The Road Home

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

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

Your GPS needs two facts before it can plot your course. It needs to know where you want to go and where you are located. We all have some idea where we want to go, but all too often people with financial problems are so lost that they believe what is generally considered the first step, the monthly budget, requires too much information to even begin the journey to financial freedom.

Take a deep breath and relax. First determine how much money you have in your checking account, wallet, and bowl where you store your car keys. I know, you don’t want to find out how much money is in your checking account, but go ahead and look in there anyway. When you have this number, write it down on a piece of paper.

Next go back over your check register or your bank statements and determine how much money is coming into your account each month. For most of us receiving a weekly or biweekly paycheck, this is pretty easy. If your income is irregular, add up everything that came in over the last three or four months. Use the average of this figure as a starting point.

If your records contain too many debits or checks to establish what categories are consuming your money, just determine how much has been going out of your accounts over the last three or four months. If you don’t have the statements, the bank will give you replacements. Compare Money In with Money Out. If more money is coming in than is going out, you can relax—just a little. If more money is going out than is coming in you know you have a problem. Look at how much money you have in the bank. Compare it to the monthly deficit. This will give you some idea of how long you have before you are overtaken by bankruptcy.

Now look at your total debt. How much do you have to pay every month to keep the bill collectors at bay? How about the four walls and the roof over your head, rent or mortgage, utilities (including that cell phone), food, clothing (this can drop to near zero), and the cost of transportation. Add up those numbers and compare them to Money In. You have the beginning of a budget. If you are spending more on “necessities” than is coming in on a monthly basis, you need to cut something out. Cable TV, deluxe smart phones, restaurants, fast food, and clothing are often good places to start simplifying your life.

Next start a record of every time you spend money, to the penny. No excuses! Write down, “Coffee $1.06.” Now decide the category. You could call that cup of coffee, food, restaurant, or even entertainment. This is your budget. It’s your call. But be honest and be consistent. Every day sort these expenses into their appropriate categories. There are phone apps that will automate this task, but you have to enter the data. After a month of keeping this record, it will be pretty easy to start the formal monthly budget, the fastest route from the swamp of financial despair to the city of financial freedom.

Own It!

This is a most instructive set of graphs.

Starting on the left and moving to the right we discover that 94% of business equity is owned by the wealthiest 10% of Americans. That means if you really want to be rich, don’t worry about the wage your employer is willing to pay. Instead, own the company. This is very much in keeping with the findings of Stanley and Danko in their classic study, The Millionaire Next Door. Roughly 80% of American millionaires own their own business. Even a successful small business is enough to catapult the owner into millionaire status. My observation on the hours worked by small businessmen caused me to comment, “There is no exploitation like self exploitations.” Their workweek often exceeds 60 hours a week. However, most of these men absolutely love their work. They don’t view it as a burden. Not every independent business is successful, but note only 6% of business equity is owned by the bottom 90%.

Moving on, 95% of all financial securities are owned of the top 10%. While they don’t specifically identify what constitutes a financial security, in context it would seem that would consist of anything but stocks and mutual funds. This could include bonds, money market accounts, futures, options, swaps, forex currency trading, and various types of debt backed security including those offered by Fannie Mae, Freddie Mac, and Ginnie Mae. I am somewhat surprised that only 91% of stocks sold on the primary and secondary markets or in mutual funds are owned by the top 10%. I would have expected those numbers to be pretty close to identical. It would appear that the very wealthy, the top 1%, are better able to find investment opportunities in unusual vehicles, such as hedge funds, that are pretty much off limits to even fairly wealthy investors.

84% of the wealth held in trusts belongs to the top 10%. The numbers for the bottom 90% start to creep up in this category to 16%. There are very good reasons for anyone with a 401(k) to at least consider a Charitable Remainder Unit Trust to will money to their favorite charity without ever paying taxes on any of these funds. Trusts are also a method of avoid the expense and time of probate. As the upper middle class begins to understand these vehicles, I am hoping that the Government does not crack down on their uses. If you put money in a trust, you do not own that money. The trust owns the money. You can name yourself as trustee, so you will still control your own money, but now you must manage it for the trust. A trustee has a fiduciary responsibility to use the money for the good of the beneficiary. Trusts can be revocable, meaning you can change your mind on how you want to use the money, or irrevocable. Once you sign on the dotted line, money held in an irrevocable trust must be used for the purpose of that trust. The big problem is finding a trustworthy trustee once you are dead or incapacitated. There are too many horror stories about trustees, both attorneys and family members, looting the trust once the creator of the trust is out of the picture. Trustees get to pay themselves an “appropriate” salary. Appropriate is an interesting word that is open to interpretation.

78% of profit producing real estate of one sort or another is held by the top 10%. The title of this category would seem to exclude vacation homes. This category could contain mom and dad renting out the old family homestead or farm once they retired to Leisure World, conscious investment in commercial buildings, apartments, or renting out single family homes. There is a lot of money to be made in real estate. I suspect a considerable number of the people who own business equity, own it in a real estate business. Even this author, who gets a rash every time he thinks about buying real estate, owner financed the sale of his pre-retirement home near the big city. Getting that check every month feels like I am receiving a second pension.

I think it quite interesting that life insurance is more evenly spread across the wealth spectrum. Most Americans will only need life insurance while they are responsible for minor children. Term life is dirt cheap, particularly when purchased by young healthy parents. You need a lot of life insurance while your children are—children. Rules of thumb include $250,000 per child (that doesn’t include the cost of college) or 8 to 10 times your annual salary. Once the children leave home, most of us have no further need of life insurance. There is an exception. A successful small businessman or family farmer may have several million dollars tied up in their enterprise. Upon their death, estate taxes could cause a liquidity crisis. If you don’t have enough cash on hand when your remains are sent to the undertaker, your children who expected to inherit your business or operate the family farm may need to take out a large expensive loan at an inconvenient time or sell the farm in order to pay the tax man. An appropriately large chunk of single premium whole life insurance could make certain that the family farm stays in the—family, with or without the help of Willie Nelson and Neil Young.

I expect that pension accounts will spread out over time just as happened with life insurance. The 401(k) didn’t exist before 1978 and it took industry over twenty years to destroy the defined benefit pension. People are only just beginning to understand the implications of these changes. They are now responsible for their retirement, not their company. These numbers are further skewed by middle class pensions in the public sector and in what remains of unionized industry. Normally, if you have a defined benefit pension, you don’t have a pension account.

Only 5% of the value of primary residences belongs to the top 1%. Only 21% belongs to the next nine percent. Roughly two thirds of American families own their home. As the net worth of a family increases, typically the value of the primary residence decreases as a percentage of total net worth. An ordinary couple approaching retirement with a net worth of $500,000 could easily have as much as 50% of their total net worth tied up in their home. If a family had a net worth of $50,000,000 even a 10% share in the primary residence would be $5,000,000. In most parts of the country, $5 million is enough to buy a palace. Who would want more than that tied up in their primary residence?

Note that last column. While it is logical that the rich don’t choose to borrow money as often as the poor, it is important to understand that avoiding debt is a key component in finding your way to financial freedom. The misuse of debt almost guarantees poverty.

Ready for the Storm

My parents retired to southern Florida. Life is a little bit different down there. The town where they once lived was hit by two category three hurricanes in one year. I was there for one of those storms. Their senior living facility evacuated to a designated storm shelter where we spent the night in darkness listening to the howl of a wind that gusted to over 130 miles per hour. The next morning the storm was gone. Some of the town had been torn to pieces. In some instances one building that had been destroyed stood next of a building that appeared to be completely untouched. However, in some instances preparation made a difference. The trailer parks in town were equipped with hurricane anchoring systems. They did a good job weathering the storm. Outside the city limits there were obviously different building codes in force. Out in the county it appeared that an angry giant picked up those trailers and threw them around like so many toys. Those trailer parks were not ready for the storm.

I admit I am a bit paranoid. I am one of those people who have called seven out of the last five recessions, but I don’t think the signs are looking very good. If they are smart, the people living in Florida are always ready for a storm. They keep an unusually large amount of bottled water and canned goods on hand. They make certain they have flashlights, batteries, candles, a camp stove, and other supplies. They know there is a chance they will not have access to groceries or water for a week if a really big hurricane hits their town.

Are you ready for the storm?

The best preparation for the storm is a secure job. If there is a downturn in the economy, how likely is it that you will hold on to your job? Are there any ways you can improve your value to your employer? I know of one instance where an employer shut down his entire operation. Then he reopened it as a single employee operation. I know the one employee. He is worth so much more to his boss than his salary, he held on to his job through a complete shutdown of a company!

Household debt will make you extremely vulnerable to excessive storm damage. Are you debt free? Your creditors won’t care if you lost your job. They expect to be paid on time. If you can’t meet that car note, expect that the repo-man will visit you home in the wee small hours of some morning.

I have spent so much time ranting about the importance of an emergency fund that I have grown tired of listening to myself talk. If you don’t have at least $1,000 in cash money, you have an emergency. One car repair can send you to a credit card charging an effective annual interest rate of over 20%. If you don’t have at least three times your monthly take home pay in insured savings, you will find yourself, like the people in Florida who did not stock up on storm supplies, waiting in line to get water from the state National Guard trucks, if you remembered to fill up your car before the storm. During 2010, 4.5 million Americans were out of work for a year or more. That is why Suze Orman bumped her recommendation for an emergency fund from six months expenses to eight months expenses.

If you have investments, make certain you stay the course through the storm. Maintain your balance between equities, bonds, and cash. During a bull market it is easy to watch your portfolio grow from 50% stocks to 70% stocks without doing anything. But if your plan calls for 50%, your ship is becoming dangerously top heavy. It could capsize in the storm. Sell something, secure in the knowledge that what goes up will, at some point, come down. If you are cautious you will be in a position to buy shares of quality companies at dirt cheap prices when everyone else is just trying to walk away with a few intact possessions after the storm passes.

After a seven year bull run, the stock market is heading down. Auto sales are at record highs fueled by subprime loans. The transportation indices are heading down. Manufacturing jobs lost in the last recession have been replaced by low paying service jobs. The median household income is still below 2006-2007, the beginning of the last recession. Service jobs can be less secure than higher paying manufacturing jobs because they are tied to smaller capital investments. It is easier to shut down a restaurant than a billion dollar factory.

I am not in the business of making predictions since I can’t seem to get my crystal ball to function properly. I don’t know when the next storm will come, but I do know with certainty that another major hurricane will hit Florida at some time in the future.

Will you be ready for the storm?

Luck Never Gives

Luck never gives; it only lends.
Swedish Proverb

I am writing this the day before the Super Bowl. Yesterday I looked at the odds. The line is 3.5 points. If you think the Panthers are going to win the game, you need to give the other side 3.5 points. The over/under, the total number of points scored in the game was set at 44.5. This means if you think more than 44.5 points will be scored by both teams you bet the over; if less, you bet the under. The Las Vegas line is the combined wisdom of every gambler on the planet. The casino sets the line so that exactly the same amount of money is placed on both outcomes. The casino knows that the outcome of any given football game is a combination of both luck and skill. They aren’t interested in betting their money on anything like a football game. They are content to let you bet your money, then take 10% of the winner’s share from you or the other guy. They aren’t interested in the outcome of the game.

A particular gambler may get on a hot streak and consistently beat the line for a year or two, but eventually his results will revert to the mean. This is also true for money managers. A fund manager may beat the major stock indices for ten or maybe even fifteen years. However, sooner or later his results will revert to the mean. In this case that would be the appropriate stock index. Actually, it is worse than that. As an open fund grows, it holds more and more positions in more and more different investments, until it becomes an index.

Now skill is very important. There are brilliant investors like Warren Buffet, but even the sage of Omaha has been less than perfect over the last few years. It could be his mind is not as sharp now that he is in his eighties as it was in his forties, or it just could be that Berkshire Hathaway is such monstrously large and diversified conglomerate that it is starting to revert to the mean.

So what is the best we can do given that we don’t control the universe?

I am a great believer in luck, and I find the harder I work, the more I have of it.”
Attributed to Thomas Jefferson

My father worked as a chemist for fifty five years. His consistent performance earned him an enviable reputation for technical excellence and technical integrity. However, he never hit the big time, because none of his projects turned out to be gigantic winners. Research and Development is like that. For every ten good ideas that are tried out in the laboratory, one makes it to the prototype phase. For every ten prototypes, one makes it to production. For every ten products, one will hit the big time. Then, when he was in his early 60s, he was working on alternatives methods for bleaching paper pulp. Right when the Government was in the process of outlawing the chlorine bleaching agents used by paper industry, my father and his team was putting the finishing touches on hydrogen peroxide based alternatives. At age 64 his career took off like a rocket. For the next twelve years, he traveled all over the world teaching factory managers how to use these new products. During this time he won a number of prestigious international awards for his work in this field. He earned considerably more money than at any time in his life.

Was it luck? Yes. Was it skill? Yes.

We basically live in a cause and effect universe that has been corrupted by the fall. Certain types of behaviors greatly increase your chances for success. Consistently practicing these behaviors over long periods of time will begin chaining probability in your favor. Even if you find yourself reverting to the mean, you are at the mean of a much higher level group of individuals. Michael Jordan was born with talent. However, he also outworked his competition on a consistent basis. While Jordan’s work ethic in practice is well known, I am also willing to bet he spent a lot of time studying the competition. That’s what great athletes do in their spare time. Even though they understand that age will eventually cause them to revert to the means of their professions, they do not intend to go gentle into that good night.

Go thou and do likewise.

Money You Don't Need and the Wooley Swamp

January 2016 was a horrible month. The market lost over 5% of its value. December 2015 wasn’t all that great and now February is off to a bad start. This brings up the subject of how much of your money should be in the stock market and how much should be buried in Mason Jars down in the Wooley Swamp.

Always ask yourself the question, “When do I need this money?”

Maybe it would be better to start with the question, “Do I need this money?” That is the question to ask before applying for a loan. Do you really need that money so badly that you are willing to sell yourself into slavery to get it, or is there a better way? Sometimes debt is necessary, as in the case of medical expenses. Sometimes debt may be the best option, as in a first mortgage. Usually, even if there is a legitimate need for that money, such as education, there might be a better way. Grants, scholarships, work study programs, ROTC, or even a job for a time are all better options than a mountain of student debt.

When it comes to cars, clothes, cell phones, and the like—are you really ready to sell your soul to the man for the latest fashion statement?

There is money that you really might need in the short term future. That money is called the emergency fund. Dave Ramsey says 3 to 6 times your monthly budget in an insured savings account or money market fund. Most authors recommend six months take home salary or total monthly expenses in the emergency fund. After the last recession, Suzy Orman bumped that number to eight months. Take your pick, but if you have less than three months in your emergency fund, you need more money. Retirees who are spending more than they are receiving from pensions, Social Security, and annuities need to keep about one year’s worth of money in an insured readily available form. Anything that can come with a check book might be worth your consideration. Many of Vanguard’s funds come with a check writing option.

Depending on a lot of different variables, in time you will begin to consider money with a three to six year time horizon. What major expenses are likely to be out there waiting for you? If you have a seven year old car, it is pretty much a certainty it will need to be replaced before six more years have passed. Will you have cash in your hand when you show up at the dealership? If not you have some work to do. How about that fifteen year old central air conditioner unit that is making raspy noises? Do you have five grand in your back pocket? This kind of money could be held in insured brokerage CDs or Treasury notes that pay better interest than the banks can offer but can be bought or sold on the open market without penalty.

Of course you will have started your retirement savings program long before the time comes when you have money that you don’t need—today. Now we are talking about money that is right for investment. Your age and your tolerance for risk will define the nature of your portfolio. Your comfort level is important. If you can’t sleep at night, rebalance until you find peace. Full faith and credit Treasury Notes, Ginnie Maes, and the like are the safest option. Then investment grade commercial paper or intermediate term tax free municipal bond funds will give you a little better return with higher risk. I love dividend paying stocks with a track record. They are not perfectly safe, nothing is, but if you don’t need the money and you utilize DRIP reinvestment, you will be able to keep buying more shares when the price goes down and fewer shares when the price goes up. The same logic applies to low cost stock index funds. You need to consider all of these instruments as well as precious metals and even real estate. Move slowly. Be careful. If you don’t have too much money in any one asset and you don’t put too much money in the market at any one time, it is likely that you will be OK.

Finally, it is OK to go wild and crazy with a little bit of that money you don’t need. Here I am talking about foreign currency, gold mining stock, selling covered calls, or buying puts. A little jalapeño adds zest to the salsa, but only a little. On some of these plays you have a potentially limitless up side, but make certain your potential losses are well defined and understood.

Oh, I almost forgot about the Mason jar. Yes, it is wise to keep a little cash around the house. A hurricane may close the banks for a week. The man with the tow truck might demand cash or maybe you might just want to take your wife out to dinner without adding to the credit card balance.