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Saving Spending Uncategorized

Money Lessons from the Pandemic

The COVID-19 pandemic has been a sobering experience, to say the least:  Lockdowns, supply shortages, skyrocketing unemployment, a stock market plummet, and, worst of all, over 58,000 deaths in the U.S. caused by a virus that is not fully understood.  I’ve been fortunate to remain employed and maintain the same income, but if the lockdown continues for an extended period of time, my employment becomes more and more uncertain.  The increased risk of losing my job has motivated me to examine my life to see what I can do to lessen the impact of unemployment and to take preventative action to ensure I can cover my essential expenses for as long as possible in case I’m laid off.

Lesson:  Use Anxiety, Fear, and Stress to Reduce Expenses

Hopefully you share my experience of not having your income impacted by the pandemic.  If you’re like me, though, anxiety and concern about “what if” have entered your mind after seeing 20% of the U.S. file for unemployment:  What if I lose my income or my income is impacted?  Let the “what if” motivate you to examine your expenses to see what you can cut out.  I’ve been focusing on reducing my expenses to the bare minimum so that I can pay for essential expenses (home, food, and transportation) for a longer period of time should I lose my job.

Eating out has long been one of my largest monthly expenses, with me sometimes eating out multiple times daily, so the pandemic and associated restaurant closures have presented a great opportunity to buy groceries and prepare meals at home.  In the past, I’d accomplish my goal of eating out less for three or four days in a row, at most, but then would slide back into old habits.  During the pandemic lockdown, I’ve loved seeing the savings of eating at home and prepping multiple meals when cooking, since I can quickly run to my fridge for food when I’m hungry and want to eat quickly.

Subscriptions and memberships to various services have also been on my chopping block.  Subscriptions are sneaky because they’re often not large expenses and aren’t attention grabbing, so often we pay them blindly every month.  In this pandemic, I evaluated many of these subscriptions that I “just pay” monthly to see if I really valued them:  Amazon Prime, credit card annual fees, Netflix, a Wall Street journal subscription, and more.  I cancelled some of these that I don’t really, really value, including unused gym memberships (I had four at one point which, yes, is ridiculous) that have been reduced to two memberships, both of which I use on a frequent basis.  In part two of the Personal Finance Foundation series (you can check it out here:  https://wp.me/p2zuKS-eo), I described how expense cutting can help you build net worth.  Reducing expenses during the pandemic has left me with more cash to save and invest, both of which build net worth, and both of which are very fulfilling to do.

Lesson:  An Emergency Fund Fosters Peace of Mind

Emergency funds are a basic component of a financial plan and for good reason.  An emergency fund serves as a buffer when you have an interruption in income or when you have unexpected expenses.    In times like these, if you lose your job but have an emergency fund, that emergency fund can tide you over.  Specifically, you can determine how long your emergency fund will tide you over by taking your monthly expenses and dividing it by the size of your emergency fund.

For example, if your expenses total $2,500 monthly and your emergency fund is $7,500, you could afford to live solely off your emergency fund for three months.  Of course, if you pick up a side hustle after you’ve been unemployed and generate some income, or if you crunch down on expenses, you’ll make your emergency fund last that much longer.

If you’re fortunate and haven’t lost your primary source of income, though, the emergency fund provides you peace of mind.  When it’s not needed, the emergency fund is a soft landing for you on a rainy day that reassures you in trying times.

Lesson:  Generosity is a Calling that Lifts Our Spirits

“Then the king will say to those on his right, ‘Come, you who are blessed by my Father. Inherit the kingdom prepared for you from the foundation of the world.  For I was hungry and you gave me food, I was thirsty and you gave me drink, a stranger and you welcomed me, naked and you clothed me, ill and you cared for me, in prison and you visited me.”

Matthew 25:34-36

A good friend and coworker of mine teaches his children that it’s advantageous to be good stewards of financial resources so that they can bless others when others are in times of need.  He emphasized to his children, “how would you feel if your brother or sister needed money but you were broke due to having mismanaged your money?”

I’ve found a degree of joy and peace during the pandemic by giving financial help to friends who lost their employment and by giving to Catholic Charities, who does a wonderful job of allocating cash donations to folks who are struggling.  Catholic Charities recently informed me of a case where a struggling mother contacted them informing them she’s unable to pay her electric bill due to losing employment.  Catholic Charities not only paid her current month’s electric bill but went above and beyond to pay all her current month’s utility bills.

If you have the ability to help others financially, I highly recommend doing so, especially if you’ve struggled spiritually, emotionally, or mentally during the pandemic.  The act of giving helps others and it also lifts you spiritually, emotionally, and mentally.  I’m a huge believer in the concept of building myself into the person I admire so that I can give him away, and I’m proud I’ve built a solid financial foundation so that I have the ability to help others in times of critical need.  If you’re not in a place to help others currently, remember the feeling of not being able to help and use it as motivation to strengthen your financial situation so that you’ll be better prepared to help in the future.

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Investing Retirement

Personal Finance Foundation – Part 4 – Invest, Invest, Invest

Having examined how you can grow net worth by reducing spending and growing income, we now come to the most powerful tool for growing net worth: Investing. Reducing spending produces quick wins in growing net worth, but there’s only so much cost cutting you can do until you are living on a bare bones budget. Increasing earned income is a great way to increase your net worth that, theoretically, has no ceiling, but we all know that raises don’t come easily. Also, even if you do get that raise, you’re still trading time for money.

What if there was a path for you to augment employment income by having your assets work for you and earn money for you?

The Miracle of Compounding Interest

I started investing when I got my first full-time job out of college. I put 5% of my salary into a 401(k) and, following my older brother’s advice, I maxed out a Roth IRA. For better or for worse, I socked money away in both accounts and didn’t spend much time looking at them except to rebalance occasionally. I say this was “for better” because shortly after I started working full time, the subprime mortgage crisis contributed to the stock market crashing and, as a result, my 401(k) and IRA accounts lost almost half their value. Had I been more attentive to my retirement accounts, I would have seen them hemorrhaging value which likely would have caused me grief. While I’m very committed to leaving my retirement accounts alone until retirement, I’d rather not test my resolve.

You may be thinking, “you’re not much of a personal finance person if you only put 5% of your salary into your 401(k).” If I remember correctly, I received a 3% match on this contribution but, you’re right that 5% is less than I’d recommend anyone invest. Over time I gradually increased my contributions so that now I contribute over 20% of my gross income to my 401(k) and also max out IRA contributions. Now I have well over a decade’s worth of compounding interest rewarding me for my efforts.

What is compounding interest? A plain English example: You start off with $1,000 and earn 10% interest annually. The first year you earn $100 in interest, which leaves you with $1,100 total. The second year you earn $110 (10% of $1,100) in interest, which leaves you with a total of $1,210. Keep repeating this math (or, even better, use this great compounding interest calculator: http://www.moneychimp.com/calculator/compound_interest_calculator.htm) and you’ll have $1,610.51 at the end of five years.

The beauty of this $610.51 growth (the difference between the red line and the blue line in the picture above) is that you didn’t trade time for money to gain the $610.51. Instead, your money sitting in an investment account worked for you to earn more on your behalf. Extend your timeline to 15 years and your initial $1,000 turns into $4,177.25. Mind you this growth is happening without you adding a penny extra. Change the initial $1,000 to $5,000 with the same 15 year timeline and 10% interest rate? You wind up with $20,886.24.

If you use your imagination a bit, you’ll see how you can leverage compounding interest in a very powerful way. It’s not very likely that you’d make contributions to your retirement accounts only in your first year of employment but never again, right? If you make the first year contribution of $5,000 then add $5,000 every year for 15 years at a 10% interest rate, at the end of 15 years you end with $179,748.65. Not bad, huh? Key takeaway: $29,748.65 in growth that occurred (your $150,000 of deposits subtracted from the $179,748.65) didn’t require your time, sweat, energy, or tears. Instead, your money worked for you.

One of the most powerful variables in growing wealth via compounding interest is time. If you extend the previous example from 15 years to 30 years, you witness astounding growth.

“Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” – Albert Einstein

The Basics: How to Invest in the Stock Market

You may be thinking, “OK, great buddy. I want some of this stock market action and having my money work for me. Where do I start?” A common place to start, and where I started, is in an employer-provided 401(k) retirement plan. Think of the 401(k) retirement plan as a wrapper for investments, and stocks as an investment you can put inside this wrapper.

A significant benefit of the 401(k) retirement plan is the tax advantages that come along with it. When you invest in the 401(k), your annual taxable gross income is reduced by the amount you invest, and the invested money is not taxed until you withdraw it. If your employer, for example, uses Fidelity to manage their 401(k) plan, you would create an account on Fidelity’s web site or use the account created for you by your employer. Once you log into the account, you’ll be able to select from likely a variety of investment choices.

One very common selection to make in 401(k) plans is a target date retirement mutual fund, which automatically adjusts the mutual funds holdings (think stocks, bonds, and cash) as you approach your targeted retirement date. In general, it’s a good idea to move gradually from riskier investments (think stocks) to less risky investments (think bonds and cash) as you approach retirement.

The volatility of stocks could cause the loss of a significant amount of your nest egg as you enter retirement, so it’s best to have some protection against this volatility. A great example: Retirement portfolios immediately after the sub prime mortgage crisis lost almost 50% of their value. It took roughly three years (until 2012) for the stock market to recover the lost value. How would you feel if you planned on retiring in a given year and then observed almost half your nest egg evaporate?

I’ve just described investing in the stock (often referred to as the equities) market, but there are many, many other types of investments. An alternative investing technique I’ll discuss next is real estate, specifically rental property, investing.

A Second Investment Vehicle: Real Estate

A brutal reality I observed during the subprime mortgage crisis were retirees needing income from their 401(k) accounts while seeing almost 50% of their balances evaporate. Hindsight tells us that the stock market recovered these losses within a few years, and then entered a very long bull market, but I could empathize with the fear and anxiety experienced by retirees who depended on their 401(k) to navigate retirement.

About the same time, I learned of a concept I found fascinating: The multi-legged retirement stool. In short, what if your retirement income didn’t solely depend on a 401(k), with its commensurate stock market volatility, but was also funded by another source of income? A three-legged stool has stability not by relying on one or two legs but on three legs. Similarly, your retirement income could have more stability if it didn’t only rely on income from the equities market.

While I love the simplicity of investing in index funds within a 401(k) and and a Roth IRA, I also love the dependable income stream produced by rental residential properties. People will always need a place to live, so there will always be a demand for residential real estate. Though we’re certainly witnessing significant disruptions of rental income streams during the COVID-19 pandemic, I sleep better at night knowing I have three disparate sources of potential income: Employment, retirement accounts, and rental property.

My long-term plan for bear markets (significant stock market downturns) is to rely more on rental property income to fund my lifestyle while simultaneously leaving my 401(k) and IRA accounts untouched so as to not make paper losses real losses. In other words, while the stock market may be down and your retirement account balances may be down, these losses aren’t realized until you withdraw money from retirement accounts, thereby selling shares at lower prices when it would be better to sell at higher prices.

In the worst case scenario of both the stock market being significantly down and your renters not paying their rent, a scenario that is highly unlikely but that is occurring with some landlords in the country as renters lose employment during the pandemic, take advantage of your emergency savings to tide you over until either the stock market or rental income stabilize.