If You Can - How Millennials Can Get Rich Slowly : Bogleheads

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http://efficientfrontier.com/ef/0adhoc/ifyoucan.pdf

If You Can

How Millennials Can Get Rich Slowly

Would you believe me if I told you that there’s an investment strategy that a seven-year-old could understand, will take you fifteen minutes of work per year, outperform 90 percent of finance professionals in the long run, and make you a millionaire over time?

Well, it is true, and here it is: Start by saving 15 percent of your salary at age 25 into a 401(k) plan, an IRA, or a taxable account (or all three). Put equal amounts of that 15 percent into just three different mutual funds:

A U.S. total stock market index fund
An international total stock market index fund
A U.S. total bond market index fund.Over time, the three funds will grow at different rates, so once per year you’ll adjust their amounts so that they’re again equal. (That’s the fifteen minutes per year, assuming you’ve enrolled in an automatic savings plan.)That’s it; if you can follow this simple recipe throughout your working career, you will almost certainly beat out most professional investors. More importantly, you’ll likely accumulate enough savings to retire comfortably.But You’re Still ScrewedMost young people believe that Social Security won’t be there for them when they retire, and that this is a major reason why their retirements will not be as comfortable as their parents’. Rest assured that you will get Social Security; its imbalances are relatively minor and fixable, and even if nothing is done, which is highly unlikely in view of the program’s popularity, you’ll still get around three-quarters of your promised benefit.The real reason why you’re going to have a crummy retirement is that the conventional “defined benefit” pension plan of your parents’ generation, which provided a steady and reliable stream of income for as long as they lived, has gone the way of disco. There’s only one person who can repair the gap left by the disappearance of these plans, and you know who that is. Unless you act with purpose and vigor, your retirement options may well range between moving in with your kids and sleeping under a bridge in the rain.Further, the most important word in this entire booklet is theifin the above “if you can follow this simple recipe,” because, you see, it’s a very, very big if.At first blush, consistently saving 15 percent of your income into three index funds seems easy, but saying that you can become comfortably well-to-do and retire successfully by doing so is the same as saying that you’ll get trim and fit by eating less and exercising more. People get fat because they like pizza more than fresh fruit and vegetables and would rather watch Monday night football than go to the gym or jog a few miles. Dieting and investing are both simple, but neither is easy. (And I should know, since I’ve been much more successful at the latter than at the former.)

In your parents’ day, the traditional pension plan took care of all the hard work and discipline of saving and investing, but in its absence, this responsibility falls on your shoulders. In effect, the traditional pension plan was an investing fat farm that involuntarily limited calorie intake and made participants run five miles per day. Too bad that, except for the luckiest workers, such as corporate executives and military personnel, these plans are disappearing.

Bad things almost inevitably happen to people who try to save and invest for retirement on their own, and if you’re going to succeed, you’re going to need to avoid them. To be precise, five bad things— hurdles, if you will—must be overcome if you are to succeed and retire successfully:

Hurdle number one: People spend too much money. They decide that they need the newest iPhone, the most fashionable clothes, the fanciest car, or a Cancun vacation. Say you’re earning $50,000 per year, 15 percent of which is $7,500, or $625 per month. In this day and age, that’s a painfully thin margin of saving, and it can be wiped out simply by stringing together several seemingly innocent expenditures, each of which might nick your savings by $100 or so per month: a latte per day, a too- rich cable package, an apartment that’s a little too tony, a dress or pair of brand-name sneakers you really don’t need, a few unnecessary restaurant meals and, yes, an excessive smart phone plan you could, if you had to, not only live without, but also function better without. Life without these may seem spartan, but it doesn’t compare to being old and poor, which is where you’re headed if you can’t save. You might even save the whole $625 in one fell swoop just by living with a roommate for a while longer, instead of renting your very own place. Again, as bad as having a roomie may be, it’s not nearly as awful as living on cat food at age 70.

Let’s assume you can save enough. You’re not home free, not by a long shot. You’ve got four more barriers to get by.

Hurdle number two: You’ll need an adequate understanding of what finance is all about. Trying to save and invest without a working knowledge of the theory and practice of finance is like learning to fly without grasping the basics of aerodynamics, engine systems, meteorology, and aeronautical risk management. It’s possible, but I don’t recommend it. I’m not suggesting that you need to get an MBA or even read a big, dull finance textbook. The essence of scientific finance, in fact, is remarkably simple and can be acquired, if you know where to look, pretty easily. (And rest assured, I’ll tell you exactly where to find it.)

Hurdle number three: Learning the basics of financial and market history. This is not quite the same as the above hurdle; if learning about the theory and practice of finance is akin to studying aeronautics, then studying investing history is akin to reading aircraft accident reports—something every conscientious pilot does. The new investor is usually disoriented and confused by market turbulence and the economic crises that often cause it; this is because he or she does not realize that there’s nothing really new under the investment sun. A quote often misattributed to Mark Twain has it that “History doesn’t repeat itself, but it does rhyme.” This fits finance to a tee. If you don’t recognize the landscape, you will get lost. Contrariwise, there’s nothing more reassuring than being able to say to yourself, “I’ve seen this movie before (or at least I’ve read the script), and I know how it ends.”

Hurdle number four: Overcoming your biggest enemy—the face in the mirror—is a daunting task. Know thyself. Human beings are simply not designed to manage long-term risks. Over hundreds of thousands of years of human evolution, and over hundreds of millions of years of animal development, we’ve evolved to think about risk as a short-term phenomenon: the hiss of the snake, the flash of black

and yellow stripes in the peripheral vision. We were certainly not designed to think about financial risk over its proper time horizon, which is several decades. Know that from time to time you will lose large amounts of money in the stock market, but these are usually short-term events—the financial equivalent of the snake and the tiger. The real risk you face is that you’ll be flattened by modern life’s financial elephant: the failure to maintain strict long-term discipline in saving and investing.

Hurdle number five: As an investor, you must recognize the monsters that populate the financial industry. They’re very talented chameleons; they don’t look like monsters; rather, they appear in the guise of a cousin or an old college friend. They are also self-deluded monsters; most “finance professionals” don’t even realize that they’re moral cripples, since in order to function they’ve had to tell themselves a story about how they’re really helping their customers. But even if they’re able to fool others and often themselves as well, make sure they don’t fool you.