Investing

Afraid of investing? Not so simple either

Posted on November 27, 2019 by The Tortoise

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

Confront the fear – know thyself and create a plan
Disciplined investing – Time is more important than timing
Correct Diversification – Choose products with built-in diversification
Asset allocation ratios – How to diversify across asset classes
Unconventional investments – Tear down the cover
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.

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.
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.
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.
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.
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:

Total US Stock Market Index Fund
Total International Stock Market Index Fund
Total US/World Bond Index Fund
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.

S&P 500 Index Fund
Small Cap Index Fund
Global REIT Index Fund
US Bond Index Fund
International Index Fund
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.

Cash and cash equivalents like CDs, money market.
Stock mutual funds and ETFs.
Real Estate Investment Trusts or REIT Index Funds.
Private REIT like Fundrise.
Real Estate buy-and-hold as rental properties, own homes.
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.

Cash in the bank, money markets.
Stock Mutual Funds – passively managed.
Stock Mutual funds – actively managed.
Public REIT Index funds
Private REIT – Fundrise
Real Estate holdings
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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Budgeting, Investing, Liabilities and Debt, Personal finance, Savings

Five metrics of personal finance

Posted on November 15, 2019November 14, 2019 by The Tortoise

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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Investing, Personal finance

The biggest enemy of your investments

Posted on October 13, 2019 by The Tortoise

Its not the fees.

Its not even the portfolio churning manager.

Its not the financial adviser.

The biggest enemy of your investments is YOU.

I realized this with my own behavior. With more passion to manage investments and as I learn more, I started to tinker my portfolio almost every month, if possible every week coming up with a new plan.

Selling stocks and bonds, reallocating in the name of asset allocation, refinancing mortgages, buying exotic investments – all are detrimental to peace of mind, and moreover to the productivity of those little bundles of money sent to work for you.

Each investment needs time to grow. Except for hard cash, when you invest in something it needs to stay there to do its job. Equities and Real Estate are long term investments and bond and bond funds are medium term. But none is a short term get rich scheme.

So what makes us do this damaging exercise? The economy around us is constantly changing and producing a lot of noise. We dance to its tune and the sense of a smart ME, does not let us ignore the noise of the experts.

For example, the last few months the mortgage interest rate went down and down, and there was huge rush for refinancing mortgages. Hopefully all the refinancing makes sense in terms of cost and long term goals. It is perfectly fine to just not do anything if your mortgage is already in the low 4% or even lower.
Similarly, the news and predictions about an impending stock market crash is making a lot of investors shaky and market pundits elated at the same time. Equities are long term investments and there is no need of any action for a crash. The markets are cyclical and any equity investment should be part of a long term (> 15 years) portfolio.
Real Estate similarly is at an all time high, with REIT returns touching new highs and homes selling for record prices. This may well be time to be cautious and investors should not change anything in their Real Estate allocation, but just wait out the present jubilation. Or simply continue buying REITs at regular intervals like equity with a longer time (20 years) horizon.
I have also seen people switching their cash from one bank to another just to capture the extra 0.2% interest rate, or get that $300 bonus for opening a new account. A $300 free money does sound alluring, but read the fine prints of the terms and conditions. You have to setup a direct deposit and also deposit a lump sum of new money into the account and hold it for 90 days to get that $300. All this will cause huge changes in your financial plan and system. And then once you get the $300, what next? Another bank may offer $400, but are you going to change your direct deposits again, and move the surplus money which could have been invested?
Simply for changing your asset allocation, selling stocks and funds can incur a huge tax bill, if the capital gains and taxation are not taken into account. For example, short term capital gains are taxed as ordinary income than long term. So even though the asset allocation looks skewed than what you want, it is better to tweak your monthly investments to slowly adjust the portfolio towards desired asset allocation.

As an illustration, below is my asset allocation now and what I want it 5-7 years later.

Note that since I moved from India, a major allocation is still Emerging Market stocks, mostly in Indian stock market. I am also holding about 18% in cash, which needs to be redeployed.

The simple way to achieve this is to freeze the Emerging Markets and Cash allocation, and for next few years my investments will be heavily tilted towards US and International (developed market) stocks and bonds.

As I reflect on the 2019 year to date, I have been victim to this behavior of myself. Following are some of the tinkering I did, which left me with little tangible benefits but probably valuable lessons.

I refinanced a 3.625% mortgage (7-1 ARM going into 8.6% on 8th year) into a 4.125% fixed rate mortgage. The rationale was that a fixed rate mortgage will make cash flow predictable. Hence if I rent out my house few years from now, I will not be hit by increasing interest rate scenario. However with recent low in interest rate, I lost an opportunity to refinance at a fixed rate even lower than the ARM.
I hired a financial adviser to suggest mutual funds across all my portfolios (401k, taxable etc.) and paid him $500 for two sessions. At the end, as I learnt more I ended up choosing my own investments, although a part still came from his recommendation.
I bought a 5 year locked home warranty, possibly not so useful in the long run. I have used them only once in last year, and most of the expensive repairs they don’t cover anyways. I could have done better to save the money instead.
I accumulated a decent amount of cash and procrastinated to invest it. In fact it was a decision on which I vacillated between buying real estate or investing in equities. I did nothing and it just sat there in a savings account, earning less than 2%. At the end of the year, now I have the urge (or somewhat a need) to buy a second car. This money had it been invested earlier, would have forced me to think more creatively on how to acquire the second car. I don’t like car loans, so probably I will now use this cash to buy the second car, a depreciating asset.

So sometimes action is good and inaction is bad.

At other times, too much action should be avoided since long term investments need the long (really long) term to perform. Here inaction is the best way forward.

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Budgeting, Investing, Personal finance, Savings

FinTech – can you be immune to it?

Posted on September 22, 2019 by The Tortoise

Fin Tech – Financial Technology is everywhere now. From Internet only banks to robo-advisors to automated loan processing to auto-invest, auto-save, the automatic word has prevailed the personal finance world.

Gone are the days when people queued up in banks to deposit or withdraw money, fill up paper forms to open an investment account and wait for hot tips to buy that fateful stock.

With the financial world so much dominated by technology, there are some tools and techniques we should employ to make our personal finance more automated and efficient, thus leaving us more time to pursue real passions.

Here are a few areas of personal finance where I think we cannot avoid the best of automation.

Banking

This is a no-brainer, however people still flock to big mortar banks like Chase, Bank of America or Wells Fargo. If you read the reviews of these banks, there are endless complaints about non-explained fees, bad customer service and old style bureaucracy.

On the other hand, I bank with a Credit Union which does not even have branches in my state of residence, and another online savings bank which is linked to the checking account in the Credit Union.

In last two years in US (and same in India), I did not feel the need for a local branch. True, once or twice when I needed to withdraw cash more than the permitted limits in authorized ATMs, I could just go to one of their affiliate Credit Union branches in my city.

Thus moving your banking to completely Internet based and using mobile apps, you are in better control of your money than dealing with the brick-and-mortar banks.

9 Best Online Checking Accounts of 2019

Savings

All the internet banks provide goal based savings accounts, the one I use definitely has that feature. It makes it extremely easy to setup savings goals (5 minutes) and let it go automatic every month.

If you still don’t want to do the planning, budgeting etc. for saving money, check out Acorns or Digit, these are two advanced FinTech companies who help you save in the background.

Acorns helps you accumulate the spare change from your everyday purchases and siphons it away to an investment account.

Digit is a bit more sophisticated in that it analyzes your spending pattern from a linked checking account, and saves off what it can. Of course you can set it up in a way you like, but they also guarantee not to cause overdraft.

Before you try out these apps and link your account, please read through reviews and understand their fees. The fees has to be justified compared to the value it will add to managing your finances.

For example, I signed up for Digit but later decided to pull back, as I already know and have set up automated transfers for my savings goals.

There are other similar apps and the following link may help.

NerdWallet’s 4 Best Money Saving Apps

Like Acorns is a micro-investing app which pulls money out of your account and forces you to invest, there are robo-advisors for bigger and planned investment.

Wealthfront and Betterment are two companies that are revolutionizing the space of robo-advisors and has features like tax loss harvesting in your investments.

This can be a completely hands-off approach to investing and let the expert designed algorithms decide your asset allocation and investment product mix.

Here is a good discussion, again from nerdwallet.com.

How Betterment, Wealthfront and Wealthsimple Compare

Moreover, the brokerage companies like Schwab also has robo-advisor options.

Tracking

What gets tracked, grows. I don’t know who said that, but tracking your Net worth and investments is important.

While you can keep the overall numbers in your head if you check your accounts regularly, there is nothing better than having an algorithm do the data crunching and show your portfolio with all kinds of analysis and charts. It is even better if it can project future growth of Net worth with reasonable assumptions.

This can be done by plain old Excel sheets and I do the same before I could trust the online sites with a consolidated view of my personal finance.

Some of the websites and services are Personal Capital, Wealthfront, Mint and Betterment who aggregates all your finances and shows the analysis reports.

While this is very convenient and tempting to look at all the analysis available, do this if you are comfortable linking all your accounts to one of these services. Below is a detailed review of Personal Capital, but do your own diligence and research.

Personal Capital Review 2019 – Fees, Unique Features & General Overview

Real Estate Crowdfunding

This one is my favorite and real innovations are sweeping this field.

While real estate is the most lucrative (and hyped) investment of all, it comes with high degree of everything – risk, reward, hard work, expertise and complexity.

Traditionally real estate portfolio is built by acquiring houses and buildings with part cash and part leverage, and then managing the day to day affairs of keeping a tenant, fixing issues, chasing rent cheques, vetting and evicting tenants etc. You need a lot of knowledge, time, experience and most important of all, a team of real estate agents, lawyers, tax professional, property managers to run a successful business.

Simple investors who have a different passion than real estate (or loves their own job), do not have so much time and risk appetite to run a full fledged business of rentals.

This is where sites like Fundrise, Roofstock, Rich Uncles come in play. They are making it easier for small investors (even non-accredited) to get a flavor of real estate in their portfolios without the heavy lifting of managing rentals and tenants.

However real estate is an ill-liquid investment and may take 7-10 years to get back the principal. Proceed with caution and read the prospectus, investment style and restrictions carefully before diving in.

I have personally invested with Fundrise but less than 10% of my overall portfolio.

The main risk is once invested, you lose control of the principal as you cannot sell on your own. However the convenience outweighs the risks, if you know what you are doing. With Fundrise for example, your portfolio is invested all across the United States in commercial buildings. It is simply not possible to build such a portfolio directly, unless you want to be a full fledged real estate professional.

Similarly Roofstock enables you to actually own a rental property in different states of US but once invested, you own and manage it with the help of certified property managers.

Tread with caution, surely real estate crowdfunding is going to take off, unless it runs into a major scam or something.

Conclusions

With so much automation in the personal finance industry, it is difficult to stay away and not take advantage of these tools. At the same time, it is scary to lose control of your money and investments.

Many people are still skeptical of online finance and not without reason, given the recent data breaches at Equifax and CapitalOne. Another reason for skepticism is due to the perceived loss of control. For example, lot of investors still prefer to hold physical real estate than trust online real estate crowdfunding. It reminds me of the obsession in Asian countries (especially India) of holding physical gold (bars or jewelry), till paper gold ETF came along and created lot more gold investors.

On the contrary, we leave so much control of our lives to experts. When we fly, we leave it to the pilots and the airplane auto-pilot system. When we are sick, we let the doctors take over. When we are educating our child, we send them to good schools.

So why should it be different for personal finance, if FinTech frees you from unnecessary headache and lets you concentrate on your real passions?

Let the experts and machines do the job (for a fee of course) but you have to do your research so as not to run into dubious sites and services.

The new mantra of personal finance – Learn, Automate, Delegate, Track.

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Disclaimer – I am not promoting any of the services mentioned in this post nor my opinion should matter in your choice. Do your own due diligence, as I have done in selecting my own set of services according to my needs and risk tolerance.

Investing, Liabilities and Debt, Personal finance, Savings

The universal truth about Dave Ramsey’s 7 baby steps

Posted on September 1, 2019September 1, 2019 by The Tortoise

Who doesn’t know of Dave Ramsey?

Even my 10 year old kid has been taught about Dave in elementary school mathematics.

Dave Ramsey is America’s trusted voice on money and business.

Well he is popular for a solid reason. In this post, I will describe why he makes perfect sense to me.

When I immigrated to US in 2017, I did not know who he is. I was trying to quench my thirst for new personal finance books, especially on the US system. Then I stumbled upon Dave’s Total Money Makeover.

As I read the book, initially his rant against debt was a bit overwhelming to digest. However thinking deeply, I realized that coming from an Asian country, I have unconsciously followed the same principle for decades.

Why this coincidence? Because the principles are universal and extremely healthy for personal finance, no matter which economy you come from.

If you do not know yet, here is a recap link to the 7 steps from his website.

Dave Ramsey’s 7 baby steps

Here are few points where I found an one-one match with how traditional Asian (India) household finances worked.

Have an emergency/contingency fund (Dave’s baby steps 1 and 3)

There are many names to this – emergency fund, contingency fund, rainy day fund. In many Asian households, it goes by the simple name of savings. Savings is in-built into the culture and an emergency fund is a default choice.

In a way, if you don’t have debt instruments (HELOC, Credit card) available to you, how else will you pay up for maintenance, car breakdown, education etc.?

Answer is simple, money socked off into a separate bank account – lo and behold, by end of the year, you have an emergency fund.

Use Cash – or debit card at the most (Dave’s baby step 2)

Before moving to US, my only credit card was a HDFC Bank Premium card. I was sold this card citing lots of benefits like reward points, airline miles, premier lounge access etc.

The truth is that I used it only for big purchases like appliances, electronics or vacation. And that too, because I knew I had to pay it off at the end of the month and just deferred the money being taken out of a CD (Fixed Deposit as named in India).

If I look back, except for getting a few discounts at clothing stores, I did not reap the reward points. Never had the idle time or need to figure out how to access the premier lounge. Once I tried to book a holiday trip through the miles, I found that I could get it for lesser by buying a cheaper economy ticket. Yet I paid an annual fee (or had to spend a minimum on the card to avoid the fee) for those unseen benefits.

Credit cards may work better in the US, but it is also a double edged sword. Americans are saddled with trillion dollar credit card debt. (source: Dave Ramsey)

All my household daily expenses ran on either hard cash (lots of places in India do not accept any cards) or debit card.

Simply put, I never felt the absolute necessity to hold a credit card. Some people say its good for emergency situations, but then the previous step already solved that problem.

Oh there is one more reason – online shopping. In India, Flipkart has a C.O.D (cash on delivery) option. If that doesn’t work or not offered, you can pay using NetBanking which all online vendors provide with major banks. It is equivalent to using debit card, but without the card number. You are redirected to the bank website and you can authorize the transaction from your account, using login and password.

Retirement savings (Dave’s baby step 4)

There are government retirement plans like Provident Fund (equivalent to 401k), Public Provident Fund (equivalent to Roth IRA) and now the NPS (National Pension System).

The first two are effectively tax exempt with the Provident Fund being tax E.E.E (exempt on contribution, growth and withdrawal). The only drawback is that the investment options are traditional – debt based with an interest rate guaranteed by the Government. The option of Equities has only come up as an option in NPS.

The Provident Fund or the NPS is now mandatory in most organizations for their employees. The amount you can invest from your paycheck typically hovers around 12% (with matching grant from employer), and is close to Dave Ramsey’s recommended savings of 15%.

There are of course private options from brokerages/banks to invest in mutual funds and stocks, as also R.E.I.Ts are now coming up.

Children’s education – use cheaper (sane) options (Dave’s baby step 5)

There is hardly any concept of student loans. Education is still affordable, though it is becoming expensive each passing year.

And despite the huge competition (owing to large population), there are no Ivy League schools to lose your shirt on getting a degree. Even the premier institutes like Indian Institute of Technology, or Indian Institute of Management are well affordable with their excellent career prospects.

I don’t have all the education expenses data, but I have not heard of any student saddled by student loan debt or carrying it well into their adulthood and married life.

Moreover in recent years, the growing start-up culture in India has also made an expensive education pretty much irrelevant.

Pay off your house (Dave’s baby step 6)

In US, people hold their mortgages for 30 years, and do not need to pay back earlier.

And it is more helped by the low interest rate regime that is sweeping the news everyday.

However in India, average mortgages survive for 3-5 years, before they are completely paid off. Both my mortgages in India were paid off in less than 5 years.

What is the reason for this? There are several factors.

Interest rates are higher – typically 8.5-10%. This causes people to take mortgages with lower than 80% Loan-to-Value, to avoid big E.M.I (equated monthly installments).
Higher down payment earns good discount from builders. One of the main sources of home buying in India is from builders.
Floating rate mortgages – The interest rate by default is floating. Fixed rate mortgages have a much higher interest rate, typically 1-2% higher. Carrying a floating rate mortgage is risky, hence the tendency is to pay it off as soon as possible.
Last but not the least – its a debt-averse culture. You don’t feel good till you actually own your home, free and clear.

Buying a house in India is stressful owing to the sector’s corrupt practices, less regulation and random mismanagement of funds by builders. Hence keeping low to no debt is prudent not to add on to the crisis.

Building wealth and Giving (Dave’s baby step 7)

The last baby step in Dave Ramsey’s plan is the absolute bliss.

This is where a lot of well to do families will be. With the above steps explained and if followed properly – they will be living in paid for houses, driving paid for cars (some with chauffeurs), have a good retirement corpus that is growing, children graduating from college without student loan debt, and an emergency fund stashed out in some savings account.

Now they can buy more investment assets like real estate, stocks and entire businesses.

You start building serious wealth and enjoy true Financial Freedom.

As Dave says, “If you live like no one else, you will live like no one else”.

Now the last part is Giving. This may not be traditionally so popular in India, due to many factors. However lot of new initiatives are now trying to organize charity and reach to the real needy.

The huge wealth inequality throws up a lot of opportunities of giving. However if you are not careful and the non-profit organizations are not well researched, you will end up making some fraud people rich. I have ended up donating to NGOs (Non Government Organization), who started showing a suspicious pattern of corruption (sometimes irritating me with calls and messages for more). It becomes clear they want to milk you in the name of charity.

However with little diligence and online/offline research it is possible to select meaningful giving opportunities.

Thus Dave Ramsey’s 7 baby steps are definitely a recipe for success with personal finance. I have only drawn a comparison with what I have lived and seen in India.

Dave’s success in getting millions of Americans out of debt and living their dream life is a testimony to the sound principles that the 7 steps represent.

Live like no one else. If you are not forced by the system, be intentional about the 7 steps.

adult adventure baby child — Photo by Pixabay on Pexels.com

Investing, Liabilities and Debt, Personal finance

The Net worth vs. Cash flow debate

Posted on August 11, 2019August 11, 2019 by The Tortoise

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).

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:

Rental property investing
Commercial property
Dividend paying stocks
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.

Increase your income and live below your means. This is very obvious, yet the most difficult to do consistently.
Invest consistently 15-20% of your income into stocks, bonds and cash. See post: Emotional Investing
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 !!!
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
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.
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.

Investing, Personal finance

Know yourself and your investments

Posted on August 5, 2019 by The Tortoise

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.

Direct stock investment
Real Estate investment
Life Insurance coupled as investment
Crypto-currency
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.

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
Maintain an emergency fund and create a cash cushion. See the post: One essential comfort zone
Invest in simple Index Funds and create a goal based portfolio. See the post: Investing in the High Five portfolio
Keep emotions under check and have a realistic plan. See the post: Emotional Investing
Last but not the least, Get Started. See the post: Shun that perfection
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.