Bunker Strategy For Surviving A 12 to 24 Month Recession

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Nobody_Knows_YouThe blogoshpere is alive with posts that trumpet that Suze Orman has changed her financial advice .. some of it inspired by this excellent article from Yahoo Finance News:

Personal finance gurus usually treat credit card debt as the plague and urge consumers to pay it off–ASAP. But this week, Queen of Personal Finance Suze Orman announced on The Oprah Winfrey Show that the old advice is wrong. The recession has made job loss so prevalent, she says, that consumers now need to make creating an emergency fund with eight months worth of expenses their top priority.

Now, I also happened to be watching that Oprah show [AJC: I can blame my wife … she watches religiously … can I help it that I am sometimes also standing withing ‘eye shot’ of the TV 😉 ] where Suze said:

If you have an unpaid credit card balance [and] not much saved up in emergency savings, I need you to listen up. My advice has changed. I want you to only pay the minimum due on your credit card balance, and instead, make it your top priority to build as much of an emergency cash fund as you can.

Now, I think that Trent at The Simple Dollar hosted the best discussion on Suze’s comments, and I suggest that read both Trent’s post and all of the comments before you read on; Trent said:

In this environment, making the decision to jump from debt repayment to emergency fund building is about two years overdue.

I propose a different solution.

First of all, ignore a huge, long-term goal like an eight month emergency fund. Instead, if you’re worried about the downturn, focus on three key things through the rest of this year (and thus, likely, through the bottom of the downturn):

One, apply some realistic frugality in your life.

Two, acquire no new debt.

Three, build up your emergency fund a little now, but be prepared to reduce it in 2010.

I agree with Trent, asking people to save up to 80% of their salary for the next 12 months is way too much too late 🙂

And, I agree with Trent’s basic ‘bunker mentality’ of tightening the belt, but I am actually going to advocate a totally opposite three-step strategy, and here it is … 7million7years’ Patented Bunker Strategy For Surviving A 12 to 24 Month Recession:

One, ramp up your Making Money 101 strategies …. during recessionary times, double them if you can (i.e. save 20% – 30% of your income; save 100% of any ‘found money’).

Two, acquire some critical new debt.

Three, use that new debt to build up your emergency fund a lot for now, but be prepared to dramatically reduce it when the recession turns.

Question: Who of sound mind acquires new debt in a recession?

Answer: Anybody who wants to survive!

Look, if you didn’t start storing nuts for this recessionary winter in 2005 / 2006 then you probably have NIL chance of building a large enough emergency fund to tide you over if you do lose your job now or soon … worse, if you do lose your job, it could take months to find another one in the current market.

So, what to do?

Simple, look for where you already have nuts stored: for many of you, it will be in your house.

IF you still have equity in your house, simply refinance out as much as you can up to Suze Orman’s 8 months emergency fund limit (however much that may be for you) PLUS a sufficient ‘buffer’ to make 12 – 24 months of mortgage payments. Now may also be a good time to consolidate your credit cards and other higher interest loans into the same loan (not normally a strategy that I would recommend … but, this is an unusual plan that we are executing) …

… and, fix the interest rate (so long as the loan conditions allow you to pay off as much extra as you like when you like!).

Why?

Well, you now have peace of mind … for only the price of 12 to 24 month’s interest on your mortgage, perhaps a very small price to pay for surviving the deepest recession that you will likely see in your lifetime.

If you don’t lose your job, you can pay back the loan whenever you feel that things are somewhat coming back to normal (i.e. jobless rates are dropping again), and if you do lose your job, you have the cash buffer to help you survive.

Sure, this is a drastic strategy, which will cost you some unecessary interest and lost investing opportunity as you borrow money at 6+% just to have it sitting in the bank at 1.9% if you are lucky, so I am aiming this strategy only at those who:

1. Believe Suze Orman, but have no hope of meeting her criteria at this late stage, or

2. Believe that their job is at reasonable risk.

For a person on a gross income of $50,000 a year, with a current mortgage of $250,000 (a lot of house!), this rather unique ‘insurance policy’ would cost you less than $100 a week … a lot of money, sure, but small change if it helps you survive the Second Great Depression (well, at least  the worst recession since the Great Depression).

If so, this is counter-intuitively probably your best chance of protecting your home and family and riding the storm … but, if you don’t get a new job within a few months then you are probably slightly closer to foreclosure.

Or, are you?

You have 12 to 24 months protection (by way of the 8 months living expenses plus interest payments buffer), whereas without doing this you have whatever you can scrape up. Compare that with the alternative: what would you do if you lost your job next month and you didn’t put this plan in place? How could/would you survive?

Your honest answer dictates whether this admittedly ‘unusual plan’ is for you …

… if it is; if you do have the spare equity; and, if you do meet the two criteria listed above, now is the time to execute this plan. If you wait:

a. You won’t be able to refi if you have lost your job, and

b. A HELOC won’t save you, as the bank will probably pull it.

So, refinance your home now and put the spare cash into another bank instead!

Of course, if you don’t have the ‘spare equity’ in your house … cross your fingers 🙂

Three Little Pigs: The Good, The Bad, The Ugly

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This is a story about Three Little Pigs – you’ve just met The Good Little Pig in this video …

The Good Little Pig

He belongs to (in fact, is the “official spokespig” of) a wonderful organization called Feed The Pig: a worthy and noble cause sponsored by the American Institute of Certified Public Accountants (AICPA) and The Advertising Council with the aim of encouraging and helping Americans aged 25 to 34 to take control of their personal finances.

Unfortunately, in their enthusiasm to bolster the meager savings rate of our next generation of movers and shakers, they seem to forget a Very Important Piece of Information …

… but, first let’s meet the 30 year old ‘Wolf’ [AJC: actually, he’s just a bachelor … but, as far as the girls go, he’s a wolf alright 🙂 ] earning $50k a year.

picture-23

The Good Little Pig – in his Sunday Roast Best Pink Suit – asks the Wolf to set aside 5% of his gross (or $2,500 this year), with the following assumptions:

picture-1

The Good Little Pig then tells the Wolf that if he agrees NOT to blow his little house of straw down, that he would show the Wolf how this will make him rich … accounting for all sorts of different life events …

… the Wolf thinks it’s a great idea!

picture-3

The Good Little Pig makes good on his promise and shows the Wolf how just saving $2,500 a year (5% of his salary) can mushroom (goes nice with pig) to anywhere from $179,000 (even if he loses his job, takes time out to go back to school, then starts his own business pretty late in life) …

… to a massive $555,000 (if the Wolf gets a job and promotions pretty quickly, followed by a bonus here or there).

The Wolf promptly blows the little house of straw down and eats the Good Little Pig.

He’s still hungry so he looks for another pig.

The Bad Little Pig

Fortunately (for the Wolf, not the Pig), the Wolf chances on The Bad Little Pig who has heard all about what happened to the Good Little Pig on the pig grapevine (vine goes very nicely with pig … particularly a nice Cabernet very slightly chilled below ambient) and admonishes the Wolf saying “how could you eat my bro’, when he showed you how a measly $2,500k could become anywhere from $179k to $555k over 35 years?!”

picture-4

The Wolf was surprised: “Why?” he said, “it’s clearly because I would be stuck in some lousy job, sucking up to my boss to get the max”.

To which the Bad Little Pig responded: “But, if you did nothing but save $2,500 a year and increase it just with minimum pay increases (nothing fancy, no promotions, no sucking up to the boss,) then I can show you how to get $678,000 over 35 years … surely, you’d like that?! But, only if you promise not to blow down my little house of sticks …”

Before the Bad Little Pig could finish his sentence, the Wolf blew the Bad Little Pig’s house of sticks down, finishing him off in just one bite (hic!).

But, not quite stuffed (unlike the pigs … in more ways than one), the Wolf went searching for more pig.

The Ugly Little Pig

Being Pig Season, the Ugly Little Pig was easy to find; he was honest and gave the Wolf the plain, ugly truth:

“Look, if you really promise to spare me – not that you can do much damage to my bricks & mortar financial stronghold (after all, the Lehpig Brothers have been around for a hun’erd and a score years or more) – I’ll tell you that you can’t get anywhere saving just 5% of your salary, no matter how many promotions you get. You can (and should) save at least 3 times that … $7,500 of your salary now and keep increasing it as your salary goes up …

… that will give you over $2 million when you retire in the lap of luxury in 35 years. Easy, simple … and (almost) guaranteed.”

The Wolf asked: “Wow! I’ll be a multi-millionaire … is that it, the best you can do?”

To which our very Ugly Little Pig answered, smug behind his brick facade: “What more do you want?! Start your own talk show if you want more, Wolf, now leave me alone”.

I don’t think that I need to tell you, what with the poor quality of mortar and workmanship these days, this was the easiest of all the pigs to get to and eat.

You see, our Wolf wasn’t as Good, Bad, or Ugly as the Three Little Pigs …

… he was an average Joe who didn’t just buy into the financial hype spruiked by the financial ‘professionals’ and the ‘do gooders’; at least not without also checking the numbers with a simple spreadsheet himself.

That little spreadsheet showed him just what I’ve been telling you all along: because of inflation (even if it only averages 4% for the next 35 years), $2 million in 35 years is only worth $507,000 today, which provides the Wolf a fairly ‘safe’ retirement income of just $25k a year (in 2009 dollars) … just half his current salary!

When asked why he ate all the pigs who were there to help him, the Wolf simply looked back at the numbers, and sighed:

“Why go without pig today, just to have the same or less pig tomorrow?”

Why indeed?

Disclaimer: No pigs, advertising exec’s, or accountants were harmed in the making of this post.

We're not there yet, but …

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ugly-dog… who knows?

Inflation may just rear its ugly head, as Modern Gal suggests:

My bet is that the long-term successful investors (like Warren Buffet) see the next big cyclical turn as being the threat of global inflation.  And by this, I mean not inflation as in 3-4%, but I mean a change in cycle to having structurally higher inflation for a number of years.  While nominal wages have (mostly) risen, real wages have not kept up with inflation for many workers.  This is the problem called the money illusion.  In other words, because your paychecks are growing larger over time, you think that you think of this as a raise or cost of living increase.  In fact, if the cost of living outpaces your raises, you have in effect gotten poorer, or your salary has lost real value.

I don’t normally talk about things that you can’t do today – and, the things that I do talk about often need to be adjusted for which part of the Making Money Cycle you are in – but, I will make a couple of suggestions and you can bookmark this post in case inflation does hit before I get a chance to write a follow up post 🙂

Firstly, what is high inflation?

To me, ‘high’ and ‘low’ are pretty meaningless terms in an inflationary context, but Modern gal suggests “let’s say inflation crept up to 5% a year … not many people are expecting a shift to a very high inflation rate, like 10%.”, which seems like a pretty reasonable range to work with, if you ask me.

Modern Gal then suggests that inflation-adjusted securities such as TIPS are sensible high-inflation strategies …

… but, here is what I think, IF you think inflation is heading up and you are in this stage of the Making Money Cycle:

Making Money 101

No great change here; get your spending under control; avoid consumer debt (although, strangely enough, it’s actually slightly BETTER for you if inflation rises AFTER you accrue the debt because your payments stay fixed – unless interest rates also rise – but, your income rises due to ‘cost of living increases’); and save money … but, if this is all you do, that inflation will eat up a lot of the benefit; as Modern Gal says:

Let’s say you have $100,000 in savings today, but you want to hold off spending until retirement.  If you decide to put your savings under a mattress (meaning you earned zero interest or dividends), in 25 years time, at a 3% inflation rate, your $100k would be the equivalent of about $48k in the future.  But let’s say inflation crept up to 5% a year, a rate that was not unusual a decade ago. Under this scenario, your $100k should be thought of as less than $30k in 25 years time.  And, if we end up with double digit inflation at 10%, the 100k adjusted for buying power in today’s dollars looks like a measly $9230.

The key Making Money 101 change (although, this is a strategy that I also recommend in the current low inflation / low interest rate environment) is to lock in your interest rate on your own home, ideally before the high inflation (which can often trigger higher interest rates) kicks in.

Making Money 201

Here, we want to take advantage of inflation which tends to push the prices of things up: the higher the rate of inflation, the more prices go up …

… so, the trick is to buy something that will rise in price with (or over) inflation BUT pay for it in current-day dollars.

What can do THAT???

Well, real-estate can, particularly in the USA where you can leverage an unusual quirk of the lending industry: you see, you can buy real-estate that will go up in value as surely as your can spell I N F L A T I O N …

… and, you can buy it with the Bank’s money and lock that ‘price’ in for up to 30 years (on some residential property).

So, that $535 payment (at 5.75% fixed interest for 30 years) STAYS at $535 even as the $100,000 property doubles in value to $200,000 over time … and, the higher the inflation rate, the quicker the property doubles … no matter what happens, your payments stay the same.

Obviously, if spending $535 p.m. was ‘good value’ when the property was $100k, it must be twice as good value when the property reaches $200k!

So, if you know that high inflation is increasing your property portfolio more rapidly, why wouldn’t you buy as much as you can get your hands on if:

a) Current interest rates seems low, and

b) If you felt that a period of higher inflation was coming?

Making Money 301

We are obviously not looking to acquire more debt, here, but there’s no reason to pay off debt either IF:

1. The interest rate has been locked in at levels lower than current interest rates, and

2. You can’t put the money to work for you in ‘safe’ investments elsewhere, and

3. The properties produce enough ‘spare’ (after mortgage interest, costs, and provisions against future vacancies and repairs/maintenance) cash-flow to satisfy your daily needs.

If the property meets these criteria then it’s probably reasonable to assume that your income (i.e. rents) will keep pace with inflation, as probably will your capital (i.e. the building itself).

Of course, if you haven’t already bought the property by the time that you stop work [AJC: a MUCH better word than ‘retire’ for us 49-years-young-stopper-workerers 😉 ], then I would advise that you look at these alternatives:

i) Real-estate (this time, bought with very high deposit / very low borrowings … if any), and/or

ii) TIPS – Treasury Inflation Protected Securities … although, you will have ideally bought these while inflation was still low(er) as competition for these may have pushed prices up / yields down, and/or

iii) Dare I say it: dividend stocks (or, any portfolio of stocks that you are happy to sell down a portion of each year to create your own ‘dividend’

…. but, avoid cash, or cash-equivalents (CD’s, non-inflation-protected bonds, etc.) as inflation will almost literally gobble these up!

Insure your future?

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If you’re on the road to your Number – let’s say it’s $2 Million by the time you are 35 – and that milestone is well before your retirement accounts vest, you have a real trade-off to make:

1. Put that money that you would have otherwise invested in a 401k/IRA/etc. to work for you now to help you get to your Number, or

2. Keep socking money into your retirement account as a ‘safety net’ in case you fail.

The ideal strategy is actually 2., as you should always ‘insure your future’ …

And, some would say that you should keep socking that money away until you have something concrete to use your money for and then you can always pull your money out of your retirement account if you need to.

But, there’s the issue of taxes and penalties on early withdrawal, right?

Speaking of Motley Fool’s mastery of the sensational headline, I thought that I had found an easy solution for you when I saw this headline on their site: Tap Your IRAs to Retire Early. Unfortunately, it was only a ‘funnel’ into a pretty boring article that tells you that you can withdraw a couple of percent of your IRA each year, earlier than your standard retirement age.

Not much use to an aspiring multi-millionaire!

If you do what I suggest:

1. Implement sound MM101 strategies (save 15% of your gross income via 401k/IRA’s/etc.), as well as 50% of any ‘found money’ (lottery winnings. tax refund checks, inheritances, etc.)

2. Pay cash for your cars, don’t acquire credit card debt, buy your own home, obey the 25%/20%/5% rules

3. Increase your income (and save 50% of any such increase) through a second job etc.

… then you will probably have the ‘capital’ saved as cash (or in ‘spare equity’ in your own home) to start the types of businesses that I suggest that you start (eg low cost – perhaps internet – businesses) or to slowly start investing in real-estate without needing to ‘tap’ your 401k.

This is the ideal … but, if your business should be growing and you need the funds to expand further, then you may be left with some unsavory alternatives:

1. Hock the house, cars, children

2. Find a partner to invest in your business

3. Raid your retirement accounts

I’d probably go for 1., then 2., then 3., or maybe 3., then 1. then 2. – or maybe I’d put the partner second (never first) – but, I’m not sure. It all depends on circumstances … which we’ll have to explore further in future posts.

In the meantime, which would you choose?

I hate budgeting … so, I’ve only ever tracked my expenses once!

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No Budget BudgetThat’s why I was so  excited a number of years ago (very early on in my Financial Re-birthing Process] to come across John Burley’s ‘No Budget Budget’.

For those who don’t know him, John Burley is a financial spruiker (originally, on the subject of ‘wraps’ for real-estate … something that I have never tried myself, so something that I can’t really comment on); after hearing him speak, I tracked down one of his courses that covered basic financial improvement “in 31 Days” …

… I don’t think I ever got past Day 1 or Day 2, but I’m really glad that I tried his ‘no budget budget’. It’s the ONLY personal budget that I have ever tried (and, don’t even get me started on the subject of business budgeting!).

Basically, the process consists of writing down every single dime that you spend (cash, check, credit) for a month. That’s it!

When I was cleaning out the house for ‘our big move’ recently, I found the actual budget that I had put together … it spans all of 3 pages (part of page 1 is scanned and reproduced here); a small ‘price’ to pay for financial freedom 🙂

Here’s how it works:

1. Grab a blank sheet of paper and a pen (actually, a little pocket notepad and pencil is ideal … but I kept a folded sheet of paper in my pocket and my wife kept a little notebook and pencil in her purse and every night she would tear the page out that she used and give it to me to add to my sheet).

2. EVERY DAY FOR EXACTLY ONE MONTH [AJC: you don’t have to start on the first day of the month; any day – like TODAY – will do] I wrote on that sheet of paper:

– The Date (each day I started a new section on the piece of paper … when you try this, you should be able to fit a week or so on each sheet)

– What we bought (e.g. lunch; drink; bread; newspaper) … we did this for every single purchase!

– Who bought it (A for me; S for my wife; I guess we would also need to add Ad and Ta for our children if we were starting this No Budget Budget now)

– How much it cost (inc. taxes etc)

– How we paid …. we used a simple system eg Cash, Visa, Check

That’s it; one month …

Also, we added a new ‘last day’ of the month, so that we could write in 1/12 of any annual expenses (eg insurance) whether paid for in that month or not.

You can see that we did this in Australia 9 years ago [AJC: the date 1st Feb, 2000 is written as 1.2.00 in Australia]

You can also see that we were mainly a ‘cash society’ back then as only the haircut (mine) was paid by Visa [AJC: at $28 back then, I must have had WAY more hair than I do now] …

So, we simply kept a log of all of our spending for each day, in exactly the same way that we did for Feb 1 for the whole month … of course, Feb is a dumb month to choose, because it’s the shortest.

I can’t find the summary page, but I recall it being something like $1,000 a month that we were spending then.

That tells you what you’re spending … now, compare that to what you’re earning (after tax):

Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.
Charles Dickens, David Copperfield, 1849
English novelist (1812 – 1870)

This worked for us, and we never bothered doing it again; didn’t see the need … now, tell me about your experiences with Budgets (or No Budgets) 🙂

Rapping up The Richest Man In Babylon …

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I was researching a post and it occurred to me that not everybody knows about the best-selling personal finance book, The Richest Man In Babylon …

… so, I found this rather ‘unusual’ summary of the book and its seven rules, which boil down to:

– Save 10% of your gross income and put it to work for you

– Reinvest the dividends (that’s how you kick in ‘compounding’ … it don’t happen automatically, bub)

– Budget your income (I’m not so sure how important this it other than to help you save the 10%)

– Own your own home

… if anybody can make head-or-tail of the other three ‘rules’ please put them in the comments 🙂

Save your way to wealth?

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We just spoke about saving your way to some capital to start a business and here’s Steve Olsen talking on his blog about a man that he met who managed to do just that by saving 50% of his income:

I heard a 60+ year old man say this today…

When I was 18 I made a decision. I decided I never wanted to be under financial stress. I have lived that decision my entire adult life and have never experienced financial stress. How did I do it? I saved 50% of my take home income without exception. I’ve had months I’ve made $100, and other months I’ve made $100,000. But regardless, I still saved 50% of my income. My income has fluctuated but my saving percentage hasn’t. This has enabled me to purchase several business and a large ranch without incurring debt. I hear people say ‘I couldn’t possibly live on 50% of my income.’ Oh! baloney, you choose not to. Sure it’s harder once you have a 400K mortgage and kids in private colleges, but you decided to live that way. You don’t need to live that way. And if you had decided when you were younger to live differently, you could have your 400K home and private college today without a dollar of debt.

I’m not trying to preach. I don’t save 50%. But I know everything this man said is true. I could have saved more, and if I had, I’d be much better off today.

First of all, I stick to my guns: you CAN’T save your way to wealth!

cash-flow-markFor example, let’s look at Mark from our 7 Millionaires … In Training! ‘ grand experiment’:

My current monthly net income after taxes is about $6,425

I haven’t tracked my expenses in detail for a while even though I’ve been using Quicken and I’m surprised to see some areas where I can easily cut down.

Current Monthly Expenses (average for the last 12 months):

  • Housing – $980
  • Gifts (gifts for family and friends, mostly family) – $925
  • Auto – $267
  • Entertainment (been to many concerts, musicals, activities and events) – $266
  • Utilities – $256
  • Dinner and Lunch outside – $228
  • Vacation (low number since I’ve used airline miles for 2 international trips) – $224
  • Charity – $191
  • Misc (Electronics, Clothes, Insurance, Cash) –  $406

The total is about $3,743.

This indicates a savings of $6,425 – $3,743 = $2682

Jeff put it best:

Your “living the good life” activities account for about 43% of your monthly expenses (gifts, travel, eating out, entertainment). I’m not proposing eliminating everything, but if you cut those expenses by 1/3 – 1/2, you could increase your monthly surplus (or profit :-) ) by 20-30%. In an extreme case, eliminating them all together could boost your monthly profit [savings] by 61%.

Sure adding an extra, say, $800 p.m. can put Mark into High Income / High Saver territory, producing a HUGE $11 mill. in 25 years …

BUT:

1. That’s ‘only’ $4 mill. in today’s dollars and Mark has to wait 25 years to get it … Mark’s Life Purpose requires $5 million in just 10 years

2. In 10 years of frugal living Mark will ‘only’ have $1.25 Mill. in today’s dollars … certainly not enough to even reopen up the spending gates ;)

It seems that you really can’t ‘save your way’ to your Number – even if Mark saves 50+% of his income – unless he’s happy with the $4 Mill. in 25 years scenario (better than being broke, right?) …

… but, the secret is in what the person in Steve Olsen’s article did with the money he saved; here it is again:

My income has fluctuated but my saving percentage hasn’t. This has enabled me to purchase several business and a large ranch without incurring debt.

Now, what do you think the businesses and ranch did for his income and lifestyle?

So, the reason why I promote making Money 101 activities such as saving more, paying cash, and delaying gratification is that it allows you to build the capital required to make a lot more money later …

… you really need to be saving more to help you increase your income:

a) By building up a ‘war chest’ (working capital, R&D costs, etc.) for your investing activities and/or business ventures, and

b) By building up a ‘backup reserve’ in case things don’t work out.

As I told Mark:

Save a little now, so you can still afford to spend more later …

… but, ONLY if you are serious about your Number, otherwise spend away! Go ahead and enjoy your life as it is, you’re already ahead of 99% of those in your age group :)

What's 17 years between friends?

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17Warning: This image has absolutely NOTHING to do with the post other than:

(a) it came up when I searched for “17” on Google Images (I don’t even know why?!),

(b) it’s very funny/cool, and

(c) I have absolutely NO IDEA how a boat lands on a car

… or, what a seemingly naked guy in a yellow raincoat is even doing there!?

____________________

In a recent post, we gave Chad a ‘starter kit’ to becoming a millionaire; and as Money Monk said:

There’s always a slow way and a fast way.

For me, the fast way has always held more appeal …

… but, that doesn’t mean that you can’t combine the two, as Jeff points out:

By taking into account annual contributions, your compound annual growth rate can significantly drop. For instance, if Chad starts with $10,000, his compound annual growth rate is 65.52%. If Chad could also save and invest $10,000 of his salary a year, his compound annual growth rate drops to 52.52%.

If Chad’s Date is firm, annual contributions might not change his analysis much, but if he extended his term or could increase his annual contributions, (or both)…the difference can substantial. For example, if Chad extended his date out another 17 years (and adjusted his number for inflation), his compound annual growth rate drops to 19.81%. If Chad also decided to increase his initial annual contribution to $15,000 and then continue to increase the annual contributions by 5% a year, his compound annual growth rate drops further to 16.69%.

Getting 16.69% annualized return is no cake walk, but a lot easier to get than 65.52%.

What’s an extra 17 years and a drop in living expenses by $15k a year between friends?! ;)

Seriously, Jeff’s point is absolutely valid and is the real secret:

Rather than gambling on the business or [insert speculation of choice: growth stocks and options; gold; oil; etc.; etc.] to pay off big time (i.e. deliver your Number in one neat check), you build a business for sale … in the meantime, you keep following Making Money 101 and save/invest in solid assets (e.g. income-producing real-estate and/or ‘value’ stocks) …

… it’s the combination of Making Money 101 and making Money 201 that delivers the extraordinary result that Chad is after.

Is your partner worth $5 million?

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picture-12I guess by now you know my true feelings about partnerships, but you may have other ideas …

… after all, your intended partner may be the Yin to your Yang … she may be the finance whiz while you run rings around operations … or he may just be your buddy since you shared a dorm together.

All I can say is: I hope that whatever your partner brings to the table, that they are also bringing The Big Idea.

You see, if you are the one with The Big Idea and you choose to share it with a partner because you [insert too scared to go it alone reason of choice: need more capital; need finance/operations/marketing skills; need somebody with a level head; need somebody to burn the midnight oil with; need somebody to hold hands with; etc.; etc.], then you are effectively paying your partner $5 million for the privilege!

By now you’re thinking that I’ve gone entirely off my rocker, so let me explain:

Let’s say that you have worked your way through all of the exercises and you believe your Number to be, say, $10 Million in just 10 years … where are you going to get it from?

Well, The Big Idea of course!

You’ve had this great idea and you will build a business around it and you will sell it for $10,000,000 in 10 years and …

… ooops!

You forgot that you invited a partner to join you … and when you sell, they are going to get half: $5,000,000.

That’s $500k a year for 10 years PLUS whatever salary that they took for those 10 years PLUS whatever perks that they got (e.g. trips, cars, laptops, phones, etc., etc.) PLUS 50% of any profits.

And, now you’re only half-way towards your Number!

Was your partnership worth it? Or, could you have hired people when you needed them for far less cost? I’m venturing that the answer is ‘yes’.

Another way to look at it is: will I be able to sell my business in 10 years for $20 million, so that my half still gets me to my $10 million 10 years Number? Or $30 million, if I decide to have 2 partners 😉

So, the question that you need to ask before considering going into business with somebody else is: am I more likely to get to my Number with or without this person?

And, I’m guessing that unless you’re a total doofus who just happens to have The Big Idea and not much else going for them, the answer will be “NO, I can get to 100% of my goal without this person, MUCH easier than getting to 200% of that same goal with them”.

So, what if you don’t have The Big Idea, but the guy who happens to have it asks you to go into business with him?

That, my friend, also depends on whether you are more likely to get to your Number with or without this person … and, their Big Idea?!

New Reader Question about debt …

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I am always pleased to receive questions and comments from readers – and, new readers in particular. For example, recently I have been in e-mail conversation with David, a new reader, who asks:

After spending half of my day reading various posts and links I have a better idea of where I need to be.  I do have a question – I have student loans that I unfortunately locked at a 9.9% interest rate back in the mid 90’s.  I still carry about 30k and I make about a $330 payment a month.  What is the best strategy for those?  I can’t refi them.  I can pay them off “quickly” but the money that I would be lopping off that is taken away from my nest egg and emergency funds.  If I pay them off on their schedule, it will cost me around $79k in the long run. What would you suggest?

While I’m not qualified to – therefore, don’t – give give direct personal advice of the financial or any other kind, I can use this question as ‘inspiration’ for this, more general, post …

This is a common problem, facing most folk these day … not specifically the student loan, but debt in general. And my response is generally the same: it depends 🙂

And, the thing that it depends on is actually two things, not one:

1. Do you have ‘spare income’ or cash floating around that you COULD be applying to this loan?

If not, then you need to keep paying the loan according the schedule and doing your level best to find some additional money through increasing income (MM201) and/or better personal money management (MM101). But, if you do have some spare cash floating around then you need to ask yourself the following question …

2. Where else could you put the money that would return more than 9.9%?

This is really a simple question, so you don’t need to beat yourself up about the answer …

If you want to start a business that can return, say 50+% if it’s successful, then you may be better off keeping the loan in place – making just the required payments, for now – and putting your spare cash towards startup/working capital for your business.

But, if you are thinking (instead) of paying down your home loan, with its current interest rate of 6% (probably at least partly tax deductible) then I would suggest that you instead pay off the student loan.

And, if you had a car that you absolutely had to purchase and were thinking about financing it at, say, 11%, then I would instead suggest that you pay cash for the car and keep the student loan in place.

The decisions, to me, only become more ‘difficult’ if you have no clear idea of a better use for your money other than “Maybe investing in something one day” … in which case, I would take the ‘sure thing’ i.e. pay off the ‘student loan’ debt,

OR

The available options are so close in interest rate earned or spent e.g. should I pay down the 9.9% student loan or buy some units in an Index Fund that should return a bit over 9.9% over the next 10 or 20 years …  in which case, I would again take the ‘sure thing’ i.e. pay off the ‘student loan’ debt.

Other than that, simply apply the principles in this recent post and you won’t go too far wrong …

BTW: don’t forget to compare interest earned and/or spent AFTER TAX. To me, a rough estimate (rather than paying for a consultation with your accountant UNLESS the decision is major or strategic) is probably usually good enough … but, when in doubt, work it out WITH YOUR ACCOUNTANT.

Oh and one more ‘trick’; if you have another asset that you can acquire new debt on to pay off the more expensive old debt, can/should you do it?

For example, if David has a house with ‘spare equity’ can/should David refi the house and pay off the student loan entirely. At an effective current (tax deductible) interest rate on the refi of, say, 6% (compared to a ‘locked in’ 9.9%) the answer is most likely a resounding YES, however, now we have to think about locking in and term:

The student loan is likely to be locked in to a repayment schedule that will see it paid off in just a few years, but a mortgage will probably be offered at 15 to 30 years to keep the repayment schedule low … if the purpose if simply to repay the student loan, then you should divert the money that you would be using on a monthly basis to repay the student loan to repaying the mortgage (i.e. pay off the mortgage with the original mortgage payments PLUS the former student loan payments).

Because the combined interest rate is now lower but your repayments are the same as before, you should actually be paying debt off at a slightly faster rate …

Of course, if you do have a hot new business or investment idea, then you may instead refi the house, pay off the student loan and apply any spare cash (over and above what the bank says that you HAVE to pay on the mortgage) to building that little ol’ warchest … but, this is an advanced – and more risky – Making Money 201 concept … only needed if your Number says so 🙂