Monthly Archives: February 2010

A Realistic Look At Financial Security

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The following post is from Kevin of 20smoney.com and SimpleFinancialFreedom.com.

There are a few ideas and terms that the masses throw around in an effort to mitigate risk and be more financially secure. The terms that come to mind are emergency fund and diversification. While these are valid concepts, I don’t think they complete the picture of financial security that we should all strive towards.

Most people would agree that economically, we’re in better shape now than a year ago. While we can debate to what degree, I think it would be wise for us to assume that we’re not better off. We should assume that we’re still in the middle of a recession (we probably are), and that things could still get worse. Furthermore, we should assume that it is very likely that we lose our job or lose our income in the near future. If not a complete income loss, we could easily see an income reduction as business revenues and sales continue to struggle.

I’m not here to convince you that these things are going to happen, but rather to convince you to prepare for the event in which they do. If things turn for the better, the economy improves, and your income increases, then great! If not, hopefully you’ll be prepared. So, what to do?

Redefining the Emergency Fund

Most people understand the purpose of an emergency fund: to save up a chunk of money that can pay for our expenses in the event of income loss or a major unexpected expense. By establishing an emergency fund, you can pay your bills and buy groceries with this fund versus tapping a credit card. This is a smart strategy, but I believe there should be more to it.

Storing supplies and consumable goods should also be a part of your emergency “fund”. Your emergency fund is used to pay for stuff when you can’t afford it. If you prepare accordingly, you can use your funds to pay the bills, but hit up your supply stash for products like toiletries, food, canned drinks, etc. The combination of emergency funds and emergency supplies means you can last longer on your own in the event of a loss of income. Furthermore, using your stored supplies for things like food will prevent you from going out to dinner when you should be saving your money during this phase. Lastly, your storage supplies can double as emergency supplies in the event of a disaster or supply shortage. By adding supplies to your emergency fund, you are increasing both your financial security and your independence; a winning proposition in my opinion.

Diversification of Income

We love to spout the fancy term diversification over and over when we’re referring to our investments, yet most of us go through life being completely non-diversified with regards to our most important financial asset: our income. The simple fact is that too many people rely entirely on a single income and are unprepared for the possibility of an income decrease or elimination. In addition to preparing a robust emergency fund as described above, a second prudent step (especially over the long-term) is to diversify our income.

While employed and making money, it’s important to spend some of your free time working on the development of a second income stream. While everybody would agree that such an idea is a wise strategy, probably less than 5% of people actually act on it. I guess television is too enticing.

To start the process, take an inventory of the skills or tools that you possess. Maybe you have excellent graphic design skills, or you can do a range of household repairs, or maybe you have quality lawn equipment. Next, analyze your contacts that might help you get going on this income/business venture. Who might be potential customers? Who might help you find additional customers?

Growing an alternative income stream takes hard work, and will be much slower than you think since you’re spending your limited free time working on it, but I believe it is a worthwhile process. Be organized, determined and patient. Over time, you will see results.

The great thing about working on a second income stream is that it has the potential to eventually turn into a thriving business. It is a less risky form of becoming an entrepreneur. Even if it doesn’t grow into a huge business, the additional income will help boost your savings and help you survive if you lose your main income.

Conclusion

Financial security is a topic that we should all take more time to thoroughly discuss. I have severe doubts about the years ahead with regards to the U.S. economy; as such, I’m doing what I can to prepare for whatever situations I’m forced to encounter. If I’m wrong on my economic views, I’ll still be in great shape with a few extra dollars in the bank and maybe some stocked closets full of goods to use. Such a conclusion would hardly be a bad one. I strongly believe we should prepare for the worst and hope for the best. When it comes to your finances, this old cliché is definitely applicable.

What are some of the ways you’re improving your financial security?

Setting Up a Frugal Home Office

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My family recently moved and we have settled into our new home. While we love our new house, it did have one glaring problem for a wanna be writer – no home office space for Frugal Dad. Not to worry, as you may remember I’ve had experience setting up a home office in laundry/utility rooms, bedroom corners, and even recently threatened to convert our outside storage building to a home office.

Initially, I dreamed about setting up my own shop remotely. It would be nice to have a place to go to do some writing out of the house without having to share the space with diners, coffee drinkers or teenagers playing online games (this is the setting of most places with wi-fi in my area).

I checked out a few online listings for office space and found a promising lead. A local real estate office was renting out one of their unused offices for only $400 a month, including utilities. I talked with the manager of the firm and rode by to check out the office. It was nice, but something told me not to sign right away.

While I came away with a favorable impression of the space, I added up the annual costs on the way home and realized it would cost me nearly $5,000 a year to fund this extra space. There had to be a more frugal alternative. I returned home to do a little brainstorming.

Setting Up a Home Office: The Before Picture

frugal home office

Yes, that’s our master bedroom closet. Well, half of it. And yes, this is the place where we just threw everything we didn’t have room for elsewhere. The fun part about moving is that you get to discover just how much crap you’ve accumulated over the years. I told my wife I was going to use my half of the closet to create a writing area. Once I convinced her that her side would be unaffected, she went along with the idea.

My first order of business was going through some old clothes I had accumulated over the years and no longer wore. I wound up bagging three bags full of old shirts, sweatshirts and miscellaneous t-shirts simply taking up space. I donated them to a local men’s shelter in our area, and they seemed grateful.

With the clothing racks cleared on one side, I moved that file cabinet into one corner of the office, and relocated an old table sewing machine my grandmother used (bottom right of that picture) to another room. I cleared out the remaining stuff (including the giant Christmas gift bag, which I embarrassed to confess still held most of the contents of our family’s Christmas stockings!).

The Frugal Home Office: After Picture

home office picture

After sliding the file cabinet into the corner, I had plenty of room for a four-foot folding table. This was the ideal size, and since I already had one on hand, I made it work. The only other supplies needed, in addition to my writing laptop, was a simple scratch pad and pen, and a small basket with basic office supplies (stapler, dry erase markers, etc.).

As you can see, not much decorating going there. I did hang a dry erase/bulletin board and my kids were nice enough to supply a few early Valentine’s Day decorations. That sticker on the side of my filing cabinet has been there for several years and reads, “Live Like No One Else.” You might recognize that quote from Dave Ramsey. For years I looked at that sticker while toiling away on my side hustles with the goal of debt freedom in mind.

The books on top of the file cabinet represent just a small section from my budding personal finance library. You might recognize a few covers as Your Money or Your Life, Work Less, Live More, The Tightwad Gazette, America’s Cheapest Family, and the recent release from Gary Vaynerchuck, Crush It. The supply rotates as I discover new reads, but these four or five books stay because I always go back to them for ideas and inspiration.

In case you are worried about me becoming claustrophobic, I should tell you that since taking the picture I used a bungee cord to band those clothes on the right side and pull them closer to the wall. They were mostly warm-weather shirts, so I won’t be needing them for a while anyway. This freed up a lot of shoulder room, but honestly it felt pretty cozy without the extra space.

I couldn’t be happier working away in my frugal home office. I’m fairly isolated from other noises in the house, even with the door open (I can always close off the bedroom door and leave this one open if the kids get too noisy). I don’t expect everyone to be able to set up shop in their closet, but if you are looking for a place to start a home business, I encourage you to get creative before rushing out and leasing office space.

Chances are there is some tiny bit of unused space in your home to set up a folding table and computer. If nothing else, it was a good excuse to clean out our closet!

Saving With Purpose: Retirement Phase II

Posted on by  at  5:00 am
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This is the fourth post in a series called Saving With Purpose: Living a More Intentional Financial Life. In this series, I plan to highlight a number of specific savings goals my family has identified we would like to achieve over the next few decades.

In the last series post we discussed ways to reach early retirement through a combination of taxable investments and retirement contributions that may be withdrawn before traditional retirement age. This post picks up where the other left off; we’ve now reached that golden age of 59 1/2 and may begin withdrawing from our traditional retirement plans.

Should we invest in both a Roth IRA and a 401(k)? Should I count on social security income, and if so, should we elect to receive early payments? What alternative investments can we make to fund retirement?

Forget Everything You Thought You Knew About Retirement

Our strategy for retirement is different from the more traditional idea of working somewhere 40 years, retiring, and drawing social security for the next two or three decades (hopefully). Our plans for retirement have been influenced by a shift in some of the long-held financial beliefs.

Things like a guaranteed 8% return in the markets may be soon be a distant memory. Sure, some years will be good and some bad, just as it always has. However, I suspect there will be more volatility and negative financial news than anyone my age remembers. So our plans have been molded by life experiences, the political climate, and even larger economic trends that have developed in our lifetimes. Our investments will be more conservative, and we will always lean to being “cash heavy,” because we value preparedness over the chance of hitting it big.

Maximize Roth IRA Contributions

Each year, my wife and I will contribute the maximum amount to a Roth IRA. I’m a big fan of the Roth IRA, for several reasons. First, the earnings in a Roth IRA grow tax free, and since you are using after-tax dollars, contributions can be withdrawn at any time, for any reason (making the Roth sort of a 2nd pseudo-emergency fund).

The Roth IRA also has no mandatory distribution age, meaning if you hit 59 1/2 and don’t want to tap your Roth IRA balance, you don’t have to. Traditional IRAs require distributions at age 70 1/2, meaning you could be forced to reduce the amount you leave to heirs thanks to mandatory distributions.

With about 27 years until we reach that 59 1/2 years-old threshold, my wife and I could save a large amount in our Roth IRAs, assuming we don’t tap contributions early to fund early retirement (something I mentioned as possibility in the last series post). Assuming a 6% average return on our $10,000 yearly investment, we would have nearly $700,000 in Roth IRA savings in 27 years.

Maximize 401(k) Contributions

In Adam’s recent post asking whether or not he should save for retirement or pay off debt, it seemed the consensus in the comments was Adam should contribute through his employer’s match, but use any remaining funds to reduce his debts. I agree; there is nothing like “free” money in the form of matching contributions.

However, there is a larger question here. After becoming debt free, should one continue to increase 401(k) contributions to the maximum yearly amount (currently $16,500), or should they invest that money elsewhere in a more diversified mix of asset classes (paid-for real estate, business ventures, etc.)? I don’t believe there is a right or wrong answer here. but it seems to me that if all you can afford to do is stretch to max out your 401(k), you may do better to spread that money around a bit. On the flip side, if you can afford to save above and beyond the yearly maximum, then you should first fund all tax-advantaged accounts, such as a 401(k).

What did we decide? After much deliberation, we decided to slash a few budget items and go after the max 401(k) contributions, recognizing we may not be able to do this every year going forward. Fortunately, we are now debt free, and through my blogging pursuits, we have what amounts to a second income. I recognize this does not work for everyone, and it certainly didn’t work for us until just recently. In fact, I haven’t even contributed to a 401(k) in the last few years while we whittled away debts and built emergency savings.

If we could find a way to continue maxing out 401(k) contributions until retirement age, we would have $1.1 million, assuming a 6% return. Add in Roth IRA contributions and growth, and we’re approaching $2 million. Of course, as I mentioned in my last post, this is not likely to happen because I want to move away from full-time employment in the next 12-15 years. If we kept up our goal of maxing 401(k) for just 15 years, we could still build a 401(k) nest egg of just over $400,000, and another $250,000 in Roth IRAs. Not bad at all.

Will We Receive a Return On Our Investment In Social Security?

In a word, no. I don’t believe we will. Put another way; don’t count on it. I personally believe social security as we know it today will not exist in another 15-20 years. It can’t, mathematically, as soon there will be many more people receiving benefits than paying in. That sort of upside down pyramid doesn’t work – just ask anyone associated with a failed Ponzi scheme.

Now, I am not as radically anti-social security as some. I just like the idea of controlling my own investment dollar, because I’m confident I can earn more than the U.S. government can. Enough of that, I’m not out to make a political statement. I am simply trying to reinforce the idea that people in their 20′s and 30′s should not expect to be able to live on social security in retirement.

If we do receive some form of payment from social security, just consider it a bonus, but certainly don’t count on it for financial survival. If the program is still solvent when I reach the age eligible to receive early payments, I’ll likely sign up. After all, nothing is guaranteed – neither my health or the continued viability of the program. Unfortunately, several people close to me paid in their whole lives and never received any benefits, or received very limited benefits through disability before dying young.

Alternative Investments for Retirement

In addition to the traditional types of investments I’ve listed here (and in earlier series posts), we are also interested in things like paid-for real estate. Specifically, we’d like to pay off our own home well before contemplating an early retirement. I have always thought living mortgage-debt free must be the ultimate in financial freedom.

Just imagine no credit card debt, no car payments, and no mortgage payments. Imagine the options available to someone in that position. Imagine the freedom they must feel with the only income requirement to earn enough to cover basic living expenses, and save for future ones. That’s it.

In addition to real estate, I will always have a side hustle or two going, and in the future may elect to invest more money to grow a current hustle, or develop a new one, without introducing too much risk into our lives. I started Frugal Dad over two years ago on less than $50, so it might be tough start something even more frugal!

In the final post in this series, we’ll look at one last topic: giving. Yes, part of our saving strategy is to give a lot away. I’ll share a few ideas I have on the subject, and as usual, try to put some specific numbers to our giving goals going forward.