You see, if you want to work on your ‘physical well-being‘ you have to define what that means …
… for you.
It will be different for everybody: for my wife it means eating strangely and exercising a lot. For me, it means, being totally sedentary, eating reasonably little/basic (except when I go out) and relying on good family ‘longevity genes’ (on my Mother’s side … hopefully, not my Father’s side of the family!) to keep me alive.
Yet, the government has managed to come up with (and, recently updated) a Food Pyramid that neatly sets out a plan for eating and staying healthy. Each ‘slice’ of the pyramid represents the relative proportion of each different food group that everybody should eat, every day.
But, the government soon found that this is enough to stop people from getting obesity-related sicknesses (cancer; cholesterol-related heart disease, etc.), but really wasn’t enough to make people, well, healthy.
What’s new about this, latest version of the pyramid is the stick figure climbing the stairs on the left hand side, like some Inca priest about to climb the pyramid at Machu Picchu for his monthly sacrifice of the young virgin (naturally, by ripping her still-beating heart right out of her chest … but, I digress).
This signifies that you can eat the right foods all you like, but won’t achieve true health unless you also exerciseyour body, in moderation.
One size does indeed fit all … at the most basic level.
Similarly with your ‘financial well-being‘ – while still a long way off being the Unified Theory of Personal Finance – we can at least lay out a basic Money Pyramid that will serve one and all reasonably well … enough to at least get you started; the bonus being that it might win me some friends back from the mainstream Personal Finance blogosphere.
Take another look at the Pyramid at the top of the post, and we can imagine the various segments as being common financial wisdom like:
1. Save 15%+ of your gross income
2. Pay down (and avoid all future) ‘consumer debt’
3. Increase your rate of savings by also allocating to your savings plan at least 50% of all future pay increases and ‘found money’ (inheritances; IRS refund checks; loose change from your pockets; money saved from quitting [insert vice of choice]; etc.
4. Buy instead of renting [AJC: which Financial Pyramid are you reading?!]
5. Invest for the long-term
6. You can fill in the other slices from your choice of any/all: live frugally; diversify; create an emergency fund; and so on …
And, this is certainly the Money Pyramid being promoted by most Personal Finance writers (other than the “Make Millions with No Money Down” and other ‘financial crackpot systems’, that I liken to the totally unbalanced “No [insert unhealthy sacrifice of choice: carbs; proteins; calories; glucose; food; etc.] Diet” diets).
The problem is, it might stop you from being poor (the financial equivalent, to not being obese) but will it be enough to make you Financially Healthy … a.k.a. Wealthy (however you choose to measure that)?
Probably not, which is why I have created the New Money Pyramid simply by adding the man climbing the stairs on the side:
This signifies that you can save money all you like, but won’t achieve true wealth unless you also exerciseyour money, in moderation.
How do you exercise your money?
Simple: you move it around! You aim high … setting a goal that has meaning to you, then:
– You invest at greater velocity (higher return),
– You leverage (the financial equivalent to exercising with weights),
… but only to the extent that your ‘heart’ (actually, your guts) can handle – start slow, get help, build up the velocity and the leverage as you get over a period of time – and, check with your ‘doctor’ before trying this at home 😉
Perhaps I just like this video because the ‘talking head’ is a fellow Aussie – although, I don’t know who he is or what his credentials are (I do know that if you watch all three of the videos listed on his blog you’ll end up with an ad for a new ‘personal finance’ educational board-game) …
… but, I do like his neat little whiteboard summary of the problem of ‘investing’ to chase capital appreciation. This was the sort of ‘wrong thinking’ that fueled the property market booms, both here and in Australia.
The investment clock is one of the best indicators on the movement and condition of the finance, property and equities markets. It was first published in London’s Evening Standard in 1937 and showed the movement of markets within a decade cycle. Many people, however did not readily accept the probability of events turning out in a cyclical fashion so it took a while for some to warm to this new area of thought.
As late as last year, I was reading articles that said that we were at One O’Clock on the Investment Clock: rising interest rates and fear that stocks were on the verge of falling (and, fall they did) …
… then, something surprising happened: the clock did a ‘fast-forward’ to where I think we are today:
At the bottom of the cycle when fear and bankruptcy are abounding and interest rates are down, remember that this is the time to be positive. It is the time when there are bargains galore, ready for the taking.
The driving factor behind the business cycle is the capitalist system itself. Recessions are a way of ridding itself of excesses. Things like speculative lending by banks, high risk real estate trading and inflation. Society simply starts going a bit faster than the economy and places a lot of strain on resources. This means we are left with inflation and high interest rates. The bank then imposes a credit squeeze for a period, long enough for those excesses from the system to force inflation down.
Always remember that during a slump the price of most things will fall, but the value of cash does not. In fact, the value of cash goes up because it is measured by its increased ability to buy things more cheaply. This is the best time to hold cash and come out of those holdings when the economy is in the doldrums.
Nobody knows how long we will languish in the ‘doldrums’, and if you count the recent stock market rally as a ‘good news’ indicator it may be almost over, but it’s clear – at least to me’ … we are already in the cycle where assets are cheap … both stocks and real-estate with the added bonus that interest rates are also cheap …
… Bargain Hunter’s Heaven.
Here’s what to do:
1. Start looking for good quality companies with a strong history of earnings growth that are undervalued (did you know that GE has produced 10 years of 10%+ year-over-year earnings growth?) that are selling for low P/E (that’s the price compared to earnings … if you can pick up GE at P/E’s of 13 and hold for a long time, you have a sure-fire winner!) and HOLD. Don’t feel obligated to borrow to buy these, but increasingly, this will be a good strategy as stocks will be the first to rebound.
2. Start looking for good quality income-producing real-estate that you can afford to HOLD … these will be the last to recover (could be a 7 to 10 year cycle to fully recover) but, prices will begin to steadily increase. So, buy soon to lock in these yummy low interest rates before they, too, start to rise. The combination of low prices and low interest rates is equally a sure-fire winner.
3. Start a service business that helps large corporates – as they recover, they will need to outsource more and more services. It can be tough (corporates can be tough to deal with) but they can also pay off big and provide a ready exit strategy (as the outsourcing ‘fashion’ begins to swing back to ‘insourcing’ and your largest customers fight to buy you out).
Just don’t forget to always keep an eye on the clock …
Hey, my name is Josh and I am 24 years old and I am a huge personal finance junkie. I really enjoy reading your site so far. I was particularly intrigued about your post about renting vs buying real estate. To make a long story short, my dad owns commercial/rental property (3 housing units, bottom floor is for business) that is mortgage free. It is in a great up and coming neighborhood in Brooklyn. If he were to sell it today it would fetch in the 2 million dollar range. He makes pretax annual income of about $100,000+ in residual income from the business and the 3 housing units. I have been for the past couple of years been trying to convince him to take a loan from the equity from his property and reinvest in other commercial properties or other properties, but he refuses claiming that it is too risky. I don’t how else I can try and sell him on this. Maybe you can help? I am just trying to help my dad become more cash rich, instead of cash poor, asset rich?
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One of Dave Ramsey’s most popular ideas is that of a debt snowball. The idea is that you pay off your smallest debts first, then roll that debt’s monthly payment into the next smallest. When the next smallest is paid off, you roll the two former payments into the next smallest debt.The snowball grows and grow with each debt that’s repaid.
Here’s a real life example; here are your three debts and minimum payments:
$10,000 @ 20% APY, $500 minimum monthly payment
$4,000 @ 10%, $200 minimum monthly payment
$1,500 @ 12.5%, $75 minimum monthly payment + EXTRA PAYMENT
The debt snowball method states that you should put all extra debt payments towards the $1,500 balance. When you finally pay off that debt, your new payment schedule should look like this:
I have only added the words “EXTRA PAYMENT” to both examples, because I want to clarify – then expand upon – BFFP’s example.
First, though, what Dave Ramsey is saying – and, what BFFP is trying to illustrate – is the concept that you take one of your debts (the highest interest rate in the traditional ‘Debt Avalanche’ or the smallest balance owing in Dave Ramsey’s more psychologically-friendly ‘Debt Snowball’ method) and pay that down completely … merely making the required minimum payments on any other loans (but no more!) to stop them from going into default.
The credit card companies will love you for this!
Then when that loan is paid off in full you apply the payment that you USED to make on the first loan that you tackled to the next remaining debt, and so on …
… it ‘snowballs’ because you are applying more and more to each remaining debt, while never having to commit more (or less) to debt servicing than when you first started budgeting.
So, in both examples we are paying $775 (i.e. $500 + $200 + $75) towards debt repayment until all debts are paid off … THEN – conventional financial wisdom will tell you – you get to start INVESTING that $775 a month and you are FINALLY debt free and on your way to … what?
Well, let’s go back and make the small correction: if you only make the minimum payments, you will never pay off any of the debts (or, way too slowly), so you need to find some extra money and make some extra payments to the first loan that you decide to tackle; let’s use an example of $225 a month as an extra payment …
… and, from now on you commit to that monthly $1,000 i.e. $500 + $200 + $75 + $225 EXTRA PAYMENT + C.P.I. + 50% of any ‘found money’ (second jobs, part-time business income, loose change, IRS refund checks, etc., etc.) for your entire working life!
So, we are on the road to success! Or, are we?
The problem is that we have to decide where we’re heading: if our aim is to become a Ramseyesque Debt-Free=Happy clone, then well and good. Your financial plan is set.
[sign off now]
But, if we intend to get rich(er) quick(er)â„¢ we have two huge limitations, neither of which the Debt Snowball or Debt Avalanche address:
If we lose just 10 years to our investing plan by delaying investing while we pay down ALL of our debt and/or pay down our mortgage we can halve our potential return.
Do you think that might be significant?
So, we don’t want our debt-repayment strategy to unnecessarily delay our investment strategy.
Money
Where are we going to get the money to invest?
Sure we can accumulate $1,000 a month (after paying off debt) – and, grow that amount through C.P.I. and ‘found money’ strategies -but, will that really set us off on the path to financial riches?
The same graph shows that for every $1,000 A YEAR we invest, we can expect $100,000 after 20 years … so, our $1,000 A MONTH strategy should yield $1.2 Million over the same time period … unfortunately, that won’t be enough for a DEPOSIT on the Number that you really need …
… and, inflation will take at least a 50% chunk of that (not to mention taxes)!
So, the solution for most people – who don’t want to lower their expectations to match this depressing, but debt-free (!) scenario – is to move INTO debt … to invest!
This is so-called ‘good debt’ and I’m not sure what Dave Ramsey and Suze Orman’s take on this is, but most financial pundits call it ‘good debt’ for a reason. Assuming that you agree, read on [AJC: if not, I’m guessing that you hit <delete> about 4 or 5 paragraphs ago]
So, here’s what we need …. a different mind-set:
Since we already know that we will more than likely need to incur SOME ‘good debt’ as part of our investment strategy (i.e. some safe level of leverage for investment purposes e.g. a loan on a rental property) …
… why pay off OLD debt now in order to accumulate NEW debt later?
It doesn’t make sense, does it?
We merely waste time and money … instead, we should resolve the following:
1. To treat all Consumer Debt as ‘bad’ and incur no further such debt, unless it’s not really Consumer Debt at all (e.g. we need to buy a car to run our catering business, and public transport or a bike really won’t cut it)
2. To apply the minimum required payments + extra payment(s) + c.p.i. + ‘found money’ not merely to the lesser goal of paying down debt, but to the greater goal of helping us get to our Number (i.e. the financial representation of our Life’s Purpose [AJC: if you don’t buy into that philosophy, then simply insert the words “helping us become financially free”])
3. To, from this day forth, look at all debt as an INVESTMENT in your financial future: and, simply ‘invest’ where you get the greatest returns: is that in paying off an old debt? Or, is it in acquiring a new debt?
Example 1
In the example above, we have three debts of 20%, 12.5% and 10% (are they tax deductible? If so, look at the after tax cost which will be 25% to 35% lower than the nominal interest rates circa 14%, 8.5%, and 7% respectively) …
Compare these interest rates to the cost of money for the types of investments that you want to make …
… in this example, all three are higher than current mortgage rates so you will probably want to keep paying them off (although a good argument can be made for paying off the 20% loan first, then buying an investment property BEFORE paying off the others).
Example 2
Let’s make two changes to our example:
Let’s assume that one of the loans is a 2.5% Student Loan, and swap the amounts owing (so that the Student loan is now the ‘biggie’) and, let’s assume that we have at least 5 more years before it HAS to be paid back (so we have time to make an investment work for us); here’s our starting position:
In this case, we tackle first the 20% loan; I can’t imagine an ‘investment’ that will provide such a quick & safe 20% post-tax return! Then, we tackle the 10% loan.
Again, an argument could be made for leaving it in situ; however, it is only $4k – and, we’ll pay it off in just 4 months – so let’s go ahead do just that:
Once we have paid off our two HIGH INTEREST loans, instead of paying down the low interest student loan, we continue to make its minimum monthly payment, and instead apply all of the previous / extra loan payments (from our OLD loans) to building up a ‘reserve’ in a bank account (it pays us a – low – rate of interest!) …
… at this rate, we will have a deposit on a small rental (or our own first studio apartment) in less than a year, then our financial picture will look something like this:
Keep in mind that if you used Reserve # 1 to build up a deposit on a small apartment to live in, then you will have no rent to pay, so you can apply part to home ownership expenses (rates/utilities/taxes) and part towards your next Reserve!
And, if you bought a rental, then you may be in an excess rent situation and have more to apply to building your next Reserve, as well … if not, then you will need to decrease the amount going towards your next reserve to cover any rental shortfalls (e.g. mortgage payment deficits, vacancies, repairs & maintenance fund, etc.).
Now, you know why this is not a Debt Snowball, a Debt Avalanche, or even a Debt Meltdown:
It’s the Cash Cascade …
… the new way to look at paying down debt!
In the two years that it would have taken you to pay off your Student Loan and buy your first property, you now own two properties and are well on your way to financial freedom!
The text of a cable sent by Mark Twain from London to the press in the United States after his obituary had been mistakenly published.
Just like Mark Twain, I think that real-estate has been prematurely ‘written off’. Do you need proof?
Just check this often-cited graph (I think that it’s from Irrational Exuberance by Robert Shiller) floating around the internet:
It purports to cover a period from 1900 to 2005 in a linear fashion … a clear bubble-spike, right?
What could one reasonably conclude from this?
A long downward trend and/or an even longer flattening until house prices catch up with, say, 3% – 4% inflation?
Now, take the period covered by the red line beginning roughly in line with where the ’10’ starts in the phrase on the graph that says “Yields on 10-Year …” – got it?
That’s roughly 1987 until today …
Now, let’s look at an a national index of housing prices covering that same period from a source that I trust – Standard & Poors (the same rating agency that produces the S&P500 stock price index):
This picture tells a slightly different story, doesn’t it?
One reason is that this one, I don’t think, is inflation-adjusted whereas I believe the Schiller one is (or at least ‘adjusted’ for something … any of our readers know what that might be?). In either case, a definite ‘bubble’ can be clearly seen in both charts from, say, 1999 to 2007.
But, have a look what happens when you break this second chart into three sections:
1. We see the tail end of a rise from (we don’t know when, because S&P apparently only started collating this data in 1987) to the end on 1989 … the extent of this rise is pretty important, because we then see …
2. … a ‘flat’ line (or worse) from the end of 1989 to roughly the end of 1998, then …
3. … all hell breaks loose from the beginning of 1999 to somewhere towards the end of 2006 when a clear crash occurs.
So, was the flattening in 2. a correction for 1. OR was the growth in 3. an over-correction of 2.?
I can’t say for sure, but I can say this:
If you draw a compound growth curve between two points: a 20 year period when the market moved from an index of 75 (roughly at the end on 1987) to an index value of 200 (roughly at the end of 2007), we can see that that represents an average compound growth rate of just on 5%
Given that real-estate compounds at 3% to 6.5% annually, depending upon which source you believe (I’m firmly in the 6%+ camp), here’s what all of us as investors have to decide …
Buy now (or soon) while the going is cheap (particularly, if you think that interest rates will also start to go up soon), or wait because you believe that real-estate is still overpriced.
Be warned: if you wait too long (is that 6 months or 6 years?), the ‘real estate discount party’ might be over!
Last month, as a reader service, I published one of the most important financial statements made in recent years, but it wasn’t made by the Treasury, the Feds, or even the Banks (!)Â …
… it was made by Warren Buffett – to give the average US investor confidence by sharing his personal financial strategies for today’s ‘crisis’ market.
Naturally, there were cynics: isn’t it amazing that people who usually have nothing (like one particular financial journalist) like nothing better than to criticize those who have everything (like one particular multi-billionaire investor)?
It’s the same counter-intuitive, yet all-too-human, failing that sees us buy when the market is high and panic/sell when it is low. Sad … but, true.
Here are some comments by Marketwatch.com, where “David Weidner penned an article about Warren Buffett” that Motley Fool thinks is “equal parts sad and stupid”; Motley Fool says:
Weidner responded to Buffett’s article by making the following points/accusations:
That because Buffett can get better terms than you, his advice does not apply to you.
That Buffett wrote the Times article to talk up shares because his recent investments in General Electric(NYSE: GE) and Goldman Sachs(NYSE: GS) preferred shares were underwater, and he needed to “stir up some buying” to get their prices back up.
That the stocks Buffett’s buying for his personal account are irrelevant, since he made his fame with his gains at Berkshire Hathaway(NYSE: BRK-A)(NYSE: BRK-B).
Gotta love a show that dangles a $1 Million ‘carrot’ in front of people’s noses and all they need to do is make some sensible life choices – on the spot, and in front of millions of people 😉
Tomorrow Rodriguez (that’s her name … really!) is a sensible girl: married, been in the army, put herself through school, has a Master’s degree in something-or-other (obviously, not math).
And, she’s made it on to one of those ‘special episodes’ – you know, the ones where they put up 9 suitcases with $1 Million in each of them, rather than the usual single suitcase: that’s 9 chances in 26 … 35% or roughly a 2-to-1 chance of walking away with $1 Million.
Deal or No Deal?
OK, but there’s a twist … first you get to pick some suitcases and the ‘Banker’ makes you a take it or leave it offer:
He’ll give you $43,000 to walk away right now! In fact, that’s exactly what he offered Tomorrow very early on in the show …
Deal or No Deal?
You say “No Deal!” (do you?) and pick a few more suitcases … the offer goes up and up, but you keep turning the Banker down, down, down, until the money gets serious.
Now, more than half the suitcases are gone (and 3 or 4 of the ones with $1 Million in them, as well) but you still have a few ‘million dollar suitcases’ as well as a few lemons left … but, you have chosen well (birthdays, tarot readings, and horoscopes are really working well for you today).
The Banker offers you $134,000 to walk away, right now!
Deal or No Deal?
Of course, you say “No Deal!” (are you sure that you do?) and Howie asks you to pick just two more suitcases … the offer goes up to …
… the amount in the photo above!
Deal or No Deal?
If you haven’t dipped out already, here’s something interesting to note; it may or may not change your mind, but it’s interesting nonetheless:
There are 6 suitcases left [AJC: one suitcase, also containing ONE MILLION in the bottom right has been cropped in the photo at the top of this post]:
3 suitcases containing virtually nothing (max. of $400) AND
3 suitcases containing $1 Million
So, the odds are exactly 50/50 that’s you’ll pick one of the suitcases that guarantees you $1,000,000 so the banker should offer you $500,000 (give or take a few bucks) …
… BUT, the Banker’s Offer is only $349,000
Deal or No Deal?
Let me know where you stopped … click on one of the options in the poll … if you’re up for it, you can also drop the reason for your vote into the Comments section below … this should be fun!
In the meantime, do you want to know what Ms Rodriguez did? We’ll talk a little more about that next week 🙂
I have been working on a project … call it a labor of love (when you find out what it is, you’ll decide that if this is my idea of ‘love’, I need psychiatric treatment) … and, I want you to participate!
Let me take you back to where this project had it’s genesis:
In 1998, I was struggling financially and directionally … I had my two break-even businesses, a lovely wife and two babies, but no money and no major prospects: it would take a miracle to get the businesses above break-even.
Then I came across the concept of the Number.
A simple idea: your Number is the amount of money that you need to have set aside (by whatever Date you happen to decide upon) so that you can be financially free to [insert goal of choice: retire; play golf professionally; write a book; volunteer abroad; move into the old-people’s home or Florida, which pretty much amounts to the same thing; etc.].
At the same time, I found my Life’s Purpose: to be constantly traveling mentally, physically, and spiritually …
… which means nothing to you, but meant everything to me (which is all that counts, right?).
Understanding my ‘life after work’ dream (in my case, it meant discovering my Life’s Purpose) told me that I needed $5 Million within 5 years. A major wake-up call considering that, at the time, I was $30,000 in debt!
If you’ve read my $7 Million Dollar Journey you will know that, because I found my Number, I made it.
I decided that I had to give back, by helping others to understand, find, and achieve their Numbers, as well …
… so, to help you figure out your own Number (and, Life’s Purpose … if you so desire) I have created a new web-site.
I have also created a unique home for you on the Internet, a place where you can Share Your Number with like-minded people … hopefully, you will connect with others who can help you on your way, and you may even be instrumental in helping them!
Take a look at these sites, then join up and Share Your Number … it’s easy, fun, and could be very, very rewarding for those who actively participate.
As readers of this blog, and ‘charter members’, your membership will always be free. And, tell your friends, they can be charter members, too 🙂
The only ‘catch’ is that I have not officially launched this site, yet, so you will be the ‘beta testers’ … try it out and let me know what you think using the form, below (just type then ‘submit’):
Let’s see … what are your health objectives?:
