“Should I feel guilty when spending money?” It’s a common question when I consult with clients. They are so tuned into frugality they sometimes start associating negative feelings with money. It’s a bad thing to start feeling.
Spending money is NOT an evil activity! In modern society we have it so easy that we tend to either overspend (the vast majority) or become hyper-frugal (a significant percentage of the demographic reading this blog). Both lifestyles are unhealthy. Overspending leads to serious problems when the bills come due and income might not keep up. Debt is a serious issue I ask clients (and readers) to consider purging. The opposite of overspending is the hyper-frugal drive. This can suck the pleasure out of life as fast as a heavy debt burden.
I tend toward the frugal side of the equation and get called out on it periodically, too. Sometimes I do things just because it’s the cheaper choice. If I were as smart as I think I am I would reconsider such decision-making. Frugal isn’t always the best answer.
Frugality for me is more about my hate for shopping. When I spend I know exactly what I want and side purchases are never a distraction.
Buying a good or service feels good even for a frugal accountant like me. I needed a longer breaker bar (torque bar) to get the lug nuts off a tractor tire so I can take it in for repair. The breaker bar I have is only 14 inches; the one I bought is 30. By the time you read this I might have that tire off with my new piece of equipment. Yes, I’ll save money on a service call by getting the tire to the shop, but it still feels kind of good knowing I have a shiny new tool in the garage.
But spending is a problem for many people. Frugality is a forced habit at best for the majority. Economically enforced austerity gives way to bad spending habits when normalcy returns. The cycle is familiar and we know it while we do it. If only we could stop.
Since most people enjoy spending money I thought I’d share 5 ways you should spend because this kind of spending makes you richer. In fact, if you don’t adopt these spending habits I outline below you will suffer serious personal finance issues. Those who have money will realize they were already spending this way. For the rest of you, please come along. I’m going to show how you will want to spend that money burning a hole in your pocket.
This may sound like common sense, but too many people defer spending to their detriment. Every so often you should change the oil in the car. It runs better and lasts longer when you do. When the roof needs replacement frugality is not your friend. The structural damage follows shortly after and gets very expensive. Then you get to spend a lot of money for no additional value. That is not a good spending habit.
Do-it-yourself (DIY) projects are a good opportunity to spend. One of the cables broke on my garage door recently. I bought new cables and discovered I didn’t have tools or the recommended bars to loosen and tighten the spring. I broke down a bought a pair (you need two) to finish the job. Now I need to keep them safe for a distant future event when I need to work on a garage door again. The cost was only $15, but it is spending. The spending saved me the cost of a service call which would have been significantly more. Some spending is good spending and increases your wealth.
The same situation occurred at the office this summer when I wanted to do some light landscaping. The place really needed it. Clients have a better opinion of an establishment with appealing décor. I acquired several quotes which all came in over $10,000. (And it wasn’t that big of a job!) I decided to do the job in-house. The cost of dirt and river rock and some seed money for some extra helping hands was under $2,000. I have several huge rolls of felt in the barn I used and unused treated fence posts from a previous farm project so that cost nothing extra. In the end I spent a couple thousand, assuaging my spending itch, and created over $10,000 in value; more if you count the added business an attractive building can bring in.
Maintenance and DIY projects are a perfect way to spend money in a way that creates value. If I would have written a check for $10,000 to landscape the office it wouldn’t have felt as good. I got the satisfaction of a job well done and the opportunity to order 10 yards of top soil and two orders of river rock. There were multiple spending opportunities for the same job. For people with an itch to spend, this might be a good way to kill two birds with one stone.
Pay Down Debt
I’ve preached this line often before. Loan payments are not completely new spending. The interest is, but it doesn’t feel like fun spending. You get nothing for the interest spending: no pretty baubles or service or vacation. Nothing. Your wealth just disappears.
The act of spending is addicting to many. Rather than spend on more stuff and putting it on the credit card at 18%, consider tricking your brain into spending the right way. Here is what I propose. Spending is about wanting something. Some people enjoy the shopping experience. Either way, turn these desires into a wealth creating machine. For the shopping addict, lay out all your debt and obsessively review your balances. Create an aggressive spending payoff habit. Set your payments up on automatic, but also send in extra whenever an extra nickel crosses your path. Turn it into a game! Have fun with this. Instead of building debt, turn debt elimination into an exciting adventure.
If shopping doesn’t trip your trigger then you probably spend just to have something new. I have something shiny and new you’re going to want: a debt free balance sheet! I mean it. Instead of a new boat, roll up your sleeves and butcher those bills. Remember, it is easier to enjoy a new toy when you don’t have to work to pay off the toy, plus interest.
Once you pay down debt you might be tempted to return to old habits which caused the financial problems. I say, “Nyet!”
The newfound habit you used to eliminate debt is a good behavior for proper future spending habits. Turn investing into an automatic wealth creating machine. Automating investing doesn’t always satisfy the itch to spend. There is a solution.
It may be hard to believe, but there was a time when I enjoyed spending a bit more than I tend to nowadays. Money was rolling in and times were good in the 1990s. I was smart enough to know good times don’t last forever so I devised a plan to satiate my spending desires with intelligent cash allocation.
Tax season was always a good time of year. My mutual funds were automated, but I needed a home for my excess cash so I wouldn’t be tempted to spend it. My solution: dividend re-investment plans (DRIPs). I wrote checks to all my DRIPs. It gave me great pleasure to finish my day with a spending splurge. I’d write a check to JNJ, Aflac, Phillip Morris, Wrigley (damn you, Warren) and more. As fast as it came in I sent it out. I don’t know what you spend your money on, but I have a nasty habit of buying as much stock as I can get my hands on. For the record, it’s a good habit to have.
DRIPs aren’t what they used to be. Brokerage accounts generally automate re-investment of dividends and many DRIPs now have fees. There is still a solution. Set a minimum amount you can easily invest every month. Automate the process. Then either write a check every time money comes in or log in and set up a transfer. Trust me, you’ll have so much fun spending on your index fund. The best part? Instead of paying interest on your purchase you’ll be paid dividends instead. Oh, the joy!
Turn investing into a game. Real wealth creation is built on the proper allocation of capital. The bank is fine for short-term and emergency funds. But your serious money needs to be working hard building a better world and the only way to do that is to own a piece of great businesses.
Another spending game to consider is investing funds you planned on spending foolishly. Excessive dining out or drinking in bars can be swapped out for an index fund investment. I’m not telling you to forgo a pleasurable life. God forbid! All I’m suggesting is that you switch some consumer spending for investment spending. And besides, you know as well as I you will enjoy those dividend checks more than interest payments.
If you have an itch to spend, income properties are for you. Many moons ago I owned a city of real estate in my portfolio. From personal experience I can attest you get plenty of spending opportunities when you own real estate.
Your primary residence is different from income property. Money you spend on your primary residence (or second home) comes from another source and can run dry. Income properties have—wait for it—their own income stream to fund expenses. If you have a serious spending itch, real estate done properly can scratch that itch raw.
You still need to buy properties right! Stupid income property purchases will force really bad spending even when you discover how bad the spending is and want to stop. Sometimes you can’t. But a small portfolio of investment property can give you plenty of opportunity to shop and buy. Researching the right property should be a priority. Once you own the property there are always things that need to be paid for: property taxes, utilities, insurance, repairs and maintenance. A property manager can do all this for you, but you can write the check yourself if you insist. Even still, you can review your monthly statement from the manger which will show all the spending. It should serve as a powerful ointment for your spending itch.
Small Business/Side Hustle
Okay, hustlers! Nothing beats spending opportunities than a small business or side gig. Even a frugal guy like me still manages many hundreds of thousands of dollars in annual spending just by owning a small accounting practice. Every two weeks payday comes around and I get ample reminders on how to spend my money.
A side gig or business is an easy way to alleviate the desire to spend. Maybe too easy. While I can brag I spend $250,000 in my business, it needs to be brought into perspective. I’ve seen too many people over the years start a business, spending like mad to get it up and running. It soon becomes apparent my client isn’t ever going to make a sale. He’s going to keep spending until he’s broke without ever actually starting the business. Then he asks if it’s deductible. (Not if it was a hobby or you treated it as such.)
Still, business owners are spending daily. At home my wallet has moths. At the office money is moving constantly. Office supplies are replenished, utilities are paid, property taxes come due, employees get paid, IT needs money. The list goes on and on. A frugal habit goes a long way toward profitability in a business. It’s easy to spend; not so easy to bring it in.
Spending/shopping addiction is a serious problem with many consequences. Shopping is a waste of time compared to time spent with family and friends. Shopping has its place as long as it doesn’t rise to addiction. Business has a natural built-in need to allocate money. If you can run a “real” business or side hustle you have my blessing. Before long you will lose that desire to spend. Take it from a three decade business owner. Spending gets old real fast when it becomes a job. (You know; a job. That thing you want to take early retirement from.)
Spending in and of itself is not wrong! Overspending is a bad habit and even a sickness. Excessive frugality is a bit of a sickness too. Careful readers may have noticed that from a certain unnamed accountant over the past few years.
I’m not here to tell you to never spend. What I want for you, kind readers, is a healthy relationship with money and spending. Reducing debt to background noise is important. Investing for your future and that of your family is imperative.
Spending easily becomes a job! Money is a powerful tool to help you live a quality life. Too much or too little is a problem. Using the 5 ways to spend listed above will make you wealthier. That is what we are about around here: quality of life which is the true meaning of wealth.
Finally, can you do me a favor? If you think this is as important as I do, go back to the top of this post and use the buttons to share on social media. You can pin the placards to Pinterest, as well. Help me spread the word. Let’s make the world a better place where people control their spending and build powerful, nurturing money habits.
More Wealth Building Resources
Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?
Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.
Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.
QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.
A cost segregation study can save $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.
Yesterday was April Fools’ Day; it was also Easter. I couldn’t bring myself to pull a prank on the day celebrated by Christians of Jesus’ resurrection. But today is fair game!
To lighten the mood as your favorite accountant traverses the bowels of the late stages of the current tax season I decided to publish something fun. (Well, it was fun to me.) Be forewarned. After two months of sleep deprivation there is something seriously wrong with my head. While I think this is funny, you may not. Of course this doesn’t belong published on a personal finance blog. That’s why I published it.
Have fun with this, kind readers. The tax season finish line rapidly approaches. Nothing scares the bejesus out of you like the mind of a stressed accountant. That’s why it’s so entertaining!
If you pay careful attention you might find a few hidden gems you can secretly use yourself to save money. I won’t say a thing if you don’t.
- One Sheet of Toilet Paper per Event
Sheryl Crow popularized this awesome method to reduce bathroom waste. Not only do you save money, you defend the environment. Considering what TP is used for, limiting TP use might be the least of Mother Nature’s concerns. Mass extinctions have started over less traumatic events.
Once word spread, Crow backtracked on her original recommendation. I’m not buying it! Crow is a one sheet of TP per episode type of girl. I can see it in her eyes. I fully endorse this time honored way to reduce spending by implementing this practice in my household. My team isn’t nearly as psyched as I am. Might need a motivational rally.
- One Set of Clothing When You Travel
I ran across this several times now. If I ever hit my head and decide to take up world travel I’m going to use this idea. As a light packer when on the road this idea resonates with me.
The process is simple. You only need one or two sets of cloths when on the road. You shower with your clothes on, lathering up and rinsing off without the hassle of undressing and dressing! After walking around for half an hour your clothes are dry anyway, except in the tropics where if you started with dry clothes they’d be wet within a half hour.
Think of all the luggage fees you don’t have to pay anymore.
- Steal Hotel Soap
Sure, your moral compass makes this sound horrible, but stick with me. I personally keep partially used hotel soap. Why waste a good product! The goal here is to outright steal the stuff or keep using every bar of soap at least once so your conscientious is soothed. Either way, you can save $3, maybe $4, every year with this one simple habit.
Remember, it’s easier to ask for forgiveness if caught than to ask for permission.
- Don’t Change/Launder Your Clothes
Before you retch, hear me out. We all know people wear clothes longer between washes as they age. Heck, grandpa wore the same sweater for 22 years before it disintegrated off his back! As a responsible blogger I will NOT ask you to go that far.
What I’m suggesting is a planned attack on laundry. If the shirt or pants you wore today isn’t visibly dirty put it to the side for a day or two and wear it to work again. (Don’t wear the same thing to work for a week straight. Co-workers will notice and file a complaint. Yes, I know the smell is all in their head, but who needs the hassle.)
Underwear and socks are another issue. I always go for the sniff test. It’s important you do this right. You can’t just pull off your shorts and bury your face in them (as much fun as that sounds). Walk outside to acclimate your olfactory nerves to freshness before returning to undertake the sniff test. (Note: put on another set of clothes before walking around outside. I’m sure I didn’t need to say that except for maybe 20% or so of readers. If you get arrested for indecent exposure I’m not bailing you out.)
Guys, don’t do the underwear/socks sniff test in front of the wife and kids. Dad, let mom handle her own sniff tests. (I warned you at the outset this would cross the line. You, of your own free will, traveled this far. Don’t blame me.)
The few simple steps outlined here should cut laundering expenses 80% or more in most Western households.
- Cut Your Own Wood and Cook Outside
I joke I cut my own wood and cook meals outside as soon as weather permits here on the family farm in NE Wisconsin. My 10 acres of the world has enough trees to keep the stove hot all summer.
Country living makes it easier for me. City living still has opportunities for people willing to think outside the box. Let’s just say every city I’ve ever been to has a t least one park with trees. Need I say more?
If the cops show up you didn’t hear it from me.
- Free Hot Water for Showers All Summer
This frugal idea is an itch I want to scratch so bad it hurts. The concept is simple. Buy a couple hundred feet of black garden hose and place it on the roof of your house. A few strategically placed nails should allow you to spread the hose out for full exposure to the afternoon sun without the hose coming off the roof.
I was this close to using this money-saver when I had calves. I could have used the God-given hot water to mix the milk replacer for the little guys. Mrs. Accountant caught me with the ladder and the whole plan crashed to the ground.
Summer is once again approaching. Late afternoon hot showers are on the menu. (If Mrs. Accountant doesn’t catch wind of my little plan.)
- Reusable Toilet Paper
Before anyone says a word, this is a real thing! They (whoever “they” are) call it “family cloth” and you can buy it on Amazon. Once again we have an opportunity to save the environment and money!
Now I know what you’re thinking, my frugal friends. You think I added an Amazon link to these reusable butt wipers to cash in on the craze. And you’re right. I don’t expect to see sales for any of these things, but if I do I’m calling you out. Got it?
- Don’t Flush Until It’s Full
Remember grandpa again. He always said, “If it’s yellow, let it mellow; if it’s brown, flush it down.” It’s a time honored practice preserving the family budget since Julius Caesar took over in Rome. Don’t go against a tried and true method of frugality.
I’ll let you decide when to use the little lever on the side of the toilet.
- Get a Gym Membership so you don’t have to Shower at Home Ever Again
This one is just plain stupid, as George Carlin would say. Why else would you have a membership? To work out! Really! If I wanted to work I’d get a job. I belong to the gym for the steam room, fellowship (because I don’t attend church as much as I should) and the free showers.
I’m not going to say I never shower at home, but it’s rare. I visit the gym three or four times a week and shower when I’m done steaming, ah, working out. Every time! This saves on the water bill and the cost of heating the water. Smart people like me is why so many gyms go out of business after a few years. Hey! Don’t blame me. They signed the contract too.
- Don’t Wash Your Hands after Using the Bathroom
Speaking of George Carlin, I’m not alone when I don’t shower every day or not washing my hands after every visit to the restroom. Check out the YouTube link of George explaining when you should and should not wash your hands. It makes perfect sense to me. (I wash after every bathroom visit, for anyone wondering.)
Bonus: Eat Your Pets
As I researched this post I found a few really neat ideas to save money I haven’t used to date. This one really resonated because I’ve done it!
You see, growing up on a farm we understood the value of treating our animals right. Then, after an appropriate amount of time we ate them. You call it hamburger; we called it Blackie or Bess. You call it a chicken wing; we called her Cluck.
Rabbits and other critters graced the menu periodically, too. I wanted to finish this post with an antidote about eating the family cat, but due the rude description in my notes Mrs. Accountant used her veto power to prevent me from sharing that frugal idea with you. You’ll have to figure it out on your own. If you’re as frugal as I think you are you’ll know what to do.
Okay, before I sign off I want to reiterate this is all fun and games. No animals were hurt in the production of this post. Tax season is wearing me down and I’m not normal anymore. My publishing schedule will be lighter until the finish line. Details are available on the Where Am I page.
I also promise to get serious, too. No more pu—, ah, cat jokes.
Twin brothers walk into the Wealthy Accountant’s office. One brother is as smart as a whip with an IQ of 147 and a wiz with numbers. The other twin, while looking identical to his brother, is a bit short in the mental category. The less bright brother is hard working, but knows he can’t outthink his twin brother.
Which twin do you think has the greatest financial advantage? Which one is likely to become a millionaire?
Would you believe me if I told you the super-smart twin is orders of magnitude less likely to amass a financial fortune? Yet time and time again I see it in my office: smart people underperforming and average people hitting it out of the park.
Here’s the funny thing. Both brothers are probably equal in intelligence. Life experiences caused one brother to think of himself as average. Perhaps the less intelligent brother preferred working outside with his hands while the high IQ brother pursued a profession.
Doctors and attorneys are awesome at playing financial offense. Many professionals share this quality. But high levels of intelligence don’t correlate well with high levels of financial wealth.
Big Hat, No Cattle
Thomas J Stanley argues in his 2001 book, The Millionaire Mind, that many professionals with a high income don’t have a corresponding level of net worth. Decamillionaires (people with a net worth north of ten million) have a term for people with high levels of income and little to show for it: big hat, no cattle.
These high earning professionals are also extremely intelligent. So intelligent, in fact, they start to believe they can outsmart the markets by timing them. They also have another weakness. Professionals need to maintain an outward appearance of affluence to convince other they are really good at what they do. Who would ever believe an accountant driving around in a bank reposed beater or attorney living in an 800 square foot home?
Average people in average income jobs are more suited to seven and eight figures of wealth! You read that right. The salvage yard owner is far more likely to have a serious level of net worth than a doctor, attorney or (gulp) accountant. Stock brokers and other financial advisors should have an inside track, but spending levels and a high level of understanding of how markets work causes many of these professionals to trade or time the market. The only traders with a snowball’s chance in hell of winning long-term are the market makers and financial newsletter publishers.
My Side of the Desk
Swing around, if you will, to my side of the desk. From my perspective you can see things clearer.
Every day people from all walks of life wander through my office. I have law firms, doctors and even accounting firms as clients. By and large this group enjoys a higher income than average. They also have a low level of net worth compared to what they earn. Worse, I’ve seen more than a few of these professionals pulling in upwards of a half million annually with only a low six figure net worth to show for it.
Before we continue, re-read the last sentence of the last paragraph. For some reason I find it vaguely important to our discussion.
There are plenty of excuses as to why these people are worth only slightly more than their last paycheck. None of them resonate with me.
Don’t leave my side of the desk yet. I have a few more clients to introduce you to.
Oh, here comes Sam. He worked in the mill his entire life. Not the smartest guy in the world, but a helluva family man. He goes to church every Sunday. His wife died a few years back. Worked in the paper mill his entire life before retiring with $4.7 million. By looking at him (or his car or his home or his . . . ) you would never guess he is rich. (Sam is a real client with a different name.)
Here comes another wonderful client. Jack has a landscaping company. He clips and maintains lawns for businesses and rich people, you know, the doctors, attorneys, financial advisors and accountants. Don’t say anything, but the guy maxes out his retirement accounts before adding more to his non-qualified accounts. Oh, and he is a millionaire too. Didn’t expect that considering the rust bucket he’s driving, did you?
The same pattern holds for farmers (they’re not all poor!), truckers, salvage yard dealers and guys laying concrete.
Don’t bite your tongue so hard. They aren’t all rich. Yes, I know guys in the military (or retired from) who are pretty darn rich. Many are pretty darn poor, too.
Not every doctor and attorney is net worth poor compared to their income. Many people in average jobs struggle. What I’m getting at is the people you expect to be rich are putting on a show. They have a big hat, but no cattle. They spend all their money putting on a façade. There’s nothing left to fund real wealth!
People with average incomes in jobs where there is little to no expectation of wealth have an easier time hiding their financial accumulations. A worn pair of jeans is more than fine to wear to work at the salvage yard or auction house. It’s expected!
When I first started investing in micro-loans on the Prosper platform I was able to see a few details on the borrower. Prosper provided a credit score and income range along with the borrower’s occupation. For some reason accountant’s needed loans in May. This blew me away for two reasons. First, an accountant should be flush with cash after tax season.
Second, some accountant’s work outside the tax field so they could need additional funds. Prosper also listed the reason for the loan request. When an accountant requests a loan to pay bills in May I’m dubious. Online lending platforms are not the cheapest way to borrow money! Any accountant worth his salt would never make such a poor financial decision. I say “his” because no woman would ever do something so foolish. (Yes, that was a joke.)
Prosper confirmed what I suspected from serving my clients. High income professionals frequently are poor handlers of money.
There is a lesson for the wise in this tale. You do NOT need a high income to be wealthy or financially independent! Average people in average jobs with average income can excel financially. The statistics are clear.
Sure, a high income can get you to seven figure net worth status faster if you can avoid the siren call of excessive spending to play the role. Even a below average income can grow into a tidy nest egg if handled properly. Minimum wage is a hard racket, for sure. But once your income climbs to a level even below the national average you have plenty of resources to fund an early retirement!
Excuses will show up in the comments. It goes with the territory on blog posts with this topic. They are still only excuses. Income level plays a role in your net worth. By age thirty you should have at least two years income invested. Once you reach 40 your net worth should exceed at least 10 times your annual income. If you are pulling down a $50,000 annual salary you should have a half mil tucked away in an index fund by your 40th birthday. As each decade passes the net worth report card should grow larger.
This is where the rubber touches the pavement. Really smart people want to trade stocks and bonds. They want to time the market because they did all the research. Of course the market makes a fool of the well educated.
There are only two ways to accumulate money in the market. The first is to drop the money into an index fund, or, if you are so inclined to engage an actively managed fund, a growth and income fund. Forget about aggressive funds and other crazy ideas. Your goal is to be rich!
The other way to get rich investing is to research listed companies for undiscovered value. Buy these gems and hold them for somewhere in the neighborhood of forever. Then go out and find another undervalued business to invest in.
Remember, you don’t want to be the smartest guy in the room. The smartest guy is often broke!
I want to be smart. Just not that smart.
It’s been a while since I showed you my working papers. Below are my unedited notes for this post. It should also be noted the working title of this post was Attributes of a Wealthy Individual; or The Smartest Guy in the Room isn’t the Richest was added at the last minute as a tribute to the Rocky and Bullwinkle cartoon. Hope the insight into my writing style helps you with your writing.
What characteristics are most common in the wealthy? High intelligence doesn’t guarantee wealth, it actually hurts! Smart people think they can outsmart the market and time it. Professionals have an appearance to keep. Doctors and sales people need to look the part. The massive spending required to “look good” reduces savings and all the profits those savings generate.
Average people have a much better chance. The salvage yard owner has nothing to prove so she socks away a massive percentage of her income and puts it into index funds because she know she can’t do better,.
I see it in my office all the time. A recent client picked up his return. He is retired with a serious seven figure retirement account before looking at non-qualified monies or other assets. He is an average guy from an average family retired from a mill job. And he’s rich.
Don’t be so smart to talk yourself into poverty. Intelligence can only dig you out of so deep a hole.
Two kinds of clients scare me most. The first ask me as they pick up their tax return what they can do to lower their tax bill. The other requires a pry bar to get complete information out of them during the year.
Each of these clients scares me because I can’t give them a good answer. The first client is really asking what they could have done better last year when the answer makes no difference and the second client gives me reasonably accurate information (if I’m lucky) meaning my advice is only “reasonably” accurate.
The worst part is some tax breaks aren’t gentle phase-outs, but cliffs. One additional dollar of income can cost $500 of tax savings! Clients receiving the healthcare credit face several cliffs as their income crosses mile markers of the federal poverty level (100%, 200%, 300% and 400%). A small amount of additional income can result is a significant reduction in the credit causing a seriously higher tax bill.
Compounding the problem is where you take a deduction. A good example here is Health Savings Account contributions. You can pay the money yourself and take a deduction on Page 1 of Form 1040 or have your employer withhold from your paycheck and deposit the funds. The second way is usually better.
HSA contributions are an adjustment to gross income when you make the contribution yourself. When handled through a payroll deduction it reduces the W-2 and hence, total income. The further up the page a deduction is taken, the better. As you move down Form 1040 options for certain credits and deductions are reduced.
Prioritizing Your Tax Planning
Money is limited so you have to pick and choose which tax benefits to focus on. We will use a hypothetical client named Fawn to illustrate how prioritizing tax options can yield massive results.
Fawn is a single mother with a son approaching the age of majority. She works full-time and earns in the low to mid 30’s with overtime.
Fawn has several issues to consider. We will assume healthcare is covered at work or she doesn’t have a health plan from the Healthcare.gov site. We do this to simplify our illustration and to focus on three potential tax planning options: Earned Income Credit, Saver’s Credit and the Student Loan Interest Deduction.
The Earned Income Credit is on a sliding scale. It starts low, maxes out around $10,000 to $20,000 (depending on how many children you have), and hovers around this maximum plateau for a while before starting a slow decline as income climbs. Fawn’s EIC is slightly under $1,000.
Earning more money will reduce her credit. But, there is a way to earn more and still get a larger EIC. If Fawn has a retirement plan at work she can divert money to this fund so it never shows up on her personal tax return. An HSA run through payroll will have a similar effect.
EIC is generally calculated off Adjusted Gross Income (AGI) and earned income with some modifications. We will not go into all the possible issues affects Fawn’s return. What I want to make clear is the advantages of reducing income on certain areas of the tax return without giving up income. In short, I want you to have your cake and eat it too.
Choices are almost always available to reduce taxes and increase a refund if plan in advance. We can pick this apart deeper, but today’s point is concept. I want you to understand a simple concept. You don’t have to earn less to avoid the loss of credits.
When higher income increases taxes due and reduces or eliminates credits at a rate near or greater than your additional income it makes sense to stop earning unless you can break through to the next level where income goes up while taxes are muted. Or you follow my plan.
Bringing Together Disparate Pieces
Every action can have multiple effects! Diverting more money into a 401(k) can do more than just reduce your reported income on the W-2. Lower income means lower tax. It also means you might qualify for a Saver’s Credit! Think of that for a moment. The very act of saving might actually reduce your income enough to qualify you for a Saver’s Credit. Isn’t the tax code great!
There is still one more problem Fawn can’t figure out how to solve. She has student loans that just came out of deferment. The payments are small and will all go to interest for a while.
The new tax law working through Congress might eliminate the student loan interest deduction after this year so she wants to pay at least $2,500 to max out this year’s deduction. Unfortunately, all this retirement saving to maximize the EIC and Saver’s Credit has reduced her take-home pay to the minimum level she needs to cover basic bills.
The student loan interest deduction might also reduce state income taxes. This is an important deduction and since it might go away, Fawn wants to max out the benefit this year.
She can’t reduce her income more without keeping food on the table. Here is where tax planning leaves the comfort of Form 1040 and heads for the real world. Fawn needs $2,500 to pay at least the full amount of the interest deduction. (Remember, all payments will go to interest first and she has at least $2,500 of accumulated interest.)
Since Fawn started making token payments earlier in the year (let’s say $500) she has some of the deduction covered already. It would probably make sense to borrow money short-term to max out the student loan deduction. Her top dollar will probably be in the 15% tax bracket so the student loan deduction will benefit her $300 if she can come up with the remaining $2,000 to maximize the deduction.
Credit card is probably a bad idea here, but a car loan or help from family or a friend makes sense. Fawn could also approach her employer and ask him for a loan. If she explained her situation nicely, the employer might buy into the idea since it helps a valued member of his team and really costs him nothing more than a temporary loss of use of a small amount of money.
The Good Game
Gaming the system is one of America’s great pastimes. It can be very rewarding as long as you keep it legal.
The above example has plenty of holes and I took some liberty with the facts. I was careful not to get hung up on exact numbers. No matter what numbers I use, your situation will be somewhat different. I understand increasing her 401(k) investment helps the Saver’s Credit limits. It might also increase the credit from10% to 20% (or more) of the first $2,000. The student loan interest deduction could improve situations all around the tax return.
The point today is to look at your tax situation and examine it for un- or under-utilized deductions and credits and then start thinking outside the box.
There are many opportunities to manipulate your tax results legally! Adjusting your 401(k) contributions higher doesn’t reduce your take-home pay as much as the additional contribution due to lower taxes and potentially higher credits.
Normal people can do this; not just the self-employed or rich! HSA and 401(k) contributions are not a drain on the budget; they are necessary parts of a vibrant financial plan.
I focused on lower income earners this post. I get plenty of complaints I spend too much time on ideas reducing taxes for the self-employed and high incomers. Every income category has opportunities.
Whether you are a good client or one who wants to know how the past could have been better or only coughs up all the information needed during tax season, you can plan with purpose.
Fawn is not a hypothetical client (though her name was changed to protect the guilty); she is a living, breathing human being I’ve helped for a few years now. I modified her factset slightly for this post and because she reads this blog and is sure to remind me when she gets around to reading this post.
We ran the numbers and it paid to borrow money to take advantage of the student loan interest deduction. She can pay the loan in full (which her awesome employer did lend to her) by April 1st. Her increased refund will kill most of the loan.
The best part is she keeps the money, the added tax savings, no matter what happens in the future.
And if we get a new tax code we get to play the game with a few different rules. So hand me the dice; it’s my turn to roll.
There was a time not that long ago when people believed higher interest rates slowed the economy, caused higher unemployment, dampened demand and put pressure on prices. The Federal Reserve in the United States and Central Banks around the planet held this belief tight to the chest. When the economy overheated, causing inflation to creep up, the Fed would start increasing interest rates until demand weakened as consumers faced higher borrowing costs.
The opposite also held true. Low interest rates were thought to spark strong economic growth as lower interest rates freed cash in family budgets for more spending while encouraging businesses to ramp up production with cheap credit. Since the Great Depression this theory held true and worked, even if slowly, in controlling economic activity. Then we had the twin recessions of the early 1980s.
All Downhill from the Peak
Stagflation in the 1970s proved difficult to contain. Two OPEC oil embargoes ramped up prices on oil, causing virtually all goods and services to increase without growing real wages to fund the price increases until wages started getting cost of living (COLA) increases each year. Inflation for the first time was chained with a weak economy.
High inflation encourages spending because the money in your pocket will be worth less in the morning. Businesses faced an opposite effect. Funding capital expenditures became more costly as Paul Volcker, the chairman of the Fed, racketed up interest rates at a steep rate. Killing inflation would require painful medicine. A weak economy was crushed. Housing suffered most. Mortgages rates were comfortably in double digit territory if you could get a loan at all.
The medicine worked. Demand dried up from the higher interest rates causing inflation to abate. It was the last time interest rate changes were so effective on economic performance.
Good Medicine Going Bad
Lower interest rates followed the brutal twin 1980s recessions. The stock market and economy rallied strongly. Pent up demand for housing lifted housing stocks and the building boom was off. The 1981 Tax Code overhaul gave businesses additional deductions for capital expenditures. It might be hard to believe expensing of assets worked this way. Back then the limit on Section 179 expensing of assets was raised from $10,000 to $25,000. Small business was ecstatic.
Increased tax deductions for capital expenditures caused a boom in production which required more workers. Increased production reduced inflation while employment skyrocketed. The world was good with only one warning cloud on the horizon: debt.
The tax cuts were funded with massive amount of new federal government debt. The annual federal deficit broke $200 billion and kept climbing. The credit card was getting a workout.
The smart money believed the excessive government spending would pay for itself with higher economic output increasing revenues. That promise has never been realized.
Lower interest rates were the perfect medicine for housing and housing creates lots of job, most good-paying jobs. By 1984 the economy was on fire with 7.4% growth that year while inflation was still easing.
The Fed was concerned by the heady growth and started increasing rates until it triggered selling by program trading. The economy barely missed a beat. In 1987 the economy expanded 3.5% and another 4.2% in 1988. The 1987 stock market crash be damned.
High interest rates took some time to reduce economic production, but not real long. Lower interest rates had an almost instantaneous reaction in the markets and marketplace. From Wall Street to Main Street, these were the good times.
The first warning signs something was fundamentally wrong showed up in the next recession which began in July 1990 and lasted for eight months.
Interest rates trended down from 1982 onwards. Periodic rate increases gave the economy indigestion causing the Fed to resume lowering rates again. Each peak in the rate cycle was lower and the lows were lower.
And the recoveries were longer, less steep and left more people behind as many high paying jobs never returned.
As the economy began climbing in April 1991 it was like watching water boil or grass grow. Growth was a heck of a lot slower than the liftoff from the 1982 recession. Some blamed it on the first Gulf War. There was merit in the observation. People stopped spending as they sat around the television absorbing their newfound entertainment: bloodshed.
One More Party
The slow growth out of the 1990/1 recession eventually broke loose with several years of 4%+ GDP expansion at the end of the millennium.
The terrorist attacks of 2001 set the tone for the next recession. President George W. Bush came on television and encouraged Americans to keep spending to show the terrorists our nation could not be deterred. The Fed added liquidity to the system (lowered interest rates) to unheard of levels. People began wondering what would happen when rates went to zero. What weapon to spur the economy would the Fed have then?
Lower interest rates did the trick. The 2001 recession was so short and mild the U.S. GDP still expanded 1% for the entire year.
But the economic expansion lower interest rates should have caused didn’t work as well this time. What was a concern in the post 1990/1 recession expansion turned into full-blown panic. The stock market lost half its value. The new money the Fed created stopped the pain on Wall Street. Main Street was not nearly as happy. Job growth was steady, but low. Only two years of the first decade of the new millennium had GDP growth over 3% in the U.S.
The stock market climbed from depressed levels and eventually made new highs. It was an unconvincing multi-year rally.
Then all the printed money that disappeared into derivatives and sub-prime mortgages came home to roost.
Current Economic Cycle
When the first cracks appeared the Federal Reserve had very few weapons in its quiver. Interest rates were already the lowest in recent memory prior to a recession.
The 2008 recession was fast and brutal triggered by a cascading set of events which culminated in money-center banks and investment banking houses on the verge of collapse. Low interest rates were not enough to stop the bleeding. Rates were now touching 0% and the economy was still in dire straits.
The Fed toyed with negative interest rates and the Japanese, Swiss, and European Union Central Banks all sent rates into negative territory where the borrower gets paid (!) to borrow money instead of paying to borrow. The lender took all the risk for a guarantee to lose money to boot.
In the U.S. the Fed started early in experimenting with alternative methods of pumping more liquidity into the banking system. It worked, sort of. The economic recovery from the 2008/9 recession never exceeded 3% in any calendar year, the slowest recovery in the nation’s history. The growth once again was steady, but painfully slow.
Wages were slow to increase as family budgets struggled to pay the bills. Low wage growth kept a lid on demand, inflation and job growth.
The current economic cycle started from the lowest interest rates in this nation’s history. The federal government kept spending at a rapid pace, all put on the credit card. The current federal national debt is over $20 trillion and growing at around a half trillion more each year. And we couldn’t manage 3% growth.
Where is the Inflation
There have been more predictions all the money printing would cause rampant inflation soon than there have been calls for the world ending. Prices fooled the experts. A basket of goods followed by the Bureau of Labor and Statistics (BLS) hovered slightly above zero with a few extended periods of deflation.
For eight years the Fed kept interest rates at 0% and the economy slowly clawed forward a few percent per year. And I think I know why.
Low interest rates were the medicine our parents and grandparents used to spur economic growth. But this time WAS different! Technology had finally advanced so far it was hurting the economy! Or more accurately, technology was increasing faster than demand could absorb.
Low interest rates no longer increases demand. Even businesses didn’t spend aggressively in the low interest rate environment until the last few years. What business did spend went further than ever. $4,000 computers two decades ago now cost under $1,000 and do a thousand times more and faster. Business spent less because the cost of capital expenditures had declined for many technologies and the cost of capital was nearly free. If technology costs would have remained unchanged, businesses would have created and capital expenditure boom.
Low interest rates after all these years seem to cause deflation instead of spurring economic growth like the good ol’ days. And higher interest rates, if the economic model is truly turned upside down, should cause the economy to overheat and inflation to expand. Here’s why.
New World Order
Keeping Interest rates so low for so long must have caused a few academics to rethink the classical model. Low rates caused bubbles and imbalances in the markets without any money trickling down to Main Street to create jobs and more demand for goods and services. It was a Wall Street pile-up where average people paid the price for the sins of a few with control over the newly created money.
It’s called pushing on a string. More money pushed into the banking system either didn’t find its way into the general economy or people refused to spend it if they did get it. This isn’t all bad if the savinga rate climbs as households save and invest a larger portion of their income.
This wasn’t the case either. The savings rate climbed slightly, but not anywhere near the levels money creation would dictate if the money weren’t spent. Where was the money going? Nowhere. The money supply was larger than ever as the Fed’s balance sheet bloated, but it all sat in money-center and Central Bank vaults around the world.
None of this matters since it was a wasted exercise carried out by central bankers. The money was created, yet most never entered the economy. No wonder the GDP was anemic.
Low Rates Caused Deflation, Now Rising Rates will Cause Inflation
Most businesses today have plenty of capacity. Here is an example from CNBC showing how low interest rates caused a glut in domestic milk supplies. Low interest rates allowed factory farms to add capacity at virtually no cost, over supplying the market and driving down prices. Industry after industry is in the same boat.
Low interest rates encouraged the over production. Higher interest rates will increase the cost of capital expenditures for businesses, eventually reducing supply and increasing prices. This is the opposite effect we might expect in the past. Higher interest rates usually slowed the economy and if raised far enough still will. But the initial effect will be to decrease supply as marginal production is taken offline.
The experiment isn’t over and my supposition could be 100% wrong, not that my batting average is any worse than that of economists. Interest rates are slow on the takeoff this economic cycle. Eventually a trigger point will be reached, causing the economy to overheat and prices to climb faster.
The higher interest rates will not work any better controlling inflation than low interest rates encouraged economic growth.
My concern is the trend. Since 1980, interest rates have been cycling lower. We went negative this time around and the fed funds rate peaked at 5.25% during the prior economic expansion. This cycle the Fed worries the current 1-1.25% fed funds rate might slow the economy. Crazy!
If lower rates don’t encourage inflation and rapid GDP growth, then higher rates probably will. At no time in history has this amount of money ever been created and hyperinflation hasn’t followed. There are no indications of rapidly increasing prices on the horizon, however.
Higher interest rates might do the trick or we could head still lower this interest rate long cycle. Only time will tell.
The earnings stream from a company is worth more in a low interest rate environment. If inflation starts the rear its ugly head the Fed will worry and jack interest rates, causing business investment to slow, marginal production to be taken offline, causing prices to increase. Remember, you heard it here first. And earnings are worth a lot less as rates rise.
Just a few things to consider as you plan the family budget.
Ever wonder how your favorite accountant takes notes for a new post idea? Below are my notes used to prompt the writing of this post, unedited. Writers might find the evolution of an article of interest.
The old world paradigm hasn’t worked for a few decades now. The old school says lower interest rates spurs demand and eventually inflation. At no time in history has so much money creation taken place for this long without a massive upturn in inflation. What is different this time?
Lower rates lead to a muted economic expansion with slow growing demand and modest job growth. The economy should have overheated by now. Why?
Instead of inflation, technology made it easy to increase production and the cost of capital was near zero encouraging this capacity expansion. Everything seems to be in a glut. From oil to food, there is plenty enough to satiate 100% of demand. Low interest rates now seem to fund capacity expansion faster than demand.
Higher interest rates will increase the cost of capacity expansion and will lead to higher interest rates.
What worked in the past is turned on its head! The Fed reduced rates for a decade and printed money with reckless abandon to further spur demand. It didn’t happen the way the textbook said it would. Higher rates, the traditional fix for inflation, may also have an inverse effect from the expected norm. When inflation does show up as the Fed increases rates the Fed may overreact and keep raising rates to kill inflation. It will work if rates go high enough. Demand can be quashed by high interest rates.
It would be easier and less painful to consider doing the opposite of what we always did in the past. It might just work this time.
Today we have a special guest post from Josh Wilson of Family Faith Finance. Josh’s idea for an article is one I would’ve written if I’d thought of it. I talk about using credit cards as a tool to better manage your finances and those juicy bonuses they offer, tax-free. But what if something goes wrong? Identity theft drips from the newsfeeds. Unauthorized charges happen.
There is a way to protect yourself. Most readers are aware of their credit card’s dispute process. But if the dispute goes wrong there are still options short of arbitration. Josh gives us the basic framework in disputing a credit card charge or issuing bank’s action before moving to a powerful tool to resolve the worst problems with lenders. I’ll let Josh tell the story.
How to Complain To Your Credit Card Company
While credit cards aren’t a prerequisite, they’re a great tool for emergencies, recurring payments, cash management, to build credit score and for bonuses. Usually having a credit card is no big deal, either, but then life interferes? Having a complaint against your credit card company is normal and if you do you’re definitely not alone. The most common complaints about credit card companies include: billing disputes, identity theft, and account closure.
When you have an issue with your credit card service it’s best to work directly with the issuing bank first before seeking arbitration or help from a third-party advocacy group. Contacting a credit card company to file a complaint can seem daunting, but most complaints can easily be handled with some research and a phone call. The process is similar for most credit card companies, but there are a few things to remember when filing a credit card complaint.
- First, it’s going to take some work. You are going to have to make phone calls, write letters, send in copies of bank statements and more to deal with a fraudulent charge on your credit card or other credit issues. Just be prepared and make sure you have everything organized.
- Second, you must document everything. It will make the process much easier. To keep good records, use email, record your phone calls and print two copies of all paperwork you send them.
Let’s review the process of filing a complaint with your credit card company:
Evaluate the charge or discrepancy. This is the first step if we’re looking at billing mistakes or potentially fraudulent charges. You want to make doubly sure that you didn’t simply forget about a charge you did make. You may have to look up the location or call various merchants when trying to figure out if you made a purchase there.
Contact the merchant or credit card company. Once you have your information together you should contact the merchant or credit card company. If it is for a fraudulent charge you should first contact the merchant to dispute it. If they can’t or refuse to remedy the error, contact the credit card company and alert them. [TWA Note: I would report a fraudulent charge using the bank’s online portal and let the bank deal with the issue. I wouldn’t call the merchant.]
Mail paperwork. More than likely you will be asked to send in some information to the credit card company. This is usually handled with a fax or scan, but may require a hard copy snail mailed. Most banks don’t require paper complaints, but if required, send in a copy, keeping the original documents for your records.
Play the waiting game and appeal if necessary. Once you’ve sent the information you need to wait while the company does their own research. Sometimes your dispute is denied. If that is the case you can appeal, asking for an explanation as to why the dispute was denied. However, most credit card companies will require you to appeal within 10-14 days of receiving your verdict on your initial complaint.
What happens when the credit card company is unwilling to resolve the issue? This occasionally happens and it’s not your fault. You can do everything right and the company may decide you are liable. Luckily there’s a government agency designed to handle this, namely the Consumer Finance Protection Bureau, which is designed to assure financial institutions follow the laws and treat you fairly. They have a process where you can file a complaint against a financial institution if you have a problem with your credit card, mortgage, student loan or any other issue involving a lender.
How do you file a CFPB complaint?
The CFPB has a unique process for filing a complaint. Once a complaint is filed they become a liaison between the consumer and financial institution.
- You file your complaint on their website. You can log in to check or update the status at any time.
- The CFPB reviews your complaint and all the documents you provided them.
- They contact the financial institution on your behalf to settle the dispute.
- The credit card company responds to you and the CFPB.
- Your complaint is updated when it’s resolved and the CFPB publically publishes the results.
Whether you file a complaint with your credit card company or with the CFPB, you shouldn’t be anxious about addressing an issue involving your credit card, student loans, mortgage, or any other loan.
This blog post is part of the Suicide Prevention Awareness Month blog tour in partnership with Debt Drop. If you are feeling suicidal, please call the National Suicide Prevention Lifeline at 1-800-273-8255 or text HOME to 741741.
In the waning days of the second millennium of the Common Era I found myself in Austin, Texas advising a hedge fund in the charge-off receivables industry. There was no way I could know that within five years I would be running my own hedge fund and then a second. There was no way I could foresee my responsibility in a suicide and the contemplation of my own.
It started in the most unassuming way. Via letter I was introduced to the charge-off receivables industry by a Tennessee hedge fund that used a Texas firm to handle their collections. The hedge fund put me up at a 5-star hotel on a PGA golf course. I wasn’t impressed by the largesse. I prefer more Spartan living even when traveling.
The charge-off receivables industry is a dirty business. Charge-off receivables are delinquent debt sold to a third party for pennies on the dollar. As an example, credit card accounts 180 past due require banks to either book a 100% loss on the account or sell the bad debt, whereas, they can use the sale price as a partial offset.
Credit card companies never lose. An account in default frequently brings 15% or more as “fresh” debt for the charge-off receivables industry. The debt buyer scrubs and grades each account. Some are slated for legal action, others for simple phone calls and letters.
Within an hour of buying a package of debt a LexusNexus report tells us everything we need to know on every account we bought. The report tells us where the debtor works, what bank accounts they have and balances, assets owned, and more. Armed with this information we let our dogs loose demanding payment. In short order many of these debtors have suit filed against them. I was called in for a reason. I know how to collect; to hell with the consequences.
Two years later I was burnt out due to the traveling. In my mind this would be the last I saw of the charge-off receivables industry.
Big Shot Hedge Fund Manager
Two years later one of the insiders I consulted with called. He wanted to start his own hedge fund in the charge-off receivables industry and he wanted me as a partner rather than advisor. After plenty of arm twisting I agreed.
Three years into our very own hedge fund throwing off a 28% average annual return my partner had a personal issue requiring him to leave the fund. A new fund was organized. Investors of the old fund could walk with their 89% gain or roll funds into the new fund where I was the sole manger.
There is a slight head rush to being the top dog at a hedge fund. I had ideas which could turn past performance even higher, as if 28% were not enough.
The Benevolent Debt Collector
Packages of debt can get large. I always dealt with less than fresh debt. We always bought from other third parties who already worked the debt. Buying straight from the bank is expensive. Older debt can be more profitable. Many times the debt we purchased was a nickel or less on the dollar. This meant $1 million bought $20 million face value of debtor accounts. Million dollar purchases were common.
So far the old and new hedge funds looked identical. My network of collectors and law firms around the nation were the same with new additions as I vetted them.
Once I got my feet set in the new hedge fund I discovered Dave Ramsey. I wasn’t an endorsed local provider (ELP) of Dave yet, but I loved what he was saying. It made so much sense and some of my tax clients and all of my hedge fund accounts could use this advice.
When debt packages were purchased I was curious who was on the list in my state. Periodically I’d see the name of someone I knew or a client. Clients showing up on the list were a conflict of interest so I sold those account to another firm similar to mine.
As I reviewed and scrubbed packages I started noticing patterns. One pattern included people who did fine with money all their life and then fell off the cliff. Another pattern included the same names showing up multiple times. If I bought three large packages this month of mixed bank accounts I might find some people listed five or more times. Somebody’s life went bad fast!
It’s a no-no in the debt collection industry to call a debtor if you are untrained; the rules are immense and the penalties for breaking them immense. I was the numbers guy, not a collector. But I felt my idea would benefit the debtor while spiking my returns so I did it anyway.
I bought large volumes of Dave Ramsey’s book The Total Money Makeover. Around this time I contacted Dave’s organization, was vetted and accepted as a tax ELP which allowed me to buy Dave’s book at a large discount. I bought boxes.
When the hedge fund bought a package of debt there could be 20,000 or more accounts involved. We bought packages on a regular basis. I scrubbed the accounts for special cases. I was looking for people who did well for a long time and had a life event that caused financial/debt issues.
I also looked for people with a lot of bad accounts. People with a large number of delinquent accounts were hard to collect from so I wanted to do a good deed.
I sent a copy of Dave’s book to select debtors in our files with a letter encouraging them to use the book to improve their current financial situation.
Later I would call these accounts. The rules require certain disclosures when you call to collect a debt. I never called to collect the debt; I called to encourage usage of Dave’s philosophy to get out of debt.
I informed these people they could resolve debt issues if they were serious about changing a few habits in life. Most of the time I got a story. There is usually a good reason why they failed and will keep failing.
The rest I reminded did not have to pay in full. It is common in the industry to pay less than the full amount to satisfy the debt. I encouraged people to work a payment plan to pay half the debt and have the rest charged off.
The goal was simple. If people were too far in to work their way out I would give them hope and a way back to normalcy. This was good for them and good for me. I paid a nickel on the dollar for this debt and if I collected even a fraction of the face value I made a huge profit.
Not What It Looks Like
My plan was working like a well oiled machine. Profits were up and I was helping people in an industry notorious for chewing people up and spitting them out.
One day a week I dedicated to calls. Many times the calls lasted much longer than anticipated as the debtor finally found someone to tell their story to who cared. Some weeks I called thirty people, some weeks only five. Either way I was making a difference and adding serious money to the funds bottom line.
Medical issues were a common problem with people who were good all their life and only recently had unpaid bills. Sometimes they even had insurance. It broke my heart. I took whatever time was needed to help them.
One day I called a debtor I sent Dave’s book to a few weeks prior. He thanked me for the book and explained his wife was dying of cancer. The doctors gave his wife a few days to a few weeks to live. He promised after he buried his wife he would start paying his bills again.
He had insurance, but the insurance did not cover an experimental procedure. He was willing to try anything to save his wife. They were only in their 30s.
The stress of his wife dying of cancer and the added burden of medical bills caused him to mortgage the house to the hilt and max out credit cards to cover medical bills. (The hospital would not proceed without payment.) He was in over his head and he still lost his wife. The next LexusNexus pull on the packages that included his debt showed his wife had passed away a few weeks later.
I ordered his account to be marked PIF for paid in full. I couldn’t collect from the man. I would not add to his burden and grief.
His accounts were still on file. Two months later a LexusNexus pull indicated he too had died: suicide.
My stomach turned. I couldn’t do it anymore. Something broke inside me that day. No matter how good my intentions I couldn’t do it anymore.
Most people dig their own debt hole and it is hard to feel sympathy at times, but many, many more also are deep in debt due to circumstances outside their control.
At the time I felt like it was my fault this client (and by now I felt he was a client, not a debtor account) took his own life.
It was early autumn, the time of year when I struggle with seasonal affective disorder. The shorter cloudy days dropped the curtain like never before. It was so bad I had the gun in my hand. I did not want to live anymore. Not in a world like this.
I lived, of course. I eventually understood it was not my fault. It was still over for the hedge fund. It dawned on me I was part of the problem as a part of the debt collection industry. The industry is like a pit bull sinking in his teeth and never letting go.
My intentions were honorable, but misplaced. I thought I could solve someone else’s problems. It doesn’t work that way.
Debt is so caustic. It destroys so many marriages, ruins so many relationships and causes so much pain.
I came to realize people who created their own mess on their own still deserved an opportunity to get their life back, an opportunity the debt industry in uninterested in. The goal is to get you in debt and keep you there. They want your money, including interest. Interest is money paid where you get nothing in return. Sellers of debt have virtually no costs and keep all the profits. To hell with people and their families.
The hedge fund was wound down and disposed of. We didn’t do so well with the second fund. The 2008 financial crisis coupled with my wakeup call hurt results.
I beg you, if you are in the debt industry, consider the people you come in contact with. People who commit suicide are 8 times as likely to have debt issues. It can’t be a coincidence. You are the front line in protecting these people standing at the edge. You must never push them over. Ever!
And you, kind readers, you must be vigilant as well. You have friends, family and co-workers suffering under a burden of debt. Offer gentle words of encouragement. Maybe buy them a copy of Dave’s book. It does help. The Total Money Makeover is for people with serious debt problems. Readers here generally don’t have these problems, but people you know probably do.
If someone you know is distraught there is help. Call the Suicide Hotline at the opening of this post. Check the link to Debt Drop. There may be financial help available, too. Never allow anyone to navigate the darkness alone.
Finally, share this post. It might save a life.
“It’s not working.”
A long time client started reading this blog and subscribed wholeheartedly into the idea of saving half her income. She discovered the blog early so she had nearly a year of effort under her belt. Student loans were the worst part of her debt, but credit cards and a mortgage also weighed heavily on her financial plan.
Saving half your income is the floor, not the ceiling. In this case, my client and her husband earn nearly $100,000 a year. They wanted to cut their spending to my levels using my yardsticks for spending. They are down to the mid 40s, a very good sign. The lament, however, has me concerned.
The only way this works is to be consistent. Years of hard work can be destroyed by a short-term spending binge. A new expensive car, a cottage up north, a trip to the casino and a new set of furniture can all be spent in a single month. The penalty will take years to fix.
All Between the Ears
Financial success and early retirement are all mindsets. There is no special ingredient needed. Patience and persistence is all you need. Responsible spending cannot be a chore; it must be an ingrained part of who you are.
My client is nearly in tears as she tells me it is not working. But it is; she just isn’t seeing it.
I question her on why she thinks it is not working. She confesses they are still broke even though they reduced spending. I ask where she thinks the money is going. She says they are putting every spare dime they have into reducing debt.
Ah, the debt bomb!
Digging out of debt takes work. Fixing decades of bad financial habits takes a few years. One year is only the beginning.
The Difference Between Expenses and Cash Flow
There are several things that drive accountants crazy. One of those things is how people have no idea what the differences are between a profit and loss (P&L) statement and a balance sheet. This lack of understanding causes clients significant pain.
A new loan, for example, is a liability, not income. People get that. You don’t pay tax on loan proceeds. They correctly place the loan on the balance sheet as a liability. When payments are made they list the entire payment as an expense on the P&L. Wrong!
My client cut her spending and plowed the excess cash into debt reduction. In her mind she was still spending, putting all the excess cash flow on the P&L when the principal part of the payment belonged on the balance sheet.
Keith’s Rule: Interest on debt is new spending. The payment to reduce principal comes from current cash flow to pay for prior financial indiscretions.
My goal is to get you to think like an accountant. You need to understand where the money really goes on your personal financial statement so you can eliminate debt and build wealth. Let’s walk through the process.
Every transaction in accounting has two sides. We will not bog down on terminology or train you in handling complex accounting transactions. I just want you to understand there is always two sides to every transaction, whether in business or your personal finances.
We will start with taking out a loan. Let’s say you bought a home for $100,000 and took an $80,000 mortgage. How will the money look on our financial statements?
You now have a $100,000 asset on your balance sheet. The other side of the transaction is a reduction of $20,000 from the checkbook for the down payment and you also have an $80,000 liability. The entire transaction takes place on the balance sheet.
You can consider the home purchase spending. In a way it is. However, accountants don’t look at it this way. The home is still worth $100,000 and can be sold, converting it back into cash. Normally a property is depreciated. That is not the issue with a home purchase used for personal purposes. Therefore, I don’t include a home purchase as spending. The insurance, taxes, mortgage interest and maintenance are current expenses only.
When the first mortgage payment is made, what happens? Part of the payment is interest and the rest is principal. In our example the payment is $1,000 with $800 going to interest and $200 going to principal. The second mortgage payment will have less interest since part of the loan has been paid off by the prior payment and the principal portion therefore increases.
The mortgage payment looks like this on the financial statements:
Personal checking account: -$1000 (balance sheet: asset)
Interest: $800 (P&L)
Principal reduction: ($200) (balance sheet: liability)
Notice how the $1,000 coming out of the checkbook is matched exactly by the principal and interest parts of the transaction. We call that having the books balanced.
Why is all this important? Our simple illustration outlines how money moves. My client felt she was not getting traction from all her efforts when in fact she was. Each reduction in spending was used to retire debt. The less debt you have, the less interest accrues, meaning you are further reducing your spending with each principle payment.
Interest expenses are current spending! Reduce debt, and hence interest expenses, and you reduce current spending without any sacrifice!!!
Our example also reveals a bitter truth about money: spending and cash flow are two different animals. If you reduce annual spending to $30,000 a year, about what the Wealthy Accountant household spends annually, you will need MORE income to cover cash flow needs.
Accelerated debt reduction hits cash flow. All the money is still gone, but debt is reduced while you still retain the asset. Your net worth is unchanged! That is what hurts. You moved money from cash to reduce a liability. The bottom line is still the same.
Where you win is next month. The reduced debt means less interest accrued before the next payment is made. Less interest means less current spending. (And what did you get for that interest expense? Use of someone else’s money. That’s all.) The next payment pays off more principle because there is less interest to pay. Before long the debt is gone.
People planning on early retirement (or retirement at any age) need to understand they live in a cash flow world. The bank does not care what your expenses are. They want to know if you have cash flow to pay them back with interest. In our example, the person taking out an $80,000 mortgage will need $80,000 of excess cash flow over spending. Debt is painful and it should be. As painful as it is, people still are too excited about saddling themselves with loads of it.
Debt-Free Cash Flow Needs
Once you are debt free you can live on your income alone. If you have $30,000 in annual spending you only need $30,000 in income to cover those expenses. No excess cash flows is needed to cover liabilities.
Investments are nothing more than moving money from cash to the investment category, both of which are assets. You are just shuffling what you own.
How I think about my finances is slightly different than generally accepted accounting principles. For example: A car purchase is an asset paid for with cash. In my business I would list this on the balance sheet and depreciate it. Same with any furniture or equipment. In my personal (mental) books, a car is current spending—the hell with depreciation—listed in a footnote. I consider most spending core spending. Cars, a home remodel and other major expenses I list separately. In the back of my mind I consider a car a current expense. But I also know it makes it look like my spending is lumpy so I list the car as a footnote so I can track my core spending more accurately.
Great care must be taken when making large purchases. If it doesn’t show up in core spending it might be overlooked. Overlooked spending can get out of control. Remember, a large asset purchase shifts money from an income producing asset (investment) to a wasting asset in many cases. (Cars are wasting assets. They drop in value until the day they hit zero.)
I explained the cash flow issue to my client. She seemed to perk up as I showed her how her efforts were reducing spending (less interest) and how each month her income was now building her net worth a bit faster each month. The student loans really had her down. But she was making progress. In a few short years the debt will be gone and investments will be sizable as long as she stays the course.
Another way of thinking of cash flow is this. You need excess cash flow (income over spending) to fund investments. With rare exception, you are either spending more than you earn or investing excess cash flow, even if in a checking account. Expenses rarely match spending exactly. You need enough excess cash flow over time to fund investments before you can retire.
Understanding the difference between a balance sheet and a P&L will help you reach your financial goals faster with fewer crises. Knowing where each transaction goes on the financial statements allows you to build your net worth faster. Once your assets over liabilities (hopefully there are few, if any, liabilities) reach an appropriate level you can chose the life you live. We call that retirement around here.