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

The Five ways to SIP

SIPIn India, the mutual fund industry has popularized this term for drip investing, dollar cost averaging or similar. The full form is “Systematic Investment Plan” and allows normal people to invest in Mutual Funds gradually and is proven to build wealth over a long time. 

For me, there is a bigger SIP in Personal Finance – Sleep in Peace. 

It may sound like RIP – but lets keep life going strong in these trying times. We will do another article on that, and in personal finance terms we will call it Retire in Peace.

SIP is a concept that is important throughout your earning and retired life, and defines a way you can manage your Personal Finance to effectively “Sleep in Peace” every night.

As we know with the current COVID-19 situation, many people are losing sleep over their financial situation.

While some can still be corrected with discipline, those following the basic principles of SIP will be unaffected by such pandemics and sail through it.

The Five components of a SIP method

1. Emergency Fund – The sleep in peace fund

The Emergency Fund is the first of SIP rules. It can be called the Sleep In Peace Fund too.

In the current situation where everything is uncertain from jobs to ability of paying mortgages and bills to medical situations, there cannot be a better cushion than possessing an emergency fund.

People who have not been able to build this fund, are now feeling the brunt of their careless handling of personal finances.

One essential comfort zone

2. No Debt – borrower is slave to the lender (there is no good debt)

In US, due to low interest rates on some loans like mortgage and auto-loans, some experts justify using leverage to build your wealth. While that may sound smart in good times, in trying times like now even a so called good debt can nosedive to a bad debt.

For example, the government is now directing banks to suspend mortgage payments (for a short period, of course), giving stimulus to real estate investors and trying to bail out or let leveraged people and businesses go down.

So greed and over-smartness with debt are now taking the sleep away from people who have bought and financed huge houses, expensive cars, invested into rental properties with no-money-down. Here are 3 situations where not having an emergency fund and being over leveraged, is disastrous now.

  • You spend more than 30% of your income in mortgage payment. If you lose your income, even the emergency fund will quickly run out paying the mortgage.
  • You bought an expensive car with bank financing and very low down payment. The auto-loans will not get any relief from Government, and your car may be repossessed in case you fail to make the payments. Also the payments could have been used in more protective ways, if the car was bought with cash in the first place.
  • You invested in rental properties with low down payment (< 20%). What happens now when many tenants are refusing to pay rent due to financial hardship or even just taking advantage of the situation (evictions are deferred now). You still need to pay the bank their share of interest and principal.

The universal truth about Dave Ramsey’s 7 baby steps

3. Do the real SIP – invest in a disciplined way

Now we come to investments and the real SIP (Systematic Investment Plan).

This process addresses two damaging financial behaviors – fear and greed.

I will not rant about the philosophy behind SIP or DRIP investing, it is pretty well known and over-emphasized in investment circles.

The advice from the legendary investor Warren Buffet applies now more than ever.

Be fearful when others are greedy, and be greedy when others are fearful. 

However in the Sleep In Peace method – be neither, irrespective of what others are doing. 

Keep investing with a plan. I have rearranged my India portfolio recently (just before the market crash) and apparently could have done better.

  • In a zeal to restructure my asset allocation, I invested a large part held in cash into the equity markets in Jan 2020. Little did I know, the markets would come crashing down in another month or two.
  • However I was not overzealous on Equity. I kept a larger part in simple fixed deposit (bank CD), so as not to go overweight in one asset class, Equity. 
  • The current market situation does not affect my peace, since the money I invested into equity markets is planned to be held for a long time (possibly till I retire). 
  • I could have done better if I remained patient and deployed it in smaller chunks over several months  – the real SIP. 

So that’s from a recent personal experience –

If you want to Sleep In Peace, invest with SIP – the systematic investment plan. 

Know yourself and your investments

4. Define and invest in your goals

No matter what is happening in the world, nothing can derail you in personal finance if you manage your finances based on your goals.

Every person has life goals like buying a house, opening a business, travelling the world, educating your children and RIP (Retire in Peace).

If you allocate your money to the various goals and keep adding to the corpus month after month in your earning years, then in trying times such as now – you have nothing to fear. Some of your goals are funded and some are in the process of getting built-up.

Just continue doing what you were doing.

The worst case scenario can be that one or two goals may need to be postponed. For example, if you were trying to retire early and lost your job or income, you may have to work longer for a few years more. But that does not completely cripple you or force you to liquidate your retirement funds.

A simple method of asset allocation

5. Pay your taxes and file your return on time

Taxes and death are certain – everything else is uncertain. 

There is no way to avoid taxes (except the legal ways to reduce or defer it – consult a CPA) and hence every personal finance system has to take into account – taxes. Not paying your due taxes and trying to be over smart, can really take your sleep away.

Whatever it takes, plan for your taxes throughout the year and pay the legitimate share to Sleep In Peace. 

In the US, Internal Revenue Service and in India, the Income Tax Department are both quite aggressive in following up with cover-ups, non-payment and mistakes. And for working professionals like me, who has to deal with both – there is no other way than honesty, prompt action and discipline in keeping track of your tax liabilities and payment obligations.

Keep your documentation up-to-date and file away returns on time to avoid major headaches.

Five components of a personal finance system

Conclusion – Ride the wave and learn something new

While this is the time for great financial worries and the clouds of a multi-year recession looming over us, there could not have been a better time for us to introspect and re-organize.

This is the time to take a hard look at your financial and other priorities in life. Locked down inside our homes, with more family time and me-only time – when is a better time to introspect and find your real dreams? 

When the world was open and running, the rush of the morning and the fatigue of the evening left little for us to think beyond the next day.

If you want to sleep in peace when all this is over, maximize this opportunity and start something new.

I am working on starting a financial coaching business where I can help people with their finances globally. What better time to serve the world than now and next few years? 

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

sticky notes on board
Photo by Polina Zimmerman on Pexels.com
Posted in Budgeting, Investing, Liabilities and Debt, Personal finance, Savings, Spending

How to manage your cash flow

A company which is listed in the stock market has to publish 3 essential financial statements.

  • The balance sheet
  • The profit and loss statement
  • The cash flow statement

Briefly, the balance sheet shows the health of the company at the reported time, profit and loss statement shows how much profit the company is making after all expenses and taxes, and the cash flow shows how the company is generating the cash from its operations as well as investments.

Free Cash Flow (FCF) is an important metric that is used by investors to evaluate the real worth of a company. 

In personal finance, while balance sheet (Your net worth) and profit and loss (how much you are making and spending) are important, managing the cash flow is key to achieve your financial goals.

In this blog, we will talk about how to manage your cash flow – no matter whether you earn a lot or earn an average paycheck.

Most people do not manage their cash flow, forget about doing a budget or any other conscious form of tracking.

At the end of the month or year, we wonder where all the money earned went.

Conventional ways of managing cash flow

There are several techniques Personal Finance experts have championed time and again.

  1. Do a budget, track every dollar. 
  2. Create an envelop for groceries, utilities, fun etc.
  3. Use separate accounts. 
  4. New automated solutions like Stash, Digit etc. 

All of these are good methods, but the problem is sticking to the discipline of maintaining it day after day, month after month.

Isn’t that boring and worrying at the same time? Few issues with these approaches are:

  • Writing down expenses every day
  • Stuffing that envelop and counting the money every time before spending
  • Keeping track of multiple accounts
  • Not knowing how much the AI driven savings app is going to deduct next month

So is there a simpler and better way?

Just like most posts in this blog, I seek simplicity and automation.

The simpler way of managing your cash flow

There are 4 goals to managing the cash flow every month.

  • Invest for the future
  • Save for the short term
  • Pay your bills 
  • Spend the rest

In fact, any wind-fall is also a one time cash flow, and can be fit into the same framework.  Lets say you got a bonus of $1000, for example, the Govt is sending a check to all Americans. And if you want to keep it simple, allocate 25% to all the 4 goals.

  • Invest $250 in your long term (retirement, child education) plans. The market is down and you can invest $250 in a mutual fund or an ETF. 
  • Save $250 for any short term goals that you have. It could be added to your monthly savings goals, towards anything like vacation, buying that new phone, or simply emergency fund. 
  • If you have consumer debt, why not allocate some to pay it off? Use $250 to pay off the highest interest or smallest balance credit card. 
  • Now you have $250 to splurge on. Buy that favorite book, order the special meal or decorate your home. 

But how do we automate and manage the cash flow every month?

  • Invest – Direct deposit investments. In fact most employers have systems to auto-deposit 401-k investments or direct deposit to your chosen brokerage firm. 
  • Save – Auto transfer to a savings account from your checking account. 
  • Pay Bills – Setup auto-pay with your credit card or debit card. Set the bill payments mostly towards beginning of the month. 
  • Spend – Use your debit card to spend – it will tell you when the money runs out. 

Once setup, the only stress you have is the last bullet, where you have to make your spending within the limits, or rather the residue after all obligations are set aside or paid off.

How it can snowball into Financial Freedom

As you get consistent with stashing money away for investing and savings, those may generate additional cash flow or assets which will come back to bolster the spending budget.

Thus cash flow is a virtuous cycle once set up the correct way. Lets take some initials and approach this from a math perspective.

  • J – Job Income
  • R – Retirement
  • I – Investment
  • S – Savings
  • B – Bills
  • E – Expense
  • P – Portfolio Income

J + P = R + I + S + B + E

I can produce P in terms of interest, dividend or rental income.

silver and gold coins

In the wealth accumulation years, the goal should be to increase J, so that I can be increased, which when invested can increase P. P is added to J and a part reinvested, saved or used.

As you reinvest P, it will generate more P till at a point, J becomes less and less important. 

This cash flow situation is called Financial Freedom.

Conclusion

We just presented a simple and fully automated cash flow management system for personal finances. It does not take much discipline and will power to stick to it, once correctly setup.

This is also explained in more detail in the post The SAFE plan – Simple, Automated, Flexible and Efficient .

Photo by Pixabay on Pexels.com

woman standing on cliff
Photo by Min An on Pexels.com

 

 

Posted in Investing, Personal finance, Savings

A simple method of asset allocation

As I started to write this post, I decided not to rant about the Corona Virus and its effects anymore. The last two posts were dedicated to the topic and frankly it is becoming a little bit weary to add to all the deluge of information and opinions on it.

Let’s look at the current situation as nothing unexpected, at least financially. Being a financial blog, let us generalize this to another black swan event, and not worry about the statistics of no. of confirmed cases vs. deaths etc.

What is a Black Swan event?

A quick Google search yields the following:

An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. This term was popularized by Nassim Nicholas Taleb’s book “The Black Swan: The Impact of the Highly Improbable.”

Lets leave it to that and consider we are in the midst of one such situation.

The keyword in the above definition is “would be extremely difficult to predict”. 

No matter what financial experts say about the markets, about investments, using sophisticated algorithms to trade stocks, the fact remains that such events are not predictable by even the multi-PhDs of Finance.

In the beginning of 2020, most of us did not know that a black swan event is so much closer, although experts have been predicting recessionary clouds for last 2 years or more.

The effect of such an event is the havoc it can do to your savings and investments. Yes savings too, as we don’t know which banks or financial institutions will go under the water, and whether government stimulus can rescue them.

It may be a rare event so far, or some rescued in 2008 but we cannot guarantee with every black swan event. Just in Feb 2020 (when it was still normal business), a very large private bank in India went bust taking with it hundreds of thousands of dollars worth of deposits of very normal people. Ironically the bank was named “Yes” bank.

Similarly by end of March 2020, the stock and mutual fund portfolios are down 20%-50% depending on how much risky the portfolio was to begin with.

The only respite from all of this is to maintain a good asset allocation as each investment avenue has its own risks. Some of the typical risks are:

  1. Cash – Banks going down and Government struggling to insure the deposits.
  2. Stocks – Markets tumbling for an extended period of time due to economic fears.
  3. Bonds – Risk of default as even good companies’ bonds can turn into junk debt very quickly. Lot of mutual funds in India were invested into Yes Bank bonds. Long term bonds can also run into interest rate risk.
  4. Real Estate – Somewhat resilient but affected by vacancy, interest rates, unemployment.

If your finances are severely affected by this storm, how do you achieve a good asset allocation once the clouds are gone and the sun is shining again on the stock market?

KISS – Keep it simple, stupid

Its not overly complicated although some financial experts make it so. Let’s say I want to hold 25% each of the 4 asset classes and distribute my assets accordingly.

Here is a step by step method on how to achieve this. It is better done in an Excel sheet as the calculations can be automated and even graphs can be plotted, although equal allocation is easy to visualize anyway.

  • List down all your assets into one column which comprises your Net worth including your home and any other property you own.
  • Now in a second column, list the value corresponding to the asset. Be conservative, do not add any speculative value.
    • For your home, just take the equity value that you have.
    • For stocks or mutual funds, take the present value.
    • For any bond investment, take the invested value or the expected maturity value (if the term is not too long).
  • Now add 4 columns for the asset classes.
  • The chart should start to look like this. Here is a simple example of a $100,000 Net worth.

Asset Allocation Table 1

  • Now based on the asset class for each, fill the right side columns in the right proportions. For example the mutual funds  may consist of equity funds, bond funds and REIT funds in equal proportions. For each mutual fund, a look at the fund report will reveal the proportions of these asset classes that it invests in.
  • Fundrise is just an example of a private REIT that is considered real estate asset class but in paper form. It is only for illustration and I am not an affiliate of the investment fund.
  • Once you allocate the numbers to the 4 asset classes and add up each column, it will become visible how your asset allocation is skewed.Asset Allocation Table 2

 

  • A visual inspection of the numbers reveals that this portfolio is heavily skewed towards Real Estate due to the largest investment in the Home. This is true for most people, as their largest investment is their home.
  • A more vivid depiction of this can be drawn using the Excel chart.

Asset Allocation Table 3

  • How to balance it? There is no ideal asset allocation as it depends entirely on the person’s situation, age, risk appetite, goals and many other factors. It is only after this simple analysis that one should approach a financial coach or investment adviser.
  • For example, if the person (who’s portfolio we have just analyzed) is not happy with the Real Estate skew, he can allocate future investments more towards Equity or Bonds (or even Cash), than buying more real estate or paying down his mortgage aggressively.
  • Being overweight in Home Equity can mean house poor and the person will find it difficult to raise funds or access cash in times of emergency or other life goals.

Conclusion

The beauty of this asset allocation method is that in a simple exercise which takes less than 10 mins and one sheet of Excel, you can look at your entire financial picture.

  1. It gives you a quick overview of your Net worth.
  2. It gives you the current asset allocation you have.
  3. It tells you where your financial situation is vulnerable to market, liquidity or economic risks.
  4. It tells you what action you need to take (whether to sell some or boost up another) regarding the various asset classes.
  5. It directs how your future investments should be structured.

The value of this exercise is immense and a good asset allocation can let you sleep in peace when the entire world is savaged by another Black Swan event.

photo of building during daytime
Photo by Matthew DeVries on Pexels.com
Posted in Personal finance

The Power of Financial Scribble

A picture is worth a thousand lines of a spreadsheet.

Managing your personal finances can be scary at times when you visit a financial coach or financial planner.

Any good financial planner worth your money will present data in a nice spreadsheet or make you fill a template form which has 30-40 questions about your current situation and your goals.

After filling out the form or trying to decipher the complicated spreadsheet and charts, you wonder if you have made any progress in your financial planning. The concept of simplicity gets ignored in the data and jargon.

Personal financial planning has to start with your goals, what you have today and where you want to reach. It is not about numbers on a spreadsheet, but more about what is your current life situation and where you want to go in next 3, 5, 7 or 10 years.

How do your write your goals in a spreadsheet or a predefined questionnaire? The answer is you simply can’t. These tools are built for data collection and analysis and not for top down planning.

The solution lies in a much traditional tool, pen and paper – even better pencil, eraser and paper. I find it extremely refreshing to write or draw my goals, current situation and how I want to go where I want to go.

It is what I call the Financial Planning Scribble.

Financial scribble

It is a lot of fun and creativity as you design your own symbols to represent personal finance as possessions,liabilities, plans and road map.

Lets say you are assessing your Net worth (your assets – your liabilities). Your assets may contain real estate, cash, stocks, bonds, gold. Now think of a symbol for each along with a space to write the present value of the asset.

For example, for each real estate you can draw a house (remember the 3-D cube with triangle for the roof) and write the value in between the figure. Similarly use an envelope symbol for your cash (even though it is not hard cash but balance in your checking account). Your vacation fund can be a picture of your favorite spot (beach or mountain) and so on…

Go creative with your assets… you have built them with sweat, sacrifice and planning. They deserve to be given a life and make you happy about them.

Photo by Andrea Piacquadio on Pexels.com

The second part of Net worth are the liabilities, or in other words, what you owe. You should not feel good about these unless you have a plan for strategic leverage, like building your rental real estate portfolio with debt or student loan to finance a good education.

Your liabilities can be depicted as something that may scare you and force you to act to reduce them. Again go creative here as per the kind of debt. High interest credit card debt is a demon with blood in its mouth, as that is what it is doing to your life and finances.

Photo by Ian Panelo on Pexels.com

The idea is to depict your personal situation today as accurately and vividly as possible. This is not always apparent in a numerical spreadsheet. The demons should scare you and the vacation fund or investments should make savings feel worthwhile.

The difference between the two (assets and liabilities) is your Net worth. See if the residual picture (your bright side covering the dark) is positive or not. You can find a symbol for the net worth, positive or negative.

Photo by Bekka Mongeau on Pexels.com

Once you get to the habit of scribbling and sketching, you will find it so useful and refreshing that you can extend it to beyond Net worth.

Your investments and asset allocation can also be depicted through sketches and you can even draw your plan and ongoing monthly investments.

Conclusion

The idea of financial scribble is not to get too complicated and lose interest in tracking finances. Finance can be fun once you depict it in your own way, not in a financial planner’s jargon and spreadsheets.

Financial scribble helped me internalize my personal situation and plans, in a clear and concise way that anytime I can draw it on a piece of paper and use it to make bigger decisions. A very rough scribble (you can be definitely be more artistic) from one of my recent planning sessions is shown below.

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

The SAFE plan – Simple, Automated, Flexible and Efficient

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

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

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

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

The SAFE Plan

Let me first present the 7 steps to SAFE plan.

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

Simplicity

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

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

Automation

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

Flexibility

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

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

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

Efficiency

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

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

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

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

Conclusion

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

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

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

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

cropped-pexels-photo-908288.jpeg

Posted in Personal finance

Welcoming Twenty – 20

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

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

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

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

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

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

Five components of a personal finance system

Photo by Pixabay on Pexels.com

So what are the action items for 2020?

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

How to wrap up 2019?

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

HAVE A GREAT 2020 YEAR AHEAD.

  • Wish 20% of your efforts produce 80% of happiness and wealth.
  • Take action like the Twenty-20 form of cricket.
Photo by Jill Wellington on Pexels.com
Posted in Investing, Personal finance

The biggest enemy of your investments

Its not the fees.

Its not even the portfolio churning manager.

Its not the financial adviser.

The biggest enemy of your investments is YOU. 

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

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

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

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

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

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

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

Asset allocation JPG

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

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

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

So sometimes action is good and inaction is bad.

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

action activity adult attack
Photo by Pixabay on Pexels.com

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. 

adult adventure baby child
Photo by Pixabay on Pexels.com

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. 

aerial photo of buildings and roads
Photo by Aleksejs Bergmanis on Pexels.com