Growing Up vs Growing Out

Theodore R. Johnson worked for the United Postal Service (UPS) and never made more than $14,000 a year, and yet, he accumulated a net worth of more than $70 million.

Incredibly, what got Johnson started was when he told a friend he couldn’t save. But his friend reminded him that if his taxes were increased, the money would be taken out of his pay and he’d be forced to adjust.

Johnson’s response was simple, he created a tax of his own to make him wealthy. And even though he made little money, he took 20 percent of all his money (wages plus Christmas bonuses) and it went straight into an investment account. Over more than five decades, that compounded to make him $70 million. [1]**

Welcome to deep dive number four.

Growing Up
For the next 3-5 years it is expected we will exist in a low rate, low growth, and a low return environment. Therefore, the conventional wisdom of buying low and selling high may not yield the results we expect or hope for. Trying to grow upwards will have its limitations and could easily disappoint.

So what’s the solution?

Growing Out
The secret to Theodore Johnson’s wealth was not in the assets he bought. In fact, all he ever did was use his savings to purchase UPS stock because he really believed in the company he worked for. He never bought anything else.

Equally, Johnson never relied on buying low and selling high to create his wealth. He stayed the course and only ever bought, he never sold.

The secret to his success was to continually reinvest his earnings (or dividends) back into more UPS stock. He compounded his wealth by buying more stock which produced more dividends which he used to buy more stock and the snowball continued. He became an Einstein disciple and finished up with a net worth of $70,000,000.

Einstein called compound interest the ‘greatest mathematical discovery of all time.’

Compounding is what I call ‘growing out’. It doesn’t rely on asset prices rising, or ‘growing up’, for an asset base to appreciate in value. It grows in any season, especially in a low rate, low return, low growth environment.

A Profitable Paradox
Ever since the GFC, the stock market in particular, has not recovered to its pre GFC levels. Ironically, this has given investors the opportunity to buy more stock at cheaper prices. Asset bases begin to grow ‘out’ instead of ‘up’.

And therein lies the paradox…the longer the market remains low the more investors can buy for the same amount of money and be better off in the long run.

Growing an asset base ‘out’ instead of ‘up’ is also the ideal way to prepare for retirement because more assets means more income. It doesn’t rely on capital gain to fund retirement.

Not surprisingly, negative gearer’s struggle with this concept the most. Reason is, asset prices must appreciate because that’s the only way you can make money on an investment trading at a loss. For mine, that’s the biggest drawback with negative gearing, it creates a mindset that remains stayed and stuck. It becomes a one-way rut. (That’s an observation btw, not a criticism).

Bulking Up
Last month I mentioned three funds we have recently been putting our clients into, yielding 8, 10 and 12.5% pa.

To give you an example of how powerful compounding is, the following shows how long it will take for each fund to double in value (approximately).

Fund A at 8% will double every 9-10 years

Fund B at 10% will double every 7-8 years

Fund C at 12.5% will double every 6 years.

Remember, compounding does not rely on asset prices appreciating. However, when asset prices do take off, you get the best of both worlds – up and out, not just up.

Have a great weekend!

Adam

** $14,000 is based on Theodore’s average wage when he retired in 1952, which in today’s terms it’s worth approximately $184,000. That said, it’s still a good illustration of the power of compounding. Imagine building a fortune of $70m on a wage of $184,000. Put another way, suppose you only earn half that wage, but were still able to build a net worth of $35m.

[1] Source: New York Times, 1991

Back paddock – Have you seen Ahn Do’s show on the ABC, ‘Brush With Fame’? It’s on Wednesday nights at 8pm. It’s a great show and not only are his paintings brilliant but so to are the conversations with his guests. His last three shows have featured Magda Szubranski, Amanda Keller and Dr Charlie Teo. I highly recommend it.

And if you enjoy a good read, his autobiography is a ripper, ‘The Happiest Refuge’.