Is it Possible To Live Without Debt?

By: Roshawn Watson

I recently received the following comment regarding living debt-free.

“Well, it is almost impossible to live without some debts and practically everyone has some debts in finance except maybe very rich people. We need to take it easy and watch them and try to control them as much as we can. This is the best way not to be buried under them and of course hard-work for sure.”

Of course, this comment begs the question: is it possible for people of average means to live without debt?

Renewing Your Mind to Be Debt- Free

Perhaps one of the biggest obstacles in living a debt-free lifestyle is overcoming the ingrained tendency to use debt to solve problems. There was a time when debt wasn’t so ubiquitous, and households of various income levels still lived and thrived. Just because debt is currently the most aggressively marketed financial product does not mean that it is impossible to live without it. In fact, the preponderance of debit cards, discount sites like Groupon and Living Social, and the return of layaways programs¹ have made it easier to resist the urge to use credit now than perhaps even a decade ago. Remember, debit cards and layaway plans exist so that no debt is incurred in making purchases. Moreover, the same patience required to purchase a new flatscreen on layaway can be used in budgeting for the upgrading of a wardrobe, purchasing furniture, or even buying vehicles. The process may be more lengthy for bigger purchases, but one would be less likely to do financial damage by planning purchases in this manner than by incurring debt. One reason for this is that people who purchase items with cash tend to spend less overall. According to recent research, we spend between 12-50% more when we make purchases using credit versus paying cash (depending on the venue).

It’s no wonder a whopping 75% of the Forbes 400, the 400 richest Americans, said the best way to build wealth is to become and stay debt free. Notice that they didn’t say, “I got wealthy first and then lived a debt-free lifestyle.” No, they freely attributed a major part of their financial success to being debt-free, partly because it gave them control over their most powerful wealth-building tools: their incomes.

If you renew your mind to the facts that 1) it is feasible to live without debt even in our modern society, 2) using debt causes you to pay more, and 3) using debt obligates your future income, then you may be able to suppress the desire to purchase items before they can fit within your budget.

The Relationship Between of Liquidity and Debt

A second weapon in your arsenal against the temptation of using debt is your liquidity. Traditional recommendations are to keep at least 3-6 months of expenses in cash as an emergency fund (EF). Of course, this is important because it is not a matter of if it will rain but when it will rain. A recent study suggests that 78% of families will have a major emergency within the next 10 years. A deciding factor as to whether families will need to borrow to stay afloat during such emergencies is often whether the EFs are fully funded. In the middle of a crisis, a loan is often the last thing one needs.

Since 2008, I have agreed with Suze Orman’s recommendation of having eight month’s worth of expenses as an EF is pretty reasonable, given some of the things going on in the world economy. As one continues to build wealth, he or she will hopefully continue to build liquidity.

Liquidity is your defense against debt.

What's Your Debt-free Strategy?

If one freely acknowledges that the cultural deck is stacked against him being debt free, and he values being debt free, then he should have a strategy to remain debt-free. For example, why would someone deliberately wait until his car runs down before financially preparing for its replacement? That’s like waiting until you have frost bite before you buy a coat.

Using the money that you already earn, you can take actions to reduce your costs and enhance the financial productivity of operating your household. It may seem counterintuitive, but despite having more means, most millionaires run economically productive households. The majority of millionaire households budget, and nearly two-thirds know how much they spend on groceries, housing, and clothing within a given year. Forty-nine percent regularly use coupons for grocery shopping versus 37% of all US households. (Interestingly, usage of coupons actually decreases with income.)

Perhaps coupon clipping is not your cup of tea. That's fine because your debt-free strategy can be a simple or as elaborate as you want. Recently, I read where one blogger limited his Christmas spending to only money that he could earn within a week. Similarly, you could limit your blow money to a fraction of what you earn in either portfolio or passive income. When I did this, I became VERY motivated to increase my “non-earned” income.The point is to enhance your economic productivity (regardless of whether that means saving more money, increasing income, or allocating some of your income towards items that you would otherwise use debt to purchase).

Your debt-free strategy is another line of defense against our culture of debt.

Delayed Gratification To Be Debt-Free

You can have it all, but you can’t have it all it once.

I think there is always an underlying assumption when anyone rallies against the dangers of materialism and poor money habits, as we discussed last week in Broke People Afford Everything, that he or she is against people having nice things. That’s certainly not the case. The issue is how one pays for nice things rather than having nice things.

I know plenty of people with comfortable six-figure incomes who struggle to spend money on designer clothes, luxury vehicles, vacations, toys, and anything else most people would deem remotely fun. This isn’t because of their irresponsible money management either; it’s because they are all so careful to limit their lifestyle inflation and to remain on their budgets. I know others who have purchased Maserati's but have to work two jobs in order to support their lifestyle. Sure they look nice on the few occasions they’re available to hang out. The truth is that the car could have happened a little later in their lives with much less of a financial impact. Instead, they have purchased the luxury vehicles now while in the middle of repaying student loans and mired in credit card debt. YUCK! Delayed gratification isn’t denial. It’s just timing purchases for when they make sense in your financial world.

If you master delayed gratification, you can own the best without compromising your financial foundation.

Closing Thoughts

Yes, it is possible to live debt free; in fact, I’m convinced when paired with consistent investing over time, living debt-free is part of a path to build significant wealth. Henry Ford commented that debt was the lazy’s man method of purchasing items. The translation is that there is work involved in becoming and remaining debt free. No one said it was easy, but if it was easy, everyone would do it. Nonetheless, if you’re willing to go against the cultural indoctrination encouraging us to worship at the altar of the almighty FICO, 1) you will have control over your income, 2) you will pay less than you credit-paying contemporaries, 3) you will be prepared for emergencies, and 4) you may just find yourself richer than your wildest dreams!

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

Related Posts

Broke People Afford Everything

The Pain Of Paying Cash

Some Thoughts on Delayed Gratification (The Simple Dollar)

7 Surprising Facts About Millionaires

¹Layaway plans let you pay a deposit (and perhaps a nominal fee) to secure an item for a later purchase. The store will hold the item for you until you pay for it in full.

Verification Code: CJYZCNYWN944 (please ignore)

Broke People Afford Everything!

By: Roshawn Watson

“Hello Baller. I need to holla at you for minute.”


I got a question for you because I just can’t figure out how you do it all. Your clothes and toys are nice. Everyone’s envious of your whips. You frequently eat at restaurants that most people only dine at on special anniversaries or birthdays. We always appreciate your twice annual post cards from the likes of Paris and Bora Bora.  Your lifestyle is pretty impressive, except for the fact that you’re a financial fake. I just want to know one thing: how do broke people afford EVERYTHING?

Different Priorities

This bankruptcy thing is too stressful, so I’ll deal with it when I get back from vacay!

It’s tough work being broke nowadays. The broke used to be able to proceed through life unnoticed (or at least with limited social pressure to overextend themselves), but now they’re expected to keep up with the Joneses, who are broke too by the way! I guess it’s always easier to display artifacts denoting financial superiority than to actually be a financial champion.

One of the biggest challenges is prioritization. Apparently, financial security, comfort, and abundance are secondary to social acceptance and lifestyle elevation. While interesting, this is not surprising because building wealth generally takes significant work and time. It’s using the crock-pot approach rather than ordering fast food. Thus, when the new Ipad comes out, one may not think to check his budget. Doing so would crimp his style. Marketers love him. His friends and family think he’s the most fun and generous. The problem is long-term: how does one get ahead financially if he is always focused on immediate desires?

Priorities (goals) determine the direction of your life. One way broke people are seemingly able to afford everything is that they have different priorities, so their is no internal pull to do things that you may deem financially responsible.

Prosperity On Credit

“Your labels may say you are rich, but your accounts tell a different story!”

There is no prosperity on credit, yet one would never know it by looking at people’s lifestyles. This is the very reason when I see most Mercedes or BMWs, my first thought is not “what a nice car!” but rather “what is the payment?”

Researcher and author Thomas Stanley noted that fancy zip codes are typically a better predictor of large credit availability than net worth. It is no  wonder that the average millionaire lives in a neighborhood where his net worth dwarfs that of his neighbors by 6-fold. It would be prudent to realize that the only people who get rich from most loans are the lenders: how do you think they are able to be the lender in the first place?

Also, keep in mind that using credit to support lifestyle often extends the cycle of poverty, especially if you are broke. That’s because the debtor is obligating tomorrow’s income today. Thus, someone who makes the same income but lacks the debt will have more means to achieve his or her goals than the person in debt. I see this all the time with people on tight budgets. They are working hard and have very little room for error. That’s why they live paycheck to paycheck: they never can “afford” to build an adequate buffer because they are too busy “affording” everything else.

Broke People Depend On Support From Others

It really doesn’t matter whether it is the bank of mom and dad, legal protection (i.e., bankruptcy), or the government, someone IS paying the bill. There are so many adults who are almost completely economically dependent on others nowadays. We surely live in strange times. Because of higher unemployment, adult children are more likely to return home after school. Such children are known as the boomerang generation, but how long must parents provide for their capable adult children? I ask this not be be mean, but at some point, one has to be concerned about enabling misbehavior.  For example, I’m a huge believer in second chances, but one of the biggest limitations of bankruptcy is that all too often, people don’t learn the necessary lessons. In these cases, the filers are not helped. The bankruptcy has just delayed their day of reckoning rather than helped them move past it. Their freedom is temporary, and they are likely to repeat their past mistakes. Requiring education is a step, but more is clearly needed if the goal is truly to encourage proper money management. That’s why it is okay to feel financial pain. As I told my Tweeps recently...,

If you only learn by hitting bottom, the faster you get there the sooner your salvation.

Final Appeal To The Savers

If you are a frustrated saver, take heart that your efforts are not for naught. Think of the cautionary tale of Teresa Giudice, of the Real Housewives fame. In the Phony Rich, I highlight how she and her husband were almost $11 million in debt with an annual household income of $79,000 according to CBS News. She was in the public eye selling their lavish lifestyles and couldn’t keep up the facade. I heard that she recently withdrew her bankruptcy petition. Bravo! [excuse the pun] I hope she will use her next season to display some growth rather than flaunting fake status.

In short, many broke people can afford the good life because they have decided to allocate their money and credit to different priorities and enlist the help of others to support their lifestyles. If you are financially responsible, don’t be grieved by the pace of your progress. The tortoise wins the race every time!

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

Related Posts

Forget Looking Rich, Be Rich!
Creating Phenomenal Wealth Over Time
The Phony Rich (Teresa Giudice net worth)
7 Surprising Facts About Millionaires

Are You Your Portfolio's Biggest Enemy?

By: Roshawn Watson


You work hard. You research companies. You even gather expert opinion and public sentiment regarding your investment choices, yet your returns are not commiserate with your effort. In fact, your long-term returns are dismal compared to market averages. This is the world of many investors today. Despite the increasingly lauded financial literacy programs, investors are struggling with two primary problems: their own nature and a well-polished Wall Street machine that loves ignorant investors.

Is Your Gut Leading Your Investments Astray?

The investor’s chief problem—and even his worst enemy—is likely to be himself. (Benjamin Graham)


A large data set analyzing household investing found just how damaging gut-driven trades can be to our wealth. Over 66,000 households with accounts at large discount brokerage firms between 1991 and 1996 were evaluated. The average household annual return during this period was 16.4%, and portfolios typically turned over around 75% of their stocks annually. The market (NYSE/AMEX/Nasdaq) returned 17.9% during that same period. However, the households that traded most frequently had an average annual turnover of 250% and only earned a 11.4% annual return whereas those who traded infrequently earned 18.5%. The obvious implication of such findings is that most individual investors were better off investing and taking a nap rather than playing the trading game.


Another study evaluated 10,000 brokerage accounts over a seven year period found intriguing differences in returns between buyers of stock and sellers. The investigators wanted to see who did better, the sellers of a stock or the buyers. On average, the shares investors sold did better than those they bought, by a very substantial margin: 3.3 percentage points per year, in addition to the significant costs of executing the trades comparing two stock. Thus, the data, opinions, and hunches leading the purchasers to think that it was a good time to buy XYZ stock were clearly wrong!

Trading typically has deleterious impact on wealth-accumulation.


The key question is if our ideas are so golden, then why doesn’t the data back them up? Often overconfidence plays a strong role in high trading levels and the corresponding lower returns by individual investors. Many times our forecasts are little better than blind guesses. While this fact alone should give us pause, often the dismal quality of our predictions has very little impact on our future judgments. Frequently, our “strong yearnings” and “informed decisions” are our the biggest threats to our portfolios.

Ignorant Investors Beware

All that shines is not gold.



Nevertheless, there is another dangerous offender that can seriously hurt investors. Investors must know that the polish and veneer of sophisticated analyses, wonderful academic pedigrees, complicated products, and A-list clientele associated with Wall Street wealth advisers often obscure the reality: few stock pickers possess the skill required to beat the market consistently, year after year. A 2009 Morningstar, a Chicago-based research firm, study focusing on individual investors  reported that just 37 percent of actively managed U.S. stock mutual funds beat their respective Morningstar indexes after accounting for risk, size and fund style.  Your odds of picking an actively managed fund that beats the market for more than a couple years are pretty small. For most individual investors, it is generally better to “easily avoid underperformance” rather than pursue the “futile chase of market-beating performance.” 


Nonetheless,  a recent good performance history and an endorsement from an advisor can be remarkably seductive to investors hungry for returns. This isn't to say that many advisers aren’t hard working and highly experienced professionals who genuinely believe they have what it takes to pick the next winners. In fact, many believe they are providing value to their clients. However, what they are typically offering are merely educated guesses at best. The problem is that these guesses tend to be no better than chance and are repeatedly beaten by the market benchmarks.


Along this same vein, the correlation data is also pretty convincing with respect to the role of chance in our returns. A correlation is a way to see the relationship between two variables. The stronger the correlation, the stronger the relationship. Thus, if a year-to-year return showed a strong correlation, then that would suggest that these two returns are strongly related to each other. Perhaps if both returns were good, you could even assume that whoever designed the portfolios (or picked the stock) yielding those returns is the most important variable. In other words, he or she possesses some special knowledge or resources yielding a competitive edge in the market. Moreover, if he or she was able to replicate these results over a longer time frame, such as 20 to 30 years, you would have a much more robust data set. Such data would be considered more valid compared with an incidental finding. This is important because a group of researchers recently looked at 28 year-to-year correlations for 25 anonymous wealth advisers and found that there was ZERO correlation between their returns. In other words, there wasn’t any discernible pattern, despite the superstars advisers being the common denominator. The most reasonable interpretation is that the differences were due to chance not the skill or educated guesses of the talented investors. By the way, if you think this consistency criterion is too stringent, consider this same metric has been used successfully to quantify the existence of skill among “golfers, orthodontists or speedy toll collectors on the turnpike.” Thus, if skill was involved in producing the sporadic market-beating returns, the correlation data should support it.

Show Me Your Financial Statement

In no way am I writing this to put down advisers but rather to educate investors. There are some investment advisers who are very informative, such as Robert at DIY Investor, and endeavor to serve their clients extremely well. However, there are many others who are mostly smoke and mirrors. They have clever sales pitches that don’t consistently translate into market-beating results for their clients, after you adjust for risk, fees, etc. Perhaps, this is why when one of the decamillionaires profiled by Tom Stanley in his famed Millionaire Next Door series was approached by a wealth adviser, he told the adviser that he would only obtain his business after his review of the adviser’s financial statements. The decamillionaire wanted to make sure that the adviser was able to generate significant returns off of his own investments not off of his ability to sell financial products. The adviser went on to scout another client. The implication of the story is that our concern should not focus on what someone says they can do for us but whether they can get results, particularly results in their own lives. That kind of authenticity is rare. Most people who sell investment products make their living from selling not investing! Being a good salesman has nothing to do with being a great investor.


That’s why Wall Street doesn’t necessarily like savvy investors. Even when Wall Street is involved with well-intentioned financial literacy programs, such as the Mutual Fund Educational Alliance, which has been around since 1971,  it ultimately served as little more than an marketing ploy for the fund industry to push their products to willful participants under the guise of educating them.

Let me say this clearly: many financial firms have an uncanny ability to extract considerable sums of wealth from an unsuspecting public. They’re the smart money. Think very carefully before betting against the house!

Closing Thoughts

In summation, between battling overconfidence and an ever-craftier Wall Street, investors are struggling to find their footing in a very tumultuous economic climate. We should not be deceived by either ourselves or others, regardless of professional credentials. If for one second, we let ourselves believe that we got the system beat (or that we can’t invest on our own), we often have already loss. Don’t be a victim of overconfidence in yourself or Wall Street!

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

Related Posts  
Young People Avoiding Investing In Record Numbers

Will the Economy Collapse in 2011?

Your Do over Guide: What Would You Do Differently?

By: Roshawn Watson

I don’t truly understand people who say they wouldn’t change a thing in their lives if they could. While I have nothing against contentment, if given the opportunity, I would change several things not because I hate my life but to get the most out of it. If you could press rewind on your life, what would you do differently?

Start Businesses

First, I would have started businesses and have done so early. Nowadays, the barriers of entry into many businesses are lower, including smaller capital and infrastructure requirements. The advantages to owning your own business include: a) your business can be created around your passion, b) you can concentrate your efforts in your chosen areas of competence, c) you would control it and d) you would have tremendous income potential. Indeed, business owners are also five more likely to become millionaires over traditional employees, partly because the financial responsibilities of business operators corresponding well to running an economically productive household including: keeping cash reserves, decreasing unnecessary expenditures, investing for growth, watching revenues and projections, etc.

Of course, there are inherent risks too, but I would rather manage risks over eliminating them entirely. Avoiding risk altogether can be dangerous too. I additionally challenge you to redefine how you consider risk. Rabbi Daniel Lapin argues that we are all in business for ourselves. For example, if you have a traditional JOB, then you are selling your skills, services, time, and knowledge to one customer (your employer). If you are a traditional business owner, you simply endeavor to have more than one customer. This begs the question if it is riskier to have one customer (your employer) or 200 or more?

Adding a side business to your portfolio could literally revolutionize your life. For instance, one kid who grew up very poor decided to create his own video games, since his parents couldn’t afford to them. His classmates saw him playing his games, liked them, so he began to sell them copies (and then their friends). Companies took notice and had him consult on projects before he even reached puberty. Although he was being paid well, he knew that he was worth more, so he started his own company and later sold it. He first retired at 19. Then, he got bored started another business that he also sold and retired again. At the time I heard his story, he sat as a chairman of the board of directors of a publicly traded company, was a well-connected venture capitalist, and traveled the world with his team helping people replicate his success, at the ripe old age of 28!
What potential do you allow to lie dormant?

Quit More Often and More Quickly

In The Dip, Seth Godin challenged the mantra that “winners never quit, and quitters never win.” He argued that winners actually quit frequently and quit swiftly. In other words, winners find what doesn’t work and move on fast. This agrees with advice I heard 15 years ago from a businessman worth nearly a billion dollars. During the conference, he indicated that one of the most important lessons he learned was to “not kid himself. Knowing is half the battle because you can take corrective actions whereas continuing in blissful ignorance sets you up for failure.
My do over would be realizing when I am getting off course faster and to channel all my resources into moving in the right direction.

Investing Earlier and Investing More Aggressively

Does saving and investing 50-80% of your income seem reasonable to you? For most people, the answer is no. However, suppose someone showed you that if you did this for a mere 7 years, you could then retire. I thought that would get your attention. Personal finance expert Dave Ramsey always says “when you live like no one else, you can live like no one else.”

Earlier this year, I asked a simple question “How would you retire in 10 years?” The purpose of the question was to challenge the assumption that it takes a working lifetime to invest adequately for retirement. There are people who never expand their mental contexts beyond that life script who get very traditional results: they slowly build wealth, depend on social insecurity, and may have to choose between paying for some expensive medication or food. This isn’t trivial, it’s a sad reality for far too many people. Investing aggressively and early a) gives your investments a longer time to grow, b) means your source of provision is not dependent on your job, and c) expands your opportunities to reach your potential with limited financial concerns. I challenge you to be the architect of your own life. Don’t allow the complacency of good to rob you of the glory of great!
My do over would be not to allow any slack... fire on all cylinders until I was “done!”

Invest In Myself

If you are frugal (wanting to get the value for your money), it’s possible that you will agonize over things that are good for you. There are several opportunities to advance your career and improve yourself: conferences, seminars, short courses, webinars, certifications, books, but not all of them you will be free or paid for by your employer. I believe there should be at least some room in your budget to invest in yourself.

An author and entrepreneur was recently asked if he regretted wasting money on products and conferences that ultimately provided him little value. For context, he spends an unconscionable amount on educational materials each year: some are several thousands apiece. His answer was a) very few provide absolutely no value (there’s almost always something to pull away from them) b) for ever dud or two, there’s one that helps him completely knock the ball out of the park to the degree that it more than compensates for the costs of duds.

Ask yourself if you are playing it too safe with respect to investing in YOU, Inc.

Avoid Debt

We have a culture of debt: debt is the most aggressively marketed financial product. Entire industries are developed to make us think that we cannot function without debt. However, the borrower is servant to the lender. Sadly, the debtor has obligated tomorrow’s prosperity and limited his ability to build wealth, at least wealth for himself, compared to his contemporaries making the same amount without the debt. For example, if you avoided car notes altogether and invested average car payment instead from age 25-65, you would have an estimated $2,000,000.
Instead, we label debt to make it more palatable by creating trivial hierarchies of debt with all sorts of eloquent rationalizations. Sometimes this involves classifying debts as “good” or “acceptable” or an “investment.” The truth is consumer debt is consumer debt. If you are truly borrowing to invest, I hope your return is substantial, given the amount of risk you are assuming by having debt. Remember, if you have to rename the debt to overcome your misgivings, that may tell you all you need to know right there.

Early on, I would have avoided it like the plague that it is.

Carry Adequate Insurance for Key Items While Avoiding The Rest

It is often said that there is no other expense that people spend so much of their money on without understanding. No one likes insurance until they need it. We all know that insurance companies do not lose money on insurance policies. For every few people who pay a few dollars in premiums and make a big claim, you can bet they have thousands more who pay premiums and have absolutely nothing bad happen to them.
Since you can’t be certain that you won’t be the “unfortunately few” who need insurance, you should judiciously use insurance policies to transfer risks in key areas. After learning this, my whole perspective changed. For example, many people are surprised that I don’t carry an insurance policy on my cellphone. However, cell phone insurance policies tend to be pure profit for the phone companies. My bet is if I replace my phone every 2 years (or so) and make sure that I get a phone that is highly rated, I do not need to pay an extra $120/contract for insurance given: a) the phone’s under warranty anyway, b) I’m not very rough (and don’t lose) my phone, c) and I could cover the cost of another phone within my budget. I also do the same thing for extended warranties (functionally they are insurance): did you know that they often represent a 50% margin, which is almost pure profit. Consider, how much could be saved by carefully analyzing our insurance needs.

My do over would be maintaining adequate coverage for the sensible things at all times and avoiding all others like the financial drains they are.

Is The Struggle Necessary?

Pain is definitely a teacher. It signals that something is wrong, so problems don’t persist undetected. However, learning from pain is also slow and unpleasant. If I was designing my life, I would obtain pearls of wisdom from others experiences via mentorship over learning from my own mistakes. Personally, I would rather someone tell me how dangerous it is to ride without seat belts than learn from first-hand experience.

Well, yesterday is over, and tomorrow is not yet here. However, if you could press rewind on your life, what would you do differently?

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Like It on Facebook, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

Related Posts

Young People Avoiding Investing In Record Numbers

Labeling Debt To Make It More Palatable

How would you retire in 10 years?

Money Down the Toilet for Security

Young People Avoiding Investing In Record Numbers

By: Roshawn Watson
Last year, a study indicated that those growing up in the 1930s are 3 times less likely to invest than those who grew up during better economic times. Fast forward eighty years, and we have had a series of economic crises collectively known as The Great Recession. What is the impact of the Great Recession on young investors?
Fear

Lehman Brothers, GM, AIG, Chrysler, and the collapses or bankruptcies of many other known businesses; a dip in the stock market by 38%; and home prices in the toilet all form the basis for recent resistance to investing. According to a recent study by Wells Fargo, twenty-somethings are more likely to save for retirement in CDs rather than investing in stock than any age group. Given the outright hysteria at times, concern is certainly a very reasonable reaction because it is unclear what the future holds. Nonetheless, most will at least admit that we have had one of the weakest economic recoveries in recent memory. Of course, there are persistent rumors of a double-dip recession looming, and the European Debt Crisis is certainly taking its toil on the global markets (IMF agreement with Greece or not). The only thing that appears certain, economically, is the uncertainty. However, that doesn’t stop people from fearing an inevitable demise in our economy.
Simply put, fear is driving young people to make some dangerous decisions regarding investing.
Ignorance

Media pundits love discussing the “Lost Decade” of investing; however, the whole hypothesis make a series of assumptions that apply to a fraction of investors. Let’s consider the data. Fixed-income funds have outpaced stock in the last 10 years; small cap investors (Russell 2000) have had an annualized return of 6.3% and MSCI Emerging Markets Index returned 12.3% annually (as of January 2011). Balance investors (typically 60% stock and 40% bonds) saw a 25% decline in portfolio balance versus the 38% decline over the last 10 years. Also, the Lost Decade hypothesis also assumes you invested all your money as a lump sum at the beginning of 2000 in the Standard and Poor’s 500 and assessed your portfolio value on 12/31/2009; most people invest incrementally rather than all at once. If you invested quarterly rather than plopping down say $50,000 in January 2000 without rebalancing, your annualized return would be 1.16% instead of a -1.25% thanks to dollar cost averaging. Note, rebalancing is realigning your portfolio to asset weights congruent with your original risk tolerance (i.e., the original portfolio weighting). Suppose your portfolio consisted of 20% bonds and 80% stock (i.e., rather than 100% stock), and you rebalanced. If you had, your annualized return would be 2.27% (vs -1.25%). If you added small cap or emerging markets, you would get...well, you get the picture. Also, consider that most people require a longer time horizon for investing (i.e., at least most people take longer than 10 years to invest for their retirements). Even if you went all the way back to post World War II, the S and P still returned an annualized, inflation-adjusted 5.8% as of January 2011. That’s significantly less than the much touted 12% but still whole a lot better than what you would get from many alternatives.

Inexperience

A third reason young investors are not investing in the stock market is inexperience: 1) inexperience with the volatility and 2) inexperience with the implications of NOT investing. While younger investors have the benefit of time, older investors have the advantage of perspective. Historically, there have been prolonged periods of economic growth, interspersed with some adjustments, corrections, and recessions; the stock market has been among the best ways to capture that growth over the long-term. Consider that if you went back World War II, stocks have annualized an inflation-adjusted 5.8%, compared to 1.8% for bonds and 0.4% for cash (as of January 2011). That in itself may instill a level of confidence in older investors that escapes anyone who has just entered the market within the last 10 years, which have been plagued by both the dot com and real estate busts. Additionally, younger investors are less likely to have personally experienced the ramifications of not meeting those retirement goals for themselves. Sure the stories of eating Alpo during retirement are unsettling, but if you haven’t personally been in a situation where you have to choose between paying for your medication or eating, then it’s hard to truly appreciate the risks of NOT investing.
Part of the reason your return is so important is because of taxes and inflation; both erode the value of money in a substantial way. While it is currently anyone’s guess where taxation is going, depending on your income, you currently can be taxed at a significantly higher rate (at the rate of earned income) for interest earned from saving money outside of a retirement account than you would if you had received dividend or capital gains income from a portfolio invested outside of a retirement account (assuming the investments were held a sufficient length of time). Inflation can similarly decimate portfolio, considering that $100,000 today will be worth only $31,000 in 40 years. Note this calculation assumes inflation will return to and remains at its historical average of 3%. In other words, just because the balance in your savings account is not declining does not exempt you from losing significant purchasing power. Making more from your money means you can counterbalance these forces.

Parting Thoughts

The decision to forgo investing in the stock market is not trivial. Those who chose to cash out of the market due to the 2008 crash have missed the gains in the market since then. In no way am I diminishing the complexity and volatility of the times that we live in; however, rather than avoiding the markets outright (whether real estate or stock), perhaps a better strategy is to adopt a more conservative stance: one that is congruent with your current risk tolerance. Personally, I want you to dominate financially and take courage. However, if you fear anything, fear NOT investing.

Lastly, if you like this article, please subscribe to my FREE email updates or RSS feed (reader), Retweet it, Tipd it, Fark it, Stumble it, and tag it on Delicious. Also, click here to receive my eBook for FREE.

Related Posts

Will the Economy Collapse in 2011?
Investors, Forget Bulls and Bears, Be Observant Ostriches

Decamillionaire Tips Round Up

By: Roshawn Watson


Have you ever wanted to learn personal finance tips from a decamillionaire? I thought so. In my first guest post since the Watson Inc relaunch in September, we'll discuss three decamillionaire-vetted tips that will make you a financial champion on literally one of best personal finance sites around!

Come back on Friday, and the link to the article will be posted right here: 

Getting into Financial Shape with the Decamillionaire Next Door

However, since I have sufficiently teased you, let me share with you the rationale right now exclusively (not in post) for why I think this is so important.

1. Job Security Is An Illusion. No amount of training nor experience can guarantee that you will have a job tomorrow. The change could literally have nothing to do with your performance or likability. That’s why it is critical to expand your knowledge-base, your skill set, and your network constantly. Of course, you should aim at stellar job performance as well. However, don’t allow a false sense of security to lull you into complacency: your family’s well-being depends on it.
2. Home Values Have Seen Better Days. People became so accustom to using their homes as investment vehicles and savings accounts. The substantial drop in home prices in many areas has rightfully given pause to many of those who employed this strategy. Banks closed lines and made lending criteria more stringent.  It is unwise to depend on reserves that you don’t completely control.
3. Selling Equities During An Emergency? Some people would rather “pay for” emergency expenses on a credit card before selling their precious blue chip stocks, especially if their blue chip equities’ values are down. However, if you use debt to finance your emergencies, you are just digging yourself into a hole. The borrower is slave to the lender. Intellectually, you may know this, but it is hard to get passed the psychology of selling equities when they are down (for some, even when they’re up it’s difficult). This is why having some cash not tied to an investment vehicle is a good idea. At least you’re not fighting against your own nature.
4. It may be hard to get loans when you need them. Have you ever heard the statement banks want to lend you money when you don’t need it? It’s funny how we will cosign for people who  banks, the very businesses who make their fortunes from buying (and sometimes selling) debt, won’t lend money to without our signing for the loan. That speaks volumes. Banks' goal is to make money, like other businesses; a crisis may interfere with that objective. Thus, I wouldn’t consider counting on them in a crisis to be wise.

I can't wait to delve into these issues and much more when I finally share the post with you on Friday! 

Also, if you are an investor, aspire to be one, or have turned your nose up at the market, you'll want to come back tomorrow for my forthcoming post regarding the 2008 crash.

Personal Finance (Yakezie and other PF bloggers)

Now, let's get  to business, I looked back, and the last Round-Up I did was back in Feburary. What!?! I'm sorry I've been away. There are plenty of uncommon personal finance articles that I want to share, and some of them are written by the same bloggers who help me promote my content via their own round-ups, tweets, votes on social bookmarketing sites, comments etc. I want to highlight their content now and give them a big virtual THANK YOU!

• Kris @ Everyday Tips and Thoughts wrote Opportunity Cost Is Not Just About Money. Here's a brief sampling "The making money part of the equation needs to be balanced with the money I save plus my ‘happiness factor.’" Good stuff!!!
• Larry @ Krant Cents wants you to be prepared to Ace Your Next Lunch Interview. I changed jobs earlier this year, and a lunch interview was part definitely part of the process.
• Joe @ Retire By 40 asks How often do you check your net worth, and does your frequency change based on what the market is doing?
• Bret @ Hope To Prosper wrote Spending to Impress as a part of his provocative Money Fail series that you should definitely check out.
• Miss T @ Prairie EcoThrifter examines the the Pros and Cons of having a Home Gym versus gym membership; as someone who previously loss 40 lbs in 10 weeks and kept it off, I can personally vouch for the merits of having a home gym (nothing against the memberships though).
• Robert @ DIY Investor argues we already know what to do including not allowing anyone to purchase a home without a 15% down payment.
• The Grouch @ The Biz of Life compares the consequence of Big Government to the adult baby.
• Kevin @ Invest It Wisely discusses the his first time getting laid off and the lessons he took from the experience
• Andrew @ 101 Centavos writes about situational awareness and asks whether he's paranoid.
• Moneycone discusses his thoughts on doing a 401K rollover and argues that it is preferable to roll your money into a traditional IRA rather than a Roth IRA, leaving it at the existing company, or cashing it out.

Carnivals I Have Participated In (* denotes editor's pick)

• Carnival of Personal Finance at Hope To Prosper*
• Carnival of Personal Finance at Boomer and Echo
• Carnival of Personal Finance at Squirrelers
• Carnival of Personal Finance at Beating Broke
• Carnival of Personal Finance at Sustainable Personal Finance*

• Yakezie Carnival at KNS Financial
• Yakezie Carnival at 20 and Engaged
• Yakezie Carnival at Mom's Plan

• Carnival of the Road to Financial Independence

Round-Ups That Included Posts From This Site

• Krantcents hosts the KC Awards - Clone Wars edition 4
• Everyday Tips and Thoughts presents weekly links 
• Invest It Wisely shares Weekend Reading