How to make a budget

Posted By Paul

In several posts Matt and I talk about creating a budget but we never really explain step by step how to come up with one, so here is what I hope is a set of simple instructions for doing just that:

First we start with:

EXPENSES

Here are some standard ones and I how I deal with them in a budget:

1) Home - this one is usually easy, your monthly rent or mortgage payment (include property taxes, insurance, etc.).

2) Car - also easy, your car loan or lease payment if you have one.

3) Car Insurance - most car insurance policies give you a premium you have to pay every 3 or every 6 months. I just do the math and come up with the monthly payment.

4) Unchanging utilities - the utilities that don't change from month to month (garbage service, cable bills)

5) Subscriptions - this is where you capture things like NetFlix membership, and health club fees. Things that send you a bill every month and it's always the same amount.

6) Automated savings - if you have something set up where money automatically goes into some sort of savings account every month, include it as an expense.

This is usually where I stop with expenses, then I move on to

INCOME:

This is really just any income you have coming in. This is an easy one, for most people it's just your pay for the month (make sure it's your take home pay, don't include stuff like 401k contributions, or income taxes taken out of your paycheck here).

If your income is variable, how do you capture that? Well what I suggest you do is enter your GUARANTEED income for the month. If you have a job that is totally commission based then I suggest you consider your guaranteed income to be zero (since that's essentially the truth). Then you can capture your specific income when you track your money (see the next step).

TRACKING YOUR MONEY:

Okay, so you have your budget set up, now what? Well what I started doing was I actually used this to track my money. Why? Well you'll notice we haven't included things like going to the movies, eating out, buying a latte. We also haven't covered groceries, utilities that vary (like your electric bill), stuff like that. People have different ways of handling this, but here's what I did:

Once you have all of your monthly expenses listed and all of your monthly income listed, if you subtract the expenses from your income the number that's left is your "surplus income".

By the way, if you get to this point and your monthly expenses are MORE than your income, you may have a big problem. Look very hard at things because changes need to happen.

You may have a negative surplus because your income varies a lot (like if you have a commission based job). That just means that you have to work that much harder to make sure that money is coming in faster than it's going out, and you need to accept that or else get a job where your income is more steady.

So let's say after doing the math you discover your surplus income is $300. What I started doing was I gave myself a $300 allowance on the first of each month (I just tracked the amount of my "surplus account" on a piece of paper, but I know some people actually keep the cash in an envelope or something like that), and whenever I spent money on something that wasn't listed in my expenses I deducted the amount from my allowance.

I also did the following:

-If at the end of the month I had any extra then it rolled over to the following month (so if I had $50 left at the end of the month, I'd still get my $300 so my running total would now be $350).

-I rounded all purchases up the nearest dollar and I didn't track anything that I paid for with change. This just simplified things a lot.

-After a while I discovered that many of my utilities varied, but only a little each month (like my phone bill). Once I realized this I included the average amount as an expense in my budget and if my bill was less than the average one month I'd add the extra into my surplus and if it was more I'd subtract it.

-Money was deducted from my surplus when I BOUGHT something, even if I put it on a credit card, this made it easy for me to know that I was never using my credit cards as a way to overspend, and when my credit card bill came I paid the whole balance each month.

-Any unexpected income that came in went into my surplus income total (for me this was rare but could be things like tax refunds, or gifts of cash). For people who have incomes that vary greatly from week to week, you can just add the money as unexpected income.

Here's why this system worked for me:

1) By watching my surplus account I could be certain that money was coming in faster than it was going out.

2) I tracked my spending on a piece of paper so I could tell at a glance what I was spending my money on.

3) If my surplus account total ever got really high I knew I was allowed to splurge a little. If it started to get low, I knew it was time to tighten my belt a little. If it ever went negative then I knew I REALLY needed to scale back immediately because it meant at that moment in time I was living beyond my means.

4) Sometimes I would have money left over and so I'd transfer some money to my savings account and then subtract that amount from my surplus total.

To be honest, now that I'm older I don't track my exact spending down to the dollar like I used to, but that's because I'm a little older and have a few more extra pennies than I did 10 years ago. But when I was fresh out of school and money was SUPER tight this system really worked for me. I never overspent, and the satisfaction of having an extra $40 at the end of the month to put into savings felt great.

Also, when I wanted to buy a big ticket item (like a TV) then I saved by scaling back my spending until my surplus total was high enough that I could buy the TV. Instead of saving first and then buying it, lots of people out there put it on their credit card and then "save" for the purchase "after the fact" by paying off the card. If you are doing this, then you are throwing away money and YOU SHOULD STOP DOING THAT NOW!

I can't stress this enough. I am amazed at how many people carry balances on their credit cards so that banks can charge you tons of interest as you try to pay it off. When you pay credit card finance charges all you're doing is taking money that you could be putting towards your financial future and handing it to a credit card company.

There are lots of ways to make and hold to a budget but this is the one that worked for me. I'd be interested in hearing about systems that worked for other people. Remember that the goal of a budget is to make sure you are living within your means, so watch closely for the signs that you're overspending and deal with it before it becomes a huge problem.

If you've never gone through this exercise before, then congratulations on taking this first step, and hopefully it will really help you get your financial life under control.

Focus on your finances

Posted by Matt

If your financial situation needs a little attention, give blogging a try.

I used to think I spent a lot of time thinking about my financial situation, but it was nothing compared to how much I've thought about it over the past few months. Writing on each topic really makes you dig into the details and I know it is helping me get my (our) finances even more organized. Also, many of the more successful personal finance bloggers got their start by documenting the process that they used to dig themselves out from under a pile of debt.

I am hoping that I'll eventually get to take the focus off of me, though. One of my goals is to come up with a systematic set of financial rules to live by over time and automate everything as much as possible so I can just sit back and not worry about it.

Isn't that what "financial security" really means?

The baby gear underground

Posted by Matt
If you have a young baby (or will soon), you may be wondering about what type of gear you need to start stockpiling. Is it a lot? By most any measure, yes. There are a LOT of pieces of baby equipment that I'd consider pretty frivolous, but the necessities do still pile up.

Friends and relatives are usually excited to get gifts for the baby; most often clothes, books and toys. Those are probably the things we received the most of (either as gifts or just hand-me-downs) and we appreciated that because the our son grew out of and get tired of them so quickly. We had so many toys that we put them out in rotations. We did buy a few on Craigslist, so my wife bought some disposable wipes with bleach to wipe them down. If I had to do it again, I'd try to get a lot less brightly colored plastic. Also, I wasn't crazy about some of the noisy ones, but our son found those really stimulating. Just put a piece of cellophane tape over the speaker to dampen the volume.

The real big-ticket items to watch out for are furniture; we bought a crib, changing table/dresser, glider and bookcase. My wife saved us big money here by shopping on Craigslist again, and were lucky enough to get a good glider as a gift. We probably would have been willing to spend a little more on that anyway, as so many new moms told us that they spend a LOT of time nursing in the glider.

I don't think you absolutely have to have a dedicated changing table, but at least find a piece of furniture that you can do diaper changes on standing up and that has room for all of the changing accessories (tissues, diapers, powders, creams, small distracting toys, etc.).

I wouldn't have guessed we needed the bookcase, either, but it was great place to stash all of the blankets we used and we did get a ton of baby books.

The price for strollers and backpacks are surprisingly high, so you might check craigslist for those, also. One warning here: we went through three cheap, used strollers before we finally discovered the BOB Revolution, which my wife absolutely LOVES. It was spendy, but my wife walks a lot so we're both glad that we finally paid to get something of high quality. If you find a deal on a used one of these, JUMP on it because it won't last long.

The one item of baby gear that I heard not to buy used is a car seat, but we used a hand-me down from people we knew because they assured us it had never been in an accident.


My overall recommendation is to try to put together your shopping list and limit your big spending to a few critical pieces. Sometimes people decide to buy all new stuff because they just want everything to be perfect for their new baby (especially the first one, when you have no experience and you're paranoid about doing everything right).

If you go to Baby's R Us and get everything on the "recommended for baby" cheat sheet they provide, you could easily spend into the thousands of dollars. If, on the other hand, you're really resourceful and/or you are friends with people who have babies, you can get by with purchasing very little. Just remember that your kids won't remember what they were wearing (and spitting up on) when they were three months old, but they'll always remember you for chipping in to a college fund.

The First Signs Of Trouble

Posted By Paul

It's easy to talk about people who are far down the road of financial chaos, but I wanted to take a moment to call out some of the initial warning signs. My hope is that if you can spot the early red flags you can make changes before it's too late:

Here are some early signs of trouble:

-You start to carry a credit card balance because you just don't have quite enough money to cover it but you plan to catch up soon.

-You have to hold off on paying bills until payday.

-You bounce a check.

-Your day to day expenses are high enough that you decide to start scaling back on your retirement savings.

-You find yourself dipping into your emergency fund for non-emergency things like utilities.

-You find yourself having trouble paying for basic needs like groceries.

If any of these happen to you then stop, take a moment to look closely at your lifestyle. It could be that you're starting to live beyond your means. Deal with it now before you dig a hole that you'll never get out of.

Article: 10 Things You Shouldn't Buy New

I thought this was a good article on things you can easily buy used for big savings:

http://articles.moneycentral.msn.com/SavingandDebt/FindDealsOnline/10thingsYouShouldntBuyNew.aspx

What to do with $500

Posted By Paul

One question I've been asked before is: "What should I do with my windfall?"

I thought I would answer that question for a windfall of say $500 (which seems to be a common amount).

Here is some ideas that I suggest to people (in approximate order of priority):

1) Do you have a decent sized emergency fund (3-6 months worth of living expenses, though more is always good)? If not then consider putting the $500 towards that.

2) Do you have credit card debt? If so then consider putting the money towards that.

3) Have you put all you can towards a Roth IRA for the year? If not, then consider putting the money towards that.

4) Do you have kids? Then consider saving for their education. See: 529 Savings Part 1 and Part 2.

5) Do you have any non-mortgage type of debt, like a car loan or student loans? You may want to put the money towards that and get your loan paid off that much earlier.

6) Do you have mortgage debt? Paying off your mortgage early isn't a huge priority, but if it's something you'd like to do, then go for it! If you don't have any mortgage debt then you either rent (consider saving the money in anticipation of someday buying a home), or you've already paid off your mortgage entirely (in which case I envy you).

If you already have an emergency fund, have no credit card debt, fully fund your Roth, are on top of college savings for your kids, have no car or student loans, and no mortgage debt, then I would say it's likely that you're pretty on top of your finances. At this point perhaps you should put it towards a cool vacation or something fun, as it sounds to me like you deserve it.

The Millionaire Next Door Pt 1: Big Hat No Cattle?

Posted By Paul



Hi Everyone,

I've started reading this cool book called The Millionaire Next Door.

The basic idea behind the book is that the authors did a lot of research on wealthy people and were surprised by what they found. They found that many of the things people envision when they think of a millionaire (where a millionaire is defined as a household that has a net worth of one million dollars or more) are false.

I plan on doing several posts as a sort of on-going review of the book, but I wanted to start off with one of the first ideas that the book describes. The idea is that there are numerous people out there who:

1) Live in upscale neighborhoods.

2) Drive expensive foreign cars.

3) Wear expensive clothes.

4) Aren't millionaires

The book describes this phenomenon using a cattle rancher term of: "Big hat, no cattle." Meaning a person who has the trappings of a very successful life, but who is living paycheck to paycheck and has very little net worth.

This reminded me of an article in an earlier post: Life And Debt In Suburbia.

So keep in mind as you look at your life with a frugal eye, that you shouldn't focus on just your income when evaluating your life. Let's say you make $300,000 a year, but you spend $295,000 of it every year. Each year you'll manage to save $5,000. Compare that with someone who makes $50,000 a year but manages to live off of $42,500. They save $7500 a year. The first person has a great income, but the second person is actually accumulating more wealth and one of the points of this book is that it's wealth accumulation that's important when looking at financial independence.

Don't let yourself be one of those people with a big hat and no cattle.

Roth IRA reversal

Posted by Matt

Paul and I have both posted several times about the advantages of using the Roth IRA to save for retirement, and I still believe in it for all the same reasons. BUT, after much consideration, I've decided that I'm not going to open one (for 2007, at least). How's that for a ringing endorsement?

I do want to increase my retirement saving rate, however, and I've elected to increase my 401k contribution rate from 12% to 15%. That still won't put me at the maximum contribution, but every little bit helps. Here's why I went this way:

1. I like the fact that the 401k withdrawal is totally automatic and almost invisible to me. Yes, I see the money come out each paycheck, but I don't really feel it. It's just another line item on the pay stub. The money that I really think about and budget with is the amount that actually gets deposited in my checking account.


2. Yes, I could have set up automatic withdrawals for the Roth, but I don't like to have any more accounts than is necessary. It's probably just a personality thing. In my dream world, I would have a single bank account that somehow encompassed all of my finances. I remember one point when my wife and I were still figuring out how to handle our joint finances and we had about nine different checking and saving accounts. It just didn't feel right.


3. Finally, the Roth's benefits aren't that compelling FOR ME. Yes, it is nice that the principal is available for emergency withdrawal, but that is what I have an emergency fund for. Yes, it would be nice if some of my income was tax-free in retirement, assuming that I'm in a higher tax bracket then, but who knows if I will be?

I'm always trying to figure out what is the BEST possible financial action I can take, and usually that means trying to put money into instruments that will yield the maximum return, but I'm also learning that it is next to impossible to predict that. I tried to set up a spreadsheet that would predict my financial outcomes in retirement, but there are FAR too many variables.

What will my salary be each year?
What tax bracket will I be in during retirement?
What will happen to the tax laws?

The list goes on and on. Remember the computer in the movie "War Games" that ran through every possible nuclear war simulation and determined that the only way to ensure a positive outcome was to not engage in war at all? Well, I've gone through lots of scenarios and the only thing I was able to determine for certain is that I should definitely save for retirement. Shocking.

So, I'm just trying to do the best I can. I don't think anyone would argue that I shouldn't put more money into my 401k account. They might make a compelling argument that it's not the BEST place for it, but who can say for sure?

The Rule of 72

Posted By Paul

I thought this was a cool rule to share as I know that compound interest can be a pain to calculate.

The Rule of 72 is a quick and dirty way to approximate how long it will take to double your money given a specific interest rate.

The idea is that you take 72 and divide it by your interest rate, and the number you get is the number of years it will take for you to double your money.

So if you have some investment at a 4% interest rate then 72/4 = 18 so it will take approximately 18 years for your money to double.

There is more in depth info on this (along with other similar rules of thumb at):

http://en.wikipedia.org/wiki/Rule_of_72

Beware Of Subscriptions

Posted By Paul

There have been several articles posted that relate to being wary of subscriptions (Paying for Storage, Lower My Cable Bill Please) but I think it's such an important point that it justified its own article.

Here is an example of how I look at spending. Not too long ago I really wanted to buy a DVD of a movie I like. It cost $16. I bought it and watched it, and I might pop it in and watch it again on a lazy Sunday afternoon, but when it comes right down to it I certainly didn't need to buy the DVD and you could certainly make the argument that the $16 was spent frivolously.

However at least it was a one time cost that is over and done with.

Now compare that to something like a gym membership, or yard care service, or a fancy cable package. These are things that you generally have to pay for month after month until you take the initiative to cancel them.

It's not that it's bad to have any of these things (provided you can afford them and the value you derive from them is worth it to you see the article Paying For Convenience), but I think it's important to think hard before you sign up for extraneous things that involve a monthly fee.

It's so easy to just get used to a monthly fee (especially if it's just $10 a month or something like that), but you stack up enough $10 a month costs and they start becoming significant.

So many businesses are switching over to subscription based services because they like the idea of making money off of their customers whether or not you use their service in a particular month.

Again, I'm not saying you are being frivolous if you use one or more of these services (I subscribe to some of them myself), but it's important to take an extra few minutes to weigh the pros and cons of something that involves a repetitive fee.

So take a quick look at your monthly services. Do you really watch those premium cable stations all that much? Do you subscribe to the 4 disk Netflix plan when you could probably get by with 2? Could you get rid of the premium cable channels and just watch the shows via Netflix when they come out on DVD? Maybe you haven't logged into your World of Warcraft account for over a year. Do you subscribe to the newspaper but never seem to find the time to read it?

For example, I used to have extended cable, but decided to try the basic package where I only get channels 2-13 plus a few others. I discovered that many of the shows I watched so faithfully on those extra channels faded from memory quickly, and the few shows that I still REALLY wanted to watch came out on DVD and could either be borrowed from friends, put in my movie queue, or in rare cases purchased. Overall I don't really miss those extra channels and the savings is significant.

It's not that you shouldn't ever pay for services that aren't basic needs but it's good to periodically look them over and make sure that the money you're paying for them is still worth it to you. Maybe it's worth it to try cutting off one service, save the money instead, and then give it six months and see if maybe the service wasn't as important to you as you thought.

Sharing the savings

Posted by Matt

Have you ever been disappointed when you proceed to the checkout section of an online shopping site and are asked whether you have a coupon code? I always wonder "where can I get these codes"?

One answer is "RetailMeNot". This site claims to share more than 45,000 coupon codes from major online retailers. I heard about this site a few weeks ago, but haven't had a chance to use them yet. (That would require actually buying something.)

Rather than hold the info back, I thought I would post about it and see if any of our readers had experiences to share.

Update: 11/04/2007: I was contacted by a representative of RetailMeNot who saw this post and wanted to let everyone know that they have a new feature to make using their site easier: widgets. These are plug-in modules for Mac Desktop, Firefox and iGoogle that bring the latest savings to you so you don't have to remember to keep checking the site.

Simple Solution For A Slow Drain

Posted By Paul

I thought I would take a break from the more high level financial talk and pass on a little household tip.

This weekend I had to unclog two sinks that were draining slowly. I took the first one apart and removed the trap and sure enough I pulled out this really gross mass of hair and soap scum. I then decided to make a quick run to the hardware store to buy a brush to sort of scrub down the inside of the pipe to get the last of the gunk off.

While at the hardware store I saw this thing called the: "Zip It" which is supposed to unclog drains easily. It was only $2 so I decided to give it a try on the other sink which I had yet to tackle.

The Zip It is just a flexible plastic strip with these little teeth on it. The idea is that you can thread it down the drain (you can even just slip it around the edge of the drain plug) and then slowly pull it out and the teeth on the zip it are supposed to grab onto whatever gunk is clogging the drain to let you draw it out.

So I took this little gadget home and tried it on the remaining slow-draining sink. It was pretty easy to thread it down and draw it back out and it actually worked really well. The first time I drew it out it pulled out this mass of gunk, so I did it again and again until the Zip It came out clean (I did it about 4 times). Once I did that I turned on the water and the sink drained fine.

Considering that it took a few minutes, didn't require any gross or expensive chemicals, and the zip it was easily rinsed off and ready for reuse. I thought it was a pretty good tool for $2. Not nearly as good as a real auger, but a pretty decent cheap and easy alternative.

I was a little concerned that if the zip it got stuck on the drain plug that it might end up breaking, leaving part of it in the drain, but I figure if that happens then you're just back to removing the trap anyway.

I think you can probably find it at any hardware store, and they also have them here at Amazon:

Paying For Storage

Posted By Paul

I have read that rented storage is becoming a huge trend in the United States as household possessions grow beyond their owners means to contain them.

One solution to this is storage rental, which can be done through numerous storage facilities that dot our landscape.

Rates for these storage facilities vary but I did a quick check and found a 5x5x10 storage room for about $50 a month. That's the price of the smallest storage room.

One rule that I live by is to always think hard before taking on a new monthly bill. In this case, look closely at what you plan to store. Is it something that you really need to hold onto? If it's equipment for a hobby you haven't pursued in years, or furniture that you just don't have room for, consider selling it or giving it away.

It's easy to fall into a trap where (for example) you get a storage unit to hold that couch that doesn't fit in your house currently but might if you move into a bigger house someday. If you don't ever need the couch you're spending the money for nothing and if you DO ever have room for it, you may very well have spent more money storing it then it would cost to buy a new one.

I've also seen people who get so used to storage rental that they treat their storage unit like an extra garage. Unfortunately it's an extra garage that comes with a bill every month.

My advice? Storage rental is great for any temporary needs (like I know some people who sold their old house and moved into a new one but the way the dates worked out they had to live in a hotel for a month and had to store their furniture), but if you ever find yourself getting a storage unit for a situation where you don't have a specific end date for the storage need, think long and hard about what you're storing and if it's really worth the expense.

Weatherization assistance

Posted by Matt

I published a post last month about home energy audits, but recently got a newsletter from my electric company with an article containing even more good news for Oregonians looking to weatherize their homes.

If your family meets the income guidelines, you will qualify for a program that provides funding for weatherization work to be done on your home at no cost to you. Click here for more information.

The program is primarily federally funded, so people outside of Oregon should check with their local utilities or their state government's website to find out what types of similar programs are available.

529 education savings update (part 2)

Posted by Matt

It's done. The 529 setup process was extremely easy last night.

• My wife and I chose the index fund option.
• I didn't have to talk to a customer service rep or fill out a single sheet of paper. I made the initial deposit with an ACH transfer from our checking account and set up recurring monthly transfers. We're starting out small at first ($50/month) until we see how our budget shakes out in the new house.
• The whole thing took probably 10 minutes at most.

The only disappointment I had was when I looked up (as promised) how to allow relatives to contribute to the account. Essentially, there are vouchers that you have to print out, write the account number on and then give out. Potential contributors then have to mail a check (!) in with the voucher. Oh well. Maybe it will get easier someday.

Overall, I'm glad to say that this was yet another one of those financial situations where making the right decision is a lot more involved than acting on it.

Is Leasing Really Fleecing?

Posted By Paul

Let me start of by saying I'm biased against leasing cars for two reasons:

1) As I mention in my article "Know Your Indulgence" I'm not a "car person" I don't really like driving so I don't really care all that much about cars, for me it's really just a way to get from point A to point B.
2) My first exposure to leasing was right after college when I was shopping for my first new car. I was in this one dealership and the salesman told me about how if I leased a car I could "drive a car that would normally be beyond my means". That statement struck me as so odd that I remember it to this day.

So in my view, leasing a car is essentially like renting an apartment. When you lease a car you:

1) Don't generally have to come up with a down payment (the same way you don't have to come up with a down payment for an apartment, but you generally do for a house).
2) Pay a smaller monthly amount compared to your payment if you bought the car (which is like how renting an apartment is generally cheaper per month than buying a home).
3) You don't really have to worry about the long term care of the car (just like with an apartment you don't have to worry about upgrading the water heater, or putting a new roof on it).
4) When you are done with the lease, you have no ownership of the car (just like when you move out of an apartment you don't "own" any part of it).

It seems like leasing is essentially a life style choice. Some arguments for and against leasing are:

Arguments For Leasing:

-After the lease is up, you can just turn in the car and get a new one, you never have to drive a car that is more than a few years old.
-Because your car is always fairly new, it's unlikely that it will break down unexpectedly.
-Also because your car is fairly new, any major problems are probably covered by the warranty. -You can often lease a car for a smaller monthly payment than you would have if you were to purchase and finance it.

Arguments Against Leasing:

-Yes, your monthly payment is smaller, but it NEVER ends.
-If you plan to keep the car for more than four years or so, then buying it is considerably cheaper in the long run.
-Many leases have mileage limits. If you accidentally drive too many miles during the lease period, you get penalized.

I know quite a few people who lease cars. A very small few of them really do like having fancy cars and are willing to live with the monthly payment for the sake of driving a cool car that they could not afford otherwise. A more common reason is that the person doesn't like taking care of cars. To them a car is something they want to pay for and never have to worry about. The lease option in that case works for them.

For me, my car is 13 years old, and still runs great. I haven't had a car payment for a LOOONG time and I don't miss it. I doubt I'll ever choose to lease a vehicle.

Oregon Kicker Check Fraud Alert

Posted By Paul

Since we have many readers in Oregon, I wanted to post an alert about a current scam that I read about in the paper.

As most Oregonians are aware, the Oregon kicker check is coming later this year. There is apparently a scam where people are getting called by someone saying they are from the Oregon Department of Revenue saying that they need the taxpayer's account info so they can direct deposit the check.

This is just an identity theft scam, so don't fall for it!

529 education savings update

Posted by Matt

Trying to be financially responsible is hard.

I'm finally getting around to setting up an Oregon 529 account for my son, or rather I will be when I get home tonight and can dig up his social security card (required for registration). The first step of the registration is reading the plan guide. It's 40 pages!

Mostly it contained things that I had already read about when doing my initial research. The only decision left to make was which type of fund to use. My first thought was to go with the "years to retirement" option. With this choice, you just indicate when you expect your child to start college and the plan administrators automatically balance the allocations with the appropriate level of risk/return. Our son would start off in the "10+ years to college" fund, which aggressively pursues growth given that there is more time to recover from any economic downturns. When he gets closer to college age, he automatically gets switched to the next fund (7-9 years) which is intended to be less risky and provide lower returns. The rebalancing continues in several stages all the way up to the day college begins (and beyond, via the "in college" fund). This is very similar to the way target-date retirement accounts work, and it makes things very easy.

I'm also considering a plain-vanilla index fund option. The returns have actually been slightly better and the expense ratios are lower to boot (as is normal with all index funds), but both are within the recommendations I have previously found (<1% annually). If we go with this option, I'll probably want to switch it over to something more conservative as college gets closer. Knowing me, I'll probably be watching it every year anyway, so that's not too big a worry.

My wife and I are both pretty risk-averse, but we'll have to talk it over tonight when I finally set the account up.

Oh, and I did find one other thing that will be interesting for at least those grandparents who still like to give savings bonds at birthday time: it is possible for people other than the account owners to contribute directly to the account. I'll try to get more details for how that works into a later post.

One View On Paying Off The Mortgage Early

Posted By Paul

Matt posted an article called The mortgage prepayment conundrum, but I wanted to share one other viewpoint I heard when talking to a friend.

The idea was this:

The main arguments against taking extra money and applying it to the mortgage are:

1) Any money you put towards paying off your mortgage early can only be accessed by a home equity loan or by selling the house. It can't be accessed easily in case of emergency.

2) Any money you put towards paying off your mortgage early could be put in an investment that can beat the interest rate you're paying on your mortgage. (You can make a greater amount of money by investing a dollar than you can save by applying that dollar to your mortgage). This argument also includes the fact that mortgage interest can be deducted from your taxes so your interest rate is effectively less.

The view I heard addressed both of these arguments by saying:

1) If you have an emergency fund built up, the need to access money you put towards your mortgage becomes less important (you won't need the money you gave the mortgage, that's what your emergency fund is for).

2) Yes you can POSSIBLY make more money investing that dollar than you save by applying it to your mortgage, but that generally assumes some sort of investment that involves some risk (like a mutual fund or stocks). The super safe investments (like Savings Bonds, CD's, savings accounts) give you smaller returns, but a dollar put towards paying down the mortgage is guaranteed to save you money.

I thought these were both valid points which made me think about my own finances. As I mentioned in the article A Simple System For Saving Money I periodically transfer money from my checking account to savings. My wife and I decided that for the next few months we're going to try transferring half of the money into savings and the other half to our mortgage, and see how that works out for us.

Shopping for a reliable car?

Posted by Matt

I recently read a great article about automobile reliability, a topic that I've been interested in ever since I owned my first car, a 1974 Datsun 610. Granted, it was 14 years old when I bought it and I only drove it for one year, but owning that car tortured me.

Examples:

• I once had to yank the battery cables off of the battery to kill the engine when the key didn't work.
• I almost ran the car through a red light at a busy intersection when the accelerator stuck.
• Accessories routinely fell off the dashboard.
• I never could get it to pass the emissions test and finally had to sell it as a "mechanic's special".

(Side note: I was surprised to learn that this car was part of the line that later became the Nissan Maxima.)

Anyway, it was the first of several cheap used cars that I drove in my early days and I always hated having to worry that one day my car was just going to die, as my Chevette later did on a remote stretch of the I-5 freeway. This was one of the biggest factors that compelled me to finally buy a brand new car (2003 Subaru Impreza) when I could finally afford it. There is definitely something to the concept of "buying peace of mind".

I was delighted to find the following quote at the end of the article that validated my vehicle choice somewhat:

While [Consumer Reports] recognizes some consistency over the years in several manufacturers, he says, "We recommend the whole line for only two brands -- Honda and Subaru".

And...my wife drives a Honda!

I'm planning to drive my Subaru for as long as I can make myself. It's a great car, but I'm often tempted to upgrade. The reason I haven't yet is I don't think that my ideal car has been created yet. I'm hoping that one of the manufacturers (preferably Subaru or Toyota/Lexus) is going to release an electric luxury car in the next few years.

The article reports "the top automaker in terms of reliability continued to be Toyota's luxury brand, Lexus -- a title the automaker has held for more than a decade" and I've been impressed by every Lexus I've ever ridden in. Also, I'm reading a book right now called The Toyota Waythat has some amazing history about the development of the Toyota Production System and why it creates such amazingly high quality vehicles.

But, my next car is probably still several years away. I'm a believer in the common suggestion that you should not buy the first model year of any vehicle, as it usually takes a year or two of production and field experience to work out the kinks. Also, I probably won't buy new again. To get the same peace of mind, I'll just have to work a little harder to find a car that has been well taken care of. The most common recommendation I hear for getting good value is to look for a car that is 3 to 4 years old as most of the depreciation occurs in those first years.

So, if Lexus releases an electric car in 2009 (please!), I might buy the 2011 model in 2015. Guess I better take good care of my Subaru until then!

Here's one way NOT to pursue wealth

Posted by Matt
Just had to share a link to this post about a hilarious craigslist ad from a gold-digger in New York who is looking to marry money. The responses are even funnier than the ad, as the financially-savvy respondents explain why the woman is a "trading position" instead of a "buy-and-hold" position.

You've Been Laid Off, Now What?

Posted By Paul

It's happened to a lot of people (including me). All of a sudden you find yourself involuntarily unemployed. So what do you do? Here are some tips that I came up with after going through it myself.

1) DON'T panic. It happens to lots of people, it doesn't mean that your life or career are over.

2) DO sign up for unemployment. You pay into it when you make money, so you might as well draw it when you qualify.

3) DON'T "take a few weeks off." When I got laid off several of my coworkers did as well, and I know several that decided to take an impromptu vacation. I can see the appeal of some fun after being laid off, but it seemed like for many people the impromptu vacation turned into months of idleness.

4) DO try to keep a normal schedule and routine. It's easy during this time to get in the habit of sleeping in until noon, lounging around in your pajamas all day, and staying up late every night. I'm really glad I didn't do this since I got a few surprise interviews that were at 8AM the next day, and I was glad that I was still in a daily schedule where waking up at 6:30AM wasn't a huge adjustment.

5) DO try to have somewhere to go every day. In my case I was lucky to have a friend who owned a small retail business so I would go over there and help them out (since I was laid off during the holiday season). Not only did I get to help my friend out, but it gave me a reason to wake up, shower, shave, and get dressed each day which helped me keep my attitude positive. Even if you only go to the corner coffee shop to read the paper, try to have something that keeps you from spending the whole day in your pajamas.

6) DO make getting a job your job. Job hunting is a lot of work under the best of circumstances, so spend some of every day job hunting. With the Internet you can do an amazing amount of job hunting in a few hours. I got in the habit of looking over 6 job hunt web pages each day and applying for any jobs that looked promising. When I made it through all 6 pages I was done hunting for the day.

7) DON'T give up. Using the above system there were days (especially around Thanksgiving and Christmas) where I would go through all 6 job hunt pages and find no new jobs to apply for and be done in 30 minutes. On those days I would go over my resume or try to find some new job hunting page I had never heard of before. You never know which lead will be the one that pans out.

8) DO take a serious look at your finances. One of the best choices I made was getting a house where I can pay my mortgage while on unemployment. That made for a much more peaceful state of mind while job hunting. Still, I knew how much was in my rainy day fund and I watched it closely as the months went by.

9) DO save your pennies. You don't have to panic and shut off your heat and electricity, but it doesn't hurt to skip the meals out or hold off on buying that new TV.

10) DON'T go without health insurance. I know it's tempting to just go without medical insurance until you get a new job, but I think this is a bad idea. If you go without your dental and vision it's not the end of the world, but don't go without health insurance.

By following these rules, my 5 months where I was without a job were memorable but not traumatic. In fact, there were some good things that came out of the experience. Not only did I learn that I could get by without a job (at least temporarily), but when I make lifestyle and financial decisions I can remember back to that time in my life and imagine how this decision would impact my life if I were to lose my job again.

Article: Dumb Retirement Moves

Posted By Paul

An interesting article listing "9 Ways To Ruin Your Retirement"

http://www.bankrate.com/dls/news/retirement/20071009_dumb_retirement_moves_a1.asp

Money insurance and POD accounts

Posted by Matt

My wife taught me something new about FDIC insurance the other day. I thought that they would insure up to $100k in each account, but it turns out that you can get more coverage if you name additional beneficiaries to your accounts. I confirmed this here and found some additional tidbits.

The basic insurance amount is $100,000 per depositor per insured bank. Certain
retirement accounts, such as Individual Retirement Accounts, are insured up to
$250,000 per depositor per insured bank.

All of your single accounts at the same insured bank are added together and the
total is insured up to $100,000. For example, if you have a checking account and
a CD at the same insured bank, and both accounts are in your name only, the two
accounts are added together and the total is insured up to $100,000.

Traditional and Roth IRA accounts are added together and the total is insured
up to $250,000

Also, the site explains Payable-on-death (POD) accounts. My wife and I just discovered these last year when we started our estate planning. I think all of our separately held accounts are now designated as POD for each other and our son. According to our banker, if one of us dies, the account passes directly to the listed beneficiaries (no will, no probate).

My wife pointed out that adding beneficiaries to the account increases the insured amount.

The FDIC insures the interests of each beneficiary up to $100,000 for each
owner if all of the following requirements are met:

• The beneficiary is the owner's spouse, child, grandchild, parent, or
  sibling. Adopted and stepchildren, grandchildren, parents, and siblings also
  qualify. In-laws, grandparents, great-grandchildren, cousins, nieces and
  nephews, friends, organizations (including charities), and trusts do not
  qualify.


• The account title must indicate the existence of the trust relationship by
  including a term such as payable on death, in trust for, trust, living trust,
  family trust, or an acronym such as POD or ITF.


• For POD accounts, each beneficiary must be identified by name in the bank's
  account records.

The site actually has an example where a couple with three children has up to $800,000 of their deposits insured. So, it is possible to keep a great deal of your money in the bank safely, but if you have more than $100k in the bank, please also consider some other investment options (even if it is just a nice boring index fund). Enough in the bank already!

The Goodwill Fashion Challenge

Posted By Paul's Wife

Think that you can’t find the building blocks to a good wardrobe at your local Goodwill or thrift store? Think again. I decided to create my own fashion challenge by shopping at my local Goodwill for major items that were missing in my closet. Before starting this challenge I cleaned out my closet and got rid of items that didn’t fit well or I hadn’t worn in a long time. I then donated them to Goodwill. With a clean and organized closet, I was ready to go shopping.

Recently when my husband and I went to New York we watched “Tim Gunn’s Guide to Fashion” on TV. He listed items that every woman should build her wardrobe around. That list of ten items includes a basic black dress, a trench coat, classic dress pants, a skirt, jeans, a classic white shirt, a day dress, a cashmere sweater and a bonus trendy item. I already had a very nice basic black dress and several pairs of jeans. So, I set out to find the rest at Goodwill.

I made sure to search the racks carefully for colors and styles that I liked, but were classic enough to wear with the rest of my clothes. I was able to find some nice grey dress pants by The Limited, a classic black skirt, a jean skirt, a brown tiered skirt, a nice black blazer by Banana Republic, a classic white shirt by The Limited as well as a blue sweater and brown pumps by Aerosole. My total bill for these classic items was $64.41! I was not able to find a trench coat, day dress or cashmere sweater yet, but I will keep looking. This will be a fun way to stretch out my shopping experience to more than one trip. Thrift store shopping is the kind of shopping where you need to be very patient. One day you might find everything you are looking for and other days you may not find anything. Keep your cool and look another day if you cannot find what you want the first time.

I have been so happy with the pieces that I picked up at Goodwill. They were great additions to my wardrobe and now I am able to wear more of my sweaters and other shirts along with my basic pieces to work, meetings and other events. I was able to build my wardrobe for less than the price of one pair of pants at a regular retail store! I was very excited to do this challenge because it proves the point that you don’t have to spend a lot of money to have a nice wardrobe.

For many years I have been a thrift store shopper for clothes but through this challenge I learned to narrow my search for specific items to avoid the trap of buying too many things and end up giving them away sooner rather than later when they wear out. Sometimes I mix my thrift store purchases with items that I have bought at regular retail stores. I do sometimes shop at regular stores when I cannot find a specific item that I need and even then I try to shop sales & make sure I really like the item and it really fits well.

Gas Mileage: How slow can you go?

Posted by Matt

Did everyone else already know that our government was providing a fuel economy website? News to me! There is a great section on gas mileage tips that includes the usual sensible driving recommendations, but also had the answer to a question that I've long wondered about: "If driving fast decreases fuel economy, does your fuel economy continuously go up the slower you drive?" The graph (and article) says no, there is an optimal speed for fuel economy that varies by vehicle.

I'm going to guess that this graph shows the maximum fuel economy that can be achieved at each speed. In other words, if you accelerate to 20 mph and then maintain that speed (on level ground?), the best mileage that you can get for the subject vehicle is around 25 mpg. I assume that your fuel economy WHILE accelerating to 20 mph will not necessarily match the graph, especially if you've got the pedal on the floor!

I guess the mpg drop off at the slower speeds doesn't really matter because you rarely get the chance to cruise below 30 mph anyway, so the more important points for frugalizers are to keep the top speed down and go easy on the pedal at all speeds. But you knew that already, right?

By the way, if anybody has access to a graph like this for late-model Subarus, let me know! The few graphs that I could find were posted by Prius owners and their curves are very different.

Article: 13 Retirement Myths

An interesting article on CNN Money today listed 13 Retirement Myths.

http://money.cnn.com/galleries/2007/moneymag/0710/gallery.retirement_myths.moneymag/index.html

College Savings Choices

Posted By Paul

I happened across this article which I thought was a good summary of some of the more popular vehicles for college savings:

http://www.bankrate.com/dls/news/Financial_Literacy/Sept07_college_savings_a1.asp?caret=57a

Are FSA's worth doing?

Posted By Paul

Now is the time of year where many companies have you decide if you want to sign up for an FSA account. Since I've been thinking about FSA's recently I thought I would do a quick posting on my experiences with them.

First a quick description of FSA's.

Note:

I'm going to focus on medical FSA's because that is what I know about. There are also FSA accounts used for dependent care, but I've never set up one of those because I don't have kids.

A Flexible Spending Account is an account that generally works like this:

1) You decide how much money you want to put into the account for the next year.

2) During that year money is taken out of your paycheck and deposited into your account. The money that goes into the FSA account is not taxed. (So if you decide to put $1200 into your account $100 comes out of your pay pre-tax each month)

3) You can use the money in the account for certain expenses. The set of allowed expenses is defined by the IRS but generally comes down to costs you have to pay for medical or dental care.

This includes stuff like:

*Doctor Co-Pays

*Fees that your insurance doesn't cover (like if you got a teeth cleaning and your insurance only pays for half of the costs, you can FSA the other half)

*Some medical or dental procedures that your insurance won't cover (like Lasik)

*Medicines (prescription or over the counter)

*Eye glasses (even prescription sunglasses)

So how do you get the money OUT of your account? The way it usually works is a system where you pay the costs yourself and then you submit the proof of payment documentation to the benefits company and they send you a check from your FSA account as reimbursement (once they have approved that the expense qualifies). Most companies that have FSA systems have web pages that makes it easy to submit claims and check your remaining balance.

So what's cool about this? It can be a huge savings since you're not paying taxes on the money used for your FSA account.

The tricky parts with FSA accounts are:

1. Generally any money you don't use up by the end of the year is lost (so you don't want to put $1000 into your FSA and then only use $100 over the year, because you'll lose the remaining $900).

2. The rules for what is allowed and what isn't can be complicated and sometimes odd. The general rule is that for the expense to be allowed it has to relate to treating a disease or injury. So bandages are allowed, but vitamins generally aren't. Tylenol is allowed, but aspirin isn't (because it can be used daily to prevent heart disease). Some expenses are allowed only if a Doctor prescribes them (like massage therapy).

3. It takes a little extra paperwork.

So do I suggest getting an FSA? I've had one for several years now and it has worked well for us. The main thing I've learned is that you should definitely set up your FSA to cover your KNOWN expenses for the upcoming year. You can try to predict your medical needs for the upcoming year but that is of course very difficult to do.

My first year in an FSA I overestimated my medical costs so I ended up with $200 extra at the end of the year. I ended up going to the pharmacy and stocking up on bandages, cold medicine, all sorts of things. It worked fine in that I was able to use the $200 but you definitely don't want a big surplus every year (you can only have so many band-aids in your closet before it starts to get ridiculous).

The following year we tried to eliminate the surplus by dropping our FSA amount by $200 and that has worked well for us as a base amount where we end up either using it all or having very little (less than $15) left over at the end of the year (and we use that extra $15 or so to restock our medicine cabinet).

The base amount gets tweaked a little from year to year. For example, my dentist had been suggesting that I get some fillings replaced so one year I added the cost in to the base FSA amount and had it done that year (you can ask your dentist for the codes for the procedures and then just call your dental insurance to find out how much of the cost will be covered). Also my wife and I both wear glasses so when either one of us plans to get new glasses in the upcoming year we'll add some extra for that.

If you're new to FSA I suggest doing something very simple like:

Take the cost of your family's prescription medication for the year, add the out of pocket cost for a dental check up for everyone in the family, and use that as your FSA amount and see how it works out. If you end up with a lot of extra, use the money to stock your medicine cabinet and then lower it for the following year. If you end up running out of FSA money early then you can decide if you want to raise it a bit the next year. Once you know your standard FSA eligible costs for a normal year then it's easy to tweak it up or down from year to year as the health needs of your family evolve.

Not Everyone Can Contribute To A Roth

Posted By Paul

There have been several posts about Roth IRA's ("The Roth as a College Savings Vehicle", "How sure are you that your child will go to college?", "The Roth IRA: A tax shelter for your golden years.") and there is all kinds of info out there about the annual contribution limits, but many articles don't even mention that unless you meet certain criteria you're not eligible to contribute to a Roth IRA.

I went on a hunt to find the specific criteria for contributing to a Roth IRA. I wanted to get the info from the source so I went directly the IRS web page.

The problem with that is that the IRS has very little information at your fingertips via their web page. My experience has been that the IRS web page just lets you access their forms and info booklets via pdf's, which I guess is better than nothing, and probably much simpler for the IRS to maintain.

So for the actual info on the criteria for contributing to a Roth IRA, you can look at the publication located here:

http://www.irs.gov/pub/irs-pdf/p590.pdf
(hopefully this link will remain valid for a while)

If you go to page 58 you can see a pretty decent table that summarizes the conditions for contributing to a Roth IRA.

Here is some basic info I can summarize:

-If you're single and your modified adjusted gross income is less than $95,000 you can contribute the full amount to a Roth.

-If you're filing jointly and your modified adjusted gross income less than $150,000 you can contribute the full amount to a Roth.

-If you're married and filing separately and your modified adjusted gross income is $0 then you can contribute the full amount to a Roth.

If you're anywhere near the borderline where you might not be eligible to contribute the full amount to a Roth IRA, I suggest you read the latest publication (and you might want to ask an accountant to confirm). Tax laws are confusing and often defy simplification.

A return to minimalism: one in, one out

Posted by Matt

I think most people in America would tell you that they probably have too much stuff. I've always felt that way, and in fact, used to almost make a hobby of getting rid of things I didn't need. In my twenties, I lived in tiny apartments with very few pieces of furniture and almost zero decoration, and still, nearly every weekend I seemed to go through my things and look for unnecessary extras. In college, I owned one pair of shoes at a time. When I first moved to Portland in the late 90's, everything I owned came with me in the back of a Subaru wagon.

It was easier when I couldn't afford to buy new things, but once I started to make more money, I had the opportunity to explore new hobbies (each of which seemed to require new equipment.) The footwear alone (hiking boots, rock climbing shoes, soccer cleats, roller blades, etc.) started to really eat up closet space. AND, I had realized that I just couldn't wear my white sneakers everywhere (office jobs, weddings), so I had to buy even more shoes. At one point, I think I was up to about 15 pairs of footwear. I've narrowed my hobbies down significantly, but I still have 9 or 10 pairs of footwear, and I think this is too many. I'm going to cut down, so let me outline my plan for you. I'm focusing on shoes right now, but I'd like to apply these rules to all categories of things I own.

1. I'm not going to toss perfectly good items just for the sake of minimalism. I'll keep most of what I have until it wears out.
2. If I determine that I don't need something that is still in good shape, I'll sell or donate it. I don't want to turn my unnecessary purchases directly into landfill.
3. I'm going to determine what I NEED and stick to only that when purchasing (more on this below).
4. Last, but definitely not least, I'm adopting a "net zero" policy. Every time I bring a new personal belonging into my house, something old has to go out.

I probably have a few pairs of shoes that can be donated or passed on to my nephew right away. Here's the "need" list that I'm hoping to end up with eventually:

1. One pair of comfortable sneakers (haven't decided what color yet; might not really matter)


2. One pair of nice, black, dress shoes for work and upscale social events (ECCO makes GREAT shoes that are comfortable and really last)


3. One pair of casual, versatile, waterproof black boots (good for rainy Portland winters; I'm partial to Timberland).


4. Soccer shoes


5. One pair of sandals for the beach


6. One pair of yard shoes (usually the retired sneakers)

Noticeably absent are all of my brown shoes. They don't go well with everything the way that black does, and not having brown shoes means I don't have to buy brown belts anymore either. I actually got started on this whole line of thinking because I was shopping for new belts this weekend. I bought a new black belt, so that means my nephew may be inheriting my old one. I'd love to get down to a single black belt someday.

I'm hoping to make a similar list for my whole wardrobe and gradually get to the point where I wear everything in my closet regularly. This brings me to the point of why I'm discussing this in a frugality blog (finally). I go clothes/shoes shopping because I just feel like I don't wear what I have or I don't have clothes that I need for specific events. Without a specific, all-encompassing list, I'm tempted to buy things that catch my eye, but that maybe aren't versatile or that I won't wear regularly.

Also, I think the fourth rule is going to be a great way to limit spending. I'm going to try to apply it to all of my durable goods purchases (not groceries, for example), but not necessarily require that I have to exchange goods in similar categories. For example, I can buy a new shirt and donate a book to the library. Also, if I find something to donate when cleaning out the garage, I'm not going to use that as an excuse to go buy something new, or save that item until I find something I need to buy. I expect that I will eventually get to the point where it will be really difficult to find something that I want badly enough to get rid of one of my remaining possessions, and that will be a good sign that the things I do have are really necessary to me.

I'll try to remember to post my progress, as I think it will be interesting to see how my priorities change around the things I own.

Is anyone else up to this challenge?

Save On Drinking Water

Posted By Paul

This is one of the tips listed in this article on small things to do to save money:

Save on drinking water

At $1.50 a pop for a gallon of bottled water at the supermarket, the desire
for healthy hydration adds up. By purchasing a water filter, you can cut
your family's water costs to 19¢ a gallon. Order a Brita Riviera pitcher at
amazon.com for $27. Replacement filters good for two months are $9 each.

The trend in bottled water blows my mind. I heard a story on NPR that was saying how bottled water was the new fast growing market for the soda companies, and that since the main buzzword for water is purity, that it was a real challenge for companies to come up with commercials that essentially say:

"Our water has nothing in it but water, but it's still better than the other guy's nothing but water."

Try watching or listening to a bottled water commercial sometime, it's really interesting.

My point is that you should never spend a lot of money on water. I see people at CostCo buying cases and cases of bottled water which I don't understand at all. After all, if you're at home you can drink water from the tap or if you don't like the taste of that you can buy a Brita pitcher and use that. If you're at work, most workplaces have a water cooler or some sort of drinking water available.

This is also a good example of how frugal choices coincide with "green" choices. If you bring a glass or sports bottle to work and fill it from the water cooler it's less wasteful than bringing in, emptying, and disposing of bottle after bottle day after day. Yes it's good if you recycle those empty water bottles but it's even better to not use them in the first place.

The only times I buy bottled water are when I'm on a trip to a part of the world where I can't trust the tap water or I'm at an event (like a ball game) where I want something to drink from the snack bar and don't want soda.

You Already Own Your Own Business

Posted By Paul

I know several people who own small businesses of their own, and I often think about the idea of starting my own business.

One thing I realized is that in a very basic sense our lives can be viewed as businesses. I have a product, which are the services I offer. A customer (my employer), who consumes those services in exchange for money, and I use that money in various ways.

You can learn a lot by thinking about whether or not you would want to invest in your life if it were just another company on the stock market.

For example some questions you may want to know about a business are just as applicable to your life:

Is the business profitable?

Does the business have cash flow problems?

Does the business have enough cash on hand to survive a rainy day?

Does the business make sound financial decisions that reap benefits in the long term?

Does the business have a lot of debt?

Is the business run efficiently?

I thought that looking at your financial life as a business was a good way to evaluate the choices you are making, and perhaps recognize dangerous trends in your decisions.

Life and Debt In Suburbia

Posted By Paul

An interesting article today on CNN Money:

http://money.cnn.com/2007/10/02/pf/100400117.moneymag/index.htm?postversion=2007100514

The mortgage pre-payment conundrum

Posted by Matt
If you've been reading any of the recent posts on this blog, you'll know that I just bought a house and will be moving soon. For the last month or so, I've been trying to figure out what type of repayment plan (or prepayment plan) for the mortgage makes the most sense. I've heard and read about money-merge accounts, bi-weekly payment plans, extra principal payments, etc., etc.

I've finally made my decision, but let me take you through the options.

1. Money merge accounts - these are popular in Australia, but I'm having a hard time coming up with a simple way to explain how they work. I usually take that as a sign that I should steer clear. If you want to read more on the topic, check out wikipedia or just google "money merge"; there are suddenly tons of articles about them.


2. Bi-weekly payments - this is a comparatively straight-forward option. Bi-weekly mortgage payments mean that you make the equivalent of one extra monthly mortgage payment per year, and the more frequent payments also forestall interest accumulation. Using a simple calculator, I determined that a bi-weekly payment schedule would cut 5 years off our repayment and save $73867.04. Sounds good, right? One warning: if you decide to do this, DO NOT sign up with one of the many fly-by night companies that sends out junk mail offering to set it up for you, as they will tack on hefty and unnecessary fees. It is a free option at our bank and probably most others.


3. Extra principal payments - probably the simplest and most flexible method. Wells Fargo bank allows us to transfer extra money to the mortgage from one of our other accounts. At some banks, extra payments are applied toward future interest payments, so make sure you follow your bank's requirements for applying payments directly to the principal balance. Wells Fargo does this for us automatically and even provides an option to schedule automatic extra payments.

After giving it the options a lot of thought and doing some more research, I decided that I don't want to prepay at all due to an important concept called "opportunity costs" (which I actually remembered from a college economics course, so I guess I got my money's worth that day!) Say I have $100 burning a hole in my pocket and decide to throw it toward the mortgage. In doing so, I give up the opportunity to spend that money elsewhere. An economist would advise that each spending decision you make first requires an evaluation of whether there is a more rewarding opportunity available.

So, here are some of the options I have to weigh and determine which has the greatest reward:

1. extra principal payments to my mortgage
2. additional contributions to my emergency savings account
3. additional contributions to my retirement accounts
4. Contributions to my son's 529 education savings account

I tried to come up with an exact algorithm that would determine which of these would put me the furthest ahead strictly in terms of my future net worth, but the number of variables make it very tricky. There's a great paper on the topic with some scary equations, but I felt like it really required one too many looks into the crystal ball (what will my investment returns be? what tax bracket will I be in later in life?). My takeaway is that options 3 and 4 above are probably the highest priorities for me right now, with one caveat: whichever option I choose, I must set up a system to regularly and automatically fund it. The main strength of the bi-weekly mortgage payment plan, for example, is that it is automatic, so it could potentially be a better choice for some people if they feel that they lack the discipline to regularly make manual contributions to their IRA.

So, my wife and I will revise our budget (after we complete our move) and figure out where the extra money should go and how we can make sure it gets there!

Know Your Indulgence

Posted By Paul

I was recently talking to a friend and they were talking about how they like to splurge on their hobby because it's "their thing."

My friend essentially identified one thing that is really important to them and that they enjoy splurging on. I thought this was an interesting exercise for personal spending, to identify "your thing" and give yourself permission to splurge a little on that.

So if you're a "clothes person" then you can splurge a little on your wardrobe or if you're a "foodie" then you can sometimes eat out in fancy restaurants.

I believe in the concept of "All things in moderation, including moderation." W can't be totally responsible all of the time, we all buy stuff that we don't need.

Perhaps it's healthy to decide on one thing that you get to be a little excessive with when it comes to spending.

For example, one of my friends is really into travel so in addition to being fiscally responsible their big indulgence is a trip somewhere every year or so.

Another example is that my wife and I really enjoy going to shows when they come into town. We generally only see one or two shows a year, but when we do it, we splurge a bit on good tickets since it's "our thing".

Neither my wife nor I are "car people" we don't particularly like driving so we buy fairly inexpensive cars, take good care of them, and keep them for a long time.

I thought that perspective had some merit since it encourages you to decide on one or two things that are really important to you, and discourages you from splurging on every shiny new thing that catches your eye for a moment.

Making Ends Meet

Posted by Paul

An interesting article on Dollar Stretcher today.

A specific case of someone who was in a tough situation where money was going out faster than it was coming in, with suggestions on what to do about it:

http://www.stretcher.com/stories/06/06oct02f.cfm

Paying For Convenience

Posted By Paul

I recently went on a trip to New York City where I got to stay in Manhattan for a week. In addition to the amazing culture, museums, and restaurants I was amazed by the efficiency of the city.

For example, just about every restaurant in Manhattan delivers, and the ones that don't deliver do takeout, and by doing takeout I mean that they really know how to package up a to-go meal in a way that you can pretty easily carry it with you.

But I digress.

The point is that my time in Manhattan really made me think about the concept of paying for convenience. I know that saving time is something I'm generally willing to pay for, but I also think it's something we should be conscious about.

If you can afford it I see nothing wrong with paying for a maid, yard care, cook, whatever but I think it's very important to take the time and think carefully about whether or not the convenience you're paying for is worth the money you are paying. Be wary of getting too used to paying for a lot of conveniences, and I suggest at least trying to do something "the hard way" before paying for a service.

For example when I first moved into my house I considered hiring a landscaping service to take care of the yard. I decided to go a year doing it on my own and I'm really glad I did. I discovered that taking care of my yard was good exercise, a great chance to get outside, satisfying, and fun. If I had gone with the landscaping service from day one I would have never discovered that I actually enjoy taking care of my yard.

So I suggest that when you are considering paying for convenience to first take a moment to think about the cost vs. the savings in your time and frustration, and make sure it's really worth it to you.

Your home is not an investment

Posted by Matt
I used to be a big believer in real estate as an investment (two weeks from now, my wife and I will be closing on our third house in less than 4 years), mainly because of the concept of leverage.

For those of you who aren't familiar with the term leverage, it just means that we get the benefits of appreciation on the entire value of the house even though we only "invest" the down payment. This is great, and it does actually work. The Portland area has seen great appreciation over the last few years and real estate has been pretty good to us overall. But:

1. We're tired of moving.


2. We're tired of making decisions about our house with prospective buyers in mind.


3. We want stability for our son.


4. We found our dream house in a great school district.


5. Every time we make money on a house, we end up putting it into the next house we buy.

I think the last point is probably the most compelling financial one for me. Yes, we can still technically count the home equity as an asset, but I no longer really think of it as an investment because we'd have to sell again to access it and we have NO desire to do that. We want the new house to be the last house we ever buy.

The good news is that, even if we don't consider our home equity an investment, it is still there in case of emergency (via HELOC) or if we decide to implement a reverse mortgage in retirement.

Overall, I'm happy with our choices over the last few years as all the moving, shopping and building (the last two houses were new construction) really helped us decide on and locate exactly what we wanted.

Start your own bank (Part 2)

Posted by Matt
I recently posted about lending through Prosper.com. Today, I read a similar article on GetRichSlowly (thanks J.D.!) about the Grameen Bank, microlending, and Kiva. I hadn't heard of Kiva before and noted a few interesting differences between it and Prosper:

1. Prosper is domestic; Kiva is for foreign lending


2. Prosper loan requests are often for debt consolidation/relief; Kiva is focused on lending to entrepreneurs


3. Prosper loans pay the lender interest; Kiva loans do not.

This leaves me in a bit of a quandary about where I'd put my money if I get to a point where lending makes sense for me. I'd like to "act local" (and, admittedly, earn interest), but I also feel better about lending to someone who wants to use the money to invest in their future rather than pay off past consumer debt. I'm probably over-simplifying. If there are any readers out there who have experience with either site, I'd love to hear about it.

Interesting side note: compare our early "Basic Rules of Finance" at right with the Grameen Bank's 16 decisions. It's a nice reality check and a reminder of how lucky we are in our country that I have to worry about my retirement investments and not about clean drinking water or setting up a pit latrine!

How to Help A Friend With Their Finances

Posted By Paul

Over the years I've had friends who were in bad financial situations ask me to help them get back on track. If you ever get approached by someone to do this, here are a few bits of advice from my own experiences:

1) Make sure this is a REALLY close friend since the only way to be helpful to someone in this situation is to really look at the normally private details of their financial life, and to put someone under the microscope like that can be a real test of a friendship.

2) Get all of the info on their financial situation. Credit card bills, paychecks, housing costs, utility bills, and so on. Lay it all out and see how it looks.

3) Look for problems. Usually if you do step two properly something will just jump out at you like their take home pay barely covers their rent and car payment, or they spend hundreds of dollars on a hobby every month.

4) Make recommendations. Give them honest blunt advice that is based on reality, like: "You can't afford your current apartment and car, consider getting a cheaper apartment or a cheaper car." This step may also include helping them set up a budget.

5) Once you've made your initial recommendations, wash your hands of it and do nothing more.

Step 5 does seem like an abrupt end to the process, but that's on purpose. The problem I've seen is that if you continue to be involved after step 4, things can get messy quickly.

For example, I had a friend who came to me and asked me to help them get their finances sorted out. After step 2 and 3 it was obvious was that their biggest problem was that they bought far too many "luxury items" (little things like CD's, meals out, stuff like that). I helped them come up with a budget that included a nice payment towards their credit card debt, and they tackled it enthusiastically.

What happened? Well after a month they started to fall into their old patterns, specifically spending money on impulse purchases. We had planned to sit down once a month to see how they were progressing, but when I started pointing out some poor spending choices at these progress meetings, they gradually started resenting me. I ended up being the "angel on their shoulder" that they wanted to ignore. Every time they did something financially irresponsible they would grow a little more resentful of me (as if I were the reason they had money problems). The end result? I'm not really sure because this friend and I don't talk anymore.

That's why I suggest making your suggestions and then be done with it. You can't be the "budget police" for someone else. Make your suggestions and then let them do it (or not do it) don't try to be their self-control.

Any other stories like this out there? Has anyone managed to help a friend out of financial dire straits with success?

Cash stash horror stories

Posted by Matt

I recently read a great article about an obscure government group called the Mutilated Currency Division (part of the Department of the Treasury's Bureau of Engraving and Printing). There are 17 examiners in this group whose job it is to identify mutilated currency and send checks out to the "victims". Good to know, in case your money is ever damaged in a flood, fire, etc., but the amazing stories of how the money gets damaged should also convince you not to try to store it yourself. One important quote:

Despite sales claims, Robinson [a retired director with 30 years experience] has yet to see a fireproof home safe. "We've had quite a few that didn't live up to promises. If the metal gets hot enough, it's going to burn what's inside," she says.

So, right now, go get your money out of the mattress/cookie jar/freezer/flower pot and take it to the bank. You're supposed to be earning interest on that money, anyway!