Rules for Lazy Investors

I  could have titled this column "How to become a millionaire" and it wouldn't have been overstated, but many of you would have probably tuned out and just deleted it without even reading the message.  Smart people see that come-on as either a false promise or an outright scam.

Let me clear the air right up front... I cannot promise anyone that they will enjoy great wealth if they read this column and follow the instructions. In fact, I can tell you that I never have been, nor do I expect in the future to be, a millionaire.  However, had I known and practiced what I'm going to tell you shortly from the time I turned 18 and started my working life, I probably would have achieved that goal. 

This is no scam and you won't have to pay me anything; the advice is absolutely FREE. If you follow it, I can almost guarantee that you will, like me, never outlive your savings and have the freedom to keep crossing items off your bucket list.

Rule One: Start early

Begin saving something out of each paycheck from day one.  The amount is up to you, but try to make it at least 5%, five cents of every dollar you get.  Where you put that is also up to you, but try to make it grow both by your contributions and with some kind of internal interest or dividend.

Rule Two:  Live within your means

Limit your purchases to what you can afford to pay for in cash and to what you actually need, not what you want.  The only exceptions to this rule are the purchase of a home, furniture, and a car, but even they should be limited to needs instead of wants.  In other words, don't buy a steak when chicken will fill you up just as nicely.

Rule Three: Trust the power of compounding

Although bank accounts and  bank CDs are currently horrible ways to save, there are alternatives that can pay enough to make your savings grow.  Most have risk involved, but there are ways to minimize risk while maximizing gain.  The best I've found are the no-load index funds of some of the largest and well-known investment companies. No- load because none of the original money you put in is taken as a commission, and index fund because it tracks and invests in all the companies in a particular stock or bond index.

The Standard & Poor's 500 Index is one you may know of, and it has stocks of 500 companies in it, so the risk of some companies performing poorly is compensated for by the other companies doing well.  The risk is lowered by that measure, and the index almost always tracks upward.

I don't know that Albert Einstein said it, but the quote I use is, "there is no greater power than that of compound interest!"  An 18-year-old can put $300 a month into an IRA and with the power of compound interest at 10-percent can retire a millionaire.  However, if he or she starts at age 40, the amount necessary becomes over $1000 a month to get to that same amount.  And most of that million dollars comes from compound interest, as the 18-year old would only save $96,000, while the 40-year-old would have to put away $300,000.  That brings us back to rule one - start early.

Rule Four:  Take every withholding allowance on your W-4

This rule will show how to "find" that extra money for retirement to put into your savings, and for that reason, it is maybe the best rule of all.

The average tax refund for American taxpayers is about $3,000.  That means that after we either self-prepare or pay a tax consultant to figure our income tax due by April 15th, most of us receive a check or direct deposit of around $3,000.  It further means that most of us have overpaid our taxes by that amount, thereby giving our federal government an interest-free loan every single pay period.  What a horrible way to save!

If you are one of those who gets a tax refund every year - and many spend it immediately on non-essentials - here is where your money for retirement savings can be found.  It is very easy to request a W-4 at work, or you can even download one from the IRS Website. It will take you less than an hour to fill it out, taking every allowance you are entitled to, and turn it in to your payroll department or your boss.

Most businesses have a payroll provision to deduct a set amount or percentage from each paycheck to invest in the company 401(k). If yours doesn't have a 401(k) or some other tax-deferred savings plan, you can set up your own plan with an investment firm or even a bank.  Just make sure you don't get access to it without some effort on your part.  You'll be surprised at how easy it is to save, but don't expect huge returns at first.  This brings us to the next rule.

Rule five: Be patient and don't expect miracles

One of the pitfalls of investing in general and compound interest in particular is that the growth of funds takes time, and the rapid growth and large gains only come in the latter stages after the fund has gotten sizeable.  Too often, people lose their patience and decide that they need to do something different with the money.  That is almost always wrong.

The absolute best way to make it to your goal is to buy and hold.  Using the index funds I mentioned earlier, a manager or a group of managers does the buying for you and you just have to wait for the returns.  Managers are not day-traders and they don't take on a lot of risk, instead spreading out your money over many investments for good returns and leaving it to grow.  Even in downturns in the markets, most index funds suffer least and recover the fastest.

Regarding the power of compounding, if you have $100 in your account and it gains a 10% rate of interest, it will grow by about $10 in a year, and by $11 the following year. Once you get a larger amount, say $100,000, it will now grow by about $10,000 in a year, and $11,000 the following year.  In two years it will have grown by 21% to $121.000, even though the interest rate stayed at only 10%.  If you are adding to the fund at the same time, those amounts are even higher.  And if the interest is paid monthly instead of yearly,  it will be more than $121,000.  That is the power of compounding at work.

Here is a short example of patience and compounding paying off and it is my own experience, so I can vouch for it.  I started withdrawing from my IRA ten years ago to supplement my retirement and Social Security income.  Even so, my IRA fund has not only stayed even, it has actually grown over those ten years.  I now have more in the fund than I did when I started withdrawing a substantial monthly amount from it.  I don't think I will outlive my savings, even if I were to live to age 100.

There you have it.  There are only five simple rules to follow, but each one is as important as every other one.  Like I said, I cannot guarantee that you will become a millionaire (I didn't), but I can assure you that you can have a very comfortable and rewarding retirement and if you don't live all the way to retirement, you can at least leave a pretty good nest egg to your heirs.