Debt Snowball, Debt Shmowball … as long as you're RICH!

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debtbazooka1Let’s face it, if your whole goal in life is to simply get rid of your debt you are probably reading the wrong blog ….

… but, I am working on the assumption that you feel that paying off debt will help you get rich(er) quick(er).

How?

Well, most people that I talk to say: “I will become debt free then I will have all that money spare to start investing … stress-free because I’ll have no debt to worry about”.

Stress free, until I point out that paying off debt early to start saving up to invest later is the long road to nowhere. You see, they will simply start investing too little, too late to make a dent in their true retirement needs … assuming that living on an ashram, eating rice-cakes three times a day isn’t their ideal future 🙂

When I point this out, they say: “Oh no, I’ll be accelerating my investment plans because I’ll be borrowing to buy an investment property … you see, I’ll have paid off all of that BAD DEBT (on my car, my TV, my house) and be ready to put all of those monthly payments into a big, fat GOOD DEBT loan on an investment property”.

Then they point me to all the methods that might be used to quickly and efficiently pay down all of this ‘bad debt’  – conveniently and cleverly collated in this blog post by my good blogging friend, Pinyo, over at Moolanomey – and:

BANG!

I’ve got ’em right where I want ’em …

You see, the concept of ‘good debt’ and ‘bad debt’ only applies when you are deciding whether to take on debt or not.

Let’s take the following two examples:

You want to buy a car on finance = BAD DEBT

You want to buy a ‘positive cashflow’ investment property by borrowing 80% of the purchase price from the bank = GOOD DEBT

Still with me? Good.

Now, here’s the twist: once you have acquired the debt, there is no more ‘good debt’ / ‘bad debt’ anymore … there’s only EXPENSIVE DEBT and CHEAP DEBT.

I don’t think that this is something that you’ve ever seen anywhere else (at least, I certainly haven’t!), so let’s take a simple example to explain:

You used to have a $25,000 student loan (at 2.5% fixed interest) and a $5,000 car loan (at 11.5%) … and, you cleverly and diligently worked at paying off the car loan at the rate of $150 a month (your minimum payment was $50 a month, so you paid it off pretty quick … good for you!), while maintaining your minimum payment of $25 a month on the student loan.

Now that the car is paid off, you are naturally planning to apply that whole $175 a month to the student loan and have it paid off in only a few years (yay!) … is this the right thing to do?

Well, let’s apply the cheap debt / expensive debt test to the alternatives available to us:

1. Pay down the student loan (save 2.5% interest), or

2. Spend the extra $150 a month on all the stuff we’ve been going without (an effective 0% earned or 100% ‘interest’ expense on the money spent, depending on how you want to look at it), or

3. Stick the money in a CD (earn 1.9% interest).

Clearly paying down the student loan is the best ‘bang for buck’ that we can get, here, and spending the money is the worst.

But, what if we add a fourth option:

4. Use that $150 a month to save up for a deposit, then apply for an 80% loan to buy an investment property (pay 6.5% interest).

Using my ‘cheap debt / expensive debt’ rule, you would immediately work on reducing your most expensive debt, which is the 6.5% mortgage loan … and, the best way to reduce it is by keeping $25k of it in the cheaper (2.5%) student loan.

However, the ‘Ramseyphiles’ would pay off the student loan (BAD DEBT), then save up the entire $175 ($150 + $25) for the deposit on the investment property (GOOD DEBT), and spend a lot more in interest for the privilege.

Now, do you see the sense in doing this?

Well, I can’t!

Why pay down a $25,000 loan at 2.5% just so that you can replace it with another $25,000 loan (plus ‘another loan’ for the remainder of the amount that you will need to buy the investment property) at, say 6.5% or 8.5% or whatever the interest rates will be a few years down the track.

Not, only do you pay more in interest, but you delay the purchase of the ‘cashflow positive’ property which means that you are putting less cash INTO your pocket and missing out on all of that extra appreciation on the property, not for the benefit of being debt free (because you will have a nice, fat mortgage on the property), but for the very minor advantage of only have one larger loan to pay rather than two smaller ones (student loan, plus $25k smaller mortgage).

If you don’t think the property is going to make you money, why buy one at all … and, if you do think it will make you money, why delay?

When thinking about finance, it’s much better to shift your focus from the means (paying off debt) to the ends (having enough passive income to fund your ideal life) …

If you’re interested in understanding more about how this works, read Pinyo’s post to get the basic Debt Snowball mechanics set in your head (he has a nice diagram), then read the Cash Cascade where I explain in video and words how to make this work – even better, in my most humble of opinions – for you 🙂

But, if your sole goal really is to become debt free, why not consider doing it the easy way as the cartoon above, suggests?

Why get your knickers in a knot over Robert Kiyosaki?

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Flexo over at Consumerism Commentary is getting his knickers in a knot over Robert Kiyosaki’s definition of “asset” and “liability”:

A house, like any other object that comes into your possession, is classified as an asset. An asset is something you own. A house has a value. Whether you assign the value as the price at which you purchased the house or the price at which you believe you can sell the house, that amount is how much your house is worth.

You can offset the value of the asset with the value of the mortgage, your liability. Your house, an asset, subtracted by your remaining mortgage, your liability, results in your wealth due to your house. That’s commonly called your “equity,” but that has a murky definition, too.

So why do so many people claim that your house is a liability if it’s clearly incorrect from a financial standpoint? Most of this stems from one personal finance “guru.” Robert Kiyosaki, a successful marketer of products, believes an asset is anything that provides cash to you, while a liability takes your cash away. These are not the traditional meaning of the words, but this establishes a framework for the ideas Kiyosaki tries to sell. Kioysaki believes you should strive to increase the assets that provide positive cash flow (Kiyosaki-assets) and reduce the assets that require negative cash flow (Kiyosaki-liabilities).

The concept is sound, but Kiyosaki’s use of the words “asset” and “liability” angers those of us who understand finance and prefer not to confuse the general public by redefining words.

First of all, let me put on the record that (a) I like the general thrust of Flexo’s blog, and (b) he is ‘technically’ correct in what he says here, BUT …

… Robert Kiyosaki is simply trying to make a critically important point (in his famous book Rich Dad, Poor Dad) that I covered in my earlier post on this subject:

Poor Dad vs. Rich Dad

My Poor Dad Says My Rich Dad Says
“My house is an asset.” “My house is a liability.”
Rich dad says, “If you stop working today, an asset puts money in your pocket and a liability takes money from your pocket. Too often people call liabilities assets. It’s important to know the difference between the two.

I guess that Kiyosaki could solve the problem by saying that “My Poor Dad says that my house is an Asset, but my Rich Dad says that the mortgage is a liability” … but, that doesn’t really present the view that you can have a fully paid off house and still live like a pauper (asset rich … cash poor).

Also, I could point you to the Merriam-Webster Online Dictionary definition of ‘Liability’ (“one that acts as a disadvantage” “drawback”) and state the obvious i.e. Kiyosaki is using the general definition, not the financial definition, but that’s not the point either …

… regardless of definitions, I feel that the ‘issue’ of taking a technical term and ‘bending’ its use in order to make a point that could mean the difference between your future financial success and failure is a relatively small one … as long as you understand that there is a technical definition of the term as well, just in case you do need to converse with professionals (who are all trained to talk in your lingo, if necessary, anyway) 🙂

So, can you live with two definitions – a technical one and a ‘functional’ one?

The lament of the trust fund baby …

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It seems that my Rich Dad. Rich Kid? post struck a bit of a chord with some of our readers; the post was essentially questioning whether your kids are rich – or should be – just because you are –  or, will soon become 😉 – rich yourself?

The universal agreement seemed to be that the best financial ‘gift’ that a wealthy parent can give their children is education … particularly education about money; something about teaching children to fish …. ?

That leads me to Diane who suggested that I write a follow-up post, saying:

I married a man who was the son of rich parents and rich grandparents. He didn’t have a lot of motivation, but I liked the fact he was not a workaholic. Divorced now, I do not know how his parents and grandparents’ trust funds have fared, both with the economy and with is father’s aging (a topic for another post, Adrian? How to help the aging parent who’s used to controlling the funds but perhaps has lost his cognitive ability and no one has recognized that decisions are impaired? But I digress…)

Let me deal with both Diane’s question and the whole ‘spoil the child?’ subject with two personal stories:

Firstly, Diane’s question about the aged dealing with finances is a real one that can only be solved with a willing ‘aged one’, some personal ethics, and an Enduring Power of Attorney:

My grandmother is 96 years young; she is in an old people’s home now – having just moved from her retirement village (i.e. over-55’s) due to an over-medication issue – her doctor’s fault. In short, she’s more capable than you or I.

She’s so capable, in fact, that in the last 2 years she personally engineered the sale of a substantial downtown property on behalf of herself and her partners, fetching a record price. She handled the realtors, the attorneys, and her partners herself. Period.

However, she also put in place a Power of Attorney (“just in case”) and has recently set up a trust fund to deal with the cash proceeds.

So, my experience is with somebody who is mentally capable of recognizing their own strengths – and weaknesses – and puts in place the appropriate strategies. She also recognized that my mother may not have the same capabilities so has set up a trust involving my mother and an attorney (not exactly how I would have set it up, but it’s not my call) to try and protect the assets for future generations.

So, my only counsel is that you have to put in place the safeguards, well in advance of the problem – with the elderly person’s consent … if they don’t want to play ball, well it’s their money  …

… which brings me to the second personal story:

I am one of three siblings, having a slightly older sister and another sister a few years younger; neither of whom exhibit any signs of financial intelligence (one has no money, no job, no prospects, and the other has no money, a part-time commission-based job, few prospects, and gave away her house to a con-man despite warnings … ’nuff said) … since I have at least some sense of financial responsibility and a desire for self-sufficiency, I can honestly say that I can’t relate.

It was explained to me once by a professional why my sisters and I are so different (and, why I am now wealthy and they are now ‘broke’ … awaiting the next regular dose of parental hand-out): you see, my sisters believe that they grew up in a rich household … that was the impression that my father gave my mother, sisters, friends, bankers … in fact everybody but my grandmother and me.

He would live beyond his means then go to my grandmother for handouts to maintain his comfortable-to-upper-middle-class lifestyle (and support his usually failing business ventures), but he would tell me our true financial situation: just over broke.

Since finances were never discussed openly in our house, I didn’t realize that I was the only one who knew the truth … so, I simply grew up in a ‘poorer’ household than my sisters, which meant that I automatically worked every weekend and every vacation and bought all of my own clothes, cars, and saved for my own discretionary spending. My sisters, of course, simply held their hands out, as and when needed.

Therefore, as the professional explained it to me, I simply grew up responsible and my sisters didn’t. As things turn out, this ‘education’ was a blessing for me …

So, here’s where the two stories intertwine:

Early in my career, I still felt that I had a financial ‘safety net’ – even though my parents were struggling, there was always grandma in the background if things really went awry … not to mention a nice large inheritance surely to come ‘one day’.

Until I realized that (a) the family assets would need to be spread over more and more people as they (eventually) moved from my grandmother to my mother, [perhaps] then to my sisters and me, and (b) my sisters (and, mother) had a huge capacity to consume … so who knows if there will actually be any assets left if my turn should happen to come? That’s the time when I made the key decision to become truly self-sufficient: independently wealthy (you read how this came about, already).

This is the point: if you rely on a safety net, chances are that you will need one, but it won’t be there when you need it.

But, if you choose not to rely on a safety net – instead, choosing the path of self-sufficiency – you will end up creating your own safety net …

… and, if the inheritence happens to come through, you have the perfect means to start your own charitable foundation 🙂

An unbelievable experiment in subliminal advertising …

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I’ll show this video [if clicking on the above embedded video doesn’t work, click this link instead] because (a) it is from the brilliant Derren Brown, the genius behind The System (that I ‘lifted’ for my own cruel experiment in spotting scams, a week or two ago) and (b) it shows that there is power behind the concept of advertising.

However, the problem is this: while ‘awareness advertising’ may indeed work (as I think this video, which I believe to be genuine, seems to prove) you need VERY DEEP POCKETS to make it work …. your message has to be in front of each person’s eyes multiple times, which takes money – a lot of it.

That’s why, for me, advertising is something best left to the McDonalds and Coca Cola’s of this world and the small guys, like you and I, are much better off with more direct forms of sales and marketing.

For example, I have used: e-mail newsletter campaigns (low cost and slightly effective),  referrals (free and fabulously effective), PR (which is totally free and reasonably effective), and educational courses (where I was actually paid to speak and that were completely effective) to deliver my message in a very cost-effective way … I am not aware of a single client who came to my businesses through any of the advertising campaigns that I allowed myself to be talked into (VERY rarely, I might add) over the years.

But, watch the video even if you are not in – or planning to be in – business … it’s a hoot 🙂

How to really practice Smart Personal Finance …

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piggy-bankThere’s a small, but growing movement to try and ‘package’ personal finance advice into various ‘systems’ …. heck, I am [still] working on my own Grand Unified Theory of Personal Finance …

Hint: it will come with all sorts of strings attached 😉

… for example, take these Tips on Practicing Smart Personal Finance from Think Your Way To Wealth [AJC: I’ll leave you to read the post, which has some great suggestions].

But, if I were to write some of my own tips on ‘practicing smart personal finance’, it would surely begin with the end: know your objective.

Then it would suggest that you find our where you are today and come up with a plan to bridge the gap between the two; for example, my list might look something like this:

1. Understand WHY you need money

2. Decide HOW MUCH money you need

3. Plan for WHEN you need it

4. Find the Annual Compound GROWTH RATE required to get you from HERE to THERE

5. Get Started … take the first step

6. Make sure you don’t spend the money that you need to grow

7. Plan NOW for how you ar going to keep your money safe once you get there

8. Ensure your plan (this is not the same as – but, MAY include – insuring your plan).

That’s pretty much what I like to call Making Money 101, 201, and 301 … and, if you do it right, it’s not merely ‘smart personal finance’ … it’s Stupendously Intelligent Personal Finance 🙂

Feel the power, Baby!

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muscle-car1

We all know one …

… you know, (usually) the guy who goes out and buys the biggest ‘muscle car’ that he can afford.

His # 1 criteria is the Number of Horses that fit under the hood of the car.

Unfortunately, those cars usually can’t get to/from the corner store as quickly as Little Johnny on his BMX bike (traffic and traffic lights), and they certainly can’t get around the track quicker than that guy from school who was always tinkering with engines and stuff … you know, Tony Romularo in his souped up 80’s bright red Alfa Sud, you know, that little Italian car with the tricked up suspension?!

You see, the muscle car has a a problem: weight.

In order to carry the engine … and, have the BIG/POWERFUL car look that muscle-car-lovers crave … these cars usually have to be big and heavy. That means that they can be slower than the simple measure of horsepower can lead you to believe.

So, you can do what others do … look for results: look at the specs, skim right past the power rating, and go straight to the only kind of performance that really matters – the one that takes into account BOTH Power AND Weight: how fast will the car do the 0 to 60 mph?

That’s the kind of results that I’m after … if it’s under 5.5 seconds, I’m there, Baby!

But, are you?

How do you explain Little Johnny and the trip to the shops? Or Tony and his ‘tricked up’ Alfa?

Of course you can’t unless you take a look at your overall objective first:

– If you want the most powerful car that you can buy, go ahead and buy the Muscle Car (after all, it looks good, sounds great, and you’ll be a hit with your mates at the pub), but

– If you want to get from A to B in the [Insert criteria of choice: fastest time possible, safest means possible, greenest way possible, lowest cost way possible … or, any specific combination thereof] then you have a more complex decision to make that may or may not include buying the biggest engine you can find.

Do you see where this is going?

There are so many financial ‘truths’ out there:

– Buy dividend stocks

– Max your 401k

– Choose only the most ‘tax advantaged’ real-estate

– and, there are many, many more

Each, in its own way, is like just one aspect of a [financial] vehicle: one is like the engine, another like the suspension, and another like the type of fuel you put into it …

… you COULD take on any of these just because it’s there; after all, millions do.

But, wouldn’t it be smarter to first look at your financial destination (your Number), the time that you have available to get there (your Date), and the skills/knowledge/interest/aptitude that you can apply, then look at the range of ‘vehicles’ (i.e. your Growth Engines) available to get you there and select only the most appropriate for you?

I like to think so …

So, how did my wife choose her current car?

She wanted a luxury, SUV Hybrid … that meant the Lexus R400h. Period.

Does it even save money (no … too damned expensive)? Does it even save the environment (uses as much fuel as the non-hybrid R300; and, what happens with the batteries once they need to be disposed of)? And, is it even a good SUV or a real ‘luxury’ vehicle (doesn’t even have keyless entry)?

And, how did I choose my current car:2008_bmw_m3_convertible_in_blue_images_1

– Performance: 0 – 60 sub 5 seconds

– Convenience: 4 ‘real’ seats to carry the kids in the back

– Handling: Had to be ‘nifty’ around a track

– Safety: Had to have a high safety rating; good crash test results; airbags and other safety features

– Convertible: Had to have a metal-folding roof

But, even those are merely a list of features: I wanted a car that I could use all year around (be a true convertible in summer; a true coupe in winter … and able to flip/flop between the two at the drop of a hat); be a lot of fun (but safe), and be fast’n’fun – and safe – both on the road and on the track.

That pretty much meant the BMW M3 … fortunately, price tag (and, fuel consumption) was never on my list of criteria or I may have been ‘forced’ to go for the VW EOS 🙂

The 401k fallacy …

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The objective of this blog is not to challenge your thinking on so-called ‘investment truths’ or ‘common investment wisdom’ …

… that’s just a means to an end.

The objective is to help you become rich [AJC: after all the title of this blog IS “How to make $7 Million in 7 Years”], but in doing so we MUST challenge your thinking on so-called ‘investment truths’ or ‘common investment wisdom’!

Do you see how one is the means and the other is the end?

So it is with many of these personal finance ‘myths’ … so many are treated as an end in themselves, rather than the means that they simply are; none more so than the Mighty 401k.

If we are to become rich, we must slay the temptation to lay at the feet of this great Financial Idol and see it not for what it promises (future financial freedom) but for what it really is: simply words written on a piece of paper.

That’s it, the 401k is just a tax-advantaged savings TOOL … it’s not even a scheme, as there is NO guidance as to what you should put in it (other than restrictions to tell you what you MUST NOT put in it).

Therefore, I have NO OPINION on whether a 401k is intrinsically good or bad for YOU … just as I have no opinion as to whether a stone carving is intrinsically good or bad for a pagan civilization … it’s what belief in its purported ‘power’ does for (or against) your [financial] future that concerns me.

It’s not the tool, but how you choose to use it that counts …

Now, I covered the 401k in many posts, but I thought that I would pick up on a great discussion going on over at my other site, where Scott says that he has no use for a 401k:

I can’t utilize many of the retirement accounts because of my income level and the ones that I can, I max so quickly that it just seems moot. For example, right now, I’m saving up cash as fast as I can to purchase the entire building that my practice is located in. This building also has another business next door that will be paying me rent, and in essence, will drop my personal mortgage significantly, while it’s getting paid off in a few short years, then I own the commercial building, not pay rent, AND receive passive income!

So my question to you would be; Should I delay the purchase date to buy this building and all the above said benefits to first max out retirement accounts that I can’t touch for 30+ years, AND get taxed on them when I do.

Which gets me to my Number faster? Purchasing commercial real estate NOW as fast as I can in my 30’s, particularly one’s that I would normally have to pay rent on and actually begin RECEIVING rent on as well, or fund a retirement account to shed some tax now?

After a bit of discussion around the possibility of finding other tax-advantaged investment vehicles, depending upon your financial positions, Jeff summarized the discussion quite soundly:

The only reasons I can come up with right now to not invest in these types of accounts first is either:

1. The amount you want to invest is greater than the annual contribution limits.

Or

2. You don’t like the age restrictions and early withdrawal penalties that go along with these accounts.

Those are both very valid concerns and certainly reasons to not use typical retirement accounts.

Absolutely, Jeff!

If you can achieve your investment goals, at the same time taking advantage of the legitimate tax-shelters available to you (e.g. 401k, self-directed IRA, etc.), then you would be a fool not to do so.

However, if you divert from a financial course that stands a reasonable chance of meeting your financial objectives – the type of course that Scott seems set to take – just so that you can take part in, say, an employer-sponsored 401k, that may not achieve your financial objectives (in the timeframe that you require, not the timeframe that the employer/government offers) then, in my opinion, you are making a huge mistake 🙂

The fallacy of dividend paying stocks – Part III

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Today, in a final post in a long series, I show you how to put what you have learned about dividends into inaction 😛

But, to wrap up this important series, first it might be nice to go “all the way way to the beginning” with some history on dividends, courtesy of our friends over at Everything Warren Buffett:

During the first half of the 20th century, dividend income made up all of the 5.3 percent return U.S. stocks delivered to investors, data compiled by the London Business School show.

At the time, companies paid out most of their earnings to shareholders, compelled by a Treasury Department rule that established penalties for “improper accumulation” of income, according to the sixth edition of Benjamin Graham and David L. Dodd’s “Security Analysis.” The book laid out the principles of value investing followed by billionaire Warren Buffett, the chief executive officer of Berkshire Hathaway Inc. and the world’s most successful investor.

“The prime purpose of a business corporation is to pay dividends to its owners,” Graham and Dodd wrote.

Between 1980 and 2000, investors increasingly sought price gains as dividends contributed 25 percent of returns. The shift occurred as companies such as Cisco Systems Inc. and WorldCom Inc. increased profits by using excess cash for expansion and acquisitions. In the five-year bull market that ended in 2007, cash to shareholders as a percentage of earnings fell to a record low of 31 percent, based on data compiled by Yale University professor Robert Shiller, as profit growth juiced by borrowed money outstripped dividend increases.

Returning money to shareholders prevents managers from wasting it on investments that may not prove profitable, according to Bahl & Gaynor’s McCormick.

“It forces companies from empire building, stupid acquisitions and nefarious activities,” he said. “You can’t fake the cash.”

The last sentence pretty much summarizes the pro-dividend position: it stops companies from making mistakes with their cash …

… but, my perspective on that is simple: who is better placed to invest my cash? Me (Mr Ordinary Investor) or, say, Warren Buffett (Mr World’s Richest Man)?

In fact, at the 2000 Berkshire Hathaway Annual General Meeting, Warren Buffett was asked about the dividend policy at Berkshire, to which he said:

We will either pay large dividends or none at all if we can’t obtain more money through re-investment (of those funds). There is no logic to regularly paying out 10% or 20% of earnings as dividends every year.

Given my somewhat ambivalent stance on dividends – I can take ’em or leave ’em 🙂 – it was interesting to see this recent and nicely coincidental article in Motley Fool:

… it’s important not to focus on a dividend yield alone, as recent happenings in the stocks below make clear:

Company

Problem With Dividend
General Electric Either must cut dividend or lose AAA rating, according to analysts.
Gramercy Capital Company forwent its fourth quarter dividend.
Education Realty Trust of Memphis Cut its dividend in half.

Even in a bear market, growing companies that pay dividends can be too good to be true — so be sure to do your research.

You see, the decision to pay dividends is a somewhat arbitrary decision of the board of directors … only loosely tied to the actual profit (better yet, cash flow) performance of the underlying business.

Profits are related to the internal performance of the business.

Dividends are related to the external relationship of the company’s management (as represented by it’s board of directors) to its owners (i.e. its shareholders).

So, when you invest in stocks, you should simply remember that you are buying a small share of a big business: and like any other investment, you should make sure that it makes a decent – and, steadily increasing – profit (called ‘earnings’) and produces strong – and, increasing – cashflows that management uses wisely.

This means that you will EVENTUALLY get your money back in some combination of two ways:

1. The share price will eventually rise to reflect increases in profits and/or

2. The board of directors may choose to distribute some of the profits as dividends.

So here are your Buy For Income INVESTING strategies if you do decide to choose stocks as an investment vehicle:

Making Money 101

You will probably be investing in a low-cost Index Fund and holding until you reach your Number; the fund will usually collect any dividends and reinvest them automatically for you. All you will see is a long-term increase in the total value of the fund (appreciation + reinvested dividends) … frankly, this is all you really care about right now.

Making Money 201

If the urge to invest in individual stocks strikes, you will probably purchase 4 or 5 undervalued stocks (i.e. where the current price does not fully reflect the current and/or future earnings of the company … notice, I haven’t mentioned dividends here) and hold them. You will probably reinvest the dividends into buying more of the same stocks as they probably still represent excellent value. You will keep doing this until you reach your Number (or decide to cash out for a ‘better investment’).

Making Money 301

You will talk to your accountant about the tax advantages of withdrawing any dividends v reinvesting v selling a small portion of your portfolio every year to live off … other than that, you won’t care if you make your yearly ‘retirement’ income by selling stock, withdrawing some/all of the dividends, or any combination of the two.

Still confused?

Think of it this way:

Dividends are what you MAY get if you speculate on some stock (i.e. a piece of paper) …

… Profits are what you WILL get if you invest in a solid business.

If you invest well, eventually the stock price PLUS the dividend (it’s not terribly relevant in what proportion) WILL rise to meet the steadily increasing profits … Warren Buffett has averaged a 21%+ annual return by this simple assumption.

Suffice it to say that I have NEVER (yet) bought a stock for (or despite) its dividend … how about you?

The upside down car?

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carpark

Trees Full of Money shows us how to deal with a situation where we’re ‘upside down’ on our car loan:

If you can no longer afford your “upside down” vehicle, here is a a better way to get out of your loan:

Step 1
The most important step in unloading a vehicle with negative equity is to accept the situation for what it is. Saying “if I sell my vehicle now I’ll lose money” is not a plan. The quicker you sell your “upside down” vehicle, the less money you loose due to further depreciation.

Step 2
The second step in selling an “upside down vehicle” is deciding on a fair market value. Lately, the value of used vehicles has been just as volatile as the stock market or the price of oil. The fair market value of your vehicle may be significantly more or less than used vehicle pricing guides such as NADA and Kelly Blue Book suggest.

Step 3

Once you’ve established a competitive price, you need to secure funding for the difference between what you owe and what the vehicle will bring.

Step 4
Once you have met the obligations of your loan, it’s time to do a little marketing and salesmanship. I little effort in the marketing of your vehicle can pay huge dividends.

Step 5
When you have identified a prospective buyer for your vehicle, be sure to ask your bank how to proceed with the transaction. Each state has different laws so be sure to contact your state’s motor vehicle division as well.

[AJC: If you do want to sell your financed vehicle, I recommend that you read the full post here, as I have only extracted TFoM’s highlights]

But, where is Step 6??!!

It should be the one that says: how do I buy a replacement vehicle?

You see, unlike many things that you may choose to own, a car is probably a necessity … now, that doesn’t mean that you need the best car, but you do need a car that can achieve [Insert objective of choice: get to/from work; haul stuff around the farm; schlepp the kids; etc; etc].

So, what do you do?

Well, you first try as hard as you can NOT to get yourself into a financed vehicle in the first place …

… you see, almost anybody who has a financed vehicle is in a negative equity situation:

– As soon as you walk a new car off the lot it has depreciated 10% to 30%, yet you still owe 100% – deposit + payout costs on the loan,

– If your loan is longer than a year or two, the car is probably depreciating at a faster rate than you can pay down the loan.

If you’re not convinced that you are already ‘upside down’ on your loan, ask for a ‘payout figure’ from your finance company – this is the amount that they would expect in a check today to hand over the title to the vehicle to you ‘free and clear’ – and, get ready to choke! Go on, try it …

So, don’t get yourself into this predicament!

But, if that is the only way that you can get into your first set of wheels (is it really, truly the only way? Or, are you just kidding yourself?!), or you are already into a financed vehicle, don’t sweat it.

Just take a look at your current monthly payments and the payout cost … if you can payout the vehicle and buy a cheaper one with cash, go for it. But, the chances are you will need to hang onto your current vehicle, as long as you can afford the payments.

Now, if you can’t afford the payments and you ARE upside down on the loan (as you surely will be), you will need some help to negotiate your way into handing back the vehicle, walking away from the loan and finding a way to start again. Now, that’s a whole can of worms that you just don’t want to open …

… so, next time you’re thinking of upgrading your car with a nice little “low-interest dealer loan” … don’t 😉

401k … a means or an end?

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There’s still this general expectation that if you earn an income then you will have a 401k … it’s seen as an ‘end’ rather than the ‘means to an end’ that it really is.

Let’s look at the advantages:

1. Tax free on deposits into your 401k … ‘boosts’ your investment buying power by up to 25% to 35%

2. Possible employer ‘match’ … further ‘boosts’ your investment buying power by up to 50% to 100%

Now, let’s look at the disadvantages:

a) Generally, limited investment choices (e.g. managed funds)

b) High fees (both explicit and hidden)

c) Restricted access to your money until government-managed ‘retirement age’

d) A fairly low ‘cap’ on amounts that may be invested

But, similar lists of advantages and disadvantages can be draw up for ANY form of investment, tax scheme, etc. etc. …

… it’s just that we mostly don’t bother. We blindly accept the 401k as the ONLY way to go.

Ryan says:

I share your distaste for 401Ks, and their fee’s and penalties, but I have to believe that there is some advantage to having tax shelters (be them 401k or not). Otherwise, won’t the government just take all of your hard earned (and passively earned!) money?

Ryan’s right … the Government WANTS you to pay tax, but only the minimum that you NEED to pay … they don’t expect a penny more. The problem is, the government is only interested in the tax portion of your personal ‘Profit & Loss’ … YOU should be concerned with all of it!

As Scott says:

Robert Kyosaki states that the wealthy aren’t the one’s paying the lion’s share of the taxes. The middle and upper middle class do.

A 401k, ROTH, ROTH IRA, etc., etc. are all simply methods of protecting assets from taxes to a greater or lesser extent …

… the problem is not with these ’shelters’ in themselves, it’s in their design. You see, they were designed for the ‘average American’ to encourage them to save for retirement.

You and my other readers are probably NOT average Americans – if you are like me, you are aiming for a Number in the millions – and will surely hit the ‘roof’ (i.e. the maximum amount that the Government ‘allows’ you to sock away during any one year) of these vehicles very quickly, as your income starts to sky-rocket from Making Money 201 activities …. then, once you achieve your Number, the limits that you can have socked away will mean little to your Making Money 301 wealth preservation strategies … it’s why I don’t even bother!

It doesn’t mean that you shouldn’t tax-protect your money …

… it’s merely that Scott has hit the nail on the head: these aren’t the ONLY tax shelters available, or even the BEST tax shelters available.

For example, and as Robert Kiyosaki suggests, investing in income-producing assets via corporate structures (LLC’s; trusts; C- and S-Corporations; etc.; etc.) and taking advantage of all the tax deductions available to you (e.g. depreciation, 1031 Exchanges; etc.; etc.) will blow away any ‘tax advantages’ of 401k’s and similar (even WITH the ‘free’ money from the employer match factored in).

So, let’s not put the cart before the horse:

– FIRST look at the types of investments that you need to make in order to reach your financial objectives – be they long term (i.e. your Number) and/or short-term (e.g. flipping a house / trading some stocks and options)

– THEN look at the best ‘vehicle’ to house them in.

As an extreme example, if you decide that a business is the way to go – and, put up 100% of your savings as ’seed’ capital’ – then having a 401k is hardly going to help you, is it?

Blindly setting up a 401k first, then seeing what investments you are allowed to make in them is putting the cart well before the horse!