How to accumulate wealth for a young person

“The biggest thing for your financial future is in yourself.”    Warren Buffet

“Mr. Chong, I am a young graduate and just started work. How can I accumulate a million Ringgit in today’s money when I retire in 40 years’ time?”

We usually think that wealth is built through money management, but more important is the management of another sort of capital—namely, the education, training, skills and experience that an individual brings to the workplace.

Human capital

Their ability to trade the human capital in you for goods and increase your earnings over the lifetimes will be critical to your financial survival, if not your success. Without the human capital and the rewards from it, one simply doesn’t have the financial capital to invest and grow his investment over time. None other return is more predictable as from the human capital, and from there you get the financial capital to advance in other returns. Utilize the human capital in you, focus on your career, do the best you can in your job, advance your career.

Notice I mentioned about human capital in you? That also includes other skills you acquire, such as some street smart investment skills and knowledge. Learn not only how to increase your return on investment in a less risky manner, and most of all, how you can avoid losing big time in the stock market.

Tis goeth down to a fundamental aspect that “An investment in knowledge pays the best interest”

For those who wish to learn about the fundamnetals of investing, you can contact me at

ckc14invest@gmail.com

Spend within your means

Few youngsters who are working now have any saving at all. Instead many could be carrying some debts; credit cards debts, student loans, car loan, personal loans from banks etc., all because of spend money on the unnecessary items, expensive cars, unearned holidays, expensive clothes, frequent eat out in expensive restaurants, pubs and cafes etc.

I personally do not advocate living like a pauper, taking advantage of others when eating out together, not giving a token money to your parents every month, not have a nice meal in a nice restaurant once a while with your girlfriend etc., but live within your means. Spending RM12 for a coffee in Starbuck, instead of a RM2 kopi in a coffee shop, every day, would be a waste of money. Spending RM30 for a nasi lemak, mee rebus, chicken rice etc. every day in a restaurant in Bangsar Shopping Centre will also be a waste of money. Drive a RM30000 second hand and low maintenance car such as Myvi instead of a new high maintenance RM250000 Volkswagen. Don’t buy every newest model of iPhone.

For this, I have a book to recommend you to read, that is “The Richest Man in Babylon" by George S. Clason. It shows how rich people lead their life within their means, save and accumulated huge amount of wealth.

The Magic of Compound Interest

“Start saving now”. Those are the three most powerful words in personal finance. Learn to pay yourself first by socking some saving each month before expenses, not save what is left after all expenses. If you start saving $5000 a year starting at age 24 now, or less than 20% of the salary of a young graduate, and increase your saving every year by 4% when your salary increases, and earning 10% compound annual returns, you would have saved $100k in just slightly over 10 years. If you continue to do that, by the time you retire at 60, you would have saved $2.2 million. But wait until age 45 to start saving for that $2.2m and you'd need to sock away $60,000 a year. This is what Albert Einstein said:

“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

With the growing Employee Provident Fund contributions, your total retirement sum can to a handsome $4 to 5 million when you retire, which will meet your retirement goal of accumulating RM1m in today's money.

How to compound your saving at 10% a year? It is definitely not from putting you money in the bank.

“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”  - Robert G. Allen

Invest in business, good business

Use whatever small saving you have and invest wisely and give the time for compounding to work. You may have a better chance investing in a business to earn a return of 10% a year, or rather part of a business in the shares of a good public listed company. In investing, I have shown that the only reliable way to do earn that kind of return consistently is through value investing as shown in the US here:

http://klse.i3investor.com/blogs/kcchongnz/75910.jsp

And locally in Bursa Malaysia here:

http://klse.i3investor.com/blogs/kcchongnz/76066.jsp

http://klse.i3investor.com/blogs/kcchongnz/75985.jsp

http://klse.i3investor.com/blogs/kcchongnz/75962.jsp

http://klse.i3investor.com/blogs/kcchongnz/75946.jsp

All the above investment strategies provide good and consistent return this few years, and it is likely it will continue to do so in the long-term. But in investing, it is equally important to avoid big losses during economic downturn. This is easy. Once you have learned the language of the business, how to interpret financial statements and to do some valuations, coupled with some experience, it is very easy to avoid lemons.  With that half of your investing battle is won.

Do not be greedy

I remember watching a video on Warren Buffet’s advice to young people a few days ago. He specially mentioned three things as below:

1. When something seems too good to be true, it probably is.
2. When someone try to sell you something like a financial product, find out how much he earns selling it to you.
3. Avoid using margin financing

Is there any tooth fairy?

Some years ago a good friend of mine asked me to “invest” in this thingy called Swiss Cash through internet with an impressive website. Investors could make 25% a month return, guaranteed. He said his good friend had made it for few hundred percent return for the past years already. My friend withdrew all his EPF money, plus the saving he had, and put in everything there. He also get his wife and daughter to invest in it. So he kept on telling me not to miss this opportunity. I told him the first point above, and he didn’t take heed. Sure enough, he made 25%, first month and then the second month. He kept on telling me to follow him to invest as it was proven that he could make so much money. But I just told him off that “when everyone makes money and I don’t, it is ok”. After that he couldn’t get into the website anymore. The rest is history.

Just delete off if you receive a message that you have won a $100000 reward. Don’t bother to read further. It is 99% true that “when something seems too good to be true, it probably is”. Don’t get greedy. There is no free lunch in this world.

Put down your phone when the other side keeps on telling you to buy this stock, or whatever investment which would double in a year. It won’t happen.

What is your cost?

I joined an “independent” financial planning company with the most number of qualified and licensed advisors in Malaysia some years ago. Every time the talk in the office was about how to sell the products and services with the highest commissions. One product call Dominion Fund, a leveraged fund was for high net worth individuals with minimum investment of RM100000 a unit which I have talked about in this link here:

 http://klse.i3investor.com/blogs/kcchongnz/44344.jsp

The commission a representative get for successful selling of this fund was 10%, not sure how much the company will receive. The fund has to pay fees for some insurance companies for the investments managed by them, and there are of course management expenses in managing the fund. So with all these layers of fees, how much profit, if any, would be left for the investors? Go figure out. The fund collapsed and all investments there became worthless when the US Sub-prime crisis strike in 2008 and investors were left with nothing.  

Cost is one of the very important factors in investing; how much you are charged by the product seller. Find out how much they earn from you.

Also read about how costs of other investment affects your return in the link below:

http://klse.i3investor.com/blogs/kcchongnz/75376.jsp

Last but not least is my favourite topic of margin financing.

Leverage in investing

A company can take up loans to do business and that is normal. Using other people’s money, OPM, to make more money is a norm for public listed company. I have deliberated this in a comment in a V.S threads using Scientex as an example on how management cleverly made use of OPM for its business and made bountiful return for its shareholders.

 For individual investors, you goal in wealth accumulation must go back to basic; save money from the income you earn, only invest when you have extra money which you can keep there for years, and most of all avoid using margin finance or borrow to invest. I have deliberated this in the links below:

http://klse.i3investor.com/blogs/kcchongnz/44344.jsp

http://klse.i3investor.com/blogs/kcchongnz/61822.jsp

There are a number of problems when you do that. For one you have to pay the investment banks a couple of fees, first a 0.5% to 1% set up cost which will be immediately taken away from you before investing, and about 5% interest charges every year. In an unexpected down market and if you just earn 3% from the money you have from the stock market, it is certainly alright, but not if you use say 50% margin, as the money you make may not be sufficient enough to pay interest charges and other cost. Hence you will need to make more than 3%, before costs is deducted, just to break even. Hence, with margin finance, you would have the urge to ty to search for riskier companies to invest in for a higher expected return.

This is alright if the stock market continue to rise. But have you seen the market continue rising without corrections, or even huge drop, 30%, or more? Please read my articles in i3investors on the rise and fall of the stock market in Malaysia since 1970s to 2008. There were numerous periods when the broad index has dropped by more than 30%, or even 50% in a short time.

If the portfolio of your shares drops by say 50% due to market volatility, whatever you have in your share investment evaporates, plus you still owe the bank some money, not to mention the constant mental harrassment from the investment banks to ask you to top up your margin. When you think of getting rich fast, you will do funny things and subject to a lot of unnecessary risk which can destroy you, and it is extremely hard for you to recover.

You may have heard some people may make a lot of money when they make a right call and their return was greatly amplified by margin. Listen to what Nassim Taleb said:

“Clearly my way of judging matters is probabilistic in nature; it relies on the notion of what could have probably happened… If we have heard of [history’s great generals and investors], it is simply because they took considerable risks, along with thousands of others, and happened to win. They were intelligent, courageous, noble (at times), had the highest possible obtainable culture in their day – but do did thousands of others who live in the musty footnotes of history:”

Do you think you are the chosen one who would beat the rest in the market and earn exceptional extra-ordinary return just by listening to rumours and tips? Please read the research on the performance of individual investor in the link below here:

http://klse.i3investor.com/blogs/kcchongnz/75376.jsp

You need to be the top 5% of super lucky investors to be able to just match the market return of about 10% in the long-term.

Also listen to a couple of super investors sharing their advice in this topic here.

“I've seen more people fail because of leverage—leverage being borrowed money. You really don't need leverage in this world much. If you're smart, you're going to make a lot of money without borrowing.” Warren Buffet

“Debt is Evil. Stay away from all forms of leverage. Don’t assume a maturing loan can be rolled over since you have no idea what the capital markets will do”. Seth Klarman

And here are what the religious people say:

“The Lord will open to you his good treasury, the heavens, to give the rain to your land in its season and to bless all the work of your hands. And you shall lend to many nations, but you shall not borrow.” Deuteronomy 28:12

“The taking of a loan is not something that a respectable individual would do without necessity, to create a burden upon themselves. When it is a necessity, then people should seek to assist their relatives and Muslim brothers, according to one’s capability.” Muslim teaching.

“Rivers can sometimes fill their banks, but the wants of human beings can never be filled.” – The Buddha

It is perfectly alright if you were to borrow money to buy a roof over your head. That you must do as a mean of building wealth and maintain a family. But there is a big difference from borrowing to invest. You will generally live in your house for many years. You are not going to sell it in a year just because it has gone up in price by 30%. Banks will not chase you for money because the house price has gone down by 30% as long as you can continue to pay the installment. They are completely two different investments.

With that, I wish you good luck.

K C Chong CFP

(27^th May 2015)