Improving Our Ratios

A couple of months ago I wrote a post that identified some financial ratios I’m starting to measure. These are great indicators of how well the plan is progressing so I like to see them go up. I’m already getting a chance to make that happen.

Between finalizing things for this year and planning to pay myself a bit more from my business every month (and investing that entire extra amount), I expect our monthly ratios to improve in January. As compared to the start of October, they will soon be:

  • Investment savings (actual investment amounts and mortgage principal payments, all of which reduce our future income needs): 48.6% of net income (was 44.6%)
  • Total savings (investment savings plus things such as saving for the next vehicle we will need and the anticipated monthly increase in our general cash account): 60.9% of net income (was 57.8%)
  • Core living expenses (what we would need each month to live a normal life without mortgage payments or extras such as vacations): 27.7% of net income (was 29.8%)
  • Investment savings / core living expenses (what we invest compared to what we spend on ordinary living expenses): 175.5% (was 149.6%)
  • Housing costs / gross income (similar to the GDS used to qualify for a mortgage): 16.4% (was 17.4%)

At the end of the year I also estimate that we will hit the following ratios, again compared to the start of October:

  • Investment portfolio total value / mortgage balance (how close we are to having investments worth more than our loans): 30.3% (was 24.3%)
  • Estimated investment income / core spending (how close we are to paying the bills without working, not counting the mortgage): 13.2% (was 11.0%)
  • Net worth gain over the last year: 53.9% (was 55.2%)

Only one of those values, the net worth gain, hasn’t improved. And that’s not bad because it’s still at a great level and the comparison point for the gain (our net worth one year ago) keeps increasing which makes the percentages smaller. The dollar value that produces that 53% gain is actually a lot more than the one that made a 55% gain.

This can also be compared to different approaches. By the time we have lived here for 2 years we will have built up an investment portfolio worth more than 1/3 of the value of the mortgage. That shows that if we just focused on paying off the mortgage first, it would be gone in under 6 years (maybe closer to 5 counting the interest saved). Of course I’m much more comfortable with putting that all into a portfolio while we enjoy low interest rates. The portfolio should hopefully end up covering a lot more than the amount of the mortgage within a few years. It interest rates stay low enough we can keep the mortgage for the rest of the 16 years we currently have left. If not we can annihilate it at any time.

The first ratio is the one I would like to work on a bit more. If we can get our investment savings up to 50% of our net income that will put us in the range of some very respectable bloggers. Unfortunately even investing more didn’t put us there since it took a higher income to do that. I think we’re pushing things far enough already that it would be hard to increase the investments further without having more income but we’ll see what we can do. However that’s just counting the regular monthly amounts. With a few one-time additions we’ll be just over 50% in total for 2012 and may do better next year.

This will take a bit of caution though. If I start getting a lot of extra income from passive income projects, half of the after-tax income will need to be invested to keep up the ratios. Preferably all of it will be invested after reaching my special income goal. If not, this will crash the ratios and make us look bad.


All the Cool Kids Are Frugal

One of the persistent threats to financial common sense is the fear of rejection. People think that if they buy the cheap option instead of spending as much as everyone else they won’t fit in. This is an illusion and the perfect example just came up.

Joe at Timeless Finance recently pointed out how Canadian retailers do a cheap imitation of Black Friday, using it as a marketing event rather than an actual sale. In his post he mentions something written by another blogger about a sale:

“Zegna black military inspired coats with a zip-out lining were $1,499 from $3,595.”

Now high-priced fashion is nothing new. We know there’s a world where people consider it acceptable to spend thousands of dollars on otherwise ordinary clothing items. But the thing that caught my attention is the “military-inspired” coats. What’s going on here?

This must be very desirable item if it can sell for nearly $4,000. But why is it “military-inspired”? Do military uniforms have a tradition of using only the finest silk? Unless this is the new wave of supporting the troops I’m guessing that it’s imitating a recent style. That means it’s military-inspired because someone else was wearing a military-inspired coat or an actual military coat. In turn they were probably following someone else who did it first.

Who was the person that started the trend? Most likely someone who couldn’t scrape together $100 to buy the current fashion at the time and had to resort to doing something inconceivable to the average person just to get wearable clothes, like shopping at army surplus stores or deep-discount vintage stores (as opposed to the high-markup vintage stores). This was so unusual that people noticed it and decided it was cool.

At last we come to the true story: the highest priced clothing is an imitation of people who can’t afford to buy even ordinary clothes! For $3,600 you don’t just get something fashionable, you also get a big serving of irony to make you even cooler.

It turns out that the regular TV show joke where someone makes a “fake” fashion line consisting of people wearing actual garbage and it turns out to be wildly popular is not that far from the truth. That’s not to say that frugality means living in a trash heap. It just shows that people will mock things one day and then spend the average family’s annual salary on them the next year.

Want to be ahead of the trend? Just find ways to spend less! Frugality is not the new fanciness, it’s the old fanciness that has always been around. This actually fits very well with the rock star approach to life. Frugality combined with a little creativity is a great way to stand out when everyone else is chasing the latest high-priced fashion.

Passive Income Update: Slow Progress

Three and a half months ago I set a passive income goal to build up to $500/month, from a starting point of $223/month. Thing have advanced a bit and now we’re up to $262.84/month. This is the current status of each part of that original goal:

  • Investment portfolio and savings interest: this counts for $259.54. By the end of the year I expect it to be producing up to $290/month and the progress will continue next year so this is advancing well.
  • My blog experiment with adsense: this month I got one click on adsense with a high payout. If something like that keeps up I can count about $3.30/month from this. It’s going very slowly but I haven’t really spent any time on it. I think the twitter marketing strategy is working but very slowly because I’m not putting much into it. If I spend a bit more time on marketing and content I think the revenue will increase nicely.
  • Product #1 (partnership with blogger): this is still undergoing some final revisions before it can be launched, so it doesn’t count for anything yet. I think the potential is very promising though. If it goes well this product alone could give me the entire target amount and more.
  • Product #2 (service for small businesses): I don’t think I’ve moved this forward at all. Once the other product is taken care of I will get back to this and see if I can add a bit of income from it.

That’s not a lot of advancement for 3 months. But like many things, this is likely to happen very slowly and then very fast.

How To Be a Rock Star

In the technical world people are always talking about rock star employees. Usually this is a reference to having the best skills. But this is completely backwards. Less than 10% of being a rock star is about talent. As Cal Newport’s book demonstrates, the most skilled musicians and the rock stars are two completely separate groups.

So what is a rock star? It’s someone who is larger than life, has a large following, gets plenty of attention (and controversy), and can pull off just about anything they want to do and demand anything they want. Obviously this isn’t limited to rock music. There are rap stars who are just as outrageous. Many top  bloggers follow the same model. It’s practically a requirement for having a “reality TV career” (ugh).

Some of the things that come with being a real rock star aren’t so attractive, like the complete lack of a private life. But if you’re looking at something smaller like being a rock star in your industry or just in your company, there are many advantages and less negatives. Your career can go a lot further if you’re leading instead of following. Do you want to be the one who gets people talking about what you said and plays the tune that everyone follows?

Here are some of the tricks to being a rock star that have nothing to do with talent:

Promote yourself everywhere. Quick, what’s Gene Simmons known for these days? Apart from a reality TV show, he gets a lot of attention as a marketing guru. A speaker in a marketing workshop I attended recently was around when KISS got started, unlike me. According to him they weren’t all that talented at the start but due to their marketing and entertainment they managed to build a fan base. When people constantly see your name and have something to associate it to, that eventually gives you a lot of power.

Say what people are thinking but not saying. Music defines a generation because musicians will say things that help explain what’s going on and pull people together, often when others are too scared to put it out there. It can be risky, but a leader is someone who does what everyone else wants to do before they figure out that they can do it. Once a few people start agreeing with what you say you become the leader because everyone can see that you’re ahead of what’s happening now.

Grab attention purposefully. This may be the single thing that defines a rock star. Everything they do instantly makes them the center of attention. Sometimes it’s a cheap gimmick, but if you can get a bit of attention you can use that to do something more important. Of course it has to be something that doesn’t discredit you completely. Showing up to a banking conference naked will get you attention, but not credibility. Showing up with a blue mohawk, and chains might just convince them that you can help traditional institutions connect with young people. Either way you would not be ignored and unknown.

Embrace risk. Because all of these things are so far outside what normal people do, sometimes they don’t work out well. This happens to all rock stars, but they learn from the reaction and move on to try something different. For a time in the 60s the Rolling Stones actually tried to be “good boys” like the Beatles and dress conservatively. It didn’t work out as well as they expected (because it was fitting in, not standing out) so they went the other way and ran with the phrase “would you let your daughter marry one of these?”. There is no formula to guarantee that everything will work out so it’s best to take it as a learning experience.

Entertain your fans. Picture a rock concert: the lighting is low but steady, the musicians are all dressed in black with short hair, they stay as still as possible, and the audience is silent because everyone is focused on the musical skills being demonstrated. Wait, that’s not a rock concert, it’s classical music! They are opposites for a reason. Classical music performances are focused on showing talent. Rock concerts are all about entertaining people, maximizing the emotions they experience, and giving them a memory they will never forget. Rock stars don’t just play fast and intricate melodies (in fact the music is usually pretty simple), they play as loud as they can and drive it home with flashing lights and explosions. Everyone likes to be entertained and they will follow you if you entertain them.

Live a story that others aspire to. As Keith Richards writes in his autobiography, “everyone liked the Rolling Stones because everyone wanted to be the Rolling Stones but they couldn’t give up their ordinary life”. This is a key reason that rock stars get so much attention. If you do what everyone wants to do but can’t, and take it to the extreme, you will get attention and followers. There are reasons most people won’t give up the safety of doing everything the ordinary way. But some of those are imaginary fears, and if you are willing to give them up and stand out you can write your own story.

Being a rock star isn’t for everyone. It’s certainly easier to fit in and follow the standard plan. But if that’s not enough for you, consider going as far as you can in the opposite direction. When you break all the rules, do things that people can’t ignore, and live the live that everyone secretly wants, you can be in control and make a more exciting life for yourself. Some people will hate you for it, but many others will follow you and listen to what you say. When you do this well you can make any crazy demands you want, like insisting that you need a bowl with 782 red M&Ms at lunch or you’ll walk out.

Is Inflation All In Your Head?

One of the big uncertainties for anyone planning to retire and live off of investment income is inflation. Working income tends to keep up with inflation, while investment income can be more limited. Some people build in a big margin of safety to allow for inflation, while others looks for things such as indexed pensions and annuities for protection. To make good plans you need to know what inflation will be, and no one knows this. There are always a few crackpots who claim that the real inflation rate is 15% and the real unemployment rate is 45%, but even using official data it can be hard to predict what will happen.

(Possibly the only inflation joke ever: The president of a mining company that produces iron calls of his counterpart at one of their major customers, a steel maker, and says, “Hey Bill, have I got some great news for you! You can tell your customers you’re raising prices this week! After all you just heard the cost of iron is going up.”)

recent post on the Boomer & Echo blog highlights the unreliability of small appliances, but it also shows how their costs have fallen over time. Using a quick and inaccurate estimate, today’s equivalent of a VCR is 1/36 of the price that it would have been a few decades ago (even if you need to replace it more frequently). This applies to virtually all forms of electronics, and even other large purchases such as cars can be relatively cheap and reliable these days if you do a bit of research.

Which all leads to one question: do we really experience inflation, or do we just choose to buy more?

Data from the US shows that $100 in 1950 is worth $960 today. So someone who retired young in 1950 would have to have a large increase in their retirement income in order to keep up. For a slightly more common example, $100 in 1982 is worth $240 only 30 years later. Since most retirees go with fairly conservative investment options, it’s hard to produce a decent starting income let alone keep up with that kind of increase over a long period of time.

But the official inflation rate is based on what people tend to buy today. If you look at the houses, cars, and kitchen appliances that people had in 1950, could you get those for 1/10 of the average price that people spend today? In part that’s not possible because the cheapest options in many categories are better than anything you could buy then. But a lot of things are cheaper now, and you would certainly reduce your expenses a lot if you didn’t buy anything that wasn’t commonly used in 1950. Only a few things would take a similar percentage of your income to get a similar product.

Even over the last few years we’ve had very low inflation rates while technology has continued to advance with the release of products that weren’t available at any price a few years ago. In this environment of slowly rising prices there are new technologies on the horizon that promise to make a much bigger difference in our lives than a thinner cell phone so the trend may continue.

Some things are subjected to visible inflation. Commodities that exist in limited quantities such as real estate and food have a clear pattern of rising prices. Fortunately real estate prices, which are a major expense, barely rise faster than inflation in most places over a long enough period. It also has a natural protection since you can buy today and finish paying off your mortgage based on today’s price in 40 years when you’re earning a lot more. Food inflation can be variable over the short term but over a long period I don’t think it’s been too bad since new technology and the sharp drop in the profitability of farms helps make it cheaper and North Americans spend a small percentage of their income on food compared to other countries.

In the end, if you’re concerned about inflation when you’re living off your investment income there are several defenses. One is to simply not inflate your standard of living by buying new things you didn’t have before, which could be enough to completely neutralize current low inflation rates. Another is to own real estate (and not buy more) so you aren’t subjected to rising rents and prices. Finally, you can turn it to your advantage. Two of the major investment choices that help make retirement possible, stocks and rental real estate, protect against inflation since they are part of the inflation calculation.

So far I’m still preparing for a certain rate of inflation. To some degree you can opt out of inflation though. Or if you prepared yourself well enough to be able to spend more every year after you retire, you can inflate the products you buy while still keeping the same margin of safety. As usual, the statistics don’t tell half the story!

Why It’s Hard to Really Take Control of Your Finances

Keeping your finances on track is hard because, as humans, we are all weak. We’ve always been well-organized, and as long as we’ve had steady incomes we have had at least a few hundred dollars to spare every month (which has since increased). This has a downside because it makes unplanned purchases seem like no big deal. There are a few too many times when we have needlessly spent hundreds or thousands of dollars on something without giving it much thought or time to save up and possibly realize that it’s not a great idea.

Contrast this to many people who report that they couldn’t handle an unexpected $300 expense and you can see the danger that lies in being on top of your finances. Once you’ve gotten to the point of avoiding big mistakes, it’s all too easy to stall there and be comfortable… until you realize that you’ve been missing out on something bigger once it’s too late.

To correct this you need two things: a solid plan to reach a higher level, and a way to limit your spending without feeling like you’re making big sacrifices. That is, unless you’re facing an emergency like having to pay an interest rate over 10%. Then do make sacrifices.

We have the plan, which is to take full control by freeing ourselves from the need to do all but the occasional work in the next 10-15 years (or sooner). We both plan to continue working beyond that point so it provides more flexibility but it’s not the most urgent goal. That makes the limiting of spending a bit of a work in progress. There are a few things we are using to help with this:

1) Trading in. While we are very comfortable with what we spend on now, we are actively making trade-offs in a few areas. We currently limit our travel, to the point where our credit card rewards are enough to cover most non-business travel. We recently turned down an invitation to a Caribbean wedding because the price offered for a week at an all-inclusive place was ridiculous for a country that should be cheap. But once we have reached our goal, we will give ourselves permission to spend any further working income on things that would be ridiculous purchases for someone who isn’t financially independent. We currently believe that we would enjoy a 1-3 month cruise for example.

2) Using the right comparisons. If we compare ourselves to our neighbours, our household is short by about 5 4×4 super-duty trucks, which we could use for off-roading across sand dunes to get the groceries. On the other hand, if we compare ourselves to bloggers such as Derek from Free at 33, our savings rate is worthy of a Halloween haunted house (we’re working on it). I’m currently comparing myself to some people who have reached a much higher level of income, and figuring out what they’re doing right. And when I compare things to my past travel experiences, any time I hear someone complain about their life being uncomfortable it draws the kind of reaction that doesn’t make for good relationships (I can usually restrain it though).

These aren’t sacrifices, since we’ve figured out that what’s important to us can be translated into getting good income from rewarding work, having lots of freedom, and spending relatively little for where we live. Comparing ourselves to people who have made the right moves helps us get what we really want sooner. We’re not giving that up just to get a big shiny motorboat.

3) Earning it. This involves the oft-overlooked pleasures of waiting for things. For example, some people will go out and spend hundreds or thousands of dollars on a personal trainer because they want to get in shape RIGHT NOW. They typically end up back on the couch pretty quickly. I spent a couple of hours at the gym with a friend learning some basics, and then spent 6 years practicing on my own before finding a (free) weightlifting program online last year that has led to much faster gains. The only expense to date has been the gym fees after I graduated. I’m still a bit uncomfortable spending $55/month and driving to the gym twice a week (maybe biking next summer) but with 7 years of commitment and good results to show for it, it’s clear that I’m getting some value from it.

For another example, I was inspired last year to start playing the guitar (thanks Keith Richards for the final push and some great examples to follow!). I immediately applied the idea of earning it. After doing some research on used guitars, I was a bit surprised that the best deal for something likely to be good for more than a year was to get a new one. My total cost for the initial gear was $230. Not bad for years or decades of entertainment, considering some people can spend that in a night at the bar! Going further, I earned the skills by not paying for lessons. Instead I found simple examples online and built skills the hard way.

Now that I’ve shown that I’m still interested after a year of practice, I’m considering the next step up which is more expensive. I don’t want to turn this into another unplanned expense that hurts our cashflow, so I decided to earn the financing as well as the skills. Taking an idea from Robert Kiyosaki, I’ve decided to make this a challenge by tying it to my goals to increase my income. Once I have reached $5,000 in total income from new products and services that I don’t currently sell (including those passive income projects as well as some new services I’m planning in my main business), I will be getting a good electric guitar. The rest of the income (after taxes) will go into our investment portfolio and I imagine those new sales will keep going to generate a lot more income. That’s a win for our income, our investments, and my own personal entertainment!

4) Using automatic limits. Despite everything I just said, I am comfortable with buying anything… as long as we’re keeping our monthly spending below a certain level. In other words, once we’re taking steps to reach our goals the rest can go to anything that catches our fancy. Mr Money Mustache’s recent post has another take on this with the idea of only doing home renovations yourself. If you go that way (which we should be doing a bit more – the only thing we hired out is not going to last), you’re naturally limited in how much you can spend at the same time that you’re saving money.

A lot of people would complain about the burden of these limits, but in reality they fit well because it’s hard to fully enjoy what you’re buying if you spend faster than that. You could pay to have your home remodeled top to bottom in a month (ok, you obviously live somewhere contractors are booked for less than 100h per week). But in addition to not having the satisfaction of seeing your own work every day, anyone who does that will probably be planning the next remodeling or even moving within a year, instead of taking the time to enjoy it.

So in the end the hardest part about being in control of your finances isn’t avoiding the mistakes, it’s doing the things that will really put you ahead. You have to enjoy pain to carry a credit card balance and pay interest on it without taking steps to pay it down faster. But once you’ve avoided the big mistakes, and even made a plan to get further, there are still many things that can get in the way. Controlling your monthly cashflow is an important step, and we will always be looking for new ways to do that!

Cal Newport Shows How To Love Your Work

Over the last couple of days I read Cal Newport’s recent book, So Good They Can’t Ignore You. Written by someone who has made a career out of doing difficult things, the book makes the case for why good careers (whether you have a job, a business, or some other creative pursuit) come from doing what’s difficult, not doing what you love. His idea is that just pursuing what you love to do is a big gamble. For a few people it works out, but for many more it fails.

In showing why this is risky he points out examples of people who have quit their regular jobs (or college) to start lifestyle design blogs, small businesses, and other new things. They quickly ran into the challenge of not having anything of value to offer and they discovered that you can’t get something for nothing. This is compared with stories of people who started in a similar position, but stayed where they were and spent a few years developing a valuable skill. Once they had that skill they used it to start getting the freedom they wanted.

Over time those who have valuable skills are in a position to demand the lifestyle freedom they want, as well as steer themselves into the work that’s most interesting to them. This leads to the combination that gives them the ultimate job, even though they may not have been very interested in the field to begin with.

This comes at a great time since I’ve been trying new things to practice new skills, make my work more interesting, and get some more freedom (hmm, sounds familiar). The book provides a lot of useful examples and tactics to help develop valuable skills and leverage them to do the work you want. For example one section focuses on why it’s important to do things that people will pay for, even if you don’t need the money. When people are actually willing to pay for what you’re doing, that shows that they value it.

Going a bit against some conventional advice, Cal also recommends trying lots of little experiments to see if things are valuable and interesting, and dropping them after a few months if they aren’t working as expected. But it’s important to understand when you’ve found the right thing and run with it, and also to prepare enough that you can credibly try these things.

One area where I could improve quite a bit is having more written plans and even a journal. I’ve tried several versions of this over time but haven’t really stuck with much consistently. With this new framework, I can see more value in having a written outline of what I’ve accomplished and what I still need to do, and a record of various things I’ve tried. The book has a few references to different ways to do this which I will try out.

There are a few areas that could be in question. For example Cal cites a musician who has clearly practiced to develop exceptional skills. However this musician is nowhere near as well-known as a band such as KISS, which by some reports were not all that talented when they started out. The musician in the book will likely make a good career but never achieve that level of popularity. It underplays the value of marketing and the limits of skills development.

That might be the whole point though. You can make a great career being well-known among a few thousand people. There are a lucky few people who are born with an exceptional talent and meet the right people at the right times to develop it at an early age. In a similar way some lifestyle bloggers have exceptional success with little apparent work. They are famous because this is rare. The rest of us might not experience a life of constant bliss, but using basic economics we can find very rewarding things to do and the freedom to practice them in the way we prefer.

I highly recommend reading this book if you have questions about what is the ideal work for you or how to get there.