How much do you really need?

2013-02-14 17.05.10My soon-to-be-nephew is having his wedding at our house; he’s an event organizer (amongst other things) so this is his opportunity to create his (and my niece’s) ideal wedding …

… we were, of course, delighted to be able to lend our house.

As he was supervising the erection of the marquee over our tennis court and false flooring over the pool, we were chatting about wealth.

During the course of discussion, the subject came up of how much do you really … and, ideally … need?

What is the Perfect Number?

If you’ve been following my blog for a while, you will know that I’ve said that you need as much passive income as you need to live your Life’s Purpose.

Even without knowing your Life’s Purpose, though, I can still tell you roughly what your Perfect Number should be:

You should aim to live no better than your closest group of friends.

Let me explain with a personal example …

We have a long-standing group of friends.

We eat often eat together. We party together. We travel together.

Not always. Not only. But, often enough.

Now, how would you feel if you travel coach, most of your other friends travel coach, but one of your friends is always at the front of the plane?

How would you feel if you like to eat out at a mid-priced restaurant once every couple of weeks with your friends, but one of your friends is always trying to arrange 5-star dining? And, 5-star hotel’ing?

I think your friend would eventually price herself out of your group of friends.

Well, I am in danger of becoming that friend.

Our friends are all quite well-off, because they are all professionals (both husbands and wives) drawing great incomes for many years. All of our children privately school together, and vacations are now flying coach (with kids) or business class (without kids), staying at international 4-star resorts at least once, and probably twice, most years.

But, our house is clearly the best in the group. Our cars are the best (and, could be better, but I’m starting to realize that I should hold back a little). And, we could be flying business class (sometimes even international first class), and easily stay in 5-star hotels.

In short, we have to be careful not to make the difference obvious.

That’s why I told my nephew (to be) – as I am telling you now: aim to live no better (but, no worse) than your closest group of friends, assuming that you wish them to remain your friends.

I can add a little more:

– Aim to be towards the top of your circle in terms of sustainable annual income.

– Aim to have a buffer, so that you can maintain that standard even if something goes wrong.

[AJC: This is not the same as an emergency fund: this means, for example living on the same $50k p.a. as your friends, but actually earning $70k p.a.]

– Aim to be able to maintain that standard of living (with buffer) when you begin to live Life After Work.

– Make sure that your Life After Work (i.e. very early retirement) makes you still ‘look’ busy

[AJC: Sitting on a beach all day while your friends still 9-to-5 it 50 weeks a year will just as quickly put you in the ‘former friend’ category as flashing your cash]

So, how much money do you really need?

Step 1: Take what your friends are earning and add 20% buffer

Step 2: Multiply that by 20

Step 3: Add the amount remaining on your mortgage (or, what your mortgage would be if you bought one of the better houses owned by your friends)

Step 4: Add any additional ‘crazy money’ that you need for some of your ‘keep busy’ Life’s Purpose activities.

Step 5: Double your final total for every 20 years until you expect to be able to accumulate that amount of money (or, add 50% for every 10 years), to account for inflation.

That should give you a very practical Number … you might even say your Perfect Number ūüėČ

Now, you just need to go out and get it.

What if money did not matter?

In my new¬†video interview with Jaime Tardy (EventualMillionaire.com) I talk a lot about finding your Life’s Purpose. Now, here is an even¬†stronger argument for finding your Life’s Purpose before working out your financial plan …

Note how the philosopher, Alan Watts, suggests that if you do what you love, the money will follow!

Failing that, do what you need to, but only for a short period of time, so that you can put aside the money that you need in order to do what you want. That’s why I came up with my original ‘$5 million in 5 year’ target (that eventually became $7 million in 7 years, achieved) …

What would you do if money was no object?

.

.

How to dig yourself out of a financial hole …

If you’d like to catch my nationally syndicated radio interview on Financial Safari With Coach Pete, click this link:

http://www.financialsafari.com/as-heard-on-show/interview-with-adrian-cartwood-11-24-2012/

_______________

I really feel for the author when I receive an e-mail like this one from Rick:

My wife is leaving her job in December, I’m a paramedic here in Chicago and we’re both college graduates.¬† Our house is upside down, we don’t have much in the way of savings for retirement or otherwise and we’re trying everything to stay afloat financially.¬† Any help would be appreciated.

[AJC: I changed Rick’s job and location to protect his anonymity]

The worst part is that I can’t really help Rick, for a couple of reasons:

1. I’m not a qualified financial adviser;

2. I don’t know anything about Rick, other than what he has told me in (exactly) 50 words.

But, I can give Rick one piece of specific advice: see a qualified financial professional to help you decide how to deal with your ‘upside down’ house, and work out why you aren’t saving enough, and what to do about it.

I can also give a fairly general piece of advice that Rick can choose to follow or not; and, it’s the same advice that I would give just about anybody who is in a similar situation (under-employed; under-saved; and under-water on their house):

The best way to dig yourself out of a financial hole is to …

… find a way to increase your income!

Cutting costs, while admirable – necessary even – is simply too limited to produce the sort of financial turnaround that Rick and others like him need.

Maybe, Rick can turn his wife’s loss of income into a blessing by refocussing her on starting a business, even it it’s while she actively looks for new employment … a business that can be run part-time (at first) when she does manage to find a new job.

I would give similar advice to Philip, who is desperate for the opportunity to shake off the shackles of being imprisoned in a job:

In 5 years I’d like to not have an office job anymore,¬†working for myself/having my own business. I’m stuck in a job, so I keep it to pay my bills. Designers don’t earn much, so I can’t exactly bankroll my parents’ retirement.¬†I’ve been too afraid to go out on my own.

The best way for you (and, Philip)¬†to overcome your fear of becoming your own boss is to actually start …

… but, start part-time.

Doing something¬†is better than doing nothing, and can quickly lead to more/better¬†opportunities¬†in ways that you could not have predicted in advance: for example, and in Philip’s case, designers can freelance, work (cheaply) on crowd-sourcing sites such as Freelancer.com, 99designs,¬†fiverr.com, and so on.

Even better, Philip could use his own design skills to help create his own web-site or product, and run that part-time to earn some extra $$$ and learn how to run a business – building up his confidence in the process, even if the business never truly takes off.

On the other hand, the business may suddenly find its own life and give Philip the confidence to quit his job and start working on it full-time.

Now, unlike Philip, you may not be a designer … I assume that Rick’s wife isn’t either … but, there are plenty of businesses that you can start part-time that require very little money.

Here are some thought starters (if a teenager can do ’em, surely you can?!):¬†What are some potential low-cost businesses that can be started and operated by a teenager?

But, you’ll never know if you don’t start …

.

There is no middle ground …

To me, making $7 million in 7 years (or some other Large Number / Soon Date) is not the goal … at least, it was never the goal for me.

My goal was always to become financially free and have the ability to live my Life’s Purpose.

It just so happened that, when I crunched the numbers, I found out that I needed to make $5 million in 5 years.

[AJC: now, thanks to my book, this process has been highly simplified, if you want to do the same]

I failed on the time frame, but ended up with $7 million in 7 years and promptly retired, at the ripe old age of 49. Now, I blog here (amongst other enjoyable ‘give back’ things that I do).

Fortunately, the goal for some is a lot lower.

For example, in my last post I showed that – if you are happy living on just 50% of your current income for the rest of your life (after adjusting for inflation) – you just need to save 50% of your paycheck every week for the next 17 years.

If this is you, then you need to be reading blogs other than this; you need to save/save/save, max your 401k, pay off all of your debt, and stay very frugal. After all, living on half a paycheck is not easy ūüôĀ

But, what about the rest of us?

Well, I asked you to spend some time with an online retirement calculator; if you took my advice, you probably found something like this:

This means that a couple earning a combined $50k a year today (with 20 years left until retirement), saving a full 10% of their income, has only a 50% chance of their money lasting as long as they do … even if they receive full Social Security benefits for the next 40+ years!

Without Social Security, this couple has virtually no chance at all (1%) of their money lasting as long as they do even if they save 15% of their paycheck for the next 20 years. If they manage to save 25% of their combined pay for 20 years, their chances of financial survival are still less than 25%.

How does creating an emergency fund, paying off all debt, and paying yourself first actually help these people financially survive after half a lifetime of work?

In the above context, I don’t think it helps much, at all.

Really, most traditional personal finance boils down to: saving 50% of your pay packet for the next 17 years, or taking your chances on Uncle Sam looking after you for the rest of your non-working life. The rest is fluff.

If that¬†doesn’t¬†appeal, stick around for the final part of this three part series, where I’ll share my¬†strategies¬†for real financial security.

 

Why cookie-cutter personal finance does not work

Marie (speaker, blogger, investor) agrees with my simple plan for wealth creation:

I have to go with your 2 step plan. All my years in PF it seem to work best than the cookie cutter approach.

The ‘cookie cutter’ approach that Marie refers to are the approaches that I was talking about in my provocatively titled guest post at Budgets Are $exy: “Why Most Personal Finance Blogs Are B.S.“, and includes: paying off all debt; maintaining an emergency fund; frugality and expense-cutting; paying yourself first via max’ing out your 401k; and, so on.

[AJC: To be fair, I was asked to write something ‘feisty’ so you should head on over and read the article (and the comments) now …]

To prove any personal finance strategy you need to have an objective against which you must measure the outcome.

To me, that goal must be: financial freedom.

But, what does ‘financial freedom’ mean?

That depends entirely on you …

If your goal is to simply replace your income, say, within 20 years, and you can train yourself – through frugality – to live on a lower income than your peers then it is possible to save your way to wealth (simply defined as financial freedom, or having enough passive income to replace your then-current income from employment).

For example, MB writes about her 12 year plan to replacing her and her husband’s dual working income:

After a couple years of full-time work I started to wonder, how can anyone possibly tolerate doing this for 40 whole years?!

[Now] our number is somewhere in the $1-2M range depending on how many kids we end up having (if any). But, then again, we are saving >50% of our salaries.

By ‘training’ themselves to live on only 50% of their salaries – or 1/4 to a 1/2 less than their peers – MB and her husband accomplish two purposes:

1. They save a lot more than most people,

2. They live on a lot less than most people

So … they need a much smaller Number than most people and they’ll be able to reach that number much, much sooner than most people.

According to my calculations, if you start off earning, say, a combined $50k p.a. and are prepared to live off just $25k of that (assuming your combined salaries increase by 3% per year, and you get a very hefty 8% after-tax return on your savings) you will be able to retire on a combined $40k passive income in not the 12 years that MB is hoping for, but a still-healthy 17 years time.

The catch is that just 4% inflation would mean that you really have the earning power of a little less than $25k p.a. today.

In other words, to actually make this cookie cutter personal finance plan work, you need to be debt-free and be able to live on just half your current annual income for your whole life.

Is this you?

If not, I recommend that you spend a little time with an online retirement savings calculator and work out what income you would need in today’s dollars (i.e. assume you retire today) …

… then, leave a comment and – in my next post – I’ll explain what that means and what you need to do to get there.

 

 

The 2-Step Wealth Generation System

This is one of my favorite posts; a great place to start for new readers, especially if you follow the links …

________________

The traditional approach to paying off debt and personal finance (interchangeable terms, it seems, according to the popular media) is simple:

1. Tear up your credit cards : pay off debt : get new credit cards : goto 1.

2. Pay off all of your bad debt : all debt is bad : goto 2.

3. Save 10% : use to build an emergency fund : dip into emergency fund : goto 3.

What is the point of all those “goto”s, you may well ask?

Well, ‘goto’ is an¬†inelegant¬†way of writing computer code … it’s something that programming dinosaurs used back in the Dark Ages [AJC: when I used to work in the computer industry; they had ‘mainframes’ in those days].

And ‘goto’ here means that each step in the traditional personal finance investment plan (as in the sample plan, above) is iterative …

… it never ends.

You never really get out of debt, human nature being what it is (self-defeating, or everybody would be debt-free). You never really get rich, making money being what it is (really hard, or everybody would be rich).

Here, instead, is $7 Million 7 Year’s Patented 2-Step Wealth Generation System:

1. Start Investing

2. Deal with emergencies as they arise

Of course, you will immediately see the flaw in the above: I haven’t created a debt reduction strategy, an emergency fund, or a pay yourself first plan.

That’s simply because, if you follow my patented 2-step plan, you won’t need a separate¬†debt reduction strategy, an emergency fund, or a pay yourself first plan!

Here are the principles upon which this strategy is built:

1. Paying off debt is investing

In previous posts, I’ve outlined my cash cascade; it works much better than any debt snowball, debt avalanche, or any other debt reduction strategy you’ve ever read about, because every single one of those ‘other’ plans works on the flawed assumption that debt is bad, therefore should be paid off as quickly as possible.

The reality is that 75% of your net worth should always be working for you … at the best possible after tax interest rate (taking your personal attitude to risk – and, your affinity to / aversion against certain types of investments – into account).

Keeping in mind that a dollar saved is EXACTLY the same as a dollar earned:

– Paying off a 13% (after tax) credit card instead of buying a 1% (after tax) CD certainly makes sense.

– Paying off a 4% APR (before tax benefits) home mortgage instead of investing in an income-producing property that may return 7.5% cash-on-cash (after tax benefits) does not.

2. Creating an emergency fund is your first emergency

Let’s say that you create a $10k emergency fund; let’s also say that this fund is big enough to cover all likely emergencies.

Haven’t you just created your worst case outcome?

That is, haven’t you just depleted your investment fund by $10k?

And, if you didn’t have the ’emergency fund’ in place, isn’t that exactly what you would otherwise only needed to have done, but¬†only in the event of an actual emergency?

Wouldn’t it be better, instead, to invest that $10k so that it is always working for you, emergency (very unlikely) or no emergency (very likely)?

But, how would you deal with emergencies ‘as they arise’?!

Well, you could simply create a source of borrowings that you can tap into only when needed (e.g. a line of credit against your home; a redraw facility against your 401k; a 0% APR credit card, sitting there – unused – just for this purpose).

If you just start investing, you will soon want to become successful by investing more and more.

And, it won’t take you long before you you are cutting costs, paying off your credit cards, putting more and more aside, reading everything that you can about personal finance and investing, and so on …

… simply because you will want to invest more. It’s exciting and¬†addictive.

That’s why these two simple steps will change your life, forever.

Go ahead, try it: my 2-step plan comes with a Lifetime 100% Compounded Money Back Guaranty ūüėČ

Why I don’t manage my rental properties …

Managing your own rental properties sounds like a good idea; you get to save some money – and, you hand choose / hand manage your tenants.

The World Of Wealth (blog) puts it nicely:

Manage your properties yourself!

Reason Number One – It’s Valuable Experience
Managing my rentals has taught me numerous life skills from how to negotiate with a contractor to the best way to (attempt to) collect rent from a deadbeat tenant.

Reason Number Two – You WILL Do A Better Job Yourself

First of all, your property manager may not actually be very experienced. Secondly, your problem may be worse if the manager IS highly experienced and recommended. In that case, you will probably find yourself be at the very bottom of their priority list.

Reason Number Three – You’ll Save LOTS of Money

Property managers and leasing companies don’t come cheap. You’ll pay 6% – 10% of gross rental income directly to the manager. A rental property with 6-10% of cash flow is rare and precious indeed, so hiring a property manager is all but ensuring your cash flow will be negative.

Reason Number Four –¬†You Won’t Save Yourself Any Stress
One of the main reasons I hired a leasing company this summer was because I didn’t think I could effectively handle 3 vacancies while I was traveling in and out of town.¬†But I was more stressed out than ever before! I still worried about when I’d get a new tenant in each unit, how I was going to make the cash flow work in the meantime and how much the repairs were costing.

I can’t comment on how much less or more stressful it would be to manage my own rentals …

… because I have used a property manager since the get-go.

But, my case might be different to yours: my properties were investments, not my source of business income. So, for me, time was more precious than money.

Even so, Dave Lindahl – well-known property ‘guru’ – makes the case for NOT managing your own properties, at least not after the first 3 or 4 that you own: burnout.

Handling all of those “Reason 4” issues that The World of Wealth blog mentions (dealing with tenants,¬†vacancies, defaults, etc.) will stress you out more than you can imagine, then burn you out pretty quickly.

Also, the argument that properties return 6% and property management costs 6%, therefore all your profits go to the property manager, don’t hold water … because, commercial properties (for example) return 6% after the costs of property management are factored in (or, so they should) …

… and, even residential property may return the same – if you purchase cheap and add value (e.g. paint, add a bedroom, etc.) before you rent expensive.

By all means, manage your own rentals, if that’s the way you want to roll.

But, have the expectation (and, build the cost into your calculations from the start) that you will employ a property manager sooner rather than later, because managing your own rental properties simply isn’t any fun ūüėČ

Why the poor get poorer …

What’s your favorite excuse for not having $7 million? Let’s make it easier: what’s your excuse for not having $1 million?

It will probably be something to do with lack of luck, opportunity, income, and so on …

And, that may all even be true (but, if you keep reading this blog, you’ll find that all changes pretty quickly).

But, tell me what excuse anybody has for not being able to retire with a paltry $1 million in 20 to 40 years time?

Take a look at the chart above: people on low incomes are spending nearly twice as much on entertainment as they spend on saving for retirement!

Now look at the same comparison for other income groups:

That ‘saving for retirement’ ratio reverses as income increases …

But, take a look at those earning high incomes of $150,000 or more: they spend nearly 3 times as much saving for retirement as they spend on entertainment.

So, let me pose a question:

Was it their high income which allowed them the ‘luxury’ of putting away so much for their retirement?

Or, was it the same mindset that compelled them to begin thinking about their financial future that set them up to:

1. Increase their income so greatly, AND

2. Save so much?

I know what I think. How about you?

How do I make money?

That’s probably the most common question that I am asked: how do I make money?

Specifically, how do I make a LOT of money [AJC: not me – I have enough – but, you. How do you make money?].

The answer, of course, is to do what others do not …

… because, most others – the vast, vast majority – are not rich.

Clearly, what THEY do is the way to make only a small amount of money. And, what they do a little of is: invest.

It stands to reason, that you need to invest a lot. But, that’s difficult if you don’t have a high income.

That’s why I say, if you want to make money, you should increase your income – a lot – and invest most of the increase.

Simple.

But, that brings us right back to the original question, albeit altered slightly to now read:

How do I make a lot of income?

Fortunately, that is much simpler than you might think …

… you simply need to find the intersection of things that: 1. you love doing; 2. other people want; and, 3. you’re good at:

I have a simple exercise that I teach, if you want to find the ‘sweet spot’ where your passion, talent, and opportunity align:

Think about each of these areas of your life:

EARN (i.e. how do you make money, or WANT to make money: past/present/future?)

SPEND (i.e. how do you spend money, or WANT to spend your money: past/present/future?)

ABILITY (i.e. what are you good at? what do you wish you were good at? what sparks your creative juices? what do you enjoy?)

DO¬†(i.e. what are your hobbies? qualifications? jobs (unless already listed under ‚Äėearn‚Äô)? what would you WANT to do, even for ‚Äėfree‚Äô?)

Somewhere in these four areas is your passion … and, these 3 simple steps will help you uncover it!

Step 1:

Take a blank sheet of paper, turn it sideways (landscape) and write down the following column headings:

EARN      SPEND      ABILITY      DO

Under each of the above headings, write 4 to 6 one/two/three word answers (e.g. teach; clothing; writing; wood-working; etc.); let the ideas flow and take as much/little time as you need

Step 2:

Once you’ve completed the above, take another sheet of paper and write the following numbers across the page (I recommend landscape, again):

4          3          2

Now, under each, transfer your answers from the first sheet of paper, as follows:

4: Write the items (if any) that appear (at least in some sort of similar/related form) across all four columns in the previous list; you may not have any.

3: Write the items (if any) that appear across exactly three columns in the previous list; you may have only one or two, if any.

2: Write the items (if any) that appear across exactly two columns in the previous list; you will likely have a few.

These, starting with the ’4′, then ’3′, then ’2′ columns, are where you will you will most likely find your passion!

Step 3:

Try combining your your answers (especially those that combine a future WANT with an ABILITY e.g. let’s say that you’re good at sewing and want to do some writing, then you have the possibility of starting a writing/publishing career, perhaps starting with a blog on sewing.

That’s it.

If you can find your passion, then find a way to make money from it, well, you’re almost home!

Let me know what this simple exercise shows you?

You can be a millionaire in your lifetime …

Australia’s (now the world’s) richest woman is worth $25b or so …

… and, she says that you can be a millionaire:

There is no monopoly on becoming a millionaire.

If you‚Äôre jealous of those with more money, don‚Äôt just sit there and complain. Do something to make more money yourself ‚Äď spend less time drinking or smoking and socialising and more time working. Become one of those people who work hard, invest and build and at the same time create employment and opportunities for others.

Of course, Gina Rinehart inherited one of the world’s biggest iron ore deposits …

… you and I have to find our own lump of wealth ūüėČ

But, I agree with her sentiment: increase your income (“spend … more time working”) and put your money to work for you (“invest and build”).

If you do, getting to a million will be a snap:

If you start off earning $25,000 and work for 40 years (earning around $80k in your last pre-retirement year), and save just 10% of your annual salary (earning 8% on your money), you will have exactly $1,000,000.

Of course, you will be used to living on $72k p.a. ($80k less 10% for savings) by then, and $1m will ‘safely’ give you only half of that to live off … oh, and you can halve that twice again to allow for inflation, so you will really be retiring on the equivalent of $10k a year, today.

But, that’s not the point; the point is that you can be a millionaire in your lifetime …

Of course, getting to $7 million in your lifetime (let alone in 7 years) still won’t be a piece of cake!

But, that’s where this blog comes in ūüôā