Chapter 7 – Housing

Chapter 7 – Housing

“Everyone has a fundamental human right to housing, which ensures access to a safe, secure, habitable, and affordable home with freedom from forced eviction.” ~National Economic & Social Rights Initiative[1]

“All of these government factors contributed to creating a situation in which millions of people were buying homes they couldn’t afford, in which the participants experienced the illusion of prosperity, in which billions upon billions were going into bad investments.” ~Forbes.com, 2008[2]

We are finally at the point where we can start discussing how spending our money impacts the financial genome.  In our lives, our expenses range on a spectrum from basic needs of survival to luxuries. How you define each expense is a personal choice; however, shelter is almost always considered a basic need, and is where we’ll start our spending.  A basic need is not to be confused with a basic right, which typically drives a political discussion.

Conventional and modern Certified Financial Planning uses a “28/36 rule,” which states no more than 28% of your monthly income should be on housing costs and no more than 36% of your monthly income should be on debt (includes mortgages, consumer debt, etc.).[3]  Dave Ramsey, a popular financial guidance advisor offers a similar recommendation of no more than 25-35% on housing[4].  Finally, the Bureau of Labor and Statistics determined 2015 average housing expenses were 32.9% of income[5].  So, based of all those numbers, the average real expense and advice is 30%, and that’s the percentage we’ll use.  Before we go further, you should check your housing costs to see how much you spend. Do you spend more on housing than 30%?

Once you’re an adult and no longer live with your parents, housing costs are generally within your control and your income is typically the basis for making that decision.  At about this point, your bias may have already kicked in and you’ve already decided that renting or buying is the best option. Please try and clear your mind of which decision is optimal because it truly comes down to timing, location, and the current financial landscape.  To have the greatest influence on the genome, the key to optimizing your income is to consider the Return on Investment (ROI) of every next dollar you spend. Additionally, when you make a decision to buy or rent, there is an opportunity cost with doing one or the other.  So, the decision to buy versus rent is based on the potential ROI and opportunity cost.

There are many types of housing that we get to choose from.  Due to my military background and my frequent moves, walking through the types of housing I’ve been in will help us navigate through the options many of us have.  The key takeaway is that I started small and moved to bigger, more expensive housing options as my income increased.

The first housing type I lived in as an adult was a military dormitory.  This was an extremely small (maybe 150 sq ft.) 1-bedroom, 1-closet, shared bathroom and kitchenette single’s room. It came furnished already, and I wasn’t required to pay for it—well, sort of.  The military pays for dorms by utilizing the funding the Department of Defense receives from federal taxes. In theory, the estimated cost of the housing is deducted from my pay.

After a couple of years, I moved out of the dorms and into a 1-bedroom apartment which had 1 bathroom, a small living room, and a kitchen.  The apartment was nearly 400 sq ft., which felt big compared to my small dorm room.  Once you move out of the dorms or military housing, you receive a Basic Allowance for Housing (BAH).  For civilians, this is just part of your normal salary. I spent about $350 a month and my salary was $1,200—roughly 30%.

A couple years later, we rented increasingly larger houses; the largest being 1,400 sq ft.  Each time we moved, I ensured that (even with all bills included) we never exceeded 30% of my salary.  The places we rented were slightly bigger or were newer.  We finally bought our first house nearly 4 years ago. Even with all utilities, our monthly housing costs are down to 20% of my salary.  This is the definition of living within your means.  If your housing expenses exceed 30%, then you have less income to go to all the other expenses.  Some people I’ve helped with their personal finances have housing expenses approaching 55% of their income.

Despite all the political missteps and the insatiable greed of lending companies and brokerages, if the public kept housing costs to less than 30%, the United States may have avoided the 2008 financial collapse.  Products like interest-only and punishing adjustable-rate mortgages would have been quickly exposed under the 30% model.  How much are you paying in housing costs?  Let’s look at how spending your salary on housing impacts the financial genome.

For starters, you are part of a $217 TRILLION global real estate market[6].  Isn’t that amazing?  Real estate is the combination of all apartments, townhomes, commercial buildings, residential homes and everything in between.  You have a choice of either renting from a company or an individual or buying your own property.  We must be careful on how we use the word “own” in our lexicon.  Typically, people need a loan to buy a house, and you’ll always need to pay property taxes.  So, while you have a loan, the bank technically owns the property.  It is also important to realize the actual value of a property is based on what a buyer is willing to pay.  Many people confuse this philosophy, thinking there must be an intrinsic value of real estate, making it better or worse than any other investment.

In the following chapters we’ll analyze the specific genome connections we connect to when buying or renting.  For now, consider us entering a new galaxy—the “housing galaxy.”  Housing is incredibly connected between all ranges of government, other individuals, corporations, shareholders, insurance companies, and billionaires.  You impact all of these.

[1] https://www.nesri.org/programs/what-is-the-human-right-to-housing

[2] https://www.forbes.com/2008/07/18/fannie-freddie-regulation-oped-cx_yb_0718brook.html

[3] https://www.goodfinancialcents.com/how-much-of-mortgage-house-payment-can-you-afford-based-salary/

[4] http://www.leavedebtbehind.com/frugal-living/budgeting/10-recommended-category-percentages-for-your-family-budget/

[5] https://www.bls.gov/opub/reports/consumer-expenditures/2015/home.htm

[6] http://www.savills.com/_news/article/105347/198559-0/1/2016/world-real-estate-accounts-for-60–of-all-mainstream-assets

Financial Genome Project – Chapter 5

Chapter 5 – The Payment System

“When the scheme faltered [John] Law resorted to a number of rescue packages, many of which have their echoes 300 years later. One was for the bank to guarantee to buy shares in the Mississippi company at a set price (think of the various government asset-purchase schemes today). Then the company took over the bank (a rescue along the lines of Fannie Mae and Freddie Mac). Finally there were restrictions on the amount of gold and silver that could be owned (something America tried in the 1930s).” ~The Economist, 2009[1][i]

The quote in the beginning of this chapter is about John Law, a banker and gambler, which fundamentally changed France’s financial system. His bank controlled many parts of France’s payment system, and it collapsed in four years. Understanding all the parts of the financial genome can help expose and proactively avoid financial failures. This chapter will help you with your personal finances.

In Chapter 4, we discussed the “involuntary” healthcare deduction from your salary before you receive your salary (current sequence pictured below). Before we discuss what we spend our money on, we’ll spend time looking out how the payment system works. We’ll look at it broadly at first and then dig down deeper when we go through individual expenses. The main reason we should look at it broadly first, is to understand that while spending money, you’re either losing money while spending money or you’re earning money to spend money. How we spend our own money is a choice we can control. You can work against you by costing yourself money, typically through hidden costs that we’ve accepted as a society. We can avoid these costs. Conversely, the genome can also reward you as you spend money. I’ll show you how to be rewarded and avoid some costs in this chapter. I’ll put potential costs in red font and potential rewards in green font.

CURRENT GENOME SEQUENCING

                In most countries with a modern banking system, employers directly deposit salaries into employees’ bank accounts; although, some may still give physical checks directly to employees. Checks require the employee to go to a check-cashing facility. Most people go to their own bank and deposit their check directly into their own bank account or get the money in cash; however, some people go to check-cashing facilities and get the money in cash. These type of non-bank facilities charge a fee to cash the check based on the value of the check. This is one way people can avoid costs, by cashing checks at their own bank versus using a check-cashing facility. Technology has helped us avoid costs by allowing us to cash checks using our smartphones directly to your bank.

According to a 2015 Federal Deposit Insurance Company (FDIC) report, only 7% of households were “unbanked” meaning they didn’t have a checking or savings account (.7% lower than 2013). Additionally, a total of nearly 20% of U.S. households obtained financial services outside of the banking system (like check-cashing services).[2] This means that people are being charged to gain access to their own money. Having a bank account doesn’t necessarily mean you avoid fees though.

Like we discussed in Chapter 1, banks can charge a variety of fees that you need to avoid. The most basic fees involve just having a bank account and those need to be avoided. Banks shouldn’t make a profit based off fees, they should reward people for trusting them to use their bank so they can loan that money out. This is called fractional reserve banking and we’ll discuss it in more detail in future chapters. If you use a bank account properly, you can earn rewards. Interest is the most common reward for keeping money in a bank. The interest you earn depends on interest rates, which are incredibly low right, but it’s better than paying fees.

So to recap the flow of income, your employer paid you by direct deposit or a check. You can cash the check by directly depositing it to a bank account or exchanging it for cash. You have two methods of accessing your money: 1) by using the money that was directly deposited into your bank or 2) by using cash. When money is directly deposited, you can use it by transferring it from your bank to the vendor’s bank with an automated payment, utilizing debit and credit cards, writing checks, or withdrawing the money from an Automated Teller Machine (ATM). This is quick chart of what the payment system looks like.

PAYMENT SYSTEM

Automated payments are becoming increasingly popular as technology increases. Consumers often automate their bill payments which sends the money directly from a consumer’s bank to a vendor’s bank. Large companies offer this service for free. The company has to pay for this service but it’s such a negligible cost to attract the hundreds of thousands or even millions of customers. Small companies or services may charge for automated payments, and people should avoid those payment methods if they can.

I’ll dedicate an entire chapter to using debit and credit cards, but the costs have become transparent. Companies like Visa (V) and MasterCard (MA) charge vendors a percentage of every sale. Most companies simply add this cost to every commodity and it becomes transparent (actually, just hidden in plain sight). To avoid this hidden cost, I recommend you use a rewards debit and credit card that offers rewards on every purchase—only if you can pay your balance in full every month. By not doing so, you’ll be charged the finance charge, at double-digit interest rates, and negate any savings.

Switching to check usage, some banks charge to provide checks, so there may be costs in using checks. Over time, writing checks will become obsolete. If 90 checks cost $15, each check actually costs 16 cents. If you’re writing a $10 check, then 16 cents represents a 1.6% fee. Lastly, and most unsettling to me, is the cost of withdrawing cash from your bank. Finding a bank that doesn’t charge you for checks or avoiding using checks is a great way to avoid those fees.

According to data pulled from the National ATM Council, the average ATM withdrawal is $60.[3] ATM owners often charge $2 or more for cash withdrawals. Bank-owned ATMs don’t charge their own customers to withdrawal cash. A $2 withdrawal fee on $60 is a 3.3% fee. A $2 withdrawal fee on $20 is a 10% fee. For some reason, avoiding ATM fees is not a priority for consumers and it should be. Cash provides anonymity of purchases—an ideological side benefit. Interestingly enough, businesses that have an inherent requirement for cash such as gentlemen clubs [so I’ve heard] or casinos charge the highest fees for ATM withdrawals. Some ATM fees at these clubs are as high as $8. An $8 ATM fee for the average $60 ATM withdrawal is a 13% fee. To avoid ATM fees, try using your own bank’s ATMs or find a bank that reimburses ATM fees. Planning ahead and budgeting also helps prevent unnecessary or impulse needs for cash.

So whether you pay a vendor using automated payments, debt or credit cards, a check, or with cash, the money will eventually make it to the vendor’s bank. This is important to note. Almost every step in the payment system requires a bank. Banks issue debit and credit cards managed by Visa, MasterCard and other card companies. Banks wield an extraordinary amount of power in the financial genome, and we should be very mindful of that at all times. As I’ve mentioned it before in previous chapters, transparency and access are nice, but can also lead to nefarious dealings within the genome. Here’s what our current financial genome sequencing looks like now. The payment system is not outside the genome, and we’ll start making connections in the next couple of chapters.

CURRENT GENOME SEQUENCING

 

[1] http://www.economist.com/node/14215012

[2] https://www.fdic.gov/householdsurvey/2015/2015execsumm.pdf

[3] http://www.statisticbrain.com/atm-machine-statistics/

Financial Genome Project – Chapter 2

Chapter 2 – Newton’s Third Law

For every action, there is an equal and opposite reaction.[1]

Before we begin our adventure through the genome, we should take a look at the most important piece to the entire complex system—you. You are a laborer and you are fueled by your income. Governments siphon part of your income in taxes for their engines. Then you consume by spending money, fueling businesses’ engines. You can also save part of your income which fuels other businesses through investment. The entire complex system that we’ve built as humans relies on laborers earning an income, getting taxed, and then spending or saving the rest. We keep this entire complex system running.

The engine of the genome starts with you receiving an income from a company or a government (local, state, or federal). The taxes go to a government and a part of that goes to salaries to generate government worker incomes. When you spend your money, it represents sales for a company, part of which goes to employees’ incomes. And something different happens in the genome when you choose to save money. We’ll discuss in a later chapter. Governments can only operate with taxes, and companies can only operate with sales. By working and generating an income, you’re keeping our current genome alive.

After reading that, does it seem so farfetched that in the movie, The Matrix, we are being used as batteries to keep the “machines” alive? We think we have control. We can simply stop working right?  Without government assistance, most couldn’t survive very long without relying on primitive skills. Additionally, once too many people stop working, then government assistance wouldn’t be available either. So without you working, the government, companies, and people surviving on government assistance would be unable to operate. By working and earning an income, you create a feedback loop that enables you to generate an income, while simultaneously supporting the governments and companies within the loop.

Income Feedback Loop

In the Income Feedback Loop above, check out that little blue arrow between Salary and You. Have you ever thought about all the connections that happen before receiving your paycheck? Let’s look at just that arrow in this chapter, before we address all the components of the feedback loop. Gone are the days when you worked and your employer gave you your earnings in cash at the end of the day. Now you must wait for two weeks, to a month, before you receive a paycheck. Also, you no longer receive your paycheck directly from your employer. Your employer probably uses a contracted service for distributing payrolls. Finally, your paycheck no longer comes directly to you—now it goes to your bank.

Your paycheck is purely electronic, and we continually drift away from paper money—known as fiat money, or paper money which has no intrinsic value, but is made legal tender through government decree. [2] Nearly every working person in a developed country receives an electronic paycheck directly deposited into a bank account. Only in undeveloped countries do people typically receive daily earnings or receive income in cash or goods. The whole electronic transfer process is nearly transparent to most of us. We check our bank accounts on “pay day” and if all went well, we have money in our bank accounts. Isn’t that convenient?

But this transparency and convenience comes at a cost and it is hidden in dark places of the genome. In these dark places, people are building businesses designed to make the genome appear transparent. By making it transparent, they have the ability to make microscopic changes that may negatively impact you—without you knowing it. In our busy world, where people typically check their online statements only to find out the balance after pay day, we often miss these miniscule disruptions to our paychecks. Our first dark spot in the genome is the “bank fee”—like small, hidden sand bars in a muddy river slowing speed boats down.

Until about 2008, before financial operations were in the negative spotlight, it cost you money to keep money in a bank account even though it was, and still is, mandated by employers in developed countries for payroll processing. Unfortunately, some banks still have a lot of fees just for having a bank account: checking account fees, minimum balance fees, and no direct deposit fee. Then banks charge when you spend your own money with ATM withdrawal fees and annual credit card fees. The banks are even gracious enough to let you spend more money than you have with overdraft and insufficient funds fees. In 2015, the nation’s 628 biggest banks made $11.16 billion from just overdraft and insufficient funds fees alone, according to the Consumer Financial Protection Bureau.[3] Since banks are “environmentally friendly”, they’ll also charge you a hard copy statement fee forcing you to go online to check your statements. If you want to travel outside of the country to spend your own money, you can expect to see foreign transaction fees. Even if it’s something that you can’t control like someone writing you a bad check, you may receive a returned deposit fee.

Genome – Fee Connection

Some fees have gone away as hard-pressed banks had to reassure people that keeping your money in banks was safe after the 2008 financial “collapse”. If you’re reading this, go through your last three statements and check to see if you are being charged any fees. If you are being charged multiple fees, you need to change your bank. I’ve shined the light on this genome dark spot specifically to help you receive 100% of the paycheck that you’re supposed to be earning. As you can see from the image above, these fees prevent you from earning 100% of your salary. Eliminating fees improves your “fuel efficiency” in your financial engine as we travel through the genome.

Do you ever find it unsettling that your paycheck doesn’t actually come directly to you, but goes to your bank and then you are charged fees for accessing it? Keeping your money is how banks make money. Banks with more than $115.1M in liabilities (i.e., loans to other banks, companies, and individuals) only have to keep 10% of it on hand.[4] Have you ever heard of a “bank run”? This is where many people want to take out their money from their accounts and the bank doesn’t have enough in reserve. Banks saw this happen in 2008 and, more recently, in 2016 when the “Brexit” (Britain’s departure from the European Union) happened. There’s been multiple times where people have tried to get their own money and were denied. Not having access to your own money is part of the modern genome that we must live with, but by eliminating fees, we improve our position in the genome.

My intent is not to demonize banks, but I do want to introduce to you that almost everywhere in the genome, there’s an equal, yet opposing force to everything you do. Sir Isaac Newton’s third law states, “For every action, there is an equal and opposite reaction.” We find this is true in the financial genome. For every dollar you make, there is a part of the genome trying to pull that money away from you. Some of it is voluntary, like with our spending habits; some of it is involuntary, like taxes, and some of it is voluntary only if you know about it—like fees.

This is only the top surface of the connection of your income between your employer and you. The Income Feedback Loop shows the aerial view of what the genome connections look like, but as you’ve just read, there are many connections in between only one aspect of that loop. The Genome Fee Connection exposes one dark connection that you need to be aware of and change if it applies to you. There are more connections between your employer and you, regarding your salary. In the next chapter, we’ll discuss payroll taxes.

[1] http://www.physicsclassroom.com/class/newtlaws/Lesson-4/Newtons-Third-Law

[2] http://www.investorwords.com/1928/fiat_money.html

[3] http://files.consumerfinance.gov/f/201602_cfpb_variation-in-bank-overdraft-revenues-and-contribution.pdf

[4] https://www.federalreserve.gov/monetarypolicy/reservereq.htm