My counterpoint to Forget Frugality

I saw a reference this week to an editorial by Ramit Sethi called Forget Frugality. While he has some good points, I think some of his advice is counterproductive and even contradictory. He argues that you should focus on earnings and negotiation instead of trying to actively cut costs.

I really think you have to do a combination of the three, and you should start with what you have the most control over, which is your own budget. Here’s what I have to say about his seven strategies. Read more

A cheap kitchen makeover

The kitchen cabinets in the house we live in have seen better days. They were reasonably well-built, but 50 years of raising families–mine is the third family raised in this house–took their toll on them. A couple of years back we painted them, to cover the scars of the years. It was an improvement, but the color dated itself pretty quickly, and we didn’t use the highest-quality paint, so the finish wore fairly quickly.

This time, we repainted them white. We used an expensive Benjamin Moore Decorator White in semi-gloss, because it looks good, but also because we’ve found it to be durable in other projects. And you’d be surprised how many half-million-dollar houses have white-painted cabinets. I’m an estate sale junkie, so I’ve seen a lot of half-million-dollar houses over the years, and I would estimate 40% of them have simple, white cabinets in their kitchens. It’s a look that doesn’t date itself, and is cheap and easy to take care of. (As a point of reference, a modest three-bedroom ranch house in the same county costs around $125,000.)

I’ve also seen people do this to improve the appearance of a house prior to flipping it.

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Is landlording profitable?

Is landlording profitable? The answer is yes. Where people disagree, I think, is on the timing, and perhaps to a lesser degree, on the strategy.

My wife read an article yesterday on real estate investing that made her mad. I’d link to it, but I can’t find it today–maybe it was pulled. But the premise was that you shouldn’t invest in real estate, because being a landlord isn’t a quick way to get rich.

I agree with the second part. But the first part doesn’t logically follow. In fact, I don’t care who you are, probably the best thing you can do for yourself is forget about trying to get rich quickly. I speak from experience. Read more

Diving into real estate

You’re not going to believe this. This week my wife and I applied for a mortgage.

Not on our primary house. We’re buying an investment property. I’m still struggling with the mortgage bit.The greatest real estate investment books of all time (for mere mortal working class people, at least) were written by a man named William Nickerson, starting in the 1950s. Nickerson took one and only one shortcut in his investing. He saved up 25% for a solid downpayment, and bought property. Usually property with something wrong with it. He liked small apartment buildings and humble single-family houses.

Then he fixed the property up. Depending on the situation, he’d sell it if it made sense, or more likely, he’d rent it out, then sell when the right opportunity arose.

And when he had enough money to buy another property, he’d buy another one. An outright sale usually would yield enough to buy multiple properties. Or if he could make a trade that made sense, he’d trade properties.

His initial $1,000 investment (which would be more like $10,000 in today’s dollars) grew to $1 million in property by the time he wrote his first book, to $3 million by his second edition in the late 1960s, and $5 million by his final edition in the mid 1980s.

Nickerson argued that his method was the safest investment in existence. He had a point. Land is the one thing God isn’t making any more of, but God is still making new people. People who need land to live on.

But how do you find tenants? What if the house sits empty for a long time? After all, my Dad rented out a property for several years and it was a nightmare. It sat empty a lot, and his tenants trashed the place.

A couple of months ago, I saw a house for rent two miles from me. The asking price was $900. Two days later the sign was gone. Now there are cars in the driveway. So someone rented it. I looked up the house on Zillow. You could buy the house for less than that, if it were available at current market value.

I kept watching. Rentals in my zip code don’t stay vacant long. So when a HUD-owned home a couple of miles away came up at a price we could afford (my wife found it), we went and looked at it. We liked it. It needs work, but that’s why it was cheap. We made an offer, and now we’re a few steps away from buying.

We have some luxuries Dad didn’t have. We’re in a hot market, so we don’t have to rent to the first guy who asks. We can get a family with references. We live close, so we can keep an eye on the place. We can use a management company to help keep everything smooth. We’ll pay more for that privilege but it’s probably worth it. And the mortgage payment is low enough that if it sits for a few months here and there, it won’t break us.

Where house flippers–at least the ones you see on TV–seem to get into trouble is dealing in big, expensive homes and being too leveraged. If the market for $200,000-$500,000 houses goes south, they’re stuck.

This house will never be on TV. Well, the Extreme Makeover guys would love to tear it down and build a sprawling, awkward castle on its L-shaped lot. It’s a low-end house, the kind of place a young family would buy or rent, live in for a few years, and then probably vacate once the kids are done with grade school–if not a bit sooner.

People want large houses in outer-ring suburbs, but they don’t need them. But a young couple that’s outgrowing an apartment does need an affordable house for a few years, and when they outgrow that, there’ll always be another family in the same situation, ready to move in.

So why don’t they just buy the house we had our eye on instead of us? I’m sure some do. But not all of them can afford the downpayment and the money it will take to fix it up.

A friend and I discussed the ethics of buying a down-and-out person’s house, back when Robert Kiyosaki was at his peak in popularity. Kiyosaki appears to have no qualms about it. We were less comfortable about that.

As far as I can tell from the records easily available, this house finished up the foreclosure process in May. A bank somewhere in New York had it for a couple of months. Then HUD ended up with it. I don’t completely understand the process yet.

As it stands now, the house is no good to anybody. HUD’s doing the bare minimum to keep it from getting much worse. It’s eating up taxpayer dollars and making the neighborhood look worse.

The best thing for the house and the neighborhood is for someone with money and who knows what he or she is doing to come in, make it inhabitable again, hopefully make it look a little better, and get someone living there just as quickly as possible.

In my wife and me, they got someone with a little money. We’ll have to learn what we’re doing on the fly.

We’re taking advantage of the former owners who got in over their heads, but when I go to work every day, I’m taking advantage of whoever made the decision to replace a working, reliable computer system based on VMS and Unix with a sprawling monstrosity based on Windows. And my wife would argue that they take advantage of me.

By buying a fixer-upper below market value, fixing it, and renting it at market value, we’re taking advantage of the house’s situation and the future tenants. But the future tenants are taking advantage of us, because they get to live in a house they couldn’t otherwise afford.

I’m not crazy about all aspects of the situation but I’m comfortable that I’m doing more good than harm.

Now, back to that mortgage question. I’m still arguing how quickly and how to pay that off. The math suggests I could ultimately pyramid at least seven properties, using rents from the first two to pay the mortgages on all of the others. And a few short years ago, a bank would have been more than happy to lend me the money it would take to do that.

One latter-day follower of Nickerson makes it his goal to pay off one of his properties per year.

I like the idea of fixing a property, holding it for as long as the tax code encourages you to hold it, then selling and using the proceeds to pay cash for more than one property to replace it. The growth is theoretically smaller, but I really don’t like debt.

But that’s really a question for another year.

How does the live-within-your-means movement apply to the current recession?

Joseph brought up some good points in the comments for the previous entry, and I don’t think a short response does them justice. He wants to know what the personal finance experts have to say about the current economic crisis.

Suze Orman actually went on TV a few weeks ago and called it an opportunity of a lifetime. I’ll explain.Joseph says this feels different from other recessions. I think it’s because it is. It’s more like 1929. The major difference is what people were investing in.

The biggest problem in 1929 (besides the crash) was that Herbert Hoover didn’t realize until it was too late that we had a big problem on our hands. That’s not the case this time. Although Bush and McCain were denying it for a long time, both readily admit now that we have a problem.

The cause of our problems today is twofold. One, we should have had a recession in 2000-2001 and we didn’t have much of one. The Fed lowered interest rates to stave off recession, and the result was something of a boom. Both political parties blame the other for this, but basically, under their encouragement, everyone and his uncle was willing to loan people way more money than they could realistically pay back. (Republicans liked this because it was deregulation; Democrats liked it because minorities who previously couldn’t get loans suddenly could get them in spades.) Then, when too many people failed to pay those loans, the banks ran out of money, so now we have banks failing.

I remember seeing Suze Orman come on TV on Sunday morning years ago and warn this was coming. The reason was simple: Too many people were in over their heads in debt, and eventually it was going to catch up with us. She even had the timeframe about right.

It didn’t take a prophet to see it. We started having problems when large numbers of adjustable rate mortgages started resetting. One month, people could make their payments on everything. The next month, their mortgage skyrocketed and there wasn’t enough money left to buy a day’s supply of Ramen noodles, let alone make car and credit card payments.

Soaring gas and food prices didn’t help either, of course. Then again, that’s all interconnected too. Back in 2001, Ford and GM started offering 0% financing, and their primary products were big gas guzzlers. Increased consumption raised fuel prices, which in turn raised the price of everything.

But for those who are able to pay their bills and keep their jobs, the opportunity of a lifetime is nigh.

Stock prices are down. Nobody knows if they’ve hit bottom yet or not. But they came back after 1929, and they’ll come back after this crisis too.

My grandfather was a wealthy man. He started his medical practice sometime during the Depression. He died in 1980, long before I could have a meaningful conversation with him about money. I can only speculate how he made his money, because the living relative who might have firsthand knowledge isn’t especially honest or reliable. I believe he bought stock in the 1930s at depressed prices sometime after he graduated from medical school. While those investments certainly didn’t pay off immediately, by the time the ’50s and ’60s rolled around, he still owned that stock, which he’d bought at Depression prices. At those prices, he might as well have stolen the stock.

I believe the same opportunity exists today. This isn’t the time to cash out your 401(k) accounts–it’s time to max out your yearly contributions, if you can afford to.

A similar situation is beginning to exist in real estate. If William Nickerson (the original make-a-fortune-in-real-estate guy) was still alive, he’d be having a field day. Nickerson made at least $5 million in his lifetime by buying distressed properties and turning them around. Before this crisis is over, there’s going to be a lot of distressed property that needs fixing up.

The bottom line is that the people who have no debt, or who have a reasonable amount of debt under control don’t have anything to be afraid of right now as long as they’re able to stay employed. They have numerous opportunities, in fact.

For one, they’re in an ideal position to convert pre-tax retirement plans into Roth IRAs, which are tax exempt on the back end. You take a tax hit when doing that, but this is the time to take that hit–prices are down.

Two, they can buy stocks and/or real estate at depressed prices, hold on to those assets, and in 20 years they’ll be rich. Once again, let’s go back to 1929. The Dow Jones Industrial Average peaked that year at around 380. If you take the worst case scenario, buying at the peak and then crashing, it took 25 years (1954) for the DJIA to get back above 380. But once it did, it stayed above that level for good.

But aside from that extreme scenario, it’s very difficult to find any 10-year period where stocks didn’t make money.

About a year ago, the DJIA was near 14,000. Today it’s below 9,000 and threatening the low 8,000s. There’s no historical precedent for it to drop lower and stay lower, and there’s no historical precedent for it to stay stuck at any level either. There’s every historical precedent for it to reach 14,000 again, and it’s much more likely for it to do it in less than 7 years than for it to take 25 years like 1929. Between now and then, individual companies will go under, but that’s why you don’t invest solely in one company. Buying an index fund that tracks the S&P 500, for example, spreads your risk over 500 large companies. If General Motors evaporates, you lose a little. But if GM gets its act together and the stock soars, you share in the gain.

Finally, when it comes to real estate, all those people who had bad mortgages have to live somewhere. It’s a terrible market to sell, but if you’re inclined to buy properties and rent them out, the environment is ideal for that and will be for a very long time. People who have enough saved up to pay cash can pretty much monopolize this game for a while, since loans are hard to come by.

There’s a positive for the country as a whole too. Did you get sick of the rest of the world buying up our companies because their economies were booming while ours stagnated? Now everyone’s in the same boat as us, so we’ve probably seen the end (at least for a while) of ruthless international conglomerates buying U.S. companies and then slashing everything that moves.

Overall, I do think this bust is a net positive for society, and not just for the reason I just mentioned. I read not long ago that many people under 40 consider the American Dream a birthright, not something that takes work and ambition. Society as a whole has been using borrowed money to artificially raise lifestyles up into the next-higher income tax bracket. Today’s crisis may put an end to that, and ultimately, that’s good for everyone, although it will be painful in the short term.

An old formula for making money

I picked up a copy of a financial classic today: How to Make a Fortune Today, Starting From Scratch by William Nickerson. In it, he presents a proven, old formula for making money.

While I don’t necessarily agree with everything Nickerson says, I’m not a millionaire and Nickerson was by the time he was my age (or well on his way at least). And his tactics are far, far safer than anyone writing about money today.

Read more

How Generation X can take this country back

I’ve done some reading in recent days. First I read that GenXers aren’t happy with Corporate America and the feeling is largely mutual. It appears I’m not the only one.

But I see an opportunity in this. We have a window to take this country back. And I have a plan.The way I see it, the unholy triumverate of big government, big corporations, and big labor has done its best to ruin this country. Big government’s mess needs no introduction. While big labor drove some necessary reforms, it lost its way, asked for too much, and today we see the result when we look at the sticker prices of GM, Ford, and Chrysler vehicles. And as for big business, I could get into specifics, but I see the problem like this: Large corporations think only quarter to quarter, chasing short-term profits and never considering the long term. They hand out raises to their workers that don’t keep pace with inflation, while their CEOs make six- and seven-figure salaries plus equally large bonuses, no matter how badly they do their jobs. Since the people who do the work feel undervalued, they tend to jump from job to job a lot, so institutional memory becomes a thing of the past.

Forget them. It’s time to escape and start over. Here’s the plan.

Minimize the risk.

You can’t very well escape corporate America’s stronghold while you’re saddled with debt. Most small businesses die within three years because at some point in that timeframe the owners find themselves unable to pay the bills. So as long as you have debt, you are corporate America’s slave.

But you can escape. It doesn’t really matter how much you make or how much money you owe–you can be debt free in seven years or less. The main reason this works is because creditors generally won’t loan you more money than you would be able to repay in seven years.

I don’t know how long this movement has existed. My mother and father in law did it in the 1980s. A classic entrepreneurial book by William Nickerson, published in the 1950s, mentions the phenomenon, so it must have existed then.

There are lots of subtle variants on the plan, but it boils down to this. Gather up all your debts–car payment, credit cards, mortgage, student loans, furniture, whatever. Figure out the minimum payment on them. Now take 10 percent of your monthly income. Pick one bill, and add that 10 percent of your monthly income to what you pay on it. (If you can afford more than 10 percent, pay that.) Make the minimum payment on all of your other bills.

After you pay off that first bill, take what you were paying on that bill and apply it to the next one. Let’s say you have two $300 car payments and a $1,000 mortgage. You could start paying an extra $300 a month on one car, for a total of $600, and pay $300 on the other car, and $1,000 on the mortgage. When the first car is paid off, the $600 moves to the other car, for $900 on the car and $1,000 on the mortgage. Once the other car is paid off, pay $1,900 per month on the mortgage.

The hardest part is initially coming up with that $300. The rest is fairly easy because you’re always paying the same amount every month, but the longer you go along, the faster you’re retiring your debt because you’re paying more principle and less interest.

How you pick the order is up to you. Mathematically speaking, you’re always best off applying your extra payment to the debt with the highest interest rate. But in every analysis that I’ve seen, the difference between paying them off in the best possible order and worst possible order is only a month’s worth of payments. Many people suggest paying off the debt on which you owe the least first, so you get the psychological boost of having eliminated one debt.

I started in November 2004. It took less than a year to pay off my car. Not long after that I got married, and it only took a few more months for us to pay off my wife’s car. Right now the only debt we have is the mortgage and my wife’s student loans. Barring unexpected emergencies this year, we should be able to pay off our remaining debt by the end of the year. (We may keep one of my wife’s student loans, since the interest rate is lower than the rate we get on one of our bank accounts.)

This is the most important thing: I fully expect to own my home outright at age 33. If I played by the rules most people play by, I’d make my last payment on it at age 58.

Here’s why I say to eliminate your debt. Take a look at what you spend every month. When my wife and I looked at our spending, we found we were spending more than $2,000 a month on car payments, the mortgage, and her student loans. Meanwhile, we were spending less than $1,000 on food, utilities, and everything else. So in theory, without debt, we could live on $12,000 a year.

Which leads to the second part of the plan.

Find a business you can start that will make you more than $12,000 a year

I’m not talking about multi-level marketing or any garbage like that. Start a real business that you control and makes money for you.

I won’t tell you what business to start, because I only know what works for my wife and me. But I’ll give you some questions that will get your mind rolling.

What can you do better than anyone else? There must be something that you know how to do really well and can leverage. Find it.

What do you know how to find or make less expensively than anyone else? This can replace the question above, or supplement it.

What do you enjoy doing? If you actually enjoy doing it, you’ll work harder and more productively. I would moonlight fixing Amiga computers if there were any money in it. Frankly I find modern computers uninteresting, so I don’t moonlight fixing other people’s computers at home, because I find it boring and stressful.

And finally, what problem do people have that you might be able to solve for them?

Mull those questions. It’s OK if you don’t immediately know the answer to any of those questions, or if you know the answer but they don’t bring a business plan to mind. Keep thinking about it, and keep looking around for opportunities.

I started looking for something in mid-2004 when I realized I didn’t make enough to support my wife and me if she was in school. I don’t remember now when I first had the idea that ultimately worked, but I followed through on it in June 2005. It took two weeks for anything to come of it, but it did finally work, and it’s still working today.

Once you get an idea, explore its feasibility. Look and see if anyone else is doing it. See if you can do it better or cheaper, or in a slightly different way than everyone else does it.

If the idea looks feasible, start doing it part-time. Don’t quit the job yet. The idea is to get established while you still have the safety net of a 9-to-5 job. If you’re thinking about a service, start advertising on Craigslist. If it’s a product, eBay and Craigslist are possible venues. The upside to Craigslist is that it doesn’t cost anything to advertise there. The real key is to look at your questions as an opportunity to get creative, rather than as blockades to your progress.

Here’s one strategy for dealing with those questions. Ask yourself those questions, especially around bedtime. Your subconscious will mull over the question even while you sleep. The answer will take some time to come, and will probably come at an unexpected time. But I’ve tried it and it works. Your subconscious mind may be the most powerful tool you have.

Notice I didn’t say to go borrow money. One of the reasons businesses die young is because they can’t pay their debts. Keep your overhead low, and you have a better chance of being successful. Operate on a shoestring.

Once you have an idea and something to do, give it a try on a small scale. At this stage, don’t put up any more money than you’re willing to lose, and don’t be afraid if your initial attempts don’t get anywhere or fail. You’re learning. If you’re starting while you still have a job and you’re in the process of paying down your debt, you can afford to fail a little. At the early stages, gaining information and wisdom and knowledge is more important than success. Get enough of those three things and you will find success, and if and when success wanes, you’ll find it again.

The problem with big government, big corporations and big labor is that they are successful, but by and large they are not well informed, they aren’t knowledgeable, and they certainly aren’t wise. That’s why we’ve seen so many spectacular failures in the last 10 years.

I see lots of small business owners who aren’t informed, knowledgeable, or wise either. When their success runs out, that’s probably the end of them. But there are also small businesses in St. Louis that stood the test of time and became institutions. Lots of Fortune 500 companies have come and gone in St. Louis since Ted Drewes Sr. opened a frozen custard stand on Natural Bridge Road in 1930. And lots more will come and go before the two Ted Drewes locations close up for good.

During this time that your small business is struggling and you’re gathering knowledge abd wisdom, you’re still working for someone else and you’re paying off your debts. But along with those struggles, you should have some encouraging successes. Follow those successes, and tweak things along the way.

Chances are, by the time you have your debt paid off, you’ll have a successful small business that’s capable of bringing in enough money to support you full-time. So you can step out of the corporate world and into business for yourself. From there, the sky’s the limit, because you’re no longer working hard to make money to support the pyramid of management above you–you only have to support yourself. And without the burden of personal debt and corporate overhead, you’ll be more free to be successful.

And how does this save America?

On May 11, 2006, Robert X. Cringely wrote, “I’m counting on Google and eBay to save America.” He didn’t elaborate, but here’s what I think he meant.

Just before the dawn of the 20th century, there weren’t a lot of large corporations in the United States, but there were plenty of bright entrepreneurs with ideas. Thomas Edison, Henry Ford, and the Wright Brothers are examples.

The problem today is that large public companies don’t breed great people like Edison, Ford, and the Wrights. The shareholders won’t stand for it. Shareholders care only about the profits on the next quarterly report, and if the company doesn’t deliver, investors dump their shares, the stock price drops, and then (and only then) executives start losing their jobs. So companies tend to play it safe to protect their executives.

We’re seeing this problem with eBay right now, of all things. While eBay remains hugely profitable, its investors got spoiled with exponential growth. Now that the profits are steady but growth has leveled off, investors are whining, and eBay is trying all kinds of goofy things to try to recapture the magic. None of it’s really working, but they sure are alienating a lot of their best merchants.

Two years after Robert X. Cringely wrote those words, I no longer know if eBay is the right company for this recipe to save America, but it has the right business model. Someone else will pick it up if eBay decides it doesn’t want it anymore.

The small entrepreneur can’t afford to compete head to head with General Motors. But Google gives small businesses affordable, targeted advertising, while eBay and other online marketplaces provide small businesses with a low-overhead distribution channel. Google and eBay (or their replacements) won’t directly save America, but the small, bright, nimble businesses that they enable will. Small businesses can afford to think long-term, they can deliver a better product with better service (and do it faster) than the huge, lumbering behemoths, and they aren’t slaves to whiney shareholders who have lots of money but little idea how to run the companies they invested in and no vested interest in the company’s long-term health because in five years they’ll have their money somewhere else.

And since small businesses have more control over their own destinies, they’re in a better position to adapt.

If we believe the Businessweek article I linked above, corporations need us GenXers. But in my experience, as well as the experience of hundreds of people who commented on the article both at Businessweek and on Digg, by and large the corporations don’t want us. So the best thing for us to do is to compete with them. And in the long run, I think this country will be better off for it.

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