R-Squared Energy Blog

R-Squared Energy Blog

http://i-r-squared.blogspot.com/2008/07/lets-talk-about-personal-finance.html


My 9th grade algebra teacher, Mr. Moore, taught us about compound interest. This was one of the most amazing discoveries of my life up to that point, and a definite life-changing event. If I only saved $2 a day, and averaged a paltry 5% of interest, I could accumulate $130,000 by the time I turned 60.

Not a fortune, but then again I am only saving $2 a day and only getting 5%. If somehow I could manage a 10% return, then my $2 a day ended up being $600,000 by the time I turned 60. And if I could manage some real savings - say $100 a month, or $3.33 a day (at the time I was making about $200 a month) - then I would have a million dollars when I turned 60. For the first time in my life, I could see a path to my goal that didn't involve winning the lottery, or otherwise striking it lucky on some long shot.

The power of compound interest has been at the core of my financial planning since that school day in 1981. I knew the ingredients to wealth: 1). Live below your means, so you can save some money. 2). Save the money in a "do not touch" account; 3). Maximize your long-term returns.


Second, I decided that I would never again invest in things that I didn't understand. I still can't tell you exactly what JDS Uniphase does. Something with the Internet. But I don't understand the field well enough to distinguish the pretenders from the contenders.

Third, I vowed that I would always understand the risks. I shun investments that I deem as high-risk, even though I may be giving up substantial rewards. Moderate returns for moderate risk have been better for me than high returns that go along with extreme volatility and an occasional disastrous year.

Finally, I decided to invest only for the long-term. No more market-timing for me. I would evaluate a company based on the fundamentals and my expectations of where trends were heading (e.g., the health care sector looks good as the Baby Boomers age) and invest accordingly.
Those principles have guided my financial planning since then. I have not had a down year since 2000. In hindsight, as a result of my strategic error with the tech stocks, I developed a sound financial plan that has been very good to me. I am probably better off now than had I not taken such big losses in 1999-2000 because of the way it caused me to change the way I invested.

Financial Rules That I Live By

Here are some of the rules I live by:

1. Live within my means. That means that I don't typically make purchases on credit that would take time to pay off. If that means I drive a crappy car - and I have driven crappy cars before - then that's what I do.

2. No credit card debt. While in some cases it may make sense to carry credit card debt (e.g., you got 0% interest for six months), you have to be disciplined. You never want to carry a balance with a > 10% interest rate. You will have a tough time keeping your head above water.

3. Save a minimum of 10% of my income. Over the years, that has probably been closer to 30% for me. I have always maxed out my 401K every year that I worked. I maxed out IRAs, Health Savings Accounts, and Education Savings accounts. Saving that money pre-tax has the added advantage that money that would have gone toward taxes is now accumulating returns.

4. Do my own taxes. Doing your own taxes can give you a lot of insight into how to manage your finances in a way to minimize the take of the tax man. Study all of those deductions, and make sure you are taking the ones you are entitled to take. For most people, doing your own taxes should not be that difficult. Take last year's tax return and start from there. If you get stuck, the IRS has various hotlines to help you out. Even if you can't complete it by yourself, you will learn something by going through the process.

5. Invest in things I understand. For me, that's primarily energy-related, but I also invest in sectors (like health care) that I think are well-positioned for the future.