Book Review: The Box

The full name of the book is The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger

It was recommended on the Ryan Holiday reading list and I filed it under business books I wanted to read. And then when Ryan also mentioned it in his book The Obstacle is the Way, I moved it up on the reading list.

It’s a book that’s hard to describe so I apologize if it seems scattered.

The things I learned from it are

  • How large business have to think about supply and demand and the changing world economy to stay ahead of things.  They have to think about the price of commodities, interest rates, inflation, currency fluctuations etc. Mind boggling.
  • How the decisions countries make in response to unions are so detrimental to the overall health of the country. I’ve seen the horrible impact of unions in companies I’ve worked at, so it was interesting to see the impact they can have on the broader economy. Reason #286 that we send our kids to private schools to keep them away from the teacher union run public schools.
  • How thinking outside of the norm and two steps ahead of the competition was how the main character Norm McClean succeeded.
  • It also spends time summarizing the world narrative (albeit a bit American-centered).  It makes me take a step back and try to see our current economic times in perspective. I can read investing books but I’m humbled be how the world and our country is constantly changing and evolving. And how smart people constantly try to predict it but are consistently wrong.  It begs the question … what am I doing to succeed in the current environment and what am I doing to prepare for other scenarios?  Also, am I in tune with how history is unfolding and am I learning and remembering how it has unfolded in the past.
  • How companies have to pay attention to small costs because they add up. The same principle applies in our personal financial lives. We live on 50% of a single income. And that is in large part due to closely watching our costs.
  • How hard it is for companies, countries and cities to stay competitive.  The ports that didn’t quickly adapt were bypassed and they missed out on a lot of business.
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Types of Budget Categories

We’ve been budgeting for about 6 years.  Every week for the first 5 years but over the past year we’ve dropped down to once a month.  We are on track to save 50% of our income this year and 60% next year.  There are several factors, but one has been our budgeting methods we built over the years.

Here are just a few ways to budget that have helped us get our money under control.  Or as Dave Ramsey would say “Tell our money where to go.”

Most folks who have a budget have their categories set.  Mortgage, utilities, etc.  But there are different ways to budget each category.  Let’s look at a few and the pros/cons of each.

Cash

This is the old tried-and-true way to get your money under control.  Pushed heavily by Dave Ramsey.

Pro

  • This one is good for categories that we have trouble controlling. So, we use this for things like coffee, family dining, groceries, etc.

Con

  • Not a good one to use for things like Insurance, Mortgage, etc.

Bucket accounts

These are categories that we keep electronically but that behave like cash envelopes.  If we don’t use the money in them, they still get more the following month and that money can accumulate to be spent on something big.  We use this for categories like Furniture, Clothes, Date Night

Pro

  • The accumulation rewards not spending and allows for bigger spending later.

Con

  • The lower spending doesn’t improve the monthly net income to do things like pay off debt or invest.

Use-it-or-Lose-it accounts

These categories are the standard way of budgeting.  For example, if you budget $100 and only spend $50, then you have $50 more in net income.  We actually don’t use these at all, but I’m mentioning them because they are the simplest method and usually how most people start out.

Pro

  • If nothing is spent in that category, that money can be re-deployed to the balance sheet to pay down debt or invest.

Con

  • It can’t be used to purchase larger items or accumulate a bit of a balance “just in case”.

What We Use

Over the years we’ve settled on using Cash and Bucket accounts for everything.  Here are few reasons why.

  • If we accumulate a little bit of an extra balance in each account, it gives us a cushion or mini-emergency fund if something larger comes up. For instance, we contribute $50/mo to our Date Night account.  But we like to keep a $100 baseline balance in case we want to splurge a little bit.  We still try to spend $50/mo so the account fluctuates between $100 and $150 as we add to it and spend from it.
  • It rewards not spending. If we spend less, the balance goes up so that we can think bigger about what we want to buy.  Also, the longer we wait, we usually can find deals and discounts on whatever it is we want to buy.
  • Note that if it gets too big, we will take the excess and use it elsewhere and decrease the monthly contributions to that account.
  • Tithing.  I love how this impacts tithing.  We maintain a few thousand dollars in this account so that we can give when we’re called or a sudden appears.  It allows us to give consistently but also be flexible when needed.

Cash Accounts (almost all of them)

  • Groceries
  • Family Dining
  • Friends Dining
  • Clothes
  • Blow money
  • Coffee

Bucket Accounts (there are a lot of these, so here are just a few)

  • Vehicle – Registration, repair and maintenance, insurance, gas etc
  • Home – Repair, household, yard maintenance
  • Utilities – Water, power (gas & electricity)
  • Recreation – This is for things like gym membership, kids sports teams and equipment etc.
  • Date Night
  • Tithing
  • Gifts

Why Budgeting as a % of Income Doesn’t Work

Occasionally, I come across the method of budgeting that allocates a certain percentage of income towards certain expenses.

For instance, if you use Mint.com, it compares the percentage that you’re spending to other people in the same geography.  In theory, this helps folks know how good or bad they’re spending their money.  But here are a few reasons, why this way of thinking can get folks in trouble.

1.) If your income is different

If your income is lower than most in your area, then it looks like you’re $20/month on Starbucks is a much higher percentage than other folks.  But maybe that’s really low for your area and other folks are simply making more income.  Oops.  Good job spending less, but you might need to re-think your income plan.

2.) It allows for expenses to rise as income increases

I met someone the other day who said that he budgets all his expenses based on a percent of income.  I asked him what he did in months where he had more income and his happy response was “I get to spend more.”.  Which is exactly what happens and exactly what you don’t want to happen.  

In our family, as our income goes up, our goal is to keep our expenses flat and all the extra income fall to the net income where we can use it to pay down debt and/or invest in good assets.  We currently save 50% of our income.  (also called our operating margin)  I expect our income to rise by more than 10% next year, so our operating margin should increase so that we’re saving 60%+ of our income.

3.) It creates a feast or famine mentality

The guy who told me he spends more when his income is higher also said that he often has to drastically decrease spending when his income is low.  And that’s because he didn’t set aside some of the income from his good months to smooth out the bad months.

WHEN IS % OF INCOME A GOOD INDICATOR?

The only time that I can think of this methodology being a good way of thinking is when considering house payments.  There are some decent benchmarks that say 20-30% of income should go towards housing expense.  We are at 10%.  Mostly because we bought a small fixer-upper and put a lot of blood, sweat and tears into fixing it up.  Not something I would recommend, but I was young, bold and had a lot more energy then.

If someone realizes that they are paying more than 30% of their income, then it becomes a question of whether they need to work on their income or lower their expectations.   Both good questions.

How to Measure Financial Peformance

A lot of personal finance blogs talk about how to make financial progress.  How to save more, earn more.  How to invest and or pay off debt.

All that is good.  But how do we measure progress?

Here are a few ways that we do it.  I’m sure there are many others.  If you’re reading this feel free to share in the comments.

1.) Operating Income – This is the income that is left over after expenses.  We measure it on a total dollar amount and as a %.  Over the past few years our goal has been to get to 50%.  Last year we budgeted to get to 49.78% and we got to 48.59%.

This year, I’m projecting that we’ll come in at 50.8%.  It’s a little bit short of our budgeted 51.86%, but I had a much smaller bonus than expected, so it’s amazing that we’re evening coming close.

This measure is important because it measures how well we’re both increasing income and decreasing expenses.  If our expenses are increasing at the same rate as our income, then this amount stays the same.  But if the operating income percentage is increasing, then we’re doing better.

The other reason this is important is because it puts in clear focus how much of our income we have to work with to use on the balance sheet to pay off debt or invest in income producing assets.

2.) Net Assets – This is measured as assets minus liabilities.  It is the standard measure of true wealth.  A lot of people might have high incomes, but if they have high debt or low assets, they can have little or no “true wealth”.

But how do we measure whether we’re doing a good job on net assets.  I’ve thought about this a little bit and there are two ways that I look at this.

A.) Year-over-Year growth – This should always be increasing to growth wealth.  Especially during the working years where it’s growing based on contributions/asset purchases as well as earnings from those assets.  Later on, during retirement, it might only grow (or maintain) from the earnings.

As of Oct 31, 2016, our net assets have increased by 34.6% from this point last year.  This is partially due to reducing our debt by 15% and increasing our investments by 25%.

B.) Allocation – Assets should be good assets and liabilities should be good ones (if any).  This is a broader subject, but a good asset appreciates and/or produces cash flow.  Preferably both.  For instance, we show our house as a huge percent of our assets because it has appreciated so much.  But it doesn’t produce cash flow, so it’s a semi-good asset.  I would much rather it be in assets that appreciate AND cash flow.  Such as rentals.

And when it comes to debt, I’m pretty much against all of it, but particularly consumer, car, and student loan debt.  But if we have any debt, it should be on income producing assets at a low LTV (Loan To Value) ratio.

One of my pet peeves is how many credit card adds personal finance blogs put on their sites.  I realize that they may have achieved a measure of financial discipline, but their readers might just be starting out and another credit card is the last thing they need.

I’ve been on some financial blogging discussion boards where the most discussed topic is how to entice readers with credit card adds.  Yikes!

3.) % Towards Retirement Amount

To be clear, I don’t see myself as ever retiring, but it’s good to have a goal.  I measure my retirement goal amount as 30 times our annual discretionary expenses.  And as our discretionary expenses go up, this amount unfortunately goes up too.

Right now, I put us at 9.14% towards that goal.  At this point last year, we were about 6%.  So, this one is going up maddeningly slowly.  But it’s one I keep an eye on.

4.) Tithing amount

This is really important.  We aim to tithe at least 10% of our income and often go over that. I’m projecting that we’ll be at a little over 11% this year.

We calculate it as 10% of gross income minus taxes.  We don’t take out anything like health insurance or IRA contributions because we believe the one item we don’t have a choice in is the taxes.  So the amount that we have discretion over is the “gross minus taxes” amount.  It makes our tithing amount a lot bigger, but we believe it’s the right thing to do.

Our method is to transfer the money to two separate accounts.  One for my wife and one for myself.  We have our favorite organizations to give to, but we can also choose to let some of it accumulate.  That way we can give extra to people or special causes that we hear about.  The regular transfer gives us the discipline to set it aside and the accumulation gives us the freedom to choose where to give it.

2016-Oct YTD Financial Update

I have a confession to make.  I hate working on our finances.  Well, “hate” might be too strong of a word, but I reeeeeeally don’t like doing the monthly process I’ve built.

I especially don’t like balancing our actual expenses to what is on our bank statements.  I use Quicken, so 90% of the time it’s really easy.  But there is 10% of the time where it doesn’t reconcile and I have to spend 2-3 hours figuring it out.

Well, I procrastinated about it for the past few months and finally did it.  And here are the results.

Income Statement (as of Oct 31, 2016 YTD)

  • Income
    • I’m about 0.86% off from the W2 income I budgeted.  So, that’s good validation of my budgeting assumptions.
    • But total income is about 3% less than budget.  Mostly because my bonus came in way less (~40%) than expected.  Fingers crossed that it goes the other way next year.  But that also resulted in a lower tax and tithing expense.
  • Expenses
    • YTD we’re about 0.70% less than budgeted but I’m projecting that we’ll be a about 2.3% less than budget by year end.  Mostly due to an error I found by which we have been tithing more than 10%.  Closer to 15%.
    • The lower expenses are due to
      • I budgeted for $100/mo for home repair and we’ve been fine with $50/mo.
      • Our mortgage payment dropped because the servicing company had been over funding the escrow account.  Sounds like a monopoly card.
      • On the other end of the spectrum groceries have come in a fair amount higher due to more children and one being a baby.  Baby food is expensive.
      • Recreation expense is coming in slightly higher than expected.  But that’s due to swimming lessons.
    • All in all, our budgeting has been pretty dead on so far this year other than those categories I mentioned.
  • Operating Income
    • YTD operating margin has been 49.99% versus budget of 51.66%.  Our goal is to be at about 50%, so we’re doing a little worse than expected but in-line with our overall objective.  I’m projecting that for the full year this will come in at a little less than 51%.
    • Note that this is better than last year where we finished at 48.6%.  As our income goes up and we control expenses, this percentage should increase.  Unfortunately, with kids in school, it’s been hard to control expenses.

Balance Sheet

  • Assets
    • Total Assets are flat from the last month, but up 19.2% over last year.
    • Cash balance is pretty flat.  We have our long-term emergency fund, short term emergency fund and our “buckets account”.  And that makes up the bulk of it.
    • Investments are down 1.2% for the month, but 25% over last year.  Note that includes contributes and returns.
    • House and cars stay flat because I don’t adjust them except for once per year.
  • Liabilities
    • Total liabilities are down 15% over this time last year.
    • Student loan is down 50% from this time last year.
    • Mortgage is down 2.6% from last year.  Argh.
  • Net Assets
    • Up 37.3% YoY
    • Another measure, which I call True Net Assets (which excludes house and college accounts) is up 34.6%.
  • Asset allocation
    • 19% – Investments
    • 6% – Cash
    • 54.4% – House Equity
    • 17.8% – Rental Equity
    • 2.7% – Cars

 

The Best Day of the Month

The best day of the month is paying down our debt.  Tonight was such a night.

But in the process I realized we won’t hit our full year debt pay down goal.  But I wasn’t disappointed.  I was sincerely grateful for the ability to pay down as much as we have.  Our goal was aggressive and relied on a few things happening at our work outside my control.  They still might happen but at a later time.

We’ll probably simply hit the amount we paid down last year.

I updated our snowball calculator and instead of paying off the last of my student loans by April, it will be more like June.  And we won’t have much left to put towards a rental property.

Oh well.  It’s not all “onwards and upwards”.  There will be setbacks, slow downs, emergencies, etc.

Our Plan for Financial Freedom

Sometimes I think it’s worth taking a step back and outlining our financial strategy.  The process of writing clarifies my thinking and there are plenty of research studies showing that writing something down helps get it done.

I’ve outlined our financial plan using my four-part approach that incorporates the four parts of the financial picture — Income, Expenses, Assets and Liabilities (Debt).

I advocate this approach in contrast to others who have a laser focus on paying down specific parts.

  • Debt freedom (Dave Ramsey)
  • Lowering expenses (Mr. Money Mustache)
  • Building business income (Ramit Sethi)
  • Asset investment (I have yet to find a good one for this one.  Financial Mentor might come close.)

That’s not to say it’s bad that they’re focused on each area, because certain people need/want help in one of those.  But everybody will need to manage the four different parts at some point.  For example, if someone pays off their debt and has extra monthly income, then what next?  If they haven’t been thinking about how to invest the extra money, they might be caught without a good plan and do something stupid with it.  And what about folks who aren’t in dire shape, but simply want to get better.  Maybe they have decent income, semi-controlled expenses, medium debt, etc, but lack a coordinated approach.  Also, sometimes someone is knocking it out of the park in lowering expenses but could be doing even better if they were increasing income or moving the asset allocation into income producing at the same time.

The only one that comes close to a great balanced approach is ESIMoney blog.

Anyway, let’s get to it…

  • BALANCE SHEET: Assets
    • Strategy Summary Invest steadily every month in broad market ETF and on the side try to find long term cash flow investments with a good ROI.
    • Stock Market: We automatically invest 15% of income in the stock market through Roth 401k.
    • Rentals:  My long term goal has been to own 10 by 45, 20 by 50 and 30 by the age 55.  I’m not sure I’m going to hit that, but we’ll see.  Here area  few comments about this part of the plan.
      • Now isn’t a good time to buy in our part of the country since real estate is really expensive.  So, we’re going to just start setting aside what we’re calling a “Real Estate Investment Fund”.  The more we can put down, the better to help it be cash flow positive.
      • I’ve committed to analyzing at least 100 potential rentals before buying anything.
      • We currently own one that cash flows great and previously we owned another, so we’ve definitely learned some lessons and feel ready to do more.  I’m also reading real estate investing books and developing a financial model to quickly evaluate deals.
    • P2P lending:  I’ve been doing this for a long time and it’s consistently produced 9-10% returns.  So it’s a nice place to park extra funds for 2-3 years (which is how long the mini $25 loans are).
  • BALANCE SHEET: Liabilities: 
    • Strategy Summary – Pay off all non-mortgage debt and then slow this down to allocate more towards investments.
    • Non-Mortgage Debt: I only have student loan debt and the plan is to pay that off by Q2 of 2017.  After that we’ll only have our home mortgage left.
    • Home Mortgage: If we throw everything at the mortgage, we could knock that out in about 3-4 years.  If it takes 4 years, I’ll be 41 years old.  Alternatively, we are thinking about splitting the debt pay-down money with half paying down the mortgage and the other half going into a separate account for future rental investment.  OR … rather than using half to pay down debt every month, we might set aside the whole thing over the course of a year in a separate account.  And if a rental opportunity comes up, we’ll plow it into that and if nothing comes up, we’ll use half to pay down debt.  That way we can stick to our goals and stay open to opportunities.
  • INCOME STATEMENT: Income
    • Strategy Summary – Stay the course at current job, but continuously look for other opportunities.
    • Salary: This one is hard because I have a steady career income that only goes up by 2-3% per year.  It fluctuates by a yearly bonus, but I have very little control over that.  I feel fortunate that I have a steady, decent income, but I don’t have the ability to increase it easily with more effort.
    • I know I could get a higher paying job, but everything I see comes with a much heftier travel schedule and I don’t want to compromise my family values.
    • Rentals: Interesting how this one is on the balance sheet also?  This is a deep subject, but suffice it to say that I think it’s a good, solid long term investment if done right.  The broad strokes are to buy at a great price, with a decent down payment, make sure it has solid cash flow, attracts a good pool of tenants and have a separate emergency fund for each unit.
    • Side gigs:  These don’t come up very often, but I’m open to them.  The challenge is balancing a very busy home life with 3 little kids and a job that sometimes gets very busy and requires travel.
    • Uber driving?:  Been thinking about this more lately.  Sometimes I can’t sleep, so it would make sense to hop on Uber just to check out what opportunities are around.  … stay tuned.
  • INCOME STATEMENT: Expenses (just the big ones)  
    • Strategy Summary – Have a solid budget, sticking to it and always work on reducing expenses where possible.  I feel like we’ve done so much to lower expenses over the years that there isn’t much left to do on this one.  
    • Taxes: Can’t do much about this except that the rentals have a better tax rate, so if I can get that income up, my tax rate will drop.
    • Debt Payments: Need to reduce these.  See Balance Sheet: Debt item.
    • Groceries: We’re at about $500/month for 5 people which I think is pretty good.  All the credit goes to my wife for this.  We definitely collaborate, but she does the work.  It is going up faster in the past 2 years because the kids are eating more, but that’s a blessing in itself!
    • Tithing: This is a non-negotiable 10% after taxes and before everything else (since taxes are the only thing I can’t control).  It’s not going away.  Note that early on we decided to tithe on the post-tax amount rather than after all the other deductions like life insurance, health insurance, HSA contributions, 401k contributions etc because it was the right thing to do.
    • Blow Money: It’s not a big expense, but worth mentioning.  We each get $50/month to do with whatever we want.  It used to be tough, but now it’s just normal.

Each of these is a fairly deep topic that I might write about more later.  Email me or comment if you have any thoughts about this.