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.

No one, including me, is immune to temptation.

I have wanted a GPS for some time. Recently I learned of this offer via a blog post at Frugal Shopping With Julie. No, I didn’t need a third Discover card (I have a regular one I’ve used forever and a day and the Discover Open Road for 5% back on gas), but I figured one more wouldn’t hurt, so I applied and got the card.

In order to qualify for the GPS offer, I actually had to use the card! This doesn’t surprise me, but I had to read the fine print to figure that out; of course, at the same time I noticed the 0% balance transfer offers (with 3% fee, so much for 0%) and 0% interest on purchases for a few months.

All of this while I’m trying to figure out what to buy to activate the GPS promotion. What to buy with the card?

The best answer: something I would normally be charging anyway, like groceries at the store this week.

The answer running through my head: something I really want, like a Cradlepoint router or an Apple Airport Extreme or a Nikon D40. Something I don’t have the money to pay for right away.

Stop. Breathe. Think.

Buying stuff that I can’t yet pay for with offers like, “0% interest for the next year!” is exactly the kind of thing that got me into financial straits years ago. The way to stay out of those kinds of straits is to avoid going down that same trap. I’ve been fooled once; I’m not going to be fooled again.

That doesn’t mean I am not tempted. The difference between now and then, however, is I can manage that temptation without giving in to it.

In the meantime, I got some organic peanut butter and crackers at the store the other night, and used that new Discover card then. I’m hoping that I get a new GPS in the mail soon, but what I definitely won’t get is into debt, zero percent or not.

In our series on basics, we’ve looked at cash flow, the wealth equation, and baseline budgeting; this time we’ll look at debt reduction.

With saving, it’s clear that even if you don’t do anything else, as long as you put money away regularly, you’ll likely do reasonably well with your money. With debt payoff, it’s much more insidious. If you have serious amounts of debt (or even if you don’t but you want to make efficient use of your dollars when paying off debt), you need a plan. Where to start?

~ Assessment: When considering debt reduction, it’s important to consider all of your debt, and if not all facets, the most important ones. Who do you owe? How much? What kind of debt is it (mortgage, student loan, credit cards, auto loan)? What’s the interest rate? Is the interest tax deductible? What’s the minimum due every month? You may also want to consider any special circumstances, like if the interest rate is variable and may change soon.

Once you’ve determined all of these, you may want to add up your monthly obligations to see how much you owe every month at the minimum. If it scares you, then it scares me too.

~ Planning: All of your debts require the minimum payment; you will likely want to concentrate on one of your debts at a time. How to choose? The Debt Snowball, made famous by Dave Ramsey, suggests paying the minimum on all of your debts except for one: the one with the smallest total. Put all of the money you can toward reducing your smallest total debt, ignoring interest rates, and when that is paid off, switch your efforts to the next smallest total debt. While this flies in the face of mathematics, many have used the Debt Snowball effectively. It seems to me that the primary advantage of the Debt Snowball is psychological–there’s a sense of accomplishment in seeing one debt shrink every month, sometimes dramatically, and eventually paying it off, which would happen relatively quickly with the Debt Snowball.

Your other option is to pay off debt by order of interest rate, paying off the debt with the highest rate first. This is much more mathematically sound than the Debt Snowball, but may lack the psychological advantages of that method. Given that getting into debt is often psychological, paying it off may be just as psychological, and you could use every bit of help you can get!

Two things that may affect your decision on which debt to concentrate on are if your interest rates are going to change soon (such as in the case of an expiring low rate balance transfer offer on a credit card or an adjustable rate mortgage) and if your interest is tax deductible (basically a mortgage or a student loan). If you have an interest rate that might change soon (almost always to a higher rate) you may want to make that debt more of a priority; if you have a loan with tax deductible interest you may want to lower that on your priority list.

~ Execution: Once you have a plan, make sure you stick to it! Whether you choose to use the Debt Snowball or pay your debt off in interest rate order, do it. Make sure you pay in a timely manner, because late fees will make paying your debt off even more difficult. If you cannot make a payment on time, contact the creditor immediately and plead your case; they may not be able to do anything for you, but they might–like waiving a late fee. Use online payment options to make sure that your efforts are not felled by the USPS running late. Put the dates of payment in your calendar and make sure you pay on time. Pay something, even if you can’t make the minimums (although I certainly hope you can). Just keep up with those payments!

~ Hacks: You may want to try one or more of these to help reduce your interest rates further or just improve your overall financial situation.

Call and ask for a better rate: In particular, credit cards are often willing to do this. Be persistent, don’t give up, and don’t be afraid to call multiple times or ask for a supervisor or manager.

Zero percent (or at least lower) balance transfer offers: Credit cards often do this for new customers and almost as often for existing–offer a reduced rate (sometimes zero) on balance transfers. Just be wary of fees (A 3% fee with a minimum of about $10 and maximum amount of $75 per transfer is common) and time limits (the rate may be good only for a few months). I would not suggest applying for a ton of cards just for this purpose but there may be times when doing just that is useful.

Debt consolidation: A debt consolidation loan combines several (if not all) of your debts into one loan. If the loan has a low rate, that can make paying it off easier than the multiple loans that it replaced, and if the interest happens to be tax deductible (as could be the case with a home equity loan or a refinanced mortgage), all the better. However, be very, very careful with these kinds of loans! If you consolidate your debts and then go right back to racking them up–like clearing your credit cards and then running up high balances again–you end up in an even worse position than you were before. Also, be careful using your house as a piggy bank–the last thing you want is to lose that!

Paying off your debt is clearly one of the most important pieces of your personal financial puzzle. You absolutely must get a handle on your debt early on while working on your finances. Coming up with a strategy and sticking to it are absolutely essential to tackling your debt; you can use some of the hacks above to try to reduce your interest rates or otherwise improve your financial situation. Go, go, go on debt payoff!

Many of us know that snowflaking–the art of accumulating small amounts of money that happen to come your way to make a “snowball”, whether used to pay off debt or reach a savings goal–can be a powerful technique in your personal financial picture.

But what is the opposite of snowflaking?

The opposite of snowflaking is when you have small amounts of money fall out of your possession on a consistent basis. This is done, in my experience, primarily two ways:

1) Little “convenience” expenses that add up to one huge inconvenient bill (like buying lunch at work every day or stopping by the convenience store for a cup of coffee in the morning);

or

2) Small monthly fees that add up to one huge headache (like the $5 more a month for the 100 text messages you only use five of on your $10 more a month for twice as many minutes that you don’t use a third of cell phone bill, or the $10 cable television package upgrade so you can get 20 more channels you don’t watch).

Just as snowflaking is a powerful way of meeting your savings or debt reduction goals, the opposite of snowflaking is a powerful way of assuring your goals get met later. It’s a way to make sure that you don’t pay debt down nearly as quickly as you could, because a bunch of snowflakes escaping from your budget could easily mean a couple of hundred dollars a month!

Keeping close track of your spending–a spending log, a weekly review of your expenses, a baseline budget, and a goal budget–can help you figure out if you have any reverse snowflaking going on, and how to stop it. Remember: every dollar spent is a dollar that goes to keeping you in debt longer or keeping you away from your goals. Make the snowflakes work for you, not against you!

Once you’ve established your spending log and used it for awhile, you can take a look at your overall budget. Your baseline budget is the one that you’re currently using (you can take a look at my baseline gas use for an example of what a baseline means).

In addition to your spending log, you’ll need your income; for this I would include any earned income (from your job, for instance) but not unearned income (dividends, capital gains, or interest) unless you actually use it for your monthly expenses. If, like me, this income is reinvested, I wouldn’t use it in my budget. If you have other types of income such as welfare or Social Security, or income which is not cash but can be used like cash in some aspects (WIC or food stamps) you would want to consider that income for this exercise as well.

You’ll want to take a look at your spending log and create some categories; what they’ll be may depend somewhat upon your own situation, but in general things like “food”, “rent/mortgage”, “electricity”, “gasoline”, “toiletries”, and “entertainment” would be included. Depending on your situation, you may want to break things down further–you may want to subdivide “food” into “groceries” and “eating out”, and “eating out” may even warrant further division such as “McDonalds” and “fine dining” and “Starbucks”.

Once you’re done with laying that out, add up your net (not gross, at least not at this point) income as well as all of your expenses, and use the cash flow equation we talked about earlier to see where you’re standing.

When people do this exercise, they are sometimes surprised by their number. Sometimes they have a very large positive number that doesn’t seem at all accurate; sometimes they have negative numbers that don’t seem to make sense. Take a few minutes and make sure your math is correct.

When you have the baseline budget established, it’s time to take a hard look. Where are you spending more money than you want? What areas can you cut back on? Maybe have a specific goal, like, “I will spend 10% less on eating out this month,” or, “I will reduce my Starbucks visits from five a week to one a week over the next three weeks.” Are there ways to work on the other end of the equation and increase your income? Once you have your baseline established, it becomes much more concrete to work on financial goals because you know where you stand and you know where your money is going–and what areas it might be possible to make changes in. That will lead to your goal budget, which we’ll look at in our next installment of Basics.

Welcome to your link payday for June 5, 2008. This week was a great pay week for me because I actually got paid three times (and I’m hoping for a fourth, though likely in vain): once from this blog, once from my part time job, and once from my full time job. The fourth would be my still MIA stimulus payment!

Anyway, some of the better posts of the last few weeks that I’ve read in the blogosphere:

JD over at Get Rich Slowly covers (and advises against) a practice that kills your tax advantages and might indicate you’re in serious financial trouble when he says Don’t Raid Your 401(k) to Make Mortgage Payments.

Mrs. Micah tickles my funny bone when she discusses The Lingerie ROI. Suffice it to say I won’t be investing in Victoria’s Secret anytime soon (I honestly don’t even know if they’re publicly traded!).

Do others judge the frugal? I’m sure there is a lot of that going on; in this intriguing post, SavingAdvice.com discusses The Benefits of Savings Habits that Make You Look Poor. I have a different problem–the benefits of looking old! I really don’t qualify for that senior discount at Jack in the Box (but I’ll take it if they give it)!

Sqawkfox runs a five part series on ways to kick start your job hunt; I particularly like part one on How to Choose a New Career, which addresses something that’s been on my mind a lot recently–pondering your passion.

While it has a rather long title, it has some great points–Trent over at The Simple Dollar discusses Money Magazine’s ‘7 Investments You Need Now’, Portfolio Theory, and My Own Plans for the Future. This discusses some very basic theory on portfolios and covers one of the books I really like, Paul Farrell’s The Lazy Person’s Guide to Investing.

And there’s your link payday for June 5, 2008!

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!

One of the sessions in the parenting class I teach has to do with money management–it’s in a parenting curriculum because it’s quite clear that as a society, we simply do not do enough to teach kids about money. Inevitably, the subject turns to the family’s finances, how to improve the situation, and debt.

While we do all kinds of mathematical exercises dealing with personal finance, there really is only one that matters in the short term:

income - expenses = cash flow

If your income is greater than your expenses, you have a positive cash flow and can create savings to use for future goals. If your income is less than your expenses, then you have a negative cash flow and are in debt. What is nice about the simplicity of this formula is that it points out that there really are only three ways to improve your cash flow:

increase your income;

reduce your expenses;

or both.

While many of the clients in my class ask about how to work on their debt, that concept is often too far down the line given where they are. While it’s arguable that you can do a few things prior to it, getting your cash flow under control and to a positive state is absolutely vital to your financial well being; without doing so, there’s no way you can pay your debt off. Stick to the basics when you’re starting off: figure out where your money is coming from and going to and get your cash flow positive! Increase your income with a second job, a different job, or overtime; decrease your expenses by figuring out where there’s waste and opportunity for sacrifice, and eventually, good things will happen.

401(k) loans drive me crazy; you immediately lose the big advantage of the 401(k), the immediate tax break, because when you borrow from your 401(k)–which is filled with pre-tax dollars–you must pay them back with post-tax dollars. Still, many people consider their 401(k) to be a kind of piggy bank for withdrawals for whatever reason.

But the danger of the 401(k) loan is not just in the loss of the tax break–it’s in the possibility of a job loss. For whatever reason, a relative of mine decided to take a loan out on her 401(k) of $7,000. She was about 1/3 through repayment of the loan when the job ended because the company folded. This leaves her in a bind–pay the loan back immediately [which she can't do--and pretty much no one with a 401(k) loan would be able to do--or she already would have done it] or consider it a payout rather than a loan–with the accompanying taxes and 10% penalty! For someone who is in dire straits enough financially with a loan like this and a job loss, this is devastating.

So consider more than just whether or not you can pay back a 401(k) loan if you’re on the fence about taking one; also consider whether or not your job (or your entire company) is in jeopardy. If your job goes away, the loan might too–not in the sense that you don’t owe on it anymore, but in the sense that it becomes income, and usually not in the way you want.

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?