A Post-Marriage Investment Plan

A fraternity brother of mine is getting married soon, and he had me draw up an asset overview explanation for himself and his future spouse. I removed most of it, and heavily edited the rest, but what remains is a good general overview of the different options for building an estate with a long-term investment plan after marriage:

As we begin, I should start by mentioning the different asset classes that can make up a diversified portfolio: You can own intellectual property that pays royalties (e.g. Keith Hernandez collecting $250 per month in royalties for his 1992 cameo on Seinfeld); you can own commodities that self-generate income (an investor owning a cattle ranch that sells two Angus cows every Friday for $3,500); you can own real estate (either owning a physical property yourself and collecting rent or by owning real estate investment trusts where you are the passive owner collecting dividend checks); you can own private businesses that you develop yourself or invest in other private businesses; you can purchase units or stock of publicly traded stocks;  you can purchase bonds from governments and companies to receive fixed-income payments; and you can own an interest-bearing account at a bank that pays you money (it can range from an FDIC checking account paying interest to a money market account that holds its value at $1.00 every day and pays you the interest on the high-quality commercial paper and government debt backing it up.)

Those are the options. That is how you build wealth in America. Some of them lend themselves to passive ownership much better than others.

Intellectual Property Income. Sure, you can own lucrative intellectual property like the Beatles’ catalog, but it would cost a cool $2 billion. The kinds of intellectual property that can be passively owned for decades often cost in the millions of dollars.

The much more attainable way to live off royalty income involves making things yourself. Ben E. King is unfortunately dead, but his estate still collects $1,232 every day from the song “Stand by Me” alone. John Madden makes more than most current professional athletes because of the licensing fees he collects from football-based video games. The guy who created my third grade Math textbook collected $1.2 million in math royalties in the past year, as mentioned in the McGraw-Hill annual report. Math! He came up with a coherent way to teach kids how to solve for x+7=3, and the legacy of his method makes him $100,000 per month.

That is the reason why my dad made me take menial jobs when I was sixteen that paid minimum wage. He wanted me to understand that the connection between effort expended and value received is not the source of permanent value. A waitress could work 100 per week and still only collect $52,000 per year. Meanwhile, a guy who drew up math problems fifteen years ago would still be collecting twice per month what our hypothetical waitress would be collecting per year.

It’s about scale. It’s about efficiency. It’s about timeless value. It’s about maintaining ownership. You don’t want to be like Billy Joel when he only made $126,000 from The Stranger because he sold the ownership of the songs to that album to outside investors ahead of time for a lump-sum cash payment. It’s crazy—a good accountant in the Midwest could have made more money last year than Billy Joel did from selling a highly successful album that reached millions of people (though Billy Joel offset this loss on the subsequent loss.) The point is that how you structure your life matters as much as the actual assets you choose. Warren Buffett is famous for delivering 20% returns for fifty years; if he was a moron about the structure of his holdings, the compounding rate would have been around 12% to 13%. That’s why I care about these things—the structure of your efforts predetermines your financial destiny.

Commodities-Based Investments. I am not someone equipped to give you an unbiased viewpoint of the benefits of commodities-based investments. Are there ways to do it successfully? Yes. Have I studied them? No. The reason is that people who have turned commodities into productive businesses can create a perpetuity that you cannot receive with one-off choices. If you buy 100 ounces of silver at $15 and aim to sell it at $30, you double your money but then have nothing left to show for your brilliance thereafter. John D. Rockefeller did not choose to store oil and sell it at a higher rate; he chose to create a business Standard Oil that still exists in various forms today (BP, Chevron, Buckeye Partners, Exxon, parts of Unilever, parts of Berkshire Hathaway, etc.) that have over $1 trillion in market capitalization. An ownership of one single share of Standard Oil from 150 years ago would give you over $200 million today.

That is why I don’t focus on the direct commodity trading side. I would rather own stakes in businesses that produce commodities because they can grow production and return cash generated from the business to you every single year. A lot of people look at things like royalty trusts and see the 12% dividend yields and think they are a good deal. Maybe, maybe not. But whey might be missing is this: Royalty trusts own a finite amount of oil to explore and terminate their corporate identity at the end of exploration. If you own Exxon, you will still have something 20 years from now. A royalty trust pays you dividend payments and eventually disappears when the owned assets get explored. I don’t like one-off opportunities; the money gets made in the singular decisions you make today that still provide you riches in 2040.

Real Estate. People who go through the hassle of owning real estate tend to go through a three-stage process: (1) They get super excited at the thought of receiving rent checks every month because it creates a feeling to see $800 checks get sent your way each month; (2) they get super-depressed when they realize the hassle of getting the property set up and dealing with tenant complaints end up becoming more than projected; and (3) once a stable tenant actually exists, the joy of being a landlord returns when you collect a passive income stream.

For a few big reasons, families have an easier time getting started with real estate compared to stocks and bonds. When you have a piece of real estate in your name, you can see it. You can touch the brick. You can walk through the kitchen. You can drive by it. It is real. When you rent it out to someone, you can appreciate the full effects of what you are doing because you actually see the connection between someone living in your property and receiving money for letting them do that. There’s no daily stock quote; you don’t get nervous the way some new investors do when they see their favorite stock decline from $50 to $40.

There are other ways to invest in real estate beyond owning property yourself. You can own slices of publicly traded Real Estate Investment Trusts (often abbreviated REITs) that pay you high dividends and remove you from the hassle of actually running your own real estate. The catch is that they are taxed at the ordinary income tax rate level. You could be paying 39.6% plus the Obamacare tax. REITs never received the benefit of the Bush-era tax cuts.

This has a significant impact on high-income investors putting money into REITS within taxable accounts. Suddenly, that 6% dividend you think you are receiving is actually a 3.66% dividend yield. That’s why your most attractive taxable account investment will rarely be a real estate investment trust. The income is a large component of the wealth you will generate from a REIT holding, and conceding a large portion of it to the government is rarely worthwhile.

If you can invest in some type of IRA or other tax-deferred structure, you may find REITs useful for aiding the amount of income produced by your household each month. When you save $10,000 in a month through REITs paying out 6%, you are in effect investing $10,050 the next month as your contribution of $10,000 from the next month’s labor will get mixed with $50 in REIT payments. Then, the next month, you will contribute $10,100 with the REIT portion growing stronger each month. This is the act of income replacement where passive sources of income gradually become larger cash generators than the labor income from your income, and the slowness in the early days is why many people make the mistake of never getting started.

Private Businesses. This is how almost every mega-fortune in the United States is made. Private businesses benefit from two very, very important attributes: higher growth rates than the typical publicly traded business, and a capitalization of those earnings. If you are a sales rep for a food company, you might go from making $60,000 to $95,000 over seven years. And that’s it. You collect that salary, and go home. There’s no additional benefit.

If you grow a private business at that rate, you not only receive the benefit of that income growth but you also can sell the business for a large pile of cash: The $60,000 business might be sold for $420,000, and the $95,000 per year business might be sold for $665,000. The S&P 500 historically grows around 6-7% (and also pays out a dividend) whereas the book value of privately held businesses grow at 12% annually across America.

This is why almost everyone you see in the Forbes 400 owns a business. That is why almost every super affluent person in your community owns a business. Things grow faster, and businesses can be sold at capitalized rate. That can be the difference between being rich in your 30s and 40s compared to having to wait until your 60s and 70s.

Publicly Traded Businesses. This is the way to make the most amount of wealth with the least amount of work. If you do something like buy the S&P 500 Index Fund, you will experience growth around 6-7% per year and collect 2% per year in dividends (based on current market prices). After making the initial purchase, you don’t have to do any more work. That’s what makes this stuff fun; the rewards continue well after your effort has been expended.

If you had $10,000 in January 1993 and put it in SPY (which currently represents 497 of the largest companies in the United States), you would have $71,600 right now. Each dollar turned into $7.16 over twenty-two years without you having to expend any additional effort.

Incidentally, my corner of the investing universe at The Conservative Income Investor focuses on the purchase of companies that are a little bit better than the typical company in the S&P 500. This difference matters—going to Wal-Mart and recognizing that there is something special about Gillette razors and Tide laundry detergent as a business will result in a different life outcome than merely sticking with the S&P 500.

If you were to buy $10,000 of Procter & Gamble stock in January 1993, you would have compounded at a rate of 11% instead of the 9% that you got from the S&P 500. At first, that two percentage point difference may not sound like a big deal. But as it compounds upon itself for over 20+ years, the end result is tremendous: Someone choosing Procter & Gamble ends up with $107,000 in cumulative wealth compared to the $71,600 that you would get from the S&P 500.

The other nice thing about these higher quality companies is that you often collect higher amounts of cash dividends during your holding period. Something like Chevron demolishes the S&P 500 over any 20+ year holding period you can find. But it is also in the unique spot of paying investors a 4.5% dividend yield right now. That makes life more fun; you can show up to work on a random Monday in March, June, September, and December and have a smile on your face because you just had a $280 dividend check deposited into your account from Chevron. I consider it a more enjoyable way to live because you’re constantly receiving cash coming your way beyond that you earn from your work.

Bonds, Interest, Fixed Income: This is a nice to generate reliable income that usually yields higher than the amount of income that you can receive from a high-quality dividend stock. Corporate bonds have historically yielded 7.2%, and U.S. Treasuries have historically yielded a little less than 6%. Right now, the United States is going through a period of low interest rates so the attractiveness of this option has diminished, but usually, bonds act as a good source of complementary income when they trade at normal rates.

Imagine buying a corporate bond index fund from Vanguard when rates normalize and you can receive 7.2% returns from your investment. Suddenly, a $100,000 portfolio in corporate bonds can add $7,200 to your account to make new investments each year. That can change your life because you own fixed income instruments that can fund your account by themselves passively. You can take the bond income and then invest in faster growth options. It’s a great way to add a balanced attack to an estate because what you sacrifice in growth you make up with higher passive monthly income.

[Rest omitted for privacy reasons.]