I came across this article on yahoo finance, one of my most frequented sites. It provides a nice overview of red flags and what to look out for when perusing your financial planning options:
Protect Your Retirement From These Investment Scams
Pay close attention to the part about Variable and Equity Indexed products. I often find consumers don't even know what they have bought soon after they have signed the contract. Usually they think they have actually purchased a normal mutual fund, and are not aware of any early withdraw penalties and/or don't understand the fees and expenses of the product. So to be blunt, they know have have put their money into something whose return depends on the preformance of the stock markets, and nothing else.
Friday, December 21, 2007
Friday, October 19, 2007
Unknown Annuity Questions
To begin, let me apologize for my long absence from this blog. I have been very busy making money, and today took the day off of handling my own affairs to assist my mother with some retirement planning. Which brings me to the purpose of this post.
The truth is, when I woke up this morning I had no intention of posting to the blog, but much to my dismay, I found some interesting issues when working with my mother this morning.
My mother is currently retired, and like many other members of the work force has amassed a great number of miscellaneous retirement accounts from various jobs and time periods throughout her life. For the past several months, we have been inventorying these plans, and then making decisions about what to do with them. Usually it goes this way: We find a plan of hers or of my fathers, decide whether to cash it in or keep it, then, depending on what we did in the previous step, either grab the windfall and buy something nice, or decide what we will buy when we eventually do get our grubby hands on that cash! Just kidding, but I couldn’t resist the humor, sorry, back to business!
I should mention that this has all been complicated by my father's sudden death at what would have been the end of his working years, and yes that's right, mom wasn't totally up to date with what was around to feed everyone for the next several decades.
Anyway, two of these plans are annuities with very small values, about $10,000 and $20,000 each, but they still must be dealt with appropriately. As all my readers know, I am not a big or little fan of annuities, especially as a tool for long-term investment, but we must play the cards as they are dealt. So with the interest of saving fees and reducing expenses in mind, I directed my mother to call the annuity companies and find out what fees and cost are involved should we decide to roll these funds over. Upon calling, she discovered that it was going to cost her almost $2,000 to roll these deferred variable annuities over into a regular IRA with a different investment company. Upon hearing this predictable message, I decided to call myself. First, I made a list of questions, one of which was "do these fees apply if my mother makes her withdraw/rollover after reaching age 59 1/2?" The larger fund answered "no," but only after asking me a variety of questions (one of which was "what is your mother's birth date") and then telling me only that it would cost about $1,500 to roll that account over into an IRA "as of yesterday's prices." I only found out about the waiver of fees at age 59 1/2 because I asked specifically if there was one!
Taken alone this could be seen a mere oversite by the customer service representative I spoke with on the phone, but I had the exact same experience when I called about the smaller plan that is with a different company. (Side note: She hasn't been in this plan for very long, so she must still wait 2 more years to avoid any fees, but again, they did not volunteer this information). I only learned she would not incurr any withdraw fees after reaching age 59 1/2 (and having 5 years in the plan) after asking that exact question. Both companies seemed content to let me make the rollover/withdraw and incurr the fees, even though my mother reaches age 59 1/2 in 6 weeks! So all I need to know now are the questions that I don't know to ask!
Monday, August 20, 2007
The Party Animal Saver
I recently got a call from an old friend of mine. We grew up in the same small farming town, attended the same secondary schools, and had the same friends growing up in that small town. Most, if not all of, the kids we had fun and games with still live in that same town. They never got out, and probably never wanted to.
My friend Steve and I both did. He joined the army and I went right to college. Steve saw the world and I learned about finance. We stayed in touch the entire time, and when his tour was finished he went to college on the GI Bill. It covered most of his expenses, and what it didn't cover he earned, working the midnight shift driving the campus bus. Steve initially studied English Literature, but in the eleventh hour switched his major to Engineering.
Steve's grandfather had been a coal miner in Pennsylvania. Talking to Steve, you can get a glimpse of that hardworking, solitary, risk-taking whim so often seen in men and women who put their lives at risk for the hope of a better future. I think it was that same impulse that drove him into the military, and ultimately, by the time he finished his tour of duty, to being the longest serving soldier on the DMZ between North and South Korea. He is an extremely intelligent, loyal, and hard working individual.
He also loves to party all night. He is completely disorganized: forgets to pay his bills, loses his wallet and keys constantly, spends every dime he brings home well before its time, and spills his coffee all over whatever electronic gadget he happens to have on his desk.
The occasion of his recent call was to tell me he had just been given the opportunity to move to Columbia to open the new South American branch of his engineering firm. He's been working at the firm since he graduated from college about 8 years ago, starting out as a grunt and steadily promoted to managing the Philadelphia office of his firm.
When he did start at the firm all those years ago, he had a conversation with an old army buddy who had attended the University of Virginia after completing his tour, and now worked on Wall Street. Steve's friend told him "Look Steve, you're basically an animal, and anything you bring home you are going to immediately devour. Do yourself a favor: max out whatever retirement plan options you have through your employer, and send $200 a paycheck to an account at ING Direct (who at the time was paying the highest yield). You won't miss it if you do it right from the start, and you won't know what you spent your take home pay on anyway." Steve's army buddy went through the process of helping him set up these two accounts, and since that day it has been on autopilot.
Steve hasn't withdrawn anything from his ING Direct account since he opened it, and I don't think he even looks at his 401k statements. To him, it's all money in the bank that he won't need for a long time, but when that time comes he should have plenty of it. I think when he started working the 401k max was $12,000, assuming he never raised it and a 9% rate of return, he probably has about $145,000 in his retirement account. Assuming an average rate of 4% on his savings account, at $200 a pay and 24 pays a year, he likely has about $40,000 in the account. Not bad for a guy who spends every dime he brings in the door! Even more impressive, at this rate, in another 8 years, he'll have about $430,000 in his retirement account and $108,000 in his savings account. Talk about a reason to party!
Steve is a good example of someone who is using the modern tools for wealth building that are available to everyone. These are tools that barely existed for the baby boomer generation, and did not exist for their parents. Unfortunately, too many people in our generation, the generation who will soon be the powerhouse of our economy, are uninformed and underutilizing these tools. As a result, they will be working long after the 'Steves' and 'me's' of the world have left working for new fun and games. Only this time it won’t be a small country-farming town, it’ll be on a South American beach!
My friend Steve and I both did. He joined the army and I went right to college. Steve saw the world and I learned about finance. We stayed in touch the entire time, and when his tour was finished he went to college on the GI Bill. It covered most of his expenses, and what it didn't cover he earned, working the midnight shift driving the campus bus. Steve initially studied English Literature, but in the eleventh hour switched his major to Engineering.
Steve's grandfather had been a coal miner in Pennsylvania. Talking to Steve, you can get a glimpse of that hardworking, solitary, risk-taking whim so often seen in men and women who put their lives at risk for the hope of a better future. I think it was that same impulse that drove him into the military, and ultimately, by the time he finished his tour of duty, to being the longest serving soldier on the DMZ between North and South Korea. He is an extremely intelligent, loyal, and hard working individual.
He also loves to party all night. He is completely disorganized: forgets to pay his bills, loses his wallet and keys constantly, spends every dime he brings home well before its time, and spills his coffee all over whatever electronic gadget he happens to have on his desk.
The occasion of his recent call was to tell me he had just been given the opportunity to move to Columbia to open the new South American branch of his engineering firm. He's been working at the firm since he graduated from college about 8 years ago, starting out as a grunt and steadily promoted to managing the Philadelphia office of his firm.
When he did start at the firm all those years ago, he had a conversation with an old army buddy who had attended the University of Virginia after completing his tour, and now worked on Wall Street. Steve's friend told him "Look Steve, you're basically an animal, and anything you bring home you are going to immediately devour. Do yourself a favor: max out whatever retirement plan options you have through your employer, and send $200 a paycheck to an account at ING Direct (who at the time was paying the highest yield). You won't miss it if you do it right from the start, and you won't know what you spent your take home pay on anyway." Steve's army buddy went through the process of helping him set up these two accounts, and since that day it has been on autopilot.
Steve hasn't withdrawn anything from his ING Direct account since he opened it, and I don't think he even looks at his 401k statements. To him, it's all money in the bank that he won't need for a long time, but when that time comes he should have plenty of it. I think when he started working the 401k max was $12,000, assuming he never raised it and a 9% rate of return, he probably has about $145,000 in his retirement account. Assuming an average rate of 4% on his savings account, at $200 a pay and 24 pays a year, he likely has about $40,000 in the account. Not bad for a guy who spends every dime he brings in the door! Even more impressive, at this rate, in another 8 years, he'll have about $430,000 in his retirement account and $108,000 in his savings account. Talk about a reason to party!
Steve is a good example of someone who is using the modern tools for wealth building that are available to everyone. These are tools that barely existed for the baby boomer generation, and did not exist for their parents. Unfortunately, too many people in our generation, the generation who will soon be the powerhouse of our economy, are uninformed and underutilizing these tools. As a result, they will be working long after the 'Steves' and 'me's' of the world have left working for new fun and games. Only this time it won’t be a small country-farming town, it’ll be on a South American beach!
Sunday, August 19, 2007
The Roth IRA
The Roth Individual Retirement Account was created by an act of Congress. The Roth allows for post tax contributions that can be invested in a number of ways, the most common being mutual funds and stocks. Almost any financial institution provides Roth IRA accounts. Banks, brokerage houses, and insurance companies offer certificates of deposits, money markets accounts, mutual funds, and stocks. Considering the long term outlook of most Roth Investors (the funds cannot be accessed tax free until age 59.5), it probably doesn't make much sense for Roth account holders to invest their dollars into anything other than stocks and mutual funds that have a reasonable amount of risk and reward potential.
Contributions to a Roth are made post-tax, therefore, unlike a Regular IRA, contributions to a Roth are not deductible on your tax return. The advantage is that withdraws from a Roth, so long as they qualified, are completely tax-free. Qualified withdraws include those made after age 59.5, up to $10,000 for the purchase your first house, or if you become disabled. A Roth IRA effectively allows you to prepay a future tax liability at a tremendous discount. This is true for two reasons:
First, taxes in the future will very likely be higher than they are now. As the population ages, and there is a smaller percentage of people in the workforce, but a greater demand made on the government for services to support the aging, taxes will need to be increased to pay for this increased demand and lowered supply. Think of the welfare states of Western Europe. Their taxes are a much higher percentage of income. They offer more services, like free health care for all, have greater unemployment, and have a larger percentage of elderly and retired citizens.
Second, the money you invest now in a Roth IRA will grow and you will experience compound returns, so if you're 30 years old and make a $5,000 contribution in 2008 that you have already paid taxes on, when you withdraw that money at age 60, that same $5,000 is now worth $66,338 (30 years at average 9% return per year). Further, even at a 25% tax rate (and believe me the tax rates in 30 years will be higher, not the same and definitely not lower than they are now) that $66,338 is effective worth the same amount as earned taxable income of $88,459. But you paid taxes on $5,000! And at a lower rate!
Beginning in 2008, Congress has allowed contributions of up to $5,000 for taxpayer’s age 49 and younger, and $6,000 for taxpayers age 50 and older. After 2008, contribution limits will be indexed with inflation and raised at $500 intervals. There was a lot of talk for years in the financial services industry that the Roth was too good to be true, and that Congress would eventually be forced to close this opportunity to taxpayers. That has not happened yet, but most Americans do not take advantage of this powerful tool. As both the Roth IRA and the Roth 401k gain in popularity and the pool of taxable income continues to shrink, it's anybodies guess what the future holds.
Contributions to a Roth are made post-tax, therefore, unlike a Regular IRA, contributions to a Roth are not deductible on your tax return. The advantage is that withdraws from a Roth, so long as they qualified, are completely tax-free. Qualified withdraws include those made after age 59.5, up to $10,000 for the purchase your first house, or if you become disabled. A Roth IRA effectively allows you to prepay a future tax liability at a tremendous discount. This is true for two reasons:
First, taxes in the future will very likely be higher than they are now. As the population ages, and there is a smaller percentage of people in the workforce, but a greater demand made on the government for services to support the aging, taxes will need to be increased to pay for this increased demand and lowered supply. Think of the welfare states of Western Europe. Their taxes are a much higher percentage of income. They offer more services, like free health care for all, have greater unemployment, and have a larger percentage of elderly and retired citizens.
Second, the money you invest now in a Roth IRA will grow and you will experience compound returns, so if you're 30 years old and make a $5,000 contribution in 2008 that you have already paid taxes on, when you withdraw that money at age 60, that same $5,000 is now worth $66,338 (30 years at average 9% return per year). Further, even at a 25% tax rate (and believe me the tax rates in 30 years will be higher, not the same and definitely not lower than they are now) that $66,338 is effective worth the same amount as earned taxable income of $88,459. But you paid taxes on $5,000! And at a lower rate!
Beginning in 2008, Congress has allowed contributions of up to $5,000 for taxpayer’s age 49 and younger, and $6,000 for taxpayers age 50 and older. After 2008, contribution limits will be indexed with inflation and raised at $500 intervals. There was a lot of talk for years in the financial services industry that the Roth was too good to be true, and that Congress would eventually be forced to close this opportunity to taxpayers. That has not happened yet, but most Americans do not take advantage of this powerful tool. As both the Roth IRA and the Roth 401k gain in popularity and the pool of taxable income continues to shrink, it's anybodies guess what the future holds.
Tuesday, August 14, 2007
These are the Times
I don't like to provide commentary on current market conditions. We all know the aggregate success of stock markets over long periods of time, and that is what I am most concerned about since my time horizon is in excess of ten years. Apart from a few months in 2002 when I believed oriental rugs where a better investment then equities, I have always had and continue to have a great amount of faith in the ability of equity markets to provide positive returns.
I am using this current opportunity to sell shares of Duke Energy and their spin off Spectra Energy. I will invest the proceeds in the Dodge and Cox Stock fund, whose price has been effected to a greater degree by the current market meltdown than the two previously mentioned companies. I have been divesting my portfolio of individual stocks for the past year, and am moving toward a portfolio of almost exclusively index funds.
Although I am relieved that the credit exuberances of recent times have finally caught up with the markets, it is always a disappointment to see your net worth travel south without seeing a new sport car in your driveway. When weeks or months like this do occur, I tend to hunker down, sort of get in front of the TV with potatoes chips and wait it out. I don’t like to make changes, and just stick to the plans I made in happier times. I also think markets like these help produce greater returns down the road, after the sharp contraction, the rapid expansion, but I don’t bet on these theories and don't suggest anyone else does either. It just gives me something to dream about during the dark nights.
A theory I am interested in learning more about is the "sell in May and go away." That is, the divesting of equities in very early summer, and the repurchase of them after Labor Day. I am not an advocator of market timing, and don’t think that if it can be done I am the one to do it, but I would like to hear any comments about this strategy anyone may have.
I am using this current opportunity to sell shares of Duke Energy and their spin off Spectra Energy. I will invest the proceeds in the Dodge and Cox Stock fund, whose price has been effected to a greater degree by the current market meltdown than the two previously mentioned companies. I have been divesting my portfolio of individual stocks for the past year, and am moving toward a portfolio of almost exclusively index funds.
Although I am relieved that the credit exuberances of recent times have finally caught up with the markets, it is always a disappointment to see your net worth travel south without seeing a new sport car in your driveway. When weeks or months like this do occur, I tend to hunker down, sort of get in front of the TV with potatoes chips and wait it out. I don’t like to make changes, and just stick to the plans I made in happier times. I also think markets like these help produce greater returns down the road, after the sharp contraction, the rapid expansion, but I don’t bet on these theories and don't suggest anyone else does either. It just gives me something to dream about during the dark nights.
A theory I am interested in learning more about is the "sell in May and go away." That is, the divesting of equities in very early summer, and the repurchase of them after Labor Day. I am not an advocator of market timing, and don’t think that if it can be done I am the one to do it, but I would like to hear any comments about this strategy anyone may have.
Sunday, August 12, 2007
Spreading Wealth Like a Virus
Researchers have proved that weight gain is actually contagious, and spreads from friends and family members to unsuspecting friends and family members. The study, which took place over thirty years, found the strongest correlation between the weight gain of friends. In fact, the study found that if a close friend gains weight, it actually increases our chances of gaining weight by 171%. Therefore, the study concluded, obesity can spread like a virus, from person to person, close friend to close friend.
This immediately brought into my mind the following question: if obesity can spread from person to person, does that mean that wealth can spread from person to person? Can wealth spread like a virus? Can the habits of wealthy friends rub off on less wealthy friends? Can the Rich teach the Not Rich how to build wealth?
I then examined what I will call my core group of close friends, that is, friends whom I have remained close with and in very regular contact with (meeting with socially at least once a week) for 5 years or longer. What I found was that we all have very similar balance sheets: we all happen to have a little more financial success than average, and enjoy approximately the same standard of living. (As a side not, I’d estimate that each of the two sexes fall within a 20-pound weight range at most.)
So this raises the question: If I were to make wealthier friends, would I become wealthier? Would I learn habits and about options that would lead me to greater wealth? I suspect the answer is yes. Does this mean that I am going to go out tomorrow and make all new friends and drop all of my good old friends? Of course not, but I do have friends whom I don't see as regularly, that for whatever reason I have not brought into my core group of close friends, that are much more successful than me and whom I could benefit from knowing. They may even teach me some things that could make me richer.
It turns out my father was right, "be careful who you choose as friends, you will become what they are." It just never occurred to me to use this as an advantage.
This immediately brought into my mind the following question: if obesity can spread from person to person, does that mean that wealth can spread from person to person? Can wealth spread like a virus? Can the habits of wealthy friends rub off on less wealthy friends? Can the Rich teach the Not Rich how to build wealth?
I then examined what I will call my core group of close friends, that is, friends whom I have remained close with and in very regular contact with (meeting with socially at least once a week) for 5 years or longer. What I found was that we all have very similar balance sheets: we all happen to have a little more financial success than average, and enjoy approximately the same standard of living. (As a side not, I’d estimate that each of the two sexes fall within a 20-pound weight range at most.)
So this raises the question: If I were to make wealthier friends, would I become wealthier? Would I learn habits and about options that would lead me to greater wealth? I suspect the answer is yes. Does this mean that I am going to go out tomorrow and make all new friends and drop all of my good old friends? Of course not, but I do have friends whom I don't see as regularly, that for whatever reason I have not brought into my core group of close friends, that are much more successful than me and whom I could benefit from knowing. They may even teach me some things that could make me richer.
It turns out my father was right, "be careful who you choose as friends, you will become what they are." It just never occurred to me to use this as an advantage.
Sunday, July 22, 2007
Average Earner to be Rich
I recently read a post on one of my favorite blogs, Watch Your Wallet, and would like to respond. In the post, To Get Rich...Do Nothing?, Watch Your Wallet theorizes that most of us spend too much time thinking about what to do with the meager extra income we can allocate to investments and penny pinching, and far too little time thinking about how we can earn more money in our career and/or business. Watch Your Wallet says we would be better served, and therefore wealthier, to focus more on increasing our earning potential, and focus less on deciding what to do with our little pennies.
While I do agree we spend a great amount of time thinking about our pennies, I do not think it is too much time. It is impossible to be over-educated about any subject that you find interesting or beneficial. Is there a law of diminishing returns with knowledge of investment options? Yes, absolutely, but that seemingly unimportant fact you come across Friday morning on Yahoo Finance may link in a beneficial way to something you will learn in the future.
I'll use my favorite example: my friends and myself! This past week, I was in Maine with a group of friends, all young professionals, and all certainly successful in their chosen fields. It was a terrific trip: ocean front cottage, boats, beer, wine, and lobster. One member of our party was an advertising executive for a major U.S. newspaper. His father also happens to be a very senior executive of the very same publication. I would estimate that he earns probably twice or more of what I earn. He has regularly contributed to a 401k since graduating from college over ten years ago, has a financial planner who manages all of his investments, and received an inheritance a few years ago which he had the foresight not to spend on a new car or three.
He leaves all financial decisions in regards to investments to his financial planner, but I'm sure my friend has no idea of what he is paying the financial planner. He does not know the dollar limits on 401k investing, which leads me to believe that he has not increased his contribution amount for at least several years. He has also left his inheritance in the bank since he received it over five years ago (lucky for him it's in Euro's). Despite this negligence, he is quite successful and wealthier than the great majority of his peers, due primarily to his wages as an advertising executive.
Here's the rub: he has worked for more years than me (we are the same age, but I did an extra year of undergraduate, and two years of graduate school), has been given the great advantage of wealthy parents, is connected to a lucrative career, and has made good financial decisions, but I believe our net worth’s are very close. Mine may even be greater.
How is this possible? I have done all of the things you are supposed to do like avoiding debt, keeping my expenses low, regular savings, and pinching pennies like someone out of the great depression. I have also routinely invested in low cost mutual funds without the benefit of an advisor, even (especially) in down markets. For example, I purchased international mutual fund investments when they where returning losses every year. I made what was considered a risky real estate purchase when I was told real estate was dead, and I have done all this without paying an advisor what seems like a small percentage or fee each year.
The basic premise of what I did and continue to do is collect what I believe are valuable assets. This allows me to ride the waves that pass over us every few years. The first wave I caught was real estate, the second was the international equity markets, and currently it's the broader based U.S. markets, which are experiencing a very strong bull market. Do these waves influence my investing decisions? NO! Absolutely not. I cannot control them. I can only control what my dollars purchase: ASSETS!
Is it important to focus on earning more from your work or business? Absolutely. If I had been earning twice as much for these past years I would probably have four times as many assets. Can you achieve wealth on average earnings? Without a doubt, in modern day America, with a solid understanding of finance, YES! It is my belief that the boom of the mutual fund industry and personal finance has finally done what our forefathers claimed to have done, which is to democratize the ability to build wealth.
While I do agree we spend a great amount of time thinking about our pennies, I do not think it is too much time. It is impossible to be over-educated about any subject that you find interesting or beneficial. Is there a law of diminishing returns with knowledge of investment options? Yes, absolutely, but that seemingly unimportant fact you come across Friday morning on Yahoo Finance may link in a beneficial way to something you will learn in the future.
I'll use my favorite example: my friends and myself! This past week, I was in Maine with a group of friends, all young professionals, and all certainly successful in their chosen fields. It was a terrific trip: ocean front cottage, boats, beer, wine, and lobster. One member of our party was an advertising executive for a major U.S. newspaper. His father also happens to be a very senior executive of the very same publication. I would estimate that he earns probably twice or more of what I earn. He has regularly contributed to a 401k since graduating from college over ten years ago, has a financial planner who manages all of his investments, and received an inheritance a few years ago which he had the foresight not to spend on a new car or three.
He leaves all financial decisions in regards to investments to his financial planner, but I'm sure my friend has no idea of what he is paying the financial planner. He does not know the dollar limits on 401k investing, which leads me to believe that he has not increased his contribution amount for at least several years. He has also left his inheritance in the bank since he received it over five years ago (lucky for him it's in Euro's). Despite this negligence, he is quite successful and wealthier than the great majority of his peers, due primarily to his wages as an advertising executive.
Here's the rub: he has worked for more years than me (we are the same age, but I did an extra year of undergraduate, and two years of graduate school), has been given the great advantage of wealthy parents, is connected to a lucrative career, and has made good financial decisions, but I believe our net worth’s are very close. Mine may even be greater.
How is this possible? I have done all of the things you are supposed to do like avoiding debt, keeping my expenses low, regular savings, and pinching pennies like someone out of the great depression. I have also routinely invested in low cost mutual funds without the benefit of an advisor, even (especially) in down markets. For example, I purchased international mutual fund investments when they where returning losses every year. I made what was considered a risky real estate purchase when I was told real estate was dead, and I have done all this without paying an advisor what seems like a small percentage or fee each year.
The basic premise of what I did and continue to do is collect what I believe are valuable assets. This allows me to ride the waves that pass over us every few years. The first wave I caught was real estate, the second was the international equity markets, and currently it's the broader based U.S. markets, which are experiencing a very strong bull market. Do these waves influence my investing decisions? NO! Absolutely not. I cannot control them. I can only control what my dollars purchase: ASSETS!
Is it important to focus on earning more from your work or business? Absolutely. If I had been earning twice as much for these past years I would probably have four times as many assets. Can you achieve wealth on average earnings? Without a doubt, in modern day America, with a solid understanding of finance, YES! It is my belief that the boom of the mutual fund industry and personal finance has finally done what our forefathers claimed to have done, which is to democratize the ability to build wealth.
Tuesday, July 10, 2007
Not Special Like the Rich
You're special!, or so you've been told for your entire life. You're so special that people always give you things and ask for nothing in return. No matter where you go - your parents house, your college, your employer, your wife, or your husband - they all give and give and give, and don't ask for a thing in return! Great!
This subject was broached recently by an article in the Wall Street Journal. Its discussion circled around good old Mr. Rogers, and his favorite saying, which of course, was, you guessed it, "you're special." The author further discussed research that indicates a growing level of selfishness and sense of entitlement in younger generations. He says that this increased sense of entitlement is in large part due to the child centered culture that has evolved over the past several decades. It's no longer important what mommy and daddy did today, but "how was school today?," and "what did you do/learn?"
It occurred to me that perhaps this new sense of entitlement, this sense of being special, has lead an entire generation to believe that they don't need to save for their futures. They think that someone else will take care of it for them, because, after all, don't they deserve that? Many young adults that I know have parents that are not wealthy, but have retired, live in nice homes, have nice cars, and take nice vacations and trips, and when the kids come, even though they're 32, the parents foot the bill for everything. When these "kids" get in trouble and can't pay their rent or insurance, guess who comes to the rescue? I think most of the parents actually prefer the relationship to continue this way, after all, they can remain an important part of their child's life, it is clear co-dependency.
But these parents are not doing their children any favors by solving every problem, and allowing them to sit back and wait for their inheritance. Most will not even get an inheritance that can sustain them after it has sustained mommy, daddy, and the dead beat son or daughter for so long. What most will receive is an amount that is not near enough to provide for an adequate retirement, and they won't be prepared to manage even that much.
Children need to start learning about money, whether they are 13 or 35, it is never too early and never to late, but now is the time to start. Mommy and Daddy, you are special, you have accomplished, earned, and saved and proved how special you are. Children, if you want to be special, you will need to prove it through your own accomplishments.
Most of the rich could not have become so if they believed that someone or something would make them rich, that all they had to do was relax, sit back, maintain status quo, and wait. To the contrary, the had to work to earn, save what was required, and make those savings earn.
I have an uncle who is a retired oil executive. He earns about $200,000 a year in investment income. He worked for the same company for 40 years. He has a small home in the city where he spent his working life, and an even smaller house at the beach. He has 4 adult children, the oldest in his 40's. None would qualify for a description of independent. But that's not the rub. The rub is that none are interested in becoming independent. They all have jobs, but none of them have jobs that can support the type of lifestyle that they want, so they all regularly receive money from him that they use to pay for their living expenses. I think this makes him feel rich and generous, powerful and useful.
But he is not teaching any of them what he understood so well, and what made him so successful. Which is, to amass wealth, you must live below your means, otherwise you will never save and will never take the basic first step to building your own fortune. How long do you think his children's inheritance will last when its manager is no longer with us?
This subject was broached recently by an article in the Wall Street Journal. Its discussion circled around good old Mr. Rogers, and his favorite saying, which of course, was, you guessed it, "you're special." The author further discussed research that indicates a growing level of selfishness and sense of entitlement in younger generations. He says that this increased sense of entitlement is in large part due to the child centered culture that has evolved over the past several decades. It's no longer important what mommy and daddy did today, but "how was school today?," and "what did you do/learn?"
It occurred to me that perhaps this new sense of entitlement, this sense of being special, has lead an entire generation to believe that they don't need to save for their futures. They think that someone else will take care of it for them, because, after all, don't they deserve that? Many young adults that I know have parents that are not wealthy, but have retired, live in nice homes, have nice cars, and take nice vacations and trips, and when the kids come, even though they're 32, the parents foot the bill for everything. When these "kids" get in trouble and can't pay their rent or insurance, guess who comes to the rescue? I think most of the parents actually prefer the relationship to continue this way, after all, they can remain an important part of their child's life, it is clear co-dependency.
But these parents are not doing their children any favors by solving every problem, and allowing them to sit back and wait for their inheritance. Most will not even get an inheritance that can sustain them after it has sustained mommy, daddy, and the dead beat son or daughter for so long. What most will receive is an amount that is not near enough to provide for an adequate retirement, and they won't be prepared to manage even that much.
Children need to start learning about money, whether they are 13 or 35, it is never too early and never to late, but now is the time to start. Mommy and Daddy, you are special, you have accomplished, earned, and saved and proved how special you are. Children, if you want to be special, you will need to prove it through your own accomplishments.
Most of the rich could not have become so if they believed that someone or something would make them rich, that all they had to do was relax, sit back, maintain status quo, and wait. To the contrary, the had to work to earn, save what was required, and make those savings earn.
I have an uncle who is a retired oil executive. He earns about $200,000 a year in investment income. He worked for the same company for 40 years. He has a small home in the city where he spent his working life, and an even smaller house at the beach. He has 4 adult children, the oldest in his 40's. None would qualify for a description of independent. But that's not the rub. The rub is that none are interested in becoming independent. They all have jobs, but none of them have jobs that can support the type of lifestyle that they want, so they all regularly receive money from him that they use to pay for their living expenses. I think this makes him feel rich and generous, powerful and useful.
But he is not teaching any of them what he understood so well, and what made him so successful. Which is, to amass wealth, you must live below your means, otherwise you will never save and will never take the basic first step to building your own fortune. How long do you think his children's inheritance will last when its manager is no longer with us?
Sunday, July 8, 2007
To be Young and Rich
An acquaintance of mine recently contacted me with a small problem he is having: a five year old daughter with an $80k inheritance. He's had the money in the bank for two years, and didn't know what to do with it. He asked if I had any suggestions. Here's what I sent him:
Richard,
If I were 5 or 6 and had 80k to invest, this is what I would advise my parents to do:
Split the money 4 - 7 ways and invest it in a portfolio of mutual funds. I would strongly suggest using index funds because their fees are by far the lowest, they are based on preexisting indexes (not a "smart" investor), and she can leave the funds invested as-is indefinitely and not concern herself with market trends. Lets face it, when you're 5 you don't want to worry about market trends or what your fund managers are doing. Remember, index funds have performed better over time than about 80% of funds that attempt to beat their performance, so they are a prime choice for long term investing in the stock market.
Also important to consider, 5 year olds have a lot of time for compounded returns to accrue, so don't be risk adverse. The market conservatively returns 9% over long periods of time, at that rate, with no other investments, she'd be worth 1.6 million at age 40, mid life crisis hello!
I like Fidelity. They have low cost index funds that are I believe high quality. Vangaurd and TRoweprice are two other low cost providers of index funds, but I just happen to prefer Fidelity.
Here are the funds I would choose (these are all Fidelity funds):
Spartan Total Market Index Fund (these are large cap stocks)
Fidelity Large Cap Value Fund (not an index fund)
Spartan Extended Market Index Fund (these are mid cap stocks)
Spartan International Index Fund
Fidelity Balanced Fund (hybrid stock/bond fund - not an index fund)
Fidelity Nasdaq Composite Index Fund
If you end up talking to a Financial Advisor, keep in mind that most work on commission, so use a jaundiced eye!
After he read my email he said,"but what if the whole market goes sour," to which I replied, "well, than you lose value, that is the risk, but she has a quite a long time to make up for any short term losses." But what I thought was: "The same thing that will happen if you don't take any action - you lose."
He asked what I would do and I told him, but what I won't do is tell him I think he is making a mistake by not following some similar course of action, and leaving a small fortune of future earnings on the table. Maybe not young and rich after all!
Richard,
If I were 5 or 6 and had 80k to invest, this is what I would advise my parents to do:
Split the money 4 - 7 ways and invest it in a portfolio of mutual funds. I would strongly suggest using index funds because their fees are by far the lowest, they are based on preexisting indexes (not a "smart" investor), and she can leave the funds invested as-is indefinitely and not concern herself with market trends. Lets face it, when you're 5 you don't want to worry about market trends or what your fund managers are doing. Remember, index funds have performed better over time than about 80% of funds that attempt to beat their performance, so they are a prime choice for long term investing in the stock market.
Also important to consider, 5 year olds have a lot of time for compounded returns to accrue, so don't be risk adverse. The market conservatively returns 9% over long periods of time, at that rate, with no other investments, she'd be worth 1.6 million at age 40, mid life crisis hello!
I like Fidelity. They have low cost index funds that are I believe high quality. Vangaurd and TRoweprice are two other low cost providers of index funds, but I just happen to prefer Fidelity.
Here are the funds I would choose (these are all Fidelity funds):
Spartan Total Market Index Fund (these are large cap stocks)
Fidelity Large Cap Value Fund (not an index fund)
Spartan Extended Market Index Fund (these are mid cap stocks)
Spartan International Index Fund
Fidelity Balanced Fund (hybrid stock/bond fund - not an index fund)
Fidelity Nasdaq Composite Index Fund
If you end up talking to a Financial Advisor, keep in mind that most work on commission, so use a jaundiced eye!
After he read my email he said,"but what if the whole market goes sour," to which I replied, "well, than you lose value, that is the risk, but she has a quite a long time to make up for any short term losses." But what I thought was: "The same thing that will happen if you don't take any action - you lose."
He asked what I would do and I told him, but what I won't do is tell him I think he is making a mistake by not following some similar course of action, and leaving a small fortune of future earnings on the table. Maybe not young and rich after all!
Annuity Puzzle
I don't like to invest in anything I don't understand. I think the greatest investor of our time, Warren Buffett, has expressed similar sentiments from time to time as well. So if a brilliant investor like Warren Buffett won't put his money where his brain can't get to, why should you or I?
What I'm talking about are annuities; variable, fixed, deferred, immediate, purple, and pink. There are so many different types of annuities all packaged differently from different insurance companies and sold under different names, it is very difficult to understand which would be most appropriate, if any, for your portfolio. This confusion leads investors (the purchases of these products) to ultimate confusion and into the arms of a perhaps untrustworthy "Investment Advisor" aka insurance salesman.
Many "Investment Advisors" will direct their clients (prey) into these products with promises of tax deferral heaven, compound returns, and the big S - safety. I'll do my best to rebut all of these benefits here, but please keep in mind that this is merely the tip of the annuity iceberg, and that each annuity contract (yes ladies and gentlemen, an annuity is a contract, and if you break its terms, guess what, you bought it, and it will cost you substantial fees) is very different and needs to analyzed on its own merits.
Tax deferral heaven. Annuities allow purchases to defer taxes on earnings and interest until the money is taken out of the annuity. These tax savings are therefore allowed to continue to compound over time, and increase overall earnings. But here's the rub, those deferred taxes, when paid, are paid out as income taxes, rather than the much lower capital gains rate your earnings would be subject to if, for example, you had simply invested at retail (sent the fund company a check directly) in an index based mutual fund. In addition, most experts agree that taxes will be higher in the future than they are today, so you will be paying at an even higher rate. As an aside, this belief that taxes will be higher in the future is what makes the Roth IRA such a powerful tool.
Compound returns. Yes its true that your annuity money will earn on its earnings over time, and you will experience compound returns, however, those compound earnings will in no way compare to the compound earnings you could have earned historically in the United State stock markets, and again if historical results are any guide (who else can guide us?), you will end up with considerably less money than if you had simply invested in that previously mentioned S&P 500 Index fund.
The big S - safety. For example, most deferred annuities will guarantee at least a very low rate of return, like 3%. They will also very often guarantee that your annuity contract will be worth at least the amount originally invested when you begin to take disbursements many years later. They will also charge you a tremendous amount for these insurances. There is often a 1-2% (of the total value of your annuity) charge for guaranteeing survivor benefits, a .1-.3% charge to guarantee a stated growth rate for death benefits, fees for waiver of withdrawal charges (a fee to waive a fee! What a terrific idea!), and a fee for something known as 'total protection.' If you feel confused, you're not alone. The important truth here is all of these fees work to reduce your earnings, and therefore the amount that is available to compound. Are you really safer with less money? Too little risk is very dangerous!
Annuities are insurance products. Your money is usually invested in the same types of instruments that you could invest in yourself, again like that S&P 500 Index fund, only there are at least two more sets of hands in the money pot: the insurance salesman aka "Investment Advisor" (who is often an independent broker who works on commission), and the insurance company. They both need to get paid for their services, and they both get paid from your money. With so many hands in the pot, someone will be left short, and it won't be the mutual fund managers who get a fixed percentage of the monies they manage, it won't be the salesman who gets a fixed commission for selling you the annuity, and it won't be the insurance company who gets paid by insuring your money against all future catastrophe, it will be you!
Annuities are appropriate for some portfolios at some times, but they are a highly commissioned financial product, and are largely oversold for this reason. Please remember that a financial advisor has a great deal of interest and incentive in persuading you to purchase one of these products. If you are considering an annuity of any kind, make sure you understand all of the fine print, even if your financial advisor does not.
What I'm talking about are annuities; variable, fixed, deferred, immediate, purple, and pink. There are so many different types of annuities all packaged differently from different insurance companies and sold under different names, it is very difficult to understand which would be most appropriate, if any, for your portfolio. This confusion leads investors (the purchases of these products) to ultimate confusion and into the arms of a perhaps untrustworthy "Investment Advisor" aka insurance salesman.
Many "Investment Advisors" will direct their clients (prey) into these products with promises of tax deferral heaven, compound returns, and the big S - safety. I'll do my best to rebut all of these benefits here, but please keep in mind that this is merely the tip of the annuity iceberg, and that each annuity contract (yes ladies and gentlemen, an annuity is a contract, and if you break its terms, guess what, you bought it, and it will cost you substantial fees) is very different and needs to analyzed on its own merits.
Tax deferral heaven. Annuities allow purchases to defer taxes on earnings and interest until the money is taken out of the annuity. These tax savings are therefore allowed to continue to compound over time, and increase overall earnings. But here's the rub, those deferred taxes, when paid, are paid out as income taxes, rather than the much lower capital gains rate your earnings would be subject to if, for example, you had simply invested at retail (sent the fund company a check directly) in an index based mutual fund. In addition, most experts agree that taxes will be higher in the future than they are today, so you will be paying at an even higher rate. As an aside, this belief that taxes will be higher in the future is what makes the Roth IRA such a powerful tool.
Compound returns. Yes its true that your annuity money will earn on its earnings over time, and you will experience compound returns, however, those compound earnings will in no way compare to the compound earnings you could have earned historically in the United State stock markets, and again if historical results are any guide (who else can guide us?), you will end up with considerably less money than if you had simply invested in that previously mentioned S&P 500 Index fund.
The big S - safety. For example, most deferred annuities will guarantee at least a very low rate of return, like 3%. They will also very often guarantee that your annuity contract will be worth at least the amount originally invested when you begin to take disbursements many years later. They will also charge you a tremendous amount for these insurances. There is often a 1-2% (of the total value of your annuity) charge for guaranteeing survivor benefits, a .1-.3% charge to guarantee a stated growth rate for death benefits, fees for waiver of withdrawal charges (a fee to waive a fee! What a terrific idea!), and a fee for something known as 'total protection.' If you feel confused, you're not alone. The important truth here is all of these fees work to reduce your earnings, and therefore the amount that is available to compound. Are you really safer with less money? Too little risk is very dangerous!
Annuities are insurance products. Your money is usually invested in the same types of instruments that you could invest in yourself, again like that S&P 500 Index fund, only there are at least two more sets of hands in the money pot: the insurance salesman aka "Investment Advisor" (who is often an independent broker who works on commission), and the insurance company. They both need to get paid for their services, and they both get paid from your money. With so many hands in the pot, someone will be left short, and it won't be the mutual fund managers who get a fixed percentage of the monies they manage, it won't be the salesman who gets a fixed commission for selling you the annuity, and it won't be the insurance company who gets paid by insuring your money against all future catastrophe, it will be you!
Annuities are appropriate for some portfolios at some times, but they are a highly commissioned financial product, and are largely oversold for this reason. Please remember that a financial advisor has a great deal of interest and incentive in persuading you to purchase one of these products. If you are considering an annuity of any kind, make sure you understand all of the fine print, even if your financial advisor does not.
Friday, July 6, 2007
Watch Those Fees
I'm a CPA and worked for several years at Ernst and Young, a big 4 accounting firm. When I was working there, I spent many days and weeks working on prospectuses, which are the shareholder reports that are the ultimate end result of an audit. Even though I was helping to produce these important documents, it wasn't until I had several years of experience with them that I finally began to get comfortable with understanding how to read and interpret them.
This is a disturbing fact of our financial systems: very few investors will ever have the opportunities I did to get up close and personal with audited financial statements. If that is the case, then how can they be expected to make informed decisions about how and where to invest their hard-earned money? The answer is: They can't! Which is exactly how many investment firms, insurance companies, and big banks would like it to remain. After all, an uninformed investor is usually a happy investor.
The sad part of this is that many investors do not want to learn more about investing. Their eyes get glossy when the subject turns to asset allocations, and they reply "I have a financial planner to make those decisions." Well, what they don't know is that he is probably just an insurance salesman, and may know less about investing than them! The bright side of this is that financial adviser gives the uneducated investor someone to blame when things go sour.
I'll give you an example. A close friend of mine, Sara, got a job as a school teacher right out of college. Soon after she started working, Sara met with a representative from NEA Valuebuilder, one of the companies that had a retirement plan for employees of Sara's school. NEA offered a 403b plan that was packaged as a variable annuity. Sara didn't know what a 403b was or who variable annuity was, but the representative was a close friend of Sara's parents, and everyone knew that Sara was making a wise choice to start saving for retirement when she was still so young.
Sara didn't asked the rep too many questions, if any at all. She wouldn't have known what to ask anyway - she had majored in fine arts, not finance - and would leave those decisions to the experts. Sara worked as a school teacher for seven years, dutifully contributing the same amount each pay check, for a total contribution over all seven years of $20,000.
We were friends for this entire period, but she never once asked me for any advice or information, so I never offered any, even though I had private concerns about how she had invested her life savings. Two years after leaving her teaching job to work full time as an artist, she could no longer contribute to the fund, and asked me to help her make a decision about what to do with the money in her 403b.
After calling NEA Valuebuilder and requesting a prospectus, I confirmed my fears. Only, it was worse than I could have imagined. Allow me to explain. In every prospectus of every mutual fund that sells shares in the United States, there is a table detailing the approximate cost of investing $10,000 in the fund over a ten year period. I turned immediately to this page when I got the prospectus, and the approximate cost was $5,600. (NEA Value Builder Prospectus) I was shocked. In all of my experience I had never seen fees this high. I immediately showed the fee table to Sara and explained what it was. I then showed her the fee tables of the index funds I suggested she consider. They each had approximate 10 year cost of under $300. (Spartan Index Funds)
The reasons for the extremely high fees are because it is an annuity, which is an insurance product. Sara's retirement savings were insured for many things at a great cost. This type of variable annuity is an antiquated investment vehicle that really no longer has a place in the great majority of portfolios, and absolutely not in the portfolio of a very young school teacher just starting out on the road to financial freedom. She didn't need this type of insurance; she needed appropriate risk and the opportunity for compounded returns.
The very sad part is that all of this information was available to Sara when she set up the plan. It could be said that the "Financial Advisor" who set up Sara's plan should have explained this information to her, but he was really just an insurance salesman, so he may not have even understood the plan, much less the prospectus.
Sara decided to cut her losses and roll her money into an IRA with low cost mutual funds. Even though her NEA Valuebuilder plan was a 403b and therefore she was allowed to roll the money into an IRA, she still had to pay NEA Valuebuilder over $1,000 to cancel her annuity contract. Over time the great advantage of the lower fees will boast her returns and more than make up for the loss. When she finally did do the rollover, the total in her account was just over $29,000. After nine years, she had only earned $9,000 in her annuity, despite never taking any disbursements. The high fees had destroyed her ability to benefit from compounded returns. That is the high cost of ignorance.
This is a disturbing fact of our financial systems: very few investors will ever have the opportunities I did to get up close and personal with audited financial statements. If that is the case, then how can they be expected to make informed decisions about how and where to invest their hard-earned money? The answer is: They can't! Which is exactly how many investment firms, insurance companies, and big banks would like it to remain. After all, an uninformed investor is usually a happy investor.
The sad part of this is that many investors do not want to learn more about investing. Their eyes get glossy when the subject turns to asset allocations, and they reply "I have a financial planner to make those decisions." Well, what they don't know is that he is probably just an insurance salesman, and may know less about investing than them! The bright side of this is that financial adviser gives the uneducated investor someone to blame when things go sour.
I'll give you an example. A close friend of mine, Sara, got a job as a school teacher right out of college. Soon after she started working, Sara met with a representative from NEA Valuebuilder, one of the companies that had a retirement plan for employees of Sara's school. NEA offered a 403b plan that was packaged as a variable annuity. Sara didn't know what a 403b was or who variable annuity was, but the representative was a close friend of Sara's parents, and everyone knew that Sara was making a wise choice to start saving for retirement when she was still so young.
Sara didn't asked the rep too many questions, if any at all. She wouldn't have known what to ask anyway - she had majored in fine arts, not finance - and would leave those decisions to the experts. Sara worked as a school teacher for seven years, dutifully contributing the same amount each pay check, for a total contribution over all seven years of $20,000.
We were friends for this entire period, but she never once asked me for any advice or information, so I never offered any, even though I had private concerns about how she had invested her life savings. Two years after leaving her teaching job to work full time as an artist, she could no longer contribute to the fund, and asked me to help her make a decision about what to do with the money in her 403b.
After calling NEA Valuebuilder and requesting a prospectus, I confirmed my fears. Only, it was worse than I could have imagined. Allow me to explain. In every prospectus of every mutual fund that sells shares in the United States, there is a table detailing the approximate cost of investing $10,000 in the fund over a ten year period. I turned immediately to this page when I got the prospectus, and the approximate cost was $5,600. (NEA Value Builder Prospectus) I was shocked. In all of my experience I had never seen fees this high. I immediately showed the fee table to Sara and explained what it was. I then showed her the fee tables of the index funds I suggested she consider. They each had approximate 10 year cost of under $300. (Spartan Index Funds)
The reasons for the extremely high fees are because it is an annuity, which is an insurance product. Sara's retirement savings were insured for many things at a great cost. This type of variable annuity is an antiquated investment vehicle that really no longer has a place in the great majority of portfolios, and absolutely not in the portfolio of a very young school teacher just starting out on the road to financial freedom. She didn't need this type of insurance; she needed appropriate risk and the opportunity for compounded returns.
The very sad part is that all of this information was available to Sara when she set up the plan. It could be said that the "Financial Advisor" who set up Sara's plan should have explained this information to her, but he was really just an insurance salesman, so he may not have even understood the plan, much less the prospectus.
Sara decided to cut her losses and roll her money into an IRA with low cost mutual funds. Even though her NEA Valuebuilder plan was a 403b and therefore she was allowed to roll the money into an IRA, she still had to pay NEA Valuebuilder over $1,000 to cancel her annuity contract. Over time the great advantage of the lower fees will boast her returns and more than make up for the loss. When she finally did do the rollover, the total in her account was just over $29,000. After nine years, she had only earned $9,000 in her annuity, despite never taking any disbursements. The high fees had destroyed her ability to benefit from compounded returns. That is the high cost of ignorance.
Thursday, July 5, 2007
Buy Assets Like the Rich
An asset is anything you own that puts money in your pocket, while a liability is anything that takes money out of your pocket. The rich buy assets, while the rest of us only buy liabilities. The most dangerous of these are liabilities that we think are assets.
I was struck the other day when a friend of mine purchased a brand new Audi sports car, complete with all leather interior and two sunroofs. She owns a dog walking service and probably earns about $80,000 a year, and, like most others of our generation, sees little to no value in saving for the future. She plans to quit working in a few years, have a baby, and raise a family. However, she's doing the opposite of preparing for that.
She put $500 down on a car that cost her future earnings of about $26,000. She got a very low dealer interest rate that puts her monthly payment at $440. She has a terrible driving record and her insurance is sky high, considering she lives in a city and needs to have full coverage because the dealership has a lien on the title of the car, about $400 a month. The first week she had the car a "client" (I think it was a Doberman) chewed off her drivers side mirror. The next week she left both the sunroofs open overnight during what turned into a very rainy evening. Finally, within her first month of possession, a truck backed into her at a stop light, damaging the entire passenger side of the car.
While her car is being repaired she is still making payments. She is out money for the cost of deductibles, and the rain has likely done extensive damage to the electrical systems. The real irony in this situation is that her husband described the car to me as an asset. Does that sound like an asset you would buy (invest in)? When does that asset start putting cash in your pocket?
I understand that most of us need a car or truck to take us to and from our jobs and errands, and that we cannot always find a reliable vehicle that we can pay cash for. It is important to plan appropriately for these major purchases and to have the savings available when the time arrives. It is also important to purchase an appropriate vehicle. For example, if you have a very long commute, or have to drive a lot for your work, then consider your comfort level and gas mileage. If you need to wear a suit to work each day, you probably need air conditioning, and if your job involves taking dogs in your vehicle many times a day, you probably don't want a sports car; a small van may be much more adequate. My friend's new Audi is both inappropriate for its use and too expensive for her. But her fundamental problem is not the Audi - that is merely the most recent manifestation of her problem. Her true issue is with her thinking. She needs to understand that a car is not an asset, and further, what an asset is and what a liability is. A car is, at best, an expense when you have no lien/debt attached to it. My cars are an expense (no debt, but there is still insurance, maintenance, and repair). But, at worst, they are an expense and also a liability.
Several years ago my grandfather died. He fought in WWII, came home from the Pacific, and worked in the shipyards as a welder. He also raised 9 children, only 4 of which were his own. After he retired from the shipyards, he bought a very small house near the ocean and worked as a security guard. He worked until he was too sick to work, and died after only truly being retired for about a month. He left half of his life savings to his wife, and the other half to be divided among his four biological children.
My aunt used her inheritance to purchase new cars for her and her husband, take a trip to Greece, and make several improvements to her house. Now the money is gone and she is still working as a bank teller with little savings, just like she has for over 30 years. The only difference is she now has two new cars to maintain. She thinks she will get the money "invested" on home improvements out of the house when she sells. My mother, on the other hand, used all of her inheritance to purchase a conservative allocation of low cost mutual funds and certificates of deposits, and has the dividends distributed to her each quarter. The value of her investments has grown in the past few years, and so has the size of her dividends. My mother now owns my grandfather's beach house, and uses the dividends to pay the costs of maintaining it. As a result, she can enjoy the house all summer long. Who purchased an asset and who purchased liabilities and expenses?
The achievement of wealth usually requires methodical asset accumulation. It is easier to accumulate assets when you aren't spending your time accumulating liabilities and sacrificing future earnings. When you sacrifice future earnings, you sacrifice unforeseen opportunity, and when you sacrifice unforeseen opportunity, you sacrifice your ability to accumulate assets in the future, all for two sunroofs and leather interior!
I was struck the other day when a friend of mine purchased a brand new Audi sports car, complete with all leather interior and two sunroofs. She owns a dog walking service and probably earns about $80,000 a year, and, like most others of our generation, sees little to no value in saving for the future. She plans to quit working in a few years, have a baby, and raise a family. However, she's doing the opposite of preparing for that.
She put $500 down on a car that cost her future earnings of about $26,000. She got a very low dealer interest rate that puts her monthly payment at $440. She has a terrible driving record and her insurance is sky high, considering she lives in a city and needs to have full coverage because the dealership has a lien on the title of the car, about $400 a month. The first week she had the car a "client" (I think it was a Doberman) chewed off her drivers side mirror. The next week she left both the sunroofs open overnight during what turned into a very rainy evening. Finally, within her first month of possession, a truck backed into her at a stop light, damaging the entire passenger side of the car.
While her car is being repaired she is still making payments. She is out money for the cost of deductibles, and the rain has likely done extensive damage to the electrical systems. The real irony in this situation is that her husband described the car to me as an asset. Does that sound like an asset you would buy (invest in)? When does that asset start putting cash in your pocket?
I understand that most of us need a car or truck to take us to and from our jobs and errands, and that we cannot always find a reliable vehicle that we can pay cash for. It is important to plan appropriately for these major purchases and to have the savings available when the time arrives. It is also important to purchase an appropriate vehicle. For example, if you have a very long commute, or have to drive a lot for your work, then consider your comfort level and gas mileage. If you need to wear a suit to work each day, you probably need air conditioning, and if your job involves taking dogs in your vehicle many times a day, you probably don't want a sports car; a small van may be much more adequate. My friend's new Audi is both inappropriate for its use and too expensive for her. But her fundamental problem is not the Audi - that is merely the most recent manifestation of her problem. Her true issue is with her thinking. She needs to understand that a car is not an asset, and further, what an asset is and what a liability is. A car is, at best, an expense when you have no lien/debt attached to it. My cars are an expense (no debt, but there is still insurance, maintenance, and repair). But, at worst, they are an expense and also a liability.
Several years ago my grandfather died. He fought in WWII, came home from the Pacific, and worked in the shipyards as a welder. He also raised 9 children, only 4 of which were his own. After he retired from the shipyards, he bought a very small house near the ocean and worked as a security guard. He worked until he was too sick to work, and died after only truly being retired for about a month. He left half of his life savings to his wife, and the other half to be divided among his four biological children.
My aunt used her inheritance to purchase new cars for her and her husband, take a trip to Greece, and make several improvements to her house. Now the money is gone and she is still working as a bank teller with little savings, just like she has for over 30 years. The only difference is she now has two new cars to maintain. She thinks she will get the money "invested" on home improvements out of the house when she sells. My mother, on the other hand, used all of her inheritance to purchase a conservative allocation of low cost mutual funds and certificates of deposits, and has the dividends distributed to her each quarter. The value of her investments has grown in the past few years, and so has the size of her dividends. My mother now owns my grandfather's beach house, and uses the dividends to pay the costs of maintaining it. As a result, she can enjoy the house all summer long. Who purchased an asset and who purchased liabilities and expenses?
The achievement of wealth usually requires methodical asset accumulation. It is easier to accumulate assets when you aren't spending your time accumulating liabilities and sacrificing future earnings. When you sacrifice future earnings, you sacrifice unforeseen opportunity, and when you sacrifice unforeseen opportunity, you sacrifice your ability to accumulate assets in the future, all for two sunroofs and leather interior!
Tuesday, July 3, 2007
Don't Live Like the Rich Part 2
I've been reading lately about increasing income to get richer and about cutting expenses to do the same. I want to point out the obvious, which is that you will actually have to do both. The tricky part is that you can't increase your spending once your income increases; you need to use that extra money to increase your savings, investments, or debt repayments. Once you decrease your fixed expenses to an appropriate level, you become virtually financially indestructible. I'll use myself as an example.
I was working as a tax consultant when I decided I wanted to attend graduate school. I didn't have any hopes of a scholarship, so I explored other payment options. I also never incur debt unless it is attached to real estate and at well-negotiated rates, so a student loan was out of the question, and since I can't incur debt I have to pay for everything in cash, including large purchases like an automobile. As a result, my fixed annual expenses are extremely low. So when I wanted to go to graduate school it wasn't a concern if I could afford it or not, my only concern was the opportunity cost of not working because I'd be in school for two years.
Eventually I worked out an arrangement with the school. We took the total cost of the program, divided it by 24, and I made those payments for the next two years with no interest. Many schools will make similar payment arrangements if you inquire.
Because of my planning and low fixed expenses, I was able to earn enough working three days a week at a local coffee shop to pay for all of my living expenses and tuition cost, even though I was only earning about 1/4 of what I had been earning as a tax consultant. I also had an emergency fund that could have sustained me for a year, so I never worried about what I would do if my fly by night barista job expired from circumstances beyond my control.
Once I was out of graduate school and back into the full time work force, my fixed expenses remained the same. This is a very powerful paragon, and one that you must achieve in order to obtain wealth through working.
I was working as a tax consultant when I decided I wanted to attend graduate school. I didn't have any hopes of a scholarship, so I explored other payment options. I also never incur debt unless it is attached to real estate and at well-negotiated rates, so a student loan was out of the question, and since I can't incur debt I have to pay for everything in cash, including large purchases like an automobile. As a result, my fixed annual expenses are extremely low. So when I wanted to go to graduate school it wasn't a concern if I could afford it or not, my only concern was the opportunity cost of not working because I'd be in school for two years.
Eventually I worked out an arrangement with the school. We took the total cost of the program, divided it by 24, and I made those payments for the next two years with no interest. Many schools will make similar payment arrangements if you inquire.
Because of my planning and low fixed expenses, I was able to earn enough working three days a week at a local coffee shop to pay for all of my living expenses and tuition cost, even though I was only earning about 1/4 of what I had been earning as a tax consultant. I also had an emergency fund that could have sustained me for a year, so I never worried about what I would do if my fly by night barista job expired from circumstances beyond my control.
Once I was out of graduate school and back into the full time work force, my fixed expenses remained the same. This is a very powerful paragon, and one that you must achieve in order to obtain wealth through working.
Monday, July 2, 2007
Don't Live Like the Rich
All of the recent excitement about the iPhone got me thinking about purchasing stock in Apple, something I wish I had done back in 2002 when a good friend of mine suggested I do so. Instead I bought shares of Boeing, and well, that's worked out just fine.
The excitement about the iPhone did not get my friends thinking about which stocks that they had bought, wished they'd bought, or might buy because it will benefit from the iPhone, no, instead, they talked about whether they would buy the iPhone itself. How strange!
To my great surprise, the consensus arrived at over dinner on my deck was a resounding no; no one would buy the iPhone. Why? It cost to much, this from a group whose wardrobe that very night I'm sure included at least one pair of $300 jeans, a few $100 t-shirts, and of course the latest fashion in flip flops. This also came from a group were each member has a new car that has been financed for 5 years, dines out several times a week, and seems to know no limit to what canine accessory their lucky pooches need next. I predict they will all have iPhones within the span of 6 months.
However, I was pleasantly surprised that there were no immediate iPhone takers. IPhones will make most of us a little less rich, but it will make some of us (Apple shareholders) a little more rich. I prefer to be a member of the little more rich crowd whenever I can, but most of my friends are members of the little less rich crowd all of the time.
The modern economy is a wonderful machine that allows its' users to be a member of one of these two classes. In the United States you can even choose which crowd to belong to. Even though you can choose, most of us are and will always be members of the little less rich crowd, but a few of us will choose to be members of the other class.
How do you choose to be a member of the little more rich class? Simply, by always living below your means. Living below your means, as long as you have enough to survive, will allow you to save money regularly, and will allow that money to last longer should you ever need to tap into it. Living below your means and saving money will allow you to purchase stock in the next Apple or Boeing, and then earn even more money when that company releases the next iPhone or super jet.
The excitement about the iPhone did not get my friends thinking about which stocks that they had bought, wished they'd bought, or might buy because it will benefit from the iPhone, no, instead, they talked about whether they would buy the iPhone itself. How strange!
To my great surprise, the consensus arrived at over dinner on my deck was a resounding no; no one would buy the iPhone. Why? It cost to much, this from a group whose wardrobe that very night I'm sure included at least one pair of $300 jeans, a few $100 t-shirts, and of course the latest fashion in flip flops. This also came from a group were each member has a new car that has been financed for 5 years, dines out several times a week, and seems to know no limit to what canine accessory their lucky pooches need next. I predict they will all have iPhones within the span of 6 months.
However, I was pleasantly surprised that there were no immediate iPhone takers. IPhones will make most of us a little less rich, but it will make some of us (Apple shareholders) a little more rich. I prefer to be a member of the little more rich crowd whenever I can, but most of my friends are members of the little less rich crowd all of the time.
The modern economy is a wonderful machine that allows its' users to be a member of one of these two classes. In the United States you can even choose which crowd to belong to. Even though you can choose, most of us are and will always be members of the little less rich crowd, but a few of us will choose to be members of the other class.
How do you choose to be a member of the little more rich class? Simply, by always living below your means. Living below your means, as long as you have enough to survive, will allow you to save money regularly, and will allow that money to last longer should you ever need to tap into it. Living below your means and saving money will allow you to purchase stock in the next Apple or Boeing, and then earn even more money when that company releases the next iPhone or super jet.
Saturday, June 30, 2007
Prepare to be Rich
I recently read an article about a trucker in the Midwest who, along with his wife of many years, had won a Powerball lottery worth over $30 million. When asked by reporters what they were going to do with the money, the couple replied "pay off debts, help some family and friends who are struggling, look for a new house, and buy a new truck." The lucky trucker than went on to explain that he had no intention of retiring to a life of leisure, and that he needed a new truck because his old truck had recently expired after serving him well for over 2 million miles.
We have all heard the story about the friend of a friend who has won a lottery, spent it all in few years, and then ended up worse off than they were before the winnings. The problem, I believe, is a lack of understanding of the responsibility of money.
When you've never had any responsibility before, why should you be expected to be responsible now? I'm not saying our lucky trucker is not responsible, I am saying that he has never had to be responsible for managing a fortune of any size, and has no idea what he is in for. It could be compared with becoming parent for the first time, only you didn't have 9 months to prepare. If he is going to continue to work because he'll get bored fishing and playing golf everyday, he isn't taking into account his new responsibilities to manage his investments, or to at least pay very close attention to the people he hires to manage his new money. He now has the great responsibility to oversee and to make decisions that could make him and his descendants very comfortable, but it will not happen automatically. He needs to begin a long process of educating himself about options, and carefully choosing his advisers. This should be a full time job. In terms of money, he has never been a parent before.
For the rest of use who are still diligently building our fortunes, it is important for us to continue to build our knowledge base as well, and to stay informed about new types of investment options. We have the time to prepare for our future responsibilities, and should be at the very least reading the business section of our newspaper or favorite website. There is a direct correlation between how well we prepare now, and how much responsibility we will have in the future. Other options include watching business news shows, or taking a basic business or accounting class online or at a community college. It is only through this regular preparation that we can be expected to truly gain a working knowledge finance.
We have all heard the story about the friend of a friend who has won a lottery, spent it all in few years, and then ended up worse off than they were before the winnings. The problem, I believe, is a lack of understanding of the responsibility of money.
When you've never had any responsibility before, why should you be expected to be responsible now? I'm not saying our lucky trucker is not responsible, I am saying that he has never had to be responsible for managing a fortune of any size, and has no idea what he is in for. It could be compared with becoming parent for the first time, only you didn't have 9 months to prepare. If he is going to continue to work because he'll get bored fishing and playing golf everyday, he isn't taking into account his new responsibilities to manage his investments, or to at least pay very close attention to the people he hires to manage his new money. He now has the great responsibility to oversee and to make decisions that could make him and his descendants very comfortable, but it will not happen automatically. He needs to begin a long process of educating himself about options, and carefully choosing his advisers. This should be a full time job. In terms of money, he has never been a parent before.
For the rest of use who are still diligently building our fortunes, it is important for us to continue to build our knowledge base as well, and to stay informed about new types of investment options. We have the time to prepare for our future responsibilities, and should be at the very least reading the business section of our newspaper or favorite website. There is a direct correlation between how well we prepare now, and how much responsibility we will have in the future. Other options include watching business news shows, or taking a basic business or accounting class online or at a community college. It is only through this regular preparation that we can be expected to truly gain a working knowledge finance.
Wednesday, June 27, 2007
Contrary Like the Rich
It's been proven, time and again, that the wealthiest among us do not make the same choices as the majority of us. For example, a recent poll found that most individuals with investable assets in excess of 2 million (that is, assets excluding principle residence) thought that now or the near future was a good time to purchase real estate. I’m not sure if I agree, but I do believe we are headed for a good time for buyers. So if now seems like a natural time to search out some valuable real estate and grab it at a steep discount, lucky you, you’re not alone.
Several years ago I when I was looking for my first house, I was renting an apartment in a quaint little neighborhood in Baltimore City. I had lived in the neighborhood for almost a year, and had already made many great friends and truly grown to appreciate the pre-WW1 Victorian architecture. I had also discovered several local shops, restaurants, and markets where I could buy everything I needed. I no longer needed to drive to get what I needed to survive and loved it. I sold my car and took the bus on the short ride downtown to my job at the time, as a tax consultant with Ernst and Young.
My co-workers at E&Y told me I was an idiot and worse. “Everyone knows real estate in the city never appreciates, if you want to make any money in real estate you need to buy in the county, everyone knows that!” Everyone did know that, which is why I was able to buy a gorgeous 3-bedroom 1-bath Victorian porch front row home with inlaid parquet floors and a perfect tin ceiling for $80,000. This, when my coworkers where buying cookie cutter homes in the suburbs for $250,000 - $500,000, and because of their distant commute to the office, they had to maintain cars and pay $200 to $300 a month just to park them downtown (not to mention insurance, gas, and car payments). I was saving a bundle, and felt that I had found a real value. I figured out that what I was saving would allow me to accumulate the same amount of savings in 10 years that it would take them 30 or more years to accumulate.
I really didn’t care what everyone knew, I cared about what I knew; that I loved the neighborhood and the house. I believed that the carefree, pedestrian lifestyle it enabled me to have was a tremendous value. Even at that time, there were cars parked in my neighborhood with values close to what I had paid for my house, and I believed the real estate prices in the neighborhood would at some point appreciate dramatically. At the closing I joked with my agent, “we’ll sell it when we can get $250,000 for it.” She smiled politely, I’m sure thinking I was a total idiot, but I sold it 6 years later for $260,000. I absolutely doubt my old co-workers homes appreciated at a pace anywhere near that.
I bought the house because I believed it to be a value when no one else did, and I happened to be right. The rich buy assets when they are a value, and sell them when they are expensive, they buy low and sell high. Supply and demand, when everyone is a seller, be a buyer, and when they are all buyers, be a seller, be a contrarian.
Several years ago I when I was looking for my first house, I was renting an apartment in a quaint little neighborhood in Baltimore City. I had lived in the neighborhood for almost a year, and had already made many great friends and truly grown to appreciate the pre-WW1 Victorian architecture. I had also discovered several local shops, restaurants, and markets where I could buy everything I needed. I no longer needed to drive to get what I needed to survive and loved it. I sold my car and took the bus on the short ride downtown to my job at the time, as a tax consultant with Ernst and Young.
My co-workers at E&Y told me I was an idiot and worse. “Everyone knows real estate in the city never appreciates, if you want to make any money in real estate you need to buy in the county, everyone knows that!” Everyone did know that, which is why I was able to buy a gorgeous 3-bedroom 1-bath Victorian porch front row home with inlaid parquet floors and a perfect tin ceiling for $80,000. This, when my coworkers where buying cookie cutter homes in the suburbs for $250,000 - $500,000, and because of their distant commute to the office, they had to maintain cars and pay $200 to $300 a month just to park them downtown (not to mention insurance, gas, and car payments). I was saving a bundle, and felt that I had found a real value. I figured out that what I was saving would allow me to accumulate the same amount of savings in 10 years that it would take them 30 or more years to accumulate.
I really didn’t care what everyone knew, I cared about what I knew; that I loved the neighborhood and the house. I believed that the carefree, pedestrian lifestyle it enabled me to have was a tremendous value. Even at that time, there were cars parked in my neighborhood with values close to what I had paid for my house, and I believed the real estate prices in the neighborhood would at some point appreciate dramatically. At the closing I joked with my agent, “we’ll sell it when we can get $250,000 for it.” She smiled politely, I’m sure thinking I was a total idiot, but I sold it 6 years later for $260,000. I absolutely doubt my old co-workers homes appreciated at a pace anywhere near that.
I bought the house because I believed it to be a value when no one else did, and I happened to be right. The rich buy assets when they are a value, and sell them when they are expensive, they buy low and sell high. Supply and demand, when everyone is a seller, be a buyer, and when they are all buyers, be a seller, be a contrarian.
Sunday, June 24, 2007
Exercise Like the Rich
This past weekend I went for a mountain bike ride with a great friend of mine who happens to own a small chain of photo development stores, a dying business to be sure, but he may have just found the right niche of enthusiast to sustain a nice living.
The ride was treacherous. We went over large roots, rocks, ruts and through all possible unforeseeable circumstance. My friend, a well practiced regular rider, had little to no trouble. Throughout the entirety of our journey, he waited for me just over the next hill. Twice I tried to keep up with him, and twice I was thrown from my bike, first by a tree I saw and could not avoid, and second by a large root i didn't even see. I wasn't prepared for the ride.
This same friend who led me through my first mountain bike ride, often comes to me for financial guidance. While he is spending his spare time reading bicycling and outdoors magazines, and watching shows about extreme sports, I am reading Fortune magazine, The Wall Street Journal, and Kiplinger's Personal Finance. While he spends his evenings working in his basement on his bikes and out on rides with friends, I am in my home office analyzing my portfolio's performance, plotting my next move, setting future goals, and assessing how well I've met my past goals.
Investing is like a sport, if you want to be good at it, you must practice regularly, and the Rich practice. Just like I couldn't keep up with my experienced friend on our bike ride, just like he had to wait for me over each hill, I must wait for him when we discuss investments, I must guide him through the myriad of opportunities, and just as he has improved his skill on his bike and on the trials far from what I could have reached without ever practicing, I have grown and improved my portfolio and investing skills far more rapidly then he has.
Another friend of mine was recently recognized for her outstanding achievements in visual arts. The award came with a cash prize of several thousand dollars. She is an artist and while she does have some investments, her knowledge of investing is very low. She asked me what I would suggest she do with the money. Based on her other investments, I suggested a low cost international index fund for however much of the money she was comfortable investing. She invested half the money, and within a few hours of mailing the check she became very nervous and upset. She regretted sending the money and wished she could get it back. She even got upset with me for suggesting she invest some of her prize money. Thoughts of losing every lucky dime ran through her mind, and what if there was a major emergency (she already had an emergency fund I had previously advised her to establish) that whipped out her savings? Then what? She tried to imagine all of the unforeseeable circumstances ahead, but did not know how to avoid them, control them, or how they would affect her.
Within 24 hours of sending the check, she had called her bank and put a stop payment on it at a cost of $25. Once the money was safely back in her bank account, she generously took out me to a very expensive dinner to apologize for the blaming. She is practiced, experienced, and comfortable with fine dinning.
The amount she had intended to invest was completely inconsequential to me. I have invested sums many, many times larger and not felt a ting of guilt or remorse. After reflecting on what happened, I realized that she had attempted to ride in a bike race without ever learning to first ride a bike. Although she owns bikes, she cannot ride them. She was so out of shape in her comfort level of investing, that this relatively small amount of money seemed like an impossible amount to put at risk. She needs exercise, training, and regular investing to get into shape.
At our dinner I explained my theory of why she became so upset, and suggested she start with a smaller amount, no matter how small, just a little bit beyond her comfort level, and then steadily increase it. She smiled and nodded, and I'm sure forgot a moment later. What was that art thing she mentioned?
The ride was treacherous. We went over large roots, rocks, ruts and through all possible unforeseeable circumstance. My friend, a well practiced regular rider, had little to no trouble. Throughout the entirety of our journey, he waited for me just over the next hill. Twice I tried to keep up with him, and twice I was thrown from my bike, first by a tree I saw and could not avoid, and second by a large root i didn't even see. I wasn't prepared for the ride.
This same friend who led me through my first mountain bike ride, often comes to me for financial guidance. While he is spending his spare time reading bicycling and outdoors magazines, and watching shows about extreme sports, I am reading Fortune magazine, The Wall Street Journal, and Kiplinger's Personal Finance. While he spends his evenings working in his basement on his bikes and out on rides with friends, I am in my home office analyzing my portfolio's performance, plotting my next move, setting future goals, and assessing how well I've met my past goals.
Investing is like a sport, if you want to be good at it, you must practice regularly, and the Rich practice. Just like I couldn't keep up with my experienced friend on our bike ride, just like he had to wait for me over each hill, I must wait for him when we discuss investments, I must guide him through the myriad of opportunities, and just as he has improved his skill on his bike and on the trials far from what I could have reached without ever practicing, I have grown and improved my portfolio and investing skills far more rapidly then he has.
Another friend of mine was recently recognized for her outstanding achievements in visual arts. The award came with a cash prize of several thousand dollars. She is an artist and while she does have some investments, her knowledge of investing is very low. She asked me what I would suggest she do with the money. Based on her other investments, I suggested a low cost international index fund for however much of the money she was comfortable investing. She invested half the money, and within a few hours of mailing the check she became very nervous and upset. She regretted sending the money and wished she could get it back. She even got upset with me for suggesting she invest some of her prize money. Thoughts of losing every lucky dime ran through her mind, and what if there was a major emergency (she already had an emergency fund I had previously advised her to establish) that whipped out her savings? Then what? She tried to imagine all of the unforeseeable circumstances ahead, but did not know how to avoid them, control them, or how they would affect her.
Within 24 hours of sending the check, she had called her bank and put a stop payment on it at a cost of $25. Once the money was safely back in her bank account, she generously took out me to a very expensive dinner to apologize for the blaming. She is practiced, experienced, and comfortable with fine dinning.
The amount she had intended to invest was completely inconsequential to me. I have invested sums many, many times larger and not felt a ting of guilt or remorse. After reflecting on what happened, I realized that she had attempted to ride in a bike race without ever learning to first ride a bike. Although she owns bikes, she cannot ride them. She was so out of shape in her comfort level of investing, that this relatively small amount of money seemed like an impossible amount to put at risk. She needs exercise, training, and regular investing to get into shape.
At our dinner I explained my theory of why she became so upset, and suggested she start with a smaller amount, no matter how small, just a little bit beyond her comfort level, and then steadily increase it. She smiled and nodded, and I'm sure forgot a moment later. What was that art thing she mentioned?
Friday, June 22, 2007
Prosper
Most of the individuals who are fortunate enough to have amassed wealth so great that the wealth itself can work harder and earn more than the individual, have done so in an nontraditional manner. That is, they have done things that most of the rest us would not have considered or even desired to do.
Sacrifice and risk are both adjectives we all most definitely try to avoid, but are of course unavoidable in the land of investments. That is unless you are so obsessed with investing (like me) that you eat rice and noodles because you know the future compounded value of that $2.50 your saving. But not all investment require the same sacrifice, and they definitely don't all entail the same amount of risk.
Take Prosper.com for example. For those of you who do not know, Prosper.com is the finance world's response to Ebay. Prosper.com allows individuals to lend money to other individuals. It effectively cuts out the big banks who used to (and often still do) take all the profits. Prosper charges a very reasonable fee, about 1% to 1.5%. Rates are determined by a reverse dutch auction, that is, the borrower enters the amount they would like to borrow and the rate they would like, and lenders bid down the rate to lend money.
Making loans on Prosper can be addicting. It's exciting and a challenge to try and find the best loans to purchase at the best rates. I also enjoying knowing and choosing who my money is being lent to. For example, having had family members caught in the credit card trap, I enjoy lending to borrowers who are interested in consolidating high interest credit card debt, and I still earn a nice return!
I have to date made 14 loans, all of which are the minimum amount that can be lent, $50. You see, the 'lenders' are only purchasing a part of a loan that prosper actually makes. But prosper will only make the loan after they have enough lenders committed to buying the loan. The smallest portion of the loan that can be bought is $50.
Of my 14 loans, one is currently 3 days late. This is the first late payment I have had since I started my prosper career 3 months ago. Did I mention that I was earning an average return of 15.9%? I am still in the experimental stage of prosper.com investing, but do the math yourself, the prospects are quite enticing. Nontraditional and rather risky? Absolutely!
Sacrifice and risk are both adjectives we all most definitely try to avoid, but are of course unavoidable in the land of investments. That is unless you are so obsessed with investing (like me) that you eat rice and noodles because you know the future compounded value of that $2.50 your saving. But not all investment require the same sacrifice, and they definitely don't all entail the same amount of risk.
Take Prosper.com for example. For those of you who do not know, Prosper.com is the finance world's response to Ebay. Prosper.com allows individuals to lend money to other individuals. It effectively cuts out the big banks who used to (and often still do) take all the profits. Prosper charges a very reasonable fee, about 1% to 1.5%. Rates are determined by a reverse dutch auction, that is, the borrower enters the amount they would like to borrow and the rate they would like, and lenders bid down the rate to lend money.
Making loans on Prosper can be addicting. It's exciting and a challenge to try and find the best loans to purchase at the best rates. I also enjoying knowing and choosing who my money is being lent to. For example, having had family members caught in the credit card trap, I enjoy lending to borrowers who are interested in consolidating high interest credit card debt, and I still earn a nice return!
I have to date made 14 loans, all of which are the minimum amount that can be lent, $50. You see, the 'lenders' are only purchasing a part of a loan that prosper actually makes. But prosper will only make the loan after they have enough lenders committed to buying the loan. The smallest portion of the loan that can be bought is $50.
Of my 14 loans, one is currently 3 days late. This is the first late payment I have had since I started my prosper career 3 months ago. Did I mention that I was earning an average return of 15.9%? I am still in the experimental stage of prosper.com investing, but do the math yourself, the prospects are quite enticing. Nontraditional and rather risky? Absolutely!
Tuesday, June 19, 2007
The Emergency Fund
The rich have emergency funds. An emergency fund is money that is not used for any purpose that can be foreseen. It is used to let the rich sleep at night: knowing that no matter what disaster may occur in the near or distant future, they have the cash to quickly bail themselves out.
The rest of us should also have this most precious luxury, and we can. How much do we need? That depends on your living expenses. These are the things you need to pay for to survive, the cost to maintain your other assets, and to pay your liabilities or debts. If you're single and all alone in this world, with no one who depends on you, poor you, but lucky you, too, because you don't need as much cash sitting in your emergency fund to sleep at night. Three months of expenses will probably do just fine. But if you have dependents, you should consider amassing an emergency fund that will sustain you and your family for a longer period of time, 6 months is a good rule of thumb.
Be careful to not underestimate your expenses, but don't plan on dining out every night either. You will likely need cash to make changes to your life when the unforeseen strikes. For example, you may need to travel to find a new job, need to move when you do find that job, pay for health insurance, rent another place to live, and you wont want to forfeit travel plans that have already been partially paid for.
Another thing to keep in mind: the smaller your living expenses, the smaller the amount you will need to maintain in an emergency fund, so there is a compounding effect of a frugal lifestyle.
Where do you maintain this small fortune? I recommend high interest earning money market accounts, and places where it will take at least 5 or 6 business days to gain access to the funds. This removes some of the temptation to access your emergency fund to buy a new car or kitchen when its not really an emergency. INGDirect has a great online money market account, and several of the big mutual fund companies have money market funds that i would also recommend. You don't want to invest these funds in a place that would put them at risk of market fluctuations or make them so accessible to yourself you could access them to buy groceries, rent movies, or get into via an ATM.
I like to maintain one years worth of expenses. I use an online money market account, and can't get the money into my hands for 5 business days. The more I saved to accumulate the fund, the easier it was to keep it. I view this fund as the foundation of my portfolio. The fund makes it possible for me to take greater risk with the rest of my investments, and allows me a great sense of security.
The rest of us should also have this most precious luxury, and we can. How much do we need? That depends on your living expenses. These are the things you need to pay for to survive, the cost to maintain your other assets, and to pay your liabilities or debts. If you're single and all alone in this world, with no one who depends on you, poor you, but lucky you, too, because you don't need as much cash sitting in your emergency fund to sleep at night. Three months of expenses will probably do just fine. But if you have dependents, you should consider amassing an emergency fund that will sustain you and your family for a longer period of time, 6 months is a good rule of thumb.
Be careful to not underestimate your expenses, but don't plan on dining out every night either. You will likely need cash to make changes to your life when the unforeseen strikes. For example, you may need to travel to find a new job, need to move when you do find that job, pay for health insurance, rent another place to live, and you wont want to forfeit travel plans that have already been partially paid for.
Another thing to keep in mind: the smaller your living expenses, the smaller the amount you will need to maintain in an emergency fund, so there is a compounding effect of a frugal lifestyle.
Where do you maintain this small fortune? I recommend high interest earning money market accounts, and places where it will take at least 5 or 6 business days to gain access to the funds. This removes some of the temptation to access your emergency fund to buy a new car or kitchen when its not really an emergency. INGDirect has a great online money market account, and several of the big mutual fund companies have money market funds that i would also recommend. You don't want to invest these funds in a place that would put them at risk of market fluctuations or make them so accessible to yourself you could access them to buy groceries, rent movies, or get into via an ATM.
I like to maintain one years worth of expenses. I use an online money market account, and can't get the money into my hands for 5 business days. The more I saved to accumulate the fund, the easier it was to keep it. I view this fund as the foundation of my portfolio. The fund makes it possible for me to take greater risk with the rest of my investments, and allows me a great sense of security.
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