All the personal finace foundations build on each other - #8 continues with the concept that personal finance is much more about behavior than it is about the numbers. Figuring out the basic principles that put you on the right path to financial success is the easy part! It is following through with the behaviors and habits that is the hard part. Most people know that contributing to a 401k is a good idea but so many don’t follow through with the behavior to make it happen. How many people this year blew right past April 15th and did not fund their 2007 Roth IRA? How many people spend more than they make? If I had to pick who was to be better off financially: a CPA with bad financial habits and a recent college grad with good financial habits I am always going to pick the recent college grad! You can’t make up for bad habits with better financial knowledge.
Archive for the 'Personal Finance' Category
We have had a little bit of a hiatus on the 10 foundations of personal finance that I started writing about last year but I wanted to finish it off. So here is #7!
I started listening to Dave Ramsey in 2006 but followed many of his principles before I had ever heard of him or the daily radio show. Dave’s view of debt is spot on: You will never find financial freedom or success if you continue to have “payments”. Credit is so easy to come by today, (although it has tightened up recently) that it is easy to pile up all kinds of stuff on credit from cars to clothes to even air conditioners (heard that on the radio today!)
Like Dave Ramsey, I subscribe to there being only one kind of debt that is part of a solid financial plan: mortgage debt. This is the “almost” part of living debt free. With that said, you need to be smart about your mortgage debt. The banks will approve you for well over what you can afford. Remember, the banks are looking to maximize profit not look out for your best interests. It takes a lot of discipline to not spend what the bank will approve you for but in the long run it is one of the most important financial decisions you can make. In my view your mortgage should not exceed 2.5 times your house hold income. Why does that number work?
Household income: $50k
Purchase Price: $150k
Downpayment: $25k
Mortgage: $125k
15 year Mortgage Payment + Taxes ($1250) & Insurance ($500) @ 6% ~ $1200 month
Monthly Take home ~$2900
Housing to Income ratio 40%.
You might balk at the 15 year mortgage but I can’t emphasize how important that is. Forget the interest savings for a minute, the number one reason to go with a 15 year mortgage is it will force you to keep your housing purchase within your means! I have had a mortgage for 5 years now on two different houses and both have been 15 year notes. If you start out with a 15 you will never miss the 30 
The 40% housing to income is on the high side but if you have yourself on a budget you should be able to swing that. Dave Ramsey recommends 25% and that should be the goal but up to 40% is ok with a household income of $50k
If you double the numbers they look like this:
Household income: $100k
Purchase Price: $250k
Downpayment: $50k
Mortgage: $200k
15 year Mortgage Payment + Taxes ($2500) & Insurance ($1000) @ 6% ~ $2000 month
Monthly Take home ~$5400
Housing to Income ratio 35%.
In addition to the 2.5 times rule I also like to use the rule that your down payment should be half of your household income. Again, it forces you to make a housing purchase you can afford.
I started using Craigslist when I was in Burlington but had limited success in buying/selling as the community was pretty small. You had a lot of college students using it so the apartment and furniture threads were pretty active but that was about it.
When I moved to Atlanta I quickly realized that the size of the Craigslist community here is HUGE. I have had great success in selling stuff on the Atlanta Craiglsist board and have actually found myself using it a lot more that Ebay. There is something to be said for how simple they keep things. It is easy to post, does not cost anything, no shipping to deal with, and people pay you in cash! Compare that with the hassles of Ebay and you can quickly see why Craigslist has taken off. I still use Ebay for niche items that don’t have mass market appeal but for most items it’s Craiglist!
Following up on my WaMu review I wanted to take a minute and review a new money management tool called Mint.com. Mint is an account aggregation service. The concept of financial account aggregation is not a new concept as Yodlee has been offering this service to banks for a number of years. As a basic concept Mint.com is not all that different. They even use the Yodlee service to run the back end of their application.
What makes Mint.com interesting is the customer experience they deliver. I do user experience for a living and can tell Mint has invested heavily in this area. I signed up for an account and was up and running in less than 5 minutes. From sign up to seeing 7 accounts aggregated in one screen took 5 minutes! Now granted, I am an advanced user who already had all my online accounts setup, but still 5 minutes is impressive. I do need to run this through the “Mom” test and see how long it would take my mom to go through and sign up.
Mint’s business model is an interesting one: they sell space to financial institutions that make offers to help you save money. They know the interest rate on your accounts and will make offers from competing banks that offer you a lower interest rate. Since I carry no consumer debt and already have a high yield savings account this feature has no value to me but for some it might be useful. I just hope they can make this model profitable.
Right now Mint only has bank accounts and credit cards included in the aggregation service but they claim to be adding mortgages and others soons. Brokerages and mortgaes would be a great addition!
Categorization is a key concept in all money management software. You want to be able to quickly see at the end of the month where all your money went. They have a super simple interface for categorizing transactions and even putting rules in place so that the same transaction next time is automatically categorized. However, they have one fundamental flaw that really reduces the usefulness of mint: you can’t create custom categories! Hopefully they will add this soon, because after playing with my accounts for 10 minutes I quickly ran into problems with the pre set categories.
Mint also has a simple budgeting system where you can set your budget each month and then track your spending against it. I do my simple budgeting in Excel but I will have to see how usefull this aspect of the service is.
Overall I am impressed so far. I think with a few changes this will really become a great little web app for managing your money.
Back in 2000 I started banking with a little known startup called Lighthouse Bank out of Waltham MA. They were one of the first banks to offer no fee checking, online banking, and ATM reimbursement fees. They had fantastic customer service and were great to work with but they started putting minimums in place. When I moved to Vermont I decided to leave lighthouse and join a local bank (Citizens) that also had online banking. At the same time, I also discovered the new found world of high yield online savings accounts and opened an account with Emigrant Direct. This setup worked great as I had local ATM’s, a free checking and an online savings account earning 5%. The only downside was I had a 3 day delay between transfers.
When I moved to Atlanta it was time to look for a new bank. Here are the key things I look for:
- Free checking with no minimum and no fee’s unless I do something stupid like bounce a check.
- Outstanding online interface to manage all my accounts. I have never balanced a check book and don’t plan on starting any time soon!
- Plenty of local ATM’s and ideally a branch close to home.
- High yield online savings account.
- Free checks is a nice bonus although I write about 5 a year
- Free online bill pay
- Great customer service with short wait times in the branch or on the phone.
When I started looking around I found that Washington Mutual met all of my criteria. Could a bank really do everything I was looking for??? After 2 years the answer is a resounding YES! WaMu is fantastic! I can’t recommend them enough! I have had nothing but a great experience with them and encourage everybody to sign up for accounts. Make sure you sign up online as they only offer the high yield Savings Account online. There is also a branch right across the street so that makes them super convenient as well!
ESPP’s are often the source of a lot of confusion so i thought it would be a good topic to post on. Most people don’t realize they are giving up FREE money by not participating in these plans.
What is an Employee Stock Purchase Plan or ESPP?
It is a stock purchase program that allows employees to purchase stock at a discount, usually 10 or 15%
Most large public companies offer these programs. Check with your HR department to see if yours does. If the program meets a few simple criteria they can be a great way to get FREE money. We all like FREE money
So how does it work?
Employees contribute after tax dollars, up to a pre-defined maximum, to an escrow account. At the end of the plan period, either quarterly or semi-annually, the company uses the escrow money to purchase the stock at the closing price minus the discount.
What about the free money part?
You need to read the fine print and see if there is any kind of holding period. If there is NO holding period you should contribute to the MAXIMUM the plan allows. As soon as you get the discounted shares, turn around and sell them the next day for an automatic 10 or 15% return on your investment!
The Home Depot Example
Here is how it works at Home Depot, we will use a sample salary of $50k for easy round numbers.
- Semi-Annual Plan
- You can contribute up to 20% of your pre-tax salary
($5k per plan period / $384 per pay check) - 15% discount on the closing price of the last day of the plan period
($750 discount) - No holding period
This works out to a 3% bonus per year or $1,500. Not bad for doing nothing but a little planning. The tricky part with this is that the 20% will take about of a third of your paycheck when you take taxes into account.
| Bi-weekly Gross Pay | $1,923.08 |
| Federal Withholding | $289.50 |
| Social Security | $119.23 |
| Medicare | $27.88 |
| Georgia | $102.77 |
| ESPP | $384.62 |
| Net Pay | $999.08 |
On the plus side this is a GREAT way to save money for big purchases and to live on less than you make.
What about the taxes? Shouldn’t you keep the stock for at least a year to pay less in taxes?
Here is how the taxes work. If you sell the stock right away, the IRS considers it as ordinary income. If you hold the stock for at least a year you will pay capital gains which is 15%. So yes, you would pay taxes if you held the stock but you always have to evaluate risk. There is an added risk to doing that and for me I just don’t think that risk is worth it. For example, we received the most recent allocation of ESPP shares in July at $38. By the time the shares were in my account (~10 days) the stock was at $40 and I sold them immediately. The stock is at $34 today!
I am an avid believer that you should not invest in the individual stock of the company you work for. You already have your income tied directly to the success of the company, you don’t want your investments to also be impacted if the company takes a turn for the worse.
There are a couple different pahses of investing. Let’s take a look at each one.
You Can’t Invest If You Are Broke!
Simple concept right? You have to be living far enough below your means in the first place to save up some money to invest. You can’t start investing if you are living pay check to pay check. If you are, read through the first 5 foundations and come back to this one.
I have money, now where do I invest it?
You are following the first 5 foundations and your savings acount balance is starting to have some zero’s on the end of it. You have an emergency fund of 6 months and you have money left over that you are now ready to invest with the hopes of seeing better returns than 5% in a high yield savings account.
There are thousands of different investment options out there. My goal here is to break it down and make this really simple: put the money in a broad market index fund or a growth stock mutual fund with a long track record of success.
I have two spots where i put my investment money: growth stock mutual funds and index funds. Let’s start with the mutual funds. Since my older sister Rachel works at Lord Abbett Investments , I don’t pay any sales charges or commissions to Lord Abbett. This is a huge advantage and the primary reason I have most of my portfolio with them.
If Rachel were not at Lord Abbett, I would have the money invested with an index fund at Vanguard. Since Crystal and i are not married yet, her 2006 Roth IRA could not be opened at Lord Abbett without paying a sales charge. We decided instead to open a Vanguard account and put the money in the S&P 500 Index Fund. Opening the account was easy and with a 12.2% return since 1976 and a .18% expense ratio this is a great investment option!
I have the money invested now what?
Leave it alone! Let the magic of compounding take over. This is one of my favorite calculators to play with:
http://www.moneychimp.com/calculator/compound_interest_calculator.htm
Take a look at this quick math:Â If you invest just $10k a year for 30 years at a conservative 10% interest rate you are looking at $1.8 million! What makes this really interesting is if you put in 31 years. You get 2+ million. So in other words, waiting a year to start investing with this formula would cost you $200k. Starting early will have a HUGE impact on your overall portfolio.
Unlike Foundation #4, this is the one that usually gets people in trouble. Here are my top 5 depreciating items to watch out for:
1) Cars - Beside your house your car is probably the largest asset that you will own. It is also one that depreciates like a rock! Most cars will loose 50% of their value in the first 4 years. There is so much to talk about with cars that I will dedicate an entire post to them in the future
2) Furniture - If you think cars are bad furniture is worse. Furniture depreciates about 25 percent on the first day out the showroom and just keeps going down from there. Don’t even get me started on the people buying $10k in furniture on credit and taking 10 years to pay it off. “Rooms To Go” is a finance company that just happens to sell furniture. Furniture deserves it’s own post!
3) Consumer Electronics - Computers, TV’s, gadgets, etc all loose value VERY quickly because technology progresses at such a rapid pace. Some companies are working on 6 month product cycles!
4) Sporting Goods - Ever shop for a set of golf clubs or a snowboard at the end of the season? Most of the time you will find discounts of at least 50% off. That means the shiny new set of clubs you bought at the start of the season is worth less than 50% of what you paid! Another category that goes down like a rock: Fitness Equipment!
5) Clothing - Fashions come and go just as quickly as the seasons. The hot sweater you bought last year is old news this year and is worth next to nothing. The higher the fashion the steeper the depreciation slope!
The best way to combat depreciation is to buy used and let somebody else take the price hit. eBay and Craigslist have made this easy but you do have to be patient to find the best deals. One aspect of eBay that is often overlooked is that eBay can now put a price on everything. If you want to purchase something new it is easy to evaluate the depreciation slope BEFORE you buy.
There are two kinds of assets: those that appreciate in value and those that don’t. Your goal should be to focus on the assets that appreciate in value:
1) Cash in a 5% Online Savings Account
2) Investments like growth stock mutual funds
3) Real Estate
Got any others?
I have designed this foundational series to have all the articles build on each other. Once you have your monthly budget set and your income is greater than your expenses it is time to start figuring out the best way to save the money left over. Hands down the best method I have found for saving money is to have automatic withdraws from your savings account or paycheck.
This method is referred to as “Paying yourself first”. In my previous budget post there was a very clear reason why the income was at the top, followed by the 401k, ESPP, and Roth IRA and finally the bills and expenses last. This makes me think along the lines of paying myself first! Saving money is the first thing I do before any money is spent on bills and expenses. It is a fantastic way to think about finances and has worked really well for me!
David Bach’s book “The Automatic Millionaire†does a great job of driving this topic home and explaining how it works. I highly recommend it!
The great thing about this topic is how easy it is, well to setup that is. Leaving your allocations alone and having the discipline to not touch the money is the hard part. Set some aggressive goals in your budget, and work hard to reach them!
So where are the opportunities to setup automatic savings?
Savings Accounts
Setup a high yield savings account with WaMu or Emigrant Direct and setup a recurring transfer for 10% of your income. You will be amazed at how fast that account will grow and you will have a 6 month emergency fund in no time.
401k
Most people have access to a 401k program at work. If you do, this is a great way to set up automatic savings. Set your 401k percentage, and put the money in some good growth stock mutual funds. A great method for increasing your 401k contribution is every time you get a raise increase your 401k percentage so the net impact to your paycheck is 0 and don’t upgrade your life style!
Roth IRA
Every Roth IRA I have seen has had an automatic investment option. Put $333 a month away and you can max your Roth IRA at $4k for the year
ESPP (Employee Stock Purchase Plan)
A lot of public companies offer this and it is an easy way to save money automatically. I will explain later how I take advantage of this at Home Depot.
Investment Brokerage Account
Just as a Roth IRA can be setup to make automatic investments, your standard brokerage or mutual fund account can also be setup to pull automatic investments out of your checking account.
With online banking, direct deposit, and electronic transactions there is no excuse why you should not make your savings automatic!
Personal finance success starts with a commitment to spend less than you make. However, where your spending falls in relation to your income can’t be known unless you map out all the money coming in and all the money going out. This is where the budget comes into play.
Budgeting for me is a fairly new concept. I have only been keeping a budget for the past year or so. During this time, I have been experimenting with a couple different methods to see what works. I have heard the envelope system is very effective but I don’t do cash (topic for another day) so I passed on that. I have tried recording all transactions in Microsoft Money or Quicken but I usually fall off that train pretty quickly. I think the key to budgeting is that it has to be simple. Since I like Excel I decided to start there and see how I got on. What I came up with is this Simple Monthly Excel Budget
*DISCLAIMER* All numbers are fictional and are just for display purposes!
Step 1)
Enter Your salary and how many times a year you get paid. If you are a single income household just enter zero for salary 2
Step 2) Grab your paycheck or go to PaycheckCity and enter your information
:
Salary 1 is based on bi-weekly paychecks so I use a multiplier to get to the monthly numbers. Salary 2 is based on monthly paychecks. After entering your income, taxes, 401k (if applicable) you will have your net after taxes. This is the money you have to spend each month.
Step 3) Now it is time to enter your after tax deductions like medical, dental, and employee stock purchase (if applicable)
If you don’t participate in an ESPP just enter 0%. Now you have your take home pay in each check.
Step 4) Enter your Roth IRA information. If you are not participating in a Roth IRA enter zero (You should be - topic for another day!)
Step 5) Enter all your non credit card expenses. Things like mortgages, utilities, etc. For utilities that fluctuate, I enter an average since Gas and Electric will usually offset each other during the year. I also like splitting up the mortgage payments into principal, interest, and taxes so I can see the principal amount each month
Step 6) Now enter your yearly expenses and divide by 12 to come up with a monthly average.
Step 7) Enter all your expenses that you put on a credit card each month. You will see why I do it this way next
Step 8 ) Now we add it all up!
Your disposable income equals your take home pay minus your expenses and your Roth IRA contribution. This is how much wiggle room you have in your budget each month, hopefully it is a positive number! If it is a negative number, you need to cut some expenses or increase your take home pay.
I use the do not exceed line above so that each month I can glance at my credit card bill and make sure we are on track as most of our expenses are on the credit card each month.
Step 9) The last couple lines give you a quick snapshot of how you are doing overall with a look at your savings and retirement rates.
So that is what works for me. What about you?
Sound simple right? In theory yes but in practice no. Just look to the negative savings rate and you will see that Americans today are spending more than they make and saving less for tomorrow.
I don’t want to make it sound easy, it isn’t! You have a lot of big companies spending an incredible amount on marketing. To add to the big marketing budgets, the marketers are getting smarter and more advanced in their techniques. Holding onto your hard earned dollars in today’s consumer driven society is hard work. Who doesn’t want a new car or some hot new gadget?
What it comes down to is commitment. You have to set a budget and commit to spend less than what comes in every month. Resist the temptation to spend crap on stuff you don’t need to impress people you don’t know!
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