Resetting Expectations

Nobody expects to work for free, and everyone expects that as they work harder, as they grow in their career, increases in income will translate to increases in lifestyle.  When can you afford the BMW?  When can you afford the vacation to Hawaii?  The 4 bedroom house?

These are the markers of success in America.  We take for granted that when we have these, we are doing well.  On TV, on the Internet, we see Lady Gaga, Justin Bieber, Kim Kardashian, people who make more every year from investments than we might make in a lifetime.  Even boring politicians earn 10X more than the average American (and in many cases 10X more than a well compensated $150k salary engineer).  The average person holds 50-150 people in their head at any given time.  This is why we have a limited group of friends and family.

This is also why we are shown the same celebrities over and over again, why entertainment news is a marketing echo chamber of the same people day in and day out.  The more well known a celebrity is, the more calls they get to appear in public, to become even more well known.

The 40 year old man has a mid-life-crises used Porsche, not a Porsche.  He is a failure.  The truly successful have their Porches at 25.

Sadly, all this stuff is a lie.  The truth is much more boring.  The 40 year old man has a Porsche because he wore Cost Co jeans for the past 20 years.  He has a million dollars in the bank.  He bought used in order to avoid the steep first-three-years depreciation.  The 25 year old with a Porsche doesn’t really own it.  He’s on a rent-to-own plan from the bank.  He’s in debt.  It sets his retirement back 5 years, or he retires with 33% less money overall.  If inflation means retirement savings need to be $3M, the 25 year old’s Porsche cost him $1M ($300k counting for inflation).

The sad truth is that even after finishing K-12 and college, 17 years old schooling, we all have at least another 10-15 years of frugal living if we want to retire with pleasure.  The compounding interest of investment heavily favors *early* investment (a 10 year delay in investing costs you at least HALF your nest egg.  If we know this in our hearts and are able to visual our dignified retirement, the bitter pill begins to have a nice aftertaste.  Living cheaply when you are young and healthy is much more pleasant than when you are old and frail.  Old age comes for everyone.

What are some new markers for success?

1.  Meeting and/or exceeding your expected net worth

Net Worth = (age / 10 * yearly income)

2.  Holding diversified investments (owning a modest home, owning mutual funds.

3.  Saving and investing a high percentage of your income.  You still get to spend it, just not now.

4.  Finding contentment outside of money.  Millionaires are millionaires because they don’t spend.  We all want to be happy, so how much better if we can have our happiness and eat our millionaire cake too?

These aren’t glamorous, but changing my expectations has brought a lasting satisfaction.  When I wake up in the morning, I know that I’m not trapped in my job.  I know that my retirement will be awesome.  I still must constantly seek out ways to encourage myself in this direction.

Essentially, I’m fighting a war against people trying to sell me a bunch of really cool stuff, stuff so cool that we are often distracted from more lasting sources of happiness, like relationships and activities.  Resetting my expectations has allowed me to cut my lifestyle down without feeling bad about it.  I thought I’d only be in the condo for  3 years.  But now I wouldn’t be surprised if it’s 15.  I’m okay with that, because if I do that, I can be a cash millionaire before I’m 40.  Not a bad way to start the second half of my life.

The House

I love this house.  It has a ton of features I like: rustic natural wood interior, high ceilings, tons of sq. ft. / dollar, huge back deck with hot tub, beautiful panoramic forest view from kitchen table, located at the end of a quiet street, located near several beautiful state parks, 3 full bathrooms.  At $600k, it’s expensive but potentially affordable.  Sure, the commute would be long.  Sure, the property taxes would be substantial (at least $500/month).  But screw it, I want this house bad.  I just won’t want to hose my financial future by  buying it with a monster mortgage.

Less than 10 days after it was put on the market, a sale was pending.  I wasn’t surprised – $600k for 2500 sq. ft. *and* a beautiful layout *and* a fabulous view is practically unheard of, and the house had no major problems.  So I’ll probably never get this house, but there will be other houses.  When I’m ready to purchase, I’ll show this to a real estate agent and wait for something comparable to come on the market.

I visited the open house in person and took several photos of my own, but below are only the photos from the MLS.

There is an opportunity cost though to locking up $600k in a house when you’re only 35.  Invested, that money would grow much faster.  In the long run, your $600k house will cost millions of dollars in lost opportunity.  Then again, you can’t get your youth back when you’re old and rich, so there’s some kind of compensating equation where the value of certain items decreases as you get older because you have fewer years of life to enjoy them.  For example, a $1M house lived in from ages 60-90 offers half as much value as a  $1M house lived in from 30 to 90, regardless of purchase price, so that has to be accounted for in the calculus.  Question:  what percentage of net worth should be tied up in a house?

Here’s a fun article.  You should read it sometime today.  It gives several different frameworks for how your money should be divided at different points in life and the reasons for them.

http://www.financialsamurai.com/recommended-net-worth-allocation-mix-by-age-and-work-experience/

NET WORTH MIX RECOMMENDATION – BASE CASE FRAMEWORK
Net Worth Allocation Mix By Age – Base Case Framework
Risk Level High Low Medium Almost None Depends On You
Level of Control Low Low Medium Low High
Age Years Worked Stocks (Equities) Bonds (Fixed Income) Real Estate Risk Free (CD, MM) Alternative
23 1 60% 0% 0% 40% 0%
27 5 70% 0% 0% 30% 0%
30 8 50% 0% 40% 10% 0%
33 11 55% 0% 35% 10% 0%
35 13 50% 10% 25% 15% 0%
40 18 40% 20% 25% 15% 0%

 

So this guy recommends that no more than 40% of my wealth be in my home.  Right now, I have a net worth around $392k according to his definition ($55k retirement, $12k outside retirement, $100k yo-yos, $225k equity).

So 57% of my net worth is in my condo.  So maybe I should sell it and invest the excess money.  By 35, he wants 25% of my net worth in a house.  So if my net worth then is say $400k higher, I’m only allowed to have a $200k home (which is still $140k less than the going rate for my 1 bedroom, 784 sq. ft. condo).

So either I need to make much more money, or I need to get the hell out of California and live somewhere where I’m not competing against people as highly compensated (and highly indebted) as SF Bay Area residents.

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The Budget

This is the template for my budget in 2014.

Approx Date Name Amount Approx Date Name Amount
1 Mortgage 1137 15 Insurance 1 81
1 Edward Jones 2000 15 Property Tax 250
1 food cash 500 16 Edward Jones 2000
1 save 146 16 Savings 1131
10 HOA 300 18 Netflix 8
11 PGE 20 30 Insurance 2 81
12 AT&T Phone 100 30 Comcast 67
12 Paizo 51 30 Gas 50
14 Github 7
15 gas 50

 

I only have Edward Jones automatically pull in amounts of $1200.  That way if I have a large, unexpected expense, my account won’t be overdrawn.  I manually send $1600 to Edward Jones sometime later in the month when I’m sure the numbers are going to work.

I try to buy as much food as possible at Cost Co., because I think they have a good quality/price ratio.  The insurance covers my car and the interior of the condo.  A while ago, I calculated all my sources of loss (i.e. I separated out the interest from the principal in my monthly house payment) and then listed them as percentages:

date Company Loss Amount Percentage Purpose
14 Github 7 0.39 tech
18 Netflix 8 0.45 entertainment
11 PGE 65 3.65 energy
30 Comcast 67 3.76 telecom
12 Paizo 75 4.21 entertainment
14 gas 100 5.61 big oil
12 AT&T Phone 100 5.61 telecom
15 Insurance 162 9.09 maintainance
1 Property Tax 180 10.1 government
1 mortgage int. 218.88 12.28 bank profit
10 HOA 300 16.83 maintainance
1 food cash 500 28.04 life
Total lost percentage 100.02
House % 55.71

 

I learned a while ago that there’s a threshold for food where you really become unhappy if you go below it, so I don’t feel bad that I’ve allocated $500 (not for restaurants).

My main concern is the HOA fee.  It covers external condo insurance, condo maintenance (grounds, pool, parking lot, roof, siding, etc.).  I never use the pool.  There’s nothing I can do to lower the expensive.  I think if I ever rent out the condo, I might be able to write it off on my taxes.

The mortgage interest is the next highest.  Again, I don’t know how to lower that.  I suppose I could have gone with a 5 year fixed mortgage rather than a 10 year, but the condo breaks even if I rent it on a 10 year, so it didn’t seem worth it to take on the risk of a 5 year, especially if I’m going to pay it off in 2 years (the savings difference between a 5 and 10 year mortgage in this scenario has to be < $4k).

55% of these losses are directly related to the condo.  Places where I could save would be:

– decrease internet access (I spend a lot of time online, and I work as a web developer at home)

– decrease phone bill (which is overstated by $15ish)

– decrease Paizo.  Paizo produces fantasy books, and the only reason I’m still signed up for it is because I have a pretty complete collection and I don’t want to miss anything.  Since it’s only 4% of my money losses, killing it doesn’t seem like it would make much of a difference.

Since at least 80% of the losses are difficult to remove, there’s really not much I can do to improve things except to make more money.  So that’s what I’m trying to do.

So that’s my budget from a high level.  I think it’s pretty efficient.  What about the low level?  How do I handle my purchases on a daily basis to make sure I’m actually living the budget?

1)  I pay everything out of one checking account.  This makes it easy to keep track of my actual spending.

2)  I use an iPhone app, BUDGT, to track daily expenditures.  I keep it simple.  The app lets you enter a purchase amount and then tap a category.  I only have 4 categories: food, gas, savings, and “other”.  Idea being that the more I can diminish the “other”, the faster I can pay down the condo.  In the case I save $5k a month, I finish in 20 months instead of 24.

I don’t like the way the app tracks savings (as a percentage of income rather than a fixed amount), so I treat my savings as expenses within the app.  For the Edward Jones withdrawls, I put them in the fixed monthly budget within the app.  For the savings amounts of $146 and $1131, I record those as expenses in the savings category whenever I decide I have enough room to transfer the money into the savings account.

Daily Budget Percentage $ Remaining Monthly Spending Income & Fixed Expenses

Any money I don’t spend of the $27.83 allocated for today will be divided equally into the remaining days tomorrow.  Every day I don’t spend money, I can see the increase tomorrow.  That’s obvious, but it’s also kinda cool.  It’s also satisfying to see that the greatest percentage of my variable spending is actually in savings.

This month I had high “other” expenses because I had to buy plane tickets for about $600 to visit my family this summer on the east coast.  And I’ve also bought some books from Amazon, a big bag of cat food ($50), some closing costs for the refinance ($75), etc.  It adds up.  I hope next month I can decrease this category enough to get much closer to the budget, but I’m not going to beat myself up as long as I consistently keep saving $4000/month.

Early in my career, I saved 1/2 my take home on my first job.  My spending expectations were low because I was just coming out of college.  On my second job, I saved 1/3 of my take home for a number of months.  But I was living in San Francisco and paying much more rent ($1060), and I didn’t keep a budget.  Eventually, I stopped the automatic takeouts on my second job, and I remember feeling very relieved to have that money to spend.

But it all flowed out.  Without a budget, spending isn’t efficient, and long term goals aren’t front and center in purchasing decisions.  Keeping long term goals front and center makes saying “no” to potential purchases a lot easier.  But if you don’t have a budget and you don’t know *when* you might be able to make the long term purchase, the alternative to purchasing is just a vague feeling of having more green paper.  Sadly, I am way too stupid to be motivated by a vague feeling of green paper.  What does motivate me?  In my next post, I’m going to talk about and show off this really awesome house I’d like to own some day.

Some every-day tips:

– Drink Moka Pot coffee at home.  It’s delicious and a very efficient extraction, so you spend less on coffee beans and start the day out with energy.

– Hot sauce makes pretty much every food more exciting, even if it’s just rice.  It’s also $1.50 a bottle.

– Hang up a picture of the things you want for the future.  I have a flyer for my favorite house on my fridge.  My iPhone’s lock screen is a pair of $10k speakers I want to own some day.

– Start pursuing goals in your life.  Getting fit doesn’t require an expensive gym membership.  You can do pushups on the floor.  A chinup bar is only $25.  Walking is free.   Listen to books on tape (cd I guess now) from the library during your commute or while you walk.  Listen to books about money and relationships.  Making progress in these other areas of your life will help you keep from feeling stuck because you’re not buying that “next great thing.”  Why do you think I’m writing this blog? 😉

Introduction

About 6 months ago, I turned 29.  It’s not 30, but 30 is next in the queue.  The idea of 30 terrified me, that I’d be leaving “young” and entering the middle.    I took an inventory of what I’d accomplished so far and how that compared with what I wanted to accomplish in the middle.

Kids.  I’ve always wanted kids.  I am way too silly to not have kids.  If I had a kid today, things would work out, but it would be messy.  I’m unmarried and I live in a 1 bedroom 784 sq. foot condo.  I’ve always imagined raising kids in a house with a wife.

But sadly I live in California, where a decent house, maybe $1500 sq. ft., runs $500k.  And while the condo had been a very smart purchase in 2009, I only had $225k of equity.  My balance sheet looked roughly like this:

Assets ($440k total):

– $340k condo

-$100k yo-yo collection (hard to sell)

– 2008 Honda Civic Si w/ 60k miles

Debt ($130k total):

-$114k condo mortgage

– $15k credit card debt

Net Worth: $310k

But if I don’t want to sell my beloved yo-yos…

$210k.

And all of that is from the appreciation in value of the condo.  I bought it for $150k, and now it’s it’s worth $340k.

So if I wanted to buy a $500k house, I’d have to take out a $300k loan.  My take-home pay is $3668 twice a month.

10 year: $3400/month, $50k interest

15 year: $2800/month, $113k interest

30 year: $2100/month, $280k interest

So if I take out a mortgage, I’m either going to pay half my income in a loan or take a 30 year and basically be renting from the bank by paying out the nose in interest.

Well crap.  I don’t like any of these options.  I don’t want to be locked into taking high salary jobs until I’m 40.  And I don’t want to give some asshole bank a ton of my hard earned money.  Bottom line – if I want a $500k house, I need to purchase with cash.

In 2009 when, I first purchased the condo, I took a 30 year mortgage for $122k.  here’s the amortization table for the first 5 years:

Year, Interest, Principal, Balance

2009 $2,980.34 $628.04 $121,371.96
2010 $7,088.74 $1,571.38 $119,800.58
2011 $6,993.89 $1,666.22 $118,134.36
2012 $6,893.32 $1,766.79 $116,367.57
2013 $6,786.68 $1,873.43 $114,494.14
2014 $6,673.61 $1,986.51 $112,507.64

 

So I’d paid off 8% ($10k) of my mortgage in the first 5 years… and i’d paid the bank $37k for the privilege.

In 5 years:

$37k for the bankers.  $10k  for me.

I was getting screwed, and worse, I signed up for it myself.

Since 2009, I spent almost all my extra money trying to make myself happy.  Mostly books, yo-yos, and electronics.  I took trips to NYC.  I bought $100 bottles of tequila.  Relative to my income, my housing costs were low.  As the economy recovered, my housing costs were much lower than people who rented, plus I made $200k in added home value.  But still:

In 5 years:

$37k for the bankers.  $10k for me.

I never calculated that number until just now.  I never wanted to know it.  I knew I should refinance, but since I had $15k in credit card debt, I didn’t know if I would qualify, and I didn’t have $3000 for closing costs, so I never checked into it.  I just lived in denial and tried to make myself happy chasing the next purchase – a camera, a knife, a gun, a video game, an ocarina.  Toys.

It wasn’t until 29 that I was forced to face this reality.  It really bothered me emotionally, and I felt a great pressure to pay off all of the credit card debt.  In December, when I visited my financial advisor (who I share with my mom), I had to ask my mom to leave the room so that I could tell him about the debt, and tell him I needed to sell all of my non-IRA money (about $8k) to pay off part of the debt.  I then told him I needed to stop contributions until I paid off the rest.  He agreed.  It was very embarrassing to me.

I had the remaining debt paid off by March 2014.  I wasn’t as intense as I could have been (I spent some money on Christmas), but I’d say 80% of my discretionary income went to paying off the debt.

Once the debt was paid off, I knew I needed to refinance (if only to lower my interest rate, which was 5.875% on the 30 year – I didn’t have enough credit history at the time to qualify for something better).  My credit score was now 816.  I called my B of A loan officer (I hate B of A really hard, but I figured the refinance would go faster b/c they already had my paperwork, and they would have decent interest rates b/c they do so many) and asked what the current 15 year rates were.  He said 3.5%.  Sounded pretty good to me.  Then he mentioned that they had a 10 year for 3.125%.  Even better!  I thought about it for a few hours and then opted for the 10 year.  I sent in the required paperwork that same day.  Here’s the amortization schedule:

2014 $2,087.12 $5,868.55 $111,131.45
2015 $3,325.99 $10,312.30 $100,819.15
2016 $2,999.07 $10,639.22 $90,179.94
2017 $2,661.79 $10,976.50 $79,203.44
2018 $2,313.82 $11,324.47 $67,878.97

In 5 years:

$13k for the bankers.  $49k for me.

A much better deal!  And because I had bought a property very conservatively to begin with, the new, increased payment was still below 25% of my take-home pay (within Dave Ramsey’s guidelines for a *15* year mortgage).  $3k in closing costs were folded in with the loan, so I now owed $117k, but the refinance would pay for itself in 18 months.

Then I learned about Dave Ramsey from a guy at work.  I wrote out a budget in Google Docs.  I figured out I could save/invest $4k-$5k a month, depending on variable expenses (i.e. if I had to visit family on the east coast, that would definitely be a $4k month, but if I stayed at home every weekend and didn’t purchase anything extra, I could save $5k).

Dave Ramsey excited and inspired me.  Saving $4k-$5k a month, I could pay off the condo in less than 2 years!  Once I paid it off, I’d have $5k-$6k I could save or invest.  I don’t have a long attention span, so I really need goals on a short time horizon.  If I prepay $4k a month starting in July 2014:

In 2 years:

$7k for the bankers.  $114k for me.

Hell yeah!  Screw the bankers.

It’s May 17, 2014.  I’ve paid off all my debt.  I had $2k in a savings account and $10k in my non-IRA account.  My IRA is fully funded for 2014.  I am pumped.  At 31, I will own a $340k condo outright, and I can completely end my connection to evil, disgusting B of A.  With no condo payment, it’ll take another 3 years to save enough money, and then at 34 I can purchase a $500k house with cash.  Or I can just let the money grow in the bank and stay in the condo for a few more years.

I may have imagined starting a family with a house, but kids are blobs for the first few years anyway.  There’s no rush.

On May 7, 2014, I cut up my last credit card and began the nuking of my FICO score.  Mostly as a way to force myself to follow through with this plan and pay cash, but in part because I know that I’ve had a bad history of self-control when it comes to credit cards.  Could I control myself now?  Probably.  I think so.  But I also think the companies issuing credit cards are evil, and I simply don’t want to do business with them.  Looking at the statistics and listening to callers on Dave Ramsey’s show – credit card companies aren’t providing Americans with a valuable service.  They’re just taking advantage of peoples’ impulses.  People in American have been trained to equate consumption with happiness.  I’m no different.  I love commercials from the 1990s.  I love products.  I have spent down to my last dollar for years chasing happiness.  It didn’t work.  I’m opting out.

Beyond Dave Ramsey’s books (primarly “The Total Money Makeover”), I’ve also been reading “The Millionaire Nextdoor.”  The primary take-away from that book so far is that purchases should be considered not as a percentage of your income, but as a percentage of your net worth.  Personally, I consider net worth as spendable cash in the bank, because I like picking conservative criteria.  If you have a $1M house and 0 cash in the bank, you probably shouldn’t be purchasing anything but the essentials.

$80k car if you make $140k a year – possible but stupid.

$80k car if you pay cash and you have $1M in the bank – fun toy.

It provides a clear criteria for knowing what you’re allowed to buy at what point in time.  You’re not allowed to buy the fancy car until you have $1M in the bank.   If  you prefer a $40k audio system to a $40k car at $1M, then at $250k you can probably afford a $10k audio system.

Salk Sound SS10 Burled Walnut

What should your net worth be?  The book says it should be:

Net worth = age / 10 * yearly income

So for me that’s $406k.  I’m pretty far from that right now, but if I save and invest like I am now for the next 10 years, I’ll have $1M in cash at age 41, when my net worth should be (conservatively) $615k.  In other words, I can catch up, and I can do it in less than 10 years.  And once I do, I’ll know exactly what I need to do in order to retire comfortably, live without fear of financial catastrophy, and buy some fancy toys along the way.

But I’m not there yet.  I have to push myself hard, at least for the next 5 years.  That’s why I want to make it a club.  I want some friends to do it with me.  5 years to pay off debt, budget, invest in the future and change our lives.