I’ve always been interested in money. Even before I became a financial advisor, I started reading all the financial books I could get my hands on. I was able to find the first edition of Your Money or Your Life (1992 edition). (It was a long time ago; if my summary is of a different book, please correct me in the comments.) It presented a very simple, two step financial plan. Step one was to reduce spending. Step two was to increase investment income. Now that I am a Certified Financial Planner, I know that this is the very essence of a successful financial plan. The author, Joe Dominguez, suggested putting a chart on the wall, and charting two lines. The line that represents monthly spending should be decreasing, while the line that represents monthly investment income should be increasing. The month they cross is when you are financially independent. At the time, bonds provided the safety and income that the author recommended.
Later, I found and read Rich Dad Poor Dad. Although the author didn’t present a well-developed financial plan, he recommended accumulating passive income. Although he doesn’t address the very important idea of risk, his thinking intersects with that of Joe Dominguez in the idea of building up investment income. Realistically, having a source of passive income is the only way a person could retire from active work. Otherwise, they’ll have to work to support their lifestyle.
Besides the ultimate payoff of financial independence, acquiring passive income has other advantages. For example, this approach suggests a simple investment strategy. In my opinion, buying income is the best definition of investment. Any strategy that bets on increasing values is speculative by definition. If a person is focused on accumulating passive income, they are most likely to focus on investments that provide an attractive current yield (such as interest or dividends). This mentality of buying income will also affect one’s attitude toward risk. The prevailing academic viewpoint is that stock market returns are random and risk is equivalent to variability. However, when buying income, risk represents the possibility of cash flow (interest or dividends) being reduced.
Further, using this approach makes tracking progress relatively simple. Each time I buy more income, I make progress toward my goal. If, for example, the goal is $2000 per month of income, and my investments produce $1000 per month of income, I know that I will be financially independent after I buy another $1000 per month of income. This strategy also puts market value fluctuations into perspective. The market value of the investments may rise or fall, but the income is likely to remain relatively consistent. That allows the investor to avoid emotional reactions. Market increases aren’t cause for celebration. Market crashes aren’t cause for panic. Better yet, market crashes provide good opportunities to buy income at relatively low prices. Focusing on yield helps keep this in perspective.
There are various strategies that can all move a person closer to retirement. The strategy that seems the most reasonable to me is to buy income. This approach makes tracking progress a simple matter and keeps the true value of investments in better perspective. It also simplifies investment decisions. Do you think this simplifies investing, or do you feel it takes a professional to make investment decisions? Do you have a bad experience or a lesson learned that you want to share? If you can, please share your own investment strategy, and why you chose it.