Advice & Wisdom April 13, 2015

I've seen over the years as a lawyer and a peacemaker, and so I'm here to answer questions tonight. The general topic is money and finance. I have questions that people have submitted by email that I will get to, and I also want to talk about money generally, concepts around money that most people hear words, but they don't understand what the real meaning of the words are and how we look at money. So I want to educate you about that. And if you have questions, go to the chat room at adviceandwisdom.com, which is below the webinar screen, and join the chat room as a guest and type in your questions. I will try to double tap, multitask, and answer questions as well as keeping track of what's going on in the chat room. So you'll see me glancing down every now and then to make sure that I've got it all put together. Okay, so let's start off with a couple of questions that came in, and then we can— those are great, they're both really good questions and are useful for getting into talking about concepts around money that everybody should know but most people unfortunately don't. So here's, here is a question that came in I'm just gonna kinda read, read the problem, and then we'll talk about it because it has lots of interesting stuff, and I'm sure a lot of people can resonate with this. So I was divorced and finished a personal bankruptcy in April 2009. I purchased a used 2009 Nissan, which was financed through the dealership at a 17% interest rate. Paying $350 a month and about $5,000 remain on the 5 or 6-year loan. I've tried to refinance but cannot. The car has 91,000 miles. I've not tried to get pre-qualified for a new car, hoping the interest rate will be lower. I don't have a credit card and I am just wondering what the heck should I do? Am I better off trying to get a credit card to rebuild credit before looking for another car or try to purchase another car. Okay, so there is some missing information here, but this is an interesting problem. We have an older car with a lot of miles on it. The good news is that Nissan tends to make a good car, and 91,000 miles is not the end of the shelf life of the car. By way of example, I have my last Outback I had 281,000 miles on it before it met its unfortunate demise in a minor collision that wrecked the front end and the insurance company totaled it. So these cars today go for a long time, and as long as it's mechanically reliable, with this financial situation, it is not— I don't think it's time to be looking at a new car. In terms of car purchases in general, my personal philosophy is anti-Detroit. I like to buy cars that are going to last a long time. Typically, I hold on to a car for 10 years, and I don't like car payments, and I don't mind having an older car, especially one that I've taken care of. My criteria for buying a new car is when the annual cost of repair equals about half of what a new car, 6 months worth of car payments would be. So just to make it really simple, if I'm paying $500 a month in total payments for a new car, that would be about $3,000 a year. And if my maintenance costs exceed $3,000 a year, it's time to buy a new car. It's cheaper to maintain an older car than it is to buy a new, newer one. And that gets us to the problem of what do we do when we owe $5,000 on the car, we're paying $350 a month, and we're paying an incredible 17% interest rate. That's probably because of the high risk around the bankruptcy and difficult financial circumstances. My— the best thing to do with high interest rate credit is to pay it off as quickly as possible and not incur any more debt. So for example, on this, I didn't run the numbers, but if you've got a $5,000 balance on the car and you're paying $350 a month, if you could increase your payments by $100 a month to say $450 a month— I know that's always a stretch— but if you could increase that, that's, that's $1,200 a year. Your car would be paid off probably in less than 2 years. And you'd be out from under this. And if you make the full payment on this, it goes to the benefit of your credit record. But you really want to get out of this 17% interest rate. The problem you've got is that if you go in and try to buy a new car, you're going to be, you're going to be stuck with, again, high car payments, potentially high interest rates, and you may, especially if you've got to keep your cash flow down to $350 a month in payments, it may just be very, very, very difficult to get anything to improve your financial situation. Best advice: high interest rate, pay it off as quickly as possible, make more payments per month than you have to make if you can afford to do it. Even if you pay $50 a month more, you are still going to pay the car off more quickly than what's left on the loan. And I'm looking here, assuming Well, I don't know when the loan was taken out, but with $5,000 left at $350 a month, 70% interest, you probably got 3 or 4 years left. If you can cut that in half, that's being really smart. And then the next thing to do in terms of, so what do I need to do? I need to buy a new car. Hold on to that Nissan, run it for as long as you can until, as I said, the maintenance cost equals half the monthly payments of a new car. And then take the money, the $350 a month that you would have been spending on the car, and if you can, try to save it. I know this is really tough in these tough times to save money when, especially if cash flow is tight, but the idea is to build up a down payment so that when you walk into the dealership, you don't finance from scratch. By the time you buy a new car, the Nissan's probably going to have 150,000 miles on it, probably not going to be worth much more than $2,000 or $3,000 or $4,000 in trade-in. That's barely going to cover just the, the taxes and the cost of registration. So if you're going to add another $3,000 or $4,000 or $5,000 onto that, um, that means you're going to get a lower interest rate from the finance companies and your monthly payments will be lower. So, uh, that is really the solution to the problem. It takes discipline to manage money this way, And that's where most people get into trouble, is because they don't have the discipline to pay more than they need to pay, to reduce high-interest card debt. They take out more debt than they can afford because the debt seems to be cheap and easy, and they get over their heads, and then they get in trouble. Managing money requires impulse control, and it requires some discipline, so that you don't get yourself into trouble. So hopefully that answers that question. I'm going to swing around and talk about some basic concepts about money that will probably help you understand the Nissan problem. Here's the next one. This is a real common problem that we're seeing these days. So here's the problem. My husband and I are on Medicare and confused about how to figure out if going solar at our age ages 65 and 72 is cost-effective. It's very confusing when I try to talk to people who sell and/or lease the systems. We unfortunately live in an area where there's a lot of heat and very few honest people. We have to spend— we had to spend all of our nest egg on doing repairs to our house and on things that were not disclosed by the sellers, so there's no money to put down on the purchase of a solar system. "I have heat-related health problems, and while we get a small break from PG&E, it does not keep up with our PG&E bill at a level that is affordable for us during the extreme heat times of the summer or when we have to use the air because of all the smoke from fires in the mountains." Okay, so the question is, is going— does going solar make sense? As a general proposition, if your PG&E bill is over, say, $200 a month, or your utility bill is over $200 a month, and we all know living here in Central California that that's pretty normal to have a pretty good size air conditioning bill, you can start thinking about going solar. And the issue becomes, what are the best ways— what's the best way to do so? There are really a number of different There are 3 principal ways that you can go about getting solar from a financial perspective. Number 1 is outright purchase. For a normal home that's burning, say, 5 kilowatts of power per year, you'll need probably a 3 or a 4-kilowatt system. You're looking at anywhere between— anywhere from $10,000 to $30,000 out of pocket Now that can be defrayed by— if you have PAC taxes to pay, there are tax credits, both state and federal tax credits, that help defray a lot of that. So you're— but you're out of pocket the money initially. You recoup it in taxes in the next year. So you really got to be thinking about if it's a purchase option, I'll purchase it now and then part of the tax savings will be part of the return on investment. When we talk about return on investment, we're talking about how much money you're making on the investment that you put in. So for example, if you put in a $10,000 solar system, how would you measure your return on investment? You would measure one by either the savings or annualized on your utility bill, and you would also measure it by whatever the increased value in your house might be, because houses with solar tend to have more value than houses without solar. Solar. So you combine those two figures together, you basically figure out what the cash flow savings is, and then through a process of discounting the present value, which I'll talk about in a minute, and anticipate what the increased equity in your house is going to be. That's your total return on investment. If you can purchase solar and you've got the money on hand to do it, typically that is that's gonna make you the most money. You're gonna get the highest ROI, return on investment, through purchase. Of course, now when you purchase, you are responsible. You bought it, it's yours. You've gotta be responsible for maintenance upkeep, but the nice thing is that these things, systems, come with very long guarantees. They are essentially maintenance-free, and once they're installed, it's sort of a turnkey operation, nothing you have to really worry about. So that's one thing to do. That's one way to do it. On a $30,000 investment though, you're not going to see a complete return on that investment for some time. It's going to take— it'll probably take you 10, 15, 20 years depending upon the cost of electricity before you get your money back and you start making money on it. So buying solar is good. It's a long-term investment. And you won't see— you won't be really making money on it until you get that $30,000 back plus some interest. And that's gonna take a while. However, you're gonna see reduced utility bills, obviously, maybe even zeroed out, and it's good for the environment. So that's a good thing. What's the second way to do solar? There are a lot of companies, solar companies that will lease a system to you. Leasing has some advantages. The one advantage is that you don't own the equipment. The solar company owns it, so they're responsible for maintaining and taking care of it. Your lease— you typically— leases require very little down payment, if any at all. So if cash is short, you will— you are— and you obviously can't afford to purchase it, then leasing a solar system might make sense because you can get the benefit of a reduced solar bill without the huge cash outlay. Of course, you are not going to get the same return on investment because, one, you don't own the solar system, and two, the only thing you're really doing is defraying the cost of your utility bill. And depending upon what the lease payments are, as long as they're under your average utility bill and your— or I should say, as long as the utility bill is reduced down to below what your lease payments are, your cash flow has improved. So the way you analyze the lease is to look at what is it costing me, uh, for utilities. And you've got to look at a whole year. You just can't look at, in California, from say May to September, maybe early October, or the hot months of the year. You've got to look at the whole year. What's my total cost for electricity for both heating and cooling through the winter months and through the summer months, and then look at what's the total cost of the lease payments per year. And at best, you want to break even, and even breaking even is probably not a worthwhile endeavor because a lease is a debt and that doesn't help you much. However, you may also be able to reduce or eliminate your utility bill enough so that the lease payment actually reduces your total cost and increases your cash flow.. And if you do that analysis and you find that you can actually save money, even if it's a couple hundred dollars a month, well, that would be worth considering. There's a third way that solar companies are— it's in the nature of a lease, but what they may be doing is they will install the equipment and guarantee you a reduced power bill or reduced bill altogether. And that can be done. It's sort of a hybrid of a lease, and basically what they do is guarantee you a lower utility bill, and what they do is they make the difference. So they lease the equipment to you, you get a lower utility bill, and they get the, they get the benefit of the savings of the, of the, as well, and that's how they make money. It's becoming more popular. The Google guy, Larry Page, he's the brother of the Google guy, SolarCity, has really developed this model of residential solar installation. And it's becoming more popular and might work. Again, I think that solar as a proposition is still not quite prime time. We would do solar because we want to reduce our greenhouse gas effect and hopefully affect climate change positively. And become environmentally conscious. But as a smart no-brainer investment, I think the cost of solar is still a little high for that. I'm not sure what the delivered cost of solar is these days per kilowatt-hour, but if you are, say, in Northern California and PG&E is your utility, you could be paying anywhere from 11 to 17 to 18 cents a kilowatt-hour. I don't think solar yet comes in under 25 cents a kilowatt-hour. So the only way it makes sense is by the subsidies, the tax rebates, and all that stuff. Obviously, if you lease, you don't get the tax advantages. That goes to the solar company, which is part of how they make their money. But you're still paying— it's still pretty expensive electricity, which is why those subsidies are out there. So that's the way to look at it. And really, like in all financial situations, you've got to look at— you're looking at one of two things. You're either looking at how you're managing your cash flow That is money coming in versus money going out, and if you can reduce the money going out without increasing, without paying a lot of interest, then that's a good thing. Or the other way you can look at it is I've got, I'm not worried about my cash flow so much, I want to grow my asset base, and so now you're looking at return on investment. How much money am I going to get back? If I take that $30,000, for example, what are my choices about where I can put that money to make it grow as rapidly as possible or in some reasonable way so that I can basically get interest on the money and make it grow. And that's the other way you can look at it. There are two different financial goals when you're looking at cash flow management versus return on investment. And so that's why it's so confusing out there is because people are not— the people who talk about this stuff and are Salesmen are not really taking the— they're not financial planners or financial advisors. They're not taking the time to sit down and say, okay, what's more important, cash flow or making a lot of money on your investment? And that's the kind of decision-making you have to engage in before you can decide which route in solar, a solar system or any other kind of system, any other kind of investment like that is is appropriate for you. I mean, it's the same thing with a car. I mean, the choice is you can buy a car or you can lease a car. You can put down a big down payment or not a big down payment. Again, you lease when cash flow is most important because typically in a lease situation, your down payment is fairly slight. It's usually a couple of payments, and so you can get in pretty inexpensively, and your monthly payments tend to be pretty low because there's a residual value at the end of the 3-year lease and you turn the car back in, assuming you haven't exceeded your mileage allowance, and you walk away from the car. Well, what you're doing when you're leasing is you're managing your cash flow. You're saying, I need a car, I need to manage my cash flow, keep my, keep my stuff down, and I'm not going to worry about the implicit interest that I'm paying on it because cash flow is more important than interest. What most people don't know in automobile leases is you're paying an implicit interest rate of anywhere from between 18% and 30%. So it's very, very expensive money, but the cash flow is low, and if cash flow is more important than interest— the interest you're paying, the implicit interest you're paying, you don't pay real interest, it's financial calculation— then leases make sense. If you like new cars every 3 years too, leasing makes sense because the owner of the car dealership or whoever, the leasing company takes the hit on the decreased value of the car and you don't take that hit. On the other hand, if you're like I, my personal preference just because of my own financial situation is I like to buy and hold. So I will buy a really solid car like I own an Outback and it's a super solid car. I know I can get about probably 200, maybe 300,000 miles over 10 years, and when the cash flow— when the car payments stop, now all of a sudden, although the car is not appreciating in value, I no longer have to make those payments and I can take that money and put it somewhere else. The car is not appreciating in value, but it's not costing me anything other than just keeping it maintained and keeping it going. So that's Leasing versus buying, two different things to think about, and you have to do a little bit of skull work to figure out what's most important. People who are on fixed incomes, Social Security, retirement, cash flow becomes more important. The problem with managing cash flow with this, with not a lot of capital, retirement and so forth, is that you're going to get sucked into higher interest. And that it's going to be more costly money. But sometimes you have to bite that bullet, take the higher interest rate to keep the cash flow working for you. So let me give you some of those. Those are the two questions that came in. If anybody else has got questions, hop onto the chat room and give me the questions. I want to talk about some basic concepts in money management. That a lot of people in my years when I was practicing law were just— were essentially unknowledgeable about money. It's not something that we're necessarily taught in school. You have to really go out— unless you go to business school, I guess. You have to really educate yourself on basic financial matters. A lot of people don't, and it causes a lot of confusion around that. So let's talk about some of the concepts I want to talk about. What is debt? Well, we kind of know what debt is, but debt is actually a little bit more sophisticated than and complex than what most people think. What do we mean when we talk about savings, and what do we mean when we talk about the value of money? Very important concept. And that gets us to the difference between interest rates What is an interest rate and why is that important? And what's the difference between an interest rate, for example, and a return on investment? And if you understand these basic concepts, you can make better decisions about, all right, how much debt, how much credit card debt do I want to go into versus how much do I want to save to make the purchase? And it helps you in your decision-making process so that you don't one, get in over your head, or two, make imprudent purchases. So let's talk about debt for a second. Everybody knows that debt occurs when one person loans money to another person. That's fundamental. And there are all kinds of different types of debt. There is basically— we can categorize debt for our purposes as being either secured or unsecured. These are legal terms. A secured debt is a debt for which there is some kind of security agreement. So when you buy a car, there's that big old long form in tiny little print, front and back, drives— I mean, most lawyers can't understand what that is. That is known as a security agreement, and what it does is it it creates a right of the lender to a whole bunch of remedies in the event that you don't fulfill your obligation. And by remedies, I mean things that a judge can do, either— or a creditor can do, or a judge can do, uh, to help a creditor collect an amount of money that is due. So when we talk about a secured debt We're talking about a debt that gives the lender some kind of right over property, that the lender can seize the property under appropriate circumstances, sell it, and pay itself back the debt that's owed. That's what we call a secured debt. Now, there are two kinds of— basically two kinds of securities that can secure debt, fundamentally. There is real property and there is personal property. Real property is like your house. So if you own a house and you have a mortgage on the house, you have a— what you literally have, and in California we don't even have mortgages at all, but we call them mortgages, but that's not what they are. In California, what we have is when you closed escrow on the purchase of a house, you signed a a very long document called a promissory note that had some really scary figure like $500,000 or whatever the purchase price of the house or whatever the amount of the loan was that you're promising to pay back. And in addition, you signed what in California is called a deed of trust, which is a security instrument that essentially gives the lender the right to foreclose on force a sale of your home in the event that you fail to make payments over a certain period of time. It gets kind of complicated legally, but basically that's it. And so the reason that the lender is willing to make the loan to you is because presumably the value of the house, the purchase price, is greater, usually by about 20%, than the amount that you're borrowing. And that's called loan-to-value ratio, LTV. So in most— the reason that we got into huge trouble in 2007 and 2008 around the world and in this country is that lenders were making loans to people who had no credit, no ability to pay, and they were grossly inflating the value of property way beyond its value because there was so much demand for investment property that the loan-to-value ratios got completely upside down. And when the whole thing collapsed The real estate people, all the lenders were all of a sudden finding that homes were going into foreclosure by the thousands. Property values— we all remember this— property values dropped, and all of a sudden there was no security to support the notes. And in most states, a borrower of a residential mortgage can walk away without recourse. In other words, the lender has only resort to the security. The land cannot sue the debtor personally for the debt, and that's the difference between what we call a recourse and a non-recourse loan. In a recourse loan, not only is the borrower personally liable, but the lender can also take recourse against the property that's securing the debt and also go after the borrower personally. In a non-recourse situation, the lender does not have the ability to go against the borrower. So essentially, residential transactions in California are basically non-recourse. In other words, the lender cannot go after the— it's called the Anti-Deficiency Statutes, and the lender generally has a difficult time going after the borrower. It can happen. There is a way around it through judicial foreclosure, but it's very difficult and most lenders don't bother with that. However, if the property value is not sufficient at a foreclosure sale to meet the debt, you know, the lender takes the hit. And if the lender doesn't want to take the hit, then the lender has to file a lawsuit called judicial foreclosure and go through that process. Very, very difficult, time-consuming, and expensive. So you've got debt. Now you also have unsecured debt. As a general proposition, think about money as a commodity. We can buy and sell money just like we can buy and sell wheat or buy and sell a car. People— there are a whole bunch of people in the world who are engaged in buying and selling money. When they buy money, they are When they sell money, they are lenders, and so when they are selling the right to use the money, they're basically renting their money out. They expect to be paid rent on that money, and that rent is what we call interest. And interest is, again, in very broad terms, is composed of a number of different items. One, the there's an inflation rate. Two, there is a risk, a non-risk rate. In other words, what is the safest investment in the world? Probably United States Treasury bond at 1.5% or whatever it's at today. So you've got inflation. So let's just, so we start building up these layering of this, and this is how we get to these interest rates. So for example, if inflation is at 2%, that's inflation. That goes on. Then we say the no-risk interest rate, where unless catastrophe strikes the world, it's always going to get paid. That's probably a US Treasury bond, and let's say that's 1.5%. So now our base interest rate has gone from, say, 2% inflation, 1.5% Treasury rate, that's 3.5%. That is a very low interest rate. But if it's unsecured, that means that there is no collateral, there's no property, either personal or real property that the lender can go against in the event of default. So now there's a huge amount of risk involved. What happens if the debtor doesn't pay? I gotta track him down, find him, sue him, and hope that he has some, has some property that I can attach after I get a judgment, after I file a lawsuit and win my case in court. And then I have to worry about bankruptcy. So as a result of that, there is a huge risk factor involved in unsecured debt. And one of the reasons why credit card debt is at anywhere between 13% and 25% is because the lender is looking at the risk, and they know from experience and from big data that out of so many hundreds of thousands of issued credit cards, they're going to have a default rate of a certain percentage. And so they charge enough interest to make a healthy profit for the risk, so they get a rate of return to their shareholders or their investors and they account for a certain percentage of being bad debts. So the good people who make their payments and pay off their high-interest rate debts are subsidizing all the deadbeats out there. And that's why credit card debt can be so high, is because— and that's why the worse your credit is, or the less assets you have, or the worse your cash flow, the more risk a lender perceives you having, a credit card company perceives you having, and the more it is going to charge you for interest rate because of the risk of default is statistically very high. Even though in your particular case you could have the highest integrity in the world, they're looking at this over the— over hundreds of thousands of people. And so that's why interest rates are so high, and that's why you have to be very careful about deciding whether or not to engage in a high interest rate transaction, uh, because it's managing cash flow versus the cost of renting that money. Let me talk a little bit about how credit cards work. You know, you know how credit card works. You take the plastic out and you slice it in the machine or give it to somebody and they swipe it and you sign your name and you walk away with whatever your purchase is. Well, that's not exactly how it technically works. A credit card is essentially a letter of credit. And a letter of credit is a legal device, a legal instrument whereby a bank agrees to pay for a purchase, for example, that a person makes. And so it's the bank— it's a three-way transaction. It's a transaction between you and the seller of whatever it is you're buying. Say you're going to Target and you're going to buy some clothes at Target. So you've got a transaction between you and Target, and it's a transaction between Target and the lender, the credit card company, because what's happening really is that you're not paying the— you're not paying for the goods themselves. The bank is paying for the shirts and shorts that you bought at Target. And then there's a third relationship between you and, and the bank which says, "If we pay for your shirts and shoes at Target, you agree to pay us back, and because you're renting our money, you agree to pay us rent on your money, which is interest, especially if you don't pay the whole balance off the next month." So it's a fairly complex transaction that's going on there and And so you have to understand that every time you use a credit card, you are renting the bank's money. And you're gonna— you all know, we all know that we pay interest on that, but just understand that conceptually, it's the bank that's spending the money, not you, and you have to pay the bank back. And I think intuitively people get this, but they really don't understand the complexity of the relationships between the purchaser and the vendor, you and Target, Target and the third-party bank, uh, Visa, whoever the— Wells Fargo, whoever it might be, and then your relationship with the bank where you agreed to pay back whatever money the bank has advanced. Now, in a debit transaction, uh, very different. In a debit transaction, the bank is only holding the money. It's your money, and it's being debited, taken out of your savings account or your checking account, and you're— it's as if you're paying actual cash. So the bank is involved but in a custodial manner as a depository, not as a lender. Now, it may charge a fee for that. They used to charge fees, and they don't charge fees now very much because there would be a hue and cry. But using a debit card is very, very different than using a credit card. Debit card, it's your cash, your transaction. The bank is holding the money. Maybe you're getting interest on your checking account, maybe you aren't. And it— but the bank's not involved, you don't owe the bank anything. Credit card, bank money you've got to pay, and you're paying the interest on it, you're paying the bank back, you're renting the money to the bank. In my situation, I mean, we were all— everybody was devastated by the financial collapse of 2008. To call that a Great Recession is the worst kind of political jargonism. It was a depression by any measure and by anybody's imagination. I personally, I still have not recovered from it, and I know many, many professional people who have not recovered from, from the collapse, and many people are still suffering. Slowly life is improving, but it's been a really, really, really long 7 years. So how do we deal with situations where we have fixed obligations? We maybe we have house payments and we have car payments and we got kids we gotta deal with and we got dogs we gotta feed like Freckles and how do we manage that? And so that's where managing your debt, lines of credit, using a line of credit or using credit cards becomes a bit of a trick and you have to decide if I have to pay $2,000 or $3,000 or $4,000 a year extra in interest to maintain my cash flow, am I willing to do that? And that is what is known as cash flow management. Businesses will often engage in cash flow management because maybe they're engaged in, for example, in agriculture, the money all comes in at once typically at the end of the year as they're selling off the crop and they don't have any cash flow to speak of from February to the time of the next harvest. So what growers have to do is manage that by having a line of credit established with the bank so they draw down on— they borrow money from the bank on the line of credit during the year and at the end of the year when their cash comes in from the sale of the proceeds from the sale of their harvest, they pay the bank back and so that's cash flow management. And so you can use debt very constructively and powerfully if you understand that it's all about cash flow management and you make sure that you never ever ever exceed your ability to repay. In other words, your revenue in always has to be greater than whatever the cost of the cash is going out. Now you may pay a lot of money, a lot of rent on that money, but if that's your only option to keep a business going then that's the price you have to pay. Where people get into trouble is where their cash flow shrinks to a point that they can no longer pay the debt service, the monthly, the monthly bills, and that's bankruptcy time. In fact, that's a definition of insolvency. And you, if you're going to be very prudent about using debt to manage cash flow, you have to always be absolutely positive that no matter what, every month you have enough money to make the basic strokes. And if you ignore that rule, then you're gonna find yourself in deep, deep, deep, deep trouble very quickly talking to the bankruptcy lawyers in your community. Okay, so we've talked about debt. Everybody knows about savings, and you also know that when you put money in the bank these days, you don't get much of a rate of return. They're not paying much in the way of interest, and that again is because the inflation rate is very low and because the Federal Reserve has kept interest rates very low, so putting money into a savings account is probably not— unless you need to save for cash for some reason— it's not always the best place to invest your money. If you have excess money left over to invest, for example, in retirement or 401 or something like that, you really need to go find a good financial advisor who does not sell stuff. Stay away from financial advisors that sell insurance or their stockbrokers Look for registered investment advisors, people who make money by making your money grow. They don't make money on commissions for life insurance that you surely do not need. And so, just a word to the wise. And then they can help you find appropriate investments to grow your money so that whatever excess you have, if you're lucky enough to have excess, you can make it go I want to talk a little bit about present value because that again is a fundamental concept of money that most people do not grasp. So the easiest way to think of it— and the reason we use this term present value is we're trying to understand in today's dollars what a future income stream might be worth. So let me give you an example. Supposing that you have $100— no, let me phrase it this way. Supposing that in 10 years you wanted to have $100 in your bank account, how much money would you have to put in the bank today at, say, a 3% interest rate in order to get a total of $100 principal and interest in 10 years? That amount of money that you would have to put in the bank today at 3% interest— and by the way, it's probably going to be close to about $90 at 3% over 10 years roughly— is called the present value of money. The other way to look at it is to say the $100 10 years from now is called the future— that's called the future value. What's the value of that money today. It's, it's a future value, so it's got a $100 value 10 years from now, but what's it going to be worth today? And the reason that becomes important is because it helps you think about, do I go into debt, do I save, do I do nothing? Because what's the present value of the dollar— of my dollar today versus what it's going to be worth 10 years from now? In high inflation times, borrowing today is cheaper because the value of the dollar is going to be less, and even though the present value will remain the same, the inflation rate will be such that your present value will actually go down. So you are better off in high inflation times having a little bit more debt, and that disfavors the creditor. That's why interest rates go high in high interest times, because creditors are trying to make up the difference. In low-interest times like what we've seen over the last 5 or 6 or 7 years, having— being in debt is not such— being in debt is okay if you can manage the cash flow, but it does not work to the benefit, necessarily to the benefit of the debtor, and because your present value is going to be a very— is going to be very close to your future value. If the interest rate is 1%, over 10 years, I might need to put down, like I said, $90 to— that's going to be the same as $100 in the future. So it's almost, almost an equivalency. So understanding present value, trying to decide what kind of investments you're going to invest in, trying to understand is it debt, cash payment, how would I do this, looking at the value of money today and where it's going to be in 10 years can be important. So let's use another real-life example. Say you're buying a car and you have a choice between zero financing and not putting any money down, or putting down, let's say, $5,000. And you've got to figure out what is— what's the smart thing to do? Do I put down zero or do I put down $5,000? If I put down zero, I may have to extend the payments out more and pay a higher interest rate. If I put down $5,000, I may get a lower interest rate, and I may not have to— my payments may not be as high, and I may not need as many years out. So one of the things you would want to look at is what is the total cost, principal and interest, at zero financing all the way out to the end. What's that total cost? And it'll usually be 2.5 times or 3 times the total cost of the car. And then if I put down $5,000, how does that, how does that affect that outcome? How does it reduce the total cost of the car? And that's the future value. If I took that $5,000 and put it somewhere else, does it make up for the difference? So just using very rough numbers, let's suppose that you had a zero down payment, 6-year loan on a car that cost $15,000. I'm just going to make these numbers up and say so your total cost is it's going to be $45,000. At the end of the time period, you will have paid $30,000 in interest for a $15,000 car. Now supposing you put $5,000 down, and at the end of the term now you've only paid— you've got a $15,000 car, now maybe you've only paid, say, $25,000 total cost. So you've saved $20,000 over the no-interest thing But the question is, what do you do with that $5,000? If you could take the $5,000 and invest it over 6 years and make more than $20,000—difficult to do—then you would go with the no-interest situation because you could actually—the present value of that $5,000 is such that you can invest it to make more than what the cost of the money is going to be. On the other hand, if the cost is less, you can invest that $5,000, then putting the money into the car probably makes sense because the overall cost to you is going to be less over the 5 years. I hope that makes sense. It can be a little complicated. The nice thing is that doing the present value calculation, any smartphone that has a calculator on it can do, should be able to do a present value calculation. And the other thing I would strongly suggest is there's some great apps out there for on Android and for Apple, Apple apps that are financial calculators, and they're really simple to use. And having, having those calculators handy to help you work through all of these different formulas, one, takes away a lot of the mystery from and the jargon that people will try to confuse you with, and it will help you make really good decisions about how much do I borrow, do I borrow at all, how much do I borrow, how much do I put down, all that sort of stuff. Figuring all that out on your own when you walk in to do a sale or a loan or buy a car or do anything that is involving credit puts you in a much more powerful position. So get a little app, learn how to use it. It can be really useful. Okay, what else did I want to talk about? Interest rates. All right, everybody knows what interest is. It's what the bank pays you on your savings, or it's what you— the interest that you pay, the 18% you pay on your credit card. So remember that an interest rate is basically— think of it as apartment rental money. If you are paying interest, then you are renting the money from the creditor, from the bank or the finance company, and the interest that you pay is the rent that you're paying on that. If you are a— if you're selling your money, you're renting your money out, then that means you've got it, for example, in a savings account or a certificate of deposit or some other investment account with the bank, the bank is paying you rent and you're collecting, you're collecting from the bank. As we all know, the banks don't pay very much money out for our deposit accounts in our savings and checking accounts, and they charge a lot of money when we want to rent money from them. So they don't like paying rent to us, but they really like it when we rent money from them and pay the difference. That difference, in a very simplistic way, that difference, that spread between what you pay on your credit card debt and what you get back on your money in the bank account is the profit margin, the gross profit margin that the bank works off of. Now it's a lot more complicated than that, but essentially it's that spread that allows banks and other finance companies to make money. So for example, a finance company might go out and borrow from a major bank $10 million or $100 million, and it will pay 3 or 4% for that money. It will rent the money to you at retail for 18%, and so now it has a 15% spread. And when you're talking hundreds of millions or trillions of dollars, that adds up to a huge amount of change. And so that's how high finance works. It's working the spread between what the cost of the money is to rent the money and how much you can get for renting the money out at retail. So it's a wholesale purchase or renting versus retail renting, and that's how credit card companies make their money. And there are people who are hard money lenders who do exactly the same thing. They'll go out and borrow money, they'll borrow money at 3 or 4% and they have super good credit risks and maybe it's secured debt and then they will turn around and rent that money out and they will make a huge profit on the spread. So that's why it's important to understand that interest is not just about how much you're paying for the rent, it's understanding that you are— that the lender is making the spread between what it can rent the money for for and what it can rent and what it can sell the money to you or sell the use of the money to you for the interest rate. So that's interest rate. The last concept I think I want to take on, and if people have questions on the chat room, feel free to throw anything out, but the last thing that I want to talk about is this concept of return on investment. Again, it's a term that financial people throw out all the time, and it is not something that is well understood by the general public, and so it's just something you should know about and think about, and because it helps again make decisions about do I borrow, do I buy, how much do I borrow, how much down payment do I put on, this sort of thing. So return on— we know that interest is the amount of money that the bank will pay you for the use of your money. Return on investment is composed of all the aggregate growth in a particular investment that you might make, both, both immediately realizable money and non-realized growth in value. Example: supposing you buy a house and now you're gonna rent the house out. If you rent the house out, you will get a assuming you have a good tenant, you will get a rental payment back. And let's just assume that you didn't borrow any money for this house. Your return on investment is going to be measured in part by how much of that— how— by the present value of that rental stream. So for example, if you're renting the house out for $1,000 a month, that's $12,000 a year over, let's say, over 50 years, what is the discounted present value of a $12,000 income stream? And I don't know what the calculation is, but I'm just going to guess it's probably on the order of— oh, I don't know— $300,000 or $400,000. In other words, if you put $300,000 or $400,000 into the bank account, you will get this $12,000 return over 50 years, and it'll come down to zero. So that is, that's one part of the rate of return. So you're getting a rate of return on the money in the form of rent that you're being paid. Of course, you have to subtract from that maintenance and taxes and all the operational costs, but we'll keep it simple for right now. The other part of rate of return is the value of the property at the time you anticipate selling it. So again, let's keep a long-time horizon. Let's say you've got this house, it's a rental property, you're getting $1,500 a month, and you're going to sell it in 10 years. So you've got— you get the income, the $12,000 a year you're getting on rental income, and let's say that the cost of the thing is $4,000 a year, so you're making $8,000 a year on income. And let's say that property values in California tend to rise and fall— it's a cycle— but they tend, when they're in a growth cycle like we are right now, they tend to aggregate growth of 2 to 3, 4% per year until we get to the peak, and then it goes crazy for a couple years and then it drops precipitously. I mean, we've seen these boom-bust cycles in California all the time. It's normal. It's what we expect. So your return on investment will be measured at the time you sell that house by the increase in value that you— between what you bought the house for. Say you bought it for $100,000 and you sell it for $250,000, all right, so you make a $150,000 profit over 10 years. That's $15,000 a year. Add into that the $8,000 net income you're making, so now you're making $23,000 a year. Discount that back to present value, and that tells you what your rate of return is going to be. And that's how you can take any kind of financial situation whether it be debt or credit, and you can compare apples to apples and oranges to oranges and make a better decision about what is, of all the choices I have in front of me, what is the best way for me to go forward. And if you're able to do that and you're able to make these kinds of, these kinds of decisions and do these relatively simple calculations with a pencil and paper and a simple little application on your phone, your iPad, or your tablet, and a little bit of skull work. I'm not saying this is— it's not brain-dead stuff, but it's not difficult either. You can figure it out. It doesn't matter what your account— if you're a pensioner and all you've got is Social Security, you can still make good decisions about how to spend that money based on understanding the value of money, the value of cash flow, understanding the nature of debt, understanding the nature of interest, you can still amazingly enough make that money work for you in pretty remarkable ways. Where people get into trouble is when they're completely unconscious about their money. They just checkbook, it's checkbook accounting. Money comes in, how much money do I have in my checkbook right now? What can I afford to spend this month? Okay, that's what I'm going to spend. 99.9% of the people on the planet, or those that have money that are not extremely wealthy, that's how they manage their finances. It works, but you can do a lot better if you do a little bit of thinking about it and think about— think of and try to be more conscious about the choices you make in terms of how you purchase— go about purchasing things, when you go into debt and when you don't go into debt. And if you do that, you will find that your life becomes less complex, it's less stressful, you manage your money more competently so you feel good about yourself, very unlikely that you get yourself into financial difficulty, and more likely than not you'll find that if you're using your money wisely by using these simple little concepts, you'll actually have some money to save, or if not save, at least go out and have a great vacation. So we've come to the end of money advice and wisdom. I'll have this posted up on YouTube probably in the next couple of days. It'll also be up on the Advice and Wisdom website. These are free webinars. I invite you to tell your friends to take a look at them if you find that the information I'm giving is useful. My job is to advise and provide wisdom where I can, and that's how I get great joy in my life, is by sharing what I've learned over— it'll be 65 years this year— what I've learned and passing it on to people who have not had the benefit of my experience in education. So I'll sit and if there are any questions on the chat room, I can sit here for a second, but I will say good night.