5
Goal-Based Investing
The last component of the Master Budget is the prioritization of your goals. Why? Because once you prioritize your goals, your actions, as outlined in the Cash Flow section of your Master Budget, should follow.
Where your money is directed should mirror the goals that you have listed in your Master Budget in order of priority. As a goal is met, you can update your budget to move up whatever is next in line so that goal gets top priority and your top dollars. Sounds easy, doesn’t it?
Different people will define investments in different ways. No matter how you cut it, an investment is a placement of your dollars that over time ends in a profit or material result. You should make money from your investments! Let no man or woman persuade you into thinking that that is not the case. The trajectory of how you make that money will be based on risk tolerance for that investment. Still, the purpose of an investment is always for you to win in the end.
The problem lies with the general public’s narrow perspective of what an investment is. Gains and profits, though great when actual greenbacks land in your hand, are not the only way someone can make money on an investment or get closer to their goals. By assessing the eight common goals of Master Wealth-Builders—retirement, home purchase, education savings, cash flow management, investment management, debt reduction, insurance, and estate planning—you can see that most of Master Wealth-Building is not magic, but is instead the product of math (and time). The only magic that is involved lies in your consistency, resilience, and ability to see yourself at the finish line while working like you’re at the starting line.
Home Purchase Goal
The purchase of a first home for many young professionals is an “I’ve arrived” moment. This step signifies true adulthood, the payoff for hard work, and achievement of the American Dream. But you should understand that there are multiple moving parts that come into play when you buy your first home, including qualification for a mortgage loan, determining the amount you can put toward a down payment, the potential need for property mortgage insurance, and tax liabilities. This is just the short list before you even take a look at your potential house! When we get to the math, you’ll see that how you’ve been saving may or may not be the best way to go about the purchase of your first home.
First things first: Your savings account alone won’t do it. In fact, your savings account could be detrimental to your home purchase goal, simply based on a little principle called inflation. For the last three decades, America has experienced falls in interest rates to historic lows. This means that the same savings account you have now—the one that pays you the half of a percent that you’re so excited about—used to pay upwards of 3 percent. Meanwhile, the costs of goods and services are continuing to increase over time, with inflation running at about a 3 percent increase annually. What this means is that your savings account that is “earning” you 0.5 percent annually is actually losing you 2.5 percent by not keeping up with or exceeding the 3 percent inflation rate that raises the cost of the things you enjoy year after year. Yeah, you’re robbing yourself !
So what do I do, you ask? You begin with clear details about the home of your dreams: its price, your down payment, and when you want to buy it. After you figure this out, it’s nothing but math. You’ll need three or four critical components to do the calculations for yourself: how much you have, a realistic expectation of how much you’ll make from investing, a time horizon or deadline for your home purchase, and how much you will contribute on a defined schedule to this goal. With this information, you’ll be able to calculate how much of a down payment you can afford and change the number of years or rate of return based on the probability of this happening. The only “magic” needed is your ability to invest with a detailed long-term goal in mind. (For more on mastering real estate, go to chapter 6.)
Cash-Flow Management Goals
If budgeting and goals-based investing were sports, your cash-flow statement would be your film study. Most athletes monitor their performance and correct their flaws by watching themselves on film. Here they can see all the minute details of the movements that they need to improve to get closer to their goals. In the same way, studying your cash flow will show you all the minute details of how to improve your spending to bring you closer to your financial goals. There’s no magic bullet to meeting cash-flow management goals. It’s clear and simple: You have a responsibility to cut or reallocate your expenses in order to be cash-flow positive and to meet your goals in the order that you have prioritized them. This is on you, and if your cash-flow statement doesn’t reflect those priorities, periodic evaluation of your Master Budget will continue to sound the alarm.
Positive cash flow is not about how much money you make. Whether you think you make a lot or a little, being a good steward of your money is the key to living well and being able to handle more of it. Look at your life and ask yourself what goods or services you are paying for that you can make or do for yourself or get for free. Saving money in a few small areas can lead to big rewards. Here are a few examples of how to cut back:
Live with your parents. One of the biggest expenses for a Master Wealth-Builder in his roaring twenties stems from his desire to be fully independent. Living on your own, paying your own bills, and having the freedom to do what you want are the hallmarks of adulthood. But according to a study by the Pew Research Center, more than 36 percent of Millennials from ages eighteen to thirty-six live at home with their parents. Although a number of factors often force young adults to live at home, there are many reasons that staying at home may be a good option. The biggest one is the amount of cash you can save versus renting an apartment.
Rent cheap. Of course, not everyone has the luxury of living at home. If you must rent, rent cheap. Renting can be a good solution if you work far away from your parents’ home or need a place to live temporarily—and the best way to rent is with an end in mind. The rule of thumb is that your housing costs should be—at most—28 percent of your gross income. If you are renting, try to come under this 28 percent suggested rate if you can. You can also consider renting a room or getting a roommate to reduce your costs. By renting cheap, you can still save money, leaving room for other wealth-generation activities like transitioning into owning a property.
Skip happy hour. Being social plays a big role in our lives—but the cost of all those happy hours can quickly add up. Instead of going to happy hour to eat and drink, go strictly to socialize with colleagues and friends. If social drinking is very important to you, then make sure to cap your expenses in your Master Budget.
Make your own dinner. Eating out may be one of the biggest dampers in your Master Wealth-Building efforts. Unlike renting, which is circumstantial and necessary for some, eating out can be completely avoided. I’m not saying you should never eat out. Having a life is important, plus you’ve worked hard for your money. I just want you to consider that the money spent on meals out could also be spent on income-generating investments that will be worth much more years later than that fancy dinner is worth now. If eating out is an important social activity for you, think about inviting friends over for a fun night in.
Drive efficiently. There are many options for you to get from point A to point B that do not involve a monthly car payment. I have not owned a car for nearly three years, and I do not regret it at all. To me, a car is just another bill that takes up space on my Master Budget. By using car-share services and myriad public transportation options, my commutes have been faster and more cost-efficient. If your family circumstances require that you have a car to get to work or get your kids to school, a fuel-efficient or electric car may be the best investment. Year over year, you’ll save money on oil and gas costs, which means more income and lower outflows.
Shop for car insurance. Instead of going with a name-brand insurance carrier or the first option you run across, be sure to shop around and find a company that suits your needs within your budget for car insurance.
Make your own coffee. I love to have my coffee in the morning, and you probably do too. But grande lattes at retail prices are ridiculously marked up! If you must have a cup of joe, home-brew your coffee for pennies on the dollar compared to your favorite coffee house.
Find the deal. When financial professionals write about saving, it can easily take the fun out of life. The objective is not to make life boring, but to make life possible. By finding good deals on trips for hotels and airfare, you can enjoy the luxuries of life at a lower cost. Consider traveling during off-peak seasons when fares and other costs are much lower than during busy times.
Ditch the landline. You’re probably thinking, “Who uses landlines anymore?” and for good reason. Landlines can be useful in the event of emergencies, but your cell phone is just as effective. According to the US Bureau of Labor and Statistics in its 2015 study, American families are spending $353 a year for landlines in addition to the $963 that they spend on cell phones. The story of the landline is the story of the evolution of technology. If you can live without it, cut it off and save that money!
Get rid of cable. Your monthly cable bill is an extremely big spend. When assessing my clients’ Master Budgets, it intrigues me how much individuals pay for cable that, outside of big games and a few shows, they do not watch at all. Many people shell out $100 to $250 per month to watch television only occasionally. If you need some form of visual entertainment, streaming sites and services like HBOGo, FireStick, Netflix, and Hulu will allow you to watch movies, documentaries, and television series for a fraction of the price.
Wear a sweater. As a child, I did not dare mention to my mom that we should turn on the heater. We did not have the extra money, for starters. Second, she wanted to “fix” the utility costs. Utility bills become variable expenses when you are unable to “fix” them. Heat and air-conditioning expenses can put a dent in your pocketbook in the winter and summer, especially when you do not monitor their use. Be sure to keep tabs on the use of your heating and air conditioning. If you can keep these costs within a small range, you’ll save yourself from surprises every month.
Ditch the gym. As a former athlete, I’m a big advocate for living a healthy, active lifestyle—and there are an abundance of ways to live healthy without a monthly gym membership. If you do not use your membership as frequently as it would take to justify the cost, it may be time to ditch the gym. If you have access to a gym in your residence, or are able to do a home workout or cardio exercise around your neighborhood, you can stack dollars to invest in more worthy wealth-building efforts.
Make a grocery list. Writing a fictitious number under groceries on your Master Budget does not mean that you are going to stick to spending that amount. Successful master planning means mastering the details. Food is a necessity, but many people find themselves buying things they do not need while in the grocery store. Be sure to check your inventory before going grocery shopping and list the things that you need so that you can stay within the budget defined on your sheet. Monitor deals and use coupons to take advantage of additional savings.
Don’t follow the hype. We are professionals at confusing things that we want with things that we need. A plethora of cool gadgets and technologies are released by the world’s most popular companies every day, and it may seem that everyone has them. Focus on your own needs and reserve a small space for wants. If you do this, you’ll always have the right tools to build.
Look for opportunities. There will always be opportunities to earn, which means opportunities to save. Your job is to make sure that you’re aware of these opportunities and are not subjecting yourself to lifestyle inflation, the process of adding expenses as your income increases. The opportunities you can find to save money will generate opportunities to make your money work for you. Who wants to work forever because they have to? What brings you closer to the lifestyle you want and the prosperity you deserve will be your ability to realize the myriad small opportunities to save and invest. If you are able to do so early and often, you’ll get to your destination much quicker.
A word on emergency funds. If you don’t already have an emergency fund, regular monthly contributions to one should definitely be a line item in your cash-flow statement. People who do not take this step often get in the way of their own progress. Investments fluctuate and life happens; without a fund earmarked for unexpected costs you may be forced to reverse the course of the compound interest by taking withdrawals from an investment account. You will lose out on all the time you previously put into growing that money.
The emergency fund rules are the same everywhere: Save three to six months of your expenses in a risk-adverse, insured, liquid account. The vague part about this rule is what determines saving three months versus saving six months of your income. Here’s how I break it down: If you are a full-time single earner, lean on the side closer to three months. If you are single and working a part-time job with no assistance from parents or a significant other, you should prepare for six months. If you are married and both of you are employed, the emergency fund should be closer to three months of monthly expenses. If only one person in a couple is working, with no access to an inheritance or assistance from family, their goal should be six months of expenses saved in an emergency account. As you get older, accumulate more familial responsibilities, and acquire more assets, your emergency fund requirements should continue to increase. You will have to calculate how much you need in your fund based on your expenses and income and evaluate your access to other resources to have that amount available to you in the event of an emergency.
Last point: Your emergency fund should be housed in an FDIC-insured, low-volatility account that is liquid and relatively easy to access. Money market accounts and traditional savings account are two of the best alternatives for holding your emergency fund and are easy to set up.
Debt Reduction Goals
In addition to your employer-sponsored accounts, many personal finance books recommend that you invest in the stock market, real estate, and other opportunities. They tell you to head straight to the market if you want to grow your wealth and park your money there over the long term, and they suggest (they don’t quite promise) that down the line you’ll be rich! In many ways, this is true. Investing requires patience and consistency over a long period of time. But what’s also true is that most Americans do not have the cash flow to do any of those things, largely because their money is tied up in debt. You can’t start to build wealth if the money that you would use to do so is parked on your credit card balances and increasing as interest adds up. The way that I see it, high-interest debt is silently robbing us—and we’re letting it! It’s a trap. The best financial return that we will ever get on our money will be paying off the balances of our high-interest-rate debt.
Debt reduction might be the number one goal for most Americans. Even though we have a lot of information available to us on the topic of debt, we are still a very debt-heavy people. The numbers do not lie. According to Nerdwallet, Americans are neck-deep in debt, and not only due to lifestyle inflation. Things are just too expensive, from food to rent to healthcare, and our paychecks aren’t catching up. The average household has credit card debt of $16,425, and additional debt in the form of car loans, mortgages, and student loans totaling over $135,000. If you are a young person starting out or in the middle of your professional career, you probably know firsthand what these debt statistics mean and what that debt load feels like.
The pro side of this is that if you start early, you’ll be able to quickly knock out this debt and have plenty of time left to save and invest in things that will grow your money. The con is if you’re like most other people, you don’t even know where to start. In truth, there is no real secret to paying down debt. Most people exercise one of the two most common strategies: snowballing debt payments and paying more than the minimum.
Snowballing debt payments. This is a time-tested strategy that allows individuals with many outstanding balances to pay them simultaneously in a way that earns many small wins that yield big results. There are several ways that you can go about implementing this method. Since you’ve already done yourself the favor of listing all of your liabilities in your Master Budget, you’ll be able to look at your debt, specifically your credit cards, and assess the balance amounts and interest rates on those balances.
One way to initiate the snowball method is the balance transfer strategy. Take a long, hard look at the interest rates on all of your credit cards. There is a huge chance that the interest rates vary among your credit cards. Now reach out to the credit card provider with the lowest interest rate and ask if you are eligible for a balance transfer. If you are eligible, transfer the balance from your high-interest card to your low-interest card and then begin your routine payments. The drop in your interest rate can lead to hundreds of dollars saved.
A second approach comes into play if your balances are too big to transfer all to a single card. In this case, pay the minimum balances on all your cards except for the one with the smallest balance. Pay that one off more aggressively, hopefully with dollars that you saved from cutting out unnecessary expenses from the Cash Flow section of your Master Budget. Notch your first win by paying that card off completely, and then repeat the process with the remaining cards and the next largest balance.
Paying more than the minimum. A credit card balance of $2,000 at a 20 percent annual interest rate costs you $400 per year in interest if you’re just paying the minimum required each month. Money spent on interest is money lost. Gone. That $400 that you lost can work for you through an investment, but first your debt needs to be paid off.
Minimum payments are a mechanism to extend payments to creditors that works to convince you that you’re being responsible—while they squeeze out interest from your pocketbook for as long as possible. By paying only the minimum amount required, you are giving the creditor the advantage. But if you pay more than the minimum required each month in order to get rid of credit card debt as soon as possible, the money you save on interest becomes your rate of return. Every payment made on a high-interest credit card is a return that would be extremely difficult for you to make with average stock market performance. For example, in average market conditions, it would take multiple years for you to earn 20 percent through the investments that you hold in your accounts.
Bottom line: If you have debt, your highest-priority goal should be reducing it.
Retirement and Investment Management Goals
You’re probably asking yourself, “What is the difference between retirement and investment management goals?” That’s a good question. In retirement, you won’t have income from employment because, duh, you’ll be retired. Strategizing for your retirement requires that you know exactly what you want to do in retirement and how you’d like to live. You’ll need to calculate “your number,” that is, an amount that you’d like to save from now until the year that you plan to retire. You’ll need to know how much your retired self will be spending on a yearly basis, your tax bracket, and how much additional assistance you’ll get from the government, such as through Social Security and Medicare. Trying to figure all this out now might give you a brain freeze. But say it with me again: It’s not magic, it’s math. Like many others, I did not really like math (and sometimes still do not) until I figured out that understanding numbers could have a dramatic effect on my goals.
The quickest way to begin to plan for retirement is to put money away in addition to your employer-sponsored retirement account. Open a Roth or traditional IRA, then begin systematically investing. Dollar cost averaging is a systematic, risk-mitigating investment strategy that requires the investor to choose a frequency for investing a stated amount of money. For example, you commit to making a $100 contribution to your investment account on the fifteenth of every month. This is beneficial because it is not contingent upon timing or the state of the market, which often complicates the process. It also allows you to account for the payment in your Master Budget. Platforms like Betterment and Wealthfront have made it easy for Millennials and Gen Xers to get started on their IRAs without worrying about account minimums and wolfish financial advisors.
Investment management, to me, is reserved for the goals that are in between where you are and where you want to be in retirement. It could be savings for your child’s education, buying your first or second home, or saving up for a wedding. Regardless, you’ll have to have your numbers in order so that a trusted professional can tell you if your expectations are too lofty given the amount of money that you are working with. This is goal-based investing in its truest form, and the gains will show in the traditional manner of percentage increases. (For more on mastering investing, go to chapter 7.)
Insurance Goals
The top four ways to become rich are an inheritance, marrying wealthy, winning the lotto, and entrepreneurship. While I believe wealth consists of more than money, it is no secret that money can change the way that future wealth is built; it can increase options and opportunities and influence the ways that the next generation of Master Wealth-Builders can build upon your design. There are few things that are surer than life insurance to help your heirs continue to run the Master Wealth-Building race that you began. Whether you are starting from a firm foundation or from scratch, insurance can be a way to guarantee that whoever is following you does not start from the same place that you had to.
The two most popular types of life insurance policies are term and whole life insurance. Term insurance insures a person for a designated period of time. For example, if you purchase a thirty-year term life insurance policy at age thirty, you will be insured until age sixty. Term life policies are cheaper than whole life policies and can be much easier to understand. Unlike a term life policy, a whole life policy is permanent. These policies do not expire and cost much more than term life insurance policies. The insurance agent’s selling point is the tax-sheltered savings mechanism, called cash value, that whole life policies offer. While the policy can pay interest (usually at a very low rate), its cost often does not justify the value of the interest to be paid to the holder. Yet agents sell these products as a “win-win.” The phrase “win-win” has always been my sign to run. If those words are uttered, I’ll meet you at the exit. Another thing to note: Policies can lapse if scheduled payments are not made on time, making it important for you to consider what you can afford before choosing such a policy.
The best advice for life insurance is to shop around for policies that cover your needs and fit within your price range. At a minimum, buy term life insurance and invest the difference.
Estate Management Goals
Estate planning can be a complex ordeal. Usually it requires an attorney and lots of paperwork, and it could cost you a pretty penny. Thinking about your death is something that not many young people want to do. I bet estate planning is one of the last priorities in your Master Budget. My advice is to designate beneficiaries for all of your accounts. This way, in the event of the unthinkable, your assets will avoid the probate process and will go directly to your designated beneficiaries. If you have a family, however, consider taking it further and consulting an attorney for a will and estate plan.
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If you can sit through the rough times and be disciplined through the good times, you will increase your likelihood of building the wealth you desire early on. Because, let’s face it, the catch-up game is hard. Catching up on debt payments, retirement planning, and emergency fund savings can be done, but it’s difficult. If you start now, you will save yourself from the exhausting task of having to catch up at a later date.
Procrastination only stifles and deadens your efforts. Being young gives you one chance to avoid that painful process of catching up because you took the time to get ahead. Follow your Master Budget and the goals that you prioritized for yourself and you’ll live a life that most cannot because you took the time to do what they would not.