Uncommon Cents

Interest rates are headed lower. For some people, this is a huge benefit; those with variable rates on credit cards and mortgages could benefit nicely, or those who want to refinance mortgages with high (or at least relatively high) fixed rates. For others, like myself, this is more of a drawback than a benefit; those interest rates I was getting on my money market accounts just dropped.

When interest rates lower, there’s less incentive to save money and more to spend. Borrowing becomes less costly, so people and businesses are likely to extend themselves more. Spending is the engine that drives the economy, so increasing spending tends to pump up the economy. That’s the idea behind lowering rates (and also the idea behind the still in progress and not necessarily all that well thought out tax rebate checks that Washington is still working out): if you can increase spending, you can prop up the economy. The problem with a fast growing economy is that it typically is accompanied by fast growing inflation, so you don’t always want such a thing.

When interest rates go higher, the economy slows down. People and businesses are less likely to borrow because they’ll pay more interest and more likely to save because they get more interest. This is a desirable process if inflation is high.

If interest rates drop (and it’s quite possible they’ll continue to drop a bit more), consider trying to get your debt refinanced at lower rates than you’ve been paying. If you’re considering a major purchase that you must borrow money for (a house is the best example), it might be a great time to do so. Where an interest rate drop will hurt you is if you have money in money market or other savings accounts; CDs have fixed rates so they won’t hit you with a rate drop until they mature. When interest rates increase, it may be time to seek out higher rate money market accounts and CDs to put your emergency fund and other can’t-afford-to-lose-money into.

Understanding the effects of interest rates on your own finances can mean hundreds, if not thousands of dollars difference every year. Lower rates are a bummer for my personal situation, but it can be a Godsend for others. Higher rates would be helpful for me, but it could drive others over the financial edge. Knowing what to do in each interest rate environment can improve your personal financial situation by hundreds or thousands every year.

…are not any different than doing the smart things in an up market.

The stock market in the United States has a long, successful track record, but it’s never going to go straight up and not occasionally come straight down. Clearly, after the all time highs in the S&P 500, Dow Jones Industrial Average, and Wilshire 5000, we are in correction territory (yes, at some point there will be a Working Backwards post on corrections, as well as on bull and bear markets). The stock market is a marathon, not a sprint. If you’ve been in it long enough, you realize that sometimes things go great, and sometimes not, but over the long run, the results have been positive–and better than other investments.

What are the smart things to do when you’re investing? They’re simple, and importantly, they’re the same if the market is headed up or headed down.

1) Take advantage of the perks offered by the government and your employer

Does your employer offer you a match on 401(k) or 403(b) contributions? Take every cent. That’s free money! If you’re offered a 401(k) or 403(b) or other equivalent plan at all, take advantage of it. Those are pre-tax dollars which can lower your tax burden considerably. Do you qualify for a Roth IRA? Go for it! How about catch up provisions for IRAs or 401(k)s if you qualify with age? Do those too! If it’s free money or a tax break, go ahead and take advantage of it.

2) Keep your costs low

Use a quality discount brokerage. I have a couple of accounts at Firstrade.com and love their low trading costs (not that I trade more than one day a year) and lack of maintenance fees and inactivity fees. Buy mutual funds with no loads, low turnover, and low expense ratios (Vanguard’s family of index funds comes to mind), or their exchange traded equivalents with marginally lower costs. Costs are one of the few variables an investor can control, and over the long term the higher costs, taxes, and fees of high cost funds and brokerages can make a huge difference in your bottom line.

3) Understand the importance of asset allocation

How much money you have in stocks, how much money you have in bonds, how much money you have in cash: that’s what asset allocation is. It’s tough to give a recommended asset allocation for everyone, but I try anyway: for most folks, my model portfolio of 50% domestic stocks, 25% international stocks, and 25% high quality bonds is what I think makes sense; if I was in retirement or had low risk tolerance, I might do something like 35% domestic stocks, 15% international stocks, and 50% high quality bonds. In any case, understand that asset allocation is important because some years one of your investments will do better than others and it’s not the same investment every year. This is yet another way of not putting all of your eggs in one basket.

4) Dollar cost average

Buy into your investments with the same dollar amount at regular intervals; that’s what dollar cost averaging is. Fortunately, most 401(k) plans allow this to happen automatically. Every month, a certain amount of money is invested.

The theory behind dollar cost averaging is that it reduces the risk of buying when the market is at a peak by spreading the investment over a long period of time. The statistics don’t necessarily back this theory up. However, the real purpose in my mind of dollar cost averaging is to get people into the habit of investing regularly. Just make it part of your monthly budget.

5) Diversify

The overall trend of the market is up. The risk of buying an individual stock is underperforming the index. The way to avoid that is to diversify; if you have a thousand shares of a single stock you have a lot more risk than if you have one share of a thousand different stocks. You can easily diversify by buying into (all together now) low cost, no load, passively managed mutual funds or their exchange traded equivalents.

The nice part of these five smart things to do with investing is that they’re smart no matter if the market is up, down, or going ’round and ’round. They’re simple, they’re low cost, and they’ve worked for many, many investors–including myself.

With all the talk about a possible recession (and there really is nothing definitive saying the U.S. economy is in one, or all that close to one), I thought I would discuss what the definition of a recession actually is.

A recession is considered to be two or more consecutive quarters of negative economic growth or two or more consecutive quarters of decline in gross domestic product (GDP), although in the U.S., the official designation is done by the National Bureau of Economic Research which has a somewhat more vague definition. A depression is essentially a more severe version of a recession.

In order to fit into the definition of a recession, there must be two quarters in a row of negative growth. Currently, there isn’t data supporting one quarter of negative economic growth, but the data also tends to lag by at least a quarter. The most recent release on GDP by the Bureau of Economic Analysis for the third quarter of 2007 indicates that GDP increased by 4.9 percent. The fourth quarter data isn’t yet available.

The data that has been available has shown that economic growth in the US has been slow for several years now–slow, but positive. That growth rate is typically affected by interest rates; in general the higher interest rates are, the lower growth is, and the lower interest rates are, the higher growth is; however, with higher growth comes higher inflation, and since the days of Alan Greenspan the Federal Reserve has been obsessed with stamping out inflation, which has kept inflation low but growth slow. As growth has continued to slow in recent times, the Fed has lowered interest rates, and today, fearing the worst, it cut interest rates by the largest amount (three quarters of one percent) in nearly a quarter century. It takes time for these cuts to work their way through the economic system, so we may not see the effects of the cuts for quite some time. Will it be enough to prevent a recession? It remains to be seen, but typically, lower interest rates increase growth–eventually.

To say a recession is coming is like saying it’s going to rain; if you wait long enough, sooner or later, you’ll be correct. The question is when a recession will occur. Could it be happening now? It’s possible, given the lag time in economic data, but to prove it you’ll have to bring the data.

I’d like to welcome those of you who are here linking from this week’s Carnival of Personal Finance, hosted by Green Panda Treehouse. Stay awhile!

Paid Twice and Mrs. Micah today double teamed the subject of not being ashamed of being unable to afford things with the lovely Mrs. M focusing on clothing in particular, which brought me to an epiphany: how long have I had some of these clothes anyway?

Clothing may be the ultimate want vs. need item. Yes, we all need clothing (not quite in the same league as food and air, but close), but no, we don’t all need to spend $25 on a t shirt or $200 on a pair of shoes. The keys to being frugal with clothes are to not spend too much to begin with and to make whatever you get last.

Granted, clothes for kids (like my seven year old niece) don’t last; the kids outgrow them in short order. I swear there are tons of clothes that she received as gifts that she never wore. However, they can still be frugal–hand me downs, garage sale items, or tax write off donations to the local thrift store all can help the bottom line one way or another.

Personally, I have clothes in my closet that are older than my niece is. This past summer at KansasFest, my attire was composed primarily of the shirts from the annual event, one for every year since 1995. They all still fit (a few a bit too big). I get most of what I wear as gifts from family and friends; I have, in the last four years, bought three long sleeved shirts for important events, and about a dozen pairs of my infamous loud shorts. Almost all of my clothing purchases are at discount stores or factory outlets. Aside from those clothes, a pair of shoes every year or so, and “special event” t shirts (Honolulu Century Bike Ride, Great Aloha Run, KansasFest), I’ve not spent a dime on clothes.

Granted, I’m far from a fashion plate, but I’ve never been sent home from work inappropriately dressed nor been denied service at an eating establishment due to being underdressed. I’m more proud of how long some of these things have lasted and the fact that my (lack of) fashion sense has let me ignore trends and keep wearing whatever I have.

Clothing may rank up there with life’s biggest essentials, but it doesn’t have to be up there with life’s biggest expenses! Buying quality items that last, ignoring fashion trends, passing on (and accepting!) hand me downs, and shopping at discount stores or factory outlets are always to spend your clothing dollars more frugally.

Two of my friends got me a new bag for the holidays; I think that at least one of them thought my little messenger bag that I bought years ago in New York City for $1.99 was overstuffed. Unfortunately, while the high tech looking bag appears larger than my old messenger bag, it actually holds less stuff. So now I’m carrying both bags, if that makes much sense.

While doing whatever the opposite of consolidating bags is, I decided to go through my gift cards:

Circuit City: $24 (not a gift; rather a “reward” for their not having my online order that was listed as in stock ready in 24 minutes–it ended up not being ready for about two weeks);

Jamba Juice: $10 (I never go there; this will likely be given to one of my friends who does);

The Coffee Bean & Tea Leaf: $10 (ditto Jamba Juice);

Outback Steakhouse: $25 (fat chance of my going there with my vegetarian partner);

Barnes & Noble: $25 times three (although one has only about $10 left; this is interesting in that I’m much more likely to go to Borders than Barnes & Noble, only because of distance);

The Home Depot: $100 (most of which has been used);

Borders: $25 (more likely to go there than Barnes & Noble, yes, but still not used);

Gap: unknown amount (credit from returning some clothes that were the wrong size; I also never shop there);

iTunes: $50 (I just used a $25 there and have about $5 left in credit at the online store);

Chiles/Macaroni Grill: $25 (won at a company function for my part time job);

Checker: $10 (received as a mail in rebate);

Jack in the Box: $20 (I think about $17 left; I used the rest of a $10 today);

Visa: $50 (I think about $30 left);

Longs: $10 times two (only about $3 left on one of them).

That’s a lot of money tied up in gift cards!

As mentioned in an earlier post, tomorrow’s my birthday. No, I didn’t go out and splurge on anything today (although I did eat out at Jack in the Box, using a gift card from one of my blogging buddies). Instead, I spent the day catching up on thank you cards from the holidays, doing a bike ride, working on my budget, doing some reading (an actual book as well as blogs), and I’ll do a run tonight as I approach the Great Aloha Run. In the meantime, here’s your link payday for January 20, 2008:

I’ve Paid for This Twice Already writes about a situation when your best laid plans don’t work as this week’s shopping list ends up longer than her arm! She is able to limit the damage and has a plan for catching up.

J.D. over at Get Rich Slowly discusses the ignored side of personal finance; rather than decreasing your spending, how you can increase your income. I’ve had a part time job as well as my full time job since last millennium sometime, so I certainly do appreciate the extra cash flow; I’m hoping I can develop a couple of other sources of income as well.

Trent over at The Simple Dollar talks about a problem we all (think we) wish we had–the inability to spend money. Trent takes a view of this possibly being a psychological problem; I admit I haven’t researched this from a professional perspective (I am, after all,

Mrs. Micah discusses whether borrowing a DVD from a friend actually saves her any money. It’s an interesting concept; if you would not have spent money on something anyway, does borrowing it do anything at all for your bottom line? Food for thought.

Finally, Lynnae over at BeingFrugal.net discusses a different kind of wealth: spiritual wealth. Given that I was able to attend service at my temple for the first time in three weeks this morning, I think I appreciated that more than I have previously.

I turn 41 on Monday (which in social work years is 287). I’m often tempted to get myself a big ticket item on my birthday, especially one that’s a milestone like last year, when I turned 280, uh, 40 (as an aside, age 41 for males in the tradition of Japanese settled in Hawai’i is considered “yakudoshi”, a crucial year in life with significant changes, so I guess this birthday is also a milestone). I’ve had my eye on a new notebook for awhile as my faithful but long in the tooth iBook G4 keeps begging to be replaced; the seat covers in my truck need replacement; my Cannondale 14 speed seems like an antique; my 3G iPod is (literally) generations behind the times. And that’s without my self-declared midlife crisis–I could do the stereotypical thing and spring for a new sports car, I guess, although I only drive trucks.

I’m not extravagant, but I’m not a monk, either. I admit it’s nice to treat yourself to new stuff–as long as new stuff doesn’t mean new debt that’ll keep building upon itself even as your new stuff becomes old stuff that needs replacement by newer stuff. This week was MacWorld and the MacBook Air looks drool worthy. But $1799 ($1699 with my educational discount and a few bucks less with my National Military Families Association discount) is way out of my ballpark.

First, I hold the line on spending on myself by reminding myself constantly of my long term goals and asking myself how a big ticket item right now will help me reach them. Yes, a new MacBook of any genre would be a big improvement over my iBook G4 and it would make recording my podcast easier, but how’s it going to help me retire early? If this blog starts picking up enough steam that I need to post more regularly and the speed of the iBook makes that unbearable, then yes, it might help, but for the most part, my iBook can still limp along until I’ve set aside enough money for the replacement notebook.

If I’m still tempted–seriously tempted–by an item, I play mind games with myself, like trying to figure out the cheapest way to get ahold of it. I can spend lots of time using the Internet researching prices and trying to figure out if I can get some kind of discount with a membership I hold or maybe even through the use of a certain credit card. I can also argue with myself on timing a purchase. Usually I can do this well enough that the immediate urge to buy something is past.

My third line of defense is to read some personal finance blogs, particularly posts that deal with frugality. Get Rich Slowly discussed ways to avoid gadget envy, which is one of the things I deal with all the time. I especially like the three month rule from The Simple Dollar; I also wait at least that long once I start thinking about buying a new notebook, partly for the price to come down, partly to see if there’s any problems with the model I’m lusting for, and partly to see if a new model is on the horizon. The longer I can put off buying it, the less likely I’ll be to put out the money.

Finally, when I’m down to it–if, despite my best efforts to talk myself out of it, I decide I’m going to spend money on this new computer or similarly priced item–I then spend even more time researching prices and vendors as well as trying to time my purchase. I tend not to buy late in the week, usually telling myself the Sunday ad might bring a better deal; I also tend to buy just after my credit card statement ships, buying myself another month to pay. Every day I can avoid spending the money on a big ticket item is a day when I get a little interest on it and the chances I’ll actually ever buy it go down a little.

In short, yes, it’s my birthday in two days, and yes, I am tempted to get myself some new computer equipment (especially today, after my iBook limped through the Skype conference recording I made for my new podcast). But even though it would make my life easier, I’m not convinced it’s worth spending the money on it, and I’ll play all kinds of tricks on myself to not spend the money or at least thoroughly research and delay the purchase. Now, if someone wants to give me a new MacBook for my birthday, I’d be thrilled, but I also know I can live without one–at least for awhile.

I love my iPod touch. There’s very few gadgets I’ve ever had that I’ve loved as much. Not only is it a great audio player, it serves as my planner, stumbler, email checker, quick Web browser, alarm clock, and about a zillion other functions. That said, I was torn when I learned about the new applications being released for the iPod touch at Macworld Expo this past week, due to the cost: $20.

Twenty dollars isn’t a deal breaker by any means, but as I continue in uncertain times with my job (and entering the month where those bills from the holidays are coming due), a dollar is still a dollar, and dollars are even more difficult to let myself part with. I didn’t think I’d be willing to pay the $20 to get those, at least not right now, until I realized something: I didn’t actually have to pay $20.

Over the last couple of years, I received as gifts two iTunes Store gift cards, one for $25 and one for $50. I’ve bought exactly two songs ever from iTunes: Bizarre Love Triangle by New Order for me and Music Box Dancer for a friend (don’t ask). This is not to say I’m opposed to buying music online; quite to the contrary, I think that it’s the way to go at this point. But I have so many CDs–including dozens I just rediscovered from early college–that I almost never buy any new music. When I do want to listen to something new, I often borrow it from the public library to actually see if I really want it. So I had $75 of credit in the iTunes Store which I remembered yesterday. That credit wasn’t going anywhere, and it wasn’t all that likely I was going to spend it on music, so I went ahead and used it for the four new iPod touch applications (you may want to see my personal blog later tonight for a quick review of the new apps). This way I was able to treat myself to some new tech items without it actually hitting my pocketbook. It’s unlikely I would have actually ponied up $20 cash to pay for these, but since this was credit that wouldn’t likely be used otherwise anytime soon, I was able to justify using it for some fun and functionality in my iPod.

Sometimes, even gift cards you wouldn’t typically use can come in handy!

A dividend is a payment made by a company to its shareholders. It is a part of a company’s profits distributed to those who hold stock in the company. A dividend is typically paid in a fixed amount every quarter in cash. Dividends could take other forms such as property or stock. Unlike interest payments, dividend payments must be approved by the company’s board of directors before each distribution. Companies will pay dividends to their shareholders with a portion of their profits as an alternative to investing those profits back into the company.

Generally, large, established companies are those that pay dividends. Many of the Dow components are dividend payers, such as Altria, Merck, and Wal-Mart. Many investors rely on dividends for part of their income. The dividend yield is the yearly dividend divided by the stock price; for instance, as of this writing, Altria pays a $3.00 dividend each year and has a share price of $76.80, resulting in a dividend yield of 3.9%. The dividend yield allows comparison of dividend paying stocks with each other as well as versus fixed income investments such as money market funds or certificates of deposit.

Some companies have dividend reinvestment programs, also known as DRIPs. The allows stockholders to automatically have their dividends purchase more shares of stocks when they are paid, rather than have a check issues to the stockholder. Some brokerage houses also allow the reinvestment of dividends. Typically the stockholder gets fractional shares of stock when using a DRIP as the dividend will almost never calculate to an exact number of shares.

In the United States, dividends have had a resurgence of popularity in the last few years as qualified dividends are currently taxed at a maximum 15% rate on the federal level. This is often below the investor’s marginal tax bracket, which makes the dividends quite attractive.

One of the things I look for when deciding which stocks to buy is a history of paying dividends. I believe that dividend paying companies tend to be robust and healthy (with exceptions, certainly!) and will survive and hopefully thrive. Dividend paying stocks are among my favorite investments, providing steady income as well as offering the opportunity for growth that fixed income investments simply cannot provide.