All About The Personal Financial Statement

All About The Personal Financial Statement

By keeping tabs on your finances, you can create a secure and fulfilling future. That’s where a personal financial statement comes in. At its core, a personal financial statement offers an overview of where you stand financially at any point in time. It can help you succeed in various aspects of your life.

Why You Need a Personal Financial Statement

There are several reasons you may want to create a personal financial statement. It can help you if you’d like to:

  • Take out a loan.
  • Apply for financial aid.
  • Make a guarantee.
  • Design a retirement, estate, college savings, or other financial plans.
  • Lease a commercial office or other types of business space.
  • Develop strategies to reduce your tax burden.
  • Run for public office.
  • Keep track of your credit.

Ideally, your personal financial statement will show that you have a positive net worth and your assets are greater than your liabilities. This can allow you to position yourself as a responsible borrower and someone who knows how to manage their money well. It may also prove that you’re thriving with your finances.

How a Personal Financial Statement Can Change Your Money Habits

A personal financial statement can be instrumental in the way you think about your money and manage it. Here’s why: When you see your net worth, you’ll realize that many of your previous and future behaviors affect that figure. It informs you of whether or not you’re on track to meet your financial goals. A high, positive net worth, for example, may mean that you’re closer to your dream of:

  • Buying a dream home or rental property.
  • Retiring early.
  • Working part-time instead of full-time so you can spend more time with your family.
  • Donating more money to a cause or organization you value.
  • Funding your children’s college.

Low or negative net worth can give you a wake-up call. It may be just what you need to change your behaviors and be more cautious with the way you spend your money. You may be more likely to get out of debt, pick up a side job, and stick to a budget if you’re displeased with this figure.

What’s Included in a Personal Financial Statement

The three major components of your personal financial statement are as follows:

Balance Sheet

Your balance sheet is an overview of your personal net worth and will list all of your assets and liabilities. Assets may include your home, car, savings accounts, and investment accounts. Liabilities, however, might be your mortgage, auto, student loans, and credit card balances. Your balance sheet will state the difference between your assets’ total value and the total amounts you owe on your liabilities. It’s a great representation of your net worth.

Income Statement

Your income statement will consist of your salary, bonuses, and commissions. If you have other income from interest, a side job, or dividends, you’ll include this information as well. Your income statement will also outline your insurance premiums, income taxes, and any other consistent cash outflows you may have. With your income statement, you can determine whether you spend more than you earn and what you can do to improve the way you spend money.

Cash Flow Statement

A cash flow statement shows how you spend your money. It breaks down your cash into three main categories: fixed, non-discretionary expenses, variable, non-discretionary expenses, and discretionary expenses or fun money. It bridges the void of information from the Balance Sheet and Income Statement. You can use a cash flow statement to figure out if you’re on the right path to building wealth and meeting your goals.

What to Exclude From a Personal Financial Statement

Now that you know what’s included in personal financial statements let’s discuss what they should exclude. Your personal financial statements will not contain any business-related assets or liabilities. The only exception is a personal loan for your business or any other tool you’re directly accountable for.

Your personal financial statements mustn’t include anything you rent or personal belongings like household goods or furniture, as their values are rarely high enough to be considered assets.

How Often Should You Update Your Personal Financial Statements?

Once you prepare your personal financial statements for the first time, your work is not done. Since your finances will likely change regularly, your personal financial statements require frequent updates. It’s essential to review and modify your statements every month or every other month. This way, you’ll always be up-to-date on where you stand with your finances and can make adjustments to your spending and saving habits as necessary.

Personal Financial Statement vs. Business Financial Statement

Business financial statements usually consist of a profit and loss statement and balance sheet. As stated, personal financial statements include a balance sheet, income statement, and cash flow statement.

With a business financial statement, you can start or grow your business and obtain small business loans to help you do so. However, personal financial statements focus on your personal life and can help you achieve your personal financial goals like buying a house, retiring, or sending your children to college.

Ways to Increase Your Net Worth

Your net worth is essentially the value of your assets over your liabilities. You can have plenty of assets and have plenty of liabilities, meaning you don’t have a high net worth. On the flip side, you can have minimal assets but no liabilities and solid net worth.

So what is the ideal net worth? It depends on your age, unique lifestyle, and comfort level. There is no hard and fast number that everyone agrees with. However, you can use a formula developed by Thomas Stanley and William Danko, authors of the book “The Millionaire Next Door,” to get an idea of where your net worth stands. The formula is Net Worth=AgeXPretax Income/10. If your pretax income is $60,000 and you’re 35, for example, your ideal net worth would be $210,000, according to this formula. There are 18 financial ratios you should know, including this one.

Of course, this is just one way to look at your net worth and doesn’t necessarily mean that you’re struggling with your finances if you’re below the $210,000 mark. It’s all about what type of net worth you feel comfortable with. Another way to use your personal financial statement is to look at your liquid net worth that provides a more conservative view.

If your personal financial statements prove that your net worth is in the negative or lower than you’d like it to be, don’t worry. There are a variety of ways you can achieve a positive or higher figure. Here are several suggestions.

  • Cut Expenses: The less money you spend, the more you can use towards saving and investing. Take a look at your budget and figure out where you can reduce or eliminate expenses. If you rarely use that gym membership, for example, cancel it. If you tend to overspend on dining out, cook more meals at home. Remember that even a few dollars here and there can add up and increase your net worth in the long run.
  • Look for New Income Sources: If your 8 to 5 job doesn’t pay enough, don’t be afraid to earn money through other outlets. Depending on your schedule, preferences, and interests, you may want to take on a second job or freelance work. Or perhaps you have many items that you no longer need or want and can sell them on Craigslist or Facebook Marketplace.
  • Buy a House: If you’re currently renting, saving for a house may be a good option. Your mortgage payments can allow you to build equity, which can increase your net worth. If you do pursue homeownership, make sure you choose a home at or below your means. Otherwise, it can turn into a liability rather than a wealth-building tool.
  • Build an Emergency Fund: Unfortunately, life happens, and your car may break down, or your roof may need to be replaced when you least expect it. In these situations, it’s helpful to have an emergency fund. With an emergency fund, you can cover these unexpected expenses and avoid debt. Most financial experts recommend three to six months’ worth of savings in an emergency fund.
  • Get Out of Debt: Although it’s easier said than done, do your best to reduce or eliminate your debt. This includes your student loans, mortgage, credit card debt, car debt, and other places you make monthly payments to.
  • Invest: The sooner you begin to invest, the better. Once you have an emergency fund, make your money work for you via investing. You may want to consider some investment vehicles, including a 401(k), Roth IRA, Traditional IRA, and 529.
  • Get Insured: Insurance can protect you financially when and if the going gets tough. Life insurance, car insurance, and health insurance are important investments that can protect your (and your family’s) financial future.

How to Prepare Personal Financial Statements

If you’d like to prepare personal financial statements, you have two options. You can go the DIY route and complete them yourself. Fortunately, there are many free and fee-based templates available to guide you through the process.

Another option is to consult a financial advisor or hire a financial coach to help you. They can provide you with the expert guidance you need to ensure your personal financial statements are thorough and accurate. Even if you create your own statements, a financial advisor may review them and provide you with the peace of mind of knowing it’s in good shape.

A financial advisor can also help you increase your net worth. Once they learn more about your particular situation, they can make appropriate recommendations and steer you toward a healthier, happier financial future.

This article originally appeared on Your Money Geek and has been republished with permission.

Understanding Inflation And How To Protect Yourself From Its Effects

Understanding Inflation And How To Protect Yourself From Its Effects

We almost always have some inflation, meaning wages and prices increase which helps job creation and economic growth. The absence of inflation is deflation, which means declining prices and could cause or worsen a recession as businesses lay off workers.

For years, we have had low inflation with relatively stable pricing, largely due to the Federal Reserve’s efforts.  However, the low inflation levels could change as our economy rebounds from the pandemic. To find higher rates, you have to go back to 1990 when inflation was 6.1%. Double-digit inflation was more common in the 1970s, with its peak at 13.3% in 1979.

The Federal Reserve’s Monetary Policy’s Actions

The Federal Reserve has dual goals: maintaining relative pricing stability and sustainable economic growth with full employment. In the Great Recession and in March 2020, due to the pandemic-related economic downturn, the Fed steered towards accommodative monetary action to drop their fed funds rates to the lowest levels of zero-to 0.025% to stimulate the economy. 

Chair Powell and the Fed intend to keep interest rates low through 2022 and have said they would be more tolerant of inflation rates that exceeded their 2% target. There is a reasonable possibility that we will see higher inflation soon.

Will The Fed Stick With Their Accommodative Policy?

Despite their intentions to stay with an accommodate policy, the Fed’s policy mandate is to adjust their stance to changing information. The 10-year Treasury note’s yield has been rising and could signal higher inflation expectations. The Fed has tools to combat high inflation such as raising interest rates. 

It is not clear if the Fed will change gears but we can prepare ourselves. Should inflation increase to moderate levels above 2%, there are ways to protect ourselves from the potential erosion of our money. Moderate inflation may provide some benefits. You need some level of inflation to promote more spending.

Reasons Why We May See Higher Inflation

  • The Fed intends to remain accommodative for a while, with lower rates and liquidity.
  •  A potential $1.9 trillion fiscal support for those businesses and households in need is on the table.
  • The number of people getting vaccinated is rising, which may help boost the economy.
  • We are saving more with the latest US personal savings rate remaining high at 13.7%, about twice the rate seen in 2019.
  • Credit card balances at the end of 2020 reflect the largest yearly decline since 1999, reflects consumer spending is down.

These factors, if combined, may unleash consumer spending to kick up our economy and contribute to higher inflation. Offsetting these factors is high unemployment levels staying stubbornly high and may keep inflation low for now.

With low inflation, it has been difficult for anyone to earn any income in a low-yielding environment without taking on more investment risk. For investors with 60/40 retirement portfolios investing in stocks and bonds, respectively, some have shifted more significant proportion into stocks.

Investors will need to seek assets that are at least keeping pace with rising inflation. Holding cash in savings and checking accounts are suitable for liquidity purposes.  However, their safety feature will diminish as their values erode with rising inflation.  Later on, we have a list of investments that can protect you during a higher inflationary environment.

What Is Inflation And How Does It Affect Your Buying Power?

The definition of inflation is a steady rise in the general level of prices of goods and services. For example,  a gallon of milk cost $1.57 in 1975 rising to $2.20 in 1985 as a result of high inflation in the 1970s to early 1980s. It now costs $3.61 in 2021. The changes in prices are due to inflation, not scarcity. 

As a result of inflation, your purchasing power, the amount of goods and services that one’s income will buy, goes down. When prices rise, purchasing power declines, usually falling by the reciprocal amount of the price increase. Your paycheck may stay flat or go up more slowly, leaving you with less money. Union members may be an exception as they receive a cost of living wages as part of their contract.  

Calculating of Inflation

The US Bureau of Labor Statistics calculates inflation monthly using the consumer price index (CPI). The CPI is the best measurement of changes in prices of all goods and services purchased for consumption in urban households. This index tracks a market basket of food, transportation, housing, health care, and entertainment, broken down into over 400 subcategories bought by end-users.

The CPI is a cost of living index with a starting reference point from 1982-1984 as the base period of 100. The CPI for January 2021 was 261 reported on February 10, 2021, the cost of living would have risen 161% since the base period [(261-100)/100= 1.61 of 161%]. If car prices rose 15% over the past five years, you may be paying $34,500 for a car that had cost $30,000 ($30,000 x 1.15%).

Economists tend to look at sequential (quarter-quarter) or year-to-year changes in the CPI. The most recent sequential rise in January increased by 0.3%, and up 1.4% since a year ago. These price increases confirm the low inflation we have had since the Great Recession began in 2007.

The Purchase Pricing Index, or PPI, is similar to the CPI but measures wholesale prices from raw material through the production stages. When PPI rises, the higher costs often are passed on to consumers.

Low inflation has stymied returns from the low inflation environment from low-risk income-based investment portfolios as we discussed here..

What Contributes To Inflation?

There are various factors that may influence inflation.

Higher Demand

Demand-pull inflation occurs when total demand for goods and services in an economy outpaces supply. In the early 1970s, a strong economy caused oil prices to rise and pushed up inflation to 12% in 1974. Strong consumer demand for goods and services could result in higher spending leading to higher inflation.

Increase In Production Costs

A different way of rising prices than demand-pull can come from increases in production costs without higher demand is known as cost-push inflation. Higher production costs can come through increased wages, raw materials, depletion of natural resources, droughts, or higher taxes. Businesses are not always able to pass these higher costs onto consumers.

There have been conflicting views on whether raising the federal minimum wage to $15 per hour would cause inflation. One side of the argument points to wage hikes which have been slow to come for many employees, and therefore, increases are overdue. Wage growth often leads to a more robust economy.

However, the pandemic-related recession has caused high unemployment that has crippled many small businesses. Many believe that we should have an improved economy and higher employment before raising wages.

Natural Disaster Shortages 

Prices can rise when shortages in goods and services associated with natural disasters such as severe weather conditions, droughts, floods, fires, or avian flu. These disasters impact manufacturing plants, businesses, and residential areas. These unpredictable events may put temporary or long-term pressures on the production of goods, causing inflation due to scarcity.

In 2010, British Petroleum’s oil spill was the largest marine disaster in the Gulf of Mexico, causing higher gas and seafood prices. This area accounted for one-third of all seafood consumed in the US. About 40% of the Gulf waters needed to be closed to commercial and recreational fishing due to the spill.

Government Overspending

The US budget deficit has been rising from already high levels since the pandemic to counter the economic downturn. A government budget deficit occurs when expenses outpace revenues, not unlike the household budget.

Multiple fiscal stimulus packages related to hardships caused by the pandemic have been essential to provide funds to businesses and unemployed workers. This boost to government spending has required the US Treasury to raise capital and increase money creation by printing money. Both US Treasury and the Federal Reserve have increased money supply to increase liquidity and keep the financial markets calm, but a higher money supply typically leads to higher inflation.

Higher Prices From Higher Demand Post-Pandemic 

Many businesses lost revenues during the pandemic because of social distancing needs. As more people are vaccinated, our economy may rebound from strong demand in travel, entertainment, dining out, and going about life more normally. We may see some prices go up with increased demand and pressure to recoup lost revenues.

Different Kinds of Inflation

The various forms of inflation that are most worrisome are stagflation, deflation, and hyperinflation.

Deflation

Deflation is when there is an overall decrease in the cost of the economy’s goods and services. When price declines are minimal, consumers may spend more. When deflation is more pronounced, we may demand less, expecting more price declines. Businesses, anticipating lower spending, will cut production to prevent swelling inventories, and layoffs may result.

This deflationary scenario is considered the opposite of inflation and its evil twin. The Federal Reserve uses a 2% inflation target as part of its monetary policy, preferring low inflation to deflation. Deflation can send an economy into a recession or a worse downturn, causing layoffs.

Stagflation

Stagflation refers to a stagnant economy reflected in high unemployment and high inflation simultaneously. This problematic situation, spurred by an oil shock, lasted from the early 1970s into the early 1980s and was challenging to resolve. 

Hyperinflation

Hyperinflation has not been around for a while. The closest the US experienced hyperinflation was during the Civil War, and I think that is where everyone wants to see it, that is, in history. Between 1921 and 1923, the Weimar Republic, Germany’s government, experienced hyperinflation rising over 300%!

Relationship Between Inflation And Interest Rates

Inflation and interest rates are not the same thing, but they relate to each other. There is a tendency for interest rates and inflation to have an inverse relationship. When interest rates are low, it stimulates economic activity, and inflation rises. But, when interest rates are high, consumers slow spending, the economy slows, and inflation declines. It takes time for the economic changes to take place.  

Investing For Protection From Inflation

As an investor, you should have a better understanding of inflation so that you can protect yourself from its effects. Some investments keep better pace with rising inflation than others. Real or physical assets often appreciate at or faster than inflation, and can provide better returns for investors. It is helpful when investing to understand the economy as we discuss here.

Money Market Securities

Cash and cash-equivalent securities make poor investments in a low-yielding environment. However, when inflation rises, the annual percentage yield (APY) will increase. Seniors have been clamoring for 5% CD yields which do not currently exist. Should inflation rise to higher levels, having cash to investing in money market accounts that are FDIC-insured will be a desirable place.

Build CD Ladders

The six-month CD rate hit a high of over 17% in March 1980 when inflation was 14.8%. I don’t think anyone wants to see inflation reach those levels or expects inflation of that magnitude. However, you can build a CD ladder to take advantage of rising APYs offered by the banks and credit unions.

You can start with short-term periods such as three or six-month CDs as inflation rises, lengthening their maturities as high inflation stabilizes, locking in nice returns. CDs are a less risky way to earn higher returns, especially if inflation is over 5%.

TIPS And Other inflation-indexed Bonds

Currently, bonds at fixed rates do not yield meaningful returns. However, bonds with variable rates are worthwhile investments in rising inflationary environments.

Treasury Inflation-Protected Securities, or TIPS, are issued and backed by the full faith of the US Government. They are considered the safest security, most liquid,  and rated AAA for the highest quality. Holders receive interest income twice per year at a fixed rate. These securities are an excellent way to diversify your portfolio for the least risk among other inflation hedges.

As inflation-protected securities, TIPs provide investors with a guaranteed real rate of return. The principal of TIPS increases with inflation and decreases with deflation measured by the CPI. At maturity, you are either paid the adjusted or original principal, whichever is greater. Like all Treasury securities, TIPs are exempt from state and local taxes.

Municipal Inflation-Linked Bonds

 Like TIPS, investors can buy municipal (munis) inflation-linked securities that track CPI and adjust the bond’s principal. These securities can keep pace with inflation better than a municipal bond without this feature.

Compared to TIPS, munis do not have backing from the federal government, are less liquid, and its ratings vary by municipality.  Funding purposes are to build roads, schools, airports, or infrastructure projects. To offset its higher risks, holders of muni bonds are tax-exempt from federal income taxes.

Corporate Inflation-Linked Bonds

Corporate bonds may have inflation-linked features, similar to the other bonds, adjusting to the CPI changes to better pace with higher prices. These securities tend to have higher risks that vary by the quality of the corporation. These bonds are less liquid than Treasury securities (every investment is!) and don’t have any tax-exemption benefits for their holders like Treasuries or municipal securities.

Variable-rate bonds have floating interest rates for coupon payments. Municipal and corporate bonds may have this variable feature that is adjusted to the current money market rate for their interest rate.

Gold

Gold is an inflation hedge and offers diversification for any investment portfolio. As a physical asset, gold is in limited supply. Central banks own gold in their portfolios as part of their foreign exchange reserves.

Gold prices were up 25% in 2020, among the best-performing assets. You can buy gold in its physical form as bars or coins. Typically, gold doesn’t pay dividends. However, some gold mining stocks pay dividends (e.g., Newmont and Barrick) individually,  as gold miner ETFs or SPDR Gold Shares or GLD, the bullion is in a fund.

Silver is an inflation hedge with a lower price point, attractive for retail investors.

Commodities

Commodities are not just pork bellies. As an inflation hedge, it is a broad group with many different products you earn and store. There are three main categories:

  •  Agriculture commodities include food, meat, timber, and cotton.
  • Energy has crude oil and its refined products.
  • Metals categories are largely precious metals and industrial metals.

As the price of the commodity rises, the product that contains the commodity will likely rise. When aluminum or steel prices rise, manufacturers may pass on the higher costs to consumers.

Real Estate Investment Trust or REITs

Real estate property makes excellent investments when inflation rises, but it may require work to maintain. A REIT is a company that owns and operates income-producing real estate. There are many different REITs for equity, retail mortgage, health care or hospitals, and data storage, providing diversification for any portfolio.

They generate stable income from above-average dividend yields. That’s because REITs are required to distribute at least 90% of their taxable income to shareholders annually.

Common Stocks

Stocks, as an asset class, have historically provided returns that beat inflation. They are a sturdy investment for the 60/40 investment portfolio, with inflation-indexed bonds likely to do better when there is higher inflation.

Certain sectors may perform better than others. Energy stocks, much like the commodity itself, are often inflation hedges. Financial stocks earn better income margins on loans in times of inflation, and healthcare insurers have performed better when higher inflation appears.

We already mentioned REITs and gold stocks as a worthy area to invest in if inflation rises. Let’s add Dividend Aristocrat companies for inflation protection. They are represented by stocks that raise their dividends consistently for at least 25 consecutive years. There are different stocks in various sectors and are available as ETFs.

Another way to invest in stocks is to buy the S&P 500 index as a fund or ETF for inflation protection and diversification. If you choose to purchase stocks individually or as a sector, you may want to avoid utilities, consumer discretionary stocks, or companies with debt-laden balance sheets, like United Rentals.

Final Thoughts

Many are suggesting that higher inflation is on the horizon over the next few years. That may be as we haven’t had meaningful inflation since 1991. Higher inflation, so long as we don’t have stagflation or hyperinflation, is manageable. There are several investments that are attractive as inflation hedges for protection.

Thank you for reading! Share any comments or feedback, we would love to hear from you. Please share this post with others if you found something of value, and come join us at The Cents of Money!

 

 

7 Deadly Sins Of Investing And How To Avoid Them

7 Deadly Sins Of Investing And How To Avoid Them

In Seven, the neo-noir thriller, detectives David Mills and William Somerset (played by Brad Pitt and Morgan Freeman) track down a serial killer who uses the seven deadly sins as a motif in his murders. Investing may not be as lethal as a serial murderer. Here, we discuss the seven deadly sins of investing,  how they may impact our stock performance through destructive mistakes, and how we can avoid them.

What Is Investing?

Investing is a way to potentially grow the amount of money you have. The goal of making investments is to buy financial securities and hopefully sell them at a higher price in the future than what you initially paid. A saver can become an investor by giving your money a chance to work for you.

Investing is the best path to achieve wealth but it’s not a straight road. Unlike saving, investing involve some risks that could cause you to lose money.  You need to understand these hazards so you may be able to mitigate them. Investors purchase stocks and bonds with long term goals, unlike traders who have short term plans.

We can lose money when investing leads to emotional behavior or bad habits. Start investing as early as you can so you can earn money on top of the money you already earned, called compounding returns. Stay focused and purposeful so you can avoid behavioral biases which often play a detrimental role. Using financial discipline when investing can help you to achieve success

The seven deadly sins passed down from the Catholic Church of the Middle Ages may cause investors to perform poorly as modern examples for each deadly sin. The seven deadly sins are lust, gluttony, greed, sloth, wrath, envy, and pride.

1. Lust

When thinking of this deadly sin, I can’t help thinking about Jordan Belfort, better known as The Wolf of Wall Street. Belfort, or what we see of him, nearly defines every deadly sin. For that reason, he and the movie based on his memoir is pure entertainment and instructive for those who lust after sex and money.

As the first deadly sin, lust is a strong craving or intense longing such as sexual desire. It can also mean hunger for money. From an investor’s point of view, falling in love with your investments can be hazardous. Heavily favoring one stock may result in too much concentration risk in your portfolio.

Overexposure To One Stock Poses Concentration Risk

Take the example of Gur Huberman’s “Familiarity Breeds Investment” study in 2001, which involves ATT’s (“Ma Bell”)1984 breakup. When ATT split into the 7 Baby Bells, its shareholders received equal amounts in each new company.

Huberman found investors tended to retain a disproportionate amount of shares in their local Bell company. These individual investors held as much as $10K-$20K of a single stock, a higher concentration than the typical stock holding in a US household’s net worth.

Overexposure to one stock poses more significant risks to your portfolio that can sneak on you from slowing fundamentals. Investing in the company you work for is common for many people. However, if you have substantial ownership of shares where you work for and in your investment and retirement accounts, you have too many eggs in one basket. Instead, you need to diversify your portfolio with different stocks, industries, and asset classes.

2. Gluttony

Gluttony is the overconsumption of eating and drinking. We have all been there, gorging ourselves over an excellent meal, and feel our regrets afterward. Dante refers to this sin as “excessive love of pleasure.” We may be engaging in gluttony by overindulging our funds into less liquid investments without leaving a cash balance to buy stocks in a correction or pay off debt.

The recent excessive trading of GameStop shares by retail traders to shake up Wall Street seemed to be foolhardy, if not reckless. Sending that stock into the stratosphere caught everyone’s attention before coming back to earth but may have been costly.

Diversification, Asset Allocation, and Rebalancing

Alternatively, some people hoard their cash in a savings account, which generates little interest income, especially in this low rate environment. Investors need to be careful in allocating money into investments and having funds for emergencies, debt pay-offs, and retirement.

The antidote to gluttony is purposefully investing with strategies that embrace diversification, asset allocation, and periodic rebalancing.

3. Greed

“My name is Jordan Belfort. The year I turned 26, I made 49 million dollars, which really pissed me off because it was three million a week.”

The Wolf of Wall Street

“Greed is good…Greed, in all its forms, greed for life, for money, for love, knowledge, has marked the upward surge in mankind and greed.”

Gordon Gekko, Wall Street, the movie

Greed is not good, but it is very prevalent in the world of investing. The Wall Street (“the Street”) culture is all-consuming. It breeds greed and the need to make more than the person next to you. Not everyone working on the Street is greedy, or a criminal but temptations are there as they are everywhere.

The definition of greed as a sin is an intense and selfish desire for something of value, referring to wealth, material possessions, power, or food. Trendy investments are often collective greed that may become long term losers. Stock manias reflect “irrational exuberance,” a phrase used by then-Federal Reserve Chair Alan Greenspan when he commented on stock’s higher asset values than fundamentals warrant.

Bubble manias of the past–Dutch tulips, South Sea, Japan’s real estate and stocks, dot-coms, housing– should provide historical context to fear and greed in today’s markets. We hear about overbought markets but justify our purchases in SPACs, bitcoin, Tesla, Nio, so we aren’t left out of some of the apparent winners.

Lock-In Some Profits

How can we better deal with our greed, so we don’t become a casualty of fickle markets? No one gets hurt taking some profits off the table. I sell a small percentage of my gains regularly, usually, after a stock rises 20%-25%. This way, I may avoid my winners blowing up, an experience I have in my past.

Recognizing the need to be rational when investing is essential. It means doing your research, or if you feel you don’t have the time, are too emotional, or don’t have the inclination, you may be better off finding a financial professional to advise you in your best interests.

Take heed from another respected investor, Warren Buffett, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” There is a Fear and Greed Index (FGI) that measures investor sentiment for those opposing emotions daily, weekly, monthly, and annually. Too much fear can send stocks down, while greed indication may push stocks up.

4. Sloth

Why do they have to pick on this cute animal known for moving slowly and spending most of its time upside down in trees? As a deadly sin, sloth translates to an absence of interest or not exerting oneself physically or mentally. Said another way, it is the avoidance of hard work and perseverance, or simply laziness.

We can usually spot sloths who are lazy about physical exercise. However, investing requires cognition or understanding of what you are doing with your money. 

Laziness can hurt you when you are jumping into stocks without rhyme or reason. A slothful investor may under-invest or spend too little time reviewing one’s portfolio. Investing is not a “set it and forget it” activity. Investors may mistake the buy and hold strategy as akin to that. The buy and hold strategy means that you have a long-term perspective, but you need to adjust your portfolio for new or changing information.

Be Aware of Biases At Work

Making investments requires research. Even if you are planning to use a financial advisor, research is necessary. You still need to find a person or team that works to understand your financial goals to work with you on your financial plan.

Slothful people may be prone to procrastinate over making decisions. The status quo bias occurs when someone may be resistant to change. The endowment effect is similar, but it occurs when someone places a higher value on what they already have. Shortly after my parents passed away,  I inherited stocks, such as ATT and IBM, conservative names appropriate for their portfolio but not necessarily mine. Yet, I held on to their stock picks as an example of an emotional bond that was irrational.

How To Avoid A Slothful Nature?

If you intend to monitor your portfolio, recognize the need to be proactive in having diversification, taking some profits, and making adjustments as warranted based on changing company fundamentals. There are many different kinds of low-cost index funds that have other purposes of fitting your investment strategies. For example, you may look at target-date index funds that may appropriately adjust holdings based on your age.

Automation

You can automate your paycheck by allocating a certain amount or percentage to go into retirement savings, so you don’t have to remember to contribute to this account regularly. It is essential to use your paycheck to make it easy to make investments, save money, and pay bills.

Consider talking to a financial planner to help you with your financial goals and make investments for you.

5. Wrath

“Heeere’s Johnny!”

Jack Torrance, off-season caretaker in The Shining

There are many images of wrath, but Jack Nicholson’s character comes to mind. Wrath is defined as uncontrolled feelings of anger, rage, vengeful, and even hatred. Jim Cramer’s very rational rant in 2007 (and transcript) as the financial crisis was unfolding, but the Fed Chair was not yet cutting the fed funds rate or adding liquidity to the markets.

When the stock market becomes volatile as it did during 2007-2009 and in March 2020, we have wrathful states that pose dangers for any investor. We become angry at bad decisions for keeping stocks too long or selling them too fast as many jumped to do as the stocks sold off in March in the shortest bear market in memory.

GameStop As An Example of Irrational Buying

Retail traders who may lack experience may seek greater risk than they can handle and make irrational buying decisions.  We saw some recklessness as buyers were bidding GameStop shares up to crazy prices beyond their poor fundamentals.

It seemed as though traders were trying to punish short-sellers such as hedge funds by engaging in combat. Stories of young investors who took out costly loans to buy shares at exorbitant prices are heartbreaking. We wrote a letter to young investors you can read here.

Studies suggest that anger may increase our risk-taking. Don’t be reckless and engage in using leverage like margin trading.

Avoid anger and other emotions when making investments. The market doesn’t hold grudges, know how to be vindictive, or have a memory from day-to-day.  Investors need to make adjustments for changing circumstances.

Learn From Mistakes And Use Discipline

Learn from your mistakes to not sell as the market is plummeting unless you need liquidity. Stay rational by not impulsively trading or investing. Give yourself some discipline by selling a losing stock after it drops 7%-8% to avoid a more significant loss. Consider taking some profits off the table to lock in those gains.

6. Envy

Have you ever felt envious? Of course, you have. Envy is a feeling of resentful longing often brought on by someone else’s possessions, better standing, or luck. Envy often leads to conspicuous consumption to match those around them at work or in the neighborhood. The phrase “keeping up with the Jones” may mean buying a new car or a boat to fit in with other people around you.

Investing circles may envy those who are “killing in the market” when they share their wins in the most trendy stocks or funds. What they may not be telling you is about the mistakes they have made in the past. At one time, people envied Bernie Madoff’s clients for above-average returns, and we know how that movie ended.

Herd Mentality Bias

Merrill Lynch may still refer to its financial advisors as its “thundering herd,” but following or copying the herd is a negative sentiment. In behavioral finance, herd mentality bias refers to the investors’ tendency to follow what other investors are doing in the market.

Think of dot-coms, GameStop, or popular acronyms for groups of stocks such as “FAANG,” standing for Facebook, Amazon, Apple, Netflix, and Google, before it changed its name to Alphabet.

It is not always the wrong move for individual investors to buy rising stocks that reflect heavy trading volume. Sometimes that is a healthy indicator of institutional buying, and it is painful to go against the smart money crowd. However, it will financially hurt when large investors start shedding stocks in their portfolios.

Don’t Chase Hot IPOs

Individual investors, who typically do not have access to new issues, often seek the hot IPOs after pricing in the primary market. The average first-day pop in the post-IPO stock is 20%, but hot names have shot up 80%-100% or more. Six months later, many of these stocks have fallen below their IPO price as the aura on these stocks is gone, a casualty to weaker fundamentals than expected.

Instead of being envious, learn about investing, risks, and develop strategies that work for you. Remember that Madoff’s returns were fictitious. It is in our nature to compare ourselves with others. However, you cannot be sure that you are looking at anyone’s full picture. Don’t waste your energy on envy.

7. Pride

“Details of your incompetence do not interest me.”

Miranda Priestly, The Devil Wears Prada

Pride or extreme pride is hubris, a Greek cousin to pride. Hubris means self-confidence, arrogance, and corrupt selfishness. One who has hubris irrationally believes they are better, superior and has excessive admiration of their self-image. Having this kind of pride is a self-destructive vice, especially harmful when you are an investor.

It is hard to work for someone like Meryl Streep’s Miranda Priestly, who always desires to be right. As an investor, the need to be right can hurt your ability to make money.

You may hold on to a losing stock and an unrealized loss rather than admit you are wrong. The justification for holding on to the stock is that it is only a loss on paper until you sell it. However, a 10% unrealized loss can widen if fundamentals warrant it. Loss aversion bias is the tendency to prefer avoiding losses to acquiring gains.

Overconfidence Bias

Another bias is overconfidence, which means having an egotistical belief in your investing acumen. It is challenging to perform better than the market averages, but those who are overconfident tend to operate with the false comfort they can perform well.

Instead, having a fear of being wrong in many investing situations can help you stay on your toes. The best investors avoid overconfidence and consider worst-case scenarios as medicine to remain aware of downsides in the market. They recognize that there is much that you cannot control about the market.

Avoiding The 7 Deadly Sins With These Investing Rules

To recap some of the ways you can avoid the investing pitfalls associated with the seven deadly sins:

Avoid concentration risk by diversifying your portfolio and do asset rebalancing.

Be aware of the emotions and behavioral biases that impact our decisions.

Don’t dump stocks during times of market turbulence.

Buying hot IPOs post-pricing is not a good idea, as there will be a better time and price to do so. 

No one gets hurt taking profits off the table to lock in gains.

Don’t engage in reckless strategies such as short-selling or using leverage to buy stocks.

Use automation to move money more quickly from your paycheck to contribute to your savings, retirement, and investment.

 

Final Thoughts

When investing, you may have run into the seven deadly sins that can impact your performance. Counter each sin, often wrapped in emotion or biases, with purposeful investing to avoid common mistakes.

Thank you for reading! If you found some value in this article, please share it with others. Consider joining The Cents of Money community by subscribing and getting our weekly newsletter.

 

 

 

Money Isn’t Everything! These Values Matter

Money Isn’t Everything! These Values Matter

According to my grandmother, “Poor or rich, money is good to have.” We need money to pay our living expenses and support who and what we care about most. Raising a family or taking care of our parents requires funds for health care, education, and the opportunity to enjoy the beauty of life. It can help us make a difference in the lives of others through giving.

Without money to pay our bills or invest, we may fall short of achieving our life’s goals and having financial security, independence, and freedom.

Money Isn’t Everything!

Money isn’t everything. It has its limitations. Obsession over money and wealth is unhealthy, mainly when it controls your life. It may prevent us from ever being satisfied with our life by continually needing to compare ourselves to others. Money matters because it is the tool we need in the absence of bartering. However, many things are more valuable and can help us achieve our full potential. Focus on those values that make you content. Review the values listed on Maslow’s hierarchy of needs. Self-actualization is the pinnacle of our self-fulfillment needs.

As individuals, we each have our list of personal values that give meaning to our lives. These values shape our personality, behavior, and attitudes. How often do we reflect on those traits that make us who we are? It is an excellent exercise to do to make sure you are going in the right direction. Since we serve as role models for our children, we need to be sure we send the signals we want them to see. They are worthy of us doing a check on our values and beliefs, which make us tick.

What We Value, Besides Money

 

1. Time Is A Precious Resource

Time is money, but it is so much more. If there is inequality in money and wealth, we have the same limited time. You can’t borrow or lend time at any cost. Anyone who loses family and friends knows the tragedy of time running out.

You can’t buy time unless you can pay someone to do a task for you, which may temporarily free you to do other things. But you can’t buy time in a permanent sense, no matter how much money you have.

Time is our most precious resource. As such, spend your time with people you most enjoy being with or doing what you most desire. Don’t waste your time; use it in productive ways.  Think in terms of daily accomplishments and whether you have achieved what you wanted to do. Like money, invest your time meaningfully. Find ways how to improve your time management skills here.

2. Manage Your Energy Wisely

Somewhat related to time is how we manage our energy. Energy affects our physical, mental, emotional, and spiritual well-being. We all have limits to what our mind and body can do. What is personal energy or power? It is the amount of effort or strength you are willing to devote to people, things, or challenges in your life.

There are people in our lives who are delightful. We get a good boost from spending our time and energy with them. Other people may deplete our energy through negative behavior or attitudes. In this challenging year, the pandemic has weighed on our lives by making it difficult to see our friends and families. We may have saved time and energy by working remotely, but we lost the uplift from seeing people in the office. Indeed, driving to work may give us the power of the bridge, separating our home from our jobs.

3. Your Health Is Our Vital Asset

We can’t take our health–physical, mental, and emotional-for granted. Yet, we often do this by not taking as good care of our body and mind as we can.  What is your health worth? Like time, it is priceless and precious. Eating healthy, daily exercising, and getting a good night’s sleep shouldn’t be hard to do. They are good habits to incorporate into your mindset. Even short daily movements have helped me loosen up considerably.

Recently, I complained to a friend about being more stressed about more things lately. He recommended several meditation sessions to try out. A few of the sessions were particularly helpful, so I work on those. Changing up your routine with good habits can be stimulating. 

I look forward to reading at night, playing music that fits my mood, and understanding my emotions better.

4. Family,  Friends, And Community

“First be a person who needs people. People who need people are the luckiest people in the world.”

Bob Merrill, lyricist Sung by Barbra Streisand

We need our family and friends for their love, affection, companionship, and to validate us. I come from a tiny family where friends were family and family were friends. The pandemic experience has required us to social distance for safety reasons. However, we have grown tired of this pandemic and staying apart from people we love. Human beings just don’t enjoy isolation. We thrive when we are with other people who are essential in our lives. They contribute to our sense of belonging, comfort, and self-worth and add to our lives’ meaning.

Community And Colleagues

Apart from family and friends, it is your community and your neighbors. Community is where you live and your colleagues at work. Work and community are spheres where you may meet new friends. We recently moved from a big city to a small town. We changed communities just before the pandemic is the ideal time for you to meet new friends. Our kids are fortunate to have met and formed relationships with good friends when they were at school. Those relationships have carried over to online and social media.

5. The Right Life Partner

Choosing the right partner you want to spend your life with is easier said than done. Only after years together can you look back and say you are fortunate to find someone to be with until you are old and gray. When you are in your 20s, how do you know if you both have the same interests, intellect, and standards?

You don’t. However, by loving one another and finding someone with who you can connect easily, learn from, trust, respect, and grow, you have the making of the right life partner.

My Life Partner

Speaking of myself, Craig and I connected instantly in what feels like a lifetime ago. We have similar interests, enjoy each other’s company. Challenges are in every relationship but knowing how to deal with each of them matters. Craig has always been my incredible support, and we both learn from each other when we have different interests or opinions. I feel lucky that we have built a tremendous enduring bond that has remained strong through the high demands of having active teens and two dogs.

6. The Virtues of Work

“Choose a job you enjoy doing, and you will never have to work a day in your life.”

Mark Twain

It has been my great fortune to find meaningful work most of my career. Every individual should explore what kind of work they most enjoy doing. For some, it is working with their hands to craft a tangible product. Many feel rewarded by helping others, while a significant number prefer making lots of money to afford a luxury lifestyle. To each, their own goals and road to success.

I have always found challenging work to be enterprising and energizing. Working has allowed me to grow my knowledge and skills outside of my home. With so many people unemployed these days, I feel blessed to have a job that will enable me to teach remotely. The virtues of working are plentiful. Work adds meaningful dimensions to your life besides compensation. I have learned new skills, expanding my knowledge, cultivating my career and reputation. Read more on the virtues of work here. 

7. Love of Learning

“Anyone who stops learning is old, whether at twenty or eighty. Anyone who keeps learning stays young.”

Henry Ford

By being a lifelong learner, you can look at the world with fresh eyes. Learning can be formal, informal, or casual. You don’t have to learn in the classroom to pick up knowledge. Most of our education comes from outside of an academic setting. Picking up new information or realizing an original thought can give new highs and optimism. Whether you are learning for a career, hobby, or personal growth, never stop learning. There are only benefits to be found in lifelong learning.

Keep your brain healthy by find activities you enjoy and challenge yourself. There are so many resources and ways to learn. I have overcome some of my anxiety by improving how to cook, updating my tech skills, working on crossword puzzles, writing better, reading books I may have shied away from, and more. Chess is one of those games that I have genuinely wanted to learn how to play.

The Queen’s Gambit

I was fascinated by watching The Queen’s Gambit recently. Netflix’s series is a story of an orphan, Beth Harmon, who aspires to play chess in the male-oriented competitive world of the 1950s and 1960s. I played chess (poorly) with anyone who would play with me (only my brother) when I was in grade school. However, I would watch these intense chess players while strolling through Washington Square Park in New York City. It was so cool! Playing chess may have eluded me, but it has always sparked my interest in learning.

8. Protect Your Reputation

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Warren Buffett

Buffett’s quote on reputation is priceless. Your reputation is your brand, whether it is for a business or you. I cannot understate the importance of how you are regarded by your social circles, at work, and in your family. Reputation is your character and quality as judged by people. It forms the basis of respect and the currency of your worth. Cultivate traits like honesty, integrity, honor, and strong morals that should be in the workplace and your life. Manage your online presence for the quality of your character you are conveying.

The ruin of your reputation usually comes more quickly and efficiently than its establishment. It can be due to a lapse of ethical conduct or doing something legally questionable. Don’t post on social media without considering potential negative ramifications.

Rule of Thumb For Questionable Posts

If you are unsure, use the rule of thumb for questionable posts. That means first considering what others–friends, family, colleagues, your current or future employers–may think.

Words, photos, videos, or anything that are reflections of you and your values may last in cyberspace for all time. Protect your reputation carefully but not at all costs, which may make it harder to restore. Even now, you may already have some questionable items that may cause harm to you in the future. For example, you may want to pull that drinking contest you won with a trophy filled with bourbon, even if it is a relic of your past.

9. Experiences Over Possessions

Having experiences top buying things most of the time for me. Unique experiences tend to be more memorable and pleasurable. Traveling by camel in the desert, ziplining, and whitewater rafting bring tremendous rushes to our adrenaline. 

Studies have shown experiences bring people more happiness than do possessions. In their 2014 study, psychologists Matthew A. Killingsworth and Thomas Gilovich found it wasn’t just the experiential purchases (money spent on doing) that provided more joy than material possessions (money spent on having). The joy of waiting in line for the experience gave participants enduring pleasure as well as consumption. Millennials are known for their preference for spending on experiences, but boomers also favored experiences in this study. 

In a 2018 study with the Center For Generational Kinetics, Expedia found 74% of Americans prioritize experiences over products. Travel tops the list of experiences that make us happy the most. Of course, these results were before the pandemic when we were able to take trips. As a result of the pandemic, experiential purchases such as traveling, concerts, and movies, have declined. No doubt, the experience economy and sharing it with others has suffered as well.

10. Find Your Passions

Passion is a powerful emotion defined as a strong feeling of enthusiasm or excitement about doing something. Your passionate interests maybe those areas of topics, skills, or activities that excite you. Being passionate is often beyond a mere interest in something and can be an internal energy source. Like experiences, you are more engaged and engrossed in the activity or learning more about it.

Finding your passion in your job or career can motivate you to improve your performance. You don’t need to work in a position that directly aligns with your interests, but there could be an overlap between your work and other activities. Being excited about interests outside of work has its benefits. It allows you to develop new skills, meet new people, and expand your personal growth in a more balanced way.

For many years, I collected coins as a hobby, starting with Indian Head pennies, which led to my interest in the history of Native Americans, which I still am engrossed in today. Later, my husband and I became serious collectors of 18th Century American furniture and art, learning about American history.   I am always fascinated to know what passions other people have in their lives.

11. Gratitude and Empathy

“He who receives a benefit with gratitude repays the first installment on his debt.”

Seneca

Expressing our thanks to all those we love and appreciate can help us live better lives—both the givers and the receivers of our gratitude experience many advantages. Our happiness rises, we feel healthier, stress declines, and it helps us cope with a range of negative emotions. Gratitude is our moral barometer and, when genuinely given, boosts our energy. Expressing gratitude is good for our finances as well.

Gratitude has been studied extensively in the past two decades. As such, gratitude is a “gateway’ to other positive emotions– joy, pride, motivation, and wonder.

A Shared Role In Our Brain

Gratitude is on par with empathy. Empathy, a relatively new term, is defined as the ability to understand and share another’s feelings. Having the ability to understand and share the feelings of another is empathetic. Scientists have linked gratitude and empathy because there is an exact role played by each in the medial prefrontal cortex  (MPFC) part of the brain. That part of the brain helps people set and achieve goals and contributes to a wide area of functions.

Feeling grateful and empathic are enduring values that produce benefits for the giver and receiver.

12. Financial Security

Sooner or later, I wanted to get back to money as the value we share with those mentioned earlier. Achieving financial security provides peace of mind when your income can cover your expenses; after having saved for emergencies and your retirement. Financial security requires adopting good habits that can support your lifestyle while you work toward financial goals. Becoming financially secure means not worrying about credit card debt because you pay your bills in full and will not pay interest charges. 

The importance of feeling financially secure allows you to have flexibility and freedom to control your life. Financial security means different things for different people. For me, it means working at a job for less pay but feels more rewarding when teaching college students. I feel fulfilled at the prospect of sharing what I know with others. Being able to schedule my time better helps me to face the needs of my family better.

Final Thoughts

Money isn’t everything, but it matters when you don’t have enough to pay your bills. Besides money, there is much to value in our life. We should protect, honor, cherish and nurture these values for giving meaning to our lives.

Thank you for reading! If you found this of interest, please share it with others. Consider subscribing to The Cents of Money and receive our weekly newsletter.

 

 

 

 

 

 

Why Liquid Net Worth Matters

Why Liquid Net Worth Matters

“Liquidity is a good proxy for relative net worth. You can’t lie about cash, stocks, and bond values.

Mark Cuban

Understanding your net worth and how to calculate it is hugely important for measuring your financial health at a particular point in time. It is simply the difference between assets and liabilities. However, it doesn’t consider the liquid nature of your assets.

For example, stocks and bonds tend to be more liquid than other assets as they can be quickly and easily converted into cash. Other assets like your house or car take time and negotiation to sell if you need money. Net worth remains a helpful benchmark but depending on the type of assets you have it may be a less accurate picture.

Liquid Net Worth Is A Realistic Snapshot Of Your Financial Condition

Liquid net worth is what really matters. It is a far more realistic reflection of your financial condition should you face an immediate need for money such as a medical crisis or a business opportunity. While liabilities remain the same for both calculations, your liquid assets have more significance when unforeseen events occur.

Those assets for readily available as cash with little or no loss of value to be counted in liquid net worth. Having liquid money provides a sense of financial security for disasters and opportunities alike.

Asset Rich Cash Poor Can Be Uncomfortable

To a great degree, when you need to take money out to pay for an unforeseen event, would it be easier to take $15,000 out of your savings account or sell your land? Depends if you have $15,000 in the bank. The expression “asset rich cash poor” comes to mind. Often, people have economic assets like land or other economic interests but are not able to easily liquidate them for money.

Land and antiques are assets we have owned and enjoyed. However, you can’t count on those assets to pay for a costly emergency in your life. When I think about mistakes I have made, those purchases stand as major regrets. You sleep easier with access to liquid assets.

What Is Net Worth?

Your net worth is your personal balance sheet that provides a snapshot of your financial position at that time. Net worth is all that you own less than all that you owe. For an expanded explanation, see 10 Reasons Why You Need To Know Net Worth.

The  Formula: Net Worth =  Total Assets less Total Liabilities

Using an excel spreadsheet with different assets/liabilities is an excellent tool for you to put all of your categories in one place that can be periodically updated. You should do it on at least a quarterly basis. However, if you are true to your monthly budgeting, reviewing your monthly net worth is better.

Try putting it on a spreadsheet first. You can use Personal Capital’s net worth app for tracking your investments. Frankly, any way you can keep on top of your net worth with an eye towards building the amount will work.

Knowing Your Net Worth:

  • is a crucial benchmark and report card at a particular time.
  • will allow you to set near-term and long-term goals.
  • track its changes for better money management.
  • highlight your liquid asset balances.
  • helps you to get a loan for a house, car, college tuition, or new business.
  • pay down high-cost debt.
  • refinance your mortgage loans.
  • encourage you to save and invest more.
  • buy your own home, rather than pay high rent.
  • is a great road map to building your wealth.

 

What Is Liquid Net Worth?

Although net worth provides a view of your current financial condition, it doesn’t differentiate the assets that can provide you with liquidity quickly and easily. When facing a medical crisis or an opportunity to buy a business, getting access to your money matters. Sure, you can sell your car quickly but likely for less than the estimated value. Understanding what assets are more liquid means they can be readily converted into cash with little or no loss in value.

The Formula = Liquid Assets Less Total Liabilities

You can either remove non-liquid assets from your total assets or discount their values from their appraisals. Additionally, you need to recognize that tapping certain assets too early such as retirement accounts could result in paying penalties and taxes. More than that, you lose momentum when you withdraw assets that were benefiting from compounding growth.

 

Your Liquid Net Worth:

  1. Understand the differences between your net worth and liquid net worth. Liquid net worth is what you need to count on for immediate funds.
  2. Liquidity varies among our assets which have different growth rates. Money market accounts are liquid but typically have lower returns than stock investments long term.
  3. Consider costs involved in the transactions such as penalties, taxes, fees, and such

 

How To Calculate Your Liquid Net Worth?

Liquid Assets:

  • Cash
  • Cash-Equivalent Securities
  • Brokerage/Investment Accounts

The most liquid assets are cash, cash-equivalent (or money market) securities, and investment or brokerage accounts. These are either already in cash or are those financial or monetary assets that can easily turn into cash with little or no loss in value.

Cash is the best form of liquidity but of course, doesn’t grow unless it is invested.  This category broadly consists of cash on hand, prepaid cards, savings accounts, checking accounts, money market accounts, certificates of deposit (CD), savings bonds, and emergency funds. If your CDs are in a fixed term like 6 months or a year, you may need to pay a small prepayment penalty but this is fairly accessible money. Separately, you need to have an emergency fund earmarked for unforeseen expenses.

Brokerage/Investment Accounts

All types of financial securities can be bought or sold in your brokerage account. Typically, they are stocks, bonds, REITs, mutual funds, and ETFs that are in these taxable investment accounts. While these accounts are liquid in a matter of three business days, you do pay taxes on price appreciation based on the time you held the security. Holding the securities for over one year is taxed at a lower 15% capital gains rate. Otherwise, you pay taxes at the same rate as ordinary income.

Less Liquid Assets

The cash value of your life insurance policy is fairly liquid but you may have to absorb small fees. Depending on the company, it can take more time (eg. 10-20 days) than access to financial securities. On the other hand, access to pensions and investments in real estate such as multifamily homes are less liquid.

Retirement Accounts

When withdrawing money from your retirement accounts before you turn  59.5 years,  you will likely be hit with a 10% penalty and immediate payment of taxes, losing the deferred benefit on that amount. Generally, if you withdraw early from a 401K plan or IRA account you will pay taxes at your marginal tax rate. The marginal tax rate is the tax rate paid on the dollar of earnings (eg 22%-24%).  On the other hand, Roth IRAs are treated differently. For those accounts, so long as you have had this account five years or more, you may withdraw contributions you made to your Roth IRA anytime tax-free and without penalty.

While you may have access to your retirement savings, these are not considered to be liquid. You should not dip into your retirement accounts unless needed as a last resort. By withdrawing these funds, you lose the compound benefit on this money for your future when you are less likely to earn money at your job.

A Temporary Exception

The federal government had waived the 10% penalty if you made a withdrawal between January 1 and December 31, 2020, for those impacted by COVID. Qualified individuals that put back this withdrawn money within a three-year time frame will be excused from paying taxes on the money.

If you are including retirement accounts in your liquid net worth, you should discount your retirement balances by 25% to be conservative.

529 College Savings Accounts

Like retirement accounts, withdrawal of money saved in a 529 college savings plan may be subject to a 10% penalty and you will have to pay taxes. The exception to this rule for 529 savings is withdrawals made for qualified education expenses such as tuition, fees, books, computer, and related costs.

If you are including 529 accounts into the liquid net worth, I would use a similar discount of 25% off the account balance.

Other  Assets

The cash value of your life insurance policy is fairly liquid but you may have to absorb small fees. Depending on the company, it can take more time (eg. 10-20 days) than access to financial securities. On the other hand, access to pensions and investments in real estate such as multifamily homes is less liquid.

Tangible assets

These assets are real and personal property that reflects your lifestyle and is harder to liquidate for funds.

Your Primary Home

If you own the primary home you live in, this may be your largest asset. While the home is an investment, it is not a liquid asset like financial securities you invest in. You cannot count on liquidating real property for quick conversion to cash. You need to figure out how the real estate market is faring in your area using Zillow Zestimate and other sources.

Selling your home is a complex process that can take several months or more to accomplish. An appraisal value is not necessarily your sales price which is often lower. Also, to complete your sale, you are responsible for fees and costs including broker fees of 5%-6% on the sales price, closing costs of 1%-2%, and attorney costs.

Most likely you are carrying a mortgage that is picked up in total liabilities. Upon the sale of your home, you will pay off your mortgage in full from the proceeds of the sale of your home, reducing your liabilities.

Your primary home as an asset should be discounted about 25%-30% off its estimated value for purposes of liquid net worth.

Other Real Estate

Besides your primary home, you may own other types of real estate, including vacation or second home, timeshares, land, and rental property. Having just sold a plot of land, I can tell you that we took a 30%-35% hit from our cost basis in an ugly market after putting it on the market over a year ago.

Use current conservative market values for real estate. Appraised values may not reflect actual sales or liquidated values. You should not be inflating your liquid or net worth unrealistically.

You would need to approximate the value of your home, cooperative, condominium, cars, boats, and any other large items. To approximate real estate values, you can look at Zillow Zestimate, Redfin, Chase Home Estimator, or real estate websites for your zip code.

Your Business(es)

If you own businesses outside of your primary income, it is tricky to calculate a value let alone consider it to be a liquid asset. While you may want to include in your net worth statement a discounted multiple of annual revenues, it doesn’t make sense to include for purposes of liquid net worth unless you had the business appraised and a ready buyer.

Personal Property Is Tricky To Value

Unless you have a meaningful fleet of cars and boats, you should not add these to your assets for your net worth or liquid net worth.  These assets depreciate too fast and sell too slowly to add fairly to your liquid net worth. If you do have that fleet, for cars, you can look at Kelly Blue Book, Edmunds, or AutoTrader. Similarly, for boats, you can consult Boat Trader.

What Else Goes Into Total Assets?

Art, rare books, rugs, and antiques may be a large part of the net worth of wealthy households handed down to the next generation. Unless they are highly desirable or rare, these assets tend to be wildly low liquidated values to count on if you needed money in a pinch. Musical instruments have their value, but again, they are very difficult to peg and their sales are less predictable to raise capital.

This category has a lot of sentimentalities but its value may be very difficult to ascertain. In my opinion, these assets should not be counted on unless you work with an estate professional steeped in knowledge and who has a terrific network to help you sell the items.

My Own Personal Experience Provides A Valuable Lesson

When I worked on Wall Street, I was restricted from making investments in financial securities. If on that rare occasion I was able to buy certain securities, I was often not allowed to sell that security when I wanted to. So, on either side of the trade, I was burned and finally abandoned investing until I left my career as an equity analyst.

So what did I invest in?

A large part of our assets was in art, rugs, rare books, and antiques. What was I thinking?

These assets are on our walls (art), in our bookcases (rare books such as the first edition of the Federalist Papers), on the floors (ancient rugs), and antique furniture (signed in the mid-1760s by the cabinetmaker).

Ever try to sell an 18th-century Tiger Maplewood card table? We have! And we are still waiting for that sale.

Beautiful stuff, but they can’t pay the bills! So I don’t include these personal assets. The few pieces we have sold were at prices 70% below what we paid for them.

I digress but a worthwhile lesson for those who are collectors.

List all your Liabilities By Current Balances

 

Mortgages

  • Your mortgage loan balance is probably your largest liability.
  • The home equity loan balance.
  • Separate mortgage loan balances for the other real estate property (listed above in assets)

Other Loans

  • Student loans at the current balance.
  • Loans associated with the business(es) even though you aren’t including the value of the businesses.
  • Personal loans
  • Credit card account balances (you should break these out individually).

Related Post: Pros And Cons of Credit Cards

Total Liabilities

As mentioned earlier, the formula is fairly easy:

Total  Liquid Assets minus Total Liabilities = Your Liquid Net Worth

Depending on the composition of your assets, it is possible that your liquid net worth may be negative, especially when you are conservatively discounting large assets like your home but including the full mortgage balance. It is important for you to consider whether you need to adjust your investment strategies, spend less, save more, and make sure you have money for emergency purposes.

 

How Can You Build Up Your Liquid Net Worth: Make Good Trade-Offs

Track changes in your liquid net worth statement as early as possible to make sure you are making progress towards your goals.

Track your spending, review for areas you can reduce and produce savings

Have an ample emergency fund of 6-12 months for unexpected events like a lost job. Invest this fund in a liquid account like money markets.

Put more of your money into investment assets like stocks that can expand wealth rather than in personal possessions.

Add to your retirement accounts to the contribution limit. Avoid withdrawing money from these accounts which trigger penalties and taxes. The same goes for 529 plans.

Making more money at your job or a side gig to boost income.

Consider buying recently used cars than luxury fast-depreciating vehicles.

Choose to invest based on your appetite for risk and where you are in your life cycle.

Related Post: How To Make Better Trade-Offs

Where Should I Invest My Money To Maximize My Liquid Net Worth

Stocks are riskier but generate higher returns than keeping your savings in bank accounts at low returns.

According to Bankrate, the best annual percentage yield (APY) which is your effective annual return as of August 28, 2020 ranges from  0.60%- 0.91% for the top ten banks. Those paltry rates which do not provide much in the way of income. Typically, banks may require a minimum balance from $1 to $25,000 and have monthly fees up to $15.

The younger you are, the more able you are to ride out the greater risk found in stock investing, with the benefits of compounding effects.

Homeownership remains a worthwhile investment with currently low mortgage rates. But your home is less liquid than financial securities.

Decreasing your loans or debt liabilities will increase your liquid net worth.

Your Mortgage Loan Deserves Your Careful Attention

Look into refinancing your mortgage if you carrying a mortgage with more than 5% loan rates. You may realize savings.

Target carefully what you borrow, for how long, and at what rate. Look at taking out a 15-year mortgage loan versus a 30-year mortgage loan. While your monthly payments will be higher for the 15-year loan, total borrowing costs will be lower.

Taking on a mortgage loan is a big cost but home prices have generally kept pace with inflation until 2008-2009 when subprime mortgages played a huge factor in declining home values.

Lower Your Debt Where Possible

Pay off your credit card debt in full. It’s likely your highest cost debt so use extra savings, bonus, or tax refund to lower this amount. Otherwise, slow your spending.

Pay off your student debt as soon as you are able.

Final Thoughts

While net worth is a more common benchmark, refining your assets for liquidation purposes gives you a more realistic picture. Tracking liquid net worth helps you to understand your ability to deal with a crisis or an unexpected opportunity. When facing an immediate need for cash, you don’t want to withdraw funds that are earmarked for retirement.

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Saving For Retirement In Your 20s

Saving For Retirement In Your 20s

Saving For Retirement Yet?

Savings, investing, and retirement are very related, yet the topic of retirement planning gets pushed off to the side.

We fear dealing with the unknown, or we are neglectful.

Instead, planning early and often for retirement will empower you to control for a stage of life that could quite exciting if done right.

It is always an excellent time to start thinking about saving some tax dollars long term.

Start As Early As Possible

You can start planning for retirement at any age, but the earlier, the better. Start in your 20s to take advantage of tax benefits, compounding interest, and peace of mind when you are older.

According to a 2017 study, 12% of Generation Zers are already saving for retirement. Another 35% of the participants plan to start saving when they are in their 20s. Gen Zers, also called iGen and Post-Millennials, seemed to have gotten the strong message that controlling your destiny, including retirement planning, should be in your hands.

A Mini Case Study 

As a college professor, I teach Gen Zers, but I learn so much from them. Recently, I opened up a discussion on marketing, lifestyle, and status with a question about how millionaires live.

Not surprisingly, many students volunteered with images of luxury cars, mansions, yachts, but one student yelled out, “They have lots of savings and invest more.”  Suddenly, the class took a turn, and others shared how they had “put some money away” while another had opened a retirement account.

One of my quieter students hesitated and then forcefully shouted out, “Professor, I am 18 years. There is no *#!^$ way I am saving now for retirement !” A hush came over the room, some students giggled, and suddenly several students started sharing their thoughts about saving, investing, and starting early on retirement.

My students said that their parents hadn’t saved much “for anything.” The students wanted to do better for themselves by planning for retirement early. They intend to put money into their retirement accounts. They don’t think Social Security will be there for them.

I always recommend books to my students and offer points toward their grade if they write a short essay. They seemed eager for points, so I suggested: The Millionaire Next Door: The Surprising Secrets of America’s Wealthy: Thomas J. Stanley, William D. Danko. If you haven’t yet read this book, it identifies the key traits of those who accumulate wealth by emphasizing that putting away money for your future is paramount.

By the way, a surprising number of my students have taken up the offer, read the book, and submitted an essay for their extra points.

 Why You Need Retirement Planning Early

  1. Life expectancy has increased significantly since 1960. Recent forecasts point to further increases to 83-86 years for men and 89-94 years for women in 2050. Assuming you retire at 65-66 years, you will need 20 years of savings at a minimum.
  2. There could be challenges for Social Security retirement income benefits. About 65 million, or nine out of ten Americans, aged 65 or older received $1 trillion in social security benefits in 2020.  These income benefits represent 33% of the income of the elderly.
  1. Defined pension benefits have a long history but were a 20th-century cornerstone for retirees. A defined benefit pension plan promises a specified pension payment or a lump sum payment from your employer when you retire. It is a particularly desirable compensation perk but declining in use like rotary phones (a now antiquated way to dial a telephone). Today,  only 4% of private-sector workers only participate in pensions, a significant decline from 60% in 1980.

 Retirement Goals You Should Consider

  • Start saving early in a retirement account even if they are initially small amounts. 
  • Raise your contributions accounts as you receive salary boosts and bonuses.
  • Put up enough dollars to earn your employer’s match.
  • Aim to contribute up to the limit allowed for your 401K employer-sponsored 401K and your Roth IRA plans. 
  • Borrow from retirement accounts only as a last resort. 

 

Retirement Accounts are Really Investment, Not Savings Accounts 

By saving early in your retirement, you are investing for the long term. Through the benefit and magic of compounding, you can have substantial funds by contributions, even if you begin with a relatively small amount in your 20s. 

 For example, Emily is 35 years old and puts 6% or $4,200 of her annual salary into the plan. Her account balance would be $279,044 with a 5% yearly return and 30 years until she retires at age 65. That amount would jump to $397,000 if she opted for a more aggressive fund at a 7% return along with higher risk. These amounts do not reflect an employer’s potential matching contribution.

Have Tax Advantages 

There are different retirement accounts, but they have a few things in common: they have tax advantages with varying growth scenarios depending on your preference. They have contribution limits set by the IRS that have increased over the years.

The best known of all retirement plans is the traditional 401K.  They have primarily replaced the defined pension benefit plans.

Most, but not all, employers provide the 401K plans for recruitment and retention purposes.

Small companies, which typically have resisted offering these plans because of cost concerns, often have many part-time or contract employees. They have been slower to adopt these plans and can choose to provide SIMPLE 401 K (see below).

Varying 401K  Plans

If you consider employment between two companies, examine the competing offers based on their sponsored plans for employer matching of your contribution.

Typically, a company will match 50% of every dollar you annually up to a percentage of your gross income, usually around 6%. Some companies match on a dollar to dollar basis but at a low rate of your salary.

Your contributions are on pretax dollars up to $19,500 in 2021, with an additional $6,500 contribution allowed if you are over 50 years as a catch-up measure.

Using pre-tax dollars, defer your federal and state taxes paid upon withdrawal, beginning age 59.5 years. Withdraws before that time will usually result in a 10% penalty. If you are retired, you must begin withdrawing required minimum amounts (RMDs)  by age 70.5 years. 

Greater Participation In Retirement Plans Can Happen

About 70% of all US workers have access to employer-sponsored plans, including 401K, 403b, 457, and the federal government’s Thrift Savings; 55% are participants. As more companies offer automation of contributions directly from paychecks, more employees will likely participate. 

If your company offers a 401K plan and will give you some kind of employer match contribution to add to your own, you are robbing yourself of that gift, and the compounding benefits for the many years you have until retirement. You are just leaving money on the table! 

Surveys have indicated that some employees say they don’t participate in their employers’ 401 K plans because they get overwhelmed by the possible choices they have and then postpone signing up for the program. Employers have encouraged employee participation by providing more information about investment choices and transitioning to opt-out offerings, rather than opt-in.

You can make changes in your selections if you think you picked a too aggressive or too conservative investing approach. Pick one and read your statements, familiarize yourself with the other choices if you want to make a change. Just make sure you start your plan and put in enough to qualify for and trigger your employer’s contribution. 

Roth 401K is similar to the traditional 401K but uses already taxed dollars, so your withdrawals are tax-free.  Roth 401K’s began in the retirement lexicon in 2006 after the introduction of Roth IRA.

Other 400 Plans For Different Organizations

403(b) plans are for employees of non-profit organizations.

The 457 plans are for state, local government employees, nonchurch, and other tax-exempt organizations. No employer contributions are allowed for this plan.

Employers with 100 or fewer employees offer Savings Incentive Match Plan for Employees or SIMPLE 401 K. Employers must choose between making matching contributions up to 3% of each employee’s pay or nonelective contributions of 2% of employee’s pay.

Traditional IRA

If you don’t have access to a 401K plan, or even if you do, you can personally set up your retirement account with a traditional IRA or a Roth IRA.

Your contribution to a traditional IRA is in pretax dollars. You defer tax payments until you make withdrawals at age 59.5. If you take out money from your IRA before age 59.5, you will pay taxes and may trigger a 10% penalty plus tax. You may contribute $6,000 in 2021, or $7,000 if you age 50 or older.

IRA withdrawals begin at age 70.5 as required minimum distributions or RMD.

The logic behind paying taxes at an older age is that you may be in a lower tax bracket. However, the reason may be in reverse, and that’s why Roth IRA’s have increased in popularity. Of course, your tax brackets will reflect how well you do in your career, and it is not likely you know that in your 20s.

Roth IRAs

With Roth IRAs, you contribute after-tax dollars, and your money grows tax-free. Your withdrawals are tax-free after 59.5 years. 

Roth IRAs have no required minimum distributions like their older IRA counterpart. You may be able to withdraw your contributions, not your earnings, before age 59.5 years without penalty if your Roth IRA has existed for five years or more.

In many ways, Roth IRA has been the preferred vehicle for personal retirement accounts and are more tax-friendly longer term.

Arming yourself with both 401K and IRA retirement accounts is the minimum planning you can do when you are in your 20s and 30s.

Borrowing Money From Your Retirement Savings Is The Last Resort

There are times when you face financial hardship and consider borrowing from your retirement plan.  Your 401K plan (not your IRA plan) allows you to borrow from your retirement assets and repay the amount with interest to your account rather than to a financial institution.

One of the most significant drawbacks of using your retirement assets is the loss of tax-deferred compound growth for the loan duration. Taking assets out of a retirement account should be a last resort. We discussed withdrawals, and if you do so too early, you pay taxes and penalties.

Final Thoughts

You have long years in front of you. Starting early in your planning, even with small amounts, allows you to benefit from compounding growth through the years. Earning interest on interest adds significantly to your retirement fund. 

Do it early so you can avoid the real angst of not planning. Procrastination is not an answer for anything! You’ll be glad you are getting a headstart!

Thank you for reading! 

 

 

 

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