Monday, May 30, 2011

Start Small

Tip #290 - Start Small. Do you ever think about people who are poorer than you and feel sorry for them? You might think it's sad that they don't have money to go to the movies or the funds to take a vacations. Do you ever think about all of the things that you can do that they cannot? Perhaps. But what about people who are richer than you? Do you feel sorry for yourself that you cannot join a country club or that you do not have a personal driver? Probably not.

Do you know why? Because most people do not miss the things that they never had. Most people do not feel like they are missing out on life because they do not have a live-in maid. Just like those less fortunate than you do not feel that they are missing out on life because they cannot go to the beach each summer.

How does this relate to saving money? Well, it is harder to cut back on your lifestyle than to never have had that lifestyle at all. Therefore, you should start out small with your purchases. Here's an example: Suppose a family decides that they want to rent a comfortable apartment that will accommodate all four of them? They rent a three-bedroom and enjoy all of the space they have. But after a year of living there they realize that the extra space they have is costing them too much. In an effort to save money, the decide to cut back to a two-bedroom apartment. In doing so, they miss their extra space. They feel like they are living with less and they yearn to have their old space back. But suppose they had started small? They would not have missed the extra space because they never had it in the first place.

When someone is starting out on their own, it is best to start out with a less-costly lifestyle and gradually build it up as you are financially able. Even if you temporarily know you are living on two incomes without kids and can afford finer things, make them a special treat rather than part of your everyday lifestyle. If you gradually increase your standard of living, you will appreciate each new upgrade rather than if you start out big and need to cut back.

In Real Life (IRL) - When my husband and I were both making an income and we had no children, we had the ability to live it up a bit. We could have eaten out quite a bit, taken extravagant vacations, and lived in a fancy apartment. But we knew that in the near-future we'd be cutting back to one income when we had kids. So fortunately, we saved most of our extra money and lived a more meager lifestyle. Although, it wasn't intentional not to live large because we knew cutting back would be harder psychologically, it worked out that not getting used to a fancier lifestyle was a benefit to us. Had we been used to staying at Marriott Hotels, Comfort Inns would be more challenging for us today. Had we been used to buying new cars every few years driving one for 10 years would be difficult. Had we been used to a fancy apartment with granite countertops and stainless steel appliances, a 50-year old home with an outdated kitchen would have been hard to get used to.

There are always exceptions. When we got married and went on our honeymoon, I remember the travel agent convincing me to go for the luxurious hotel with the fancy outdoor fancy pool when I was looking into staying at a more modest hotel. As it was a once-in-a-lifetime event, I am glad we did it. But that was a special occasion. For our regular vacations those first few years we still looked for the best deal on a nice, comfortable hotel without going overboard. While I wouldn't want to look back on my life and say "Gosh, we should have flown to Paris when we had the opportunity," I think starting out small and gradually increasing your standard of living is easier and more doable financially than getting used to luxuries that you will need to later cut back on. Start small.

Instead if you start out slowly and build up your lifestyle, you will not miss what you didn't have.

Tuesday, May 17, 2011

Find the Right Balance to Meet Your Financial Goals

Tip #289 - Find the Right Balance To Meet Your Financial Goals. There are many ways you can meet your financial goals. Some ways work well at different times in your life. And some ways work well for different people and their circumstances. But in many cases, a combination of three main methods may be the best way to meet your goals such as increasing your savings. You can earn more money. You can decrease your expenses or you can make more return on your investments. Each of these singly will increase your savings. But finding the right balance among all three of them will work better to maximize your savings.

Let's look at an example. You are a family of three - husband, wife, and an 8-year child who will go to college in 10 years. You have $100,000 saved in a retirement account that is earning 5% per year and $20,000 saved in a college account for your child, earning 4% per year. You hope to retire in 25 years. Suppose your household makes $60,000 per year after taxes. Mortgage, utility, and food expenses add up to $30,000 per year. Health and wellness expenses add up to $6,000 per year. Automobile, gasoline, and clothing expenses add up to $8,000 per year. Lastly, entertainment and travel expenses add up to $6,000 per year. This leaves you with $10,000 per year for savings. Out of that savings, you put $8,000 toward retirement each year and $2,000 toward your child's college account.

After you sit down and crunch the numbers, you realize that you will not reach your goal of saving $100,000 (in today's dollars) for your child's college fund. In fact, you realize that you will need to save a total of $4,500 per year (about $2,500 more per year than you are currently saving). Then you look at your retirement numbers and calculate that in order to earn $1,000,000 at the time of retirement, you need to be saving $14,000 per year ($6,000 more than you are saving now). And you also realize that you will most likely need to buy a car in about 5 years and need to save $5,500 per year for that. All total you figure you need to increase your savings by $14,000 per year to reach your goals. How should you go about that?

One way to increase your savings is to cut down on expenses. However, you already live a frugal life and don't have much that you can realistically cut without making dramatic changes in your life. After scrutinizing your budget, however, you calculate that you can save $1,000 per year by using coupons and shopping at less-expensive grocery stores. You decide that your family can forgo your annual vacation and cut $2,000 of your entertainment/travel budget. And by shopping at thrift stores for clothes and riding your bike instead of driving places, you think you can cut another $1,000 off your budget. So you have come up with $4,000 more money that you can put toward savings. However, you are still $10,000 short of your goal.

Another way to increase your savings is to improve your investment return. Suppose your child goes to school in 10 years, and your investment toward college is earning only 4% return. After speaking with a financial advisor, you realize you can take on slightly more risk with this investment and think you can earn an 6% return on your money. This means you need to save $4,000 per year for college (an extra $2,000 per year). For retirement, you know you can take on more risk and can probably earn an 8% return on your money. In this case, you only need to save $5,000 per year toward retirement to meet your $1,000,000 goal, which actually frees up $3,000 per year for savings elsewhere. By this example, you only need a total of $14,500 in savings to meet your goals. But you are still $4,500 short of your goal.

Realizing that there is only so much that you can cut your expenses. And while the return on investment you can make is technically infinity, it is unlikely that you want to undertake that kind of risk, you know you can increase your income to bring in more money. If you have a school-age child, perhaps you can take on a part-time job 20 hours per week earning $10 per hour. In one year, you can make about $10,000 per year ($7,500 after taxes), $6,500 short of your goal that you needed.

Now let's combine all three strategies. Increase your return on investments, and you only need to save $14,500 total per year. Combine that with cutting expenses of $4,000, and you are now only $500 short of your goal. Mix in the $7,500 you can make with your part-time job, and you now have an extra $7,000 to play around with. Add back in that vacation? Cut down your work hours to 15 hours per week? Reduce your retirement risk? It's all up to you. Find the right balance of all three strategies. By utilizing all of them, you can tailor your desires with your needs to put hold on to more money and meet your savings goals.

In Real Life (IRL) - I have been out of the workforce for 4 years. Other than selling on eBay which nets me a few thousand per year, I haven't brought in a steady paycheck of any kind since early in 2007. In order to live on my husband's income, our first line of defense was to cut back on spending. When we had two good incomes, we had extra money flowing to go out to eat when we wanted or to go on a quick weekend jaunt somewhere fun. But when I stopped working, all of that changed as we had very little extra money above our expenses. But at that point in time, staying home with my baby was more important to me than eating out in a restaurant (as if I had time. Ha!). So in order to cover our expenses, we lowered them. We cut out restaurant meals. We cut out weekends away. We cut back on shopping.

And while I was always a good saver for the future, there is something about having a baby that makes you feel a huge responsibility. Will we have enough for her schooling? Who will care for her if something happens to us? Do we have enough money for the future? In that regard, we researched saving for college, I took out life insurance, and we increased our retirement savings. We also analyzed how much risk we were willing to undertake to meet these goals.

Then child number 2 and 3 came, and we suddenly had more expenses - preschools, activities, more health insurance and dental insurance, an addition to our house. Fortunately, my husband's salary increased, which covered some of our increasing expenses. We stuck to our budget and stayed with our investment strategies. But the expenses kept coming - car expenses, braces, higher college costs, Bat-Mitzvahs in our future. And at that point, we realized, we did not want to cut out any of our other expenses or take from savings to pay for these new ones.

We live as frugally as we want to. We don't want to cut out any more restaurant eating. We don't want to stop going to the beach every summer. And we are comfortable with our investments. We don't want more risk. We weathered the economic downturn a few years ago pretty well since we mixed in low-risk investments with our high-risk ones. Sure we may be able to make more on our investments, but not without more risk and sleepless nights that we are not willing to undertake. And with our children getting older and going to school for longer hours, it makes sense that at this point, increase our income is the best way to increase our savings account.

Last week I went on my first job interview since leaving my job four years ago. And I am starting work in two weeks just three miles from my home! I am excited that with my income, we will be able to cover the expenses we will have, while still maintaining the savings that we want to do and keep our investments at our desired risk level. At this point in time, increasing our income makes sense, along with our level of frugality and investment risk that we are comfortable with. It is the right balance for us. When our children were younger, fewer expenses and less income made sense. When I was younger and single more risky investments and higher income made sense. How do you maintain your lifestyle, keep your savings and be comfortable with your investment risk? What kind of balance is right for you at this stage of your life?

Thursday, May 5, 2011

Using Credit Is Okay Sometimes

Tip #288 - Using Credit is Okay Sometimes. I'm going to say something on here that I don't see on many personal finance blogs. I have read dozens of personal finance and money-saving blogs over the past few years. And the almost universal theme I see in all of them is that the writer started his blog because he racked up a lot of debt and learned how to dig himself out and wants to pass his experience and advice on to others. Sometimes this advice is in the form of "Throw away all of your credit cards," "Live a debt-free life," or "Wait until you have the money set aside before you buy what you want." In fact even Dave Ramsey got started down his successful career because he was in a lot of debt at one time and pulled himself out of it.

Now here's my comparison to that line of thinking. If you are an alcoholic and want to stop drinking, then looking to alcoholics who have given up alcohol and have been living a sober life for years is a great place to start. And like alcoholics, people who have absolutely no willpower when it comes to going on a shopping spree with their credit card and no money in the bank to pay back the bill in 30 days when it comes due, that advice most personal bloggers give is probably sound.

But what if you were never an alcoholic? What if you hardly ever drink or just like a glass of wine with your meal once in awhile? Whose advice do you look for so that you won't become an alcoholic? The answer? Probably no one's. Why would you be looking at a reformed alcoholic for drinking advice since you don't abuse alcohol? Now substitute alcohol for credit cards. If you aren't out-of control with them - if you use them to make big-item purchases or to go away on vacation, why is that bad for you? It's not always. There are plenty of people out there who are just not educated in finance who just want to figure out how to best build up their savings, how to spend less, or how to invest. To those people, I say, it is okay to have credit cards. It's okay to take out a loan if you need one. It's okay to float your money for a month to earn interest - as long as you have a financial plan and a budget, and are living within your means.

Let's look at some scenarios of when using credit is okay or not okay:

Example 1: Marnie has a budget and a financial plan. One of her goals has been to buy a car. She's been saving money for 5 years for it and has $10,000 in a CD earmarked for the car. The CD is earning 6% interest, and it is coming due in 6 months at which time she will buy her car. But her car dies suddenly and she needs to buy one this week instead of 6 months from now. She can get a loan from her credit union for 4.5% interest, and she can pay it back in 6 months when her CD comes due. Should she take out a loan? Many people tell her she should never take out a loan on a decreasing asset. But if she breaks her CD, she will lose her interest. Besides, she is borrowing at a lower rate than what she is earning. Is using credit okay in this situation? My advice? Take out the loan. Marnie's story shows she is responsible with money. She has been saving long-term for a goal, and she has a budget and a plan. When her CD comes due, she can pay back the loan and all is good. If the interest she is making is greater than the loan she is taking, then by all means she should take the loan.

Example 2: Mindy has $12,000 on her credit card balance. She pays the minimum $250 each month on the card. Her dad told her, it will take her 15 years to pay off her balance by just paying the minimum, but she doesn't care. She thinks as long as she can pay the minimum she is in good shape. Plus she tells herself that she always has $350 leftover each month that she can put toward the card, but she chooses to only put the minimum amount towards it and spend the remaining $100 on a night out.

Mindy's friends call her and tell her they have found a fabulous deal on a cruise - 6 days in the sunny Caribbean for just $800. Mindy knows that she can afford it because even if it makes her minimum payment higher on her card, she can still pay it and forgo going out to dinner each month. Is using her credit card wise in this situation? I think all of us would probably agree here that Mindy is not responsible with money. She might, in fact, be termed a crediholic. She cannot give up using her credit card and has no understanding of how little she is paying back when just paying the minimums. My advice? No way! Have someone sit down with you and work on a plan to accelerate your credit card repayment instead and explain how credit cards work.

Example 3: Craig is 35 and single. He has $350,000 saved toward retirement and puts away $20,000 more per year towards it. He also has 6 months' worth of money in the bank in case of an emergency and two savings accounts set up - one for for a car and one for a house. He should meet his car goal next year, and his house goal in three years. His take-home pay is $7,000 per month and he uses his credit card buy all of his items - his groceries, clothes, vacations. He pays off his balance each month. Lately, Craig has been reading personal finance blogs and most of them say that credit cards are bad. He wonders if he should get rid of his cards and start paying cash from now on. What do you think? My advice? No. He sounds like he is set for retirement, his car, and his house. Sure, he may spend more money in the grocery store for an impulse buy that he might not do if he paid with cash. But he can limit is losses with credit cards and they give him some insurance if he uses it for air travel or car rental. And for big purchases, as long as he is deciding on how much to spend before he buys, then using credit is a better deal. It not only gives him some refund power if there is something wrong with the product, but it also gives him 1% reward with each purchase. As long as his financial plan is sound, then he does not need to live like a pauper - giving into an occasional carton of ice cream at the grocery store will only help him enjoy life more.

I can give many more examples where I think it's okay to use credit cards or take loans. Conversely, I can think of several examples, and know many in person who need to stay clear of debt of any kind. Which type of person are you?. Are you a crediholic? Can you not control yourself if you have a credit card in your hand? Do you like to buy things "above your means" such as a fancy sports car and put it on a loan? If so, give them up and follow what many financial bloggers are saying about credit cards or debt. On the other hand, are you responsible with your money? Do you have a savings account? An emergency fund? A financial plan for the future? Do you take out a loan only when you know you are doing it for the right reasons and can pay it back in a reasonable amount of time? Do you decide in advance what you will buy and then happen to pay for it with a credit card? If so, then it's okay to use credit and take out a loan. Just like an alcoholic, crediholics should stay away from debt and credit cards. But just like there are millions of others out there who can control their drinking, there are many who can use credit and debt wisely, too.

In Real Life (IRL) - Our credit union has a great deal on IRAs. From January until April you can add more money to any existing IRA CDs. For example, I have some IRA CDs. One of them is earning 4.9%. I opened it a few years ago and there are still 5 years left until maturity. If I were to put my $5000 Roth money that I invest each year into a current IRA at this credit union (or anywhere else for that matter), I'd be able to earn 2.6% for a five-year certificate. On the other hand, during January to April, I can add on to a current IRA that I already have such as the one earning 4.9%. I love this deal and only found out about it last year.

I've always wondered how much longer they will continue to offer this deal. Last year I made 2009 IRA contributions in early 2010. But this year, I started to think about whether they would even continue this deal next year and decided I wanted to make all of my and my husband's 2011 IRA contributions now while I know they still have this offer. Problem was, I didn't have the money available for it. Sure, I knew by year-end, we'd have the $10,000 saved up to put toward our IRA. But in April? We only had $3,000 of it saved. So what did I do? I took a loan. Yes, I did. We have a home equity line of credit for $50,000. We owed nothing on it so it was available, and current rates are 3.25%. So I borrowed $7000 from it with plans to pay it all back this year with the money we would have put toward the IRA.

Did I do the right thing? I think so. I'm currently making more in the IRA (4.9%)than I am paying out on the Home Equity Loan (3.25%). Yes, the home equity loan rate can change but it would have to go above 5% for it to cost more than I'm earning on the IRA since the interest is tax deductible. Also, I am getting the gift of time. Even if the bank continues this great IRA add-on offer, I would have to wait to put the money in the IRA until January 2012, and I will have lost out on 9 months' worth of interest, while the money sits in a checking account waiting to be invested. So I am earning about $262 in those 9 months and paying out about $170 (before a tax deduction) if I keep the loan for the whole 9 months. Plus I am assured of getting this great deal from the credit union that might not be available next year.

Had I said to my husband "Let's go take the trip around the world we've been wanting to take and just use our equity fund, I would not think taking a loan in that instance is wise. Each situation and each person is different - sometimes it's wise to use credit. Other times it's not. What do you think? Do you think having some debt or using credit cards and taking out loans is okay?

Please check out other financial ideas on Frugal Fridays at Life As Mom.

Tuesday, May 3, 2011

How well will you do?

Here is an interesting game from Urban Ministires of Durham. Of course you are stuck with the scenerios they give you as well as only a few options. But it is an interesting look at how quickly someone can fall in the hole financially.

Play Spent

I'm embarrassed to admit that I came away from this game in the negative. Fortunately, I've made better decisions and have had better circumstances in real life. How did you do?