Personal Finance Friday – Money Part 1 of 4 – What is Money?

We all deal with it everyday, its an obsession for many either those who have too much or too little, but I don’t think a lot of people stop to think about what money actually is. Money is one of the greatest inventions of all time, it is mental leap that is one of the great signs that we are indeed different than animals, it stands up there with the wheel and fire as a tool for its impact on human civilization. Why you ask? Its just money… well lets think back to before money, to a place a long time a go and place far far away (probably Africa and the Middle East). Humans spent there time in small groups, who looked out for each other, and if you wanted something someone else had, you had to trade them for something you have. That could have taken the form of an object you had or maybe in a task that you could do for them. Now as you can image that works to some level, but think about the issues of doing anything more complicated in time or place than, “Hey Fred, can I have that loaf of bread if I give you these 6 chicken eggs?” Say Fred wants to build a house but doesn’t know how, he’s going to need the help of a ton of his fellow tribe’s members, and trying to keep track of what he actually owes them in favors, bread, and labor is ridiculous. Also you know that people are people and even back then there were the jerks who would keep asking for more, “Hey man come on Fred don’t you remember when I helped you build your house, you still owe me! Come help me plow my field again (for the 10th year in a row).” It was hard to organize things, it was hard to say what was worth what, because there was no standard, how many eggs is a piece of timber worth? Who knows! It may depend on the person and place!

Then someone had the brilliant idea to put a “thing” in the middle of these transactions, a medium of exchange. The idea was, what if everything we did we used a standard unit of measure, and didn’t trade directly for each item but instead traded for this middle ground, this medium, this unit of value. And so money was born!!! At first it had modest roots in sea shells, or beads, but later evolved with Gold and silver being the longest run and most widely used standard version of money (at least until pretty recently). Lets think about what this new unit of value, or medium exchange allows! It allows you to create a stinking civilization, that’s what it allows! Now people are not shackled by time when it comes to exchanging value. You have 6 eggs now, but don’t want any bread, no problem, sell those eggs to someone else and save the money for when you do need bread. You want to build that house, no problem you can ask everyone you need help from what it will cost to help you, you have some certainty, you now know how many eggs you need to sell to build your house, you can plan how many chickens you need, how much feed for those chickens. You can now calculate a timeline as to when you can build your house. It allows for planning on a massive scale. Did you just bring in a huge harvest and have more money than you need right now, great give it to a bank to protect it and they will lend it to someone who needs that money and can put it to use now. And the spiral of progress goes up and up, the level of complexity a society can handle becomes exponentially larger.

Given that money is an abstract concept, its not just tied to the US Dollar, or Euro, it can be anything that people accept as a common medium of exchange, gold and silver can still serve that purpose, but due to convenience most people don’t hassle with it. So what makes for good money, there are many definitions out there, but in general good money has a stable value (so you can measure things easily over time), it has to be commonly accepted (so it can operate as the economic lubricant), each unit needs to be interchangeable (so one unit doesn’t become more valuable than another), not easily forged or limited in availability by its nature (so inflation doesn’t explode a subject of part two of these posts), and easy to carry around or account for. In future posts I’ll go further into some of this things and how they effect our personal finance lives.

But next time you take out a 20 dollar bill and buy something think about the amazing ancient tech that you are using and all its done to make our lives SOOO much better than our ancestors. (but don’t obsess over it, its just another tool in the end :) )

Personal Finance Friday – Career Path

While doing some research for work this week I came across this info-graphic below. I thought it was really super interesting and something all college bound kids and even adults should see. I think you could interpret this information in many ways, one is maybe how varied your career outcome may be no matter what degree you end up getting. Another is realizing just how big the business, education and healthcare sectors are, it looks like you’ve got a 50% chance of ending up there. I’ve always been an advocate for choosing a practical college degree and pursuing your passion in relation to that degree, but I also have heard of many cases of people with very impractical degrees (I won’t mention them so as not to offend) ending up in very lucrative positions all over the spectrum. Though on average the less practical and in demand the skills are the harder time a person is going to have putting that degree to use.

Also below is another picture with some interesting salary information that I put up a while ago but I thought might be useful in conjunction with the career path info.


Personal Finance Friday – Trump, Debt and Real Estate

This is not a political post (those who know me know my opinion!), but I thought given one of our candidates for president is known as a Real Estate Mogul maybe a little explanation on how his world works might be helpful to understand and helpful to your own personal investing.

Trump is the self proclaimed King of debt, which to many may not sound like the greatest title to be calling yourself but in his world of real estate, debt is the cornerstone of almost all transactions. Why is that? Well the answer is a little complex and multi-dimensional. The first principle for any asset that someone wants to purchase is that generally people prefer to put less cash upfront now and more cash sometime in the future. This is because generally its hard to save up large amounts of cash so if you can buy something big now and pay only part it, it makes sense for a lot more people. This is true with cars, and phones, and especially real estate. On the other side of the equation, people who have money and want to lend it, prefer to have their money secured by something, so that if something goes wrong, they have something to back up the value of the loan. People and banks are less willing to lend on an asset who’s value moves around a lot (stocks, art, etc) or that depreciates over time (cars, phones, boats). They’ll still lend but its usually for shorter periods of time, and at higher interest rates because its just plain riskier. Real estate on the other hand kind of checks many of the boxes a lender would want, its relatively stable (relatively!!!!), it generally goes up not down over time (generally!!!!), and it can’t really be moved or hidden (ohh sorry lender, I don’t know where my house went, sorry you can’t collect on this loan :)). So it makes great security for a loan. Because it makes great security, that means the amount that can be lent, the interest rate (price), and the amount of time (longer) are all better because the lender feels way more comfortable taking the risk.

When it comes to investing in real estate the characteristics that make it attractive to lenders, also make it unattractive to invest in unless you use debt… let me explain. When it comes to investments generally the higher the risk and more volatility the more return you require to make it worth your while to invest in. Given that real estate is pretty stable and slow moving the amount of return required is actually pretty low. So for example you buy a $500,000 apartment building for cash and you receive rents of 20,000 net of all of your repair costs, you are making 4% on your investment. Not too bad on a pretty safe asset, when you factor in 1 to 2% value increases each year you can make 6%, even better. But maybe not as high as you’d expect if you invested that into the stock market over the same period of time (maybe 8 – 9%). That’s were the temptation, and desire to add debt to the equation comes in… Lenders really like lending on real estate, its hard to come up with $500,000 cash, and if your going to make a big investment you’d like to earn more than 6%. So you go to your bank and ask for a loan…

Lets look at my example now, but you’ve taken out a $400,000 loan. The payments on that loan say are about $18,000 a year. Now you are only making $2,000 a year, thats way less than the $20,000 you were making before! BUT lets look at it from a return on investment perspective. You only had to put $100,000 into the deal. That $2,000 is the equivalent of earning 2% on that investment, still worse than what you were expecting before of 4% BUT now lets think about the appreciation you were expecting, we said 2% a year. Well 2% a year on $500,000 is $10,000. If you add the $2000 net rent and the $10,000 appreciation you have $12,000 total expected returns, that works out to 12% on your $100,000 investment, and that is a very good rate of return probably better than the stock market over a long period of time.

What you have done in this hypothetical situation is taken a nice boring low returning investment and turned it into a risky high return investment, all with the magic of a little debt, or as many people call it leverage (in many circles leverage can be a dirty word). So that is what Trump has done to make his money (I’m over simplifying of course), and that is why he’s experienced bankruptcies in the past as well, when you amp up the risk its possible that you lose that bet and have to hand everything back to the bank (think Monopoly style!)

So that’s a brief description of how that works, and in general its the same for apartment buildings, skyscrapers, golf courses, warehouses, and shopping centers, just with little twists here and there.

Personal Finance Friday – Peer to Peer Loans Part 2 – Investing

Last time I described what Peer to Peer lending sites are, this time I wanted to talk about some of the things to think about if you wanted to invest in the loans on the site. As I said before, this isn’t an asset to dump your life savings into because of the company specific risk you take with each of the loans, along with the credit risk of the borrowers. BUT earning 5% on pretty safe assets (excluding the company specific risk) or even as high as 8 – 10% on some of the more risky loans is not a bad return, when a savings account earns you effectively zero. Each of the sites offer a range of credit profiles to invest in, from very good “AA” credit, people with very high credit scores to “D” and “E” level scores that are super risky. The good credit loans, will usually pay about 6% in interest and over time you’ll have about 1% of them default, so that means you net 5%. The bad credit loans, can have interest rates of 25%! but its likely that 10 – 20% of them will default meaning a portfolio (or group of them) will end up netting on average about 10% or so but with a lot more volatility as compared to the good credit loans. Something else to consider when investing is where the economy is, if everything is going well then defaults will be generally low, but when rough times come these are the type of loans that people will default on first, so the defaulting amounts can vary over time. I was invested in these through the financial crisis, and luckily I was conservative and only invested in the best credit quality. So my experience was earning a net 2.5% return during that period of time, versus some who had invested in very risky credit and end up losing money (again it all comes down to risk and reward, those who have invested in the riskier loans since then have done very well). Another thing to take into consideration with these loans is their lack of liquidity. Liquidity is how fast something can be turned into cash. Once you purchase a piece of one of these loans you have to wait for the borrower to pay the loan off to get all your money back (you get payments along the way of course). So you should consider the funds locked away for the duration of the loan (Prosper and Lending club both have 3yr and 5yr loan options, with 5 year loans having slightly higher interest rates). But if you really need the funds, both of the sites also have a place you can sell your loans to others usually for a small discount, which solves some of the liquidity issue. That can be hassle though if you’ve put a portfolio together of 200 $25 loans ($5,000), so it should be considered a last resort. If you’ve got your emergency savings, you don’t have any high interest debt this can be a fun (you can read the reasons for the loans and pick them individually or automatically) and interesting way to earn a little bit extra on your money. If you ever decide to try it and have any questions, let me know I’d love to share any information I have with you.

Personal Finance Friday – Peer to Peer Lenders Part 1

Some of you may have heard of or These are the two of the most popular “Peer to Peer” lending sites. What does peer to peer mean? It means on these sites there are both people getting loans and people giving loans. The sites are supposed to be a way to eliminate banks from the equation and give people direct access to lower cost loans and much better investment returns (depending on if you need money or have money). So for example Tim needs money to buy a new computer and asks for a loan for $5000 (its a super nice computer, his a graphics designer), that request gets vetted and then posted on the site. Paul, Sally, Jill, Steve, and Jack all have some extra money they want to invest, they see Tim’s posting for a loan, think its a decent risk given Tim’s credit rating and other info and all decide to invest $1000 each, and so the loan is funded. I have been investing in these loans and have taken a couple of loans, from Prosper in particular, over the last 10 years. Both sites have good reputations overall (there has been some recent news on Lending Club, but from a customer service perspective they seem to be okay). So why should you care? Well if you’ve got a ton of credit card debt or other high interest debt and your credit is okay, then you might be able to consolidate (up to $35,000 per loan) and save some money and maybe get onto a better track. If you’ve got your emergency saving set and you want to have some lower risk but still decent return investment (you can go high risk on these site as well) then its a decent option. In another post I’ll give more details on the investment side of the equation. The only major issue with both of these firms, at least the last time I read through their investment materials, is that if you invest in a loan offered on their site, you don’t actually own that loan, all you have done is linked your money to that loan. Legally all you own is a unsecured obligation of the firm itself, which means if the company goes under you may lose some of your money even if the loans you have invested in are doing fine. I would have a lot more money invested in these firms if it wasn’t for that issue, so be cautious and don’t put your entire life savings into either one of them. That said they have been a good option over the last decade. Continue reading

Many of you have heard of the term Hedge Fund and probably wondered, “What does that mean!? What exactly is it, why is it only associated with big institutions or rich people?” Well let me give you a quick summary and I welcome any questions below about them. We invest in many hedge funds at the College and visit with them all the time to discuss what is going on so we get a good view of this aspect of the investment industry. A hedge fund simply put is a unconstrained mutual fund. In a normal mutual fund (or ETFs but thats a subject for another post) that many people have heard about or are invested in they have a very specific goal, like a tech focus, or a large company or small company focus, or maybe international, or growth oriented. Mutual funds only buy and hold stocks and maybe a little bit of cash they don’t do anything more than that. Hedge Funds on the other hand can go anywhere or do anything investment wise, they can short stocks (bet against them), they can buy gold, they can buy or sell options on stocks, they can own bonds, or even private companies. In practice when you invest in a hedge fund they usually have a specialty, like bonds, or distressed companies, or events like mergers, etc. They are experts in that area, and work long hours to dig up different angles on different potential investments. The origin of the term Hedge Fund has to do with early hedge fund’s desire to “Hedge” which is an investment term for protect against risk. These early funds used options and stock shorting to protect their investors while still producing good returns. Now a days there are all sorts of hedge funds that specialize in all sorts of things. One of the main negative features of hedge funds is how long your money is locked up and the fees. Hedge Funds will usually have a time restriction on when you can actually take out your money like once a year or sometimes even as long as once every three years. And for the privilege of investing with them you pay usually 1.5 – 2% of the amount of money you put in along with 15 – 20% of any profit they make you. For some of the good ones, that’s a great deal! But if they don’t do well it can eat into any small amount of return you may have gotten. All that said, these investments are generally restricted to “Accredited Investors”, Accredited Investors are basically large institutions or relatively rich individuals that the government has deemed sophisticated enough to risk their money in this way. In the past few years some hedge funds have begun to create mutual fund products that allow everyday individuals to invest. But I would warn that any institution who is marketing to the public is likely to be of lower quality, and that is for several reasons which I won’t go into because it will make this post even longer!

Credit Scores – Part 4 – Building Credit

A question that comes up sometimes is how do you even get a credit score if no one will give you a loan unless you have a credit history!! It does seem like a catch 22. Well there are two easy ways to start your credit history. One of them happens almost automatically if you go to college… student loans. If you get a student loan while in college, those prove your identity and as soon as you start paying on them you begin establishing an on-time credit history. Another quick way to establish your credit is to get a secured credit card. This is a credit card that has a small limit, and has some savings account or other account that guarantees your balances. So for example you can get a secure credit card that has a $500 limit, for buying gas and what not, you’ll need to have $500 in an account as back up for the bank. This means the bank has no risk about you not paying, so they don’t care that you have no credit history. As long as you use the card and pay it off monthly you start to establish your credit history.

Below is a link to a description of how a credit score is calculated with much more detail…

How its Calculated – Credit Balances – Another important aspect of what goes into your credit score is your credit available and credit balances. So for example if you have 3 credit cards all with $5,000 limits, you have credit available to you of $15,000. Now if you have $4900 on each of those cards your net available is $300. For a credit score that is a bad situation, and if you think about it it makes sense. On average a person who had nearly all of their credit lines utilized means they are close to a financial breaking down, if some emergency comes along and they don’t have any credit available (and if they have that much credit card debt they most likely don’t have their emergency savings in place) then they are in serious trouble. So the credit score takes that into account, that’s why if possible you don’t want to carry balances on your cards, never mind the interest charges. Now if that same person has zero on their cards, it looks way better, that person must be doing fairly well, and if they are looking for a loan they are probably a safer bet. Yes it is ironic that those who need the money get punished and those who don’t are rewarded, but when you think about it from a risk perspective it makes sense. This is also why some say you shouldn’t close down credit cards, in general that’s true but if you have 10 credit cards your not using it might be better just from an administrative point of view to close a few of them and just ask for larger credit lines on the remaining accounts, that would get you to the same place. Next post will be on building your credit score especially if your young or have no credit history.

Personal Finance Friday – Credit Scores – Part 2

How its Calculated – Payment History – So how is a credit score calculated, well its complicated and if I said I knew exactly how they were calculated I’d be lying. But I do know some principles about them that I can share. First paying things on time, matters. That portion of the score is trying to measure how responsible you are, do you think ahead and plan when and how to pay your bills? If not you are probably going to run into trouble later and so your score will be lower. For this I would suggest automatic payments! First off they save you time, and second you don’t have to worry about being late. Of course you need to make sure you have your budget in place (the base of financial planning) other wise you may end up running out of money which would of course be a bad thing and defeat the purpose of doing automatic payments to begin with. Another thing to think about when setting up an automatic payment is where the money is coming from. If you charge it to a credit card, remember that as soon as that card expires you are going to need to make a bunch of changes, and that might be worth it to you if you are getting points or other rewards from your credit card and feel like your responsible enough to keep track of that. I do most of my bills through a credit card, and I have to admit something always falls through the cracks in that transition. If you auto pay out of your checking account that isn’t an issue, though you have the possibility of running out of money if your running on a thin budget. Also on an annual basis it would be a good idea to pull your credit report (for free) and just check out what is being reported and make sure there aren’t any mistakes. They’ll have a list of all of your accounts and which payments have been made on time or late, you can then dispute anything that doesn’t seem correct. Next post will be on credit balances and how they effect scores.