Wealth Creation Advice for Your Children and Grandchildren

“You can either pretend to be rich now, or really be rich later, but not both.” In other words, frugality now is essential to building wealth. The key to obtaining great wealth is to first recognize that in most cases the return to capital is much greater than the return to labor. In fact, in some sense, the whole point of your career is to make the transition from getting your money from labor to getting your money from capital. Once you are generating a lot more wealth from your investments than from your work, you can retire comfortably and confidently.

Whether you are part of the poor getting poorer or the rich getting richer usually depends upon which side of the interest rate you are on. When the interest rate goes up, the poor say: “Oh, no. Now I will have to pay more.” while the rich say: “Oh, great. Now I will be getting a better return on my money.” But to invest, you need money to make money. Where does that money come from?

There are some investments that pay off big time. A college education is one of them. But that doesn’t mean that you should borrow excessively to go to college. Keep the expense down by getting tuition waivers, scholarships, and student-work arrangements. Going into debt should never be taken lightly. It is a major barrier to wealth creation. Avoid debt whenever you can. Debt is only to be taken on as a last resort when the payoff is clear.

Take public transportation, especially if it is subsidized or free as in Kansas City. If you must have a car, buy a dependable used car, and not a fancy new car. With a car, you need liability insurance, because it is often required by law, and you probably can’t afford to hire a gang of lawyers to defend yourself if you get sued. But if you have enough money to replace your rusty old car with another dependable rusty old car, you may not need collision insurance unless you are an especially poor driver. It is important to remember that insurance has to have a negative expected value. The odds have to be against you in a gambling casino. The house on average has to make money, which means you on average have to lose money. The same is true in insurance. Self-insurance is usually better on average than commercial insurance if you have enough money to self-insure.

The key to wealth creation is to appreciate the power and importance of compound interest. The number of years it takes to double your money after checking the box that says “Reinvest Dividends” is given as follow: Number of years = ln(2) / ln(1+(APY/100)) where “ln” refers to the natural logarithm and “APY” is the annual percentage yield of your investment including the value of the additional shares you obtained by reinvesting your dividends. For example, if APY=10 percent, then APY/100 = 0.10 so the number of years to double your money = ln(2)/ln(1.10) = 7.27254 or about seven and a quarter years. To calculate how many years it would take at 10 percent APY to grow your investment by a multiple of 10 use the formula: Number of years = ln(10)/ln(1.10) = 24.1588579 or just over twenty-four years before your investment reaches ten times its initial value. An investment of $10,000 becomes $100,000 in a little over 24 years, and $1,000,000 in just over 48 years. At that rate, an investment of just $10,000 at age 20 becomes more than $10,000,000 by age 93.  Young people who ignore the power of compound interest may be leaving a lot of money on the table.

But where do you get a good return on your money? For most people the answer is the stock market. As long as corporations keep emphasizing shareholder value with great dividends and stock buybacks that drives up their stock price, you can expect to get a good return over the long term. One conservative strategy is to simply invest in broad market exchange traded index funds with very low expense fees such as Schwab’s SCHB, Vanguard’s VTI, or iShares’ ITOT. When you get older you may want to transition to the corresponding broad market dividend funds. Purchasing shares in individual stocks sometimes amounts to gambling while investing in broad market funds tends to be less volatile and does not require the day-to-day attention to a particular stock’s performance.

Young people tend to think in terms of the next few weeks or the next few months and not so much in decades. Old people in their 80s and 90s have learned to think in terms of decades, but it is too late. Thinking long-term can pay off big time if you are young, and not so much if you are really old. In retirement my wife and I often go trash walking in the campus parking lots. Unfortunately, it is in the student parking lots where we often find (in addition to lots of trash) loose change — pennies, nickels, dimes, and quarters, and occasionally a few dollars. We hardly ever find money in the faculty-staff parking lots. 

When you and your friends eat at McDonalds, do you buy the big mac or the quarter pounder with cheese, or do you buy the chicken sandwich off the dollar menu? Being secretly rebellious can be fun. Don’t let them know that you are beating them at the frugality game. Take pride in being secretly “cheap.” Buy as little as possible and pay as little as possible for what you buy. Thinking longer term means not trying to impress your friends by buying the latest, most expensive gizmos or keeping up with the latest fashions but knowing that many years from now at your class reunion, you may be the wealthiest person in your graduating class.

( Important Note: The author takes no responsibility for any investment decisions, decisions regarding insurance, or other actions you may take in response to reading this column. The author is not a certified investment advisor. If you want specific investment advice, you need to contact a professional, certified investment advisor. )

As of May 1st, I-Bonds now offer 9.62 percent interest

Great news!!! As of May 1st, I-Bonds offer a 9.62 percent interest rate. But for most middle-class Americans, there is nothing here to celebrate. As currently structured, I-Bonds are not designed for lower or middle-class people.

I-Bonds were presumably created to try to get middle-class people to save more money and spend less. In theory I-Bonds should be especially helpful in times of inflation to reduce overall consumer demand as well as in recessions in providing savings to draw upon to keep consumer demand from falling too abruptly. The I-Bond savings limit of $10,000 per person was supposed to benefit the middle class without giving the wealthy another way of leveraging their wealth to further exacerbate economic inequality.

We all like to think of ourselves as being in the middle class. But remember that two-thirds of Americans do not have a college degree and forty percent of Americans could not come up with $400 in an emergency without having to borrow money. Most of the wealth of the sixty-six percent of Americans who own their own home is tied up in the value of that home. Still, getting people to save more money is a worthy goal.

However, the other features of an I-Bond limit its usefulness to the very people that I-Bonds were created to benefit.  Money invested in I-Bonds may not be withdrawn for one year. Money withdrawn after a year, but before five years, is subject to a loss of three months of interest payments. Wealthy people have very low marginal propensities to consume because giving them a little bit more or less money has virtually no effect on their spending patterns. However, poor and middle-class people have high marginal propensities to consume in that they adjust their spending up or down significantly as they get more or less money at the margin. Consequently, for I-Bonds to serve as an automatic stabilizer in times of inflation and recession, the poor and middle-class should be the primary beneficiaries of I-Bonds, but they are not.

The challenge is to design an attractive flexible investment that will work for poor and middle-class people and to make sure that they know about it and how to access it easily even if they are currently unbanked or underbanked.

People with little money need access to their money whenever an unexpected expense arises. For example, an automobile accident may require the repair or replacement of their vehicle. A medical problem may require unexpected expenditures. An unanticipated increase in rent may mean withdrawing money from savings while looking for a cheaper place to live. I-Bonds just don’t work well for people who would like to save more but can’t afford to tie up their money for extended periods.

Since most people in the middle-class are not familiar with the bond market anyway, they probably don’t know about I-Bonds to begin with so they may not feel left out of this opportunity to try to stay ahead of inflation.

Unfortunately, what at first appears to be a great wealth-building opportunity for the middle-class, turns out to be just another snack for the wealthy (or at least for those wealthy who want to bother with such a small amount of money ($10,000)).

Stock Market: Prudent Investment or Gambling Casino?

My father, Edward Cady Marsh, was a Wall Street investment banker. He took the train in to Wall Street each morning from Westfield, New Jersey and returned in the late afternoon. He specialized in industries such as the automobile industry, the steel industry, and the grocery industry. His compensation was based in part on his recommendations to the board, regardless of whether the board accepted and acted on his recommendations. As someone who lived through the stock market exuberance of the late 1920s and the crash and depression thereafter, he was very aware of the downside of stock market investing.

I learned early on that the profitability of a company was only one aspect to consider. The stock’s price was of equal importance. Overpaying for a very profitable company’s stock could be just as big a mistake as buying a cheap stock that had poor profitability prospects. Another factor that retail investors often overlook is the time horizon of stock market pricing. My own experience suggests that the typical stock is evaluated on a six month return basis. In other words, on average the market appears to be pricing stocks on the basis of how well they are expected to perform in six months. After the Great Recession the stock market bottomed out in March of 2009, but the economy took about six months before it was clearly heading up again.

If you get into a great stock too early, your investment may just flounder around rising and falling without much direction before it finally takes off, whenever that might be. Getting in to a good stock too early can be just as bad as getting in too late after its price to earnings ratio has reached unrealistic levels.

Another common mistake made by retail investors is sitting on too much cash and not investing for fear of short term losses. The general pattern of the stock market is to fluctuate up and down for some time and occasionally slip into a bear market, but, more importantly, suddenly move upward to establish a new level. It is these sudden upward moves, when you have too much of your investable funds in cash, that can make stock investing unprofitable. Many studies have pointed out that missing out on just of couple days of extraordinary gains in a very profitable year can eliminate most of the profit.

For the retail investor, investing in individual stocks can be very dangerous. Although most stocks tend to move up and down with the market over the short run, individual stocks can drop dramatically or move up unexpectedly. For the retail investor, investing in individual stocks is more akin to gambling that investing. As a retail investor, I have benefited from investing in broad market index funds with very low expense fees. Professional investors are much better positioned to determine which stocks are best to invest in at a particular price and time. However, sorting out the good professional investors from the bad and overcoming the fees charged by professional investors might not be worth the time and trouble. Index funds with low fees can sometimes be more cost effective and efficient than actively managed funds.

Clearly there are trends that may signal substantial increases in profitability going forward. A professional investor might consider whether the time is right to invest in stocks of companies producing lithium in anticipation of a big increase in the sales of electric vehicles that require lithium batteries. But what if there is a breakthrough in battery technology that replaces lithium with some other ingredient? In that case, the value of lithium stocks could drop dramatically.

Individualized medicine is another area ripe for expansion in coming years. Most of our doctors do not even have a sample of our DNA. Moreover, the randomized trials compare the average person’s response in the experimental condition with the average person’s response in the control condition to determine the statistical significance of the average person’s response to a drug or other medical intervention. But if the distribution is bimodal with half the people at one end and the other half at the other end, the average person may not exist. With more and more individualized data becoming more widely available, a professional investor may want to consider investing in companies with personalized medical data (e.g., DNA) that are able to zoom in to subsets of individuals sharing common characteristics to get closer to the uniqueness of an individual patient in order to provide individualized diagnosis and prognosis. For the retail investor these potential breakthroughs may introduce too much uncertainly and potential volatility but may be of interest to the professional investor.

Finally, one might consider the use of leveraged funds. Such funds provide multiples of the price movements of their corresponding indices either in the same direction (leveraged longs, UDOW) or in the opposite direction (leveraged shorts, SDOW). The opposite strategy would be to seek out the least volatile stock indices which tend to the ones that emphasize dividends. One approach might be to move from a broad based stock index fund into a fund emphasizing dividends when the stock market seems overextended in an irrational exuberance phase. If one is really into gambling, substituting broad-market leveraged shorts would be an alternative strategy at such times. On the other hand, when the stock prices have fallen significantly, one could move into broad-market leveraged longs, which could dramatically increase yields when (and if) the market recovers. Note that the expense ratios for these leveraged funds tend to be quite high and may be restricted to accredited investors.

In general, successful stock market investing requires being reasonably cautious and very patient. Most importantly, the investors style and strategy must match their personality. What works for one person may be entirely inappropriate for someone else. If you become distraught and tear your hair out when your portfolio’s value drops with a market decline, including a bear market that lasts for some time, then your style and strategy do not match your personality.

( Note none of the above commentary should be considered professional investment advice. This commentator does not accept any responsibility for losses incurred as a result of reading this commentary. Investors who want professional advice should seek out a professional investment advisor.)

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How to get on Bernie Sanders’ list of millionaires and billionaires

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You used to be able to afford a good retirement from a guaranteed pension earned on the job. In the decades following World War II there was a strong demand for workers in industrial jobs and the building trades. Unions were strong representing as much as 35 percent of our workforce. Unions had countered the power of companies to control block of jobs and drive down wages. By unionizing workers, wages moved back up closer to what would have been the equilibrium wage under free and fair competition. Under the Theory of the Second Best, union power countered company power to restore relatively efficient allocation of labor resources in our economy. Our economy’s productivity was rising and wages rose at about the same rate as productivity rose.

But then starting around 1975 all that changed. After the government brought in the military to break the air traffic controllers’ strike, unions began to decline. As revealed in “Optimal Money Flow” the second invisible hand of market power overcame Adam Smith’s first invisible hand of free and fair competition.  Union representation dropped to less than 10 percent of the workforce. Productivity continued to rise, but wages flattened out in real terms after adjusting for inflation. The money that would have gone to workers on Main Street was increasingly being diverted to the financial markets on Wall Street.

You are asking: What does this money flow distortion have to do with becoming really wealthy?  If you are already old, not much. But if you have young children or grandchildren, it is crucial to understanding the system, how it works, and how they could easily make a fortune over time.

It is hard to get rich the easy way (win the lottery), but easy to get rich the hard way (saving and investing every penny you can in the stock market). Capitalism won’t work very well for you if you don’t have any capital. But people have been discouraged from saving money because the flood of money into the financial markets has driven down interest rates. What is the point of saving money if you can’t earn much on your savings? The low interest rates have caused many people to go deep into debt with almost no savings at all. 

It is true that bonds and certificates of deposit, not to mention savings accounts, pay so little that it is hardly worth bothering with them. But what if you save every penny you can and put it into a broad-based stock index fund?  The difference is rather dramatic. With dividends and the rise in stock valuations, it is easy to average around 7 percent per year which allows you to double your money approximately every 10 years. Compound interest comes into play in using your wealth to build even more wealth all by itself. 

But won’t you feel guilty if you have millions of dollars while so many others are struggling to get by with many elderly having to taking jobs at hair salons or fast food joints to get by?  No doubt, you will. Bill Gates and Warren Buffett are suffering from this sense of guilt and have been giving away a lot of money through the Gates Foundation. You may suffer the same fate if you carefully and consistently follow the “get rich game plan” and actually become wealthy yourself.

As long as the wealthy cannot find more lucrative places to put all their ever increasing wealth, the stock market will continue to rise over time. This does not mean a smooth and continual increase in valuations. What is most interesting about the stock market is that it will fluctuate for a while or even drift upward or downward a bit, before making a sudden and unexpected move upward to a new higher trading range. What this means is that trying to play the ups and downs of the market is generally a fool’s errand. Just keep putting money in month after month, year after year regardless of where the market is at, and in the long run you will get an enormous return. 

What does this tell us about capitalism?  After all, in primitive times everything was thought to be owned by God so no one other than God owned anything. For native Americans, the spirit world owned everything. In reality, without the rule of law, the big guy owned everything. If you had a chicken, it was the big guy’s chicken. If you had a pear tree, those were the big guy’s pears. The King, the Pharaoh, the Emperor or the Czar then told us that God had granted them dominion over everything. You could not hunt deer in the forest or take fish from the stream without the approval of the King. 

The direct ownership of capital came about under John Locke’s conception of private property.  Locke’s idea was that you owned your own body so you could gain sweat equity over some resource from the woods by putting your work into cutting a tree branch into a spear and shaping a spear head from a stone. Your work with an object translated into the ownership of capital through sweat equity. This implied that hard work paid off. The incentives drove you to work harder to earn more capital. 

This worked great for a while as long as the craftsmen and craftswomen could afford to create their own tools which became their property as a result of their sweat equity in creating them and working with them. Land on the frontier in America became the farmer’s property through the sweat equity of working that land. But then bigger machines were needed that required more money to obtain than could be justified with one person’s sweat equity. The nobility or aristocracy stepped in to supply the water wheel or factory equipment. The ownership of capital then became separated from the sweat equity of using that capital. You could drive a truck for 40 years and gain no ownership stake in that truck or in the corporation that owned that truck no matter how hard you worked. The incentive structure broke down with no acquisition of capital through sweat equity.

What is the situation today?  You work hard in production, services, retail or delivery and earn no capital and get a rather modest return for your efforts. Those with capital (large portfolio of stocks) might spend a few minutes adjusting their stock portfolio each day, before heading out to the golf course. They are eager for you to work hard every day, so that their stocks will pay higher dividends and rise in value. After all, they have to be able to pay for their yacht, private jet or many vacation homes. Whether you are part of the rich getting richer or poor getting poorer really depends a lot on how little debt (if any) you have and how much stock (hopefully lots of stock) you own.    

This Excel Spreadsheet shows how your money grows.

To sign up for this monthly Money Flow Newsletter, go to:  https://optimal-money-flow.website/  Lawrence C. Marsh is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: “Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone.”   
You can donate the entire purchase price of the book to student scholarships by buying a printed hard-bound copy of the book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh  
For additional details see the Optimal Money Flow book website at:

or my 2018 paper presented at 2019 American Economic Association conference in Atlanta, GA:

The full purchase price ($24.95) will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh