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Pretired lesson: The Power of the Chunk

boulderToday’s lesson is about The Power of the Chunk™. The Power of the Chunk is a critical concept to understand in reaching pretirement.

The funny thing about this concept is that I have found people who are strong in math (**cough**nerds**cough) have a hard time getting it, than creative and feeler types.

The principle of The Power of the Chunk was founded long ago when I left my first (very) low-paying journalism job to travel around the U.S. with a couple friends of mine. I got rid of most of my stuff and left a few things with my Dad for safekeeping. I also used his address as my forwarding address for any lingering bills and gave him some money, probably around $400, just to make sure I didn’t leave anything unpaid.

When I returned two months later, I found my money had been spent on some new electronic toys for himself. He promised to pay me back over the coming months in installments. As the money came back to me, I did what we all do — I pissed it away on nothing! 

And, thus, The Power of the Chunk was born. $100 IS worth more than $10 over 10 months!

It’s about Psychology

Now, for the nerds, this is most definitely NOT a time-value of money discussion, although at the margins there is some inter-relationship. This is about psychology.

Think about this for a moment: If I handed you $500 in cash, I guarantee you would tuck it carefully in your pocket and would likely deposit it into the bank the same day if you could. Yet how many people blow $7 on coffee in the morning and $10 at lunch, every day for years? (I am as guilty as anyone!) Do the math (OK, nerds, do your thing) and you’ll see the $10-$20 that slips through your fingers really adds up.

My favorite example has to do with the IRS withholding. You get to set the level on that endlessly confusing W4 that no one will help you with. The employee strategy on that form comes down to three possible strategies:

  • Try to nail it so you come out about even.
  • Try to come out so you definitely get money back.
  • Try to come out under so you aren’t giving the government a free loan.

The last one is the one I hear the most often and the one I think is the dumbest. The amount of money is too small (unless you’re too highly paid to need to read this blog) to generate any significant interest (either in your bank account or theirs). I always, when I was working, aimed for over-withholding so I would definitely get money back.

Why? The Power of the Chunk.

If I had this “extra” money trickled into my paycheck, it would likely just go toward buying more crap. Or a nicer way of putting it is my lifestyle would subtly rise to meet the amount of money available.

But by keeping it away from myself all year, I would usually receive a nice tax refund — my chunk. Now, of course, I realize, many (most?) of us will simply use that savings on something else, say, a big screen TV or new computer. Maybe not optimal for someone trying to reach pretirement, but, hey you saved up for a tangible item, when 90% of the population will just swipe their credit card and pay interest on top of a stupid purchase. And a few smart ones of you will actually take that chunk, which otherwise would have been pissed away on nothing, and you’ll invest it, putting yourselves that much closer to your personal finish line.

There’s another angle to The Power of the Chunk worth thinking about:  the giving end of the chunk. What if you owed a family member $1,000 (interest free) and you’re paying them $100/month until you’re even? And let’s say you did receive a nice tax refund so you could pay them back early. Should you pay off this small loan at once or should you keep paying in installments? Now setting aside the fact that you’re also robbing your family member of the Chunk’s power, I still say it’s better to pay it back early.

That’s because at Pretired.org, lowering your monthly living expenses is 90% of the game. Simplify your financial life so you can focus on the next steps in your journey.

Use your chunks to remove annoying ongoing expenses.

I paid up-front to buy my own cable internet modem. Now I don’t have to pay every month to “lease” one (that scam should be illegal in my opinion).

Or maybe you’re ready to put solar panels on your roof. It might take awhile to make back your $15,000 investment, but perhaps it makes sense for your pretirement goals to drop your monthly utility costs.

Now this concept is not necessarily going to apply to larger dollar amounts, especially when interest is involved. You may need to do some thinking about how disciplined you can be with the non-Chunked funds. Very, very disciplined people can eke out some advantages by not using the Chunk’s power and leveraging their money in interesting ways. I, however, live in the real world, where an impulse buy here or there is a lot more likely than severely tight budgeting.

Make a plan for how you want to use your Chunks before they show up. Do they all go into your investment pile? Toward mortgage principle? Down payment for a house?

The Chunks can come to you from many places so you need to ready for them when they show up. We talked already about tax refunds, that’s a common one. How about bonuses from work? From selling some of your crap on Craigslist? Maybe downsizing to a cheaper car?

You never know when the next Chunk is going to come along. It’ll pay to be ready for it.

My long, strange relationship with money

first_house

We moved here when I was five years old

Money and I have always had an odd relationship.

After all, how is it that I, your humble host, have come so far as to wind up writing a blog about my attempt to reach pretirement?

While I’ve had some good luck, some bad luck, learned from a lot of mistakes and was smart enough to make adjustments when needed, the real reason I’m here isn’t really any of those. I had one thing on my side that has been with me through it all: I have always been well-grounded in what life is really about. I never fell in love with money.

We moved to a little family farm when I was five years old, leaving behind a suburban rental house. I guess my parents were excited to be back-to-the-landers, something that was in vogue at the time and seems to come back into fad with every bad economy. Dad worked at the local plant and spent all his free time fixing the shack of a house. One year we had two feet of snow in our kitchen. Mom was a housewife and eventually sold Avon (leaving me in the backseat during sales calls).

My first memory of money of any kind came with the fifty-cent pieces my grandma would tuck into birthday cards. It sure felt like a lot of money! But since there was nothing for me to spend it on, it was irrelevant.

Money began to take on real meaning when the local convenience store put in an Asteroids and a Centipede game. Ah, so the more quarters I find, the more fun I can have! The money hoarding began in earnest. Quarters mysteriously disappeared from my parent’s change jar.

When my parents finally divorced, we went from poor to dirt poor. Mom was trying to make it as a real estate agent, just as things were collapsing. She waited tables at a local diner in the evening to make ends meet. We ate government cheese (not recommended!).

A whole other aspect of money struck me when I took my first official “job” at 14 years old, cleaning the gym at school, including the nasty locker rooms. That’s when I realized that, “THIS SUCKS!”

My mother was relatively savvy with money, but still never reached any level of financial independence. My father always wanted to be rich and so spent himself into deep debt many times trying to keep up with the Jones’s. I’ve lost track of how many times he went bankrupt, but I’m sure it’s at least four.

In my teens, I was probably rebelling against his mindset by deciding chasing dollars wasn’t for me. Naturally I went too far to the other extreme and almost intentionally chose a life of poverty. I was happiest when everything I owned fit in my car. And I was never uncomfortable. I gradually made more money, but the more I made, the more I spent. Fortunately I did learn from some teachers and others and never had any debt.

I always knew I would go to college, but I had no idea how it would be possible. When my dad moved to California, I went along since it was more of an adventure than staying where I had been with my old friends and also college is much cheaper there. Aside from those first few years where I lived with him, I put myself through college with no help from my parents otherwise.

Writing was the only thing I was really good at and enjoyed doing so I chose a career in journalism. It went fine, although advancement was nearly impossible as newspapers were shedding jobs rapidly. So at age 29, it finally hit me that it was a dead-end. I moved into marketing, nearly doubling my salary (from nearly nothing to almost twice that) and finally leaving the poverty line behind.

But then, suddenly I found myself strapped to a roller coaster.

Timing is everything sometimes. Just as I moved into marketing, the dotcom boom went off. I went from one dotcom to another (literally laid off from one on the day that was to be my final interview at another). Well next thing you know, hundreds of thousands in stock options were coming my way. My cube-mates and I would giggle to ourselves as we ended days $50,000 richer than we started them.

As you might guess, I screwed that up, too. Well, maybe screwed up is too strong, I did much better than many and worse than some. It benefited me greatly and I would not be writing here today without that money. However, had I understood then what I know now I would be looking at retirement, not pretirement and I could have reached pretirement without that money (and so can you!). And that’s why I feel I can contribute to the pretirement discussion.

Anyway, when the money started to roll in, I read up on investing and listened to all sorts of experts. My best move, it seemed, was real estate. Now you might assume after reading this section that the next thing to happen was I lost it all. Fortunately, no. I actually did quite well. But I could have done much better. And I committed two mortal sins I didn’t know I was committing at the time: I over-improved my properties and I used principal to do it. But I made money, too.

The great recession cost me hundreds of thousands of theoretical dollars but fortunately I always remained solvent and above water on equity. I was even making nice money from rent when many were being turned out of their homes!

I finally settled down, got married and we bought a larger house with a view of the water. I sold the house I owned before I met my wife and used that money to pay off my half of our house. We also added to our family last year so now I have college funds to think about.

Now I’m a stay-at-home dad and I do consulting to cover my remaining bills. I’m not yet financially independent but I’m close. I’ve learned so much on my journey. I’m looking forward to sharing some of what I’ve learned and a little about my next few steps as well. Hopefully I can avoid too many more big mistakes in the future. After all, I’ve already made enough mistakes for a lifetime.

My situation

Monopoly_houseI’ve been putting off writing this post since, like I said, I’m always a little uncomfortable talking about myself, and with money issues it’s even worse. But to reach my goals, I have to face my own situation with open eyes and laying it all out here methodically helps me focus and plan.

Remember, for *me* pretirement is when ALL my monthly bills are covered with passive income. For others, it may mean just getting close enough for a part-time job to cover the gap.

I’ll spare you all the details for now, but here’s the quick overview:

  • I owe nearly $50,000 on a HELOC (to be explained later) but otherwise my half of our mortgage is paid off. My wife is working on her half separately (also to be explained later).
  • I own a fourplex that I’ve been trying to sell for a few years now. Income from the fourplex is a reliable $1,300 on paper. In reality it’s much lower in recent days (mostly related to some fixes in preparation for sale and some long vacancies). When it sells, I should net around $140,000.
  • Other real estate: I own other real estate with a family member that runs a deficit of $250/month (plus lots of surprise expenses). I’ll spare you the details for now.
  • No other debt (woohoo!)
  • Raw monthly bills clock in at around $1,000/month.
  • I have nearly $50,000 in the market, but am not taking any distribution yet.
  • I’m 45 years old and a stay-at-home dad. I quit my horrible job last year (pre-pretired) mostly to get ready for the new baby who was on the way and also because I couldn’t work with crazy idiots any longer. I’ve just begun consulting which I fit in around my dad duties and currently brings in around $1,000/month.

So that’s the landscape. Am I pretired? Let’s total it up with some easy-to-read rounded numbers:

INCOME

  • Fourplex: $800 (not really accurate, but a reasonable proxy given how unstable it has been)
  • Potential income from current investments: $200 (not taking a distribution currently)
  • Consulting: $1,000

TOTAL: $2,000

EXPENSE

  • HELOC loan: $130
  • Monthly bills: $1,000
  • Other property costs: $250

TOTAL: $1,380

Woohoo, looks like I’m pretired! Suck it, corporate America! Oh, but wait, let’s look a little deeper:

INCOME

  • Fourplex: $800 (While this is a pretty realistic number on average, expenses and vacancies have made this jump around drastically. When a perfect storm such as sudden expenses coinciding with a couple vacancies, it can be a cashflow nightmare. And I always feel like a surprise is waiting around the corner.)
  • Potential income from current investments: $0 (When it’s theoretical money, it’s best not to count the cash until it’s in your pocket. For now it’s still being reinvested, so it shouldn’t count as income — yet. Let’s put zero for now.)
  • Consulting: $0 (For me and my strict goals, I don’t want to count ANY work. Also, this could end — or go up — at any time. Let’s put zero just to see what happens.)

TOTAL: $800 (on a good month)

EXPENSE

  • HELOC loan: $130 (would go up if I had to rely on this stash for fourplex or other needs)
  • Monthly bills: This doesn’t count anything beyond core bills. One car repair or leaky roof and this goes up quickly. Let’s move it up to $1,500 so we have some cushion.
  • Other property costs: Additional expenses happen here all the time with rental vacancies and repairs. Let’s guess the coming months average $500.

TOTAL: $2,130 (And could even get worse in a hurry.)

Looks like I’m not quite free yet. In reality the situation isn’t as dire as the most negative scenario (although I worry continually about that happening). Nor is the most positive situation stable enough to rely upon. I easily break even right now with my consulting money and I am in no danger of getting tipped over from an expense spike because I have the HELOC to use if needed.

Which brings me to my point about the inflection point. With some key strategic moves and potentially going back and snagging a few more paychecks, I think I can get there.

My rough strategy right now is:

  • Sell my fourplex and move those funds into dividend producing funds or something similar so I have relatively reliable income. I have also considered simply buying some lower maintenance real estate and that’s still on the table, but I’m pretty sick of the rental game at this point. If the property isn’t sold, I need to get this running more smoothly so it’s a more reliable cash generator.
  • Cut expenses wherever possible. Not sure I can cut much further than I have, but we will see. Actually we could move to a smaller/cheaper home and the extra cash would set me up nicely, but this blog is about living in the real world. We may move at some point but we like where we live and we’re in decent shape overall. We’ll see.
  • Build up the cash-generating nest egg much further to close the gap and eventually reach pretirement!

I don’t know how long this will take, but I have feel great that the journey has begun.

The system is rigged

gamblingNow I don’t mean to sound like a conspiracy theorist or wild-eyed  hippie. But if we’re going to try to work the system, we need to understand how the system works. And by now I hope you’ve figured out that the game isn’t rigged in your favor.

The Occupy movement understood this well. Unfortunately they didn’t understand how to build a long-term movement, but that’s a story for another day.

Here is my oversimplified view of how the American capitalist system works and how it traps workers into long lives of servitude.

First let’s look at the organizing principle of the U.S.: It’s right there in the first words of the Constitution:

We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.

Does that sound anything like the place we live today? Let’s break it down:

Our Founding Fathers are rolling in their graves at how this country has begun corrupted. As a dear friend of mine once said: “Everything here has to be a business”.

Don’t get me wrong, I love this country and the good that we’ve done here and around the world is breathtaking. But it’s clear we’re not living up to our ideals. We’ve become a capitalist machine, eating up our own citizens for the sake of profit.

The way the system really works is pretty simple once you step back and take a look at it:

  • Ensure the labor force is always much larger than the work that needs to be done. This gives business leverage to keep labor costs down.
  • Destroy labor unions to keep that leverage strong.
  • Pay workers just enough to stay relatively comfortable and fed (don’t want them get violent), but not enough to stop showing up to work.
  • Use the allure of easy credit to keep control of the masses.
  • Provide low-cost entertainment so the people don’t have time to think about their situation.
  • Drench folks in advertising that leaves them with an unquenchable desire for more  stuff.
  • And just for good measure, use powerful propaganda to convince people they’re doing the right thing for themselves and the country.
  • Oh, and as if that wasn’t enough, we’ll dole out shitty health care coverage to those that feed the system with their labor.

There’s a reason a mortgage is 30 years, right? They want to own you right up until those working years are over. Creating a way to pay for homes under very long term loans makes housing prices go up. It didn’t make $500,000 houses affordable, it moved housing prices up to $500,000. Cheap interest rates exacerbate the effect, driving housing prices even higher. Notice that what the typical family pays for housing stays fairly static in percentage of their income (and real dollars quite often) as interest rates move up and down. (Note, however, that another trap has been the move to double income families — both paychecks now cover the same percentage of family housing cost as one income used to — and sometimes more. But that’s a good story for another day.)

How can anyone escape the clutches of such a powerful system? Do you have to be wealthy? I believe there’s a way out of this trap and the younger you are, the easier it will be for you. Personally, I still have some distance to go, but I think I can get there. Stay tuned!

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