But, I need more!

I’m still receiving questions and comments regarding this post: Will you ever put a penny in your 401k again?

Jeff said:

I can see how some people couldn’t stomach the additional risk of Real Estate investing…and thus the decision to get a company match in a 401K is an easy (near automatic) choice. For me, I want to determine a return that is reasonable for each option, and then compare it to the associated risk before I make a choice.

There are two wrong ways to look at this whole question, and one right way.

First the wrong ways:

1. Shouldn’t I invest in the 401k to get the tax benefits and the employer match?

2. What do I do if the choice between the 401k and the other choices that I’ve been looking at seem close?

You see, the first question aims at maximizing company benefit, and the second aims at maximizing investment returns. These are not the same thing … and neither are they the thing!

The one and only question that you need to answer is:

3. What do I need to do in order to get to my Number?

If you don’t know your destination, any road will do …

… but, once you do have your destination clearly in mind, typically only one road (and, you may have to look hard to find it) will usually jump right out at you!

For one person it may be that the save-and-forget 401k option is right, but for another only a more active form of investment will get their to their Number.

The rule of thumb: the longer the time frame that you have available, and the smaller your Number (say $2 million in 20 years) the more likely it is that the 401k + own-your-own home + remain-dent-free strategies will work for you.

But if your Number is larger/soon (say, $5 million in 10 years) then you have to do something more or you simply won’t make it …

Ideal Budget Allocation?

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Special Announcement: Who did I select as my 7 Millionaires … In Training!?

Click here to find out!

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Recently, I pointed you to some typical personal budget allocations at varying income levels i.e. $100,000 p.a.; $250,000 p.a.; and $550,000 p.a. (before tax).

So, I was very interested when I happened upon this chart from Crown Financial Ministries, a Christian organization that helps people with their personal budgets and debt reduction strategies. This chart illustrates their concept of an ‘ideal’ personal budget allocation.

I should point out:

1. This ‘budget’ is after-tax (assume 35% tax rate)

2. Being a religious organization, it (naturally) also assumes tithing (I presume it’s 10% of gross)

3. You can be sure that it represents low-to-average salary levels – given its target audience – so you may want to combine this with other estimates (such as the ones above) for higher income levels.

For most personal finance bloggers this is a way to assess your current budget so that you can make sure that you reign in your spending and save every last dollar.

While this is wise and honorable, I provide these numbers for a totally different purpose: so that you can assess your future budget. This is the budget that you would like to have when you retire.

Use these resources to try and put together the lifestyle that you want to live when you retire – as though you were living it today.

Once you have your Required Annual Expenditure firmly in mind, you will need to account for the inflation that will occur between now and when you do stop work …

… for example, if you think that inflation will only be 4% and you intend to retire in 20 years, you will need to double the income that you anticipated (for 10 years add 50%, and so on).

How will you fund that if you have retired?

By having at least 20 times that saved up on or before the day that you stop work, is how!

Debt snowballs, avalanches, meltdowns …

I’m about to find out if you can make money online!

FREE eBOOK

(well. free to readers …. come on over and see my new blog to see what all the fuss is about)!

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Now for today’s post

There are three basic ways to deal with debt:

1. Sweep it under the carpet and hope it goes away … pretty much the middle-class American mantra

2. Peck and poke at it … barely keeping it under some sort of control

3. Systematically demolish it … the subject of this post

The methods for ‘demolishing’ debt basically all have to do with snow (Why? No idea!):

a) Snowballs – where you deal with the little guys first in order to ‘psych up’ with a few, quick wins

b) Avalanches – where you deal with the high interest debts first, so your debt repayment strategy builds up momentum

c) Meltdowns – where you try either of these methods (or some other way) and fail mid-stream

The Debt Avalanche, nicely described (and named!) here is mathematically the best way to deal with eliminating all debt. I also covered this method in a recent post.

As I said in that post, it stands to reason that if you tackle the high interest debts first, you lower your overall interest bill – hence debt. Therefore, you pay the lot off quicker …

… but, not much quicker as Dave Ramsey is quick to point out:

He says that the debt snowball isn’t terribly slower at paying off debt, but has a psychological advantage of allowing some quick ‘wins’ … by ordering your debts from smallest to largest and paying off the smaller ones first, you get to see the results that will hopefully sustain you as you start to tackle the larger debts (also, you are applying larger and larger amounts to each debt, as you have fewer and fewer ‘minimum payments’ to maintain as you go along … but, this is true with both methods).

Then you have the ‘Debt Meltdown’ aptly described by Diane, one of the Final 15 on my 7 Millionaires … In Training! ‘grand experiment’:

I’m in such a financial mess that I am working on 101 and not sure I’m going to survive that at times.  But I should.  I know I make a lot more money than many folks.  I shouldn’t be in this situation.  I could probably go back and show how it crept up because I was down to about 2k in debt, at 1.9% interest rate (sans the student loan), before I bought my house 2-1/2 years ago.  I’ve got 30k in debt now roughly and some months lately am not sure how I am going to meet all of the must-pay bills.

This is typically what happens when you start on any debt repayment schedule and something ‘comes up’ …

Diane should have stayed the course until all debts were paid off then bought her house, ensuring that her total mortgage wasn’t any more than the total monthly debt repayment schedule … if less, she should have applied the balance to her investment strategy (if she didn’t yet have an investment strategy, then she should have started that before considering the house).

All Diane can do now, is start a Controlled Meltdown …

… anyway, of all these methods, I actually like the Controlled Meltdown best  – and, for that to work you actually need to begin with the Debt Avalanche:

1. Order all of your debts from lowest interest rate to highest (regardless of size … if you have two debts at the same interest rate, tackle the smaller one first, just to please Mr Ramsey)

2. Decide how much each month you are going to apply to debt repayment (min. 10% – 15% of your net salary … after contributing to 401k … sorry no Starbucks, movies, or sushi for you!).

3. Pay the minimum on all of the debts except the one that you are tackling (always the highest interest rate loan that you have left). Put all of the rest of that month’s debt repayment into this ‘high interest debt’.

4. Repeat until …

[AJC: and, this is where a Millionaire … In Training! differs from the ordinary folk]

5. The interest rate on the remaining loans is lower than the return that you can get by investing your money elsewhere (buy some real-estate, leverage into some stocks, start a little business) … just remember not to accumulate any more debt and keep repaying the minimum on the ones that you do have.

6. Also, don’t forget to tie the investment time period to the loan: let’s say that you have a student loan at 2.9% that must be repaid in 2 years … make sure that you can sell (or refinance) your investment to pay it back: the student loan is acting as a proxy for your investment loan, so don’t get caught out.

This is the fastest method because you don’t need to pay off all of your debt right now!

The Controlled Meltdown (patents pending) recognizes that being 100% debt-free is not a useful financial goal; being 100% financially-free is … and, to achieve real financial freedom, you are going to need some well-directed debt to help you accelerate you Net Worth to the point that it indefinitely sustains you.

Your existing ultra-low interest rate loans are a great place to acquire that debt …

… because you already have them and just need to redirect that debt towards good rather than evil 😉

401k v Real-estate. A close call, then?

Special Announcement: After 4 months of ‘try outs’, the Final 7 Millionaires … In Training! will be announced this Thursday on my Live Show this Thursday @ 8pm CST (9pm EST / 6pm PST) at http://ajcfeed.com ….

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I wrote a series of posts about a hypothetical ‘battle’ between the Mighty 401k and Humble Real-Estate. For those with a sharp eye, I posed the original post as a question, not a recommendation.

However, it is my contention that, for many people, the 401k will lose when compared to many other forms of active investment – including, but not just real-estate!

For those of you who read this highly contentious post – and, the follow-up posts (which you can find by following the ‘track-back’ links listed at the bottom of the original post) – you will, hopefully, realize by now that my point was simply this:

Don’t blindly follow the pack by simply plonking your money into your 401k to get the ‘free money’ employer match and tax-benefits!

Do your homework first … there may be better investment options out there, for you.

The example that I used was comparing the 401k to investing in 4 or 5 single-family homes as rentals; Pinyo said that he ran the numbers and the 401k ‘won’ (but, he didn’t provide any further details) and Jeff says that he ran the numbers are found it to be a close call – you always know that you’re in trouble when somebody begins with “I appreciate your attempt …” 😉

Anyhow, here’s Jeff’s comments:

I appreciate your attempt at explaining why Real Estate investing should at least be considered over equity investing in an employer-matched 401K. I ran the numbers using your assumptions (adding in tax consequences–property and income–and cost of property insurance) and, although the annualized return was much closer, your Real Estate investing scenerios came out slightly ahead. I expected this result as investment property investing usually carries increased risk (and hand holding) and thus should provide increased reward.

In going through the process of comparing investment options, I was suprised by a few things. 1) the Real Estate investment option, according to your scernio, suffered from 8-15 years of undiscussed or accounted for negative cash flows after costs, such as property tax, insurance, mortgage payments, and your 25% unrealized income either due to maintenance or unoccupancy, and 2), more importantly, the overall outcome (equity v. real estate) varied drastically based on 2 assumptions: estimated appreciation of real estate over 30 years and estimated return in the equities market over 30 years. Even a 1% point swing in either of these assumptions made a huge difference in projected outcome, i.e., which investment option was better.

I looked through your blog (not exhaustively) for a post discussing your reasoning behind these 2 estimates, but failed to find one. Since it seems that the accuracy of these estimates (best and worst cases scenerios over 30 years) is essential in determining if either investment option has a clear advantage, I was hoping you could either point me to a post of yours discussing them, or let me know of any books, articles, etc, that led you to your estimates.

As I said to Jeff, the mere fact that it is at least a close call means that it is no longer sensible to just automatically plonk your money into a 401k just to get the employer match.

Surely, your goal isn’t to gain ‘free money’ and/or tax benefits …

… it’s to end up with a sh*tload of money, right?!

You can only do that if you investigate all the options available to you. By that, I mean all the options that interest you!

For me, that’s stocks (but not mutual funds); real-estate (but not single-family homes); gold/silver (but not other commodities); etc.

For most people, it will simply mean putting up the 401k scenario against one or two other choices, just as I did in the original post with real-estate.

With all the online calculators available out there, it’s not hard to do a rough analysis, using the 401k option – with numbers that make sense to you – as your baseline.

If, as Jeff found, it turns out to be a close call, then stick with the 401k … it’s simple and at least gives the appearance of being low-risk.

For me, though, if it’s a close call I usually choose the most ‘active’ form of investment as I know that I haven’t factored in all the upside potential.

But, to answer Jeff’s questions; it all boils down to your estimates – or at least appears to:

Now, while I used 8% as the return from the 401k to allow for the very-slight-risk (even over 30 years) that you will pick the worst market time to start investing, you will find that the typical index fund will return upwards of 11% over 30 years minus costs (index fund costs; sales commissions; employer admin; etc; etc.).

This all depends upon your 401k and the options that your employer allows – a reasonable rule-of-thumb is to allow 1.5% for costs. So you could rerun the numbers at 9.5% returns.

Now, what company match will you assume? I allowed 100%.

However, will your employer give you 100% match now and for the next 30 years (since, you’ll likely change jobs 4 times in 30 years)? Think very carefully before answering this question!

You will also find that your contributions are maxed to $15k or so a year, which kind of makes this analysis moot, because any serious investor will be wandering what to do with the rest of the money that they want to invest.

On the real-estate side, according to Todd Ballenger author of the new book Borrow Smart, Retire Rich “since 1945, the median house price in the United States has risen by an average of 6.23% per year”. Others will quote studies saying that single family homes only keep pace with inflation (currently 4% – 5%).

So, I selected 6%, which I feel is a little low, and allowed 5.25% for a fixed mortgage (which, now, is also a little low), and 5% rental return (which will start to become a little low again), and 25% of all other costs (incl. insurance, property taxes, R&M, etc.) which could be high or low.

Again, run the numbers and if it’s a close call, don’t bother with the investment option.; stick with the set-it-an-forget-it 401k.

But, let me pose a small question: does investing either way do it for you?

Does it make your Number?

If either way does (and, in the time frame that you want to get there), don’t sweat it … again, go for the 401k and relax.

Life wasn’t meant to be that difficult 🙂

But, if it does not ‘do it for you’, hang tight, I have more for you soon …

A different way to diversify …

Despite my apparent posts to the contrary, I think it is OK to diversify, but only when you have reached your financial goals (i.e. Your Number) – or, are damn sure that lower/diversified returns are going to get you there – and are transitioning to Making Money 301, when you are trying to protect your assets.

Even then my perspective of what constitutes ‘diversification’ is probably very different to what common wisdom would suggest. However, today, I want to look at a different kind of diversification …

Let’s start by looking Bill’s comment:

I guess you are trying to espouse that one must FOCUS on ONE thing which creates the abundance of ACTIVE income and then leverage further to create PASSIVE incomes via real estates…

Focus is indeed a great way to build wealth … you pick something that will give you the best return (at least, one that you believe in your heart-of-hearts) and ride that sucker until it proves otherwise!

You don’t need to diversify your wealth-building activities: it can halve the outcome – or worse, you actually double your chances of a (partial) failure!

But, when it comes to passively investing the proceeds diversify away!

Don’t leave all of your profits in the investment that is generating the wealth – here’s just one example:

You have a business operating out of a shop, warehouse, or office: a simple way to diversify is to use the income from the business to buy the premises.

If you ‘go under’ you can simply re-rent the premises to somebody else (if you buy well, and hold a cash buffer against such a disaster). And, if you sell the business, you have tenants – with a business that you could always take over again, if they bust!

Similarly, if you have any kind of business (or job, for that matter … which is simply a business where you are selling your time on a pre-determined contract on a semi-exclusive basis) you invest some of your income.

But, this is an example that is NOT diversifying: you have a business operating in one geographic area and you reinvest the proceeds of your business into opening up new locations. You will find that your empire can unravel due to some unforeseen circumstance as quickly as it was created … then, where is your backup.

I started real-estate investing, using the income from my businesses before I started expanding my businesses internationally. I already all-but-completed my 7 million dollar journey before I even had a business that was able to be sold (eventually) … and, I did it all on the same income that any reasonably-well-paid professional can claim.

The advantage of this kind of diversification is that I had built a backstop for my business, in case my expansion plans backfired.

No the diversification that I am talking about is to:

1. Focus on one area in which to create income, and

2. Focus on one other area in which to build (passive) wealth.

I would be happy with just one business and one – bloody big – office building. To me, that’s diversification enough!

I'm about to find out if you can make money online – Part V

I spent most of yesterday’s post talking about starting businesses (for College-age kids, but it’s a great way to go for anybody looking to start something low-cost and part-time) … so, it’s time to update my occasional series on starting an on-line business!

But, we’ve tried the scams and ignored the schemes and so far haven’t yet found an “off the shelf” way to make money online.

So, now it’s time to try Plan B: create my own Information Product.

My plan is to take some of the information that I have already published on this blog and my other one and turn it into an e-book. The purpose isn’t to make money for me … it’s to show you how you can make money online.

So, I will ‘open up the books’ here [AJC: if I can find an easy web-based tool for accounting that let’s me publish reports, I will literally ‘open up the books’ so that you can see how it works out, financially … let me know if you know of one?] …

Why Information Publishing?

Well, it lets me do something that I won’t do on my blogs: turn stuff that I know into stuff that I can sell … and, it allows me to sell all sorts of affiliate stuff (so, all the referrals that I make to various books and other useful products on this site, without any financial benefit to myself, can be sold WITH affiliate commissions on the new site).

Again, for your benefit. How?

Because you can think of some area where you are (or can quickly become) an ‘expert’ and follow in my foot-steps … assuming that my site produces a useful income. That’s the purpose of this test!

So, as I write this post I am literally sitting down having this morning hit on the concept for a commercial version of my blogs, and am looking for the ‘right’ way to implement it.

For this, I have decided first to try out Derek Gehl’s new product, BeBiz – supposedly a way to create an sales-oriented internet site pretty quickly … since I don’t yet have the product (I am thinking an eBook to start with) or the means to create my own web-site from scratch, I am hoping that this product will lead me ‘by the hand’ as this product demo [AJC: which I have just paused to write this comment, and which I am about to continue watchingbefore typing and more] promises.

We shall see …

[AJC: Rather than fill this blog with more posts on this subject, I just created a brand new blog – yes, AJC is officially an idiot … instead of sitting back in his hammock, drinking pina coladas like he’s supposed to be doing now that he’s fully and healthily/wealthily retired at 49 years old, he wants to create yet another blog to fill in his time! I hope to use this blog to chronicle how to start an easy – well, I hope it will be easy – web-site that actually makes enough money to make it worth while for somebody like you … and, I plan to do that one in ‘real time’ i.e. write posts as I do stuff on that blog]

Start the next Facebook?

Alex asks:

I think I have a fairly solid financial intelligence, although I am always on the lookout for learning new information on stocks, and real estate and the like. When I was a sophomore in high school I spent my saved money on stocks instead of a car like everyone else. But what I want to know, is how to START. It seems like you need money to make money, but right now I am just about to begin college, and while I have no intention whatsoever of spending my life (especially my youthful 22-40 years) working, right now I don’t have the money to buy real estate and begin to build an income generating property portfolio. In four years when I graduate, I will have no college loan debt, but I don’t want to “enter the workforce” because I will never get rich working for someone else. Do you think its possible to do something like 2 million in 4 years, so that when I graduate I will have enough money to use to make more money with? And if so, how do I start that now? I currently have about $16,000 in stocks.

So Alex wants to go from $16k to $2 Million in 4 years …

… as I pointed out to him, that’s a 400% compounded return. The stock market averages 12%; Warren Buffett averages 26%

But, I did point Alex to two places that can return 400% or even more: the lottery and business. I humbly suggested that he start the next Facebook.

Alex responded:

Well maybe I was too hasty in throwing out the figure 2 million. I guess what i really mean is how do I build up a large enough sum of money to actually begin making money with? All of your “money making 101″ strategies seem to already require a sizable pile of money with which to begin implementing them. Also, the real estate strategy of building up passive income through rents is an extremely long term one. If I were to buy a $160,000 dollar house at 6% with about 30,000 down (assuming my 16k turned into 30k during my college years), my mortgage would be around 720 a month. Realistically, I could probably rent that property for about 1100 a month. So we are only talking about somewhere around $3600 per year. Its a strategy that takes over 25 years to really begin producing enough passive income to support just a modest, middle class lifestyle.

Now, I’ll let you in on a little secret, and the younger you are – College age is ideal – the better this works:

Skip Making Money 101.

There, I said it: don’t worry about all the save 15% of your salary stuff; all the pay down debt stuff; all the diversify into Index Funds stuff …

… simply forget all the personal finance blogs, altogether.

Jump straight to Making Money 201.

Start a business – the internet is ideal – because I can’t think of any other legal way to give you a shot at making millions … and, it’s clearly possible because others have done it.

But, wait … surely you can’t expect to create the next Facebook?!

No, you can’t … but, you won’t need to: you only need to focus on making as much money (income) as you reasonably can – while still concentrating on getting good College grades.

Here’s the SECRET:

While you are making oodles and oodles of cash (well, at least a few extra bucks), you don’t spend it … in fact, you don’t even tell anyone that you have it. Your business could be generating an extra $100 a week, $1,000 a week, or even $10,000 a week and you still don’t tell anybody.

Why?

Because your secrecy lets you keep living like a penniless college kid, mooching off family and friends like any ‘normal’ college kid does, while you’re busy investing 99% of what you earn.

Will this work?

Maybe … but, if you flame and burn [AJC: did I forget to mention this was high risk / high reward 🙂 ], so what?

As long as you’ve been careful to avoid accumulating personal debt, you’re still just as poor as your buddies; you learned a lot; and, you had a helluva ride …

… one that you would never had been able to take if you actually needed Making Money 101 😉

That’s why you take risks when you are young, before you are saddled with debt, commitments, and angst.

I think I’ve been confused …

LuckyInvestor has been busy building a kind of reference manual / index to our ‘grand experiment’ at 7m7y.com … take a look and let him know what you think (what is he missing? what’s in/out of place? suggestions?) … the only reason why I won’t directly support the site is that I am not sure where it is going and I cannot control if he eventually puts in advertising, which is against my principles for this program (but, he is welcome to) … so, any help that you can / want to give him … check this out: http://luckyinvestormn.blogspot.com/

Now, on with today’s post ….

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If you think you’re confused, then you really are confused!

This seems to be Ethel’s dilemma, one that we inadvertently uncovered when she wrote me an e-mail (on Networth IQ) asking for help on transitioning from Making Money 101 to Making Money 201.

After reading my answer to her original problem Ethel left a long – and critically important – comment, saying:

“However, I feel that my audience wants more … they have a ‘big dream’ … they want it now (well, soon’ish) … and it requires fuel – lots of it (money!) – and lots of free time, to boot!”

I think this *is* me, but the issue is that I haven’t defined my dream. It isn’t the standard, “Retire at age X and live like a king” style of dream – I’m happy with a modest lifestyle. But I want to have (a) time to volunteer and (b) money to support others in volunteer and charitable work, and I want to change the world through this work.

I think I’ve been confused by all the focus on retirement (like in your magic number article). Retirement is exceedingly easy for me; I could probably have everything I need in a 401(k) and IRA by the end of a couple of years, let it sit for 30 years, and be done with retirement planning.

What I should have been defining is how I want to change the world BEFORE then, how much time this will take, how much money this will take, how much I can earn mid-dream, when I want to do it, and if I will have time after this to get all the resources for the rest of my life (retirement), or if I will need to start getting ready for retirement now as well.

So . . . when I start thinking this way, I see that most of my dreams are best accomplished in my 30s and 40s, maybe early 50’s. That’s where I’ve been messing up. I should worry less about retirement, which is a low-resource period when I dream about my life. I should worry more about ages 30 to 45, when I want to accomplish my biggest, most time-and-money intensive dreams. I don’t intend to be retired during this time, but I would like to cut back my hours at work so I can give time as well as money, and so I can spend more time with my husband and children.

The trick for us is that we are essentially just starting out. So I need to go from just over $0 to (magic number for my mid-life dreams) in 5 years. This isn’t too scary, since I will be earning during mid-life still – just not as much. But it is still ambitious – and when I reduce hours at my job, I will need either fewer expenses, or a passive income / savings to cover the gap between expenses and job income.

Thanks, you’ve helped a lot by making me question if I should even be trying to get rich(er) quick(er). Yes, I should – but now I know what I need to know to figure out how much money, how fast. My magic number is just going to take a little more work to figure out, since it’s not just “get here and then stop active earning”.

I’m glad that Ethel asked the question on NWiQ and gave me the opportunity to respond here, because she has summarized very neatly in this comment what I have obviously so far failed to make clear on this blog.

And, that is:

Retirement is not some nebulous date in 30 years when society ‘norms’ say that it’s time to stop working …

… it’s when you need to stop preparing to live and actually start living!

You ‘magic number’ is not merely a number ….

… it’s a DATE.

A date when you need to stop working (or, at least stop working as hard) to concentrate on LIVING your Life’s Purpose.