Don’t Drown In Sunk Costs

January 23, 2013
This activity makes no sense. Unless the guy in the Oxfords is placing the penny down to see what cheap soul picks it up.

This activity makes no sense. Unless the guy in the Oxfords is placing the penny down to see which cheap soul picks it up.

 

It’s amazing how many people will congratulate themselves for such money-saving machinations as calling the cable or phone company to get their monthly bills reduced by a buck or two, yet won’t expend similar effort to save themselves tens of thousands. Here’s an example:

You borrowed $200,000 to finance your house 5 years ago at 6.57%, after putting 20% down. Should you refinance?

Yes.

30-year rates are now 3.47%, 15-year rates 2.84%.

Your balance should now be $187,124.51. (That’s right. After 5 years, 94% of your balance remains. Pretty impressive, huh? Sorry, but this is how interest works. It’s why you should be a lender.)

You can pay 6.57% on the $187,124.51 for the next 25 years, continuing to make monthly $1,273.36 payments. But if you refinanced, you’d pay:

$1,277.90 a month for the next 15 years. For an extra 4½ bucks a month, you could burn your mortgage a decade quicker. Would that be worth it?

Depends on how much refinancing costs are.

We’re assuming that your credit is good. If your credit isn’t good, refer to page 33 in Control Your Cash: Making Money Make Sense and treat consumer debt like the hantavirus that it is. If you’re carrying balances on your credit cards, balances that you pay the minimum on and don’t expect to pay off for years, dig deeper. You’re an individual, not a government. You can’t do this indefinitely, and better you endure brief sharp pain than enduring dull pain. In fact, you shouldn’t even be wasting your time reading blog posts. Go out and get a second job, and stop spending money beyond the essentials. Once you’ve done that, and you’ve eliminated your consumer debt, come back.

(Good. With those folks out of the way we can get down to business.)

So what are the costs of refinancing, anyway?

The largest expense is the loan origination fee, which will almost always be 1% of the new loan. $1,871.24.

Appraisal fee. The lender doesn’t want to refinance your lean-to at Windsor Castle prices. Call it another $500.

Inspection fee. Even if it is a lean-to, it needs to be habitable. Pencil in another $225 or so. You’ll also need a pest inspection. Maybe $50 if you live somewhere like North Dakota, $75 if you’re in Florida, The Palmetto Bug State. You might also need a flood certification, $75, to prove you live (or don’t) in a flood zone.

There are also credit reporting fees at around $150. Plus recording – formalizing and registering the transaction documents with your county assessor’s office or whomever. Call that $35.

Depending on which state you live in, a reprobate lawyer might need to get his piece of the action. $750 for attorney review, because reading a series of boilerplate documents requires someone with an advanced degree and a goodly amount of self-loathing.

There may be other fees too. When you ask your lender to quote a rate, make sure they include a breakdown of all closing costs, including the costs charged by any closing agent. Compare the interest rates of any “no-cost” refinance to one with costs. Lenders will usually increase the loan’s interest rate by 25-50 basis points to cover the costs not collected up front.

Tally it up, and that’s $3,681 for the privilege of paying another $230,022 over the next 15 years, instead of paying $382,008 over the next 25 years. An investment that pays 41-fold, maybe minus a few multiples for the accelerated payoff. Hopefully you don’t need to be convinced further that that’s a fantastic deal.

Last week we wrote Part I of how we manage to remain liquid, comfortable, and reasonably affluent in Year 5, maybe 6 of The Recession That Politicians Wouldn’t Let Wither. Some people thanked us for and were inspired by the first-person perspective. Others decried us as out-of-touch and haughty with no understanding of the world beneath us, Mitt Romneys in a sea of 47-percenters.

The secret to building wealth is that you don’t need to shoot superlatively high. Sure, Sergey Brin and Larry Page beat you to the idea of creating a search engine that could metastasize into an entire online ecosystem, where hundreds of millions of people willingly share personal information that can be monetized. Brin and Page are billionaires several times over, while you aren’t and never will be unless Obamanian/Bernankite hyperinflation becomes reality. Does that mean you should look for the next cosmically resonant opportunity instead, which simple probability dictates that you’ll probably fail at?

NO. There are other choices beyond aiming that high, and aiming small. Taking a few hours to save $152,000 over the period of a home loan is what people with a wealthy mindset do. The ones who don’t, don’t because it:

  • Is more involved than just picking up the phone and calling Verizon Wireless’s billing department.
  • Involves using the services of other people, some of them experts who charge fairly for those services.
  • Requires a little math.
  • Might result in nothing. (If there were less of a difference between current mortgage rates and what you’d borrowed at originally, for instance.)

Cursing the darkness might make you feel briefly better, but that’s not what we do here at Control Your Cash. Instead, we prefer to take aggressive, intensive steps to significantly increasing revenue (or significantly reducing expenses.) If you’re going to chase pennies, chase them tens of thousands at a time.

Filed Under: Estate Planning, Finance, Real Estate Tagged With: , , ,

How Do You Guys Do It? Part I

January 18, 2013
We're so rich, we can hire people to portray us in our featured photos.

We’re so rich, we can hire people to portray us in our featured photos.

 

We try to keep things nice and impersonal on here, for several reasons. The primary one is that it’s 2013, and a resourceful person with patience and a vendetta can find out more about you than you might be comfortable disclosing, so why make it easier for them?

But without sharing too much with you, we’ve managed to position ourselves so that we don’t have to work. And believe us, we don’t. At least not at conventional jobs with a boss, and a workplace, and a regular schedule, and a break room (“This yogurt is Michelle’s. Please do not touch”), and a sexual harassment policy and an annual employee picnic. We can live off our passive income, and have no desire to go back to the real world. Those of you who have regular jobs and enjoy them, we might not understand you, but we salute you. Thanks for keeping our gross domestic product high.

We wouldn’t give up this lifestyle for anything. We get to travel extensively, live in a nice house, drive serviceable if not ostentatious cars, and never have to worry about creditors taking any of it away. So how do we do it?

That’s easy: we sponge off the government!

Kidding. Sure, there was some serendipity along the way, but the vast majority of our success can be credited to not doing stupid things. We could write a book (heck, we did) about all the stupid things you could build wealth by avoiding. Here are a few of the biggest culprits in this, the inaugural post in an irregular series:

Tobacco, alcohol, drugs. As best we can tell, the median price of a deck of smokes is around $7. We’re not going to do the math for you, as any idiot can multiply $7 by 365, but the good news for those of you who are scarfing down a pack a day is that you’re probably keeping the weight off. No wait, on further examination a lot of you are fat. Also, any weight you’re failing to gain is that of healthy pink lung tissue, and why would you want to cultivate that?

A “gram” of pot costs $15 to $20, given that your dealer probably isn’t arranging it on a scale calibrated in grams, nor operating under the purview of your state’s Bureau of Weights and Measures. That’ll get you one or two joints, but hey, none of you are serious pot smokers, right? Just once in a while, just to get a good buzz, I hardly ever smoke, only when there’s no beer around, it’s better for you than alcohol you know, etc.

So yeah. If you can put it in your mouth and emits smoke, it’s keeping you from being as rich as you’d otherwise be. Pointing that out hardly counts as thought.

Okay, fine. But you expect me to give up alcohol, too? That’s crazy talk.

We don’t “expect” you to give up anything. We wrote about this on Money Funk a couple years back and the commenters told us we were being judgmental, which is ludicrous. As if pointing out that alcohol purveyors expect money in exchange for their sweet brown liquids is somehow heresy.

The major booze trade organization’s own estimates say it’s close to a $400 billion industry. Divide that into the number of people who live in the United States (subtracting the kids and the people on dialysis, of course) and then try to determine which side of average your own alcohol expenses are on.

The catcalls are starting already, we can hear them. Fine, you need it to relax. Some of us don’t. You can’t imagine being in a social setting and not drinking. We don’t dispute that, but some of us have broader imaginations.

You know what’s funny? Even The Cheapest Man on the Planet, the guy who would rather do indoor craft projects 30 nights in a row with construction paper he dug out of his neighbor’s garbage than go to a movie once a month, can’t bring himself to say that drinking is about as unnecessary as expenses get. And it’s not as if our hero is some socially well-adjusted extrovert, either.

Education. “The Greatest Investment You Can Make”. An utter lie, and maybe the more we repeat this the faster it’ll sink in. Why is it a lie? Because formal college education is not uniform. Here’s where people love to cite studies showing that people with bachelor’s degrees earn more than high school dropouts, and people with advanced degrees earn more still.

Amassing college credits, without respect to what subject they’re in, is like consuming calories without respect to what food they’re coming from. That Bachelor of Arts in comparative literature will benefit you even less than eating a diet consisting exclusively of chocolate will. At least the chocolate doesn’t have to be financed to the tune of tens of thousands of dollars, nor does it take 4 years to eat.

The arts in general: bad, at least financially speaking. (Last we checked, while several universities promise significant non-financial rewards, their admissions offices still expect payment in legal tender.) Math and science: good. Marvel at the works of Degas and Milton all you want, but if you must, don’t spend years and (borrowed) money for the privilege. Because it’s not a privilege, it’s an expense.

That doesn’t mean you’ll be ready to take on the world with a high school diploma. You probably won’t. But you can learn a marketable, worthwhile trade without committing huge money nor huge time to the endeavor. Those studies referenced above? For some reason, they never specifically compare liberal arts graduates to steelworkers or machinists. To some effete people, there’s a stigma to working with your hands. To us, there’s a stigma to incurring pointless debt that you’ll take decades to pay off. Ceteris paribus, the $52,000-a-year electrician with a contractor’s license is a better human being than the $30,000-a-year retail clerk who can parse Noam Chomsky’s theory of universal grammar.

That wasn’t so hard, was it? None of that stuff is painful, or even inconvenient. It’s not like we’re telling you to go without sleeping or shaving. But it’s a start. More next time.

Filed Under: Education, Entrepreneurship, Estate Planning, Finance Tagged With:

Both Sides of the Ball

August 29, 2012

Watson knows offense

 

One of our favorite new discoveries is 6400 Personal Finance, whose author has zero patience for people who insist on living their financial lives passively; being done unto instead of taking charge. He recently said something so pithy, so brilliant, that we’re angry we didn’t think of it first. Paraphrasing, he says building wealth is offense. Saving and conservation are defense. It takes both to win.

Yet if you listen to most people – self-styled experts, your peers, the man on the street – almost all of them concentrate on the subtractive side of the ledger. Defense. How to save money. How to cut your expenses. How to cram 4 people into a house barely half the size of a basketball key.

How did we get here? If you’ll excuse another sports analogy, there’s an old bromide that “90% of baseball is pitching and defense.” Which makes as much sense as saying that 90% of a magnet is its north pole. Most adults who take that axiom on faith don’t realize that it’s a lie intended for children. When you’re 8 years old, swinging a bat and being the center of attention is fun. Standing in left field waiting to make a play on a ball that might never come is less so. Therefore Little Leaguers need to be convinced that focusing on the latter will help them win games. The kids won’t internalize the saying, but if you repeat it enough then hopefully it’ll tip the scales a little and the kids will start hustling when they’re in the field.

Even those of you who didn’t play organized sports are conditioned to act defensively. To refrain from doing the dumb activity, as opposed to undertaking the smart activity.

Somewhere along the line, people twisted the definition of “economize”. It used to mean doing as much as possible with what you have. Now, it seems to mean doing as little as possible with what you have. Just read this sturdy fellow who apparently has decent income, a reasonable net worth and zero debt, yet spends his free time collecting rocks by the side of the road because it doesn’t cost anything.

Why are people so reluctant to build, rather than to preserve? Because offense isn’t immediately easy to grasp, as defense is.

Defense is reactionary. Defense means anticipating what’s coming, and plotting to combat it and minimize any damage. Offense is creative. It means relying on your skills, expertise and experience to do something remarkable. (You have to rely on yours, as opposed to anyone else’s, because God knows no one else is going to go out of his way to help you build wealth.)

Is offense riskier than defense? Of course it is. But the great irony about shifting your focus to offense is that if done correctly, playing offense shouldn’t take any more effort than playing defense does.

Playing good defense means:

  • Making sure your boss sees you come early and stay late, even though you’re getting no immediate reward out of it.
  • Doing everything that’ll result in a good performance review, in the hopes that the next promotion has your name on it. Which it well might, assuming that your boss’s fraternity brother’s unemployed daughter doesn’t decide that she might like to try her hand at whatever it is you do for a living.
  • Economizing for its own sake. Having the wherewithal to afford a nicer house or a better car, but refusing to just because you’d rather hold onto the money. Even though you have no idea what to do with said money. 

Playing good offense means:

  • Taking those extra uncompensated hours you would have spent at the office, and using them to learn about the stock market. Even having the Fox Business Network on in the background while you passively listen to the hosts and analysts will give you at least the basis of an idea of what building wealth entails, and expose you to the jargon. Ask the folks at Rosetta Stone – total immersion is the only way to learn a new language.
  • Getting pre-approved for a mortgage. You can’t buy your first house without one (unless you pay cash, which probably means you’re already rich.) Nor can you buy your second house without one. In the first case, you’re throwing off the tyranny of renting. In the second, you’re making it easier to eventually build another investment that, if done correctly, will mean far more to your bottom line than will pleasing your superiors at your place of employment.
  • Setting up a limited liability company (Hey, we have a book about this)
  • Taking the money you’ve saved via your commitment to defense, and doing something with it that requires more thought than just sticking it in a savings account. Or even a CD. Or even a 401(k).

None of this is hard, but it’s out of the ordinary. It comes with the possibility of greater rewards way in the future. So far off in the future, in the eyes of the unimaginative, that they can’t see it. Better to apply yourself to what you know and stay in your comfort zone. Even though that doesn’t come with any guarantee, either.

If you think that your income should derive solely from the sweat of your brow, you’re living in the wrong millennium. Rich people don’t feel guilty for leveraging their time and money. They can’t. They understand that it’s the only way to get rich.

We’ve said this before, but here it is again using a different example. Sergey Brin started with nothing extraordinary, and is maybe 100,000 times richer than you. Does that mean he works 100,000 times as hard as you do? No, that’s impossible. Does it mean that he’s been allotted 16,800,000 hours each week, instead of the 168 the rest of us get? No. But it does mean that he isn’t relying on his salary, handsome as it may be, to build wealth.

Make it a moral imperative to find other sources of income, rather than to merely cut back. Any idiot can squeeze a penny, or tell you how to, and plenty of idiots do.

Unfortunately, the English language is limited in that what we’re advocating is known to the world as “passive” income. From one angle, that makes sense. “Passive” as distinguished from “active”, referring to income earned directly from work.

But again, people have misinterpreted what should be obvious. They take “passive” income to mean that they don’t have to do anything to earn it. Or that passive income isn’t even truly “earned” in the conventional sense. Even the IRS agrees with this assessment, having classified an entire set of income as “unearned” and implemented a structure for taxing it.

Passive income takes plenty of effort to achieve. It requires not just some higher-order thinking, but the fortitude to see that thinking through. It means disabusing yourself of the idea that the two most important things in the universe are a) avoiding getting fired and b) spending as little as possible.

Spending as little as possible is swell, if you want to live a boring life. Worthwhile things, both goods and services, cost money. Buying some of them will result in no discernible increase in your net worth (e.g. a trek to the Central African Republic, a new ensemble at Chico’s.) Buying others will (e.g. the services of a fee-only financial advisor, a house with a greater potential for appreciation than a cheaper house that you’d otherwise buy.) But again, this post isn’t about saving money, especially not as an end unto itself. It’s about learning how to build more wealth, and not relying on external forces to do it for you.

Download one of our ebooks to get started. It’ll take less time to read than the hours you’d lose by working through lunch a couple of times.

Filed Under: Estate Planning, Investments, Making Smart Choices, Math, Net Worth Tagged With: , ,
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