Residual Income, The Dream Killer or The Dream Creator?

Today, I want to discuss a fundamental concept called residual income. A related concept is passive residual income.

Have you ever asked why and how society funnels money, eventually leaving 15% of families poor, 80% as middle class and 5% of the population as wealthy? Have you ever wondered why the rich get richer? Or why is it that by age 65, 90% of the population is working or dependent, 5% is wealthy and the other 5% deceased?

What is inflation? Well, inflation is used so that the money people stuff under their mattress eventually becomes useless. It is a 3% funnel back into society.

What are taxes? Taxes are a chunk of income used to return a portion of what people earn to pay for government expenses. It is another 35% residual income for society.

What is a credit card? Well, it a 3% service charge funneling your money to credit card companies with each swipe.

What is a mortgage? A mortgage is a 30 year contract to remove the residual income from rent. By the way, financially speaking, the ability to have control over possibly reducing rent may be more valuable than having the mortgage.

What is a grocery store? It is a residual expense to keep you fed, despite the fact that you might be able to handle your own food production.

Now, if that weren't enough, companies became smart and started adding to the list of expenses that you need each month. You have mortgages, rent, electricity, water, gas, telephone, cable, internet, newspaper/magazine/gaming/online subscriptions, property taxes, fitness memberships, health insurance, home insurance, whole life insurance, and car insurance/registration/gasoline.

Some families are very happy because they earn over $200,000 with a combined income. However, this is no match for a simple cable bill, which is paid $120 per month for the entire life of most people. Using the average age newborns live to, which is 80, this becomes $115,200 of payments over one's life. If I factor in compound interest, paying $1440 annually at a 5% interest rate, this becomes $1,468,498. Wow, looks like the $200,000 just went out the window when you decided to own cable throughout your entire life, costing $1,468,498!

The wealthy know that high salaries mean very little. Just look at the lottery winners and athletes that have gone broke after 5 years (there are other reasons of course and this may be a whole blog in itself). It is those who eventually have more residual income flowing in than out that win over the long run. Wealthy people probably didn't purchase cable until they had enough passive income to cover it.

Now, if you have gotten a chance to create a solid passive residual income stream, how would you feel knowing that legislation existed to ensure its stability?

What is really interesting is if we look at how each of the previous decades has brought an additional product or service to market which introduced an additional passive income stream for a new company.

Another interesting concept is looking at what it would take to accumulate $50,000 of passive residual income rather than looking at what it would take to accumulate 1 million dollars which might indirectly be used to bring $50,000 of passive residual income.

Dedicated to Adam Ward.

This post was reposted from http://sizuservices.blogspot.com/2012/12/residual-income-dream-killer-or-dream.html, originally written on December 26th, 2012.

The Standard of Living Financial Law

They say, "Earn like the wealthy, but live like the middle class".

Imagine throughout the next ten years, you were to maintain the same standard of living, consistently. What would happen?

Well, this law can either work for you or against you. Imagine that you were to lose your job or even worse, lose a loved one. Now, imagine that you maintained the same standard of living. Although your income decreased dramatically, you did not adjust or make new sacrifices. Where would this lead you in five years?

Now, imagine that when an unexpected bonus or tax return came in, you simply ignored it and dropped it into a wealth building account. Or imagine, when an unexpected raise came, you decided not to change your spending habits, but rather maintain the same standard of living. What would happen over your lifetime?

Most people plan for and spend money before it even hits their account. Part of this is based on gratitude and not being content with what we already have. But remember, "To all who have, more will be given, and they will have more than enough." Matthew 13:12 (see also Matthew 25:29, Mark 4:25)

What are your thoughts?

This post was reposted from http://finlit.biz/business/the-standard-of-living-financial-law/, originally written on November 21st, 2013.

Trading Stocks Two or Three Times a Year

So I got a watch alert today, that told me that my position in Verizon went up 10%. So what I did was balance out, selling off enough stock to get to my target balance.

In case, you don't know the math behind it. The basic concept is this. Suppose you have a target balance of x in a particular stock. Then, suppose the value goes up 10% so you now have a balance of 1.1x in a particular stock. If you sell off .1x (hopefully you either get free trades or you have a large enough position that the commision is small), then you will have .1x in your money market account and your target balance of 1x in the stock. If the value then drops to the original price. Then, the position in the stock will be (1/1.1)x so you will need to buy (.1/1.1)x of the stock, to obtain your target position. This will leave (.1-.1/1.1)x in your money market account and a target balance of x in the stock. So you just made about 1% event though the stock ended up back at the original price. A similar case holds if the stock dipped and then went up. Wow this math is probably too complicated for most people already. I like to cover details, because that is where the truth lies.

Anyways, you can use real numbers or real date and check out how balancing works. Try just having a target balance of 1000 and when the stock price increases by 10%, sell enough off to get back to the target balance of 1000 and when the stock price decreases by 10% buy enough back to get to the target balance. This is why balancing is good each year. I also like a 60% safe, 40% more agressive ratio. This is very conservative, but works for me, because I like to protect the principal.

So let me explain why I like Verizon and why I don't like Google. Think of companies as machines. At any time, you can work on the machine, to make a larger machine (production capability) or you can crank the machine to produce (production). I believe any investment should be good now. Speculation is well and dandy, but is a bit like gambling. You guys already know how I already feel that there is a thin line between stocks and gambling. In stocks or real estate, the numbers should work now. Then, if things go well in the future, its just icing on the cake.

By the way, the production versus production capability comes from Steven Covey, so I might as well throw my book recommendation in now.

Imagine going to the bank for a loan. The bank will give you the loan, but you need to pay interest while you are trying to make your money. You need to start being profitable quickly. Such is the same with companies. A stock that pays dividends is making money and cranking the machine enough to pay back investors. The need for additional money is to be able to take on larger deals, but they are paying back investors now.

Now, Google just continues to buy more and more small companies which may or may not pay off and they just continue to expand the machine. The question I have to ask myself is do I want a piece of a company. Why, would I want a piece unless I could get like 50% of the company and make some decisions that affect the company to actually get paid back. I basically have to hope stock goes up, based on speculation, and hope someone will buy it from me when I feel like giving up the stock. Do I make money when the stock goes up. No. I must release the position at the right time to get value. Timing the market is very difficult. Investors on average get a return of 2.1%, trying to time the market, not even beating inflation which is at 2.5%. And trust me, some of those day traders are some pretty smart people. One person even wrote a bot to go out and look at the conceptual feeling of a stock by automatically gathering twitter and facebook posts. When the general feeling was bad, they might sell, etc. Anyways, the point is, the more agents discuss stocks, the more people exchange stocks, the more money the agents make, the less the investors make. So please don't read this post and go out and buy Verizon or Google!

The third piece of the puzzle is that I like the strength of the company Verizon and believe they are in a good solid position to do well.

So let me tell you what I just told you. I believe in making only a few trades per year (like to balance). I also like companies that are paying dividends now and have a solid position.

This post was reposted from http://sizuservices.blogspot.com/2012/07/trading-stocks-two-or-three-times-year.html, originally written on July 17th, 2012.

Applying Izu's 100-200 Property Valuation Rule

Today, I wanted to look at three examples where the property valuation rule could have been used to save a headache. If you are going to overpay for your home or investment property you may want to think about using the property valuation rule as one more guideline in your arsenal. The reason is that if rents are a certain rate, than the value of the home in that area can only go down so far, before a renter says, "Wow, prices are really low compared to my rent." In general, if the mortgage, property taxes and insurance combined cost less than rent, you will have no problem finding a buyer.

The first example is a home that was purchased for $730,000 with $500,000 down. The house would have rented for about $2,700 per month. My estimates would put the value somewhere between $270,000-$540,000. Sure enough, when the housing bubble burst, the value was then estimated to be $400,000. This person was able to keep the home because there was such a large down payment. Staying power will allow the person to own the home long enough to recoup some losses.

The next example is of a home that was purchased for over $600,000. The rental price was around $1,700 per month. According to the rule, the value would be between $170,000-$340,000. Sure enough after the burst, the family sold the home for $320,000. Overpaying in the first place along with leaving little room for error can be devastating.

The final example is a case where the rental prices actually decreased. The rental value was around $1,000 and the purchase price was $160,000 (my estimate would be $100,000-$200,000). This was an investment property. The rental prices than proceeded to drop to around $500 and the value of the home dropped down to $40,000 (my estimate would be $50,000-$100,000). The rental property was then lost. As an investment property, the target purchase price should have been closer to $100,000. Remember, if the numbers don't make sense, don't do the deal. This would have allowed some room for error and still been manageable when rent prices fell. The investor simply would have had to tighten up the budget, as if the home was one being used for personal use. In general, this is doable after having gained some experience renting the property.

Here are some articles to support valuating prices based on rent:

• http://finance.yahoo.com/news/don-t-buy--these-7-cities-are-renters--markets.html
• http://www.businessinsider.com/best-cities-buying-a-home-2012-8?utm_source=0817&utm_medium=yahoo&utm_term=&utm_content=&utm_campaign=partner#detroit-michigan-3

Dedicated to Wil Andrade

This post was reposted from http://sizuservices.blogspot.com/2012/11/applying-izus-100-200-property.html, originally written on November 11th, 2012.

Paying Cash For Cars

So, I once heard someone say that the second richest man in America, Warren Buffet, always bought used cars. This was a kind of guideline for the general concept that, "People who are well off tend to save for things they want and then pay cash." Although I didn't find any truth to saying above, I did find some of Warren Buffet's advice:

• Stay away from credit cards and invest in yourself.
• Money doesn’t create man it is the man who created the money.
• Live your life as simply as you can.
• Don’t do what others say, listen to them, but then do what you feel is the right thing to do.
• Don’t buy brand names; instead just wear those things in that make you feel comfortable.
• Don’t waste your money on unnecessary things; rather spend it on those who are really in need.
• It’s your life so why allow others to rule our life.

People who do well financially live within their means, pay their credit cards off each month and live modestly. In general, I feel like I can spot those who are well off, just by checking out the car they drive. The funny thing is, those with the brand new car, I consider not well off and those with an older car, I consider well off. Its almost opposite of what you see. My sister once told me, "I feel like you are a lot better off than most people, but you would never know by looking at what you have."

The only debt a person should have is their mortgage. Take a good hard look at yourself and see if this is true. That's right, pull in the student loans, car loans, credit card debt, etc. You may think everything is under control, but unfortunately you may be one event away from financial ruin. Keep in mind, this event may be completely out of your control.

FIVE YEAR COST

From this interesting article: http://www.consumerreports.org/cro/cars/used-cars/buying-advice/used-car-savings/overview/used-cars-ov.htm

• "According to the used car savings analysis, buying a 2005 Toyota Camry with a V6 engine, for example, could save you about $13,000 over five years compared with buying a new 2008 version."
• "buying a three-year-old Ford Focus can save you more than $8,000 over the first five years"
• "On average, our findings show that you can save 32 percent in the first five years by buying a three-year-old car. Similarly, with a one- or two-year-old car, you can save 19 and 27 percent, respectively."

PAYING CASH

But how much is it really costing you to decide to buy and get a loan rather than save up your money first?

National Automobile Dealers Association gives an average price of a new car sold in the United States as $28,400 and using the national average interest rate of 5.73%, that gives us $32,729.40 total, paying $4,329.40 in interest, if you are lucky enough to get that good of an interest rate.

Now, lets compare this to purchasing a car a few years old. One might get a discount of 35% since the average depreciation is 65% over the first five years (as much as 20% is lost in the first year from depreciation). This would be a purchase price of $18,460. Investing the difference of $9,940 at a rate of 5% (tax-free municipal bond with you being the bank), you would have $12,686. Since you also saved $4,329.40 in interest, you really made a decision that was worth $17,015.40!

MAINTENANCE

How does maintenance factor into all this?

From this article: http://www.consumerreports.org/cro/2012/06/what-that-car-really-costs-to-own/index.htm

• "While maintenance and repair costs increase, even over eight years they still don't average one-sixth the cost of depreciation."
• "In the end, though, it is almost always less expensive to hang on to your current car than to buy a new one. Even the most-expensive repair bills for an old car can't outweigh the cost of depreciation on a new one."

SUMMARY

By the way, I paid cash for my 93 Nissan Sentra in 2007 for $2400 with 90,000 miles and have not had to do any major repairs yet, knock on wood. My recent car insurance quote was $369 for the year, which is much less than people are paying for their new cars. My maintainence might be $1,000 per year and gas is about $300 per month. I might argue that maintainence on my vehicle is less than that on a new vehicle just because people need to pay more to maintain a liability with more value.

The funny thing is if you had $28,000 in your bank account, would you use all this money to purchase a car? Most people wouldn't. On the other hand, many people have no problem purchasing a car with money they don't own. Next time you purchase a vehicle, just remember your decision to get something nice rather than something great may be the difference between owning or not owning your home in 30 years.

This post was reposted from http://www.sizuservices.blogspot.com/2012/07/paying-cash-for-cars.html, originally written on July 31st, 2012.

Izu's RIPOFF Acronym for Whole Life Insurance

In just this last week, this is what I have seen:

THREE STORIES IN ONE WEEK

A whole life insurance policy that has been held for over ten years, paying in about $1620 into the policy each year, about $960 of which was supposed to go towards the separate account. The cash value after all that time was about $10,000. The owner of the policy and his wife are now out of work and were told to take a loan from the cash value to pay the premiums. Doing this, the cash value will last a few years before the policy lapses. If the owner gets back on his feet, he will have to pay the loan back as well as continue with the premiums to avoid lapsing the policy.

A whole life insurance policy that has been held for about seven years. The owner had been laid off a few years ago, drastically reducing his salary, so he has been taking a loan from the policy to pay off the premiums.

A whole life insurance agent that was ecstatic about taking someone's entire retirement savings and moving it into a whole life insurance policy. This policy is one of the newest flavors of whole life known as indexed universal life. From the best of my knowledge, this agent truly believed she was doing something good for the client despite how much money she made from the transaction. I believe that people who sell these policies either don't know or don't care.

ALSO KNOWN AS

Whole life insurance comes with many different names: whole life, universal life, indexed universal life, variable universal life, cash value life. Personally, I think the industry changes the name so that people don't recognize whole life when they see it.

RIPOFF

Retirement and College Savings: It is debatable whether it is even legal for agents to sell whole life policies as retirement and college savings vehicles. However, this is exactly what is happening. Insurance is not an investment! The purpose of insurance is to spread the risk to a large group of people but in the end, the insurance company is the one that profits. By the way, in general, it is better to save for retirement and then worry about college savings.

Inhibited Money Transfer: Whole life insurance agents often transfer retirement or other savings into a whole life insurance policy. However, if the owner changes their mind and wishes to regain control of that money, they may be forced to face surrender charges. In addition, the owner may find a lot of the money put into the policy is gone. It is much more difficult to move money out of a whole life policy than it is to move money into one.

Promised Rate Guarantees: Many policies guarantee specific minimum rates. The "guarantee" is based on the financial ability of the insurance company to pay. In addition, the company does not guarantee administration costs or mortality expenses, which means these can be raised at any time. If the company struggles to pay any guarantee, they have the option to pay the guarantee but with higher account costs. This means, families are getting a lot less money than they expected.

Optional Coverage for Life: Guaranteed renewable term insurance can be held until age 100 if desired but the owner can stop the policy at any time they desire. With whole life, the owner is placed into a "golden handcuffs" (as those in the industry call it), where the owner must continue to pay for coverage if they want the other benefits of the account. This coverage becomes very expensive as the owner gets older.

Fraudulent Commissions: Most people don’t know the commissions being paid for these policies. A high commission in general cannot be good for the client. For example, rolling over $150,000 into a whole life insurance policy will probably generate at least a $75,000 commission. If the owner cancels early enough some of this commission may be recouped since there are laws which allow a client to recoup commissions. However after a few years, the owner will not be able to regain the commission paid. Some companies have been sued when clients took out huge home equity loans to fund a whole life insurance policy. Please don't throw your entire life savings into one of these accounts!

Fake Tax Free Retirement: Many agents try to sell whole life based on tax free benefits by mentioning that loans are tax free. However, one could also take a loan using a house or stocks as collateral. Typically, taking a loan from a retirement account will allow the interest to be paid back to the account. On the other hand, interest from a loan against a whole life insurance account will typically be paid to the insurance company. A loan is always a tax free since the lender pays the taxes. Since when did taking a loan count as a tax free retirement strategy?

RECOMMENDATION

Go with the "Buy Term and Invest the Difference" strategy. This is a tried and true principle that continues to work. You may also want to learn why you might need life insurance and about the various types of term insurance. For more information, contact me anytime: scottizu@gmail.com.

Dedicated to Chris Izu.

This post was reposted from http://sizuservices.blogspot.com/2012/11/izus-ripoff-acronym-for-whole-life.html, originally written on November 24th, 2012.

Jim Rohn's 70%-30% Financial Independence Rule

The rule I am about to share with you absolutely works. On the surface, it may not seem obvious, especially if you have not used these principles in your own life.

I love my children. They teach me so much. Yesterday, when they left my car, I saw the big mess they left with all their belongings. I was speaking with my son and I realized that they did not see the mess. As parents, we have to teach them what to look for, how to see things and help them to find things they normally wouldn't notice. As we teach, we learn ourselves about leadership and patience. The natural cycle of life puts us into a leadership position.

It reminded me that as we grow in life, we may be presented with the same story, the same setting, yet have a different interpretation. Things we may have thought were boring as a child, bring so much joy as an adult. Things that we used to find funny, we can't see the humor in anymore.

Sometimes we can be quick to judge, quick to draw a conclusion. Truth has a way of bubbling up to the surface though, so the key is to continue to search, continue to explore. Wise people not only learn from their own experiences, but can also learn from other people's experiences.

EXPENSES

So, the rule, in a nutshell, has 4 parts. The first part states that one should only ever use 70% of their income on expenses. Most people probably think that this is not practical since they are already overextending themselves. However, most people probably can say that they used to be making 70% of what they are making now and they were covering their expenses. If you ever have trouble applying a financial rule, work hard towards increasing your income by becoming more valuable to the market place and when you do, apply the increase to the financial rule. As an example, if you are out of debt and you don't have a retirement account, maintain the same standard of living after your next pay increase and use the raise to fund your retirement account.

CHARITY

The next part of the rule states that you should donate 10% of your income towards charity. Whenever, I consider taking advice, I always ask myself, "What if I am wrong?" So imagine this isn't a good move and you spend 30 years giving to charity and you still end up broke. Well, the positive side is that you did something fulfilling with your life and helped to create a change in your community. From another perspective, changing your perception from one in which you ask, "What do I get from this?" to the alternate, "How can I give more?" allows you to become the type of person who is valuable to the market place, hence increasing your earning potential.

From yet another standpoint, giving and gratitude go hand in hand. By giving you allow yourself to feel gratitude which gives you a certain peace of mind since gratitude and negative thoughts like fear, doubt, worry cannot be felt simultaneously. Finally, by giving to charity, you have the opportunity to affect someone's life and possibly have a direct impact, which may later stimulate the economy.

ACTIVE VENTURE

Ten percent of your income should be used to fund an active venture. Everyone should own a small business. Small businesses give you huge tax advantages (will blog on this later). Small businesses stimulate the economy. This category can also include education and self-improvement. Classes and books may be expensive. It may also include actively loaning out money to a friend as startup funding or supporting a Kickstarter project. This might also include investing in real estate. All of these things can stimulate the local economy.

Most people don't realize they can stimulate the economy just by connecting two people who are looking for each other. They can talk and communicate, creating one more transaction, one more connection. They can speak to each other in the lines at the grocery store, coffee shops, online.

Some people live by the rule of "Eat, drink and be merry for tomorrow we die." I love this philosophy because to me it means that we should enjoy life and be grateful. However, I think that living happily may be completely different than partying as marketed in the media. Everyone has been given a specific set of talents. My hope is that people can use those talents to their full extent. A wasted talent may translate to a village of hungry people or a cousin out of a job.

PASSIVE VENTURE

Ten percent of your income should be used to generate passive income. In this category, you would include investing in global companies and the global economy. Picking big companies, no-load mutual funds, passive index funds, etc to stimulate growth in our country.

This may also include real estate if you have property management and are hands off in decision making.

Dedicated to Cheng Xu.

This post was reposted from http://sizuservices.blogspot.com/2012/10/jim-rohns-70-30-financial-independence.html, originally written on October 14th, 2012.