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Archive for the ‘Basics’ Category

Are you a consumer, saver, investor, speculator or loser?

Tuesday, April 15th, 2008

Lets start by doing a little quiz. Who doesn’t like quizzes?

Question #1

You have a $1000 windfall do you:

1) Go out an buy a big screen TV
2) Dump that into your ING account (Open an ING account, link at left)
3) Buy some more shares in your index fund
4) Buy some penny stocks
5) Convert it all to $1s and make it “rain” at the club

Ok so that quiz was easy. But really what are the differences here?

You are a CONSUMER you exchange your money for something with no lasting value or greatly depreciating value

We are all consumers. We must buy products and services just to get by. However, consuming destroys our wealth. When we buy a product or service, we shift a bit of our wealth into the pocket of the seller by handing him more dollars than he spent on the product or service he hands over to us. The difference in dollars is the seller’s profit. In exchange, we end up with a product or service worth less than what we just paid the seller for it. Worse, its value falls rather quickly – even down to zero if we consume the product or service in full.

Profit is not a bad thing. Sellers deserve a profit for providing value to consumers. A bad thing is consumers consuming excessively. Too many Americans today give too many dollars – even dollars borrowed from banks – over to sellers in exchange for products and services of little lasting value. Across billions of transactions each year, sellers collect mounting slices of our wealth. Consumers, in turn, collect mounting piles of worthless objects and wistful memories.

You are a SAVER when you do not trade your money for goods or services

Many of us are savers. We save money when we keep a little – or a lot – of our cash income in our bank accounts by taking control of our exchanges with sellers. Just because sellers offer us cool, fun, or interesting things doesn’t mean we must possess or experience these things to live a fulfilling life. How many times have you rushed out to see the latest Hollywood movie only to leave the theater thinking, “Well, that was a waste of time and money”? Yet, the time is lost forever and your money is in the pocket of the ticket seller.

Time and money are essential ingredients to building wealth. While many Americans seek to “get rich quick” with “no money down,” financial freedom begins with our own cash savings and a large dose of patience. Compounding interest, dividends, earnings, and gains from wise investments will, over time, offer us a greater chance at financial freedom than years of playing the lottery ever will.

You are an INVESTOR when you choose to exchange your savings for an asset you know will appreciate or is with more than its face value

Some of us are investors. We invest when we exchange our savings for assets worth significantly more than the price we pay for them. Why would someone want to exchange his valuable assets for our smaller cash savings? Time and money. The assets may be valuable because, over time, they are expected to put significant cash flows – dividends, interest payments, royalties, net rental fees, etc. – into the pockets of their owner. However, the owner may not want to wait for time to pass before he can pocket the cash flows himself. Instead, he prefers to pocket our smaller cash savings right now.

Think of it as paying $10 for a $20 bill. No doubt the $20 bill is worth $20, but the seller’s price is only $10. We pay the seller’s $10 asking price and instantly own an asset worth $20. Such an exchange is how we wisely invest our savings in assets like stocks, royalty trusts, small businesses, and rental properties. If we repeat these exchanges over and over again, we become wealthy. This is how the world’s wealthiest investor, Warren Buffett, invests his billions. How does he find such great deals? Speculators hand them to him.

You are a SPECULATOR when you choose to exchange your savings for an asset that you have not fully reasoned its worth

Many of us are speculators. We speculate when we willingly exchange our cash savings for assets the worth of which we do not know. Speculators do not take the time to study an asset and determine its worth. Instead, they just pay the seller’s price and hope that the price will be higher later. Some speculators speculate and make millions. Many, however, lose their shirts by hoping that luck – the gambler’s unreliable friend – will save them from total loss.

Ironically, speculators make America a great place to invest. The speculator soon forgets the valuable assets he owns when he jealously watches an asset he does not own increase dramatically in price. To quickly raise the cash he needs to buy the increasingly expensive asset he covets, the speculator willingly sells his valuable assets at discounted prices. Always on the lookout for a bargain, the investor stands ready to scoop up the speculator’s valuable assets at prices well below their worth. This is how speculators transfer their wealth to investors like Warren Buffett, who patiently grows wealthier every year.

You are a LOSER if you exchange your savings for absolutely nothing worthwhile in return

You might be a loser if…

…you waste your savings on things that you do not remember

…you send $1000 to Africa because you won a lottery but they ‘need $1000 to release it’

…you invest in diamonds

…you engage in MLM

..insert yours here
If you consume in moderation, you create cash savings, which you can invest in assets sold to you at bargain prices by those who speculate, just don’t be a loser…

Refinancing; Home Equity Loan (HEL) and Home Equity Line of Credit (HELOC) basics

Saturday, February 9th, 2008

Since the federal reserve has been cutting rates like interest is goin out of style there has been a renewed interest in home equity loans and home equity lines of credit. So what exactly are these? What is the different? Should I care?

What is a HEL (home equity loan)?

This is a type of loan where the borrower uses the equity in their home as collateral. These loans a lot of times are used to finance home projects, pay off high interest credit card debt, or pay medical bills. A home equity loan requires good credit history and a good amount of equity in the home. In this loan, the borrower receives a lump sum at the time of closing and nothing more can be borrowed. The max amount of money that can be borrowed is determined by variables including credit history, income and the value of teh home. The amount that can be borrowed is usually up to the entire appraised value of the home minus the first mortgage. Closed end loans have fixed rates and can be amortized for periods of usually up to 15 years.

What is a HELOC (Home Equity Line of Credit)?
A Home Equity Line of Credit (often called HELOC, pronounced HEE-lock) is a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower’s equity in his/her house. This is also called an open-ended home equity loan.

What is the difference between a HELOC and a come equity loan?
The different is that in a HELOC the entire sum of money isn’t given to you up front. Instead you are given a line of credit, very similar to having a credit card. At closing you get a specific credit limit that you can borrow up to. During the period of time you are allowed to borrow you can borrow and pay back what you owe plus interest. Depending on how much you use the home equity line of credit you will have a monthly payment, generally only the interest on whatever is owed. Another difference is that the interest rate on a HELOC is based on the prime rate as set by the federal reserve. This means that the interest rate will change over time. Generally HELOC rates are lower than home equity loans because they are variable, however if there is significant economic turmoil you could get stuck with a very high interest rate.

For each, what are some of the advantages and disadvantages?

Home Equity Loan Advantages:
-All the money up front
-The interest is tax deductible
-Low closing costs

Home Equity Loan Disadvantages
-Fairly high interest rates
-No grace period, payments start right away
-No flexibility

HELOC Advantages:
-The interest is tax deductible
-HELOCs are viewed as not as bad in the eyes of creditors as a traditional home equity loan
-can be interest only
-no prepay

HELOC Disadvantages:
-Variable interest rates mean that rates can rise over time.
-Failure to keep to terms can and probably will result in foreclosure.
-No caps on interest rate
-Minimum draw amounts

As far as times to get home equity loans go, this is a good time. The federal prime interest rate is the lowest it has been in years. If you have sizable high interest debt, a HEL or HELOC might be a good idea…just remember putting up your home for collateral is dangerous!

Free Iphone, fixing your 401k, and evil mutual fund managers (via expense ratios and fund fees)

Monday, February 4th, 2008

I know, first thing you are wondering is FREE Iphone? WHERE CAN I GET IT!? Well, just hold on a few and read through. I was talking to one of my friends from work about viking death metal (no joke) and rock band (pretty much the best video game ever) and somehow the conversation drifted toward the 401k plan at our company. He said he had been dabbling in a few of the funds offered and seemed surprised when I said I was dumping 90% of mine (and my girlfriends) into our one index fund. So of course he asked me why? Well, its very very simple. Nearly every mutual fund available in our plan has an expense ratio greater than one.

Mutual Fund fees ruin returns

What the hell is an expense ratio and why do I care?

The expense ratio is the percent of total assets that the investor is charged just to be in the fund. This is supposed to cover the costs of running the mutual fund…but honestly it really is how mutual fund houses and managers steal your money to make themselves multimillionaires. Here is the simple version:

The Penny Saved IphoneMutual fund from your 401k you are in:

BIG MUTUAL FUND: expense ratio: 1.50%

Lets say youve been working for a few years so you have 20k in your 401k. Lets say you get a return this year of 10%. Wow sweet an extra $2000! But wait a minute, your mutual fund that are in has an expense ration of 1.50 so they keep 15% of that. You only get $1700 and they keep that other $300.

Lets say you were instead investing in the index fund with an expense ratio of .10 (actual number for mine). Instead of the fund keeping $300, they would be keeping $10. That extra money, why, thats your free iphone right there. Ok so maybe you can’t actually pull that $300 out and buy an iphone (though you could if it was a Roth IRA) but you get the point.

But dont mutual funds make more money than index funds?
No, 85% of mutual funds fail to beat the market average.

Other types of expenses that mutual funds might charge:

Front-end load
This is basically a fee paid when shares are purchased. It is also known as a “front-end load,” and this fee goes to the brokers that sell the fund’s shares. Front-end loads reduce the amount of your investment. A good example is if you have $1,000 and want to invest it in a mutual fund with a 5% front-end load. The $50 you pay comes off the top, and so only $950 will be invested in the fund.

Back-end load
This is where the brokers take their cut when you decide to sell shares. This is even worse because they take part of your capital gains as well. Some mutual funds let you out of these if you stay with them long enough but its just one more robbery trick.

Level load / Low load
The only difference between level loads and low loads as opposed to back-end loads, is that this time frame where charges are levied is shorter.
Load of Crap
Most of the above fees.

Most career advice sucks

Monday, January 21st, 2008

…and by that I mean either obvious or just plain wrong. I have seen a lot of career advice on the internet and quite frankly a lot of it is BS. Here are some of the gems I found from various blogs, msn articles, and webzines:

“Be innovative” aka “Be creative” aka “Try new things” aka “..introduce new ideas”
-Written a thousand ways, and always I respond: ‘Ya think?’
“Volunteer for boards”
-Im not sure about you but there are no ‘boards’ at my work to volunteer for. Oh and the kind of companies that have boards generally SELECT people for them.

-“Don’t ruin your reputation”
-And here I thought getting super drunk and dancing around on the table at the company Christmas party was a good idea.

-“The best strategy is to just be the best in your area. That makes you indispensable”
-Wrong. In fact, I’ll give you a bunch of reasons why:
1) I worked at Hewlett Packard for six years. During the first threeish years I worked there, I did very little more than I was asked. Sometimes not even that. For the last three years I worked there I worked my ass off. During the last year I was there I was working on a large project and people around me were dropping like flies during the layoffs. I was originally supposed to be support for the project but because of the layoffs I turned out to be the only engineer on the project. Keep in mind I was in college, and so receiving college level pay, I was not a huge liability. Just as we finished the first phase of the project I was laid off. I was the ONLY engineering resource left on the project and the only one who knew fully how it worked. And I was let go before I could finish completely or do any documentation . There is no such thing as being indispensable. It doesn’t matter what you are doing or what you are getting paid or where you are on the ladder.
2) Now, its a good idea to be an expert in one area but you should also understand as much as possible in all aspects. Being rounded is a good thing. What if your area of expertise goes away, what then?
3) Getting pigeonholed into doing one thing all the time sucks. You know Bob in department B thats been doing the same thing for 30 years….do you really wanna be him?
Dont be Bob

“Do what you were good at in school”
When my dad was in college he was pushed hard by councilors to go into physics because he was REALLY good at it. As it turns out he hated working in a lab and went on to do other things. Just because you are really good at something doesn’t mean you should do it. This problem is particularly big when still in college. I switched majors somewhere in the range of four times before I finally settled on something. Just because a class is fun and you are good at the subject does not mean you should bank your life on it. Being good at something in college does not equate to real life success. Plus, there are very few jobs directly related to drinking beer.


Sometimes the smartest financial decision…is not the decision for you

Sunday, July 8th, 2007

If I were giving advice to someone, I would tell them not to buy a new car. I would also tell them not to finance a car, but instead to save up and buy a late model used car. I would also advise someone to buy a car with low insurance premiums that gets excellent gas milage. All of that said, this weekend I bought a new car with higher insurance premiums that gets average gas milage (though much better than my previous car). I also financed it through my credit union. However, it wasn’t an impulse buy, it was something I did a lot of thinking about.

There were several reasons I went the route I did:

Professionalism – my previous car was fun (A Dodge sports car) but was more akin to something a high school kid would drive than a college graduate working for a consulting firm.

Need to get rid of my previous car – I was almost up on my warranty and did not wish to pay for an extended warranty. Also private party sales of my car are very slim.

Low interest rate – I was able to secure a very low interest loan through my credit union.

Personality – The car I got is very much a reflection of my personality.

Carpe Diem – I actually deteste this saying, but for me to have a new car, this is the time.

Budget – It fits into my budget

Resale value – It is one of the highest resale value cars on the market…which was actually one of the reasons I decided to get one new instead of used. The used prices were not much lower than the new prices.

Color – As odd as this sounds, the color I wanted was only available on the ’07 model.

Without further ado:


How to get rich Venn diagram..

Tuesday, June 12th, 2007

So I saw something on the binary dollar that I absolutely love.  Its a how to get rich Venn diagram…however I thought that they left out one huge thing.  Their two points were make lots of money and save lots of money.  I decided to take it one step further (anyone hear the money truck coming?)

Venn Diagram

Ah yes, beautiful.

Top 5 basic personal finance mistakes

Saturday, April 14th, 2007

Top 5 in a semi ordered fashion:

#1 – Lack of a Budget
Most people do not have a monthly budget.  Infact its staggering how little idea most people have of where their money is going.  When I was first looking into organizing my finances, I realized that I had been spending over $800 a month on eating out.  $800!  A friend of mine that was also organizing their finances figured out that they had spent over $100 a week on CDs and DVDs on average.  This is the absolute first thing to do when you want to clean up your finances.  Check out my budget calculator on the downloads page.

#2 – Missing Bill Payments
How often do you rent a movie, then forget to take it back until it is 3 days overdue?  How about that cable bill that you put off paying?  Small charges for late fees add up.  Lets say in one month you have 2 overdue movies, 1 late bill payment, and 1 late credit card payment.  You could be paying over $50 in fees that are absolutely unncessary.

#3 – Not maxing out your companies match on 401k
This one is simple.  If your company matches, say, 3%, you should be putting at LEAST 3% in every month.  This is FREE money.  FREE!

#4 – Racking Up Credit Card Debt – and then paying the minimum
Spending more than you bring is is a bad idea(suprised?).  Not paying it off quickly is even worse.  This goes along with not having a budget set.  Lets take for example someone I worked with a few years ago.  He bought a brand new TV on his credit card.  He was excited because it was ‘only’ costing him $80 a month.  By the time he was done paying it off, his $2100 plasma TV cost almost $3000. 

#5 – Buying a New Car
This one is near and dear to my heart.  Why?  I am guilty of it.  A new car is one of the absolute worst investments you can make.  Ive seen more people spend too much on a new car than I have seen frat boys passed out on a saturday night (almost) “But Jesse I just started this new job and Im getting paid well….”  then put aside the money you would spend on the new car until you have enough to buy a late model used car. 

Interest and Compounding Interest

Thursday, March 29th, 2007

First of all, what is interest?
Interest is the cost of borrowing money. The person doing the lending gets a fee for allowing the borrower to use their money for a set rate of time. The original amount that is loaned to the borrower is called the principal and the percentage of that original amount which is paid over a period of time is called the “interest rate.” That percentage times the principal is the interest. For example lets take Dave and John.

Dave: John I need to borrow $10 to buy a qdoba burrito. I will pay you back tomorrow…
John: Why would you buy a qdoba burrito?
Dave: It tastes good.
John: Ok, here is $10 but I will charge you 10% interest per day on that.

…..Next Day…..

John: Ok that will be $10 + (10% X $10) so, that will be $11 please.
Dave: whoa $11?
John: Yeah, you should learn what interest means.

So what is compounding interest?
Compounding interest means that whenever interest is calculated, it is based on the original principal AND also any interest that has been earned. So the more often that that the interest is compounded, the faster the total (principal + earnings) grows.

What is this important for me?
Compounding interest is what allows something now to be worth many times the original investment many years from now (say, retirement age). Check out my retirement section for a bunch of examples of that.

How can I calculate compounding interest?
There is a rule called the rule of 72 that makes this fairly easy. It’s not exact, but it gives a pretty good approximation. 72 divided by the interest is equal to the number of periods needed to double the principal. So:

72/i = n

What is a typical example of this?
The stock market. Over the past 75+ years the stock market has averaged a rate of growth of around 11% per year. So if we say 12% just to make dividing 72 easy, thats 72/12 = 6. So at 11% per year it would take just over 6 years to double your money. Thats why people always talk about 6-7 years to double your money investing. It’s based on the average market return.

Roth IRA Basics

Thursday, March 29th, 2007

What is a Roth IRA?
Its an individual retirement account named after William Roth Jr of Delaware, the chief sponsor of the legislation that created it. It is a relatively new entity, it wasn’t established until 1998. A Roth IRA, unlike the 401(k), is not something that is employer sponsored, it is an extra retirement account the government will let you create (if you make under $99,0000 per year). Just like the 401(k) you must be 59.5 to withdraw your earnings without penalty.

What are the advantages of a Roth IRA?
-Because you contribute money after the government has already taxed it, withdrawls of contributions are tax free. Even better, the earnings grow tax free. In other words, if taxes are higher in the future, your Roth IRA doesn’t care. At retirement you still get to withdraw your money without paying higher taxes on it.
-It is very flexible in how it can be managed. In other words, you can have a big mix of investments in it.
-Because you have already paid income tax on it, you can pull out your contributions (not your earnings) at any time. This is a huge advantage over the 401(k).
-Most people will be in higher tax brackets as they get older, meaning that you will pay less on your contributions now than you will when you retire.

What are some disadvantages?
-You still have to be 59.5 to withdraw earnings without heavy penalties.
-It is not tax deductible
-There is always the risk that congress will decide to tax earnings on Roth IRAs between now and your retirement.

What is this about restrictions on how much I make?
You can only contribute to a Roth IRA if you make less than $99,000.00 per year.

What is this about restrictions on how much I can put in?
As of right now you can only put in $4000.00 a year if you are under the age of 50, and $5000.00 if you are over the age of 50.

Should I max out my Roth IRA or my 401(k)?
First max out your employer match of 401(k) and then max your Roth IRA and then back to the 401(k) if you can afford it. This is an effective way of hedging your bets on paying taxes now versus in the future. Roth is taxed now, 401(k) in the future.

Bond Basics

Saturday, March 24th, 2007

What is a bond?
A bond is basically just an official IOU. Everyone has had to borrow money at some point in their life. Well, the same goes for corporations and governments. When you buy a bond, you are lending money to some entity like the government. The problem is that when a government or coporation needs to borrow money, it is usually more than they can get from a bank. So what do they do? They issue bonds to the public. In return for the loan the entity promises to pay you a rate of interest over the life of the bond and to repay the principal after a set time. The interest rate is usually referred to as the coupon and the date that the entity has to repay the principal is called the maturity date. The bottom line is that a bond is just a loan for which you, the investor, are the lender.

What is the difference between a bond and a stock?
Though they are both investment related they are actually very different things. Stocks are equity in a company where as bonds are debt that a compay owes. When you invest in a stock, you buy a piece of the comany. When you buy a bond, you loan a company money. The bond is basically the less sexy younger sibling to stocks. Bonds are especially boring compared to stocks during bull market times because they offer much lower returns than stocks.

What is an advantage of bonds?
There are a few advantages of bonds. The first is that if a company files bankruptcy, a bondholder has a higher claim on assets than a shareholder. Secondly, a bond is fixed income. When you buy a bond you know the exact amount of money you will be getting and when you will get it.

What are the disadvantages to bonds?

The main disadvantage is that generally they do get much lower returns than stocks do. Also, if a company does very well, it makes no difference, you get paid the same no matter what. The bond is a very safe choice.