Live Below Your Means

One common bit of personal financial advice is to “live below your means.” But what does that mean exactly? And why? I mean, why is it smart to live below your means?

And, besides that issue with the common wisdom that dictates that you strive to live below your means, is the fact that the meaning of the word “below” is objective and subjective at the same time. Below has an objective meaning, certainly. So, living below your means would imply that, in keeping with the wisdom of living below your means, you spend less than earn.

Can we stop there? Is that as much direction as you need? Will spending one dollar less than you earn every month lead to your accumulating wealth? No it will not.

The words are hollow, really. And do not mean all that much or are all that helpful.

So, yes, you should plan to spend less than you earn. Now you must move on and put a number to it. But, remember, a goal is something of a destination and when it comes to saving money, the first goal is to save ten percent of your gross income.

There is, however, nothing magical about that ten-percent figure other than it has the power of all goals to direct your actions—and that is powerful stuff, indeed!

Ten percent is an objective number and, for the purpose of goal-setting, works much better than simply intending to live below your means.

And, then, you need to frame the goal, itself, within the context of time. An example would be as follows: Save ten percent of my gross income every month.

But when it comes to saving money, ten percent is really only be a good first step but ten percent is not really enough for a whole host of reasons. For one thing, if you are spending 90% of your income, you are living way (way!!) too close to the financial edge. It is simply more prudent to back away from the precipice in a deliberate fashion.

How do you do that?

I recommend a three-front strategy to those I coach in this regard:

Step One: Cut spending and add the amount you reduce to your savings. The thing is, you can only cut so much.

Step Two: Earn more. Yes, this will usually mean working more hours or a second job but it is often the surest and quickest way to build a nest-egg.

Why is it important to build a nest-egg; that is, why is it so important to have a ready-reserve of cash savings? To answer that question, let me begin by asking you a question:

Are you broke?

I define “broke” as having no savings and being broke is a serious financial issue.

You see, when you do have some savings, this will be were we turn to cover expenses for which we failed to plan adequately. If you are broke, that is, if you have no savings, what do you do when one (or more!) of those expenses pops up in any given month?

Well, sometimes, it is possible to rob Peter to pay Paul. And what I mean by that is that we let some other bill go unpaid but I am sure you can see how that strategy can quickly cascade to cause several other financial issues.

So what most of us do instead of robbing Peter is that we resort to borrowing the money in one form or another. It used to be we would turn to credit cards but now many of us are maxed-out on that count and what is left are car title and payday loans.

If you find yourself resorting to any of those contingencies, you are in immediate need of professional help to get your personal finances in order. Growing credit debt or, worse still, title or payday loans, are sure signs that your financial ship is sinking.

And the last step is my strategy to grow your savings is to save more from now on. I will cover a strategy to do that in a later post or you can read my book, The Debt Whisperer to read the plan in more detail now.

Through the Looking Glass and the Eye of the Needle Both

People say it all the time…heck…ask a kid in high school and they will say it...the truth is, we all say it…“I want to be rich!”

But what does that mean…exactly?

I mean what is “rich?”

It is not a bad practice to consider your dreams; there is nothing wrong with day-dreaming, per se. An issue can arise, however, when we take those thoughts to the next level and verbalize them; especially when we verbalize them to others.

When we do that, express our dreams to others, it is often the case the something gets lost in the translation. Such is the case when someone says to someone else, “I want to be rich.” Usually, what they mean to say is that they want to have a lot of money; rich being a generic term for the condition of having “lots” of money.

But, in most cases, that is not really what they want, at all. And therein lies the problem: You can’t fix a problem you haven’t identified.

People dream of being “rich” because they believe that having a lot of money would solve all their problems. It won’t. Not the big ones.

I haven’t talked to my sister in over five years. And we both have “lots” of money. The money on either side is of no use in resolving the issue that has kept us at odds all these years. And what is ironic about our situation is that the tensions arose over a money-related issue and at a time when the amount of money involved was insignificant.

Truman Capote, the writer, once said that more tears have been shed over answered prayers than unanswered prayers. I get that. Be careful what you wish for…

So, yea, dream of hitting some big lottery jackpot. Maybe dream of some distant relative dying and leaving you some huge windfall. Or simply save a little of your paycheck every month for a long time.

As it has been said—if writing a check will fix the problem, it’s not a problem. That money you put away every month will put you in a position of being able to write bigger checks and bigger problems take bigger checks.

It is entirely possible to be happy with a lot of money and happy with not so much money and the opposite is just as true. So money must not be the deciding factor in any of those equations. But when you dream of being rich, put a number on it, develop a plan to get you there, and then get to work on working your plan.

And by doing that, you will not only be rich someday, you will increase the odds that you will also be happy along the way.

Money Can’t Disappear but Value Can

Where does the money go when your stock loses value? Or where does the money go when your house loses value?

And the answer is no money is lost—only value except in one instance.

But before I share that one instance with you, you must understand that stock prices, like real estate prices, are estimates of value.

If you want either, and you buy it, then you have agreed to its worth (value) at the time of the transaction and you have converted your cash into equity.

If you buy a single share of stock for $10 and the price goes down to $5, you have not lost $5 of cash money unless you sell at that point.

But did the person from whom you purchased that stock for $10, does he have your $5? What if he bought the share of stock that he sold you for $10 for $15?

What if you choose not to sell when the price is down and hold onto it and the price goes up to $15 and you sell at that point? Have you lost any money and had you actually lost any when the price was at $5?

Value is not cash. That is how many of us overestimate our net worth. For example, let’s say we buy a new car for cash. We pay $30,000 for the car plus another $2,000 for the other related costs such as license and taxes.

How does that reflect on your net worth assuming you paid cash? Do you simply exchange the cash amount for the same amount as the net worth of your new car? No way! That car is worth, MAYBE, $25,000. In other words, you have lost $7,000 and your net worth after the transaction is down by that amount.

$7,000 is a lot of money to pay for that new car smell, wouldn’t you agree?

But a share of stock is accounted for differently on your balance sheet (net worth statement).

If you buy it for $50, there is a direct exchange of cash for equity on your net worth statement. And whether the value of the share goes up or down, it can reside there for the same $50. It is only when you sell it and bank the money will a profit or loss actually be realized.

The reason that many people lost real money during the housing crash of 2008 is that they decided to sell (or were forced to sell or foreclosed on) when the value of the market was down. If they had been able to hold on for just five years the value of the property would have recovered and they would have avoided the loss of actual cash money (vs value).

Losses in value are apparitions only real if you make them so: Only when you have to deplete the store of value by selling the asset will you actually incur an actual loss.

Don’t Bank on Stocks

Wall Street does not exist to make you rich, it exists to make Wall Street rich.

Jeremy Siegel is the author of the book, Stocks for the Long Run. In that book he claims that the best strategy for most investors is to simply buy and hold stocks for the long term. The foundation of this plan is to never sell stocks until you reach retirement age and you need the money from the sale of assets to support your lifestyle.

In that book, he also claims that you can expect to average annual returns of six-percent by following his strategy.

But since publishing that book in 1994, the author has recognized the fly in his ointment—namely that as Boomers begin to retire in large numbers, there might well not be enough buyers as they begin to flood the market with their equities. Do you recognize the market dilemma personified in that last statement?

What happens when supply exceeds demand?

And the author, himself, has expressed the following:

…in the developed world share prices could fall by as much as 40-50% over the coming decades because of boomer selling [and]…unless they retire later, baby-boomers could see their standard of living in retirement halved, relative to their final year of work.

But where is the real issue in all the information just presented? Sure, the looming prospect of a flooded stock market and prices slashed by one-half are reasons for concern but the real is issue are those six-percent returns he touts in support of his claims.

Are the problem is best clarified by The Rule of Seventy-Two:

The Rule of 72 is simply an easy way to determine the length of time it will take for an investment to double at a given rate of return. To arrive at the answer, you simply divide the number 72 by the given return expressed as a whole number.

How long will it take, then, for your money to double, when your return is the six-percent that has Mr. Siegel so excited?

72/6 = 12

Meanwhile, the rent dividend provided someone who lives in their own house, whether mortgaged or owned outright, is more like 12%!

If the author is promoting his strategy based on returns, why would he ever propose stock equity over home equity?

And the answer is...well, I don’t know...he shouldn’t and, if you had a choice, which would you choose, a six-percent return or a twelve-percent return?

Stock market promoters, re: hucksters, mostly, crack me up. But don’t laugh; if you play their game, it’s your money that keeps them in yachts, penthouses, and private jets!

And, you probably are—playing their game I mean. And whether you hold individual stocks or not, if you have a 401(k), the odds are you are invested in the stock market.

And the real problem with stocks is that, unless you hold a vast quantity of stocks that pay dividends, you cannot extract their value without selling out. Do you see the problem with that as it relates to what Mr. Siegel stated?

You could well be in the position of needing to liquidate your stocks at exactly the worst time in history to do so!

On the other hand, you do not need to sell your home in order to realize the rent dividend it pays you.