JL Collins

The Simple Path To Wealth

The soul of simplicity to financial freedom boils down to the big three: you avoided debt; you spend less than you earn, and you invested the surplus. There is more. Invest in the low-cost index fund – VTSAX. 

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The Simple Path to Wealth book cover

Book Notes

“You know if you could learn how to cater to the king, you wouldn’t have to live on rice and beans”, said the Minister.
 
The monk replied, “If you could learn how to live on rice and beans, you wouldn’t have to cater to the king.”
 
 

Debt, the unacceptable burden

If you intend to achieve financial freedom, you have to start thinking differently. It starts by thinking that debt is not normal. It should be recognized as this vicious, destroyer of wealth-building potential it truly is. It has no place in your financial life.
 
 
The Downsides of Debt:
 
a. Your lifestyle is diminished. 
b. You’re enslaved to whatever source of income you have.
c. Your stress level is high.
d. You endure the same type of negative emotions felt by any addict – shame, guilt, loneliness. 
e. Your options are so narrowed and stress level so high that you risk turning into self-destructive behavior. It’s a dangerous cycle.
f. Your debt turns your attention on your past.
g. Your brain tends to shut down on the subject with a vague hope that it will magically resolve later.
 
Debt is the single most dangerous obstacle in building wealth.
 
How to Get Rid of Your Debt:
  1. Make a list of all your debts.
  2. Eliminate all non-essential spending. 
  3. Rank your debts by interest rate.
  4. Pay the minimum required on all your debts and focus on your money to paying the highest interest rate first.
 
Things I would not do while paying down debt:
  1. I would not pay a service to help.
  2. I would not worry about trying to consolidate my loans, not even for a lower interest rate.
  3. I would not pay the smaller loans first for a psychological boost. 
 
 
How to Think about Money
  1. It’s not just about spending.
  2. Start thinking about what your money can earn, not what your money can buy.
  3. Consider the opportunity costs. This is simply what you give up when you use that money for something, say a car, over an investment.
 
The magic of compounding in short is the money you save earns interest. The interest then earns interest as well. Like a snowball, it starts small. Think of the opportunity cost as its evil twin. The power of compounding is greater than the opportunity cost of what you spend.
 
Once you have your F-You money, all you need to do is make sure you continue to reinvest to outpace inflation and to keep your spending below the level your stash can replenish. If you are not yet financially independent, and you see this as an attractive goal, you will be well-served to look at your spending through the prism of opportunity cost. 
 
 
 

Investing in a raging bull or bear market

  1. It is not possible to time the market.
  2. The market is the most powerful wealth-building tool of all time.
  3. The market always goes up and its always a wild and rocky ride along the way.
  4. Since we can’t predict the swings, we need to toughen up mentally and ride them out. 
  5. I want my money to work as hard as possible and as soon as possible.
 
 

The market always goes up

Through disaster after disaster, the market always makes its way higher over time. It’s a wild ride along the way. There is a big ugly event. 
 
To understand why the market always goes up, we need to look at what the market actually is. When you buy a stock in a company, you own a piece of that business. The stock market is made up of all the companies that are publicly traded. 
 
The CRSP US Total Market Index – it is an index of virtually all the publicly traded companies in the US. It is the index Vanguard currently uses to model their total stock market index fund, VTSAX. By design, they are precisely the same. 
 
VTSAX owns about 3700 companies (this will vary). Owning a piece of VTSAX means owning a piece of this businesses. 
 
 
Why it always goes up:
The stock market is always self-cleansing. Owning stock is owning a part of living, breathing dynamic companies each striving to succeed. 
 
 
Why most people lose money in the stock market
  1. We think we can time the market. 
  2. We believe we can pick individual stocks. 
  3. We believe we can pick winning mutual fund managers.
 
 

Portfolio ideas to build and keep your wealth

 
There are only two portfolios:
 
  1. The Wealth Accumulation Portfolio 
Keep adding to the pot and let it ride. Put all your eggs in one basket and forget about it.   Add as much as you can along the way. The more you add, the faster you get there.
 
Here’s the basket – VTSAX 100%
 
You’ll be owning about 3700 publicly traded companies. The fact that this is a low-cost index fund means you are making your money work hard for you. Stocks provide the best performance over time. 
 
 
  1. Wealth Preservation Portfolio
Add another index fund. Enter the world of asset allocation. We are going to decide how much we allocate to each, once a year. A portfolio of 100% stocks is considered very aggressive, is rewarded with top long term results, yet very volatile. 
 
75% stocks – VTSAX 
20% bonds – VVTLX Vanguard Total Bond Market Index Fund – Bonds help smooth the ride
5% cash – Holding in the local bank
 
 
Life is balance and choice. Add a little more of this, lose a little more of that. Fiddling with your investments almost always lead to a poor result. 
 
 
 

TRFs: The simplest path to wealth of all

 
Target Retirement Funds 
 
Each of these TRF is known as a fund of funds. This means that the fund holds several other funds. Each with different investment objectives. In the case of Vanguard, the funds held are all low-cost index funds. The TRFs ranging from 2020 to 2060 each hold only four funds: Total Stock Market Index Fund, Total Bond Market Index Fund, Total International Stock Market Index Fund, Total International Bond Market Index Fund.
 
To those four funds, the TR2010, 2015, and 2020 funds add a short-term inflation-protected securities index fund. As the years roll by and the retirement date approaches, the funds will automatically adjust the balance held – becoming steadily conservative and less volatile over time. You need not do a thing. Expense ratios range from 0.14% to 1.6%, depending on the fund.  
 
If you decide to own TRFs, they are on the tax-advantaged bucket. If you want a portfolio as simple as possible and as effective, TRFs are for you. They have the simple path to wealth stamp of approval.
 
 
 

The 401K, 403B, TSP, IRA, and Roth Buckets

 

Which investments go into each bucket? 

 
There are two types of buckets:
 
  1. Ordinary buckets
This is where we hold investments that are not part of tax-advantaged plans. This is where we want to put investments that are already tax-efficient. Tax-efficient investments are typically stocks and mutual funds that pay qualified dividends, that is dividends received favorable tax treatment and avoid paying out taxable capital gains and distributions. Such distributions are typical of actively managed funds that engage id frequent trading in their portfolios.
 
VTSAX is a classic example of a tax-efficient investment. The dividends it pays are modest and most qualified. 
 
Investments that are tax-inefficient are those that pay interests, non-qualified dividends, and those that generate capital gains distributions. These are things like some stock funds, bonds, CDs, and REITS. These we want to keep ideally in our tax-advantaged buckets as their payouts are then tax-deferred.
 
 
  1. Tax-advantaged buckets
None of these tax-advantaged buckets eliminates your tax obligation. You only defer it. We are talking about when the tax is paid. 
 
Employer-based tax-advantaged buckets
 
401K, 403B
a. Contributions you make are deductible from the income you make for tax purposes
b. Taxes are due when you withdraw your money
c. Money withdrawn before the age of 59 and a half is subject to penalty. After age 70 and a half, your money is subject to RMDs.
 
Roth 401K
a. Contributions you make are not deductible from the income you make for tax purposes
b. All the earnings from this investment are tax-free
c. All withdrawals after age 59 and a half are tax-free
d. Once you reach age 70 and a half, RMDs take effect
e. There is no income limit from participating
 
TSP
These are retirement plans for federal employees including military personnel. Think of them as a 401k but better. Offers a nice, but not overwhelming selection of very low-cost index fund. 
 
Individually based tax-advantaged buckets 
 
IRAs
Buckets you hold on your own separate from employer-type sponsored plans. You can only fund this with earned income. This is an addition you can contribute. 
 
Three types of IRAs: 
a. Deductible IRA 
b. Non-deductible IRA 
c. Roth IRA 
 
 
Let’s look at our three investments:
 
Stocks – VTSAX currently pays around 2% dividend and most of the gains we see are in capital appreciation. It is tax-efficient. However, this is a large portion of our holding. So we will also hold it in our tax-advantaged buckets
 
Bonds – VVTLX 
 
Bonds pay interests. Other than tax-exempt municipal bonds, these go into the tax-advantaged bucket.
 
Cash is also all about interest.
 
 
The Soul of Simplicity
 
The more complex the investment is, the less likely it is to be profitable.
Index funds outperform actively managed funds simply because actively managed funds require active managers.
 
 
My Path for my Kid: First 10 Years
 
  1. Avoid debt. Nothing is worth paying interest to own.
  2. Avoid financially irresponsible people and certainly don’t marry one.
  3. Spend the next decade working your ass off, building your career and your reputation
  4. Think of your career as an expansive drone. The possibilities are endless.
  5. Think to the college you have honed and used them for new adventures.
  6. Don’t get trapped with an expanding lifestyle. Unwind it if you already are.
  7. Save and invest at least 50% of your income. Put this in VTSAX.
  8. Fund your 401k.
  9. Fund your ROTH IRA when income is low.
  10. Fund your Traditional IRA once your income begins to rise.
  11. Do this for the next 10 years or so and you’re well on your way to FI.
  12. Have more than 50% and you’ll get there sooner. Save less and it will take longer.
  13. If you get lucky with the market, the same as no. 12.
  14. Celebrate market drops. Each (when on wealth accumulating stage) dollar you invest will get you more market shares.
  15. Never think that someone can estimate this drop.
  16. Sometime in your early to mid-30s (or 10-15 years since you start), your career will surge and closing into FI.
  17. Once 40% of your assets can cover your expenses, consider yourself FI.
  18. Put another way, FI is 25x your annual expense.
  19. If 20k a year, you need 500k.
  20. If 4-8M a year, you’re going to need 120M.
  21. Controlling your needs as it is with building your assets.
  22. Once your FI, live on your investment.
  23. Decide or try something new once FI. If you keep working, invest 100% of your income. Live on your investments. 
 
 

Withdrawal Rates

 
How much can I spend anyway?
4%, maybe more
 
So you follow the simple path big three:
  1. You avoided debt.
  2. You spend less than you earn.
  3. You invested the surplus.
 
How do I pull my 4%?
 
You will have to choose your assets to pay the bill, rather than your labor. Your assets now equal to 25x your annual spending. 
 
Hold them as follows:
VVTLX in the IRA as it is tax-inefficient.
VTSAX in the Roth IRA because this is the last money I would spend. 
VTSAX also goes into the taxable account because it is more tax-efficient. Also holds in the regular IRAs. Hold it in Roth IRA, Regular IRA, and Taxable account.
 
The process couldn’t be much easier to transfer money anytime. 
 
 
The mechanics on how to withdraw the 4%:
 
Assuming you hold the assets with Vanguard:
a. Transfer a set amount of money from any of your investments to whatever set schedule you choose.
b. Transfer any capital gains or dividend distributions as interests are paid.
c. You can log into their website with a few clicks to transfer money anytime.
 
 
Guiding Principles on the approach:
a. First, in constructing the 75 and 25% allocation, we look at all of our funds combined regardless of where they are held.
b. We have all our dividends, interest, and capital gains distributions in tax-advantaged accounts reinvested.
c. We have the dividends and capital gains distributions from VTSAX in our taxable account sent directly to our checking account. Since the payment of these is a taxable event, it makes no sense to reinvest them only to turn around and withdraw these things shortly thereafter.
d. I want to let my tax-advantaged investments grow tax-deferred as long as possible.
e. As I’m within 10 years in 70 and a half, I want to move as much as I can from regular IRAS into Roths consistent with remaining in the 15% tax bracket. 
f. Once we hit age 70 and a half and are faced with RMDs, these will replace our taxable account, and the taxable account will be left to grow again. 
 
 
Pulling the 4% in action
  1. Think about the non-investment income we still have coming in. This earned money is what gets spend first. 
  2. Upon entering retirement, the assets that are in the taxable accounts that are ugliest are the first we spend down. 
  3. Once those are exhausted, we shift into withdrawing our taxable VTSAX accounts. Until 70 and a half.
  4. Each year I calculate what income we have, and consistent with the remaining 15% tax bracket, I shift as much as I can from our regular IRAs to our Roths. This in preparation for the RMDs coming up at age 70. When the time comes, I want our regular IRAs balances to be as low as possible.
  5. Once we reach 70 and a half we will stop withdrawing from our taxable account, and let it alone to continue to grow once more, and instead, we will start living in our RMDs that now must be pulled from our IRAs. 
  6. While I’m fairly certain the money in our taxable account will last until we reach 70 and a half, if it were to run out, we will simply withdraw from the IRAs ahead of the RMDs. 
  7. Despite my efforts to lower the amounts in our regular IRAs, the RMDs will likely exceed our spending needs. At this point, we will reinvest the excess into VTSAX into our taxable account.
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