Category Archives: Compounding

Patience is the Key to 10X Investing

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“The stock market is a device to transfer money from the impatient to the patient.”  Warren Buffett

Patience and successful investing are necessary natural partners. Investing is a long-term prospect, the benefits of which typically come after many years. Patience, too, is a behavior where the benefits are mostly long-term. To be patient is to endure some short-term sacrifice or difficulty for a future reward. Patience is an important investment skill which we need to develop more fully and learning it could help you reach your financial goals.

Patience involves staying calm in situations where you lack control. Being a patient investor might not be easy, but there are tools to help you overcome impatience. Here are a few strategies you can use to cultivate patience and clarity of thought in your investing decisions.

  • Have a plan and think long term. Set long-term financial goals and keep them front of mind during volatile times. A written financial plan is a great idea. Long-term thinking helps you mentally separate your investing journey from your long-term financial destination. Keeping a long-term perspective will give you the psychological fortitude you need to grow your portfolio over the long term.
  • Understand that market volatility is normal. Market volatility is a normal part of life. It might still be unpleasant in the moment, but recognizing that you’ll encounter volatile markets will help you mentally prepare for corrections or other downturns.
  • Look for fear or fundamentals. Consider whether a recent stock decline reflects investor fear or actual negative fundamentals. If markets are driven more by fear, you may not need to worry too much about it: Fear-based corrections often turn around quickly. Even if fundamentals have declined, markets may be pricing in a future far worse than reality. In either situation, be patient and stick to your investment strategy.
  • Remember, time is on your side. Take solace in the long history of capital markets. Corrections are temporary and usually brief, and even bear markets eventually end. Historically, markets go up far more often and by a much greater margin than they go down. Owning stocks for the long term is one of the best ways to profit from economic progress, innovation and compound growth.

Time and patience are two of the most potent factors in investing because it brings the magic of something Albert Einstein once called the 8th wonder of the world- Compounding. It’s not easy, but hopefully these practices can help you focus on the long term and take comfort in stocks’ exceptional performance history.

Its difficult to be patient

Your brain makes it hard to be patient. Human beings were designed to react to threats, either real or perceived. Stressful situations trigger a physiological response in people. This is called the “fight-or-flight” response — either attack or run away, whatever helps alleviate the threat.

The problem is, your mind doesn’t recognize the difference between true physical danger and psychological triggers, like a market crash. Being patient is difficult because it means overcoming these natural instincts. Turbulent financial markets can trigger the response causing real-world impacts you’ll need patience to overcome.

During pandemic-driven bear market, your brain perceives a threat to your financial well-being. Even though stock market volatility isn’t a physical threat, the fight-or-flight response kicks in, emotion takes over, and your brain starts telling you to do something. Your investment portfolio is perceived as being harmed and your metabolically influenced to take action.

With investing, action too often translates into selling something because selling feels like you’re shielding your portfolio from further harm. But selling at the wrong time — like in the middle of a major downturn — is one of the biggest investment mistakes you can make.

If you can find a way to invest inexpensively in the market and stay in the market, you can start to build your net worth. Success in investing requires patience.

“In the end, how your investments behave is much less important than how you behave.” Benjamin Graham

You need patience when what you are invested in is performing poorly—and you need it when what you don’t own is performing well.

one of the most valuable traits an investor can have is patience. If you are a patient investor and decide on great businesses, there is virtually no scenario where you will not make money.

Investing your money in great companies over time will grow into a fortune. Switching in and out of investments cost investors significant returns over time.

“Waiting helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”  Charlie Munger

When it comes to investing, staying invested is quite often the most prudent and smartest approach for long-term investors. While there will always be market volatility and corrections, the key to successful investing is to stay focused on your goals.

References:

  1. https://www.entrepreneur.com/video/342261
  2. https://www.etmoney.com/blog/time-and-patience-two-key-virtues-to-become-successful-in-investing/
  3. https://www.thestreet.com/thestreet-fisher-investments-investor-opportunity/patience-the-most-underused-investing-skill

Believe in the Power of Compounding

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“Compounding is the eighth wonder of the world.” Albert Einstein

It is said that Albert Einstein once noted that the most powerful force in the universe is the principle of compounding. In simple terms, compound interest means that you begin to earn interest on the interest you receive, which multiplies your money at an accelerating rate. This is one significant reason for the success of many top investors.

Believe in the power of compounding

The key to successful investing is patience to search and wait for great companies that are selling for half or less than what they were worth (intrinsic value), and to hold the investment for the forever. The task is to try to buy a dollar of value for a fifty cents price, and to hold the investment for the long term.

  • Compound interest is the interest you earn on interest.
  • Compounding allows exponential growth for your principal.
  • Compounding interest can be good or bad depending on whether you are a saver or a borrower.
  • Think of stocks as a small piece of a business
  • Think of Investment fluctuations, volatility, are a benefit to a patient investor, rather than a curse.
  • Focus your attention on businesses where you think you understand the competitive advantages
  • The more people respond to short term events allow patient and value investors to make a lot of money.
  • Buy stocks when things are cheap. It’s important to control your emotions.

The key is that if you spend less than you earn, you put something away, and that little something can become more and more and eventually what you want to do is you want to be your own boss.” Mohnish Prbrai

Four important factors that determine how your money will compound:

  1. The profit you earn on your investment.
  2. The length of time you can leave your money to compound. The longer your money remains uninterrupted, the bigger your fortune can grow.
  3. The tax rate and the timing of the tax you have to pay to the government. You will earn far more money if you do not have to pay taxes at all or if the taxes are deferred.
  4. The risk you are willing to take with your money. Risk will determine the return potential, and ultimately determine whether compounding is a realistic expectation.

Rule of 72

The Rule of 72 is a great way to estimate how your investment will grow over time. If you know the interest rate, the Rule of 72 can tell you approximately how long it will take for your investment to double in value. Simply divide the number 72 by your investment’s expected rate of return (interest rate).

“The first rule of compounding: Never interrupt it unnecessarily. The elementary mathematics of compound interest is one of the most important models there is on earth.” Warren Buffett

The power of compounding is truly visible with billionaire investor Warren Buffett, the Oracle of Omaha. He first became a billionaire at the age of 56 in 1986. Today, his net worth is over $100 billion at the age of 90-plus. And that’s after he donated tens of billions of stock to charity. His wealth is due to compounding, over 99% of the billionaire’s net worth was built after the age of 56.

When you understand the time value of money, you’ll see that compounding and patience are the ingredients for wealth. Compounding is the first step towards long-term wealth creation.

References:

  1. https://www.thebalance.com/the-power-of-compound-interest-358054
  2. https://www.valuewalk.com/2020/07/power-compounding-getting-rich/

Power of Compound Interest

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It is said that Albert Einstein once commented that “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

The Power of Compound Interest shows that you can put your money to work and watch it grow. The power of compounding works by growing your wealth exponentially. It adds the profit earned back to the principal amount and then reinvests the entire sum to accelerate the profit earning process.

When you earn interest on savings and returns on investments, that interest (or returns) then earns interest (or returns) on itself and this amount is compounded monthly. The higher the interest rates, the faster and the more your money grows!

The sooner you start to save, the greater the benefit of compound interest. This is one reason for the success of many investors. Anyone can take advantage of the benefits of compounding through starting a disciplined savings and investing program.

Yet, compounding interest can be good or bad depending on whether you are a saver or a borrower, respectively.

Three factors will influence the rate at which your money compounds. These factors are:

  1. The interest rate or rate of return that you make on your investment.
  2. Time left to grow or the age you start investing. The more time you give your money to build upon itself, the more it compounds.
  3. The tax rate and when you pay taxes on your interest. You will end up with more accumulated wealth if you don’t have to pay taxes, or defer paying taxes until the end of the compounding period rather than at the end of each tax year. This is why tax-deferred accounts are so important.

Finally, it’s important to resist the temptation of seeking higher interest rates or returns, because higher interest rates and returns always bring higher risk. Unless you know what you’re doing, no matter how successful you are along the way, you always want to avoid the possibility of losing money.

Benjamin Graham, known as the father of value investing, was aware of the risk of ‘chasing yield or return’ when he said that “more money has been lost reaching for a little extra return or yield than has been lost to speculating.”

References:

  1. https://www.primerica.com/public/power-compound-interest.html
  2. https://www.thebalance.com/the-power-of-compound-interest-358054

Best Ten Investment Rules

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“Bad decisions and poor behavior are the primary reasons why many fail to meet their financial goals.” Bloomberg

The greatest value of money is its ability to allow you to control your time. That is “being able to do what you want, when you want, where you want, with who you want and for as long as you want provides a lasting level of happiness and emotional well-being that no amount of “fancy stuff or things” can ever offer.”

Furthermore, thinking about money – earning it, saving it, spending it, and most of all, how to invest it – has several basic rules that every novice and seasoned investor should know and follow.

And, it’s never too late to start building your fortune in the stock market.

What follows are ten basic investing rules that can guide every investor:

  1. Start early, pay yourself first, invest for the long term, be diversified, watch your costs, and let compounding work its magic. Investing is simple, but following through can be challenging. Humans are plagued by an inability to just “sit there and do nothing.” Failing to do nothing leads to costly errors and loss of capital that erode returns. Understanding what is required is very different than being able to perform,
  2. Behavior and Mindset are Everything: Rationally and positive mental attitude are essential. The inability to manage emotions, thoughts and behavior is the financial undoing of many. “Behave!” Avoid ill-advised decision-making and poor behavior which are the biggest reasons why many investors fail to meet their financial goals.
  3. Spend Less Than You Earn: Budgeting is simple: Income goes on one side of your household balance sheet, expenditures on the other side and make sure the latter is less than the former. Don’t buy a boat, don’t get a new car, and avoid buying lattes if you cannot afford them.
  4. Wealth comes from owning assets and compounding over the long term. You can accumulate wealth via the stock market and owning appreciable assets. Since, it’s not the buying and selling that makes you money. It’s the waiting. When you buy a quality stock, plan on holding it forever. In buying an asset, buy it below its intrinsic value (margin of safety or growth at a reasonable price). Always remember…Price is what you pay; value is what you get.
  5. Cut your losers short and let your winners run: Letting your winners run generates all sorts of desirable outcomes: It allows compounding to occur, gives you the benefit of time and keeps your transaction costs, fees and taxes low. Similarly, cutting your losers short forces you to be humble and intelligent. It rotates you away from the sectors and stocks that are not working. Best of all, you are forced to admit your own fallibility.
  6. Asset allocation is crucial: What is your relative weighting of stocks, bonds, real estate and commodities? Studies show that asset allocation is the most important decision an investor makes. “Stock picking is for fun. Asset allocation is for making money over the long haul.” The weighting you select for various asset classes [stocks, bonds, real estate, cash, commodities, etc] is a function of such factors as your age, income, risk tolerance and retirement needs. It is what serious investors focus on.  For example, cash is an inefficient drag during bull markets and as valuable as oxygen during bear markets, either because you need it to survive a recession or because it’s the raw material of opportunity, says Morgan Housel. Leverage is the most efficient way to maximize your balance sheet, and the easiest way to lose everything. Concentration is the best way to maximize returns, but diversification is the best way to increase the odds of owning a company capable of delivering returns.
  7. Hope for the best, but expect the worst: Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in. Brace for disaster via diversification and learning market history. Expect good investments to do poorly from time to time. Don’t allow temporary under-performance or disaster to cause you to panic. A corollary rule is: Save like a pessimist; Invest like an optimist.
  8. Fear and greed are stronger than long-term resolve: Warren Buffett likes to say:  “Be fearful when others are greedy and be greedy when others are fearful.” Investors can often be their own worst enemy, particularly when emotions take hold. Gains “make us exuberant; they enhance well-being and promote optimism. Studies of investor behavior show that losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
  9. If the business does well; the stock will follow: A stock is part of a business. If a company is growing its revenues, has a moat around its business, and is well managed, you can expect the stocks price to increase. Only listen to those you know and trust; and only buy stocks of companies you know and understand. Only buy companies you know and understand. Risk comes from not knowing what you’re doing.
  10. Invest In Yourself: This is the most important investment you can make. Educate yourself, develop an expertise and add to your professional knowledge and skills. Ignore the noise (forecast and predictions) of the crowd and financial pundits.

Good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated, according to Morgan Housel, behavioral finance expert and the author of The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when the magic of compounding runs wild.

Investors need to understand the challenges that face them when investing their money: “Capital markets are about making the best probabilistic decisions using imperfect information about an unknowable future. You will never have perfect information that allows you to bet on a sure thing.”

References:

  1. https://www.cnbc.com/2020/06/19/fathers-day-letter-to-kid-money-life-lessons-people-learn-too-late-in-life.html
  2. https://ritholtz.com/2021/07/top-10-rules-for-money/
  3. https://ritholtz.com/2012/10/ritholtzs-rules-of-investing/
  4. https://ritholtz.com/2015/09/jason-zweigs-rules-for-investing/
  5. https://www.cnbc.com/2020/09/08/billionaire-warren-buffett-most-overlooked-fact-about-how-he-got-so-rich.html

7 Investing Principles

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The fundamentals you need for investing success.  Charles Schwab & Co., Inc

1. Establish a financial plan based on your goals

  • Be realistic about your goals
  • Review your plan at least annually
  • Make changes as your life circumstances change

Successful planning can help propel your net worth. Committing to a plan can put you on the path to building wealth. Investors who make the effort to plan for the future are more likely to take the steps necessary to achieve their financial goals.

A financial plan can help you navigate major life events, like buying a new house.

2. Start saving and investing today

  • Maximize what you can afford to invest
  • Time in the market is key
  • Don’t try to time the markets—it’s nearly impossible.

It pays to invest early.  Maria and Ana each invested $3,000 every year on January 1 for 10 years—regardless of whether the market was up or down. But Maria started 20 years ago, whereas Ana started only 10 years ago. So although they each invested a total of $30,000, by 2020 Maria had about $66,000 more because she was in the market longer.

Don’t try to predict market highs and lows. 2020 was a very volatile year for investing, so many investors were tempted to get out of the market—but investors withdrew at their peril. For example, if you had invested $100,000 on January 1, 2020 but missed the top 10 trading days, you would have had $51,256 less by the end of the year than if you’d stayed invested the whole time.

3. Build a diversified portfolio based on your tolerance for risk

  • Know your comfort level with temporary losses
  • Understand that asset classes behave differently
  • Don’t chase past performance

Colorful quilt chart showing why diversification makes long-term sense. The chart shows that it’s nearly impossible to predict which asset classes will perform best in any given year.

Asset classes perform differently. $100,000 invested at the beginning of 2000 would have had a volatile journey to nearly $425,000 by the end of 2020 if invested in U.S. stocks. If invested in cash investments or bonds, the ending amount would be lower, but the path would have been smoother. Investing in a moderate allocation portfolio would have captured some of the growth of stocks with lower volatility over the long term.

4. Minimize fees and taxes; eliminate debt

  • Markets are uncertain; fees are certain
  • Pay attention to net returns
  • Minimize taxes to maximize returns
  • Manage  and reduce debt

Fees can eat away at your returns. $3,000 is invested in a hypothetical portfolio that tracks the S&P 500 Index every year for 10 years, then nothing is invested for the next 10 years. Over 20 years, lowering fees by three-quarters of a percentage point would save roughly $13,000.

5. Build in protection against significant losses

  • Modest temporary losses are okay, but recovery from significant losses can take years
  • Use cash investments and bonds for diversification
  • Consider options as a hedge against market declines—certain options strategies can be designed to help you offset losses

Diversify to manage risk. Investing too much in any single sector or asset class can result in major losses when markets are volatile.

6. Rebalance your portfolio regularly

  • Be disciplined about your tolerance for risk
  • Stay engaged with your investments
  • Understand that asset classes behave differently

Regular rebalancing helps keep your portfolio aligned with your risk tolerance. A portfolio began with a 50/50 allocation to stocks and bonds and was never rebalanced. Over the next 10 years, the portfolio drifted to an allocation that was 71% stocks and only 29% bonds—leaving it positioned for larger losses when the COVID-19 crash hit in early 2020 than it would have experienced if it had been rebalanced regularly.

7. Ignore the noise

  • Press makes noise to sell advertising
  • Markets fluctuate
  • Stay focused on your plan

Progress toward your goal is more important than short-term performance. Over 20 years, markets went up and down—but a long-term investor who stuck to her plan would have been rewarded.

References:

  1. https://www.schwab.com/investing-principles

Bobby Bonilla Day: The perfect example of the power of compounding

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Bobby Bonilla’s contract with the Mets is a brilliant example of the power of compound interest

For former baseball player Bobby Bonilla, July 1 and every July 1, from 2011 through 2035, marks his annual payday, when the New York Mets send him a a check for $1,193,248.20 as part of a deal set up 20 years ago.

In 2000, the Mets cut Bonilla from the team and terminated his contract early. The ball club owed him $5.9 million for that season. Bonilla and his agent chose to defer collecting what was owed and instead agreed to spread the payments out over 24 years, starting in 2011, with an 8% annual interest rate.

When all is said and done, the total payout will be $29.8 million on a $5.9 million initial investment.

Bonilla’s contract with the Mets is a brilliant example of the power of compounding. Compounding is when you earn interest on your earned interest and it can have a powerful impact on growing your money over time.

You and anyone can defer spending your cash by saving and investing it now, giving it ample time to grow. “When you are young, time is your best friend,” says Certified Financial Planner Vid Ponnapalli. “And the magic of compounding is your best resource.”

Putting away money now and combined with the power of compound interest helps you bank some flexibility for later.

Reference:

  1. https://www.marketwatch.com/story/this-retired-baseball-players-contract-is-the-perfect-example-of-the-power-of-compounding-2018-07-16
  2. https://www.marketwatch.com/story/what-is-bobby-bonilla-day-it-is-the-beauty-of-compound-interest-11625145948

The Five Simple Rules to Investing | TD Ameritrade

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Investing does not have to be complicated and can be a hedge to expected strong inflation.

https://youtu.be/NxEcO7ITtMo
 

“Global investment managers are more worried about the risk of inflation on markets than they are about the risk of Covid-19.” Bank of America survey

72% of global fund managers expect strong inflation to be transitory, despite US prices surging 5% year-on-year in May, according to Bank of America’s latest survey. The Bank of America survey polled 224 managers with $630 billion in assets under management between March 5 and 11, 2021.

In their collective opinions, trillions of dollars in federal stimulus spending in the United States helped set the economy on the path to recovery, but it’s also fueled concerns about ballooning levels of debt and the rapid inflation that could accompany the injection of so much money into the fragile economic system, according to an article in Forbes. 

Despite the risks, investor sentiment overall is still “unambiguously bullish,” the survey found, with 91% of fund managers expecting a stronger economy in the future and nearly half of fund managers are now expecting a v-shaped recovery in global markets. 

“Investors (are) bullishly positioned for permanent growth, transitory inflation and a peaceful Fed taper,” said Michael Hartnett, chief investment strategist at BofA, adding that 63% of the investors believe Fed will signal a taper by September.

References:

  1. https://www.forbes.com/sites/sarahhansen/2021/03/16/inflation-not-covid-19-is-now-the-biggest-risk-to-markets-bank-of-america-survey-shows/?sh=6f5fd2db3b1f
  2. https://www.reuters.com/article/us-markets-survey-bofa/investors-see-transitory-inflation-and-peaceful-fed-taper-bofa-survey-idUSKCN2DR0Z9

Saving and Investing

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“The easiest way to wealth are saving and investing in your mind and in appreciating assets.”

Save and invest today for the life and financial freedom you want later. Investing for the long-term is the only way to truly build wealth and achieve financial freedom.

Retirement doesn’t mean what it used to for a lot of Americans. It used to be something you could count on — and when it came, you were going to pursue the goals and lifestyle you dreamed about and love.

Today, many Americans don’t believe that they will retire, while others are not waiting until retirement and are doing what they love now.

Regardless of your unique circumstances or life’s priorities, it important to save and invest now so later the resulting financial freedom will allow you – in a tax advantaged way – to enjoy a better and happier life later.

A smart investor:

  • Plans for life’s unexpected challenges and investing in uncertain times
  • Conducts research on a product before investing
  • Assesses the impact of fees when choosing an investment
  • Understands that risk exists in all investments
  • Avoids “get rich quick” and “can’t lose” schemes
  • Recognizes the power of compound interest
  • Recognizes the importance of diversification
  • Plans for and invests according to his/her future needs and goals
  • Recognizes the benefit of long-term, regular and diversified investment
  • Verifies that an investment professional is licensed

Establish Emergency Savings

Unexpected emergencies often sabotage our financial goals, so getting in a savings mindset and building an emergency fund is crucial. Start small and think big by setting a goal of a $500 rainy day fund. Once you’ve reached that goal, it will be easy to continue!

Open Your Savings Account

If you don’t have a savings account, now’s the time! Ensure your savings account is federally insured with a reputable financial institution with no fees (or low fees).

Set up Automatic Savings

The easiest way to save is to save automatically!

Choose the amount you would like to automatically save each period. Even $10-50 of your paycheck, weekly or bi-weekly, can provide substantial savings over time.

Contact your employer to set up a direct deposit into your savings account each pay period or set up an automatic transfer from your checking account to your savings account at your financial institution.

Even small amounts, saved automatically each pay period, make a big difference.

Get Serious About Reducing Your Debt

Paying down debt is saving!

When you pay down debt, you save on interest, fees, late payments, etc. Not only that, by having savings you’re less likely to need credit for emergencies – allowing you to keep a lower credit usage percentage.

When you reduce your debt, you save on interest and fees while maintaining or improving your credit score! Create a debt reduction plan that works best for you. Utilize America Saves resources to see the different options to pay down debt.

Get Clear On Your Finances

Create a Spending and Savings Plan that allows you to easily see your income, expenses, and anything leftover. Once you have a clear view of your finances, you can determine where to make changes and what else you should be saving for based on your financial goals.

It’s always the right time to create a saving and spending plan (aka a budget). It’s also a good idea to revisit that plan annually or when a major shift occurs in your income or expenses.

Here are several tips to help ensure that your money is working smarter and harder for you.

Step 1. Determine your income.

To create an effective budget, you need to know exactly how much money you’re bringing in each month. Calculate your monthly income by adding your paychecks and any other source of income that you receive regularly. Be sure to use your net pay rather than your gross pay. Your net pay is the amount you receive after taxes and other allocations, like retirement savings, are deducted.

Step 2. Determine your net worth which is your assets minus your liabilities

Net worth is assets minus liabilities. Or, you can think of net worth as everything you own less all that you owe.

Calculating your net worth requires you to take an inventory of what you own, as well as your outstanding debt. And when we say own, we include assets that you may still be paying for, such as a car or a house.

For example, if you have a mortgage on a house with a market value of $200,000 and the balance on your loan is $150,000, you can add $50,000 to your net worth.

Basically, the formula is:

  • ASSETS – LIABILITIES = NET WORTH

And by the way, your income is not included in a net worth calculation. A person can bring home a big paycheck but have a low net worth if they spend most of their money. On the other hand, even people with modest incomes can accumulate significant wealth and a high net worth if they buy appreciating assets and are prudent savers.

Step 3. Track your cash flow which is both your expenses and your spending.

This step is essential. It’s not enough to write out your actual expenses, like rent or mortgage, food, and auto insurance, you must also track what you are spending.

If you’ve ever felt like your money “just disappears,” you’re not the only one. Tracking your spending is a great way to find out exactly where your money goes. Spending $10 a day on parking or $5 every morning for coffee doesn’t sound like much until you calculate the total cost per month.

Tracking your spending will help you pinpoint the areas you may be overspending and help you quickly identify where you can make cost-efficient cuts.  Once you’ve written out your expenses and tracked your spending habits, you’re ready for the next step.

Step 4. Set your financial goals.

Now you get to look at your present financial situation and habits and decide what you want your future to look like. Ask yourself what’s most important to you right now? What financial goals do you want to achieve?

Some common goals include building an emergency fund, paying down debt, purchasing a home or car, saving for education, and retirement.

Step 5. Decrease your spending or increase your income.

What if you set your financial goals and realize there’s not enough money left at the end of the month to save for the things you want?

You essentially have two choices. You can either change the way you manage your current income or add a new source of income. In today’s gig economy, it’s easier than ever to add a stream of income, but we know that everyone’s situation is different, and that’s not always an option.

Even if you can add income, you may have identified some spending habits you’d like to change by decreasing how much you spend.

Take a look back at your expense tracking. For the nonessential items, consider reducing your spending. For example, if you find that you are spending quite a bit on entertainment, like movies or dining out, reduce the number of times you go per month.

Then apply the money that’s been freed up to your savings goals.

For more ideas on how to increase your savings, read 54 Ways to Save.

Step 6. Stick to your plan.

Make sure you stick to your spending and savings plan. To make saving more efficient, set up automatic savings so that you can set it and forget it! Saving automatically is the easiest way to save.

Reassess and adjust your plan whenever you have life changes such as marriage, a new baby, a move, or a promotion.

Following your plan ensures that you’re financially stable, are ‘thinking like a saver,’ and better prepared for those unexpected emergencies.

References:

  1. http://www.worldinvestorweek.org/key-messages.html
  2. https://americasaves.org/media/yordmpza/7steps.pdf
  3. https://old.americasaves.org/blog/1754-creating-a-budget-for-your-family

Financial Planning 12 Step Process

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A financial plan creates a roadmap for your money and helps you achieve your financial goals.

The purpose of financial planning is to help you achieve short- and long-term financial goals like creating an emergency fund and achieving financial freedom, respectively. A financial plan is a customized roadmap to maximize your existing financial resources and ensures that adequate insurance and legal documents are in place to protect you and your family in case of a crisis. For example, you collect financial information and create short- and long-term priorities and goals in order to choose the most suitable investment solutions for those goals.

Although financial planning generally targets higher-net-worth clients, options also are available for economically vulnerable families. For example, the Foundation for Financial Planning connects over 15,000 volunteer planners with underserved clients to help struggling families take control of their financial lives free of charge.

Research has shown that a strong correlation exist between financial planning and wealth aggregation. People who plan their financial futures are more likely to accumulate wealth and invest in stocks or other high-return financial assets.

When you start financial planning, you usually begin with your life or financial priorities, goals or the problems you are trying to solve. Financial planning allows you to take a deep look at your financial wellbeing. It’s a bit like getting a comprehensive physical for your finances.

You will review some financial vital signs—key indicators of your financial health—and then take a careful look at key planning areas to make sure some common mistakes don’t trip you up.

Structure is the key to growth. Without a solid foundation — and a road map for the future — it’s easy to spin your wheels and float through life without making any headway. Good planning allows you to prioritize your time and measure the progress you’ve made.

That’s especially true for your finances. A financial plan is a document that helps you get a snapshot of your current financial position, helps you get a sense of where you are heading, and helps you track your monetary goals to measure your progress towards financial freedom. A good financial plan allows you to grow and improve your standing to focus on achieving your goals. As long as your plan is solid, your money can do the work for you.

A financial plan is a comprehensive roadmap of your current finances, your financial goals and the strategies you’ve established to achieve those goals. It is an ongoing process to help you make sensible decisions about money, and it starts with helping you articulate the things that are important to you. These can sometimes be aspirations or material things, but often they are about you achieving financial freedom and peace of mind.

Good financial planning should include details about your cash flow, net worth, debt, investments, insurance and any other elements of your financial life.

Financial planning is about three key things:

  • Determining where you stand financially,
  • Articulating your personal financial goals, and
  • Creating a comprehensive plan to reach those goals.
  • It’s that easy!

Creating a roadmap for your financial future is for everyone. Before you make any investing decision, sit down and take an honest look at your entire financial situation — especially if you’ve never made a financial plan before.

The first step to successful investing is figuring out your goals and risk tolerance – either on your own or with the help of a financial professional.

There is no guarantee that you’ll make money from your investments. But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefits of managing your money.

12 Steps to a DIY Financial Plan

It’s not the just the race car that wins the race; it also the driver. An individual must get one’s financial mindset correct before they can succeed and win the race. You are the root of your success. It requires:

  • Right vehicle at the right time
  • Right (general and specific) knowledge, skills and experience
  • Right you…the mindset, character and habit

Never give up…correct and continue.

Effectively, the first step to financial planning and the most important aspect of your financial life, beyond your level of income, budget and investment strategy, begins with your financial mindset and behavior. Without the right mindset around your financial well-being, no amount of planning or execution can improve your current financial situation. Whether you’re having financial difficulty, just setting goals or only mapping out a plan, getting yourself mindset right is your first crucial step.

Knowing your impulsive vices and creating a plan to reduce them in a healthy way while still rewarding yourself occasionally is a crucial part of a positive financial mindset. While you can’t control certain things like when the market takes a downward turn, you can control your mindset, behavior and the strategies you trust to make the best decisions for your future. It’s especially important to stay the course and maintain your focus on the positive outcomes of your goals in the beginning of your financial journey.

Remember that financial freedom is achieved through your own mindset and your commitment to accountability with your progress and goals.

“The first step is to know exactly what your problem, goal or desire is. If you’re not clear about this, then write it down, and then rewrite it until the words express precisely what you are after.” W. Clement Stone

1. Write down your goals—In order to find success, you first have to define what that looks like for you. Many great achievements begin as far-off goals, that seem impossible until it’s done. Though you may not absolutely need a goal to succeed, research still shows that those who set goals are 10 times more successful than those without goals. By setting SMART financial goals (specific, measurable, achievable, relevant, and time-bound), you can put your money to work towards your future. Think about what you ultimately want to do with your money — do you want to pay off loans? What about buying a rental property? Or are you aiming to retire before 50? So that’s the first thing you should ask yourself. What are your short-term needs? What do you want to accomplish in the next 5 to 10 years? What are you saving for long term? It’s easy to talk about goals in general, but get really specific and write them down. Which goals are most important to you? Identifying and prioritizing your values and goals will act as a motivator as you dig into your financial details. Setting concrete goals may keep you motivated and accountable, so you spend less money and stick to your budget. Reminding yourself of your monetary goals may help you make smarter short-term decisions about spending and help to invest in your long-term goals. When you understand how your goal relates to what you truly value, you can use these values to strengthen your motivation. Standford Psychologist Kelly McGonigal recommends these questions to get connected with your ideal self:

  • What do you want to experience more of in your life, and what could you do to invite that/create that?
  • How do you want to be in the most important relationships or roles in your life? What would that look like, in practice?
  • What do you want to offer the world? Where can you begin?
  • How do you want to grow in the next year?
  • Where would you like to be in ten years?

Writing your goals out means you’ll be anywhere from 1.2 to 1.4 times more likely to fulfill them. Experts theorize this is because writing your goals down helps you to choose more specific goals, imagine and anticipate hurdles, and helps cement them in your mind.

2. Create a net worth statement—To create a successful plan, you first need to understand where you’re starting so you can candidly address any weak points and create specific goals. First, make a list of all your assets—things like bank and investment accounts, real estate and valuable personal property. Now make a list of all your debts: mortgage, credit cards, student loans—everything. Subtract your liabilities from your assets and you have your net worth. Your ratio of assets to liabilities may change over time — especially if you pay off debt and put money into savings accounts. Generally, a positive net worth (your assets being greater than your liabilities) is a monetary health signal. If you’re in the plus, great. If you’re in the minus, that’s not at all uncommon for those just starting out, but it does point out that you have some work to do. But whatever it is, you can use this number as a benchmark against which you can measure your progress.

3. Review your cash flow—Cash flow simply means money in (your income) and money out (your expenses). How much money do you earn each month? Be sure to include all sources of income. Now look at what you spend each month, including any expenses that may only come up once or twice a year. Do you consistently overspend? How much are you saving? Do you often have extra cash you could direct toward your goals?

4. Zero in on your budget—Your cash-flow analysis will let you know what you’re spending. Zeroing in on your budget will let you know how you’re spending. Write down your essential expenses such as mortgage, insurance, food, transportation, utilities and loan payments. Don’t forget irregular and periodic big-ticket items such as vehicle repair or replacement costs, out of pocket health care costs and real estate taxes. Then write down nonessentials—restaurants, entertainment, even clothes. Does your income easily cover all of this? Are savings a part of your monthly budget? Examining your expenses and spending helps you plan and budget when you’re building an emergency fund. It will also help you determine if what you’re spending money on aligns with your values and what is most important to you.  An excellent method of budgeting is the 50/30/20 rule. To use this rule, you divide your after-tax income into three categories:

  • Essentials (50 percent)
  • Wants (30 percent)
  • Savings (20 percent)

The 50/30/20 rule is a great and simple way to achieve your financial goals. With this rule, you can incorporate your goals into your budget to stay on track for monetary success.

5. Create an Emergency Fund–Did you know that four in 10 adults wouldn’t be able to cover an unexpected $400 expense, according to U.S. Federal Reserve? With so many people living paycheck to paycheck without any savings, unexpected expenses might seriously throw off someone’s life if they aren’t prepared for the emergency. It’s important to save money during the good times to account for the bad ones. This rings especially true these days, where so many people are facing unexpected monetary challenges. Keep 12 months of essential expenses as Emergency Fund or a rainy day fund.  If you or your family members have a medical history, you may add 5%-10% extra for medical emergencies (taking cognizance of the health insurance cover) to the amount calculated using the above formula. An Emergency Fund is a must for any household. Park the amount set aside for contingencies in a separate saving bank account, term deposit, and/or a Liquid Fund.

6. Focus on debt management—Debt can derail you, but not all debt is bad. Some debt, like a mortgage, can work in your favor provided that you’re not overextended. It’s high-interest consumer debt like credit cards that you want to avoid. Don’t go overboard when taking out a home loan. It can be frustrating to allocate your hard-earned money towards savings and paying off debt, but prioritizing these payments can set you up for success in the long run. But, as a rule of thumb, the value of the house should not exceed 2 or 3 times your family’s annual income when buying on a home loan and the price of your car should not exceed 50% of annual income. Try to follow the 28/36 guideline suggesting no more than 28 percent of pre-tax income goes toward home debt, no more than 36 percent toward all debt. This is called the debt-to-income ratio. If you stick to this ratio, it will be easier to service your loans/debt. Borrow only as much as you can comfortably repay. If you have multiple loans, it is advisable to consolidate all loans into a single loan, that has the lowest interest rate and repay it regularly.

“Before you pay the government, before you pay taxes, before you pay your bills, before you pay anyone, the first person that gets paid is you.” David Bach

7. Get your retirement savings on track—Whatever your age, retirement planning is an essential financial goal and retirement saving needs to be part of your financial plan. Although retirement may feel a world away, planning for it now is the difference between a prosperous retirement income and just scraping by. The earlier you start, the less you’ll likely have to save each year. You might be surprised by just how much you’ll need—especially when you factor in healthcare costs. To build a retirement nest egg, aim to create at least 20 times your Gross Total Income at the time of your retirement. This is necessary to keep up with inflation. But if you begin saving early, you may be surprised to find that even a little bit over time can make a big difference thanks to the power of compounding interest. Do not ignore ‘Rule of 72’ – As per this rule, the number 72 is divided by the annual rate of return on investment to determine the time it may take to double the money invested. There are several types of retirement savings, the most common being an IRA, a Roth IRA, and a 401(k):

  • IRA: An IRA is an individual retirement account that you personally open and fund with no tie to an employer. The money you put into this type of retirement account is tax-deductible. It’s important to note that this is tax-deferred, meaning you will be taxed at the time of withdrawal.
  • Roth IRA: A Roth IRA is also an individual retirement account opened and funded by you. However, with a Roth IRA, you are taxed on the money you put in now — meaning that you won’t be taxed at the time of withdrawal.
  • 401(k): A 401(k) is a retirement account offered by a company to its employees. Depending on your employer, with a 401(k), you can choose to make pre-tax or post-tax (Roth 401(k)) contributions. Calculate how much you will need and contribute to a 401(k) or other employer-sponsored plan (at least enough to capture an employer match) or an IRA.

Ideally, you should save 15% to 30% from your net take-home pay each month, before you pay for your expenses. This money should be invested in assets such as stocks, bonds and real estate to fulfil your envisioned financial goals. If you cannot save 15% to 30%, save what you can and gradually try and increase your savings rate as your earnings increase. Whatever you do, don’t put it off.

After retiring, follow the ‘80% of the income rule’. As per this rule, from your investments and/or any other income-generating activity, you need to generate at least 80% of the income you had while working. This will ensure that you can take care of your post-retirement expenses and maintain a comfortable standard of living. So make sure to invest in productive assets.

8. Check in with your portfolio—If you’re an investor, when was the last time you took a close look at your portfolio? If you’re not an investor, To start investing, you should first figure out the initial amount you want to deposit. No matter if you invest $50 or $5,000, putting your money into investments now is a great way to plan for financial success later on. Market ups and downs can have a real effect on the relative percentage of stocks and bonds you own—even when you do nothing. And even an up market can throw your portfolio out of alignment with your feelings about risk. Don’t be complacent. Review and rebalance on at least an annual basis. As a rule of thumb, your equity allocation should be 100 minus your current age – Many factors determine asset allocation, such as age, income, risk profile, nature and time horizon for your goals, etc. But you could broadly follow the formula: 100 minus your current age as the ratio to invest in equity, with the rest going to debt. And, never invest in assets you do not understand well.

  • Good health is your greatest need. Without good health, you can’t enjoy anything else in life.

9. Make sure you have the right insurance—As your wealth grows over time, you should start thinking about ways to protect it in case of an emergency. Although insurance may not be as exciting as investing, it’s just as important. Insuring your assets is more of a defensive financial move than an offensive one. Having adequate insurance is an important part of protecting your finances. We all need health insurance, and most of us also need car and homeowner’s or renter’s insurance. While you’re working, disability insurance helps protect your future earnings and ability to save. You might also want a supplemental umbrella policy based on your occupation and net worth. Finally, you should consider life insurance, especially if you have dependents. Have 10 to 15 times of annual income as life insurance – If you are the bread earner of your family, you should have a tem life insurance coverage of around 10 to 15 times your annual income and outstanding liabilities. No compromise should be made in this regard. Review your policies to make sure you have the right type and amount of coverage. Here are some of the most important ones to get when planning for your financial future.

  • Life insurance: Life insurance goes hand in hand with estate planning to provide your beneficiaries with the necessary funds after your passing.
  • Homeowners insurance: As a homeowner, it’s crucial to protect your home against disasters or crime. Many people’s homes are the most valuable asset they own, so it makes sense to pay a premium to ensure it is protected.
  • Health insurance: Health insurance is protection for your most important asset: Your health and life. Health insurance covers your medical expenses for you to get the care you need.
  • Auto insurance: Auto insurance protects you from costs incurred due to theft or damage to your car.
  • Disability insurance: Disability insurance is a reimbursement of lost income due to an injury or illness that prevented you from working.

10. Know your income tax situation—Taxes can be a drag, but understanding how they work can make all the difference for your long-term financial goals. While taxes are a given, you might be able to reduce the burden by being efficient with your tax planning. Tax legislation tend to change a number of deductions, credits and tax rates. Don’t be caught by surprise when you file your last year’s taxes. To make sure you’re prepared for the tax season, review your withholding, estimated taxes and any tax credits you may have qualified for in the past. The IRS has provided tips and information at https://www.irs.gov/tax-reform. Taking advantage of tax sheltered accounts like IRAs and 401(k)s can help you save money on taxes. You may also want to check in with your tax accountant for specific tax advice.

11. Create or update your estate plan—Thinking about estate planning is important to outline what happens to your assets when you’re gone. To create an estate plan, you should list your assets, write your will, and determine who will have access to the information. At the minimum, have a will—especially to name a guardian for minor children. Also check that beneficiaries on your retirement accounts and insurance policies are up-to-date. Complete an advance healthcare directive and assign powers of attorney for both finances and healthcare. Medical directive forms are sometimes available online or from your doctor or hospital. Working with an estate planning attorney is recommended to help you plan for complex situations and if you need more help.

12. Review Your Plans Regularly–Figuring out how to create a financial plan isn’t a one-time thing. Your goals (and your financial standing) aren’t stagnant, so your plan shouldn’t be either. It’s essential to reevaluate your plan periodically and adjust your goals to continue setting yourself up for success. As you progress in your career, you may want to take a more aggressive approach to your retirement plan or insurance. For example, a young 20-something in their first few years of work likely has less money to put into their retirement and savings accounts than a person in their mid-30s who has an established career. Staying updated with your financial plan also ensures that you hold yourself accountable to your goals. Over time, it may become easy to skip one payment here or there, but having concrete metrics might give you the push you need for achieving a future of financial literacy. After you figure out how to create a monetary plan, it’s good practice to review it around once a year.

Additionally, take into account factors such as the following:

  • The number of years left before you retire
  • Your life expectancy (an estimate, based on your family’s medical history)
  • Your current basic monthly expenditure
  • Your existing assets and liabilities
  • Contingency reserve, if any
  • Your risk appetite
  • Whether you have adequate health insurance
  • Whether you have provided for other life goals
  • Inflation growth rate

A financial plan isn’t a static document to sit on — it’s a tool to manage your money, track your progress, and one you should adjust as your life evolves. It’s helpful to reevaluate your financial plan after major life milestones, like getting m arried, starting a new job or retiring, having a child or losing a loved one.

Financial planning is a great strategy for everyone — whether you’re a budding millionaire or still in college, creating a plan now can help you get ahead in the long run, especially if you want to make a roadmap to a successful future.

For additional financial planning resources to create your own financial plan, go to the MoneySense complete financial plan kit.

References:

  1. https://www.pewtrusts.org/en/research-and-analysis/articles/2017/04/06/can-economically-vulnerable-americans-benefit-from-financial-capability-services
  2. https://www.forbes.com/sites/forbesfinancecouncil/2020/05/26/your-mindset-is-everything-when-it-comes-to-your-finances/?sh=22f5cb394818
  3. https://www.schwab.com/resource-center/insights/content/10-steps-to-diy-financial-plan
  4. https://www.principal.com/individuals/build-your-knowledge/build-your-own-financial-plan-step-step-Guide
  5. https://mint.intuit.com/blog/planning/how-to-make-a-financial-plan/
  6. https://www.federalreserve.gov/publications/files/2017-report-economic-well-being-us-households-201805.pdf
  7. https://news.stanford.edu/news/2015/january/resolutions-succeed-mcgonigal-010615.html
  8. https://www.investec.com/content/dam/united-kingdom/downloads-and-documents/wealth-investment/for-myself/brochures/financial-planning-explained-investec-wealth-investment.pdf
  9. https://www.sec.gov/investor/pubs/tenthingstoconsider.html
  10. https://www.nerdwallet.com/article/investing/what-is-a-financial-plan
  11. https://www.axisbank.com/progress-with-us/money-matters/save-invest/10-rules-of-thumb-for-financial-planning-and-wellbeing
  12. https://twocents.lifehacker.com/10-good-financial-rules-of-thumb-1668183707

 

The Magic Penny…The Power of Compounding

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Imagine that a stranger walks up to you tomorrow and either offers you a one time payment of one million dollars ($1,000,000) in cash now or offers you a ‘magic penny’ that doubles in value everyday for thirty-one days.  In other words, when you wake up the next day, you miraculously have two pennies; on day three, four pennies; on day four eight pennies, and so forth.

Which would you take?

Believe it or not, thanks to the magic of compounding, the ‘magic penny’ would be worth over $10 million dollars after thirty-one days.  In other words, you would be better off taking the ‘magic penny’ than accepting a one-time payment of $1,000,000.  The illustration below shows the math:

Starting to save for retirement late can greatly reduce your overall nest egg

Investing Early Is Crucial

Getting started saving and investing early is perhaps the most important retirement axiom in personal finance.  The magical penny not only provides a vivid example of the sheer power of exponential growth, but also helps reinforce the value of early savings. By missing just the first nine days of the thirty-one days results in a significant difference in final outcome in accumulated values.

Reference:

  1. https://www.forbes.com/sites/shaharziv/2019/07/30/can-you-correctly-answer-the-magical-penny-question