Archive for the 'Financial' Category

The three roads to wealth

I once met a man who was not interested in obtaining wealth. Then he heard about the lottery. I once knew a woman who did not want a raise. Then she discovered they were paid in dollars.

Ninety-nine out of a hundred of us want to increase our wealth. It appears we all were made for a mansion built in heaven. Generally speaking, wealth builds in one of three ways.

1. Professional

The professional road to wealth travels through formal education and licensing. Doctors, lawyers, engineers, accountants, etc. spend many years in institutional environments preparing for standardized tests. In the end, professionals have something that’s rare because most people don’t like to read and study.

Like a rare diamond, degrees and licenses are highly valued in the marketplace. That’s why attorneys can make more in an hour than others can make in a week. Physicians can make more in a surgery than others can make in a year.

(They can also spend it faster than others. I once knew a surgeon whose annual income was greater than his net worth. That’s not easy to do.)

A professional’s earning power stems from his or her knowledge. It’s true: Knowledge is (earning) power.

2. Corporate

The industrial revolution welcomed corporations into the economy and we have not turned back. Corporations create mega wealth for those willing to endure their bureaucracy.

A friend of mine wants to quit his corporate job every other week because of the politics and the personalities involved. He longs for a tractor, a spread of land and the independence such a work life provides. But that work life pays in corn, not Chuck E. Cheese tokens. And his kids really like Chuck E. Cheese.

Corporate employees often trade freedom and adventure for the dollars they make. They make get an 18% bonus but they also may work in a prison-like compound. The whims of managers up the ladder can bring sudden location and position changes. But if employees are willing to make the moves, the corporate ladder leads to wealth.

Corporate economies of scale produce vast resources. When every Dairy Queen from Texarkana to El Paso sends you a cut of their Blizzard sales, a flurry of financial gain blows to the franchisors. But let’s not forget the franchisees. They represent the third road to wealth: entrepreneurship.

3. Entrepreneurship

As a banker of entrepreneurs, I see the wealth that self-employment creates. It’s not guaranteed, of course. A lot of ventures don’t work. But when they do, it can be big. Remember: High risk, high reward.

When someone creates a new product or service that solves a problem or saves time or money, people will pay for it. Most people have ideas that would make the world a better place. Entrepreneurs actually execute on those ideas. And there’s often as much creativity in the execution as there is in the idea itself.

Of the three roads to wealth, entrepreneurship can be the most lucrative. The wealthiest people in America invented things and started businesses.

But if you don’t have the stomach for owning your own business, you might try the bar examination. If not that, perhaps you have the patience to endure Dilbert in the next cubicle over. Wealth is available down all three roads.

Kevin Thompson is a columnist for The Boerne Star in the Texas hill country. Follow him at http://www.kwt.info.

Advertisements

How credit scores work

Do you ever feel like a number? Major corporations try desperately to make you not feel like one. They want you to feel like a person, or at least a name. But as companies consolidate to reach the scale necessary to survive in a competitive marketplace, we are often more digit than human.

We all have numerous numbers, but one number remains mysterious to most people: the famous (or infamous) credit score.

Three companies dominate the credit reporting world: Equifax, Experian and Transunion. I’ll call them “The Big 3.” Banks and finance companies report customer payment data to The Big 3 every month.

Generally, lenders report your name, address, date of birth, Social Security number, current loan balance, payment amount and whether you made your agreed upon payment that month.

The Big 3 also collect information from federal, state and county public records. Overdue taxes, lawsuit judgments, etc.

The Big 3 assemble information on you over time. Whenever lenders want help deciding whether to make you a loan, they turn to one or all of The Big 3 for a history and a score. The Big 3 has your payment history in their files, but they turn to one particularly company for the score. The company is called FICO.

FICO stands for Fair Isaac Corporation. Two mathematicians, Bill Fair and Earl Isaac, started the company in California in the 1950s. Fair and Isaac believed that a systematic review of payment-related data could better inform credit decisions.

Over time, they and their team of quants developed an algorithm that they believed could predict the likelihood that a person will repay a debt.

They pitched their idea to 70 large lenders and finally got a bite in 1972 when they built an automated credit scoring system for Wells Fargo in California. Other lenders began signing on.

By the early 1990s, The Big 3 began using Fair Isaac’s system and “FICO” became a household name. Roughly speaking, here’s how it works.

The system compares a person’s financial situation to hundreds of thousands of other people who were, at some point in time, in a very similar position.

It analyzes how likely those people were to repay their debts and then assigns a rank to the current consumer based on the average performance of the people in a like situation.

Payment history and amounts owed are the predominant factors analyzed, though length of credit history, level of new credit and types of credit used are also considered.

FICO’s score range is 300-850. The Big 3 may add a bell or whistle to the score to make it their own. That’s why your score may be slightly different between agencies or, hopefully, even above 850. (Transunion goes to 900.)

If your score is dramatically different between agencies, a particular lender may be reporting to only one or two of The Big 3. Or, heaven forbid, someone else’s information is on one of your reports.

It can happen more easily than we’d like. If a credit clerk at a lending company somewhere mistypes one digit of a Social Security number, you may have a $1,600 Dodge Viper car payment on your hands.

AnnualCreditReport.com is the best place to do so since it’s free and officially sponsored by The Big 3. Some people check all three reports at once. Others like to stagger their checks in order to monitor their information throughout the year.

Either way, it’s good to keep a close eye on your reports. If you’re going to be a number, might as well be a good one.

 

Kevin Thompson can be contacted at kevin@kwt.info.

The oil slump and its effect on Texas

Texas Railroad Commissioner David Porter recently quoted the president:

“We cannot drill our way to lower gas prices.” – Barack Obama, March 2010

Well, Mr. President, it appears we did – at least in part. Here’s a synopsis of how a barrel of oil sells for $100 in June and $50 six months later.

  1. American Ingenuity. Through rock fracturing and horizontal drilling,  U.S. oil companies figured out how to extract oil from previously unproductive lands. With barrel prices north of $75, it made economic sense to drill relatively expensive unconventional wells in rural U.S. locations and then transport the runs to market.
  1. Arab Stubbornness. Since oil flows like water in the Organization of Petroleum Exporting Countries (OPEC), they don’t need costly setups to increase production. They can turn it up or down at will. Historically, they have throttled back to keep oil prices relatively stable. Whether the Saudis are irritated that the United States failed to topple Syria’s rogue regime or simply perturbed that U.S. producers haven’t restrained their production, they have decided not to turn off the spigot this time. They seem content with $40, even $20, oil in exchange for a return to their historical market share.
  1. Laws of Economics. Supply is up due to the aforementioned reasons and the resumption of production in Algeria, Libya and Iraq. Meanwhile, global demand has moderated for several reasons. First, China overstated its growth and overstocked. Second, Europe’s economy remains sluggish. Third, stiffer machine efficiency requirements are reducing fuel needs.

 High supply and low demand has caused the price of oil to fall to a new equilibrium.

 A big question among U.S. producers and oil & gas states like Texas is: For what price does oil need to sell in order to maintain profitability? Most seem to think between $60 and $80.

A bigger question is: Was price stability sufficiently considered in recent years or was the focus more on whether wells would produce?

My hunch is companies considered capacity more than price. It was more “Will the ground produce?” and less “Will the market pay?”

Oil firms have begun laying off workers (e.g., Schlumberger recently announced it will cut 10% of its workforce). With Texas’ unemployment rate lower than the national average (5.1% vs. 5.8%), we have some room to absorb.

And Texas’ economy is more diverse today than thirty years ago, though only in terms of employment base. JP Morgan Chase economist Michael Feroli has noted that the industry’s share of state economic output is roughly the same as it was in 1985.

This is cause for alarm, as is the high level of leverage that oil companies used to put wells and pipelines in the ground. Banks now own billions in oil industry loans and trillions in derivative contracts (i.e., oil price hedges).

If prices don’t bounce back in the next 6 – 12 months, banks will sustain hefty losses in the form of loan defaults and underwater contracts. That will limit access to capital in other industries.

Finally, the oil field services companies that sprang up in the last decade will be collateral damage if prices don’t rebound soon. Hopefully, all these players have set aside bounty from the boom to buffer a bust.

Retired Southwest Airlines co-founder Herb Kelleher knows that’s not likely the case. He recently recalled a bumper sticker from the late 1980s: “Dear Lord, give me another boom and I promise I won’t screw it up.”

Follow Kevin Thompson at http://www.kwt.info.

What’s on your PFS?

As a banker, I’ve seen some very bright people butcher a personal financial statement (“PFS”). In finance terms, the PFS is an individual’s or couple’s balance sheet.

A balance sheet is called such because both sides of this equation must equal, or balance: Assets = Liabilities + Net Worth (another name for Net Worth is Equity). It is a snapshot-in-time picture of an entity’s financial health; the more positive the net worth, the better.

Basically, a PFS lists what you own and what you owe. If you’ve ever filled out a standardized home mortgage application, you have completed a PFS, you just may not have known it.


What You Own

The “What you own” side of the PFS includes your all your assets, i.e., things of value. “Value” can be subjective. So, it’s important we find objective sources to assign a market value to our things.

Let’s look at the most common asset categories.

1. Cash – No asset is more accurately valued on a PFS than one’s cash (checking and savings accounts, and, if you’re a conspiracy theorist, the dollar bills in your gun safe).

2. Financial Investments (e.g., stocks, bonds, mutual funds, annuities, etc.) – Under this category are two important sub-categories:

A. Non-retirement vs. Retirement – Non-retirement assets are more “valuable” than retirement assets. My 401k statement may say $25,000, but taxes and early withdrawal penalties make it really worth $19,000 (or less) in a crisis. Non-retirement accounts are only subject to capital gains taxes.

B. Publicly-traded vs. Privately-held – I know I could sell my Valero stock this afternoon for about $40 a share. But most companies are not listed on a “public” stock exchange like New York or Nasdaq. These startups or family businesses have a much smaller pool of buyers, if any at all.

Publicly traded investments held in non-retirement accounts are almost like cash with the caveat that they are more volatile.

Other financial assets, like ownership in a privately-held company, are harder to value and even harder to turn into cash. A CPA familiar with your industry can help assign a “potential” market value to your business.

3. Real Estate – Primary homes comprise the bulk of most people’s real estate assets. Estimating what your home and other real estate (rentals, land, etc.) would sell for is almost as hard as predicting what your business would sell for. We are emotionally invested. We know how much work we’ve put into them.

A place to start is the tax value. Then, you can compare recent neighborhood sales. But only a market appraiser can apply relevant adjustments to arrive at a “probable” market value.

Ultimately, an asset is only worth what someone is willing to pay for it at a given time. Under duress, things sell for less.

Therefore, be conservative in your value estimates of real estate and “personal items” like autos, jewelry and art. Your banker will be impressed by your restraint and your family will have a more accurate picture of their status should a worst case scenario occur.


What You Owe

Now for the “what you owe” side of the PFS, also known as Liabilities.

As a general rule, liabilities (debts, loans, etc.) are easier to get into and harder to dispose of than assets. It takes years to build a business that’s worth $200,000. It takes only a few signatures to get into the same amount of education debt.

One bad year can erase the business’ $200,000 value. The education debt will stick with you like a faithful spouse – through good years and bad.

Once, when my family was growing and we needed a larger vehicle, I was so proud that my good credit had gotten me a long repayment period and, therefore, a low monthly payment. Then, imagine my horror four years later when my french fry-encrusted vehicle was worth far less than the loan balance.

While assets can be tricky to accurately value, it’s easy know to know the “value” of your debts; your lenders are tracking them quite closely. What’s hard is remembering what debts we have!

“Oh, right. I did pay for those fillings with Care Credit.”

“What? Did we put the washer and dryer on the Big Bank credit card?”

“Have we paid off the ‘new’ couch yet?”

Common household debts can be separated into two key categories: secured vs. unsecured.

Secured debts have assets pledged to them that the lender could sell if the debt is not repaid (a situation called “default”). These pledged assets are known as collateral.

The most common secured debts are: vehicles and other big boy toys; houses and other pieces of real estate property; and big-ticket consumer furnishings that go into houses.

The most common unsecured debts are credit cards, education loans and personal or “signature” loans.

These unsecured loans tend to have higher interest rates to compensate the lender for the risk of not having assets to sell in case of default. An exception might be education loans that are subsidized or guaranteed by the federal government.

Two sub-categories of secured debts are those attached to appreciating assets vs. those collateralized by depreciating assets. Appreciating assets, like a home in a healthy neighborhood, gain value as the years progress. A sports car, a depreciating asset, loses value by the mile.

Generally speaking, loans secured by assets growing in value are wiser financial decisions than loans secured by depreciating assets. But at least the latter are backed by something you can sell if the sky falls. A PFS of unsecured consumer debts is the fastest way to financial ruin.


Your Net Worth

Then comes the all important subtraction. If the combined, legitimate, real-world value of one’s assets is greater than the sum of his or her debts, net worth is positive. If the debts are greater, it’s negative.

The sooner a family can get to a growing, positive net worth, the better equipped it will be to provide for landmark expenses like college educations and retirement.


Kevin Thompson is the Boerne Market Manager for Centennial Bank. He can be reached at kevin.thompson@bankoncb.com.

Follow the money

As a banker, I’ve handled piles of “money” that could buy life’s finest luxuries. They could also start a small campfire. What’s the difference? The reputation of the printer.

Uncle Sam says stacks of dollar bills are worth more than kindling. So far, we have believed him.

Russian-born novelist Ayn Rand wrote in her 1957 classic, Atlas Shrugged, that “when you accept money in payment for your effort, you do so only on the conviction that you will exchange it for the product of the effort of others… Those pieces of paper, which should have been gold, are a token of honor- your claim upon the energy of the men who produce.”

At its core, money is nothing more than a tool, a medium of exchange, a signal of value. There is nothing inherently good or inherently evil about it. Like fire, it can be used for good or evil. The difference lies in how we humans care for it.

First, on a personal level, you can tell alot about a person by how she cares for her money. Is she flippant with it or intentional? Does she make it last? Does it do some good? Or does it slip like water through her fingers?

God said your money flows in the direction of your priorities. His observation in Matthew 6 came on the heels of a command to store up treasures in heaven. How does one “store up treasures in heaven?” By using one’s resources, money included, to make eternal impacts on people’s lives.

Second, on a national level, you can tell alot about a country by how it cares for its money. Do politicians and central bankers protect their currency’s value? Do they let wealth grow organically, as the result of the hard work of their constituency? Or do they speak it into being in order to make financial hardships seem less harsh?

Do a nation’s leaders maintain a level playing field so that money flows according to the free decisions of free people? Or is the landscape skewed so that the governors help determine winners and losers?

America’s central bank, the Federal Reserve Bank, has “printed” trillions of dollars since 2008. The purpose has been two-fold: (1) to keep people buying houses (because interest rates are low) and (2) to keep Congress spending money (because the Federal Reserve keeps purchasing US Treasury bonds.) Scarily, inflation has been reduced to an afterthought.

In addition, from green energy initiatives to nationalized health care to talk of wealthy companies’ (e.g., oil & gas) and individuals’ “paying their fair share,” the dark clouds of government intrusion loom overhead like shadows at dusk.

“Sound money” advocates easily reject these “easy money” policies. Ms. Rand, for example. One of her protagonists in Atlas Shrugged was industrialist Francisco d’Anconia. His speech midway through the book delivers as good a defense of capitalism and limited government as ever was offered, including this prescient warning:

“Money is the barometer of a society’s virtue. …When you see that in order to produce, you need to obtain permission from men who produce nothing- when you see that money is flowing to those who deal, not in goods, but in favors – when you see that men get richer by graft and pull than by work… you may know that your society is doomed.”

As an outsider looking in, Mr. d’Anconia reminds his listeners, and us, of the United States’ unique contribution to economic history.

Americans, he says, “created the phrase ‘to make money.’ No other language or nation had ever used these words before. Men had always thought of wealth as a static quantity- to be seized, begged, inherited, shared, looted or obtained as a favor. Americans were the first to understand that wealth has to be created.”

Not merely printed.


Kevin Thompson is Senior Vice President at Boerne Market Manager for Centennial Bank. He can be reached at Kevin.Thompson@BankonCB.com.

Debt vs. Leverage – there is a difference

Though I work for a lending institution, I enjoy a periodic dose of Dave Ramsey. For those unaware, Mr. Ramsey has built a small empire helping people get out of debt and manage their money better.

Through radio, books and conferences, he has almost single-handedly turned “debt” into a four-letter word. His “Total Money Makeover” takes readers through a handful of “baby steps” that result in their being able to call his daily radio show to give a “debt-free scream”.

Dave’s logic is sound, his examples clear. For instance, if you invested the equivalent of an average American car payment in a growth stock mutual fund every month for forty years, you would finish with more than five million dollars.

Without a doubt, many Americans find themselves in precarious positions financially. Student loan debt that never turned into a high paying job. Car loans that eat up too much of a family’s budget. Short-term credit card debt that has turned into a long-term problem. A death spiral of pay-day loans.

These scenarios, and a spendthrift U.S. government, have given debt a bad name. But there is another side to the story.

In the finance world, debt and leverage are used interchangeably. Not so in everyday life. “Debt” has a negative connotation, as in something you (or your federal government) get buried in. “Leverage”, meanwhile, conjures a more positive picture of something moving or lifting for the better.

Leverage is not a dirty word. When an entrepreneur hires an employee, she is leveraging that person to expand her capabilities. When a professional takes out a mortgage, he is leveraging his future earning potential to increase his standard of living.

Leverage is a form of teamwork that accomplishes more good collectively than the individual parts could do on their own.

Now, if you’re eating rice and beans on the Dave Ramsey plan, I’m not trying to sell you a steak. Healthy discipline should follow unwise spending. It’s always the right time for self-control.

What I am suggesting is that careful lending has as healthful a place in an economy as currency itself. “Careful”, of course, is the operative word.

It makes no sense for me to loan the recent high school grad $40,000 for a new Mustang when the payment will be more than his apartment rent. It makes no sense for our federal government to be in $1.6 trillion of UNSECURED debt (though “only” $1.1 trillion is held by non-US government entities).

It makes a lot of sense for me to loan the single mom $10,000 to buy an efficient, reliable car with which to get to work on time. And it often makes sense for someone to borrow money at X% if he/she can in turn likely make X+Y% from another investment.

Appropriate leverage presents a borrower with an opportunity to keep a promise. It implies that he is trustworthy and capable of acting responsibly. We humans grow in positive ways when we make and meet commitments. In general, leverage promotes ownership and ownership strengthens a society.

Moreover, one could make a strong argument that the finance industry drove the technological and industrial innovations that have improved quality of life the world over.

In a perfect world, we all would have ample liquidity to bankroll all our purchases. Interest expense would be nonexistent. But in a balanced approach to pursuing life, liberty and happiness, interest expense may be a small price to pay for the progress it provides.

Kevin Thompson writes weekly for The Boerne Star in the Texas hill country. He can be reached at kevin@kwt.info.

Financial tips for grads

From my post as a local bank lender, I have reviewed many personal financial situations. Credit reports, financial statements, tax returns, paycheck stubs. The good, the bad, the “What were you thinking?”

Since it’s the time of year for me to give unsolicited advice to people who aren’t listening, here’s a message on money.

Be very careful who you marry. This may seem like an odd way to start a financial advice column, but nothing destroys wealth like divorce.

A corollary: Nothing will get you through financial setbacks like a solid marriage. Make patience a top virtue of your marital choice and you’ll be well on your way.

Live below your means. Overextension is a scourge of our time. Keep margin in your schedule and in your finances. Don’t spend every dollar you make. Save some, invest some, give some.

When you give, give generously. The more it hurts, the more it helps – most of all you. Generous people prosper. It’s a spiritual law like “You reap what you sow.”

Be a producer first and a consumer second, not the other way around. It’s the only sustainable way to live. Some of your elders in Washington are still trying to figure this one out.

Keep it simple. Only do things financially that you understand. At some point, some relative will invite you to invest in something that will sound too good to be true. It will be.

Underestimate the value of things, especially if you own them. Something is worth only what someone else is willing to pay for it right then. Your Xbox is worth $50, not $300.

Don’t talk about how much or how little you paid for things. That’s annoying.

The value of what you own (your assets) minus what you owe (your liabilities) equals your net worth. The more positive the number, the better.

But it’s not necessarily your assets that give you financial stability; it’s the recurring cash flow generated by the assets. Many assets don’t generate any cash flow.

Pay your bills on time – no – early.

If you get in a bind, communicate with your creditors. For lenders, the worst news is not bad news; it’s no news. The bank doesn’t want your Honda Civic back. Explain the situation and ask for a mutually acceptable plan of action. Then do what you say you’re going to do.

Keep your image consciousness in check. We all have some. It drives what we drive. But if your car payment equals your rent payment, it’s not in check.

Never have an auto loan over $10,000. Just don’t.

Don’t take out more student loans than the average starting annual salary of someone in your chosen profession. In other words, don’t go to SMU for a social work degree. (See http://wp.me/pEqWm-aG for more thoughts on student loans.)

Plan and track every dollar you spend. You’ll never grasp your total financial picture unless you grasp the picture’s tiniest components. iPad app or spiral notebook, the method matters not. The habit does, especially in an era of easily forgettable electronic payments.

Sometimes you’ll take a job because you’re passionate about it. Other times you’ll just need the experience. Both reasons are valid.

Beware a high salary that locks you into a situation that doesn’t inspire you. Expenses will quickly rise to fill income and will be hard to undo. Many miserable people are paid quite well.

Finally and most importantly, store up for yourselves treasures in a higher economy, one not subject to recession, layoffs, fraud or theft.

Kevin Thompson is vice president of Texas Heritage Bank and a weekly opinion columnist for The Boerne Star in the Texas hill country. Follow him at http://www.kwt.info.


Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Join 739 other followers

Archives


%d bloggers like this: