Category Archives: Financial Planning

Net Income vs. Free Cash Flow

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The world of free cash flow (FCF) and net income are intriguing. These two financial metrics often dance around each other, but they’re not quite the same:

  1. What Is Net Income?
    1. Net income (profit or earnings) represents the bottom line on a company’s income statement. It’s the total profit a company has made after accounting for all expenses, taxes, and interest.
    2. Net income is calculated as:
      Net Income=Total Revenue−Total Expenses
  2. What Is Free Cash Flow (FCF)?
    1. FCF is a powerful metric that goes beyond net income. It measures the cash a company generates from its operations minus the necessary capital expenditures (like buying new equipment or expanding facilities).
    2. FCF considers both cash inflows (from operating activities) and cash outflows (such as asset investments).
    3. The formula for FCF is:
      FCF=Cash Flow from Operations−Capital Expenditures
  3. Why Might FCF Be Higher Than Net Income?
    1. FCF can exceed net income for several reasons.
    2. Non-Cash Expenses:
      1. Depreciation and amortization are non-cash expenses that reduce net income but don’t directly impact cash flow. If these expenses are significant, FCF can be higher.
      2. Working Capital Changes: Changes in working capital (like accounts receivable, inventory, and accounts payable) affect cash flow. If a company efficiently manages its working capital, FCF can surpass net income.
      3. Capital Expenditures: FCF can be higher if a company has minimal capital expenditures (e.g., it doesn’t need to invest heavily in new equipment).
      4. Timing Differences: FCF considers the actual timing of cash flows, whereas net income is based on accrual accounting. Timing differences can lead to variations between the two.
  4. Why Does It Matter?
    1. Investment Decisions: Investors often focus on FCF because it reflects a company’s ability to generate usable cash. Higher FCF means more flexibility for growth, dividends, or debt reduction.
    2. Sustainability: A company with consistently positive FCF is better positioned to weather economic downturns or invest in future projects.

Media Perception: Media reports often emphasize net income, but understanding FCF provides a deeper insight into a company’s financial health.

Remember, while net income is essential, FCF tells us whether a company can use that income to fuel growth or weather storms. So, next time you analyze financial statements, watch net income and FCF—they’re like two dancers performing different moves on the same stage!

Retirement Isn’t An Age

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Retirement isn’t an age. It’s a point at which your finances are where you can permanently leave the workforce. ~ USAToday

Retirement refers to the time when someone permanently leaves the workforce, usually in their later years.

Retirement is often synonymous with the idea of financial independence, which is when your savings and investments are sufficient to cover your living expenses and support you for the rest of your life.

Many Americans think of retirement as a certain age. And certain retirement benefits are indeed associated with a specific age. For example, the minimum age to start collecting Social Security benefits is 62, but you’ll have to be 66 or 67 to collect your full benefits.

However, retirement isn’t an age. It’s a point at which your finances (the magic number) are where you can more than cover your monthly living expenses and permanently leave the workforce.

The “magic number” rule of thumb for retirement is to have 25 times your annual expenses or to spend only 4% of your portfolio per year during retirement.

Source:  https://www.usatoday.com/money/blueprint/retirement/what-is-retirement/

The Magic Number Rises

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More Americans say they don’t feel financially secure…rising inflation and incomes that aren’t keeping pace get most of the blame. ~ Northwestern Mutual

The “magic number” for retirement has surged in recent years thanks to high inflation. According to Northwestern Mutual’s 2024 Planning & Progress Study, Americans now believe they need $1.46 million in savings and investments to retire comfortably.

Yet, this number reveals more about Americans’ anxiety than precise planning. We often overestimate our financial needs

This ‘magic number’ figure has leaped 15% in a year and an astonishing 53% since 2020. Meanwhile, retirement savings have dwindled to a mere $88,000.

The “Silver Tsunami” of retirement approaches, with millions of Baby Boomers riding the waves into retirement.

Track and prioritize your spending is vitally critical. This involves prioritizing the spending that’s most important to you and letting things that are less important fall off. You’re saying no to some things so that you can say yes to others. You might even want to employ loud budgeting.

Loud budgeting gives you permission to say no to social engagements by saying you don’t have the money for it. To put loud budgeting to work, you commit yourself and share that you’re doing it. Loud budgeting lets you spend money on true priorities while skipping things that won’t really provide or align with your values and priorities.

Loud budgeting can be a simple way to push back when you’ve spent too much. But it works best when it starts with a solid budget and a financial plan that helps you balance future goals with what you need for today. The idea isn’t to say no to everything, but loud budgeting should help you say no when needed.

Ultimately, your financial goal is to have more income coming in each month than expenses going out.

But make sure that you’re thoughtful about your spending so that you feel good about what you’re getting when those dollars leave.

Source:

  1.  https://news.northwesternmutual.com/planning-and-progress-study-2024
  2. https://www.northwesternmutual.com/life-and-money/what-is-loud-budgeting/

Retirement Planning

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Planning for retirement is a way to help you maintain the same quality of life in the future.

You should start retirement planning as early as financially and emotionally possible, like in your early twenties or thirties. The earlier you start, the more time your money has to grow.

That said, it’s never too late to start retirement planning, so don’t feel like you’ve missed the proverbial boat if you haven’t started.

Keep in mind, every dollar you can save now will be much appreciated later. Strategically investing could mean you won’t be playing catch-up for long.

Additionally, retirement planning isn’t merely about counting the days until you hang up your work boots and calculating your magical financial number.

It’s about ensuring that your golden years exudes comfort, financial security, personal relationships, meaning and purpose. Here are five financial steps to guide you as you prepare for career and life transition:

  1. Know When to Start: Determine when you want to retire. Will it be an early retirement at 62 or a grand finale at full Social Security benefits age (around 67)? Remember, the earlier you claim Social Security, the less you will receive monthly, but delaying it can enhance your benefits.
  2. Calculate Your Magic Number: Calculate how much wealth or nest egg you need to sustain your desired lifestyle. Consider living expenses, healthcare costs, and the joys you wish to indulge in during retirement.
  3. Prioritize your financial goals: Pay off debts, build your savings, downside if necessary, and calculate your monthly expenses.
  4. Choose Your Accounts: Explore retirement accounts. Will it be a 401(k), an IRA, or both? Each has tax advantages, contribution limits, and investment options. Mix and match wisely.
  5. Invest Wisely: Your investments must propel you toward your financial destination. In your youth, invest aggressively. As you approach the retirement, dial back to a more conservative mix.

Whether you’re a few decades or a few years away from retirement, having a plan can help you feel confident that you’ll be prepared when the time finally arrives.

Source: https://www.nerdwallet.com/article/investing/retirement-planning-an-introduction

Intrinsic Value

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“Every investment is the present value of all future free cash flow.” Everything Money

Cash flow refers to the net amount of cash and cash equivalents that comes in and goes out of a company. Businesses take in money from sales as revenues and spend money on expenses. Cash received represents inflows, while money spent represents outflows.

“Intrinsic value can be defined simply as the discounted value of cash that can be taken out of a business during its remaining lifetime. “ ~ Warren Buffett

A company’s ability to create value for shareholders is fundamentally determined by its ability to generate positive cash flows or, more specifically, to maximize long-term free cash flow (FCF). FCF represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets.

Intrinsic value is defined as the discounted present value of all future cash flow of a business.

The only reason to lay out money for an investment now is to get more money later.  When you invest in a bond, its very easy to see the future cash flow and the terminal value of a bond, its printed on the certificate.

When you invest in a stock,

Investing in any financial asset involves laying out cash now in order to get cash later out of the investment.  And investing in a business, can the business deliver enough cash to you (the owner) soon enough that it makes sense to buy it as its current market value?

How much am I willing to pay for a business, considering it makes $24B in cash flow per year, and is growing at 10% annually.

Once we determine the business intrinsic value, we compare that number to the business’ current market capitalization.  Market cap is the product of the total shares outstanding and the current market stock price.

  • Market cap is higher than intrinsic value = overvalued
  • Market cap is lower than intrinsic value = undervalued

Discounted Free Cash Flow since one dollar today is worth more thant $1 in five years due to opportunity costs and lost of purchasing power of that dollar.

  • Step 1:  Find the current free cash flow – Free cash flow is the amount of money left over for the owners of the business, after factoring in cash outflows that support its operations and maintain its capital assets. The ideal FCF for valuation would equal Operating Cash Flow minu Maintenance CapEx
  • Step 2:  Grow the current free cash flow out 10 years in the future – the growth rate used will have a big impact on the final intrinsic value calculation. Check historical growth rate for cash flow and industry growth rate for cash flow.  Or, look at trend and future capital investments.
  • Step 3:  Add a terminal value – what you can sell the business for in 10 years.  Use FCF multiple.
  • Step 4:  Discount all future cash flows to present value at a rate of 12% to 15%
  • Step 5:  Add together all future cash flows to find intrinsic value
  • Step 6:  Add a margin of safety (of 20% to 30%)

In the current market environment, most companies will be trading above the intrinsic value.

References:

  1. https://www.investopedia.com/terms/f/freecashflow.asp

Best Investment Advice by Brian Feroldi

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  1. Don’t sell too early. Let your winner run and experience the magic compound growth over the long term.
  2. Capital is precious and limited, buy high-quality, avoid garbage. Doing nothing is almost always the best investing strategy and tactic. Valuing and researching great companies is also extremely important.
  3. Sometimes, the best stock you can buy is the one you already own. Add to your winners and not your losers. Winners tend to keep on winning.
  4. Your biggest edges as a retail investor are focus, discipline and patience, don’t waste it.
  5. Get comfortable doing nothing. Doing nothing is almost always the best investing strategy and tactic. It’s really hard to get comfortable doing nothing, but you have to get comfortable doing nothing. Valuing and researching great companies is also extremely important.
  6. Know what metrics to look at, and when to look at them, and when to ignore them. Study the business cycle. Know what valuation metrics matter, when they matter and when they don’t.
  7. Personal finances come first. Make sure you have an emergency fund, because life happens.
  8. You’re going to be wrong a lot. Get comfortable with that. If you buy ten stocks, six will be losers, three will be market beaters and one will perform extraordinarily.
  9. Find an investing buddy, or rather don’t invest alone. Get involved in a good community of investors. Find like-minded people. The Internet makes that so much easier.
  10. Watch the business and not the market price of the stock. What really matter in the long-term is the company’s fundamentals.

References:

  1. https://www.fool.com/investing/2021/03/20/top-10-investing-lessons-for-our-younger-selves/

More Than One in Four Americans Say Their Debt is Unmanageable

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Nearly one in five Americans are feeling bad or very bad about their financial circumstances. ~ OppFi’s 2022 Personal Finance Study

The FinTech company, OppFi, surveyed nearly 1,100 Americans to learn more about Americans’ financial situations,.

Respondents had mixed and uncertain feelings about where they stood financially, with nearly one in five feeling bad or very bad about their circumstances.

Key takeaways

  • Half of respondents to the survey are currently in debt, and 52% of those in debt say their debt is not manageable.
  • Just over 1 in 3 respondents have frequently experienced stress or anxiety about their finances since the COVID-19 pandemic started.
  • 1 in 4 took out a personal loan during the COVID-19 pandemic, most often to cover basic necessities such as food, clothing, and housing and credit card debt.

Americans’ financial health is often measured by benchmarks such as debt, savings, spending habits, and the ability to pay their monthly bills, writes Ashley Altus, CFC, a personal finance writer for OppU. OppFi survey respondents reported having difficulty with many of these things. Half said they’re in debt, and nearly half said they can’t pay their bills on time. Almost 2 in 5 live paycheck to paycheck, and 1 in 5 said they spend more than what they earn.

Budgeting is widely considered an important aspect of personal finance, but 1 in 10 said they didn’t have a budget at all.

Fewer than half (47%) said they have a savings account or emergency fund. Of those who did, nearly 1 in 5 said they could live off it for three weeks at the most.

How COVID-19 impacted Americans’ financial situations

The COVID-19 pandemic threw the American economy into chaos, with numerous businesses closing. In April 2020, the unemployment rate reached a level not seen since the 1930s. Near the end of 2021, 10 million households were behind on rent despite three rounds of stimulus checks.

More than half the people we surveyed said the pandemic worsened their financial situation. The biggest reason? Employment – more than 1 in 5 were working fewer hours and 15% lost their job. Others cited their own illness (17%), and 15% said their credit score decreased.

Financial stressors

One result of financial difficulty may be stress. Just over 1 in 3 respondents said they have frequently experienced stress or anxiety related to their finances since COVID started, with the most common stressor being paying bills other than mortgage or rent (cited by 35%). Debt was identified as a source of stress by 28% and 26% were stressed about not having enough savings.

Other stressors included basics like having enough food, high energy or gasoline prices, and paying mortgage or rent. Financial anxieties also reach as far as retirement, with more than 1 in 10 saying they’re worried they won’t have enough to retire on.

References:

  1. https://www.opploans.com/oppu/articles/personal-finance-study-2022/

Stay the Course

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While volatility can be troubling for investors, financial experts caution against making any rash decisions when markets fall. Volatility can lead to opportunities to buy more of your favorite stocks and set yourself up for future gains.

Expect and accept volatility

You, as an investor, should accept market volatility — which is relatively common — as a normal part of the process of investing and the best way to outrun inflation, said certified financial planner Brad Lineberger, president of Carlsbad, California-based Seaside Wealth Management. “Embrace the volatility, because it’s why investors are getting paid to own stocks,” he said.

This means you should stay calm even through extreme movements. While stocks always move up and down, long-term market returns are still based on the same things: dividend yields, earnings growth and change in valuation, according to Zach Abrams, a CFP and manager of wealth management at Shaker Heights, Ohio-based Capital Advisors.

investors should worry about Jerome H. Powell, chair of the Federal Reserve. The Fed raised interest rates by a quarter percentage point in March for the first time since 2018 and projected six more increases this year.

“The market reaction in the past four to six weeks can almost all be attributed to the Fed and how interest rates have moved,” Mr. McMillan added. “There’s been very little response to events in Ukraine.”

Investors haven’t fully appreciated what rising interest rates mean for the stocks in the financial sector, especially banks and insurance companies, which have suffered from a prolonged stretch of near-zero interest rates, said Andy Kapyrin, the co-chief investment officer of RegentAtlantic. “The market hasn’t yet priced in the benefits financial stocks are going to see from higher interest rates,” he said. “Banks in particular can make a much higher interest-rate margin as short-term rates rise.”

Stocks that could suffer from higher rates include shares of small, emerging software and e-commerce companies and other capital-intensive tech firms that have depended on borrowing heavily at low rates until they can turn profitable, Mr. Kapyrin said.

Individual investors should maintain a long-term horizon even in retirement, which can last 30 years or more, said Simeon Hyman, a global investment strategist at ProShares. That means ignoring stock plays based on temporary upheavals.

“Historically, downturns in the equities market from major geopolitical events are fairly short-lived,” Mr. Hyman said. “If you look at what happened after 9/11, the global pandemic or the invasion of Kuwait, the downturns were measured in weeks or a couple of months.”

References:

  1. https://www.cnbc.com/2022/05/05/stocks-are-tumbling-heres-what-to-keep-in-mind-.html
  2. http://www.capstonefinancialga.com.advisor.news/staying-the-course-may-be-the-key-to-wartime-investing/

Savings and Checking Accounts

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Savings

A savings account is an account for emergency savings or saving towards a specific goal, such as an upcoming vacation.

A savings account is a basic type of financial product that allows you to deposit your money and typically earn a modest amount of interest, writes Bankrate.com. Savings accounts are typically found at banks and credit unions. You don’t need a large amount of money to open a savings account, and you also have easy access to your money.

A savings account is a good place to keep money for a later date, separate from everyday spending cash, because of their safety, reliability and liquidity. These accounts are a great place for your emergency fund or savings for shorter-term goals, like a vacation or home repair.

Once you’ve made a deposit, the money in your savings account will begin to earn interest. The amount you earn will depend on a few factors, including your savings account APY, the amount of money you deposit and how long you keep money in your account.

Your bank may choose to compound interest on a daily, monthly, quarterly or yearly basis. At the end of each compounding period, your accrued interest is deposited into your account. From there, your new account balance (deposits plus interest) will begin earning interest.

Beyond quick access to your cash when you need it, savings accounts often offer higher interest rates than checking accounts. You might even find some savings accounts with a higher APY than money market accounts.

These accounts are federally insured up to $250,000 per account owner and offer a safe place to put your money while earning interest.

Consumers are typically limited to six withdrawals or transfers a month from savings accounts due to Regulation D, a Federal Reserve requirement that distinguishes between transaction and nontransaction accounts. A savings account is considered a nontransaction account, and, therefore, the number of transactions is capped and any above the limit are subject to a fee.

Savings terms to know

  • Compound interest: Method of calculating interest where interest earned over time is added to the principal. Compounding is usually done on a daily or monthly basis and more frequently it is done, the faster your savings can grow.
  • Interest: Money that you earn for having your funds deposited with a bank.
  • Interest rate: A number that doesn’t take into account the effects of compounding.
  • Annual Percentage Yield (APY): A rate that takes into account the effects of compounding during the year. It’s best to compare yields rather than interest rates.
  • Minimum balance requirement: The minimum amount needed in a savings account to avoid a monthly maintenance fee.
  • Money market account: A type of savings account that may offer checks, and/or an ATM or debit card for teller machine withdrawals. Here’s more on the best money market accounts.

Checking

A checking account helps you manage your day-to-day finances, like paying your bills, buying groceries and gas and withdrawing cash from an ATM.

A checking account should be thought of as a transaction account. Checking accounts are easily accessible and are used frequently for everyday transactions, such as transferring money or writing checks. To make transactions convenient, checking accounts usually come with a debit card, checkbook and mobile app with payment features for sending money to other people, even if they bank elsewhere.

Banks typically don’t pay interest on money in checking accounts. As a result, money in checking accounts doesn’t grow. Checking accounts are not meant for building savings and, as such, do not typically provide supplements to saving like interest, though you may be able to find a checking account that pays interest, especially at credit unions.

Checking accounts have three key features to look for:

  • No monthly maintenance fees (or easy ways to waive them).
  • Free access to a large ATM network.
  • No or low overdraft fees.

The best checking accounts usually don’t have a monthly service fee or they offer an easy way for you to avoid it. They also may reward you with interest, cash back or a sign-up bonus. Checking accounts are important for paying your bills and other expenses. They typically have no transaction limits to keep track of.

References:

  1. https://www.bankrate.com/banking/savings/what-is-a-savings-account/
  2. https://www.bankrate.com/banking/checking-vs-savings-accounts/

Older Americans Have Not Saved for Retirement

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Nearly one-third of older Americans have less than $10,000 saved for retirement.

Almost three in 10 older Americans between 55 and 67 years old have less than $10,000 saved for retirement, according to a new survey from Sagewell Financial, a banking and financial technology company focused on seniors’ money management.

Whereas, four in 10 older Americans had less than $50,000 saved for retirement. 

Paying for retirement by older Americans

The Sagewell Senior Certainty Survey of older Americans revealed:

  • 27% have less than $10K saved for retirement, and 40% have less than $50K
  • 57% are concerned that they will run out of money
  • 82% do not feel confident about their access to cash or liquidity in retirement
  • 73% said they welcome some income smoothing (receiving consistent income in the form of 1 or 2 consolidated monthly checks.)

“It is disheartening to learn that more than a quarter of Baby Boomers have less than $10K saved for retirement – that number jumps to 32% among women,” said Sam Zimmerman, co-founder and CEO of Sagewell. “Nearly 60% of seniors expect to live on less than $3K a month in retirement. We are at a crisis point now, and it will worsen unless we take drastic steps to improve the way our seniors plan for and live in retirement.”

Inflation and Recession

Older Americans are being hit hard by soaring inflation, painfully high gas prices, and fear of a looming recession which has outpaced increases in their benefits this year. These challenges have many older Americans worrying about their financial security and future. 

“If you have inflation and a recession combined together, it’s a whole different beast,” said Zimmerman. “This is a time for action. The quicker you move, the more agency you have in reducing the impact of a recession.”

Given the darkening forecast, it’s not too soon to plan ahead and prepare for a possible recession.

First, don’t do this

While there are money moves you can take to help ride out a downturn, that generally shouldn’t include bailing out of the stock market.  

“The worst thing people can do is they get nervous and pull money out the market,” said Jordan Rippy, a personal finance expert and accounting professor at Johns Hopkins Carey Business School. “Most people should be invested in the market for the long term.” 

Cut your budget

Instead, look for ways to trim your monthly budget. That can mean culling things like subscriptions and streaming services, while also negotiating discounts on your cable, cell phone and other bills. 

Pay off your debt 

It’s expensive to carry debt in an inflationary environment. In particular, you want to pay off credit card debt — or any kind of debt with a variable interest rate — right away. That’s because those interest rates will rise and add more debt. 

Keep contributing to your 401(k)

Do not press pause on saving for retirement. Indeed, if possible keep stashing the same fixed percentage of your income in your 401(k) or other retirement savings plan. Even if the market is volatile your assets will grow over time if you don’t try to time the market. 

This approach, known as dollar-cost averaging, ensures that people look past the usual dizzying swings in the stock market and keep building their nest egg.

Create new revenue streams

Try to diversify your income sources so that if your company downsizes and you lose your job, you’ll still have money coming in.

The Sagewell Senior Certainty Index is an online, random sample survey of 1,004 Americans between 55 – 67 who are approaching retirement or recently retired. The survey was conducted to gauge how seniors, particularly those who are online, view the certainty of their retirement planning. 

References:

  1. Jeff H, (June 21, 2022), Sagewell Senior Certainty Index, https://www.msn.com/en-us/money/retirement/nearly-one-third-of-older-americans-have-less-than-2410000-saved-for-retirement/ar-AAYHJVK
  2. https://www.sagewellfinancial.com/sagewell-senior-certainty-index-june-2022/
  3. https://www.cbsnews.com/news/inflation-recession-saving-money-tips-gas-how-to-prepare-financially/