Working with Your Spouse Financially

In the book The Millionaire Mind and The Millionaire Next Door, the authors point out that millionaire’s tend to marry people who support them financially.  One of the easiest ways to wreck your financial plan is for there to be competition between a husband and wife financially.

If you have ever heard a couple say things like, “well you bought a new dvd player, so I can go buy a new dress” or “you spent $300 at the mall, so I decided to go buy a new television” you know what I’m talking about.  If a members of a marriage feel like they are in competition with each other for spending, they are off to a bad start.  Here are some simple tips to avoid this type of competition.

• Regularly discuss financial goals — If you are both headed toward the same goal financially it is much easier to work together.  This can be saving for a vacation, saving for retirement or getting ready to start a business on your own.
• Give each person a fun budget – Some couples find it is beneficial to give each person a budget for fun stuff each month.  As long as each of them stay within their budget, neither feels like the other is getting an  unfair use of their combined money.
• Try to give instead of take – The ideal situation is when both parties are doing their best to help meet the needs and desires of the other.  This works much better than when both parties are doing their best to take as much as possible.  Of course this needs to come from both sides to work.  If one person (often the woman) is giving all the time and the other person (often the man) is taking all the time it can breed a lot of resentment.

The biggest key here is to have open communication about finances with your spouse.  A good way to start is to set some small financial goals that you can meet together.  Even setting a small goal of trying to save up a $2,000 emergency fund can be a great exercise in working together financially.

Do  you have any suggestions or tips that have helped you work well financially with your spouse? Please share in the comments.

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity.  Watch for more financial posts in the future.

Passive Income

Last week we talked about defining wealth in terms of long you can go without a job before running out of money. With this definition of wealth we can increase our wealth from two sides. One side is to reduce our spending the other is to increase our savings and our income that isn’t tied to work.

Money that you don’t have to work for is usually called passive income. This includes interest and other types of income that you get more or less automatically. Here is a list of some passive income sources:

• Interest income - Money that the bank pays you for the use of your money.
• Rental income - Real estate lease or other sources of income in exchange for the use of property.
• Royalties - Money for the use of intellectual property.
• Dividends - Profit distribution to owners of a company.

If you can increase your income from these types of sources it reduces your reliance on your job which (in our definition) makes you more wealth because it moves you closer to financial independence.

There are a lot of small things you can do to increase your passive income. For example, if you have a savings account that is currently earning less than 4%, consider putting that money in a bank with a higher interest rate. If you have an average balance of $5,000 per year this will give you an additional $200 per year in interest.

That may not seem like a lot of money, but if you consistently look for ways to maximize your passive income, it shouldn’t take too long to get to the point that one of your bills is paid each month from passive income. The beauty of this type of thinking is that it encourages you to not only increase your passive income, but also decrease your expenses. Instead of just trying to make more money you are striving to have more freedom by working from both ends simultaneously.

Are any of Productivity501’s readers actively trying to do this? If so, what steps have you taken to increase your passive income?

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity. Watch for more financial posts in the future.

Definition of Wealth

One of the most important things you can do in aligning your finances to be more productive is define what wealth means to you.  Obviously being wealthy is something of a relative term.  Someone at the poverty line in the US would be seen as extremely rich in other parts of the world.

The Rich Dad Poor Dad books give an interesting definition of wealth.  They say that wealth is determined by how long you can survive at your current standard of living if you quit your job today.  So once you stop getting  your regular paycheck, how long can you live off your savings and passive income sources before you go broke.

I think this is a very healthy description of wealth because instead of focusing on being rich, it focuses on having the freedom to do what you want while maintaining your quality of life.

Once you’ve come up with your definition of wealth you’ll start to see that there are multiple ways of achieving it.  With the definition above, you can become wealthy by making more money, but you can also increase your wealth by lowering your cost of living.

Lets say you normally spend $50,000 per year on living expenses and you have enough money in savings to go 6 months if you quit your job today.  If you change your lifestyle and drop your expenses to $25,000 per year, you’ve effectively doubled  your wealth.  You can now go 12 months without going broke (actually a little longer because your money should be earning interest).  If you work for a year and set aside the extra $25,000 you can now go for 18 months.

By working to increase the amount you make (and save) while decreasing the amount you spend, you can increase your wealth from both sides of the equation.  The trick is to lower your costs in a sustainable way.  You can’t just stop spending money, but you can cut out things that can be replaced with better alternatives.  For example, if your current entertainment is to sit and watch cable television, you could replace that with going on walks in the evenings.  It is better for you and will save you around $50 per month.

As your wealth increases so does your freedom.  If your wealth is 2 weeks (the amount of time before you’d go broke without a job) you are very much a slave to your employer.  If your wealth is 1 year, you have the opportunity to take career risks that other people just can’t. Once you get to the point where you can go 5 years without a job, it frees you up to make financial decisions like starting a business, taking a sabbatical, or taking a risky job with the potential for very high payouts in the future.

What is your definition of wealth?

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity.  Watch for more Wednesday financial posts in the future.

Subprime Problem Explained

Thanks to everyone who helped answer my questions in the previous subprime post I now have a much better understanding of what is going on. I thought I’d go ahead and explain it here. The first reason is to share with anyone who is interested. The second is so the financial wizards among my readers can correct me if I got anything wrong.

Over the past several decades home prices have been going up. This has made them a fairly safe investment. If someone can’t make their payments they can always sell the house–usually at a profit–and pay the mortgage company back. In order to create as many loans as possible, mortgage companies will take a group of mortgages and turn them into a special type of investment vehicle and sell them off. This gives them cash to create more loans. For example, they will take 1000 mortgages and sell the rights to receive payment off to other institutions. Since different institutions have different risk tolerances they take the investment vehicle and divide it into several different segments. The first segment gets paid first. The second gets any money left over and the third gets any money left over from the first and second segments.

So when money come in from people paying on their loans, it first goes into the green bucket. The green bucket is sold to institutions who want very little risk. If the people who bought the green bucket have already received their money the payment goes to the orange bucket and so on.

This makes the green bucket very very safe. 66% of the mortgages would have to go into default before it would matter to the people who own the green bucket. The orange bucket only requires that 33% go into default before they start loosing money. If anyone doesn’t pay, the red bucket starts losing money.

This arrangement is why there are companies willing to sell their investment for $0.30 on the dollar. If they own the red bucket there is a good chance they will get very little of their money back.

Originally I didn’t understand why companies would be willing to sell their mortgage backed securities for 1/3rd of their face value. As you can see they don’t actually own the mortgage, they own a position to receive the payment from the mortgage.

This is causing some problems because the people who will lose money if homeowner stop paying are not they ones who actually hold the deed. In at least once instance, courts have ruled that the banks who purchased the mortgage backed securities can’t foreclose because they aren’t actually the owners of the property. So there are people living in homes that they have simply stopped paying the mortgage on and it doesn’t look like they will get kicked out any time soon.

For people (like me) who would be interested in investing in real estate if the prices drop significantly, it doesn’t look like things have hit bottom. The housing market is going to stay relatively high until a bunch of foreclosures start flooding the market. This is already happening in Detroit and some other cities, but most home prices are still within 10% of where they have been in the last 3 or 4 years.

So did I explain it correctly? Are there any major points to the way these investments were structured that I misunderstood?

10 Signs You Will Be Poor

Here is a list of signs that indicate someone is likely to be poor in the future. If any of these apply to you, it might want to consider making some changes.

10. The only type of CDs you know about play music.

Not understanding basic investment tools is one sure sign that you will mismanage your finances. This is especially true because a basic financial education is so readily accessible on websites, through library books, etc.

9. Your bank account balance goes down each month.

You don’t need any fancy charts to see if your net worth is improving or decaying. If you usually have less money in your accounts each month then your lifestyle is not sustainable on your current income. You’ll have to change something to keep from running out of money. Until you make some significant changes, you will continue to become poorer.

8. You carry a balance on your credit cards.

Normal interest rates on credit cards are extremely high. If you are willing to pay 20% in interest each month, it is very unlikely that you’ll make wise financial decisions in other areas. Even if you do, the amount you are paying in interest is likely to offset any gains in other areas.

7. You leave money on the table.

Not participating in an employer matched retirement plan is one way people leave money on the table. Health savings plans and other tax savings setups are other opportunities you shouldn’t overlook. If you regularly skip over opportunities to get free money you are unlikely to do well financially.

6. You look forward to getting a large tax refund.

A large tax refund usually means you didn’t plan ahead correctly. Any extra money you gave the government is basically an interest free loan. If you plan correctly your refund should be very small or you should have to pay a small amount.

5. You notice the “cost per month” price on items.

If the first price you notice on a new item, is the cost per month you aren’t thinking like a financially responsible person. This is especially true on items that you shouldn’t borrow money to purchase like consumer electronics. For items like a car or house, you should make sure you can make the payments, but your starting point for determining if something is worth the cost or not should be the price not the payment.

4. Social Security is your retirement plan.

Social Security may still be around when you retire. It can offer some nice life insurance style benefits right now, but if your entire retirement plan is based on Social Security you aren’t thinking like a financially responsible individual. If this describes you, I’d suggest you immediately sit down and see what your projected SS benefit will be and decide if you can live off that amount. And don’t forget to calculate in 6% inflation which means $100 today will only have the purchasing power of $96 next year and so on.
If you were to get fired today, you would be broke in two weeks.

3. Your bank fees each month are more than any interest you earn.

This is similar to leaving money on the table. Financially responsible people pay attention to bank fees. If you are being charged $10 per month by your bank you should know why and you should have a plan for making that charge go away. Banks should be paying you for the privilege of keeping your money, not the other way around.

2. Your retirement plan projects receiving large inheritance.

If your parents or a relative leave you a large amount of money when they die that is great. However if that is your financial plan you may be in for some disappointment. First, if they are truly wealthy they are probably going to be more interested in leaving their money to someone who displays financial responsibility. Second, they may find other uses for their money. It isn’t uncommon for someone to spend their life savings on healthcare costs at the end of their life. With some of the newer technology being developed, it may be possible for people to increase their lifespan but at a very great expense. Don’t count on that money being there.

1. Your wheels cost more than your car.

It doesn’t just have to be the wheels on your car. Any time your financial priorities are out of balance it is a pretty sure sign you aren’t going to acquire any wealth. Other examples include: Your video game collection is the largest portion of your net worth. You don’t have any money to repair your car, but you a new plasma television.

Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity.  Watch for more financial posts in the future.

Productivity and Finances

A lot of people tend to think of productivity in a vacuum.  They want to get more done.  However at the end of the day your work translates into money which translates into purchasing power.  Sometimes instead of just concentrating on how to do more work, it is more efficient to concentrate on the conversion process–how the work turns into money and then turns into things you need. 

For example, if you currently work for $50 per hour and  you are able to make a change that allows you to turn  your work into money at a rate of $75 per hour, you’ve increased your productivity by 50%.

On the other hand, if you can make your money go further you can also increase your productivity.  For example, if you live in an area where your housing costs are $30,000 per year and you move to an area where your housing cost is $15,000 per year (but your income and other factors are still equal) you’ve significantly increased your productivity.  The amount you have to work in order to pay for housing has been cut in half.

Don’t get so caught up in trying to do more that you miss opportunities for productivity other than just doing more work.

This post is the first of several Wednesday posts on finances.  Watch for more financially related Wednesday posts in the coming months. 

Help Me Understand the Subprime Mess

I don’t understand the subprime mess.  I mean I understand the idea that if you try to loan a bunch of people money who are likely to default (bad credit, poor financial skills, etc.), then you have a high chance of them … well, defaulting.  That part makes sense, but the way it is causing problems for banks doesn’t make sense to me.

This isn’t a standard productivity post, so feel free to skip this one if it doesn’t interest you.  It is more of a personal question to my readers who more more financially savvy than me.  If you find financial markets interesting–and especially if you understand them and care to leave a comment–please read on.

So lets skip the whole part of the subprime mess where lenders gave loans to people who really shouldn’t have qualified for it at discounted rates that are now starting to reflect the true risk of their loan and triggering a bunch of foreclosures. That part I understand.  That is the part we hear about.

Here are the two things I don’t understand:

1. Why does this matter to the banks that bought up the mortgages?
2. Where are all the cheap houses that are being foreclosed on?

So starting with the first question: Why is this hurting banks?  Recently, Etrade sold several billion dollars worth of mortgages to Citadel for 28  cents on the dollar.  That is a pretty steep discount and is supposed to reflect the fact that Citadel assumes that 72% of the original investment will just evaporate. What I don’t understand is why the liability is on Etrade (and now Citadel’s) shoulders.  Every mortgage I’ve every had required mortgage insurance until I owned at least 20% equity.  So either these were homes selling for $80,000 that they somehow got to appraise for $100,000 and thus didn’t not require mortgage insurance, these were special loans that didn’t require insurance, or the mortgage insurance is somehow packaged into the loan (which would make the mortgage insurance thing seem like even more of a rip off).

If mortgage insurance is involved then there should be a bunch of insurance companies getting into trouble instead of the banks that purchased the mortgages.  More importantly, if the mortgages use the houses as collateral, then why does the bank think no one would be willing to pay more than 1/3rd of what the house last sold for?  This brings me to my second question.

Second question: Where are all the cheap houses?  For banks to start unloading  their mortgage investments for less than 1/3rd of their face value they have to really be losing money.  Keep in mind that the banks aren’t dealing with just one loan, they are dealing with thousands of loans.  For a bank to say, “We have 1,000 mortgages for $100,000 each and for each of these loans we only expect to be able to collect $28,000.” is a pretty big step.  That would mean that after the bank forecloses they are only able to recover $28,000 from a $100,000 house.  Take into consideration that there are some people that won’t default and that means the average foreclosure will value a $100,000 house at less than $28,000.

So where are these homes?  I can’t find anyone selling houses for that type of discount.  Detroit has a bunch of run down houses for sale in the $30,000 range, but those weren’t ever $100,000 homes.  I haven’t seen any real estate market in any part of the country where people are only will to pay no more than 1/3rd of the price a home went for in the last 4 or 5 years.

So what am I missing?  Can anyone shed some light on my confusion?  If banks are losing as much money as they say they are then someone should be getting a really good deal on houses.  Is this happening in your part of the country?

Tuesday’s Tip: Pennies

I don’t know if this is actually a productivity tip or not. It might actually waste more time than anything else, but I feel like it is a good thing.

Do you have a huge collection of pennies that are building up? My wife and I have a metal box full of our lose change. We run most of our expenses through our credit cards, but we still end up with a bunch of coins. I have found a use for pennies.

The toll roads in Chicago take pennies. I don’t know if this works in many other major areas or not. There is something deeply satisfying about throwing 80 pennies into the machine to pay for your toll. Of course you probably don’t want to sit at the toll both counting out 80 pennies. If you have a passenger in the car that can be their job. Otherwise you can count out the pennies into appropriate quantities when you are at home and keep them in the car for use while you are driving.

Let me reiterate that this is unlikely to directly make you more productive, but for me it provides me with a deep inner happiness and when I’m happy I am more productive.

My Experience Selecting a CPA

For the past year, I’ve been spending a lot of time learning about the IRS rules for income tax, particularly the rules for a business. After many hours of the IRS website and pouring through other books, I finally decided that I’d be better off sitting down with a CPA. I’ve talked with several and so far I’m not impressed.What I’m finding is that at least some CPAs seem to be very use to people just taking their advice and not asking any questions. A recent conversation went something like this:

Me: It appears that my business can deduct X. Is that correct?

CPA: No.

Me: Why not?

CPA: Because publication 15b says you can’t.

Me: I just read publication 15b and it says I can deduct X except in certain circumstances–none of which apply to me. Also based on 15 b, if I can’t deduct X then I can’t deduct Y or Z because it is the same test. Can I deduct Y and Z?

CPA: Yes most definitely.

Me: Then why can’t I deduct X?

CPA: I think I read it in a book somewhere. I’ll get back to you.

As you can imagine these, types of conversations at $100 per hour are frustrating. Technically they cost quite a bit more than $100 per hour. If I’m talking to a CPA I can’t be working for one of my clients.

What is strange is that most of the time I’m not dealing with obscure issues here. I’m asking basic questions about common health insurance and retirement setups. When I do get into obscure issues I understand that the CPA might need to consult a reference, but I’m getting the impression that CPAs are just reading the same tax books you can buy from your local bookstore.

I assumed that a CPA would have some type of product that would let them type in an issue and see a consolidated list of all the guidelines issued on a certain issue, all the U.S. Tax Court cases related to the issue, and all the appeals (and results) that moved from Tax Court to the regular legal system.

So here is how I suggest you select a CPA. Find a few areas of the tax related to your business and read everything you can on it. Look up the topic on the IRS website, read anything you can find about it in the library, browse the local books store tax section and read the pages dedicated to your selected topic. It doesn’t matter if you come to a full understanding of your particular topic, but you need to be familiar with many of the issues and exceptions.

When you sit down with a prospective CPA, give them enough background about your situation and setup and then ask them questions about the topics you’ve researched. Don’t tell them you’ve done extensive research on the topics. You should be able to tell enough from their answers if they will be a good match for you. If they simply type every question you ask into Google while you sit there, you should probably consider someone else. What I would be looking for is something like:

Well, the tax code says you can do X, Y, and Z. The IRS says you can do X & Y, but the tax courts generally hold that you are in compliance if you do X, Y, this part of Z, and keep these particular records.

I may be better off going directly to a tax lawyer and using a CPA simply for filing the paperwork. I imagine the cost per hour would be much higher, but the overall cost would be much lower. If a CPA gives you bad advice it can become very expensive.

Here are some resources for anyone wanting to learn more about income tax:

1. www.irs.gov - This can be a little difficult to navigate, but most of what you need to know can be found on the IRS site.
2. www.ustaxcourt.gov - You can find all of judge’s opinions for tax cases here. This is extremely valuable because it shows you how tax code is actually being applied. The opinions are surprisingly accessible for non-lawyers. The amount of information can be daunting and the opinions aren’t cross hyperlinked so it can be difficult to navigate to the cited cases.
3. Free Tax DVD - This is a DVD of a small business tax workshop. It is free and has some good information about tax issues for small businesses.

AT&T DSL Only Option

This week I noticed that AT&T is offering DSL without requiring phone service.  For about $29 per month you can get 3.0Mbps down and 512Kbps up.  This also gives you free access to AT&T wireless access points across the US.  This service would normally cost $39 per month, so if you need it, this can work out to be a very good deal.

Personally I wish they offered faster upload speeds.  (They have a 768Kbps up service, but it isn’t available in our area.)   I do a lot of online meetings where I share my screen and the lower speeds cause problems.

This “DSL without phone service” package is something new.  (I don’t think it was available two months ago when I was looking at a faster alternative to my cable modem.) I know a lot of people who don’t have a normal land line telephone that have been stuck using a cable modem because the combined cost of a phone line plus DSL was greater than the cable modem charges.  The new service offers these people some additional options.

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