A Bright Idea

UPDATE: Amazon is now selling flood lights for 2.50 a bulb

I’ve got a bright idea! We should all be using LED light bulbs. (Pun intended). I recently picked up a steal of a deal on amazon and bought 16 – 60 watt LED light bulbs for just under 32 dollars. At this price, I think it is outrageous that any one is still using an incandescent light bulb at all.

I’ve put together this pretty chart that shows how quickly you will be paid back in term of reduced costs on your electric bill if you replace your incandescent light bulb with an Amazon 1.99 LED light bulb. I assumed an electrical cost of 0.12 $/kWh. As you can see if you are using an incandescent bulb all the time you will be paid back your initial 1.99 investment in only 14 days.

light-bulb

If you are like me and had a huge stockpile of light bulb you purchased when they went on sale and think yea yea I’ll replace my incandescent bulbs when they eventually burn out.

WRONG! WRONG! WRONG!

In the time, you wait for that incandescent bulb to burn out you will spend enough in energy costs to buy 4 LED light bulbs! Fight your human tendency to loss aversion and toss them out today and upgrade!

In case you want to check the payback time on various light bulbs or you live in Hawaii and have crazy high energy costs here is link to my spreadsheet.

SPREADSHEET

My link to the light bulbs on Amazon is an affiliate link. I will get paid if you purchase the light bulbs there. I am intending to setup a win-win situation, where my mission to make the world a more efficient place and your desire to save a bit of money are nicely aligned. If you can find LED light bulbs at a better value elsewhere by all means get them there.

Roth IRA vs. Traditional IRA

In the personal finance world an often debated topic is whether to contribute to the Roth IRA or the traditional IRA. An IRA stands for individual retirement account. The two accounts are mutually exclusive. The IRS currently allows you to contribute 5,500 dollars per year to IRA accounts (6,500 if you are over the age of 50). The two account have different tax advantages. The Roth IRA allows you to withdraw earnings tax free but requires you to contribute to with after tax dollars. The traditional IRA differs in that the traditional IRA allows you to contribute with before tax dollars, but requires you to pay income taxes on the withdraws.

So how do you choose which account to contribute to? The first step is understanding the problem. The problem is that without using IRA’s you are being inefficient from a tax standpoint. What IRA’s do is help you defer your taxes until a later point. The value in this is that we live in a progressive tax environment where as you earn higher and higher amounts of money you pay a progressively higher and higher rates of tax on each dollar you earn. If you are able to spread out when you take income and pay taxes on certain amount of money you will be able to put more money into the lower tax brackets.

A Quick Example

Albert and Bob are both are average gold miners. They both earn 88,000 per year. Albert takes advantage of his traditional IRA to the maximum and Bob doesn’t use it at all. The table below shows how much difference there will be between the two of them in just the last ten years leading up to their retirement. In the example I’ve assumed they are both single filers and take all the standard deductions and exemptions.

tira-example

So using an IRA is clearly helpful. Albert saved $4,238.75 when compared to Bob.

Now to optimize between choosing a Roth IRA and traditional IRA I like to start with the best case scenario for how a person would go about minimizing taxes over their entire life. What would that look like? In the chart below I’ve shown the average college graduates income in two different cases. The first is the optimal income scenario and the second is the typical income scenario.  If you wanted to pay the absolute minimum amount of taxes you would take the amount of money you are going to spend over your lifetime and take it as income evenly over the number of years you are going to live, so from 14 to whenever you kick the bucket (average life expectancy in the US is 79 years). In the typical scenario I’ve shown what a typical college graduate’s income looks like over their lifetime. At first you have relatively little income and as you acquire more human and skills capital your earning potential increase.

life-time-income

Clearly the optimal case won’t play out very often, because no 14-year-old is going to have near the salary to get close to their average life time yearly spending. This ideal scenario does give us a helpful clue about where we should be hunting though.

When taxable income is low compared to life time average we should be looking to increase taxable income and when taxable income is high we should be looking to minimize taxable income.  I’ll spare you the math this time but the optimal point for when traditional IRA’s are better than Roth IRA’s is when your future spending needs are less than your current taxable income. When your future spending needs are less than your current taxable income you are better off delaying when you pay taxes on money until later in life when you are able to fit more money into a lower tax bracket. This is actually the case most of the time. There are only a very select number of years at the start of a person’s earning history when their future spending needs are higher than your current taxable income. This is because more than likely your spending needs now are similar to what they will be in the future and unless you happen to be going further into debt every year your income in currently covering your spending needs and some additional savings.

KEY ASSUMPTION AND MAJOR RISK TO CONSIDER

Stable tax environment. This is a safe assumption if you are a typical wage earner. Historically speaking, effective tax rates for the middle class have not fluctuated significantly. All bets are off if you are making enough to be in the top tax bracket. Then again if you making enough money to be in the top tax bracket you likely are ineligible to use many of the advantages of an IRA. If you think our current tax environment is unstable you may want to diversify between both types of IRA’s in case future tax rules are changed.

Limited liquidity needs. Both type of retirement accounts perform much better when held as equities for a long period of time. If you will need cash from your IRA in less than a few years an IRA might not be the best option for you.

KEY TAKEAWAYS
  • Forecast / estimate your future spending needs.
  • Compare that to your current taxable income.
  • If your future spending needs are lower than your taxable income, then choose the traditional IRA.

Most of the time, choosing a traditional IRA is the optimal solution.

The Roth IRA in my opinion is not a useful retirement account because when your taxable income is low compared to your future spending needs you won’t have the ability to save money because you are not as likely to have enough cash to fund your current spending needs, much less fund a retirement account as well.

 

The One Credit Card Everyone Should Have

Previously I talked about how important it is to use rewards credit cards. Today I wanted to share with you the best credit card I have ever found and explain why it is the card everyone should be carrying.

Unlike basically every website in the world that discusses/reviews/recommends credit cards I am not getting anything in return for this recommendation. In fact, when I was doing research for this post I found that most credit card sites don’t even mention this credit card. My only motivation for creating this post is purely to help you operate your lifestyle in a more efficient way. I have no bias what so ever when I give you this recommendation.

So what is this secret miracle cure all credit card?

The Fidelity Visa Signature Card.

IMG_1725
My Fidelity Visa Signature Card

This card is special because it offers 2% cash back on EVERYTHING. If you are using cash or debt cards to make your purchases this is a life changing amount! You might think, oh who cares 2% is nothing, but the difference is huge. It is going to take me an entire post next week to fully explain the implications.

This card does require you to sign up for a Fidelity brokerage account to receive your cash back. This is a slight inconvenience, but only takes a one-time effort to setup and from then on you can deposit your cash back into your brokerage account and have your brokerage account transfer the cash into your normal checking account.

Another point worth mentioning is that this card does not have any annual fee. You will never have to worry about using it enough to justify its cost like other rewards cards.  The interest rate is 14.24% on purchases, but it shouldn’t matter because you will not be paying interest on the card, right?

There are other cards out there that offer higher percentages of cash back rewards (and I recommend a few of them), but none are as simple as this card. Everyone should be carrying this card as a baseline. Without having to think you can be assured you are getting 2% cash back everywhere Visa is accepted.

Let me know in the comments what tactics you typically use when it comes to credit cards.

Efficient Capital Strategy – Use Credit Cards

I have read several personal finance books over the last five years. One of the books I read was written by Dave Ramsey.  In his book he talks about using an envelope system to budget. If you aren’t familiar with the envelope system, you basically have separate envelopes for every budget category in your household (i.e. groceries, water bill, house payment, entertainment, etc.) and when you get paid you put the budgeted amount of cash into the corresponding envelope. When you buy something it comes out of corresponding the envelope, and when the envelope is empty you stop buying things.

I think this method is for people with absolutely no self-control. If you have just a little self-control and care about being better in life like I do, then you need to be using credit cards rather than cash and envelopes.

Paying in cash is not efficient!No Cash

Let me explain why. Every time you use a credit card the credit card company charges the merchant a small fee to process the transaction. You pay the merchant the exact same amount whether you use cash or credit. Where you gain efficiency is that some credit card companies offer to split their earnings with you as a way for you to use their business. These are called rewards credit cards.

Before I get into the benefits of rewards credit cards, let me interject my disclaimer for credit card use.  You MUST pay off your credit card in full every month. Just like with the envelope system, where you cannot use more cash than is in your envelopes, you should not be charging more than you have the cash to pay for.  Acquiring credit card debt with high interest payments is a very poor idea and inefficient way manage your capital.

Ok, so back to rewards credit cards.  There are basically two schools of thought when it comes to rewards credit cards.

  1. Sign Up Bonus Only

The first school is to look for credit cards with initial sign up bonuses. Many credit companies offer high bonuses to sign up with them and then spend X amount of dollars.  After the initial sign on bonus the “cash back” incentive is usually nothing to very low (less than 1%).  Therefore, to make this reward work in the long term you have to look for and sign up for new reward credit cards with high bonuses.  In my opinion this option has higher total rewards, but is much more time intensive.

  1. Best Overall Rewards

The second school of thought is to look for credit cards that offer the best overall rewards.  Credit cards that offer best overall rewards offer “cash back” in the form of up to 2% of the money you spend.  Although this may seem like a lot less than initial sign up bonuses, the 2% is for the duration you hold the credit card; thus, you set it up once and the time needed to manage your finances will be minimal.

Both of these types of rewards credit cards give you money back for your purchases and help you gain something from your spending, rather than using cash and gaining nothing.

Risk and Reward

When most people think of risky things they think of the bad things that can happen. Thinking only in terms of “bad things” is an incorrect application of risk. The technical definition of risk is: the amount of uncertainty in the outcome of an event.

This definition of risk relates to the efficient use of capital through investing, because the amount of uncertainty in the return you are expecting from your investment is directly correlated to the amount of return you will get. I know that sounds confusing, but stick with me this gets good. Think of it this way, if a bank offers you 1% return on your investment you should expect to get exactly 1% return on your investment. If you invest in the stock market you should expect to get around 7% return on your investment.  Unlike the bank, the stock market return is unpredictable.  Your actual return on investment can range from +45% and -35%, but on average you can expect your long term investment return will be 7%.

To demonstrate this concept I’ve drawn the picture below. The far right of the picture shows what the stock market expected returns looks like. People are averaging about 7% a year, but they experience years where the return of +45% and other years where the return of -35%. In the middle I’ve shown what the bond markets expected return looks like. On the left of the image is what a typical government bond would look like. If we took it to the extreme left a bank savings account would have no distribution. It would just be a flat line because you are going to get exactly the return the bank tells you. No more no less.

Risk Return

 

So how can we use this concept to manage our capital more efficiently?

By planning when you will need to use your money you can invest at the appropriate risk level. For example if you don’t need your money for another 35 years you should be willing to take on a large amount of risk, because the investment carries the highest long term average return. Sure you will have bad years where you lose more money than you’d like to admit, but you will also have amazing years to go with it.

If you need your money in a few months to buy a car don’t invest it in the stock market. Yes, you could end up driving a Porsche, but you might also end up having to buy my neighbor’s car.

The Porsche

 

Beater car
My Neighbors Car

 

 

 

 

In a future post I’ll cover negotiation to help you get a really good deal on my neighbor’s car, unless he reads this also. Please subscribe on the right hand side of this post so you get that update.