| Fund Your IRA Every Year or How to Retire Wealthy by Driving Used Cars Buy stocks the way you would buy used cars. The truly amazing fact is, if you also buy used cars, you can get rich on these two actions alone.– Ron Muhlenkamp
This essay was originally published in Muhlenkamp Memorandum Issue 34, April 1995. Stocks and Used Cars: The Road
to Wealth? It is not hard to save $2,000 per year by driving a used car. The hypothetical table shows that by investing $2,000 in an IRA every year, you can accumulate $1 million (at 12%) in 36 years or $928,000 (at 10%) in 40 years. 1 There are three keys to saving
$2,000 per year by driving a used car: Do Your Homework
For stocks, you need to be a little more careful. The principal difference between buying used cars and buying stocks is that, with stocks, many more of the charlatans (used car salesmen) write books. Be sure the author has a successful history of making money by investing, not just by selling books or magazine articles. These authors will give you criteria to use and a framework to work from. Peter Lynch’s One Up on Wall Street is among the best I have found. Beyond that, read Ben Graham, Irving Fisher, and Warren Buffett. (Do not confuse the recent best seller about Buffett with the writings by Buffett.) Jim Roger’s Investment Biker is a must for anyone considering foreign investing. It also provides an interesting perspective for those who are not. When shopping for cars, your next step is to check out the data in Consumer Reports. Their data is based on consumer surveys and is so organized that in 20–30 minutes you can rule out the 80% of cars you do not want to own and focus on the 10–20% that you might. If you want to refine the Consumer Reports data, talk to your mechanic (or as my neighbor did, to your tow truck driver). If you do not yet have a mechanic you respect and trust, ask your neighbors with an interest in cars whom they trust. Do not be afraid to ask several neighbors. I have never met a person who resented being asked for advice, and just because you get several opinions does not mean you have to follow all of them. "With both cars and stocks, look for the gems, but expect to compromise, particularly on the non-essentials. If you accept only perfect gems, you will miss a lot of good stocks and do a lot of walking" - Ron Muhlenkamp When shopping for stocks, I begin with The Value Line Investment Survey®, looking for companies with good balance sheets and a good return on equity capital (ROE). The ROE should be 15% or better; an ROE of 10% or less is not worth their being in business. I don’t like to state rules of thumb because they are subject to change with inflation and interest rates, but today I would like the price to earnings ratio (P/E) to be less than the ROE and the expected growth rate. Next, call the company to get their financial statements. Check the numbers and the footnotes in the annual report (it is audited) to be sure the Value Line numbers are accurate. At this point, you will have identified up to a half dozen car models that satisfy your criteria. Now it’s time to shop the newspaper, because you would like to buy from a private individual. You would rather avoid a dealer because dealers dress up the cars they sell and know how to disguise problems. But the main reason you want to buy privately is because you would like to judge the current owner as well as the car. The degree of care the car has received can enhance or negate the record that you got from Consumer Reports. There are no used cars I would buy sight unseen, but there are people (very few) whose used cars I would buy sight unseen. In such cases, I would be buying based on my knowledge of the owner. Once you have identified a model that fits your criteria and a car that appears to be in good shape, be willing to pay your mechanic to check it over (it is cheap insurance). Similarly with stocks, you would like to talk to the management of the companies you are interested in buying. For the individual, this is not always practical, but you can often get a reading on management from the company’s annual report. The letter to shareholders should give you a summary of what management sees in their markets and what they are trying to accomplish. The best management will spell out the company’s goals in specific terms. The proxy material will tell you how much stock management owns and whether they are compensated in ways that encourage them to work for the shareholders. In nearly all cases, the quality of the company’s management is more important than the characteristics of the industry they are in. Finally, check with the company’s customers. If the customers are happy, the company is doing something right. The Winners,
the Losers, and the In-Between Finally, be aware that no matter how much effort you put into it, on occasion you will get a lemon. When this happens, sell it and go on to the next vehicle. Selling a lemon may be a blow to your ego, but it’s a lot less painful than keeping it. You will find that commissions for selling a stock are low. You will also find that selling a lemon you paid $3,000 for is a lot less painful than the new lemon your neighbor bought for $20,000. How long will all this take? My
daughter-in-law knows nothing about the mechanics
of cars and knew nothing about shopping for them.
Using the above advice, she spent four hours in the
library and five or six hours shopping. In the end,
she The Road We’ve
Traveled In the meantime, I have been fully funding my IRA since the law became effective in 1981. I have contributed $29,500 (in 1981, you could only contribute $1,500). I have not done anything fancy or heroic, just put the money in two good no-load, total-return mutual funds. As of March 31 of this year (1995), the market value was more than $76,000. A glance at the table shows that it has been compounding at better than 12% per year, and I am on track for a prosperous retirement. We’ve seen some articles making the case that not everyone should fund their IRAs. We agree. When you become confident that your tax-deferred assets (pension plan, profit sharing plan, and IRA) will exceed $1 million by the time you reach 60, it makes sense to cease funding your IRA (and to take a full measure of comfort in what you have accomplished). 2005 Update 1 for 2006, the allowance
for IRA contributions is $4,000.
Fund Your IRA Every Year
or How to Retire Wealthy by Driving Used
Cars
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