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How do you manage your budget?

mdf

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I think most of the talk of "risk tolerance" (in general, not just here) is misguided. Most people talk a good game, and think they have much more risk tolerance than they really do. "Oh, you were talking about an actual loss, not a theoretical one?"
We certainly saw that around the water cooler after the 2008 crash.
 

Magi

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I think most of the talk of "risk tolerance" (in general, not just here) is misguided. Most people talk a good game, and think they have much more risk tolerance than they really do. "Oh, you were talking about an actual loss, not a theoretical one?"
We certainly saw that around the water cooler after the 2008 crash.

Amen.

Watching my portfolio drop through the floor proved helpful to understanding I really can relax while the market explodes.
 

jack97

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Sharpe is a smart guy. The 1997 paper you linked to has some interesting information on how morningstar calculated things 20 years ago.


EDIT - And here's a chapter from his 2017 work (on the same site) that corroborates what I've been saying in this thread, and goes into greater detail about why it works.

Yes, this paper uses beta for portfolio comparison. I think you need to think more about factors used for index funds, and not the stock picking strategy of active managers as mentioned by Sharpe
 

jack97

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I think most of the talk of "risk tolerance" (in general, not just here) is misguided. Most people talk a good game, and think they have much more risk tolerance than they really do. "Oh, you were talking about an actual loss, not a theoretical one?"
We certainly saw that around the water cooler after the 2008 crash.

Here's the event...... SP500 index and the VIX, a volatility indicator. Been studying this, if one waited it out the crash, losses are recouped after 5 years. If young, you can ride it out. If you're going into retirement around this time, then it blows. Having some funds in bonds can keep one afloat until the recovery happens, From a tax point of view, switching over to bonds is a no brainer in taxed advantage accounts such as an IRA, 401K and HSA. In a taxed account, I count capital gain taxes as losses as well and may pull out pending how much excess returns are in the account. IMO, the switchover or how much you have in bonds is really the true indicator of risk tolerance.

PCR_1.jpg
 
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jack97

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Here's the same indices but extends further back in time. The span from 2000 to 2013 was a wild ride, VIX is something I keep an eye on.


3-s2.0-B9780128112526000219-f21-01-9780128112526.jpg



edit, giving how the tone has changed..... I should add this disclaimer. Exactly timing the market is impossible however I point out the volatility index as a means to gather one of many pieces of information on what the "market" is doing so that one can decide the next appropriate course of action.
 
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KevinF

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I think most of the talk of "risk tolerance" (in general, not just here) is misguided. Most people talk a good game, and think they have much more risk tolerance than they really do. "Oh, you were talking about an actual loss, not a theoretical one?"
We certainly saw that around the water cooler after the 2008 crash.

It's all theoretical losses (and gains...) until you have to sell something. :)

But yes, to your point, after 10+ years of pretty much non-stop gains in the market, it's easy to think that you have this "investing thing" all figured out. I've thought a few times that this ride was over, but it just keeps on trucking.
 

Mendieta

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One of the interesting things that was probably not mentioned is amortization. A 30k car that you used for 10 years was really 3k a year (plus maintenance of course). But how do you budget that? I prefer to budget short term. Take the finance payments as part of the monthly budget. If you go for 60 payments, then you will be happy to be out of that monthly drag, and hopefully keep it 5 more years (or 15), "for free".

Similarly with the house. If you are lucky to buy, and you can get in a 15y mortgage, you are much more likely to pay it off and enjoy it "for free". In the meantime, the mortgage must fit in the budget which encourages saving
 

KevinF

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One of the interesting things that was probably not mentioned is amortization. A 30k car that you used for 10 years was really 3k a year (plus maintenance of course). But how do you budget that? I prefer to budget short term. Take the finance payments as part of the monthly budget. If you go for 60 payments, then you will be happy to be out of that monthly drag, and hopefully keep it 5 more years (or 15), "for free".

Similarly with the house. If you are lucky to buy, and you can get in a 15y mortgage, you are much more likely to pay it off and enjoy it "for free". In the meantime, the mortgage must fit in the budget which encourages saving

I understand where you're coming from in terms of "freeing up car payment money". I don't like to think that way because then every 10, 15 years (or whatever your "new vehicle" purchase frequency is) you need to re-arrange the budget to find car payment money.

I prefer to think that every 10 years I'll need to find $25,000 for a new vehicle purchase (or whatever numbers work for you), so $2500 a year or somewhere around $200 a month. But it's really a bit less as you can take advantage of compounding interest in your favor (instead of paying compounding interest and benefiting the bank).

Same with car maintenance... I know -- after years of experience -- my yearly outlay for oil changes, brake jobs, new tires, etc. So I have the "new car fund" and the "current car maintenance fund". Neither are exact; I don't have any insight as to the price of a new car years in the future or jf there will be "surprise" car maintenance issues, but between the two, my mechanic can tell me pretty much anything and it's not the end of the world.
 

Uncle-A

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Here's the same indices but extends further back in time. The span from 2000 to 2013 was a wild ride, VIX is something I keep an eye on.


3-s2.0-B9780128112526000219-f21-01-9780128112526.jpg



edit, giving how the tone has changed..... I should add this disclaimer. Exactly timing the market is impossible however I point out the volatility index as a means to gather one of many pieces of information on what the "market" is doing so that one can decide the next appropriate course of action.
The Tech crash around 2000 was the one that hurt me the most. I remember that Greenspan kept raising the interest rates because of the "Irrational Exuberance" and caused the Tech Bubble to burst. I had too much Tech in the portfolio. "Live and Learn" but Tech was my life at the time.
 
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Monique

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One of the interesting things that was probably not mentioned is amortization. A 30k car that you used for 10 years was really 3k a year (plus maintenance of course). But how do you budget that? I prefer to budget short term. Take the finance payments as part of the monthly budget. If you go for 60 payments, then you will be happy to be out of that monthly drag, and hopefully keep it 5 more years (or 15), "for free".

Similarly with the house. If you are lucky to buy, and you can get in a 15y mortgage, you are much more likely to pay it off and enjoy it "for free". In the meantime, the mortgage must fit in the budget which encourages saving

I understand where you're coming from in terms of "freeing up car payment money". I don't like to think that way because then every 10, 15 years (or whatever your "new vehicle" purchase frequency is) you need to re-arrange the budget to find car payment money.

I prefer to think that every 10 years I'll need to find $25,000 for a new vehicle purchase (or whatever numbers work for you), so $2500 a year or somewhere around $200 a month. But it's really a bit less as you can take advantage of compounding interest in your favor (instead of paying compounding interest and benefiting the bank).

Same with car maintenance... I know -- after years of experience -- my yearly outlay for oil changes, brake jobs, new tires, etc. So I have the "new car fund" and the "current car maintenance fund". Neither are exact; I don't have any insight as to the price of a new car years in the future or jf there will be "surprise" car maintenance issues, but between the two, my mechanic can tell me pretty much anything and it's not the end of the world.

Thank you for both of these perspectives. These are exactly the sorts of alternatives I'm looking for (two ways to account for the same expense).

I bought my new car last November when I was in a very different financial position. I have the payment coming out of my monthly budget, which I think is appropriate as I don't have any car-specific savings. Perhaps once I do have it paid off, I'll continue to take that amount and apply it to ... something. Whether it's car purchase, maintenance, or a more general "big expenses" bucket.

When I got out of college, I accumulated a lot of debt. Then we had car payments and a mortgage. There's a difference between maximizing the actual financial math, and doing something that makes you feel like you're making progress so that you keep doing it. In our case, once we paid off the shortest-term loan, we kept paying that amount to a savings account. The same with every subsequent loan. That - in addition to being fortunate in that our skills aligned with a profitable career path - let us eventually pay off our mortgage. I've heard - it makes sense - that we should have invested that money rather than paying off the loans early. Certainly, long term investments would earn more interest (especially if you don't have to pull it out at any particular time). But there was a huge satisfaction and sense of relief in paying off those loans and, in particular, knowing that the house was paid off.
 
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The Tech crash around 2000 was the one that hurt me the most. I remember that Greenspan kept raising the interest rates because of the "Irrational Exuberance" and caused the Tech Bubble to burst. I had too much Tech in the portfolio. "Live and Learn" but Tech was my life at the time.

My parents pulled out of the market when the bubble burst. It hurt their savings badly. As others have mentioned, it's really hard to hold steady. I am positive that if they'd held fast, they would have been fine - more than fine. All they had to do is be lazy like me and just ignore their investments ;-) But again ... easier said than done. I worked in a finance-adjacent company for a long time. I think the constant low-grade exposure to how the stock market works, and how people in the industry think about it, has inoculated me against freak outs. We'll see during the next crash.
 

jack97

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The Tech crash around 2000 was the one that hurt me the most. I remember that Greenspan kept raising the interest rates because of the "Irrational Exuberance" and caused the Tech Bubble to burst. I had too much Tech in the portfolio. "Live and Learn" but Tech was my life at the time.

That chart did bring back memories...... I lived and worked through that crash, the bay area had the ".dot" bubble and here in the northeast we had the "optical network" bubble. Lots of hype, fast and speculative money was flying around. High tech startups would scramble for a fast IPO, get the high evaluation and a large market capitalization. This was the goal of the venture capital back then, get an idea, hype the market and go public so that they can cash out. All this without a sustainable company business plan. That crash also change the high tech landscape as far as job opportunities on both side of the coast. That said, I'm sorry that one hurts the most. As for "Live and Learn", even if one had a fund tracking the SP500, the tech crash and the credit bubble at 08 resulted in effectively 13 years of savings just going "sideways" (no growth & no loss if you ride it out). This can be explained since the SP500 index along with passive and active funds that tracks this was based on market capitalization (# of shares times price per share ). As such, is prone to Irrational Exuberance, if a company or a sector is hyped, it can draw speculative money to enlarge the market capitalization. Lots of financial/economy prof who are contemporary of Shiller were looking at the data leading up to these turbulent times. Some from the Fama/French circle who were studying factors noticed low volatility stocks or portfolios had better performance than a straight forward market cap. Below is one example of a backtest ***, instead of a portfolio weighted to the market cap of the SP500, a low volatility weight is placed to the SP500 index. What you will see is the low volatility weighting gave a smoother ride through the tech crash and thru the credit bubble recovered faster, 3 years instead of 5 years. The rationale is the low vol factor would not weigh highly the stocks where the large crowds are jumping on board due to speculation thus causing high volatility, see the VIX chart leading up to the tech crash.

Low-Vol-and-Vanilla.jpg


As for the present, some are concern about FANG (Facebook,Apple Netflix and Google) these are the tech giants holding up the SP500, again through their market cap. If one or some of these giants suddenly fall so goes the index. I'm a firm believer this risk can be mitigated by using indices other than market cap. See the Morningstar link of SPHD, go to the portfolios section, it has no FANG yet performs as well and better when dividends are included. Also, I purposely allocated my funds where the majority of FANG are in my IRA and 401K so that I can switch over to bonds with no tax consequences.


*** disclaimer, past performance is no guarantee of future results...... but it could lead to high likelihood.
 

jack97

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I'm a firm believer this risk can be mitigated by using indices other than market cap.

Before the analities swings by, I should correct myself, the risk from FANG can be mitigated by the market cap of size as well. Due to passive index fund popularity, a slew of indices are now offered, some track small and mid cap stocks only. Shown below is the back test***, pending time spans, the SP600 (small cap market capitalization) has out performed the "market" (SP500)

Cumulative-Index-Levels-600v2000.png



*** disclaimer, past performance is no guarantee of future results...... but it could lead to high likelihood
 

scott43

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Just going to throw this out there..this is a nice investment justification piece..but most people have no time or inclination to get this involved in investing..it's like me telling people how to compute the theoretical maximum speed of an internal combustion engine based on materials properties and flame-front propagation velocity..some people just want to drive the car.. Just saying..:huh::beercheer:
 

jack97

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^^^ no worries, I wanted to keep out of the technicalities and keep it simple but a previous exchange lead me to this path. You can make it simple, invest in the SP500 and bonds. I just added this other stuff for people looking for more.
 

Uncle-A

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My parents pulled out of the market when the bubble burst. It hurt their savings badly. As others have mentioned, it's really hard to hold steady. I am positive that if they'd held fast, they would have been fine - more than fine. All they had to do is be lazy like me and just ignore their investments ;-) But again ... easier said than done. I worked in a finance-adjacent company for a long time. I think the constant low-grade exposure to how the stock market works, and how people in the industry think about it, has inoculated me against freak outs. We'll see during the next crash.
Even though I lost a LOT, the 401K came back and now I am good, but it did take some time.
 
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Monique

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^^^ no worries, I wanted to keep out of the technicalities and keep it simple but a previous exchange lead me to this path. You can make it simple, invest in the SP500 and bonds. I just added this other stuff for people looking for more.

That's cool, but I don't think it's budgeting. Perhaps all of the investment discussion belongs in its own thread.
 

Seldomski

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Investing feeds back into the budget discussion for the 'when' factor. When do you need the money that you are saving? The answer to that determines whether investing is even a good idea.

Emergency fund - cash/checking account/saving account/money market. Typical returns are <1% annually
"I need a car in 5 years fund" - maybe a CD or short term bonds. Returns 1-4% annually.
Money that you need 10+ years from now, this is where stock market/portfolios make sense. Retirement money, future home down payment, toddler's college fund, etc.

The gambling part comes for the 5-10 year window. This is where your personal risk tolerance will be tested.

I suggest that as you succeed at whatever budget you create, you re-evaluate all of your finances and see if you can get some of that money to work for you. If you have a fund for your next car, an emergency fund, vacation fund, home repairs fund, etc - you may consider it as having too much cash. What is the likelihood of all of these things happening? Can one or more of these be put into a short term investment like a CD? You'll need that car in a few years, so lock the cost for that into a CD and stop thinking about saving for that until it matures. If your car dies in the mean time, use the home repair fund for the new car until the CD matures.
 

Plai

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Investing feeds back into the budget discussion for the 'when' factor. When do you need the money that you are saving? The answer to that determines whether investing is even a good idea.

For me, that's only if you have retirement and emergency (investment) funds. Traditionally, investments should have longer time horizons (strategically speaking), 10-30 years. Discretionary funds driven by/in the market are a bonus few really achieve; please don't gamble here unless you're willing to lose it.

But, +1 on re-evaluating your finances periodically (yearly) is a good practice.
Here's hoping you can be one of the few with "discretionary investment funds' ;-)
 

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