What’s an eco-friendly standard of living?

Posted on April 30, 2013 by Adrian

Fellow blogger, Jonathan Ping, was kind enough to include a chart from one of my earlier posts in one of his recent posts, so I thought that I should repay the favor by including one of his charts, here:

I recommend that you read his original post, but the chart itself is pretty self-explanatory; it shows the problem in personal finance … and that’s:

As your income grows so do your expenses.

It’s called ‘lifestyle creep’ and is one of the key reasons why the actual wealth of high-income earners (as indicated by the grey shading between the green income line and the red expense line) is not necessarily that much higher than that of some medium- (or even low-) income earners.

The obvious solution, according to Joe and many other pf bloggers, is to reduce your spending:

This way, you decrease the red expense line relative to the green income line …

… in the process, enlarging the grey-shaded area between the two lines i.e. allowing, at least in theory, even low-income earners to increase their wealth!

The problem with this strategy is that saving – especially, saving more (probably a lot more) than you do now – is really, really, really hard.

Austerity hurts. Austerity is against nature (well, my nature).

It gets worse: saving now so that you can spend later simply doesn’t work!

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

In other words, you need to drop the red savings line to no more than half the green income line … not later, but now … and keep it there for the rest of your life.

Never fear, I have a better plan …

… it’s one that is far more natural, because it allows you to maintain your current standard of living, even increase it over time:

Let’s say that you start off as an average-income earner; here are your steps to success:

1. You can start to save a little, perhaps more than you have done in the past. Don’t worry, this austerity is temporary … after all, you already know how I feel about too much belt-tightening.

2. Once you have a little money beginning to pile up, you should find a way to put it to use to help you grow your income. Perhaps you could: start a part-time business; buy an ‘absentee-owner’ franchise; or open a car wash. You could work a little smarter and score that big (or little) promotion. Maybe you could collect a windfall: a tax refund; find a rich aunt who dies and decides not to leave all her money to her cat after all; or, you get really lucky and hit a small jackpot at Binions.

3. As your income grows, you should increase your spending by no more than 50% of your after-tax ‘pay rise’. The rest must go back into your little pile of money. Then you should concentrate on finding even more ways to put it to use to help you grow your income. Are you beginning to see a pattern here?

4. As your income grows at a (much) faster rate than your spending, you will slowly begin to see that you are actually already tending towards saving 50% of your income without even trying!

Keep it up for 15 to 20 years, and you’ll be able to sustain that savings rate all the way through – and beyond – retirement, as you build a big enough bucket of wealth (your net worth) as shown by the green-shaded area between your income and expense lines.

What’s more, this fully sustainable standard of living is always more than your current standard of living, so you never, ever need to tighten your best. The secret with this plan is that you simply don’t loosen your belt as fast as other high-income earners tend to do.

Obvious, really …

Now, that’s what I call eco-friendly finance 😉

[You can also read this post in the Carnival of Personal Finance: http://wealthpilgrim.com/carnival-of-personal-finance-happy-days-are-here-again-edition ]

How to do a personal budget …

Posted on April 5, 2013 by Adrian

Whilst it’s very tempting to go to your 4-F‘s (friends, family, financial planner a.k.a. ‘lifestyle planner’, financial advisor a.k.a. accountant) for advice on budgeting, I find that it’s quite a personal exercise.

In order to budget they – actually, you – have to ‘get’ … well … you.

Confused?

Let me give you an example:

I tried going to my accountant when I got back to Aus after a few years in the US, and here’s how the conversation went:

Him: Well, you could start off with a budget of $150k per year and see how you go

Me: Start by writing 4 things on your whiteboard:

1. Private Schooling for 2 children

2. One to two overseas trips per year

3. Invest in at least one startup per year

Him: OK, now what?

Me: Write $50k next to each of those

Him: OK, that’s $150k total

Me: That’s $150k per year, then you can add your $150k ‘starting budget’

Him: Oh shi …

The steps to perform the only kind of budget that really makes sense are as follows:

1. Do a One-Time ‘As Is’ Budget

I described this kind of budget in this post, and it truly is the one and only time that I have ever made a personal budget.

It consisted of everybody in my family (at the time, only my wife and me) carrying around a pencil and piece of paper for a whole month …

… and, writing down every single thing that we spent a penny or more on during that month, whether by cash, check, credit card, or electronic transfer.

At the end of the month, it was fairly easy to categorize the expenses and tally them up. Of course, we also needed to prorate in some expenses, such as insurance, that are paid one-time, and prorate out similar multi-month expenses that may have been paid during that month.

At the end of it, you should have a fairly accurate picture of what you are currently spending.

2. Create your ‘To Be’ Budget

After my earlier post, you should have a reasonable idea as to how to do a Top Down Approach To Investing analysis.

It consists of working out how much money you need in order to stop work (retire … early!) i.e. Your Number, and when you need it i.e. Your Date.

Then you can work backwards to find out how much compounding you need and what investment vehicles can get you there.

But, the missing step is working out how much starting capital you need …

… now, I can’t tell you that, as it depends upon what you have in mind.

But, the chances are – and, to me, this is the sole point of doing your budget anyway – you will need to find a way to increase your savings to build up that little investing war chest of yours.

And, the best way to do that, is to start by paying yourself twice!

[AJC: most of the ‘how to’ detail in this post has been covered in the earlier posts that I have listed, above … don’t be afraid … go click some links!]

Now, that’s how to do a personal budget 😉

Should I buy a new car?

Posted on April 2, 2013 by Adrian

Since you’re unlikely to win a car …

[AJC: if you haven’t seen yesterday’s April Fools Day post, you can check it out here …]

… you may be thinking about buying one.

For example, Michael asks:

My business is going well and I’d like to update my old Ford Ranger pickup (160k miles) with something new. I saw that there is a bonus depreciation on vehicles over 6000 lbs GVW so I was looking to use that to save on taxes. I settled on a new Range Rover Sport. But here lies the issue…

It makes me uncomfortable to think about how others will perceive me in the Rover. [But, if I buy another type of car] the lack of tax advantages would probably end up costing me more than the “pretentious” Rover.

Before we worry about what brand of car to buy, I would question why Michael’s buying a new car, rather than a new investment property.

Other than that, he should simply buy the cheapest car that meets his requirements.

You see, unless the vehicle specifically supports your business (think delivery truck), it’s just a depreciating liability (it doesn’t earn you any money, so it sure ain’t an asset!) …

… which means that any money that you don’t spend on it (or can claw back in tax deductions, etc.) is the next best thing to not spending the money in the first place!

Why spend money just to feel uncomfortable?!

Don’t spend more money just to get rid of the discomfort: spend less (e.g. buy a lower-profile American or Japanese car; one that costs less than 60% of the list price of a Rover) or none at all.

Why not put off buying the car, altogether?

On the other hand, if your business is producing enough cash to support its own growth and is producing enough to fund outside investments, there’s no reason why you shouldn’t spend what’s left …

… after all, that’s what money’s for, right?

The only personal finance chart you need …

Posted on December 10, 2012 by Adrian

When I’m not blogging, you can often find me hanging around on Quora, the brilliant question and answer site …

… and, that’s where I found Chris Han’s personal finance chart (to the left).

Chris says:

Wealth is the shaded area in the diagram.

You can increase the shaded area by increasing the slope of the green line, or by decreasing the slope of the red line.

Decreasing the slope of the red line becomes significantly harder over time as you grow accustomed to your lifestyle.

Chris is right, but he needs to add a 4th bullet-point, and it’s the same observation that I made when I used a similar chart in this post to explain how businesses should manage their finances for growth:

4. Notice that it is easier to grow Wealth dramatically by increasing the slope of the green Income line than it is to decrease the slope of the red Expense line.

So, let’s break this down …

Regular personal finance will tell you to concentrate on the red (expense) line.

These authors will say that frugality, paying yourself first, and debt reduction (thereby, reducing your interest expense) will increase your wealth through the combined effect of:

– Decreasing expenses, and

– Time.

Decreased expenses allow you to save more, and time allows the full effect of compounding.

Voila! 40 years to fortune!

But, I think that you give up too much for too little, if you follow their advice:

First of all, you give up too many of life’s little pleasures now for little-to-no-reward later (if you can’t afford the lattes now, you sure won’t be able to in retirement).

Next, you have to wait – hence work – for far too long.

Instead, you should focus on the line that they are missing: the green (income) line. If you take my advice, you will concentrate on:

– Increasing your income,

– Using that increased income to build up a larger investment pool, quicker,

– And, aim to get better returns (hence, even more income) through better – and, more leveraged (i.e. using even more debt) – investments

Of course, you can’t simply ignore expenses, but they are best kept in control through delayed gratification, which means:

– Waiting to make purchases; the more major, the longer you should wait, and

– Not increasing your lifestyle (hence expenses) as your income increases.

It is this combination – increased/reinvested Income and controlled/slow-growth Expenses – that can quickly create a huge wedge of Wealth.

This is a very useful chart … you will do well to remember it.

Why the poor get poorer …

Posted on September 20, 2012 by Adrian

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 rich do you need to be before you can buy an island?

Posted on August 27, 2012 by Adrian

Normally, I avoid answering questions outside of my personal experience, so you should be able to surmise that you need more than $7 million before it makes sense to buy your own slice of paradise.

Instead, I feel that a little logic and a minute or two with a calculator will allow us to come up with a reasonable estimate:

First, let’s take a look at how much an island will set you back …

… I’m not talking something that Richard Branson might buy; perhaps something like Blue Heaven Island in Bora Bora, which will ‘only’ set you back a tropical $4,990,000!

But, buying an island is not as simple as having $5m; take it from Mike, who says:

When you are in the middle of the ocean, separated from the nearest stores, schools, and hospitals, the price can reflect that. Also, to get to and from your island requires an expensive boat.

Wise words; maybe ‘Mike’ has bought an island or two, in his time?

So, it seems, to be able to buy a “decent island” you need to have enough net wealth to cover:

1. The cost of the island

2. It’s annual running costs

3. The cost of your own home

4. Your own annual (non-island) living costs

There’s no way to answer these questions accurately without making a whole host of assumptions, but I’ll take a stab, anyway:

i) If an island costs $5m, then the annual running costs should be estimated at between 10% and 20% of the purchase price. This is purely an educated guess. Let’s say $750k p.a.

ii) If you own a $5m island, I’m guessing that your own home/s will cost the same, let’s say another $5m

iii) If you can afford a $5m home and island, I would estimate that your minimum annual living costs will be another $500k – $1m p.a. Let’s say another $750k p.a.

Applying our Rule of 20 (i.e. you can retire when you have about 20 times your required annual living expenses in the bank) you will need ($750k + $750k) x 20 = $30 mill. (PLUS: $10m for the purchase price of your island plus your home/s).

There you have it:

I think you need at least $40m net worth before even considering buying a ‘cheap’ island.

I won’t be buying an island anytime soon, how about you?

A financial playbook for professional athletes …

Posted on June 11, 2012 by Adrian

A couple of weeks ago I wrote about the dismal financial track record of professional athletes:

78% of NFL players and 60% of NBA players are bankrupt within two years of leaving the game.

Before you jump to the stereotypical conclusion that sports people have had one too many hits to the head, realize that the IQ of professional athletes is no better or worse than yours or mine:

The l.Q. of superior athletes ranges on average from 96 to 107

That’s why I think the reason is simple and generic: anybody who gets money quickly loses it almost as quickly.

To prove my point, look at the financial longevity of lottery winners, who should represent a fair cross-section of society [AJC: setting aside that you must have a low IQ to want to enter the lottery]:

More than 1,900 winners of a Florida lottery who won between $50,000 and $150,000 went bankrupt within five years.

So, if making money too quickly is a sure indicator of later financial disaster, what do you do? Refuse the money?

Not likely!

But, the one advantage that pro-athletes have over the rest of the pupulation is their ability to follow a playbook …

… so, here is the $7 million 7 years playbook for dealing with Found Money (i.e. any large amount of money that suddenly falls into your lap):

If you’re lucky enough to receive such a windfall (e.g. win the lottery; land a professional sports contract; star in a major motion picture; get acquired by Google; etc.), you should spend enough to fully celebrate your good fortune (even more so if it was a result of hard work rather than luck).

But, the amount you spend should be a reflection of how much Found Money you have, up to a maximum of 50% of the amount that landed in your lap. For example:

– If you find $20 on the street, buy yourself a latte and a magazine and then put the other $10 in your end-of-month savings ‘cookie jar’

– If you sell your business for $2 Million don’t spend $1 million

– If you get a $200 a week pay increase:

… do spend $100 immediately (enjoy!)

… don’t spend $100 extra a week (unless you HAVE to)

Here’s a table that will help you decide how much to save and how much to spend, depending on how much Found Money you suddenly come across:

[HINT: For the money that you do want to spend, still apply The Power Of 10-1-1-1-1, but reward yourself with a little from each box e.g. spend $10 today; $100 tomorrow; and, so on (in total) up to your spending limit from the table above.]

If you find yourself toward the high end of this table (e.g spending $1,000 or more), spend it on something – or, some things – that you will remember for a long time.

Oh, and if you’re not a professional athlete … well, you can still follow a playbook as simple as this one, can’t you?

Life’s tough at $250k a year …

Posted on April 10, 2012 by Adrian

I was chatting to a friend last night and was amazed at his reaction to what I had to say.

The conversation went something like this:

Me: Did you see that article about the guy who can’t live on $350k a year?

Him: What guy?

Me: Oh, some guy written up in the Wall Street Journal the other day.

Him: I didn’t see the article. What about him?

Me: He’s a lawyer or law professor or something who earns $350k a year and can’t make ends meet.

Him: Yeah, I know people like that. Remember Elton John nearly went broke?

Me: Yeah [laughs]. But, that’s not what I’m talking about. He says he can’t even afford to own a house because he lives in New York … in Queens or Brooklyn or somewhere like that … and between his taxes … I think he pays nearly half in taxes … and his rent, he is really struggling.

Him: Poor him [laughs]

Me: [laughs]. Yeah I guess it seems funny. But, I actually know where he’s coming from. I own my house and my cars outright. OK, I have two kids in private school, so that’s expensive. But, we struggle to stick to our $250k a year spending budget.

Now, here’s the weird part: my friend didn’t seem surprised at all …

… like NOT being able to live on $250k a year (before taxes) when you have NO mortgage, NO car payments – in fact, NO debt at all – is nothing unusual.

I made $7 million in 7 years so, for me, spending ‘only’ $250k a year is probably being frugal.

What’s his excuse?

And, how much annual expenditure are you banking on your Number being able to produce?

The ‘No Lease’ car lease …

Posted on January 20, 2011 by Adrian

The wrong way to buy a car is to lease it:

You’re financing a depreciating asset: so, as the car goes DOWN in value over time, your investment in it is going UP, payment by payment.

Dumb, huh?

The frugal way is to buy a used vehicle and run it into the ground.

But, what if you like and can afford to buy a ‘certain quality of car’?

Well, I would never buy a new one, and I would usually buy one of a lesser standard than I can afford, because cars do depreciate and are simply NOT an investment (even when you think they are).

Now, this is a blog for aspiring MULTI-millionaires, so I am going to spare you the usual reasons for buying used rather than new [hint: something to do with depreciation vs future resale value curves], because you can actually afford to buy new!

No, what I have to share works on the assumption that you can afford to buy a new car, but you do have budgetary contraints: i.e. a Number that has to fund your required standard of living for life. You can’t afford (literally) to have your money run out before you do!

If you’re either too rich or too poor for that to apply then this post [AJC: actually, my whole blog] does not apply to you …

But, this post DOES apply if you have a new car budget, be it a new $250,000 Ferrari 458 Italia [yum] or a new $11,000 Chevrolet Aveo [yuk]:

No, the problem is that IF your mindset is to buy a new vehicle, then how do you feed your desires in 3 to 5 years when your ‘new’ car becomes just another ‘used’ car?

However you justified the ‘new car’ purchase – new car smell, new car warranty, new car reliability, new car status – in just 3 to 5 years, the ‘gloss’ will have well and truly worn off, and you will be in exactly the same position as you are in today:

You will want ANOTHER new car!

And, you will want another one – similar to the first one (or better!) every 3 to 5 years thereafter, until you are too old to care about cars anymore … and, take it from me, you will be pretty old when THAT happens 🙂

That’s why, when I ask people to calculate their Number, I ask them to come up with their required annual spending plan (and, multiply by 20), then add in any one-off costs: usually just houses plus your first post-retirement vehicle purchases (what’s your chances of your spouse settling for less than you?).

But, for non-annual repeat purchases (the annual ones should already be in the budget … get it?), I simply ask them to calculate a lease / finance rate for the occasional purchases they are interested in (e.g. cars, around the world trips) as though they were going to finance those purchases, and build that cost into their required annual spending plan (basically, their expected retirement living budget).

This will include your replacement vehicles … the ones that you will need to buy after the first 3 to 5 years in retirement.

How to calculate the correct amount?

It’s actually quite simple:

1. Choose the car from today’s model lists that seems to be likely to suit your purposes from a new car pricing web-site.

Right now, I drive a BMW M3, my next car is likely to be no less expensive. But, I actually want more, so I will build in the cost of a Ferrari 458 Italia (that should pretty much cover me for any other car I decide to ‘graduate’ to as I get older, e.g. top-of-the-line Mercedes). If I didn’t aspire to more in the future then I would use the current list price of a 2011 BMW M3 as my ‘base’.

2. Find the current price of a 5 year old Ferrari F430 (because the 458 Italia wasn’t around 5 years ago) from a used car pricing web-site.

3. Subtract 2. from 1.

4. Find an online auto leasing calculator and use 3. (i.e. the amount over the trade-in of your current auto that you will need to come up with every 3 to 5 years) plus the age of the vehicle that you selected in 2. (i.e. how often you expect to want to changeover cars) plus select an interest rate that is likely to reflect long-term averages for investment returns on your remaining money (6% – 8% is plenty)

5. The calculator should then spit out the monthly amount that you need to add to your required annual spending plan

Now, why should you choose “an interest rate that is likely to reflect long-term averages for investment returns on your remaining money” rather than the expected cost of FINANCING such vehicles?

Didn’t you read the opening paragraph of this post?!

You’re not financing anything, you are SAVING to replace you current auto (or, the one that you first bought when you reached your Number and stopped working), and you are building in the LOST OPPORTUNITY COST of having your cash tied up in your cars rather than sitting in your investment account working for you, and you are accounting for inflation pushing up the price of your future, future, future replacement vehicles.

What if you make a mistake with you future financial position or the price of your next car?

Well, you simply hang on to the cars that you already own for a while longer … or, ‘down-size’, if you have to …. who says that you HAVE to replace your cars every 3 to 5 years?

Now, you can apply this same strategy before you retire: it’s called saving up for your next car (and, the one after that, and the one after …) rather than financing it 😉

AJC.

PS If you run these numbers again, here’s an even better strategy:

Instead of buying a new car, buy a slightly used – but much better – make and/or model of vehicle. Because I’ve found that cars – just like radiation – have a half-life (but, different for each brand of vehicles) and some depreciate 20% as soon as you drive them off the lot, you may find that you can buy a much better car for the same money albeit 1 to 2 years old. If you choose well, you may find that you are (a) driving a better vehicle and (b) can keep this vehicle for another 4 to 6 years before replacing it (because ‘classic cars’ tend to remain classic long after your shiny new American/Japanese/Korean production-line ‘beauty’ has well and truly gone off the boil). Plug a 6 to 8 year replacement cycle into you calculator v the 4 year one that you chose for new and see what that does for your retirement plans!

Why climb Mt Everest?

Posted on December 13, 2010 by Adrian

Thanks to all of those who entered my SECOND $700 in 7 Days Giveaway; you still have a couple of hours to sneak in and submit your entry for what looks like a better than 1 in 30 chance to win the first prize of $350 in cash … that’s like $10 just for filling in a 2 second form!

If you refer friends, you will be in the running to win the second ($150), third ($50), and fourth prizes of ($50) CASH as well … right now, I’ll be struggling to give all of those prizes away, so that’s a pretty good hint. But, since you’re late to the party, you’ll have to find the entry form yourself. HINT: xxxx 😉
_______________________
I wasn’t spanked by my readers nearly as much as I expected for sharing my happiness with my mansion purchase (actually, two mansions: one in US and one in Aus), then again the purpose wasn’t to brag but to counter the idea that spending is bad.

In fact, spending is only bad out of context … $7 million in 7 years kind of context … when not spending would be even more absurd.

Anyhow, Josh did pull me up:

What’s the point? Maybe I’m missing something. Maybe it’s because my assets are in the 7-figure range and not the 8-figure range. But why spend $X Million on a home?

I live debt-free in a home that cost $300K. I could have bought a $2M+ home, but it seems so impersonal, pretentious, and secluded. I want people to come over and feel comfortable drinking beer with their feet up on the coffee table, or to let their kiddos run around carefree after coming inside on a rainy day. Even now, some people feel uncomfortable in my house because it is “so nice” for the area in which we live.

Well, why do people climb Mt Everest? What’s the point?

Because (a) it’s there, and (b) they can!

So, I have a very simple rule on spending that has kept me in good stead – through poorer and richer:

I spend money when it doesn’t make sense NOT to!

I became rich because I wanted to travel spiritually (that’s free); mentally (that costs me in time and ‘venture’ capital); and physically (that much traveling costs me a LOT of time/money: hey, I retired at 49 so I WANT to travel Business Class and stay in at least 3/4/5-star hotels).

So I set out to make my $7 million in 7 years to allow me to begin the life that I wanted to live (without needing to work) and was fortunate enough to succeed …

… and, one of the side benefits of that financial success is that I have plenty of cash for cars and houses, and vacations and bling. And, for charitable gifts and deeds 🙂

I write this blog because I wish the same for all of you …