Foolish Man Built His House Upon the Sand

This morning I was doing my morning scripture study and read a passage of scripture that I was very familiar with, but never thought of it in the domain of finance before.

In the New Testament, Matthew chapter 7 versus 24-27, it reads:

Therefore whosoever heareth these sayings of mine, and doeth them, I will liken him unto a wise man, which built his house upon a rock:

And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell not: for it was founded upon a rock.

And every one that heareth these sayings of mine, and doeth them not, shall be likened unto a foolish man, which built his house upon the sand:

And the rain descended, and the floods came, and the winds blew, and beat upon that house; and it fell: and great was the fall of it.

This is such a simple analogy, yet is packed with so much wisdom. As I look back at my financial path it is very obvious to see how fast the house falls when built upon a sandy foundation.

The current financial storm that we are in the middle of has made apparent the fact that it is not IF the storm will come, it is WHEN the storm will come.

Here is the rock of a foundation described above that is surely to withstand the financial storms of life:

1. Pay yourself the first 10% of all you earn

2. Build a 3-6 month emergency reserve

3. Pay off all debt tied to depreciating assets - this includes cars, credit cards, etc. The two acceptable forms of debt are real estate & businesses.

4. Write a will

5. Invest your surplus in wise investments with those wise and experienced in their handling

6. Allow time and the miracle of compounding interest to be aid you

Tomorrow I will explain the process of moving from the sand to the rock. There is a formula that if followed will guarantee a smooth transition.

As the great Warren Buffett said, "You never know who is swimming naked until the tied goes out."

Are You Paying or Collecting?

My brother had a very interesting observation the other day. We were having a conversation about building wealth and he said that one of the best gages is to understand your "Interest Collected vs. Interest Paid ratio" (ICIP Ratio...I just made that up). The more I thought about it the more I completely agree that it is one of the best ways of knowing how financially healthy you really are.

Let's compare two different people:

Mr. DooDad is a good earner, 125k year, but really enjoys his toys. As a matter of fact, he has yet to see a toy he does not like. Because of this "DooDad" addiction, his ICIP ratio looks like this:

House $1500/mo interest

Car 1 $250/mo interest

Car 2 $175/mo interest

Boat $475/mo interest

Credit Card $225/mo interest

Interest Paid $2625/mo interest

401k $125/mo

Money Market $12/mo

Interest Collected $137/mo

Mr. Doodad collects a measly $137 a month in interest and pays $2625 a month interest. So his ICIP ratio is 1:19.

Mrs. Wisdom is also a good earner, 100k year, but she has used her cash to buy assets that she can collect interest on. She has been wiser with her money, buying her cars in cash and never using a credit card. Her ICIP ratio looks like this:

House $1000/mo interest

Rental House1 $750/mo interest

Rental House2 $1100/mo interest

Interest Paid $2850/mo interest

Rental House1 $1400/mo interest

Rental House2 $1750/mo interest

401k $1500/mo interest

Roth IRA $750/mo interest

Indexed Fund $2500/mo interest

Money Market $150/mo interest

Interest Collected $8050/mo interest

Mrs. Wisdom collects a whopping $8050 a month in interest and only pays out $2850 a month so her ICIP ratio is 3:1. Over time, as her renters pay off her rental house mortgages, her ratio will climb to 8:1.

Spend 10 minutes and figure out your ICIP ratio. Are you closer to a Mr. Doodad or a Mrs. Wisdom? How long will it take you to retire by following Mr. Doodad's plan? The rhetorical question's answer is probably forever!

Now What?

After yesterdays post on "How Much Should You Be Saving Annually" you probably realize how much you underestimated the amount of money needed to invest to live in retirement. As I see it, three options arise:

1. Increase current income – if you are going to be a passive investor, you are bound by the economic factors of 8% annual return, 3% inflation, and 4% withdrawal rate, you simply must earn more money to allow for today’s requirements and tomorrow’s future
2. Become an active investor – if 8% won’t get you there, you must learn different strategies for netting a higher return. Real estate or investing in businesses could be an option.
3. Build a business – one of the great advantages of being self-employed is the autonomy you have to build something of residual value. When you are an employee, in most cases, you work for today’s wages and the day you retire your income stops. By building a business, you open the door to producing an asset that could be sold at retirement for a lump sum payment or residual income.

Most likely, any of the options above are going to require more knowledge than you currently have. The good news is that with the internet, almost all of what you need is at your fingertips and much of it is free.

Begin by talking with people you know who have already reached their financial goals with a fully funded retirement. Discover how they did it. Get to know others who are on their way and figure out what they are doing. Read some good books, go to some classes and seminars to increase your understanding of these options.

What you should not do is:

1. keep doing what you are doing
2. keep hanging out with the same people who are also not on track
3. keep reading the same things you have been reading
4. keep watching the same things you have been watching
5. keep spending your time doing the same things you have been doing

“When we are no longer able to change a situation, we are challenged to change ourselves.”  ~Victor Frankl

“If you don't like something change it; if you can't change it, change the way you think about it.”  ~Mary Engelbreit

How will you get it back?

The total net worth of Americans was $51.5 trillion as of 12/31/08, down 18% in the last year, reaching its lowest level since 9/30/05 (source: Federal Reserve). 

Those numbers seem low considering the Case Shiller home price index has dropped 16.7% in the last 12 months and the S & P is down 40.97% over the last year.

Whether it is 18% or more, new action must come from it. Some will live more frugally. Some will delay retirement indefinitely. Some will realize the job they are in simply will not provide them the income they will need to live the life they want and will go out and start new businesses. Some will begin investing in new ways.

What is your plan? How much net worth have you lost? How will you make it up? How much money do you need at retirement to live the life you desire? How about to maintain the current lifestyle you have?

Now is the time to build the strategy. Now is the time to take action. What has worked in the past will not work in the future. Time has elapsed and market dynamics have changed. A new philosophy for wealth accumulation must be built sooner than later.

Trade My Rolls for Your Station Wagon?

Don’t things change quickly? For the last 8-10 years it was the Donald all over TV with the hit Apprentice. The primetime show was laced with images of black jets with TRUMP painted in Gold, sleek helicopters, and fancy cars.

The Donald’s home town now has an emerging trend quite different than what you would expect… frugality. The NY Times reported that a real estate broker, Sharon Baum, is feeling like it is not in her best interest to be sporting a green Rolls Royce around town. She was quoted as saying “But now, with the recession, it’s not an appropriate time — nor do I want to be riding around in a Rolls-Royce.” The car was her trademark since 1996 and now she is concerned about the image she is portraying. Her plan is to garage the car and drive her station wagon around.

Saving is "En Vogue" now, which, based on statistics is a long time coming. In the third quarter of 2008, the personal savings rate was 1.2%. When the government started tracking the savings rate in the first quarter of 1952 it was 8.6% and it was 7.9% just 20 years ago in the third quarter of 1989.

Although, we have quite a hole to dig out of, it is nice to see frugality coming back in style. MSN Money reports a growing trend of second hand shoppers, some 60 million Americans! There was a day a couple of weeks ago where I would have lied to my mother about the fact that I was buying something from a second hand store. The smell alone makes me want to run the other direction. Now it is the cool thing to do.

Both of these examples are extreme and I am sure there is a more palatable middle ground...I will be looking for it. In the meantime, station wagons and second-hand clothes, here we come. I wonder if couches on porches are coming back soon too? 

Is It Coincidental

My wife and I just moved out of our condo and as we made one last trip down the hallway I was reminded of an observation I had made many mornings.

Of the 10 or so units on our floor, six or seven received the New York Times, three received the Wall Street Journal, and only one received the local Oregonian newspaper. In the two other buildings we had lived in the only paper I had ever seen was the Oregonian.

The difference became apparent that in our most recent condo we lived on the top floor and the median income was significantly higher than the other two buildings where we did not live on the top floor.

I have since began paying closer attention to what different income classes read and it varies greatly, one class from another. Yet within the income class, birds of a feather flock together.

What are you reading? Does it even matter? 

I am certainly not suggesting that reading the right newspaper is the sure path to riches...

For a great Japanese proverb states, "If you believe everything you read, better not read."

The important questions is, "what else do “they” do differently?"

I.O.U.S.A.

If money plays a role in your life then I highly suggest watching the movie I.O.U.S.A. Roger Ebert said, "...it accomplishes an amazing thing. It explains the national debt..."

Visit the official movie website

Reuters said "I.O.U.S.A." "may be to the U.S. economy what 'An Inconvenient Truth' was to the environment."

We must educate ourselves on the forces that will determine our ability to live the American Dream.

Watch the 2 minute trailer

Or watch the Byte Sized 30 minute version of the movie

http://www.youtube.com/watch?v=O_TjBNjc9Bo

To get involved I recommend 

http://ww.pgpf.org/getinvolved/signup/

Lifetime Winner

“When you improve a little each day, eventually big things occur. When you improve conditioning a little each day, eventually you have a big improvement in conditioning. Not tomorrow, not the next day, but eventually a big gain is made. Don’t look for the big, quick improvement. Seek the small improvement one day at a time. That’s the only way it happens—and when it happens it lasts.”

- John Wooden

This quote is coming from arguably the best college basketball coach of all time. He won the National Championship 10 out of 12 years at UCLA! What a philosophy to live by.

I don’t know about you, but the “get rich quick” or “buy now, pay later” messages of the day are sure seductive. They certainly offer an easier road to travel. (That LypoDissolve pill that makes all of your fat magically disappear with no change in diet or without ever working out is tempting, but come on, really?) No hard work, self discipline, or persistence required.

After years of reflecting on these two varying philosophies I am reminded of a statement from a business course I took:

All interpretations are valid; however, they are not equally powerful.

As I reflect on all of the people I most admire, none of them were a one hit wonder. They were people who persevered. They kept after it, never giving up. It is through the very un-sexy work of discipline and persistence where the most valuable attributes are developed. It is these very attributes that build a foundation for future success. This cycle, if repeated over the years produces lasting success.

Don’t shirk the hard work if you really want to be a lifetime winner!

College Costs What?

College costs keep rising. How much and how do you possibly fund it?

First, the newest numbers:

On October 29, 2008, the College Board released college cost figures for the 2008/2009 academic year in its Trends in College Pricing Report. Not surprisingly, costs went up in every category. Here are the highlights: To view the 2008 Trends in College Pricing report, Downloand College Cost 2008.

Public colleges (in-state students):

Tuition and fees increased an average of 6.4%

Room and board increased an average of 5.2%

Total average cost for 2008/2009: $18,326

Public colleges (out-of-state students):

Tuition and fees increased an average of 5.2%

Room and board increased an average of 5.2%

Total average cost for 2008/2009: $29,193

Private colleges:

Tuition and fees increased an average of 5.9%

Room and board increased an average of 4.8%

Total average cost for 2008/2009: $37,390

"Total average cost" includes tuition and fees, room and board, books and supplies, transportation, and other miscellaneous costs.

The College Board stated, however, that average cost is not necessarily representative of what most college students pay. The Board noted that there is considerable variation in price among institutions, and that almost two-thirds of undergraduate students enrolled full-time receive grants that reduce the actual price of college.

I suggest two different ways to insure you are prepared:

1. Maximize an ESA College Savings Fund – ESA stands for Education Savings Account. ESA allows for a maximum annual contribution of $2,000 per student. The earnings in the account grow tax-free as long as distributions are used for eligible expenses, which are not limited to college costs.

$2000 invested annually at 8% for 18 years equals $74,900

2. Buy a rental property –when your child is young, buy a property for multiple reasons:

§   it will appreciate at 3-5% for ten plus years before college money is due

§   rental rates will increase at 3-5% producing some cash flow to help with expenses

§   use it as a teaching tool for your child; help them learn to care for it, find and screen renters, manage the finances of the property, pay taxes, etc. This will be a life altering experience that will give them a leg up in a financial education deprived world we live in

$200,000 house appreciating at 4% over 10 years will be worth $296,048

$1200 in rent increasing at 4% over 10 years will climb to $1776

Cash is King

A couple of years ago a wise, old, financial mentor of mine said to me after reviewing my financials, “I am very impressed. You have built up quite a net worth at a young age and are on a path to go far in life. However, if there is any advice I could give you it is that cash is king!” 

At the time I had good equity in a growing company, lots of real estate holdings and very little cash reserves. Although I understood what he meant, I did not know what he meant. I use the word know to mean - understand it to the point of creating powerful thought and action.

Fast forward three years. What if I had taken his advice to heart and been on a quest to accumulate cash? Everything is on sale right now!

Real estate as evidenced by the Case Shiller report shows discounts approaching 20% off in the nations largest 20 cities.

Stocks and bonds (at home and abroad) have had their prices slashed dramatically this year:

Dow Jones Industrial Average -- over 35% down

Nasdaq -- over 40% down

S & P 500 -- over 40% down

Emerging Market Stocks -- almost 60% down

REITS -- over 40% down

Welcome to a buyers market without any buyers!

Very few have cash right now. They may have equity but cannot get to it. This is the time you want to be buying, in a buyers market without any buyers. If you have cash, now is the time to be building your fortune like those in the time of the Great Depression did.

Warren Buffet was quoted as saying, “When the prices are right, I can buy companies faster than Imelda Marcos can buy shoes.”

Lessons I will apply the next cycle:

1. Don’t get greedy when everything is racing up – remember Nordstrom has the Twice Yearly Sale, real estate and stocks have a Twice a Decade Sale

2. Take money off the table - it is not necessary to go all in, every hand. get comfortable with the coffers full of cash, poised for the next big sale

3. They are called cycles for a reason – prices go up and prices come down, round and round they go. be a buyer in the down cycle

4. Be a contrarian! 

5. Start now - now is the time to begin preparing for the next great opportunity. be a student now. build your wealth habits now.

Chains of Habit

“Chains of habit are too light to be felt until they are too heavy to be broken.” - Warren Buffett

It is my belief that a vast majority of the economic struggles we are experiencing today have been brought on by poor habits and a disregard to the fundamental laws of money. The NY Times reported that “For decades — from the 1950s through the 1980s — Americans spent about 91 percent of their income, on average, and put away the rest. In the last few years, they have spent close to 99 percent and saved only about 1 percent.” Recent government data shows the personal savings rate has been negative for the last two years. At some point the merri-go-round has to stop. 

Where would we be today if we had adhered to the Five Laws of Gold from the classic book, Richest Man in Babylon?

FIVE LAWS OF GOLD

1. Gold cometh gladly and in increasing quantity to any man who will put by not less than one-tenth of his earnings to create an estate for his future and that of his family
2. Gold laboreth diligently and contentedly for the wise owner who finds for it profitable employment, multiplying even as the flocks of the field.
3. Gold clingeth to the protection of the cautious owner who invests it under the advice of men wise in its handling.
4. Gold slippeth away from the man who invests it in businesses or purposes with which he is not familiar or which are not approved by those skilled in its keep
5. Gold flees the man who would force it to impossible earnings or who followeth the alluring advice of tricksters and schemers or who trusts it to his own inexperience and romantic desires in investment