Financial Literacy

When you begin living on your own and working your way into a higher income, one mis-step many make is to sign a lease on a great apartment that takes all your income. I know, you finally want to be in a hot downtown area with the great workout room, dog park, pool, valet trash, with a fabulous view. You got the nicest apartment you could find and at the limit of your budget. Too many renters discover too late that it was really too much money and later regret it.

This is the detrimental path after you’ve reached too soon for the high-end apartment in the hot area:

• The apartment consumes all of your income so your lifestyle spending goes on your credit card.
• Rent sharply increases year after year.
• You wake up in 5-10 years to discover that you are broke and cannot afford to renew your lease.
• You realize you’ve been sinking in rental quicksand with few affordable living options.

In growing cities, this quicksand was bound to happen from the start. Living in the hotspot is not cheap and if your income isn’t rising as fast as your rent is rising, then you are falling behind into serious financial struggle. When rent is consuming all of your income, you will have nothing for savings, nothing for investments, and nothing for retirement – with highly predictable financial troubles ahead.

You must save money every month while you have a chance while renting. If you had a home there are some large potential expenses: new carpeting, new roof or driveway, appliance replacement, etc. While you are renting, you have an opportunity to save the money that you would be using on these expenditures. In addition, anytime you are renting, you should set money aside as if you were an owner building up equity. You could start by saving 10% of your rent into a separate account and work toward raising the savings rate to 20%-30% of your rent. This way, you are creating and controlling your “housing equity” and building up a fund that can be applied toward a down payment when you are in a position to purchase your own place. Purchasing your own home/apt/condo fixes your housing expense while renters keep getting rent increases over the next decade or two. You do not want to be a continual renter and realize in your 50s that you have no savings, no home equity, and are struggling with rent increases. This financial situation can be equated to leasing a brand new car vs. buying a 3-5-year old car with low miles. Leasing is the most expensive way to pay for a vehicle while buying a used car with lows miles is the cheapest way to buy a vehicle. Renting your expensive apartment and leasing a new car is going to eat away your financial stability in large chunks each month. This can be fine in the short-term but financially destructive as a medium or long-term lifestyle choice.

There are two financial flywheels that you can add to your routine cycle of earning and spending money. One of them you want to avoid and the other you want to employ.

The Hamster-Wheel Cycle

This is the so-called rat race which consists of earning money and then quickly spending all of it. Since all of your earnings are spent, so there is no extra money for maintenance, saving, or investing. If you remain in this earn-spend cycle for your entire career, you will likely experience financial struggle and it may be very difficult to ever retire.

2. The Debt Flywheel

This is borrowing money in order to spend more than you are earning. The more money that you borrow, the more interest expense will be devouring your disposable income, leaving you less to spend. This is a negative flywheel, one that damages your financial life as long as it exists. As this flywheel grows in size, you are pre-spending more of your income and the more you’ll experience financial struggle. Simply having this flywheel makes your earn-spend cycle more difficult.

3. The Investment Flywheel

This is earning income from investments that regularly pay you income (interest, dividends, rent, etc.). By routinely feeding this wheel with new additions of money, and re-investing all of the investment income into more investments, your investment income will become an ever-growing flywheel. This is a positive flywheel, enhancing your financial life as long as it exists. As this flywheel grows in size, its investment income provides more financial options, more financial stability, and the possibility of an early retirement. Starting this flywheel is the most certain structure to break the earn-spend cycle. 

If you are having trouble saving any money to start or grow investment flywheels, then I offer the two easiest potential sources of funds:

• Cut your taxes. There are several types that you can actively minimize, such as income tax, sales tax, property tax, etc. and then save that money or use it to pay down debts.
• Cash back credit cards. Instead of using a credit card that provides airline miles or other non-cash benefits, search for a credit card that pays you at least 2% back in the form of cash.

Years ago, I assisted someone in setting up her investment flywheel in a tax-free retirement account (basically a fixed-income portfolio with auto re-investment). She just told me that her investment income is now increasing by $46 per month. She had not added any new money recently, her investment flywheel is compounding upward on its own, every month. So she receives a pay raise of $46 each month, and this raise becomes a little larger each month. It is my best advice to start and build your own investment flywheels. Even if you can only add just $20 a month to an income-producing investment, over time you will be improving your financial stability.

When taxpayers receive their annual Social Security Retirement Income statement (SSI), they look at the benefits page to see the monthly amount that they will receive. There will be a number for declaring your maximum SSI benefits at age 70, your full retirement amount around age 67, and early retirement at age 62. As exciting or disappointing as these dollar amounts are, the embedded assumption is that you will continue working until the day you file for SSI benefits, and that you’ll be earning an increasing amount of income each year.

This means that if you stop working any time before you file at those ages, then your actual SSI payment will be lower than that estimate. You can calculate what your real SSI payment will be by using the online calculators on the SSI webpage. Look up “Social Security Detailed Calculator” or it is on this page today: https://www.ssa.gov/oact/anypia/anypia.html

Your SSI payment is based upon the highest 35 years of your actual annual income. For example, if you stop working at age 60 and file at age 62, then you have two salary zeros for age 60 and 61. Those zeros will likely reduce the amount of SSI money you’ll be receiving compared to the estimates that you had been reviewing from your Social Security statements each year. One financial advisor wrote that a client approached him after she had retired at age 61 and filed at age 67. To her horror, she discovered that her SSI payment was $1,206 lower than the estimate on her SSI Statement. So, her retirement plan is short by $14,472 in income per year, plus the annual inflation adjustment. The grand total of missed income, if she lives to age 85, is $300,000 in cash payments during her retirement from her calculation misunderstanding.

When you are formulating your retirement plan and making critical decisions, do not:

• Wing it on your own (which most people do)
• Ask your company’s Human Resources department (which a lot of people erroneously do)
• Ask your brother-in-law, who is a stock broker or insurance agent (which never ends well)
• Definitely do not take any advice from Social Security Administration staff (they do not know your whole retirement situation, financial goals, or let alone all the SSI rules and nuances)

Only act on advice from a full-time professional that only does retirement planning. Get referrals first, interview many advisors to narrow them down, go over references, and then do all the homework you can up front yourself so you can ask intelligent questions and understand their financial language. Or you, too, may unexpectedly find tens of thousands or hundreds of thousands missing from your retirement.

Rob Grownkowski, a tight-end for the New England Patriots, just won his third Super Bowl ring a few days ago. Unlike other pro-athletes that are bankrupt 2-3 years after their career ends, Gronkowski hasn’t spent a single penny of his NFL salary from his 8 years in the league. He even banked 100% of his original signing bonus. Instead, Gronkowski just lives on money that he makes in endorsement income. He has now teamed up with Capital One to offer tips on his “Gronkonomics,” challenging people to save money.

His other tips:

• No designer clothes, he wears old clothes until they are rags
• No outrageously expensive jewelry, homes, or big-ticket luxury items (although he has splurged on a few cars recently – only from endorsement earnings)
• If I do spend extra money, it is usually on charity through my foundation

FinnApp estimates Rob Gronkowski’s net worth at $153 million, far more than anyone would expect from his annual salary. He currently has a base salary of $5.25 million and it can go up to $10.75 million, depending on how much time he plays and how well he does.

Comedian Jay Leno has a similar financial habit. “When I first started out as a kid and an unknown comic, I’ve always had 2 incomes – one to bank and one to spend, and I only spent the smaller one. I made money at a car dealership and from comic gigs.” At the peak of his career, when he was making $30 million a year from NBC’s Tonight Show, he still never touched it; Leno only spent the money he made from comedy shows on the side. “So I made sure that I had at least 150 comedy shows a year, to make certain I never touched a dime of the Tonight Show money. So many entertainers blow all their money but savings gives me peace of mind. If my career ended right now, financially I’ll be fine.” Jay Leno is 68-years-old and still performs comedy gigs plus he has a TV show, Jay Leno’s Garage that is 4 years old. Jay Leno’s net worth is estimated to be $400 million.

You do not have to be a high-income celebrity to employ this 2-income tactic, all you need is a second income source:

• I know several couples that bank one salary while the other salary is used for living expenses.
• A family acquaintance is single and while he has a job, he would spend weekends working a multi-level marketing program with cleaning products. He kept it up until that side income paid two times his salary, then he saved 100% of his salary while only spending the MLM income.
• A relative’s second income is flipping real estate. She and her husband both work (and have 2 children) and they buy a cheap fixer-upper to live in while they make repairs to it on weekends. After 2 years (to maximize the IRS tax-exemption), they would sell the home and roll all of their equity into their next larger fixer-upper. They repeated this again and again, into more expensive homes, and worked their way up to multi-million dollar fixer-uppers for very large capital gains.

Of course, you can save a portion of one income, it doesn’t have to be 50-50 – but consider it a target: having two incomes and saving one of them for your maximum financial stability.

There is nothing the matter with rewarding yourself with fancier gadgets, vehicles, apparel, boats, or increasing your lifestyle. However, many people do not consider the deeper consequences of owning them until there is irreparable trouble. When a new item begins taking up your time, money, and effort, then these limited resources must be taken from where you used to place them: someone or something else. These “others” could be your spouse, kids, work, business, relatives, retirement savings, friends, and personal goals. Can these prior relationships or activities survive with your diminished time, money, and effort? As an example, I know someone who was divorced after he began spending big on several exotic cars plus driving trips with buddies. That may not have been the primary reason for the divorce; however, it was the last straw that the relationship could not survive. (It is also a classic move to short a stock once the CEO starts spending more time on his yacht or court-side seats than working; because the company performance will soon tank from the CEO’s lack of attention).

Once we have acquired something new and expensive, we feel like we have to use it a lot or the purchase was a waste; whether it is an Xbox console or a $750 pair of Louboutin shoes.

What are some of these items with sink-holes of consequences of time, money, and effort?

• A large screen TV – more hours per week on movies and television, holding parties for watching
• Buying a horse, or even a dog – exercising them for hours each week plus potential medical bills
• Any boat, let alone one that has sleeping berths for overnight stays – current boat owners keep the old joke fresh, “A boat is a hole in the water that you throw your money into”
• Hobbies – your own pilot’s license, yacht captain’s license, racing bicycles
• Apparel and accessories – it is tough to stay home alone or dine at Taco Bell if your closet is filled with the latest high-end designer goods
• Any kind of club: country club, book club, shooting club, dance club, garden club, etc.
• Collecting: watches, antiques, cars, art (a friend spends a fortune on Persian rugs every year)
• A second home – requiring twice the home maintenance plus the added travel

There is nothing wrong with taking up a musical instrument or buying 2 mega yachts. The critical question is: Have you considered where the time, money, and effort will come from to support and maintain all of it? Is everyone else in agreement with you about the new lifestyle – or will it strain and break the relationship? Will you lose or job or business in the process? For example, I know someone who lost his job and doomed his career because he didn’t realize how much time he needed to devote (during work hours) on the build-out of his spectacular trophy home for weekends in a distant coastal town. So before you begin adding new elements to your lifestyle, carefully evaluate all of their costs, over time, to the parts of your life that are most important to you.

A recent study claims the average American plans on spending $992 over the holidays, and of those that will borrow money, they are expecting to put $1,054 on credit. Any time that you are unable to pay off your credit card balance each month, it is likely that may be spending beyond your means.

While some people are naturally frugal, many of the rest of us:

• Don’t consider budgeting until all our credit cards are maxed out
• Don’t consider starting a car reserve until our car dies there is no way to get to work
• Don’t start set aside money for medical issues until we can’t afford a treatment
• Don’t open and add to retirement accounts until we see our relatives struggle in retirement
• Don’t start saving money until we have plans for a home or wedding
• Don’t contribute to an annual gift reserve until we’re still paying for last year’s gifts and are buying new ones on credit
• Don’t make “paying yourself first” a permanent part of our financial planning until you, or someone close to you, loses their job for an extended period of time

Basically, we know we should budget and save. However, we do not have enough motivation to actually pay attention and do it until we take a hit on the chin so hard that we don’t want that to happen ever again. The better path is to read enough and learn enough from others’ financial mistakes and advice. Then move toward the sustainable living-below-your-means lifestyle on our own, without a calamity forcing us to re-evaluate our financial habits. It is my best advice that you do not wait for that calamity, because it can take years to dig out of a financial hole that you do not even realize that you are in.

If there is no money in your wallet, it isn’t because there is a hole there – it is because there is a hole in your mind. Unless there were an exogenous financial setback, then the hole represents your missing discipline to delay immediate gratification. Since your ability to wait or deny yourself is absent, your long-term plans requiring some savings take a permanent back seat to immediate spending and — voila’ – no money in your wallet.

Recently, this came up when I attended a gathering where there were two couples in their early sixties and none of them had a penny to their name. One couple has two very-high income earners with advanced degrees. But they built a spectacular-custom home they cannot afford, borrowed for furnishings, continually borrow for cars, vacations, and even going out to eat. I expect that within 3 years, they will lose everything they have and still owe an insurmountable amount of money. They know that they can never retire and just hope their day of financial reckoning never arrives. The other couple includes a retired nurse and a husband that supervises a construction crew. They routinely spend so much money at a casino that they’ve needed to call a friend to bring a can of gasoline so they could drive their car back home. The wife also supports her mother’s out-of-control spending. Between money being vacuumed up by the mother-in-law and the casino, they have never had an extra penny for saving or investing, let alone maintenance and repairs of what little they do have.

Both couples earn more than the average family, and yet, they have zero in savings. Their lack of savings has nothing to do with:

• The Economy – they can get all the work they want
• Salary – they earn more than average American family
• Children – one couple has no children and the other couple’s children are long out of the home

So structurally, there is nothing preventing them from saving money, it is only psychological. At least 2 of the 4 people admitted great regret and ongoing stress over their current financial situation; plus the financial struggle that they’ll be facing in their future. (Note: 61% of workers are forced to retire before they want to from health issues or being laid off). No matter what your level of income, a similar booby prize awaits anyone that refuses to make savings a priority and maintain that saving habit. Living below your means is not an Olde Timey concept, it is financial reality and those that fail to do this face a predictable and painful future. Whether you are 16 or 56, a portion of any earnings must be set aside into savings and investments for future spending.

Who doesn’t want to retire early? Or at least have the option to do so? There are claims that if you save most of your salary, live a bare bones lifestyle, then in a dozen years you will be able to live off your investment income for life. You can begin travelling, volunteering, and enjoying newfound time and freedom. There are many online communities for early-retirement seekers sharing tips, strategies, and stories on how they reduce their cost of living. One such group uses the acronym FIRE for Financial Independence Retire Early. Unfortunately, there are also bloggers trying to cash in, hype their story, and provide false hopes and bad advice to get clicks to boost their blog ad revenue.

I looked into several of these bloggers a while ago and found that the “success” stories include gaping financial holes:

• Having no insurance for health, dental, vision, apartment, etc.
• No home reserves for new roof, maintenance, repairs, flooring, next vehicle, etc.
• Live cheaply abroad for now and not paying into social security that will shrink any retirement income
• Live off the grid with no utilities – not doable around most cities or for most families for long
• Omit that their “retirement” success depends upon the $5,000 per month they earn from their blog while pretending they live on investments alone and not an active business
• Their version of “retirement” is not relaxing or traveling. To make their retirement feasible, they are swapping a paying job for working on DIY projects. Some appear to be nearly full-time when you include: making your own soap and detergent; doing your own home and car repairs; grow and can your own food; walk and bike to eliminate your vehicle; make your own furnishings; making your own clothing; harvest and chop firewood for your home stove; etc.

When there are some egregious finance errors on these blogs, sometimes I would post a comment. Nearly all of my comments were suspiciously deleted by the administrator. For example, if I mention that the blogger:

• Is relying upon investment returns that are extremely unlikely to occur, not recognizing stock market peak-to-peak can take 20 years
• Brags about their recent early retirement, and I use arithmetic and their own budget to point out that they will have to go back to work within 4 years
• Many misuses of William Bengen’s retirement account spending rate of 4.5%, and unknowingly increase their risk-of-ruin when they are least able to earn money. (Bengen’s calculations are only statistically valid for less than 30 years)
• Ignoring the retirement tax-torpedo for withdrawing large amounts from a 401(k) or IRA, triggering the maximum tax on social security income
• Their Medicare budget isn’t nearly large enough and they did not purchase a supplemental plan
• Taking giant financial risks with stock options that cannot end well

Financial literacy is always important, but it is critical when making major life decisions – like ending your career and truncating your earnings. The soundest plans are based upon increasing your financial literacy. In my opinion, beware that some of the most popular posts and Youtube channels about retiring early are frequently riddled with errors, omissions, unlikely assumptions, serious risks, and fatal errors that may doom your financial goals.

Financial technology, nicknamed “FinTech,” is a buzzword term that was all the rage and in vogue for several years, but is now beginning to slow. Fintech refers to software for financial services. While it previously referred to back-end banking and brokerage services, fintech now includes consumer-side applications for online loans, mobile apps, cryptocurrencies and blockchain, online shopping, fundraising, investment robo-advisers, personal money management, and more. Fintech can also include behavioral analytics, artificial intelligence, data mining, and adaptive learning to make decisions.

Many fintech tools allow people to manage their personal finances easier and possibly create disruptive business models. Fintech platforms and tools attempt to add convenience, speed, and agility in the marketplace. Unfortunately, like any growing fad, there is a downside.

1. Breaches of personal information:

• For the last few years, hundreds of millions of financial records were leaked
• Financial firms are most attacked by hackers
• In spite of security protocols, half of financial leaks are from human error
• Last week, the Obamacare website leaked the personal date of 75,000 people

2. Lowering lending standards:

• A new FICO score called Ultra-FICO (coming out in 2019) reduces the formula weighting from your past history of missed payments, increasing your probability of getting a loan
• Online lenders offering tiny loans at high rates
• Lending platforms for people and businesses unable to get standard bank loans

3. Regular companies adding “fintech” to their name:

• One self-proclaimed “thought-leader in fintech” just has a regular equipment leasing company
• Fintech stock broker, Robinhood offes “free” stock trades,” but they simply hide their real cost
• One scammer took control of a tiny biotech public company. He fraudulently renamed it to “Riot Blockchain,” and the stock price exploded. The SEC is investigating him for running a “Pump & Dump” scam and illegal insider trading.

4. Zillions of failed startups trying to catch the tidal wave of investment money flooding into fintech

$15 billion may be invested in fintech this year, and many are trying to grab a piece of it. There are all manner of ridiculous ideas that are already in the graveyard: trying to match social networking with your money; offering tiny credits to use a loan platform; pre-revenue business ideas; not understanding compliance (banking and finance are two of the most regulated industries); no prospectus – just a 2-minute animation video; and dozens of new brokerages that were going to “turn the industry on their head,” that ended up being sold for pennies to the big players.

When someone’s income goes to zero, only then do they fully realize how critical it was to have emergency savings beforehand. When your income goes to zero, this is the moment a fuse has been lit on an unsustainable spending bomb. While you’re searching for new employment, it is important to determine exactly how long you have before your spending bomb goes off. Below is a template to help you determine how long you have before your bank and savings account hits zero.

My first assignment out of college was determining how many people, per department, needed to be laid off to restructure a business for a lower-level of sales. Unexpected layoffs like this is why it is important to have enough money saved to pay for your expenses – for the length of time it takes to find a new job, in your profession, in your geographic area. This could be 3 months to 12 months, depending upon your local economy and personal skills.

The first step is to determine your current monthly fixed expenses:

1. Housing: rent or mortgage, association dues, and insurance
2. Utilities: electric, gas, water, trash, cellphones, internet
3. Health Insurance: a new plan (or Cobra) for your family
4. Food, (not dining out in restaurants)
5. Transportation: vehicle payment, insurance, gasoline

Add up these necessary expenses, cut back on them where you can, and you have your monthly minimum budget that you’ll have to fund from your savings until you gain new employment. How much savings do you have? Divide that amount by your monthly minimum and this calculated number reveals how many months that you can financially survive without new income. You may qualify for state unemployment benefits or severance pay – so this is a credit to add back to your monthly expenses. This helps extend your savings, but this normally doesn’t add more than some weeks or months to your available money.

As you’re getting closer to your financial cliff of unsustainability, then it is time for very uncomfortable decisions. Now is the time to severely downsize your living situation while you still have the funds to do so. Delaying this painful decision is not an option. Many people delay taking action by putting their head in the sand and hoping for a miracle. The result is that they’re forced to rack up credit card balances and 401(k) loans. Then their cars are repossessed and their home is foreclosed upon – and they lose all the equity they had built up in all of them. Even if you get a new job after a few more months, you may be buried in unsustainable debts and still have to declare bankruptcy anyway.

Everyone’s situation is different, but your savings determines how long you can support your monthly expenses, and what you may have to do when you’re close to running out of money. Give yourself a long runway to find a new job by setting building up a savings account that is at least 6 months of your expenses.