Yesterday while discussing the cost of ownership I had to rein myself in from diverting onto investing versus working. As I mentioned my friend Paul has asked me a couple time whether I’m earnings more via investing than if I worked. I began to discuss two topics which I’ll now cover in some detail.

My Simple Path to Wealth

I’ve read copious wealth and self help books over the years. Not because I care about money, but because I wanted to make sure money was never something I had to care about. It all started with one sentence from my friend Penny. We were at this totally cool and weird party, Ivan in his codpiece splendor had finished singing and gyrating on the old bank counter. I’d love to share a photo, but I only have an ever lasting mental image…thanks for that Ivan!  Anyway, Penny said something along the lines of she was sure I’d be rich. Despite having no money, since I’d not long returned from a two month holiday in North and Central American and was still recovering from viral meningitis, I thought yeah she’s right.

As I was still to weak to work, I spent a lot of times pondering my future during those days and thinking about what Penny had said. I knew I loved Dino time (my time) and wanted to maximise that over my life. So I concentrated on how to achieve financial freedom as enjoyably, quickly and with as least risk as possible, with a goal to ultimately living where ever I wanted and working for others as little as I could. My goal is actually unimportant, the important thing is coming up with a goal. The first step to goal setting is getting to know yourself, what’s important to you and what you truly want out of life. My view is not many people take the time to do that. Perhaps I was lucky getting meningitis and almost dying. My recuperation provided me the time to sit and think, to ponder what was important to me and what I wanted. Contemplating your goals is the best time you’ll ever spend.

Step One: Write down a list of what’s important to you. Without that you’ve got little chance of ever being happy.

More broadly speaking anytime you have a major decision to make write down a list. Jot down all the pros and cons, give each a score of importance and then tot up the score. It’s amazing how this simple task clears the mind and makes difficult decisions easier. Despite knowing this and using it many times I still occasionally find myself wasting weeks fretting about a decision when in less than hour I could make the best decision using this simple strategy. Embrace the power of lists!

Step Two: Make a plan. I’ve mentioned this before, but plans are so important I’m happy to say it all again. While many financial advisors, commentators and bean counters focus on budgets and encourage people to draw up budgets I do not. That’s right screw that budget up right now! Budgets are like diets. They deny you the things you want and have a useless short term nature. I have no idea why people think budgets or diets will work. They don’t. You must associate good things with what you want to achieve. Positive things, which will inspire you. You must think and act and plan long term, budget and diets setup exactly the wrong patters. That is why planning and saving are so important, just as eating healthily and exercise are important if you want to loose weight.

Plans don’t need to be complicated. For many years I used simple bubble diagrams with a five year time frame. While the plan was all text and mainly figures, putting it inside six monthly bubbles along a timeline tricked my graphically oriented partner into thinking I was displaying her the plan, rather than just listing bullet points chock full of numbers. That was our big picture plan. A one page document with ten bubbles with 4-5 bullet points in each.

You need to work out what type of plan will most motivate you. I recommend a five year plan with six monthly targets as a starting point.

Step Three: Make it so. Once you know what you want and have a plan making it happen almost seems to take care of itself. Once again what I did is not really important, but I’ll quickly tell you in case you’re stuck as to where to start. My plan was very simple. I figured out how to maximise my income, how to save as much as possible of that income and how to invest it to achieve a good return. See I said it was simple. It may be more difficult to figure out how to maximise your income depending on you employment, but in most jobs all you have to do is open you eyes. Look around you and see who with your skills is earning more than you and how they’re doing it. For me that meant becoming a contractor.

None of this should seem daunting. I didn’t come up with the entire plan one day. It evolved over the years as I walked along my path. Once you know what you want and start planning you’ll enjoy it so much you’ll keep planning and thinking about what you want.

The only thing that has remained constant with me is time. I continue to enjoy Dino time. The most important point behind all of this is the topic of time. Make time your friend, make time work for you. The sooner you start on your path the better. One of the most important things I learnt about retirement is that it takes at least 15 years to achieve once you make retirement a goal. Sadly most people leave it way to late.You need to make sure time isn’t running away from you.

As I mentioned yesterday all of this becomes a lot easier if you understand and appreciate compounding. Nothing ever seems to happen in the first ten years of compounding on a forty year scale, on a graph the line barely moves above the starting point. However, you are laying the foundations and will see the results in the final ten years of those forty years. Take a look at the graph below for an example. You must focus on the last ten years, your plan’s outcome and not on the drudgery of your current budget, if you haven’t screwed it up already. Check out Wealth and Happiness and Is retirement running away from you? for more on this topic.

Investing vs Working

As I said yesterday, my short answer for Paul on whether I earn more from investing than I would by working is ‘absolutely not’. If I returned to business consulting I’d earn significantly more than I currently do by investing. The long answer is ‘absolutely yes’. Through investing I’ll earn significantly more.

The long answer is that I expect through my focus on investing and constant endeavour to improve my investing I will ultimately be better off financially and I’ll enjoy the trip along the way a lot more. I love investing as I’m a competitive A type freakazoid and investing pits my skills against some of the brightest people in the world. I enjoy investigating companies. It’s much more fun looking at companies from 1,000 feet and thinking about their future than trying to advise them on how to manage their projects, control their costs or capitalise their assets. Companies shape the future and getting to know them gives me visibility into the future, which is gold to a future thinker like me.

Investing lets me stay at home and be with my kids as they grow up. Though they’d probably argue investing keeps me glued to my computer! Investing lets me tend and enjoy my beloved garden, have a yummy dinner on the table each night and take holidays whenever I want. That’s the stuff I enjoy. Investing also lets me do other dull stuff like our shopping and laundry so we have all weekend to enjoy being a family. In short investing dramatically improves my own and my families quality of life.

Here some financial details assuming a starting fund of $1 million, 3% outperformance to an index returning 10% and net income of $60k available to be saved after accounting for tax and other expenses associated with work, like childcare, clothes, incidental expenses.

• After nine years you’ll be earning more from your outperformance that you would be from working.
• After eighteen years your gross wealth will be greater.
• After 45 years your wealth will be twice as much.

If the outperformance end up being 5% then those figure change to three years, six years and 28 years. An 8% outperformance, which would make you a superstar legend investor so you probably shouldn’t count on it, though many retail investors deludedly think that’s achievable, you’ll end up a multi-billionaire. Now I should say I’ve ignored tax in my calculations, but that wouldn’t affect the overall picture too much. [Update: I've now built tax into the spreadsheet and it does change the picture considerably. Investing doesn't come off as well, but still come out ahead.]

The money is pretty meaningless to me, but it’s a handy score keeper which I can ultimately use for my benefit and the benefit of things I care about. In fact I think investors who focus on the money are at a serious disadvantage and I laugh every time I see someone say, ‘just make money‘. Money is the root of fear and greed and they are two massive disadvantages to overcome.

The above graph starts with one million dollars at forty and uses a 3% outpeformance over an index. You can download the spreadsheet here and play around with it using figures meaningful to you. You may think it’s pretty useless, as it’s based on assumptions like $1M, being able to obtain 3% outpeformance and future income, but at the very least I hope it helps you understand the power of compounding.

If you enjoyed reading this you might enjoy one of my early posts from June 2008, Is retirement running away from you? There is a basic retirement calculator embedded in the post, which may be of interest to you. You may also like one of my favourite posts, Wealth and Happiness, and my first on this topic Your Money or Your Life.

As with everything I say, I describe what is right for me. It may not be right for you. Just as there are many paths in investing, there are many paths in life. I hope you’re on or find your path.

Related posts:

1. Investing and the Government
2. Inch Worm – Enjoy the Journey while Planning for the Future
3. Random Ramblings on Margin, Market Timing and Investing Secrets
4. Quick Thoughts on Becoming Wealthly
5. Is Retirement Running Away From You?
6. Wealth and Happiness