Conventional personal finance makes us think way too small

Remember to dream big

Remember to dream big

A recent Business Insider article did a kick-ass job of explaining the power of compounding interest for young people. It made some great points about how saving and investing even small amounts when you’re young is so much better than trying to catch up when you’re older, but it’s adherence to the limits of conventional financial wisdom infuriated me!

The article is all about how you shouldn’t wait to start investing in retirement accounts. It’s does a surprisingly good job of demonstrating the huge effect compounding interest has for people who start investing in their 20′s instead of their 30′s. Once you hit 65, that amount you invested in your 20′s has had time to double three or four times. It’s a curious thing, the human brain has trouble extrapolating the results of compounding interest and exponential growth.

So here’s the example in the article. Person A starts saving $200/month when she’s 25, and person B starts saving $200/month when  she’s 35. Person A ends up with $400,000 when she hits 65 while person B has just $200,000. It’s a powerful example, but I think it’s missing the point because both person A and person B are thinking too small.

My beef with conventional personal finance

That’s where my praise of this article ends. My beef is not with this author, instead I’ve got a beef with most money/personal finance writers and how they frame their questions.

Why do we expect so little of our citizens? Why is it always a stretch to assume that our citizens can manage to save and invest $200/month ($2,400/year)? Posts like this one anchor our opinions of what a reasonable savings level should be. This leads to Americans failing to even consider what might happen if they invested just a little more.

What if we weren’t so entrenched in their small-minded personal finance philosophies? What if we decided how much to save based on how we want to live when we retire? And what if we chose when we want to retire, instead of just accepting age 65 (or later)?

A new way to consider retirement

In the Business Insider article person A (who saves $200/month starting at 25) ends up with $400,000 at age 65. If we apply the 4% withdrawal rule, that means she’ll be living on $16,000/year (without considering pensions or social security).

Person B would be doing even worse (saving $200/month starting at 35). She’d earn only $8,000/year. She’d better have other sources of retirement income or else she’ll run out of money quite quickly.

Instead of considering such sad examples, why don’t we consider a more reasonable spender who’s decided to approach life a little differently. Person C makes about $50,000 at age 25, but since she’s frugal and money-savvy, she only spends about $35,000/year (much more than I spend). Even if she never makes more money as she grows older (a silly assumption) she should be able to save at least $600 every month. She’s easily able to save triple her friends A and B because she’s somewhat conscious about how much she spends. At age 65 she’ll have $1.2M to retire on*. This will provide an annual income of $47,000/year which sounds quite a bit nicer than $16,000 or $8,000.

Person D is a little more aggressive when it comes to saving money. She makes $50,000/year like person C, but she only spends $25,000/year (more than I’ve spent in either of the last two years). She’s able to $1,500/month because of her frugal focus on life. Instead of worrying about how much money she’s got at age 65 ($3M), person D gets to decide for herself when she wants to retire. She just has to determine how much money she wants to bring in passively each year. Since she only really needs $30,000/year in income, she gets to quit working at 45 instead of 65*.

compare retirement

Why doesn’t everyone customize their retirement?

Why doesn’t the mainstream media include examples like person C and person D in their articles? Why not expand the possibilities of the readers?

I guess the answer is simply that mainstream financial articles have to cater to the lowest common denominator in order to maximize their ad revenue. But imagine for a moment what might happen if these authors took a risk that might piss of their editors. What if they showed examples like people C or D? It might just help a few more average people (read: American over-consumer) to question their beliefs about what level of spending and saving is normal.

If there’s one thing I want you to take away from my blog it’s this. Just because your friends, family, and coworkers tell you that a certain expensive hobby, luxury brand of car, or classy bar is “normal”, you don’t have to listen to them.

Normal means so many things to so many different people. You’ve got to realize that there’s no such thing as normal. You can design your life to be exactly how you want it. Stop thinking small when it comes to saving and investing. Start thinking bigger and decide when and how you want to retire on your own terms.

*Obviously these are quite conservative assumptions in order to make a point. These numbers don’t even account for raises our heroes will almost certainly earn throughout their lives.

You don’t always get what you pay for

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If there’s one thing I’d like readers of this blog to take away from my posts, it’s this. 

You don’t always get what you pay for.

The motto of my blog is “conventional financial wisdom is overrated” because I believe there are massive inefficiencies in the consumer economy that you and I can take advantage of to live a more prosperous, joyful life.

This relates to valuing bikes and public transit over cars, eating healthfully on a budget, and generally seeking more happiness instead of more money. Folks like you and I aren’t drawn to products just because of their price tag. We only pull out our wallet when we see how products can add to our family’s quality of life.

Ranking the best places to live

So when I slid open the internet this morning to see what was new in the world, a giant example of not getting what you pay for smacked me in the face. It was an article written by Chicago Magazine about the 12 best neighborhoods to live in in Chicago.

It’s full of all kinds of sortable data with everything from crime rates to housing prices to ethnic diversity. I for once love info-graphics and sortable data. I could play with it all day long (in fact I did at work for a little bit). Now if you’re not a Chicagoan, this info’s certainly not as interesting, but I’d like to use it to prove my point about the silliness of conventional financial wisdom.

Here’s how the magazines authors determined the 12 best neighborhoods to inhabit. They considered crime statistics (safer is always better), demographics (diversity has value), education (Chicago Public Schools are something of a disaster), median income, housing prices, and access to public transit (yes!). We can agree that the authors may have had some bias towards one neighborhood or another based on their experiences, but on it’s face it seems like a fairly rational and rigorous process.

Price doesn’t correlate with happiness

The thing that I found intriguing was that neither income nor housing prices seemed to correlate with how desirable a particular neighborhood is. That’s not entirely true, there is a correlation between super low income neighborhoods and low overall scores, but once you get to neighborhoods with incomes near the national average ($51k) and above, it doesn’t seem to have much of an impact. The same effect is true of housing prices. It seems that people are willing to pay wildly more to own a home in a neighborhood that’s not actually that great to live in.

A local example

Let me give you a more concrete example of what I’m talking about. I live in a nice little neighborhood called Lincoln Square. The folks in my neighborhood make about $55,200 (US median income is $53,000), the median home price is $582,000, and the violent crime rate is 2.6/1,000 people. The neighborhood has a ton of history some hip bars and restaurants, and there’s nothing better than running through the many parks  and along the river on a warm summer’s day (if summer ever does return…). Lincoln Square made the list of the 12 best neighborhoods to live in, which made me quite proud to be a resident.

Now let’s move about a mile south east to Lake View. It’s another fine neighborhood with plenty of adventure and culture. It’s the home of world famous wrigley field, boys town, and numerous classy houses and condos. I used to live there, so I can attest, it’s a nice place to live. But here’s the thing, the median home price is $1,080,00 and the violent crime rate is 5.3/1,000 people (both double Lincoln Square’s figures). And to top that all off, Lake View didn’t even make the list of the nicest places to live.

Inefficient markets

So why would anyone move to a similar neighborhood, just a mile down the road where the average housing price is more than double, it’s twice as dangerous, and it’s a decidedly worse neighborhood in which to reside (according to Chicago Magazine)?

The answer? You don’t always get what you pay for. It’s that simple, if you take advantage of the copious free data that are available to you before making big financial decisions, you really can thwart the control and misery of conventional financial wisdom. Economists like to think that we operate in an efficient market where you’ll always get what you pay for, but I disagree. Consumers have become so blind to recognizing quality that if you’re willing to do your homework, you’ve got a chance to live a happier, more efficient life without sacrificing any of the best parts.

You can do the same thing when choosing type of used vehicle to purchase, what sort of clothing to buy, and which restaurants to dine at. For the longest time you get what you pay for no matter what. This can be true depending on the market, but relying on it exclusively is a silly way to live.

Where do you not get what you pay for?

The frugal Colorado adventure

skiing

The Rocky Mountains in all their glory

Being an unabashed personal finance enthusiast, I tend to have a number of conversations about money where I get to listen to a variety of people talk about what’s awful (but sometimes good) about money, how much we make, how we make it, and what we do with it.

These conversations about life and finance invariably lead to the penultimate question for which we all seem to have a different answer.

What is the right balance between spending for today and saving for tomorrow?

About three weeks ago, I confronted another version of this classic conundrum. I happened to be carousing with friends at a arcade bar (that’s right, all the arcade games are free and from the 80′s) and a buddy of mine mentioned that he was road tripping to Colorado in a few weeks. He’d be staying a few months out there, but floated the idea that I come along and snowboard for a few days, then fly back.

Being the frugally minded fellow that operates this blog, my internal lizard-brain response was “No way! Do you have any idea how expensive snowboarding trips are?!” What I actually said was “I probably can’t swing the vacation time”, which I knew was a poor excuse.

As soon as I got home, I started running the numbers and texting my friend about the details. The resulting adventure turned out to be one of the most kick-ass trips I’ve ever experienced while costing just $403. That’s less than what a lot of people spend on gas every month!

After quite a bit of planning over the following weeks, we spent one day driving out there, two days boarding, and the final day volunteering with Habitat for Humanity to build a house. Everything just seemed to fall into place this time.

Transportation

Total Cost: $118 (filled up the gas tank 3 times)

I road tripped out to Denver with a couple of buddies. We ran off the road once during a morning blizzard, but besides that, it was quite enjoyable. We talked quite a bit about philosophy and got a chance to catch up for 18 hours. The trip was 1,001 miles so we filled up my friend’s car a bunch of times. I paid for gas three times, which was still muuuuch cheaper than a plane ticket (and way more fun).

Coming back from Denver, I got a  ride to the beautiful Denver airport, arranged a flight with my frequent flier miles, and got picked up by another friend once my plane touched down in Illinois. Not having to pay for the flight was huge! (Saved $330)

Lodging

Total Cost: $0

Here’s the beautiful thing about being young, frugal, and adventurous. We completely avoided what’s often the most expensive part of vacation. I slept on air mattresses and couches in a few of my friend’s apartments in Colorado. I made sure to pick up the cost of a few of my host’s beers, and they most graciously provided me with blankets, towels, and a place to crash. The accommodations were everything I needed.

Snowboarding Costs2014-03-07 11.31.55

Total Cost: $174 (lift ticket, board/helmet rental, snow pants)

Whenever you start planning a snowboarding trip, the costs just seem to keep adding up. Lift tickets, equipment rental, snow pants, etc. The list goes on and on.

On this front, I ran into a couple of happy coincidences. First off, as soon as I told friends that I was going to go, another friend who’d been skiing earlier this winter mentioned that he had one extra lift ticket that he’d give me for free since it’d do him no good (Saved $120).

My friends in Colorado also happened to have a half off equipment rental coupon. Sometimes you just get lucky when you tell others what you’re trying to accomplish. Communities are powerful tools!

Food and Beer

Total Cost: $111 (Beer, restaurants, coffee, and fast food)

I’d have to say this was the least frugal part of the whole trip. We enjoyed quite a few fine cervezas at fancy breweries since the town of Denver is choc full of them. However on the snack front, we did pretty well. I packed nuts, pretzels, raisins, apples, and bananas, so we had healthy snacks and the fixins for some good breakfasts. Now that I look at the numbers, we were there for days, so $28/day isn’t too bad compared to what vacations can cost.

So overall it was quite a successful trip. I made it back in one piece, experienced some of the best snowboarding in the world, spent quality time with a ton of old friends, and got to do some drywalling on a Habitat for Humanity house.

Have you ever lucked into a frugal vacation like this?

Making time to write

winter snowEven though these never-ending, frigid temperatures seem to be making everyone else crazy, I’ve got to admit that I’m enjoying life more fully than ever before. Instead of hibernating this winter, I’ve ventured out to experienced it fully.

I’ve been intentional about sucking out the marrow of life, if you will, and I haven’t worried so much about writing. I haven’t posted anything in a few weeks mostly because I’ve been dedicating more time to real-life people. That’s taken the form of new adventures with some bad ass friends and family members as well as some much needed self reflecting.

During the past few months, I’ve taken the time to go to funky dance clubs, to grunge rock concerts that reek of pot, and to breweries that have expanded my alcoholic horizons (in a good way). I’ve explored a zoo during a snow storm, a botanical garden with plants that move when you touch them, toured a few museums, played around in ice filled parks, and viewed Jupiter through one of the country’s oldest telescopes at a historic observatory. Every time I think I’m going to have a calm, relaxing weekend, a friend seems to invite me on an impromptu road trip to Colorado or a routy show.

Life’s been so exciting that my brain’s been way too spent at the end of each day to whip out the computer and actually compile a post about my life, finance, or anything else really*. I’ve been spending so much time pursuing other passions that I’ve neglected my love of blogging. And honestly, I’m not too worried about it.

I figured I’d just write a quick little post about some of the passions that have been consuming my time.

Activities & projects

My amazing new girlfriend – This one’s pretty self explanatory…

Juggling – Remember how I said I was going to learn to juggle? I wanted to prove that practice is more important than talent. I spent 10 minutes per day teaching myself how to juggle every day during the month of January. I went from being about to keep the balls in the air for about 2 seconds, to being able to juggle indefinitely. I can juggle pretty much anything now as long as it’s round-ish and the weights are similar. I’m even working on a few behind the back and under the leg tricks to wow my adoring crowds (like 3 of my friends).

Greening my church – It’s been an interesting experience working on a committee to make my church more energy efficient. This is what I do for a living at a larger company, so it’s interesting working in a more free-form, loosely organized group. Instead of convincing folks to spend money on energy efficiency, most of my job has been to convince them to not spend money on silly energy projects that don’t make sense. But the project has been coming along nicely. We’re saving money and improving the environment all at the same time.

Baking Bread – I’ve been spending quite a bit of time in my kitchen recently, trying out new recipes and exploring new ways to extract flavor from food. I’ve been inspired by Michael Pollan’s new book (Cooked). I should write a post all about the book. It’s all about the value to spending the time to prepare food, build community, and enjoy really good food made from real ingredients. The one recipe I’ve really been working on is baking bread. I’ve gone from just using a simple bread maker to kneading my own dough and cultivating my own yeast culture. It’s such a rewarding because even mediocre homemade bread is a crowd pleaser with my friends and family. My mind keeps wandering towards the idea of selling my baked goods… but that’s more of just a silly daydream.

Inventing – A couple of friends and I are working on building a prototype. It’s  a silly little invention for the construction industry, but it’s been fun so far gathering all the parts to build it. I’m re-learning how to wire up an Arduino micro controller. It’s great to get my hands dirty again actually building something. At work, all I ever create are reports and power points. Making a physical thing where no thing formerly existed is a uniquely rewarding experience.

A Balanced Life

At the suggestion of a few other bloggers, I think I’m going to try to make sure I’ve got some time for blogging built in along with all of these other fun activities. I used to post 3 posts a week, which seemed doable a few months ago, but not now.

I should be able to come up with at least one or two good posts if I dedicate about 4 hours a week to blogging. It’s nothing to sneeze at, but it’s also fairly easy to fit into the rest of my life. And if I want to stick with this hobby for the long term, I really need to pace myself.

How much time do you spend writing? Do your other passions ever wear you out?

*I also have to admit that watching the entire second season of House of Cards has consumed 13 hours of my life over the last two weeks.

cottage food laws: How to sell homemade food

cottage food laws

Some french bread I made the other day

I’ve recently been thinking about turning one of my favorite hobbies into another income stream to help fund my early retirement. As you all know by now, it’s important to have diversified income streams if you ever hope to quit your main job and pursue your passions. The idea that’s tickled my fancy recently is selling bread that I make in my kitchen at farmer’s markets. As I started researching the concept, I learned that it’s a strictly controlled, yet entirely feasible practice regulated by the cottage food laws.

Cottage food laws are essentially the rules that make it legal to sell certain foods you make in your kitchen to other people. You see, most food that you buy from other people has to go through rigorous inspection and the kitchens have to meet health code standards.

What are cottage food laws?

 

These regulations make a lot of sense when you think about food production on a mass scale. I think we can all agree it’s a good idea that the kitchen of your local Panera Bread has to meet certain cleanliness standards and the workers are required to wash their hands after they use the bathrooms. These are some regulations that we can pretty much all get behind.

But these rules all start to seem pretty silly when you apply them to a dude who wants to sell his homemade cookies at a food stand or at a farmer’s market. That sort of thing used to be totally illegal in most states. State legislatures all over the country got together and agreed that there are certain types of “low-risk” foods that people could sell at certain venues for a limited profit. These “low-risk” foods include things like breads, cookies, cakes, jams, herbs, and teas. They’re unlikely to cause a major disease outbreak even if they’re not prepared properly.

It’s tough to be against this sort of legislation because it allows people to use their own kitchens to make a little bit of extra money and invigorate the local economy. It’s really a win-win for everyone.

How this whole thing works

Let’s go over a few ground rules that are similar to most states with cottage food laws. You’re limited to specific “low-risk” foods, you can’t make more than a specified amount of money each year (so it’s not a get rich quick scheme), you can only sell you wares in specific locales, you need to register as a cottage food operation with the city, and you need to register with the department of health. All of this should cost you about $100, and they you’re good to start baking!

But because these rules were set up differently in different states, there are dramatic differences between starting my home-made bread operation in Illinois as opposed to California. Check out my handy dandy charts below that explains the differences.

Where am I allowed to sell my bread?

cottage food law

Illinois’ cottage food laws are quite restrictive

How much can I make in a year?

  • Illinois : $25,000/year
  • California: $45,000/year

How many different types of food can I make?

  • Illinois: 16 types (including things like breads, fruit butters, and pastries
  • California: 29 types (including waffle cones, mole, and vinegar)

It’s safe to say that a Californian has more opportunities to start a cottage food operation than I do here in Chicago. A Californian could make their own trail mix and sell it in local restaurants, local businesses, and over the internet. If their trail mix was popular, you could see them making $40,000/year while filling a trail mix shaped whole in the community’s economy.

Though my options are quite a bit more restricted in Illinois, it’s an idea that has kept jumping to the top of my mind over the past few days. You see, I love making bread! Just this past week I made white bread, wheat bread, pizza dough, corn bread, and french bread. Sometimes I use my bread maker for the whole recipe, sometimes I just let it make the dough, and sometimes I do the whole process myself.

There’s nothing like the aroma of home made bread wafting from the oven on a winter’s eve. Sure, sometimes I’ve messed up and ended up with a totally burnt loaf or one that refuses to rise, but the vast majority of my loaves turn out exactly as planned and my friends love them. Since I like baking bread so much, I’ve run into the issue of making more than I can possible eat. Once I started giving loaves away to my friends and family, I started wondering if I was allowed to sell them in any capacity.

Ideally, I’d set up an online business. If it were legal, I’d build a website and ship bread to whoever wanted it. But after looking into the cottage food laws it became clear that there’s only one legal avenue of making money from my bread in Illinois. I’d have to sell it at a farmer’s market.

Chances are, I’ll never actually get around to doing this simply because it would take so much time, but it’s good to know that I could if I really wanted to.

Have you ever tried to sell anything homemade in your state? Do you have any interesting cottage food business ideas?

 

When it’s finally time to find a new job

It’s a truly frightening moment when you realize that It’s finally time to get your next job. Sometimes you just know that you’re ready. After quite a bit of deep thought and conversation, I’ve decided that I need to start the long and painful process of job hunting.

The biggest issue I’m running into is that I’m comfortable in my current job. I started three years ago, and I’ve done quite well. I keep beating my expectations and enjoying the difference I’m able to make in the world. I have a great group of work friends, my boss and I have a super fun and productive relationship, and the company I work for tends to treat its employees the right way. It’s so rare to find such a trifecta in a today’s work world, so you’ve got to appreciate it properly when it all comes together.

But here’s the thing. Being comfortable is a bad reason not to take my next career step. That’s what I keep coming back to. Since there’s no more room to grow in my current role, I know that it’s finally time to branch out.

Branching out

Sure, I could stick with my current job for the next ten years. It would be quite comfortable and I’d amass a pretty hefty nest egg if I save and invest appropriately, like I have been over the past two years. But what’s the point in doing that if I’m bored along the way?

There’s a time in life when you have to take any job that you can get, and you do it even if it’s dizzyingly boring. You just have to get up every day to punch the clock and bring home the bacon if you’re being crushed by a mountain of debt, or if you’re falling behind on supporting your family. This is not that time.

When your finances look just fine, when you’ve got the beginnings of an early retirement nest egg formed, it’s no time to be bored. It’s time to stretch myself to my limits to see what I can accomplish in this world. If you look at my Goals page, you’ll see that I initially wanted to retire at 35 and become a high school science teacher. I think I’m going to shake that up a bit.

I’ve been asking myself recently, what would I do with my life if I was already retired. Teaching science to high schoolers does rank near the top on my list, but I’ve got a new one that just makes me giddy. I’d like to be the Chief Sustainability Officer of the City of Chicago. It’s a wildly cool job that brings together a bunch of aspects of the local community and the city government to build a more sustainable and prosperous city.

I realize that looking to become the CSO of Chicago is about as ambitious as saying that I want to become an astronaut, but you gotta have big ambitious goals! So in order to get there in 10 years, I’m going to need to have a variety of exciting jobs that let me try out new opportunities where I succeed, fail, and learn along the way.

Where do you start?

I’ve got a question for you.

Where do you typically start when you’re looking for a new job.

  • Existing Contacts: I have a few contacts at various companies that I’d like to work for, so I’m going to talk with them to see who’s hiring. I know this is the number one way most people find jobs, but I still don’t like how it’s about who you know and not what you know.
  • Apply Online: I’ve gotten every job I’ve ever held by applying online. I had two sweet internships in college simply because I sent in my resume and filled out the application, and the same trick worked for the job I’ve been in for 3 years now. What I hear from friends and coworkers is that this is extremely rare. So is it even worth doing?
  • Networking: I’ve always felt like gaining new contacts with the express purpose of finding a new job is a little sleazy. I know this is something I just need to get over, but I’d rather try using existing contacts and applying online before I go this route.

Since I have such limited experience, I really don’t know what the best way to go is.

How do you go about starting your job search?

Car debt vs credit card debt

car debt vs credit card debt

Either kind of debt can leave you buried…

Being a financial blogger seems to open me up to a wide range of financial questions from complete strangers. One of the most frustrating questions that I’ve been asked a number of times is this “Isn’t car debt better than credit card debt?”

The folks who ask these questions never seem to like my answer. I always say “It’s more complicated than that. We’d need to look at why you’re in debt in the first place.” and this always seems to upset them a little.

You see, typically the folks asking questions like this are looking for quick justification to keep living life they way they’ve chosen. They just want someone to tell them that they’re doing it right already.

But in reality, asking which debt is better is a lot like asking “would you rather be dropped into a pit full of lions or a pit full of T-Rex’s*?

So as long as we can all agree that both kinds of debt are bad to have, I’ll finally go ahead and take on the question of car debt vs credit card debt.

The reader’s pickle

So the brave reader that asked me this question seems to be in quite a financial pickle, but I’m sure with a little time and effort he’ll be able to dig himself out. He’s got mountains of of student loan debt, but he makes enough money $60,000/year that he’ll be alright. What he’s worried about is his credit card debt ($6,000) and his 7  year old car (also worth $6,000) that’s recently run into significant mechanical problems.

So let’s start at the beginning. When his car broke down recently, he had a few auto shops diagnose the problem and they both gave him a quote for a little over $3,000. As a first step, I’ve got to applaud our friend for getting two independent quotes. Nice job, sir.

Because the cost to repair the vehicle is almost 50% of what it’s worth, he wants to replace his car with a new one. RED FLAG! I strongly advised him to just repair his car since it’s a quality brand, Volvo, and it only has 80,000 miles on it. I’d be surprised if that car doesn’t make it to 150,000 with routine maintenance and a little attention. In fact, I already wrote a whole post about how it’s almost always smarter to drive your car into the ground than sell it and buy a new one.

But I digress. Our friend won’t be persuaded against driving a new car (of course I advised that he purchase a used car, but he’s got his mind made up on this point). Some people will only spend their money on new cars no matter how much you show them the folly of their ways. Now he’s wondering how he should use the $6,000 he’ll receive from selling his old car.

Option #1: Use the $6,000 as a down payment on a new $25,000 car

Option #2: Use the $6,000 to pay off 100% of his credit card debt and 100% finance the new car.

When he first posed the question to me, my gut initially leaned towards option #1. Auto debt is just so silly. I believe that we should just save up for the cars we want to but and use no debt, but if you’re going to finance, finance as little as possible.

The rational economist in me woke up and took a look at the numbers. He’s paying 23% interest on his credit card debt, and apparently he can get a 100% financed car at a 3% interest rate. You’ve got to admit that from an economics perspective, he’s got to take advantage of option #2.  Clearing out his credit card debt and replacing it with lower interest rate car debt is clearly the right choice.

The real question

So far, all he’d been asking were math questions. Although buying a used car is most likely more cost effective, when faced with option #1 (car down payment) or option #2 (credit card pay off), there’s a clear answer (#2).

Then he asked the real question that I don’t know the answer to. I’d like to ask the opinion of the readers of this blog, because this is a question of opinion and psychology instead of pure math.

Do you think our reader would do a better job paying off revolving debt (like credit card debt) or structured debt (like a car loan)? 

Personally, I think I’d rather have revolving debt to pay off. It would give me motivation to pay off as much as I can as quickly as I can. Besides the standard minimum payment, there’s no guideline for how much I should be paying. I’d save as much as was possible and throw all of my extra cash at it. However, for other less aggressive debt repayers, this type of debt clearly spell disaster because they just don’t pay it off.

Now if I had structured debt payments, I guess I’d be inclined to just pay the strucutred amount instead of aggressively paying down the balance as quickly as possible. That being said, it’s probably a better model for most people because they’re forced to pay a consistent amount each month.

Would you rather pay off revolving or structured debt? Which do you think you’d pay off faster?

*Every time I think I T-Rex’s I can only picture the one from Toy Story…

Rich people and the capital gains tax rate

2014-01-09 12.57.08We all know that the US financial system is rigged in favor of the rich. There are countless examples of policy makers being influenced by wealthy corporations and individuals in order to make those individuals even wealthier.

We could talk about income inequality and the massive redistribution of wealth from the middle class to the upper class all day long. But instead, I’d like to tell you about an incredibly powerful little rule that I believe everyone would take advantage of if they really understood it.

It’s called the capital gains tax rate. I’m sure you’ve heard of it before, but do you really understand it? It’s the topic of today’s post because it will change the way you think about rich people, how they earn their money, and how it will help you retire early.

It’s not a new idea

Capital gains taxes are simply taxes we must pay on the income we earn from  appreciating assets we’ve invested in like stocks and mutual funds. When you actually pull out the money to spend it, you have to count it as a type of income on your tax return, and pay the government a certain percentage of it, simply because you earned it.

There’s nothing new about the capital gains tax. It’s been with us here in America in some form since 1913, and it’s here to stay. It hasn’t even changed all that much in the last 20 years. The reason I’m writing this post now is because I recently learned the specifics of how it works and it surprised the heck out of me.

I’ve been steadily investing in index funds for a few years now and I’ve done a lot of research along the way. But I’ve never really focused on how withdrawing money from an investment account would affect my taxes. I guess I always figured that it’d just be treated like normal income, because that’s pretty much what it is. Only, instead of me putting in time and effort for a paycheck, my money is working away in it’s investment accounts churning out more and more dollar bills.

Taxes are lower on money you don’t work for

To many of my more financially experienced readers, this is going to come across as common sense. But to those of you just starting your financial independence/investing journey, this should be mind blowing.

Here’s how capital gains taxes work (in 2014). You are taxed differently depending on what income tax bracket the rest of your income puts you in. The following table demonstrate how much you’ll pay in capital gains taxes on income earned from investments.

rich people

The giant rich people loop hole that you can take advantage of

You should instantly start to realize how you can take advantage of this in early retirement! The two cornerstones of this blog are frugal intentional living and investing wisely so you can retire whenever you want to.

As an individual, I spend money on some silly, silly things, and I still only spend about $24,000/year. I’ve got a fairly aggressive plan to retire early in about 10 years, and if I can manage to keep my annual income needs under $36,000, I will pay zero taxes once it all comes from earning on index funds.

I’m going to say that again. As long as 100% of my income comes from capital gains, my federal tax rate will be 0%! The appropriate response is “say-what?!”

So let’s go through a couple of examples just to clarify how awesome this little loop hole can be for you as well as the high spenders you know.

  • The financially free family of 5: Our family of five has been saving and investing since the parents earned their first paychecks 20 years ago. They’ve recently decided to start a non-profit family band and tour the country. They withdraw $75,000 per year from their investment accounts because that’s the perfect salary for peak happiness. Guess how much they pay in federal taxes? Just $375! That’s less than the cost of one of their trumpets!
  •  The single wealthy toy tycoon: She’s a built massive wealth over her long and fruitful career as a toy saleswoman and she’s ready to quit working. She enjoys living lavishly while roaming around the world. She’s decided to spend $150,000/year for the rest of her life. Supposing that she’s built up the appropriate nest egg which will throw off that kind of income ($3.75M per the 4% rule), she only has to pay 6.2% of her earnings to federal income taxes.
  • The single Lifestyle business adventurer: Let’s say our hero is just 30 years old and he’s ready to take the plunge into entrepreneurship. He’s decided to start a lifestyle business (like Kraig) that will produce half his income, and his nest egg of investments will earn the other half. Since his investments throw off $15,000/year, and he anticipates making $15,000/year from his business. He’ll have to pay standard income tax on his business income, but he’ll pay 0% on the $15,000 he draws from his investment accounts.

What does all this mean?

Once I fully grasped the concept of the lower capital gains  tax rates, my mind was sufficiently blown. If there’s one thing you should take away from this post it’s this.

Our tax code was written to incentivize investment returns over earned income. The government wants people to invest in stocks and fund new companies because that’s how our economy grows. So they decided to take fewer taxes from people who make their money from capital gains.

And for some reason, if you can live on less than $36,000/year (as an individual), the government doesn’t think you should have to pay taxes! (but only if your income is coming from capital gains)

It also means that rich people get to pay lower tax rates on their income simply because their income doesn’t come from a paycheck. If it were up to me, I’d write the tax code a little differently, but I’m not going to look a gift horse in the mouth too closely…

Do you think capital gains tax rates are fair? How will they play into your retirement plan?

the cons of unfiltered optimism

downside of optimism

Optimism alone wont get you through this storm

This is the first part of a two part post about the pros and cons of unfiltered optimism.

After we celebrated the completion of planet Earth’s most recent orbit around the sun, I thought it’d be appropriate to talk about optimism and goal setting. Many folks take this time to draw up New Years Resolutions, which are most certainly filled with unfiltered optimism which will never really lead to accomplishments.

There’s something incredibly powerful about setting huge, scary, motivating goals, but we’ve also got to recognize that most of our ambitious resolutions eventually fall flat and provide no motivation at all.

Before I happened upon the book, Bright-Sided by Barbara Ehrenreich (she also wrote Nickel and Dimed), I touted the merits of optimism a little too much, without really understanding the downside. We all want life to be great, but we need to realize that optimism alone wont get us there, and it could in fact be hurting more than it helps.

It’s time to talk about how being overly optimistic in all areas of life can actually have a negative impact on your well being.

Smiling Cancer patients

Before reading Barbara Ehrenreich’s book, I have to admit that I bought into a ridiculous myth. I had always assumed that cancer patients keeping an upbeat and positive attitude led to better health outcomes.

It seems pretty logical that someone who’s got a positive attitude is more likely to beat cancer than someone who’s depressed about it all the time, but it’s total bullshit. Study after study has proven that simply being optimistic about your health outcomes won’t change your actual health outcomes.

It seems that most cancer patients are encouraged to keep a positive attitude even when their lives are falling apart mostly because it makes their friends and family more comfortable. Sometimes it’s healthy to feel upset and angry for a while. Repressing those negative emotions won’t help anyone in the long run.

So I think it’s clear that if you’re going through a rough time in your life, turning your frown upside down and keeping a positive attitude won’t actually make your life better. Optimism might be good for some life endeavors like entrepreneurship, sports, and learning new skills, but it’s not a magic pill that always works. It’s nuanced and it’s only selectively useful, so deploy it carefully.

On the other hand, being a sour puss all the time for no reason isn’t good for anyone. One of my favorite pieces of advice my mom bestowed upon me as a child was this phrase. “Moderation in all things”.

Get what you want… now!

Probably the most toxic result of the self-help/optimism industry is the belief that you can get whatever you want, now! As long as you want it bad enough.

It can be a useful sentiment for folks with super low self esteem who never stand up for themselves, but I’d say that most Americans have the opposite problem, an excess of self-esteem. We believe that we are trustworthy, righteous individuals who deserve to have anything we desire at a moments notice.

Have you ever been invited to a “house flipping” seminar? I didn’t realize that these things existed until my name happened to get onto their emailing list. Apparently they hold conferences from time to time in gigantic conference halls where they teach people how to flip houses. For a moderate fee, you can go learn about how to make “easy money” with “virtually no risk”.

Since Americans are nothing if not optimistic, many believe these claims and dedicate their time and money to pursuing a fool’s errand. The thing that upsets me the most about events like this is that it preys on the most desperate citizens who are willing to gamble the last of their money in the hopes of striking it big. They clearly make most of their money off of overly-optimistic folks who don’t understand the true risks of house flipping.

It’s sad that the self-help/optimism industry has perverted unfiltered optimism to this extent, but I suppose that’s what sells books, drives internet traffic, and drums up business. Instead of putting in the hard work over time, you can just want it badly and reality will realign to fit your needs.

 

A dangerous tool

It’s clear that unfiltered optimism has the potential to be a dangerous tool. Though believing in yourself and staying positive can accomplish wonderful achievements, it’s not too hard to find examples of perverted optimism in the marketplace.

It’s easy to see the hazardous effects of excessive optimism in casinos, the stock market, car sales floors, and any number of slippery occupations. These are areas where a small divergence from rational thinking can be a lot of fun, but lead to financial ruin.

I’ll definitely be a little more measured about how I talk about optimism in the future. I used to see it primarily as a force for positive change and self improvement, but it’s an easily corruptible sentiment. Like my wise mom always says, “moderation in all things”.

Have you ever been too optimistic? Have you ever believed in your own abilities too much?

Proof that practice is more important than talent

I’ve recently picked up a silly hobby. I’m learning to juggle and I want to tell you why. My motivation is not to join the circus or even to hone my clown skills. Instead, I’m learning to juggle to prove a simple, yet powerful point. Practice is more important than talent, and it applies to almost every aspect of your life.

Want to know the truth. I can’t juggle. I’ve never been able to. I’ve always looked towards people who could juggle with jealousy and envy. I believed for the longest time that some people were just naturally good at it, and that I was not born with that gene.

Imagine, for a minute, how damaging that belief was to young Cash Rebel’s psyche. I had the notion that because I possessed no discernible talent at a certain skill, I’d never be good at it. It kept be from going out for football, it kept me from learning Spanish, and it kept me from juggling.

So I’ve decided to rid myself of the talent. I’ve decided to believe that I can accomplish any task so long as I’m willing to put in the time and effort (See the 10,000 hour rule). When you really think about that statement for a moment, you’ll realize that it’s a radical notion. One that has the potential to alter how you perceive the world and the challenges around you.

My objective this month

So here’s my objective for the month of January. I’m going to dedicate 10 minutes a day, every day, during the month of January to learning how to juggle. Some days, I’ll spend a little more time, and some days I’ll neglect it entirely. It’s an experiment to see if a small amount of consistent practice can actually make a difference over the course of just one month.

So far, it’s been just 9 days (I’m writing this on the 10th of January), but I’ve been astounded at the progress. When I tried juggling on New Year’s morning in front of my friends, I could catch 3 balls in a row before they all careened to the ground despite my futile flails to keep them in the air.

So I decided to try and track this metric. How many balls could I catch before losing control? Check out this graph of the first nine days of January.

practices and talent

the results of consistent practice are astounding!

That’s right, after four days of trying to learn the basic, and making decidedly minimal progress, I’ve suddenly improved my juggling skills by 700%. There’s a distinct change in day five. The whole process just seemed to click and my hands started moving on their own, independent of my conscious thought.

I no longer try to focus on the balls as I throw them up, I just keep everything in my peripheral vision, and my incredible brain figure out how to keep all the balls in the air (I love puns!). Aren’t our powers of coordination breath taking once we learn to control them?

The simple truth

But none of you who are reading this blog care about juggling, and I get that. Hell, I don’t even care about juggling. The point is all about making progress at a new skill. This example is really applicable to all kinds of actually useful life skills like budgeting, investing, and saving money.

The simple truth is that even though you may be bad at one of those important life skills right now, dedicating a little bit of time each day to read about investing, evaluate your budget, and considering your purchasing decisions can have out-sized results.

A buddy of mine recently let me know that he spends over $1,000/month on alcohol. He loves going out, and that’s how he’s chosen to live. He’s been asking for money advice recently because this isn’t really a sustainable habit. What might happen if he took just ten minutes each day to evaluate his partying decisions and alcohol purchases? Do you think he’d find ways to reduce his outrages spending on beer by 3%, 10%, 50%, or 80%?

Sure he’s bad at budgeting for alcohol right now, but in 9 days his life could be different. He could save $500/month and start paying off his credit card debts or start investing! If I can get 700% better at juggling in just 9 days, what might you be able to accomplish in the same time frame?

I’ll let you know how much I improved by at the end of January? What are you getting better at this month?