The market and you

The market and you

After listening to the talking heads blame this and that for the latest financial situation- and OPB’s love to link everything to the coming election – I want to throw a little of my take on this out there.

I keep hearing folks walking around out here saying “It’s the fault of George Bush”   I’m not a big fan of Georgy-boy – but folks – if you think the president sitting in his office is responsible for this current economic meltdown – you need to wake the heck up.   I was listening to “World Have your Say” and I think a British caller said it best:

We’ve been telling people for so long that they can have anything they want that people have run up debts they can’t hope to pay off in their lifetimes.  It’s time for people to start living within their means and stop thinking they can afford to just run up debt.

If you’re expecting a new president to fix these problems – you’re probably going to be sorely disappointed.  They can exacerbate or help stem the tide – but tough times are definitely coming.  This will likely take YEARS to recover from – since it took us years of bad behavior to get to this point.  But the problem started somewhere else.  It started with each of US running up the largest individual debt loads in the history of our country without doing our homework.  It seems we’ve lost touch with what it looks like to be financially healthy.

So lets sit down and have a little lesson on what has traditionally and financially been described as being on track.  One of the best courses I took in college was a financial planning course.  It helped me as much as almost any of my CS courses.  Here’s the principles:

1. You’ve done a monthly budget.  You know what is coming in (pay, annuities, interest, etc) and what’s going out (rent, food, gas, utilities, loan payments, etc).  Unless you have set this all down, you don’t even know if you can afford to live where you live.  Without this, you don’t even know what you can afford/not afford.  But with this, you can answer questions like:

  • Am I living in a place I can really afford, or do I need to downsize.  Can I upsize?
  • What are my fixed monthly costs (utilities, rent, medical, etc)
  • How much money do I have for discretionary/entertainment
  • etc.

2. You’re habitually (read EVERY paycheck) saving at least 30% of your income.  Whaa?! you cry.  That’s not possible!  Well, the savings rate of Chinese has reached nearly 50%.  Yet, Americans have been averaging 1% or LESS per year in the last 5 years.  One of the leading indicators of a healthy economic system is the savings rate.  America’s is abysmal and the day of reckoning is starting to become reality. Things that must be saved for:

  • 401k/retirement – for most people, your goal is to have your contributions maxed at 15% of EVERY paycheck (and hopefully that’s matched to some degree by your employer).  Above/beyond that you should be contributing the $5k yearly max to your Roth IRA each year.
  • Contributing to your fully-funded emergency fund and to a minimum 6-month living expense account (see below)
  • Anything left should be put into a good mutual fund until you hit 30% (or more)

3. You have at least $1000 in an emergency fund.  In cash, ready to be used for a car breaking down, unexpected expense, etc.  This helps you maintain your savings goal of #1 so you’re not schizophrenically starting/stopping/changing your contributions.

4. You have at LEAST 6 months of living expenses on hand in CASH.  Not in bonds/stocks/retirement accounts.  This is money above and beyond anything else sitting there ready to be used with no other strings attached.  The way you know you have enough is that if you lost your job, no relatives could send you money (aka absolutely NO other money is coming in), could you pay all your bills, rent, home/car/student loan payments, buy food, gas, and have enough money to go looking for another job for a solid 6 months.  Better still is having 9-12 months saved – especially if you have a professional job that might take some time to find a position.  Odds are very good this is going to be in the $20,000-$30,000 range for most folks.  More if you have a family.

I personally have 9 months saved up with enough money to go to 2 targeted conferences with job fairs and pay for 3 flights with hotel+car rental during that time.  In addition, I have enough for first/last month and moving expenses in case a new job takes me to another city.

Why in cash?  Well, because if you lose your job, odds are good the time that happens will be a financially tough time in the economy at large.  Hence the reason you got laid off.  That means that stocks and other investment vehicles will probably be down as well.  When I worked at Intel and the dot-com crash happened, the stocks crashed too.  Then you get laid off and if you try to liquidate those stocks for your living expenses and you had half of what you thought you had.  And you’re stuck because you can’t wait to liquidate them when things are better.

Also, when the dot-com crashed, there were lots of computer folks looking for the same jobs.  I knew people looking for work for 12 months.  Don’t just think because you’re highly skilled means you won’t be out of work.  Often when layoffs happen, nobody else is hiring either – and there will be lots of folks with good skills fighting for the very few jobs open.  That’s why you need to save up more than what normal market conditions would require.

To beat inflation, you can put the 3 month blocks of living expenses in rolling over CD’s spaced so that every 3 months one of them becomes available.  Your goal is NOT to build money, but beat inflation but be immediately available and guaranteed.

5. Alway be insured My professor had a rule:  You must be adequately covered by insurance for all possibilities you can’t absorb with cash in hand.  This was kind of a surprise for me.  My professor said that if you aren’t comfortable/able to pay for some eventuality – you need to be covered by insurance.  Some examples:

  • Health Insurance – I know, this is brutal – and a good percentage of our country does not have this.  If you don’t have health insurance, you should be doing everything in your power to get it – even partial coverage.  You are guaranteed to need health coverage at some point in your life – even if you are as fit as a fiddle. Without coverage, you’re playing with serious fire and you should NOT be going on to buy houses or cars or other things until you are covered.  This is number 1.  If not, prepare to become a sob story on the radio.  I have no sympathy for you and you don’t deserve government bailout if you’re driving a new car but don’t have health insurance.
  • Long-term disability – should cover you to a minimum of 80% of your current annual salary.  Surprised me – but you can’t believe how many folks get disabled in car accidents/back injuries/etc that will debilitate them for the rest of their lives.  Without this coverage – you’ll be saddle with the double problems of not being able to work and likely having persistent and expensive medical outlays at the same time.
  • Car insurance – a single car accident that seriously injures someone in another car or folks in your own car (including yourself) can result in lawsuits that can run up to a million dollars.  I’ve personally seen it.  And if you’re not covered – you most likely will be dragged into a court room and lose your house or anything else of value on top of trying to recover from injuries you’re trying to deal with yourself.  You simply must have coverage and not the bare minimum.  Just a few years ago, $100,000 in coverage was thought to be adequate, that number is now $300,000.  If you don’t have coverage – you can expect to lose your home or have your wages garnished for near the rest of your life.  All in the blink of an eye.
    Now, I used to drive an old Nissan that was worth $1500 blue-book value.  I simply dropped insurance to cover my own car in an accident at that point.   However, I still kept $100,000 in coverage for injury/other drivers.  I saved $30/mo that way.  Reason being that I had enough money saved up that I could absorb that money IF I got in an accident.  And you know what – the gamble paid off.  I had no accidents and ended up saving about $400 in one year.  However, this requires that you actually HAVE the money to replace the car and can actually absorb that hit.  It’s a gamble that if you lose, you can just shrug and pay off – not live on Ramen noodles for 6 months.  This is the principle of ‘if you can absorb it – don’t insure for it.  If you can’t absorb it – then insure for it’
  • Home/renters insurance – I went without this for some time when I didn’t have much in the way of possessions.  The cost of insuring it was not worth the few $1000 worth of stuff I had.  Now that’s not so true.  Don’t believe me?  How much would it cost to replace the clothes, books, kitchen wares, computer, electronics (xbox, stereo, tv, dvd player), furniture, bed,  paintings, blinds, etc in your home or apartment?  If you could re-buy it yourself and not cry any tears – then just go without insurance.  But unless you’re a monk (which I dabbled with!), you’ll have about $10,000 worth of stuff – even if you’re living frugally.
    Also, in an apartment, just ONE irresponsible person can burn the building down – so your exposure is higher.
  • Life insurance.  I have no heirs or dependents – so I don’t bother.  Sure, you could get it and donate it to some good cause, but I don’t bother.  If you have kids/wife, I believe the amount you need is equal to 5-10 years of living expenses – but I’m not sure of that exact number – look it up.

6.  Buying a home – you cannot afford a home unless you have a 20% down payment in cash, and your monthly mortgage payment (WITHOUT DEDUCTIONS) is 40% or LESS of your TAKE HOME (after tax) pay on a 15 year FIXED mortgage.  You should also have on hand the 6-12 month emergency fund funded to take care of the new mortgage payments as well.  This sounds outrageous and overly harsh considering the financial vehicles being peddled today (interest only, second mortgages, etc).  But traditionally, and for most years up until this point, this was the rule of lenders for home buyers.  By following this rule you can absorb repairs that will likely run thousands of dollars, can absorb a market decline, refinance to a 30 if you get into financial trouble, AND still have a life.  This also means you’ll likely be buying 1/2 the house other people are buying with your same income.   But when you can barely afford the monthly payments on your 30 year mortgage, already have a floor rented out, AND then get hit with a job loss/new roof/etc – you have absolutely no out or way to work with the bank.  Which is exactly what you’re seeing play out all over the country.

You also cannot afford to buy a house if you don’t have the first 5 things covered (fully funded retirement, fully funded emergency funds, insurance).  First things first.

7. You have clear financial goals and review them yearly at minimum  You do not let your finances go on autopilot – even if you have no immediate goals.  Mutual funds for your retirement need to be reviewed every year at bare minimum.  Other goals you might be working on:

  • Paying off all debt
  • Weddings
  • Dream vacations
  • Savings for a child/children
  • Saving for child college fund
  • Additional money for investment purposes or starting a business (businesses should almost *always* be started from home while you have gainful employment until they are making money and can pay for themselves and you)

And so forth.  Basically: you have plans and are working towards them.
And least you think this is all impossible, I do this AND contribute 10% of my salary to charity (all save owning a house anyway – because I haven’t got the 20% down yet).

I’m sure there’s others – suggestions you’ve heard?

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