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

The universal truth about Dave Ramsey’s 7 baby steps

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.

  1. 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).
  2. Higher down payment earns good discount from builders. One of the main sources of home buying in India is from builders.
  3. 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.
  4. 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. 

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Posted in Personal finance

Financial Freedom : FIRE or WATER

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

Financial Independence Retire Early. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Net worth vs. Cash flow debate

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

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

Five components of a personal finance system

The Starter Kit

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

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

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Posted in Budgeting, Personal finance, Savings

Five components of a personal finance system

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

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

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

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

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

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

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

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

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

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

There are 5 parts to the system:

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

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

1. Automate

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

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

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

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

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

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

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

Advantages:

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

Risks

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

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

2. Cap

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

There are two ways to address this:

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

Advantages:

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

Risks:

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

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

3. Archive

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

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

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

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

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

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

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

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

Advantages: 

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

Risks:

  • None at all.

4. Remind

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

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

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

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

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

Advantages: 

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

Risks: 

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

5. Learn

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

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

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

Advantages: 

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

Risks:

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

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

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

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Posted in Investing, Liabilities and Debt, Personal finance

The Net worth vs. Cash flow debate

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

And so it goes on and on…

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

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

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

The Net worth approach: 

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

Budget – Grow the tree upside-down

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

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

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

Investing in the High Five portfolio

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

cp_formula

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

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

The Cash Flow approach:

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

This can be achieved with several avenues for example:

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

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

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

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

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

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

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

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

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

A combined approach:

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

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

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

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

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

Know yourself and your investments

Shun that perfection

How a cassette player caused debt aversion

Enjoy the journey and the destination will follow. 

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Posted in Investing, Personal finance

Know yourself and your investments

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

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

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

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

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

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

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

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

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

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

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

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Posted in Personal finance

Take off to the aerial view

Today I am flying to India. I am very excited and looking forward to visiting what is my second home now.

As the long flight from US started very early this morning, a few thoughts on personal finance hovered around my mind.

Before the flight takes off, there are a number of events that take place more like items in a checklist. As the plane’s technicians go through their routine yet stricter checks, as a passenger we too go through some disciplined steps like reaching the airport on time, checking in, clearing though security and finally boarding in a queue. All of these steps are important and must be done in sequence.

Then as I put on the seat belt and the plane takes off, the mind switches off from the low level sequence to a higher level composure. The plane rises above the clouds and I can see the world top down.

Personal finance is also the same. As you go through the low level details of controlling your expenditures, paying your credit card on time, automating a few bills on the way, you slowly but steadily reach the state of composure as if your financial life has taken off the grounds.

You no longer worry about petty coupons and discounts, or avoiding the crave for that latte, or even recording each transaction in your budget app.

Instead, now your systems are automated and you have a pretty good idea of how much is spent every month and how much you can invest.

Now your focus shifts to the clouds and you need to only take a top down view of the financial landscape. You start learning more about various investments, real estate, taxes and start strategizing on how to grow all areas of your personal and financial life.

You can now see personal finance is not just about money but when managed well, can allow you to cruise in other areas of your life as an aircraft in a turbulence free sky.

For example, this holiday is completely planned and paid for and I do not need to stress about credit card balance to afford the cost of the trip.

Complete the ground steps in a defined sequence as the suggested posts below, and then focus on the bigger clouds.

Budget – Grow the tree upside-down

One essential comfort zone

Investing in the High Five portfolio

The clouds that you can focus on once done with above are:

  • Taxes and how to find tax efficient investments
  • Insurance
  • Estate planning and wills
  • Passive income generation
  • Career goals
  • Your potential for earning more
  • Having fun

From time to time you do need to come down and go through the low level steps again, as I am in transit now in JFK airport.

I will be flying to my destination in a couple of hours again.

At the end the sequence matters. You can imagine how chaotic it would be to rush through security without checking in your bags first.

The cruise comes later when you are a disciplined traveler and follow the steps.

Posted in Personal finance

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

I talked a lot about budgeting, saving and investing money in the earlier posts.

Budget – Grow the tree upside-down

One essential comfort zone

Investing in the High Five portfolio

However a fact of life is no matter how hard you try, there will be big purchases.

Some of them will be needs, while others may be simply wants.

These purchases are typically big ticket ones and can range from a thousand dollars to several hundred thousand dollars. For example, it can be an Apple iPhone/iPad to buying real estate for a primary home.

How do you decide when the purchase makes financial sense? After all, money will be spent and an opportunity to invest will be lost forever.

The P.V.T equation explained below helped me make the decision many times.

Although I have made bad decisions and recovered, but on hindsight sticking to a principle would have helped to be sensible 90% of the time.

What is the P.VT. equation?

The acronym stands for three important elements of a purchase decision.

  1. Price
  2. Value
  3. Time

To assign a score value to a purchase, it will have to be a combination of the relative success with above three parameters.

The main thing to guard against a purchase is whether it is a waste or not. So if we measure the waste factor, and try to keep it as low as possible, it is a sensible purchase.

The formula is as follows:

WF(Purchase) = WF(Price) x WF(Value) x WF(Time)

Where WF is the waste factor, in terms of how much of that parameter we are giving up during the purchase. Since it is a multiplication, a WF of zero will be approximated to 0.01 (1%).

Lets take 3 examples, an iPad, a car and a house.

iPad Pro: 

Price ~ $1000 and lets say it being Apple, we cannot manage a discount.

So WF(Purchase) = 1.0 [we consider the full price as 100% waste factor]

Value – How much value will it add to your daily life? Are you going to use it for work, or just recreation? It will also depend on whether you have other laptops or similar tablets at home. Lets say you are going to use it for personal work (like reading, keeping tab of investments etc.).  So you will use it 40% of your screen time.

Thus WF(Value) = 60% or 0.6

Time – How many years are you going to use it compared to the typical life of an iPad? Given that it is a technology product, the maximum life it can be used without needing replacement or becoming obsolete is probably 5 years. But you may be upgrading anyways after 3 years.

So WF(Time) = 2/5 or 0.4

Finally, WF(iPad) = 1.0 x 0.6 x 0.4 = 0.24

So 24% of the price is wasted. If you could have bought the iPad at 25% discount, then the purchase value will increase.

WF(discounted IPad) = (1.0 – 0.25) x 0.6 x 0.4 = 0.18, so now the purchase makes a little more sense.

Car: 

Typically it is a good practice to buy used cars at a discount. So lets say you buy at 40% discount, usually a 2-3 year old car.

Let us also say that this is your primary car and you don’t fancy owning 2-3 cars, so you will use it 90% of your commute time. And lets say you are going to upgrade after 5 years, even though a car can be kept for 10+ years.

WF(Price) = 0.6, WF(Value) = 0.1 (high value to you), WF(Time)=0.5

WF(Car) = 0.6 * 0.1 * 0.5 = 0.03

See this is much better usage than the iPad with a WF of 0.24. Now if you hold the car for 9 years, then 9/10 will give a better score.

WF(Car) = 0.6 * 0.1 * 0.1 = 0.006

House: 

This is the biggest purchase in most people’s lives and possibly can be better quantified as well.

We will make the following assumptions:

  1. Price – You will buy the house at 20% discount to the retail/asking price.
  2. Value – If this is your primary residence, the value may be very close to 100%, or the WF will be 1% (to avoid zero).
  3. Time – A house can be held for 20-30 years, but lets say you plan to upgrade after 10 years or so. So WF(Time) = 20/30 = 0.66

WF(House) = 0.8 * 0.01 * 0.66 = 0.005

So the house purchase makes even more sense than the car. Even though the house is used only 1/3 of its whole lifetime and the car is used 9/10 years, the house purchase makes more sense. It also had a lesser relative discount than that of the car.

The above P.V.T equation also reveals another hidden aspect. You can adjust one parameter vs. another. For example, if you are going to use the house or car for longer, you can afford to buy at a less discount. Your WF(Price) will increase but will be offset by the other two.

You can even use this formula when you are trying to compare paying a higher price for a high quality product or buying cheap for a not-so-durable product.

High Quality: WF(Price) = 0.8 or higher, WF(Value) = 0.6, WF(Time) = 0.1 (it will last long) , WF (Purchase) = 0.048

Low Quality: WF(Price) = 0.5 (less price), WF(Value) = 0.6, WF(Time) = 0.5 (last 1/2 as long), WF (Purchase) = 0.15

As you see, it makes sense to buy the high quality product if the value is same for both. At least in this case, however there are situations where if you can get a significant discount and know that the item will last longer, the lower quality product (non-branded) may outperform a branded one. 

Thus making purchases with such logic will keep your home clutter-free as below. You just have to choose a suitable threshold of the WF. For example, anything below 0.05 (5%) may be a good thumb rule to make the purchase.

Disclaimer: There will be many other factors in a purchase decision. The above formula acts as only a quick thumb rule and should not be the only criterion for decision making. 

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Posted in Personal finance

Beware of ripoffs

Everyone does financial mistakes, some large some small.

The personal finance industry is designed to chase you for your money, for obvious reasons. The people working in this industry has to make a living and profit. Nothing wrong with it, however there are some unscrupulous greedy professionals and companies who will siphon off your money before you realize what happened.

I too have been a victim of such tactics, where that sinking feeling is unavoidable once you realize you have been swindled. You vacillate between blaming yourself for being careless to simply justifying as how would I know.

I have made other stupid mistakes many times, thankfully most of them were small.

Here are 2 big ones which I will remember throughout my life, and hopefully draw some lessons not to repeat the same.

Insurance masquerading as investment

In 2005, when I started my journey of personal finance (I was earning for 8 years with no savings/investment), I decided to open an investment account with one of the big international banks in India. They had what was called a “Wealth Management” division that would help me all the way in opening an account to choosing my investments. What a convenience! I just had to commit a specific amount to be invested by a certain time, either through a lump sum or regular investment.

So I met with what they call a Relationship Manager. The lady came to my home to advise me, suggested some good mutual funds (I later researched they were decent performing ones) and setup an investment account. I was thrilled and excited to start my first investment, and then came the unsuspecting pitch.

She told me investments in mutual funds are risky, so alongside I should also invest in something very stable with tax-free and better returns than a CD. Diversification, Tax-free and stability all sounded perfect music to my ears, and I resonated to her plan. What followed next was I signed up for a so called U.L.I.P (Unit Linked Insurance Plan or Cash value life insurance).

So far so good, only couple of years later I inquired about the fund value or the surrender charges. By this time, I started reading about charges and commissions on financial products. To my utter disbelief, the product I signed up for (which seemed perfect then) had a special charge of 60% of my first year’s premium. They called it the Premium Allocation Charge. Wow!! Why would you charge to allocate my money? and 60%?

Even robbery at gunpoint would have sounded harmless in comparison. 🙂

That was my first big ripoff, I eventually bailed out of it few years later by minimizing my loss. In the subsequent years, the I.R.D.A (Insurance Regulatory and Development Authority of India) realized this dishonest practice by insurance companies and their agents, and reduced the charges to more like 4-6% and now it is clearly documented in brochures and illustrations.

Lesson: Do not mix investments with insurance. Insurance companies have no edge over low cost mutual funds. If there is a guarantee of principal, the returns are paltry and most of the profits are distributed to their agents. For insurance, term plan has no better substitute.

Fact check: In later years, I came across a relative who was selling such products. He told me agents who perform well are rewarded with paid for vacations to destinations in Europe. No wonder where 60% of my first premium went. 

Real estate bought wrong

Real estate is a high return, high risk product. Even when you are buying a home, you have to be knowledgeable in every step of the process, guard yourself against potential rip-offs. Everyone you come into contact is trying to make big bucks (and very quickly) in that industry.

My share of stupidity in this area is huge.

I bought my second home (condo) in India from a new builder, but who was also very well known to me. His claim to fame was honest communication, promised execution, good discounted price and quality of construction. The deal was really a good one, from both price and quality.

As things progressed (the development cycle was for 3 years), I became confident and  upgraded to a bigger sized condo. As the earlier one was not delivered, it was an arrangement to switch the contract to the new one and I would be paying the difference.

It was like upgrading to business class from the economy class, by paying the fare difference. Except that it was not such a smooth ride. 

The blunder I did was not to insist in a new contract being signed immediately and the title of holding the new condo to be defined. Since the builder was known to me personally, I somehow gave the benefit of trust and waited patiently for him to switch the contract. Meanwhile as the payment system demanded from his office, I continued making the scheduled payments up to almost 90% of all dues.

A year down the line, things went south for this builder and I realized that something is wrong. On digging further, it came out that the new condo was not approved in the building plan and cannot have a regular title yet. Just to clarify, there is no Title insurance or Title company in India. Usually the transactions are directly between buyer and seller (or builder) with an optional broker mediating in between.

It took me the next couple of years to untangle the mess, and I lost a huge amount of money and mental peace in getting the title legitimized.

Lesson: Know the process and only thing you trust is the paperwork. Do not take any verbal assurances. In the above incident, I had only myself to blame for the stupidity. 

Fact check: I later came to know it was a deliberate lie (while selling the unit to me and in my follow-ups) by the person (builder) I knew very closely for years. Trust no one. 

So those are the two biggest financial suicides I signed up for.

crime scene do not cross signage
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Posted in Budgeting, Investing, Personal finance, Savings

The Starter Kit

If you are just starting off with organizing your personal finance, or restarting from scratch, here is a step by step way to get started.

Most of the times, we get started haphazardly, the first account in the local bank or the ad-hoc insurance policy or even the next stock tip forces us to open a  brokerage account.

However there is a need to get started in a more planned way.

When I moved to the US couple of years back, the below is how I setup my money system. I had a similar one running in India for a long time and it has given me very good results.

Here is the starter kit that you need to get organized and get started. 

Since it is built in a systematic manner, it will help you automatically organize and keep your finances in order.

A checking account

This is the first step as you need a place to deposit your income, be it direct deposit from your employer or you get checks at the end of the month.

Get a simple checking account at a Credit Union which provides you with a basic ATM and Debit card. Try to find a credit union or bank which has very low fees. Obviously they will have some like overdraft fees that we will anyway avoid, but others like ATM access are something unavoidable, so shop around a little.

This is where all your income will come in and get deposited. 

A credit card

We are going to be responsible spenders, right? If not, do not get this and use your debit card from your checking account.

The key to being a responsible spender is to make a budget, stick to it and pay off the credit card bill in full every month. Lets just assume you agree to all of this. 

There are many credit cards in the market with various features like cash back, travel rewards etc.

As a starter kit, you will just get one from the same bank or credit union where you hold your checking account. The reason is ease of payments and setting up automatic transfers from your checking account to pay it off at end of month. 

The bonus will be of course if  the card also has generous cash back benefits or other similar perks. But get a free one and not one with annual fee loaded just for extra perks.

The credit card will be your main expense vehicle. It gives you automatic fraud protection, insurance and easier account tracking. 

Budgeting

If you do not do any further, you have setup the very basic system. You earn money which get deposited into the checking account, you spend with your credit card (on a budget!!) and your checking account pays it off every month.

But this sounds like living paycheck to paycheck or Living on the Edge, right?

We are going to do better – save and invest. 

First what we need is a planner. As the above system of checking account and credit card gets working in a flow, you will start getting an idea of how much you are spending every month.

For the next 2-3 months, track your spending to categorize your money into only 4 parts.

  • Food and Dining
  • Utilities and Transportation
  • Clothing and miscellaneous
  • Surplus

You will automatically get motivated to squeeze the first 3 categories and increase your surplus every month. 

Check out this post on how to budget: Budget – Grow the tree upside-down

The above technique will help you generate surplus for both savings and investment, make it your goal to only increase it and not fall back to paycheck to paycheck cycle.

Savings Account

There are unexpected events or expenses that will always come up. You need to be prepared for it and the only way is to build up a cash cushion.

One essential comfort zone

This is similar to Dave Ramsey’s first 3 baby steps, where you start with saving $1000, then get out of debt (hopefully you have none if you started with this) and finally build a cushion of 3-6 months of expenses.

I use an online savings account like CapitalOne 360, Ally Bank or Synchrony. There are many others, and online banks provide little more interest on your deposits than brick-and-mortar banks, or the one where you have your checking account.

Setup an automatic transfer of your Surplus from your checking account to this Savings account. Set this up for beginning of the month, so that your budget works with just the right amount needed (to pay off the credit card at end of month). 

Investment Account

Get to this step only when you have a running budget, able to generate surplus consistently and stacked up 3-6 months of expenses in your savings account.

From here on, you become a pro in personal finance as you are about to invest and grow your net worth. 

There are two main investment accounts, a retirement account and brokerage account.

Contact your employer for a 401k (Pretax or Roth) account and contribute to it, if there is a match. If this exhausts your projected surplus, no worries you have got started.

If there is still surplus, good news. Open a brokerage account in one of Schwab, Vanguard or Fidelity. Preferably open a Roth IRA account if your income is within eligible limits.

Roth IRA rules

Then invest in one or two broad index funds with very low expense ratio (< 0.05).

Here is a classic 3-fund portfolio from Vanguard index funds.

  • Vanguard Total Stock Market Index Fund (VTSAX)
  • Vanguard Total International Stock Index Fund (VTIAX)
  • Vanguard Total Bond Market Fund (VBTLX)

Similar portfolio can be constructed from Schwab Funds too.

https://www.wallstreetphysician.com/three-fund-portfolio-using-schwab-index-funds-etfs

Managing and growing the investments

You have done a great job in the above steps and at par with average disciplined investors.

In investment world, “average” is what wins. If you get average returns of 8-9% over a very long time (decades), there is nothing more you need to do. 

To know how to structure and maintain your investment accounts, read this blog post

Investing in the High Five portfolio

Conclusion

The above is a simple 5-step process to take you from a personal finance newbie to a disciplined investor and saver. Taking action in a systematic way is the key to financial bliss.

If you need motivation to get started, read this:

Shun that perfection

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