Category: Savings

Posted in Budgeting, Investing, Personal finance, Savings, Spending

The SAFE plan – Simple, Automated, Flexible and Efficient

Posted on by The Tortoise

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 Investing, Personal finance, Savings

Afraid of investing? Not so simple either

Posted on by The Tortoise

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

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

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

Fear

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

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

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

Simplicity

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

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

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

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

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

Solutions

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

Confront the fear – Create a plan

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

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

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

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

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

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

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

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

Correct Diversification – Choose products with built-in diversification

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

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

Here are few models of simple diversification:

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

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

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

Asset allocation ratios – How to diversify across asset classes

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

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

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

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

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

Unconventional investments – Tear down the cover to reveal the costs

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

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

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

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

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

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

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

Load than churn- Grow vertically, not horizontally

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

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

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

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

Conclusion

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

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

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

This is as much diversified as it can be.

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

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

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Photo by Ingo Joseph on Pexels.com

 

 

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

Five metrics of personal finance

Posted on by The Tortoise

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

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

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

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

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

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

Net worth

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

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

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

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

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

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

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

The Net worth vs. Cash flow debate

Quick ratio

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

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

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

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

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

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

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

The Quick Ratio is then calculated by:

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

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

One essential comfort zone

Debt/Equity ratio

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

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

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

For example repeating the earlier example in section Quick Ratio:

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

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

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

This can be measured by yet another useful ratio.

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

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

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

The Paid Piper of Hamelin

Emergency coverage

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

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

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

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

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

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

Budget – Grow the tree upside-down

Savings ratio

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

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

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

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

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

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

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

Investing in the High Five portfolio

Conclusion

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

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

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

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

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Posted in Budgeting, Investing, Personal finance, Savings

FinTech – can you be immune to it?

Posted on by The Tortoise

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

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

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

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

Banking

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

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

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

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

9 Best Online Checking Accounts of 2019

Savings

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

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

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

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

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

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

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

NerdWallet’s 4 Best Money Saving Apps

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 Investing, Liabilities and Debt, Personal finance, Savings

The universal truth about Dave Ramsey’s 7 baby steps

Posted on by The Tortoise

Who doesn’t know of Dave Ramsey? 

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

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

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

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

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

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

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

Dave Ramsey’s 7 baby steps

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

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

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

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

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

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

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

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

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

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

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

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

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

Retirement savings (Dave’s baby step 4) 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

  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 Budgeting, Personal finance, Savings

Five components of a personal finance system

Posted on by The Tortoise

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 Budgeting, Investing, Personal finance, Savings

The Starter Kit

Posted on by The Tortoise

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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