Finance Basics

Datapoints logoThe basics of personal finance are pretty straightforward, but it’s easy for us to think that because we’re in a specific season of life, like graduate school, they don’t all apply. Here is a basic list of finance fundamentals as discovered through extensive research for books like The Millionaire Next Door:

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Those are pretty basic fundamentals – the only one I would quibble with is following financial markets, which many experts say is a waste of time. The reality is that following the market is probably an indicator of overall financial diligence. It’s correlation not causation.

It is easy to think that while we’re in a very tight season of life, as grad school is, that basics like spending less then we earn and savings aren’t possible.

While I would be the first to agree that it is very difficult, I would set it as a practice to live on a budget (spend what you earn) and save, even if it is a very small (almost token) amount. The point is that these practices will carry over into our future when our financial picture changes.

I’m continually challenged that to be “faithful with the little things” isn’t primarily a promise of future blessing, it is a promise that I will be changed. I continually screw it up, but let’s try again today.

Little things make big things happen.” – John Wooden

Alternative path to wealth

Dollar signLast week I teased that aside from hoping to strike it rich with a miracle investment, there was a better route to go. Here is my brilliant three-step plan:

One: Earn More

Dave Ramsey teaches that your most important wealth building tool is your income. To build wealth, you need to generate income. Saving money (income minus expenses) and investing (return on saved money) are impossible without generating income. Obviously more income increases your chances (but certainly doesn’t guarantee) of having a surplus. If we aren’t currently generating a surplus, we need to either (or both) cut expenses and/or generate more income. Here is some advice on generating more income.

Two: Get rid of Debt

Getting out of debt accomplishes two super important things. First, you take over control of your income. Debt is a lien against your future income. Take control of your future income – it will allow you to save which is step one in accumulate wealth. Second, if you are paying interest on debt, you can have a guaranteed return on an investment by keeping that interest for yourself. See this.

Three: Save cash

This seems counter intuitive, but having a large cash reserve is valuable for several reasons. First, you can negotiate significant discounts on things you are forced to buy. Second, you are prepared when assets that we know and understand become significantly discounted. Like when we get our next recession.  There is a lot more to be said about the advantages of liquidity, but I recommend trying it to see how it feels.

 

Concession from last week. While I’m steadfast that we should let go of the myth of being a great investor, it’s really important to understand that yielding a couple of extra percent yields a massive difference in returns over time. Over 20 years, the difference between earning 6% and 12% on an investment isn’t 2x the return, it’s 3x. This goes up even more over time and/or return.

The Myth of Investing to Wealth

WarrenOur country loves the “Horatio Alger” story – the old rags to riches. In our culture, one of the most popular narratives to riches is through being a great investor.* If I can figure out the market, I’ll be able to see something others don’t and it will make me wealthy. Warren Buffett is the hero of this story. I poured through his biography (The Snowball, 832 pages!) when it came out looking for secrets and clues. One potentially controversial belief I’ve developed:

I don’t believe being a “great investor” is a reasonable path to wealth.

We need to let go of the myth that we are one hot stock tip away from financial success. This narrative is baked into our entire culture. TV networks like CNBC and Fox Business are built on this myth (Here is the 8 best TV shows ranked by a website dedicated to investors). Entire print industries (Money magazine, financial help books) have this narrative intertwined in their unspoken promise to the reader.

I’m convinced it doesn’t work and in fact it’s a massive waste of time and distraction from actually accumulating wealth. Why? Here are three of many reasons:

  • Not enough initial capital

A friend of mine recent came and asked for some advice on which stock to buy with a $1,000. I didn’t have the courage to tell them it didn’t matter. Warren Buffett, the wealthiest person in America and perhaps the best investor in our history has earned around 20% compounded return. Maybe you’re a better investor then Warren Buffett, but if you’re as good as him in 10 years your $1,000 will be worth $7,268.

The point is that most of us don’t have enough upfront capital to take advantage of outsized returns, even if we were to get them. Does this mean we shouldn’t save or make wise investments? Of course not. It should pop the bubble that I’m only one key investment away from financial freedom.

There is a huge separation between how it feels for my $1,000 to be up (or God forbid down) 8 points this morning and the actual impact that will have on my life. That’s why some of the best investors don’t follow the market or invest in individual stocks. That’s why it “doesn’t matter”. There are a dozen other more important financial decisions each month that will affect my financial future far more than the short term fluctuations a $1,000 investment.

  • Have to live on the returns

My dad went to a three-day seminar on how to use stock shorts and options to make a killing in the market. One major problem (beside the fact that nobody actually “beat’s the market”) is that if my dad did this from home he’d still have to pay for his regular living expense from his earnings. For example, if he earned 20% on a huge sum of money like $250k, he would clear about $50,000 in income before taxes. The problem is that he’d use most of that money up, you know, eating and stuff.  It would make it almost impossible to actually accumulate wealth unless you had your living expenses covered by an actual income or you had some amount of money large enough ($2M+) that $50k wasn’t a significant deduction from returns.

Another example. People have asked me about real estate investing. I think it’s a wonderful investment, but unless you have a significant amount of capital don’t plan on making a living doing it for many years. It’s a great side job, but if you’re living on the returns it’s a poor way to accumulate wealth. In fact, almost everyone I know that has done well in real estate has done it by working (improving, changing use, managing, etc.) rather then passive investing.

  • Not really an expert

This one hurts a little. My pride tends to try to convince me that I know more then I really do. I’ve noticed that the professional investors from books like The Big Short and The Snowball spend a tremendous amount of time and attention learning their craft inside and out. I know several professional investors personally, and I’m continually taken aback by how much they put into understanding each investment. Even after exhaustive consideration, they build investment models around the inherent acknowledgement that they will be wrong some of the time.

If someone says you should invest in such-and-such because the kids are using it or something, I beg you to stay away. Virtually all public information is trash. One of the core tenants of all investing is “Invest in what you know”. Being honest about what I really know isn’t easy, but it will save me a lot of dashed expectations and refocus me back on activities that pay huge dividends.

 

Next week: If you aren’t going to waste time/effort/dashed expectations chasing the next great investing tip, what should you do instead?

 

*This rags-to-riches through a great investment is woven into our DNA across all cultures. Jesus told a popular parable about this with a twist – investing everything you have to acquire the truest treasure of life.

BOUNDARIES in Finances

BoundariesObviously God must guide us in a way that will develop spontaneity in us. Suppose a parent would dictate to the child minutely everything he is to do during the day. The child would be stunted under that regime. The parent must guide in such a manner, and to the degree, that autonomous character, capable of making right decisions for itself, is produced. God does the same. – E. Stanley Jones

In this summary of his transcendent book “Boundaries”, Henry Cloud outlines one of the most important principles in human development:

“Simply stated, it is this: people have a need to be in control of their own lives, and they have a need to know that God is behind that idea.”

Managing finances is a litmus test for our values. Understanding Cloud’s principle has implications for how and why we must develop financial skills.

Financially, many people confuse these two:

  1. God promises to meet all our needs (Philippians 4:19 and Matthew 6:25-34).
  2. God desires us to take responsibilities for our actions.

I believe the confusion surrounds our fixation with outcomes. It is assumed that an appropriate outcome either signifies appropriate actions or that the ‘ends justified the means’. The Bible goes to great lengths to separate the connection of SITUATION from ACTIONS: “Don’t worry about evil people who prosper”( Ps 37:7 and many others).

Money is a very outcome laden subject. For example, most people don’t realize that you can make good investment decisions that still lose money and BAD decisions that make money. The truth is that the quality of the decision making process is separate from the outcome of the decision.

In that vein, the Bible teaches us to separate our actions from God’s outcomes. We are responsible for our actions; God is responsible for our outcomes. The context is different, but this is the idea behind I Corinthians 3:

I planted, Apollos watered, but God was causing the growth. So then neither the one who plants nor the one who waters is anything, but God who causes the growth. Now he who plants and he who waters are one; but each will receive his own reward according to his own labor.

See that the reward is for the LABOR not the growth or harvest. This is a vitally important financial concept because it releases us from the outcome and empowers us to focus on taking responsibility for our actions.

 TAKING OWNERSHIP

The vast majority of financial messes I see are caused by someone’s head being stuck in the sand. This ostrich mentality results from feeling overwhelmed by either the size or scale of the mess or the inability to navigate the complexity of it, so a person ignores the issue until it intersects with real life. Dallas Willard described this collision: “Sometimes reality is what you run into when you’re wrong.”

The unfortunate truth is that ignoring problems doesn’t lead us to less stress, worry, or increased happiness. The opposite is true – when you know you have a large financial burden, ignoring it creates inner stress and it weighs on our spirits. It ‘enslaves’ us.

Instead, as Dr. Cloud pointed out “freedom and responsibility go hand in hand.” We must take dominion over that which we have personal responsibility. This most certainly includes our finances.

Money is a little confusing for some because a critical Biblical concept of money says that “God owns it all.” This is true – what we are discussing here isn’t money but your and my DECISIONS about how to handle our money. We have to take ownership of our decisions. Again Dr. Cloud:

What ownership basically is about is the possession of what God has entrusted to us. Ownership says, “that is mine, and I am responsible for it.” It is what Jesus was calling us to in the commandment to “take the log out of our own eye first.” (Lk. 6:42) So, in order to take responsibility for our lives, we must own what is ours.

We own control over our financial decisions. When we refuse that control, , we are subjected to a life at the mercy of sales people, shiny stuff, collections callers, ‘rich people’, evil corporations, big government, debt, car payments, student loans, lower salaries, and financial emergencies. Dave Ramsey describes control over our financial decisions as ‘happening to your money’ instead of ‘wondering what happened to your money’.

POVERTY MENTALITY

Many (even those in occupational ministry) don’t understand this division of actions and outcomes and it leads to a couple of unhealthy perspectives:

“Rich people must have done something immoral to gain their wealth”

“Rich people stepped on people on their way to the top”

“I’ll never be wealthy because….”

“The system is set up so the average guy can’t win”

“The little guy can never get ahead”

“I’m not a finances nerd so I won’t ever have enough….”

“You have to have money to make money”

“The love of money is the root of all evil so I won’t ever be rich”

These perspectives connect ACTIONS and RESULTS to create false narratives. “I don’t” so “I won’t”. They have all come about because the situations described can and do occasionally occur. But correlation doesn’t imply causation.

Instead, if we come to the Biblical perspective of separating the actions from the results, we can conclude that there are some poor people whose actions we would LIKE to emulate and many rich people whose actions we would NOT like to emulate. In the same way we don’t need to envy or covet others’ wealth. Why they have it (RESULTS) isn’t our business; it belongs to God. Similarly, if you find yourself with wealth, you don’t need to feel guilty about it. The fact that you have it doesn’t validate you, your decisions, or anything else. It just is. It is the result of providence. What we do with our wealth (ACTIONS) is the more important matter over which we must take ownership.

Personal Finance Lessons

slideAdam Nash is an active member in Silicon Valley’s tech scene. He has given this presentation to a number of major tech firms – specifically addressing engineers.

While you might be thinking ‘I’m wired as differently as possible from an engineer’, I believe you’ll find great value in this simple walk through personal finance.

One of the most important things to take away: Always understand and remember your personal bias. In other words, know what you don’t know. Nash points out that engineers are at greater risk because they think they are rational but in reality they are not. His talk focuses on these main areas:

  • You Are Not Rational (Behavioral Finance)
  • Liquidity is Undervalued (Emergency Fund)
  • Cash Flow Matters (Spend less than you Earn)
  • The Magic of Compounding (Investment Returns & Debt Disasters)
  • Good Investing is Boring (Asset Allocation)

Nash spends over half the time talking through the first subject – Behavioral Finance. I strongly believe this is the right balance – personal finance theory and strategies are very simple – changing personal behavior is not.

LINK:

http://www.businessinsider.com/personal-finance-lessons-adam-nash-2015-5?op=1

Solomon’s Guide to Investing

money treeWhat are the keys to being a successful investor? Though in this space we often focus on debt, I stumbled across these investing principles that are too valuable to miss. I’ve read many, many investing and personal finance books, so when I came across Ecclesiastes 11:1-6 last night in my reading the passage opened up like a cliff notes of recognizable, key financial concepts. Here they are:

  1. GIVE and SOW First

Verse 1: “Cast your bread upon the waters, for after many days you will find it again.”

I just finished reading “The Blessed Life”, and it impacted me in some major ways. The principle of ‘first-fruits’ is interlaced throughout the scriptures. The idea of sowing BEFORE you know the result of the harvest is critical. The concept of ‘first-fruits’ says that you give the first part of the harvest BEFORE you know the full bounty of the harvest. Additionally, in the Hebrew law it says you are to consecrate the firstborn (Ex 13:2) BEFORE you know how many total children you’ll have. We also see this in Jesus when God GAVE his firstborn (John 3:16) before we could respond. That’s the power of Romans 5 “But God demonstrates his own love for us in this: While we were still sinners, Christ died for us”.

In secular financial arenas there is a principle called “Pay Yourself First”. That is, if your financial security and saving money are your biggest financial priorities, you have to set aside money BEFORE you pay your bills, spend elsewhere, etc. This is a principle taken straight from scripture with the beneficiary switched. The scriptures teach that rather than our own security, we are commanded to seek FIRST the kingdom of God and all other things will be added unto us.

The commentaries on “casting your bread upon the waters” give a couple of helpful hints at connecting and applying this scripture:

  • “Bread” represents that which is necessary for life.
  • You have to release it yourself. Nobody can do it for you. In doing so it changes your heart and motivations. This is represented as a calculated decision.
  • The “upon the waters” indicates a flowing river or open ocean – meaning it needs to be cast under the assumption it isn’t ever coming back. Your motivation for giving cannot be to receive.
  • When you give or sow, you ‘lend to God’ (Proverbs 19:17) and God will reward you. “Whoever is kind to the poor lends to the LORD, and he will reward them for what they have done.” That’s why “The generous will prosper; those who refresh others will themselves be refreshed” (Proverbs 11:25). Even though this is true, reward shouldn’t be our motivation. Jesus taught his disciples to lend without expectation of return (Luke 6:35).

It doesn’t matter how much you sow (two mites is a start), but the principle here is that you can’t stand in a field waiting for a harvest before you start giving and sowing. Put first things first. I think it’s critical that this is the first verse in this passage.

  1. DIVERSIFY

Verse 2: “Give portions to seven, yes to eight, for you do not know what disaster may come upon the land.”

This financial principle has been widely accepted as the only way to weather the ups and downs of the financial markets. Four times throughout these six verses the phrase “for you do not know” is used. Diversification acknowledges that unknown market conditions will cause some business sectors (agriculture, commodities, small businesses, real estate, etc.) or geographic sectors to thrive or struggle.

  1. IT IS WHAT IT IS

Verse 3: “If clouds are full of water, they pour rain upon the earth. Whether a tree falls to the south or to the north, in the place where it falls, there it will lie.”

A successful investor realizes that bad things happen. They are a part of life. As Forrest Gump acknowledged when it was pointed out that he had stepped into poop, “It Happens”. In fact, despite our greatest efforts of engineering it, life itself is uncertain.

The reality is that all successful people and investors have had failures. Human nature (often inflated by social media) causes a lot of pretending one way or the other – either people pretend they are failure proof and everything is fantastic all the time or others glorify their failures. A healthier perspective acknowledges the failure for what it is, gleans what can be learned from it, and doesn’t let it affect my intrinsic value as a person.

I have a close friend who owned over 20 rental homes. When the market collapsed in 2008 his bank called his note due, even though he had never missed a payment. He lost all of those houses in a two year long process as his bank went into receivership.

The reality is that failure (ours or others) is the number one teacher in life. We need to remove the stigma and realize that if a tree falls on your house, it is done. It can’t be undone any more than you can make the rain go back into a cloud. Accept it, and move on. That’s why the same author pointed out “for though the righteous fall seven times, they rise again, but the wicked stumble when calamity strikes”. As many others have pointed out, character is measured by the getting up, not the falling down. The friend I mentioned in the previous paragraph went on to start a small business and now, 5 years later, he has several locations, a couple dozen employees and several million dollars in gross revenue.

  1. DOLLAR COST AVERAGE

Verse 4: “Whoever watches the wind will not plant; whoever looks at the clouds will not reap.”

When people call in to discuss their financial problems with Dave Ramsey on the radio, they often comment that they are waiting to have kids until they can get on top of their financial problem. To Dave’s credit, I’ve never heard him endorse this. Instead, he points out this timeless truth: There is no perfect time for anything.

Inaction can be caused by fear or by laziness. Proverbs 22:13 says that a lazy man refuses to go outside because there is a lion or he might get murdered in the street. In a 24/7/365 news cycle there are often stories that use fear to drive viewership. But a prudent investor ignores the fear and panic of the day and uses a simple technique called “Dollar Cost Averaging”. Simply, if you invest at a steady pace over a long time, you’ll buy fewer investments when the prices are high and more when the prices are low. In doing so you’ll insulate yourself against some of the volatility that is inherent in any market. There is no perfect time for anything. As the old Chinese proverb says: The best time to plant a tree is twenty years ago. The second best time is now.

  1. NOBODY IS RIGHT ALL THE TIME

Verse 5: “As you do not know the path of the wind, or how the body is formed in a mother’s womb, so you cannot understand the work of God, the Maker of all things.”

In his book “MONEY Master the Game”, Tony Robbins interviews a dozen or so billionaires (that’s someone who has made a million dollars a 1000 times). One of Tony’s main takeaways is this: All of them quickly admit that they don’t know what’s going to happen in the future. In fact, they spend virtually all their time and intellectual energy NOT trying to predict markets and the future, but rather building a system or portfolio that can survive and profit from the greatest variety of fluctuations. As one interviewee stated, “Sometime in your lifetime your favorite investment (gold, real estate, stocks, etc) will go down in value by 50%”. It’s not if, but when.

The reality is there is a lot we don’t know or understand. This verse emphasizes twice that “you do not know” and “you cannot understand”. This needs to be built into any investor’s worldview from the beginning. This principle is emphasized at the end of verse 6 as well: You do not know which will succeed, whether this or that…

I’ve also heard a number of very successful entrepreneurs explain that all ideas have this in common: They seem great at the time. James Altucher, who has sold multiple businesses for 8 figures, has said and written many times that he started 6 or 7 business at the same time because he had no idea which of the ideas was any good. In fact, they all seemed great at the time. Verses 5 and 6 point out that we “do not know which will succeed”. This is a critical business principle.

  1. FINISH: CONTINUE TO WORK ALL THE WAY THROUGH HARVEST

Verse 6: “Sow your seed in the morning, and at evening let your hands not be idle, for you do not know which will succeed, whether this or that, or whether both will do equally well.”

One commentary explained this verse as such: Do not be lazy; get up and be about your work. Also, do not quit half-way through the job. If the sowing in the morning happens not to take, then the sowing in the evening will. We must put out whatever effort is needed to succeed. We do the work, and it is God who prospers the effort.

Solomon explained it this way: The slacker is so lazy that he buries his hand in the bowl and he doesn’t even bring it back to his mouth. There is a season for every activity under heaven. Don’t quit early, work through the appointed time, and live with the results.

The world values success. God values process. The verse seems to indicate that if ‘both do equally well’ it isn’t because you were smarter, worked harder than your neighbor, were spiritually blessed or otherwise deserved success based on your merit. The point is to not “become weary in doing good”.

CONCLUSION

I believe the timeless truths of these investing principles will prevent you from ‘piercing yourself through with many sorrows’ and instead allow you to experience freedom from the anxiety and fear that often accompany investing.