Tuesday, October 13, 2009

Guard Thy Treasure

Rule #1: Do Not Lose Money

In his book The Richest Man in Babylon George Clason describes how someone could become wealthy by saving and investing 10% of his earnings every year. However, what was done with that money was very important. The vehicle for the money had to be safe. In the book he tells the story of one man who gave his money to someone pretending to be an expert investor and he never saw the money again. He was the Bernie Madoff of Babylon! So if you work hard to be able to put that 10% aside, the first rule has to be: do not lose the money. Or as he put it in step 4, “Guard thy treasures from loss.”

Their Investments Were a Waste of Time

Have you lost money in the market? You are certainly not alone. And yet, it may not be as bad as you think, for your investments are not what will create your wealth. Instead, look at the last lesson in Clason’s book: “Increase thy ability to earn.” In a study done at Harvard Business School that followed a group of people who wanted to become millionaires, they found that their investing was largely a waste of time. Those who did become wealthy did so not in the market but by continually increasing their earning potential. They made themselves more valuable and earned more, or they grew their business; ultimately their cash flow, not their investing, made them wealthy.

Rule #2: Refer to Rule #1

This bit of wit and wisdom is attributed to Warren Buffett, who detests risk, and has carefully built up a track record of strong returns. Yet even he, a full-time investor in the market, has lost money. So what can we do? Look for a place to put your money that cannot lose money, and yet has potential for making gains when the market goes up.

The Power of Zero

One solution that has these qualities is the equity-indexed annuity (EIA), which offers returns tied to a market index, such as the S&P 500. It also features a minimum return rate guarantee like traditional fixed annuities. In the past this minimum, or floor, was often 0%, and so the insurance companies used the phrase “the power of zero.” That is, when the market goes up, you participate in the gain. When the market goes down, your annuity holds it’s value. Now, however, many annuities have a floor not at 0% but somewhere between 1 and 3%. Indexed Annuities are popular with investors who want to benefit from the upside potential of the market without forfeiting the security of a guaranteed return.

So to follow the path of the richest man in Babylon – to guard and increase your treasure – consider indexed annuities as one vehicle to get you where you want to go.

No comments:

Post a Comment