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Net Investible Wealth

April 21, 2018 No Comments

Saturday, April 21, 2018

Delray Beach, FL – Principles of Wealth: #14 of 61

Income is an important factor in the acquisition of wealth, but it is not a measure of it. Nor are expensive possessions. The only measure of financial wealth is net investible worth.

It had a pool in the back and automatic doors on the garage in front. It was the nicest house I had ever lived in and our first home. Three bedrooms. Two baths. Friendly neighborhood. $170,000.

“Do you think I’m being foolish?” I asked. “Spending so much on a home?”

Eddie looked at me as if I was crazy. “Your income last year was more than double the cost of the house,” he said. “And your income this year is higher still.”

“So?”

“I close hundreds of houses a year in this area,” he said. About a third of them are for homes that cost more than a half a million. And they are bought by doctors and lawyers that make no more than you do.

“So?”

“They drive Mercedes. You drive Hondas. They drink Dom Perignon. You drink Proseco. They all look rich, but most of them are in debt. They spend their money faster than they make it.”

“So?”

“How much did you have in savings last year?”

“About $175,000.”

“And this year?”
“About $250,000.”

“That’s what I thought. You are worried about buying a home that cost you about six or seven months of salary. That alone tells me you are an extremely conservative spender.

“More importantly, you’ve made this promise to yourself to increase not only your income but your savings every year. And you’ve been doing that for years.

The doctors and lawyers I know are spending two to five times their yearly salaries on their houses. These guys have great incomes but they also have great debt. Debt that is often greater than their assets. They are buying prestige and keeping their fingers crossed that their financial situation will always be strong. They have zero savings and no net worth.”

“That net worth thing. It’s always troubled me. How can I count my house or my cars? I’m always going to need them. I don’t want to be forced to sell them.”

“Okay, then don’t count them. Count only the net worth you have after subtracting them. Call it something…”

Years later, when I wrote about it, I called it net investible wealth.

Miscellaneous Essays

2 Steps You Can Take Today to Get Out of Debt Fast

June 19, 2013 No Comments

Do you spend more than you make? I used to.

When I started working as an editor at a Washington, D.C.-based newsletter publishing company, my salary was $14,000. My wife was earning less than that. Our two salaries barely covered our basic living expenses. On top of that, I was attending graduate school and we were paying off student loans. Then our first son was born. For the first six months of his life, he slept in an open drawer in our bedroom.

Meanwhile, I was spending money I didn’t have on things I couldn’t afford. Struggling to pay for my education and brand-new family, I overspent because it seemed to provide some happiness, some relief.

But the thrill of buying stuff soon waned. Each new object brought less relief. Eventually, I realized that I was getting 80 percent of my pleasure from experiences that didn’t cost much money. But recognizing that you don’t need junk food and kicking the habit are two distinct things.

Here’s how I got myself out of debt:

First, I got rid of all my credit cards. I figured that what I couldn’t buy with cash was either worthless or worth saving for. Although the fear of going without credit was great, I never experienced any anxiety after I trashed the cards. It seemed like a drastic decision before I made it, but after half an hour I never gave it another thought.

The second thing I did to get out of debt was to start saving. I had made myself a promise that I would save a percentage of my take-home pay, but I never did it. The breakthrough came when I was talking to a friend about how the IRS manages to collect a big chunk of our income through the evil genius of withholding. I recognized I had to do the same thing to myself. The only way I was going to save money was through force.

The solution was available in a new-at-the-time savings-bank program, one that withdrew a set amount of money from my primary account every month and put it in another one. That program allowed me to gradually increase my saving from 10 percent of my income to 25 percent and pay down my debt in a few years.

If you are spending more than you are making, get rid of your credit cards. And to get used to spending less, remind yourself repeatedly that most of the junk you buy (a) becomes unused after a few months and (b) doesn’t provide you with much value anyway. Remember that the best things in life – the picnics you have with your family, the walks you take by yourself, the time you spend with your friends – are free, or nearly so.

Create a separate bank account that you’ll use to pay down your debt, or have your debts automatically deducted from the one account you have. You might even consider a debt consolidator. (But watch out. Most of them are crooked.)

Increase the amount of your take-home that goes into debt payments every month. You might start, for example, with 10 percent and then increase that by 5 percent a month. Six months from now, you could be living on half of what you spend now – and I’ll bet you will be feeling a lot better about yourself. You’ll have less stress, more energy, more confidence, and the beginnings of a lifelong habit of wealth building.

There are so many ways to save money. You can spend less on just about anything without giving up either the pleasure you take in buying or the quality you get from your purchases.

Miscellaneous Essays

Dealing With Debt

October 17, 2012 No Comments

A dream:

You are on a beach of golden sand. You have a large bucket, large enough to carry a million dollars’ worth of golden sand. You put a scoop of sand in the bucket. Then another. With each scoop, you feel richer. But then you notice something. The bucket isn’t getting fuller. There is a hole in the bottom, out of which sand is escaping.

You work faster, hoping to fill the bucket by adding more sand quickly. Yet, as fast as you fill it, the sand escapes. Still you move faster, and still the bucket will not fill. In fact, the level of sand in the bucket is getting lower!

This is the problem with trying to get richer through debt. Debt allows you to have things that you can’t afford. But there is a cost to it. And sometimes the cost is very high—so high that, no matter how hard you work, the wealth you hoped to acquire disappears.

At some rudimentary level, we all understand that debt is dangerous. But in our daily lives, many of us view it as a necessity. We buy homes with it. And cars. And boats, and toys, and vacations. Some use debt to buy the basics: clothes, food, and furniture.

Debt is not necessary. It is a luxury. Sometimes debt is useful. Sometimes it is wasteful. But debt is always dangerous.

I had my first serious run-in with debt when I was thirty years old. My wife K and I were renting a condominium in Washington, D.C. Our landlady came to us with an exciting opportunity: We could buy the condo for $60,000 with no money down. For just a hundred dollars a month more than what we were already paying for rent, we would be paying a mortgage. It sounded like a great deal, so we took it.

What we bought was a negatively amortizing mortgage with a three-year term and an 11% interest rate. What that meant was, every three years we were paying $19,800 in debt service and another $3,000 in closing costs.

We didn’t realize what was going on because our monthly payments were only $550. I was too foolish then to ever ask myself, “What is the cost of this debt?”

I tried to find another bank to take me out of this scam but none would. The mortgage we had signed was not backed by the government (Freddie Mac/Fannie May), which meant that no other bank would touch it.

It was like the dream with the leaking sand. Our golden condominium was nothing but fool’s gold.

And we were the fools. I wasn’t able to get us out of that deal until years later when I was wealthy enough to pay off the mortgage. Even after calculating the rental value of living in that condo, the deal cost me more than $30,000, and I had nothing to show for it.

I learned that when banks make it easy to borrow money, it’s not because you are a nice, deserving person. I learned that if you can get a loan despite poor credit (as ours was at the time), there is usually a scam involved. It also taught me to always ask the two critical questions about debt, “How much will it cost?” And, “Can I afford it?”

It was an expensive lesson. But the lesson seemed cheap thirty years later when, in 2005, the real estate market bubbled out of the pot. I sold my speculative properties and got out of the market. I made and saved millions, while my friends who ignored my warnings got killed.

Debt is unnecessary and it is dangerous.

It is unnecessary because there are always less expensive ways of getting what you want. And it is dangerous because it can sometimes be very expensive.

Let me give you two examples.

Let’s say that, like most Americans, you are in the habit of buying things with credit cards. After a while, you notice that you have accumulated $30,000 in total debt. You decide to cut up your cards and repay your debt. You can devote $400 a month to paying it back. How long will it take, and how much will it cost you?

The answer may surprise you. It will take you ten years to pay off the credit card debt. And your total payments will be $47,428. Of that, $13,278 will have been in interest payments.

Or let’s take a $150,000 home on which you take a $120,000 loan with a 6.5% interest rate. The mortgage payments are $914 a month, which you can afford. But how much will that house really cost you? Including interest payments? You will end up paying $329,303 for that house. Almost half of that—$153,050—will have been to interest payments.

The commercial community (bankers and manufacturers) doesn’t want you to be afraid of debt. And neither does the government, as I explain in the box. These institutions want you to like debt. They want you to use it. They want you to go into debt because it is good for them.

When you take out a mortgage to buy a home, or sign a lease on a car, or use credit cards to pay for your lifestyle expenses, the commercial community profits. The manufacturers make money on products you may or may not need. And the banks make money on your debt.

The mainstream financial media rarely talks about the dangers of debt. That’s because they make their profits from the financial institutions and manufacturers whose advertisements support their publications.

And the government actually encourages its citizens to take on debt. This was the recommended strategy for getting us out of the Great Recession that the (second) Bush administration (and the Federal Reserve) advocated and it’s the same scheme that Obama’s people are advocating today.

Debt is like a cancer. It lurks within. It guts your wealth, while you are paying attention to other, seemingly more important things. Then one day, it breaks through and gives you a fever. You call in the doctors and they cut you open, only to have them find the mess that is your financial body. The doctors then sew you up and walk away.

Here’s what you should know about debt:

As a general rule, you should live without it. You should find other, less expensive ways to acquire the things you need.

There are some cases where debt makes sense. I’ll talk about that at the end of this essay. But let’s look at what you should not do.

Unless you are wealthy, don’t lease your car. Buy it. Buy the car you can afford, not the car you believe will make you happy. Any non-appreciating asset (such as a car) will never make you happy if you have to pay its debt service. I didn’t buy my first luxury car until I was a multimillionaire.

Don’t buy anything with a credit card. Keep only one credit card for renting cars. Use a debit card to buy clothes and groceries. If you don’t have enough money in your bank account to use your debit card on a purchase, don’t buy it. If you don’t have enough money in the bank to buy something, it means you can’t afford it.

If you can’t afford the debt on your house, sell it (if you can) and buy something cheaper. In any case, start paying off the principle balance of your house (the amount you owe, not the interest you will owe) as fast as you can. Make it a goal to own your house free and clear as soon as possible.

If you have debt, pay it off as fast as you can, but not before you have filled up your bucket for emergency savings. By emergency savings, I mean money you will need to pay your bills if you lose your job. Six months’ income is what some financial advisors recommend. I’d recommend a year. It may take you that long to replace your lost income.

Pay off your debt even if the interest rate is low. In theory, you should put your extra money elsewhere if you can earn more on it than you are paying in interest. If, for example, you can get 4% in municipal bonds and you have a student loan at 2%, it makes more sense to buy municipals bonds and pay your student loan off slowly. But in reality, the extra 2% you are earning on the spread is not worth the risk in carrying the debt.

When I started earning money, the first thing I did was get rid of that terrible loan on the condominium I told you about earlier. The next thing I did was pay off the mortgage I took on a home. I paid it off in two or three years, even though it was a thirty-year mortgage. I loved the idea of owning my home free and clear. So I put every extra dollar I had toward paying down that mortgage. The bank didn’t like it, but the day I tore up that montage…I felt like I had been emancipated from financial slavery.

If you are troubled by debt, know this: you can get out of it just as I did.

When you are debt free, you can begin to use debt strategically. But to do so, you must always ask two critical questions: How much will it cost? Can I afford it?

Buying cash-flow real estate properties is one such example. Real estate values in many markets today are as low as they’ve been in ten or twenty years. And mortgage rates, at 3%-5% for people with good credit, are very low. This makes sense.

It may also make sense to take on debt to finance a business. But again, you have to be very careful. You must be sure that the return you are getting on your debt is guaranteed to be considerably higher than the cost of the debt.

But I don’t want to leave you with a happy feeling about debt. Debt is unnecessary. And it is dangerous. So get rid of it as fast as you can.

Miscellaneous Essays

Obama Versus Romney Who Will Win? And Does It Matter?

August 29, 2012 No Comments

Over the past several weeks, readers have expressed their interest in the upcoming presidential election and its impact on America’s future. More particularly, many readers see this election as a contest between freedom and capitalism and some newfangled version of socialism… and they are worried that if Obama wins, they will become a lot poorer.

Well, here’s what I think. As far as your financial future is concerned, it doesn’t matter who is elected. Despite differences in ideology and rhetoric, our next president will take essentially the same path in terms of “saving” the economy.

I’m not saying that there is no difference between the candidates’ economic views. Obama wants to redistribute wealth. Romney wants to diminish social spending. But neither of them will make much long-term headway at realizing their ambitions. What they will succeed at is what both Republicans and Democrats have been doing nonstop since World War II: expanding the federal government by increasing its debt.

I’m not an economist. In analyzing our country’s economic policies, I take a businessman’s perspective. Businesses have many goals, some altruistic and some selfish, but they are all ruled by the logic of the balance sheet. Without a positive balance sheet, no business can last.

The Economy Is Out of Control

Our economy, I’m sure we can agree, is in ruins, and our federal government has unprecedented levels of debt. On top of our outstanding debts, we keep spending more money than we’re taking in. But only a partisan fool would suggest that this is due to Obama. The national balance sheet was already $9.9 trillion in the red when he took office. He has done a good job of pumping that up to $15.9 trillion. But had McCain been elected in 2008 we would be in roughly the same place.

The reason for that is simple. Every modern-day president knows that his only chance of being elected or re-elected depends on the economy. If the electorate believes that the president is “doing a good job” with the economy, it will re-elect him. If it believes he has made things worse, it will elect his opponent, who will be arguing that he can fix it.

But today there is no way to fix the economy.