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Cash Flow June 17, 2008

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This is the area that gets much attention.  Most people call it income and/or salary, which I think is a mistake.  Emotionally, calling it income or salary strongly attaches it to your job or more generally to the thought of a career.  Really, it is only incoming cash which could come from multiple sources.  Divorcing the incoming cash from the idea of work is fundamental to acquiring wealth.

Much attention goes to budgeting cash flow as it should because it is needed to feed the beast.  Here is an easy way to calculate cash flow.  Look at your main checking.  It should list your monthly deposits.  Add up your last 6 months of monthly deposits and divide by 6.  This is your average monthly deposit.  Now look at your outgoing cash.  Do the same, add up six months worth, and divide by 6.  Now look at your credit items like your credit cards and your home equity loan.  What was the balance 6 months ago?  Compare it to now.  Add the two items together.  For example, if your credit card balance was $1,000 six months ago and $1400 now add the extra $400 to the outgoing.  Vice versa if your outstanding credit is lower.

This should give you a quick look at your cash flow.  Now, if it is negative you have an issue.  Obviously, you can’t go on forever with a negative cash flow.  Some people suggest a full accounting by recording every item bought over a month.  For me, this is unecessary, but if you are inclined go for it.  

If you have little room between your incoming and outgoing then think about how to increase your incoming.  Maybe create a company which you can put together on your time off from your main job.  Many a successful company was started this way.  I always suggest working harder on incoming than outgoing money because it will create more wealth in the long run, but if you have a real spending problem, then get help.

No matter what, start thinking in terms of cash flow instead of self-limiting concepts of income, salary, career.  Those thoughts are money traps, keeping you from your potential!

Cash flow is the second most important concept to creating wealth behind working net worth, so figure it out today!

What’s your Net Worth? June 16, 2008

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This week we will spend some time discusssing important financial equtions that all folks should know and understand.  The first and single most important equation that is critical to know is “working net worth.”
This is a basic finanical number everyone should calculate every month until your net worth is ingrained in your brain.  If it isn’t going up, then you have major issues in your financial life.  So let’s calculate it. 

First, list all your assets and their approximate values.  Now break the list down into two categories.  The first category is appreciating assets.  Place all your assets that appreciate over time in this category.  This should include your home, other real estate, stocks, bonds, mutual funds, savings accounts, etc.  The second category is non-appreciating assets.  Here you put your cars/trucks, furniture, TV’s, personal items, etc.  Next create a list of your liabilities/debts. Your mortgage, credit card balances, car loans, etc.  Now subtract your liabilities from your assets.  This is your net worth.  Don’t panic if this is a negative number!  Now, subtract your liabilities from your appreciating assets.  This is your working net worth.  This is our most important metric.  This is the number that we want to see grow and will determine how well your wealth plan is working.

Now here is where some interesting things happen.  First off, you can have growing amount of debt and still have a growing working net worth.  In fact, done with a porposeful plan, you might end up with much debt at retirement, yet be in great financial condition.  Now I know this is contrary to what many folks out there are hearing.  The “no debt” crowd is really yelling their nonsense these days.  The bottom line is that as long as your working net worth is rising you are reaching your goals.  We will talk about debt service later this week after we have discussed cash flow.

Now, my requirement is that my working net worth should appreciate 15% per year in order to reach my goals.  Once you are fully conversant with this number, you can calculate what your rate of return must be to reach your goal.  Fortunately, I have been beating my goal over the last ten years (since I have started this habit).  There are some years that I haven’t while other years I have, but the bottom line looking at the long term I have exceeded my goal. 

There are two basic ways to increase your working net worth.  The first is to add to your investments.  Of course, everyone should do this annually, but the question is always which investments.  For this I have a plan.  At the Shafer Wealth Academy (www.shaferwealthacademy.com)  we spend much time in both figuring out our net worth and developing a plan to increase it.  The second way is the rate of return you are getting on your investments.  This becomes more critical as your working net worth increases, since your total assets will start to dwarf your annual investment additions.  Basically, it is my belief that folks must get a rate of return from their investments above 12% in order to achieve meaningful wealth.  There are many strategies that have proven effective at getting that return.  And, by now my readers know, that investing in mutual funds will not give you a return any where near that mark.

So go ahead, figure out your working net worth now.  And if you want a proven technique in building that number up, contact me at dave@shaferwealthacademy.com or continue with the herd, your choice!


Experts; What does it take to be called an expert? April 28, 2008

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Bad news travels fast.  Real Estate market is lost for a generation.  Stocks falling in the face of a recession (depression). Interest rates dropping on CD’s, annuities, savings, etc.  Yea, it is all out there now.  Every naysayer with a keyboard is opining about the “fall of the empire.”  Just a few years ago it was opposite.  All these keyboard experts were talking about “flipping houses,”  the stock market rebound, and “trust deeds.”

And then everybody, I mean everybody had a real estate license.  The other day my neighbor had a city exterminator over to catch a rodent.  He saw her for sale sign in the yard.  Suddenly, this guy, a self disclosed part-time real estate agent was rendering  advice.  “I predicted this bad real estate market,” he says.  “You should take your home off the market and sell in 2011.”  No comment on whether he sold houses to folks in the 2003-2005 period while he was predicting a market devaluation.

Truth be told, the majority of real estate agents ignored the truth of what they were doing.  They knew they were selling  homes, lots of them for over market values.  They knew how the appraisers were appraising homes over value.  They knew their clients couldn’t afford the homes, got questionable loans, etc.  Yet, they just smiled and sold homes.  I suppose you could argue that since so many of the agents were new or part-time they were incapable of seeing the truth.  Just like those internet keyboard experts, they were making judgements without knowledge or experience.

Folks, if you follow the herd, you will be hurt.  If you don’t figure out how to think independently, or at least hire folks who can think independently for you, you will be hurt. 

I talked to two folks over the weekend about the Shafer Wealth Academy(www.shaferwealthacademy.com).  It was interesting.  They started to tell me about the economy and what to invest in.  I asked them what their net worth was.  Neither of them had a positive net worth.  Think about  this, you call someone up who is offering to help you build your net worth, and start to tell them about good investments.  Yet, you are poor.  Oh, and by the way, they were both “former” real estate agents!  So far I have talked to several real estate agents, mortgage originators, mutual fund/insurance salesmen, a CPA, and a stock broker.  All were basically broke.  Think about that the next time you get advice from a so-called expert!

Retirement Strategies REdux: Old School v. My Way April 21, 2008

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Mary and Joe are typical folks, they have about twenty years to retirement with two kids fast approaching needing money to attend college.  Joe has been fortunate and has had the same job for over 15 years, while Mary works part-time for a local business and still does the majority of taking care of the kids.  They have accumulated around $100,000 in a 401K and owe $100,000 on a home that is worth $300,000 by aggressively paying off the mortgage and owning the home for 15 years.  Their emergency fund is meager at $8,000.  They know they need to figure out a way to get more money for retirement, but frankly, are at a loss how.  They make an appointment with John, the financial planner.  Mary pulls up in a 7 year old Honda minivan and waits for her husband.  Joe running a few minutes late pulls up in a 4 year old Chrysler 300.  Joe parks next to a new Lexus and admires it as they go into the office.  John meets them at the door and acknowledges Joe looking at the Lexus and mentions he has just leased it a few weeks ago.  Joe is impressed.

John, takes all their information and runs the numbers.  He looks them in the eye and delivers the bad news.  At their present rate they will not have enough to retire on.  They need to do something now!  Mary and Joe are a little embarassed about their situation, but they thought they were doing the right thing, paying off their mortgage and putting 8% of Joe’s salary in to the 401K.  Frankly, Mary knows because the wives talk about this, that they are better off than most of their friends.  So she is a little peeved at John’s rather cavalier attitude toward their retirement savings.  Then John throws in the kicker.  He can help them achieve success.  He starts to talk about asset allocation mentioning that they have all their money in one mutual fund.  He pulls out a prospectus that is for an international mutual fund that returned 28% last year.  Joe is impresses as he knows his fund returned a meager 3% last year.  Then Joe pulls out another prospectus for a Precious Metals Mutual Fund that returned 85% last year.  Joe is fully impressed now.  John suggests he take control of the $100,000 in the 401K to manage it.  He tells the couple to keep up the good work paying off the mortgage, but they need to put away more, much more if they want to retire comfortably.  John also suggests they need some life insurance so he suggests a $250,000 10 year term insurance which he says is dirt cheap now.  Joe and Mary look at each other with the same thought.  They are already pretty thrifty, but there goes the one night a week they eat out together and maybe Mary could work more hours after all the kids are old enough that they don’t need Mary to be there when they get home from school.  But, if that is what they need to do, then they will figure it out.

On the way home Joe is sold but Mary has some doubt about John.  She remembers reading “The Millionaire Next Door” in her book club a few years back, so she is not impressed with John’s car.  Her intuition also tells her that the returns that he showed them for those two funds were a little high, they must be risky she thought.  She thinks  they should talk to someone else.

Can you spot the mistakes?

1.  The assumption that leasing a nice car means that you know what you are doing financially is incorrect and probably the exact opposite.

2.  Mutual funds as a class underperform the market and specialized mutual funds have even more variability which means that those two mutual funds will probably underperform for many years to come to make up for their amazing performance last year.

3.  They use little leverage on their finances and are decreasing it by paying off their mortgage.

4. The majority of their net worth is home equity which gets a 0% rate of return.

5.  Suggesting to a frugal couple that they need to be more frugal is like throwing gasoline onto a fire.  They drive older cars, eat out only once a week and work 1 1/2 jobs between them while caring for two kids.  Life shouldn’t be this onerous for this couple.

My Way:

Move their 401K money to a discount brokerage account and buy $100,000 of Berkshire Hathaway B’s.  Warren Buffett’s returns 21% over 43 years and 18% over  the last 10 years.

Re-finance their home with a $250,000 mortgage now available at 5.75%.  This gives them $150,000 cash.

Take $25,000 and purchase a $200,000 duplex in Dallas, Texas that is cash  flow positive (See my Friend Jeff www.bawldguy.com for details)

Purchase a $450,000 equity index life insurance contract.  Fund it with $25,000 year for five payments.

Reduce the 401K amount to the 3% company match to cover the extra expense of the larger mortgage.

Place the $100,000 left over into a money market fund or high paying savings account to act as an emergency fund and reserve fund for the real estate.

As each year goes by make the $25,000 life insurance premium payment. 

Taxable income goes down as the mortgage interest goes up substantially and the real estate investment throws off tax advantages.

Let’s look down the road five years.  The real estate investment has a cash flow of +$3,000, +$3,000, +$4,000, +$5,000, +$6,000 as rent could be increased.  This $21,000 is held as reserves for deferred maintenance and is not counted for assets.  College aid was applied for the kids and this amount was not counted!

The insurance contract has a cash surrender value of $110,000 since the front loaded fee’s have been paid.  But this works as the couple’s emergency fund available to them with no tax consequences.  The big positive is that this is not counted toward income or assets for college aid.  So they have moved over $100,000 off the college aid books allowing the kids to qualify for more aid.

The Brokerage 401K is worth $228,776 with Warren Buffett continuing the 18% he got the last decade.

The duplex is worth $250,000 getting slightly less than 5% return. They have around $80,000 in equity.

Their home is worth $380,000 getting the same 5% return.  They have over $150,000 is equity.

Their taxes have gone down due to the mortgage interest deduction and the investment real estate.

Their passive income from the real estate is 500/month.

Their kids received large amounts of student aid for college.

They have a emergency fund/reserves over $130,000 so they sleep well at night.

The costs to do this was $5,000 for the refinance, $5,000 to buy the duplex, $12 to buy the stock, and the commission and fee’s for the insurance contract.

There are no ongoing fee’s (other than the insurance contract) payable to a financial planner.

No reduction in life style needed.  In fact as the couples net worth rose, they started to take a nice vacation once a year and Mary will stop working  as soon as the kids are out of college.

Old School V. My Way:  You make the choice!

PS  I used conservative numbers all the way through my way!

PSS  As usual this should not be construed as financial advice with respect to any particular stock or any general investment advice that might come under the auspice of the SEC.  It is only the ramblings of a derelect and a individual that does not have a license to issue stock or mutual fund or real estate advice.  Please see an “expert” for all tax issues.