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Newbie Lessons - All your questions answered

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Hi All,

I mentioned that I was thinking of doing this in a blog to help out all the newbies who seem to have lots of questions that are constantly repeated. I'll slowly work on this when I have time - At the moment I think I have about ten chapters planned - but I'd appreciate anyone else's input, comments, pedantic spelling corrections, flames - whatever - feel free to contribute, and for the newbies - if something isn't clear PLEASE ask - because I want to make this as newbie friendly as possible.


Budgeting - the foundation of financial independence.


It's generally been my experience that there seems to be a lot of people who hit their thirties and then start to wonder about this creature called "financial security". They start to wonder about things like Mortgage and kids and unexpected financial events in their life and really start to think about how do I get financially comfortable when these events happen? A great many people live hand to mouth and live for the moment, rather than planning ahead and end up realizing when it is almost too late that they haven't planned for their future.

Let me make this point clear. ANYONE can retire very comfortable. It doesn't matter what your income level is, your level of education, whether you went to a private school or any other factors - all it takes to become financially independent is 1) Self Discipline and 2) A small amount of Knowledge.

The average Australian will earn approximately 1.8 million dollars during an average working life. For every Australian working today 8% will become "Financially Independent" when they retire. (we'll talk about this definition in a second). Out of 100 people aged 15 today, by the age of 65

38 will be deceased
38 will be living in poverty
16 will still be working
7 will be retired on a livable income
and 1 will be wealthy.

The way that the ABS (Australian Bureau of Statistics) defines "Livable income"? - In retirement your income is 60% or greater of your last year's pay. "Wealthy" is defined as your retirement income is greater than 80% of your last years pay. Yet with just a small amount of information and self discipline - those numbers could be MUCH better.

So with those scary numbers in front of you lets talk about budgeting, because budgeting really is the foundation upon which you will build your financial security in the future.

Most people think that they know how to budget. My income is x my expenses are y, if I take y from x and end up with a positive number - I'm good. Unfortunately proper budgeting has a bit more to it than that. You should sit down with a full years worth of expenses in front of you and then classify these expenses as Vital, Necessary or Lifestyle expenses. You then take these expenses and work out how much that means from your periodic wage (Eg monthly, fortnightly, weekly).

Of course your expenses are not nice and neat and broken down into discrete periods that match your pay packet. You'll tend to get periods that are expenses heavy when your car rego, rates notice, insurance bill etc etc all happen at once. These events need to be planned for by allocating funds towards them out of your periodic pay packet.

It's as simple as creating a control account (which is what you ACTUALLY have as disposable income after you've paid ALL your expenses rather than what your current bank balance happens to be. If there are expenses that you can plan for, (EG you want to spend $500 on Christmas presents for the kids this year) - you allocate this an an expense in your control account, and work towards it slowly over time.

You'll soon find that when you are aware of all your expenses, your ability to save money will be greatly enhanced. But here is where the self discipline I mentioned previously (and the little bit of knowledge) come in.

Self discipline - There's money in the bank - damn that 52 inch plasma TV looks good doesn't it? Or how about that day spa package in the Hinterlands eh? Oo can I pimp the car out with a tight car stereo system?

Knowledge - So we need to apply some self discipline and some rules to our disposable income. Ready? here we go...

Budgeting Golden Rule number 1
Pay yourself FIRST - For every dollar that you receive - you should put 10% aside for future investment. This should be classed as a VITAL expense in your budget.

Why? Because of the benefits of compounding and the advantages of leverage. If you know exactly what your expenses are and what your disposable income is (after rule 1), you can (subject to adequate security), through the advantages of leverage support a proportionally higher share portfolio. Every $1 dollar saved can be worth if properly and safely structured $4 each year and every year, year after year after year.

I'm not going to add the famous example of which you would rather receive. A million dollars today, or $1 doubled every day for a month. For those of you interested you can look it up, it basically shows you the power of leveraging and brings you to the important realization that compounding effects are greater over longer time frames.


Budgeting Golden Rule 2)

If you want it - plan for it - Don't impulse buy and don't go into debt for something that depreciates in value.

Pretty simple rule - amazing how often people don't follow it. Keep rule 1 firmly in your head at all times and realize that every dollar saved is worth far more in the future.



I'm going to stop here and see what comments and questions arise and finish with the following...

A Budget is not and end in itself, rather it is a means to an end and its' purpose is to

A) allow a prudent access to a small amount of cash flow, and
B) to provide a leveraged exposure to income producing appreciating assets

Realize that through compounding that the increasing cashflow from the assets will eliminate the need for budget surpluses over time and ADD to your disposable income.

Sir O


EDIT -
Dear Newbies,

If you have a question in relation to this thread - please ask me in the thread rather than PM'ing me. I have limited amounts of time each day and if one of you ask's a question, there will undoubtedly be others with the same question.

I don't want you pished at me by copying your private message to me into the thread, so ask me here please.

Sir O
 
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Re: Newbie Lessons - Chapter one: Budgeting

Thanks for the info Sir O.

I am looking forward to the next one.


Hi All,
I'm not going to add the famous example of which you would rather receive. A million dollars today, or $1 doubled every day for a month.

For those that are interested in the figures:

1: 2
2: 4
3: 8
4: 16
5: 32
6: 64
7: 128
8: 256
9: 512
10: 1024
11: 2048
12: 4096
13: 8192
14: 16384
15: 32768
16: 65536
17: 131072
18: 262144
19: 524288
20: 1048576
21: 2097152
22: 4194304
23: 8388608
24: 16777216
25: 33554432
26: 67108864
27: 134217728
28: 268435456
29: 536870912
30: 1073741824

$1,073,741,824

*Disapears into dreamland for a bit :)*
 

nomore4s

Commonsense isn't that common
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Re: Newbie Lessons - Chapter one: Budgeting

Can I pick a month with 31 days in it?:p:
 
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Re: Newbie Lessons - Chapter one: Budgeting

Thanks for the info Sir O.

I am looking forward to the next one.




For those that are interested in the figures:

1: 2
2: 4
3: 8
4: 16
5: 32
6: 64
7: 128
8: 256
9: 512
10: 1024
11: 2048
12: 4096
13: 8192
14: 16384
15: 32768
16: 65536
17: 131072
18: 262144
19: 524288
20: 1048576
21: 2097152
22: 4194304
23: 8388608
24: 16777216
25: 33554432
26: 67108864
27: 134217728
28: 268435456
29: 536870912
30: 1073741824

$1,073,741,824

*Disapears into dreamland for a bit :)*

hmm...interesting. Oh and hey we have the same user name :eek: lol
 

Trembling Hand

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Re: Newbie Lessons - Chapter one: Budgeting

Looks like a good thread. Hopefully will not get hijacked by fools :(
 
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Re: Newbie Lessons - Chapter one: Budgeting

Every $1 dollar saved can be worth if properly and safely structured $4 each year and every year, year after year after year.

And how do we go about achieving this incredible 300%PA return on investment?

realize that every dollar saved is worth far more in the future.

Well that depends on whether the return you are earning on it is significantly higher than the rate of inflation. eg. if the money is in a bank earning 4% when inflation is 5% then it's actually worth LESS in the future.

And don't forget the impact of TAX. The examples of the power of compounding interest that are often repeated everywhere never take tax into consideration. Re-run the calculations with tax and inflation included and you'll soon see how rediculous some of these common compounding interest myths really are.
 
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Re: Newbie Lessons - Chapter one: Budgeting

Well that depends on whether the return you are earning on it is significantly higher than the rate of inflation. eg. if the money is in a bank earning 4% when inflation is 5% then it's actually worth LESS in the future.

And don't forget the impact of TAX. The examples of the power of compounding interest that are often repeated everywhere never take tax into consideration. Re-run the calculations with tax and inflation included and you'll soon see how rediculous some of these common compounding interest myths really are.

Forget the calcs - it's conceptual!! Like sharetrading, it's a mental thing. Remember, it's not necessarily what you earn, it's what you don't spend. Forget extremes like earning 500K vs 50K per year.

I feel this topic is the start of money management. If you can't manage your day to day finances it'll make it harder to manage share finanaces.

Good points on budgeting.
 
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Re: Newbie Lessons - Chapter one: Budgeting

And how do we go about achieving this incredible 300%PA return on investment?
This is budgeting - and baby steps at that. I can't vomit up 20 years of experience and fit it onto a single page and have it make sense. Structure, Investment classes, leverage, provisional cash forecasting, Timing etc etc etc etc etc - will be coming in the future. Is there anything about BUDGETING that is not clear?

Well that depends on whether the return you are earning on it is significantly higher than the rate of inflation. eg. if the money is in a bank earning 4% when inflation is 5% then it's actually worth LESS in the future.

And don't forget the impact of TAX. The examples of the power of compounding interest that are often repeated everywhere never take tax into consideration. Re-run the calculations with tax and inflation included and you'll soon see how rediculous some of these common compounding interest myths really are.


I don't disagree with you at all in what you have said. I was trying to get across the concept of compounding and the use of time in a fairly simplistic manner. This IS for newbies after all, I didn't want to complicate things to early. I do take into consideration tax implications in my models - but they are proprietary and I'm not just going to upload a master model which took several years to finetune.

Do you want more commentary on this issue?

Sir O
 

prawn_86

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Re: Newbie Lessons - Chapter one: Budgeting

Great idea Sir O. I have made this thread a sticky one, and have a couple ideas for it, which i will discuss with the other mods and admin, the main being removing posts that are off topic, so we can keep a thread as a "one stop shop" for new investors.

Will report back soon :)
 
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Re: Newbie Lessons - Chapter one: Budgeting

Thanks for making this sticky Prawn.

I haven't yet seen anyone say.

"You've forgotten the importance of........"

or

"Should you give more detail on......."

and this is the sort of feedback I'm looking for... Anyone got anything or should I keep trucking along? (Not today - other lessons to come later)

Sir O
 
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Re: Newbie Lessons - Chapter one: Budgeting

You forgot to mention to be easy on your transgressions.

Budgeting is hard. It usually means going without, when others aren't.

Your budget will fail when (not if) you can't resist the temptation to go past your rules.
If (not when) you can forgive your mistake and continue with the plan after such a mistake rather than letting it all fall apart, you will have succeeded.

Obviously this doesn't mean you can break the budget every time an opportunity to do so comes along, but rather recognise that sometimes such things will occur and important to continue with the plan rather than letting it drop.
 

Julia

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Re: Newbie Lessons - Chapter one: Budgeting

Excellent and much needed idea, Sir O. Goodonya. Couldn't agree more about the necessity for basic budgeting. It forms the foundation for everything else.
 

ice

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Re: Newbie Lessons - Chapter one: Budgeting

Damn, looks like it has to be me, since no-one else wants to mention it.

Independance is spelled independence.

Sorry for the pedantry but I devalue anything with spelling errors and your blog doesn't deserve that.

ice
 
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Re: Newbie Lessons - Chapter one: Budgeting

Hi Sir O

can u provide a link to the ABS data, worrying figures,
looking forward to chapter 2! :)
 

skc

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Re: Newbie Lessons - Chapter one: Budgeting

You forgot to mention to be easy on your transgressions.

Budgeting is hard. It usually means going without, when others aren't.

Your budget will fail when (not if) you can't resist the temptation to go past your rules.
If (not when) you can forgive your mistake and continue with the plan after such a mistake rather than letting it all fall apart, you will have succeeded.

Obviously this doesn't mean you can break the budget every time an opportunity to do so comes along, but rather recognise that sometimes such things will occur and important to continue with the plan rather than letting it drop.

Thats a pretty good thing to say Sinner. I like it. What I've also found is that when dealing with couples its generally the less um focussed partner who decides they can't do without whatever piece of stuff it is they want. Not to sound like a control freak but it's important if you are in a couple to get consensus you can both live with (especially important for the lifestyle expenses).
Sir O
 
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Re: Newbie Lessons - Chapter one: Budgeting

Damn, looks like it has to be me, since no-one else wants to mention it.

Independance is spelled independence.

Sorry for the pedantry but I devalue anything with spelling errors and your blog doesn't deserve that.

ice

Damn it!!

Fixing it now.. Sonova - won't let me edit it now :(

All right just call me..

Sir Can't-type-for-schitt from now on and apologies for not picking that up
 
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Re: Newbie Lessons - Chapter one: Budgeting

Hi Sir O

can u provide a link to the ABS data, worrying figures,
looking forward to chapter 2! :)

Sure - It'll take you a while to find it, but it's buried in amongst the following...

http://www.abs.gov.au/AUSSTATS/abs@.nsf/mf/4102.0?opendocument?utm_id=LN


1 Australian Bureau of Statistics 1997, Australian Demographic Trends, cat. no. 3102.0, ABS, Canberra.

2 Clare, R. and Tulpule, A. 1994, Australia's Ageing Society, Background Paper No. 37, Office of Economic Planning Advisory Council, Canberra

3 Rosenman, L. and Warburton J. 1997, ‘Retirement Policy, Retirement Incomes and Women’ in Ageing and Social Policy in Australia, Cambridge University Press, Melbourne.
 
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Re: Newbie Lessons - Chapter one: Budgeting

Not wishing to labour a point (I know I have mentioned this in other posts), but for me personally, I found Ashley Ormond's book "$1 million for life" a really approachable and effective way to budgeting and investing overall for a fairly novice investor who just wants a more passive approach. David Bach's books were pretty good too for budgeting, but more USA-focused when they talked about superannuation (401k's, ROTHs etc).

Ashley has a website www.investing101.com.au/club.htm where he puts some good articles up, and they're all free. He's also got a list of books there, some of which I hadn't personally heard of before (e.g. The Madness of Crowds), and I consider myself pretty well read.

He doesn't try and spruik anything nor talk 'get rich quick'. He approaches a 'budget' in the way that you take $500 (as the basic plan) per month and save up, buying maybe a couple of times a year. In that way, the investing bit is taken care of for you and all done in ETFs, LICs, REITs, index funds etc.

I personally got the book out from the library, then liked it so much I bought it. I refer back to it quite regularly, with post-it tags all over the most-read bits.

What was particularly interesting was his 18 November 2008 post - Million Dollar Habits - Pittard Conference to a group of REAs and how they could get wealthy from small beginnings, but you have to start.

Worth reading, and a good insight into the idea that 'a dollar today can be worth more than a dollar in the future', meaning that if you spend a dollar today, you effectively remove it's ability to compound over time and provide more dollars down the track. I think it was Buffett who coined (no joke intended) that one.

(mods, feel free to move this post if I've missed the point).
 
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Re: Newbie Lessons - Chapter one: Budgeting

What I've also found is that when dealing with couples its generally the less um focussed partner who decides they can't do without whatever piece of stuff it is they want. Not to sound like a control freak but it's important if you are in a couple to get consensus you can both live with (especially important for the lifestyle expenses).
Sir O

Agreed (and with Sinner). What I have found though, is that a great way to do it is not argue. That won't work. You need a bit of smarts....

Invest, and then when you get your dividend statement, fund quarterly, whatever, sit down at the breakfast table and 'WOW, did you see what I got in the mail today ? $100 from XYZ, and I didn't need to do anything' - then show them. The other half got interested when I did the same a long time ago and suddenly, that pair of shoes she'd seen yesterday was forgotten about...in favour of 'how do I get a piece of that action too ?'. It was then "hey, XYZ company paid for dinner tonight, that's cool !"

This should bring them around somewhat to get interested enough to learn, or at least take notice that THEY should be doing it too ! When I took her to the city and showed her that all these other people pay me when they go and buy this, that and the other, she loved the idea.

Watch things rein in, albeit maybe slowly. Shares are somewhat intangible and so it can take a bit of convincing.
 
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