Accounts You Need to Have for Financial Security


Today I wanted to talk about how one in general should be allocating funds.  As stated previously, this blog is primarily concerned with strategies to grow funds quickly, assuming that an investor is starting out with little money but working a steady job with a reasonable income.  It also assumes that an individual has scaled her “lifestyle” so that she is making more than she is spending.  This is the most basic requirement for becoming wealthy.  Virtually everyone can scale back to have extra income left over, but it takes a degree of sacrifice and patience since one will need to wait a bit longer to buy things but they will be quite a bit less expensive when one does (because one will be paying cash rather than buying them on credit).

The first place a person should put extra income is in a cash account that is readily accessible.  This should be built up until it contains enough to cover several months worth of expenses.  These funds are used to take care of the various unexpected expenses that occur (such as the car breaking down, heater going out, roof leaking, unexpected surgeries, etc…).  These funds should be guarded judiciously and not spent for things such as vacations, shopping, etc… since these are the funds that prevent you from needing to take out loans or run up the credit cards if something happens.  This account will also be used to live on if one loses one’s job, allowing time to find a good job, not just one taken out of desperation.

                                   

The second account is a retirement account.  This is the money you will live on when you’re ready to retire and also should be guarded carefully.  The only reason to access this kind of account is if you’re about to be out on the street if you don’t.  Absolutely don’t use this money for any other purpose, including taking out a loan against it.  The reason is that if you start saving in your 20’s each dollar will be worth over $128 when you retire, so if you take out $10,000, for example, you just robbed yourself of $128,000 in retirement worth, which translates into $12,000 per year in income.  This account should be filled with index funds when you’re young and gradually be filled with more dividend paying stocks, bonds REIT’s, and cash as you get closer to retirement.

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The third account is your investment account.  This is the account that will use the strategies in this newsletter to grow large, allowing you the financial freedom at some point to work or not work, as you choose.  This account will be invested in stocks starting with 1-3, and eventually growing to 10-20 as your wealth builds to the $500,000 – $1 million range.   Because the money in this account is not critical – you still have enough money to pay for emergencies and fund your retirement with the other two accounts – you can afford to take the risk of one or two of your positions taking a substantial loss.  Also, if you find you are not a good stock picker, such that your investment account does not do as well as the markets, the other accounts will make sure you end up in a good position as well.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Small Investor Book Club Update


For the SmallIvy Book Club we’re reading The Compound Effect by Darren Hardy this month.  At the end of the month I’ll write about my impressions and let everyone else write their’s.  If you’d like to join us you can get a copy by clicking on the book cover below.

The Compound Effect

One thing Hardy stresses in his book is that there are little choices (good and bad) that don’t seem to mean anything when we make them, but cause things to end up as they do in two, five, ten years or more.  I know this is definitely the case for gaining financial independence.  When my wife and I started “acting abnormal,” as Dave Ramsey would say (because normal people are broke), it definitely was a lonely journey with a lot of doubt.  All around us people were buying new cars every few years, going on expensive trips, and eating out almost constantly.  They were also buying big homes with big mortgages.  (This one particularly worried me since the leverage they were getting would mean they’d make a lot more on their expensive home than I would on my modest home if housing prices continued to rise as they had for a long time, but the housing crunch made me glad we had made the choice we did.)  Few of them were putting much money away for retirement or college savings accounts for their children, let alone investing money outside of their retirement accounts.

Meanwhile we were buying used cars with 80,000 miles on them for a few thousand dollars (and paying cash), eating most meals in, bringing lunches, and going on driving vacations where we’d stay and 2 star hotels.   We bought a modest home for which we put 20% down.  After a few years we refinanced from a 30-year to a 15-year loan and then paid that off in about 12 years.  It really didn’t seem like we were getting anywhere for a long time.

But then we were able to pay off our home early.  The stock market, after sitting idle for about 14 years between 1998 and 2012, finally started to pick up steam and cause our retirement accounts and taxable accounts to climb in value.  (Actually, there were times of great gains in those periods, but there were also two huge financial crises – the 1999 dot com bust and the 2008 housing crunch – that erased a lot of the gains that we had made.  During that time, however, we were building up our stock holdings, which meant that when the markets finally did really take off, we were ready to take advantage.)  Once things started happening and the compound effect took hold, it seemed like everything changed fast.

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We reached financial independence about four years ago.  This means that we could stop working and make enough from our investments to live on.  At that time it would have been a fairly  meager living, but really not too bad.  In the last few years we’ve almost gotten to the point where we could fully replace salaries from investments – as I said, things happen fast.  This means I’m 45 and could probably just quit working if desired, which I don’t, but it does allow me the flexibility to care about what work I do).

Hopefully some others out there are reading The Compound Effect with me so that we can all discuss it at the end of May.  I hadn’t planned on discussing it before I had finished the book, but couldn’t help myself.  I hope others are enjoying the book as well and finding things they can use in their lives.

Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Teaching Children How to Be Wealthy


We learn most of our financial knowledge from our parents and usually have similar spending habits.  Unfortunately, money and sex are both subjects that are rarely talked about between generations, resulting in young adults with a poor understanding of both.  By teaching children where money comes from and how to manage it, you can set them on the path to a life of security instead of a life of worry.  Here are important points to cover.
1.  Money can be saved, invested, spent, and given. 
When one receives money, it can be saved, invested, spent, or given.  Saving provides immediate security.  Investing provides multiplication of wealth and future security.  Spending provides current enjoyment and the zest of life.  Giving allows us to grow and become better people.  Children should be taught that an appropriate level of each activity should be part of one’s financial life.
2.  Money is earned by providing something of value to others.
In our Capitalist society, one earns money by providing something of value to others.  Something of value is something that meets their needs.  This can mean operating a business that provides something needed, or working as an employee and providing something your company needs to them in exchange for a salary.  It can even mean digging something up out of the ground that is needed, or refining something into something more valuable.  The more valuable the thing provided, i.e. the greater the need fulfilled, the more money can be earned.  As an employee, the more value you bring to the company, the greater your salary can be.

      
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3.  Wealth and financial security is created by building pipelines.
People who spend all of their wages may seem to be doing well, but they are taking a great risk that something will happen to their ability to produce their wages and end up in financial ruin.  Also, except for the few souls who pass away suddenly, they will eventually not be able to earn their wages due to sickness or there will come a time where they do not want to work anymore.  Financial security is earned by using some of our wages and our energy to create pipelines – investments that provide income to us.  By buying shares of a mutual fund, buying a rental property, writing a book or a song, or building a business we create the ability to generate income without working.  This will both supplement our current income (allowing us to spend and give more) and allow us to replace our income when needed or desired.  Individuals who become wealthy are those who delay the acquisition of things and/or work additional hours while able in order to build their pipelines.

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4.   When we pay interest, we pay for everything twice (or more).
One will never become wealthy while paying 20% credit card interest.  Even keeping a perpetual house payment by constantly withdrawing equity for home improvements and other spending will have a huge impact on future wealth.  Likewise, if one keeps a car payment throughout one’s life, one will forego over a million dollars in wealth at retirement.   If we save up cash and buy things, we will pay substantially less than if we buy things on credit.  This in turn will leave more money for saving and investing.  Loans should be taken out very rarely, and then the debt should be paid off as quickly as possible.

     
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 5.  An emergency fund turns an emergency into an inconvenience and provides more options.
Most people are able to pay their monthly bills, but then sudden emergencies cause them to take on debt.  Eventually, they will have all of their income (or more) consumed before the month starts, making it impossible to save or invest.  By keeping 3-6 months’ worth of expenses in a savings account, the sudden car repair or minor medical issue can be resolved via a check instead of a loan.  Likewise, the loss of a job becomes an issue to work through rather than a crisis.
6.  Save up for big things you will need to buy or replace monthly.
Most individuals will need to take out a loan to replace a car, an air conditioner, or a roof.  Many put vacations on their credit cards and then pay for them over then next several years.  If you regularly save for the big expenses, you will have the money available when the come times.  Not only will this result in savings on interest (which will give you more money to save for future purchases). It will allow you to negotiate for better prices.  Everyone likes cash-up-front, and may people will give you a discount if you can pay in full.
Teach your children about how to handle money, and you will greatly reduce the stress in their lives.

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Follow me on Twitter to get news about new articles and find out what I’m investing in. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.