Uncommon Cents

While this is being listed under “Basics”, it may surprise some that the argument between which to do first: save for goals (retirement, a home purchase, college education, or other long term goals) or pay off debt.

The answer I have for this argument is a bit complicated, and includes a little of both, but the short version is: both are important.

When you’re at the point of dealing with this saving vs. debt reduction argument, it’s pretty much a necessity you’ve examined your baseline budget and gotten a handle on your cash flow. If you’ve not done these, do so first! Once you’ve got your cash flow positive from month to month, let’s go ahead and work on what to do with those positive dollars.

First off, start with an emergency fund. Consider a money market or high yield savings account (possibly with ATM card and check writing, like at Capital One Direct) for this money. How large of an emergency fund? We’ve discussed this before, but if you’re considering this choice, I’d suggest having at least $1,000 in there (if, however, you’re at the point that you’ve paid off all of your unsecured debt–basically everything but a mortgage–you’ll want to bump up that emergency fund to something between three and six months of your earnings). So the first part of this answer is, “save–for a $1,000 emergency fund”.

Second, consider your time horizon: if you are less than five years away from retirement, you will want to make saving a priority over debt reduction; however, if you’re on the opposite end of that timeline, debt reduction–and hopefully debt elimination–is certainly a priority.

Third, you are likely to want to do a bit of both at the same time, the question is how much of each you do. If you’ve decided debt reduction is your priority, make a plan and stick to it. Put the majority of your positive cash flow into paying down–and paying off–that debt. Consider the Debt Snowball or some of the other options we’ve written about previously. If you’ve chosen to concentrate on savings, put the majority of your positive cash flow into that (we will discuss some thoughts on how to put your savings dollars to best use at a later date). No matter which you’ve chosen, though, make sure you pay at least the minimums on your debt promptly–late charges and possible hikes in interest fees for paying late or insufficient amounts will make it even harder to overcome these debts.

Finally, keep at it! Persistence and perseverance are the keys to your eventual financial success. There will be many difficult moments along the way, but the sooner you start–and the more diligently you follow your plan–the quicker this will all happen. A journey of 1,000 miles begins with one step–so take the step of figuring out which to work on as your first priority: debt reduction or savings.

I received the following email from a reader:

“Any suggestions on what to do with money that I’d like to have earning at least a little interest but need to be able to access quickly? I’m thinking perhaps a money market, but I’m not sure where to find a good one.”

This kind of money, which commonly is an emergency fund, is what is called “chicken money”, a term I credit to Terry Savage of the Chicago Sun-Times. Chicken money is money that you cannot afford to expose to the risk of the stock market (or any other kind of similar fluctuation).

Chicken money is commonly in either money market (or similar high yield) accounts or certificates of deposit. The issue with using CDs is exactly what our reader cites–the need to be able to access it quickly. While you certainly can get money out of a CD, you pay a penalty if you do it when the certificate hasn’t matured.

That mostly leaves a money market or similar account. Local banks here have been paying pathetic rates; credit unions are a bit better, Internet only banks tend to be even better (to check out current rates as well as any special promotions, consult with Bankrate and Bankdeals). Internet only banks have their advantages, but due to their lack of physical branches that can make access difficult. Having a debit or ATM card associated with the account is beneficial (although there tends to be limits on how much you can withdraw during a day and the network of no charge ATMs might be limited), and check writing would give about as close to “full” access of an Internet bank’s account as possible.

Two options I have personal experience with are ING Direct and Capital One Direct. ING Direct’s Orange and Electric Orange accounts tend to have decent rates (and if you would like, I have bonus referrals available that will give you a few more dollars, contact me for details) and provides a debit/ATM MasterCard; they also have a network of “no fee” ATMs. The good news for me is that there’s such an ATM within two miles of home; the bad news is that there might not be such a situation for you. They do not, however, give you a checkbook (for my Electric Orange account I can have checks issued by them; they mail them out, which takes a few days). Like most online banks, they prefer to deal with money transfers online, which is instantaneous between accounts at ING Direct, but takes a few days to other institutions.

For accessibility, Capital One Direct adds a checkbook to its ATM card (which, unlike ING’s, is not a debit card). This is helpful for me, as I often make deposits from that account into a local bank. However, their ATM network seems very limited compared with ING’s–I cannot find a single no charge one within 75 miles of me, which is basically the entire island, and likely the entire state. The checkbook in many ways makes the money more accessible than the ATM card and does not subject the user to the typical $500 (or so) per day limit on ATM withdrawals. I was offered a special interest rate when I opened my Capital One Direct account as a Costco member but I was not able to find such an offer perusing Costco.com.

So there are two options for chicken money; both are quite safe, pretty liquid, and pay about as high a rate of interest as can currently be found. Capital One Direct has a checkbook which can be quite useful in terms of liquidity; both have ATM cards; ING Direct’s ATM card doubles as a debit card and they appear to have a larger network of no charge ATMs. Take a look at these (and other) options if you have a need to stash away these kinds of dollars.

The last time we looked at “Basics”, I discussed the cash flow equation, which is:

income - expenses = cash flow

Now, once cash flow is positive (and the more positive, the better) the wealth equation is also simple:

(cash flow + sensible safeguards + wise investments) x time = wealth

Simple, but not necessarily easy. Once your cash flow is positive, it’s time to do some smart things with your money and let time do its thing.

What are these smart things?

Sensible safeguards: these are your emergency fund, term life insurance, long term care insurance, and disability insurance. You don’t want to toss money away, but you also don’t want to under insure. Keep a reasonable amount (many say a minimum of $1,000, others say six months of salary–personally, I split the difference and say three months of take home pay) in a money market account with check writing and an ATM card (Capital One Direct is the one I use). If you have dependents, get term life insurance; you may also want to consider disability and long term care insurance.

Wise investments: what we’ve been discussing on this blog forever. Passively managed, no load, low cost, tax efficient index funds and exchange traded funds. High quality bonds and bond funds. Traditional and Roth IRAs, 401(k)s, and their equivalents. Reasonable asset allocations. Investments made at regular intervals. Diversification, diversification, diversification.

Time: you know what this is, and the more you have the better.

Wealth: the dollars you end up with at the very end.

The one other thing that you need will be discipline. We’ll cover that later, but in the meantime, remember that formula. It’s a simple, get-rich-slowly, tried and true over time formula that will help you reach your goals–it’s helped me build a six figure portfolio in less than half a decade!

Last week, CNNMoney.com ran an article titled, “Drowning in debt: Deceptive credit card practices.” It pointed out the many ways a credit card company tries to get at your dollars. Fees, fees, and more fees–late fees and over limit fees as well as annual fees all eat away at your dollars. In addition, if you’re late on a payment, the credit card companies will hike your rates as much as they can! Apparently, some credit card companies not only have a payment due date, but even a payment due -time of day- when the payment has to be in. This is a significant disadvantage for those who still use paper checks or money orders and the U.S.P.S. to pay their bills (score one for online bill pay!).

Another way the credit card companies can hit your pocketbook is by shortening their billing periods. I have been a big fan of Discover Card, partly because they’ve had great customer service for me and partially because they’ve had long, 30 day billing periods. I learned this month, however, that my payment date was being moved from the first of the month to the 28th of the month. I can live with that, but it’s not clear to me if my billing period is being shortened, so I’ve asked Discover if my statement closing date is also changing; no answer yet.

Here are some ways to try to keep credit cards from eating your dollars:

Use a card with no annual fee! So many people want airline mileage cards, but they seem to all charge fees. There’s no way I’ll use a card that has a fee, so I have other reward cards.

Pay on time. Late fees can be very expensive, $29 is typical. Keep that in mind when you’re trying to stretch a few days.

Pay in full! This will keep the interest rates from meaning anything. If you can’t pay in full and are carrying a balance, consider doing a balance transfer to a card with a lower–possibly zero percent–rate of interest.

Use online banking. This will prevent late payments, and since most cards let you pay on their Web site at no charge, save you money on postage too.

If you are late or over limit, call immediately! While they may not be totally forgiving, often the credit card company will agree to waive fees.

In addition, if you are carrying a balance with a hefty interest rate, call to see if they’ll be willing to lower it. They may, they may not, but if you don’t ask you’ll never know.

Remember that a credit card is like a tool: when used properly, it can do great things (build your credit rating, put off needing to hand over cash immediately, give you extra benefits like extended warranties and price protection, and offer many types of reward programs), but when used irresponsibly, it can do great harm. Use them wisely!

This past Valentine’s Day, Trent over at The Simple Dollar discussed how he’s been spending less time managing his personal finances because he’s learned how to balance on his financial bicycle (read “improve his financial behavior”) and is starting to shed his training wheels (meaning his budgeting and planning tools). He also stated that he’s noticed that he trusts himself more and that he’s opening his Excel spreadsheet less often and checking his account balances less than daily. In short, it appears that Trent has been able to use the tools of basic personal finance to improve to a point where he may not need them anymore.

I think that’s wonderful. I also think that while I can understand where he’s coming from (both as a licensed clinical social worker and someone who has used a lot of these tools himself for years), I think I’m not where he is yet in terms of being ready to shed them–and even then I’m not convinced it’s a great idea.

I won’t make a professional case for it, but I sometimes believe that issues with money (particularly out of control spending) are similar to issues with food or, worse, issues with substances and maybe even mental health. Getting these situations to a manageable state requires discipline, support, and structure. Discipline–being able to put off immediate gratification for long term goals. Support–the help of other people, sometimes in similar situations (I firmly believe that the proliferation of personal finance blogs, particularly by those who are in debt, are a huge source of social support for those in financial turmoil. In some ways, finances are the last taboo–no one likes to talk about them–and the anonymity of the Internet can serve as a virtual support group.). Finally, structure–having and following a plan, and doing the same thing in the same situation over and over again.

Tools like a budget and a spending log and behaviors like regularly checking your account balances and scheduling bill paying time help with both the discipline and structure parts of your financial behavior. When I’m feeling unsettled financially, I take a few minutes and log down my expenses for the day, check my account balances, write out what my bills are for the next month or two, and estimate my income over the same amount of time. I tend to do this about once or twice a week. I worry that when I’m feeling great financially I’m like the drunk who feels fantastic and decides to skip their Alcoholics Anonymous meeting for a few days or the schizophrenic whose been doing great and decides he doesn’t need his medication anymore–that I’ll stop doing the things that helped me get and stay where I am and fall into my old pattern of behavior, and before I know it, all that hard work is down the tubes.

Perhaps it’s an issue of not trusting myself as much as Trent does. Or perhaps it’s the experience I’ve had dealing with other people and myself in trying to change behavior about fitness and finances and health. I’m not yet ready to give up those training wheels, if that’s what they really are. I may never be ready. I realize that behavior is learned over time, but I think that if I believe I still need to keep a composition book around where I write down all of my expenses, then that behavior might be the best one that I’ve learned to help me keep my spending under control.

I guess what I’m saying is this: if the training wheels help me to keep balance–even if it’s only in my head–then they’re still doing their job, and I’ll keep them on my bicycle as long as I need to.

For fixed income investors who don’t think much of bonds, finding decent returns has become more and more challenging. Money market and high yield savings accounts have rates that have plunged in recent months, and certificates of deposit have not done much better. It’s become a real challenge to find decent returns, but since this question came up yet again this week, I thought I would go through some possibilities; some of these are similar to what we’ve discussed before, but some are new, or at least a new slant:

Check Credit Unions

Credit unions tend to have better rates than banks; sometimes you qualify to be a member through your employment, membership in an organization, or just where you happen to live, work, or worship. While I wouldn’t expect stunning rates, you certainly won’t harm anything by looking.

Go Online

Online banks (ING Direct, Virtual Bank, Capital One Direct, and others) may offer better rates than you have available locally (and don’t forget I still have bonus referrals for ING and Virtual Bank, contact me for details!). You can also check Bank Deals and Bankrate to see what might be available for you locally and on the Web.

Don’t Tie Your Money Up For a Long Period of Time

Conventional wisdom holds true–if you go with a longer term, you get a higher rate as far as a CD goes. However, given that a “higher rate” isn’t all that high, you’re taking a big risk by tying up your money when rates may increase before the term of the CD is done. Chasing rates in this way doesn’t appear to be wise; you may be better off staying in a high yield or money market account to keep things liquid.

Consider Other Options

If you have debt, consider paying it off or at least paying it down. Remember, if your debt is at 5% and you pay it off, what you’ve done is like earning 5% on that money. This might be one of the best things to do with money that you would otherwise have parked.

Yes, there is a need for even the most aggressive of investors to have at least some cash around, and finding somewhere secure and high yielding to plant it and watch it grow is a smart idea. In these challenging interest rate times, however, you may need to take a harder look around than ever to figure out just where you want to have your money sit.

A few weeks back we looked at how I shop online to try to get the best price possible. This week, it went into practice, even though the end result was far from frugal.

My buddy Richelle’s birthday is this week, so a bunch of her friends, myself included, decided to get her a gift from Edible Arrangements. Their stuff is great, but it’s expensive! Six of us chipped in for an arrangement that listed for $74, with separate delivery and tax charges. So, in the spirit of frugality, I looked for online coupons.

Checking out the usual suspects, I was able to find a $3 and a $4 coupon, but I was hoping for more. So more digging led me to a 10% off coupon that worked only in concert with the order being paid for with a MasterCard. This reminded me that sometimes there are discounts in places we don’t always look.

Discovercard.com, Visa.com, Mastercard.com, and AmericanExpress.com all list various discounts available or enhanced reward programs. Groups you belong to may also offer discounts (National Military Family Association, mentioned previously, is one example; National Association of Social Workers is another). Your employer, bank, or credit union may also have arrangements with vendors–mine offers a discount with Sprint, for instance. Even my car insurance company has GEICO Privileges which extends better prices to their customers.

So don’t give up on your first run through! Sometimes better discounts are to be had by looking in places you may not always look. I don’t give up until I find 10% or $100 off (whichever is less) in terms of a discount. Keep searching, keep hunting, and look places you may not otherwise look.

Much has been made of the economic stimulus package and the expected $600 per person (with a lot of catches dependent on income) tax rebate coming from the federal government this year. The idea behind this part of the stimulus package is, well, to stimulate the economy. For the most part, that means the government wants you to do one thing with it: spend it.

While spending that money may be the best thing to do for the nation’s economy, it may not be the best thing to do for your personal economy. Here’s a few other things to consider doing with $600.

1) Pay off debt. This good old fashioned personal finance staple is never out of style. If you’ve got debt, particularly high interest revolving unsecured debt (this mostly exists in the form of credit card debt), consider paying it down or outright eliminating it.

2) Save it. Maybe your emergency fund is a little low (or non-existent). Maybe you found a great deal on a CD somewhere (in these tough times, if you have, let all of us know where!) and want to put a bit of money away for a few months or a year. Maybe you’ve paid off all of your debt (congratulations!) and aren’t sure what to do with the stimulus rebate yet, so you’re considering parking it in a money market account. Nothing wrong with any of these either.

3) Invest it. If you’re following a pre-established plan for investing, keep following it with this “extra” $600, or maybe buy a fund, ETF, or stock you’ve had your eye on. If you’re not following a pre-established plan for investing, maybe it’s time to start! If you’re somewhat risk averse, consider going with a high quality bond fund rather than something in the stock market. It’ll be too late for the 2007 IRA contribution, but 2008 is front and center. Keep it socked away for the long term.

4) Diversify. Not in the typical sense; just do a little of each of these, or split the difference between just a couple.

For myself, I’ll be saving my rebate, because my personal savings account tends to take a bit of a hit with tax time for a month or two, so this will help to replenish those.

What are you planning for your tax rebate?

The term subprime refers to borrowers who have issues with their credit history. The credit rating and history of the borrower is what is subprime (meaning poor or non-existent), rather than the interest rate of the loans given to subprime borrowers, which are higher than typical. Subprime loans also carry more risk for both the borrower and the lender. The lender is lending money to a borrower who has not demonstrated through a healthy, verified credit history the ability and willingness to repay the loan, justifying the higher interest rates–just as a higher return is expected in investing for taking more risk, a higher rate on the loan is expected for the lender taking more risk. The borrower takes a higher risk of defaulting as the payments are higher and they have not demonstrated a history of being a good credit risk. While subprime lenders offer loans to those who would otherwise not be able to borrow enough money to, for example, purchase a house, the unfortunate downside of subprime is that many borrowers are unable to repay the loans.

In regards to the current subprime mortgage crisis, a subprime borrower would often take on an adjustable rate mortgage that usually starts with a low “teaser” interest rate for a few years then resets; combine this with a rise in interest rates over the past few years (prior to the last six months) and the subprime mortgage borrower often ended up unable to pay their mortgage, leading to defaults and foreclosures.

The subprime crisis is not yet over–it led to the fall of Bear Sterns last week and it is not yet known what effect it will have going forward. The lesson to learn from subprime is this: in terms of dealing with bonds, buy quality; build a healthy credit history so you do not have to engage in a subprime loan; and only borrow what you can afford. The next few months will tell us just how extensive the damage due to subprime has been.

As an extension of our previous discussion on online banking, how many of you use online bill pay?

Often online bill pay is offered by not just your checking or savings account provider (whether that’s a brick and mortar bank, an Internet only bank, or a credit union) but often also by the creditor (like the credit card company). Online bill pay offers the promise of lower cost (look, mom, no stamps!), quicker delivery (often payments are credited the same day they are made), and avoiding the variance of the otherwise wonderful system known as the United States Postal Service.

Despite these advantages, for a long time, I was a holdout. I believed that sending paper checks in the mail helped me to hold onto my money longer and generated more interest, although it wasn’t all that wise in retrospect. Even in “high yield” accounts there’s not enough lag time to make up for a 41 cent stamp, and the dangers of late payments (and their associated fees and interest charges) got me to wise up.

Still, online bill pay has not been without its glitches; one month I swear I made a payment but it never got credited. Another time I neglected to specify the date I wanted the payment made as the payment’s due date and immediately had to rush over to the bank to cover the $350 I didn’t have in my checking account. And finally, while I typically use the automated bill pay on the creditor end (like DiscoverCard.com to pay my Discover bill), this isn’t offered with all of my bills; I used to use Netbank’s electronic bill pay, but am not so thrilled with ING Direct’s version.

Do you use online bill pay? What are your experiences like? Are the drawbacks outweighed by the benefits? Have you had issues like I have?