Archive for finances

Practical: Pay Yourself First

Personal finance writing is full of the saying pay yourself first.  This made sense to me theoretically since you need to save, to build wealth.  However, from a practical sense I didn’t know what that meant: How exactly do I pay myself before I pay a bill?

After further inspection, I came to the conclusion that sticking to a budget is a way to pay yourself first.  The idea of a budget is to set an upper limit, the most you will spend for a time period.  The complement of the budget is the minimum saving you will accrue in that period.  In this sense, the budget allows you to pay yourself, with the remainder.

Finally after deliberation and a moment of eureka, I came to the conclusion that you could rearrange your bank accounts so that the only cash flow inlet your expense account sees is the budget.

https://adventuresinmissingthepoint.files.wordpress.com/2011/03/cash-flow.png

This flow ensures that you invest a minimum amount, which is the mathematical complement of the budget.  This is a way to ensure that you pay yourself first, at least as I understand the statement.

My pay goes into a high interest savings account, which then gets separated into investing and an expense budget.  With the investment income going to expenses, my flowchart has a Rich Dad, Poor Dad influence.  The arrow doesn’t necessarily need to go there, depending on personal interests.

For setting budgets, my personal favorite book on the topic is Your Money or Your Life.  I like that book because it provides a rational way to set up a budget and ensure that you are not over nor under, on spending.  The method is subject to change, scale, and variation, not a one time recipe.

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Out from the TV Rebound

I think I rebounded out of the television withdrawals I was having a few months ago.  It is interesting for me to read that post now:

There’s less background noise (both audio and visual) that either needs to remain silent or requires an increased amount of conversation. It also requires finding new mind-numbing idleness or totally eliminating them.

Another alternative is to find more outside the house events, and possibly spend “the cable bill” on alternative entertainment.

In fact I did just that.  I created a big list of books I wanted to read (and for me, reading books spawns an out-of-control* desire to read more books).  I have so much “to do” — which is now damn near my entire library’s economics section (if you’re keeping track at home, circa 330 in the Dewey system) of books — that I’ve forgotten about television as an outlet.  Of course, I still watch movies, play boardgames, and high five, so I’m still keeping it real.

*Out-of-control in terms of exponential growth, unrelated to the withdrawal and rebound chemical dependence theme in these two posts.

My main conclusion is that it’s easy to not watch television by focusing on the positive alternatives it allows: for me, gettin my literate on!

More generally, I think the easiest way to make a drastic change is to focus on the positive alternatives which align more meaning to one.  Sure, cutting cable for 25 years can allow me to have $132,000 in the future.  But for what, to buy 27.5 years of cable television in the future?

Many see cable as a luxury and some see it as a waste, like in the link above.  But, the link above does not answer why it is a waste.  For me at this time, it’s a waste because television is a less engaged life.

Specifically, I think I will get more out of learning a new subject that interests me than watching an infinite stream of football games, pop culture, etc.

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Financial Independence Model

I’m interested in financial independence, as I think it is very responsible thing to do, as well as the most sustainable way to live life.  I remember first learning this from Rich Dad, Poor Dad.  A lot of people do not like that book.  I think the major reason is that the thought of passively making income is so overwhelming that one’s “fight” reaction takes over.  It’s just my guess, though.

Essentially, passive income is earnings where your efforts are not actively needed.  It is much easier to define active income: a job (where time and skill and traded for $bling).  In financial terms, passive income is generally investment capital traded for $bling.  Examples of passive income are dividends, apartment rent (if you own an apartment complex), and the part of the pyramid scheme where you profit from others’ efforts.

Passive income can also be viewed as potential.  As ERE’s post describes, the 25 and 33 scalars, applied to one’s annual budget, are commonly used for estimating this potential.

  • If you need your money to last 30 years and you invest it 100% in index funds and you withdraw your annual expenses every year, you need 25 times as much money in index funds as your annual expenses (including taxes).
  • If you need your money to last 60 years instead and follow the same procedure, you need 33 times as much money.

(If I remember correctly) this concept of potential is defined in Work Less, Live More.  The book, as well as firecalc, describe how those numbers take into account risk, so that one will be financially independent.

The time to generate these amounts are below,

https://adventuresinmissingthepoint.files.wordpress.com/2010/06/sustainable-fi-equation-1.gif

in general terms, and

https://adventuresinmissingthepoint.files.wordpress.com/2010/06/sustainable-fi-equation-2.gif

in a more applied form.

Applying the equation above in terms of the percentage of your pay that you save, you’ll come up with a pretty graph.  I have two versions, out of respect for the scale.  The first is in a scale for Joe American.  The second is for the whacky nut job ladies that plan to leave millions of dollars to their cats.

https://adventuresinmissingthepoint.files.wordpress.com/2010/06/american-sustainable-retirement1.png

https://adventuresinmissingthepoint.files.wordpress.com/2010/06/ere-sustainable-retirement1.png

It’s interesting to see that saving extremely, in terms of one’s earnings, provides a nearly inversely proportional relationship in time for retirement.  These are not revolutionary ideas.  I just like visualizing numbers.

It’s interesting to note that spending less, as opposed to making more, has a greater impact to achieving financial independence, faster.  This is logical, if you look back to the equation.  The accumulation denominator is a function of earning and spending, yet the state of the system in the numerator is a function of spending scaled by a factor of 25.

Work Less, Live More

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The Phone Bill That Buys Me a 6-Pack

Two years ago I started automatically investing $137 every month.  I based it off a calculation of a known surplus in my budget.  After reading a Rowdy Kittens’ post, I noticed the monthly amount is close to a bill for a cell phone with a data plan.

When I bought a 6-pack of expensive beer a few nights ago, the guy behind me asked what kind of job I had that allowed me to buy that kind of beer.  He was joking, so we just laughed.  On the walk home, I realized it’s the kind that doesn’t require having a phone plan.

After two years, the dividend now pays me $30 per quarter, which is one 6-pack of expensive beer per month!  It’s not a lot.  But, it’s fun to identify “cross-over” points.  Just like the marathon is one mile at a time, so are a lot of other aspects of life.

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Quantitative Interest Returns

Today, I learned about Benford’s law from Jacob.  If you read either of those links, you can see that if you apply Benford’s law to an exponential function you can find the probability distribution of the exponential function.  As Jacob’s post mentions, compounding interest is an exponential function.

After I compared time and interest rate dependencies in the exponential function, I started wondering more about relative interest return rates.  I believe applying Benford’s law now closes that loop.

https://adventuresinmissingthepoint.files.wordpress.com/2010/03/benfords-law.png

The bar plot is the probability distribution of Benford’s law, and the line plot is the cumulative probability distribution of it.  Then, you can apply this to principal in a loan, fraction of a desired capital investment goal, and so forth.

Say you take out a loan, and pay 20% down.  The loan is free from 48% of the total interest compounding.  In other words, the loan is growing at 52% of the total loan potential, as a function of the lending interest rate.

It’s something to think about, and it’s also a tool to use if you apply time to calculations, like if you start to default on payments/investments.

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Financial Tracking

I try to spend as little time thinking about investments, but some times it gets the better part of my brainz.  The metric I focus on most is passive income: how much I earn by just being.

I update my Google Document a couple of times a month.  In the document, I have:

  • individual data: the points above are a sum of dividends, interests, and the like
  • a 10 period rolling average
  • a regression
  • and, a 95% confidence interval.

I know focusing on one metric is not a good idea; however, as an advocate for sustainable designs and graphs with dense and easy to understand material, this is my favorite metric.  I usually see people track net worth.  To me, that is a more complex way to imagine retirement/laycation cashflows.

I have only seen one retiree’s cashflow, the Canadian Dream’s.  I’m interested in non-conventional, home-made trackings. To me, conventional is a brokerage statement.

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Capitalism Pays Investors

For some reason when I hear the word capitalism, I think of the characters Randolph and Mortimer Duke from Trading Places. The Duke brothers, Randolph and Mortimer, are crooked investors on Wall Street.  The two only care about themselves, which is apparent in the plot.  The brothers make a friendly bet, for $1, over the welfare of one of their employees and a street begger, whom they force to trade places.

These brothers are the antagonists.  They have so much money that they need not worry about anyone else.  After dabbling in readings about economics, I’ve come to a turnabout.  These characters are capitalism’s heroes, regardless of their poor morals.  Their income thrives off of their investments: their company’s equity, assets, and employees’ knowledge.

Investors in capitalism encourage spending: Investors get cashflow from consumers.  I think society has a misunderstanding that the rich have assets or the potential to consume assets.  But in reality, the “rich” people are the ones who have a sustainable, passive income that is higher than their expenses, like Mortimer and Randolph.

A sustainable, passive income that is higher than your expenses does not require a lot of buying power, i.e. cash or assets.  And, this cashflow is one form of retirement that will last forever, so you can rest your worries from Social Security, 401k, or whatever other method the government encourages.

America’s status quo is to have a job that covers your expenses.  A lot of Americans live at a level they cannot afford, including maintaining an average credit card debt of $8,000.  Investors have interestingly marketed irrational consumer behaviors, solely for selfish reasons.

Looking at catching up, more generally.

I’m not the first to these thoughts.  Rich Dad, Poor Dad is an interesting, light read detailing cashflows more indepth.  Early Retirement Extreme provides a unique paradigm the stereotypical American would probably find absurd, as he retired in his early 30s due to his low cost of living.  I find a view considering time as a key factor for investing to keep investment thoughts and plans optimistic.

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