Saving versus Investing

Saving and Investing are two different things....

As I noted in Real v. Fake Investing, a lot of people obsess about where to invest, not how to invest.   They think the name of the game is finding the secret key - the winner stock - putting down a bet and then winning the lottery when it pays off.

And yes, when I was in my 20's, I thought that, too.   Why?  Because I watched a LOT of television, and that is all they preach on television.  The shouting guy says "buy" and "sell" as if those decisions will make you rich.  And the shouting guy is dead wrong - as his record attests to.   Invest using his advice, and you will be broke.

There is a difference between SAVING and INVESTING, and for most middle-class Americans, the best we can do is to SAVE.

Why is this?  And what is the difference between the two?

Well, SAVING, as the name implies, means putting money aside for a rainy day.  That rainy day could be your retirement, or perhaps an emergency fund.  Or money to buy a car, or fix your roof.   If you set money aside for these inevitable contingencies, you will have it when you need it - as opposed to borrowing it and paying interest, or worse yet, being broke later in life.

As I have noted before, the bulk of the money you end up with in your 401(k) will likely be the money you put in it.  Sad, but true.   So the more you put in, the better off you will be.

True, you might be able to double or triple your money, over time.   In a good market, you might double your money every seven years.   But then you will hit a bad market (as we have) and be lucky to break even for a few years.   Over time, you will do well, of course - provided you SAVE.

INVESTING, as the name implies, is taking a pile of money and using it strategically to make more money.   This requires some knowledge on your part - some smarts - as well as insight.   But most of all, it requires that you are willing to assume some risk - often a lot of it.

If you SAVE money, there usually is little risk.   You put money in an FDIC insured account, or into blue-chip stocks, or government bonds, and other relatively safe investments.   The worst that can happen, usually, is that your gains don't keep up with inflation.

With INVESTING, however, you can lost some or all of your money and end up broke.   You buy a speculative stock, and it gets hammered, you might lose half your investment.   It goes bankrupt, you lose it all.   And in the last few years, this has happened to me,  only with stocks that at one time, would have been considered "blue chip" - such as General Motors.

Over time, of course, you can't afford not to invest at least a little bit.     But what do you invest in?  If you are an average, middle-class American, you have no special insights into the market (and no, what you hear on TeeVee, shared with 300 Million other people, is not a special insight).

You can try stock-picking.  It is not a swell idea.  Why?  Because even if you spend hours researching a stock, there is someone else who spends days, weeks, and years doing it.  There is a guy who does nothing but watch that stock.  You can't beat him.

And my own experience with stock-picking reflects this.   Some of my best "picks" were embarrassing accidents.  Some of my thoughtful choices went bankrupt.  I bought $3000 of General Motors Stock, and it is now gone forever.  I bought $750 of Avis stock, while intoxicated, on a whim, and it soared to $12,000 in value.   I bought stock in a company called Morningside, and it shot up 50%.  Great insight?  Hardly.  I mistook the company for a different one with a similar name.  Duh.

You might as well go to Vegas.   My portfolio of "picked" stocks is doing OK, overall, only because I have diversified it to include corporate bonds, income-producing stocks (that pay dividends) and some blue chips.  It isn't making a lot of money - but it isn't losing any.  Perhaps I am making 5% a year, if that.  I could make more, but can I afford the risk?

So what else is there to do?  Ahhhh.... Mutual Funds!  These were touted to us in the 1980's as the answers to all our prayers.   Really smart guys who know about stocks would take our money an invest it for us.   And in return, they get..... well, some of our money.   How much?   I can't tell you.   No investment adviser, even the ones at Fidelity, can tell me how much they make and where they take the money out.

The fellow at Fidelity - which is one of the better companies - says they don't charge me fees.  But someone is paying for that glass-paneled office and that oak desk.   By August 1, 2012, we are supposed to get statements from our Mutual Fund companies, detailing exactly how much they are making from our money.   I am willing to bet they try to obfuscate this data as much as possible.

Some funds are more egregious that others, of course.  Some take out 5% up front, and it can take you a year or more just to break even.   Others take out fees every year.  Some do both.  It is never clearly explained or understood.

The bottom line, is, though, if your money makes 10% in the market, you are going to get something less than that.

But all that being said, Mutual Funds are, in some regards, the only game in town, particularly if you are investing (or is it saving?) in a 401(k) plan.

Of course, there are other ways to "Invest" - such as in your own business.  I invested in Real Estate back in the 1990's because I felt that at least it was something tangible that I understood and could control.   And knowing the market and property values, as well as how to manage the properties, I did pretty well.

Others, who got into the market late, and who didn't understand the market, values, or management, lost their shirt.   These are the types of "Fake Investors" who just buy whatever is being hyped on television.  And they always lose their shirts.   They buy Facebook stock.  They buy Gold.  They buy Apple - after it has shot up in price.

So what is the answer?  I wish I had one - a sexy answer that was simple and unique and clever, and guaranteed to make you a pile of money over time.  But there isn't one.  There is no Genie or magic lamp.

The best you can do is to SAVE money, and invest some of this in a variety of things, putting no one big chunk into any one thing, unless it is a very, very safe investment.   Warren Buffet can afford to gamble a million dollars - we can't.

And do the research on your investments, or at least try to.   But part of this research is learning about companies and what balance sheets should look like, as well as understanding all those numbers such as P/E ratio and the like.  Quite frankly, most people don't have the capacity to really be able to understand investments and accurately and correctly distinguish between a "good" investment and a "bad" one.

And to some extent, this is why our 401(k) system is ultimately flawed.   By turning us all into investors we are being asked to so something we have no skills at.   And for many people, this will work out horridly.   It is a given that a few folks will put all their money into high-risk investments and likely lose it all and end up destitute.  A few others might "strike it rich" or at least do moderately well, over time.  The bulk of us, if we are lucky, can only hope to do "OK".

And that is assuming that all these people SAVE in the first place - in order to INVEST.   A startling number of Americans have not even bothered to SAVE at all - or have saved very little.   Investing in the wrong stocks or funds is one way to possibly end up broke.  Failing to SAVE, however, guarantees this result.

And perhaps that is the most fundamental difference between SAVING and INVESTING.

The More Complicated You Can Make Any Financial Transaction...

The more complicated you can make any financial transaction, the easier it is to rip-off the consumer.

I went to the grocery store the other day, which is usually not something I do alone.   I had a shopping list of things to buy, and I pretty much avoided buying stuff not on the list.   What amazed me was how so many items did not have prices marked on them, or on the space on the shelf nearby.  Sometimes you had to hunt for the price, and other times it simply wasn't there.

And I put a few "unpriced" items in my cart, and you can guess how that worked out.   Yes, they were scandalously overpriced.

But of course, Winn-Dixie has all these scams and schemes and promotions for prices.  To begin with, if you have a "frequent shopper card"  you get a discount off the marked price - to another marked price that is next to the retail price.   On a $12 bottle of virgin olive oil, the mark-down is $5.   Is there anyone who says, "Well, I guess I'll pay the full price, instead of getting a frequent shopper card" - is there?

And the second game is that you get pennies off on gas - only at the local $hell station - if you buy so many groceries.

The third game are "in-store specials" where the department manager marks down prices further, for loyalty club members.

Shopping alone, it was hard to monitor the prices as they are rung up on the cash register.   This problem is compounded by the fact that the price rings up at full retail, and then a "credit" appears randomly on the tape, showing the discount.

It wasn't until I got home that I realized that some of the in-store "specials" credits were not credited.  For example, shrimp was marked down to $8.99 a pound as an in-store "special" whereas the regular "special" price was $11.99 a pound, and the regular retail price was $13.99 a pound.

OK, it is just a couple of bucks.   But then you see that the "in store discounts" for deli meat and cheese are not applied, and well, you are looking at five or six bucks.

It is annoying - and most people are tempted to think, "Well, maybe I read the sign wrong" or "It's not worth the hassle to go back and ask for a refund."

One way to avoid this problem is to either write down these in-store bargains or set them aside in your basket, and watch as they are scanned.   Buying in smaller lots also allows you to check the prices as they are scanned.   Yet another technique is to go into the store with a list and a finite goal of how much money you want to spend - $20 or $50 or $100 - and add up your purchases as you go.   It is a great way to control over-spending.

But it illustrates how the pricing scheme is anything but transparent.   Like at a car dealer, there is a "sticker price" that no one pays, then a "discount price" that is their "regular" price, and then a discount below that, designed to entice you to put the product in your basket - but is never rung up properly.

And yes, on other occasions, I have noticed this and caught it in time, usually when buying fewer items.

The more complicated you can make any financial transaction, the easier it is to rip-off the customer!

And this is not even taking into account the biggest aspect of this scheme - the fact that most consumers compare the "discount" price to the "regular" price as an indicia of savings.

For example, I went to the Publix the other day.   This is a Georgia Publix, not a Florida Publix.   A Georgia Publix is like the hillbilly cousin of its sophisticated Florida kin.   You get the idea.

But the prices are still as high as the Florida version, and I was amazed to see at the deli, how everything was literally 50% higher in price than at the Winn-Dixie.   But people were still buying, enthusiastically noting how the cheddar cheese was "on sale" for "only" $9.99 a pound!   By comparing the phoney "sale" price to real market prices, they failed to realize they were overpaying by as much as 50%.   The same cheese at another store was only $5.99 a pound, "on sale".

The marketplace is a battlefield, to be sure, and it has always been thus.   When I was a kid, it was S&H Greenstamps, instead of free gas.   We were supposed to collect these and paste them in a book and redeem them for a toaster.

Or, if you bought so many groceries, you could get a free plate, and eventually have a whole dining set!  And yes, my Mother did this - and ended up with a dozen plates.  

When they offer these ancillary deals - or phoney discounts from inflated "retail" prices, it distracts the consumer from the underlying transaction.   Yet few places don't engage in these kinds of promotions.   Wal-Mart at least, doesn't have a "Frequent Wal-Marter Card" just yet.   But wait for it.

I will go back to Winn-Dixie with the receipt and the sticker from the purchases that did not ring up properly and get my $5 back.   It is a hassle, true.  But marking things at one price and selling at another is outright fraud.

Solar Powered Hot Water Heater? Maybe Not.

Solar powered hot water heaters are an interesting option.  But do they make sense financially?

As I wrote in "Should You Unplug From the Grid" (and Part Deux) the idea of using solar or wind power for your home is an attractive fantasy.   But it is a fantasy for most of us - and not a very cost-effective one, at that.

I recently researched this, online, and was shocked at how much these systems cost - and how complex they are to install and maintain.   For the thousands of dollars involved, and the effort, the payback is somewhat limited - and could take years to realize.   By the time you pay back the cost of one of these systems, you might be ready for a new one.

A good business for the manufacturer and installer.  Maybe less a bargain for the homeowner.

What are the pros and cons of these systems?  Mostly cons, I'm afraid:
 

Tax Incentives: yes, there are tax incentives.   But the manufacturers and installers of these systems know that, and raise prices accordingly.  As a result, they are staggeringly expensive, as you buy them on the premise that the gub-ment is paying the tab.

Complexity: Simplicity often works best in the long run.   Like a hydronic heating system in miniature, a solar powered hot water heater has a pump, plumbing, a controller, and a tank and expansion tank.   All of these elements wear out over time or require periodic maintenance and adjustment.

Costs: Staggering.  A simple electric hot water heater can be had for under $500 an installed by yourself in half a day.   A solar system can cost ten times this much and require professional installation.  The kit above retails for $3999, and that is installing it yourself, which can be a daunting task.   You'd better know how to sweat copper, be comfortable with drilling holes in your roof, and also know how to do basic wiring, too.

A professionally installed system?  You should expect to at least double that amount.  You are looking at $8000 or more to have one put in.

Drilling holes in the roof:  Adding holes to the roof is never a good idea, but you will need two large ones for the pipes, as well as some lag-screws to hold the panel.   These are potential leakage sources, over time.

Re-roofing your house:  When the time come for a new roof, you will have to remove the panel and re-install it, adding to your roofing costs.  

Limb Damage:  Every time the wind picks up, a Georgia pine drops a limb on our house.  Sometimes this sounds like a body has landed up there.   Some of these panels are evacuated glass and would shatter to pieces.  Homeowners insurance would cover only part of the repair costs.  In our case, with $10,000 deductible, none.

Appearance:  Well, they do look like hell, don't they?  Of course, they do tell the world you are environmentally conscious, right?

Payback:  Well, the proof is in the pudding, right?  What is the payback on this?  Or is there one at all?

If you sell your house in five years, you may never see the payback from this.  And the new owner might not see solar hot water as adding anything to the value of the house.  While a hot water heater may draw a lot of current, it is pretty small compared to your air conditioner.   Our electric bill can top $400 a month in July, but be as little as $89 in the Fall, when the A/C is off.  How much of that $89 is our hot water heater?  Hard to tell.

But assuming we spend $4000 on the "do it yourself" kit, and the equipment lasts 15 years, that is $266  a year, not counting opportunity costs, inflation, interest rates, etc.  That works out to $22 a month in costs.  On an $89 electric bill, is $22 of it our hot water?   It had better be, to break even!

For a professionally installed unit, costing $8000, well, we'd better save $44 a month on electricity - just to break even.

And here's the deal - breaking even is not some special treat.   To make this worthwhile, you would have to show a profit over time - and fairly soon, too.   Dealing with the hassle of installation and maintenance should pay back not merely break even.

But what about with the tax breaks?  Well, you can get a 30% credit from Uncle Sam.  This could lower the cost of our "kit" to about $15 a month, over 15 years.   Presumably, at that rate, we could show a payback, over time, say, if we saved $30 a month in electricity.

Our current hot water heater says, according to the EnergyStar label, that it uses $410 of electricity a year.   And bear in mind this does not go down to ZERO with solar - you still need an electric hot water heater for backup when the sun isn't shining or at night.

But even assuming $410 is saved annually, we install the "kit"  for $3099 (re-using our existing heater) and get a $30 tax credit for the kit, our cost is still $2169.30, or a payback of at least five years.

So the payback?  Well, if we run this thing for 15 years, which is about the service life of the pumps and controls (based on typical design life, and my experience with hydronic heating, and yes that is the same damn type of pump that I had to replace in that system) we see a payback, after 15 years, of $3680.70 - or about $20 a month.

$2169.30, invested at 7% interest over 15 years, yields $5,985.17

Um, this is not a really good deal.  And that is being generous - assuming a really cheap system, self-installed, and rosy scenarios with regard to electricity savings.

So, one of two things.  First, you would have to get the cost down by a lot, to make this attractive.  A $1000 system, maybe.  $3000?  Even with a tax credit, the better investment is a mutual fund.   Second, the hassle factor is immense, and not enough, in my opinion, to warrant the rate of return even if the thing were $1000.

I will keep researching this.  They do make flexible pool heaters that use a flexible plastic tubing mat that is easy to install and is freeze resistant.   But for some reason, these are not widely used for domestic hot water.  Such a system might not need a pump and expansion tank, if it just used city water pressure to circulate the hot water.

But I can find no such system available online - yet.

Run Your Life Like A Business!

Most folks think that balancing their checkbook every month means they are doing well.  If you manage your personal life as though it were a business, and you may see very clearly where all your money is going.

When I started my practice, I was completely unprepared.  While I knew the legal end of things, like most Lawyers, I had no idea about how the accounting side of things worked.   By the way, if they offer a course in Accounting or Bookkeeping in High School, College, or the local Community College - take it.  It will explain so much to you in life.  Hell, I didn't even know the difference between an Invoice and a Statement (do you?).  It pays to develop talents.

In short order, I realized that I needed to log and account for every expense associated with the business - and keep a sharp eye on expenses.  I also needed to track how much I was making and pay taxes in advance.   The motherly teat of "withholding" was withdrawn, and I was on my own for the first time.

And man, were there a lot of painful lessons!   Let me just say this:  It sounds easy, but it ain't.  And you don't want to get in the situation of not paying your estimated taxes on time, because you have no handle on your expenses and your income.

This rude wake-up call made me realize that my personal finances were in a similar shambles.  We made money - and we spent it.  And like most Americans, if we paid all the bills every month, we thought we were "doing OK".    We had no idea of what our debt load was, interest rates, or net worth.   We had no idea whether we were getting ahead or falling behind.   Our only financial document in our life was the check book register, and half the time that wasn't filled out right.

I took a course at a Community College on how to use Quickbooks, and learned that the hardest part of using the program was learning some basic Accounting rules.  That was the hardest part.   But once we got all our data entered, we could then see where the expenses were, and how much money we were owed (I was shocked that one client was nearly $90,000 in arrears!).

I also realized that hiring people wasn't making me any more money - but in fact, less.  People these days demand jobs as a "right" - but in many cases, they are a detriment to a workplace, not an asset.  And the folks who think a job is a "right" are most likely to be a detriment.

But I digress.

I realized that I needed to clean up my personal finances as well, so I set up a second "company" in Quickbooks (actually a third company, as we had our Sub-S corp that owned the investment Real Estate).  I started logging all our purchases and income and, well, it became readily apparent that a lot of our money was going to "Other" every month.

We would take money out of the ATM machine for incidental expenses - lunch or designer coffees, or small purchases at stores of things we thought we needed.   It was no small amount - hundreds and hundreds of dollars a month.

(And how often do you see this in life - people running to the ATM to take out $20 to spend on gas, cigarettes and a snack?   They put $10 in the car and buy ciggies, a soda, and chips.  Repeat, ad infinitum).

It was impossible to cut back significantly on the big-ticket items - the mortgage, utilities, insurance (although we did make some headway).   But "Other" - that was killing us - to the tune of hundreds if not over a thousand a month!

Tracking these purchases, with a debit card, was helpful.   Getting out of the starbucks habit, and buying lunch every day, was another.  We learned to make our own meals and live with regular (free) coffee - or tea.  Getting rid of bad habits - habits which most Americans have and think are normal was a big key.

We also started monitoring our net worth.  And this came about because my bank - the one I owned founding stock in - wanted me to submit a financial statement every year, showing my net worth, to justify them keeping my "callable notes" (and ulcer-maker if there ever was one) on the books.   The idea of calculating my net worth had never occurred to me, before.

When you start thinking like a businessman, a lot of things become crystal clear.   Suddenly, just spending money wantonly doesn't make any sense.  You spend money on one thing, it means you can't spend it on another.   So you have to choose what is important to you.  If you want the fancy car, maybe that means no fancy coffee.   Or maybe if you want money in the bank, it means neither.

I suspect a lot of these "paycheck-to-paycheck" Americans are living the way I was, and they will remain "paycheck-to-paycheck" by definition - not because of their economic circumstance.   If you have no financial discipline - and no means of tracking your spending, debt, and net worth, then you will, by default, be "paycheck to paycheck" for the rest of your life.  You will spend up to your income and never get ahead.

And it doesn't matter how much you make - you can live "paycheck to paycheck" on $172,000 a year.

And this was not some sudden revelation, like Saul's conversion on the road to Damascus.  It has been an ongoing thing of a decade or more.   Every day, it seems, I discover something new - a new way of looking at life that is different and clearer than before.

And it has been a fun and interesting journey.  I only wished some of these revelations came earlier in life.

Getting a handle on your finances, however, is key.  You need to know where you are spending money.  And no, I don't mean some stupid online thing like "mint" that just shows you pie charts of spending.   You also need to log your net worth, regularly, and see whether it is increasing - or going down.

When you run your life like a business, it is far easier to show a profit.

When Opporuntity Knocks - And It Will!

Opportunity will knock on your door in your life, at least once.   Will you be able to answer?

I have had several opportunities in my life to make money.  And I was able to take advantage of most of them.  Others often turn away opportunities, often because they chain themselves to possessions and debt.  One problem with opportunity, is that it often requires sacrifice.   And this means you have to be in a position to be mobile and agile, when the time comes.

Your friends want to start a start-up company.  There is no money, and everyone will be paid in stock.  Can you take this chance, or are you tied down with car payments and cable bills?   It sounds silly, but there are legions of people in Silicon Valley who will tell you, after a few drinks, that they were offered jobs at famous start-ups, and would be Millionaires or even Billionaires today, but for the fact they thought that a car payment was more important -and they had no money saved in the bank to live on, until the company was profitable.

Of course, such extreme opportunities are pretty rare.  But you may have others in your life - and whether or not you can take them will depend on how your finances are structured.  If you are heavily in debt and have no assets whatsoever, well, most opportunities will pass you by.

In my own life, I've had a lot of opportunities, and fortunately I was able to grab onto some of them.

I had a chance to start my own practice only a few years out of Law School.   It was not easy to do, but one reason I could was that my mortgage payments and other obligations were low.  I had a small mortgage on a small house and didn't do what many of my peers did when they got that "great job" - which was to go out and buy the most expensive house they could find, preferable an hour and a half from work.

I had no car payments and only about $200 a month in Student Loans.  So I could afford to take a risk and "coast" on savings while my practice was established.

I had a chance to buy my office building in Old Town Alexandria for my practice.  Again, not having a lot of debt on my principal residence, I could make this work.  If I had bought a mini-mansion, I would have had a nice house, but never my own practice.  Which is better?

A friend of mine started a bank and asked me to invest - the buy-in was $10,000.  Five years later, it is worth $50,000.  Opportunity knocks.
 
I had the chance to buy some investment properties.  Again, not having cable bills and a huge personal mortgage, I could put that debt load to good use on a property that was self-funding.   My peers with their fabulous mini-mansions had fancy houses, but only one each.  I had four - with three of them paying for themselves.

Which is better?

And so on down the line.   At times in my life, I also "fell off the wagon" and accumulated more debt.  And while this seemed like a lot of fun at the time, it also meant that, at the time, I had to pass up opportunities that would have been sure money-makers.

But what happens if Opportunity Doesn't Knock?  Yea, sometimes it doesn't - or people don't perceive opportunities laid in their lap, but instead go out looking for long-shot deals.  They get so far behind in life, buying consumer goods, that they latch on to the nearest con artist who wants to sell them something - and end up screwed utterly.

They want to double-down their bet, and end up just doubling-down their debt.   These are the folks who leveraged themselves to "invest" in negative-cash flow Real Estate in 2005 (or worse yet, zero-income producing mini-mansions as personal residences) and are now utterly broke today.

Yes, Opportunity may not knock - but it is guaranteed that Adversity will.   Bad things will happen in your life - you will lose a job, have a health crises, whatever.   You will likely be laid off at age 55, years before you "planned" on retiring.

And if you are so leveraged you cannot take advantage of opportunities, how will you deal with adversities?

Just food for thought.

You Have to Pay it Back

Unless you can relieve a debt through bankruptcy, you have to pay it back.  There is no third path.

I have received a number of inquiries lately from folks about their personal predicaments with regard to savings and debt.

First of all, I am not Soozie Freaking Orman, or Dave "Praise Jesus and give him 10%" Ramsey.  I am not going to say "You're Approved!" for your latest new car purchase.  I will just tell you that you are an idiot for even considering it.

And this isn't Ann Landers, either.  I don't give advice.

If you are in debt, you have only two choices:  Pay it back or work it out through bankruptcy.   There is no third choice, no "trick to the tiny belly" and all that other crapola they try to sell you these days.

And if you believe that sort of thing, they will take all your money and leave you destitute.

And if your debt is student loan debt, well, you can't even discharge that through bankruptcy.  Student Loan Debt forgiveness is very, very hard to come by, and you have to show a real hardship to get it.

And by real hardship, I don't mean doing without Cable television, a smart phone, and a new car.

You do have one area of control in your life, and that is in SPENDING.   And what I have learned in this blog, going from living on over $100,000 a year to less than $50,000 is that spending is the key - and we spend a LOT on crap we don't need or want.

For example, Suzie has $50,000 in student loan debts and pays $100 a month for Cable Television.   How can she ever pay off this debt?   It seems intractable.  Hard to believe she actually went to college and can't grasp how compound interest works!  Yes, the first year is almost all interest.  The last is almost all principal.  Google "loan amortization" sometime, Suzie!

Which is why, if you make even one extra payment a year it can knock years off a loan.   What?  They didn't teach this in Kollege?

Consider a 10-year student loan, $50,000 at 8% interest.  That's $606.64 a month in payments, over ten years.  Now Suppose Suzie decides to pay an additional $45 a month on that loan.   $45 a month - not a lot of money - not even one full loan payment a year.   What is the term of the loan now?  Yup, nine years.  It knocks a full year off the loan.

Why?  The magic of compound interest.  When you pay down principal, you pay less interest, which means more of the remaining payments go toward principal, which in turn knocks down more interest.  Even a small additional payment every month makes a difference, over time.

Yet, most people fail to see this.  "I paid an additional $50 last month," Jeff cries, "and my student loan still isn't paid off!   So obviously, that idea doesn't work!"

Might want to give it a wee bit more time there, Jeff!  But that is the attitude of the young.  They put $100 in their 401(k) and don't become instant millionaires, so they quit.   No, really, I've seen this happen!

Seriously, these people went to College and took Calculus and still can't figure out compound interest?

Getting back to Suzie, suppose she calls the cable company and cuts the cable entirely.   She needs it like a hole in the head, anyway.   Just bad normative cues.   She takes that $100 a month and puts it toward the student loan.  Now the term of the loan is eight years.

Seems like magic, right?  After all, $50,000 is a "lot of money" and $100 is a "small amount".   Right?  Subscription services are evil this way, which is why I say, cut them out whenever possible.  Stupid stuff like XM radio and Onstar are just worthless wastes of money - enormous amounts of money, over time.

You can play with the numbers - the interest rate, the balance owed, the term of the loan, whatever.   What ends up happening is pretty amazing.  If you make an extra mortgage payment every year on your house, for example, you can slice seven years off a 30-year mortgage.  But you have to cut your spending by an equal amount.  That's the trick!

And where you get the money to make these extra payments really doesn't matter.  I use Cable television as an example of an utterly worthless subscription service you could really live without (and yet many folks think is like oxygen).   Giving up Starbucks, cutting up credit cards, not "shopping", doing without a smart phone, making your lunch and taking it to work - all of these can save you an enormous amount of money over time.  $5 a day is a lot of money, yet many people spend that on coffee at Starbucks.

The key is, of course, to get into habits like this.  Most of us - myself included - spend up to our income and pay the minimum amount due on our debts.   We have more 'stuff' in our lives and enjoy going out with friends to restaurants and eating lunch out with our co-workers, and of course, watch 4.6 hours of TeeVee every night, after driving home in our shiny new Acura.  And then we wonder why we are broke, fat, in debt up to our eyeballs, and unhappy.

It is a choice, a conscious choice.  And one we all make -for good or bad.   There is no easy way out, no trick, no "Obama debt forgiveness plan" (college graduates really think this?  What do they teach in college  these days?  Macramé?)

And these same college graduates read my blog and miss the entire point of it.  They pester me whether it is "OK" to buy a brand-new car, since used ones are "so expensive these days" and Brand X "doesn't depreciate much" (both lies we tell ourselves), and hey, maybe Dad will co-sign the loan for me?  Sorry!  No Sale!

This blog isn't about consumerism, and how to spend more money, but how to spend less and spend it more effectively.   Your average salary slave pays a ton of money for a brand-new econobox - more than twice what I pay to drive used BMWs.    He drinks lite beer and pays more for it than I pay for champagne.    He pays more money to live in Foreclosure Mews Townhouse Estates that I pay to live in a State Park on an Island.  Why? because he isn't smart about how he spends, and when he spends, he does it all with borrowed money.

So what is the "trick to the tiny belly?"  It is not in spending more but in spending less - and being smart about how you spend.   Paying off debt so you are not on the hamster wheel of interest payments for the rest of your life.

Many people want the opposite - they want all this brand-new "stuff" right this very second and are not willing to sacrifice now to have it later for less cost, or even free.  So they sign loan documents, and sacrifice the later for the now.

The problem with this approach is that if you sacrifice now it is done and over with, and it does not hang over your head later.   Moreover, it is not an open-ended commitment.  When you leverage your later for the now, what happens when later changes - for example, you are laid-off at age 55 and still paying back loans for stuff you bought  when you were 30?  Bad things happen, that's what.

There is time to change course - to rethink your life and stop viewing it through the consumerist mindset touted by television and the media.  And yes, this goes against everything you have been taught since you were a child.  That spending is "fun" that consumerism is "great" and that being hopelessly in debt is "normal" and the only problem in life is how to raise your credit score so you can acquire more and more debt and more and more crap.

The hardest part of getting out of debt is making the decision to do so - seriously!

And yes, it is not impossible to do.  I have friends who are very frugal and smart with money, and have lived this way since age 21.   They do very well for themselves as they avoid going into debt for something as stupid as a car, and instead put money in the bank.   It isn't impossible to do - it is just that few people choose to do it.

So, my "advice" for Suzie is this:  Cut back on spending - and you know there are places in your life you can cut back.  Get rid of cable.   Cut out the smart phone.   Cut out the Starbucks.  Get a roommate and split the cost of rent (or have them help pay off your mortgage).  Stop shopping.  Cut up credit cards.  Whatever. 

In everyone's life there are places they can save money.  I switched from drinking coffee to drinking tea, and saved $450 a year.  No, really!  Amazing what a few minutes with a calculator will reveal.

It can be done.  You have to choose to do it.   And it means changing your whole value system.  Once you stop watching television, however, it becomes much, much easier.  You have to stop engaging in weak thinking and stop using the television and your brain-dead neighbors and co-workers as normative cues on how to live your life.   This is why immigrants do so well - they don't buy into the crap that native-born Americans do - they save their money and build wealth.  And we hate them, because they are successful and show us up at every turn.

But, alas, some folks still want the secret "trick" that lets them buy the new car, keep the Cable TV and the smart phone, and still reduce their debts.  But it ain't happening.   They would rather mortgage their lives than make small sacrifices.   And in this regard, my giving advice to them is like telling a pothead to stop smoking pot, if they want to move out of Mom's basement. 

"No, seriously, dude, besides giving up pot, what can I do?"

Uh, dude, you just took the only real answer, off the table.

Sorry, but there is no Genie.  And if a Genie seems to appear, well, watch out!

That's all I can say.

But Can You Really Afford It?

 A shiny new car!  You can afford the monthly payments, right?  Or can you?

One thing the "Affordable Health Care Act" is forcing us to do, is consider health care as part of our budget.   For many of us, this is already the case - we fulfill our part of the Unwritten Social Contract by buying health insurance, because we are not idiots and not white trash.

Others prefer to go without health care, claiming they cannot afford it, while at the same time buying a motorcycle and cable television.

But beyond health care, there are other things that you should be funding as well - such as your Estate.

Many a young person forgoes contributing to their 401(k) program on the premise that they will "do that later" and the $300 a month they are not spending on their own retirement is money that can buy beer or a new car.

They don't realize how hard it is to try to play "catch up" later on in life, and how advantageous compound interest is to them - when they have nothing but time.

So they would rather have a shiny new econobox car and no money in the bank, than a real net worth and an old clunker.  That is, in a nutshell, their choice.   And  it is a choice a staggering number of Americans have made these days - and this is going to come home to roost, in a big way, as the bulk of the baby boomers retire in the coming decade.

One popular search that finds this blog is, "How can I retire on $1500 a month?" and that is sad indeed.   These are folks trying to live single on Social Security.  You do the math on that - how can you live on $1500 a month.  You'd probably be better off without a car at all.

How did those folks get there?  It didn't happen suddenly at age 60.  It started at age 23, when they bought that new Camaro - which has long since rusted out and gone to the junkyard.    They wanted to have a hot car at that age.   But hot cars last maybe a few years, at best.   The hot car of 1985 is a bad joke, today.

Trashing your future for a car is nonsense.  But people do it all the time.

Why?  Well, Joe Salary Slave takes home $3000 a month, after taxes, which might be about $50,000 a year, gross.  He pays $1200 on rent or a mortgage payments, leaving him $1800 to spend on utilities, food, and other expenses.  To him, $500 a month on a car payment doesn't seem like a lot of money, compared to $1800 he has to spend!

But of course, if he is a young person, his insurance is another $200 to $300 a month, particularly after a couple of speeding tickets.   Pretty soon, his disposable income is down to bubkis - and we can't figure out why he is broke.  After all, it can't be the car - that only costs $500 a month!

But it gets worse - a lot worse.   In order to have more "stuff" now, our young salaryman decided not to participate in his company's 401(k).  Or maybe, after facing a tighter budget, he cuts his contributions severely.  This is a dumb move.

And maybe, if his company doesn't offer health insurance, he doesn't bother to fund his own plan - thinking that as a young person, he is healthy enough, and spending $99 a month on health insurance is a "waste" anyway.   It is short-sighted thinking.

The problem is, you have to fund these things over time.   And if you don't, well, you will be in a bad place later on.

Here are some simple rules of thumb to apply before you take out a loan or buy some big-ticket item - or even a small item with a recurring monthly fee (like cable TV or a cell phone):

1.  What is Your Net Worth?    If you can't answer this question, borrowing and spending are bad ideas.  I know I was in that situation when I was 25 - not having a clue as to whether I even had a net worth.   And probably the reason why, was, it was negative.   Yes, what little savings I had and equity in my home were dwarfed by car payments, credit card debt, and student loan debt.  My net worth would not go positive until I was about 30.   And that is just sad, let me tell you.   And unnecessary.

2.  How large is the purchase relative to your net worth?   I wrote before about the fellow I saw who had a $70,000 BMW parked in front of a $120,000 modular home.   A pretty stupid way to live, frankly.  But many people do this.  I was at another neighborhood recently, where the homes sell for under $200,000.  The neighbor had a new Mercedes, BMW, a Luxury SUV, an expensive boat, and a Jet Ski parked out  front.  His depreciating assets cost more than his home.

Yes, you can kid yourself that you can "afford" to lease a brand-new BMW or a Mercedes, or even buy one.  But it is pretend wealth not real wealth.  And spending $70,000 on a car when your net worth is barely $50,000 makes no sense at all.   In ten years, that car will be worth $15,000 - I know this, because that's when I would buy it.   And the damage to your net worth is staggering.

If you are looking at a car that costs more than your home or your net worth, think about this carefully.   In the few years it takes to pay off a car loan, you could more than double your net worth.   Or have a cool car for a few years.   Which is dumb and which is smart?

3. What are the hidden costs?   As I noted in the real cost of owning a car even a $20,000 car can cost $8000 a year, in terms of depreciation, gas, oil, tires, insurance, etc.   When I tallied all this up, I realized that even a "paid for" car costs you, in terms of depreciation - even if you don't drive it much.   Every day it sits there, it is worth less.  And yes, some day you will sell it and realize that loss.

The monthly payment is only part of the deal.

4.  What is the overall transaction cost?   Most people think in terms of monthly payment.   If you learn nothing else here, get out of that mindset - it is the road to poverty.   When you say "my car costs $500 a month" you are talking only about car payments, not the overall transaction cost over time.  When you add that up, it can be staggering - and make putting a new set of tires on your old car seem pretty cheap in comparison.


5.  Are you fully funding your 401(k) and Health Insurance?  If you answer "No" to either, than you have no business buying more shit.  You are just hurting yourself, over time.  And this is why we have to have a "mandate" for health care coverage - because deadbeats like you spend their health care dollars on a Camaro and then stiff the hospital (and the rest of us) for the money.

If you are not funding your retirement, well, it will catch up with you, over time - and you will be miserable at an older age.   Even in just a few short years, it will catch up with you.   If you have no savings and are heavily leveraged in debt, forget about buying a house or starting a business - or doing anything other than working as a drone to pay your bills.

Yes, Americans complain they work "paycheck to paycheck" - but they do this voluntarily and willingly - in most instances.   I examine the finances of many such complainers, and usually find their budgets padded with smart phones, Cable television, and not one, but two new car payments.  They have all the toys and all the bills.  But of course, savings and health care are not among them.

They can afford it - but they really can't afford it.   Not if they did the real math.