Time value of money

$1 tomorrow is worth less than $1 today. $1 today = $1 tomorrow + time value of money. This time value of money is represented by interest in savings account and earnings in investment accounts.

Time Value of Money

Time Value of Money

People in general would prefer to consume $1 today than wait till tomorrow. Now, there are two categories of people – those would would postpone their consumption in return of interest/ earnings. And there are those who would prepone their consumption by paying interest.

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Are you financially smart?

I live with someone who is incredibly smart (ivy-league doctor). Read the 7 examples that lead me to believe that she is not financially smart.

1. If she has money, she will invest. If I see a good investment opportunity, I will think about how to ‘fund’ it. Like other financially smart people I have learned to say How?

2. She does not understand the time value of money – she always lends me money interest-free when we play Monopoly. And then she wonders why I always win – because I will buy every property that I can on the board by taking money from her (or the bank) interest free. Financially smart people are always on the lookout for interest free money.

Keep in mind the following though:

a. High interest debt like credit cards is a suicide but interest free debt is a blessing if invested properly. Read a related post here.

b. Do not over – spend because the seller is offering you an interest free loan. Interest rate should not dictate your purchase size in this case.

3. We own a house that we are in the market for refinancing right now. We got the original mortgage in 2014 (0% down payment). When we talk about refinancing at 100% LTV or pay down 20%, she often talks about ‘But the house might be worth much more in 5 years?’

She seems to think that the house appreciation will benefit us more if we make a down payment. While I know that the house appreciation will benefit us exactly the same amount whether we put nothing down, or 20% down, or even 100% down (pay off the mortgage).

We own the house, irrespective of whether there is mortgage on the house or not. Our equity in the house depends on how much mortgage do we owe to the lender, but our exposure to real estate is the entire value of the house (irrespective of the mortgage amount).

You will see other variations of this problem too – and sometimes even financially smart experts get confused. Here is a good example:

Here a couple would like to plan for an early retirement and the Number 1 personal finance magazine in the country advises them:

The equity in the rental property does not matter (as far as the impact on net worth is concerned). Let us say two examples assuming the rentals are worth $200,000

  1. Equity of $78,000 and debt (mortgage) of $122,000
  2. Equity of $50,000 (and the rest $150,000 is mortgage)

When/ if the real estate market crashes and the value of property falls to say $160,000 – the couple has lost $40,000 from what they own today (irrespective of the debt/ equity ratio).

In case 1, the equity falls to $38,000 and the mortgage is still $122,000 -> so net, they ‘owe’ $84,000. Actually look at it this way -> you owe the bank $121,000 and your property value is $38,000. So now you owe net $84,000.

Earlier you owed $122,000 – $78,000 = $44,000. You have lost $40,000

In case 2, you owe $150,000 to the bank and the equity falls to $10,000 -> so the net you owe is $140,000. Earlier net owed was $150,000 – 50,000 = $100,000. So you lost $40,000.

To summarize this point – the couple owns rental property worth $200,000 -> and they will gain/ lose the entire amount by which the property increases or decreases in value. The amount of equity does not matter.

The other problem with the above expert advise is “sell rentals when you have difficulty finding tenants” – I would say NO, that will be too late. Selling the rental now when it is a turnkey investment might give you a good selling price rather than waiting for the real estate market to go bad before selling it.

4. She was unhappy that she did not get any refund while her colleagues got tends of thousands of dollars back.

She does not explicitly realize the fact that she was getting less taxes withheld during the year so essentially what her colleagues are getting back now, she has been getting all along with every paycheck.

Hopefully she will appreciate taxes due vs tax liability difference some day soon (else I will start to consider myself a failure lol, just kidding).

5. She hated debt and was paying off her student loans as fast as she can – this works great in 2 situations: if you have money then you will end up spending it rather than investing it and if the debt is high interest rate.

She was paying down her loans that had an interest rate of 2% while I take as much loan as possible as I can get at 2%.

The reason – I am confident that I will make much more through my investments. How much more? I am hoping that I will make about 8% over long term.

But debt is risky and since 8% is uncertain, I will not take debt at say more than 4% to speculate. If someone is loaning me money at 2%, then I will surely take it. If someone is giving it to be at 5%, then I will definitely not take it.

For things like 3-4%, I will have to run specific numbers (using my Excel).

6. She was not claiming her mother as a dependent, I made her file amended returns for three years, got back $3,000 in refund each year. This money is not all that much given what she earns today but this was a hell lot of money when she was doing her residency and earning $50,000 a year.Exemption section on 1040 Tax Form

Her CPA never asked her and she never mentioned it. I wish she would have met me sooner. One of the main reasons I urge people to understand taxes is for situations like these: a CPA will only know what you are telling them, sometimes they will not ask you the right things because they do not know your situations.

7. She was about to buy a car for $42,000.  I asked her ‘Will you wait 10 days if I get it for $5,000 less’? She said – yes. 10 days later, we bought the exact same car for $36,000. We saved $6,000.

financially smart

More on car buying negotiation techniques some other time, but essentially I negotiated the price of the car down to $36,000 from $42,000. I was able to do so because I was not in a hurry – I got multiple quotes from multiple dealers and essentially made them bid against each other.

Should you afford what you can afford?

I live (and want to live) a comfortable life but I do not want to maximize my consumption just because I have money to do it.

In 2014, I was in the looking for a house to buy (primary residence). Like most rational people, I wanted to start with a budget. I wanted to find out answer to the following question:

“Given my income, what is the least amount I should spend on housing?” I searched for days and weeks, but did not find an answer.

Let me first elaborate on my question. I have good income. I tend to be frugal (simple living). But I did not want to be frugal to the extreme, I did not want to end up below the ‘suggested bottom’. I had often heard people talk about “You should not spend more than x% of your salary on housing”. I wanted to hear something like “You should spend at least y% of your salary on housing”.

I did not find my answer, here is what I found – I found hundreds and hundreds of websites and blogs telling me ‘the upper limit of how much should I spend’. Here are some examples:
1. Your monthly total debt should not be more than 43% of your take home pay
2. Your house should not cost more than 2.5 times your gross annual base pay

This related to my car buying experience too – the salesman always kept on coming back to monthly payments saying “It is only $391 a month, you can afford that”. And I was thinking in my mind “Should I afford it just because I can?”.

Coming back to my housing question – I do not have an answer today on how much is the minimum you should spend. Frankly, I did not start to write the post looking for an answer.

Affordability calculator

Affordability calculator

All I would like to discuss today is – should you afford what you can? Since no website was able to tell me the ‘suggested minimum’, I believe most people are not thinking along those lines.

Per the affordability calculator present on www.zillow.com, someone earning $100,000 a year without any other debt can afford a house worth $489,216. They make the calculations using some assumptions and those assumptions are not our focus today.

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Bobby’s theory of Relativity

Time can be converted to Dime and Dime can be converted to Time. Read on to how what should you do (Time-> $ OR $ -> Time) and how should you go about doing it?

Albert Einstein proposed theory of relativity in the year 1905, whereby he established that matter can be converted to energy and energy can be converted to matter.

Today, I am proposing Bobby’s theory of relativity – it states “Time can be converted to money AND money can be converted to time”.

Time can be converted to money

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Shark Tank Audition

Read on to find out how my Shark Tank audition went and how I was sitting there documenting my thoughts so that I can share them with you.

This was the most beautiful face at the audition, so beautiful that I had to remove my face:

Winner of the ‘Most Beautiful Face at Shark Tank Audition, Miami, 3/3/2016’ (Awarded by One More Dime)

I had my Shark Tank audition on 3/3/2016 but I will still write the post as if this was today.

Here is how the day went:

I planned to leave at 6.30am – I was in my car at 6.35am. Continue reading