No such thing as a free lunch …


This concept has come up three times recently, so it deserves a post of its own!

First Time

My son asked me why he can’t buy a car (when he’s old enough) on finance, and I explained it to him…

… he then asked me the million dollar question:

What about if there is a 0% finance deal on the car? Can I finance it then?

And, my answer was:

There’s no such thing as a free lunch.

Second Time

Ryan was posting about his car and Josh commented:

I would suggest buying used until you have cash to buy a new…BMW, you have no maintenance bill for 4 years, 50,000 miles.

And, my answer was:

There’s no such thing as a free lunch.

Third Time

I wrote a post about a hypothetical real-estate deal, with the key feature of a rental return guarantee. Rick said:

The description sounds like a good deal to me for a low risk- a guaranteed 7.5% return + possibility of great appreciation. It really sounds too good to be true.

And, it is (too good to be true); you see:

There’s no such thing as a free lunch.

… really, there isn’t. Somewhere along the line you are paying.

Let’s take the last case first: guarantees are usually not worth the paper they’re written on. Especially when they are “thrown in” to make a “great deal” sound even better. In the real-estate deal the ‘guarantee’ could actually cost you money, if the developers/promoters have to borrow money against the future value of the project to make a current payment to you.

In most  new projects where, say, a 2 year rental guarantee is offered, the value of the guarantee is built into the price that the property is offered to you at … might explain some of the very dramatic rises and falls in RE values in Florida, for example.

Similarly with the second example of the ‘free servicing’, which is – of course – built into the price of the car. Naturally, if you simply MUST have a brand-new BMW then you will get the ‘free’ servicing with it. On the other hand, if you can buy a used BMW just after the ‘free servicing warranty period’ has expired, you will be buying at the best possible price point, because (in a normal market) you should expect a sudden drop in the value of the car … this sudden drop represents the real, current value of the ‘free servicing’.

If you understand this concept, then so-called 0% down deals should become obvious … YOU are actually paying for all of the interest, at commercial rates, up front!

I did some consulting work for a finance company that underwrote so-called “2 year interest free” loans on furniture sales for large retailers; they made their money because the store paid a fixed amount up front when you signed up to the deal, then the finance company HOPED that you would not be able to make all your payments on time, because the ‘fine print’ on the deal then let them charge you interest at credit card rates (19% p.a. to 29% p.a.) on the entire financed amount for the entire time that you had the “0% loan”.

Here’s the test; always ask:

… and, if I don’t take the [insert: free lunch du jour] how much do I have to pay then??

Then you can decide if the free lunch is something that you can afford!

Put your money into CD's? Not exactly what we meant!

Casting Call


Last days for ‘pre-applications’ to become one of my 7 millionaires … In Training! Click here to find out more …


Here’s another in my Money-Video-On-Sundays Series …

This clip from the popular comedy, The Office, is sad but true … how many students are also ‘investing’ their money into CD’s the way that this guy does, rather than saving and paying down debt?


PS Take a look at the latest Money Hacks Carnival here ….

Applying the 20% Rule – Part II ( Your Possessions)

In my precursor post called Applying the 20% Rule – Part I ( Your House), I defined the 20% Rule and the 5% Rule as follows:

You should have no more than 20% of your Net Worth ‘invested’ in your house at any one time; you should also have no more than 5% of your Net Worth invested in other non-income-producing possessions (e.g. car/s, furniture, ‘stuff’). Why?

This ‘forces’ you to keep the bulk of your Net Worth in investments i.e. real assets (stuff that puts money into your pocket … not stuff that drains your finances)!

As a reminder, I represented this as a simple formula:

20% (max.) for your house + 5% (max.) for all the other stuff that you own = 75% (min.) of your Net Worth always in Investments

I also pointed out in that article how the Current Market Value of Your House will usually go up over time (current market conditions aside) but, the Current Market Value of Your Possessions will usually go down over time (collectibles aside!).

Whereas houses generally appreciate … possessions generally depreciate!

Now, as much as I hate to point this out (because the ‘frugal blogging community’ will probably fry me!) you can actually use this interesting financial anomaly to buy more stuff

… and, according to the $7million7year ‘philosophy’ the process of making money and getting rich should sometimes mean ‘delayed gratification’ but should never have to mean ‘no gratification’!

That means, that when starting out you may have to buy what you need and maybe even buy a house and generally screw yourself up financially (that’s where the ‘frugal blogging community’ comes in handy, because they will show you how to minimize – perhaps eliminate this risk – even better than my basic Making Money 101 Principles can help you).

If you do, by following my Making Money 101 steps and reading (and following) as many of these posts as possible, you will get yourself on the right track and find that:

 1. Your House fits the 20% Rule,

2. Your Meager Possessions fit the 5% Rule,

3. And, you are sensibly Investing the rest!

What now … well, pat yourself on the back and wait … until:

i) You have saved up enough cash to buy whatever it is that you are salivating over – repeat after me: we will never borrow money to by depreciating ‘stuff’ again – and,

ii) You have revalued your stuff (eBay and Craig’s List are two excellent sources of ‘current market valuations’ for all sorts of ‘stuff’) and found that they have lost so much value since you bought them that they now total less than 5% of your Current Net Worth, and

iii) The (hopefully, now increased) equity in your House still fits into the 20% Rule – and, you have applied everything in Applying The 20% Rule – Part I (Your House) if it doesn’t, and

iv) If you do buy the ‘New Stuff’, the total Current Market Value of your Possessions still fits into 5% of your current (hopefully, by now increased) Net Worth.

…. if you can check all of the above ‘boxes’ … go ahead and buy it, guilt free – you deserve it!

Now, the astute investors out there will have realized that if you increase your Investment Net Worth (i.e. the minimum of 75% of your Notional Net Worth that you keep in income-producing INVESTMENTS) – as you should, by an average of 8% compound a year or better – you will be able to increase the other 25% that is in your home equity and possessions to match!

In other words, you will (if you so choose) be able to match an increase in lifestyle arising from a better financial position …. life doesn’t get any better than that, does it?

Celebrating Spending Week!

For the remainder of this week I want to do something that I believe has never been done in the history of Personal Finance: encourage spending!

Why would I do a ‘heathen’ thing like that:

1. Well spending is good for the economy … it’s how we got things going after WW2 … go ahead be a Patriot!

2. Money has NO PURPOSE until you spend it

3. Money SPENT NOW is worth more than MONEY SPENT later (due to a little thing called Inflation)

4. Learning when/how to spend is AS IMPORTANT as learning how to save … after all, you WILL spend b/w 50% and 90% of your weekly paycheck!

5. If you don’t SPEND when you CAN and SHOULD, society has a word for you: Miser and we don’t want to confuse being SENSIBLE with being STUPID, do we?

But, there is a why and a wherefore that I will be exploring for the rest of this week … enjoy!

And, don’t forget to let me know what you think … we want to be on the cutting-edge of Personal Finance thinking, not the BLEEDING EDGE … your feedback will help us determine where we stand.


Making Money 201 – Going for Broke!

If Making Money 101 could be drastically over-simplified as ‘saving’; then Making Money 201 is equally over-simplified as being about building your income.

If you were serious about getting your financial house in order quickly, then you probably already did some income building to help you pay debt off quickly while you were working your way through Making Money 101.

Unless you’re a CEO of a Fortune 500 company, or a top professional doctor / dentist / attorney / accountant, then you will need to think about starting a business.

And, to accelerate your business or professional income you may also decide to get into the business of active investing (renovating/flipping real estate, trading stocks and options, etc.).

This is the stage that you get to take RISKS (that’s why you need a solid foundation and plenty of runway … you WILL fail at least once, twice, three times …) because that is the only way to get the big financial REWARDS.

This stage is hard work!

But, it is where you actually sow the seeds that will eventually make you rich …

There are plenty of books and a few blogs around, but most of them are specific to just ONE WAY of making money … the author’s way; some are good and some are lousy.

By the end of this stage you will be earning more than 90% of the US population and will be accelerating rapidly down the runway to financial health … but, spending will also increase dramatically and you will struggle to hang on UNLESS you ALWAYS remember your Making Money 101 lessons about saving!

Paradoxically, you will be the ‘richest’ that you will ever be in your life during this stage IF to you, being ‘rich’ means being able to spend lots of money

… the problem is that your ‘wealth’ is only based upon your income, therefore only lasts as long as your business or job does.

Also, many of the Making Money 101 rules now need to change, as do almost all of the tools ….

For example, dollar cost averaging and index funds are replaced with sensible investment and savings rules and strategies.

You are still far from ‘rich’ …

In fact, you are still Just Over Broke … but, starting to break free!

Where do you stand?

In a recent post, I shared one view (not mine) on what it takes to be considered rich

…it’s $5 million !

Now, here is an article by Bankrate that brings that number right down to the other end of the scale …

Check out this table showing the spread of annual income:

Income level (percentile)

Median income (rounded)
Level VI (90 to 100) $170,000
Level V (80 to 89.9) $99,000
Level IV (60 to 79.9) $65,000
Level III (40 to 59.9) $40,000
Level II (20 to 39.9) $24,000
Level I (less than 20) $10,000

Source: Before-Tax Family Income, 2001 Federal Reserve Board Survey 

First, let’s see where you stand in relation to this table?

If you aren’t in the top brackets (although, many of our readers are), it might be comforting to note (according to the Bankrate article): “if you are bringing in $40,000 a year, you’re doing better than half the households in America. Or, as a Washington think tank recently pointed out: If you’re a teacher married to a policeman, your combined household income puts you in the top 25 percent of all households in the nation.”

What intersted me most, was the relatively low income that it takes to be at the absolute middle of the top 10% of all income earners in the USA … ‘only’ $170,000.

This amount seems to correlate with a New York Times survey that said the ‘rich’ were bringing in between $100,000 and $200,000 per year …

… and, if you are like most Americans – earning less than $40,000 – this sounds like a king’s ransom … but, it’s not.

You see, there’s a big difference between what you might bring in as income and what some people call sustainable retirement income .

Take a look at what the Bankrate article tells us how much these same people currently have as their Net Worth:

Net worth (percentile)

Median net worth (rounded)
Level VI (90 to 100) $833,600
Level V (80 to 89.9) $263,100
Level IV (60 to 79.9) $141,500
Level III (40 to 59.9) $62,500
Level II (20 to 39.9) $37,200
Level I (less than 20) $7,900

Source: Family Net Worth, 2001 Federal Reserve Board Survey 

Look at the top level, the same ‘rich’ people who earned $170,000 a year in the first table, only have a median net worth of $833,000 according to the second table.

Now, if you take this $833,000 and apply the ‘safe’ annual withdrawal rate of 4% as advocated by most misinformed financial advisors (for me, the safe withdrawal rate is more like 2.5% p.a.), it seems like these so-called ‘rich guys’ can only afford to spin off $33,000 a year.

Now, that’s less than the teacher and the fireman! So, what’s wrong?

Well, for a start there are actually very few really Rich people in this country – so few that there should be another category in BOTH of the above tables: the top 1% of the USA population by Net Worth and Annual Income. 

Secondly, the so-called ‘rich guys’ earning $170,000 are just like the rest of the working population working at a JOB … Just Over Broke.

When their job stops, they stop being ‘rich’ … period.

So, where do you stand?

How much should you take out of your business?

This is one of the most difficult questions if you are a business owner and, like most business owners, it is your primary source of income.

You might say, of course it’s your primary source of income .. that’s why I’m in business! But, that is the fallacy that we will be exploring in upcoming posts.

For now, let me tell you about a conversation that I had with a friend over dinner last night:

My friend said that he had a friend who owned a payday lending business – sounds a bit unsavoury to me, but generates mountains of cash for him.

My friend’s point was that this guy would admit that he’s not very smart, but has a very simple system for dealing with the $3 mill. that his business spins off every year:

1. He gives $1 mill. to Uncle Sam

2. He invests $1 mill. (my friend didn’t ask where or how)

3. He spends $1 mill.


But, it’s also wrong …

What would happen if the business had to close down tomorrow (e.g. change in government regulation)?

Unless this guy had managed to save $20 mill. to $40 mill. he wouldn’t be able to keep up a $1 mill. lifestyle (common wisdom says that you should only withdraw 4% from your portfolio every year … I say about half that) …

I believe that it is 10 times HARDER to go backwards in your life (in the event of a financial disaster like if this guy’s business had to close down) than taking a slower run-up in lifestyle in the first place.

This is what I did:

I always drew a minimal salary and tried to live at the median level of the circles that I moved in (for me, this was upper-middle-class college educated professionals).

When my businesses started throwing off more money than that, I invested EVERY penny of the rest, in my case mainly into: (a) reinvesting in the business to expand it, and (b) opening new businesses (3 more), and (c) passive real estate investments.

As I built up equity in (c) – I ignored the ‘value’ of any business until I sold it – I used my ‘divide by 20 – 40 rule’ to decide how much I could spend each year.

Maybe my friend’s friend should have given $1 mill. to Uncle Sam, spent $250k a year to start off with, and invested the rest?

Maybe, after a few years, if financial disaster struck it wouldn’t matter any more what happens to his business …

Never buy a new car … really.

[pro-player width=’530′ height=’253′ type=’video’][/pro-player]

A quick tip for you …

… never buy new, this is more true for cars and even more true the higher the price of the car.

For example, the sticker price on my car, was $120k, but I looked around (actually, I just did a quick google search or two) and found the exact make/model/year (2007) that I wanted at a specialist dealer.

I found a car, in my own city no less, that was just 6 months old with only 1,700 miles on the clock in perfect condition for less than $90k … $30k buys a lot of enchiladas in anybody’s book!

I don’t think that I just got lucky …

I have found that the higher in price you go, the more fickle the customer … they buy cars on a whim and churn them quickly when they find out they would have rather had a boring ol’ Merc!

This works at pretty much any price range, too. If you want a more standard car, check out the leasing company sales (maybe at auction) for executive vehicles … a downturn means executive redundancies … redundancies means near-new cars available cheap!

The effect is even more pronounced when you buy imports (except for top line Italian sports cars, and certain Mercedes and BMW’s) because they depreciate by as much as 20% the minute that you drive them out of the showroom!

[Hint: next time don’t even go into the dealer’s showroom to buy that new car, just wait for the ‘other guy’ to drive their’s out, then offer him 85% of what he paid … give the poor sap your card … you just might get a call].

I once had a SAAB and every time I tried to sell it the price dropped more than I could accept: the first time I tried to sell it, I wanted $45,000 for it, but was only offered $35,000. So I waited a year …

Then when I tried to sell it for $35,000 I was only offered $25,000; the next year I got sick of waiting and just sold it for only $15,000!

I would rather have been the guy offering $15,000 than the guy selling.

Happy bargain hunting!