Monday, October 27, 2008

Announcing Smart Financial Values

The big day is finally here.  It took a little longer than I had hoped, but the revamped version of this blog has been launched.

Please head on over to Smart Financial Values ( to check it out!  From now on, all new material will be posted at Smart Financial Values.

Tuesday, October 21, 2008

Big changes coming to Financial Values

You may have noticed that recently I have not been posting as frequently as usual.  This is because I am working hard at giving this blog a new, more memorable domain name and an updated look.  I am really pleased at the way it is shaping up and I hope to announce the launch of the new and improved blog before the end of the month.  Stick around, I think that you'll like it.

Sunday, October 19, 2008

Good advice and a vote of confidence

Warren Buffet, one of the most successful investors ever, and currently, according to Forbes magazine, the richest man in the world, submitted a fantastic letter to the editor of the New York Times.  If you are an investor and have not yet read this letter, you owe it to yourself to do so.

Buffet explains that while he cannot predict the direction of the market in the short term, "fears regarding the long-term prosperity of the nation's many sound companies make no sense.  These businesses will indeed suffer earnings hiccups, as they always have.  But most major companies will be setting new profit records 5, 10, and 20 years from now."  Buffet also says that if prices continue to look this attractive, his personal investments will soon consist entirely of stocks of American companies.

The advice that Buffet offers - to be greedy when others are fearful, and fearful when others are greedy - is great advice but often tough to put into practice.  It can be difficult to put money into stocks and stock funds in these conditions.  But this is exactly what prudent investors like Warren Buffet are doing.  You should be doing it too.  As I mentioned earlier, stocks are on sale now.  Buy as many as you can before the prices go back up!

Thursday, October 16, 2008

Finance Fiesta

A Financial Values blog post has been included in the Finance Fiesta.  Head on over to Broke Grad Student to check out the other great entries in the carnival.  I especially enjoyed the post on Living Almost Large about the challenges that new immigrants to the United States must face because they do not have a credit score.

Tuesday, October 14, 2008

Unexpected money - what do you do with it?

What do you do with unexpected money?  Every once in a while, most of us end up with small or large amounts of money that we did not expect.  It can be from a bonus at work, a tax refund, a gift, an inheritance, or something else.  My wife's Great Uncle passed away, and we recently learned that she will inherit about $4,600 from his estate.  We certainly had not expected to receive a generous gift like this.

While you might not receive unexpected cash infusions very often, I believe that how you choose to use them can have a big impact on your overall financial situation.  Although everyone's financial situation is different, this is how I would prioritize the use of any windfall:

1. Establishment of emergency funds.  If you are living paycheck to paycheck and have no savings cushion, this is a great time to create one.
2. Debt repayment.  Knocking off debt ahead of schedule is always a good idea.
3. Charitable giving.  Giving is important.   Even if you are not regularly supporting charities that are important to you when you receive some unexpected cash, it can be an easy time to start.  After all, you weren't counting on that money for anything else.
4. Retirement savings.  Are you behind the curve?  Catch up!
5. Other long term savings goals.  Use unexpected money to boost your savings for a down payment on a home, your kid's college expenses, your next car, or anything else that you are saving for.
6. Something fun for you and your family.  Take at least part of the money to buy something nice for or do something fun with your family. 

After looking over our finances we decide to us this gift for these purposes:

$500 - Give to charity.  We believe that giving is important and try to give at least 10% of our income to charity.
$800 - Furniture for Baby's room.  We needed some furniture for our new baby's room.  This is a purchase that we would have made anyway, but we might not have spent quite this much.
$500 - College fund for our daughter.  We don't have any debt other than our mortgages and we are doing well with our retirement savings.  However, we are not yet saving as much as we should be for our 8-month-old daughter's college expenses.
$1200 - Savings account.  One of the weakness in my own budget is that I tend to keep a pretty anemic savings account.  As money builds up in my savings I always feel that it could be put to better use in one of my investment accounts.  However, now that I have a child, I really want to work on building up that savings account balance.  When do kids need braces?
$1000 - Investment account.  This is a good time to invest.  We created this account so that at least some of our long term investments are not locked up in a retirement account.
$600 - Something fun.  We have not yet decided what to use this part for.  Possibly for photography classes for my wife--something she has always wanted to do.

We think that this allocation works very well for our situation.  How would you use an unexpected influx of cash?

Sunday, October 12, 2008

Don't hesitate

I have known many people, both friends and clients, that knew they needed to start saving and investing (for retirement, their children's college expenses, or something else) yet they kept putting it off.  The most common reason was that they didn't know what to invest in and they didn't want to make a bad choice.  So, they didn't invest in anything.

A poorly chosen investment, generally speaking, is better than no investment.  If you start investing in a mutual fund or college savings plan and later learn that your fund or plan isn't the best option for meeting your needs, that's OK.  You can always discontinue investing in the product that you don't like and move on to what you have learned is a more suitable investment.  You will probably be able to transfer all of your funds from the first investment into the second.

I tend to spend whatever money is not specifically set aside for something and I think that most other people do too.  So, if you are delaying your investing for any reason, you are likely spending money that you should be saving and losing time that you can never regain.  If you are investing in anything, even a less than perfect investment, you will have something to show for it months and years from now.  You can always refine your investments as your knowledge of investing grows.  If your not investing, it is just going to be that much harder to meet your goals when you finally start.

You can never make up for lost time.  If you know that you need to invest but are not currently doing so, then get to it.

Friday, October 10, 2008

When the markets go down, where does the money go?

A reader recently asked a great question:
Where do the missing billions [now trillions] go?  When the stock market goes down does that money just disappear or does someone somewhere gain as a result?
Unfortunately, wealth does not follow Newton's Second Law of Thermodynamics.  It can be both created and destroyed.  When the stock market goes down wealth disappears.

Consider the example of a kid with $5 and a baseball card that he bought for $1.  If the other kids in the neighborhood think that the player on his card is the coolest player in the league and offer to buy the card for ten bucks, how much money does this kid have?  Unless he sells the card, all he's got is five dollars.  He also has a baseball card that even though he only paid for one dollar for it is worth ten dollars.  So, his net worth has gone up by nine dollars because the value of the baseball card increased.  However, the baseball card isn't money (and stocks aren't money).  Only money is money.

Now as the season goes on, the other kids start to think that this player quite as cool as they thought he was.  If Johnny, who owns the card, wants to sell it now all he could get would be two dollars.  Therefore, his net worth has just decreased by eight dollars.  That eight dollars has just plain disappeared.  If Johnny agrees that the card in only worth one dollar then he might sell the card.  However, if he thinks that everyone else is wrong about this player and given time they will come around to like him, Johnny might decide to hold onto the card in order to sell it for a better price later.  Johnny will not actually realize any financial gains or losses until he sells the card.

As the value of Johnny's card went up and down, his net worth increased and decreased.  That wealth was first created and then destroyed.  When Johnny's net worth went down nobody else's wealth went up as a result.  Stocks work the same way as that baseball card.

When you buy a share of stock, you are buying partial ownership of a company.  The price of stocks is set in an auction type market.  People value stocks based on the expectation of the future cash that the company will earn.  If lots of people believe that a company will generate lots of cash they will all buy stock in this company.  As they compete with each other in the market to buy these shares they will drive up the price.  If as time goes on, the company fails to earn as much money as expected, the perceived value of the company will fall.  As the perceived value of the company falls, fewer people will be interested in buying the stock and the price of the stock will fall as well.  If stocks that you own lose value, it is because the perceived value of the underlying company has decreased.  The value of your portfolio then falls.  That wealth that you had yesterday has been destroyed today.

Any gains or losses from your stock investments are called paper gains or losses for as long as you actually own the investment.  Until you sell the investment and convert it back to real money, all your gains and losses are just numbers on a sheet of paper and can change at any moment.  They are not real money until you sell.

On a side note, it is possible to bet against the market by "short selling" a stock.  If you do this, you will make money when if the market goes down and lose money if it goes up.  However, the total amount of money lost by investors as a stock falls is not connected to money made by anyone who might be shorting that stock.

Wednesday, October 8, 2008

Worst argument ever for a bailout

I very much believe that government action is needed to help stabilize our economy.  However, some of these bailouts, even if necessary, are hard to swallow.  According to this article, less than one week after AIG received an $85 billion bailout, the company spent almost half a million dollars to send a group of their executives to a Southern California resort.  In addition to paying for golf and catered buffets, AIG spent over $23,000 on spa treatments.  What do you suppose AIG spent money on before they ran their company into the ground?

If there are any AIG executives that read this blog, can you please leave a comment to let me know what you were thinking?  For the rest of you out there, what are your thoughts on reigning in corporate excess?

Monday, October 6, 2008

Breakdown of mutual fund fees

Disclaimer: My wife asked me to warn my readers that this post is longer and a bit more technical than usual.  However, we both agree that it contains important information and is well worth reading.

When you invest in a mutual fund, you have no way of knowing how much money you will earn from that fund.  However, you do know - or at least you should know - how much money you will pay in order to invest in that fund.  You also know that for every mutual fund, the total amount of money you earn is equal to the funds return minus the fund's expenses.  Therefore, when I am given a choice between two similar funds, one with high fees and one with low fees, I will choose the low fees every time.

I am right to do so.  Low fee funds as a whole outperform high fee funds.  Walter Updegrave at CNN Money recently compared the fifteen year track record of all large company stock funds.  The quartile of funds with the highest fees had an average annual expense ratio of 1.78% and the quartile with the lowest fees had an average annual expense ratio of .43%.  The expensive funds, over fifteen years produced an average return of 8.42%/year.  Not bad, but significantly less than the average return of 9.86%/year produced by the low cost funds.  Not surprisingly, the difference between the fees (1.35%) almost entirely accounts for the difference in performance (1.44%).

In order to make sure that you are paying reasonable fees, it is important to understand what kind of fees mutual funds charge.  All funds - even "no load" funds - charge fees.  They all have operating expenses, offices to lease, and employees to pay.  Here is a basic primer on the types of fees that mutual funds charge:

1. Annual Fees:  The following fees are annual fees.  They are taken out of your investment every year.  You will never see a bill for them nor will you see your account balance suddenly drop.  They are taken out, drip by drip, over time.

Management fee:  This fee is an annual fee that pays for the investment managers of your fund.  It pays their salaries and a few other expenses related to managing the fund's investments.  All funds have this fee.

12b-1 fee: This fee is used to pay for marketing and distribution expenses (which could include sales commissions).  By law, this fee can not be greater than .75% per year.  Not all funds charge this fee.

Expense Ratio: The annual expense ratio is the management fee plus the 12b-1 fee.

2. Sales Charge:  If a financial advisor is receiving a commission for selling a fund to you, the bulk of it will likely come from a sales charge or "load".  Not all funds charge these fees.  Funds with a sales charge, or load, are usually sold as class A, B, and C.

Class A funds charge a front end sales charge.  A front end charge is paid at the time that you purchase shares of the fund.  This fee can not be higher than 8.5%.  If you purchase $1000 of a class A fund with a 5% load, the mutual fund company will immediately keep $50 (5%) of your deposit and credit your account with $950.  You will pay this fee every time you purchase additional shares of this fund.

Class B funds charge a back end sales charge.  A back end sales charge is paid when you cash in your investment.  Some class B funds will lower the back end load for every year that you own the fund until it disappears after several years.  However, the fund will likely charge a higher 12b-1 fee until you have owned the fund long enough to eliminate the back end load.

Class C funds do not charge either a front end or back end sales charge.  However, they will likely have a much higher 12b-1 fee for as long as you own shares of the fund.

I recommend purchasing funds without sales loads.  If you do pay a load, make sure that you are getting something for your money.  That sales load you are paying is compensating the person who sold you the fund.  If you are not getting valuable advice, you should not be paying these fees.

Also, if you choose to pay a sales load, class A shares are generally the best value in the long run, followed by class B, followed by class C.

3. Other fees:

Brokerage charge:  If you chose to purchase funds through a broker (online or brick and mortar) you may be charged a brokerage fee.  This fee will be charged every time you buy or sell shares of the fund.  If you are making one large purchase it might not be a big deal.  However, if you are adding to your account every month, this type of charge can really add up.

Redemption fees: A redemption fee is a fee that you are charged when you sell shares of your fund.  It is a separate fee from a back end sales charge, limited by law to no more than 2%, and it is not charged by all funds.  Most funds that do charge this fee will charge it only if you redeem your shares within a few months of purchasing them.  Frequent trading of mutual funds can drive up management expenses so companies like to discourage this practice.

As you purchase mutual funds I would encourage you to avoid sales charges and try to minimize the management fees and 12b-1 fees that you pay.  I believe that Vanguard funds and E*Trade funds are some of the best and cheapest funds out there.  If you are looking for a good point of comparison, they are a great place to start.

Wednesday, October 1, 2008

Preparing for a financial storm

These have been tumultuous days for our financial markets and our economy.  Many economists are convinced that we are heading into a recession.  Some are even talking about a slowdown of the same order as the Great Depression.  The truth is, nobody can accurately predict what our economy and our financial markets will do.  But, there are steps that you can take to prepare for the future.  These recommendations will not only prepare you for rough times; they will help prepare you for any economy and are smart moves to make regardless of what happens in our economy or financial markets.

Here are five smart moves to make right now:
  1. Build up your emergency cash reserves.  Make sure that you have enough money on hand to carry you through tough times.  What if you or your spouse is laid off?  What if the gas bills and food bills keep going up and your income does not?  The more cash that you have set aside, the better position you will be in to handle whatever life throws at you.
  2. Pay off your debt.  If you have credit card debt, pay it off.  Pay off your student loans.  Pay off your car loans.  The less debt you have, the more control you have over your financial situation.  Remember, debt is a fancy term for spending tomorrow's income today.  If you have already spent your future income, it gives you far less financial flexibility in the future.
  3. Make sure that you and your family have enough life insurance.  It is devastating to lose a loved one.  It is even worse to lose a loved one and be in a financial bind because of it. Don't let this happen to you.
  4. Keep up your retirement savings, education savings, and everything else that you are saving for.  If you can, increase your savings.  Nobody knows when the stock market will hit bottom.  However, we do know for certain that stocks are a better value this month than they were last month.  Take advantage of it.
  5. Make sure that your investments are exposing you to the right amount of risk.  If you are saving for a goal that is less than 10 years away, then that money probably shouldn't be in the stock market.  If you are saving for something more then ten years away, then you can afford losses in the short term.  If your investments are exposing you to too much or too little risk, realign them.  (But be sure to remember that your retirement savings deadline is a moving target.  You will not cash in all your investments on the day you retire.  You will need some of the right away, but some of them you will not use for 10, 20 or more years after you retire.)
These five steps will help you be in control of your finances regardless of what the economy does.  By taking these steps, you will position yourself for good markets, bad markets and everything in between.  If you have not addressed all of these issues then do it now. 

Sunday, September 28, 2008

How I turned 20 minutes in $334

My wife received a telemarketing call from a company offering to provide our phone and internet service at a significantly lower rate than we were getting from our current company.  The offer sounded very compelling, but I didn't want to go through the hassle of switching companies.  So I called up my current company, explained to them that I was happy with their service and wanted to continue to work with them.  I also told them about the deal offered to me by the other firm.

The representative on the other line put me on hold for a few minutes while she looked over our billing history and was able to make some changes to our account that brought our monthly bill down.  She then offered me three months of free service and a $100 credit.  All of these savings put together will amount to $334 over the next year.

Not bad for twenty minutes work.  I am often surprised at just how much cable, internet, phone, and credit card companies will do for you if you call them to ask for a better rate or to waive certain charges.  The best part is, making the phone call costs only little bit of time.

Saturday, September 27, 2008

The danger of inappropriate risk - part 2

I explained in the last post why taking on too little investment risk can endanger your retirement.  However, too much risk can also put your financial goals in jeopardy.

Because any stock investment can drop in value by 25% or more in any given year, you need to take on this risk carefully.  If your savings goals are many years from now, it makes sense to harness the power of the stock market's relatively high returns, even with the risk of losing a substantial amount of your investment.  However, as your savings deadline approaches, you should consider shifting into more conservative investments.  Here are a few factors that might help you determine whether you can afford to take on the risk of stock investments:
  1. Is your deadline flexible?  If you can afford to postpone retirement, a new house, or whatever your goal is for a few years in order to recover from market losses, then you can probably afford more risk.  If your goal is set in stone and you can't or don't want to adjust it, then you should probably invest in more stable investments as your deadline approaches.
  2. Is the amount of money you need for your goal flexible?  Perhaps your goal for retirement or buying a new house is not tied to very specific amount of money.  More is always better, buy you might find yourself in a situation where you would be able to weather a drop in the value of your investments and still meet your goal.  If so, you might decide that the possible higher return is worth the increased risk.
  3. How well funded are you?  Often you will find that the more money you have, the more risk you can afford to take.  If your retirement savings are pretty slim and you are living a fair modest lifestyle, you probably can not afford to take any risk that will lower your investment income.  However, if you have more than ample retirement funds and want to take on additional risk, you might very well decide that you are in a position to do just that.
  4. What is your general comfort level with risk?  This is tough to quantify.  However, some people genuinely would rather avoid greater risk even at the expense of almost certainly having less money in the end.  If this is how you feel after understanding what the cost of lower risk is, then it could be a good choice for you.
It is much easier to set up a portfolio for the future that contains the right mix of investments than it is to fix one that clearly had taken on too much risk.  If you have an investment portfolio that has lost money that you really could not afford to lose, figuring your way out of this situation is very difficult.  One the one hand, you have already lost more than you are comfortable with and you don't want to lose any more.  On the other, you don't want to shift into conservative investments until you have recouped your loss.  What do you do?

It is hard to give generic advice in this situation.  Every situation is different and there is not always one correct answer.  However, when I was a professional financial advisor, in most situations like this, I did give the same advice.  It is very difficult to cut your losses and shift to a more conservative portfolio.  If your investments are exposing you to more risk than you can withstand, you need to eliminate that risk - the sooner the better.

Wednesday, September 24, 2008

The danger of inappropriate risk - part 1

The stock market's wild swings up and down are making daily headlines.  The government is putting together a massive 700 billion dollar program to prevent our entire financial system from collapsing.  Large, well-respected companies are going under or being bailed out.  This seems like a good time to talk about risk.

During times like these, many people become scared of the stock markets and hesitant to make investments.  Although you can save for retirement without using stock-based investments, it will be tough and you run a much increased risk that you will not save enough.

In the long run, government bonds - which are very safe investments - return an average of 3.7% per year.  The S&P 500 - a very broad index of 500 companies and a good measurement for the stock market in general - has a long term rate of return of 11.2%.  But, as you well know, if you invest in the stock market, you need to weather volatile times.

Suppose you are 25 years old, plan to retire at age 65, and have nothing saved for retirement.  You believe that you will live to the ripe old age of 95 and want to save enough to provide $50,000, adjusted for inflation, for every year of your retirement.

Let's examine the outcome of three different investment options:
  1. You can be very conservative and invest only in government bonds.
  2. You can choose a moderate portfolio of half stocks and half bonds.
  3. You can be aggressive and invest entirely in stocks until you retire when you will shift half of your money into bonds.
Assuming 2.5% inflation, rounding up to a 4% return on bonds and rounding down to an 11% return on stocks, you would need to save money at these rates in order to fund your retirement:
  1. Conservative: $1864/month
  2. Moderate: $554/month
  3. Aggressive: $232/month
There is certainly risk involved in investing in stocks.  They can drop dramatically in value.  If your investments drop in value just before your retirement, you could be facing big problems.  However, as the example above shows, most people cannot afford to invest enough if they are not investing in stocks.  Therefore, choosing investments that are too conservative dramatically reduces the odds that you will achieve your investment goal.

Tuesday, September 23, 2008

My favorite kind of sale

I'm not much of a shopper.  Perhaps that is one of the reasons that I generally do a pretty good job of managing my money.  Not to say that I don't have my weaknesses, but generally speaking, I don't like to buy things.  However, if I am buying things, I really like to get them on sale.

My absolute favorite thing to buy on sale is investments.

If I go to the grocery store and see that my favorite food (fresh berries of any kind) is on sale, I stock up.  If it's a good sale I will buy much more then I otherwise would have.  This is a natural reaction and a reasonable thing to do.  It makes sense to stock up while the price is low.  While most people have no trouble seeing this logic when it comes to fruit, cans of tuna, or salad dressing, many resist doing so when it comes to far more important purchases - investments.

If you are investing in the stock market, either through individual stocks or better yet through mutual funds, these are great times to be adding to your investments.  Currently, the S&P 500 - a broad index of five hundred major U.S. companies - is at about 1200.  The last time that anyone had an opportunity to buy into this basket of stocks at this price was in mid 2005.

True, the S&P 500 is down almost 25% from its high so your portfolio has likely taken a bit of a tumble.  However, if you are in it for the long term - and you should be if you are investing in stocks - your day-to-day balance shouldn't be a concern.  It can be nerve-wracking to watch the market and your retirement savings lose value day after day.  But you never know just where the bottom will be or when it will be your last chance ever to purchase a stock or a fund at these low prices.  The market might keep going down.  That can be a great thing if it gives you the opportunity to make more investments at relatively low prices.

You will never know exactly when the stock market has bottomed out.  The only thing that you can know for sure is that everyday the market goes down, your investments are on sale and are a better deal than the were the day before.

Sunday, September 21, 2008

What to do if your plan doesn't fit

Creating a financial plan is not always the liberating comforting experience that people hope it will be.  While for some it can be an exercise in reassurance that they are on the right path, for many others it can make their financial goals seem out of reach.  I hope that you are in the first category.  If are not, then please read on.

If the amount that you need to fund your retirement, your kids' education, a new car, and everything else in your plan adds up to more than you think you can possibly save, don't despair.  Just by knowing this, you are already closer to a more secure financial future than you were before.  Ignorance of your problems doesn't make them go away.  In fact, ignorance makes them grow larger - the longer you wait the more difficult it becomes to get your finances on track.  Therefore, by tackling your finances now, you are doing yourself a huge favor.

If you simply don't have enough money to meet your financial goals, you have only three options: earn more, spend less, or adjust your goals.  They all have advantages and disadvantages.

Earning more, if possible, is a great solution.  It should be easy to see how bringing in more money will help make your financial goals more possible.  However, if it were easy to bring in more money, you would probably be doing it already.  For most people, earning more money requires working longer hours or getting another or a different job.  If this is an attractive option for you, then by all means, go for it.

Spending less is a fantastic way to help you meet your financial goals.  The less you spend, the more you have to save.  Almost everyone can benefit from cutting back on their spending.  Once you start to trim your expenses, you might find that it is easier than you expected.  Many people worry that their "quality of life" will drop significantly when spending less.  Sure, you might miss the fun that your spending provided, but you will gain a great deal of satisfaction and security from knowing that your financial future is (or getting closer to being) on track.  Also, after cutting spending, many people come to realize that their "quality of life" depends less on material things and more on life's happy intangibles.  

Living a more frugal life not only increases the amount of money that you have to save, but it can often decrease the total amount that you need to save for retirement.  If you are able to cut your annual spending by a few hundred or few thousand dollars per year, that thriftiness should carry though into your retirement, and you will need less to achieve your retirement.

However, there is only so much money that you can cut out of your spending and it might not be enough to allow you to fully fund your goals.

If you cannot cut back on your spending enough to fund your goals and you are not in a position to increase your income, then you have only one option left: adjust your goals.  If you cannot or don't want to change your income or your spending habits then you will need to modify your goals.  Sometimes, this makes sense.  Perhaps if you delay your planned retirement date by a few years you will be able to live the retirement that you want without changing your current lifestyle.

Beware of making default changes to your goals by failing to plan.  Modifying goals often makes sense.  However, if you fail to save enough for your financial goals, you will not be able to achieve them.  You will, in essence, be forfeiting control of your financial life.  Perhaps your goals need to change.  However, make sure that you actively make that decision - decide what to change and by how much.  Don't let poor money management change your goals for you.

This is very simple in theory, but don't be fooled - it can be very difficult to put into practice.  If you don't have enough money to make your plan a reality, you need to either earn more, spend less, or adjust your plan.  Which ever decision you make, make it on purpose.

Missing money

Do you have any missing money?  You might!  Head over to Missing Money to find out.

As people move from one city to another or close one account and open a new one, they often lose track of exactly where all of their money is.  Missing Money helps reunite you with your misplaced funds.  If you have any money left in old bank accounts, any un-cashed paychecks, any utility deposits that have not been refunded, old insurance policies, or money hiding out in other places, this free web site can help you find it.

I believe that I generally do a good job keeping track of where my money is and has gone.  However, I was pleased to learn that the Virginia Department of Revenue appears to owe me some money.

Thursday, September 18, 2008

Be Your own financial planner part 6 - Be flexible

Congratulations, you are well on your way to being your own financial planner.  You have already made a plan to:
  1. Purchase adequate life insurance for you and your family
  2. Establish an appropriate emergency fund
  3. Track where your money comes from and were it goes
  4. Pay off your debt
  5. Save for retirement, and
  6. Prepare for other major financial events
However, your financial planning is not coming to an end, it is just beginning.  As time goes on, your situation will change.  The market will go up and down, you will move, lose your job, get a raise, have kids, buy a new house, and change your goals.

Therefore, your financial plan will need to be updated over time.  I would recommend that you re-examine your goals and make sure that you are on target at least once every two years.  If you prefer, you can do it once a year.

The final step in creating your financial plan is to remember to be flexible and to regularly reassess your plan.  Your situation and your goals will change over time.  An outdated plan won't do you much good.  So, every year or two, go through steps 1 - 6 again.  You might find that you don't need to make any changes.  But it is always worthwhile to ensure that you are still on target.  Good luck!

Sunday, September 14, 2008

Be Your own financial planner part 5 - Map our your financial goals

Many of the biggest financial events in your life are predictable.  As your own financial planner, it is your job to plan and prepare for them.

Your car will only last so long.  Your kids, if they go to college, will probably do so right after they graduate from high school.  If you are planning on moving to a larger house as your family grows, you probably have a good idea of when you want this to happen.  Events like these happen whether you plan for them or not.  However, they will be easier on your finances if you have planned for them.

Sit down and take a few minutes to think about the major financial expenses you expect to experience over the next five years.  And the next ten years.  And the next twenty years.  When do you think that you will need a new car?  Will your house need significant work at any point in time?  Do you need to save for a vacation?  College tuition?  Will you be moving or purchasing a second home?  Try to think of every specific major financial event in your life for which you can you plan.  Write down what the event is, how much you need to save, and how long you have to save.

The sooner you will need the money for your goal, the more conservative your investments should be.  If you will need the money in five years or less, I would recommend saving your money in a very stable investment such as a savings account, CD, or government bond.  If your goal is more than 15 years away, you almost certainly will want to allocate at least some of your savings for that goal into a stock fund.  For anything in between it's up to you.

More aggressive investments might help you reach your goal faster.  However, they can also tank at just the wrong moment and leave you short of funds.  If your timeframe and goal amount is flexible, you might want to be more aggressive than if your goal amount and time frame are set in stone.  For example, if you are setting aside money to purchase a new car, you might be able to delay your purchase by a few months or purchase a less expensive car than you had previously planned.  If, however, your goal is very specific, there might not be any room for the risk that more aggressive investments entail.

Once you have your goals and timeframes laid out, head over to this savings goal calculator.  Plug in the information about your goals (one at a time), your time period, any money already allocated for this goal, how much you can save every month, and your expected rate of return.  This calculator will then tell you how long it will take you to reach your goal and what amount you would need to save each month to hit your goal at the end of your designated time frame.

There are also a number of great specific college savings calculators.  The CNN Money College Savings Calculator is one of my favorites.

This exercise has helped you complete step six in your financial plan: Prepare for the major financial events in your life other than retirement.

Thursday, September 11, 2008

Be Your own financial planner part 4 - Plan for your retirement

Planning for your retirement will likely be the single biggest financial goal in your life.  Ideally you will be saving for decades and living off the money for decades more.  There are no loans, scholarships, or shortcuts for retirement savings.  Either you save enough to live the lifestyle you want or you don't.

How much should you save for retirement?  That is up to you and depends on when you want to retire, what kind of life you want to live in retirement, and how much you have already saved.  At a bare minimum, I believe that you should be contributing enough to your 401(k) to max out any employer match available.  You should also be contributing to an IRA.

However, you don't want to just follow rules of thumb, you want to make a personal financial plan.

In order to save enough for your retirement you need to estimate what level of income you will need for retirement.  This is one of the reasons why it is important to understand how much income you are living on right now.  Take a few minutes to relax and picture what you want your retirement to be.  Where will you live?  Will you continue to work at all?  Will you want to travel?  What will you do with your time?

Some people believe that 70% of your current income level is a good estimate for what you will need in retirement.  I think that for the sake of estimating your total needs, it is better to start at 100% and work down (or up!).  Personally, I find that when I have more free time, I spend more money - not less.  However, I think that there are a few parts of my budget that I will be able to cut or eliminate once I am retired.

How do you think your financial needs will change in retirement?  For starters, you will no longer need to save for retirement.  If you have been saving 10% of your income, then perhaps you can live on only 90%.  If you are no longer working, will your clothing, dry cleaning, or transportation expenses change?  Will your house be paid off?  Will your house need repairs or remodeling? Will you be taking up new hobbies or devoting more time to your existing hobbies?  How much will that cost?

Once you have your estimate, it's time to plug in your numbers to see what you will need to save to meet your goal.  Yahoo Finance has a great calculator to help you figure this out.  Click on the link, plug in the numbers for your situation and see what you need to save.  If you don't know what to use for any of the variables, (such as inflation or investment returns) its okay to leave them at their set defaults.  Even if you are solidly committed to retiring at a certain age or with a certain level of income, I would encourage you to spend a few minutes trying out different scenarios to see how it effects your savings needs.

When you are done with this you should know how much money you need to be saving every month to prepare for your retirement.  Are you already at your goal?  If so, congratulations!  If not, then do what you can to meet your goal right now.  If you can't hit your savings target right away, don't panic.  However, keep working up towards it.  Until you are on track to fund your retirement, whenever you get a raise at least half of your new money (and preferably all of it) should be put aside for retirement savings or debt reduction.  The longer it takes you to increase your savings rate, the higher your savings rate will need to go.  If you are not saving enough, time is not on your side.

Now you have completed step five in your financial plan: figure out how much to save for retirement and start saving that much.

Saturday, September 6, 2008

Be Your own financial planner part 3 - Debt can ruin your financial well-being

In an ideal world you would never need debt because you would always have enough money.  Our world is far from ideal.

I don't believe that there is such a thing as good debt.  However, there is a huge difference between very bad debt and less bad debt.  Managing your finances well might include taking on less bad debt such mortgages, student loans, and loans to start a business.  These types of debt tend to be less bad because:
  • the purpose of the debt is to leave you with an appreciating asset (house), valuable skills, or an increased income
  • they tend to have relatively lower interest rates
  • they often include tax advantages further lowering their cost
Credit card debt or any other debt that involves spending money that you don't have for things and experiences that you can't afford is very bad debt and will destroy your ability to manage your money well.

Imagine if you walked into a store and picked out a sweater to purchase.  As you picked it up, you notice a sale sticker on the tag - it reads: Today only, pay 70% more than the lowest marked price!  Would you buy the sweater?  Of course not.

However, whenever someone racks up charges on their credit card that they cannot pay off in full, this is the deal that they agree to.  Credit cards typically require a minimum payment of 4% of your balance every month.  This means that if you have a $10,000 balance, your minimum payment will be $400/month.  If your credit card charges you a 20% interest rate and you make only minimum payments, then it will take you almost 16 years to pay off your debt and it will cost you over $17,000 in total payments.  This is very bad debt.

America has a problem with credit cards.  Almost half of all households do not pay off their credit card balances every month.  That means that almost half of all households are spending beyond their means and likely failing to invest for the future.  Of households that do carry credit card debt, the average amount is $2,300.

If you have credit card debt, or other types of very bad debt, you need to pay it off as soon as you can.  If you only have one account, you should pay whatever you can above and beyond the minimum payment until your debt is gone.

If you have more than one account with very bad debt, you should make the minimum payment to all of your accounts.  You should also pay whatever extra amount above the minimum that you can afford to the account with the highest interest rate.

If you have credit card debt you should also seek to minimize the interest rate that you pay.  There are two ways to do this:
  1. Call your credit card company and ask for a lower rate.  It won't always work, but it is worth a shot.
  2. If you still have good credit and are getting credit card offers, see if you can find a way to transfer you debt to a card that offers no interest or low interest.  (If you do this be sure to carefully consider any fees that might be charged for balance transfers.)
Once you have taken care of your life insurance needs and have set aside some cash for emergencies, knocking off any very bad debt that you have is the fourth step in your financial plan.

Friday, September 5, 2008

Be Your own financial planner part 2 - Know where your money comes from and where it goes

Imagine what you could do with two million dollars.

Would you spend it?  Save it?  Give some away?  Would it change your life?

The good news is you almost certainly will have at least two million dollars pass through your hands over the course of your lifetime.  The average American with a college degree will earn 2.1 million dollars over the course of their adult working life.  Don't have a college degree?  You can still expect to rake in 1.2 million.  If you have a masters degree, 2.5 million.  PhDs can expect 3.4 million and those with professional degrees will earn a whopping 4.4 million over their adult working lifetime.

Think about the total amount of money that you have earned already over the course of your life.  How many years have you been working?  Can you estimate your average salary well enough to make an educated guess about how much money you have brought in?  Are you happy with the decisions that you have made?  What do you have to show for all of your income?

If you don't know how much money is coming in and where it is going, you will struggle to accumulate wealth.  Over the course of your lifetime you will earn a significant amount of money.  Some of it, you will need to spend on housing, food, healthcare, taxes, and other things.  What about the rest of it.  Do you know where it goes?

Knowing is as important as doing when it comes to financial planning.  Planning for your retirement is one of everyone's biggest financial challenges.  If you do not know how much money that you are taking in and how much you are spending, there is no way that you can accurately estimate what your needs in retirement will be.

Handling the money that you earn is the very bedrock of your financial plan.  You do not need to have a huge salary to plan your finances well.  However, if you do not know how much money comes in, how much goes out, and where it goes to, you will not be able to effectively plan to use this money to meet your goals.

Step three in creating your financial plan is to know how much money you having coming in, how much goes out, and where it goes.  You don't need to track every penny, but you do need to have a very good feel for what happens to your money.

Wednesday, September 3, 2008

Be your own financial planner part 1 - Be prepared for emergencies

You will have financial emergencies in your life - your car will need work or your furnace will break down.  You will also experience other hardships that have a major financial component - you will experience the loss of a loved one or you might lose your job.

There is nothing that you can do to prevent things like these from happening to you.  However, there is a great deal that you can do to ensure that you are financially prepared for them when they do happen.

There are two main elements to financial preparation for emergencies: life insurance and cash reserves.  These are the first components of your financial life that you should address.  Until you are prepared to deal with financial emergencies that could happen tomorrow, there is no point in saving for financial goals that are still years away.

Imagine that you work out a stellar financial plan that will enable you to fund your retirement and all of your other financial goals but neglect to set aside emergency cash reserves or purchase life insurance.  If your car breaks down the next day and you need to pull money from a retirement account or take on debt to have it repaired, or worse yet, if you or your spouse is run over by a bus, all of your planning won't have helped you.

Therefore, I believe that the first step in any financial plan is to purchase the proper amount of life insurance for you and your spouse.  You should include enough insurance to replace lost income, cover childcare expenses, and take care of any other financial hardships that would be brought about by you or your spouse's death.  Term insurance is generally the cheapest, and often the best type of insurance for these needs.  This earlier post has more information on determining your needs for insurance and this one discusses the different types of insurance available.

Once you have your life insurance squared away, you need to make sure that you have an emergency cash reserve set aside in a savings account.  This money should be set aside only for emergencies and should be in a separate account so that you are not tempted to spend it or use it for anything else.  Many professionals recommend that you keep 3 - 6 months worth of living expenses on hand.  Personally, I keep a bit less than 3 - 6 months of living expenses.  I like to have my money invested and working for me as hard as possible.  Because I work for the government I consider it very unlikely that I will lose my job on short notice.  I also have access to credit and investments should I need to raise a large amount of cash quickly.

The proper amount of cash reserves is something that you and your spouse will need to decide together.  I would advise you to set aside at least $1,000.  However, decide an amount that makes you and your family comfortable.  Frugal Dad has a great post about his thoughts on the proper amount for an emergency fund.

Once you have met your life insurance needs and set aside cash for emergencies, you are less susceptible to the financial ups and downs of life and are ready to tackle the rest of your financial goals.

Step one in your financial plan is to obtain adequate life insurance.

Step two in your financial plan is to set aside an emergency cash reserve.

Tuesday, September 2, 2008

Be your own financial planner

I started this blog because I believe that, armed with desire and a small amount of information, anyone can do a great job as their own personal financial planner.  I want to help you manage your money and plan your financial life better.

When I was a professional financial advisor, I worked with clients that had millions to invest and clients that had only a few hundred dollars.  I devised a unique plan for each client, but the concepts behind each plan were (and still are) universal.  These general concepts are:
  • Be prepared for financial emergencies
  • Know where your money comes from and where it goes
  • Debt can ruin your financial well-being
  • Plan for your retirement
  • Map out your financial goals
  • Be flexible - situations and goals will change over time
Over the next several days I will discuss each of these concepts and how it relates to your own personal financial plan.  It is my goal that at the end of this series, you will have the knowledge needed to create your own basic financial plan that will take into account your needs for emergency cash reserves, life insurance, debt elimination, retirement savings, education savings, and other long term financial goals.

Saturday, August 30, 2008

Why one million dollars just isn't worth what it used to be

Forty years ago, if you had one million dollars, you had it made.  While one millions dollars is still a huge some of money, being a millionaire just isn't what it used to be.  Either you are old enough to remember when bread, candy bars, and soda cost a nickel or have have heard your elders lament how expensive everything is these days.

The slow (or sometimes quick) rise of prices over time is caused by inflation.  Most researches agree that over the past 93 years in the United States the price of goods and services has risen by an average of approximately 3.5% every year.  According to this great inflation calculator on, an item that cost $20 in 1968 would cost $126 today!

Inflation is easy to measure for some goods, such as ground beef.  One pound of ground beef purchased today is going to be just about the same thing as a pound of ground beef purchased 50 years ago and will probably be the same in another fifty years.  Because of this, it is easy to measure price inflation for ground beef.  But how do you measure the inflation rate of computers?  A laptop computer today might cost, on average, $1500.  Ten years ago, you could also get a laptop for about the same price.  However, the one you buy today is a much different, much faster, much better product.  Because of factors like this, overall inflation is very difficult to measure and many researchers disagree about the rate of inflation that the U.S. has experienced over time.  If they don't agree on the historical rate, you'd better believe that there is no consensus on prediction for the future rate of inflation.

What does this mean for you?  It means that when you are planning for the future, you better make sure that you take inflation into account - you don't want to plan $20 for an expense that will actually cost you $126.  Even though you don't know what the rate of inflation will be, you can be certain that you will experience the effects of inflation to some degree.

Because people are living longer and retiring earlier, inflation is becoming an increasingly significant factor in retirement.   If you retire at age fifty and live to age 90, your retirement will cover a span of 40 years.

Investments with a fixed rate of return - savings accounts, CDs, and most bonds - can be great investments, but offer you no real protection from inflation.  In fact, many bank savings accounts pay such low interest rates that, depending on the rate of inflation, your account might actually be losing value even as you collect interest.

However, investments such as stocks, mutual funds that invest in stocks, and TIPS (Treasury Inflation Protected Securities - a savings bond that pays a base rate plus the current rate of inflation) all tend to grow faster than inflation.  If you are planning for a long term financial goal, you need to include investments like these in your portfolio.

One million dollars isn't what it used to be.  In fact, to have the same buying power as a 1968 millionaire, today you would need more than 6.3 million dollars.

Friday, August 29, 2008

Financial Values post included in Finance Fiesta

For the first time, a Financial Values blog post has been included in a carnival.  A carnival, for those not yet in the know, is a collection of recent blog posts on similar topics.  Please be sure to head over to Master Your Card for the latest edition of the Finance Fiesta.

Thursday, August 28, 2008

New Links!

I frequently search the web and the blogosphere for the best personal finance sites out there.  There are two great sites that I have just posted links for:

Smart Spending - This site has great saving and spending advice.  It is a collection of blog posts from different authors and typically has several new posts everyday.  I particularly enjoyed Donna Freedmen's post on Doing without in your 20s - by choice.

Frugal Dad - A great blog on living a frugal life.  10 Truths about Frugal Living was a great post and is worth a read.

Be sure to check out these sites and the others that I have provided links to in the right hand column of this page.

Are there any other great sites out there that you think I should know about?  If so, please send me an email or leave a comment!

Tuesday, August 26, 2008

Your values and your money

Warning: This post gets a bit philosophical.  My next few posts will get back to the nuts and bolts of how to manage your money and prepare for the future.

In order to determine how to manage your money, you need to think about much more than just your money.  You need to think about what you want your life to be like.

Yesterday I told you that I was happy with where my money goes and how I spend my money.  The reason that I am happy about it is that the decisions that we make about spending our money help us to live the life that we want to live.

It is very easy to become seduced by advertising and consumerism and spend money without regard for whether or not it is in your best interest.  If you do not consciously make decisions about how much of your money to spend and how much to save you will almost certainly make poor decisions about your money.  Furthermore, if the decisions that you make about your money are not rooted in your values, you will find that your plan is difficult to stick to and your goals will be difficult to achieve.

Establishing your goals is a matter of setting priorities.  How do you best use a limited resource to meet unlimited wants and needs?

Our list of goals includes making sure that we have financial reserves to ride out a financial emergency, saving for our children's educational expenses, taking regular vacations, supporting charities, and achieving financial independence at a relatively early age.

The reason that we make sure that we are financially able to cover emergencies is because I want my family to be well provided for regardless of our short term circumstances.

The reason that we invest in a 529 plan for my daughter is because we value her future success and want to give her every opportunity to succeed that we can.

The reason that we save for vacations is because we value time with our family and seeing new parts of the globe.

The reason that we support several charities because we believe that it is important to make the world a better place and because we believe that this is what God wants us to do.

And the reason that we are planning to be become financially independent relatively early is because we value our time together and we value the freedom to decide how to spend our time.

We also spend time and money to enjoy our lives right now.  But we make sure that what we spend to enjoy ourselves today does not prevent us from meeting our goals for the future.  Because these goals are linked to our values, when we consider how additional expenses would hamper our efforts to achieve our goals, it becomes much easier to stay on track. 

Does this work for everyone?  I don't know, but it's a big help for us.

Monday, August 25, 2008

Where my money goes

This weekend I analyzed all of my spending for the previous thirty days.  There were no really big surprises for me, but it was a good snapshot of where our money goes.  This is it:

42% - Real Estate - this includes the house that we live in, an investment property that we own, and homeowners insurance

18% - Savings and Investment

10% - Food - both groceries and eating out

10% - Baby - anything purchased for our six-month-old daughter

5% - Utilities - electricity, gas, phone, internet

5% - Household - things for the house, drug store items, and postage

5% - Clothing

4% - Transportation - gas, bus fare, and parking (remember we have only one car, it's paid off, and I bike to work)

1% - Entertainment

1% - Life Insurance

1% - Gifts

(These don't add up to 100% because I rounded them off)

The bad news is that the above outflows of money account for 110% of our income during those 30 days.  However, overall we do live within our means.  Overspending this month made our checking account balance shrink, but did not require any debt.  Furthermore, there are a few special considerations that explain why we spent so much this month.

1.  We have started to cloth diaper our daughter.  We believe that it is better for her.  In the long run this will save money.  However, the start-up costs, which we paid during the past 30 days, are high.

2.  We live outside the United States, but visited the U.S. during this past month.  Because there is a greater availability of products and they are cheaper in the U.S. than where we live, shopping across several categories - baby, household, clothing - was unusually high.  We also paid for long-term parking at the airport during our trip, so transportation costs were much higher, as well.

3.  Some of our utility bills are paid every two months.  So our utility payments are artificially high.

However, we also do give roughly 10% of our income to charities.  We just didn't happen to make any gifts during the past thirty days.

This experience has reassured me that we are on target.  We are saving and investing a good amount of our income and generally spending less then we earn (which we did even this month because 18% of our money was put into different savings and investment accounts).  There are some places we could and probably should cut back - mostly in food.  As a start, I took my lunch to work today.

Saturday, August 23, 2008

Thoughts about managing money well

Investing well is not all that hard to do or to measure.  All you need to do is earn a relatively high rate of return.  A good investment for you, is almost certainly a good investment for anyone else.

However, managing your money well is much more difficult goal to achieve and to measure.  Money is a tool that can help you achieve your goals, realize your values, and live the life that you want to live.  A good decision on what to do with your money might be a lousy decision for someone with different goals.  Therefore, in order to manage your money well, you need to know what your goals and dreams are, so that you can use your money to live the life that you want to live.

As you look over how you spend (and save) your money think about whether your spending patterns are helping you live the life that you want to live.  Are your choices with your money moving you closer to achieving your goals?  If not, why not?

One exercise that can help you figure out your values and goals is to think of your past accomplishments.

A few of the things that I am most proud of about my own life:

1. I have a strong marriage to a wonderful woman.
2. I am raising an absolutely incredible little girl.
3. I learned how to speak Chinese.
4. I ran the Great Wall Marathon.
5. I am successful in a difficult and competitive career.
6. I have traveled extensively and seen many parts of the world.

Think about what you have done in your life that make you the most proud.  Did your spending habits, either directly or indirectly, have any affect on your accomplishments?  Did they help you, hinder you, or neither as you accomplished these things?  What are the best decisions that you have made with your money?  Why is it that you think of these decisions as being so right for you?  I will talk more about how to manage your money according to your values and goals in a post in the next few days, but for now think over these questions.

Friday, August 22, 2008


If you have been with this blog from the beginning, you know that I have been tracking my expenses for the past 30 days.  If you have been doing so too, and I hope that you have - congratulations - the 30 days are up and there is no need to keep tracking purchases if you don't want to.

Over the weekend take a few minutes to look over your spending and calculate how much you spent and what you spent it on.  Divide it up into categories and figure out how much of your money was spent in each category.

We will talk more about how you can use this information.  For now, just figure it out and, if you want to, think it over.  Does it surprise you how much or how little you spent overall?  Within different categories?  Did you have a good feel for how much you were spending and where it was going?

Thursday, August 21, 2008

Budgeting system #3 - let the bank manage your envelopes

I used to think that I had the great financial mind in my family.  Now I know that it's not me --my brother is clearly a financial genius.

My brother and his wife recently explained to me the budgeting system that they invented for themselves.  It's incredible.  If there was a Nobel Prize for budgeting systems, this one would be a pretty solid candidate.

It works very much like the envelope system described two days ago, but with a technological twist that means you don't need to make all of your purchases with cash.  You will need an internet friendly bank and a cell phone or another device capable of accessing the internet.

As with any budget, first you create your categories and determine how much money to allocate for each one.  Then instead of envelopes, you open a checking or savings account for each category.  In addition, you should have a "main" checking account.  You could easily have more then 10 checking accounts - but don't worry there is a simple way to manage these accounts and you will only actually write checks and pay bills out of your main account.  You can think of the other accounts as electronic envelopes.  They are only there to help you budget - not to use like a traditional bank account.

Set up all of your accounts so that whenever you get your paycheck (which will go into your main checking account), the proper amount is automatically transferred into each of your separate accounts.

When you go shopping, you can use your cell phone or Blackberry or whatever to check the balance of each of your budgeted accounts.  When you purchase something,  you can put it on a credit card.  Then, while you are still standing at the cash register, use your phone to transfer the appropriate amount of money from whatever category the purchase falls under into your main checking account.  At the end of the month, you will then have enough money in your main account to pay your bill.

Using this system enables you to know how much you have to spend in every category, prevents you from overspending, and allows you to use whatever payment method you prefer.

Sheer genius for the tech savvy budgeter.

Wednesday, August 20, 2008

Budgeting system #2 - tracking your purchases

If you don't like the idea of the cash-based envelope system, or you want know exactly where every penny that you earn winds up, then you might want to budget the old fashioned way -- track every purchase.

Just like with the envelope system you will need to divide all of your spending into different categories and assign a weekly or monthly budget to each category.  Then either using a pen and paper or a computer, you keep track of ever dollar that comes in and every dollar that goes out.

If you use a computer program such as Quicken or Microsoft Money you can link your bank accounts, investment accounts, credit cards, mortgages, and more.  The program can then automatically download all of your transactions.  It is also often smart enough to categorize them for you.  A program like this takes a great deal (but not all) of the work out tracking your spending.

The best part of using a program like this is that you can, if you are so inclined, really analyze where your money goes.  It can show you, at the touch of a button, how much money you spend every year at McDonalds, or on yarn, or getting your haircut, or whatever else you want to know.

Tuesday, August 19, 2008

Budgeting system #1 - the envelope system

If you are spending more than you want to be, then you need a budget.  If your debt and spending are out of control and you need to take drastic action, the envelope system might be the right system for you.

The envelope system works wonders to bring spending under control.  Better yet, it does so without requiring tedious recording of all of your purchases.  You don't need any special software, books or anything else.  All you need are a few envelopes.

The first step is to figure out how much money you have coming in every week.  Then, take some time to list out the different categories that you regularly spend money on.  You will probably need categories for: transportation, groceries, utilities, entertainment, dining out, saving, rent or mortgage, debt reduction, clothing, and gifts.  Include a category for anything else that you spend money on.

Next, figure out how much money you have every week to allocate between these categories.  Then determine how much to put in each category.  Write the name of each category, and the weekly amount, on the front of an otherwise blank empty envelope.

At the beginning of each week, pull out enough cash from your bank account to fill each envelope with the alloted amount.  Then, spend nothing but what you have put into the envelopes.  In order to make this work, you need to do all of your spending in cash.  Bills, of course, can not be paid in cash, but everything else comes out of those envelopes.  If you have extra left over from one week, that's great - let it keep building.  If you run out too soon, you need to make changes in your spending to make sure that it does not happen again.  If you keep consistently coming in under budget in one category and run out of money before the end of the week in another, then you might want to adjust the amounts set aside for those categories.

The great thing about this system is that it is simple to implement and absolutely guarantees that you will not spend more than you want to.

Monday, August 18, 2008

I don't budget - I spend the leftovers

Budgeting is a great tool that helps you get more out of your money.  If you are struggling with debt, can't ever seem to save any money, or wonder where all your money goes, you need to budget.  I confess that I don't budget, but I do generally keep track of income and expenses and have a good feel for where my money goes.  My wife and I have no debt other than mortgage debt and we aggressively save for the future.  That being said, I am certain that we would be better off if we did budget.  However, we spend most of our time living abroad and deal with expenses in different currencies.  I have not found an easy and convenient way to keep track of everything.  If you know of one, please tell me about it.

Over the next few days, I will share a few different methods for how to track your expenses.  Today, I would like to share with you how my wife and I are able to met our financial goals without budgeting and tracking our money.

A large part of managing your money properly comes down to establishing your values and  priorities and using your money in a way that reflects those values and priorities.  We have set a high priority on a comfortable retirement.  Therefore, we have set up automatic funding for all of our retirement accounts.  We value education.  Therefore we have set up a college fund for our daughter that is automatically funded every month from our checking account.  Time together as a family is a priority for us.  Therefore, we make certain to set aside enough money to take vacations together.  We believe that it is important to give generously to causes that we care about.  Therefore, we plan out our giving for the the year ahead of time.

All of our high priority goals are automatically funded.  As soon as that money comes into our checking account, it is automatically whisked away.  We know generally how much our bills will be every month.  So, what ever is leftover is what we spend.  Doing this almost invariably means that we spend less then others in our same income bracket.  However, because we know that we are using our money for the things that matter most to us, it makes it much easier (most of the time) to cut back in some areas where our friends and colleagues indulge.

One of the reasons that it works is because we have always been good at not spending beyond what we earn.  If you have a problem with debt, this might not be the best method for you.  This plan isn't perfect, but it works for us. 

Saturday, August 16, 2008

What debt does to your lifestyle

Many people get into financial trouble because they live for the moment and fail to plan for the future.  One of the easiest ways to sabotage your own finances is accumulate too much debt.

While the use of debt to purchase a house, start a business, or in some cases make a major purchase such as a car can be smart, debt is always dangerous.  Debt used to finance a lifestyle - dining out, vacations, remodeling, or shopping - is especially dangerous.

Lets take a look at two young couples to see how debt can effect your lifestyle and financial well-being.

Both couples make a combined income of $70,000/ year.  However, they both handle that money very differently.

Couple A is not presently concerned about saving for retirement.  They eat our frequently, take great vacations, drive nice cars, and thoroughly enjoy life.  However, their salary does not quite cover all of their expenses.  They manage to rack up $5,000 of credit card debt every year.

Couple B likes nice things too, but also wants to plan for the future.  They save 10% of their income for retirement and give $3,000 to charities every year.  Couple B also makes sure that not to spend more than they have and does not accumulate credit card debt.

So for right now, couple A has $75,000 to support their lifestyle, where as couple B is choosing to make do with only $60,000.  However, lets see what things look like if both couples continue down this path.

After five years have gone by, Couple A is still spending and accumulating debt.  However, one of them gets a $5,000 raise, bringing their annual income up to $75,000.  They decide that it is finally time to start planning for retirement.  Taking stock of their situation they realize that they have nothing saved and have accumulated $25,000 in debt.  If they are paying 18% interest on their debt, that means that they need to pay $4,500 in interest payments every year.  They will need to pay even more to pay down the balance on their cards.  So, they decide to set aside $6,000 every year to pay down their debt and to begin saving 10% of their salary for retirement.  When you add all of this up, couple A has nothing saved and now despite a nice raise, has only $61,500 each year to spend.

Believe it or not, one of the members of Couple B gets a $5,000 raise after five years too!  They continue to give $3,000 to charities and to save 10% of their income for retirement.  This means that couple A now has $64,500 left to spend and assuming an 8% return on their investment, already has $44,000 put away for retirement.  If this $44,000 is given another 25 years to grow it will be worth $442,000 even if Couple A never adds another dime.

Here are the important points that I see in this illustration:
  • Taking on debt means spending future income today.  Doing so only sets you up for future disappointment.  While couple A probably had a lot of fun in those first five years, it will be a long time before they will be able to spend at that level again.  Even though they got a raise, they had to cut their spending by almost 20%.  Couple B meanwhile, will likely generally be able to steadily increase their spending as time goes by and their income level rises. 
  • Couple A had five years of better living than couple B did.  However, after only five years, Couple B has no debt, a substantial amount of money saved for the future, and a higher level of spending then couple A.  All this while still donating a significant amount of money to causes that matter to them.
  • Over those first five years, couple A did have more to spend and probably had a lot of fun.  However, couple A will never catch up to couple B.  There is now a $71,000 difference between the net worths of each couple.  Even once couple A pays off their debt, they will still have significantly less money saved for retirement.
  • The longer one lives above their means, the more damaging it is to their long term financial situation.
  • Even while saving for your future, it is often possible to give generously to causes that you care about. 

Friday, August 15, 2008

A guaranteed instant 100% return - really!

Generally, when you see advertisements for investments that will double your money you should probably stay away.  Get rich quick schemes just don't work.

However, most Americans do have an opportunity to earn a 50-100% return on retirement savings.  If your employer offers a 401(k) plan, a 403(b) plan, or a Thrift Savings Plan and offers to match your contributions, you should at the very least invest enough to obtain the full match.  Period.  Doing anything else is very literally turning down free money.

Even if your employers plan has high-cost investment options or investments that you don't particularly like, if you can get free money by participating, it is almost impossible to do better with another investment.

Let's say that you make $50,000/year and your employer will match your contribution - dollar for dollar, up to 5% of your salary.  That means that you need to contribute $2,500 per year in order to receive the maximum $2,500 contribution from your employer.  If your investment grows at an average of 8%/year, and you contribute every year for 40 years, when you retire your investment will be worth almost $1.4 million!  Without your employer's matching contributions, you would need to earn an annual return of nearly 10.5% in order to achieve the same amount of money after 40 years.

If you are eligible for an employer sponsored retirement plan with employer-match contributions and you are not yet contributing enough to get the full match, do yourself a favor and fix that immediately.

Thursday, August 14, 2008

Life insurance for babies?

Yesterday, I received a letter from a life insurance company offering me a whole life insurance policy on my six-month-old daughter.  I can hardly think of a product that I need less.

Life insurance is a fantastic product that is used to help alleviate the financial burden created by the death of a family member.  While any death in the family is emotionally devastating, the death of your spouse can also be financially devastating.  Most six-month-old children (my daughter included) don't bring home a salary or offer much help around the house.  While the death of a baby would be absolutely heartbreaking, there is nothing that about the loss of a baby that a few thousand dollars can replace.  While life insurance money will not replace a spouse, it will help fill financial needs created by the loss.

Furthermore, life insurance for a baby is incredibly expensive.  The rate that this company is offering is $3.18/month for $5,000 of coverage.  By way of comparison, my term life policy costs me 23 cents/month for $5,000 of coverage.  I know, this isn't a fair comparison - whole life insurance builds up cash value.  Lets take a look at how that cash value builds up:

The letter I received claims that after 25 years the policy can be cashed in for the amount of premiums that you have paid in.  This cash value is one of the main benefits of the policy.  The company suggests that once your child is 25 you can give them this money as a nest egg.  Assuming that you purchased this policy the month that your child was born, you would have paid in $954 in monthly payments over those 25 years.  So you will end up with 25 years of insurance coverage (which you didn't need) and $954 which grew at a rate of 0%.

Lets take a look at what would happen if instead of purchasing the insurance policy, you invested the money in a low cost mutual fund for your child.  If you took the same amount of money - $38/year - and invested it at an 8% annual return, when your child is 25 your investment will be worth $3,000.  Which one do you think your child would prefer?

My advice: skip the life insurance policy and start saving for college.

Wednesday, August 13, 2008

Annuities: investments generally worth avoiding

An annuity is something of a cross between an insurance policy and an investment.  They are complicated, expensive, and generally probably not something that most people need.

An annuity is an investment vehicle.  You purchase an annuity bit by bit over time or in one lump sum.  The money inside the annuity will be invested for you until you "annuitize" your policy.  Once annuitized, you no longer own the money inside the account.  Instead you hand the money over to the insurance company who runs your policy.  In exchange, they agree to make a regular, fixed payment to you for the rest of your life.  It is almost like life insurance in reverse.

When I was a financial advisor I sold exactly zero annuities.  While having a fixed stream of income from an annuity can be very attractive, in practice I found that my clients were always better off investing on their own without an annuity.

The fee structure for these vehicles is enormously complex.  Even after attending seminars for financial advisors about specific annuity products, I recall not entirely understanding all of the different fees that an investor in that annuity needed to pay.  The one thing that was incredibly clear to me was that advisors who sold annuities made a great deal of money.

Because of the high fees and complexity of annuities, I quickly realized that they were not right for my clients.  This does not mean that annuities are always a bad choice or that anyone who tries to sell you one is a crook.  However it does mean that you should very carefully consider an annuity purchase.  Once you have purchased an annuity, it is usually very difficult - and very expensive - to move your money out of it.  Most annuities have "surrender fees" that you have to pay if you wish to transfer your money within the first 7 - 10 years that you own the annuity.  There might also be some very serious tax implications if you transfer money out of an annuity.

If an advisor recommends that you purchase an annuity, make sure that you know what you are getting into.  Ask him why he is recommending the annuity.  Ask him to explain all of the fees involved and ask him to show you the projected results of purchasing the annuity vs. investing the same amount of money in mutual fund.  You should also ask how many of his clients own annuities.  They are very specialized products, and in my opinion, they are generally not the best investments for most people.  If an advisor tells you that he recommends annuities to all or most of his clients, unless he has a very specialized market, I would be concerned.

Tuesday, August 12, 2008

What if you got money smart?

There are plenty of things that we should all do - eat our broccoli, floss our teeth, rotate our tires regularly, and manage our money well.  However, even though we know that we should do these things we often just don't do them.

Liz Pulliam Weston has a great article about what would happen to the U.S. and world economy if suddenly all U.S. consumers got "money smart"and paid off all debt, did not overspend on houses and cars, saved for retirement, and had adequate savings on hand for emergencies.  It is an interesting piece and I encourage you to read it (but not yet - finish reading this first!).

Take some time today to think about what your life would be like if you started doing all of the things that you know you should be doing with your money.  What would your life be like if you:
  • Had a plan to save for retirement and children's college expenses
  • Followed that savings plan
  • Paid off all of your debt
  • Never spent more then you earned
  • Had adequate life insurance
  • Made sure that you had several months of living expenses in your savings account
  • Regularly supported charities that you believe in
How would your life change?  Would you have less stress, less worry?  Probably.  Would you need to cut back on spending?  If you are saving, do you know how to tell if you are saving enough?  Too much?

Take a moment to think about what your life would be like if you knew that you were doing all of the things listed above.  If you are already on this road, congratulations.  If not, once you finally start down the path of making good decisions about your money you will probably find that the costs are not so great as you expected and the rewards are far greater.  If you need some incentive to get started now, take a look at this earlier post.

Monday, August 11, 2008

Portfolio rebalancing - buying low and selling high automatically

You probably know the old adage that you should buy low and sell high.  However, did you know that there is an way to make your portfolio automatically do that - even if you are not investing new money?

Suppose you decide that investing 70% of your money into a stock fund and 30% of it into a bond fund is the appropriate asset allocation for your retirement account.  Because these investments will rise and fall at different rates your ratio of 70% stock to 30% bond will not hold.  Properly managed, this is a good thing.  However, if you do not rebalance your account, because your riskier investments tend to grow fastest, your portfolio will slowly expose you to greater risk.

In order to maintain your proper asset allocation, you need to periodically rebalance your portfolio.  In this case, that would involve periodically transferring money from the fund that recently performed the best into the fund that did not perform as well.

In addition to keeping your investment risk at the appropriate level it will force you to buy low and sell high.  If the stock market has a great year you will need to sell some of your stock investment, at this relatively high price, to even things out.  If stocks have a lousy year, you will sell some of your bonds to put more money into the relatively lower priced stock market.
I recommend that you consider establishing a schedule to rebalance your portfolio every 6 - 12 months.  Many investors find it difficult to sell their best performing investment and transfer money into their worst performing investment.  However, doing so is often a very rewarding financial move.  If you have a regular schedule for doing this you can make what could be a difficult, emotional decision into a simple administrative action.

You should also rebalance your portfolio off schedule if the markets have made a dramatic move and you notice that your chosen asset allocation is off by more than a few percentage points.

Friday, August 8, 2008

A few things I do or have done to save money

I would like to share with you a few things that my wife and I do or have done to save money. You will notice, that this list is not called "things that you can do to save money." Because I don't know about your particular situation, I don't know if any of these will work for you. If they do, great. If not, I hope that they will at least be able to spark some ideas for things that you can do that will save you some cash.

  1. We did not own a car for four years. During these four years we lived in a highrise downtown in a major city. While there were times that we missed having a car, we never really needed one. We walked or biked to work, occasionally went on shopping trips or other driving excursions with friends, and took a lot of taxis.
  2. Currently, we only have one car. Now that we have a child and are no longer living downtown, we found that we needed a car. However, we only wanted one car, so we carefully chose a neighborhood that is on a major bus route and has a grocery store, butcher, and baker all within walking distance. I bike to work in the summer and take the bus in the winter.
  3. We canceled our cable. Because of, other sites that allow you to legally watch TV online, iTunes, and Netflix we just don't watch TV very much. We have been without cable for several months now, are saving almost $50/month, and don't miss it one bit.
  4. We rarely drink soda. Given that you can easily pay $3-4 for a soda at a restaurant, we usually stick to water. If we want a Coke (or beer, or glass of wine) we order it. But only if we actually want it.
  5. We consult each other before making any large purchases. My wife and I have a standing agreement that we will consult each other before purchasing an item with a value of $100 or more. This not only ensures that we are on the same page for major spending, it often helps to curb impulse buys. It still surprises me how often one of us will suggest purchasing something, the other will agree, only for the first person decide that they don't really want to spend the money after all.
  6. We don't have cell phones. Nor do we want them.
What is important about these decisions for us is that we have found ways to save money that don't make us feel that we are giving anything up. Is there anything in your life that you could cut back on or eliminate? You might be surprised at how little you miss it once it is gone.

Have you already found things that you can save money on? Leave a comment and share your experience.


I just read an article on WalletPop about Keith Taylor and his impressive website, Modest Needs.

Taylor's website allows people to lend a helping hand to the working poor in America.  He accepts applications from people who need one time financial help (medical bills, car repairs, and the like), posts their needs online, and allows people like you and me to fund these needs.  His goal is to stop the cycle of poverty for low-income workers before it starts.  Taylor screens the applications carefully - only 20% make it through - and employs rigorous anti-fraud measures.  I have not used this site, but I encourage you to check it out if you are interested.

However, the WalletPop article glosses over what I think is one of the most important lines of Taylor's story.  Back before he ran Modest Needs he personally gave his money - $350 a month - to people in need.  At that time, he was only earning $33,000.  This means that he was giving $4,200 per year, almost 13% of his relatively modest salary, to charity.  That impresses me.

I believe that any good financial plan should include charitable contributions.  Some of the reasons that I think you should include charitable giving in your personal financial plan:
  • Giving reminds you of what it really important in life.
  • There will always be people with more money than you.  Giving reminds you that the vast majority of people in this world have much, much less than you do.  According to the Financial Times a net worth of $2,200 puts you in the wealthiest half of the planet and a net worth of $61,000 makes you wealthier than 90% of the world.
  • Giving tends to create a greater sense of satisfaction in what you do have.
  • Giving helps others and makes the world a better place.
If you do give, my advice is to make certain that you are giving to a financially responsible organization and to be very deliberate in where you give.

Many solicitors for charity pass on far less money to the cause than you might think.  Some fundraisers keep 80-90% of the money you donate to cover their own costs, passing along only 10-20% of the money to whatever charity they claim to be raising money for.  Fund raisers and charities are required to let you know what percent of your donation is used for the cause and what is used to cover other costs.  Always ask.

Choose to support one or more organizations that you are passionate about.  Don't fritter away your donations in small amounts.  Like the rest of your finances, giving should be planned.  My wife and I discuss at the beginning of the year how we will give.  When we get phone calls and door to door solicitors (other than young children) asking for money, we explain that we plan our giving ahead of time and ask for information about their organization by mail.