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Financial Freedom: Building the bankroll, part 2

We’ve seen that a key part to underwriting Bumhood is living below your means and using the resulting extra cash from income to build savings.

The corollary to this important principle is that your money needs to work for you. That means it has to earn money instead of you having to go to work to earn a paycheck.

How to make this happen? Invest. Your strategy should not be excessively conservative, because truly safe, FDIC-insured instruments such as high-interest savings accounts and CDs don’t return enough to keep up with inflation. Although clearly some cash should reside in your bank or credit union, where it will be insulated from a major market crash such as the one we recently saw, to grow your money you have to take some risk. This means investing something in the stock market or (yes!) in real estate.

Investment plans that work to support bumhood are long-haul arrangements.* Savings should be invested for the long term in reasonably stable instruments such as fairly staid mutual funds and left there, even when the market slides. Low-overhead mutual funds are an excellent choice, because the various costs involved in maintaining them do not bite significantly into your gains. Vanguard and Fidelity funds lead the pack here.

Some mutual funds buy stocks; others buy bonds; still others are balanced funds with a variety of investments. Read the prospectus for each fund that interests you, and be sure your choices don’t duplicate each other. Most advisers suggest that equities investments be allocated about 60 percent to stocks and about 40 percent to bonds, because as a general rule when stock values fall bond values rise. (This is a huge oversimplification, as I’m sure we’ll hear from readers. Study up on investment products. Several “For Dummies” books on the subject have good to excellent reviews, and regular reading of the Wall Street Journal and the New York Times business section can be instructive.)

Stocks and bonds are not the only places to grow savings. Some people have done well investing in rental real estate. This also is a long-term hold: expect to keep the property for 10 to 20 years before it turns a profit. As we’ve seen, for investors real estate presents no less risk than the stock market, and so you  need to be prepared to watch values go up and down. A quick perusal of Amazon’s offerings on real estate investment will clue you to the amount of snake oil out there: be extremely careful, and do not operate without a trusted adviser who can prove his (or her) expertise. As with the stock market, it’s important to do your homework and know what you’re doing before investing. If real estate interests you but the prospect of dealing with renters does not, consider a real estate investment trust (REIT) or an REIT mutual fund. Sometimes limited partnerships invest in commercial real estate, although this tool is probably not for everyone.

Because money sitting in the bank does nothing for you—it just sits there—it’s crucial to put your savings to work by investing in a diversified set of financial instruments, ranging from the relatively safe (CDs, the money market) to relatively risky. The degree of risk depends on your age (i.e., how many years you have left to make up any losses) and your personality. To make money work for you, you’ll need to take some risk with some part of your savings. But as you draw closer to your projected escape from the day job, it makes sense to pull back from riskier investments and shift funds to more conservative tools.

One way or another, at any age your savings should be working for you, and some part of it should be in stocks or instruments that earn similar returns. Over the years, my savings have returned about 8 to 9 percent, on average. Of course, that faltered when the Bush economy crashed. While the artificially pumped-up economy was hot, some months I would earn $8,000 on a $250,000 investment. Although all that went away when the market collapsed, returns are now back up in the 8 percent range.

Thus if I draw down the widely recommended 4 percent—more than I need to live on, as a matter of fact—savings will continue to grow even without my adding any  new cash.

And voilà! Full-blown financial freedom: Return on passive investments that meets or exceeds the amount you need to support yourself. The less you spend on your lifestyle, the more you can save, the more you can invest, and the sooner you can get off the day-job treadmill. Living below your means, faithful, regular saving, and wise investments can spring you free sooner than you think.

The Financial Freedom Series

An Overview
Education
Work
Debt
The Health Insurance Hurdle
Own Your Roof
Bankrolling Bumhood, Part 1

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* I am not an investment adviser! I am just a writer sitting in front of a computer. No part of this information should be taken as investment advice. For advice on financial planning, consult a tax professional and a certified financial planner. Always read all prospectuses and related information before investing in any stock, bond, or mutual fund.

3 thoughts on “Financial Freedom: Building the bankroll, part 2”

  1. Like you, I have been saving/investing for a long time. I must say that I lack your confidence about a return to “normal-ish” returns. My growth funds are still down over a 10 year period!

    Meanwhile, the banks are making pots of money becuase they can borrow near zero and lend at–well more than that. And the savers can’t get any return on their money.

    I hope you are right, Funny.

  2. Yes, mine are still down from where I think they should be. I see that as a repercussion of the crash, and I think the hangover will be with us for quite a while. I don’t expect my investments to recover their former glory (or at least a healthy glow) for at least another two to three years.

    Consequently, except for the small drawdown from my 403(b) I’m required to take to convince the State of Arizona that I’m “retired” (so as to make the bureaucrats cough up my accrued sick leave pay), I’m trying to leave savings alone in spite of being “retired.” Social Security makes it possible to live on part-time pay. I’m hoping to do that for the next three or years, barring any serious health problems.

    However, I do feel some confidence that the nest egg will go back to something close to what I think is a respectable figure. In February my big IRA (which is outside the employer plan) earned $6,156. It won’t have to do that every month (assuming it doesn’t decide to lose $6,000 now and again…) for the bottom line to return to normal over the next couple of years.

  3. For me, the question isn’t whether the stock market will produce good earnings over the next few years (I’m fairly confident it will), so much as whether I will have the good sense and discipline to get out, at least partially, before the next bubble induced crash. (Of course, if that happens, it will be the first time in the 35+ years I’ve been investing in the stock market that I manage to do it.)

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