I recently purchased a house and the mortgage company sold my information to a life insurance company. They gave us a call and now we’re a little overwhelmed trying to figure out how to “diversify our finances”. Should I get an accountant? Would he help me with this? We’re a little worried about the additional expense.
The first thing I can tell you Nicole no-last-name is that you probably don’t need to be worried about the additional expense of an accountant. Generally folks in your position hire an accountant because it saves them money. Generally, an accountant also only handles taxes or accounting. Some will give investment advice, and it can be a reasonable way to get it.
The second thing I can tell you requires a little bit of a story: In the nutrition and diet world there is no lack of self-professed guru’s who claim to know the best way for you to lose weight, or the foods that will keep you healthy. They extol the virtues of their particular diet plan. Claiming miraculous results, and always ready to cherry pick examples and studies which support their particular food-cult. If you’ve been steeped in American culture at all in the last 50 years its impossible not to have noticed the endless “now its good for you”, “now its bad for you”. The best nutrition advice I ever got comes from the book “In Defense of Food” by Michael Pollan:
1. Eat Food
2. Not too much
3. Mostly plants
This advice I found particularly wise because of its humility. Rather than making psuedo-scientific arguments about human diet instead it just tells the reader the simple rules that account for most problems.
The investment equivalent of these rules must be:
1. Buy assets
2. Keep fees low.
3. Mostly stocks.
A great way to drive me crazy is to talk about the “investment” you made buying a nice vacuum. There’s nothing wrong with vacuums, but you’re spending money. Investing means to part with money for the time being in order to generate income, while being reasonably certain of the safety of your principal. Buying gold, for example, doesn’t satisfy this first test, as Warren Buffet said it best in his annual letter to shareholders in 2011,
Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.
Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices. A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Keep fees low
This is where whole life insurance generally fails, as well as funds with “loads”. When you have to pay someone thousands of dollars for an investment they refer to as a “product”, you’re fees are not low. Index funds, from say Vanguard, are a much better candidate. Your money is invested at a rock bottom cost. Sometimes 0.1% of your invested assets.
To be fair, this is perhaps the only piece of my advice that isn’t necessarily timeless. In 1999 it was probably bad advice, but in general it has been good. Over time stocks have been the best or one of the best performing asset classes in the world. It’s easy to see why this is the case. Stockholders are the ultimate owners of the businesses in the world. Gold doesn’t care if you make money or lose money. Insurance exists to protect you from disaster, not to make you wealthy. The raison d’etre of a business it to generate a profit for its stockholders.
Don’t fall prey to snake-oil salesmen. If you follow this advice I don’t promise millions, and I can’t promise that you won’t lose money. There will be times where you will lose hundreds of thousands of dollars. In the long run, however, if you stay invested and ride out the ups and downs of the market I think it’s very probable that you will enjoy a satisfactory return.
Sometimes life throws you a curveball and you need to come up with some money on short notice. It might be that you need to replace the windshield on your car, you might suddenly need to take a flight to see an ailing parent. Life works better if there is some slack in your finances.
Why do I bring this up? This article came across my desk earlier this week. Fully two-thirds of American’s don’t have $1,000 lying around in case of an emergency. One hopes that the news isn’t as grim as it sounds, and there are a few problems with some of the facts in the article. (Food prices have been dropping like a rock as a share of disposable income). Other than that it paints a depressing picture about the state of most people’s finances, it also explains the popularity of low/no deductible insurance plans and extended warranties.
The Expense of Illiquidity
Many of the people who can’t come up with $1,000 aren’t even poor. 38% of households making over $100,000 can’t come up with the $1,000. These are people who make more than $8,000 per month, and their finances are run so tightly that they can’t set aside 12% of their income for one month to provide some cushion. This is crazy, mostly because it could mean that you end up paying substantially more for everything.
If you can’t afford to replace your cell phone if you break it that means you either need to buy some sort of insurance, borrow money from friends/family, sell assets, or put it on a credit card. If you throw it on the credit card carrying a balance comes with high aprs. If it takes you 2-3 months to come up with the money you’re looking at $60 of finance charges. Cell phone insurance with a $250 deductible typically runs $8-10 per month or about $100 per year. Naturally my advice there is to not carry cell phone insurance and use that $250 to get a used phone, but that’s just me.
This is repeated over and over for every valuable thing a person owns! Extended warranties for laptops, large appliances, and so on. The profit margin on an extended warranty from Best Buy is estimated to be about 50%. That means, on average, that you’re taking a 50% haircut when you fork over warranty money. All of which could be avoided if you just saved a little bit of money.
The Standard Solution
Dave Ramsey, a popular personal finance guru, suggests that you save up $1,000 for an emergency fund, even if you have credit card debt. Leaving $1,000 in a savings/checking account generates a little interest (well, 3% if you use a high-interest checking account), but mainly it provides you with piece of mind.
It’s easy to get used to the constant stress that comes from living on the edge without an emergency fund. You begin not to realize the pressure you feel every day. Every strange hiccough your car gives creates anxiety. Once you save your first thousand dollars it’s like taking off ski boots. The uncomfortable pain you had been living with all day is suddenly gone. It is replaced with the glorious power to write a large check and not have to care.
The Good Solution
Maybe this is the part where you expect me to say, keep an emergency fund of 10 months expenses sitting around. After all, we haven’t discussed the big emergency. What if I lose my job? Having a giant pile of cash sure helps, but watching a supply of cash melt away while you’re on a job hunt is a recipe for its own sort of anxiety. Yes, this is better than having nothing, but instead I propose that you rethink your budget entirely.
The lower your expenses are relative to your income the better you’ll be able to handle what life has to throw your way. This takes discipline. It’s practically an assumption in the US that your expenses = your income. This is terrible. Instead you need to make sure that your fixed expenses, the bills you have to pay, are a small percentage of your income. They should be less than your income from your main job.
This is easiest if you’re married. The person with the smaller income should be able to cover the mortgage/rent, health insurance, food, utilities, auto insurance, and any finance charges that have to be paid month to month. This means that if one of you loses your job you can search for a new one indefinitely simply by tightening the belt on your wants.
If you’re single this requires a bit more work. Typically when you lose your job you’ll get one last paycheck which you’ll have to stretch for, say 6 months. If you have no income from a side business, then you’ll need to make sure that your fixed expenses are no more than 8% of your income. Considering that you ought to be spending no more than 50% of your income this shouldn’t be impossible.
The thing you have most control over here is your costs. If you make $36,000 per year you should spend $480 on rent, food, and so on. Naturally this gets significantly easier if you make even $200 per month from a side business, that income you can directly add to your fixed expenses. This assumes that if you lose your job your side business will stay intact.
You might be inclined to ask, “Adam, if I’m not spending such a large percentage of my main income why aren’t you including that as money that could be used in the event of job loss?” Well, that money should be shoved into tax advantaged retirement accounts. Any leftover goes into brokerage accounts. In just a few years income from your investments will start to become substantial enough that you could survive on it if you had to.
Your goal this month? Save $1,000. Apparently, that’s enough to put you in the top third of the population.
In personal finance we sometimes have an obsessive focus on cost savings. I think the focus comes from the fact that it’s often a blind-spot for folks when they get into budget trouble. People would always like to make more money. More money is a panacea for problems. People tend to equate cutting costs with cutting happiness. When given a magic lamp no one wishes for their costs to be zero, they wish for wealth. This attitude can spill over to your business as well. Landing new clients is sexy and exciting, but it’s crucial to keep your costs in control as well.
Differences Between Cost Saving in Business and Personal Finance
There are a few differences that we should note before we look into the similarities.
First off in personal finance its usually better to cut $5 of spending rather than make $5, just because of the way income taxes work. If you’re in the 25% bracket and I reduce your electricity bill by $15 per month that’s the same as getting a $20 per month raise.
A business doesn’t need to think this way. Since all costs to a business are tax deductible To a business a penny saved really is only a penny earned, while to your household a penny saved could be almost two pennies earned.
In personal finance most of your consumption is assumed to be directly related to your happiness. If you cut spending on going out to eat, it is seen as hardship because you’ll be less happy. In business the point is to maximize, in the long run, the gap between your revenue and your costs. Psychologically this makes it a little easier to cut expenses in business.
Difference Between Frugal and Cheap
In personal finance this isn’t so important. Everyone can decide what cheap means to them, and while you should make an effort not to be rude (don’t screw folks at the check in the restaurant), generally you don’t have to stay up at night worrying about it.
In business this is a constant worry. Is your ad-spend wasted? If I cut back on payroll is that going to cause revenue to drop more? If I don’t fund computer upgrades is that going to cost me more in hours worked? This isn’t at all easy, and you don’t even have the tax advantages available in personal finance. At every level from your side-business to mega-cap corporations people have a great deal of difficulty getting a handle on this. In part because the challenge increases with the business. If you do freelance writing, it’s pretty straightforward. Does my word processor work? If you’re running Coke it’s an endlessly confusing barrage of questions. Was the dip in profits associated with our new ad campaign, was it due to foreign exchange effects, are the departments reporting to me being honest about their budget needs or are they just trying to maximize their take.
Quick Cost Savings
If I had to pick an area for quick cost savings I’d look at energy efficiency, simply because it is eminently calculable. Utility rates are fairly stable, and if you use a 10 watt bulb instead of a 60 watt bulb you just have to multiply your usage by the power savings. IRR’s (internal rates of return) associated with this are all over the place. Solar panels with tax credits and current utility buyback rates can be north of 10%, but those buyback rates may not be sustainable. Moving from incandescent bulbs to CFL or LED bulbs can have an IRR north of 100%, it’s crazy.
Once you zone in here, there is a lot to find. Improving insulation generally offers a good IRR (north of 20%). Better windows are somewhat worse, generally around 10%. Buying a car on this basis is practically the worst idea. The cars with the best MPG are generally new and expensive. Buying an old smallish car is almost certainly going to work out better for you.
The other quick way to save some money, I’m sure you’ve all heard before, is to start making phone calls to company’s that charge you monthly bills. Generally their ongoing costs are very low, but their customer acquisition costs are high. Line level employees are often given sweeping powers to discount your bill for long periods of time. Obvious targets for this are: your internet subscription, your gym subscription, and your phone subscription.
You may have noticed that I didn’t mention your TV subscription. That’s because you don’t call to discount your TV subscription, you call to cancel your TV subscription.
If you have any idea’s for cost savings please don’t hesitate to point them out. I’m always on the lookout for more efficiency in my finances.
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I’m hoping that this list might save some people some time. After spending a certain amount of time with tax-advantage vehicles there is an inclination to try to get “creative.” Unfortunately, creativity in this space is mostly disallowed, and more often than not it’s a bad idea.
Collectibles in an IRA
The idea: Let’s say that I’m a big fan of Magic: the Gathering. Magic is a trading card game and some of the cards can be quite expensive. Valuable cards used in high-profile tournaments and can run between $50 and $100. Some even sell for as much as $5,000. You might be inclined to think, well, I could just support my hobby tax free. I’ll put money into an IRA and spend that money on these expensive cards that I would have purchased anyway and now I still get to use the “invested” money. Since these cards have marched upwards in value over the last 23 years, you might even have a sensible argument that the money was reasonably invested.
The IRS: The bottom line here is that you can’t own collectibles in an IRA. I think the fear the IRS has here is that you it would be very easy to turn a hobby into a tax deduction if they allowed something like this. (Which, really, is exactly what you’re trying to do). It’d be very hard, I think, for the IRS to distinguish between people who owned, say, an antique arcade game for investment purposes and those who held it because they enjoyed playing antique arcade games. They do make certain exceptions for some US minted gold coins.
Why it was a bad idea anyway: Most collectibles aren’t good investments. First, off they aren’t very liquid finding a buyer for thousands of dollars of magic cards isn’t straightforward. The bid-ask spread (the difference between the price you can buy something at and the price you can readily sell it at) in our magic card example is something like 50%. Most collectibles have similar spreads.
Correctly guessing the future value of collectibles is very difficult and not to be underestimated. They also have the unfortunate quality of just sitting there. They, themselves, don’t throw off cash, and the market gods help you if you decided to invest in Beanie Babies.
Ultimately, if you think some specific collectible will do well, you’re often better off investing in the company that makes them, at least that company is trying to make money, and if it’s part of a diversified portfolio you also get around most of these other drawbacks.
Your Business in an IRA
The idea: Let’s say that you have some freelancing job. Wouldn’t it be great if you didn’t have to pay tax on your profits? Well, what if you formed an LLC and deposited all of its ownership interest in your roth IRA?
Then just do a 72t withdrawal and bam, you’re living tax free!
The IRS: Not even a little okay. Basically if you have any control over the an entity inside your IRA the entire IRA could be declared invalid. This is a very bad thing. You then immediately owe taxes and penalties on the contents of the IRA. What’s more the IRS may even penalize the trustee of your IRA. In practice this means that any self-respecting institution will not allow you to do something like this.
Why it was a bad idea anyway: Your retirement accounts are stupidity insurance. If you put money into an IRA and a 401k it gains not just tax protections, but also many protections from creditors.
You can make serious mistakes with credit cards, real estate, or in your own business. Declare bankruptcy, and in many situations still have a secure retirement. This is an amazing boon. If you engage in certain transactions with your IRA you can lose this bankruptcy protection.
This is one of the few countries in the world where failing once doesn’t ruin your whole life, you wouldn’t want to put yourself in a position where your risky startup could put a bullet hole in your retirement.
Life insurance in an IRA
The idea: If I’m going to buy life insurance anyway, premiums are not typically tax deductible, but my cousin says that life insurance is a great investment. I’ll buy it through my IRA and then I won’t have to pay tax on the premiums!
The IRS: Typically life insurance can’t be purchased in an IRA. There are exceptions, and those exceptions require both specific types of retirement plans (“qualified plans”) and that the “insurance value” of the life insurance plan be incidental compared to the retirement value.
Why it was a bad idea anyway: I don’t want to say all non-term life insurance is a scam.
Your House in an IRA
The idea: The biggest investment I’m ever going to make is probably in my house. I want my biggest investment to be tax sheltered so I’ll try to put it in my IRA, by using my IRA for the down payment.
The IRS: There are many ways to access IRA and other retirement money to use for the down payment on your first house. None of these ways allow you to actually hold the house in your IRA.
Contrary to popular belief, however, it is possible to own real-estate in an IRA. The rules regarding this are a little complicated, but the upshot is that
A) you have to hire an unrelated management company to rent it out, do upkeep, etc.
B) if you get a mortgage the percentage of the real-estate that is mortgaged doesn’t really count as being in the IRA. This means that you have to calculate that portion and make sure that this percentage of the rents you earn doesn’t end up in the IRA and that you do pay taxes on that percentage. This gets complicated fast and you’ll almost certainly need an accountant that has experience with this sort of thing.
Why it was a bad idea anyway: The whole point, if you don’t have a strong opinion of changes in your tax bracket, of the IRA as a tax shelter is that it saves you all of the tax on earnings your investments make.
For your primary residence, up to $250,000 of the gain is tax free! This increases to $500,000 if you include your spouse. Notice I didn’t say if you sell your house for less than $250,000. I said up to $250,000 of the gain is tax free. Given that the median home price is about $222,000 most of you will not have to pay taxes on the gain when you sell it even if the home price doubles. If the home price triples you’ll want to make sure that you get married a few years in advance of the sale.
Even if you have a really expensive house losing the tax benefit of the first half million dollars of gain in your IRA isn’t great news. Also, price appreciation of real-estate over retirement investing timescales is like 3-4%. Compared to stocks this return is quite pitiful.
Stocks, Bonds, and Mutual funds
For now, you’ll just want to stick with these. Getting creative is valuable. Use your creativity in your other endeavors. When it comes to taxes creativity isn’t generally a good idea.
Advance loans are a new form of funding for cash-strapped businesses. There are many difficulties associated with raising funds quickly. Advance loans have arisen to plug the gap. This guide will go into how advance loans work for businesses.
What are Merchant Advance Loans?
Merchant advance loans are loans taken out against the future sales of a business. It’s like being paid for sales that have yet to be made. All lenders demand is that they have a reasonable chance of recouping the money. This can be shown through providing a health check of the business and giving an insight into the company’s business plan.
These loans are typically short-term. In many cases, a direct debit is setup to repay a certain amount of the money each day. The agreement may also be in the form of taking a percentage of every sale made. Merchant Cash Advance is the service that has pioneered this type of financing. While it’s existed in some form for a long time, Merchant Cash Advance has made it available to businesses of all sizes for the first time ever. There are several lenders that offer these type of loans including Business Lending Pros.com.
What Types of Sales Can Be Financed?
Anything that amounts to income for a business in the future can be conceivably part of an advance loan agreement. The most common type of cash advance you’ll find on platforms like Merchant Cash Advance is credit card sales. From the perspective of a lender, receiving payment from these sales is easy. When everything is done electronically, everything is transparent and relatively easy to handle.
But there are other types of future sales companies can finance. These can include future cash sales and net-30 commercial sales. But the repayment methods are extremely complex, and are thus undesirable from the point of view of many lenders.
How Much are you Entitled To?
Unlike a conventional bank loan, you can’t waltz into the room and ask for as much as you think you can get away with. The amount you’ll be offered will depend entirely on your past sales history. Your past sales history may not be stellar, which is why you’re asking for funding in the first place, so you may be able to convince lenders that the situation will improve.
Generally, the amount of money you can ask for is between 80% and 150% of your monthly sales. If you do ask for above 100% of your monthly sales, be prepared to take a massive risk. If you fail to deliver improvement, you are likely to fall into financial difficulty.
A cash advance factor is what you pay back. This tends to come in the form of a number, such as 1.09 or 1.50. In this case, 1.09 means if you took out $100,000 you would have to pay $109,000. 1.50 means you would have to pay out $150,000.
Since most cash advances are repaid between three and fifteen months, you have to think carefully about the amounts involved before deciding whether the loan amount fits in with your financial plans.
What are the Disadvantages?
Like with all loans, there are disadvantages. Companies should think about why they need the money in the first place. The product is the solution in this case, so if the product is also the reason why you need funding this probably isn’t the right funding option for you. On the other hand, if you are a growing company that needs to take advantage of a sudden spike in sales this is the loan option for you. But like with any loan, you need to do your research and see which lender is best for you. This isn’t an agreement to go into lightly.
The Panama papers leaks happened about a month ago. No doubt there is still more to come as the leak was 2.6 terabytes of data. Most of the news stories I’ve seen cover this mostly name drop politicians alongside more nefarious individuals alongside the implication that somehow these folks are cheating the system. At the center of the controversy is the Panamanian legal firm Mossack Fonesca. People indicated as having set up accounts with Mossack Fonesca include, Ian Cameron (the father of David Cameron), several close associates of Vladimir Putin,
The firm handles hundreds of accounts for clients. Many of them are held by owners whose identities are not disclosed. They also provide some level of wealth management services. This generally means that they try to invest the money held in the businesses registered to them in a sensible. If you have a significant amount of money, and you desire some privacy you might be inclined to open an account with Mossack Fonesca. Crazy thing is, it doesn’t even cost that much. It’s something like $1000 to set up an account and then there are ongoing maintenance fees. If you had known in advance that this leak was going to happen, and you wanted to make some folks think that you had real money (and were possibly a jerk), you could have just gone ahead and set up an empty account. (Unsolicited advice: Don’t do something like that, it’s going to turn out to be more trouble than its worth.)
Sidenote: A Rant on Privacy
One of the most bothersome things about this whole fiasco, in my view, is that ordinarily pro-privacy liberals have started making the same tired arguments against privacy that neocons like to make. “If you have nothing to hide why do you need privacy,” has been a dumb argument for centuries and it doesn’t get any smarter just because you can target it at someone you don’t like. Most millionaires in the United States practice “stealth-wealth”, meaning that their neighbors, friends, and even family don’t know that they are millionaires. Like clockwork you see these news stories, “Old lady dies and leaves millions to local school. ‘We had no idea that she could afford food, let alone owned all of the Wendy’s restaurants in town’ say neighbors.” Why do most millionaires in the United States keep their wealth a secret? Something like 70% of lottery winners go bankrupt. There are plenty of reasons to use shell companies as well. Check out Donald Trump’s situation for example.
So What’s the Big Deal?
So all these rich guys just need an account that’s private, I can get behind privacy, so who cares? There are three major cheats that I’m aware of:
- Tax cheating: The trouble starts if your company starts dealing with another company you own. Maybe you pay your Panamanian company $1,000,000 a year for consulting. That consulting never actually happens, but it doesn’t look as suspicious because no one knows that you’re really paying yourself. This means that you can effectively sidestep taxes. Expenses aren’t taxed, just profits, so all that money can flow to Panama tax free.
- Bribery: Perhaps you’re a politician and you’re for sale. You’re very willing to sell out a vote for money, but you want, like actual money, not help with your re-election. You vote the way a company wishes you to, then your Panamanian company bills them for bogus consulting. No problems because you aren’t associated with the Panamanian company according to the outside world.
- Appearing Poor: Let’s say that you’re a politician and you need to appear to be a man of the people. You don’t want it getting out that you’re really a billionaire, that’d ruin your image. Instead you have most of your net worth in a Panamanian shell company. No one knows you own it, and you lie and don’t report it to the government. Boom, you’re “poor”. This, in my view, is totally justified if you don’t have an obligation to share your net worth, and I recommend that most people not share their net worth. However, it’s clearly fraud if you are required by law to disclose it.
- Sheltering Assets: Suppose you want to divorce your husband, but you don’t want him to take away half of your stuff. You create a shell corporation, it bills you for nearly all of your net worth and by the time you serve the husband with divorce papers he gets to find out that the marriage is largely penniless.
- Money Laundering: Suppose that you’re criminal and you need to spend your money. Perhaps this could be done in one step, but I think it might require two. Set up two shell companies call them Good partners and Evil & co. Set it up so that Good partners owns Evil & co. Make a payment to Evil & co. Evil & co then makes a dividend payment to Good partners. The money at Good partners is now clean and spends just fine, because as far as the world knows Good partners has nothing to do with you.
There are other nefarious things you could do as well, and this isn’t an exhaustive list. This is why everyone’s pissed. The argument goes, why would you have an account with them unless you were trying to do one of the above? Mossack Fonesca says that it complies with regulations to prevent the above from happening, but ultimately no one really believes them.
How big a deal is this?
It’s a pretty big thing. Backlash has already caused the prime minister of Iceland to resign. (Alright, Iceland is a huge country). The biggest impact in my view might be David Cameron, the Prime Minister of England and the leader of the Labour party. His father was referenced in the papers.
If you don’t follow English politics this is a big deal because about a year ago Jeremy Corbyn became the leader of the Labour party. Jeremy Corbyn is a very radical leftist, and was widely considered likely to lead the Labour party to a disastrous election cycle. If this scandal sticks to David Cameron in a big way then it could mean a massive move to the left for the UK. Of course the Labour party might be too shattered from Corbyn’s election to take advantage of it.