I’ll never forget the morning Ryan Pepper walked into my office with a spreadsheet and a smile. At 64 years old, he’s one of my happiest retirees: fit, healthy, and in love with life. That morning Ryan walked briskly to my desk and handed me a piece of paper.

“What’s this, Ryan?” I asked.

“It’s a spreadsheet I made,” he said, grinning from ear to ear. “In 1997. Every year since I’ve gone in and entered my total savings from the year.”

I looked it over, and the first year’s entry immediately jumped out at me: $32,000. That’s how much Ryan had in savings in 1997.

My jaw dropped. Not because I’d never seen 32 Gs (at Capital Investment Advisors we manage well over $1 billion in client assets, after all). My jaw dropped because I knew how much the Peppers’ savings are worth today: $1.35 million.

How did he and his wife, Allie, get there in just 16 years? They did it by avoiding the things that can go wrong—the pitfalls of bad investing. Doing this requires deft psychological navigation of the market, as well as having a solid philosophy for your investment strategies.

This chapter is about avoiding the major pitfalls of investing. I’ll show you how to emulate the Peppers so that, when you come see me in 16 years to retire, your 2014 spreadsheet will make my jaw drop just as much as theirs did.

Made Mistakes in the Past? It’s Not Too Late to Start Over

Avoiding pitfalls is an essential part of successful investing. Doing so takes an understanding of the psychological factors that so often play into investment mistakes. Perhaps it won’t surprise you to learn those mistakes typically occur when people act in the opposite way of the five money secrets.

Nowhere is this truer than secret #2: Figure out how much money you need to have saved before you retire. The biggest pitfall of retirement planning is hands down the failure to save enough money. I see it time and again with people who call in to Money Matters or walk into the CIA offices. Accumulating those savings takes more time than any of the other secrets. If you were planning to neglect any of the five, this is not the one you’d want to pick.

That’s the big one. The good news is: if you missed out on one of the other five, it’s more easily repaired. For instance, you can always pick up another core pursuit or two (secret #1)—start taking cooking or art classes, try mountain biking, or study portrait photography. Why not?

Suffering under a big mortgage is another common pitfall, but you can fix that by paying off your mortgage—even if it means going into economic shutdown mode (more on that momentarily). Furthermore, you can refinance from a 30-year mortgage down to a 15-year, make extra payments, and—even if you don’t start until age 50—you can still be free and clear by 65.

Having multiple income sources can be achieved by working longer or having a part-time job. And you can always learn to be an income investor, as I showed you in Chapters 8 and 9.

So you can overcome the pitfalls of not learning secrets 1, 3, 4, and 5 early on in life. But not having saved enough money (secret #2) is a deep one that’s hard to climb out of. This is why the Peppers are such important role models for you.

Live Like Ryan Pepper: Happy, Active, and Free

Ryan Pepper lives life! He just finished running the Louisiana Ironman. If you’ve never heard of an Ironman, it’s the most grueling kind of triathlon you can possibly do.

How grueling? A 2.4-mile swim followed by a 112-mile bicycle ride, topped off with a 26.2-mile run. You know a race is tough when they put the swimming portion first so people don’t drown! But that doesn’t bother Ryan Pepper. At 62, he set a PR (personal record) by shaving an hour off his time. An hour! He went from 15½ hours down to 14½. Think about how long that is. You could almost get two full nights of sleep in the same span. Ryan was competing for approximately eight REM cycles.

Talk about a man who lives by the wise words often attributed to Abraham Lincoln: “In the end, it’s not the years in your life that count. It’s the life in your years.” There’s no doubt Ryan Pepper is living with a tremendous amount of purpose.

What about Allie, Ryan’s lovely wife? She loves their active and dynamic lifestyle of traveling, visiting their grown children, and supporting Ryan in his events. This is a very active and happy couple, fully engaged in putting as much life into their years as possible.

The Peppers’ mortgage will be paid off in the next year or two. When they “retire” from full-time work in about a year, they will have several different streams of income. Ryan is also going to continue to work part-time as a consultant to bring in an extra $20,000 to $40,000 per year. Why? Because he knows how powerful an extra income source can be on the quest to an early retirement.

The Peppers have been income investors for many years now. They believe in yield; they believe in steadiness of income. They know that when they retire, they can count on a certain steady level of cash flow coming from their investments. They’ll have a small pension. They’ll both have a modest amount of social security. And by the way, we’ve been planning this for years now, and they understand from a cash flow (yield) perspective that they can easily fill the gap—FTG—when it comes to spending.

But enough about that. How did they go from $32,000 to $1.35 million in 16 years? It took some doing. Let me explain.

It Wasn’t Always This Good: How Ryan and Allie Turned Their Life Around

Between 1984 and 1994, Ryan worked for a company called Digital. During those years, Ryan and Allie used to spend a lot of money on what they would now consider “junk”—frivolous habits combined with credit card and student loan debt. According to Ryan and Allie, they loved to spend and basically spent whatever they earned. They just kind of forgot to save.

The Peppers were headed toward the unhappy group of retirees. In fact, they weren’t just headed toward unhappiness—they were on a collision course.

During the 1980s and early 1990s, Ryan made a decent living: somewhere in the neighborhood of $50,000 to $60,000 a year. Yet, all they could manage to do was break even. Then, between 1994 and 1997, he got a job consulting for a company called Convergent Media Systems and started making around $110,000 a year. Allie was a preschool teacher bringing in $18,000 a year, working about 30 hours a week for a small private school.

One day Allie walked by the kitchen table and happened to notice Ryan’s 401(k) statement. It said they only had $32,000. “Ryan!” she exclaimed. “We haven’t been saving any money. What the heck are we doing?”

That was the moment they changed their lifestyle. That was the day they started walking on the path that leads to a happy retirement. How old were they on that portentous day?

Allie was 47 and Ryan was 48.

So they weren’t fresh out of the crib, if you catch my drift. And they still managed to turn their retirement—and their lives—around.

Ryan’s income continued to slowly grow at his job. In the early 2000s, Allie went to work for Gillman Insurance Company; by 2004, her income had gone up to roughly $25,000 a year. She quit in 2011 after having peaked at $42,000.

In the year 2000, Ryan left the software-consulting world to become a financial advisor at American Express Advisors. It didn’t go so well. He basically made no income for the year, hated it, and went back to consulting in 2001, and that’s when his income started to step up a little bit—he was making about $140,000 to $150,000 a year working for Accenture. As of 2013, he was making around $220,000 annually.

The Peppers went from having $32,000 in 1997 to $810,000 by 2007—just 10 years. To be fair, $200,000 was from an inheritance, but that still required them to save more than $600,000 with no outside help. Where did that money come from, you ask? From their own savings, growth, blood, sweat, and tears.

The Peppers started by avoiding all the psychological pitfalls of investors. Wouldn’t you like to be a Pepper, too?

Fear and Greed: Two Powerful Emotions That Can Ruin You Financially

On October 6, 2008, I remember seeing brilliant financial strategist Jim Cramer on the Today Show telling people point-blank to take any money they might need in the next five years out of the stock market, because he was worried about another precipitous stock market decline.¹ Interestingly, he was partially right: from October 6, 2008, until March 9, 2009 (slightly more than five months), the market did continue to drop to the tune of negative 34 percent for the Dow Jones Industrial Average.

But what happened over the course of a full five-year period? From October 2008 until October 2013? Despite the large drop at the beginning of that time period, the stock market was actually up by 50 percent at the end of it. In Cramer’s defense, he did say that if you had more than a five-year time horizon and could withstand another correction, it was best to hold on, but this is still an example of fear and emotion driving your financial decisions.

My point here is twofold.

    1. Even Jim Cramer was afraid people would lose more money, because by that October morning in 2008 he had already seen the market go down nearly 30 percent in a year’s time.

    2. Even though he warned of a further correction and was right, if investors had held on over that five-year period, they ultimately would have made 50 percent in the Dow Jones Industrial Average. But scores of investors over the final months of 2008 and early 2009 fled the stock market in droves.

What happened from March 9, 2009, to March 9, 2013, the next four-year period? The Dow rallied from 6,547 all the way to 14,397 on March 8, 2013. That’s almost 8,000 points to the upside, or approximately 120 percent!

Investors, in mass, were afraid. So they made emotional decisions to get out of the market—just in time for it to go up by over 100 percent.

On the other side of the pendulum are the periods dictated by greed—the fear of not making enough. We all know what this looks like. These investors say to themselves, “Hey, my neighbor said he made more than 30 percent on his investments over the last six months. I need to take some extra risk in my portfolio to try to keep up!” Unfortunately, that type of mentality can bleed into every other area of their life. “My colleague owns three condos in Florida, so I need to go buy one.” “My sister just bought a bigger house; isn’t it time we got a bigger house too?” And so on.

When there’s a housing or stock market bubble like there was in the late 1990s, and people notice stocks climbing 20 and 30 percent over a matter of weeks or months, they get greedy. Their fundamentals of diversification and balance are supplanted by greed, and they start chasing the hottest areas of the market just in time for them to blow up.

This is a well-documented psychological phenomenon over the course of history. Whether it’s tulips in seventeenth-century Holland, condos in Las Vegas, or the tech bubble, when the value of an asset goes up, investors in mass start to think they need more of it. As the buying herd gains momentum, the asset’s price skyrockets. Then, all of a sudden, everyone realizes it’s not worth as much as they thought and there’s a rush to the exit door.

So the price for an asset that is in a bubble goes from $10 to $50 to $1,000—and then crashes back down to $50. It’s been happening since the first instance of recorded money, and probably long before that.

Other Psychological Pitfalls

You’ve no doubt heard of the herd mentality, which is often fueled by greed, fear, or a combination of the two. “Hey, everyone’s getting out. I need to get out, too!” and “Hey, everyone’s getting in. I need to get in, too!” are both examples of different types of herding.

Another psychological pitfall is known as benchmarking. There are so many markets around the world: the large-cap U.S. market, the small-cap U.S. market, the energy market, the gold market, the European markets, the Asian markets, the Australian market—I could go on. If you were so inclined, you could follow the price of oil, copper, gold, palladium, and even bitcoins (if you’re the Winklevoss twins).

There are hundreds of benchmarks to look at besides the S&P 500 and the Dow, and there’s always going to be a winner in any given year. There are so many of these to choose from, no one can ever know ahead of time what the best market around the world will be.

Thus, benchmarking is the phenomenon of always seeing something better—the greenbacks are always greener on the other side. “Hey, my portfolio is up 12 percent this year, and that’s good, but the European stock market is up 25, shouldn’t I be over there?” Benchmarking can run you ragged and lead you to constant disappointment, which leads back to greed-based herding behavior.

The biggest mistake I see is investors relying on past performance. That’s when an investor takes a list of 20 or 30 choices and looks only at the percentage returns. “Oh, that fund did 22 percent last year, this fund only did 5. I’d better buy the one that did 22.” The decision is made without having any idea if that 22 percent is good, bad, or in line with what it should have been. No research is done to see what sectors were responsible for the 22 percent gain. Investors end up chasing an investment based on what it has done, not understanding why an investment did what it did, or what its prospects are for the next five years.

I’ve seen many investors select a fund because it averaged 7 or 8 percent a year for the past several years without asking if the fundamentals of the investments inside the fund have shifted dramatically for future years. For all they know, it might be next to impossible for that increase to replicate itself.

It’s very important to understand the investments you own. That’s one of the reasons I’m so emphatic about using my bucket approach—it promotes greater understanding of what you own, while still keeping things simple. As an investor, it’s easy to understand that you own stocks in one bucket, bonds in another bucket, and alternative income investments in another bucket. Furthermore, the bucket approach keeps you aware of the various kinds of assets you own within each bucket, giving you a better understanding of how each bucket should perform in various market environments.

In other words, the bucket approach gives you an easy, no-fuss way to comprehend what’s under the hood. You can understand what you actually own rather than “blindly” looking at the track record of a fund, ETF, or stock.

Anchoring is another psychological pitfall. Let’s say you’ve had a stock in the family for many years and you have an emotional attachment to it. Or maybe your mom bought you some shares of a stock when you turned 13 and you don’t want to sell because you’re comfortable with them. That comfort and sentiment doesn’t make it a safe stock or even a good stock to continue to own. It just means you’re comfortable with that stock. Psychologically, you may think it’s safe, when in fact it could be a disaster waiting to happen.

I’ve also seen people fall victim to narrow framing. This is when you make decisions without understanding all the implications. Perhaps you worked for Coca-Cola, Home Depot, or Cisco. You like the company and think you understand what they’re about—which is fine—but you have a tremendous amount of money invested in that one company. It’s 40, 50, or even 80 percent of your investments because you “understand” it—or at least, you think you do.

Again, it’s not a safe stock just because you understand the company that it represents. This is a result of a psychological disconnect between fundamentally sound investing and a false sense of comfort. Don’t let these psychological tricks hurt you.

Another psychological pitfall can be caused by the influx of media (think 24/7 news outlets like CNBC, CNN, Fox News, MSNBC, Bloomberg, you name it). The news can very quickly skew your own emotional pendulum between fear and greed. Back in July of 2010 when the world was watching the onset of a complete financial crisis in the relatively tiny country of Greece and worrying about the repercussions for all of Europe, I remember seeing author and financial forecaster Robert R. Prechter, Jr. talking about his forecast for the stock market.

The Dow was somewhere around 9,600, and Prechter was warning that there was going to be a major drop in the next several years—a drop to Dow 1000 (about 90 percent). Nearly three and a half years after his prediction (also reported in the New York Times), the Dow was trading more than 65 percent higher. So, he called for a 90 percent drop and instead the market went up by more than 65 percent. How’s that for sensationalism?

News channels are trying to report the news, but they’re also trying to get ratings. Talking heads and pseudo-experts with extreme viewpoints are going to get the most news attention. If Prechter’s view had been that the Dow was going to move up and down within reason, where’s the scandal?

Having a balanced opinion isn’t sexy, but we know that over time the symmetry and balance of the bucket approach helps to eliminate many of these emotional pitfalls, for two reasons.

    1. Income and cash flow—now both within your control. If you don’t need it, you reinvest it. If you do need it, you start taking it. You’re okay with some fluctuation in the value of these buckets because you’re still getting your income from your bucket as a whole.

    2. The balance makes it easier for you to have at least one of your buckets working well at any given time—and perhaps multiple buckets firing on all cylinders. This will help prevent you from falling prey to herding, anchoring, benchmarking, media sensationalism, and the long list of other insidious psychological pitfalls.

When in Doubt, Stick to the Bucket Approach

Back in 2008, before I knew them, the Peppers were invested very heavily in stocks (near a 10 on the risk continuum). The great work they had done from 1997 to 2008 was being erased as their portfolio was down by more than 35 percent. Instead of panicking and jumping out of the market completely, they employed a balanced bucket approach. They focused on what they could control—their balance and their portfolio income.

This helped them stay with a balanced investment plan that included dividend-paying stocks, various types of bonds, and several energy-related investments that continued to pay distributions. This balance was key to helping them stay the course.

Subsequently, the stock market rebound of 2009–2012 changed the situation. The Peppers were finally hitting their stride as power-savers, and their investments began to rebound in price. Their kids had been out of college now since the earlier part of 2002, which helped Ryan begin to fully max out his 401(k) at work. He even put another 15 percent of his money into buying discounted stock from his employer.

As I mentioned earlier, the Peppers inherited around $200,000 when their parents passed, but other than that, their journey from $32,000 to $1.35 million was due to systematically saving and investing close to 30 percent a year and avoiding the psychological pitfalls of investing that I just described. They stuck to the bucket approach and allowed their own savings to grow to a level where they can now retire whenever they choose. Because of good decisions, their reservoir of savings will now generate income for them when they do decide to retire. And trust me: they’ll be retiring soon!

Another pitfall you should put on your radar is the potential of being charged fees for your investment decisions. Avoid costs that can ding your bottom line. Most investors pay fees on fees, which can end up taking away 5 to 30 percent of their return per year. It’s a slow, extremely leaky bucket phenomenon. Don’t let it happen to you.

The slick creativity of financial institutions to invent and implement fees would be impressive if it weren’t also such a hindrance to the retirement savings of hardworking people around the country. The first step to avoiding these fees is to identify them, and I’ve come up with some guidelines to help you do it. I call it the “seven layer dip of fees” (see below).

Divorce: The Most Expensive Mistake You’ll Ever Make

As callous as it sounds, another pitfall is divorce. Barring unusual circumstances, staying married will definitely save you money. Think of it this way. I recently went out to dinner and was introduced to a friend of a friend. He was about 60 years old, and evidently he’s been divorced four times.

You can pretty much say with great conviction that there’s no way this poor guy can retire early or happy. The economics of divorce are pretty simple. You divide your assets in half each time you go through it. So if you get divorced four times, even if you started with $20 million, you’re going to be down to $1.25 million by the end. And something tells me this guy didn’t start with $20 million.

Divorce economics—getting your net worth cut in half—is brutal. There’s a reason more millionaires in The Millionaire Next Door are still married and have never been divorced. It’s also reflected in my happiness study: simply put, it’s easier to be a happy retiree if you are married. The numbers don’t lie.

Don’t Get Comfortable: Rebalance Your Buckets Every 6 to 12 Months

I’ve seen so many retirees and preretirees make the mistake of not rebalancing their accounts, and it breaks my heart. They simply don’t pay attention to their investments. Remember: knowledge is power.

Let’s say your buckets are set up so you essentially have a 50-50 Rule of stocks and bonds. Five years pass without you ever looking at your portfolio, and all of a sudden it has become 75 percent stocks and 25 percent bonds—but you’ve never rebalanced your investments. Unwittingly, you have an extraordinarily different risk profile today than you did five years ago, just by the virtue of one area growing rapidly and another area not growing rapidly.

If you never rebalance your 401(k) or your investment accounts, you run the risk of the market itself taking you out of balance. Adopt a philosophy of checking your portfolio every 6 to 12 months to make sure you’re maintaining an appropriate “balance of the buckets” for you and your family.

A Lack of Liquidity: Don’t Let It Happen to You

Another big mistake a lot of investors make is having investments that, by nature of the product that they are sold by an insurance salesperson, stockbroker, or financial planner, don’t allow them access to their money in the event that they need it. I’ve seen people really get burned in investments where there’s a lack of liquidity, trapping them in the investment for 5 to 15 years—either because there’s no market available when they want to sell, or there are significant penalties to access their funds.

An illiquid investment can be a recipe for disaster. I’ll be frank: it’s one of the reasons I’m not a big fan of annuities. Keep reading and I’ll tell you why.

The Truth About Annuities

I’m constantly asked, “What about a variable annuity? I buy it and it guarantees me a steady stream of income in retirement, right?”

I am certainly an advocate of investments that will pay you consistently once your working days are behind you, but I’m not convinced a variable annuity is the best tool for getting the job done.

An annuity is a product sold by insurance companies designed to invest money from an individual. They then pay out a stream of income to that investor over multiple years. A variable annuity promises a minimum return from an “income perspective,” plus the possibility of a larger income stream, based on how well the annuity’s investments do over time.

Understand the following before buying a variable annuity:

“Real” Versus “Theoretical”

Most variable annuities consist of two pools of money—one “real” and one “theoretical.” The real pool is what you place in mutual fund-like investments (called subaccounts) within the variable annuity. You can withdraw this entire pool of money at any time—minus, oftentimes, a surrender charge.

The theoretical pool is your initial investment amount that grows at a predetermined rate set by the insurance company; for many annuities that rate is 5 percent per year. (By the way, who’s backing these rates? Annuities are not insured by the government. Just an FYI.)

But here’s the catch: you don’t have full access to the theoretical bucket. The theoretical bucket is there for you to take an income stream from in the future.

Surrender Charges

Surrender charges can be significant—often between 2 and 10 percent—and can be imposed as long as 10 years after purchase.

Brutal Fees and Commissions

Annuities often come with brutal fees and commissions—the annual expenses average 3 to 3.5 percent. Sales commissions from the original sale of the annuity can range from 4 to 8 percent: a significant incentive for those selling annuities.

Be wary of annuities that promise things like “guaranteed 5 percent income.” Annuities with long surrender periods and/or high annual fees lock up your money and then slowly pay it back to you. And what happens if the market does poorly over the next 10 to 20 years and the baby boomer generation needs to collect on the “theoretical bucket” guarantee all at once?

Stampede! Remember AIG? Yikes!

The benefits of a variable annuity generally don’t justify the high annual fees and surrender penalties. Of course, there are always exceptions. For example, if you’re panic-prone, they might help you avoid making bad investment timing decisions. As always, though, be careful of a “free lunch”—there’s no such thing. And if you are ever thinking about buying an annuity, have a third party (someone not working on commission) give you an objective view of the benefits and costs of doing so.

How to Find Objective Advice

Where do you find someone who provides financial planning without getting paid sales commissions? That’s easy. NAPFA: The National Association of Personal Financial Advisors.²

This is a network of fee-only financial firms and advisors who specifically do not work on commission or the sale of any particular financial product. In full disclosure, I have been a member for many years—but the website will help you find a fee-only planner near you in any area of the country. All you have to do is enter your zip code in the “locate an advisor” tab.

Here is a description taken directly from the NAPFA website:

    The National Association of Personal Financial Advisors (NAPFA) is the country’s leading professional association of Fee-Only financial advisors—highly trained professionals who are committed to working in the best interests of those they serve. Since 1983, Americans across the country have looked to NAPFA for access to financial professionals who meet the highest membership standards for professional competency, client-focused financial planning, and Fee-Only compensation.

In other words: they only make a fee if they make money for you.

Do You Believe in Miracles? Ryan and Allie Pepper Do

I think the Pepper story is a minor miracle. To go from $32,000 to $1.35 million in 16 years is a tremendous feat that very few people in America pull off. For proof of this, one need look no further than today’s scary retirement statistics. Did you know:

    • More than one-third of the country isn’t saving. Thirty-five percent of Americans don’t contribute to retirement accounts.³

    • The ones who have saved haven’t saved enough. Fifty-seven percent of workers report that they and/or their spouse have less than $25,000 in total savings and investments (excluding their homes and defined benefit plans). And 28 percent have less than $1,000 (up from 20 percent in 2009).⁴

    • Many seniors are poor. One out of every six elderly Americans is already living below the federal poverty line.⁵

    • Men and women are working longer. A record 33 percent of Americans now plan on working past the age of 70—which makes sense, when you consider they don’t have money saved to retire.⁶

    • The cost of healthcare is formidable. Fifty-one percent of Americans doubt they can pay for medical expenses in retirement.⁷

Those are some depressing statistics—but the Peppers’ story sets them in sharp relief. In a world where alarmingly high numbers of Americans aren’t saving and don’t expect to have enough saved, the Peppers were able to do so in a fairly short period of time. To me, that’s more than remarkable; it’s inspiring.

You, too, can avoid the pitfalls that have ensnared so many well-intentioned Americans, but don’t waste any more time. Every day is another dollar wasted. Get started immediately and fly in the face of the odds. Not only will you be able to retire early—you’ll be able to retire happier than you ever dreamed.