Like many folks who want to be financially independent and retire early (FIRE), we end up reading quite a few books on the subject. We recently read The Simple Path to Wealth, by JL Collins and would like to share our review and what action we’ve taken as a result of reading his book. This review is for the Kindle version of the book, which at the time of this writing, has a 5 star rating with 211 customer reviews.
The book starts off with an introduction on how the creation of the book grew out of his blog (jlcollinsnh.com) and a series of letters to his daughter. Whereas some of us like to dig deep into investing, saving, and other financial topics, the truth is that the majority of people just don’t have the time or don’t want to invest the time – so just keep it simple. As the title of the book suggests, keeping things simple is the clearest path to success. A nice quote in the introduction of the book points out one of the main problems with complex investments, “Here’s an important truth: Complex investments exist only to profit those who create and sell them”. Hard to argue with that.
Mr. Collins presents his story and why it’s never been about retirement, but rather the pursuit of financial independence. Part of the journey towards reaching financial independence is having ‘F-You’ money. Basically, F-You money (as you can likely imagine) is that money that you’ve set aside to give you some financial freedom. It’s not necessarily enough money that you can stop working forever, but it’s enough that you can step out of the workforce for a while or take a chance on a new opportunity. A question I’ve asked myself on the idea of F-You money is: Does our emergency fund count as F-You money? I don’t think so, at least not for us.
Debt – You just have to avoid it like the plague
After the introductory material, the following chapters provide an orientation to gain your bearings towards a simple path to wealth. As a society, it seems like most Americans have accepted debt as a normal part of life. However, this acceptance is the single most dangerous obstacle to building wealth. Mr. Collins points out that easy (EZ) financing increases the average costs of vehicles, homes, and college since obtaining the required debt is easy to obtain. Throw in some credit card debt and before you know it, you are drowning in debt and the associated interest payments make it extremely difficult to build any wealth. Along with making it difficult to build wealth, there are other downsides to debt including a diminished lifestyle due to interest payments, you are enslaved to whatever income you have, increased stress levels, etc. If you do have debt, what’s the best way to get rid of it? The book provides guidance based on the interest rate of the debt and also provides a simple plan for tackling your debt.
How to think about money
For some reason, a million dollars ($1,000,000) seems to be a magical number. If I was just a millionaire. As the book suggests, just about anyone could retire a millionaire if you make smart decisions. One smart decision is to start investing as early as you can due to the magic of compounding. I’m not sure exactly where it was stated, but Albert Einstein is often credited with the following statement:
Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.
However, a million dollars isn’t really some magic number that you need to reach. Maybe you need more or perhaps you need less. The better question provided by the book is, what do YOU need for financial independence? What lifestyle do you want to live? Mr. Collins provides examples of numerous celebrities who earned tremendous amounts of money but ended up completely broke just a short time thereafter. Instead of thinking about how you are going to spend the money you earn, change your thinking to how is that money going to work for you? If you spend the extra discretionary income you have, consider the opportunity cost. That spent money can no longer work for you earning you more money. Not to say that you shouldn’t enjoy the fruits of you labor, but you want to reach financial independence, right?
The book lays out a very simple formula: Spend less than you earn / Invest the Surplus / Avoid Debt
The stock market
There are a few sections of the book that discuss the stock market and I won’t go into great detail here (you should read the book!), but here is a list of the key points that resonated with me:
- Over the forty (40) year period from 1975 to 2015, the average stock market return with reinvested dividends was 11.9%! I found this hard to believe but after checking multiple sites online, this average return rate seems correct. That said, even Mr. Collins mentions you shouldn’t necessarily bank on getting this return for the next 40 years. He’s just pointing out the facts of the last 40 years.
- Bull and bear markets are going to test your investing principles and beliefs. You can’t time the market and neither can any of the fund managers or talking heads on CNBC.
- Over long periods of time, think decades, the market always goes up. Crashes will happen and the market has always recovered. Toughen up and let it ride, because the typical investor is prone to panic and poor decision making. You may get lucky and time things right once or twice, but over the long haul you’re more likely to be wrong than right in your timing.
- The stock market is self cleansing. The weak companies will not survive and new companies and ideas will come in.
Index funds and Vanguard love
So if you can’t time the market and the fund managers can’t either, what do we do? Simple enough – index funds. As the book title suggests, let’s just keep things simple. Simple is good, simple is easier, and simple is more profitable. A basic concept presented in the book is that since the odds of selecting stocks that outperform the market are vanishingly small, you’ll obtain better results by buying every stock in a given index. Since there is no ‘active’ management in an index fund, there are no fund managers to pay, and the result is that the expense ratios for index funds (sometimes referred to as passive index funds) are much lower than an actively managed fund.
And who is best known for providing low cost index funds? Vanguard of course! Mr. Collins makes it clear in the book and on his blog that is a proponent of investing with Vanguard. Part of what sets Vanguard apart is that they are client owned and operated at cost, which allows the fees (at least for the index funds) to remain low. The Need2Save family also owns some actively managed funds provided by Vanguard and those funds expense ratios are reasonable. Mr. Collins also mentions that he is not paid in any way by Vanguard.
Asset allocation and portfolio ideas
Now that we know that index funds can lead to a simple path to wealth, what type of asset allocation should you aim for and exactly what funds?
The book suggests two portfolio ideas, essentially based on where you are in your career. If you are still working and providing contributions to your investment accounts, you would have a Wealth Accumulation portfolio. If you are no longer working and are instead drawing on your investments, you would have a Wealth Preservation portfolio.
For the Wealth Accumulation portfolio, Mr. Collins recommends just one fund – Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX). It may sound unwise to put all your eggs in one basket, but you really aren’t with this fund. The reason is that the VTSAX fund provides exposure to the entire U.S. equity market. So you are essentially investing in every public domestic company. The expense ratio for VTSAX at the time of this writing in an ultra-low 0.05%. Keep in mind that for the Admiral shares the minimum to invest is $10,000. If you don’t have that much to start, then the Investor class fund (VTSMX) is an alternative with a 0.16% expense ratio and a $3,000 minimum investment.
For the Wealth Accumulation portfolio, Mr. Collins recommends adding in a bond fund – Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX). From the Vanguard site you’ll see that this fund provides exposure to the total U.S. investment grade bond market. The expense ratio for VTSAX at the time of this writing in an ultra-low 0.06% with a minimum $10,000 investment. There is also an Investor class fund (VBMFX) that charges 0.16% with a $3,000 minimum investment.
In regards to the allocation between stocks (VTSAX) and bonds (VBTLX) for the Wealth Preservation portfolio, the book suggests that it’s really dependent on your risk tolerance, but a suggestion of 75% VTSAX, 20% VBTLX, and 5% cash is made. Mr. Collins also mentions that you probably want to start contributing some to the bond fund around 5 to 10 years before retirement. Over the course of you retirement the ratio may change, but it’s hard to see ever leaving stocks completely due to inflation if nothing else.
Some discussion is given to international funds, but the argument is made that in today’s global economy the large number of U.S. companies have overseas exposure. Therefore, a dedicated international fund is not required.
A few miscellaneous points
The final sections of the book describe where to hold your investments: in ‘ordinary’ buckets or tax-advantaged buckets. The tax man is going to get his cut eventually, so you may want to have tax inefficient investments in tax-advantaged plans to defer the taxes when your effective tax rate is likely going to be lower. Here at Need2Save we are building up our posts on tax-advantaged plans, so please check out our The 411 On Your 401(k) post. In addition to 401(k) and 403(b) plans, the book describes Traditional and Roth IRAs and we plan on having posts on IRAs soon.
As mentioned above, eventually Uncle Sam wants his tax money and you will very likely need to start taking Required Minimum Distributions (RMD) at age 70 1/2. There are numerous online calculators and strategies to deal with RMDs. The exception to RMDs is money that you’ve hopefully put into a Roth IRA.
Another topic mentioned in the book is Health Savings Accounts (HSA). Check out our Debunking the Fear of Health Savings Accounts and High Deductible Health Plans post for more information on HSAs.
What action did we take after reading this book?
So what did we do after reading The Simple Path to Wealth? Although we believed that we had a pretty simple plan for reaching financial independence, we realized that most of the funds in our 401(k)s and IRAs were actively managed funds. The expense ratio on these funds are too high (embarrassed to admit that a couple were around 1%) and the long term return rate on these funds weren’t really any better than the overall market. The brokerage firms, including Vanguard, don’t make it easy to determine how the fees are reducing your overall returns.
Although we don’t have much control over the options in our 401(k), we do have control over our IRAs. So we both decided to completely move our IRAs out of Fidelity and into Vanguard. And as the book suggests, we went all in on the VTSAX funds. I think we had around six to eight funds in our IRA accounts at Fidelity and now there is just the one at Vanguard. It’s certainly simpler to look at and hopefully it will help us towards that simple path to wealth.
Overall we enjoyed the book and agree with the simple principles outlined. It was a good wake-up call for us to take a good look at the expense ratios for the funds we owned and also the large number of funds in our accounts. Trying to pick the ‘right’ funds from what is available is pretty much a guessing game, so going with an index fund that covers the entire market is certainly simpler.
To purchase The Simple Path to Wealth, please consider purchasing the book through our Amazon link. Note that Need2Save will receive a small commission if you decide to purchase using this link.
Also, this was our first book review post. We would appreciate your feedback, so please provide us a comment and let us know how we did and what to improve on next time.