Posted in Personal finance

Financial Freedom : FIRE or WATER

F.I.R.E – Need I explain it? Everyone who is interested in reading about personal finance (and hence this blog) is already familiar with the term. In case you do not know, here it is:

Financial Independence Retire Early. 

The concept is very simple, where you accumulate a target amount (net worth) or cash flow, through which you can substitute your working income and retire earlier than usual. 

The main motivation of FIRE enthusiasts for retiring early is to stop working in a 9-5 routine and be able to do what you want, like travel or pursue your hobbies.

However like everything, there are two sides to the Financial Independence coin. One side is retire early as in F.I.R.E, the other is retire slow and enjoy working as long as you can. 

I decided to write this blog post to unravel my thoughts on this.

While the FIRE approach seems lucrative to achieve, there are some disadvantages to that approach.

Similarly the retire slow approach may work well for most people, but it needs to be done with discipline so that as you grow old, the work does not become a necessity to fund liabilities.

With disciplined and good personal finance habits, you can glide into retirement and enjoy the journey as well as the time in retirement. 

Since the first one is called FIRE, metaphorically lets call the second one WATER.

Let me first explain why the first one is more like a FIRE and may have disastrous consequences if not handled properly.

  1. One of the main strategies of achieving FIRE is to earn, save and invest aggressively. Most of the times it means extreme sacrifice (read minimalism) to save 50-70% of the income to reach that magical number.
    • For the family too, the pursuit of FIRE can mean unnecessary sacrifices to not being able to afford (at least artificially) a nice vacation, car, a restaurant meal or even a latte.
  2. I have read and watched some couples on YouTube who are pursuing FIRE. A few characteristics are:
    • They are always looking for deals and the cheapest way to get things done.
    • They are too focused on money, possibly ignoring more important aspects like career growth. For example, a young professional in his/her 20’s, if so focused on earning more will fail to build marketable skills, and will jump from one domain to another as soon as he/she smells more money.
    • Numbers are good, but if every daily action of theirs is dedicated towards achieving that magic number in a bank, I am not sure how enjoyable that journey is.
    • Finally ask yourself: Is that all I am excited about?
  3. Lets say a person reaches his/her number, and now retires early.
    • In the pursuit of money, he/she would not have done what he/she was naturally good at. Imagine if every artist, every scientist, every sportsman just obsessed about financial freedom and retiring early.
    • Once he/she retires, the person would have lost the age and opportunity to work on something really satisfying. In many 9-5 jobs, people are doing great things and achieving life changing experiences for themselves and for others. For example, people working in the high-tech industry who are changing the world everyday should not think about retiring soon.

On the contrary to F.I.R.E, if you work in your field with passion and make the money gradually (making it a secondary factor instead), you would have still achieved F.I.R.E but in the slow and steady way. Disciplined personal finance is neither about aggressively chasing a number nor indulging in unnecessary luxuries.

This slow, steady wealth building and never retire attitude can be compared to WATER. 

Like a body of water – it builds up from a small stream travelling through the river, and then into a mighty ocean, but nature does not let it stop there. The ocean can be considered the final destination, but an ocean never retires. It carries on its work day in and day out, sustaining a diverse form of life and occupying 70% of the earth, controlling huge natural consequences for the planet. That’s the freedom of the ocean.

In this WATER way, you work with all your talents and grow yourself bit by bit everyday. As your talent and experience grows, you achieve big things and gain pride in yourself when you look back. It makes you do more and achieve new goals and heights in your job and business. This is how most entrepreneurs (and intrapreneurs) live their life. They move from 9-5 jobs to opening businesses and do not intend to stop ever. 

There is no retirement in the WATER approach. You keep flowing always like a river, then get into an ocean and still carry on till death stops you.

Note that in this approach, there is no money number and no mention of how you can earn more, negotiate a higher salary and likes. Money will follow as you gain more experience and achievements. 

That does not mean though you should not save and invest. You can still lead a comfortable life and grow your net worth while indulging in meaningful luxuries. It makes the journey much more worthwhile and since there is no hard destination or number, you learn to enjoy the journey more.

The Net worth vs. Cash flow debate

For me, I don’t know if ever I will reach my magic number (I know mine though). Hurrying and worrying about it will not make my life better.

I will rather focus on working hard, learning, managing my money and writing about my experiences and thoughts in this blog. In the process I develop money systems and principles that I like to share. 

Five components of a personal finance system

The Starter Kit

I will hopefully never have to say “I have reached my number, and retired.”

I will keep flowing and see you in the next post. 

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Posted in Budgeting, Personal finance, Savings

Five components of a personal finance system

There are many articles on how to be frugal, how to save more, earn more and invest for high returns.

All this is good advice, and the Internet is full of such articles, blogs, videos, courses.

However the key to saving money and investing for growth is action and the discipline to implement the good practices.

If you go through most of the articles, some common themes emerge such as:

  • Pay yourself first
  • Do a proper budget or at least allocate money to your various expenses
  • Big tax refunds are not cause to celebrate
  • Get out of debt
  • Regularly invest a little
  • Use Robo advisors
  • and so on…

Yet lot of people (some say 78% of Americans) live paycheck to paycheck, and will not be able to cough up $400 cash in times of emergency.

With so much of good advice and technology out there, why then we still have the problem with more than 50% of the population? What is different with the 10-20% who manage to create and keep wealth?

I think the answer lies in being organized, intentional and disciplined. As Dave Ramsey said “Personal Finance is more behavior than numbers”.

It requires a system to be organized and manage your money. Once the system is in place and you get into the habit of it, you will automatically resist impulsive behavior.

In this post, I will highlight some of the systems that I follow to organize this area of my life. And remember, the more organized and intentional you are on personal finance, it impacts rest of the areas of your life as well. Cliche, right? Yes but difficult to implement.

There are 5 parts to the system:

  1. Automate
  2. Cap
  3. Archive
  4. Remind
  5. Learn

Just for fun, lets rearrange and call this the CARLA system (Cap, Automate, Remind, Learn and Archive). Really the order does not matter.

1. Automate

Automation is the heart of any system. And with most of the financial products employing high end technology, there is no reason to avoid automation.

A simple automation makes the “Pay yourself first” a breeze like operation.

For example, in my case, the first bi-monthly paycheck (pre and post tax) simply goes to my mortgage and investments (retirement, 529 plan, HSA, investments). I just cannot see it in my checking account by the 2nd or 5th of the month.

How do I run my expenses and pay my bills then? Another automation.

All my bill payments are set on the one and only credit card that I use. It is completely automated so I don’t need to remind myself to pay electricity, water or phone bills. The same credit card is used for first half of the month to buy essentials.

By the same system, the second bi-monthly paycheck pays off the credit card bill in full.

A portion of that also goes into savings for short term goals (provided the credit card was not overused – we will talk about caps in next section).

Advantages:

  • Naturally implements the Pay Yourself First.
  • Automated bill payments, so no chance of forgetting and running into credit problems.
  • Earn points on the credit card, as all expenses are charged to the one.
  • The credit card is automatically paid off within the month.

Risks

  • Need to control expenses as the credit card balance should not overshoot the projected amount.
  • Unexpected debits to the checking account (checks issued, or charged by institutions) may cause overdraft scenarios if not careful or kept track of such expected transactions.

The Starter Kit explains how to setup a system from scratch.

2. Cap

One of the toughest part of personal finance behavior is to cap your spending. No amount of technology or automation can address this adequately. There are budget apps, reminder apps, envelope system but at the end of the day, if you are armed with a credit card, there is no stopping you.

There are two ways to address this:

  1. If you are using a credit card, then absolutely you will need a budgeting and expense tracking app. I use YNAB (You Need a Budget) but I have heard people liking Mint or Personal Capital. In these apps, you can set limits for spending under each category like Food, Transportation, Utilities and Fun. Here is a referral link to YNAB.
  2. However a more effective way and not to run into debt, you can automate to transfer the estimated monthly expenses to another checking account, and use the ATM/debit card of that account. As soon as you see the account is drying up, you know you have to rein in your spending. As you do this more, you will slowly understand the pattern and be able to make or adjust estimates.

Advantages:

  • Having a cap of expenses is non-negotiable in the pursuit of good personal finance habits.
  • You know exactly where each dollar is going and how to optimize or reduce the outflow.

Risks:

  • The first approach definitely has the risk of running into credit card debt, and not able to pay in full.
  • The second approach is safer but if you are not keeping track, can hit you with overdraft fees or embarrassing card decline at the checkout counter.

Yet another simple budgeting mechanism is described in Budget – Grow the tree upside-down .

3. Archive

A good archiving system is also key to good personal finance habits. Not only habit, but it keeps you stress-free. Remember the scrambling during tax filing season, looking for bank statements, dividend results, interest certificate etc.

Moreover we have multiple sources of information, statements coming through email, snail mail, website downloads, or even previously archived repositories.

A simple system I follow consists of a uniform folder structure across multiple sources of information.

There are 4 aspects of personal finance that you need to keep track of.

  • Banking – Accounts, statements, credit cards, interest certificates.
  • Investments – Portfolio Statements, dividend statements, recommendations, documents from financial advisers.
  • Taxation – Everything related to your taxes year wise. Returns, documents sent to CPA, CPA communication, IRS communication and so on. For each year, I have the following folders.
    • Year
      • Source documents – Everything I sent to the CPA
      • Processing – All drafts and iterations I had with the CPA
      • Final – Final copies of the filed return and acknowledgements etc.
      • IRS – In case there are any direct interactions with IRS after filing (notices, response, tax due, tax paid etc.).
  • Insurance – Insurance policies, forms, statements, estate planning documents.
  • Bills and Receipts – Miscellaneous bills and receipts if they do not fall into above categories.

With the above organization, you can simply create the archival system in all your information sources.

  1. Gmail – create these as labels or email folders.
  2. Evernote – you can create notebooks and store documents as notes under each notebook.
  3. Google Drive – create folders. You can save attachments from gmail directly to these Drive folders.
  4. Laptop local drive – Sometimes it is best to store in the local drive than cloud. That is, if you are uncomfortable storing documents containing sensitive information (SSN, date of birth) into the cloud. Be sure to periodically back this up into external hard drives.
  5. Physical documents – Paper statements can be either scanned and stored in above places, or simply dropped into file cabinet drawers, with appropriate labels. The labels should follow the same categorization.

Once you have the uniform structure across all these platforms, storage and finding information is easy.

Advantages: 

  • Easy to file and find.
  • Following same structure in all systems that you use.

Risks:

  • None at all.

4. Remind

So you have automated, capped and archived personal finance. But what about still those actions to be taken, follow-ups to be done and making sure time sensitive things do not fall through the cracks?

I don’t want to describe personal productivity or time management here, but an essential part of managing personal finance is timing. There are taxes to be paid quarterly, investments to be made, or simply a phone call to be made.

Choose whatever system works for you as reminders, be it an app on your phone, or calendar on the laptop.

For me, plain gmail works as it has a snooze facility, by which I can redirect any email to come back to my Inbox at the time I need to take action. In my opinion, it is an important tool in time management as now I can remember to take action at the right time. It just pops in my Inbox on that Sunday prior to the week I need to take action on that. 

Another good platform for keeping track of your laundry list is Trello. I use it quite extensively and the concept of board and cards, helps keep things visually clear.

Advantages: 

  • Even if you automate everything, there will be things for which action needed to be taken timely.
  • Remain stress free and auto-magically respond or follow-up with people at the right time. Sometimes this surprises people as they may have promised to do something (or get back to you) and you follow up on the agreed date. 

Risks: 

  • Unless you stick to one system (Trello or Gmail), you run the risk of multiple apps keeping track of your to-do lists and confuse you enough not to take action or update new items.
  • You may run the risk of irritating some people who do not like to be followed up, especially if they wanted to forget what they promised.

5. Learn

I cannot emphasize this enough and with the plethora of information on the Internet, whatever I say will sound like cliche.

However as with any field, it is important to keep yourself up-to-date with advances in personal finance topics. 

One of the simplest ways is to dedicate a couple of hours every week, to read about different topics, blogs and videos of personal finance. You can subscribe to magazines like Money or Kiplinger. Or simply come back to this blog as I normally post every week.

Advantages: 

  • Learning is always good, and opens up new opportunities for you.
  • You build your own system and strategy as you read and learn techniques others have used.

Risks:

  • Don’t get obsessed by personal finance reading, as it can get repetitive very easily. You may end up wasting lot of time reading the same message in different ways.
  • You may take wrong action or jump into investments without fully understanding the consequences, or simply following some author’s thumb rule from a book.

These are the Five essential elements of a good system that can be setup with minimal infrastructure. It worked for me and I hope you find it useful. 

My CARLA system (Cap, Automate, Remind, Learn and Archive) – a system to automate, manage and grow personal finance. 

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Posted in Investing, Liabilities and Debt, Personal finance

The Net worth vs. Cash flow debate

What is your net worth? Let me see, probably close to a million. So what? Are you financially independent? No. Why? ’cause I don’t have enough cash flow to replace my W2 income. Ok then, net worth is a worthless metric. But it projects my comfort into the future.

And so it goes on and on…

Does it sound familiar? There are two schools of thought. One says be conservative, save, invest for growth, have little to no debt and build your net worth slowly. The other school scoffs at this conservative approach, and instead propounds building wealth and cash flow through acquiring assets, leverage and working out deals.

None of them are wrong. However what is right for you (and me) is important. For that, it is extremely important to understand the benefits and risks attached with each approach.

In more practical sense, you will do both in the right proportions that you are comfortable with.

The Net worth approach: 

Here your main cash flow is your W2 income. Your ability to live below your means gives you the leverage to save and invest the rest.

Budget – Grow the tree upside-down

As you invest your money into stock mutual funds, CD, money market, bonds and a house of your own to live in, you are increasing your net worth slowly.  This is how most people start and someone starting off should. The difference between income and expenses, is the main contributor to your net worth. Additional is the appreciation and growth that your investments achieve. You also pay down mortgage of your house which builds equity, adding to your net worth.

In my opinion, this is a perfect approach to build wealth as long as you enjoy what you do in your W2 job and have a good work-life balance.

This is also the simplest since there is no extra debt burden (except probably your house, which you can pay down if you want). Your investments are also passive and takes hardly any time from your schedule, except occasional re-balancing and tracking.

Investing in the High Five portfolio

With a spreadsheet like Excel, you can easily calculate your projected net worth in “t” years in the future, assuming a “r” rate of interest (or growth).

cp_formula

However this approach takes a lot of time and patience, disciplined living on a budget and regular investments. You will not have something to brag about in a few years, but you will sleep in peace as you have liquidity, less or no debt and enjoy your work.

The risk of this approach is if you retire early and do not have enough corpus to live off for the rest of your retired life.

The Cash Flow approach:

The cash flow approach on the other hand, only focuses on generating cash flow. It means you have enough assets or mechanism (businesses, activities) which generate cash month after month, in a predicable fashion.

This can be achieved with several avenues for example:

  1. Rental property investing
  2. Commercial property
  3. Dividend paying stocks
  4. Passive income from books, royalty of other IP, YouTube videos etc.

There are many resources on Internet to give a list of passive income ideas.

However in the cash flow investing approach, I wish to draw attention to the big ones like Rental Property Investing and Dividend Stocks.

These are two ways which makes a very predictable cash flow stream if done right.

However to get this predictable cash flow, one has to do the investment right. For example, real estate has many hidden costs and running expenses, which if not taken into account will quickly convert an on-paper cash flow asset into a black hole for your money.

Similarly dividend stock investing, if not researched correctly can cause the principal investment value to go down. Same for income producing corporate bonds, where the ability of the company to make the regular payouts needs to be researched.

Last but not the least, income producing real estate is typically obtained through leverage, which means steadily increasing debt.

For example, if you want to generate $5000/mo in cash flow from real estate, you need to buy as many houses that will in total produce that much positive cash flow. Lets say each house produces $200/mo in positive cash flow after mortgage, taxes, insurance and expenses. Now you will need to manage at least 25 such properties to generate the requisite cash flow. Self managing 25+ properties is more than a full time job, and if you hire a property manager you will have to part with the cash flow (fees), and hence no. of houses under management will need to increase. This is all not to mention that now you have 25+ mortgages in your name. The risk – 10 out of 25 properties suddenly loses the tenants and remains vacant for 3 months. Now you have to be able to make 10 mortgage payments every month from other sources of income for an extended period of time. 

I am not saying Real Estate Investing is bad, lots of millionaires and billionaires have achieved their wealth creation through this. However you need to know yourself and act accordingly after you understand all the risks involved.

A combined approach:

 Is it possible to have best of both worlds? Sure there is, if you are not in a hurry to get out of your job and have the patience to slowly build both your net worth and cash flow. 

A few simple ideas which comes to my mind are below. I have done some myself and plan to do the rest.

  1. Increase your income and live below your means. This is very obvious, yet the most difficult to do consistently.
  2. Invest consistently 15-20% of your income into stocks, bonds and cash. See post: Emotional Investing
  3. Live in and then rent – Convert your existing house to a rental once you move out to another one. Or just rent out a portion of your house. This has the advantage that the mortgage you have is an owner occupied one (less interest rates typically), also it is paid up consistently as you spend more years and gets factored in your regular budget. See post: Don’t twist your ARM, fix it !!!
  4. Pay off your old houses completely but do not sell. Convert your equity play into a rental now. The paid off house will generate much better cash flow with substantially less risk, as there is no mortgage payments to worry about. See post: The Paid Piper of Hamelin
  5. Find sources of passive income which you can buy with your accumulated savings, like investing in a profitable business, crowd funded real estate etc. These have much less risk if you do your homework, at least there is no risk of foreclosure etc.
  6. Write a book or start an online course about your area of expertise.

In short, increase your net worth and cash flowing assets in a sensible fashion, with less to no debt and consistent action. 

Here are some of my previous posts which may inspire the above principles.

Know yourself and your investments

Shun that perfection

How a cassette player caused debt aversion

Enjoy the journey and the destination will follow. 

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Posted in Investing, Personal finance

Know yourself and your investments

I am back after a long hiatus, as I enjoyed a fabulous vacation in India. These are times when I can introspect and know myself better and deeper. Nothing to do with the spirituality of India, but just an opportunity to separate my mind from the daily rat race, and consider what is really important.

Like everything else, personal finance is also very personal. You got to know yourself thoroughly to understand how to restructure your finances, savings and investments to fit and serve your own unique needs. It cannot be driven by advertised claims from pundits, or hyped up investment professionals.

There are several occasions when I made the mistake of trying out something which did not fit my personality or immediate goals. It was just giving in to the popular notion of what I should be doing, without thinking twice about it.

Once I was nominated or elected for a post in the HoA (Homeowners Association). While the work or responsibility was not very complex, but the surrounding politics and conflicts required a lot of different people handling skills. I utterly failed in this endeavor and quickly realized that it is not for me. I have better things to do and spend my time on.

Similarly as I read more on Real Estate Investing and the numerous strategies, I wonder is it possible for everyone to jump in and spend so much time or build such skills to be successful? Or is it better to stick to your own vocation and invest passively, thereby spend your valuable time doing what you can do best. This will also increase your income and put you through a better path to success. This is of course provided you like your job and not desperate to get out of the 9-5 routine.

Some of the investment avenues that people jump into without much education or risk analysis.

  1. Direct stock investment
  2. Real Estate investment 
  3. Life Insurance coupled as investment
  4. Crypto-currency 
  5. Exotic Art and collectibles

If you are like me, who likes to keep things simple outside his area of expertise – here is a no-nonsense investment plan.

  1. Try as hard as you can to stay out of debt. Create a budget to track your income and expenses and live within your means. See the post: Budget – Grow the tree upside-down
  2. Maintain an emergency fund and create a cash cushion. See the post: One essential comfort zone
  3. Invest in simple Index Funds and create a goal based portfolio. See the post: Investing in the High Five portfolio
  4. Keep emotions under check and have a realistic plan. See the post: Emotional Investing
  5. Last but not the least, Get Started. See the post: Shun that perfection
  6. Use the following tools to get started. See the post: The Starter Kit

Finally invest in what you understand fully and comfortable in dealing with.

Rest everything can be ignored and continue a stress-free financial journey.

gps on phone
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