Tag: assets

004, Liabilities

Paw Paw

Liabilities…Do you want to be Average in your Financial Progress? The little cutie above is Emilee. She’s above average in my book. She doesn’t have any liabilities. Liabilities are like the alligator she’s riding. If you don’t stay on top of them, then can drag you down.

Liabilities are simply what you owe. Everyone is trying to get into your pocket to get your hard earned money. In the traditional sense, liabilities are thought of as loans. But I argue that in personal finance, liabilities cover a broader range of obligations that require them to pay them every month. These are those seemingly small “I can afford it” things that really take a toll on you over the long haul. These are very important to get right. The idea behind these transactions is that the company wants you to think these obligations are a small insignificant thing. Don’t be fooled. This is financial death by a thousand cuts. They only want no or a small down payment and for a low monthly payment. Those really add up over the years.

I’ve personally experienced this in car buying more than anywhere. Unfortunately for me, I didn’t realize I was being taken to the cleaners in enough detail to act accordingly. I’m a slow learner and being in the military can be a bad influence when it comes to finances. Banks know your income is secure. They know if you are late on payments they can call your commander to put pressure on you. They also know “giving the car back” is not an option unless the military guy wants disciplinary action. It may have changed a little today with not being able to call someone’s commander, but there are still very real consequences to not paying on time. Anyway, early on I would buy a car and then trade it in before I paid it off. I did that several times before I finally made it to the big time! I could “afford” a brand new car they said. It was a 1990 Pontiac Grand Prix. The new V-6 model. You know, I’m going to get the small rocks right and save gas! But boy did I miss the big rocks on this one. I financed it with the 5 year plan to keep the payments affordable. I took it hook, line, and sinker. They smelled this sucker a mile away.

My numbers will likely be a little off, but in the ball park. I bought it for say $25,000. By the time I was done with the “easy” payments which really weren’t easy for me, I’d paid like $35,000. So at the end of the 5 years I was finally the proud OWNER of a 5 year old car that was driven daily by a young father with two kids. It was scratched and dented on the outside. The inside was not any better. Carpet was stained, headliner was stained from when someone opened a can of Coke and was starting to come loose and hang down. I would be lucky to get $10,000 for it on a good day. So, bam. In 5 years I turned $35,000 into $10,000 by buying that car. But I had a nice car for about 2 years and saved some gas! I got the little rock right, but missed the big rock. I never bought a new car again. I’ve reached the pinnacle of the financing sucker with cars. If I would have burned my Honda Accord to the ground in the parking lot of Greenville Dodge as soon as I wrote the check for it, I would have lost less money! If I would have invested that $25,000 I lost in the new car deal in an appreciating asset that got 10% interest, today that $25,000 would be worth approximately $223,857 today (23 years later). The car dealer doesn’t tell you that. That’s compounding interest. It works both ways. I lost $25,000 on 1995. The bank has $223,857 today. Who won? I guess that’s why banks have awesome buildings and I don’t. I got the numbers from here: http://www.moneychimp.com/calculator/compound_interest_calculator.htm. The picture below is from the EZ Calculator app you can download for free dollars. The numbers are not exactly the same, but close enough to prove my point. That difference is a small rock. I missed the boat with that purchase.

When you get the big rocks of assets, liabilities, and net worth right, you’ll win. Instead of death by a thousand cuts, you’ll be successful by a thousand small wins! The average consumer will spend hundreds of thousands of dollars during a lifetime bleeding money (and compounding interest) to finance charges, administrative fees, and interest. They will pay some on cars, some on consumer goods, maybe some college loans, and a bunch on a 30 year mortgage. These folks don’t pay all the interest and fees up front or at once. Doing so would highlight just how crazy expensive financing costs right in your face. Instead, they keep their hand in your pockets, and just take just a little, for a long time causing you to loose opportunities to invest.

Now, armed with how this stuff works, think about reversing it. Now you are aware. So, let’s say Average Joe spends $400,000 towards servicing liabilities. The $400,000 is a low number for average folks, but just trust me for now. Smokey Joe on the other hand at least gets the big rocks right. He will cut this figure drastically. He still messes up on some small stuff, but gets the big rocks right. Smokey will likely save say 80% of the $400,000 in interest and fees over his lifetime. Yes, I made up the 80%, but it surely isn’t unrealistic. That 80% will keep $320,000 in his family’s pocket. Or use a more conservative figure of 50%. He’s keep $200,000 in his family’s finances. He doesn’t get a large pile of cash up front or long down the road some day. By efficiently using his hard earned money, he still buys what his family needs. He doesn’t give 50% – 80% of his money away to liabilities, and instead invests it in a slowly growing appreciating asset. Over time, he’s sitting back receiving dividends from from the money he invested in appreciating assets, or letting it continue to grow for his family’s legacy. Or whatever he wants, he did well by spending wisely to accumulate a nice pile of money.

I’m sure most know that loans are an expensive way to buy things. The only worse way, in personal finance, to finance a car is to lease it. But, there’s even more to the story than just an expensive way to spend your valuable money. You can make financing something good a very bad deal. Remember the appreciating and depreciating asset discussion? Average Joe finances only depreciating assets. So, when he’s done paying the purchase price, fees, and interest, he looses big time. Whatever he purchases, is worth less than the original purchase price. So, he pays more and ends up with less. Now Smokey messed up a few times along the way. But he remembered the difference in assets. He would only finance things that are appreciating assets. While he still paid more than he could have by being inefficient, at least Smokey Joe was left with an asset that was worth more than the day he bought it.

Let’s math this up a little.

Average bought a $1,000 flat screen TV, sofa, bed, or something like that. He financed it. Say he financed the TV at 10%. Since he has great credit, he gets the premium 10% interest rate versus the more common 18-21% on the folks with jacked up credit. Say it takes him 2 years to pay off the credit card or loan. He would pay $1,107 for the TV or 10.7% more than if he had paid cash. You can check it here: https://www.bankrate.com/calculators/mortgages/loan-calculator.aspx. Let’s also assume that 5 years later, Average wants to buy a new TV. He lists it on Craig’s List and sells it for $200. The cost of this deal is what he paid for the asset, minus the cost of selling the TV. Running the numbers, he bought the TV for $1000 plus the $107 in interest. His cost is $1,107 minus the selling price of $200. His ultimate cost is $907 in real dollars. Of course, Average repeats this over and over again throughout his life and can’t seem to get “get ahead”.

Smokey financed $1,000 of investment grade gold, silver, or maybe he just got a great deal on a small business. He got the same 10% interest rate for the same 2 years. He financed the $1000 for the appreciating asset. At the end of the finance terms Smokey’s paid $1,107 just as Average did above. Now fast forward 5 years as Average did in his TV purchase. Smokey’s asset appreciated a measly 10% in 5 years. It didn’t do nearly as well as he had hoped since he knows when buying low cost index mutual funds historically return more than 7+ percent over time. So, basically his asset’s growth and the interest he paid cancel each other out. When Smokey decides to sell his asset at 5 years, he gets 10% more than he paid for it. But the interest wipes out his gains. While this doesn’t seem good, he’s still in way better financial shape as Average. The value to his financial position from this transaction is zero dollars. Not good, but remember Smokey makes mistakes too. If he would have paid cash at least he would have about $107 dollars more. Why not $100? Compounding interest is the reason. More on that later. Smokey could use that $1000 to buy a TV for cash or try investing again. He has $1000 in in pocket. But for Average to buy a $1000 TV for cash, he would have to use his $200 from the sale of his TV and also come up with another $800!

These aren’t huge numbers. Both were only doing a $1,000 deal. Let’s look at percentages.

Average spent $1,107 and sold it for $200. That amounts to a $907 loss or approximately an 82% loss of position or 18% efficiency. Smokey broke even at zero percent. So, Smokey achieved an 82% higher efficiency of his valuable money.

You’ll have hundreds or even thousands of transactions like this over your lifetime. If you can be 80% more efficient on every purchase, how far do you think you can go? Let’s see the kind of difference makes over a lifetime. Average Joe and his wife make $45,000 per year, the average American income. Smokey’s family makes the same $45,000. To bring it back to some math and numbers let’s say Average worked 30 years and earned $1,350,000. Average’s efficiency is 18% from the numbers above. So, his $1,350,000 will yield approximately $243,000 of value. He finally OWNS his home, but he’s still financing his car. Sounds like the average American right?

Smokey worked right next to Average and earned the same $1,350,000. But since his efficiency is even, his $1,350,000 is worth $1,350,000. That’s $1,107,000 ($1,350,000 – $243,000) more! His money is much more efficient. That’s assuming Average JOE continues to finance things and Smokey never has investments that make money. He owns the house next door worth $243,000, both the family’s $30,000 cars, and has the remaining and has the rest is invested in $1,043,000 in gold, silver or a business that never appreciated. His lifelong investment broke even too. The more money you put into appreciating assets the better off you will be over the long haul. It’s pretty hard to invest in conservative appreciating assets and do as poorly as Smokey did. But he still has over $1,000,000 in assets. This is a simplistic view of two transactions extrapolated as if all transactions were the same. The big rock is that the percentages very different and are significant enough to make a large difference in your personal finance.

That’s the power of knowing the big rocks. Numerous small decisions like Average made above over an extended period of time can really drag your financial independence down. Most people are Average Joes.

Don’t be Average.

003, Get off Your Assets!

Paw Paw

img_0303Assets

Assets are simply what you own. Don’t just blow by that last sentence. Go back and look again. The last word is key. To this date, I still don’t own my home. From the first time you are asked to fill in your address for a credit card, bank account, etc., you’ll be asked if you rent or own your house. There’s no box to check or explanation that your house is financed. It’s just rent or own. Looking back, the first time after I financed my first house I thought I was making great progress because finally the “own” box could be checked on credit applications. I can remember thinking it’s weird because the house was deeply financed. But I was told that’s the normal and correct thing to do. Somehow that little interaction was the first step down the crap line of BS that the financial world sells, the ones that pick your pocket anyway. I knew it wasn’t technically correct. But I played along and somehow felt better, more comfortable, and maybe even a little more successful. Their strategy to underplay debt had worked. The language that’s the norm in our society today is wrong. I don’t “own” my house. I have equity in the bank’s house. That’s the true situation from a financial perspective. Assets are what you own.

Assets are something that someone else will pay you money or trade you something else of value to get. Things like owning stocks, bonds, profitable businesses, and investments. A house, a car, a motorcycle, a travel trailer, motor home, and land are all assets. Those are things that have value. Other people will pay you in exchange for those type of things.

This word asset is used frequently, but not always correctly from a financial perspective. People say your looks are an asset, but that’s not true. Maybe they said your brains, or work ethic, or some other characteristic was an asset. Those are not assets. They are characteristics. These days folks seem to use incorrect words to describe things. Maybe they are just using it for emphasis, but it’s still wrong. Words matter. If you repeat things long enough you get more comfortable with what you are saying. You may even start believing it. Don’t fall into that trap.

Assets are generally categorized into one of two types. Appreciating assets and depreciating assets. It’s a little more complicated that that, but if these two categories are understood and used properly, large gains can be made over time. Even the investors with the fancy degrees don’t get every move right. Just keep playing and moving forward.

Appreciating and depreciating assets are the two big rocks in this post. All assets are not created equal. Some assets go up in value in certain situations. Others go down in the same situation. Some things change rapidly and some slowly. Some stay stagnant over time. While there are numerous variables that can effect assets, usually they are just affecting the rate that the asset appreciates or depreciates. Generally they go in the direction described above over a long time. That’s what we’re playing for here. The long game is what we want to win.

An example of an appreciating asset is PepsiCo Stock that I own. When I was young, one of the things I explored was something called a DRIP. DRIP stands for Dividends Re-Investment Plan. Under the plan small numbers of stocks can be bought. Once you own the stocks, the dividends are used to buy stocks instead of receiving a check for the dividend. If you haven’t figured it out yet, dividends is money a stock sends its investors. That’s one of the benefits of OWNING stock. So, back in like 2000 or so, I purchased $500 of PepsiCo Stock. It was only like 5.2 shares. Not much at all. I’ve never added a penny to the stock. So, for like the last 18 years the dividends were reinvested back into PepsiCo stock buying more shares. When I checked the value of the account today my $500 investment is now worth $2,734.09. That’s more then 5 times my initial investment. You can argue details about PepsiCo isn’t a great stock, DRIPs are too expensive with fees, or whatever. But can’t argue that it increased in value more than 5 times my original investment of $500. Assets like that are what you should be after. The Big Rock here is you have to do something. Anything is better than nothing.

Appreciating assets is where you want most of your effort to go to achieve forward progress. Simply put, it increases in value over time. They are worth more tomorrow than they are today. Some examples are low cost index based mutual fund, stocks, a savings bond, savings account in a bank. Over time, your assets will allow you to achieve the financial freedom to do the things you value most in your life. The more appreciating assets you own, the harder they will work for you. Compounding interest also works in your favor to multiply the positive affects over time. When your assets are providing more income than your expenses, you are financially free, financially independent, retired, or whatever you would like to call it. Generating income from clocking in at a job, going to work at your business, or looking for new jobs to create income to cover your expenses can be over!

Depreciating assets are the opposite. They are worth less and less over time and may even eventually have no value. Just about anything with a motor would fall into this category. A boat, car, motorcycle, or even a weed eater. RARELY can you purchase one of these items and then sell them for more after a short time of use. These are major drains on your valuable resources, mainly money. Rather than creating more value at a later date they drain your resources as they decrease in value. Then, as in the car, when it no longer works it is usually replaced. Then the cycle of bleeding value repeats.

The key here is to limit your losses on depreciating assets and maximize the acquiring appreciating assets. When looking at future purchases, ask yourself which type of asset are you buying. Will it lose value and have to be replaced? Will it be worth more in the future? It’s obvious that the depreciating assets are holding you back from forward progress. Appreciating assets tend to grow or provide dividends (money). If they are producing dividends, reinvesting those dividends to buy more appreciating assets will push you forward towards a financial goal. If you are investment is in a business, say a coffee shop, profit you make thatis invested back into the business is similar in that you would do that in order make the business more valuable.

My little granddaughter (in the picture) may or may not become a great fisherman one day. Of course, she’ll never know if she can unless she fishes. She has to cast her line in the water to find out. Are you fishing for the type of fish that will be worth more than the minnow you bought for bait? It’s never too late, or too early, to get off your assets and purposely cast your line in the water.