Sunday, September 13, 2009

Don't Forget About Me...

To my loyal readers, I do apologize, but I am going to be suspending my blog posts indefinitely...I will eventually pick up my computer and return back to blogging.

Sunday, August 30, 2009

Avoiding Lifestyle Inflation

"I dont know what, they want from me, Its like the more money we come across, The more problems we see" -Puff Daddy (AKA Diddy)

It is always shocking to me to read articles about professional athletes and celebrities who make millions in a matter of years and seem to lose it all just as quick. It is hard to believe that it is possible to squander 20 millions dollars over a lifetime and even more impossible do it over a matter of a few years. Most people say, "If I had just one million dollars, I could probably live off that for the rest of my life", but are they being truthful?

I believe, given the circumstances that we are in today, that most people would not be able to live off one million dollars for the rest of their life. Unfortunately, this is due to a condition that is called "Lifestyle Inflation".

Lifestyle Inflation is defined as spending more money on non-necessity items as your income increases.

Do you remember that family the "The Jones's". They were the ones with the nice cars that are currently one payment away from getting repossessed, the McMansions that are on the verge of getting foreclosed on and no savings to show for all of the money that was earned. Well, the recent recession has taught up that keeping up with "The Jones" is a bad idea, but unfortunately, many consumers still continue to try to keep up. Below are some recommendations to avoid getting caught up in lifestyle inflation.

  1. Do not compare yourself to others.
    • Quite often people feel pressured in spending more money due to the fact that people around them are spending. Whenever someone gets a new car or a new home, why is it that people feel like it is necessary for them to do the same? What needs to be understood is that what is for someone else may not be for you. Be content with what you have and improve on it as needed.
  2. As you make more, save more.
    • One key to financial freedom is to save money. Whenever receiving a raise or other increase of income, rather than finding something new to spend the increase on, put it in an online savings account or start a new investment fund.
  3. Treat yourself responsibly by not spending money that you do not have.
    • In anticipation of earning more money, people often spend money that they have not even received. This is bad because spending in anticipation can possibly backfire in the case that the money does not come through after it has already been spent. This causes more debt and potential to get in a situation that is near to impossible to get out of.

Remember, be smart and avoid "Lifestyle Inflation". Live within your means and avoid trying to keep up with everyone else. Take time to develop your plan and stick to it.

For more information on the article that inspired this post, please check out the following link:

How (and Why) Athletes Go Broke

Sunday, August 23, 2009

Improving others by improving yourself

"You cannot help someone build a house when your foundation has not set". ~Me

Conceited, cocky, selfish, etc. etc. These are the words that you will most likely hear when you seem to put yourself first before everyone else. However, why is there such a negative stigma with this? My guess is, the people who are usually saying those words are typically saying them because you are refusing to do something for them. In a sense, wouldn't that make them "Conceited, cocky and selfish"?

While growing up, I was taught in my household that we need to look out for others as we look out for ourselves. We were taught to try to see the good in people and always give others the benefit of the doubt. While these were admirable lessons learned, I have received a healthy dose of reality checks as I have grown up. I have learned that "Everyone does what they want to do as long as it benefits them in some type of way".

Living in servitude to others is not necessarily a bad thing. After all, a volunteer experience can be very fulfilling as it does provide a feeling of accomplishment as well as giving back to the community. However, in this day and age, it seems like the more you give to others, the more others are willing to take. One mistake I have noticed that people constantly trying to improve others by doing things for other people and neglecting themselves.

The problem with this that I have identified is that this typically results in one going without while making sure that others have. For example, how can you pay for someone else's gas but not have enough gas to get yourself to work? It is my experience that the best way to improve others is to work on improving yourself.

On my journey to improve my finances, I have implemented many changes in my lifestyle. While implementing these new changes, I have been able to spark curiosity from the people around me to ask about how I have been able to accomplish these changes. I am able to share with others my experiences and make recommendations for them based on things that have worked for me.

In addition to that, I find that whenever I have sacrificed myself on behalf of others, the end result always consisted of no change. I believe people are a lot more receptive to recommendations when they are ready to change rather than when you are ready for them to change. By allowing people to observe the positive change in your life, it may inspire them to do adopt some of those same changes.

For some recommendations on how you can improve yourself, check out my articles about Investing in your health, Investing in your knowledge, Investing in your Experience and Investing in your Future.

I believe that improving others only occurs through self-improvement, please leave your thoughts about this in the comments below.

Stay Disciplined!

Monday, August 17, 2009

Stocks: Buying on Margin

Lately, I have been investing in the stock market and have been doing pretty well. I guess a lot of what the experts said about the stock market snapping back was true cause I have definitely been able to experience a lot of gains since the recent market recovery. Even though I feel like I have been taking steps in the right direction, there is always room for improvement. During a conversation with one of my colleagues, I was asked about "margins", which is something that I have heard of but do not fully understand. Of course, this would be a perfect opportunity to educate myself about this procedure as well as write an article about it.

"Buying on Margin" has a very negative connotation due to the fact that this is a practice that contributed to the Great Depression that occurred during the 1920s. From my understanding, many people took at loans to purchase stocks however, when those stocks did not appreciate, many people were left with loans that they were unable to repay. The following information is quoted directly from Wikipedia:

During the Crash of 1929 preceding the Great Depression, margin requirements were only 10%. Brokerage firms, in other words, would lend $9 for every $1 an investor had deposited. When the market fell, brokers called in these loans, which could not be paid back. Banks began to fail as debtors defaulted on debt and depositors attempted to withdraw their deposits en masse, triggering multiplebank runs. Government guarantees and Federal Reserve banking regulations to prevent such panics were ineffective or not used. Bank failures led to the loss of billions of dollars in assets. Outstanding debts became heavier, because prices and incomes fell by 20–50% but the debts remained at the same dollar amount. After the panic of 1929, and during the first 10 months of 1930, 744 US banks failed. (In all, 9,000 banks failed during the 1930s). By April 1933, around $7 billion in deposits had been frozen in failed banks or those left unlicensed after the March Bank Holiday.
As with most things, when there is an unclear understanding of how something works, it is very easy for something that is supposed to be used for positive to turn negative. However, after doing some research, the whole idea of buying on margin is not nearly as complicated.

The terms "buying on margin" basically means to borrow money from a broker to buy stock. The money that is being borrowed is not a conventional loan that you can obtain from a bank. It has a lot more regulations and guidelines that have been implemented to try to help prevent a repeat of the "Great Depression". Below are some of the highlights for a margin account:

  1. Typically requires a minimum investment of $2000.
  2. Usually requires a set margin maintenance fee (used to insure there is enough "cushion" in the event of loss in stock value)
  3. Allows you to borrow up to 50% of the purchase price of a stock.
  4. This account typically carries an interest rate imposed by the broker on borrowed funds.
  5. Penny stocks, OTCBB (Over-the-counter bulletin board) and IPO (Initial Public Offering) stocks do not qualify for margin purchases.

With all of these requirements, it is hard to see the benefits of having a margin account. However, the example below can illustrate why this account has the potential to return great rewards:

Let's assume that you have $5000 in your cash account. You want to purchase a stock that is worth $10 and you believe that it will double in the matter of a year. Instead of limiting yourself to $5000, because you have a margin account, you can purchase $10000 worth of the stock (borrowing up to 50% [maximum] of the purchase price of the stock). In a year, the stock ends up doubling from $10 to $20 and you decide to sell the stock. So the value of the amount of stock you own goes from $10000 to $20000, however, you have to pay back $5000 + interest which is the based on the original amount that you owned. For our example, let's assume that there is 0% interest, resulting in a net profit of $10000.

If you had just used a regular cash account, your profit would have only been $5000.

Margin Account:

Initial Cash Investment: $5000
Amount Borrowed: $5000
Initial Investment Amount: $10000
Final Investment Amount: $20000
Net Profit (Final Investment - Amount borrowed - Initial Cash Investment) = $10000

Cash Account:

Initial Cash Investment: $5000
Amount Borrowed: $0
Initial Investment Amount: $5000
Final Investment Amount: $10000
Net Profit (Final Investment - Amount borrowed - Initial Cash Investment) = $5000

As you can see from the above example, it seems like a really good idea to proceed with investing using margins due to the fact that the return on investment is double of what it is by using cash alone. However, it would be irresponsible to just provide the possible benefit of the accounts without discussing the cons of this type of account.

In the case that your thoughts were incorrect about the particular stock in the previous example and instead of the stock doubling in value, it was halved, things change drastically. Let's review the previous example using these new numbers:

Margin Account:

Initial Cash Investment: $5000
Amount Borrowed: $5000
Initial Investment Amount: $10000
Final Investment Amount: $5000
Net Change (Final Investment - Amount borrowed - Initial Cash Investment) = $-5000

Cash Account:

Initial Cash Investment: $5000
Amount Borrowed: $0
Initial Investment Amount: $5000
Final Investment Amount: $2500
Net Change (Final Investment - Amount borrowed - Initial Cash Investment) = -$2500

As you can see, in addition to the potential for growing your profits exponetitally, you also expose yourself to the potential to grow your losses in the same manner. One more important thing about margin accounts is that the broker reserves to the right to issue a margin call in the event that the value of the stocks has decreased below the threshold of the margin maintenance fee. Since the stocks that are purchased are held as collateral by the broker, they can force the investor to prematurely sell these stocks in the event that the investor's account goes below a certain amount.

An example of this is the following:

Initial Cash Investment: $5000
Amount Borrowed: $5000
Initial Investment Amount: $10000
Margin Maintenance Fee: 25%
Final Investment Amount: $7500
Actual Margin Funds: $2500
Marginal Funds Required in the account: $1875

With the stock price being reduced to $7500, the investor is required to have at least 25% of margin equity in the account. So, the investor is required to have 25% * 7500 of margin money in the account, that amount is $1875. The broker would not issue a maintenance call on this money due to the fact that there is $2500 of margin money in the account exceeding the required amount of $1875.

If the margin maintenance fee was increased to 40%, the marginal files required for the account would be increased substantially. See below for the new requirements:

Initial Cash Investment: $5000
Amount Borrowed: $5000
Initial Investment Amount: $10000
Margin Maintenance Fee: 40%
Final Investment Amount: $7500
Actual Margin Funds: $2500
Marginal Funds Required in the account: $3000

As you can see, the broke would initiate a margin call this margin account to make sure that there is coverage for the amount of money borrowed. This will either result in the investor depositing more money into the account to cover for the call or if the investor does not have the money to the deposit, will result in the broker selling the stocks (investor's permission may not be required).

This defeats the "buy and hold" strategy to attempt to wait out negative swings in stock as the investor may be forced to sell their stock prematurely.

Although this is an advanced topic, it is good to have a bit of an idea of some of the tools that are available to enable you to obtain financial freedom quicker. Please let me know your comments about buying on margin and some of the experiences you have had with "buying on margin".

Stay Disciplined!

Sunday, August 9, 2009

Finding the balance in your life

I've learned that you can't have everything and do everything at the same time. ~Oprah Winfrey

What generally happens when you eat too much salt? (high blood pressure) What generally happens when you eat too much? (obesity) What typically happens when you sleep too much? (nothing gets done). Although each are necessary, they all have to be done in moderation. A wise man once said that "too much of anything is a bad thing".

I believe one of the biggest reasons why we fail when taking on a new endeavor in life is that we try to take too much of it too fast. I know personally, I tend to get tunnel vision and disregard everything else going on in my life to concentrate on that task. During this time period I usually allow other important things (friends, family, other obligations) fall to the wayside while I am concentrating on my task at hand. This results in not having as strong ties to the people who mean the most to me and well as me not fulfilling previous obligations.

I am not trying to say that you should not devote time and focus on whatever task that you wish to accomplish, however, I do believe it is important that it is not the only thing that you spend your time/resources on. Focusing that much attention on one task does not eliminate the other responsibilities that were going on prior to acquiring the new task.

Personally, the lack of balance in my life is due to the fact that I have been devoting an abnormal amount of time to preparing for my future. I have been very focused on saving for retirement and making investments that I rarely spend money on things that I "want". I have been told over and over by many people that I need to concentrate on living my life today.

To contrast, I have seen the exact opposite. Those who buy whatever they want when they want it and amassing large amounts of debt in the process. My fear is that I have come across some people who I feel like have not dedicated enough resources to their future and I will end up owing large amounts of money to institutions forcing me to have to work indefinitely.

What it comes down to is that there needs to be a balance. Whether it be a new girlfriend/boyfriend, a new project at work, a new video or even trying to reach a financial goal, we must learn that we cannot let a single task monopolize our time. This results in us burning out with the particular task and usually results in the task not getting completed with our best effort. To prevent this from happening and to ensure balance, I recommend to do the following things below:

  1. Always make "Me" time.
    • There are many things that people to do to escape from regular life. Some people travel, some people sing, some people Facebook but whatever you can do to relax, you should do at least once a week.
    • Relaxing is necessary but too much relaxing can mis-align your balance.
  2. Use "Context Switching" to multi-task.
    • Context Switching is defined as "the computing process of storing and restoring the state (context) of a CPU such that multiple processes can share a single CPU resource." (Wikipedia Link)
    • Translation: A person (single CPU) executing one task (process) at a time for a dedicated amount of time (based on priority) then switching to a new task to execute that task.
    • Prioritizing your tasks properly can contribute to finding the correct balance.
  3. Organize your time wisely.
    • Having a simple written plan of what you have to do and the steps it will take to accomplish it will help you organize and prioritize the tasks that need to be accomplished.
  4. Accept that you cannot do EVERYTHING.
    • You have to pick and choose your battles and some battles are not worth fighting.
    • You have power to tell people "no" and it is one of the most powerful tools that you have when dealing with balance.
    • It is important to make sure that you do not over-extend yourself because this will not allow for balance to occur when you are spending the majority of your time on a task.
  5. Do not be afraid to ask for help (Contract help if you need it).
    • A lot of people are overwhelmed due to the fact that they do not know what they are doing. Many things that seem complicated can be understood to be very easy after learning from someone who has already completed it.
    • No one in this world was put on here to exist alone, it is easier to have a much more enjoyable life with the help of others to help relieve some of the tasks.

What are some of the other ways you maintain balance in your life? Leave your suggestions in the comments below.

Stay Disciplined!

Monday, August 3, 2009

Importance of Interest Rates and Compounding

To follow up with my previous article about choosing the best online savings bank, I want to explain the importance of Interest Rates. An interest rate is defined as the following in Investopedia:
The amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets. Interest rates are typically noted on an annual basis, known as the annual percentage rate (APR). The assets borrowed could include, cash, consumer goods, large assets, such as a vehicle or building. Interest is essentially a rental, or leasing charge to the borrower, for the asset's use. In the case of a large asset, like a vehicle or building, the interest rate is sometimes known as the “lease rate”. (link)
This is the main way banks make their money because they lend it out to the consumer and we pay back what we borrow plus interest (which is basically the agreed upon cost that you pay the bank for lending you the money). Well, banks charge a sizable amount of interest for the loans that they make to consumers, they rarely return the favor when borrowing your money.

This is evident by the sub par 0.1% interest that some banks pay you yearly to borrow your money. For more information about how banks work review the video below:

Money As Debt

Well, as the consumer, it is time for you to get in on some of the action. After all, as hard as you work for your money, you should get the same benefits of receiving some type of return on the money that you are lending out. This is where the importance of the interest rate that you are receiving comes in because this rate determines how much money your investment/savings will bring you back in a year.

For a quick way to calculate how long it will take your money to double at a certain interest rate, review my previous article about the Rule of 72.

The interest rate alone is not the only factor that contributes to the return your money will bring you. There is another factor called "Compounding" that is defined as the following by Investopedia:
The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings. (Link)
Compounding combined with a solid interest rate is a recipe for success. This allows you to fast track your savings (when starting early) because the money that you make from interest is then re-added into your principal amount, resulting in making more money from interest on that particular amount. This is much better than the alternative, simple interest, as that only pays interest on the principal alone. Below is a an example to comparison between compounding and simple interest:
You have $100 invested in two different banks. One bank offers simple interest while the other bank offers compounding interest. You are going to leave the money invested in the bank for a period of 50 years and the bank has guaranteed that they will pay you 10% interest for your money each year.
Simple Interest
Principal Balance: $100
Interest Rate: 10%
Value after one year: $100 + (100 * .10) = $110
Value after five years: $100 + (100 * .10) * 5 (no. of years) = $150
Value after ten years: $100 + (100 * .10) * 10 (no. of years) = $200
Value after twenty years: $100 + (100 * .10) * 20 (no. of years) = $300
Value after fifty years: $100 + (100 * .10) * 50 (no. of years) = $600
Formula to calculate:
Future Value = Principal + (Principal * Interest * no. of years)

Compounding Interest

Principal Balance: $100
Interest Rate: 10%
Value after one year = $110
Value after five years = $161
Value after ten years: = $259
Value after twenty years = $672
Value after fifty years = $11739
Formula to calculate:
Future Value = (Present Value) * (1 + interest rate)number of years remaining
I am hoping that the information in this article has helped to convince you to understand the importance of interest rates and the significance of compounding interest versus simple interest. As usual, if you have any questions or comments, leave them in the comments section below.
Stay Disciplined!

Sunday, July 26, 2009

Saving your money...Best Online Savings Bank

A penny saved is a penny earned. ~ Benjamin Franklin

Ben Franklin was on to something when he said the quote above. Due to the recession, we are starting to understand the importance of saving money. Whether it be to survive during unemployment, or to take advantage of an opportunity that presents itself, having savings is a necessity. There is also the importance of making interest with that money.

There are many places where you can put your money. There are higher risk investments such as stocks and mutual funds that requires your money to be invested with the possible risk of the equities losing value resulting in a loss of money. There's also other investments such as bonds that offer less risk but typically requires your money to be tied up for a certain amount of time. For the average saver, a good interest rate and reasonable access to their money are the requirements for where their money resides.

Although there are many factors that are used for where most people decide to save their money, I personally keep my "savings" money in an online savings account.

Why Online Savings Accounts?

If you walk into your local bank branch, you will find that they offer savings accounts. These accounts are backed by the FDIC (Federal Deposit Insurance Company) and allow you more immediate access to your funds as well as the benefit of talking to someone in person in the event that you need to discuss the account. However, these accounts offer a very low interest rate. (0.1 - 0.3%) which defeats the purpose of saving the majority of your money.

Online savings accounts are also backed by the FDIC and have the benefits of having a much higher interest rate as well as reasonable access to the funds in that account. The typical three day delay of accessing your funds is usually a good deterrent to impulse buying, but is quick enough to get access to the money in the case that there is an emergency where the money is needed. The higher interest rate is the main benefit from having one of these accounts.

See below for an example of why a higher interest rate matters:

Bank 1
Bank of America "Regular Savings Account Interest Rate": 0.1% (Link)
Amount to Save: $1000
Years to allow the money to save: 20 years
Amount of money at end of 20 years: 1,020.19
Interest Paid after 20 years: $20.19

Bank 2 "Online Savings Account Interest Rate": 1.85% (Link)
Amount to Save: $1000
Years to allow the money to save: 20 years
Amount of money at end of 20 years: 1,442.85
Interest Paid after 20 years: $442.85

Difference: $442.85 - 20.19 = $422.66

That is a $400 difference which helps to explain the importance of getting the best interest rate possible for your money.

Below are the different links to the websites of each of the online banks.

Although each of these saving accounts have individual pros and cons, the ultimate decision in deciding which account to choose is dependent on the individual saver. I recommend to go with the bank that has the highest interest rate because in my experience, most accounts typically have the same benefits as other online savings accounts.

As usual, I hope that you find the information in this blog useful. Please let me know your thoughts about your saving in the comments below.