Why the Dow Jones hitting 20K is meaningless

The Dow Jones just recently hit a milestone price of $20,000. While we think this is good, we believe this is nothing to be excited about. Essentially, our lack of enthusiasm over this $20,000 mark comes from how the Dow Jones Industrial Average (DJIA) is calculated.

When the DJIA started in 1896, it was a true average. To find the index price you would simply add all of the stock prices for the companies in the collection and then divide by the number of companies.  Today it’s a little different in that the sum of all of the stock prices is now divided by a number less than 1. Essentially, the index will be larger than the sum of all of the included companies’ stock prices. This divisor fluctuates based on how many stocks are offered as well as when a company is added or removed from the index. Basically, this number will move a lot.

The other issue with the DJIA formula is that it is price weighted. The index rewards large price increase to stocks rather than looking at total market cap. For example, let’s say you have a company that sells 10 shares for $5 each and I have a company selling 100 shares for $0.50 each. Both companies are worth $50. Now let’s say both companies grow 20%. So your company is now selling 10 shares for $6, while my company is selling 100 shares for $0.60. Again, both companies are worth the same amount. However, the DJIA would increase more with your company due to the larger price increase.

Another reason to not get excited over the Dow Jones is that the index only includes 30 companies. This is a very small number in today’s market. Meaning that the Dow Jones would not be representative of what the market is doing as a whole. While there are great companies included in the index, we feel that a larger sample size of corporations would be more reflective of the market.

Overall, we’re not thrilled with the Dow Jones index. However, we understand that there is some emotional value to looking back and saying “wow, I remember when the Dow was at 18,000”. While the Dow Jones hitting 20,000 is definitely a milestone, we recommend using other market indicators like the S&P 500 to get a more accurate representation of how the overall market is performing.

To learn more about the Dow Jones Industrial Average, you can visit their site at http://www.djaverages.com/?go=industrial-overview

Bottom Line: You’ve got to save more

Robert Powell wrote an interesting article in USA Today this week, where he summarized some recent research of David Blanchett, Michael Finke and Wade Pfau.

The summary of his summary is… you’ve got to save more.

5% of your salary won’t cut it.  10% won’t cut it.  Even 15% of your salary every year from age 25 to age 65 might not cut it.  The bottom line is that retirement keeps getting more expensive for people.

The reasons boil down to 1)Lower expected real (inflation adjusted) returns now and in the future, and 2)we are living longer.  By the way, they didn’t mention this, but there is also a large probability that you will receive less from Social Security in the future.

We don’t know the future, but we can see that stocks are near their high (price) relative to their earnings.  Since earnings are the engine that drives the long term price of stocks, and stocks usually revert to their long term mean, there is room for growth, but probably not at the same rate that occurred in the past few decades.  And as inflation returns to normal levels, we will likely see that your real returns will be a few percentage points lower than historical norms.  This means that whatever we save will grow more slowly, and that the amount we will be able to take out during retirement will be less as well.

Oh, and by the way, we are living longer, so we will need more money, not less.

And then there is the Social Security issue.  Current proposals in congress look to “solve” the issue for the next 75 years.  But if you read the fine print, what they really mean is that you will get less in retirement.  And the younger you are today, the less you will get in retirement.

What does all this mean?

Well, we need to take care of ourselves.  And we need to be more frugal and intelligent in how we do it.  So increase the amount you are saving, and do it today.  Find a second job to generate investing income and invest all of it.  And take care of yourself, because you might need to work a few extra years.

What’s the upside?  Well, if this doomsday scenario doesn’t come to fruition, you will be in great shape to enjoy a fantastic financial life.  And if it does, you are still okay.

One simple habit to make taxes less stressful

It’s tax season.  This is a truly exhausting period of time for many, as they wonder how much they owe, where their documents are, etc.  But it doesn’t have to be that way.

One simple trick that you should do every January is to set up two folders for the year.  Put them in the front of your desk drawer where they are super easy to find.  Label the first folder “Taxes 2017” and label the second folder “Healthcare Expenses 2017”.

I use these folders to capture everything related to taxes and healthcare expense during the year.  If I’m not sure, I still put it in the folder.  And here’s my method.  I put whatever document I have in the back of the folder.  This means that they are in chronological order at any point in the year, with the earliest ones on top.

If I donate to charity, I put the receipt in the back of the tax folder.  If I go to the dentist, I put the receipt in the back of the Healthcare Expenses folder.  When I pay the property tax bill (I don’t have a mortgage anymore), then I put it in the back of the tax folder.  You get the idea.

For those of you who work for an employer and get a W-2, that’s about all you need.  If you also have other income, pensions or social security and need to estimate and pay quarterly taxes, I do one other thing.  I fill in 4 tax vouchers, estimating what I will have to pay.  And then I put the dates in my calendar so I don’t miss it.  I used to do this in paper and envelopes, but now it’s all done electronically.  So I have a spreadsheet that helps me estimate quarterly taxes.

The key is to spend a little time up front to get organized.  This will give you peace of mind throughout the year, and a much easier tax season next year.

Let me know what systems you guys use.


Going Back to school, is it worth it?

After working for some time, many realize that what they’re doing isn’t what they would like to do their whole life. Going back to school to change career paths can be daunting and even financially devastating. Recently, I’ve started looking into going back to school to get an MBA. Here are a few things that I am looking at as I work towards this decision.


1) ROI

ROI stands for Return on Investment. In this situation, it’s how well you are doing after school. Are you making more money? Is the payback period on your loans short enough that you won’t be in debt forever? As you’ve probably experienced, going to school is expensive. Taking out more student loans sounds like a drag. However, many programs publish the average salary of their graduates. Use this to start calculating how long it might take to pay back these loans. Obviously, we don’t want to be paying back debt until we’re 70. So plan conservatively with your payback timeframe.


2) School recognition

School recognition is huge when going back for another degree, consider it as brand recognition. Think of it like this, if you offered a random person on the street a can of Coke or a can of store-branded Cola, what will they pick? The Coke, right? Because it’s a known and trusted brand. The same thing happens with schools. Nationally recognized schools help assure organizations looking to hire you understand that you went through a rigorous program. Shoot for a top 50 school in your discipline with national recognition. Large state schools are a good option to get national recognition while reducing costs.


3) Career path afterward

To be clear, this is highly depended on the position you accept after getting your degree. Did you accept a senior position with a fortune 500 company? A consultant position with a top consulting firm? Did the company you’re working for promote you based on your new skills? Utilize school resources like the alumni network or job fairs to help you find that next position to put you on the career path you wish to follow. Personally, I’m looking to where I want to be in 10 years and whether or not the position will help me get there.


4) Financing (company pay vs student loans)

Unless you are an executive in a very large company, it is very unlikely that the company you work at will pay for your entire degree. However, a lot of companies do have continued education funding. For instance, the company I currently work for grants approximately $5,200 a year for classes. While this isn’t a lot, it’s still financing that I won’t have to get through loans. The thing to consider most through utilizing company funding is time to complete the degree.

Another option is to quit your job and go back to school full time. The issue with this is that you will be spending more due to having no income, possibly having to move, finding new housing, etc. For this situation, we’ve determined that the payback period is too long to quit your job unless you are accepted into a top 5 program nationally. Even then there is still a possibility that the expenses to get the degree are too much to provide a reasonable payback period.


5) Networking (online vs in class)

Going back to school is as much about networking as it is about studying hard and getting a degree. Creating a network of similarly thinking individuals and friends will help with finding potential opportunities in the future.

While it may be cheaper and more flexible to get a degree online, it sacrifices the networking potential of attending classes and meeting new people. If you have great networking skills this may be a non-factor. However, for the majority of us, meeting new people and struggling through class together helps build networks that we can use in the future to find financial opportunity.

One big positive from Online degree programs is flexibility in location.  If you are doing an MBA program where you are still working and going to school part-time, it may take up to 5 years to complete.  In the meantime, you might be asked to change locations for your job, or might take a new job opportunity in a different location.  The online program will allow you location flexibility without penalty.  Just be sure to pick an online program that has a good or even great reputation.  See point 2 above.


6) Time to completion

For me, the time it takes to complete a degree is probably the most important factor. Taking your time and using company financing is good, however if it takes you an extra 3 years to complete then you’re losing out on 3 years of financial gain. Transfer credits, overload your semester, or in general do what you can to reduce the amount of time you are in school. Doing so will help with reducing the payback period of your loans as well as with maximizing your earning potential.

How to save for buying a house

A friend of mine recently purchased his first house, and it got me thinking.. How do you plan for purchasing your first home to ensure financial stability and maximize long term growth potential? When looking to buy a house for the first time there are a few points that need to be evaluated carefully: 1) location 2) affordability 3) down payment 4) saving 5) timing.

  • Location

Location is everything when purchasing your first home. It will be the factor that determines whether your house appreciates in value or depreciates. Highly desirable housing locations will always appreciate in value over time. So what makes a location highly desirable? We want a house that will appeal to a large demographic. First and foremost, school districts. Owning a home in a great school district appeals to people with kids. Next, we want to look for proximity to amenities and entertainment. This isn’t as crucial as school district, but will help with appealing to a larger demographic.

  • Affordability

Unlike the traditional personal finance mind set of looking ahead, you want to look at what you can afford now. Doing so allows you to live comfortably and continue to progress towards your savings goals in other areas. If we planned ahead, purchasing a house that we could “grow into” we open ourselves up to needing roommates, or taking cash away from other areas (i.e. saving). In general, your housing costs should not exceed one third of your monthly income. A quick and easy way of determining what you can afford now is to use Zillow’s affordability calculator. This calculator also provides a great breakdown of expected monthly costs such as taxes, principle and interest, insurance, and mortgage insurance.

  • Down payment

Some banks will allow as little as a 3% down payment on a house. However, we suggest having a minimum of a 10% down payment on the house. For your first home, expect to pay PMI, or Premium Mortgage Insurance. This will increase the monthly payments to the mortgage company be a small amount. Essentially, PMI means that we weren’t capable of putting a 20% down payment on the house. Once 20% ownership of the house is accomplished, PMI can be dropped from payments.

  • Saving for a down payment

There are a few ways to save for buying a home. The first way is a conservative approach is collecting through a savings account. The benefit to this method is that there is little variation from growth. Meaning you can pull and use this money whenever you decide to place the down payment. The downside to this option is that it will take a while to save a significant amount. The second option is more aggressive in that you save through investing in a low cost index fund. This introduces more risk due to market variation. Though it also has the potential to grow with the market, reducing the amount of time needed save for a significant down payment. Utilizing this method means you need to know how the market is performing when you are ready to place a down payment. Our preferred method would be to save through investing in the market. Although its riskier due to market variations, history shows that more time invested in the market equates to less risk of loss.

  • Timing

Obviously, purchasing a home is expensive. Multiple fees come into play when proceeding through the closing process. Based upon the costs associated with buying and selling a house, we recommend that when purchasing a home you plan to live there for at least 5 years. This timeframe should be considered the time it takes to break even. Depending on the market, selling before this timeframe risks potential loss. If you plan on moving or making big life changes in a 5 year period it may make sense to rent rather than buy. The New York Times offers a great rent vs. buy comparison to help determine whether or not renting may be a better option.