Tag Archives: Saving

Retirement Accounts: 7 Case Studies

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retirees7Everybody has a slightly (some – like me – dramatically) differing view on the whole subject of 401K’s, ROTH IRA’s, and other forms of so-called ‘retirement accounts’.

If you are in a job, then it might be an easy decision: pull the trigger on maximum withdrawals from your salary and attract the generous employer match. Or, is it?

But, if you are self-employed – or, you have more flexibility in how you choose to handle your retirement accounts than the typical employee – then it becomes a bit more confusing: do you outsource or self-manage? Do you try and save your tax now (on deposits) or in the future (on your withdrawals)? Do you even bother …. ?

Well, if you are still confused, let these 7 ‘case studies’ from our 7 Millionaires … In Training! ‘grand experiment’ guide you:

Scott – Not everybody chooses to have a 401k – or, any type of retirement account, for that matter – and some even do it because they feel that they have an even better ‘retirement plan’. Scott is one such example … what do you think? Is he doing the right thing?

Lee – Is at (or past) typical retirement age for most of us. He thinks that he has made some (a lot?) of mistakes with his finances, yet he at least has some money put aside. But, it’s not enough to meet his goals … and, is it really enough to live off?

Josh – On the other end of the age/work scale is Josh, who still has the ‘luxury’ of living at home with his folks: free rent = more to save (or spend?). Should Josh even be saving in a system that doesn’t allow him free’n’clear access to his money until he is 3 times his current age? And, should Josh be using his ‘retirement account’ in the Grand Casino that is the Options Market?

Ryan – Is a highly paid rep. for medical equipment with some ideas of his own. He is exploring the options as to whether he should be investing INSIDE his 401k etc. or OUTSIDE, both for him and/or his wife. What advice could you give him?

Diane – Is currently assessing her options; while she does so, she is drawing down on her retirement account. Should she take the penalties and pay down debt and/or continue to draw down her living expenses?

Mark – The title of his post is 201k in reference to the beating that the stock market has given it recently, but Mark has a long-term view; it seems to me that he hopes to reach a large Number through investments, etc. and leave his retirement accounts simmering along nicely … if the meat’n’potatoes of his Wealth Strategy don’t pan out, then perhaps he’ll have a nice hot financial stew waiting for him when he reaches 60?

Jeff – Here is an example of a reasonably well-salaried government employee who has one foot in each camp: his Grandpappy once told him to invest in his 401k so that he does, as well as have a couple of residential properties. How much money – in today’s dollars – does a high-saving guy expect to accumulate by the time he reaches 60? Is it worth the wait?

You be the judge … be sure to read the comments and add some of your own 🙂

The Frugal Billionaire

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scrooge-35232scrooge1I just love people who pursue frugality for frugality’s sake … like it’s an end, rather than a means to an end.

For example, take this really interesting post on Grad Money Matters where he points to a bunch of rich old men who live like misers:

Some of the world’s wealthiest people … also happen to be some of the most frugal.

  • Despite having a net worth of $62 billion and being the world’s richest man, famously frugal investor Warren Buffett still lives in the same home he bought for nearly $31,500 some 50 years ago.
  • John Caudwell used to ride his bike 14 miles to work everyday and cut his own hair because he didn’t want to be bothered going to the barber despite having amassed a fortune of over $2.2 billion. Caudwell also purchased all of his clothing off the rack at British retailer Marks & Spencer.
  • Jim Walton, member of America’s richest family and Wal-Mart scion, reportedly drives a 14-year-old Dodge Dakota despite having a net worth of $16.4 billion.
  • Retail Tycoon Frederik Meijer, worth $2 billion is known to drive cars with very high MPG and prefers to only stay in budget motels.
  • Gene Burd, a 76-year-old journalism professor at the University of Texas has donated over a million dollars to financial foundations but walks 6 miles to work everyday, lives in a very tiny apartment, picks up pennies on the ground, and wears shoes that he found in the trash.
  • Ingvar Kamprad built a $33 billion fortune after founding Ikea but the Swedish tycoon drives a 15-year-old Volvo, tries to avoid wearing suits, and flies coach. It’s also said (surprise, surprise) that Kamprad furnishes his home entirely with affordable Ikea furniture.
  • Indian billionaire Azim Premji worth upwards of $17.1 billion drives a Toyota Corolla and stays in the company guesthouse rather than 5-star hotels when he’s traveling on business. At a lunch honoring his son’s wedding he even served the food on paper plates.
  • We would be amiss to not mention some of the highest earning dead celebrities who are perhaps the most frugal of this list due to their inability to spend 🙂 For example, top earning dead musician, Kurt Cobain made about $50 million last year. Elvis Presley made $42 million despite having died in 1977 and, in third place, Peanuts creator Charles M. Schulz earnings were about $35 million.

*About the author: This list was compiled by Lewis Bennett, writer for an Individual Voluntary Arrangement (IVA) site.

I have a word to describe this kind of behavior: sick.

You need to ask yourself two questions:

1. Did these people become rich solely because they were frugal?

2. Is their current level of frugality sensible, given their net worth?

There’s no doubt in my mind that you will NOT become rich unless you learn how to delay gratification, but that is not the same as NO gratification. If you can afford to spend on a reasonable lifestyle and you choose not to, you MAY be just as ‘sick’ as the person who lives beyond their means and spends uncontrollably.

On the other hand, if you simply have no interest in the ‘trappings’ of life, that’s entirely a different matter … but, one then wonders why you bother with the whole “let’s get rich” thing, anyway?

But, here’s what I suspect really happens:

1. Some rich people are so driven by the process of making money that they never know when to stop … some take one step, one chance, one risk too many and lose their money, while others just keep going on and on and on, driving themselves – and, their families – to an early grave. There are exceptions of course: those like Warren Buffett who so enjoy what they are doing that they would be doing it even if they were not paid.

The ‘antidote’ is to work out your Life’s Purpose and if it’s to make money … then go until you drop! If not, pursue the financial path until you have acquired enough money to live your Life’s TRUE Purpose, then stop … and, live!

2. Some learn the lesson early that you need to delay gratification and live frugally if you want to avoid spending all the fruits of your labor (rather than reinvesting in your future) but become so driven by the process of saving money that they never know when to stop …

… in my opinion, there’s NO lesson to be learned from a multi-millionaire or billionaire who lives like a miser … other than they are great counterpoint to those billionaires who live overly and ridiculously flamboyantly.

To me the ‘right’ path is simple: live comfortably within your means … whether that is a $50k a year lifestyle or a $50 million a year sustainable one.

Fluctuations? Well, fluc you, too …

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I am pleased to say that I have readers from all around the world, which brings up some interesting problems and opportunities that purely US domestic investors may not need to think about too much.

For example, take Arkhom from Thailand who asks:

Just wondering, and this is a very simplistic view, that altho US stocks are definitely cheap in the long term, wouldn’t the value of US dollar also expected to decline sharply also in the long term? The USD view is conventional wisdom, with all that money being pumped/created for rescues and with current strength due to flight to safety in US treasuries. If that’s the case, it would most probably take the edge off the returns for US investment? Otherwise, in your case, wouldn’t it be more prudent to look for long term investments in, say, Australia?

I mentioned that I was having a little argument of sorts with my wife as to the best place to invest the little bit of cash that we received upon the sale of my Maserati in the US. Since we currently maintain two homes: one in the US and one in Australia, we have a unique opportunity to decide where to ‘park’ our money.

Firstly, let me explain why this is usually not a huge consideration for most small investors:

– If you are US-based, then exchange rate movements only matter indirectly.

By that I mean that the value of US businesses – hence stock prices – don’t necessarily jump directly with exchange rate movements (unless the company is primarily invested overseas, or derives the bulk of its revenues from import/export). But, logic tells me that all businesses are eventually affected … they all buy goods, equipment, and/or components, inevitably some of which comes from overseas.

A strong US dollar makes these cheaper and a weak dollar, more expensive … but, the effects on that company’s stock price are generally slower as they must first flow via the company’s profit and loss statement.

– If you are an overseas-based long-term investor then exchange rate movements may have less effect than you at first intuitively expect.

The reason is that your money may flow into the US (if you are in, say, Thailand), but must must eventually flow back out again so that you can spend the money! So, it is really the long-term CHANGE in the exchange rate that affects you.

– For an investor who lives in two economies (like us), then we can earn and spend money wherever we like and move funds as necessary between the two economies … so, we can make earning and spending decisions independently of each other.

For example, to buy the Maserati we moved funds from Australia to the US at roughly 80 cents in the dollar; and now that the vehicle is sold we can move it back at approx. 66% cents to the dollar, or a ‘net gain’ of 15% or so.

The two questions then become:

1. Can we gain more than 15% over the next 12 months by investing in the US instead of moving the funds to Aus and investing there, and

2. Does it really matter? Where do we intend to SPEND the money?

The answers to these questions usually lead me to: it doesn’t much matter!

In theory, yes, but in practice, no …

You see, if you move the money to invest and move it back to spend, then you are not only gambling on the current currency exchange conditions being favorable, but also the future ones being equally favorable. It’s hard enough to make such predictions today, let alone tomorrow!

Now, exchange rate fluctuations ARE very important for a special class of investor … but, not for the average investor unless the exchange rates are totally out of whack … but, who’s to say where the Aus v US dollar really is set to lie over the next 20 years?

Can you tell me with any degree of certainty?

I can’t tell you … so, all I need to really think about right now is where do I really want to spend my money today, tomorrow, and in 20 years time 🙂

Spending your Net Worth

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

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

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

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

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

This depreciation is something that we can take advantage of …

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

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

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

Investments: $75,000 (75%)

House Equity: $20,000 (20%)

Cars: $2,500 (2.5%)

Other Possessions: $2,500 (2.5%)

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

Investments: $105,000 (80%)

House Equity: $25,000 (18%)

Cars: $1,250 (1%)

Other Possessions: $1,250 (1%)

Which allows you a number of options:

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

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

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

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

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

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

Where do all these rules come from?

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I’m a maverick, yet I like rules … how do you figure that?

Well, the rules that I like are actually ‘rules of thumb’. You see, when I was $30k in debt, I was in the financial wasteland with no idea how do dig my way out …

… so, I did the only thing that I am really good at: I read books. A lot. All non-fiction. Mostly about how to make money.

I can read a 100-pager non-fiction book in the matter of an hour or so and absorb most of the salient points … I may then go back and work at snails pace through detailed explanations, if necessary.

And, I like to read books for instructions: do this, do that. Which I’m then pretty good at modifying for my own use.

So it was for my financial troubles; I started reading:

First Rich Dad, Poor Dad – the first book (and best, in terms of how it opened my eyes) on personal finance that I ever read.

Then The Richest Man In Babylon – which explained the power of compounding and reinvesting.

Then every other Robert Kiyosaki book that came out over the next four or five years.

And, I attended every financial spruiker seminar that came to town (Robert Kiyosaki, Peter Spann, Brad Sugars, and so on … )

… all the time looking for the ‘rules of the money game’.

What I found was that there was no ‘one size fits all’ set of financial rules that everybody should follow … but, there were various recommendations as to what you should do in this circumstance or that.

Over the years, by trial and error (largely a lot of trial – and tribulation – and plenty of error) I found various ‘rules of thumb’ that seemed to make sense to me, and some that I had been following without even realizing it, just like the rules that Jeff questions:

Where are all these rules coming from? Did I miss a bunch of information in the brochure?

If I understand correctly, we have the 20% rule for home equity vs. net worth, 25% rule for mortgage vs. income, and now the 5% rule for cars.

I had been following these rules, largely by coincidence, for most of my successful working life (i.e. during my 7 year journey), when I chanced upon a book that I had never heard of, written by a guy I had never heard of, who lived in a (now) bushfire ravaged area not far from my home in Melbourne, of all places!

Naturally, I had to read the book …

He worked from the premise – one that I happened to agree with – that at least 75% of your Net Worth should be in investments – OUTSIDE of your home, your car, your possessions, and basically anything else that is unlikely to yield you an income or be readily salable at a profit (where will you live if you sell your house?).

That leaves 25% of your Net Worth to spend on: houses, cars, possessions, as follows:

20% House

2.5% Cars

2.5% Possessions

Simple; except that I’m happy to blur the lines a little between cars and other possessions into one 5% ‘pool’.

Of course, this only helped to understand how much equity to hold in these items, and not how much you should finance on a house (that’s where the 25% Income Rule comes in) and cars/possessions [AJC: Easy … buy used and pay cash!].

I have explained how these rules work in practice in these three posts (please follow any backlinks):

Your House

http://7million7years.com/2008/04/11/applying-the-20-rule-part-i-your-house/

http://7million7years.com/2009/01/12/how-much-house-can-you-afford/

Your Cars and Other Possessions

http://7million7years.com/2008/04/12/applying-the-20-rule-part-ii-your-possessions/

Left Brain v Right Brain

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brain

Are you left-handed?

I find myself noticing actors in movies and on TV who are left-handed …. it seems (but, maybe my reticular activating system is blinding me to the statistics) that more leading actors are left-handed than the typical 10% or so that is the society ‘norm’.

Artists, too …

So, is there truth that the right-brain controls the left hand? And that the right-brain is responsible for our emotional / creative side? In which case, left-handed people are more creative?

I’m not sure.

But, I DO know this to be true:

Most decisions are made emotionally then justified rationally

I heard this once many, many years ago … and, even though it is widely quoted, I have not managed to find the source … but, I have found it to be true in business, investing, and in life.

It helps to explain impulse purchases despite reading the classic ‘frugality’ blogs like Get Rich Slowly.

It helps to explain the behavior of the stock market, supporting the findings of the Dalbar Study.

It helps to explain my wife 🙂

It helps to explain why the real answer to the Deal or No Deal conundrum is “Not Sure” …

… the reality is, you will NOT know what you will do in the same situation until you are faced with the same ‘on the spot decision’ yourself.

UNLESS …

Unless You Have A System to Guide You

Anytime you have a ‘rational’ decision to make – and, you can at least anticipate that you will one day need to make such a decision – then you MUST prepare ahead of time with a system that  you strongly believe that you must follow in order to achieve [insert very strong emotional outcome of choice].

The System, of course, will be a rational system: it will be well grounded in research, logic, and proven results.

And, it must be one that – in advance of the real decision that you will face – you strongly believe and/or have faith in.

Religions offer such a system for Life … if you subscribe to one, you do it because of Belief and Faith and then you follow it ‘religiously’ – according to your level of belief – or suffer the consequences …

… consequences that may range from guilt and/or discomfort on the mild end of the ‘consequences spectrum’ to great fear of [insert religious punishment of choice] on the extreme end of that same spectrum..

And, this blog is slowly unfolding such a system for Personal Finance. If you do not follow it, you may (on the mild end) feel guilt and buyer remorse, and (on the extreme end) fear that your money may run out before your do. Somewhere in the middle should be the very real fear that you won’t achieve your Number in time (i.e. by your Date)

The key is that when the decision pops up, the emotions around failing to follow the system must outweigh the emotions (temptations?) leading you towards the irrational decision …

…. ultimately the execution of the decision will always be made ‘in the moment’ and emotionally, and then you will justify your success – or failure – rationally later on so that you can live with your choice.

That’s why you need to commit the 7million7years version of this ‘truism’ to memory:

Most decisions are made emotionally then justified rationally unless you have a system to guide you!

Now, go find a system for personal finance that you feel that you MUST follow – and, a strong reason for doing so (e.g. so you can get on with living your Life’s Purpose … seems a pretty strong reason to me; how about you?) – and then follow it, or suffer the consequences … harruummph! 😉

My spectacles are still cracked!

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On the subject of diversification and rebalancing (you can’t have the latter without the former, although the reverse is certainly NOT true), Rick says:

I don’t expect the market to behave consistently over any significant period of time. The reason I chose an example with no gains was to show that rebalancing can make a profit from volatility even when there is no underlying price appreciation. I suspect that is the mathematical explanation behind the study SiliconPrairie referenced. If a market was continually increasing then 100% stocks should do better- not that that is very realistic either!

I can believe some rebalancing could do better- especially with all of the market volatility we’ve had this year. I really wish I could time the market. I console myself with the fact that no one can really time the market with long term success.

I can rebalance though- as it can be done with a calculator rather than a crystal ball!

What Rick says is true …

… just understand that if you are committed to a diversification / rebalancing strategy, you will most likely:

a) under-perform the market over LONG periods of time (simply because you will have less in the market – on average – than a 100% stock portfolio)

Remember: the market (DJIA) has NEVER returned less than 8% in ANY 30 year period over the past 100+ years – I strongly suspect that if you were 100% invested the day before the market started to crash in October 2007 and simply waited 30 years, the same will hold true – and,

b) have to content yourself with not being able to reach a Rich(er) Quick(er) Number:

http://7million7years.com/2008/09/30/its-the-gradient-of-the-curve/

That’s OK for some … but, the premise under which I write is that it’s not OK for my target audience. That’s all 🙂

Is it OK for you?

House or Home? 7 Case Studies …

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The real advantage of my 7 Millionaires …. In Training! ‘grand experiment’ for the rest of us is that it provides some great ‘real life’ case studies of the topics that we talk about on this site.

For example, we talk a lot about your house, as – for most people – it’s your largest single purchase  …. assuming that you don’t intend to actually get rich and go off and buy yourself some REAL investments 😉

Here is where each of the 7MITs are at with their current housing; if any of these case studies interest you, click on the link to read their full post and be sure to scroll down and read all the comments:

Scott talks about both his current home (he has kept his previous home as a rental) and compares his current dual income to the 25% Income Rule – although, there is a question about his wife’s income to be answered.

Ryan isn’t sure whether he bought the ‘bargain’ home that he thought he was getting; should he pay down the mortgage to compensate? Read the post – and the comments – then let us know (either here or there) what you think?

Jeff is a Navy Pilot, so it should come as no surprise that he: (a) moves a lot, and (b) gets some housing assistance. Jeff is seeking to capitalize on his unique situation by flipping his current home … why don’t you add your comments to those that are already on his post?

Mark has a home that he wants to keep as a rental. Is he making the right move … and, is he using the right metrics to help him make the right decision? Also, in the comments, we examine whether Jeff’s (yep, back to the Navy Pilot) house is a home or an investment.

Josh is the ‘free accommodation at home’ guy … sigh! I (slightly) remember those days. But, does Josh have a housing decision to make (he has been give the task of managing his grannie’s flat)? Read his post (and the comments … feel free to add one of your own) and YOU decide!

Lee asks the critical question: house or home? We also have (read my comment) a totally new version of the Old Age Pension to offer Lee …

Diane lays an interesting ‘life situation’ on us: when do Life Partners combine assets and liabilities and when don’t they? Also, if finances are separated, how do you calculate where you are REALLY at financially? It can (and should) be done, but how? Diane has taken the same ‘live at home with parents’ path as Josh (for now) … what advice can you add?

If you are still deciding how much house YOU can afford – and, want to learn more about the 25% Income Rule and the 20% Equity Rule – start with this post, and work backwards through the links.

How fast is frugality?

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save-v-invest

I love it when I read interesting posts on the personal finance blogs and other forums … take Mighty Bargain Hunter‘s view that frugality is the fastest way to a better bottom line:

It shouldn’t be the only way you’re improving your bottom line, but it does give results, fast.

For someone who already has their finances under good control, some money-saving activities are simply too little payback for too much time … [but] what about the people who aren’t as well off?  Maybe they’re making $40k or $50k, but have a lot less saved up than they probably should for their age.  This is the situation for which packing your lunch, buying generic, buying used, skipping Starbucks, and clipping coupons will help.

And it helps immediately.  The week you take lunch to work at $2 a day instead of hitting Subway at $5 a day, you’ve improved your bottom line by $15.  Boom.  Or brew your coffee in the morning instead of hitting Starbucks.  $10 per week.  Boom.  Instant gratification.

Building up income streams takes longer, especially the kind of income streams you want (passive ones) … higher income may be better in the long run, but that’s the long run.

Frugality is here and now.

Businesses have taken this view for a long time now … they call it cost-cutting 🙂

Usually a business that is spending its time cutting costs is a business that you should selling out of, not buying into …

… it’s current finances may begin to look great, but its future may be bloody awful (that’s why it’s busy cutting costs!).

On the other hand, a GREAT business invests in their future (sales and marketing, product development, R&D, production, etc.) while managing their costs.

So, let’s put it to the test: how fast is frugality?

Well, to find out, I put four scenarios into the Magic Excel Blender and here’s what it spat out:

Save: If you earned $100,000 a year and cut corners so that you could save 20% to stick in your mattress, at the end of 20 years, you’d have $400k stashed away.

Invest: If you only managed to save 10% a year and spent your time investing the proceeds wisely (@ 8% p.a.) you’d end up with $460k in (say) stocks.

Save + Invest: But, if you did the sensible thing and invested your savings instead of stashing it under your mattress (in other words, save 20% then invest it @ 8% … hardly rocket science), you’d end up with more than $920,000 after 20 years, and still have dividends each year to live off … a much better result for only a little extra work together with some belt-tightening.

MM101: However, if you did the really sensible thing, and built up your income (so that you can afford to reinvest the dividends), saved well (at least 20%, but only of your original level of income), and invested both the dividends and the savings wisely (@ 8% p.a.) after 20 years you’d have over $2.5 million.

Frugality may be quick (in that we can afford to pay a bill; pay down a pressing loan), but will never make us rich …

… that’s why we take a multi-faceted view to personal finance:

Making Money 101 – to ensure that our costs are under control and free up some cash to help us invest in MM201

Making Money 201 – to grow our income by investing what little cash we may have (to begin) wisely and maintaining sound MM101 ‘habits’ to ensure that we have ever-growing streams of investment income, keeping our growing personal ‘needs’ (read: expenses) in check, so that we can eventually reach our Number

Making Money 301 – to manage our Number (i.e. our nest-egg) so that it lasts as long as we do, while living the life that we have designed for ourselves, not the life that others have resigned us to.