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Q2 hedge fund letters, conference, scoops etc
Today I am going to write about a topic I have never written about before: personal finance. I am writing about this not so much for you, faithful reader, as for my kids. My four- and 12-year-old girls are too young for this discussion, but my 18-year-old son, Jonah, is right on the cusp of needing to learn about it.
When I got married in 2000, one of the best gifts given to my bride Rachel and me was lunch with my friend Mark Bauer. Mark and I became friends when we studied at the University of Colorado – he was always my dependable study partner. He is 10 years older than me, which at the time meant he had double my maturity (I was 28).
A few months before our wedding Mark, asked if he could have lunch with Rachel and me. At lunch Mark explained that many marriages come to ruin over money issues.
Mark told us,
A tool that has been very helpful for me is a family budget. On the surface it sounds easy – you project your “revenue” (for your family that would be your and Rachel’s salaries) and then subtract your expenses, and that gives you your net income. If you have money left over then you have savings, and then you can afford to spend money on whatever your hearts desire.
At that point I was a bit disappointed in Mark’s wisdom. I was a few months away from completing the CFA designation, and that was on top of my masters degree in finance. The simplicity of his advice was frankly a little insulting to me.
Mark read my unimpressed facial expressions but continued:
The problem with a normal budget is that though it captures well ongoing daily expenses like a mortgage, the cable bill, groceries etc., it ignores future expenses. Let’s take your car for example. It’s paid for, which is great. But in five years this car will need to be replaced and “suddenly” you’ll discover that you have a onetime $20,000 expense, which should not be sudden and is actually anything but onetime unless you are planning to drive this car for the rest of your life. But the car is just the beginning – you’ll take vacations, buy furniture, your kids will go to college, and then there’s retirement.
Now this discussion was starting to get more interesting.
Sit down together and identify all of your expenses, current and future. Once you have identified your future major expenses, create a sinking fund for each one of them.
He explained about sinking funds:
I learned the term from my wife. She used to work for United Airlines. An airline is a very cyclical business, but United knew that they had to repaint their planes every so many years. They set a certain about of money aside for plane repainting, during both good and bad times. When the time came for a plane to be repainted, they had money in a separate account. It didn’t matter if their business was booming or struggling, the planes got repainted.
Think of “sinking fund” as sink (synch) ronizing the future to the present.
Let’s take your car as an example. If in five years you’ll need to buy a new car for $20,000, you’ll be probably be able to get $5,000 for your present car, and thus you’ll need $15,000. That means you need to save $3,000 a year or $250 a month. This $250 a month should become a line item in your budget, and the $250 should go into a separate account. Or you can use one savings account and track sinking funds on a spreadsheet, but some banks will allow you to create separate savings accounts. You can get fancy and start assuming rates of return, but unless I am dealing with an expense that is at least five years out, I ignore compounding. Take the vaguely right approach rather than the precisely wrong one.
Once you’ve identified your future expenses, create your budget; and I guarantee that you’ll discover that your true income is much lower than you thought. Just because these expenses are going to happen in the future doesn’t make them less real.
What happens to a lot of families that don’t plan for future expenses is they get surprised by them and are forced to borrow. Borrowing makes everything exponentially more expensive, because compounding interest turns from being your friend to your enemy – you start paying interest on interest and the rat race begins.
At this point and I could not wait to go home and fire up Excel and start budgeting. As Rachel and I were guesstimating our monthly and future expenses, we had to make calls to her and my parents. We had both lived with our parents and were oblivious as to how much things cost. Once we figured out how much we’d spend on recurring items like utilities, groceries, car insurance, clothes, etc., we started to think about our future big-item expenses. Suddenly a lot of unexpected things showed up on the list: furniture, car insurance deductibles, a new TV (that was when big TVs cost a lot of money) … and this was all before we had kids.
Read the full article here by Vitaliy Katsenelson, Advisor Perspectives
