Free Money Finance

Taking a Day Off

Hope you all are enjoying a nice, relaxing day with family like I am.

While I am taking the day off, here are links to some great articles -- the best FMF had to offer last year:

• Best Posts of 2011


• Best Guest Posts of 2011


• Best Excerpts of 2011

Enjoy!

One Financial Mistake

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 one financial mistake you have made (at any point in life) that God used to teach you?”

Here was my response:

“For me it wasn’t one individual mistake, but the fact that I did not manage my finances according to biblical principles — and thus my net worth suffered. When I discovered what the Bible has to say about earning, saving, investing, giving, and the like and then applied it to my life, things changed dramatically for the better and I’ve never looked back.”

You want specifics on what I applied and how those actions helped me financially? See The Bible Will Make You Rich for details.

Want Better Pay? Hit the Gym

Here's a piece from CNN Money that says working out can pay off big-time. Their thoughts:

Exercising three or more times a week leads to 6% higher pay for men, on average, and 10% for women, Cleveland State researcher Vasilios Kosteas reported recently.

The hike is due to exercise-induced productivity boosts, he says, and is separate from the well-established link between obesity and lower earnings.

6% is a nice chunk of change over the course of a career. Let's take two guys, each starting their careers at age 22 earning $30,000. One works out and thus his salary is 6% higher than the other's. They each average annual raises of 3%. At age 65, the guy who works out has earned $160k more, plus likely has all the added benefits of better health and lower costs (medical bills, life insurance, etc.) that those who work out get. Pretty sweet, huh?

Of course there's more money in simply growing your career a "meager" 1% a year, but why not do both -- grow your career PLUS workout for an extra 6%? It all adds up, right?

Should Americans Be Forced to Save for Retirement?

As we all know, Americans are dreadful at saving for retirement. I have run post after post throughout the years showing the stats of how ill-prepared most are for the day they won't/can't work.

Of course there's Social Security, but anyone who is counting on it for their full retirement is going to be unpleasantly surprised. It's just not enough money for most people to survive on and have a decent quality of life.

So what should we do about this problem? After all, it's our collective problem -- not just an issue for those who don't save. We don't want homeless 70-year-olds sleeping on our streets or gangs of elderly people breaking into our homes to survive do we?

One solution is to force Americans to save more for retirement -- similar to the way we force people to pay for Social Security. This piece from Market Watch sums up the idea as follows:

It’s time for the U.S. to create a mandatory, defined-contribution plan, not unlike those in other parts of the world such as Australia or the United Kingdom. Or so says Meir Statman, author of “What Investors Really Want” and a professor at Santa Clara University.

“Libertarian-paternalistic nudges have moved many non-savers into defined contribution retirement savings, but left many behind, along with those with limited access to defined contribution retirement savings plans,” Statman wrote in a paper that’s currently being considered for publication in a highly regarded professional journal. “It’s time to switch from nudge to shove and replace libertarian-paternalistic voluntary defined-contribution accounts with fully paternalistic mandatory defined-contribution accounts for all.”

The article doesn't make a conclusion -- whether this is a good idea or not -- it simply details the proposal by Statman as well as looks at other, similar plans in countries throughout the world.

I kind of have mixed thoughts on this one. On one hand, I do not want the government involved in handling/managing my retirement money. If anything can make a bad situation worse, it's government oversight, involvement, and management.

On the other hand, something needs to be done or else we're all going to be footing the bill for the hordes of elderly people who didn't save while they were working.

I'm interested in your thoughts on this one. Should there be some sort of forced retirement savings? Are there other solutions that would be better? Or perhaps you don't see any problem at all.

Please leave your comments below.

Do You Pay Your Kids for Good Grades?

Here's a piece from the Wall Street Journal that debates the pros and cons of paying your kids for getting good grades. So my question for you today is this:

Do you pay your kids for good grades?

We do not pay our kids for grades. However we have set up an incentive plan for our daughter. Here's what happened...

When she was younger she had a Spanish teacher that she didn't like (at a local co-op -- our kids are homeschooled for the classes we can teach, but neither of us knows a foreign language). So as she approached high school, she was adamant that she would not take a foreign language class. Our problem was that our state requires at least two years of foreign language to graduate from high school.

So while our daughter didn't want to take a foreign language, there was something she wanted: an iPad.

Seeing the opportunity, here's what I offered her:

• I would hire a tutor for here.


• She would apply herself to learning Spanish with the goal of passing the CLEP test for college Spanish 1.


• When she passed the CLEP test, I would buy her an iPad.

She loved the idea and we had an agreement!

I found a Spanish tutor on a recommendation from a friend. The tutor was a teacher at a local high school and tutored students on the side. My friend's kids had taken the teacher's classes and loved her.

My daughter hit it off with the teacher and they started meeting every other week when my daughter was in 8th grade. Now at the semester break of her 9th grade year, she's completed high school Spanish 2 and wants to keep going. I'm now hoping to get more than the Spanish 1 CLEP credits out of the deal. :)

One problem we ran into was that it's going to be better for my daughter to take all her Spanish classes and then take the CLEP tests. But that's a couple years down the road. So while she had completed her classes and COULD take the CLEP test, it's better to wait and see if she can pass multiple Spanish CLEP tests (and thus enter college with 6 to 9 credits rather than 3.) But she's basically earned the iPad now -- she's done everything we asked (and according to the teacher would be ready to pass the Spanish 1 CLEP) except for actually passing the test.

So we reached a compromise. We bought her an iPad mini (which she preferred over the iPad). If she passes the Spanish 1 CLEP, then she's already received her payment. If she doesn't, she will reimburse us the cost of the iPad mini from her savings.

BTW, we gave my son the same deal (he's now taking Spanish with the same tutor) and I even had offered to let him pick a class different than Spanish to pass the CLEP for. He doesn't want an iPad, but does want a new phone, so I offered that as an incentive. His response: "Nope. Too much work." :)

Anyway, that's it for my school-incentive efforts. Do any of you have stories of your own in this area?

Reader Profile: DK

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 DK. He sent me the following details about his financial life:

I am a 31 year old male.  I currently work as a personal trainer, which is what I've done for nearly 9 years now.  I have a wife and two kids(3 and 4 years old), and my income ($95,000.00) is the only one.

I would say we are in a "recovering" financial situation.....

Our Chaper 7 Bankruptcy was final in August of 2011.  I was literally bankrupt financially, relationally, emotionally, spiritually and physically.  It was the worst time of my life and I'm actually suprised I made it through it.  My wife and I were one court date away from a finalized divorce and she and the kids were living 1000 miles away from me.  However, by the grace of God, we came to the decision that we couldn't be apart, and we didn't care if we had to live in a tent, our family was going to stick together.

What had preceeded all of this drama was a total uneducated view of money, and improper handling of money. I had never been taught the right way to save and/or spend.  We were making $140,000.00 per year, and we were broke and in debt up to our eyeballs.....it was horrible.

Ok, now the good part.....

My family is together and better than ever!  I have learned very hard lessons and done a ton of study and education on personal finance since those horrid days.  I probably read one financial book a week for the entire year.  My favorite book now is "The Richest Man in Babylon". 

We currently have no consumer debt.  No car loan, no credit cards, no home loan.  Only 2 school loans which are both at under 3% interest.  We live in a very nice rental home in a very nice neighborhood.

I currently give 10% of my gross income away every paycheck, and as my favorite book says, I pay myself 10% of my gross income as well.  We have about $35,000 now put away for retirement, and another $35,000 in cash assets (money market, CDs, stock/bond).  I also sock away another $500 per month into a Universal Indexed Life policy.  Great protection for my family plus a nice nest-egg for when I'm 60 years old.

I am looking forward to continual growth in all of my savings accounts and my current goal is to develop passive income-producing assets.  I know I still have a long way to go, but I wanted to share my story and hopefully encourage someone who may be in a desperate situation such as I was.  I do have to give all credit and glory to God for saving my family and helping us out of our situation.
 
If I had to give one piece of advice that I whole-heartedly believe in, I would say that no matter how much you make, give 10% away (donate), and keep 10% for yourself (emergency fund, retirement, ect.).  Learn to live off the rest and you'll be fine.  I do these numbers from my gross earnings, but you could do it how you want.

Merry Christmas

Just wanted to wish all FMF readers a very Merry Christmas!!!! Hope you all have a great day celebrating!!

It's Christmas Eve!

Well, it's the day before Christmas and I'm celebrating with family. I hope you all are having a wonderful day as well (and not out rushing around for last minute gifts -- ugh!)

I will be taking tomorrow off as well as a few days around New Year's, but other than that FMF will keep posting as usual.

Merry Christmas (eve)!

Generous Hands are Blessed

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

For the rest of the year I'm going to be highlighting verses relating to the poor on Sundays as a reminder of why I'm doing my $25k Red Kettle Challenge. Here are two for today. I've already shared these, but this time they are from the Message translation:

Proverbs 22:9: Generous hands are blessed hands because they give bread to the poor.

Proverbs 21:13: If you stop your ears to the cries of the poor, your cries will go unheard, unanswered.

Remember, I'm matching your donations dollar for dollar, so everything you give doubles in value! If you'd like to donate, go to my online Red Kettle.

Hope you're having a blessed holiday season.

Chase Freedom Categories for the First Quarter

Most readers know that I use the Chase Freedom cash back credit card. IMO it's the best overall booster card out there today and a must-have for those of you with a multi-card strategy.

The Chase Freedom card offers 5% cash back on certain categories each quarter. But you have to register online in advance to get the bonus for the next three months. This post is to remind you to REGISTER NOW.

The 5% bonus categories for January through March are:

• Gas stations - YES!!!! I LOVE it when they have gas stations as a bonus category because, as you might imagine, gas is one thing I buy regularly.


• Drugstores - I don't buy a ton from drugstores, but my Walgreen's has a TON of gift cards that I can buy and get 5% cash back.


• Starbucks stores - I don't drink much "dessert coffee", and when I do it's usually from McDonald's. It's just as good and is less expensive than that at Starbucks.

I should be able to hit $1,500 spent on these categories with no problem. That's an easy $75 bucks back!

To get set up so you receive the 5% back for these categories, simply go to the card's activation website here and follow their simple process. It takes about 30 seconds.

It's Better to Give in Big Chunks

Let's say you have $1,000 to give next year to various charitable organizations. Which gives you the most bang for your buck:

• Twenty $50 gifts


• Ten $100 gifts


• Two $500 gifts

Turns out the latter is 39% better than option #1 and 14% better than option #2. The reason? Costs. From Money magazine's December issue:

It typically costs charities about $15 to raise small gifts. That means you're better off giving more to fewer charities:

• 20 gifts of $50 each: $300 in fundraising costs; $700 to benefit the cause


• 10 gifts of $100 each: $150 in fundraising costs; $850 to benefit the cause


• 2 gifts of $500 each: $30 in fundraising costs; $970 to benefit the cause

I have seen this play out in real life -- from the donor's side.

I used to "spread around" my contributions, trying to give a lot of charities a little bit of money. Then, as you can imagine, I received tons of extra solicitations from every one of them: mailings, calendars, address labels, small "gifts", requests with stamps, phone calls, and on and on. The avalanche of marketing materials was overwhelming -- and the costs must have been tremendous.

Over the past couple years I have purposely focused our giving on only a few charities. We now receive much less "marketing" and the costs in the system are much lower as a result. So more money is actually doing the work we want it to. It's been a lot less stressful opening the mail as well. :)

So if you're a giver, you may want to consider giving to fewer causes and in larger amounts. Doing so means that more of your money is going to the purposes you intend for it.

Star Money Articles and Carnivals for the Week of Dec 17

As a reminder, I am currently running the $25k Red Kettle Challenge.

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


• Wise Bread has uses for stale cereal.


• The Simple Dollar advises to use the peak-end rule.


• Lazy Man and Money discusses a hotel credit card scam.


• My Dollar Plan lists holiday gifts that give back.


• Nerdy Finance Carnival last week and this week.


• 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.

Most Soon-to-Be Retirees Don't Have Enough Saved

The December issue of Money magazine lists this interesting stat on the last page:

The median retirement savings for households near retirement (55-64): $120,000

One word: yikes!!!!

Let's look at the math a bit:

• Let's assume a person right in the middle of this age range: age 59 1/2


• We'll give him six more years of work


• So far in 37 years of work he's managed to save $3,243 per year


• We'll add in $20k more in additional savings for the six years of work he has left


• This gives him $140,000 in savings at retirement


• He can withdraw $5,600 each year from this savings if we use the 4% rule (which I know is not worth much in many cases, but we're just trying to get close)

This plus Social Security is going to make for slim pickings when it comes to funding retirement. Is it any wonder that "work longer" seems to be the #1 response to "how are you going to afford retirement"?

It's this sort of low-end, barely-getting-by retirement that I'm trying to avoid. In fact, I want to be on the opposite end of the spectrum -- I want to have enough saved so I can live comfortably at my current standard of living from just the earnings on my net worth and never have to spend any principal. How do I plan to get there? A combination of the following:

• Saving/investing like a fiend


• Looking at creative retirement options


• Investing in rental real estate


• Considering phasing into retirement with an early semi-retirement plan

I'm still a few years away from seeing if this plan has legs to stand on. You'll be among the first to know one way or the other. ;)

Price Matching at Best Buy

Remember our discussion of "showrooming", the practice of looking at/checking out a product at a store, then leaving and buying it cheaper online? It was quite a lively conversation! Well I recently had an experience with it and wanted to let you know how Best Buy handles it.

I got a new phone in early December and needed a case for it. Verizon had an "Otter" branded one for $49.99 that was too bulky and looked like it could withstand a direct hit from a nuclear warhead. I needed a case for sure (I got a Samsung Galaxy 3S and they seem pretty fragile without a case). Verizon said I would get 25% off because of my company's agreement with them, but I wanted to look around a bit first to see what the options were.

I found several I liked at Amazon, but buying there meant I'd have to wait for them to ship it to me. This meant several days being VERY CAREFUL with my phone while using it without a case. So I decided to drop by Best Buy and see what they had to offer.

I shopped a bit there and noticed that they too had Otter branded items. They had the same one as Verizon and it was also priced at a full $49.99. I looked up the item on my phone at Amazon and it was available for $27.99 -- over $20 cheaper!!!

On a whim I asked the Best Buy associate if they price matched with Amazon. I assumed he was going to tell me to go and pound sand, but instead he said they would! He noted that they had two criteria for the match:

• The item on Amazon had to be the exact UPC as the one in the store.


• The item had to be shown as "in stock" at Amazon.

He said that as long as these were true, they would match the Amazon price. All I needed to do was to show the page to a Best Buy associate on my phone.

I eventually didn't buy anything there since they didn't have exactly what I was looking for. I went back to Verizon, got a different case, and took my 25% discount. I thought later that I should have asked them if they price matched as well since I could have saved a few more bucks, but it was the last stop of the day after visiting several stores for gifts, they were packed, and my daughter was ready to go home NOW. So I was ok with getting it and getting out of there quickly.

The key finding for me in all this is that Best Buy DOES price match Amazon -- which makes me more willing to go to Best Buy for items. This is probably not new news for some of you, but it was for me!

BTW, I LOVE the phone! :)

Reader Profile: JP

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 JP. He answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I'm 33 years old, married (excellent wife, very financially mindful) with one son who is 22 months. We are thinking on a second one.

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

Cash Flow

Income: $150,000 a year $8,000 disposable /month (after health insurance/flex $350, 401k contributions $565, and tax deductions $2,400)

• Home - $2,890
• Nanny / daycare - $1,850
• Dining Out - $450
• Groceries - $500
• Bills & Utilities - $700
• Student Loan - $750
• Auto & Trans - $350
• Travel - $150
• Shopping - $200
• Gifts & Donat. - $100
• Personal Care - $100
• Misc. - $30
• Health & Fitness - $50
• Total - $8,005

Balance Sheet

Assets:

• Emergency funds (savings/MM/CDs): $42,000
• Fund to spend on housing (short term investments): $33,000
• Retirements (401k / IRAs): $96.000
• Life insurance policies $1M
• Primary house valued at $460,000

Liabilities:

• Mortgage ($371,000) ARM 7 @ 3.25%
• Student Loan $117,000

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

Two key issues, one is trying to reduce expenses while trying to increase income. And the second one is related to housing.

My wife and I are thinking on having a second child, but will need to either move to a bigger home or expand our new one. After doing the financial math and considering what is available in the market for other houses, it seems that it is cheaper to renovate than to move to any of the available bigger houses. The key decision I'm struggling with now is how to finance this renovation.

Option 1 is through short term loans (401K loan -- 4.5%  but with the benefit that I'm paying my self back and the 4.5% interest goes back to my 401K account and also use some credit card leverage (35K - currently I always pay it by month end). Then I'll refinance after renovation is complete and pull some money out to pay most short term loans.

Or Option 2, which is through a not well known 203K loan (an FHA loan that allows you to borrow principal plus an amount for renovation), low fixed rate of 3.25% for 30 years, requires FHA upfront payment, but puts the housing payments at $2,740 for 30 years. Keep in mind that for the first 4 years the comparison can't be made apples to apples as the interest of the 4.5% is pay back to me with option 1 while with option 2, the interest of 3.25% is to the bank. 

What should I do?

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

Maximize income while creating a savings funds so that in the next 5 years I'm able to open my new business. As I do business strategy and transformation consulting, I would like to do business turnarounds on my own (e.g. purchase a small company and flip it).

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

Absolutely 'Live within your means", but if you want to have a nice live and great means, then maximize your income so that you could continue to live within your means but your "means" are higher / as desired. I'm also a big fan of using Mint.com and creditkarma.com both are free application, great mobile versions and help you tremendously in managing your financials (first one) and your credit score (second one).

Case Studies Of People Who Have Successfully Quit

The following is an excerpt from How to Engineer Your Layoff. If you're interested in quitting your job and profiting from it, this book is for you! Today's post details how the author successfully walked two different people through quitting their jobs and leaving with decent severence packages.

“An athlete cannot run with money in his pockets. He must run with hope in his heart and dreams in his head.” – Emil Zatopek

Over the past several years, I have coached roughly a dozen people through their layoff process. The 2009 downturn was brutal and caused a wave of disatisfaction across various industries, particularly those which are highly cyclical.

In the following chapter, I share with you five examples (two in this excerpt) of people who have successfully quit their jobs with a severance package. Names have been changed for privacy purposes.

What’s important to note is not so much the dollar amount of each example’s severance package, but how many months of living expenses are covered in each severance package. Our living expenses vary because we all are in different stages of our lives and live in different areas of the world. US$15,000 a year is plenty for someone living in Beijing, but below poverty level for someone living in Des Moines. Meanwhile, $60,000 a year is good living for a single person practically anywhere, but could be considered lower middle class for a family looking to raise a family in New York City or San Francisco!

Lana The Bartender / Artist

I first met Lana in 2007 at a lounge in San Francisco. She had just graduated from San Diego State with a major in English literature. When she overheard me talking to my friend about a book project, she couldn’t help but interject and ask what I was writing about.

Never to ignore a beautiful lady, I told Lana that I was writing a book about the incestuous start-up community in Silicon Valley. The book would be filled with juicy stories of arrogant, newly rich brats who threw their money around like confetti. Included in the book would of course be a steamy love triangle between the rich protagonist, a bartender, and a poor, but gorgeous immigrant woman.

Lana was sufficiently intrigued to put down her tray and share her story with us! You see, even though she was the waitress for our section of the lounge, she hadn’t given us the time of day up until then, even though we arrived 10 minutes prior. Lana told us that she decided to move to San Francisco’s Mission District to be an artist. She was just temporarily waiting tables so that she could pay the rent and afford to take art classes part-time during the day.

Lana recommended I get a copy of the classic writing book by Strunk & White, Elements Of Style, and came back with two frosty Sierra Nevadas on the house.

We gave her a $10 dollar tip, exchanged contact information and wished her good luck.

We traded a couple e-mails over the years, encouraging each other to keep up our respective arts. With daytime classes and a night job, Lana struggled for time and energy. Meanwhile, with my 12-14 hour job in finance, all I wanted to do was grab a beer after work, watch some TV, and sleep!

In the summer of 2011, I ran into Lana again in The Mission district. Instead of waiting tables, she was now the bar manager at one of the most popular locales in the neigborhood. I asked her how her artwork was going and she said she was actually making decent money selling her paintings! She admitted to only making $1,000 a month after three years, but she absolutely loved it. She just wished she had more time to paint because she knew that if she could just dedicate five more hours a day to her work, she was sure she’d be happier and could earn at least $2,000 a month in income, which would be more than enough for her.

By this time, I had already coached four of my friends from various occupations how to engineer their layoffs. Lana’s case was slightly trickier because even though she was the bar manager, she was still only making about $20 dollars an hour and didn’t have that big of a financial safety net. I didn’t want to help her engineer her layoff only for her to run out of money.

We talked in depth about the following points:

• How serious is she about leaving her job? She confided in me that she was tired of standing all day, being nice to customers while hardly making anything, and wanted out. She was getting depressed that after four years of college, she was still working at a bar four years later.


• How big is her financial safety net? Lana told me she’d saved up about $10,000 after putting away roughly $2,500 a year for four years. She didn’t have a 401K or an IRA, but she did have a liquid money market account. Lana basically paid her savings account $200 a month first before spending money on anything else.


• How much income will she be giving up? For the first two years out of college, Lana made about $25,000 a year waiting tables. For the last two years, she started making about $40,000 a year, but her hours were just killing her to the point where she was sleeping until noon, going to lunch, and then running straight to work.


• What is her monthly operating nut? At the time, Lana lived very humbly in a three-bedroom house with two other roommates. Her portion of the rent was $800 a month, which left her with roughly $1,600 a month in disposable income after her $200 a month in savings. The $1,600 would be used for food, clothing, travel, nightlife, and art supplies. In fact, Lana was spending as much on art supplies as she was on food!


• How many months of living expenses can she cover with no income? With $10,000 saved up, Lana can live for roughly four months at her current rate of expenditure. If she cut down on her art supplies, travel, and nightlife, her savings could last her six months. Six months is the minimum amount of savings I recommend one should have before taking a leap of faith if one cannot negotiate severance.

Time to get to work.

With the above information in hand, I suggested Lana go through her budget, pretend she suddenly lost her income and had to cut down on all expenses except for the essentials. If after two weeks she was still OK, then she should consider making her move. With two years of experience at the existing bar and a good rapport with Larry the bar owner, who loves her, severance of 1-3 months was not out of the question.

According to patrons of Lana’s bar, she was by far the most popular bartender/bar manager around. She was friendly, attentive, and very attractive. Some of the guys there said that the only reason they came to the bar was because of Lana! For the past two years, she generated over 10X her $20 hourly wage for Larry, and he didn’t want to see her go. At the same time, he knew that Lana’s art was getting more and more popular among the local community and didn’t have the heart to hold her back.

Larry had always wanted to be a musician, but couldn’t make ends meet, so he took over his father’s bar when he died ten years ago. Every now and again, Larry would bust out his guitar and play for the crowd. Oh how stiff his fingers are at 58 years old.

Lana spoke to Larry about her dreams to be a full-time artist ever since she was in grade school. Her job at the bar was never meant to be full-time, but she loved working with him and the community so much that she didn’t want to leave. When she got to $1,000 a month in art income for five straight months, she felt comfortable about finally making the move. Lana never mentioned to the owner how much she was making from her art. Instead, she mentioned to Larry how she was so excited to see people slowly take an interest in her work. Lana knew that Larry had always wanted to be a musician and knew he would be able to relate.

Lana promised to always come back to spend time as a patron and hang out with the customers she got to know so well. Furthermore, as a favor to Larry, she said she’d be willing to paint an abstract scene of the bar for free. Maybe Larry would even hang up her artwork proudly above the top shelf.

Larry was so touched by Lana’s generosity that he told her to follow her dreams, even though he hated to see her go. With his encouragement, he provided her with a 360-hour severance that totaled roughly $3,800 as a parting gift. It was the least Larry could do for having such a wonderful employee.

With $13,800 saved up, Lana gave it a go as a full-time artist. Last I heard, she moved into a one-bedroom apartment with a new boyfriend and is happily enjoying painting all day long. Every other week, Lana still stops by the bar where she used to work to say hello to her old colleagues and clients. They all love her and are reminded of her every time they see her painting above the entryway.

Lana’s Severance Package

• Severance (Three weeks per year, 22 weeks): $3,800
• Cobra: None
• Unused Vacation (5): $540
• Gardening Leave: None
• Total Severance Value: $4,340

Lyndon The Management Consultant

The luckiest people on earth are those who don't make a lot of money. They've got very little downside and can really pursue their childhood dreams. Imagine that upon graduating from college, you landed a plum corporate job that paid just enough to keep you motivated, but not enough to let you enjoy your freedom. The longer you worked, the more you realized there was really no escape, because there was simply too much at stake. This is the problem that plagued my friend, Lyndon.

Lyndon had a mid-life crisis. At 33, he’d worked for 11 straight years at one of the foremost management consultant firms in the world, and made roughly $300,000 as an "Engagement Manager.” Obama says he's rich, but Lyndon wasn’t buying it because his 1,200 square foot, two-bedroom apartment in New York City cost $4,000/month. If he bought the condo, he'd have to shell out over $1,000,000, even in today's market. To add further insult, $300,000 is really only $180,000 or so after federal (33%), state (7%), and city (4%) taxes!

All Lyndon ever thought about is being a National Geographic nature photographer. Every single vacation was planned around some remote destination that takes two days to reach, and therefore another two days to return. Yet as a consultant, Lyndon was at the mercy of his clients. Instead of traveling to Mt. Kilimanjaro, he was on a plane to Minneapolis in the middle of winter.

In several years, Lyndon knew he’d probably continue to make more money and perhaps make millions as a partner in his 40's. But what was the point if he was not completely happy? The 65-hour workweeks and minutiae were grinding his soul raw. He wanted out. Yet, how does a 33 year old, who's on a path to seven figures remuneration, rationally decide to quit his job and try and to make it as a nature photographer?

I know, an ant is playing the world's smallest violin somewhere underground. While thousands are unemployed, Lyndon is on a path to financial freedom, works at one of the world’s most prestigious companies, yet he's unhappy! He doesn't feel the plight of the less fortunate whom in his eyes are just in transition. To Lyndon, everything is logical. When markets crumble, people get dislocated, but eventually get relocated when the markets rebound. Oh, how Lyndon wishes for dislocation.

Unfortunately, nobody will give Lyndon much sympathy, except his fellow well-todo friends. Ironically, it is the sympathy that Lyndon seeks, which makes him only hang out with people of his same socio-economic class. He understands most of America won't understand him, so he shuns most people.

I first met Lyndon in NYC when I was getting my face ripped off working from 5:30am to 8pm everyday downtown. We met at an apartment party and instantly connected because of our love of tennis. Every now and again we’d catch up for a drink in SF or NYC and pontificate on what a screwed up world we live in.

Both of us had been thinking about engineering our own layoffs ever since we first started working! New York City is an absolute grind, but it makes everybody who survives the place that much stronger. I only lasted from 1999-2001 before I had to get the hell out. I had debilitating allergies, a backbreaking work schedule, and gained almost 20 pounds in my two, long years there. I literally felt I would die young if I stayed much longer.

Once I got out of New York City, I was able to survive another 11 years in the financial world before exiting. I kept in touch with Lyndon after leaving NY and I remember when we specifically discussed in 2009 the idea of starting our own blogs. A few weeks later I decided what the hell I’ll give it a go, and he decided, “What the hell? You have time to write a blog?!” Three years later, thanks to my online endeavors, I no longer need to work. But, the good thing for Lyndon is that in these three years, he’s made and saved plenty of income and has me to give him advice!

The last thing his firm wants is more bad press since they’ve been dragged through the mud since 2011 due to an insider trading scandal. The company’s once pristine reputation is now tarnished like dog diarrhea on a gum filled New York sidewalk.

As an Associate Principal (one level below Partner), with 11 years tenure, Lyndon was respected by his peers. He wasn’t on the fast track, but Lyndon made enough and didn’t complain when the world around him seemed to be imploding. I told Lyndon that anybody who had at least 10 years of work experience was in the “protected class” of employees. Firms like his employer must treat long tenured performers gingerly when letting them go if they want new blood to join their organization.

With a combination of 11 years of service and the negative scepter of the insider trading case, Lyndon went to work implementing his separation package strategy. Over the years, Lyndon had developed a good relationship with his manager over squash, the only affordable indoor sport New Yorkers can play!

Lyndon talked to his manager about his desire to do something new. “It’s not about the money or my career progression,” Lyndon said. He told his manager about his love for photography and his desire to travel the world, despite traveling constantly already for his job. With business still lagging due to tightened corporate client budgets, Lyndon made his case that his departure would save the firm money, and perhaps save the job of another colleague who had a family (Lyndon has no children).

Lyndon emphasized how he loved working for his boss and for the company, otherwise, he would not have lasted 11 years. And part of that was the love he received from his bosses who had taken care of him for all this time. Lyndon mentioned he would always speak highly of the firm, regardless of case’s verdict. Eventually, he also planned to work for one of their largest clients. Commenting on the lawsuit was a strategic mention to remind his superiors that the last thing the firm needed was more negative press. Working as an eventual client sealed the deal.

After about a month of discussion, Lyndon successfully negotiated his separation package and invited me to Rio to eat Brazilian Churrascaria, hike the favelas, and lay out on Ipanema beach.

Lyndon’s Severance Package

• WARN Act (Three months salary): $56,250
• Severance (Two weeks per year, 22 weeks): $95,192
• Cobra: $2,400, six months at $400 a month.
• Unused Vacation (28 days): $17,260
• Gardening Leave: Three months
• Total Severance Value: $171,102 (20 months of expenses in NYC, 50 months of expenses anywhere in South America)

Kind to the Needy

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

For the rest of the year I'm going to be highlighting verses relating to the poor on Sundays as a reminder of why I'm doing my $25k Red Kettle Challenge. Here's one for today:

Proverbs 14:31 (NIV): He who oppresses the poor shows contempt for their Maker, but whoever is kind to the needy honors God.

Remember, I'm matching your donations dollar for dollar, so everything you give doubles in value! If you'd like to donate, go to my online Red Kettle.

Hope you're having a blessed holiday season.

Is $250k a Fortune? Depends Where You Live

As the President and Congress debate about taxes on the "wealthy" -- defined as those making $250k more per year -- NBC News brings up an issue we've talked about several times, the fact that how much you make goes farther in some cities than in others.

And the differences can be massive. Consider these few quotes from the piece:

You can buy a four-bedroom, two-bathroom house in Redford, Mich., (just outside of declining Detroit) for $60,000, or pay $1.7 million for a similar home in Los Altos, Calif., in the heart of Silicon Valley.

You need to earn $250,000 in Los Altos, Calif., to live the life that $60,000 provides in Fort Smith, according to the addicting cost-of-living-comparison calculator at Sperling's Best Places website.

Now some will counter with, "Yeah, but you can make more money in higher-cost-of-living cities." While this is true, the higher pay is not enough to make up for the higher expenses (on average.) Of course there are non-financial issues of living in one place or another (like nearness to family) that could make the financial hit worth it. That's up to each individual/couple to decide for themselves.

The piece then offers a way to really super-charge your finances -- combine a high income with a low cost-of-living city. Their thoughts:

You can really cash in on cost of living discrepancies if you line up a telecommuting programming gig at Silicon Valley rates and then make your home in the outskirts of Detroit or on the Arkansas-Oklahoma border.

I'm guessing that this sort of arrangement is both more and more popular (as companies want to keep/get the best employees) as well as realistic (with technology today, almost anyone can work remotely at least part of the time).

A similar approach would be to live in a low cost-of-living city but have a high income job in that city. That's been my career strategy. You all know that I have only lived in low-cost cities during my working years. You also know that I earn a decent salary. Put the two together, and it's financial magic.

I'm guessing some of you are in the same boat. Anyone else out there using the high-income, low-expense city strategy?

P.S. The reason I put "wealthy" in quotes at the top of this post is because the term "wealth" refers to net worth IMO -- how much someone owns once all their debts are paid. And yet the debate in Washington associates "wealth" with income. We know from common sense that those who make more money have a greater opportunity to accumulate more and have higher net worths. But we also know that this opportunity is often squandered, that those who earn more tend to spend more, and thus their wealth is not close to what it could be. I talked about these differences when I wrote about income statement affluent versus balance sheet affluent people.

Real Estate 101: Questions?

The following is a guest post by FMF reader Apex. As most of you know, he has been writing a series on investing in real estate.

There have been 13 posts in this series covering the topics that I have felt were most important.  However some readers may still have questions.  Before I wrap up the series I wanted to find out if there were any questions that readers felt were not adequately dealt with in any of the posts or if there were any other topics of interest that I did not address.
 
If there is enough content to address I will put together a FAQ post before doing a series wrap up.
 
Please post any questions or suggestions for further content in the comment section of this post.  I will not respond to any comments in this post that I intend to address in a future post.  I will try to address any questions that I feel qualified to comment on but my experience does not cover every aspect of real estate investing.

Real Estate 101: Taxes

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.

Many people cite the tax advantages of real estate investing as one of the primary benefits.  The tax advantages are real and they are certainly a benefit but I think many people give them more weight than they are worth.
 
The primary tax benefit that people refer to when they talk about the tax advantages of real estate is the depreciation of the property you purchase.  When you purchase real estate for investment purpose you can depreciate any portion of the investment that is not land.  Typical allocation to land is usually around 20-25%.  This means that if you purchased a $100,000 investment property you could expect to be able to depreciate about $75,000 of the investment.  This value is depreciated over 27.5 years for a residential property (39 years for a commercial property).  That would mean each year for the next 27.5 years you would get a tax deduction against your earnings on the property of a little more than $2,700 per year.  If the property had a profit of $5,000 for the year you would only have to pay taxes on $2,300 of that value.
 
To be sure this is a very nice benefit, but it is not exactly free money.  For starters you will be paying $100,000 of cash towards this property either up front or over the course of a loan.  You can deduct all of the interest paid on a loan but the principal payments are not tax deductible.  The depreciation allowance lets you deduct about 75% of those principal payments over time, but not all of it.  That means that over the course of 30 years you will pay $100,000 in real cash to own this property and only get to deduct $75,000 of it against your taxes.  The other $25,000 you will have paid tax on, even though you no longer have that cash.  It is tied up in your property. 
 
Now to be fair if you invest in equities you do not get to deduct any of the cash that you use to purchase stocks, but it is also true that stocks are easily converted back into cash whereas real estate is not.  It’s important to realize that you are not getting a $75,000 dollar tax deduction against profits without putting anything in.  You will actually put in more cash than you get as a deduction.  The deceiving and seductive part of the depreciation deduction is that in the beginning you come out way ahead.  Your mortgage payment is mostly interest which is deductible as an expense so you are paying very little towards principal.  This makes your taxable profit much lower and in addition you still get that $2,700 tax deduction.  This is why your taxable profit is considerably lower than your actual profit or your cash flow in the early years.  But as time goes on, this relationship will invert itself. 
 
Sometime between years 15 and 20, this formula will cause your taxable profit to exceed your actual profit.  By year 27 you will be paying almost all principle on your loan, which means hardly any of those payments will be deductible.  That will make your taxable profit much higher.  You mortgage payment will likely be considerably larger than your $2,700 depreciation allowance and very little of it will be deductible.  The result is that your taxable profit will exceed your actual profit and your cash flow.  What’s worse is on years 28-30 you will have no depreciation left and yet you will still be making those same mortgage payments.  Again there will be hardly any of that mortgage payment that is deductible and without any depreciation left your taxable income will greatly exceed your actual profit and cash flow in years 28-30.  If you blew the money that depreciation benefited you in the beginning, you may find yourself coming up cash short in the end.
 
The second reason this is not quite the benefit it might seem like is because all the deductions you received from the depreciation now become taxable income if you ever sell the property.  You received the deduction while you owned it but the IRS will classify those as recaptured capital gains upon sale.  They will be taxed at a minimum of 25% regardless of which tax bracket you are in.  You may have been in the 15% bracket when you took the depreciation deduction but you will still pay them back at 25% when you sell.
 
This brings us to the second major real estate tax benefit known as a 1031 exchange.  This refers to a section of the tax code that allows you to sell a real estate asset and transfer any taxable gains to a new asset without paying any taxes.  There are a number of requirements that need to be met to do a 1031 exchange, but the key one is that the asset that you exchange into has to be a like kind asset.  That means real estate must be exchanged into real estate and likely the same kind of real estate.  You won’t be exchanging into stocks even if they are REITs and you probably won’t even be exchanging into a golf course even though it could be classified as real estate.  Thus there is no getting out of the real estate business if you want to continue to avoid paying those taxes on capital gains and on past depreciation. 
 
The 1031 exchange allows you to transfer into different real estate assets and even into some kinds of managed partnerships which would allow you to take a hands off approach.  That is a big benefit because it allows you to change the structure of the real estate you invest in and the level of your involvement without incurring taxes.  But regardless of how you do it, if you want to use the 1031 exchange to avoid taxes you will forever remain invested in real estate.
 
The third tax benefit is simply that you can deduct every expense you incur for any reason as long as it is business related.  I already mentioned the deduction for interest paid on your mortgages.  In addition any repairs, maintenance, tenant acquisition costs, professional services fees, vehicle costs, tools, utilities, property taxes, dues of any sort, management costs, employee costs, and office costs are all deductible.  However, this benefit is not unique to real estate, every business can deduct these costs against revenue.
 
In fact every business can depreciate capital assets the same way real estate does too.  The thing that makes real estate depreciation unique is that real estate assets don’t really depreciate the way normal business equipment assets do.  Depreciation is designed to spread the tax deduction of a depreciating asset over a time that approximates its useful lifespan.  When most businesses depreciate a capital asset such as equipment, the asset has very little value left after it has been depreciated.  With real estate assets this is generally not true.  With a little bit of routine maintenance and upkeep the depreciable building asset actually retains or gains value.  This is why there is a special rule about recaptured capital gains for depreciated real estate assets that taxes them differently than other depreciated assets.
 
One topic that always comes up is whether it is worth it to take the depreciation due to some of the recapture issues I mentioned here and if one has to take it.  Let me assure you that the benefits you receive in the beginning will give you more capital for future investment making it very well worth it.  But most importantly the IRS does not allow you to forgo your depreciation deduction.  When you sell a property the IRS will determine what your depreciation schedule should have been for that property and they will require you to pay taxes on the amount that should have been depreciated whether you actually took the depreciation or not.  Not taking the deduction for depreciation will result in you paying taxes twice and that is something you certainly do not want to do.
 
The tax advantages of investing in real estate do provide a nice added benefit to the investment.  Properties that make very low profits will often have no taxable profits for many years, perhaps a decade or more.  Some investors judge their returns by taking into account the benefits of depreciation.  I will warn you to be very careful of using this metric.  It can be used to justify a mediocre or even a poor investment.  I would much sooner have a property that had considerable taxable income left after depreciation. 
 
There is a reason my column on Running the Numbers did not account for any tax benefits from depreciation.  Tax benefits are real but they come after everything else.  If everything else looks good then the tax benefits just make them look a little better.  If everything else looks poor then the tax benefits aren’t enough to make it a good deal.  Success in real estate investing does not come from tax benefits.  It comes from running a profitable business.  Be careful not to over-estimate the value of tax benefits.  No amount of tax benefits can make an unprofitable business, profitable. 

Update: Click here to read the last post in this series.

2012 Resolution Update

As some of you may recall, I shared my 2012 financial resolutions early in the year. Since we're rounding out the last month of 2012, I thought I'd give you an update on where I stand:

• Expand my gap if possible. I didn't do the complete review of Quicken I wanted to "find" extra money, but I didn't add a lot of needless spending either, so I'll give myself an "incomplete" on this one.


• Review my investments. I did do this, but not in the way I thought when I wrote the post. Instead of review and rebalance my stocks and bonds, I instead entered the world of real estate investing. After a failed attempt at buying and a few other rejected offers, I purchased my first place And not to spoil the surprise or anything, but I'm closing in on place #2 as well. :)


• Make major purchases. Our scorecard: 1) trip to Caribbean -- done, 2) new furniture for the living room -- not yet, 3) another potential trip -- will be taking one early next year, 4) a new bed -- yep, 5) advanced landscaping -- not yet, we decided to wait another winter to see the situation with all the trees.


• Update retirement plan. I actually worked through my retirement numbers twice this year. Once was early in 2012 when I re-did them based on the guest post How Much Income Do I Need For Retirement? The second was in the late fall when I did some projections factoring in rental real estate income.


• Consolidate charities. I have done quite well on this one. I have (for the most part) avoided the $10 here and $25 there charities and am concentrating my dollars on a handful of bigger gifts. The one you all already know about is my $25k Red Kettle Challenge.


• Invest in my career. The biggest way I've invested in my career this year is in expanding my network. Through two new volunteer opportunities (I run a committee for one organization and am on a committee for another organization) plus an existing one (where I am board president) my network has expanded greatly. And as they say, it's better to build it when you don't need it...


• Update my will. I haven't done this, but it's been a bit on purpose. I'm guessing the new U.S. budget/tax laws will impact estate planning, so I didn't want to update my plan just to have to turn around and update it again.

In addition to these tasks which were stated at the start of the year, I have made one additional move of note: I increased my umbrella insurance to $4 million. With the addition of rental properties, I think it's prudent to make this move.

How about you? Did you have financial resolutions this year? How did you do compared to your goals?

Reader Profile: JL

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 JL. She answered my questions (in red below) as follows:

Please tell us a bit about yourself.

I’ve been a lurker, and occasional commenter, at FMF for several years.  I really never intended to do one of the Reader Profiles; I enjoy my privacy too much.  But, I think now I have something to share that would be helpful to all FMF readers, young and old.  And I’m ready to share.

I worked in corporate finance; my husband was an engineer, both in our mid-60s. I had worked at several large publicly-held companies prior to when I retired in 2001 after the dot-com crash.  I then stayed home managing what by then was a substantial investment portfolio.  DH also worked hard on building his career; long hours were common for both of us. 

DH and I had always been frugal.  We consistently saved at least 25% of our income, more if we could.  One time, many years ago, we challenged ourselves to spend all of our income for one month and to not save a dime.  We failed the challenge.  We just couldn’t find anything that worthy of our money.  So we saved even more.

We married in the 1970s and the entire time our plan was to be financially independent.  We accomplished that by our late 40s.  We continued to work as we enjoyed our professions and usually enjoyed the jobs we held.

DH retired last year.  We then worked together in managing and continue growing our portfolio.  We also cared for my 90 year old mother.  We felt as long as she was alive we needed to stay around to take care of her.  There would be plenty of time later to move and travel to the far-off places we dreamed of.  We were comfortable, relaxed and happy.

Then the worst case scenario hit.  DH died suddenly in an accident.

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

My net worth is in the mid 7-figures, but this includes about $1mil of investments tied up in a trust as described later in this profile.  While DH and I always wanted to grow our net worth, now I’m pretty content with my financial situation.  What once was to support two people now needs to support only one. 
 
My income from a small pension and survivor social security is around $40k per year.  I reinvest all of my investment income.
 
My expenses are also around $40k per year as I am still pretty frugal, the house has no mortgage and real estate taxes are low due to California’s proposition 13.  I track my finances with Quicken, but more details of my financial situation would not add any extra value to readers of my profile.
 
I live a comfortable life and I hope to have plenty of assets to fund my future years.

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

I’m facing two significant financial challenges.

First is taking care of my aging mother.  She has dementia that is getting worse.  Her monthly expenses in a care facility are about $4000; her income is $2000.  I’m making up the difference for now. That’s not included in the $40k expenses mentioned above; so the shortfall is coming from my savings.  It also takes a significant amount of my time, so I cannot yet travel.  Future costs could be exorbitant depending on how long my mother lives.  Based on her life span and those of my ancestors, I need to plan for a long life as well.

Second, DH and I were amending our estate plans, but he died a week before we were to sign the new documents.  Our estate plan (wills, trusts) had last been changed over 10 years before.  So when DH died the estate plan was extremely outdated.

We had separate assets (not community or joint property) for a variety of reasons.  With outdated estate plans, all of his non-retirement assets are in a non-revocable trust that I can access for necessities, but not much else.  I am now a fiduciary for the assets in the trust, responsible to the ultimate beneficiaries…DH’s family.  It’s not a total disaster, but it creates immense complexity and tax implications which could have been avoided.

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

I’m undecided on future plans as I’m taking one day at a time.  I have no intention of returning to work, so I’m taking care of investments and taking quiet time with friends, family and the outdoors when I can.

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

1. My best suggestion is, above all else, live below your means.  Our incomes were good, but our saving habits made us wealthy.

2. Build your careers.  There are many good pointers on the FMF site, take heed.  You do not get ahead solely because you are a skilled worker; you get ahead because you also work smarter and harder than anyone else.

3. Enjoy life.  I am comfortable with my financial situation now, but wish that DH and I had enjoyed the fruits of our labor more than we did.  Hindsight says we should have played a little more and worked a little less, particularly later in life.  (Sounds like a cliché, but it now rings so true).

4. Individuals and couples alike should review their estate plan at least annually.  Do not take a passive view like DH and I did.  We never thought that my mother would outlive either of us or that DH would die so soon.  The unexpected happens and everyone should plan on that.
 
5. And, my best piece of non-financial advice is to kiss your loved one every time one of you walks out the door.

Active Investing Success is Rare

Many regular FMF readers are familiar with Old Limey, a regular, popular commenter here. Through his comments we know that he is a retired engineer who took his relatively modest retirement savings, invested it during the dot com boom, and turned it into a multi-million dollar portfolio.

I recently emailed Old Limey to ask if he'd write a series for FMF on "how to be successful as an active investor." Since he has regularly made comments about how others can/should be successful at active investing (versus passive/buy and hold investing), I thought he surely had suggestions for how the rest of us could succeed as well. I even thought I might give the effort a try with part of my portfolio. And, of course, I knew the readers would LOVE hearing from him.

He responded quickly with the following thoughts (edited for length):

For the following reasons I am not willing to write a series on active investing.
 
1) I am no longer an active investor. These days I primarily only own municipal and corporate bonds, and CDs, that will be held until they mature between now and 2040.
 
2) Being an active investor requires a lot of knowledge that requires much reading to acquire. You also need to subscribe to a large database of funds, ETFs, and indexes, the cost of which is about $900/year. The database also needs to come with a very comprehensive charting, ranking, and analysis program. Learning how to use this software is beyond the capability of the average person and requires a great investment of time, first to get up to speed, and then on a daily basis whenever you feel that it's necessary to move money from one investment into another. It's really out of the question for a person that has a very busy and time consuming day job. You need to have a passion for making money as well as an education that is very solid in mathematics and analytical techniques.
 
3) Once you start you need to do a post mortem on every trade that you make and learn from both your successes and failures.
 
4) Active investing is an ongoing learning experience and it takes a very disciplined individual to become successful. You have to be the exact opposite of a Buy and Hold investor. You have to abhor losing any of your precious money, especially since the more money you have, even small percentage losses can result in losing a large amount of money.
 
5) You need to attend lectures and seminars, read some books on investing, and learn from some of the most experienced active investors around.
 
6) In order to become a successful active investor you have to be very disciplined and not allow your emotions to get in the way of your decisions.
 
7) The more experienced you become, the more successful you will be, but you have to have a sense of when to be a participant and when to stay out.
 
8) I went through some stressful periods as well as some very exhilarating periods. Some people just aren't cut out to be active investors, especially if they are also experiencing stress from other sources such as work related and family related situations.
 
9) I was very active from 1993 through 2007 and it was a great relief to reach a point where I had enough money to quit the rat race, move to the slow lane, and settle for income rather than capital gains.
 
10) Lastly, I feel that the current state of the US economy, debt, and employment situation is far too dangerous to take the kind of risks that are needed. Don't underestimate the unique and incredible impact that the Internet and the Computer revolution made. This revolution fortuitously started just as I was retiring and was starting down the path of becoming an active investor.

When I was writing the software that I was able to market very successfully, I was working at home, for 2 years, 7 days/week, from 8am to midnight with small breaks for food.

That mammoth task ended one day when my wife came into my office with a hammer in hand, vowing to smash my computer if I didn't find a way to wrap it up soon and market it.

She was a great help when an ultimate 1602 orders started to roll in and we were kept very busy making CDs, having manuals printed, and hauling packages to the Post Office. That MS-DOS software is now obsolete.

A fellow program developer of mine told me that he used to stay in his office and his wife would put a tray of food outside his door, He came to the same resolution that I did in order to save his marriage.

These days, I don't see anything comparable for an extended Bull market on the horizon, all I see is a lot of strife, tension and unrest all over the world.

This is a totally different and far more dangerous world than existed from 1993 through 2007.

Here's my summary of Old Limey's thoughts above on why it's very difficult to be a successful active investor:

1. It requires a VERY unique individual -- one who has just the right temperament, abilities, and amount of time to make such an effort successful. This criteria alone eliminates all but a handful of potential candidates.

2. The market conditions need to be correct even for those with the talents in #1. It was just right when Old Limey invested, but today's market is not a fertile field for investment gain.

This basically says that virtually no one can be successful with active investing today.

I was a bit surprised at this response since Old Limey seems to be such an advocate of active investing. I noted this in my response and he replied:

Active investing is of course still alive and well today, particularly with many investors that trade stocks.
 
Even an index fund investor could become an active trader if he followed a simple trading strategy. For example, a very simple approach would be to follow four indexes and maybe put 60% in the strongest one and 40% in the second strongest.  You would then need to use an analytical method that calculated the relative strength of the four indices. Then, every day you would check the relative strength values to ensure that you were still invested in the strongest two out of the four.
 
To refine it even more you could layer on market timing by saying that if the S&P 500 falls below its 200 day moving average you would sell your two positions and move into some kind of income investment. Then when it moves back above its 200 day moving average you sell the income investment and move back into the two strongest indexes out of the four you have chosen. A simple system of this type would have saved a Buy and Hold investor from taking such a beating in the huge drop and then got him back in soon after the recovery started.
 
One module in the software that I wrote would have enabled a person to test out this strategy from 9/1/1988 (or a later date of your choice) to the present day and then play around with all of the variables until you found the combination that had the greatest success as measured by making the largest overall gain along with experiencing the smallest max. drawdown. It's the drawdowns that are so hard to live with. On the day that the max drawdown occurs you are sitting there having experienced a huge drop in the value of your portfolio but you have no idea whether you have hit bottom. That's the whole purpose behind active investing. It's attempting to extract the greatest gains while suffering through much smaller drawdowns.
 
The obvious criticism of approaches like this is that history usually doesn't repeat itself, but it would almost always be better than Buy and Hold. What I have described is just one simple strategy. There are of course scores of different strategies that have been developed. The software I developed had over 80 modules, each one using a different strategy. When I wrote my software I was in contact with over 250 users of the database and received lots of good ideas from the best of these experienced investors. I also gained a lot of information and ideas from attending the annual conference that was held at a different city each year.
 
Another thing is that 20 years ago there were only a fraction of the investors that exist today and news travelled a lot slower. This helped the active investor to outshine the investors that were not using any kind of backtested fund selection and market timing techniques. Today we have a very different environment with the Fed supplying stimulus money to the large investment banks that use it, largely for their own benefit to drive the market the way they decide. They also use supercomputers that run preprogrammed methods to make thousands of stock trades per day, some trades the buy and sell orders are less than a minute apart in order to reap thousands of small gains with negligible losses. I read an article that mentioned that the very best graduates of MIT in Computer Science end up working at the huge investment banks and not in technology companies here in Silicon Valley.
 
The other thing I should mention is that if your active trading is taking place in a market and during a time period in which the general trend is strongly upward everything gets a lot easier. My huge gains between 1993 and March 2000 were the result of trading in funds that concentrated in the Nasdaq companies that were in steep uptrends. When the top arrived and it then started steeply down there was a huge rush for the exits and I got totally out over 3 trading days, and stayed out for quite a while until things settled down. A very good sector that follows the rise and the fall of the stock market is the Junk Bond sector. Its huge advantage over stocks is that it has far, far less volatility. This very low volatility gives you a lot more time to make your trading decisions. A friend of mine runs a small Hedge fund and sends me a copy of his monthly market letter, all he ever owns are junk bond and various income funds and yet he far exceeds the performance of stock indices and maintains very low drawdowns. This market letter would help most Buy and Hold investors but for people that aren't invested in his fund the price is $1,400/year. I get a free copy because he used to use my software, as did quite a few people that published market letters. If you look at a longtime chart of the Nasdaq 100 index you will see the huge peak that topped in March 2000, this peak outshines every other stock market index and looks like a profile of Mt. Everest (a peak I was very close to in 1983 when I climbed a nearby trekker's peak that was close to 20,000ft.).

Ok, so you can be successful with active investing today (or at least better than the results you get with passive investing), but it requires:

1. A VERY unique individual -- one who has just the right temperament, abilities, and amount of time to make such an effort successful. This criteria alone eliminates all but a handful of potential candidates.

2. The market conditions need to be correct even for those with the talents in #1. Today's market is not conducive for active investing success.

Personally, this is disappointing to me, but not surprising. I had hoped that active investing was available for the masses (or at least a good sub-section of the population) since I wanted to give it a try (and share my results with you.) But having this conversation with Old Limey reinforced my thinking that it's very difficult (if not impossible) to be a successful active investor. So I'll stick with my simple index fund investing on one hand and concentrate on real estate investing on the other. This seems to be a good balance between growth (stocks and appreciation of real estate) and income (generated by the real estate).

And in case you're interested, here are a few other pieces I've written through the years that suggest it's rare to be a successful active investor:

• Why Most Investors Can't Beat the Market


• Is It Possible to Beat the Market?


• Active versus Passive Fund Management

The Giver Gains

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

For the rest of the year I'm going to be highlighting verses relating to the poor on Sundays as a reminder of why I'm doing my $25k Red Kettle Challenge. Here are two for today:

Proverbs 11:24 (NIV): One man gives freely, yet gains even more; another withholds unduly, but comes to poverty.

Proverbs 14:31 (NIV): He who oppresses the poor shows contempt for their Maker, but whoever is kind to the needy honors God.

Remember, I'm matching your donations dollar for dollar, so everything you give doubles in value! If you'd like to donate, go to my online Red Kettle.

Hope you're having a blessed holiday season.

How Millionaires Became Wealthy

Time recently highlighted a survey of multi-millionaires asking them how they became wealthy. The results:

• 27% are entrepreneurs


• 15% are corporate executives


• 7% are managers


• 6% are investors


• 6% are doctors and dentists

A few other key notes:

• 75% of wealthy entrepreneurs and business owners attribute their success to prudent risk taking. This group is also most likely to cite serendipity, or “being in the right place at the right time.” Just 58% of professionals including doctors and lawyers attributed their success to risk taking.


• 96% of professionals attribute their success to education while 81% of entrepreneurs feel that way. Professionals are also most likely to credit frugality as a significant factor in building their wealth. Nearly all (99%) corporate executives, meanwhile, cite “hard work” as a significant wealth creation factor.


• 80% say smart investing is a great way to join the millionaire’s club.

Some comments from me:

• I have grown my net worth through a combination of factors. First I was a "manager", and then became an "executive." Along the way, I spent less than I earned and saved and invested the difference to grow my wealth.


• I attribute a lot of my success to my education and rate my graduate degree as the main reason for my financial success.


• Of course, frugality is important as well. Without at least a degree of it, it's very difficult to significantly grow your net worth (which is why I list over-spending as the worst money mistake anyone can make). Of course you have to live and enjoy life as well, so that's why I practice moderate and selective frugality.


• "Hard work" is almost a given in wealth creation, isn't it? Very few become wealthy without it IMO.


• It's interesting to see so many say that "investing" is a way to become wealthy. I would see investing as part of another method, but I think few become wealthy with investing alone. Warren Buffett is the exception to the rule.

How about you? What has been the main reason(s) for your financial success?

Real Estate 101: Financing

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.

The number one roadblock preventing most people from expanding in real estate is access to capital.  Real Estate is a capital intensive business.  Everything in the business revolves around access to capital. 
 
It was one of the 6 reasons I listed in the first column in this series about why you should not invest in real estate.  It was also listed as one of the first steps along the path in the third column on where to start.  Many people want to get started in real estate but do not have enough capital to even get started.  Others can pull together one or two deals but then they hit the capital roadblock as well.  They want to expand into more properties but they are stuck perhaps for years trying to get the capital for their next deal.  Regardless of where you are on the real estate journey, most everyone hits the capital roadblock sooner or later.
 
There are two different sources of money that you will use when investing in real estate, your money, and other people’s money (a.k.a. OPM).  The percentage of each of these sources of money that you use will determine your leverage ratio also know as a debt to equity ratio.  This ratio is determined by dividing the total amount of borrowed funds you have by the total value of all the properties you own.  For example, if you owned 4 properties worth $125,000 each and had $300,000 of borrowed money your debt to equity ratio would be $300,000 / $500,000 or 60%. 
 
Your Money
 
While it is possible to use only your money, it is almost always impossible to use only other people’s money.  In order to get access to other people’s money, you have to have some of your own money to start with.  There are many ways to get your own money.  It usually starts with a decent paying job from which you save a good portion of your money.  It could also involve getting a second job or second source of income.  If you have owned your own house for a number of years you could extract equity from it by doing a cash-out refinance.  It can come from selling things you can live without.  It can include downsizing your car, your house, and your lifestyle.  It can come from virtually anywhere.  You simply have to decide how badly you want it.  If you are driving a new model Lexus but can’t find the cash for a down payment, then you have made lifestyle choices that have prevented you from getting where you want to get. 
 
In my first column I finished the section on capital with this sentence: Unless you are already cash rich, expect to feel somewhat poorer for a while.  If you are unwilling to feel somewhat poorer for a while, then you are the reason you are unable to find the capital to get started in real estate.
 
Other People’s Money
 
Your own capital will only get you so far and for most people that isn’t very far at all. Your money is limited. Other people’s money is vast.  When your money is gone, there is no way to replace it quickly, thus most expanding real estate businesses depend on access to a considerable amount of other people’s money or OPM. 
 
You get OPM by simply borrowing money from whatever sources are available to you.  Getting some OPM might not be too difficult but the more debt you take on, the harder it is to get more.  Those who will be borrowing the money to you will be scrutinizing your debt carrying capacity.  They will be examining your income streams, business model, taxes, and credit ratings in detail.  Eventually many will simply refuse to give you any more money until you can improve your financial standing in their eyes.
 
Because of this there are two primary rules that I consider essential when acquiring financing.

• Rule #1: Get the money for as long as possible.  You know you are going to need more money to purchase future properties so why would you want to be required to pay this money back any sooner than absolutely necessary?  That would just require you to get even more money later.  That may be difficult or impossible to do, and of course borrowing new money always has a cost.  As such you should prefer terms on your loans that are as long as possible.  If you need access to more money in the future, the last thing you want to do is take out a 15 year mortgage on a property you are buying today.  This will require larger payments resulting in significantly reduced cash flow.  If your business is generating less cash that will extend the amount of time it takes to generate enough cash to purchase your next property.  This is why I always prefer 30 year mortgages even if the interest rate is slightly higher.


• Rule #2:  Get as much money as you can get.  Maybe you have enough cash to put 50% down on a property.  Maybe you just feel more comfortable only being leveraged 60% instead of 75%.  There can be any number of reasons why you might choose to borrow less than the maximum.  Don’t do it.  If you are borrowing on a given property, borrow the maximum you can get on it.  If you are more comfortable with lower leverage then buy every third or fourth property with cash, but do not take out 50% or 60% loans on a property.  Always take the maximum they will give you.  It is always more difficult and more expensive to get more money out of a property once you have a mortgage on it.  If you purchase a property with all cash you can go back and borrow against it later.  When you do, you should once again borrow the maximum amount that they will give you.  You can manage your own leverage ratios across all your properties to ensure you do not over leverage yourself but do not put smaller leverage ratios on each property.

Where to Get Financing
 
When seeking financing, the best place to start is with traditional banks using conventional financing and government backed loans.  These are known as agency loans and nearly every person who has ever taken out a house loan on their personal residence has this kind of a loan.  They are backed by agencies such as Fannie Mae, Freddie Mac, or FHA.  These loans typically have better rates than those not backed by a government agency and they also have longer terms.  Many agency loans are amortized over 30 years and not required to be paid in full for 30 years.  It’s almost impossible to find a private non-agency loan with those terms. 
 
Luckily investors are able to qualify for these loans if the property has 4 units or less.  For the first 4 properties these loans can be acquired as easily as they can on your primary residence.  You can get up to 10 agency loans but anything beyond 4 gets considerably more difficult and there are currently very few lending institutions who are willing to offer agency backed loans if you have more than 4.  If you have hit your limit of 4 agency loans you will want to contact as many lending institutions and brokers as you can find until you find one that will continue to do agency loans beyond 4 properties.
 
Other financing options include lines of credit on your personal residence or on any investment properties you may have that have appreciated in value.  Lines of credit offer the advantage of allowing you to take out money when you need it and pay it back when you don’t.  They are a great cash flow management tool.  The next financing option is a private or commercial loan that is not government backed.  The terms and rates on these will be less favorable so you need to make sure it does not put your cash flow in jeopardy.  You can also take out loans using other assets as collateral such as stocks, bonds, jewelry, cars, any assets you have that have value in them that you want to extract for the purposes of securing more financing capacity.  You could also consider borrowing from friends or family if you are in a relationship that supports that and understand the relationship risks that can come from that type of arrangement. 
 
It is worth noting that OPM can be as addictive and seductive as the drug those initials sound like, so it’s important to remain disciplined when borrowing money.  Certainly one can put themselves in a highly over-leveraged state doing things like this.  I am not suggesting you should leverage everything you have to purchase real estate.  I am merely pointing out that there are multiple ways to get access to financing and capital.  As long as you keep your debt to equity ratio at a reasonable level and keep your cash flow margin well within the safety range I would not have much concern about any of the steps I have outlined here.  I would feel comfortable with a debt to equity ratio that did not exceed 80% and a cash flow margin that stays above 10%.  If that debt to equity ratio is higher than some people would feel comfortable with, they should choose a lower number that they feel meets their margin for safety.
 
Lack of access to capital is probably the number one frustration of most beginning real estate investors.  Everyone runs up against the money roadblock.  Sometimes the only path is to wait until you can save enough money to go around the roadblock that is right in front of you.  Of course there is always another roadblock after that one.  However, the more cash flowing properties you can acquire the more cash they will throw off.  Eventually they will be the source of removing the capital roadblocks.  But until that time arrives which can be quite a long time for many real estate investors, you need to consider every option for getting access to capital and always be on the look out for new sources of funds if you want to keep your real estate business growing and expanding.

To read the next post in this series, see Real Estate 101: Taxes.

Star Money Articles and Carnivals for the Week of Dec 3

As a reminder, I am currently running the $25k Red Kettle Challenge.

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


• PT Money says you can give by volunteering.


• Master the Art of Saving talks about the impact of living in a small town.


• Financial Samurai asks if he should use a wealth management company.


• Money Crashers has a retirement savings infographic.


• Lazy Man and Money is moving to Boston. 


• My Dollar Plan has inexpensive gift ideas for teachers.


• Nerdy Finance Carnival


• Festival of Frugality


• Carnival of Wealth

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.

Are You Better Off than You Were Four Years Ago?

A big question in the presidential campaign a few weeks ago was "are you better off than you were four years ago?" Both sides had their points-of-view (of course) and tried to influence the electorate to their way of thinking, hoping it would lead to more votes.

Personally, I avoided anything related to politics this year on FMF. Why? There were several reasons:

1. This is a personal finance blog, not a political blog. Though money and politics are clearly related, there are so many other things tied up in politics that having a money-only discussion was pretty much impossible IMO.

2. People don't think rationally during political discussions, especially in years where the race was (supposed to be) as close as it was. I was sure nothing positive would come from bringing it up.

3. I was personally so tired of all the commercials, phone calls, mail, and on and on that I was sick of politics by mid-May and wanted to spend as little time and effort on the subject as possible.

4. IMO, it doesn't really matter that much anyway. First, I think there isn't really that much difference in the impact of one party's plans over those of the other -- at least in such a short period as four years. And second, while the economy/government certainly has an impact on your finances, it's not the biggest factor influencing your financial health by far (see below).

But now that we're a ways away from the election, the smoke has died down, and the winners have celebrated and the losers licked their wounds, I thought I could address the question for myself with little negative backlash (I can hope, can't I?). Am I better off than I was four years ago?

The simple and clear answer is "Yes, I am better off than I was four years ago." Much better off, in fact.

But this "simple" answer needs a bit of perspective. Namely:

I have been better off every election year than I was at the start of the previous four years. It didn't matter who was president or what the economy was doing, my answer has always been the same: "Yes, I am better off than I was four years ago."

The reason I can answer this way has very little to do with who was running the country and MUCH more to do with what I did during those four years. Namely, I took the steps necessary to grow my finances -- the few, key moves that anyone can take to grow their net worth. I spent less than I earned, grew my career, saved, invested, and avoided bad money mistakes. These basics, and not who is running the country, are much more important in determining whether you answer "yes" or "no" to the "better off?".

Of course, the government can have a major impact on finances, but this is generally only in very extreme situations. For instance, if the whole economy imploded (much more than what we've seen over the past few years) or if inflation ran rampant, it would impact EVERYONE negatively -- and then almost everyone would have the same answer ("no"). But absent a disaster like that, what YOU do has much more impact on the status of your finances.

So my recommendation is to focus more of your effort and energy on what matters most and what you can influence -- taking the correct steps you can to grow your net worth. And of course you can vote and be active in politics as you see fit -- I'm not saying to throw up your hands and forget the government (besides, there are more issues and reasons to vote than just money). But don't blame or credit a president for your financial gain or loss, blame or credit yourself.

Two Free Book Offers

Would you like to have two books absolutely free? Well have I got a deal for you...

The first is Get Noticed & Get Hired: Action Steps, Strategies and Resources to Become Empowered & Employed [Kindle Edition] which for this week is absolutley free (it will go back to being a for sale item next week.) A summary of the book from Amazon:

Going through a period of unemployment can be one of life's most stressful situations. In many cases it seems to trigger a domino effect of pressures and strains ranging from emotional to financial to relational. Television and news reports are filled with stories about people who have sent out hundreds of resumes without getting a single interview. Many who have made it to the interview stage are shocked not to be selected even though they had the right experience and skill sets necessary for the position.

In Get Noticed & Get Hired, veteran corporate executive Steve Matter delivers an entire workbook for directing you from job loss to becoming empowered and employed.

This book is filled with action steps, resources and strategies to help you focus and prepare for your journey back into the workplace.

To get your free book, click the link above and order away!

The second book is "The Secret of Generosity". A summary of the book from Amazon:

Have you ever felt like your pocket has a hole in it? Big expectations followed only by even bigger disappointments? If so, you are not alone. Knowing that His people felt this way, the Lord spoke into our emptiness. In the only direction we aren't looking, He pointed the way towards redemption and restoration. Generosity has a secret, a deep, liberating, and life-altering secret. Discovering it will bring life to our souls and hope to our hearts.

Here are the details on how to get it:

For the month of December, anyone who emails the author ([email protected]) and puts "Free Ebook Giveaway" and the name of the site they saw the deal on, will get the ebook (PDF) emailed to them for FREE. Details can be found here.

Enjoy!

He Who is Kind to the Poor

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

For the rest of the year I'm going to be highlighting verses relating to the poor on Sundays as a reminder of why I'm doing my $25k Red Kettle Challenge. Here are two for today:

Proverbs 19:17 (NIV): He who is kind to the poor lends to the LORD, and he will reward him for what he has done.

Proverbs 14:21 (NIV): He who despises his neighbor sins, but blessed is he who is kind to the needy.

Remember, I'm matching your donations dollar for dollar, so everything you give doubles in value! If you'd like to donate, go to my online Red Kettle.

Hope you're having a blessed holiday season.

How Do You Stack Up Compared to Millionaires?

Dr. Thomas Stanley recently shared some average financial figures from Millionaires Next Door (he wrote the book) as follows:

• The typical millionaire next door is 57 years old.


• The market value of the home is less than 20% of net worth.


• Debt totals the equivalent of less than 5% of net worth.


• Annual income tax is the equivalent of about 2% of net worth.


• Total annual realized income is approximately 8.2% of net worth [median], or the equivalent of $8.20 of income for about every $100 of wealth.

Here's where I stand on these measures:

• I haven't reached my 50's yet.


• Our home makes up about 7% of our net worth. This is because 1) we bought a house we could easily afford, 2) the value of our home has declined since we bought it, and 3) our net worth has gone up since we purchased the house 13 years ago.


• We have been debt free for over 15 years now (other than credit cards which we pay off each month).


• I haven't calculated income tax as a percent of net worth, but I would guess it's in this range.


• We are just about average in our income to net worth relationship.

How about you? How do the millionaires (or striving-to-be-a-millionaire) out there stack up to these averages?