On Time and Money

Simply put, we are a nation of instant gratification. That said, it may not be such a bad thing. We should spend the bulk of our time doing what we’re best at. Just because you can do something doesn’t always mean that you should.

If you’re putting in long hours at work, it’s more feasible to get a sandwich from Subway than to cook at home (going to McDonald’s is a different story). Convenience goods generally cost more. Like getting a gallon of milk from 7-Eleven.

Many people are do-it-yourselfers. I’m not one of them. Why go through the trouble of learning how to fix something that you’ll likely deal with just once?

Changing you own oil for your car is the perfect example. Why do this yourself when you can take to a shop, and get it done within minutes? The cost for this service is low. In addition, you don’t need to worry about getting dirty and disposing the oil when you’re done.

Doing a task in which you’re not good at is a mis-allocation of resources. If your time is worth more in your primary business, you should seek to outsource tasks that are not your core business. These generally include tasks that are redundant in which you can write a simple to-do list for. These tasks require little or no creative thought. If you cannot completely outsource them or automate them, you may need to hire an employee to perform them.

Ultimately, the value of your time and specific situation will dictate what things you spend your time on. When I was younger, my time was worth less than it is now. So, it was a rational decision to carry out a few of the tasks that I wouldn’t do today. Back then, I have more time and less money. Thankfully, things have changed now.

We have limited room for how many tasks we can handle. We can’t focus on a long laundry list of high priority tasks. Therefore, reality eventually forces us to prioritize. Knowing where your critical path lies and staying on it are critical elements of being successful.

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Everything Can Always be Made Better

Innovation doesn’t stop once we become experts. Becoming an expert can have serious consequences if you’re not careful. When you rely on your expertise, it’s easy to become complacent. And resistant to change.

No matter what level you achieve you should always be questioning yourself. Is the way you’ve always done something still the best? Often times. the ultimate solution for continued success lies on something far outside our circle of competence. For example, industries become outdated. A better typewriter, for example, will not achieve anything when the world is shifting to computers. The same can now be said for traditional desktop PC’s because the market is shifting to laptops and mobile.

Indeed, it’s important to continuously be studying your closest competitors. That said, disruptive technologies can affect your business even when they’re outside your industry. This is how Apple became a dominant force in the music industry. Samsung, being a large conglomerate, has become a leader in mobile computing through manufacturing Android phones. Traditional computer manufacturers including Dell and HP could have been big players in mobile.

A disruptive technology is generally a breakthrough that causes a revolution within an industry. This causes many new entrants to strike it rich while many established businesses go bankrupt. As stated earlier, this breakthrough often comes from companies that were outside of the industry being disrupted. Or, they had not traditionally been a direct competitor.

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Like Europe We Have Our Own Problems

Lately, the media has been extensively covering the bad financial news coming out of Europe. Meanwhile, the financial problems here in the U.S. have persisted. This is not intended to downplay the importance of Europe to our economy and the global financial system. On the other hand, we have our own critical economic headwinds to be concerned with.

For starters, we have many states and localities that are nearly bankrupt. This is somewhat comparable to the members of the European Union. States, like European Union countries, cannot control their own money supply. Therefore, they have to raise taxes and cut benefits. One key difference, however, is that states don’t have the option to leave the union unlike the members of the EU.

The federal deficit is one of the biggest problems we currently face. The aging demographics only compounds the problem. Medicare especially will add strain to our government’s financial problems. The mushrooming costs of Medicare are simply not sustainable. In the future, our health care system will have to adapt and become more cost efficient. Health care costs have been rising much faster than incomes and inflation.

Our national debt has reached a level in which it will be a drag on the economy. According to Carmen Reinhart and Kenneth Rogoff’s This Time is Different, large federal deficits are a drag on economic growth. In this type of situation, government spending crowds out private investment. In addition, government spending has a slightly negative multiplier on the economy. This is the opposite of private investment.

The odds of government debt default are very high once a nation’s debt to GDP (Gross Domestic Product) ratio gets to be over 90%. That said, the term ‘default’ is much broader than simply failing to make the payments. The most common form of default is through inflation. In this situation, the decrease in value of a country’s currency reduces its debt burden. This is a form of cheating creditors because they are being repaid with money that’s less valuable compared to the principal that was originally lent.

In the end, large and growing federal deficits lead to subpar economic growth. Recovery from large deficits can be long and painful. At best, we will go through a muddle through period. This is a period similar to the environment we are currently in. Yes, GDP is growing. On the other hand, the growth rate is slow with unemployment persistently high. To many, this feels as if the last recession never ended. This has all happened despite the fact that the government has been on a spending binge.

The largest spending binges occur after financial crises according to the research done by Reinhart and Rogoff. The financial crisis of 2008 was no exception. In the long run, however, the extra spending will only add to the problem.

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Three Headwinds that Today’s College Students Face

You should always treat your education like it’s an investment. That said, when the cost of any investment rises beyond that point at which a reasonable return can be made, it’s time to look at different options. This may include not making a decision at all. It is also important to note that by doing nothing, you are still taking a position. In fact, we see this in investing all the time. For instance, by deciding not to be in the stock market, you are taking a position in either cash or an alternative investment.

In recent years, tuition prices have risen to unbelievable levels. Despite this, young students are advised they should go to college regardless of the cost. This can be bad advice. There are three major problems that students are dealing with today. Obviously, the high tuition fees result in high student loan balances. The average borrower in his or her 30’s today has a student loan debt balance of $28,500.

The second major headwind is the fact that the job market has been weak since the 2008-09 recession. This economic recovery has been unusually weak. Indeed, the unemployment rate for those who have degrees is generally lower. However, companies are reluctant to hire inexperienced workers and invest a large amount of capital to train them. This only makes the debt woes worse. Coupled with a high balance, new graduates are unable to make their loan payments. If they get behind on these payments, penalties and interest raise the loan balance. Student loan debt is also difficult to get rid of through bankruptcy. This is because most debt is issued or guaranteed by the federal government. Similar to that of income taxes, it’s much more difficult to default on government debt than private debt.

The third headwind college students face today is globalization and technology. Many mid-level professional jobs have been eliminated through automation and outsourcing. Being able to obtain a steady career with long-term employment is becoming rare. Since the economic recovery, retail and food service have been the fastest growing job sectors. This shows that there is a mismatch between what the market demands and what colleges are preparing students for.

The media, especially the financial news, likes to talk about the value of human capital. With the price of robotics falling and the productivity improvements of software, companies can get more done with less people. Where the jobs will come from in the future is unclear. This does not ensure that the future will be grim. Productivity gains lead to lower prices which is a great benefit for consumers. Lower prices can, in the end, lead to new industries and new innovation. If consumers can get more for less, history shows they willingly spend more. 

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Choosing the Right Type of Investment Property

The properties that make the best rentals generally fall just below the typical median priced home. There are several reasons for this. For starters, this is a home in which the typical renter can afford. By simply being available to a bigger group of people, this will keep vacancy loss costs lower. In addition, most renters will be able to afford their payments and remain in the home longer.

The bigger the home, the more attractive it is to another buyer rather than a renter. Despite having better resale value, more expensive homes don’t necessarily make a good income property. Since most people who live in these home prefer being home owners, they are less likely to renew their lease.

Another big problem with more expensive homes is that there are more costs involved. They tend to be larger and contain more fixtures. They tend to consist of more repairs and maintenance. This is especially the case each time a tenant moves out. If you get an irresponsible tenant, they can do considerable damage. It’s not unheard of to have to pump thousands of dollars into the property after evicting a bad tenant.

It can often be a challenge to balance rental value with resale value. Cheaper homes do not appreciate as much and don’t sell as fast. This is partly because it appeals more to other investors than other home owners. Obviously, another investor is likely to be bargain hunting. Many investors will pass until they find the perfect deal. Since they will not be living in the property themselves, an investor will treat a property as a commodity.

Condos and townhouses are at the opposite end of the spectrum from expensive homes. They typically offer good cash flow. However, being able to sell a property in a weak market is very difficult. Banks and lenders don’t want to finance them. Also, the price is so low that the fixed costs of financing (if you can get it) are so high in relation to the property that is generally isn’t worth it. For an investor who has cash and is just looking for cash flow, condos can be a great investment. Despite the obvious drawbacks, they have far less costs regarding repairs and maintenance between tenants.

That being said, the type of property you choose to invest in matters greatly. Most investors should seek a balance by choosing properties that are good quality that still make good rentals. This is where you stand to make money on rental income as well as long term price appreciation.

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Narrowing Your Focus to Find the Right Location

When you narrow your focus, you are better equipped on finding yourself the best possible deal. When buying a home, you can use this strategy by focusing on a specific neighborhood.

If you’re new to a city, it’s wise to take some time to know what area you want to live in. Once you’ve done this, you can narrow your focus to a specific area. This has several benefits. First, you become an expert quickly. You become more aware of trends that affect the area. You also have a good understanding of what type of home you like. You also know approximately how much each house is worth. When you establish a degree of familiarity, you are better able to make an informed decision.

A home in a good location will always be worth more than a home in a mediocre area. This isn’t solely dependent on the neighborhood. It also depends on the street and the property that surrounds it. Generally, you should trust your intuition when selecting a location. If a property is available for an attractive price, but it doesn’t feel right, you should pass on it. Even if it’s available for a great price, it’s probably not something you would be happy with. This is why narrowing your criteria is critical. It can save you from making a mistake and settling for less than what you originally wanted.

As mentioned earlier, specific streets and lots do matter. Very few people like being on a busy street. In addition, it’s preferable to have trees and good landscaping. This is especially important in a desert environment.

Zoning is another important element of finding the right location. It can make a huge difference in the future of that location and neighborhood. School zoning is another factor that can add or subtract value from a location. Be sure to do your homework by researching the reputation of the schools your neighborhood is zoned for. These are all factors that matter and will make an enormous difference in the long run. If you have strict criteria and never bend on your requirements, you will find a home that you’ll be happy with.

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Why Real Estate is a Good Investment Choice

Real estate allows an investor to control a valuable asset with only a small commitment. For investment purposes, an initial investment consists of a 20% down payment plus some closing costs. If you are buying a fixer, then your investment will be higher. That said, your initial investment is much smaller in relation to the value of the asset you are purchasing. Few investments allow this kind of leverage.

Indeed, leverage can be a double edged sword. It can magnify your investment results when things go well. It can work in reverse as well. That is why a margin of safety is vital. A margin of safety is a principle typically associated with investing in securities. It can also be applied to real estate.

Margins of safety for real estate can include the spread between your income and expenses. This is where you only settle for properties offering good, consistent cash flows. For example, a residential property in a distressed market is likely to be underpriced. Your mortgage payments are low in relation to what you’re getting for rent. Being a residential property, there are also plenty of people to rent the property to. Compare this with a commercial property with a greater return on investment but is attractive for only certain types of businesses. You have a much higher risk of vacancy loss. This simply means the property is sitting empty while you are paying the mortgage, taxes, and upkeep. This is why the residential property is the better investment choice despite having a lower ROI.

Another metric that is useful is the market’s price to medium income ratio. This is an important metric to avoid getting caught up in manias and bubbles. When the price for a median home is much more that three times the median income, the overall market is overpriced. As Warren Buffet has said, there are times in which it’s best to do nothing. Opportunities will eventually come.

In addition to getting positive cash flow, real estate is a good inflation hedge over long periods of time. There will be bubbles and panics again in the future. However, real estate will always revert back to its intrinsic value. Investors are best off when they don’t get caught up in the highs and lows. Instead, only buy properties that offer positive cash flow while you wait for price appreciation to accumulate.

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How We Make Financial Decisions

Financial decision making is simply more tricky than it seems. When we make our decisions, they always seem rational at the time. In addition, economists mistakenly have looked for ways to justify our decisions as being rational. Obviously, this cannot be the case.

We often buy things on emotion. Economists would rationalize this by saying that the item we bought gave us the most utility at the time. In reality, the thing we bought could have been a snickers bar or a soda. Something with no real value, in other words. But it gave us a feeling of satisfaction. Does this qualify as a rational decision? I think not.

Many irrational decisions people make involve those that provide the most pleasure or the least pain. This casuses even the most disciplined of people to slip every once in a while. For instance, a motivated health guru doesn’t eat healthy 100% of the time.

Another decision making problem we have lies with our illusion of being able to predict the future. We are hardwired to look for patterns. Then, we take those patterns and expect trends to continue indefinitely. Obviously, very few trends continue indefinitely. Most of these trends are nearly random and regress to the mean over time.

Bull markets start once everyone has given up on a particular asset class. This makes it undervalued. Anything that’s undervalued will begin attracting savvy investors. A new trend is born. When a new asset establishes a track record of rising prices, it attracts more investors. The trend strengthens and becomes psychologically reinforcing. Usually, the asset is at or above its intrinsic value at this point.

When prices get unreasonably past their fair values, a bubble is born. A crash becomes inevitable. But its difficult to stop and cash in. This is because it’s impossible to know when prices peak. A rational investor could stand to miss a big portion of the upside because a bubble could persist for longer than one would reasonably assume.

Governments also play a big role in bubbles. In fact, they will do anything to keep the party going. Keeping interest rates low is the perfect example. Lax lending standards and rising debt levels are a red flag that a bubble exists. Examples of this include buying stocks on margin and leveraging real estate.

The nature of bubbles reflects that most investors buy near the top. If an upward trend doesn’t exist for an asset, no one talks about it. Out of sight, out of mind. Gold simply wasn’t discussed in the 1990’s. The law of large numbers would show that the asset pool was too small at the beginning of the bull market in order for the majority to have owned it. If the masses were holding any particular thing, the prices would have been higher. And no new trend could get any traction.

We make our decisions based on what others are doing. In order to achieve long term success, try looking for the assets no one else is buying or discussing.

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Think Twice Before Making Extra Principal Payments

Many homeowners are in a rush to pay off their home loans. This is not always a wise decision. First, you lose liquidity and put your home equity at a higher risk. This is especially the case if you have little cash set aside and if you have few liquid investments. You should always strive to have at least six months of savings set aside.

Consider the following two situations. The first is a homeowner who routinely pays extra on her mortgage with the intent of the home being paid off early. Yes, it is true that if you pay a little extra each month, you will pay the home off substantially faster. Now, the second homeowner only makes the minimum payment each month.

Let’s imagine that a few years go by and both homeowners lose their jobs. And can no longer make their mortgage payments. Who is better off? The first homeowner has more equity than the second owner. However, the real estate market is slow and she may not be able to sell the home before it goes into foreclosure. And, yes, the second owner is in the same situation.

That being said, the second homeowner, who had been just making the minimum payment, has more options. She knows that the bank has little incentive to foreclose on the property. This is because the mortgage balance is high. That is, the bank isn’t in a position to gain hardly anything by foreclosing. The firs homeowner is a better target for the bank because they can sell the property and recover their losses.

Let’s also pretend that the second homeowner either saved or invested the money in which she was considering paying extra on the mortgage. She now has multiple options. She can keep current on her mortgage from these savings. This is the case whether she kept the money in a savings account or invested the money in liquid investments like stocks. Or, if she stops making the payments, the bank would be in no rush to foreclose.

Banks are incentivized to foreclose on properties with low loan balances first. This is because they can recover their losses easily. A home that is underwater or has a high balance will cause the lender to incur a loss, which is why lenders are seldom in a rush to foreclose on an underwater home. This is especially the case in a weak market because it would only add to the inventory of homes for sale, which is one more thing driving down prices.

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Recordkeeping for Income Tax Purposes

Recordkeeping is one of the most cumbersome tasks associated with running a business. It is something that many people put off. Having your financial information at your fingertips is important for making business decisions and keeping your accounting up-to-date.

That being said, recordkeeping is required and necessary to complete your income taxes. If your business gets audited, good recordkeeping habits could prevent you from having to pay the IRS a large sum of money. You may need to provide records to keep all of your expenses. Records can consist of receipts, bank statements, credit card statements and more. Failure to provide proper evidence could cause your deductions to be disallowed.

As a small business owner, your time is valuable and limited. You should strive to get your bookkeeping done as productively as possible. This could consist of using software to do much of the heavy lifting for you. For example, QuickBooks reduces the amount of work you have to do by eliminating redundant tasks. When you print a check in QuickBooks, the expense is already posted in the proper category. It’s vital that you keep yourself form doing duplicate work.

You should also avoid commingling funds with any account that you make non-business purchases with. This is true regardless of whether your business is incorporated. In the event you get audited and the IRS agent notices that many personal items are bought through your business account, the agent will be more likely to disallow an expense. Meals and entertainment are generally 50% deductible. However, it must be absolutely clear that they were business expenses. It is always a best practice to separate personal and business transactions.

If you use your vehicle for business use, you do not have to keep track of each expense. Instead, you can track your mileage. You will be able to take a deduction based on the number of miles you drove throughout the tax year.

In addition, records are needed each time you buy or sell an asset. You need to prove what you paid for an asset in addition to what you sold it for. Assets that are capital expenditures require depreciation. That is, the amount of the tax deduction would span over the useful life of that particular asset.

One of the questions I get asked most frequently by clients is hou long is it necessary to maintain records. At a minimum, you should keep records that are within the statute of limitations of the IRS. This is generally the later of three years after you file or two years after you pay any taxes due. You should keep copies of your income taxes even longer. The statute of limitations assumes that you filed those returns and paid any taxes that were due. If the IRS has no record of a return that was filed, then there is no statute of limitations. Having said that, it’s best to err on the side of caution when maintaining your financial records.

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