Investing Archives - The Broke Professional

Is the Market Going to Crash Soon? Who Cares!!??

This is going to be a quick public service announcement post.

Lately, I’ve been hearing a lot of talk in the media about how the market crash is coming and we need to panic.  The cover of the latest issue of Fortune magazine had a guy with a sign saying “The End is Near”.

I know these types of story lines and images are made to sell ad space and make publishers lots of money.  But here are two indisputable truths when it comes to long term investing:

The stock market WILL go down.

Most people, especially the financial media, look at a stock market decline as an abnormal event that requires you to make some snap investment decisions.  The fact is, market declines are expected and should be assumed when you make your investment plan.  Here is a chart of the historical performance of the S&P 500:

The starting value of the S&P was 250 in 1930.  The most recent valuation had the index at 2800.  That’s more than a 1,000% return.  Not too shabby.  But as you can see in the chart, there were many dips along the way.  It was a very bumpy ride and will most likely continue to be bumpy.

Corrections and recessions are to be expected.  Investors should not be surprised when they occur.

Indisputable truth #2:

For long term investors, market drops SHOULD NOT change behavior.

When there is a market drop or recession, you will see the pundits talk about where to “shelter” your investments.  The safety of bonds will be talked and written about.  And you will see people panic and do very stupid things with their money.  Especially with their retirement accounts.

Market drops should be expected during your investment journey.  If you’re investing in a 401K or IRA which you can’t touch until age 60, there is no reason a recession should spook you when you’re age 40.  If anything, a market drop might compel you to increase your contributions since stocks will be cheaper.

As long as you make a sound investment plan that takes market drops into account, your retirement accounts should be able to weather any recessions, which last 2 years on average.  Stay the course and keep contributing to increase your shares.

No, the end is not near after all.

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Pay Off Debt With a Strategy

Debt is a way of life in America.  It’s easy to acquire and everyone has got it.  The vast majority of people buy homes and cars with debt.  It’s almost impossible to go to college with no student loan debt, especially for any type of graduate or professional school.

People are comfortable with debt, even high interest credit card debt.  And that is a problem.  But that’s for another post.

The problem I want to discuss in this post is how people pay off debt.  And the big problem is that many people, even high income professionals, have no debt payoff strategy.  They usually pay the minimum and then maybe (or maybe not) throw some extra money once in a while at the debt.

This is very inefficient since there are certain types of debt that should be paid off first and there are certain debts that are actually okay to have around.  Some debts should take priority in being paid off over others.

Having a clear debt payoff strategy will allow you to get out of debt faster and, most importantly, minimize the stress associated with having debt.  A debt payoff strategy will allow you to know how much you will end up paying in interest payments and how long you will be paying the debt off.

Here are three debt strategies to consider:

Strategy #1:  Pay the minimum and pray

This seems to be the strategy favored by most Americans.  Safe to say I don’t recommend it.

It can be soul crushing to just get by paying the minimum payment while knowing there are decades of debt in your future.  Probably why most people just try to forget their debt even though it’s eroding their wealth.

Let’s just move on to the next method.

Strategy#2:  Snowball method

The snowball method was popularized by Dave Ramsey and is perpetuated by his rabid followers.  I don’t agree with a lot of things Dave says (such as not having credit cards), but the snowball method is one of the good things he’s put forward.

(Quick tangent:  I’m not a big fan of these finance “icons” or “gurus” like Dave Ramsey or Suze Orman.  The reason is that they are not genuine.  They did not get wealthy by doing what they tell their followers.  Things like “save up a $1,000 emergency fund” and “get your 401k match!” is good advice, but it’s not how Dave Ramsey got rich.

He got rich by putting all of his energy into growing his business.  He got rich by selling products and building his empire, not by creating an emergency fund.  And I’m pretty certain he laughs at the idea of an emergency fund.  Same goes for Suze and any other larger than life finance guru.

They’re business people and they got wealthy by focusing on that.  I would respect these guys a lot more if they were sincere in helping people.  But all they do is create books and courses for the “working man” that have the same old advice in a shiny new package.  Rant over.)

I’m on to you Dave…

The snowball method is simply making a list of your debts by balance, and focusing on paying off the one with the lowest balance.  Obviously, you make the minimum payment on the rest of the loans to keep them current and avoid late fees.

But then you throw everything you can at the loan with the lowest balance.  When that is paid off, you roll (like a snowball!) the minimum payment of the paid off loan into the loan with the next lowest balance.  And proceed to obliterate it with all you have.

I used to dismiss the snowball method because technically it’s not the mathematically best way to get out of debt.  But money is so much about psychology that having a system like this that propels you forward is much better than being discouraged by debt and not having a strategy at all.

Seeing those low balance debts disappear does have a positive effect on your psyche and will keep you in the fight.  For debt payoff novices especially, I would recommend the snowball method.  Just put your head down and plug away at the lowest balance debt and move on to the next.

Strategy#3:  Avalanche method

The absolute mathematically quickest way to get out of debt is the Avalanche method.  It’s the method I use and it has saved me tons in interest.  I’m not sure who coined the term, but I like the idea of an avalanche destroying my debt as opposed to a snowball.

With the Avalanche method, you list your debts in order from highest interest rate to lowest.  Every month you would pay the minimum on all your debts, and focus on eliminating the debt with the highest interest rate.  Then you turn that minimum payment around into the debt with the next highest interest rate.

This is the quickest way to get out of debt.  There’s no argument about that.  But it does require some more upfront work with no apparent payoff in the form of more money.  But once you eliminate the first few higher interest debts, the rest will be engulfed in the avalanche in no time.

The best method

Too many people are in denial about their debt.  I see this a lot regarding student loans.  Doctors and lawyers usually have very high student loan debt.  We’re talking six figures easily.  This kind of debt can seem crushing and it would be easy to turn a blind eye and just make the minimum payment month after month.

That’s a surefire way to pay the most interest possible over your lifetime.  Having a debt payoff plan at all would be great progress for a lot of people.  So using either the snowball or avalanche method is fine by me.  But I think the best way to pay off the debt would be a hybrid version of the two.

How this would work is focus on paying off the first couple of low balance debts to get some progress under your belt.  Once you do that, shift your focus to your highest interest debt to really attack that total balance.  So start with the snowball and switch to the avalanche.  It’ll feel much better to be out of debt in a few years rather than a few decades!

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Plan Out Your Paycheck

The key to getting ahead financially is to spend less than you earn.  There is literally no other way to achieve financial freedom.  This applies to billionaires and regular old working people.

But it’s not easy.  We hear about the athletes and actors who are in debt because of overspending despite making millions of dollars over their careers. If you make $10 million but spend $11 million, you are not in good shape.

However, this is a problem for people of all income levels.  Things like credit cards, mortgages and other personal loans have made it super easy to spend more than you earn.  Easy access to credit makes people more greedy for things like fancy cars and big houses which can create more debt.

A big reason why Americans find it difficult to save our hard earned, and highly taxed (federal tax, state tax AND sales tax!) money is that very little planning is done when receiving that bi-weekly paycheck.  Everyone looks forward to Friday payday but for most people the money hits their checking account with no thought to where it’s going next.

And this is where the trouble begins.  Most of the time that money just gets spent on various bills.  And nothing is left over for savings.  Rinse lather and repeat every 2 weeks.

Now it’s easy to see why lack of planning is a big reason people have a hard time saving.  So what’s the solution?

Checking is the Central Hub

I like to think of my checking account as the control center of my finances.  Money goes in and is then distributed to where it needs to go.  It’s not a place where I like to park money since I like to have my money either invested or paying off debt.

This requires a mindset shift since most people, including my past self, just park their money in checking and paid bills as they came in and tried to save if possible.  Not a real financial strategy since most of the time you’re just trying to keep your head above water.

I consider this a very REACTIVE way to handle your paycheck.  You just kind of pay bills as they show up and have no real savings strategy.  Worse, any extra money that happens to be sitting in checking usually just gets spent.

A more PROACTIVE way to handle your paycheck is to have multiple destinations set up before the money arrives.  That way you can be sure money gets where it needs to be according to your financial goals.

Pay Yourself First Every time

Most people have heard the financial cliche “pay yourself first”.  It’s another core financial concept just like “spend less than you earn”.  While both of these sayings sound fun and useful, they can be difficult to implement.  While most people WANT to save, it just doesn’t end up happening (evidenced by the fact that the average American saves less than 5% of their income).

So if you can’t will your way to save, the next best thing is to get out of your own way and let robots do the work.  This is done through automatic saving and investment plans which are very easy to set up.

Want to save $500 a month in your emergency savings plan?  Set up an automatic monthly deposit.  Finally want to max out your Roth IRA?  Just start a monthly transfer from your brokers website for a $458.33 monthly transfer from your checking account (That’s the $5,500 IRA max divided by 12 months).

You can also set up automatic payments for your credit cards.  This way you’ll never have a late payment and you can use the full grace period the card issuer gives.

It might take a few months to get all of your major goals and bills set up but once you do, money will be moving in and out like clockwork.  You’ll be able to meet your financial goals with a minimal amount of maintenance needed.

And that’s the best way to pay yourself first.  Set up automatic transfers into all of the different accounts you want to save into.  Those transactions should shape how much you spend.  Unfortunately, most people just save whatever they can AFTER they have spent to their heart’s content.

There’s usually not much left for savings after that.

Conclusion

“Spend less than you earn” and “pay yourself first” are two common personal finance phrases that are difficult to put into action.  But these are the two things you have to do in order to meet your financial goals.

The best way I’ve found to do both of these things is to have a plan for any money that hits your checking account.  With technology today it takes a few clicks or smartphone taps to set up automatic transfers from your checking account into your savings account of choice (emergency savings, IRA, brokerage account, student loan accounts to name a few).

Once you get all of these transfers set up, managing your money becomes a breeze.  And you can meet your financial goals with minimal ongoing effort.

Treating your checking account like your money managing robot will make sure your spending less than you earn and paying yourself first month after month.

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Big Tax Changes You Need to Know About

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law.  This was one of his pet projects and something he has promising since his campaign.  He also promised that this law would give middle class families a huge tax break.  That remains to be seen.

The TCJA went into effect on January 1, 2018 and it comes with many big changes.  For some people, the effect will be large and there will be lots of planning that needs to get done.  For others, there might be a small change here and there but nothing that would require any real behavior change.

The TCJA provides the first sweeping tax change since the Reagan era.  So it’s important to know how it will effect you.  In this post, I’m going to go over some of the biggest changes in the tax law and what changes you need to make, if any.

If you want to read the bill in its entirety, be my guest.  Otherwise, here are the biggest changes you need to know about.

Much Bigger Standard Deduction

When you file your taxes at the beginning of the year, you have the option of taking the standard deduction or itemizing your deductions.  I’ve written about this before here, but the most common itemized deductions are mortgage interest, property taxes and charitable contributions.  If you have a high amount of these types of payments during the year, chances are you will save more on taxes by itemizing.

This will change for a lot of people this year.  For 2017, the standard deduction amount for single filers was $6,500 ($13,000 married).  The new standard deduction for 2018 will be $12,000 ($24,000 married).  Meaning there will be many more people choosing to take the standard deduction.  This simplifies the tax code in general, but it comes at the expense of other favorable tax treatment as I will explain below.

Behavior change: Most homeowners choose to itemize based on their mortgage interest deduction.  If you won’t be able to do that for 2018 because of the new standard deduction amounts, then the popular mortgage interest deduction doesn’t really provide any benefit.  Depending on your financial plan, it might be time to consider paying your mortgage off early.

State Income and Property Tax Limits Imposed

In 2017, you could itemize your deductions by writing off your state income tax and property tax.  This was an unlimited deduction for the most part.  Helpful for everyone, but especially for those with high state and property taxes.  But change is afoot.

For 2018, you can only deduct a maximum of $10,000 combined state income and property tax.  This is a huge change and will hit those who live in big coastal cities the hardest.  Homeowners in high tax states can easily pay $20K in state income tax and property tax combined.  This rule puts them in a real bind.

Behavior change:  Move or start renting.  For those who live in states like California or New York and have been contemplating a move to a cheaper part of the country, this will give you a little more motivation.

Elimination of Personal Exemptions

This is a key change that will hurt many working professionals with kids.  In 2017, for every member of your family (including yourself), you could take a tax deduction just for being alive.  The value was $4,050 for each family member.

So a family of 4 could take a deduction of $16,200.  This deduction is completely eliminated for 2018.  This is one reason the standard deduction for 2018 will be higher.  It will make the tax code simpler, but will hit couples with children the hardest.  It is slightly offset by the next change I will discuss.

Behavior change:  Not really much you can do here.

New and Improved Child Tax Credit

Tax credits are much better than deductions.  They provide a dollar for dollar reduction in the tax you owe, while a deduction simply adjusts your income a little lower.  The Child Tax Credit has been a nice one that has been around for about 20 years.  It provided families a $1,000 credit for each eligible child.

The problem was, the income phaseout limits were pretty restrictive for many professionals.  For married couples, once their income hit $110,000 the credit was reduced.  For high income professionals, the Child Tax Credit was a pipe dream.

But it is getting a big face lift for 2018.  The Child Tax Credit will now be worth $2,000 per eligible child.  Also, the income limit increases from $110,000 for married couples to $400,000.  

This will make the Child Tax Credit a reality for many couples.  It will also lessen the sting of the personal exemption elimination.  This change is a nice win for all.

Behavior change:  Have more kids!

Tax Bracket Adjustments

The tax bracket changes are another big one.  Essentially all the tax brackets (except the 10%) will be reduced.  And the 35% bracket is widened considerably, which will help high income couples.  Here is the old 2017 bracket:

Here is the new 2018 bracket:

So most people will see a slight decrease in their taxable income.  Not too bad.  This will be the way most people will see some tax savings.

Behavior change:  Employers should be adjusting paychecks to reflect the new tax changes by February.  Just take any extra money you find and add it to your savings and investment plan.  There is no use to have savings if you don’t use the money right?

Student Loan Interest Deduction

Just kidding!  No changes here thankfully.  The deduction maximum of $2,500 remains the same.  Though it would be nice if it was a little higher since tuition rates, and thus student loan balances, are constantly increasing.

Conclusion

The big winners of this tax reform seem to be large corporations, who saw their maximum tax rate changed from 35% to 21%.  Whether this will translate into more cash for employees and a healthier economy, only time will tell.  Families who can take advantage of the Child Tax Credit will also win.

The big losers are high income single filers who own homes in a high cost of living area.  They get hit on so many levels, but especially the state and property tax limit.  Another thing to consider is that these changes are not permanent for the most part.  Many of the big changes will “sunset” in 2027, which will then revert back to the old tax laws.  Nothing in politics is permanent after all.

These changes will affect our returns we do in 2019, so we still have some time to see what the effect on the country as a whole will be.  But it’s important to know the big changes and how you will have to change the way you approach money.  Stay tuned!

(Micheal Kitces CFP provides a great and detailed overview of the tax changes here.  If you want to dig in a little more, this is a great resource.)

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Start Tracking Your Net Worth in the New Year

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Everyone has heard the stat about the high failure rate of New Year’s resolutions:

8% of New Year’s resolutions fail

80% fail by February

Greater than 90% failure rate

So if you’ve made a New Year’s resolution for 2018, your chances of achieving it look grim.

The two most common New Year’s resolution goals are health and money.  Which means that there are a lot of failed financial New Year’s resolutions year after year.

My thought is that many people make very vague resolutions.  Goals like “I need to save more” and “We need to spend less on eating out” sound very nice in theory.  But are very hard to put into practice.

Along with being too vague, many resolutions fail because we don’t have an understanding of where we are.  It’s a cliched example, but you need a destination and a starting point in order to have accurate directions.

Making vague resolutions is like picking out a destination without knowing where the starting point is.  So you have no way of knowing if the direction you’re taking is going towards your goal or completely away from it.

You need to know where you stand financially before you can make an effective goal, let alone reach that goal.  I feel the best way to find your financial starting point is not by seeing how much you have in your checking or savings account.  It’s not the equity you have in your home.  And it’s definitely not how flashy your car is.

The best way is finding your net worth.  With the technology available today, calculating your net worth is very simple.  If this is the only financial resolution you make this year, you will be much better off than you were last year.

Why Net Worth Matters

The net worth calculation is very simple:

Assets-Liabilities=Net Worth

There is always discussion about what is considered a liability or an asset.  Some people consider home value an asset.  Some people don’t consider home value since it takes a lot of work to get money out of a home.  The details are endless.

But in general, as asset is something that adds to your wealth while a liability is something that takes away from it.  Common assets include your checking and savings accounts and retirement accounts.  Liabilities include credit card debt and student loans.

So net worth is basically a snapshot of your financial health.  But just like any snapshot, one picture doesn’t tell the story.

A new medical school graduate has little in savings and hundreds of thousands in student loan debt.  That will give him a large negative net worth.  A high school student probably has some spending money but very few liabilities since he lives with his parents.  So he would have a slightly positive net worth.

Does that mean the high school student is more wealthy than the new doctor?  The answer is no because net worth should be used to measure your financial GROWTH rather than a static number that looks at your wealth.  In 10 years time, the new doctor will likely have a net worth light years ahead of the high school kid.

So the key to wealth creation is to grow your net worth over time and grow it quickly.

My Net Worth Tracking Strategy

There are so many different opinions about how often you should track your net worth.  Some say every month (some people even track it every day!).  While others say once a year is enough.  The key is to find a pace you’re comfortable with and keep it consistent.

Personally, I check my net worth every quarter.  I actually enjoy checking up on my accounts and seeing how they’ve changed.  It also allow me to make sure there’s no fraud or any funny business going on in any of my accounts.

And doing it quarterly is enough time to see if new strategies I’ve implemented are actually making a difference.  Plus, most companies operate in quarterly statements so there must be some wisdom in it.

As far as what high tech tools I use, an Excel spreadsheet and a Word document are my weapons of choice.  I use the Excel document to help me calculate my net worth and I record the values over time in my Word document.  Easy peasy.

But one piece of technology that helps check my work and give me more insight into my net worth and retirement is Personal Capital.  I’ve been using it for years to view my net worth and they have been getting better over time.

All you need to do is connect your various accounts and Personal Capital will monitor them.  They can’t make any transactions so there is no need to worry about security.  They simply monitor your account value and have your net worth displayed nicely in graph form.

Which is great since net worth growth is the true measure of financial wellness.  Physically seeing it as a graph really drives it home.

Other cool features of Personal Capital are the Investment Checkup and Retirement Fee analyzer tools.  They can analyze the holdings in your investment accounts and tell you where you may be over or underweight.  And they will also check the fees in your accounts so you can make sure you’re not paying too much.

And it’s all free.  There is an option to talk to a real financial adviser for a fee but that’s completely up to you.  Most of the powerful features of the program are no cost.

Conclusion

Deciding to grow your net worth is the best thing you can do to turn your financial life around.  Thinking in terms of net worth rather than just making and spending more money will allow you to see your finances in a whole new way.

Suddenly, paying a huge monthly bill for that fancy luxury car when a regular old Toyota will do just fine doesn’t seem that enticing.  A decision like that can keep your net worth from growing the way you would like.  Thinking in terms of net worth rather than just focusing on your checking account is the real way to get wealthy.

Tracking your net worth consistently with Personal Capital is an excellent way to start the journey towards real wealth.

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Dollar Cost Averaging is the Best Way to Invest

Ask the average American or young professional what things SHOULD be doing with their finances.  You’ll get the usual answers like budgeting and saving.  They will also talk about how they need to spend less on things like eating out and clothes.

One other thing you’ll almost always hear about is the desire to invest.  Most people know they need to invest for things like retirement or a future house down payment.

The problem isn’t that we aren’t interested in investing.  Or that we don’t want to invest.

The main problem is that people don’t know HOW to invest their money.  They want to know which types of accounts to open and how to transfer money to keep investments growing.

This post will outline what I think is the most efficient and effective way to invest: Dollar Cost Averaging.

Dollar Cost Averaging: Slow and Steady Wins

There are essentially three ways to invest your hard earned money:

1.  Invest a lump sum all at once:  Mathematically, this is the most efficient way to invest.  Having a large amount of money invested in things like stocks or mutual funds will give your investment growth a turbo boost.

And studies have shown this.  Lump sum investing will give you the highest return over any other method of deploying your money.    And I would agree if you have a large sum of money, put it to work all at once if you intend to invest it.  No need having cash on the sidelines not working for you.

While this is the best way to invest, it’s only applicable a few times in life.  If you get a large sum from an inheritance, selling a business or a large bonus, then you should employ this strategy.

But most people get paid their salary in small intervals throughout the year.  So lump sum investing is not really in the discussion.

2.  Dollar Cost Average (DCA):  We live in a monthly payment kind of world.  Almost all of our bills including mortgage, auto loans and cell phones are debited once a month.  We’re used to being dinged monthly for the services we use.  Why not use that same mindset when it comes to investing our money?

This is why I love DCA and why it is my own preferred investing strategy.  Instead of investing haphazardly or when we hear a hot stock tip from a co-worker, DCA takes the emotion out of investing and lets you stick to your investing plan for the long term.

How does it work?  Let’s use a Roth IRA for example.  You know you need to save a little more for retirement beyond your company 401k, so you would like to set up a Roth IRA to be invested in the stock market.

Once you set up the account and select your investments (my favorite is VTSAX but that’s a story for another post), you will be asked to link your checking account.  Then you select how much you want taken out monthly and set your withdrawal date.  And that’s all there is to it!

You will be dinged monthly just like you would for any other bill.  But this is a good ding since that money will be invested for you retirement instead of being spent on the latest iPhone insurance.

3.  Don’t invest at all:  This is not recommended.  But it seems like it’s the American way since 1 in 3 Americans have no money at all saved for retirement.

Buy Low and Sell High

The best way to make money selling things is buying at a low price and selling at a high price.  That’s the logic behind dumpster diving and being a garage sale vulture.  And that’s also the logic behind making money as an investor.

Being invested in the stock market can literally be a roller coaster ride.  There are going to be ups and downs.  Sometimes really big ups and downs.  But as long as the price of your investments is more than what you paid for it initially, you will make more money.

Buying your investments at a low price and selling at a higher price is what makes investors money.  Many people get spooked and sell their investments when the stock market takes a sharp dive, like it did in 2008.  As a result, they lose a lot of money by buying high and selling low.  This is bad.

The beauty of investing via DCA is that it FORCES you to buy low.  If you decide to invest $100 a month into a mutual fund that costs $10 a share, that $100 investment will get you 10 shares.  If the mutual fund doubles to $20 a share next month, you will end up with only 5 shares.

While that is still more expensive than last month’s investment, DCA allows you to scoop up more investments while the shares are cheap.  Most people will actually do the opposite.  They will put a large amount of money into a “hot” stock or mutual fund while it is expensive.  This is not the way to invest.

DCA keeps the emotion out of investing.  By investing in regular intervals, you will keep your accounts growing while ensuring you are not buying too many shares at inflated prices.  This will set you up for nice investment gains when it comes time to sell.

Conclusion

DCA is the preferred way to invest for young professionals.  Early in your career, you will probably not have a lump sum to invest immediately in the stock market.  So investing as you get your paycheck is the most efficient way to deploy your capital.

DCA can come in many forms.  It can be an automatic deduction from your paycheck into your 401k account every 2 weeks.  Or a monthly withdrawal from your checking account into an IRA.

No matter what form it takes, DCA will keep your investment accounts growing steadily and will allow you to get the most shares at the lowest price.  No need for market timing since it doesn’t work anyway!

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The Investing Book That Won My Heart

Reading books will make you a better investor.

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Life is a journey, but the beginning of that journey can have a profound effect on the rest.  Reading one book in particular completely changed the trajectory of my investing journey.

While you can learn to like new foods as an adult, most of our food preferences are formed when we are young.

Most sports fans, myself included, root for their hometown team.  I’m a born and raised New Yorker, so the Giants are my team.  If I was born anywhere else, I would most likely have rooted for that hometown team.  (Though never the Philadelphia Eagles.  NEVER.)

In the same way, while my views on investing have slightly evolved over time, my core investing philosophies came from a book I read years ago and immediately connected with.

That book is The Bogleheads Guide to Investing (hereafter referred to as The Guide).  I’ve read a few investment books before I read The Guide and they just didn’t connect with me.  I’ve read a bunch of investment books after I read The Guide and most of them were not as memorable.

The Guide was a life changing book for me because it presents an investing blueprint that made sense and was easy to implement.  The idea of technical analysis and digging through charts and graphs while following the comings and goings of companies doesn’t appeal to me.

(As a simple introduction, a Boglehead refers to a follower of the philosophy of John Bogle, the founder of The Vanguard Group.  This book as a comprehensive investing guide written by some big time Bogleheads.)

Here are the two reasons why this is my favorite investing book:

Investing Should Be Simple

If you want to make money off of the general public, keep them confused and helpless.  Electricians and plumbers want people to call them anytime they have a problem.  They can charge for materials and whatever they want for labor while we simply nod and hand over the check.

They DO NOT want you to go on YouTube and find out the solution to the problem on your own.  Contractors don’t want you to go online and get the materials you need at a cheaper price.  They will go out of business.

But the more you look up things on your own, the more knowledge you’ll gain and the simpler things will become.  You will also save a lot of money in the process.  And let’s face it, you don’t need to get a PhD in plumbing to become a good plumber.  You need to find solutions to various plumbing issues.  Doing this over time will make you an expert.

The investing industry is very similar.  Investment advisers and brokers have a (wait for it…) VESTED interest in keeping you confused.  They want you to think investing is a very complicated topic that requires decades of expertise to master.  That way, you will be forking over your hard earned money without question.

The Guide says otherwise.  It showed me that as long as you are aware of your financial goals and risk tolerance, knowing what to invest in becomes very simple.  The key is to stick to your plan despite the ups and downs along the way.

And there will be ups and downs.  That’s the nature of investing.  And this is where most investment companies will get you.  They will make you believe that only they know when the markets will go up or down and that’s why you need to keep paying them.

The simplicity of it all will shock you.  But it will also empower you to take control of your investments and focus your time and energy on everything else that matters in your life.

Investing Should Not Be Expensive

The aforementioned investment advisers and brokers who want to keep you confused and take your money?  They don’t come cheap.  Most financial advisers who manage your investments will take a cut of your assets every year, usually 1% or more.

Plus, they can potentially put you into investments that have high expense ratios while not offering you similar ones with lower expense ratios.  (An expense ratio is what you’re charged by the mutual fund company just to be invested in the fund.)  And advisers can receive a kickback from mutual fund companies for putting you in a certain investment.

This goes on top of the fee the adviser takes.  Not good.  The effect of high fees on your investment returns has been well documented.  Most mutual fund managers cannot beat the average market return in one year, let alone for decades.  So there is no way to justify high fees.

The worst part is that a lot of these fees are well hidden.  Most advisers and brokers just take the fee out of your returns rather than having you hand them over a physical check.  That way you don’t feel like you are paying anything.  It’s not illegal but it does seem slightly unethical.  So what’s an average investor to do?

The answer according to The Guide is to stick with mutual funds that have rock bottom fees and track the performance of the overall market you are looking to invest in.  In real terms, this means investing with index funds from Vanguard.  This will give you two major benefits:

1.  You will be paying very low fees

2.  Your investment portfolio will be very simple to manage

These two points will put you way ahead of the majority of investors.  Those investors are paying high fees and buy and sell at the whim of the market.  Investing with Vanguard index funds for the long term will allow you to fully take advantage of compound interest.

And you can do this all on your own without the help of an adviser.  Just sign up for an account with Vanguard and go from there.  No grubby hands trying to find their way into your wallet.

Conclusion

The Guide has taught me to focus exclusively on index funds from Vanguard, and that’s where the vast majority of my investments are.  The only exception is the 529 college plan for my son, which doesn’t contain any Vanguard funds.

Focusing on Vanguard index funds has provided a great return for my portfolio.  This can definitely be attributed to the recent near decade of growth for US stocks, which I’m primarily invested in.  But more importantly, The Guide has showed me that investing with in low cost index funds will give my money the best chance to grow over the long term because of low fees and simplicity.

If you can’t tell by now, I highly recommend this book.  It will set beginning investors on the right path while showing veteran investors that this is ultimately the best way to invest your money.  And it will turn you into a devoted Boglehead like me.

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Sweat the Big Things. Part 1: Housing

This may be a bit much for your family of 3

 

The first personal finance book I ever read was The Automatic Millionaire by David Bach.  It was a great intro to personal finance and I would recommend it to anyone looking for a great personal finance book.  One idea the author introduced is called the Latte Factor.

The Latte Factor is the idea that if you cut out your daily $5 latte and instead invested that money in stocks, you would have hundreds of thousands of dollars available to you at retirement.

And it’s true!  If you invest $25 per week into a stock portfolio with a 7% return, after 25 years you will have $72,947.  This doesn’t take inflation into account, but not bad for skipping your daily coffee fix.

The problem is, millions of people have read The Automatic Millionaire, but millions of people are still spending $5 (or more) on their daily coffees.  Lots of people actually enjoy their lattes so giving them up consistently for decades is just not gonna work.

The Latte Factor essentially shows that cutting back on little things and then investing the difference can produce wealth.  And it certainly can.  But it’s not enough to change behavior since it takes decades to see any progress.  And even though $73,000 after 25 years is nothing to sneeze at, many people will need at least $1 million+ in retirement savings to have a similar standard of living as their working years.

That $73,000 suddenly doesn’t seem that impressive after decades of sacrifice.  So what’s the solution?

Focus on the Big Things

People would do better to focus on the big wins in life rather than focusing solely on little things like lattes.  This is especially true for professionals with high incomes but low net worths.  Saving $25 a week as a student would be huge.  Saving that much for a professional making six figures?  Doesn’t move the needle.  With higher incomes you need to set your saving sights a little higher.

There are three big things everyone should focus on:  Housing, transportation and taxes.  If you’re intelligent in these 3 areas and avoid the big mistakes, you will have more wealth than you can handle.

(This post will just focus on one of the big three:  Housing.  Stay tuned for upcoming posts on the other two)

Housing

Buying a home will be the biggest purchase most of us will ever make.  We will probably buy multiple homes during their lifetime, so getting this transaction right will set you up for financial success.

And getting it wrong will have you in a financial hole for your entire life.

There are three main factors that you need to focus on when buying a home:

1.  Credit Score:  Some people can buy a $500,000 house outright with cash. I plan to be one of those people but am not quite there.

Until that happens, me and most people in the country need to borrow money from a bank to buy that house. This type of loan is called a mortgage (which literally means “death pledge”)

Mortgage interest rates are pretty low nowadays, but to get the lowest of the low rates you need a great credit score.

Notice I said GREAT credit score and not just good. Having a great credit score can sometimes save you an entire point on your interest rate, which could result in tens of thousands of dollars of savings over the life of your death pledge.

If you don’t have a great credit score, read this and work on it.  Barring a history of bankruptcy or some major bills in collection, everyone should be able to increase their credit score year after year.

2. Down payment: Having a 20% down payment for your home purchase does three amazing things:

-Disqualifies you from having to pay Private Mortgage Insurance, which is usually about 1% of the purchase price of the home per year.

PMI, as it is known around the block, is what the lender will charge you in case you can’t come up with a traditional 20% down payment.  This goes straight to the lender’s bottom line and may or may not be tax deductible for you.  In any case, it’s a payment you can do without.

-Gives you instant equity in your home. This makes it pretty certain, though not a guarantee, you’ll make a good profit once you sell the house down the line. Not having enough equity will affect you during a housing downturn, like the one we had in 2008.

If you have little equity and your house loses 30% of its value, you are either stuck living there for a long time or have to go through a foreclosure or short sale to sell the house.

-Makes your monthly mortgage payment more affordable.  If you have a 20% down payment, it reduces the amount of mortgage you need and will give you some room to negotiate interest rates depending on your credit score.

If you stretch for a home by getting a low down payment loan, you are increasing your monthly payment which is holding you back from your other financial goals as well.  Plus, you’ll be paying the aforementioned PMI on top of everything.

Physician loans are a slight exception.  They allow you to get a home with a very low down payment without having to pay PMI.  On the flip side, they tend to charge slightly higher interest rates than traditional loans.

3.  Use numbers, not emotions, to buy a home:  Buying a home can be a highly emotional decision.  And that’s just how the home buying industry wants it.

There are many parties that end up making a lot of money from the sale of a home.  The bank that issues your mortgage makes interest off of you.  Your helpful and friendly agent also makes a nice percentage of the sale price.  Builders and contractors also make some nice money.  The only one not making money is you, the home buyer.

There is a whole industrial complex whose sole job is to make buying decision emotional for you.  That’s why they have certain types of lighting and music in stores.  The know emotional customers are overpaying customers, and that will keep the profits rolling in.

The best way to combat this is to work backwards by finding out what you can afford and looking for the best homes in that range.  This should be done before you look up homes or talk to an agent.  Model homes and home buying websites will try to make all their homes glamorous and “must haves”.  Starting your home search based on those false notions will lead you to pay more than you can afford.

A conservative rule of thumb I like is that your mortgage payment shouldn’t be more than 25% of your gross income.  So if you gross $5,000 a month, you shouldn’t be spending more than $1,250 on your mortgage.

And always remember to add 1% of the purchase price of your home as an annual maintenance cost.  Because maintaining a home will cost you, even if it’s a new home.  Many home buyers don’t account for this in their budget, and it can be a rude awakening that can slowly chip away at your checking account.

Your Home Will Make or Break You

As I said before, buying a home will probably be the largest transaction you will ever make.  This is one transaction that will make or break your finances.

By keeping a high credit score, having at least a 20% down payment and not buying a home beyond your means, you will save thousands upon thousands of dollars over the life of your loan.  Investing these type of savings can produce hundreds of thousands of dollars in retirement funds.

And that will buy you a lot of lattes.

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Take Full Advantage of Your Workplace Benefits

There are few things in life as potentially exciting and nerve wracking as getting that first job out of college.  After years of studying during college (and possibly grad school), building contacts throughout your field, polishing and re-polishing your resumes, going through rounds of interviews, you finally receive the job offer you want.

The salary is in line with what you’re looking for, you have a pretty decent commute and there is plenty of room for advancement.  Finding yourself in this “dream job” scenario is definitely a cause for celebration.

But once the party is over, it really pays to look at the COMPLETE picture of what your new position can offer you.  If you don’t, you risk potentially losing a lot of money and benefits.

Receiving a paycheck is the obvious benefit of working at a new job, but it is not the only benefit.  Every workplace is different, but there are many benefits that you could potentially be eligible for that go unused.

And no matter how nice upper management or HR seem, they will usually not go out of their way to tell you about all the benefits you’re missing.  Here are some of the benefits that many people leave on the table but really shouldn’t because it’s like throwing away free money.

Health Insurance

One of the biggest benefits of employment is affordable health insurance.  While healthcare premiums are usually cheaper for employees, you still have to choose the correct health plan based on your needs.

With the emergence of high deductible health plans (HDHP’s), this decision has become a little more difficult.  HDHP’s have lower premiums than traditional health plans, but they have higher deductibles to meet.  Which means you’ll have to pay more out of pocket before the insurance will start to cover anything.

This can be a good situation if you don’t usually spend money on healthcare throughout the year.  That’s because if you enroll in a HDHP, not only will you have much lower premiums than a traditional low deductible plan, you can also enroll in a Health Savings Account (HSA).

HSA’s allow you to set aside pre tax funds to pay for future healthcare expenses.  The best part is that the account is yours for life and can grow tax free.  A very effective tax savings tool.  Read more about them here.

But if you tend to spend a lot of money on healthcare, a HDHP may not be the answer for you.  Most companies will give you plenty of resources to make the right decision.  The employee still needs to do the work and choose the best plan for them.

Another aspect of health insurance that has caught on recently is the addition of “wellness incentives”.  These are discounts your company gives if you meet certain criteria regarding your health.

For example, my current company gives a discount on your health insurance premium if you are a non-smoker.  Getting a yearly physical with lab work will get you another discount as well.

This helps you by saving money and it helps the company because healthy employees means more productivity.  Many colleagues overlook these easy discounts.  It’s almost like free money since you just have to fill out some forms.

Retirement

With the overall demise of workplace pensions, most employers offer a 401k retirement plan.  This means that the employee is completely responsible for their own retirement.  If you do it wrong, you could end up with nothing in retirement.  If you do it right, you could be a multi millionaire.  No pressure!

A big advantage of 401k’s is that contributions are deducted before taxes, meaning you don’t pay any taxes on contributions the year you contribute but you will pay when you eventually withdraw the money.  The ideal scenario is to contribute as much as you can when have a high income with high taxes, and withdraw the money when your taxes are relatively low during retirement.

Another great perk is the 401k company match.  This is the amount your company will contribute into your account up to a certain percentage.  A common match offer is the company matching your contribution up to 3%.  Some generous companies will throw in some money even if you don’t contribute at all.  At least contribute enough to get the full match.  From there, you should look at your entire financial situation to see if paying off debt or contributing money elsewhere would be a good move.

Many employees don’t contribute to their 401k.  And it’s a darn shame.  According to the Bureau of Labor Statistics, only about 30% of employees who have access to a 401k contribute anything at all.  That’s going to produce a lot of poor people in retirement.  It’s a great “forced” savings plan that will save you on taxes today and provide you with money to live on down the line.  I can’t think of an easier way to pay yourself first.

As I mentioned before, 401k’s require participation on the employees part.  And they can be confusing for financial novices.  Here is a great guide to help get you started with understanding your 401k plan.

Health coverage and retirement accounts are two of the biggest benefits offered by employers.  It’s important to take full advantage of both of these offerings.  If you have any questions about how to fully optimize your plan, contact your HR department or shoot me an email.

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Inflation is Not a Big Deal. Here’s Why.

James can trade down to a slightly used BMW and save a ton on insurance and maintenance.

Imagine a reverse savings account.  You put money into it and it will slowly erode over time at a constant rate.  Let’s say that rate is 3%.  So every year the amount you have in the account will decrease by 3%.

So you deposit $100, then at the end of the year, you’re left with $97.  If you don’t add anymore money, the following year you would lose 3% more.  You would have to keep adding money just to keep your original $100 deposit.  Doesn’t sound like a good deal.

This is inflation.  It creates an increase in the price of goods over time which erodes the buying power of your money.  The most quoted inflation rate is around 3%, which is the Consumer Price Index (CPI) provided by the Bureau of Labor Statistics.

And many of us have seen this in our lives.  A gallon of milk in 2017 doesn’t cost the same as it did in 1997.  Same goes for a gallon of gas.  I’ve even written before that the only way to beat the inflation monster is to make more money and to do it FAST.

Making more money is a surefire way to beat inflation, but it’s actually a lot easier than that.  Many of you probably have a much lower personal rate of inflation than the 3% figure.

Here’s why the idea of inflation destroying our income and retirement while we stand by helplessly is just not true.

You Are Not an Average

According to the CDC, the average weight of a male in America is 195 pounds.  Besides that being a concerning statistic since that’s already considered overweight for most males, it also doesn’t tell you much about an individual male in America.

Sure, there are males in this country who are exactly 195 pounds, but many are below that weight and many are above.  The 195 pound number is the weight of a fictional “average” right down the middle American male, which most males are not.

And even if you are 195 pounds, there are other factors that make that number even more useless such as height and athleticism.  So that 195 pound number in a vacuum means almost nothing.

I look at inflation in the same way.  While the oft quoted rate of inflation is around 3%, not everyone is affected by that number in the same way.  Prices vary widely in different parts of the country.  Inflation could be at a rate of 5% in New York while it can be 1% in Iowa.  That 3% is a countrywide average.

Inflation also affects good and services in different ways.  Computers cost a lot more 20 years ago than they did now.  Milk costs more now than it did 20 years ago.  Cars cost more now but they last a lot longer than they did before.  That 3% assumes a constant inflation rate among all types of goods, which is just not true.

An average can serve as a good benchmark, but your personal situation can make the number utterly useless.  I never liked the idea of comparing average salaries or savings rates, as everybody’s situation is unique.

You Are Flexible

Now let’s say that you are indeed this average person, and your personal rate of inflation has been increasing at a steady rate of 3%.  It doesn’t mean it has to stay this way!

One of my favorite quotes of all time is from British philosopher Alan Watts:  “You’re under no obligation to be the same person you were 5 minutes ago.”  And this applies directly to the inflation argument.

If the CPI has been showing an average rate of inflation of 3% for the country, there is not much you can do about that.  If your personal spending has been growing at a steady rate of 3% year after year, you can change that right now!  We’re not robots that need to keep spending money on the same things over and over.

There are lots of ways to do this.  We can cut out things we don’t need or just spend less on them.  We can buy less expensive versions of things we usually buy (skip Whole Foods and go to a normal store).  If you take a good look at your personal spending, you can definitely find ways to keep more of your money and reduce that inflation rate.

The fact that we can be flexible and adjust our spending to reduce our inflation rate turns traditional retirement planning on its head.  Most retirement plans and calculators automatically assume that your inflation rate will be 3%.  This can easily be changed so this means that most people can actually retire earlier than they thought.

We also may not need to save as much money as we originally thought.  This can make retirement planning seem a lot less scary and disheartening.  That being said, I’m usually pretty conservative when it comes to saving and investing.  So assuming an inflation rate of 3% is not the worst thing, because it will at least ensure that you will have enough money to reach your goals.

Conclusion

Don’t get me wrong, inflation is definitely real and it has very real effects on people’s lives.  But it’s not as big of a deal as its made out to be.  Capitalism wants people to keep consuming until the end of their days.  If you follow along, then your inflation rate will certainly be 3% or even more.

But it doesn’t have to be that way.  You can adjust your spending so you actually spend less of your money than you did in the past.  Humans are a lot more flexible than they think, and I believe everyone can find ways to make inflation a very minimal factor in their personal economy.

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