Go Ahead, Drop the F Bomb

About twelve years ago I decided it was time to get serious about investing so that some day I could retire. I knew my knowledge and experience was inadequate so I set out to find a teacher. There aren’t any. Financial advisers do not want you learn how to fish. It would put them out of a job. So I sought out a financial adviser. What I found were mutual fund salesmen. A mutual fund salesman is not a financial adviser. He is a commission salesman. He can’t sell you anything that is inappropriate, but he can choose reasonably appropriate products that do the best job of lining his pockets. I did discover one, for real financial adviser. Unfortunately, he wouldn’t talk to anyone who was unwilling or unable to commit at least $1,000,000 for five years. That left me out. I did find a newsletter that was pretty good. At least it taught me the basics of value investing and pointed me in the right direction to start my still ongoing learning process.

Be careful about newsletters and their claims. No one can see into the future. There are some legendary investors like Warren Buffet who have an incredible track record, but they do not sell newsletters.

Christians always talk about stewardship. That means they believe, at least on some level, that they don’t really own anything. What they have belongs to God. They are just managing those resources on his behalf. I got a long way to go on this one, but I am getting better. Back in the day the Duke didn’t have time to manage his finances, farmland, and peasants. He was too busy fighting wars, engaging in political intrigues, and chasing his mistress around the mead hall. He hired a steward to take care of the business of running his dukedom. This made the steward the second richest man in the dukedom. If he screwed up, the duke could always execute him. If the steward really screwed up, the duke could have him tortured for a while before executing him. Unfortunately, we no longer have that option when choosing to dismiss a corrupt or incompetent financial adviser.

If you insist on using a financial adviser, find one that works to a fiduciary standard. Wikipedia states, “A fiduciary duty is the highest standard of care at either equity or law. A fiduciary (abbreviation fid) is expected to be extremely loyal to the person to whom he owes the duty (the "principal"): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents.”

If a financial adviser isn’t willing to sign a written oath he isn’t a fiduciary. Even if a financial adviser is willing to sign a document establishing a fiduciary relationship with you as his client, that doesn’t mean there is any guarantee you will make money if you follow his advice. However, if he sells you a product that benefits his pockets, you have the basis for a lawsuit.

If the financial adviser is working to a fiduciary standard, he will be a fee only adviser, charging by the hour or charging a set price for developing and managing your personal financial plan. He will never work on any commission-based compensation scheme. That is inherently a conflict of interest.

If a financial adviser is working to a fiduciary standard, he will reveal any potential conflict of interest, recusing himself if necessary. (Recuse to disqualify (oneself) as judge in a particular case; broadly : to remove (oneself) from participation to avoid a conflict of interest) Merriam Webster As a Government employee working on contracts, I was required to recuse myself from participation in that contract if I owned stock in any of the companies bidding on the contract.

Unfortunately brokerage houses actively encourage their brokers to promote the sale of products to their clients that the house may be shorting because they believe the value of that product will fall. When they are caught, lawyers become rich. Rarely someone may go to jail.

In the Right Financial Plan by Larry Swedroe, a very good book, the author recommends that his advice is always based on the latest academic research, not someone’s opinion. How do you find out if this is so? Ask. If people make grandiose claims without solid and appropriate references, run away. Cherry picking data is always a tipoff to a lack of academic rigor in financial advice.

Finally, an adviser should be willing to meet with a client on a regular basis. Making certain that the entire plan which includes investments, taxes, and estate planning is integrated and up to date. Your goals and your plans are constantly changing with the changes in your life.

Reforming the relationship between financial advisers and clients actually was a pretty hot topic following the crash of 2008. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 attempted to address this issue by authorizing the Security and Exchange Commission to extend fiduciary duty to all brokers and advisers. As of March 2013 this has not happened. The financial industry is fighting back, maintaining that, “The higher standard of fiduciary duty, vs the lower standard of suitability, would be too costly to implement and reduce choice for consumers.” (Wikipedia) I am not surprised.

The next time you run into someone who wants to be your financial adviser, go ahead have some fun, drop the F bomb. Ask him if he is offering you a fiduciary relationship. Ask him if he would be willing to sign a fiduciary oath.

As always, Let’s be very careful out there today.

Student Debt? Don't Don't Bite the Hook.

For a variety of reasons I have been thinking a lot about student debt. About six years ago, before I ever thought about getting into a personal finance ministry, I wrote a list of 10 financial rules for young couples as a gift to a young woman and her husband. In that document I stated that, “Borrowing for school (with and only with a goal) is OK. Scholarships and work study grants are better.” I explained that a goal included things like, “I will earn a MSRN with a specialty in geriatric medicine. Since the Baby Boom is passing into old age, I will be guaranteed employment for the next 20-30 years.” Or “I will earn a BS in petroleum engineering. The developing world will need and desire an increasing amount of petroleum based products for the foreseeable future. Since it is becoming more difficult to tap new reserves in places like the Gulf of Mexico or refine lower grade crude I will have a job.”

Student loans were once a somewhat undesirable alternative for students without the family resources to pay cash, who for one reason or another were not eligible for enough scholarship money. It was OK because over a lifetime it was expected a college graduate would earn about $500,000 more than the same person with only a high school diploma.

Much has changed since the good old days. When I earned my first degree at Furman University, it was considered a bargain in a quality private liberal arts education. No more! The cost of attending Furman runs about $42,000 a year. That is Ivy League type cost. Furman isn’t an Ivy League School. Nobody cares if you knock your Furman class ring on a prospective employer’s desk. When I paid for my second degree in engineering from the University of South Carolina in the early 1980s I could take all the courses I could choke down for a paltry $600 a semester in tuition. With a scholarship, a work study grant, savings from our jobs, and my wife’s income, we could swing that without taking on any debt. No more!

Since those days the cost of higher education has run out of control, five times the rate of inflation. I think one of the main reasons for this distortion in our economy is the presence of large numbers of student loans offered and/or guaranteed by the Federal Government. Universities can raise their prices without lowering their student population. There is always more money. Just borrow it.

My generation discovered the quickest way out of student debt was bankruptcy. The laws were changed. Student debt is not forgiven, even in bankruptcy. If your child does not graduate, that debt is not forgiven; if your child can not find a job, that debt is not forgiven; if your child is dead and you cosigned for that loan, that debt is not forgiven. (Really, look it up.)

Student loans are growing out of control. Student loans have topped credit card debt. As of a few seconds ago, the student debt loan clock has passed $1,087,850,725,000. For new graduates that number works out to nearly $27,000. If you add graduate students to the mix the number is more like $42,000 in debt per student. This kind of debt is crippling. If a graduate even tries to live a normal middle class American life style starting with that kind of burden, they are condemning themselves to a lifetime of debt slavery.

Except in very rare circumstances, I can no longer recommend student loans. If you are a semester away from a medical degree and you find yourself a few thousand short. OK. If you are starting medical school with no resources, consider a hitch in the military or the National Health Service Corps. A few years of service to your country beats a lifetime of debt. There are similar opportunities for teachers willing to relocate to urban slums or impoverished rural communities for a few years.

Even with a good plan, too many things can go wrong. Even without a degree or a job, student debt remains and continues to grow if deferred for reasons of economic hardship.

There is a lot of scholarship money out there. It is very difficult to get. However, think about the math. Scholarship math works like this. If it requires 100 hours of research and writing to earn $10,000 in scholarship money, that works out to an after tax income of $100 an hour. Pretty good pay for someone still in high school working on a part time basis.

I think the new model can be found in this post I put up a couple of years ago.

Children and Money (True Story)

Even if a student does not qualify for scholarships straight out of high school, a Pell Grant expended at a community college while living at home will give that student a chance to mature while moving towards a degree. If that student kills it at the community college level, their chances at receiving a scholarship at an inexpensive in state public university offering 4 year degrees will be much greater. If they finish their bachelor’s degree with honors the sky’s the limit. They will probably get a job with an employer who offers educational benefits. My employer paid for my master’s degree.

By the way the student in that earlier post is currently working as a bio-mechanical researcher at the National Institutes of Health, while he completes his requirements before applying to medical school.

Quite frankly, although an 18 year old high school graduate is legally considered an adult, almost all of them simply do not have the financial sophistication to fully understand the ramifications associated with student debt. Many of them also lack the maturity to use that money in a completely responsible manner. I have read too many horror stories of university debit cards connected to money from student loans used for beer, road trips, and new clothes. That debt does not go away because a young person made a foolish mistake.

Then there is always a job. A student can work part time or even full time for a few years to help fund their own education.

Kissin' Don't Last Cookin' Do

There is way to much good material in The Future for Investors by Jeremy Siegel to cover in a single blog article. However, let me give you a taste of his thoughts on investing. The subtitle of the book is, “Why the tired and true triumph over the bold and the new.”

The core message is it isn’t what you buy that makes you rich. It is the price you pay for what you bought. Most people buy a story and then pay too much for growth. Just ask the people who bought Apple last year. That would include me. Last year my wife inherited a modest managed IRA from her father. It contains a pretty good balanced mix of bond funds and individual stocks. I saw a small amount Apple sitting in there and asked the broker, “Why?” He gave me an explanation I didn’t buy, but my wife and I decided to go ahead and this account ride for now. Professor Siegel tracks many examples over the course of the last century where boring sectors beat the latest hot growth stocks of the era. One of the chapters in the book is titled, “Growth is not Return.” How true. China has grown at a faster rate than Brazil, but an investor with a Brazil fund beat the investor with a China fund. The Chinese market has been consistently overvalued, by too much money chasing too few profitable corporations.

The author has discovered the best investments for the long run are not found in the latest sexy trend. They are often found in boring reliable companies producing boring reliable products and paying boring reliable dividends. As we say in West Virginia, “Kissin’ don’t last cookin’ do.” Consider this list of the best investments found in the companies that were a part of the S&P 500 in 1957. Check out those rates of return for the years 1957 to 2003. A paltry $1,000 investment in Phillip Morris at 19.75% would yield a return of $4,626.402!

1)Philip Morris (now Altria) 2)Abbot Labs 3)Bristol-Myers Squibb 4)Tootsie Roll Industries 5)Pfizer 6)Coca Cola 7)Merck 8)PepsiCo 9)Colgate Palmolive 10)Crane 11) H.J. Heinz 12)Wrigley 13)Fortune Brands 14)Kroger 15)Schering Plough 16)Proctor Gamble 17)Hersey Foods 18)Wyeth 19)Royal Dutch Petroleum 20)General Mills

19.75% 16.51% 16.36% 16.11% 16.03% 16.02% 15.90% 16.54% 15.32% 15.14% 14.78% 14.65% 14.55% 14.41% 14.36% 14.26% 14.22% 13.99% 13.64% 13.58%

If you are interested in how to find these undervalued companies, Siegel recommends a simple test first proposed by Peter Lynch, “Find the long term growth rate….add the dividend yield….and divide by the p/e ration. Less than 1.0 is poor; and 1.5 is OK, but what you are really looking for is a 2 or better.” This is essential the inverse of the PEG ratio. Using this measure you would look for PEG ratios less than 0.5. In today’s overheated market, those kinds of bargains are hard to find. In early 2009 during the dark days of the last crash, undervalued quality companies producing good products, good profits, and a steady cash flow were much more common.

Just remember, “Kissin’ don’t last cookin’ do.”

And for heaven's sake, let’s be careful out there today.

Good Debt, Bad Debt, Gen Y Debt

A article entitled “Why Gen Y is Losing the Debt Battle,” explores some of the possible reasons that young people (born 1981-1995) are already carrying heavy loads of bad debt so early in life. From my own interactions with young folks at least some of the reasons seem pretty obvious.

The article differentiates between “good debt” and “bad debt.” The author considers a mortgage and student loans as good debt since she contends this is debt that builds assets. I disagree. Over the past five years I have been changing my position on student debt. The class of 2011 graduated with an average of $26,660 in student debt. That number is tolerable if the student can find a job in their field that pays somewhat more than $26,660. Unfortunately, “53.6% of workers under the age of 25 who held bachelor’s degrees were jobless or underemployed.” (Associated Press) Personally, I know young folks who racked up over $100,000 in student debt. It isn’t that unusual. That is a mortgage without a house. From my observations six figure debt puts a young person’s life on hold for about ten years. That kind of debt delays marriage, buying a house, and starting a family. Even worse, there are also young people who have incurred student debt without the obtaining their desired degree.

A persistent high unemployment rate encouraged many young people to stay in school, hoping that when they graduated with another degree the economy would have improved along with their level of education. It isn’t working; in part because my generation, the baby boom, are holding on to their jobs since they are not financially prepared for retirement; in part for global macroeconomic forces beyond our control; in part because many degrees, particularly in the fine arts and liberal arts, are essentially worthless.

There also seems to be a multi-generational trend towards more and more debt. My grandparent’s generation paid cash for just about everything but the farm. My parent’s generation added the car loan and started the credit card revolution. My generation discovered new vices like home equity lines of credit and the first notable use of student loans. We also deeply abused credit cards. A number of authors have noted that Gen X and Gen Y are addicted to debt. They view the accumulation of debt as rite of passage, evidence that they are adults. Too many young folks are running up their credit card balance for no good reason. Many of them are carrying a car note, as well as those student loans.

The article observes that, “Results found Generation Yers had an average total debt load of $28,930, including $4,113 in credit cards, $7,358 in lines of credit and $12,410 in car loans on average.” The author does not define lines of credit. My calibrated eyeball notes that the average American (age 25-34) was earning about $32,000 in 2011 according to Census Bureau data. That kind of income can not reasonably support that kind of debt unless the young person is still living in their parents’ home.

Finally the article examines the effect of the digital revolution on Gen Y buying patterns, noting that it is just too easy to buy something by hitting a button on a smart phone. Psychologists have observed that parting with our money by paying with cash or a check is a lot harder that using plastic. Now we don’t even need to swipe our card to increase our debt load. Soren Christensen CEO of Advanced Wealth Advisors believes the ability to buy anything; anytime; anywhere; by using the Internet encourages reckless spending. We no longer need to drive the Model-T into town with cash in our wallet to buy a new pair of jeans.

Even “good debt” is dangerous. The members of Gen X and Gen Y who purchased homes prior to the 2006 meltdown have learned that lesson all too well. We live in dangerous times. The old model guaranteed a college degree was a passport to a lifetime job with a good company. The old model told us that the price of residential real estate only went up. The old model told us our company and our Government would take care of us in our old age. The old model isn’t working.

I am afraid that Gen Y will learn that the borrower is slave to the lender only after the shackles are firmly clamped around their wrist and ankles.

Contentment Is Great Gain

I am less than completely satisfied with myself. We recently bought our retirement home in another city. The builder should break ground on this construction project in the next two weeks. It is absolutely everything my wife wanted in our new home. It is almost everything I wanted, but the price went $12,500 over my price range and I expect there are a few surprises still in store. We can afford it. I have the cash set aside for the purpose. Afterwards, when we sell our current home, our liquid net worth should increase by a decent amount.

I have discovered that buying a new home is a lot like buying a car, “Oh! You wanted a steering wheel with your car? You have to buy the Bloomingdale upgrade to get a steering wheel.” I consider myself a pretty cagey buyer. I read the fine print. If I don’t understand the fine print, I ask for an explanation. This can take a lot of time. I have also discovered there are things that are not in the fine print. During the preconstruction meeting (after this meeting there can be no changes without an expensive written change order) I discovered the company would only landscape the yard back 15 feet from the house. That would leave a small dirt bank covered with pricker bushes and weed trees. Beyond the bank a 20 foot strip of bare dirt with a few pricker bushes. That isn’t happening, not with a new home. Grading and sodding the entire yard? That will be an extra $1,800.

I am once again reminded of this passage from First Timothy Chapter 6.

[6] But godliness with contentment is great gain.
[7] For we brought nothing into this world, and it is certain we can carry nothing out.
[8] And having food and raiment let us be therewith content.
[9] But they that will be rich fall into temptation and a snare, and into many foolish and hurtful lusts, which drown men in destruction and perdition.

The reason we can’t put our current house on the market until after the move, is stuff. After 25 years in the same house we have accumulated so much stuff it is a hindrance. We are in the process of giving it away, selling it, and just plain throwing it out. There is still so much stuff we can’t do the cosmetic things, carpet and paint, until we move out. I have been told that, “they that will be rich,” in verse 9 could be more accurately translated, they who would live richly. Unbridled American consumerism is truly filled with many foolish and hurtful lusts, but godliness with contentment is great gain. The first part of that trap is debt. The second part is too much. Ask yourself the question, “How much is too much?” before you buy it.

Again from 1 Timothy Chapter 6

[10] For the love of money is the root of all evil: which while some coveted after, they have erred from the faith, and pierced themselves through with many sorrows.
[11] But thou, O man of God, flee these things; and follow after righteousness, godliness, faith, love, patience, meekness.

What makes you happy? What makes you really, really happy? It isn’t stuff. Health, a loving family, a rewarding career, the experience of beauty, what is inside faith, love, patience; that is what matters. Not stuff.

Don’t worry, I am not planning to become a naked sadhu, leaving behind the material world to live in a cave to perfect my meditation techniques. I remain a pragmatic American Protestant. I agree with John Wesley, “Earn all you can. Save all you can. Give all you can.”

Or as Paul put it in 1 Timothy Chapter 6:

[17] Charge them that are rich in this world, that they be not highminded, nor trust in uncertain riches, but in the living God, who giveth us richly all things to enjoy;
[18] That they do good, that they be rich in good works, ready to distribute, willing to communicate;
[19] Laying up in store for themselves a good foundation against the time to come, that they may lay hold on eternal life.

Who Are You?

Caterpillar: Who... are... you?
Alice: Why, I hardly know, sir. I've changed so much since this morning, you see...
Caterpillar: No, I do not C, explain yourself.
Alice: I'm afraid I can't explain myself, you see, because I'm not myself, you know.
Caterpillar: I do not know.
Alice: I can't put it any more clearly, sir, because it isn't clear to me.

Where you live, where you shop, how much money you make is who you are, at least to Acxiom, a company collecting your personal data. You have been slotted into one of 70 categories. Here are a couple of examples from an article entitled “What Type of Consumer Are You?”

Married Sophisticates: You're in your late 20s or early 30s, recently married and likely have a household income between $50,000 and $100,000. You probably own a home, most likely in an upscale suburban neighborhood. You're a fan of "green and trendy cars," shop at Banana Republic and The Gap and are a loyal Netflix Inc. subscriber.

Apple Pie Families: You're part of an upper-middle class family, likely living in a smaller city or nearby suburb. You probably drive a minivan. You shop at stores like Home Depot, Target and Best Buy, read Sports Illustrated and listen to NPR.

Retailers pay big bucks for this information. By studying how and where different categories of consumers cluster companies can decide where to place new stores and how to advertise their products.

People resent being slotted by big businesses. Many claim using this kind of demographic data can effectively lead to a lack of choice, essentially discrimination based on race or income. That would be correct. It is unlikely that Walmart will build a store on Rodeo Drive in Beverly Hills 90210 or that Tiffany & Company will open a jewelry store in South Central LA.

Really though it isn’t the statisticians at Acxiom who are putting us into slots. We do that to ourselves. Recently we bought our retirement home near another city that is warmer and less expensive than suburban Washington, DC. Construction should be complete in the July August time frame. I would have picked a smaller, less expensive house, but my wife needs space to properly display the antique furniture we have inherited from our parents. The decision to live in one of those “Apple Pie Families” neighborhoods will deepen our demographic slot whether we like it or not. The community has covenants that discourage keeping farm animals as pets or storing a collection of 1948 Dodge pickup trucks in your front yard. This house will require a certain level of upkeep, as well as property taxes that will have to be paid. The people who buy these houses have typically locked themselves into a 30 year mortgage. Some of them have decided to have children. They will raise their children in apple pie American way. That will cost about $200,000 per child excluding college. I have seen them out walking their purebred dogs with their nicely dressed children or coming home from work in some pretty nice new cars.

Most of us don’t consciously answer the caterpillar’s question, “Who are you?” until it is too late. One day we wake up bound by a chain of our own making. We choose a life style. Then we have to find and keep a job that can support that life style. Usually that entails a lot of compromise and some regrets, usually tempered by our love for our family. Then, after many years have passed, we take the time to read personal finance literature in the hopes that we can learn to use our money to find our freedom. Ultimately that is what money means to me, freedom.

Before you bite the hook, ask the question, “Who am I?” Does marrying this man really make sense given who I am? Will leasing this $35,000 car really bring me enough happiness and fulfillment to justify postponing retirement for a year? Do I really want to spend the next 30 years in this cubicle? The earlier you ask yourself these questions the more likely it will be that you can live a conscious, awake, free, fulfilling life.

Are You Lost? (Part III)

I hesitate to discuss the BUDGET!! It is one of those subjects that cause people to lock up in fear thinking, “If I go on a budget it will be like working on a chain gang. I will never enjoy anything in my life again.” From a combination of somewhat legitimate fear, plus sloth, coupled with a desire to remain in a comfortable deluded mental state rather than confronting reality very few people ever stick with a formal budget. This is too bad. There really isn’t much debate. If you are looking for the tool to guide you to financial independence, whatever that means for you, the formal budget is the gold standard.

I have to be honest, for almost all of my life I have lived without a budget, except the one in my head. That one worked pretty well because I was raised to squeeze a nickel so hard the buffalo bellowed. I also had a third generation terror of debt. The only time I ever borrowed money was to buy our home. I paid it off in a little less than 10 years. I carefully watched the ebb and flow of my money. If I didn’t like what I saw, I tracked every penny for a month. That seemed to answer most of my questions. I also spent most of my life working towards one or another long term goal, cash for cars, degrees without debt, paying off the house, and retirement.

Spending less money is not the goal, the purpose of a budget. Ultimately, the purpose is freedom, enough money to have and to do what is really important—to you.

I have another problem with how the budget is generally taught. It is my experience that change that sticks is slow incremental change. I have seen folks with serious financial problems get struck down with the holy lightning of frugality, permanently changing direction overnight. It just isn’t all that common. What is important is that you start—today. Not tomorrow. What is important is that you take the blinders off your eyes. Really look at your financial situation. Be compassionate and forgiving to yourself if that is necessary, but be honest. If you can’t be honest with yourself you are truly lost in the wilderness. Find your own personal long term goals. This will be your source of power to continue on those days when living on a budget really isn’t any fun. Learning to live better for less is a challenge. Find a way to make it fun. It’s your life. Enjoy it.

This stuff really, really works. Live it! Forty years from now you will not regret the way you lived your life.

If you are committed to calculating and recording your net worth on a monthly basis, you already know if what you are doing is working as planned. If your net worth is headed upward at a steadily increasing rate and you are happy with your job and your life. This may be all you really need to do. If your net worth is headed down or is a negative number, perhaps you need to do more. If your net worth is headed up, but you hate your soul sucking cubicle, your desire for freedom might indicate a formal budget. It might be the key to a new life.

There are intermediate steps short of a full court press formal budget. If you are disciplined and have a gift for juggling a large number of figures in your head perhaps you can get away with devising your own compromise system.

For example:

Charlie brings home about $1,800 a month. He is contributing 5% to his 401-K so he can get his employer’s matching money. His rent is $700 a month. His car payment is $200 a month. His utilities run about $300 a month including cable TV and his iPhone. However, he has a hard time paying off his credit card every month. He is worried. He doesn’t understand why. He eats peanut butter sandwiches, ramen noodles, and canned tuna fish. He isn’t married. He doesn’t have any expensive hobbies. Where is all going? Well, it turns out Charlie is young and single, so he spends a lot of time at bars with his buddies and their girlfriends. By recording every single penny spent for a month he discovered his bar tab was running over $300 a month. Charlie decided to cut the cable saving $60 a month and limit his “entertainment” expenses to $150 a month. To make certain he didn’t cheat, he wrote beer money on an actual factual envelope. At the beginning of the month he put $150 in real U.S. dollar bills in the beer envelope, swearing an oath to himself that he would not exceed that amount. When he noticed that $100 was gone by the end of the first week, he decided to drink beer at home with his buddies at $1.00 a bottle rather than $5.00 a bottle (with tip) at the bar.

I hope Charlie uses some of the money he saved to improve his diet, but let’s save that topic for another day. I do hope you get the idea that if you are mindfully watching your expenses, putting safeguards in place to avoid your particular weaknesses and shortcomings, as well as relentlessly tracking your net worth you are probably going to be OK. If you see a drop in your net worth that you can’t explain, jump on it. Immediately! Return to tracking your daily expenses until you have the problem nailed down.

You may have noticed I used a simple example, a single man without any really serious problems. When he decides to get married, the personal finance stakes just got higher. When the young couple buys their first house they raise the stakes again. When they fill their yard with little boys and girls, they are all in. Each time you raise the stakes in your life the arguments in favor of a formal budget get more compelling. Also, once you choose to introduce a spouse into the mix, the formal budget process limits and controls arguments over money.

If you are in trouble don’t look for a way out. Go ahead and do the full formal budget. I don’t think I could improve on Dave Ramsey’s teaching on the subject, so here it is from an earlier post.

Dave Ramsey Cash Flow Planning

Here is a link to a wide variety of free budgeting software. Personally, I think for most folks the old fashioned paper and pencil forms are just fine. They can be copied from the back of any of Dave Ramsey’s books or his course material. He stated that he is OK with sharing these materials, but he is not OK with you selling his copyrighted materials. You can also buy these forms at any business supply house.

Free Household Budget Spreadsheets

I hope that somewhere in this series of posts you have found a map to guide you home.

Are You Lost? (Part II)

Your finances are a vector, a quantity with both magnitude and direction. Your instantaneous net worth is constantly growing and shrinking, affected by both external forces as well as your behavior. In calculating the two components of your net worth you now know your location on the financial map. Since your finances can’t stand still, take some time to determine their current direction and velocity. I will now ask you to track your expenses, to the penny, no excuses for one month. If you are like most Americans, you know what is coming in your paycheck. Even most of our country’s commission sales force has a monthly “draw” that buffers the irregular nature of their income. If you are an independent small business person you will need to make a similar record of your daily inflow.

Take a little spiral notebook with you everywhere you go. If you use a debit card for most of your purchases, your bank will keep this initial record for you. When you spend even a penny record the amount and the nature of the purchase. At the end of the day take that list and transfer it to your monthly total sheets. Guess what? I am not going to tell you what categories to use. I will let you discover what makes sense to you, remembering that the purpose of this exercise is complete honesty. What point would there be in finding ways to game your own system or telling lies that hurt no one but yourself.

Ask, “What categories would make the most sense given the way I actually live my life?”

For example, food is a universal category, but how to break it into its component parts? In my case it might look something like this.

Food

1)Grocery Store Food – generally food that requires some effort to prepare, including raw vegetables, microwave dinners, fruit juice, and even boxes of crackers would fall into this category. I often put cheese on my crackers. I would not bother to separate toilet paper from my grocery bill, too much effort. The important part in selecting sub-categories is consistency and self awareness.

2)Convenience Food – This would include lunch at the cafeteria, vending machine snacks, fast food, and meals at restaurants (including the cost of tips and drinks)

3)Beer – Since I drink my beer at home in the evening rather than in a tavern, it makes more sense to me to include it as a separate category under food, a part of my caloric intake. Since I am trying to lose weight, this calls out this expense in a manner that also is mindfully reminding me that this practice is affecting my weight.

If you want to include all alcoholic beverages under entertainment that is perfectly OK. It is your expense register.

Utilities:

If you live in an all electric apartment and have a fixed price land line or a fixed price cell phone just one category for all utilities may be enough. If you live in a house it gets more complicated.

1)Electricity – Air conditioning in the summer will be the big “draw” (engineering humor)

2)Natural Gas – Keep your eye on heating costs in the winter

3)Cable TV – One of my two favorite expenses that can be controlled or eliminated.

4)Cell Phone – The other expense that can be controlled or even (gasp) eliminated.

5)Water – Usually this expense is not too high or too controllable. Choosing not to flush the toilet every time is a little too extreme even for someone like me.

You will find that keeping an expense record is an iterative form of budgeting. Since there is a certain amount of pain associated with recording an expense, then looking at what you have done over the course of the day with mindfulness, you will quickly discover behaviors you wish to change. You will begin to ask yourself important questions. Do I want to spend $10.00 a day on coffee and a danish? Do I like how it feels to pay a $30.00 late charge to the credit card company? Did I really “deserve” a car with a $500 monthly payment when I only take home $2,000 a month? If you are honest with yourself, I expect your behavior at the end of the month will be different than your behavior at the beginning of the month.

You are now ready to start budgeting, either a quick and dirty form of budgeting for the lazy or if you are generally successful in achieving your goals with money or something more radical if you need it.

Are You Lost?

One dark evening I received a desperate tearful phone call from my wife. She told me she was lost. She couldn’t find her way home. I did what any husband would do is such a situation. I asked, “Tell me where you are?”

She replied, “I don’t know where I am. I’m lost.” Then she cried some more. The story had a happy outcome. My wife was in an apartment parking lot. She found a man who knew where she was located. Between the two of us we were able to quickly get my wife on the familiar road to our home.

If you are lost whether on an unfamiliar street on a dark night or in a financial mess the first step is calming your mind by asking the right questions about your internal condition. We covered those questions in Back to the Beginning.

Back to the Beginning

When you are ready, you must then ask the question, “Where am I?” In order to determine the right road to your destination you must first know your current location. In answering those questions about your financial situation, first calculate your net worth. I am going to ask you to perform that calculation using certain assumptions.

I will ask you to break your net worth into two components, liquid net worth and real estate net worth. For the purposes of this calculation consider any investment or debt that can be instantly valued to the penny and liquidated as a component to your liquid net worth.

For Example: Consider a Recent College Graduate

-$ 1,000 Credit Card Debt
-$20,000 Student Loan
-$13,000 Car Note
+$ 4,000 Credit Union Checking Account
+$14,000 401K

Total Liquid Net Worth: -$16,000

Our young graduate has a negative liquid net worth. If that is your situation, it isn’t all that unusual. It can be fixed.

Let us assume that the young person in our example also bought a small condo near her place of work. She received first time home buyer aid from her state, so she only had to make a 3% down payment. To calculate her real estate net worth she goes to Zillow for an estimate of her property’s current value. Then she calls the bank or looks at her spread sheet to determine how much she still owes on the mortgage.

Let’s say those amounts are:

$90,000 Zillow Estimate
-$85,000 Remaining Mortgage Balance

Total Real Estate Net Worth: +$5,000

Our young graduate has determined her location, the first step in finding her way to finding financial independence. I recommend that you perform this calculation once a month, every month for the rest of your life. It is a very quick way to determine if what you are doing is producing the results you want. Even with multiple investment accounts, this only takes a few minutes every month. If your last name is Rockefeller and your concerns include large real estate developments and factory depreciation, you are excused. Your accounting staff and auditors will perform these calculations on a quarterly basis.

You may have noticed that I have not included the value of the car or any furniture this young lady might own as a component of her net worth. That car is worth something, maybe more or less than book value. She won’t really know what that car is worth until somebody writes her a check. Besides that, she needs the car to drive to work. It is a depreciating illiquid asset. If she decides to sell the car, then she can deposit the money in her checking account turning it into a liquid asset. The same logic could be applied to real estate, but with a little bit of luck and a lot of time real estate will be more likely to appreciate in value. This makes it an investment as well as an expense. Unless you are the owner a perfect low mileage Saturn Sky with the dealer installed turbo package or some similar rare fast car it is not an investment. It is purely an expense.

By the way, the next step is not the monthly budget.

Lost by David Wagoner:

Stand still. The trees ahead and bushes beside you
Are not lost. Wherever you are is called Here,
And you must treat it as a powerful stranger,
Must ask permission to know it and be known.
The forest breathes. Listen. It answers,
I have made this place around you,
If you leave it you may come back again, saying Here.
No two trees are the same to Raven.
No two branches are the same to Wren.
If what a tree or a bush does is lost on you,
You are surely lost. Stand still.
The forest knows where you are. You must let it find you.

What If?

What if there was money left over at the end of the week or the month? What if after the bills were paid, the groceries were in the refrigerator, and the gas gauge in your car read full, there were a few extra bucks in your wallet? Then what could you do? Maybe you could get rid of that pesky credit card balance that never goes away. Maybe you could get rid of that student loan that has been chained to your leg for the last ten years. Maybe you could even take your wife and kids out to a nice restaurant for Sunday dinner.

It could happen, you know. You can learn how to spend less and earn more. You can take the first step today. If you start each day with intentionality in your heart, a willingness to learn and take action, a week will come when you will have a little left over money.

What if after a few years of building a careful intentional relationship with your money, reaching the point where you are systematically building your 401K for retirement and saving for your kids’ college education, you find there are a few extra bucks left over to budget? Then what could you do? Maybe you could start paying down that mortgage. Maybe you could open a taxable investment account. Maybe you could even take your wife and kids to Disneyworld instead of dad’s cabin on the lake.

It could happen, you know. If consistently, over time you do the right things like learning how to carry a zero balance on your credit cards or living with a rust bucket ten year old car until you can pay cash for its replacement. You can learn the fine art of living a better life on less. Ultimately contentment does not come from a multitude of things.

What if after twenty or thirty years the day comes when you can retire with dignity? The mortgage has been paid off. The kids are grown up and on their own. You have enough in your investment accounts to fund an appropriate lifestyle for the years God may give you. What if after all that you have a little surplus, a little left over money, then what could you do? Maybe you could set up a trust for your children and grandchildren. Maybe you could help fund your grandchildren’s college accounts. Maybe you could give a little extra to your church. Maybe you could even take your wife on that Mediterranean cruise she has wanted for the last ten years.

It could happen, you know. There are plenty of examples of fairly humble people who never earned all that much in any given year who are enjoying a comfortable retirement. Some of them are still planning for the future. I won’t lie. It isn’t easy and there are no guarantees, but you can learn how to move the odds in your favor through a combination of frugality, hard work, and financial discipline.

What if after you pass from this world there was some money left over in your estate? Who you could bless? Maybe you could help fund your children’s retirement. Maybe you could guarantee that your family could stay on your farm. Maybe you could help endow a hospital in a third world country.

It could happen, you know, but it has to start in your heart.

P.S. If you don’t take any action you will never get any results.

Integrity

“If you want to know how rich you really are, find out what would be left of you tomorrow if you should lose every dollar you own tonight.”
William J.H. Boetcker

A while back I read an article on marriage written by a woman scarred by a number of divorces. Basically, she recommended women should look for three characteristics in a husband.

Integrity, Integrity, and Integrity.

Thomas Stanley author of the well know classic, The Millionaire Next Door also wrote a less well know book on what kind of behaviors were critical in creating self made, first generation millionaires entitled The Millionaire Mind. Honesty was the number one indicator of success in this broad statistical study undertaken by a respected sociologist.

Amy Rees Anderson, a successful entrepreneur and investor advises her readers in an article entitled, “Success will Come and Go But Integrity is Forever” that, “Integrity means doing the right thing at all times and in all circumstances, whether or not anyone is watching. It takes having the courage to do the right thing, no matter what the consequences will be. Building a reputation of integrity takes years, but it takes only a second to lose, so never allow yourself to ever do anything that would damage your integrity.”

Sounds a little like the words Shakespeare put in the mouth of Julius Caesar, "The evil that men do lives after them; the good is oft interred with their bones."

Simply put, integrity is complete consistency in your words and your actions; if you espouse a value system; you live by that value system. That is a high standard in a world that frequently seems to reward bad behavior. However, integrity should be your goal in life. Your honor and the love of your friends and family are ultimately what you will carry to the grave. When you fail to live up to your own expectations of decency and morality, don’t excuse yourself. Ask God and/or the person you have wronged for their forgiveness and vow to do better next time. None of us are perfect. Let God sort out the details of justice in the universe. Your job is to concentrate on how you can make this a better world as you make yourself a better person.

Wise employers understand the importance of integrity. Warren Buffet observed, “In looking for people to hire, look for three qualities: integrity, intelligence, and energy. And if they don’t have the first one, the other two will kill you.” Just think how important the integrity of others is in your relationships. Friends, business partners, and even family members who can be trusted to do the right thing on your behalf even when it is not in their best interests are worth more to you than gold.

The price of gold rises and falls over time. Integrity is forever.

Top Ten Indicators of Success From the Millionaire Mind by Thomas Stanley Ph.D.

1. Being honest with all people
2. Being well disciplined
3. Getting along with people
4. Having a supportive spouse
5. Working harder than most people
6. Loving my career/business
7. Having strong leadership qualities
8. Having a very competitive spirit/personality
9. Being very well organized
10. Having an ability to sell my ideas/products

Do You Want to Get Better at Managing Your Money?

Do you want to get better at managing your money? Find someone who knows more than you know. Ask her questions. Be eager to learn. Forget your preconceptions and prejudices. Open your mind to new possibilities. Then listen; evaluate; experiment; learn. Even if you disagree with a teacher or discover a path is not for you, ask yourself is there even one thing I can learn from this person. The answer is almost always, “Yes!”

Since I went on that last long vacation prior to my retirement, I have been blessed with the opportunity to learn from both some recognized masters and a rising star. Books are a wonderful opportunity to meet and learn from people with encyclopedic knowledge of their subject. Think about the amount of time that went into writing that book. How much would John C. Bogle, the founder of the Vanguard family of funds, charge for an hour of his time? If someone like that writes a book, don’t miss the opportunity to read it. Go to your public library. How can you beat consulting with world renowned experts at no charge? Even if you end up paying $25.00 for a quality hardback, what a bargain. Be sure and share that book with others. Never miss the chance to be a blessing. It is written, “When a blind man carries a lame man, they both go forward.”

Here is a brief list of some of my recent consultations with some of the best.

One Up on Wall Street by Peter Lynch

One of the classics. I was honored to be given this book as a gift at my retirement. It challenges some of my basic assumptions on how to evaluate small cap stocks. I still need to experiment with his methods using annual reports and research papers on stocks that I already own before I start putting my money down on companies that the stodgy old conservative value investor inside of me still considers risky. I intend to learn everything I can from this book. I never want to stop learning.

I Will Teach You to Be Rich by Ramit Sethi

This young man particularly addresses the problems of well educated, intelligent, ambitious, young people in language they understand. His advice on creating or bettering a career (mostly found on his blog) is of particular value. He has challenged me to better utilize some of the “cloud” type resources that are free on the Internet. He has also reminded me I could do better with my pure cash by utilizing a high interest account at an electronic bank. These services are offered by Schwab, who is already my broker. I have known about these opportunities, but a combination of sloth, fear of a bank without a building, as well as loyalty to my credit union has stopped me from taking advantage of the higher rates found at online banks. I might have to use an ATM, a very scary thought.

On Investing: The First 50 Years by John C. Bogle

If you want well documented statistical proof that investing in low cost index funds beats paying retail for products sold by commission salesmen, here it is. He also reminds those of us who pick individual stocks to be very careful. Really, this man should be honored by his country. He invented the index fund. He structured his company in such a way that the shares (hence the investors) own the company. It uniquely benefits the investor with low costs. Vanguard is no longer alone. Fidelity, BlackRock, and Schwab to name just a few of the companies that are now offering competitive products, particularly in the new field of Exchange Traded Funds.

The Future for Investors by Jeremy Siegel

Benefit from a lifetime of academic research by one of the best known professors from the Wharton School of Business. This man has quite a record, including his notorious prediction of the dotcom collapse of 2000. I haven’t finished reading this book, but I am really excited by the depth of his research and the power of his logic. He must be smart. He agrees with me.

One more thing, no one has all the answers. Not even me.

As always, remember managing money contains risk. That is to say, it contains elements of both skill and luck. If you are blessed, thank God. He is your provider. It is God alone who judges; he decides who will rise and who will fall. Perhaps the most basic and oft repeated premise of this blog can be found in James 1:5, “If you need wisdom, ask our generous God, and he will give it to you. He will not rebuke you for asking.”

Middle Class Myths (The Car Payment)

One of my personal pet peeves is the car payment. Totally intelligent, responsible, middle class Americans believe they can not live without a car payment. I tend not to go after this myth as often as cable TV and cell phones. It is much easier to make an argument against a $150 a month cable bill than going after the car payment. After all, if you live in most places in this country you need a reliable car.

I recently read an article in Zero Hedge. The automakers have introduced the 97 month car loan. No really, I am not making this up. The Wall Street Journal is reporting that while the average price of a new car is now $31,000 (up $3,000 in the past four years) the average monthly car payment has dropped from $465 to $460. Experian reports that 17% of all new car loans were for 73 to 84 months. Four years ago only 11% of car loans fell into that category.

This is insane. By the time a customer has paid off a 60 month car note, the car has lost over 40% of its value according to Edmunds (their website is a very valuable resource when buying a car). Their graph does not extend beyond five years, but my calibrated eyeball extrapolated the trend line out to 97 months. I would guess your car has lost 85% of its value. Congratulations on a 97 month car loan at 4% you have paid about 115% of full retail for an asset that is worth 15% of that retail price.

You can live in this country without a car payment. I have done this throughout my entire life. I won’t lie, back in the day I drove some pretty nasty rust buckets. However since 1988 I have been able to pay cash for new cars. My current strategy is buying new then keeping the car until repair costs over the course of a year begin to approach the cost of a few new car payments for a similar car. That seems to happen after a car passes 175,000 miles. Given the way I drive, I typically keep a car for between 12 to 14 years. Until 1988 I replaced a car when the cost of repairing a car exceeded the value of the car once repaired.

I bought my first car, a 1967 Chevy Nova, in 1973 for $600. According the Inflation Calculator, in today’s dollars that would be $3,058.31. I got about 7 years and 75,000 miles out of that car. $3,000 seems like a reasonable lower limit for a car. I wouldn’t recommend a $1,000 car unless you are a professional mechanic with some spare time on your hands. Let’s say that $3,000 car lasts you for four years. During that time pay yourself a $400 a month car payment. At the end of four years, even with no interest you will have $19,200 in hand. A quick visit to CarMax shows me a 2011 Honda Accord SE 4D Sedan with leather seats, air conditioning, and cruise control with 28,000 miles for $19,998. That is a really sweet car. It only took you four years in a beater to escape the car payment trap for the rest of your life. After you have driven that 2011 Honda for another eight years or so, you will have enough money to pay cash for a new BMW, if that is what you really want.

Please believe Bible when it says, “The rich rule over the poor, and the borrower is slave to the lender.” Think about it. If you are in debt, the lenders have a legal claim to your time. Whether you like it or not, you have to work until you have paid off that claim.

Now let’s go ahead and have a little fun. The $1,000 Car song by the Bottle Rockets.

A $1,000 Car

Defense in Depth (Budgeting in Retirement)

In “Betwixt and Between” I began to explore the concept of budgeting in retirement, as the normal preretirement budgeting process no longer makes any sense to me. Before retirement, income is balanced against outflow (projected expenses, savings, and giving) until the two numbers sum to zero. This is just basic bookkeeping. We undertake this discipline to build our wealth, so that we can retire with dignity. In retirement there is no longer a regular (or even an irregular) paycheck. In retirement the purpose of a budget is to responsibly spend our hard earned money in a manner that will make all that effort worthwhile.

Betwixt and Between

In researching this problem, I discovered Farrell Dolan’s concept of different boxes for different kinds of money and different kinds of expenses. Since then I have read a book that contains some of the same ideas. I have too many problems with that book to recommend it, but I think in this particular case both authors are headed in the right direction.

I concur with Larry Burkett, the godfather of Christian personal finance authors. He stated that if you haven’t paid off your mortgage, you have no retirement plan. Don’t carry debt into retirement. It is a recipe for disaster. The only exception to this rule might be someone with a truly golden pension or parachute and only a few years left on a 3.5% mortgage. Even then debt in retirement worries me. Go ahead, pay it off.

There is a hierarchy of resources in retirement. There is also a hierarchy of expenses. These items require different treatment. The best analogy I have at the moment is defense in depth, a military concept. Rather than committing all your assets to stop an enemy at a single line of defense, say a border, different kinds of assets are positioned in a manner that trades space for time and enemy casualties. The use of multiple, over lapping, redundant layers of protection are more effective than any single barrier, no matter how strong.

The first category of money contains your renewable resources. These are the checks, however small, that come in on a regular basis such as pensions, social security, and annuities. Ideally, these assets should be balanced in a conventional manner against necessities including rent or property taxes, health and other kinds of insurance, utilities, groceries, transportation, and clothing. Allow a line under food for restaurants. Although I no longer eat lunch at the cafeteria, it is unlikely that I will completely give up the convenience and pleasure of eating out.

The second category of money is cash. This would include your little stash of twenty dollar bills hidden in a drawer somewhere in your house, checking accounts, money market funds, and plastic money. If you use a credit card, pay it off every month. If you ever carry a balance on a credit card, lock it up until you have paid it off. If you use a debit card make certain that you turn off the so called overdraft protection feature. U.S. banks collect $31.5 Billion a year in overdraft fees. You don’t need to accidently pay $35.00 for a cup of coffee because you made a mistake balancing your checkbook.

The purpose of cash is paying for irregular and somewhat unpredictable expenses in the foreseeable future, say a year. These expenses can be considerable. Over the next five or six months, I will buy a new house in a different city. I will pay someone to move one pile of stuff from where I live to my new home. I will also pay to move a pile of my mother in law’s stuff from a storage unit in a third city to my new home. Before I can sell my existing home, I will need to do all those cosmetic things like paint, install new carpet, replace a badly stained toilet, and possibly buy a new air conditioner. I need to have the cash ready and available when the time comes to pull the trigger. Someday, when I am living near a city that is warmer and cheaper than Washington, DC I hope I will be using some of this money to take a Mediterranean cruise.

The next line of defense, now the source of my cash, are investments held in taxable accounts. These include bond funds, stock funds, and individual assets. In an ideal world these investments would generate enough income to pay for the country club, the cruises, classes, and our other dreams. Unfortunately we do not live in that world. Although preservation and income rather than growth are the paramount issues, I still hope my assets continue to increase over time.

The next line of defense is tax favored accounts. This would include 401-K accounts, IRAs, and Roth IRAs. Leave that money alone for as long as possible. Continue to let it grow tax free until you really need it.

Your final line of defense is the equity in your home. Someday, barring an unexpected death, you will be old enough that you are no longer able to maintain a home. When that day arrives, or when your other funds are growing low, it is time to sell your home and move into an apartment or a retirement facility.

I have worn myself out studying safe withdrawal rates. Nothing is perfectly safe in this imperfect world, but all the evidence seems to point back to the 4% rule. I have written a large number of posts exploring this and other options. Basically it comes down to this. If you withdrawal an amount equal to or less than 4% of your investment total when you first retire every year during retirement, there is a high probability that you will not outlive your money.

A Few Additional Considerations:

4% Rule Assumptions:

Most withdrawal simulations assume a well diversified 50% stock 50% bond portfolio or a 60% stock 40% bond portfolio. Some more conservative researchers recommend a 3% draw; the more optimistic allow for a 5% draw; still others allow a certain amount flexibility based on market conditions and age.

Annuitizing your 401K:

If you find that your total renewable resources are just too low to meet your basic needs, explore any options your company might offer for annuitizing your 401K account. Although I do not generally recommend retail annuities due to the very high fees associated with these instruments, my former employer offers a pretty good deal that would allow me to convert my tax favored retirement account into a guaranteed lifetime income stream.

The Emergency Fund:

I have decided to leave my official six month emergency fund sitting right where it has been for many years, in a 6 month insured CD in my beloved Credit Union. To continue with my military analogy, I consider these funds my personal bodyguard regiment.

Giving in Retirement:

Because I have accumulated some wealth over the course of my life, I hope to continue giving at a level greater than would be indicated by my inflow of “renewable resources.” I am also in the process of setting up a charitable remainder trust as a part of my will, so that God willing, I will be able to care for others and give to charity after I have passed from this vale of tears.

Rent? Own? or Own to Rent? (Part III)

“Because he wants to keep you living in his slums and paying the kind of rent he decides. Joe, you had one of those Potter houses, didn't you? Well, have you forgotten? Have you forgotten what he charged you for that broken-down shack? …. Can't you understand what's happening here? Don't you see what's happening? Potter isn't selling. Potter's buying! And why? Because we're panicking and he's not. That's why. He's picking up some bargains.”
George Bailey Quote from It’s a Wonderful Life.

Recently, the topic of the movie “It’s a Wonderful Life” came up in the course of a conversation. My friend quoted George Bailey, the hero of the movie as he tried to calm down an anxious crowd by noting that Henry F. Potter, the evil rich banker wasn’t selling into the panic. He was buying. It was one of those moments of understanding in which I felt a shot of electricity go through my body.

I’m here to report Henry Potter is buying.

The Blackstone Group is buying 15,000 single family homes in the Tampa, FL area. They already have up to $1 Billion in hand for this purpose. Their intention is to turn entire neighborhoods into rental communities. This financial service and asset management giant is making an unprecedented bet that our country is moving from an ownership society to a society of renters. The Blackstone Group is not alone. It is reported that KRR and Waypoint Homes are also buying up homes in the hard hit Tampa area. Blackstone will not be content to just be a slumlord. They are planning to monetize future rents from these properties into bonds or other financial instruments that will then be sold at a profit to retail customers. Once this happens they will be making a profit with little or no risk. The risk will have been transferred to the bond holders, mom and pop America.

Blackstone is not alone. Bloomberg reports, J.P. Morgan Chase is already into the hardest hit real estate markets in the country including Las Vegas, Florida, Arizona, and California. They are already moving ownership of these rental properties to some of their wealthiest clients. Somehow I bet they are being offered a better deal than I can get.

What is disturbing about these and other similar activities are not that Henry Potter (One of the American Film Institute’s top 50 villains) has seen an opportunity to take the money and run. What bothers me is that he is doing it at taxpayer expense. Many of these properties are owned by Fannie Mae, a quasi-public corporation created by Congress. There are well documented reports out there that some of these sales are real sweetheart deals, essentially giving these major corporations the opportunity to buy at 0% interest.

There are authors who believe that the opportunity to pick up cheap rental properties has already past. Again, there is an ebb and flow to the movement of money. Housing is subject to the laws of supply and demand just like any other commodity. There are a finite number of people with a finite supply of money who wish to live in a particular area with a finite number of houses. If there are more buyers than houses the price goes up. If there are more sellers than buyers the price goes down. If Henry Potter is still buying, I believe there is still some decent opportunities left on the table. When Henry Potter starts to sell those bonds to retail customers, then I will suspect that this little boomlet is over.

There is a way to invest in real estate without $1 Billion in cash or the specter of broken toilets in the middle of the night disturbing your slumber. They are called Real Estate Investment Trusts (REIT). Invetopedia defines a REIT as, “A security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.”

As always there are dangers inherent in REITs. Share values move up and down with the underlying value of their assets. Needless to say REITs were pummeled the 2006-2009 meltdown. Those dividends also ebb and flow with rental market returns.

There are REITs available for just about any segment of the real estate market that interests you from humble storage units to prestigious office buildings. Your shares can be backed by either properties or mortgages. I own shares in one specialty REIT that is involved in the pulp and paper business as well as the development of retirement communities. Even through the crash it did OK. Now it seems to be waking up along with the nascent housing recovery.

Here is a link to a blog post by Charles Hugh Smith. I always enjoy his posts. He really makes me think about what I believe to be true. In this case, I disagree with his premise that the boom is over because I observe that Henry Potter is still buying properties. I include it because it contains a wealth of links to articles both from the traditional press and the blogosphere covering this subject from widely varying viewpoints.

The Crowded Trade Buy to Rent Housing

Rent? Own? or Own to Rent? (Part II)

When I first started learning about money I was already aware that rental property could be a good investment. Once upon a time my father bought a small house for this purpose. He had a low cost, high quality employee taking care of some of the maintenance and repair issues. That would be me. The more I read about buying rental properties, the more I decided this was just not right for me. As I have grown older I am less willing and less able to take care of maintenance and repair in my own house, let alone taking care of a stranger’s broken toilet in the middle of the night.

When the young woman mentioned earlier in the article was buying her new home, I revisited the issue. Given the situation in that city, I could buy a house for $100,000. Let’s say I could get $700 a month in rent, the going rate at the time. That would be $8,400 a year, less $840 for management fees, less $2,000 in taxes. That is still $5,560 in income, a little more than 5.5%. Try getting that in today’s bond market. In addition there are certain tax deductions associated with such a venture including depreciation. I am not an expert on taxes. I pay my wonderful CPA to make such problems disappear. I consider it some of the best money I spend on expert assistance. Even though there was a good probability of both decent income and the potential of capital appreciation associated with rental property in that market, once again, the specter of broken toilets in the middle of the night, particularly broken toilets in another city dissuaded me from following that course of action.

We have all heard the get rich quick, no money down pitch on late night infomercials. One more time. Say it with me, “If it sounds too good to be true…..” This is how Dave Ramsey first became a millionaire. It also landed him in bankruptcy court. Using leverage is exceedingly dangerous. As long as everything is going up in value it works fine. If things head South and your creditor wants his money—NOW—you are in trouble. This is not limited to small time players. I know a very wealthy man, perhaps the richest man I have actually met who is fighting this battle. He was in the process of developing a large retirement community around a world class golf course using borrowed money when the market crashed. That development filed for bankruptcy. What looked like a gold mine turned into an ugly political and financial nightmare. It looks like the local taxpayers are going to end up footing a large portion of the bill. Many of his other large commercial properties are in danger. He is scrambling like mad to meet his cash flow requirements. Although these properties are worth a fortune, they are underwater. He can not sell them for enough to cover his debt in the current market. Given what I know about this man, he will persevere and overcome, but he is in a fight for his financial life.

The term landlord conjures visions of Snidely Whiplash, eviction notice in hand, throwing a helpless old widow out into the snow on Christmas Eve or his more modern cousin, the slumlord riding in the back seat of his long black Cadillac making the rounds with Sammy Four Fingers, his all purpose driver, bodyguard, and leg breaker. However, sometimes perfectly innocent people become landlords in spite of their best laid plans. I know of two young couples who owned their own condos. They managed their money diligently, saving for that big house in the suburbs. The day came when they had 20% in hand and the necessary cash flow to easily meet the bank’s requirements to buy the house of their dreams. In both cases there was one fly in the ointment. Their condos were underwater. If they sold, they would have to sell at a loss, making up the difference with cash. In both cases they wisely decided to become landlords, renting out their desirable condominiums until the market recovers. I believe the market will recover. I don’t think anyone who can hold out for the long run will lose any money on residential real estate in suburban areas around Washington, DC. I don’t see the Federal Government getting smaller or less important. So far they have been lucky. They have been able to find acceptable to excellent tenants. Their condos have not sat empty for long periods of time, causing those dreaded cash flow problems. As far as I can tell, renters are the biggest problem with rental properties as an investment. Some of them are destructive deadbeats. From what I have seen, at least in Maryland, the laws and the court system work in favor of the renters. Evicting a bad tenant appears to be an expensive time consuming process. Perhaps I don’t have a balanced picture of landlord rights. To be honest there are not a lot of evicted tenants who work at a government research laboratory or attend a conservative middle class Protestant Church in suburban Maryland.

Rent? Own? or Own to Rent? (Part I)

I have been thinking about mortgages and single family homes, perhaps in part because I am in the process of buying my retirement home in another state. Thankfully, this time I will not need a mortgage. The real estate bubble of 2006 proved conclusively that buying a single family home is not always a good idea. Real Estate does not go up forever, even with assistance from Congress and the Federal Reserve.

Still, families seem to do best in single family homes. Owning a home of our own is a deeply ingrained part of the American dream. Actually, I think it is more than that. Even our distant ancestors wanted a cave they could call their own.

If you are single ask yourself, “Do I really need a house?” The answer is no, but buying a house may be a wise investment, even given your marital status.

Always start with the down payment. For young couples that is likely to make or break the deal. Back in 1987 when I bought my first and only home, pretty much all down payments were 10%. That has changed over the years. During the boom 0% down was pretty common. Now banks are looking for 20% down. I think new buyers should target 20% as well. This allows them to avoid the considerable cost of mortgage insurance. It also gives them an equity cushion in case they are forced to sell into a declining market.

Remember what happened in 2006.

I want to recommend a 15 year mortgage, but I’m not going to do it. A 15 year mortgage will save a buyer a lot compared to the cost of the traditional 30 year mortgage. However, for many young couples the lower payments of a 30 year mortgage might make the difference between continuing to rent or fulfilling their American dream. A 30 year mortgage was all I could handle back when we bought our first home, but over the years my salary continued to increase. I put all the spare money I could find into extra payments to principal, allowing us to pay off a 30 year mortgage in less than 10 years. I might have done better beginning a serious push to retirement before I paid off that mortgage, or not. I did miss the dotcom bust of 2000 that destroyed some of my coworkers’ retirement accounts. My mortgage had a 9% interest rate. That is radically different than the 3.5% interest rates commonly available today. Investments are a lot more likely to beat 3.5% than 9%.

The next consideration is cash flow. Calculate affordability on the basis of one income even if you are a two income family. People do lose their jobs. Many couples were hammered in the 2006-2009 meltdown. If husband or wife lost their job, the money to support a two income mortgage wasn’t there anymore. If they didn’t have enough cash to cover the difference between the selling price and the amount still owed on the mortgage, they were in deep trouble.

There is another reason to live in a one income house. Young couples frequently want to start a family. Moms want to spend time with their babies. This is good for the baby and good for the mom. There just isn’t any better daycare available at any price. Give your wife the option of becoming a stay at home mom. Your babies don’t need to live in an expensive home. They need their mommy’s love. When they start school mom can rejoin the workforce. That might be a good time to consider a bigger, two income house in a better neighborhood with better schools.

Buy or Rent Rule of Thumb:

It seems there is always a rule of thumb. Always remember, a rule of thumb is a rule that only works thumb of the time. Take the annual cost of renting a property then multiply the result by 15. If the sale price of the property is greater, rent. If the sale price is less, buy.

Examples:

A young woman I know lives in a city where the rent for a decent apartment was running around $700 a month. She was eligible for first time buyer assistance from her state government, giving her money for a down payment and a mortgage below the prevailing rate. She could buy a very nice little house for around $93,000.

Renting in a certain city costs somewhere around $700 a month.
Hence $700 a month X 12 months in a year X 15years = $126,000
Therefore, if this home sells for less than $126,000, buy it.
If the home sells for more than $126,000 rent.

Buying this house was a no-brainer. I don’t think she will live to regret her decision.

The year I bought my home, my rent jumped over 10% in one year! At the time the mortgage payments on a $100,000 home were less than the rent on our two bedroom apartment. I don’t remember the exact number for our rent but it was just over $1,000 a month. I had just enough money to walk in the door of my new house with an additional $3,000 loan from my father in law. Today, I don’t think I would advice a young couple to make such an aggressive move, but I decided, “If I’m going to ride this train, I have to jump on board,” and I did.

Here is my calculation:

Renting costs somewhere over $1,000 a month.
Hence $1,000 a month X 12 months in a year X 15years = $180,000
Therefore, if this home sells for less than $180,000, buy it.
If the home sells for more than $180,000 rent.

Our new house cost $98,000. We needed $17,000 in cash to cover the 10% down payment, points, fees, taxes, stamps, and mystery charges.

Let’s revisit a couple of traditional rules of thumb for determining how much house you can afford.

You can afford a house that costs 3 times your gross annual salary.
Your monthly mortgage payment should never exceed 35% of your monthly take home pay.

Hey! Let’s be CAREFUL out there today.

May God Have Mercy on Us All

Being a teenager has never been easy. At that time of life we are rash, impetuous. We are filled with longings and passions we don’t yet know how to direct or control. This has always been so. Romeo and Juliet are easily identifiable characters no matter what century or nation reads their story. The mercy of God and the sometimes desperate prayers of parents have blessed all of us at various times in our lives, but especially during those turbulent years. In the past most of the foolishness of those years disappears, only to be remembered through rose colored glasses in chance meetings with old friends.

Today the stakes are higher. Seth Godin warns his readers that in the digital age, just like performing artists and authors we all have a backlist, an accumulation of our works, good, foolish, and evil. He almost hired a young woman, “until I googled her and discovered that the first two matches were pictures of her drinking beer from a funnel, and her listed hobby was, "binge drinking." Backlist!” Ask Prince Harry about the power of cell phone cameras and the Internet. In the past your backlist could come back to bite you. My father told the story of a young man looking for a job. Although, he had graduated with a good degree, at one time he was thrown out of school for a fire extinguisher fight in his dorm. He wasn’t hired. However, in those days there were no cell phone cameras, no Youtube, no Facebook, no email.

I am learning that the greatest gift I can give the young are my blessings. On those occasions when I am honored with a confidence from someone caught in that turbulent time of life, I try to let them know they are not alone and that they are not crazy. My generation walked those paths; that I understand; that it is going to be OK; in the hands of our Lord, profoundly OK. Just ask the younger brother in the parable of the Prodigal.

Pray for the young people in your life. Pray that they find their way. Pray that they find good jobs, good husbands, that they are blessed with every blessing that makes life worthwhile.

Teach them by word and example how to build a good backlist; how to be a good employee; how to exceed the expectations of their supervisor; how to use their skills however inadequate to the best advantage of their organization.

If you are in a position of power, extend mercy to others, remembering your own folly and mistakes.

In Exodus 17 we are told the story of a battle. When Moses held up his hands Israel prevailed, when he let down his hands the enemy prevailed. Hold up your hands for the generations to come who will give you your Social Security checks.

Hold up your hands in blessing. Give someone you don’t even know the victory.

Exodus 17

[9] And Moses said unto Joshua, Choose us out men, and go out, fight with Amalek: tomorrow I will stand on the top of the hill with the rod of God in mine hand.
[10] So Joshua did as Moses had said to him, and fought with Amalek: and Moses, Aaron, and Hur went up to the top of the hill.
[11] And it came to pass, when Moses held up his hand, that Israel prevailed: and when he let down his hand, Amalek prevailed.
[12] But Moses' hands were heavy; and they took a stone, and put it under him, and he sat thereon; and Aaron and Hur stayed up his hands, the one on the one side, and the other on the other side; and his hands were steady until the going down of the sun.
[13] And Joshua discomfited Amalek and his people with the edge of the sword.

The Importance and Limits of Frugality

“Frugality is the quality of being frugal, sparing, thrifty, prudent or economical in the use of consumable resources such as food, time or money, and avoiding waste, lavishness or extravagance.” (Wikipedia)

What is normally termed frugality in personal finance literature conjures images of Suze Orman’s rants against the daily $5.00 latte at Starbucks. Let’s do the math. Five dollars a day multiplied by 365 is $1,825 in for real after tax American Dollars. That is the limit for frugality in this particular instance, or is it? Frugality is the foundation of wise money management. It is not an attempt to avoid spending money. It is a strategy that will give you better options for the use of your money.

It is unlikely that you will put that $1,825 under the mattress in your spare bedroom. Perhaps that money could be invested. With a little luck after a year of so that $1,825 might well become $2,000 or more, not life changing but a step in the right direction. This is the major criticism against those of use who champion frugality as a way of life. The critics observe that denying myself an inexpensive simple pleasure, like Starbucks, really doesn’t change much of anything. I would answer, “A single snowflake is irrelevant but enough of them can paralyze a city. Frugality is not a single decision it is a way of life.”

There is merit in that criticism. $1,825 is not a big life changing win. The biggest wins typically are found on the left hand side of the money equation, money in. If a teenager saves $1,825 he can spend it on a cheap car or he could buy a couple of used lawnmowers and a string trimmer. Given current levels of teenage unemployment in this area that is probably a pretty good option. If he signs up 5 neighbors (this would be pretty easy in my neighborhood) at $25.00 a week for 24 weeks, he will have $3,000. If he is smart, he could add various options of opportunity as they present themselves, “Mrs. Smith, that hedge in your backyard sure could use trimming. Would you like me to take care of that for you?” Let’s say our industrious young man pulls down another $2,000 in work and tips over the course of the growing season. $5,000 can buy a pretty decent car and he still has the lawn care equipment for next year. Or $5,000 could just about cover a year’s tuition at Montgomery County Community College, the beginning of an education that could change his life.

“In behavioral science, frugality has been defined as the tendency to acquire goods and services in a restrained manner, and resourceful use of already owned economic goods and services, TO ACHIEVE A LONGER TERM GOAL.” (Wikipedia)

Frugality is not an end in itself. It is a conscious decision to use our money in a manner that maximizes our pleasure, not just in the moment, but over the course of a lifetime. Depending on who you are or what you value $1,825 might mean an airplane ticket to Hawaii, a child in a private school, early retirement, or even a daily $5.00 latte at Starbucks if that is what you really want. If you have 3 children under 6 years old and a wife who breeds Chihuahuas, time spent at Starbucks with your laptop or newspaper might make the difference between sanity and the cost of inpatient psychiatric care.

I am pleased to announce that we who champion frugality are finally starting to have some effect on our nation. Just this morning U.S.A. Today reports, “Survey: Frugality Reigns 5 Years After Crisis.” The article covers the results of a survey undertaken by Fidelity, a respected investment house. Perhaps, at least some of us have learned something from the 2006-2008 disaster.

Here are some findings directly quoted from that survey:

— 56% reported their financial outlooks changed from feeling scared or confused at the beginning of the crisis to confident or prepared five years later.

— 42% increased the amounts of regular contributions to workplace savings plans, including tax-deferred retirement savings accounts or health-savings accounts.

— 55% said they feel better prepared for retirement than they were before the crisis. However, among the group of survey participants who reported they continue to feel scared, just 34% said they're better prepared for retirement.

— 49% have decreased their amount of personal debt, with 72% having less debt now than they did pre-crisis. Just 31% of those who indicated they're still scared reported that they have reduced debt.

— 42% have increased the size of the emergency fund they've established to meet large unexpected expenses. Among those self-reporting as scared, only 24% have a bigger emergency fund than they had pre-crisis.

—78% of those saying they're prepared and confident said the financial actions they've taken are permanent changes to their behavior.

I can’t end this article without a tip of the hat to Trent Hamm, author of The Simple Dollar, book and blog. He literally earns his living writing about living a better life for less. Here is a link to his frugality archive. Explore it at your leisure. You will surely find something of value that could be applied to your life.

The Simple Dollar Frugality Archive

Money Is a Lot Like Water

Money is a lot like water. It is always moving. Consider your house, at the same time your largest investment and your largest expense. The value of your home, as well as the price you are paying to remain in it are constantly changing. Local events like the construction of a new factory might increase its value. If the only factory in town closes, its value might drop to nothing. Real Estate professionals remind us that there are three components to evaluating a house location, location, and location. There is some truth in that saying, but there are also global forces that affect the magnitude and period of the waves of valuation.

In an article entitled Your House is An Undiversified Bond Investment, the anonymous author observes that like a bond, the valuation of a home moves with the prevailing interest rates. As the rates go up, the value of the house tends to goes down. As the rates drop the value of the house tends to go up. When you buy a home, in essence you have issued a bond to the holder of the mortgage. For access to the money necessary to purchase a new asset, you have promised to make good on the principal and the interest over the term of the bond, typically 30 years. Why 30 years? I would guess that in the past, 30 years was the expected working life of a typical employee. This means the house should be paid off just about the time he or she retires.

Just as there is a market for sovereign debt (Government Bonds) and corporate debt, there is a market for mortgage debt. In the distant past your mortgage tended to stay in the hands of the bank that gave you the money to buy your home. Somewhere along the line that changed. Back in 1987 I took out a mortgage from a Savings and Loan in Florida. After a few years that mortgage was sold to a bank in Oklahoma. It stayed in Oklahoma until I paid it off. More recently banks had the bright idea of packaging mortgages into secondary bonds. Much like certain chicken products safe mortgages and subprime mortgages were ground up, bleached, mixed with some chemical preservatives and sold as white meat. It was a disaster. When the word about what was in those products became general knowledge it very nearly caused a meltdown of the world financial markets.

In addition to local and global forces, the individual buyer should be limited by common sense. There are some rules of thumb that can be stretched, but stretched too far they will come crashing down on the unfortunate family who tried to build their home without carefully counting the cost. Ultimately there seem to be some limits to just how much house a family can afford. The traditional rules of thumb are you can afford a house that costs 3 times your gross annual salary. Another traditional rule of thumb is your monthly mortgage payment should never exceed 35% of your monthly take home pay. Families who violated these rules during the housing bubble are still paying the price. They are stuck with their heads underwater in homes that are worth less than the price at which they can be sold.

The author of the article tracks the value and price of a hypothetical home in his market, San Francisco. It was built in 1991 and sold for $450,000. After the buyer put down 20% the payments on a 30 year fixed mortgage worked out to $3,428. Then the market went wild. Home prices rose with rising incomes and declining interest rates. The owners were able to refinance at lower rates while the equity in their home took off like a rocket sled on rails. At the peak in 2007, that home sold for $1,300,000! Then reality set in. There were just not enough buyers who could afford such a property to justify the price. The marketplace decided that at those prices they weren’t going to invest any more money in mortgages. The money flowed off in other directions. Some of it, as we know, just vaporized. The author notes that after over 20 years that house is right back where it started. With a 20% down payment the mortgage payment is $3,600 a month. Yes, the price of the house has doubled in 20 years but financing costs have declined by about 70%.

Like the waves in the ocean, driven by tides, wind, currents, and even the efforts of the Army Corp of Engineers the levels of water and money rise and fall, but tend, over time, to return to predictable levels.

Now let’s be careful out there.

Back to the Beginning

I want to take a minute; slow down from what I am doing; pause and reflect. I would ask you to do the same. I started getting serious about the study of money after I turned 50. I wanted to learn how to invest so that I could afford to retire. Over the next few years I was given a number of opportunities to help counsel some folks in the basics. As the years passed, I continued the drive towards retirement with a monomaniacal intensity that would have made Captain Ahab proud. I also learned to give and receive, offering Dave Ramsey’s Financial Peace University at my church and writing this blog for a small but growing number of readers.

I find I have become a part (howbeit a rather insignificant part) of the personal finance (PF) industry. Like any other human endeavor, the PF industry has its problems. PF teachers range from solid to outright charlatans. All of them who have at least published a book have something to sell. That is OK. This is America. Some of them are very good, but have troubling conflicts of interest inherent is giving advice on particular financial products that also line their own pockets. Some financial advisors are nothing more than commission salesmen. It is unlikely that such a person would be capable of giving completely objective advice to a client. Can you imagine an annuity salesman telling a potential customer, “Take your money to Vanguard. Put it in a diverse group of low cost index funds. You could significantly improve your returns over our annuities with only a slight increase in risk. Let me suggest some possible options, but remember, it’s your money. Ultimately, you are responsible for your decisions.”

Personally, what bothers me the most about these writers, at least the serious responsible PF gurus is the one size fits all approach to personal finance. One size does not fit all. Every person has their own story, their own relationship with money. It was built, not just over their lifetime, but each story is imbedded in the story of parents and grandparents, in some cases centuries of cultural experience and values.

Gaining control of your finances is not always easy. Life isn’t fair. Some of you face problems I can’t even imagine. Bad things do happen to good people who are trying very hard to do the right things. If you have lost your job due to a medical emergency, it is hard to even think about balancing a family budget.

Take a minute…. Stop…. Breathe in…. Breathe out…. Relax….

Ask yourself some questions. Don’t make things worse than are or try to sugarcoat the truth. Just look into your own heart. Accept what you see there. If you have made mistakes, forgive yourself. If you face problems that are not of your own making, just accept that they exist. Resolve to always take the high road; accepting responsibility for improving your life; leaving justice in the hands of your higher power.

I told you, this isn’t going to be easy.

Do you know what you want? What you really want? I don’t think most of us have really spent the time necessary to separate the noise of our culture and a thousand different ads from the deep desires of our heart.

Is money your friend or your enemy?

Does money control you or do you control it?

Do you hate money?

Do you fear it?

Do you lust after money?

As you spend time unraveling your relationship with money you will discover your path. It will be your own unique path. Yes, there are principles that are unavoidably important. Debt is a curse not a blessing. A household can not continue to spend more than it takes in over an extended period of time. Giving is the way we say thanks to the universe for everything we have been given. Dishonest money dwindles away, but he who gathers money little by little makes it grow. These are just a few examples of inescapable truth.

Now you are ready to begin your quest. Each time you make a decision involving money, make a conscious decision. Stop. Reflect. Ask God for guidance. He gives wisdom generously, without ever finding fault. This is a promise from his Word.