Lifestyle savings etc. a nice comment from an enlightened person

Lately, thoughts have been springing into my mind as to what I should save for, what my real goals in life are, etc. I was navigating through some links and landed on this post about Lifestyle inflation. More than the post, this comment from Ron made a lot of sense. He sure must be an enlightened person. With his kind permission (haven't received it yet, since I have no way of communicating except leaving a comment on the same blog), I publish it here for my future reference and for any readers. I hope to emulate him some day..

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Some very interesting comments and I see everyone is very committed to saving…but I wonder for what? What are you saving for, why do you want to earn more money? I am not being facetious; I really want to know the reason behind your efforts.

One of the seven habits: Begin with the end in mind. I see the blogger has a goal of a million dollar net worth…same question…why? What will having that net worth accomplish? And what are you measuring? And what is the nature of the net worth you are after, specifically?

I mean, do you want a million in equity (say, in real estate) or a million in the bank earning 5%? Two totally different scenarios.

Many people fixate on some number but it is often like leaning the ladder of success against the wrong wall. My clients come to me with that same idea sometimes; that is, to grow their net worth to some magic number as if it will resolve their financial issues somehow.

Look, as a goal I guess a million is as good as any but, really, if you are saving just to reach a number…what is the life you want? What would an ideal day look like, feel like?

Money is a tool…but for what? To build the life you want, IMO. So isn’t that the real goal? What is the life you want and, now, break that up into pieces and cost those pieces out:

The house I want: $x
The car I want: $x
Number of kids: $x

So on and so forth. Then you add that all up and you will have a bottom line and that is your real goal.

I wanted a small but comfortable home in a safe neighborhood and a five year old car that I would keep for five years and then sell and start over. Cost for that: $1,000 a month where I live. Plus expenses: Another $1000 a month.

My savings earn me $15,000 a year ($300K at 5%) and the rest I earn working three days a week doing what I really enjoy doing and what I would do for free if I could afford to do so. And I also manage to save some of what I earn so my savings are growing, as well.

I am married and we have a daughter and we look for all the world like a typical middle-class family. But we pay for it all with 24 hours of work a week; meanwhile both spouses work in all the other houses on the block.

We are not better or smarter, we were just able to decide what we wanted, price it out, and fund it with just enough work to get the REAL job accomplished (the life we wanted). Four day weekends are great!

Good luck!

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Pay auto/car Loan or Invest in a CD or other investment. When do you break even

The previous post of mine on auto loan had lots of discussion and ifs and buts. I decided to make it pretty simple this time. Here is the case. You have $10000 with you today, that you can use to pay off a car loan of equivalent amount which is at a interest rate of 5.5% or you can pay the monthly installment on the car loan and invest the current $1000 you have in a CD or shares..

Analysis
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Current car loan = $10000
Interest rate = 5.5%
Term = 2 years or 24 months

From Bank Rate Calculator the equal monthly installment is $440.96

Let us say Best CD rate available is 5% (which is impossible at this time). So the case under study is that you have $10000 in hand today and you have $440.96 from your monthly income available to you to pay the car loan

Pay the car loan
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In this case you paid off the car loan and you put the $440.96 in a Savings account like ING Direct. Let us say in an ideal scenario you are making 4% on your savings account (ING doesn't offer this interest at this time). So putting $440.96 in a Savings account for 2 years, at the end of 2 years, (from dinkytown)

Total = $11,505
Taxes = 28% of (11505-10000) = $421.4
After taxes total savings = $1083.6
After paying taxes, money you have with you = $11083.60

Put in a CD
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From Bankrate $10000 at 5% for two years will yield a total of $11,052.

Total = $11,052
Taxes = 28% of (11,052-10000) = $294.56
After taxes, net with you = $757.44
After paying taxes, money you have = $10,757.44

Paying the car versus CD
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Difference you lose by not paying the car loan and investing in a CD = $11083.6-$10757.44 = $326.16

Incentives for not paying the car loan is the fact that you are only liable to $441 a month, if you lose the job or if you are on bench in consulting, then you have $10000 with you and you are only liable to $441 a month. So, that makes it easier for your mental peace

If you do not put in a CD and invest in shares or something, then what percent interest rate on your $10000 investment justifies your not paying off the car loan? lets calculate that. This means that your $10000 has to become $11,505 in 2 years. Using the formula for compound interest, that would be 7.26% assuming interest compounded annually. That is a very low interest rate compared to gains on Shares. But then, you never know about Shares. You might as well lose your money.

So, that's the calculation folks. Know your facts, analyze your situation and make a good decision :)

What happened to the $1. Can you explain? - A simple math brain teaser that leaves you thinking..

So you think you are good at Math and at simple calculations. Here we go. Try and solve this..

Three guys came to a motel and asked for a room with 3 beds. The manager said that the room rent was $30. They said they will check the room and pay for it. So the boy took them to the room, they liked it and each paid with a $10 note and the net amount came to $30. The boy went back to the manager and gave him $30. Then the manager realized that they had discounts at that time and that the room rent was actually $25 for the day. Since he was honest, he gave $5 (5 1 dollar notes) to the boy and asked him to return that money to those guys in the room. While going to the room, the boy thought that they cannot share the amount of $5 equally and since they didn't pay him the tip last time, he thought that he will take $2 and give them back $3 so that each gets $1 back. He silently slipped $2 into his pocket and went to their room and gave each guy $1. Everyone was happy.

But here is the question about it.. Initially the three visitor guys gave $30. Each paid $10 and got $1 back. This means each paid $9 and so the total they paid is $27. $2 were stolen by the hotel boy. We have the count for $27 + $2 = $29. What happened to the remaining $1 ???

How much do you understand your auto loan - Can you find the fault in this calculation?

A small discussion with my room mate brought up the subject of auto loan that I have on my car and why I should / should not pay it off. I have some savings in my savings account and I have an auto loan on my car. If I open a CD (Certificate of Deposit) with Indymac bank they will give me an APR of 5.5% and my car loan is financed by a Credit Union at 5.5%. The argument that my roomie was making was that I should pay off the car loan instead of opening a CD. His reasoning was that, though the car loan and the APR on the CD were the same, I am actually losing money, because on the interest that I earn on the CD, I have to pay a tax. And since I am single and fall in the higher tax bracket, I will end up paying 25%(+) on the interest earned. Which means that I will actually be making around 75% of the 5.5% which is around 4.13% which means that I am losing around 1.37% (5.5-4.13) on the whole amount that I am planning to open a CD with. In a way, it made sense for a brief moment.

But then, further investigation showed that it is not a valid argument to me. Here was my case that I presented. Let us say you have $10000 with you, and you have two choices, put it in a CD for two years at the rate of 5.5%, or pay off your loan which is 5.5% and ends in 2 years. If you don't pay off the loan now, you keep paying it in monthly amounts of $440.96 (Calculation from Bankrate calculator) with your salary. If you put it in CD for 2 years, you make a simple interest of $1130.25 (550+550). Let us say, you pay 28% tax on it. So your net interest earned from that amount after paying taxes off is 72% of 1130.25 which is $813.28 and the total interest you pay on the car loan for these 2 years is $582.96 (Calculation from Bankrate calculator). So I argued that I actually am making $230.32 (813.28-582.96) extra by not paying off the car loan.

Sounds logical right, but the above calculation is wrong because it was one-sided. The reason is, if I pay off the car loan with the $10000, then I don't need to pay them the $441 that I was paying every month, which means that I can put it in a savings account like ING Direct for an APY of 4.3% or an APR of 4.21%. This means that the total amount I make in two years with this monthly savings would be $11541 (Calculation from dinkytown). This means I make an interest of $1541 in two years. After cutting the tax at the rate of 28%, I will be left with around 72% of 1541 which is $1109.52. This means the total I save is this 1109.52 plus the interest I would have paid for the car loan which is 582.96. So the net total I would have saved is $1692.48 So by not paying off the loan today, I am actually losing is $879.20. So the conclusion of the whole calculations is it is better to pay off the car loan, if you have the cash instead of saving in your bank account and having the loan aside and paying monthly payments.

Agreed this calculation has some flaws because of some assumptions. It assumes that the rate from ING Direct will be 4.21%, but since it is variable it can go up or come down. Also, we are assuming that you will have continuous money from your salary, and that you will actually put aside the car loan amount payment in a Savings account instead of spending it on the next cool thing like the Iphone :) It also assumes that you would pay the money off instead of having it in your savings account, which you can withdraw in case of an emergency. You obviously can't get a car loan again on your car in case of an emergency right :) It also assumes you have 10k or the total amount of your car loan with you in your savings. But anyways, under the given set of assumptions, it makes sense to actually pay off the car loan rather than put the amount in the CD or Savings account. One more thing, you can consider is taking the amount from a special offer like 0% APR (be careful with the Balance Transfer fee in the fine print) on Balance Transfer from a credit card company like Citi and paying off the loan, provided you have a good credit history. That way, you don't pay the interest to the auto loan provider and you can pay off monthly amounts to the credit card company. And when the balance transfer offer ends after one year, take another card and transfer the balance to that. All this provided you actually have time to do some research on these and wish to save some dollars :)

Feel free to challenge the above calculations or present counter arguments :)

PS: There is a big fundamental mistake in the above calculation, and the net amount you actually save is $272.19 and not $879.20 as mentioned above. Can you prove this?