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Why your Budgets FAIL (and what to do instead)

February 22nd, 2018 at 12:31 pm


Are you in a constant battle with your budget? For the first two years of my marriage, I was too. We wanted to be financially responsible and were taught that financially responsible people kept budgets. But budgets are hard.  Luckily, there is something much more effective than a budget to keep you and your family on the right financial path!

Let's start by learning why budgets don't work:

Why Your Budgets Fail:



1. There is no correct allotment
This is probably the main reason people fail.  We tracked our expenses for months.  We figured out how much we spent at grocery stores, gas stations, bills, etc.  We set our budget to those amounts.  We failed, repeatedly.  The reason being that if the allotment was too low, you struggle, run out, then fudge.  

If the allotment is even a little high, you feel like you don't need to try in that category and you actually get worse.  When you see an extra $20 in your "bills" fund you think about what monthly payments you could get that cost $20 or wonder how much more comofortable the house would have been if you set the AC one degree cooler.  If you see it in your "groceries", you relax a little and buy a little nicer meat or more cottage cheese (probably overspending the $20).  If you see it in your "apparel" budget, that cute pair of shoes is not only irrisistable, but "deserved" as a reward for your financial prudence.  You get the picture.

No matter what amount you choose, in some months you will have extra and in some months you will struggle.

2. Categories are confusing
To start off, you've got to set up clear, mutually exclusive categories.  Is nail polish "toiletries", "apparel", or the "wife's discretionary"?  Is the soda you buy for a party "groceries" or "fun"?  It is a personal choice, but you need to think it through ahead of time.



3. Split receipts are a pain
If you buy your kid some socks at the grocery store, does it add to your "grocery" expenses or does it get split out to your "apparel" category?  Costco or Super Walmart receipts are particularly troublesome because just about any type of expense could be on it.

4. You have to break the budget to save money
Last year, we bought a welder and all the accessories from a friend at a crazy good price.  We had been wanting one for years and even have a money-making opportunity that requires one.  We expected to pay more than twice the price we paid.  Had I been on a strict budget, I surely wouldn't have had the required $600 in my "tool" category.  I had just bought some other used tools for my husband's Christmas present.  

When there are great sales on things you plan on getting, you need the financial flexibility to act.

5. Budgets break your soul
What is the purpose of budgeting?  Improving your financial security.  Budgeters will never get there.  You can't feel safe if you are constantly checking your balances and trying to get ends to meet until your next deposit.  

I feel so strongly against constantly checking your balances that when I actually was low on funds during college, I haredly ever checked my bank account. Instead, I would only buy things that I needed regardless of whether or not I had the money. Maybe that was reckless, but I felt it was okay because it had a definite end point as I wouldn't be a college student forever. Because I convinced myself every dollar was my last dollar, my dollars stretched like never before and I actually began to build a sizable buffer underneath my expenses. Yes, sometimes I ate "bread sandwiches" or "salsa rice" or even "salsa-supplemented-with-chili-powder rice", but not once was my bank short the funds needed to cover my credit card's auto-pay-in-full. To me, this felt more free than constantly worrying about how much money I had.

No one wants to feel trapped.  It isn't fun, it isn't healthy, and it isn't worth it.



What to do instead:
For the last three years, we have used an alternative method: tracking and analyzing expenses.  Roughly twice a month, I review my receipts, bank account, credit cards, PayPal, Amazon, and any cash purchases I've noted.  Every item on the receipt is categorized and entered into my annual financial spreadsheet.  I literally enter how much I spent on eggs in a separate line from my lettuce. My spreadsheet then crunches all the numbers and spits out everything I might wonder about our spending and saving habits. It takes a little time, but I can usually get through it in a half-hour and I don't have to think about it constantly like a budget.

I review that data briefly whenever I wonder about it and in depth annually. Every category is compared to the previous year's averages where we can easily spot any "lifestyle inflation" we've accidentally given ourselves. Usually just knowing you've spent more on apparel than normal curbs the issue. I also double check to make sure our over all spending increases don't out pace our take home income increases. To me, that is the most important thing to consider. We currently live off (not including giving or investing) 50% of our take home income. That is a goal I've worked towards and am so happy to have achieved. I don't want to let it slip.

I didn't solve the problem with identifiying categories, but I have practiced enough years that it is easy for me to search my heart and know the purpose of each item. I think it is actually a benefit now as I force myself to acknowledge that some electronics are "home" and others are "toys".



There are so many advantages!
1. I am not trying to target a specific number with each category which really realieves stress and opens up flexibility for smart deal shopping.

2. I can focus on continual improvement as I try to lower (or maintain) each category's monthly average.

3. I have a record of all purchases and dates.  I can filter for specific items and see exactly how many boxes of goldfish I buy annually.  This helps me know how much I can buy without worrying about expiration dates.  I can figure out exactly how much a baby shower cost me by summing the various items.  I can look back and know by my hardware purchases when it was that my father-in-law came over last year and worked on the project car.  I can use filters to know roughly how much I spent in sales tax (for tax return purposes).  This data captures so many things!

4. I can easily figure out good deals.  Since I have the spreadsheet on my phone, I can quickly look up while in a store if I got a better deal on oatmeal at Winco or Costco.  For items that I like to compare, I add information in a unit price section so it is even easier.

5. I can crunch the numbers any way I imagine. I am not stuck with some app that has a thousand features, but won't accept formulas as prices or that won't let me search for all entries with the word "cereal" or won't let me consider my expected income (standard paycheck) vs. bonus income (includes overtime, bonuses, side gigs, etc). I am a control freak and this is the ultimate control.



What we still budget
There are only 2 categories that we still budget out: giving and investing.  The reason those are still in the budget is because they are more like a quota.  We want to spend the full amount each year.  For those unique categories we try to increase the expense, not decrease it.

For those two “budget” items, we’ve found that is by far easiest to stick to your budget with automation. Make sure to have a percentage of your paycheck deposited into your 401k automatically.  Many charities have the ability to accept direct deposits as well.  If you can, set up your direct deposit allotments to put either a dollar amount or a percentage into separate banking accounts for savings, giving, investing, or any other allotment you never want to shortchange. Actually, just go to your library this week and check out The Automatic Millionaire by David Bach. He'll walk you through all the what's, why's, and how's of a conservative way to accomplish goals and get rich over time.

There you have it.  Don't fight the system. Ditch the budget and do something that actually works!

-Milly

Download Milly's Free Spending Tracker Here




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

What to Expect from the S&P 500

February 13th, 2018 at 11:39 am


Many people are counting on an 8% compound interest to get them to retirement. Dave Ramsey’s book “Total Money Makeover” even claims a 12% return! Where on earth did these numbers come from? Are they at all a reasonable expectation?

What is the Long-Term Return on the S&P 500?
To start, I plotted the S&P daily opening values since 1871 (when they started tracking) and added a trendline. I choose to use a trendline to back out all of my expected returns so that all of the data within the range count towards the return. Because the odds of buying at the beginning and selling right at the end are astronomical, I think this trendline method gives a better idea of what people actually experience.



Looking at the equation of that trendline, I could conclude that the S&P 500’s annual return is 4.49%. That is a lot less than 8%.
As you can see though, we need to look a lot closer at the data to see if it actually matches in the trendline. With this zoomed out view, it is impossible to tell if the first 100 years are skewing the trendline down away from the 8% people expect. Because we are seeking the exponential return, a logarithmic graph should show us the data more clearly.



There! Now you can actually see the data. As suspected, the old data is very different from the new data. We are going to have to consider this data in pieces based on historical changes.

I’m going to walk you through several historical periods to get you adjusted to what is historically normal. If you want to just skip to the current period, be my guest and scroll down to 1995.

1871-1914: Industrializing World before the World Wars



During this exciting 38 year period where we experienced serious industrial expansion, urbanization, and erected the brand new Statue of Liberty, the annual S&P 500 return was only about 1.9% growth. Yup, definitely skewing the data down.

1914-1945: World Wars and The Great Depression



During this 31 year period the overall return was only about 1.32%: -1.1% during WW1, 2.14% between the two wars, and 4.83% during WW2. I find the cycle between the wars particularly important to look at as we are currently going through massive build ups followed by devastating crashes. The difference here is that we were still on a global gold standard so the recovery didn’t involve a boost from printed money (inflation).

1945-1971: Tense Global Cooperation



This 26 year period the US experienced several civil rights movements and the major world powers fought the cold war and indirect wars though Korea and Vietnam. This is our first period to yield high S&P 500 returns at 8.9%! Yay!

1971-1995: Goodbye Gold Standard



In my opinion, this is the most important dividing line in our financial history, the flight to fiat currency. In 1971 we got the "Nixon Shock" and the US Dollar decoupled from gold. Since 1971, the very essence of what money is has changed. All major currencies have abandoned any physical backing and floating exchange rates emerged. I don’t know that we can really count any data prior to 1971 towards identifying trends. (see fiat currency).
During this again profitable period of 24 years, the S&P 500 grew by 8.5%, but it lost some ground in the monetary policy switch and shifted to the right before resuming the growth.

1995-Present: Federal Reserve Induced Oscillation



In the piloting world, there is something called PIO, pilot induced oscillation. This is caused by a pilot pulling up, but the airplane delaying its response. The pilot’s instinct is to pull up harder, but when the plane finally starts responding, it is too hard of a pull, sending the plane towards a stall. To correct the error, he or she will quickly nose over and try to dive. Again, the delayed response of the plane intensifies the action as it convinces the pilot to keep pushing down. If the pilot doesn’t fight the instinct to recover, the rollercoster motions will increase in intensity until it suddenly stops and the plane lay in pieces on the ground.

I fear we are experiencing the same phenomenon in the financial world:

Since entering this increasing rollercoaster of crashes and bailouts and bubbles, we’ve dropped back down to, a 4.4% annual return on the S&P 500. That’s just under the all-time historic average of 4.5%, but this time we aren’t gold backed.

That 4.4% might actually be a little high. The graphed data includes 2.5 full cycles: three ups, but only two downs. The next bear market will push the trendline down.

Now I understand that I'm looking at much less data now making the numbers somewhat cherry picked. It is over 20 years though. 20 years is definitely significant in a 40 year career path. I don't really care if I can count on a 100 year return of 8%. I don't plan on working 100 years!

I can't use more data because things probably won't work out the way they did over 20 years ago. Can we really pull numbers to predict the future from before Bill Clinton and Greenspan (former Chairman of the Federal Reserve) started playing with money? I'm worried we can only really expect the 4-5% overall return until money game shifts again. When it does shift, who is to say it will be back to the 8% we got for only 50 years out of 147 or the 8% we got for only 24 of the 47 non-gold backed years?



Unfortunately, one of my hypothesis is that it will actually be a lot worse. If you recall the PIO example, it doesn’t just oscillate forever, expect a catastrophic collapse:

Dotcom boom and bust
With the excitement of the internet, new companies popped up all over and investors poured money into anything ending in “.com”. No one cared how much a company earned, only how many views they received. The Dotcom bubble had formed and the S&P 500 spent 5 years shooting up at a rate of 24.8% annualized.

Eventually, it became clear that many of these companies had failed business models and were going bust and there was a major sell off. The S&P 500 plummeted for two and a half years at a rate of -18.0%. The Federal Reserve slashed interest rates and encouraged investing.

Housing Crash
With the slashed interest rates and incentives, it became very easy to buy a home. With the extra buying of houses, the sticker prices of the houses increased. At first, the increased price simply offset the decreased interest rate, but then people started noticing trends and got greedy. With the house prices shooting up, people started buying houses and using them as banks. Some would buy as big of a house as they could with special interest only loans. The assumption was that they would sell it in a few years for much more than they were in debt for and turn a huge profit. Others took out home equity lines of credit on the appreciation they received on the home they already owned. With this buying frenzy, prices continued to shoot up, and paper wealth abounded. The S&P 500 again shot up for 5 years, this time at an annualized rate of 11.0%. People had thought they found the secret to unlimited wealth. That is, until some people started realizing they couldn’t actually afford the payments that the bank was so willing to sign them on.

Banks began to receive house keys as people walked away from their mortgages. As the buying frenzy reversed, house prices plummeted, destroying the crazy dream of living off home appreciation and putting many families “under water” owing more than their home was worth. The S&P 500 dropped at an annualized rate of a whopping -38.5% for one and a half years. Again the Federal Reserve slashed interest rates, but this time to unprecedented levels. In the dotcom aftermath the interest rates were slashed from around 5% to 1-2%, but this time they went all the way down to 0.1% for years. In addition, the Federal Reserve bought up securities, increasing the money supply.

Dollar Crash?
Again the Federal Reserve is fueling a crash by creating a “bailout bubble”. Each one getting larger than the one before. The interest rates stayed at experimentally low levels low for a full decade. For some reason, people are again thinking this can go on forever and the S&P 500 has grown at a rate of 12.1% for almost 9 years. Investors have become complacent knowing that the Fed refuses to let the market slide and will bail them out in the case of disaster. That’s what it did all through Obama’s administration, but who knows where the new Federal Reserve Chairman and Trump have their priorities: normalizing or market stability?

I worry the next crash will actually break confidence in the US Dollar. I don’t see any way the Federal Reserve can avert the oncoming crisis. I see two options:

1. They could continue to raise rates and shrink their balance sheet (sell the securities acquired after 2008). This would send the stock market into a crash and increase the price of servicing the debt to levels we can’t pay, causing countries to drop the dollar. The dollars would all find their way back home and become worthless.

2.They could reverse rhetoric and start easing to save their struggling economy, but sacrifice the dollar in inflation, also triggering countries to not want the dollar or dollar securities.

Luckily, I am not the one choosing the options. My hope is that there is a third option that those in power will come up with once they notice the cliff they are running towards.

It is hard to know what this will do to the S&P 500. The hundreds of years of data is somewhat useless since we have never had a market like the one we have today. My personal guess is it will crash, then grow but mostly due to inflation.



It all comes out in the inflation wash
If you read my explanation of what inflation really is, you understand that we are really hovering around a 5% inflation! In other words, unless the stock market starts beating its 4% growth, your gains are just adjusting your money to inflation (or pent up inflation). If you have a mixed portfolio with bonds, you're losing to inflation. By all means, that is much better than losing the full 5% to inflation, but it does make retiring a challenge.
I re-ran my retirement numbers with the following grim assumptions:
1. Any money I gain in the stock market will be negated by inflation
2. Any pay increases you gain will be negated by a higher cost of living and taxes

In effect, it is as if we just kept replaying today over and over until retirement.

The good news is with these assumptions, we expect to be millionaires in today's money before I'm 50! The bad news is my husband will have to work till he's 69 before we can retire. Luckily, I should eventually be able to help him out, so I doubt it will really be that long. The numbers are still sobering though. Even maxing out our 401K ($18,000/year) isn't necessarily going to cut it.

If you want to run your own numbers with these depressingly conservative assumptions to see what could be ahead, here's a simple and free spreadsheet.

Bottom line:
If anyone is telling you long term rates (especially Dave Ramsey's crazy 12% expectation), ask how they derived those numbers. The data can be cropped, skewed, and made to tell anything you want. When it comes to something as important as retirement planning, you've got to do your own thinking and figure out what makes sense to you (and don't forget inflation!).
Good luck!
-Milly




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.

Bitcoin vs. Gold

February 7th, 2018 at 01:43 pm



The 2017 Bitcoin Frenzy has led to quite a debate on which is better, Gold or Bitcoin? Some are even calling Bitcoin Digital Gold. I see two ways of addressing this question: Which makes the better money and which makes the better investment. Let's start with the first question:

Which is the Better Money? Bitcoin or Gold?

Scarce
For a currency to work, the quantity must both be fairly low and fairly stable.  If the currency is too abundant, then huge quantities would have to be used for everyday purchases.  If the quantity fluctuates too much, it becomes difficult and speculative to price goods or form contracts.

What makes Bitcoins usable is its elegant, indestructible self-regulation.  Bitcoins cannot be created at the whim of a computer developer.  Actually, no one even knows who created it.  It isn't regulated by a single party, but by the entire system itself (decentralized) and the computer code is open source for all to inspect.  You can't hack your way to Bitcoin creation because the way to create Bitcoins is essentially using your computer to figure out numbers that fits an increasingly difficult sequence.  That number is part of the coin.  If you and your computer can figure out a usable number, then you have legitimately mined the coin.  You can't modify the structure, because it is continuously validating itself and checking for problems.  Because the release of bitcoins is asymptotic, there will never be more than 21 million coins released.  The supply is scheduled (by an adaptive level of mining difficulty) and limited.

Although Bitcoin itself is scarce, there is an infinite number of other cryptocurrencies that can be created and popularized.  Over a thousand types have been created already!  Litecoin, Bitdeal, Beatcoin, BipCoin, Bit20,  BitBTC, Bitcloud, Bitcoin 21, Bitcoin Cash, Bitcoin Planet, Bitcoin Plus, Bitcoin Unlimited, BitcoinDark, BitcoinFast, BitcoinTX, Bitcore, Bitcurrency, Bitdeal, bitEUR, Bitgem, bitGold, Bitland, Bitmark, BitSend, BitShares, bitSilver, BitTokens, bitUSD, BTCGold, BritCoin, Bytecent, and Bytecoin are all trading on the market.  Some are bringing in millions or even billions of dollars.  For this comparison, we will only consider Bitcoin itself and make the VERY poor assumption that if Bitcoin were to be used as a currency, it would be the only cryptocurrency to do so.

One of my friends humorously stated that gold is so rare that you can buy it at any pawnshop in any city.  It is true that there's a lot of gold out there, roughly 165,000 metric tons of it (what that looks like).  It is still scarce though because the available gold supply grows more slowly than the demand for it.  Unlike Bitcoin, there is no substitute for gold.  No other material in existence has the same useful material properties (nearly impossible to corrode, extremely malleable and ductile, efficient at transmitting heat and electricity, and very pretty).

If there is a sudden breakthrough in lowering mining costs, especially if it allows us to mine deeper or in the ocean cheaply, then we could see a supply jump.  That would lower gold's credibility as currency, but I think the yellow metal will always be aggressively sought after.

Winner: a protected Bitcoin

Fungible
I know, it's a funny word.  Fungible means non-unique.  If someone pays me a dollar, I am not worried that they gave me a 2016 dollar instead of a 2014 or a serial number ending in a lucky 7.  For something to work as currency, each piece must have a standardized value and not require a collector's evaluation.



Bitcoins are identical.  Sure the strings of numbers vary to identify the coin, but the users don't know what those strings are.  They are hidden within the code.  All the user sees is a quantity on the screen.  It could be any Bitcoin, or more likely, fractions of many Bitcoins.  By lacking a physical form, I don't think you can get any more fungible without also being easily counterfeited.

Gold is a little more collectible.  People are more willing to pay top dollar for rare or flawless coins, nuggets, and intricate jewelry.  When that happens though, it isn't being used as money.  Those coins and trinkets are effectively outside of the money supply and are a product of themselves.  When gold is melted down, refined, and made into uniform pieces, fungibility is not a problem.  Right now though, gold tends to be special and people care what form it is in.

Winner: Bitcoin

Divisible
It us useful to have a currency with enough precision to represent the finest subtleties of worth.  This allows for transactions of tiny amounts, or slight differences in value.  Imagine if there were no subdivision to the US dollar.  Buying produce by the pound would be a game of "The Price is Right" as you try and get the most tomatoes without tipping it to the next dollar.  Sales taxes would be difficult for stores to directly pass on to the buyer.  Stock market values would be more stair stepped.  It is also important that the sum of the divisions equal the whole.  Four $0.25 pieces cannot be worth more or less than $1.

Bitcoins can be subdivided in to a hundredth of a millionth of a Bitcoin, also known as a satoshi (0.00000001 BTC).  In other words, Bitcoins would have to reach a value of $1,000,000 USD per coin before it is less precise than pennies (1 satoshi = $0.01 USD).  My understanding is that it is also possible to open up more decimal places if needed.



Gold is also highly divisible.  It has been pounded to 0.000002 inches thick for coating astronaut visors.  That is so thin that it is actually translucent!  A single ounce of it can be stretched 50 miles (5 microns thick).  It can be divided into such small particles that you would get more gold scooping up a random cup of dirt.  At some point the divisions of gold will get too small to handle properly or see clearly and counterfeiting would abound.  Imagine trying to buy something small like a candy bar.  It would be hard to weigh out tiny flecks of gold.  It could become standard to use volumes of a standard gold solution or use "gold bills" with tiny flecks laminated inside.  At that point counterfeiting becomes much easier though.  Copper or other metals could be used for smaller quantities, but then your small coin to large coin rates would fluctuate with the relative metal prices.

Winner: Bitcoin

Durable
There have been societies that operated off food as currency.  It is a great system because what is more inherently valuable than food?  I guess water and air, but usually those are both available without cost in these situations.  One problem is almost all foods are poor long-term stores of value.  To invest your life energies into a currency, you need some assurance that it won't be destroyed or made worthless.

Bitcoins are difficult to destroy, but easy to lose.  Since the beginning of Bitcoin, there have been just over 10 coins destroyed on creation.  It turns out, it is possible to earn a block of coins, but not claim them all.  If you claim fewer than the reward, the remaining coins disappear forever.

It is much more common to lose them.  You could send coins (not very likely to happen by accident) to a bogus receiving address, never to be used again.  Thousands may have already been lost to this method. Another method is to put an OP_RETURN script on them (I don't know what that means either), which paralyzes them from future use.

Probably the biggest problem is if one loses access to an account via computer crash (with no backup or paper record), forgetfulness, or dies without passing it on.  There is no third-party you can call to open the account for you.  Likely the largest holder of Bitcoin is its creator with about a million coins.  There is also speculation that this mysterious person has died with those coins never to be circulated.



Gold, on the other hand, is here to stay.  It cannot be destroyed.  I guess you could chemically dissolve it and disperse it to the point where it is no longer economically practical to mine again, but that's about it.  It is also possible to lose gold, but unlike Bitcoins where there are more combinations than the entire energy of the sun could go through with a perfectly efficient computer, I imagine gold usually eventually gets found.  In any case, you'd never accidentally lose it to shelf-life or damage.

Winner: Gold

Transferable
You must be able to easily exchange the currency to properly use it in commerce.



Bitcoin has a great advantage in that it can be digitally transferred.  I can pay someone from across the globe with Bitcoin.  In person it is just as easy.  All you need is your smartphone with a specialized app.  

Of course Bitcoins are not widely accepted yet.  Sure you can use Bitcoin for Overstock.com, Newegg, Subway, Microsoft, Dish Network, and Virgin Galactic as well as anything from charities, to local shops, but I don't think anyone pays their rent in Bitcoin.  I believe most of the companies that do accept Bitcoin trade for their preferred currency as soon as possible.  They don't actually want the Bitcoin, they just want to tap into the paper assets the Bitcoin owners have.  If the Bitcoin volatility settles off, we could see a change here.  

Another problem Bitcoin is facing is it is expensive to transfer and very slow. Users are repeatedly suprised by extreme and varying transaction fees and sometimes loose access to their coins for days as they are stuck in transactions.

The other restriction to Bitcoin exchange is the requirement of hardware and internet.  If the power goes out or service is disrupted, you are stuck.

Gold, unfortunately, loses ground here.  The advantage to gold is that you could use it in a pinch even without electricity.  It has been used as money for thousands of years, so even if they are not set up to take gold, they might make a deal.  

I don't think physical gold could ever return to the normal currency status though.  Imagine if you had to mail out gold pieces before ordering anything online!  That would be even more expensive and slower than Bitcoin. Even in person it could be a pain.  As mentioned earlier small denominations could prove problematic.  In order to make tiny fractions usable, they will have to be packaged.  That could get bulky or counterfeitable.



There is a solution though!  GoldMoney Mastercard lets you preload your card with a certain amount of gold you buy out of their vault.  You can then use your card just as any other prepaid card.  You simply are selling back your gold at whatever the current market price is and GoldMoney sends the dollars to the seller.  The physical gold is also available for your request at any time if you'd prefer to cash out in gold.  Of course, you are still limited to companies that take Mastercard and you'll have internet and hardware restrictions.

In theory this system is brilliant.  Just be careful because this is a major tax grey zone and the company is unproven.  Similar companies such as e-gold and MtGox have failed and the users lost. I think this company will do fine, but do your homework first.

Winner: Bitcoin

Overall, is Bitcoin or Gold best as a Currency?
Both mediums of exchange do very well on most categories and MUCH better than the US Dollar when it comes to scarcity.  I think the transfer of gold is just too crippled in the digital era and Bitcoin was designed as an attempt at a perfect currency. Bitcoin takes the overall best currency win.

Note: This is still taking into consideration the HUGE assumption that Bitcoin has a monopoly on cryptocurrency and other variations are barred from the market or fail for other reasons.



Unfortunately, just because Bitcoin is a more useful currency than gold doesn't necessarily make it a good idea to buy.

Which is the Better Investment? Bitcoin or Gold?

Inherent Value
Bitcoins don't exist!  They are just a blip on the screen and are as real as Pokeballs.  Just because they don't exist, doesn't mean they aren't valuable.  A Picasso painting is only useful for looking at, yet they can be worth millions.  The same can go for other unique and rare virtual items.  Americans spend billions of dollars every year purchasing pixels.  Some even flip-sell in virtual markets.  When all is said and done though, there is nothing of value in the Bitcoin except its clever novelty.



Gold actually is fairly similar in this aspect.  Most gold isn't productive either.  52% is used in jewelry, 34% is reserved as money (government holdings, individual retirement, etc), and only 12% is used industrially.  The remaining 2% is unaccounted for.  In the extreme case where all "pretty" or "hope to resell" gold was dumped on the market as people need money, the industrial demand should still command a fair price in the growing technological world.  This isn't a very great way to look at it, but I'm not going to devote more time to the study:  12% of $1,330 (Feb 2018 price) is $160 per ounce, so you could probably expect that much as a bare minimum.

Winner: Gold

Market Cap
First off, Bitcoin's price passing gold's price (and even trading in 5 figures) means nothing.  If twice as many Bitcoins were released in each block, then the price per Bitcoin would be roughly half the current amount.  If we wanted to look at gold in pennyweight, Bitcoin would have passed its price in 2013.

What does matter is market cap, or how much money are people willing to collectively dump into that investment vehicle.  Most experts agree that in all of history roughly 165,000 metric tons of gold has been mined.  That is 5.4 billion troy ounces.  With the current market price of gold of about $1,330 USD (Feb 2018), that is a market cap of about $7 trillion US dollars.  As of 5 Feb 2018, there are a total of 16,845,938 Bitcoins mined.  With a Bitcoin price of $8,271 USD, the market cap is about $139 billion USD (over 50 times smaller than gold).



That is actually quite impressive considering cryptocurrency has only been around for a few years.  It is amazing that something so new could capture that much market.  There are three problems with this picture though.

1. The Bitcoin market cap changes pretty dramatically day to day.  Since Jan 2017, the weekly Bitcoin price spread has averaged at 22%, whereas the weekly gold price spread has averaged at 2.3% in the same time period. Bitcoin's record weekly change since 2017 could be as high as 80%, but gold only had one instance over 10% in many years (when President Trump was elected) and quickly resumed it's normal pace. Bitcoin is extremely volitile.

2. Bitcoin isn't the only cryptocurrency out there.  Ethereum, the second largest cryptocurrency as of writing, was only released in July 2015.  At initiation, its market cap was about 3% of the size of Bitcoin's.  A year later it was 10% the size of Bitcoin, 11 months later (June 2017) it peaked at 83% the size of Bitcoin.  If there were no other cryptocurrenies, Bitcoin would have lost almost half of its market to Ethereum.  Of course there are over a thousand other cyrptocurrencies that are also trying to eat Bitcoin's market.  Although Bitcoin has gained some of that market share back (Ethereum's market cap is about 60% the size of Bitcoin's), it is easy to imagine another currency disrupting it's position in the future.

3. Bubbles always grow... until they don't.

(here's my Cryptocurrency Excel Spreadsheet, dated 5Feb2018 ,if you want to play with the data yourself)




I love the idea of cryptocurrency, but I just don't know that Bitcoin is going to be the winner.  Something I learned from Peter Lynch's Beating the Street is a company gaining market share in a depressed industry is generally a great buy.  Bitcoin was losing share in a booming industry.  In other words, we might be paying top prices during the hype for something that won't last.

Another Lynch rule Bitcoin breaks is that if your shoe shiner is telling you to buy a particular stock, it is time to get out of that market.  We are to the point that people who have never bought precious metals, foreign currency, or even an individual stock in their life have heard about the millions some have made in Bitcoin and are advising on the matter. Even as Jannet Yellen gave a testimony to congress in July of 2017, a man held up a "Buy Bitcoin" sign in the background.

Here's a place where you can listen to up to date podcasts about the financial markets, he almost always does a few minutes at the end on Bitcoin: Peter Schiff Show

Winner: not Bitcoin

Politics
Bitcoin's position is precarious when it comes to government.  Bitcoin is legal in most countries, but rules and restrictions vary by country and are still evolving.  In the swish of a pen, Bitcoin could become illegal, deemed a "security" and have massive regulation, or be heavily taxed.  The anonymous nature of the coin would make it difficult to enforce, but companies would not be able to offer Bitcoin as a payment option, restoring it to its original limited peer to peer nature.

Gold could also come under condemnation.  Particularly since WWI, governments have been manipulating gold away from the people.  The good news is that, as a physical commodity that has been around for longer than human law, things change less frequently and there is a long list of precedent cases to draw from.

Winner: Gold

Definition of a Bubble



If people are buying an item solely for the purpose of reselling due to a climbing market, you can bet you're in a bubble.  If you buy whatever is going up in stocks instead of researching the actual company or at least the dividend history, you need to rethink your strategies.  I think most people who buy Bitcoin buy it because they see huge gain numbers that previous holders have seen and get dollar signs in their eyes.  They don't actually want the Bitcoin, they want profits.

In contrast, I think many people who hold gold don't do it because they think gold's value will skyrocket, but because they think the dollar will tank.  They aren't looking to flip-sell.  They are looking to protect.

Winner: Gold



Overall, is Bitcoin or Gold the better Investment?
Although the argument for Bitcoin as a currency is extremely compelling, I don't recommend it as an investment choice.  If you are dead set on Bitcoin, don't just buy it because it is gong up, but because you believe it is the future of money. Or even better, invest in a company that facilitates the transactions and benefits from Bitcoin volatility, whether up or down.



Gold does provide a decent hedge against the dollar and is a sound investment.  Of course, in a future post, I will show you something even more powerful.  Subscribe to my newsletter in the left sidebar so you don't miss it!

Good luck!
-Milly




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

Should I buy Gold or Silver?

February 5th, 2018 at 09:52 am

This is part 2 of Milly's "Precious Metals for Beginners" series. For part 1 see: Why you NEED Precious Metals in your Portfolio.


One of the first things to consider is what type of metal to buy.  I'm only going to consider silver and gold in this analysis for 3 reasons.

1. Other precious metals such as platinum and palladium are foreign to the average person.  Yes, they are valuable.  Yes large dealers know what their worth and you could probably sell them when ready.  You'd have a much harder time selling them to your neighbor though.  They look a lot like silver and most people have no clue what their worth is.

2. Copper and other industrial metals have little value when compared to other things you could put in storage.  At today's prices, a pound of copper is less than $3.  The upside to copper is it is fun.  For less than $2 extra on your gold coin order, you can get an extra replica (made out of copper, larger, and with a different reverse) just to play with.  Or you can get other designs just for fun.

3. I've only studied gold and silver, so anything I say about other metals is unfounded.

Denomination
In some ways asking if you should buy gold or silver is akin to asking if is it better to put your cash savings in $1 bills or $100 bills.  Both operate by the nearly the same means, but have different liquidity and portability.

Silver is a great choice because it is more divisible.  Although gold can be pounded to 0.000002 inches thick and easily broken down to less than a cent's worth in value, the smallest bars major dealers circulate is 1/2 gram and rarely under 1 gram (that's tiny and very thin!).  At today's $1,330ish spot price, 1 gram is worth about $43 USD.  Silver, however, is at about $16.70/toz (at the time of writing) and also can sell in 1 gram bars that's $0.54 a bar!  Smaller denominations make it much easier to actually use for things like groceries.

The problem is, if you try and put some of your life savings into precious metals, that could amount to quite a bit of silver.  You can carry enough gold just on your person to start a new life.  It is also easier to hide since gold is much smaller than it's silver equivalent.  If gold were $1,330/toz and silver were $16.70/toz, the gold would be about 80
times lighter and about 147 times smaller than the same value of silver!

I guess, it comes down to how you imagine needing the metals. Will they be used for day to day life? or bulk wealth preservation? Probably a mixture of both.

Markets
Another consideration is the two have separate markets and their relative prices vary.  Right now, Gold is about 80 times the price of silver.  Since 1995 (just before the dotcom boom), that ratio has averaged around 62.  In other words an ounce of gold will buy more silver today than it has for most of the last couple of decades.  Silver is "on sale" in terms of gold.  Of course, there is always the possibility that this is the new norm.

Another thing to note is that silver might be more volatile than gold.  If you normalize the two metals in 1995 like I did in the graph below, you see that silver jumps to a higher percent gain than gold does in both the dot com and housing crises, then comes back together at the resolution.  If you are trying to play the market, buying low and selling high, silver might be the more useful vehicle.



One final market consideration is found in monetary policy.  Fiat currency is starting to fail on a global scale.  No country is willing to admit this because they are desperately trying to keep confidence in their paper money, but the complex systems of national debt, supposed assets, and inflation have reached unsustainable levels.

In the background, India, Russia, and China are buying up immense amounts of gold.  A while ago I heard some whispers about a backing of the dollar by gold and other assets. A few months ago I heard one about indirectly backing the Chinese yuan with gold.  Both of these seem like very far fetches, but what choice do we really have?  With Donald Trump's nominating 5 of the 7 Federal Reserve Governors recently and in the near future and Trump's history of "stirring the pot", who knows?  Maybe he could actually pull something off.

Regardless, I think it is clear that countries know that gold is their best chance for a favorable end game, but it is a very delicate game. There is a lot more money than gold (at the current prices) and no one wants to loose the confidence of their currency.

If any country does make the jump, it will likely put a huge upward move on the gold price and not have the same amount of force on silver.

Of course, that also means a higher confiscation risk, especially with the historical precedent. I don't think silver will be cost effective for the government to confiscate, at least not at the individual level.

Summary:
Silver is better for day to day bartering.
Gold is more efficient in terms of size/weight.
Silver may be a better deal right now.
Silver may be better for playing the market.
Gold may be better for long term moves.

How you should invest is based on your personal needs and philosophies.

Good luck and enjoy your shiny wealth!
-Milly

This is part 2 of Milly's "Precious Metals for Beginners" series. For part 1 see: Why you NEED Precious Metals in your Portfolio.



Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.

Inflation - A Tax on your Savings

January 29th, 2018 at 02:38 pm



You get taxed on your income, you get taxed when you spend it, you get taxed on your property, you get taxed when you visit other properties (hotel tax), and you get taxed when you die.  Americans are subject to taxes in every form.  What most people don't realize is that the government taxes savings as well.

Yep, after you put in your hard effort earning at a discount, buying at an increase and trying to make those ends meet, the government steals away a significant portion of the money responsible people and businesses set aside.  The money is taxed as you earn it, then anything unspent gets taxed repeatedly until it is reduced to nothing.  

What really drives my crazy is there's an old economic saying that you get more of what you subsidise and less of what you tax. The government is taxing the very behavior that prevents individuals and companies from needing bailouts and welfare programs. What does that lead to? More dependency, less freedom.

How are they stealing savings?
One word: Inflation

How is inflation the government stealing savings?
It should be fairly obvious that inflation causes the buying power of your savings to go down.  You might be able to buy milk today for $3.  In a few years, it might cost $5.  In other words, if you put your money into a stagnant account it lost 40% of its buying power.  By setting it aside for your future, you just made your $3 worth $1.8.

Even with an inflation as the current target of 2%, prices will double 2.3 times in the average lifetime. Increase that to 5% and you're looking at almost doubling 6 times! Even normal inflation levels can drastically reduce your wealth.

What is less obvious is how this puts it into the government's pocket.  Imagine you are in severe debt.  Wouldn't it be nice if dollars were worth less?  With a government as in debt as the United States, it is pretty easy to see why they might like inflation.

Inflation is a socialist.  It takes from the prudent and prosperous to benefit the reckless and failing.

But wait Milly, inflation has been near zero for a decade and hasn't been high since 1981.
I guess it all depends on how you measure inflation.

When you look at inflation data, it is usually represented by the CPI (consumer price index).  What is the CPI?  Supposedly it represents the price of household goods.

A tricky method many economists use is the "Core" CPI, a CPI that excludes energy and food.  The justification is that energy and food costs are much more volatile and large moves in those prices don't necessarily indicate true inflation.  The truth is that CPI isn't that great of an indicator unless you are averaging over a long time anyways, negating that argument.

The problem with "Core" CPI is that it is held artificially low by more heavily weighing items that rapidly decrease in price as technology develops.  Remember buying a 1G thumb drive a few years ago?  What does a 1G thumb drive sell for today?

Often they'll even take it a step further using hedonics. With the hedonic regression, they break items down past their unit price into their constituent parts. In other words, TV screens might be much more expensive than they were in 2000, but maybe the per pixel price has gone down, so they announce deflation. Who knows what formulas they use for completely new features on smart TVs. I can buy an amazing smart TV today for a few thousand dollars, where as in 2000, I would have had to pay a team of computer engineers to research it first. With that mentality, a smart TV's price has come WAY DOWN! Just look at the communications portion of 2017's CPI. Did your phone costs go down 4.9%?

Now look at your own expenses from groceries to electricity to toys.  You know prices are going up.  When prices do go up, what is the first thing you start trying to adjust to meet your budget?  Probably energy and groceries, exactly what "Core" CPI doesn't include.  Energy and food matter a lot to the consumer!

The bottom line is that by using different indicators and clever math, inflation can be carefully crafted to whatever the Federal Reserve wants it to show and that means low inflation.  They've even kicked their game up a notch and are making a huge show to try and increase inflation, as if that is a good thing.  If they can get us excited about avoiding deflation, their job gets a lot easier.

Latest CPI data broken down into subcategories and months
Weighting of categories and locations for the CPI (in 2014).  

I ran the numbers against my personal spending percentages for 2016 and the weighting they give each category (at least in 2014) seems reasonable.

Why are they concealing the true inflation?



Every time the Federal Reserve adds dollar, money  already distributed decreases its share of buying  power.  The United States depends heavily on borrowing.  If they let the rest of the world know what they are doing to the value of the dollar, who would loan us money?  At a minimum, they would demand interest to adjust with real inflation, something we simply cannot afford.

Officially low inflation also keeps domestic benefits cheaper.  If they released what the true inflation was, they'd have to also increase Social Security benefits.  Tax brackets would raise as well, limiting the money we give them.

Economists' Plea for More Inflation!
Just hiding inflation won't work forever though. On June 9, 2017, a group of 22 prominent economists including former Federal Reserve President Kocherlakota, wrote a letter urging then current Federal Reserve President Yellen to raise the target inflation rate above 2%.  The argument is that with only 2% of room to play, there will not be enough "ammunition" in an economic downturn to raise up employment with near-zero interest rates (closely tied to inflation).  In other words, if the expected inflation was at 5%, near-zero interest rates would be closer to 5% lower than expected and produce a much faster recovery than a 2% lower than expected interest rate.

Kocherlakota also states, "periods of zero nominal rates are likely to "be more frequent".  With the current 2% inflation target, the rates will need to be at the "zero lower bound about 30 percent to 40 percent of the time."  It is clear that Kocherlakota sees that the economic times have changed and drastic measures must be used.

What is crazy is the Fed's are saying it is great that we are on track and even above our target 2% inflation as if that is good news. They also say that 3% is okay since inflation has been so low for so long. Three problems with that thought:

They are acting as if their target 2% is a benchmark to beat. Shooting an arrow a yard above your target isn't a good thing.  They are making it sounds like we don't need to worry about anything, we are already exceeding our annual goals!

It hasn't been near zero for long. It  averages pretty close to 2% since 2008.

Even if we were near zero for a decade, that mind-set is very hard on the consumer. Imagine going years of near zero inflation. In your perceived prosperity, you load up on all forms of debt.  Then, suddenly prices jump in one year. Between higher living costs and adjustable interest debt (such as credit cards) your budget becomes VERY tight.

Note: the other way they could achieve these results is to toy with Europe's idea of NEGATIVE interest rates.  In other words, paying someone 3% for them to hold your money for you.  This idea could only work if money is trapped in the system.  Like in [href="http://money.cnn.com/2017/01/04/news/india/india-cash-crisis-rupee/index.html]India[/url], we could see a situation where paper money is forced to be converted to digital money, where Uncle Sam can see, track, and tax it all.

So how should we be measuring inflation?
Good question!

You could think of inflation as having two components, the supply of money and the velocity (how frequently the money is passed from person to person in a year) of that money. One is formed by monetary policy, the other by the behavior of the people within the economy. Let's start with money supply:

M3 - Broad Money



Money supply is measured in several categories.  The most useful in this case is M3, or broad money.  This includes cash as well as assets easily liquidated into cash (savings accounts, money market accounts, CD's, repurchase agreements, etc.)  If you look at a historical chart of this number, it has been steadily increasing until 2006, when the Federal Reserve announced they would no longer provide M3 numbers (source).

When my daughter is about to do something she knows she'll get in trouble for, she shuts the door or asks me to go into a different room.  If broad money was increasing like it was when openly disclosed, what do you think has happened since 2006? If you check out shadowstats.com for a private sector calculation of the numbers, you can see a dramatic ramp up in money.  Is there any wonder why there was an inflated real estate bubble and a massive falling out in 2008 with double-digit percentage increases in broad money?

Note: to learn more about where money originates look here: What is Money? and the US Dollar Machine

Velocity
This component seemed strange to me at first. Why would exchanging money make it worth less? Try thinking about it this way. If twice as much money passes through your hands annually, but there are still the same number of products, the product will have to cost twice as much to prevent a shortage.

The Federal Reserve doesn't seem to be worried about inflation because they believe in a "goldilocks economy" that is not too hot and not too cold which is easily tuned with economic easing/tightening if something does get a little out of balance.

What they fail to realize is how behavioral based the velocity component is. Right now, as businesses and families feel economic strain, they look towards securing their future and save money as best as they can.

What happens if inflation breaks out even just a little? Suddenly, analysts will advise corporations to spend on upgrades, inventory, and raw supplies while their money has more power. With the increased corporation spending, prices will rise and individuals will catch on. With a subtle shift, that saving could turn to a spending frenzy that grows exponentially.

I think we are sitting on a situation even more volatile today than in any of the historical hyper inflation stories. On the corporate level, companies rely on computer data and analysts more than ever. With this data and statistical analysis, the strategy has become operate on the tiniest margin possible to capture the largest market share. What happens when a company as large as Walmart or Amazon notice a bad inflation trajectory? Dollars will pour into the economy as fast as the companies can wisely manage it as they scramble to protect their tiny margins.

On the individual level, social media can create massive behavioral movements in just a few days. As each move is made, more parties will catch on and the more aggressive each party will have to become.

What can we Do about it?
There really isn't much we can do to stop the problem except spreading awareness and electing officials brave enough to stand against the Federal Reserve.  Luckily, you can protect yourself from the effects.  When you are storing your economic resources, don't leave the bulk of it exposed to inflation.

The commonly advertised way to do remove the effects of inflation is by investing in TIPS (Treasury Inflation Protected Securities).  When inflation increases, so does the payout.  One major problem, the official inflation tracks CPI, not the money supply/velocity.  Your savings will still get eaten by the dying power of the dollar and you are back where we started.

Here's what you should do.  Keep your emergency funds liquid and ready, but diversify your deep savings such as retirement.  Most people think diversifying their portfolio means investing in various stocks and bonds.  But what happens if it is the dollar that crashes?  All of those deals and obligations become worthless regardless of how diverse they were.  Instead invest in some domestic stocks, some foreign stocks, some real estate, some precious metals, some in long shelf-life food storage, and most importantly invest in your own personal education and skills.  With a diverse portfolio like that, you can weather any depth of economic crisis and make it out just fine.

Further reading:
Peter Schiff's Crash Proof 2.0
What is your money? and the US dollar machine
Upcoming US Economic Collapse - How and Why (coming in a future post)
How NOT to Prepare for the Economic Crisis (coming in a future post)




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

What is Money? and the US Dollar Machine

January 25th, 2018 at 02:24 pm



Why do we have Money?
The purpose of money is to store our economic value (time, efforts, resources, etc.)  Without money, a carpenter would have to find a chicken farmer that needed a new table if he or she ever wanted eggs.  Because of monetary systems, the carpenter can produce a table, sell it to anyone, and use the money over time to buy groceries from various sources.  Money greatly increase the efficiency of an economy.

Commodity Currency



Money comes in various forms.  Commodity currency is money that has value in of itself.  Salt has been used in Eastern Africa, tea bricks in Central Asia, Parmigiano cheese in Italy, cocoa bean in Central America, and pemmican in North America.    Cattle, knives, and even potato mashers have been used as well.  The most obvious example of commodity money is precious metal.

A lump of gold has substantial value no matter where or when you live.  It is easily worked, carries a current, and is stunningly beautiful.  To further ease transactions, the metal currency is often minted into coins or bars that are recognizable, standard in size, hard to counterfeit, and noticeable if shaved or clipped.  This allows it to be exchanged without a scale and without fear of purity issues.  The advantage of commodity currency is it will always be worth something.  The disadvantage is that it is less portable and cannot be transported digitally.

Representative Currency



Another type of money is representative currency.  This is a certificate that can be redeemed for a commodity (something of value).  Effectively, the object stays in place, but the title of ownership changes hands.  The United States operated under this form of currency for nearly a hundred years.  The United States’ paper money used to be exchangeable for actual silver at the Federal Reserve.  An advantage to this method is the commodity doesn’t have to be continually packed by the owner and it doesn’t get worn or abused.  A disadvantage is it masks the commodity and puts it in someone else’s control.  If there is doubt that the certificate can be redeemed, the purchasing power of the certificate will plummet.

Fiat Currency



The final type of currency is what almost everyone carries today, fiat currency.  This is currency that only has value because someone says it does.  It is monopoly money when playing a game, tokens when at an arcade, stickers when paying the postage, fancy green paper with historical figures when paying in cash, and a blip on a computer screen when ordering online.  In their own domain, they are each valid currency.  If I were to pull out a checkbook while playing Monopoly, it would ruin the game and if I were to use Monopoly money at the grocery store, I wouldn't have any eggs for dinner. 

If the rules within the domain are unchanging and fully backed, the system works.  I’ve never had a hyperinflation problem while playing Monopoly, because I've never designated an official "game rule maker" who announced midgame that prices would double with each dice roll.  The problem with the real world is there are "game rule makers": the US government, the US Federal Reserve, and other law makers or currency regulators throughout the world.  They constantly play with currency supply, interest rates, commodity prices, taxes, tariffs, and treaties to meet their objectives. Unfortunately, this manipulation has caused the collapse of both the currency and the economy dozens of times in the past.

The US Dollar



The US dollar is even one step more convoluted.  They are not owned by the US Government, but by the Federal Reserve System.  If the US Government needs more dollars than what it collected in taxes, it sells government securities (government debt) in the form of Treasury bills, Government Bonds, and Government Notes. These are bought by other countries, investors, or the Federal Reserve and will eventually need to be paid back with interest. When the Federal Reserve buys the securities, it creates money out of thin air and is reffered to as "printing money", even when digitally created.

Reserve Currency Status



In 1944, 44 delegates from 44 Allied nations gathered together in Bretton Woods New Hampshire to discus global finances in the WWII aftermath.  At the time of the Bretton Woods Conference, the United States was the leading exporter and creditor and the dollar was exchangeable for a fixed quantity of gold (representative currency).  Because of the United States' strong currency, the delegates selected it to be the international reserve currency.  

As the global reserve currency, other nations would have to first trade their money for dollars before exchanging with other countries to settle debts or purchase comodities. Countries also hoarde dollars as their own personal reserves the same way a household would hold some available cash for difficult times. It also serves as some protection against adverse exchange rates with their local currency. No one wants to scramble for dollars when they are needed because that is also likely when they are the most expensive.

Because countries need dollars, it creates an extra demand. This proping up of the dollar and gives the United States a huge advantage in power and prosperity.  As the only legal producer of the US dollar, we also get a discount on transactions by avoiding exchanges.  Much of the prosperity we experience today is directly dependent on holding the reserve currency status.

In 1771, the United States released a series of economic measures known as the Nixon Shock.  It was in these monetary policies that the US dollar lost its representative currency status and fell to a true fiat currency.  This should have plummeted the value, but other countries weren't willing to declare their dollar holdings worthless.

The US Petro Dollar



Knowing the dollar had to be backed by something, even if indirectly, in 1973 the United States made a brilliant deal to protect Saudi Arabian oil fields (specifically from Israel) on two conditions. They had to agree to only sell oil in US dollars and invest their excess profits in US government debt securities.  By 1975, this deal was expanded to all OPEC nations, creating the US petrodollar.  These deals forced other nations to buy US goods to obtain US dollars despite the physical worthlessness of the paper money.  The deals also gave artificial demand to US government debt securities, lowering the interest rates significantly.  Basically, the US is able to print money to buy oil, then have the oil producers buy the debt used to print the money!  It is this circular system that allows the US to print nearly as much money as it wants.

In the past, some oil producers have tried to switch away from the petrodollar system and have felt the full force of the US military.  In Iraq, Saddam Hussein traded his oil for Euros, so we searched for an excuse to take him out.  With the 9/11 attacks, we chose to ignore the fact that most of the hijackers were Saudi (our petrodollar ally) and instead drew up plans against Iraq as the answer.  Kaddafi sold oil in Dinars and met the same fate.  Just about every military decision since the Industrial Revolution is oil dependent.  Vietnam, Pearl Harbor, and even the assassination of Archduke Franz Ferdinand (triggering WWI) all have underlying oil motivations.

Basically, the United States of America, knows that oil rules the world.  If the petrodollar system is threatened, the economy will collapse.  Even President Franklin D. Roosevelt once said, “I hereby find that the defense of Saudi Arabia is vital to the defense of the United States”.

Unfortunately, China has a growing thirst for oil and is now Saudi Arabia's biggest customer.  At the same time, the US oil orders are declining.  Saudi Arabia feels somewhat betrayed by our relaxing of policy against their enemy, Iran, and is questioning the need to maintain the petrodollar system.  In 2010, Russia and China struck a deal and now will exchange oil directly, skipping the dollar.



If oil is bought without the US dollar, nations will have much less tendency to hoard dollars and they may find their way back to the US, quickly.  Countries will want to cash in on their US debt holdings and the dollar value will tank as the domestic money supply skyrockets into hyperinflation. The US dollar is in trouble.

Good luck!

-Milly





Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

A Penny Saved is 1.57 Pennies Earned

January 23rd, 2018 at 02:53 pm



There is a long standing understanding that a penny saved is a penny earned.  I submit that the statement is false.  Here's why:

When you save a penny by substituting out cheaper alternatives, using coupons, or other means, you become one penny richer.

When you earn a penny, it must enter a pool of tax piranhas before you can take a fraction of it home.

Let's start at the Federal Income Tax



When looking up my effective tax rate of 2% on my federal tax return, I really don't feel that bad about taxes.  To make me even happier, it has been going down every year since we were at 7% in 2013 (before we had 3 tax credits, I mean children).

Since we are talking about the marginal level, we will ignore the effective tax and look only at the tax on that last penny earned.  For most Americans, this is a 15% tax ($18,550-$75,300 taxable income for 2016).

Social Security & Medicare Tax
Also taxed at the federal level and collected by the IRA are the Social Security Tax (6.2%) and the Medicare Tax (1.45%).  This is a flat tax with no brackets or caps until $118,000.  These taxes are in addition to the federal income tax and neither one is deductible from the other.  The vast majority of Americans pay the sum total of a 7.65%  tax towards these funds.

State Income Taxes



Each state has its own income tax and tax brackets ranging from 0-13.3%.  I'm going to use California as an example.  The average Californian household income was about $64,500 in 2015 (source), If they don't have a $4,522 worth of deductions, that puts them in a 6% tax bracket ($59,978-$83,258).

Running Total: 28.65% tax

Unfortunately, that's not the end of the story...

Invisible Taxes
Yup, we have those too.  It turns out businesses must also pay additional Social Security and Medicare taxes when they pay you.  Your employer sends off both portions before you see any money.  Although one is "paid by company", the company sends both portions out of your wage by simply paying you less.  This adds another 7.65% tax, bringing you up to a running total of a 36.3% tax.

Corporations also pay an "income" tax.  Economists debate as to how much of that tax is actually transferred to the workers and how much is "paid" by the share holders, but 20% of the 15%-35% tax is a pretty good estimate (source).  Because I have no clue how to estimate how much earnings per employee is a good estimate, I'm going to leave off this tax in my numbers. Just know that your income is taxed even higher.

A Penny saved is 1.57 Pennies earned



With a tax of 36.3%, you would have to work the equivalent of a 1.57 cent wage to take home 1 penny.

$0.0157 * (1-0.363) = $0.01

There you have it, while earning extra money is really nice, much of it disappears long before you see it.  Dollar for dollar, saving is a more powerful tool.

Limits
Obviously, there are limits to this thinking.  There is only so much money you can save and infinite money you can earn.  It is also true that there is infinite money you can want to spend.  You can have a million dollar salary and still be broke.

It is also important to note that saving money isn't really saving money if it leads to a more costly alternative.  Ignoring the oil changes and being forced to buy a new engine, is obviously a bad idea.

Where to focus your efforts, depends on where you are on your financial journey.

-Milly





Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

Ultimate Anti-Take Out Plan

January 22nd, 2018 at 09:19 pm



It's been a long day at work and an hour past your usual dinner time.  As you approach your home, you drive past your favorite Thai restaurant.  You had better have a equally tempting anti-take out plan.

You are pregnant and feel rotten.  The more you think about food, the more disgusting it sounds.  At the same time, you know if you don't eat something soon, you'll just be sicker and your family will be grumpier.  You had better have a simple anti-take out plan.

You just got back from an extended vacation.  Anything perishable in your fridge has perished.  You haven't done any meal planning and don't have time to hit the store anyways.  You had better have a robust anti-take out plan.

The window between helping someone move and your child's performance is closing rapidly.  You are going to have about 20 min total to cook, eat, and change clothes.  You had better have a lightning-fast anti-take out plan.



Want a 5% Raise? Get an Anti-Take Out Plan
According to the Bureau of Labor Statistics, the average American household spends $3,008 on food away from home.  Zagat determined, that 4.5 of meals are eaten out weekly.  That's 43% of their entire food budget on about a fifth of their meals!

Surprisingly, lowest 20% of income earners, the middle 20% of income earners, and the highest 20% of income earners all spend 5.1-5.4% of their total income on eating out.  With this plan, I've reduced my eating out to less than 1% of my annual spending and even less of my annual income!  In other words, rich or poor, we can all give ourselves about a 5% raise with a solid anti-take out plan.

What type of raise do you get annually?  1-2% to keep up with inflation?  3-8% in a developing career?  Imagine if you could tack on an extra 5% this year! Since that is a tax-free raise (see my post: A penny Saved is 1.57 pennies Earned!), it is probably actually closer to 7-8%.  That is the power of an anti-take out plan.

The Anti-Take Out Plan
Option #1: Lightning Fast Meals
My favorite is meals that I can make in a flash.  If you can have a fresh, tasty, home cooked, inexpensive meal in less time than driving to a restaurant, it makes it easy to follow through.  Make sure your anti-take out plan only uses ingredients that you pretty much always have on hand.  I can make a tortilla soup in 15 minutes (instructions below), but I don't usually have 4 tomatoes available to blend (canned tomatoes?).

The key is to have lots of ingredients ready to use in the freezer.  Pre-cooked meats and diced veggies are a life saver!  Every time I cook chicken breasts on our smoker, I throw in twice as many as we need, dice it, and freeze it in Ziplocks.  Make sure to lay them flat so they are easy to break off into smaller portions or thaw quickly.  Whenever I get a bag of onions, bell peppers or broccoli are on sale, or I pull beets out of the garden, I dice them all up and do the same thing.  I even do this after cooking a pot of beans to avoid the price of canned.

If you aren't going to do any of these, at least buy frozen cooked meatballs, diced grilled chicken, and frozen veggies.  It isn't quite as cheap, but it sure beats eating out!

Here are some of my lightning fast meals, make a list of your own and post it on your fridge.

Lightning Blender Tortilla Soup (adapted from Danica's Daily):

Stick the following ingredients in a blender: 4 tomatoes, 1 large carrot broken in half, 1/2 onion, 1/2 bell pepper, 1 clove garlic or 1 tsp minced garlic, 1 Tbsp Taco Seasoning, 2 chicken bouillon cubes, and up to 2 cups water depending on what blends nicely in your blender.  Sometimes I also add a handful of tortilla chips to make the broth thicker.

Blend until smooth

Pour into sauce pan with remaining water, add any other ingredients you want: a drained can of corn, a drained/rinsed can of black or pinto beans, and fully cooked diced or shredded chicken (if you happen to have it on hand).

Cook until it doesn't taste oniony (boil 5 min?)

Serve topped with tortilla chips, cheese, and sour cream (cilantro, avocados, and/or olives if you are feeling fancy and have the time to chop it while it cooks)

Spaghetti with meatballs


Boil water and prepare noodles according to package

Meanwhile, thaw pre-cooked frozen meatballs in microwave

Lightly grill the meatballs in a sauce pan or on a George Forman

Add a can of spaghetti sauce to the meatballs and cook till warm

If you have time while the rest cooks, butter up some bread, sprinkle with garlic salt, and broil for a couple minutes (check often!) for garlic toast.

Grilled Veggie Quesadillas


Grill all sorts of veggies, beans, and leftovers together with some garlic salt (favorites: onions, tomatoes, corn, spinach, beans)

Layer with cheese on a tortilla and top with another tortilla or fold in half

Grill in pan or on griddle, flipping once (unless you are using your $4 thrift store quesadilla maker woot!)

BBQ Ranch Chicken Quesadillas
This was our fall back meal in college, but it always felt like we were getting a special treat.

Thaw frozen cooked diced chicken

Put cheese and chicken on tortilla and smother in ranch and BBQ sauce, top with another tortilla or fold in half

Grill in pan or on griddle, flipping once

Chicken 'n Ranch Grilled Sandwiches (From Life in the Loft House
This is a brand new discovery I got from my "Monthly Meals" Pinterest Group Board.  I LOVE IT! Here's the recipe

Mexican Tuna Wraps (From Kim's Cravings)
The flavors sound weird, but it turns out SO GOOD!  I usually have my super easy homemade yogurt on hand, but if you don't have plain yogurt, you can just use all mayo.  Make sure to drain things very well it always goes a little runny the second day (still good, just pour it off... or drink it).  The only thing I change is I omit the olives and avocados (for time and cost) and use a little less tuna (a 7 oz can).  Here's the recipe

Microwave Baked Potatoes


Scrub a few potatoes

Stab them several times with a fork (to prevent explosions)

Double wrap them in tied grocery sacks

Nuke them in the microwave for a few minutes per potato (we do about 15 min for 4 potatoes)

Top with baked potato toppings (butter, cheese, sour cream, chives, peas, salt, pepper), or BBQ sauce and ranch, or warmed up chili and cheese.

Stir Fry Ramen
Break ramen noodles apart and boil for like 5 minutes

Drain most of the water

Add seasoning packet, 2 eggs, 1 Tbsp butter, any veggies you have on hand, any meats you have on hand, and optional seasonings (soy sauce, crushed red pepper, crushed peanuts, etc)

Stir Fry until desired consistency

Cheater Omelets


Fun fact: I was an omelet chef my freshman year in college.  I learned how to make a lot of omelets in a little amount of time.  I also learned how to flip spatulas, spin pans, and made stick figures out of omelet slices (the many adventures of Greg the Egg), but back to making omelets.

Put a little oil in the pan and get it medium hot

Throw in some onions, bell peppers, or whatever (zucchini tastes good too, get creative) and saute

Whisk 2 eggs together (or even use a blender because the more homogenized the easier it is)

Pour into pan with veggies

Work the edges of the egg with a high temperature spatula, tilting the pan to get the uncooked egg underneath the cooked layer.

Get the whole omelet loose so when you shake the pan, the omelet slides freely

Flip the omelet upside down to finish cooking the top side

Top with cheese

Optional: serve with salsa and sour cream or baked beans

Note: If you are making lots of omelets, it might be worth it to go the normal route and have a separate pan for sauted veggies.  In that case you would flip the omelet, top with veggies and cheese, and fold in half like a taco.  But then again, if you are making more than two of them, it isn't really a lightning meal.

Huevos Rancheros
Fry an egg
Place on lightly toasted corn tortilla
Top with cheese, refried beans, Mexican style rice, or whatever else you have and salsa


#2: Frozen Meals
Ever have leftovers?  Lots of the freezer meals you see online require planning ahead, setting something in a slow cooker at least 4 hours before consumption, and waiting.  That's great if you know you're going to be low on time (scheduled events with a small dinner window).  Most of the time, though, you'll need your anti-take out strategy last minute.  You need something that can heat up in a microwave and still taste great.

Whenever you finish a meal and there is enough leftovers for tomorrow's lunch and then some, think to yourself if you've ever seen something like it as a frozen entree (think Lean Cuisine and TV dinners).  Meats, cooked veggies, beans, cheese, breads, pastas, rice and broths all freeze very well.  Fresh veggies and milk based soups/sauces don't.



Whenever you make a classic freezer item, go ahead and make some extra and portion it out for your next anti-take out strike.  Whenever I make pizza, I make an extra pan, cut it into gallon-sized Ziplock squares and stack them in the freezer.  It can be thawed in the opened bag in the microwave, then popped onto a pan under the broiler to avoid the soggy microwave finish (or just use one method).

Option #3: Commercially Ready Dinners
These are generally more expensive than prepping your own meals, but they sure beat eating out!  Don't feel guilty if you have a bunch of commercial ready-made food in your freezer as long as you don't use it for normal dinners.  You are saving money and it probably isn't any worse than the fast food alternative.

Some frozen foods we like are: chicken nuggets, green chili steak burritos, orange chicken, pot pies, corn dogs, and steamer bags of veggies.



Some boxed/bagged foods we like are: Bear Creek Country Kitchen soup mixes, stuffing, instant potatoes, ramen noodles, and pancake mix.

Just because you are eating out of a box doesn't mean you have to feel like it.  You can make your own dip concoctions for your chicken nuggets or corn dogs while they cook.  Put shredded lettuce and salsa on top of your microwaved burrito.  Dress up a can of tomato soup with some grilled cheese for dipping.  Add a side of canned veggies or quick rice.  Top your main dish with cilantro, basil, cheese, sour cream or anything else you want.

Here's one complete meal that you can make as fast as you can boil a few pots of water:
Pot 1: Instant Mashed Potato Flakes (follow directions on box)

Pot 2: Stuffing Mix (follow directions on box, I throw in a hand full or two of Craisins for extra flavor)

Pot 3: Gravy= Put as much measured water as you want gravy in a pot.  Add 1.5 tsp chicken bouillon (this brand is preferred for both flavor and cost) for each cup water.  Bring to a boil.  Separately mix 1 Tbsp cold water and 1 Tbsp corn starch for each cup gravy.  Whisk corn starch slurry into boiling broth.  Cook until thickened.

Microwave (optional): Throw some frozen veggies in a bowl, add a little water, cover with a plate, and nuke it until heated through.


Option #4: Snacks
One final strategy is to buy yourself some time with filling snacks.

When we are out of town at the doctor's I would much rather bring some Trail Mix granola bars to keep my kids happy for an extra hour and warm up some leftover lunch when I get home.  I keep quite a few in my van's center console and at only $0.25/bar (Costco), it saves me quite a bit on fast food.

Find what snacks are convenient for your family and keep good in a hot car.



At home, if we get back late and need something to hold us over, smoothies are our go to "half-meal".  We keep Kirkland Signature 3-berry blend as well as Wawona festival blend in our freezer at all times.  Throw in some homemade yogurt if you have it, any near-date fruit you have, some fruit juice if able, and oats if you want it to be more filling.  Don't tell my husband, but I always throw in a carrot with the tropical smoothies or beets with the berries (color match).  Blend till smooth.  Once you've downed a full glass of real food like that, you can get away with something pretty small, simple, and late for dinner.

Which Anti-Take Out Plan is for You?
Probably all of them.  You need to have several options available to make the system robust.  You need fresh food when you feel like it, prepared food when you are out of ingredients, and sometimes you just need food NOW.  If you only have microwavable burritos in your arsenal you will get tired and hit that Thai restaurant.  Get stocked up on several strategies.

Just reading this blog post isn't going to change anything long-term.  You need to make a plan and get organized.  Spend the next few minutes with a piece of paper or at least a bulleted list on your mobile device.  List every lightning meal that you usually have the ingredients for.  List all of the commercially prepared meals you usually have on hand.  Put the paper on the fridge and add to it every time you remember another one or come up with a new concoction that is worth repeating. (Then pin this to help your friends too!)



Above all else, please don't be caught saying "I can't afford the down payment on a house", "I can't max out my IRA", or "I am one of the 69% of Americans who have less than $1,000 in an emergency fund"... "because I'm too lazy for an anti-take out plan."

-Milly




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast.  Anything I recommend should be personally analyzed and discussed with your financial adviser.

Why you NEED Precious Metals in your Investment Portfolio (especially in 2018)

January 19th, 2018 at 11:40 am



Gold and Silver should be a part of anyone’s savings and investing. My personal goal is to have it represent 10% of my retirement portfolio and up to a quarter of my emergency savings.

I didn’t start out believing in gold. It gets a lot of hype in sensational language, which always makes me skeptical.

My biggest obstacle to adding precious metals to my portfolio was is it is hard for me to imagine going back to using gold and silver as currency. It is just too out of place in today’s modern society and impractical in the digital world. If there were a dollar crisis, my tools would probably be worth more than useless metals and I can use them now.

I knew their are some inherent physical properties to the metals that make them valuable in industrial and medical applications, but I still don’t think it would cost nearly as much if those were the only competitors for the metals. Only 10-12% of the gold out there is used industrially. It is mostly people just liking precious metals and speculating in the metals that keeps the prices so high. I didn’t want to invest in other people’s fancies.

Let me Change your Mind
Now I see gold and silver in a new light. A lot of the people who don’t like precious metals point to the S&P 500 and show that gold isn’t going anywhere, but the stock market is. Well, it may be true that US stocks have matched or out performed gold, but not by nearly as much as we are led to believe.

Gold as an Investment
From 1971 (when the US abandoned the international gold standard) through 2016, gold has actually tied the return of the MSCI US (large and mid cap US market) at a return of 10.6% annualized. That wasn’t all in the huge gold jump that happened at the beginning either. The last 10 years has returned an average of 7.7%, lagging the US stock market by only 0.5% (source with pretty pictures).

I did my own math and graphing with an exponential trenline (to avoid cherry picking dates) and came up with both the S&P 500 and the Perth Mint gold prices returning 7.3% annually.

That is not a lot of missed gains compared to the risk of a major market correction any day. You might pay the 0.5% in fees to your brokerage anyways. If you agree with Lewitinn in Yahoo Finance that 93% of the stock growth since November 2008 is resultant of Federal Reserve moves, then that is a lot of risk. You could see 93% of those gains come crashing down any day, especially if the Federal Reserve isn't able to do the tightening and normalization they planned (rate hikes and unloading the balance sheet).

Precious Metals as Protection
Even with all of those investment benefits, I still see precious metals as the way to preserve wealth, not to invest. I suspect much of the gold rise is actually dollar weakening. No matter what any politicians or leaders do to the US dollar (and you know what they are going to do), precious metals will hold value. Jim Rickards once asked someone how their family preserved their wealth for 800 years. The response was a third in land, a third in art, and a third in gold. These are the things that last.



Another benefit to precious metals is they are individually and physically owned. I believe Jim Rickards’ “Ice-9” prediction (Road to Ruin). There will come a day when the government will be forced to freeze all digital money except for a small amount for gas and groceries, much the same way as they have done in Greece. Even if the money never is seen again, or inflation happens to an extent that it isn’t worth anything when we get it back, precious metals will preserve.

Why 10%?
One question you might be asking: If you believe that much in gold and silver, why only 10%? One answer is I’ve seen a compelling prediction of a $10.000/oz price of gold. That's in today's dollars, so if there is major inflation, the number will be higher. This isn't some fudged Wall Street chart pattern prediction either. This is a mathematical analysis done by a world expert on currency wars and is based on the required non-deflationary price of gold. If we reach $10,000, your 10% would become about 100% and even if you loose everything else, you’re insured.

Why not more than 10%? Right now we are in a very difficult time for investing. According to John Keynes, we are in a depression which is highly deflationary. Companies are laying off workers (who in turn find part-time jobs, "creating" jobs on federal reports), individuals are deep in debt, and savings are at a record low. In times like this, short term opportunities are the way to go.

At the same time, countries around the globe are cheapening their currencies with monetary easing. The US government simply cannot afford the real value of their dollar denominated debt to increase. Eventually, they will have to change course and switch back to monetary easing "money printing". Inflation will win at some point.

In his book, The Big Drop, and in this article, Jim Rickards explains the thoughts and methods behind a "barbell" strategy that is loaded up on the ends as a protection against inflation AND deflation, with cash in the middle ready to pivot positions as needed. So if you put 35% of your investments in hedge funds, private ventures, angel funds, and the like for your deflation hedge, and leave 30% cash (and treasury bills) in the middle, you only have 35% to diversify into a inflation hedge. As stated earlier, those should include precious metals, undeveloped land, and fine art (try 10%, 20%, 5%). If you want to tweak those numbers you are always welcome to.

I know that was a lot of external thoughts and analysis in a beginner's precious metals post. The bottom line is you don't want to put it all into gold.

In any case, Jim Rickards recommends 10% and most precious metal companies recommend 10%. If people who do more research than me and are an even bigger believers in precious metals than me recommend 10% in gold, I should say the same.



What about confiscation?
When looking into gold as an investment, fingers are often pointed to Executive Order 6102 signed by President Roosevelt in 1933, which required gold to be traded in to the Federal Reserve for the official gold price of $20.67 per troy oz. The criminalization of “hording gold” in the US lasted all the way until 1974, after we left the gold standard. Other gold controls have occurred in Australia and much more recently in India. I’m not going to let fear of confiscation prevent me from buying for 5 reasons:

1. There was a good reason for gold confiscation at the time. It is one thing for the government to confiscate items that cause destruction such as illegal weapons and drugs, but the confiscation of gold comes down to one thing: they needed it, so they took it. As terrible as it is to have the “land of the free” to secure themselves a discount on your savings, it was this confiscation that allowed us to keep on the gold standard for about 40 more years. Without this questionable move, we would have had a run on the gold reserves and it is impossible to say what that would have done to the American future we live in today. Was it the right thing to do? I doubt it, but I may be reaping the rewards today. (or maybe it just means it is going to be that more painful when the ungrounded financial system fails)

2. Gold owners were compensated. It is against the constitution for gold to be sized without just compensation. Sure, the government might do something sneaky like dump a bunch of gold supplies into the market to suppress the price just before they close the market so that they can buy at discounted prices. Even if they don't, you’ll still miss out on some massive gold hikes in the event of a gold crisis. Either way, you’ll probably still be better off buying gold today and selling it to the government in a few years than just holding onto dollars. The shakier things get, the more gold will go up.

3. Not all gold was confiscated. There were exceptions for industrial uses and some personal exceptions as well. Rare coins were exempt and individuals were even permitted the equivalent of 5 troy ounces of coins.

4. Owning gold is the patriotic thing to do. If there is going to be a future gold confiscation, wouldn’t it be much better for the United States to get a bunch of gold from it’s citizens than to have that gold sitting in India, China, and Russia? I don’t want to give away real money for fiat currency, especially when it is in a crisis, but at least it is going to someone who wants the United States to be strong. We want as much of the world’s supply of gold in our own borders. Owning gold is the patriotic thing to do.

5. The risk of confiscation is smaller today. In 1933, the dollar was backed by gold (what it is backed by today). They had to stop a run on the gold reserves when the gold peg was strained.
Today, we live in the world of floating exchange rates.
If the US really gets into a bind, instead of confiscating gold, they can just print whatever money they want to cover their debts. Yes, creditors will be upset about taking a "haircut" when paid in a debased currency, but they took an inflation risk when they bought the government securities.


Good luck!

-Milly

This is part 1 of Milly's "Precious Metals for Beginners" series
For Part 2, click here: Should I buy Silver or Gold?





Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.

How to Pay off your House for Much Less

January 18th, 2018 at 12:54 pm



When it comes to finances, nothing makes me more excited than seeing a ton of money leave my bank account each month. I just can’t wait to enter it into my “House Payment Analysis” spreadsheet, to see the amount saved go up a few hundred dollars, and be one month closer to payoff. Why does this make me so happy? Well, a lot of it is because I love numbers, but also because we made a plan to own our home in just under 7 years, 76.9% faster than the 30 years the loan was signed for.

Forget the Tax Deduction
Some people say you shouldn’t pay off your house because there are so many tax benefits. While there could be strategy in focusing on debts without tax benefits first, not paying it off for tax reasons doesn’t make any sense. Yes, you won’t get a tax deduction for the interest you are paying, but that’s because you don’t have to pay it at all! Would you rather get $100, pay the bank $100, and have Uncle Sam give you back $20 he took from the other part of your paycheck? or would you rather get $100, keep $80 and give $20 to Uncle Sam without anything extra coming out of the remaining paycheck?



Saving/Investing vs. Paying Down your House
Other people are more comfortable saving their money instead of dropping it into their house. In the current state of things, I can get as high as 1% interest on my savings, maybe 2% if I have a lot to save and can stash it away for a long time in a certificate draft (CD). My mortgage rate is 4.625%. Despite it’s phenomenal performance from 1971 to 1995 even the S&P 500 isn’t set to beat that rate (in a future post, I'll show you how I came up with those numbers). In other words, unless you are in a more specialized index, the interest you save on your house is probably your biggest gainer.

If you get a higher return out of savings or dividend stocks than you are paying on your house, and it fits within your risk tolerances, you might do better with a mortgage offset account. That is, pay the minimum on your home and put the excess you could have put on your house into the high return investment. The investment account will grow faster than your house would have paid down. Once you have enough money in the account to pay off your home, you can either withdraw it and become debt free, or keep it for a few more years and pay it off with some money to spare.

Close your Mortgage in Half the Time!
(For a LOT less Money)

So how am I paying it off so quickly?  It turns out that just adding a little to your monthly payment can make a HUGE difference.  Even $5/month extra will save a few thousand dollars and a few months over a 30 year loan.  At the beginning of your loan, most of your payment goes towards all the interest you owe on the principal (the amount needing paid off), not reducing the amount you still owe.  You'll just have to pay nearly all of that interest again next month and make you feel like you're running in place.  Adding just a little straight to principal will give you much more bang for your buck.

Not sure how to find a few extra dollars?  Stay tuned for more posts.

Make sure when you add the little extra that it is explicitly marked as towards the principal.  Otherwise, it will likely go towards the next payment and not get any compounding effects.

Here’s my simplified formula to pay off your mortgage in half the time:
Because this ignores some funny exponential math, it isn’t exactly half the time, but pretty close.  If your 30 year mortgage rate is over 4.6%, you’ll pay it off a little faster.  If it less, it will take a little longer (but you'll be saving more money anyways). You’ll have to do your own math if you are in the middle of your loan or have a different length.  Click here for my free fancy calculator so you can see what happens with YOUR numbers.

Your monthly payment has three components:

1. Principal = The principal is actually the amount of money you still owe on the house, but they make it confusing and reuse the term.  The principal payment is the money that actually goes towards paying down the house (towards the actual principal).

2. Interest = The amount charged as interest on the remaining principal.  It decreases as you have less money borrowed.

3. Escrow = This covers your home insurance and property taxes.  The lender forces you to pay it to a special account to ensure they never get stuck with back taxes or an unfunded burnt down home.  Even after you pay off your home, you will continue to pay these amounts, but directly to the insurance and government instead of escrow.

Your loan is worked out such that your monthly payments are constant despite the lowering interest.  This is done by increasing the principal payment slowly over time.  Principal payment plus Interest should equal a constant.

Here's the equation you've been waiting for.  Just look to your statement to see what your numbers are:

Escrow + 1.5 x (Principal + Interest) = amount you need to pay each month to cut your loan length in half!

Alternative way of looking at it because words and math are hard to mix: Take any statement, add the principal and interest payments together, the divide that number in half.  The result is the additional amount that you need to pay to principal each month.

Did you notice?  You add less than 50% to your payment and it counts as two (200%) payments!



Alternative Double Principal Method
My father had a different approach which also cut the mortgage length in half.  He would simply write another check for whatever the principal portion of each payment was and put it straight to principal.  The advantages of this method is that the number you need is written right on your statement and it is relatively easy to implement at the beginning when the principal portion is so small.  As the principal portion grows, theoretically so does your paycheck making it is okay that you'll be almost doubling your whole payment near the end.

You are going to be SO MUCH better off with this method in comparison to the straight 30 year loan, but I see 3 disadvantages to the Double Principal method in comparison to my half Principal + Interest method:

1. The beginning is when you have the greatest power to knock months off your loan and save money.  You won't save quite as much money with the double principal method.

2. You might make more money as you go, but your lifestyle will grow too.  I think we all know life only gets more and more expensive.  In your future you'll probably add children, catch the travel bug, demand better kitchen appliances, get more picky about food, or otherwise increase your cost of living.  Also, I wouldn't count on wages growing faster than inflation for the next decade.  We are in a currency war and, in the words of Jim Rickards, "the only way to win a currency war is to stay out of it".

3. Maybe the most significant flaw in this method is you can't automate it.  Every month you will have to look at the numbers and make a payment.  Autopay won't work.  As I learned from David Bach's book, The Automatic Millionaire, the key to growing wealthy over time is automation.

As life gets more expensive and your principal portion jumps up more and more rapidly, you will need a huge amount of discipline and capital to keep this method up.  I don't trust myself that much.

Alternative 15 Year Plan
You could instead look into getting a 15 year loan from the get go.  The advantage is that they usually have a lower interest rate and they force you to stick to your early payoff plan.  This is a great idea if you need help sticking to the early pay off plan.  The only problem is you also have to hope life won't throw you any dramatic curve balls in the next 15 years. 

Worst case, you do have to drop down to a smaller payment and refinance to a 30 year loan.  You'll have to pay closing costs, but those fees will likely be added to the principal so you don't need the cash on hand in your rainy day scenario.  It will set you back, but hopefully you'll have enough years paying it off at a 15 year rate that it will make up for the loss. 

I personally like the safety net of being able to go back to a low payment for rainy day purposes.  This way, I can put the extra principal payments in the "investment" category of my spending tracker instead of "bills", effectively lowering my living costs. 

Unless you can get a substantially lower interest rate and you are confident in your other rainy day funds, I’d just go with the full 30 years and cut it in half on your own.  It won't cost much more.



The Home Improvement Pitfall
I have a friend who bought a home at the peak of the market.  He and his wife are among the most intelligent people I know, so paying his house off early was a no-brainier for them.  They set a plan to pay it off in 10 years despite the high price tag.  They stuck with the plan for a while, but as time went on, they made some trade-offs.  Instead of paying the extra towards their mortgage, they started paying it into the house with kitchen remodeling and various flooring. 

10 years later, when they would have been all paid off, they moved.  In that amount of time, the housing market had crashed and they were forced to sell for less than they still owed, even with the updated kitchen. Had they stuck with the plan, they would have come out of the transaction with the entire sale price (minus fees) as liquid money for a down payment on the next home.

Moral of the story: If you pay off your home, you can always sell it for something.  Stick to your payoff plan and get there as fast as you can.  You never know what the market or your life has in store for you.  If the market just goes up, you can always do the projects later.  It won’t hurt you to focus on payoff first.

-Milly




Disclaimer: I am not a licensed or certified financial coach, planner or adviser, just an enthusiast. Anything I recommend should be personally analyzed and discussed with your financial adviser.