Monday, July 31, 2006

People still getting a charge out of Credit Cards.

Even though we hear over and over in the media, we, as Americans are still charging up a storm. According to a recent Federal Reserve survey, the median balance on Credit Cards in 2004 was 2400 dollars. This does not bode well. This means that many people are losing 240 dollars or more annually, just on credit card interest payments.

There are some bright sides to the survey though. Only 3% of all debt is Credit Card debt. This means that what is often termed good debt: mortgages and college, are much larger amounts. This is important because mortgages are debts that have an a tangible asset associated with them: real estate. In the event that these debts cannot be repaid, at least there is an asset that is available.

Although the increase is somewhat concerning, it is not quite so large when you consider inflation and the fact that over 20% of credit card users pay off their bill each month. This means that many people are using their cards responsibly. The key to keeping our national economy in good shape will be making sure that a few bad apples don't spoil the bunch.

Source: http://www.federalreserve.gov/pubs/bulletin/2006/financesurvey.pdf

Friday, July 28, 2006

Decisions about my Savings Account

Recently, I've discovered that there are even more high-yield savings accounts than I had imagined. However, for me, more important than the exact high-yield account that is used, I feel like these need to be my goals and guidelines with regard to my mid-to-long-term savings:

Use it instead of Credit Cards for unexpected expenses but only when necessary.

Covering 6 months of expenses is unrealistic for most people including myself. I will try 2-3 months as part of a contingency plan in the event of an accident, health problem, or unexpected Job loss. I know people don't think it will happen to them, but I worked with someone who had been laid off. So you should consider what you would do if you lost your job, if your roof caved in, if your car got wrecked. These are not crazy situations and it is important to be realistic about your plans if something like this happened.

I think that cash or some other non-volatile holding is a good protection for at least some of their wealth as an insurance against stock market volatility. How much? Perhaps just enough for my emergency fund (See above).

Somewhere between 50-75% of savings should be in that type of account to ensure that you are making interest on this money. Even just 1000 dollars can make over 5% annually in a high-yield account. Since my history shows that most will be left alone, I'm also considering a CD. However, I like the liquidity of a savings account so that the money can be easily accessed if an emergency or opportunity arises.

Tuesday, July 25, 2006

Why thinking about Retirement now is important

Paying off my debt is the first step though. I work hard. I think that most people would say the same thing about themselves. However, in this hustle and bustle of 403Bs, Roth IRAs, defunct pension funds and Medicare worries, we often lose sight of what retirement is all about and why these financial issues are so important.

Recently, I had a nice, long vacation. Eleven days to be exact. And during that time I did some relaxing, some chores, and overall just enjoyed myself. This was what I would expect out of my retirement and what I am saving for.

But I realized that many people are not in that position in their retirement. They are having to choose between their heart medicine and a decent dinner. This is not meant to scare anyone. However, the simple fact is that in our retirement we will likely be earning less than we do now. The worst shock of retirement for many people is realizing that the day they retire they will only have about 1/3 or 1/2 of the monthly income that they used to live on.

Some people are able to adjust, but many aren't. They end up broke because they spend too much, sad because they can't work anymore and aren't living the way they used to, and finally having to make choices that are not easy or fair for a person who 'worked hard' for 40 years.

Seeing this as a phenomenon has made me want to reclaim those retirement years. Even in the next several decades we are going to see people live easily into their late eighties. If I retire at 65 or even 70, I could still have close to 20 more years of my life. Although my generation is being retrained to think about retirement at 70, I'd still like the idea of a semi-retirement at 55 or 60. What does that mean then? I mean, retiring but not being able to eat because I am so poor is not terribly exciting.

So, I think the key is to lower my current standards of living to be a little closer to what I think that my retirement could be like. This saved money is then applied to debt and retirement savings. You know the drill from here. As each debt is paid, apply the full monthly payment to the next debt in line until all are paid off. Then take that monthly amount and invest it for retirement and shorter term goals to ensure adequate income as I grow older.

So that's my plan and I'm stickin' to it!

Thursday, July 20, 2006

Paying Off Your Credit Card Could Cost You Hundreds of Dollars

Most people follow the standard advice of financial planners and other advisors when deciding what debt to tackle first. This advice is usually fairly basic: pay off the highest interest debt first (usually credit cards) and continue to take that same monthly payment and apply to the next debt etc down the line until all the debt is paid off. But recently I considered this I am getting ready to start paying down principal on my student loans and last credit card.

I discovered that this advice is not true for everyone, especially not in the case of a windfall. The reason that this is not true is because of the doom that compounding interest can bring. Here's a simple example to show you why time, not just your interest rate, should be a big factor in deciding your lump-sum payoff targets.



Scenario

There are two loans: one at 17.5% (a credit card with a 2000 balance) and a personal loan at 7% that has a 10000 balance. Each debt has a normal payment - the credit card is 125/month and will be paid in 19 months. The loan payment is 150/month and will be paid in 85 months.

All of a sudden, a 500 windfall (taxes, lottery, gift) comes in and you decide to pay debt doing a lump-sum paydown. For most people, the choice is a no brainer - the credit card. It has a higher rate. However, in this situation, some calculations show that even though the interest rate is higher, the actual monthly amount of interest accruing on the credit card is LOWER than the loan.

And in this case, it is a dramatic difference since the loan has an average of 31.78/month and the credit card has an average of 15.42/month. This means that the amount of accrued interest is close to twice as much on the loan as on the credit card.


Since this is a windfall (a one time extra), the rule of being able to "snowball" doesn't really apply. The idea of snowballing is that each paid off bill provides more extra income to pay down the next debt. However, this is a windfall that will not come in again so there is not any "extra" income that will be realized next month unless this lump-sum paydown will end your obligation.

So, instead of the instant payoff, you simply consider how much money that this will save over the life of the remainder of the debt repayment. In the case of the loan, you would save about 286 dollars whereas only about 108 dollars would be saved on the credit card.

Even the hybrid scenario doesn't work out better. That is, in theory, if you put the money on the card and took the "extra" 108 dollars from the savings on the card and put it on the loan right away, you would still save only about 58 extra dollars for a total of 166, which is still less than the 286 that could be saved by tacking it onto the loan directly.

The reason that this is important is not just the time (years) it will take to repay the loan, but it is also the large balance. A two thousand dollar credit card is nothing compared to a 10000 dollar student loan.

The bottom line: Total Loan amount and Time to repay the loan are often more important in determining savings (from lower interest payments as a result of a lump-sum paydown) than the interest rate on your loan.

To determine the rate and lumpsum payment on your debts, try using Young Money's Calculator. I use it frequently for the nice reporting feature that shows the amount of interest per payment over the life of a loan using various scenarios.

Wednesday, July 19, 2006

The Debt/Income Equation - Six Ideas for Getting Out of Debt

There is no avoiding it, the debt-income equation is the key to everyone's financial future. It is a key factor for everyone's fico score. If your monthly debt exceeds your monthly income, you are in trouble. It is that simple. And many people are in the same boat. The average credit card debt in the United States However, if you are in debt, how can you hope to repay it? Often times, interest rates for credit cards are the culprit. If you have a good credit score (check it at freecreditreport.com), you may be able to do a balance transfer or negotiate with your current lender to reduce your rate. But what do you do when there is no way to get the rate reduced?

Here are some options:

1. If you have an emergency fund, consider using that savings (either some or all) to pay off your credit card debt. It is likely that in this case you can mitigate your risk by paying it off in chunks over time to save money in interest and make sure you can handle any new expenses with existing savings. These payments may, over time, give you some wiggle room to renegotiate the interest rate later and if a real emergency happens, you can suspend the paydown.

2. Consider an outside loan. If your credit is good, you might be able to apply for a loan at your local bank to pay off your card at a lower interest rate. If the bank does not turn out to be a good option, consider online lenders like prosper.com for either the full amount or a just a portion, if you don't think you can pay off the loan in three years.

3. Borrow from family. Be aware that this could have personal/family implications, but if there is a family member (whom you trust and who trusts you) that could help, you might consider borrowing the money this way, and even include some kind of interest in the payments back. However, if you have had a bad history with money in the past, you might want to avoid the damage to your relationship that this option may cause you if you feel you may not be able to repay it. Before you undertake this option, write up an agreement regarding the amount, the interest, and the payment schedule that is signed by both parties. This 'mini-contract' will likely not be used, but it can provide some sense of security about the arrangement for both of you.

Additional Tips:

1. Cut as many non-essential expenses as possible while paying down these debts to make sure your repayment period is as short as possible. See my article about gym memberships as an idea of how to start looking at your expenses objectively.

2. Do not attempt a lump-sum paydown until you have mastered your finances by not using the card or debt in question for at least 6 months. This will ensure that you have your finances in order and are able to pay your monthly bills without issue using your current monthly income.

3. Never use it again, but don't cancel the account right away. Canceling the account can hurt your credit score. It is probably best to just stop using it.

Tuesday, July 18, 2006

Six Tips for Planning for life with a home and mortgage.

Recently there was an article on InvestorGeeks about whether or not you should buy or rent. I am a proponent (for the most part for many people) that renting is the way to go. If you a renter and you have decided to embark on that quest to buy a home or condo, there are a few things that I would advise you to do and consider during the process that might save you tons of time and sanity (and that I wish I knew before I started!).

Before the Purchase:

1. Consider the type of Real Estate broker you are getting. If it is someone you know and trust, that is great. However, be aware that there are two types of brokers - a buyer's broker and a seller's broker. Even if you walk into a real estate office and get an agent on your own, they might not be acting completely on just your behalf. It is possible to have two 'sellers' agents that is - each one advocates for the seller, even though one works with you to close the deal. Consider this before you commit to an agent.

2. Take some time on your offer:
- Consider the advice of your home inspector carefully. Your home inspector will likely give you several things to consider (especially for an older property). Even if you like the price, consider asking for a few things in your negotiation. Negotiation is an art and if you don't ask for items (and be very specific in your offer), you will likely 'leave money on the table'.
- If you buy a condo, make sure that the condo agreement is up to date and you are certain of any portions of the new property which you may be responsible for. Be direct, and up front, and consider talking to the president of the condo association to get those items straight and to get a feel for the community you are moving in to.

3. Be prepared to walk away. Even if you feel like this is "the one", sometimes something about the deal just doesn't seem right. Until you make the offer, you have the power to walk away. Make sure that you think about the process a while and what it will be like, emotionally, logistically, and even financially to live in this new home. Consider expenses, driving more or less, visiting family, new furniture or fix-ups that might be needed.

After the Closing:

4. Resist the temptation to 'redo' everything right away because you 'cant stand it'. There are often reasons for the way things are in a home. If you live in a home for a while, you sometimes discover that the shortcomings are charming and don't need to be fixed. Or sometimes a room that might have seemed great at first with a new coat of a dark color paint is actually already dark enough. Funny observations about your new home will make you appreciate and enjoy it and ensure that changes you make are ones that you will be happy with in the long run.

5. Start an emergency fund or contribute more to the one you have now. If you don't have an emergency soon, you are lucky. Repairs on a home or condo (or assessments if you have a condo association) are a big expense that people forget about. Even stashing a small amount away in a savings account for these incidentals (although new water heaters/roofs/air conditioners that cost upwards of a couple thousand bucks don't seem incidental) can really help defray these unexpected costs.

6. We've all heard that the three factors that contribute to the value of a property are location, location, and location. Don't think that property tax is any different. Be prepared for the tax bill that is coming. Check out the tax rates in the area you are considering. And it realize that it will go up, oh yes, it will go up. Although that mortgage is nice and fixed (you DID get a fixed mortgage right), expect a small increase in your tax bill for your property each year, in addition to other town services that might now be an expense. Plan for these up front to avoid unexpected surprises or consider getting them included in your mortgage if you want to avoid the process of paying separate bills. Most advisors consider that you should be putting about 1% of your sale price away for home repairs each year.

Saturday, July 15, 2006

What Happened to the Emergency Fund?

One of the first things that I learned about personal finance from my grandfather is to have an emergency fund of six months worth of expenses. This still seems absurd to me in this day and age and given my income to debt ratio. Even though I think an emergency fund cannot be underestimated, according to a Federal Reserve survey, 8% less people even have savings accounts since 2001. The savings mentality is drifting away. Instead large percentages of people's net worth is in retirement accounts.

This is a key mistake for most people. They confuse 401k loans and home equity lines of credit with emergency funds. In my opinion, neither 401ks or home equity should be touched until you are approaching retirement. Instead, a separate account (either savings or money market) should be set up and used for emergencies.

That is the perfect self-insurance plan. It is for just what it sounds like - emergencies. Working at my first job out of college was great, but there were lay offs. Luckily I was not one of those who lost their job, but it made me realize that anything can happen. Even if you are smart and talented you can still lose your job, get into an accident or have some other emergency really throw you for a loop.

Even still, I think that 6 months is too much for most people, but 3 months is reasonable. Together my partner and I have been saving for several years now and the fund is still not quite there. Some of it was depleted recently to pay off a credit card that will save me several hundred dollars in interest over the next year.

Even small amounts contributed regularly (right after payday but before bills) is best. These will add up over time and make sure that once it is a sizeable amount that you get it into a high-yield account so that you will get substantial interest.


Source: http://www.federalreserve.gov/pubs/bulletin/2006/financesurvey.pdf

Thursday, July 13, 2006

Beating the minimum to invest rule - and why kids (and their families) should do it.

Double Your Money Fast
When I was in middle school and high school, I would talk to my grandfather about investing. He would talk to me and teach me neat tricks like the Rule of 72. Being interested in math and money, I was quickly interested. However, I found that the most difficult issue for me was that investing was so expensive. Even through college I was never able to get enough cash together for the minimum that was required for an initial investment in a mutual fund. My grandfather would simply say that the solution would be to save the money in a savings account until I had enough.

This was difficult and it was not until I was able to start working at a job after college and had a 401k that I was able to do this, mostly because the money was gone before I even noticed it. This brings me to the main idea here. Although many of the nicer funds that I would like to get into today have high initial minimum investments like Vanguard, I don't feel pressured or upset by that anymore. The reasons are simple: e-trade and ETFs.

Its Easier to Invest Now than it used to be
With tools like E-Trade and Sharebuilder, virtually anyone can get into the investing game. All you need is a bank account and a computer with an Internet connection. ETFs are Exchange Traded Funds. These are quite similar to mutual funds in the sense that they are not a single stock but rather a basket of stocks which means that your investments are automatically diversified.

So, with even a small amount like 250 dollars, you can reasonably start investing and building an account. Most services charge between 8-15 dollars per trade though, so it is best to choose only one particular mutual fund or etf at a time to reduce the costs. However, with even a small amount invested regularly and arranging for the dividends to be reinvested, it is simple to start building wealth.

Building a retirement account when kids are young
And since time is the biggest factor in any kind of investing, the sooner you start the better. If when you are 14, you are able to sock away 250 dollars every 3 months in this manner, that is 1000 per year, yielding an estimated 3785 dollars by the end of 3 years assuming a quarterly rate of return of 2.5%. This money at age 18 could be left alone until retirement at age 68 (with NO additional contributions) and the same kind of interest averaged at 10% yearly, to provide a retirement fund of 445,000 dollars. This is very little money for a huge retirement return.
(To be fair, the idea for these calculations came from an article on MSN Money, but I think my version is more realistic.)


Given the unstable state of Social Security, a small amount of money from relatives and odd jobs could add up to a hefty chunk of a great retirement for little grandchildren or nephews when they get old....

Wednesday, July 12, 2006

Building wealth is hard work

I've had this realization recently. For young people (and I'm defining this broadly), working is highly underrated. We are conditioned to working a 40 hour week or less if at all possible. This however is very limiting. Many of us have a commute of 30 minutes or less to and from work and sleep roughly 8 hours per day. All in all, this adds up to 61 hours (including sleeping on weekends). However, each week has 168 hours in it. This means that there are close to 100 hours in the average week that are being wasted. Regardless of how much money or skill you have, one asset you definitely have is your time, and you can invest it!

For many people, these hours are spent doing some fun things and some chores. However, regardless of what you are doing, chances are you might be able to work more and build wealth by doing it. Young people, especially those in college, training programs, or school have copious amounts of this free time. Any activity that could be done with any portion of time that builds wealth could be useful.

While I was in college, I worked at several work-study jobs and freelance projects doing web design and computer repair. Even at minimum wage, it was possible to rack up significant money by investing my time. In addition, I found that I enjoyed these activities. So, I took small portions of my earnings and reinvested them in cheap books to learn more. Then I invested more of my 'free time' to learn as much as I could. In this way, I snowballed my skills until I had built a significant resume with substantial experience. Now, my full time job as a programmer for websites is directly related to that experience I was gaining 'on-the-side' and the fact that I was interested in the field enough to get a degree in it.

The key thing here is to realize that money is not the only goal. In fact, the more important goal is to live. By engaging in secondary, part-time jobs, you can be exposed to various industries, all types of people, and critical lessons about business. All of this can come from all types of jobs, whether it is a checkout clerk at a store or a burger flipper at the local McDonalds. These jobs show you the importance of your money and can provide an incentive to become skilled in a field and appreciate how hard people work for what they have. So, build your self-worth by finding additional work.