Originally posted 2008-12-04 15:56:42.

Game theory is the mathematical description of the structure of strategic decisions when the choices of two agents directly influence the other. Much work has been dedicated towards finding optimal strategies; in fact much military and political strategy is built on mathematical foundations, but it also governs economic decisions.

Consequently some knowledge of game theory can be very helpful.

The simplest way to describe a game is by using a payoff matrix. Suppose player 1 has strategies A and B and player two has strategies C and D. Then there are 4 outcomes: AC, AD, BC, and BD each with a certain pay out.

The most famous game theoretic problem is the prisoners’ dilemma, where two criminals are interrogated by the police. In the prisoners’ dilemma, a prisoner has the choice of ratting on his partner or keeping quiet. Here is the payoff matrix.  Hence quiet-quiet = 3 years for both, quiet-rat = 10 years and 0 years. rat-quiet = 0 years and 10 years and rat-rat = both 5 years.

What is the optimal strategy? It turns out that the optimal strategy for the individual is to rat on your partner. Ratting on your partner is a so-called Nash equilibrium after John Nash who was portrayed in the movie A Beautiful Mind. A Nash equilibrium is the optimal strategy for an individual given full knowledge of the other player’s strategy. In other words it is the choice of strategy where the payout of the individual can not be improved by changing strategy. In the case of the prisoner, since 0 years is better than 3 years and 5 years is better than 10 years, a prisoner can not improve his position by keeping quiet

This is an interesting case where the global optimum will not be chosen. This is what makes it a dilemma. People with too much sparetime can now make a game theoretic model of whether for two hostile nations it is in the best interest to for a non-nuclear nation to pursue a nuclear program given the idea of a Nash equilibrium (answer: it is).

Now, bripblap asked if the same holds in terms of wealth.

Let’s look at that. I’d like to rephrase the question in terms of whether trade has a global optimum (it does). When trading people are often confused by vague definitions of price and value, so let’s define those first. Price is the objective measure of at which a trade took place. If I traded 10 hogs for 10 cows, the price of 10 hogs is 10 cows and vice a versa. Value is wholly subjective. I am trading my 10 hogs for 10 cows because  I believe 10 cows are of greater value than 10 hogs. The person I am trading with believes the opposite.

Drawing a payoff diagram in terms of value shows that the optimal strategy in a free market is to only accept a trade when I believe that I am receiving more value (wealth) than I am delivering. The trade does not take place unless both counter-parties think the same. Hence, value is always created. That is the beauty of a free market system.

Conversely, if the trade was coerced (taxation), at least one party would think he is getting less value than he is receiving. This can lead to zero-sum or even negative-sum games. So why do we do this? The reason is that payoff is not strictly linear. Most humans, for empathetic reasons believe that a situation where a majority of people are slightly discomforted is optimal if it means that one person avoids severe pain (disutility). In other words, when it comes to extreme hardship, the needs of the one outweighs the needs of the many.

Another thing that can lead to negative payoff is buyer’s remorse. Although a rational person would base decisions on all available information at the time of the trade, few people are rational. Hence people will often choose suboptimal strategies. This, as well, can lead to zero or negative sum games. This does, however, not necessarily mean that the other person gets more value, but it is often so.

Originally posted 2008-11-07 07:36:27.

In a nutshell, engineering is making certain simplifying assumptions of the real world and building a piece of technology by combining separate parts to build a functional whole. During this engineering process, the degrees of freedom, that is, the play between its components is reduced as much as possible. This is possibly due to the limitations of the brain power or comprehension of the human engineer. As a result, most technology only has a few degrees of freedom. Some of the most complicated devices, like nuclear bombs only have a few dozen (this is a lot).

The 20th century saw many fields get engineered. I will discuss three of them. The first field to receive the engineering treatment was the socio-economic system. As a result, communism was a new design that led to enormous suffering. Fascism was another. I am not going to go into details, but socio-economic engineering are all based on the idea that humans are essentially “particles”, and so if we have enough particles and we know the “microphysics”, that is, the laws governing individual particles, we can predict, design and create large scale human behavior. Some of these designs failed. Other designs have so far been successful. If you wonder why you prefer particular brands, you are the result of one of the successful experiments.

The next field to be subjected to engineering was physics. The result was the nuclear bomb and the power to wipe out human civilization. Through a fantastic show of diplomatic skill, game theory, and forced collaborations, politicians avoided getting us all killed. This was possible because there were few degrees of freedom; here, that is, few nations had the bomb. Now that more and more nations become club members, the problem is getting more and more complex. I hope it does not become unsolvable. Although the inventors of the bomb knew the consequences, game theory clearly states, that the risk of the other guy “cheating” when you don’t is much too large. Therefore I fully support development of nuclear weapons … on our side, because the human level of civic mindedness is too low. To put it in other words. I am sympathetic to the anti-nuclear crowd, but the problem is that I do not think that the anti-nuclear crowd of the opposing side is anymore effective than ours. It’s the complete picture that counts. Now, despite scientists refusing to take responsibility for their actions of creating the bomb, politicians avoided mutual destruction.

This was not the case for financial engineering. Financial engineering is the synthesis of new contracts by combining existing contracts. Like with all technology, it’s use depends more on the user than on the inherent qualities of the technology. Guns don’t kill people. People kill people. Incidentally, people kill more people with cars than with guns. I digress. Financial engineering could have been used to greatly reduce risk in the system. Unfortunately, the choice was made to use this protection to “fight bigger wars”. This is not much different than from what happens in collision sports (Without any direct knowledge, I get the impression that Wall Street recruit a large number of ex-jocks?) when better protective technology is introduced, like helmets and padding. Better protection does not lead to safer play. Rather it leads to more risk taking. While the small injuries are reduced, it tends to increase the likelihood of rare but dangerous events, which were previously avoided by playing it safe, as the smaller injuries were bad enough. This is the problem whenever the goal is to win.

The reason nuclear war did not break out was that there could be no winner.

The next field to be engineering is biology. Whether this will lead to the equivalent of communism (like Darwinism lead to eugenics in Germany, the US, and many other “scientific” countries), or the equivalent of everybody having his own bomb is a matter to be determined. Imagine that the genetic kits that Freeman Dyson imagines being part of science fair projects being used to make something similar to, oh say, a computer virus. A genetic virus constructed by an clever teenager lacking the wisdom and full intelligence/appreciation of the consequences of his actions. The difference between biology and computing is categorical. A computer virus may destroy your files. A genetic virus might destroy your food, or your life. It is in my opinion a huge problem, when technology is invented by people with little wisdom (in general anyone younger than 60) when it comes to human experience and have that technology be used by the very same. An pragmatic solution would be the nuclear solution: Let the young invent the technology, but hand over its use to the wisest generation.

Perhaps there are some technologies that should not be used. Unfortunately, it would seem that humans have not attained the required degree of wisdom to make such choices in advance. However, to our defense, as humans, it seems we are able to make the right choices reactively when we are standing on edge of the cliff. Let’s just hope that this strategy of no foresight will keep working for a long time.

Originally posted 2009-08-09 00:23:03.

In case you don’t read all the comments (note that it is possible to get all the comments in a single feed), I wanted to highlight an idea from Oasis in a recent comment of having a downsizing party.

You invite your friends to your home, the price of admission being a bottle of wine and in exchange they can bring away your clutter. Practically speaking, you could either mark it, put it in boxes, simply say yes or no when asked, or point out each item and ask if anyone wants it. Actually you don’t need the wine part, I just thought it was a clever idea. You could also organize it as a potluck.

In fact, getting really “primitive”—I may be overly generalizing here, but I understand what we think of as primitive people are very happy to give their stuff away (gift economy and all that)—a group could take turns hosting such parties. That way you would always keep your possessions trimmed and you might have an opportunity to acquire some new stuff. Also, it makes eating out a more worthwhile experience.

The only problem I see with this is if your friends are mostly downsizers themselves. I have run into that problem myself often enough: I got about 100 CDs I’m trying to get rid off. Do you want them? No, thanks, I’m trying to downsize. So best if you can invite some hoarders

Originally posted 2010-03-09 13:55:59.

This is a guest post from Zev. Many of you may know him from the forums and some of you may recognize the name from the copyright page in the book. He contacted me out of the blue earlier this year offering to correct the book manuscript for me. Knowing that my English is not perfect, I took him up on the offer and we spent about three or four months passing the manuscript back and forth getting rid of 99.9+% of my errors—I’ve never seen so much red ink on any of my papers. During that period he chose to become financially independent himself. You can see the steps he’s already taken in his journal.

I had the privilege of being one of the first readers of the ERE book, and, having balked at actually pursuing ERE earlier this year after discovering and poring over the blog–”I live in New York City; I don’t want to be an urban hermit; I fail to see the miser’s contribution to society”–the book gave me a broader outlook, ultimately leading me to decide to become financially independent–nothing resembling “retirement” really enters into it–within five years; my ERE/FI date is 7/15/2015, and so far I’m running about a year ahead of schedule.

The primary reason for my decision, to put it in extreme terms, is to resolve the tension in my life between greed and passion.

Like many in the labor market, I have mostly based my decisions about what sort of work to do on what will provide the maximum return on my time. This has led me to be self-employed in the same transcription business for my entire adult life (I’m 32). I’ve become steadily more productive, savvy, and reputable in my business, and my income has risen accordingly. I am one of those “rational economic actors” that economists like to presume in their theorizing; I have “followed the money.” So far as I can see, this puts me right in the middle of the pack of the American workforce, albeit with a lot more control of the fruits of my labor: I sell my labor to the highest bidder, with the usual considerations of legality, ethical standards and safety–if there’s a black market for transcription, I haven’t heard of it.

Also like many people, working full-time has crowded out the activities I feel most passionate about, which, as is typical, are far less remunerative–reading, writing, playing music, making films. For someone with a middle-of-the-road constitution, at best–I sleep nine hours a night–”work-life” balance realistically translates to giving my best hours to my business and doing mostly passive activities and errands during the rest of my waking hours. This pits my social life, passionate interests and day-to-day upkeep (not to speak of downtime) against each other for the scraps of my schedule.

Truth be told, I’ve had a number of false starts in pursuing other careers–music/songwriting in my mid-20s, filmmaking a couple of years ago–and while the poor compensation didn’t scare me off, the opportunity cost of not maximizing my income, and the prospect of not ever having meaningful savings, did. Ironically, I never socked away so much as a dollar until setting my ERE/FI goal a few months ago. This lack of savings also puts me right in the middle of the American heap–”I must be rightfully compensated, so I can spend spend spend, because I deserve it.” This “because” has actually been more mysterious to me than that–”Why? To what end?” do I earn what I earn, do I maximize what I earn? I paid lip service to my neglected passions–”My income allows me to buy the gadgets with which to compose music and make films; my flexible work schedule gives me time to pursue them”–but as Jacob writes in the ERE book, the gadgets largely became tokens of my interests rather than tools to execute on them, and I would haul them from this closet to the next. My free time I have overestimated, both in quantity of hours and quality of focus.

So, while I guard against seeing ERE/FI as a panacea, I do see it as a potentially transformative opportunity to be freed from “maximizing profit” as my raison d’être, as well as a compelling answer to why I currently pursue it. I have the nagging feeling that this pursuit of maximization is more neurotic and deeply, culturally embedded than can be cured by a modest dividend-paying portfolio, but I feel an equal urgency to give myself the gift of the best 40-50 hours each week, freed from all anxiety about making a living INDEFINITELY, and see what creative output comes out of that.

Originally posted 2010-11-12 09:05:45.

When I write posts, I face the same dilemma as a researcher presenting results. If you have hung around the research circuit for a while, you notice that there are different ways of thinking about exactly the same thing. Some focus on the detailed technical aspects of the calculations: “This is described by this ginormous equation”. Others focus on the basic understanding: “Here is a simple toy model, that …”.

In myField, the difference between toy models and the complex computer simulations I run is about 50%. This means that the toy models are pretty good and a useful way to think about the problem. They are also quite useful to mark out unchartered space (damn you, competing researchers!).

The same holds for the model presented yesterday.

Suppose we pick a 10% savings rate. This means for every $10 we make, we save $1 and spend $9. After 9 years we have $9 saved. These $9 can be spent in the 10th year during which nothing is saved . After 10 years, we thus have $0 in savings. This is how the math works.

While it is possible to work on and off, professional careers certainly “discourage” sabbaticals. Therefore we will have to stack them. (Yes, the calculations are approximately linear. What about compound interest? I’ll get to that!).

Thus if we pick the 10% rate, we could work 18 years, saving $18 and then taking 2 years off. Or we could work for 27 years and take 3 years off at the end (after which we need a job “to make ends meet”).

Reinvested compounding returns will change this. If the return rate is high (10%), it will change fundamentally. If the return rate is low, it won’t change very much. I submit that there is a real and present risk that the return rate will be low.

Hopefully I do not need to repeat that it is easy to find 30 year periods in the S&P500, where the return rate has been in the low-middle single digits! Yet, this fact is ignored by practically all personal finance bloggers and book authors who gladly use 10% (historic average) or even 12% (from the 1980-2000 bull run). Ignore it at your peril. Seriously, I’m concerned, but it’s hard to be heard against the chorus of the majority.

So which rate should be used?

Going with the present aggregate P/E of 17, the earning yield is 5.8%. I will ignore taxes, but they would influence the above number to the tune of 0-30%, so 5.8 would turn into 4.1-5.8%.

Historic inflation rates have been 3-4%, but what really matters are future inflation rates (see comments below). Subtracting this from 5.8%, we get 1.8-2.8% or rounding off 2-3%. Using the law of 72, this gives doubling rates of about 25-35 years. Of course this is only the case if all the money was invested in the beginning which is not the case. If it is invested annually, the money won’t double, rather it will end adding somewhere between 0 and 100% to the invested amount. Let’s say 50%. Hence saving $27 over a period of 27 years will turn into $40.5 in inflation adjusted dollars, which will allow about 4.5 years of retirement. (Warning, if anyone complains about accuracy, I will post the annuity equations along with a long and boring explanation on how uncertainties in the input parameters eradicates any kind of technical improvements).

So when compound interest is assumed along with an earnings yield based on current numbers (which may change, but still influence everything invested currently), then saving 10% means that after 27 years of working, your retirement would last not 3, but 4.5 years. Therefore 10% is probably a decent savings rate if you plan to work until you are physically and incapable of working anymore. It is probably too little, if you plan to spend decades playing golf.

Originally posted 2008-09-12 07:57:32.

There is an abundant swath of personal finance tools, 10 step programs, weight loss programs, etc. that are all intended to fix our problems. This country is HUGE on methods but poor on fundamentals.

To beat obesity, you’ve got to consume less and burn more. There is no alternative. And to do that, you’ve got to change the culture.

– Bill Clinton

This is a culture that buys its solutions. In technology we trust! Take a pill. Buy our software package. Follow this easy program. However, the problem is not with the number of solutions that are available for purchase. The problem is that the prevailing attitude that solutions are bought from someone else rather than created by oneself. Therefore to stop being poor people need to give up their consumerism.

The problem is that it is really hard to explain the fundamental problem as it can’t be sold in shrink-wrapped packaging by definition. It seems to require some kind of epiphany just like some people almost need a heart attack to finally take their physical health seriously.

Much thanks to LB for the donation.

Originally posted 2008-03-24 07:37:34.

After going on about the zen and glory of padded envelopes for some time now, I have realized that a refresher on how to retire extremely early (for those who are younger than 35) and how to retire in short order (for everybody who is older) might be in order. After all, this is this blog’s name, so here is a step by step guide on how to retire in 5 years in just 6 incredibly tough quantum leaps (sorry, no babysteps, kids).

1. First build up the required dose of motivation. In my experience, at least 800 milliJacobs(*) are required, but more is always better. The reason for your motivation is not so important. Maybe you are tired of paying for your friendly banker’s kids’ college education. Maybe you think the focus on consumption has gone haywire with the introduction of the electric can opener. Maybe you just want to do things that are more interesting that padding resumes and worm^Hking for the man. These are all good motivations.
2. Get your priorities straight. You are not going to get there through small changes and the eternity of babysteps. Nobody becomes an Olympian by taking the easy path. Early retirement must take precedence over creature comforts and other spurious needs that advertising and marketing tells you to have. No pain, no gain.
3. Stop spending money. Ideally you should spend money on a place to sleep and a place to eat. Early retirement and financial independence is largely incompatible with having a personal game room or taking out a second mortgage to install a bowling alley in the basement. Allow $50 for food a month. If you run out, stop eating (refer to points 1 and 2). It builds character! I’m just joking, but watch what you eat, you can only benefit. You should allow about $5 a month for transportation. This will easily be enough to resole shoes or get new tires for your bicycle. I’m not joking.
4. Achieving financial independence is like taking on a second job. People have been so accustomed to buying products that they can not make anything themselves anymore. Well, it is possible, but it requires some effort. To assist with this effort, throw out your TV. This gives most people an average of 4 hours a day: First to learn how to live without buying everything at Walmart. Second, to apply those skills. Learn how to cook very nice meals for $50/month. You should also get back in shape to actually be able to ride a bicycle without suffering from heart attacks or sweat for that matter. Learn about money and learn to network for things: my ironing board for your bicycle. Learn how to do simple repair jobs, mending socks, fixing a broken radio, toilets that won’t flush. Make that one toilet. After all, how many do you really need?
5. Watch your bank account grow by staggering amounts as you spend less than $500 out of your paycheck a month, mostly on rent, while pocketing the difference.
6. Multiply your monthly expense by 300 and compare it to your bank statement. Once the latter is higher than the former, you are free! Come join us other early retires as we wonder what makes someone want to work for 40 years of their life while only having a pile of stuff to show for it at the end.

(*) Meaning I probably used about 25% more tenacity than was absolutely required.

I would say in summary that for me the path to early retirement was more of a journey to an unknown destination. I did not have a plan of what to do, when I decided to become financially independent. In fact that was not even my original plan (I just wanted to avoid mortgaging myself to a job). Practically everything out there, books, retirement plans, tax laws, is tailored towards having people work and work and work with, as I see it, consumption of stuff being the only justification for their existence. Has anyone else noticed how politicians refer to people as consumers rather than citizens? Wow! I mean, just wow! I guess it’s true that respect has to be earned then.

People’s situation are complex, but one thing, I think, that many people don’t realize is that they have a lot more control over their own life than they think they do. If they knew this would they really choose the option of working from dawn until sunset merely to fill their homes with more and more things?

I wouldn’t and I haven’t. All it took was a decision.

Originally posted 2008-08-14 17:45:14.

The interesting thing about management is how similar it can suck despite situations being completely different. This suggests suggest commonalities between either managers themselves or the way organizations are structured. For instance, if it is simply due to the way organizations are structured, maybe they can be restructured. We can not choose different managers (we got what we got), but it is possible to regulate the incentives in a game theoretic ways to ensure that mangers are not rewarded by interrupting the flow of operations.

In my mind the job of a manager is not to tell the productive people what to do—unless they’re inept. The job of the manager is maintain the environment to ensure the best conditions for productivity. This is similar to how the job of a farmer is not to tell the corn how to grow but to create the best soil conditions for such growth. Some managers seem not to understand this.

Here are some examples …

1) You need to do a simple thing (buy a plane ticket), but the company has decided that an approval form is needed for this. This form must be approved 30 days before buying the ticket and the ticket must be bought 30 days before the travel. You submit the paperwork 90 days before. A few days before the deadline, you haven’t gotten anything back, so you call the approval office to trace it down. It turns out it’s been sitting on Bureaucrat X’s desk for the past two weeks. Also X just went on a 3 week vacation and X is the only person who can approve this particular form.

2) Manager A discovers that it is possible to channel X amount of money to one of his department H, if his organization of departments H, I, and J, which are loosely connected, can be approved as a Type Z organization. There are funds available for Type Z organizations. A thus institutes executive order #652 to have departments I and J pretend to be part of H by having each employee work on some H department projects for a couple of weeks a year.

3) Manager X from Department A has been promoted to Head Honcho of both Departments A and B, which have very different work cultures—something which X hasn’t noticed. While X was in charge of A, X instituted some policies that worked very well for A. A now extends these policies to the Department B.

What are your examples?

Originally posted 2010-11-19 11:09:20.

If you look at some of the largest companies in the US, companies, which used to run railroads, mines, and build cars and big engineering projects, you will now find that the biggest companies are now in the business of selling burgers, spray cheese, cholesterol lowering drugs (makes sense, huh?), premium sports packages, and until recently consumer/mortgage debt.

Excuse me, but WTH happened?

I realize that this must be the world consumers want, or at least the world they have been told that they want. But seriously, if living in a world where you spend 8-10 hours a day trying to distill liquid cheese, flipping burgers, manipulating financial risk factors, creating drug ads, or simply pushing paper and filing reports to maintain this system just to go to the cinema to see some cleaned up remake of an old movie and later spend $50+ to enjoy a good meal is your idea of a good life, you probably got bigger problems, the least of which is a lack of cooking skills.

If you fit this profile, your main problem is that you have not thought about the world itself—thinking was never part of your education. You have simply taken the world for granted and applied yourself to fitting into it. If we use the rat-race analogy, it is like rat who navigates a maze but which does not see that the maze has been intentionally constructed and that the rat is part of an experiment. I am not saying that the world above has been intentionally constructed. I see the “maze” more as the systemic outcome of the effects of many small self-interested decisions.

Several people have asked me how they can make the world a better place. A common strategy works under the assumption that there is indeed “someone/something” in control of “the system” and so they work to target that “something” in a top-down approach: Let us invent a new technology, let us write a new law, let us educate people, let us just sit here and complain about it and write manifests. Did anyone bring the Cheez Whiz?

The biggest challenge in doing this (and why you will most likely fail) is that you are competing on the same terms and being heavily outgunned, you will fail. To change the world, it is a waste of effort to engage the sharks on their turf. Fortunately, most people learn like children, that is, by emulating others. Not by listening, nor by thinking, but by emulating. That is your edge.

Hence, to change the world, simply “be the change”. If you got a good thing going, people will naturally want to emulate you. Your change must be viable (not utopian) and desirable. I think a combination of synergistic frugality and investing in the companies of the “current” economy (regardless of whether it is selling selling burgers, spray cheese, cholesterol lowering drugs,…) to leave the system is viable. With sufficient numbers, a new system will emerge bottom-up.

Originally posted 2009-12-07 12:30:31.

This is a guest post from firefighter, whom you may have seen in the comments. This is the last in the queue that I have lined up (if you have sent me your story and I have not posted it yet, write me a mail to complain). However, a few people said they would write up their story/plan, so more posts should be forthcoming.

My journey to early retirement actually began quite unintentionally in the late 1990’s. I work for a large municipal fire department. My father has always been a financial guru of sorts, so when I came home after my second day of rookie school loaded down with benefit booklets filled with health/dental/disability/life/retirement options to peruse I went in to see my dad for recommendations. After looking at a health insurance book for a minute, he grabbed my 457 (like a 401k) deferred compensation enrollment form, wrote “25%” in the salary deferral line and said, “Fill the rest of this out, turn the form in, and don’t look back.”

The department I work for automatically enrolls employees in a pension plan which takes an additional 7% out of my paycheck for funding (this is separate from SS). Together, these two deferrals took away almost 1/3 of my paycheck without me even seeing it. I was saving 32% of my pay almost unconsciously.

I should say a little bit more about my dad and the eccentricities of my family. I think my father’s three great loves in life are my mother, golf, and the Roth IRA. We have an unusual family tradition of getting together New Year’s Day and writing out checks to make our new tax year Roth IRA contribution. “Too good of a deal not to.” and “This won’t last long…eventually Congress will realize the mistake it made” are frequent rants of the old man. So, not putting aside a few hundred dollars a month for the yearly Roth check really wasn’t an option for me. There’s another 5-10% of my pay out of my hands. 40% of my pay…gone.

Well, until I got married five years ago, I never had a credit card. Debit card, yes, credit card, no. It was a hassle once or twice while trying to establish utility connections (they wanted a credit history), but I worked it out. No credit card necessitated my keeping some cash in a readily accessible account for emergencies. Yes, the old boring emergency fund. So I had 10% of my pay set aside for that. After the cash balance accumulated to a level I felt okay with, I kept the 10%+ going into a savings account at a brokerage firm (with a 3-day delay on transferring money out) and bought some blue chips. This left me with ~50% of my pay being saved with very little willpower or budgeting necessary. All I had to do was look at my checking account balance before I bought anything. There really was no way for me to go into the red.

As Jacob has pointed out in a more extreme way, one neat facet about saving 50%+ of your income is that for every year you work, you have at least one full year of living expenses saved up. This has held up for me. I started working full time at 21. 12 years later, now married, my wife and I have a little more than 12 years living expenses saved up. My wife and I plan to have 20 years living expenses saved up for retirement at age 40 (age 38 for her). Assuming my wife and I will be able to continue to save 50% of our pay for the next 7 or so years, we’ll be ready. Here’s how saving 50%+ has been the past 12 years:

• The first seven years were easy. As a single guy, saving 50%+ did not crimp my lifestyle at all and my paycheck was by no means large. I lived with my parents some of that time and frankly, I’m embarrassed that I didn’t save 75-80% at that time. It would have been easy. Age 20-25ish can be incredibly important for retirement savings. Quite frequently at work, we see young people who, upon getting a nice, “stable” job with the fire department, go out and finance a new car. This purchase is so common, it’s known in the firehouse as “the rookie mistake.” They fail to realize that the 25k they just spent on a new vehicle will likely cost them 100k+ down the road in retirement savings. Well, I didn’t make that rookie mistake, but I certainly could have saved more without sacrificing much.
  
• The next three years were even easier! I got married and it was even easier to save! My wife is reasonably frugally minded like myself. She made a decent salary as an elementary school teacher. We continued to save 50% of my salary, lived on the other half and saved almost 90% of hers. In her job, she was eligible for both a 403b and a 457, so we maxed both out, and really never even saw her paycheck. We got an awesome dog, life was good and saving was easy, until…
  
• The last two years have been a savings challenge with the arrival of our son. My wife decided to stay home to referee between our action-oriented son and the sheep/child herding dog. No more 90% saving there. Good friends, family, and a baby shower took care of most of the “start-up” costs of child rearing, but left us with plenty of additional costs including diapers and doctor’s visits. (As far as health insurance goes, the birth of my son was a double whammy, because we had to make the additional payments for him and my wife, since her coverage through her work ended.) After a little scrambling, we were able to get the savings rate back above 50% with the help of a small promotion at my work and a part time job I got working a couple days a month.
  

So we’re on track and just a teeny bit ahead of schedule. We have saved almost 13 years of living expenses for 3 people (and one dog). Our percentages are different, and so is our timeframe, but just like Jacob we will stick with the high savings plan. Our goal is to have 20 years living expenses saved up by 2016 and retire with enough passive income to generate $3k/mo- 1k/mo for the Mrs., 1k/mo for our son, and 1k/mo for me. Astute readers of Jacob’s may notice that 20 years of living expenses would have to be withdrawn at 5% to generate 1 year of living expenses. Most financial pros recommend a sustainable withdrawal rate of only 4% or less.

Several personal caveats to that, though. Chances are good that either my wife and I will do some type of paying work in retirement to regenerate the additional 1% and put it back in some type of retirement account. This would take about 4 hrs a week at my current part time job to generate this income (Sound familiar, Jacob?). Hey, Roth contributions can only come from earned income, and woe upon the Mrs. and I if we miss one tax year’s contributions even if we’re “retired.” Our son will (hopefully) not require that 1k/mo forever. By planning for him to be an equal share we have built some “fat” into the equation, so when he leaves the nest, we’ll be able to drop the withdrawal rate down to 3.3% or so. We currently live in a very high cost area. If necessary, we could reduce our living expenses by about 20% by moving one hour away after retirement with virtually no change to our standard of living.

So, despite a fairly rough twelve years in the stock market, (our largest retirement account has a 12 year annualized return of only 3.8%) we are indeed on course to retire in 2016 with right around 20 years of work under our belts and 20 years of living expenses saved up. We’re not quite yet at Jacob’s stage, but we’re over halfway there and things look good! Saving works, take heart!

We do have a glitch in the otherwise seemingly perfect matrix in that the Mrs. has a pre-existing health condition which necessitates high cost health insurance, but we also have an ace in the hole with my previously mentioned pension. If readers are interested and Jacob has space available I can write more on the merits of pensions or the perils of group health insurance at a later date. I’m well above the 600 word mark and have probably worn out my welcome as a guest poster.

Thanks for reading.

Originally posted 2009-11-17 16:50:44.

It is basically making it a lot easier. Thanks guys!

This is a response to Frugal Bachelor who noted that pf bloggers have gotten awfully quiet about the market. On the same note, pf bloggers have also gotten awfully quiet about the 100 push up challenge, but I digress (as usual).

For me and other people who do not want to rely on the job market as a source of income, this market crash is not a tragedy. It is an awesome opportunity! I am bullish on extreme early retirement

What we are seeing is the greatest wealth transfer in a generation from those who are selling to those who are buying. Many people make the mistake of completely ignoring what they are buying. Yes, the market has crashed, but I now have many more shares than before (larger fraction of the entire economy) and they are cheaper to buy too. How can this not be a good thing?

I’ll tell you why. Because people have developed some screwed up perceptions about wealth. You see, in this economy wealth has come to be asset based rather than income based. When something is income based, you get a salary, or dividends or interest payments. Someone is actively giving you money. If these money transfers are large, you are rich. When something is asset based, you rely on appreciation of something you own, that is, that someone else will buy what you own for more than what you paid for it. This is essentially nothing but long term trading and it is not a good idea. It is especially heinous in an inflationary Keynesian economy. Here people get used to assets inflating. If they own them (houses), then they are happy (nobody cares about those who do not own houses who are naturally unhappy). If they do not own them (oil), then they are unhappy and talk about taxing windfalls. Asset bubbles are simply an emergent systemic behavior of a Keynesian (government stimulus) based economy.

Assets do not make you rich. Income makes you rich. Assets make you wealthy. However, as many are discovering, paper wealth is not real wealth. What makes the current market great is that there are many more opportunities for buying income generating assets.

For extreme early retirement, I am not going to stake my financial stability on past results, even when they are based on Monte Carlo simulations, rather I am going to arrange for an alternative income stream (stock and bond based) that will generate enough income for me without ever having to sell anything.

This means I do not care so much about my networth as I care about two other factors. Those factors are

1. How much income I’m generating
2. How much I spend

Thanks to the market decline the first one just got easier. Twice as easy with the caveat that some companies might halt their dividend. In terms of how much I spend, I am already doing pretty well.

As far as I am concerned, with an income generating portfolio, the market can stay flat forever, something it has done before for 10-15 years. I do not have a net worth target. I only have income and expense targets and these are a lot less volatile than asset based targets.

Originally posted 2008-11-24 10:55:42.

As I have mentioned before extreme early retirement (<35) does not happen due to a prudent investment plan. It happens either by following an extreme savings plan or by being lucky (rich uncle, lottery, penny stocks, real estate, …). These reason is that the time it takes to reach financial independence, around 5 years, is simply too short for an investment plan to pan out.

Now, once you got “enough” money: $150-250k, if you are frugal, or $1,000,000, if you are not, then question becomes where to put it.

Here are a few things I have considered.

1. Treasuries (or CDs). Invest the whole amount in treasury bonds. This was the way of Joe Dominguez of Your Money or Your Life. However, these days I think one would have to be a pretty big patriot to lend money to the government. While return of principal is guaranteed, it’s not guaranteed that said principal will have any buying power in 30 years. Treasury notes avoids locking in a low rate. On the other hand one becomes subject to the monetary meddling of the Feds. Alternatively, one could buy CDs from a more conservative central bank like the ECB. (everbank.com offers such CDs).
2. A modern approach is just to buy a low cost index fund. According to large numbers of people, such index funds are the source of all things good and splendid. They are simple, easy, effective and they have even been rumored to cure cancer. Indices currently only provide 1-2% in dividends. These dividends could be set to invest automatically. At the same time, one could take automatic monthly withdrawals of 3-4% (Don’t forget to add the fund fee in the percentage). Historical calculations of the viability of this approach can be done using FIRECALC.
3. Those who are reading this probably have the personal drive, talents, and miserly qualities to set up a no-cost option. No more than 20 individual stock positions will be sufficiently diversified to emulate funds with hundreds of stocks in them. Use a broker that offers a few free trades a year and sell some of the winners. And rather than reinvesting dividends take it as an opportunity to sell of a little less. The Dow Jones is price-weighted, so simply buy the 20 most expensive (in price stocks). The S&P is market cap weighted. Here you buy the 20 biggest companies for a very close approximation to the entire index
4. Another strategy is to buy shares in solid dividend payers and then just live off of the dividends. Bear in mind that companies that appear solid now are not necessarily going to be solid forever, nor are they likely to grow much as they retain less earnings to do so (their money is being paid out). Dogs of the DOW is such a strategy. The dogs need not be from the Dow though.
5. A more interesting strategy are high yield income assets such as junk bonds, REITs, buy-write closed end funds, convertibles, etc. These currently yield around 10%. In my opinion they are best acquired as ETFs. They are quite a bit less volatile that a pure equity strategy (betas below 0.5) and the yield is much higher than 4%. However, they may suffer from inflation whence the surplus (the 6% you’re not spending) should be invested back as an inflation hedge. Note the danger if your effective inflation exceeds 6%. On the other hand they provide a strong cash flow without the need to sell anything and incur capital gains. This cash flow could be kept sufficiently low to keep taxes a 0%.
6. A potentially better strategy is to keep the fixed income portion at a level that only supplies cost of living. This means that if cost of living is $6000, then about $60,000 will be in high yield funds and the rest will be invested for growth/gain/inflation protection.

Personally, I’m leaning towards the last strategy. The idea of have a steady flow of cash with some potential for appreciation fits my temperament better than putting it all in the hands of extrapolating traditional market returns. (I’m scared of a Japan-like slump).

Originally posted 2008-05-22 20:11:32.

Predicting the future always provides an excellent opportunity to make a fool out of oneself. One is almost destined to be wrong on some part or the other. If nothing else, the timing might be off, or the details may not be exactly right.

I have noted that whereas pre-1980 predictions mostly envisioned the future as a completely revamped and clean place, post-1980 and onwards envisioned the future as a harsher reality superimposed on the past.

Let’s face it. We’re not just going to tear down the current structures and start afresh. Evolution does not happen by starting from scratch. Rather structures evolve by adding corrections onto existing structures until said structures may not be recognizable from their original purpose(*).

(*) Consider for instance, the plantaris muscle in the leg.

Regardless, some external “boundary conditions” can to some extent be predicted. Cornucopians usually claim that “human ingenuity” is the sole constraint to human progress and that it will (re)move these boundaries, once they are encountered. There is of course a selection bias in that boundaries that were not moved are usually ignored e.g. “nuclear energy that is too cheap to meter” never happened and it is not talked about as a cornucopic failure. We did, however, get internet access that is too cheap to meter, almost.

What follows are the externally imposed boundary conditions. Other people have already discussed and published the arguments for these conditions. Some investigation on the library or the internet should provide plenty of reading so I am not going to discuss or repeat them here.

One thing we will see over the next 20 years is a global decline in oil production. See this post for some first steps to prepare for peak oil. Price volatility (as we have seen over the past several years) is a sign that the supply is maxed out.

Energy and resources (commodities) will be more expensive. Since the infrastructure will not change, this means that as oil, gas and by implications, wood, metals, and food get more expensive people will not move into housing that is less expensive to heat although such houses will increasingly be built. However, these houses do not yet exist and residential real estate takes many decades to turn over (how old is your house?) The cheaper solution is turn down the thermostat, shut off unused rooms, get out the blankets, etc. McMansions might be converted into multiplexes. Garages will be turned into in-law units as social security fails and people are forced to adopt their parents.

Standard of living as measured in consumption (not to be confused with quality of life) will decline or it will require even more work to maintain it.

The car fleet has a 10 year turnover. In ten years, oil may be twice of what it is now. This is hard to predict. Gas currently costs $9/gallon in Europe. They still drive, but a lot of people have no need for a car since the infrastructure was built to accommodate a high gas price environment (following the first and second oil crises in the 1970s, taxes were levied to keep gas prices high). In the US people will likely keep their trucks and SUVs but drive less or try hard to move closer to work. Enterprising soccer moms might start car pooling for the daily commute from suburbia. Alternatively, small businesses might move into suburbia. This will require a change in zoning laws.

Overall people are fat and out of shape and it is getting worse. Diabetes will become a far greater killer. For instance, more Vietnam veterans are currently losing limbs, eyes,… due to diabetes than young soldiers ditto in Iraq. In 20 years, people who did not take their health seriously will be sorry (since medicaid will probably be bust at that point) and there will be a lot of them. There may be a cure. On the other hand, not finding a cure is very lucrative (think insulin). Joint replacements will be popular among the rich who have lived most of their life on a chair. I think the next revolution will be in biotech. Biotech is not resource intensive and it is limited by human ingenuity insofar that species depletion does not remove options before they are take. I am here thinking of the destruction of habitats and species due to continued human expansion. There may be a world wide epidemic, but this is unimportant unless it is at the level of the plague in which case the survivors will experience a boon of growth opportunities.

Human resources will be cheaper. There will be more people. While their bodies can be kept out of the countries physically (and we will see this on an increasing scale as people enacts laws to counter their personal loss of competitiveness) their effect can not be excluded from the market place – I think it is unlikely that we will see a return to mercantilism. What this does to real estate is hard to say. On the one hand, people will earn less. On the other hand, there will be more people competing. Shared living as mentioned above certainly solves part of this problem.

You may wonder how early retirement extreme fits into this and what happens if I turn out to be wrong.

What are your predictions?

Originally posted 2008-03-28 07:11:41.

For some, a challenge, that is, a game is an effective way to step of the effort. It can also serve as a spark for those who are ready to change.

A few Yakezie bloggers (Single Mom, Rich Mom, Barbara Friedberg Personal Finance, Money Funk, and Move to Portugal) recently started a challenge about who can reduce variable costs the most over the next month.

To win, I recommend the crowbar method. It’s very simple as it is essentially a 100% reduction (don’t spend any money) and as such it will win. Of course this will only work because the competition only runs for a month. For longer challenges, you’d need something like the 21 day makeover.

I never really thought deeply about tricks to reduce discretionary expenses. What used to work for me, though, was

• Walk everywhere. One is less likely to go out to buy something discretionary if it has to be paid for with physical activity.
• Only carry $20 in cash. No plastic. This means not only does one have to walk to shop, one also has to walk to the bank. And one can not spend more than $20. (Without another trip to the bank of course.)

Fun ways to add to the competition is to allow the proceeds of selling stuff to add back on the expenses. Much of my discretionary spending is driven by selling old stuff. This keeps the total amount of stuff I have at an appropriate level and that makes the choice of homes much more flexible than if I had a lot of unused stuff around. It also provides a natural brake on spending. It is easy to just pull out a credit card. Too easy; so there is no challenge. If, on the other hand, the acquisition of new stuff or even the purchase of an experience (for shame ) depends on “making a sale”, it becomes much more satisfying.

Originally posted 2010-06-10 10:12:32.

I do not have any children, so this discussion will be largely academic. However, if I had children, I believe that instilling the proper financial values so that children know what to expect from money is much more valuable than a 529 plan or any kind of donation, gift, or allowance. My parents saved about $16000 for me to spend on my education. However, through their actions they also taught me how not to spend money that I had not earned and that I had to save if I wanted something. Thus I did not spend that money on my education figuring that I should not use it because I had not earned it. After some prodding on their part I did use about $1000 on some furniture, but that’s it. I did not touch the rest until I had learned enough about investments to grow it better than the savings account it was sitting in.

In retrospect, I would gladly have exchanged that sum of money with the “idea” of saving money, investing it, and letting it work for me. I wish they had taught me that.

So here it the one savings/investment rule, I would teach to my hypothetical children.

• Always save and invest 50% of your income.

If this idea is implanted early on, the person will hopefully always adjust his or her lifestyle so that the cost of living does not exceed 50%

Assume a modest allowance of no more than $10 before year 12 and investing half of that at 8%, the 12 year old would have a net worth of $2,000. This is approximately what the median net worth of a 30 year old is. Now add in some baby sitting, garden work, etc. topping out at $100 per week at age 18 at which point the kid would have a net worth of $15,000. Add three years of college with a weekend job and our graduate has a net worth of $30,000. I highly recommend against student debt other than using student debt in an arbitrage scheme. Taking on student debt to increase the standard-of-living is just plain crazy. Now assume annual raises and a starting salary of $36,000 that ends at $52,000 at age 30. At this point, our kid has a net worth of more than $300,000 and a capital income that is almost half the wage income. Staying at $52,000 for another 10 years and the 40 year old is a millionaire with an annual capital income for $80,000. This is what I would teach, not by telling, but by leading. It is what I do myself except that my rate is higher than 50% because I was a late starter.

Originally posted 2008-01-08 07:25:19.

For someone who is not working a 9–5 job, time takes a very different meaning than for someone who is still on the clock. Moving from one frame of mind to another can be very challenging indeed.

Since the mechanical clock was invented and work was scheduled—about 300 years ago—we have gotten so used to dividing time into equal segments that this has become almost invisible.

I was reminded of this yesterday when we were discussing the weather forecast. We consider forecasting important first and foremost in terms of the timing. What will the weather be like on Thursday? We consider this vastly more important than the fact that “soon it will rain” or “temperatures will hit 100F.” Now, it so happens that (as far as I know) timing a dynamic system like the weather is much harder than getting the ranges right. If we weren’t so focused on looking at the clock, we would find the weather forecast more useful. To wit, from a retired or time-independent point of view, all I need to know is whether I should get my ice-skates out or whether it’s time to bring out the sunscreen. If it rains today, I’ll simply go tomorrow instead; no particular need to plan a given day.

A similar perspective on time is found in the world of investing. It is often said that market timing is impossible. This may or may not be true. From my perspective, it doesn’t matter. I simply need to find a business which is stable and pays a dividend or a business that is undervalued. Who is to say when the market realizes this? It may take a day or it may take a year. All I know is the range—the “climate” so to speak; I don’t care about “the weather.”

Another way of thinking about this is that certain things operate in “compressed time.” This is the case for the stock market, where we have long periods of “no activity” which is interrupted by bursts of “much activity”. The long periods of no activity can be considered compressed as the long interval contains as much information as a short burst of frantic activity.

The same holds for creativity. If work is not routine, it is likely characterized by short periods of frantic activity (like writing this blog post) and long periods of inactivity.

This, however, only appears to be the case for someone who plots activity as a function of linear time. If it is plotted as a function of neural activity, the processing is more likely to be constant. The apparent inactivity of the creative person is merely due to not observing the (re)building phase of new ideas. The inactivity of the stock market is due to ineffective or discontinuous information distribution.

Time-perception is a curious little meme. It can be fairly developed—some people will be able to tell you, fairly accurately, what time it is without looking at the clock. I think that the elimination of time[-perception] ranks as high as the elimination of the ego in terms of personal development. It will eliminate “waiting”, where “waiting” is just mapping activity to time an being annoyed by the apparent lack of activity.

Waiting is simply due to plotting the wrong variable. A variable that has been trained into most people all their lives.

Originally posted 2010-09-06 15:37:27.

Long ago I used to believe in eternal human progress. I believed in the singularity. I believed that the future would eventually look something like Startrek. When I was 24 that got turned upside down. I’m not going to repeat all the arguments for the triad of overpopulation, climate change, and resource depletion here. Others have done a better job at that than I can. Suffice to say, having your world view turned over in a “doomfull” way is stressful. Furthermore, it is typically something you have to carry alone. Most people would rather stay in denial, put their fingers in their ears and go “lalalala”.

However, eventually this feeling of hopelessness always seems to be replaced with another form of hope. It’s really just a transition from A to B.

Imagine that you grew up believing you were going to live forever. Now at some point you find out that some day, you are going to die. If you read this you are probably aware of your own mortality, yes? Do you remember when you became aware of it—I mean really aware of it as something that was definitely going to happen to you at some point and not just some abstract concept that happens to others. I don’t really remember it. I think it happened around when I was 19, but it wasn’t a singular outstanding event.

Many people take comfort in that their offspring will carry on their legacy. Truth to be told, your DNA may live on, but your DNA isn’t really you. If you’ve done really well talking to your grand children, your legacy may last 3-4 generations. Beyond that you’re gone. I never got a chance to talk to my great grand parents—consequently, I don’t carry their legacy.

Now imagine that the entire civilization may die in the same sense. How does that make you feel? Some don’t care about that nearly as much as who’s going to win the World Series [in baseball]. I cared a lot. I believed in eternal progress [despite the fact that our civilization has only really believed in that for a couple of hundred years... as mentioned above, how quickly we forget]. Now, I believe in a more cyclical nature of civilization. It is sobering to realize that the Roman Imperial standard of civilization (as measured by city size and running water) was lost and not regained until well into the 19th century. Many believe that our civilization is somehow unique and immune to its eventually fall and decline unlike ALL the civilizations that went before it. I don’t. Some day our cultural icons are going to be gone from human memory. Moon launches may become legend—we don’t carry records written in stone but rather in a very perishable form.

It is important to realize that civilization is a fairly abstract concept. Civilization is an emergent behavior of our combined actions. Like human tissue civilization gets continuously destroyed and rebuilt. As far as I remember, the turnover of all the atoms in a human is on the order of 15 years. All the molecules, which make you you, were somewhere else 15 years ago. This also means that nothing is going to happen to our civilization tomorrow. Change is rather slow. Impacts on individual humans may not be.

It is perfectly possible to live your life while being perfectly oblivious to any kind of collapse. Some of it is too slow for most people to notice. You don’t notice the increased population density (there are now 50% more people than when I was born … when I visited the place I grew up last year much of the nearby farm land had been paved over with subdivisions). You don’t notice that the air gets less clean decade by decade. Some of it is due to the wrong focus. Many think that the political battle is between left vs right when it’s really between consumers and investors.

You can remain oblivious. You can declare that you don’t really care. You can fight for it. Or you can stand aside. Those are your four choices.

Fighting is good, but to remain happy it is best to realize that there’s little a single individual can do and set your expectations accordingly. Work from a baseline of zero: That you can’t do anything about the big problems. Then appreciate anything you get beyond that. Conversely, don’t fall into the trap that there’s nothing you can do personally about your situation. Concern yourself with things you can control. Learn to live with what you can’t.

Incidentally, that’s a pretty useful life philosophy overall. Much unhappiness derive from unmet expectations.

From an individual perspective, everything you do should start with yourself. Work on local change. All superstructures are based on several people thinking along the same lines. All responsibility is ultimately personal; that’s what makes you an adult…if you seek to blame others, you’re just a child—it’s too bad that our culture has devolved into having a substantial fraction of immature and childish people. Consequently, it is useless to rebuild the superstructure without establishing the foundation first. This is why I’m no longer active in the peak oil community—it lacks a foundation. You can’t build a sustainable world as long as people believe in easy technological fixes to their problems.

At least that’s how I see things. You can’t save others before you can save yourself. You shouldn’t blame others until you are free of blame yourself. Philosophy is not something you talk about, it’s what you do.

That’s a lot of moralizing, but it is in my opinion a good way to life. In particular, it is quite possible to live a full life even if civilization was to reach a tipping point and turn over in your lifetime—they tend to decline fully within a span of about a century and it seems to be a bumpy ride down. And if no such tipping is forthcoming or it’s postponed beyond your “expiration date”, I think it is still a good way to live.

Hopefully, I’ll be able to say something a little wiser 50 years from now, but for now, this will have to do.

PS: I don’t really love the end of the world. I just couldn’t resist the title which is of course paraphrased from Dr. Strangelove. I imagine that those who lived through the cold war had a similar attitude towards thermonuclear holocaust as I do towards ecological overshoot.

Originally posted 2010-10-28 23:19:43.

One of the cornerstones of consumerism is the development of desires. Insofar that marketing and product developers can not think of novel products a good strategy to keep consumers buying is to engage them in a cycle of upgrading.

Upgrading can be a competition both with others but I think it works more effectively when compared to oneself.

Ideally one would choose to buy a product that is accurately and deliberate chosen to just satisfy one’s needs (see graph), no more, no less.

However, it can be hard to ignore one’s wants, especially given the brochures and advertising about all the shiny new features of the next model.

The best way to step out of this cycle is to avoid taking turns incrementally buying the next level up for all one’s consumer categories.

Instead consider piling all that money into the one superior product.

In other words, buy the best of the best.

This has two effects

• It allows one to funnel one’s consumerism into product research. Consumer research is ceteris paribus a better way of dealing with consumerism than spontaneous consumption.
  
• Once one owns the best product, it makes very little sense to buy someone worse.
  

Now buying the best of the best is an expensive proposition when it comes to large scale items. Start with small items.

In particular, start with items which are in semi constant use: small consumer durables, like kitchen utensils and appliances, sun glasses, tools, …

Note that this is not the hard core cold turkey way of getting out of consumerism but it will work quite well as a soft way, particularly because it steers consumerism in a slightly different direction, namely durable luxury goods, which eventually makes the disposable consumption lifestyle obsolete.

Personally I am reaching a state where I got several items in constant use which are between 10 and 15 years old. I expect this is strictly a function of when I acquired them and I see no reason why I wouldn’t be using them when they are 25 years old a decade from now.

Don’t forget to combine this second step with the first step out of consumerism. You can read the story of how I got out of consumerism and how it is possible to spend very little and be happy.

Originally posted 2010-05-12 00:07:12.

The following is a list of the things I’ve learned during my first 30 years about how to live a good life.

Take it for what it’s worth.

1) Decide what your priorities are

Your main priorities are your health, food, shelter, and who/if you marry in that order.

Your other priorities are your children, your friends and your network, your career, and your financial situation.

Selecting the right flat screen TV, keeping up with current fashion, or getting season football tickets is not important.

I think if you follow these priorities, you’ll do well.

2) Your health

“Take good care of your body, because where else are you going to live?”

It’s hard to feel the difference between a healthy body and an unhealthy body when you’re 25. It’s very easy to feel the difference when you’re 55, because you’ll look like you’re 40 and feel like you’re 25.

Being healthy will make you feel good. Feeling good will make you look good and looking good will make you feel sexy.

Exercise daily. A little is better than nothing but do not settle for mediocrity for your top priority.

I believe the best forms of exercise are: crossfit, kettlebells and clubbells in that order. They’re each so good that you can stick with just one.

Make exercise part of your lifestyle!

The discipline required for this will first transform your body and then your mind.

Also don’t forget to floss daily

3) Food

Eat good food.

Five servings of fruits and vegetables is not just recommended. It’s vital.

Good food does not mean a hearty steak with sauce and potatoes. It means a well-balanced meal with the right amount of calories and the right composition.

Pick either the Zone diet if you’re into bean counting, the Warrior diet, if you’re an austere Spartan or the South Beach diet, if you think you’re a movie star. These are lifetime diets and not quick short term fixes.

Do not eat “many small meals” as this will never give your digestive system any rest. That approach is only recommended if you for one reason or another needs to eat massive amounts of food.

Never get on a short term diet – they set your hormonal system up for all kinds of trouble! If it took you five years to get fat, it will take you about five years to get lean again.

4) Simplify your living quarters

Avoid stuff and clutter. Make your possessions low-maintenance and low-volume.

You are not what you own despite what the commercials try to tell you.

On the same note, sitcoms are basically designed to portray what the perfect consumer-life.

Resist the brainwash. Eventually 0% APR offers will seem like a joke to you.

Most people buy houses which are way bigger than they need them to be. The reason is mainly to have a place to keep all the unused or rarely used stuff they accumulate. Resist the temptation.

If you already have a lot of stuff, do the following. Divide your stuff into three equally large piles: essentials, probables and unneeded. Take your unneeded pile and give it away to charity or your friends and make them happy. Take your “probable” pile and do a yard-sale. Now you have your remaining pile of “essentials”. Repeat the exercise again with your “essentials”. Your remaining essentials should be able to fit into a couple of suitcases. You’re done.

Do not buy a replacement until you have gotten rid of the previous item.

Now, for every item you buy, buy it as if you’re not going to replace it again for another 10-20 years. Do not buy into fads. A high quality jacket can last you 20-40 years. Major appliances 10-15 years. Utensils a life time.

Notice that businesses do not purchase crappy tools. They buy the best they can afford. Do the same.

When deciding where to live, try to live close to where you work, so you can walk or bike to work. If you must have a car, buy a new Toyota Corrolla or a new Honda Civic. Keep it for ten years. Then buy a similar vehicle. If you must have a bigger car, get the Camry or the Accord. You do not need an SUV or a van unless you’re a family of seven. Four people really do fit into a compact. You are not what you drive.

5) Who to marry

If you are going to marry choosing the right partner is very important. You want to get it right the first time! Be engaged for more than a year before you marry. Get a pre-nup. Try to estimate how your partner is going to turn out in the long run.

Note that people have different personalities depending on whether they’re in love or not. Most couples are only in love for six months – it’s a hormonal thing. Many couples run into a make or break crisis after two years.

One of the best ways to get under the skin of another person is to see how well they do during a crisis (The boat is sinking!). Do they freak out and start praying? Do they overreact? Do they think “everything is going to be alright and someone will rescue them”? These are the people you do not want to marry. You want to marry a survivor.

6) Education

There is a big difference between getting an education and being educated.

Learn to think and learn on your own. This is a highly valuable skill which is not taught in college. Rather what is taught is what information to repeat and how to repeat it. That is a big difference.

Do not drop out of high-school!

Do not delay finishing your education, because you don’t feel like it. You’re losing valuable time.

Learn a useful skill. Universities frequently suggest that you should study what you like. The reason for this is that if you study what you like, then you’re most likely to stay in the educational system for a longer time and thus be a good “customer” of the university system. If you go to grad school you’ll even serve as a very cheap source of highly skilled labour. The university does not care what happens to you after that. You may have a Ph.D. in ancient Egyptian algebra, but what is it good for?

Sometimes a degree in needed as a stamp of approval to get your foot in the door. Get the lowest degree needed for the doors you plan to enter.

Highly recommended fields of study are: Engineering, accounting, medicine, copy writing, and other applicable “rocket science” skills in high demand.

Not recommended are useless skills such as archeology, ancient history, and strange languages or any kind of skills that can easily be outsourced.

7) Career

You are not your career. Do not put all your self-worth into one basket, because if your career is temporarily failing, you’ll feel like a failure.

Try always to exceed your job description. Put in extra effort.

Work towards getting recognized in other areas/sectors of your company or other companies. That way you’ll always have a job offer waiting for you.

A good network is just as important as good skills.

It’s better to be employed at a lower wage than unemployed on a higher dole. Aside from money, employment also earns you experience and it builds your network.

If you’re stagnating in your current job, seek another.

Learn about management even if you’re not a manager. Even if you not managing other people, you’re still managing yourself. It will also allow you to spot bad management decisions of your manager – try to stay clear of those.

You do not have a right to work and you do not have a right to a minimum wage. Your working is a transaction you make with your employer and you are both free to end the transaction if the terms does not satisfy either of you.

Children

You must consciously decide why you want to have children and if they are worth the 18 year commitment.

Your job as a parent is not to provide fun activities and special programs for your children in the hope that they may grow up to be successful high-income earners like yourself.

Your job as a parent is not to give your children gifts and money so that they will be happy and love you.

Your job is to provide a good role model whom your children will try to imitate. They will do this because they are children and you are their parent.

They will try very hard to live up to your standards, if and only if you set equally high standards for yourself.

You can not change your kid’s IQ or personality. However, you can change how they behave and what they learn.

Remember, children are gullible and they will believe anything you tell them. The best thing you can do for them is to teach them to think for themselves and be skeptical.

If your kid’s turn out to be well-adjusted adults who can take care of themselves and stay out of trouble, you have done well indeed!

9) Financial independence

Start saving and start saving hard! Put $1500-$2000 into savings every month and increase that amount by the inflation rate (about 3-4%) every year. If you can’t do that you must either adjust your consumption downwards, get a better paying job or a second job.

$1500-$2000 each month is the key here!

For most people it is usually more effective to cut consumption rather than increase the income. Cutting consumption means cutting your liabilities. Move into a smaller house/apartment – maybe in another part of the country even, get a smaller car, cancel the gym-membership and train at home, cancel the cable, get rid of the cellphone, do your own nails/hair, stop going out, stop renting movies, stop buying the newest computer games or DVDs, agree on more modest xmas presents, get a hobby which doesn’t cost much money (computer programming, reading, or singing) or even better, get a hobby which earns you money (like crafts, fixing cars, gardening, blogging, or investing).

Work on delaying your gratification. Don’t let your immediate desires determine your consumer habits. If you think you must own something, write it down on a list. At the end of the month, check your list, most likely you will have forgotten why you wanted some of these items in the first place. Keep making a list every month. If an item shows up on a list five months in a row, then get it, but only if you think that it’s really worth it.

Do not envy your neighbor’s possessions. Remember that most people are all “Big hats, no cattle”.

If you have credit card debt, cut the cards up and pay them off. Do not get a home-equity loan. Do not get a car loan. If you have any of those pay them off as fast as possible. These are deadly to your financial independence.

Student loans are more benign. If you can lock in a low rate, pay them off slowly while increasing your savings.

Start a cash position with your savings. ING Direct, Everbank, and First Immigrant are good. When you have more than a few months worth of pay in that account buy a low-cost low-risk mutual fund and stick to it!

Do NOT buy an index fund. Now is not the time. Find a fund manager who can think on his own and invests in value stocks. If his cash position is currently large and he has a low turn-over, he is likely to know his stuff.

If you want to invest on your own, realize that you’re initially like a person who wants to treat his own appendicitis using kitchen utensils only.

If you learned everything you know about investing from a TV infomercial, you should probably stay away. Whenever you see currently lots of brokerage ads on TV, the general market is very likely peaking, whence these guys need to dump their high-priced stocks on chumps like you. Spend several years educating yourself! Start slowly.

Do not buy Google unless you know something about marketing and advertising that the rest of the world does not!

After about 15 years of high savings, you should be able to retire and keep living a low-consumption life-style. At this point you will be a millionaire, driving a Honda Civic, and your meaning of existence will go way beyond shopping.

10) Buying a house

A house is a consumer object. It’s used/consumed, wears down and has to be replaced. People only get rich buying and selling houses during good times and they go bankrupt just as often when good times turn bad. Generally nobody can predetermine when good times become bad an vice versa.

A house is an expensive proposition, so do NOT speculate/gamble on the direction of the house price. In other words, do not take out a loan, hoping that house prices will go up. Historically, house prices rise with inflation (at 3-4% a year) and not the 15-20% we have seen during the past few years. In addition, historically what goes up must come down. Things revert to their normal. Otherwise there would be no normal.

Approach house buying as if you were investing for the long term. The NAV formula can be used. With the current numbers, if the house price is lower than 110 times the monthly rent for a similar house (look around), you should be buying the house. If the house price is higher than 110 monthly rents, you should be renting. Currently, the most financially sound strategy in the US is generally to rent.

Originally posted 2008-01-30 07:20:50.