Basics of Investing - Part 1

What is Investing?
Investing is to purchase an asset with the expectation of capital appreciation, dividends, and/or interest earnings.  Investments can be made in anything that appreciates over time such as real estate, antique cars, coins, art, etc.

We will focus on securities - debt (bonds), equities (stocks), but not derivatives (options).

What are stocks?

One share of stock represents a fractional ownership in a company.  The value a share of stock has is based on the value of the company and the number of outstanding shares.

Stock is bought and sold privately and/or publicly, in a stock exchange.  In the US, the NASDAQ or NYSE.

To purchase or sell on an exchange, you must go through a broker with a seat on the exchange.  Online trading software makes this easy and relatively inexpensive.

Investors can invest in individual stocks by purchasing shares in companies they believe will increase in value over time.  Alternatively, investors can invest broadly in the U.S. and foreign markets using mutual funds.

The Stock Market
As shown in the chart below, the U.S. stock market is generally increasing in value when viewed over a period of many years.

However, when viewed on a short term basis such as a day, a month or a year, the stock market can be seen to fluctuate up and down.  No surprise.

The point I would like to make at this time is that investing should be considered a long term endeavor.  Short term investing, such as day trading is risky business and very few succeed at it.






Savings vs. Investments

Saving
Generally, less than five years is saving.  Use savings accounts, CDs, money market accounts, piggy banks, etc. for saving.  For savings, our goal is to preserve our money.







Investing
Five years or more is investing.  My favorite investment vehicles are stocks, mutual funds and/or real estate.   When investing, our goal is growth.

Why Invest?
We harness the power of investing to achieve goals not possible with savings vehicles.  Consider the following chart.

18-Year College Savings vs. Investments Example

In the chart above, we assume a $120 per month contribution for 18 years and an average annual market growth rate of 8%.  The blue shaded area represents the savings growth over the 18 years which would come to roughly $30,000.  Look at the orange shaded area, which represents the investment growth.  Over time, the investment begins to significantly overshadow the savings growth.  That's the power of investing in the market.

Next up:  In "Basics of Investing - Part 2", we'll begin to cover a new types of investment vehicle: bonds.

See you soon!

How to Get Out of Debt

In this fifth entry in our Financial Freedom series, we will discuss how to get out of debt.

• First things first.  So that we don't fall back into debt while we're trying to pay it off, first we have to start with an Emergency Fund.

• Next, we need to get and stay on a budget (see Annual and Monthly Budgeting)

• Now.  Let me have your undivided attention for just one second.  Yes you.   Thank you.  Now pay close attention.  This is very important.   Stop borrowing money. You'll never pay off your debt if you keep signing up for more.

• To get out of debt we need to apply focused intensity.  Shut off all discretionary services and expenses.  Someone mowing your lawn and washing your car?  If so, do those things for yourself at least until you get the consumer debt paid off.   Paying for expensive cable TV service?  Cut it out temporarily.  Nowadays, a cheap antennae will get you several HD quality channels in most areas.  Make that work for a while.    Eating out a lot?  Nip it in the bud.  The idea is to free up as much income as possible so that you can pay off your debt rapidly.

• Temporarily, stop retirement and all other savings and investments outside of your emergency fund.  If you have debt other than your house, there's no better place for you to invest than in your own debt.

Use Dave Ramsey's Debt Snowball Method
The Debt Snowball is a technique for paying off debts from smallest to largest balance, not based on interest rate.  Paying debts off from smallest to largest balance allows you to get a quick win when you knock out a small debt and free up cash to apply to the payoff of the larger ones.

Your debt payments are the snowball.  They start smaller, but when a debt is paid off, the payment that you were making on that debt is added to any extra cash you have and applied to the next larger debt.  Thus, as the snowball rolls downhill, it gets larger.  Here's the steps...

1. List debts in order of smallest to largest balance

2. Each month, prepare your monthly budget paying only the minimum required payments to each creditor.

3. Pay every extra dollar you can scrape up on the debt with the smallest balance

4. When the smallest debt is paid off, use the payment you were making on it to pay extra on the next largest debt in subsequent months.

5. Repeat steps 2 - 4 until all your debts except the house are paid off.  Most families can do this in 1 or 2 years.   Wouldn't it be awesome if you did too?!

For an example, see this site.  Also, try Dave Ramsey's Debt Snowball tool.



That's it!  See that wasn't hard was it?

Next up in this series, Basics of Investing.  See you soon!

Monthly Budgeting

This is the fourth entry in the financial freedom series.  The topic for today is monthly budgeting.  The main concepts to remember about monthly budgeting are.

• A monthly budget is not complicated.  Its nothing more than a plan for how you will spend your income for the upcoming month

• Alternatively, we could have a semi-monthly or bi-weekly plan to better align our budget with our pay schedule

• Write it down – no computers, spreadsheets, web sites, smart phones, iPads, software and/or other misc. electronic gadgets until later, please.

• Make it a Priority!  Your budget can't work if you don't have one

Here are some specific steps to take when creating your budget.

Please note step number 3.  The reason we want income minus expenses to equal zero is so that we know we have planned what we will do with every dollar of income.   Here is an example.

Notice that income is a positive number on the budget and expenses are negative.  When we add them all up, we should get income - expenses = 0.  

Also notice the Blow Money category!  This category should handle your entertainment and miscellaneous small purchases and other expenses. 

I hope you didn't miss the Giving,  Annual Budget and Emergency Fund savings categories above from previous postings.

Next time we'll discuss "How to Get Out of Debt".  See you then!

Annual Budgeting

As the third entry in the financial freedom series, let's walk through how to create and live on a budget.

No political intent here.
Simply trying to be
a little humorous.
I'm actually a fan.

The main thing to keep in mind about a budget is that it is NOT a straight jacket.  A budget actually enables us to make the most of our income.  A budget is simply planning ahead to decide how we are going to spend our income.  That's why a budget is better known as a spending plan.

A budget also:

• Increases predictability in household finances.  
• Lessens the number of surprises.
• A budget helps us get in control of our finances instead of them controlling us.

The result is more peace and harmony at home.










Now, lets get down to the nuts and bolts of how we do budgeting.  As you know, some expenses occur every month.  Other expenses occur at various times throughout the year.  Therefore, we need to do Monthly and Annual budgets.

Annual Budgeting
Use an escrow account approach for expenses that are predictable, but not monthly.  Start with a calendar and list all the known expenses you will have for the year.  Record an estimate of the amount of each expense and the dates when the money will be spent.  Here are some examples of common expenses that belong in your annual budget.

I'll bet you can think of several more not listed here.  See what these expenses all have in common?

• They do not happen every month
• They are predictable in terms of when they will happen.  In fact, you can put them on the calendar
• They are (for the most part) discretionary in terms of how much you spend

Dave Ramsey calls this type of expenses Lump Sum Expenses.  See his page on this subject here.  You can also print off a free form from this page for managing Lump Sum Savings.

Example Annual Budget Sheet

Here's an example of a spreadsheet that can be used to help capture and track our annual budget items.  You certainly don't have to use a spreadsheet for your annual budget, but I have found it useful as opposed to a pencil and a notepad because changes can be made quickly and easily.  

Here's the steps to creating your own annual budget.

1. List all the known irregular expenses you will have for the upcoming year as a line item on the annual budget sheet.  Refer to the examples above.  Remember not to list monthly expenses or expenses you are not sure whether or not they will actually occur.  Record an estimate of the amount of each expense and the dates when the money will be spent.
2. Add the whole year's worth of projected expenses up.  In the example above, the annual total is $3,175.
3. Divide the annual total by twelve.  This is the amount you will need to save each month for annual budget items.  In the above example, $265 per month will need to be set aside in order for the family to have the money they need for the expenses when they occur throughout the year.

Note that the annual budget works just like the escrow account associated with a typical mortgage loan.  In most mortgage loan situations, the homeowner's mortgage payment includes the loan repayment amount plus an extra amount equal to 1/12th of the annual homeowner's insurance premium and property taxes.  The mortgage company takes the extra amount paid by the homeowner each month and saves it until the insurance premiums and tax payments are due.  This is exactly the same as how the annual budget works except it is you setting aside the funds and spending the money when it is appropriate to do so, not your mortgage company.

I recommend keeping your annual budget funds in a separate account from all other household funds.  In other words, keep it simple and easy to keep track of.  Don't mix these funds up with money that has any other purpose.  E.g. Don't put your Emergency Fund money in the same account as your Annual Budget money.

If you would like to have a fully functional electronic copy of the example annual budget spreadsheet above emailed to you, send a request to jim.sweatt@gmail.com.  Please indicate in your email whether you would prefer to receive your spreadsheet in Excel (Windows) format or Numbers (iOS or MacOs) format.

Next up in this series, Monthly Budgeting.

So What's the Problem with Debt?

As the second installment in this series on the steps to financial freedom, I would like to discuss the subject of debt.  Specifically, I want to put the focus on the problems that debt brings into our lives.

So what's the problem with debt?









Debt allows us to get things quicker than we would be able to otherwise, right?  That's got to be a good thing!  I mean, young adults can go to college when neither they nor their parents have any money.  We can lean on our credit cards to help us make ends meet when there is more month left at the end of the money.  We can always drive a new car without having to sacrifice (ouch!  pain!) to save for it.  These all sound like good things!  What's the deal?

One problem is that when we go in debt, we trade a lot of our future for a little of our now.  A nice vacation funded by debt lasts a week, but the debt obligation for that vacation may last for months or even years into the future.

Interest payments drain the purchasing power from our paycheck.  Whenever we borrow money, we pay back more than we would have if we had paid cash.  For example, we thought we got a great buy in that car we bought for $14,000 with a book value of $15,000.  However, we really took a beating because we bought it on credit.  After interest payments, we really paid $16,000.

Debt repayment obligations cause lost opportunities.  This is a huge!  Being loaded down with debt payments locks up our future income such that we can't take advantage of opportunities when they arise.  Here are some hypothetical examples.

• some great investment property becomes available at a killer deal
• that dream home we've always wanted goes up for sale
• there is a wonderful young couple in our church who wants to adopt but needs help with travel expenses
• An elderly widow in our neighborhood is struggling to pay her utility bills

If we are shackled with debt payments, we have to say "Bummer. Can't do that right now."  These opportunities and others just like them will fly right by.  Instead of the joy we could have had, we'll only be left with regret.

Debt brings unnecessary RISK into your life.  We always assume our income is going to stay the same as it is now or get better.  We rarely consider what would happen if we had a negative event like a layoff, unexpected illness or injury, etc.  I'm convinced that most of the time people would decide against going into debt if they spent a few minutes thinking about the potential down side.

And lastly, "the borrower is slave to the lender" (Proverbs: 22:7).  Debt places us in the role of servant to a master other than God.  It takes our focus off of Him.  Debt is a huge distraction and God wants our undivided attention.  He does not want us to have other masters.  Anyone who has ever been overwhelmed with debt payments will testify to the fact that it is more difficult to worship God while we have the anxiety, pain and frustration in our life that comes with living paycheck to paycheck (or worse).

Next up in this series:  "Annual Budgeting".

The Amazing Emergency Fund

In a recent post, I covered tithing, which I consider to be step 0 on the road to financial peace.  In the next, several posts, I plan to cover the remainder of the steps as follows.

• The Amazing Emergency Fund
• Annual and Monthly Budgeting
• The Debt Snowball
• Investing for College and Retirement. This will be a topic requiring several posts, including
• Basics of investing - What is Investing, Why Invest?, When Should You Begin Investing? 
• Investment Vehicles - What are CDs, Stocks, Bonds, Annuities, Cash Value Life Insurance, Mutual Funds, Index Funds?  How do they work?  When should I use them?
• Investment Strategies - Market Timing, Day Trading, Momentum Trading, Dollar Cost Averaging, Buy and Hold.  What are they?  How do they work?
• Retirement Plans - How much do I need?, 401K, Roth 401K, Traditional IRA, Roth IRA, 403B, etc.
• College Plans - Coverdale Education Savings Accounts, 529s, etc.
• Mortgages - Types of Mortgages, Mortgage Guidelines, Reverse Mortgages, When to begin paying off your mortgage early.
• Giving

Hopefully you are looking forward to some of these future posts.  Let's get started!

The Amazing Emergency Fund

The Emergency Fund is your backstop against the unknown things that life throws at you.  Sometimes literally.  Remember when that truck slung a rock up off the highway and cracked your windshield?  Yes, that's what I'm talking about.  The purpose of an emergency fund is to keep you from falling back into debt when a negative financial event happens in your life.

Whereas tithing is step 0, the Emergency Fund is step 1 in building a solid financial foundation in your household.  Start with $1000 ($500 if you make $15,000 per year or less).  Later, after you're out of debt except for the house, we will increase it to 3-6 months expenses.

That's a lot of money.  How can I save it?  Make it a priority!  Its amazing how resourceful we can be when we want to be.  Could you save $1,000 quickly if someone offered you an otherwise all-expenses paid dream trip for a month in Bora Bora?  Of course you could!  Have a yard sale.  Sell something on eBay.  Work some extra hours.  Cut off the cable.  In a nutshell, do whatever you have to do.  This is an important thing to do for your family.


Keep your emergency fund in a separate account.  Don't mix it in with any other money you have.  You want your emergency fund to be readily available if you have an emergency, but Hands Off! for any other purpose. 

What is an emergency?  Here's my definition:  "an emergency is something that happens that affects a necessity of life, i.e. food, shelter, transportation, that cannot be overcome without otherwise going into debt.  Examples of emergencies:  tire blowout, unexpected illness, job layoff, air conditioner/heater quits working.  Get my drift?  This list does not include vacations, eating out, Christmas presents, or clothing purchases.  That was purposeful. Those things are all wants, not needs.

The beginnings of true Financial Peace.  I think you will find, as my wife and I did, that once you have an emergency fund in place, you can rest easier at night.  That's a great start towards true financial peace.

Why can’t a credit card or equity line be my emergency fund?  The short answer is this.  The last thing you want to do when you face a crisis in life is go into (more) debt.  That puts you behind the 8-ball, vulnerable and ready for a sucker punch from the next emergency.  Its crazy how problems tend to come one after another in times of financial weakness.  If you go into debt because the transmission in your wife's car blew up, you can almost plan for a leaky roof.  Its weird that it happens that way, but it does.

Well, that's all for today.  I hope you will jump right in and get that emergency fund saved if you haven't already.  One very important thing to do is agree with your spouse that you will not touch your emergency fund unless there is a true emergency.  Hold each other accountable on this!

Next up in this series:  "So What's the Problem with Debt?".  See you soon!