020, The 2018 Christmas Gift

I wanted to take some time to wish everyone a Merry Christmas! I hope that everyone, their families, and friends have a wonderful and blessed Christmas. The picture above is my little granddaughter and her dad. What a precious picture of her first Christmas. I’m always thinking about the kids best interest which inspired a new Christmas plan for the kids.

Last year for Christmas 2017, my wife and I wanted to get our young, adult kids something beyond the typical “stuff”. We knew we wanted the “Gift” to somehow be related to personal finance and the discipline that is required. After much thought and discussion, we decided to start with the very basic, first step of FI. That’s Financial Independence to the “newbies”. Our gift to them would be conveying the need and proper use of an emergency fund.

So, last year for Christmas, this is what we did: We started each kid a savings account at our bank – a joint account for convenience. Their Christmas gift was a seed of $500 on Christmas morning. The start to an emergency fund.

However, our goal was not just to give, but to teach. To sweeten the lesson of needing an emergency fund, we threw in a way for them to double their gift. On Christmas morning, we told them that we’d match up to $500 if they added another $500 to their savings account by Christmas of 2018! We wanted them to have some skin in the game too.

Now, although we’ve pounded this necessary step of an emergency fund into the minds of our children multiple times, some are better at actually saving, budgeting and delaying instant gratification. There are also differing levels and understanding of an emergency fund. As it is with a lot people, something always seems to come along that puts the emergency fund on the back burner. Throughout the past year, the level in each of our kids savings accounts varied wildly. And as frequently happens, an emergency occurs when the account balance is down.

So, our “gift” sounded simple enough, right? Not so much.

You see, my wife and I have six kids between us. They are at various ages and stages with differing personalities, strengths and, yes, weaknesses. But we were offering to give them a 100% return on their own investment. We give you $500. You add $500 and get an additional $500.

As I write this (December 24th), the amounts in the emergency funds varied from $0.06 to over $4,200. Also, some of the deposits came as late as December 24th as to not miss the matching. FYI: Sliding to the finish line in just a nick of time is no way to run an emergency fund! As you can see, there was quite a range of how much seriousness the kids approached this worthy endeavor. However, we understand that FI is a process. Sometimes a painful process.

Now, here’s the initial intent as it was in my mind, including the numbers. We would deposit the initial $500. That money could only be used for emergencies and should be replaced if the balance fell below $500…as soon as possible. Then, sometime through the year, they would put away a little bit or lump sum until they added $500 to the account. The initial $500 plus their $500 they deposited in the account would equal $1,000. Then we would match their $500 contribution on or before Christmas of 2018. That $500 match would take their account up to $1,500.

Obviously I wasn’t clear to all the kids. Yes, they were even all in the same room and got to ask questions. I’ve also discussed the concept multiple times throughout the year with several. After talking to one of the kids a couple of weeks ago about his understanding of the Christmas gift, I committed to writing it down in order to ensure clarity. Since that conversation, I’ve also decided, for this year, to make it more complicated and add a bonus program. I like to try to encourage sound practices and discipline. So, here comes the 2018 Christmas deal:

1) For Christmas 2018, each kid will be gifted a deposit of $500 on Christmas Day. That’s their Christmas gift. Simple.

2) Bonus #1, The Match. Each kid should deposit $500 above and beyond the Christmas gift ($500) by December 24, 2019. This money must remain in the account on December 24, 2019 to qualify. If this is met, we’ll match the $500 with a deposit on December 24, 2019.

2) Bonus #2, Monthly Deposits. Each kid that does a direct deposit of $42 per month or a manual deposit of $42 per month will receive a $100 bonus on Christmas Day 2019. You must deposit $42 or more each month to qualify for the bonus. This is to reinforce paying yourself first & making small consistent deposits. The twelve $42 monthly deposits will amount to the $500 needed for the 100% match.

3) Bonus #3, The Intent Bonus. To meet our intent, each child that has $2,500 in their savings account on December 24, 2019 will get a $100 Bonus on Christmas Day 2019.

Here’s how I came up with the amount in Bonus #3, the intent amount of $2,500.

1) $500 2018 Christmas gift

2) $500 Kid’s contribution for 2018

3) $500 2018 Match

4) $500 2019 Christmas gift

5) $500 Kid’s contribution for 2019

If you add all the value of the above items 1-5, it adds up $2,500. Of the $2,500 they would have $1000 of their money in the account, the rest would be gifts. So, the incentive to follow the plan is pretty good by most standards.

And finally, here’s our thoughts on the emergency fund and our intent in general for this gifted lesson: An emergency fund is money on hand to cover emergencies. When an emergency arises and you spend from your emergency fund, you should return that money to your emergency fund as soon as possible. Having a $1,000 unplanned issue like a car problem should cause only an inconvenience , not a crisis. Also, this emergency fund’s value should increase every year until there is 3-6 months of expenses saved. (Expenses are everything that you need to pay each month to live like food, housing, bills, gas for the car to get to work, etc).

So, that was our gift to our kids for 2018. What do you think? Please leave comments as to your thoughts. I’d love to hear any ideas or improvements on this idea of mine.

Again, Merry Christmas to all!

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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.