David R. Henderson  

Financial Advisor

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NOTE: This post is NOT financial advice. Rather, it's my relating of some interesting stories that my tax accountant told me.

Every March I have my annual meeting with my tax accountant. The meeting lasts 30 minutes. In the first 15, we go over my numbers and in the last 15 he tells me stories about various investments he has been in, some of which made him a lot of money and some of which lost him a lot. I've noticed that one thing almost all his losers have in common is the absence of due diligence on his part. I always find the last 15 minutes exhilarating. Here's a guy who has an Associate degree from the local community college, is a few years younger than me, and has a net worth in the 8 figures. Talking to him is far more exciting to me than talking to the average academic economist.

So each year I tell him that I would like to take him out for a nice meal and pick his brain. Each year I don't. This morning I did: the only time he could make was breakfast.

He told me stories about various people he's known over the years and has noticed a pattern in those who build a nice fortune and those who don't. He did so this morning and said that there are three key elements that all the successful ones had in common. "I know one," I said, "diversification."

"No," he said, "that helps, but that's not it." The three he named are:
(1) Don't have a lot of overhead. Don't commit to a large rent. Don't have a large mortgage or, if you do, pay it down quickly.
(2) Be "footloose." That is, be able to adjust quickly when things go bad. So, for example, he told the story of a friend who was doing well but then had his rent on a municipal property jacked up by a local government that saw that he was doing well. His friend didn't renew the lease but went elsewhere quickly.
(3) Take advantage of--and maximize if at all possible--all of the tax-advantaged ways of saving that you have access to: max your 401(k), max your Roth, etc. He told of a man who worked for a large company and who, over his working life, maxed his 401(k) and now has $1.4 million in that account alone.

His stories and thinking reminded me of the spirit and, to some extent, the letter of Dwight R. Lee's and Richard B. McKenzie's excellent book, Getting Rich in America: 8 Simple Rules for Building a Fortune and a Satisfying Life. As I said in my review of the book in the Wall Street Journal, their book "is the how-to handbook for becoming the millionaire next door."

I'm willing to bet--call it a hunch--that most people, if asked to name someone who they think is a humanitarian, would not put a tax accountant who makes a lot of money high on their list. But I've gotten to know this one over about 25 years and, with his careful thinking about how to make and keep wealth, thinking that he seems willing to share with those who will listen, my accountant is a true humanitarian.

UPDATE
Here is a note from my tax accountant referred to above, after he saw this post:
"One correction. I never did get my AA. I dropped out to pursue my golf. Never made it as a pro. Enjoyed our breakfast."


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COMMENTS (7 to date)
davevanv writes:

I would be surprised if extremely wealthy people used a diversified approach to investing in order to gain their wealth.

Bryan Willman writes:

I know a number of people who made it big by working very hard to execute on advantages in one major thing. (Software.) So much for diversification.

But the other parts are true - don't waste money, don't get stuck with stuff, always think in terms of net of tax and real value net of taxes and inflation.

In fact, my bit of free advice would be to always think about what you have after taxes (and all other costs), and how that does and will compare with inflation.

Finch writes:

I remember that being the one implicit lesson of The Millionaire Next Door, although it was obviously not the explicit one: risk it all on one venture and get lucky. The second lesson, also implicit and not explicit was: when in a high income tax environment, it's better to make your money on capital gains.

The first message obviously isn't very useful. The second message is useful in some environments, but no longer applicable in the US. In 1970 (the data in TMND is dated), being a high-earner wasn't a great path to riches - you needed deductions you didn't have if you were a doctor or something like that - but today it is at least okay.

I've rarely read such a well-regarded work in which the authors totally missed the point of their own research. Diversification is a path to the middle class.

Mark Brophy writes:

I'm one of the millionaires next door. I earned my money because I wasn't diversified in my investments most of the time. I was right about 70% of the time. I got enough money to play the investing game by refraining from incurring any home mortgage debt. Your cash flow will improve if you rent.

You can make money only by thinking independently. College teaches you to be a conformist, as Brian Caplan notes. College is good for employers, but not good for you.

As the accountant notes, it's amazing how many people don't max out their retirement plans even when the employer matches the contributions. You can't play the investing game without first getting the basics right.

I never had an employer. Companies were always willing to pay me much more to work for a few months at a time. Hiring an employee is like adopting a child in the eyes of the government, so employers respond by paying low salaries. If job security is important, you're unlikely to become rich. Ask for a big raise even if you're afraid that you'll be fired. Insecurity and change are unpleasant facts of life, but you'll thrive if you can cope.

SheetWise writes:
"I've noticed that one thing almost all his losers have in common is the absence of due diligence on his part."

It's a funny thing, financial professionals can be some of the biggest offenders in that way. They've been there, seen that -- and end up believing they can't be fooled. ALWAYS get independent background checks.

IVV writes:

But how do you reach $1.4MM when you're limited to deposit $15K/yr?

Ah, yes, earn 7% a year for 30 years. Easy with a company match. Difficult without one. Ah, the beauty of being late Gen-X.

Douglass Holmes writes:

Diversification makes sense in investing, if the things you are investing in are not your area of expertise. Financial investments are not my area of expertise, so I diversify there. But who would expect Tiger Woods to diversify into other area of sports? The person who successfully diversifies into other areas of expertise is the exception, not the rule. Michael Jordan had limited success going into baseball.
Someone who is really an expert at something should throw everything he has into it, time, talent, and money. A few will succeed wildly. Most of us will not, but with patience and following some of these simple rules, a lot of us can amass a good bit of wealth. The rest, who don't follow these rules are still much wealthier than our ancestors.

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