Step 4. Create your long-term budget. You do this by turning your short-term budget into a long-term budget. A real budget is a plan for the future. It should take into account more than just your day-to-day, month-to-month, or even year-to-year expenses. Buying a home, having children, sending them to college, retiring—all this costs money, and if you don’t budget for it, you either won’t get it or you’ll break the bank trying. Figure out what you’ll need to reach your goals, estimate how much capital you’ll need now to be able to buy what you’re shooting for, and create a time line to see how long it will take you to get what you want. Keep your assumptions conservative: plan as though you won’t get a raise and your capital won’t give you stellar returns. The best way to be realistic about a budget is to be a constant pessimist, at least as far as financial planning is concerned. If you’re relying on 20 percent returns from your capital in order to buy a house in five years, you probably won’t get there. If your investments do that, well, congratulations, but if they don’t and you have planned for a lesser rate of return, you won’t be disappointed or in danger of going broke.
Step 5. Hold yourself accountable every month. It’s not enough to create a budget and cross your fingers. Unless you keep detailed records of where your money actually goes and then compare your actual spending to the budget you planned, all of this is meaningless. It’s hard to live successfully on a budget, and many people will find that they fail month after month. If you measure your actual spending against what you projected, most of you will find that you spent more than you planned. That’s all right as long as you’re improving. At the end of every month you should go over in detail where you spent more than you expected. In the future, you’ll know where you need to watch yourself. Even if you find yourself living within your budget or beating it, you should keep holding yourself accountable.
Step 6. If you fail, take drastic measures. For some of you, no matter what you do, you can’t seem to live within a budget. You need to automate. I really don’t favor this method, but here’s how it works. You can set up automatic payments tied to your paycheck schedule. You don’t want to set up automatic payments to something like a savings account, where you can easily withdraw money. You want to send your capital to a retirement account, where you’ll have a lot of trouble trying to access it. Why? Once you’ve decided that you cannot trust yourself with your own money, you need to make sure you do not have the opportunity to spend it. I don’t think many people actually belong in this category, and the idea of automating your savings or automating your bill payments goes against my core beliefs about money, but I know some of you out there have no other options. If you do automate your bill payments and your savings, you’ll need to cut up your credit cards too. Otherwise you’ll build up massive amounts of credit card debt, and no matter how well your investments do, you’ll never be able to establish any kind of foundation for real wealth.
Beyond your budget, it’s important to try to save money on housing, but within reason. It’s not worth living a totally Spartan existence, and you shouldn’t live somewhere you hate. But when it comes to things like rent or mortgage payments, where you can expect to pay the same amount of money every month for as long as you stay in the same place, keep in mind that if something terrible happens, you don’t want to be committed to making large recurring payments every month.
When I started my hedge fund, I didn’t buy a palace on the Upper East Side of Manhattan. I lived in a nice but hardly ostentatious one and-a-half-bedroom apartment in Brooklyn Heights. It wasn’t a bad neighborhood, nor was it a bad apartment, but it cost much less than I could afford if I was earmarking a third of my income for a home. I knew that I had to plan for the worst; I’d been homeless before. I understood that my hedge fund could go belly-up, so I didn’t overspend on housing. I had a healthy amount of fear, which is exactly what I recommend for you. (I was able to sock away much more money because of my decision to save on property and not care that people might judge me as not being wealthy.)
My approach to building a budget isn’t revolutionary or particularly original. Just like everyone else, I think it’s important to keep track of where your money goes, to cut down on discretionary spending, and to invest as much as you possibly can. Boring, but true. What’s really essential, and what most people don’t do, is connect their short-term, month-to-month budget with their long-term goals. Figure out how much you need to invest to get what you want, and make sure you invest enough money each month to be able to buy what you want when you expect to want it. It’s much easier to be disciplined about your spending when you can tie it to a concrete objective in that not-too-distant future. Of course, there are some things you absolutely must purchase. Spend what you have to in order to eat healthily, but that doesn’t mean going out every night; it means paying for the fruits and veggies. Trust me: being unhealthy will cost you when it comes to health and life insurance premiums. It’s also a liability on its own; you don’t want to get sick and not be able to work. At my hedge fund, there was no such thing as a sick day. Even one or two sick days a year can be bad for your career.
There are two more items that must be in your budget, and you should purchase them even before you save, because they are the greatest bulwarks against poverty: health insurance and disability insurance. The goal of this chapter is to make sure you don’t become poor, and there’s no better way to do that than by protecting yourself from downside risk. You need to make sure that you’ll still be able to get by even if you get sick or seriously injured. Most people get this insurance through their employer, or they might be in a family with someone whose employer offers a health plan. Let’s talk about health insurance first. I think this is more important than disability insurance, but that’s a tough call. Generally speaking, with a health plan you get through work your employer will cover some of the bill, but you’ll still pay premiums that can add up to anywhere from about $500 per year for a less-comprehensive plan for someone who’s single, to $2,000 or $3,000 for someone with a family. Some people don’t elect to take their employer-sponsored health plan. If you’re one of them, the first thing you need to do when you go to work tomorrow is talk to your human resources department and sign up for it. Believe me, it’s worth it. I know how important health care is because when I got mononucleosis while I was living in my car, I had no insurance. I had to go to a farmworkers’ clinic forty miles away from where I usually lived—or parked, as it happened. I ended up with hepatitis and a jaundiced liver, all because I had no health insurance. You don’t want to end up in the same position. If my sister hadn’t taken me in after that fiasco, I don’t know what I would’ve done.
Medical expenses are the number one cause of bankruptcy. You don’t want to get wiped out by enormous medical bills, especially if your employer is willing to foot most of the bill. Not everybody gets coverage at work. About 15 percent of Americans have no health insurance. Some of them are covered by Medicaid, but many are not. I don’t care how expensive it is, and boy, will it be expensive. (This is a great reason, by the way, to lose weight and quit smoking, as this will substantially lower your premiums—not to mention the money saved on cigarettes and, of course, lung cancer, emphysema, and heart disease.) You might be in perfect health. That doesn’t matter. When people say things like “Invest in yourself,” they’re usually talking about getting an education, going to college or graduate school, things like that. But I mean get health insurance. So many people are blindsided by a health problem and their lives fall apart financially because of it. If you get sick, you do not want the added burden of having no money. So please, do yourself a favor and get health insurance coverage.
Disability insurance is also essential. Like health insurance, you should be able to get it at a discount through your employer, but make sure you know what you’re getting. There are different types of disability insurance, and you don’t want to become disabled and find out that you’re not getting nearly the amount of money you thought you
would. Most policies will cover you for up to 60 percent of your income, meaning that if you become disabled and can no longer work, every month you’ll receive 60 percent of what you would have made working, usually up to some dollar amount that serves as a cap. When you shop around for a disability insurance policy or look at the policy you can get through your employer, pay attention to the kind of coverage they’re offering.
It’s tempting to look for the least expensive policy. You might think you’re getting a deal, but you’re not. The least expensive policies are the worst policies, and if you get the wrong kind of disability insurance, it’s possible that even if you become terribly disabled, your insurance company could give you nothing. With disability insurance, you get what you pay for. So what kind of policy do you want? There are three types of long-term disability insurance: own-occupation disability insurance, income replacement insurance, and any occupation coverage. Own-occupation disability insurance is the most expensive and the most desirable kind of policy. With this type of insurance, you’ll get disability payments if you’re injured and can no longer do the job you had while you were paying for coverage. Unlike other types of disability insurance, you keep getting paid even if you go back to work in another field. Some of you might be unable to afford own-occupation insurance; in that case, you’ll have to get another policy. That said, good disability insurance is more important than investing, and unless you’re fairly young and just entering the workforce, you should be able to afford an own-occupation policy. Unfortunately, most employers won’t offer this kind of policy. I don’t care. Getting disability insurance through your employer is cheaper and easier than getting it yourself, but if you can get only income replacement insurance or gainful occupation coverage at your job, go and get an outside policy. Why? Depending on the extent of your disability, it’s likely that you’ll want to keep working, but income replacement insurance is exactly what it sounds like, and that makes going back to work difficult. If you start working or earning income from, say, your investments, and you have this type of insurance, then your insurance company, which is insuring your lost income, will pay you less money. If you earn enough, they can stop paying you entirely. Usually, income replacement insurance is less expensive than own-occupation disability insurance, but it’s not substantially less expensive, and sometimes it actually costs more. It’s never the more desirable policy.
Finally, you might be offered any occupation coverage. Under no circumstances should you buy this variety of disability insurance. It’s the least expensive way to get coverage, but if you do become disabled, you’ll wish you’d gotten a different plan. The problem with gainful occupation, or any occupation, coverage is that it pretty much lets the insurance company determine whether or not you’re disabled. With any occupation coverage, you’re not considered disabled if you can perform any occupation. This is almost as bad as having no coverage whatsoever.
There are a few more things to keep in mind when you buy a long-term disability policy. First, you’ve probably seen the terms “non-cancelable” and “guaranteed renewable.” A non-cancelable policy lets you pay a fixed premium throughout the entire term of your insurance coverage. With a guaranteed renewable policy your premiums can go up over time. It’s not hard to see that a non-cancelable policy is the way to go. Second, especially with a non-cancelable policy, the younger you are when you get disability insurance, the lower your premiums will be. Third, these plans all have waiting periods between when you become disabled and when you start getting payments from your insurer. The waiting period can be anywhere from two or three months to half a year to an entire year or even two years. The longer the waiting period, the lower your premiums will be. I suggest that you get a policy with a waiting period of no more than six months unless you have a great safety net or a lot of money invested. The fourth and final point about long-term disability insurance: your policy will usually stop paying out benefits when you turn 65, but some policies will give you only five years of coverage. I strongly recommend getting a policy that covers you until retirement.
What about short-term disability insurance? I consider it useful but not necessary, unless you have very little in the way of savings and no family to help take care of you. The usual short-term disability policy covers you for three to six months, although some can go as long as two years. If you’re doing your best to build wealth and stay out of poverty, you should have enough money to last six months without working. If you don’t, buy a policy. short-term disability insurance is much less complicated, and you’re far less likely to get cheated out of your benefits by insurance companies that profit from denying people’s claims.
Pay off your credit card debt, create an honest, reasonable long-term budget, and make sure to get health and long-term disability insurance. Do these three things, and even if you don’t invest to become wealthy, you certainly won’t end up in poverty. I want to help you get rich and stay rich for the rest of your life, but I can’t do that if you’re setting yourself up to get poor and stay poor.
Now that we’ve dealt with everything that’s holding you back, let’s talk about how we can push you forward.
3
PLANNING FOR RETIREMENT
You’ve established a stable foundation and built up some capital. How should you put it to work? What should your priorities be when investing for long-term prosperity? You start with the future because the future is cheap. If you pay for your future expenses now, meaning if you invest a small part of your income today for the purpose of covering your costs twenty or thirty years down the road, your future costs of living, hopefully in luxury, will effectively be much lower. You won’t actually pay lower prices, of course, but by investing a little money today, you’re taking care of really big expenses in the years to come. The longer you keep your capital in a position where it can compound at a reasonable rate, the more you’ll have when you start relying on that invested capital for income. If that sounds too much like financial gibberish, let me put it this way: when you save and invest a little bit of money now, it will be a lot of money by the time you retire, as long as you’re a marginally competent investor. That’s worse than being an adequate investor, and everyone can be adequate. You’ve heard this all before, but I’d rather be repetitive and right than original and dead wrong. Where I come from you don’t get points for being wrong in a really clever, counterintuitive way; you just lose. I want you to be a winner, so I’m asking you to look at the other side of the equation that makes things in the future so inexpensive. The future isn’t actually cheap; if anything, inflation should cause future prices to be much higher than the price you pay right now for similar goods and services. The future is cheap only if you decide to start paying for it today. If you’re still in your 20s and you start investing as little as 5 percent of your annual salary in the right kind of account right now, you should be able to produce all the money you’ll need when you retire. I know many of you are much older than that, and I know plenty of people my own age who haven’t started saving for retirement. If that sounds like you, don’t waste another minute. You need to put aside everything you can and more to get ready for retirement. If you’re over 40 and you haven’t started planning and investing for retirement, it won’t be nearly as easy for you to build a hefty retirement fund. That doesn’t make it impossible to retire comfortably—trust me, it’s far from impossible—but it does mean you’ll have to work harder and save more to make up for lost time.
Yep, retirement. You in the younger crowd, I know you abhor that word. You hate to think that just as you’ve finished school and started to work, your first priority becomes saving and investing for retirement. But don’t think of it as your first priority because it’s your responsibility to take care of yourself forty years down the line. Think of it as getting a really great price on something that, like it or not (most people do like retirement), you’ll have to pay for eventually. When you put together a budget for your household, the necessities come first,
right? Rent, food, water, heat, and everything you need to live, or to have a modern standard of living as opposed to a medieval one—you budget and pay for those things before the discretionary stuff, right? Well, investing for retirement, at any age, is like going to the grocery store and finding that all the food you have to buy in order to feed your family is on sale for 10 percent of its actual price. You’re going to have to retire, just as you need food, and you might as well take the sale that’s offered instead of trying to squeeze by later, when the future becomes the present and starts getting expensive.
Many of you, the ones who want to get rich first and foremost, might be turned off by my talking about something as boring and necessary as retirement. I understand where you’re coming from, but you need to know that without a big retirement fund, you’ll never come close to getting rich. (Actually, “retirement fund” is a misnomer, implying that you pull money out of it from time to time to support yourself. From now on, let’s call it “retirement capital,” because you can use it to generate more money even after you retire.) The same tools and the same rules apply to building retirement money as apply to building any other kind of wealth. Your investments in retirement accounts and your investments in discretionary accounts will both take advantage of the fact that the future is cheap. The only real difference between the two kinds of accounts, aside from what you might put in them, is that retirement accounts get tax benefits and, in the case of some 401(k) plans, matching employer contributions. Not only is the future cheap when you take care of the costs up front, but when you contribute to an IRA or a 401(k) plan to pay for a piece of that future, you get the equivalent of a discount or a rebate. (If you work for the government, you might have a 457 plan, and if you’re a teacher or nonprofit employee, you’ll likely have a 403(b). These are equivalent to 401(k) plans in all the ways that count.) The money you invest in a traditional IRA or a 401(k) isn’t taxed when you earn it; it’s what is called “tax deferred,” meaning that you pay no taxes on contributions to your 401(k) or IRA and you pay no taxes on capital gains in either account until you start withdrawing money for retirement. Then it’s taxed as ordinary income in the year you withdraw it. The “rebate” is more of a “buy one, get one free” special in many 401(k) plans, where your employer will match your own contributions to your 401(k) up to a certain point. When the company you work for matches your contributions, it’s as though the company is paying you to take advantage of the fact that the future is cheap, which just makes the discount that much bigger. If you have a 401(k) plan, it’s provided and administered by your employer, although companies outsource the actual administration the vast majority of the time.
Jim Cramer's Stay Mad for Life Page 6
