It’s been 7 months since the inception of Let’s Take This Online and 3 months since I’ve made any kind of update at all. I fell short on just about every goal laid out in The Beginning including the one where I was actually supposed to write posts. I even became too ashamed to log in and face the growing pile of spam comments.
So I think it’s fair to ask now – where the hell is my blog income? The income that was supposed set me financially free in exchange for navigating you all through the vast sea of my bullshit?
It turns out maintaining a site takes some time and effort. Significant time and effort actually, and there was a lot of shit I wasn’t willing to do anymore. The top two became worrying about marketing and finding random ass images to accompany my posts since all of you have ADHD.
Therefore, I’m shifting the site to be a bit more personal in nature. The main purpose will now be to document my thoughts and financial strategies rather than drive in traffic. However, I’d still like to publish on the internets in case others could benefit or bring other points of view. After some time, the site might even be a nice piece of work to pass off to my dog or cat.
As for the damn pictures, I’m making my own despite the fact that I suck at all things artistic. It will at least be much more gratifying to create something rather than tack on a crappy/stolen image at the end of a post as an afterthought. It’s also been unexpectedly exciting drawing these cartoons – like I’m rekindling the right side of my brain that’s been dormant for the last 20 years.
Without further ado, meet Byron.
Byron is first and foremost a dork but is the product of many prototype sketches. I haven’t been completely inactive the past few months. I plan to make Byron very representative of myself – just another helpless soul getting steamrolled by life.
Please help me welcome him into the quirky worlds of personal finance and financial independence! Yes, the two worlds can co-exist.
Any time I find a pile of cash laying around, my natural instinct is to use it to pay off debt. I guess that’s better than buying a boat or something, but is it the optimal move to make?
Should we keep the cash liquid for security and future investments or should we pay down debts to increase cash flow and buy some peace of mind?
I usually start by asking myself why I have debt in the first place. Personally, I hate all consumer debt and hope to never have it again outside of a mortgage. This includes car loans, furniture loans, Walmart Layaway, and credit card debt.
It doesn’t matter if it’s 0% APR and you’d rather invest the cash into the next Enron. It’s ridiculous to pay $10/month for a sofa. Paying down consumer debt should be a no-brainer in my opinion. Just be sure not to replace your new found cash flow with something else!
I consider mortgage debt as consumer debt, but it’s a little special because the government says so. You get a nice 15-35% discount on the interest depending on your tax brackets. Your home also has a chance of holding or increasing its value over time, but you’d be kidding yourself if you called it an investment. That backyard pool or the toilet that cleans your bunghole will not pay for itself later.
For these reasons, it’s not always clear whether you should pay down the mortgage. From a strictly financial point of view, it’s probably sub-optimal to do so particularly with interest rates near the floor.
At the same time, you can’t put a price on peace of mind…or can you? Is having your money tied up in a house any less risky than having it in cash? If your stupid kitty sets your paid-off house on fire or a hurricane blows it away, there goes all your equity. You’re now dependent on the insurance company to make you (and your neighbors) whole again.
Perhaps your local real estate market tanks and your house loses 20% of its value. If you paid off the mortgage, then that 20% loss is very real because you already dumped all your cash into it. While the loss is still “real” if you had kept your cash in the bank instead, you at least have the flexibility to react. That might include buying your neighbor’s house at a 20% discount if you think it’s temporary or simply weathering a storm due to job loss.
The other side of the coin is holding too much cash. Despite the McDonald’s value menu staying constant the past few decades, inflation or currency devaluation is a real risk. Particularly these days with the federal government printing money out their ass and dumping it into the markets. Just imagine a world where a Big Mac costs $5 today but $15 two years later. Unlikely to happen here in the USA, but crazier things have happened.
Only you can determine the risks between home equity and cash, but one thing I’d never recommend is making extra principle payments over time. By doing this, you’re depleting your cash reserves while your payment amount stays the same. The only time this would make sense is if your interest rate is excessively high compared to alternative low-risk investments or you’re tempted to go to Vegas anytime your balance crosses $5,000.
I am actually a proponent of killing mortgage debt. I believe it’s a liability and a form of consumer debt. However, I plan to do so through a lump-sum payment. Until then, I’ll continue taking mortgage deductions and playing the Power Ball lottery (investing).
I usually don’t understand paying off investment debt unless you’re just wildly successful and don’t need it or you start to become credit limited by the banks. The only investment debts I have are rental properties so perhaps my perspective is limited.
If you’re able to save up some capital investment, you’ll typically leverage it as down payment to fund a business or rental property. Hopefully, this business will generate a positive cash flow.
The whole point of the initial investment was to yield a return on your money higher than the cost of borrowing. Investment debt is just a tool to start or expand your business. To pay down debt is spending your capital to increase cash flow…to raise capital which you already had. You’re stunting your growth.
But sometimes that’s okay. Grow too quickly and you could lose it all. Not everyone, myself included, wants to be a Donald Trump…thankfully. The hard part is always determining when you want to stop.
Do you want 15 paid off homes yielding a comfortable $15,000/month or 5 mortgaged commercial apartments with multiple partners but throwing off $25,000/month? Only you can decide.
Readers, how do you prioritize in managing your debt? Do you wait to pay off debts in lump-sum payments or make consistent principal payments? How do you view the risk of using debt to expand versus having consistent and predictable yield? What is your stopping point?
This week’s post will be a little short because well, I’m a little lazy. The other week, my nice woman-friend had a great idea to deepen the cut against cable television. I frequently insult her technological incompetence, so I would feel terrible not giving her proper credit. Perhaps everyone already knows this tip already, but I’m going to make you read until the end to find it.
You’re Still on Cable TV?
I’ve been off cable for about 4-5 years because it’s an easy way to simultaneously cut expenses and increase productive time. Further, the evolution of internet TV has made the transition much more manageable.
I never had a problem with watching too much TV, but I have witnessed my roommate get sucked into a stupid ass show like Storage Wars for 2-3 hours at a time. I couldn’t understand it. He knew the show was scripted and he knew it sucked. But he’d sit there and take it until he hated himself.
Even if you argue TV is a legitimate pastime from which you derive true joy, it’s still worth cutting cable for the sole purpose of avoiding ads. Cutting cable also forces you prioritize your content, so you don’t end up watching crappy shows just because they’re there.
The easiest way is to simply cancel your subscription forever and tune out from the distorted and mind numbing TV world. I get it though. I need my fix of the Kardashians and Rob and Chyna too. Still better than Fox News in my opinion.
So if you’re going to keep Cable TV, you should at the very least harass your cable company every 6-12 months. Don’t be shy…ask them directly if there’s any way they can give you a discount. The oppressed call center slaves might be happy to give you something if it means they can prevent a cancellation and thus a beating from their masters. You just have to ask.
This level requires actually cancelling your cable TV package. No bull-crap DVR rentals or HD upgrade fees. You’ll supplement your TV needs through various combinations of Netflix, Hulu, Sling TV, and any other subscription services. You won’t be able to watch shows live, but that’s actually an advantage because you’ll see less ads and have to prioritize which shows are worth setting aside time to watch.
As for sports, Sling TV might give you ESPN, but you’ll be missing your local NFL games. The way around this is to buy a digital antenna to watch over the air broadcasting. The picture and sound are very clear, but you’ll lose replay/recording capabilities. That’s okay though because we all know watching a recorded game isn’t the same anyway.
The main issue here is that if you watch a variety of television, you’ll need a bunch of subscriptions. Netflix and Hulu are about $10 each and Sling TV starts at $20. Forget about movie or premium sports channels. Oops, now you’re back to where you started. You might as well do one of those Double Crap packages from Comcast.
The How to Actually Cut Your Bill Method
I’m not proud of it, but this method resorts to good ole fashion cable
stealing sharing. Remember back when people would physically split cable lines throughout an apartment? I guess it’s kind of like that, except now you can do it anywhere in the country. The only thing stopping you is your ethics. Just remember though, companies like Comcast burn a kitten every time they get a new subscriber.
You’ll need something like a Roku 4 or an Apple TV 4. Do not get an Apple TV 3 because there is no app store for it. Nearly all of the major channels have an app providing access to their shows and even live TV. All you need are the login credentials to an active cable subscription.
This is where Mom and Dad, your Storage Wars addicted buddy, or maybe a little side deal with the co-workers come in. You can potentially gain free access to all your channels, limit the ad intake, and watch programs on your schedule. Further, due to the convenience, I’ve also found myself resorting less to other disreputable methods of obtaining shows.
Companies are finally starting to realize many people prefer to receive content through internet and apps rather than a crappy cable box. Perhaps that’s the reason they’re not so strict on the app login restrictions yet. However, it only takes a small minority abusing the system to screw it up for everyone.
Readers, am I late to the party? Is everyone already aware of this little tip? Is it technically stealing when someone allows you to use their subscription, or is it just cheap? Or is it frugal? I believe it’s a little better than splitting cable lines since it requires you to know the person well enough to obtain personal information. At least that’s the justification I’m going to use.
If there’s one thing I hate more than my cat smearing his crap on the floor after a misfire, it’s private mortgage insurance (PMI). PMI is the bank’s way of enabling homeowners to buy houses they can’t afford while still profiting off them. And no, I’m totally not bitter about this.
What is PMI?
Private mortgage insurance is insurance for the lender in case a borrower defaults on a mortgage. Lenders require PMI on home purchases with less than 20% down payment.
Let’s say you put down 5% on a $100,000 house ($5,000) but then decide to jet to Thailand for a premature early retirement a few years later. You enjoy the beaches and neglect the mortgage, making you kind of an a-hole.
The bank then forecloses and repossesses your house. Since the bank is not in the business of real estate investing or property management, they get rid of it as quickly as possible.
Although the bank only loaned out $95,000 on a $100,000 house, the cost of selling could be $6,000 – $10,000 alone. The property value may also fall from the time of initial loan to bank repossession. Private mortgage insurance fills the gap and ensures the bank will get its money back if a borrower defaults early.
If you had put down $20,000 (20%), the bank would have only loaned out $80,000. It’s much easier to recoup $80,000 than $95,000 and therefore banks would not require PMI. Furthermore, at 20% you have more skin in the game and probably won’t fly away to Thailand.
How Much Does PMI Cost?
Okay, who cares about the bank – how does this impact you?
The cost of PMI is typically between 0.5 – 1% of your loan balance per year but is heavily dependent on your credit score. Unfortunately, it’s difficult to know the exact amount until you get your credit pulled by a lender. As an example, I have excellent credit and my “factor” was .0062 or 0.62%.
On the $100,000 house, you paid 5% down and took out a mortgage for $95,000. Your PMI cost could be 0.62% of $95,000 which would be $589 per year or about $50 extra per month.
One factor to consider is that mortgage insurance is fully tax deductible up to an adjusted gross income (AGI) of $100,000. After that, the deduction phases out until it disappears completely at an AGI of $109,000. The PMI tax deduction was extended through 2016, but there’s no guarantee it will be extended in future years.
How to Avoid PMI
I’ve looked desperately, but there’s really no legitimate way to avoid PMI. Lenders do however provide several options to take the hits.
Option 1: Lender Paid PMI
There’s something called lender paid private mortgage insurance (LPMI). The lender “pays” for your PMI upfront at closing, but they make up for it by raising the interest rate of your loan by 0.25 – 0.5%.
This is great for the first few years because you pay only a little bit more in interest in exchange for eliminating the PMI payment. However, PMI can be cancelled or will naturally go away whereas LPMI is baked into the loan permanently until the house is sold or refinanced.
You’ll save in the short term but pay more in the long term. Welcome to America. This could make sense if you’re going to sell the house after 5-7 years, but then you probably shouldn’t be buying a house in the first place due to high transaction costs.
The other thought is to have the lender pay for PMI and then refinance your loan before the long term pain sets in. The catch there is that refinancing costs thousands of dollars and you need a large reduction in interest rate to make it worth it. At all time lows right currently, it’s more likely we’ll see flat or rising rates.
Option 2: Piggyback Loan
All the primary lender cares about is getting their 20% down payment so that they’re covered. Classic bank. If you put down 5% and can find a secondary lender to provide the other 15%, that is called a piggy back loan. Popular options are an 80%-15%-5% or an 80%-10%-10% arrangement, which can remove the PMI requirement.
I’ll leave the details for another post, but the drawbacks include a slightly higher rate on the primary loan, a significantly higher rate and 15 year amortization on the “piggy backed” loan, and extra closing costs. Typically, these extra costs will nullify most or all of the savings from removing PMI.
Option 3: Pay Up
None of the first two options should sound appealing to you, but perhaps you still want the house. I understand. I’m just like you.
Your best bet in that case is to just suck it up and pay the PMI and try to get it cancelled as soon as possible (see next section).
If you have the cash, you might consider putting down the full 20%. On the $100,000 house, you’re saving about $600 in PMI per year by putting down an extra $15,000. That’s a 4% annual return. Not bad in a world where customers can pay banks to store their cash!
How to Cancel or Remove Your PMI
The Traditional Way
Different lenders have slightly varying rules, but in general, they will remove PMI once you have at least 20% equity in the house. This is equivalent to having a remaining loan balance of 80% (sometimes 78%) of the purchase price or less.
By simply paying your mortgage bill every month, you will naturally reach this point. The lender should then automatically remove PMI. To find out exactly when, simply take your purchase price and multiply by 0.78 (e.g. $100,000 * 0.78 = $78,000).
Then look at the amortization schedule to see how many months/years it would take for your remaining loan balance to reach this amount. With current interest rates at 3-5%, it should take about 6-8 years of regular payments.
The Quicker Way
You could also speed up the process by making extra principal payments until you force your way to 20% equity. This might make sense if you suddenly find yourself immersed in a pool of cash a couple years after the purchase. Oh, does that only happen to me?
One thing to be aware of is that most lenders have minimum time requirements before they’ll remove the PMI. Don’t submit a baller 5-figure check six months after your purchase only to find out you still have to pay for PMI for 18 more months.
The Lucky Way
This is the way I did it, but it requires luck and…that’s about it. Back in 2012, I succumbed to the almighty #yolo movement and bought a primary residence with hopes, dreams and 5% down. No money? No problem!
Obviously, I learned about PMI the hard way. However, I also learned it could be removed relatively quickly if the timing is right – through property appreciation.
The house was roughly $325,000 in a developing neighborhood. The PMI was about $160/month, which was driving me nuts. Unfortunately, even if I could pay down my loan, which I couldn’t, I still had to pay for PMI for a minimum of 2 years.
Sure enough, 2 years fly by and I found myself in the middle of buying a rental property. In order to complete the deal, I was required to order an appraisal on my primary residence (long story). The value came in at $415,000. Grossly inflated and wrong, but who’s complaining? I showed my primary home lender and with some relatively easy paperwork, they removed the PMI within a few weeks.
Ok, Good For You?
It was great for me but might be a gamble for you. The PMI removal game costs $450 to play and get an appraisal. If the value comes in high, you win. If the appraiser has a more “conservative” view of your home value, they’ll give you a refund. No, I’m just kidding – they’ll laugh in your face.
A $450 appraisal was a no-brainer in hindsight since I would have paid more in just 3 months of PMI payments. However, I’m not sure I would’ve had the cojones to order it if I wasn’t required to for my rental purchase. If you truly believe your property has appreciated 15-20% within 2 years though, it may be worth a shot.
So Should You Get PMI?
The answer to every financial question like this one is that it depends. At one end of the spectrum, you may hate debt and want a lower monthly mortgage. It would make sense to wait until you can comfortably afford a 20% down payment.
On the other end, perhaps you’re all about opportunity cost. You speculate that you can flip the house to the next fool 3 years later for a higher price. In that case, you would want the lowest down payment anyway to maximize your return. You don’t care about PMI because the gain from appreciation gain dwarfs it. If you accidentally end up being the last fool, then you can abandon ship because you only put down 5%.
You’re probably in the middle somewhere. It’s a very similar to the question of how much your down payment should be. Peace of mind vs. flexibility and opportunity cost.
In my opinion, PMI allows you to buy a house you probably can’t afford. If your future looks bright and you understand what you’re paying a premium for, then it might be okay.
However, you should acknowledge this money is not helping you “build equity” or any other crap justification. You are paying a premium to put down a lower down payment. Don’t let realtors or lenders convince you otherwise by claiming it will be a great investment in the long term.
Readers, what are your thoughts on private mortgage insurance? Do you carry it? Why or why not? Were you able to cancel it early? Do you believe it encourages reckless lending at the cost of the homeowner?
In Part One, we went over where oil and natural gas come from and how we extract them from the depths of the Earth. But who cares about that? You probably care more about how oil runs the world and impacts our immediate lives.
So what drives oil and gas production? Money probably, but on a deeper level, the progress of society. The number one need for developing countries around the world is energy. Cities, economies, and standards of living all require it. Some may argue, “But at what cost to the environment?” Then, they’ll finish the rest of their Starbucks latte.
We know from Part One that finding oil and gas is basically a crapshoot sometimes. Reporting how much oil you have is even worse. Oil companies provide reserves estimates to the government and investors to inform how much producible oil they think they have.
This oil is still in the ground and may take decades to make it to the surface and sales. Given the high uncertainties, companies typically disclose only conservative estimates in which they have 90% confidence in.
Here’s the typical process: geologists and engineers look into the Magic 8-Ball and find that a certain area of land contains 500 million barrels (1 bbl = 42 gallons) of oil for example. If they’re really good, they will extract half of it (250 million barrels) to the surface and abandon the other half due to technical limitations. This is normal.
Now at the time the company makes the capital investment (gamble), they will base their decision on the 250 million number. In actuality, the project may actually produce 300 million or only 100 million. No one can know until the oilfield is abandoned which can take 30 years or more.
The company has much more confidence in delivering the 100 million however, so that’s what gets reported as reserves. This all goes out the window for Middle East or China, because it’s unclear what the hell they report. There are definitely financial motives to inflate your reserves numbers.
If a company is not continually exploring for or acquiring new oil fields, they’ll eventually run out of reserves. Replacing production with future reserves is what keeps the company in business.
Oil and Gas is Cyclical
I’ve made the oil and gas business sound like a casino, so why does it always seem like oil companies are drowning in money?
Well, they aren’t, especially these days. Some smaller companies are fighting off bankruptcies right now as they can’t repay the investments from the days of $100+/bbl with the $40/bbl revenues of today. Staff continue to get cut as expensive oil projects get cancelled. No more free fruit in the mornings.
Perhaps people outside the industry only like to remember $4 gas because it hurts their pockets. They may forget about the massive layoffs during low prices due to the euphoria of discounted road trips.
No sympathy though. Oil and gas is s a commodity business, which means it’s a cyclical business. Unfortunately, only a few companies can stay disciplined enough to weather the eventual downturns. This industry has had many examples of rainy days to prepare for but seem to fail every time. Sure enough, when prices recover, you’re guaranteed to see some greed and excess again.
Back in those glorious days of $4 gas, people really hated oil companies for jacking up the price. I don’t blame them, but someone should really clue them in that companies like Exxonmobil or Chevron have absolutely no control over the price.
Most of the oil production in the world occurs in countries that hate us. These countries (OPEC) can influence the price much more than we can, but they still can’t control it.
The recent decline in prices was a direct result of Saudi Arabia attempting to regain market share. The not so secret plot was to flood the market with oil and reduce prices enough to make American shale production uneconomical.
To their credit, American companies stood their ground, but needed to generate more revenue by continuing to produce more oil and gas. This created even more supply and sent the price spiraling downward enough that the oil dependent OPEC nations became cash flow negative. Oops, that backfired.
I’m sure it’s more complicated than this, but it’s just an example of how supply, demand and market forces control oil price.
The oil and gas industry is also an extremely capital intensive one. An upfront investment of a mid sized deepwater project can easily cost $5 billion. This easily dwarfs the occasional lavish party or several executive stock bonuses. I’m not saying it’s justified, but you can see how people can get carried away with greed when prices are high.
However, high prices spur investments into R&D (new technologies) and development of oilfields that were unimaginable even 30 years ago. One well in the Gulf of Mexico might cost 150 million dollars and find nothing but water. No one will take that kind of risk unless the payout of high oil prices are in place.
High prices allow operational efficiency and technologies to improve. “Unconventional” shale production or “fracking” are recent examples. I know a company that had knowingly sold off hydrocarbon bearing land 30 years ago because the technology wasn’t there yet. About 5 years ago they acquired some of the same leases, this time with the capability to extract it.
My last point on economics is that sometimes, it’s not all about the money. I mentioned that it’s not uncommon to leave over half of the oil in the ground before abandoning a field. Maximizing profit often reduces the percentage of oil you extract out of the ground. Some governments though prioritize maximizing oil production (getting the most out of the ground as technically possible) over profits.
Alternate Energies – The End of Oil?
As a biased industry employee, I don’t believe we’ll see the complete end of oil and gas in our lifetime. If we’re lucky, maybe we’ll start to see a true shift towards alternate energy.
The electric cars for example have made great progress, but ultimately the batteries are still powered by natural gas or coal. I always felt we should move straight from gasoline to natural gas vehicles since it’s much cleaner and North America has so much of it.
Regardless, it makes sense to continue investing heavily into oil and gas. Why? Because we have over 100 years of experience and technology. It doesn’t make sense to ditch it for something new and unproven. Continuing to provide the world with affordable energy will buy us time.
As oil truly runs out, I believe economics will spur investment into alternative energy rather than politicians or environmentalists. Oil prices will become unsustainable as we run out of it and investment in alternative energy will look much more attractive.
As much as people hate Big Oil, they will be the ones best positioned to start the process. They will have the capital from record oil profits. They already have all the engineers and R&D on staff. Most of all, implementing gigantic capital projects is their bread and butter.
Readers, I promise to shut up about oil and gas for a while after this post. Do you see the end of oil in our lifetime? Is powering our world with conveniences such as transportation, heating/cooling and electricity worth potentially damaging our environment? Should oil companies be blamed for producing oil when there’s a clear global demand for it?
As an oil and gas employee, the recent scandal over at Wells Fargo reminded me how fortunate I am to not have to sell crap products to unsuspecting customers all day. Oil and gas (aka petroleum, fossil fuels, hydrocarbons) sell themselves because the world is already hooked on them. Just like a 9 year old willing to stab his sister for the last Adderall pill, companies will spend billions and countries will go to war to get their hands on some black gold.
That makes oil a very political commodity. It touches citizens of nearly all developed or developing countries. But not everyone knows or cares where it comes from. As a result, there are many misconceptions or just plain ignorance floating around.
In Part One, I hope to go over the basics of where oil and natural gas come from and how we extract it from the ground. Part Two will focus more on the industry drivers, economics and one employee’s view on how they all function together.
Where Does Oil and Gas Comes From?
If you think petroleum comes from dead dinosaurs, you’d be somewhat correct. As organic matter (microscopic plants and animals containing the element carbon) dies and gets buried by sediment over millions of years, it essentially gets pressure cooked in Earth’s easy-bake oven.
Eventually, the source matter turns into crude oil or gas depending on what kind of biomass was deposited and how it was cooked (deeper = higher pressure and temperatures). When I say gas, I am talking about natural gas and not gasoline, which is a refined liquid oil.
As the petroleum gets generated, it is free to move out and live its own independent life. You see, underneath the ground is mostly just rock and water. Since hydrocarbons are lighter than water, they will naturally migrate upwards through the pore spaces between the rock. Sometimes they’ll make it all the way up to the surface, which is why you can have natural oil seeps leaking into the ocean with no oil companies to sue.
Preferably however, the hydrocarbons can instead get trapped in the subsurface because the pore space between the rocks get too small. This could happen 5,000 ft or 30,000 ft below the ground. Oil migration stops and it begins to accumulate to form a reservoir. If you’re imagining a large underground pool of oil, that is completely wrong and I blame the Simpsons.
Rather, imagine you had a few baseballs. If you stack them on top of each other and built a wall, there would be some space in between them for fluid to flow through. A reservoir is the same thing, except with sand grains instead of baseballs.
Take some beach sand, bury it and compact it enough for it to become a rock (sandstone). Then fill it with oil over a few hundred million years and boom – you have your oil reservoir.
How is Oil and Gas Extracted?
Okay, so Mother Nature did her part. How do we then ruthlessly exploit her to carry groceries in our Chevy Tahoes? By the way, even if you drive a Prius or an electric car, you’re likely just as guilty as the rest of us.
The only way to extract oil and gas is by drilling wells into the ground. A well is simply a deep hole with a bunch of steel pipes inside it, allowing the oil to flow from the oil reservoir to the surface.
Once you reach the hydrocarbons, you might think it’s like a straw where you suck out the last tapioca of your bubble tea. Sort of, but it’s more like someone’s squeezing the crap out of your bubble tea cup and you’re using your mouth to control the flow. If you fail, then tapioca escapes your mouth and goes everywhere, which would be an uncontrollable blow out.
Why is it like that? Well, think about a reservoir 20,000 feet below the surface. That’s 20,000 ft of rock above pushing all its weight down on it. If you then poke a hole in it with a smooth, 4 inch diameter pipe, all that oil and gas will want out quickly. Thus, the well operator must balance this pressure with their own fluid (mostly water) in order to safely manage the flow of oil and gas at the surface.
There are many more complications of course, but failure to balance this pressure is the sole reason for most oil and gas disasters such as the Deepwater Horizon incident.
Drilling 20,000 ft is one thing, but who’s to say there will even be oil or gas present when you get there? This is of particular concern for exploration wells in undiscovered areas. Drilling $100 million dollar wells and finding nothing but water is not uncommon. Success rates of finding brand new oil can be as low as 20-50%.
Or, there might be oil and gas, but the rock in which they sit in has such small pores, they can’t move (flow). The oil right near the well might make it into the well, but what about the oil 200 ft away?
You can drill more wells but that costs money. You might also have a hard time determining where to even drill it, because some parts of the reservoir can be very productive while others can be pure crap.
We can create simulation models based on real data, but it’s akin to recreating the map of San Francisco (the oil reservoir) given only 4 intersections as your starting point (well data). I’d venture to say that only a few industries face as many technical (and sociopolitical) uncertainties as the oil and gas industry.
If it’s so hard though, how do oil companies always rake in the cash monies? Well, they don’t, particularly these days. But I’ll save that for next week’s post on economics and drivers. Until next time, boys and girls!
Readers, I don’t recall learning about oil and gas in school, and thus had a completely screwed up perspective on it until I chose it as a major. I think that’s a shame because the world depends on oil and gas every day for societies to function normally. What are some common misconceptions in the industries you work in that everyone should understand?
A Deal From the Devil
What if I told you…you could drive a new car with little or nothing down, a low monthly payment, and no worries about future maintenance? What if you could ditch the car for a new one a few years later? Welcome to the world of car leasing!
Car leasing gets a bad rep in the personal finance world and perhaps for good reasons. But as my favorite scam artist, Robert Kiyosaki, likes to say, there’s 3 sides to a coin: heads, tails and the edge. Like most things, car leasing has its advantages and disadvantages, so you shouldn’t immediately dismiss it before understanding it.
What is Car Leasing?
Leasing allows you to drive a car for a few years without the headaches that come with owning it. It’s somewhat similar to renting an apartment or house, except cars are guaranteed to depreciate over time whereas property values may not.
A car depreciates the most during the first 2-4 years. This loss in value is what you’re actually paying for when you lease a car. Thus, you may not care as much about the sales price as you do about the car’s value after the lease is up, the residual value.
A $35,000 vehicle that has a residual value of $22,000 after 3 years might have lower leasing costs than a $30,000 vehicle with a residual value of only $12,000. Some cars hold their value better than others.
The Mechanics of a Car Lease
A car lease is a little less intuitive than a straight purchase, but not terribly so. There’s two components in a lease: depreciation and rent charge (aka finance or money factor). Let’s use an example with numbers to better demonstrate how they work.
A car has an MSRP sticker price of $30,000. The dealer’s bank sets the residual value of the car after 3 years at $18,000. Typically, there’s not too much room for negotiation here but that might depend on the car company. Your best bet is to negotiate the MSRP side just as if you were purchasing the car.
Let’s say you negotiate the MSRP price down to $27,000. Sales tax in Texas is 6.25%. You can probably tack on another $1,000 for title, registration, and crap dealer fees. These “acquisition fees” or “dealer fees” are usually revealed after you negotiate the sales price, so it would be wise to ask about them up front.
In our example, the final out the door “OTD” price is $27,000 + $1,688 taxes + $1,000 fees = $29,688. This is also your gross capitalized cost. If you are trading in a car, the trade in value will be deducted to obtain the adjusted capitalized cost.
The residual factor in this example is .62 or 62% of MSRP on a 36 month lease. This means the bank believes the car will be worth 62% of the original MSRP or $16,740 after your lease is up. If you do higher mileage per year or a longer lease, your car will be worth less.
The total depreciation cost of the car is $29,688 – $16,740 = $12,948. This translates to $360/month. A significant detail that could differ for you is what the sales tax is based on. In Texas, sales tax is based on the total sales price of the vehicle. In other states, taxes are based only on the depreciation cost (6.25% of $27,000 vs. $12,948).
Finance or “Rent” Charges
$360/month would be a pretty nice deal, but then how would the dealers/banks stay in business? The finance component is dependent somewhat on your credit score but also on how badly they want to screw you over.
The dealer may claim this number is set by the bank, but I suspect it’s the secret lever they can pull to put the deal back in its favor. For example, they may cut $1,000 off the MSRP for you but then add it right back through the mysterious rent charge.
Why do I suspect this? Because the dealers can be shady as hell about it. They may not even mention it during negotiations. Instead, they’ll only talk about monthly payments. Monthly payments are easy to understand but also easy to bake in hidden costs. Here’s how it could go:
You defeat Boss #1 (the sales guy), settle on the final price of the car, and think the battle is over. They then send you to the finance room to “just sign paperwork.” Suddenly, Boss #2 reveals himself in the form of a slick-looking banking douche-nozzle.
He or she (equal opportunity) will most likely gloss over everything, particularly the rent charge. It is your job to find it and ask them how they came up with it, because it’s the second component determining your monthly lease payment.
In this example, the rent charge will be $3,000. There’s no great explanation on how this is calculated because it’s up to the dealer or bank. Your best bet is to do some research online and see what other people have paid.
The Money Factor
The money factor is another way to measure the amount you’re paying for the rent charge and can be defined as follows:
Money Factor =
In this example, the money factor would be:
Money Factor = = .0018
In order to convert this to a familiar APR, multiply it by 2400, which would yield 4.3%. If your credit is good and the dealer is charging you above 4%, you should require an explanation on how they’re determining the money factor.
Total Monthly Payment
The total monthly payment is calculated by simply adding up the depreciation and rent charge components and dividing by your lease term. For our example, the monthly payment would be:
[$12,948 (depreciation) + $3,000 (rent charge)] / 36 months = $443/month. And remember, this is with $0 money down.
In order to achieve this same payment on a 3 year loan, you’d need to fork over about $15,000 (~50%) as down payment. On a 5 year loan, you’d need $5,000 down. You’d also need to worry about purchasing extended warranty. If you live in a state that bases sales tax on only the depreciation, the lease payment could be even lower.
One comment I’d like to throw in is that it’s generally not advised to pre-pay a lease. You might get a slight discount, but it’s likely not worth the risk. Let’s say you pay the full $12,948 + $3,000 = $15,948 up front and then total the car 3 months later. Your auto insurance and the GAP insurance from the lease will cover the vehicle and the dealer’s cost, but now you’re out a car and $15,948. Theoretically, you might recover most of it back from the dealer, but that’s not something I’d like to test.
Pre-paying a lease will also not reduce your debt to income ratio if you’re looking to obtain a mortgage. The lender assumes you’ll need another car when the lease is up, so the monthly obligation is counted against you whether the lease is pre-paid or not. The only way out is to buy the car out and sell it or keep it, which may then impact your reserves.
The Edge of the Coin: Is Leasing for You?
Let’s go back to our example on the $30,000 car. If you decided to purchase the car and take out a loan, you could put $5,000 down and make payments of $443/month. It would cost you ~$31,500 out of pocket at the end.
As we saw, a 36 month lease would have the same monthly payment of $443, but without a down payment commitment. At the end of the lease, you would be out ~$15,948. However, you’d have the option to purchase the vehicle at its residual value of $16,740.
If you did this, the total out of pocket would be $32,688. Not a whole lot more than purchasing from the beginning, but with much lower risk. Have a lemon, or is the car already giving you maintenance headaches? Walk away. Accidentally produced a set of twins and want another type of car? Walk away. Simply weak-willed and want the next best thing? Walk away. This assumes you are staying within your 10-15,000 miles per year limits.
A lot of people look down on leasing. They consider leasing as renting a nicer car you can’t afford and owning nothing at the end. Well, there’s some truth to that. However, what you’re really paying for in a lease is flexibility, reduced risk, and the ability to defer the purchase decision while still enjoying a new car.
You’re going to pay for depreciation no matter what. Yes, you may be able to buy a 2-3 year pre-owned car for about the same cost as a 3 year lease. However, you’ll bear more risk in the form of future repairs and the greater than expected loss in value if you have to sell it. Even my good ole reliable Toyota just 6 years old had a repair job that cost $1,500. If I didn’t have extended warranty, I would have been absolutely livid.
If you know your life will not change in 3-5 years, drive a lot of miles, and view cars strictly as a means of transportation, you’ll likely be better off purchasing. As long as the car is half decent, you should get up to an additional 150-200,000 payment free miles. You’d also be better off purchasing if the car you like sucks at holding its value.
Leasing, in some smart cases, allows you to drive the primo miles on great cars with lower costs and risks. Good candidates for leasing include those who have great credit, drive an average amount of miles, and desire flexibility.
Readers, what’s your take on leasing and have you ever considered it? I used to shun the concept of leasing until I got about 5 years into my paid off vehicle. I had an itch to try something new, but had a hard time accepting the inevitable loss that comes from selling. Is it better to rent/lease depreciating assets or ride them out to their dying day? How much is spending time on maintenance and giving up flexibility worth to you? On the other hand, I love using things that aren’t worth much it’s no big deal if they scratch or break!
In my early twenties, I recall heading straight to the business section of my local library at least once a month. I figured by learning the crap out of money and how others got rich, I could do it too.
Well, here I am a few years later writing to you poor souls about my largely unsuccessful journey. I’d like to reflect on the possible reasons for failure and why I may never be able to make it to the top. Perhaps you all can resonate with a few of these.
I Still Make Financial Blunders
The first square you start on in the personal finance game is reducing expenses. After reading through books, articles and blogs, they all start to sound the same, which probably means you’ve gotten good at it.
I did it all as well: counted pennies, banned beverages, wore clothes from grade school, pissed off a lot of Comcast employees, and lived with a roommate to cut rent (<$650/mo).
I once passed out during a flag football match and someone called an ambulance. When the paramedics arrived, I told them to get their grubby little hands off me because I didn’t want a $1000 taxi to the hospital. I probably would have paid another $100 for a nurse to check my blood pressure and tell me I didn’t eat enough food. Then I’d need a real taxi back to my car.
Was it smart to refuse the ambulance? Probably not, and no I was not actually a jackass to the paramedics. However, this was the thought process that ran through my head.
Unfortunately for me, this miserly mindset tends to go out the window when it comes to the automobile. A couple of years ago, I purchased a brand new SUV for about $40,000. What good is saving $100 by dressing like a hooligan when you blow $40k on a car? At least if you blow $40k on a down payment for a house, it might actually hold its value.
I’m Either Too Grateful or a Complete Ingrate
One concept that’s easy to understand but difficult to master is that life is all relative. One minute, you’re on top of the world because you got that new job that doubled your salary. The next minute, you log onto Facebook and you see your cousin opening up a sweet Brazilian Steakhouse. You immediately wonder what the hell you’re doing in life?
You rationalize and think, “Well, that’s a ton of work and risk, no thank you.” Maybe your defensive instincts say, “Well, she probably just couldn’t make it in the corporate world like me” before realizing what a terrible person you are. From there, you can either reject the negativity and proceed along your merry way or you can waste your life energy by comparing yourself to others.
I strive to do the former by reminding myself where I fall in the distribution of life situations in this world. I should be grateful to even live in a free country, let alone worry about financial independence. Some may also read this post and take offense. They’re working 60 hours a week to support a family on $50,000 a year. Meanwhile I’m sitting on a soap box writing about why I’ll never make it rich. In their books, I’ve already made it and now I’m just rubbing it in.
On the other hand, if I feel guilty all the time, I could become content and write off potential opportunities that may be out there. Particularly these days, I keep my head down and my mouth shut to try and keep my oil and gas job. Everyone tells me the job market is a bloodbath right now, so I don’t even take a peek.
I overlook job vacancies created by the vacuum of forced retirements. I settle with being paid 20% less than colleagues doing the same job because I’m lucky to even have one. I ignore the fact that the greatest opportunities can come when the sky is falling around you.
I Simply Don’t Have What it “Takes”
After reading many books on how people got filthy rich from scratch, I noticed a common theme. You have to sell the crap out of your product, and sometimes that product is yourself. I learned this from Gary Keller’s book The Millionaire Real Estate Agent. At the time, I considered becoming a realtor because the job seemed flexible and the potential unlimited. I also felt I could do a much better job that the other scrubs out there.
Unfortunately, doing a good job is only half of the battle for realtors. The rest is marketing. You can’t do a good job if you have no clients! While Mr. Keller’s book confirms it’s possible to make $100k or even $1 million per year, you’ll have to sell yourself completely to do it.
This means putting my stupid little face on stupid little calendars and spamming the hell out of people. It means reminding everyone around me that I’d like to sell their house as soon as possible. Ultimately, it means finding people and convincing them to put their money in my pocket. Is that unethical or “dirty”? No, of course not. Realtors spend time to provide a service and advise clients based on their knowledge and previous transactions, but the job may not be for everyone.
While I’m using real estate agents as an example, the same applies to most businesses or even climbing the ranks of the W-2 Employee club. During my interviews, I sure as hell made it seem like my greatest priority in life was figuring out how I would maximize profit for the company. Perhaps I’m a sell out too, but how far can you take it?
In the oil and gas industry, executives love to focus on safety. It’s the first thing they talk about, before profits and operational performance. While safety training and rituals are legitimate out in the field, it’s absolute nonsense to carry that over to the office. To place ergonomics on the same scale as helicopter crash casualties is a disgrace.
Do the executives who implement retarded office safety policies truly believe what they say, or is it just a show for the investors and the company image? Would you be able to impose this sort of BS on hundreds of people below you on the corporate chain with a straight face? Perhaps this is why engineers who base everything on logic prefer to stay in the lower ranks. Personally, I know a small part of me dies anytime I have to make a presentation on holding the handrail.
Readers, what are your reasons for not being filthy rich yet? Is that even a goal worth striving for if it means sacrificing everything, being absolutely relentless on getting what’s yours, and selling yourself out? Speaking of sellouts, don’t you think it’s funny when you see Lebron James endorsing Kia vehicles on TV? How much do you think people in the sales industry actually want to help people versus push product and maximize commission?
What is Gold?
Gold is an interesting thing. Some call it a commodity but it serves no practical use. Others call it an investment but it provides no yield. Gold bugs will call it a currency but you can’t buy anything with it.
We don’t have to be so picky with labels though. Ultimately, gold is a precious metal. It can rise or fall in value relative to your initial purchase. You can exchange it for other currencies to buy goods and services.
Gold as a Commodity
Gold is unique in that its value comes solely from people’s belief in it. Just like paper money though, that doesn’t mean it’s useless.
There are only a few natural elements that are as stable as gold. Others are gases or liquids at room temperature, are too reactive, or they give you cancer (radioactive). Gold is also rare in nature but not too rare to make it impractical.
Gold’s physical properties and natural abundance have allowed it to function as the global symbol of wealth for thousands of years. The almighty dollar has only been around for a few hundred years at most, depending how generous you want to be.
Although it can’t be burned to haul groceries in your Chevy Tahoe, gold does indeed serve a purpose in society after all. That purpose is to store and represent wealth over time.
Gold as an Investment
If you purchased gold 28 years ago in 1988 at a peak price around $490/oz, you would have to wait 17 years until 2005 for the price to recover. You would have seen your investment erode by half during its lowest point.
Conversely, if you first purchased gold in 2005, you would have seen your investment triple at the peak price of $1,700/oz in 2011 before settling down to today’s price (August, 2016) of $1400/oz.
If you think that’s volatile though, you should check the chart of the S&P 500.
Since 2000, the S&P 500 has lost nearly half its value twice and is now at an all time high. But that’s okay, because the market always goes up, right? Time in the market rather than timing the market. Just casually throw everything into index funds for the rest of your life and you’re set.
That was my attempt at sarcasm. While convenient, the set it and forget it strategy completely ignores the most fundamental tenet of investing: past performance is not indicative of future results. The historical data of the S&P 500 is also heavily skewed, with an average inflation adjusted price of only $400 between 1928 and 1990 (70% of the data). From 1990 to now, there is extreme volatility that jack up the average return rates.
Unfortunately, I don’t have the solution for you. My point is that people will say investing in gold is ultra-risky while they have no problem throwing 50-75% of their net worth into an equally risky S&P 500 index fund.
Gold as a Currency
Using gold coins to buy goods and services would suck. You typically don’t need $1,400 worth of cat food at one time. Paper currency, or fiat money, is a far more effective tool.
However, that tool is owned by a federal government, and governments can mismanage money with disastrous consequences. Even right now, no one seems to care about the obnoxious amount of money printing done by the United States Federal Reserve. We just gloat over record high stock prices without questioning where it’s coming from.
Ultimately, all debts are repaid one way or another. Remember Germany’s currency after the First World War? Or simply look up Zimbabwe’s hyperinflation in 2000-2008. The government screwed over its citizens so badly that by February, 2009, Zimbabwe’s dollar was “worth 10 trillion, trillion original dollars”. 10 to the 25th power. People resorted to bartering or obtaining foreign currencies through the black market. If you want to learn more about the accounts that happened in Zimbabwe, I highly recommend the book When Money Destroys Nations.
As insulated as we are in the US, it’s important to know that this kind of crap goes on in the modern world. It’s going on right now in Venezuela. Here’s the general process:
- Government implements either bad or corrupt policies and creates massive debt
- Government prints money to pay interest on their debt and ultimately buy time
- Citizens lose confidence in their local currency and hyperinflation may occur
- Government restricts businesses from raising prices in an attempt to maintain stability, forcing them to operate at a loss
- Everything sells out, stores go out of business, and basic necessities are in short supply
- Citizens resort to bartering and foreign currencies and gold may be outlawed
- Some sort of revolution or reset occurs
The major advantage gold holds over paper money is that it can’t be printed. It keeps governments honest, which is exactly why the US went off the gold standard in 1971. They were bankrupt!
Gold is Insurance
You’ll notice this post is categorized under “Insurance and Protection” because that’s what gold ultimately provides. When your local inflation rate skyrockets from 20% to 150+% in 3 years like in Venezuela, you can bet on gold and not your government to bail you out.
In fact, the government might try and confiscate your gold for themselves! Sounds ridiculous, but it happened right here in the USA. Don’t keep your gold in bank vaults because the government can open them.
Some may say you’d be better off with bullets rather than gold in a crisis, but history says otherwise. Firstly, currency collapse is not instantaneous. It takes years and if properly prepared, you’ll have time to make your moves.
Second, people don’t automatically resort to DayZ style violence. In Zimbabwe, an extensive network of barter emerged. Communities became stronger with members more dependent on each other than ever.
But before it gets to bartering, people will look to acquire foreign currencies or gold first. Anything stable that can hold value. Unfortunately, it will be too late or too expensive by then because people won’t want your crappy and worthless currency.
On the other hand, if you already acquired gold and the price jumps 5000% with respect to your local currency, you’ve preserved your wealth. You can hopefully exchange that for basic necessities while you wait it out or perhaps buy a way out of the country before it turns ugly. Since gold is globally recognized, you’ll be able to swap currencies and start your life over in a new country.
What’s that though? USA is the supreme leader and always will be because ‘Merica? You might be right, but crazier things have happened. Just ask the British Empire in the 1800’s or maybe the Roman empire. It wasn’t a complete apocalypse for its citizens, just a shift in world power…but it can happen.
So Should You Invest in Gold or Not?
Personally, I recommend owning physical gold rather than investing in gold. One involves actually holding it in your hand and the other involves speculating on gold price. I have done both.
You can buy shares of the GLD fund which represents the gold price. You can also choose to leverage gold by investing in gold mining company stocks or funds. I made a rapid 30% return on a modest sum of money doing just that before chickening out earlier this year.
I consider this pure speculation and not investing. Despite research or whatever BS theories I came up with, it could have easily gone the other way. You should only put in what you can afford to lose unless you’re a bad-ass.
If you want gold as insurance however, get physical gold bullion. A reputable dealer from personal experience is APMEX. Why physical gold? Because just like you want legitimate insurance companies actually paying out your claims, you’ll want the real deal in your hands when crap hits the fan. The time when everyone wants physical gold is when there will be none available.
The amount of physical gold in circulation versus gold promised in contracts, futures, or ETFs is minuscule. In a true panic, your gold futures will get cancelled and they’ll send you a check for the market price that day. That’s great, but when hyperinflation is eroding your fiat money 10% per week, it defeats the point of owning gold as a hedge against currency collapse.
How much gold to hold depends on your outlook of your country’s stability. Zero is appropriate if you trust our world leaders to figure it all out. Perhaps 5% of your net worth will be enough to sit tight and preserve wealth during heavy inflation periods. Maybe you’ll need 10% to escape and start a new life for your family after a crisis. In any case, you should stash it away and hope you never have to sell it.
Readers, what are your thoughts on gold? Do you hold any Gold ETFs or physical gold and why? Does all of this sound like tin-foil hat material or do you also have concerns on the global debt crisis and money printing around the world? What would you do if our currency undergoes severe inflation?