If you didn’t think so before, then this really objective 😉 ‘quiz show’ will prove otherwise …
… not sure, though, what Michael Moore has against the ‘rich’:
1. Who else is going to fund all those charities that help the poor and underprivileged?
2. Who else is going to pay all those taxes support the rest of the nation?
3. Who else is going to provide jobs for the ‘working class’?
4. Who else is going to have time to watch his dumb videos (the rest of America is too busy working)?
For most people how much they earn and how much they spend is connected.
They are either always spending too much, or managing to save too little, and this remains the same no matter how much their income increases … it seems to be simply the ‘way they work’!
In a recent post, I illustrated this concept with this chart provided by Trent over at a Simple Dollar (in this post):
In a visual way, my spending used to look something like this over time (with green representing spending and blue representing income):
Most personal finance blog readers understand by now that their spending should be less than what they earn … they now understand at least the green line should be somewhat disconnected from the blue!
Think about it:
If you want to build up a nest-egg for retirement, how much of your current salary can you afford to spend?
100%? Of course not.
90%? Not likely.
85%? Nope. Won’t do it.
Michael Masterson publishes a neat set of guidelines for what % of your gross income you should save at various income/salary levels:
How Much You Earn What % of your gross Income You Should Save
If you are making less than $30,000 a year 15%
More than $30,000 but less than $50,000 20%
More than $50,000 but less than $150,000 25%
More than $150,000 but less than $300,000 30%
More than $300,000 but less than $500,000 35%
More than $1 million but less than $2 million 40%
More than $2 million but less than $5 million 50%
More than $5 million 55%
How would you achieve a 40% – 55% savings rate at higher income levels? Unfortunately, Michael doesn’t say!
But, it’s easier than you think if you have the luxury of starting when your salary is still in the $15,000 – $30,000 range:
1. You start by saving 15% of your gross (usually via your 401k – at least this is how most people will start), and then,
2. You add 50% of the gross value of all future salary increases (if you can’t manage gross, just pretend that really only receive half of any extra ‘take home’ pay),
3. You throw in 50% of any future ‘found money’: money you find lying in the street, spare change from your pockets, you tax refund check, lottery winnings (what were you doing buying lottery tickets, in the first place?!), inheritences, etc.)
You pretty quickly find that this approximates Michael’s recommendations.
The problem comes at higher income levels; once, I gave the real-life example of a guy who earns $3 million a year from his business (presumably after reinvesting some of his profits in the business to keep it expanding):
– He pays one third in taxes
– He invests (saves) another third
– He spends a third
Seems sensible, except that Michael suggests that he give Uncle Sam 33%, that he saves 50%, and that leaves just 17% – or, $510,000 – for spending. And, our ‘friend’ is spending $1 million!
The problem is this:
When his income stops, his lifestyle will have to stop because it’s unlikely that his investments would be able to support a $1 million lifestyle.
At any income level, as your income increases it’s important to disconnect how much you earn from how much you spend …
… for example, even if you think you are a millionaire, cap your spending when you get to the $150,000 – $250,000 level and put all the rest into passive investments.
That means that you can spend $150,000 – $250,000 or 5% of your passive investments (not including the value of your primary business or source of income), whichever is the greater.
Because that is sustainable, even if your income eventually stops.
I wrote a highly controversial post a while ago about how dumb it really is to pay off your mortgage – especially if you have a goal of getting wealthy (which is the whole point of this blog).
Others, like Ric Edelman and a whole bunch of other ‘Dave Ramsey / Suze Orman Busters’ agree … in fact, when Todd Ballenger’s team saw my posts on this subject they sent me a copy of his new book, Borrow Smart Retire Rich, to review (I am reading it as I write this).
He makes the point very clearly, articulately and forcefully: sometime is Ok t pay off your mortgage, but ot if you want to accelerate your wealth.
However, not everybody agrees; Wealthy Reader wrote a whole post refuting my own post. The arguments basically boil down to these:
Real estate has appreciated at about 3.8% a year historically (excluding the bubble). This is also about the rate of inflation. So unless you are in a hot real estate market, there is no upside.
According to Todd Ballenger in Borrow Smart Rich “since 1945, the median house price in the United States has risen by an average 6.23% per year”. I used 6% in my post comparing R/E to your 401k.
But, would you settle for just average appreciation potential when buying an investment property (remember, we are talking about buying an investment instead of ‘investing’ that money into your own mortgage by paying it down early).
If the average appreciation is truly 6.23%, I could do better than that with my eyes shut … I would just tell a Realtor to buy me anything near the water or in a yuppie area in any major US city – as long as I was prepared to hold it for long enough.
[AJC: Yes, any discussion of RE today says: “well Florida boomed, now look what’s happening!” … yet if you look at quality Florida real-estate over a 20 or 30 year period, you’ll achieve average growth far in excess of the nation’s average … they simply don’t make any more ocean-front land … even my 13 y.o. son knows that. He tells me that land on the lakes in Wisconsin sell for many times higher prices than the land even one block in: one has a rare commodity – access to put your boat in/out of the water – and the other doesn’t!]
If that’s too risky, I would just avoid buying anything in the dust bowls of the US countryside, or in any of the run down ghettos in most major cities – these properties are also included in the average growth rates.
[AJC: Yes, people will say: “But look at Harlem … it was a ghetto, now it’s booming”; this is true of SOME of the dust bowls and run-down ghettos some of the time … if you want to have a better-than-average chance of finding the next ghetto-turned-to-gold find the area/s where the artist colony is … invest there and wait 10 years. You’ll be sitting on gold! Again, do you think the returns might beat the 6.23% average?]
The bottom line: you should have no fear of meeting or beating 6%+ returns in well-chosen real-estate over a 10 – 20 year period.
The interest is compounding so you don’t just pay 8%. That’s why you pay so much interest over the life of the loan. That 8% is compounding each month (at .6%) on the entire balance. So again there is no convincing argument.
Well, hang on a minute, by paying down your 6% – 8% mortgage to avoid the compounding nature of loans, aren’t you simply avoiding putting your money into another form of investment where the increase will also compound?
I mean, we aren’t planning to spend all that extra money that we could be putting into our mortgages into drinking more beer and eating pizza (yet)!
A simple example would be to put that money into a low-cost Index Fund; don’t they appreciate at over 11% annually – and, at no less than 8% (break-even) – over a 30 year period. And, didn’t I write a whole post showing that investing in real-estate could do even better?
The majority of tax payers either can’t or choose not to itemize. According to the Urban Institute, only 35% itemized in 2004. Also, there are limitations on deductions. So the famed mortgage interest tax deduction is mostly irrelevant here.
One Wealthy Reader reader (!), Jeff, jumped on this one saying:
Although trivialized by this blog, the mortgage interest tax deduction is a substantial benefit received by millions of Americans each year. You appear to argue since only 35% of Americans itemized their deduction, that this tax benefit should be completely discounted. This statistic, however, is not persuasive and it provides no insight into the number of homeowners that have mortgages that cannot or do not take advantage of this tax break.
But, if you truly feel that there is no tax-advantage to the 8% claimed benefit of either keeping or paying down the mortgage, what about the 25% – 35% tax-advantage that you would get by ‘investing’ that money instead into a tax-advantaged account such as a 401k?
Or, what about using it instead to fund a fully tax-deductible loan on an investment property (preferably one with depreciation benefits and/or good rental returns as well)?
Finally, Wealthy Reader throws in his ‘trump card’:
There is no investment that is as secure as a paid off mortgage and that also returns 8-12%.
How the hell is a paid off mortgage secure?
Is it because your money is now invested in your house? If so, how is it any less secure if some of it is in your house and some more of it is in the house next door and the one next door to that one?
Is it because the bank can’t touch you once it is all paid off?
Well, if that takes you 15 years to accomplish that (instead of the usual 30 years), what will the bank do if you lose your job and can’t keep up with the house payments in Year 12?
Guess what, they will still foreclose on you whether your equity is 20% or 40% or 60% or even 80%.
Surely the only thing that matters here is investment risk and investment return, after tax?
Like everything else, just run the numbers through a spreadsheet, it doesn’t take a rocket scientist to see that an 8% return is not as good as a 12% return (both must be on the same pre-/post-tax basis) …
… and, if you really can’t find an investment that will safely return 12% over 30 years, I agree: go ahead and pay off your mortgage, because you sure ain’t no investor 😉
Recently, I wrote a post agreeing with Ric Edelman who says that the three most typical financial goals (buying a house, saving for college, and retirement) are a fait accompli [already certain] so why bother?
This opened up a whole plethora of comments relating to goal-setting; for example, Moneymonk says:
I do not think it’s a goal, it become one when you say ” I want to put a down payment of x,xxx on a house, I want xx,xxx in my son’s college account by 18. I want to have x,xxx,xxx by the age 65 in my fund. It when you put a specific amount on it, then it becomes your personal goal.
And, if that’s what you want to do, Caprica conveniently points us to Tim Ferris’ goal-setting process:
I think Tim Ferris has covered this topic in his 4 hour work week book best.
There are doing, being and having goals. Having 7 million dollars is a reasonable “having” goal. It is a good definite goal.
While having a few “having” goals is all well and good, Tim advises to look beyond “having” goals and look more at those things you wished you had time for. These are your “doing” goals (i.e. what do you want to do that you wish you could always do? e.g. play the piano, learn to sky dive, paint, build, etc) and your “being” goals (i.e. what kind of role do you wish you could fulfill with your family (e.g. a good dad), friends (e.g. a helping hand) or become a pillar of the community (e.g. charity worker)).
Tim Ferris, in his interesting book called the “Four Hour Workweek” – although, I can’t figure why anybody would want to work that much 😉 – introduces an interesting exercise called ‘Dreamlining’; he says:
Create two timelines–6 months and 12 months—and list up to 5 things you dream of having (including, but not limited to, material wants: house, car, clothing, etc.), being (be a great cook, be fluent in Chinese, etc.), and doing (visiting Thailand, tracing your roots overseas, racing ostriches, etc.) in that order. If you have difficulty identifying what you want in some categories, as most will, consider what you hate or fear in each and write down the opposite. Do not limit yourself, and do not concern yourself with how these things will be accomplished…This is an exercise in reversing repression.
Now, Tim’s worksheets are great, but when you write your Rear Deck Speech properly (from my 7 Millionaires … In Training! ‘grand experiment’), you will find that it encapsulates the true ‘being goals’ that Tim talks about, and it does it in a really powerful way: by ‘forcing’ you to look back on your life after it is (almost) done.
If you really think deeply about this, the most important aspects of your life are all about ‘being’, not ‘having’, a least not in a purely materialistic sense …
As to the ‘having’ goals, they are important too, and this process and worksheet should help you to think through this.
Here is the way that I think about it:
To start any journey, you need a Destination and then you need to decide when you intend to get there and choose your mode of transport accordingly. You also need to ensure that you have enough money to buy the gas or tickets.
Financially speaking, your ‘destination’ – or the only one that really counts – is your Life’s Purpose … it’s your final stop, after all!
But, the real purpose of this exercise, from a financial perspective, is that it helps you to find you Number (the ‘fuel’ that you need to get there), your Date ( the ‘when’ you want to be ‘financially free’), and the method that you will use to get there (saving, business, investing – real estate, stocks, options, etc.).
Now, some people then like to sit down with a map and travel guide and plan every stop and way-point along the road (a.k.a. ‘intermediate goal-setting’) … for others just traveling the road and taking whatever stops that seem interesting/necessary along the way is good enough.
So, if you then want to do some serious goal-setting of the MoneyMonk kind, don’t let me stop you … it’s probably a very good thing to do!
… but, whenever I try that, I am always painfully aware of how difficult life is to plan.
Who was it who first said: “When Man plans, God laughs?”
