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Posted in Budgeting, Investing, Personal finance, Savings

Who moved my cheese? How to deal with changes in financial plans

The title is taken from a famous book as below. Even though it is meant to be a management philosophy, it applies to the subject of personal finance as well. 

Financial Planning does not work? 

There is a proverb in the military – Plans are good till the first bullet is fired.

Some of us who are obsessed about managing or advising on personal finance can go really overboard with planning. Have you heard about those retirement numbers, college planning or even financial freedom number?

While long term planning is good, problem with personal finance is that it is a not a standalone aspect of your life. It impacts and gets impacted by life events – birth/death/marriage/divorce in the family, choice of career or college, changing goals and circumstances and finally your own priorities may change.

How my circumstances kept throwing my plan astray

Lets take an example in my case, as I transitioned from India to US.

Till 2005, I did not know a zilch about managing finances. In fact I was pretty bad at it, just enjoying my life and like many, used to blow up my entire paycheck in frivolous expenses, needless shopping and eating out. So in a nutshell there was no plan.

Then in 2005, I decided I can at least start investing some money out of my paycheck. Good plan but was it anything long term? No it was too flaky as I jumped from one hot fund (mutual fund) to another. This was the time when the Mutual Fund and Private Insurance industry was taking off in India in a big way. I also lost money investing in an insurance plan (actually a bad plan) that was masquerading as investment.

Beware of ripoffs

Eventually as I got better with finances, I actually created a long term plan complete with everything – retirement fund, children’s education fund, vacation fund and corresponding projections several years into the future. I built separate portfolios for each, and tracked them to utmost precision even calculating year after year growth.

However God had other plans for the family. In a series of unfavorable health and personal issues, we decided to move out of India at least for a few years and relocated to US.

This obviously altered my earlier plans completely, since my place of work and source of income changed. The retirement numbers started to look different, the college education fund seemed minuscule when compared to US college costs and all the plans are to be redone again.

Well what do I plan for now? I don’t even know whether I am going to move back to India again in few years or not.

In a global economy mobility is a part of life and no one stays in the same place or country throughout their working life. Moreover as you move, international taxation is another beast which can alter your long term investments (like tax sheltered) into immediately taxable entities. 

Plan to adapt, not adapt to a rigid plan

So finally you have to take into account an ever changing plan, moving from Plan A to Plan B and keep adjusting according to your circumstances.

When I read about estimating expenses at retirement, I wonder how can someone calculate that? Following factors and more can make it completely non-deterministic.

  1. Where will I retire? Different cities and countries have vastly different living and medical costs.
  2. Will it be only me and my wife? What if the children stay with us?
  3. What do I want to do in retirement? Will I work or travel more?
  4. What health condition will I be in?
  5. What other obligations (including social and family) will I have then?

So projecting your expenses at retirement based on today’s lifestyle is like predicting the weather 20 years from now, based on 20 years of past data.

Same goes for College funding. Even if you are saving in 529 or other accounts, do you have a goal or a number in mind? How do you arrive at a number for college costs, when the costs are going up every year? Isn’t that also as variable as retirement? The following factors come to my mind immediately.

  1. Do you know what career will your 5 year old choose when he/she turns 16-18?
  2. Do you know which college will she go to? Ivy Leagues, State or Community colleges? Are the costs not vastly different?
  3. Are you even going to stay in the same state or country when the time comes for college?

In today’s volatile world, planning too far away (more than 3-5 years) is futile.

Planning based on solid principles, not circumstances

The best way to plan your finances is to look at your current goals, aspirations and develop good money habits.

Below steps will help you be in control and act nimbly to adapt to changing situations.

  1. Live below your means – no matter which country or which circumstance you are in, you can always strive for this and become better. Living below your means is common sense, yet so uncommon. 
  2. Budget – Goal based budgeting – This is very important as it ensures you have control over the cash inflows and outflows. Again something which does not change with your place of work or future plans.
  3. Invest with simplicityFind investments that are easy to understand. Index funds, mutual funds, Real estate, CDs and savings accounts.
  4. Keep some portion of portfolio liquid – Sometimes this can be called an Emergency Fund or Contingency Fund. No matter what you call it, it is useful. When I moved from India, I kept a portion of my India portfolio into Fixed Deposits (similar to CDs here in US) and then built up an emergency fund in US too. This gives me option in both places if I decide to just leave work for some time or get laid off. 
  5. Remain consumer debt free – This is also related to freedom. Except for one mortgage in US, I am completely debt-free otherwise or rather bad-debt-free. Being debt free coupled with a portion of portfolio in cash, gives you plentiful of options to enjoy life at your own terms. 
  6. Keep investing for long term – Unless your investments are in countries with troublesome political climate, long term investments (a part of the portfolio) can be left to grow with time. Long term investments work on the principle – its not market timing, but time in the market that will reward your investments. 

To plan and execute above steps in the most efficient way, read the following posts.

Five components of a personal finance system

The SAFE plan – Simple, Automated, Flexible and Efficient

Finally do plan but let life change it

Money decisions should not dictate all your life’s decisions. Money is only a tool to live a good life.

Let your financial plan adapt to your own goals and aspirations, rather than rigidly follow personal finance gurus and templates. 

If someone screams in YouTube to pay off mortgage, it does not mean you have to follow as your plans may be completely different. Similarly you may not fall for all those high reward promising credit cards if you are not going to use those benefits.

A chess player does not know what the board will look like after the next few moves. 

person playing chess
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Posted in Budgeting, Investing, Personal finance, Savings, Spending

The SAFE plan – Simple, Automated, Flexible and Efficient

Safety in financial world is an oft-repeated word, and is mentioned in contrast to risk and growth.

We talk a lot about risk-return trade-off, safety of invested principal in long term and short term investments.

There is another way of looking at Financial Safety. The SAFE plan described below is a way of setting up financial life that is SAFE by design, not in the traditional sense of Safety vs. Risk but automatic habits that ensure you don’t stray from common sense.

Common Sense and Simplicity in Financial Plan is hard to achieve. True it is counter intuitive, but most people land into financial trouble due to complicated behavior – be it spending recklessly, chasing high unrealistic returns or simply throwing caution to the wind.

The SAFE Plan

Let me first present the 7 steps to SAFE plan.

  1. Invest in pre-tax accounts like 401k and HSA.
  2. Set up a direct deposit of the remaining taxable income to a checking account.
  3. Set up credit card payment to be auto paid from the checking account on the 30th of every month.
  4. Set up an auto-invest plan where 10-20% of the taxable income is diverted to a brokerage account or another IRA account (like Roth IRA). 
  5. Spend your monthly expenses on the credit card. Keep an eye on the credit card balance with the money left over in the checking account.
  6. Save the left over surplus, if any. 
  7. Continue and repeat next month … 

Simplicity

The above steps are nothing new. They have been suggested by numerous financial coaches and gurus. However the importance of the SAFE plan is how the steps are stitched together and flows through a seamless automation.

Since we have established the Simplicity of the SAFE plan, lets look at the Automation part and how to set this up. 

Automation

  1. You just need to figure out the % you want to put in 401k or HSA, and inform your payroll department. This can be decided based on the following factors.
    • Your cash flow needs after this deduction.
    • How much to invest to capture any employer provided matching contribution.
    • Max limits of the 401k or HSA.
  2. Direct deposit of the taxable amount to checking account.
    • This is handled by your payroll department automatically.
  3. Setup credit card auto-pay from your bank account for the 30th of every month.
    • This one if not done, can prove to be dangerous as missed payments are very costly.
    • The trigger will also help you pay-off something even if you have amassed a debt.
    • You can configure to pay off the entire balance, minimum payment or a fixed amount.
  4. Setup auto invest for 10-20% of the taxable income. The exact % can vary as it will depend on your household expenses.
    • Even if your budget does not allow this today, find at least a small amount ($50-$100) to divert automatically to an investment account.
    • This will build the habit and set you up for regular investment.
    • The amount can be increased over time as the budget frees up extra cash.
  5. Live within your means. This is again a cliche, but very difficult to be consistent month after month. You can manage it with some automation and discipline though.
    • setup a notification when your credit card balance crosses 90% of your projected expense for the month (or simply the money left in the checking account).
    • Put a Level 5 tornado/hurricane warning when it is crossing over the money left over in your checking account.
    • Typically the projected expenses can be simply set to the money left over in your checking account. You cannot spend more than that without incurring consumer debt or dipping into other savings/investments.
  6. Save the surplus – If you have surplus at the end of the month (that is, Credit card balance < Money in checking account) you can save it for future goals, short term and mid term.
    • I wish banks provided this facility, but it can be set up to transfer a fixed amount once you have an idea of your monthly expenses.
    • Some apps like Acorns or Digit automate this although in more complicated way. 
    • Do not leave the money in the checking account otherwise next month it will create an illusion that you can spend more.
  7. Let the automation run month after month. 

Flexibility

Once setup correctly, the basic version of the SAFE plan is low maintenance and enables an almost debt free living. 

Of course, we have not taken into account mortgage payments, prior debt pay down, saving for education – but these can also be fit into the plan. In the step where you are investing 10-20%, you will break that into smaller chunks of various debt pay down and remaining amount can be invested for various goals.

Thus the plan is also extremely flexible to adapt to individual situations. 

Efficiency

The last part of the SAFE plan is that it is efficient in managing money. 

The following good principles are built-in into the plan. 

  • Pay Yourself First – Pre and Post Tax investments are deducted in the beginning.
  • Low maintenance – no coupon cutting, daily budgeting etc. 
  • Keeps you debt free – just keep tab that your credit card balance is below money left over in checking account. 
  • Encourages more savings at the end of the month – creates a healthy race to increase it, by reducing your spending. 

The efficiency is evident if you do this for even one year. You will see the difference in your credit score, savings balance, net worth and above all, peace of mind. 

Conclusion

This plan has been working for me for a long time. The simplicity and automation helped me manage it seamlessly without getting distracted from my main job – which is not finance. 

And the in-built savings and investment discipline in the plan has helped me invest and accumulate cash for emergencies, short term purchases or just a cash cushion. 

Here is my version of the 7 steps of the SAFE plan (the % are approximate and rounded)

  1. Invest some in the Roth-401k and H.S.A. 
  2. Direct deposit first paycheck. (50% of monthly)
  3. Use the credit card from same account. Set up auto-pay on 30th of every month. 
  4. Investments/Pay downs
    • 10% to mortgage account
    • 10% to savings for property taxes, insurance and maintenance
    • 20% invest in mutual funds via brokerage account
    • 10% to a 529 Plan 
  5. Next paycheck direct deposit on 15th of month. (50% balance monthly paycheck)
    • Living expenses capped to 40-45% of monthly total. 
    • Pay off credit card balance within this limit – I make sure it is $0 as it enters following month. 
    • Sometimes it is hard to stick to the limit, then I have the cash cushion (from previous months’ savings, step 6) to dip into. 
  6. 5-10% savings for vacation/travel, fun, cash – diverted to a high-yield online savings account. 
  7. Keep track every Saturday morning using Y.N.A.B. 

cropped-pexels-photo-908288.jpeg

Posted in Personal finance, Spending

Good Buy or Good bye a house purchase

I had been thinking of upgrading to a bigger house for some time now. This is a difficult decision when you struggle to justify more debt, more wants and lifestyle creeps.

There are various factors to consider in deciding whether you buy that next dream house or say goodbye to your wants for a duration, till you are better prepared.

There are two aspects to this –

  • a numerical analysis
  • a behavioral analysis

Numerical Analysis

white graphing paper

What can you afford?

It is definitely not what the lender tells you in a pre-qualification or pre-approval letter.

You have to see the following numerical aspects in your finances.

  • Do you have cash for down payment? Usually 10-20% of the purchase price is a good thumb rule. 20% is better to avoid Private Mortgage Insurance, which will increase the monthly payment otherwise.
  • Add the mortgage payment to other costs like Property Taxes and Insurance.
  • Are there any up-front rehab costs? Can you get those repaired by the seller?
  • After adding up all costs, adjust your monthly budget to see where you will stand once you buy this house.
  • See the impact to your net worth and asset allocation once you spend the cash for down payment. Although it moves from cash to Home Equity, it can skew a previously well thought out asset allocation across stocks, bonds, real estate and cash.

What should you pay?

There are two main items where you have to shop around and get the best deals out there.

  • Purchase price. Since here we are dealing with numbers, the only thing that matters is whether you are paying too much.

    • List price offer or a multiple offer situation can quickly escalate the price and throw all deals out of the window.
    • Assess what all rehab needs to be done. It is better to get a contractor estimate during the inspection period, so that you can back out if found expensive.
    • Try to buy 10-20% below the price after subtracting any projected rehab expense.
  • Interest rates – This will depend on your credit score and the interest rates available in the market.

    • Getting estimates from various lenders will help compare the best rates.
    • Take into account closing costs and points as these can be significant and varies quite a lot across lenders.

What are the future costs?

A house purchase does not end with the closing. In fact, in terms of expenses it has just started.

Many people take on big house purchases only to realize later that the recurring costs or the holding costs of the property are too high and severely constraint their finances.

  • Holding costs

    • After you have accounted for the P.I.T.I (Principal, Interest, Taxes and Insurance), you need to make sure you still have enough slack in your budget to save for unforeseen expenses.
    • You need to have a cash cushion (preferably separate from your 3-6 months worth of emergency fund) for this property. The HVAC can go bust, the roof may get damaged in the next storm or there could be a disastrous water damage.
    • You also need to consider increase in Property Taxes and Insurance year after year.
    • To correctly account for the holding costs, you need to budget an amount every month and sock it away in the Home Maintenance Fund.
  • Future sale or rent value

    • No one stays in the house forever. You will also move at some point.
    • It is important to decide how you project the use of this house once you move out. Do you plan to convert it to a rental or sell it?
    • Decide on a tentative time frame when you may move out. Based on this and the neighborhood real estate projections, find out what the future sale value or rent will be.
    • Will the rent cover all the P.I.T.I expenses per month? Add a few more expenses like reserves for maintenance, capital expenditures (big expenses like roof),  property manager (whether you use or not, just budget for it). To effectively analyze this, learn about Cap rates, Gross rent value etc.
    • If you plan to sell it, will the appreciation rate be enough to justify your costs, with a sale commission of 6% and all the money you will spend on Property Taxes, Insurance and upkeep of the house over the years.

After you can define a good deal by satisfying most (if not all) of the above parameters, it is time to take stock of some behavior patterns.

Behavioral Analysis

woman wearing white dress standing near building

Do you really need to upgrade? What are you going to sacrifice?

Often it is our wants that itch us constantly to make that lifestyle upgrade. Whether it is keeping up with the Joneses or simply growing out of your current residence, it is a natural behavior trait for most people.

Answering the following questions may steer you to a better decision.

What is the motivation? A better neighborhood, schools or simply more space?

What exactly is the motivation? Is it due to moving to a better neighborhood, or moving to a better school zone? Or is it that the family grew and everyone needs more space?

This should be evaluated purely on basis of needs. For example, for more space can you rearrange or sell off unnecessary furniture and create more space in the process?

How will you clean and maintain the bigger house?

While buying a bigger house sounds exciting, think about maintenance. A bigger house brings in more maintenance headache. And we are not talking about money expenses here (we did that in the numbers section), but the overall energy you will need to keep it clean, mow the lawn and maintain the appliances, carpet etc.

Do you like more debt or want to manage debt?

For most people, buying a house with cash is not an option. So invariably you will take up a larger mortgage, whether you have one currently or not. Overall your debt increases. This has to be justified by the future stability of your job or the state of the industry or business you are dependent on. Or simply the peace of mind and how much debt will still keep you comfortable.

Is this going to be your long term buy?

If you buy a house (not an investor deal) and turn around to sell it, you will lose a bunch of money. Even after few years, it is difficult to break even. So if you are not staying in the house for longer, it will be another expensive switch few years down the line.

Thus it is better to justify all the needs and factors and make sure it will be a long term buy.

Can you rent first and then check out similar homes in the area?

Often the reason could be to just move to a better neighborhood for schools, or get more space. However instead of finalizing a buy, you can always rent a house in the desired area and then check out better deals as they hit the market.

This has the disadvantage of spending some money on rent, but in this section we are analyzing non-numerical aspects. Renting for a year or two will give better idea of the neighborhood, bigger house etc. and better justify the buy decision for a longer term.

Conclusion

All the above factors may seem daunting and may not be possible to satisfy to make a rational decision.

Some of the factors like rent to value ratio can be area specific. If your area is very expensive, then some of the numerical analysis will not give favorable results.

Hence it is important to consider other factors and take an overall informed decision.

This will also prevent the almost inevitable buyer remorse which is very common as you inch towards the closing date.

Once you take a decision, enjoy your mansion.

concrete building surrounded with flowers near roadway
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Posted in Personal finance

Welcoming Twenty – 20

Twenty20 cricket or Twenty-20 (often abbreviated to T20), is a shortened format of cricket. This is much shorter than previous forms of the game, and is closer to the timespan of other popular team sports. It was introduced to create a fast-paced game that would be attractive to spectators at the ground and viewers on television. https://en.wikipedia.org/wiki/Twenty20

The Pareto principle (also known as the 80/20 rule, the law of the vital few, or the principle of factor sparsity)[1][2] states that, for many events, roughly 80% of the effects come from 20% of the causes.

This year 2019 I started the-log-house.com and made a few important steps towards more clarity in my personal finances. It took less than 20% of my time weekly, and yet gave me 80% of the clarity I was looking for.

As I documented my thoughts, ideas and opinions on the blog posts, the likes and followers encouraged me to chug along. Thanks to all my followers and all those who liked or read my posts over the past year.

Next year 2020, I plan to make this blog less subjective and more actionable. Yes just like the Twenty-20 form of cricket described above.

One of the most liked posts in 2019 is all about action.

Five components of a personal finance system

Photo by Pixabay on Pexels.com

So what are the action items for 2020?

  • Got a year end hike and bonus. Invested 50% of the bonus, and will try to keep expenses the same as 2019.
    • This will increase the cash flow a little better, so that I can invest more.
  • Tweak the asset allocation among various classes – Equity, Bonds, Real Estate and Cash.
    • This may require some selloffs and aids in tax adjustments.
  • Get a better handle on tax planning this year.
  • Prioritize goals, analyze 2019 expenses and make a budget for 2020.
    • Simplify and automate investments. This is already the case for me, but the monthly amounts may need tweaking based on 2020 plan.
    • Save at least 20% of my gross income towards retirement.
  • Cash allocation
    • Maintain or improve the emergency fund.
    • Auto and home insurance paid off for 2020. Now start saving monthly for next renewals in Dec 2020.
    • Paid off property taxes. I don’t escrow but keep saving monthly portion in a savings account with interest.

How to wrap up 2019?

  • If you have been using YNAB, create the reports from it and analyze the total amount of expenses, investments, savings and taxes paid.
  • Start gathering the tax documents. For me, I have to prepare for Foreign asset reporting and it needs quite a complex paperwork, not to mention figuring out the estimated tax liability.
  • Update the net worth and wealth progress metrics. See this post if you are interested.
  • I redeem the credit card rewards at the end of the year.
    • Last year I got cash back.
    • This year I am getting myself a Bose speaker system, a DVD player (for my old DVD collection) and gifts for the kids. My credit-union-no-frills credit card gave me 1x point for each dollar spent. Not bad to reward my discipline.
  • Wipe out credit card debt. I pay off at the end of every month, and definitely want to enter 2020 with ZERO consumer debt.
  • Go on a vacation, hope you too have been saving up monthly for this goal.

HAVE A GREAT 2020 YEAR AHEAD.

  • Wish 20% of your efforts produce 80% of happiness and wealth.
  • Take action like the Twenty-20 form of cricket.
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Posted in Investing, Personal finance, Savings

Afraid of investing? Not so simple either

There are two aspects of investing that are often in war with each other. Fear and Simplicity.

This post is going to look at these two traits of investors.

While Fear is a natural human reaction to market gyrations and an impediment to investments, lack of simplicity on the other hand is another destructive feature of investor behavior.

Fear

For any investor starting on the journey of personal finance and investment, fear is the first thing that comes to play. Following are very common symptoms and questions.

  • What if the stock market goes into a downward spiral?
  • What if the real estate that I buy goes down in value or the rental property is trashed?
  • Even with perceptibly safe investments like bank CDs and money market, the bank can run into liquidity issues or simply go out of business. 

It is this kind of fear, especially the one regarding stock market that keep investors waiting on the sidelines for months and years. And then when the stock market is up, they become euphoric and participate in the bubble, only to confirm their worst fears when the market tanks.

Simplicity

On the other hand, as an investor matures and gets the thrill of investing in the stock market, real estate, he becomes bolder and starts investing in all sorts of esoteric investments like lending products, life insurance cash value and derivatives, futures, options.

While it is good to constantly look for opportunities to make your investments work, one of the fundamental rules of good investment is : “Invest only in what you understand.”

This has become a cliche since the time Warren Buffet revealed that he has followed this principle throughout his investment career. However very few investors have the discipline to keep their portfolios that simple to understand.

Sometimes it is also done in the pretext of diversification. But there are enough easy to understand investment avenues that give instant diversification.

In this post, I wish to provide some solutions on how to deal with these two conflicting behaviors, which are destructive to wealth building.

Solutions

  1. Confront the fear – know thyself and create a plan
  2. Disciplined investing – Time is more important than timing
  3. Correct Diversification – Choose products with built-in diversification
  4. Asset allocation ratios – How to diversify across asset classes
  5. Unconventional investments – Tear down the cover
  6. Load than buy new – Grow vertically, not horizontally

Confront the fear – Create a plan

The best way to address the fear of the stock market and other investing factors is to have a plan.

A plan consists of a hierarchical set of investments that cushion the risk. The plan has to be highly customized to the individual but here are some generic guidelines.

  1. Have an emergency fund – Keep a stash of money in low risk bank accounts (with FDIC guarantee) that can act as ready money available in a bad economy and job loss, unexpected expenses etc. Typically the stock market takes about 12-18 months to recover when it tanks, so some people can be ultra-conservative (specially if one is planning to retire early) and keep cash to tide over expenses for these 12-18 months.
  2. From your monthly budget for investments, allocate a small portion (10%) to play-it-safe, for example to grow the emergency fund or some kind of fixed income investment.
  3. Invest in well diversified index funds first before any other investment. These are low cost and perform well over a long period of time. The S&P 500 index is known to return about 9-10% over multiple decades of time period.
  4. Assign a time value to each investment account and invest accordingly. For example, 401-k accounts are for long term, brokerage account can be for medium term and CDs for very short term. That way, there will not be any pressure to withdraw or sell when the market or economy tanks.
  5. Go slow and do it right with real estate investment. This is the biggest investment we make in our lives and for most people, it is emotional and hence not done with right investment mindset.

Disciplined investing – Time in the market is more important than timing

There are times when we read about a particular investment or hear about it on the news channel, and want to jump in right away. For example, this year 2019, REITs performed exceptionally well and the Internet is full of articles on how to invest in REITs.

But next year it may not be the same. Does it mean I do not invest in REITs? I do invest but in a defined proportion and in the account that is shielded from distribution tax.

Similarly chasing the highest performing stock or mutual fund will result in only speculation, not investment.

  • Keep your investment in a monthly mode once chosen, by setting up automatic investment plan.
  • If you are well diversified, you do not need to worry about which asset class is over-performing. That is the purpose of diversification, isn’t it?
  • Time in the market is more important than timing the market. This simply says keep investing in the same asset month after month without worrying about Mr. Market.

Correct Diversification – Choose products with built-in diversification

Mutual funds, ETFs, REIT Index funds are all products with built-in diversification.

Yet there are portfolios that I have seen which are over diversified. For example, holding more than 4-5 mutual funds with overlapping portfolios does not make sense.

Here are few models of simple diversification:

  1. Total US Stock Market Index Fund
  2. Total International Stock Market Index Fund
  3. Total US/World Bond Index Fund
  4. Global REIT Index Fund

I personally have the following combination – 6 funds at present but I am always looking to consolidate with less. May be the last two can be combined with a Total World Stock Index Fund.

  1. S&P 500 Index Fund
  2. Small Cap Index Fund
  3. Global REIT Index Fund
  4. US Bond Index Fund
  5. International Index Fund
  6. Emerging Markets Index Fund

Asset allocation ratios – How to diversify across asset classes

While the above Mutual Funds or ETFs give instant diversification, they are still victims of the volatility of the trading market.

The stock market instruments can move higher or lower depending on the overall sentiments in the economy. However due to automatic investing and reducing the risk in  a hierarchical manner, it should be okay to digest this volatility.

Although the mutual funds provide in-built diversification in stocks, bonds – there can be other investment outside the stock market that will diversify at the asset category level.

The following asset classes can be added to a portfolio to spread the risk evenly.

  1. Cash and cash equivalents like CDs, money market.
  2. Stock mutual funds and ETFs.
  3. Real Estate Investment Trusts or REIT Index Funds.
  4. Private REIT like Fundrise.
  5. Real Estate buy-and-hold as rental properties, own homes.
  6. Commodities like gold, silver.

Unconventional investments – Tear down the cover to reveal the costs

There are ambiguous investments where the returns are packaged in a way to show it as an attractive investment. Some of these are wrapped around insurance products, while others are mere speculative in nature.

Sometimes these are also packaged as guaranteed return products like annuities, fixed income insurance products etc. While there is nothing wrong in guaranteed return products, these need to be analyzed to see what return they are actually producing.

The concept of IRR (Internal Rate of Return) and NPV (Net Present Value) provide powerful tools to calculate the real return that can be compared to more traditional instruments like treasury bonds, stocks and mutual funds.

Recently I was offered a product in India where I have to pay X amount per year as premium for 12 years, and then I will get a guaranteed return of 2X per year for next 12 years. It sounds interesting as it guarantees a cash flow in future and produces a absolute double return of the original investment.

But when you put it through the IRR formula for 12 + 12 years, you will see the return is close to 5%. 5% guaranteed return can still be good, if I am okay to leave the money invested for so long. These products typically have very little liquidity. Hence I would have been stuck in the contract for next 12-24 years for a return of 5%. Why not invest simply in stock mutual funds, which should produce more than 5% and with much better liquidity if kept out of IRA accounts?

Similarly I have been offered Guaranteed NAV plans (NAV – net asset value), where it is market linked but the company is guaranteeing a limited upside. The problem is not that we cannot take advantage of such instruments, but we need to understand that thoroughly.

One question to ask always: How is the company making money out of this? If you probe with this mindset, you will see things that were designed to be overlooked by the investor. For mutual funds, I know the answer is very transparent – through the Gross Expense Ratio in most cases.

Load than churn- Grow vertically, not horizontally

Anyone who has done day trading knows the extremes of churning. However individual portfolios are also susceptible to churning by high-beta fund managers, or the investor himself as he loses patience to hold on to a particular investment.

With 3-4 mutual funds in the portfolio, it takes a lot of patience and courage to stick to them when your investment brain is screaming – Do Something, its been a year!!

The best way to get around this very humane behavior, is to divert your attention to saving and investing more, rather than changing your investment vehicles.

If you have to do something, take a look at your monthly budget, analyze your spending and see if you can LOAD up the existing investments rather than CHURN them.

Conclusion

The above steps address both the fear in the minds of investors and also gives them a simple formula to allocate their investments with complete understanding.

My investments are diversified in the following manner, and are stacked in decreasing amount of risk.

  1. Cash in the bank, money markets.
  2. Stock Mutual Funds – passively managed.
  3. Stock Mutual funds – actively managed.
  4. Public REIT Index funds
  5. Private REIT – Fundrise
  6. Real Estate holdings
  7. Unit Linked Insurance Plans (well understood ones)

This is as much diversified as it can be.

  • #1 and #2 provides enough cushion.
  • #2, #3 and #4 are volatile and longer term, but liquid. 
  • #5, #6 and #7 are the only non-liquid investments, and I am careful to maintain the ratio of such investments to less than 50% of overall net worth. Only real estate can skew this ratio, since this is a high value and often appreciating asset.

Put your best foot forward with diversified shoes, but ones that you feel comfortable in.

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Posted in Budgeting, Investing, Liabilities and Debt, Personal finance, Savings

Five metrics of personal finance

We all know the importance of metrics and data driven decisions. Specially in today’s world, everything is driven by data, big data or small.

Why should personal finance be left behind? Just saving and investing money does not mean much if we are not able to quantify our financial situation and be able to improve it year over year. So lets look at some of the metrics that we can develop or borrow from other financial scenarios.

There are many  financial terms and metrics for evaluating company fundamentals and corporate performance. We can take a small subset of that and use them to measure the health of our finances.

These ratios and metrics really give you a picture as to where you stand, what will happen in a worst case scenario (lets say the stock market goes down) or you lose your job.

It is like your annual health checkup, you may feel alright but you don’t know fully what your body is going through internally.

Without much more introduction, let me explain the 5 key metrics I use to keep track of my finances. They have told me stories that I did not know without calculating them.

Net worth

This is the most obvious and most popular one. There are different viewpoints regarding this, some people say its only a vanity number yet others think it summarizes your financial position.

In short, Net worth is all assets you have minus all liabilities you have to service.

So if you have $1000 of assets but owe someone $200, then your net worth is $800.

What to include in the assets is also controversial. Some people include their home value, while others will say home is really not an asset.

My view is if you are not going to stay in the home throughout your entire life, then you can count its present value (or at least purchase value) as the asset price. The liability section will account for the mortgage balance you have.

This Net worth number may sound like a vanity or it can give you a milestone to reach. For example, for many people reaching the first million in Net worth is a big deal.

A positive net worth signifies healthy finances, on the other hand a negative net worth means trouble as the person is over-leveraged.

The Net worth vs. Cash flow debate

Quick ratio

OK so you have a positive net worth and want to celebrate. Not so soon.

In reality, majority of your asset may be made up of not-so-liquid instruments like house, cars, jewelry etc. Moreover your liabilities may be mostly short term debt like credit cards. Lets take some numbers.

You live in a $300,000 house, and has only $1000 cash. You have a mortgage of $250,000 and $25,000 credit card debt. What is your net worth?

Net worth = $300,000 +  $1000 – $250,000 – $25,000 = $26,000.

So you have a positive net worth, mainly due to the Home Equity trapped in your house.

However the cash you have is not enough to pay your credit card bills or possibly even the monthly minimum amount (after other expenses). This can cause trouble or through interest charges can slowly eat away the net worth and push it towards negative.

Hence it is important to have a cash cushion to cover your short term obligations. And short term obligations may not mean only credit card debt, they could be impending quarterly taxes, property taxes, insurance premiums and any other short term debt. Typically all payments to be made quarterly or annually within the next one year can be added up as short term obligations.

The Quick Ratio is then calculated by:

Quick ratio = (Cash and cash equivalents) / (total short term obligations)

With a Quick ratio of above 1, you know your finances are well equipped to cover upcoming obligations.

One essential comfort zone

Debt/Equity ratio

Personal Finance Equity is really the Net worth that we calculated first.

Lets say in the positive net worth, you have a mortgage in terms of a long term liability.

But think of a dire situation, when you are asked to pay off the debt at a very short notice. Such emergencies can be losing a job and not able to pay the monthly payment. The lender may demand a complete pay-off or a short sale of the home.

For example repeating the earlier example in section Quick Ratio:

Net worth = $300,000 +  $1000 – $250,000 – $25,000 = $26,000.

Here the debt of $275000 cannot be covered with the Net worth.

But lets say you also have $350,000 of investments in long term accounts like retirement portfolios. Now your net worth is $376,000 which if worst comes to worst, can be used to pay off all your debts and save you from foreclosure or bankruptcy.

This can be measured by yet another useful ratio.

Debt/Equity ratio gives how much of your net worth is leveraged. In the above example with $350,000 of investments,

D/E ratio = ($250,000 + $25,000) / $376,000 = 0.73

D/E ratio below 1.0 is safer as you know you can be debt-free if you want, though you need not liquidate your investments immediately if they are earning more than the interest on your debts and you have a good Quick Ratio above 1.0 to cover your immediate payments and obligations. 

The Paid Piper of Hamelin

Emergency coverage

Since we are already talking about dooms day, it cannot be complete without the concept of emergency funds. Almost every personal finance book or article starts with this concept. But there is a large deviation in the range of the amount to be saved for emergency fund, some say 3-6 months, 1 year or even just a set amount.

Lets approach this as a scientific ratio like we have done so far.

We will calculate how many months you can survive covering your true expenses if you lose your income.

Emergency coverage = (Emergency fund value) / (monthly living expenses + monthly payments)

Note that monthly payments may not mean only mortgage or car payments, it should also account for monthly share of any annual obligations like taxes, insurance etc. Typically it should not affect your lifestyle (barring non-essential and lavish expenses) if you have to spend out of your emergency fund these many months.

The Emergency Coverage directly tells you how many months can be covered by the reserve fund. It is an individual choice to select the number, but typically 6 months is a good norm.

Budget – Grow the tree upside-down

Savings ratio

So far all the ratios indicate the current state or health of your finances. None of them talks about or helps grow the Net worth.

The savings ratio is pretty simple and easy to guess from its name. How much are you saving from your take home pay? It could mean saving for long term investments like retirement funds, children education fund or general investing.

However it should exclude savings done towards goals which are ultimately expenses in the short term – vacation, down payment of a car or house, or for meeting upcoming obligations.

The real savings should contribute to growing your Net worth on a year on year basis for a long term.

Savings ratio = (money saved away per month for retirement and investments +  principal part of mortgage payment) / (take home income per month)

If the numerator includes amounts which are deducted pre-take-home like 401k, then it may make sense to consider a gross income as the denominator.

The Savings Ratio indicates growing net worth, and can be turned into a goal – for example I will achieve a 20% savings ratio this year. 

Investing in the High Five portfolio

Conclusion

These five ratios can be used to monitor personal finance health, and growth of net worth in the long run.

Also the simplicity of these ratios make the math very easy, you can also set these up in Excel and just update the variables on a monthly or yearly basis.

Finally these ratios with the recommended values give you the peace of mind. The following set of recommendations are a good thumb rule.

  • Net worth > 0 [choose your goal or dream here]
  • Quick ratio > 1.0
  • Debt/Equity ratio < 1.0 [0.5 is even better]
  • Emergency coverage > 6
  • Savings Ratio > 20%

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Posted in Budgeting, Personal finance, Spending

10 things worth spending money on

After months of dillydallying, I bought a second car. I also have a list of home improvements that I want to see get done. With the holiday season approaching, the vacation dreams are taking shape too.

However all these cost money, some little some a lot. And didn’t we say, we want to save more, invest more so that our retirement corpus grows with time? The $20000 spent on a car (decent, used or new), if invested instead can go a long way in boosting retirement savings over 15-20 years.

But life also gets in the way. We do have emergency fund for the unforeseen, worst case expenses. So are we going to just live frugally and save the rest?

After all, desires and dreams also make your life worth living. You have to find a balance on how to live a fruitful life and yet not damage your personal finances. However, it is very important to avoid consumer debt in all cases, and be ready to save and pay cash for these desires and wants.

I did exactly that. I had neat sum saved up in a savings account, and was procrastinating how to invest it. I also knew at the back of my mind that the family may need another car. Finally I gave in to the need and bought the car.

Thinking through this phase, I realized there are few expenses which are better made when the need arises. So I compiled a list of 10 such expenses, which are intangible investments in a way. These apply to my situation, yours may be different and so make your own wish-need list.

Insurance

We think bad things cannot happen to us or our family. However life is uncertain. I experienced this last December, when a very close family member in India met with an accident and passed away suddenly. He left behind a wife and a school going child, and being the only bread earner in the family, the whole situation was very shocking and sad.

Life insurance, health insurance and disability insurance are things no one should ignore. The exact amount of  the need should be assessed and insurance purchased as soon as possible.

I have also seen in India, people do not want to buy pure term insurance in which you do not get back anything if you survive till maturity. That’s precisely the meaning of insurance, to transfer the risk of  a life/event to the company. Many unscrupulous agents push cash-value, investment plans at a higher cost and lower insurance just to lure the people who wants to get back a return.

Keep the investment for the low cost mutual funds and ETFs, and buy insurance for what it is. And there is no better alternative to a cheap and effective term plan.

Peace of mind is worth paying for. 

Car

A good car is a must for our commute, weekend trips and running errands. As I researched my way through used cars in various forums like Carmax, craiglist and dealers, one common theme came up.

You can get cheap deals (Dave Ramsey’s proverbial $1000 car) but they may cause you more headache down the line. If you are anyway buying it, you better buy it to use for a number of years. I don’t plan to trade in my car in just 2 years, just to upgrade to a bigger and newer model.

It is always better to wait a few more months, save up more through a budget and then pay cash for a decent car (2-4 years old) with low mileage. These are the cars I bought in last two years.

  1. 2017 – Toyota Corolla from a private party – 2015 model, < 20k miles for $11,000 cash.
  2. 2018- Toyota Camry from a dealer – Certified Pre-owned 2017 model, < $25k miles for $18,000. I traded in the Corolla, as I wanted to pay cash and did not want to hold two cars. So I just had to pay the difference in cash.
  3. 2019 – Honda Accord from the same dealer – 2017 model, < $20k miles for $17,600 paid in cash.

So with the Camry and Accord, my needs are met for the next few years. Me and my wife do not have to timeshare our work anymore, it was only possible earlier as I was working from home. I think it is money well spent, and with no debt (a.k.a car payments).

Debt-free mobility is another name for Freedom. 

Vacation

If done correctly, and afforded with cash, this is one of the events I look forward to every year. And who doesn’t?

While in India, we used to go to the beach town of Goa every year, after the Dec 25 – Jan 1 rush is over. It gave us access to the same festive ambiance (since the beach shacks are still celebrating with their longer stay clients) at a much lower cost. The airfare and the hotel prices start dropping after Jan 1.

Now from US, one of the vacations I save for throughout the year, is visiting India in the summer. It is very relaxing to be able to meet family and friends and also keep my children bonded to their roots.

Whatever you do, make sure you enjoy it. A vacation bought with debt only brings back stress and payments, and hence make sure you save up for this event throughout the year. It’s an investment for your well being, and like any regular investment this should be planned and saved in small increments.

After all, stuff do not make you happy, experiences do. 

Home improvements

This can be small to big ticket items. You can fix or enhance small things like paint a wall or room, or bigger improvements like a kitchen or bathroom remodel.

While it can be very costly to do the high end remodel, this is a project that can pay off in the long run. Some well designed improvements like in the kitchen, bathrooms, an extra room increases the home value, while others may just increase your happiness and convenience to the family.

We had this problem where we did not have an extra space in the house, for my children to practice their dance lessons. We had to move the couch or dining table every day and it was becoming quite inconvenient. The natural reaction was we need a bigger house.

But then we realized we use our garage for only storing junk, and may be the car in the night. Throughout the day, it is an unused space that can be used. Cooling (AC) the garage effectively is a problem, but the kids are not going to practice for more than 30-40 mins anyway. So I spent about $2000 to have a shiny epoxy floor and some lighting installed. In that $2000, we now have a beautiful hobby space, and my wife improved it further at very low cost (just interior decoration and a bigger fan) to shift her music studio there.

At night, we still park the Camry inside. Its all about space management with an investment of $2000.

Home is where the heart is. Do not neglect it or underestimate it’s intangible value. 

Netflix

After the above expensive proposals, here is sweating the small stuff. However its not small, as cable expenses can add up to hundreds of dollars for some people.

While in India, I realized that I do not need the 100+ channels that the local cable or some of the high end services were advertising and everyone buying them.

Except for certain sporting events, I just ended up surfing and jumping from one channel to another killing time and really not watching anything to the full. I guess choice spoils you and your time.

So then I discovered Netflix (it was still new in India few years back) and subscribed to it. I knew if I needed entertainment, I can just start a movie and sit through it better than listening to a news anchor shouting at the top of his voice, throwing his political opinion.

Netflix has remained with me since then and the only TV subscription I have in the US. The $9/month is a good investment and much more value for money than any other TV subscription.  With free YouTube complimenting the rest, I don’t need to spend any more on passive entertainment.

You will be more entertained when you channelize your focus to one medium. 

Books and Courses

From my childhood, my introvert nature has one true friend – Books. I love reading and it has increased over the years to varied topics like technology, business and personal finance.

A part of my budget is spent on kindle books and paperbacks. This is also the reason why I do not need anything beyond Netflix, as my free time is well spent reading otherwise.

When I came to US, I discovered the local library which opened up a further avenue for my reading at $0 cost. The public libraries are an excellent initiative and maintained by the city here. Sadly they are long lost in most Indian cities, only some schools still have them.

To grow myself intellectually and improve my skills, Coursera has also been a huge help. Nowadays they run many good courses with a $49/mo plan, where you can take the course at your own pace (faster the better as you pay every month) and it gives you a certification. I am presently doing this amazing course on personal finance.

Personal and Family Financial Planning

and finished the following recently.

Finance for Non-Finance Professionals

The certificate I received looks something like:

Coursera certificate

Its certainly a wise investment and a satisfying experience to learn continuously out of work and school.

Education is much more affordable and accessible now than ever before. Use it and grow your skills and knowledge. 

Eating out

The finance gurus will scream – Live within your means, should not eat out, drop that latte and save the $3.50 everyday. But what is the problem if you have budgeted for it, to eating out with family twice a month? Or a set amount like a $100, which can amount to 2-3 dine outs for the family depending on what kind of food and restaurant you eat at.

It is a way to unwind once a week or two, and treats your taste buds to different cuisine. Socializing with friends and family also makes you happy and you get back to work on a Monday fresher and looking forward to another week.

Of course, daily and random eating out can have adverse effects on health and finances, hence like everything else, it also has to be budgeted and planned for.

Dine out not for the food, but for the experience. 

Productivity stuff

I have talked about automation in personal finance and other areas of life in an earlier post.

Five components of a personal finance system

Similarly with the automation of FinTech, you can use lots of tools to improve your productivity in managing personal finances.

FinTech – can you be immune to it?

Some of these websites and tools charge a monthly/annual fee, while some others may be fees for investment or specific service.

These fees, if reasonable, can be well paid to get the convenience of automation and services that will improve your productivity. Some of the online services and apps that I use are:

Elevate – Brain training and brain games – this is an excellent app which trains your brain and tests skills in Math, Reading, Writing, Listening and Speaking.

Rentometer and Dealcheck – Real estate information in USA. They help in evaluating rental properties. However, subscribe to the paid version only if you are seriously going to invest in rental property. I used them for a year but then dropped my plans as I am not investing in this hot real estate market. The reason I mentioned them here is the service is very good and constantly improving. I even wrote to the CEO of Dealcheck and gave him a suggestion of a new feature. I was happy to see that they rolled out the feature in next few months.

You Need a Budget (Y.N.A.B) – I use this for my daily and long term budgeting. The features are worth paying the $84/year and helps me to keep a holistic view of my cash flows.

I am sure you will find your own useful apps and after the trial period, if it seems useful in the long run, do not hesitate to sign up for the paid version.

Only thing to keep in mind is that we sometimes turn on the subscription and then forget to use it till the next year, when the credit card on file is charged automatically.

One way I manage it is – I download the app on my phone, and keep it all in one folder called “Productivity” or “Personal finance”. I visit this folder daily at least for the apps that I need to use. It gives me an instant look at the others in the folder which are lying unused. Once I figure out I am not going to use it in the near future, I cancel the subscription. This is how I discovered that I was not using Rentometer and Dealcheck after a few months. Most of these subscriptions let you finish the tenure that you already paid for, so you can keep using it and ramp down your usage.

Paying to get back your time and establish a system is worth its penny. 

Offline Automation

What is the offline automation? Just like online apps and automated services, there are some things in life that are unavoidable but you don’t want to spend your valuable time on them. For example, Amazon has made it so easy to get things delivered that running errands have cut down by a lot for most people.

For me, tasks like mowing the lawn or fixing the plumbing (when it develops a problem) are simply not expertise I want to build or spend time on. Hence I outsource this to contacts and experts who know their job, and in turn I don’t mind paying them regularly for their services. I also subscribed for a Home Warranty who dispatches service professionals when I have a problem with my household appliances.

It can get costly though if you want to use this blindly. You have to develop a good idea of the cost of each service through collecting quotes or researching on the Internet.

But at the end, I think its money well spent if it saves me the headache and time to try to do everything myself. And indirectly, I get to help the local businesses run.

Expertise is available and widely distributed, make use of it judiciously. 

Giving

Last but not the least, Giving is never regretted. In fact, what you give gets back to you in multiples of the original amount.

This is God’s way of paying interest to the good people.

I am not an expert on charity, and as long as you can find a legitimate and genuine organization which helps the needy, this is an activity worth spending money on and automating the giving every month.

Even if its just $20-$50, automate it so that there is no hesitation left. Sometimes we know we should, but we keep postponing it till we think we have enough surplus to give.

It is difficult to get over the inertia, so just like “Pay yourself first”, pay your rent on the Earth and help the not-so-fortunate brothers and sisters.

Giving is a way to abundance, even if it sounds counter intuitive. 

Conclusion

In personal finance, the gurus and pundits constantly talk about saving, investing and minimalism. However life is not about accumulating wealth alone – money is a way to gain freedom and is only a means and not an end.

The real freedom is when you are happy doing the things you love, and some of them do cost money, defying all financial logic and the only return is happiness.

If you love music, you know what I mean.

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