Finance 101: September 2022
In September the financial advisors at Ruedi Wealth Management wrote 5 more “Finance 101” columns for The News-Gazette’s Business Extra section. Make sure to look for them every Sunday, but in case you missed the columns from September all five are below.
Slow FI and Coast FI
David Ruedi, CFP®, RICP®
In past columns, we have written about what is known as the “FIRE” movement – short for Financial Independence/Retire Early. This group of motivated super-savers seeks to achieve financial independence and be free from the need to work as early as possible. They usually do so by living radically frugal lifestyles that allow them to save most of their income.
Though financial independence is a goal everyone should be moving towards, not everyone is able to save most of their income. On top of that, working extra hard and living a spartan lifestyle just to be rewarded with financial independence down the road can cause unhappiness and lead to burnout. As a result, many people have started to find a better balance between enjoying life now and saving for the future by intentionally slowing down the race towards financial independence (FI).
Intentionally slowing the march to financial independence is often called “Slow FI.” The idea is to maintain a course towards financial independence while enjoying life along the way. Slow FI practitioners may deliberately choose a lower-paying job, work fewer hours, or spend money on things that bring them happiness. These decisions will certainly delay financial independence but are considered worthwhile tradeoffs because they allow them to be happy now.
A specific milestone on the path to financial independence is called “Coast FI.” Coast FI is the point where your existing retirement savings, if left invested, will eventually grow to a value that will allow you to retire at the age you desire. At this point, there is no longer a need to save additional money for retirement, which makes it possible to work a lower-paying job that is more enjoyable or work fewer hours and “coast” until retirement.
Slow FI and Coast FI are natural responses to the overly frugal lifestyles required to retire extremely early. By ensuring they are on track to achieve financial independence at an age they are comfortable with, people who pursue Slow FI and Coast FI are free to spend a bit more money or work less without feeling guilty or worrying about money. This allows them to truly enjoy every phase of life instead of waiting for a future retirement date to be happy. But as you may have guessed, all of this takes careful planning. If you aren’t sure how to plan your route to financial independence yourself, you may want to talk to a financial planner.
David Ruedi is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.
What is Wealth?
Paul R. Ruedi, CFP®
If you look up the word “wealth” in the Oxford dictionary, you will likely find it defined as “an abundance of valuable possessions or money.” At first pass, it seems like another term for rich, or simply a person who has a lot of money. But there is a key even in the dictionary definition that the word wealth or wealthy means something slightly different than rich: abundance.
I think of wealth not as a specific dollar amount, but more as a person’s ability to fund their lifestyle with the assets or money they have. If a person has more than enough to fund his spending, he is wealthy. If he doesn’t, he isn’t wealthy, even if he is a multi-millionaire. That is because wealth is not a dollar amount, but an equation. That equation is essentially how many years of spending can a person’s current assets support. The second part of that equation, ongoing spending, is just as important, if not even more important, than a person’s dollar amount of savings or assets.
Suppose one person has $1 million of savings and another person has $2 million. The person with $2 million is wealthier right? Well suppose the person with $1 million spends only $50,000 per year, while the person with 2 million spends $250,000 per year. The person who has $1 million can support himself for decades. The person who has 2 million can only support his spending for 8 years or so. All of a sudden, the person with $1 million sounds a lot wealthier.
But if you asked the person with $1 million, who sees their neighbor with $2 million driving fancy cars and taking expensive vacations, they likely won’t feel wealthier than their higher-spending neighbor. But this is another case of the tortoise and the hare, where those who spend fast take their spending up-front, but those who keep their spending in check slowly and steadily build true wealth they can’t outlive.
Of course, everything must exist in balance, and you wouldn’t want to live a harshly frugal lifestyle in the interest of being “wealthy” at some future date that may never arrive. You must find a way to enjoy life now while building up your wealth for your future, and that requires careful financial planning. If you aren’t sure how to do that yourself, you may want to talk to a financial planner.
Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
Fishing for Investing Wisdom
Daniel Ruedi, CFP®, RICP®
As a financial advisor I see parallels with investing in almost all aspects of my life. One of my favorite activities, fishing, is no different. A lifetime of fishing has intuitively taught me several universal truths that apply in investing as well.
The first is the importance of diversification. People often know not to put all their eggs in one basket in order to reduce their risk. But diversification also increases the chance you own what is working. When I head out fishing, I bring several different lures and baits with me. Though I would like to believe I know for sure which lure will work best in advance, I won’t really know what is working until I am out on the water. Having a diversified array of lures in the boat at all times makes it more likely I will have that day’s magically successful lure in the boat.
I can’t help but think how similar this is to stock investing. Yes, it is important to hold a large number of investments to make sure no single investment takes your whole portfolio down with it. But an equally important reason to diversify if to make sure you own the big winners in any given year. In the same way that one good lure may catch all your fish in one outing, stock returns are driven by a handful of star performers. It is essential to own those star performers if you want to reap the rewards of investing.
Fishing also teaches that although you hope you catch a fish on every cast, many times you are disappointed. But that does not mean you should try one cast and give up if you have a bad experience. You will need to be patient, keep a level head, and continue diligently casting. These are the exact same things required for successful investing, as people will need to wait through some tough times without giving up in order to reap market returns.
When fishing and investing, you also have to accept what you can’t control and recognize there is an element of luck involved. But if you focus on what you can control and stay patient, you set yourself up for the lake to deliver fish and the market to deliver returns. If you aren’t sure if you have the expertise or patience to be an investor, you may want to hire the financial version of a fishing guide to put the odds in your favor.
Daniel Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
The Flaw of Averages
Paul A. Ruedi
As a financial advisor who has to correctly use statistics when creating financial plans, one of my favorite books covers how seemingly simple statistics can be completely misunderstood. The book was written by a Stanford University professor named Sam L. Savage and is cleverly titled The Flaw of Averages. As the title hints, even a statistical concept like an average can be misunderstood and result in flawed decision-marking.
Any time you reduce an entire data set to a single number, it hides the reality of that data set. Take for example the averages of two series of numbers. The first series is 4, 4, 4, and 4. The average of those numbers is obviously 4. The second series is 20, 0, 8, and - 12. The average of those number is also 4. Though the average of the two groups of numbers is the same, the underlying data set is radically different in a way an average simply doesn’t capture.
As humans we often use averages to set our expectations when making decisions under uncertainty. But averages can be misleading and get people into trouble. Savage uses the example of a statistician who drowns in a river that is three feet deep on average. He uses a cartoon to illustrate the river with shallow sides and a deep middle section. The river truly is 3 feet deep on average, but lurking within that average is a section deep enough to cause trouble.
As you can see, having an incomplete understanding of statistics can lead to serious consequences. Anticipating stock returns for financial planning purposes is a prime example of this. The average annual return of the S&P 500 going back to 1928 is just above 10%.* But that data set includes extreme returns well above and well below 10%. Though the long-term average return is around 10%, investors should not expect to receive that number in any given year, much less several years in a row.
For this reason, you simply can’t make financial planning decisions using assumptions of average stock returns. You must incorporate the entirety of a much larger data set to understand all the different potential outcomes investors could experience. If you are concerned your financial plans may be based on average assumptions, you may want to revisit those assumptions. If that all sounds way too complicated to do yourself, you may want to seek the help of an expert.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Patiently Waiting
Paul A. Ruedi
Though the stock market is off the lows we saw in June, investors have been waiting for around nine months for their portfolios to recover their previous high account balances. Though nine months isn’t a particularly long time for someone with a sense of financial history, it is long enough to make people get impatient with stocks. But at the risk of sounding like the bearer of bad news, I have to remind everyone that spending time below previous highs is just the deal we make when we invest in stocks.
I have previously discussed a study from Dimensional Fund Advisors that looked at S&P 500 returns from 1926 all the way until 2021, and found that 30% of months included a new high from the S&P 500. But if 30% of months included a new high, that means 70% of months did not include a new high, and that time was spent below some previous high-water mark.
Given these numbers, not only is spending time below previous highs normal, it is what you should expect to experience the majority of the time as an investor. That can be very difficult for investors emotionally, especially when months turn to years without a return to previous highs.
The logical question people ask in response to this inconvenient truth is “how long will investors have to wait?” Though nobody can predict the future, I think it is important to know how long investors have waited in recent history. It took the S&P 500 over 7 years to recover its old highs after the dot.com bust in the early 2000s.
After recovering this high-water mark, it proceeded to crash again during the 2008 financial crisis and would not return to those high price levels for over 5 years. But the market has also recovered much faster than that, as it only took a matter of months for the S&P 500 to recover from the early 2020 pandemic-induced decline. Of course I must mention past performance is not an indicator of future results.
Successful investing requires patience, as investors will spend a lot of time waiting for their portfolios to recover a previous high. But those who have the patience to wait out the years of negative or below-average returns are rewarded with staggering long-term returns over a lifetime of investing. If you don’t think you have the patience to be a successful investor yourself, I’d highly encourage you to find a financial advisor who does.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.