Book SummaryThe Simple Path to Wealth, by JL Collins

1-Page Summary1-Page Book Summary of The Simple Path to Wealth

Most people realize money is important for getting what you want out of life—but they don’t want to spend a lot of time thinking about it. The Simple Path to Wealth grew from a blog series Collins subsequently wrote simplifying money and investing for his young-adult daughter. To get along in the world, you need to understand money, he argues. Your options are to take charge of your money—put it to work for you as your “servant”—or be mastered by it.

Of course, everyone has better things to do than obsess about money—for instance, live your life, raise children, make your mark on the world, or enjoy retirement. But ignoring money leaves you open to being taken advantage of by financial advisors who profit from your ignorance by, first, convincing you that you need help, then by selling you complex and costly investments that perform poorly.

In contrast, The Simple Path to Wealth argues that investing isn’t complicated—you can do it yourself. Collins’s “simple path” is: Spend less than you make, stay out of debt, and invest in index funds. If you follow this prescription, you’ll end up wealthy and live a more fulfilling life.

Take Two First Steps

Before starting to invest, do two things:

1) Save until you have “F-You Money,” a financial cushion that gives you the ability to make choices about what you want to do rather than being a victim of your circumstances. For example, having F-You Money allows you to walk away from a job you hate, take a “sabbatical” to do something you dream of, or avoid poverty if you’re laid off.

F-You Money, plus the money you invest for your long-term future, both buy you freedom—and your freedom is the most important thing your money can buy. Ultimately, your goal is financial independence: the point where you can live on 4% of your nest egg a year without having to work for the rest of your life. (Your nest egg remains stable or grows if you withdraw only 4% a year and the market grows.)

2) Get out of debt. While borrowing gets you the latest consumer products, it keeps you from saving and building wealth because your income is consumed by debt and interest payments. Also, debt makes you a slave to your employer: You have to stick with your job, even if you hate it, because you have to make debt payments.

Change Your Mindset

The rest of the book focuses on investing, which requires changing your mindset about money. To build wealth and become financially independent, stop thinking about money in terms of what it can buy and instead think of it in terms of what it can earn.

Wealth accumulation is made possible by compounding, in which money you invest earns interest, and you add the interest to the original sum, making it larger so it earns even more interest. With compounding, a relatively small amount of money invested in stocks grows significantly.

Here’s how it works. Based on the average market return of 11.9% a year with dividends reinvested from 1975-2015:

• If you invested $12,000 in stocks in 1975, it would have been worth $1,077,485 in 2015.
• If you instead invested just $130 a month or $1,650 a year for 40 years, you would have accumulated $985,102.
• By increasing your $130 a month to $150 or $1,800 a year, you would have accumulated $1,136,656.

But you don’t actually have to wait 40 years to achieve financial independence:

• If you made $25,000 a year and invested half or $12,500, you could be financially independent in around 11.5 years (drawing 4% a year on accumulated wealth of more than $312,500 and continuing to live on $12,500 a year).
• If you decided to live on your full salary of $25,000 when your nest egg reached $312,500, and you just left your nest egg alone for 10 years, it would grow to $961,946 without your adding anything. If you quit your job after 10 years, you could draw $38,478 a year at a rate of 4%.

Stock Market Truths

To invest successfully, you must understand and accept certain truths about the market:

1) The market is the most effective wealth-building tool ever: Your money should be in the market working as effectively as possible for you as soon as possible. Collins touts Vanguard's VTSAX Total Stock Market Index Fund as the simplest and most effective investment for tapping into the market’s wealth-building capabilities. (Collins notes that he isn’t being paid by Vanguard to promote its funds.)

2) The market always goes up over time: You can predict that it will be higher in 10-20 years than it is today. It’s been on an upward trajectory for 120 years. The Dow Jones Industrial average started the last century at 68 and ended at 11,497 (in 2010). As investor Warren Buffett has pointed out, this period included two world wars, a depression, periods of high inflation, oil shocks, and a dozen recessions and financial panics. Despite dips, the market maintains an overall upward trajectory.

3) The market is volatile: Market crashes (drops of 20% or more) are inevitable—a major plunge typically occurs about every 25 years, plus there are more frequent smaller drops in that timeframe as well as several bull (increasing) markets. There’s always a major crash somewhere ahead—for example, on October 19, 1987, on Black Monday, the market suddenly dropped 22% or 500 points. In addition, even bigger disastrous events like the 1929 Great Depression are part of the predictable process.

4) Investing successfully requires accepting risk and having the discipline to stay the course during downturns: To succeed as an investor, you’ll have to prepare yourself intellectually and emotionally for downturns and tough them out. If you panic instead and sell, you’ll lose.

How to Invest: Three Questions and Three Tools

Investing doesn’t have to be complicated, and you don’t need an advisor to help you. In fact, it’s easier and more profitable for you when you keep it simple. **Getting started in investment requires...

The Simple Path to Wealth Summary Introduction

Most people realize money is important for getting what you want out of life—but they don’t want to spend a lot of time thinking about it. The Simple Path to Wealth grew from a blog series Collins wrote in response, simplifying money and investing for his young adult daughter. To get along in the world, your options are to take charge of your money—put it to work for you as your “servant”—or be mastered by it.

Ignoring money leaves you open to being taken advantage of by financial advisors who profit from your ignorance by, first, convincing you that you need help, then by selling you complex and costly investments that perform poorly.

In contrast, The Simple Path to Wealth argues that investing isn’t complicated—you can do it yourself. Collins’s “simple path” is: Spend less than you make, invest the extra in index funds, and stay out of debt. If you follow this prescription, you’ll end up wealthy and live a more fulfilling life. The majority of the book focuses on exactly how to invest.

Accumulating wealth requires changing the way you handle and think about money, including:

• Rejecting a consumer-oriented lifestyle focused on spending and borrowing....

Shortform Exercise: Start Saving F-You Money

“F-You Money” is a financial cushion that gives you the ability to make choices about what you want to do rather than being a victim of your circumstances. For example, having F-You Money allows you to walk away from a job you hate.

Do you have any F-You Money saved at this point? Why or why not?

The Simple Path to Wealth Summary Part 1: How to Think About Money | Chapter 1: Debt Isn’t Normal

Investing for financial independence requires thinking about money differently, starting with debt. Debt is the biggest obstacle to building your wealth because when you’re making debt payments, you can’t save.

However, debt has become so common in our society that almost no one questions it. We erroneously see it as normal and even necessary for success (many people believe you should incur “good debt,” such as a mortgage). Banks, credit card companies, car dealers, retailers, and others promote debt because it allows them to sell more products more easily and at a higher price because of the interest they charge. At the same time, the easy availability of college loans and car loans has encouraged carmakers and colleges to increase the amount they charge.

Besides not being able to accumulate wealth, when you have debt:

• You’re a slave to your employer: You have to stick with your job, even if you hate it, because you have to make debt payments.
• You’re constantly stressed: You feel worried, ashamed, and helpless about how much you owe.

How to Pay Off Debts

Paying off your debts is simple in concept but difficult in practice. You must...

Shortform Exercise: Rethink Your Debt

Debt is the biggest obstacle to building your wealth because when you’re making debt payments, you can’t save. If you have debt, Collins advises you to focus your full attention on getting rid of it by following the steps in this exercise.

Step 1: List all your debts, in order of interest rate (with the highest rate first). How much do you pay a month on debt? How does this affect your spending and saving options?

The Simple Path to Wealth Summary Chapters 2-4: Change Your Mindset to Build Wealth

Most people don’t start their working life thinking they will retire as a millionaire, or thinking about becoming financially independent so they can quit work as soon as possible. However, any middle-class wage earner is capable of reaching one or both of these goals by accumulating wealth over time through compounding.

With compounding, the money you invest earns interest, and you add the interest to the original sum, making it larger so it earns even more interest. With compounding, a relatively small amount of money invested in stocks grows significantly.

Here’s how it works. Based on the average market return of 11.9% a year with dividends reinvested from 1975-2015:

• If you invested $12,000 in stocks in 1975, it would have been worth $1,077,485 in 2015.
• If you didn’t have a lump sum and instead invested just $130 a month or $1,650 a year for 40 years, you would have ended up with $985,102.
• By simply increasing your $130 a month to $150 or $1,800 a year, you would have accumulated $1,136,656.

This would have happened despite the market ups and downs over that 40-year period, including the 2008 financial crisis.

In terms of achieving financial...

The Simple Path to Wealth Summary Part 2: The Market and How to Invest | Chapters 5-9: How the Market Works

The market is made up of all publicly traded companies that issue stock—when you buy stock in a company, you own a piece of that business. Various indexes, such as the Dow Jones Industrial Average and the S&P 500, use selected stocks as a measure of how the market as a whole is doing.

By investing in index funds, you can passively grow wealth at the pace of the market. In 1976, John Bogle, founder of The Vanguard Group, introduced the first public index fund for investors, replicating the S&P 500. (Shortform note: An index fund is a type of mutual fund containing stocks chosen to replicate the market’s performance. In contrast, actively managed mutual funds are stocks chosen and managed by professionals who attempt to outperform the market. We’ll discuss index funds further in the next chapter.)

Stock Market Truths

To invest successfully, you must understand and accept certain truths about the market:

Truth #1: The market is the most effective wealth-building tool ever. Your money should be in the market working effectively as soon as possible.

Truth #2: The market always goes up over time. You can predict that it will be higher in 20 years than it is...

The Simple Path to Wealth Summary Chapters 10-11: How to Invest Simply

Investing doesn’t have to be complex. People selling investments profit by making them complicated—they convince you that you need professional help to understand investment. Yet the actively managed funds they sell are costly and underperform index funds. You can do better on your own. In reality, getting started in investment only requires answering three questions and applying three wealth-building tools.

Three Questions for Investors

Every investor must answer three closely related questions:

1) What investment stage are you in? Are you in the wealth accumulation (income-producing) stage, the wealth preservation (post-working) stage, or a combination of the two (for instance, you’re between jobs)?

2) What level of risk are you comfortable with?

3) What’s your investment horizon? In other words, for how many years do you plan to accumulate wealth? If you’re just starting your working life, your investment timeframe will be much longer than if you’re close to retirement.

These questions are interrelated in that your risk tolerance will correspond with your investment horizon—you’ll take more risk early and less later as you near retirement. Also, your...

Shortform Exercise: Answer the Key Questions for Investors

Before you begin investing, Collins recommends answering three questions.

First, what investment stage are you in: the wealth accumulation (income-producing) stage, the wealth preservation (post-working) stage, or a combination (for instance, if you’re between jobs)? Do you expect this stage to change in the next decade? (If so, how?)

The Simple Path to Wealth Summary Chapter 12: Adding Bonds to the Mix

In previous chapters, we’ve discussed stocks and why you should invest in them. Now, we’ll explore why you should add bonds to the mix.

The difference between stocks and bonds is:

• When you buy stock, you’re buying part of a company.
• When you buy bonds, you’re loaning money to a company or government entity.

Each bond has an interest rate and term:

1. Interest rate: This is the rate the issuer of the bond (the borrower) has agreed to pay the buyer (the lender—you or the fund you’ve invested in).
2. Term: This is the time period the money is loaned for. Bonds are classified as short-, medium-, or long-term. For example, U.S. Treasury bonds issued by the federal government are classified as:
   • Bills: 1-5 years
   • Notes: 6-12 years
   • Bonds: 12+ years

For example: A $1,000 bond offering 10% interest and a 10-year term, would pay $100 a year in interest, or $1,000 over the term of the bond.

Why You Need Bonds

While stocks and index funds are your most effective wealth-building tool, adding bonds to the mix provides several benefits:

• **Bonds are less volatile than...

The Simple Path to Wealth Summary Chapter 13: Two Portfolios: Wealth Accumulation and Wealth Preservation

Now that you know the basics of investing, this chapter focuses on designing your portfolio. Two stages in your investing life determine the mix of assets in your portfolio: the wealth accumulation stage, and the wealth preservation stage. If you answered the three questions for investors in Chapter 10, you have already determined your current investing stage.

The Wealth Accumulation Portfolio

When you’re young, you should focus totally on building wealth. In that regard, do two things:

• Accumulate your F-You Money as soon as possible.
• Then, focus on stocks, which, as we have seen, provide the best performance of all asset classes. Your best and simplest wealth-building vehicle is VTSAX, Vanguard’s Total Stock Market Index Fund.

Remember that the stock market goes up and down and...

The Simple Path to Wealth Summary Chapters 14-18: Rebalancing Your Portfolio

Once you’ve determined your investment stage and allocated the desired percentages to stocks and bonds, your next consideration is whether and when to rebalance your portfolio.

Your portfolio’s balance will change as a result of the differing growth rates of various assets over time. You may want to restore your original balance, or you may decide you prefer less risk and therefore want to increase the percentage of your portfolio held in bonds.

How to Rebalance

If you hold a mix of stocks and bonds, you should consider rebalancing your allocations once a year, or when the market swings 20% or more.

Rebalancing typically requires selling shares in the asset class that has grown (typically, stocks) and investing more in the slower-growth class (bonds). It can be done online with most investment firms and takes only a few hours. Like changing your car’s oil, it’s simple but valuable to do periodically.

Factoring in Risk

To determine what proportion of your nest egg you want to keep in bonds (that is, how conservative you want to be regarding risk), consider the following:

• Your temperament: Are you cautious by nature or are you comfortable taking...

The Simple Path to Wealth Summary Chapters 19-20, 22: Investment Plan Options

Previous chapters introduced two life-stage portfolios consisting of two index funds (stocks and bonds) and possibly TRFs. These funds are your investments. Next, you need an investment plan or account in which to hold them. Options include 401(k), 403(b), TSP, IRA, and Roth accounts. There are two categories of accounts:

1) Taxable (brokerage) accounts: Use these accounts for investments that are tax-efficient, meaning those that generate lower taxes than an alternative or none at all. Tax-efficient investments include total market stock index funds that produce low dividends (which are usually “qualified,” meaning they receive favorable tax treatment) and capital gains. VTSAX is a tax-efficient investment: the dividends it pays are small and mostly qualified. There usually aren’t any taxable gains distributions because buying and selling in VTSAX is rare. Taxable accounts are useful because they have fewer restrictions than an IRA or 401(k) on withdrawing your money.

2) Tax-advantaged accounts (which are tax-deferred or tax-exempt): Use these accounts, such as IRAs and 401(k)s, for holding tax-inefficient assets—for example, bond funds that generate taxable...

Shortform Exercise: How Much Are You Investing?

If your employer provides a 401(k) or 403(b) investment plan, Collins recommends contributing the maximum amount the government allows, especially if your employer provides a match.

If you have an employer-provided 401(k) or 403(b) plan, what percentage of your income are you investing in it and why?

The Simple Path to Wealth Summary Chapter 21: Health Savings Accounts

Besides saving for financial independence or retirement, you should also save for out-of-pocket health care expenses. The best way to do that is to open a Health Savings Account or HSA (this is different from an FSA or Flexible Spending Account).

Here’s why you should open an HSA: If you have a high-deductible health care plan, which is increasingly common, you’ll need to have a significant amount of money available for paying the deductible.

HSAs, which are similar to an IRA, were created to enable people to set aside money tax-free for potential out-of-pocket expenses as well as other qualified medical expenses....

The Simple Path to Wealth Summary Part 3: Pitfalls to Avoid | Chapters 23-28: Advisors, Stock Picking, and Cons

This chapter looks at several pitfalls investors should beware of, starting with financial advisors.

1) Financial Advisors

Financial advisors include money managers, investment managers, brokers, and insurance salespeople (who sometimes masquerade as financial planners).

As previously explained:

• Managing other people’s money is extremely profitable. Financial advisors profit from people’s insecurities by making investing seem complicated and intimidating.
• Although most advisors promise to get better results by actively managing mutual funds, they don’t. Simple index funds perform better and cost less.
• Financial advisors are costly at best and ripoffs at worst.

How Advisors Earn Their Money

Advisors earn their money in three basic ways, which influence the advice they give to clients.

1. Commissions

An advisor gets paid a commission, also known as a load, whenever you buy or sell an investment. For example, major loads are charged for American Funds, but no loads are charged to buy Vanguard funds.

In addition, some funds charge a yearly 1% management fee for the advisors who sell the funds. Because they’re actively managed, these funds...

The Simple Path to Wealth Summary Part 4: Living on Your Investments | Chapters 29-30, 32: Withdrawing Your Money

The big question when you stop working or retire is: How much money can you withdraw from your portfolio each year without running out of money before you die?

The common recommendation of 4% a year (the 4% rule) is one piece of retirement advice that actually works. The rule was developed in 1988 by three professors who ran computer simulations to test the impact of different percentage withdrawal rates on various portfolios over a 30-year period. They updated the research in 2009 (adding another 21 years). They found that:

• Over 30 years, a portfolio split 50-50 between stocks and bonds, with a 4% withdrawal rate adjusted for inflation, remained stable 96% of the time.
• In 55 years, the portfolio lost ground only twice. In the other 53 years, it continued to grow robustly, meaning the holder could have withdrawn more than 4% without reducing the total.

Collins draws the following conclusions:

• Withdrawing 3% or less a year is as close to a safe bet as you can get.
• If you hold 75% of your assets in stocks and 25% in bonds, you can safely withdraw under 4% a year and take an increase for inflation.
• If you don’t take annual inflation increases, you can...

The Simple Path to Wealth Summary Chapter 31: Drawing Social Security

The Social Security system has been sustainable in the past, but as large numbers of Baby Boomers retire and live longer, the payroll taxes that support it will fall short of payouts if nothing is done to fix it.

Thus, depending on your current age, your experience with Social Security likely will vary. Collins argues that:

If you’re 55 or older, you’ll collect the full amount you’re entitled to because politicians won’t take anything away from such a large group of voters. That’s why the solutions proposed so far to shore up the system only affect those 55 and under.

If you’re under 55, you won’t get the same deal, but you’ll still receive benefits. You can expect that:

• You’ll get any benefits you’re promised, but they'll be smaller than those older recipients are getting today.
• The benefits will cost you more. The income cap—the amount of income on which you pay Social Security taxes—will keep increasing.
• The full retirement age will continue to go up.
• ...

The Simple Path to Wealth Summary Chapter 33: Conclusion

Encapsulating the principles in this book, here is the initial 10-year investment path that Collins recommended for his daughter:

• Avoid debt.
• Spend the first decade of your career working hard to build your skills and reputation.
• Take time for (inexpensive) adventures.
• Don’t increase your spending as your income increases. ( Remember, financial independence is not only about building wealth, but also about...