Category: Invest

What Should I Include in My Net Worth?

Your Net Worth is all of your Assets minus your Liabilities. In other words, all your money + equity – your debts. The Net Worth value is important to track, even if just once a quarter, to make sure you are building wealth. A doctor making $300k/yr could have a low Net Worth if they spend 99% of their income; whereas a teacher could have a higher Net Worth than that doctor if they save $10k over the year. Your Net Worth quantifies how well you are converting your income into wealth, as opposed to luxuries that have no value after they are used. For many, equity from the home they live in is a large chunk of their Net Worth. This isn’t bad, per se, but it means only a smaller portion of your Net Worth is being productive (i.e. earning interest).

Here is what to include in your Net Worth with examples:

Cash – The balances in your Savings + Checking accounts that aren’t already spent, Cash in a safe or safety deposit box (or under your mattress), savings in your HSA or FSA, money owed you that you realistically expect to receive soon, etc

Subtract Debt – Credit Card balances, auto loans, and other lines of credit

Investments – Retirement accounts (401k, 403b, 457b, 529, IRA, etc), investments in your HSA, brokerage accounts, Robin Hood, WeBull, peer-to-peer lending

Real Estate, minus any mortgages or loans – Take a fair appraisal and subtract your mortgage balance. Zillow may or may not give you a realistic value. You could compare estimates from Zillow, Redfin, and ReMax to get in the ballpark. Personally, since we have only owned our home for a few years and want to be conservative, we’re using the last official appraisal. Not required, but do be conservative and honest here. We also don’t update this value but maybe once a year or two as we want to see the organic growth of our Net Worth from frequent saving and investing, not frequent “artificial” increases from our home value jumping around.

Precious Metals – This shouldn’t be a huge chunk of your portfolio, but some is usually good. Gold and Silver aren’t the best investment nor even the best hedge against inflation, but it’s part of not keeping all your eggs in one basket. There are times when gold is worth it’s weight in, well… gold. For example, some Jews fleeing Nazi Germany sewed gold coins into their clothes knowing they could restart their lives elsewhere (rather than having German Marks in say Japan or Argentina).

? Vehicles – IF using conservative values and mostly offseting loans, in our opinion. To be honest, the only reason we included our vehicles’ value in our Net Worth is because Personal Capital automatically added the loans (update: when we had the loans, but they are paid off now). Because vehicles decrease in value each year and we only buy reasonable ones (currently <$10k) we actually need, we wouldn’t sell them unless we were destitute because they get us to and from work and family. When a car loan was in Personal Capital, we added a manual asset offsetting the loan. This manual asset was always less than the actual value of the vehicle. In our opinion, the Net Worth should be about growing your passive investments and overall wealth; not having expensive luxuries that decrease in value but look valuable on paper. Would you rather have $200k “equity” in a super car or $200k in a 401k? Unless your net worth is >$2-5 million depending on your other lifestyle choices, the 401k is the correct answer.

Financial Status Update – Jul 2020

Oh my, what a crazy 2020 so far. Not that 2019 or especially 2018 were tame, but COVID-19 and a rolling global shut-down knocked everyone back. Add-in a whole host of smaller events like Tropical Storm Isaiah hitting the East coast, historic flooding in China starting to affect some supply and industry, Kobe Bryant dying in a helicopter crash, etc…

But 2020 hasn’t been a bummer year for our Net Worth! We paid off our second/final auto loan and committed to maxing out our retirement accounts at of the beginning of the year, before Coronavirus hit. We continued steadily saving through it all, even though I was furloughed for a few weeks. I had made myself extremely useful in a number of roles; not quite irreplaceable but close. This limited the number of weeks I had to take off unpaid compared to others. Continuing to buy during the massive 30% dip (3/19/20 below) meant that we saw great returns on the way up. We didn’t Dollar Cost Average per se (http://prudentcoin.com/dollar-cost-averaging-is-timing-the-market/), but invested like normal as soon as we had the cash.

There were two financial moves we made but wouldn’t necessarily recommend, but happened none-the-less:

First, we changed my 401k plan’s allocation; it had been in a Target Date Retirement plan with 70% stocks and 30% bonds. We had been fearful of a market crash and it better fit our risk profile. After a near 30% market drop, but knowing it could drop even further, we decided to re-balance to a 90/10 fund. This ultimately made us more money when the market rebounded as bonds hadn’t dropped quite like stocks had. However, we wouldn’t recommend as we were going against our own investment principles and actually timed the market. Sure, it worked out this time… or did it?

By being in a lower percentage of stocks for several years, we were seeing lower returns than we would have if we were 90% in stocks. So, even though our portfolio fell less in March 2020, the greater returns of the stocks over the preceding years would have been more than enough to cover the difference (blue line is 90/10 and orange is 70/30 stock/bond with Vanguard Target Date retirement funds):

Source: https://markets.ft.com/data/funds/us/compare

Our second abnormal money move was… we had money left over from a cash-out refinance on our house last fall. We had put in a lot of sweat equity, given the kitchen and frankly the whole house was nasty when we bought it 2.5 years prior. We wanted to get back to a 75% LTV so we could finish a few more needed projects, like a garage that needs a new roof, door and opener, siding, etc. We maxed out our 2020 [Roth] IRA’s plus filled up the last of our limit for 2019. We did this in March, when the market was 20-25% down from it’s previous high, as we knew it was a good value. Even if the market went lower, we were content. We hadn’t planned on this, but it was too good an opportunity to pass up.

Since our last Financial Update was in December of 2018, let’s cover 2019 with a chart too. The major bump in the Fall was our cash influx and adjustment of our home’s value from the refinance and new appraisal. While that certainly was very nice, the major takeaway should be the steady growth from consistent contributions and staying in the market throughout the entire year.

2019 was a year of slow and steady growth, but it is exciting to see that in 2020, even with the crazy times, compound interest really becomes exponential as the balance adds up. But that doesn’t happen unless you make sacrifices on the front end. In 2020, we are saving ~50% of income + in our 9th year of delaying gratification and busting rear working 80+ hours a week. That’s what it takes to see this kind of growth after 5+ years into our FI journey. Our stretch goal this year was to hit a $320k net worth, and we are surprisingly on track to even surpass that. We will see!

We are not saying we’ve made it, but so excited how far we come after the sacrifices we’ve made. Please go back and read our updates and mindset from several years ago. As our net worth grows, it might be hard to relate if you are just starting out. But read our 2016 posts, especially: http://prudentcoin.com/being-frustrated-with-where-you-are-at-financially/ There is light at the end of the tunnel. For us, a solid Financial Independence (FI) is still 10 years out, but we have some FU money now. Start with the basics: save and invest, then save and invest more…

Dollar Cost Averaging is Timing the Market!

There is a common misconception about Dollar Cost Averaging (DCA). Let’s say you’re paid twice a month, and on each payday you regularly contribute to your retirement accounts. “I’m dollar cost averaging!” you might say. No, you’re not. You are doing something even better! Investing as soon as you have the money and maximizing time in the market with compounding over decades because no one can guess the future. See The Market goes UP and DOWN.

Dollar Cost Averaging implies you are choosing when to invest the money you already have.

Let’s say you saved $2,000 over 3 months in a savings account…

  • Option A: The stock market dips for three days straight and you buy! You are timing the market. Only hindsight is 20/20; you’re betting it was actually a good time to buy.
  • Option B: You keep the cash in savings because “the market is over-priced”. Again, you’re timing the market.
  • Option C: You’ve been studying the market for those 3 months and you are sure which stock is under-valued. Confident in your answer [but having absolutely no idea what will actually happen], you click “Trade”. You are timing the market.
  • Option D: You Dollar Cost Average by buying $500 worth of stock a week for the next 4 weeks. Or should it be $250/wk over 8 weeks? Or… It’s the reasonable option, right? Right? Again, you are timing the market. You are smoothing out the volatility, sure, but will have lower or higher returns based purely on happen-chance.

Exploring “Option D: Dollar Cost Averaging” further… Let’s say stock prices plummet starting on week 3 of your averaged stock purchases. You’ll be ecstatic you waited to buy at least some of your shares. What if instead of a recession, stock prices soar week after week after week? You’ll be kicking yourself for not buying all your stocks when prices were low. What if stock prices stay flat? No harm, no foul.

No matter which stock market scenario, you were guessing. Dollar Cost Averaging could have made you money, lost you money, or not mattered at all. All you did was average your volatility; any return potential was pure guessing!

Have some made money actively trading? Yes.

Has anyone consistently beat the overall market, such as the S&P 500 index, for 2+ decades straight? Only a handful like Warren Buffet. And no disrespect to the legend, but besides his hard work and acumen, there are always outliers in statistics for even improbable or uncontrollable factors. Could someone flip heads 50 times in a row. Absolutely! Very unlikely, but entirely probable. There is a reason Warren Buffet advises index fund investing. The returns you would have seen from passive index fund investing over Buffet’s career would have made you a millionaire many times over anyways.

Instead of Dollar Cost Averaging, focus on…

  • Spending much less than you earn
  • Hustling to increase your income
  • Increasing your savings rate
  • Passively investing in US index funds

This combination has historically proven to be an exponential creator of wealth, no matter your starting point or career path. And there are no clear shifts in the market proving it still isn’t. After all, we’ve seen incredible market crashes over the past 75+ years and each time the economy in general, and businesses in particular, come back.

Of course, if you are a business owner, there is the potential that re-investing in your business provides the greatest returns. But it is also placing all your eggs in one basket. Eventually you should diversify in the stock market, real estate not associated with your primary income, etc.

FIRE Options: Financial Independence Retire Early

FIRE, or Financial Independence Retire Early, is for those who don’t believe they will be employable for a full 45+ years or they won’t want to be. And to be honest, the most important part is the “FI”. Financial Independence is empowering, no matter what age, lifestyle, or income. JL Collins describes it as “F*!# You” money on his blog. And you don’t even have to be full FI to see the benefits. Your ability to say yes or no won’t come from a position of fear of losing your job or missing the next promotion, but one of “I don’t need you like all your other employees do”. And in a twist of fate, that will likely give you more options than them.

I won’t belabor the “How” as many have already covered this topic. Search “Trinity Study” and “3.5 to 4% Safe Withdrawal Rate” for more. Let’s focus on the “What” and “Why”.

None of these terms or definitions are my own, merely boiling down some of the FIRE acronyms for simple understanding…

FIRE

FI or Financial Independence: Have enough money invested where your passive income (no work other than occasionally re-balancing or meeting with advisors/agents) can completely cover your current and future lifestyle. Often earned through giving your all at a 40-60-80+ hr/week job for 10-15 years until you completely reach your financial goals, then working, or not, on your own terms. For many, this is $40-60k/yr of indefinite income from $1-1.5 million in investments.

Note: Owning rental property can lead to FI, but for many landlords, it’s a very active endeavor managing tenants and repairing/maintaining the property. So although you have the money/income, you technically aren’t FI because if you stop working, so will your income. Transferring the operation of your business, rental homes or otherwise, to managers and becoming an absentee owner may be all that is required, given you have enough business income to offset their fees and still afford your lifestyle.

RE or Retire Early: I mentioned earlier that Financial Independence is the most important goal. If you want, you can keep working, or find another gig with less hours or more meaningful work, or you can quit working altogether. The choice is yours. But don’t excuse not saving and investing because you cannot see yourself quit working before 65 years old.

PROS:

  • Enjoy full retirement and FI earlier than any almost anyone else and for 50+ years
  • Once you’re done working, you are done! No more levels of bosses, pointless meetings, endless policies and procedures, poor health and wellness, etc

CONS:

  • 10-15 years of work that will almost certainly burn you out
  • You may have to move from the HCoL area when you have earned FIRE, away from your existing social circles and old haunts
  • You missed out on enjoying your 20’s and some of your 30’s

Lean FIRE

You will be eating lean and living simple with Lean Fire. For many, this is about ~$750k of investable assets generating $30k or so per year. The dollar amount varies, but most in this camp expect to need between $2k to $3k/mo to maintain a low cost of living indefinitely.

PROS:

  • Reach FIRE earlier, because you have to save less
  • Enjoy your 30’s, and maybe even some of your 20’s
  • You’re going to move to a low cost of living area, maybe even internationally, so why would you slave away for more years than absolutely required?

CONS:

  • Stuck with a lower middle class income for the rest of your life, regardless of future goals or surprise medical expenses
  • No fudge factor
  • Have to re-enter the workforce when you are much older and your skills are rusty if you eventually want a better lifestyle (see Barista FIRE)

Fat FIRE

You’ll have enough to live fairly well in a high cost of living area (HCoL) like New York City or SoCal, or live like royalty in a low cost of living area (LCoL). Many need $100k/yr and $2.5 million invested at a minimum to live like this indefinitely.

PROS:

  • You will live like a king or queen enjoying a luxury vacation all day everyday, as long as it isn’t ridiculous
  • Your social circle, family, and favorite places are all in expensive areas
  • Leave a large inheritance to your adult children and even grandchildren

CONS:

  • Your working career will likely span 15-20+ years in a high-stress, but high-paying job
  • What if you only want to live with excess for a few years, then you delight in simpler things? You would have worked for 5-10 years longer than you needed to, maybe even missing out on your 40’s.

Barista FIRE

Similar to Lean FIRE, where you NEED to draw from your investments when you leave full-time work, but also MUST immediately pick up a part-time, lower-paying job or gig for additional income to offset a better lifestyle and perhaps provide some benefits/discounts. You could have reached Lean FIRE with your investments and the additional income takes you to full FIRE, or require the additional job to reach even Lean FIRE.

PROS:

  • Reach almost-FIRE fairly quickly, as you might only need $500k saved and invested
  • Barista-type jobs can be in pleasant places all over the world, where you might want to retire and plug into a local community anyways

CONS:

  • The grass isn’t always greener: You’re probably glorifying a low-paying job from the cubicle or corner office of your high-paying job. Similar-enough boss, a schedule to follow, lower pay and you are burning your hands in hot water while washing dishes and dealing with impossible customers.
  • What if you don’t want to work anymore, or can’t, or have surprise medical bills with no insurance?

Coast FIRE

With Barista FIRE, you’re “retired” but you MUST work?! With Coast Fire, cut back how much you save while keeping the same or similar job, or something completely different that still pays the bills. But you don’t have to save anymore nor will you withdraw from your investments until much later in life. You’re working to pay for your current lifestyle, letting your nest egg compound in the background. At Coast FIRE, you’ve saved enough in your nest egg, if left to compound until you reach your desired retirement age, you will have enough money to fully retire without contributing a single cent more (if your calculations are correct). And you’ll have a better lifestyle for the second half of your working career since you are saving less, or nothing, for retirement once you reach your Coast FIRE number.

PROS:

  • Better lifestyle in your 30’s, if you saved up enough in your 20’s to start coasting
  • Many people prefer to stay employed, but in a less stressful and/or only 40 hours per week job (or less). Provides health insurance, travel perks, sense of purpose, decent lifestyle, etc.

CONS:

  • Be cautious of completely stopping all saving for retirement before reaching FIRE. Continue to contribute up to your employer match or maxing an IRA each year, at a minimum. When your coasting period is 15-20 years or less, there is a statistical 10-30% chance the 7-8% returns after inflation may not happen. The safer bet: decrease your savings rate from 50%+ down to 15%, so you can still inflate your lifestyle considerably while also building a safety net.

The advantage of Coast FI is access to more money, time, and a better Quality of Life at an earlier age. The tradeoff of Coast FI is a smaller retirement nest egg or retirement at a later age.

Flamingo FIRE

We recently discovered this term by an Aussie blog based on the same name, and we really like it. In fact, it is a really good way to view our own plan! In a nutshell, use your after-inflation return and calculate how many years for your portfolio to double. If it’s the historical stock market return of 7%, then your portfolio will likely double in 10 years. When your investment portfolio is 50% of your FIRE number, Coast FIRE for that many more years while your portfolio doubles in the background. And then do whatever you want! Like Coast FIRE, Flamingo FIRE lets you sample semi-retirement, easier work, or however you want to cover your current living expenses. Since many don’t/can’t quit all work cold turkey, and will likely get bored and pick up a income-producing hobby at some point, it’s a good way to step down your work.

PROS:

  • See Coast FIRE pros, but likely fewer years of working/Coasting

CONS:

  • Not many, but see the Coast FIRE cons

MISC

  • BalloonFI – Inflate your lifestyle (balloon) to match your safe withdrawal rate
  • LifestyleFI – Adjust your lifestyle to your net worth

Our Plan

Short Story: A mix between FIRE, Coast FIRE, Flamingo FIRE, and Fat FIRE.

Long Story: Between the Great Recession and taking a long time to discover a career then building skills and experience to earn >$40k/yr, earning a college degree while working 2 jobs and 70+ hours per week, plus several children who will graduate high school before we could reach full FI… We have decided to pursue FIRE as best as we can, then probably a Coasting Fat FIRE depending on how things go. For us, the current goal is saving $50k/yr and investing it mostly in a Total Stock Market index fund.

Because no one knows the future or what the job market will be in 15, 10, or even 5 years, we want to reach Lean FIRE and then full FIRE as soon as possible (~40-43 yrs old). But we also want to travel and spend time with our kids before they leave the house; so we are doing those things on a budget focusing on experiences rather than luxury vacations. Think road trips and staying with family near natural beauty.

Once we reach FIRE, likely after our oldest two kids leave the house, we will work fewer hours (just 40 hrs a week sound nice) and either continue to save 50% of our income to reach true Fat FIRE by age 50 or drop our savings rate to 10-20% and increase our travel budget. …and retire when we want to. Either way, our goal is to enjoy FI with our older teen/young adult children, and hopefully eventual grandchildren.

Dividend Growth Investing, and why you shouldn’t

Who wouldn’t want a steady stream of income, whether the stock market is up or down? Who wouldn’t want a sure thing, when others are scared about stagnant returns this year?

The Answer: This golden goose doesn’t exist.

What is Dividend Growth Investing?

  • Investing only in companies that pay Dividends (i.e. annual/semi-annual distributions to its investors) and will slowly grow with the economy.
  • Most dividend-paying companies are mature, being some of the largest companies in their market segment. Think AT&T, ADP, The Coca-Cola Co., Chevron Corp, etc. They will still grow, but slowly with the greater economy since they already have such a large market share. While some of their profits are reinvested, the profits they cannot use wisely are distributed as dividends to shareholders.
  • Dividend Aristocrats are the best of the best, some of the biggest companies in the USA increasing their dividends for over 25 years straight.

The problem is…

…Dividend Growth Investing stocks have the same risks as other stocks. Remember, stocks are part-ownership of a company vying for market share in a changing economy. They can and do see negative stock returns or even fail, just like non-dividend paying companies.

  • 2008-2009, 2020- : Dividends can and will be reduced or suspended. But only during bad economic times, not when the sun is shining. If you need the income, you now have to sell likely strong companies when their stock is down 30%.
  • Cash: We should all have some cash to weather the storms, dividends stocks or no. Shouldn’t the rest of your portfolio be invested broadly in stocks with higher returns? You can and should control the volatility and a buffer with your cash/stock/bond percentages.
  • Tax Liability: Uncle Sam always gets his due. With dividends, you take what you’re given and cannot control your tax liability. With stock sales, you are in control of what year you will be taxed in and at what rate. And what if you don’t need the income and want to re-invest?
  • Smoother Ride with LOWER long-term Returns: There is no free lunch. By investing in more established companies with less growth potential, you are borrowing from your returns in 20-40 years for some cash now.
  • Retirement Accounts: Some of these negatives are reduced by holding your investments in a 401k, IRA, or other retirement account. But then, you are investing for decades from now instead of immediate income, so what benefit would dividend stocks have?

In a horrible economic climate, stocks and dividends will fall and you would have to sell at a loss if you need cash now.

And if times are good, other stocks will have higher returns.

So a dividend stock is mainly useful during poor, but not bad, economic times. I don’t know about you, but my crystal ball isn’t all that clear. You would either have to hold onto Dividend stocks during great times, seeing lower overall returns, or buy the Dividend stocks during poor times, when they are already priced as desirable stocks to own.

So What Should I Do?

When companies have net income, they have a finite set of options. A CEO, CFO, and Board will spend that cash on whatever gives the best return.

  • Re-invest in the business and its products to grow further
  • Pay off debt and/or buy back shares
  • Hold cash to buy deals when they become available and weather economic storms
  • And if there is no better use, distribute cash via dividends to investors

Ultimately, you want to invest in companies who have found and can capitalize on further growth, instead of companies that have climaxed, given the investment risk is essentially the same.

The good news is you don’t have to choose to invest in Dividend Stocks or not. Buy a S&P 500 index fund, or better yet, Total Stock Market index fund such as VTSAX. You will own some dividend-paying stocks by default, but have greater control over your tax liability, re-investment plan, and ultimately see greater returns long-term.

  • The S&P 500 has an average dividend yield of roughly 2%
  • VTSAX is around 2% but has been much lower
  • For comparison, the best Dividend Growth stocks are in the 3-5% range