Sunday, December 28, 2008
Monday, December 1, 2008
When I was in my 20's, I, like most kids out of college, got into debt. It took me a decade to get out of debt and while I was cutting checks to the credit card companies, the stock market was going up 15 or 20% every year. I wasn’t in position to capitalize on the opportunities. Opportunity was knocking, but I wasn't at home to answer the door.
It is critical to get our financial house in order so we are in position to act when these opportunities present themselves.
So what does this mean? Unfortunately, if you are in your 20's, you will likely find this topic somewhat interesting, but not something you need to concern yourself with at this time. If you are in your 50's or 60's, you may feel like you are too late and missed the boat. And those of us in our 30's and 40's feel like we are behind and need to catch up.
But regardless, I personally feel like some of the best opportunities are ahead of us and we need to do what is necessary to be in position to act. As you read about the Boomer's Wake more and more, you will learn that the opportunities we identify may not be the same old traditional investments we are used to hearing about, but can still result in building wealth and staying ahead of the crowds.
In order to be ready to take advantage of these opportunities, we need to clean up our personal financial situations so we can move quickly when the opportunities present themselves.
This is one of the only times when we will discuss basic personal finance concepts. Some of what we cover here may seem very basic and yet we can so easily find ourselves becoming sloppy when we most need to be organized. So if nothing else, these should be good reminders.
Avoid bad debt and excessive cash flow killers
Books like Rich Dad Poor Dad can give you all the information you need on this subject. In my opinion, bad debt is any debt that is used to purchase items that decrease in value and/or do not produce income. Credit card debt and auto loans are generally bad debt, while a mortgage on a positive cash flow rental property is generally good. Clearing out your bad debt will raise your credit score and ability to make a down payment on the right investment in the future.
Maintain and understand your personal balance sheet and income statement
This is not so basic, but is critical to understanding where you stand financially. Your balance sheet is basically a list of all assets you own and a list of all debts you have. Your net worth is simply the sum of the assets minus the sum of the debts. Go through the exercise and make sure you are clear about your assets and debts.
Equally important is understanding your cash flow, also known as your income statement. This is a similar spreadsheet to the balance sheet. But this one lists all sources of income you receive each month and all types of expenses you are responsible to pay each month. Income includes salary, dividends, support and other income. Expenses includes monthly bills, housing payments, taxes and other expenses. Your cash-flow is your income minus your expenses.
Obviously, positive cash-flow gives you the ability to take on more debt and pay back the loans without dipping into your savings. Negative cash-flow means your ability to payback a new loan is in question.
The most simple goal for cash flow is to increase income and decrease expenses until you have positive cash flow. But only after you max out your 401k, pay off your bad debt/credit cards and pay both principle and interest on your good debt.
Monitor your FICO score and keep good credit
Using a service like MyFico.com can help you keep track of your credit. Simply put, you need a high credit score (750+) to give you the best chance of getting a great loan.
Given the current crash in Real Estate prices, it is only a matter of time before you will have the chance of a lifetime to buy your dream home or a great investment property. Get your credit score up in the 700's before you need a loan.
Keep clean and organized records
As you build your investments, 401k, equities, investment properties, and other more complicated investments, it will be critical that you keep good records on all of the investments. Filing your taxes will become increasingly challenging and having quick and clean access to all your information will be key. Start with simple files and excel spreadsheets that tracks both income and expenses, or move up to a program like Quicken if you want more sophisticated tracking and reporting.
If you are self employed, you can often itemize your expenses and deduct them from your taxes. Keeping records and receipts will help get this organized each year.
If you own investment property, you will need to track your income and expenses related to the properties separately from your other records.
When you own mutual funds, CDs or other investments outside of your retirement accounts, you will receive 1099s and K1s. You need to track all of this and provide it to your accountant.
And if you start to trade stocks, you will need to keep a journal of the price you purchased the securities at and the price and date when you sold them.
As you take your investments to the next level, make sure you raise your organizational skills at the same pace.
Secure lines of credit before you need them
This was easier done before the current credit crisis, but still possible if you have home equity lines of credit or even very low interest credit cards. You can take out the cash and simply pay interest. This will lock in your credit line at the level you borrow. In tight times, lenders will cut your unused credit lines down, obsoleting the value of the line and removing your ability to borrow. If your only source of additional cash is a credit line, it may make sense to pull out some cash and put that cash in a CD or other secure interest account until you find a great investment opportunity or find yourself in need of the cash.
Properly earn, spend, invest and save
The following is a very general rule of thumb for saving and investing. After maximizing income and minimizing expenses, the following is the order you should spend your additional monthly cash-flow. Of course it is always advised to discuss your personal situation with a financial planner.
Remember, you need to maximize income. Get a raise, second job or additional source of income if you can. And, you should minimize expenses. Identify what is really needed each month. Minimum expenses should be much less than your monthly income after taxes. You should have ample positive cash-flow at this point.
With remaining positive cash-flow, you should consider doing the following in this order:
1. Invest to receive matching 401k contributions. If your company matches the first 4 or 5% of your 401k contributions, contribute enough to get the full match. 401k matching is the only free lunch and your contributions are one of the few tax free investments. This, combined is about the best guaranteed return on investment you can ever make.
2. Pay off credit cards, from the highest interest rate to the lowest. Remember to pay the minimum payments on the lower interest rate cards and knock off the highest rate card first.
3. After identifying the minimum monthly expenses you are require to pay, keep 6 months worth of cash in a savings account or CD to cover your expenses in case of an emergency.
4. Buy a home or condo. Most consider this to be the most important investment in their lives. I suggest you find a place that can become a good rental property or even buy a duplex and take on tenants or roommates to reduce your total monthly expense.
5. Maximize your 401k. 2009 limits are $16,500. Although you won't receive any additional matching, it is still tax free and among the highest single year returns you can get right now.
6. Open up a brokerage account. Apply for margin and the ability to trade options. You won't do this in the beginning, but having the ability to short a stock or buy a put or call will become a key investment option in the Boomer's Wake investment arsenal.
A simple way to start investing is to invest in 5 different stocks from different sectors, hopefully in boomer or echo boomer friendly industries. Most should be dividend paying stocks but buy at least one stock that has more upside potential. Make sure you have the ability to buy more shares over time and to not invest all your money at one time. When the market seems most fearful, that is a great time to buy some of your favorite stocks.
7. Buy an investment property. Finding cash flow properties is difficult, but it is critical to invest for income and not simply for increases in property values. Calculate the total expenses including interest, taxes, fees, maintenance and vacancy factor. Take the income expected and subtract the expenses. Make sure you can cash-flow break even in the first few years. Although we tend to use interest-only for cash flow projects, always purchase investment properties using traditional principle and interest loans. Over time, you should be able to increase rents and with the depreciation and tax benefits plus possible increase in value, your investment will ultimately return more than you expected.
8. Buy into oil and gas partnerships. Besides participating in projected energy shortages we will face over the next 10 years, you will receive a huge, year one tax write-offs as well as an income stream for years to come.
9. Start a business or invest in a small business with great potential return.
If you are investing at this level, it is time to build a team of advisors to help take your net worth to the next level. (and we will cover this in a future article)