Hands Off

Setting Your Financial Goals

We don’t believe that there’s a one-size-fits-all when it comes to financial goals. Someone working in their area of passion might have a far longer term goal than someone who wants to retire as soon as possible so that they can pursue their passion.

However, we believe it’s important to have a financial goal. When you have a goal, you have a sense of direction, you have clarity, you can clearly measure your progress. It can be motivating and invigorating to move yourself toward a goal.

So what do you do if you don’t know exactly what your goal should be? Taking it a step further, what if you have not yet found your area of passion, you don’t know what you want your life to be about? What then?

In that case, we recommend making financial independence your goal. Financial independence doesn’t mean you have to stop working, but it does mean that you have the luxury of not having to work for money when you don’t want to. So if you decide at some point that you want to stop working and travel, or stop working to have a family, or you want to work in an area where you can’t get paid, you’ll have the freedom to do so. When Dave started writing, it took him six years to finish his first novel. Had he been dependent on a full time job, he never would have had the luxury to do so. Similarly, those who want to start a nonprofit organization might have to put in years before any funding becomes available, and financial independence can facilitate that dream as well.

We encourage everyone to think hard about their goals, not just for money, but for their lives. Get a clear picture of what you want to do and understand what the financial implications might be. And if you don’t yet know what you want, you can always pursue financial independence. That way, when you work out what you want to do, you have the luxury of being able to pursue those dreams.

Financial Goal Highlights

Lattes and Letdowns

Credit Cards

The financial gurus are divided on credit cards. Some hate them, blaming them for so many people being over their heads in debt. Others love them, advocating using credit cards as a way to accelerate your path to financial freedom.

Which gurus are right? Both are, of course.

 
The thing to realize about financial gurus is that each one is speaking to a certain segment of the public. In the case of credit cards, their are some who get tripped up by them and are better off cutting up their credit cards. Others thrive with them and make hefty profits from the credit card rewards (paid for by the high fees assessed against the first group).

So which segment are you in? Ask yourself a simple question. Does easy access to credit tempt you to spend money you’d never spend in cash? If so, you should probably listen to the gurus telling you to tear up your cards. If not, if you have plenty of self-control around credit cards, then you can use them to build your wealth faster.

Here are a few tips and tricks we recommend using around credit cards:

1) Credit cards have extremely high interest rates, but these interest rates don’t apply to everyone. If you pay your credit card off in full each month, then you’ll never pay interest.

 
2) Some credit cards come with 0% interest for an introductory period, often 12 months. These cards can be great for when you need cash for a short period of time, and expect to have the funds to pay off the card by the end of the introductory period. For instance, someone buying a distressed property might use such a card to make repairs, knowing that they will either flip the property at a profit or refinance the property before the introductory period expires. However, even in this case, you must keep making the minimum monthly payment on the card to maintain the introductory rate. And beware, because these introductory rates are not as generous as they may seem. The credit card companies are in the business to make profits. These introductory rates encourage many people to run up large credit card balances, and once the introductory period ends, they could wind up paying high balances on these cards for years to come.

3) If you do get stuck paying interest on a card, one easy trick is to call up the credit card company and ask them to lower your interest rate. They won’t always say yes, but most of the times we’ve tried this trick, we’ve gotten a reduction in our interest rates.

 
4) You can also ask the credit card companies to reverse certain fees as a curtesy. For instance, if you get assessed with a late payment fee, just calling up the credit card company and asking them to reverse the fee works surprisingly often.

 
5) To improve your credit rating, you can ask the credit card company to increase the credit limit on your existing cards. Why does this raise your credit rating? Because one of the factors considered is the portion of your available credit you’re using. If your expenses stay the same but your credit limit is higher, you’ll be using a lower percentage of your available credit. Note, this only works on existing cards. Signing up for new cards to reduce the percentage of your available credit you’re using can actually hurt your credit rating short term.

6) Another way to make money on credit cards is by getting cards with strong rewards programs and sign-up bonuses.

 
7) Beware of cards with high fee structures, such as annual fees and high foreign transaction fees (if you travel frequently).

Credit Card Highlights

Lattes and Letdowns

Mutual Funds vs Index Funds

Which of the following would you expect to perform better? A fund consisting of hand-picked stocks selected by top-notch professional investors, or a fund consisting of every stock on the market, with no investors making the selection?

It’s logical to say that the professional investors would put together the better funds. Yet, we consistently see that mutual funds run by professional investors underperform index funds, which just take a bit of each stock.

Why?

The biggest reason is the fees. Mutual funds typically charge high enough fees to erase whatever advantage they might have over the general stock market. Moreover, gains on mutual funds are typically much higher than gains on index funds. This is due to the fact that mutual fund managers are constantly buying and selling stocks, and if stocks are held for under a year, they profits are taxed as short term capital gains. Even if you own the mutual fund for many years, since the stocks the fund owns change all the time, the entire fund is taxed as short term capital gains. Index funds, on the other hand, hold onto the same stocks for the long haul, which is why these funds are taxed at the lower long term capital gains rate.

If you’re investing through a retirement fund such as a 401(k) or ROTH IRA, you might not have to worry about capital gains tax. But if you’re investing regular funds, the tax implications can be significant. 

Index Fund Highlights

Wheels and Deals

Cars and Transportation

Transportation may be the area where it’s easiest to see an early financial win. This is because transportation is an area where people pour significant money, much of which gets lost. 

Unlike buying a house, which tends to go up in value over time, cars almost always go down in value. And new cars go down in value far faster than used cars do. 

It’s easy to imagine two people who live on the same block, who both own cars, and drive to the same office building. Yet, one of them might be paying six times as much for the same drive. 

While virtually all cars go down in value, they don’t decrease at the same rate. New cars lose their value far faster than used cars. It’s not uncommon for new cars to depreciate by 20% or more during their first year alone. So if you paid $50,000 for a car, a year later, it might only be worth $40,000. 

Car brands like Toyota and Honda are famous for their reliability and longevity. A ten-year-old car from one of these brands might still run great and might only cost a few thousand dollars. A year later, it may only have depreciated by a few hundred dollars. That’s a huge difference. And if you’re someone who is trying to invest and build toward financial independence, you can have that extra money growing and getting you to your financial goals faster.

Which brings us to the question of buying vs leasing cars. Dealerships might try to entice you into leasing with talk of no money down and a reasonable monthly fee. Don’t fall for it. As we said above, cars tend to lose their most value in their first year. Any guess which year they lose their second most value? Their third most value? That’s right, it’s years two and three.

When you lease a car, you typically take it for the most expensive years of the car’s lifecycle. Then you return it to the dealer in exchange for a new car, which you will also drive for the most expensive years of its lifecycle. The dealerships know how much the car is supposed to be worth after three years, and they make sure your lease terms cover every bit of that depreciation. And if you do anything to make it depreciate faster, like scratch it up or put too many miles on it, they’ll come after you for extra fees.

As a general rule, you’ll save tremendous money on transportation by buying your cars used. And even if you buy new, avoid leases, which can be huge drains on your budget.

Car Highlights

House Hack

Housing

Housing is the number one post-tax expense for most people. If you can find ways to greatly reduce your housing costs, or even turn housing into an income producer, you can super charge your way to financial independence. 

While owning a home can be a strong investment over time, beware of becoming house poor. In The Cash Machine, Kyle and Libby bought a house far bigger than they needed in the hopes that they’d eventually have a family big enough to fill it. On paper, the house was a strong investment, because it appreciated over time. But since they never intended to sell the house, they weren’t enjoying full benefit of that appreciation. Meanwhile, their costs on this gigantic, luxury house, including mortgage, taxes, and upkeep, were draining their short-term cash and causing them financial pressure.

Dylan was also benefiting from the real estate market appreciating by buying valuable properties. However, Dylan bought properties with multiple apartments, and he’d live in one and rent out the others. The result was that his tenants covered all the costs of the property, which gave him the upside of the appreciation without the downside of high monthly costs.

In general, there are four ways that people make money from rental real estate investments. 

1) Appreciation, when the property goes up in value.

2) Cash flow. This is the amount of money left from the rent after all the expenses have been paid.

3) The mortgage being paid down over time. 

4) Tax breaks the government gives to encourage real estate investments.

The House Hack strategy Dylan uses can be particularly powerful because house loan terms are more favorable for properties you intend to live in than they are for properties that you only intend to rent out to others. House Hacks can be done on properties of up to four apartments, and the entire property can still qualify for a primary residence mortgage, which generally has a lower down payment and lower mortgage than a commercial loan. Amazingly, you can move out after only one year and repeat the process on a new property, and both properties will remain on primary residence mortgages for the duration of the loan terms. If you live in a location where rents are high enough to cover the costs of the property, including mortgage, the House Hack can be an incredibly powerful tool to achieving financial independence.

Housing Highlights

Veal Scallopini

Tax Strategy

For most people, taxes are their number one or number two expense (right up there with housing). It’s also the number one expense that most people would gladly minimize. We’ll voluntarily pay more for higher priced cars or houses, but almost no one wants to pay more in tax.

Most people consider tax obligatory. It’s important to realize that taxes are not. Many of the wealthiest people in the world pay little or no tax. That’s not because they dodge the tax bill, it’s because they plan in advance to avoid taxes.

If you’re not a US citizen, one of the easiest ways to avoid tax is to move to one of the countries that has no taxes. This is one of the reasons that a place like Dubai is currently exploding, because they offer a high standard of living, a fairly low cost of living, and no taxes.

If you are a US citizen, moving out of the country may not be a big help as the US is one of the only countries that expects its citizens to pay federal income tax regardless of where they live. Though if you live abroad and your income comes from abroad, the first $100,000+ of income would be exempt from taxes. And moving can still be a way of saving on state taxes, which fluctuate greatly from state to state. Some states even have zero income tax.

For most, moving is not the ideal solution to avoiding taxes. Fortunately, there are many other ways.

Governments often give tax breaks as a way of incentivizing behavior. If they want you to put up solar panels, they’ll give a tax break. Want you to drive an electric car? Tax break. In the United States, the government wants to encourage real estate development, so there are very favorable tax laws around real estate, including for your primary residence.

Certain investment categories have tremendous tax breaks associated with them. Real estate investments can be a great source of tax breaks. Retirement funds are another category. The 401(k) allows you to invest money before you pay income tax on it. The money grows with no capital gains tax, and then you pay income tax on the money you pull out. The ROTH IRA is the opposite. You invest post-tax money into the ROTH, it then grows with no capital gains tax, and you don’t pay taxes on the money you pull out. Of course, both retirement accounts require you to wait until you’re almost 60 years old to take out money, so there can be downsides.

The key distinction to remember about taxes is that you need to be forward thinking with them. If you go to your accountant in March to prepare your taxes for the previous year, they have little power to save you money on your taxes. However, if you go to a tax strategist in January and ask how you should spend your money that year to minimize your tax burden, then they can give you a plan to reduce or eliminate your taxes. 

Tax Highlights

Enemy Number One

Small Business

In the stock market, the average company has a valuation of than 15 times their annual profits, and in certain industries, its not uncommon to see businesses valued at over 50 times their profits. On the other hand, a small business may only be valued at 2.5 to 3 times its annual profits. The lower valuation means that investments in small businesses have the potential to give far higher returns than investments in large ones. For instance, if a business that makes $100,000 a year in profit is sold for 2.5 times its annual profits, it would cost $250,000. And if it continued to generate $100,000 a year in profit, that would be a return of 40%, five times as much as the average stock market return of 8%. 

The numbers can be even better because it isn’t necessary to have 100% of the cash in pocket to purchase a business. Many business sellers will offer financing, allowing you to pay a portion of the business off over time. Also, in the United States there are federal government loans under the Small Business Administration that can be used to cover much of the cost of buying a business. And if the business has assets, banks may lend money against those assets that you can use to buy the business. Put all that together and it’s possible that even small amounts of money put into a small business purchase can yield significant annual returns.

But all this comes with a significant warning. The returns on small business investments are only strong if you can keep the business profitable, which is not guaranteed. And unlike the stock market, which is an entirely passive investment, your small business purchase might require you to work for your income. 

Put this all together and small business can be a fabulous wealth building tactic for those skilled in business, but it can be a serious risk if you don’t know what you’re doing. 

Small Business Highlights