### Archives For Investing

I pulled this out of our mail the other day:

Seriously? Someone at the Pennsylvania Lottery must be playing a joke. Big Savings? Let me get this straight. You’re going to use a coupon to buy a lottery ticket, and that’s going to bring you big savings? Let’s think about this just a bit.

#### What Are Your Chances of Winning?

Let’s use the September coupon for our example. This coupon gives you one \$2 Mega Millions with MegaPlier ticket for free if you buy one \$2 Powerball with Power Play ticket. Basically, this is just one set of numbers because a regular ticket costs \$1 for one play and the Power Play (or MegaPlier) doubles the cost of the ticket.

The Pennsylvania Lottery’s website says your overall chances of winning a prize with a Powerball ticket are 1 in 35.11.

We can figure out your chances for winning any of the specific prizes with some simple math. If your chances of winning a prize are 1 in 35.11, that means you have a 2.8482% chance ((1/35.11)*100) of winning every time you play Powerball. (Not very good, huh?) Basically, you can only expect to win something once out of every 35 tickets you buy. But that doesn’t tell us how much the ticket is really worth because your prize can range from \$3 to \$14,000,000 (or \$6 to \$14,000,000 if you buy the Power Play option) given the current jackpot. To figure out the value of your ticket, we’ll need to do a little more math.

#### What’s Your Ticket Really Worth?

By using the odds given for each specific prize level, we can figure out the average prize for a winning ticket. Overall, you have a 2.8482% chance to win on any given ticket. You can use the same process to figure out your chances of winning a given prize. For example, the Pennsylvania Lottery website says you have a 1 in 61.73 chance of winning the lowest prize of \$3. That’s a 1.61996% chance ((1/61.73)*100) of winning \$3 on any given ticket. Since you have a 2.8482% chance of winning any prize, you’d expect a little more than half of your winning tickets to have a \$3 prize. (The math is simple: 1.61996/2.8482 = 0.568766 * 100 = 56.8766%.)

Continuing this process for each prize level, we can figure out your chances of winning a specific prize any time you have a winning ticket. This table shows those chances for a regular Powerball winning ticket.

 Match Prize Chance of Winning This Prize on a Winning Ticket 5 Numbers + Powerball Jackpot (currently \$14,000,000) 0.000018% 5 Numbers \$200,000 0.0006833% 4 Numbers + Powerball \$10,000 0.0048552% 4 Numbers \$100 0.1845% 3 Numbers + Powerball \$100 0.2573% 3 Numbers \$7 9.7787% 2 Numbers + Powerball \$7 4.4604% 1 Number + Powerball \$4 28.4363% Powerball Only \$3 56.8772%

Now we can figure out the value of a winning ticket simply by multiplying the prize by your chance of getting that prize on any given winner. Doing that tells us that the average winning ticket for regular Powerball is worth \$7.65 (\$8.65 – \$1.00 for playing). Adding the Power Play to the mix changes the prize values, so the average winning ticket for Powerball plus Power Play is worth \$24.04 (\$26.04 – \$2 for playing). (And technically, it would be worth a little less than that because there’s always the chance you might have to split the jackpot with someone else. But I don’t feel like finding the stats on that or doing the math.)

That leads us to the next question. If the average winning ticket is worth \$7.65 (or \$24.04 for Power Play), then what is the average ticket worth? You only have a 2.8482% chance of winning that \$7.65 (or \$24.04). We need to take into account the cost of your losing tickets, which you’ll have 97.1518% of the time. Remember, you have to buy 35.11 tickets before you can expect to have a winning ticket (based on the odds). That leaves you with 34.11 losing tickets. If you’re playing regular Powerball, you’ll need to spend (that is, lose) \$34.11 to win \$7.65. If you’re playing Powerball with Power Play, you’re looking at a cost of \$68.22 to win \$24.04.

Our last bit of math will tell us the average value of any given ticket. Let’s check regular Powerball first. On average, you’ll spend \$34.11 to win \$7.65 leaving you with an overall loss of \$26.46. Divide that by the total number of tickets you had to buy (35.11) and you’ll find that the average regular Powerball ticket is worth -\$0.75. To put it another way, instead of buying a \$1 Powerball ticket you might as well throw three quarters in the trash. (Oh wait, I forgot…the Pennsylvania lottery benefits older residents – every day. So maybe you should just donate the three quarters instead.)

What about Powerball plus Power Play? It certainly looks like a more attractive value proposition at first glance since the average winning ticket is worth so much more. On average, you’ll spend \$68.22 to win \$24.04 leaving you with an overall loss of \$44.18. So that means the average Powerball plus Power Play ticket is worth -\$1.26. This time, instead of donating three quarters rather than buy a Powerball plus Power Play ticket you should donate five quarters! In terms of absolute dollars, you lose more with Power Play but the % loss is better than regular Powerball. (In regular Powerball, you lose 75% of your money forever. With Power Play, it’s “only” 63%. Granted, it starts looking a little better when the jackpot is very large, but your chances of splitting the prize increase as more people buy tickets. This means the lottery is always going to be a losing bet.)

Let’s put this all into a little perspective. Buying a Powerball lottery ticket would be the equivalent of getting a \$10,000 gift, going out into your back yard, and then proceeding to burn \$7,500 of it for “fun”. Big Fun – according to the Pennsylvania Lottery.

#### You Want Big Savings? I’ll Show You Big Savings.

I’m not going to take the time to prove that the lottery (in any form) is a waste of your money. You can simply look at the July 2009 – June 2010 annual income and expense report from the Pennsylvania Lottery to see that they only end up paying out about 61% of their total sales to winners. Talk about a great business! I’d take a 30% net profit margin any day. (The other 9% goes to other expenses.)

Looking at those numbers from the other end, we see that lottery players as a whole are buying something with a guaranteed return of -39%! You want big savings? Here’s a thought. Stop paying the poor people’s tax.

### Don’t play the lottery!

Welcome to the Carnival of Personal Finance #271 – The Secret to a Successful Budget eBook Edition! My friend Craig Ford at Money Help for Christians is launching a new eBook today. It’s designed to help you discover the secrets to successful budgeting.

I think it’s a great resource for anyone who’s ever struggled with budgeting, so I’ve included some quotes from his eBook throughout this carnival. You can get the book for 30% off if you buy before midnight (EDT) August 31st, 2010. Be sure to read through to the end of this carnival because I’ll be giving away two FREE copies to two lucky winners!

#### Editor’s Choice

Here are my top picks from the submissions this week:

• Mike Piper from Oblivious Investor presents Dealing with Investment Confusion, and says, “What’s the best approach to dealing with the confusion that comes from being a new investor?” – [Mike shares some good advice for people who are confused about investing. It won’t immediately cure your confusion, but applying this strategy over and over will help you make informed decisions you can stick to.]
• Briana Ford from Go Banking Rates presents Why Americans Can’t Afford to Die [Infographic], and says, “If you never thought about this problem before, take a look at how expensive funerals really are. You may discover you, like many Americans, simply can’t afford to die.” – [What can I say? I’m a sucker for infographics.]
• Len from Len Penzo dot Com presents A Simple Trick to Get Your Credit Card Interest Charges Waived. – [I wish more people realized the power of Len’s simple trick!]
• Lauren from Richly Reasonable presents 4 Bad Deals, and says, “The term “Bad Deal” is relative. Not only is Necessity the mother of Invention, she is also the mother of many a Bad Deal. Necessity has a TON of children.” – [Funny, smart, and witty – and likely to open a few eyes at least!]
• Jacob A. Irwin from My Personal Finance Journey presents Adjusting My Monthly Budget to Account for Home Ownership, and says, “A look at the steps I have recently taken to adjust my personal budget to account for the various elements of home ownership.” – [At our current rent rate owning a home just doesn’t make sense. Just look at all the costs involved!]

Congratulations to the editor’s choice picks! Here are the rest of the articles from this week’s submissions.

#### Money Management

• MD from Studenomics presents Quick College Students Guide To Personal Finance.
• Jason from One Money Design presents How Do You Live Well on Less Pay?, and says, “There are plenty of people that don’t make a lot of money and have trouble covering basic expenses each month. There are 5 essential tips to follow to live well on less pay.”
• Revanche from A Gai Shan Life presents Shopping for the single life .
• ispf from Grad Money Matters presents The American Dream of Home Ownership: 10 Things You Can Do as a Student.
• Jim from Wanderlust Journey presents Royal Caribbean Cruise Lines Shareholder Benefits.
• Jason from Live Real, Now presents Check Your Bills, and says, “Can you automate your finances too far?”
• Elle from Couple Money presents Financial Tips for College Success, and says, “Many college students are surprised to see how easy it is to build a financial foundation for themselves. Learn how to set up bank accounts, pay your bills, and start a graduation fund.”
• DE(a)BTh from Murder Your Debt presents Your Wasted Life, and says, “You thought financing a house and a fast car meant freedom. That an expensive education would lead you to a rewarding career where you could earn lots of money. You were wrong, weren’t you? You hate your career but you’re stuck. You’re stuck because you swallowed the lies you were sold. The lies that material possessions bring success. The lies that more money means more happiness. And now what? You’ve got it all; the cars, the house with the huge yard, the sexy outfits and shiny shoes. But you’re STILL not happy!”
• vh from Funny about Money presents Social Security’s Bizarre Rules, and says, “Social Security’s restrictive rules make it impossible to get out of poverty when unemployment forces one into early retirement and stock-market losses militate against retirement fund drawdowns.”
• J. Money from Budgets Are Sexy presents What would you do with an extra \$1,000?, and says, “Montel Williams wants to know ;)”
• Bob from Christian Finances presents How to spend unexpected income: 3 questions to ask, and says, “It can be tough to know what to do when you receive a large sum of cash – this article will give you some questions to help you figure out what to do with it…”
• Mr. GoTo from Go To Retirement presents How Much Long Term Care Insurance Should You Have?, and says, “Insuring against a long term care event is part of personal risk management. Estimating the amount of long term care coverage to obtain requires careful consideration of several factors.”

### If you are working 40 or more hours a week to earn your money, don’t you think it is worth an hour or two to set up a budget?

#### Isn’t it worth spending about an hour every week to manage the money you work so hard to earn? It is always better to manage what you have than to work yourself crazy trying to get more money.

– from page 21 of The Secret to a Successful Budget by Craig Ford

#### Investing

• Dividend Growth Investor from Dividend Growth Investor presents 33 Dividend Champions to Consider, and says, “Dividend investor David Fish has created a list of dividend stocks which have raised distributions for 25 consecutive years and has named it the dividend champions list. His list includes 100 companies, which is more than twice the size of the Dividend Aristocrats. I ran a screen on the list in order to identify stocks for further research.”
• Mike from The Financial Blogger presents Use the Loonie’s Strength to Invest in the Eagle Market, and says, “Canadian dollar is strong compared to the US dollar at this time. Use this as an opportunity to invest in US stocks.”
• Div Guy from The Dividend Guy Blog presents Dividend Investing with Less Than \$1,000 Part 3: How to Pick Your ETFs and/or Dividend Funds, and says, “Starting to invest is quite motivating but as a young investor, you must put greed and hype aside and start by looking for sound investments.”
• Squirrelers presents Small Stocks = High Return and High Volatility, and says, “Small stocks, particularly those in the lowest deciles, have performed very well over the long-term. They can be an important part of your asset allocation, provided you can stomach the associated risks.”
• D4L from Dividends Value presents My Top 6 Performing Dividend Stocks Just Might Surprise You, and says, “As I have stated many times, my goal is to create an ever growing income stream from dividend stocks. Secondarily, it is my desire to beat the S&P 500 over time. With that said, I rarely look at the capital performance of individual stocks. However, I recently sorted my portfolio by Total Gain % (total gain/basis) and was mildly surprised at the top performers.”
• ElizabethG (Modern Gal) from Modern Gal presents Investing for Inflation in 2010.
• DSO from High Dividend Stocks presents Big GE and it’s big dividend, and says, “One of America’s oldest and most prestigious companies has become an accidental high yielder.”

### Budgeting in and of itself is useless.

#### Budgeting is part of a larger financial plan.

– from page 9 of The Secret to a Successful Budget by Craig Ford

### You need to focus your finances on accomplishing one major task at a time.

#### If you don’t, the danger is that every dollar will be diluted to a point that it makes little impact helping you reach your goals.

– from page 9 of The Secret to a Successful Budget by Craig Ford

### The goal of the budget is to help you spend less than you earn.

#### Therefore, this becomes the single criteria for an effective budget – does it help you spend less than you earn?

– from page 12 of The Secret to a Successful Budget by Craig Ford

#### Reviews

• PT from PT Money presents Free Prepaid Credit Cards, and says, “A thorough, original review of the best free prepaid credit cards, including those that are free of activation and monthly fees. These cards are great for those who need to avoid debt, or those that can’t get a traditional bank account.”
• Silicon Valley Blogger from The Digerati Life presents Citi Dividend Platinum Select MasterCard Review, and says, “Here’s a review of a credit card I actually like.”

#### Real Estate

• FMF from Free Money Finance presents How to Hire a Home Inspector, and says, “When you buy a home, you need to be sure you hire a good home inspector to identify any potential problems. This post gives tips on how to do this.”
• Jeff Rose from Good Financial Cents presents Should You Upgrade to a Larger Home”, and says, ”
In many markets, home owners are looking at homes in the next price range up as good buys, since foreclosures and a slow market are resulting in good deals. But, as tempting as it is to upgrade to a larger home, is it really a good idea? Here are some things to consider before upgrading to a larger home.”
• Rob from Two Wise Acres presents 3 Things to Avoid When Buying a Home, and says, “When buying a home, it’s critical that you avoid these three credit mistakes.”
• ctreit from Money Obedience presents Do renters really save money in the end?.

#### Taxes

• pkamp3 from Don’t Quit Your Day Job… presents Tax Incidence, and says, “Who really pays for a tax when it is enacted? If the government enacts a new tax on washing machines, is the entire tax on Maytag? The consumer? Cameron Daniels breaks down the details.”

### A budget lets your spouse see your values and priorities in a tangible way.

– from page 16 of The Secret to a Successful Budget by Craig Ford

#### Career

• Kristina from Dinks Finance presents A DINK in The Office, and says, “As a married or unmarried employee with no children, are you treated differently than your colleagues with kids?”
• Nicole from Nicole and Maggie: Grumpy Rumblings presents Why did you go to graduate school?, and says, “Nicole and Maggie discuss reasons for graduate school and how sometimes we’re directed into a career for the right reasons and sometimes we fall into it for the wrong reasons. But it turns out OK anyway (or maybe it doesn’t, but you can always change your mind).”

#### Economy

• Bret from Hope to Prosper presents Trillion Dollar Public Pension Shortfall, and says, “An article in the New York Times stated that there is a \$1 Trillion dollar public pension shortfall. Despite repeated denials from PERS and public employee unions, public pensions are in big trouble.”
• JLP from AllFinancialMatters.com presents Democrats, Republicans, and the Federal Debt Since 1979, and says, “Though the title may suggest it, this is not a “political” post.”

### Budgeting is a process, not an event.

#### You won’t wake up tomorrow with an effective budget. Instead, you will start with a decent budget that later becomes a good budget. Eventually, it is a great budget.

– from page 16 of The Secret to a Successful Budget by Craig Ford

#### The Secret to a Successful Budget eBook Giveaway!

As promised, I’m giving away two free copies of The Secret to a Successful Budget courtesy of Craig. To enter, all you need to do is leave a comment on this post telling me how budgeting has helped you OR your biggest struggle with budgeting. I’ll use random.org to select two winners tomorrow evening (August 24, 2010) at 5:00 PM EDT so be sure to enter by then!!! I’ll update this post to announce the winners, but use a valid email address when you comment so I can reach you if you win. Good luck!

[Update: Laura has won a free copy of The Secret to a Successful Budget! Congratulations!!!]

I’ve been thinking lately about ways people make money. And I have what I believe may be a Grand Unified Theory of Making Money. It still needs some refinement, but here it is: There are three ways to make money: selling time, selling a product, investing, or some combination of these.

That’s extremely simplified, so let me elaborate a little.

#### Selling Time

This is probably the most common way people make money. If you work for someone else and get paid by the hour or a yearly salary, you’re essentially selling your time. But having a “regular” job isn’t the only way to make money selling time. There are several ways:

• Sell Your Time to an Employer – This is your typical job. You’re hired by an employer to do a job, and they pay you an hourly wage or a salary.
• Sell Your Time to Consumers/Clients – This is freelancing, contract work, or certain types of self-employment. You’re hired by clients (essentially, many employers) to do a job/jobs, and they pay you an hourly wage or set fee.
• Sell Other People’s Time to an Employer – Think of temp agencies or a company that hires people and then fills an employment contract for another business. These aren’t extremely common, but you’re seeing more of them.
• Sell Other People’s Time to Consumers/Clients – This is what a lot of businesses do, especially in service industries or professional companies (like CPAs, investment firms, law firms, etc.). They hire employees at a certain rate/salary, and then sell their services at a higher rate.

Clearly, the problem with this strategy for making money is the limitation of time. There’s only so much time available – even when you’re selling other people’s time. Sure, you can raise rates, but only to a point. However, there’s a big difference in the limit between the first two examples and the last two.

#### Selling a Product

Next up is selling a product. This can be any kind of product – basically anything that isn’t “time”. Again, there are several different ways to make money by selling a product:

• Sell a Product for Someone Else – If you’re in a sales position where you get paid by commission, you fall in this category. Also, think of bloggers using affiliate deals or multi-level marketing (MLM) schmucks who haven’t developed their “downline”.
• Sell Your Own Product – Farmers with road-side stands, bloggers with their own books for sale, and people selling a product they create/manufacture themselves are all in this group.
• Get People to Sell Someone Else’s Product – Think retail businesses or MLM schmucks who found suckers to join their downline. Also, affiliate marketing networks (like Commission Junction) would be in this crowd.
• Get People to Sell Your Own Product – Businesses that create or manufacture their own product and then hire people to sell that product fall into this group. In the online world, this would include businesses with affiliate marketing programs or bloggers who create their own products and offer a cut to anyone who will sell it for them (via affiliate links).

Depending on which strategy you’re using here, you could be limited by your own time or abilities or the sky could be the limit. The only problem here is that you need to have people willing to buy. But that’s not necessarily a problem if you have a good, useful product and/or you’re a good salesperson.

#### Investing

Investing is a way to leverage your own or others’ money-making efforts. You can:

• Invest Your Own Money – If you’re buying securities or other investments or if you’re starting your own business with your own money, you’re in this crowd.
• Invest Other People’s Money (OPM) – If you’re borrowing money to invest or if you’re managing someone else’s money and taking a cut (think mutual funds), you’re in this group.

Again, there can be a variety of limitations here: your resources, others’ resources, your time, availability of good opportunities, etc. However, this is probably the one area where people have made ridiculous amounts of money – especially when they combine it with any of the other methods.

#### Any Combination of the Methods

I won’t even go into the possibilities here as they’re simply too numerous. But in reality, this is what many people/businesses do. Take my wife’s grandfather for instance. He started an agribusiness, which has become quite successful. In the whole process of starting/growing his business, he has:

1. Sold his time to clients by combining, spraying, chopping, etc.
2. Sold other people’s time to clients by hiring them to combine, spray, chop, maintain equipment, etc.
3. Sold products for other people/businesses like fertilizers, insecticides, pesticides, and herbicides, etc.
4. Hired other people to sell others’ products
5. Sold his own products (mainly corn)
6. Hired other people to sell/produce his own products
7. Invested his own money in his business
8. Invested other people’s money in his business through prudent borrowing

You can probably take any business and break it down into some combination of these methods.

#### Why in the World Does This Matter?

Well, beyond the interesting theoretical implications, this matters because it can help you figure out how to make more money! Take a look at what you’re doing now. What are your limitations? How can you expand your opportunities to make money by looking at other methods? Maybe you’ve never considered any of these options beyond what you’re currently doing.

If you want (or need) to make more money, thinking about the various methods might help spark a new idea for you. And that seems like a good enough reason to write about it!

As I said before, I feel like this Grand Unified Theory of Making Money needs some refinement. Which methods did I leave out? Can I simplify the statement: “There are three ways to make money: selling time, selling a product, investing, or some combination of these.“? What do you think about this theory? How will you apply it to your situation?

Yesterday I posted an article about how to create a balance sheet. Part of that process includes calculating your net worth. After I wrote it, I realized I should talk about net worth from a Christian perspective. After all, the tag line for this site is “Personal Finance from a Christian Perspective”. There’s nothing particularly Christian about that article. It’s helpful for Christians and non-Christians alike to review their balance sheet and net worth. But as Christians, we must be especially careful to realize that we are more than our net worth.

There is danger in obsessing over your net worth – in defining your success based on a number. It is wise for you to prudently manage your finances, and tracking your net worth is part of that process. But you must always be aware that your value comes not from what you own but from who you are in Christ. It is in being a child of God that Christians find their true worth.

Our net worth is infinitely positive. Christ has canceled the debt of our sin and we will inherit immeasurable heavenly riches. What you own or owe here and now does not matter in eternity.

This warning goes both ways. Those who are rich must grasp this concept just as much as those who are poor – even more so. It is easy for the wealthy to trust in their riches and forsake God. Their prosperity may even tempt them to think of themselves more highly than the poor. Both outcomes are sin in God’s eyes, and the rich must be careful to avoid both. The rich should not glory in their high estate, and the poor should not be shamed in their low estate.

The Bible actually has much to say about this topic. I’ve chosen a few verses to help you see why it’s important for us to understand our true net worth. Consider what God’s Word says:

The rich and the poor have this in common: Yahweh is the maker of them all.

Proverbs 22:2 (WEB)

17 …and lest you say in your heart, “My power and the might of my hand has gotten me this wealth.” 18 But you shall remember Yahweh your God, for it is he who gives you power to get wealth; that he may establish his covenant which he swore to your fathers, as at this day.

Deuteronomy 8:17-18 (WEB)

Riches don’t profit in the day of wrath, but righteousness delivers from death.

Proverbs 11:4 (WEB)

For what does it profit a man if he gains the whole world, and loses or forfeits his own self?

Luke 9:25 (WEB)

10 He who loves silver shall not be satisfied with silver; nor he who loves abundance, with increase: this also is vanity. 11 When goods increase, those who eat them are increased; and what advantage is there to its owner, except to feast on them with his eyes?

Ecclesiastes 5:10-11 (WEB)

Focusing too much on your net worth can cause you to glory in your riches or to feel shame in your poverty. We must remember that the Lord is pleased with neither. What does please the Lord? Those who glory in their knowledge and understanding of Him and who boast about His loving kindness, justice, and righteousness.

23 Thus says Yahweh, Don’t let the wise man glory in his wisdom, neither let the mighty man glory in his might, don’t let the rich man glory in his riches; 24 but let him who glories glory in this, that he has understanding, and knows me, that I am Yahweh who exercises loving kindness, justice, and righteousness, in the earth: for in these things I delight, says Yahweh.

Jeremiah 9:23-24 (WEB)

A balance sheet is useful because it helps you see what you own and what you owe. It’s also useful in estate planning as it allows you to clearly list everything in one spot and can help you determine how much and what kind of planning you need. If you want to create your own personal balance sheet, here’s what you’ll need to do.

#### 1. Give It a Date

A balance sheet is a snapshot that’s only accurate on one particular date. When you create your balance sheet, you need to put down the date you made it or last updated it. Simply write “As of {Month Day, Year}” at the top just under your name.

Now you’ll want to break the balance sheet into two parts. On the left, you’ll list your assets. On the right, you’ll list your liabilities and calculate your net worth. Let’s start with your assets.

Your assets include anything you own. This doesn’t mean you necessarily own it outright – just that legal ownership belongs to you or your spouse. You’ll want to list your assets in categories by order of liquidity – how quickly you can turn the asset into cash. Additionally, you’ll want to indicate the ownership of each asset (Husband, Wife, Joint, etc.). And finally, be sure to use the fair market value – the price you can actually sell it at. What you paid doesn’t matter. All that matters now is the price you can get if you try to sell the asset.

The first category will be cash and cash equivalents (things that are almost like cash). This group includes actual cash, checking accounts, savings accounts, money market accounts, and similar assets. Next up are your invested assets. Stocks, bonds, mutual funds, retirement accounts, businesses you own, and any other investments you’ve made fall into this category. Finally, you can list your personal use assets – things like your automobile, furniture, clothes, and house. Some people don’t include personal use assets or they use a lower value. It’s up to you, but I say if you can and would sell it then list it on your balance sheet.

In the right column, start listing your liabilities – anything you owe. Write down your liabilities in the order that they’re due. Short-term debts will go first (like credit cards or auto loans) and long-term debts will go last (like student loans or mortgages). Include any personal debts as well if you’ve borrowed money from family or friends. List the total amount owed along with who owes it (Husband, Wife, Joint, etc.). I think it’s helpful to also list your interest rate in the description of each debt.

#### 4. Calculate Your Net Worth

This is the easy part. Your net worth is simply your total assets minus your total liabilities. It’s what’s left over if you were to sell everything and pay off all your debts. Since you’ve already listed your assets and liabilities, all that’s left is to subtract.

If your net worth is negative, you owe more than what you own. If it’s positive, you own more than you owe. It’s as simple as that.

#### 5. Update It Regularly

Now all you need to do is update your balance sheet regularly. Once a year is fine, but you can do this more often if you like. Remember to change the “As of” date each time you update your balance sheet.

If all this sounds like too much work for you (it’s really not that hard), programs like Quicken and websites like Mint will help you create your balance sheet and keep it up to date automatically.

\$30,000. That’s the minimum you should have saved to buy a \$150,000 home – and that just covers your 20% down payment! That’s a lot of money. Saving for a down payment on a home can take a long time. The last thing you want to happen is to see your savings drained by a stupid mistake. Putting your savings in the wrong investment option can destroy your dreams of home ownership. Here’s what you need to know so you don’t take on too much risk.

#### How Long Do You Have?

When it comes to choosing an investment option, you need to consider your time horizon – how long you have until you need the money. This is true of any financial goal. The longer you have, the more risk you can afford to take (and the higher your return might be). Once you know your time horizon, you can start considering your investment options.

#### Cash – Time Horizon: 0 – 5 Days

Think cash is king? Not when it comes to savings options. Cash may seem like the safest option, but you’ll lose money to inflation. The only reason you should have your down payment in cash is because you need it within a week. Though I wouldn’t walk into a closing with that much cash! A checking account is the equivalent of cash because it usually yields no interest, so just take a check instead.

#### High-Yield Online Savings Accounts – Time Horizon: 5 Days – 2 Years

I skipped regular savings accounts because the interest they offer is pitiful compared to high-yield online savings accounts (like ING Direct). High-yield savings accounts offer a decent short-term interest rate and are backed by FDIC insurance. This means they’re risk free up to the insurance limits. If you have less than two years until you need the money, this could be your best option.

#### Certificates of Deposit (CDs) – Time Horizon: 2 Years – 5 Years

CDs are a good option if you have a longer time horizon because they’ll let you lock in a fixed rate for a specific number of years. There are three problems here though. First, there is often a minimum purchase amount for CDs – usually \$1,000. Since you can’t add on to a CD you already own, you’ll have to buy a new one every time you have the money.

Second, CDs can take some managing if you don’t keep them all at the same bank. If you’re chasing the highest rates, you’ll probably have to utilize several different banks. This means having several accounts in different places – and that’s not necessarily a good thing.

And third, putting your money in a CD means it is locked up. You generally can’t get to it early without penalties. This is why I recommend using a high-yield online savings account if you’ve got less than two years. You can pull your money out of there at any time with no penalty.

If CDs don’t sound like something you’d want to try, I’d recommend looking at short-term government bond mutual funds. Vanguard offers VSGBX and VFISX which both have an investment minimum of \$3,000. However, you can make additional investments of only \$100 (or \$50 if you use automatic deposits) after that point. You can avoid the \$20 service fee by signing up for electronic delivery of your statements and other documents. These funds are quite stable and low risk while generally offering slightly higher rates than CDs.

#### Intermediate-Term Bond Funds – Time Horizon: 5 Years – 10 Years

Intermediate-term bond mutual funds offer slightly higher returns than the other options but with slightly more risk. You should only consider them if you have five to ten years until you’ll be buying your home. Again, Vanguard is a good choice here. The same minimums apply, but you’ll want to look at funds with the ticker symbols VIPSX, VBIIX, VFITX, VFICX, or VBMFX. You won’t get stellar returns with these options, but they’ll pay you more than enough to beat the other choices and keep up with inflation.

#### Conservative Stock/Bond Portfolio – Time Horizon: 10 Years – 20 Years

If you have a good long time until you’ll be buying a house, consider looking at a conservative mix of stocks and bonds for your savings. A good target would be 20-30% in stocks and 70-80% in bonds. A mix like this will give you a reasonable chance of outperforming other options for your savings, but your longer time horizon will decrease the risk of losing money. If you need help figuring out how you should allocate your investments, check out my free portfolio allocation calculator.

#### Moderate Stock/Bond Portfolio – Time Horizon: 20 Years +

Finally, if you’re not planning to buy a home for at least twenty years or more, you might consider using a moderate mix of stocks and bonds. In this case, somewhere between 40-60% in stocks and 40-60% in bonds would be a reasonable choice. Again, the long time horizon will help ensure you minimize your chances of losing money, but the more aggressive investment choices will give you the chance of higher profits. See the above link to my free calculator if you’d like to see what a sample portfolio would look like.

What savings options would you use and why? What advice would you give to those who are saving for a house? Share your thoughts in the comments below!

In our last Investing Basics article, we talked about mutual funds. Today, we’ll discuss options and futures. Later in this series, we’ll look at short-term savings vehicles.

#### What Are Derivative Securities?

Options and futures belong to a class of securities known as derivatives. These are securities whose value is derived from another underlying asset. In the case of options, the underlying asset is often a stock (thought it can be an index, exchange-traded fund, currency, or bonds). For futures, the underlying asset is usually a commodity (like grains, oilseeds, metals, petroleum, livestock, food items, or fiber) but can also include stock indexes, currencies, or bonds. In reality, options and futures can be based on nearly anything if there’s a market for them.

#### What Is an Option?

Options are securities that give you the opportunity (or “option”…) to buy or sell the underlying security at a specific price over a set period of time. If the option lets you buy, it’s a “call option”. If it lets you sell, it’s a “put option”. Options that cover a long period of time are often called LEAPS (Long-term Equity AnticiPation Securities).

Long-term options that let you buy a certain number of shares from a company are called “warrants”. These can be for 5, 10, or even 20 years. Although they are similar to regular options, they can only be issued by the company that issues the underlying stock. Regular options can be issued by anyone. Warrants are usually added to bonds when the issuing company needs to “sweeten the deal”.

#### What Is a Futures Contract?

A futures contract is an obligation to deliver or accept a certain amount of the underlying asset at a specific price on a specific date. (Many people just call them “futures” but that’s just a shorter way of saying “futures contracts”.) Where an option gives you the choice to buy or sell, a futures contract is a commitment to buy or sell. So if you buy a pork bellies futures contract and hold it until the delivery date, you better have a place to store 40,000 pounds of future bacon!

When used for hedging purposes, futures contracts are most often bought and sold by processors and manufactures or producers and farmers. Futures contracts allow these people and businesses to lock in their costs or income. Many of the farmers in my church use contracts to lock in the prices for their milk, corn, and soybeans. This helps them plan their income easier and protect against declining prices, but it also obligates them to deliver a specific amount regardless of how their cows or crops perform.

#### You Don’t Need to Know Much about Options and Futures

Honestly, the average investor doesn’t need to know much about options and futures. There are some limited applications where they can be used to hedge (protect) an investment. But for the most part, people use them to speculate (in other words, gamble!). And speculation is not investing. However, it is useful to have a basic knowledge of options and futures so you can recognize the risks and the potential benefits. If you want to keep learning about investing, make sure you sign up for free updates to Provident Planning!