money.
Lotteries are fueling the get-rich-quick dream by offering the hope of instant wealth--never mind that a person has a better chance of being struck by lightning. The worst part is that state governments are targeting their messages to poor people who feel the lottery is their only way out. One survey of poor versus rich neighborhoods showed 140 lottery outlets in a poor neighborhood and just five in a wealthy neighborhood. Some people call lotteries a regressive tax--though voluntary, it's still a tax, paid by the people who can least afford it. If a lottery ticket buyer took that $2 per week and let it compound at 8 percent a year, she'd have more than $5,000 in 20 years. Five dollars a week would turn into nearly $13,000. In some people's minds, this is peanuts compared to the chance to win millions. Instead, they wind up with nothing and are out-of-pocket several thousand dollars they can ill afford.
The stock market holds great potential for building wealth, but not if it's misused in the attempt to get rich quick. Day trading, which involves buying a stock in the morning and selling it before the market closes--sometimes turning over the same stock several times in one day--makes brokerage firms rich but generally not the traders themselves. There are so many fees associated with the practice and it's so difficult to capture profits consistently, that most day traders lose money. Even ordinary people who aren't day traders pour huge sums into risky stocks and ignore the signs suggesting they're about to lose some or all of their investment. Someone very close to me put $100,000 into a stock when it was trading at $19 per share, convinced it was going to $100. It's now selling for less than $2 and he's still hanging on to it. By riding it all the way down, he violated two of Wall Street's basic rules: (1) Never fall in love with a stock and (2) cut your losses short. There are countless stories about people who have risked their retirement funds, their children's college funds, and even their homes on some high-flying stock they were sure would be their ticket to wealth. Some got out before losing it all. Others weren't so lucky. Those who lost their families and their self-respect in the process are the most tragic.
Pyramid schemes and other flaky "investment" deals have always been around. As long as people grasp at easy riches and haven't figured out that such schemes never work, there will be new suckers for these scams. A recent example involved a pyramid scheme called "Changing Lives" in Lewiston, Maine. It seemed innocent enough: People would ask their friends to join their group and pay $2,000 to the person who had been in the group the longest. When the senior members had collected $16,000, they left, allowing more recent additions to replace them in the top spot and reap the profits from the next group of recruits. When the attorney general shut it down and threatened prosecution unless people returned the money, the town went into a tizzy. Some of the money was returned to the original owners as directed. But not all of it, and the outstanding debts created rifts in friendships among people who had known each other for years. When money ruins relationships, the consequences are more far reaching than people imagine.
I won't say a lot about debt in this book because you know if you have it and if it's making you uncomfortable. You don't need me telling you to get out of debt because it's costing you a lot in interest charges, and so forth. But do keep in mind that high debt--or more accurately the stress caused by high debt-- can make people do some pretty crazy things. Many of the people who buy lottery tickets or who have turned into problem gamblers or lost money in risky stock ventures were simply trying to find a way out of their high debt. "If I could just get a quick $20,000 or $50,000 or $100,000, I could pay all my bills and finally get my finances straightened out," they say. But the riches seldom come, the money spent on lottery tickets or bad stocks is down the drain, and the debt remains.
If you do have a debt problem, first work on removing any negative emotions attached to it. You're not a bad person. You're not stupid. You might have made some mistakes in the past (although they didn't seem like mistakes at the time), but what's done is done and wishing you'd done things differently won't help. Try to detach yourself emotionally from your personal balance sheet and approach it as if you were managing a business. If you think the liabilities are too high in relation to the assets, start accelerating debt repayment. But don't get all crazy about it. Just set some goals and work toward creating a healthy balance sheet. Understand that it won't happen overnight. It's always easier and faster to get into debt than to get out. If it makes you feel any better, you're not alone. In the 1990s, the total value of all outstanding household debt reached unprecedented highs in the United States, mounting to more than half a trillion dollars.
IS INSTANT WEALTH REALLY ALL IT'S CRACKED UP TO BE?
Did you know that sudden wealth can actually be bad for you? This relatively new phenomenon has been studied by financial advisors and psychotherapists alike as more and more people fall into huge sums of money and don't know how to handle it. We've all heard stories about lottery winners whose lives changed completely--often not for the better--after winning the jackpot. They say their relationships with friends became strained, either because the friends expected the lottery winners to give them money, or the friends became so envious that it tainted the relationship. The newly wealthy people weren't sure how to act around their friends: Should they pay for dinner or buy them lavish gifts now that they could afford it, or would doing so throw it up in the friends' faces that they now had all this money? No matter how hard the lottery winners tried to keep things normal, the mere fact that they had won the money--and that their friends had weird feelings about it--changed everything. In interviews, some lottery winners actually said they wished they could have their old lives back. Who wants to be rich and friendless?
People who inherit money have all kinds of mixed emotions about it. First, most people are uncomfortable reaping monetary benefit from a death. Then, depending on their relationship with the departed, they may feel guilt, anger, sadness, and a variety of other emotions that complicate their feelings about the money. You can't spend with abandon when in the back of your mind is the nagging thought that if your loved one were still around, you wouldn't have the money to spend. If you really miss the person who died, just looking at the bank balance or receiving the monthly brokerage statements can remind you of his or her absence and make you sad all over again. This is not to say people who inherit money are necessarily worse off for it, but it can be a lot more complicated than people think.
Another fact of instant wealth is that it can kill ambition. Oh, no, you say, pointing out that you'd still be a productive, functioning member of society no matter how much money you came into. Why, then, is the Getty family in such a mess? Why did Jessie O'Neill, who inherited $3 million at age 28, write a book called The Golden Ghetto: The Psychology of Affluence (Hazelden, 1996) and devote her life to helping heirs and heiresses deal with the psychological aspects of sudden wealth? I have several clients--we call them "trust fund babies"--who inherited way too much money at far too early an age. They don't need to work, so they spend their time on the golf course while their friends are out working hard and making something of their lives. Let's face it, most of us would think long and hard about working if we suddenly didn't have to anymore. It can be very easy to slip into a life of indolence when there's no motivation to work. And without a productive outlet for a person's talents and skills, self-esteem suffers, the downward spiral begins, and the idle wealthy soon discover that they can't find meaningful work, even if they wanted to. This situation doesn't have to happen, but it's one more complication that can arise when a person comes into a lot of money all at once.
Then there's the sheer responsibility of handling all that wealth. If you think you worry too much about money now, just wait until you have a lot of it. Then you have to worry about managing it and keeping it away from the tax man, not to mention all those crazy people who like to sue rich people at the drop of a hat just because they have money. When you don't have much money, you don't have a lot of decisions to make. When you have a lot of it, you're faced with many decisions about what to do with it. How much can you spend now and on what? How much should you save for the future? How should you invest it? What about tax planning? Estate planning? Philanthropy? If you think your life is complicated, talk to someone who spends his or her day talking to stockbrokers, accountants, and lawyers, and at the end of the day still has to make the ultimate decisions about what to do with the money. It makes you want to opt for a life of voluntary simplicity. Has it ever occurred to you that you're not as rich as you'd like to be because subconsciously you're not ready for the responsibility of managing such a large amount of money? Just a thought. Read the rest of this book and you'll be prepared to handle anything.
LET'S GET REAL
Enough talk about people who got poor trying to get rich or people whose lives were ruined by sudden wealth. There's nothing wrong with money or the honest pursuit of it. Obviously I believe that, or I wouldn't have written this book and I wouldn't be in the profession I'm in. And obviously you don't see anything wrong in attempting to increase your net worth or you wouldn't have bought this book.
However, if you're expecting a sure, quick, painless road to riches, you're reading the wrong book. I wrote this book because of all the craziness today surrounding the pursuit of wealth. People want it fast. They want it easy. They want it without risk. And they want too much of it for their own good. They've lost sight of the basic principles surrounding wealth creation because there've been too many exceptions hyped up in the media. Most people acquire wealth by working hard and investing wisely. Sure, it's possible to get lucky and have a pot of money dumped in your lap that you didn't have to work for. But that's the exception. If you keep hoping that will happen, you won't do what you must to obtain the wealth that's waiting for you. You have to exchange your dreams for concrete planning and replace passive waiting with focused action.
THE SEVEN PRINCIPLES OF WEALTH CREATION
Let's quickly review the basic principles of wealth building. These are very elementary and intuitively you know they're all true. But in the frenzy to cash in on the dot-com revolution, whether you were an active participant or had your nose pressed up against the glass, you may have lost sight of them. Even if you've heard them before, they'll have more meaning now, especially if you are one of the casualties of the now-deflated Internet stock bubble.
1. The surest way to get money is to work for it.
When you're starting at zero, without a stockpile of cash to put to work for you, your most reliable source of income is yourself. Think about it. You can make millions of dollars over your lifetime, simply by exchanging your time and labor for cash. People who think of themselves as wage slaves underestimate their own cash-generating value and also fail to appreciate a society that allows them to make their own way in the world. If you don't like your job, you can get another one. If you want to make more money, you can ask for a raise or train for a promotion or new career. You can even start your own business or become self-employed and essentially name your own price. We tend to take our free-market system for granted, but many immigrants to the United States are amazed at how easy it is to make money here simply by applying yourself and working hard, an opportunity not possible in many other countries. You say you want to be rich? It's easy. Go to work! As you'll see in Chapter 2, that's how most people do it today, even if their labors are sometimes aided by ingenuity and a little luck.
2. The surest way to have money is to save it.
Money is like energy. It never disappears, it just gets exchanged into something else. Unfortunately, daily living forces us to exchange most of our money into things like food, shelter, clothing, and the occasional vacation. If we didn't have these needs, we could hang on to more of it and eventually become rich. Most people who aren't as rich as they'd like to be automatically associate money with spending. The first thing they think about when they contemplate winning the lottery or otherwise coming into a big sum of money is what they would spend it on. (Come on, admit it. You've done it too.) Do you know how rich people approach money? They think about preserving it, sheltering it from taxes, using it to make more money, and eventually passing it down to the next generation. Nonrich people enjoy money for what it can buy, which means they never keep it around very long. Rich people enjoy money for its own sake, which means they accumulate it and derive pleasure from the sheer fact of having it and making it grow. You don't have to be mercenary or have an unhealthy relationship with money to become rich. But shifting your focus from spending to saving would make it easier to hold on to more of your money. With this approach, you let it work for you instead of the other way around.
3. The surest way to build wealth is to let it compound.
Compound interest has been called the eighth wonder of the world. It truly is amazing how money grows when it builds earnings on top of earnings. Here's an example of how it works. If you were to invest $10,000 at a compounded rate of 10 percent, it would take 47 years to earn your first million. But it would take only 7 years to earn your second million, because the bigger your investment grows, the more earnings it generates. And those earnings generate earnings on their own in a kind of snowball effect. The rich keep getting richer because the money rolls in faster than they can spend it. But there's one key to compounding: You have to start with something. Seed money, even a small amount, is absolutely essential to get the compounding going. If you can add to it regularly, so much the better. But don't think that just because you don't have much money to start with that it's not worth the bother. Even $50 a month--the price of dinner for two--will be worth nearly $30,000 in 20 years if compounded at 8 percent. Increase your savings by 10 percent every year and you'll have more than $72,000.
4. Sometimes it's wise to take risks.
The only way to earn high investment returns is to take some risks. This is one of the basic tenets of investing. Depending on the type of investment and how much time you're willing to give it, the consequences of taking these risks may be one or more of the following: You could lose all of your money. You could lose some of your money. You could watch the value of your investment go up and down but not really lose any money because you don't need to sell it yet; in other words, the investment has good long-term potential and you're willing to hold it in exchange for the opportunity to earn high returns down the road. Paradoxically, the rich, who can afford to take risks because they have so much money to spare, don't really need to. They can keep getting richer by letting their money compound at even a low rate of return. The nonrich who are trying to become rich must take some risks in order to get where they want to be. But intelligent risk taking is the key. More about this Chapter 7.
5. Sometimes it's better to avoid risk.
Some risks are worth taking, others are not. One way to determine whether a risk is worth taking is to evaluate how devastating the consequences would be if the dreaded event were to occur. What if your house burned to the ground? What if you had a bad car accident? What if you were diagnosed with cancer? Because these events have the potential to cause financial ruin, it makes sense to transfer these types of risks to an insurance company. When evaluating any riskÐ reward proposition, the two-pronged question is always "what do I have to lose?" and "what will it cost me to avoid or minimize this risk?" Rich people obviously have more to lose, so they spend more on various kinds of insurance, including umbrella policies, which protect their fortunes from miscellaneous unforeseen disasters. Nonrich people don't need to spend as much on insurance because they don't have as much to lose. Once the basic risks are covered, they are better off directing any discretionary income to their savings and investment accounts.
6. The surest way to save taxes is by contributing to a retirement plan.
Every dollar not paid out in taxes can be used to generate more wealth. Rich people understand this, which is why they hire smart accountants and lawyers to help them find various legal ways to save on taxes. But the surest and easiest way to save taxes is available to anyone who works for a living: Simply contribute part of your salary to a retirement plan. Here's how it works. Let's say you earn $50,000 a year. If you report the full $50,000 in income and have average deductions, you'll pay about $8,551 in taxes. But if you contribute $5,000 to a retirement plan, you'll pay just $7,151 in taxes, a savings of $1,400. So not only do you have $5,000 safely tucked away in a retirement plan that's growing tax-deferred for your benefit later on, you also have $1,400 that you otherwise wouldn't have. You can invest this money in a regular after-tax account and get it started growing as well. Keep in mind that with this strategy you are no worse off than if you didn't make the retirement plan contribution. You are not sacrificing the $5,000, because it's still your money--you just can't get to it yet. Anyone who wants to be rich must think long term and be prepared to postpone the present use of money in order to build it into something greater in the future.
7. To generate wealth, give some away.
I'm not going to suggest that you send money to charitable organizations if you're not yet in a financial position to do so. In fact, it may be better for you to be a little stingy with your hard-earned money until you can establish a solid savings plan that's growing and compounding. I am talking about a broader definition of wealth and approaching life with a spirit of generosity. Sometimes people can be so focused on money as the only measure of wealth that they fail to see it in a larger context. They are so intent on saving a few bucks here and there that it completely consumes them. This is not the way to get rich. A better way is to share your wealth as you go through life, and by wealth I mean whatever you have in abundance, which at this stage of your life may be time and talent if not money. All the major religions teach this tenet, and I've seen in my own life that the more you give away, the more comes back to you. The principle works in mysterious ways, but it does work.