Wednesday Wealth Recap

  • When investors wonder whether to buy a stock, insider buying is one of the best clues they can hope for. Alexander Green explains how to interpret this signal correctly.
  • It’s been a tough year. And now we may be in a market bubble. But it’s not all bad. As Nicholas Vardy notes, there’s more than one way to profit from a market downturn.
  • It’s spooky season. But that doesn’t mean your investing returns should be scary. Chief Trends Strategist Matthew Carr proves it with the top Halloween stocks to buy.

Making more income is the best way to build wealth. So long as you don’t spend it as fast as you make it.

In other words, the shortcut to getting wealthy quickly and efficiently is to…

  1. Increase your net investable income.
  2. Save the lion’s share of it.

What do I mean by “the lion’s share”? Between 70% and 90%, depending on how close you are to your Magic Number.

(Net investable income is my term for what you have after you deduct two asset classes from your net worth. One includes the money you have set aside in your “start-over fund” – cash, coins, etc. Another includes the value of your house and any other tangible assets, such as jewelry or family heirlooms, that you want to keep for the rest of your life.

Your Magic Number is the amount of money you need to have saved and invested in order to quit work and enjoy retirement. That is, a lump sum of money that can provide enough interest income to live off of.)

Most people don’t do this. As their income rises, so too does their spending. Some actually spend more than the extra money they make.

Why? Because having extra things – a bigger house, a newer car and assorted luxury toys – is what we’ve all been told wealth is about. We work hard to buy this stuff. And then we are happy. The more stuff we buy, the happier we are.

That’s true in Hollywoodland, but in real life the truth is very different. Spending more on “happy” stuff is a junkie’s habit: to get the same thrill (in this case, ego thrill), you need to take bigger hits.

I like to use Mike Tyson as an example. He had career earnings of more than $400 million. And yet, amazingly to me, he ended up tens of millions of dollars in debt. He accomplished this financial feat by spending his money on $2 million bathtubs, $3.4 million worth of clothes and jewelry, and two Bengal tigers that cost more than $10,000 per month to feed, train and insure. Iron Mike also made some bad “investments” and ran up a multimillion-dollar bill with the IRS.

Recently a friend sent me an article from Sports Chew that provided other amusing examples of out-of-control spending habits:

  • Vince Young’s rookie contract with the Tennessee Titans provided him with a $26 million paycheck. Like Tyson, he was brilliant at spending it. He has made dozens of crazy purchases, but one is typical of this mindset: He spent $22,000 of that money on a Southwest Airlines flight from Houston to Nashville. Why $22,000? Because he wanted some “alone time,” so he bought every seat on the plane.
  • After making many millions as an NBA ballplayer, Latrell Sprewell was offered a $21 million contract extension by the Minnesota Timberwolves. He said he was offended by the “lowball offer,” saying, “I have a family to feed.” They countered with another offer: zero.
  • Curt Schilling, a longtime pitcher for the Boston Red Sox, probably thought he was “investing” his money when he put his life savings, $50 million, into something called 38 Studios, a video game company. It promised to create titles to compete with EA Sports and Activision. His total return? Zero.
  • Terrell Owens has made about $80 million playing for the NFL, but today, according to reports, he is broke. Much of his income went to the usual things – mansions, luxury cars, big champagne bills – but a good deal of it went to “investing,” such as the $2 million he spent on a bingo hall, which violated NFL gambling policies and returned him nothing.

These are not isolated examples. In fact, according to Wyatt Investment Research, 78% of NFL players and 60% of NBA players file for bankruptcy within their first five years of retirement.

Lest you write this off as a “poor dumb jock” problem, consider this: The average American has more than $100,000 in total debt and less than $1,000 in savings.

There are several lessons to be drawn from this:

  • There is a natural tendency to spend more when you make more. If you want to become wealthy, you must be alert to this tendency in yourself and resist it.
  • It is also natural to want to reward yourself for earning more money, but how much you spend on that reward is unrelated to the psychological benefit it gives you.
  • Along the same vein, there is no relationship whatsoever between the worth of toys and how much you pay for them. A $300 watch can look as good and work as well as one that costs $3,000 or $30,000.
  • Speculative investing is a type of gambling. The guy who sells it to you will call it an investment, but don’t fool yourself. If you don’t understand the deal from the inside out, chances are you will lose 100% of your money.

Wealth acquisition, as I said in the beginning, has everything to do with increasing your net investable income and saving an increasingly larger percentage of it. When you boost your income, give yourself a reward. Buy or do something fun. But don’t spend more than a small fraction of that extra income. The rest you should put into savings.