PDF Summary:The Simple Path to Wealth, by JL Collins

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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.)

The more you save and invest, the sooner you’ll have F-You Money and the sooner you’ll be financially independent. Saving and investing half your income is achievable when you learn to live modestly on the other half and don’t borrow.

Financial independence is as much about living frugally as it is about having savings and investments. If you’re laid off after 20-plus years and quickly find yourself broke, you haven’t learned to live within your means. But you can learn to live so that you’re not a slave to money because of your lifestyle and thus, not a slave to your job.

Collins and his family achieved financial independence and retired early by doing three things: avoiding debt, saving 50% of their income, and investing in Vanguard index funds. In this book,...

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• Step 3: Pay the minimum on all debts, then direct any remaining money toward paying down the debt with the highest interest rate first (this saves the most money).
• Step 4: When the highest-interest debt is paid off, focus on the one with the next-highest interest rate, and so on.

Collins differs with popular financial advisor Dave Ramsey in advising that you pay off the loans with the highest rates first. Ramsey and others tell you to pay off your loans in the order of their size, starting with the smallest ones first. Ramsey contends that starting small and racking up some successes gives you a psychological boost that motivates you to take progressively bigger steps.

But Collins argues that starting small to give yourself the quickest success is a crutch; you’re adapting your methods to your comfort level. Instead, you should become comfortable with the right strategy: in this case, paying off the loans with the highest interest rate first to save the most money.

(Shortform note: For more on the alternate method of paying off debts, read our summary of The Total Money Makeover here.)

What...

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Many people can’t build wealth because they live a high-consumption lifestyle relative to their income—they spend whatever they make and therefore have no money to save and invest.

Even high-income people have trouble making ends meet or they go broke by overspending. For example, boxer Mike Tyson ended up bankrupt in 2003 despite earning over $300 million—he blew it on fleets of luxury vehicles, Siberian tigers, a 21-bedroom mansion, an entourage of hangers-on, and more.

Like Tyson, many people think of money in terms of what it can buy. If your goal is building wealth and achieving financial independence, you need to think of money in terms of what it can earn. With this mindset, even lower-income earners can become wealthy by limiting their spending and investing whatever they don’t need for expenses.

Even if you overspent in the past, it’s never too late to start thinking differently about money and how to use it. Remember the “simple path” formula: Spend less than you make, invest the extra, and stay out of debt—and you can “buy” your financial independence.

Think About Opportunity Costs

Collins doesn’t argue that you should never spend money, just...

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1. Owning stock is owning part of a company working hard to compete and succeed in an economy that rewards the strong and eliminates the weak. So again, the strongest prevail and their stock values increase.

Truth #3: The market is volatile: Market crashes (drops of 20% or more) are inevitable—a major meltdown 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 process. Each time there’s a major drop, analysts and pundits proclaim that it’s abnormal, causing many investors to panic and sell. However, even the most alarming downturns are normal.

(Shortform note: Collins argued in a podcast that even the 2020 market drop due to the COVID-19 pandemic—the DOW lost 35% of its value from February 19 to March 19—wasn’t abnormal.)

During crashes or bear markets (those trending downward), remember...

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• Having F-You Money is essential. Life and jobs are uncertain, but you’ll have more room to make choices if you have F-You Money. If you don’t have this financial cushion now, start building it—it’s never too late.
• You should be a long-term investor, even if you’re older. Don’t follow the typical investment advice and shift too great a percentage of your money from stocks to bonds (often considered to be a safer investment) to protect your nest egg as you near retirement. At age 60, if you’re in good health, you might have another 30 years to build wealth, which is a long-term horizon. Maybe you’ll want to keep building wealth in retirement to leave money for a younger spouse, grandchildren, or a charity.

Three Wealth-Building Tools

The next step after answering the three questions is building your investment portfolio. To do it, you need only three simple tools: a stocks index fund, a bonds index fund, and a money market or bank account.

1) Stocks: Collins’s preferred option is investing in VTSAX, Vanguard’s Total Stock Market Index Fund. (He writes that he’s not being paid to promote Vanguard.) Stocks give you the best returns over a long...

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Risks of Bonds

Although bonds are viewed as steadier than stocks, they have several risks:

1) Default risk: The biggest risk is that the bond issuer will default and not pay you back. To help investors determine default risk, bond rating agencies (the primary ones are Standard & Poor's Global Ratings, Moody's, and Fitch Ratings) rate bonds based on creditworthiness. The scale ranges from AAA at the top to D.

The lower a bond’s rating, the higher the risk of default. Default risk is a key factor in the interest a bond pays. Poorly rated bonds are harder to sell, so the borrower or issuing agency offers higher interest to make them more attractive to buyers; investors get more interest when they assume more risk. All the bonds in VBTLX are highly rated, with none lower than Baa, which reduces the default risk.

2) Interest rate risk: Besides default, another risk of bonds is interest rate risk. This is only a factor if you decide to sell a bond before the maturity date (the end of its term). To sell it, you have to offer it to buyers in the so-called secondary market.

Whether you get more or less than you paid for the bond depends on how much interest rates have...

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• Adding a bonds index fund
• Determining the asset allocation—that is, what percentage of your money should be in stocks and what percentage should be in bonds. Also, you should review and adjust your allocation—referred to as rebalancing—once a year. It typically takes a few hours. Chapter 14 looks at asset allocation in more detail.

In semi-retirement, Collins allocates his assets this way:

• Stocks in VTSAX: 75%
• Bonds in VBTLX: 20%
• Cash in a bank account: 5%

This is a typical wealth preservation portfolio. You can adjust it to your circumstances: If you want less volatility, increase the percentage in bonds; if you want more growth and can tolerate market fluctuations, boost the percentage in stocks.

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1) When should you shift toward bonds? This depends on your situation and risk tolerance.

• If you have a fixed retirement date, gradually shift a greater proportion of your portfolio into bonds five to 10 years before you retire.
• If your retirement date is flexible and you’re risk-tolerant, you could keep your entire nest egg in stocks until you retire. Your investment will grow faster, possibly enabling you to retire sooner. But if the market declines, you might have to delay retirement.

Whenever you shift between accumulation and preservation, you should adjust your allocations.

2) Does age matter? It’s more useful to think of life stages rather than age because circumstances may vary considerably among people the same age. However, as your age advances, it starts limiting your options—for example, due to limited physical ability or age discrimination, you won’t have the same employment options you had when you were younger. In addition, you’ll have less time to let your portfolio recover from downturns. These risk factors will influence how soon you diversify into bonds.

3) When should you rebalance? There isn’t a prescribed time, other than...

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(Shortform note: The maximum annual contribution to a 401(k) or 403(b) in 2020 is $19,500. The catchup contribution is $6,500 if you’re age 50 or over.)

Collins’s views on these plans are that:

• They’re usually good plans, but the investment companies offering them have larded them with excessive fees.
• You should maximize your contributions and take full advantage of the employer match (it’s free money).
• You should choose an index fund option with a low expense ratio (Shortform note: An expense ratio is an annual fee calculated as a percentage of your investment. For example, if the expense ratio is 1%, you’ll pay $10 a year for every $1,000 invested. Investopedia.com wrote in 2020 that 0.5% to 0.75% is a reasonable expense ratio for an actively managed fund; more than 1.5% would be high.)
• When you leave your job, you should roll your 401(k) into an IRA to retain the tax advantage.

Following are the key aspects of basic plan types.

401(k) and 403(b) Plans

• Your contributions are tax-deductible.
• You’ll owe taxes when you withdraw the money.
• You’ll pay a penalty if you withdraw money before age 59½.
• You have to make RMDs, or required...

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• You’ll pay tax and a 20% penalty if you withdraw the money for non-medical purposes, unless you’re 65+ or become permanently disabled (then you’ll owe only the tax due).
• A spouse can inherit an HSA to use for medical expenses, but for other inheritors, it will be taxed as income.
• You may choose to pay your medical bills without dipping into your HSA and just let it grow.
• You can invest your HSA anywhere, but if you expect to use it in the short term, it’s best to keep it in a bank savings account.

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2. The “Assets Under Management” (AUM) Model

The second way financial advisors make money is by charging flat management fees, usually 1-2% of your total assets. While this is presented as more “professional” than the commission model, this undercuts the growth of your nest egg and, later, your income in retirement. Your advisor is basically skimming your investment returns, which could have earned you more when you reinvested them.

For example, if you had a nest egg of $100,000, and you invested it for 20 years for a return of 11.9% a year:

• You’d end up with $947,549.
• Factoring in a 2% management fee, your return would be 9.9% a year and after 20 years, you’d have $660,623—which is $286,926 less.
• In addition, you’d have given up the interest that $286,926 could have earned, compounded over 20 years.

Under the AUM model, your advisor’s personal interests can still influence her advice. For example, if you want to withdraw money for a child’s education, she may advise against it because her annual fee will decrease.

3. Hourly Fees

Many advisors shun this model because it generates less money for them than commissions and fees. When advisors...

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• Request that your investment firm transfer to your bank account a certain amount of money weekly, monthly, or however often you choose.
• Also request that capital gains, dividends, interest be transferred to your account as they are paid.
• Or, log in to the website and transfer money yourself anytime (or combine automatic and manual transfers).

Beyond the mechanics, you should determine some guiding principles for withdrawing your 4%. Here are the principles Collins and his wife adhere to:

• In creating a 75-25% stocks-bonds allocation, they look at all their funds in total, not the allocation of individual accounts.
• They reinvest dividends, capital gains, and interest in their tax-advantaged accounts.
• They have their dividends, capital gains, and interest from taxable accounts sent to their checking account.
• They allow their tax-advantaged investments to grow tax-deferred as long as possible.
• While Collins and his wife are under age 72, they’ll move as much money as they can from their regular IRAs to Roths, while staying in the 12% tax bracket.
• When Collins and his wife turn 72, RMDs will replace what they were withdrawing from the taxable...

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1. When do you need the money? If you need it now, take it—but for each month you’re able to delay, your monthly payment will increase.
2. How long do you expect to live? Are you in good health? Do you come from a long-lived family? The longer you live, the more you stand to gain by delaying payments. The break-even point for people between the ages of 62 and 66 is 84, meaning that if you live longer than 84 years, you’ll collect more if you wait until after age 66. You might want to claim benefits sooner if you don’t think you’ll live to age 84.
3. If you’re married and earn more than your spouse, when you die, your spouse can swap their benefit for your larger one. If you put off taking Social Security until age 70, your spouse will get more when you die. In the interim, they can claim their lower benefits.

Although Social Security likely will survive in some form, plan as though Social Security won’t be there for you—that is, follow the simple path to wealth of living beneath your means, staying out of debt, saving F-You money, and investing in index funds. If you get Social Security, it will be a bonus.

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Once you’ve achieved financial independence and can live on 4% of your investments, continue your career or try something new. If you keep working, invest all of your income (which will increase the amount 4% represents). Consider buying a house, having children, and giving to charity. The reason you save and invest is to create options and opportunities to enrich your life.