Retire At 45

Budgeting: Part 4: Learning From Children

2009-06-05T08:55:00.000-04:00

"Children are like wet cement. Whatever falls on them makes an
impression."

- Dr. Haim G. Ginott

A few years ago, we were vacationing in Kennebunkport, Maine for two weeks. At the end of the first day, we were thoroughly enjoying ourselves. The weather was great, the coastline was beautiful, and the lobster rolls were delicious. But there was one big problem.

Kennebunkport has a small downtown area of shops and restaurants. Depending on your point of view, you might call Dock Square a "quaint retail district" or "the usual tourist trap", but at any rate, it's so centrally located that it's not possible to avoid it for two weeks. Personally, I found it quite enjoyable to browse through these shops because many of the buildings are right against the Kennebunk River (some on stilts) and most of the shops are quite easygoing. (Kids OK. Dogs OK. Bathing suits OK. Coffee OK. Food OK. Loitering OK. You get the idea.)

Unfortunately, however, my children were driving us absolutely crazy whenever we passed these shops! They kept picking up everything and holding it up and asking us to buy it for them. Since it was only the first day and most of the items held up were total junk, there was a universally negative response from the parents, which was met with an equally negative response from the children. In spite of all the no's, the continual nagging went on all day. In fact, as the day wore on, it only seemed to get worse. The children were determined to find something to acquire, and it seemed they were going to ask hundreds of times about hundreds of items until we relented. It was almost as if some "spirit of consumption" entered their body and said they must not leave without buying something! Obviously this is very wearing for any parent, and we were alarmed that if this continued the whole time, it would ultimately ruin the vacation.

After the kids were asleep that first night, my wife and I sat down to discuss what we were going to do about the problem. Now one thing I always try to do as a parent is to imagine myself as one of my kids and try to understand exactly what they are thinking. If we are honest, I think we have to admit that the emotions and actions from children are not usually fundamentally different than that of adults - with kids, everything is just a lot more exaggerated. After a little reflection, it suddenly occurred to me that the kids' behavior was not really that irrational after all.

The reason why they were treating their parents like a slot machine was because, in fact, we were acting a lot like a slot machine. We kept saying "no" to them, but there was a hesitation in our voices. Kids always pick up on that immediately. They could tell we were thinking about it. Also, we didn't care to spend our limited vacation time giving a lengthy rationale for each response, and this was interpreted as indecisiveness. So the bottom line is that they intuitively assumed that mom and dad had no real game plan for what could be purchased, and that because we hesitated without explanation on each item, there was a small chance that if you asked enough times with enough items, eventually some request would be granted. And do you know what? They were right! We had no game plan and if we were sufficiently worn down, we would probably just say "yes" to something at some point!

So we formulated and agreed on a simple plan. We were going to give them a framework for buying things themselves. I had no idea whether this would work, but I felt it was worth a try. I still have no idea whether this was good parenting, but I know one thing: it solved all the nagging. Immediately. In fact, we were truly startled by how well it worked. Here's what happened.

The next morning I sat down with the children and explained the new rules:

I am giving each of you $25 to spend on our vacation trip.
The $25 is entirely yours to spend however you like provided nothing is age inappropriate (e.g. no sharp knives).
Once the money is gone, there will absolutely, positively be no more money given.

Immediately after explaining rule #1, my oldest asked, "How much do shrimp cost?" Trying to hide my laughter, I then also had to add some additional guidance that all meals and desserts and activities would be provided at no cost to them. (This was vacation after all.)

(I know some people will argue that you should never give children money unless they earn it. Others will complain that $25 per kid was a ridiculously large amount of money to entrust to small children who could barely add things together. Still others will say that the amount was "unfair" because it was way too small relative to the large amount of money it costs to stay in a resort area for two weeks in the summer. So let's be clear: I'm not holding this out as an example of the "right way" to teach kids about money. I'm holding it out as an example of how kids respond.)

After this discussion, the very first thing my oldest child did was to march into a toy store, pick up some item, and ask how much it cost. I cringed as I read the price tag aloud: $24. It seemed really poorly built and I was certain it would be discarded after a couple of days. Nonetheless, I needed to abide by the rules I had established. If the kids wanted to buy it, then we would buy it. Upon hearing the price, to my great relief, my oldest blurted out, "No way! We're not spending all my money on that!"

Suddenly there was a lot of comparison of prices between stores and comparison of features between items. My oldest child seemed to learn more arithmetic in those two weeks than at any other time in life. There was also a willingness to wait and see whether something better turned up tomorrow. All the mindless nagging about potentially buying every item in sight was gone, and was replaced by a reasonably careful consideration of how to spend their money. But it was even better than that. The advice from mom and dad about purchases had previously been totally dismissed as parental gibberish. But now we were suddenly sought out as consultants! "Do you think this will break easily?" "Could I get this cheaper somewhere else?" "Why is this model so much more expensive than the other?" "Would I be able to take this back if it didn't work?"

All in all, it was an incredible turnaround of behaviour. So what changed? Two things changed: ownership and budgeting. First, ownership of the money themselves made them value it and respect it. Second, having a very simple, clearly defined budget made them take a holistic approach to spending it wisely.

By the end of our vacation, I was very proud of the way my kids handled their money. I even had them write down on a 3x5 card all the different things they were able to get for $25. You would be surprised how far $25 goes when you are so careful with it! On the last day, I also snuck out and purchased a couple of quality items from the toy store that the kids had admired, but could not afford with their money. How startled they were to unwrap these items at our next Christmas!

My initial fears that the shopping district would ruin our vacation were unfounded. On the contrary, not only did we have a great vacation, but the entire spending issue proved to be a great learning experience for both the kids and the parents.

If a budget works this well for kids, think what it can do for adults.

Budgeting: Part 3: All About Choices

2009-05-28T00:09:00.002-04:00

"Your life is the sum result of all the choices you make, both consciously and unconsciously. If you can control the process of choosing, you can take control of all aspects of your life. You can find the freedom that comes from being in charge of yourself."

- Robert F. Bennett

[ I'm picking up right where I left off after a year of various time-consuming issues. I have many new things I'd like to write about, but I believe in finishing what I start, so I'll be continuing this budgeting series for now. It's probably a lot more appropriate for many people now than it was a year ago. I know it is for me! ]

Every single day of our lives we are faced with a barrage of spending decisions. Sometimes it can be almost overwhelming. Are we in control of our spending? Or is our spending in control of us? Even those of us who don't feel like we are "out of control" nonetheless often feel like our spending decisions are not always explainable. Why do we say "yes" to certain purchases one month and then "no" to the same purchases the next month? Why do our choices on some occasions seem almost arbitrary?

A large part of the confusion about spending is that purchase decisions are usually framed in isolation. For example, the following three purchases could be framed as simple yes/no decisions:

"Should I purchase this new car or not?"
"Should we eat out tonight or not?"
"Should I replace my air conditioner or not?"

A small step up from yes/no framing are the sorts of questions that are framed as "Can I do better?" Thus, the previous examples could perhaps be reframed as:

"Is this the best price I can find on this new car?"
"Do we have a coupon for this restaurant?"
"Will the air conditioner be on sale later this year?"

Another typical framing is some variation of "Is it worth it?" For example:

"Is this car really worth $18,000 to me?"
"Do we really enjoy eating out that much to spend $40 on dinner?"
"Am I prepared to spend $2000 to have the house be cool this summer?"

Yet another framing is some variation of "What are my other options?" In other words:

"Would I be better off with a $6,000 used car or a $18,000 new car?"
"How about ordering takeout for $30 to avoid charges for drinks and tips?"
"Could I get by with a couple of $200 room air conditioners?"

There is nothing wrong with the how any of the questions above are framed. Even a simple framing of a purchase decision will help you avoid stupid mistakes. It's a good thing to eliminate purchases that you haven't properly considered (i.e. "Should I buy this?") or that you don't really value for the money (i.e. "Is it worth it?"). And it's always good to find the best price (i.e. "Can I do better?") and consider your other options. But let's face it: even after you've done all that, there will still be millions of things in the world that you consciously value and are reasonably priced - far too many things than you could ever really purchase in your whole life!

It's a sad fact of life that many people really don't go beyond the above approaches with their decision making process. Instead, having only muddled through each purchase in isolation and having found that there are lots of cool things in the world to be had, people often continue to purchase things with this framework until a certain trigger is reached. Now where exactly the trigger is reached depends on attitudes toward savings and debt. For some people, the purchases continue until the checking account is zero. For others, the purchases continue until the credit cards are all maxed out. For still others, the purchases continue until 3/4 of their income is spent, at which point the remaining 1/4 of their income is saved. So please note that a simplistic approach to purchases does not always imply debt. Such a paradigm is not necessarily irresponsible. On the contrary, a lot of reasonably frugal people operate with a simple framework and manage to save a substantial amount of money. As I said earlier, the trigger point to stop spending is determined by preconceived ideas about savings and debt, which vary wildly from person to person.

However, regardless of the differing trigger points to stop spending, there is something badly broken about this sort of process. Each individual purchase may be reasonably well considered, but as a whole, I would argue that such an overall spending pattern is rather arbitrary due to the lack of a holistic approach.

So what do people lose with such an approach? Money? Probably not. What is lost - for lack of a better word - is happiness. If you are truly determined to save 10% of your income and you stop spending when that limit is reached, then it's not money that's at stake. One way or another, you will save 10%. But without proper context, the 90% of your income that was spent will not really be spent on the things that you value the most!

Think about how one arrives at the spending limit with such an arbitrary approach. You spend, spend, spend until the trigger is reached and then stop. Without a holistic approach, what determines which things were spent first and happened to arrive before the cutoff? Random chance? Advertisements? Other people? I certainly don't want those things to be the determining factors in what I buy with my money.

That is where budgeting comes in. A good budget will be able to frame spending decisions in context and emphasize this critical point: Whatever you spend on one item leaves less to spend on all other items. This is the true insight of a properly constructed budget. Another powerful concept is to consider saving money as just another budget item. Saving (or borrowing!) is usually thought of merely as a by-product of your income and spending - it's simply the part of your income that is left over after all the spending is finished. However, since saving money (consumption deferral) is so critical, I would encourage people to view a "savings" line item as competing with all the other items. Thus, when you are creating a budget, you should weigh each new item not only against the other items, but also against your savings target. Here is the basic idea:

Make a list and rank order everything you want/need to purchase.
Work through the list in order. After each item, calculate the cumulative total of everything you've decided to purchase so far. Compare the total to your income and decide whether you are comfortable with the resulting saving (or borrowing) total.
Revisit the list whenever you consider a purchase of something not originally on the list, or whenever you want to revisit your savings rate.

Does our family really do this? Well...yes. But perhaps not as you might imagine. We certainly don't sit around with calculators to figure this out, and we certainly don't agonize over each item. We also know we haven't captured everything and we don't worry about it. We know we will have to adjust things as we go. However, the main idea is still very much there. When we decide to spend more money on something else, we know we've weighed that against the other items in the budget and against how much money we are saving, and we're at peace with the decision. We also do this exercise when truly unexpected items arise. So if the refrigerator fails, of course we don't sit around and do spreadsheet analysis while food spoils. We march down to Sears and buy a refrigerator. We intuitively know we value a working refrigerator more than most items, so we know we should buy it. However, we're also aware that buying a bottom-of-the-line refrigerator will either bump other items in our budget or will change our savings goal. And we know that if we choose to buy a fancier refrigerator, we know exactly what we're trading off for that additional cost. We've already decided what's first in line to go!

I anticipate that there will be objections to this sort of process, so let's work through a few of the obvious ones:

"You don't understand. I already purchased a new car with credit and I'm still paying off the loan. I don't really value the car as much as I value other things I see right now, but I still have to make the payments on the car loan." Absolutely. Whether you value the car highly right now is basically irrelevant. You value your credit worthiness and perhaps you want to stay away from anything legally messy like a repossession. Hence, you value your commitment to your obligation to paying the car loan very highly, and so it's near the top of the list. Nothing about your situation contradicts the budgeting process I described.

"I have to eat. I need a place to live. I don't see how these sorts of things can be prioritized and placed in a list." Obviously one has to have basic needs met to live. Clearly you must have food to survive. Thus, "food" should be at the very top of the priorities list. But be careful: you must eat a reasonable quantity of something nutritious or you will die. On the other hand, a $5,000/month grocery or dining budget is clearly a luxury. Thus, you must break down the food budget into strata. You MUST eat something, so for example, you (probably) must budget $20/week for food. You cannot choose anything instead of this or you will die! But what about an additional $20/week? Getting by on $20/week for food is very tough, but it can be done! If things are very, very tight, then you have to make a choice between that additional $20/week or housing or clothes or other pressing items. If things are not tight for you, then first be thankful it is not, but also realize that your food bill can grow unchecked to $50, $100, or $200 or more per week. At some point, that incremental amount of money is not going to be worth it compared to what you could spend on other items, and that is exactly what this whole blog post is about: finding the right balance between all your spending items.

"There's absolutely no way I could compare every item I think about purchasing against all the other items! It would take half my waking hours and paralyze all my decisions if I really did that." The initial creation of your budget will absolutely take some solid hours of work. Assume that you'll have to spend a good chunk of one weekend and that you'll need to involve other people in your household if you want to do it correctly. But beyond that, the time involved is pretty minimal. Once things are all set up and ranked, it only takes a couple of minutes to handle a brand new spending decision, and if the purchase isn't that large, you can handle the adjustments after the fact. It's really not that difficult.

Go back and look at the quote at the top of this post. Don't dismiss it as flowery words! It's a powerful idea that can really apply to all aspects of your life. But since this blog is about finance, I will narrow down the scope and paraphrase the original quote: "In the realm of your personal finances, a budget is your tool to help you control the process of choosing the things you value most. And in that realm, if you can control the process of choosing, you can control all of your finances. You really can find the freedom that comes from being in charge of yourself."

Budgeting: Part 2: Creating A Framework

2008-05-06T08:26:00.001-04:00

"High achievement always takes place in the framework of high expectations."
- Charles Kettering

In the first part of this series on budgeting, I discussed the importance of starting the budget process by looking at the big picture. Now let's try to bring those lofty ideals down to earth. When I asked myself some significant questions about life (listed in the previous article), I found that some of the things that were important to me were:

Travel. (...more specifically, wanderlust. More on that another time!)
Learning.
New experiences.
Diversity of experiences.
Family.
Service.

I also discovered some things that weren't so important to me:

Limited desire for structure.
Limited desire for recognition.
Limited desire for "things" or "stuff".

I've already generalized quite a bit of my life in constructing the list above, but it can be generalized further. Hopefully you can pick out some common themes in the above list. Newness. People. Independence. Freedom. So let's do one more level of generalization:

Most of what I appreciate in life requires a lot of time, but not a lot of money.

Now, of course, your desires are undoubtedly much different than mine. Maybe you really want to stay in the town where you grew up. Maybe you want to own a luxury boat. Maybe you want to run your own business. The important thing to understand is that with limited time and resources, only some of your goals in life can realistically fulfilled, so it's important to create a framework for what things are most important and work toward them. Otherwise, it's likely you may only achieve things that aren't very important to you, or worse yet, by failing to prioritize, you may not achieve much at all.

So far this all looks great as a theory, but like all theories, there is often a big disconnect when you attempt to apply them to the real world. Suddenly things get messy and you discover that what seemed so consistent in theory can often be quite contradictory in practice! So without ducking the issues any further, as an example, let's attempt to run a very common and very big expenditure through my personal framework. Let's talk about budgeting for a car. (Groan!)

So what kind of car should I buy? According to the above framework, the car shouldn't require too much of my time, or I won't have as much time for other things I want to do. I suppose that means reliability, so perhaps a new car? On the other hand, new cars cost a lot more and I don't care about impressing people with my car. Also, time is money, so buying a new car means spending more hours working so that I can pay for it. Well then, maybe I could take public transportation - it's cheap, and reliability is someone else's problem. But public transportation only runs at certain times to certain destinations, so this is not going to work out very well with the whole freedom and structure goals. At any rate, whenever there are mechanical issues, I should have someone else fix them to save me time, right? That sounds right except that I really like learning about new things and so I might actually enjoying performing the repair.

So it's easy to see that my goals are not always aligned with each other. Sometimes they can be complementary, while at other times they can be contradictory. Goals can also change over time. Prioritizing the goals or creating a hierarchy of importance can help a little, but in the end, everything is not going to be nicely consistent. We can't realistically expect that life can be reduced to a decision tree.

So what good then is the framework? The framework does not give you the answers to your choices in life. The framework is designed to make sure you are asking the right questions. That may not seem very helpful to some people at first blush, but think about how you would answer a friend who asked for your help with an individual purchase.

For example, suppose a friend who knows little about computers asked, "What kind of computer should I buy?" As a helpful response, you would want to ask your friend some questions. "What do you want to use it for? How much do you have to spend? Do you want to be able to take it on trips? Do you want to store photos and music on it?"

As another example, suppose a different friend who knows very little about investing asked, "I have $2,000 to invest, so what should I do?" You would probably continue the conversation along these lines: "When do you need the money back? How comfortable are you with potentially losing some of this money? Are there any special tax considerations with this money?"

In both cases, you simply want to make sure that the right questions are asked. However, there are no automatic answers to the questions and no automatic choices. After your friend has answered the questions, he or she will still have to mentally weigh everything and make a gut decision on the purchase. The best choice will not necessarily be clear and mistakes may be made. Nonetheless, your friend is in a much better position to make a good choice than someone who did not ask and answer these questions.

When making decisions, people often do not ask many questions or they ask the wrong questions. This is what I try to avoid by having a framework. Just as it is helpful to have a decision framework for an individual purchase like a computer or an investment, it is even more helpful to have a framework for the entire budgeting process.

Budgeting: Part 1: The Big Picture

2008-04-09T00:47:00.001-04:00

"These people who are always briskly doing something and as busy as waltzing mice, they have little, sharp, staccato ideas, such as: 'I see where I can make an annual cut of $3.47 in my meat budget.' But they have no slow, big ideas."
- Brenda Ueland

Budgeting ought to be about very big ideas, yet somehow we have managed to trivialize the budgeting process and transmogrify it into various pedantic exercises. Budgeting has taken on such negative connotations that it is no wonder that one third of people don't budget at all and two thirds say they are unsuccessful at budgeting. For many people, budgeting has become merely:

An exercise in arithmetic. "If the numbers all add up, then I've really accomplished something."

An exercise in irrelevance. "I made up a budget once. I never did understand it. It was just a bunch of numbers. It never did anything for me."

An exercise in technology. "I learned how to use all the features in Quicken or Money, so I guess I have a pretty good budget."

An exercise in statistics. "If my spending conforms to what other people spend on average, then I must be doing OK."

An exercise in fantasy. "I construct the budget I would like to follow, but it bears no resemblance to reality."

An exercise in guilt. "I'm always over budget. I feel terrible. If only I didn't have a budget, I would feel better."

An exercise in magic. "I thought creating a budget would magically make all my debt disappear and I would be on the road to riches."

An exercise in power. "I will make make other members of my household conform to my spending plans!"

An exercise in negativity. "I can never do anything or have any fun because of my stupid budget."

In order to avoid these traps, try to start with the big picture in mind before you begin to work on your household budget. DON'T start with the average housing or grocery bill in the country. Instead, ask yourself big-picture questions such as the following:

When I look back at age 70, what would I like my life to look like?

When was I the most happy in my life? Why?

If this morning I was diagnosed with a terminal illness, what would I do during the next 6 months?

Am I satisfied with my contribution to the planet?

What do I regret NOT having done in life?

Unfortunately, while the average person may see the value in asking such questions from time to time, they probably think that such "heavy" questions have nothing to do with budgeting.

But the reality of achieving lifelong objectives is that the big picture needs to permeate everything in your life - including budgeting. With any endeavor, the first question you want to ask is: What is my objective? Budgeting is a tool that can help you accomplish your objectives, but how can you properly construct your budget if you don't know what your objectives are?

And pushing it further: Why limit your objectives to this year's income statement? I suppose you could read Dickens to "learn the street names in London", or you could listen to Beethoven to "hear what a violin sounds like", but how foolish it would be to stop at that point! In the same way, why use a budget merely to make ends meet or to save some money?

It is often said that money cannot buy happiness. Fair enough. However, we usually recognize that money can to a large extent be traded for time and vice versa. We also often define money as a store of value. Budgeting, being a tool to manage money, can therefore be extended to help manage those most precious of commodities - time and values. And if economics can be defined as "the allocation of scarce resources among competing ends", then I contend that the household budget is nothing but economics in action at that level. Budgeting is all about choices, and you are the decider!

When people find out that we have a formal household budget, they often ask why we bother. Surprisingly to many people, the real reason we have a budget is not to save money or to provide discipline (although it probably does both of those things). We formally budget our financial resources in order to make sure that our finances are aligned with the big picture of what my spouse and I are attempting to accomplish with our lives.

Are you doing the same?

Negative Reactions To Early Retirement

2008-04-01T00:53:00.001-04:00

"Keep away from people who try to belittle your ambitions. Small people always do that, but the really great make you feel that you, too, can become great."

- Mark Twain

While I certainly don't associate retirement with "greatness", I nonetheless have found that when discussing the possibility of early retirement, I encounter a substantial number of negative reactions, occasionally bordering on the belittling attitude Twain mentions above. In my previous article, I indicated that our family and the Nielsen family experienced the same two negative reactions from many people: (1) You're going to be bored. (2) You're being quite irresponsible.

It seems our two families are not alone in this regard. A recent comment to same article on this blog asked the following questions:

"What keeps you going in the face of the two reactions by your friends? I am in a job that I dislike but is bearable for a few more years. I am working to pay my house off so I have choices of which job to have after I quit without worrying about pay as much. I have a few select people who understand this, and the rest (who don't know what I am doing exactly but are life-long friends and know something is going on) are really reacting to me not spending what they figure I must earn. I'd love to see your thoughts on how you have handled the reactions and kept going."

I think the negativity mainly comes from misunderstandings, along with a healthy dose of financial ignorance in some cases. Very rarely do I find that there is an undertow of jealousy or antagonism involved.

Many people feel that early retirement is irresponsible because they think it would necessarily involve abdicating my responsibility to adequately provide for my children. This is not the case. Obviously I owe my children a safe, loving environment and appropriate food, shelter, and medical care. Beyond that, I also owe them an opportunity for success and happiness in the broadest sense of the words - including education, recreation, and many other avenues of life. However, I do not owe them everything Madison Avenue advertises, nor do I owe them whatever someone else has in life. Specifically, for example, I don't owe them an iPod, an ATV, or a new vehicle just because they see them in advertisements, and I don't owe them a 7-bedroom house, weekly dinners at Morton's, and a yearly vacation in the Hamptons just because some of their friends choose to spend (and borrow) that much money.

Once you accept that many "needs" in life are unnecessary, a much smaller income level is possible. I've also learned that even if the desired income level is defined, most people still don't have an appropriate ballpark idea of how much money someone would have to accumulate to support that income level. Some people guess wildly too low and other wildly too high. Educated people sometimes guess way too high, and this leads them to assume that you can't possibly have that much money.

Financial articles in the mainstream press are often not helpful in this regard. I remember a prominent article last year on Yahoo Finance that claimed that even if one had a house that was paid off at age 65 plus $4 million saved for retirement, you were probably in trouble. The article suggested that under such circumstances, it was very likely you would have to downsize from a 4-bedroom home to a 2 or 3 bedroom home, and replace the mid-range sedan or SUV with a Honda Accord. This seems preposterous to me. We can talk all day long about sustainable withdrawal rates for portfolios, but at the end of the day, if a 65-year-old person (who incidentally qualifies for both Social Security and Medicare) has a $4 million stash and no mortgage, that is a lot of money. Did the writer of the article realize that with $4 million, a 65-year-old person can purchase an inflation adjusted annuity that starts at $250,000 / year, is adjusted up for inflation each year, and the payments are guaranteed for life? Think about it. You could buy a new Cadillac every year on that kind of income. (I don't necessarily think an annuity is the best choice, but because it's a defined and guaranteed income stream, it lucidly supports my contention that $4 million is a decent chunk of change!)

As for the comments from others that I would be "bored" in retirement, I can only suggest that is likely to be a psychological projection. A lot of people basically vegetate when they're not working, and so if someone can only imagine watching television and lounging around the pool during off hours, it's not very surprising they would consider life without work to be boring. Under that paradigm, it certainly would be boring. However, I do find that, for me, almost every major activity outside of work is more intellectually challenging and fulfilling than the activities I perform at work. Note that I'm certainly not disparaging work. There can be intellectual stimulation and a certain degree of fulfillment in a corporate job, and I'll even admit that my daily work experience is not really all that negative from that standpoint. However, my current vantage point is that I most certainly would not be bored if I had to expand my "non-work" activities to encompass most of my time.

So specifically how do we handle these reactions? It depends on the particular response:

Mindless disagreements. If someone continues to simply repeat the same criticism over and over without any true engagement of ideas, then it's time to move the conversation to a different subject. (There's no point in banging your head against the wall.)

Lifestyle disagreements. When someone tries to understand our point of view, but can't understand how or why we would choose not to acquire a more "upscale" or "consumerist" lifestyle, I usually try to explain that everyone draws the line somewhere. Everyone has a point at which more acquisition and spending become simply waste and decadence. I don't usually criticise where others draw it for themselves, so I encourage others to agree to disagree on where the line should be for me.

Financial disagreements. If someone understands your motivations and accepts your chosen lifestyle, but merely disagrees on the financial cost, then the conversation can actually be very useful. If you have friends who engage you at this level, consider yourself lucky. They can often poke holes in your arguments, force you to readjust your plans to reality, or at the very least, make you explain your assumptions and calculations in a clear and convincing fashion. This is a great thing, although it can sometimes involve some financial transparency if the conversation gets detailed.

In summary, disagreement and negative reactions can be helpful if they allow you to more fully explore and understand your own motivations or to engage in conversations with friends at a deeper level.

On the other hand, I would strongly urge anyone not to abandon their own ideas about what they hope to do with their life just to please someone else - especially if that person is not even a close family member. It is amazing to me how much we often crave acceptance from even the most casual of acquaintances. For many of us (myself included at times), we can be manipulated by a salesperson we have never met before and will probably never meet again. We may purchase or upgrade a product or service simply because we don't want to "disappoint" the salesperson or appear "cheap" or "unstylish" to him or her. Amazing!

Thus, when a friend or co-worker puts down early retirement as a losing proposition, it does affect me to a point. It sometimes does sting when someone says to me, "Come on! You could be making some serious bucks when you're 50! Think of your children! Do you really want to drop out of corporate life as a quitter? And if you stop working, you'll eventually run out of money, and then you'll end up flipping burgers or living on the street because no company is going to hire anyone with a big employment gap. Don't be irresponsible. And what's wrong with you, anyway? Don't you want to someday be proud to own a Lexus? Besides, I know you'll be much happier working. You'll be bored if you stop. Come on...everyone secretly aspires to be a Vice President. When you say you wouldn't want that, it only tells me you're either lying or you're content to do nothing with your life. Or maybe you just think you can't make it, so you pretend you don't want it."

Sigh... I'm afraid my desire to please only goes so far. Hence, I can't structure my life around comments like that. I just can't. If I really want to do something different with my life and my whole family is behind me, it would be the epitome of cowardice and underachievement to change that to please friends and acquaintances who think otherwise.

Reflections on the Nielsen's Early Retirement

2008-02-24T23:47:00.001-05:00

"The trouble with retirement is that you never get a day off."
- Abe Lemons

Over the past few years, I've read many personal stories about early retirement. Unfortunately, in most cases the story details didn't resonate very much with me. Sometimes the person in question retired after a supreme event of good fortune, such as receiving a large inheritance or cashing out of a hugely successful stock option grant at one's place of employment. In other cases, it appears that a career change was redefined as "early retirement". (e.g. "I accumulated almost $100,000 and then retired early. Soon after that, I was bored so I started earning money in a different line of work six days a week, and now with that extra income, I'm really enjoying early retirement more than ever." Huh?)

Other articles describe an "extreme" lifestyle where someone lives on $7,000 a year or some similar number. Still other articles feature someone who does not have a plan but merely "hopes to retire early". And then there are the occasional self-serving articles where the person in question "retired early" by writing a book about how to retire early.

All these articles had some entertainment value for me, but they didn't resonate with me because I could not imagine myself in a similar situation or relate to them in any meaningful way. However, a recent Money magazine article about a military family who retired early really struck a chord with me.

On the surface, the family in the article seems much different than my family. They live in the midwest. We live in the Northeast Corridor. They worked in the military. We have always been civilians. Their primary source of retirement income will be their combined pensions. Our primary source of income retirement income will be stock dividends. They will have lifetime medical benefits provided by the government. We will need to pay for medical expenses. On the other hand, it appears they are starting retirement with many years on their mortgage, while we will probably be mortgage free when we start retirement. We also have a sizable sum earmarked for our kids for college, while this is still a big concern for them. Additionally, we don't share the same family backgrounds, the same occupations, or even the same hobbies.

Yet a closer examination reveals a whole host of financial and lifestyle similarities between our two families:

Early retirement was a conscious, but evolving, plan over 15-20 years.

The success of the plan mainly depended upon consistent execution.

Frugality was important, but was never taken to extreme levels. Consistency in all areas for long periods of time was more important than a few spectacular penny-pinching maneuvers.

They adhered to a budget for long periods of time.

Their spending level is in the general ballpark of what we are planning.

Interestingly enough, upon discussing the possibility of early retirement with friends, we have also experienced the same two negative reactions from many people: (1) You're going to be bored. (2) You're being quite irresponsible.

Career success was a reasonably large factor, but their strategy did not require an extensive climb up the ladder.

They saved about 35% of their income at first, and even more as retirement approached.

They invested mainly in equities.

They felt like quitting many times, but ultimately persevered.

In addition to a modest $400K in savings, they can also draw about $60K / year from their military pensions, which are adjusted up for inflation each year. While a pension seems intangible to many people, a pension is just an annuity stream and one can easily calculate its value. Using publicly available annuity quotes from Vanguard, I attempted to put a value on their military pensions. Here are the results:

Male; Age 44.5; Missouri resident

Annuity income = $36,900

Paid monthly ($3,075/month)

Adjusted for inflation (yearly to CPI)

Value of annuity:

$955,982 (Single Life)
$1,044,396 (Joint / 50% survivor benefit)
$1,132,810 (Joint / 100% survivor benefit)

Female; Age 40.5; Missouri resident

Annuity income = $36,900

Paid monthly ($1,800/month)

Adjusted for inflation (yearly to CPI)

Value of annuity:

$629,494 (Single Life)
$646,343 (Joint / 50% survivor benefit)
$663,193 (Joint / 100% survivor benefit)

Depending on the survivor benefits chosen, the total value of both annuity streams is worth somewhere between $1.6 to $1.8 million. Again, just as our projected spending level is similar to theirs, our projected necessary wealth accumulation is (perhaps unsurprisingly) also in the same ballpark.

Congratulations to the Nielsens. If all goes well, we hope to be joining them in about 5 years.

Net Worth Update 2007

2008-01-08T23:45:00.000-05:00

"Your net worth to the world is usually determined by what remains after your bad habits are subtracted from your good ones."

- Benjamin Franklin

I've calculated our net worth at the end of 2007 and appended it to the previous ten years of data I posted last year. I was perhaps hoping for a bit more progress last year, but I'm nonetheless satisfied with the results.

You may also wonder why I only update our net worth statistics once a year, as I've noticed a number of personal finance blog authors provide monthly or even weekly updates. In our case, we have a portfolio consisting primarily of equities, and the total portfolio dollar amount size has grown to dwarf even our yearly savings. Thus, I'm afraid that a monthly net worth update would merely be a reflection of monthly market fluctuations, which I don't think is a useful thing to calculate and post.

Year	Net Worth At Year End
1997	$80,641
1998	$134,135
1999	$224,502
2000	$300,710
2001	$337,281
2002	$401,199
2003	$477,903
2004	$549,144
2005	$684,813
2006	$864,380
2007	$950,346

TIPS Rates Too Low

2008-01-04T00:12:00.000-05:00

"I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I do nothing in the meantime."

- Jim Rogers

In June of 2007, I posted an article describing why TIPS rates were very attractive at the time. How things change in seven months! Back then we had a rate of about 2.7% to 2.8% (plus inflation) across almost the entire yield curve. Now the entire curve is well below 2% and the short end is below 1%.

The total return on 10-year TIPS has been about 11% or 12% since last June. To me, this figure represents the excess over typical bond returns that I originally hoped to achieve over several years by entering at an attractive price. Looking to exit here...

Financial Goals For 2008

2007-12-26T23:15:00.000-05:00

"Simplicity is the ultimate sophistication."
- Leonardo da Vinci

My financial goals for 2008 are quite simple and easily articulated:

Save 40% of my income. Barring a job loss, this simply involves adhering to budget.
Stay invested. It's always a risky time for investments because risk is why you are paid.
Complain less. Recognize that true contentment is never obtained through money.

Lastly, before starting 2008, let us reflect on the past, for it was three years ago today that the world awoke to the shocking realization that a quarter million people had perished without warning in the Asian Tsunami triggered by the 2004 Indian Ocean Earthquake.

Remember the victims. Help the survivors. Embrace life.

Dividends 2007

2007-12-09T17:20:00.000-05:00

"Profits are an opinion, cash is a fact."
- Unknown

The dividend dates and amounts for the year are basically known at this point, and so I calculate that across all accounts we will receive approximately $11,400 in dividends and interest for 2007. (More than 90% of this amount is dividends on common stock.)

We still have a long, long way to go, but at least our passive income is finally in the correct order of magnitude for the first time!

Jackpot!

2007-11-26T23:31:00.000-05:00

"Where observation is concerned,
chance favors only the prepared mind."
- Louis Pasteur

Who says you can't make money from personal finance books? A number of years ago, I used to buy a lot of financial books, and it has come to my attention that some of these used books are now worth more than I paid for them new - in some cases, a lot more. Using Amazon and eBay and other sources, I've determined that several of my old financial books are now worth more than $100 each, but the biggest jackpot is a 1991 book by Seth Klarman entitled Margin of Safety. An Amazon.com listing of the book shows prices from $1,125 to $2,399. My copy is in pristine condition and would appear to fetch more than two thousand dollars!

Margin of Safety has apparently become a collector's item because it's the only book Klarman ever published and it was never reprinted. For some hedge fund managers and others, it's also become a status symbol to be able to display the book on their coffee table.

It's a good book, but for $2,000, I think I'll take some notes and have it pay for next year's vacation. So take a look around on your bookshelves and see what you have. It might be worth more than you think.

Thanksgiving Table

2007-11-22T10:37:00.000-05:00

"Gratitude is not only the greatest of virtues,
but the parent of all the others."
- Cicero

I often feel that I complain far too much, and my biggest complaints usually involve work or money. This is unfortunate as I know in my heart of hearts that many people in other places and other times have never had it so good. As an exercise in gratitude, I decided to create a different kind of "Thanksgiving Table" this Thanksgiving morning.

I put all of my expenses in a spreadsheet, divided each of these expenses by my annual income, and then multiplied that by the number of minutes in a 40-hour work week. The result is how many minutes I must work each week to pay for each item. Furthermore, instead of complaining about "high taxes", I looked up the services I receive for the federal, state, local, and property taxes I pay, and substituted those in place of the taxes I paid. This was very enlightening. Lastly, for maximum impact, I started the clock ticking on Monday morning and arranged the items roughly in the order of Maslow's hierarchy of needs.

This exercise had nothing to do with comparing myself to anyone, so please don't take it that way. I'm well aware that there are millions of people in the world less fortunate than myself, and this post is in no way meant as braggadocio. I'm also aware that there are millions of people with more assets and/or income, and this exercise was also not meant to suggest that my financial situation is anything stellar. This article is not meant as a guilt trip for those readers who are rich, nor a put-down for those who are poor. This post is only a personal expression of gratitude and thanksgiving, but I do hope others will also find gratitude for their own situation, whatever that may be.

The bottom line is that I am truly humbled by how much I receive for such small effort on my part. I hope my complaining in 2008 is greatly reduced by meditation upon what I have discovered. Happy Thanksgiving to all!

Day	Minutes	Finish Time	Expense	Comments
Monday		9:00 AM		Before I start the clock ticking, I want to acknowledge that many of the best things in life are free and many of the things I enjoy cannot be bought with money: a loving family, good health, and a free country.
Monday	7	9:07 AM	Water	Only had to work 7 minutes to provide the week's supply of clean water for drinking, cooking, and bathing. Sadly, this most basic of all needs is something many people on the planet don't have.
Monday	114	11:01 AM	Food	By 11AM on Monday, there is enough food for my entire family, and frankly, we eat very well. If we had to, we could easily survive on half our food budget.
Monday	143	1:24 PM	Shelter	Mortgage and all maintenance costs of our house and yard.
Monday	69	2:33 PM	Medical	Health insurance and out-of-pocket medical and dental expenses.
Monday	35	3:08 PM	Heat	This includes heating the house, as well as hot water and cooking.
Monday	4	3:12 PM	Local Police	Wow! 4 minutes of work to provide police protection for my safe neighborhood for the week.
Monday	4	3:16 PM	Fire and Rescue	And another 4 minutes to provide fire and rescue operations.
Monday	9	3:25 PM	Clothes	For the whole family...
Monday	37	4:02 PM	Defense	As near as I can figure, this is what it costs me per week for national defense. Not nearly as much as I would have thought.
Monday	5	4:07 PM	Justice	5 minutes a week to maintain all levels of our judicial protection system, the envy of the world.
Monday	4	4:11 PM	State Police	Additional police protection...
Monday	27	4:38 PM	Electric	Lights. Computer. Air conditioning. Everything you plug in.
Tuesday	99	10:17 AM	Social Security	As I have mentioned before, you will get back more than you probably expect.
Tuesday	33	10:50 AM	Medicare	Of course I'm not eligible yet, but I've had several relatives that were provided hundreds of thousands of dollars of medical assistance after age 65. This is not to be taken for granted.
Tuesday	3	10:53 AM	Unemployment	Safety net for my job.
Tuesday	44	11:37 AM	Local Schools	This is one of the bigger expenses and is also a bargain. Less than an hour of work per week sends all my kids to local schools ranked in the top 5% of the nation. I have been in these schools many times. They are good schools with good teachers.
Tuesday	40	12:17 PM	Colleges	Not a recipient of the college subsidies yet, but hopefully will be one day.
Tuesday	1	12:18 PM	Library	Incredible. One minute to provide for the library for the week. Our local library is huge and within walking distance of our house. My kids have been entertained for hours with literally thousands of books we checked out over the years.
Tuesday	6	12:24 PM	Trash/Recycling	Sure beats hauling it to the dump and the recycling center myself every week.
Tuesday	61	1:25 PM	Household	Soap, toothpaste, toilet paper, trash bags, etc. All the ongoing (non-food) consumables that keep the household running.
Tuesday	57	2:22 PM	Automobile	Depreciation, insurance, gasoline, maintenance. The whole works for two vehicles.
Tuesday	5	2:27 PM	Roads	Combined federal/state expenditures of my taxes for this item...
Tuesday	15	2:42 PM	Recreation	Taxes for local parks. Dues for neighborhood pool. Health club. Bicycles. Etc.
Tuesday	39	3:21 PM	Telecom	Two cell phones. Land line. Broadband Internet.
Tuesday	47	4:08 PM	Dining	Eating out twice a week for the whole family. Often this is a fairly nice place. A luxury to be sure...
Wednesday	78	9:26 AM	Vacation	Another indulgence...
Wednesday	261	1:47 PM	Charity	Gifts to charities and to others less fortunate than myself.
Wednesday	163	4:30 PM	Other Expenses	Things that I either don't care to track or to display to the world, plus taxes where I couldn't pinpoint where it was spent.
Thursday/Friday	990	5:00 PM	Savings	Yes, it's a lot. A little over 40% of gross income, which is our target. Basically, Thursday and Friday wages of every week go to savings.

Reframing The Question

2007-11-15T00:20:00.000-05:00

"We may consider ourselves lucky when, trying to solve a problem, we succeed in discovering a simpler analogous problem."

- George Polya, How to Solve It

In his book entitled Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing, Hersh Shefrin poses the following question:

The Dow Jones Industrial Average closed 1998 at 9,181. As a price index, the Dow does not include reinvested dividends. If the Dow were redefined to reflect the reinvestment of all dividends since May 1896, when it commenced at a value of 40, what would its value have been at the end of 1998? In addition to writing down your best guess, also write down a low guess and a high guess, so that you feel 90 percent confident that the true answer will lie between your low guess and your high guess.

I took a wild guess: 40,000. For a low and a high, I chose 20,000 and 60,000. This turned out to be totally wrong - not even in the right ballpark. The correct answer is 652,230. (!)

Apparently I am at least in good company, as the author goes on to state that "virtually nobody finds that the true answer lies between his or her low and high guesses." The author cites this as an example of overconfidence. People generally overestimate their knowledge and abilities, and thus they are frequently surprised by events.

While I think it's a very interesting example, I really felt that the question itself was a much better example of framing than overconfidence. It turns out that the human brain does not work very well with exponential functions like compound interest, so it's not really too surprising that the average person has no clue where the Dow index would be 100 years after inception.

So I propose that we state the problem a different way:

From 1896 through 1998, what has been the annualized total return of the Dow, including reinvested dividends? Again, pick a low and high number that makes you feel 90% confident the true number lies in the interval.

This is a much easier question to answer than the first. You might very well have heard the long run average return for stocks reported as 12%, or 9%, or 10.5%, or various other numbers, depending on the time period and the index involved. You might also have heard that 5% or 6% or 7% plus inflation is a good ballpark number. You might also intuitively know that GDP growth + inflation + dividend yield is a reasonable proxy for long term returns, and you might calculate something like 10% that way. Personally, I've also read that the worst 30-year period for the S&P 500 returned 8%.

So it was fairly easy for me to pick 10% as my guess and 13% and 8% as my high and low. Now let's resolve the original question using the new answers.

Average guess = 40 * (1.10 ^ 102) = 666,982
Low guess = 40 * (1.08 ^ 102) = 102,632
High guess = 40 * (1.13 ^ 102) = 10,376,647 (!)

Interesting, right? First, note that the guess for the average is very, very close to the right answer. Second, note the bounds that are produced by 8% and 13%. Hardly anyone would pick those numbers the way the original question was framed. But in the second framing of the question, you only had to include 10% in your interval. I'll bet a fair number of people would get the question right that way. In fact, I'm nearly certain that the percentage of correct answers would be dramatically better if the question were asked the second way.

Can we learn anything practical from this exercise? I think so. If nothing else, try to reframe questions that appear confusing. A person can very easily be duped by salespeople in the financial arena - not necessarily because they are gullible or uninformed, but because statements and questions are (often deliberately) framed to make it appear that your interests are being served when in fact they are not.

Never let a car salesman or a mortgage broker reduce everything down to a monthly payment and nothing else. Your brain will tend to think you are getting a good deal the way the information is presented. Similarly, don't try to attempt variants of the Dow question above. For example, don't say to yourself: "It looks like I spend about $50K per year. After about 30 years of inflation, that would probably be...oh...I don't really know...probably about $70K." You are likely to make severe financial errors this way. Instead, reframe the question and ask yourself what is a realistic yearly inflation rate given everything you know. Then use a tool (such as a financial calculator, Microsoft Excel, or even a compounding table) and solve the original question. If you choose 3.5% per year, for example, then your original estimate of $70K was less than half the actual number!

Personal finance is hard to master because it involves knowledge, insight, and personal discipline. At the very least, make sure your decision making framework is on a level playing field by insuring that you frame your financial questions in a way that you can realistically make good choices.

Relative Valuation

2007-10-22T00:55:00.000-04:00

"All things are relative."
- Albert Einstein

"All relatives are things."
- Groucho Marx

"My relatives took all my things."
- Rodney Dangerfield

I've gotten quite concerned that I'm increasingly seeing only an appeal to relative valuation in the analysis of stocks listed in Hong Kong and Shanghai. So for example, yes, Company A trades at 70 times earnings, but other peers trade for 90 times earnings, so Company A is cheap and should be bought. Another theme is that if Company A is listed in Hong Kong and valued at $10B, but is also listed in Shanghai (or Shenzhen) at $15B, then the Hong Kong shares are a relative bargain and so they should be purchased. Not dual listed? No problem. It's still a bargain because it probably will be dual listed in the future, and of course the A shares will be worth more and so the H shares are still a bargain even now.

Is this not the same logic we find in all asset bubbles? Back in the dot.com era, I recall reading many analyst reports that stated that while the company in question was just started two years ago and had never shown a profit, nonetheless the company was only trading at 50 times sales, while a similar company was trading at 80 times sales. It was then presented as a tremendous bargain.

(Now to be sure, fallacious reasoning does not necessarily imply that the conclusion is incorrect. On the other hand, it's a pretty strong red flag! We should not presume to be so lucky as to accidentally arrive at the right conclusion after using faulty logic!)

Broadly speaking, of course, relative valuation is fundamental to how we value anything and should not be thrown out altogether. To be more precise, the root cause of the relative valuation phenomenon in asset bubbles is not so much that a relative valuation is made, but that the comparison is usually restricted to a conveniently small set of variables that may themselves all be outliers. In the late 90's, Internet companies were compared with selected metrics of other Internet companies, but they were not frequently compared with a variety of traditional valuation techniques and with companies outside the sector and with companies from other time periods. Had this been done more often, the valuations would certainly not have looked so attractive.

At the peak of the housing bubble, there were houses in our area that sold for $600,000, while identical houses on the same street rented for only about $1,500 per month. $600K houses were extolled as bargains because by using only a comparable sales method, they were simply compared with other houses listing for $630K. However, these same houses looked frighteningly expensive when viewed on a rental basis or by replacement cost, to say nothing of whether the prices were out of whack with the income of residents in the area.

As such, I've shuffled my equity portfolio a bit this past week, which is a rather rare thing for me. I've sold all my China positions that I held directly: CEO, SNP, and ACH. My position in CEO more than doubled in a matter of a few months, while SNP and ACH both more than quadrupled since I purchased them. I've redeployed about 10% of the proceeds into AIB and BCS, and the rest of the money will await further analysis. All changes are reflected in the left nav bar.

Health Care Costs

2007-10-16T07:28:00.000-04:00

"I was gratified to be able to answer promptly.
I said I didn't know."

-Mark Twain

I'm quite confident that within a few years I can get to the point where my passive investment returns will cover my mortgage, my groceries, and my utilities. I'm also reasonably confident that I'll be able to cover most of the discretionary expenses that I'm likely to run up. I'm even moderately confident that my investments will be able to cover the inflation increases that all of these expenses will encounter going forward. But healthcare...that is overwhelmingly the big wildcard and I profess no confidence whatsoever in my ability to pay for it without being gainfully employed.

This blog has several readers from different countries, so to make sure everyone is on the same page, let me provide a very terse summary of the U.S. healthcare system.

The medical care itself is good. I have no complaints about that.

Medical care is very expensive, and if you have to pay for it directly, it is even more expensive because you do not get the negotiated rates that an insurer does. I have received bills where the direct cost of service was 3 or 4 times the negotiated rate.

Unless you are part of a special program like Medicare or the Veterans Administration, you will be expected to pay for your own medical costs, either directly or by purchasing health insurance.

If you don't have any money and can't pay, you (probably) won't be denied medical care for serious issues, but you (probably) will still owe the money.

Any significant medical issue can totally wipe out the savings of even moderately wealthy people if they don't have health insurance. When something major goes wrong, it's very easy to quickly rack up bills in the tens of thousands of dollars or even the hundreds of thousands.

Health insurance is also quite expensive, as you might expect from points #2 through #5.

Most people who are insured get their insurance through their employer. In a lot of cases, the employer pays for a significant portion of the insurance premiums. In other words, health insurance is often a benefit of your employment.

Health insurance premiums have been rising more rapidly than the overall rate of inflation for a number of years.

Health insurance premiums escalate with age. The premium you pay if you are in your late 50's is generally about 3 times what you pay if you are early 20's.

So as you can see, the above is not exactly the system one would design if one were hoping for an early retirement! Consider how things are stacked against that:

If you stop working, it is highly unlikely (except in certain rare circumstances) that your health insurance will be subsidized by your employer. You will be paying for it.

Without health insurance, you run the risk of losing all of your savings if a significant medical event occurs.

You face the prospect of paying rapidly escalating health insurance premiums, partly because of significant medical care inflation, but also because you are always aging and being bumped into higher age brackets with even higher costs.

Last year I began to investigate the cost of medical and dental insurance and the first thing I looked at was how much my current policies cost me AND my employer. (Most workers who are not self-employed don't have a good handle on these numbers, as the employer cost is not always prominently disclosed and the employee part is spread throughout the year via deductions from your paychecks.) What I discovered was quite frightening: the total cost of my family medical and dental insurance was almost $19,000 per year! And the next thought I had was that if this is what it costs a large company, then as an individual, I would probably have to pay far more than that.

However, I recently spent a fair amount of time looking through the eHealthInsurance website, which is a clearinghouse for insurance providers. In many cases, the policies look far cheaper than my employer policy, which on the surface does not make sense to me. It would appear that one could obtain a roughly similar policy for perhaps half the cost. (And interestingly enough, many of the policies offered on eHealthInsurance are provided by my current insurance provider.) I'm an analytical person, so I looked through all the fine print on the coverage details of many different policies, and checked the doctor and dentist list of each as well. But I very well may be missing something obvious. I've been relatively sheltered from the true cost of insurance because most of my employers throughout the years have paid for most of it. So like the Mark Twain quote above, I really just don't know.

This is no small matter for early retirees who will pay for insurance themselves. If health insurance costs $20K per year instead of $10K per year, that will likely mean that an additional $250K (or more) in savings will be necessary to support the difference.

So does anyone know what's really going on here? What are your experiences with health insurance policies that were not sponsored by an employer? Can they really be less expensive than policies provided by a large company to their employees?

Emerging Markets

2007-09-19T08:26:00.000-04:00

"A hidden connection is stronger than an obvious one."

- Heraclitus of Ephesus

There has been much talk lately about emerging market equities. Are they overvalued or not? Is a P/E of 14 or 15 too low because of the (potential) growth rate of earnings? Or is the P/E too high because it is now similar to more developed markets and does not provide adequate compensation for the additional risks of emerging markets? Or are emerging markets currently fairly valued?

I confess I don't know the answer to that question.

But let me shift the focus to a related question. Regardless of your opinion of the current valuation, it cannot be denied that (in hindsight) 4 or 5 years ago, emerging market indexes were very undervalued. Now someone might counter that the only reason for the recent stellar returns is that emerging markets have risen way too far and are in a bubble. Hence, the argument would be that perhaps emerging markets were simply fairly valued in 2003 and are overvalued now.

Mathematically, however, this argument does not ring true. Suppose we concede that emerging markets are currently grossly overvalued and we peg "fair value" at half the current price. This would put the current P/E at about 7. While some may argue that such a P/E ratio would be appropriate to discount risks, I seriously doubt that many would claim such markets would definitely be overvalued at that level. So for sake of argument, let's say fair value is one half the current price. Even if emerging market equity indexes were currently 50% less, the appreciation during the last 4 1/2 years would still have been more that 20% annualized.

So it seems to be the case that in the Spring of 2003, emerging markets were quite undervalued, yet there was little recognition of that. The recent returns have been staggering. The total return of the Vanguard Emerging Markets Stock Index Fund from 2003 Q2 to present exceeds 350%, or more than 40% annualized over the past 4 1/2 years.

I tried to search the web for articles and analysis of emerging markets in 2002 and 2003. (The web is probably not the best medium for findings historical articles. A trip to the library to examine the archives for Barron's and Business Week would probably yield better results.) From what little information I've uncovered and pieced together, I don't really find that the attitude about emerging markets was all doom and gloom back then. Rather, it appears that emerging markets were simply totally off the radar screen for most people - unnoticed rather than unloved.

So the example of emerging markets five years ago prompts the question: What asset class is unnoticed and undervalued now? If such an asset currently exists, it's very likely that it's NOT being heavily written about in your newspaper and discussed on the web.

I Love Overdraft Protection

2007-09-17T08:28:00.000-04:00

"Life is about timing."
- Carl Lewis

I have previously written about how overdraft protection is a key part of my cash flow financial autopilot.

An example from a few months ago illustrates the value of overdraft protection. It was the night before we left for summer vacation and I realized that a whole bunch of bills were all going to be due within a couple of days of each other. The mortgage payment, electric bill, telephone bill, monthly credit card bill, and the bill for a new dishwasher were all due while we were gone and automatically scheduled to be debited from our checking account. Worse, the checking account had close to zero in it because we had just paid in advance for most of our vacation expenses. The paychecks to cover all this would not arrive for several weeks. This was definitely a worst case scenario.

Normally I would not even think twice about this kind of situation, as my overdraft protection will handle it properly. However, I was concerned that this was really quite a lot of money to overdraft and perhaps I should scramble to see if there was cash available in some brokerage account to quickly transfer. After thinking about it for about five minutes, I decided it was not worth spending a whole lot of effort and worry at a time when I should have been helping my family to pack and preparing to relax. I decided to simply let go of the whole matter and let the overdraft protection work as usual.

In retrospect, this was clearly the right decision. I got a good night's sleep, we left early enough in the morning to beat the traffic to the beach, and we had a wonderful vacation where I never worried about the overdraft situation. When I returned, I noticed a total of $2,700 had been overdrafted from my HELOC (Home Equity Line Of Credit) account. It took two paycheck credits (one of which occurred during vacation) to build up enough in the checking account to pay off the HELOC. As soon as the paychecks hit, I paid off the overdraft in full as I always do.

The total interest bill: $3.66!

What a deal! As I mentioned in my earlier post, with a more typical overdraft for me that occurs a few times a year, the overdraft amount is a couple hundred dollars, the full payoff occurs in less than a week, and the interest bill is usually less than 50 cents. (There are no fees of any sort for my overdraft protection, only interest charges.)

In return for a few dollars a year, I don't have to worry about the exact timing of my cash inflows and outflows. Overdraft protection is a leveler that evens out the credits and debits, preventing the possibility of bouncing a check at any time - even on vacation. On average, I pay about five dollars a year in interest for what I consider an invaluable service. In my opinion, that is practically the definition of a good deal.

Personal Inflation

2007-09-10T08:24:00.000-04:00

"Invest in inflation. It's the only thing going up."

- Will Rogers

I have a rather unfortunate habit of saving financial papers beyond their useful life. When it comes to financial documents of any sort, I'm clearly a packrat. It's not that I really want to keep so many papers, but rather that I don't want to take the time to sort out what is not needed and throw it out.

So I continued to save and save and now the four drawer filing cabinet is full, at which point I finally got the message that this has gone on for too long and needs to be confronted. Armed with a good shredder for 90% of the papers and a good scanner for the rest, I've been working through the cabinet for the past few days.

One of the more interesting finds has been a number of old receipts and other papers that show how much the prices of things have increased over a long period of time. This did not really surprise me, but the anecdotal examples from my own past drove the point home very clearly for me. Inflation is real. And very persistent. The current cost of some of the items is pretty amazing compared to the old receipts.

Here are some examples where I could make a fair comparison between an old receipt and the current cost of the exact same item:

Apartment lease from early 90's. Cost: $705/month. Current cost: $1195/month.
Annualized inflation rate = 3.35%

Water bill from late 90's. Rate: $1.40/10K gl. Current rate: $1.55/10K gl.
Annualized inflation rate = 1.28%

Sewer bill from late 90's. Rate: $2.70/10K gl. Current rate: $3.66/10K gl.
Annualized inflation rate = 3.88%

Receipt for roll of 100 stamps for early 90's. Cost: $29/roll. Current rate: $41/roll.
Annualized inflation rate = 2.34%

College tuition bill from early 90's. Cost: $490/credit. Current cost: $1012/credit.
Annualized inflation rate = 4.64%

Studio piano receipt from early 90's. Cost: $3290. Current cost: $5900.
Annualized inflation rate = 3.72%

I have said it before on this blog, but I'll say it again: Because it happens slowly, people tend to underestimate the long term effects of inflation. Even if you are clever and frugal, you will be affected by it. If your income is flat indefinitely, there is only so much substitution one can make until inflation will eventually force a reduction in living standards.

The average annualized inflation rate in the United States over the past century has been about 3.5%, and interestingly enough, a few anecdotal items from the filing cabinet seem to be in the same ballpark.

Resolve

2007-08-29T08:58:00.000-04:00

"Obstacles cannot crush me.
Every obstacle yields to stern resolve."

- Leonardo da Vinci

There has been a confluence of events in my life this summer, some large and some small. Together, they have created a quiet resolve to make early retirement really happen.

Assuming that a goal is realistically obtainable, the biggest determinant of success is usually motivation. For a lengthy project, a high level of resolve is at the same time both very easy and very hard. For example, you may decide you are going to exercise 30 minutes today, and assuming you don't have a medical condition preventing you from doing so, this should be quite easy to accomplish. However, suppose you decide you are going to exercise 30 minutes every day for the next year. Everyone knows that is not easy! Each new day presents you with the same small step that is easy to accomplish, but taken together as a whole year, the steps become hard.

Can I stick to a budget again for 5 more years? Can I endure my current employment for 5 more years? Can I resist tapping into my savings and blowing it on something for 5 more years? Can I remain absolutely disciplined in investing my savings for 5 more years?

Each day I can easily do those things, but as a whole, they sometimes look very hard. That tells me that in the end, if I fail, it will likely be that I simply didn't want it bad enough, and that is a sobering thought. Will I look back and see that I didn't want early retirement as much as I wanted a new car, a remodeled bathroom, or the thrill of a penny stock?

A few days ago, CNN/Money published an interview with a Nobel Prize winning psychologist who researches how and why people make investment decisions. When asked about money and happiness, he responded: "Happiness is determined by factors like your health, your family relationships and friendships, and above all by feeling that you are in control of how you spend your time." [emphasis added]

That is a very good description of what I am pursuing with my early retirement goals.

Controlling Impulse Purchases

2007-08-13T09:18:00.000-04:00

"What you don't have, you don't need it now
You don't need it now, you don't need it now"

- U2, Beautiful Day

I'm amazed at how much some people spend on impulse purchases. I'm not just referring to M&M's and gum at the checkout counter, but also to a lot of large purchases that are made on impulse. As I see it, there are three related (and progressively sophisticated) sales arguments related to the impulse decision.

Argument #1: You need it right now.

This is the initial argument for buying something now and the root of the impulse decision. Our entire society is structured to facilitate impulse shopping: store layouts, credit cards, "one-click" shopping, periodic sales, etc. So if you want to save money in life, you better have a strategy for dealing with the marketing machine. The most successful approach for most people seems to be to have a policy that you will wait a certain period of time. I like this approach because it's a generalized approach that doesn't involve gimmicks like pretending salespeople are "evil" or leaving your credit cards at home when you visit the mall. If you've thought about the purchase for a while, then by definition, it is not an impulse purchase. (Whether it's a wise decision is another matter, but at least it's not an impulse purchase.)

Argument #2: You won't have this opportunity again.

This is usually the counterargument to the use of a waiting period. The salesperson tells you that if you wait until tomorrow, the store might be sold out. The flier in the mail says the sale is only good until the end of the week. A lot has been written about these tactics and how well they work, but suffice it to say that 99% of the time, you'll have plenty more opportunities, and sometimes at even better prices. Here's a true story to illustrate:

We once bought a high-end mattress set that had a display price of about $1400. As you probably know, the price of a mattress is highly negotiable in most stores. It was near the end of the month and the sales lady was quite hysterical in her attempt to get the mattress out the door by the end of the evening. At first it was a simply "on sale today" for $1200. Then she found a "special sale" of $1050. Then she rummaged around in the back of the store and announced that this mattress was overstocked and she could let it go for $900. Later, we heard how "this model was probably going to be discontinued", how "my manager can cut you a special deal tonight", and how "I really need to make my quota for the month" - probably the only honest comment of the night! Eventually she came down to $650. She was almost in despair when I firmly told her that we always had a 24 to 48 hour waiting period to think about large purchases. She offered $615 if we would buy it right now. I felt really bad, but I asked if this price would be good for a couple of days. After she said yes, we thanked her and walked out the door.

Two days later, we decided we definitely did want the mattress and based on our comparisons at other stores, we found that $615 was actually a good price. When we went back to the store, we encountered a different salesperson. We politely told him the name of the other salesperson (to be fair, the commission was hers) and told him the price we were quoted. He looked at us like we were from another planet. "No, no, no, that cannot be right" was all he kept saying. But do you know what? Yes, five minutes later he absolutely did sell us the mattress at that price!

The point of this story is not how much you can haggle for a mattress. Undoubtedly, many people can do a much better job at that. My point is that no matter what you are told by salespeople and by sales literature, today is probably NOT the last day you will ever get that price point. Even in the most extreme of circumstances, it is probably not the last opportunity.

Argument #3: An upgrade is not an additional purchase.

This is the most subtle of the arguments because it's a perfect setup to make a series of mental accounting errors. Behavioral finance theory asserts that people will attempt to frame decisions to segregate gains and integrate losses, and what better way could there be to integrate a loss than by lumping it together with another larger purchase. You know the routine.

You need a new refrigerator and you don't want to be ripped off, so you do your homework. You look at all the models and compare the features and decide which features you really need. Then you read all the product reviews. Finally you shop around and find the best price and you even wait until it is on sale. Now you are certain you've located the best fridge for your needs and at the best price. So far, so good. You confidently walk into the store and announce to the salesperson that you'd like to buy Model A, currently on sale for $499. The salesperson informs you that "Model A is manufactured by a great company, but we don't sell very many of that particular model - it's the older model where the ice maker only dispenses cubes. Model B is the newer model which has all the same stuff, but also dispenses crushed ice. Almost everybody buys Model B; we sell tons of Model B. We've heard lots of great things about Model B. It's also on sale for only $599, which is not much more than Model A, and which is the lowest price it's ever been on sale here."

Five minutes later you've signed the papers for Model B. Now why do we do that? Partly we do it because of the sales appeal to ego (i.e. "newer model", "everybody buys Model B", etc). But we also do it because we don't perceive it to be an impulse decision. We don't think, "Hey, I've just made a well planned refrigerator purchase for $500, and a $100 impulse purchase for an ice crusher." No, we integrate the $100 impulse purchase right into the $500 purchase. $100 looks much smaller that way. In fact, we hardly notice it. In our minds, we are still thinking about what a great job we did researching Model A and getting a great sale, even though we've bought Model B! Notice again how easily we segregate gains, but integrate losses. In fact, most people do not even need a salesperson to nudge them in this direction. Notice how easy it is to say, "Well, I'm already spending $500, so another $100 to get the newer model is not really a big deal." It's interesting that the $100 loss is "not a big deal" when we integrate it with the bigger purchase. However, if Model A was originally $600 but then went on sale for $500, we are very quick to segregate the $100 gain and crow about it. In that case, the same $100 was, in fact, a big deal.

So be alert to the upgrade impulse. You'll notice it everywhere - option packages on cars, warranties on consumer electronics, upgrade packages on new homes. Be especially alert if there is financing involved. For example, suppose you are buying a newly constructed home for $250,000 and the builder is offering 100% financing. If you borrow $250,000 at 6% for 30 years, your mortgage payment will be $1,500 per month. As you are filling out the paperwork, the builder rep suggests that you could upgrade the kitchen countertops to granite. "The difference in monthly payments is almost negligible," he tells you. "The monthly payments will be $1,530 instead of $1,500." Would you upgrade?

Now the point is not whether granite countertops are something one should buy. What you choose to spend your money on is entirely your business. The issue is whether you would still make the same decision if framed differently. In your mind, try to frame the decision so that you aren't comparing the $30/month with the much larger number of $1,500/month, and try to isolate the purchase as much as possible. For example, would you be comfortable constructing a budget where you break out a separate line for granite countertops: $360/year? Would you still make the purchase if you knew the countertop upgrade cost $5,000? ($5,000 amortized over 30 years at 6% is $30/month.) Would you still make the purchase if you knew the upgrade would cost $10,800 after interest expenses? Alternatively, imagine that the builder never offered an upgrade, but you were contacted separately by a reputable home remodeling store. Would you be willing to separately pay them $5,000 to upgrade the countertop during construction?

If you answer "yes" to all those questions, then the upgrade probably makes sense for you. There is certainly nothing inherently wrong with having nice things. However, if you answer "yes" to some questions but "no" to others, then your choice depends on how the decision is framed. The inconsistency in the answers is a powerful warning sign! It's probable that you would like to purchase the item but not think about the costs, or that you are being manipulated, or both.

And finally, you may be asking why the big deal about impulse purchases anyway? The reason it's important is that the success of any large project depends on planning and execution, and financial projects are no exception. Large projects like paying off your debt, saving for your children's college expenses, and saving for your retirement require setting goals and follow-through. In order to have success in reaching financial goals, you must plan well and execute. Repeated impulse purchases destroy your budget and severely weaken your chances of achieving your goals. Nothing is guaranteed in life, but you have to focus on what you can control, and impulse purchases are yours to control if you choose.

Navigation Bar Details

2007-07-26T09:02:00.000-04:00

"The rules of navigation never navigated a ship;
the rules of architecture never built a house."

- Thomas Reid, Essays on the Active Powers of Man

I've decided to explain my left nav bar, partly because I've never done so and partly because it answers some old questions posed in a couple of reader comments. Here is a brief description of each section:

Blog Archive: Standard blogger post archive.

Topics: Standard blogger listing of my labeled posts.

My Core Holdings: These are stock holdings where I feel comfortable buying a significant amount and holding for a long period of time. They tend to be large-cap, dividend paying companies and in many cases, I will probably hold them for the rest of my life. I am basically a diversification freak so each of these holdings are almost without exception about 1% to 2% of my total portfolio of assets. I am well aware that there are people who can persuasively argue that such a level of diversification is either totally overkill or hopelessly inadequate. Nonetheless, I have been investing in individual stocks for almost 20 years and this is the level of diversification with which I've grown to be comfortable. Always make sure you respect your own risk tolerance and other constraints or you will regret it.

I also own mutual funds, and I have another post where I detail my mutual fund holdings. The reason I don't list my mutual funds on the nav bar is simply because I have not found a suitable widget for listing mutual funds. (Suggestion are welcome!)

My Smaller Holdings: These are smaller equity holdings that I've acquired for one reason or another. They are not trading positions. (I haven't been involved in trading for quite a number of years.) They are generally smaller cap and more risky ventures than more core holdings. All together, my smaller individual holdings comprise about 5% of my total portfolio of assets. This category is probably what some people call their "play money" or "throw-away money". However, I do not "play" with my money. I don't have these investments for excitement or experimentation. The objective is to make money. Because they are higher risk positions, I use a special broker so that the commission is still reasonable relative to the small position size.

Resources I Use: These are excellent financial and information resources.

Blogs I Read: Please take the heading at face value: blogs I read. Just because a blog is on the list does not mean I always agree with the content, or that it has a reciprocal link to my site. And it is not intended to be a "best of" list, as I don't even spend enough time on the web to ferret out all the interesting blogs. The common denominator is that they are all blogs that I continue to read, and I read each one for different reasons.

Places I Vacation: I'm actually not sure I why I have this section in the nav bar! It doesn't really have much to do with personal finance. Perhaps it's just a little reminder of something to look forward to while I'm editing the site. Maybe I will remove this section after a while if it seems like it is just adding clutter.

Finally, I need to point out that nothing on the nav bar should be considered a recommendation of any kind. I am not recommending that anyone purchase any of these stocks, vacation at any of those locations, or read any of the linked resources and blogs. The lists are simply a declaration of my personal situation and nothing else.

Roth IRA Conversions as a Tax Timing Tool

2007-07-05T10:30:00.000-04:00

"Observe due measure, for right timing is
in all things the most important factor."

- Hesiod

Nigel from Retire To India recently wrote a good article entitled Roth IRA Conversion During Early Retirement. The article describes the Roth IRA conversion process and explains the possible positive implications of conversions for early retirees. The article also links to the relevant portion of the Fairmark tax guide website, which is a great site for learning about most anything related to taxes on investments. For general background on conversions, I would refer you to the above article and to the Fairmark site. There is also a reasonably informative Wikipedia article on Roth IRAs.

While there are numerous articles on Roth IRA conversions, most of the writing tends to focus on the mechanics of the process, the specific tax guidelines involved, and the tradeoffs between a traditional and Roth IRA. Nigel's article is one of the few I have seen that explores how the timing of the conversion can benefit people in specific situations.

I would like to generalize upon Nigel's article by suggesting that Roth IRA conversions are an extraordinary powerful timing tool for taxes. While I'm not a tax professional, it occurs to me that most legal methods for reducing taxes mainly involve timing - shifting when the tax is imposed. While this doesn't sound as glamorous as some dubious scheme to create a big deduction, proper tax timing can actually make a fairly big difference in your net worth over time.

In order to understand why timing is important, it is necessary to recognize two basic things about the U.S. personal income tax code: (1) it is progressive; and (2) it is calculated on a periodic basis, generally a calendar year. Those with a quantitative background will immediately recognize that to minimize your total taxes - not just for a particular year, but for your whole life - you should time your income such that you are being taxed in the lower brackets as much as possible.

For those that are not so mathematically inclined, let me illustrate it visually, which is actually the way I think about it. Imagine that there are a large number of empty water glasses sitting on your desk. Each glass is labeled with a different year - 2007, 2008, 2009, etc. You have a large pitcher of water which represents your total income over your whole life. You pour water into each yearly glass representing when the income is recognized by the IRS. The size of each glass represents the amount of money you can earn that year before you start actually paying taxes at all (or alternatively, before you are in a higher tax bracket). The glasses are all different sizes because some years you have more deductions and credits than others. When you pour more water into a glass than it holds, the water spills onto the table, representing taxes you had to pay.

Your task is straightforward: Empty as much water from the pitcher into the glasses without spilling any on the table. (Translation: Time as much income as possible into lower brackets and against available deductions and credits without paying the higher rates.) As you visualize it, the idea should become clear: Never leave any glass unfilled if you can avoid it!

Unfortunately, income is usually not so easy to time because the general rule is that tax is due in the year that you worked for the income. For example, you can't simply wait until next year to cash your paycheck and defer the income that way. You also can't defer income by asking your employer to pay you next January for the work you did today. IRA and 401(k) plans are actually one of the few options that common workers have to legally shift the timing of when your income is taxed.

By making a pretax contribution to a 401(k) or IRA, you are choosing to pay taxes on the contribution when you later withdraw the money. By making a post-tax contribution to a Roth 401(k) or Roth IRA, you are choosing to pay taxes on the contribution now, in exchange for not paying any taxes on the future investment earnings of that contribution (so long as it stays in the account according to certain rules).

The general timing approach that a lot of people seem to take is to try to always defer whatever taxes they can. Intuitively this sounds appealing because you can pay later. However, this is not always the best idea. If you are in a higher bracket later, you could wind up paying more.

Conversely, you can't assume that a Roth is always the best deal either. As an extreme example, suppose you save ALL your money in Roth IRA and Roth 401(k) accounts. When you retire and start withdrawing money, you won't be taxed on any of the withdrawals, so you might think this was clearly the best choice. However, all those water glasses valued at $20K or $30K are sitting around unused. You've essentially wasted the tax credits and deductions for those years because you had no taxable income. This means you overpaid on your taxes - you could have paid less by originally contributing some to a traditional IRA or 401(k) and then withdrawing it during those retirement years that you otherwise would have had no income. In the end, your net worth would have been higher because you would end up not paying tax at contribution time (because it is deductible) and not paying taxes at withdrawal time (if your withdrawal income is fully covered by your tax deductions and credits).

This all brings us to what I consider one of the best tools for income timing: Roth IRA conversions. When you elect to make a conversion, you convert your IRA from traditional to Roth and the conversion amount is considered taxable in the year in which you make the conversion. Compared to the rest of the tax code, conversions are extraordinarily flexible, since you essentially get to pick the year you want the income to be taxed.

So what does all this mean to early retirees? It means a lot! The typical early retiree has a lot of flexibility and is probably more likely than average to:

Have accumulated a significant amount of tax deferred income (which can probably be timed with conversions)
Have accumulated a significant amount of money in taxable accounts (which can even out any cash flow issues with the conversions)
Own a home (which generates property tax deductions)
Potentially still have children living at home (which generates child credits)
Consider moving (to/from states with higher or lower tax rates)
Work for brief periods of time (i.e. second career, entrepreneurship, etc)
Have considerable flexibility and discretion with cash flow

An early retiree has a lot of years left to exploit conversions to minimize overall taxes. Each individual situation will be different, but here are a couple of scenarios that are likely to be common:

Lots of deductions. We own a house and have children. We also make substantial charitable contributions. Thus, we have a lot of deductions and credits. I calculate that we would pay no taxes at all on roughly the first $40,000 of income each year. After I stop working, this means it would be possible to very gradually convert all my 401(k) and IRA accounts to Roth by converting $40K each year. I might not end up paying any tax on all that income I saved in retirement accounts during my working years.
Moving to another state. If you've already decided you are going to make a conversion and you're also planning on moving to another state, then performing the conversion while you are in the lower tax state could save you a lot on state income taxes. For example, if you live in New York and are planning on moving to Florida, you would pay a hefty New York state income tax if you converted before you moved. If you waited until after the move, you wouldn't pay anything in state income taxes. (Florida has no state income tax.)
Working again for a brief time. If you decide to go back to work for a year, that would probably not be the best time for the conversion. In other words, if you're planning on not working the next year, waiting until next year for the conversion would likely make more sense.
Going back to school. If you are going back to school for a few years before starting a second career, you are likely to have no income for several years, followed by a lot of income again from your second pursuit. Don't let those empty water glasses go to waste during your school years! You might be able to convert tens of thousands of dollars each year without paying anything because your conversion income will be entirely offset by deductions and credits.
A severe market downturn. This idea is probably more controversial, but it could be useful in some limited circumstances. I don't advocate jumping in and out of the market, but attempting to time a Roth IRA conversion to the bottom of a market cycle is less dangerous than general market timing because you don't have to buy or sell anything - you just choose the tax year. The idea here is that if your IRA goes down sharply in a general downturn, you could benefit from converting when the amount is low and then letting it rise back up with the market tax-free in a Roth account. During the market meltdown of 2001-2002, I actually converted one of my IRA accounts that contained nothing but the Vanguard European Stock Index fund. (I balance my portfolio across all accounts.) I converted when the value was temporarily depressed and never sold anything. I paid far less in taxes than what I would have to pay now to convert, as the index has more than doubled since then.

Stranger Than Fiction

2007-06-22T07:34:00.000-04:00

"It is strange - but true; for truth is always strange
Stranger than fiction; if it could be told"

- Lord Byron, Don Juan

I was browsing the children's section of my local Barnes and Noble yesterday when I noticed a young girl walking up and down the aisles, pulling books here and there from the shelves and putting them into a large basket. She looked like she was about nine or ten years old, so it seemed a little bit odd for her to be organizing the shelves, but I figured perhaps her parents worked there and she was assisting them.

After selecting a children's storybook to be used as a gift, I headed over to the personal finance and investing section and lamented the many, many books giving out very dubious advice. At last it was time for me to leave and I headed to the checkout counter. Directly in front of me in line was the shelving girl with her basket, and standing next to her was her mother and her two siblings, one older and one younger. Each child had a basket with about 25 or 30 books in it. I was confused at first, but then all of a sudden it came to me: They are going to buy all those books!

As you can imagine, there was quite a wait as the clerk rang up about 80 books. And interesting enough, no one in the family acted like the purchase was in any way unusual, so I can only assume that such shopping binges are common for them. When it was finally my turn, I remarked to the clerk that the previous customer sure bought a LOT of books, and she replied under her breath, "Yes, more than seven hundred dollars!"

Now I think it is great that they like books, but is it really necessary to spend $700 on children's books each time you go to the bookstore? This is insane. We have a very fine public library system where nearly all of those books could have been borrowed at no cost for up to 12 weeks at a time. Alternatively, there were many comfortable sofas and chairs in the store - the family could have simply read the books at the store. It wasn't even clear that the girl had given much thought to her selections, as she had been picking up books left and right and just glancing at them for a few seconds before putting them in the basket. (That's why I assumed she was pulling out books that were out of order on the shelves!)

Maybe this family is obscenely wealthy and costs simply do not matter to them at all. Fair enough. Still, it might not be a bad idea to teach the kids a little self-control as they are growing up.

1987 Ford R.I.P.

2007-06-20T00:50:00.000-04:00

"A hundred years from now it will not matter what my bank account was, the sort of house I lived in, or the kind of car I drove. But the world may be different because I was important in the life of a child."

- Dr. Forest E. Witcraft, Within My Power

I junked my commuting car recently. I bought the car for $3,250 when it was already 10 years old, and I drove it for 10 more years. That one car saved me a lot of money for a long time.

My co-workers thought I was crazy for driving a "bomb". My relatives said I should have sold it long ago to a poor, starving college student. And considering the status of the paint job at the very end, I'm sure the neighbors were quite happy to see it go as well. My children, however, cried and cried as the tow truck drove away.

Small children are not so impressed by gloss and style and status. They saw only only thing: fun memories of traveling and being together in that car. Many people spend their whole life never really understanding things that are obvious to preschool children...