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
Photo by Immortal shots on Pexels.com

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.
Photo by Jill Wellington on Pexels.com
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.

brand trademark cobblestones community denim pants
Photo by Ingo Joseph on Pexels.com

 

 

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.

two men and woman sitting next to each other
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Posted in Investing, Personal finance

The biggest enemy of your investments

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.

Asset allocation JPG

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.

  1. 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.
  2. 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.
  3. 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.
  4. 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. 

action activity adult attack
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Posted in Budgeting, Investing, Personal finance, Savings

FinTech – can you be immune to it?

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

Investing

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. 

 

 

Posted in Personal finance

Five FAQs of personal finance

Throughout my journey with personal finance, and through the mistakes and learning, I compiled a list of Top 5 questions that come to my mind, time and again. 

So I decided to compile these as a FAQ and try to answer them to the best of my knowledge and experience. 

  • Buy vs. Rent
  • How many accounts to have
  • How and where to invest
  • How to save more money
  • How to manage my portfolio

Buy vs. Rent?

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One of the biggest financial decisions in everyone’s life is to buy a house. However there are pros and cons that need to be weighed against renting similar or better homes. There are lots of views and articles on Internet which give both a logical as well as emotional opinion to this question. In my opinion (just another), only You know better whether you are ready to buy a home.

To put it logically from what I know, there are few costs and factors that need to be considered.

  • Save up for a down payment of at least 20%.
  • Consider closing costs, it can easily be in the range of $4000-$5000.
  • Consider any rehab budget if you are not buying a recently updated home. You will pay for it either way. 
  • Aggregate of all monthly expenses of home ownership should be less than the current rent paid. These expenses are: 
    • Mortgage payment
    • Taxes
    • Insurance
    • Maintenance (1% of home value per year)
    • HoA fees
    • Lawn care and utilities
      • if you had paid these apart from rent, you need to make sure the costs are almost identical

Only after you have made the calculation above, and convinced yourself that total monthly housing expenses will be less than the rent, you can consider buying provided there is the cash cushion of down payment and closing costs.

One argument which is floated in favor of ownership is that rents are going to increase per year, whereas the mortgage will remain constant. However please consider that Taxes, Insurance and Maintenance will go up too year after year.

On the other hand, the mortgage will get paid down giving a little more advantage to the ownership since you are building equity and hence net worth.

The other factor is how long you are going to stay in the home to recoup the costs of mortgage interest, taxes, insurance, upgrades, maintenance etc. 

One day (in a few years), you may want to move out and convert this house into a rental.

Will the rental numbers in the area completely cover all the expenses? You certainly don’t want to pay for new house as well part of the expenses for your tenant.

All of these factors should be taken into calculation before making the big decision. 

The following post may help in setting up the calculation, but I suggest do your own homework too. 

How to decide on a purchase – the P.V.T formula

If you are interested in scenarios of managing a mortgage or multiple properties, here are couple of previous posts on the subject. 

The Paid Piper of Hamelin

Don’t twist your ARM, fix it !!!

How many accounts should I have?

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There are many banks and financial institutions who are vying to keep your money, earn fees and lure you into a long term relationship. These marketing flyers and lure of higher interest rates or credit offers make us open many bank accounts indiscriminately.

The more you spread out without a purpose to each account, it will become unmanageable and have overlapping features. There are many cases where people (or spouses after the death of one) forgot about their accounts, and the money lies there idle never to be claimed again.

So bank and brokerage accounts all should be tied to specific goals and purpose in your regular financial picture. Typically the following should suffice:

  • A checking account and a debit/credit card
  • A savings account, if more than one, each should be for a specific saving goal
  • A retirement account (typically 401k or IRA)
  • An investment account (outside the 401k/IRA for medium term investments)
  • A special purpose account depending on needs
    • 529 – Kids’ education
    • HSA – Health Savings Account if you have high deductible insurance

Beyond this, it becomes fancy and unmanageable.

The following post shows a step by step guide to open and manage these accounts.

The Starter Kit

How and where do I invest?

One of the main hurdles of personal finance is to find out how and where to invest. There are many risk-return trade-offs from cash savings to mutual funds to real estate, and even exotic investments like art and commodities.

The simplest investment however is a balanced indexed fund, where there is an automatic asset allocation of stocks and bonds and which can vary according to your age and risk tolerance. These are also called Target date funds. Being an index fund, the costs are extremely low (0.0x%) and you get instant diversification.

Most portfolio should not need more that this. However if you are a little bit more knowledgeable, then you can create your own basket of index funds. For example, the three fund portfolio is very popular. Here is a good link: Three-Fund Portfolio

One of my previous posts mentions the various investment accounts that you can setup. 

Investing in the High Five portfolio

Know yourself and your investments

How do I save more?

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This is one of the questions which has many different ways of asking.

  1. How do I spend less?
  2. How do I pay myself first?
  3. How do I increase my income?

The answer lies in all of the above questions. You have to do all to be able to save for emergency, goals, vacations and fun.

The topic on how many bank accounts to have, takes into account this aspect. It is very important to build a cash cushion along with your investments and lifestyle.

See below posts on why and how to do this effectively.

One essential comfort zone

Budget – Grow the tree upside-down

How do I manage my portfolio and reach my goals?

black mazda steering wheel
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Managing your investments and financial system may not be a complex or time consuming task. It needs essentially three things. 

  1. Automation 
  2. Tracking 
  3. Learning

The following post describes a step by step process for managing and growing your personal finance system. 

Five components of a personal finance system

All it takes is to first setup the automatic payments and investments, then a weekly tracking mechanism and weekly reading and exploring more.

With time, you will start flowing like a pro. 

Shun that perfection

Conclusion

While the list of FAQs above is not exhaustive, these are questions that I have seen people struggle with or make irrational decisions on. Or to put it another way, I have done same mistakes and learnt that if you manage these aspects well, you don’t need to worry any more. 

beard cafe coffee shop connection
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