You were told long ago that you should save 10% of your weekly income. You were assured this would make you rich, but it didn't. What happened? Did you get discouraged because the money you thought was going to come your way didn't? Your advisor's lack of knowledge about what to do with that 10% was probably part of the learning experience. Your advisor didn't know, because your advisor had not succeeded in saving his way to wealth. This article will show you how to carefully and intelligently design a plan for creating a secure financial future.
What is Money?
Do you know what money is? Do you know how money "'works"? Do you know how you can get more of it without significant risk? Do you know how to make your money multiply?
The ability to create, manage, and spend money wisely is inherent to living a life by design. We will begin by looking at what money is. By considering a thumbnail sketch of the history of money, you will discover some of the challenges inherent in designing a lifestyle that will help you create wealth.
Long ago there was no money. If you wanted pheasant for dinner you would trade something for that pheasant. You traded a string of beads you had made that day for the pheasant. What you did not grow or make yourself, you traded to someone who did make or grow what you wanted.
2,000 years before the birth of Christ the concept of money began. Some 1,300 years later, money became standardized, at least in the country of Greece. Aristotle noted,
"The various necessities of life are not easily carried about, and hence man agreed to employ in their dealings with each other something that was intrinsically useful and easily applicable to the purposes of life, for example, iron, silver, and the like. Of this the value was at first measured by size and weight, but in process of time they put a stamp upon it, to save the trouble of weighing and to mark the value."
Those looking for an extra advantage over those they did business with would shave off portions of gold and silver from the "nuggets" that were used as a means of exchange. This was the first "inflation." The Roman Empire fell in part, because of this "shaving." Copper coins which early on weighed a pound eventually were shaved to less than one ounce. Similar dishonesty occurred world wide in developing countries. This brought in the notion of weights and measures. Metals (iron, silver, gold, copper) were in demand for several reasons. Metals were essential ingredients in fine jewelry, objects of worship, tools, weapons and so on.
In the 18th and 19th centuries, gold became the standard unit of exchange in the United States and many other developed countries. The problems with metals as a standard was that metal was very heavy to carry around. Carrying gold and silver was clumsy and not effective for trading goods.
Money is a Belief
Enter paper. Various governments began to store precious metals and issued paper imprinted with various amounts in terms of dollars, pounds, francs, etc. on the paper. It was "monopoly money" with one exception. There was an equal amount of "monopoly money" in print as there was value in the metals in government storehouses. The paper itself was worthless, but the governments issuing the paper "vouched" for the value of the paper. They created a belief. It wasn't long before the metals backed very little of the money.
Once beliefs are created, then those who wish to take advantage of believers enter. Instead of people shaving gold and silver in financial exchange as was done centuries ago, banks formed to create an area of exchange. It was here that shaving would begin again. Banks created another belief. If you brought your paper to let them keep safe for you, they would return it to you on demand with interest. Of course your money was not safe. It was being loaned to other people to build and speculate in other pursuits. This process is certainly beneficial to growth, but it also opens the way for corruption and erosion of the value of "money."
As time passed, governments would issue more currency (creating inflation) and spend money without having anything to back up the paper they were distributing. This created federal deficits. (Spending more money than was being taken in from taxes.) Money was no longer real. The belief had become belief in an illusion.
For some reason unbeknownst to this author, most countries allowed the creation of central banks. Central banks in the United States are part of what is called the Federal Reserve. When the United States needs money, say one billion dollars, they ask the Federal Reserve for a loan. The United States then owes the Federal Reserve one-billion dollars plus interest. However the government does not produce income, so it cannot pay back the Federal Reserve. Therefore the United States taxes its people for part of the money and then borrows money from its citizens by issuing bonds. The bonds promise to pay the citizen interest on the loan to the government.
This money in turn is paid to the Federal Reserve to pay the interest the government owes to the Federal Reserve.
Who benefits in this transaction? The cost of printing one billion dollars by the Federal Reserve is approximately $1,000 in paper. Most of the difference is profit to the owners of the banks. The government is benefitted in that it can spend money without responsibility for the repayment. Because the government is essentially a non-producing entity, it can only collect taxes and place the burden on the person paying taxes and accumulating their portion of the national deficit.
The loser is the citizen. However, it does not end here. This may seem very distant and unreal to you. Consider the following impacting reality and realize why learning to create money in a purposeful fashion is critical to living a life by design:
The Federal Reserve, in large part, determines how much you will be paying in interest for the next home you purchase. They have the right to set interest rates to smaller banks at any level they wish. Smaller banks then loan you money. When interest rates go up, smaller banks do not benefit significantly, but the Federal Reserve certainly does. Additionally, the Federal Reserve is loaning the bank you do business with your money. You then pay an unreasonable interest rate for your new home. Here's what happens.
True Cost of a Home
You decide to purchase a new home. $135,000. Unless you have cash on hand, you will borrow the money from your banker. In 1995 the interest paid on new homes was a relatively reasonable 8%. Most home-buyers take advantage of the traditional 30-year mortgage as their time frame to repay the $120,000. (Assuming $15,000 for a down payment.) The home buyer will pay $881 per month in principal and interest only, for 30 years. The total of principal and interest payments on the home over the period total $317,000.
A $135,000 home financed at 8% for 30 years really costs you $317,000.
Approximately seven years into a mortgage, many people move into a new home. When they begin looking they will most likely believe they have built a significant equity position in their home. Having lived in a home seven years, one would expect to have nearly 25% equity after seven years (7/30). However, you have not paid 7/30 of your loan. Loans are not paid off in equal monthly proportions as your stable monthly payments lead one to expect. By the seventh year of a 30 year mortgage, you still owe about 90% of the original principal. You have built very little equity in your home.
Playing the Game
What all this means is that you have been entered into a game in which the odds are definitely tilted in favor of the house (the government and those loaning the money). Living a life by design means that you can play the money game and win for you and your family while not creating losses for others. Playing to win, however, does take some strategic planning. Winning means building a surplus of those illusory dollars so that when you decide to "retire" or lead a more independent and less structured life, you can.
It is still a rarity to find someone who is planning their retirement 20 or more years in advance. In the 21st century it is more important than ever to do so. The taxes that were taken from your payroll checks for social security simply will not be available for you when you retire, barring a miracle equivalent to the parting of the Red Sea.
It is enticing to note here that the earlier you begin taking control of your money, the earlier you are likely to begin truly enjoying the rewards money can buy. As it turns out, time and interest (return on investment) are more important than the amount of money you invest for your ultimate freedom years.
As with every aspect in life by design, you want to know where you are before attempting to set goals, directions and plans to move ahead.
A Budgetary Crisis?
Is your personal budget a microcosm of the United States? As of this writing in 1995, the United States is 5 trillion dollars in debt. That's approximately $18,000 per human being in the United States. The debt is growing about 15% per year. The government takes in about 1.1 trillion dollars per year in revenues. It spends about 1.4 trillion dollars per year.
Compare this to a family budget. If you bring in $50,000 per year before taxes, owe $250,000 in debts and spend about $40,000 after taxes, you are in the same shape as the government. (This completely excludes what you personally owe the national deficit and debt. No one knows when this rapidly growing credit card payment will come due.)
Fortunately, most people budget far better than our government. Unfortunately, most people are in debt and are operating at a net loss each year. It is impossible to live a life by design in this situation. Life by design means that you are in charge of your life. When you are in debt, you are not in charge of your life. How do you know if you are in debt?
You make a balance sheet with assets and liabilities listed and discover whether your financial worth is positive or negative. If it is negative, you are in debt. Fill in all of your assets and all of your debts. Think of everything. An asset's value is what you could sell it for today. A book may have cost $30, but you cannot sell a book for $30. A used bookstore will give you $2 for such an item. A $4,000 ring is really worth about $400. Jewelry is worth roughly 10% of retail. The same is true for many seemingly good "investments."
In the book, Life By Design, we discuss how to REALLY create a budget that will work in putting you on your road to financial freedom. One of the charts has a line noted simply as "monthly available." This is the money you should have available after expenses. The dollar figure next to monthly available is a very important number. It is your "flex" money. All flex money should generally be used to pay off debts (including credit cards) which have no asset backing up the debt.
In other words, if you have a $2,000 credit card bill and it is simply an accumulation of small debts and purchases it needs to be paid off as soon as possible. Credit cards charge 15% or more for interest and every dollar you pay off has a 15% guaranteed return on investment. That makes this a priority. High interest credit cards should be paid in full, first. Then, those cards that carry lower rates should be paid off.
How much of your monthly income should you be keeping to enjoy your life tomorrow? If you are more than 10 years from retirement, you probably want to save 10% of your income as a minimum. If you are less than 10 years from retirement you want to save (invest) more than 10% per month. If your retirement will begin after 2015 you cannot be certain that there will be "social security." There is no reason to believe that the fund will be solvent at that time. Therefore your investments and savings will need to augment any pension plans that you are offered. If you have no pension plans sponsored by an employer, you are going to need to design your entire financial security yourself.
How to Become a Millionaire
Materialism is not what life by design is all about. Living a life that you can completely enjoy and experience happiness in is what design is about. In order to truly live a life by design you want to plan your finances so the lack of money does not become burdensome.
When you decide to live your life with fewer obligations (some people call this retiring) you will want to have money waiting for you to live comfortably. One million dollars is a reasonable dollar figure to be able to retire on as long as you continue to care for your financial situation in retirement.
You do not have to earn one million dollars each year to be a millionaire. You can attain the millionaire status with a very small amount of money each month and some time. Each month take at least 10% of your gross income and immediately invest it in stock mutual funds.
Over the last 6 decades, stocks, in general, return over 10% per year. There are certainly ups and downs, but nothing matches the performance of investing in corporate America. You can begin to invest in stocks through mutual funds. A mutual fund is a pool of investors that purchases stocks or bonds or both. You can invest in mutual funds with no commission charge. These are called no-load mutual funds. If someone tells you that you need to pay a commission for a mutual fund, simply find a fund that is doing better or as well that you can invest in for free. There are thousands of them. Some well known companies that offer no-load mutual funds include Fidelity, Vanguard, Scudder and Twentieth Century. There are many others. To find out the phone numbers of various mutual funds, buy a copy of Investor's Business Daily at your news stand and look at the listings of mutual funds. The phone numbers are listed by the company names. Call the funds that look interesting and ask for a prospectus. Most of the daily business papers tell you the returns that mutual funds have accomplished up to date.
By investing monthly in mutual funds that are well managed you will eventually build your wealth to the level of a millionaire. It sounds far fetched, but see how easy it is.
Formulas for Becoming a Millionaire
TDR=W That formula is the key to wealth (w). Time (t) multiplied by dollars (d) multiplied by your return on your investment (r) equals wealth.
To be more specific, let us set a goal to have a million dollars invested in mutual funds. Here is how you can become a millionaire. The first chart will reveal how old you will be when you will have $1,000,000 in mutual funds that have historically returned about 10% per year. These are large cap stock funds that invest in larger companies. The second chart will show you when a 12% average yield will turn you into a millionaire. Over the past several decades, small stocks have returned approximately 12%.
As you look at the charts, remember that $2,000 per year is only about $167 per month. It doesn't take much to build a small fortune.
Your specific goals may vary quite a bit. Your specific investment vehicles may return more than 10 or 12 percent. As you can see, it takes very little to develop an investment fund that is going to meet your financial needs in retirement. Remember, this is only one investment vehicle. There is another excellent vehicle that you can begin now if you are buying your home.
How to save $5,000 per year
What is not included in the charts above is the equity you build in your home. Equity is an asset that is as real as money you invest in stocks or the furniture in your home. Equity is the value of a house minus what you owe on the house.
Imagine that instead of taking out a 30 year loan on the $135,000 home we discussed earlier, that you would take out a 15 year loan. How would that change the numbers?
Your monthly payment of principal and interest on a 15 year loan of $120,000 would be $1,147 per month. That compares with $881 per month using the 30 year mortgage. Your total payments would be $206,460 instead of $317,000. A savings of over $110,000! Better yet, you probably will pay about one half percent less in interest on your loan with a 15 year loan. That means that your actual principal and interest would be $1,113 per month. That is only $231 per month more for your home and your total payments will be $200,340. You save $115,000 by paying your mortgage off in 15 years instead of 30 years. What would you do with $115,000?
Even though you are paying $231 per month more for your home, ALL of that money is going to equity in your home. This is how to play the banker's game. You get the best possible interest rate and the most favorable terms and end up saving $7,000 per year over 15 years by paying off your mortgage in more financially logical terms.
If you are not buying a home, you can re-finance your current loan using a 15 year mortgage. If you are going to live in your home for more than two more years, you'll rapidly recoup your closing costs and then quickly build equity in your home.
If re-financing is unwise because interest rates are higher than when you bought your home, you can most likely make principal payments in addition to your regular payment each month. Your lender will take these principal payments right off the balance of the loan. Even investing $100 per month extra, can cut years off a mortgage. Ask your lender for an amortization sheet showing how much of your money goes to principal and how much goes to interest.
Creating Money out of Thin Air
You can create money out of nothing by making a few phone calls or doing just a few simple tasks. Here are a few examples.
What are you currently spending money on now, that is a complete waste of your hard earned money? (Cigarettes, alcohol, impulse items, etc.)
Completing this exercise made you aware that you can literally create money out of nowhere by simply saving, instead of spending. Once you begin saving, you can then begin investing!
Pay Yourself First
When you are working 40-50 hours per week, you deserve to keep some of the money that you are earning. When investing, remember you are taking the money you have earned and making it grow for your future use. Advertisers have convinced many people to "spoil yourself" by spending money on fleeting moments of pleasure. Reconsider the advertisers message and spoil yourself with a lavish lifestyle when you truly want it and deserve it. Always pay yourself first.
When you get paid, send 10% directly to your money market fund or your bank account. It's your money, you earned it. The government is taking far more than 10% aren't they? Did they earn it? Do you deserve at least half as much as Uncle Sam is getting? That's right, you're seeing it more clearly now. You earned your money and you deserve to keep it for your use in the future.
You are investing in yourself and your future.
Understanding Mutual Funds
Mutual Funds can be mysterious at first glance. Here is a simple thumbnail sketch of what mutual funds are. For more detailed information about mutual funds ask your librarian to direct you to some good books on investing.
A Family of Mutual Funds is like a family. You have parents and children. In a Family of Mutual Funds you have Fund Managers their funds. Thousands of investors send these funds money to invest. Your money is pooled with these investors and through this process you are able to own a diversified portfolio from the very beginning of your investing days. Earlier in this chapter you learned that Fidelity, Vanguard, Scudder and 20th Century are all families of funds. Each of these companies have dozens of funds.
Types of Funds
There are many types of funds. Some fund managers run funds that invest in large capitalization stocks like Caterpillar, Disney, and IBM. Other funds invest in small stocks. These are typically called "growth funds." Funds investing in bonds are not surprisingly called bond funds. However, much like children, the names of funds do not tell you what is inside the fund. Fidelity Magellan Fund is well known as one of the all time best performing funds. However, you have no idea what this fund invests in until you request a prospectus.
What to Invest In?
By taking a trip to the library you can look up various mutual funds in the Morningstar Mutual Fund Guides. They rate various funds and explain the risk and reward potentials for thousands of funds. Look for Morningstar's four star or better picks and you will improve your odds of making an excellent decision. What is a good fund today may not be good tomorrow. Becoming even a little familiar with a few of the major families of funds and their track record will greatly help you choose where to send your money.
There is an element of risk in investing in mutual funds. A major stock market crash could drain your portfolio. Historically these crashes have been relatively short lived and the markets recover in general as do most specific stocks. History has taught us that stocks are the best place to invest (along with real estate) and with mutual funds, there is little need to worry about diversification as you are buying into a "pre-diversified pie." Each dollar you invest is literally diversified instantly.
Real Estate is the most lucrative investment for most investors once a portfolio of stocks or mutual funds have been developed. There is not space in this book to cover the various aspects of real estate. Your home is certainly a solid investment if you paid a fair price and get average or better appreciation. There are numerous books that detail investment real estate. However, before jumping in, it may be wise to develop a solid portfolio of mutual funds. The instant diversification takes most of the major risk out of the process and the objective here is not to speculate but to create and design a wealthy future to live in. Land, like real estate, is best left to the experts that know what they are doing. Buying undeveloped land can be boon or bust. Now is not the time to take such a risk.
Collectibles and Misc.
Baseball cards were big money collectibles in the 1980's. In the 1990's the value has tapered. Old cards in mint shape are still valuable, but the new products are unlikely to produce much of value because of the popularity of card collecting. Jewelry and diamonds are poor investments. The day you buy a diamond ring it's value immediately drops about 80-90% regardless of what the "appraisal" says. Gold and platinum have some potential in scenarios that put the United States in a financial crisis. Because the United States will someday have to pay the national debt and erase deficits, inflation will once again rear it's ugly head. This makes gold, silver and platinum worth holding as a percentage of your portfolio. Stamps and coins are cyclical in their collecting value. Like baseball cards, when the hobby is popular, it is far less profitable. When it is out of vogue it is far more profitable. Lotteries and games of chance are not investments. They are entertainment and they are designed for you to lose most or all of your money.
What is Money?
Money is something that two parties agree has value in expediting a transaction of goods or service. Because it takes agreement, it is a belief. Money is not the root of all evil. The love of money is. To become addicted to a belief is to severely limit your ability to function in life. Ignoring money is as foolish as chasing after money.
Most of the people who are in prison today are in prison for something that in some way had to do with money. Most of the people who live lives by design have a great deal of money. The difference is the sequence of events and the goals involved. Money itself only solves a few problems. Living a life by design can mean doing what you love and getting paid for it. It can also mean doing what you don't like a little longer while you become a master of what you wish to do. People who mis-use money, idolize it. It is not viewed as a product of happiness but the reverse. People who end up in jail often believe that money would have made them happy. It would not have. Doing what you love and designing your life is what will give you long term pleasure. Money is a by-product of design and living life by design.
Money is a fascinating subject to learn about. What you will learn in the next chapter will not only fascinate you, but intrigue you. The very origin of life speaks to the very core of living life by design. For without design, there would be no life.
Life By Design is available on 6 audiocassettes. To obtain your copy, see our Catalogue of Products and create your financial journey of wealth! Kevin Hogan Success Dynamics Corporation 3432 Denmark #108 Eagan, MN 55123