A Critical Piece of the Financial Independence How-To Manual: The Simple Path to Wealth by JL Collins
A fundamental premise here at Trapped in Work is that there are a lot of Working Joes out there that are trapped in an unfulfilling career simply because they don’t know how not to be. Not that they aren’t intelligent—indeed, I worked with a lot of them at my former corporate law firm that were probably in the 99th percentile of raw intellect—but they just don’t understand that there is an alternative path to the hyper-consumption treadmill that creates indentured servitude. My mission here is to help to educate this group by adding to the financial independence how-to manual. The formula is simple at the highest level of generality: spend less than you earn, and use the balance to buy your freedom over time. But the details regarding how to make these installment payments on your freedom are, for many, unclear at best and downright scary at worst.
I have been a hard-core index fund investor for the better part of 16 years now, and this discipline has been a critical component of our family’s journey to financial independence. Any doubts about this investing approach that I ever subconsciously harbored were eviscerated by John Bogle’s book titled The Little Book of Common Sense Investing published in 2007. Mr. Bogle’s empirical analysis of the superiority of index investing gave “Bogle-heads” like me (and I suspect Mr. Collins as well) warm and fuzzy feelings (based on objective data) that our investment philosophy was not only simple and easy, but was in fact superior to more costly and time-consuming “active” investment strategies. With his book The Simple Path to Wealth Mr. Collins achieves the same objective, with the added benefits of (1) being accessible and understandable even by those that don’t already know the difference between an ETF and a mutual fund, and (2) offering valuable lifestyle-choice guidance that makes investing in freedom possible in the first place. As a tax lawyer that has studied tax-advantaged accounts and investing for many years, I take for granted the things that I know about the operation and mechanics of these arcane topics. For some time now I have referred people that wanted to do some additional reading on sound investment philosophy to Mr. Collins’s excellent “stock series” blog. The Simple Path to Wealth takes that excellent information, expounds upon it, and packages it in one easy to use resource.
The Importance of Having “F-You Money”
Before diving into the (straight-forward) details of index investing and tax-advantaged account operation, The Simple Path to Wealth explains the basic principle of “why you need F-You money”—his term, not mine (and a particularly descriptive one at that). “F-you money,” as Mr. Collins explains, gives you the freedom to make big-picture life-altering decisions without the immutable requirement of being tied to your next paycheck. In Mr. Collins’s case—and in the situation of your humble correspondent here at Trapped In Work—it can allow you to retire early, or to simply “step to the side for a while.” For Mr. Collins that luxury afforded him the opportunity for a number of invaluable life experiences along the way; first to tour Europe as a 25-year old just starting out in the workforce, and later to spend meaningful time with his young daughter that ultimately shaped the nature of their relationship (for the good). Similarly, I’m currently relying on our “F-you money” accumulated and invested over 16 years of indentured servitude to spend real time with our three young daughters and to step to the side and assess how me and Mrs. JF can better devote our remaining years to pursuing our productive passions. As a reader of Trapped In Work, you undoubtedly have your own reasons for wanting F-you money.
The Power and Simplicity of Index Investing
As discussed before here at TIW, index investing is one of the few things I’ve discovered in this life that is both (a) good for you and (b) easier than all of the other competing options. The Simple Path to Wealth lays out in clear and compelling detail why that is the case, and in a way that even an Art History major can understand (no offense intended Art-History majors, just saying). It describes the obvious truth hiding in plain sight—that paying higher fees for complex investment products that under-perform the broad market average is ridiculous. And that presuming that you can with regularity and consistency predict which direction the stock of an individual company is headed is a fool’s errand. Mr. Collins also makes clear why Vanguard is the top choice for an investment firm once you decide that indexing is the best game in town. Vanguard’s unique legal structure that aligns the interests of its investors and its owners is truly unique, and is the genesis of the company’s core philosophy of reducing investment expenses for people like you and me. All the other companies do it solely because they need to compete with Vanguard for your money.
The Dollar-Cost Averaging Debate
Mr. Collins also makes a persuasive argument in opposition to trying to time the market through “dollar-cost averaging”—or the practice of putting large sums of money into the market in smaller pieces over time in order to average out your entry (or purchase) cost. Mr. Collins rightly concludes that dollar-cost averaging in reality is adjusting your investing approach to suit your psychology, and the fact that the practice ultimately likely impairs your long-term investment performance has been proved and documented in a study published by Vanguard in 2012. Nevertheless, as someone who has from time to time (emotionally, not logically) engaged in the practice, the psychological/emotional value of dollar-cost averaging can be very real and not without value. To invest a large sum of money only to see it reduced in value by 2-5% in a day or a week can be very painful—even if you are a long-term investor that knows you will not be touching the investment for 10+ years and that it will almost undoubtedly be worth more when you do eventually sell. I think of it as a coping mechanism that can have value when dealing with large sums. Some fundamentally sound financial decisions simply are not consistent with our underlying individual psychologies.
Another common example of this logic v. emotion phenomenon is encountered in the analysis of whether you should pay off your mortgage or invest the cash in the market. If you have a 30-year fixed mortgage at 3.5%, your after-tax interest cost on this money is 2.45% (assuming a rough 30% combined federal and state tax bracket, so every $100 of interest paid saves you $30 in taxes). Many readers here will know intellectually that they will likely earn well in excess of 2.45% per year on this money by investing it in the market over the next 30 years, but nevertheless will make the emotional/psychological-based decision to pay off the debt and own their home free and clear. That has not been my decision—cold, hard financial arbitrage analysis wins out on this one for me—but I do get the psychological value perspective.
A Warm Glass of Milk (or Maybe a Cold Mug of Beer) to Help Your Digestion of the 4% Rule
No matter how many times I read the data and analysis of the so-called “Trinity Study” that supports the conclusion that a 4% annual withdrawal rate from a portfolio comprised 75%/25% of stocks and bonds, respectively, is 100% likely to support 30 years of grocery store trips and all of life’s other essentials, I still feel a bit uneasy. The logical side of my brain concludes that the analysis is mathematical and based on 85 years of objective historical data. But the emotional side of my brain never gets tired of hearing smart people like Mr. Collins confirm that the analysis is legit. This is particularly important for someone like old Joe Freedom here that may be looking for his portfolio to last well in excess of 30 years (that only gets me to 71, and while I have no intention of living beyond the point of full physical capability, I do hope I still have some kick left at that age).
The Simple Path to Wealth does a thorough job of explaining both the academic theory of the 4% rule extrapolated from the Trinity Study as well as its operation in practice—that is, how to withdraw the 4% and why you need to be flexible in adjusting this amount over time.
A Powerful Motivator
Part of my philosophy here at Trapped In Work is that Working Joe is often shackled because he is not able to see far enough into the future to understand how his financial decisions today shape that future in a very real and meaningful way. In The Simple Path to Wealth Mr. Collins provides a great motivational tool in the form of empirical evidence documenting how saving and investing today can and will buy you freedom tomorrow. Throughout the book Mr. Collins also serves as something of a personal financial/life coach. I particularly enjoyed the quote from Jack Canfield at the beginning of the Afterword: “Everything you want is on the other side of fear.” The Joe Freedom Household is testing out that maxim RIGHT NOW. Another tasty nugget in Mr. Collins’s own words: “If you decide to pursue financial freedom you are going to have to choose to spend your money on investments. Somehow in our culture this has come to be seen by most people as deprivation. That has never made much sense to me.” (See Chapter 35). In other words: Buy freedom. Not stuff.
Finally, I thoroughly enjoyed Mr. Collins’s description of the FI crowd that we are all writing about in our blogs: “While rare, [the financially independent minded] are not alone. Over the years I’ve come across any number of people embracing life on their own terms. They are intent on breaking the shackles of debt, consumerism and limiting mindsets, and living fee. They are filled with ideas and courage.” (See Chapter 34). In The Simple Path to Wealth, like in his blog, Mr. Collins provides priceless information regarding how to achieve financial independence—information that is capable of changing the trajectory of a life. If you are seeking an escape hatch from an entrapment chamber of work, I recommend you find a copy and read it (twice) right now.