AAR56 - Engineering POV on Building Margin Into Personal Finance

0:00A lot of people treat personal finance like a checklist. Hit the savings number, hit the debt ratio, and you've passed. You're done. That's it. Congratulations. But in my day job, and in case you don't know, I'm a mechanical engineer. in the aerospace industry, if a part barely passes on paper or barely passes analysis, that's not good enough. The real world doesn't match the spec sheet, and so you must build in margin. I know this applies to a ton of other industries out there as well. Today, I want to dig into what it actually looks like when you apply this same sort of concept to money, how you figure out your margin instead of just borrowing someone else's rule of thumb.

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2:29Good afternoon, everyone, and welcome back to At Any Rate. My name is Evan Rate, and we are here to help you make sustainable financial changes without breaking a sweat. And today's episode is going to be another solo episode. Congratulations, play round of applause sound effect. And today I want to discuss something that is relevant and applies to my current occupation. This is also going to apply to a ton of other occupations out there. but in case for for those of you listeners that don't know my day job my full-time job is a mechanical design engineer for an aerospace supplier so in the aerospace industry and as you can imagine that comes with a lot of you know restrictions on everything everything is very tightly controlled very visible and what that means is that something like margin is is very very important and that has to be built into everything we do everything any you know suppliers to us do and anything any customers above us do.

3:20Margin has to be present absolutely everywhere. And really the reason for this is that nothing is ever going to turn out how it seems. No machine part is ever going to be dead nuts perfect on. It's physically never going to happen. No part that's meant to handle a certain temperature range, no fluid that's supposed to be a certain temperature is ever going to be exactly that temperature. And these all might sound like small examples, but something that I also want to touch on here that is very prevalent in the engineering industry and manufacturing industry is something called stack-up. So what stack-up is, is say you have a part and it has two steps to it, one smaller step, one step below another.

3:59If each of those have some, we'll just say a plus or minus one inch tolerance just to make the math easy. So either of those can be one inch off. Okay, cool. You might say, okay, I'm within an inch. Well, once you stack those two tolerances on each other, you now have a total change of plus or minus two inches. And so you might not be prepared for that. And this can be very prevalent in your finances because as we all know, there are so many little aspects of our lives, little financial decisions that all add up to who we are financially, where we are financially, where we're going financially.

4:30And if you don't account for each of those little things, or at least have visibility, I talk a lot about visibility on here. If you don't have visibility to what those little things are, little decisions of yours are, then that can stack up to have a massive difference. It truly is not a big deal if you want to buy a nice coffee every day. There's nothing wrong with that. But if you want to buy a nice coffee every day and you want to get that slightly more expensive car and you just think you might need that little bit of extra RAM on your laptop and your water bottle's six months old, you probably need to get a new water bottle now so you can go get in the wallet or something.

5:03All these sorts of things stack up by themselves, no big deal whatsoever. I'm an advocate of doing things that make you happy and using your money to make yourself happy. But if you plan to do all of these things and make that happen, it's just not going to work. And that's why we need to build not just visibility into things, but also build margin into our situation so that when we design that part, we clearly understand what the tolerances are and build margin to accept what the actual change can be. And when it comes to finances, sometimes you're going to buy more iced coffees than you planned.

5:35or maybe sometimes you're going to decide in the moment that you need that little bit of extra RAM on your PC. And when those little changes happen in some kind of a controlled manner, we want our finances to be prepared to handle this. The kind of mindset that I want to contrast this with is what's most prevalent out there. It's what's most clickbaity. It's what's exciting. It's what's easy to follow. It's what you can write out in a quick Instagram post and everybody can feel like they read it and learn something and improve from it. And that is just a general pass mail task. Wow, really screwed that up.

6:06Pass-fail mentality. And these are things like generic rules, like I know that we've mentioned before as well, because they can be good references. But when you follow them and actually take that as a pass-fail, that's when they really fall apart. But examples like three to six months of an emergency fund or having X percent debt to income ratio or saving X percent of your income. And if you don't meet these things or if you do meet these things, you've either failed or passed. The issue with this is it treats finances like a binary. And I don't believe in treating hardly anything like a binary.

6:40There's a ton of gray area in nearly everything in life and everything the humans are. and what that means for our finances is that let's say you know you're planning to save 200 bucks a month in one month you save 195 you could choose to look at that and say i failed i would say to look at that and say okay sure you didn't hit your target but on this on a you know a scale of how bad you did you didn't do that bad you did pretty dang okay congratulations that's fine and if you saved you know 220 okay that's great you passed fantastic you could push it further potentially but I think you did a good job.

7:15We need to not just scale things binarily, if that's even a word. We want to be paying attention to how poorly we're doing or how much better we could be doing. And we can do that by adding margin on top of things. So for example, again, just making up numbers here, do not follow these exactly. That's exactly what I'm saying not to do. Let's say you want to be saving 200 bucks a month and you're aiming for 200 bucks a month. That's fantastic. If that's your goal and that's where you really want to be, say you've done the math, you know, to hit a certain financial goal for yourself, you need to be saving 200 bucks a month.

7:47I would say to take that and take a, some kind of a percentage down and above it and kind of give yourself a tolerance, a range to aim for, give yourself a bit of margin and you don't have to do this for every single, you know, financial goal you have or financial decision you want to make. Some can be vague enough that they're not too big of a deal, but I would say if it's a, if it's a number that has any gravity to it and any importance for you and for your future, then add that little bit of margin on it. It will, it will make things feel much more flexible for yourself, much more free for yourself.

8:21And you won't feel so constrained to hit an absolute perfect exact number because the real world just isn't going to let you do it. I guarantee you, you're going to save a little bit more, save a little bit less, or even if you do save the right amount, you could have saved a little bit more or should have saved a little bit less, whatever it is. But adding a little bit of margin on things, I think is a great mental exercise to give yourself a little bit of room. And this is something that, like I mentioned, we use a ton in the engineering industry. This applies to everything. Every single thing has tolerancing.

8:51And that tolerancing also has built in margin so that wherever it is in there, we can make it happen. And we're not going to be scraping the bottom of the barrel to get by. But even if it's worst case scenario inside of a tolerance, there's still margin left over on that. And so this can also apply to expenses of yours. Say you know that you need enough money to get by on rent and your rent is, again, just making up a number of$1 ,500 a month that you need to put towards rent. You need that$1 ,500 a month. If you set your goal to hit right on$1 ,500 and you go buy one more iced coffee than you plan to buy, now you're below where you need it to be.

9:26And I know that's a small example, but again, stack up can easily happen. You can get an extra iced coffee, get a little bit more RAM on your laptop, you know, go buy a smart light bulb. I don't care what it is. Do these little moves that individually wouldn't make a massive difference, but add it up. Now you have a few of them and now suddenly rent is much more difficult to get to than it would have been. You're having to pull from other places, maybe even have to go in debt potentially, or, you know, be delayed on a payment, get late payment, whatever the outcome is. The important thing is that if you give yourself some margin, give yourself some breathing room and say 2000 is what I bare minimum need.

9:59So I'm going to aim for maybe between, you know, 2 ,100 and 2 ,200 and give yourself that range. Now, you know, wherever you end up in there, you're giving yourself a little bit of room, but also even if you just barely make it into your tolerance, you're still going to have some padding on top just in case something happens. Another case that I think applies really, really well is an emergency fund. We've talked a ton about emergency funds on here, so I won't dive into them, you know, into the function of them or how to treat them too, too much. But the way that an emergency fund can apply is it's meant to handle load cases for you.

10:33In engineering, we always have to have something that is essentially meant to handle a load case of any kind. And that might sound very basic and obvious because in engineering, if something needs to handle pressure, well, there needs to be material there that can handle the pressure. And that's obvious and clear. But with our finances, we feel like we can just kind of fly by the seat of our pants much more easily and not need to feel like we need to put much material behind it because we think we'll be able to just scrape by. I think it's important to recognize what an emergency fund can actually be there for.

11:04So things like job loss, random medical expenses that you just weren't expecting, which is going to happen at some point in your life, and repairs to your house or something like that. All these things have different probabilities to occur and different severities to occur, but you for yourself need to judge how likely they are and actually pay attention to giving yourself enough material, so to speak, or enough funds to cover things. So again, why strict rules just aren't going to work for people. People love to throw around a$1 ,000 emergency fund. I've heard$10 ,000 emergency fund. I've heard six months worth of expenses.

11:39And again, we've mentioned some of these as kind of potential rules of thumb in the past, but we want to look at that and look at your personal situation. So look at things like, are you in a single income household or do you have a partner that's maybe also working so you wouldn't need as much margin as somebody else does? Do you own something like a home or multiple cars that could need repairs at any point or some renovation needs to occur at any point that could be unexpected? And so you might need to increase your margin further than somebody who has a cheap car and lives in an apartment.

12:11They probably don't have nearly as much to need to worry about. If you have children, then that can obviously be a huge expense expected, but also have huge unexpected expenses that can crop up. Being able to scale your emergency fund, as an example, up or down to handle these different cases is very, very important. And they will all give you different levels of exposure. And we want to have visibility to that. And then, like we mentioned, give yourself some margin on top of that. If you look at the likelihood of all these different things occurring and you say, okay, I think that the$3 ,000 would be good for me, I would say aim for$3 ,500,$4 ,000, depending on your situation, how risky your situation might be.

12:53Give yourself more room, more margin above and beyond it. And I know that this might all sound like it's coming from a very privileged point of view to say, oh, you know, always aim on the high side of things and always give yourself more money. Well, a lot of people don't just have more money to give around to these situations. And I 100 % acknowledge that and respect that. But I would say that something like an emergency fund, if there's anywhere in your life that you're going to give yourself margin, an emergency fund needs to be it. It's great to save. It's great to invest. It's great to grow your wealth.

13:25But the money that you will miss out on by not growing as much of your wealth as you could have is going to be far, far less than the amount of money you're going to lose or the amount of stress you're going to go through if you have to go into debt to cover something that you shouldn't have. If you have to pull money from somewhere that you didn't want to, to cover an emergency because you weren't prepared for an emergency that did happen. Always give yourself more margin on an emergency fund, even if that's the only place that you do it. Now, this next one applies to engineering very, very well as a whole.

13:56I wouldn't say that necessarily applies to what I make on a day-to-day basis, but it applies to the engineering knowledge and experience that I have and much more of the surrounding industry. And what this is, is redundancy. redundancy in systems every every system that any of our you know components or assembly go into has some kind of redundancy redundancy in in things like aircraft uh rockets any kind of you know defense aerospace medical whatever it is all these different these different uh all these different industries have built in redundancy systems will fail at some point or will degrade at some point.

14:35And if there is no backup, then you are just going to be falling without a net and not be prepared whatsoever. In income, in finances, I like to compare this to side income. It's fantastic to have side income and it's very easy to see a second revenue stream, whether that could be a side gig, a side job, or that could be having investments that are growing or having other ways to build your wealth on the side. Having these kinds of avenues aren't just about growth. It's fantastic if you can grow your wealth more quickly than you could have otherwise. But the fact is that at some point, there's a good chance that something will happen with your job.

15:12And I don't mean you're going to be fired or laid off necessarily or anything extreme like that, but you're going to move jobs and maybe there's going to be a bit of a break between that employment. Maybe your partner who was also employed, again, has a lapse in employment for whatever reason. It could be a horrible reason. It could be a completely fantastic reason, like taking a break off between, between jobs. But if we don't have some kind of redundancy to back ourselves up, then these gaps that occur are going to completely screw us over. An emergency fund can be a huge part of this. An emergency fund can be a great thing to cover these lapses of employment, but what can be even more powerful again, you know, in an ideal world is having some kind of completely separate stream of income that can not necessarily cover your expenses while you're going, but just keep you on the right track, keep you from, from nosediving and having to, you know, pad that nosedive for as long as you can, but instead turning it into, you know, maybe you're declining for a little bit because you're not completely able to cover your expenses, but it turns it, but being in that downturn is a much more financially controllable and financially safe to some degree place to be than a complete out of control nosedive where you're just burning through savings to get by.

16:24you'd be surprised when you start cutting back your spending and expenses how much even again just making up numbers different people are going to be very different a few hundred several hundred bucks a month can make an amount of money that might not seem that large compared to your steady normal stream of income can do a lot a lot and cover a lot of your expenses if you're able to cut back for a little bit and so that can turn let's say a lap a lapse in employment for example turn that from a nosedive cover it all with your savings we need to just you need to get by to, okay, I have to spend a little bit to get by, but I'm not losing that much.

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19:01Bitcoin services provided by Block Inc. brand. For additional information, see the Bitcoin disclosures at cash.app.legal.podcast. What's the best way to get started in the market? Download my ebook for free at stockmarketpdf.com. this next one I actually feel very very strongly about and I also think has a very good case for being compared to the engineering industry and this is looking at debt to income now I'm not going to be diving into specific ratios or anything like that I'm going to be talking about what what society tends to view as acceptable and even more specifically what banks tend to see as acceptable because more than likely if you're going to be getting a loan of some kind and going into debt of some kind for some reason more than likely that debt is going to be coming from a bank That loan is going to be coming from a bank.

19:45This could be for most people, that's going to be for a car. It's going to be for a house. For a lot of people nowadays, it could be furniture, getting a lot of furniture. Maybe you just moved, just got a new home, whatever it is. And I also feel very strongly about this personally because of the recent process of us purchasing a home. In case you're not aware, we just purchased a new home back in August of last year. Absolutely freaking loving it so far. It has been one of the best things in our life, but that's a whole side topic. the importance is that when we were going through the process of you know applying for mortgages shopping around to see what could get approved and everything prior to even shopping around for months prior to that i had already gone through and been doing the math we even have a really good calculator that's exactly what i use throughout that process totally free available online really quickly it's e-investing for beginners.com slash home again e-investing for beginners.com slash home and that's the exact same calculator i used during this process but But what I was going through was, here's how much we're earning.

20:43Here's what our current expenses are going to be. Here's what we're going to be able to do as a down payment. Here's what savings we'll have left over. Here's what the approximate mortgage and home expenses are going to be. I knew that was never going to be dead on. But again, as with everything, I added margin on top of it. So if it's estimating the total expenses are going to be$2 ,500, then I'm going to aim for$2 ,600,$2 ,650 and know that I'm comfortable at that number. That way, anything that I've underestimated along the way, which I have underestimated something, I guarantee you, I'm going to be able to handle that little bit of change that I might not have otherwise.

21:16But anyways, I had already gone through this calculation to know what we could afford. I was shocked when I started shopping around to see that pretty much every bank out there would approve us for a home half again as expensive as we were planning to get. And I don't mean that at all. As a brag, we are not making a ton, a ton of money. where you don't have a massive amount of income coming in. But the thing is that these banks assume that you can get by on absolutely zero margin. They assume that you can go ahead and spend, you know, 50 plus percent of your income on this house and you can scrape by on the rest of it and you're going to be okay.

21:52And that's kind of the idea that they put out there. And so I can imagine that if somebody, if the first thing that somebody did was talk to a bank to say, hey, you know, we're thinking of buying a home. Here's our current financial situation. what kind of a home can we afford and the bank tells them oh you could afford this kind of home you could afford that much and then you look at those homes you're like wow this is freaking gorgeous this is awesome life is easy it banks are not giving you any margin any breathing room any ability to make mistakes because they just want to get you in as large of a payment as possible so that they're going to earn as much interest on those payments as possible that is that's their end goal.

22:28They are in it to make money. And that is not some, you know, that's not some hidden thing. That is their business model. That is the business model of mortgage companies, mortgage lenders. And you have to be aware of that. And so instead, if you go into it and you have calculated that all for yourself and you can use our home buying calculator, that's great. Or you can, there's plenty of other tools available online to see how much you can actually afford and give yourself a set amount of margin. So I know there's calculators available where you can give it, whatever general financial information that it needs and then say, I don't want to spend more than X percent of my income on this.

23:03So let's say that you know that you've budgeted all your stuff out and you know that you could afford to put 30 % of your income towards housing. Everything else would be okay. You're still saving and investing. You've still got some spending money. You can afford other needs in your life and that's how much you have left over for your home. I would say bring that down 5-10 % again just kind of ballpark numbers here vary that based on your situation again like we talked about before if you're if you're a single income household or if you have other high potential expenses in your life that could crop up in any moment then you're going to want to pull that even further down 10-15 % and give yourself that much additional margin if you're maybe in a dual income household don't have a ton of other fixed expenses don't have many other risky things going on in your life financially, then okay, maybe you can give yourself only 5%, 10 % margin and you're going to be okay.

23:54But the point is, don't just look at the number that you can afford and say, cool, that's the number I can afford. Find the number that you can afford, find exactly what that is as close as you can, and then give yourself margin on top of that. That is incredibly important. Related to engineering, stuff like yield points. So when when we look at the stress in a system, part of what I do at my job is stress analysis on things, among other aspects of the analysis process, but analysis on systems, on components during stress events. These stress events could be pressure, could be temperature, could be forces exerted, could be impulse, whatever it is.