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Saturday, November 12, 2011

No, no, no, and no. . . Investing Like You are Poor

In some financial article I have somewhere for the blog, a writer made a very insightful comment which I am paraphrasing about too many people in our communities are investing like they have just stepped off the boat, even though their relative financial comfort should call for a more conservative approach. Yet they are investing recklessly, make it or break it style. It was one thing for our grandparents to put what little they had into a single basket. The worst that could happen: they'd be left with nothing in their pocket. But where they are on the financial spectrum, that type of investing is simply inappropriate. They are simply taking on too much risk, and in the process they often end up loosing more financial footing trying to 'get rich' when normative investing would be more suited.

A team that is mid-game and keeping the score close (i.e., they have a reasonably comfortable life an some good years ahead of them) simply should not be throwing their football into a disorganized, crowded end zone. But, it is happening far too often and I've seen more than enough shares at our favorite frum women's forum to know that this issue is prevalent and relevant.

In this imamother thread a wife brings her concern to the chat room (a bigger issue is that the husband isn't listening to the wife and they aren't a team as he plans to enter into a passive income activity that isn't really passive and is sure to involve her even though he probably doesn't even realize that between sips of kool-aid). She is rightfully concerned about her husband's plan for an inheritance. He heard from a relative about a lady who buys homes in other states, rents them out providing income, and then sells them a few years later.

Ah, investing in a cash-guzzling non-liquid asset with inheritance money, sight unseen, in a state you don't live in because you heard a tip from a relative. Screams bad idea!

I don't want to talk too much about real estate investing and get side-tracked, but I would recommend a first time investor create a situation of maximum flexibility: flexibility in the family budget to cover shortfall/losses, flexibility on the time frame, flexibility regarding property management or self-management.

When people who lack funds run into money (be it an inheritance, a platinum album, the lottery), they often act out of emotion. Below are some questions that I recommend those who run into money to consider. Readers are free to add their own questions.

1. Is our own personal financial situation under control?

2. Have we invested in our own income earning potential?

3. Are we investing in the future income earning potential of our children?

4. What are our predictable future financial needs and what level of liquidity do we need?

5. What level of risk is appropriate for our family?

6. What level of involvement in an investment works for our family?

7. What type of industries/investments interest us?

Especially for non-passive investments (and I'm not talking about passive from a tax perspective):

8. What will it cost to maintain this investment? What are the risks?

9. Do we currently have the relevant skills, experience, and support needed to make this work?
10. Are we on the same page regarding our investment(s) and can our family manage this considering all other needs?

While no one really wants their money sitting around losing money to inflation, there is absolutely nothing wrong with letting your money sit while you explore your get on the same page.

23 comments:

Conservative SciFi said...

Your approach is eminently reasonable, probably too reasonable for the husband in the imamother situation. It is much more fun to pretend, even for a short time, to be a macher, than it is to carefully invest your time and energy in investigating options. That's why the brokers with their tips, and the sister's friends with real estate, can get investments. I am not referring to frauds, either, but rather overly rosy cash projections. In my limited experience, the risk of fraud is lower than the risk that the promised return of 6 or 8 or 10 percent will really yield -2 or 0 or 2 percent after realities such as tenants moving out, stocks falling in value, business requiring more cash, etc.

Of course, sometimes those investments are really big winners. This is how the really big funds, of schools like Harvard and Yale, or Kleiner-Perkins make big money. They act as venture capital for 20 risky endeavors. If one of them is Google, or Genentech, even if the other 19 go broke, they come out way ahead. If I (or you) invest in one of the other 19 with our limited resources (we'd never actually be allowed in, since we aren't wealthy enough), we'd just lose.

The lesson is to diversity your risks, some in cash, some in real estate, some in stocks, maybe even a little that you can afford to lose with cousin Moishe's new business idea which might make it big.

JS said...

The real issue is understanding what you're investing in. It's true for stocks and bonds and other financial products and it's true for real estate and businesses.

It's ridiculous to invest in or try to run a business when you don't even understand the very basics of a balance sheet. I know people who have sworn to me up and down that they are making a lot of money with some pyramid scheme (sorry, multi-level marketing opportunity). They were making hundreds a month they swore. Slight problem: they weren't accounting for all that they had to spend on the products, the time they spent doing the selling parties, etc.

Same with real estate for example. What's a safe amount to be leveraged. What are the tax implications? How much will it cost to hire someone to manage the property? How much time will you need to invest? What rent is realistic? What happens if you can't find a renter? What if the renter doesn't pay? Are there squaters' rights?

Don't invest in something you don't understand. Or, at the very least, if you do, make sure losing the money won't put you out on the street.

Zach Kessin said...

Really If you want to invest in Real estate go listen to a bit of Dave Ramsey. He made a fortune in Real estate, then lost it, then made another.

You need to account not only for the case where it all goes right but also the case where it all goes wrong.

Here is the thing about real estate (All of this is from my listening to Dave) What happens if you tennets don't pay and then you have to evict them and it takes a month to get someone else in. Can you afford to feed the thing while it is empty? Can you afford to wait and say no to renters who might not be the best quality?

If you want to invest in real estate do so, but *IN CASH*. Doing it leveraged up to your eyeballs is a good way to go majorly broke.

Oh and don't take investment advice from broke people.

Anonymous said...

Wall Street Journal had this article about investing in Real Estate. I agree with the advice.

http://online.wsj.com/article/SB10001424052970203537304577028390121257670.html?mod=WSJ_PersonalFinance_PF15

Avi said...

These types of posts never generate much response from your peanut gallery, SL, because we all agree with you. :)

Anonymous said...

What if one doesn't have money to invest or save? Our scenario is that we live out of town and received a scholarship so tuition is not outrageous, we don't send our kids to overnight camp, we don't go on vacation, we own one car, we shop at bargain stores, use coupons a lot etc . No ipads, ipods, kindles smartphones etc. no cleaning nor babysitting help. We live paycheck to paycheck and are able to save very little, approx 200 per month. Any suggestions on how to build a nest egg for the future?

Miami Al said...

Anonymous 6:43,

Here are some things to consider. I am NOT a financial planner, this is NOT financial advice, these are a list of vehicles to CONSIDER because if done carefully, won't jeopardize your scholarship situation.

First, look into a retirement plans at work. At a minimum, the scholarship committee should let you get the full match, so 3% of salary + 3% match, that will also lower your taxable income and pay stubs, which if the scholarship committee is sloppy, might increase your scholarship. Though you are probably better off tax-wise in a Roth 401(k), the scholarship situation makes it important to lower your W-2 income.

Second, careful with your savings. You probably can't sit on piles of cash (the scholarship committee is probably okay with a $1k-$2k emergency fund, but beyond that, they're going to assume that you can pay more. Consider keeping your emergency fund in cash or cash equivalents instead of a financial institution, if they see savings, they assume you can afford more, but $1000 in a savings account and $2000 in Savings bonds (or a wad of $100 bills) won't show up anywhere. Savings bonds pay lousy interest, BUT they don't show up on your tax return until cashed in, might be a way to escape scrutiny, but in a pinch, you can bring the savings bonds to the bank and get your cash immediately. You'll show a small amount of interest income, but not enough to draw attention from the committee, they'll see the "income" of $10 - $20 in interest and consider it immaterial, ignoring the value of the bonds themselves.

Third, prepay your mortgage. Having no mortgage would draw attention, but prepaying $100/mo won't. It won't show up on your tax return or financials, reducing your mortgage by $1200/year extra won't show up to the scholarship committee either (unless they are doing real financial analysis work). This may take a lot of time off your mortgage. This won't improve cash flow now, but it improves your assets and will improve cash flows when you have no mortgage in those late years.

If you can repay your mortgage a bit this way, consider opening up a HELOC. They aren't as popular (or cheap) as in the boom, but that let's you get the best of both worlds. You have access to cash via the HELOC instrument, but nobody is going to demand you pay for tuition out of it (you probably don't even have to disclose it if you have no balance on it, or a small one of $1000, it'll look like debt). That way, in normal times, you reduce your main mortgage (reducing mortgage debt), but in a crunch, you can borrow it back via HELOC, then switch your "extra payments" from the main mortgage to the HELOC until you cover it off.

If you can pick up side income, particularly SMALL amounts (< $600) that won't generate a 1099, use that cash to purchase savings bonds or other instruments that will preserve cash without showing up on a bank/brokerage statement.

Fourth, more aggressive would be purchasing "whole life" insurance in small increments. Whole life is a mediocre investment, but an interesting vehicle. You imply that your kids are all in school, meaning that you are at most 12 years away from being out of tuition squeeze. Whole life is a TERRIBLE investment in years 1-7, okay investment in 8-10, and a pretty decent investment for 10+ years out. Given the need to build a nest egg without triggering a loss of scholarship, this might be something to consider as well.

JS said...

I'm very conflicted on your question Anon 6:43. The advice Miami Al gives you is pretty decent, but it really chafes me to plan out your financial future around the idiosyncrasies and absurdities attendant in receiving scholarships. I have to assume Al's advice would be drastically different if you weren't on scholarship. And that's the difficulty. The best thing to do, scholarship be damned, would be to save up an emergency fund and do your darnedest to cut expenses and increase income. Take on another job, get new training or schooling, polish up the resume, etc. But, all of that may jeopardize your scholarship. In my view, jeopardize it. Even if you're in a scenario where every new dollar coming in is one less dollar of scholarship (worst case scenario and unlikely in my opinion regardless), you'll still be better off long-term. Tuition is paid for a finite period of time. Your extra income will take you far beyond that period.

There really are no grand tricks here. It's finding a way to lower expenses and finding a way to raise income. Fancy investments and saving secrets and such come later. Get your basic financial house in order: emergency savings and retirement savings and improve your expense/income ratio.

If it were me and the scholarship committee starts to harass me over increased income and I'd flat out tell them you'll pay more, which is only fair, but not everything. That if they take everything you'll just lower your income and they'll end up having to give you more. Push back.

Don't look so much at how much is left over at the end of the month. Look instead if your financial goals are being met. Having $200 left over at the end of the month isn't so bad if you've got an emergency fund, you're funding retirement accounts, and are paying all your bills in a timely matter.

Don't be lazy and don't get stuck in a malaise and don't get trapped in the thought of "it's all gonna go to tuition anyways." Figure out how to increase income. Think of what other people in this country do working menial jobs or taking on second or third jobs. Don't think something is beneath you. Again, see if you're being held back by lack of training or education. See if a different field would be more lucrative. You want to get ahead in life and not struggle so hard - find a way.

Miami Al said...

Anon 6:43,

My advice was to answer your question, how do you build a nest egg given that you are on scholarship, and my answer was how to build up a nest egg that won't be "demanded" to pay for one semester of tuition.

To double up on what JS said, working on increasing income is key. Given that you have 12 years of tuition pain, increasing income in those 12 years is "nice" but increasing income in year 13 is golden. For that to work, consider investing in education and additional skills. If you can build your human capital up (more education, for example) that will increase your income in the out years, so much the better.

If you don't already have a college degree, work on that. If you have one, work on a masters. You can do it slowly, 4 years for an AA at a community college will be a leisurely pace, another 4 years for the bachelors, and then work on the masters for 4 years. Other options are things like law school, or other training for the professions.

These options would show you with a career migration in 4-12 years from now (depending on where you are educationally), which may result in a nice increase in salary, but more importantly will result in a career path projection.

Moving from a "normal job" to a entry level lawyer/accountant/financial analyst (JD, MAcc, MBA respectively) will likely be a lateral move in terms of pay, but the upward potential is huge.

Things that produce windfalls now (second job) are counter-productive, it'll burn you out, 100% of the increase will go to tuition, AND if you find you can't actually work two jobs forever, the scholarship committee will be VERY unforgiving of salary decreases, putting you behind the eight ball.

It is better to have an annuity payment that pays over time than the equivalent cash, since your effective marginal tax rate + tuition tax rate is nearly 100%, with a cliff when your last child leaves school. Since your scholarship situation prohibits investing in ACTUAL hard assets (stocks, bonds, real estate, etc.), invest in your human capital.

A lesson I learned from my grandmother, they can take your money, property, and business, but they can't take what's in your head. She learned it from a nefarious government, but the lesson is just as true in modern America as pre-war Germany. Look at the OWS crowd, they are demanding assets be taken from the wealthy, but to be relieved from the debts spent building up their human capital, what else is "tax the rich" and "forgive student loans" as a war cry?

Since they go after financial capital and NOT human capital, best to over invest in human capital and under invest in financial capital.

I would give the same advice if tax rates were 70%, invest in yourself, not wealth, and then when tax rates fall, you'll be positioned to make money then. The fact that it's tuition dollars and not tax rates or corrupt government officials affects the morality, but not the economic impact.

JS said...

I think a lot depends on what the scholarship committee is like and how much "push back" you can give them. If it's really true that between taxes and scholarship reduction you'll effectively be taxed at 100%, you need to be a bit "creative" in hiding assets and income. On some level it pains me to advise less than 100% disclosure, but there's a difference between outright cheating and playing the rules to your best advantage.

Have you tried a forthright conversation with the scholarship committee along the lines of "Look, I'm living paycheck to paycheck. This is not sustainable. What are you willing to do to help me as I try to earn more money?" If they'll only take 50% of new earnings after tax, maybe it's worth it to take that second job if you can endure it.

Either way, you don't want to be too clever by a half and be overly concerned with the scholarship tax. You'll be done with tuition payments eventually. When they're done, you'll have the benefit of whatever extra income you earned along the way that was being eaten by scholarship reduction. So, you find a way to earn 10k more a year and the scholarship committee grabs a big chunk of that - you're still better off since once tuition is done that's all yours. Better yet if that 10k is not a one time thing, but a growing income in a new field or business.

Look, no one's gonna turn down extra money just because they have to pay a tax on it. Your key is looking long-term and trying to keep as much of that money away from scholarship take-back by following the rules to your best advantage and convincing the scholarship committee that their not grabbing it all is to both of your advantage.

Miami Al said...

JS,

If the 10k is a growing income, you're better off with it.

If the 10k is an annual income from labor, of which you pay $3500 in taxes and $6500 in extra tuition, you're neutral, but the time you spent earning that $10,000 is time you neither spent with your children NOR learning new skills to earn money.

If the 10k is annual income from labor, and next year you can't keep the job, then good luck convincing the scholarship committee to give you the extra $6500 in tuition.

The scholarship committee is not evil. However, they are working on behalf of the school, and the people on it are volunteers, generally from upper income families, that don't understand that that part time job might not be there next year.

JS said...

Al,

Agreed. That's why I suggested talking to the committee and negotiating a non-100% effective tax. A lot of it depends on how much you really want that extra income and what skills you have. If you're not capable of getting more education/training or switching to a more lucrative career (and, let's face it, not everyone is) then a second job may be your best bet at trying to get ahead even if it means less time at home.

You need to look also at what the goal is here. Is it having an extra few hundred a month so you're not stressed out about living paycheck to paycheck? Is it just building an emergency fund? Just not having to worry about retiring someday? Being able to afford a bar/bat mitzvah party? Or are you looking to put yourself on a new trajectory career-wise and financially?

There's a lot of information we just don't know here, so it's all just generic advice.

Avi said...

Al/JS, I'd just like to remind you guys that the "scholarship tax" is not a tax, it's simply living up to your obligations to pay for (wonderful) services rendered. How come neither of you are advising them to work more and increase their human capital not to save for the future, but so that they can minimize the amount of tzedaka they are taking from the school, its parent body, and its donors?

Miami Al said...

Avi,

Because Anonymous asked how to build a nest egg, not how to be a better human being.

For that, consult a spiritual advisor, not an economics forum.

conservative scifi said...

Avi,

It makes a wonderful Hanoch Teller story when a poor man works four jobs to pay back debt or cover tuition bills. It may even set a fine example for the man's children.

It makes a terrible real life to spend every waking moment apart from shabbat/yom tov working at menial (or even not so menial) labor and spending zero time with a wife and children.

It's easy for me (and perhaps us) (unless you are also very poor) to suggest that the poor man spend his life working to avoid tzedekah. While I don't love the very high tuition I pay, if part of it permits someone with a meager wage to spend additional time with his/her family, I can accept that expense willingly.

Anonymous said...

Thank you so much Miami and JS for your insightful advice! I am truly grateful to you for taking the time to go into such detail.

I should have specified that we do not have an emergency account nor retirement accounts, the two hundred a month is not a left over amount, rather it's what we are (usually) able to save each month.

Finally, we rent our home and we're in kiruv full time in small town usa so our salary is very low.

JS as I mentioned in my first post our expenses are already extremely reduced, not sure what else we could eliminate...we do eat poultry and meat rarely so there goes that expense :)

JS said...

Avi,

My advice was geared towards that time period where you're not yet earning enough to get completely off of scholarship and still have left over.

The way I see it, scholarship works like this as income goes up:

1) Not earning enough, get scholarship

2) Earning more, still on scholarship, earnings going mostly/completely to reduce scholarship

3) Earning more, no scholarship

4) Earning enough to pay tuition with lots left over

The issue is when you're at stages 2 and 3 you may not have much more disposable income than you did back at stage 1. That really stinks and makes a lot of people not even try to earn more money, which as I said above is a mistake in my opinion.

As for whether paying more tuition makes you a better person, I'm really conflicted. If the schools have it built in to the payment system that certain people don't have to pay as much, why are you morally obligated to pay any more? It's not even clear to me that this is receiving charity. There's probably a better argument for someone on scholarship not spending on luxuries out of fear of losing the scholarship (for breaking a contractual/financial arrangement) than some moral sense of not spending on someone else's dime.

For example, if I put my income into a 401(k), the government charges me less taxes. If the school has a similar rule that retirement savings are okay and not counted against you for scholarship, should I avoid my 401(k) so I pay more? Should I contribute to the 401(k) but pay more to the school anyways?

It's the complicated issue of whether the school is a business or a communal institution. It acts like one or the other depending on its interests.

JS said...

Anonymous,

If you're in kiruv, these would be my suggestions:

1) Argue with the school to get more scholarship. After all, you're doing Hashem's work and they should respect that. You're klei kodesh, no? Do they give more if you're a rabbi? Maybe your ticket is getting smicha if you don't have it.

2) Accept that you've chosen a path in life that will never provide you with financial security. Some sacrifices are worth making. It appears this is one for you and your family. Build up whatever meager savings you can, and try to find other sources of income and ways to lower expenses.

3) View kiruv as something you do for a set period of time and then move on. In other words, treat it like those who learn in kollel for X years and then get a job. I have no idea what your age is, but you can set a target date for leaving the kiruv life or transitioning it to part-time and get job training or other skills to allow you to earn more money. So, for example, you do kiruv for 5 more years and during that time you go to trade school or a community college so that at the end of 5 years you move from kiruv to a different job. Obviously you need to find out what your skills and talents are and work that to your advantage - don't just assume you can become an accountant at age 40, for example.

4) See if you can get more government aid. Maybe you already get this. Maybe there's aid out there you don't know about or you earn just a bit too much to qualify for.

Anonymous said...

1. I'm a woman btw, we've already negotiated the scholarship as much as they're willing to go.

2. We willingly accepted that path in life, my post was not a complaint but a request for ideas.

3. We're in this until Moshiach comes.

4. We do get some aid.

Thanks again!

Conservative Scifi said...

Anonymous,

Does Kiruv have to be a full time job? I realize that as the wife, you are probably busy not only with the hosting aspects of kiruv, but also with multiple young children, and the entire home life. You probably don't have time to get another job, anyway.

Could your husband spend some of his time getting further education to prepare a dual career?

I imagine (but may be wrong), that most kiruv activities happen at lunchtime or evenings during the week or on Shabbat or sunday. That leaves regular work hours more open to regular employment. If he developed skills as an accountant/bookkeeper if he likes math, store manager/Human resources/psychologist if he likes working with people (likely if you are in kiruv) or some other specific skill set, after four or five years of part time education, he could obtain a part or full time job that would provide you with much greater income security. That would probably make your kiruv work more pleasurable, as well, since you wouldn't depend on it for your income.

Anonymous said...

Conservative Scifi: You read my mind. I was going to make the same comment. I would also note that I know Kiruv couples where the wife does have a paying job apart from the Kiruv work. Usually its teaching. I believe that Kiruv can be more effective when done by someone who has to balance work in the outside world with an observant life because the people you are trying to reach can better relate to that. Its hard to be suggesting to people that they take off all the yom tovim, leave early for Shabbat and don't do any of their errands and housework, etc. on Shabbat if you aren't showing how that is doable while juggling a full time job in a world that does not revolve around an orthodox schedule.

Upper West Side Mom said...

Joel C,

You are totally clueless as to how Americans view Thanksgiving. It is a really big deal and not only because of the food. Is any given chag or Shabbat not special because we might spend time thinking about what we will be eating? Thanksgiving is a day to give thanks for what one has and for having the opportunity to live in this amazing country. It is also a very, very special family day.

I think the people of Lakewood should not go to school or Kollel on Thanksgiving. They should be home thanking G-d for the opportunity to live in a country that tolerates all their shenanigans.

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