Spending your Net Worth

Currently, over at the 7 Millionaires … In Training! ‘grand experiment’ we have been looking at the 7MIT’s cars and their attitudes, thereof.

I introduced them to the 5% Cars + Other Possessions Rule, which Jeff seems to have forgotten covers all of your possessions outside of your home … not just your car:

It seems like all you’d need to do is wait a bit and eventually your car will depreciate enough to be under 5%.

Does anyone really count their cars as part of their net worth? I view them more as a disposable item and not something that I try and calculate my net worth with.

But, Jeff does touch on an interesting ‘quirk’ of cars and other possessions that is different to what generally happens with houses and investments: they go DOWN in value over time.

This depreciation is something that we can take advantage of …

… you see, we can use the fact that our Net Worth should be increasing – while these other items are probably decreasing – to allow us to go shopping every few years or so!

[AJC: But, don’t forget to always pay CASH!]

Think about it, if 75% of our Net Worth is in investments (this is called your Investment Net Worth … it does NOT include your house, cars, and other cr*p that you may have lying around) and 20% is in your house and 5% in your cars/possessions, then you may have a Net Worth IQ asset column that looks like this:

Investments: $75,000 (75%)

House Equity: $20,000 (20%)

Cars: $2,500 (2.5%)

Other Possessions: $2,500 (2.5%)

But, in 3 years time – assuming a ‘normal’ market (and, who can really assume anything these days?!), it might look something like this:

Investments: $105,000 (80%)

House Equity: $25,000 (18%)

Cars: $1,250 (1%)

Other Possessions: $1,250 (1%)

Which allows you a number of options:

a) Pay down some of your mortgage (up to $2,500) to bring your house back to the maximum equity that these rules ‘allow’, or

b) Buy a newer car or some more cr*p (up to $2,500) to reward yourself for your good work, or

c) Decide to become rich(er), quick(er) by realizing that the rules were designed to have a MINIMUM of 75% of your Net Worth in investments … but, there’s nothing wrong with investing more ūüôā

d) Some sensible combination of any/all of the above

I like (d) … to be totally honest, I don’t go for the overly-frugal nonsense: once I reach a financial milestone, I see nothing wrong with allowing myself a little enjoyment … that’s why I’m sitting back on my hammock right now with a Pina Colada and enjoying the Aussie sunshine ….

… regardless of how YOU choose to look at it, when you have a set of guidelines that you can follow, doesn’t it make it easy to at least see what the choices are?

Devolving the Myth of Income … Part II

In Devolving the Myth of Income ‚Ķ Part I we explored the following¬†question: “what‚Äôs your definition of ‚Äėrich‚Äô ‚Ķ would being a highly-paid professional (such as a doctor) or a high-flying executive (such as a high-tech sales rep) earning megabucks-per-year do it for you?”

Today, I want to finish exploring this subject by looking at question recently posed on Networth IQ a web-site for people to track (and discuss) their own Net Worth.

The question was posted by mario  (you may need to register and log-in to see his Networth IQ Profile):

Like many Americans, I have a great deal of equity in my home, built up by “trading up” over the past 20 years. At this point I have over $2M of equity in my home, which represents two-thirds of my overall net worth. While this is all good, I am starting to feel like this flies in the face of my diversification goals; how can I consider myself diversified if I have 66% of my net worth tied up in one piece of real estate? I would sell the house in a minute except for the tax consequences. Does anyone have a strategy other than selling?

Here is a guy¬†with a high-flying sales career, earning more than¬†$250,000 a year and he’s less than 50!

He also has a house worth $2,000,000 …

…. now, you could be describing me!

But, there’s only¬†two differences:

1. If I choose to¬†stay in bed tomorrow … that’s OK.¬†Stay in bed the next day … fine. The day after, the day after … it doesn’t matter.¬†Even¬†if I never bother getting out of bed again … the money¬†keeps rolling in.

2. I can afford my $2 Million house, my Maserati and my $250,000 a year lifestyle!

Let me explain …

In a recent post I wrote about the Fisherman and the Investment Banker; ‘Mario’ is the Fisherman, I am the Investment Banker¬†… what happens when Mario’s ‘fishing career’ stops?

When Mario stops, his income stops, and he can no longer afford his lifestyle. This is mainly because, Mario’s Investment Net Worth is¬†much lower than his Notional Net Worth.

Here is what the Mario’s of this world – that is,¬†those with high-flying corporate jobs and those in high-income-producing businesses¬†(and there are plenty of both!) –¬†need to do to ‘bullet proof’ their lifestyle:

1. Stay in the habit of saving¬†– maintain the same good savings and debt control habits and¬†(relatively) low-cost lifestyle as I hope you had when you were starting out, because you will need¬†these habits¬†when the income eventually stops flowing in …¬†that will happen when you retire but it may happen even sooner than you think.

2. Only buy as much house as you can affordobey the 20% Rule  and make sure that you only carry enough mortgage that you can afford without compromising you savings and investing goals.

3. Revalue your house every 3 to 5 years  Рwhenever your equity exceeds 20% of your Net Worth (Mario!), refinance the house and put 100% of that money towards your Investment Plan.

4. Accelerate your Savings Plan– save at least 50% of non-reinvested business income, every future pay increase, bonus, tax refund check, found money (the loose change in your pockets, Aunt May’s inheritance, that lottery win … anything and everything!). Enjoy the other 50%¬†… go ahead … you worked for it!

5. Implement your Investment Plan – Every time that your Savings Plan builds up sufficient funds, add to your investments by buying and holding for ever any mix of the following that suits your skills and¬†interests¬†(do NOT trade with this money … build up a separate ‘spec fund’ if you want to do that):

a) Income-producing real estate, and/or

b) 4 or 5 direct stocks in companies that you understand and would love to own, and/or

c) Low cost, broad-based Index Funds.

I prefer¬†investing in exactly this order, simply because you can leverage (i.e. borrow more) and improve returns by selecting/managing carefully (a) over (b) over (c) … but, that’s personal choice.

This simply boils down to saving more and spending less (now) to live well and securely (later) … no matter what you income is today … delayed gratification in action!

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How to avoid being 'house rich' yet 'cash poor' …

I recently read about a very interesting predicament for a reader on Free Money Finance  Рone that is, unfortunately, all too common.

 Here is what the reader asked on the post on FMF:

¬†To start off, my husband and I purchased our home in 1987 for a little over $100,000…..[ her husband died after a whole series of family tragedies]……The house is the only asset I have left and the only thing I have to pass down to our children.

Now, you will need to read the entire post on FMF just to understand the tragedies that this poor woman has had to endure …

…. on top of that, she now has to face an uncertain future because their only form of ‘financial planning’ was to own their own house.

 This is an all-too-common story. In fact, I am reminded of two recent stories from my own family:

1. My wife’s mother died living on a government pension, no vacations, walked wherever she could, and otherwise penny-pinched to survive. Yet she died and left her three daughters (including my wife) a house worth nearly $800k and no mortgage!

2. My 95 y.o. grandmother (still living!) spends all of her income on supporting my mother and two sisters (all capable of working, but choose not to), struggles to pay her own bills (she had to borrow $40,000 from me to pay a Land tax bill). She¬†gave my son a check for his birthday when we went to visit her last Christmas … the check bounced!

However, she just sold an investment property that she had held on to for many, many years (clearly, it became so run down that income was very low) for $4.5 Mill!

Kind of reminds me of the guy who lives like a miser but has a secret $1,000,000 stash of cash stuffed into his mattress.

These are examples of being ‘asset rich’ and ‘cash poor’ and, unfortunately,¬†describes so many Americans reaching retirement age.

The solution is the 20% rule

If you didn’t read the original post, this ‘rule’ says: have no more than 20% of your net worth tied up in your house (plus another 5% max. tied up in cars, furniture and other possessions).

That is simply another way of saying that you must have 75% of your Net Worth in income-producing assets (if you are at or near retirement age) or in a mix of income and growth assets (if you are at least 10 years off retirement).

If you are nowhere near retirement, and this will be your first home purchase … go ahead and break the 20% rule … but, reassess every year and make it your goal to build up enough free equity (that is, more than the 20% rule allows)¬†… when you do, be sure to¬†use that equity to invest or you will end up exactly where this post says you don’t want to be!

Having a house … and only a house … is no way to live.

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Devolving the Myth of Income … Part I

What’s your definition of ‘rich’ … would being a highly-paid professional (such as a doctor) or a high-flying executive (such as a high-tech sales rep) earning megabucks-per-year do it for you?

If so, strap in, because I am about to devolve the myth of income by looking at two case studies, both from Networth IQ a web-site for people to track (and discuss) their own Net Worth.

To start, here is an excerpt from an e-mail that I received from docsd  (you may need to register and log-in to see his Networth IQ Profile):

I have been awaiting approval on a home that I am purchasing and just received word today that I was approved for the loan and that the closing process will proceed. My wife and I plan on staying in the home for many years to come, as it is an older historic horse farm on several acres outside of Louisville, KY and this home fulfills my wife’s dreams of being able to have horses. I actually came to a compromise with her regarding this house because my goal has always been to live as far below my means as possible while accumulating wealth and her goal was to have a considerable and high-end horse estate on several acres (obviously not inexpensive living, especially if this is a 500k-million dollar home that you plan on staying in). The compromise we made was to wait as long as we could to find the best deal possible so that we can fulfill both of our desires between the property and the low personal overhead to help with wealth accumulation. That time has come and we found the property, basically stole it for tens of thousands below its most recent appraisal and we qualified to purchase it while still holding on to our current home. We are purchasing the new home for 325k and our current home is valued at between 307k and 314k.

I feel I am in a unique position as the owner of 2 homes this early in starting my career and have a feeling I can make a much better situation out of my current home by holding on to it instead of selling it quickly in this market….however, I am worried that it is too pricey to be able use as a rental property investment at this time. Provided I refinance it to the going rate, around 6%, which is considerably better than the 8% we qualified for when we bought it just over 2 years ago, the total monthly liability for us would be just over 2k per month and I’m just not confident we can get that much monthly for rent here at the moment. This house is a very nice and large house in one of the more exclusive parts of town (in an area that has been averaging nearly 10% appreciation for homes per year across several years and not impacted near

What would you do if you were the ‘Doc’?

Obviously, we don’t know nearly enough about his situation … and, we can’t give specific financial advice, anyway … but, we can make some general observations:

Firstly, we can see a hard working¬†professional (we presume) earning over $150k per year … easy street!

Then we see the problems that go along with it: too much house, too much lifestyle, too much debt … even though our ‘Doc’ says that he is focused on saving and wealth creation.

But, Doc has some bigger issues to deal with:

Assets   $ Diff % Diff
Cash $3,400 $400 13.33 %
Stocks $0 $0
Bonds $0 $0
Annuities $0 $0
Retirement $0 $0
Home $313,500 $6,000 1.95 %
Other Real Estate $0 $0
Cars $8,220 ($280) -3.29 %
Personal Property $25,000 $0 0.00 %
Other $0 ($1,500)
Total Assets $350,120 $4,620 1.34 %
Debts   $ Diff % Diff
Home Mortgage(s) $279,510 $0 0.00 %
Other Mortgage(s) $0 $0
Student Loans $142,725 ($125) -0.09 %
Credit Card $0 $0
Car Loans $0 $0
Other $15,440 ($780) -4.81 %
Total Debts $437,675 ($905) -0.21 %
 
Net Worth ($87,555) $5,525 5.94 %

1. Student debt and other debt (plus his mortgage) of nearly $160k that must be paid off!

The ONLY reason not to concentrate solely on paying it off now is if (a) the interest rates on these loans are lower than mortgage rates, and (b) the money that should be used for paying off these loans will instead go into long-term, buy-and-hold, income producing rental property.

2. The ‘doc’ has a negative Net Worth!

Now, that’s always understandable for a professional with large student loans to pay off early in their career; I¬†don’t know how long¬†‘our doc’ has been working,¬†but to be looking to compound this Net Worth deficit by upgrading lifestyle is not something that I would usually recommend.

But, there is also an emotional/lifestyle decision to be made here: 

For example, we need a wife who is onside, so it would be tempting to simply swap one home for the other (keeping in mind it’s probably ‘only’ a $50k – $100k¬†‘swap’ … new house is slightly more expensive than the existing,¬†but there will also be closing costs and selling costs, etc.).

But, I have a question around the horses … this house comes with a new lifestyle: are the horses just an¬†expense (i.e. buy, feed, maintain) or also an income (e.g. agisting other people’s horses, selling horses, giving riding lessons, etc.)?

If the latter, I would consider upgrading just to keep the ‘little missus’ happy, but only if I was committed to earning more and using that extra income to accelerate debt repayment¬†… if the former … hmmmm.

Given that we are not really assessing the Doc’s situation, because we don’t know enough, we need to realize that high income = high wealth only when that income is put to:

a. Debt reduction, then

b. Passive Investments

Lifestyle comes from the perpetually sustainable income that good passive investments should spin off … at least, that’s how I live.

In Part II, we’ll look at the super-high-flying-sales-rep …

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Calculating your Investment Net Worth

I found a site that I really like; it’s called Net Worth IQ and it’s a social network around calculating (& sharing if you feel so inclined) your net Worth.

 To be conservative in calculating your Net Worth, you should LEAVE OUT:

a) Any ‘equity’ in your house that you NEVER intend to release as investment (i.e. borrow against for purchasing, when the timing is right, income-producing-buy-and-hold-investment-real-estate).

b) Any supposed ‘equity’ that you have in your business.

Let’s call the result your INVESTMENT NET WORTH …

¬†It’s the only one that matters!

Why?

Well,there are only TWO reasons to even bother calculating your Net Worth:

1. To ensure that your ‘portfolio’ matches the Rules of the Rich (e.g. the 20% ‘rule’ on home equity that I talk about in a¬†recent post), and

2. To check whether your INVESTMENT NET WORTH (which should be in passive income-producing investments by then) can FUND your ideal retirement with at least 99% chance that your money won’t run out before you do.

I must confess that for the purposes of¬†the Net Worth IQ¬†site … I broke those two rules, so I should lower my Net Worth by approx. $2.5M, and I may make that change later – I haven’t decided yet.

BUT, I have already done the calcs and am acutely aware that my INVESTMENT NET WORTH can EASILY fund my retirement starting next year (I’ll be 50 … now, that’s old, Man!).

If this makes sense to you … check out some Tips that I have already left on that site and this¬†blog.

Now, what’s YOUR Investment Net Worth … more importantly, can it fund your IDEAL retirement?

The 4-step, never-fail plan to making a fortune in real estate …

There is a lot of BAD stuff written about real estate and a little bit¬†of GOOD stuff … start by finding and reading some of these good books (google “John T Reed” and see which books he recommends and which ones he pans).

The truth is that most people MAKE money through a business, then KEEP money by investing in real estate.

If you can’t (or won’t) start a business (even on the side) then you can at least accelerate your LIFE SAVINGS PLAN by buying and holding income-producing real-estate.

Right now, it’s very simple:

1. If you don’t yet own your own home (but would like to) BUY one now and LOCK in the interest for 30 years.

Why?

Home prices are relatively cheap (if you think they will get cheaper then wait a little longer … if you’re not SURE they will get cheaper, buy now).

Money is cheap Рmortgage rates are probably 2% lower than they will be by 2009 or 2010.

You want to keep buying that cheap¬†money for as long as possible …

… but, only IF you are prepared to take the next step, which is to …

2. Assess the increased / excess equity (what your house is worth – what you still owe) in your house yearly and use that excess equity to buy another as soon as you can scrape up a reasonable deposit (20% if you are conservative).

3. Lock in the interest rates for 30 years; rent the property out; keep raising rents; reassess the value of all of your properties yearly.

4. Repeat until Rich!

Now, this will take 10 to 30 years …¬†to accelerate: start that little (or big) side-business and use the excess cash-flow to buy more investment properties rather than Porsches!

Simple … and, you couldn’t be starting at a better time in history.

Do you really care that weekly contributions of $34 could potentially grow to over $76,000 in 20 years?

I just received a hilarious e-mail in my in-box from Fidelity. It said: Did you know that weekly contributions of $34 could potentially grow to over $76,000 in 20 years?*

*This hypothetical example assumes a participant earns $30,000 every year and defers 6% of his/her weekly pay ($34/week) at the beginning of every week for 20 years to a tax-deferred retirement account earning a 7% annual rate of return compounded weekly.”

Why is that funny? Well, in 20 years, $76,000 won’t even buy you a car!

That’s the problem with these “save your way to $1,000,000” advertisements (and, books) …

… while you certainly should put away at least 10% of your gross income (hopefully, it¬†eventually comes to a lot more than $34 a week!), and

… while you may (and should try to at least) make it all the way to $1,000,000 in the bank (or CD’s or 401K) by the time you retire in 30 or 40 years:

(a) You will probably be too old and tired to enjoy it … hell, I’ve waited to 49 to retire and I already feel too old ..¬†and

(b) $1,000,000 will buy you diddly squat because of a little thing called inflation.

Inflation is the thing that causes a  sixteen ounce loaf of bread to cost $0.19 in 1950 and $2.10 in 2008!

You don’t have to look too far to see this inflation-effect taken to it’s extreme:¬†in Zimbabwe raging inflation is the thing that means even¬†Z$750,000 isn’t enough to buy¬†that $2¬†loaf of bread!

What does this mean if inflation averages, say, just 3%?

Let’s say that¬†you are 25 years old today, aiming to save $1,000,000 by the time you retire …¬†by the time you reach¬†65 and cash in your $1,000,000 ‘retirement check’ that would be the same as your grandfather¬†retiring today on just $315,000 savings!

Does that sound like a lot? Let’s see …

$315,000 would give your grandfather just $15,000 a year to live on (allowing for small yearly ‘pay increases’ after 65, so that he could also keep up with inflation).

Would you want to retire on just $15,000 a year?

No?

Then the only choice that you have left is to try and get rich …¬†quickly, slowly, any legal, safe and ethical way that you can …

Stick with me, and I’ll show you how! Really.

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Against the odds …

For those of you who follow this blog, you will know that a key part of getting ahead is increasing your income.

And, you will already know that I think one of the best ways to do this is to start your own business … perhaps part-time, at first, to limit your risk … and, definitely¬†in combination with other financial strategies that I will be sharing with you over the coming weeks.

For me, the gold-standard in this area is still The E-Myth Revisited by Michael Gerber … a book that I will unashamedly admit changed by life.

But, for anybody heading down the entrepreneurial path, I equally highly recommend a book by Guy Kawasaki (ex-Apple, founder of garage.com) called Art of the Start.

Guy can also be found on his blog, where I found this interesting post, that deals with the various myths around being an entrepreneur.

The problem is that the guest author is an academic who uses ODDS to establish that some types of businesses are better than others, and to suggest that it is the type of business that you go into rather than your ‘entrepreneurial ability’ that determines your success.

Here’s where I disagree¬†…

YOUR odds of succeeding in any business venture are exactly 50/50 … either you WILL or you WON’T succeed!

Obviously, that makes no MATHEMATICAL sense, but going into business rarely does.

That’s why the rewards for those who DO succeed can be so high. If it were easy¬†– and if success was GUARANTEED¬†–¬†we’d ALL be doing it!

For example, we intuitively know that the ODDS of being a huge success are so small in, say, sandwich shops.

In fact, the article suggests that the odds of mega-success in that type of business are 840 times smaller than starting, say, a computer business.

Yet, who wouldn’t like to be Mr Subway, Mr Quizno, Mr Togo, or Mr Potbelly?

I’ll¬†even put up $1,000 that says that each of them knew EXACTLY what they were getting themselves into when they started out.

But, somewhere along the line each and every one of these entrepreneurs¬†… in fact, EVERY SINGLE SUCCESSFUL ENTREPRENEUR IN HISTORY¬†… simply said: “screw the odds”.

Having done some ‘odds screwing’ of my own (a number of times, with great success) over the years,¬†I humbly suggest that you do, too.

Please let me know how well you do …