The Bank of Mom and Dad (MAD)

In order to help teach our children about banking and saving, we started what we called The Bank of MAD, which stands for “The Bank of Mom and Dad.”  Each of our children were given a passbook. As they made deposits we credited them in their pass-books and each month (or when they were interested) we credited interest.  This bank pays 5% interest for all funds deposited into it.  (Sorry, the bank isn’t accepting any new depositors.)

This resulted in a very interesting micro-economy in our household.  As our children would do various jobs around the house, I would pay them from the money I kept in my dresser.  They then would typically deposit the money into the Bank of MAD, at which point I would put the money back into my dresser.   Eventually they started skipping the cash step and just started writing the deposit into their pass-books when they did a job.

I started to wonder if this is really what it was like in the real economy, where you work for a company, so they write you a check, which you then deposit in the bank.  You then write a check to pay your bills, and the money goes back into their account.  While you may not be paying your boss directly, there is probably some sort of circular path the money takes.

Eventually they would decide to buy something, at which point I would typically put it on a debit card and deduct the money from the Bank of MAD account.  The only time I had to go to the real bank to get more cash was when one of them made a run on the bank and decided to cash everything out.

My son also said he wanted to tell his friends about the Bank of MAD.  Actually, I told him they could work out an arbitrage scheme, where they would borrow money on a 30 year loan at 3.75% and put it in the Bank of MAD at 5%.  Unfortunately, as I stated earlier, the Bank of MAD isn’t taking any new depositors.

The other thing I noticed is that my son at times wanted to save every dime and not spend anything, then at other times he would want to withdraw everything to buy something.  I’ve tried to work with him to get him to save some, spend some, and give some.  It is probably better that he makes his mistakes now, though, rather than when he is out on his own.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Picture Credits: Marc Garrido i Puig, Website http://www.garridos.cat , downloaded from stock.xchng

Commissions versus Allowances

With our children, we decided to have jobs instead of chores, and commissions instead of allowances.  OK, I decided to do so and my wife has gone along with it, sometimes more eagerly than at other times.  What is the difference?

Obviously, when you have children you suddenly have a lot more to do in the household since there are now three or more people making messes instead of just two.  While this means a lot more work for you and your wife when the children are young and simply can’t pick up after themselves, as they get older they need to start 1) cleaning up whatever they have messed up and 2) help with the family responsibilities.  An example of the latter would be feeding the pets, or mopping the floors, or cleaning the gutters.

With many families, the children are expected to do certain chores , where chores are generally things that need to get done to keep up the house.  In these families, children are then either given an allowance, or ask their parents for money whenever they have something they need to buy.   If given an allowance, at least they can learn some budgeting and money management skills (provided the parents don’t rush in to save them whenever they run out of money at an inopportune time).

The trouble with the chore/allowance scheme is that there are often chores left undone and nagging ensues (unless you are a far better parent at commanding obedience than I am, which many are).  (Read with a whiny voice) “Johnny, when are you going to take out the trash?  This trash needs to go out, Johnny.  Johnny, I need you to take out this trash!”  It also teaches the paycheck mentality, where a fixed amount fo money is expected each week for a specified amount of work.  Doing more wouldn’t result in more money, so no additional effort is put forth.  At times, a little less can also be done and the same reward is still gained.

I would rather have my children learn that greater rewards can be gained through greater effort.  For this reason, our children are on the job/commission system.  In this system, certain household tasks (Things that are for the general household)  are placed on a job list on the refrigerator.  (They are expected to take care of things like their rooms, picking up their things, etc… just as a matter of course.)  Each job has a corresponding commission, which is a fair rate – what I would pay an adult to do a similar job.  For example, putting away the dishes might pay $2, $3 with the silverware.  Mopping the floor might pay $5.  Helping weed one of the beds might pay $3 for fifteen minutes worth of work (where I set the amount of progress that should be made in 15 minutes).

The idea is that:

1) They learn that money comes through work, it is not bequeathed to you each week or month because you breathe air.

2) It provides an incentive for them to want to do these needed tasks.

3) It provides a way for us to provide money to them for their needs and wants, and

4) It causes them to place value on the money they get.

In general the system works fairly well.  The needed tasks normally get done – at times we are even asked if there is anything they can do to earn some money.  At times our children will become very ambitious, looking for every job available, usually to buy some expensive thing. Our children have saved up for and bought a 3DS and an iPod.  There have been some issues that have come up:

1) Tasks may not always get done when they need to be done.   Obviously the trash needs to be taken out when the can is full and the table needs to be set before dinner.  At times our son would say he didn’t feel like doing these jobs when they needed to be done.  I explained to him that we don’t always feel like doing our jobs, but if you are not reliable and do them when your boss needs you to, you will not keep your job.  After explaining that he would lose the job and not be able to make money anymore, he generally improved at following the needed schedule.

2)  They sometimes fell that they should not help unless they are paid.  This has happened a few times, where they feel they should get paid for doing tasks that we did not want to put on the job list.  In this case we calmly explained that there are some things you just do because you are part of the family.  In general this has worked well.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Picture Credits: Christa Richert, Website http://de-de.facebook.com/people/Michael .. , downloaded from stock.xchng

How Much Does that Cost?

Wealthy people don’t typically become wealthy through a single good investment.  The plan to be wealthy.  Then, they execute the plan.  The mathematics really are very simple – it is the committment that is difficult.

One of the biggest challenges in becoming wealthy is finding money to invest.  Growing wealthy requires putting money away regularly.  It doesn’t need to be a whole lot of money, but it needs to be consistent.

The trouble is that most people increase their spending until their income equals their outgo each month.  Actually it is worse than that, because most people will run up credit until their payments equal their income each month.  This means that if anything happens at all, they could see the creditors calling.

Today I thought I would list some of the typical expenses people have, what it costs over the course of a year, and then what it costs over a lifetime.  Please see the table below.

Item	Cost	Yearly Cost	Investment Loss (45 years, 12% return)
Daily Latte	$5/weekday	$1,300.00	$1,980,000.00
Vending Machine Candy Bar	$0.75/weekday	$195.00	$297,000.00
Car Payment (5% APR)	$500/month	6012.5	$9,150,000.00
Home Payment (5% APR)	$1200/month	$15,066.67	$22,900,000.00
Cell Phone	$100/month	$1,200.00	$1,830,000.00
Lunch Out	$7/weekday	$1,820.00	$2,770,000.00
Dinners out (4 per week)	$200/week	$10,400.00	$15,800,000.00
Lottery Tickets	$2/week	$104.00	$158,000.00

I’ve included small things, like a candy bar from the vending machine, and large things, like a house.

The final column gives the investment loss.  This is how much money you would have at retirement (45 years later), assuming that you invested the money each year instead of making the payment/regular purchase and received a 12% return on your investments.  Note that this is close to the historical return of the stock market, so the numbers are fairly representative.

First of all, notice that a $1200 monthly house payment (which is about a 30-year loan at 5% on a$225,000 house) will cost you almost $23M in cash at retirement.  Maybe Mom and Dad’s basement is the place to stay!  Or maybe at least it is worth getting less house, paying it off with a 15 year loan, and then resisting the urge to add home equity loans and withdraw the equity again.

Even “little” things like that daily latte cost a lot.  Skip it and get coffee from the office coffee maker and you’ll have almost $2M extra in your pocket at retirement.  Withdraw 8% from that each year, which you should be able to do without the principle ever decreasing if invested in stocks,  and you ‘ll have a monthly income of over $13,000. That is about ten times the average Social Security payment that people receive.  Given that it is very unlikely that Social Security will be around in another 15 years, it might be a good idea to skip that stop at Sixbucks each morning.

Even that $2 lottery ticket you buy each week will cost you about $160,000 at retirement.  That would be enough to replace the Social Security benefits of a moderate income worker!  A daily candy bar from the vending machine will cost over $300,000 at retirement.

The point here is not to go without everything.  The point is that if you can cut back on a few things, you can set yourself up to have a much better life later on.  Just as having a side of fries or a soda at every meal can result in weighing fifty pounds more, buying a few extra things every day can also greatly affect your financial life.  Simple things like only having a latte once in a while, or not having the cell phone plan with all the bells and whistles, or delaying getting a house by a few years can make all the difference.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Photo credit:  Nick Benjaminsz, downloaded from stock.xchng.

I Got to Change a Life this Week.

I was at work, talking to the department secretary, “Libby”.  She was saying that she was looking at buying a car and was asking me what I thought of a new model that was coming out.  The conversation went something like this:

Libby:  “My old car is getting to old.   I’m looking at this SUV.  It’s the first year for this model.  What do you think?”

SI:  “I don’t really buy new cars – instead I find cars that are 5-6 years old.”

Libby: “Why not?”

SI:  “I don’t want to lose all of that money to depreciation.  If I buy a new car, in four years I’ll still be in a four-year old car but I will owe more on it than I could buy a four-year old used car.”

Libby: “What do you mean?”

SI: “A car will lose about half of its value every four years.  This means that if you buy a new car for $30,000, it will be worth $15,000 after four years.  This means that you lose $15,000 during those four years, or about $3,500 per year.  This is even worse if you buy a car on payments since then not only are you losing money to depreciation – you’re also paying interest.  Even at 5% interest, you’ll pay about $1000 in interest per year over those four years.  This means that the new car is costing you about $4500 per year.”

Libby:” But is a used car going to be reliable?”

SI:  “When I moved here about 10 years ago, we bought a Toyota Camry with 130,000 miles on it.  We drove it up to 250,000 miles without any major issues.  We finally sold it, just because we were tired of it, but it is probably still on the road today.”

Libby:  “But what about the repair costs?  Don’t you end up spending a lot of money on repairs?”

SI:  “If you buy new, you are losing $3500 per year no matter what.  If you buy a four-year old car, you are only losing $1750 per year.  If you buy an eight-year old car, you’re only losing $750 per year.  Even a transmission, which will cost around $2500, will cost less than the $2750 extra you’ll be paying each year if you buy new instead of buying an eight-year old car.  Plus you aren’t going to replace the transmission every year.”

Libby:  “That sounds good.  Maybe I’ll look for a used car instead.”

SI: “Good choice.  While you may need to finance this one, if you buy a 5-6 year-old car and save the extra you would have been paying in payments to the bank, you’ll have enough money to pay cash for the next one in 5-6 years.  You could also pay cash for a beater car – at around $2500 – then save up money and trade up in a couple of years.  Some people are even able to pay nothing for their cars by looking for deals to bu and then selling them within a year or so.  Of course that’s not really convenient.” I’m hoping she will take my advice and be car payment free within a few years.  Think of how nice it would be to have an extra $400-$500 coming in each month to spend.  It makes it a lot easier to save and invest.

Please contact me via vtsioriginal@yahoo.com or leave a comment.Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Picture credit:  abcdz2000

Setting Up an Investment Account for your Kids

One of the best gifts you can give your children is a small investment account when they leave the house.  If you can start them out with a portfolio of maybe $10,000 to $20,000 in stocks, they will have the money for a down-payment on a house when they are ready and money to draw upon as needed.  By starting them in investing, you are also making it more likely that they will become lifelong investors.  This in turn will lead to financial security in their lives.

Believe it or not, building an investment account of such a sum for them is really not as difficult as it may seem.  When they are born you also have 18 years until the time they’ll be an adult.  If you are able to average around 10% from the investments, that is enough time for the funds to double almost three times.  This means that an investment of just $2000 may be worth around $16,000 by the time they are going off to college.  Of course if the market does very well, as it did in the 1980′s, the account may be worth a lot more.  If it doesn’t, like in the 1970′s, it may be worth a bit less.

Obviously the first step is finding the money to fund the account.  Most mutual fund companies require minimums of $5,000 or more.  Vanguard, which is one of the better companies for small investors, requires a minimum of just $2,500 for many of their funds.  If you have received a lot of monetary gifts for the new baby, consider putting these away into a mutual fund rather than spending it all on baby stuff.

Once you’ve saved up enough money to meet the account minimums, select one broad-based mutual fund and set up a custodial account for your child.  You are looking for a fund that invests in a large sector of the market, rather than a fund that is concentrated in any one area.  You are also looking for a fund with low fees and expenses since the difference in fees and expenses is typically what makes the difference in performance for funds over long periods of time.  You may consider an index fund, which typically has the lowest fees of all.  Avoid funds that have large fees for purchases or redemptions.

When selecting a mutual fund, avoid the temptation to pick a fund that has done well over the past year or the last several years.  While it is tempting to pick a winner and assume you will get similar returns during the next several years, a fund that has done well may actually lag behind others over the next several years since the stocks it now owns have already gone up in price.

After the initial investment, try adding to the fund during the first few years as you can.  Perhaps add some of the birthday money received (you’ll find that they quickly have plenty of toys and clothes are outgrown almost instantly) and some extra funds you have.  Don’t worry too much about how the fund performs during any given year- there will be good years and bad years.  Trying to time the market by jumping in and out will normally result in poor performance.  If it helps you psychologically, save up money and invest more during dips.  The important measure is how the fund did versus the return of the market.  If your fund consistently underperforms its market segment by several percentage points, say over a period of three years or more, you should think about switching to a better fund.

Once the fund has built up to a substantial size (say maybe $10,000), you may consider selling some of the fund shares and buying another fund to increase your diversification.  For example, if you have a large-cap fund, you may consider selling half and buying into a small cap fund.  Be aware, however, that the sale may well result in capital gains, which may then require a tax return be created and perhaps taxes be paid.

Maintenance of the account is fairly easy.  As stated above, once the account becomes large, or if you move funds from one mutual fund to another, it may be necessary to prepare a tax return – check with your accountant for the minimums.  If you do not move things much, however, and the funds you select do not generate many dividends or capital gains, this may not be necessary.

Once your child turns 18, they will then have full control of the account.  You have no choice in this.  Well before that point (perhaps starting when they are around 10), it is important to start explaining investing to them and let them follow their account.  By watching their account grow, they will (hopefully) realize that by leaving the account alone, they can have their wealth grow.

You can explain to them, for example, that if they just spend some of the gains, rather than selling all of the shares and using the principle, they can both have money to spend and the original money.  Each year, show how much their account balance increased and how they could take some of that increase and let the rest remain to purchase more shares.  On down years, show them that they can purchase more shares at the lower prices and be in even better shape the next time the shares rise in price.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

Follow me on Twitter to get news about new articles and find out what I’m investing in.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Photo by Milan Jurek, downloaded from Stock.xchng.