Markets know best

It is not hard to come across investment opportunities that seem too good to be true. From the piece of real estate that can never fall in price because it is at a great location to the stock of a company that has great management so it will perennially keep appreciating are all "tips" that one often keeps hearing about. We also hear about the people who made a killing by actually investing in those. In this article, I will talk about when it makes sense to go by these tips and when it does not.

Efficient Markets

This is a technical term that actually is very useful to understand markets. Basically it says that the price of any item (including real estate and stocks) at any time is "correct". By correct it means that if you were to see the movement of price, it would increase in about 50% of the time decrease in 50% of the time. In other words, it is not possible, on an average to make profit.

How does it work?

While the proof and even the interpretation of this statement is very involved, some reflection will convince you that it should be correct. Consider the case of a property that is at a very good location. In this case, it may be the case that the property will be priced higher than others but why would it keep appreciating? On the other hand, if everyone knew it would appreciate than everyone would try to buy it and would make better and better offers to the seller. This would stop only when all the "excess appreciation" was factored into the price. Exactly the same thing works the company with a good product or a good management.

Can one make money out of tips?

A little reflection will tell you that the only way to make money out of tips like this is to get - and act on - them before others do. So your reaction may be to act on them immediately while others are still evaluating. This is often also mentioned in the tip itself. Unfortunately, that is unlikely to help you either.

The reason it does not work is because usually the person giving the tip has no special "love" for you. He could have given the tip to anyone else. Most likely, he chose the order in which to give the tip at random which means that a large number of people must already have received it and much of the price appreciation must already have taken place.

On the other hand, it is a great way to commit fraud. If even some people blindly believe on tips, than prices will increase for a short time. So the person giving those tips can hoard the item in question and sell it when the prices increase. This was the reason a why a couple of years ago promotional SMS about stock tips were banned.

But I believe in this tip

At times you will come across a tip that you think makes sense. Before investing on the basis of it, do ask yourself the following questions - 

1. What new information do I have that others either do not have or do not believe in?
2. Has there been any price movement in the last few days or weeks which may have been due to others getting the above information?
3. What is risk involved? What does it mean for my financial health?

When do markets NOT know the best?

This is one last thing that is important. There are a large number of cases when the market price may be wrong - often for large amounts of time. This often happens when

1. There is a monopoly - a single buyer or a seller.
2. Information is available to a select few - for instance when government comes up with a master plan for a city or a major contract is awarded.
3. Some new technology or innovation comes up - consider the dot com boom and bust
4. The world is going crazy - for instance when the central banks print a lot of money and flood the market with it

But in each of these cases again the only way you can make money is by getting out before everyone else realizes that they made a mistake. On the other hand, the potential to make huge losses is very large. If you realize that such a situation exists, the least that you should do is be very careful.

In Search of the Way to Save

Looking to the stars - Calvin & Hobbes

Personal finance is personal. Rule-of-thumbs may be a good start, but it surely isn't for everyone. I certainly have my own way to budget, and out of all the apps I've looked through to help me, not one found to be a perfect fit. I then stumbled upon an iOS app, earmark. It's a social saving-spending app for you to set the top five things you'd like to buy and share it with everyone, including status updates when you forego spending to save for said five items. Pretty neat.

Three things I like about this:

1. Clarity. It would help me take a step back and remind myself that I have saving goals to achieve. In moments of need of clarity, I think this app would help me when my mind start playing the justifying-a-purchase games.
2. Motivation. We are social beings and our motivations sometimes require that social interaction. "Not buying this for that trip, proud of myself", and then receiving a supporting reply from a friend, "you go girl! let's make it to Makkah". Seriously, saving for hajj is hard...
3. Communication. Sometimes other people make our personal spending plans. Hanging out, do this, eat that. Those things add up.When we make it known to friends we're saving for something, it makes communicating personal intentions and rejecting an offer a lot easier.
4. Behaviour. People get easily hooked on social media outlets. If we get hooked on the app, we get hooked on our goals, we will achieve it.

What I don't like, but they might actually be right, is;

"We hate budgeting. 

So does everyone, ever.

We hate budgeting. So does 99.9% of the population.

We also like spending money. So does 100% of the population. 

Earmark helps people who hate budgeting save money while spending it."

I like that I've set myself a budget. It's life changing. But I guess for those who haven't, this app might actually work. For myself. I don't know. I don't have an iPhone. What I'm interested in most is whether I can apply earmarking [designate (something, typically funds or resources) for a particular purpose.] for myself.

So, what I'm proposing to do is to:

1. Unify my goals. I'm going to follow the findings that people become better savers when they have a single goal (pdf link). So I'll unify a single goal to the items I'd like to buy with a goal of higher calling or a long-term based goal like retirement.
2. Partition. Increase the chance of success of earmarking by separating the money physically, especially if the money has a visual reminder (pdf link). So, create a custom printed wristlet, or wallet (2), with a picture as my reminder.

Now, if I have a wallet for zakah, what are my visual cues...

"Is the description of Paradise, which the righteous are promised, wherein are rivers of water unaltered, rivers of milk the taste of which never changes, rivers of wine delicious to those who drink, and rivers of purified honey, in which they will have from all [kinds of] fruits and forgiveness from their Lord, [...]"

47.Surat Muĥammad (Muhammad; 15)

"He will forgive for you your sins and admit you to gardens beneath which rivers flow and pleasant dwellings in gardens of perpetual residence. That is the great attainment."

61. Surat Aş-Şaf (The Ranks; 12)

One way ticket to Jannah. Insha'Allah.

The Emergency Budget

I was reading an article on twocents.lifehacker and as I reached the comments section, I noticed two awesome inputs suggested by commenters:

1. Create an emergency budget
When I set my budget, I made one assumption. Ceteris Paribus. All other things constant. I would still have my job and all needs remain the same. But there are other scenarios that might happen like losing main source of income, a brand new member in the family, and so on. So, a quick way to live in a state of an emergency is to reduce and eliminate those that can be eliminated to prioritize the fulfillment of needs. Iheartbudget have a great article on this.

2. Have an emergency fund consisting of a "My Car Died" and "My Job Died" fund.
The second suggestion is to categorize emergency fund into two. An emergency if something happens to your car or appliances and an emergency because you lost your job from downsizing, quitting, or retiring. They are both straight forward and I feel by categorizing it, you have a clearer idea of why the money is lying around, and what to do with it once the situation calls it to action.

My Car Died fund should be a cash account fund because it's something that should be ready to use. My Job Died fund can be a mixed portfolio because in the long run, it doubles as a retirement fund. One caution is if the fund is not diversified and you happen to lose your job and the fund is affected by a greater force like inflation or stock market crash.

So, with both points in mind, I guess it's time for me to modify my budget into budgets, and my emergency fund into funds.

Training Your Wealth Accumulation Muscle

Image from abqjournal.com

Spend less than earned. Accumulating wealth is easier said than done. Accumulating snow and turning it into a snowman however, never felt that difficult. We start with a handful then roll it on the ground until it gets really big. It turns out that the method to building a snowman, called the snowball method, is the most effective way to pay off debt. I am proposing that it can also be an effective way to build our wealth accumulation muscle.

The snowball method can be similarly applied to how we build wealth. We start with small wins that gets us immediately hooked to the challenge to better the previous win. It keeps going and rolling until we reach the big win.

Let's play a game!

You'd like to save $2000, that is your created imaginary debt. Split your debt unequally in amounts that you need to pay off and prepare envelopes for payments to the debt. The maximum split is 5, but let's say you have split it up into 4 different debts of $100, $400, $700 and $800 totaling to $2000. Search "average credit card interest rate" on Google, you'll have an average number for all those debts, in this article's case it's 15.6 percent.  

Now, you might be asking why maximum split of 5? Because we'll be using Bankrate's minimum payment calculator and it gives the maximum of 5. The rule is you need to pay all the cards monthly, so if you're focusing on one card with the lowest balance, you'll need to pay the other cards at minimum. Enter the debt amount, interest rate and minimum payment percentage to get your minimum amount. 

Can we fix our finances? Yes!

Can we pay off our debt? Yes!

Can we build wealth? Yes, we can!

The Vehicle You Deserve To Have

I have a 20 (+/-) year old car and I've been thinking of purchasing a new one. It's time, maybe. The car is running fine with no issues, but the air conditioner and that it's a gas guzzler (Nissan Pathfinder). I've always been a firm believer that the car I need is the car that will get me from point A to B and fits my budget. The problem, I don't really know which car exactly fits my finances. Until I was given a recommendation to an article by the financial samurai about the 1/10 rule for car buying. It's simple, the vehicle you buy should be 1/10 of your gross annual income. If you make 50,000/year, you deserve a 5,000 vehicle.

And so, now I know that I am currently deserving a combination of public transportation and walking or a scooter.

The Golden Rectangle Budget

1.618 The Golden Ratio

One of the reason why many stories and parables in the Quran are perfect when it comes to personal finance is because it is a reminder. Reminder that includes three aspects; the past, present and future. So, I have been thinking how we can put all three aspects in our money management since they play a part in our budget. Example, the past plays a part in things we consume now and pay later, things like credit or utility bills. The present is the food we eat. The future are for things like retirement, investments and emergency savings.

This goes back to our previous topic, budget percentages, what is an aesthetically pleasing distribution for those three aspects? I looked to the golden ratio to guide me since it seems to be a magical number. I came up with this:

We have a choice of making the last proportion as charity or the past. Should we choose to have charity rather than the past, the things we consume now and pay later like rent, electricity, water, trash, sewer bills, can be bundled in the present. If we have a mortgage, it should fall under the future, since it is an asset that fluctuates like an investment. A car loan however would only decrease in price, it should fall into the present.
In truth, charity actually falls under the future because it is our investment for both dunya and akhirat. It is your choice to make.

So, how should we distribute our income in percentages?

Present 62% (food, transportation-gas, rent)
Future 24% (investments, savings, mortgage, charity)
Charity or Past 14% (utility bill, car loan)

If we would like to have the past and charity as separate categories, it would result in:

Present 62%
Future 24%
Past 9%
Charity  5%

It still looks like an ideal budget. In this scenario, what should be categorized into the past would either be utilities or a car loan, as one or the other will fall into the present. Simple and aesthetically pleasing, right?

Budget Percentages

Where Did The Money Go?

There are many advice on how we should spend a percentage of our income and budget accordingly. I've been trying to fit my budget on these guides, but I've never been able to fit the profile. I've realized that budget percentages only serve as a guide on what's normal for us to spend. Each of us have different lifestyle, conditions, needs and wants. It's almost impossible to fit in perfectly unless we live according to the ideal of the budget.

For example, most parents who live in the USA send their children to public school. So, it's natural that most parents don't have a budget for their children's education. But for parents who send their kids to private schools, or who live in countries where schools aren't free, will have their children's education on their budget.

Dave Ramsey Budget Percentages

Charitable Gifts 10-15%
Savings 5-10%
Housing 25-35%
Utilities 5-10%
Transportation 10-15%
Food 5-15%
Clothing 2-7%
Medical/Health 5-10%
Personal 5-10%
Recreation 5-10%
Debt 5-10%

What we can do is determine which budget percentages we can use as a guide to determine if we are overspending. Dave Ramsey's Budget Percentages is a good start. We can use parts of it as a guide. For example, spending 25%-35% of our income on housing. If we make $4,000/mth, then we can spend $1,400 on housing. If we'd like to save, we can budget housing and utilities together so that housing and utilities is budgeted $1,400/mth. That is an ideal situation. People that make $2,000/mth will have to find a place that rents $700/mth.

The rest, we have to list what we spend on monthly and see how much it takes up from our income. Next, we will cover a topic on determining which cars are affordable according to our income...

The Gadget Purchase Rule

What's Next For YOU To Buy!

I'm an avid gadget-news follower, but I don't really buy them. I've mastered the skill of waiting. The wonderful thing about gadgets is if you know what's coming next, and the one after, you'll be able to delay gratification. I've wanted an Apple computer for a long time. Maybe since 5 years ago. Every year I've successfully waited for the next Intel chip, and the one after it. However, since all those years, I've not saved up any money for my purchase. Which is a terrible waste of time and money I could have saved.

I've created "The Gadget Purchase Rule" for people who, like me, love gadgets and would love to purchase them. The rule determines which gadget is affordable within your means.

It's a very simple rule;

price of gadget/20% = amount needed to save

After succeeding to save the amount, you will be able to take 20% of amount saved as a reward to purchase the gadget. Also an additional rule, if the gadget is updated yearly and you plan to update yearly, you'd have to save that amount yearly.

Example, An unlocked contract free iPhone, $649/20% = Save $3,245. You'll have a savings of around $2,596 and an iPhone as your reward. If you'd like to upgrade yearly to a new iPhone, you need to save $3,245 every year. If you can't do that, then it is not a phone within your means.

Another example, I'd like to purchase a Mac Mini. $799/20% = Save $3,995. I plan on using it for a good 3-5 years before upgrading. I'd need to save $3,995 in at least 3-5 years and finally deserve to have it.

It might sound too extreme at first, but really that is the challenge to not only delay gratification but also build up savings. Because we should treat our savings like trees, plant when there's too few, but when in abundance, it does not mean we can cut and use it all.