Category Archives: Starting Out

The Cash Cascade ™

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I wrote a series of posts about Dave Ramsey’s Debt Snowball, and have found this great summary / illustration on Blueprint for Financial Prosperity’s blog (does he just sign his checks BFFP to save ink?):

One of Dave Ramsey’s most popular ideas is that of a debt snowball. The idea is that you pay off your smallest debts first, then roll that debt’s monthly payment into the next smallest. When the next smallest is paid off, you roll the two former payments into the next smallest debt.The snowball grows and grow with each debt that’s repaid.

Here’s a real life example; here are your three debts and minimum payments:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment
  • $1,500 @ 12.5%, $75 minimum monthly payment + EXTRA PAYMENT

The debt snowball method states that you should put all extra debt payments towards the $1,500 balance. When you finally pay off that debt, your new payment schedule should look like this:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment + $75 + EXTRA PAYMENT
  • $1,500 @ 12.5%, $75 minimum monthly payment

I have only added the words “EXTRA PAYMENT” to both examples, because I want to clarify – then expand upon – BFFP’s example.

First, though, what Dave Ramsey is saying – and, what BFFP is trying to illustrate – is the concept that you take one of your debts (the highest interest rate in the traditional ‘Debt Avalanche’ or the smallest balance owing in Dave Ramsey’s more psychologically-friendly ‘Debt Snowball’ method) and pay that down completely … merely making the required minimum payments on any other loans (but no more!) to stop them from going into default.

The credit card companies will love you for this!

Then when that loan is paid off in full you apply the payment that you USED to make on the first loan that you tackled to the next remaining debt, and so on …

… it ‘snowballs’ because you are applying more and more to each remaining debt, while never having to commit more (or less) to debt servicing than when you first started budgeting.

So, in both examples we are paying $775 (i.e. $500 + $200 + $75) towards debt repayment until all debts are paid off … THEN – conventional financial wisdom will tell you – you get to start INVESTING that $775 a month and you are FINALLY debt free and on your way to … what?

Well, let’s go back and make the small correction: if you only make the minimum payments, you will never pay off any of the debts (or, way too slowly), so you need to find some extra money and make some extra payments to the first loan that you decide to tackle; let’s use an example of $225 a month as an extra payment …

… and, from now on you commit to that monthly $1,000 i.e. $500 + $200 + $75 + $225 EXTRA PAYMENT + C.P.I. + 50% of any ‘found money’ (second jobs, part-time business income, loose change, IRS refund checks, etc., etc.) for your entire working life!

So, we are on the road to success! Or, are we?

The problem is that we have to decide where we’re heading: if our aim is to become a Ramseyesque Debt-Free=Happy clone, then well and good. Your financial plan is set.

[sign off now]

But, if we intend to get rich(er) quick(er)™ we have two huge limitations, neither of which the Debt Snowball or Debt Avalanche address:

1. Time to invest, and

2. Money to invest.

Time

We all know the time value of investing early and investing often:

If we lose just 10 years to our investing plan by delaying investing while we pay down ALL of our debt and/or pay down our mortgage we can halve our potential return.

Do you think that might be significant?

So, we don’t want our debt-repayment strategy to unnecessarily delay our investment strategy.

Money

Where are we going to get the money to invest?

Sure we can accumulate $1,000 a month (after paying off debt) – and, grow that amount through C.P.I. and ‘found money’ strategies -but, will that really set us off on the path to financial riches?

The same graph shows that for every $1,000 A YEAR we invest, we can expect $100,000 after 20 years … so, our $1,000 A MONTH strategy should yield $1.2 Million over the same time period … unfortunately, that won’t be enough for a DEPOSIT on the Number that you really need …

… and, inflation will take at least a 50% chunk of that (not to mention taxes)!

So, the solution for most people – who don’t want to lower their expectations to match this depressing, but debt-free (!) scenario – is to move INTO debt … to invest!

This is so-called ‘good debt’ and I’m not sure what Dave Ramsey and Suze Orman’s take on this is, but most financial pundits call it ‘good debt’ for a reason. Assuming that you agree, read on [AJC: if not, I’m guessing that you hit <delete> about 4 or 5 paragraphs ago]

So, here’s what we need …. a different mind-set:

Since we already know that we will more than likely need to incur SOME ‘good debt’ as part of our investment strategy (i.e. some safe level of leverage for investment purposes e.g. a loan on a rental property) …

… why pay off OLD debt now in order to accumulate NEW debt later?

It doesn’t make sense, does it?

We merely waste time and money … instead, we should resolve the following:

1. To treat all Consumer Debt as ‘bad’ and incur no further such debt, unless it’s not really Consumer Debt at all (e.g. we need to buy a car to run our catering business, and public transport or a bike really won’t cut it)

2. To apply the minimum required payments + extra payment(s) + c.p.i. + ‘found money’ not merely to the lesser goal of paying down debt, but to the greater goal of helping us get to our Number (i.e. the financial representation of our Life’s Purpose [AJC: if you don’t buy into that philosophy, then simply insert the words “helping us become financially free”])

3. To, from this day forth, look at all debt as an INVESTMENT in your financial future: and, simply ‘invest’ where you get the greatest returns: is that in paying off an old debt? Or, is it in acquiring a new debt?

Example 1

In the example above, we have three debts of 20%, 12.5% and 10% (are they tax deductible? If so, look at the after tax cost which will be 25% to 35% lower than the nominal interest rates circa 14%, 8.5%, and 7% respectively) …

Compare these interest rates to the cost of money for the types of investments that you want to make …

… in this example, all three are higher than current mortgage rates so you will probably want to keep paying them off (although a good argument can be made for paying off the 20% loan first, then buying an investment property BEFORE paying off the others).

Example 2

Let’s make two changes to our example:

Let’s assume that one of the loans is a 2.5% Student Loan, and swap the amounts owing (so that the Student loan is now the ‘biggie’) and, let’s assume that we have at least 5 more years before it HAS to be paid back (so we have time to make an investment work for us); here’s our starting position:

  • $1,500 @ 20% APY, $500 minimum monthly payment + $225 EXTRA PAYMENT
  • $4,000 @ 10%, $200 minimum monthly payment
  • $10,000 @ 2.5%, $75 minimum monthly payment

In this case, we tackle first the 20% loan; I can’t imagine an ‘investment’ that will provide such a quick & safe 20% post-tax return! Then, we tackle the 10% loan.

Again, an argument could be made for leaving it in situ; however, it is only $4k – and, we’ll pay it off in just 4 months – so let’s go ahead do just that:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment
  • $10,000 @ 2.5%, $75 minimum monthly payment
  • $10,000 Reserve #1 @ (1%)  + $200 + $500 + $225 EXTRA PAYMENT

See what we are doing?

Once we have paid off our two HIGH INTEREST loans, instead of paying down the low interest student loan, we continue to make its minimum monthly payment, and instead apply all of the previous / extra loan payments (from our OLD loans) to building up a ‘reserve’ in a bank account (it pays us a – low – rate of interest!) …

… at this rate, we will have a deposit on a small rental (or our own first studio apartment) in less than a year, then our financial picture will look something like this:

  • $10,000 @ 20% APY, $500 minimum monthly payment
  • $4,000 @ 10%, $200 minimum monthly payment + $200 + $500 + $225 EXTRA PAYMENT
  • $10,000 @ 2.5%, $75 minimum monthly payment
  • $10,000 Reserve # 1 @ (1%)
  • $40,000 @ 6% FIXED, $240 required monthly payment
  • $10,000 Reserve # 2 @ (1%) + $185 + $500 + $0 EXTRA PAYMENT + $185 Rent

Keep in mind that if you used Reserve # 1 to build up a deposit on a small apartment to live in, then you will have no rent to pay, so you can apply part to home ownership expenses (rates/utilities/taxes) and part towards your next Reserve!

And, if you bought a rental, then you may be in an excess rent situation and have more to apply to building your next Reserve, as well … if not, then you will need to decrease the amount going towards your next reserve to cover any rental shortfalls (e.g. mortgage payment deficits, vacancies, repairs & maintenance fund, etc.).

Now, you know why this is not a Debt Snowball, a Debt Avalanche, or even a Debt Meltdown:

It’s the Cash Cascade …

… the new way to look at paying down debt!

In the two years that it would have taken you to pay off your Student Loan and buy your first property, you now own two properties and are well on your way to financial freedom!

What do you think? Will it work for you?

Your employer may be stealing from you!

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Intrigue over at 7m7y.com! Who’s the Millionaire … In Training leaving? And why? Click here to find out …

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“Oh, little 401k, how I hate thee … let me count the ways” (2008, Anon.)

I don’t know who first uttered these words 😉 but, they strike a chord with me; here are some (admittedly, slightly cynical) reasons NOT to like the humble 401k:

1. Little or no choice of investments

2. Have to wait to traditional retirement age to receive the benefits

3. Stuck with low-returning investment choices

4. Little or no opportunity to ‘gear’ (I guess the employer match and tax benefits counts as a kind of gearing)

5. Fees

6. Your employer may be ‘stealing’ from you

Stealing?!

Yeah, in a way … but, first let’s take another quick look at fees [AJC: Inspired by a comment left on a post by Dustbusterz … thanks ‘Dusty’!]; in 1998 (!) the Department of Labor received and published an independent Study of 401(k) Plan Fees and Expenses.

It found the following average fees being charged by the larger 401k funds:

Total Annual Plan Fees

Lowest       0.57%
Mean         1.32%
Median      1.28%
Highest     2.14%

(Source: Butler, Pension Dynamics Corporation, in Wang, Money, April 1997)

Now, this goes back to 1997, but I just covered some very recent work by Scott Burns, noted financial columnist, and published in his new book, Spend ’til the End, which points to the fees continuing to trend up, citing average (mean? median?) fees of 1.88% now.

Remember that, according to Scott, even a “1% increase in a fund’s annual expenses can reduce an investor’s ending account balance in that fund by 18% after twenty years”!

I calculate that a 1.88% fee reduces your returns after 20 years by a whopping 38% …

But, do you know how your employer actually chooses your funds / 401k provider? On the basis of better returns to you? Given the possible 38% ‘hit’, you would assume at least on the basis of lowest fees for you?

Right?!

Nope … not a chance. In fact, the study quoted an earlier report that found that “78% of plan sponsors [employers] did not know their plan costs” (Benjamin) …

… Great! You are putting your financial future into the hands of your employer, 3/4’s of whom don’t even know what the plans that they are choosing will cost you!

So how do they choose the plan that’s right for you [AJC: ironic snicker]?

The study found, one of two ways:

1. In my opinion, an unethical way: The Study of 401(k) Fees and Expenses quoted a prior report that found employers most often choose “the institutions that furnish the firm other financial services – banking, insurance, defined benefit plan management – to provide their 401(k) plan services and may not make an independent search for the lowest cost provider.”

Your employer feathers the bed of their own business relationships with your retirement money. Nice!

2. In my opinion, a criminal way: That would have been enough for me, if I hadn’t accidentally come across what is regarded as the Retirement Industry’s ‘Big Secret’ … it’s a doozy: it’s where the 401k provider shares some of the fees that you pay them with your boss!

Think about it; your employer provides you with a match to encourage you to remain employed then gets back some of that in fees, rebates, ‘free’ services, or just good old ‘relationship building’ at your expense, literally!

How do the funds and your bosses get away with this? Simple, nobody’s looking: “Revenue sharing is a poorly disclosed and relatively unregulated practice, which falls into the gap between Department of Labor and SEC oversight.”

OK, so does this mean that you shouldn’t participate in your employer’s 401K?

Not at all … it just means that you should do the following:

1. Decide if the 401k is going to do the job for you … will it get you to your Number? At a maximum ‘investment’ of $15,500 per year and a compound annual growth rate of 8% – 12% less fees, this is highly unlikely … you run the numbers then make your choice!

2. If not, is it still wise to continue your 401k (consider it a backup plan) as well as more aggressively investing elsewhere?

3. If you can’t do both, you have no choice but to decide which investing strategy is going to have to give way to the other?

4. If you do decide to continue with the 401k, choose any ultra-low-cost Index Fund option that may be on offer over any other selection; if not available, choose a ‘no load’ fund (be careful … some ‘no loads’ are actually just ‘lower load’). And, do your own homework on fees, because you just know your employer ain’t doing it!

5. Lobby your employer to pass back any revenue-sharing back to the employees

6. Insist that your employer choose funds that work best for you over the funds that work best for them.

What you do with this information is entirely up to you; I don’t need a damn 401k … never have and never will 😉

The Lazy Way To Riches

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picture-2

I am indebted to KC for showing me the lazy way to riches …

… well, I already live like this (have done so for years) and it hasn’t appeared to have hurt my bank balance – indeed, it seems to have helped!

But, it’s always nice to see all of these Great People of History who agree with me 😉

Deal or No Deal – Part 2 – Reader Poll

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Gotta love a show that dangles a $1 Million ‘carrot’ in front of people’s noses and all they need to do is make some sensible life choices – on the spot, and in front of millions of people 😉

Tomorrow Rodriguez (that’s her name … really!) is a sensible girl: married, been in the army, put herself through school, has a Master’s degree in something-or-other (obviously, not math).

And, she’s made it on to one of those ‘special episodes’ – you know, the ones where they put up 9 suitcases with $1 Million in each of them, rather than the usual single suitcase: that’s 9 chances in 26 … 35% or roughly a 2-to-1 chance of walking away with $1 Million.

Deal or No Deal?

OK, but there’s a twist … first you get to pick some suitcases and the ‘Banker’ makes you a take it or leave it offer:

He’ll give you $43,000 to walk away right now! In fact, that’s exactly what he offered Tomorrow very early on in the show …

Deal or No Deal?

You say “No Deal!” (do you?) and pick a few more suitcases … the offer goes up and up, but you keep turning the Banker down, down, down, until the money gets serious.

Now, more than half the suitcases are gone (and 3 or 4 of the ones with $1 Million in them, as well) but you still have a few ‘million dollar suitcases’ as well as a few lemons left … but, you have chosen well (birthdays, tarot readings, and horoscopes are really working well for you today).

The Banker offers you $134,000 to walk away, right now!

Deal or No Deal?

Of course, you say “No Deal!” (are you sure that you do?) and Howie asks you to pick just two more suitcases … the offer goes up to …

… the amount in the photo above!

Deal or No Deal?

If you haven’t dipped out already, here’s something interesting to note; it may or may not change your mind, but it’s interesting nonetheless:

There are 6 suitcases left [AJC: one suitcase, also containing ONE MILLION in the bottom right has been cropped in the photo at the top of this post]:

3 suitcases containing virtually nothing (max. of $400) AND

3 suitcases containing $1 Million

So, the odds are exactly 50/50 that’s you’ll pick one of the suitcases that guarantees you $1,000,000 so the banker should offer you $500,000 (give or take a few bucks) …

… BUT, the Banker’s Offer is only $349,000

Deal or No Deal?

Let me know where you stopped … click on one of the options in the poll … if you’re up for it, you can also drop the reason for your vote into the Comments section below … this should be fun!

In the meantime, do you want to know what Ms Rodriguez did? We’ll talk a little more about that next week 🙂

Blogs, blogs, and more [bleep'ing] blogs!

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blogs-illo

It seems like I am embroiled in a torrent of writing; even my 11 year old daughter asks why I am working at my computer all day on something that makes me absolutely no money … she suggests that I go out and get a ‘real job’.

I guess neither my daughter nor I actually understand the concept of ‘retirement’ 🙂

Which leads me to Dustbusterz’s e-mail opinion, which may be shared by others, hence my posting it here:

You post on too many places, and it becomes confusing and difficult to keep up with the concept. It seems you go to one site, get a little info, then go to another site, get a little info , then get a bit of info in email. And trying to tie it all together just wracks the mind. I believe it would be much simpler for everybody if you chose one concept(such as video posting every day) instead of this post here post there kind of treatment.

Thanks for sharing, Dustbusterz!

If it helps, here’s how it works:

Blog 1: 7million7years.com – This is my main blog where I share ideas and strategies on Personal Finance. The rough framework is sketched out via the tabs across the top (eg Road Map to Riches; Making Money 101; etc.).

Blog 2: 7m7y.com – Because blogs (yes, even mine!) can be ‘theoretical’, I thought that I would start a 7 year ‘experiment’ by helping 7 volunteers (and as many of our readers as want to participate) to make their Number (hopefully, in the millions). This is a sequential process, albeit tailored to the needs of each of the 7 … making money takes time, so the ‘lessons’ will inevitably be spaced out over a long period of time.

Blog 3: ajcfeed.com – This is not really a blog at all, but my live Internet chat show … my son’s idea; not sure why I am doing it, but I enjoy the ‘real time’ aspect. And, my Youtube videos (posted at yet another site: ajcvault.com) get multiple viewings. I guess some people like to hear an Aussie with a funny voice/accent speak!?

Whereas Blog 1 is random/theoretical, Blog 2 is paced/practical and centered around the needs of each of the 7 MITs.

Blog 4: findoutifyoucanmakemoneyonline.wordpress.com (which has taken a pause, while I set about launching Blog … actually, Site … 5) – This is purely for fun and to see whether it’s possible to make money online … with this blog it’s ME who is the subject of the ‘experiment’!

Blog 5: There isn’t one (officially) yet … but, I will be making an announcement very shortly! In the meantime, you can get a ‘sneak peek’ here.

Read one or all blogs/sites, together or independently … it doesn’t really matter as long as we can all get something out of it.

Thanks for your suggestions, Dustbusterz, I’ll see what I can do (like this post for example) to make it all easier to navigate!

Riding in the big boat while carrying the little boat …

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There was a great article in eLance’s blog today (AJC: I didn’t know they had a blog, but I used the site to find my research assistant, Muhammad, who lives in Pakistan and is doing a great job for me at $4 an hour!) …

… here is a summary (with my thoughts in italics):

Tips for Incubating your Small Business Idea While Still Working Full-Time

Sep 4, 2008 6:38pm

Have you considered starting a business while still employed?

My Shanghai-born friend, Annie, says the Chinese have a term for this: “riding in the big boat while carrying the little boat.”

Some entrepreneurs only launch their business officially once they leave employment. However, they incubate the business concept while employed.

Other times, they actually launch the business and run it on the side while still employed. They may continue to run it as a side business for a period of months or even years. Only later do they leave their jobs.

No matter how you do it, I’ve got 6 practical tips for starting a business while you’re still employed:

1. Consider Your Employer Your Banker
I am a huge fan of bootstrapping a business, i.e., using personal money to fund growth. One form of using personal funds is to set aside a portion of your salary to fund your business. That means you need to protect your funding source — your job — until you are ready to cut the cord.

The author of this article suggests that you need to canvass your employer on ‘moonlighting’ otherwise you should wait until you leave your job to start the business – I would suggest that if the business is critical to your financial future (and, if you’re reading this blog, it probably is) then you should take steps to find a replacement job asap – and, let the new employer know that you are “working on a business ‘on the side’ to improve your business skills” … they might even see that as an asset!

2. Write a Business Plan
Sure, much of your plan will turn out to be incorrect (same goes for most startup business plans). But it’s not the plan that’s important … it’s the planning.

I agree – to an extent: as with your Life’s Purpose, having a Plan for your business is a great idea … but, trying to plan every detail is (at least for me) a waste of time … but, don’t let me stop you! If you want to see a practical approach to planning for any business – certainly, fast-moving startups – read Guy Kawasaki’s Art of the Start.

3. Get your Spouse’s Buy-In
Your husband or wife needs to be committed to your startup. If it isn’t a shared dream, or if your spouse is resentful of the time you are spending away from family, you’re adding stress on your relationship.

You want to stay married and have a business that sucks up all of your non-working time?! ‘Nuff said ….

To secure buy-in from your spouse, talk frequently about your dream. Paint a picture in words. Get him or her involved, too. Nothing creates buy-in better than being actively involved in business decisions.

4. Choose the Right Business

Here are some examples of businesses that can be operated on the side indefinitely for years, or eventually taken into full-time businesses:

  • Software development
  • Web design
  • Freelance writing
  • Online businesses
  • Graphics design
  • Consulting
  • eBay business
  • Event planner
  • Any hobby that you can turn into a business

The author recommends these because you can often be flexible in hours and/or hire outside staff/contractors … the catch is that a number of these businesses aren’t dramatically scalable, which is the #1 criteria that I look for in a business …. remember: scalable = salable.

5. Set Aside Dedicated Schedule for Your Startup

Many entrepreneurs who have successfully started a side business do it by setting aside dedicated hours each day for their startup. I’ve known budding entrepreneurs speak about going home to “start the second shift.” That’s exactly how you have to think of it. Commit to spending X hours per weekday and/or on weekends on your business. Stick to a regular schedule – it makes it easier. P.D. James, the novelist, worked for years as a hospital administrator, arising early to write for 2 hours each morning before work.

This is the best piece of advice in this already excellent post … it is hard to come home from work, only to have to go to ‘work’ … but, it must be done (hence, the prior discussion with spouses and bosses).

6. Turn Your Employer Into Your First Customer
Think of your employer as your first big sales target (assuming your product or service is relevant to your employer). Many a business has gotten off to a great start when the owner’s former employer became the first customer.

Good luck on this one! Still if you CAN get your employer to become your first big customer, it’s a great start: not sure how the whole employee/supplier co-existence thing will actually pan out … I think it will be better if you are able to transition from employee to supplier …

If yuor objective is to build a second income stream to support your investing activities – or, perhaps to build up capital to start That Big Business of yours [AJC: I would never let a little issue of capital stop me from starting that one NOW 😉 ] – then this article provides some great suggestions …

… however, if you want to build a ton of money, fast, then you may have building the next Facebook in mind and this article (along with this one) presents a way to get off the ground with minimal risk.

Finding your lifestyle break-even point …

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7 Millionaires … In Training! has been featured in iReport; you can check it out by visiting: http://www.ireport.com/docs/DOC-145792 and, this article has been mentioned in this weeks Carnival of Personal Finance!

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rich_doctor

I wrote a post a while ago that explained why most doctors aren’t rich … the point wasn’t to appeal to all the medico’s in our audience; it was to demonstrate that income does not equal wealth.

Jeff, a navy pilot who I would happily trade a month or so of my life with (Maserati for Hornet for a month? Fair trade, if you ask me) commented:

Your analysis failed to consider Scott’s ability to incrementally contribute money from his income over the 10 year period. I just thought it was odd that you left it out, since the mantra of this blog (at least in the beginning–money 101 and early 201 stages) is to save as much of your income and invest it. Why wouldn’t Scott be able to follow this advice? …and more importantly, how would incremental contributions affect Scott’s ability to reach his goals?

Also, I bet the doctor making $700k per year in your example isn’t having a hard time investing $150k/year after tax. Why couldn’t a professional making $350k+/per invest $150k/year after tax (assuming they were following your money 101 steps)?

As I mentioned to Jeff at the time, my point wasn’t really meant to be mathematical … it was based upon my (and, Scott’s – who is the doctor mentioned in the original post) ‘real life’ experiences/observations …

… let me explain using four hypothetical doctors as examples:

‘Good Doctor‘ saves a good proportion of his ridiculously high income (what would you guess: 20%? 30%? More? Less?); lives within his means; etc. but will still most likely ‘only’ get to the $2M – $4M range +/- a few mill. if he is reasonably passively investing. That’s just experience talking …

‘Bad Doctor‘ spends more than he earns … there’s no limit to what some people can spend …  just refer to the Millionaire Next Door example from my previous post, if you don’t believe it’s possible to earn $700k a year and still be ‘broke’!

‘Typical Doctor‘ doesn’t wake up to the difference b/w good/bad doctor until he reads a few books and blogs … typically too late to really become ‘good doctor’ … he can’t save, say, $150k immediately – if ever – because he has ‘commitments’, but he sees the light and builds up to his own saving maximum over time … it’s this ‘lost time’ that is his undoing, so he ends up somewhere less than ‘good doctor’, say, $1M – $3M.

‘Business Man Doctor‘ sees the light and realizes that income/savings alone won’t get him to where he wants to go. He reads my post, and the rest is history 😉

Now, here is the issue:

In all of our four examples, the doctor is doing well – just like the two doctors in Dr. Stanley and Danko’s book – earning $700k p.a. … the problem is, if they are spending all of it to live on now (one of those two doctors was certainly doing that!) how are they going to keep it up in ‘retirement’?

Let’s check the math: $700k salary x 2 [for 20 years inflation @ 4%] x 20 [for min. size of passive nest egg] to ‘replace’ $700k spending power …

… that’s just shy of $30 Mill. in 20 years by my math!

So, there lies the real problem for any doctor / professional; how do they replace their income in retirement?

The mechanism is obvious – they need to channel part of their income into passive investments, and allow time for those investments to grow large enough to replace 70% – 125% of their final income depending on how much their spending will go up (most likely) or down (golf / travel, anyone?) in retirement.

There are only two ways that I know to achieve this:

1. Find their Replacement Income’s Break-Even Point: That is, as their salary increases over the years, how much do they allow their spending to go up in order to control their final spendable salary so that their nest egg neatly replaces it?

Let’s see:

Perhaps if they live off just half their salary ($350k) they may be able to get to somewhere in the near vicinity of $15M assuming that they allow themselves 20 years to get there (i.e. if $30 Mill. in 20 years was required, in our earlier example, to ‘replace’ the future value of $700k today, then $15M might do the same for $350K?)

How do we get that $15 Mill.? Well let’s see what happens if we save the other half of their salary:

$350k – 35% tax X 8% (say, after tax return of their ‘passive investments’). By my reckoning, if they increase these $350k (less tax) contributions by 4% to keep up with inflation each year, they may just get to $15M in 20 years. Success!

Naturally, this works for anybody on any salary … except the lower your required salary, the more that the ‘tools of the poor’ (401k; employer match; etc.) kick in to replace your final salary at perhaps less than a 50% of total income savings rate.

2. Find their Lifestyle’s Break-Even Point: The problem with the above example, of course, is that our ‘good doctor’ has to suffer with living off only half the income that he earns … now that he’s ‘retired’ he’s having to make do with playing at the local Public Golf Course while his professional friends are at the Country Club … poor sod.

To a greater or lesser extent this is the choice that conventional Personal Finance wisdom asks you to make: live large now and live poor later, or sacrifice lifestyle today to go for a longer period of being able to live the same lesser lifestyle in retirement (while your less-financially-astute friends simply take their chances).

But, this totally misses the point: what if the 50% Lifestyle simply ain’t good enough … are you going to take ‘second best’ (albeit for as long as you live) lying down?

If your answer is YES; then go back and revisit 1. with your own numbers and there you have your financial plan!

If your answer is NO; then you have come to the right place …  but, saving/investing alone is probably not going to do the trick 😉

Can you diversify a business?

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I’ve just loaded 3 new videos into the Vault (click on this link, or check the VodPod Widget on the right hand side of this page for the latest) …

Now for today’s post …

Now listen up!

You want to keep working that job forever? Stop reading today’s post! If you’re determined to stay poor forever, you deserve the extra 2.5 minute break 🙂

You want to work your job AND invest in real-estate? Well, keep reading, because SOME of what I’m about to say, applies to RE, too.

But, if you want to blaze the business path … hang about, because Dustbusterz has a GREAT question for you:

Tell me here ,if I am wrong in my assessment. I believe diversifying(i.e. buying or starting many businesses) is better than having all your money tied into just 1 business.
Currently, we own about 5 small businesses, which bring in small amounts of cash. Our intent here is that we will build these businesses up gradually over a set time frame , and at the same time, continue to buy or build more businesses to add to our income stream.
By having these several businesses, we somewhat mitigate future problems if say,1 of these operations should suddenly be stricken with cancer and we are unable to restructure and save it.
So having 10 smaller businesses (1 goes bankrupt or gets sold) it is less of a drain on your income stream as having all your cash in only 1 or 2 bigger businesses.

As I said to Dustbusterz, there are some great reasons TO enter into multiple businesses and some equally great reasons NOT to …

… but, I have to admit, diversification was never on my list … until now )

First, let’s look at why you might want to buy/start just one business:

– You can concentrate on it ( THE reason not to ‘diversify’)

– One business can become many through territory expansion, franchising, joint ventures, etc.

– A bigger business can be more atractive to the people who will pay you more (say, 6 years’ profits) than the typical ‘small business purchaser’ (who might only pay 3 to 5 years’ profits); these uber-purchasers include: e.g. the private equity firms, large corporations, IPO, etc.

Now, let look at how you may end up with multiple small businesses:

– The businesses are related in some way (this is how I ended up with a portfolio of businesses)

– The first business that you buy or start doesn’t have enough potential so you open up another on the side and … it just keeps rolling from there

– You are in the business of ‘flipping businesses’ … really!

Before I continue, let’s take a break to satisfy the real-estate guys:

With real-estate you can own one property or multiple … across a single location or many. It matters not, so long as you put good management in place.

And, if you decide that you are going to be in the business of flipping RE – well, then you have no choice but to be hands on with multiple properties … you just have to hope that it all holds together!

Not so with businesses; the management requirements in small business – indeed, any business – are relatively HUGE (certainly, when compared with the management stresses in real-estate). This usually points to having one business that you grow and grow, slowly and carefully adding management layers underneath you.

I believe that by diversifying, you are exponentially INCREASING management risk (hence, failure) … which may or may not offset the potential diversification ‘benefits’.

But, it can be done … as I said before, I managed it.

And so has Brad Sugarswho is a bit of a legend where I come from … I recall going to a free ‘business seminar’ and being surprised by the speaker: a lanky kid in his 20’s in a slick business suit. And, he’s gone from there to found a well-regarded multi-national business coaching company.

Brad spoke about how he would buy small businesses, often with ‘no money down’ and fix their basic money and management problems, and then sell them off. Brad often didn’t even work in the businesses himself, so I guess that you would say that he’s to ‘random’ small businesses as Ray Kroc was to McDonalds.

I particularly loved this technique that Brad shared:

1. Buy a business for as close to zero dollars as possible (this IS possible … just offering to take on the lease payments – as a take it or leave it ‘final offer’ – is often enough),

2. Install a manager

3. Help the manager build the business up

4. Sell the business to the manager (after all, they have seen how quickly it has grown!)

5. Repeat!

Personally – like RE flipping – this is a ‘business’ (that buys/sells businesses), not an investment. It’s not the kind of business that I like, because there’s no HUGE upside; although, if you can scale upwards of 50 such transactions … 😉

A new look at our 7 Millionaires … In Training!

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I’m hoping, but not sure if you are staying in touch with the goings on at our ‘sister site’ http://7m7y.com – the home of what I still call our ‘grand experiment’ to make a lot of people rich by applying the principles that I write about here …

Jeff asks:

I have a question about how your readers now fit into the conversation on 7m7y.com as the site’s focus changes. Since you have named your 7 MIT the posts and comments have naturally shifted focus toward those individuals. As I review the discussions, it appears to me that the conversations and comments have become almost exclusively between you and the seven with little engagement from outside.

Do you see a place here still for the team of benchwarmers who have been to practice but didn’t make the team? I have learned a lot about myself and my desires through the series of exercises that led up to the 7MIT selection. Will there be more “try this at home” exercises moving forward or will 7m7y.com become increasingly tailored to the seven?

You see, I don’t just want to create 7 Millionaires … In Training! I want to create 70, or 700, or even 7,000 Millionaires … In Training!

So, there are no ‘bench warmers’ in our 7m7y Community – don’t be a wallflower (!) – but, you do get to choose your level of involvement:

1. You could just passively read along and pick up a lot of valuable information that isn’t in this blog, and

2. You could comment/criticize/congratulate, and

3. You could ask/answer questions of anybody (including the 7MITs and me), and

4. You could participate in the same exercises that I purposely post online, and

5. You could even share your own progress by e-mail/comment/feedback.

If you do want to participate – and I sincerely hope that thousands of readers like Jeff will – I suggest that you hop over to that site and bookmark it because it is an unusual blog … by it’s nature: http://7m7y.com is fluid, not static!

That’s also why I have come up with some additional navigation options for that site … let me know what you think!

____

Visit us at the Money Hacks Carnival, kindly hosted this week by The Financial Blogger.

The Big Papa lives in the 11th Dimension!

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It should be obvious by now, that I am no Einstein … but, we do share a couple of things in common, the least of which is that we both believe in the power of compounding: Einstein is alleged (there is some doubt whether this is even true) to have called it “”the greatest mathematical discovery of all time”, as well as “the greatest force in the universe”, and even “the 8th Wonder of the World”.

Whether that’s true or not, Einstein and I shared one other passion:

Albert Einstein spent the last 30 years of his life “in a fruitless quest for the fabled unified field theory” … this is the Mother of Theories, the one that ties all the other theories of physics (hence, the mechanics and origins of our Universe) together.

This is not directly my passion (I’ll come to that) but I have been dying to talk about this since I first saw a documentary that explained all of this … it just fascinated me, so I will bore you with it – with a weak promise of tying some sort of financial angle into it, just to reel you in to my own morbid fascination:

You see, the closest that modern physicists have come to tying up all the loose ends of science (e.g. what is the Big Bang? What came before it? How can a subatomic particle be in two places at once? etc.) was with the discovery of String Theory.

Once thought to be the Big Mama of science, it all came apart when the String Theorists all came to similar conclusions: these ‘strings’ could be mathematically ‘proved’ in 10 dimensions – therefore, the Universe is in 10 dimensions …

… the only problem was that there were 5 totally different sets of equations which all ‘proved’ the strings (albeit, differently) in 10 dimensions … 5 theories ain’t one theory; in fact, it’s almost as bad as none!

But, then a group of scientists working on proving gravitational waves discovered that their formulas worked well in 11 dimensions.

Aha! Now a group of ‘string theorists’ went ahead and re-worked the 5 lots of ‘string theories’ in 11 dimensions (instead of the original 10) and discovered that they were all the same theory!

The scientists who discovered this (while they were riding on a train to work, by the way!) described it as similar to standing at the base of a hill: depending upon which side of the hill you happen to be standing, the view could be very different … but, it’s only when you stand on top of the hill that you realize that you are looking at different aspects of the same landscape depending upon which direction you happen to be facing at the time.

Using this new insight, scientists are now working on solving the issue of ‘parallel universes’ (the theory says they exist); what happened to cause the Big Bang (it’s what results when two or more parallel universes collide: baby universes!); and, much, much more …

So, God lives in the 11th Dimension!

I promised a financial angle, but I can’t find one other than to share my passion:

Like Einstein, I believe that there is a Unified Theory, but of Personal Finance instead of physics.

I instinctively seem to ‘know’ this .. I have certainly profited from it … and, I have already written pieces of it (including a ‘schematic‘ of what it might ‘look’ like) …

… but, I don’t have it all well-articulated or nicely laid out, yet.

Yet, I believe that when we stand on top of that mountain, each of us will see that the various discussions on the sensible financial forums (e.g. blogs, books, etc.) – discounting the ‘get rich quick’ crackpots; various financial con artists; and the ‘one trick ponies’ (who luck on one way of making a little money, then proceed to create an information publishing empire from it) …

… are really just different aspects of the same sound financial framework.

If you look out at the “young and just getting started” vista, you will see one aspect; when you look at “work for 40 years then live quietly and comfortably” you will see another aspect; and, when you look in an entirely different direction you will see all of us in the “aim for a big Number and get there” group.

Same hill, same earth, but slightly different paths and different terrain to cross … same underlying ‘laws of finance’.

So, in encouraging me to keep writing this blog – and, in challenging, commenting, criticizing, supporting it – you are helping me to clarify in my own mind what this ‘unified financial theory’, if there really is one, might really look like.

When I can write the ‘equations’ out, you will be the first to know!

There, the ‘secret’ of why some rich, ‘retired’ guy is doing all of this – when he should be lying back in his hammock, drinking Pina Coladas – is finally out 🙂