Go Not to the Elves for Counsel

Early in Tolkien’s telling of the Lord of the Rings, Frodo and his little band meet some elves in the woods. In the course of their discussion of the current situation and possible future events, Frodo has occasion to quote the Proverb, “Go not to the elves for counsel, for they will say both no and yes.”

Laughing, the leader of the elves replies, “Is it indeed? Elves seldom give unguarded advice, for advice is a dangerous gift, even from the wise to the wise, and all courses may run ill.”

I do not believe in one size fits all answers to questions of personal finance or any important component of the good life. There are some immutable principles like debt is a curse, but how you work out the details of your life is ultimately your business.

Consider the question, “Should I pay off my mortgage early or use that money to save for retirement?” The answer depends on your personality as well as your understanding of your current and future condition. I hate and fear debt. When I was working off my 30 year mortgage, rates stood at 9%. To me paying down that 9% loan rather than doubling down on retirement savings was a no brainer. I still believe I made the right decision. Not only did I get my house paid off in less than 10 years, but I avoided the dotcom crash of 2000. Not all my coworkers were so lucky. The decision was the right one for me at that time, but the outcome contained a measure of luck.

Let us move the clock forward 25 years to the present. A hypothetical young couple paying down a 3% fifteen year mortgage face the same question, “Should we pay off the mortgage or invest the money for our retirement?” Now the question becomes a lot harder. A 3% mortgage is almost unbelievably low. Who would be in a hurry to pay off such a loan? Siegel’s constant tells us we can expect 7% to 7.5% return on our investments in the market over sufficiently long periods of time. It looks like it is time to double down on the 401(k).

Or is it?

This morning the Shiller PE Ratio stands at 25.6. Historically that is a dangerously high number signaling a correction or possibly even a crash. But will it happen this year? “Don’t fight the Fed,” is right up there with, “Don’t spit into the wind,” as sound advice. The Federal Reserve Bank is doing everything in its considerable power to keep the Shiller PE Ratio at artificially high levels. Maybe it is a good time to invest? Or not? John Hussman, the erudite manager of a family of funds, using very sophisticated predictive tools is looking at a 2% return on a balanced portfolio over the next ten years.

If the bank thought it could get a guaranteed 7.5% in the market over the next fifteen years would they lend money to you at 3%?

If you job security is a little on the shaky side, maybe paying down that mortgage would be the safer path? If you have a very secure job it might prove a good time to roll the dice with your 401(k). Although it doesn’t feel like it, at your young age you are playing with relatively small amounts of money over very long time periods. The odds of reaping Siegel’s promised rates of return by your 65th birthday are pretty good. If you are close to retirement and still carrying a mortgage, I might recommend a different path.

I want to teach myself and my readers how to make wise decisions. Ultimately, we all need to make our own financial decisions and accept personal responsibility for those decisions. I can’t make those decisions for you any more than you can make my decisions for me. Be comfortable with who you are. Walk your chosen path to the best of your ability in the light given to you by our Lord and Savior.

Then, perhaps, one day we can say with confidence:

2nd Timothy 4: 7-8

I have fought the good fight, I have finished the race, I have kept the faith. Now there is in store for me the crown of righteousness, which the Lord, the righteous Judge, will award to me on that day—and not only to me, but also to all who have longed for his appearing.

When to Take Social Security Given Other Types of Retirement Assets Part II

The argument for delaying Social Security is pretty straight forward. If you live past the tipping point you get more money. The actuarial tables tell us an average 66 year old American man has another 16.79 years left on this planet. At age 83 you win big time by delaying. Once you pass full retirement age (for me 66) my Social Security draw will increase by 8% a year until I reach 70.

That is a pretty righteous incentive to wait.

The arguments in favor of an earlier draw are a little more subtle. They start with flexibility, a key component in my “defense in depth” concept of budgeting in retirement.

Defense in Depth (Budgeting in Retirement)

An extra $1,616 a month (at age 62 from yesterday’s example) will provide a lot of additional flexibility. If that money allows me to leave a healthy growing 401(k) untouched by taxes that might prove more profitable in the long run. Living on renewable resources rather than depleting reserves in the early years of retirement will allow the magic of compound interest to continue working in my favor. If your retirement savings are barely adequate, you are taking a big risk to the future health of your 401(k) if you have to withdraw money every month in those early years of retirement. Social Security mitigates that risk.

Who says you have to spend that money? If you invest those funds starting at age 62 at an expected 7% rate of return, the bankrate.com calculator tells me you will have an additional $207,171.04 at age 70. You have essentially self insured for the potential expense of long term care. At age 60, $300,000 in long term care insurance for a couple with minor preexisting conditions might run over $7,000 a year. That could be a deal breaker for retirement at age 62. The odds against requiring nursing home care for long enough to pass the waiting period on your long term care policy prior to age 80 are pretty slim. The $140,000 you spent on premiums in those 20 years are gone forever. If you self insure, you (or your heirs) might get to keep the money.

Jonathan Pond suggests that if your net worth is less than $500,000 you can’t afford long term care insurance; if your net worth is in excess of $1,000,000 you don’t need it; self insure; if your net worth is between $500,000 and $1,000,000, think about it.

For more on the long term care decision:

Long Term Care Insurance

Then there is the quality of life argument. At age 63, my mind is still working (at least most of the time). I can walk 5 miles. There are things I can do in retirement today that I might not be able to do in another 20 years. Money spent on experiences, given my current condition, might be money well spent. If I wait, I may not have the opportunity to fully enjoy the fruits of my labor.

Finally, there is the old “bird in the hand” argument. I try never to make a financial decision on the basis of fear or greed. This can be difficult in our nation’s current financial situation. I am tempted to take the bird in my hand rather than wait to get two birds in that bush over yonder.

For the record: My wife began to draw her Social Security at age 62. Lord willing and the creek don’t rise I plan to wait until full retirement age, in my case that would be 66. Then I will begin to draw my Social Security and my wife will flip her draw to a spousal benefit off my draw which will increase her monthly benefit.

When to Take Social Security Given Other Types of Retirement Assets Part I

This is two part article on a very important question, when to take Social Security. Before making that decision, you must decide how long you will live. You will also need to spend some time considering how you plan to use different kinds of money in retirement. If you don’t have enough income to pay for groceries, you will need to take Social Security as soon as you retire. This is happening to far too many people in my generation who lost a job in the Great Recession. Age discrimination is real. They are not finding new jobs in the ongoing recovery. They need Social Security today. If you have the resources that will allow you to delay Social Security, that might be a very good idea.

Here are the basic facts from a particular example generated by the Social Security Administrations Quit Calculator.

If you were born in 1952, are currently earning $100,000 a year here is what you can expect to draw.

$1,616 a month: Starting at age 62 $2,217 a month: Starting at age 66 $3,017 a month: Starting at age 70

In this particular example, the crossover point for 62 or 66 occurs at approximately age 76.75. If you live to age 77 you win by delaying Social Security.

The crossover point for 62 or 70 would occur at approximately age 79.2. If you live to age 80 you win by delaying Social Security?

Or do you?

What could you do if you take that money today that you couldn’t have done if you choose to delay? How would it change your long term budgeting strategy in retirement? There are certain kinds of money we expect to spend in retirement. There are certain kinds of money we delay spending in retirement. There are even certain kinds of money we hope that we will never have to spend in our lifetime. Consider the family farm.

I have been learning that in retirement there are several kinds of money. I propose that generally, they should be spent in the following order.

1)Renewable Resources: These guaranteed income streams include pensions, Social Security, and annuities. In a perfect world, this money would replace your paycheck.

We do not live in a perfect world.

2) Cash: These funds include savings accounts, checking accounts, and money market funds. Their purpose is flexibility. Whether you need $10,000 to move to your new retirement home, $10,000 to repair your existing home, $10,000 to pull the trigger on a stock trade, or $10,000 for a vacation on the French Riviera you need to put your hands on the cash on the day the bill comes due. Besides covering large irregular expenses, if your guaranteed income stream is not sufficient to cover your regular monthly expenditures, you will be spending cash on a regular basis. My experience indicates, that you will need to have more cash on hand in retirement than you might think will be necessary.

3) Taxable Investment Accounts: Almost every stock and mutual fund I own is set up on an automatic DRIP reinvestment program. I use the dividends to purchase more shares in that investment at no cost, thereby putting the power of compound interest to work. I can divert that stream of dividends and interest from purchasing more shares to a regular quarterly deposit in my checking account or I can prune a position that has grown too large or I believe to be overvalued as a source of cash. If necessary, these positions can be liquidated on a regular ongoing basis to renew available cash.

4) Tax Preferred Accounts: For most people, this is your 401(k) and your Roth IRA. Money in the 401(k) has never suffered the cold dead hand of the taxman. All of it is going to be taxed when you cash it out. That is why you delay actually using these funds until you have depleted a large portion of your taxable investments. The Roth IRA can grow tax free. If you can leave it alone, leave it alone.

Before I retired, the tax consequences of my actions were not that important a consideration. I am basically a buy and hold investor. I pay income tax on dividends in my taxable accounts, but I seldom sell much of anything so I don’t spend a lot of time worrying about capital gains. Money went into my tax deferred investments with the hope it will never come out in my lifetime. It is my desire that I will be able to fund my charitable remainder trust with those investments, guaranteeing a lifetime income for my wife, 20 years of income for my heirs, and the remainder for the Lord’s work. Now, how I choose to liquidate my holdings has real noticeable consequences, especially if I have to tap my tax deferred investments.

5) Primary Residence: If you live long enough, there will come a day when you need to sell your home, either to create a source of income or because you are no longer physically or mentally able to live in a house by yourself. I don’t like to think about that possibility.

Although the defined benefit pension is disappearing, almost all Americans still have one guaranteed income stream, Social Security. When to tap that stream is an ongoing debate.

Reality Check

Does 3 months salary in an emergency fund sound like a lot of money just doing nothing?

This is true. However, in our personal experience we found that what money we managed to save in the early years of our marriage always managed to get spent on something. We really didn’t pass the 3 month mark without spending it on something until we had been married for something on the order of 14 years. First it was education and cars. Then it was buying our first home. Because we saved money that we didn’t know was our emergency fund, we were able to pay for everything but the house without going into debt. That is a major blessing. A couple of time we were really close to the line (under $1,000 in savings) but we made it.

I try not to spend a lot of time on big numbers or long time periods when writing this blog. I fear some readers might find it discouraging. However, if you think 3 to 6 months take home salary in an emergency fund is a big number, consider these numbers.

$31,252 Average Cost of a New Vehicle

$25,200 Average Cost of a Wedding Excluding the Honeymoon

$5,219 Average Cost of the Honeymoon

$241,080 Average Cost of Raising a Child (Excluding College)

$270,200 Median Cost of a Home

$216,000 Approximate Cost of a Four Year Degree from Furman University

$60,000 Approximate Cost of a Four Year Degree from the University of South Carolina (In State Commuting Student)

$1,000,000 Amount of Money Required for a $40,000 a Year (4%) Annuity in Retirement

Avoiding debt is the single best personal financial goal for any young couple. An emergency fund is the first step towards making debt free living a reality in your life. Deferring gratification by saving and paying cash for your goals with save quite literally hundreds of thousands of dollars over an average American life of 78.5 years.

If you persevere, some day you might be able to use some of that money to pay for your grandchildren’s college education. Wouldn’t that be wonderful!

When to Seek Professional Guidance?

How do you decide when to hand over some control in your life to a professional? When I was much younger, I did some work on my own cars. I had not yet injured my lower back. My knees still worked and automobiles like a 1968 Ford are pretty simple to figure out even for an amateur shade tree mechanic, like me. Times have changed. I can’t even see most of what is in the engine compartment of my 2010 Acura. I don’t know what the little black boxes I can see contain. I can’t even change the oil filter without putting the car on a lift. It is time to turn some control and decision making power (but not an abdication of personal responsibility) over to a professional. When I lived in Maryland I was fortunate to have a coworker who repaired and maintained cars in his spare time. He was very good, very cheap and most importantly, very honest. If he didn’t have the right tools or the expertise he would tell me what questions I should ask before I selected a professional shop to handle the problem.

There are some principles that can be generally applied in all such situations.

First of all look at the problem. How is your current approach working for you? Einstein famously said, “Insanity is doing the same thing over and over again and expecting different results.”

If what you are doing isn’t working, for God’s sake try something else.

What are your interests and expertise?

How much time are you willing to invest in finding your own path to a solution? After losing small amounts of money, listening to advice from supposed investment advisors who were actually mutual fund salesmen. I concluded I would never again pay someone to lose my money for me. I didn’t start with any expertise, so I decided to buy stocks the same way I bought stereo equipment, look for the best quality at the lowest price. I also learned that passion over time leads to expertise. I also learned that if you really want to remain ignorant (although I can’t imagine why everyone is not passionate about managing their investments) all you need to know is four words, Vanguard Life Cycle Funds.

How complicated are your problems?

Most people can do their own taxes. If all you are dealing with are a job, a house payment, and a 1099 from a credit union easy to use programs like TurboTax are more than sufficient. Do it yourself. If you are lazy or a little frightened by the increasing complexity of your tax returns, hire somebody from a company like H&R Block. I rely on my CPA; may she be blessed. Early on I concluded that I would never spend the time necessary to become fluent in the U.S. Tax Code. I depend (perhaps more than I should) on the expertise of this wonderful woman. This year my combined tax returns for the IRS and two states ran 88 pages. The claims on the various forms are all interconnected in ways I do not even want to understand. If something goes wrong, she is qualified to defend my return before the IRS. In fact, if that happens she will perform this service at no additional charge! I consider that money well spent.

What are the consequences of a mistake?

Back in the day I practiced Tai Chi as a martial art. Our instructor was qualified by an internationally recognized master (really) to teach Tien Shen Pai, Tai Chi, and Xing Yi. He spent a great deal of time and money studying alternative health modalities. His diet was an important part of his discipline. What he was doing with his body worked. He can perform physical feats that most men half his age can only watch on television. However, when my teacher or a member of his family needs to go to a doctor he is quick to visit his MD. If you are facing a serious or life threatening problem, whether it is legal or medical, don’t mess around. Seek professional guidance. If the consequences of your inaction are death, imprisonment, or bankruptcy don’t try to save money by doing it yourself. It just isn’t worth the risk.

How to find a professional?

There are two places to start the search for a professional the Internet and personal referrals. Internet reviews can be quite useful if there is a sufficiently large number to provide a critical mass of useful information. If a five star system is used, the two, three, and four star ratings will give you the most useful information. Normally these reviews tell you what and why the reviewer liked or didn’t like the person in question. For example, since my wife and I have recently moved to a new home we will need to find a new General Practitioner. I will be looking for an all purpose country sawbones, who will take care of business without a lot of time wasted on unnecessary tests or referrals to specialists, unless of course, I have an acute problem that is beyond his or her level of competence. My wife, on the other hand, is looking for a compassionate soul who will listen to her problems and spend the time necessary to explore different possible treatment options. If a review says, “Doesn’t care about my feelings.” It isn’t going to be a good fit for my wife. If the review says, “A very through professional who is an integral part of a network of specialists and laboratories.” Maybe I should look elsewhere.

By far the best means of locating a professional is personal referrals. If a knowledgeable friend recommends the services of a professional, that is gold. I asked one of the elders in my church I knew to be a CPA if he would do my taxes. He said he didn’t have the time to take on a new client. However, he knew a woman who used to be a member of our church whom he considered outstanding in every way. That is how I located my CPA.

There is a final question, chemistry. Even if a professional is competent, affordable, and ethical he might be a bad match for you. My Tai Chi instructor once introduced one of his assistant instructors to his master. He thought this very gifted woman would benefit from the expertise of a recognized expert in their field of study. This man has trained world champions. Unfortunately, this old Chinese master screams at and insults gifted students in order to push them past their self imposed limitations. He tells the less gifted they are doing just fine, while continuing to take their money. This woman is an unusually sensitive soul. She was so upset by the experience she never returned to the master’s studio even though our teacher explained that his teacher’s behavior was a great honor. If you just can’t work with the guy, whether he is a lawyer, doctor, accountant, car mechanic, or kung fu fighter don’t try to figure it out. Just move on. Life is too short.

Just Some Random Stray Voltage from a Questioning Mind

Are you more likely or less likely to win a game if you get to make up the rules?

Of course we all understand that if we play a game by rules created for the benefit of others, we will lose every time. If we get to make up the rules, we are more likely to win at the game we call life. If you take money from another human without understanding this simple principle you can find yourself playing to lose. That is true whenever you cash a paycheck. It is true whenever you borrow money.

Are you playing a game that makes you happy? If the game you are playing is making you extremely unhappy, why don’t you think about playing a different game with a different set of rules, one that favors you?

If we choose to take a paycheck from an individual or an organization, to some degree we are entering into a fiduciary relationship with our employer. We are agreeing to act in the best interests of that employer, even if what we are doing is not necessarily in our own personal best interests. Assuming there are no criminal activities involved, the employer/employee relationship should be a covenant, an agreement between two ethical entities that is mutually beneficial. Unfortunately, that is not always the case. Sometimes criminals seem to have a better understanding of the concept of covenant than legal businesses.

Maybe that is why they call MAFIA organizations, families?

Life is about finding balance. In this case the balance is finding freedom in structure. If you define financial freedom as the ability to live a good life without accepting a paycheck from the man, you are still not off the hook. Finding structure in freedom is really not that different than finding freedom in structure. If you are playing the same 18 holes at a particular golf course day after day, will there come a point in time when the game of golf is no longer a source of joy?

Turning your back on the world for the religious life still won’t solve your basic problem. The nuns in Mother Teresa’s order wear wedding rings to symbolize their marriage to our Lord and Savior. Mother Teresa would complain that she understood the difficulties faced by married couples. She was married to a husband who was at times quite difficult and demanding.

So take a few minutes. Look around at your life. Are you finding the balance between structure and freedom that leads to happiness or is there some room for improvement? If you are working for a paycheck, can you find a way to live in greater freedom, playing the game by at least some of your rules, while still acting in the best interests of your employer? Quite likely, you can improve that relationship. If not, it might be time to consider another path.

Did buying all that stuff you didn’t need with money you didn’t have really make you happy? Is working for a paycheck just to give the money you have earned to a bank for the privilege of driving an aging automobile that is worth less than you owe to work every day to get more money for the bank? Personally, I don’t want to play that game. I don’t think I would ever win if I choose to play the game of life by the bank’s rules.

Pay Yourself First

The most basic principle in building wealth is spending less than you earn. Saving money is not encouraged by the Government, the media, the banks, or the spoiled little brat that lives somewhere inside all of us.

If you do not decide where you want your money to go, there are plenty of people who are more than willing to make that decision for you. However if you ever want to reach financial freedom, you need to pay yourself first.

Every month before you spend a penny on anything else, do two things with a predetermined portion of your money. If you are a Christian, pay God first. Give something without expectation of return. It is good for your soul. Then, pay yourself second. Put some percentage of your take home pay into savings. If you aren’t a Christian go ahead, follow the advice given by just about every personal finance author for the last one hundred years, pay yourself first. Then give something to charity. It is good for your soul.

The initial savings goal is 10% of your take home pay every month. I will let you decide on how much you wish to give to charity. Start a “rainy day” fund in a bank or a money market fund. The goal here is six months cash reserve (six months take home, both salaries). It will take some time to reach this goal. Don’t beat yourselves up about this but keep putting a little something aside every month.

When is the emergency fund sufficiently large to begin a fanatical effort to pay down your credit card debt? This is a matter of debate among personal finance authors. The low number is $1,000 in the emergency fund—then a full bore attack on your credit cards. The high number is eight months of living expenses before attacking high interest debt. It is your life. You need to make a reasoned decision based on your job security, controllable versus uncontrollable expenses, and the size of and interest rates on your unsecured debt.

Once you have two to four months cash emergency fund in an insured money market fund or savings account and you have paid off your credit cards and other high interest debt then begin to save for a dream. For most young couples this will be money for a 20% down payment on their first home. For many older couples the big dream is a comfortable retirement.

Automate the savings process. Here is how that works. Most of us have our paycheck electronically deposited to our checking account. When this happens have the bank automatically transfer a predetermined amount to an insured savings account or a money market fund. In your mind decide that money that goes into this account never comes out of that account for anything but emergencies until the balance reaches your “sleeping point.” Then additional funds above and beyond the sleeping point will only be spent on a predetermined dream or transferred to an investment account such as a Roth IRA.

If your employer offers matching money with your 401 (k), for heaven’s sake, take the money and run. You simply can not beat an instantaneous 100% tax deferred return on an investment. Often employers offer 3% in matching money. This is a good way to begin saving for retirement. If you withhold 3% of your gross income before you ever see it, you will never miss it.

You may have noticed there is an undertone to every suggestion in this article. Make all your decisions in advance. Consider these decisions an ironclad contract with yourself. As far as possible, automate the processes involved in implementing your plan.

Decide, I will save X% of my take home pay by means of automated transfer of funds.

First I will build an emergency fund of $Y.

Then I will attack any debts with more than a Z% rate of interest. I would suggest any interest rate over 7% or 8% should be considered a high rate of interest.

Once I have paid off my high interest debt, I will begin to save for a (fill in the blank).

It is your life. How you choose to fill in the blanks is your decision. If you choose not to fill in the blanks, remember, someone else is always watching your money.

One more suggestion; set yourself up for success by beginning with easily achievable small goals that are then increased incrementally until you achieve your ultimate goal. If 10% take home pay to savings seems overwhelming, start with 3% to be followed by a 1% monthly increase until your reach 10%.

Fifteen Years or Thirty Years (Another Great Debate)

How did we arrive at the 30 year mortgage? During the Great Depression the Federal Housing Administration (FHA) began to change the way mortgages were financed. The Roosevelt administration wanted more people to own their own homes, so they began to stretch out the term of the mortgage from the traditional 5 to 7 years; first to 15 years; then to 30 years. (History of Mortgages Obringer and Roos)

If you think about it, 30 years makes a lot of sense. Assuming a 40 year working life, 30 years gives you some time to save for a down payment and then some time to concentrate on saving for retirement once you are debt free.

There is an alternative to 30 years of debt, the 15 year mortgage. Some authors favor the 15 year mortgage as the savings over the course of a lifetime can be dramatic. Using today’s rates, here is how the numbers break out.

30 Year Fixed Mortgage:

Size of Loan: $200,000
Rate: 4.42%
Monthly Payment: $1,003.89
Total Payments: $361,400.40

15 Year Fixed Mortgage:

Size of Loan: $200,000
Rate: 3.39%
Monthly Payment: $1,418.99
Total Payments: $255,418.20

If you choose the 15 year mortgage, you will save $105,982.20 and you will have an additional 15 years to invest $1,418.99 a month towards your retirement. Assuming a 7% return, $1,418.99 a month for 15 years will give you a final savings balance of $449,769.18.

The clear winner (by almost $500,000!) is the 15 year mortgage.

However, life is not as simple as mathematical examples. Reaching a salary level that can support an extra $400 a month in housing expense might require years. Those would be years spent throwing money down the old rent rat hole, years your landlord would be getting your mortgage deduction. Those would be years when the wife would have to work, perhaps delaying starting your family, perhaps denying her the opportunity to be a stay at home mom.

Because life is not a mathematical example, I am OK with the 30 year mortgage. In everything I write, I am assuming the reader is a responsible adult. Just because you sign a 30 year mortgage, that does not mean you have to pay for 30 years. I paid off my mortgage in a little less than 10 years. Just switching to biweekly payments will save over $28,000 over the 30 year lifetime of your mortgage.

It is reasonable to assume that as your career develops over the course of a lifetime, you will receive promotions and raises. It is also reasonable to assume that the Federal Reserve Bank will continue to lower the value of the dollar. It is likely you will repay your mortgage with dollars that are worth less than the dollars given you by the bank to buy your home.

Given today’s unusually low mortgage rates, it does not appear the banks are all that worried about inflation, but who can say. That is why I do not recommend Adjustable Rate Mortgages (ARM) under any circumstances. If you sign one of these things you are taking all the inflation risk, guaranteeing the bank’s return no matter what happens in the economy. Don’t do it. When the interest rates are low there is a great deal more upside risk than there is opportunity for downside savings.

Remember debt is a curse. The ability to loan money to others is a blessing.

There is no “good” debt.

Always! Pay off your debts as rapidly as possible.

Buying a home with a mortgage rather than renting may be a rational decision that will both give your family a better life and save you money in the long run. Who knows what the future may bring? Home ownership might once again prove to be average family’s largest investment, providing a sizable percentage of retirement savings, but don’t count on it.

South Carolina First Time Home Buyers

Most of the states offer first time homebuyer programs or assistance to various categories of buyers. If you think you might qualify for one of these programs, it is worth a visit to a website and a phone call or two to check out what is available. I am always on the lookout for free money. Unfortunately these programs are a moving target, subject to the winds of state politics and the hard realities of the marketplace. What is currently offered in my new home state of South Carolina is not all that great. Although I know that in the past it was a very good deal. I discussed the current situation with a representative of the program. There will be new offerings available to law enforcement officers, correctional officers, teachers, firefighters, veterans, and EMS personnel in late April, so if you fall into one of those categories, standby for something better.

In order to qualify for the basic South Carolina First Time Home Buyers Program you can not have owned a home anytime within the last three years unless you are a single parent, a veteran honorably discharged within the last 25 years, or 100% disabled.

The South Carolina First Time Home Buyers Program is completely self funded. They receive no taxpayer money from the state. They raise funds by selling bonds on the open market. Right now the open market is pretty hostile to first time home buyers programs. Currently they offer a rate of 5.00% on fixed thirty year mortgages. That is about 0.75% over the prevailing market rate of 4.29%. Normally their rates are 0.25% to 0.50% below market rates. They have a new bond issue pending. They expect to offer a much better rate sometime in the near future.

These loans are actually issued by one of the program’s approved lenders. They are FHA loans that only require a 3.5% down payment. Unfortunately all new FHA loans issued for more than 80% of the appraised value will require PMI for the entire term of the loan. This requirement and a higher that market rate means that I can not consider these FHA backed loans a very good product for the typical consumer.

Depending on the nature of the loan, minimum acceptable credit scores can range from a low of 580 for certain Government backed loans, to a score of 650 for conventional mortgages. Generally scores between 620 and 639 are considered risky. 760 to 850 are considered golden.

The South Carolina First Time Home Buyers Program requires a minimum score of 640. This program allows a debt to income ratio of up to 45%! I would be nervous with a debt to income ratio of 30%. I would be shivering in terror if that ratio went past 35%, but that’s just me.

So why do people who probably shouldn’t be buying a house line up to get loans that are currently not a very good deal. It’s the down payment. The new normal is 20% down. On a $200,000 home that is $40,000 cash in hand. With a 3.5% down payment that number drops to $7,000. As they say in the late night infomercials, “But wait! It gets better!” The South Carolina First Time Home Buyers Program offer $5,000 cash money that you can use for your down payment or closing costs. Depending on your income and the value of your home this $5,000 will either be a loan or an outright grant. This feature drops the effective down payment in this example to 1%.

The South Carolina First Time Home Buyers Program offers a very interesting optional extra for a one time fee of $700. This outstanding little benefit allows you to receive a tax credit of up to $2,000 a year on the first 30% of your total mortgage interest charges for that year. That is a tax credit, money 100% directly off the bottom line of your tax bill, not a tax deduction that will give you something like 25% off the bottom line depending on your tax bracket. “But wait! It gets even better,” you can still deduct the remaining 70% of your mortgage interest charges! The requirements for this particular aspect of the program are too complicated to be listed here, but if you qualify it is well worth your time to look into this offer.

“Take things as they are. Punch when you have to punch. Kick when you have to kick.”
Bruce Lee

Learn how to best manage your money in the world as it exists. Be wise. The banks, the states, the Federal Government, and the real estate industry all want you to buy a home for their own reasons and for their benefit—not yours. Depending on the times, your financial condition, and the offerings of a particular program, these special offers could be a once in a lifetime opportunity to live the American dream or a trap for the unwary.

Especially when buying a first home: “Let’s be careful out there.”

Just A Voice Crying in the Wilderness

This is not the article I planned to write this morning. However, I just finished reading an article entitled, “Retirement: A third have less than $1,000 put away” by Nanci Hellmich in USA TODAY. The results of another survey are available and they are horrifying. Not only are Americans not saving for retirement, they don’t even have a decent emergency fund. We are heading for a demographic disaster. Over the next twenty years millions of Boomers, with or without retirement savings, will simply be physically and/or mentally unable to continue working for a paycheck. For most Americans the defined benefit pension is a forgotten relic of a bygone age. Many of the municipal and state employees who are expecting to find a defined benefit pot of gold at the end of a 20 or 30 year rainbow are going to be severely disappointed. There simply isn’t enough money. Look at Detroit.

Here are the basic numbers for today’s working Americans excluding the value of their primary residence and any defined benefit pension. At any age, less than $1,000 is an emergency that requires immediate action. Less than $10,000 may not be a serious problem for a young couple with decent jobs, just starting out their life together. However, if they are married with children, less than $10,000 in the combined total of an emergency fund and retirement savings is a problem that needs to be addressed—Quickly!

•Less than $1,000, 36%
•$1,000 to $9,999, 16%
•$10,000 to $24,999, 8%
•$25,000 to $49,999, 9%
•$50,000 to $99,999, 9%
•$100,000 to $249,999, 11%
•$250,000 or more, 11%

One more time for the new reader, here are the quick and dirty basics of retirement math.

For an example, consider the terminal combined gross annual income of a couple as they near their planned retirement date at age 66. Let’s say $100,000. The best studies indicate that the average American couple spends about 80% of their preretirement expenses once they are actually retired. That means they need $80,000 a year, indexed to inflation, in order to maintain their lifestyle.

Let’s say this couple can draw $30,000 in combined Social Security benefits at their full retirement age of 66. That means they need to replace $50,000 a year to maintain their lifestyle in retirement. The famous Trinity Study and many other peer reviewed academic studies and responsible financial industry studies indicate that somewhere around a 4% annual draw from your retirement accounts is safe 98% of the time.

What this means is that if you have 50% of your retirement savings in stocks and 50% of your retirement savings in bonds, you can draw 4% of the total out of these accounts during the first year of your retirement. You can then continue to draw that amount increased to cover inflation out of your retirement accounts for the rest of your life with only a 2% chance that you will outlive your money.

In order to draw $50,000 indexed to inflation for the rest of your life, you will require $1,250,000 in retirement savings. In order to make the calculation for your particular case, just take the desired amount of income and multiply that number by 25.

Although this method of calculating retirement savings is intentionally simplistic, it is based on the best, most respected studies I have been able to locate. Of course if you have a defined benefit pension you can deduct that number from your retirement target salary just like you subtracted Social Security from the total number. If you live in a high cost, high tax metropolitan area, you can move to somewhere cheaper and warmer. This could significantly lower the 80% initial target. For example if you move to a place where the cost of living is 80% of your current place of residence, 80% of 80% is 64%. $64,000 minus $30,000 in Social Security becomes $850,000. There are an infinite number of retirement calculators on the Internet. Some of them are quite sophisticated. I probably tried all of them, at least once, before I actually pulled the trigger on my retirement. I suggest you do likewise.

The key takeaway is retirement is expensive.

No matter your age, save for your retirement. If you haven’t started, start today. If you have started saving, bump that savings rate every time you get a raise. If you aren’t getting every penny of matching money offered by your employer, increase your contributions. If you are 50 or older even 10 years in savings overdrive (25% or more of some combination of pre and after tax income into retirement savings) can produce results that are almost unbelievable. If you are still younger than 40 you shouldn’t have any problems if you make even a reasonably serious effort. If you avoid debt, time and the power of compound interest are on your side. Unfortunately the study notes, “Debt is weighing heavily on many people, with 58% of workers and 44% of retirees saying they have a problem with their level of debt.”

Here are the numbers for retirees. Once again these savings totals exclude the value of the primary residence and any defined benefit pension.

•Less than $1,000, 29%
•$1,000 to $9,999, 17%
•$10,000 to $24,999, 12%
•$25,000 to $49,999, 8%
•$50,000 to $99,999, 7%
•$100,000 to $249,999, 11%
•$250,000 or more, 17%

Source: Employee Benefit Research Institute

20% Down?

There are two ways to pay for something. You can save, letting the power of compound interest work in your favor, or you can take out a loan and let compound interest work against you at much higher rates. Either way, you pay. Cash is almost always the preferable option, unless you are lucky enough to have a 3.5% mortgage from the early 1960s in the 10%+ stagflation of the late 1970s. Unfortunately for most couples, 100% down on their first home is simply not an option.

So how much of a down payment do you need to buy that new home?

The new answer is 20% down. That is the minimum requirement to avoid Lenders’ Mortgage Insurance generally termed, Private Mortgage Insurance (PMI). Unless you can come up with a 20% down payment, the lender will require you to pay for an insurance policy to protect his bank from the possibility of your default. Typically the annual cost of PMI runs from about 0.3% to 1.15% of the original loan. On a $200,000 home that might be something like $200,000 X 0.01/12 = $166.67 a month for the next 30 years. That could be $60,000 that is not going into your Roth IRA or some other worthy cause. If that money went into your Roth at the rate of $166.67 a month for 30 years at a very realistic 7.0% rate of return, you would lose $203,340.68 that you could have spent in retirement. Small decisions involving the power of compound interest can drastically affect the outcome of our lives.

If you live in a high cost metropolitan area, double those numbers!

While most private mortgage loans will allow you to drop PMI payments when you reach 20% equity by some combination of paying down the original loan and an increase in the value of your property over time, it is up to you to notify the lender and prove that this is a fact by paying for a home appraisal. Finding a qualified home appraiser who will realistically value your home is not a given. Short sales or foreclosures can skew the comparable home values in your neighborhood. Fannie Mae and Freddie Mac lenders can not work directly with appraisers. Therefore they work through Appraisal Management Companies. Some of the people who work for these companies are unqualified or may be unfamiliar with your particular neighborhood.

Some mortgages will require PMI for the first two or three years of the loan, no matter how your equity position changes during that time period. Some of the new FHA loans will require PMI for the entire term of the loan. I have a sneaking suspicion this might well become the new normal, so be careful what you sign.

To avoid PMI on a home valued by an appraiser at $200,000 the buyers need to cough up $40,000 in cash. That is a very tall order for a young couple. However, that is the best path in the current environment.

There is another reason to bring a substantial down payment to the table when buying your first home. When the real estate bubble popped in the slow motion train wreck of 2006 to 2009 as many as one third of the home owners in America found they were underwater. This condition is also called upside down. This occurs when you still owe more on the house than the house is worth. In such a situation you can not sell the house unless you can come up with the difference between the sales price and the mortgage balance in cash. As the unemployment rate spiked to the highest levels in nearly 30 years, far too many Americans lost their jobs at the same time they could no longer sell their homes in order to avoid foreclosure. Even if they found a new job in another city they were still saddled with a mortgage in another town. If they couldn’t find a renter, they were forced to continue payments for an empty home or face foreclosure and personal bankruptcy.

Under the best of conditions, debt is a dangerous companion to invite into your life. Be careful. I know that paying rent seems like throwing money down a hole. We did it for twelve years. Your genes, your Government, the banks, and your friends are all telling you to buy a home without carefully counting the cost. Waiting an extra three or four years to build an emergency fund and a substantial down payment may prove to be the best and cheapest mortgage insurance policy you can possibly buy.

Two Roads Diverged In a Yellow Wood

TWO roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;
Robert Frost

We have all read the poem by Robert Frost about the choices we make in this life. Maybe we read this poem for the first time in junior high school. Not too many years after that we begin to make those kinds of choices; some are difficult to undo; some dramatically alter the outcome we call our life. Of course I believe there is hope. God has a hand in all this. In all your ways acknowledge Him, and He will make your paths straight.

Then take personal responsibility for your decisions and for your life.

As you choose a career, there are four paths you can follow.

As you make your selection, remember nothing is perfect. If someone is willing to pay you money to do something, there is something wrong somewhere. If it was all that great you would be paying him to get to do it.

Remember, nothing lasts forever. Layoffs happen. Plants close. Entire industries vanish into history. Record stores were the perfect business. The sale of vinyl discs at obscene profits without any competition was a perfect business model. Then, with the advent of inexpensive tape recorders, AM pop radio stations, long a corrupt ally of the record industry, put the first nail in the coffin of the perfect business. The Internet, iPods, Amazon.com, and Youtube, have nailed the coffin shut. The once common “record” store” is now a curiosity, often run by eccentrics from my generation who are still lost in the 60s. Yes, you can still buy popular CDs at Walmart and a few other big box stores, but the perfect business is gone forever.

Follow Your Dreams

This is the most common advice preached by motivational speakers. This is because we want to believe it is true. If you love mathematics, geology, and the sound of oil coming out of the ground, petroleum engineering is probably a safe path to follow. If you are an artist, even if you are a very good artist, it is possible that no one will want to buy your paintings, at least until after you are dead. If you choose a career for love, be sure and be ready to live with the consequences. The world does not owe you a living.

Heed the Hardhearted Realists

Look at the numbers. Who is hiring? What are the projected futures for different industries? Make your decision based on the facts. Accept the fact that you may spend 40 years in a soul sucking cubicle in order to feed and care for those who you love. By definition most of us are mediocre. 68% of us fall within one standard deviation of the mean. 99.7% of us fall within three standard deviations of the mean. What makes you think you can be an outlier like LeBron James or Wolfgang Amadeus Mozart? Maybe there are things that are more important that fulfillment or success, like caring for your family, living a life of integrity, serving your God, and extending mercy in a fallen world?

The Great Compromise

This is the path I followed. I split the difference between the dreamers and the realists. I tried to find the least objectionable career path that would support a lifestyle acceptable to me and to my wife. Believe me, if you follow this path you will have regrets. Choosing to major in U.S. history and English literature, landed me barely acceptable jobs in dying American factories for nine years. Deciding that I did not wish to spend the rest of my life as the night superintendent in some smelly noisy factory, I set my sights on an engineering degree and a job in a research laboratory with coworkers who did not find it necessary to use the services of a root doctor. There were some good years and there were some really bad years when I struggled as the proverbial round peg in a square hole. I spent 32 years working as an engineer 5 years in a factory without a degree and 27 years in a laboratory with a degree. Most Americans would consider me a success. They might even envy the career path I have chosen, but I must live with my regrets, always wondering if somewhere in the forest, there could have been a better, more suitable path.

Light a Candle

There is a fourth way, the way of the entrepreneur. Look around you. Is there a service or a product that you can offer to others? Rabbi Daniel Lapin asks the question, what if making money was not like cutting a cake? When a cake is divided into pieces; some get a larger piece; some get a smaller piece; some don’t get anything at all. What if all you were; your money, your skills, and your life was a candle? What if you choose to take the light and fire from your candle to other people who are waiting for someone to light their candles? What if you could find a way to serve others without working directly for an employer? What if you could view wealth as nothing more than a medium of exchange that facilitates your ability to serve others in a mutually beneficial exchange? If you have the skills, ingenuity, and drive to follow this path, I think it more likely that you will truly end up doing the things you love. Successful artists are also men and women who have learned how to run a business.

I have seen people who did what they loved only to come to a bad end filled with regrets and bitterness, blaming the results of their own folly on the banks, politicians, or macro-economic forces beyond their control.

I have seen people devote their entire lives to the pursuit of worldly success only to be discarded by the world they served or left alone to face old age hated by their own children whom they neglected while pursuing money and power.

I tried to find the best course between these two extremes, an acceptable career that would support the lifestyle that my wife and I wanted. I too have many regrets.

Can we do more than to seek justice, love mercy, and walk humbly with our God, knowing that He will bring every work into judgment, whether they be good or evil?

The Road Not Taken By Robert Frost

Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;

Then took the other, as just as fair,
And having perhaps the better claim,
Because it was grassy and wanted wear;
Though as for that the passing there
Had worn them really about the same,

And both that morning equally lay
In leaves no step had trodden black.
Oh, I kept the first for another day!
Yet knowing how way leads on to way,
I doubted if I should ever come back.

I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.

One Income

Buying that first house will be the largest financial gamble for most couples. In most instances, both husband and wife will have a job when they are first married. When my father was forty years old, a man without any particular skills and a high school diploma could reasonably expect to support a wife, two kids, a mortgage on a 1,200 square foot brick box, and one car if he was willing to work 40 to 50 hours a week at a boring, fairly meaningless job on an assembly line. I am afraid those days are gone forever. Today, at least for most couples, it will take two incomes to get started. The bride and groom might be bringing student debts to the table, along with car payments, perhaps even a credit card balance or two. When we were married in the mid 1970s, most young couples at least started out with a slightly positive net worth. Ours consisted of a little over $1,000, two paid for used cars, and a pretty decent stereo system. Our first major purchase as a married couple was a 19 inch black and white television for approximately $125. Today, student loan totals of $100,000 are a possibility; essentially a mortgage without a house. Unfortunately, for most young couples the first years of a marriage must be spent preparing for starting the rest of your life together, especially the cost of starting a family.

Paying down high interest debt and building an emergency fund are your first priorities. After those two beasts are under control, then start to think about building a down payment to buy your first home. Banks, the Federal Government and the governments of the several states really want you to buy a home. They have jointly conspired to offer all kinds of tax breaks and special programs for different categories of buyers. Special plans are available for first time buyers, veterans, or couples with a combined income under some threshold. Those are just a few examples of what is out there. Of course the home mortgage deduction is the single biggest tax loophole in existence. I do not hear very many reformers from either party calling for the elimination of that particular loophole.

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.

Ask yourself, “Do I really need a house?” The answer is no, but buying a house may be a wise investment as well as a means to fulfill a biological imperative.

If our newlyweds are college graduates living in a major metropolitan area, they might well have a combined annual income in excess of $100,000. Even those of more modest means could easily be earning a combined total in the neighborhood of $60,000. You don’t need to find ways to spend all that money. Instead live on one income if at all practical. Use the second, smaller income, to pay down existing debts or to build equity for the next big step your life. In our case that step did not turn out to be our first home. Instead, we went back to school for our second degrees. A Federal grant, scholarships, and a work study program paid for most of those two degrees. The rest came out of savings or from the income produced by whichever one of us was not in school at the time.

If the next big step in your life is buying a home and starting a family, plan on doing it with one income. Banks will qualify you for a loan based on your combined incomes and credit scores, but do not fall for that trap. Two adults, a toddler, and a baby really do not need even a 1,900 square foot home. Take a step back to your grandparents’ vision of a home. Start small. You really don’t need to be carrying $500,000 in debt to support a 3,000 square foot home even if you can afford it on two incomes.

There are just too many things that can go wrong. The young man who put down the first offer on our home lost his job just before going to closing. It is sad to say but that was a better outcome than losing a job the day after closing. Then it would be too late. There is a high probability that he would not have enough money left to cover the mortgage until he found another job. He could have ended up in a situation where the home was underwater. Then he wouldn’t have enough money to cover the difference between what he owed on the home and the selling price.

It happens. Remember 2006-2009.

Over the years, I have added this one caveat to my mortgage decision lecture. Calculate affordability on the basis of one income, not two. Young couples often decide to start a family. When babies appear on the scene young women want to stay as close as possible to their children. Fulfilling this perfectly normal instinctual desire is good for both mother and child. At least give your wife the option to be a stay at home mom for a few years if that is her desire. In five to seven years you will sell that first home and move on to something better in another city. When you are old, the time your wife spent with her babies is likely to be her most precious memory. By that time your first home, if it still even exists, will be a maintenance nightmare draining the lifeblood out of some other young couple’s combined resources.

Death and Disability

I don’t spend a lot of time discussing insurance. I guess I just assume it is a given that people with a car have liability insurance, people who live in a building have either renters’ insurance or home owners’ insurance, and people with minor children have life insurance (term – not whole life). For a brief time in our history following WWII, health insurance was a given if one family member had a job. Unfortunately that is no longer a safe assumption. This morning I looked at a brief report from Learnvest funded by the Guardian Insurance Company examining what 20 somethings and 30 somethings think about life insurance and disability insurance. The results are somewhat depressing but not surprising.

Much of the problem is self inflicted. Insurance salesmen have such a bad reputation that 25% of those surveyed would rather clean out their refrigerator than speak to an “insurance professional.” In fact, 6% said they would rather eat a live bug than talk to an insurance salesperson. Surprisingly, the same participants in this survey trusted “financial advisors,” most of whom operate on the same commission sales model as the dreaded insurance salesman. There is another problem inherent in the product. It isn’t life insurance, it is death insurance. Nobody, especially young adults, wants to think about their own death.

However, if you have minor children or plan on having minor children in your life, you need to think about your death. The rules of thumb are $250,000 per child or 10 times your annual salary. That should be enough to get your children to age 18, but not enough to get them through college. 30 year level term insurance is not all that expensive. Since the cost is dependent on your age and the results of a medical examination, get enough insurance for the planned size of your family, not the actual size, at the earliest reasonable date. Even though a stay at home mom doesn’t need to protect her income with life insurance, there is a monetary value associated with all that she does for her family. For this reason, she should carry enough low cost term insurance to pay someone else to perform these services in her absence.

There may be another reason to think about at least some life insurance, student loans. While Government student loans can be dismissed with the death of the debtor, the problem is more complex with student loans from a private source. Most of these loans require a cosigner. That would usually be the parent, but it could be surviving spouse. In such cases, expect to pay for your loved one’s student loans, even if they are dead. In community property states, such as California, the surviving spouse might well be required to pay off those student loans even if they did not cosign for the loan. If such a tragedy befalls you, consult an attorney. This could get complicated. If you know that your survivors are going to be on the hook for your loans, dead or alive, a small amount of low cost term life insurance might be a good idea.

For the record: When I graduated from engineering school, we had about $2,000 and one paid for car. My new employer offered a very low cost life insurance policy equal to roughly one year’s salary. I decided to sign up reasoning that if I died it would give my wife a year to deal with my death. Of course I have long since outgrown any need for this insurance. I just left it in force since it was so inexpensive that I didn’t really even notice the cost as it was deducted from my pretax earnings. If I leave it in force until age 65, it will convert to a free $30,000 burial insurance policy. Since I am almost 65 I will continue to pay for this unnecessary coverage.

Actually, you do have disability insurance, Supplemental Security Income (SSI), a component of Social Security.

From the Social Security Website:

Supplemental Security Income (SSI) is a Federal income supplement program funded by general tax revenues (not Social Security taxes):

It is designed to help aged, blind, and disabled people, who have little or no income; and

It provides cash to meet basic needs for food, clothing, and shelter.

Social Security will calculate the amount of disability payment using a complex formula based on your earnings history. Most monthly payments will fall between $300 and $2,200. The average payment in 2014 is $1,148. The maximum possible disability payment in 2014 will be $2,642. This is enough to put food on the table, but not enough to replace your income. In the early 1980s when I first looked into disability insurance, it was an expensive rarity. Since I worked in a factory (considered a moderately dangerous occupation) the rates were well beyond my pay grade. Since then the cost of disability insurance has dropped significantly. Sometimes employers offer low cost group policies.

You definitely should consider buying private disability insurance, even if you work in a safe little cubicle. According to the Council for Disability Awareness, one in four of today’s 20-year-olds will become disabled before they retire. Back injuries, cancer, heart disease, and other illness are responsible for most long term disability, not accidents. If you have a history of back problems or any psychiatric issues finding disability insurance could be problematic. Consider long term disability insurance with a longer waiting period, sometimes called the deductible, before the benefits kick in. This could significantly lower the cost of the coverage. If you have a three to six month cushion in your emergency fund this should not be a problem. The ideal goal would be enough to replace your take home income. This would be somewhere around 60% to 70% of your gross income.

The Learnvest survey discovered that young adults don’t understand their insurance coverage. Over one third don’t even know what kind of insurance they own. 20% don’t know the value of their own death. 35% don’t know what coverage their significant other owns. As always, stop, breathe deeply and take personal responsibility for your own situation. Take some time to discover your current condition and your needs. After researching the problem carefully, set your own goals. Once you have decided what you want then go out and price competing policies. Particularly with life insurance the Internet has changed everything. When shopping for low cost term policies, it is easy to get the facts without dealing with time consuming high pressure sales tactics. This is one of those instances when you need to watch your own money. Don’t expect that someone else will have your best interests in their heart.

Back to Basics (Young, In Love, and Nearly Broke)

Early this morning when I should have been sleeping, I was remembering what it was like to be young, married, and nearly broke. I thought about all the advice given to young people about saving for retirement, buying insurance, buying the first house, and the 10,000 other necessities required in our debt based consumer society. If you are young, in love, and nearly broke, take a deep breath. Focus on two ideas.

Rule Number 1! Avoid debt like the plague.

Then concentrate on what Dave Ramsey calls the four walls, although it is actually four walls and a roof.

If you will let me get away with this statement, the first wall is the roof over your head. You need a place to live, usually a rented apartment. How much apartment can you afford? The rule of thumb is your combined gross annual income divided by 40. For example: $50,000 / 40 = $1,250 Maximum! The other rule of thumb is 30% of your salary can be spent on rent. Watch this math magic: $50,000 / 12 = $4,166.67 monthly salary; $4,166.67 X 0.30 = $1,250. You need a safe, reasonably convenient place to live, but nothing more than that. If you live in San Francisco meeting this rule of thumb will be difficult. You might have to cut corners in other areas to avoid a dangerous or unhealthy home environment. If you live in Greenville, SC you should be able to find something for less than the rule. That should free up some money for other purposes. While I am on the subject, you don’t need new furniture from the Room Store (90 days same as cash). This is a beautiful time of your life. Enjoy it as it should be enjoyed. This time will never come again. Take a tip from the old Bob Marley song, Is This Love.

I wanna love you every day and every night:
We'll be together, with a roof right over our heads!
We'll share the shelter of my single bed;
We'll share the same room, yeah! Jah provide the bread.
We'll share the shelter of my single bed

The next wall is utilities. Make sure you can pay the electric bill. Most often water is included in the rent. That leaves electricity, cable TV, Internet, and phone. You don’t need cable. Cut it. You do need Internet and a phone. Find a way to minimize that combined monthly bill. You don’t need an expensive smart phone plan, a land line, and 30 Meg Internet service. I come from a different era, so I won’t try to tell you what the best compromise solution should be for your life, but you can get by with less than you think you need. Obviously, you can control that electric bill, at least some of the time. Keep the thermostat turned down in the winter. Set it higher in the summer; instead of running the air conditioning use box fans. To paraphrase the song sometimes, “There ain’t no cure for the Wintertime blues.” If your apartment building has heat pumps, a winter like this one is going to cause you to run those coils even if you lower the thermostat. Expect a higher power bill. Build it into your monthly budgets.

The third wall is food. Almost all Americans (myself included) spend too much money on fast food and convenience food. Take an honest look at how you spend money in this area. Charles Hugh Smith once said, “A healthy home cooked family meal and a home garden are revolutionary acts.” Flowerpot gardening on apartment balconies is a little too hard core for me, but we all can do better. You don’t really need that $5.00 latte from Starbucks. Spend the $5.00 on a thermos from Walmart. Brew your coffee at home. “Save money. Live better.” The Simple Dollar blog is a great place to learn about lowering the cost of consumables. The author specializes in finding elegant ways to live a full, rich life without buying into the lies of our credit based economy.

The Simple Dollar

The final wall is clothing. That is simply not a problem in America. Unless there are young children in the mix, most of us could go the next two years without buying any new clothes. I know, you ladies will say, “How about pantyhose? I have a job.” OK, but how about you wear the ten pairs of shoes you already own rather than buying ten more pairs over the next two years? I also know that good safety shoes are expensive. They don’t last very long in a shipyard or on a construction site. More and more, young Americans are discovering places like Goodwill stores and consignment shops. In every city in America you can find high quality clothes, sometimes unworn with the original tags, for pennies on the dollar. If you are cutting it close, budget $0 for clothing this month. If you find a $200 dress in a consignment shop for $25, you can probably pay for that out of your “contingencies” envelope.

Now for the roof, transportation. We live in America. With the exception of sections of a few major metropolitan areas, mass transit either does not exist or is impractically. In most of this country a car is a necessity. For young couples, just getting started, that would be one car, not two cars. Back in the day, we did that for a couple of years. It was inconvenient but it didn’t kill us. Driving one used car instead of two new cars will do wonders for your family budget and your financial future. I wouldn’t spend less than $3,000 on a used car unless you are a competent mechanic. A $1,000 car is likely to be a money pit. After you put another $1,000 into repairs, you will still have a $1,000 car. Most of time people entering marriages already own a car. If you have one that is runs well and is paid for and one is still carrying a note, guess which one you might want to consider selling?

You’ll get there. Really. Focus on the basics. Just keep doing the right things. One day you will wake up wondering what happened to all those years. You will have a house crammed with the flotsam and jetsam of 30 years of married life. You will be ready for retirement since you have been socking away 15% of your pretax income into the company 401(k) and your Roth IRA. Now if you can just come up with another $30,000 for a perfect wedding for the little princess….

For now, just enjoy a love song by Bob Marley.

Is This Love

Do Something Wonderful

“Being the richest man in the cemetery doesn't matter to me. Going to bed at night saying we've done something wonderful... that's what matters to me.”
Steve Jobs

Carmine Gallo is the author of The Innovation Secrets of Steve Jobs: Insanely Different Principles for Breakthrough Success. He is also an author, keynote speaker, and a communications consultant to businesses and advertising agencies. Gallo is also waging a one man crusade against the cluttered PowerPoint slide. If he saw almost any presentation by one of the engineers at my laboratory, I am sure it would cause him to throw a screaming fit.

He starts his presentation by noting that Steve Jobs did what he loved. That is pretty unusual in and of itself. So many of us can not find someone to pay us a salary doing what we want to do. We get paid to do what the man wants us to do. Some of us make the great compromise. We find the least objectionable path that will provide an acceptable standard of living for our families. The entrepreneur finds an unmet need that he can fill. Very few of us are willing or able to do what we love after counting the cost. Steve Jobs was one of those people.

Gallo’s second point is, “Make a dent in the universe.” Here he is talking about vision. Nobody cares about your mission statement. The author of the Invitation begins the poem with this line, “It doesn't interest me what you do for a living. I want to know what you ache for and if you dare to dream of meeting your heart's longing.” Gallo would agree. The world isn’t interested in your agenda. They want to know what makes your heart sing. What is your vision? Make it simple, bold, and concise. Except for the Manhattan Project that created the first atomic weapons the race to the moon was the most complicated technical program in history. Kennedy reduced that enormously complex and fabulously expensive effort to a tweet, “Man on the moon in ten years.” If you can’t write a vision statement that can be sent as a tweet, go back to the drawing board.

Steve Jobs was brilliant at what Gallo terms, “Kick starting the brain.” He intentionally took input from many different sources when designing a new product for Apple. Once he took a project team from the home in Silicon Valley to New York City so they could get input from artists and Broadway performers. The layout of Apple stores is based on what Steve Jobs and his team saw in the Four Season hotel chain. The best short list describing attributes that indicate intelligence that I found in my readings comes from Godel Escher Bach by Douglas R. Hofstadter. This is exactly what Steve Jobs did whenever he developed new products.

1) To respond to situations very flexibly;

2) To take advantage of fortuitous circumstances;

3) To make sense out of ambiguous or contradictory messages;

4) To recognize the relative importance of different elements of a situations;

5) To find similarities between situations despite differences which may separate them;

6) To draw distinctions between situations despite similarities which may link them;

7) To synthesize new concepts by taking old concepts and putting them together in new ways;

8) To come up with ideas which are novel;

“Say no to 1,000 things,” is the fourth point in Gallo’s lecture. Rather than creating a device or a service that is more complex, seek simplicity. The easier it is to use a website or a product, the more likely it will be that someone will actually use it. Gallo showed some video from Apple of a group of two year olds playing with some Apple products. If a two year old can understand and use your device you are probably heading in the correct direction.

The fifth point is make the customer’s experience, “Insanely Great!” People, particularly visual artists, love their Apple computers. They rave about the experience. There is not a Starbucks coffee shop on every street corner in America because they sell a better cup of coffee. Howard Schultz set out to make Starbucks into a “third good place.” We need three good places in our life. The first good place is the home. With half of American marriages ending in divorce that is something of an assumption, but OK. The second good place is the workplace. Again sociological studies might not agree with that conclusion since most Americans view the workplace as not much more than a necessary evil. In the ideal world home, the workplace, and the third place all have things in common, familiarity, safe relationships, and a convenient location. The third good place is a vital part of our psychological health. It can be found anywhere, a beauty parlor as in the movie Steel Magnolias, another example, a barbershop as in the movie of the same name, and the quintessential example, the neighborhood pub as brilliantly portrayed in the long running TV series, Cheers.

Having a good product or service is only the beginning. Gallo states that the successful innovator must, “Master the message.” Again simplicity is an important component of a successful message. Studies indicate that people don’t pay any attention to boring things, like cluttered PowerPoint slides--go figure. They respond much better to simple visual images. In applying words to these images, Gallo recommends what he terms, the rule of three. Psychologists have determined that humans only process three or four images or ideas at a time. Any more content in your message will be lost. The iPad II was introduced as thinner, lighter, and faster than the original model. That was all you needed to hear in a commercial for this product. In 2007 when Steve Jobs introduced the first iPhone his audience expected to see three new devices an iPod, a new kind of phone, and a breakthrough Internet communication device. They got the iPhone, three new devices in one package.

The last and most important point is, “Sell dreams not products!” People are interested in their own problems, hopes, and dreams. They don’t care about you or your agenda. The vision statement for Dave Ramsey’s organization is, “We sell hope.” Harley Davidson is not in business to sell overpriced motorcycles to fat middle aged men. They are fulfilling adolescent dreams of freedom. There is nothing that sounds like a Harley. That sound is patented. Having operating chrome plating baths, I am simply astonished by the chrome on Harley Davidson motorcycles. Nothing else in the industry looks like that. When my neighbors rode off on their Harleys they were no longer harried cubicle dwellers. They were Peter Fonda heading off into an electric sunset. Joel Osteen, arguably the best Christian motivational speaker in the world, always preaches a message of hope. General themes are you can become a better you. Your miracle is just around the corner. God is good and interested in your problems. Those are a sample. The general theme is then always broken into real problems. Joel always hits ‘em where they live. Unemployment, underemployment, no husband, inability to conceive, and getting out of debt are just a few of the very human problems that will underlie the inevitable message of hope.

Now go out there and live a bigger dream!

Smart or Lucky?

I am once again in the process of learning enough about options to feel comfortable about experimenting with covered calls, the simplest and safest option strategy. Several years ago, I felt I had learned enough to give it a try. I called up my broker and paid him to execute the trade to make sure I didn’t make a mistake. Turns out he made a mistake. It only took him 20 seconds or so to realize he had fouled up, but in those 20 seconds I lost $90 plus the cost of two trades. My broker was very apologetic and immediately refunded all of my money. He was a professional in every sense of the word. However, the experience spooked me. Over time I forgot most of what I had learned about options.

This morning I listened to an interview with Mark Cuban, the eccentric owner of the Dallas Mavericks. One of the subjects mentioned in passing was his Yahoo stock trade. Turns out this is considered to be one of the top 10 stock trades in history. Mark Cuban pretty much laughed it off. He said he was just lucky. He said if he had waited 6 weeks he never would have been able to execute such a trade. Of course I had to learn more.

Here is the story. I have read several different articles, but most of this information will come from Investment XYZ.

In 1995 Mark Cuban and Todd Wagner started an early version of YouTube called Broadcast.com. They sold their stake in the company to Yahoo! for $5.7 Billion in Yahoo! stock. At the time Yahoo! was worth about $130 Billion. It went up to $300 Billion then crashed to about $10 Billion. The Internet bubble was making Mark Cuban nervous. He decided to protect his 14.6 million shares of Yahoo! with an options strategy called a “collar.”

He sold out of the money call options on his shares. “Out of the money” means that the strike price is higher than the current market price. The value of a share of Yahoo! at the time was $95. The strike price for the call was $205. That means that if the price exceeds $205, the individual who bought the call option will execute his right to call away Mark Cuban’s shares at $205. Simultaneously, Cuban bought out of the money put options to cover a potential drop in the price of Yahoo! shares. These put options had a strike price of $85 a share, guaranteeing that Mark Cuban could not possibly lose more than $10 on a share of stock. He sold an identical number of 146,000 call contracts and bought 146,000 put contracts. These were all three year contracts.

Here is where it gets interesting. The cost of the puts exactly offset the income generated by the calls. The cost of this transaction was ZERO! No one is sure if the cost of the brokerage commissions was rolled up into this deal or not, but most suspect the parties involved included the commissions as part of the entire package. If you can swing somewhere around $1.4 Billion for a single stock trade, you can get a better deal than if you are trading $10,000 at a time.

After entering the “collar” Yahoo! share prices reached $237. If Mark had to sell his shares at the agreed upon price of $205, that would lock in a final value of around $3.0 Billion less commissions. The details of the execution get a little hazy and vary a bit from telling to telling, but everyone is pretty clear that Mark Cuban walked away with at least $2.5 Billion after all the dust settled. Soon after this event the Internet bubble burst. Yahoo! shares dropped to $13 a share. If Cuban held on the value of his shares would have dropped to $190 Million. He would have been comfortable, but he would have never become the owner of the Dallas Mavericks or the star of a reality TV show. Some of the minority partners and early employees of Broadcast.com were wiped out. Mark looked very unhappy as he remembered how these events hurt others whom he seemed to care about. It was pretty obvious he did not want to talk about it.

The author of the Investment XYZ article notes that while it seems selling a $110 out of the money call for the same price as he paid for a $10 out of the money put might seem weird, it can be explained by a market phenomenon called “skew.” The market always places a higher value on downside protection than it does on than upside potential. The author also explores the hidden cost, loss of interest income that Cuban could have enjoyed by modifying the basic deal. He expects Cuban left somewhere around $200 Million on the table. Kind of like if I said Joe Montana could have done a better job in Super Bowl XXIV. His quarterback rating was only 147.6! Finally the author notes we will never know exactly all the details of who made and lost what in this deal, since the participants would have certainly hedged their initial positions just as Mark Cuban hedged his initial stake in Yahoo!

Once again stories like this raise the smart or lucky question. I guess the answer is both. The next question is the effect of hard work, study, and business smarts has on luck. Mark Cuban is notoriously competitive both as a businessman and as a sports team owner. He plays to win. Evidently he has a personal thing going with Donald Trump. They love to needle each other after one of them fails at something. After Cuban’s first TV show flopped, Donald Trump sent him a nasty letter. Cuban had it framed. It is one of only two items that always sit on his desk. The second item is the trophy from the Dallas Maverick’s championship. Cuban celebrated that victory with a $90,000 bottle of champagne he drank in a Miami nightclub where he had previously been razzed by Miami Heat fans.

The Battle for Your Mind

Back in the early 1990s I was paying down my mortgage as fast as I could given my resources. My logic at the time was if I keep my tax deduction by continuing to pay on this mortgage for the full 30 years, I will be giving the bank $3.00 so that I can receive a $1.00 tax refund. How about if keep the $3.00? Even though I will have to give the Government an extra $1.00, I will get to keep $2.00. Some of my coworkers ridiculed my decision. They said, “Don’t lose your tax deduction.” In fact some of them suggested it might be a good idea to take out a second mortgage to invest in the stock market for higher returns. My suspicion is most of them did not invest that money in the stock market. Instead I’m willing to bet they used the increasing value of their home to buy or lease that new SUV I noticed parked in their driveway. I have never regretted that decision for even one minute. For most of us paying off that mortgage will be the biggest single raise you will ever receive in your life. Talk about freedom. What could you do with an extra $1,000 a month?

I didn’t think to ask a very important question until much later. If investing in pets.com was such a good idea, why would the banks lend you money at a lower rate of return than they could get from that famous dog sock puppet? The company is long gone, but you still see the puppet from time to time.

There is a battle for your mind. Powerful forces, economic, political, and religious all want to keep you ignorant, confused, and blind. This is about control. They want to keep you enslaved. Anytime anyone asks you to sacrifice your money or your freedom, be suspicious. The bank is not giving you $30,000 because they believe you deserve to enjoy a new car. Advertisers are not spending up to $4.0 Million for a 30 second television commercial just because they are bored. Although, it appears there is a bit of ego involved in some of those Super Bowl commercials.

The banks, the politicians, and the television networks all want to keep you deluded, lost in a dream of their creation. They do not want you to wake up. They do not want you to know the truth. They do not want you to be free.

I keep coming back to this subject. Perhaps I am more aware of this today due to the revival of ancient ethnic and religious divisions in the Ukraine. Perhaps it is because I have seen a dangerous escalation of political rhetoric in my own country. Anytime anyone encourages you to consider their political opponent as less than human, run away. That is always the first step on the road to death camps. It is much easier to kill something that is not human. Anger and hatred never lead to freedom. They never lead to enlightenment.

Here are some statements that should cause you to question the motives of a leader or a celebrity commentator. It certainly is not an inclusive list.

This time it’s different.
We have to do this for the children.
It is a crisis of global proportions.
We must act today.
We must kill the (fill in the blank) to keep them from destroying our way of life.
It’s an issue of national security.

There are also lines of reasoning that should make you nervous, such as the infamous yes set.

Do you love your children?
Do you love your country?
Do you love Jesus?
Then support my efforts to (fill in the blank).

In matters that touch upon questions of personal finance, look out for three warning signs fear, greed, and envy. Anytime a salesman, politician, or religious leader is attempting to generate any of those emotions in your mind, he does not have your best interests at heart. We are told, “For God hath not given us a spirit of fear; but of power, and love, and a sound mind.” The purpose of this blog is financial freedom. Each of must answer the question, “How much is enough?” in our own heart, remembering that, “He that is greedy of gain troubleth his own house.” Sometimes it is hard not to envy another’s gifts, beauty, or success. Nevertheless remember, “For where envying and strife is, there is confusion and every evil work.” Instead of counting your neighbor’s blessings, try counting your own. That is the better way.

Let me ask God for a Micah 4:4 blessing for each of you and for your house.

“Everyone will sit under their own vine and under their own fig tree, and no one will make them afraid, for the LORD Almighty has spoken.”

Just for today, wake up. Peace and freedom are a possibility.

Mortgage Math

Back when I bought my first home the world was a simpler though not necessarily better place. When you bought a home the universal rule of thumb was a house that cost less than 3 times your annual salary. You always needed to have a 10% down payment in hand plus something like another 7% of the selling price of the home for fees, points, inspections, taxes, and lawyers. There weren’t very many options when it came to finding a mortgage. The banks and the mortgage companies had the upper hand. The going rate was pretty much the going rate.

Today the new rule of thumb seems to be 2.5 times your annual salary. After the subprime loan debacle of 2006 everyone seems to be running scared. During the glory years of the housing bubble the rule of thumb went up to 4-5 times annual salary! Washington Mutual, the bank that made this suggestion is now deservedly bankrupt. Down payments can range from 0% in special cases or 3% in first time home buyer programs to the customary 10% to the new customary 20% down payment that allows the buyer to avoid the dreaded Private Mortgage Insurance (PMI). The Internet gives the home buyer more information and options than in the past. Since banks no longer have a tight control on information, they are trying to make the information that is available less useful to the average consumer.

How do the banks decide how much house you can afford? Of course they will consider your credit score in deciding how much money to lend you and more importantly at what rate, but they also use two ratios that you can calculate in advance of shopping for a new home.

A Front End Ratio of less than 28%: This number is the mortgage payment (principal + interest), plus taxes, plus all required insurance costs divided by your gross monthly salary.

Example:

Gross monthly salary of $5,000 ($60,000 a year) X 0.28 = $1,400 a month or less in a total payment to the bank or mortgage company. Just for grins let’s say $140 a month will go into escrow to pay your taxes, PMI of $150 a month, and your homeowners insurance runs $50 a month. That would leave you with $1,060 a month for principal and interest. A $200,000 loan for 30 years at 5% would require a monthly payment (principal + interest) of $1,073.64.

Maybe if this family was looking at buying a $225,000 home with a 10% down payment, they ought to lower their sights a bit, but they are in the right ballpark.

A Back End Ratio of less than 36%: This number is the mortgage payment (principal + interest), plus taxes, plus all required insurance costs, plus all other reoccurring payments such as car payments, student loan payments, and alimony or child support payments divided by your gross monthly salary.

Example:

Gross monthly salary of $5,000 ($60,000 a year) X 0.36 = $1,800 a month or less in a total payment to the bank or mortgage company. Let’s say $140 a month will go into escrow to pay your taxes and your homeowners insurance runs $50 a month, PMI will takes $150 a month since you don’t have enough to put 20% down; in addition you have a $300 a month car payment and student loans take another $150 a month. This calculation allows the family $1,010 a month for principal and interest.

The bank will prefer the smaller number generated by these two ratios. In this case they would go with the Back End Ratio.

In a world filled with different mortgage rates, points, and upfront fees how can a person without a financial calculator and an understanding of the Present Value of Money make an informed decision? Marcie Geffner of bankrate.com suggests comparing the break even point. All this method requires is the monthly mortgage payment (principal + interest) and the upfront fees in order to make an informed decision.

Consider these two options:

$200,000 conventional 30 year mortgage at 6% with no points or fees Monthly mortgage payment of $1,199.10

Or

$200,000 conventional 30 year mortgage at 5.75% with 1 point and a $1,500 upfront fee Monthly mortgage payment of $1,167.15

A point is 1% of the cost of the home, in this case $2,000. Adding $1,500 in fees brings the upfront cost to $3,500.

Divide that number by the difference between the two mortgage payments. $3,500/$31.95 = 109.5 months to break even or a little over 9 years.

If you are planning to stay in the home for longer than 9 years paying the up front fees to get the better rate make sense. This is not the textbook perfect method, but it is simple and it does provide the buyer with a useful method to compare different offerings.