"The single most important variable in the quest for equity investment success is also the only variable you ultimately control: your own behavior."
A quick note before proceeding with the strategy explained below.
a. You should have life and disability insurance to insure against the loss of your earning power which funds your wealth building.
b. You should pay off any high-interest debt such as credit card debt.
There are four key behaviors:
1. Setting specific goals using dollars and dates on the calendar.
'A vacation house someday..." doesn't cut it. Delineate a specific dollar figure per year starting at the age you’d like to retire at then account for 3% per year to keep up with inflation. Based on this number you can calculate the lump you'll need at the beginning of retirement. Knowing how much you have now and how much time you have until retirement you can calculate how much money you must invest every month to get there.
A financial planner is helpful with these calculations and there are simple online retirement calculators as well. Not sure how much you will need per year in retirement? Me neither. The good news is that as physicians we make above-average salaries therefore "save as much as you can" is likely to put you in a good place for when you are ready to make specific calculations. This is my current strategy.
2. Establishing a plan to achieve your goals.
Once you have calculated the contribution required to meet your goal it is imperative that you commit to this as your most important monthly bill. It cannot be achieved in lump-sum amounts i.e. with yearly bonuses. It must be performed with regular frequency- monthly.
Now is a good time to discuss if your plan needs adjustment along the way. What if in year four you find that your returns have been less than you calculated to meet your goals? You can continue the plan as is and trust that over time your earnings will approximate the long term average. You could also increase your monthly investment. If you are under performing as you approach retirement you can work a little bit longer, even if it's part time. You could also decrease the withdrawals you are planning on in early retirement.
Please note two things here.
1. A financial planner is invaluable for helping you model different scenarios as you problem solve.
2. The actions you may take are all behaviors you can control. Fund performance is not.
"It's never about what markets do. It's never about what your funds do. It's always about what you do."
3. Dollar cost averaging. (Investing the same dollar amount at regular intervals)
When you invest the same amount every month your money buys more and more shares as the price drops and conversely less shares as the price rises. You are buying the largest number of shares precisely at panic-stricken market bottoms while your monthly contribution buys the fewest shares at irrational market tops. Dollar cost averaging abandons any attempt at timing the markets and blindly applies the exact same amount every month. Your reward? A below average cost per share that a successful market timer dreams of but cannot reliably deliver.
Now that we see how our monthly contribution buys more shares when prices are low, consider this
"It is irrational in the extreme for someone who is not finished buying yet to want the market to go up."
As well, the more violent the ups and downs (volatility) the better dollar cost averaging works.
The author points out that if you receive a lump sum such as a rollover, bonus or settlement you do not dollar cost average this. You invest it all at once. Having the money in-hand but dollar cost averaging is a form of market timing "...against very long odds" and emotions, not exclusively rational thought, is at play here.
4. Using a systematic withdrawal from your portfolio to meet your retirement income needs.
The author recommends a 5% withdrawal rate. This is the percent of your retirement principal you would withdraw per year to live on. Although this math has merit, new research suggests a flexible withdrawal rate may be more beneficial for some retirees.
I believe a personal calculation made with a financial planner and tailored to one's goals and specific situation may lead to a better outcome. I do not feel strongly about a one-size-fits-all withdrawal rate but the message is this- You should calculate a withdrawal rate which allows you to enjoy your retirement while simultaneously harnessing the power of equities to ensure you never run out of money.
If and when a retiree encounters a bear market they may stop selling equities (at depressed prices) and use the cash reserves they have diligently saved. This buys time for the equities to recover in value.
This completes my summary of Nick Murray's book and I hope you've come away with a better understanding of reliable wealth building. Please share with those who you believe would benefit.
Thanks for reading!