Financial Education 402: Make the World a Better Place

Okay, I get it’s cliche, but money is only worth what someone else will give you for it. And if you make it this far, like saving a ton of money, what are you really going to do with it? 

Give Directly is sponsoring a 12 year basic income experiment in Kenya and paying everyone in the village is $22 a month. $22 a month! When I think about universal income that we could make work in the USA I come to numbers like $700 or a $1000 a month. In other words, money  can go something like 40 times farther in actually poor places like sub-saharan Africa than in highly developed places like the USA. Don’t get me wrong, there is need here as well. The opioid crisis is pretty bad, that’s probably why I was burglarized last year, but it’s not like it is in the poorest places in the world. 

When I see numbers like that, $22 a month being a huge change for people, it’s heart breaking. Sometimes I want to leave my life behind and go to a place like that. For one, I have enough money I would not have to work the rest of my life. For two, I like to imagine that the opportunity in those places is enormous. I could start a bank and loan out money, and go check on all of the people with farms and businesses I was loaning to. I could probably fund two teachers, myself, educating dozens of children, out of my pocket, not their parents. you see, public education is not a right around the world, it’s a privilege that we enjoy, and frankly one that I like that we have made a right. I could help with engineering projects and construction.

Give Directly is just one example. For better or worse, sometimes donations to medical centers or universities seem to be a status symbol. I mean, it’s a better status symbol than the car you drive, or how many bathrooms your house has. There are hundreds of great charities and non-profits in the world. Be sure to find a way to pay your fortune forward to those less fortunate.

A while ago I was reading about Bill and Melinda Gates  and Warren Buffet and they planned to leave their kids “enough money to do anything, but not enough money to do nothing”. Now that I am older and more well read than I was when I read that, it means something different to me now. In the United States, that’s probably about a half million dollars. At three quarters or a full million dollars, and a paid off house, you don’t necessarily have to do anything the rest of your life, regardless of your age. No, it’s not a luxurious existence, but it’s not poverty either. Past a million dollars, you’re basically increasing your standard of living for the remainder of your life. In other words, $2 million given to an 18 year old, or a 40 year old, with decent management, would allow that person to never have to work again, and live on something like $60,000 to $70,000 a year income. I’ve spent most years of my life living on less than that. And on the other end of the spectrum, going to medical school, starting or buying a business, can all eat up several hundred thousand dollars quickly, but having a million or two doesn’t really present that many more options for a career. The only thing I can think of as a career that could take more than $500,000 is starting a business that takes a long time to show any revenue, like a car company.

Point being, leave this place we call Earth better than you found it. You can’t take the money with you when you die, and you could possibly die in a traffic accident tomorrow. So somewhere between planning for a long term future, and living today as if it is your last there is a good balance, and it’s different for you than for me. Hopefully if you read all the way through this little series you learned something. In particular, I hope that this series helps at least one of my friends who is living paycheck to paycheck prepare for the future, and eventually, help another person less fortunate than her or him.

Financial Education 401: Work Toward Financial Independence

You could get laid off. You could get fired. Your company could go out of business. Or maybe you want to take a year and sail around the world. Maybe you want to take a year off to write a book. The Great Recession could be remembered as a blip compared to the 2020s Greatest Depression. Depending totally on your employer is risky business. Oh I’m sure you have a great employer, and a great relationship with that employer, but things change.

You can quit working, at any age, for life, basically as soon as you have 25 times your annual expenses saved in stocks and bonds. Now, that comes with roughly an 95% chance of success over 30 years, however at 30 times your annual spending saved, your chance of not running out of money decreases to hardly anything. Even at a 5% withdraw rate (20 times spending) you have an 82% chance of not running out of money over 30 years. (However, in early 2018 CAPE ratios are over 30, meaning stocks are over priced, so don’t expect 17% annual gains over the next decade like the last nine years.)

In the last post I mentioned saving money outside of retirement tax advantaged accounts, and this is a large part of the reason. As a person in your 20s or 30s, you have an awfully long time until you are in your 60s and can access those funds. So saving money in a brokerage account, or even a savings account allows you to access that money when you end up with a horrible boss and want to quit your job or you want to go climb Mt. Everest more than you want to spend two months at the office. 

Money is a tool, and it buys time. When you are Bill Gates, your plane takes off whenever it is convenient for you. You can talk to whomever you want to. You can sleep whenever you want to. When you want to talk to a CEO, he definitely calls you back. I’m not at all saying that people need to aspire to that kind of wealth. I'm saying, if you have $500,000 in the bank in the USA, or $1 million, you don’t have to put up with other people dictating how you spend your time. It’s a spectrum of course. The more confidence you have the less money you need to exit negative situations.

I’m writing this series also in part because due to paying off my student loans, getting my Kansas Rural Opportunity Zone Tax Refund, and my pension vesting in the last several months has put me at 5X or five times my reasonable annual spending. Maybe more like 4X, but defining how much X is, what I can live on can be nebulous because every year has one time expenses, like a new bicycle. Point being, I could walk away, and be fine, for months! It was kind of surprising when I realized that. I had a bad day at work and I thought, ‘what if I just quit, right here and now?’ It was a perspective change and that’s what I referred to in the introduction. Wealth creates opportunities. It’s not fair. I don’t deserve the wealth that I have. Yet I have been exploring opportunities recently that I had never considered before, and that's fun.

Financial Education 302: Retirement Savings

So you’re getting your employer match on your 401(k), great. Welcome to the beginning of serious saving. Everything up to this point has been risk avoidance, reducing debt, and reducing expenses. Now let’s start making money. 

Do you have a Roth IRA? If not, get one, unless you as a single person make more than $120,000 a year. You can probably contribute $5,500 a year to it, $6,500 if you are over 50 years old. If you don’t have an employer retirement plan, this is the way to go. Why the Roth IRA instead of a traditional IRA? Future Taxes. Future taxes will probably be higher than today. Due to our current deficit and national debt current taxes are not sustainable. Although a Value Added Tax (VAT) is highly likely that wouldn’t affect income taxes… What I’m saying is, if you have any money to throw toward retirement, even $500 saved over a whole year, a Roth IRA is money that can grow tax free, and be withdrawn tax free in the future. That $500 in 10 years might be $1000, and it’s yours, tax free. Plus, unlike most retirement accounts, you can withdraw the contributions tax free and without any penalty.

On the odd chance you make more than $120k for a single person, put it in a traditional IRA. You don’t really get any tax breaks, except for the growth before you start withdrawing. 

After you max out your Roth IRA or traditional IRA, and of course you’re getting your “free” money from employer matching, it’s kind of up to you what to do. You could increase your 401(k) contributions, and get some tax benefit. Every $100 invested in a traditional 401(k) only reduces your take home pay about $75. So it’s not a bad idea to max out your 401(k). Of course, that’s a bit of crazy talk, because the employee contributions to a 401(k) in 2018 are $18,500, and $24,500 if you are over 50. I mean, that’s close to a year of super frugal living expenses, not to mention that that does not count employer contributions.

While maxing out your 401(k) is a great option, honestly, save money outside of traditional retirement accounts. I didn’t pay tens of thousands of dollars to climb Mt. Everest using retirement savings. You can simply continue to add to your savings account that I mentioned several posts ago. However, with interest rates around 1%, it’s not a great investment. I recommend opening a brokerage account and investing in stocks and bonds. What do you then invest in? SPY for starters, it’s basically the largest 500 publicly traded companies in the United States, as tracked in the S&P 500. It pays a dividend every three months, and as far as stocks go it’s fairly low risk, and as far as expenses go it costs 0.09% a year, which is pretty low. If you want a bond fund, I like FAGIX, because I use Fidelity and it returns about 4% annually in the form of monthly dividends. If you want to buy a stock, AT&T or Verizon both pay hefty dividends, and come on, they aren’t going out of business any time soon. And if you are in the market for a crazy growth start up I’ve been investing in OKTA, because I happen to know they have a very large corporate customer, but that’s pretty risky, so don't do it unless you can stand to lose the money.

Why would you save for retirement outside of a retirement account? Next lesson…

Financial Education 301: Hedges and Insurance

Hopefully the first four articles were all the easy stuff, because the next few concepts are a little more difficult. It’s easiest to break down where money goes to two categories, expenses, and investments. I haven’t mentioned investments yet, but  if you have a little $1,000 emergency fund and you are getting the employer match at work on your retirement accounts, you’re doing just fine at this point. However, I don’t think that expenses and investments give the full picture of where our money goes, there is a third category, hedges, also known as insurance. 

I thought long and hard about buying a house. How much does it cost? What if I have to move? What if I lose my job? What if it goes down in value? Graduating in December 2009 taught me a whole lot about recessions. My advisor in college was visibly sad when he said that he did not have any job opportunities for his grad students. In his early 60s he said it was the first time that had happened. At the time as a 23 year old it was hard to really comprehend what that meant. A year of unemployment from engineering taught me what he meant. Which is a long way of saying, a house is a hedge against future negative personal economic circumstances. A house is insurance on a bad situation. If you live in the same apartment for ten years, then lose your job, and have no savings, you might get evicted in a month or two. If you buy a house, and live there for ten years, you will have at least 25% equity in the house, and when you lose your job, and have no savings, you can talk to the bank and get a reverse mortgage or refinance, and stay in your home for much longer than a renter would have the luxury. Taking this to the logical conclusion, when you pay off your house, you only need to pay property taxes on it every year, which in a pinch you could get a reverse mortgage to cover during a year or two years or even five years of unemployment.

There are other types of insurance too. I have life insurance from a third party (not my employer). Basically I met a relatively good insurance salesmen about two years before I went to Everest the first time, and thought a life insurance policy would be a good idea. I also have car insurance and home owners insurance. Both of my policies are relatively comprehensive. You can save money by going only with liability insurance, but I personally like having full replacement insurance because when something bad happens, like your house is burglarized, you don’t want to have to argue about what is covered and what is not. Plus, insurance is really well priced compared to the risk of a negative event happening. 

Another type of hedge, owning a bicycle. I remember once in Dubuque, the weather was nice, and my van was being repaired overnight, so I rode my bicycle to work the next day and then back to the repair shop because they did not have the usual loaner car. Another type of hedge would be having a second job, or more specifically, a second or third income. That way if you lost your primary income, you would have a little something coming in. Of course, when I was coaching track and field I was making 30 times as much from engineering as I did coaching, so it would not have been enough to support me had I been unemployed, but the extra savings from that job would have helped me last another month or two. 

I’m not here to tell you what kind of insurance to get, or what hedges to have. However, these are things for you to think about and consider. For example, disability insurance, the number of Americans that go on disability at some point in their lives is astounding. Similarly, having a second job, even if it’s a hobby job can provide a little security in the event your main job doesn’t work out.

Financial Education 202: Get any “Free” Money

Specifically I’m talking about employer 401(k) contributions. If your employer matches a certain percentage of your 401(k) contributions, be sure you contribute at least that much! If your employer matches dollar for dollar on the first 6% of your salary that you contribute, make sure you contribute at least 6%. It’s like getting a 6% raise in that case. 

However, it’s not just these contributions that you should watch out for. If you work at an employer that still has a pension, then getting that to vest means that assuming you live to retirement age, that’s a stream of money for life, or perhaps a lump sum when you leave the company. Either way, we’re probably talking about thousands of dollars worth of money, however, you have to be vested and stay the maybe three years or five years to take that pension with you when you leave the company. The same goes for stock options, although I’ve certainly never gotten far enough up the corporate ladder to get any of those. 

Another way that you might have “free” money is if you have any unclaimed tax refunds, insurance claims, inheritances, old retirement accounts or pensions that you forgot about. There are billions of dollars of money in the United States where the owner, and the government or the company holding the money are not in contact with each other. Certainly this applies more likely to older people that have had several jobs, but it is something to keep in mind every year as you do your taxes to make sure that if you are getting a refund, you actually get it.

Another aspect of this are employee perks such as free coffee. You certainly don’t need to take advantage of it, but if someone is giving you decent free food, there is no shame in eating it. 

Financial Education 201: Look at Your Spending

This can be painful. If you aren’t really saving any money, like you are 30 with no retirement savings, or don’t have even $3000 to put down the minimum 3% on a house, it might hurt. You can look at your debit and credit card statements to see where the money is going. You can use Personal Capital or mint.com to track your spending too. I recommend one of the websites because it can spit out what you spend on average every month over the last 12 months, and that’s as honest as it gets. 

The reason this is important, even if you only do it one time, is that you will inevitably see some expenses that are disproportionate to the value you get out of it. For example, it’s not uncommon to pay $100 per month for cable, and yet only spend one or two hours a day actually watching television. Cut out one recurring bill like that and you suddenly have $100 that you can save every month. Subscription services are a great example of something that you might not get the value out of now as you once did. 

There are plenty of personal finance sites that will go to the extreme when it comes to finances, going so far as move to a low cost country to reduce expenses or eating a lot more Ramen. There are many valid points about how to reduce your spending, but I'm only going to focus on the big three, and some experts only talk about the big two.

1. Housing is typically the largest expense that most people have. If you can reduce the cost of your housing you will come out way ahead. When I lived in Iowa a good friend of mine was paying $800 a month for an apartment without a garage. I paid $450 for my smaller, older, and a little more run down apartment, with a garage. That’s $350 a month that I was able to put toward whatever else I wanted to, such as climbing Mt. Everest. Looking at one month at a time, it may not seem huge, but over the course of a year that’s $4200 in after tax cash for not a huge difference in deliverables, which is to say, a place to eat and sleep for a single guy. 
2. Transportation, more specifically your SUV or car, is probably one of the largest expenses you have too. Between the car loan interest, the depreciation, gas, oil changes, tires, and inevitably repairs, vehicles cost thousands of dollars a year. I drive a Honda Insight that I paid for in cash that gets about 48 miles per gallon, and I still spend about $1000 a year on gas alone. Point being, if you can reduce the cost of your transportation, you will save more money.
3. Food costs money. Strictly speaking, this may not be a big part of your budget. It is entirely possible for a person to eat well on $100 a month. However, it is also possible to spend $100 in one day on three meals out and several drinks at the bar. I am a huge fan of going out to eat. I’m also a fan of eating in, but I don’t have a dining table, so I really don't have guests over very often. Yet, going out to eat quickly gets expensive. It’s hard to have a dinner meal for myself, with a glass of wine, at a restaurant for less than $30 including a tip. While I like going out, going out four nights a week can become an expensive hobby. Not to mention lunches, breakfasts, and the vending machines. Point being, substitute a meal at home every week for a meal out, or bring your lunch to work sometimes, and you can save money. Also, read the labels at the store and try the generic brand items. Wal-Mart has this Great Value brand rising crust supreme frozen pizza for $2.78, it tastes good and it’s huge! I usually cut it in half and it makes two large dinners for me. I could probably even stretch a single pizza to four meals if I was not running a lot. It’s amazing what buying a few generic brand foods can save you.

There are other ways you may be spending a lot. Perhaps retail therapy, perhaps you are into shoes, perhaps you get disappointed when you don’t have a package from Amazon when you get home from work. I don't know what your personal situation is, it is personal finance after all. The idea is to find your highest expenses, and reduce them a little.

Financial Education 102: Pay Down Your Debts

Debt isn’t necessarily a bad thing if you can use that money for a positive thing, however, it’s better to have less debt than more usually. First, let’s talk about interest rates. Higher is better when someone is paying you, lower is better when you are paying someone else. Unfortunately, people that don’t make much money or aren’t very good with their spending often get lured into these higher interest rate debts and loans. Often it’s a function of circumstance, and was unavoidable. 

The pay day loan industry is the perfect example of offering little loans at huge interest rates, even over 500% annual interest! That means that if you were loaned $100, and took a year to pay it back, you would pay $600! If you’re reading my blog, I doubt you have ever done a payday loan, but on the odd chance you have, pay that thing off!

Next up is credit card debt. Rates range from 6% to 25%, typically in the 20% range. So if you had $1000 in credit card debt and took a year to pay it down, would pay $200 interest on that money. A simpler way to think about it is, you go out for dinner and spend $30, which is not crazy for a single person especially if you have a couple drinks of alcohol. That meal could cost you $36 if you take your time paying it off. That’s $6, just for the privilege of paying with the credit card! If you’ve got credit card debt, pay it off. That stuff is expensive. 

Then we come to student loans. Ugh, student loans are tough because you it’s much harder to get rid of them, even if you declare bankruptcy they can follow you. These kind of depend on the interest rate. Personally I say if it’s over 7%, try to pay that off quick. If it’s lower, I had a couple at 2.8%, you can take your time paying them off, but rest assured, every day that you do not have loans accumulating interest is a day you are saving a little bit of money. 

Car loans are also super common type of debt people have. Car loans often come with really good interest rates, even 0% sometimes. However, vehicles are depreciating assets that lose around 15-20% of their value each year for the three to five years at least. In other words, that’s great that you just bought a mid-size car for $25,000 (with $0 down), and got a great 2% interest loan, so you are only paying $40 a month in interest, which is only 1.5-3 hours of work (after tax) a month. However, that car will only be worth something like $21,000 after one year. So you just paid $480 or so in interest for the year, plus you lost $4000 in value on the car. Point being, drive your car as long as you can stand to get inside of it, because they are not an investment, but a significant expense.

Finally, the mortgage. A mortgage is probably the best kind of debt. While student loans enable a high paying career, there is always the risk that something goes wrong and you or your loved ones are stuck with the loans, and nothing to show for them. A mortgage on the other hand includes a physical place, a piece of property. While it can flood, and it can burn down, it can’t really be stolen and it’s extremely rare for it to disappear (like in a sink hole or in a land slide). However, if you own less than 20% of your house, and you are paying Private Mortgage Insurance (PMI) every month, that is quite expensive and worth paying extra until the bank owns less than 80% of the value. Of course, there is nothing wrong with paying down the mortgage further, and at some point in the financial journey, it probably makes sense. Of all the types of debt this is the least concerning, so leave it for last.

In short, while it feels insurmountable, paying a little extra on your debt payments goes a long way toward saving you money on interest rates. The first time you pay off a debt, celebrate! It’s a big accomplishment and paying off debt and building the habits to stay away from debt are a lot harder than making money.