Are you ready to discover how to get out of debt once and for all?

If you want a permanent debt solution then I have shocking news for you: Debt is not a financial problem. Hard to believe, but true.

Debt is actually a personal problem masquerading in financial clothing to deceive you. That is why so many people have persistent problems with debt. They look outward for financial solutions when the true solution is found by looking inward.

In this article I will clearly define the source of all your debt problems and provide a simple 3 step solution so you can get out of debt once and for all.

The Permanent Debt Solution

Defining your debt problem correctly is critical to solving it.

That is where most debtors run into trouble. They mistakenly define debt as a financial problem thus developing financial solutions. That is why their debt returns shortly after paying it off. They fail to identify the root cause of debt opening the door to repeating the vicious cycle.

A permanent debt solution requires a plan of attack based on proven principles that will actually work. Unfortunately, when you just pay off your balances you relieve the painful symptoms but the underlying condition that put you in debt in the first place still lurks under the surface like an insidious cancer ready to return.

Debt’s real cause is personal life habits and attitudes that result in overspending. In other words, the true solution is personal – not financial. That is a key principle. Understanding this principle is what will make or break your success in slaying the debt monster – permanently.

Treating The Symptom Instead of The Cause

When you get a headache what is the logical response? You reach to the medicine cabinet for immediate pain relief. Unfortunately, the various pills do nothing to cure the underlying disease: they merely treat the symptom. The cause could be excessive stress, brain cancer, dehydration, eye strain, or any number of other issues. By taking a pill you’ve treated the symptom – not the underlying cause.

The same is true with debt. Everyone knows they need to make more and spend less to solve their debt problems. As a result they pursue financially driven solutions to relieve financial symptoms. It all seems logical on the surface.

Whether you choose to consolidate your credit card debt to lower interest rates or you choose any of the quick-payoff strategies (inheritance, gift, sell an asset, bankruptcy, home equity line of credit, or refinancing), the reality is you are treating the symptom and not creating a lasting cure. You are performing the financial equivalent of blowing your nose when you have a cold.

The only permanent solution is to change your life habits and attitudes that got you into the problem in the first place. You are the cause of your debt, and you will be the solution. Your financial problems are merely the accumulated reflection of the many small financial mistakes you are making on a daily basis – often without knowing any better.

That’s why teaching a debtor to spend less and earn more is like telling someone to lose weight by eating less and exercising more. Everyone already knows that is the answer. The difficult part is not knowing what to do, but actually getting it done. The solution is your daily habits and attitudes.

How I Broke Through The Debt Barrier

I first discovered this approach to debt recovery in my work as a money coach. I started out making the same mistakes as everyone else. I thought debt problems were financial so I coached my clients to financial solutions. The lackluster results proved it was the wrong approach.

The breakthrough came when I noticed my wealthy clients were living the mirror opposite habitudes compared to my get-out-of-debt clients. For example:

• My wealthy clients viewed their financial situation from a position of self-responsibility whereas my debt clients were victims of their finances.
• My wealthy clients had strong financial awareness and paid attention to the details, but my debt clients only focused on finances when problems surfaced and preferred the whole “financial thing” would just go away.
• My wealthy clients planned their finances but my debt clients had no plan.
• My wealthy clients organized their plans around delayed gratification whereas my debt clients pursued instant gratification.
• My wealthy clients associated their self-worth with intrinsic values and my debt clients associated self-worth with extrinsic stuff.

These are just 5 examples from a long list of opposing traits. They are guidelines or tendencies that generally hold true. While there may be personal variation, on the whole the patterns were unmistakable. These mirror opposite habitudes produced mirror opposite financial results in life.

Amazingly, when I applied these principles by coaching the underlying habitudes instead of specific financial actions the debt problems solved themselves over time.

This is obvious when you think about it. Your daily financial decisions result from your habits and attitudes that drive those decisions. For example, consider the following habitude choices and their obvious financial implications:

• Do you buy fancy coffees throughout the day or do you make a pot of your favorite coffee in the morning and bring it with you?
• Do you lease a new car every few years or maintain your reliable used car?
• Do you preemptively insure against the losses you can’t afford to take or are you exposed to risks that can wipe out a lifetime of hard work?
• Do you dine out frequently or cook healthy meals at home?
• Are you a minimalist or do you desire the latest designer fashions?
• Do you shop to get what you need or do you shop for pleasure and recreation?

When you focus on financial solutions you treat the symptom instead of the cause. When you focus on the habitude, you focus on the underlying cause so that the symptom takes care of itself automatically and without any self-discipline.

Let me be clear – this isn’t a quick fix. The results you produce from this approach will occur gradually over time. Just as it took time to accumulate the debt it takes time to unwind it when you work with root causes.

However, the solutions are as permanent as the new habitudes you adopt – and that makes all the difference.

The Habitudes That Cause Your Debt

Debt problems are emotional, not rational.

That’s why you keep buying things you can’t afford and spending more than you earn.

Everyone knows the first law of finance is to spend less than you make, but it is easier said than done for many. How do you overcome the emotional barriers that keep you mired in debt?

The easiest path is to adopt the key financial habits that close the gap between knowing what to do and actually getting it done so that you put your debt freedom on auto-pilot. These new habits result in new decisions that produce new financial results: it is simple cause and effect.

The good news is this means you have the power to improve your financial situation no matter where you are at today. You created your habits, and your habits produce your long term financial results. That means you’re in charge and have the power to make positive changes.

Consider the following 7 financial habitudes that can take you to debt or wealth. The habits you choose will literally determine your financial success or failure.

1: Emotional Spending - Here is a simple test to determine if you’re an emotional spender:

• Do you use shopping to relieve stress or escape boredom?
• Do you use shopping as a pick-me-up or entertainment?
• Do you celebrate by shopping for a treat?
• Do you ever shop as a form of “retail therapy”?
• Do you use shopping for social connection?
• Do you have clothes in the closet with the tags still attached?
• Do you have more than one of the same item?
• Is your credit card bill so large that you can’t afford to pay it off at the end of the month?
• Do you ever feel an endorphin rush when making a purchase?
• Do you experience anxiety, guilt, or remorse after shopping?
• Do you ever hide purchases from friends or loved ones?

If you answered “yes” to one or more of these questions then you might have an emotional spending problem.

Emotional shoppers become addicted to the temporary endorphin high that comes from buying. You’re genetically programmed to pursue what makes you feel good but that can turn spending into a physiological habit like a drug. That’s why excessive spending is about the emotional experience from buying stuff and not the stuff itself. The purchase brings temporary yet immediate gratification (even if it causes debt).

The wealthy habit is to spend based on needs – not wants – and to plan purchases rather than buy spontaneously. A good habit for breaking emotional spending is to force a two day cool off period for all non-planned purchases so your emotions can settle down. If you still want it after two days then it may actually be worth buying.

2: Addiction - Closely related to emotional spending is addiction, but this can be an addiction of any kind – not just shopping. Gambling, drugs, and sex addictions are highly destructive – both financial and otherwise. The ensuing debt spiral may be the least of your worries but is often a consequence.

The wealthy habit is to avoid all forms of addictive behavior and live in balance – admittedly easier said than done. If you face addiction issues the solutions are beyond the scope of this article. Seek professional help and consider one of the 12 step “Anonymous” programs tailored to your specific addiction.

3: Entitlement - Entitlement thinking is the belief that you magically deserve all the good things in life regardless of what your financial statement says. After all, why shouldn’t you have designer clothes, a big screen TV, pedicures, and a new car? Everyone else does, right?

The wealthy habit is to only purchase what you can afford to immediately pay for. The wealthy attitude is you are only entitled to what the balance in your savings account shows you’ve earned.

4: Instant Gratification - Closely related to entitlement is a debtor’s tendency toward instant gratification. You want everything now and are willing to pay on credit thus multiplying the cost of the item.

The wealthy habit is to pursue delayed gratification from a 10-20 year time horizon instead of immediate gratification today. That means paying cash for all purchases to lower the cost. This isn’t a sacrifice to the wealthy mindset because you are choosing long-term freedom over immediate lifestyle by investing for tomorrow instead of spending today. It could also include career training or night school instead of watching television so that you can improve job skills and earning capacity.

5: Self-Worth Connected To Stuff - Advertising tries to manipulate you into believing products will make you more attractive, smarter, happier, or live longer. The debtor buys into this false belief system by connecting happiness to more-better-different stuff.

The wealthy habit is to separate your spending from your feelings of worth. You are not defined by your possessions. Ask yourself why you spend? Are you satisfying a genuine need or a contrived want? Your things do not determine your worth as a human being.

6: No Plan – Debtors tend to disconnect spending, saving, and earning from each other. There is no budget, no plan for retirement, no tracking of numbers, and no strategy for increasing earnings. In short, the debtor lives month to month because there is no plan to do anything different. Many questions are never considered such as how to handle a job loss or medical emergency. The default answer is often debt because there was no better plan.

The wealthy habit is to run your personal finances like a business with plans and actions steps designed to produce a financially secure result. Develop reserves for the inevitable rainy day and insure those risks you can’t afford to lose. Save monthly from earnings for retirement. Planning is a wealthy financial habit.

7: Complacency - Nothing accelerates a debt spiral like complacency. The debtor attitude might be “I’m already in debt, so what’s the big deal if I spend a little more?” Complacency is a dangerous spiral because the pleasant feelings you experience when buying are disconnected from the painful feelings you experience when the credit card bill arrives. The problem is that a series of small impulse purchases, even when minor, will eventually add up to serious debt. You can get away with it for one day or one month, but over a period of years the compounded effect can mean foreclosure or bankruptcy.

The wealthy habit is to respond proactively to any warning signs of impending financial problems. Living paycheck to paycheck, using credit to pay for living expenses, and stressing over money are all warning signs that you need to take action. One solution is to only spend cash because credit cards encourage complacency since they don’t feel like real money.

Bonus: View Credit As Money - The debtors habit is to use credit to extend purchasing power as if it was real money. That works in the short term but has the opposite effect in the long term because the added interest costs make everything more expensive. Buying on time impoverishes you and makes the banks rich.

The wealthy habit is to earn interest instead of paying it. This may decrease short term purchasing power but increases long term purchasing power resulting in greater wealth over your lifetime.

But It’s Not My Fault!

I can already hear the objections.

“But Todd, this habit stuff is all fine and good for most people but my debt is different. It was caused by medical emergency, unexpected layoff, divorce, student loans, (add your reason here). I didn’t accumulate my debt through bad habits like you talk about.”

Are you ready for some tough love? You are the cause of all your debt problems including debt resulting from unexpected events. You are solely responsible.

For some, this is a bitter pill to swallow. Facing this truth can be uncomfortable, but you must see the cause of your financial problems looking back in the mirror or you may never get out of this vicious cycle of debt.

Taking responsibility is difficult: It means you have to give up the victim role. But it is the only way you can empower yourself, take charge of your life, and permanently solve your financial difficulties.

When you are a victim to debt you give away all your power to solve it: After all, it is someone else’s fault. It is outside of your control. There is nothing you can do about it.

However, when you own responsibility you take back your power. The fact that you caused your debt means you have the power to cure it and never let it happen again, and that is a good thing.

The surprising reality is it doesn’t matter whether you are truly a victim to your debt or not – the result is the same.

Maybe you lost your job because of an economic downturn, or you ran into unexpected medical expenses, or a sudden and desperate family problem came up. These are all very common paths to debt and they all imply the debt was not your fault. After all, the circumstances that caused it were beyond your control. How could it possibly be your fault?

Why Debt is Always Your Responsibility Even When the Problem That Caused It Is Not

The sad truth is misfortune is one of the leading causes of debt because it happens so frequently, and that is the key point. Misfortunes are not unexpected: they happen frequently. While it might be true that the unfortunate circumstances were beyond your control, the fact that they resulted in debt is fully within your control and 100% your responsibility.

Owning responsibility can be uncomfortable. However, the goal is to get out of debt and self-responsibility is the most practical and efficient path to achieving that goal. This is about practical solutions – not about feeling good. Being a victim to your debt only keeps you stuck in the pattern: self-responsibility is what opens the door to freedom.

When you take responsibility you recognize how the seemingly unpredictable circumstances of your life are actually predictable when viewed over your lifetime. The chance of any one financial calamity occurring in any one year is small, but over your lifetime you should absolutely expect and plan to experience one (or more) of these setbacks. You must plan for them with proper insurance and an emergency fund to carry you through those inevitable difficult times or debt will be the result.

In other words, the probabilities are extremely high that you will experience at least one job loss, unexpected illness, devastating lawsuit, horrific medical expense, divorce, identity theft, or other financial emergency in your lifetime. If you don’t plan accordingly it can throw you into sudden “unexpected” debt and wipe out a lifetime of financial progress – even though it is totally unexpected.

That’s why you are responsible. Even though you may be a victim of the specific event, you are fully responsible for improper planning given that nearly all lives are touched by one or more of these events at some point. That means the financial outcome is your responsibility even if the actual event that caused it is not.

How Risk Management Prevents Debt

Risk management planning is the wealthy alternative to unexpected debt.

Financially successful people know that bad things happen to good people and manage those risks with appropriate insurance and reserve funds. The rule is simple: always insure those losses you can’t afford to take. For example:

• Adequate life insurance to provide replacement income if the primary breadwinner passes.
• Disability insurance to protect against major injury causing loss of income.
• Fire insurance to protect against fire destroying your home and possessions.
• Liability insurance to protect against a devastating lawsuit that could wipe out an entire lifetime of savings with just a single mistake.
• Health insurance to protect against the high cost of getting sick.
• Emergency reserves to help pay unexpected expenses when the car suddenly dies, you’re temporarily laid off, or serious illness strikes.

When you plan for unpredictable (but inevitable) adversity then you are prepared so that the inconvenience of a temporary setback doesn’t result in financial calamity. Proper insurance and emergency reserves are a normal and necessary budget item similar to food and utilities. If you don’t think you can afford insurance then look for ways to reduce your spending so that you can. It’s not optional because eventual debt is the likely alternative.

The truth is nobody looks forward to adversity. But when you are prepared the consequences are temporary and manageable. When you don’t prepare the financial results can be devastating.

How To Get Out of Debt In 3 Simple Steps

Okay, enough of the responsibility stuff. The fact is you are in debt so what are you going to do to solve it?

I like to keep things simple so let’s use an analogy to illustrate how eliminating debt problems works so you never have to experience this pain again.

Imagine you have a flat tire. You can reflate the tire for a quick fix to get you down the road, but unless you find the source of the leak and fix it first the tire will flatten again.

Permanently repairing a flat tire requires 3 action steps:

1. Identify the source of the leak. Why is air getting out? It could be a nail in the tire, bad valve stem, or any number of other causes. You must first identify the root cause so you can permanently fix the problem.
2. Then you must take action by repairing the cause of the leak. Until you do whatever is necessary to fix the root cause the tire will just flatten again and again no matter how many times you reflate it.
3. Once you’ve completed steps 1 and 2 then it makes sense to reflate the tire – not before.

Debt works the exact same way. You must plug the holes in your budget by fixing the cause of the debt before actually pursuing financial solutions (reflation) to pay the debt off.

Unfortunately, most people do just the opposite. They mistakenly go straight to step 3 by hiring a debt consolidation company, or transferring balances to a HELOC or a 0% credit card, or they try a quick fix by selling assets such as a house, boat, or car.

Unfortunately, all of these methods are the financial equivalent of reflating the tire without ever finding the huge nail that caused the leak in the first place. That is why so many debtors repeat the cycle over and over again – paying off credit cards only to run them up again. The source of the leak never got fixed so the tire just goes flat again.

Below are 3 steps to identify and repair you budget leaks so that you can permanently solve your debt problems.

Step 1: Identify the Cause:

As stated above, the cause is you. More specifically, your debt is caused by your habits and attitudes that determine hundreds of daily financial decisions. Literally, your financial situation is a matter of habit. You must own this truth to focus your efforts on the appropriate cure.

Step 2: Implement the Cure:

Once you’ve identified the habits that cause you to get into debt the next step is to adopt new habits that move you toward wealth.

With this step you literally engineer your life to create wealth one habit at a time. This means stopping all the slow leak habits and replacing them with wealth building alternatives. Below are 3 questions to consider:

• What behaviors got me into debt in the first place?
• Are there specific situations that brought about my current debt problems?
• Why didn’t I stop accumulating debt when it started?
• What has previously kept me from solving my debt issues?

Once you identify the habits and attitudes that started your debt problems and kept you from solving them, then it is time to apply whatever strategies might be helpful from the list below to plug the leaks in your financial flat tire:

• Make a realistic budget with spending limits for each category. Start by adding up and categorizing all spending from the prior 12 months to create a benchmark budget, then shave what is unnecessary until your planned spending is less than your income.
• Track your daily spending. Now that you have a budget the next step is to stick to it – tracking will help you do that. Another reason to track all your spending is it raises your consciousness around each expenditure to create further saving. The way it works is you ask yourself two questions for each expense: “Is this getting me the highest and best value for my money?”, and “Is this taking me toward my goals or away from my goals”. These questions align your spending with your values and goals by directing all spending toward getting you want you want out of life.
• Learn how to curb emotional spending. Another way to stay on budget is to prepare a shopping list before leaving the house so that you only buy what is on the list and within budget.
• Set a shopping schedule that you don’t deviate from to eliminate “retail therapy” and shopping as entertainment.
• Forced Wait Times: When facing any unplanned buying decision always require a “cooling” period of a day or more. No unplanned, emotional buying allowed. Force yourself to wait 24-48 hours and then reconsider if you really need the item.
• Identify which emotions you attempt to satisfy through the shopping habit then find alternatives that bring greater enjoyment to your life. Activities such as exercising, listening to music, or enjoying nature cost little and can be a healthy and economical alternative.
• Leave your credit cards at home. Consider freezing your cards in a big block of ice so that it requires time and inconvenience to use them. By spending only real cash you are more connected to the cost of things and less likely to overspend.
• Identify and avoid shopping situations that cause excessive spending. For some people this might be shopping alone, and for others it might be a social situation with friends who encourage you to pleasure shop. Whatever situations encourage you to spend should be avoided.
• Create accountability by telling all your friends and family about your planned habit changes. Ask them to ruthlessly support you by calling you out if you backslide into old patterns.

• Cure shopping shame by always showing your family and friends what you buy. Do not hide any purchases except gifts (temporarily).
• Join a debt support group in your community or online.
• Develop other habits besides shopping that make you happy and replace the shopping habit with these more productive alternatives.
• Reduce your exposure to advertising – particularly for the products you’re most vulnerable to wanting. If you have a passion for fashion then drop those magazine subscriptions. Unsubscribe to internet marketing letters that prompt your desire for their products. Record your favorite television shows and fast-forward through the ads. Don’t allow Madison Avenue to dictate your values.
• Remember the other side of the coin – increasing income. Can you temporarily work overtime to get your debt under control? Is there seasonal or freelance work available, or can you convert a hobby into income?
• Finally, remember to adequately insure those risks you can’t afford to take. Yes, it costs money and adds expense to your budget, but you don’t want one of life’s unpredictable yet totally expected hiccups to send you back into debt. Be prepared with reserve funds and proper insurance.

Each of these strategies has one objective – to plug all the habitual ways you leak money so that you never go into debt again. You must persist in plugging these leaks until you are spending less than you earn. That is the bottom line. You are not complete with Step 2 until you are in compliance with this foundational law of personal finance – spend less than you earn. That is the sole criteria for completing Step 2.

It may take you months to achieve this objective. That’s okay. The key is to not go into overwhelm. Just pick one debt producing habit and start living the wealth producing alternative until it is comfortable and then pick another. Most people overestimate what they can accomplish in one month and way underestimate what they can accomplish in 3 years of dedicated effort. Be persistent. One habit at a time will get you to the goal with minimal pain.

Finally, set proper expectations by realizing this isn’t a quick fix solution. It’s about long term financial management and permanent habits that convert your debt into wealth. It is a permanent solution that addresses the root cause of the problem and is worth the effort.

Remember, the goal for this step is to spend less than you earn. When you reach this point you will have the monthly savings necessary to begin paying down your debt in Step 3 below…

Step 3: Treat the Symptom

Now that your financial life is positive cash flow, it is time to pay off all your debt in the most reliable, efficient way possible. This step is broken into 3 sub-steps to make it easy to complete. Staying with our flat tire analogy, you’ve fixed the hole in the tire so now it is time to reflate.

1. Begin by organizing all your debts to minimize the monthly bleeding. Consider which consolidation and refinancing strategies can help you lower interest costs and eliminate penalties and fees. Contact your existing creditor and try to negotiate special terms. Every dollar saved in interest and penalties is one less dollar you need to pay off.
2. Sell your stuff for a quick payoff. Do you have jewelry, an extra car, R.V, furs, or a boat that is seldom used? What things can you sell to make a quick dent in your debt and accelerate the payoff process?
3. Once your interest costs are minimized and quick payoff strategies are implemented then organize your remaining debts according to either the debt avalanche or debt snowball methods using this free calculator. Structure your debts using the rollover method so that as soon as the first debt is paid off then the freed-up payment amount is used to pay down the next debt even faster. Continue the process of paying off debts (building like a snowball) until you are completely debt free. It is the most cost effective and emotionally satisfying way to get out of debt.

• Debt Avalanche: This creates the fastest payoff by ordering your debts from highest interest rate to lowest interest rate. By concentrating your payments toward your most expensive debt first you lower the total interest cost and payoff the debt faster. The downside is if you have a large debt at a high interest rate it could feel slow to start.
• Debt Snowball: This is the most emotionally satisfying payoff strategy because debts are ordered from lowest balance to largest balance so you can see results faster. This gives greater odds of staying the course to completion because of the emotional reward of watching entire debts get wiped out rapidly.

The key is to have a clear plan and execute your payoff strategy with discipline. Start by minimizing interest and expenses on your debt to stem the bleeding. Then figure what stuff you could sell to make a quick dent in your debt. Finally, structure the remaining debts into a disciplined payoff strategy. This is the fastest, most reliable path to debt freedom.

When you follow these three steps you may be surprised how fast you can get out of debt. The key is to take it one step at a time and be persistent.

Conclusion

There are many ways to get into debt, but there is one simple 3 step process to eliminate your debt problems permanently.

It begins by taking responsibility and recognizing your habits and attitudes are what caused your financial debt symptoms to appear. Your debt is a personal problem masquerading as a financial problem. The cause of your debt is within you – not outside of you.

Your first task is to replace debt producing, personal habits with wealth producing alternatives. This requires you to take full responsibility for your debt which can be difficult. It means you have to give up the victim role. However, it is also empowers you to redirect your life from debt to wealth.

Once you’ve righted your financial ship it means you are spending less than you earn. This allows you to use those freed up savings to pay off your debt following the structured 3 step process above: stem the bleeding, sell unused stuff for a quick payoff, and then accelerate your remaining debt payoff with the debt snowball/debt avalanche.

The key is to adopt the right attitude. Reducing your spending and paying off your debt does not have to be a sacrifice. It’s about getting what you want out of life. It is about getting rid of the dark cloud of debt, the wasteful interest expense, and about taking control of your life and redirecting your resources toward what you find most fulfilling.

Your goal is much bigger than just getting out of debt. This 3 step process sets the foundation that can literally translate your debt into wealth and transform your financial situation for a lifetime.

I hope it helps you. Please let me know what you think in the comments below…

Here’s Some Handy Calculators To Make The Math of Getting Out of Debt Easy!

• Debt Snowball/Avalanche Calculator: How fast can I get out of debt using the rollover method?
• Credit Card Payoff Calculator: How long will it take me to get out of debt using a variety of repayment strategies?
• Debt Reduction Calculator: How fast can I get out of debt by adding a fixed amount to each monthly payment?
• Debt Repayment Calculator: How fast can I get out of debt by selling my stuff and making a single, lump-sum additional payment?

The post How To Get Out Of Debt – The Complete Guide appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

They were all in ridiculous bubbles that ended very badly for investors.

This may sound like a bold prediction, but in fact, it’s not. It is simple risk vs. reward analysis based on valuations.

This simple, mathematical analysis has saved my portfolio twice from past bubbles and can save your portfolio this time.

Let’s explore how it works…

Treasury Bonds Bubble Analysis

Interest rates peaked back in September 1981 and have been falling ever since to reach today’s extreme lows.

According to O’Shaughnessy Asset Management, 2013 provides the most difficult environment for generating income in 140 years. Since 1871 there has never been a lower yield period in history – not even close.

The average historical yield on a 6o% equity /40% bond portfolio has averaged 4.36% and is now at an all time low of just 2.0%. Clearly, we are in extreme territory for low interest rates.

In fact, research on 30 years bond rates going all the way back to before the Civil War (1790) shows the United States has never been able to borrow long-term capital more cheaply than it can right now. Unbelievable!

Further proving how extreme our current point in history really is, Timely Portfolio’s did a fascinating study on 10 Year U.S. Treasuries (constant maturity similar to IEF) evaluating what would happen if interest rates went to their theoretical minimum – zero. Are you ready – drum roll please – a paltry 17% gain. Shocking but true.

That means that if interest rates went as far as they could theoretically go on the downside the entire upside left on 10 Year Treasuries is a mere 17%. That’s not much considering it is the mathematical, extreme case limit for how far it could go. Your actual returns would depend on how long it took to reach this limit. For example, Market Sci blog showed that if it took 4 years to reach zero percent interest rates then the annualized return would be just 5% and the total return would be 21.6%.

This may not sound too bad until you realize that 0% yield is not very likely. Given that Japan’s record low yield for their 10 Year Note was .47% it is interesting to note the maximum upside is reduced to a mere 13.8% and if it takes 4 years to get there your annual return is just 4.1% with a total return of 17.6% – before inflation! If you net out inflation the real return is miniscule at best.

The implication is clear – the upside potential in bonds makes no sense compared to the downside risk.

The problem is bond prices move inversely to interest rates and interest rates are approaching their theoretical floor. In other words, as rates decline bonds rise in value. As rates rise bonds lose value. There is little room left for interest rates to fall and tons of room for rates to rise creating an unfavorable risk reward ratio.

This problem is further exacerbated by the fact that current low interest rates would cause a modest rise in rates to cause disproportionately large losses that could dwarf any income received in the interim. For example, as of this writing a mere 1% rise in interest rates on the Treasury long bond should equate to a roughly 20% price decline wiping out 7 years of income at current interest rates.

Do you think it is reasonable to expect a mere 1% increase in interest rates from these historically low levels over the next seven years as the above example illustrates? After all, far worse has occurred in the past when markets were less volatile. For example, the 30 year Treasury yield rose 240 basis points in just 9 months back in 1994. Just imagine what a 2 – 3% rise (or more) would mean to investor portfolios given the above example.

Why The Bond Bubble Is More Important Than Previous Bubbles

This is critically important because fixed income’s traditional position within asset allocation is as a “safe investment”. In fact, we have entered one of those rare points in history where the risk/reward analysis on bonds could conceivably be more dangerous than equities because the historically low coupon implies historically unprecedented volatility and downside price risk.

In other words, capital loss risk to bonds is highest when starting yields are lowest. Given that yields are at all time historical lows many historical benchmarks for capital losses in bonds are unrealistically conservative. The future could easily be far worse than the past.

For example, according to Welton Investment Corporation the deepest (-15.3%) and longest (8+ years) Aaa corporate bond drawdown occurred from 1954-1963 because of a tiny 1.8% increase in interest rates – a hiccup by today’s volatile standards. The reason is because the starting yield in 1954 was an equally tiny 2.85%.

In other words, the drawdown severity and duration is not determined exclusively by the magnitude of the interest rate rise. It is determined by the relationship of the interest rate increase compared to the starting yield. Today’s record low yields imply historically high risk of capital loss.

For example, Welton also analyzed what could happen to Aaa corporate bonds under different interest rate increase scenarios:

1. A 6% increase spread over 5 years would result in a 36.2% drawdown and a 6.4% annual loss.
2. A 4% increase in just one year would result in a whopping 34.8% drawdown and a 34.8% annual loss.
3. Even a modest increase spread over many years could cause zero return (or worse) for more than a decade.

These losses may not look horrific by equity market standards, but it is important to note the money parked in top quality bonds is considered “low or no risk”. That is clearly no longer the case and it has serious implications for traditional asset allocation models.

Some might argue that if you hold the bonds to maturity then price risk is only a temporary problem, but that is a dangerous half-truth. Today’s investors frequently hold their bonds in diversified pools of mutual funds and ETF’s giving up any ability ride out the downturn and hold a specific bond to maturity. The losses can become permanent.

Whether you think interest rates will rise or not is irrelevant. The point is the downside risk of loss is high in what many investors consider to be their safest investments and they are getting paid paltry returns to accept that risk. The risk versus reward ratio is absurd. It makes no sense.

In short, the risk to fixed income portfolios is extraordinary right now.

Limitations, Caveats,

Given the unfavorable risk/reward ratio, what should you do as an investor?

That depends on many factors including your investment goals, time horizon, specific portfolio composition (duration, quality, etc.) and how much interest rates actually rise.

Of course, I do not have a crystal ball and have no clue when and to what degree interest rates will rise. I just know it will eventually happen and the downside risk when it occurs does not justify the return being offered to accept that risk. That is the only relevant point. The math is unequivocal on this fact.

The only questions remaining are timing and severity – both are complete unknowns.

What we do know is eventually, investors will demand greater return to accept the risk associated with lending their money. As nations become increasingly in debt how many more short-term fiscal manipulations can be applied to keep interest rates artificially low? I don’t know (and neither does anyone else). What we do know is a turn of the tide in interest rates is merely a question of when – not if.

And yes, I’m fully aware that naysayers have been saying the same about Japan for a very long time and been completely wrong. True! I’m the first to admit this analysis says absolutely nothing about timing – a critically important fact. The bubble could continue for years before turning, but that doesn’t change the mathematical reality that it is clearly a bubble because risk to reward analysis makes no economic sense.

Would you lend to the U.S. Government for 5 years for an 88 basis point return? Nobody in their right minds should risk substantial downside losses for a maximum potential upside gain close to zero (or worse) net of inflation.

What Can You Do To Protect Yourself?

I’m not in the investment forecasting business.

I rarely write posts like this because forecasting financial markets is a fools game that has no place in sound investing. The future is unknowable and anybody who plays in forecasting the market is destined for humility.

What I’m sharing with you here is not a forecast. It is risk/reward analysis of a broad market sector based on mathematics.

There are rare times when valuations in specific markets reach such absurd levels that the risk versus reward ratio allows you to make investment decisions without any specific forecast. I’ve done this twice in the past (publicly) and I’m doing it a third time right now.

1. How did I know to sell all my investment real estate in 2006 right before the market top?
2. How did I know to sell my investment management company in 1997 and remove traditional equity allocations from my portfolio 3 years too early before the big top in stocks?

Actually, I never knew either market was at or near a top. That would be a forecast.

All I knew was the risk/reward analysis was extraordinarily unfavorable to where participating in that market no longer made sense. It was based entirely on business common sense and required no forecast.

I want to be clear that I had no idea when the actual market tops would occur in the past or how they would come unwound, and the same is true with the bond bubble today.

For example, when I sold my investment real estate holdings in 2006 the only thing I knew was my $600/month apartment tenants who didn’t qualify to rent from me were getting 30 year mortgages on $300,000 homes. I knew their credit and rent payment histories as their landlord, and I was 100% certain they didn’t qualify under any reasonable lending standards – yet they somehow got loans. (Of course, we found out after that fact there was massive lending fraud.)

I also saw the real estate investment deals my financial coaching clients were examining. Valuations got so absurd near the top in 2006 that deals were transacting where it was literally impossible to make money from operating the property. Even if you had zero vacancy, no maintenance costs, no turnover costs, and none of your expenses ever increased, the property would still be cash flow negative. The only possible way to profit from ownership was if a greater fool came along and paid an even stupider price for the property than was being asked at the time. It was a recipe for disaster.

It doesn’t take a rocket scientist to see the risk to real estate when the absolute lowest credit quality buyers are already fully invested in the market and prices are so high they make no economic sense using absurdly optimistic assumptions. The balance of supply/demand had to tilt to the downside. It was business common sense.

What I didn’t know was when or how much real estate would decline. The fact that selling all my real estate by the end of 2006 was nearly perfect timing was actually total luck. Truly, I had no idea. The real estate markets could have remained overvalued for years and gone to even more unfathomable extremes. I didn’t know where and when the bubble would end: I just knew it was a bubble and the valuations made no sense. I sold my properties for more than two times as much as I was willing to pay for them, paid the taxes on the gains, and never looked back.

Similarly, when the stock market bubbled in the late 1990′s, I eliminated all of my traditional equity allocation in my portfolio and sold my investment management company by the end of 1997. In this case my timing was way too early. The markets continued to rise relentlessly going from ridiculously overvalued to unbelievably overvalued before the final top in 2000. Again, it is just business common sense that when the entire NASDAQ index is selling for more than 200 times earnings at the top it can only end badly. It was just a question of when – not if. The valuation was unsupportable. It was business common sense.

Everybody and their mother wanted to get rich in stocks back then. Every coaching client wanted hot stock tips. Heck, I even had a client end our relationship when I started teaching him how to understand the risk inherent in his 100% tech stock portfolio. He was blind to the message and lost most of his net worth in the downturn that followed. The psychology was absolutely frothy, and amazingly, it continued that way for years creating the most overvalued stock market in U.S. history.

I had no idea on the timing for the bubble burst and in this case I was way too early. Ultimately, the position was vindicated by the massive decline that followed, but I want to be clear that this type of analysis tells you absolutely nothing about timing – only ultimate outcomes. The markets can remain irrational for far longer than you can remain solvent so be careful what you conclude from this analysis.

And that brings us to today’s bubble du jour – the bond market. I have absolutely no clue when the final top will occur. It could finish this week or continue on its merry death march for a few more years. It is impossible to know because nobody can predict the future… least of all, me.

With that said, what you know from the above analysis is supply demand is now grossly out of whack. According to Fidelity more than $1.1 trillion was allocated into bond mutual funds and ETF’s since 2007 while equity funds received just $33 billion – an astonishing 33 times more to bonds than stocks. Bank of America provided similar numbers showing U.S. investors pulled $600 billion dollars from U.S. equity funds while simultaneously adding $800 billion to bond funds – a massive, one-sided tilt in allocation. Research demonstrates that extreme, multi-year capital inflows into an asset category has historically lead to unfavorable risk reward ratios in subsequent years as reversion to the mean takes hold.

According to Reuters, even the biggest names in bond management (PIMCO, Loomis, DoubleLine) are making business moves into equity funds and diversifying their businesses. The writing is on the wall.

Bottom line is valuations make no sense in the interest rate market. Would you loan money for 30 years at 3% to a government that is so deeply in debt that it is mathematically impossible to repay its debt? Of course not! It is insane. Completely insane.

Yet fortunes are traded every day on that exact premise and people have major chunks of their retirement savings invested accordingly. Hopefully you will be wiser. Caveat emptor.

Appropriate Investment Strategy

Only you can decide what is appropriate for your portfolio.

This is an educational newsletter and does not offer personal investment advice.

With that disclosure in place, you probably want to know what I’m doing with my own money given this information. The answer is I will do the same thing I did before the stock market bubble burst and the real estate bubble burst: I exit the market.

Because markets can stay insane far longer than you can remain solvent I never short a market based on risk/reward analysis. It makes sense for my investing to remove risk by eliminating or reducing market exposure based on unfavorable risk/reward ratios. I’m willing to accept the risk of leaving the last few breadcrumbs on the table and being temporarily wrong for years in exchange for giving up the risk of being invested during the highest risk periods when mathematical expectation is unfavorable.

Others may view their investment situation differently and be equally correct. For example, U.S. Treasury bonds are one of the few asset classes that have maintained low to negative correlation with equities in recent years providing a valuable portfolio diversifier that has substantially reduced volatility in the past.

However, as I teach here and here, investing done right is about building a portfolio of favorable risk/reward ratios resulting in positive mathematical expectation. This is the math that governs how money compounds and it is inviolable. Mathematical expectation trumps all other investment considerations, and bonds show limited upside potential with strong downside risk.

You are now armed with the necessary knowledge. The choice is yours.

What do you think about this latest bubble situation? Tell me in the comments below…

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I sold the hedge fund business and became financially independent at age 35. What’s wrong with that?

After all, it bought me the freedom to embark on a 6 month trip and live the dream I had put off since college – long-term travel through the Middle East and Europe with nothing more than a backpack, credit card, and no worries in the world. My whole life lay before me as one grand adventure.

Seriously, I have no right to complain.

Yet, it was one of the worst financial mistakes of my life. It cost me millions – many millions of dollars. I was so caught up in living my dream that I lost all financial perspective.

I had no idea at the time that I had just followed the classic recipe for a foolish expensive financial mistake, but I was about to find out the hard way. Hopefully these lessons will help you avoid doing the same.

What Causes Financial Mistakes

In a perfect world there would only be two causes of financial mistakes – bad information and flawed reasoning.

If humans were perfectly rational with accurate programs in our heads we could take the information provided, process it to an accurate conclusion, and consistently make smart financial decisions.

I wish it was that simple. However, it doesn’t work that way in practice. We don’t live in a perfect world and our brains don’t work like perfectly programmed computers.

Sometimes we get bad information that diverts our thinking with inaccurate inputs. Or we use incorrect information to conclude something that is actually a half-truth but inadvertently becomes a whole truth. It becomes THE TRUTH when, in fact, it is not.

My personal experience is the bad information problem, while appearing significant on the surface, is a relatively small factor in the really bad financial decisions that I’ve blundered. Rarely have my financial mistakes been driven by bad information. I would consider the information issue a relatively minor problem easily solved by due diligence.

More insidious is the bad reasoning problem because we humans aren’t rational computers. We make decisions emotionally and support the decision through rationalization. The ability to rationalize a bad decision knows no boundaries and is remarkably insidious. I say this with deep humility having observed my own decision process for decades and coached hundreds of clients through the same. Nobody is perfect. We all make these mistakes, including you and me.

For example, my own decision to sell the business was driven by my emotional attachment to living my dream of traveling the world free as a bird with nothing more than a backpack and a credit card. I was so attached to that dream that I rationalized selling the business for less than it was worth under the delusional premise that this action was necessary.

It wasn’t, and that was a critical error.

The truth was I slaughtered a valuable cash cow business for a few pounds of hamburger when I should have savored the sweet milk it produced for decades into the future. This mistake cost me millions of dollars – literally.

I was blindsided to alternative ways of viewing the situation by my narrow focus on my dream. My reasoning became one dimensional. My analysis was polar: the classic prescription for a bad decision. Somehow I got in my head that if I wanted to travel the world I couldn’t do it while working in the business; therefore, I had to sell it. Wrong.

It never occurred to me to hire and train staff to run the business in my absence so I could retain the income and still enjoy my freedom. Oops. Or I could have hired another money management company to take over day-to-day operations giving me the freedom I desired while still retaining ownership. Double oops. There were many possibilities. I just couldn’t see them. I was blind. That is how bad financial mistakes are made – blindness.

The point is I got distracted by other competing goals (my dream of world travel) and failed to focus adequately on managing the financial implications of the decision properly. My flawed reasoning allowed the sale of the business to become an “either/or” decision when it was nothing of the sort. Either I sell the business or I don’t live my dream of world travel. Nonsense! There were many ways I could have lived my dream and kept the business. I just didn’t look for them because… well, I wasn’t looking.

Here’s More Examples

As it turns out, my financial mistake is not an isolated example of this problem. In fact, it is quite common. It’s the most common way we make foolish blunders so please pay close attention and don’t follow in my footsteps.

While there’s no definitive research providing hard data, anecdotal evidence from my work with hundreds of financial coaching clients tells me the number one cause of the truly expensive, large scale financial mistakes is conflicting goals causing you to not properly weigh the financial implications of your decision.

For example, every day there is someone who accepts an offer to sell his home far below value because he isn’t getting any better offers and has conflicting needs to either move or get out from under an oppressive mortgage payment. The desire to get on with his life is rationalized as the reason to sell below value – sometimes at absurd prices. Many times I’ve been told of people who accepted a lowball offer out of desperation only to hear someone tell them they would have paid more if they had any idea they were willing to sell that low. There are always alternatives.

I know of bloggers who have sold their successful web sites for 1-3 times passive revenue (advertising, etc.) when the financial aspects of this decision made no sense. The reasoning will be familiar by now. They were either tired of writing and wanted to move on, or they were tired of dealing with the technology, marketing, and other backend issues related to the business and just wanted to focus on writing. Seldom is the discussion about financial considerations. Finance is pushed to the background because the focus is dominated by personal motivations, and therein lies the problem.

[FMRightQuote]“Experience is simply the name we give our mistakes.”[/FMRightQuote]

Another example is the coaching client who comes to me in need of an investment plan after making a series of horrendous investment mistakes causing massive losses. What has surprised me is how many of these investors have succumbed to the life insurance salesman’s pitch. “At least you won’t lose this one: it will always be there for you and your family.” True, but at what cost. It is a distracting half-truth appeal that blindsides the investor from seeing more effective and efficient solutions to the problem. They are perfect prey for that pitch because their painful loss blinds them to alternatives.

I could continue on with many examples but you get the point. When you have conflicting motivations behind a decision it is very easy to overlook important financial considerations. The result is an expensive mistake.

However, when you focus on financial considerations the decisions are usually sound… at least from a financial viewpoint.

How To Minimize Financial Mistakes

There are two ways to minimize financial mistakes:

1. Educate Yourself – That is what this site is all about. As you improve your financial intelligence your reasoning skills will improve. You will develop a good nose for sniffing out financial nonsense. Due diligence skills will help you overcome information problems. The rational part of your brain will be driven by software that applies proven principles. All of this will result in better decisions.
2. Focus On Financial – Develop self-awareness that notices when conflicting goals are narrowing your field of vision. The goal is to always catch yourself getting sidetracked before making an important financial decision – not after.

Over the years I’ve improved on both fronts. My motivation is strong because I know how much these mistakes have cost me. Given my financial background, I’ve reached a point where distraction is my most dangerous enemy causing multiple bad financial decisions in my life. It has literally cost me millions not just once – but several times. In other words, this idea may sound simple but I can’t overstate it’s importance. Seriously!

Yes, even financial experts make horrendous financial mistakes. I’m living proof that it is remarkably easy to do when you allow your mind to get distracted by competing goals. It is one advantage to having a financial coach as a collaboration partner. Your coach is not distracted by your emotional needs like you are.

Learn from my mistakes. Train your mind to properly weigh financial considerations and look for alternative possibilities when your field of vision is getting narrowed by conflicting objectives.

When you balance the decision you’ll nearly always discover alternative solutions so that you can have your cake and eat it too. It doesn’t have to be “either/or”. You can have both when you open your mind to seeing the alternatives.

Now it is your turn. Come clean with your favorite financial blunder in the comments below. Owning it helps you grow beyond it and helps everyone else learn from each other’s mistakes. Share your experience below and let’s all benefit…

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The post How Smart People Make Dumb Financial Mistakes (so that it doesn’t happen to you!) appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

• According to the New York Times, 75% of Americans have less than $30,000 in their retirement accounts, and 49% of middle-class workers will retire poor or near poor.
• According to Hewitt Associates, 4 out of 5 workers will fail to meet all their financial needs in retirement.
• Employee Benefit Research Institute reports that 81% of workers nearing retirement age (45 or older) have less than $250,000 in savings and an astounding 48% have accumulated less than $25,000 as they approach retirement.
• Only 14% of American workers are confident they will have enough money to retire according the annual Retirement Confidence Survey.

The evidence is overwhelming that something is wrong with traditional retirement planning. It’s an old world model in need of a major facelift.

The problem is baked into how the retirement system is designed—it’s not realistic. The skills and knowledge required to successfully execute a traditional retirement plan are beyond most worker’s abilities:

• You must voluntarily save a significant portion of your income with discipline throughout your career (8%–30%, depending on the age you begin saving).
• You must develop sufficient investment expertise to implement smart asset allocation and investment decisions.
• You must know in advance when you and your spouse will die to know how much savings are required.
• You must know in advance when you will end work—either voluntarily, due to sickness, or possibly because of lay-offs out of your control.
• You must know what the future inflation rate will be over your remaining life (even though trained economists can’t accurately predict this number even one year in advance).
• You must know what your investment portfolio will return over your remaining life (even though nobody can predict this number for one year not to mention 30 years).
• You must be disciplined enough to never raid your retirement nest egg when adversity strikes like getting laid off, health problems, kid’s college, or getting divorced.
• And then, to top it all off, you’re supposed to manage your retirement savings so that you spend your last dollar as you exhale your last breath.

Yeah, right! No wonder most workers are failing at retirement planning.

It is an almost unbelievable list of skills and knowledge that few (if any) workers possess. It requires you to have the savings discipline of a celibate monk living in a brothel, investment skills that exceed most pension and mutual fund professionals, and the actuarial skills of an insurance expert. Those sound like pretty demanding standards for someone who aspires to quit work.

Traditional retirement planning is a broken model. The system is failing people because the absurd list of skills required to succeed is unrealistic.

Walking the Talk Makes All The Difference

The reason the broken model persists is because most “retirement experts” that teach this stuff have no real experience being “retired”, living off their portfolio, and surviving without earned income. Reality is very different from theory: the retirement map most experts teach is not the territory.

After “retiring” a decade and half ago and raising a family of four with almost no earned income, I can tell you that retirement living isn’t nearly as neat and clean as the sterile books would (mis)lead you to believe. I’ve survived multiple bubbles in stocks, real estate (and probably bonds someday soon) and the conventional rules of thumb are hazardous to your wealth.

Below are some particularly important ideas you’re not likely to hear about from a traditional financial planner at your next retirement planning meeting:

• Increasing Longevity Has Changed The Rules: Life expectancy is increasing every year, and the higher income classes can expect the greatest longevity in old age. If you have the wealth to fund a secure retirement then you should also expect to outlive the averages (unless your genetics indicates otherwise). 90% confidence intervals for a healthy couple at age 65 are already growing past the age 100 barrier. In other words, forget the statistical averages. You must financially prepare to live far longer than anyone would tell you because the alternative is to risk outliving your money, and that is not acceptable.
• Spending Principal Is Dangerous: When your assets have to survive 30 years or more it means you cannot safely spend investment principal like conventional retirement planning would indicate. This means you must live on portfolio income exclusively during the early years because there is no safe way to amortize principal over a 30+ year time horizon given all the unknown variables (see The 4% Rule and Safe Withdrawal Rates for more detail). That requires you to amass a much larger investment portfolio than traditional retirement planning would indicate or consider alternative portfolios to produce inflation adjusting income and growth.
• Inflation is Your Number One Enemy: Inflation is the number one nemesis of retirees. That’s because a retiree is, by definition, a saver, and inflation is the cancer that consumes savings. Inflation is all the more insidious because you have no control over it, can hardly detect it from year to year, cannot estimate it accurately, and small differences will compound over many years to potentially double the amount of money you need to safely retire. Inflation is one of the top risk factors to your financial security.
• It’s Tough to Grow Purchasing Power While Living Off Savings: It is exceedingly difficult to grow a portfolio fast enough using conventional, passive, asset allocation to increase your saving’s purchasing power net of inflation, lifestyle expenses, volatility effects, and the inevitable mistakes and surprises of life. Few people grow their portfolios faster than inflation after subtracting just transaction costs, mistakes, and other issues. When you start subtracting lifestyle expenses from your savings the hurdle is extraordinarily difficult to clear.
• The Average Return Lie: The big reason it is so difficult to grow your assets net of inflation, spending, mistakes, and investment expenses is the “average return lie”. The experts love to quote average historical returns but the only return you can actually spend is the compound return. Average returns are a statistical fiction. The seldom-told truth is compound returns are always less than average returns and the culprit is volatility. The greater the volatility the greater the difference between average return and compound return. For example, if your investments are up 50% one year and down 50% next year then the average return is break-even but your account actually lost 25% when compounded. The 25% loss is the only return that matters to a real retiree and it is caused by the volatility effect.
• Sequence of Returns Risk: Now that you understand the volatility effect, let’s add insult to injury by introducing sequence of returns risk. You will quickly see why living off your retirement nest egg is more risky than commonly understood. Imagine an adverse period of returns that runs a decade or more. This occurs regularly in actual market history with the most recent example beginning in 2000. If you started your retirement in 2000 with a conventional passive indexed portfolio and supported living expenses from assets according to the conventional 4% rule you would have incurred a portfolio drawdown just from spending that exceeds 50% (not to mention investment mistakes, investment expenses, volatility effects on compound return, and more). Given the dismal investment returns over the same time period your monthly spending would be approaching or exceeding 10% of assets (depending on assumptions) which is unsustainable and certainly not safe. This is not some theoretical mumbo-jumbo. It happened to countless real-world retirees who relied on conventional wisdom and got burned. It results from an adverse sequence of investment returns like we had since 2000. Research shows this sequence of returns risk during the first 10-15 years of retirement accounts for 80% (or more) of the variance in safe withdrawal rates during retirement. It is incredibly important to understand, yet few retirees do. Make sure you fully understand exactly how this works because it will make or break your retirement security.
• Poverty Consciousness: The process of living off your assets with no earned income creates a poverty mentality for anyone successful and actuarially minded enough to build the wealth in the first place. It causes a feeling of lack even though you’re surrounded by a plentiful portfolio. It is why you see multi-millionaire elderly people in their 80’s pinching pennies and refusing to enjoy their money even though they couldn’t spend it all if they tried. It is difficult to understand until you live it. Basically, your financial reality narrows when you become 100% dependent on your assets with zero earned income. The result is tragic: a poverty experience even though you are surrounded by abundance.
• Forget the Clichés About Retirement Happiness: Finally, a satisfying retirement isn’t anything like the clichés indicate. A fulfilling life is built on much more than endless rounds of golf and little umbrella drinks under a palm tree at sunset. I’ve tried all extremes from workaholic to pro-leisure circuit, and everything in between. In my experience, the most satisfying retirement includes a lifestyle business that produces some income without inhibiting freedom to do what you want with your life. It takes pressure off your assets and relieves the poverty mentality while providing a sense of purpose, community, mental stimulation, contribution, and social connection. Vacations are more enjoyable when contrasted with meaningful work. The truth is work provides underrated benefits during retirement because most people need something more to wake up for than just personal self-indulgence.

In Summary

If you want to learn more about how the financial aspects of retirement planning work make sure to pick up my latest book How Much Money Do I Need To Retire? Retirement planning doesn’t work in practice like most experts preach. The differences aren’t small either. They are game changing.

From saving to investing to life planning, the retirement experience operates under a set of rules very different from what is commonly believed.

In the comments below please add to this discussion by sharing your experience with traditional retirement planning. How will your retirement differ from your parents and grandparents? What has worked for you in traditional retirement planning, and what hasn’t? What are some of your favorite ideas in retirement planning?

I’d really like to know what you think about these ideas…

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It’s so “old-skool” to work like a dog for 40 years scrimping and saving so you can retire and do nothing of substance for the remaining 30 years. That’s no prescription for happiness. It makes no sense.

Increasing longevity has changed every aspect of retirement planning – from asset allocation to life fulfillment and everything in between. People are retiring younger, adding encore careers, lifestyle businesses, and working into their seventies and eighties – not because they have to, but because they want to.

It is time to retire the word “retirement” and redefine our lives toward fulfillment – which means financial independence at any age.

Birth-School-Work-Death… Plus Fulfillment?

There used to be 4 stages to life – “birth”, “school”, and then “career” followed by a progressive decline to “death”. The traditional approach to retirement planning has always been about financing that final decline to death using savings accumulated during “career”.

But something changed. People in their 60’s aren’t declining toward death. 60 is the new 40. Retirees are living longer, healthier lives with dreams and ambitions yet to be fulfilled.

When Social Security was created the average life expectancy was 65 years. Now 90% confidence intervals for a healthy couple at 65 are breaking the age 100 barrier and continuing to rise. What this means in plain English is retirement life expectancies are exceeding 30 years. That is a game-changing result.

The whole concept of “retirement” was never intended to fund 30+ years of leisure. It is a broken model bursting at the seams evidenced by the trouble with Social Security, underfunded pensions, and the rise of self-funded 401(k)s to shift the burden of savings from the institutions to the individual.

The reason for these changes is simple: Financing 30+ years of leisure is mathematically very different from financing traditional retirements of 20 years or less:

• With post-career lifespans exceeding 30+ years (and growing) there is no such thing as a “safe withdrawal rate” in retirement where you can spend principal from savings.
• Instead, workers today must build a nest egg large enough to support post career lifestyle strictly from cash flow for decades.
• Additionally, inflation effects become more unwieldy when compounded over longer time horizons creating an unprecedented level of uncertainty about asset purchasing power.
• Finally, asset allocations must be changed to include growth introducing new portfolio uncertainties about sequence of returns effects and the negative consequences of volatility compounded by spending from assets.

In short, achieving financial security following the old-school retirement planning model requires more savings than most people can accumulate to fund a lifestyle most people don’t really want. It is a serious problem.

Welcome To “The New Retirement”

Fortunately, there is a solution, and those who embrace this “New Retirement” model are finding it a more satisfying life plan than the traditional model.

The New Retirement is about breaking the old “career” stage into two separate periods thus allowing you to achieve financial independence at any age. It is about pursuing fulfillment rather than leading a life of sacrifice.  It works something like this…

You launch a traditional career just like the old model where you pursue income growth and financial security. The financial purpose of this stage is to establish your foundation:

• Buy a home.
• Satisfy base lifestyle needs including furnishings, clothing, transportation, etc.
• Build your nest egg including both tax-deferred and taxable savings.

The problem occurs when you get stuck at this stage repeating this foundational do-loop in an endless quest for more-better-different without ever advancing to the next stage. You get stuck with ever-increasing lifestyle needs while engaging in a futile attempt to build enough savings to retire only to realize late in life how the mountain is simply too tall to climb.

The “New Retirement” is about breaking this do-loop by changing the playing field once the foundation is established so that you move from “accumulation” to “fulfillment”. It’s about enjoying a lifestyle business or encore career that allows you to build a life so satisfying that you never want to retire from it.

Here’s how it works…

Introduction To The New Retirement

The new retirement recognizes that traditional retirement planning was just a euphemism for elderly financial independence and that financial independence can be enjoyed at any age. You don’t have to wait until an arbitrary age like 65: You can be financially independent far sooner than you might have previously believed.

Similarly, financial independence doesn’t have to mean doing nothing and never earning another dime like in the old-world retirement model. You can redefine financial independence to include part time work, encore careers, and other income streams that take the pressure off your savings. (See the parable of the Investment Banker and Mexican Fisherman.) For example, you could…

• Work 6 months out of the year and do whatever you want the remaining 6 months. An accountant could prepare taxes from February through April 15 and again in September-October for late filers taking the rest of the year to pursue his passion for fly-fishing in the summer and snow skiing in the winter.
• A pilot could convert his expensive flying hobby into an additional income stream as a part-time flight instructor and occasional pilot-for-hire to corporate executives.
• An artist could convert his passion for wire-frame sculpture into a community of wire-frame art enthusiasts via a web site that monetizes through selling supplies, courses, and seminars.
• Or a financial junkie like me could grow his passion for sharing financial insights into an income stream that supports a location independent lifestyle while working just 10 days out of each month.

The objective is to interject a new stage following traditional career that isn’t about sacrificing your life to make a buck, but instead focuses on fulfillment and some income generation. In other words, convert the Birth-School-Work-Death life plan into Birth-School-Work-Fulfillment-Death life plan. This gives several huge advantages over the traditional retirement model where no earned income exists…

• The additional income from the fulfillment stage reduces the spending from savings so that your savings accounts can continue to compound and grow.
• You achieve financial independence at any age and lead your dream life much earlier because the total savings required to support lifestyle when small amounts of earned income are included is dramatically lower.
• You reduce the risk caused by long-term inflation since it is far easier for your savings to outgrow inflation when you are not spending from principal at the same time.
• You reduce the negative impact caused by sequence of returns and volatility because spending principal isn’t magnifying these problems.
• You gain the underrated benefits of productive work including a sense of contribution, community, mental stimulation, social connection, and much more.

Balance Is The Key

In short, a whole new stage to life has been created by increasing longevity called fulfillment. Unfortunately, many workers haven’t realized it yet and are still laboring under the old model. This new stage allows you to cut the “work” part of your life plan short and advance to “fulfillment” much sooner.

We used to live in a world of polar opposites where you worked hard and built wealth until you hit the magical age of retirement where you suddenly flipped the switch and lived the pro-leisure circuit. Now, that model no longer makes sense:

• Most people want to enjoy life while they work and not sacrifice their healthiest years at the altar of the almighty buck.
• They want more leisure time to pursue personal interests.
• They want more time for family.
• Few people want to completely stop working because work plays an important role in a balanced, fulfilling life.

The New Retirement has surfaced as an alternative that allows you to build your financial foundation (including a small nest egg) using a traditional career and then switch horses mid-career.  It is a way to redefine life from the polar extremes of career followed by retirement to something more balanced where the focus is on quality of life.

The idea is to build a life so fulfilling that you never want to retire from it. The sooner you make that switch the happier you will be.

The lesson is clear: don’t wait to live your life or put off your dreams until old-age. Redefine financial independence so you can enjoy it earlier rather than later.

If that sounds good to you then the only question remaining is, “What’s keeping you from making it happen?”

What are your next steps? What are hurdles must you clear? What knowledge gaps must be filled?

I know it is self-serving, but that is what financial coaching is all about. You can learn more here.

And let me know what you think about these ideas in the comments below. How does the New Retirement relate to your current life plan? What changes are you motivated to make?

You Might Also Like…

• How Much Money Do I Need To Retire? This ebook takes conventional financial planning practices head-on – and surprisingly – financial planners are loving it and giving rave reviews!
• How Anyone Can Retire in 10 Years… or less! – If you want to retire sooner with absolute certainty then this popular article will show you exactly how to do it.
• 5 Essential Questions For Pre-Retirement Planning: Discover the “what”, “where”, “when”, and “how much” of pre-retirement planning so that you can prepare for a successful transition into retirement.
• 5 Ways To Reduce How Much Money You Need To Retire By $300,000 (or More!): The easiest, most certain way to bridge your retirement savings gap.

The post The Smart Alternative To Retirement Planning appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

1. I published 5 ebooks on Amazon Kindle this summer.
2. My subscriber list broke the 6,000 barrier (and growing) making Financial Mentor one of the top financial web sites on the Internet.
3. I’m also excited to announce that I will be speaking in front of 400 financial bloggers this week at the Financial Bloggers Conference teaching cutting edge retirement planning strategies.

To celebrate this week of milestones, I’m giving  you (my loyal readers) the newly revised edition of my most popular and best-selling ebook, How Much Money Do I Need To Retire? for absolutely nothing.

Seriously! No hooks or strings attached.

This book has “wowed” readers garnering numerous testimonials from experts over the past 3 years – and now it is even better. I nearly doubled the content greatly expanding some areas, adding entirely new concepts, and updating the research with the latest findings.

The cost is truly nothing, but it is only this week while I’m speaking at the conference from Thursday, September 6 to Sunday September 9th. After that, the price returns to normal never to be discounted again. You can download the book from the Amazon sales page here.

If you enjoy the book and feel like supporting my efforts to grow this web site and bring quality financial education to more people then there are two things you can do to help:

1. You can “like” the sales page at Amazon (the button is right underneath the title in the middle).
2. You can leave a review. The link to the review page is at the end of the book in the “Postscript” section.

Leaving a quality review (nothing big – just a couple of sentences) that explains how the book helped you or includes a valuable idea or two you got from reading the book can make or break my success on Amazon. It is super important.

So anyway, get your copy now while the cost is zero. The offer ends on Sunday – no exceptions. You don’t even need to own a Kindle: Amazon has apps that convert any computer, cell phone, or tablet into a Kindle so anyone reading this article has access to the book at no cost.

I hope you enjoy my gift, and I look forward to reading your reviews on Amazon. The link to access the review page is http://amzn.to/NPK0xM .

Thanks for your support!

The post This Week Only – I Give You My Bestselling Ebook (No Strings Attached) appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

It’s because I’ve been creating something much bigger and more valuable for you.

I’ve spent months and great expense assembling one of the largest collections of financial calculators found anywhere on the internet.

Why would I do that? Because one of the top complaints I hear is how the math behind smart financial decisions can sometimes be daunting. The equations are complicated. It holds you back so I wanted to solve that for you. That’s my business – helping you make smarter financial decisions.

These calculators simplify nearly every aspect of financial planning into plug-and-play simplicity. All you have to do is familiarize yourself with this new resource so that you can conveniently find the perfect tool for your situation.

Let’s explore how you can get the most value from these calculators…

What’s Special About These Financial Calculators?

Not all financial calculators are created equal.

Some require you to opt-in or violate your personal privacy by downloading your personal information into a database to be used for marketing purposes. Others are spread throughout the internet making it difficult to locate exactly what you are looking for.

My calculators are all in one convenient location and completely private because they operate within your personal computer’s browser. You can find exactly what you want easily and nobody will ever see any of the information you enter into any calculator on my site because that information never leaves your computer.

To find these calculators go to the main calculator page located here. You can see how they’re organized into categories to make it easy to find exactly what you are looking for…

• Retirement Calculators
• Mortgage Calculators
• Credit Card & Debt Payoff Calculators
• Auto Loan Calculators
• Savings Calculators
• Investment Calculators
• Loan Payment Calculators
• Personal Finance Calculators

Once you are on the main calculator page you can search to find exactly the calculator you want by using the two drop-down menus in each category. One menu organizes the calculators by name and the other menu organizes the calculators by the question the calculator answers. Go ahead and click on the menus and see for yourself before reading on…

How I Use These Calculators

Because there are more than 80 calculators (which might overwhelm a few people) I thought it might help to give a sneak peek into some of my favorites that I use with financial coaching clients so that you can familiarize yourself with this new resource.

Retirement Calculator: My ultimate retirement calculator is designed for the new world of retirement planning and is receiving rave reviews from experts in the field. It includes all the traditional features offered by the old-world retirement calculators plus it allows you to include up to 3 phased income streams, a lump sum payment, and more. It is designed for scenario analysis so you can quickly and easily change a single variable and see at a glance on the spreadsheet how it affects the overall financial outcome of your life. It is for people who understand that smart retirement planning is about much more than calculating a mythical savings number.

Mortgage Calculator:  If you want to know how much your mortgage payment will be for any combination of terms this calculator makes it easy and provides a printable amortization table. If you want to know how fast you can pay off your mortgage and how much interest you will save applying biweekly payments and extra payments then this calculator will figure it all out with the click of a button.

Credit Card Calculator: I love to show clients how much minimum credit card payments are costing them and how fast they can get out of debt by adding a one-time lump sum or other repayment strategy.

Auto Loan Calculator: A common question is whether you should lease or buy your next car. This calculator makes the math simple.

Savings Calculator: Clients are blown away by the lifetime cost of small, daily spending habits when they use this latte factor calculator. They are equally fascinated by various wealth compounding lessons found in this compound return calculator. Even though I work with compound returns every day the results defy intuition and never fail to amaze me. Play with these calculators using real numbers from your own life and you will be amazed too.

Investment Calculator: If you are analyzing an investment property, annuity, or trying to determine the future value of an investment then these calculators convert the complex math into easy-to-understand results.

Loan Payment Calculator: If you want to get out of debt and have various loans to juggle then this Debt Snowball calculator will show you the lowest cost, fastest path to debt freedom. Just enter your loans and it does all the planning for you.

Of course, this list only scratches the surface showing you the few I use most frequently with coaching clients. There are more than 80 specialized financial calculators in total so look around and choose your personal favorite based on your situation.

How You Can Help

If you like these new, free resources then please tell your friends. The best way to give back and share the love is to say “thank you” through the social currency of the web – +1, like, pin, and links as follows…

• +1, like, and/or bookmark the main calculator page here.
• +1, like, and/or pin your favorite calculator directories (retirement, credit card, savings, etc.).
• Write a review post on your web site or comment in Facebook and Google+ about your favorite calculator and how it helped you.

Again, there is nothing for sale and nothing to buy. This resource is completely free and completely private.

I hope you like it.

Please tell me in the comments below which calculators were most helpful to you. Was this a useful addition to the web site? I welcome your input…

Financial Mentor Around The Web

• My work on the 4% Rule and safe withdrawal rates in retirement was published in the prestigious academic peer review Journal of Personal Finance. It is read by Ph.D’s and top level wealth advisers so you are in good company when you read this blog.

The post 80 New Financial Calculators – Wow! appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

It doesn’t require luck, genius, or special connections.

You don’t have to attend overpriced, weekend financial seminars or learn the latest tricks and gimmicks sold by slick marketers.

As John Bogle wisely stated, “The secret is there are no secrets”.

The truth behind how to build wealth is public domain knowledge, simple to understand, and nobody is going to get rich selling it you.

In fact, it is so simple it can be explained in just two sentences…

1. Make more than you spend and invest the difference wisely.
2. Develop simple daily habits that result in wealth accumulation.

I know… you’re probably a little disappointed.

You wanted something new, different, and clever – the missing ingredient that has held you back and will produce breakthrough results. The fabled “secret ” every marketer tries to sell. Instead, I give you something dangerously close to what Grandma would have said.

But listen to the voice of experience. I’ve coached hundreds of people from debtors to the wealthy and the pattern is unmistakable. And it’s not just me singing this song. These same truths were taught by Benjamin Franklin hundreds of years earlier and reiterated by numerous authorities ever since including J. Paul Getty.

It is timeless wisdom that has been proven over the centuries, and will probably work for you also (if you just put it into practice).

In short, if you want wealth in this lifetime with the highest probability of success then these two sentences contain the essential wisdom you need to know…

Spend Less Than You Make And Invest The Difference Wisely

The first sentence summarizes how to manage your personal finances so that you grow assets. It explains the importance of creating positive cash flow that you invest to produce additional positive cash flow.

Notice how it is composed of three separate yet connected ideas to form a single concept…

1. Spend less
2. Earn more
3. Invest wisely

There are endless variations on how to achieve this objective but they all follow two simple themes…

• You can reduce spending immediately through various forms of frugality.
• You can increase your income through various strategies including changing jobs, getting a raise, or starting a business.

In short, you must create a gap between how much you earn and how much you spend that results in savings to invest for growth and additional income.

The twin themes of spending less and making more are not mutually exclusive, but they do require very different mindsets.

Frugality is about living on less and requires self-discipline. For most people there is a feeling of sacrifice when following this path thus making it difficult to succeed. If that is you then frugality is a slow and difficult path to wealth because you will be in constant battle between lifestyle desires and financial freedom goals.

For others, frugality is a pleasurable journey in simplification where fulfillment results from redirecting earned income toward financial freedom goals rather than squandering it on spending. It is not uncommon for extreme frugalists to save 70% of income and achieve financial independence in less than 10 years, but it’s not everyone’s cup of tea.

Another alternative is to raise the income side of the equation. The advantage to this approach is there is no theoretical limitation to how fast your wealth can grow because your earning capacity is unlimited.

Many wealth gurus teach the income side of the equation as the “fast path” to wealth; however, if you don’t master the spending side of the equation you still run a high risk of failure due to the all-too-common mistake of allowing spending to rise as fast as income.

The greatest wealth builders focus on both sides of the equation together. They maximize savings by controlling spending while growing income at the same time. It is the quickest, most certain path to increased savings for investment.

The third component to the equation – invest wisely – is also simple because everything you need to learn is available for free in the public domain. You don’t have to take investment seminars or build extraordinary expertise. There are two well proven paths…

1. Paper Assets: Conventional buy and hold using low cost index funds and proven asset allocation models. Vanguard Funds offers you everything you need.
2. Real Estate: Direct ownership of positive cash flow real estate in your local area.

In summary, achieving financial freedom is really quite simple.

1. Spend less than you make and invest the difference wisely.
2. Rinse and repeat until the income from your investments exceeds your expenses. At that point you’re infinitely wealthy and financially independent.

With that said, the sad truth is few will achieve financial freedom despite the desirability of the goal and the simple path you must follow to achieve it. The reason is explained in the second sentence….

Your Wealth Is Determined By Your Habits

The reason so few people achieve wealth is because they don’t adopt habits that lead to wealth.

As you already know, the formula is simple and fully proven. The only thing remaining is to take action with enough consistency to achieve the goal… and that is where the problems occur.

Here’s the formula for how this works… [(Small, Smart Choices) * (Consistency) * (Time)] = Wealth

Procrastination is the single biggest wealth killer. You plan on getting around to it someday. You know what you should do but there is always some other priority. The kids need braces, the car needs repair, the kitchen needs remodeling.

Action is where the rubber meets the road. It is one thing to know what to do, and it is something else entirely to get it done. That is why habits are so critical.

Habits are the reason postal workers become millionaires while lottery winners go broke.

It doesn’t matter if you look at the writings of Benjamin Franklin 250 years ago or Stanley and Danko’s recent bestseller The Millionaire Next Door. They all say essentially the same thing – the distinguishing characteristic of people who achieve wealth is they manage their money well. They have good money habits.

They don’t earn the most. They aren’t the smartest. They don’t have any special training. They just have good money habits – brain dead simple.

The reason good money habits are essential is actually scientific and results from the mathematics behind how money compounds to grow into wealth. Small changes done over long periods of time can create massive results. It is an easy path to wealth.

That’s why daily habits are so important.

• A daily habit of frugality saves small amounts every day that compound and grow over long periods of time to become substantial wealth. Try this Latte Factor calculator to prove it to yourself.

• A daily habit of increasing your earning capacity through training and education will add small amounts every day to your income potential.

Both of these daily habits will create an increasing spread between what you spend and what you earn which will increase your wealth at an accelerating rate.

This is not rocket science. It is just daily habits dedicated toward a specific goal – building wealth.

The habit causes the action which produces the result. It is simple cause and effect.

Habits are the easiest and simplest way for you to cross the bridge between how to build wealth using the simple formula above and actually doing what it takes to achieve the goal.

You don’t have to intellectualize the process or overcome massive obstacles. You don’t have to get ready to get ready. Instead, you just start today by adopting one habit that serves your wealth goals. Here are some potential starting points…

1. Sign up for an automatic savings program.
2. Opt-in to your company 401(k) (if they offer it).
3. Prepay a small amount on your mortgage.
4. Find an unnecessary expense and eliminate it.
5. Clean up clutter by selling unused assets (RV, boat, jewelry, etc.).
6. Repair something instead of replacing it.
7. Develop a niche expertise in your profession that commands a higher wage.
8. Start learning about asset allocation or investment real estate.

Just pick one habit and start today. Practice the habit until it becomes permanent then pick another habit and do it again. Then another and another until you can see your wealth grow.

The greatest obstacle to building wealth is procrastination. Habits are the simplest way to overcome procrastination and get into immediate action.

Habits reduce the entire wealth building process to bite sized pieces that are easy for anyone to digest. The compounded effect of all these tiny actions over a lifetime becomes wealth.

It is simple cause and effect.

In Summary…

The formula for wealth is simple – spend less than you make and invest the difference wisely.

The mechanism to take action on the formula and produce results is equally simple – adopt wealth building habits.

Here’s how it looks in a different format… [(Small, Smart Choices) * (Consistency) * (Time)] = Wealth

The only question remaining is whether or not you will do what it takes.

Will you follow these proven, simple formulas to achieve amazing financial results, or will you return to your same old patterns that produce the same old results.

The only thing standing between you and wealth is the willingness to act on this timeless wisdom.

Please share your thoughts in the comments below. How have these principles worked for or against you in life. What takeaways did you get from this article? What is going through your head? I really want to know…

You Might Also Like…

• The Easiest Way to Build Wealth Calculator – You will blown away at how much small, periodic spending costs you over a lifetime. It is not the actual spending but the forgone interest earnings that kill you. This calculator is a mind bender!
• Millionaire Calculator – So you wanna be a millionaire? This calculator will figure out how long it’s going to take.
• How Does Your Wealth Building Skill Rank? Take this test – Find out if you’re ahead or behind in the wealth building game.
• Why Most Wealth Building Systems Fail – Find out which broken link in the cause and effect chain has held you back… until now!

Financial Mentor Around The Web…

• This article was originally published as a guest post on FreeMoneyFinance.com and won best blog post of the year for 2011 in the “Best of Money” writing competition.

The post A Ridiculously Simple Way To Build Wealth appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

Darrow Ascending To Shield

(This guest post is from one of our readers, Darrow Kirkpatrick, a life-long rock climber who also became financially independent and retired at age 50. In addition to a 25-year career as a software engineer, Darrow has climbed widely throughout the United States including  Yosemite Valley. Take it away, Darrow…)

Do you have a defining moment or metaphor for your life? An event or accomplishment that set your personal bar and taught you more than any classroom ever could about the line between success and failure?

A defining moment in my life came in the summer of 1981, when I climbed the Shield route up the 3,000 foot vertical face of El Capitan in Yosemite Valley, California. My partner and I spent 5 days on the rock face, hauling every life-sustaining necessity along with us, sleeping at night on hammocks or small ledges. It was the adventure of a lifetime.

El Capitan is known to climbers as a “big wall.” Failure rates are high: many parties retreat far below the summit. So what is the line between success and failure ?

As it turns out, there are a few factors that make all the difference. And they are the same factors that lead to success in other areas of life, including building wealth and achieving financial independence….

Commitment

The single most important factor for success in climbing, finance, or in life is commitment to a meaningful goal. You simply must be highly motivated to achieve anything substantial. Why? To maintain the focus and energy you’ll need for the long and difficult work required, and to overcome the serious obstacles you will encounter.

Some obstacles will be constant annoyances — like a stressful work environment, or the thirst you get from climbing in the hot sun all day on rationed water supplies. Other obstacles will be momentous — like saving your first $100,000, or climbing past the 30 ft. long overhang we encountered half way up El Capitan.

The small, continuous obstacles demand your best in patience and perseverance. The large ones require focused energy and skillful action. And the root factor in developing all of these qualities is commitment. You develop that commitment by choosing a worthy goal, preparing for success, and believing it is possible.

In building wealth and financial security you will be committed when you internalize this principle: living on less than you make and investing the difference wisely WILL make you financially independent. Once you fully understand that this applies to YOU, and that, with the right behaviors in place, wealth is the only possible outcome, you will be 100% committed. And that motivation will carry you through the inevitable challenges. Believing in your goal will keep you on course and away from energy and attention-sapping detours.

On El Capitan, we were totally committed to reaching the top. Every ounce of mental and physical energy was focused on completing the climb. It was the only option we talked about, or contemplated. There was enormous momentum from feeling “we are prepared, we know what to do, we are going to do it, and it’s going to be awesome!” And that momentum gave us the energy to climb through the inevitable obstacles.

Such commitment doesn’t appear out of thin air. Nor is it blind faith. It is built on essential preparation….

Practice

Realistic commitment is built on supporting behaviors or habits you develop through practice. The specific domain doesn’t matter. It could be athletic, financial, or personal. The essential point is that the recurring behaviors you manifest are what will create results in your life, for better or worse. Because unlike wishes, dreams, or even goals — your habits are what you actually do.

In building wealth, the first habit is learning. You must educate yourself about money matters as a continuing, long-term process. Early on, you will make many small financial decisions that add up to significant results over time. Later you will be involved in larger and more substantial transactions. Every decision counts. But the world changes, and you change. So never stop learning.

On El Capitan, well-trained behaviors gave us the ability to do the safe and efficient things automatically, without the need for conscious deliberation, and to keep going even when we didn’t feel like it.

Another key financial habit is saving. Plan to save and invest a portion of every dollar that comes to you. Don’t consume all the resources put at your disposal: you, or somebody you love, may need them later. Living below your means and investing the balance wisely is an essential habit for financial success.

On El Capitan, we were rested and fit, in the best physical condition of our lives, fully prepared with the finest equipment of the day. The resources we had stored up gave us the confidence to commit to our ultimate goal.

Another key financial habit is demanding value. Every dollar that leaves your hands should return at least a dollar in actual life value to you. There are many experiences and things in life, too many to count, that would be “nice” to have, but are simply not worth their cost. Being well versed in your own personal valuation metrics, and using them instinctively, is essential.

Success on a big wall is about persistence and endurance, but, with thousands of vertical feet to cover, efficiency is at the heart of the process. Getting full value from every motion, every minute, every calorie of energy is key. Just as in personal finance, activities or possessions that don’t contribute to upward progress simply hold you back.

On El Capitan the essential ingredients for success were in place, but we had to deploy them effectively….

Structure

The world offers seemingly limitless options. Almost any substantial endeavor must first slay the complexity monster. There will be a host of data, tools, technologies, techniques, products, services, systems, instructors, and institutions. You must sift the essential from the unimportant, then organize and focus.

In the financial realm it’s important to keep your investments, your relationships, your tools, as simple as possible. Accountability, feedback, and control are fundamental. A common mistake is accumulating a mishmash of unrelated investments — often based on recommendations from friends, family, or media — until you don’t know what you have, or how you’re doing. Managing less, choosing the few right priorities and tracking them regularly, will optimize your attention.

Organization is an essential habit for success on a big wall too. On El Capitan we carried more than 300 individual pieces of climbing gear, every one of which was critical to upward progress at some point during the climb. Without a good system for organizing and handling that equipment, efficiently transferring it from one partner to another as the climb advanced — progress would slow and burn out altogether.

One of the most important organizational tools for personal finance is to monitor your progress. Begin by knowing your net worth: add up your assets including bank accounts, investments, and real estate equity. Then subtract any debt. Update this number several times a year. Also calculate and understand the performance of your entire investment portfolio, annually. These metrics provide essential feedback on your progress, so you can make course corrections as needed

Teamwork

Life is a team sport, and finance is no exception. I credit my wife, son, parents, friends, colleagues, and mentors with much of my own financial success. The fact is, I simply couldn’t have done it without them.

The same was true on El Capitan: teamwork was critical. A strong, dedicated, enthusiastic partner was a key ingredient to success. A good partner shares the often severe physical and psychological strains of living and working in the vertical environment, contributing to efficiency and morale.

Off the rock, a long-term, committed relationship pays enormous dividends in both happiness and financial well being. Two can live cheaper than one by sharing expenses such as housing, and vehicles, and buying in bulk. They can also combine resources. In our case, I had the high-paying job, but my wife had the more reliable health benefits. A good partner also provides accountability for financial goals. You can encourage and cheer each other on when the going is tough.

Not just any partner will do. Unspoken connection and communication are essential. On El Capitan, we were often out of view and out of earshot, separated by a hundred feet or more of windswept rock, connected only by a thin rope. My partner and I had to know and trust how each other would react to a broad range of conditions. A climbing partner’s judgment must be beyond reproach: they literally hold your life in their hands. A similar level of trust is required of a financial partner.

Though we didn’t have a personal guide on El Capitan, we did reap the wisdom of those who had gone before us. In financial life, I did have a personal guide. Early on, I subscribed to an investment newsletter that taught me the virtues of patient, low-cost, diversified, value-oriented investing. That was foundational to my financial education and eventual success. A guide, mentor, or financial coach can play a critical role in helping you anticipate and avoid the most serious dangers encountered when pushing your limits….

Safety

Big walls, and financial markets, are foreign, potentially hostile environments. Risk can never be fully eliminated. Seemingly small moves can result in large losses. But many of the techniques used to stay alive on a big wall work equally well at staying safe in your financial life. To survive and prosper, you can rely on time-tested principles of testing and redundancy.

Frequent testing is the safest way to get feedback. A key principle is to fail small and fail fast. For example, El Capitan required thousands of feet of difficult aid climbing — using ultra-thin pitons hammered just fractions of an inch into the rock to support body weight for upward progress. Any one of those placements could potentially fail at a moment’s notice. You can bet we carefully tested each one, and backed it up with solid anchors below, before fully trusting our weight to it!

“Failing small and fast” applies to finance as well. Don’t bet your life savings on a complex annuity or a technology start-up. If you feel compelled to try something new, do it with a small amount of money, over a short time frame. That way you get quick feedback on your decision, and can learn from it, before it takes on wealth-threatening proportions.

Redundancy is another time-tested safety principle. Never trust your entire success to a single point of failure. Climbers learn to build anchors so that loads are evenly distributed and single points of failure are eliminated. They check, and re-check, critical knots and connections. When it comes to life-saving systems, or large sums of money, always review the details!

In personal finance your emergency savings are an essential backup. Without it, unexpected events could leave you short on operating cash, forcing you into selling investments at distressed prices, losing a home, or declaring bankruptcy.

For investing, redundancy means diversification thru asset allocation. You distribute your holdings over a range of uncorrelated asset classes. So if one of your investments under-performs for a time, another will likely step up to take its place.

On El Capitan we carried extras of all essentials. We planned on 5 days to complete the climb, but carried 6 days of food and water. We had extra layers of clothing and rain gear, to endure any kind of weather. And we carried spares for the most critical pieces of climbing gear, so that dropping or damaging something couldn’t stop us.

Success – Topping Out

When you reach the summit of El Capitan the view is breathtaking. You see the entire length of Yosemite Valley, from the heights of Tuolumne Meadows and Half Dome to the East, past El Portal and out to California’s San Joaquin Valley in the West.

Standing there for the first time, after successfully climbing the Shield, I realized a new vision of life’s possibilities. There was no doubt in my mind then, or now, that any goal, no matter how grand or ambitious, could be achieved, with commitment and dedication.

I no longer climb as hard, or as often, as I once did. But I still apply the lessons learned on El Capitan to my life. The teachings received long ago in Yosemite’s granite crucible benefit me to this day.

You don’t have to be a dedicated climber, or even an athlete, to get the same benefit. You can apply these lessons to any life challenge large or small — in the gym or on a hike, raising a child, getting a degree, starting a business, or building wealth.

It’s not the size of the goal that’s important, but committing to it and leveraging your own gifts and talents through practice, structure, and teamwork. In the end you will find it was the personal journey that mattered, more than the destination. Success begins with a commitment and behaviors that are available to everyone. Just like on El Capitan, there are many routes to the summit. See you at the top!

About the Author

Darrow Kirkpatrick is an author, software engineer, and investor who participated in several technology start-ups and retired at age 50. He is married to a schoolteacher and the father of an amazing artist and engineer. He is an experienced rock climber and enthusiastic mountain biker, and writes regularly about saving, investing, and retiring at CanIRetireYet.com.

(Note From Todd: I would love to see more reader’s share their experiences and insights related to investing and building wealth. Larry Weber shared his insights about distance running and building wealth a few months back. It doesn’t have to be extreme athletics – any insight that has helped you is fair game. The premise I’m trying to teach on this site is the principles of wealth building and smart investing are universal and apply to all aspects of life. We’re embarking on a much bigger truth here and life leaves clues on every stage we play – including big wall rock climbing and endurance running. What stage have you learned your lessons on and how do they apply – motherhood, war, acting, zoology? Who would like to be next and share their insights??? I want to hear from you!)

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The post What Big Wall Rock Climbing Can Teach Us About Wealth Building appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom

You will inevitably confront this question in your pursuit of financial security.

The problem is the answer is far more complex and confusing than generally understood.

The intuitive response is to get out of debt. We all want the security of owning our castle free and clear with one less expense to deal with. The prospect of making monthly payments for the next 30 years is antithetical to freedom.

However, there are times when intuition and finance disagree.

The decision to pay off your mortgage early isn’t just about getting out of debt because complicated equations involving return on investment, time-value of money, and inflation are involved. Remember, this is finance. You can end up with “Alice in Wonderland” scenarios where debt is the cheapest solution and a dollar paid tomorrow might actually be preferable to debt freedom today.

Curiouser and curiouser…

In this article I pull back the curtain exposing the many dimensions to paying off your mortgage early. The objective is to balance your intuition with financial savvy so you can make a smart decision. The correct answer is not cookie-cutter but must be custom fitted to your personal financial situation.

Let’s explore how this complicated process works…

How To Pay Off Your Mortgage Faster

If you decide to pay off your mortgage early there is no shortage of advice on how to get the job done. Unfortunately, it all boils down to the same three little words – “pay more principal”. There is no magic secret. The only real difference is form, not substance.

Paying mortgage principal early is a powerful money saver because small debt reductions compound dramatically over the life of the loan thus eliminating many times the payment in interest.

For example, this mortgage payment calculator shows you that a 30 year, $100,000, 6% mortgage has a monthly payment of 599.55 with only $99.55 going to principal in the first month. If you add just $100 to that monthly payment you literally double the principal paid in the beginning, eliminate 108 payments over the life of the loan, save $39,900 in interest costs, and shorten the payoff time from 30 years to 21 years.

Not bad for an extra $100 per month…

If that sounds appealing then here are the various strategies for early mortgage payoff starting with the simplest and moving toward the most complex…

• Add Principal to Your Current Monthly Payment: Assuming your mortgage doesn’t have a prepayment penalty (check first) the simplest early payoff strategy is to just add principal to your monthly payment. You could try a one-time lump sum where you put the proceeds from selling a boat, motorhome, or unused jewelry to good use. Alternatively, you can add a little extra every month by sending your raise or bonus directly to the mortgage company. The concept behind this strategy is you got by just fine without the money before so you’ll never miss it if you never see it.
• Biweekly Payment Schedule: Rather than make one mortgage payment per month, try making half the payment every two weeks. Since there are 52 weeks in 12 months that causes 26 half-payments or 13 full payments instead of the usual 12 – one extra payment per year. Depending on your situation this can cut up to 6 years off the life of your 30 year loan. Check out the details first because some mortgage holders offer this payment schedule without charge and others will hit you with a fee. I suggest you try using this bi-weekly mortgage calculator with extra payment capability to test both this early payoff strategy and the previous one to see how fast you can be free and clear!
• Refinance to a Lower Interest Rate: Another strategy is to refinance to a lower interest rate mortgage while keeping the term (pay off date) the same. The key is to not take any money out or extend the term when you refinance. Your new loan should offer a lower payment due to the reduced interest cost so that when you keep making the same payment as before all the extra will go to principal payoff. The nice thing about this strategy is it doesn’t require any additional money out of your pocket to achieve the desired result (unlike the two previous alternatives) because all the savings comes from reduced interest costs.
• Refinance To A Shorter Term: Rather than pay over a 30 year amortization try reducing the term to 15 years. The monthly payments will be higher but the interest rate is usually lower thus offsetting some of the monthly outflow. Another variation on this theme is to keep your 30 year mortgage but make your payments as if it were a 15 year amortization. You won’t get the reduced interest rate of a 15 year term, but you also won’t pay refinancing costs either. Some people prefer this variation for its increased flexibility and reduced cost while others prefer the enforced discipline of the required monthly payment. Either way, you can use this mortgage payoff calculator to estimate the monthly payment required to be free and clear for any date you choose.
• Downsize To A Lower-Cost Home: Changing homes isn’t for everyone, but I would be remiss as your financial coach to exclude this strategy. You could move to a lower cost area or buy a smaller house in the same area. The smaller mortgage principal means you can be debt free faster using the same monthly payment.

The key point to notice about all these early payoff strategies is how they aren’t mutually exclusive. You can combine them in various ways to turbo charge results.

For example, you could downsize your home while financing that less expensive home at a lower interest rate on a biweekly mortgage. Then you could sell that boat and jewelry you never use putting those lump sums toward the mortgage while also dedicating this year’s raise to additional monthly principal payments. You will be amazed how fast you can get out of debt following this prescription.

The only limit to how fast you escape the bondage of mortgage debt is your creativity and dedication to this noble cause.

Pay Off Mortgage Early – The Pros…

Now that we know how to pay off your mortgage early let’s look at the benefits to following this strategy…

• Save Money: The first and most obvious reason to pay off your mortgage early is it can save you tens of thousands of dollars in interest costs.
• Peace of Mind: The second reason is peace of mind from owning your own home. It gives you a warm-fuzzy to know you have a secure place to live and you won’t be put out on the street at the first temporary setback in employment.
• Reduced Cost Of Living: For most people, mortgage payments are your biggest monthly expense after taxes. Without a mortgage payment you can save more, work less, or take that dream job you always wanted but couldn’t afford because of the lower salary.
• Get Rid of PMI: When you accelerate paying down principal your home equity will reach a threshold where PMI should no longer be required. This saves you money long before the mortgage is paid off and allows you to accelerate the principal pay-down while still making the same monthly payment.
• Asset Protection: Many states have laws that protect home equity in the event of lawsuit or other legal proceeding. Homestead rules can provide substantial home equity protection. Also, retirees sometimes use home equity as an estate planning strategy to protect assets for the surviving spouse should one partner consume all available resources in a prolonged illness or nursing care facility. In short, there are many situations where home equity can represent a more secure asset with special legal privileges when compared to other investments.
• Retirement Planning: A free and clear home takes on additional significance for near retirees. If you are entering retirement with a fixed income (Social Security, pension, fixed annuity) then it can be a real benefit to pay off all debt rather than put money in fluctuating investments. This allows you to reduce financial variables and more reliably match forecasted income to expenses. Additionally, after retiring, that mortgage payment can require pulling money from tax deferred accounts when that money would be better off left to grow. Finally, if your taxable income is reduced in retirement it can reduce the benefit of the mortgage interest tax deduction tilting the equation in favor of payoff.
• Guaranteed Return On Investment: With the stock market and real estate going up and down like a roller coaster, it is comforting to put your money toward your home and know with certainty what the ROI will be. You get the imputed rental value of a place to live and the immediate return of eliminated interest expense. The certainty of this return stream is a huge benefit for investors who feel beat-up by unreliable financial markets that supposedly will pay more… but may not.
• Achievable: Paying off your mortgage feels more motivating than most financial goals because it is concrete. It is big enough to get excited about yet tangible enough that you can wrap your head around it. It is achievable and will make a significant difference in your life. Contrast this to retirement planning which feels more ethereal and hard to grasp for most homeowners.

In short, there are many benefits to paying off your mortgage early – and some are very compelling!

Payoff Mortgage Early – The Cons…

Before you break out the champagne and burn your payment book it is important to consider the downside to paying off your mortgage early. This isn’t the slam-dunk decision it appears at first glance because of some complicated financial issues…

• Lose The Tax Break: I start with the tax break issue not because it is the most important but because it is the most commonly cited and misunderstood. Yes, mortgage interest paid is generally deductible on your tax return if you itemize, but there are some important “caveats” to this deduction worth considering: (1) The rules are complicated and may cause you to lose some of the deduction you thought you were getting. (2) In certain circumstances you may get as much value by taking the standard deduction as by itemizing deductions meaning your mortgage interest payments merely replaced the standard deduction and provided no real savings. (3) Even if you get the deduction you are still paying $1 to get a 35 cents (or comparable) tax break – not a very good deal. (4) And the effective value of the deduction diminishes over time as the loan matures and you pay less and less interest with each payment. In short, there are many tax rules and situations where you won’t be able to fully utilize the mortgage interest deduction. The rules are complicated so talk to your tax professional if this issue is important to your decision.
• Low Return On Investment: A home mortgage is likely the cheapest money you will ever borrow – and the interest is usually deductible further decreasing the effective cost. For example, if you are in a combined state and federal tax bracket of 35% then a 6% mortgage could have an effective cost under 4%. This means two things: (1) Higher cost, non-deductible debt should be paid off first and (2) long-term investment returns will likely provide a higher return on your capital as evidenced by Ibbotson and Associates research showing a diversified portfolio returning in the 8% range.
• Savings Are In Cheap Dollars: A key point to consider is how all the savings you are expecting only come after the mortgage is paid off meaning those savings must be discounted for inflation. For example, let’s assume you pay off your mortgage in 25 years instead of 30. Using this present value calculator you’ll see that $1,000 saved 25 years into the future is only worth $375.12 in today’s terms at a 4% inflation rate. In other words, you have to discount all savings by inflation because the payments you avoid will be in depreciated dollars. This is quite important.
• False Sense Of Security: You’re not going to like this idea, but you never really own your property – even if it is mortgage free. This is a throwback to feudal times where the king (“royal = real” relating to the latin for “king” connecting real estate to royal estate) was the owner of all land and received “tax” for the right of possession. Today, our local governments are the modern equivalent to feudal lords who collect property tax annually. In other words, you always pay rent to someone whether the bank is out of the picture or not. If you are not completely clear about this truth just stop paying property tax for a few years and see what happens. The truth is your monthly payment is merely a question of degree and to whom – not whether it exists or not. This ugly truth makes the idea of true mortgage freedom an illusion.
• Lost Diversification: This one is “the biggie” so pay close attention… Most investor portfolios are denominated in their domestic currency and thus carry the risk that inflationary government policies will depreciate their investment purchasing power over time. A residential real estate mortgage is the only practical way for most people to short their domestic currency and hedge against inflationary economic policy.

  In other words, the way mortgage financing works is you borrow (short) your currency and use the proceeds to buy an inflation adjusting asset (real estate). Few people understand how conventionally financed real estate is little more than a leveraged play on inflation. That is why it’s such a powerful wealth building tool more than 90% of the time, and it blows up horribly when the rare deflationary event strikes (i.e. 2008).

  When you pay off your mortgage you are unwinding your short currency hedge. This means you lose the ability to be short today’s more valuable dollars and repay them with depreciated dollars in the future. The importance of this financial fact cannot be overstated given today’s record government indebtedness and overt government policy directed toward creating inflation.

  I repeat… this is a HUGELY IMPORTANT factor in deciding to pay off a mortgage early or not! It is critical.

  But don’t trust me on this issue. Consider these two facts…

  1. This inflation calculator (which likely understates inflation’s true impact) shows you how the Federal Reserve has destroyed more than 95% of the U.S. currency’s purchasing power since they began monetary policy. If that time period is too long, then look at various 30 year time periods (the life of a mortgage) for similarly dismal stats.
  2. In a February interview with CNBC, Warren Buffett called mortgaged real estate “as attractive an investment as you can make”. He further stated, “If I knew where I was going to live for the next 5 years or 10 years, I’d buy a home and I’d finance it with a 30 year mortgage. It’s a terrific deal… If I had a way of buying a couple hundred thousand single-family homes… I would load up on them. And I would take mortgages out on them at very low rates…”

  Did you get that? Read it twice! Warren is a pretty successful investor who has some clue on these matters so strong statements like this are worth listening to. He’s telling you about the value he sees in locking long-term, low cost interest financing on an inflation adjusting asset. The last time this strategy paid off was in the inflationary 1970’s when the Savings and Loan industry went bankrupt for being on the wrong side of the transaction and homeowners literally laughed all the way to the bank with ridiculously cheap mortgage payments on appreciating real estate.

  Are you going to be able to do the same on this next time around?

  When you prepay your mortgage you give away that advantage so tread carefully on that decision.

• Interest Rate Below Expected Inflation: Given record low mortgage interest rates as of this writing, it is entirely possible that the interest rate on a fixed rate mortgage (forgetting the fact that it might also be deductible) could turn out to be lower than the inflation rate. If that ended up being true (nobody has a crystal ball) then a bizarre financial situation is created where you are literally paid to borrow money in real terms (after inflation) even though you are paying interest every month. In other words, you make more by owing than by owning. Strange but true. When you prepay your mortgage you give away that financial advantage.

What’s important to note about this entire list of negatives is how they aren’t intuitively obvious. 

The list of positives to paying off your mortgage discussed earlier are easy for anyone to see, but the negatives require a fair degree of financial sophistication – from esoteric tax strategy to long term inflation effects, short hedges on currency, and discounted present value equations. It is heady stuff – financial geekism – yet it is every bit as valid to your bottom line as the more intuitively obvious reasons for paying off your mortgage early.

That is why there is so much misinformation on this subject. The concepts are complex and sophisticated once you get past the obvious reasons for wanting to get out of debt.

In short, the decision to pay off your mortgage is an intellectual battle where the emotional-intuitive desire to be debt free is matched against the intellectual realities of modern finance.

Unfortunately, this makes the decision process complex…

How Do I Make The Right Decision For My Situation?

If you are somewhat confused right now then you are in the perfect spot. You get it, and that is a good thing. The confusion results from the tug-of-war between emotion and intellect trying to sort through the complex factors explained.

The next step is to give you a structured way to sort these issues so you can make order out of chaos and formulate a well-reasoned decision whether paying off a mortgage early is the best decision for your situation – or not.

The key is to realize there are two steps to this decision process…

1. Personal Finance Considerations: This is a decision between paying off your mortgage early or taking care of other personal finance issues first that better reflect your personal values. This decision is prioritized ahead of any investment considerations.
2. Investment Return Objectives: This is a decision between paying off your mortgage early or investing the difference. This decision only comes into play after the personal finance issues in the previous step are satisfied first.

Let’s take each of these steps one-by-one…

The First Step Is To Figure Out What Is More Important Than Paying Off The Mortgage

I’m a firm advocate of getting your financial foundation in place before pursuing more advanced financial strategies. Your wealth can only grow as high as your financial foundation can support (similar to how a skyscraper’s height is limited by the depth and strength of its foundation).

Below is an order of priorities for building your financial foundation that may take precedence over paying off your mortgage…

• Guaranteed 50% Return: Many employers still offer 401(k) retirement plans that include employer matches – typically 50% of every dollar you put in up to 6% of annual pay. This guaranteed 50% return on investment is pretty hard to beat so it usually makes sense to make sure you are maximizing this benefit before prepaying your mortgage.
• Maximize Tax Deferral: Even if your company doesn’t offer a 401(k) plan it may make sense to maximize tax deferred and tax free retirement savings before paying off your mortgage. Granted, tax issues are complex and vary based on individual circumstances so it’s impossible to make a blanket statement, but every tax deferred savings opportunity you don’t use is lost forever and can never be recovered because annual limitations apply. In other words, use it now or lose it forever. The investment math often tilts in favor of maximizing every tax deferred investing opportunity available… before paying off the mortgage.
• Pay High-Interest Debt First: Even after maxing out all your retirement savings options it still may not make sense to pay down your mortgage early when you have other debt. The reason is most other debt will be at a higher interest rate – particularly credit card debt where the interest is much higher and not deductible. Use this debt snowball calculator to figure the fastest way to get out of debt. The order of precedence is to pay off the highest interest/non-deductible debt first followed by low interest/deductible debt (i.e. mortgage debt) last.
• Financial Stability: Once you’ve maxed out your retirement plans and paid down your high-interest, non-deductible debt you may want to consider building a 3-6 month cushion should unemployment strike. Some naysayers claim a home equity line of credit serves the same function making this step unnecessary. The thinking is that mortgage prepayments increase equity thus providing a positive return while you don’t need the funds but can still be withdrawn through a line of credit should you fall on tough times. Either way, developing a safety cushion for difficult times is a prudent step in building your financial foundation.
• Insurance and Financial Security: One of the main goals for paying off your mortgage early is financial security, but there are many dimensions to financial security beyond just being out of debt. For example, medical bills are a primary cause of bankruptcy so does it make more sense to increase your medical insurance coverage before paying off your mortgage? That’s a tough question because each choice manages risk – but in a different way. Similarly, the Council for Disability Awareness claims you have roughly even odds of being disabled for 3 months or more at some point during your career with 1 out of 7 workers being disabled for 5 years or more. Would disability insurance give you more financial security than prepaying your mortgage? Again, an interesting question to consider…
• Kids College Funds: Do you have kids? Then funding a 529 college account, prepaid college tuition, and/or Coverdell IRA are additional ways to maximize tax deferred savings that should probably take precedence over paying off your mortgage.
• Underwater Mortgage: If you are upside-down on your house (owe more than it is worth) then really think twice about throwing good money after bad. I’m not going to get into a big discussion about strategic defaults here, but suffice it to say there may be more secure assets for you to invest in than a house that is underwater.

Should I Pay Off My Mortgage Or Invest?

Once you’ve built your personal financial foundation (maximized tax deferred savings both for college and retirement, paid off high interest debt, and properly insured) then the question becomes, “should I pay off my mortgage or invest?” Notice how this question only becomes relevant after the prior issues are handled.

The answer to the “pay off mortgage or invest” question is actually quite simple – whatever gives you the highest after tax return on your money is the right decision.

Financial advisers will quickly point to research showing long-term historical returns for a low cost index portfolio around 8% (+ or – depending on assumptions) and match that against much lower mortgage rates (as of this writing) and proclaim immediate victory… but it’s not that simple.

Investment returns are highly variable with periodic “lost decades” where even pathetic mortgage interest rates represent a superior return over a traditional investment portfolio.

The problem is the future is not the past and returns vary, but mortgage interest saved is a bird in the hand. With that said, you would be hard pressed to find 20-30 year periods (the life of a typical mortgage) where an investment portfolio would not provide a higher return than recent mortgage interest rates.

The problem with any investment return comparison is nobody has a crystal ball. Unless you have a direct connection to the Higher Power then you are stuck right back where you started with a decision between a guaranteed (but low) return for prepaying your mortgage versus an unknowable but potentially higher return for investing.

In other words, you are left deciding between the certainty of mortgage payoff versus the uncertainty of investing. While financial science provides a relatively clear answer (investing should provide the higher return over the long term), this is really an emotional decision about your risk tolerance, confidence in the future, and belief in the science of investing.

It is why so many prefer to get out of debt despite the relatively compelling math.

Final Thoughts – The Human Variable…

With all that said, there is still one very important element missing from this conversation…

Life doesn’t usually go as planned. We humans are not computers who implement our brilliant plans with mathematical precision. Life throws obstacles our way, plans change, stuff happens, and that is just the way life works.

It is foolish to make long-term plans in an intellectual vacuum that fails to account for the random nature of life.

With that in mind, below are some fun ideas worth adding to this discussion…

• Flip The Logic: If you choose to invest instead of paying off your mortgage then consider this question – would you be willing to refinance the equity out of your mortgage (thus increasing your debt) to add to your investment accounts? If not, then you are logically inconsistent. (BTW, I write this with a wry smile because it is describing me perfectly – see below…)
• No Discipline: For every 10 people who claim to be making the minimum mortgage payment and investing the difference I would hazard a conservative guess that more than half fail to follow through on the investment part of the equation. The road to financial mediocrity is paved with the best intentions. In other words, an optional savings program that requires self-discipline is frequently no savings program at all. Contrast this with someone who places a 15 year, biweekly mortgage on their home thus creating enforced discipline. One happens with certainty regardless of life’s wrinkles… the other is optional.
• Expect the Unexpected: Nobody expects to lose their job, have a major medical problem, become disabled, or invest in a fraud; yet, over the course of a 30 year mortgage the odds that you will experience one or more of these admittedly rare and unfortunate events are far greater than you would like to believe. When your home is paid off it is easier to weather these storms with a minimum of personal adversity. Plan for the unexpected because eventually it will happen.

Conclusion:

I suppose the best way to conclude this lengthy analysis is by sharing what I’ve chosen to do with my own mortgage(s).

The truth is I used to be in the pay-off mortgage early camp. I hate debt and have a high value on freedom. In the late 1990’s I paid off my mortgage only to watch my investment portfolio double the next year while all that capital was tied up in my house.

Ouch! That was expensive…

Admittedly, things could have worked out very differently. I could have paid off the mortgage in 2007 instead and seen a decline in investment values the following year. However, in general, my investments outperform mortgage interest so it generally makes sense for me to prioritize investment capital.

With that said, I also find that I’m not fully rational on this issue. I would never refinance my home and invest the equity to pursue those higher returns. From a pure logic standpoint that makes no sense: I’m not willing to liquidate investments to pay off the mortgage, and I’m not willing to increase the mortgage to fund investments. Hmmm…. I guess I’m not as rational as I would like to believe.

The truth is the decision to pay off your mortgage is quite complex.

Fast forward to current times and I’m several years into a 30 year mortgage on my current home that, prior to writing this article, I would have refused to pay off. The interest rate is pathetically low, tax deductible, will likely end up below the inflation rate over the life of the loan, and it gives me some measure of inflation protection with a small short position against the dollar.

So I’ve been at both extremes – pay it off fast, and never pay it off – only to now end up somewhere in the middle of the road going forward.

I now firmly sit on both sides of the fence as follows…

• Because my retirement and kid’s college are fully funded I don’t need to prioritize those accounts.
• I have no debt besides the mortgage so no issue about paying more expensive debt first.
• I have all the insurance I need.
• Which means the discussion literally comes down to paying off the mortgage or investing.
• The math is clear that my highest return is with investing, but I’m also emotionally connected to having no debt and love the freedom of minimizing my cash flow needs. For that reason, my decision is to funnel a portion of increased revenues from this business toward prepaying the mortgage even though it is technically irrational from a return on investment perspective.
• In summary, I’m not willing to dedicate any of my investment capital to paying off my mortgage, but I’m also not willing to leverage my house to increase investment capital. This is irrational, but it is the honest truth where I stand on mortgage vs. investing. Regarding new income production, I’m fine with dedicating a portion of the revenues from this business toward paying off the mortgage rather than perpetually building investment capital while retaining debt. I guess the logic is that I’m getting a diminishing emotional return on more investment capital when compared with less debt. For economics geeks, it means I have a higher marginal utility on debt reduction than capital increases.

 I would like to declare this a balanced perspective in that I’m comfortable with my portfolio “as is” so I’m willing to “diversify” and lower risk by paying off mortgage debt with extra income, but in the end I know the truth… it is my emotional desire to be debt free and reduce risk that is driving the decision. I know the math and I should be investing – exclusively.

So there you have it – I’ve personally lived at both extremes of the decision and now stand firmly in the middle. The decision doesn’t have to be either/or: you can pay a little to debt reduction and save for investing at the same time.

Like everything in life, happiness is often found in the balance. I guess paying off your mortgage early is no exception.

So now that you know my situation, where do you stand?

How has this analysis helped you sort through the decision and what conclusion did you reach? Which issues hold the greatest sway in your decision? Please share in the comments below…

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The post Pay Off Mortgage Early Or Invest- The Complete Guide appeared first on FinancialMentor.Com authored by Todd R. Tresidder If you're reading this post in an RSS reader, please update your subscription to http://feeds.financialmentor.com/financialmentorcom