Free Money Finance

Our Trip to DC (And a Few Ways to Save)

From October 12 to October 17 our family took a trip to Washington, DC. I thought I'd share with you what we did, the financial impact of the trip, and a few savings tips we picked up along the way.

Background

Both my wife and I lived in the DC area (before we knew each other -- she worked in Virginia just out of college and I lived in the heart of DC one summer in college when I interned for the federal government. FYI, I am old. Reagan was president then.) So we were both somewhat familiar with the city, surrounding area, and the various sites to see. We both have fond memories of our time there so DC has always been a place we wanted to show our kids.

This past summer our kids (who are homeschooled) had classes on American history and government, and a trip to DC seemed like the perfect wrap up. So we picked a time, I took vacation days, and we got to planning.

Spending Philosophy

I've noted that I'm a believer in moderate and selective frugality. These principles especially apply while on vacation. Specifically, I'm willing to make some sacrifices to save money as long as they aren't too big from both time and "hassle factor" standpoint. My point of view is that we're on vacation and I don't want to kill the mood because we wanted to save $3.

Case in point: did we want to drive or fly?

Google Maps says that it's 652 miles (11 hours and 18 minutes) from our house to DC. So roundtrip costs at 55.5 cents per mile (the rate my employer reimburses me -- which is supposed to cover all expenses associated with driving my vehicle  -- FYI, parking and tolls would NOT be covered in this amount) would cost us $724. But much of this cost is hidden. Really, the only visible costs would be gas, parking, and tolls. So maybe it would cost us $250 or so at most.

On the other hand the best flights (from Lansing, MI, an hour away from our house) would cost $850 for the four of us (direct flight.) Obviously this would require more out-of-pocket costs than driving. But it would also save us over 22 hours of driving -- a HUGE hassle/energy suck. Plus if we drove we would likely need at least one additional hotel room night either in DC or on the road.

So we went with flying.

Case in point #2: what hotel should we stay in?

I do not want to spend my vacation in a bed bug-infested rat trap that's 50 miles away from the action just because it's $50 a night. But I don't need to stay in the $400 a night place next to the White House either. So we picked a Hampton Inn close to a metro stop for an average of $170 a night. More on this later.

Planning the Trip

Now that you know our general approach to spending on vacation, here's what we planned to do:

• Our flight left at 9 am on October 12 which meant we needed to be up and out of the house by 7am and at the airport at 8 am.


• We booked the hotel with no problem. It had a pool for the kids, was close to the metro, and had the standard free breakfast Hampton offers. For those interested, here's where we stayed.


• My wife did some research on the metro and we decided to purchase SmarTrip cards, a plastic version of the paper fare cards. More on these later.


• We took some food with us, but we knew our hotel had a CVS nearby for snacks, plus we knew we could get apples, etc. from breakfast and store them in the room if we needed food.


• We planned to see the "key" attractions, some that were set at fixed times (like the White House tour), and had a rough estimate of what we would see on what day.

The Trip

Our flight left without a hitch and we were at our hotel (took shuttle from airport) shortly after 11 am. Our room was ready so we settled in, then hit the city to see the sights. Over the next five days we saw the following (FYI, we never took a cab -- all of this was walking and the metro):

• Arlington Cemetery
• Botanic Gardens
• Bureau of Engraving and Printing
• Capitol (got a personal tour from a member of our Congressman's staff including getting on the House floor)
• Ford's Theatre
• Holocaust Museum
• Jefferson Memorial
• Library of Congress
• Lincoln Memorial
• National Air and Space Museum
• National Archives (Declaration of Independence, Constitution, Bill of Rights)
• National Gallery of Art West (older art)
• National Gallery of Art East (modern art)
• National Mall
• National Museum of American History
• National Museum of the American Indian
• National Museum of Natural History
• National Zoo
• Old Post Office
• Peterson House (where they took Lincoln after he was shot)
• Smithsonian Castle
• Supreme Court
• Vietnam War Memorial
• Washington Monument
• White House (got on the grounds into the gardens on Saturday)
• WW II Memorial

As you might imagine, we walked for many miles each day. We were usually out of the hotel by 9 am or so and back around 4 pm, totally exhausted but having had a great day (BTW, the weather was in the 60 to 75 degree range during all the days we were there and it only rained part of one day).

The Final Budget

Here's what we spent:

• Flights: $850
• Hotel: $850
• Metro: $104
• Food and misc: $281
• Parking at Airport: $42

• Total cost: $2,127

A Few Tips and Thoughts

What would an FMF post be without some tips and thoughts from me? :)

Anyway, here are some random takeaways:

• We went at a great time. Weather was good, there were no crowds, and costs were reasonable. We saved money because we were flexible.


• We saved because of the days we picked. Our hotel was $123 on weekend days (Friday, Saturday, and Sunday) but was $228 on weekdays. We had three days at the first price and only two at the second.


• The points I got from the stay (and by using my Hilton credit card) put me over the 80,000-point mark. I now have two free nights set for the pre-cruise trip we're planning in early 2013.


• The SmarTrip cards saved each of us $1 per trip ($4 per trip for the group.) So at 3 or so trips a day, it was a no brainer to get them. Our cost was $10 each for the cards at CVS. This came with $5 of ride credit as well as $3 each that got rebated back, so the true cost was only $2 each.


• CVS was a lifesaver. We used our frequent buyer card there to save on a case of water (something like $3), ice cream (on sale, a treat), and a few supplies. If we hadn't had our card, prices would have been much higher (and actually we didn't need the card at all -- just our phone number that's tied to the card).


• Our meals went as follows: LARGE breakfast in the morning (which was free at the hotel -- the value of this perk alone was $30 or so a day), took a few snacks with us to munch on (we did stop a couple times at McDonald's or Subway when we were really hungry, but just for a snack), then ate an early (and usually very good) dinner around 3-4 pm. This eliminated the costs of lunches. We also had snacks in the room as needed.


• Admission was free everywhere we went. Absolutely no admission costs.


• We got "free" luggage as follows: the airline wanted to charge us $20 per bag each way to check luggage. Carry-ons were free. But we only had two carry-on bags that were the right size. So we bought two more at $40 each and carried them on for free. We avoided the $40 round-trip costs per bag and still have the bags to use as we want!


• Food was a bit higher because we usually ate at a nice place for dinner. After all, we were on vacation! Oh, and we had several treats as well. :)

Overall, it was a very good trip. The kids would have rather gone on a cruise or to Disney, but even they found things to enjoy about seeing history and the government.

Pictures

As you might imagine, I'm leaving out a lot of details. If I didn't, this post would be 25 pages long. So since a picture is worth a thousand words, here are a few pics that fill in some of the holes. Click any of them if you want to see a larger version.

Various bills at the Bureau of Engraving and Printing.

Turtle "biting" my son's finger at the National Zoo.

Taken from the gardens at the White House.

Beautiful day at the Washington Monument.

Part of the Berlin Wall (can't remember the museum where we saw this).

Picture from top of the Old Post Office (great views up here.)

Reader Profile: MC

The following is the latest post in my "Reader Profiles" series. Each post in this series details the financial situation and challenges of an FMF reader. The purpose of this series is to help us all identify with people like us (in similar situations -- not all will be, of course, but eventually I'm sure you will find someone like you here), get to know the frequent commenters on the site, and hear some financial wisdom/challenges from people other than me.

If you're interested in contributing to this series, then drop me an email. The series seems to be very popular with readers and I need a steady stream of new ones to keep it going.

Next in the series is FMF reader MC. He answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I'm 31 y/o, married, 1 kid (18 months).  Plan expanding to at least 1 more kid next year, and possible a third a few years later.  I work FT making about 115k a year working in intellectual property.  My wife is a stay at home mom.  I have an engineering degree, and my wife is a stenographer (works occasionally to get out of the house)

Describe your financial situation (who works in your family, how your income is (general), how your expenses are, etc.).

I'm very detailed in my spreadsheets, so I budget for everything on a yearly basis (i.e., any expense (car, dog food, medical) I budget for each month based on my yearly expected expenditure for that budgeted item).  I've watched my spending habits over the past 2-3 years, and developed a model budget based on the past, as well as what I want in the future.  I try very hard to squeeze every last bit out of my paycheck.  With that said, this might be more detailed than most people (FYI, K, M, and Y are our initials in the budget below)

• Mortgage: $1503.83
• Car Insurance: $168.8
• Gas (House): $50
• Utilities: $275
• Cell Phone: $204.65
• Cable: $165
• Life Insurance: $19.15
• Student Loan: $1,250
• Xmas: $100
• Retirement: $0
• ESA: $20
• Groceries: $500
• Gas Car: $225
• Entertainment: $600
• Costco: $70
• Dry Cleaning: $20
• Dog Food: $40
• Toll Tag: $15
• Haircut: $30
• House Expenses: $100
• Y Fun Fund: $200
• Animal Care: $40
• Gifts for other people: $150
• Car Main.: $80
• M fun fund: $50
• Gifts (for each other): $100
• Baby Supplies: $100
• Maid: $150
• Netflix: $10.81
• iPad: $30.64
• K Bday Party: $40
• K Presents: $30
• Little Gym: $67
• Air Filters: $12
• Carbonite: $8
• ACL Tickets: $31
• Amazon: $6
• Medical: $50

FYI, on top of my salary, my company gives me 7.5% in a 401k.  Thus, even though I'm personally putting $0 in retirement, I am effectively putting in 7.5% via my company.

I know something budgeted things are way different than most, but this is what works for us (e.g., other peoples gifts, or saving for a kid's birthday party).

What are the current financial issues you're facing (saving, paying off debt, etc.)?

We currently own our home (over 20% in equity) on a 20 year note @ 3.875%.  We have 30k in an e-fund, and 30k in retirement (my company currently "gives" 7.5% of my salary to retirement each month).  We also have about 12k left in Student Loans.  We contribute 1250 a month to it, and expect to have it paid off by July 2013.  After that, we will be debt free.  We currently invest 0 in retirement, as we are paying off our debt.  After we pay off our debt, we are planning saving up for a year or two to buy a new car in cash, then go hard core at our retirement (15k or more a year)

What are your plans for the future (retire early, build your career, etc.)?

Right now our immediate future goals are to pay off our debt.  Intermediate goal plans are to buy a new car in cash, save for retirement, and possibly move in 3-5 years to a bigger house.  Long term goals are to retire by 50 or so.  But our main driving goal is to build a happy life for our family.

What's your best piece(s) of financial advice and/or your general philosophy on personal finances?

Study.  There isn't even studying you can do on PF.  I read blogs, listen to podcasts, watch the news, and read forums on PF.  Knowledge is truly power.  And stay out of debt.  It is evil.

The Pros and Cons of Menards

Over the past few years, Menards has become my home improvement store of choice. But a couple recent events have made me wonder if I should re-think my position. So I've decided to list what I see as the pros and cons of this chain (primarily versus Home Depot and Lowe's, though there are others like True Value, Ace, etc.) and let you all chime in with your thoughts. Perhaps between all of us we can find the "best" home improvement store. :)

Pros

Here are what I see as the reasons for shopping at Menards:

• You can "save big money." If you've ever seen a Menards commercial or been in one of their stores (yes, they play ads over the intercom) you know the song: "You save big money, save big money, when you shop Menards." Now whether this is true or not, they have certainly got me believing it (for the most part -- see below). Do they really have the lowest prices? How can you be sure -- who drives around from one home improvement store to another comparing prices?


• Best employees. This is one I can say for sure -- they have the best employees. I rate them the best for the following reasons: 1) You can actually find someone to help you. At the other home improvement stores there's never anyone around when I need them. 2) They actually want to help. Every time I've asked a Menards employee for assistance, I've always received a positive, welcoming reply. I have yet to get a "you're bothering me" response, which is what I've had elsewhere. 3) They actually know what they are talking about. Not that the other store employees don't, but my experience is that help in other stores can be spotty in the know-how department.

Cons

On the other hand, there are some reasons not to like Menards:

• How they do pricing. They often get to a lower price by offering a Menards rebate, not straight cash. So an item you purchase may be $10 off, but that $10 comes to you via mail (which is a hassle to complete and mail in the first place) and is good for redemption only on a future purchase at Menards. This is not a bad deal if you shop there a lot and have time to complete rebate forms. For me these are negatives.


• They don't sell gift cards other than at their stores. I can buy Home Depot and Lowe's gift cards from my grocery store using my American Express Blue Cash Preferred Card and get a straight 6% off any price by doing so. Menards only sells their gift cards at their stores (at least in our city.) And since they don't take Amex, the best I can get is 1% cash back unless the Chase Freedom card has "home improvement stores" as one of their quarterly 5% cash back options.


• They run out of stock early. This has happened to me twice recently. In the middle of September, I went to Menards for grass seed. A clerk told me they were out and that they weren't getting any more this year. He also noted that it was "too late to plant grass", something I knew was wrong because I had done so successfully last year at this time. I went four blocks to Home Depot and they had plenty of grass seed. Three weeks later, the exact same thing happened, this time with grill covers. Menards was out for the year. Home Depot had many options. This is the first time I've noticed this problem, but if it keeps up much longer, I'll just go to Home Depot and save myself a trip.

So, what about you? Do you prefer Menards, Home Depot, Lowe's, or someplace else? Why?

Should Churches Borrow Money?

For those of you new to Free Money Finance, I post on The Bible and Money every Sunday. Here's why.

Recently the Christian Financial Alliance asked several bloggers the following question:

“What is your stance on the issue of churches borrowing money?"

Here was my response:

“Every time the Bible mentions debt, it warns about the dangers of it. So while debt isn’t prohibited, its use is cautioned. For this reason, I think both Christians as well as churches should avoid debt in all but very specific circumstances and when they do [take on debt], have a clear and reasonable plan to pay it off quickly.”

FYI, you may also want to check the link above to see what other bloggers had to say on the issue.

What do you think of my response?

Real Estate 101: Getting It Rented

The following is a guest post by FMF reader Apex. He has been investing in rental real estate for more than four years and is authoring a Real Estate 101 series, posting every Friday, based on his experiences.  (To read the series from the beginning, start here.)   The series is designed to give prospective investors the basic tools they need to succeed.

After you make a purchase there can be a temptation to ease into the property.  You might want to take some time to get more familiar with it.  It can be easy to get distracted by little details and tasks, but this is the time you need a single-minded focus on one major task.  That task is to get the place rented.  This advice is equally applicable to re-renting a property after an existing tenant moves out.  When you have a vacant unit your primary focus must always be getting it rented.

Getting It Ready

If you are purchasing a property that needs rehab, you should start making arrangements as soon as your offer is accepted.  Ideally you would like to get any needed work started the day you close on the property.  Once the rehab is nearly finished you want to start advertising the property so you can have showings lined up as soon as it is finished.  Do not try to show a property before a rehab project is finished.  This is likely to be a waste of time as very few prospective tenants will be able to see past the current state of the property.

If the property just needs freshening up with some paint and carpet you should start taking steps to make those things happen in advance.  If you have a tenant moving out you can get the carpet measured and ordered so it is ready to install right after they move out.  If you are purchasing a property, get permission to get it measured in advanced so you can schedule the carpet for shortly after you close.  Do not however spend any money prior to closing on a property as closings do fall through.

Aggressively Market It

If a new property is in good enough shape to show, get permission to show it prior to close.  I have done this multiple times although not all sellers will allow it.  I had one property that I closed in the morning and moved a tenant in that afternoon.  I had to tell the tenant that the close was still pending and it could fall apart or get pushed back.  They wanted the place enough to take it on that contingency.  That kind of quick turn around is usually not possible, but it does show that you can and should be working on the next steps while you are waiting to close.  If you have a tenant moving out you should start advertising the unit at least 30 days prior to their move out date.  I like to start 45 days in advance to get the people who are looking more than one month ahead.

Time is Money

This is important because time is money, literally in this case.  It is easy to tell yourself that you just have a few minor expenses.  Property taxes and the mortgage payment are probably the big ones.  If you own the property with no mortgage your expenses could be very small.  You may feel like you can take your time to find a tenant because your expenses are low.  That is the wrong mindset.  If you justify that way of thinking you will start using it more often once you convince yourself it is an acceptable way to think. 

Every day that a property sits empty is costing you money.  That money expires each time the sun goes down and it can never be recouped.  The money you lose is not just the expense you incurred while the property was sitting idle.  That makes it easier to justify, but it is not accurate.  The money you lose is the money you could have gotten in rent.  If a property costs you $600 per month in expenses but rents for $1200 per month, you do not lose $600 each month it sits idle, you lose $1200.  This is easy to see when you realize that your bank account balance will be one $1200 check lower than if you had it rented.  Most people would not casually overpay $1200 for a large expense like a furnace just because they didn’t feel like looking for the best price.  Yet a number of owners are complacent about getting a property rented.  It does not make any difference if you spent $1200 you didn’t need to spend or failed to collect $1200 you should have collected.  You are out the same $1200 either way.  We seem to recognize wasteful spending, but it is easier to overlook the same waste when it is caused by a failure to get a property rented.

That is not to say that you should never have a vacancy.  Vacancies do happen and they are a normal part of the business.  The important distinction is that your goal must be to keep vacancies as limited as possible.  An empty property should create a sense of urgency, especially in the beginning when you have fewer properties.  Some investors take this part of the business far too casually.  They do not feel the urgency about it that they should.

I encountered a shocking example of this at a foreclosed duplex I considered buying.  One side was empty and a long-term tenant occupied the other side.  While talking with the existing tenant I discovered that they had lived there for 7 years.  The same owner had owned the property the entire time.  When I asked them about the other half of the unit they said there had been 2 different tenants in there but only for about 2 of the 7 years.  For over 5 of those 7 years that half of the duplex sat idle.  This owner clearly did not feel a sense of urgency about getting his units rented.  It is likely he had a full time job and just didn’t give this business the attention it needed.  He had a reliable tenant whose rent probably covered most of his costs so he may have felt it wasn’t urgent that he rent the second half immediately.  Based on the rent for the occupied half of the duplex he likely failed to collect as much as $70,000 in rent.

This is an extreme example, but it is not an isolated one.  I know of multiple instances of rental properties sitting idle for many months for one reason or another.  This is a not a productive way to run your rental business.  You cannot succeed if you are not generating revenue. 

Will it Rent?

There can also be some anxiety over whether or not you can get a property rented.  Let me assure you that every property will rent.  It’s simply a matter of price.  Market prices are just as important when renting as when purchasing.  It is important that you set your rent at the proper market rate for the type of property you are trying to rent.  If a property is not renting then there is a good chance you have set your rent too high.  This is yet another reason why cash flow margin is so important.  If you have little to no cash flow you will feel pressure to hold to a rent price that keeps your cash flow positive.  However, tenants will not pay more for your property simply because you need more rent to cover your expenses.

You have to be brutally honest with yourself regarding how your property compares to competing units.  If your property has disadvantages to comparable units you will almost surely not be able to get the same rent as those properties command.  Lowering the rent by $25 or $50 per month is far more cost effective than missing out on 1,2 or 3 months of rent holding to a price that is simply higher than the market is willing to pay.  If you cannot find a tenant after looking for 30 days then your rent is likely too high and you should lower it.  I was surprised to hear a story from my agent where he had a property that would not rent at $800 but at $790 he was getting calls.  My properties do not have that kind of hypersensitivity to price but his apparently did.  It’s important that you know your market and know what price people will pay.  Even if you aren’t sure, you can easily find comparable rental rates.  You can then find the market rent for your property by lowering it a little bit every 15-30 days until it rents.  You will find the price that it will rent at.

I now know my market well enough that I don’t typically have to adjust my asking price much.  I set my rent near the top of what I assess the market rent to be for my properties.  If someone tries to negotiate on price and my property has been listed for more than a week, I may tell them I can go down $25 but I can’t go any lower than that.  For the properties I am renting that has worked well.  It might take a little time to get a handle on the right rental rate for your properties.  The more you do this the better you will get at determining what price and process will work best for you and your properties.  The good news is you will get it rented, and if it’s a decent property you will get a good price.  Just be willing to adjust a little bit until you find the true market rent and you will be receiving your first rent check in no time.

Update: For the next post in this series, see Finding Good Tenants.

Star Money Articles and Carnivals for the Week of Oct 22

Here are some pieces I found especially worthwhile and some of the carnivals Free Money Finance was in this week:

• Wise Bread tells how to build your first budget.
• Lazy Man and Money has found some great baby gear.
• My Dollar Plan lists Roth IRA limits.
• Carnival of Wealth
• Nerdy Finance Carnival
• Carnival of Personal Finance
• Festival of Frugality 

Enjoy!

P.S. Carnival Hosts -- If my post is in your carnival in a given week, please send me the URL to the carnival and I will include it in my weekly roundup.

American Express Blue Cash Preferred Card Changing Its Terms

Readers of FMF know that I like and use the American Express Blue Cash Preferred card. It was even on my list of the best cash back credit cards for some time. The key reasons:

• It pays 6% cash back on grocery store purchases.


• You can use it to buy gift cards at grocery stores and get 6% cash back on all sorts of purchases -- restaurants, home improvement stores, etc.


• There is no limit to these rewards. In other words, if you rack up $15,000 in charges at 6% on this card in a year, you would get back $900. Sweet!

The one downside of the card is that it has a $75 annual fee. There is a similar card from Amex with no annual fee but the grocery cash back is only 3%.

However, things are a'changing.

I have heard from several people that this card will begin capping annual rewards starting next year (I don't recall seeing this message in my statement, but perhaps I overlooked it.) Here's a comment left on one of my posts recently:

Just received a notice on the Amex preferred. The 6% at grocery will be capped to first $6000. It still comes out ahead even with the annual fees, if you purchase gift cards. I do lot of driving, and pick up gas gift cards from the local grocery, giving me 6% discount on my gas. The change will be effective next renewal after Jan 2013.

And another:

Did you see that Amex is capping the 6% supermarket rewards on Blue Cash Preferred to the first $6,000 of eligible purchases and then 1% - likely as an attempt at shutting down the gift card loophole. This is from the October statements. Change is effective January 15, 2013. A pity. Still obviously attractive but I would imagine most families of 3-4 exceed $500 in groceries a month even without the gift cards.

I even had a reader email me a screenshot of the notice. So it appears it's both true and widespread.

Too bad. The gravy train was good while it lasted.

The question now is whether or not the card is still a good deal. I think in most cases, the qualified answer is "yes."

While you can't earn $900 on $15k in charges any longer, you can earn 6% cash back on $6,000 in charges. Even after you take out the $75 annual fee, your net cash back on $6k of charges is 4.75% which is still quite good.

We spend about $5,000 a year on groceries, so with $1k extra in gift card purchases we will keep the card and get the full $360.

Of course if you're a one card (or couple cards) sort of user, this card may or may not make the cut depending on how much you charge, where you charge, what you charge, and so on.

What about you? Do you have the card? If so, will you keep it with the new terms?

What is the Main Reason for Your Financial Success?

I was recently taking a survey for a financial services firm (I don't usually take these, but I have an affinity for this group) and the following question came up:

Considering your past experiences, which of the following do you consider the most helpful in terms of success now and in the future?  

• Parents/guardians
• Graduate school
• College
• High school
• Elementary/Middle school
• Friends
• Past/current jobs
• Myself
• Other

The context was money-related, so I took this to mean which of these has been most important in helping me become successful financially. It's a good question IMO -- and one that made me stop and think. Here's how I considered each one:

• Parents/guardians -- While my family was very loving and gave me a wonderful life growing up, my parents taught me little about handling money, so this was an easy one to skip. If anything, my lower-middle-class upbringing was more influential. It taught me that I wanted to move up a notch or two economically and motivated me financially for much of my life.


• Graduate school -- This was one for major consideration. My grad degree was one of the best -- if not the best -- investments in my entire life. Without it I'm positive my lifetime earnings would be a fraction of what they've been over the past 25 years.


• College -- My undergrad degree (and more specifically, my grades and extracurricular activities) got me into grad school, but that's about it. Almost any decent school could have done this.


• High school -- Yes, my high school career got me into college. But not a great college -- a decent one. So this one was off the list.


• Elementary/Middle school -- Really? It seems strange that this could beat out all the other choices available.


• Friends -- From both a networking as well as a "you'll do as well as the five people you spend the most time with" standpoint, this is worthy of some consideration. But for me personally, it wasn't close to some other options.


• Past/current jobs -- Grad school lead to a GREAT first job. That position was with a name-brand employer that by simply being listed on my resume has opened doors for me throughout my career. So this one was certainly worth consideration. But which was most important -- the grad degree that got me the job or the job itself? It's kind of a chicken or the egg situation.


• Myself -- I would call this one "hard work" or "determination" and would rate it high on the scale. As I noted above, growing up I decided that I did not want to be barely getting by all my life. As such I was an over-achiever in school and very driven educationally and in my early career. So this was worth serious consideration too.


• Other -- I can think of three other potential considerations: 1) luck, 2) marrying my wife, and 3) learning the principles of accumulating wealth. All of these have had a major impact on how well I've done financially and were worth consideration as the "most helpful in terms of success now and in the future."

In the end, I selected "graduate school" as the main reason for my financial success. It certainly isn't the only reason, as you can see from my thoughts above. But IMO, it's the one thing that would impact my finances the most if it was missing.

Now that I've shared my thoughts, what about you? What is the main reason for your financial success? Is it one of the items listed above? Or something else?

Thoughts on Two Personal Finance Truths

I recently ran into a couple articles that reinforced personal finance truths I've noted previously on FMF. It's been a while since I covered them, so I thought I'd review the pieces with you.

The first one (of all things) is an interview with country music singer Kenny Rogers. What grabbed me specifically was this exchange:

FOX411: In your late 30’s your career was at a standstill and you were broke.
 
KR: I was broke in my 50’s! This is a business where you stay broke.
 
FOX411: Wait a second, in your 50’s you’d already made some major money.
 
KR: Yeah but you can spend major money too! It’s one of the downfalls of the business. I had nothing as a child. I kind of blew it out as an adult. When I was a kid growing up in the projects I walked to school through a very wealthy neighborhood and everybody had automatic sprinklers and I thought, ‘That is so cool. Someday I want to have automatic sprinklers.’ So when I got a lot of money the first thing I did was get automatic sprinklers on a 1,200 acre property. I would drive around on my golf cart watching the sprinklers go off. I loved that!

Ha! He's so right! No matter how much you earn, you CAN spend it all! I like to say that if you earn $5 million a year and spend $5 million + $1 a year, you're going backwards financially. No matter what your income, you have to spend less than you earn if you want to grow your net worth.

These points highlight the differences between people who are income statement affluent (they make a lot of money) and those who are balance sheet affluent (those with high net worths.) While having a high income can certainly help you grow your net worth, making a lot of money doesn't necessarily (and often doesn't) lead to a high net worth. Why? Because people simply over-spend, committing what I have labeled the worst money mistake anyone can make.

I have a whole category titled "spend less than you earn" that lists high earners who have spent it all and then some. A few highlights:

• More Rich People Who Lost it All


• Seven Costly Pro Athlete Screw-ups


• Stars Who Have Lost Fortunes

The second piece covers another long-time topic here at FMF: that where you live has a major impact on your finances. Choosing a place to live is a balancing act because the cities where you can earn the highest incomes are also usually the most expensive to live in. Thus you need to weigh income versus expenses to see how each net out. As I highlighted over six years ago, it's usually better financially to go with a moderate income and low expense city from a total return standpoint.

This new article comes to about the exact same conclusion. Here's where they ended up when they compared incomes to living expenses:

In first place is Houston, where the average annual wage in 2011 was $59,838, eighth highest in the nation. What puts Houston at the top of the list is the region’s relatively low cost of living, which includes such things as consumer prices and services, utilities and transportation costs and, most importantly, housing prices: The ratio of the median home price to median annual household income in Houston is only 2.9, remarkably low for such a dynamic urban region; in San Francisco a house goes for 6.7 times the median local household income. Adjusted for cost of living, the average Houston wage of $59,838 is worth $66,933, tops in the nation.
 
Most of the rest of the top 10 are relatively buoyant economies with relatively low costs of living. These include Dallas-Fort Worth (fifth), Charlotte, N.C. (sixth), Cincinnati (seventh), Austin, Texas (eighth), and Columbus, Ohio (10th). These areas all also have housing affordability rates below 3.0 except for Austin, which clocks in at 3.5. Similar situations down the list include such mid-sized cities as Nashville, (11th), St. Louis (12th), Pittsburgh, (13th), Denver (15th) and New Orleans (16th).

They go on to note that only two very expensive markets made it into their top 10: Silicon Valley (San Jose-Sunnyvale-Santa Clara) and Seattle. The former simply has the high incomes that can support its high expenses. The latter is still expensive (though not as bad as most other pricey cities) but has decent enough incomes to compensate.

The major losers in the income/cost comparison? They include Boston, San Francisco, New York, Los Angeles and the like. Yes, incomes are high, but these are eaten and then some up by even higher living expenses.

Of course there are many other factors to consider when deciding where to work: opportunities in your chosen field, closeness to relatives, and so on. I'm not discounting those nor am I saying anyone should make a decision of where to work based totally on finances alone. I'm just saying you should consider the income/expense ratio as one of the factors if you have options where to work/live. In my experience, most people don't consider these issues at all.

BTW, the option that's worked for me all these years is to have a very high income in a very low cost-of-living city. Case in point: this page and the list of all the cities I've lived in. :)

Should Christians Give While Getting Out of Debt?

For those of you new to Free Money Finance, I post on The Bible and Money every Sunday. Here's why.

Recently the Christian Financial Alliance asked several bloggers the following question:

“How do you believe a Christian should approach giving while trying to get out of debt?”

I've already addressed this subject on FMF and here was my response:

“I think you can do both if you work at it. We lived frugally enough that we paid off our mortgage, saved, and gave all at the same time. That said, many people can’t do all three to the extent they would like, especially at the start. But I would still suggest they do all three — just at lower levels than they may like. Then as their income increases and they cut costs, they can pay off even more debt until it is gone completely.”

FYI, you may also want to check the link above to see what other bloggers had to say on the issue.

What do you think of my response?

6 Reasons You Need a Spending Plan

Note: For the most part, this post is for those who are at the beginning of their personal finance journey. As I've noted previously, once you have control over your spending you can dial back on how much budgetary control is needed.

Whether you call it a spending plan, a budget, or something else, you need to have a way to keep track of your finances. It doesn’t seem like a lot of fun at first, but a spending plan can really help you take your money management up several notches. It's so vital that I put it near the beginning of my 30 steps to great finances.

With that said, here are six reasons you need a spending plan:

1. Know Where the Money Comes From

A spending plan helps you keep track of where your money comes from. This isn’t just about the money you earn working a traditional job. Your spending plan should also include money from other income sources, including investments, odd jobs, and gifts.

Examine your income trends to get a better idea of your average monthly income, as well as times of the year when you can expect more or less money. Your spending plan can help you tweak matters, and look for ways to more efficiently make more money.

2. Understand Where the Money is Going

Your spending plan helps you see where the money is going. How are you using your money? What are your regular expenses? Are there quarterly or semi-annual expenses coming up? Your spending plan helps you keep ahead so that you aren’t unpleasantly surprised each time the insurance premium is due, or you need to pay property taxes.

3. Make Long-Term Goals a Priority

It’s easy to lose sight of the important long-term goals you might have. Retirement is hard to picture when it’s 30 years in the distance. Even college for the kids is a long 10 to 15 years away. A spending plan helps you bring these long-term goals into focus. Your spending plan requires that you look at your current situation, and where you want to be. With a spending plan, you focus your efforts and work toward your long-term priorities.

4. Large Goals Become More Manageable

A good spending plan helps you break down your goals into something manageable. Large expenses, such as new flooring or a family vacation, can seem overwhelming when you look at the total cost. Instead, use a spending plan to break down your goals into something more manageable. Figure out how much money you need each month to accomplish your goal, and use your spending plan to assign funds to that goal every pay period. With your spending plan laying it all out for you, it becomes easier to see exactly how you can direct your finances to best effect.

5. Prepare for the Unexpected

Your spending plan can also help you prepare for the unexpected. Use your spending plan to designate money for an emergency fund each month. Build your emergency fund faithfully, and you won’t have to worry (about money, at least) the next time your car breaks down, or your child breaks his or her arm. You’ll be ready with your emergency fund money.

6. Increased Peace of Mind

The best reason for creating a spending plan is the peace of mind that comes with it. When you know where your money comes from, where it is going, and you now that you are prepared for emergencies and the future, you will enjoy better peace of mind. A spending plan keeps you from worrying as much. As a result, you are healthier in your life and in your relationships.

No matter how you manage your finances, make sure you include everything in your spending plan. Set it up in a way that puts you in charge. Think of yourself as a resource director, and it will be easier to give every dollar a job that will help you reach the financial destination you seek.

Real Estate 101: Finding Your Niche

The following is a guest post by FMF reader Apex. He has been investing in rental real estate for more than four years and is authoring a Real Estate 101 series, posting every Friday, based on his experiences.  (To read the series from the beginning, start here.)   The series is designed to give prospective investors the basic tools they need to succeed.

When you begin your search for properties you have to start somewhere.  After you have seen a few properties you will start to find things you like and things you don’t.  Perhaps homes of a certain age require more work than you want.  Maybe certain neighborhoods are too expensive. 

The more you look the more you will refine the criteria you think makes for a compelling investment.  However, you can only do so much refining in the abstract prior to purchase.  Once you have purchased a property you will now start to find out what is working as expected and what is not; what features make it easier to rent and which ones make it harder; what type of properties and neighborhoods attract the tenants you desire and which ones make it harder to get good tenants. 

Everyone’s process of discovering what works best for them will be different.  Your refinement might happen quickly or it might be more gradual.  It might take some time and a number of properties to be able to identify those things that are important to you and to how you want to run your business.  The most important thing is to identify what your criteria for success is and to work at refining your process to improve your level of success based on that criteria.  I call this process finding your niche. 

I found my niche after I purchased my second property, and it has guided my course for over three years.  Operating my first property for a year had given me some insights that I used to adjust what I was looking for in future properties.  When I found my second property and began operating it, the pieces of the puzzle that I had been trying to define all came together.  Comparing it to my first property made clear the intangibles that I had overlooked.

Operating that property and others like it for over 3 years has only confirmed and strengthened the confidence I have in the niche that I focus on.  This refinement reduces the type of properties I now consider, but that tighter focus has made the entire process of purchasing properties easier and faster.  I now know what I am looking for.  I know when I have found it, and I can pull the trigger quickly because I now have first hand knowledge about how that property will perform.  Having a niche to focus on has proven to be the most effective way to expand my business.  It has freed me from the uncertainty of trying to consider many different types of properties, most of which I will have had no first hand experience with.

Every real estate investor is different.  I cannot tell you what your strategy should be because there are dozens of different ways to be successful investing in real estate.  The best chance for you to succeed is to find a strategy that closely fits who you are.  You cannot merely copy someone else’s model.  You are not them, and the reasons it works for them, may not work for you.  You must be comfortable with your niche. 

If your primary motivation is ROI and none of the other aspects of real estate investing bother you in the least, then you need to focus on the type of properties that produce the best returns for the least amount of cash invested.  If the amount of headaches you have to deal with is a big factor for you then you need to focus on the type of properties that need the least amount of work, rent easily, and attract the best tenants.  You can decide to focus on small apartments with a caretaker who handles most minor tenant issues.  You can focus on high-end properties that have high-class tenants with high rents.  You can focus on cheap properties that cater to government subsidized housing so you know the rent will always be paid. 

The choices available to you are vast.  However it is important that you do not continue too far down this path without attempting to find out what your niche is.  Each of these different options requires a different strategy.  It requires different levels of expertise and effort.  Failing to concentrate on a core strategy will dilute your ability to become skilled and efficient at any one of them.  Your plan can evolve over time and can encompass more than one strategy, but to think that you can take on a myriad of different properties and succeed at running them all is likely to be a costly mistake, especially in the beginning. 

I have narrowed my niche down to the following.  I look for properties that produce good solid returns, not the best returns possible, but very solid.  I combine that with high quality properties, preferably newer with minimal need for repair, in good neighborhoods in the suburbs.  I specifically try to avoid 1 and 2 bedroom properties with single car garages.  Instead I prefer larger properties, 3 and 4 bedrooms, with double car garages.  I have found that these rent very easily and attract reliable, stable, long-term tenants that treat my properties with respect for the most part.  In time this strategy will likely evolve, but that’s what it currently is. 

There are a few things that helped me to define my niche.  I learned that properties that are harder to rent are a big turn off for me.  Showing properties can be a considerable time effort.  If I have to show a property a dozen times that is a big burden.  The properties I own now typically rent with just a few showings, often on the first one.  I have also found that smaller properties with fewer bedrooms tend to turn over faster.  The larger properties attract families with children that care about the school district and do not want to uproot their families as often.  This keeps my turnover and my workload down.  Furthermore the larger units command more rent.  On a pure ROI basis they might not perform quite as well as the smaller units but on a cash flow per unit basis they perform drastically better.  Cash flow per unit is more important to me than cash flow per dollar invested.  While my dollars are limited, my time is even more limited.  Maximizing cash flow per unit is a big part of my strategy.

These are all factors that have gone in to defining my niche.  The factors that will be important in defining your niche might be similar or vastly different.  Only you know what those are.  The quicker you can identify the factors that are important to you the faster you can define what your niche is.  The better defined your niche; the more satisfied you will be with both your investment and with how your business is running.  That personal satisfaction is going to be essential in allowing you to continue operating your business.  Even if the business is profitable, if you are finding it un-enjoyable in a number of ways, you will likely not stick with it.  The problem is probably not with real estate per se.  It’s probably that you have not found a niche that is a good fit for you.  Find that, and you will find success that will last.

Update: To read the next post in this series, see Getting It Rented.

Checking Out Annuities

Shortly after posting The False Promises of Annuities and Annuity Calculators, I ran into this piece from CNN Money. In it a reader writes in and asks whether or not an annuity is right for him. The response gets into the pros and cons of immediate annuities as well as references a resource for checking out options -- some things I thought we all might be interested in.

So with that said, here are the key points the piece makes about owning an annuity:

• Its biggest benefit is that it offers guaranteed income for life. You give the company a lump sum and they send you a check every month for as long as you live.


• Returns vary (and are low now due to interest rates being low), but it's likely that you couldn't get the rates/return the annuity gets without taking on an extra amount of risk. Do you want to do this? Can you do it?


• The downside of annuities? Once you give them the lump sum, it's theirs. You have no control over it.


• One point I thought was especially good was that you shouldn't think of an annuity as an income source, but also as insurance. Here's how the piece reconciles the fear that you would buy an annuity, die soon, and lose all your money: "But even if you die unexpectedly soon after buying one, you haven't thrown your money away any more than someone who bought car insurance but never ended up in a horrific accident did. With an annuity, you're buying insurance against the possibility of living so long that you outlive your assets." I think that's a very insightful statement.


• One common complaint against annuities is that they are expensive. But the piece doesn't talk about expenses, so I'm wondering if the costs are outright (do you have to fork over $1,000 -- or whatever -- to buy an annuity) or are they hidden (they are simply part of the (lowered) return -- and are hidden like a mutual fund's expenses are hidden)?


• The article makes a great point in that annuities are ONE of the options you should consider in funding retirement. For instance, your retirement portfolio might be a combination of annuities, Social Security, other investments (stocks, bonds, real estate), side income, and part-time work. When looked at as PART of an overall plan, annuities make much more sense. CNN Money even has a different piece on the options we all might want to consider when developing a multi-prong retirement income plan.

The piece links to a website where you can get a quote on an immediate annuity. For grins I went to the site and plugged in a few options that could be pertinent to me. Here's what I got:

• Amount invested: $1,000,000
• Ages of husband/wife: 55/58
• Added benefit: joint life income (if one spouse dies, the other still gets the payments)
• Monthly payment for life: $3,973
• Annual Payout Rate: 4.77%*

• Amount invested: $500,000
• Ages of husband/wife: 55/58
• Added benefit: joint life income (if one spouse dies, the other still gets the payments)
• Monthly payment for life: $1,987
• Annual Payout Rate: 4.77%*

• Amount invested: $500,000
• Ages of husband/wife: 65/68
• Added benefit: joint life income (if one spouse dies, the other still gets the payments)
• Monthly payment for life: $2,318
• Annual Payout Rate: 5.56%*

Note: Here's what the site says about the "annual payout rate":

*Annual Payout Rate – Percentage of the purchase price (i.e., the premium) which is paid back to you each year and includes both interest and return of principal. The Payout Rate is NOT an interest rate. It is significantly higher than the actual interest rate credited to the premium.

And so the games begin! Why can't they give you the actual interest rate? I'm guessing it's because it's not that good...

Overall, the article left me with a better impression about annuities and how they could be used than I had before reading it. However the website with the quotes looked a bit cheesy and I was put off by the “annual payout rate" they offered versus "actual interest rate" I wanted. It felt like they were trying to mislead me.

Anyway, I'll keep annuities in mind. They may or may not work for me in retirement, but at this point I won't rule them out for at least part of my retirement planning.

How about you?

I Hit the Limit with American Express and Chase

Who knew there was a limit on how many credit cards you could have from one issuer? I didn't -- until I found this out from two different companies recently within the space of a couple days. Here's the story.

After I posted on my most recent credit card moves, I made three other changes:

• I applied for an American Express Hilton Hhonors card for two reasons:

1. They had 40k bonus points available (FYI, you can purchase 10k points at $0.01 per point, so 40k points equals $400 in this case). We will be taking another cruise early next year (oh yeah -- stay tuned for the details) and I needed the points to try and hold down expenses.

2. Hilton hotels (Hampton Inn, Hilton Garden Inn, and Doubletree) are my company's choice of hotel when we travel, so I already have a lot of points with them. The Amex card gives me 6 points per dollar spent at Hilton hotels, which will be helpful in getting another 40k points (to have TWO free nights at a hotel I'm looking at.) FYI, we stay at Hampton Inns when we travel as a family too because we've found them to be clean, affordable, and have a good breakfast that gets us going and saves money in and of itself.

• I applied for an additional Ink Cash Business Card. This one was purely a bonus play -- I was looking for another easy $250. Plus I kinda wanted to see if they would issue me another one so quickly after I got my first one (I filed for it under a different "business".)

• I got a Fidelity cash account and hooked it to my 2% cash back Fidelity American Express card. I should be seeing cash rolling in quickly.

A few days after I applied for the Amex card, they called me. It appears they have a limit on how many "lending cards" you can have with them. But the lady was very nice and suggested a couple cards that appeared to be inactive. She asked if I wanted to cancel either of them to make room for the new one. One of the cards I actually use on special occasions, but the second was a pure hold-over from a long time ago. I canceled it and then the Hilton card was approved.

Within a few days I received the card, used it on the trip, and received the 40k miles credited to my account immediately. Sweet! I'm now only a few thousand points away from 80k (two nights' free).

The Chase experience was similar but different. Similar in that they also contacted me, but different in that it was in the form of a letter. The letter basically said I was rejected because I had too many credit cards with them already. I'm sure I could have found some inactive ones to cancel, but since Chase wasn't as easy to work with as American Express, I figured it wasn't worth the effort.

So I focused on the Ink card I had. I set up my cable and internet to auto-pay with it (5% cash back), bought something at Staples with the card (5% cash back), and gave a donation to my church (which got me the second part of their $250 bonus.) Ch-ching!

I still have a couple credit card moves to make in the next few weeks:

• I will cancel the Citi card I wrote about last time. It's never going to be something I'll want to use again since it's now just a 1% cash back card.


• I need to look through the various inactive cards I have and cancel some of them. I'll especially look at the Chase ones since I may want a new card from them.

Anyway, I was surprised that both American Express and Chase had a limit on how many cards they would issue one person. I was sure that credit limit would be a constraining factor, but not number of cards. Has anyone else ever encountered this issue?

Retirement Guideposts

When it comes to figuring out how much you think you'll need for retirement, I'm a big fan of calculating your specific retirement number -- using your income needs, your assets, your estimated costs, and so on. IMO, this gives you the best estimate of what you'll really need and how you stand towards that goal. For a similar perspective, read the thoughtful excerpt titled How Much Income Do I Need For Retirement?

However, it's also useful to have general rules-of-thumb -- benchmarks that can give you a rough estimate of whether you are on track or not. Moneyland recently published a set of guideposts from Fidelity that list the following retirement benchmarks:

• At age 35, you should have saved an amount equal to your annual salary.


• At age 45, you should have saved three times your annual salary.


• At 55, you should have five times your salary.


• When you retire at age 67, you should have eight times your annual pay.

The piece also notes that Aon Hewitt set the goal at 11 times final pay (by age 65) to ensure "retirement happiness" (whatever that means).

FYI, they are assuming that your salary roughly equals your spending. If the two are far apart (which they should be if you've spent 40 years growing your gap) then the amount should be times your spending.

For example, I have roughly 21 times my annual spending already saved but I only have 9 times my salary. It's the expense number that really matters since that's what you are trying to cover with your retirement savings.

Of course there are assumptions factored in to the numbers above (like you get Social Security, your income grows faster than inflation, etc.) But the results at least give you a ballpark answer to the question of "Am I saving enough for retirement?"

So how are you doing based on the estimates?

I'm doing fine and am actually looking to far surpass these results. I'd like to save up an amount that generates enough income to cover my annual expenses without ever having to touch the principal -- something I call the safest retirement. This is one reason I got into rental real estate. I hope I can spend part of my net worth on properties that generate enough income to fund a good portion of my retirement.

As for my retirement, here's a rough outline of how I see myself transitioning through the years:

Next Five Years

• Keep working (at my "regular" job) and saving


• Get my kids started in college (this is a major expense for us as you might imagine)


• Invest some assets in rental real estate to generate income (looking for 10% return)


• Develop some alternative sources of income to fuel the savings fire

Years 6 to 10

• Get kids completely through college


• Continue to manage my real estate -- buying and selling as opportunities present themselves


• Either cut back on hours at my "regular" job or transition into another job, one requiring less time but still generating a decent income (remember that my expenses are well below my current salary -- I can get a job that pays me 40% or so of what I make now and completely cover all my annual expenses)


• Keep the alternative sources of income flowing

Years 11+

• Live mostly off income from real estate and other investments


• Keep working some to pay for healthcare and "stay in the game" (so I can ramp up work if circumstances call for it)


• Travel a good bit :)

Some Things that Could Impact the Above One Way or the Other

• My wife could decide to go back to work


• The real estate efforts could be better or worse than expected


• The market could jump/tank and I could have to adjust accordingly

So that's it for me. How is your retirement savings coming along? Do you have a strategy in place for retirement?

Non-Financial Stewardship

For those of you new to Free Money Finance, I post on The Bible and Money every Sunday. Here's why.

Recently the Christian Financial Alliance asked several bloggers the following question:

“Other than ‘time, talents, and treasures’, what is an area God has led you to be a better steward?”

Here was my response:

“With my health. It’s something that most people don’t think about as a stewardship responsibility, but to me it is. God gave me this body so that I could accomplish His purposes, and I can’t do that if it’s weak, tired, and run-down.”

FYI, you may also want to check the link above to see what other bloggers had to say on the issue.

What do you think of my response? What would you have said?

Help a Reader: Scholarship and 529

A few years ago I wrote What to Do with 529 Money If Your Child Gets a Scholarship. Well, a reader has had this situation happen to them and recently left this comment:

My daughter did receive a full ride scholarship and I have a 529 plan for her (books are the only expense we pay for). Should I take out the amount from her 529 each year for that year's scholarship portion and invest elsewhere for her? I wanted her to be able to use this for a house after college. She might continue with more college after her 4 year scholarship but I don't expect more than 1 year. I feel the penalty for taking it out because of her scholarship is a bit crazy but that's our government. Would appreciate your advice on this.

What are your suggestions for her?

Real Estate 101: Making an Offer

The following is a guest post by FMF reader Apex. He has been investing in rental real estate for more than four years and is authoring a Real Estate 101 series, posting every Friday, based on his experiences. (To read the series from the beginning, start here.)  The series is designed to give prospective investors the basic tools they need to succeed.

It’s a long journey to get to the point of making an offer on a property.  You have probably looked at dozens of properties.  You have run numbers on many of them and you have finally found one that you are interested in purchasing.  The only question left is how much to offer. 

Of course you want to pay as little as possible.  To do that you have to know what a property is truly worth.  For all the different valuation metrics that are available there is only one that matters.  This may surprise some people because it isn’t based on a calculation or some measure of actual value.  A property’s worth is simply what other buyers are willing to pay for it.  That’s it.  That’s what a property is worth.  Some may protest.  What about what it cost’s to build it, or what kind of return you can get on it, or what its intrinsic value is?  Those are all different measures of the value of a property, but you don’t get to purchase on those valuations, you purchase on market price.  That is the only valuation that matters when you are a buyer or a seller. 

This can be both good and bad.  Sometimes the market values things at more than they are truly worth.  Sometimes it values them at less.  This means a property may be valued at a price that will not work as an investment, and that’s why you have to know your numbers.  But you have to get passed the idea that your numbers have an influence on what a property is worth, because they simply do not.  If you are buying a pure investment property such as an apartment then investment numbers are going to be a factor but it still comes down to other investors.  If they are willing to pay more than you, then your numbers are irrelevant.  Your first and most important job when determining what to offer is to know your market.  You need to pay close attention to what properties like the ones you want to bid on are selling for.  That gives you a very good idea of what the property you want to buy is worth.  If that price is too high to allow you a good investment return, then you will need to consider other types of properties.

The second thing you need to assess is the competitive demand for a given property.  Certain properties are in higher demand than others.  Good single-family homes for example have many homeowners bidding on them so you are competing with a much larger pool of buyers than if you were buying duplexes for example.  If you want to buy a property that is in higher demand you will have to factor that into your bidding process.  If you are bidding on a property that has multiple other bids submitted, your bid will need to be competitive.  You will need to combine what you know about the market value of properties like the one you are bidding on with how much competition you have.  I have walked away from some properties simply because there were too many offers.  To be competitive I knew I would have to bid more than I wanted to pay so I simply moved on to greener pastures.

A good example of this process is a property I purchased almost three years ago.  I knew from experience that the market for that particular property was $130-$135K.  I had seen a handful of other bank owned properties just like it sell in that price range.  The bank listed the property for sale below market price at $117K.  As a new investor it is important not to let the asking price be an anchor for your valuation of the property.  Asking price is just a starting point and it may have no relation to a property’s actual worth.  Remember, market price is the only valuation that matters, not asking price.  That property was worth close to $135K and I knew it.  Of course the asking price does tend to act as an anchor for many buyers which tends to hold down their offers, so I was eager to put an offer on this property before too many other buyers found it.  I had planned to put in an offer in the mid $120’s.  This offer would be under market but above ask and I was hopeful that if things moved quickly I could pick it up at a discount. 

I was prepared to put my offer in on the second day it was listed but found out it already had 5 other offers in only one day and would likely get more before the bank stopped taking offers.  My agent and I discussed the situation.  We speculated that there were probably a couple buyers who didn’t really understand the market and thought they could purchase it for what was being asked or perhaps even below.  There were probably a couple investors who knew it was below market but were trying to pick it up at a discount like I was.  Then there were probably at least one or two savvy investors or buyers who knew the market well and were willing to bid close to market.  I knew this property made very good money at its true market price and I was convinced it was likely that one of my competitors did too because likely they were bidders on some of the other properties I was comparing with as well.  The difference of a few thousand dollars in the asking price would make almost no difference in the long-term returns or the cash flow of the property.  Given that, and the strong demand for this property I decided to offer just above the known market range at $136K.  Two days later my offer was accepted.

You almost never find out after a deal what any of the competing bids were, but in this case the listing agent told my agent that we barely won the bid, probably because it was so close.  The next closest bidder had offered $135K, exactly what the market price was.  That is no coincidence.  They knew the comparable sales prices and likely made the same calculation I had.  They just calculated $1,000 too low.  That was nice confirmation that we had calculated correctly.  Keep in mind this purchase was in early 2010.  The housing market could not have been in worse shape at that time.  Properties were being purchased below ask all the time.  It would have been very easy to rationalize that you simply don’t pay over asking price in that market.  But asking price is irrelevant.  This price was wrong.  The bank may have purposely chosen the price to attract extra demand and bring in extra bidders, or they may have just mispriced it.  The reason doesn’t really matter.  What matters is I knew what it was really worth, I knew the competition on this property was strong, and I knew the price it made sense at for me.  All those things allowed me to buy a great property at the right price, and at a price that offered a very good return.

I would love to have gotten that property at $125K, or $117K, or $110K.  Likely some of my competing bidders thought they might be able to get it for that, but they were wrong.  That property was not available at those prices.  There were at least two bidders that day at the true market price.  And here is the thing, there usually are.  If your competition is soft on a property or non-existent then you can usually get it for a discount, but if you have limited competition then likely the discount you are getting is the actual market price.

Now there is another strategy that some investors take, which is to attempt to buy properties at well below market prices.  This strategy can work but it tends to not be very easy.  Investors who use this strategy will typically make a lot of offers before they get one accepted.  The properties this works best for tend to be diamonds in the rough. 

Why would a property sell for well below its market value?  Even if a seller is desperate, there are other buyers out there who would bid on a good property.  Typically there are reasons a property would sell at such a low price.  It is in a poor neighborhood.  It has difficult structural issues.  It just simply needs a lot of rehab.  This is the diamond in the rough.  Hopefully you can actually turn it back into a diamond!

This can be a time consuming strategy that involves a lot of failed attempts before success, and this is typically followed by a significant rehab project.  I simply do not have the time for that nor do I seek those types of properties at this time.  However there is another reason I don’t chase these types of deals right now and that is because I simply don’t have to.  There are hundreds of great properties out there in good neighborhoods, that are highly desirable, and that generate very good investment numbers.  They won’t quite generate the kinds of ROI numbers you can get if you are able to purchase a diamond in the rough with a low-ball offer, but that is not my highest criteria for success. 

The last thing I want to mention is the difference between purchasing from an owner and purchasing a foreclosed property directly from a bank.  When purchasing from an owner you are dealing with their emotional attachment to the property but also their need to sell.  There is usually some room for negotiation here but there can also be a stubborn refusal to accept reality.  You cannot make them sell the property at market price if they don’t want to.

A bank is the exact opposite: Unemotional, unattached, and no need to sell the property on a particular schedule.  However, you also cannot make the bank sell at market prices if they don’t want to.  When buying from a bank, if the price is too high, there is only one thing that will change that and that is time.  The property that I used in my column on “Running the Numbers” was one that the bank had originally listed for $20K higher than I purchased it for.  I knew that price was wrong.  The correct price was around $125K but they had listed it for $144,900.  I let it sit on the market for 3 weeks and then I offered at $115K.  My agent told me that was too low for the bank to consider, but I wanted to attempt to meet at the market price.  It turns out he was right.  They countered at $138K, so I raised my price to $122K.  They came back at $137,500.  They were telling me that they were at their bottom price.  Now the truth is I was willing to pay up to $130K for this property and if they had continued to negotiate we could have easily ended up there.  But banks don’t work that way.  They generally have a formula that involves regular reductions in price over time.  One week after they had given me a bottom dollar of $137,500, they dropped the price to $134,900.  I waited another month and they dropped it to $124,900, just like clockwork.  I immediately offered exactly at the asking price and the offer was accepted in a day.  There were two other offers that came in as well.  This shows they had finally gotten to the true market price for the property.  The price that I knew was right because I knew the market.  When they got to the market price they got multiple offers for the property.  When they were over priced they received no offers. 

What I am hoping to get across is that a property will sell for what its market value is.  Even an accepted low-ball offer is usually selling at market value.  There is something about that property that makes it so that no one else wanted it at that price.  Your job is to find properties that have good numbers when they are sold for market prices.  There will likely be a day when that gets tougher to do.  Until it does, there are plenty of good deals to be had.  You simply have to know your numbers, know your market, and know your competition.

Updated: To read the next post in this series, see Finding Your Niche.

Star Money Articles and Carnivals for the Week of Oct 8

Here are some pieces I found especially worthwhile and some of the carnivals Free Money Finance was in this week:

• EDITOR'S CHOICE! Carnival of Personal Finance 


• The American Debt Project highlights a business he'd like to own.


• Wise Bread lists 25 things to do with a rotisserie chicken.


• The Simple Dollar covers giant Christmas lists.


• Lazy Man and Money likes investing in baseball teams.


• My Dollar Plan says to share food expenses with friends.


• Carnival of Wealth (last week) and one from this week


• Nerdy Finance Carnival


• Carnival of Personal Finance


• Work Save Live talks about emergency funds.


• Carnival of Wealth Management


• One Smart Dollar highlights the best balance transfer cards.

Enjoy!

P.S. Carnival Hosts -- If my post is in your carnival in a given week, please send me the URL to the carnival and I will include it in my weekly roundup.

How to Quickly Manage Your Diversification

The following is an excerpt from Dividend Growth: Freedom Through Passive Income.

Dividend investing can be appealing as it doesn’t require you to check your portfolio every week. However, the trick is that you still need to manage your portfolio once it is built and make sure that you are not over- exposing your investments to specific risks.

In order to do so, I would suggest you use a sector distribution list to ensure that you don’t spend too much time on diversification so you don’t put yourself at risk.

One of the most important reasons why you should have bought this book is because you don’t have enough time to properly manage an active portfolio. Dividend investing can be appealing as it doesn’t require you to check your portfolio every week; however, the trick is that you still need to manage your portfolio once it is built and make sure that you are not over- exposing your investments to specific risks.

In order to do so, I would suggest you use two methods to ensure that you don’t spend too much time on diversification and don’t put yourself at risk.

Make a Sector Distribution List

The first thing to do before building your portfolio is to identify the sector that you want to invest in. I’ve showed you how to determine great stocks regardless of their industry, now you will do the opposite: you will look at all of the sectors and then select the one you want in your portfolio. Then, you will be able to go back to your stocks on the radar list and pick the one that fit your sector needs.

Think of selecting sectors that should do well in the future and pick strong dividend payers in each of them. This way, although you might be wrong on the sector, you will own the “best” stocks in each industry. Concentrating on one sector (such as energy, financials or telecoms) will create greater fluctuations in your portfolio. Depending on what you are looking for (growth, steady income, etc.), you may classify your sector like this. Growth sectors will offer greater capital gains potential, but you will have to be ready to ride higher fluctuations as well. Steady income sectors will provide a nice steady dividend, but might not be the sexiest investment options. Here’s a quick review of each US sector (I used sector description from Bloomberg).

• Basic Materials: If you are looking for dividend-payers, you might forget about basic materials right away. Historically, those companies don’t pay much dividends since they need their cash flow to invest in new mines and productions. Only a few stocks pay over 3% in dividend in this sector. Among them, you find Southern Copper (SCCO), Du Pont (DD) and Nucor (NUE).


• Communications: The telecoms and internet providers are among the most generous dividend-payers. You just have to think of both giants AT&T (T) and Verizon (VZ) paying over 5% in dividend yield. This is a sector where you can find huge companies that are well-established and decide to distribute a generous dividend. Across all sectors, they are part of the top three in highest dividend yield.


• Consumer, Cyclical: Considering we’ve had such a volatile economy I’m not sure I would invest a lot of money into cyclical industries. They are generally not super generous in term of dividend yield either. However, a few interesting stocks are worth mentioning: Wal-Mart (WMT) with a low dividend yield but always increasing, Hasbro (HAS), and Darden’s Restaurants (DRI) are also interesting.


• Consumer, Non-cyclical: Often seen as one of the ultimate defensive sectors, consumer non-cyclical stocks are usually showing lower dividend yield (such as KO, CL, DPS, TAP), but great and diversified companies. You also find the high dividend-paying, but controversial tobacco companies. You shouldn’t expect much growth form this sector, but it’s a great place to pick a few solid stocks.


• Energy: The energy sector in US is not known for high-paying dividend stocks. Once you have looked at a few exceptions (such as CVX& COP), you are down to pick stocks giving 1% or 2% dividend. This is definitely a sector where you would gain to look north of the border and get a few Canadian companies.


• Financials: After everything that happened in 2008, several investors are having cold feet before buying financials. As you can see in the previous quadrant analysis, AFL and BLK are showing strong metrics too. Dividend metrics are not at their best yet, but there is still room here. REITs might be an interesting sector too along with… Canadian Banks! Obviously.


• Industrial: There are a lot of huge companies that are spread around the world in this category (such as MMM and CAT). Defense and Aerospace (LMT & GD for example) offer great dividend yields as well. Mind you, industrial sector will follow major economic trends as most companies don’t upgrade their equipment during recessions.


• Technology: This is definitely one of my favorite sectors. Recently in 2012, companies such as Apple started paying dividends. They could become an interesting addition to a great pool of stocks already (INTC, HRS, GMRN, STX, MSFT, etc). While technology evolves very fast, there are a lot of companies that kept huge liquidity in money market funds. They represent one of the most sustainable dividend sectors in the overall market.


• Utilities: This is the realm of steady and high dividend yields. In this sector, it’s not hard to find a 4% dividend stock (there are also a few great 5% stocks too!). The utility sector is known to maintain dividend payout ratio around 50% (electricity) and 60%-70% (water) and it is useful to follow those guidelines. This sector will bring stability and push your overall portfolio dividend yield higher.

How Can You Manage Portfolio Diversification Efficiently

There are several tools to help you manage your portfolio efficiently without losing too much time on diversification. For example, you can calculate and manage the beta of your portfolio. To learn more, check out Dividend Growth: Freedom Through Passive Income.

Help a Reader: To Refinance or Not Refinance?

I recently received this email from a reader:

I have about $12k left in a student loan (projected pay off July 2013). I'm currently investing $0 in retirement (Dave Ramsey Plan), but will be contributing what I'm currently contributing to pay off my debt when I pay off my debt. My current home loan is 3.875%/20 years (only 6 months in, refinanced earlier this year), with a balance of 153k.

I squeezed $100 out of my budget this month, and given the current mortgage rates, I'm at a dilemma.

I can currently get refinanced to 2.75%/15 year, that would cost about $100 extra per month, but add about an extra $100 in equity per month, for a given difference of about 13k extra in equity over 5 years.

Should I put the extra $100 in my debt repayment, and then eventually into retirement; or put the $100 into my house equity via the refinance?

• Note 1: I do have an emergency fund (about 30k), and have some retirement (about 30k).


• Note 2: Re the refinance, the closing costs would be about $900, thus the total cost over 5 years (including closing costs, and extra payments), would be about 7k, but I would have about 13k more in equity. The way I view it is I'm spending 7k to get 6k in returns, almost doubling my money.


• Note 3: Re my student loan, it is at the typical 6% interest rate, but I'm projected to pay it off in about 9 months, so they extra $900 ($100 per month over 9 months) towards it wouldn't make too much of a difference in the long run (e.g., pay the debt 1 month faster)


• Note 4: I'm really reluctant to pay down my student loan with my e-fund. I really like the e-fund in place, and by not using it, it forces me to pay down my debt faster.


• Note 5: The only reason I'm considering refinancing is how low the mortgage rates have gotten. 3 years ago (when I bought the house), I got a 5.875%/30; refinance 6 months ago to a 3.875%/20; and now I can get a 2.75%/15. In theory, I would like to refinance after I pay off my debt, but the driving force is i) how low the rate is now and ii) what will the rates be in 2013 when I project to pay off my debts.

What is your advice for him?

How Much Should I Save Toward Retirement If I'm Starting Late?

The following is a guest post from Marotta Wealth Management.

I often get comments like "It's too late for me to do this" or something similar. Granted, it's usually better to start financial efforts (saving, investing, growing your career, etc.) sooner rather than later so compounding can work for you. But it's better to start now rather than put it off any longer. And while you'll need to make sacrifices if you start late, it's not hopeless.

Knowing how much you should save for retirement is critical. But what if you are late getting started? The longer you delay, the shorter the time that compound interest can do its magic on your savings.

We typically recommend that you save 15% of your take-home pay each year. Money in the bank isn't compounding. Invest the money in an age-appropriate portfolio and rebalance regularly. Make sure your investments choices have low fees and expenses. Assuming you start at age 25, you should have sufficient assets to retire at age 65 after 40 years. Short-term market volatility should not deter long-term investing.

Retirement planning is like the pioneers who set forth on the Oregon Trail. The hardy souls who began their journey in early spring had to average 15 miles a day to reach their goal. But those who delayed until summer needed to maintain a faster pace. The same is true of saving for retirement.

Beginning at age 25 and retiring at 65, the appropriate savings rate is 15.4%. But starting just five years earlier, you could reach the same goal by saving just 11.1% each year. Starting early is more important than saving more.

If you start at age 20, you will have saved nearly an entire year's salary by the time the couple delaying is putting in their first 15%. In fact, the family starting earlier will be ahead of the family starting later all the way up until age 65. This is true even though they will be saving 5.3% less of their salary each year.

Deferred consumption is the definition of capital. When a family defers consuming and saves and invests instead, they put that capital to work. Having more money invested early means their investments are making money and adding to their savings, which reduces the amount they need to add. Money makes money.

Starting at age 15 is even better. For students who work summers and start saving, the safe lifetime savings rate is only 8.04%. Starting early is so beneficial that you can lower the rate you need to save each year. Thus every sage investor suggests beginning as young as possible.

Late April or early May was the best time of year to set begin the arduous trek to the West. If you waited too long, you would have to push farther each day or risk getting trapped in the mountains by an early snowstorm.

The same is true of retirement planning. The later you start in life, the higher the percentage of your lifestyle you must save. Starting at age 25 you should save 15.4% of your lifestyle each year to reach financial independence by age 65. For every year you delay, add about 1% in your 20s and 2% in your 30s.

Here's one of my favorite math problems: If a wagon train averages 10 miles a day for the first half of the Oregon Trail, how fast does it have to travel the second half to average 20 miles a day for the entire journey?

Most people wrongly answer 30 miles a day. But if the trail is 2,000 miles long, to average 20 miles a day you would have to travel the entire trail in 100 days. But if you averaged 10 miles a day traveling the first 1,000 miles, you would have already used up 100 days. You would then have to travel the second thousand miles instantly to overcome your slow start.

Starting at age 30, we suggest you save 21.4% each year. By age 35 it rises to 30.1%. And at age 40 it is 43.2%. Saving half your salary is difficult at any age. Lowering your standard of living to begin saving at age 40 is even more challenging.

By age 45 the percentage rises to 64.2%, and at age 50, you must save 100% of your lifestyle to reach retirement at age 65.

Saving 100% of your lifestyle sounds impossible, but it is not. If you earn $100,000 after taxes, you must limit your lifestyle to $50,000 and save the remainder. This strategy will allow you to retire at age 65 with a lifestyle of $50,000.

Changing your lifestyle by spending less and saving more is always the fastest way to catch up from a slow start. Most important, it reduces the amount you must save to reach financial independence. Lowering your lifestyle is like traveling twice as fast and cutting half the distance you need to reach your destination.

Social Security can also provide a larger percentage of your retirement. If you are willing to retire on an average monthly income of $1,230, you probably don't need to save at all. But that certainly is not what any financial planner would recommend.

Start early and enjoy a more leisurely trip. But if you have delayed, don’t give up. Make a commitment to adjust your lifestyle as needed.

Help a Reader: Where to Meet Solid Money Management Mates

Here's an email I recently received from a reader:

A close female friend to our family (to point of being our child's guardian) is a level-headed, sensible, focused MBA. She is 38, single, has no kids, and is still looking for "Mr. Right".

The dating scene is focused on glitz and not substance, and this lady is substance -- but still cute to boot (I realize this statement contradicts itself, but people are people). Her parents have been married for over 40 years, practical "millionaire next door type" father, and a devoted and smart mother. She is busy in her career but not too busy for the right person. So, the issue is, "Where do you and your readers think the best place is in this current day and age to meet a practical person, someone with their financial and life goals in focus and on an upward trajectory?"

As marriage and divorce are IMMENSE financial issues along with emotional issues, meeting the right person (rich, in the middle, or poor) with the right mindset for life growth is an imperative for financial AND emotional happiness. So, any ideas? Does Dave Ramsey have a "singles group":)?

What are your suggestions?

Divine Intervention to Sell Homes

For those of you new to Free Money Finance, I post on The Bible and Money every Sunday. Here's why.

As most of you know, I've started the process of becoming a real estate investor. For background, see these posts:

• My Road to Becoming a Landlord


• My Process for Determining a Suitable Rental Property


• Real Estate 101: Why You Should NOT Invest In Real Estate

And, as most of you also know, I write a weekly post on Sundays about money and the Bible.

So, when the two subjects came together in an article recently, I just HAD to post on it. :)

This piece from AOL Real Estate talks about the tradition of burying a statue of St. Joseph in your yard to help your house sell faster. It tells the story of a lady whose home sat on the market for a year. Then she buried a statue (given to her in a kit -- yes a KIT -- by a friend) in her yard and it sold in three weeks. Some highlights:

She took the palm-size St. Joseph figurine and followed the instructions: She buried it upside down, 6 feet from the back door, and read a prayer afterward. Three weeks later, an interested buyer made an offer on the house. The sale closed in December 2011.
 
"How can I not believe?" Berkowitz said.

And the seller had this comment, which I thought was funny:

She does feel a little guilty about participating in a Christian tradition. "I feel like a traitor because I'm Jewish," Berkowitz said with a laugh.

You have probably heard of the St. Joseph statue superstition. Obviously there's no way to say that this practice does or doesn't work (who could prove it either way?), but it does seem fair to call it a superstition. But I guess people who do it think "what could it hurt?" and that's my take as well. If it floats your boat, why not try it? I personally have never done so and I don't think it helps, but then again, what could it hurt?

Thoughts?

Broke Athletes

Has anyone seen this? It's the ESPN series 30 for 30 -- with this show being about athletes who made a bundle of money and then lost it all (a topic we've covered here several times). I have it on DVR and will probably watch it this weekend, but I thought I'd highlight it for those of you who love personal finance and sports since it's being shown a few times over the next week.

Real Estate 101: Running the Numbers

The following is a guest post by FMF reader Apex. He has been investing in rental real estate for more than four years and is authoring a Real Estate 101 series, posting every Friday, based on his experiences. (To read the series from the beginning, start here.)  The series is designed to give prospective investors the basic tools they need to succeed.

What if before you purchased a stock, you could get a very close approximation of what kind of return you would get on it in the coming years?  What if before you started a new business, you could make a close estimate of both your overall revenue and expenses to determine what your net profit would look like?  Obviously that would make the decision to invest or start a business much easier to make, but unfortunately there is no crystal ball into that future.

With real estate, however, the future does have a crystal ball and it’s the present.  The near future in real estate looks very much like the present.  This is because rental properties are basically commodities.  Similar properties in similar local neighborhoods will rent for similar prices and have similar expenses.  Furthermore the supply of properties does not change much from year to year and neither does the demand.  This creates a relatively stable environment that makes calculating how a real estate investment can be expected to perform in the coming few years straightforward and remarkably accurate. 

If you research real estate financials you will find there are literally dozens of different numbers and ratios that you can use to measure the performance of the business.  I am going to focus on 4 different ratios, which combine to give a complete financial picture of the investment.  They are cap rate, cash on cash return, return on investment, and cash flow margin.  These are all very straightforward to calculate.

You will notice that I do not account for appreciation in any of these calculations.  Appreciation over long periods of time can improve return on investment significantly.  The problem with appreciation is that it is difficult to project accurately, and it has no immediate cash impact on your business until you either sell a property or borrow against the increased equity to access more cash for future purchases.  All things being equal you should favor a property that is more likely to appreciate, but in the short term your business will thrive much better on high cash flow properties than it will on high appreciation properties with low cash flow.  As such we will focus on cash flow and profit calculations without factoring in appreciation. 

To explore these calculations we will use real numbers from a property I purchased in June of 2011.  This is a 4 bedroom, 3 bath townhouse that was built in 2007. 

There will be two assumptions in these numbers.  First is 1/2 month of vacancy per year, which is about 4.1%.  My vacancy has thus far been much lower than this, because I have long-term tenants with long leases and have had almost no vacancy between renters.  Eventually you will have some vacancy so it is important to make a realistic assessment of what your actual vacancy will be without underestimating it.  Second is an allowance of 5% of revenue for unscheduled costs.  This includes repairs, maintenance, and replacement.  Normally this number would need to be much higher than this but since this is a townhouse most of my large expenses are covered by my association dues.  My actual numbers have been far less than this number as well because of how new the property is, but they will eventually catch up when I have some larger replacement costs.

Here are the numbers.

Purchase Numbers

• Purchase Price: $124,900
• Mortgage Balance: $93,675 (75% loan to value, 30 year mortgage with 5.25% interest)
• Closing Costs: $3,500

Monthly Revenue

• Rent: $1,400 ($1460 – 4.1% vacancy allowance)

Monthly Payments

• Mortgage Payment: $517 (Interest-$410; Principle-$107)
• Association Dues: $210
• Taxes: $133
• Utilities (water): $35  (trash is provided by the association)
• Insurance: $10  (master insurance policy is provided by the association)
• Allowance for other costs (5%): $70
• Total Monthly Payments: $975

From these we will calculate some basic numbers needed by the financial ratios. 

• Cash Invested = Purchase Price + Rehab Costs – Mortgage Balance + Closing Costs

          $124,900 + $0 - $93,675 + $3,500 = $34,725

• Monthly Cash Flow = Revenue – All Payments

          $1400 - $975 = $425

• Monthly Net Income = Cash Flow + Principle Pay down

          $425 + $107 = $532

• Monthly Net Operating Income = Cash Flow + Debt Service (Mortgage Payments)

          $425 + $517 = $942

While these numbers are needed by our calculations, they are valuable on their own as well.  From these numbers we see that this property produces $425 of cash flow each month.  This is real cash that is deposited in your bank account each month.  It also produces $532 of net income or profit.  This would be the amount you would pay taxes on except that you will receive a substantial deduction for depreciation and likely pay taxes on half of this or less.  For instance my depreciation allowance on this property is about $330 per month.  That means I gain $425 per month in cash, I have profit or gain in equity of $532 per month but will only pay taxes on about $200 per month.  The Net operating income of $942 shows how much money this property would make if it were fully paid for.  This is what your cash flow would look like if you purchased it with all cash or after you had paid the mortgage off.

From these numbers we can now calculate the ratios that will tell us how this property will perform as an investment:

• Cap Rate = Annual Net Operating Income / Current Value (Purchase Price)

          $942 * 12 / $124,900 = 9.1%

• Cash on Cash Return = Annual Cash Flow / Cash Invested

          $425 * 12 / $34,725 = 14.7%

• Return on Investment (ROI) = Annual Net Income / Cash Invested

          $532 * 12 / $34,725 = 18.4%

• Cash Flow Margin = Cash Flow / Revenue

          $425 / $1400 = 30.4%

The cap rate is 9.1%, which is a solid number.  This is the return you would get if you purchased the property with all cash.  You will find that if you use more cash and less leverage you will get lower overall returns on your investment but higher amounts of cash flow.  

The next two numbers show us how this property will perform using the financing terms we have chosen.  By using 75% leverage this property’s cash return on the money invested is increased from the 9.1% cap rate to a 14.7% cash on cash return.  This is a 60% increase in cash for every dollar invested.  The Return on Investment (ROI) which accounts for the portion of your mortgage payment that went to equity in your property comes to 18.4%.  This is the more than double return I had mentioned during the benefits column that can be achieved by using leverage over cash.  These two numbers show the actual return you are going to get on this property.  Cash on cash return shows your cash in hand return and ROI shows your total profit return. 

These two ratios are dramatically affected by how much leverage you use.  Because of that the cleanest way to compare one property to another on a pure performance basis is the cap rate.  It’s worth pointing out that if a property is purchased with all cash, then the cash on cash return and the ROI will be the same as the cap rate.

Cash on cash return and ROI work together to tell you how well this investment will perform.  Cash on cash return is important because this tells you what percentage of your investment is being returned to you in cash each year.  This can be used as income or as capital for future investments.  There is one danger with looking only at cash on cash return however.  You can affect this number by changing the financing terms.  Different amortizations and payment terms can make this number look better than it is.  For instance I have some loans that are interest only because they are lines of credit.  They appear to perform vastly better on a cash on cash return basis because the loan payments are only interest.  This is why ROI is also important because when comparing ROI the loan term differences are accounted for and the returns look more similar.  ROI is also your true total return on the property.  You want to be sure you are not convincing yourself something is a better investment than it is by focusing too intently on a single measurement of performance, and you want to avoid making short term financing decisions based solely on numbers that may not be the wisest choice for a long term investment. 

Finally we see the cash flow margin is 30.4%.  This means you are able to keep almost 1/3 of the rent you collect after making all of your payments.  This is an important measurement because you want to make sure there is a margin of safety in your cash flow numbers.  30% is a very safe cash flow margin.

Overall these numbers show that this property performs quite well as a real estate investment.  Since it is a townhouse with association dues involving overhead, a single family house or a duplex can often produce even better numbers depending on the purchase price.

This property turns out to be ideal for the current investment strategy that I have.  It is in a very good neighborhood.  It is almost brand new.  It attracts high quality, stable, long-term tenants and as such my real numbers are actually higher than what I am showing here because the allowances I am using are higher than I am currently experiencing.  Because of the quality of tenants I can attract my tenant issues are minimal.  Since it is a townhouse my maintenance demands are reduced because I only have to deal with inside issues, the association handles everything external.  The intangibles of this property are very high.  Those intangibles are very important to my strategy so I am pleased to get such solid numbers on a high quality property.  It tends to be the case that the higher the quality of property the lower the overall numbers because the sales prices tend to push up on better quality properties and the increased rent usually can’t keep pace with the higher sales prices.

I would like to be able to conclude this column with specific targets for these measurements.  Unfortunately it’s not possible to give universal targets.  Different areas of the country will produce different numbers.  Different eras of real estate investing will drastically affect the kind of numbers one can achieve.  We are in an era where the returns are at the high end of the range.  These numbers won’t always be achievable.  Also different types and qualities of properties will produce different numbers.  Older duplexes will probably produce better numbers than newer single family houses.  But newer single family houses may produce better future appreciation, less maintenance, and depending on location may result in higher quality tenants.  There are far too many variables to say what any of these numbers should look like.

I will, however, offer two pieces of guidance.  The first is around cash flow.  Because of how critical cash flow is, any property you buy should always be able to produce some reasonable cash flow.  If your cash flow margin is in single digits it’s getting uncomfortably low.  Preferably cash flow margin should be in double digits and certainly not below 5%.  This target is easily attainable in this market. 

The other guidance I would offer is to examine your ROI and decide if that number is something you think is worth the effort and worth your investment.  If you get a reasonable cash flow margin by using more cash but at the cost of a low ROI perhaps that is not a sufficient return to justify the investment in real estate.  Personally I would like to see ROI that is in double digits.  You could accept high single digit ROI on an all cash deal but once ROI was down near 5% the return is probably not high enough to justify real estate over alternative investments.  With the use of leverage double digit ROI is also easily attainable in this market.

With these 4 ratios you can effectively compare every property you are considering to determine which ones give you the best returns and which ones do not.  Remember that these numbers do not account for appreciation so over time your return will exceed these numbers.  However, for the purposes of making the initial investment, these 4 ratios will give you all the information you need to make a well-informed decision.

To read the next post in this series, see Real Estate 101: Making an Offer.

Teaching Kids Financial Self-Discipline

The following is a guest post from Dr. Craig R. Everett, the author of Toby Gold and the Secret Fortune, an urban fantasy novel that introduces financial literacy principles to children ages nine and up. I will soon be reading this book with my kids.

Financial independence boils down to two main factors.  First, it requires the ability of the individual to spend less than he or she earns, which requires budgeting.  Second, the individual must be able to invest that regular surplus over a prolonged period of time.

Both of these factors depend on one particular character trait: Self-discipline.

Unfortunately, self-discipline is a trait that appears to be in relative short supply in today’s culture.  Kids want everything “now” and for the most part, they get it.  Parents recognize that this is a problem, yet seem unable to address it.  According to a 2002 report by the non-profit group Public Agenda, only 34% of parents feel that they’ve succeeded in instilling the value of self-discipline in their children.  One has to wonder if even those 34% may be fooling themselves.

For parents who are concerned about teaching their kids financial self-discipline, here are a few ideas to try at home:

• Play games that reward waiting.  For example, here is one that is based on the famous “Marshmallow Test” at Stanford in the 1960’s.  Have your child sit at the table and place their favorite treat in front of them.  The first time, start off easy.  Tell them that they can either eat the treat right now, but if they wait 2 minutes, they can have TWO treats.  Then each week, do the game again, but extend the waiting time.  This reinforces the principle that delayed gratification will be rewarded.  For older kids and teens, a variation of this game would be for you to wait for your child to come to you asking for money for something, let’s say a new game or app.  You give the child a choice.  You tell them that they can have the money for the game right now or, if they wait two weeks, they can get two games instead.  The idea is to use the opportunity of them really wanting something to teach them patience.


• Make their allowance conditional on keeping a budget and expense log.   The expense log is critical – kids need to get in the habit of keeping track of exactly how and when they spend their money.  On allowance day, have them show you how much money they have left from the previous week, plus a list of exactly where each penny was spent.  This habit will make effective budgeting a very easy next step.


• Use the time-honored principle of “matching funds” to encourage saving.  For many adults, the only reason they participate in their employer’s 401k program is because the company matches at least a portion of everything they save.  Do the same thing for your kids.  Every week, make a trip to the bank with your child to deposit the money they’ve saved from their allowance and then match it with your own additional contribution.  This gives them an immediate reward for saving, which will strongly reinforce the habit.

These are just a few suggestions worth giving a try.  The overarching principle is to look for any opportunity to reward your child for exercising patience, particularly when it comes to money.  The rewards do not have to be solely financial.  Sincere praise when a child demonstrates a worthy character trait – such as self-discipline – goes a long way. For many kids this is even better than a cash reward.  As a father of five, I can testify to the fact that some techniques work wonders with some kids but not others – even within the same family.  It’s a matter of trial and error to find the approaches that work best with each of your children.

Why "Six Reasons You’ll Never Retire" Is Wrong

The following is a guest post from Lance at Money Life and More.

I read a LOT of financial news and personal finance blogs. Normally they have a lot of similar view points. Lately I have noticed one thing that the mass media and personal finance blogs seem to differ on. In regards to retirement, the media focuses on fear mongering and stating that you will never be able to retire while personal finance bloggers seem to focus on how you can set yourself up to be able to retire comfortably in the future.

So What Brought This To My Attention?

I recently read an article on MSN titled "Six Reasons You'll Never Retire" and I couldn't disagree with it more. I don't have an issue with the author because everyone needs to write articles that'll get attention and get read. I'm hoping it scared some people into saving more for retirement. I, however, am going to tell you why those six reasons don't mean you'll never be able retire. They may mean you have to work harder to achieve your retirement goals but it can still be done.

Reason 1: Corporate Pensions Slashed

“Companies did this to cut their costs, and unless you have amazing luck investing, the defined-contribution plans will deliver less income after you retire.”

The statement that defined-contribution plans will deliver less income after you retire is definitely a possibility. YOU can make it a false statement. It is a fact that most corporations no longer offer defined-benefit pension plans. These days many companies do offer defined-contribution plans like 401(k)s instead.

Do you want your 401(k) to provide as much income as a traditional defined-benefit pension? It is possible. The problem is most people don't want to make the sacrifice to save enough to generate that income in the future. YOU aren't most people though. If you want to have a pension-like income in retirement save like you mean it. 5% won't be near enough. Bump it up to 15%, 20%, 25% or more and you'll have a shot at making it a reality.

Reason 2: Dropping Income

“A September 2011 Census Bureau report revealed that a typical U.S. family became poorer between 2000 and 2010...  Specifically, median household income fell 2.3% to $49,445 in 2010 and has dropped 7% since 2000 after adjusting for inflation -- and income was the lowest since 1996.”

If you're reading this blog my guess is you aren't trying to be the median household and I know that I'm not. It seems like a lot of people focus on these median statistics but in reality the median doesn't matter in your personal situation. You need to take responsibility for your income and grow it as much as you can. While the average may be dropping, if your personal income is growing it doesn't matter what the rest of America is doing. Work hard by working smart and increase your income. Don't settle for being the median.

Reason 3: Higher child care expenses due to rise in 2-income families

“While this arrangement offers financial benefits, it also adds to parental stress and boosts child care expenses for many families. For example, in 2011, fees in licensed centers ranged from as high as $14,050 a year for a 4-year-old child to $18,200 a year for an infant...”

Child care, like most everything else these days, is getting more expensive. Is anyone shocked? I'm not. This doesn't have to derail your retirement. Be creative and arrange your work schedules so you don't have to leave your kids in child care all day. Do you live close to family members who like to be involved in your kids' lives?  See if they don't mind watching them a day or two a week. There are plenty of alternatives out there to plopping your kid into a "licensed center" all day every work day. Find one that works for you.

Reason 4: Collapsing investment returns

“...stocks have earned slightly more than 2% a year in the past decade, while the average annual return of the Standard & Poor's 500 Index from 2002 to 2012 has been 1.8%.”

I don't claim to have a crystal ball. I can't see the future. What I do know is that taking one ten year time period to prove a point isn't a sound analysis. If I had picked a different ten year time period the return may have been 8% a year or even more! While returns haven't been the best lately I believe that in the long run things will even out like they have in the past. The long run is not 10 years though. The long run, in my opinion is at least 20-30 years and might be even longer than that.

Another problem with this analysis is they are projecting one set of stats into the future. Have you ever heard about the roulette wheel? Just because the ball landed on black the last 100 times doesn't mean it will land on black again for 101st time in a row. I'm not telling you things will get better tomorrow but I'm pretty sure if you dollar cost average over the next 30 years you'll be much better off than 1.8% annual return.

Reason 5: Insufficient Savings

“If you have $10 million saved up, and it yields the typical money market rate of about 0.5%, that means $50,000 a year in income. ... According to the Employee Benefits Research Institute, 17% had more than $250,000 saved up in 2011. The report doesn't say what percentage had more than $1 million, but 60% of those surveyed reported having saved less than $50,000.”

If you have $10,000,000 saved up I sure hope you don't have it sitting in a money market account earning just 0.5%. I know of savings accounts that pay out more than 0.5%.  If you manage to squeak out 2%, which is very reasonable, you'd take home $200,000 a year which would more than cover many people. That doesn't even begin touch the principal either. There is no doubt that you need to be cognizant of your rate of return and how much money will be available every year, but these numbers are ridiculous to me.

When it comes to how much money people have saved for retirement do you want to be part of that 17%? I do! The difference between myself and the 60% who had less than $50,000 is I'm going to take action to join the 17%. In fact, I'm going to need a lot more than $250,000 and I'm going to save to get to the amount I need to retire. Find your number (how much you need to save for retirement) and figure out how much you need to save each year to get to that goal. Don't wait. Start today. Time is your best friend. If you don't save you only have yourself to blame.

Reason 6: Inheritance Too Small

“If you don't have enough money saved up on which to retire, you have three options: work until you die, inherit enough to retire on or retire with insufficient money to pay your bills.

For example, 78 million baby boomers -- born between 1945 and 1965 -- are expected to inherit $8.4 trillion (including $2.4 million that has already been received), according to Boston College's Center for Retirement.”

I think the $2.4 million is supposed to be $2.4 trillion but I have made similar typos before so I can't blame the author for that. In my opinion, inheritance shouldn't even be brought up in retirement planning. People shouldn't rely on an inheritance to be able to retire. It shouldn't matter if the inheritance is too small or not. You should prepare for your retirement yourself and rely on nothing but what you can provide for yourself. That is the only way you can be certain you will be able to retire.

My Advice to You

Don't be a victim. Don't fall for the media gloom and doom hype. Think for yourself and take action to put yourself in the position you want to be in for retirement. Start saving today. Start saving a big chunk of money so you can live how you want to. If you're scared you haven't started soon enough there is no better time than today to get started. The longer you wait the worse off you will be. What are you waiting for?

Your Take: Food in Theaters

Here's a conversation we haven't had in a while, but is always sure to create a heated conversation. Perfect stuff for a blog. :)

A few years ago I asked if it was ethical to sneak food/drink into a movie theater. There was feedback from a theater employee who said it was ok, but when I emailed my local theater, they said it was not allowed. And comments from readers were certainly mixed.

I had pretty much forgotten the debate until I recently saw this piece in my local paper asking the same question. So since I have a good amount of new readers since the last time we discussed the topic, I thought I'd ask again:

Is it OK to bring food to the movies? (Even if the theater says you shouldn't?)

I've already detailed why I don't see that many movies in theaters any way and since I wrote that post, things have gotten worse. Prices are higher than ever, movie goers seem ruder than ever (TURN OFF YOUR PHONES, PEOPLE!), and theaters seem much less "special" than they used to be. Besides, with the advent of big-screen TVs, cable, Red Box, etc., there are very few movies these days that I feel I HAVE to see on a movie-sized screen.

Many of you are probably the same. But let's forget that issue for now. The question is, when you DO go to the theater, do you think it's ok to bring/sneak in your own food, candy, drinks, etc. into the theater even though the theater forbids it (which most do)?

Let the fun begin...