Wednesday, October 10, 2007

A different measure of success

I recently conducted a poll on, and asked people to calculate the percentage of adult earnings that their current net worth represents. Although I haven't received an overwhelming number of responses, I think it is a rather eye-opening exercise. If you're like me, it really makes you think about what you've done with all the money you've earned over the years, and what you have to show for it. By being consciously aware of these things, you may be able to alter your spending and savings habits to keep more of what you make.

So as you progress throughout your working career, keep track of your earnings. For example, I maintain a spreadsheet that lists, by year, my gross income, 401(k) contributions, and net take home pay. All of this information is readily available and/or easily calculated from your W-2 statement or year-end pay stub. This allows me to see, at a glance, my annual earnings, contributions to employer sponsored retirement plans, taxes withheld, and what I got to take home. I can then compare how well I've done at saving (and growing) what I've brought home over the years. It also makes it easy to find out how well my 401(k) plan is doing, since I know the cost basis, which can be helpful in determining whether I need to make any adjustments.

Look at your results regularly, and maybe it will help you stay focused on your savings goals. Good luck!

Financial aggregate sites

The Simple Dollar featured an article on financial aggregate sites yesterday, and the primary concern was regarding the issue of security. The way these sites work is that they require their users to share their login information to various financial institutions, which is then used to collect the users' financial data and present the information on one screen, with some useful analysis tools thrown in.

Now I have no problem banking online, and I feel pretty safe I as long as I exercise reasonable precautions (not saving/sharing passwords, running anti-spyware & anti-virus software, keeping my computer updated, and only using trusted/nonpublic computers). I'm pretty confident that my bank would give me my money back if a hacker steals my login data and empties my bank account.

The problem with third party aggregate sites is that I have to share my sensitive user IDs and passwords. I'm not so sure that banks would be willing to cover my losses if these sites were to become hacked, since I voluntarily gave them my login data. It's kind of like giving a friend or family member my credit card or ATM card; I am still liable for any charges and withdrawals that they incur. Also, many of these financial aggregate sites are backed only by venture capital, so I'm not super confident that they would be able to restore my losses in a timely manner--if at all. A commenter of the Simple Dollar article mentioned the lack of regulation, and we've all heard of nightmarish experiences that some users of PayPal (which is not regulated like a bank) have had to deal with, such as frozen funds, blocked accounts, etc.

If you insist on using these sites, you can minimize your risks by setting up alerts, and monitoring your accounts closely. Bank of America offers an optional feature called SafePass where sensitive transactions require a unique 6 digit code sent to your mobile phone; other financial institutions may have something similar.

To truly put my mind at ease, however, I suggest that financial aggregate sites work with financial institutions to come up with a more secure solution. For example, if I had a "view only" password from my bank that I could provide to the aggregate sites, it would make me feel much safer. To perform an actual transaction such as transferring funds or paying a bill, the aggregate site would redirect me to my financial institution's web site where I'd be required to enter my "full access" password in order to complete the transaction. This would limit the liability that the aggregate sites have to face, since they would only have the ability to look at my financial information, and not touch it. I am not sure how willing financial institutions would be to cooperate with financial aggregate sites on something like this, but I would think that they'd at least consider it in the interest of their customers, and from a loss prevention perspective.

Wednesday, October 3, 2007

On the subject of frugality

I've been thinking a lot about the topic of frugality lately, and just read a good writeup on it at The Simple Dollar (via Get Rich Slowly). I also like the Wikipedia entry for frugality, which is as follows:

"Frugality (also known as thrift or thriftiness), often confused with cheapness or miserliness, is a traditional value, life style, or belief system, in which individuals practice both restraint in the acquiring of and resourceful use of economic goods and services in order to achieve lasting and more fulfilling goals. In a money-based economy, frugality emphasizes economical use of money in meeting long term personal, familial, and communal desires.

Might also mean economical or avoiding waste."

To me, being frugal is about prioritizing my (limited) resources to focus on things that are most important to me, and bring me true happiness. It isn't about deprivation, neglecting wants, or being stingy for the sake of accumulating money above all else. It is about maximizing the returns on my hard earned money so that I get the most value (taking into consideration quality and price) in accordance with my priorities.

While I consider myself to be frugal, other people may not view me in the same light because their priorities are different than mine. For example, my house is much bigger than I need, and not representative of the typical Millionaire Next Door at all. "Your Money or Your Life" describes the concept of having "enough", and a smaller, more modest home would certainly meet my needs.

Am I being wasteful by having a larger residence than I need? Perhaps, since my utility bills are bigger than a smaller place would generate, and my land usage is more than I require. I struggle with this dilemma sometimes, but in the end I realize that life would be pretty dull if we only satisfied our needs. I truly enjoy my home, and the fact that it's an appreciating asset is icing on the cake. I could downsize and live completely debt free, but I've done that before and buying stocks just isn't as satisfying to me as building home equity.

On the other hand, I'm very economical in other areas. For example, I don't buy designer clothing as I don't care about brand names. I don't drive a luxury car, or carry a ton of gadgets. I recycle as much as I can to reduce my impact to the environment. I don't smoke or drink alcohol/soda/coffee, and while that's primarily health driven, I also consider them a waste of money because I derive no pleasure from those substances. I brown bag my lunch to work every day (I do spend quite a bit amount of money on organic foods, so while I may not be saving money in the short term, it is cheaper than eating out in the long run if you consider the health benefits).

So frugality is a matter of perspective, and I try not to judge others based on what they choose to spend their money on as long as they're getting true enjoyment out of it. However, if they fail to live below their means, then I would not consider them to be frugal. Achieving wealth requires that you spend less than you earn, and invest the excess. Being frugal can help you accomplish that by eliminating wasteful spending on stuff which doesn't bring you happiness, leaving you with more to invest.

To summarize, my acid test for frugality is:

1. Does it bring you true, long term happiness?
2. Does it prevent you from meeting your financial goals?

If you answer 1) yes and 2) no to those questions, then you've passed the frugality test.

Tuesday, October 2, 2007

My retirement plan investment strategy

I just read a recent interview with famed economist and lawyer Ben Stein. I've gained a lot of respect for him lately, especially after a piece he wrote for CNN Money about sticking with long term investment goals instead of following short term market trends. I am definitely all about investing for the long term, and it's reflected in my investment strategy.

Because I have a long-term horizon (I don't plan to touch my retirement funds for at least 30 years), I am almost completely invested in stock funds. My 401(k) plan offers the following stock fund choices (next to them are how my contributions are allocated):

The Aggressive Asset Allocation Portfolio fund is comprised of 20% bonds, 24% international equity, and the remainder is split between the S&P 500 index, large caps, and small cap funds. It is similar to a target retirement fund in that it invests according to my risk tolerance level, only it doesn't adjust the portfolio mix over time.

How did I arrive at this particular investment mix? My primary goal was to be invested in stock funds, however within that I wanted diversify amongst the various fund choices, so I decided to put an equal amount (25%) into each fund type: an index fund, an international fund, a managed portfolio fund, and US stocks. This allows me to see how the fund types perform over time compared to one other, and as you can tell from the chart below the international equity fund is kicking butt at the moment:

401(k) Investment Asset Allocation (as of 10/07) -

Ben Stein believes in foreign stocks, and so do I. 25% of my contributions are directly earmarked for the international equity fund, and another 24% within the Aggressive Asset Allocation Portfolio fund, making my total foreign investment a hefty 31% of my incoming contributions. Note that unlike a global fund, an international equity fund does not invest in US stocks. If I only had access to a global fund, I would raise my contribution allocation accordingly to increase my exposure to foreign stocks.

A lot of experts advocate regular rebalancing of retirement portfolios, usually on an annual basis, to bring investments back in line with the target asset allocation. However, like Ben Stein, I don't believe in rebalancing--at least not for myself at this time. Why would I want to sell off assets that are doing well to invest in underperforming (relatively speaking) funds? Not to mention the detrimental effect the sales fees will have on my portfolio. If I was nearing retirement, I could see an argument for using rebalancing as a tool to control my risk exposure, but until I start shifting a significant portion of my investments out of stocks it makes little sense.

I am fortunate that my current 401(k) plan offers funds with extremely low expense ratios. Most of them are at 0.50% or lower, except for the small cap fund, which is still at a reasonable 0.80%. Because of this, and the fact that I like the fund choices available to me, I was comfortable with rolling over my 401(k) accounts from previous employers. It makes managing my retirement funds easier, and reduces the amount of paperwork I have to file. I only wish I could use the same custodian for my ROTH IRA, which is invested elsewhere in a S&P 500 type index fund.

My advice for young adults

Young people have it tough these days. Escalating educational costs, schools and parents that fail to teach personal finance, and societal pressures to spend make it difficult to get ahead financially. Not to mention, companies are increasingly laying the burden of retirement savings and rising health care costs on workers, who in turn cannot rely on a broken social security system which is headed to the brink of collapse.

Fortunately, young people have a few factors in their favor. The most powerful element going for them is time, which, when combined with the power of compounding, can perform miracles. For most people, this is the simplest path to financial security.

To make the most of the power of compounding, max out your retirement contributions at the onset of your career and don't stop contributing. Those early dollars will generate the most growth later on (assuming you don't cash out or borrow against them), so the more you put in the better off you will be. Invest in aggressive mutual funds instead of more conservative bonds and money market accounts, since you have the time to ride out bumps in the stock market.

Another advantage young people have is flexibility. For example, if the cost of living is high in your area, consider relocating to an area where your salary will go further. CNN Money publishes an annual list of the best places to live, and offers a cost of living calculator so you can compare cities. The easiest time to move is when you're young and mobile, before settling down and starting a family. I chose Phoenix because the cost of living was reasonable compared to California (plus I don't mind the heat!), and I could afford to buy a house while young to start building equity right away. I would probably still be renting had I stayed in California.

If you're attached to your hometown, consider moving back home with your parents until you're in better financial shape. It's a surefire way to pay off debts quickly and start saving for retirement. Some people scoff at the idea of living at home, but if done for the right reasons (i.e., to get rid of debt or save for a house) there's nothing wrong with it.

Be smart about insurance. You won't need life insurance unless you have dependents, but be sure to purchase disability insurance to protect against the likelihood of being out of work due to injury or illness. I've known several coworkers who have had to utilize disability insurance, so it's not a rare occurrence.

These tips should give you a good start toward building a secure financial future. The key is to start early, and save as much as you can. Don't put off saving for any reason, even to pay off debt, because retirement plans limit how much you can put in and don't allow you to go back and make up for missed contributions.