The Babylon System for Financial Success (Part 1)

Highlights

  • The Richest Man in Babylon is a compilation of fictional short stories first published in 1926 that continues to provide valuable insight on achieving your financial goals.
  • Regarded by many as a timeless classic of financial literature, this easy-to-read book reveals a simple system that allowed Arkad, a camel dealer in ancient Babylon, to go from a poor scribe to the city’s richest man.
  • The Richest Man in Babylon offers valuable guidance for creating, growing, and protecting wealth — lessons that can be adapted to our modern financial system.

“Our wise acts accompany us through life to please us and help us.  Just as surely, our unwise acts follow us to plague us and torture us.”

Arkad, The Richest Man in Babylon, by George S. Clason

A couple of weeks ago, a friend recommended The Richest Man in Babylon, an entertaining read that is regarded by many as a timeless classic of financial literature.  (You can order a copy from Amazon here.)  The book, by George S. Clason, consists of a collection of short parables that were first published as separate pamphlets in 1926.

The stories are set in ancient Babylon with a poor scribe – Arkad — cast as the central character.  In the course of his employment, Arkad meets a rich money trader named Algamish, who befriends Arkad and agrees to teach him his system for financial success.

Far from being a get-rich-quick scheme, the Babylon system for financial success requires dedication, discipline, and patience.  While Arkad struggled at first, he persevered–so much so that he eventually became the richest man in Babylon.

The lessons at the heart of the Babylon system for financial success have withstood the test of time, and continue to provide a roadmap for creating, growing, and protecting wealth.  I will be discussing these lessons in a two-part discussion. 

Lesson 1: Pay Yourself First.

A part of all you make is yours to keep.  It should be no less than a tenth no matter how little you earn.  Pay yourself first.  Do not buy from the clothes-maker and the sandal maker more than you can pay out of the rest and still have enough for food and charity and penance to the gods.”

The first component of the Babylon system for financial success is to save at least 10% of your income before spending any of it.  As for the rest, no less than 20% should be used to pay down debt and the balance should be used for living expenses and entertainment.

An automatic savings plan, whereby a specified portion of your paycheck is directly deposited into a savings account, is a great way to pay yourself first.  Better still, have the deposit made to a tax-favored retirement account, such as an IRA or a 401(k) or other type of employer-sponsored qualified retirement plan.  You can learn about the pros and cons of the different alternatives here.  Suffice to say, if your employer will match part of your contribution to a plan it sponsors, that is probably the best way to pay yourself first.

Lesson 2: Invest Your Savings Wisely.

Learn to make your earnings work for you.  Make it your slave.  Make its children and its children’s children work for you.” 

For Arkad to become wealthy, he needed to learn how to invest his money wisely.  Today’s investor has a big advantage in this regard, in that there are a number of straightforward investment vehicles that make wise investing simple.  In fact, many of these investments have a long track record of outperforming custom, professionally managed portfolios.

One example is the so called “all-in-one fund,” which offers a diversified portfolio of stocks and bond index funds in a single investment.  The best of these are single funds that invest in index funds that represent many different asset classes, including stocks, bonds, and short-term investments.  Commonly, the fund manager will offer a family of all-in-one funds, with the consistent allocation to each asset class depending on the investment objective of the fund. Vanguard’s family of all-in-one funds is one example.

A target date fund (also referred to life cycle funds) is a special type of all-in-one fund that is designed for retirement savings.  Target date funds change the amount that the fund invests in stocks, bonds and other investments in allocations as the investor ages.  These funds are structured to take more risks when the investor is young, and gradually get more conservative as the investor moves closer to retirement.

Lesson 3:  Invest in What You Know.

Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep. To the man who has gold, yet is not skilled in its handling, many uses for it appear most profitable. Too often these are fraught with danger of loss…and show small possibility of profit.”

While all-in-one funds may be a great choice for many, there is no single investment vehicle that is appropriate for everyone, and the all-in-one fund is no exception. For instance, most are geared towards smaller portfolios. Moreover, by necessity, all-in-one funds take a one-size-fits-all approach; that is, they cannot be tailored to the particular needs of an individual investors.

Accordingly, many investors can benefit from working with an investment advisor.  However, investors who do chose to work with an investment advisor would be wise to steer clear of advisors that use “proprietary” investment strategies with rules that are hidden from view.  In some cases, these proprietary strategies are a disguised attempt to pick winners and losers, and time the market, based on little more than personal opinion.  As history has repeatedly demonstrated, these attempts are much more likely to fail than to succeed.

Others rely on so-called super-secret computer algorithms to direct trades. These so called “black-box” models often also hide the true risk associated with the strategy under the guise of a need to protect the promoter’s “proprietary technology.”

Instead, in my view, investors are much better served by advisors who have adopted a “glass-box” model, where the decision-making process is transparent. As discussed here, I also believe it’s important that the advisor uses a rules-based approach that can be thoroughly back-tested and, as discussed here, is insulated from emotion-driven decisions.

Glass-box strategies may also utilize computer-run algorithms to drive investment decisions, but the logic, risks and research that supports the strategy is fully and fairly disclosed.  In some cases, a glass-box model can be easy to understand and implement.  One example is the so-called “lazy portfolio” model, a passive investment strategy that requires minimal maintenance. 

A lazy portfolio is one that consists of a small number of low-cost, well-diversified, index funds.  The amount allocated to each fund depends on the investment objective of the investor.  For example, a lazy portfolio constructed with Vanguard funds for an investor who has a long investment horizon and places an equal emphasis on portfolio returns and risk mitigation might look something like this:

  • 35% Vanguard Total (U.S.) Stock Market Index Fund (VTSMX or VTSAX).
  • 15% Vanguard Total International Stock Index Fund (VGTMX or VTIMX).
  • 50% Vanguard Total Bond Market Index Fund (VBMFX or VBTLX).

Lazy portfolios are passively rebalanced at fixed intervals (typically annually) to bring the amount invested in each fund back to the original target allocations.  This is accomplished by selling shares of the funds that have done the best, and investing the proceeds in the funds that have suffered the most.  The idea to sell high and buy low.  (You can learn more about building and managing a lazy portfolio here.

Passive rebalancing has a long track record of outperforming active investment strategies that try to outsmart the market.  One reason is that passive rebalancing reduces the chances of making poor decisions because of emotion and greed.  To put it into Arkad’s words: “Be not mislead by thy own romantic desires to make wealth rapidly.”

In two weeks, I will publish part 2 of this discussion.  In that post, I will review three additional components of the Babylon system for financial success, and explain how they can help you grow and preserve your wealth.  I hope you will join me. 

Thank you for reading,

Mr. Market Commentator

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