Your house is costing you money

In reality most of these mislabeled items are expenses. Your primary residence is an expense; your car is an expense. Just like the new shoes you bought or the dinner you had last night, these are all expenses. These items cost you money in return for some kind of gain. An investment on the other hand costs you money but provides no gain beyond an increased value in the future.

The purchase most people label an investment is their home. You will commonly hear that renting is throwing away money because you aren't building any equity and other arguments along those lines. The only way you will make your home work as an investment is by staying there for a large portion of your life.

Let's take a hypothetical person who believes he had made money on the house he sold in 2009. He bought this house in 2003 for $150,000 and sold it for $190,000. The balance remaining on the principal for his mortgage was $133,223, so he claims to have pocketed $56,777.

How much did he really make?

But is that really the case, did he manage to make $56,777 by flipping the house he lived in for 6 years? Most of you already realize this is much more complicated than just looking at the difference between his loan and the selling price. First, he had to pay interest on that loan, which adds up to $54,795, already nearly wiping away his imagined "gains". The closing costs when he bought the home were $6,000. The closing costs when selling the home were $11,400.

On top of that there is an annual property tax of around 1.35% adding up to $2025. Homeowner's insurance, maintenance costs and renovations add up to around $2250 per year. So here is a summary of the important information:

So we are looking at total money lost from this "investment" of $41,068. But let's not forget that he did live there for 6 years. Assuming he could have rented for $900 per month, he saved $64,800 on rent. So in the end he "made" $23,732.

So he made a few bucks from this whole transaction, how does it measure up against other investments? You can get the equivalent amount of money from investing $3,235 a year for 6 years at 8% returns. Just the interest on his mortgage in those 6 years was $9,132 per year. The total costs during the 6 years were $16,307 per year. Subtracting out the rent makes that $5,507 per year.

If, in comparison, he would have invested that $5,507 per year at 8%, he would have made $40,398. So in reality he made $23,732 by buying a house, paying his mortgage, insuring it, maintaining it and doing all of the necessary work involved. On the other hand, he could have invested the cost of owning a home into a mix of stocks and bonds or other investments he prefers, and at an 8% return made $40,398 without all of the effort required to flip the home.

Don't be a danger to yourself

Looking at most of these items as investments only convinces you to spend more time and money there than is healthy. The real estate bubble was fueled by this flawed view that no matter your income, you should be getting yourself into a home because the price will go up so fast that you just can't lose. Well people lost... big. Don't fool yourself into thinking that you should buy a home now even though you aren't ready.

• All customer service representatives are not equal.
  

  Numerous articles I read posted suggestions in the mindset that I would be talking with a representative similar in nature to the representative they had spoken with. The truth is the representatives are just like you and me, some are quick to help, very upbeat, and offer many solutions to your problem, while others may have more refined negotiation skills and give you a run for your money. It's important to remember that while these representatives are hired to provide the best customer experience, they are also employed to retain customers and revenues.

• No one wants to help a jerk.

  Ever held a customer service, retail, food services, or healthcare job? The quickest way to have the representative shut down and become unresponsive is for you to become difficult. Your customer service representative didn't create the pricing model for your cable provider, so why address the situation as if he/she is the one profiting from your monthly bill. Being polite and separating the representative from the company is vital to having the representative "want" to help you. I was extremely thankful for every reduction to my monthly bill that my representative was able to give me and continually told him how appreciative I was for his help and saving me money.

• Stand strong and let the representative do the talking...

  I must admit, I hate confrontation, and avoid it at all costs if possible. However, the longer I stayed on the phone, the more the bill kept plummeting in price. I opened up my negotiating with a quick reference to an Internet promotion I received from one of my provider's main competitors in the area promoting a $99 a month promotion for Internet, TV, and phone. My rep fired back with "well sir, comparing that promotion to your current plan is like comparing apples to oranges. We also offer a $99 base promotion for those services."

  Wait, I thought, the blogs and articles I read said this simple tactic was supposed to reduce my monthly bill by $20... Being the pro negotiator that I am, the thought crossed my mind to just accept my bill and perhaps try again at a later date. However, I had a goal to try and reduce my monthly bill so I decided to try one more angle before abandoning my efforts of saving money. I told the representative that I was struggling to meet the payments, and that the competitors $99 promotion sounded very enticing. This must have been the ticket, because he opened right up and I could hear him typing away on the other end.

  In the end I spent about 25 minutes on the phone with him, and when we seemed to reach a roadblock of some kind, or what he thought to be a satisfactory dollar amount on the amount reduced, I asked him what else we could do to reduce the bill. I continued to pressure him with this, and realized that one of my greatest weapons in the conversation was silence; I constantly asked what more could be done and let silence fill the remainder of the conversation until the representative could work something together. I hypothesize that while the silence was uncomfortable for me, it was probably more uncomfortable for him.

• Up sell hell

  "How did my bill get upwards of $230? I started at $160 a month, and... oh yeah, they offered me a special promotion on Showtime and Starz months ago for only $20 additional a month, and then I got the upgraded Internet for only $10 more." While the $20 and $10 promotions here and there may seem like a great deal, they are raising your monthly bill slowly and steadily. As the representative was talking to me I thought to myself, "do I really even watch Starz, or Showtime enough to merit $20 a month?" Consider what services you are receiving, determine what channels/services are important and weigh the others against their cost and determine if you think they are as great a deal as they were originally presented to you. Be willing to be flexible with the services that you rarely use. It's a great way to reduce your monthly bill without having to negotiate anything.

• Set a goal!

  While I almost caved on my goal initially, I began to get in a rhythm after the representative opened up. I set a goal before I made the phone call to reduce my monthly phone and cable by $40 - $70 dollars, brining the bill to within the $160 - $190 range. My goal kept me pushing and pushing the representative to find any savings he could until I reached my target range.

Negotiated Success

So what happened? I ended up reducing my cable bill by $57 dollars and cutting back on two premium channels that I hardly ever watched. I consider this a huge success in terms of reducing my bill as well as overcoming my anxiety to call and negotiate with an individual. I challenge all of you interested in reducing your monthly phone and cable bill to call and talk with your cable provider and negotiate your bill to a more reasonable price. Whether you enjoy negotiating or dread it, this is a great exercise that offers great rewards and the ability to practice your negotiating skills.

We always hear about compound interest and it’s “power” to make you wealthy. Whether you’ve heard it from Dave Ramsey, from an online community or just from relatives, you likely know about this mythical power.

But no one really takes the time to explain why compound interest is so great or explain to you the mechanics that make it that way. I’ll start by using Dave Ramsey’s example of Ben and Arthur. Ben started saving $2,000 a year from age 19 to 26. In contrast, Arthur began saving $2,000 from age 27 until retirement at 65. Both are getting a 12% return every year. (See this example here)

That’s pretty impressive, saving only $16,000 early in your life instead of $76,000 later gives you $756,830 more for retirement! But this is using a 12% return, which is unrealistic. Let’s change this to a more realistic 7.5% return instead of living in a fantasy land. Here’s what we get:

Using this more realistic rate of return somewhat hamper’s the “power” of compound interest that Dave Ramsey is trying to display. Nonetheless an investment of $16,000 is yielding $376,994 while the $76,000 is yielding $452,513. For Ben that’s an increase of 2,256.21% and for Arthur it’s an increase of 495.41%.

Even when we use realistic numbers, there’s something to this compound interest thing. So what is it that makes such a dramatic difference? This money is accumulated through your contributions, which early into your saving is from actually putting cash into your accounts. Here are some snippets from my excel sheet:

What I want to point out is that the contribution from interest increases as the principal increases. The first year of savings, interest is only contributing $150 compared to the $2,000 of cash contributed. But as we get to the 6th year, interest on the principal is already contributing $1,087, more than half, compared to the same $2,000 cash contribution. If you were getting 0% interest, this would be like increasing your cash contribution to $3,087 and further increasing it every single year. Let’s take a look at the very important transition point where the contributions from interest surpass the contributions from cash.

For Ben, his contributions from interest surpass his cash contributions on the 12th year of his investments (He stopped cash contributions altogether on his 8th year). For Arthur, it took only 10 years from when he began investing for this to happen, it was quicker because he continued his contributions (18 years after Ben started investing). Due to Ben starting his contributions early, he was able to reach this point 6 years before Arthur did.

Because of this huge head start, Arthur took until age 48 just to catch up to the total that Ben has been able to accumulate (that’s 22 years after he started investing!). By contributing 16,000 before Arthur began any contributions, Ben was able to contribute $110,253 in savings while Arthur had to contribute $44,000 to save up $112,056.

So what would happen if we had a third brother who has been saving $2,000 in cash every single year from age 19 to 65 enter the scene?

The lesson here is that the earlier you can start contributing money, the sooner your interest contributions can surpass your cash contributions. And the sooner that happens, the more money you will have in the end for each dollar you invested in the beginning.

The Power of Compound Interest

The power of compound interest is that at a certain point, the contributions to your total savings from just your interest will surpass the contributions you make with cash. At this point you are able to passively increase your savings far more than you could on your own

 

Compound interest is powerful but people must decide how to make use of that power without sacrificing everything else in their lives. It would be possible to live as frugally as one can imagine and store a huge amount of money in savings, but is that a good option?

Compound Interest Run Wild

We have two sisters, Jane and Jill. They both earn they exact same amount of money, let’s say $40,000 a year.

Jane is the most frugal person you can imagine; somehow she manages to live off of only $1000 a month. She bought a very cheap house and car, eats on the cheap and has nearly no expenses. Because of this she’s able to invest $27,999.96 every single year from age 19 to 65. She ends up with a total of $11,613,077 in her retirement account.

On the other hand we have Jill. She is an average person who lives by the rule of saving 15% of her income for retirement. This adds up to $6,000 a year. Jill bought a house within her means and lives responsibly yet buys the things she enjoys in life. By the time she hits age 65, Jill has a total of $2,488,520 in her account

That frugality surely paid off for Jane, she has over $9 million more than her sister for retirement. Using the rule that you can live off of 80% of your pre-retirement income and imputing these numbers into any calculator, we see that both sisters can afford to withdraw far more per year than their $40,000 income.

 

So what has Jane really gained from living so frugally her whole life? With $11.6 million to her name, she can live a very good lifestyle and / or leave it for her children. Is 20 years of a very good living or a hefty estate a good trade-off for 46 years of an extremely frugal life, and could Jane even make such a dramatic switch from pinching every penning?

Jill managed to have a very good life where she was able to responsibly save for retirement while being able to afford to do the things she enjoys. She doesn’t have near the amount for retirement that Jane has, but $2.5 million can definitely provide a comfortable life.

These numbers show us that if you are responsible, you can have a very good retirement and still enjoy the things you love. Even if you aren’t able to invest 15% of your income from age 19 to 65, there is time to fix yourself up for retirement. The rule of thumb is that you need about 12 times your income in retirement, that’s $480,000 for these sisters. Jill, who saved less than Jane, has 62 times her annual income!

Don’t Buy Into the Frugality Hype

You don’t need to always follow the guidance of people who tell you that if only you stopped drinking that cup of coffee every day or that you should always be driving a used clunker for a car. The key to having a comfortable retirement is balancing the savings needs with your life. If you enjoy cars, buy an expensive car, as long as you don’t jeopardize your retirement savings for it.

This proposal creates a board that will assess the accuracy of the grades given out by rating companies. Clearly there will be pushback which S&P has already begun.

Companies are able to shop around to get the best rating from different agencies, but I think more of the inaccuracy in ratings was caused by their poor use of statistical analysis than their attempt to court issuers of financial instruments.

This is a good addition to the financial regulation bill and the ability for companies to shop around for their ratings definitely needs to be stopped.

Look at how staggeringly large that red line on the right is, I fear for the stability of our nation. $1.4 trillion? That is a very big number that I can hardly fathom, AND it's 3 TIMES LAST YEARS RECORD!

Alright, I'll stop with the sensationalist writing and get to the meat of this. The graph does indeed look scary and uses scary rhetoric, but how true is it? Well the numbers are correct, no doubt about it. But as you can read in my article about Exponential Growth, using big numbers is just a rhetorical trick that is loosely based on reality.

To properly look at the U.S. deficit problem, we need to get a more objective view. We can do this by looking at the deficit to GDP ratio, in other words, how much does the country spend as compared to how much it makes. If we hear that that Bill spends $250,000 this year when Jill only spends $25,000, it sounds like Bill is in quite a bit of trouble. But when we learn that Jill has an income of $35,000 a year and Bill has an income of $1,000,000 a year, we see that in context, Bill's spending is much more manageable than Jill's. A large number by itself, out of context, is meaningless.

So let's look at the historical deficit compared to GDP of the United States.

The deficit is still high as expected. But looking at it historically, we can see that it is nowhere near the deficits of the past. Not quite the "Worst Deficit of All Time" as the first graph claims. But does this excuse having a high deficit? No.

High deficits are bad, but unfortunately they are necessary. A government should be running a deficit during times of recession and subsequently paying down that deficit or running a surplus in an expansion. So while high debt is bad, it is a necessary evil if we want to avoid a much worse economic outlook.

I'm tired of people posting idiotic graphs like the one at the top of this page just to make a point that matches their worldview. There is a real discussion happening about the effects of deficits and the proper strategies to getting out of them. But the reality is only being clouded by things like this.