The Elements of Investing: Part I

Pompeii, Italy

Burton G. Malkiel and Charles D. Ellis have written an amazingly simple and short book titled, The Elements of Investing.  This compact book hits on all cylinders of investing and the first one is the most important – SAVE.  This simply means, follow The Golden Rule of Investing.

A Charles Dicken’s character, Wilkins Micawber, came up with this basic law.

“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness.  Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

While saving is absolutely essential, there is an equally important part of the investing plan and that is timing.  Save as early as possible.  In the Golden Rule post William Bernstein points out the importance of getting started early.

Here is a little spreadsheet exercise.  Assume a 19-year old (shall we call him Gallant) is able to save two thousand dollars per year and does this for eight years.  The total investment is sixteen thousand dollars.  Further assume the portfolio grows at an annualized rate of 10%.  While this is nearly impossible, assume this is true for the sake of this argument.

Now assume Gallant’s first cousin, Goofus, started a tad later, say age 27 or just when Gallant stops saving.  Goofus also saves two thousand per year or the same as Gallant, only Goofus continues to put away two thousand per year until retiring at age 65.  65 – 27 = 38 so Goofus saved 38 x $2,000 or $76,000.  We also assume Goofus was able to match the same annual return of 10%.  Who has the larger portfolio when they retire at age 65?  That is the spreadsheet exercise for you to work out.

There are many ways to save.  One family friend came up with this creative method and that is to purchase sufficient stocks in a company to where the dividends cover expenses.  Example:  Work toward owning sufficient shares in Comcast to where the dividends cover your monthly Internet expenses.  Buy shares in Verizon to where the dividends will pay for the monthly cell phone costs.

Another suggestion is to always live on last year’s salary (assuming one receives salary increases) and save the difference.

Take full advantage of 401(k) or 403(b) plans if they are available.  Find you own ways to save and invest in the stock market.

If you feel incompetent when it comes to investing, select a Vanguard ETF such as VTI and put as much money as you can into that single security.  Or set up a Robo Advisor account with Schwab (free) as I’ve done with the Schrodinger portfolio.  Search Schrodinger on this blog for more information.

Live modestly and avoid credit card debt.  Pay off credit cards first if you currently have that kind of debt.  I recall a mid-western college prof telling his students, borrow money for two things – education and a house.  Pay cash for everything else.

There you have the first key element for getting started on the elements of investing.  Pick up a copy of the Malkiel-Ellis book.  Read and apply the simple concepts.  There are five short chapters and the first one is on saving.  Look for Part II here at ITA in the future.