Core Principles of Investing Explained

Myth: Wealth is solely a result of living below your means.

Fact: Frugality is merely the first step toward building wealth, not the final destination.

Let me introduce you to an inspiring couple I know. When we first crossed paths, they were living in a cramped, dimly-lit apartment in a neighborhood where real estate is affordable but often synonymous with neglect. Fast forward a few years, and their lives have transformed dramatically.

While their wealth isn't displayed through extravagant purchases or flashy cars, it’s evident in how they spend their time: traveling frequently, skiing, kayaking, and hiking. They no longer feel the pressure to work outside the home, which gives them the freedom to explore life on their own terms.

On weekends, I occasionally join them for errands, and I often catch them meticulously checking grocery receipts, ensuring they weren't overcharged. It’s tempting to believe their wealth stems from this kind of frugality. But I remind myself that many struggling individuals also scrutinize their bills — they’re not millionaires yet.

This situation illuminated a vital lesson I took years to grasp: while being attentive to spending is crucial, it’s not the root of wealth creation. True financial growth comes from launching businesses and making strategic investments. Frugality is merely a stepping stone toward a more significant financial journey.

Why Investing Doesn’t Get Enough Credit

In the realm of personal finance, there's an overwhelming emphasis on saving. While it's undoubtedly important, this focus often overshadows the critical aspect of earning more.

Increasing your income — while keeping your expenses stable — is one of the most effective strategies to grow your net worth. Unfortunately, this approach is frequently overlooked, and here are a few reasons why this might be the case:

• Low-Hanging Fruit: It’s easier to cut a small expense, like a $35 cable bill, than to initiate a side hustle or purchase rental property that could generate an extra $800 monthly.
• Simplicity: Simple frugal habits, like cooking at home, are easy to grasp, while more complex financial topics, such as understanding mortgages, tend to receive less attention.
• Accessibility: Many find it easier to believe they can save money by shopping wisely rather than taking the leap to start a business, which requires more confidence and carries more risk.
• Instant Gratification: Small savings, like snagging a good deal, provide immediate satisfaction, while the rewards of investing take time to materialize.

The takeaway here isn’t to abandon frugality altogether; rather, it should be viewed as the initial step that can help seed your future investments and businesses, leading to long-term wealth creation.

Understanding the Different Types of Investments

Investments typically fall into three main categories:

1. Owner: In this category, you own assets like stocks, businesses, or real estate. Your wealth grows from the performance of these assets.
2. Lender: Here, you act as a lender through instruments like bonds or peer-to-peer lending, where you earn from the interest spread.
3. Holder: This includes low-risk options like CDs and savings accounts. The goal is often to maintain the value of your capital, but real growth may be elusive.

This article will primarily focus on investments where you are the owner, as they typically offer greater potential for wealth accumulation.

Exploring the Three-Fund Portfolio

Let’s dive into the first investment strategy: the Three-Fund Portfolio. Before we get into the details, let's clarify some terms:

• Broad Market: Refers to the overall market, encompassing all major sectors and companies.
• Index Funds: These are funds that track a specific index, such as the S&P 500, giving you exposure to a wide range of stocks.

The Three-Fund Portfolio suggests allocating your investments across three broad market categories:

• U.S. stocks
• U.S. bonds
• International stocks

Initially, you could invest an equal third in each category. Over time, as market conditions fluctuate, your allocations will change. Therefore, it’s essential to rebalance your portfolio annually to maintain this structure.

As you approach retirement age (around 55-60), consider shifting your focus to a 50/50 split between U.S. stocks and bonds, which can help reduce risk as you start drawing from your investments.

Extra Strategy: The 110 Minus Your Age Rule

If you’re looking for a slightly more tailored approach, consider the “110 minus your age” strategy. This formula helps determine the percentage of your portfolio that should be invested in stocks:

• For example, if you’re 30 years old: 80% in stocks (56% U.S. stocks and 24% international stocks) and 20% in bonds.

Feel free to adjust the formula based on your risk tolerance — for a more aggressive approach, use “120 minus your age,” or for a more conservative strategy, use “100 minus your age.”

Implementing the Five-Fund Portfolio

Building upon the previous strategy, the Five-Fund Portfolio diversifies your investments even more by incorporating five categories of index funds:

• 20% U.S. large-cap stocks
• 20% U.S. small-cap stocks
• 20% International emerging markets
• 20% International developed markets
• 20% U.S. bonds

This strategy allows for broader exposure across various market segments. If you want to sprinkle in some fun investments, you can allocate a small percentage (around 10%) to alternative ventures, adjusting the other categories accordingly.

To keep track of your investments and portfolio performance, consider using Personal Capital. It offers a comprehensive view of your financial landscape, including your investment allocation.

Investing in Real Estate

Real estate can be an excellent avenue for building wealth, but it’s crucial to focus your efforts. Choose a specific niche and a strategy that aligns with your goals:

• Niches: These could include residential, retail, apartments, office spaces, notes, or Real Estate Investment Trusts (REITs).
• Strategies: Options include rentals, flipping properties, or wholesaling.

My personal focus has been on generating passive income through rental properties. The approach simplifies to acquiring properties, renovating them, and subsequently hiring a property manager to handle operations, allowing me to enjoy the profit while paying down the mortgage or investing in more properties.

Launching Your Own Business

Interestingly, many entrepreneurs don’t consider their ventures as investments. However, owning a business can be one of the most impactful forms of investment. Here are two primary business types:

• Lifestyle Businesses: These businesses prioritize personal freedom and flexibility. If you enjoy being your own boss and prefer a smaller scale, this could be your path.
• Growth Businesses: Aiming for significant expansion, these businesses are designed for scalability, possibly leading to acquisition or going public.

Deciding between the two depends on your personal goals and the level of ambition you wish to pursue.

Your Next Steps in Investing

So, how do you incorporate these strategies into your life? Here’s a simple challenge:

#1: Choose one investment method from our discussion. Whether it’s a portfolio strategy, real estate, or launching a business, find what resonates with you.

#2: Identify the smallest actionable step to get started. This could mean setting up a website for your business or researching real estate markets.

#3: Set a deadline for this small step. Will it be within two days, or perhaps five?

#4: Take action.

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