investments

Use the Snowball Effect to Get Better Financial Results

According to the Cambridge Dictionary, a snowball effect is a situation in which something increases in size or importance at a faster and faster rate. It sounds too simple and general, but it is a useful principle that can be used to achieve significant results over time. Practical examples of this are as follows, along with how the opposite can also be true:

Savings/Investments: Do you find it hard to save or invest? Start with saving just the smallest amount possible and then build upon there. For example, if you start with a small percentage, such as 2% and increase it by 2% each year, then within 5 years you will be investing 10% of your income. If you are unable to save at all, then you need to either increase your income, decrease your expenses, or possibly do both.

Paying off debt: Want to pay off your personal and business debts quickly? Allocate a small percentage of your income towards paying off your balances, starting with the smallest balance first. Once you have paid off the smallest balance, then use those payments towards the next largest balance. If you start with the largest balance then you will lose the moment due to a lack of sense of achievement.

Increasing your income:  If you increase your income by 10% per year, then it will double in about 7 years and in approximately 5 years if you increase it by 15% per year. Even more modest increases can make an impact over time. Small actions, such as allocating a consistent amount of your time and resources to increase your business volume will add up significantly over time. For example, that one extra phone call (made or received), blog post, additional employee hired, etc. matters. For a multitude of tips, search prior blog posts.

Avoid this approach: Most people want instant results and because of this they either stop too soon or start too strong in an unsustainable manner. There is nothing wrong with strong approaches, but it must be sustainable over the long-term. All you have to do is apply this approach to weight loss and fitness and see how many of your friends and family start an exercise program and eat extremely healthy and then stop after a few months. It is hard to go from no exercise to spending an hour and a half 5 days a week exercising.

Over time your results will get better and better, but give it time to be productive. Think of your actions as planting a fruit tree, as it will take time to bear fruit.

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What is all the Hype About Generating Passive Income? Here are Four Examples

I’m sure that you have seen YouTube commercials about generating passive income while lounging in a pool with your collection of high-end sports cars collecting dust in your oversized garage. Is this really practical and can you really generate massive amounts of passive income? The answer is yes and no . . .

Passive income defined: Passive income is any income that is derived from sources that you do not actively participate in to generate that income. Examples can include rental real estate, businesses that you do not materially participate, and royalties.

Can you really do it?: Yes, you can do it, which is the simple answer. However, it is much more difficult than the commercials let in on. Here are several ways to generate passive income starting from the least amount of capital needed to the most:

Side business: Start a business on the side while you are either working as an employee or if you already have a business. In order to make your endeavor take as little time as possible, then your need to focus on a either a product or information based business, while skipping a service-based business. The reason for not choosing a service business is because it will most likely require much more of your time.

Existing business: No matter which business you are in, you can make your business less and less dependent upon you so that you are not required to materially participate in the day to day activities. However, this can take at least several years or more to make this happen, and you have to make sure that your sales can support the additional expenses. The approach must be methodical whereas each aspect of your responsibilities is either transferred to employees or outsourced. It is easier to do this if you have a business that is not very complex.

Real estate: Depending upon where you purchase real estate, this can take a lot of capital. However, if you choose a rental property wisely and continue to build your portfolio, then eventually your rental income can substitute your regular income over many years. A good place to start is to either purchase a building for your existing business or to rent your home if you plan on moving.

Investor/lender: Once you have a sizable amount of cash, then you can and should look for privately held businesses to provide capital for. This can be in the form of equity or debt. If you are very selective then you can build a great portfolio over time with returns that are much higher than traditional investments, although the risk will usually be much higher.

There you have it now go for it!

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Don’t Sell Your House

Usually your first house is a “starter” home that you purchased because it fit into your budget at the time. A few years later you then sell your house, move up to a bigger home, and may even repeat this process several more times. But what if you didn’t sell your home and rented it out instead? Let’s look at the pros and cons of doing so:

Pros:

Easier Way to Have an Investment Property: If you were to purchase an investment property then you generally need a much larger down payment of say 20% – 30% compared to a mortgage for a home, which you may not have available. Additionally, the interest rate and payment terms are generally less favorable than a residential mortgage. Since you already purchased your existing home as your residence, you already have financing in place, which is avoids this issue.

Transaction Costs: Look at any settlement statement and you will see that the transaction costs greatly reduce the proceeds after selling your home. By renting out your home you will have avoided these costs.

Appreciation and Rental Income: If prices in your neighborhood are rising and there continues to be strong demand for housing then most likely your house will appreciate and so will the rent that you can charge. A rental property can also provide diversification to the stock market.

Cons:

No Down Payment for New Home: Homeowners usually use the equity from selling their home to purchase another home, but if you do not sell your home then you will have to either save up for a down payment or access your equity through a loan.

Negative Cash Flow: If your cash flow will be negative for the foreseeable future, then it doesn’t make sense to rent out your home. You have to also be able to have the cash to cover expenses when your house is vacant.

Leverage and Debt: Debt is a double-edged sword (that can be another article). You want to make sure that you aren’t so leveraged that it puts a large strain on your finances, especially if/when bad things happen.

You Are Now a Landlord: Who wants to be a landlord and clean toilets? This is a very common argument, but the answer should always be never because who likes problems? You should make sure that you have reliable handymen, plumbers, etc., and screen your tenants as much as possible. However, you should like the fact that you have created a financial asset for your well-being.

Most homeowners never even consider renting out their home, but it can be a viable financial strategy depending upon your situation. Just make sure to run the numbers first.

3 Ways to Wealth (Almost Anyone Can Do)

Aside from inheriting your wealth, there are 3 main ways to become wealthy over time that almost anyone can do and there really are no secrets. They all depend upon income, savings and investments as follows:

Slow and Steady Corporate Route: This is the most common, easiest, and accessible way for most people even with average wages or slightly above average wages. It may take some time, say 25 to 30 years, but you must do the following: increase your wages by at least 3 – 5% per year, start investing no later than your 30’s, save approximately 15% of your income, earn a rate of return of about 7%, and don’t touch your investments. Many people have a match from their employers, which can be included as part of their savings, so essentially they are saving around 12% of their own money. It’s a very practical, but slow way to wealth, with the largest obstacles being the starting age and your savings percentage.

Corporate Executive Route: This way is available to less people, but if you want to accelerate your wealth then the corporate executive route is much quicker. Your wages will grow double-digits, along with large, but variable bonuses, and access to stock options. Stock options can really increase your earnings and wealth, which will enable you to become wealthier sooner. Since your income accelerates so quickly you should be able to save a much larger part of your income than 15%, plus the rate of return on your stock options has the potential to be very high. There is a smaller pool of people who can take this route, but it works. The downside to this approach is variable income, risk of stock options dropping in value or becoming worthless, and the ups and downs of the corporate world.

Successful Business Owner Route: Running a small business can be challenging, but very rewarding. If you run a small business well, then your earnings will be way above average and your business will increase in value over time. The quicker you grow your business and increase profits, then the quicker you will become wealthy. Additionally, some business owners purchase the real estate where their business operates, which generally increases wealth even more and faster. You need to invest your income just like the other ways, but an added bonus is the value of the business. If you create a saleable business, then this can be your ticket to early wealth and retirement if you decide to sell. But who wants to retire in their 40’s? I can think of a few.

Other factors to consider that can help you are: minimizing debts, staying healthy, having a strong, supportive family, and taking smart risks/good decision making.

Don’t Start a Side Business Unless You Consider This

It seems so easy to make money from a side business. Just resell items through Amazon or some other website and now you’re raking in the dough! Sometimes that happens, but many times it does not. Here are few things to consider before doing so and some ways to make it more profitable:

The Value of Your Time: Once you get past the start-up period, are you making more than your wages or main business? For example, if your main job or business nets you $75 per hour and your side job nets you $15 per hour, then that is a poor use of your time. Ideally, your side business should make more per hour than your main job, otherwise you should consider investing  your time at your job or main business.

Expectations: What can you realistically expect to make? Calculate how much you can bring in and see if the additional time and focus is worth it.

Why?: Why do you want to own a side business? Is it for personal satisfaction or solely for monetary gain?

Ways to make it profitable:

Choose the right side business: Generally, a service business will take the most amount of your time and is harder to leverage because it depends mostly upon the owner. Choose a business that can operate with the least amount of your time or where tasks can easily be delegated.

Passive only: If you have the capital, but not the inclination to operate a side business, then you can invest in a business as a passive activity with minimal input.

Run the Numbers: No matter which type of business you choose, you need to perform research, analyze, and project what you expect the results to be. Since we usually tend to project very rosy outcomes, then try to come up with 3 different scenarios, including worst case, average, and best case. Your time and money are too valuable to invest them poorly.

Struggling Business Fail to Spend Money on These 3 Things

There are characteristics of successful business and also for struggling businesses. It is almost as if they do the exact opposite of each other. Three areas that struggling business owners tend to ignore because they see them as costs instead of improvements to support and grow their business are technology, people, and infrastructure/equipment. Let’s take a look at each to see the importance of each one.

Technology: Technology can help an organize with scheduling activities, taking orders, processing information, performing work, communicating with customers, collecting customer payments, financial activities and reporting, and assisting with an unlimited number of tasks. Technology must be implemented and used properly for a business to see a return on its investment. Additionally, it can take some time to get it up and running before you start reaping the benefits.

People: People are the life of an organization. Making sure that you have the right people will help your business run smoothly. Don’t be afraid to hire and train people to support the growth of your business, but you must make sure that they have the right resources, training and direction so that they can succeed. Can you imagine how a business can be transformed if it just hires one sales person that brings in 10 times the cost of their salary?

Infrastructure/Equipment: Have you ever been to a restaurant that looked like it hasn’t been updated since the 1970’s? It starts to lose its appeal and then the disturbing thought of what the kitchen must look like comes to mind. Have you noticed that franchises tend to be updated more often (generally they are required to), and their success rates far outpace non-franchised restaurants? The same can be said for equipment that can help virtually any industry to serve their customers better.

When a business ignores these investments they tend to suffer and their profitability goes way down, eventually leading to the demise of their business. The wise business owner will count the costs before making these investments and predict how the business will benefit. The struggling business will just see costs and never invest anything.

Pay Less Tax on Your Investments

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It’s great to accumulate wealth by investing and saving you money, but did you know that taxes can take a large bite from your investments? Every investor, including those with 401(k)’s, IRA’s, and traditional brokerage accounts need to be aware of the impact of taxes. Here are a few tips and items to watch out for:

401(k)’s: A 401(k) can be a great way to save money for retirement as it is automatically deducted from your paycheck every time you get paid. If you are in the 25% tax bracket, every $1,000 you contribute saves $250 in taxes, plus savings for state taxes as well. You want to contribute as much as possible to reduce your taxes and save for retirement, especially if your employer has a matching contribution.

There is one common mistake that I do see often with 401(k) accounts and that is withdrawing money before retiring. It could be because you really need the money or you switched jobs and cashed out your account. You must resist the temptation to do this! Generally, there is a 10% early withdrawal penalty plus you will owe income taxes on the money withdrawn. This can easily add up to a third or even half of the money lost to taxes that you have withdrawn!

IRA’s: An IRA (individual retirement account) has similar tax characteristics of a 401(k). A strategy to maximize the tax-efficiency of your IRA may be to convert some or all to a Roth IRA. A Roth IRA has more favorable tax aspects as there are no taxes when you make a qualified withdrawal. Before making this decision, a thorough analysis should be done to make certain this strategy is beneficial for your situation.

Traditional Brokerage Account: A regular taxable investment account needs to be monitored closely to make sure you are not unnecessarily paying taxes. There are three straightforward ways to do this:

  • Invest in tax-efficient mutual funds, ETF’s, and reduce the number of times you trade in your account. Every time stocks or bonds are sold, it may result in additional taxes
  • Hold your investments for longer than one year to pay lower capital gains tax rates. This strategy compliments the first point.
  • Compare the returns of tax-free municipal bonds to regular bonds to see which produces the higher overall rate of return.

Traditional IRA vs. Roth IRA

Traditional IRA:

An individual retirement account that allows individuals to contribute pretax money to investments. The investments grow tax-deferred until the amounts are withdrawn at retirement, generally age 59 1/2. The maximum amount you can contribute for 2015 is the lesser of your taxable compensation or $5,500 ($6,500 if you are 50 or older). There are phase-outs for tax deductible contributions if you or your spouse are covered by a retirement plan at work and your income exceeds certain levels.

Roth IRA:

An individual retirement account that allows individuals to contribute after-tax money to investments. The investments grow tax free and there are no taxes when withdrawn at retirement, generally age 59 ½. The maximum amount you can contribute for 2015 is the lesser of your taxable compensation or $5,500 ($6,500 if you are 50 or older). The eligibility to contribute starts to phase-out once your modified adjusted gross income reaches $183,000 if your filing status is married filing jointly and $116,000 if single or head of household.

Price vs. Value

Understanding the difference between price vs. value will probably save you a lot of headaches, improve your finances, and even your life.

To simplify, price is the dollar cost, while value represents the benefits or worth received.

Price is very easily measured, and is an okay measure to use when purchasing goods and services of relatively low significance. Goods are easier to compare because there are usually less variables to consider. As the purchase becomes more significant then so should the role of value.

Value is much harder to compare because some of the benefits are intangible. An example of a product purchase is a personal vehicle. You may have found two similarly priced vehicles that have many similar features, but the less apparent differences are the resale values, operating costs, and repair costs.

An example of determining the value of services can be made with an investment advisor. A good investment advisor will help you to not only achieve investment returns that are in line with comparative benchmarks, but also minimize the tax impact, allocate resources properly, and make sure that you do not make rash decisions, such as selling when the market bottoms out.

Take a step back and think of decisions that you make only on price. Now, factor in value and compare your experience and results. I am sure that you will be surprised.

Backwards Tax Planning

The title of this article should really be “Proactive Tax Planning.” Backwards tax planning is what you want to avoid by taking steps to minimize your taxes throughout the year. Steps you should be taking throughout the year include:

Businesses:

Entity Selection: The entity that you use to operate your business has a very large impact on your tax situation. Although there are ways you can make changes to the way your business is taxed retroactively, there are additional hurdles you will have to jump through, and there is no guarantee that your elections will be accepted. Generally, these elections have to be made within the first 75 days of the year.

Large Purchases: This includes purchasing vehicles and equipment, which must be placed into service before the year is over. If you were looking for a large deduction for 2014 and have not done so, then it is too late.

Timing of Receipts: If you are on the cash-basis, which means that you record sales when your customers pay you, then you can delay sending out December’s invoices so that you can get paid in January.

Individuals:

Investment Planning: The nature of your investments can have a large impact on the amount of taxes you pay, especially if your investments generate a lot of income. Your investments should be allocated to be tax-efficient.

Benefit Elections: Some elections can be made at any time during the year, but others, such as FSA (flexible spending accounts) and dependent care accounts usually need to be made at the end of each year.

Charitable Contributions: Properly planned charitable contributions, including donations of appreciated stock or valuable household items can produce an excellent tax benefit.

There are numerous tax strategies that can be employed, but you must be proactive to be able to take advantage of them.