Investing: The Ultimate 3MM Guide

Introduction

It’s time to learn about investing, the 3MM way. This is probably the section where a lot of you are going to be thinking, “Ok, here comes the confusing/intimidating/straight-up scary part.” 

I get it. Investors are rich people. 

When we started our 3MM business one of the first strategies Ben insisted upon was investing, and I knew he was right, but I was terrified to take it on. Through the years I have learned so much from him, and this whole investing business seems so straightforward now. 

So many outlets will use buzzwords and lingo that are designed to confuse you. They’re hoping that you will give up and just pay them to invest for you. 

Don’t believe them. Don’t be afraid. And don’t be intimidated. 

The simple, straightforward strategies of 3MM are all you need.

How We Define Investing

We are fond of Warren Buffet’s definition of investing: The exchange of buying power today for more buying power in the future.

Why do we like that (admittedly awkward) phrasing?

Because it’s so open-ended. 

It makes no judgments about which things are considered investments. It doesn’t say “stocks” or “gold” or whatever.

It doesn’t even say “money”.

As 3MM Investors, we are open to any possibility. We don’t limit ourselves to any one type of investment.

We have only two caveats:

1. The investment must be productive. (It must actually make money)
2. The investment must demand of us almost zero time commitment after purchase.

Investing is our prime method of generating passive income. If it doesn’t fit these two rules, it cannot be counted on for income or passivity.

Investing vs Speculation

Before we move on, we need to clear up a few things that we do not consider ‘investing’. 

Speculation is what most people do when they ‘play the stock market’. The hallmark of a speculator is hope.

Speculators buy a stock (or property, or gold, or whatever) and hope it will go up. They have no real evidence that it will. They say things like “It’s gone up 15% and still has room to run!”

Investors, on the other hand, have tangible evidence that what they bought will increase buying power in the future. Investors still hope, but the hope is secondary to actual evidence (and lots of evidence at that).

As 3MM investors, we do not speculate. Not ever. When we buy an investment we have overwhelming evidence that it will increase in value.

Investing vs Trading

Trading is again what many people think of when they think of the stock market. It happens over short durations. For non-Wall-Street-investors like you and me, multiple trades (both in and out of one position) can happen over hours or days.

Traders do this to try to profit off short-term movements in the stock (or gold or cryptocurrency) market. 

This takes time. Lots of it. And we just don’t like the idea of staring at a computer screen for hours each day. We started this business to get away from that.

Instead, once we buy an investment, we go on vacation. We don’t even look at it. The short-term fluctuations in its purchase price don’t worry us. We only care about the income it produces.

Investing vs Saving

Speculating and trading are both very risky. The risk of permanent loss is very high. 

But neither of them is as risky or damaging to wealth as saving.

WHAT?!

The problem is the way people save. Most people throw their money into a savings account, or they buy Certificates of Deposits, or maybe they even buy US treasury bonds. 

There are very few guarantees in the investing world, but here’s one I can make:

With the current return rates on those, you are guaranteed to lose money in the long run.

Why? Because of the single biggest destroyer of wealth in the world…

Inflation

Each year the dollars you own are worth less and less. They have less buying power than they did yesterday. They will have less buying power next year than they do now.

Inflation is the exact opposite (using our definition) of investing. 

Why do bonds and CDs and savings accounts lose money?

The current risk-free bond yield is about 1.5%.

The best savings account I could find in the last three years earned 2%.

And Certificates of Deposits are hovering around 0.7%.

Meanwhile, bad old inflation averages 3% per year. 

According to howmuch.net, The dollar has lost around 96% of its buying power from 1913 – 2019. It takes $100 dollars today to buy what $3.87 bought in 1913.

I understand that investing is scary. I personally know exactly zero people who are not frightened by the idea. 

But I want you to see that investing is not what you should be afraid of. 

Inflation is.

So how do we beat inflation?

We must invest. And we must invest in things that are highly likely to earn more than 3% per year. 

Remember, you need to earn 3% just to stand still.

Don’t worry. It’s all much easier than you think. 

Watch this:

We just time-traveled to 1913 (that’s where the data from howmuch.net starts).

In each hand, we hold $3.87.

$3.87 in the left hand.

$3.87 in the right hand. 

We use the money in our left hand to buy a special investment that will always match the inflation rate. There is no risk of failure. There is nothing to fear. 

We use the money in our right hand and invest in what will one day be called the S&P 500. We know that between now and 2019, there will be:

• 19 recessions
• a great depression 
• two world wars (and countless smaller ones).  
• two major oil crises. 
• Stagflation
• The dot.com bubble
• The Great Recession
• The Covid Pandemic

And then we time-travel back to 2019 (again, limited by data easily available), 106 years later, and pick up our earnings. 

From the safe, risk-free investment, you receive $100. Woo. 

Your ‘risky’ money that had almost literally been through the end of the world, however, is now worth about $1,800.

You are 18 times richer. Even after all that. 

When you factor in inflation, your “safe” investment has netted you zero dollars. Your safe investment has exactly the same buying power it did in 1913. 

I don’t know how many times richer you are with your investment money because trying to divide by zero will destroy the universe or something. 

There will be more bumps on the road. Here’s the second guarantee I can make: there will be another recession. It might start tomorrow. Who knows?

But it won’t cost you nearly as much money as inflation will if you don’t invest.

Opportunity Cost

There is one last and very important concept you need to know before we get into the nuts and bolts of investing the 3MM way. 

Opportunity cost. 

Opportunity cost is an abstract idea and many people forget about it entirely. When it causes you to lose money, you cannot tell. Just about everyone has lost lots, and I mean lots, of money to opportunity cost. 

And just about no one realizes it. 

Every time you spend a dollar on anything that isn’t your best investment, you lose money to opportunity cost. 

If I can get returns of 10% on my best investment, and then I buy a boat for $30,000, I not only lose $30,000, I also lose all the money that $30,000 could have earned if it were properly invested. 

Let’s say my investment has another twenty years of life left. My $30,000 boat cost me…

$30,000 x 1.1 (10% gain per year)^{^20 (for 20 years)} – $30,000 (the original investment) =

About $170,000 in lost investment income. 

My boat might be insured for $30,000, but its actual cost is closer to $200,000.

As we dive into our investment approach, we will be talking a lot about efficiency. This is why. We want to make sure we are investing in the most profitable way so we can minimize the damages done by inflation and opportunity costs. 

Our Investing Philosophy

We built our business and investment framework by following the example of one of the world’s greatest investors: Warren Buffett.

Buffett, and his partner Charlie Munger, took a failing textile business (called Berkshire Hathaway) and transformed it into a business worth half a trillion dollars.

How?

They followed a few simple rules and executed them over and over.

Many of those rules, the ones that can apply to a small home-based business (ie. almost all of them) have become our rules.

We have scoured every Berkshire shareholder letter and read every bit of Buffett-and-Munger wisdom we could get our hands on. (They are remarkably transparent when it comes to business and investment philosophy).

[ You can read every Berkshire shareholder letter for free at Berkshire’s website, or you can buy collected versions on Amazon. The collected version might not have the most recent letters, but it is more comfortable to read. ]

This is the result. Simple investing rules that have served us well, and will serve you well, too.

‘Stocks’ Are Fractional Ownership in Real Businesses

Not things to be speculated on or traded with short-term price movements.

I feel like the gravity of stock ownership has faded lately. People seem to forget they own a piece of a major company.

We own Apple. We literally own it. Our shares entitle us to a portion of their earnings. Everyone employed by Apple works for us.

As shareholders, Tim Cook works for us. 

Just take a minute and let the weight of that sink in, because it is the bedrock that the whole 3MM methodology is built on.

We use earnings from our small businesses to buy partial ownership of some of the biggest and best companies on earth. 

That’s why we can work so little but earn so much. We have literally millions of people working for us. 

We Are Not Picky

When we are considering investments, we don’t care what the investment is. We care only about:

1. The earnings we can pull from it
2. The growth of those earnings

When comparing two or more potential investments (and we almost always have at least two to choose from) we look at the earnings today and then try to make an educated guess as to what the earnings will look like in five years.

Which investment will pay us the most money, per dollar invested, over the next five years? That’s the one we choose. 

Maybe it’s a rental property. Maybe it’s shares of the S&P 500, maybe it’s a business we’ll buy in its entirety. 

We don’t care.

We buy Earnings, Not Popularity

We have seen so many of our friends and acquaintances make the dumbest investment choices because ‘Everybody’s talking about XYZ’.

But often ‘what everybody is talking about’ is a company that sounds cool, but has no earnings at all. 

And if we’re not buying earnings, we’re not investing. We’re speculating. We’re hoping that someone in the future will think it’s cooler than we do now.

There’s an official name for that, by the way. “The Theory of Greater Fools”. 

We think it’s appropriately named.

We Plan to Hold for the Long Term

When making an investment decision, we often think in five-year spans. What will earnings look like in five years?

That doesn’t mean we are planning to sell in five years. And it doesn’t mean that we won’t sell before five years.

We just think that any attempt to predict beyond five years is meaningless. Things change too fast. 

So how long do we plan on holding? As long as our return on investment is acceptable. 

For most of our investments, that means forever. They will transfer to our daughter and she’ll keep them forever as well (pocketing the dividends, of course).

Once you buy a really good investment, there is almost never a reason to sell it. If there is a reason to sell, then it wasn’t a really good investment.

The Goal is to Grow Earnings Each Year

In their shareholder letters, Buffett and Munger repeatedly state their goal: To increase per-share earnings. 

Our goal is the same. Leslie and I have chosen the goal of 15% earnings growth per year. 

We don’t care how we get to that figure. Some years it will be by expanding the earnings of our business side (the actual cash generated by our store, website, rentals, or whatever).

And some years it will come from increasing the earnings we lay claim to through our stock market investments. 

As you will see, when we invest in the stock market, we consider those earnings as every bit as real as the ones from our other businesses. 

Investing for Beginners

Shares

When people “buy a stock” they are actually buying a ‘share’ of the business. As 3MM investors we think and talk about our shares as partial ownership of a business. 

We do this to keep ourselves focused. Many before us have gone down the slippery slope of viewing their ‘stock’ as something that is to be traded as market prices go up and down. 

We don’t want to slide down that slope. 

Ownership is a very real and powerful thing. We are entitled to a ‘share’ of the business’s profits.

Earnings Per Share (EPS)

This is a number that helps us understand how much money (earned by the company in a year) we are entitled to. 

Simply put, this is the total amount of money earned by the business in a year after expenses and taxes have been taken out, divided by the number of shares outstanding. 

You can find this number anywhere. A quick google for the term “Apple eps” tells me that each share of Apple stock earned $2.19.

If I own 100 shares of Apple, I am entitled to $219 of their earnings for the year.

BUT, even though that is my share of the earnings, I won’t be able to put $219 in my pocket. 

That’s because Apple only pays out about 18% of its earnings as dividends. The dividend goes into my pocket.

The rest is reinvested by Apple for both earnings and dividend growth.

Dividends

Dividends are the portion of earnings that are paid out to shareholders. Payments are usually distributed quarterly and count as income. 

That means they are taxed.

Remember that part. We’ll get back to it soon. 

As 3MM investors we approach dividends very differently from most people. The investing world is full of people who obsess over dividends. Dividend growth is their main concern. They make purchases based on who pays the most dividends. 

But we don’t want dividends. 

Well, we kinda don’t want them.

For one thing, we have to pay taxes on them. They’re taxed at a lower rate than normal income, but it’s still taxed. Most Americans will pay a 15% tax on dividend income. 

But also, money paid to us in dividends is money the business is not reinvesting to grow its earnings. 

We much prefer something called retained earnings.

Our Secret Formula for Success: Retained Earnings

‘Retained earnings’ is all the money the company did not pay out in dividends. 

We love retained earnings.

Why?

For one thing, we don’t pay tax on them! So they are 15% more efficient than dividends right off the bat. 

But the real secret-weapon-reason is this:

All companies can reinvest retained earnings, BUT really good companies can reinvest that money so that each dollar invested is translated into at least one dollar of market value.

Above I said Apple had $219 in earnings. Let’s say they retain about $180 dollars of it (the rest is paid out in dividends.

Apple is an excellent company. They have a good track record of turning each retained dollar into more than one dollar of market value. 

Therefore, I can reasonably expect Apple to turn that $180 retained earnings into a $180 increase in my stock holdings. If I own 100 shares of Apple on Jan. 1st, I can reasonably expect those 100 shares to increase in market value by at least  $180 by Dec 31st. (On average and over the long term – wobbles in the market can throw this relationship off in the short term).

AND that $180 is tax-free! (until I sell it).

Can you see why we love retained earnings? Can you see why we would rather great companies just retain all their earnings instead of paying them out as dividends?

Here’s an example of a company that has retained every dollar they’ve ever made: 

Berkshire Hathaway

Do you know what their total return has been over the last 55 or so years?

2,744,062%

Investing in Stocks, Real Estate, Bonds, and Gold

Gold

Gold is one of the most popular assets people ‘invest’ in. You probably own gold in some way (even if you don’t realize it, most managed retirement plans own gold-related properties).

But as 3MM investors, we don’t like gold. 

Gold is actually one of the riskiest, most surefire ways to lose money.

In fact, you might have noticed that we put ‘invest’ in quotes in that first sentence. 

Why? Because gold doesn’t meet our first criteria for being an investment: It does not produce.

What do we mean by that? Let’s do a thought experiment.

I magically grant you a 100-pound block of gold. It’s sitting right there on the floor of your bedroom. 

Now watch it very closely. Watch it every day for the next 100 years. 

What changed?

Absolutely nothing.

It did not grow. You do not have any more gold than when you started. 

But Ben, gold goes UP in value. I’m richer now.

Not really. Let’s continue the thought experiment.

We take your 100-pound block of gold and we travel back in time to 1913 (to line it up with our previous thought experiment). 

We take the block to a jeweler and have it appraised. 

Your block of gold is worth $26,244 in 1913 dollars. Nice!

(There are 14.58 Troy ounces per pound of gold. Times 100. Times Troy ounce average price from https://nma.org/wp-content/uploads/2016/09/historic_gold_prices_1833_pres.pdf ) 

Now we travel back to 2019 and have the block appraised again:

$2,208,870! Ben, I’m a millionaire! How could you possibly say gold is not an investment!?

(14.58 Troy ounces x 100 x average gold price in 2019 according to this chart https://www.statista.com/statistics/274001/gold-price-per-ounce-since-1978/)

Even if we ignore inflation (which, by the way, would have eaten up about $700,000 dollars of your profit) you still actually lost something like $4.6 million dollars.

How?

Opportunity cost. 

Had you sold that block of gold back in 1913 and bought the broad market, you would now have an investment worth around….

$6,840,000.

And that’s not even the best part. You would actually own 6.8 million dollars worth of productive businesses.

Those businesses would be giving you around $380,000 per year in earnings.

($6.8 million divided by $2,607 (2019 end price of S&P 500) times $146 (2019 earnings per share of S&P 500). Prices and earnings from multpl.com)

How much is your block of gold producing after 106 years? 

Still $0 per year. 

People flock to gold because its price has remained remarkably steady over the last 200 years or so. 

But we believe it is a bad investment because its price has remained remarkably steady over the last 200 years or so. 

Bonds

A bond is simply a fancy rich-guy version of an IOU. 

You loan your money to a company or the government. They agree to pay it back with interest after a period of time. 

They can become very complicated (and very risky), but for the purposes of the guide and the 3MM method of investing, we’ll look at the safest and simplest: US Treasury bonds. 

So you loan your money to the Treasury. They agree to pay it back with interest. This is very safe because for the Treasury to default (fail to pay back your loan) the US government would have to completely collapse.

Here’s a fact that might surprise you: The US government (as of this writing) has never defaulted on, or even missed a payment on, a debt. 

Treasury bonds are widely considered “risk-free” investments. 

And we begrudgingly admit that bonds are investments. 

Just not very good ones.

The problem is that bond rates are so low. Lower than inflation. You cannot use them to gain wealth. You can only use them to slow the damaging effects of inflation. 

So when do we use bonds?

When we turn to bonds, it is sort of like admitting defeat.

It means that we can’t find reasonable places to invest the excess cash produced by our 3MM business. We give up and buy short-term bonds to mitigate some (but not all) the harmful effects of inflation until a better investment comes our way. 

Full disclosure: We haven’t had to resort to this fallback position in years. 

Now, there are bonds that produce more money than inflation takes away. 

BUT they are much riskier. They tend to involve companies with not-the-greatest credit scores.

And they require a certain amount of babysitting (watching to see if you think the company will default on your loan).

All-in-all, these bonds aren’t worth our time or the stress they produce. We can make more money from our 3MM business anyway.

Will bonds always be bad? 

It could change. Maybe bond rates will break into double digits in the future. Then they would come back onto our radar screen.

Real Estate

Now we’re getting somewhere.

Real Estate can be an investment. It can produce income.

But not always.

When most people think of real estate, they think of buying properties to rent out, of being landlords.

Which is fine, but remember, there are other options. 

When we talk about real estate as an investment, we are also talking about:

• Farms that produce crops or livestock
• Land that grows timber that will be sold 
• Land with mineral or natural gas rights  
• Anything else that produces income

Real Estate investments can also come in the form of Real Estate Investment Trusts (REITs).

These can be traded just like stocks. They tend to have some specific angle. Maybe you want to invest in land that grows and harvests timber. There’s an REIT for that.

REITs usually pay a dividend, and that dividend is often higher than your average corporation, so they are viable investments.

What are the downsides?

Opportunity cost is a big one. I generally find better opportunities in the broad market.

There is just generally less opportunity for compounding (discussed in a minute) to work its magic. 

I’ve also heard stories (but have not seen for myself) of dividends that are great at first but then dry up unexpectedly. 

In short, there is a real opportunity here, but usually, the time commitment to find and maintain them just isn’t worth it to us. Might be for you, though.

Stocks

This is where most of our investments live. But that doesn’t mean we have some special attachment to stocks per se.

But it is where we find the most opportunity that meets our two criteria.

(As a reminder 3MM investments must actually produce income and require very little or no time commitment)

Stocks can and do often provide many opportunities to fulfill the first criteria.

(Though not always. You would be amazed how many companies out there lose money at the end of a year, even ones big enough to be in the S&P 500)

But the amount of time commitment required to find them, and then track them (you don’t want to be caught by a surprise shift in the profitability of a company you own, trust me) eliminates almost everything from our universe of acceptable investments. 

What we want is to buy partial ownership of a very large, very secure company that will provide us with a share of their earnings each year.

AND we want to be able to count on those earnings growing faster than inflation over time.

AND we want that company to exist, unchanged, for at least 100 years (the rest of our daughter’s lifetime.)

And that company does exist. But many people cannot see it because it exists abstractly.

S&P 500 Indexes

Imagine for a second a gigantic conglomerate. (A conglomerate is a combination of many businesses in many different industries).

This conglomerate owns hundreds of American businesses. When the market value of any one business declines (maybe their industry collapses or new technology makes them obsolete) the conglomerate sells them off and replaces them with something new. 

This conglomerate has a fantastic record of turning each dollar of retained earnings into at least one dollar (usually more) of market value. 

The best of its businesses make up most of its holdings, and the worst make up the least. It pays a dividend (but not too much, usually around 1.8%) and retains the rest of its earnings for growth. 

THIS is what our dream investment would look like.

AND it exists. This is essentially what the S&P indexes do. 

So when we invest, we invest in indexes. It is the most time-efficient way to invest hands down. 

Could we get better returns by hand-picking stocks?

Most people don’t. And even if we could, the performance increase over the index would not be worth the time it would take. 

I would rather spend that on living, thank you very much.

Here’s what you need to do: Start thinking of the S&P 500 as a single, gigantic business. You can find its earnings, just like any other business (we use multpl.com).

And it has the attributes we want in a great business because it is made of great businesses. If it isn’t a great business, it falls off the index.

The most important parts for us are these:

• It has a great history of growing its earnings (at a rate that beats inflation)
• It has a great history of growing in market value (at a rate that beats inflation)
• And most importantly, it has a great history of turning each dollar of retained earnings into more than one dollar of market value. 

Investing with Vanguard

We believe the absolute best place to invest with indexes is Vanguard. See, in order to “invest in an index” you actually need to invest in an “index fund”.

These are simply mutual funds that track an index. 

Vanguard was founded by the man who invented the concept of the index fund, Jack Bogel.

But that’s not why we love Vanguard. We love them because their rates are low and they have an incredible history of not screwing their customers.

Which, in the financial world, is kind of rare. 

You can invest directly with Vanguard by going to their website and opening an account.

Or you can invest by buying one of their ETFs in your brokerage account. 

Leslie and I personally buy their VOO ETF. It tracks the S&P 500.

We do this because it makes it easier to calculate the earnings that we use for our income reports and to calculate our intrinsic value.

Whichever you choose, ETFs or Vanguard accounts, it makes no real difference.

Investing with ETFs

Wait, what are ETFs?

ETF stands for Electronically Traded Fund.

Simply put, it’s a way to trade large and unwieldy funds of many billions of dollars in small units.

They were created to add liquidity to large funds, allowing people to trade in and out quickly with low costs.

There is an endless supply of ETFs to choose from, but don’t get distracted…

As with most things in life, the simplest is usually the best.

The two we use most frequently are VOO, which tracks the S&P 500, and VTI which tracks the ‘total market’. 

Investing Long Term

Alright, so we have an idea of what we look for in investments. 

We want productive assets like real estate, stocks, and yes even bonds (maybe someday, if rates improve).

So how long do we hold them?

For as long as it makes financial sense.

(I’m going to focus on the S&P 500 for this part but the same principles hold true for all productive assets.)

Remember our example of buying the S&P 500 way back in 1913?

Well now we are back in the present day and our investment has grown to almost $7 million.

Most people look at that $7 million as the important number. They get hung up on the social pride that goes with “being a multi-millionaire”.

But the real value lies in the almost $400,000 in earnings those shares produce. 

Let’s say that about 1/3 of that money (so about $130,000) comes to us directly in the form of dividends. 

The rest ($270,000) is retained for future growth (see our section on retained earnings). 

The S&P has a great history of turning each retained dollar into more than one dollar of market value.

That means that we can reasonably expect the market value of our S&P shares to increase by around $270,000 in the coming year.

That is nearly ten times what we paid for it back in 1913!

When would it make financial sense to sell an asset that pays me more than ten times its cost each year?

Basically never.

And here comes the BIG question:

If I never sell it, how do I actually make any money? How do I spend it? How do I actually use it?

If I can reasonably expect those S&P shares to increase in value by $270,000 each year (and don’t forget about the dividend payments) I can sell off any amount up to $270,000 each year without decreasing the total worth of my position.

It’s like magic. Watch:

In 2019 we have $7 million. We get $130,000 in dividends. The S&P retains $270,000, and we can reasonably expect the market price of our shares to increase dollar-for-retained-dollar.

So at the end of 2019, we sell $270,000 worth of our shares and pocket the cash (after taxes of course.)

We have pulled $400,000 out of our investment ($130,000 in dividends + $270,000 from selling shares). How much do we have left? 

We still have $7 million dollars. 

Let’s look at an actual example:

We’ll use numbers that are a bit more realistic as well: Our actual investment target, an amount of money that you can make from home, working three months per year. 

We will use actual market data for this one. These numbers were pulled from multpl.com. 

Let’s go back to 2010 (All numbers have been inflation-adjusted):

In 2010 we have $1 million invested in VOO (the Vanguard S&P 500 ETF). 

• We receive $18,300 from dividends.
• The S&P retained $47,626 of earnings. 
• We sold $47,000 worth of our VOO shares.
• Our balance at the end of 2010 (after withdrawing $65,300 in dividends and sold shares) is $1,058,000 (Remember, we are using real historical data here. Go to multpl.com to check our math)

In 2011 we have: $1,058,000 invested in VOO

• We receive $21,244 from dividends (dividends tend to increase over time).
• The S&P retained $48,662 (earnings also tend to increase over time).
• We sold $48,000 worth of our VOO shares.
• Our balance at the end of 2011 (after withdrawing $69,244) is $971,823.

In 2012 we have: $971,823 invested in VOO

• We receive $23,046 in dividends
• The S&P retained $40,752 (earnings don’t always increase in the short term)
• We sold $40,000 worth of our VOO shares.
• Our balance at the end of 2012 (after withdrawing $63,046) is $1,025,482

In 2013 we have: $1,025,482 invested in VOO

• We receive $19,894 from dividends (dividend rates can sometimes decrease)
• The S&P retained $44,589
• We sold $44,000 worth of our VOO shares
• Our balance at the end of 2013 (after withdrawing $53,894) is $1,179,695

In 2014 we have:  $1,179,695 invested in VOO

• We receive $25,413 in dividends
• The S&P retained $40,503
• We sold $40,000 worth of our VOO shares
• Our balance at the end of 2014 (after withdrawing $65,413) is $1,247,508

In 2015 we have: $1,247,508 invested in VOO

• We receive $26,319 in dividends
• The S&P retained $26,170
• We sold $26,000 worth of our VOO shares
• Our balance at the end of 2015 (after withdrawing $52,319) is $1,109,621

In 2016 we have: $1,109,621 invested in VOO

• We receive $25,938 in dividends
• The S&P retained $33,873
• We sold $33,000 worth of our VOO shares
• Our balance at the end of 2016 (after withdrawing $58,938) is $1,224,785

In 2017 we have: $1,224,785 invested in VOO

• We receive $25,913 in dividends
• The S&P retained $32,276
• We sold $30,000 worth of our VOO shares
• Our balance at the end of 2017 (after withdrawing $55,913) is $1,413,564

In 2018 we have: $1,413,564 invested in VOO

• We receive $26,836 in dividends
• The S&P retained $39,369
• We sold $39,000 worth of our VOO shares
• Our balance at the end of 2018 (after withdrawing $65,836) is $1,233,600

In 2019 we have: $1,233,600 invested in VOO

• We receive $26,966 in dividends
• The S&P retained $37,609
• We sold $37,000 worth of our VOO shares
• Our balance at the end of 2019 (after withdrawing $63,966) is $1,447,674

Over the course of the decade, we withdrew a total of $613,869.

AND our balance has increased by $447,674. 

(For this example, all numbers are after inflation has done its work. Also, whenever we were forced to round off a number–like dealing with partial shares–we rounded in whatever direction would yield the most conservative results.)

So when do we sell our investment?

Every single year.

But also never.

You can think of it as money that grows on a tree. We can harvest the leaves, but we never want to cut the tree down. 

Investing and the Magic of Compound Interest

How is this possible?

It’s the magic of compound interest. 

Only, it’s more than that.

The phrase ‘compound interest’ gets thrown around a lot. In short, compound interest is what you get when you reinvest your profits.

Which is exactly what we’re doing. 

But the companies we are invested in (the 500 largest in the United States) are also earning compound interest.

AND they’re reinvesting their already compounded interest into more compounded interest. 

AND you are investing in their compounding.

This multi-layered effect is why most of the time, we prefer investments in the stock market to investments anywhere else. 

All that extra compounding happens automatically, with no additional effort from us.

So, while we like real estate, to get the same compounding effect takes significantly more work and time. 

You have to find new properties to buy or build. You have to manage tenants.

We don’t shun real estate (or bonds for that matter) but we are always conscious of our number one metric: Dollar per hour of work.

If real estate is going to add too many hours, we skip it. If managing it fits into our three months per year, we go for it.

How Does This Fit into the 3MM Business Plan?

We, as 3MM investors, want to use the profits generated by our small businesses to buy more and more S&P earnings.

Eventually, the amount of earnings we have a right to will be greater than our yearly expenses. 

That’s when we begin selling the extra.  

As of right now, Leslie and I are still growing our business. Our goal is to grow our share of the S&P earnings by 15% per year. Some of that comes from the natural earnings growth that most of the companies in the S&P 500 strive for. 

The rest comes from our continuing investment. 

How and Where to Start Investing

There are two ways to go about investing for your 3MM business. You can either go directly through a mutual fund (we recommend Vanguard and will explain why in a second), or you can open an account with a brokerage and do the buying yourself.

Because we track the retained earnings of our investments, Leslie and I chose the second path. We recommend that you do too.

Mutual Funds

There are many mutual funds out there that are selling identical products. There are really only two differences between them:

1. The fees they charge to manage your money, and
2. The structure of the ownership of the fund itself

Because these are identical products (meaning they all track the same indexes) you should pick whichever has the lowest fees and the safest ownership structure (more on that in a second as well).

All of these places (Fidelity, Schwab, etc.) will blast you with these heartfelt, emotional advertisements.

And it’s all crap.

They do it because they know they are selling identical products and they are desperate to stand out from the crowd. 

Ignore that and stick to our two criteria above. 

Fees Matter!

Fees on mutual funds can seem very low. Like a few dollars per year for every $10,000 you have invested.

But it adds up.

Some back-of-the-envelope math I did for another article shows that our retirement account (chosen by our employer and not by us, regrettably) will charge us over $100,000 dollars in fees by the time we retire. 

Structure Matters!

I never see anyone talk about this anywhere, but they should.

Most mutual funds are shareholder-owned. That means the goal of the fund is to maximize profits for the people who own shares of their stock (so shares of Fidelity or Schwab).

Please note: I mean shares of the business, not the fund itself. The goal of funds with structure is to make money for them, not for you. You will always be the second fiddle.

This is why we like Vanguard so much. There are no shareholders. It gets a little brain-loopy, but the fund is owned by the people who invest in the fund.

The best way to visualize it like this: Investors pay fees to Vanguard each year to the tune of $7 billion. 

From that $7 billion, Vanguard pays its 17,600 employees and its overhead.

Everything that is left over (and here is the best part) is returned to the fund.

In a shareholder-owned fund, everything that is left over is given to the shareholders. See how that incentivizes them to charge more, but give less to you?

Vanguard

So we recommend Vanguard because it has the lowest fees right?

Nope!

Fidelity currently has the lowest fees (they charge nothing for some of their funds). 

So why don’t we recommend Fidelity?

We don’t trust them. Fidelity is shareholder-owned. 

And all the shareholders are in the same family. 

So yes the fees are lower, but I sleep better at night knowing that Vanguard is not owned by a single family of billionaires. 

So what do we actually do to get started?

Go to vanguard.com. Do a little reading on the company and what they have to offer. Their website will guide you the rest of the way.

Just remember that for the purposes of 3MM investing, we want broad-market index funds. Leslie and I prefer anything that tracks the S&P 500.

Brokerage and ETFs

The second way, and this is the one Leslie and I use, is to open a brokerage account and buy Electronically Traded Funds (ETFs) that track the same index we would have been using anyway. 

We want to track the S&P 500 Index. We do this because it is composed of the 500 largest companies in the United States (weighted by market capitalization – their total value in the stock market).

We like this because it is easy to calculate the earnings per share (it is published quarterly by Standard and Poors) which we use to help determine the intrinsic value of our business as well as for the numbers we state in our income reports. 

When we begin to sell off shares of our investments (like the 2010-2019 example above), being able to calculate earnings will give us an idea of how much we can safely sell each year. (Again, just like in that example.)

Brokerage

First, pick a brokerage. As of this writing, there isn’t much difference. I believe all the major ones now offer free trades.

We use TDAmeritrade. We have no real reasoning behind this. I opened an account with them about 15 years ago for the purposes of trading derivatives and have been with them since. 

As long as they have free trades and a user-friendly interface, you’re good to go.

Once you open an account (which will take a little while, as there are some Homeland Security hoops to jump through) you can fund it and get underway. 

You won’t be invested directly in mutual funds this way.

Rather you will be using ETFs to accomplish exactly the same job. 

Again we use Vanguard for this. Their S&P 500 ETFs (Ticker symbol: VOO) is our primary choice. They also have a total market ETF (Ticker: VTI). There are others, but we don’t use them in our 3MM business.

Stock Market Crashes

But what do we do when the market crashes?!

First, I want to put this out there: Most of the time, when the “market crashes” it really isn’t. Just this morning my news feed gave me no less than seven stories about inflation concerns, jobless claims, covid recovery stalls, unemployment, low housing starts, and other portents of economic doom. 

Actually, since I started writing that paragraph, I got another. 

Don’t get me wrong, the market does go off the rails from time to time. And it can be seriously scary. 

I began my investing career in 2007. Just in time to really pay painful attention in 2008 and 2009. 

But I want to open this section with this: Most of the time, stock market panics are fabricated by news outlets. Most of the time it’s just hot air. 

But people believe it. People panic. And people look at me like I’m crazy for wanting anything to do with anything as dangerous as “The Market”. 

Just the other day I had a friend text me for trading advice. He wanted to know how to trade when the “market is crashing like this”.

My first response was, “Wait, the market’s crashing?” That’s because I never watch the market.

So I checked things out on my phone.

What was the market doing when he texted?

It was down 3%. 

3% is not a crash. 

I kid you not, just yesterday I saw a headline that used both “plummet” and “bloodbath” to describe 1.5% decline.

Finance stories need to make it feel like a crash. They need people to click those links.

So most of the time we do exactly what we always do because the market isn’t crashing.

The Real Crashes

The market really does crash though. ANYTHING can happen AT ANY TIME. 

I have no idea what will happen tomorrow. 

Anyone who tells you they do is lying. 

So what do we do? Let’s run some scenarios:

Tomorrow the market drops 15%

What do we do? 

First, we want to know why it has dropped. 

We take a look through news headlines. Generally, they say things like “Stocks plummet as investors weigh inflation concerns (or jobless data, or a Russian cyberattack, or whatever).”

Now, this is when we ask the most important question in our investing lifetimes:

“How will it affect earnings over the next ten years.”

Most of the time it won’t. 

A cyber attack caused an oil pipeline to lose $100 million dollars? I expect the S&P to earn 24 trillion in the next decade. 

Inflation is up 1% higher than average?

The S&P will make 23.76 trillion instead. 

My point is, over the decade all of the super dramatic news stories don’t amount to much. 

Actually, it does amount to something. 

We now get to buy our earnings 15% cheaper. That is great news for us! 

Tomorrow an International Pandemic Breaks Out 

and the Market Drops 33%.

Sounds a bit too real, right?

Now we’re sitting up and paying attention. This is the sort of thing that has a chance to disrupt our earnings. 

And it did. 

According to multpl.com, yearly (inflation-adjusted) earnings at the end of 2019 were $146 dollars per share (multpl gets its data directly from Standard and Poor’s)

By the end of 2019, those earnings were down to $96 per share.

Why the decline? 

The world had shut down. International travel had ground to a halt. Governments were mandating quarantine and lockdowns. Businesses were shutting their doors. 

This is serious uncertainty.

And we as 3MM investors have two ways to approach this:

1. Using objective numbers (scarier, but more conservative)
2. Using the high-water mark numbers (probably more realistic, much less scary)

What follows is a psychological framework for how we, as 3MM investors, approach global financial crises. 

Covid was exactly that. The world has not seen such a thing in 100 years. 

When it happened, we were not the least bit concerned about our financial strength. We were far, far, more concerned about our day jobs. The risk of losing our jobs was much greater than our risk of permanent financial loss from our investments.

OK, here we go. First up, using objective numbers. 

Using Objective Earnings Data

This simply means using the actual earnings data published by Standard and Poor’s (though multpl.com is much more user-friendly). 

As a 3MM investor, you should maintain a spreadsheet that tracks the number of ETF shares you own (in our case VOO) as well as any other individual stocks you might own. 

It should also track the earnings per share (eps) of each of these. 

(Pro tip: if you use google sheets, you can use [=googlefinance(‘cell ID’,“eps”)] to automatically populate this data for common ticker symbols. Unfortunately, it does not work for VOO)

Each quarter, when S&P releases its quarterly report, we update these numbers.

As Covid spread around the globe, the earning numbers published by S&P fell… and fell… and fell.

To maintain our annual earnings we would have needed to pour lots of money into buying shares. 

This would have worked out great as prices and earnings returned to normal, but it also would have taken money away from our efforts to grow our business (non-investment) earnings, which wouldn’t make sense for a lot of people. 

So all-in-all looking at the literal actual earnings is not the best idea when your business is growing.

So when should we use actual, objective earnings?

If our business has grown as much as it can (or as much as we want it to). By this point, we probably want to pour every extra dollar into investments anyway. 

OR

If we have moved to the ‘consume’ phase of the plan, where we sell off shares to equal the retained earnings of the index. 

This works nicely when we are selling shares because we dial back our consumption when market prices are likely to be at their lowest, and dial them up when prices are at all-time highs. 

Using High-Water Mark Earnings Number

This is probably the best method if your business is still growing or if you have not yet begun selling your shares.

This method is also much easier.

You still want to track your earnings number in a spreadsheet, same as above.

But when some global crisis happens that causes earnings to decrease, you ignore the new lower numbers.

You essentially only pay attention to the highest earnings number posted by the index. 

Why?

The logic is this:

Decreases in earnings among American companies have always been (and almost certainly always will be) temporary. 

Meaning it is just a matter of time before earnings go back to your high water mark (and beyond). 

Let’s look at the worst earnings downturn in our lifetime: The Great Recession (again the following numbers are from multpl.com)

From peak to trough, earnings fell from $108 (Dec 2006) to $19 (Dec 2008).

That’s more than an 80% decline. 

Now when we buy our shares each month, we have a general idea of how much money it costs us to buy $1 of earnings. 

Let’s say we usually need to spend $25 to buy $1 of earnings.

Let’s also say that the year is 2008 and the financial world is melting down around us.

I look at the earnings of the S&P and I see that instead of the usual $25 to buy $1 of earnings, I have to spend $70!

(This is because earnings have fallen to around $19 per share, but the index has only fallen to around $1,330.)

What a ripoff, I’m not paying that! Using objective data I would not be buying shares right now.

Well, hold on.

If I use the high watermark method, I don’t look at it that way. I ask myself, how long will earnings stay this low?

At the time, I remember seeing estimates that earnings would stay depressed for ten years. 

It sounds bad, but I also want to ask myself:

In ten years, would I be happy that I bought $108 of earnings (our high watermark number) for $1,330?

And yes, I would be happy. That’s a good return on investment for a passive vehicle. And I will have the magic of compounding working for me long after earnings return to normal. 

So we buy shares. And it turns out we are buying at some of the cheapest prices in my entire life. 

How did that all pan out? Earnings crossed the high water mark again in less than five years and, as of this writing, that investment has more than tripled in value. 

The high watermark method helps protect you from fear and might allow you to see opportunities that you would otherwise miss. 

The Moral of the Story

Warren Buffett is fond of saying, “Be fearful when others are greedy and greedy when others are fearful.” 

That sounds pretty good to us. Market crashes will happen. No one can predict when the next one will happen. 

Instead, we want to be both psychologically and financially ready for it when it does happen. 

Putting it all Together 

The Berkshire Hathaway model (the model we built our investment philosophy on) is really a simple one.

Businesses that are fully owned by the company carry out their day-to-day work and send all profits (the money after they pay their expenses) back to headquarters.

Buffett, Munger, and a very small team of investors then make decisions about how to best invest that money to accomplish their goal:

Grow per-share earnings.

To do that, they first look to invest in-house. Are there any logical investments that can be made within the businesses they fully own? New Projects? New advertising? New markets to enter?

Then they look to acquire new businesses in full. Is there anything for sale at a reasonable price?

Finally, they look to the stock market to buy pieces (also known as shares) of businesses. They consider the retained earnings from these pieces of businesses to be real and important.

Here’s the really cool part:

We can do all of those things with our small home-based businesses. 

We, too, have money flowing into headquarters (maybe from our job, maybe from our small business, maybe both). We pay our expenses (bills, food, shelter) and our overhead (whatever we need to run our small business.

Then we look to invest what’s left over in-house. Maybe a Facebook ad campaign? Maybe more inventory to sell? 

Next, we look to buy productive assets. Now, we can’t go buying multi-million dollar companies the way Buffett can, but we can look for rental properties or even local businesses that have management in place. (Remember, we don’t want to trade hours for those new dollars).

Finally, we look to buy pieces of businesses in the stock market. Buffett and his investors look to buy individual stocks. They can do that because they commit large amounts of time to investigate the stocks they buy. (I heard a rumor that Buffett reads 500 pages of financial reports each and every day).

We don’t want that sort of time commitment, so we go for the 20% effort that yields 80% of the results: The S&P 500. This reduces our burden from reading 500 financial pages per day to 60 seconds of mouse clicking per month. 

Leslie and I try to grow both our business income and our share of stock earnings at about the same rate each year. 

We keep a spreadsheet that tracks our share of the earnings that the businesses we own (even small portions or ‘shares’ of). We consider these to be real earnings because, on average, each dollar that has been earned by our investees has been translated into at least one dollar of market price.

Eventually, the earnings from those investments will exceed our cost of living. When that happens, the operational portion of our business (the part that we have to actually spend time and effort on) becomes optional. The investments have become a self-feeding machine and we can retire.

And we can retire with a reasonable expectation of leaving retirement with more money than we entered it.

What’s the point of that?

Because we can leave our investments to our daughter (in a seriously tax-advantageous way) and she can continue to reap the benefits. It will be enough for her to do anything, but not so much that she can do nothing.

So there you have it. Our final piece to the 3MM puzzle.

Our Business Guide shows you how to set up a small, low-risk, easy-to-run business from home.

Our Productivity guide shows you how to run that business within the promised time frame (three months per year or two hours per day, your choice).

And finally, this investing guide shows you how to leverage that home-based business into a self-feeding investment machine that gives you and your children generational financial security.

Thanks and good luck!

Recommended Books

The Little Book of Common Sense Investing by Jack Bogle (All-Time Best Investing Book – Required!)

One Up on Wall Street by Peter Lynch (All-Time Best Investing Book – Required!)

Berkshire Letters to Shareholders (I learned more practical business lessons from these essays than from six years of college)

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