Investing 3MM-style

Ok, so I’m writing this because Leslie was looking over my shoulder. And she, in her infinite wisdom, pointed out that I’ve been throwing some heavy terminology at you without clearly explaining myself, especial when I’m talking about investments.

I apologize. I’m a bit of a nerd for investments.

So let’s take a step back and make this all as clear and painless as possible.

First, a definition: Investing is simply setting aside money today to have more money in the future.

Simple enough. And many of you already do it; in your 401(k)s, your IRAs.

BUT, there is a difference between how most people invest, and how the rich invest. Part of the difference is practical (meaning, they take different physical actions than most) and part of it is psychological (They think about money differently than most).

Today we are going to master both. There’s no magic to being a millionaire. It’s not something reserved for people who won some divine or genetic lottery. If you are reading this page, you already have all the skills you need to learn to invest like a millionaire.

So what are we waiting for? Let’s do this!

Why am I investing anyway?

Let me take you back to my sixth grade classroom. Why, you ask? Aside from letting you scope out the tremendously bad haircut I got right before yearbook photos, this was the year I learned the secret to investment success. In all the years since, over all the investments I’ve made, and through all the classes I’ve taken and the books I’ve read, everything has always boiled down to this fateful bad hair day in sixth grade.

And on and on it went, faster and faster. Soon the dollar-people built a second factory, then a third.

I have no idea why we watched that video, or what the lesson was supposed to be, but I was enchanted. The idea that money could work for you. That money itself could make more money.

The video was, of course, about the concept of compounding. (I have no idea why sixth graders were being taught such a thing, but I’m glad we were.)

In all the years since, throughout my college education and my business experience, I have never lost that visual.

Each dollar we make is a little worker in our financial factory, churning out more little workers.

This is the magic of compounding. If I invest $7,200 this year (our 3MM goal), I am sending 7,200 little workers to earn me more cash next year.

If I invest those $7,200 dollars in the market and they earn 8% (A commonly accepted long-term, after-inflation average for the US market as a whole) those little dollar-workers will earn $576 dollars for me ($7,200 x 0.08) while I sleep, drive to work, play with the kid, what have you. The year after that, those 576 dollar-workers will join the original 7,200 for a grand total of 7,776 dollar-dudes. Then they will earn $622 dollars.

Do you see that? Without a single penny of further investment, I got $576 dollars in passive income, and an automatic yearly raise to go with it.

Only, I do add further investment. Month after month. And month after month, my passive investment income grows.

When you invest wisely, you put your money to work for you. Ok, so how do I invest wisely?

You only ever hear of unwise investors

People are afraid to invest. In my own little social group, as I really get to know someone, I will eventually broach the subject of investing. I do this gently, usually with a line like, “You know what I find fascinating? The stock market.”

Do you know how many people have responded in any sort of positive way?

Exactly one. And he’s related to me so it probably doesn’t count.

I get it. You only ever hear about the bad guys on Wall Street. The Wolfs and the like. And you hear about people losing their shirts in mere hours.

And these things do happen, but not to us. These things, the bad guys and fortunes lost, happen to speculators.

We are investors. We don’t gamble on hot tips or inside advice. We invest in a way that gives us the highest probability of success.

When it comes to stocks, we invest in one of two things: Either all of the publicly traded companies in the United States at once

or

The 500 largest companies in the United States, all at once.

You hear people talk about the importance of diversity. This is diversity. When I invest, I don’t invest in one hotshot sector like technology. I invest in all of the sectors. For now, it’s all the diversity we need. We’ll talk about portfolio diversity later.

Index Funds And The Safety Of Crowds

This is possible because of something called indexing.

Index: An index is simply a basket of stocks, weighted by the size of each individual company included in the index. Instead of buying just one stock, you buy all of the stocks in the index.

As of this writing, Microsoft is the largest company in the United states. The index that tracks the 500 largest companies in the US (called Standard & Poor’s 500) owns a ton of shares of Microsoft.

Apple is currently the second largest company in the US. So the S&P 500 owns slightly less shares of Apple than Microsoft.

On and on this goes over the next 500 or companies.

So how does this help us?

Because the index as a whole is self-cleaning. If one company goes bad, it shrinks in size, and therefore the index shrinks it holdings in that company. It doesn’t cross its fingers and hope for a rebound. It doesn’t speculate on the future of that company. It simply re-balances.

So, let’s imagine that Apple somehow collapsed over night. All Apple products are made illegal by an executive order. Apple’s size will shrink, it will soon fall off the index (the moment it becomes not the 2nd largest company, but the 501st largest).

But this is not like pulling a tooth. It does not leave a gap. People don’t stop buying smartphones and tablets just because Apple is now gone. They just have to buy them from Apple’s competitors instead. So Google grows. Microsoft grows. Amazon Grows.

Had I invested in just Apple, I’d be ruined. By investing in the S&P 500 index, I not only invested in Apple, I invested in Apple’s competitors as well. Yes, the value of my account would hurt in the short term, but the damage would heal as the cash that Apple had been collecting becomes diverted to its competitors.

So it’s not like pulling a tooth. It’s more like pulling a weed from your garden. Other plants will take advantage of newly available nutrients and grow to fill in the gap. If Apple falls away. It’s competitors grow to fill in the gap. And whatever company used to be the 501st largest company will now join the 500 companies that make up the S&P 500.

That’s what I mean by self-cleaning. You don’t have to watch for individual companies to go bad. The Market does it for you.

The beauty of investing in indexes is that you are not trying to profit by having one company strike it rich. You are instead capturing the movement of dollars in and out of all (or the 500 largest) publicly traded companies in the US.

OK, but how?!

Back in 1975 a man named Jack Bogle changed the investing world.

I really don’t have the space here to do this guy justice, but let’s just say that he’s a personal hero of mine, and soon he will be a hero to you as well.

How did he change the world? Remember those indexes we were talking about? Remember how they’re the best investment you can make? He’s the guy who made them available to us common folk.

Before Jack, the world of indexes was for big banks, big companies, and big wallets.

But along came Jack. He created The Vanguard Group, an investment advisory group, and the world’s first ‘index fund’

Index fund: A mutual fund that tracks an underlying index (like the S&P 500). Useful because it allows even people with small amounts of money to invest.

Jack Bogle’s belief was that instead of trying to beat the market (by speculating on individual stocks) you would make more money by just trying to match the market.

He showed that even if a management firm managed to beat the market in any given year, the cost of hiring all those analysts and professionals ate up all the gains made. So even if you did find a fund that outperformed (which was statistically unlikely) you still unperformed the market because of all the fees you paid.

A countless amount of data has proven him right. While a small number of people do beat the market in any given year, their triumph is short lived. Over the course of your working lifetime, there will probably be no mutual fund that beats the market. Most will do far worse than the market. All the while Jack’s Vanguard funds (and we 3MMers) will match the market.

Jack’s second great insight was this: if every mutual fund decides to match the market, the only difference in their actual performance must come from the fees they charge. Therefore, for you the investor, the logical choice is to invest with the fund that charges the lowest fees.

Ever since, Vanguard has been managing funds that anyone can join, while preemptively lowering fees for its customers.

That needs a moment of clarification. See, Vanguard is owned by its customers. When you invest with them, you become a fractional owner of the company. This means that when costs to run the fund can be reduced, the company can’t just pocket the difference. It has to send those profits to its owners (you and me).

So here’s what you do

There are two ways to invest in Vanguard funds. You can either

1) Invest directly in the mutual fund through Vanguard.

or

2) Buy shares of the ETF through your brokerage account.

Which ever you choose, you want to focus on a fund that tracks a large number of companies, spanning a large number of industries. Vanguard does offer funds that follow special groups (like specific industries, or companies that follow specific social, environmental, or governmental values). These are great, but for now, focus on the total market until you learn the ropes.

Option # 1: VSTAX

You can deposit your money directly with Vanguard’s Total Market mutual fund (called VSTAX).

The problem here, and the reason we didn’t go this route, is that you need at least $1000 dollars to start. We didn’t have $1000 dollars, so we went with Option #2

BUT, if you do have the $1000 dollars required to open an account, you get the benefit of fractional shares.

Fractional shares: Don’t have enough cash right now to buy one full share of the mutual fund? No problem! You can just give them whatever amount you do have and they will give you a fraction of a share worth the same amount.

Fractional shares are more efficient because you never have extra cash sitting around uninvested simply because it wasn’t quite enough to buy a share of the fund.

Option # 2: A brokerage account and VOO or VTI

In the old days (back when we got started) this was a much less efficient way to invest. Back then you had to pay your broker a commission each time you wanted to buy a share of stock. Don’t quote me on this but I think we used to pay nearly $10 per trade. This might not have been bad if you were going to buy 1,000 shares at a time, but for us and our measly investments, it was painful.

Thankfully those days are gone! There are several brokerage accounts out there now that offer commission free trading, which I never would have thought possible.

Robinhood is the media darling of the no-commission brokerages. In fact they are the one that launched this whole commission free revolution. I have used Robinhood and when it comes to simple interface and ease-of-use, they can’t be beat.

That being said, we primarily use Thinkorswim by TD Ameritrade. They, too, have gone $0 commission, but they are much harder to use and less newbie-friendly. I use Thinkorswim because I also trade complex option positions and when it comes to options, they are the best of the free software.

A quick note about ‘free’ trades. Nothing is free. Not ever. These brokerage firms make their money by gathering the orders you submit, as you submit them, selling that data to other companies that will make high-frequency trades based on your data. Overall, I think this is a crappy practice, but there is also nothing I can do about it. It’s the same with Apple, Amazon, and Google. They’re all mining our data and I guess we just live with it and try to make the most of our free trades. Given the investing method we advocate, free trades translates directly to more money at the finish line.

Also ‘free’ only means you don’t pay the brokerages. You will still pay a small fee (like measured in cents) to the exchanges that carry the trades. Just so you know. Full disclosure.

Once you’ve opened a brokerage account with whoever, you want to look for one of these two stock tickers: VOO or VTI.

VOO is an ETF that tracks the same S&P 500 mutual fund that you would buy directly through Vanguard. Only now you don’t need $1000 dollars to join. You just need enough to buy a single share.

VTI is an ETF that tracks the same total market mutual fund that you would buy directly through Vanguard.

But what’s an ETF? ETF stands for Electronically Traded Fund. It’s basically a way for you to invest in mutual funds using the stock exchanges. You buy shares just like any other stock. They pay dividends just like any other stock.

The only down side to buying these ETFs is that you usually end up with a few bucks stuck in cash. You bought all the VOO your $600 dollars would allow, but there’s still $27.50 sitting in your account, waiting for next month. Not a big deal. Doesn’t bother us one bit. But I thought you should know.

Which should you pick, VOO or VTI? Flip a coin. In the long run the difference between the two will be negligible. We use VOO because of some other trading and investing stuff I do, but that has nothing to do with what we’re after here.

What about SPY?

Ah, SPY. SPY is the Standard & Poor’s 500 ETF. It is the largest ETF in the world. It’s shares trade hands 100 million times per day. It is the grand-daddy of ETFs.

So why don’t we buy SPY over VOO? Expense ratios.

Expense Ratio: Each of these Funds charges you a small amount each year you own it. These expenses are usually described as ratios that will tell you how much you will pay each year. (These change over time, so be sure to check on them from time to time. A five-minute Google, tops.)

Why don’t I use SPY? It’s expense ratio (as of this writing at least) is 300% HIGHER THAN VOO. And because I am a devout and humble student of Jack Bogle I know that the only difference between SPY and VOO are the expenses. So why would I pay more for the same thing?

Have you heard of Fidelity!?

I have! As of this writing, Fidelity has recently released a few zero-cost mutual funds. That means they charge you nothing to manage your money. 0% expense ratio.

I know, I just said that I was a devout and humble student of Jack Bogle and I go with the lowest expense ratios, BUT…

I don’t know what Fidelity’s game is, but I do know that nothing is free.

In short, I haven’t looked into this and I have never been a customer. On this site, we only want to speak from experience, so for now, I’m mute on Fidelity’s 0% expense ratio. I just can’t recommend something blindly.

Honestly, though, I’m suspicious. I want crystal clear transparency here, and I don’t see it. My guess is that it will stay at 0% for a few years, then jump back up once enough clients have invested too much cash to bother switching.

I have faith that if there was a sustainable way for a mutual fund to have zero fees, Vanguard would be the first to do it.

Let’s talk a moment about the end of the world

Or the end the USofA. Because that’s what it would take, to ruin you. The question all new investors have is, “What happens if I lose everything?”

It’s a fair question. You might lose everything. When you invest in S&P 500 or the Total Market, you are investing in the complete financial strength of American business. I would argue that’s stronger than the US government itself, push comes to shove.

If California were a country, it would be the fifth largest economy in the world.

Texas alone has as higher Gross Domestic Product than Russia

It’s easy to forget just how much economic force is behind the United States. So you might lose everything, but before that happens, thanks to the self-cleaning nature of the S&P 500, all business activity in the United States would have to cease. What could make that happen? A meteor? An eruption at Yosemite?

What I’m getting at is this: If something happened that ended all American businesses, money would be the last thing on your mind anyway. Stealing food from the feral gang across the street might be more important to you by that point.

The truth is, I can’t guarantee you will earn any money at all in the market. You might even lose a lot of money. But I can guarantee that you will lose money to inflation if you never try. I can guarantee that without investing, you will never save a million dollars on the median American salary.

Some back-of-the-envelope math states that, without investing, you would have to save $840 per month to reach one million in less than a century.

Bad things will happen. You will see your account value shrink. And I will show you exactly what to do when the market crashes so you can keep your cool and keep on growing your wealth.

And if you don’t invest, if you keep your wealth in cash, that nasty old inflation will steadily be eating away at it. If you don’t invest, there is a 100% chance you will lose money.

So what do we actually do?

Step 1) Set a goal. Use an investment calculator to calculate the amount you will need to invest each month to reach your financial goal.

Step 2) Pick a day. Any day. (We chose the last day of each month because that’s when we reconcile all of our books).
Step 3) Each month, on your chosen day, transfer your monthly amount to your brokerage account (with TD Ameritrade, this transfer is instant).
Step 4) Buy as many shares of VOO or VTI as you can with your profits.
Step 5) Repeat. Each and every month. I don’t care if the market is up or down. Always buy on the same day. Always buy at least your goal amount. This is called ‘dollar cost averaging’.

Why Not Just Invest In My Own Business?

So what if you’ve been chugging along in your business for a year now. You are confident that you could reinvest you next $1,000 into your business and earn 20% within the year. Why not stop investing in the market, and invest everything into your business?

Because of diversification, moats, and the rarity of excellence.

You could (and should) invest in your own business. But at least some of your profit should be invested outside your business. Here’s why:

Diversification

Your small business has a risk built into it. All businesses do. Think of it as ‘sector risk’. Something could change in the fundamental functioning of the world that renders your business obsolete.

Think newspapers. Once one of the greatest businesses in America. But along came the internet and now…. who even reads the newspaper anymore?

We invest to pull money out of our business, away from sector risk, and put it somewhere that is relatively resilient to it. When newspapers failed, the market did not, because new internet companies grew to take their place.

Leslie and I fully acknowledge that any and all of our active income streams could be taken from us. We could lose our jobs. Amazon could ban us. Some new social media frenzy could render blogs obsolete. But the money we have invested outside of our businesses will go on earning money, even all of our other incomes fail.

We take at least $600 per month out of our businesses and invest it in the market.

Moats

In the business world, a ‘moat’ is the long-term competitive advantage a company holds. The greatest moat in the world right now is Apple.

No one has the brand awareness that Apple has (even my 95 year-old grandfather knew what Apple was).

Think about what it would take to compete with Apple. You’d have to be able to hire the best designers, the best creatives, and then you’d have to control the best supply channels, distribution networks, advertising agencies….

This is moat. If Apple falls, it will not be from an outside competitor.

Your small business, almost certainly, does not have a moat. Not yet. We’ll talk about building moats later. But that’s ok, because you can buy other people’s moats!

When you buy VOO, you buy Apple. You buy a share of its moat. In fact, you buy a share of the 500 largest moats. You take money out of your fragile young business and you store it in the greatest economic fortress in the world.

Leslie and I own businesses in competitive fields. We could lose to a bigger, better funded online store. Our blog could fade into obscurity, crowded out by celebrity gossip sites. But the money we have invested in 500 of the largest moats in the world will keep on working for us.

Rarity of Excellence

Warren Buffett is widely considered the greatest investor of all time, and you can’t hire him to handle your investments. But you can get him to work for you. When you buy VOO, you buy Berkshire. When you own Berkshire, Buffet works for you.

Truly incredible business people are few and far between. And when they come along, they are gobbled up by the biggest, richest companies. You can’t hire them. But you can get all of them to work for you.

Tim Cook works for me, because I am a shareholder. Buffett works for me, because I am a shareholder. Jeff Bezos, Jamie Daimon, Statya Nadella, Sundar Pichai… they all work for me because their primary responsibility is to their shareholders.

And the more shares I buy, the more they work for me.

I love my businesses and I love what I do, but I have to be realistic. I can’t compete with any of these titans. So if I can’t beat them, I’ll employ them instead.

Leslie and I work hard, and we are no dummies, either. But we will never be Warren Buffett. So we want to pull cash out of our businesses, and put it to work under the best business people anywhere.

Putting It All Together

• We want to build a small, easy-to-run business
• We want to take profits from that business and buy large and powerful businesses
• We do a little work and use it to…
• “Hire” the best business minds to do the work for us

Up Next: Let’s find the right business for you with our Big List of Side-Gigs