The Six Stages of Boom, Bust, and Recovery

The advent of boom and bust business cycles is certainly not a new phenomenon.  Economic expansions and contractions have been commonplace throughout human history.  The thing that made the recent economic downturn so painful is the fact that it followed successive decades of “fine-tuning” the economy by government and quasi-government institutions that skewed incentives and systematically diverted economic resources away from their optimal use.  When this artificial stability (necessarily) collapsed, the result was a much more intense adjustment than most people had anticipated.

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The Smart Money

There is a popular phrase in investing terminology called the “smart money.”  Typically this phrase is used to describe the investors that are ahead of market sentiment.  These are the people with the foresight to sell before the market crashes and buy before the market booms.  The critical question to ask is how we can become part of the smart money?

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Getting Rich Quick or Getting Poor Slow?

There are many schemes to “Get Rich Quick” but all of them rely on some form of luck or market timing that is not indefinitely sustainable.  Thus, all of these “get rich quick” bubbles eventually burst.  The only RELIABLE way to get rich quick is by selling “get rich quick” systems to all of the suckers.  (It may not have been PT Barnum who said that there is a sucker born every minute, but whoever did appear to be right)

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Life’s Largest Expense

A survey of millionaires conducted by Thomas J. Stanley and William D. Danko for their book “The Millionaire Next Door” found that taxes are their single highest expense item.  Because of this, managing taxes is one of the highest impact items that can increase your net personal income.  It is also worth mentioning that taxes work differently for employees and business owners.

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The Infinite Compounding Fallacy

The financial planning profession has a long history of demonstrating the power of compounded growth to clients.  Typically, a chart will be shown that shows the difference between investing $100 per month at 1%, 5%, 8%, and 10% rates of return for 20, 30, and 40 years.  As expected, the results are typically astounding.  The extended impact of compounding for a longer period of time at a higher rate of return creates a tremendous difference in the amount of compounded returns after a long period of time.  Thus, the fundamental assumption behind all contemporary financial planning models is to invest money into financial products that have historically compounded at a high rate.  This is supposed to enable you to enjoy a happy and comfortable retirement from your compounded returns.

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Losses Loom Larger Than Gains

Everybody hates to lose.  One of the trends that many people experience in the world of investing is a noted tendency to become ‘gun shy’ when they experience volatility in their investments.  The reason for this is because our psychological makeup is much more afraid to lose than joyful over gains.  This leads many people to either become irrationally risk-averse or to take risks that they are not aware of in a desire to achieve safety.  The problem this creates is that fear of loss can make people blind to the opportunity for gain.

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Buying Low and Selling High

The cliche “buy low and sell high” has been around seemingly since the beginning of time.  However, there is quite a bit of depth behind this simple piece of wisdom.  In order to discover this depth, we need to ask ourselves what kind of person will buy low and what kind of person sells high.  We also need to ask what situations result in low prices for you to buy, and what situations result in high prices for you to sell.

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Re-Thinking Wealth Building

Wealth building has become a key topic of conversation in the financial media.  Traditional financial advisors frequently talk about equity and debt.  (aka ‘stocks and bonds’)  This is certainly a part of wealth building, but the current world has become highly complex.  In order for people to achieve their financial goals, they need to think about wealth building differently.  Many people go through booms and busts but never manage to get ahead.  This is especially important for people who over-invest in buying a home and under-invest in other financial assets.

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Wealth and Income

During business and economic discussions, it seems that distinctions are rarely made between income and wealth.  Income represents the resources that are accumulated annually.  Wealth represents the total amount of resources that have been accumulated throughout the tenure of your life.  Income must be earned by you year after year.  Wealth can be used to generate income year after year, without any direct input from you.  (Now we’re talking …)

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