Let’s Talk About Personal Finance

This is a digression from my normal posts on energy and the environment. As I have said before, this is not a blog on investing or personal finance. Despite that, finance and energy often intersect, so it is a topic that comes up frequently. It is a topic that I am frequently asked about via e-mail, especially in today’s economic climate. Maybe my experience can help someone else avoid some of the mistakes I made. This is not advice directed at the advanced investor. They would have learned these lessons long ago. This is addressed to the average family who may have a negative savings rate, and is struggling to make ends meet.

The idea was spawned by a recent story in The Guardian:

Subprime crisis: US foreclosures bring homelessness to the middle class

Homeless people living in cars and mobile homes across the US are being joined by a new breed: the middle-class. As mortgage foreclosures continue rising month on month, growing numbers of middle-class professionals are losing their homes and downsizing from four bedrooms to four wheels.

Guy Trevor lost his job as an interior designer when the market contracted, thanks to the mortgage foreclosure crisis. “I see myself as a casualty of a perfect storm,” he said. “The people sleeping at the parking lot are very friendly. They’re just like me – they come from normal, everyday homes. I think a lot of people in this country don’t realise that they, too, are a couple of pay-cheques away from destitution.”

I am going to sharply disagree that Guy Trevor lost his job due to the mortgage foreclosure crisis. My guess is that he lost it due to poor financial planning. And while there are exceptions, generally this should not happen to anyone. So I want to give some advice on managing personal finances. What are my qualifications to do this? Let me give you a personal history.

My Personal Finance History

When I was growing up, I was always working and trying to save money. I bought my first pickup with money I saved from working a paper route for 2 years. I mowed lawns, picked up aluminum cans, and have worked pretty consistently since I was an 11-year old on my paper route. I was a born saver, and not a spender. I dreamed of one day becoming a millionaire. I did not want to rely on Social Security for my retirement income, as was the case with all four of my grandparents.

Putting aside the judgment of whether this was a noble goal for a child, in my 9th grade algebra class I finally saw that it could be realized. My 9th grade algebra teacher, Mr. Moore, taught us about compound interest. This was one of the most amazing discoveries of my life up to that point, and a definite life-changing event. If I only saved $2 a day, and averaged a paltry 5% of interest, I could accumulate $130,000 by the time I turned 60.

Not a fortune, but then again I am only saving $2 a day and only getting 5%. If somehow I could manage a 10% return, then my $2 a day ended up being $600,000 by the time I turned 60. And if I could manage some real savings – say $100 a month, or $3.33 a day (at the time I was making about $200 a month) – then I would have a million dollars when I turned 60. For the first time in my life, I could see a path to my goal that didn’t involve winning the lottery, or otherwise striking it lucky on some long shot.

The power of compound interest has been at the core of my financial planning since that school day in 1981. I knew the ingredients to wealth: 1). Live below your means, so you can save some money. 2). Save the money in a “do not touch” account; 3). Maximize your long-term returns.

Since that time, things have gone mostly according to plan. However, I have made some mistakes. As a 20-year old I was working full-time for Campbell Soup Company in Paris, Texas, but I was also going to college full-time and putting myself through school. (I worked the night shift – 10:30 to 7 a.m. – and then got up and drove an hour to college). I had accumulated about $30,000 from saving and investing my earnings (I had “discovered” mutual funds), and this was almost twice my annual earnings at Campbell Soup. I was well ahead of schedule for my goal of a million dollars by the time I turned 60.

But then I made one of the biggest financial errors I have ever made. I bought a brand new Toyota 4×4. Of course the payments were only $330 a month, but over the course of the payments this would consume half of my savings to that point of my life. And if you do the math since then, that new truck and subsequent higher insurance payments has cost me close to $100,000 (what I could have earned had I invested the money). On the other hand, this time period also saw me make a wise (or perhaps lucky) move. Due to the volatility leading up to Black Monday, I sold all of my mutual funds on the previous Thursday, October 15, 1987. (I made a similar defensive move earlier this year that has saved me a lot of money).

During my 20’s, I graduated from college and decided to go to graduate school. Those were some lean times, but even then I managed to save money. My graduate stipend – for teaching and doing research – was $12,000 a year – a pretty big pay cut from my Campbell Soup days. I was married, and rent was going to cost us five to six hundred dollars a month. So, with the money we had saved up as a down payment, we bought a condo. Instead of $600 rent payments, we had a $200 mortgage – and I eventually sold it for a profit.

While in graduate school, I researched the cheapest foods I could get without starving my wife and me, and we watched every penny. I ate grits on a number of occasions, and I would go to the $2.99 Pizza Hut buffet and eat enough for lunch and dinner. My wife and I once got into a fight because she bought a trash can for the kitchen. We had been using paper sacks. She took the trash can back. This was the reality of a situation in which I was determined to live below our means.

By the time I was 30, I had graduated, had two children, and was working as a chemical engineer. My wife – based upon a mutual decision – would stay home and raise the kids, and that has been the case for the past 15 years. Our savings at the time amounted to more than a year’s salary, and I was generally on target to reach my million dollar goal. Then I made major strategic error #2.

Technology stocks were booming, and I was seeing some pretty clueless people get rich. AOL, JDS Uniphase, Cisco, Amazon.com, PMC-Sierra, Ciena were among the hot stocks of the day. I read story after story of why these companies could only go up: It’s technology, for crying out loud!

So, about that time two things happened. I took my first expatriate assignment to Germany, and as a result I had to sell some of my mutual funds. Unlike some of the mutual fund companies, ETrade had no qualms about me having an online account from Germany. So I started trading tech stocks. (In fact, I started out with chemical companies, made some fast money, got overconfident, and jumped into tech stocks with both feet).

Initially, I made some fast money, and decided this was pretty easy. I started investing on margin. But then things turned down. If JDSU was a buy at $200 a share, it was an absolute steal at $150. Down to $100? I wished I had more money to put into it so I could average my cost down. Do you know what JDSU trades for today? About $12, and that still carries of forward PE of over 30.

This incident was the second defining moment of my financial life. I returned to the U.S. at the end of my expat assignment, and I pondered the future. My fast-track to a million dollars had been derailed. I almost felt like I was starting from scratch. So I made some decisions. First, I knew that engineers in the oi
l industry earned more money than engineers in the chemical industry. Further, I felt like oil production was going to peak in the not too distant future, and the oil industry was probably going to be printing money as prices skyrocketed. So, I left the chemical industry and joined the oil industry.

Second, I decided that I would never again invest in things that I didn’t understand. I still can’t tell you exactly what JDS Uniphase does. Something with the Internet. But I don’t understand the field well enough to distinguish the pretenders from the contenders.

Third, I vowed that I would always understand the risks. I shun investments that I deem as high-risk, even though I may be giving up substantial rewards. Moderate returns for moderate risk have been better for me than high returns that go along with extreme volatility and an occasional disastrous year.

Finally, I decided to invest only for the long-term. No more market-timing for me. I would evaluate a company based on the fundamentals and my expectations of where trends were heading (e.g., the health care sector looks good as the Baby Boomers age) and invest accordingly.
Those principles have guided my financial planning since then. I have not had a down year since 2000. In hindsight, as a result of my strategic error with the tech stocks, I developed a sound financial plan that has been very good to me. I am probably better off now than had I not taken such big losses in 1999-2000 because of the way it caused me to change the way I invested.

Financial Rules That I Live By

Here are some of the rules I live by:

1. Live within my means. That means that I don’t typically make purchases on credit that would take time to pay off. If that means I drive a crappy car – and I have driven crappy cars before – then that’s what I do.

2. No credit card debt. While in some cases it may make sense to carry credit card debt (e.g., you got 0% interest for six months), you have to be disciplined. You never want to carry a balance with a > 10% interest rate. You will have a tough time keeping your head above water.

3. Save a minimum of 10% of my income. Over the years, that has probably been closer to 30% for me. I have always maxed out my 401K every year that I worked. I maxed out IRAs, Health Savings Accounts, and Education Savings accounts. Saving that money pre-tax has the added advantage that money that would have gone toward taxes is now accumulating returns.

4. Do my own taxes. Doing your own taxes can give you a lot of insight into how to manage your finances in a way to minimize the take of the tax man. Study all of those deductions, and make sure you are taking the ones you are entitled to take. For most people, doing your own taxes should not be that difficult. Take last year’s tax return and start from there. If you get stuck, the IRS has various hotlines to help you out. Even if you can’t complete it by yourself, you will learn something by going through the process.

5. Invest in things I understand. For me, that’s primarily energy-related, but I also invest in sectors (like health care) that I think are well-positioned for the future.

If you are already buried in debt, and now struggling under higher food and energy costs – then it will be difficult to put your financial house in order. My advice would be a cut in your standard of living, followed by elimination of any high interest debt as quickly as possible. Don’t try to invest money in anything if you are carrying a credit card balance at 17% interest. Get that paid off first. Then start saving a little each week before you think about bumping your standard of living back up.

Remember, the sacrifices you make now are intended to lessen the need to make sacrifices later. Eat, drink, and be merry may be a lot of fun, but even better is to eat and drink in moderation, save some money as a result, and prosper in the long run.

20 thoughts on “Let’s Talk About Personal Finance”

  1. while every story of financial ruin is founded in living beyond one’s means, not all methods of getting their are the same. Some are through carelessness, lack of education, and taking risks. I took risks but it was for a good reason.

    Like you, for years I ran on a cash basis including the first eight or nine years of my own consulting company. Then the tech crash happened, 90% of my customers vanished within a small number of months. All my marketing efforts were for nothing as even my peers with direct employment were walking the streets. a CEO friend of mine and I started talking about ways we can make money and he asked a “why isn’t there… and described a product involving personal surveillance in one’s home. I’ve fleshed out the idea, we took it to some angels and they said “great idea, implemented and we’ll talk about funding.” The implementation, took a bit longer than we thought but after about 18 months we had a complete and fully functional demonstration system. We were about another 12 months away from full production. The Angels said “now find some customers and we will talk about funding.” In the next six to nine months, we had three or four people saying “sure, we might be able to use that if you get into production.” then the angel said “not good enough. we meant customers actually giving you money and have started receiving products.”

    I should have learned my lesson at this point and said “screw you” to the venture capital/angel community. But no, my CEO friend a few months later said “what’s all this about bit torrent?” fast-forward another three years and we’ve developed six provisional patents and a working prototype of a commercial scale bit torrent environment including advertising insertion, auditability and the ability to pay for people propagating films. We had some content propagation companies that were ready to write a check except for the fact that the main developers wife thought the whole idea was a cluster fu*k and contributed to our downfall by savaging her husband’s productivity on the project but we had no idea what was going on until shortly before we gave up and the developer told us.

    I wasn’t able to do anything in part because I was getting sick and spent the next year wondering why my brain wasn’t working right and about four months nothing able to breathe when I ate and being shuttled around from specialist specialist until a gastroenterologist discovered I had a bad gallbladder and a bad thyroid. By the way, take thyroid disorders seriously. I was in such bad shape bad that I was acting like I was drunk or stoned for months and I lost a customer because it.

    at the same time dealing with my wife’s disability because of 24×7 migraines and the drugs they use to stop the pain.

    But in all that time, I managed to live on all my savings and a relatively small amount of consulting. we cut everything back to a minimum for many many years and now I’m to be rewarded for taking a chance on trying to build companies and a better life for others by losing almost everything I have. I’m trying like hell to rebuild my consulting practice to get another $4,000 or $5,000 a month coming in the door to try and stop some of this train wreck but it’s not easy. there are so many things to do in marketing, and disabled spouse care that I’m running out of steam.

    startups can suck your good sense dry if you truly believe in what you’re doing. That self-deception makes it very hard to walk away especially when you see your peers around you having trouble with work and somebody is saying they might give you money.

    In addition to your guidelines, I would add, never take a chance on a startup unless it is with somebody else’s money and never do any work you don’t get paid for in cash. If you can’t get paid in cash, keep the outstanding invoices to a bare minimum. if you’re working in a direct job, keep unpaid overtime to a minimum. the promise of reward for unpaid overtime is the same type of Siren song of the angels sing when they say “we might give you some money” and just as likely to be satisfied.

    Yeah, I’m cynical. I know I’m going to dig myself out some way but I have no idea what my life is like or where I’ll be living six months from now. And that is a state I would not wish on anyone.

  2. The next time you decide to exit the stock market ahead of a big downturn, please post something for the rest of us! (grin)

  3. RR – good post again. You forgot to mention something else from your personal experience. Relocate to where you can live within your means.

    The story you quote in the Guardian talks about LA and Santa Barbara county. Those are some of the most expensive places in the country to live. Even with a good job it is difficult to make ends meet.

    You can’t be afraid to pack up and leave friends and family to go to a place where you can live within your means. That is why Houston is seeing such dynamic growth. We are getting econmic refugees from other parts of the country. I read recently that 1 in 10 new jobs in the country were in Houston. You can’t go anywhere without seeing a help wanted sign for entry level jobs. The difference is that it is possible to live on those wages and still work your way up.

  4. Good advice.

    For me, investment decisions are easy. Paying off student loans is the priority. After that, I will start saving for a house down payment and paying into a low-fee index tracking fund for retirement.

  5. A few years back, I realized I could move an Airstream trailer noto the parking lot of a factory I own near downtown L.A., and stop paying rent.
    I figure in 5 years that will save me and family 90k, not even counting interest, and that’s after taxes.
    That will buy about 40 acres in my wife’s native country of Thailand, to buy eucalyptus.
    However, I also think we may be seeing a historic opportunity to short oil. If you buy puts, your risk is limited to the amount you invest.
    A last thought: I was saving money slow and steady ike RR. Then I started up a business and lost it all, like anon. But the factory I bought shot up in value, and on paper I am rich.
    Sometimes you have to take chances, and I have no advice for anybody beyond that.

  6. King-
    I am a greenie-weenie, but I do not understand the hysteria about drilling. Very few blowouts, if any. After the rigs are retired, they can be tipped over and become great habitats for fish etc.
    Very difficult to find a party to vote for in America. And thanks for noticing my moniker!

  7. Benny – if living in a parking lot in LA is the UK Guardian standard, then according to them – you are homeless!

    Drilling has gotten much cleaner and smaller than it used to be. They are drilling right now in my residential neighborhood. Greenies don’t like drilling because they argue that we should jump straight to renewables. The reality is it isn’t an either/or, it is both. We need to drill AND develop wind/solar and other renewables.

  8. knowing what you want, self discipline, self-sacrifice, self analysis.

    not much of these going around these days.

    maybe the cause of much quandry/dissatisfaction/blame gameing.

    we have met the enemy and IT is US[ wise oppossum].


  9. King-
    I just read the U.S. will spend $700 billion on imported oil, annually, at current prices.
    Imagine that money instead invested domestically, in infrastructure, new oil wells (shale and offshore) energy-saving tools and equipment, solar power, geothermal, Volt-type cars etc
    Some people say energy independence is a pipe dream. I say the dream of prosperity may depend on energy independence.

  10. “Today the WSJ “does Peak-Demand Benny”

    LOL…he did sound like Benny. He was half right too. The only problem is,falling demand doesn’t solve more rapid supply declines. Innovations like PHEV’s will take care of demand,and biofuel production will take care of supply issues. Cellulosic fuels aren’t a pipe dream any more. What those guys are doing in the lab is freaking awesome. I’d really like to invest in some of those companies working on modified yeast.

  11. Robert…off-topic, but would love to hear your thoughts on the “Pickens plan,” which is basically about wind plus natural gas.

  12. You’ve never had a down year since. How about this year. S&P down 20% from its peak in 2007.

  13. You’ve never had a down year since. How about this year. S&P down 20% from its peak in 2007.

    I am up about 3% YTD. Not nearly as good as a friend of mine who shorted the market. He was up 30% or so in January alone.

    My energy stocks are doing OK, considering the overall market. My international stocks are doing OK. I also sold most of my other stocks and parked the money in a money market fund. That was the defensive move I made in mid-May, before this latest slide.


  14. david – we’ve been discussing the “Pickens Plan” a lot around here the last few days . As a public relations ploy it is brilliant because you can reduce it to an easy to understand sound bite:

    “Harness America’s abundant wind energy to replace natural gas power generation and use natural gas for transportation to stop shipping trillions of dollars overseas.”

    Unfortunately, the math doesn’t work out so well. The problem is lack of infrastructure, which turns out is very hard to do. States like North Dakota and Kansas have the best wind potential but very few people. You need to build transmission infrastructure to carry the power to urban areas where it is needed. Exporting power over the Rockies is very expensive as well as getting it to the East Coast. There is little to NO support for new transmission infrastructure.

    He needs Federal help to get it done, particularly to clear environmental lawsuits.

    Wind growth isn’t limited by wind resources, turbine makers just can’t turn out big turbines fast enough. More factories are needed. A $65 million factory employing 100 people can only turn out 500 1-MW turbines a year.

    Lastly, there is no CNG or LNG infrastructure. Like a PHEV, you could install a compressor in your house to fill your vehicle up overnight. But because of low energy density your range is maybe 100-150 miles for CNG. There are very few refilling stations around. CNG growth is likely to be limited to fleet sales, which isn’t enough to achieve TBP’s vision.

  15. King-
    I agree with you…huge changes in our our infrastructure are probably not warranted, if more incremental change are market-worthy.
    The PHEV might require some rewiring of apartment garages, and maybe parking meters will double as auto power poles (provide electricity to cars). Perhaps office building etc will wire up too. Lots of work for electricians, but nothing major. Sheesh, from what I can see, every curb-corner in America has been flattened to allow wheelchair access. Sometimes I think we can do anything.
    I am curious if we can go to 220v on PHEVs. My crude understanding is 220v cuts recharge time in half.

  16. Benny – the 220 V change is easy. The electric service panel at our house is in the garage. I could wire it up myself.

    From my perspective, the problem is environmental law, environmentalists, their attorneys and their pet politicians. What at one time seemed like sensible legislation to clean things up has run seriously amok and is now preventing us from fixing the problem.

    I can without a doubt say that environmentalists are making the environment WORSE by blocking just about every proposed new project.

    There is a good example in the WSJ today: Barney Frank’s Wild River . The good congressman is trying to get an industrial riverfront declared “wild & scenic” just so he can prohibit an LNG terminal. Nevermind that LNG tankers sail past Fall River on their way to the Gulf of Mexico just to unload their cargos to send natural gas to – Fall River. The gas has to travel an extra 4,000 miles spewing greenhouse gases all the way.

  17. Cellulosic fuels aren’t a pipe dream any more. What those guys are doing in the lab is freaking awesome. I’d really like to invest in some of those companies working on modified yeast.
    Not a pipe dream any more? You know something we don’t?

    As I have said before, I can see GM bugs being useful for producing pharmaceuticals, and OK for producing food. For a low value product such as fuel (after all, we just burn it), GM makes no sense. That’s just my 2c.

    And even if they made it work, you have to remember that ethanol has some real drawbacks as a fuel, as those ethanol refiners are learning, at their cost.

    Before you part with the money, I’d be sure to follow RR’s principle #5.

  18. King (to your July 8 post),
    What you described (finding a place where you can live within in your means) is exactly what I did and what got me to TX. We lived in NY (on Long Island). We bought our first house in ’91. Our house appreciated over 200%, but so did taxes, energy, etc. (not necessarily to the same magnitude). My salary definitely did not. If we were coming into the market as first-time home buyers, we couldn’t afford to live where we were living, but we could afford the mortgage we had. We certainly weren’t saving much beyond my 401k contribution. And my kids would never be able to afford living on LI when they eventually left the nest.

    The writing was on the wall for the local housing market. First the stall, then the decline. We had already figured we should cash out. I wish we had done it a year sooner, but we were able to get a decent price for our house. It enabled us to buy a house in north TX, pay off our credit card debt, actually build up savings and pay for things with cash or debit card (saving the credit card for the 0% interest deals like Robert said).

    One mitigating factor: I kept my job and now work out of my house in TX, for the same salary. My salary wasn’t sufficient in NY but sufficient for here.

    I think we escaped just in time. With the housing market what it is, and, more importantly, the mortgage market so tight, I don’t see many of my old neighbors able to do the same. But just in case, I still try to entice them with stories of new houses under $200k and gas below $4 and electricity below 15 cents/kWh (but not for long, unfortunately).

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