Why Conventional Wisdom On Following A Budget Is Wrong And How To Manage Your Money Better

The Case Against Following A Budget
Following A Budget Is Not The Path To Financial Independence

The conventional financial advice you get from mainstream sources is to keep a strict budget of your monthly income. That advice is wrong. This can actually hinder you from achieving financial independence. If you look at how large companies manage budgets, you will see how flawed the idea really is.

 

Budgets In Large Companies:

Large companies have many departments and determine what the operating budgets of these departments should be for the year.

Where I worked, in the Engineering Department, we might have had a budget of $100 million for the year. This was a publicly traded company so the people who were responsible for the budget in our department weren’t actually spending their own money. They were spending the company’s money. Their only concern was that they didn’t go over the budget because it will affect their yearly bonus. But what happens to them if they are significantly under budget at the end of the year? Does the company give them a bigger bonus or a cut of the money they saved? No, of course not. In fact, if they are under budget at the end of the year, the company will give them less money for their budget next year figuring they gave them too much last year. So what does the budget manager do if he knows that he will come in under budget? He goes on a spending spree in the last few days of the year.

In our case that usually meant buying equipment for jobs that we might have next year or even just buying rooms full of laptops or anything else that we may need next year or down the road. After all, it’s free money right? Use it or lose it. It’s actually worse than that because if he doesn’t use it all, he gets less to use next year. Now, does this sound logical to you? It doesn’t to me but, based on the consequences of coming under budget, that is what it leads the budget manager to do. It’s not his money so it’s like having a bunch of money that expires on December 31.

Now think about what would happen to the extra budget money if this was a small company privately owned by the founder. Would he blow that extra money just so that he doesn’t under spend the budget? No, because it’s his money, and anything he saves by under spending the budget goes right into his pocket! This is how you should think of your own finances.

 

Personal Budgets:

The mainstream financial advice is that you allocate your  monthly income into a budget. If this advice is so good though, how come most people live paycheck to paycheck and are nowhere near being financially independent? It’s because keeping a budget is artificial and causes you to spend money you would not normally spend just like the manager in a large company that buys things he doesn’t need just because he is under budget.

Most people budget for categories that they think they need or are told they should budget for like restaurants, clothes, entertainment, car payment etc. When they are finished with their budget, they come out with $0 at the end of the month. Now, they may budget some money for savings but it is usually a small amount. So with a budget like this, if you allocate $300 a month for restaurants, but at the end of the month you only spent $100 on restaurants, what are you going to do? You will most likely go out and make sure you spend that other $200 at a restaurant right?

You see how keeping a budget makes you spend some artificial  predetermined amount? It also keeps you in the mindset that you need to spend money on these things every month. What you should do is start from the idea that you will try to save as much as you can every month and only spend on things you actually need or want within reason. If you need some new clothes this month then buy it, but if you don’t need any next month there is no reason you should have a budget item that forces you to buy more clothes. Save that money instead. This gets you into the mindset that saving and investing the money you worked for is more important than some of the things that you would normally buy. It makes you think twice about if you really need it. If you do this, you will eventually find that some of the things you thought you needed are not really that important.

Try to think like the owner of a private business. Every dollar you don’t spend adds to your wealth. Remember, for every year of expenses you save, you can stop working one year earlier.

Why Reward Card Churning Is Not Worth It And What To Do Instead

 

This steam punk mechanical display in Kiev, Ukraine is an approximation of what it feels like trying to keep track of reward card churning.

If you want to save a lot of wasted time and aggravation, then take my word for it when I say reward card churning is not worth it. It seems that everywhere you look there is a blog bragging about how many first class flights they flew and how many free nights they spent in a five star hotel in some exotic location just by exploiting this “Little Trick” or by sharing with you “The Secret The Credit Card Companies Don’t Want You To Know”. It sounds exciting doesn’t it? Who knew that credit card companies are eager to foot the bill for people to travel the world in luxury? Hmmm, how do credit card companies stay in business if they are just handing out all this free stuff to anyone who asks? Who cares how they do it, I just want to sign up now before they close the loophole and I have to go back to flying standing room only on Ryanair and sleeping in one of ten bunk beds in a one room hostel with 20 other practically homeless backpackers.

The Dream

The dream that they are all trying to sell is that by signing up for the right reward credit cards and receiving the signing bonus miles or points, you will get free or extremely discounted travel. They take it a few steps further and give you some scenarios of which reward cards are best for you according to your needs. Even if you don’t travel there are still cards for you where you can get all kinds of merchandise with your points. By this point some people may be skeptical, remembering the last time they thought they were getting something for nothing and how that turned out. What about the yearly fees? Oh, you can just cancel the card before the year is up and go on to the next card and big sign up bonus. A few websites will even help you keep track of what you can redeem your points for on different airlines, hotels and stores. All you have to do is click on this convenient link, sign up for this credit card, and spend $1000 or so in the first three months and you are on your way to hobnobbing with the likes of Sir Richard Branson at the finest travel destinations in the world.

The Reality

Credit card companies are like casinos in that the house always wins and you will never see a fifty story hotel built on the Vegas Strip from the winnings of some blackjack player with a “system”. I’m sure from analyzing their customers’ behavior, they know that they will come out ahead because most people will eventually forget or not be able to pay their monthly bill in full and then the 15-20% interest kicks in. Even assuming you will always pay your bill in full and avoid any finance charges, you still have the yearly fees to pay. Now some will argue that it is still worth it if you get more value from the points than you pay in the yearly fee. This may be true in some cases, like if you spend a lot per year, but when you are juggling multiple cards, the yearly fees can add up to a lot of money.

In my mind, the biggest reason not follow these schemes is that the time you have to invest and the benefit you receive is just not worth it. Have you ever tried to figure out which types of points are accepted or compatible with which companies? Once you spend hours figuring that out, you then have to spend more hours trying to find a flight or hotel that you can use the points on. To make matters worse, the rules and values for the points are always changing and they also devalue your points like American Airlines did not too long ago. The end result is that you now have an unpaid full time job as a lawyer trying to figure out all these programs and how to best redeem your points before they expire or are devalued.

So if reward card churning is not worth it or profitable for the average person, why are so many blogs pushing it as a viable strategy for everyone? Probably because they get $100 to $200 or more when people sign up through the link on their blog. So the reality is that these bloggers get a lot more money out of getting you to sign up for credit cards than they do for any of their reward card churning schemes that they try to glamorize.

So Should I Swear Off Of Credit Cards?

No. To me, the simplest deal with the least hassle is getting a no fee credit card with cash back. That way you are not forced to buy your flight or book your hotel room from that specific company. Usually you can find much better deals for where you want to go or stay just by searching a travel website like Kayak.

Here is an example :

I plan on going to Europe this summer. I have about 70,000 miles from an airline reward card that I had yet I could not find a flight for those miles even though I searched many different dates and even cities all over Europe. This took a lot of time to do and the end result was that I did not have enough miles. I also set up searches on Kayak for flights to Europe that show up in my email a few times a week. I eventually got a ticket to Spain for only $370 on another carrier. The carrier that I have my miles with charges about twice the price for the same flight. So why should I be boxed in with one company when I can pay cash to the most competitive company?

Let’s look at the actual numbers:

New York City, US to Madrid, Spain

Traveling from mid June to late July using the exact same dates for all three examples.

1 Stop Flight

Option # 1:

80,000 Miles + $50 fee or $622 cash without using miles

So I have to spend $80,000 to get a ticket worth $622 meaning I get $622/80,000 = $.0078 for every dollar spent

Non-Stop Flights

Option # 2:

125,000 Miles + $50 fee or $672 cash without using miles

So I have to spend $125,000 to get a ticket worth $672 meaning I get $672/125,000 = $.0054 for every dollar spent

Option # 3:

$370 cash on a competing airline. Since I know that I already get $.02 for every dollar spent, I only have to spend $370/$.02 = $18,500 to buy this ticket with my cash back money.

As you can see, it takes a lot more spending to buy a ticket on one of the airline miles cards than it does with a cash back card in most cases. Even if you account for sign up bonuses and other ways of accumulating miles without spending, you are still paying more and your choices are limited to dealing only with that airline and their partners. It’s kind of like going to a concert or the airport and finding out that a bottle of water is $4. Why is it so expensive when you can buy the same water a few blocks away for $1? It’s because you are captive in their venue and they control the price without any competition.

So What Card Should I Get?

Well, if you already have a bunch of cards, maybe you shouldn’t get any new cards. The card I use for everything is the Fidelity 2% cash back card. Fidelity offers a 2% cash back Visa card on everything if you have a brokerage account with them. It gets deposited right into your brokerage account. You can spend your money when and where you want to spend it with no black out dates or expiration of your rewards. There are other cash back cards out there. Do a little research, pick the best one for you, then figure out what you will do with all of this newly found time that you are not wasting with reward card churning.

(I am not affiliated with Fidelity or any other company mentioned in this article, nor do I receive anything for writing about them).

 

 

 

 

What Can A Billion Dollars Buy You? Not Much

A billion dollars can not buy you much

 

When people daydream about being rich, they believe that if they had a billion dollars, they could buy anything they wanted. What they don’t realize is that they can already buy pretty much what they want.

There is a saying: “Money isn’t everything, unless you don’t have any”.  But what if you have more money than you could ever spend? What can a billion dollars buy you that mere millionaires or thousandaires can’t buy? Even if billionaires can buy things that mere mortals can’t buy, is the quality worth the price or do they just spend one hundred or one thousand times the normal price of something just so they can feel special? Let’s take a look at the things they buy and compare them to what an average middle class person has to settle for:

     Housing:  Billionaires often have very large and maybe many houses in different places.  Sometimes you hear about their houses on those lifestyle shows. Often you hear that someone has a house with thirty bedrooms and thirty eight bathrooms. Besides the obvious questions about why they have more bathrooms than bedrooms, do they ever really sleep in more than one bedroom? I can only sleep in one bed at night. So the only thing better about their house is maybe the quality of materials and the number of rooms and square footage. With that comes the requirement to have a staff to maintain the garden, pool, cleaning etc. Their money does not buy them a bed that somehow let’s you sleep for five minutes yet gives you the equivalent of eight hours of rest. So they get the same thing the average person gets except it is bigger with more expensive materials.  Even middle class people have Mcmansions with more rooms than they use so this is not that exclusive.

     Cars:  Most billionaires are not really into cars except maybe a few nice cars to drive or be driven around. Let’s use the example of billionaires who really are into exotic cars. What can they buy that the average person can’t?  Well they can buy a Bugatti Veyron for over a million dollars and about 1000 horsepower.  It can do zero to sixty in a probably 3 seconds and probably tops out at 200 MPH. Forget about the fact that they are never in a big enough hurry that the zero to sixty time will make a difference, or that they will never get it close to 200 MPH unless they are on a closed track, the car does nothing special. It still has four wheels a seat and a steering wheel. It doesn’t have an anti-matter engine  and it doesn’t fly. It is not that much better performance wise than a $60K Corvette or BMW.  Surely it is not twenty times better as the price suggests.

     Food:  Yes, they can buy the finest food, but so can you. Maybe you can’t afford to spend $200 every day in a restaurant on steaks that cost $15 in the supermarket, but you can still eat very well and very healthy if you chose to. Also, just because they can buy the finest filet mignon and lobster, they can’t  eat it every day or eat unlimited amounts because there is only so much you can eat of those types of foods before it severely affects your health. Billionaires can also buy the finest wine, but you also can’t drink unlimited amounts of that either. Most people can’t tell the difference between $20 wine and $200 wine anyway.

     Travel:  Here is a secret most people don’t realize: billionaires can only buy private planes that fly as fast as regular commercial planes. No matter how much you are willing to spend, you still have to fly at the normal speed to your destination. There is no such thing as walking through a portal in New York and two seconds later walking out of a portal in Singapore.

I could go on about things like jewelry, art, vacations, education, etc, but the conclusion will still be the same.  There is nothing new under the sun. Whatever a billionaire can buy, most people can buy the same thing that functions the same way. And no matter how much money you have, you cannot buy more time.

Brexit vs. Bremain: The Danger Of Following What Everyone “Knows” To Be True

It is a few minutes past midnight on Friday June 24, 2016. The news all over the internet and the T.V. is that the vote on whether the UK should leave EU is now confirmed, and the “Leave” has won over the “Remain”. Is this a big deal? Well if the reaction in the financial markets is any indication, the yes, it is a really big deal. But I don’t live in the UK, so why does it matter to me in the US? Well for one thing, the S&P 500 futures were down about 100 points, or about 600 points down on the Dow. The British Pound against the US Dollar is lower than it has been since 1985 they are saying on CNBC. Asian and European markets are all down heavily. Gold is up about 6%. Okay, so I just gave you the run down at this instance in time of some of the global markets, so what does that prove?

Well in the last week or so, it was “common knowledge” that the UK would remain in the EU. This “fact” was so well known that most of the smartest investors have been bidding up the British Pound and the US markets because it was a foregone conclusion. What we are seeing now is that when everyone seems to know something as obvious, it is not always so. Also, when something is obvious there is not much money to be made because everyone is already on board. The bigger risk is in the opposite happening.

Here are some more obvious truths from the past:

1989 The Nikkei in Japan is almost at 40,000 and land in Tokyo is so expensive that a $100 US Dollar bill cannot buy the land that it covers if you laid it down on the ground in Tokyo. What did everyone “know” at this time? Everyone knew that Japan would take over the world and every MBA better learn Japanese and they are not making any new land in Tokyo.

1999 NASDAQ is at 5,000. Everyone “knows” that tech and the internet are the wave of the future and that dividend stocks are worthless because the biggest gains come from growth stocks.

2006 The US National Housing Price Index has never gone down on a national level, so naturally it never will. Everyone “knows”, after talking to a real estate agent, that you should buy more house than you can afford because it will be 20% higher next year. It’s even a better idea to lie about how much you earn and get an adjustable rate mortgage because even if the loan resets higher than you can afford, you can just sell the house and lock in those sweet profits.

2016 The year is not over yet, but what does everyone “know”? They all know that the key to early retirement is to put all your money in a low cost index fund because the stock market always goes up for as far back as I can remember (which is 2010).

The point I’m trying to make is that the so called experts are often wrong. I can be wrong, and you can be wrong so why put all your eggs in one basket? If you owned only a diversified basket of stocks, you would still be down a lot because when markets go down everything becomes highly correlated. If you owned some stocks, some bonds, some real estate, and some gold, you would not be as exposed to being wrong on one idea or asset class. This also goes for where you keep those assets. If everything you own is in one country that is the same as betting all your money on one idea.  Yes, I “know” betting against the US has been a losing proposition, but I also remember when it was common knowledge that US stocks returned 14% over the long term. Now it seems that it’s common knowledge that dumping all your money into an index fund no matter how high the market is will get you 6% over the long term.

Here is a quote from a very good book about manias and bubbles:

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one.”

Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay