Big losses in US stocks yesterday. The Dow fell 167 points, or 1%. The start of a something bigger? We wait to find out…
We have reached the age where we have to resist the urge to give unwanted advice to younger people. Just this morning, a young woman was crossing the street:
“Hey, none of my business, but that’s a dangerous place to cross. The cars whip around the corner here… and they can’t see you because of the scaffolding.”
“Thanks,” came the polite brush-off.
And now we are about to give you, dear reader, some advice. Not a stock tip. Not a trade. Nope… This is advice about crossing the street, circa 2014.
And this advice could be worth a fortune. Especially, if you are under the age of 40. If you’re over 40… you may know someone younger who could use it.
Are You Really “Middle Class”?
The US stock market is near it’s at all-time high. Unemployment is officially below 7%.
A crazy man sits in the park carrying on a vigorous conversation with nobody. A fat woman begs for spare change on the street:
“Please, mister, can you spare some change? I’m hungry.”
It has been seven years since the first signs of the financial crisis… and now things are back to normal, right?
The poor are still poor. The rich are still getting richer. And the middle class?
What middle class?
Charles Hugh Smith, of the Of Two Minds blog, reports that many people would like to have a middle-class lifestyle… but only the rich can afford it.
The “middle class” has atrophied into the 10% of households just below the top 10%. The truth is painfully obvious: A middle-class lifestyle is unaffordable to all but the top 20%.
Smith figures there are 10 key criteria for entry into the “middle class.”
1. Meaningful health-care insurance (not phantom “insurance,” with deductibles that cost thousands of dollars a year that offer no non-catastrophic care at all)
2. Significant equity (25%-50%) in a home
3. An income-expense ratio that allows you to save at least 6% of your income
4. Significant retirement funds
5. The ability to service all your debt and expenses over the medium term, if your spouse becomes unemployed
6. Reliable vehicles for each wage earner
7. You don‘t rely on government transfers to maintain your lifestyle
8. You have non-paper, non-real estate assets, such as family heirlooms, precious metals, tools, etc., that you can transfer to the next generation – that is to say“generational wealth“
9. The ability to invest in your kids (education, extracurricular clubs/training, etc.)
10. Leisure time devoted to the maintenance of physical/spiritual/mental fitness
Who can afford all that?
Smith added up the cost of these things. It came to $106,000. Trouble is America’s middle class doesn’t earn that much. Only those in the top 20% of household incomes qualify.
So, what happened to the middle class?
We’ll get to that on Monday. But first, we’ll leave you with some advice… and a whole weekend to think about it:
Want a middle-class lifestyle… with middle-class finances… and middle-class attitudes?
Forget it. Trying to enter the middle class is like trying to get a job as a galley slave. You get chained to an oar. You sit. You row… until you drop dead.
The middle class, as Smith tells it, is desperate to continue its “aspirational consumption financed by debt.” It’s a trap – set for you by the oligarchs and “poligarchs” (people whose votes can be bought cheaply) who control Washington and its major industries.
And if you’re young, you face a lifetime of backache… trying to keep up the pace. You will be forced to pay for the most expensive health care in the world… the most expensive military in the world… and the most expensive education system in the world. All while your real income falls.
These heavy burdens didn’t “just happen.” They are the result of dirty dealing by America’s goons and poltroons… its oligarchs and poligarchs… and all the company of modern crony democracy.
More on Monday…
Further Reading: You can read more of Bill’s ideas about where the US economy is headed… and how to escape the “galley slave” life of a middle-income earner… in his bookThe New Empire of Debt, which he co-wrote with Addison Wiggin. As a Diary of a Rogue Economist reader, you can claim your FREE hardcover copy of Bill and Addison’s book here.
Follow the “Royal Road to Riches”
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
These “heavy burdens” will get a lot lighter if you can get your hands on some capital… and compound it over time.
When you compound your investments you earn profits on your profits.
Very simply, if you have a $10,000 investment that earns 10% in the first year, you’ll be left with $11,000.
If you earn another 10% the next year, you’ll be left with $12,100. Because you earned 10% on $11,000, instead of on $10,000, your 10% profit now yielded $1,100.
In year three, you’ll have $13,310… and so on.
Over time, the numbers get enormous. In 10 years, you’ll have more than doubled your money, to $25,937. In 20 years, your compound return will be 572.8%. And you’ll be left with $67,275.
That’s why Albert Einstein called compounding the “eighth wonder of the world”… and why veteran market observer Richard Russell calls it the “royal road to riches.”
But there’s a catch…
The more you fork out in investment fees, the less your wealth will compound.
For instance, if you earn a gross 10% on your $10,000 investment, but you pay 2% in fees to a money manager, you’ll compound at a rate of just 8%.
That means you’ll have just $10,800 at the end of year one… $11,664 at the end of year two… and $12,597.12 at the end of year three.
But over longer stretches of time, you really start to notice the drag of those 2% fees.
In 10 years, you’ll still have more than doubled your money. But your compound return will be $21,589.25, compared with $25,937, if you had compounded at a 10% annual rate.
And over 20 years, you’ll be left with $46,609.57, compared with $67,275, if you compounded at a 10% annual rate.
That’s still not bad, but it’s $20,665.43 less than you would have earned had you not incurred that annual 2% fee.
So, here’s a simple secret for successful investing to end the week: The more you pay in fees, the less you keep.
A hedge fund will typically charge you a fee of 2% on the capital you place under management… and another 15-20% on any “alpha” (performance over the benchmark) it generates for you.
This is despite the fact that hedge funds have done a miserable job for investors of late. Last year, for example, the S&P 500, including dividends, returned 32.4%. The HFRI Equity Hedge Index, which tracks the average performance of hedge funds, returned just 14.3%.
Mutual funds charge less than hedge funds. But the fees are still too high.
For instance, in 2012, the average annual expense ratio of all US actively-managed equity mutual funds was 0.92%. That’s better than the “2 and 20” fee structure of hedge funds, but it’s still a big chunk out of your principal.
And active mutual fund managers have a hard job beating their indexes. For instance, on average, from 2009 through to 2013, passive indexes beat actively managed large-cap mutual funds 72.4% of the time. This means if you invested in a passive index fund, you had a roughly 3-to-1 chance of outperforming an investor who relied on the stock-picking “skill” of an active manager.
The good news is fees for passive funds are lower than for active funds, even though returns tend to be higher. If that’s not a win-win, we don’t know what is.
In 2012, the average expense ratio was 0.13% for all passively managed funds (meaning they simply track an index, rather than try to beat it by picking stocks).
Even cheaper is an index-tracking exchange-traded fund (ETF). For example, the Vanguard Total Stock Market ETF (NYSE:VTI) charges a razor-thin 0.05% in fees. And it does the same thing a passive mutual fund will do for you.
Make these low-cost index-tracking ETFs the core of your long-term portfolio, and you will compound wealth far more efficiently than you would by investing in higher-cost, lower-return, actively managed funds or hedge funds.
You’ll still need time to build wealth. But your path to wealth will be a lot more certain.