A few months ago, we published the first installment of “The Andrew Experiment.” This was a case study of Andrew, a Dough Roller reader and listener who was feeling overwhelmed by the process of investing and starting to build wealth.
The purpose of the experiment was to test my hypothesis: With the right coaching, any randomly selected person with enough interest to regularly read/listen to Dough Roller could be taught to overcome the overwhelm associated with managing their own finances. They could be coached to develop an effective wealth building process and become a competent DIY investor. And they could do it all in a short period of time.
Now that it’s been a little while, let’s check in with Andrew. How do you think he’s done?
Starting With Better Questions
In our first installment, we discussed establishing Andrew’s true financial goals (in conjunction with his fiancée). I challenged Andrew to answer two questions related to his original goal of becoming a millionaire by age 40:
- Why did he want to be a millionaire by age 40?
- What does being a millionaire by age 40 mean to him?
Andrew pondered these questions and had some long discussions with his fiancée. He admitted they really didn’t know what they wanted for their future. He and his future wife both enjoy their jobs and are in rewarding careers. Neither currently has a desire to retire early.
However, they acknowledge that work and life situations can change quickly. At some point, they want to start a family. This is why they want a plan that allows for many future options.
The couple felt that building wealth would provide them with the flexibility to make choices in the future. Being a millionaire by age 40, while not a magical dollar amount or time frame, would provide a lot of future financial flexibility. It was also a measurable benchmark to start working towards.
I agreed that while the goal had not changed at all, the reasoning behind it was stronger. It was no longer a couple of random and arbitrary numbers. The goal now had meaning, while being specific, measurable, and time-sensitive.
More Questions To Answer
Now that we had a meaningful goal, Andrew was eager to start building a portfolio focused on index investing. His primary questions were what assets to invest in and where to hold them.
I recommended we slow down again and ask a few more questions before going too far down this road.
- Does this investment strategy actually match his goals, temperament, and interests?
- Is it plausible and likely to work?
These questions may seem obvious and overly simplistic. However, many people think of investing options as limited to stocks and bonds. They sometimes assume that investing success is simply choosing the right stocks, asset classes, or specific funds.
This is because most people get their investing “education” from financial advisors and the investment industry — others who sell investment products or are paid a percentage of the assets that they manage. They therefore ignore the myriad other investment options that may be more appropriate to an individual’s goals.
It is one of the many conflicts of interest in traditional financial advice.
Investing in stocks and bonds is a great way to passively grow wealth which has already been accumulated. Over long periods of time, the power of compounding money at a return of 8-10% — as typically assumed with paper assets — can have massive effects.
However, becoming a millionaire in only 13 years, as is Andrew’s goal, is really not an investment problem. Building wealth quickly is primarily about developing a high savings rate.
As discussed in part 1, Andrew is starting in a relatively rare and enviable financial position for a 27 year-old. He has a high household income and minimal debt (aside from a reasonable mortgage). He also has substantial assets, due to good early saving and receiving inheritances from two different relatives.
While avoiding specific asset and income numbers to respect Andrew’s privacy, I will share how we started due diligence with his investment process.
Given Andrew’s starting investment balance, he would roughly need to double his money twice in the next 13 years to achieve his goal of becoming a millionaire by age 40. This would require earning an annualized rate of return of approximately 12%.
Looking at historical stock returns, it is plausible that this could happen. However, it is highly unlikely given current high stock valuations and low interest rates. Vanguard founder, John Bogle, who is not known as an alarmist, predicts returns in the next decade of only 4-5% for stocks and closer to 3% for a balanced portfolio.
Andrew had started saving money prior to our meetings. At our first meeting, I challenged him to develop a system to budget and/or track spending. This allowed him to know how much he was saving and where he was spending.
Since then, he has brought his fiancée on board with his plans, and together they have begun tracking their spending. In doing so, they identified several areas of waste which have since been eliminated from their budget.
They also started to max out their tax-deferred savings into retirement funds to minimize their current year IRS bill, saving them thousands more in taxes. These simple changes substantially increased their savings rate, without sacrificing lifestyle.
If they simply maintain their current high savings rate for three years, combined with the assets with which they are already starting, they would be approaching a half million dollars by age 30. This means they would still have to double their money once in the next 10 years to achieve their goal.
Using the rule of 72 tells us that they would then have to earn an annualized rate of return of about 7.2% over the ensuing decade, if they never contributed another penny to their investments beyond the first three years. Given this information, achieving their goals through index investing seems like a more plausible — though still not certain — solution.
The Power of Saving
To further drive home the point of the impact of saving, we played with the numbers.
We calculated what would happen if Andrew’s and his fiancée’s current work situation and savings rate were sustained for the full 13 years, between ages 27 and 40.
This is conceivable, as they are both early in their careers and would expect pay increases over time. They are currently saving for their upcoming wedding and honeymoon within the year. They also recently made some expensive upgrades to improve a newly purchased home, including buying new windows. This money will all be freed up for other things, including increased saving in the future.
They could, through the brute force of saving, exceed the goal of being millionaires by age 40 without making any drastic changes to lifestyle or even having to earn a penny of investment income!
Learn More: Here’s How Much to Save (and How to Do It!)
Resetting Expectations For High Earners
Andrew — and many others like him, who are high earners — underestimate what is possible because they don’t pay attention to spending and fail to do simple math. When starting, Andrew thought that being a millionaire by age 40 was a bit of a stretch goal and wasn’t sure it was achievable. His primary reason for wanting these coaching sessions was to learn to invest, as he assumed that was the key to building wealth.
He had no idea what he was spending or where his money was going. Simply developing a plan to track spending, and then making a few minor adjustments that did not decrease quality of life, substantially increased his savings rate. This process also enabled him to determine how much he was saving, allowing for these elementary calculations.
Learning to invest is a very wise choice for Andrew or others like him. Due to his earning power and willingness to save, this decision is made a bit easier. It can also be worth millions of dollars in increased returns and decreased fees and taxes over a lifetime.
However, it puts the horse before the cart. Investing prowess only matters because he has the ability to earn and willingness to save first.
Resetting Expectations for Lower Earners or Smaller Savers
Many of you may be reading this and thinking, “This is all well and good for Andrew, but I am not starting with any nest egg. I have a much smaller income, or I am drowning in debt. What good is this information to me?”
This all comes back to our earlier points about asking better questions to get to better answers.
If you are only able to save small amounts of money right now, you too can build wealth quickly. However, you will need different or additional strategies, beyond those used by Andrew.
Like Andrew has done, you need to focus first on creating a wealth-building engine. This will give you the capital to invest. Without Andrew’s high income and head start in assets, you also may need a higher rate of return on investments than can be expected from stocks and bonds.
This can come in one or more of a variety of different strategies outside of, or before considering, traditional paper investments. These can include:
- Getting aggressive with paying off debt to free up money to save, which can then be further leveraged with tax savings.
- Making big changes to lower fixed expenses like housing, transportation, and food to drastically increase savings rate.
- Investing in education to get a better job, or investing in skills and/or equipment to start a business to dramatically increase income.
- Using creative strategies like “house hacking” or “side hustles,” which can address both sides of the savings rate equation by decreasing spending while simultaneously providing increased income.
- Using leveraged investments combined with sweat equity, as possible with mortgaged real estate, to provide dramatically higher returns than possible with paper investing.
Is Investing Irrelevant?
I do not want to give the impression that learning to invest in paper assets is not useful and important.
As stated above, for someone with the same earning power and will to save that Andrew has, learning to invest wisely at a young age is likely the most lucrative financial decision he will ever make. It will literally be worth millions of dollars over a lifetime.
The take-home message of this installment of “The Andrew Experiment” is that before investing matters, we must find a way to create the capital to invest. Becoming a millionaire in 10-15 years is not fundamentally an investment problem. Therefore, it does not primarily require an investment solution.
Now that we have clearly established this point, we will begin to dive into developing an investing strategy. We will choose one that will allow Andrew to grow his wealth. In the end, it will enable his family the future lifestyle flexibility they desire.
In our next installment, we will discuss the processes we used to build Andrew’s investment portfolio and plan. I hope you’ll continue to follow along!