Income Insurance; Or Not!

Nuggets For The Noggin
This Nugget written by Jim “Gymbeaux” Brown, Revised December 2009

It is the end of the year and most businesses, that would include you of course, have already prepared their 2010 business plan and budget. But just in case you haven’t, this Nugget may help you figure out just what you need to be doing for the next twelve months.

What is the first question you ask yourself or a coach might as you when establishing goals; you do have goals, don’t you? “How much money do you need to make?” The emphasis is on the word “need”, meaning you have a number in mind that you MUST make in order to pay the bills you have and maybe put a little aside for that “rainy day” we hear so much about.

Well Breaux, the rain hasn’t stopped in several months – or put another way – the rainy day has become what one might call a “normal” day. Look at these numbers:

• Economy drops 20% (that is just a number it does not represent a factual number).
• Agent A’s income for the previous year was $68,000 and that was Agent’s A break even point where Agent A had sufficient income to pay all of her business expenses, pay all of the living expenses and as stated above maybe put a small amount aside for the rainy days.

Along comes the rain. Now Agent A’s income, keeping in line with the economy, has also dropped 20%. 20% of $68,000 is $13,600 for a net income of $54,400. If Agent A was not saving at least $13,600 a year for rainy days, there is a deficit and Agent A is spending more than Agent A is making.

Now look at Agent B who the previous year earned $250,000. Agent’s B’s income also dropped 20% over the same period in time maintaining pace with the economy or $50,000 for a net of $200,000. The question then becomes was Agent B saving $50,000 a year for rainy days?

Here is another very serious thought to consider. If Agent B’s average sales price was $400,000 and the average Board’s sale price is $200,000, do you think that Agent’s B’s income might be affected a bit more than the economic average? Hmmmmmmm?

I hate to tell you the answer. In most cases certainly not yours, neither Agent A nor Agent B were saving $13,600 or $50,000 respectively. Income can best be compared to the storage space in our homes. The more storage space you have, the more stuff you collect to fill it. Purchase more storage space like a shed or off-site storage and you guessed it, you collect more stuff. Being in the Military for 20 years had one very definite advantage over most folks. Every 2 or 3 years we moved and when we move you guessed it, we got rid of stuff. But if you don’t move, the stuff overwhelms you. Then one day, one or more of your children leave home. Wow, I have more room now that Johnny has moved out. Yes and you have more room for more stuff. The unplanned consequence is that Johnny does not have enough room in his new place so he still uses your home for some of his “stuff.” And this vicious circle seems to go on forever. “I can’t get rid of that; I might need it some day!” Well the same is true for income; we tend to not only spend what we make, we spend more than what we make by using charge cards.

Income and expenses are no different. The more money people make the more money they spend and I know this because……. We are in very odd economic times and while I am not an economist, I think I know enough about past economies that would lead me to believe that the world is in for a very rude awakening when future revenues fail to make up the difference between what was spent today and what comes in tomorrow as revenue or lack thereof. That is a formula for inflation. I can only hope I am wrong but I don’t think so. Financial planning becomes essential for survival.

A great many people do not control the amount of their income as do people in sales have the ability to do. Need more money? Make more sales! The formula is that simple. There are other ways to make more money and they are, (1) cut your expenses to the bone – that effectively increases your disposable income. (2) Earn more money on the sales you make – that also effectively increases your disposable income. (3) Be more selective regarding the quality of probable buyers and probable sellers you work with meaning you work with fewer people but the ones you do work are ready to buy or sell and waste less of your time on those who are not. While that does not directly increase your income it does increase your dollars of income per hour worked and that is always good thing. (4) Become an expert on the Federal Income Tax Code or hire someone who is and take advantage of tax savings, especially for Independent Contractors. Saving more on taxes is effectively earning more to save or spend. (5) A combination of all four.

This is what I know. Correct that, this is what I positively know! The following is a plan and any plan is better than no plan just in case you do not have one:

Review your expenses for the past 12 months. Every expense, not just the car payment, house payment and utility bills – EVERY KNOWN EXPENSE! While you track them, try to identify if there are any seasonal increases/decreases like spending more on electricity and gas during the summer months. Here are some expenses that most people should think about:

• Insurance premiums like annual Flood Insurance. Semi-annual, or quarterly payments like various insurance premiums. Health insurance or supplemental health insurance. E&O.
  Christmas, birthday, anniversary, wedding and shower gifts, Mother’s Day, Father’s Day (this is typically a great deal more than you first think it is)
  
• Annual dues to trade organizations like the Board of Realtors, MLS, personal designations like CRS, or groups such as the Women’s Council of REALTORS®, etc.
• License renewals
• Personal development like attending Family Reunion (convention for those not with Keller Williams), off-site training (travel, food and lodging), books, CDs, DVDs for your personal growth library (you do have one don’t you?)
• Unscheduled repairs to your car(s), home, tools and equipment
• Personal loan payments
• Student loan payments
• Credit Card payments
• Charitable donations and church donations
• Political donations
• State income taxes as applicable
• Federal income taxes as applicable
• Property taxes
• Telephone service
• Internet service
• Cable Television
• Co-pay medical payments
• Gas for the car
• Tuition for the kids
• Emergencies (especially evacuations due to storms)
• Unscheduled trips to visit relatives due to family emergencies
• The cost of pets (much higher than you might think)
• Date Nights (entertainment in general)
• Cost of hobbies, golf, crafts, photography, etc.
• Cost of smoking
• Cost of drinking (and that does not mean milk and water Breaux!)
• Expected or unexpected increases in any of these categories (requires planning)
• Accounting expenses
• Legal expenses
• Advertising and marketing expenses
• Customer gifts and entertainment
• Tools and equipment required for work (or still needed for work)

You hopefully get the idea and here is a way to fine tune the list. Get some of your co-workers and form a mastermind group. Ask them to bring their check books with them and then using the above list, work towards improving the list by reviewing what they have spent money on over the past year. A side benefit of this activity is that you may identify more deductable expenses than you had realized were available for tax purposes.

Let me give you an example of just how out-of-control expenses can be. How much do you spend at Christmas? Do you know? Do you really know? A lot of folks buy Christmas presents all year long which if they are bought on sale may not be a bad idea. How many birthday gifts do you buy? How many flowers to you buy? Wedding Shower gifts? Do you spend $3,000 a year on gifts? You might at first say, no way. But if you have a family of 5 (3 children) that is $630 a year per person. But wait, do you have parents to consider? Now we are down to $428 per person. Add in a niece, nephew, an aunt or uncle, someone getting married, etc, and suddenly $3,000 is an insufficient amount to budget. Tell me I am wrong on this. But wait, if you divide $3,000 by 12 months that means you have to budget $250 a month in order NOT TO OVER SPEND during the year. If you think you are spending $3000 a year on gifts, are you saving $250 a month for that purpose? If you are like most folks, I doubt it.

Before you can set a financial goal for the year, you MUST absolutely identify every penny that you know you will spend and even might spend. How can you just pick a financial goal out of thin air if you really do not know how much you are currently spending? I would wait for the answer but unless you are independently wealthy, there is no answer to that question.

At this stage in creating your financial plan, take time to analyze your expenses and cut them where you can. When you identify exactly how much you are spending in the various categories, it becomes very obvious that you may be spending entirely too much on several categories. Cut and consolidate where you can. Do your homework on what is most cost effective like hard line telephone service in addition to cell phone service. Consider the new technology available like Vonage or MagicJack to cut phone costs. Where else can you make cuts? Do you really need that “new car” car payment?

If you are in real estate sales, how can you “cut your commission” on a sale or listing if you do not know how much on average working a sale or listing REALLY costs you? Do you know?

If you have children, are you planning NOW for them to attend college LATER? How much does it cost for a college education? Let’s say for argument purposes that it costs a frugal $25,000 a year (at some time far into the future and that is going to probably be a very low estimate). That is $100,000 for a four year college education PER CHILD. Let’s say you have only one child who is 5 years old and you have thus far saved nothing. Therefore you have approximately 13 years to put away $100,000. Without considering the effect of earning interest on your money, saving monthly with the goal of saving $100,000 for when your child reaches 18 and goes off to college would mean that you would have to save $641 a month times the number of children you have. Here is the good part; if your child receives a scholarship, you can use the money to implement Plan B – buy a boat! Want a better plan? Buy a rental house for each child. Let someone else pay the rent (mortgage) on the home. When your child is ready for college, sell the home to pay for the college costs.

Now you must account for the things you do not know and the big one is the rainy day. Let’s go back to Agent A who said she “needed” to make $68,000. If Agent A did not go through the expense part of this Nugget, I would suggest that $68,000 is an insufficient amount and that $75,000 would be a more conservative estimate. If you then calculate a percentage over and above that amount for your “rainy day” contingency, you have a more realistic goal. How much more would be sufficient?

Well Breaux, there is yet one more step. If you read the Nugget “The SECRET is in the BAG”, you know that everyone should have a BAG (Big Ass Goal) and that would not be a financial goal. A BAG goal would be more like putting all your children and maybe even your grandchildren through college – now that is a BAG! Or being financially independent but to know that, you would also need to know what your future expenses will be and then how much money you would need to maintain an income and life-style without working, another huge BAG! You decide, what your BAG is?

Once you identify your BAG, you need to estimate just how much longer you intend, must, and/or be required to work to attain it. Therefore, your annual financial goal needs to include (1) what you need to make to break even, (2) money for a rainy day, (3) an amount that will insure you attain your BAG and, (4) paying yourself 10% FIRST! Where did number 4 come from? Read The Richest Man In Babylon by George S. Clason. Clason suggests that you take 10% of whatever you earn and pay yourself before you pay anyone else. Of course you still need to pay all your bills but imagine the nest egg you could build yourself by paying yourself 10% FIRST! Keep in mind, we all tend to spend what we make. Therefore get in the habit of spending only 90% of what you make!

Using Agent’s A’s numbers, Agent A NEEDS $68,000 annually (based on the upcoming 12 months and obviously this will change from year-to-year). Agent A calculates that she needs to earn at least 15% more for that “rainy day.” And not knowing what Agent A’s specific BAG is, let’s add in another $15,000 (that would be conservative for most BAGs). Now we have a financial goal:

$68,000 – Need to have
$10,000 – Rainy Day Fund (equal to 3 to 6 months of income in reserve)
$15,000 – BAG account
TOTAL $93,000 (Remember it was once only $68,000)

Now we are talking!

That means Agent A needs to earn $7,750 a month. What does Agent A need to know to insure that she earns a gross $7,750 a month?

Not just the Market’s Average Sales Price but HER average sales price; they are not necessarily the same. For the purpose of this Nugget, HER average sales price is $175,000.

Now Agent A needs to know what HER average commission percentage is on each sale and how much of the total commission does Agent A get to keep. This is a bit more complicated for agents on a 100% plan where part of the commission is earned on one percentage and the balance for the year on a 100% plan. To make this easy, let’s say the first $36,000 of earned commissions is on a split of 70/30. And for calculation purposes, let’s say the gross commission on a $175,000 sale is $4,500 and therefore the agent’s net would be approximately $3,150. If you divide $36,000 by $3,150 you discover that Agent A would need to close 12 sales on a 70/30 split to reach the point where Agent A would then receive 100% of the commission. If Agent’s A’s goal is $102,000, subtract $36,000 from $102,000 and that leaves $66,000 to be earned at 100%. Divide $66,000 by $4,500 and you discover that Agent A needs to close an additional 15 sales to reach her goal. 12 Sales at 70/30 plus 15 Sales at 100% equals a total of 27 sales for the year. That equates to 2.25 Sales a month or approximately half a sales each week.

This is where it gets interesting. Gary Keller’s The Millionaire Real Estate Agent (MREA) book indicates that you should expect to close 2 sales for every 12 people you put into a MET Database and who you touch 33 times a year FOREVER! But let’s be conservative and say it is 1 sale for every 12 people. This principle works for real estate sales. If you are in another form of sales like car sales, there are numbers that work for you as well; find out what they are! Using the above numbers, how many people would you need in a MET Database in order to reach Keller’s numbers? 348. Does Agent A know 348 people? How many do you know? Keller also stated that you should expect to close ONE sale for ever FIFTY people you have in an UNMET Database PROVIDED you contact them ONCE a MONTH FOREVER!

Therefore, first put everyone you know into a MET database. Calculate how much money you established using the formula above as your financial goal. Then calculate how many people you need to put in an UNMET Database to make up any shortage.

You must then become disciplined to your goal. Gary Keller suggests that you play red light – green light with your money. Simply put; is what you are about to spend money on going to help you reach your life’s big goal (BAG)? If yes, green light – spend it. If no, red light – don’t spend it. I like Joe Tye’s Direction-Deflection-Question (DDQ) to help you in this regard.

IS WHAT I AM ABOUT TO SPEND MY HARD EARNED MONEY ON LEADING ME TOWARDS MY LIFE’S GOAL OR AWAY FROM IT?

Use the DDQ every time you contemplate spending a dime! The one category that should never be cut is education. Remember, “Education” is what you get when you read the fine print; “experience” is what you get when you don’t.” If you want to get better at what you do, create a self-education plan and stick to it!

One more suggestion from the book “Somebody’s Gotta To Say It” by Neal Boortz. Neal suggests that from this day forward, NEVER SPEND ANOTHER DOLLAR BILL. Spend only $5.00 bills and larger. When you receive your change, do what you will with the loose change but put the dollars in a jar on your dresser. These one-dollar bills add-up in a hurry and it would be very easy to save $1,000 a year or more from your loose one-dollar bills. This is a great savings technique that provides you with emergency funds, date-night funds, etc. Try it, you’ll like it!

If the economy shifts for the better – you are in fabulous shape. If it turns even further south, you should be okay. Remember, the market is what the market is and it never stays the same. You must reevaluate your financial goal every year based upon REAL numbers from the year(s) before. Now that you know, what are you going to do about it? Do they teach this stuff in our schools? I don’t think so.

Planning example:

It has been my experience that most real estate agents seem to fail to plan or account for funds due to maintain their businesses. Here is a breakdown of some known fees that should be accounted for MONTHLY instead of waiting until the end of the year and then be short of funds.

Annual license Renewal $ 55.00 Due December 31 each year
E&O Insurance Renewal $184.00 Due December 31 each year
Board Dues $364.50 Due December 31 each year
MLS Annual Renewal $295.00 Due July 1 each year

Total Amount Due During The Year $898.50

If you begin to withhold EACH MONTH $75.00, you will have sufficient funds available when these dues become payable.

You are strongly encouraged to literally write yourself an invoice each month for $75.00 or and then pay the bill – no exceptions – by placing the money into a savings account in order for that money to be available when it is needed to keep your business running smoothly.

Imagine how better off you would be if you deposited in a savings account EVERY MONTH an amount sufficient enough to insure that all your licensing, dues and annual expenses are accounted for when they become due. Now imagine how you would feel if you also deposited into this savings account 30% from every commission check you received for the purpose of insuring you had enough funds to pay your state and federal income taxes.

Remember The Millionaire Real Estate Agent premise, LEAD WITH REVENUES – NOT WITH EXPENSES. If you fail to save enough money to be able to pay your annual renewal dues and your income taxes in cash, you are only adding to your cost of doing business by either putting the expense(s) on your credit card or taking out a loan, either way you are not only paying your renewal fees and taxes, you also are adding to the cost by now incurring interest fees as well.

This is a great time to discuss having not only a business budget but also a family budget. Most real estate agents combine their income and expenses but these need to be maintained separately. In fact you should maintain at least three banking accounts:

• Checking account for home purposes
• Checking account for business purposes
• Savings account for taxes and known renewal fees

Whenever you receive a commission check, immediately deposit it into your business account. From that account make a deposit $75.00 into your savings account plus an additional 30% for tax purposes.

You should have created a family budget including income sources. From the budget and projected income you should know how much annually you need to contribute to the family budget from your real estate business. Therefore, you should write a check and deposit it into your home checking account for home expenses. By maintaining two checking accounts, your accounting for taxes would be greatly simplified when you write checks from your business account to pay ONLY BUSINESS EXPENSES.

Real Estate Schools teach you how to pass your license exam but touch very little on running a business. It would be hard to find a successful business of any kind that did not have a working budget to identify expenses and income. As a real estate agent you are a business. Without the knowledge of how much it costs for you to be in business, how can you possibly know when you have made a sufficient number of sales and received a sufficient “net income” to pay all your expenses and make a profit? Don’t even think about it – YOU CAN’T!