Here’s what the model looks like in regard to hitting ‘your number.’

The financial planner (or ING.com) ask you how much you make now, how old you are, how old you want to be when you retire and what income you want to have when you retire. They then create a couple simple formulas that are as follows:

To determine what ‘your number’ is, they take the desired income you want and divide that by a rate of return they think they can get on your money when you are retired, like 5% since you can’t be risky with it and risk losing it late in life. So if you want to have $100,000 in annual income, you would need to have $2,000,000 in savings to achieve that ($100,000 / 5%).

They take that $2,000,000 mark and put it in the following formula:

Years Until Retirement X Annual Savings X Rate of Return on Savings = Your Number.

What happens next is they take the age you said you want to retire at and subtract your current age from it and plug it into the formula above. Then they take the average rate of return they think they can get for you and plug that in. So what’s left is the Annual Savings (or Monthly) that you need to contribute to your savings every year until you retire to hit ‘your number.’

One twist is to add a spend down factor to your scenario where you tell them how long you want to have an income of $100,000 in retirement and they figure out how much is needed (less than $2M) to provide this income for a given amount of years.
The problem with this is that what if you say you want to retire at 50 and want to have an income of $100,000 for another 30 years since most people in your family die before 80. But what if you stay healthy and active and live to be 85 or 90? You are broke at 85 and have to go work at Wal-Mart to pay the bills and will probably have to move in with your kids or have them subsidize your lifestyle from their income.

This is exactly what ING asks in their planning outline, ‘Provide income through what age?’ How on earth can you know this? Why wouldn’t you strive to have it be perpetual so it covers your life without worry and can be a blessing to your kids after you leave? I’ve heard too many nightmare stories where people said ‘oh, I’ll only live to be 80, so why not enjoy all of it while I’m still here.’ And then they go on to live to be 85 or 90 and are stressed and have to change their lifestyle drastically just to survive because they spent everything they had.

Now if this sounds foolish to you, it is, but it’s promoted by many financial advisors as the best plan for you and it makes no sense at all.

The other problem with hitting ‘your number’ is how do you know what taxes will be like when you retire? What if they are higher and you have your money in a taxable account, like a 401k or IRA? Let’s say you need that $2M to give you the $100,000 a year you are living on now and it will be taxed just like your income is now if it’s in an IRA or 401k, so you’ll get the same cash to live on monthly after taxes. But the government makes a big change and increases the tax rates by 10%. You would then get $10,000 less income than you had planned.

What about inflation? Nobody knows how that is going to pan out, especially since we’re in such a high inflation state right now with Oil skyrocketing causing everything else to go up in cost. If you plan on hitting retirement in 20 years and inflation is only 2% (which is the goal of the Federal Reserve), then the value of your $100,000 income will have gone down 45.6%, meaning it would be only worth $54,400 in today’s terms.

So you see the major flaws in trying to hit ‘your number’.

So what are the alternatives?

Here are a few that I believe in:

1. Create a Cash Machine, a micro business that generates income for you based on your current skills and abilities. There are many resources on this, but my two favorite are Tim Ferriss’ book ‘The Four Hour Work Week’ and Loral Langemeier’s book ‘The Millionaires Guide to Creating Cash Machines For Life.’

2. Buy income property. Owning real estate is a brilliant hedge against inflation, because rents go up as inflation does as does the value of the property, increasing your Net Worth in the process. Also, financing for real estate gets cheaper over time on fixed loans since you pay the same every month while your rents go up and inflation causes that loan payment to be cheaper.

3. Invest in Cash Value Life Insurance. Insurance is the backbone of our society and has many favorable loopholes in it for investment purposes. The best strategy to look at Life Insurance through is the L.E.A.P. model by Robert Castiglione that is followed by a number of top advisors in the Nation.

Unfortunately, as our country moves forward through it’s maturity, there will be those that are on the government ticket (Social Security, Disability, Welfare, retirement from working for the DMV, IRS, City, State, etc) and those that create their own financial freedom through wise saving, investment and innovation. Obviously those in the latter group will have more financial freedom as has been proven throughout history.

My hope is to help save you from the perils of following the masses with not just your money, but also the rest of your life. Unfortunately, this takes work and investment in yourself with time and study, but the alternative is much worse in the long run.

First off, I have to admit that anytime I hear someone say we need to reduce our ‘carbon footprint’ or conserve our precious natural resources and be friendlier to the environment, I want to go by a Hummer. Not the chinsey Jeep looking kind, but rather the one Arnold made famous in the mid-90’s that is Military grade and can climb the Empire State Building.

Please realize, too, that I live by numbers as they rarely lie and help eliminate the emotion of buying so many of us get caught up in.

With that said, please don’t get caught up in the hype of the gas prices and the brilliant marketing some car manufacturers are using to leverage it.

This whole post was sparked because some friends of mine traded in their paid off Dodge crew cab diesel truck (an ‘04 I think) that ran perfect and had not a single defect, for a brand new Chrysler 300 because it got better gas mileage and Chrysler has the ‘$2.99 gas for 3 years’ promo going. The bust is they got the V6 and didn’t get the one with the Hemi V-8 that would have been a blast to drive, all in the name of gas savings.

Their logic was sound, so they thought. That was until the math guy (me) showed up. Actually, I couldn’t tell this to their face, so I had to vent (and save you from their fate) through this post.

They thought the following:
‘I’m tired of paying nearly $5 a gallon for diesel and then only getting 12 mpg in this HUGE truck. With the new Chrysler 300 we’ll get 17 mpg in the city and up to 24 on the highway and at $2.99 a gallon, we’ll save tons!’

Here’s where the math comes in.

They drive approximately 10,000 miles per year.

With the truck, that equals 833 gallons at only 12 mpg (which is a low estimate). At $5 per gallon (a high estimate) that’s $4,166 per year in gas expense, or $347 per month.

With the new 300, that same 10,000 miles equals 500 gallons assuming they get 20 mpg (which is an aggressive estimate). At $2.99 per gallon for the first three years, that’s $1,495 per year in gas expense, or $124 per month.

At this point most people would say ‘Hey math guy, they’re saving $223 per month! How is that bad?’

We’ll here’s the kicker, they traded in their truck and had to take out a $10,000 loan. Assuming they got it for a 4 year term and got a rate competitive with what BankRate.com says 4 year car loans are going at today (6.92%), their monthly payment would be $239.09 per month. So there goes that $223 per month in expected gas savings.

Granted, they got a new car under warranty and are only out an estimated $16 per month. Not bad. But what happens in year 4 when the gas is no longer subsidized and they have to pay full price? What happens if they don’t get as good of gas mileage as they expected? What if diesel gas drops in price?

Obviously I’m being anal with this example, but I wanted to prove the point that you need to look at the math before you go make an emotional decision that is driven by the hype of the marketers in our world today.

One other note, nobody does anything for free. $2.99 gas is made up for somewhere. My guess is the higher car price. An ‘07 Chrysler 300 last year this time was $24,550 at the base price. This year’s ‘08 300 base price is $25,270. That $720 increase can subsidize a lot of $2.99 gas, especially since our scenario was only showing 500 gallons being used per year.

Leave a comment as to whether or not you agree with my views on this ad, I’m curious to see if I’m not the only one who sees the world this way.

<More to come>

The reason I say the goal should be as big as possible is simply due to our ability to achieve that which we set the mark at. It’s been proven over and over throughout history that human achievement is only limited to the constraints our mind puts on ourselves. The 4 minute mile is a perfect example of this in that once Roger Bannister beat that mark in 1954, scores of runners did it, too, within the year since they now believed it was possible. By setting a big goal of what legacy you want to leave, even if you do not achieve it, but come close, you’ve accomplished something significant still.

My whole goal of having this step is to get you to think about and at least verbalize what it is you want to accomplish with your wealth. The problem is most people never think about this and end up wherever the wind takes them through life because they have no vision. It’s like the following quote from Alice in Wonderland:

Alice: I was just wondering if you could help me find my way.
Cheshire Cat: Well that depends on where you want to get to.
Alice: Oh, it really doesn’t matter, as long as…
Cheshire Cat: Then it really doesn’t matter which way you go.

To help you with a few ideas of what big looks like to the average person, what if you could leave your family enough assets to fund your children’s 7 Foundations, pay for your grand children’s college, first home and 2 years worth of living expenses to fund their Storehouse and finally leave enough to fund a local charity for a full year. These are just the tip of the iceberg in my mind and hopefully get you thinking about what’s important to you to leave behind and set some simple goals to achieve it.

Retirement is often defined by not working anymore and spending time doing the leisurely things of life that you’ve put off your whole working career and you want to indulge in now. The sad thing is that those in retirement have so much experience and wisdom to share with others and typically don’t because they’re off gallivanting across the US in their motor home or are on some cruise through the Mexican Riviera.

I believe that you should strive for reaching your Tipping Point as soon as possible so you have the financial freedom to invest your time where you want, not where you have to. Whether it’s mentoring a young person, spending time serving the less fortunate, creating more businesses and inventions to change the world, it doesn’t really matter as long as you’re sharing your knowledge and wisdom to help others.

So with that philosophical view aside, achieving your Tipping Point really does open the flood gates for you. The reason it’s so powerful is that once you achieve the goal of having passive income coming in regularly enough in amounts to cover your monthly expenses, you can now repeat the process and do it again and again, faster and faster than before. It’s just like any other skill in life, it’s always the hardest doing it the first time. Robert Kiyosaki talks about how he did this in 7 years originally and generated $10k per month in passive income from his rental properties. Over the next 7 years, his monthly passive income had risen to $250k, and 2500% increase. He is a great example of the Tipping Point in action.

The reason you want to achieve the Tipping Point is because it leads right into our final foundation of the wealth mountain.

To get the final step in this series click here!

Now you are probably looking at me weird if you have read any of the other posts on the prior levels to Your Wealth Foundation since I speak with such disdain of having a ‘debt free mindset’ and those that promote it. Let me explain. I’m not a fan of racking up a bunch of bad debt and actually think that most people have horrible debt structure in their lives with most of it on credit cards, car loans, and even timeshares. I just don’t want people to make becoming debt free their primary aim since that leaves them lacking in the end. Notice, too, that paying off your mortgage, or becoming completely debt free, is the fifth level in this process and not the first. Again, I am not against it, I just don’t think it should be the primary goal.

So what does becoming debt free look like? There are two ways to do it. Obviously, the first is to eliminate all liabilities and owe nothing to anyone. This is the traditional method, but I think it’s outdated. I’ll explain why after I define the other way to become debt free.

Everyone has heard of Microsoft, but what most people don’t know is that it is a debt free company. This is a big deal since it is such a massive company and many companies of that size are leveraged to the hilt to keep expanding. If you look at Microsoft’s financials though you will see that they have billions of dollars of liabilities. How can this be? How can they be a debt free company but still owe billions of dollars to banks and investors? It’s because they have more cash in the bank (aka Current Assets) than they do liabilities. This means that at any time they could write a check and eliminate all of their liabilities. This is the second definition of being debt free and is the one I advocate for everyone.

I’ll put it another way. Which would you rather have, no liabilities and $50k in the bank or $300k of liabilities and $350k in the bank? In both cases your net worth is $50k. I think you’ll agree that the latter ($350k in the bank) just feels better and is the right answer. The reason is that with $300k in liabilities, which typically is represented as a mortgage, your payment on it is static meaning it never changes. By never changing it is actually going down in cost a little every month due to inflation. So your $2,000 a month payment may cost you $2,000 in today’s dollars, but ten years from now, it may actually only cost you about $1,500.

But what about that $350k in the bank? What happens to that over time? If you have it invested in something safe and secure like a bond, it goes up every year. How much does it go up by though? It compounds, meaning that it goes up by more every year than it did the previous one. So what happens in this example is that the cash in the bank gets bigger faster because it is compounding and the cost of the $300k in liabilities gets cheaper and cheaper to manage. This is why I am such a fan of becoming debt free the Microsoft way.

Also, by paying all of your liabilities down to zero before you have significant cash reserves you end up in a position of no liquidity. You end up with a good net worth, but your liquidity is low, meaning you will have a hard time riding through any unforeseen catastrophes and you won’t be able to capitalize on profitable opportunities either. It’s the worst of both worlds. I would even go so far as to say that having more liquidity and a little lower net worth is better than having a higher net worth and low liquidity. Liquidity is king.

Go to step 6 here!

That is one reason we refer to this account as the storehouse. The other reason we call this account your storehouse is that it better defines what this is to be used for. Storehouses throughout history have been used for two primary purposes; first, in times of famine or limited resources, the storehouse helped communities survive. Second, they were used as assets to trade for great opportunities.

The first milestone to achieve with the storehouse is to accumulate capital equal to 12 months living expenses in it. This is not the same as 12 months of income since income is taxed and if you were not working you could cut a few corners to tighten things up to make your reserves last longer. The reason we want to shoot for 12 months living expenses in the storehouse is that there are almost no catastrophes in life that happen that we couldn’t recover from or adjust our lifestyle to fit in more than 12 months. By having this reserve you would take away the stress of having to make tough decisions quickly and under pressure, which typically results in the wrong decision being made.

The best place for your storehouse is in a money market account. The reason a money market account works so well is because it is easily accessible without any penalties should you need to use it and you can find credit unions and online banks that are giving reasonable returns on the money in the accounts (5-6% right now). By getting this kind of return you are actually having the money work for you (a little) and are outpacing inflation, so the money does not lose its value over time. The worst places for a storehouse to be located are a 401k, IRA or in real estate because they are not liquid, mainly due to penalties in the first two and the long sales or refinance process in the third. By liquid, I mean the speed in which you can convert the asset to cash in your hand.

For those of you that cannot trust yourselves to keep your paws off the money and only use in the most dire extended emergencies, you can put it in a 90 day or 180 day CD and roll it over regularly. The CD is a much better solution than a 401k or IRA because it doesn’t have any penalties to remove the funds at the end of the term and it is more liquid. Do not put it in a CD that is any longer than 6 or 12 months because you don’t want to be penalized to access it should you really need to.

Once you hit your mark of having 12 months worth of capital in your storehouse, now comes the really fun part, building for the long term. The opportunities are endless here and this is the spot that I recommend most people find a financial advisor to help them through their options. Personally, I am a fan of holding long term wealth in real estate, but you can also keep it in 401k’s, IRA’s, whole life insurance, direct investment oil wells, self sustaining service businesses (ie: laundromats, DIY car washes, etc), precious metals and so on.

The cool part about the storehouse once you hit your 12 month living expense mark is that you can use the capital above that 12 month line for investment opportunities. It’s a great problem to have, too, because deals will come out of the woodworks for you when you start amassing a significant storehouse. Don’t worry about it now, but deals will just start showing up because of your capital base. The key is to not dip into that 12 month amount though. Investments of all kinds can be risky, which is great because it causes the returns in them to be higher to offset the risk, but you do not want to risk losing your 12 month reserve. This capital is there for long term emergencies and there’s is nothing worse than making a bad investment and losing all of your capital and then being hit with a real emergency or hardship to compound the problem.

Steps 5 and 6 in Your Wealth Foundation are my favorites, so if you enjoyed this step and the freedom that it brings by achieving it, click here!

Now on to my point.  I think the people who have been spewing advice on how to cut corners this holiday season and how to pinch pennies have actually been talking non-stop for the past decade on this subject and don’t actually seem to be making any real change in anyone’s life for the better.  The reason is that cutting spending and reducing expenses is the evil little cousin to making money or accomplishing capital accumulation as my buddy Todd likes to say.  It is a slippery slope that many will get you on by convincing you that by reducing your expenses, lowering your overhead and cutting back will actually make you wealthier in the long run.  It just isn’t so.

Making money is a totally different skill and takes a completely different focus than cutting back and reducing expenses.  It doesn’t matter how much you saved by NOT paying interest on your credit cards or how much you saved by NOT buying that Xbox 360, it is not the same as making more money and depositing it into your bank account.  The logic goes something like this… if I pay extra on my mortgage, I’ll pay it off faster.  By paying it off faster, I’ll pay less interest expense to own my home.  By paying less interest, it’s like making that much because I would have had to pay it and now I don’t.  The problem is, let’s say you pay off your mortgage early and you save from paying $150,000 in interest.  If it’s like making $150,000 since you didn’t have to pay it, where is the $150,000 you claim to have made?  It’s not in your bank account like it would be if you really did make $150,000.

So what does all of this have to do with holiday spending?  It’s a long way to say that instead of focusing on what you can’t buy, think about how to make more money in the next few weeks to afford buying what you really want and not have this overhanging guilt that you bought something you couldn’t afford and that you should just be grateful for what you have and that living within your means is meant to reduce your expenses, not increase your income.

So what can you do to get extra income in the next few weeks?  A brilliant book I read a few months ago by Loral Langemeier goes over this.  It’s called ‘Creating A Cash Machine For Life’ and walks you step by step down the path of creating more income with skills you already have and getting cashflow in 7 weeks or less, sometimes even as fast as 7 days!  Loral understands the reality that cutting expenses is not the way to wealth and actually has a whole series of books focused on creating wealth and increasing income, because when this happens, expenses get covered and you have extra to stash away for your long term needs.

Even without the book you can come up with a handful of ideas to generate a few hundred to even a few thousand dollars to cover those mad rushes in the stores to fulfill your family’s every demand.  So start asking yourself ‘how can I make an extra $250 this weekend that would be fun for me to do?’ instead of convincing yourself to not spend and enforce massive amounts of self discipline to boot.

What do I mean by Bad Debt? I define it as debt that is either not tax-deductible or is higher than your tax-deductible interest (aka Mortgage Interest).

Just about everyone knows that credit card debt is considered bad debt since the average household is now carrying $9,300 from month to month on average and they are brainwashed from birth to live to eliminate it. But the thought of what is considered bad debt typically ends there. The other bad debt that I see all the time (and am currently an offender of) is car debt. For those of you that want to argue with me about this, you can just skip the next few paragraphs. For those that want to be enlightened, keep reading.

My point about car loans being bad debt is that if someone actually pays off their car loan, within 6 months they go out and buy another new car and get another loan. What they end up with is a lifelong car loan habit since they never get completely rid of it. The sad thing is that they pay this high monthly payment for something that is always going down in value and if they were to save that money instead, they would have quite the storehouse of cash from it.

You may say, ‘But I’ve got 0% financing! How can this be bad debt?’ First of all, it’s a farse. If you took 0% financing like most manufacturers offer, you took it instead of a cash rebate in the neighborhood of $3,000 to as high as $7,000. Factoring in the price savings you could have had with the cash rebate, by taking the 0% financing, you are actually paying 5% to 10% in interest.

For example, if you bought a $35,000 car with 0% financing on a 5 year term, your payment would be $583 per month. If you took that 0% financing instead of, say, a $5,000 cash rebate, that choice would actually have cost you 6.5% due to paying more for the car.

So now that we identified bad debt, let’s talk about a couple strategies to eliminate it. The ‘guru’s’ out there would say to find the debt with the highest interest and start paying extra on it. This would obviously save you a few bucks from paying less interest over time, but the problem is that this isn’t always practical, especially if your largest bad debt is also the highest interest. It may take a long time and you could get some mental momentum by paying off the smaller balances first and giving yourself something to be proud of. The thing I feel the ‘guru’s’ miss out on so much is the psychological part of handling money and all the emotional triggers it hits in our lives. So first, pay off the smallest bad debts and get them out of the way. It reduces the amount of bills you have to manage, so it reduces the chance of missing a payment and hurting your credit and gives you that pat on the back early in the game, which is critical.

While you’re paying off the small debts first, focus like a laser on them. Pay the minimums on EVERYTHING else. I mean it. Treat your money like an army. The more concentrated an army is with it’s efforts, the more powerful it is and harder it is to stop. The more fragmented an army is, the easier it is to wipe it out. So, pay the minimums on the debts you’re not trying to pay off next and focus all of your extra debt elimination money on one debt at a time until it is gone. It makes them disappear faster and you get big gains, which in turn gives you more encouragement that you’re actually making progress.

The real secret to success in all of this is to not touch the Emergency Fund I discussed in Step 2 while you cause your bad debts to go away. You keep that savings muscle strong and start trusting yourself even more and it becomes the foundation for the next step… Creating the Storehouse.

You can read step 4 here.