We have all heard about diversification when it comes to our investments.  Most people tend to believe that putting all your eggs in one basket is a highly risky approach to doing things.

This could apply on several levels. First, in terms of diversification among asset classes. For most of us, it’s probably not the best idea to be investing 100% in stocks – or bonds, or any other asset class.  Even if you did diversify well, you probably wouldn’t want to put all your money in one particular investment in an asset class. For example, within stocks, you wouldn’t want to put all your money into one particular stock – diversification within asset classes is important too.

All this being said, I think we can agree that for the average person, investments ought to be effectively diversified. But what about income?

There is regular chatter among many personal finance bloggers about the value of diversifying income streams. But I wonder this: among most mainstream (non-PF Blogger) folks, why is diversification of income not seen as being as critical as diversification of investments?

Think about it – most people will not put all of their investments into one particular company.  Sure, there are some who don’t believe in the concept of diversfication vs. investing in what you know, but that’s not super common. By default, if people have a 401k, they’re probably invested in many different companies by virtue of having mutual funds.  Or, if they own a home, they might have some equity in place. Perhaps they have bonds, or cash. Either way, it’s highly unlikely that their investments are tied up into one single company.

However, when it comes to income, many people seem to view it differently. Frankly, I used to be the same exactly way until the last year or so.  This meant looking at a job as THE source of income. Without a job, there’s no income.

Realistically, that’s probably the case with most people, I’d assume. It’s the way our society seems to be set up. However, this mindset seems to lag the sophistication we collectively have about diversification of investments. Shouldn’t income be diversified too?

If the primary source of people’s day to day money needs is their income – while savings are for retirement and other longer term needs – then it seems to make sense that income should be protected. This can happen by having a great career, but even then – you could be at the mercy of your employer, your industry, or economic conditions.  So, why not diversify income sources?

Again, while many personal finance bloggers think about this, I wonder why this concept of income stream diversification isn’t has seemingly top of mind as investment diversification?

Recommendation: let’s consider it to be essential to have multiple sources of income.

If we wouldn’t invest all our savings in one company, why invest all of our income potential in one company? Let’s really take action and work on multiple streams of income in the New Year!

My Questions for You:

Why do you think it is that many people might be hesitant to invest all their money in a particular company, but will totally depend on an income stream coming from one company in employment?

Are you taking action on generating an income stream that’s different from your day job?

We all want to be able to have enough money for retirement.  Many people are not on track to do so, which makes it paramount to understand what actually helps us get enough money for our older days!

A recent article from Smart Money listed three factors that are drivers of retirement success. Here they are, and I’ll follow with my comments.

1. Employing a consistent, long-term savings and investing strategy
2. Working with a financial adviser
3. Saving money in your workplace retirement plan

Here are my thoughts:

1. I absolutely agree with this.  Being disciplined with our savings efforts, and doing in regularly over a long period of time, can do wonders for one’s retirement. It’s really straightforward in principle: save, do it regularly, do it early in life, get a solid rate of return, and let compounding work it’s magic.  Now, there’s more to it, such as protecting cash inflow, managing one’s career, and diversifying income streams.  In any event, regularly saving and investing consistently over a long period of time is a great practice.
2. Hmmm. I  manage my investments on my own.  Would it help to have an adviser? Apparently, according to the article, it would.  They show that people who have an adviser have a higher probability of replacing income in retirement than do those without an adviser.  With me, it’s kind of a control factor, wanting to make the decisions on my finances individually. I’m not into sharing these decisions:) Plus, admittedly, there could be some hubris involved. Beyond that, however, I just feel safer managing my own money. Maybe this is something I should revisit, in terms of considering a financial planner.
3. Yes, I agree with them on saving in a workplace retirement plan.  When you do so, it can often become automatic. This aligns well with #1 above. Plus, when you consider that some employers offer a 401k match, it becomes an even more attractive option. Just don’t use that 401k for credit card debt, needless to say!

As you can see, the one area for which I’m not totally on board is the adviser factor. I’d like to learn more about the study that yielded the findings quoted in the article, just for my own curiosity so I could better interpret the data.   Who knows, I might be able to be convinced to revisit this one.

Also, their recommendation to save at least 10% is good, but I would suggest higher. To be fair, they did say “at least”.

Anyway, I’m all in on #1 and #3, and skeptical on tip #2.

My Questions for You:

What do you think about these tips? Any more that you would add?

Considering my own thoughts on advisers, I’m curious what yours are. Do you have one? Are you considering one? Feel free to convince me on your views:)

Many of us are big proponents of living within one’s means, and saving for retirement and other life needs. In order to do that, we often try to save as much as feasible based on our current income level.  This makes sense, and is a cornerstone of growing one’s wealth.

To this end, saving money almost becomes a sport to some people. Check that – it IS a sport to many, who spend big chunks of time looking for deals, cutting coupons, reading about ways to save money, and so on. Some people, like me, even write about ways to save money! As any regular reader knows from the Squirreling Gone Wild series, I personally enjoy observing and hearing about people who go to extremes to save a few bucks. And yes, sometimes I take part in the fun too.  I truly enjoy saving, both in terms of finding ways to cut costs and in getting deals. Some people get so caught up in squirreling away money any which way they can, that they cross lines of fairness, which clearly isn’t cool.

When saving becomes an obsession, it’s easy to forget about making money. I shared my thoughts about this in the post Saving is Great, but Don’t Forget to Make Money Too.  When consumed by saving, income growth – or worse, income preservation – is often forgotten.

I thought about his some more, and am considering the ROI of time invested in both saving and income growth. Here’s my question:

Is it more productive in the long run to increase time on income preservation and growth, while reducing time spent on saving?

To some degree, we’ve explored part of this topic in a few prior posts.  Clearly, spending time on saving is important. It’s just that when we take it a step further and analyze it, there are diminishing returns to our time.

Meet Jane

Let’s take an example of a random person – let’s call her Jane – who makes $4,000 per month after taxes. Jane’s expenses are $3,600 per month, netting her $400 in savings per month.  Jane is saving 10% of her income. Let’s also assume that she does so without giving it much thought.

Next, let’s say Jane decides that she wants to look for ways to save more. Let’s say she starts looking for coupons, spending an hour a week searching and cutting/printing. Let’s say she goes an hour out of her way each week to go to different places that can save her money on regular purchases – groceries, gas, cleaners, etc.  How about we also assume that Jane spends another 2 hours per week online reading about ways to save money, talking about shopping, or thinking about saving on good deals. Maybe another hour tracking her spending in great detail, recording all transactions and filing away all receipts. Total weekly time spent focusing on saving is maybe 5 hours, and let’s say that projects to 20 hours per month.

How much can she save? Well, it depends on her situation, but let’s say that she can cut her expenses from $3,600 per month to $3200. That’s $400 in savings for 20 hours of her time. $20 per hour isn’t bad!

After a while, however, Jane can only cut so far.  The next month, if she spends 20 hours of time focused on savings-related activities, how much could she save? She already took care of the low-hanging fruit, so now it takes more work. Maybe now she’s identified the opportunity to save another $200. So, based on 20 hours, that comes out to $10 per hour. The third month maybe she’ll cut another $100 from her expenses, making her payoff $5 per hour.

Eventually, there’s only she could save, and her ROI in terms of time starts to diminish.

What about time spent on income?

First off, if Jane is working, she’s already spending the better part of the day generating income. Hopefully, she’s positioning herself to continue earning income and maybe make more. But what if she invested some of that time on income – let’s say 12 out of those 20 hours?

She could spend those 12 hours researching different side businesses. Or, she could spend time pursuing an advanced degree part-time. Perhaps she could learn about investments. Maybe should devote that extra time to her current job, and really make herself invaluable or even promotable.  Or she could spend some of the time working, and the rest networking, meeting other professionals and learning about opportunities.

What would her ROI on that time be?

It might be low. It might be wasted time. Or, it might be well worth it and pay massive dividends down the road. If she really invests her time right, she could work toward growing that income much higher. Who knows, maybe she could double her income, increasing it $50,000 to $100,000? Or more?

If she spent all her time obsessed with saving, she couldn’t gain $50,000 back in reduced expenses. There’s a limit to what can be gained that way.

By investing some time in income growth, there ROI could range from zero on the low end, to an upside that could be quite high.

If in the end, saving or growing income is all about having more money. Thus, it pays to think about ROI on time, and consider balancing time between saving and income growth. There’s a combination there that’s right for each of us, based on our own individual needs.

And the portion of wealth creation that’s spent on saving…if it’s an exhilarating sport to you, enjoy it! I know I do:)

Those of us who are personal finance bloggers or blog readers know that it doesn’t necessarily take remarkable luck and good fortune for someone to eventually become a millionaire. Sure, those things are a tremendous help, there is no question about that. However, an individual or family with a more modest level of income and not coming from wealth still has a chance to get there, provided they start saving early enough.

Yahoo! Finance had an article on 7 common millionaire myths that are commonly held. Below are those myths, with my comments:

1) Millionaires Don’t Pay Their Taxes.

As the article states, they already do, and this is not likely to change in the near term. While we all want to be millionaires, there’s no need to hate on those who are, just because they’re millionaires!

2) Millionaires Just Inherited Their Money

Some sure have, but the viewpoint that all have inherited big money is simply not true. Many of them have worked hard for their money. I think that this myth is one that’s perpetuated in order to make people feel better about their own situations. Believe me, I’m no millionaire but I’m not going to stick my head in the sand and think that all millionaires just had the money handed to them. Some did, but not all. Sometimes that’s evident.

3) Millionaires Feel Rich

I’m not a millionaire, so I can’t tell you exactly how they feel. It would be nice to find out from personal experience someday! That said, from what I have seen, I suspect it’s the drive to cover life’s necessary expenses, and a bit of ”paranoia” about being broke, that has driven people to get to the point of being wealthy.  

4) Millionaires All Have High-Paying Jobs

No, they don’t. Some people are able to live within their means, maximize the savings minus expense gap,invest properly, and avoid big financial and life mistakes. With a mixture of discipline (and in some cases a little luck), there have been innumerable middle-class people who have accumulated wealth.

5) Millionaires All Drive Fancy Cars

Many people became millionaires by living within their means, and being able to discern wants and needs. If I had a million dollars handed to me today, I still wouldn’t buy a new, upscale branded car. Rather, I would buy a reliable used car.

6) Millionaires Hang Around the Golf Course All Day

If they did this, they had better be worth well more than a million dollars! Otherwise, their millionaire status would be gone in a hurry. This myth is a bit strange.

7) Millionaires are Elitists

Some may be, and I’m sure many are out there. I have also seen a few that are outwardly just like the average person, but behind the scenes when you get to know them their hidden snobbery comes out. Also, I have seen a few that are not elitists and frankly, don’t want to spend any money at all if they could help it. I think it’s tough to generalize about the attitudes of millionaires.

What do you think of this list?

I think there is much wisdom to be gained from those that are. Having a mentor, role model, or millionaire teacher are ways to get help and wisdom. In order to absorb that wisdom, I believe one must cut out biases, perceptions, and jealousies, and focus instead on embracing reality.

I also think that some people who want to be wealthy try to act like they’re already there. You know, driving a car that’s really a step or two above what they should be driving, buying a home that’ s not a good fit based on their income and savings, or purchasing designer clothes despite not saving much money.

A buddy of mine who is in his mid-30′s and dating shared with me a story about a woman he went out with who told him about her vacation preferences. She said that when traveling, she preferred to stay in 5-star resorts and get pampered as that was her standard. She just wouldn’t stay in someplace lesser. His take was that this was a huge red flag, and the relationship never got started. Clearly, to him, she was someone with very high tastes that was living well beyond her means. He’s not stingy at all, by the way. He’s a good guy that would be generous to anyone he is with (in case you’re reading, my friend!).

Anyway, I think that outside of those who inherited or got extremely lucky in some way, many people who are millionaires got there because of hard work. In addition, they got there by living within their means, saving a significant percentage of their income, making smart health choices (such as deciding to stop smoking), and being responsible overall in their lives. For example, making smart decisions such as saving enough money in tax-deferred accounts, and only making an IRA withdrawal when the rules are clear. Furthermore, these aren’t necessarily extraordinary income earners, either.

What do you think? Do you agree that these are generally myths? Do you have any examples from your own life to prove or disprove these assertions?

This article was included in the Carnival of Personal Finance at Budgeting in the Fun Stuff

Many of us who blog on personal finance tend to write a lot about frugality. It’s been a salient topic over the last few years, with the economic pressures that have disrupted the financial lives of millions of people. Frugality, as such, has gone from being socially unacceptable to almost de rigueur. Being frugal has become cool in some circles. Cut expenses to the bone, live on less, and save your way to financial bliss!

I do agree with the idea that cutting expenses to live within one’s means is very important. Additionally, the world is chock full of examples of average wage earners who have been very disciplined with saving a healthy percentage of income, leading to a very comfortable retirement and in many cases, financial freedom.

That said, I also think that it’s important to take a holistic view of personal finance and look beyond the realm of saving money. While frugality is a great thing, we also need to earn money in order to have any to save. And more important than that, what is the role of money in our lives, taken in the broader context of other important aspects of our existence?

Starting with the broad view, I like to look at money as being a part of the HWR framework - health, wealth, and relationships. Each one is an important part of our lives, and each one impacts the other. For example, if you improve your health by getting in great shape and improving physical endurance and mental alertness, you’ll put yourself in position to earn more. So money, while not an end goal (at least for me), is a part of the whole quality of life equation. Financial freedom, while not panacea for all our problems, would likely improve quality of life, all other things being equal.

Now, diving further into the topic of money, let’s examine how we can get closer to the point of achieving financial freedom. Again, given the attention many people (including me, admittedly) devote to frugality, one would almost think that it’s the concept that can most drive our wellbeing, as long as we adhere to the principles of living within our means.

There is some truth to that, to be sure. But there are two things at play here:

1. Bringing in revenue
2. Managing expenses

I can relate it to marketing and finance in the corporate environment. Without the innovative, hard work of those in marketing, there wouldn’t be revenue coming in the door. Without the folks in finance, expenditures would be too high, and money couldn’t be reinvested in the business or paid to shareholders.

In our lives, it’s our career that is the engine that drives our personal finances. You could pinch every penny possible, but if your career goes down the drain and disappears, you’ll be left scrambling. You might have to dive into that emergency fund – which, ironically, might have been funded by your career to begin with! Ultimately, what we want to do is maximize the income to expense gap.

To that end, in addition to managing expenses, I recommend investing time, energy, and focus in your career. Aside from an inheritance or other source of outside income, it’s the best place for people starting from scratch to begin to build their financial future and grow income. If you don’t invest in your career, you’ll have little stability and irregular financial income. If you do invest in your career, that could still be the case due to circumstances, but at a higher level of income. If you do it well, and get some good luck and fortune along the way, you have the means to build a nest egg.

That brings me to the next part – saving. By minimizing expenses, you can put yourself in a position to live within your means. Living within your means requires discipline, and the ability to distinguish between wants and needs. Actively managing expenses will allow for one to maintain a given level of expenses, with annual inflation adjustments.

By actively managing both career (cash inflow) and spending (cash outflow), we can increase the income minus expense gap. This gap equals savings. Once we have money saved, we can start investing and earning an after-tax rate of return that exceeds savings. Doing this early enough, with a good asset allocation, will allow us to grow our wealth.

The key concept: it’s all a system, with money just one part of quality of life – and with regard to money, it takes focus on both cash inflow and cash outflow to put us in position to drive toward financial freedom.

What are your thoughts? Do you follow a similar framework when it comes to your approach toward money in your life?

This article was included in Carnival of Personal Finance #263 at Suburban Dollar.

They’re out there. Lurking in our midst. Frugal, seemingly modest-living people, that are quietly hiding their secret.

What’s that secret? They’re millionaires.

I came across this story from The Seattle Times that was yet another example of a stealthy millionaire. This particular example was of a lady who recently passed at the age of 98.

We often hear about people who made their millions in seemingly typical ways: business, fame, inheritance, etc. But we also hear stories about everyday people that become millionaires through frugal living. Some of these can be quite boring, yet inspiring. Work at a job, do a 401k rollover when moving to each new job, and let the money accumulate and compound. Yet other stories, inevitably, are inspiring and compelling.

This one I find to be of the latter variety. This lady did not just live within her means, it would appear, but would go well out of her way to pinch pennies:

• She bought a coat for $2, then used the zipper to lace her shoes (why pay for shoe laces?)
• She never went to a salon; rather, she cut her own hair or used a wig
• She would heat her home with wood she hauled in with a wheelbarrow, even into her 90′s; she didn’t want to pay to heat her home

What she also did, besides living within her own means, was become knowledgeable about investments. She apparently studied finance on her own, and became self-taught in the subject, though she held such hard jobs as picking cranberries, shucking oysters and filleting fish. Is a million dollars not enough? Maybe to her that’s the case!

So, this is a lady who:

1. Lived within her means
2. Worked to grow her income through investments

The result was a $4.5 million nest egg, of which she left $1.o million for the local school district and $3.5 million for her town to build an indoor swimming pool. Very interesting choice, with the pool, but I give her credit – she did it her way. Kudos to her.

I’m a proponent of trying to live with an income minus expense gap that facilitates saving, having a sound stock investment strategy, and also trying to grow the top line through career management. While there wasn’t career management involved here, she followed the general framework of saving and investing.

A compelling story, odd yet inspirational in its own way. An ordinary person who successfully saved money, and left for causes dear to her. As long as someone doesn’t hide their wealth to mislead or take advantage of others, why not be private if you choose?

What do you think? Is this inspiring to you, or just plain quirky?

I recall a conversation with a former colleague of mine, a sports fan like I am, talking about a $500,000 bonus that a former collegiate sports coach had lost based on violating terms of his contract. We were both shaking our heads, each of us having a hard time understanding how someone could basically just throw away this kind of money with a simple mistake.

My former colleague then made a comment to the effect of: “If you had $500,000, you might be able to retire.” This comment surprised me, as he was generally very bright guy, good at his work and a very sensible, level-headed person. The reason this was surprising to me is that he was in his late 30’s, with a family, and felt that he might be able to retire on that amount. Mind you, this means retire with no pension to supplement – just the $500,000 principal.

Intrigued, I asked him how this would work. He was someone who watched his expenses, like me, so I expected an answer based on extreme penny pinching. Rather, he told me that one could earn 10% in the stock market, and then would have $50,000 per year coming to them. Not bad as retirement income, passive income nonetheless, he said.

Of course, I had to jump in with my own feedback. Sure, 10% each year could happen, but the market would be up and down, so it isn’t a reliable way to earn a steady amount passively. That said, even if you had some investment that paid at that rate, you would have to pay taxes, have transaction costs, etc.

When I told him that his $50,000 would buy him less and less every year, he didn’t get it. The biggest thing he seemed to miss was the time value of money: a dollar today is worth more than a dollar tomorrow.

I didn’t get into a full discussion with him, but if I could go back and continue the conversation, I would tell him about the concept of PV – present value. PV = the value of future cash flow in today’s purchasing power. The calculation is as follows:

C / (1+I)^T

C = cash payment
I =  inflation rate
T = Time – years into the future

In explaining the concept, I would illustrate with the following example:

Lets say you had $50,000 due to you. Which way would you like to receive it – all up front, in equal $5,000 installments for 10 years, or all at the end of 10 years?  No reinvestment, compounding, etc. Just straight cash payments. Inflation rate is 3%. Let us examine the PV of each scenario.

Scenario 1 – All up front. PV is $50,000.

Scenario 2 – $5,000 at the end of every year, for ten years. PV is $42,651.

Scenario 3 – $50,000 at the end of the 10th year. PV is $37,205.

Clearly, getting the money up front is a better deal. Why? The time value of money – a dollar today is worth more than the same dollar tomorrow.

So, when my former colleague does his retirement planning, and projects what his needs will be in the future, lets hope he considers the impact of time on the value of his money. We should all do so.

This article was included in Carnival of Personal Finance #256 at My Dollar Plan.