Don't skip this section!
If you only learn one thing from this blog, it should be this.
In colloquial terms, Pareto's Principle is the 80/20 rule. This basically states that the 20% of the key results or attributes come from 80% of the inputs. These figures don't necessarily work out to exactly 80% and 20% in reality but you get the idea. Here are a few examples:
80% of the country's wealth is possessed by 20% of its residents.
80% of all the online content is generated by 20% of its users.
80% of the gym's equipment and resources are used by 20% of its members.
80% of the customers contribute to 20% of the business profits.
80% of the value you add in your job are realized through 20% of the time and effort you put in.
20% of your clothes are worn 80% of the time.
In this blog, we will apply the 80/20 rule to improve the following:
Our Investments
Our Budgets
Our Lives/Time
Applying Pareto's Principle to Investing:
We will rely on index ETF funds and/or futures to provide maximum diversification among multiple asset classes without cluttering your portfolio with a long list of securities.
One word of warning: You might have a portfolio with several different individual stocks. As much as you're tempted to do so after reading this, DO NOT attempt to apply the 80/20 rule here by "cleaning up" the # of stocksand only keeping the ones that have provided the best returns recently or some other criteria. If you feel you have too many stocks, then sell them all and reinvest the proceeds into a well-diversified stock index fund (more on that later.)
Unfortunately, investing in individual stocks is a complex and risky process and it's very difficult, if at all, to accurately predict which stocks will perform well in the future even if they've made impressive gains recently.
Applying Pareto's Principle to Budgeting:
We will focus on cutting back on the big ticket items in your budget if possible and the items that have the most minimal impact on your standard of living relative to their price. This frees up more money to pay off debt and invest for the future.
For further exploration:
Please read the section on Pareto's Principle in Tim Ferriss's book The 4 Hour Work Week.
You can either buy and download it online
Or get it at your local public library
He explains it in greater depth and it was one of my main inspirations for writing this blog.
If you're unable to read his book, at least read the Wikipedia article on the subject
Thursday, January 31, 2013
Myths about Investing
In order for my advice to be most effective, you need to drop a few limiting beliefs and myths. It's likely not all of these will apply to you.
Myth 1: The only safe investment is a Bank deposit.
If inflation does not exist, this would be true. Savings accounts have not been paying more than 0.5% interest from 2008 to 2012 yet inflation has been much higher. Money in a savings account is not safe from the losa if purchasing power.
Myth 2: Your house is the best investment.
Even in a strong real estate market, I would not advise having no other investments other than your house. It's like a stock investor only investing in the stock of his/her own company. You may get lucky bit you will be exposing yourself to unnecessary risks if the cards don't play out to your favor.
If you are young and do not have much saved, you will need to save many years before you can afford a down payment. That's many years where you could hace invested in stocks, bonds, commodities and taken advantage of compound interest.
That's not to say you shouldn't buy a house or invest in real estate in a well-diversified portfolio. (More on that later.)
Myth 3: You can get rich by investing following the news on the Wall Street Journal, CNBC, etc.
No. If it were that easy, we'd all be multimillionaires. Yet many novice investors tend to have this naiive misconception. I've dedicated an entire chapter on this (the Efficient Market Hypothesis.)
Myth 4: Stock prices (or Gold prices, Treasury prices, etc.) are already too high. There's no way I'd put any in my portfolio!
Money managers who felt the NASDAQ was too high in 1999 lost big shorting it. The NASDAQ eventually doubled and peaked in 2000 before dropping below their 1999 levels. Were these managers "right"? Yes, but their timing was off.
Myth 1: The only safe investment is a Bank deposit.
If inflation does not exist, this would be true. Savings accounts have not been paying more than 0.5% interest from 2008 to 2012 yet inflation has been much higher. Money in a savings account is not safe from the losa if purchasing power.
Myth 2: Your house is the best investment.
Even in a strong real estate market, I would not advise having no other investments other than your house. It's like a stock investor only investing in the stock of his/her own company. You may get lucky bit you will be exposing yourself to unnecessary risks if the cards don't play out to your favor.
If you are young and do not have much saved, you will need to save many years before you can afford a down payment. That's many years where you could hace invested in stocks, bonds, commodities and taken advantage of compound interest.
That's not to say you shouldn't buy a house or invest in real estate in a well-diversified portfolio. (More on that later.)
Myth 3: You can get rich by investing following the news on the Wall Street Journal, CNBC, etc.
No. If it were that easy, we'd all be multimillionaires. Yet many novice investors tend to have this naiive misconception. I've dedicated an entire chapter on this (the Efficient Market Hypothesis.)
Myth 4: Stock prices (or Gold prices, Treasury prices, etc.) are already too high. There's no way I'd put any in my portfolio!
Money managers who felt the NASDAQ was too high in 1999 lost big shorting it. The NASDAQ eventually doubled and peaked in 2000 before dropping below their 1999 levels. Were these managers "right"? Yes, but their timing was off.
Prologue
Forget what you learned about Finance, Investing, Trading, Economics, etc. from your favorite financial news source, be it that financial newspaper you get every morning or the TV channel about the stock market.
Forget what your favorite financial guru told you, especially that one with his N-step plan to financial freedom.
Forget what your Business/Finance/Economics professors told you in school.
No, I'm not telling you everything you've learned in this subject is wrong. On the contrary, much of what you've learned is correct but you need to keep an open mind that not all of that will be helpful or practical for your financial future.
A few additional recommendations for this material to "stick":
1) If you don't understand the words, phrases, or jargon I'm using, please look it up. I recommend www.investopedia.com for Finance-related terms. I'll try to define key jargon but I may not always remember to.
2) Please read the book through in order from front to back even if you already understand some of the material. I sometimes might present it in a way you've never seen it before. Also, some of the material may not make much sense until you've absorbed all of the lessons - things will more likely come together at that stage.
3) Do not just read the material and be done with it. Try to apply the concepts to your own investing and personal finances! Although I'm presenting a fairly conservative investment approach, I recommend only investing the money you can afford to lose for at least a few months before you get acquainted to how this strategy works. If you have a personal financial advisor, please show him/her this book and work with him/her in the implementation.
Forget what your favorite financial guru told you, especially that one with his N-step plan to financial freedom.
Forget what your Business/Finance/Economics professors told you in school.
No, I'm not telling you everything you've learned in this subject is wrong. On the contrary, much of what you've learned is correct but you need to keep an open mind that not all of that will be helpful or practical for your financial future.
A few additional recommendations for this material to "stick":
1) If you don't understand the words, phrases, or jargon I'm using, please look it up. I recommend www.investopedia.com for Finance-related terms. I'll try to define key jargon but I may not always remember to.
2) Please read the book through in order from front to back even if you already understand some of the material. I sometimes might present it in a way you've never seen it before. Also, some of the material may not make much sense until you've absorbed all of the lessons - things will more likely come together at that stage.
3) Do not just read the material and be done with it. Try to apply the concepts to your own investing and personal finances! Although I'm presenting a fairly conservative investment approach, I recommend only investing the money you can afford to lose for at least a few months before you get acquainted to how this strategy works. If you have a personal financial advisor, please show him/her this book and work with him/her in the implementation.
Disclaimer
Before you follow any financial advice presented on this blog, please understand the following.
2 Hour Finance assumes knowledge of the security selection, tax laws, security laws, etc. as of 2013. It is possible, although not likely, that the implementations suggested may no longer be possible or feasible in the future due to additional security regulations. If it's in the far future and some of the index and commodity securities suggested are no longer traded, please ask your broker what alternatives are offered.
This blog expresses my own opinions, knowledge, and interpretations of concepts related to finance, investing, and economics. I'm no registered securities representative, broker, financial advisor, etc. and cannot be held responsible for your loss of money, investment under-performance, or any other mishaps from following my advice. All investments contain risk and you are advised to understand the risk and perform your own due diligence before taking on any advice offered in this blog.
Also, this is not a get rich quickly scheme. However, one can acquire wealth by diligently applying the principles in this blog over many years.
2 Hour Finance assumes knowledge of the security selection, tax laws, security laws, etc. as of 2013. It is possible, although not likely, that the implementations suggested may no longer be possible or feasible in the future due to additional security regulations. If it's in the far future and some of the index and commodity securities suggested are no longer traded, please ask your broker what alternatives are offered.
This blog expresses my own opinions, knowledge, and interpretations of concepts related to finance, investing, and economics. I'm no registered securities representative, broker, financial advisor, etc. and cannot be held responsible for your loss of money, investment under-performance, or any other mishaps from following my advice. All investments contain risk and you are advised to understand the risk and perform your own due diligence before taking on any advice offered in this blog.
Also, this is not a get rich quickly scheme. However, one can acquire wealth by diligently applying the principles in this blog over many years.
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