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017, Just Start Doing Something

Where are you on your journey to FI? If you haven’t started yet, get moving towards something! Marathons start with that first step. FI is very similar. It starts by doing one step. Then continue taking steps to get you closer to the finish line or further down the path. Just keep stepping towards the goal. Marathons and FI can’t be done in one step either. Only through consistent steps along the path will you ever get to your goals.

So, if you have already started that’s great! You can’t finish what you don’t start. But if you haven’t started, get going! Even if you are unsure of exactly what steps you need to take, take a step. It could be paying off debt. It could be starting a savings account. Maybe start an IRA or a Roth IRA. Maybe it’s enrolling in your company’s 401k, 403b, or Thrift Savings Plan. Just take a step.

Don’t wait until you understand every aspect of personal finance before you begin. Some people can or will try to analyze every aspect so hard that they never start. They may be afraid to make a mistake. That’s the “paralysis by analysis” often referred to from time to time. Don’t let that become a road block towards starting. Someone who starts with sound basics such as the big rocks mentioned in other posts here will be just fine. Suppose only 80% of the goals are met. That’s still way better than sitting at the starting gate!

Once you are stepping, keep on keeping on! Every month try to do what you did last month as the minimum. Take another step. Keep on stepping. Maybe automate an extra car payment. Maybe automate an amount to go into that savings account, IRA or 401K. Keep on adding to what you did last month.

Another good pattern to get into is to increase your savings a little at a time. For example increase maybe 1% contribution to your saving each month or quarter. Maybe put 50% of a raise, bonus, or tax refund into savings instead of spending it. Increases like these will also help you get a bump in progress. Every little step helps and adds up over time.

You should also learn more detail about each of the areas of your personal finances. Read an article or two a week to gain more knowledge. Maybe read a financial blog or listen to a podcast. Perhaps you go to the library and check out a book. If you are not a member of the local library, you should become one. It’s a great source for resources. If you don’t like reading, check out an audio book!

In a year’s time, the results can be surprising. Say the goal was to increase savings 1% per month. It was a tough month so only eight 1% increases were possible throughout the year. That’s still 8% more than in the beginning of the year. Maybe a goal was two articles about finances per week was the goal. Again, the year was tough and only one per week was able to be completed. That’s 52 articles read in the year! Not too shabby.

The point of the post is to start doing something to get to a better financial position. Once started, continue to get more knowledgeable and increase forward progress. After a period of time, through small steps the progress made will be significant.

Take that first step, that next step, or that higher step. Just get going an keep on keeping on!

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016, Mentorship

We all start out with a “blank slate”. This is a pic of one of my 7 grandkids. Yes, they all came into the work with a blank slate.

According to Merriam-Webster a mentor is a trusted counselor or guide. This word is is usually thought to be someone who helps you with their career. These are generally older people who have been around for a long time. They are also usually considered successful in their fields whatever that may be.

But mentors come in many different types. There are apprentices, journeyman, and masters in career fields. There are elders in churches. There are parents, grandparents, aunts, uncles, and other family members. To become a chef, you have to pay your time and work under a chef. Mentoring relationships are all around you.

I’ve heard on a few podcasts that you are the average of the 5 people you spend the most time with. There’s even a Ted Talk about it. It makes sense on a basic level.

Take an inventory of who you spend the most time with. Are they helping or hurting you when it come to your financial goals?

I have had many mentors over the years. Not all were helpful for my financial health.

By no means am I saying that all of the people you hang out with should be mentoring you in your financial journey. Maybe you will be the mentor. You should try to have at least one friend that is like-minded about financial independence. If all the people you spend time with are deep into the consumerism lifestyle and not supportive in financial independence, it will be a lot harder to stay motivated. They won’t understand what you are doing. They may not believe in the concepts you are trying to apply. Being around like-minded people in the financial independence area will help and support you. You can ask questions or get asked questions. You can debate the finer points and differences. But both of you will be coming from a solid place in finance.

Luckily, there’s the financial independence community. While reading blogs on financial independence there are frequently posts stating that the blog is the only place they can talk openly about their finances and be supported. If you don’t have a real person around to talk to, try a blog. You can join Facebook groups too. Lots of folks are supportive in the Facebook groups. You can use some of the social media to augment your local friends. Maybe you can even find local groups that have meet ups, lunches, or dinners.

Whatever you do find a friend, neighbor, family member or social media to help you on your journey. The more time you spending talking, thinking, or doing financial deeds, the more mature you become in financial independence. So, if you need a mentor, find one. If someone needs a mentor, be one. It doesn’t matter that you may not have all the answers. If you don’t know, think of it as an opportunity. No one knows everything! You just need to listen and learn. Never stop learning. But being a mentor or mentee in financial independence can be a very rewarding endeavor.

So, if you don’t have have a mentor, become a mentee. Everyone’s slate starts out blank. Fill your slate with the good stuff, then pass it along.

015, Lucky # 7

Awe…ain’t she cute!

Hopefully you noticed that my posts were less frequent lately. It’s true. The blog has taken a back seat for a over a week now. But I haven’t. I’ve been busy with preparing for a new grandchild.

Last week, the Mrs and I were on edge because the due date for the newest bundle of grandkid joy was on Wednesday of last week. We had prepared our work that we would leave at minutes notice and subsequently be out for a couple of days.

Well, that text came early Thursday morning. The water had broke and contractions started. So we hauled off for the 4 hour drive to be with the kids when the new grand baby arrived.

Clover Selah was born around 1030 am. Momma and baby girl are fine. She weighed in at 9.1 pounds and was 21″ long. That’s a keeper!

The Mrs and I spent 4 days down there to help where we can with getting Clover settled into the new world. Clover is grandkid #7.

So, that’s what we’ve been up to. What would PawPawFi be without the grandkids right? I mean the Paw Paw does come before the Fi part.

Hope all is well with y’all. If you have something you wanted me to cover, please let me know. I’ll get back to writing real soon.

014, Opportune Cost of a Couch

When you don’t invest, you also loose all compounding interest you would have made from the investment. That doesn’t sound all that bad until you look at the numbers in detail. So, let’s look at this in more detail.

Let’s consider a $1,000 gift, a tax return, or just $1,000 you saved at some point in your life. If that money is blown, you not only don’t have the $1,000 from before, but you’d lose all the compounding interest. Still, that doesn’t seem like it’s enough for Average Joe to show restraint and invest in his retirement. So what right? It’s only a grand.

Twenty year old Average blew his $1,000 on a new couch and a great meal at some high dollar steak house. He’s young, working hard and deserved the best. He deserved to splurge with his new found extra money.

Twenty year old Smoking Joe, on the other hand, heeded advice he had heard that investing early is the surest way to maximize his money. So, he invested his $1,000 in a tax sheltered retirement account in a low cost mutual fund with a 10% return over the last 20 years and forgot about it. He never added any money to his investment.

What is the total impact at retirement? A lot. The compounding interest on investments has a massive effect over 20 and 40 years. So much so that at age 60, Smoking Joe could withdraw over $1,800 every year and theoretically never run out of money by implementing the 4% rule withdrawal model. The 4% rule will be covered in a later post. For now, just trust me that it works.

That $1,000 invested at age 20 is literally a $45,259.26 decision. At age 60, Average can’t even remember what his couch looked like. But Smoking on the other hand can buy 1.8 new couches every year if he wanted. That $1,000 is a big decision when looked at with the opportune cost model.

Now, fast forward just a decade. Average and Smoking were sitting at a park watching their kids play. Average said his old couch is 10 years old and he needs a new one. Average was bragging that he bought a good quality couch 10 years ago and it served him well. He went on to say how he had spent his $1,000 tax return on a brand new couch. Smoking commented that he invested a $1,000 tax return at the same time and it was doing fairly well. Curiosity got the best of Average and he had to ask Smoking how the investment did. Smoking pulled out his phone and showed him a the balance of $2,593.74.

Impressed with this, Average was determined to get in on some of this investing. He decided instead to invest $1,000 he had for the new couch immediately and nurse that couch a little longer until he could save up for a couch. So, that’s what he did.

Jump ahead another 10 years. Now Average and Smokey are sitting next to each other at a kids sporting event. Average was proud that he had followed his friend Smokey’s investing advice. Average was telling Smokey that his $1,000 had grown from that initial investment to $2,593.74 just as Smokey’s had done a decade earlier! Again curious, Average was curious about Smokey’s investment. So, again, Smokey pulled out his phone and showed Average his $1,000 had grown to $6,727.50.

This can go on and on, but I summarized how $1,000 will grow from age 20 to age 60 below in a chart. You can see that by delaying 10 years, Average’s investment would be only $17,449.40 versus Smokey’s $45,259.26. That 10 year delay for Average’s investment cost him more than half of what it could have been had he invested earlier.

You can check my numbers here.

The above examples shows the power of compounding interest. It’s a very powerful tool that you should take advantage of as soon as possible. The earlier the better in the long run. If you miss the early opportunities, you’ll have to put a lot more of your money away to have the same wealth that you would have if you invested earlier. A late start is still much better than not starting at all. So, don’t delay in getting started.

That $1,000 couch can cost you $45,259.26 in your retirement. Was it worth it?

013, Mortgaging a House

architecture clouds daylight driveway
Photo by Pixabay on Pexels.com

So, we covered ratios in the last post. The focus of that post was to show you the basics of a ratio for buying a house. Now you know and understand the ratios that are recommended in relation to your income. You understand that the 20% recommended down payment is the minimum you should put down on a house. Let’s run through a few examples to show you the impacts of a few scenarios. Sometimes a picture is worth a lot of words. In this case, the picture will be a spreadsheet. Before we get started, here are some of the areas we’ll cover.

I ran all of the calculations through Mortgagecalculator.org. It has the most complete variables necessary to truly capture all of the costs. Be wary of the bank calculators that only show principle and interest. While that’s a big portion of your monthly rate, it’s not the whole picture. So, I’m going to lay out a few things in this post to help you truly capture the total costs you can expect.

First, there’s the purchase price. You may hear people say things like “I paid $200,000 for the house”. They are referring to the purchase price. By the end of this post, you will know the cost of the house will be much more than the purchase price… unless you pay in cash.

Then there’s the down payment. You’ll want to put 20% or more down on a house so you avoid paying PMI (Private Mortgage Insurance). Remember that’s where you get to pay for the bank’s insurance in case you don’t make good on your money. That 20% should be your minimum. You can put down as much more as you want.

Next comes taxes. You can’t get away from taxes. Taxes can be a considerable expense…especially in Texas, where I’m writing this post. What Texas loses in income tax, they make up for in property taxes.

You’ll also want to have insurance. This isn’t the PMI insurance. This is the homeowner’s insurance that you pay for things like a hail storm that trashes your roof, fence, etc. The bank will require you to have insurance if you finance. If you pay in cash, it’s a good idea to pay just to protect your home from an unexpected diseaster.

What we’ve covered above is referred to as PMTI. PITI is simply Principle, Interest, Taxes and Insurance. Everyone will pay those when financing a home. But don’t forget or confuse PITI with PMI. Remember PMI is that insurance for the bank that you get to pay. So, the total monthly cost will be PMTI plus PMI. The less you put down the more PMI’s cost goes up.

In order to show the differences in PMTI plus PMI, I’ll set a few variables so you can see the impact of the changes. I’ll also randomly choose Grand Prairie, Tx as our city of choice to nail down the exact taxes for a property. Limiting the variables should help you see the long term impacts to your finances for the choices you make.

The house will be a $200,000 house in Grand Prairie, Tx. The interest rate is going to be set to 4.33% which is fairly close to the current rate. Your rate will likely vary somewhat based on down payment and your credit score. So, 4.33% is good for illustration purposes. The property taxes for Grand Prairie are 2.921736% of your home value or $5,843.47 every year. That amount will be divided by twelve and added to your monthly payment. Homeowner’s insurance is set at $1,000 per year. Again this will be broken down and spread across your monthly payments. The three scenarios will be putting 5%, 10%, 20% down for your down payment.  The Term will also be either a 30 year or 15 year fixed rate mortgage.

Price Down Pmt % Down Term (yrs) # PMI Pmts Montly Pmt Total PMI Pd Total Int Paid Cost for House
$200,000.00 $10,000.00 5% 30 79 $1,592.98 $7,679.17 $149,698.07 $357,377.24
$200,000.00 $20,000.00 10% 30 71 $1,539.23 $5,325.00 $141,819.22 $347,144.22
$200,000.00 $30,000.00 15% 30 40 $1,485.40 $2,833.33 $133,940.37 $336,773.70
$200,000.00 $40,000.00 20% 30 0 $1,364.90 $0.00 $126,061.53 $326,061.53
$200,000.00 $10,000.00 5% 15 37 $2,086.49 $2,929.17 $68,666.11 $271,595.28
$200,000.00 $20,000.00 10% 15 26 $2,006.69 $1,950.00 $65,052.11 $267,002.11
$200,000.00 $30,000.00 15% 15 14 $1,926.89 $916.70 $61,438.10 $262,354.80
$200,000.00 $40,000.00 20% 15 0 $1,780.42 $0.00 $57,824.10 $257,824.10

Take a good look at the chart.  Study it for a bit and see if you can find the Big Rocks.

The first thing I see is that the final cost for the house could be anywhere from $257,824.10 to $357,377.24.  So, depending on how you set up financing for your house, you could pay a lot more.  Maybe this would help with some perspective on just how much that is.  Let’s say you make $57,000 per year.  If you are inefficient you would work for more than 3 years just to pay for the interest and PMI if you put minimal down and finance for 30 years.  You’d only have to work for one year to pay for the interest if you put 20% down and got a 15 year mortgage.

The second thing I see is that by far, the biggest difference in what you pay in interest is determined by the length of financing.  The longer you finance, the more you pay in interest.  Many folks say that they will finance for 30 years and pay early.  Statistically, they don’t though.  So, if you are in that small percentage, you’re likely not. I tried that and didn’t do well.  It wasn’t until I locked myself into the 15 year mortgage that I actually stuck to it.

The last thing I see is more of a reflection.  Being in the military, I’ve never truly owned any houses. I mortgaged them.  So, I’ve pretty much have been paying interest for most of my adult life.  While I did make money on every house I’ve mortgaged, it was done through improvements, etc.  I’ve never run the numbers, but I’d be lucky to break even considering all the interest I paid.  I wonder if I would have come out cheaper if I only rented and paid cash for a house.

So, as you can see from the chart above, there’s a lot of ways you can buy a house. This post points out a few different ways and for many different lengths of time.  Use this information and the thoughts to do it as efficiently as you possible can.  In just this one example, it could mean you save about $100,000.  What can you do with $100,000????

You now have the tools to make an efficient decision. Don’t be Average!

012, Financial Ratios, It’s all About the Numbers

What’s in a number? A number standing alone is meaningless. Especially in personal finance. Something like $10,000 without comparing it to other factors is surrounding the number is just an amount of money. If that $10,000 is buying someone’s car outright with cash for someone who makes $30,000 a year, it’s a significant amount to that person. That same $10,000 paid as a down payment on someone’s $250,000 Bugatti sports car who is making $5,000,000 per year is less significant in that person’s personal finance. That $10,000 is hardly anything compared to the $5,000,000 annual income. But someone who’s buying a $100,000 car outright with cash for someone making $300,000 per year, the financial impact is exactly the same as the first person buying the $10,000 car in the first example. The ratio is what matters in these examples.

We started to touched on Ratios a little bit in the last Post with Warren Buffet’s house. In that example we were comparing his home’s value to his net worth as a percentage. His house is really a very, very small part of his net worth. This post will look at important financial ratios that banks, landlords, and many other people who try to manage personal finance.

Financial Ratios Everyone Should Know, Wallet Hacks and Millionaire Mob are just a few sites that give some ratios. The first is the most basic. Then each one after that give some more ratios to understand. I give you those three so that you can dig in at your own time and at your own pace.

Since several of the readers have asked about buying a house in the near future, we’ll cover a few ratios for buying a house. I first heard of a ratio for buying a house when I purchased my first house. During the application process, the loan officer informed me that I could get a loan for up to 28% of my income for the house. But there was a caveat. The total of all my debt could not be more than 32% of my income. Since I was an Average person, I had more than 4% (32% – 28%) in consumer debt. This limited my first home to less than the standard 28%. I don’t remember exactly what the numbers were at the time. The point is that I had a lot of credit card debt and it effected my loan to buy my house. That was one of the earliest wake up calls that I may be in trouble. So, I started tracking these ratios periodically.

I’ve never really thought about that ratio for several years now. While writing for this Blog, I’ve noticed these ratios have changed! They haven’t changed for the better either. The newer ratios are 28% for your house and 36% for the total debt ratio. While that may seem better, it’s not. This is not in your best interest at all. Here’s why I don’t agree with the ratio.

The 28/36 ratio allows for 4% more than the old ratio. That’s a 100% (4% to 8%) increase in consumer deb! So what they are doing is allowing you to charge more depreciating assets! They haven’t increased from 28% for the generally appreciating asset called your house. Not that I’m a fan of financing to the maximum, but the above shows where the banks interests are focused. What they did was basically allowed for the Average consumer to borrow more money for the highest interest rate category. That means they make more money and you lose more money to interest.

So, you loose the flexibility to use that second 4% that you could put towards an emergency fund, for food, or for investing. You are also loosing the opportunity cost of that 4% compounded over the years if you invest it in your retirement. That’s worth you seriously considering before you decide to max out how much you can borrow on a house and credit cards. Let me say it again:  That’s worth you seriously considering before you decide to max out how much you can borrow on a house and credit cards.  The old 28/32 ratio was hard enough to recover. The 28/36 ratio would be much harder. So, don’t be Average and max out your credit. Live below your means and invest the remainder in your future.

By now, most of you by now have read about how much credit can cost you. You know to avoid it on depreciating assets. Assets that don’t appreciate in value or provide income should never be financed.  So, when buying a house, don’t forget that wasting money on depreciating assets can really mess up your chances to minimize your interest costs. Remember all numbers in relation to your objectives of financial independence. Don’t get caught up in the Average American dream of owning a house at the expense of your financial future.

Maxing out your credit to purchase a house will significantly hinder your ability to save for your future. It will strap you for cash and for emergencies if you don’t have those in place before you finance a house. So, before you even consider buying a house make sure you have a fully funded emergency fund and an appropriate down payment.

Why is the down payment of 20% or more stressed by so many financial people? Because of two major reasons. Fist, it shows the mortgage company that you have skin in the game. You have 20% equity, so the bank has less risk. You are more likely to pay on time and not walk away leaving the bank with a house. They are not in the house buying business. They reward you for this by giving you a favorable interest rate. So, you’ll be financing less and at a lower interest rate. Over the life of your loan, the reduced financed amount and the lower interest rate will be a significantly less amount you pay to the banks.

Secondly, you won’t have to pay for Private Mortgage Insurance or PMI. PMI is insurance that the bank makes you pay for to insure that they actually get the money back that they lent you. That’s right, they make you pay insurance for them! You get absolutely no value for this either. So, you are losing money here too. In most instances, 20% down will eliminate this PMI. PMI increases with the cost of your house. More expensive house will require a more expensive PMI payment. So, just save at least until you get the 20% down to avoid throwing this money away by paying for the bank’s insurance for your home loan. Don’t do it. If you can’t afford this 20% down, wait until you can.

So, don’t be Average. Learn your financial ratios so you get a better picture of your major purchases such as a house.

011, Enough Already

How much is enough?  Since a home and vehicles can be such a large part of your expenses, especially when you are young, let’s address that first. You surely don’t need the excessive stuff above. You may want it, but you don’t need it.

How much house is enough? Warren Buffet is a extremely rich guy. If you don’t know him, take a few minutes on google and check him out. He lives in house that’s .001 Percent of his Net Worth. Think about that for a second to let it sink in. For some perspective, if your net worth was $1,000,000 your house would be $10 ($1,000,000 X .00001). Yep, that’s ten dollars. The $10 represents how difficult it would be to purchase the house from your cash or investments. This house he bought in the 1950s is an insignificant part of his wealth. He could afford a way more expensive house if he wanted. He’s said he’s happy where he lives. If he felt he could be happier in another house, he would move. But he’s content. There’s no need for him to spend any more to chase a bigger house to keep up with others. He has what he needs and wants.

Granted, he’s worth $60-80 billion, so he’d need a massive house to even begin to approach 1% of his net worth. But that’s not the point necessarily. When you have enough, you don’t need more. When you are content, you don’t need more. When you are happy, you don’t need more. That’s my point.

You’ve often heard things like “your home is your biggest investment”. While your house is an appreciating asset, it doesn’t generate any income. Money is tied up in your house where you can’t spend it or truly invest it. Practically, that means that if your home is your biggest investment, more than half of your net worth isn’t going to generate income. Having that much of your net worth inaccessible and tied up means that you can’t spend it. It also means that it’s not generating income. So, you’ll have to work longer to build assets that can actually generate cash either now or in retirement. That’s the classic house rich, money poor scenario. You have an expensive house, but you don’t have much money for other things like properly investing for your future. Being house rich can severely limit your flexibility to get ahead financially.

This is really amplified when you are young. Your young years can have the most impact on your wealth in retirement when you invest efficiently. When you neglect your retirement in your early years, it’s much harder to catch up due to the time that has passed. The compounding interest from these early years really help to build up an investment nest egg of investments to carry you through your retirement years. Don’t become house rich and cash poor.

Here’s a great article looking at home ownership in total. Avoid the Dream House Trap. It talks about how an expensive house can strap you with large expenses. Those expenses, if not properly balanced against your income, will be felt financially a lot more. It will limit your ability to have flexibility to properly invest in other income generating assets to help you through retirement. The Average people in America frequently overlook how a house can trap you in the rat race just to stay afloat.

You need a roof over your head to shelter yourself from the elements. People do live in grass huts, modest homes and mansions. They all provide the basic requirements of shelter to keep you alive. People are also happy in each of those examples. Each example is also more costly. Grass huts are cheap, modest homes are reasonable, and mansions are extremely expensive. So, choose your housing carefully without overestimating your needs.

Next, let’s talk about cars.  We’ve touched on those before.  This is likely the second biggest expense that can cost lots of money if not done smartly. Since I’ve been into Choose FI a lot lately, here is an article about new cars and here’s a podcast if you listen to those.  The bottom line is that your transportation costs can eat up quite a bit of your income.

Over the course of your, at least 40 years of driving, decisions you make can literally cost you hundreds of thousands of dollars if you are not wise in your choices.  Those hundreds of thousands of dollars can either boost your income during retirement or drag you down.  The choice is yours. If you haven’t read my article about the brand new car I bought, please go back and read my post.  Buying a new car was not a good financial move for me.

You do need transportation. Most will drive cars or trucks versus mopeds or bicycles. Just as in houses, the choices vary widely. They will impact your finances one way or another. Make well informed decision on how your choices will impact your finances. A cheap used car can get you from point A to point B just as well as a brand new high dollar sports car. So, it’s truly up to you which path you choose. Choose wisely and position yourself for success in retirement.

These two major expenses can make or break your finances in the long run. They are the Big Rocks. So, make wise decisions based on facts and solid information that will meet your financial goals. Don’t overestimate your needs and max out your wants. Find the sweet spot that can work for you. If you have to have the cat’s pajamas, you’ll pay more for things at the expense of your financial security in your later years.

Make finding contentment a goal with whatever you have.