personal finance

This is rather obvious, but not much appreciated in day-to-day life, so I thought of giving it a shout-out.

Over the last couple of months, I have been in the process of eagerly seeking a change in my current graduate student lifestyle. A part of this change, would come in the form of a real-life job in an industry. Those who have been following this blog since the beginning are probably aware of the fact that I have been studying towards my PhD - and wasn’t all too happy about the way things have been going for a long time. Finally, sometime in the last couple of months, I bought an artificial backbone from Dogbert at an enormous price ( ) and that has given me the necessary courage to create my own destiny instead of relying on some general-purpose ignorant idiots. Looking for a job at this juncture is probably going to cost me my PhD degree, but I think I can live in peace even without those three alphabets.

Anyways, after I conveyed my thoughts to my superiors, it has been really interesting to observe a change in their attitude towards me. My time and knowledge of certain things (which were utterly disregarded till this point) have now suddenly become top priorities for some folks. People are now really listening to what I want to say and I am hearing a few good words about the work that I have done so far. [Either that, or it's just like people are obligated to say good things about you when you are gone (cough*eulogy*cough). :)]. All in all, it’s almost exactly opposite of what has been going on so far and it sure feels good - although it’s too late for any amends at this point.

It’s probably human nature to take certain things for granted - till those certain things become hard to come by. This happens to the best of us when it comes to money, character, relationships, and other important assets. Unfortunately, the value of such assets is almost always appreciated only near the breaking point - when you are about to lose an asset, or have just lost it and when it’s too late to regret.

In this spirit, let’s take a moment to recognize and appreciate our hidden assets (whatever they may be) - let’s do it right now … before it’s too late.

Let’s sing a slightly different tune with this post - instead of the usual debt bashing. When I say “bad” debt, I am referring to the “good debt, bad debt” terminology that’s gathering some attention in financial circles - I am not referring to it in a classic technical definition point of view as “the portion of receivables that can no longer be collected“.

To understand the significance of debt in general, it’s instructive to imagine a society in which the facility to borrow money does not exist at all. Think in terms of education, industrial development, housing “requirements”, entrepreneurial endeavors, emergencies, and other aspects of our life that involve borrowing (and lending) money in some form or other.

While you are at it, try answering these questions: Would you be willing to wait till you are 35 years of age for higher education (think in terms of advanced graduate, law, medical degrees, etc.) - at which time you could probably pay for your entire education with cash in hand? Would you be willing to wait till you are 60 before you buy a home with your savings? How would you even start setting up a promising company/small business unit (say for example, a manufacturing unit) that would probably require a couple of million dollars of initial funding?

The common crucial denominator in the above issues is time - with respect to the psychological and physical (monetary) value associated with it. There are certain things in life that need to happen at the right time - whether you have the financial resources available at that time or not. In light of this, debt should be viewed not just as financial leverage - but also as leverage against time and as such, it has an enormous value when applied correctly.

In layman terms, the correct application of debt requires understanding the concept as timely financial help borrowed in the anticipation of future earnings. Most of the times, the part that says “anticipation of future earnings” is ignored or undermined or totally miscalculated and that’s where problems start appearing. Some people probably tend forget that any borrowed stuff needs to be returned in a timely manner and then, all of a sudden, money borrowed for good purposes becomes “bad debt”.

I think it’s naive to only bring up negative connotations associated with credit card business, payday loans, and subprime mortgages when talking about debt and painting the whole concept of borrowing money with a broad “debt is slavery” brush. Debt is slavery only when we use it mindlessly.

In summary, there is no such thing as “bad” debt - there is just bad implementation, unreasonable temptation, and occasional miscalculation. Like most financial issues, debt is simply a question of affordability and feasibility - there is absolutely nothing profoundly bad about it. Just my two cents.

A few days ago, CBS Evening News ran an article titled “Caregivers Rise to the Challenge” which featured some families that were struggling to keep up with taking care of their aged parents (in terms of time and money). Here is an excerpt from the article:

Winchell’s family may be America’s new norm. An estimated 34 million Americans care for loved ones age 50 and over. A just-released healthcare study of a thousand caregivers finds half of them are spending more than 10 percent of their income on it. One in three used some of their savings to cover costs. Just like the Winchells.

When asked if they had any savings put away for their own retirement, Stacy Winchell said, “No and I don’t foresee that at this point in time that there will be any retirement.”

…. But without her own financial cushion, it might be her own children who have to be there for her, when the time comes.

People who are struggling to maintain their own financial well being, in addition to looking after their parents and their kids, are what I call the “sandwiched generation”.

Notice the sort-of-treadmill effect in the above example? Stacy doesn’t have anything saved for her retirement - which effectively means that her children will probably have to spend their savings towards her post-retirement well being - which very likely means that they will probably have less for themselves in future. It’s an interesting cycle (played out all too well in most developing countries) - one which will not come to an end unless one of the generations takes the additional pains of providing for their parents as well as their kids.

A few months ago, Jonathan @ My Money Blog voiced concerns along these lines - which effectively summarized the classic dilemma that the sandwiched generation faces:

But what if they do run into issues, for whatever reason? I know that I’d step in to help for sure. For one, I know that my parents regularly give my grandparents money. I don’t know how much or how often, it could be just spending money, but I know they do send something. I guess this is what some people call the “sandwich” problem. Young families have their own retirement worries on one side, their kid’s education in the middle, and their parents’ needs on the other side.

Do you worry about your parents’ retirement plans? Should a child ask their parents about such details or get involved? How does one incorporate this into their own financial plan?

Check out the comments below Jonathan’s post to get a feel of how some people are addressing the issue.

I guess we would all ask these questions to ourselves at some point of time - whether our parents are in a good financial position or not. With what intensity you ponder over these question probably depends on your culture, temperament, and your personal relations with your parents, but most of you will think about this for sure.

I am probably among the fortunate young (in a relative sense) people who may not have to worry too much about the post-retirement financial concerns of their parents. My dad and mom voluntarily retired when they were 49 and 46 years old, respectively. They planned their finances very well (although we barely made “middle-class” in the kind of society we lived in) and are probably set for the rest of their lives.

Although, it’s reassuring to know that my parents are taking good care of their money, I am still keeping some part of my income earmarked for them - in case of unanticipated health care issues in future. Plus, we (me and my wife) are slowly acknowledging (and preparing for) the fact that, in future, our careers and/or lifestyle decisions may be affected by our willingness to be caregivers for our parents - if and when the need arises. This is, of course, in addition to working towards our own financial well being - so that our children won’t have to worry about our financial stability after we retire.

As for health issues, there isn’t much we can do right now - except to make sure that we maintain a reasonably healthy lifestyle and to that our health care costs are not our children’s burden. As for our children (when we have them), we are not yet sure how much financial help they would need - for now, saving for their education is our only concern. It all boils down to saying that when we save about 25% of our income, part of those savings are earmarked for kids and parents.

Another thought to take home from this discussion is to acknowledge that your financial and physical health not only affects you, but also a generation before you and a couple of generations after you. If you get into trouble (in terms of health or money), whether out of sheer obligation or out of willingness, people who care about you are generally bound to come to your aid (unless you have been a total ass all your life) - and although they may not admit it, it will cause them and their family some discomfort. As such, it is up to you to make sure that they don’t suffer because you didn’t plan your finances well when you had a chance, or because you never cared about your health.

Do you belong to the sandwiched generation? How are you dealing with it?

Observe and understand.

1. In debt

2. Living paycheck-to-paycheck

3. Sucked by money leaks

4. Frugal living

5. Frugal living with multiple income streams

6. Stingy

7. Happy

Peace out.

This question comes up when the authors of The Millionaire Next Door discuss the concept of “Economic Outpatient Care“. Simply put, Economic Outpatient Care, is the *help* parents tend to give, in the form of economic gifts, to their children - in the hopes that such gifts will help the children accumulate more wealth and make them financially independent.

The authors then report that small children who are helped by cash gifts from their parents early on, grow into adults who are financially less responsible than those who do not receive cash gifts. Moreover, when they grow up, these children (the ones who received cash gifts) usually display a lack of initiative, low productivity, high consumption, and typically tend to develop a dependency on the cash gifts from their parents.

When it comes to adult children (although you can extend it to children of any age), this is what The Millionaire Next Door says:

The more dollars adult children receive, the fewer dollars they accumulate, while those who are given fewer dollars accumulate more.

This is a statistically proven relationship. Yet many parents still think that their wealth can automatically transform their children into economically productive adults. They are wrong. Discipline and initiative can’t be purchased like automobiles or clothing off a rack.

It may seem counterintuitive at first, but it becomes clearer if you think in terms of motivation. Once you start getting money without doing anything, where would be the motivation to work hard for it? If your depleting savings are immediately replenished by a healthy donations, where would be the motivation for the development of frugality and sensible spending habits?

This reminds me of a dog story that happened a few years ago. A family we knew had this particularly vicious dog that had a habit of barking nonstop at people who knocked on their door. One day, when we visited them, the dog started barking like crazy - so, the dog’s owners asked me to feed some biscuits to the dog to make it stop barking!! To me that didn’t make any sense at all - it was like rewarding the dog for barking. Once the dog realizes that it gets a treat for bad behavior, where is the motivation to stop barking? Needless to say, the dog still barks at people who knock.

Anyways, enough digression. The point is that undue financial gifts may reduce the motivation for your children to be economically productive. It makes them think that they are financially fit - which in turn makes them spend more. So, giving them more free money may in fact make your children poorer in the long run.

The book points out four specific characteristics of children who receive economic subsidies from their parents:

• Economic gifts lead to greater consumption and less savings.

• Children who receive gifts tend to view their parents’ wealth as their own.

• Usage of credit is greater among children who receive economic gifts.

• Those who receive financial gifts tend to invest much less than those who don’t .

Think about this the next time you pull out your wallet to bail your children out of financial difficulties. This doesn’t mean that you should never help your children at all - it means that you should make sure that you challenge/encourage your children enough to think/work towards finding their own solutions to their financial problems. Don’t let the smell of free money divert them into a complacent attitude towards managing their money wisely.

Towards ensuring that you raise your children into economically successful adults, here are ten things that the book recommends:

1. Never tell children that their parents are wealthy.
2. No matter how wealth you are, teach your children discipline and frugality.
3. Assure that your children won’t realize you are affluent until after they have established a mature, disciplined, and adult lifestyle and profession.
4. Minimize discussions of the items that each child and grandchild will inherit or receive as gifts.
5. Never give cash or other significant gifts to your adult children as a part of a negotiation strategy.
6. Stay out of your adult children’s family matters.
7. Don’t try to compete with your children.
8. Always remember that your children are individuals.
9. Emphasize your children’s achievements, no matter how small, their or your symbols of sucess
10. Tell your children that their are a lot of things more valuable than money.

The issue of percentages comes up almost every time we talk about any kind of numerical data. This is especially true in the investment world where people generally tend to talk in terms of percentage gains and losses - rather than the absolute values. That’s simply because it’s easier to interpret financial changes on a common scale of 100. However, there are certain pitfalls that one should be aware of when dealing with percentage values. Here’s a quick (and elementary) look at some of these traps.

Absence of a time frame

When it comes to investments, simply stating percentage gain/loss is not nearly enough. There is something else that MUST go along with the percentage data: it is the duration or time frame. Without the time frame, most financial percentage figures are effectively meaningless. For example, simply saying “Get a 100% return on your investment” doesn’t make any sense -100% return in how much time? 69 years 8 months (corresponding to 1% annual return)? or 3 years 10 months (corresponding to 20% annual return)?

So, whenever you judge the performance of a stock (or compare two stocks), make sure that you are aware of the time frame before you start comprehending numbers like “300% increase”! *cough* penny stocks emails *cough*

Arithmetic mean against geometric mean

Let’s consider this statement “Our picks have yielded 25% average annual returns over the past two years“. Sounds genuine - after all it mentions the time frame clearly. But let’s run through an example and see how this can be pretty deceptive.

• Initial investment: $100

• Value of investment after one year: $200 (100% return this year)

• Value of investment after second year: $100 (50% loss this year)

• Net gain/loss amount over the two years: $0

Now, when you calculate “average annual return” using arithmetic mean, you are basically taking the average of 100% and -50%, giving you a 25% average annual return. But obviously, since your net gain amount is $0 (or 0% over two years), the simple arithmetic mean is not really telling you the entire story in this case.

This is where geometric mean comes into picture. Click here to learn how to calculate geometric mean of a given set of percentage values (including negative percentages). If you apply the geometric mean for the above example, you will end up with 0% average rate of return - which is correct. This rate of return - calculated using geometric mean - is known as “annualized return“.

Another way to look at it is that geometric mean takes into account the effect of compounding, whereas arithmetic mean does not.

I won’t be surprised to find a lot of proponents of volatile stocks using arithmetic mean to make their case of higher returns. So make sure you are aware about the difference between “average return” or arithmetic mean and “annualized return” or geometric mean.

Irrelevant time frames

Sometimes, data is presented with reference to a time frame (perhaps with careful consideration to the geometric mean) but this time frame may be largely misleading. In fact, I still don’t have a good explanation of what makes an “appropriate” time frame, but I am working on it.

For example, let us consider the share price of the S&P 500 exchange traded fund (SPY) over various time spans, going backwards from yesterday:

• 1 year return: 10.99%

• 5 year return: 69.69% [11.16% annualized (geometric) return; average (arithmetic) annual return of 13.94%]

• 10 year return: 62.83% [5% annualized (geometric) return, average (arithmetic) return of 6.28%]

Now, it is obvious that the annualized return differs if you choose different time windows over the history of the share. Depending on how you want to make your case, you could choose one of these time windows and go crazy with it. For example, you could pick the 5% annualized return for the last 10 years and blast the ETF’s performance, or you could pick the 11.16% return for the last 5 years and try to make a generalized statement like “… gives almost a 12% return on an average“.

Additionally, in all probability, people who want to downplay the 10 year performance will use geometric mean to make their case (geometric mean is always lower than the arithmetic mean), and people who want to glorify the 5-year performance, will use the arithmetic mean.

Readers should be wary of such pick-and-choose explanations. Try to find data that is most relevant to your investment time frame.

The disconnect between percentages and amounts

These types of examples are rarely seen in the investment world (I haven’t seen any), but are often observed in blog monetization circles. Here is an example:

My advertising income increased by 300%

Yeah right! It was 5 cents yesterday and today it’s 20 cents.

Obviously, in this case, the percentage value creates a greater boasting impact than the actual dollar value - so it might be used as a good marketing ploy to sell ideas/products.

It helps to have this scaling effect in your mind when you compare your income/net worth with others. For someone with $1,000,000 in hand, 10% means $100,000; whereas, for someone with $1,000 in hand, it’s just $100 (think in terms of buying power).

This becomes very obvious when you think in terms of percentage discounts on clearance products. What’s more attractive, a “50% off” sale on a $2 item you need or a “5% off” sale on a $100 item you need?

So, there you have it. Pay more attention to percentages in future.

This past week, a faculty member casually asked me about my recommendation for a MP3 player for her son… so I casually asked how old her son was. “He is nine years old” was the answer!! Man.. I never felt more outdated in my life… I still don’t have a MP3 player.

Here is another example I found on Amazon forums:

Question: Best mp3 player for a 9 year old, what do you suggest?

Answer: I purchased a Samsung YP-T7J from Amazon.com last year for Christmas for my eight year old. I liked it because it isn’t so small she would forget she had it and it was easy to navigate for a child. Actually she showed me how to use it…lol.

What’s with kids (and/or kids’ parents) and electronic gadgets these days? Is the idea of having some free fun without battery powered devices becoming obsolete or something?

I am not sure if it’s a good trend (technological advancement) or a bad one (technological dependence), but whatever it is, it’s certainly much different than how things were when I was a kid, and it will certainly have some impact (again, I don’t know whether positive or negative) on the growth and development of future generations.

To put things into perspective, here are a few things my friends and I did in ancient times to “have fun” - when MP3 players were unheard of and computers were rare (or too expensive for our parents). Most activities were just plain free - and those which required some hardware, didn’t cost more than a few peanuts:

1. Skipped stones on water: Do people even remember this anymore? It involved throwing some flat-ish stones across a body of water and watching them bounce multiple times. We spent hours trying to experiment with different shapes and sizes of stones, and various throwing actions, to generate the maximum number of bounces.

By the way, according to a MSNBC report, the world record for this activity is held by Russell Byars who made a stone bounce 51 times!

2. Collected stamps, coins, comics, and all sorts of silly *collectible* stuff: Nothing I collected ever turned into anything valuable, but it sure kept me busy. Plus, except for a few bucks of initial parental contribution - and occasional raiding of my own pocket money, it didn’t cost anyone a fortune.

3. *Handwheeled* bicycle tires: I don’t know how to explain this, but *handwheeled* comes closest to what we used to do. We used to find trashed/damaged bicycle tires and then run around while rolling them alongside with our hands (or sometimes with short sticks). This was usually accompanied by weird sound effects from imaginary vehicles.

4. Played with marbles: Again, loads of fun without the need to spend a lot of money. I remember playing with them ever since I was old enough to understand that marbles are not meant to be swallowed. Most marble games were extremely simple to play, but generally used to be very competitive.

5. Flew kites: Where we lived, almost every apartment/house had a flat roof open terrace. On dry, windy days, flying kites was one of the popular activities - among the young and the not-so-young. Kite fights, if you have ever heard of them, are awesome.

6. Played with spinning tops: I have played with all sorts of tops as a kid - my favorite ones being wooden tops which were spun with the help of a long thick string. It took quite a bit of practice to get the top spinning right. Years later, I found out that this simple toy is based on one of the most complex engineering concepts.

7. Made paper toys: This wasn’t really origami or anything … just a few simple folds to make things fly or float, but it was a lot of fun. Apart from the fun part, constructive activities like these allow a lot of scope for creativity - without burning a hole in your pocket.

8. Played hide and seek and outdoor chasing games that didn’t require a dime of hardware: There must be like infinite chasing and hiding/seeking games in existence, but I don’t see kids playing them anymore. Perhaps they like their video/computer games better.

Never felt the need for electronic devices as sources of entertainment - in the form of MP3 players or video games or whatever that was available (walkman, etc.) at the time. That explains why I felt like a caveman when I heard about a nine year old kid asking for a MP3 player.

I wonder what’s going to happen a few generations down the line - when all remaining memories of these old-fashioned frugal games will be wiped out. I guess there will be some sort of a Moore’s Law effect with regards to the ever decreasing age at which children start playing with expensive electronic gadgets.

Maybe we are looking at prams with iPod connections and infant-operated GPS units for our Baby Einstiens.

Feel free to share any particularly interesting, essentially non-hitech and inexpensive activity you indulged in as a kid. Maybe we can build a global library of such endangered (or already extinct) activities for future reference.

Image credits: discovermagazine.com, www.namibstamps.com, www.edwebproject.org, www.landofmarbles.com, www.kitelife.com, www.nwce.gov.uk, www.igniteseattle.com

A couple of weeks ago, I discussed about my default habit of leaving the original plastic covers on consumer products … for as long as they keep sticking to the shining surfaces. Along similar lines, here is another “save it for later” habit that I have developed over the years.

I nibble on chocolates for as long as it’s humanly (and hygienically) possible. I eat a very small portion, bit-by-bit, on any given day, and then I wrap the rest of it for future bit-by-bit sessions. Generally, the habit extends to any food item that I really like - although, it’s more obvious when it comes to chocolates because they are more readily available than other tempting foods and can last for several days (probably even months). In case of rare dessert treats, especially if it’s a very nicely prepared portion of tiramisu or flan, there is a good chance that I will spend more time on dessert appreciation and consumption than on the entree - in spite of the small serving size of the dessert.

Again (like for the earlier “saving it for later post“), as I introspect on the possible underlying reasons, the only explanation I can come up with is the desire to make the pleasing experience last as long as possible. I don’t remember having to consciously build on this habit in the past - so probably, I must have had one of those “light bulb moments” during my childhood, when I suddenly realized that instead of wolfing down that well earned chocolate bar (which, by the way, was extremely rare in those days) in a few minutes, I might as well enjoy the goodness for the next several days! [well ... that's more like a "duh" moment].

On further introspection, I think it’s one of the most valuable self-taught lessons in my life on efficient resource management. Over the years, I have applied it to food, pocket money, salary, clothes, good will, accidental gifts, windfalls, campfires, etc. and I have to say that it has worked pretty well in most cases. It always feels great to save some good fortune (or valuable resources) for later use instead of blowing everything up in a matter of minutes.

Here is another example: think in terms of an awesome 4^th of July fireworks celebration - how would you like it if, instead of a 40 minute dazzling display, all the firecrackers were exploded in the first minute itself?

On a cautious side, there is obviously a limit to how far one stretches this habit of saving the good stuff for later. All nice things (food items or not) have a viable time frame - in the sense of a “best if used before” date. Delay the “consumption” for too long and things will start to rot. The trick is to find the right balance - and as trite as it may seem, that’s always where the buck stops … doesn’t it?

Image credit: concise.britannica.com

More than a month ago, I discussed certain features of my slow but steady investing progress, and expressed concerns over owning two different ETFs that essentially track the same markets (EEM - iShares Emerging Markets ETF and VWO - Vanguard Emerging Markets ETF).

At that time, a few readers suggested that I should choose VWO over EEM because the former offers a lower expense ratio (0.3%) than the latter (0.76%).

In the process of educating myself on this subject, I came across an interesting article comparing the two ETFs in question.

Here is an excerpt from the article on Seeking Alpha:

Another thing in the article that I thought was strange was the author’s implication the VWO is a better choice, if you have to have emerging market exposure, than EEM because the expense ratio is a lot less. For the record VWO’s expense ratio is 0.30% (according to the article) and EEM’s expense ratio is 0.76% (according to Yahoo Finance). I think of this as forest for the trees analysis. At this point I will note that VWO has an OEF equivalent (VEIEX). Since VWO’s inception in March it has lagged EEM by at least 200 basis points (I am eyeballing the chart). For one year EEM looks to have outperformed the OEF equivalent by about 300 basis points. And for two years EEM seems to be ahead by about 1000 basis points. Even if the numbers are off, EEM has clearly outperformed by more than the expense ratio at every normal time interval since its inception.

The author seems to imply that EEM is a better performing ETF in spite of it’s higher expense ratio. I am still trying to find more information on this issue before I decide to go with one or the other ETF.

Meanwhile, I tried to check up the constituents of each ETF and found this article. Looks like there are differences in the weights these ETFs assign to different markets - although they may be tracking the same markets. That’s probably one of the reasons why there is a difference in their performance.

Any insights into this?