going the distance: the key to long-term financial success

“Financial success doesn’t happen overnight, but is the product of years of work.” That kind of pithy saying is obvious almost to the point of being painful, so why point it out? Well, I wouldn’t bother, except for the fact that most people don’t actually act on it; they don’t seem to know what thinking in the long term actually means. So let’s get into specifics, shall we?

Spending trends are more important than events. Did you spend more than you earned in November? Who cares? What matters is, are you spending more than you earn over time? One month isn’t going to make or break you; what matters is the long-term trend. Does your spending go up faster than your income? When you get a raise, does it immediately go to improving your lifestyle — or do you set aside some of that raise to pay off your debt faster or bump up your monthly 401(k) contribution? Do you have a plan to not only to save a certain amount, but to increase that amount year after year?

This is one of the reasons why a buffer should be your very first savings goal. When you’re no longer swamped with the day-to-day stress of wondering whether you can pay the bills, you can spend more time looking at the trends — both external (like the price of gas) and internal (like how much you decide to put aside each month).

“Always in motion is the future.” Ten years is a long time from now — so why base your plan on a bunch of assumptions about where you’re going to be? Instead, you need to make flexibility a priority, which in turn means building up discretionary income by resisting lifestyle inflation, paying down your debts, and saving up for new purchases, rather than taking on new debt. The more discretionary spending you have available, the better you’ll be able to handle whatever life throws at you.

Your investment plan can’t be based on occasional luck. So you (or your financial planner) predicted the latest crash and pulled all your assets out of stocks just in time, or invested in Apple stock when it was at 200, or made a killing selling covered calls while the market was going nowhere. That’s great, but…that’s not what’s really important. What’s really important is whether you (or they) perform well consistently, year in and year out, for decades. The flip side is also true: don’t be too quick to dump a strategy or planner for underperformance, either. A conservative portfolio looked like foolishness in 1999…and sheer genius in 2001.

See what I mean? The long-term view means ignoring events in isolation, and looking at patterns and systems instead. Not why you spent $300 on electronics last month, but how you’re controlling your spending over the year; not how you’re going to pay your recently-raised rent, but what your plan is for maximizing your discretionary spending; not what the market’s doing this week, but what it’s doing this century.

And if that kind of systematic planning just isn’t your thing, well, that’s what geeks are for.

self-compassion over self-esteem (in finances and beyond)

Many of us born after a certain year have had “self-esteem” drilled into us since we were children. “Good job!” is still ringing in our ears after the innumerable times it was said to us — to the point where the words have almost  become meaningless. And why not? Confidence seems to be the underpinning of almost every form of success, even more so than intellectual ability, and the best way to build confidence in someone is to continually tell them how awesome they are, right?

Wrong.

Per the book by Dr. Kristin Neff of our very own University of Texas, this is more like “stuffing ourselves with candy.” We get a brief “high” of increased self-worth…which then crashes in despair when reality tells us something different. We try to pump ourselves back up by more “positive self-talk”, ignoring our faults and placing the blame for failures on something (anything!) outside of our responsibility…which sets up a continual high/crash cycle that ultimately goes nowhere. After all, how can we improve — really improve — if we refuse to learn from our mistakes?

This affects every aspect of life — including finances. Full of confidence in our ability to stick to a budget, we get aggressive in cutting back on perceived luxuries like new clothes or electronics; the next month, we stare in horror at our five-hundred-dollar Nordstrom or Fry’s bill, and give up budgeting entirely in despair. Full of confidence in our ability to time the market, we load up on “sure-fire winners”; then the bubble pops, and in the ensuing financial and emotional crash we pull our money out of the market entirely. It happens everywhere, all the time; self-esteem not only blinds us, it hobbles us and keeps us from growing.

The alternative? Self-compassion.

Self-compassion goes by several names, like humility or perhaps intellectual honesty, but it is, in its basic essence, deciding not to judge yourself. This does not mean refusing to evaluate your performance in any given area; rather, this means separating that performance from your worth as a human being. It means allowing yourself to make mistakes, with the knowledge that we grow by making those mistakes and allowing ourselves to embrace and learn from them. By acknowledging that we can and will make those mistakes, we can better deal with the consequences.

Of course, this applies to finances as well. When making a budget, we might set more realistic spending limits, or create an “oops” category for mistakes, or set aside a regular time to adjust next month’s budget based on last month’s spending. When designing a financial plan, we might be more willing to seek outside help and opinions, more able to take the right amount of risk, and less likely to panic and “sell everything” in the face of the unexpected.

So, great; how do we do that? The first step, of course, is in acknowledging that self-compassion is a valid choice — perhaps the hardest step for many of us, with our artificially-inflated egos that are more afraid of giving up that false self-esteem than we are of the inevitable real damage that it causes. But by taking this step, we are allowing ourselves to take the next: to surround ourselves with compassionate people. By choosing friends and advisors that judge our actions without judging our character, that compassionately tell us what we need to hear rather than what our egos want to hear, we are setting ourselves up for real growth.

And the more often we hear truth delivered with compassion, the more our self-compassion will grow, our egos shrink, and our lives improve.

systematically solve your financial problems, part 4

So: you’ve identified the problem, chosen a system, and established criteria for success. Now all that’s left is to implement the system and wait for success to find you, right? Well…no. As I mentioned last week, every system is an experiment, so as with all experiments, you need to periodically review and tweak your system.

This is what trips most people up. Once a plan is in place, they feel this rush of relief, almost as if they’ve already beaten whatever problem they’ve come to solve. So they go on their merry way…and are completely blindsided when their system blows a gasket or simply fails to start. No, every system needs regular care and feeding, whether it’s weekly, monthly, or even yearly.

Example: a budget. You get tired of not knowing how much money you have to spend, so you sit down one day, go through your receipts, and come up with one. All the numbers add up, everything looks great…until next month rolls around. You find that you overspent on eating out, so you grit your teeth and resolve to underspend by that much the following month. But that month you have friends in town, so of course you eat out even more, and find yourself hundreds of dollars in the hole…and you give up. It just wasn’t working for you.

Well, of course it wasn’t! Remember: every system is a continual experiment. Instead of just throwing up your hands, tweak your system. Maybe you need to allocate more money to eating out. Maybe you need to switch to the envelope method. Whatever it is, it’s almost guaranteed that you won’t get it right the first try…and what works today may not work a year from now. No budget is ever exactly on target, and there is no such thing as a “normal” month; what makes budgets work is when you sit down each month and adapt your budget to Real Life. (By the way, YNAB is excellent at this sort of “rolling with the punches”.)

Or maybe you decided that making a budget was exactly what you and your spouse needed to see eye-to-eye. So you sit down, make a budget, explain it to your spouse, they agree…and then promptly blow it out of the water the next time they see a sale. You could give up…or you could tweak your system. A “monthly money date” is an excellent way to make sure you and your spouse are on the same page re: finances. (Oh, and the system of “just not talking about money at all”? That won’t work. I promise.)

Now, this sort of thing doesn’t come easy to most; we’ve got lots of other things to worry about, and taking time out for our finances doesn’t often make the priority list, even when we know it should. This is where financial coaches really shine. I’m not talking about normal financial advisors, who are mainly interested in selling you insurance and investment products; I’m talking about the ones who work with you to create and maintain your financial systems. Like a personal trainer, they not only give you the information you need, but they also guide your development as you grow, regularly reminding you to tweak your systems — from budgeting to investing — and giving you ideas on how to do so.

Unfortunately, while you can’t throw a rock without hitting a financial advisor, the kind of financial coach I’m talking about (who often does financial advising and then some) is a bit trickier to find. There is my own practice, of course, and I’d be delighted to work with you; also, I highly recommend my friend Jennifer Jaime, a CPA and excellent financial coach.

Whether you get an expert to help you or no, remember this: financial success — or failure! — rarely comes from a single decision. Rather, it comes from your systems, and the day in, day out decisions that come from them. Care for them consistently, and you’ll get where you want to go.

systematically solve your financial problems, part 3

We’re in week three of talking about using systems to solve your financial problems, and before we dive into this week’s step, I want to step back and take stock of what is we’re actually doing.  “How to create a system” seems awfully vague, doesn’t it? Can this possibly be useful?

Of course, the answer is “yes”, but it’s important to understand why. Think about your financial situation for a moment. How did you get here? (Insert obligatory Talking Heads reference.) If you’re like most people, the answer isn’t that all your money fell on you out of the sky, nor is it that it was all taken away in a single day. No, most people are where they are as a result of many choices: from larger ones, like going to Vanderbilt, getting a job as a professional clown, or starting a family, all the way down to how many times you choose to eat out each week. None of these choices by themselves is going to make or break you — rather, it’s the sum of them, the direction you’re heading, the path you’re walking, that determines where you will go. Creating a system is simply plotting out that path, so that in the end, you get where you want to go. You’re not going to get out of debt or save up for your retirement in a day or a even a month — you need a system to gradually take you there, over months or even years.

So: next step! First, you identified the exact problem you were going to solve, then you identified a system to try. The key word here is “try” — there is no One Perfect System. Once you realize that every system is an experiment, then you’ll realize that failure is not only okay, it’s expected! First, though, you need to set up criteria for success — how will you know the system is working? — and make a special note of it. If it’s obvious — I’ll know that my system for handling debt is working because my debt will decrease — then great. Make a note of it anyway; this will be important in step 4. If it’s not obvious, take some time to figure out your criteria for success. Things are tense between you and your spouse when it comes to money? Start tracking how many times you fight about money, or how many times you get that sinking feeling in your gut when talking about it, or some other arbitrary-but-meaningful measurement. Even if it’s entirely arbitrary and in your head, it’s vital to identify criteria for success before continuing.

Why? We’ll go into detail on this next week, when we get to the final — and arguably most important and least followed — step to creating a system.

systematically solve your financial problems, part 2

Last week, we talked about a crucial step in creating a financial system: identifying the correct problem. Now, in some cases this is dirt simple: “I’m in credit card debt and I want to get out” or “I need to start saving for retirement but I never seem to have any money left over.” Maybe they’re more complicated — “my spouse and I always fight about money” — but you’ve sat down, talked it over, and figured out that you each just need a little money that you can call Mine Not Theirs. Now that the problem is identified, we can start looking at possible systems.

Good news: generally, there’s no need to come up with a system out of thin air. Money — even credit cards — have been around long enough that people who geek out about finances have come up with some good systems for handling it. Credit card debt? It’s really hard to beat the envelope method. Need to save for retirement? Pay yourself first, start slow and ramp up. Need money that’s yours and not your spouse’s? Check out Yours/Mine/Ours. Find a financial expert, blog, or book, and talk/read until you find something that resonates.

Alright — so you’ve found a system, or maybe a few systems, and you’re trying to figure out what to do. You’re probably hesitating — will this system work? For me? Is it the best system? What if I don’t like it? What if it’s hard?

STOP.

That’s lizard brain talking. It’s natural for it to resist change — after all, back in the early days of homo sapiens, foolish change might mean death. In the case of money, though, it’s your lizard brain that’s being foolish.

True, the system might not work. It might need tweaking, or it might not be the right system. So it’s fine to do a little research, maybe ask a financial geek with experience. The key to remember, though, is this: every system is an experiment. Nothing is permanent. You don’t have to make a choice and then follow through forever. Rather, pick a system and get started. Not sure if it will work for you? Well, there’s only one sure way to find out! Once you’ve got some experience with a system, you’ll have a much better idea of what kind of tweaks it needs or whether you need to try something completely different.

Picked a system? Great. Stay tuned next week for the next step.

systematically solve your financial problems

A while back, I wrote a post on “working the system”, where I talked about how systems are a great way to solve your financial problems. (It’s worth going back and reading, if you haven’t recently.) “Great,” you say. “But…how do I do it? How do I know which system will work for me? How do I even know where to start?” These are good questions, and I’ll be covering them over the next few weeks.

First, identify the problem you want to solve. This seems obvious, but it’s critical. Don’t run off and start building a system until you’re sure it’s solving the right problem! If you’re stressed about money, sit down and think about why. Is it because you never know whether you’ll have enough money to pay the bills? Or can you generally pay the bills, but the credit card debt seems to be piling up? Or is it because you haven’t started saving for your child’s education, and you don’t know where to start? The systems for solving each of these problems will look very different! If you’re not quite sure (and believe me, it’s not uncommon to be stressed out without immediately knowing why!), then sit and think about each of the things that *could* be stressing you out — you know, all those things you’ve been trying to avoid. The one that gives you a sick feeling in your stomach? That’s the one you want to tackle first.

If you and your spouse are fighting about money, it’s doubly important to identify the right problem. This will take some effort, because you’re going to need to sit down with them and figure out exactly why you’re fighting — and it may have nothing to do with money at all! Oh, you may think you know (She can’t follow a budget! He won’t let me spend any of our money!), but I guarantee that unless you take the time to really understand your spouse, you’re going to end up running around in circles trying systems that don’t work.

Next up: finding the right system! In the meantime, though — have you ever spent time barking up the wrong tree because you didn’t properly identify the problem, whether in relationships or money? Tell your story in the comments below, and I’ll tell you mine! 

the ins and outs of espp’s, part 3: so now what?

So I gave you a summary of what ESPP’s were all about, then went into detail on the intricacies of ESPP’s and taxes. Now: what exactly are we to do with all this information? Should you participate in your company’s program, or not? And if so, how long should you hold on? Well, everyone’s situation is different, but for most people, I would say this: participate in your company’s plan as much as you are able, and sell as soon as you can. I’ll break down the reasons why, so you can see whether this applies to you in particular.

Participate, because it’s free money. The discounted price at which you get to buy the stock is, if you sell immediately, almost always guaranteed free money. (Among the exceptions are companies with extremely volatile or rarely-traded stock.) If you don’t participate, you are, as they say, leaving money on the table. Obviously you don’t want to go into debt over it, but if you can swing it, do it!

Sell immediately, because to do otherwise is to greatly increase your risk. Holding onto these shares is, in most cases, a highly risky proposition. Yes, holding onto them for long enough to make a qualified disposition may give you some tax advantage, but is it really worth dealing with the ups and downs of your company’s stock?

Moreover, if you think of an “investment” as a “source of future income”, you’re already highly invested in the company you work for. For diversification’s sake, do you really want to put even more eggs in that basket?

“OK,” you may say, “but what do I do, then, with this sudden influx of cash?” Well, your first instinct may be to splurge — and if so, that’s OK. Set aside some amount you feel comfortable with — say, 5 or 10% — and go for it. Consider giving some of it away, as well; chances are, if you have access to an ESPP, you’re in a position to help other folks out. Set the rest aside — either for basic financial goals or long-term ones, like retirement or your children’s education.

Of course, I know several engineers who quite simply and literally have more money than they know what to do with. You know who you are — and that’s perfectly OK. I may go into more detail on recommendations in a future post, but for now (assuming you’re already maxing out what options you have in the way of tax-advantaged accounts), I’ll just recommend parking the money in a well-diversified balanced stock-bond fund, such as the T. Rowe Price Balanced Fund, the Vanguard LifeStrategy Moderate Growth Fund, or the Fidelity Balanced Fund. Any of those will give you a nice, simple, inexpensive compromise between returns and stability until you decide you want to pull that “mad money” out.

Now that I’ve said that: what do you currently do with your ESPP, if you have one? Has this post given you any new ideas?

the ins and outs of espp’s, part 2: fun with taxes!

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In the last post, we talked about the basics of ESPP’s, and I warned you that the tax situation warranted a post in and of itself. Well, here it is! With a few pictures, hopefully it will come clear.

Let’s start with the basic diagram below. At this level, the tax situation is rather simple: the difference between the price at which you bought the stock and the price at which you sold it is income, and thus is taxed.

Sounds simple, right? Well, the trick is how it is taxed. There are three options:

Compensation (ordinary income): Part of your ESPP income is taxed as compensation, i.e. at your normal income tax rate.

Short-term Capital Gains: If you held your shares for a year or less after you purchased them, the part of your ESPP income not taxed as compensation is taxed as short-term capital gains. Currently, that means they’re taxed at the same rate as compensation.

Long-term Capital Gains: If you held your shares for more than a year after you purchased them, the part of your ESPP income not taxed as compensation is taxed as long-term capital gains. As of September 2017, that means they’re taxed at 20%, 15% or 0%, depending on your income.

OK, that doesn’t sound so bad. So that means that all we have to do is figure out how much of the income is compensation, and we’re home free, right? Well, yes…and that’s the tricky part. There are two situations we need to go into: “disqualifying dispositions” and “qualifying dispositions”.

Disqualifying Dispositions: If you did not hold your shares for more than two years after the “grant date” (beginning of the offering window; see previous postand more than one year after purchasing them, this is a “disqualifying disposition”. In a disqualifying disposition, the difference between the amount you paid for the shares and the amount they were worth when you bought them — in other words, your discount — is counted as compensation income. The rest — the difference between the amount the shares were worth when you bought them and the amount they were worth when you sold them — is capital gains; long-term if you held the shares for more than a year after purchasing them, short-term otherwise.

Sounds relatively straightforward, but what if your stock drops after you buy it? Well, the sad fact is that it the discount still counts as compensation income, even though you didn’t see a red cent of it! To be sure, the capital losses offset your income — but only up to $3,000. (The rest must be carried over to future years.)

Qualifying Dispositions: If you held your shares for more than two years after the grant date and more than one year after purchasing them, this is a “qualifying disposition”. In a qualifying disposition, your compensation income is equal to the difference between what you paid for the shares and what you sold them for or the discount (difference between what you would have paid for the shares and what they were worth) on the grant date, whichever is lower. The rest is long-term capital gains since, by definition, you held the shares for longer than one year. So an ideal situation would look like this:

That’s good — more of your income is taxed at the (lower) long-term capital gains rate. But here’s a bizarre twist: in the following situation, you would actually pay more in taxes for a qualifying disposition than for a disqualifying disposition!

Note that if this were a disqualifying disposition, your compensation income would be much smaller (look back at the second graph), and the capital gains much larger. Ouch — good things do not, apparently, always come to those who wait!

And that’s how ESPP taxes work. You’ll remember that forever, right? Well, if perchance you think something more important might displace its spot in your memory, feel free to bookmark this article and refer back to it later. (Heck, I’ll probably end up doing that myself!)

So…now what? This theoretical knowledge is all well and good, but what we should actually do with our ESPP shares? Do we participate in our company’s ESPP, or no? Do we sell some or all of the shares immediately? How long should we hold on to them? I’ll discuss all of these questions in the final post in this series.

the ins and outs of espp’s, part 1

Employee Stock Purchase Plans are, like much in the stock-related world, a double-edged sword. Depending on how you swing them, they can either be a handy supplement to your paycheck or just another source of complexity and, in the worst case, a way to flush income down the drain. As many of my fellow geeks have access to them — though not as many as a decade ago — I’d like to take some time to talk about them. Even if you’re already familiar with ESPP’s, it’s a good idea to know what’s out there — not every company’s plan works the same as yours, and it’s handy to know what the possibilities are when you’re job-hunting!

The idea behind the ESPP is relatively simple: as part of the benefits your employer is showering upon you — like manna from the heavens — you are given the opportunity to buy their stock at a discount. Nothing in the world of employer benefits is ever that simple, of course, so I’ll walk through the caveats.

The money for purchasing this stock is withheld from your paycheck. In this way, ESPP’s are much like 401(k)’s: you allocate a certain amount of your paycheck to be withheld, and that amount never graces your bank accounts. Also, there are heavy restrictions on when you can change that allocation; generally you can jump out if you like, but you can’t jump back in until the beginning of the next ESPP period.

The stock is often (not always) purchased in one chunk, at the end of the ESPP period. In this case, rather than buying stock each time you get a paycheck, it’s all purchased at the end of an ESPP period (generally 3 or 6 months). You can expect to see fun little jumps in your employer’s stock price on that day, as some/many/most employees (depending on the company) turn around and sell their newfound shares (and speculators buy or sell in response to this).

There is a cap on how much you can purchase. The cap can be either a maximum percentage of your paycheck, or a maximum number of shares bought, or both.

The discount varies greatly with the employer. Most common is a range from 5%-15%; alternately, the company may “match” your contributions to the ESPP up to a certain percentage of your income. Also, the discounted price is not always the fair market value on the day the stock is bought; it could be the lower of that price and the price at the beginning of the period, or even the price at the beginning of a window of periods! For example: say your employer’s stock price was $10 when you joined a year ago, $20 at the beginning of the last period, and $30 today, the end of the latest ESPP period. Depending on your employer, the buy price could be 5%/10%/15% of $30, $20, or even $10!

Depending on the company, it may not be a guaranteed win. In most cases, if you sell immediately you’ll lock in your profit and get a nice bonus. However, if you work for a company with a highly-volatile stock price (e.g. a “microcap”), you can lose your discount (and more!) by the time you sell your stock.

The taxes on ESPP’s are…interesting. So interesting, in fact, that I’ll be devoting my entire next post to them!

See you then! In the meantime, tell us about your ESPP — has it done well by you? And does it fall into one of the above descriptions, or is it a variant that wasn’t covered?

FG monthly reminders

To cut to the chase: being a lover of systems and automation, I’ve created a monthly e-newsletter with practical, straightforward reminders and tips to help you stay on top of your personal finances. I’ll talk about checking your credit report, updating your budget,  paying estimated taxes, staying on the same page as your significant other…you know, all the stuff you feel you should do, but keep putting off.

Of course, this will be free, and you can unsubscribe at any time. Sound interesting? Subscribe here.