Posted by Dave on December 15, 2010
This is a guest post by Dave, who is also looking to retire no later than 45, but unlike Tim has no kids and doesn’t want any. Dave is from Ontario and is working towards his CGA certification.
I returned from Mexico last night to find a tremendous amount of snow had fallen in Ontario in the week that I had been out of the country. It took me half an hour to chip the ice off of my car in the -22 with the windchill weather after leaving 30+ degrees with humidity yesterday. This was not what I would call a super fun task, but thinking about it, I realized I was pretty lucky compared to the few people I had met in Mexico.
It always seems to surprise my wife that I actually talk to people when we are on vacation. I don’t really talk to fellow vacationers but I like to learn at least a little bit about how the people that work at the resort live. I made several acquaintances while at the resort from which I was able to ascertain at least a little bit of the lifestyle that is lived.
Looking at how I live compared to how the employees I talked to live, I noticed the following:
Their lifestyle is much simpler than ours:
…At least the employees of the resort. They do not need to worry about transportation, as they receive free shuttle rides to and from their workplace. Also, employees get to eat and drink whatever the patrons of the resort are offered. The individual’s financial goals also seem significantly simpler than my own (at least the individuals I spoke with). One guy just wanted to have enough money to afford a Blackberry, another was just trying to save up enough money to get a flight to the United Kingdom to move and work with his girlfriend.
To me this is a much easier way of life. All basic needs are looked after and there is some spending money for “wants”. I would not exchange my comparable wealth and the “problems” that go along with it, but the simpler lifestyle does provide a comparison and perhaps ideas to further simplify my own.
There is very little planning for the future:
I’m not too sure how the Mexican Social Security system works, but I don’t think there is much in the way of retirement planning. Average life expectancy is similar to Canada, but there did not appear to be a significant desire to increase their earning capacity or seek a promotion. Compared to Canada, where most people are always striving forward and never really all that happy (or so it seems) with where they’re at it is a significantly different lifestyle.
I feel incredibly lucky to be given the opportunities that I have been given – to have an excellent education, the opportunity to make as much or as little money as I want and all the other benefits of living in Canada. I would however love the weather that I just left, but I guess that’s what vacations are for.
Posted by Robert on December 14, 2010
This is a guest post by Robert, who lives in Calgary and works as a financial adviser. He is married, has three kids and plans to retire at age 35. Robert and his wife then plan to return to school and become teachers, eventually living and working overseas.
Some people see money as a renewable resource. Those people earn and spend. Others see money as a non-renewable resource. Those people earn and save. There are people who see money as a “seed” resource. These are people who use their money to invest. This is sometimes referred to as “putting your money to work for you.”
Suppose you found an old oil lamp. It’s covered in dust, so you rub it and out pops a genie. The genie tells you he will grant three wishes. What will your first wish be? If you would wish for more wishes, this is the same idea as using money to earn more money. This is done by investing. When my money can work and earn more money, there are two possible outcomes. Either I can earn more in the same amount of time, or I can earn the same income by working less.
This is where the modern self-funded retirement comes from. When people were provided a company pension, they didn’t need to invest. Now, more and more people are pushed by their companies to invest for their own retirement. They are encouraged to save and the funds are invested with the hope that it will fund a retirement around age 65. However, many people don’t have the mindset or the interest to invest, and they adopt the default strategy of hope.
My wife and I started out seeing money as a non-renewable resource, so we saved as much as we could of what we earned. Then we began to invest it, eventually in dividend-paying stocks. It soon became apparent how our money earns more money. If we don’t spend that money, it compounds to earn even more money. This is how our money works for us and earns money for us. This is eventually how we will stop working (retire) and continue to have an income.
The be clear, dividend income is not the only way to use money as a seed resource. Other possibilities include interest income, rental income and royalty income. Any passive source of income is able to replace earned income, allowing a person to become financially independent and possibly retire.
Once we retire, no matter how early or late, we will have an income (from dividends, in our case) that is likely lower than the earned income we have now. The major difference will be that we don’t have to save any amount, because we will have already completed that. We won’t need to save for an unexpected illness or other interruption in income, because that will no longer be a risk. This will require a total change in the way we relate to money. Every month, our dividends will be deposited to our bank account. Even if we haven’t spend everything by the end of the month, we will still have the same amount deposited the following month. So where we originally saw money as a non-renewable resource and then a seed resource, we will come to see our money as a renewable resource, coming in regardless of our actions or circumstances.
When you don’t spend all your money, do you save or invest? How are you preparing an income for your early retirement?
Posted by Canadian Dream on December 13, 2010
Today’s guest post is by a very special guest, Meir Statman, who recently wrote a fascinating book called What Investors Really Want which looks to apply behavioral finance to our investing behaviors. Today he shares his views on people investing between hope and fear.
Hope for riches and fear of poverty always grip us, leading us to buy in hope and sell in fear. We frustrate ourselves and our financial advisors when we shift the balance between hope and fear. Our hope for riches grows when stock markets boom and our fear of poverty recedes.
We berate ourselves and our financial advisors for investing so much of our money in bonds that give us much freedom from the fear of poverty but little hope for riches. Our fear of poverty grows when stock markets go bust and our hope for riches recedes. Now we berate ourselves and our advisors for investing so much of our money in stocks that gave us much hope for riches but little freedom from the fear of poverty.
Financial advisors tell investors to rebalance their portfolios, reducing their investment in stocks after their prices increase and reducing their investment in bonds after their prices increase. But investors are driven by hope and fear to do the opposite. They increase their investment in stocks after increases in stock prices and decrease their investment in stocks after falls in prices. Increases in the uncertainty of stocks magnify fear and lead investors to pull money out of stocks, while reductions in the uncertainty of stocks magnify hope and lead investors to put money in stocks.
Hope and fear animate the normal behavioral investors of behavioral portfolio theory but they do not animate the rational investors of mean–variance portfolio theory. Moreover, whereas “mean–variance investors” consider their portfolios as a whole and are always risk averse, “behavioral investors” do not consider their portfolios as a whole and are not always risk averse. In the simple version of behavioral portfolio theory, investors divide their money into two layers of a portfolio pyramid, a downside-protection layer designed to protect them from poverty and an upside-potential layer designed to make them rich. In the complete version of the theory, investors divide their money into many layers—each of which corresponds to a goal or aspiration.
The pyramid structure of behavioral portfolios is reflected in the upside-potential and downside-protection layers of “core and satellite” portfolios. Schwab’s version of core and satellite combines a well-diversified Core to serve as the “foundation” layer of the portfolio and a less-diversified Explore layer to seek “returns that are higher than the overall market, which entails greater risk.”
Behavioral investors consider the individual stocks they hold as part of the upside- potential layer of their portfolios and are willing to forgo the benefits of diversification in an attempt to reach their aspirations. The desire of investors to attain their upside-potential aspirations leads them to take higher risks in these layers than they take in the downside- protection layers. For example, their aspirations lead investors to buy aggressive growth funds, individual stocks, and call options, all of which have positive expected returns accompanying their high risks. Moreover, at the extreme, the desire of investors to reach their aspirations leads them to buy lottery tickets and participate in other gambles that have negative expected returns.
Investors do not gamble because they seek risk. Rather, they gamble because they badly want to reach their aspirations. Some gamblers, thinking that they have positive expected returns, misjudge the odds of their gambles, but other gamblers know the odds and gamble nevertheless because gambles with negative expected returns offer them the only chance to reach their aspirations. In that behavior, they are similar to the investor who is in a casino with $1,000 and desperately aspires to have $10,000 by morning. The “optimal portfolio” for this investor is concentrated in a single gamble, one that offers a chance, however small, of winning $10,000. Investors who diversify their gambles are less likely to succeed than the investor who concentrates them because diversification provides virtually no chance of winning the aspired $10,000.
Investors, financial advisors, and companies sponsoring pension plans must be careful to draw a line between upside potential and downside protection in such a way that dreams of riches do not plunge investors into poverty.
