YMOYL Chapter 9, Part 3: Capital, Cushion and Cache

Reminder! Casual Kitchen is running an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

We'll return to our more typical food and health-related content later in February. As always, thank you for your time and attention as we re-run this series!

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This week, we'll finally (finally!) tie up the last few loose ends of Chapter 9 with an analysis of Capital, Cushion and Cache. First a quick review:

* Capital is the primary nest egg that you'll use to generate investment income. This income will supplement--and eventually replace--your work income.
* Cushion is a separate account that contains a minimum six month cash reserve.
* Cache is a source of still more investment capital--beyond Capital and Cushion--that provides yet another layer of financial protection.

We've already discussed Capital, so we won't spend time on it here. After all, if you've been diligently following the YMOYL process like you should, then you've been tracking and aggressively adding to your Capital since Chapters 3 and 4.

Cushion
Your Cushion is essentially a garden-variety emergency fund. Everybody should have an emergency fund. This is an elementary concept of personal finance. The question isn't whether to have one, the question is how many months' worth of expenses should I hold?

YMOYL's authors (as well as many personal finance experts) recommend six months. Laura and I keep one full year of expenses in our Cushion. For some, perhaps 18 or even 24 months might be appropriate. You'll have to decide what's right for you given the nature of your work, the reliability of your income, and what resonates with your personal sense of financial safety. I'd argue that six months of expenses is an absolute minimum, nine months is better and--for us, at least--twelve months is optimal.

It's probably best to keep your Cushion completely separate from your regular bank account, especially if you have a tendency to spend money that's too easy to get at. You may even want to set down, in writing, a list of clear and strict rules for when you would use this money. What kinds of emergencies is it for, specifically? Under what circumstances will you tap into this account?

Yes, I know. We've all sworn off gazingus pins by now. Still, it's only sensible to make it extra, extra difficult to spend your Cushion on something it was never intended for.

Finally, think about the tradeoffs you make by having a big versus a small emergency fund. Are you sacrificing money that could be prudently invested in your Capital account, earning passive income? Or is the peace of mind from having twelve (or more) months of cash sitting safely somewhere worth more than a small amount of foregone investment income? As always, it's up to you to decide, and there are no hard and fast rules here. But please remember: most people do not have emergency funds at all. You have a high-class problem just by virtue of the fact that you're deciding how big yours should be.

Cache
Now, onto Cache: First, a caveat: Cache is something you'll focus on much more after you reach the Crossover Point. If you're only just beginning your road to financial independence, don't worry about this concept yet. Just keep your head down, keep managing your Wall Chart and keep making income-generating investments.

Second, the authors do a suckola job describing the concept of Cache--no surprise given all the other problems with Chapter 9. It's almost funny how the book briefly introduces the idea on page 271, then drops it, and then randomly picks it up again twenty pages later. It's a sad oversight, because the concept is extremely useful.

Hmmm. I guess that's why I'm writing this series.

Here's how to think about Cache. Imagine yourself in your post-Crossover Point life. You're not working (or at least you're in a financial position where you don't need to work), and you're funding your expenses with income-generating investments in your Capital account. Sounds pretty good, doesn't it?

Well, unless you spontaneously forget all the principles of YMOYL, you'll still be living within your means after you've reached the Crossover Point. You'll still want to be sure your spending decisions are appropriate expenditures of your life energy.

Moreover, once you leave full time work, your monthly expenses are likely to go lower--possibly much lower. Remember all of those disturbingly high job-related costs you listed back in Chapter 2? Buh-bye.

There's more: it's highly plausible that you'll earn some side income from time to time. Maybe you'll start up a high-traffic food blog that earns you a few hundred bucks a month (*cough*). Maybe you'll do some consulting in your spare time for a local business. Maybe you'll learn a new profession and take on some part-time work just for fun.

Finally, you might on occasion receive windfalls like a bigger-than-expected tax refund. Remember, the tax code treats most forms of passive income far more favorably than regular salary income, so your post-Crossover Point tax expenses are likely to decline too.

All of this suggests you'll most likely continue to save and accumulate money even after you've stopped working. This money's gonna add up, and it's going to generate still more passive income. That's your Cache. That's why you don't need to worry unnecessarily about longer term issues like inflation, and that's how you'll protect yourself from any unexpected big-ticket expenses. You've inoculated yourself against these risks with extra Cache.

The bottom line: You are likely to have higher income and lower expenses than you expect once you reach your Crossover Point. Simply add that money to your financial resources, put it to work, and you'll have yet another layer of financial security.

Structuring your Capital, Cushion and Cache accounts
I'll close this week's post with some thoughts on different ways you can structure your Capital, Cushion and Cache accounts. As with most things, simple tends to be superior, so with that in mind I'll share a laughably simple model you can consider for your finances:

* A checking account to pay monthly expenses,
* A savings account to hold your Cushion/Emergency Fund,
* A brokerage account, containing your income-generating Capital,
* A separate brokerage account, where you can put any additional Cache.

I'm often asked what I think about IRAs and 401(k) accounts, or purpose-specific accounts like educational IRAs. My stock response is to tell people to take advantage of the things they want to take advantage of. If your company provides a generous 401(k) match, by all means take it. If you think setting up a separate educational IRA will really help you fund your kids' education, go for it. Do what works.

But my general view is complexity is the enemy. You will have only so much bandwidth to manage so many accounts. So it's probably best to keep things simple: keep a minimum of accounts and try to make the bulk of your income-generating investments in one primary investment account.

One final thought for readers regarding IRAs, Roth IRAs and 401(k)s. Don't get me wrong: these standard retirement account types have their advantages. However, recognize that by following this book, you are embracing a highly non-standard approach towards retirement. Depending on your age and how diligently you follow the YMOYL process, you may very well reach your Crossover Point years before you can enjoy penalty-free access to assets sitting in these standard retirement accounts.

Keep this in the front of your mind as you allocate and invest your Capital.

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Appendix/Side Thoughts:
1) On the concept of enough: Readers, what is "enough" to you? I've seen estimates that Joe Dominguez reached his personal Crossover Point on a $300,000 investment portfolio. For him, three hundred grand was "enough." And if any of you have ever read Early Retirement Extreme (I've periodically linked to it in my Friday Links posts), that blog's author, Jacob, reached his crossover point on just $150,000.

Jacob's and Joe's ideas of "enough" may seem laughably low to you. But then again, I know people from my former career who don't feel they have "enough" even though they're sitting on nest eggs in the double-digit millions. If anything, this is just proof that the principles of Your Money Or Your Life can be effective across a truly vast range of income and net worth levels. But the principles will only work if you're willing to make them work.

2) The various personal anecdotes in Chapter 9 are worth rereading: Every reader will find something to identify with, or an example to learn from, in each of the anecdotes in the Chapter 9. Everyone has different ways of processing the emotions, risks and personal issues that emerge at each of the various stages of enlightenment with money.

"Rosemary," for example, recognized that she's ultra-conservative with money, so she chose to keep extra Cushion in place to assuage her concerns. "Clair and Mike" are going to have a real problem when their existing Treasury bonds mature--they will face the same reinvestment risk we discussed two posts ago. "Carl" postponed leaving work until he learned to be more self-sufficient around the home. After all, he didn't want to waste life energy paying others for things he could do himself. "Ted and Martha" created an itemized list of every long-term liability they could think of and inoculated each expense with long term bond investments. "Alan and Tricia" took the most idiosyncratic path of all: they returned to work and then became FI all over again. And so on. There's an unlimited number of ways to walk the path of YMOYL.

3) For further reading on Cushion and Cache: Let me recommend yet another book I found extremely useful (despite its get-rich-quick-sounding title): The Buckets of Money Retirement Solution by Ray Lucia. This book teaches a surprisingly elegant system of setting out various buckets (or Caches, if you will) of capital to meet all of your financial needs. Very much worth a read.

4) Yes-butting and you: Note the quote on page 277 that says Watch out for those "Yes, but..." conversations in your head. Oh, how that warms my heart. I think I can say with total confidence that no one reading this series will allow themselves to get sucked into a yes-but conversation. Not on my watch.

5) Finally, some gratitude: It's vaguely embarrassing that it took me three posts to cover Chapter 9. But there's a lot to discuss here, including plenty of material that should be in this chapter but regrettably isn't. I'm grateful for my regular readers' patience with this series, and even more grateful to see so many new readers visiting these posts here at CK... despite their length. As always, thank you for your attention and interest.

Coming Up! Becoming a Sophisticated Investor: Six Steps








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If you enjoy reading Casual Kitchen, tell a friend and spread the word! You can also support me by purchasing items from Amazon.com via links on this site, or by linking to me or subscribing to my RSS feed. Finally, you can consider submitting this article, or any other article you particularly enjoyed here, to bookmarking sites like del.icio.us, digg or stumbleupon. Thank you for your support!

YMOYL Chapter 9, Part 2: Here's What To Do With Your Money: Alternatives to Treasury Bonds

Reminder! Casual Kitchen is running an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

We'll return to our more typical food and health-related content later in February. As always, thank you for your time and attention as we re-run this series!

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In our last post, we explained in ugly detail why we can't rely on Treasury bonds alone for our passive income needs. Today, we'll review a broad range of investment alternatives that will empower you to earn money from your investment capital.

First, however, a friendly warning and a few caveats. Today's post is long (more than 2,500 words) and packed with a lot of information. You're going to need to carve out 20-25 minutes at a minimum to ingest everything here.

Now for the caveats: Just as Joe Dominguez's advice to rely on Treasury bonds fails in the current era, some (or all) of the advice I give will also fail at various points in the future. Further, most of what you're about to read in this post is my opinion. Just that. And I'm wrong sometimes. Actually, I'm wrong a lot. As an empowered YMOYL reader, it's up to you to weigh the opinions of others, and then make your own investment decisions.

That said, an empowered investor should always be diversified in the broadest sense, so your job is to build a broad mix of income generating investments across every asset class. Thus, in addition to placing a portion of your capital into Treasury bonds, CDs and other lower-yield, lower-risk investments, you will also make investments elsewhere in the risk spectrum, including:

* Tax-free municipal bonds issued by your state of residence.
* Preferred stocks, which in the current era yield as much as 5-8%.
* Corporate bonds, perhaps in the form of a low fee bond index fund.
* Consumer products stocks (examples: PEP, PG, UL, JNJ, etc.), which can be bought at yields ranging from 2.0-4.0% with (importantly) dividend growth potential over time.
* Conservatively managed utility stocks (such as: ED, PPL, etc.) which can be bought at yields from 4-5%.
* Publicly traded REITs, yielding anywhere from 3-6%.
* Dividend-paying bank stocks based in the USA or Canada, now that our banking sector has stabilized. Yields here can range from 2.5-4%.
* Conservative, dividend-paying industrial stocks (HON, EMR, CAT, BA, and many more). Depending on their stock prices, yields can be as high as 3-4%.

Chapter 9 offers readers additional income generating investment ideas too, including:

* Mutual funds (which I generally hate because of their high fees and generally mediocre investment performance. Read Common Sense on Mutual Funds by Jack Bogle to wrap your mind around the drawbacks of these investment products).
* Index funds (which have far lower fees than traditional mutual funds, but which are usually not optimized for income generation).
* Lifecycle funds, such as Vanguard's low-fee LifeStrategy funds (I'm not particularly familiar with or conversant in these products).

Each of these investment categories has risks. Duh. Your job is to slowly experiment with each to see which meet your needs, which you feel comfortable with, and so on. Eventually, you'll want to own at least something in nearly all of the categories I've listed above as you build your broadly diversified income-generating investment portfolio.

Most importantly, you're going to rely on yourself, not on "experts." And when I say experts, I mean both those who make money selling financial products and those in the media who make money selling opinions. Finally, you're going to follow YMOYL's dictum about avoiding excessive fees and commissions, and keep your investment costs as low as possible. Do this, and you should be able to generate passive income from your investments that meets (and perhaps exceeds) the 4% hypothetical yield we discussed back in Chapter 8.

Readers just beginning their investing journey may have extremely basic questions at this point. How do you find these investments? Where do you go to buy them? How do I choose a stock? What do I even do? And so on.

There's really just one answer: Stop with all the questions and just get started. Go to Schwab.com, Fidelity.com or TDAmeritrade.com and open up a brokerage account. Get four or five well-regarded investing books (Note: at the end of this series I will provide readers with an official YMOYL-specific reading list which will make you better educated about investing than 95% of humanity), read them carefully, and then just start. Begin making some investments. Pick one or two, make a small investment of your capital, and keep reading and keep learning. You will learn and gain context as you go. Your success as an investor will depend on your willingness to learn by doing.

Scared? Intimidated? Afraid you'll make a mistake and lose some money? Irritated that this process seems difficult and that it might take a long time? These are all perfectly normal feelings. But, for goodness' sake, if those feelings stop you from taking action, you've somehow managed to learn nothing from the entire book. Reread Chapters 1 through 8, do all the exercises again--and this time do them for real. You haven't yet wrapped your mind around what it really means to be FI.

Create your personal list of investment criteria
We already know Chapter 9 has some flaws. But, once again, even a flawed chapter can still teach important fundamental principles. And pages 271-272 of Chapter 9--where the book outlines Joe D's personal investment criteria--is yet another exceptional example.

And just as Joe's one-dimensional "buy Treasury bonds" strategy doesn't function well in the modern era, his list of investment criteria has a few flops too. See, for example, criteria #2 (your capital must be absolutely safe) and #6 (your income must not fluctuate), neither of which are realistic for investors who go beyond Treasury bonds for their income needs.

But the meta-principle of establishing a list of personal investment criteria is incredibly sound. Create your own. Once you've shaped your own list of what specifically you're looking for in an investment, you'll better understand your true goals. You'll better understand your risk tolerance. And best of all, you'll have a checklist to help you filter and select specific investments that meet your needs.

As a reference for readers, here's Laura's and my personal investment criteria:

1) 90% or more of our investments must generate income.
2) Our investments must be well diversified across multiple asset classes (bonds, tax-free munis, stocks, preferred stocks, REITs, funds, cash).
3) Depending on the attractiveness of interest rates, we may invest in CDs or Treasury bonds.
4) Stocks should make up only 40-50% of our investment portfolio to help limit risk.
5) Nearly all of our stocks must pay regular dividends, and we must be diversified across industry sectors.
6) No single stock can be more than 5% of our total assets.
7) No one fund--either a mutual fund or bond fund--can exceed 15% of our assets.
8) We seek to minimize all fees and commissions.
9) We seek to minimize active trading, and seek to minimize short-term selling that triggers gains taxable at higher short term tax rates.
10) We seek to make our investment income tax-efficient, which means emphasizing tax free municipal bonds and tax-favored income from dividend-paying stocks.
11) We dedicate roughly 5% of our capital towards highly speculative investments (stock options, very speculative stocks, etc.).

If you're new to investing, you won't be able to make a list this long or with this kind of specificity. Don't worry. You'll shape your own list of criteria over time as you gain more and more experience. Get started, keep learning--and it will happen.

Dividend paying stocks
I'll close this week's post with a few observations about dividend-paying stocks. First and foremost: the best thing about stocks is that they can go down.

Yes, you read that right.

If you've purchased a stock with a safe, sustainable dividend and the stock declines, you now have the opportunity to purchase that same stream of dividend payments at a lower price. All else equal, the yield on a stock gets juicier as the stock price goes down.

In other words, YMOYL readers investing for income should be gloriously happy when the dividend-paying stocks they own go lower.

Here's another way to think about dividend paying stocks. The price of the stock doesn't really matter. If you own it for the dividend payments, and you have a reasonable degree of confidence in the safety of the dividend, what does it matter if the stock goes down or up? All you care about is the dividend, and now that same dividend can be had for less. Thinking about stocks in this way is enormously liberating.

The second best thing about dividend-paying stocks is this: Over time, the company can hike its dividend substantially. An example: Laura and I bought our first shares of Coca-Cola [ticker: KO] back in 1999, right at the beginning of the so-called "lost decade" for stocks. It was a brilliantly-timed decision (uh, sarcasm!), and if you were to consider the stock price and nothing else, it's been a mediocre investment at best. But over the 13 years that we've owned KO, the company increased its quarterly dividend from 16c per share to 51c per share. More than triple! Enterprising readers should be able to put two and two together here and see a rather obvious solution for managing inflation. [Edit: As of today, it's been 18 years since we've owned this stock and, adjusting for splits, KO's quarterly dividend has increased from 16c to 70c per share, more than a quadrupling of our income. Time is on your side, sometimes monstrously so, when you own high-quality dividend growth stocks.]

Let's say it once more, with feeling: All investments have risk. Dividends get cut. Interest rates go down. Stocks correct. And I (and you) don't have the foggiest idea what stock prices or interest rates will do over the next year, the next ten years or the next century. They may go up, down, or all around.

However, there have been precious few periods in modern economic history where so many good-quality stocks yielded so much more than "risk-free" government bonds. One such time was the mid-1930s, in the latter years of the Great Depression, when stocks were so universally loathed and reviled as an asset class that it was presumed that they needed to pay juicy dividends to compensate shareholders for their far greater risk.

Roll that over in your mind, and you might arrive at some interesting implications on the outlook for stocks in the coming years. [Edit: I had no idea how right I would be with this prediction, and the US stock market has performed quite well over the past several years. That said, even with the stock market having meaningfully appreciated, you can *still* find very attractive dividend yields among many, many high-quality stocks. Keep your eyes open for them.]

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Appendix/Side Thoughts:
1) Czarist bonds: Joe D's habit of giving YMOYL students a yellowing Russian Czarist bond is a brilliant metaphor for understanding that nothing is certain. PS: Russia defaulted on its debt again in the late 1990s.

2) Don't confuse yield with return--and don't be unrealistic with your assumptions about returns: I can already anticipate some readers complaining: "Four percent? I don't want a stinking four percent! I want a return of at least 10% a year if not more."

First of all, let's review some terminology. Yield is the income that your investments throw off (remember our formula M x Y = PI?). Your return is the combination of your investment income plus any increase or decrease in the price of the investments you hold. An example: Let's say you own a $50 stock that pays a $2 annual dividend, and during 2012 the stock goes from $50 to $55. Your "yield" on that stock is 4% ($2 divided by $50), but your "return" was 14% ($2 in dividend plus $5 in appreciation divided by $50). Note that you can rely somewhat more heavily on your yield than you can rely on your return, because investments can (and regularly do) decline in value.

Last, a word of warning, and I'll try to phrase it gently: if you are counting on earning "10% if not more" on your investments, you need to grow up. There may be occasional periods in the future where stocks return 10% or more a year, but those periods are unlikely to be the norm. Never build your investment plans on unrealistically optimistic assumptions.

3) Here's where I make sure my readers are aware of all of the risks of owning stocks:

* Stocks can go down. A lot.
* Dividends can get cut, suspended or eliminated entirely. (They can also be hiked, see KO above.)
* On occasion, you'll see a stock with dividend yield that looks too good to be true. It probably is. An unusually high dividend yield is often signal of a coming dividend cut.
* Never, ever reach for yield. I'll write more about this subject in the coming weeks.
* Entire sectors of the stock market can fall out of favor--for longer than you think.
* Things can happen that you never even thought of. Both good and bad.
* No one knows the future. Be humble about this, and be prepared to be wrong about your investments.

4) One final thought about stocks: Buying a stock and then getting mad that it doesn't go up right away is an act of supreme narcissism. Please keep in mind that the stock doesn't know who you are, and it doesn't care about your feelings.

5) Thoughts on the 2008-2009 credit crisis and aftermath: If there's one thing that has scared away (and scarred for life) many people who would otherwise have already started their journey towards freedom from work, it's the credit crisis that set off the 2008-2009 market crash.

A few thoughts: First, for a variety of reasons, credit crises tend to happen every 20 years or so (our last one here in the USA was the Savings and Loan crisis of 1989-1990). In the 2008-2009 crisis, which was a doozy, almost all major US banks (plus lots of other stocks in many other sectors) were forced to reduce or suspend stock dividends. Worse, quite a number of banks that looked like they had seemingly juicy dividends ended up failing and wiping out stockholders completely. (Again: never reach for yield--dividends that look too good to be true, probably are).

But remember: the credit crisis happened already. Now--more than three [make that eight] years after the crisis, and now that our country's financial sector is on extremely firm footing--it's time to pick through the rubble and look for good candidates for income-generating investments. Ironically, at exactly the time when banks are a truly hated sector of the stock market, you can find many well-managed banks (e.g., WFC, USB, JPM, plus dozens of smaller regional bank stocks) paying extremely attractive dividends, with lots of room for dividend increases. And don't forget: you may have as many as 15 years of runway until our next credit crisis.

6) Other, Unusual Investments: A few words regarding Chapter 9's What About Other Investments? section on pages 285-287. The authors address two types of "other" investments:

* Direct ownership of rental properties (which requires significant experience and expertise),
* Loaning money to friends and family (two words: no way).

Enter into both of these areas at your peril. A major problem with rental properties is this: a single property will likely make up a vast percent of your assets, which means you'll be undiversified. It may be safer and more profitable to invest in apartment REIT stocks instead.

As for loaning money to friends and family, perhaps one risk reduction strategy here might be to require any possible borrowers to read YMOYL as a pre-condition of receiving a loan.

7) Thoughts on risk tolerance: "Risk tolerance" is one of those finance euphemisms many people toss around without understanding. In almost every instance, people actually do not know their risk tolerance until it's too late.

Here's what's more typical: an investor thinks he knows his risk tolerance, and then has his investments cut in half during a 2008/2009-type stock market correction. Then and only then, he realizes his risk tolerance was way, way lower than he thought it was. This is a classic setup for an overconfident investor who gets blasted out of stocks at market bottoms.

I don't care who you are, how smart you are, how cool you are, or how experienced you think you are: your risk tolerance is lower than you think it is. For most people it takes a big and unexpected investment loss to drive this lesson home. Save yourself the losses and just learn it now.

8) "Experts" don't know either: Finally, if anybody tries to tell you they know what stocks or interest rates will do, they are lying. Remember this the next time you see some stock market pundit pontificating on CNBC, or the next time your read some authoritative-sounding article telling you to buy or sell.


Coming Up: YMOYL Chapter 9, Part 3: Capital, Cushion and Cache








How can I support Casual Kitchen?
If you enjoy reading Casual Kitchen, tell a friend and spread the word! You can also support me by purchasing items from Amazon.com via links on this site, or by linking to me or subscribing to my RSS feed. Finally, you can consider submitting this article, or any other article you particularly enjoyed here, to bookmarking sites like del.icio.us, digg or stumbleupon. Thank you for your support!

YMOYL Chapter 9, Part 1: The Fatal Problem with Chapter 9

A reminder for readers: Casual Kitchen is running an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

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Your Money or Your Life is a nearly flawless guide for dominating your personal finances. Seriously, all you have to do is read it, complete the exercises, and you will systematically accumulate money.

What YMOYL is not, however, is a flawless guide for dominating investing. Chapter 9 proves it.

The problem with Chapter 9 dates back to the book's first edition. When Joe Dominguez wrote it, he offered readers a deceivingly simple, one-size-fits-all solution for what to do with our money: invest exclusively in US Treasury bonds.

As we're about to see, this is a solution from another era--when interest rates were far higher--and it cannot be your only solution today. In its day, however, Joe D's idea worked, and it was so clean and simple that he could thoroughly explain it in just one chapter.

Which left the authors in a terrible bind when it came time to revise the book in 2008. It's not like they could shoot down Joe's idea and leave readers hanging with nothing to replace it: Sorry, but rates are too low in the current era to rely solely on Treasury bonds. Joe's idea won't really work any more. Too bad. Good luck transforming your relationship with money!

And so the authors tried to make Chapter 9 into a broader investment resource so readers could go beyond Treasury bonds for their passive income needs. What they actually created, however, is a crappy and superficial chapter that attempts to cram the entire investing industry into thirty-two pages. In other words, what used to be a simple chapter explaining Treasury bonds evolved into a messy chapter explaining everything. Badly.

Look, no book is perfect. And (up until the end of Chapter 8 at least) few books are as life-changing as this one. So, we're going take the good from Chapter 9, and we're going to learn from what it gets wrong.

Why Treasury bonds won't work
Okay. Let's first go over why it's a horrendous challenge today to fund a post FI-life exclusively with Treasury bonds. I'll explain with a quick example:

Let's assume your expenses are $3,000 a month ($36,000 a year) and you're living in an bygone era of 6% Treasury yields. How much capital in total will you need to be FI?

Remember our formula: Money x Yield = Passive Income, or M x Y = PI for short.

Then, plug in the numbers: M x 6% = $36,000 a year. Solve for M, and you arrive at $600,000 in capital needed to fund your post-FI life: $600,000 x 6% = $36,000.

That's dandy, except for the sad fact that we're not alive in an era of 6% Treasury yields. We're alive now, when the 10 year Treasury yields a paltry 1.6%, the 5 year Treasury yields a pitiful 0.62% and the 2 year Treasury yields a pathetic 0.24%. Even the 30 year Treasury, the US government's longest-dated debt instrument, yields a sorry-ass 2.58%. [Edit: Readers, these interest rate numbers are from five years ago (obviously), and it's instructive to see how they can change over even reasonably brief time periods. For example, right now in January 2017 the 10 year Treasury yields a slightly more attractive 2.44% while the 30 year yields 3.02%]

So how much capital does it take now, in an era of 1.6% Treasury yields? Once again, here's your formula: M x 1.6% = $36,000. Solve for M, and we come up with $2,250,000.

Yes, you read that right: $2.25 million. To generate thirty-six grand.

[Edit: Using today's numbers, we'd have M x 2.44% = $36,000, which means you'll need capital of $1.475 million. Quite a bit better. Also note how sensitive these numbers are to even small movements in interest rates when rates are especially low.]

A simplified way to think about it is this: if interest rates are roughly a third of what they were two decades ago, you're gonna need roughly three times the capital to fund the same level of expenses. Therefore, if you use Treasury investments--and nothing else--to fund your post-FI life, you're gonna need far more capital now than you would have needed back in Joe Dominguez's day.

So, what does this all mean? It means you're going to have to figure out a way to meet your needs differently. You will not be able to fund your post FI life with one single, easy investment solution like Treasury bonds. That solution was a historical artifact of Joe Dominguez's time, and it's simply not an attractive option in the modern era with interest rates where they are.

One last thought: if you're jealous of the readers who lucked out and discovered YMOYL during a high interest rate era, think again. Even those investors faced risk, and most of them had no idea it was coming.

What risk did they face? Reinvestment risk.

Remember, bonds eventually mature. Imagine if you were totally lucky, and you managed to buy a bunch of 30 year Treasury bonds back in 1982 when yields were at a scrumptious 11-12%. Well, guess what? Those bonds would have matured in 2012. Which means you'd get your principal back and have to reinvest it now at those days' crappy rates. Think about it. Even those investors were exposed to the risks of declining interest rates--they just didn't know it until much later.

The bottom line: the idea that there ought to be investments that pay juicy yields yet are free of all risk is a childish fiction. Everything has risk. It's time to grow up, embrace that risk, and find alternatives. That's what we'll discuss next week.

Coming Up: YMOYL Chapter 9, Part 2: Here's What To Do With Your Money: Alternatives to Treasury Bonds








How can I support Casual Kitchen?
If you enjoy reading Casual Kitchen, tell a friend and spread the word! You can also support me by purchasing items from Amazon.com via links on this site, or by linking to me or subscribing to my RSS feed. Finally, you can consider submitting this article, or any other article you particularly enjoyed here, to bookmarking sites like del.icio.us, digg or stumbleupon. Thank you for your support!

YMOYL Chapter 8: The Crossover Point

For new readers: This is an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life that we're running throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

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We've got just two more chapters to go, and just a few transitions left to make in our thinking about money. And the key mental shift readers make in Chapter 8 is to change how we think about savings:

"Before FI thinking takes over, a 'normal' person might regard savings as earmarked for a splurge in the future--a down payment on a bigger house or a whizbang vacation towards the ends of the earth." (p. 236)

This quote is only partly right. Most "normal" people don't save any money at all, so when they "regard savings" it's an exercise in pure fantasy.

Your case, however, is different. Now that you're executing the steps of YMOYL, you're consistently saving excess cash every month. It's a regular habit for you.

But even people who have built a habit saving money can slip into being what I call vague savers: people who save money inconsistently, who periodically vaporize their savings on big splurges, or who save in an undirected way without clear and concrete goals. Don't get me wrong: vague saving beats not saving at all, but it's still a wage-slave based approach to handling your wealth. I want you to aim higher.

And that's why YMOYL uses a different word for that money you're socking away every month. They call it capital.

"Savings are funds put aside from time to time and kept unexpended. Capital, however, is money that makes you more money. Capital is money that keeps working for you, that produces an income as surely as your job produces income." (p. 237)

You're probably already nodding your head at the concept, so let's go over an example: Let's say that after months of patiently applying the YMOYL steps, you amass a savings cache of $20,000. Again, the proverbial "normal person" might see that money as a kickass family trip to New Zealand, or (slightly more responsibly) as a big step towards a down payment on a big new house.

As a financially savvy YMOYL reader, you might also choose either of those options--but only if that choice provided fulfillment and value in proportion to life energy spent. Furthermore, you grasp instinctively that neither a big new house nor an overpriced trip to New Zealand gets you any closer to freedom from work-spend.

However--and this is the important part--if you invested that $20,000 at a hypothetical 4% yield, you'd create $800 a year (or $67 a month) in brand new income. Forever.

In other words, YMOYL readers instinctively view sums of money using this formula:

Money   x   Yield   =   Potential Passive Income

Thus in our example of $20,000, we'd have:

$20,000   x   4%   =   $800 per year, or $67 per month.

One more important insight: when you piss away your capital on some splurge-related expense, you don't just bear the direct cost of the thing you splurged on. You also bear the opportunity cost of forgoing all future income you could have earned on that money. You lose out twice: you lose the twenty grand, and you also lose that yearly $800 in future passive income.

Train yourself to think about money this way. If you can make spending decisions with an eye to the opportunity cost of your capital, it is merely a matter of time before you become wealthy.

Problems and Pitfalls With The Long Term Interest Rate
Now, let's spend a moment addressing how Chapter 8 lays out the concept of "Monthly Investment Income." Remember, in this chapter you're adding an extra element to your Wall Chart: income from your investments. And to start off tracking this number, the authors give readers a shortcut: just take the capital you've currently saved, multiply it by 4%, and put that number on your chart. Next month, add in any new money you've saved, and apply 4% to that number. And so on.

If you've only just begun saving money, feel free to use this shortcut. But please recognize that this 4% is hypothetical. To paraphrase a Wall Street saying: you can't eat a hypothetical yield. At some point--soon, I hope--you'll want to begin making income-generating investments and earning actual income.

If you're a more advanced reader who's already earning investment income in the form of dividends, interest and so on, skip this step and just plot your actual earnings.

One other point. Some readers may consider the "4% shortcut" misleading. After all, there's no real explanation anywhere in the chapter about how to generate this hypothetical 4%--and worse, now that we're in a bizarre low interest rate environment, risk-free investments like bank CDs and long-term government bonds pay way less than 4%.

All true. Frankly, this is a flaw in the book's investment strategy: it simply isn't designed for periods of ultra-low interest rates. Fortunately, this flaw--which we'll discuss in much more depth next chapter--isn't fatal. It's still reasonable to earn a 4%-ish yield (or perhaps even better) with a diversified, conservative portfolio of dividend-paying stocks, preferred stocks, municipal bonds and bond funds. You'll have to take on some risk, but not a terrible amount of risk. More on this next week.

For now, just remember that interest rates fluctuate, and eventually, we will return to a more "normal" interest rate environment. Most importantly, don't let worries about interest rates sidetrack you from the central point of Chapter 8: Think of your swiftly-growing pile of savings as capital, and use it to generate income. This is the key step that will eventually free you from dependency on work.

The Crossover Point
Okay. The final concept of Chapter 8 is the Crossover Point.

You've already wrapped your mind around the strategy of making money from your money. Now, simply let the months go by while you patiently and relentlessly execute the YMOYL process.

What you'll start to see is rapid and accelerating growth of your capital as you steadily add savings each and every month. Start putting that money to work, and you'll begin to see similarly accelerating growth in income from your investments. With a combination of investment compounding and disciplined execution of the steps, your "Income from Investments" line on your Wall Chart will gradually and inexorably rise, until it approaches your "Total Monthly Expenses" line.

This process will unfold over time and, at first, things will move slowly. But you never know what the future may bring. You're highly likely to increase your job-related income. You might also drive your expenses far lower as you seek creative ways to align your spending with your values. Combine both, and this process may move more quickly than you ever imagined.

"The Crossover Point provides us with our final definition of Financial Independence. At the crossover point, where monthly investment income crosses above monthly expenses, you will be financially independent in the traditional sense of the term. You will have a safe, steady income for life from a source other than a job." (p. 241)

Do you see what you've been building towards? Can you now visualize your progression towards financial independence as you stay patient and continue to follow the steps?

If I know my readers, I'm betting there are some very bright lightbulbs going on and off in your brains right now as the reality of The Crossover Point sinks in. You don't necessarily have to start laughing and crying at the same time like "Steve" the carpenter (p. 245!), but be sure to take some time to enjoy the insights and implications of this process. You will be working for a finite time. Remember this, and remember how far you've come in your journey to take back your power over money.

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Appendix/Side Thoughts:
1) "I'll never get to the Crossover Point. This is just too depressing to think about." Some readers might feel like they're so far away from the Crossover Point that they dread even getting started. I empathize.

But indulge me for a moment and consider another perspective: You've allowed yourself to become pre-emptively depressed about something that you're too defeatist even to try. Reread that sentence and think about its hideous circularity.

Forget what's in the distance, and just start earning some money from your money. Just start. Don't worry that it's a small amount. Don't worry that your "Income from Investments" line is literally a mile below your "Total Monthly Expenses" line. And don't worry that the process might take a long time. That's all fear and ego. Forget all that. Keep it simple, keep doing the YMOYL steps, and keep plotting numbers on your Wall Chart. It all will happen in time. Don't get ahead of yourself.

One final thought: if you're still seriously getting depressed thinking about the Crossover Point, consider the possibility that you either haven't paid close enough attention while reading the book or you haven't sincerely done the exercises. Read the book again--and this time do the exercises. Commit to it.

And if I may offer a prediction: you'll be astonished at how much faster the process goes than you currently think it will.

2) On subjective reality and money: This point is related to Side Thought #1. Reality can be surprisingly subjective. If you believe you won't ever save up enough money to become independent from work, you're correct: you won't. However, if you believe you will reach this goal--and if you take steady and concrete steps to accomplish it, you'll also be correct: you will. Never permit pre-emptive defeat.

3) Scale benefits of passive income: The best part about passive income is its near-frictionless scalability. Consider two FI-ers, one with $10,000 in capital saved and another with $20,000. Both will do exactly the same amount of "work" investing their capital--yet the investor with twenty grand earns double the investment income from her capital.

This scalability exists at nearly every level of personal net worth: it takes about the same amount of effort to manage a diversified portfolio of stocks whether you have a million dollars or tens of millions of dollars. And this concept holds true in the institutional investment world too: oddly enough, it's actually somewhat easier to manage a multi-billion dollar stock portfolio than a stock portfolio in the $10-100 million dollar range. (Extra credit for readers who can reason through why this is true.)

Here's the point: Once you start saving aggressively and putting your money to work for you, you can earn surprisingly meaningful amounts of passive income for very little incremental effort. Get going, so you can take advantage of it.

4) "For those wishing to go all the way to Financial Independence" Note the nuance in this quote, which appears in the middle of page 245. Just because financial independence seems preposterously far into the future doesn't mean you can't use this process to achieve other important goals. You can use YMOYL to get on top of your debts, to find more breathing room between your income and your spending, to rethink your work and your life, and to put your spending and consumption in alignment with your values. And so on. It doesn't all have to be geared toward financial independence alone.

Moreover, as the book says, "financial independence is the by-product of following the steps. You don't need to have financial self-sufficiency as your goal in order to arrive there." (p. 247).

Most importantly, don't throw the book across the room and miss out on all the value in it just because financial independence seems too far off to bother with. That's no different from our acquaintance who threw the book away after some blurb about cutting her own hair set her off.

5) "This doesn't mean you must stop working for money." (p. 251): Yet another nuance: just because you earn enough money from investments to quit work doesn't mean you have to. In fact, you might keep right on working--and enjoy your work far more. After all, you're there by choice.

6) A personal note on re-reading YMOYL: I've mentioned before that when Laura and I first read YMOYL ten years ago [Edit: make that 15 years ago], the book had an enormous impact on us. But it's been an even bigger surprise to experience this book's impact on us now that we're reading it a second time.

I wonder if we got a little bit financially overconfident, and allowed some of the principles of this book to "wear off" and slip away over time. Certainly our spending slipped out of alignment with our values over the past few years, and--no coincidence--we've had more disputes and disagreements about money in the past few years than is normal for us.

But this re-reading of YMOYL is helping bring things back into focus. Our spending is now in far better alignment with our values. Laura and I have successfully hashed out quite a few money issues as we've re-read the book together. And we're back to saving money each month, nearly effortlessly--despite the fact that I'm now retired, and Laura's only working part time.

There are a couple of major takeaways here. One big one: YMOYL works over a vast range of income levels. It worked when I was making medium-sized money on Wall Street, and it works just as well now at a fraction of our prior peak income. Another key takeaway, at least for me: it pays to stay humble about maintaining a lifestyle that's consistent with your principles. Things can slip out of alignment more easily than you might think, especially since we're all literally surrounded by a culture of consumerism. It's all too easy to slip back into old, unconscious patterns and habits.

Hmmm. Something tells me we may want to re-read it again--in ten more years.


Next: The Fatal Problem with Chapter 9






How can I support Casual Kitchen?
If you enjoy reading Casual Kitchen, tell a friend and spread the word! You can also support me by purchasing items from Amazon.com via links on this site, or by linking to me or subscribing to my RSS feed. Finally, you can consider submitting this article, or any other article you particularly enjoyed here, to bookmarking sites like del.icio.us, digg or stumbleupon. Thank you for your support!

YMOYL Chapter 7: Redefining Work

For new readers: This is an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life that we're running throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

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It's time to put work in its proper place in our lives, and break the connection between our jobs, our income and our identities.

Like every other chapter in Your Money Or Your Life, Chapter 7 builds on the steps before it, so let's quickly put this chapter in context. First, YMOYL makes you far more conscious of the money you spend, and it annihilates your ignorance about where your money goes. Second, it helps you escape consumerism when you align your spending with your values and principles. Third, thanks to the maxim what gets measured gets controlled, your expenses fall materially as you follow the steps.

In other words, after two or three months of carefully following this book, you'll be saving significantly more money. Every single month.

This sets off an important virtuous circle, because once you're regularly saving meaningful amounts of money, and once it starts piling up in your bank account, you'll find yourself less and less dependent on your paycheck. And as you complete more and more months of your Wall Chart, your near-term financial needs will become less and less pressing--until they're simply no longer a source of stress in your life. If you're doing each of the steps, this will just happen. Trust the process.

For many readers, this will be their first real taste of freedom from the cycle of work-spend. And with this taste of freedom, you can start to take a longer view about the work you do. What is your work really for? Is it satisfying? Should it meet more than just your financial needs? How much primacy does work really deserve in your life?

The way I see it, Chapter 7's purpose is to help us transition from a necessity-based definition of work to a self-actualization-based definition of work. In other words, now that we have greater financial resources, we can move away from other-centered reasons for work (I work for the money, to put food on the table, to pay off my debts, to become CEO, to impress others, etc.), and we can begin to consider inner reasons for work (I work to make a difference in the world, to help others, to acquire specific skills, to be challenged).

Here's the insight: you simply cannot make this psychological transition while you're under financial pressure. And that's why so many people feel like they're locked into jobs that suck. (It's also why people lash out in the comments of many personal finance blogs.) But once you're no longer in a position of financial weakness, you can start to live life on your terms rather than on your employer's or anyone else's terms.

The Two Year Buffer
Now for some practical advice. Instead of getting overwhelmed by a huge long-term goal like financial independence or permanent freedom from work, I encourage readers to focus on an aggressive, interim goal like saving up enough money for two full years' worth of expenses. If you've already passed the two year milestone, feel free to pick the next largest increment that feels right to you--five years of expenses saved, seven years, ten years, whatever.

In time, you will come to consider a two year buffer a mere steppingstone on your journey towards financial independence. For now, though, this should be a highly motivating and extremely effective financial goal for many readers.

"Two years of expenses saved" is also a big psychological benchmark. It's enough dough to protect you over an extraordinarily long period of unemployment. It's plenty of money to support you through a significant career change, a long sabbatical, or a major rethinking of your professional goals. It could be enough capital to start a business, or at the least enough money to fund your expenses during your startup period.

For me, the two year buffer was an enormously important hurdle. Once I reached it, it completely transformed how I thought about work. I felt liberated to take more chances in the workplace. And I was far less bothered by objectively petty things like office politics or dickhead coworkers. Hey, once work is in its proper place, work-related stress falls into its proper place too.

Finally, and most importantly, hitting two years helped me begin to believe that I could take it much further, and it laid the groundwork for me to hit a three year buffer, a five year buffer, a ten year buffer and so on. [For more on this, see my controversial posts Extreme Savings and How Much Money Do I Need to Retire?]

Where are you in your process of redefining work? What are the concrete steps you intend to take to put work in its proper place in your life? Keep using this powerful book, and in a surprisingly short time, you'll begin putting a healthy mental and financial distance between you and the work you do.

One last word of caution: Life can be quite a bit easier, existentially speaking, when there's a boss telling you what to do and a job taking up the majority of your time. And it can also be easier to blow off your own goals, and instead adopt the default-option goals imposed upon you by your boss, your company, or by the socially conditioned people around you.

After all, once you remove work as the centerpiece of your identity, and once you stop acquiring stuff and striving after other peoples' goals, then what do you do? Once you've realized that those goals were illusory and false, what's left?

You've got to find your own goals. You've got to find your own purpose. In other words, there's a benefit and a drawback to putting work in its proper place. The benefit: it gives you the empowering opportunity to choose your own life path. The drawback: it can be lonely--even frightening--to think for yourself like this.

Which is why some people may decide it's easier to avoid thinking for yourself. It's easier to go back to being in the crowd: working, spending, and living out the goals everyone else seems to have. Those people will scurry back to their cubicles and their old way of life, and they'll try to forget they ever laid eyes on this dumb book.

But not my readers.

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Appendix/Side Thoughts:
1) Did we win the Industrial Revolution? A fascinating question from page 203. On one level, duh, of course we won it. Look at life expectancy data, look at diseases conquered, look at literacy rates, look at wealth and poverty statistics. Look at the long list of basic amenities that everyone in the developed world now has that were beyond the reach of the richest kings and queens two hundred years ago.

On the other hand, look at what we're doing with these miraculous blessings. Are we happier? Less materialistic? Less shallow as a culture? Are we living life on "our terms" any more now than we did then? Think about this for a few minutes and you can easily conclude we lost the Industrial Revolution. Badly.

2) Confusing consciousness with worry: Recall the anecdote on page 210 about the two doctors who were so "busy" that they couldn't imagine keeping track of their spending. Worse, they rationalized not keeping track because they didn't want to "worry" about where their money went. Confusing consciousness with worry is classic ego defense. Classic.

Remember, it takes laughably little time to execute the steps of YMOYL, and the process actually creates time--not to mention it also creates money, via the what gets measured gets controlled principle. Using a false rationalizations like "I don't want to worry about my money" actually costs you.

3) "Retirement security is no longer secure." There's a fallacy baked into this statement (on page 204), because it incorrectly assumes that retirement security ever was secure. Many workers today hearken back to the good old days when a company (supposedly) took care of them and gave them a pension and a gold watch after 30 years of service. My father, who was born in 1930, actually worked for a company that literally did give him a gold watch after 33 years. Well, it was a gold colored watch.

A couple of thoughts. Even back in the supposed good old days of our parents (or, depending on your generation, grandparents), when everybody walked uphill to school both ways, a surprisingly small percent of workers got traditional pensions. Sure, they were somewhat more common than they are now, but they were never that common. Second, how do you think those pension plans provided for those workers' retirement? They had to do the same thing you're doing now: invest in a conservative mix of stocks, bonds and cash-based investments [Edit: we'll have much more on this later]. Also, plenty of pension plans failed, had crappy investment performance, and so on. Third, you had to stay at the same company your whole working career. And fourth, you would have had no protection from the worst risk of all: That you'd work till you were 60-something, retire, and then die before you could enjoy your years of freedom.

Today, we're basically all treated like grownups. There are great ways to save for retirement (IRAs, 401(k) and 403(b) plans, and of course our own aggressive savings plans using YMOYL), but at the end of the day, the truth is the truth: we have to figure out a way to look after ourselves. There's no company that's going to play the "parent" role and take care of us.

4) How to get a high paying, high integrity job: This section, which starts on page 228, might be the weakest part of the entire book. Granted, the authors include a caveat saying "This chapter isn't designed to be a job-hunting manual." That's for darn sure. The advice is vague, with statements like "Finally you must be able to recognize when you have been successful in achieving your goal." This entire section should have been nuked.

5) Don't confuse reading this series with actually reading the book and doing the exercises: I've talked about this already, but it bears repeating. And repeating, and repeating. I do not want dilettantes reading this series. In fact that's one of the reasons why the first few posts in this series were so long: I wanted to scare away the lightweights! What I want here are readers who take action, not people who read the series, talk about it, and mistake that for taking action. This book will make a difference in your life, trust me. But you've actually got to put it into practice.

6) More books to add to the reading list: One of the pleasures of reading is how any given book can give you a ton of great ideas for your next book. This chapter contains a good list of titles I'll probably be reading in the coming months:

Amy Saltzman: Downshifting
Studs Terkel: Working
Arlie Russel Hochschild: The Time Bind
Michael Phillips: The Seven Laws of Money


Next Up: Chapter 8: The Crossover Point






How can I support Casual Kitchen?
If you enjoy reading Casual Kitchen, tell a friend and spread the word! You can also support me by purchasing items from Amazon.com via links on this site, or by linking to me or subscribing to my RSS feed. Finally, you can consider submitting this article, or any other article you particularly enjoyed here, to bookmarking sites like del.icio.us, digg or stumbleupon. Thank you for your support!

YMOYL Chapter 6: Valuing Your Life Energy By Minimizing Spending

Reminder for new readers: This is an in-depth, chapter by chapter review and analysis of the book Your Money Or Your Life that we're running throughout the month of January. Join us! You can buy YMOYL here, and you can find the first post in the series here.

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Meet your needs differently.

This is the central idea of Chapter 6 and one of the most important ideas in the entire book.

Are you the kind of person who's interested in truly creative solutions for managing your expenses? Can you determine honestly and objectively whether a purchase is a real need, or if that "need" is based on mere social conditioning or status seeking?

Can you look beyond that thing you think you want, and instead seek to satisfy the core need beneath that want? Do you even have to buy something to satisfy that core need? Very few of our needs are material.

Sincere YMOYL readers will systematically ask these questions about all of their expenses with one goal in mind: to get your costs down--way down--so you can accelerate your progress toward financial independence.

If at this point you're asking "How? How do I get my costs down?" that's for you to decide, and it depends on how creatively you choose to address this challenge. Are you the kind of person who demands money-saving tips to come to you, but then shoots most of them down? Or do you actively choose to seek out ideas to save money--and actually apply them? After all, tips and ideas are everywhere: the internet is filled with personal finance blogs offering advice and solutions on how to save more.

I think that might be one of the reasons the authors radically revised this chapter in the current edition. In older editions, Chapter 6 contained a huge 23-page section called "101 Sure Ways To Save Money" that was loaded with all kinds of specific money-saving tips. In the 2008 edition, they cut out that section and refocused the chapter on more thematic savings advice. After all, YMOYL is less about offering specific individualized advice and more about helping readers think differently. I'm guessing the authors would prefer to create enterprising, solution-minded readers who will seek out their own answers to getting their costs down. Teach a man to fish, in other words. It's implied that readers must seek out their own solutions for their own specific needs.

That one tip that sets you off
Of course, any list of ideas for saving money--it doesn't matter whether they're in "specific tip" form or "general theme" form--will have both hits and misses for any given reader. Some will resonate with you, some won't. Some will sound smart, some will sound stupid.

And some ideas will make some readers so angry that they'll literally give up on the book.

Laura and I have an acquaintance who literally quit reading YMOYL right here, in this chapter. Why? Because she stumbled onto a tip to cut your own hair, and for whatever reason, that tip literally set her off. She even wrote an angry email to me about it, saying she couldn't believe this book would suggest this--and no WAY was she ever, ever going to cut her own hair.

So she put the book down and stopped reading.

There are two layers of tragedy here. First (and worst) is how her reaction to a tiny (and irrelevant) part of the book caused her to reject the entire body of work. It shouldn't surprise readers that this acquaintance has made zero financial progress since. Which raises a personal question I'd like to ask readers: Do you really seek solutions as you work on your financial situation? Or are you waiting, just waiting, for the first sentence that pisses you off and gives you a "reason" to throw the book across the room?

The second layer of tragedy was that our acquaintance never attempted to explore her visceral reaction. Why did she put down the book? What was it about this specific tip that made her throw the baby out with the bathwater, that triggered her to spontaneously reject an entire ecology of insights on how to improve one's financial situation?

When you read something that makes you out-of-proportion mad (and money-related topics tend to do this to lots of us) it usually means you're scratching at some important inner truths. That trigger, that feeling, that emotion... there's almost always something there, if you're willing to explore it. There might be an insight into a problem, or a solution to a mental block, or you might have uncovered an unconscious mental script in your mind that's somehow holding you back. Dig, and find out what's going on there. I'm betting that mental script impacts other areas of your life too, and you'll be glad you uncovered it.

On impressing others: Let's spend a moment on the theme of impressing people, because it also has two layers: an obvious layer and a not-so-obvious layer.

As the book says, if you stop trying to impress other people, you will save thousands, perhaps millions, of dollars. Obvious. And yet when I look back on my Wall Street career, I can think of many, many well-educated, thoughtful and extremely bright people who spent enormous amounts of money impressing others.

Why? Well, in most cases they somehow managed to convince themselves they weren't trying to impress other people--while they bought stuff to impress other people.

Which takes us to the not-so-obvious part. Your ego will always try to convince you that you never try to impress people. After all, that's something only an insecure person would do. You (it will reassuringly tell you) being the confident and highly self-aware person that you are, would never do anything that shallow. Right? Right?? Yep, that's your ego talking.

Self-aware Porsche owner (photo by Michael Goldsman).

Your ego, which understandably wants you to have a good self-image, will therefore work very hard to convince you that you need that gazingus pin. Or Lamborghini. Remember this the next time you try and tell yourself you're not trying to impress others.

A final word before we get to the Appendix/Side Thoughts. I'd love to hear your creative and unusual ideas to save money as you work through this book. I'm looking for all kinds of ideas, because you never know what might help--or set off!--another reader who reads this series in the future. It could be anything: how you eliminated your car and started using Zipcar, ways you've creatively reduced your housing costs, creative bartering or job-exchanging arrangements with friends or neighbors, how you rethought family entertainment, baby-sitting, how you used Couchsurfing on your last vacation, and so on.

If you've got a creative idea from your life that's lowered your expenses and helped you meet your needs differently, share it in the comments!

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Appendix/Side Thoughts:
1) Finding "quick wins" for saving money: There's no reason getting your costs down has to be unnecessarily difficult, so start by looking for steps you can take quickly and efficiently. Better yet, look for steps that serve you in multiple ways. A few examples: reducing the amount of meat in your diet, and you'll improve your health and save money on food. Using an inexpensive bicycle can help you save on gas, commuting costs, gym memberships and future medical bills. Buying a smaller home will save you tens (or hey, hundreds) of thousands of dollars on mortgage costs, energy costs and taxes. And so on.

2) On insurance: I could easily write a full post on insurance [Edit: hey, I did write a full post on insurance!], but for now, let me just make this point: As you get out of debt and on your way towards financial independence, you will find you don't need the insurance you thought you did. Once you have several thousand--or even tens of thousands--of dollars sitting in the bank, you will be able to significantly increase your deductibles on things like auto and health insurance. This saves you hundreds or even thousands of dollars of per year in insurance premiums.

You'll also increasingly realize you don't even need to insure for many types of losses. Now that you're flush with liquidity--thanks to all the money you're regularly saving--what used to be a "catastrophic" loss simply isn't that catastrophic anymore. (PS: For more on this, I recommend Charles Givens' excellent books Wealth Without Risk and More Wealth Without Risk.)

3) Apply the "wear it out" concept to big-ticket items and save boatloads of money: Wearing a shirt for 30% longer might save you a few bucks, which is nice but not meaningful. But driving a car 30% longer (or heck, 100% longer) can drive gigantic financial results. Get your big ticket decisions done right and the smaller expenses don't matter so much.

4) Impulse purchases: According to the book, half of our purchases are spur of the moment (PS: I've found this clearly holds true with grocery shopping). This is awesome, because it opens up an enormous savings opportunity: by applying just a few minor techniques to minimize impulse-related purchases, you can slash your spending in half. This tip is a lot less obvious than it sounds.

5) Cost of children: There's a consensus out there that child-rearing simply has to be insanely expensive, which is one of the reasons behind this well-known joke about kids:

Q: How much money does it take to raise children?
A: All of it.

And yet if there's one thing my years on Wall Street taught me, it's that the consensus is often wrong. Often grievously wrong. With that in mind, I found it particularly interesting to read (on page 189) about how one couple applied the Fulfillment Curve to save tons of money on gift-giving for their children. Granted, Laura and I don't have kids, so I'm clearly out of my depth here--but I'd love to hear readers' views and ideas on creative ways to save money when raising children. And don't tell me there's no solutions out there.

6) Gift-giving: One more thought on gifts: one of the greatest days of my life was when my family changed our holiday gift-giving routine from "everybody buys everybody a gift" to "we put all our names in a hat and each person draws one name."

Instantly, Christmas became one tenth as expensive and a million times less stressful. Recently, we took it one step further and dispensed with gifts altogether. Hey, the holidays aren't about gifts, they're about getting together with loved ones. Why not focus on that? What does your family do about gift-giving during holiday time?

7) On environmental stewardship and saving money: It goes without saying that the less you can consume, the better it is for the environment. From page 193:

Anything you buy and don't use, anything you throw away, anything you consume and don't enjoy is money down the drain, wasting your life energy and wasting the finite resources of the planet.

That said, don't let your concern for the environment make you into an easy mark for marketers. Keep in mind that "green" is slowly but surely being twisted into another aspirational market segment designed to persuade you to spend more money. Don't be deceived: Should I buy a new one? is the wrong question. Do I need to buy this at all? is the correct question to ask.

8) "I'm enoughing" I love this expression and I'm going to start using it. Honey, I'm not going to buy that Fabergé Egg after all. I'm enoughing.

9) Lateral Thinking: One more book recommendation: Lateral Thinking: Creativity Step by Step by Edward De Bono. This book has heavily influenced my thinking on brainstorming, idea generation and looking at problems in different ways. Most of the ideas I've dreamed up on how to "meet my needs differently" have come from using principles in De Bono's book.


Next Week: Chapter 7: Redefining Work











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