Tepom.com

Paying off a Direct Loan student loan

2009-04-07T06:05:00.002-04:00

My wife and I just parted with some cash that was burning a hole in our pocket. We considered some home projects like scrapping the carpet in the bedrooms for hardwood and installing recessed lighting in the living room. But at the end of the day when we couldn't agree, we settled on paying off one of her student loans.

Logging in to our trusty finance tool, mint.com, we saw that the smaller loan had the highest interest rate of all of our debt (7.9%). So I went to www.dl.ed.gov and easily made an online payment.

But a word of advice: if you have multiple loans with the Department of Education, make your payment online, but be sure to log in again to make sure it was applied how you would like it to be. I had to call and clarify because there wasn't a place for me to choose which loan the payment was to be applied to. The day after the payment was made, I saw that the it was distributed based on loan size. 60% of the payment went toward the loan that made up 60% of my balance and 40% went toward the smaller loan that I was trying to pay off.

You'll always want your payment to go toward the loan with the highest interest rate!

If you want to be sure that your loan with the highest interest rate is paid off, call customer service at 1-800-848-0979 after your payment is made and give them instructions for how to apply it.

Are you sitting on a few thousand bucks and not sure what to do with it? Instead of getting a new computer, hot tub, car, or home improvements, consider paying down some debt. At the end of the day, it feels great!

Thinking of an FHA mortgage? Think again!

2009-04-01T18:21:00.005-04:00

If you're looking to buy a home and don't have a lot of money to put down, your lender might suggest an FHA loan. While you may have been planning on putting five or ten percent down, you might be intrigued by a loan that requires you to only put three percent down. It's something that I was suckered into when I bought my home in 2007, and I'm still kicking myself for it.

Let's go through a quick scenario. Say you're going to buy a house for $200,000 and only have about $12,000 cash in the bank that you can access to cover closing costs and a down payment. If you can talk the seller into covering some of your closing costs (not unreasonable in this environment), you'll have about $10,000 left to put toward a down payment, which just happens to be five percent. But you're nervous about parting with all of your cash. Then you hear about an FHA loan, which will allow you to put only three percent down($6,000). That extra four grand in your pocket would sure come in handy when buying furniture for the new place!

But you're a fool if you think the convenience of putting down $4,000 less comes without a price. The price will actually be $3,500. That's right -- the Federal Housing Authority will charge you a fee of 1.75% of the purchase price for the convenience of putting down 2% less than you would have to with a more traditional loan. They simply roll that fee into the principal of the mortgage and call it "mortgage insurance" (not to be confused with Private Mortgage Insurance, or PMI -- you'll have to pay that, too).

Given your current financial situation, your lender will give you two options: the FHA loan, which will require 3% down plus closing costs, and an "80/15" mortgage, which is actually two mortgages; one for 80% and one for 15% of the home's value. With the FHA loan, you will put down 3% of the price before the lender shadily tacks on 1.75% to the principal balance, leaving you with 1.25% equity (3% minus 1.75). When your first payment comes due, your principal balance will be around $197,500. With the 80/15 mortgage(s), though you will put 5% down, all of that actually goes toward the principal. So when your first mortgage bills come, you'll owe a total of $190,000.

Two other related factors in the matter are PMI (associated only with the FHA loan) and different interest rates associated with the two separate mortgages (one rate for the 80% loan and a higher rate for the 15% loan).

PMI is a monthly fee that lenders charge for people with a mortgage that has a balance greater than 80% of the home's value. With the FHA loan, your mortgage will be 98.75% of the home's value, so you can bet your ass you'll be paying the $85/month PMI. On the other hand, with the 80/15 mortgage, because neither mortgage will exceed 80% of the home's worth, you don't need to pay PMI. I know it sounds silly, but it's how it works.

The only catch with the 80/15 mortgage is the different interest rates, but any downsides will be canceled out by the fact that you're not paying PMI. An FHA loan is one big mortgage with one interest rate. Let's say 5%. The 80/15 mortgages will have different rates. The 80 will be at a low rate, similar to the FHA loan, while the 15 will have a higher rate. Your interest rate might be 5% on the "80" and 7.25% on the "15." This calculates to be an effective interest rate of 5.37% with a monthly payment of $1,063.56. The FHA loan, though it has a lower effective interest rate (5%, remember?), has a monthly payment of $1,145.22 after you factor in the $85/month PMI that will be required by your lender. All of these assume a 30-year mortgage.

So why do I recommend 80/15 mortgages to first time homebuyers that are strapped for cash? For two reasons:
#1) You start off with 3.75% more equity in your home from day one. On a $200,000 house, that's $7,500!
#2) Your monthly payment will be significantly less, leaving you with extra money to spend (or better yet, to send toward extra principal each month).

If you're in the market to buy a house but can only put 3% down, run away from FHA loans. My advice is to wait and save up that extra few thousand bucks.

Good luck!

Taken for Granted

2009-03-30T18:31:00.001-04:00

Yeah, yeah, yeah, I know I haven't posted since December. I got a new job and started going to the gym in the morning, so blogging time fell in my priority list. The good news is that I lost nine pounds! But let's forget about that for a minute and talk about macroeconomics and taking things for granted...just like you used to take daily Tepom.com posts for granted.

The down economy has taught the world about how sweeping problems under the carpet -- no matter how small -- can easily blow up in our faces. But it's promising to hear that Americans' savings rate is increasing and our consumer spending is in steady decline. Government stimulus and easy credit are quick ways to get things moving again, but it's not the be-all-end-all. Just because the economy will die of thirst if we stop the flow of water doesn't mean that we should stick a fire hose in its mouth.

Conservative oversight of our finances at a personal level is a big piece of what's going to get us out of this mess, but it's much more complicated than you might think. Our financial soundness and stability is about more than just saving ten dollars at a time, earning points with credit card purchases, and gaining 1.5% extra return in a savings portfolio. It's about planning for the worst and taking less for granted.

What are some of the things that our parents may have taken for granted that we Gen-X and Gen-Y'ers now know that we can't?
1. If you work hard, you'll have job security
2. If you buy a house, it will appreciate in value
3. When you turn 65, you can retire, move to Florida, and cash your Social Security checks for the rest of your life.
4. You can have as many children as you'd like whenever you'd like to have them.

I'm sorry to say it, but this economy has taught me that I should never assume anything; there are too many smart people standing in the unemployment line. Though my wife and I are both gainfully employed and don't expect to be laid off, we've made some significant life choices to improve our financial resilience that go beyond bargain hunting:

1. Established a moratorium on home projects
2. Began saving cash to refinance with much more equity (we're hoping to significantly lower our currently affordable monthly mortgage payment)
3. Agreed to wait at least six years to have children
4. Set a goal to open our own business, but only after our house is paid off

Some might argue that a conservative portfolio with complete debt elimination and low-risk investments isn't the best plan, but my wife and I have agreed to pursue it. But given the current macroeconomic situation, lower returns and lower risks look a little more promising than they used to.

Says Gabrielle to her husband Carlos on Desperate Housewives: "Save our money? What?!? Come on, nobody does that anymore!"

If you currently have a job, have you changed your spending habits to "weather the storm?" Have you taken any major steps besides cutting back on the little stuff?

Much thanks to my reader Tim Cederman-Hayson (www.cederman.com) from Queensland, Australia for kicking me in the ass and reminding me to start posting again :-)

Best wishes,
- Scott -

Applying Corporate Accounting Terms to Our Personal Finances

2008-12-03T10:49:00.006-05:00

Corporate accountants and CPAs commonly use a lot of terms, ratios, and acronyms that can be confusing to anyone without a four-year degree in the field. Though the figures that accountants calculate and discuss are important for reporting on the financial health of businesses, their definitions and different applications might seem out of sight to the average American.

Here on Tepom.com, I preach the importance of financial planning, budgeting, and overall fiscal responsibility in a way that's meant to be easy to read and applicable to any average person with a roof over their head, a checking account, and a credit card. The purpose of today's post is to define some of those esoteric accounting terms that are used by big businesses and show you how they relate to the finances of you and your family. I'll discuss both terms and ratios, both of which are used by corporate accountants to report to shareholders and Boards of Directors on the monetary wellbeing of organizations.

Terms
Assets: Anything that you own that is worth money, be it your house, cash in your checking account, or money that someone owes you. It should be noted that for reporting purposes, the value of an asset is independent of any debt associated with it, such as a mortgage.

How it applies to you: The value of your assets is the most primitive of financial calculations. Basically, it measures how many things you have, how much money you have, how much your house is worth, etc. Simply put, the more assets you have, the better off you are.

Liabilities: The amount of money that you owe people or businesses, be it a credit card balance, an auto loan, a mortgage, or a personal loan from your mother. Like assets, it is important to report on liabilities independent of any associated assets, such the value of the house related to the mortgage.

How it applies to you: Liabilities are a fundamental part of the equation when it comes to your financial health. Measuring liabilities basically brings you back down to earth for those of you with lots of expensive stuff. Unlike assets, liabilities are not nearly as visible because they're not tangible; they kind of hide in the dark. All too often we judge one's wealth on his or her assets without considering the liabilities. If you walk into someone's home and see HDTVs, nice cars, and expensive art, you may think he's rich. But if he bought it all on credit, your perception is quite the contrary to reality; which brings us to equity.

Equity: Also referred to as Net Worth, this is simply all of your liabilities subtracted from your assets. As an example, let's say you own a house worth $150,000, a car worth $10,000, and have $5,000 cash in your checking account. You also owe $100,000 on your home in a mortgage, have no car loan, and have $3,000 in credit card debt. Your total assets equal $165,000 (150,000+10,000+5,000) and your total liabilities equal $103,000 (100,000 + 3,000). Therefore, your equity equals $62,000 (165,000 - 103,000).

How it applies to you: Equity may be the most important accounting term for you to be familiar with. It's by no means a difficult concept, but it is a key component of your financial health and something that we should all be aware of. For example, my wife and I currently have negative equity, meaning that we have more liabilities (debt) than we have assets. Mostly, this is because each of us has student loans and the value of our house has gone down since we bought it. Negative equity is common among young Americans, but as they get older, it generally becomes positive as you continue to spend less than you make. I like to track my equity (Net Worth) here on NetWorthIQ.

Though negative equity is less desirable than positive equity, it isn't the monster that you may think it is. My wife and I wouldn't have the jobs that we have today without having gone to college. And we wouldn't have been able to afford college on our own, so we took out student loans, which in turn pushed our equity down into the red. But because the education that we purchased increased our earning potentials, we will be able to more rapidly push our equity back into the green and [optimistically] into the clouds.

Current Assets: Assets that can be converted into cash within a short period of time (usually one year or less). Examples include cash, of course, as well as items that can be quickly sold and money that is owed to you that you expect to be paid within a year. For example, if you have a baseball card collection that could be sold rather quickly for $10,000, you could classify that as a current asset. Also, if you own an occupied rental property, you could classify a year's worth of rent payments as a current asset (FYI, monies that you are owed are called Receivables). On the other hand, money saved in controlled retirement accounts that cannot be cashed in for a number of years as well as the value of your home would not be considered a current asset.

How it applies to you: It's important to separate current assets from the pack because they represent your current buying power. Current assets control how much you might be ale to afford to spend on an upcoming purchase, such as a vacation or an investment. Let's say that you have a 401(k) worth $100,000. If you're considering buying a house and need a down payment, that $100,000 won't do you much good because it isn't current -- you can't touch it until you're 65 (without a penalty). In this type of situation, only your current assets will be able to help you.

Current Liabilities: Liabilities (debts) that must be repaid within a short period of time (usually within one year). Examples include credit card balances that you intend to pay off within a year, your next year's worth of mortgage and auto loan payments, the current year's taxes, etc.

How it applies to you: These have an affect on your current buying power, just like current assets. Even if you have a tremendous level of current assets you must consider your current liabilities -- the things that you're going to have to pay in the next year -- before making any real decisions. Let's say you want to buy a new computer for $2,000. Even if you have $2,000 in the bank, you still may not be able to afford it after you take into account your upcoming $1,000 mortgage payment and $300 car payment. This brings us to net current assets.

Net Current Assets: Similar to Equity and Net Worth, Net Current Assets (also known as Working Capital) is your current assets minus your current liabilities. It is a measure of your true current buying power. In the previous example, we mentioned a person with $2,000 in the bank (current assets) and upcoming mortgage and car payments totaling $1,300. This would leave the person with Net Current Assets of $700.

How it applies to you: A failure to recognize Net Current Assets, in my opinion, is one of the biggest reasons people get themselves into trouble financially. When they're deciding whether or not an item is affordable, they will only consider their current assets rather than their net current assets. In the end, when bills come due, once-eager shoppers will resort to increasing their debt because they didn't plan ahead and take the time to really decide if they could afford what they were buying. So before you make that next big purchase, consider not only what you have in the bank, but what you're going to have to pay in the near future.

Gross Income: The amount of money that you earned during a certain period minus the amount that you spent during the same period. I calculate this number in my own personal finances once a month. Free web-based software, like Mint.com, makes it very easy to see how much I bring in and how much goes out.

How it applies to you: Unlike assets and liability figures that measure assets and debts at a particular instant -- like, "today, I have $2,000 in my checking account and a $1,500 credit card balance," gross income is a measure of behavior during a period of time, be it an hour, a day, a month, a year, etc. It shows us how much money we make versus how much money we spend. The value of gross income is very easy to calculate in a given month by looking at your bank and credit card statements and adding all the "plusses" and all the "minuses." If you find that you're spending more than you make, it will be important for you to create a budget. If you find that you're spending less than you bring in, you can pat yourself on the back, knowing that you're doing better than a lot of other folks!

Financial Ratios
Professionals also like to use ratios when they're evaluating a corporation's financial health. They simplify the evaluation and can help compare current health with that of previous years or with the health of competing companies. In the stock market, ratios help when investors compare some ratios of two or three different companies when they're trying to decide where to put their money. Some of these ratios can be very helpful when applied to our own personal finance objectives:

Current Ratio: Equals current assets divided by current liabilities. Much like net current assets, it shows you how well off you are today and indicates your current buying/investing power.

How it applies to you: This is similar to your net current assets, but just in different terms. Net Current Assets will basically tell you specifically how much you can afford to spend or invest in the next few months, while the current ratio gives you a relative value, which can help you see how your buying power increases or decreases over time. So if one is "good," the other should be good, too. Keeping track of your current ratio over time is a good way to see how your spending and saving habits and financial health are related. For example, back in college, I had some serious spending issues. I had nearly no money in the bank and about $9,000 in credit card debt. As you might imagine, both my Current Ratio and my Net Current Assets stunk. My net current assets would have been negative because I had a lot more credit card debt than I had money in the bank. My current ratio would have been less than one. Your current ratio will never be negative, but if it gets below one, you should start to worry because it means that you might not have enough in the bank to cover you next few months of expenses (much like the American automakers).

Debt Ratio: Total Liabilities divided by Total Assets. It shows the relationship between all of your debt and assets, including both short and long-term values. Unlike the Current Ratio, it's better to have a debt ratio less than one. Basically, any value greater than one means that you're worth more dead than alive (just kidding). Any value less than one means that you have more assets than you have debt.

How it applies to you: Some people will argue that any and all debt is bad and should be avoided at all costs. I tend to disfavor debt myself, but it should be noted that debt is important and useful if it is controlled and maintained. This ratio is meant to show you an easy-to-read relationship between how much debt you have and how much all of your stuff is worth. This is the precise equation you would use to determine whether or not you are "upside down" on your house (you owe more than it's worth). Younger people tend to have higher debt ratios, but over time, as long as they live a life of on-time loan payments spending less than they earn, the ratio will eventually shrink to a level below the threshold value of one.

As an example, let's say you buy a home for $150,000 and put zero money down. In your first month you will owe exactly what the house is worth. So your total assets and total liabilities would both be $150,000, creating a Debt Ratio of exactly one. Then as you make your mortgage payments, the amount that you owe will start to go down, slowly at first, and then more rapidly as time goes on. Meanwhile, the value of the house will begin to rise because of inflation and maybe even more if it's in an up-and-coming neighborhood. Before you know it, the house will be worth $200,000 and you'll only owe $100,000, making your Debt Ratio .5 (100,000/200,000). Like I said before, the lower your number, the better. When you have all assets and zero debt, your debt ratio will simply be zero.

There are a plethora of financial terms and ratios that I won't get into today that can be applied to the average American's personal finances. If there are any accountants out there, I'd welcome any feedback or additions to my analysis.

Preventing the January Spending Hangover by Controlling Holiday Spending

2008-12-01T06:27:00.004-05:00

Much like drinking, spending in excess during the holiday season can give you a nasty hangover in the following months. Not long after we make our financial New Year's resolutions, we're faced with bills that can tumble our annual goals like a Jenga tower. So before you make the trip to the mall or navigate to your favorite online store, make sure that you know your tolerance for spending. And if you're already carrying a balance on your Visa, you're a lightweight and should sip rather than gulp when passing your plastic to vendors.

Take a look around your house. Or if you have one, look in your attic or in your garage. How much crap do you have laying around that simply takes up space and is never used? If your house is anything like ours, you're probably overwhelmed. Somehow all of those "useful" little gadgets like foot baths, back massagers, golf-themed desk ornaments, ugly sweaters, and wall-mounted singing fish have lost their holiday luster. Chances are, those for whom you're buying gifts this season have their own similar stockpiles of Chinese-made widgets that outlived their usefulness by January 10th of the year following that in which they were given. Turn things around this season by giving reasonable gifts that neither waste your money nor beg to be dumped in storage by your family and friends.

Here on Tepom.com, I've always been a proponent of planned and controlled spending. This is especially important during the holidays. All too often we decide to wing it with gift giving, buying whatever for whomever we deem important in a valiant -- yet irresponsible -- effort to be extraordinarily thoughtful. But just as we should create a spending budget each month for groceries, restaurants, and travel, we should plan ahead of time for our end-of-year gift giving extravaganza. Here are a couple of easy ways to do so:

Don't be afraid to buy a Christmas gift in the summer
If you're out shopping in the spring or summer months and see something that reminds you of a friend for whom you'll most likely get a Christmas gift, buy it. There's no rule that says there needs to be snow on the ground to buy a holiday gift. By buying early you'll avoid the pressures of last-minute shopping and hopefully avoid the default Applebees gift card. You'll also spread out your spending throughout the year.

Save regularly and specifically for gifts
An old coworker of mine had a great system for saving for the holidays. He set up a regular savings transfer every month though his online banking. Twice a month, on payday, he transferred $75 to a special account designated for Christmas gifts. Though it was tough at first to part with the $150 per month, it made the price tags of the PS3s, iPods, and new bikes much easier to swallow.

Social pressures are another reason that we spend too much during the holidays. Honestly, I believe that we put way too much thought into how others will judge our gift giving. We may want to impress someone with a lavish gift. Or we may feel obligated to spend a certain amount on someone because we spent a higher amount on another person. Or we might want to wow our obscure friends and colleagues with an incredible bout of thoughtfulness by remembering to buy a gift for everyone that we've ever shook hands with. Here are a few tips to handle the social pressures of gift giving:

Look out for #1
It's only natural to want to show off a little bit with our purchases, whether they're for ourselves or our loved ones. And as much as we like to impress our friends, coworkers, and family members with expensive gifts, we only hurt ourselves if we can't really afford expensive gifts. So before embarking on your holiday shopping adventure, remember that impressing others comes at a cost. No one over the age of twelve will think any less of you for being financially responsible with your gift giving. And furthermore, before over-extending yourself with a gift for your boss, remember that he knows how much money you make!

Check reciprocity and equality at the door
This is one of my biggest pet peeves when it comes to Christmas. During a season when we're supposed to be focused on family and love and peace and all that stuff, many of us are too focused on equality and reciprocity of gift values. "If my brother's gift cost $50 and my sister's gift cost $30, then I need to spend another $20 on my sister." Bullshit. Unless you're giving all of your grandkids a card with $50 in it, you can easily overdo it by trying to achieve total equality. "Well, my friend bought me a $50 gift card, so I need to spend at least $50 on her." Horseshit. You should buy gifts for your loved ones that you think they'll appreciate and enjoy. Don't get them gifts just to even the scales. The more we steer our holiday values toward consumerism and dollars and cents, the further we migrate from the true values of the season.

Send Christmas cards
Some of us more than others can bring thoughtfulness to near-obsessive levels. Wanting to think of everyone, we may buy small gifts for everyone in our Rolodex. And sure, they'll be thankful for us thinking of them, but the costs can really add up come New Year's. Instead of getting a gift for each of your coworkers, your spouse's coworkers, and all of your family friends, fill your outbox with Christmas cards. For less than a dollar apiece, you'll remind your life acquaintances that you care and you're thinking of them. Truth be told, not everyone expects something from you. So when you send your cards in lieu of gifts, think of it as going above and beyond.

The holidays are a fun time of the year during which we eat, drink, and spend a little too much. But by planning ahead of time and controlling your gift spending, you can reserve your brainpower in January for figuring out how to work off those December love handles rather than how to pay off that looming credit card bill. When it comes to buying gifts, don't put more pressure on yourself than your wallet can handle. After all, the holidays are about being with each other, not buying for each other.

Renting to Strangers: How to Become a Spy, Lawyer, and Private Investigator

2008-11-25T11:55:00.012-05:00

As banks foreclose on more properties, more Americans are finding themselves in a position to rent a dwelling rather than buy one. And as homeowners move and are unable to sell their homes for a reasonable price, we're seeing a proportionate increase in the supply of rental properties. If you're upside down on your home and need to move (a previous topic on this site), I've always recommended renting your home for whatever you can get for it. Or if you just bought your first investment property, you, too may be searching for that perfect tenant. But being a landlord is not for everyone. So before you put pen to paper, consider some of these points to prevent some headaches that are often associated with renting to strangers.

Become a Spy

My parents have been landlords for two rental properties that are adjacent to their primary residence. For them, having their tenants as a neighbors has improved their relationship with the renters while enabling them to keep a close eye on the homes. When you rent to strangers, you usually don't know much about their lifestyle. They may drink, smoke, have destructive pets, throw wild parties, or bury human bodies in their spare time. Unless you have some view into who and what is going in and out the front door on a regular basis, you could very well find yourself with a tricky situation. In hindsight, I can't imagine how quickly I would have been kicked out of my college apartment if my landlord (or parents, for that matter) saw the terrible, evil debaucheries that we commited on a daily basis...

If you are renting out a home that's located in a place that you can't regularly visit or at least drive by, consider hiring a property manager -- you may well save yourself time and money in the long run. If you're still close with your neighbors, they can work as great accomplices in your spying operations, too. You certainly need to give them their privacy, but your home is too valuable to be trusted to an unknown, unsupervised tenant with nothing to lose but their $1,000 security deposit. So if you don't live nearby, make sure that you have either a trusted neighbor or a hired property manager to check in on the place every now and again.

Become a Lawyer

When my wife and I first moved to Wilmington, we rented a house on the southeast side of downtown. After living in the home for a few months, we realized that we were in a somewhat tough neighborhood and were turned off by the fact that someone had come onto our property twice to steal something. Eight months into our lease, we bought a house.

We contacted our landlord to see how we could legally break our lease. However, she had protected herself when she had us sign a bulletproof lease which gave her unlimited power during our negotiations. We asked her if there was any way we could move out and pay a penalty or forfeit our security deposit. Nope. We offered to pay the finder's fee for a new tenant. Nope. As unreasonable as we thought she was, she was able to show us, line-by-line, the language in our lease that prevented us from moving out before its termination date. There was nothing we could do. She had successfully protected herself from the likes of Scott and Michelle Bliss and she ended up receiving every penny of rent that was due until our termination date. Phew -- I'm glad those days are over.

She had language in the lease that was so detailed, it discussed who would pay the legal fees if we had a dispute in court. It detailed how many people could occupy the property and how many nights our guests would stay. It nitpicked over the maximum allowable weight of our dog and what constituted a proper cleaning when we left. It had warnings and legalese and penalties regarding any possible risk that could ever arise. And as stuffy and annoying as it was, it protected our landlord from losing any money in the event that we wanted to move out early. Though you should certainly be a reasonable human being with your tenants, you should always do as our old landlord did and allow yourself to be as nice (or not nice) as you wish by protecting yourself on paper. If you're ever at war with a tenant, it will serve as your coat of armor; and the heavier it is, the more protected you will be. Pay the money and get yourself a professionally prepared lease that is fair and resilient.

Become a Private Investigator

Most of the time, tenants are honest, hard-working people that pay their bills on time and will treat your home as they would treat their own. And sometimes, they're unemployed, broke, transient, dirty liars that will tell you anything that will convince you to rent to them, upon which time they'll take you for a wild ride that would make even Mr. Toad wet his pants. Consider this short story:

When we were trying to legally break our lease, our landlord told us that we could only get out of our last four months' rent if we found another qualified tenant that would be willing to sign a new one-year lease at a higher monthly rate. So we started our search. We had applications coming in left and right, but every vagrant that applied had some sort of complicated story that received two thumbs down from our landlord. And then we met "Alex." Alex had no pets and a documented steady income. He was well-dressed, well-spoken, and ready to put down the full security deposit and first month's rent. But when I called his most recent landlord as a reference, here's the story I got:

Apparently, Alex destroyed the rented house with a combination of wild parties and equally wild live-in beast that was once classified as a dog by a clearly inexperienced vet. Surprised, I asked why Alex would have given the landlord's name as a reference if he had demolished the home; the answer made the story a bit juicier. It turns out that Alex didn't pay his rent for a few months and owed the landlord a couple of thousand dollars by the time he was evicted. Alex said that he would only pay the money if the landlord swore to give him a good reference. He agreed and Alex paid his money, but, as I was figuring out, the landlord wasn't keeping his word. Naturally, Alex never rented our house.

So while it's true that most would-be tenants are fully capable and willing when it comes to their rent payments, you need to remember that there are still a few axe murderers out there. As long as you are renting to a stranger, make sure that you verify -- and double-verify -- your prospective tenants' income, credit history, and references. Unless you play the part of a private investigator, you're setting yourself up to get screwed. If you're renting a home for money and not running a charity, you have to verify an applicant's information before signing anything, no matter what anecdotal self-victimizing story he or she gives you. The minute that you accept to a sob story in lieu of three months' worth of pay stubs is the minute that you hand your house keys the Tasmanian Devil inside. Check out E-Renter.com: it will probably prove to be $35 well spent.

I welcome any previous landlords to share their tenant horror stories to help encourage their fellow readers to become a spy, lawyer, and private investigator.

A Curmudgeon's Analysis of the US Automaker Bailout

2008-11-21T06:49:00.008-05:00

A friend on mine once called me a curmudgeon. And I agreed -- well, kind of. A curmudgeon is defined as a crusty hotheaded cantankerous old person full of stubborn ideas. Generally speaking I'm a pretty nice guy, but it will be difficult to bring out my non-crusty, agreeable, go-with-the-flow side if you bring up the US automaker bailout.

With $700 of "bailout" money ripe for the picking, corporations large and small are looking for their piece of the pie -- including US automakers. Things are starting to look like the aftermath of a funeral. A rich man with a missing will has passed away unexpectedly and all of his grandkids are milling around. They're trying to get a piece of the estate, justifying their worthiness by any means possible. The funny thing is, a bunch of self-important knuckleheads in our legislature are going to decide who gets what.

This week marked the first time in my life that I watched C-Span for two nights straight (much to my surprise, my brain didn't turn into cottage cheese). The CEOs of the big three automakers were giving testimony to the self-important knuckleheads about why they should be permitted to borrow approximately 3.5% of the money that has been allocated to "fix" the economy. As I watched these three assholes ask for money, I began to understand why their companies are about to die. When asked if they (the automakers) would ever return with their tin cups, Rick Wagoner, CEO of GM, replied "well, I can only guarantee that I won't be back if you can guarantee me that the economy won't continue to fail." That moment is when they lost my support.

At that moment, I realized that those cocky SOBs didn't have a humble bone in their bodies. Instead of accepting responsibility for messing up, they instead blamed the market. Because of their own denial of mismanagement and their refusal to be introspective and propose real change, the American taxpayer shouldn't give them a penny. General Motors, Ford, and Chrysler are as American as a brand can be, but they've taken their good ol' boy status completely for granted. And I'm sure they were surprised when it was hinted that we would dare let them fail. But guess what, guys...the buck stops here.

Let's say your son came to your door asking for a thousand dollars because he was in trouble. Sure, you had the cash on you, but before handing over any of your green you'd probably ask why he needed it and how he'd plan to pay it back. The why and how are important because they indicate his ability and willingness to take the situation seriously. If he needed money because of a drug problem, you'd probably only loan it to him on the condition that the drug use would stop. Without that commitment, you'd be better off loaning it to someone else actually willing to do what was needed to turn his life around. The blame game of the big three proves to me that they're not ready to turn things around.

The big three have shown that they don't take the loan seriously because in two nights of watching C-Span I didn't hear a single one of them offer a plan large enough to reverse years of poor decision making and stubborn management. In fact their plans fell quite short of those required to justify this mega loan. They blamed their problems on the economy, not their outdated business practices. They believe that they're entitled to this money simply because they're as American as George Washington, not because they have a realistic recovery plan. Simply put, the Detroit automakers are as competitive in the auto industry as the Detroit Lions are in the professional football industry.

So here's my cantankerous message to the big three: Shame on you. Don't you dare testify to our self-important knuckleheads and tell them that if they don't give you the money, hundreds of thousands of jobs will be lost -- that's on you, not them. You're the ones responsible for not competing with international auto manufacturers. You're the ones that ridiculously thought that your companies could survive on national pride alone. You're the ones that somehow feel entitled to borrow this money just because of your brand name. You're the ones that have driven your companies into the ground for years, yet look to the economy as a scapegoat. I've got news for you: Your cars and management have sucked for years, yet 13 months ago, the Dow was at an all-time high. Get real...

And I hope that if the big three fail, our nation will learn an important lesson about the dangers of unionized labor. I'm all for people earning a living wage, but it must be determined by the market. Getting a group of workers together to strongarm an employer by dictating and enforcing their definition of a fair wage is simply an unsustainable, unrealistic endeavor that hurts more than it helps. I understand the reasoning behind unions, but as it's showing now, they can bring a giant to its knees. And when that happens, everyone loses. Tepom to the UAW: This is just as much on you as it is on the automakers.

Golf, Kids, and Other Things You Should Avoid Until They're Affordable

2008-11-19T06:59:00.007-05:00

I've played exactly 36 holes of golf in my life. And the first 18 were played in August, 1996 with Bill Lyons, a friend of the family from Upstate NY. I was 13. As you might guess, my parents weren't golfers, so I looked forward to trying my hand at something I had seen, but never participated in. Any of you golfers out there will probably agree with me and understand when I say that driving a ball with a cheap, borrowed 3-wood is just a little bit more difficult than tapping an orange ball through a windmill at the local mini-golf. You might say that I was, well, awful.

Drive after drive, I sent ball after ball into the woods. None of the hungover men I was with had the patience to chase after them or even to send me on a one-kid search party. I had the notion that the balls were expensive and I felt guilty. I had officially became the golf ball grim reaper, sending several boxes full to shallow graves in the deep dark forest. "How much do these even cost?" I asked sheepishly. And Bill, god bless him, gave me an answer that I still remember more than 12 years later: "If you've got to ask how much the balls cost, you can't afford to play golf."

This is an interesting principal that most of us dismissed with a laugh on that day. Bill's a naturally funny guy, but he had a point. Many of us non-golfers grew up in a house without much of a golf influence. That means no sets of clubs as a Christmas gift, no free lessons, no country club memberships, etc. Golf is an expensive hobby with lots of fixed and variable costs. If you already own your clubs and you or a family member have a paid club membership, then it's probably an activity you can afford. But if you're young, in debt, and without much savings, chances are you'll have to ask how much the balls cost. And you know what that means.

Kids
People all over the world dream of having kids one day, and every day, thousands of those dreams come true. But in America, I see lots of people having children before it's financially feasible. Of course there are many factors that influence our decision about when to have children. Maybe you want to be young so you can play with them and share more years together. Or maybe you're pressured by your parents to give them some grand kids. Many children -- including me and my parents -- are born into a family that is having a tough time getting by financially. And most of the time, everyone turns out just fine.

But tegardless of the reasons we choose to have children, it's less than ideal to have them when you're not on solid ground. If you're struggling to pay down debt, if you don't have family health insurance, or you're having difficulty paying your rent or mortgage, bringing a child into the situation will undoubtedly cause you more stress and financial discomfort. I'm not saying that bringing a child into a middle-class family is a poor decision that will leave everyone hungry and homeless. I am however saying that the financial burdens of a child will be reduced if you wait until you're already in a comfortable place. Think of it this way: if you don't need a new car today, it's better to wait and save your money until you do need one rather than take out a large loan and make payments for several years. The latter option won't necessarily put you in the poor house, but the first is clearly a better financial situation than the other. Simply put: If you have to ask how much doctor's visits, diapers, and formula cost and you have doubts about your ability to pay them, you might not be able to afford to have a child today.

Pets
I adopted my first dog from the County Animal Shelter and immediately took her to the vet to get her shots. Afterward, when I was walking back to my car, a man approached me with his family behind him and asked where I'd gotten my puppy. He and his family were very friendly but clearly poor, with old clothes, a rusty car, and unkempt hair. I told them that if they hurried, they could get to the animal shelter before it closed, and all they had to do was pay a $10 adoption fee and agree to have the dog spayed/neutered within two months. Then he asked, "Do you need to have the $10 today?"

Clearly, it is an extreme situation when a family of five doesn't have ten dollars to spare and are in the market for a furry friend. I felt like telling them that dogs cost a lot more than ten dollars -- the first round of shots alone cost fifty! Thankfully, I didn't have any convincing to do when he realized that he was priced out of dog ownership.

I certainly don't mean to pick on the guy, but the situation inspired some sentiments of improper pet ownership. Though pets have low fixed costs -- often a small adoption fee and a bag of Ol' Roy -- they can quickly turn into a burden. My friends Brian and Christiana once had a cat whose vet bill soared to thousands of dollars. Though it's easy to become attached to a cat, dog, ferret, or fish, remind yourself that if you're struggling to make ends meet, you're better off waiting to get a pet. Pets deserve reasonable care and attention. If you have to ask how much pet food, adoption fees, flea control, and vet visits cost, you probably can't afford to have a pet.

Grad School
This might come as a surprise to you. Unless someone in your family is paying for your education, make sure that you figure out whether or not you can afford grad school before you apply. Many of us want to get it over with right after getting our bachelor's degree just as a matter of habit and sequence. And if you're going to use student loans to pay for your graduate degree, be extra careful.

A friend of mine had well over $100,000 in student loans from his undergradute education before he even started grad school. Now he has over $140,000 in student loan debt. If he had asked me before applying for his advanced degree, I would have recommended that he take a couple of years to work down his balances and get comfortable with his payments before getting over his head.

A strategy that I've seen some employ is to take out a loan to pay for a small portion of grad school, say, the first year, and to work during the program. I've also seen husbands and wives take turns, with one working while the other goes to school. Another option might be to get a job with a company that offers tuition reimbursement. Even if it means taking more time to get your degree, there's a good chance an MBA or an MFA could be paid 100% by your employer!

Don't get ahead of yourself with grad school; it's very expensive. An advanced degree is an investment that you should vet thoroughly before commiting, just like any other.

A House
This last one is pretty simple. Unless you want to follow suit with many other Americans that are in foreclosure today, don't buy a house unless you're in a good position to do so. Don't try and convince yourself that it's affordable. Don't try to convince yourself that it's a good idea. Don't try to convince yourself that you're entitled to own a home just because you're married or because you earn a certain salary. Instead of trying to convince youself, prove it to yourself. In the end, it's going to come down to dollars and cents. Click here to figure out how much home you can afford. Remember to be honest. If you're not, you're only cheating yourself :-)

For some people, owning will never make sense. Take my friend Quang, for example. He's single, works long hours, and rents a room in a house in northern Virginia. He's close to work, he likes the location, and rent is dirt cheap. In my opinion (and his, too), it will never make sense for him to buy a place because of the outrageous price of real estate in his area and the headaches that come along with homeownership. Because his rent is so cheap, he can afford to save an incredible portion of his income that he would otherwise have tied up in an expensive home. Let's not forget that he doesn't pay for any home maintenance or repairs.

Many of us feel entitled to have children, own a pet, buy a home, go to grad school, or play the back nine because they're very American things to do. But unfortunately, those are all very expensive undertakings. Our culture, our national heritage, and social pressures can sometimes take precedence over our own financial wellbeing. And though these purchases and activities are very important to some of us, it's important to recognize that for the working majority, these things come with time and patience. So before you take that first step toward the maternity ward or the country club, get your ducks in a row and make sure that it's not going to break the bank in the long run.

Why a Black-Coffee Management Style Would Have Saved Starbucks

2008-11-18T06:23:00.004-05:00

In a waiting room magazine I once read that Howard Schultz, the founder and CEO of Starbucks, ironically prefers black coffee to any of the outrageous hot or cold drinks offered by the morning/afternoon/evening "fix" giant. The pied piper of java himself sticks to the core of coffee, and I think that says a lot about him as a person. Black coffee is strong and bold; it is foundational and pure; it's as American as Lewis and Clark; and though it is so incredibly simple, it's almost against-the-grain. Now I understand that not everyone likes black coffee. Some think it's bitter and rather plain, which is why Starbucks' overhead menu is bigger than that of McDonalds. And just as their menu appears to be slightly cocky and over-the-top (a 13-shot venti soy hazelnut vanilla cinnamon white mocha with extra white mocha and caramel? You've got to be kidding me!), in recent years their business plan started to follow suit by adding dozens of stores to every corner of the globe. Today, with profits down an astounding 97%, the executives at Starbucks are starting to feel an awful lot like mortgage lenders, cleaning the gum off their faces from a freshly-popped bubble.

Now that the economy is looking like a typical season for the Pittsburgh Pirates (they suck, BTW), consumers are cutting back on spending like never before. And luxuries -- like Starbucks -- are hurting the most. We're through with our smoke-'em-if-you-got-'em (and-borrow-'em-if-you-don't-got-'em) spending habits and have moved to a more conservative way of living, as if we just discovered that we can actually brew coffee at home. We're starting to treat fru-fru coffee as a luxury now as opposed to an everyday entitlement. And guess what -- if Starbucks had stuck to a simple, black-coffee management style, they would've seen it coming.

Am I saying that we should never drink Starbucks because it's a luxury? Absolutely not. Actually, I almost always drink Starbucks when I'm at the mall watching my wife spend money on clothes that cost a hell of a lot more than my cup of coffee. I can probably count on two hands the amount of times that I visit a Starbucks each year. But when I think of coffee spending getting out of hand, a story comes to mind. While enjoying a hot drink with my in-laws at their local 'bux, I spotted a woman waiting in the 15-person line. She carried her own purple mug (going green -- nice), but it had a homemade sticker on it; I investigated. On the sticker was printed the exact specifications of her favorite [complicated] drink, the details of which I will not bore you with. I couldn't believe it! This seemingly frivolous experience (which we recognize with every $4 coffee joke we make) had become an obvious daily habit of this woman. After I watched her pass her mug across the counter, I noticed many of the other patrons in line ordering their drinks without even glancing at the menu. They were hooked, too.

A big reason that the economy is where it is today is that people spent outside of their means for several years. Today, the average amount of household credit card debt is over $8,000. And though the woman with the purple mug may have very well been wealthy and within her means while indulging in her $100/month habit, I've got to imagine that at least half of those people in line were part of the startling outside-of-our-means American spending statistic.

Did Starbucks know that consumer debt was spreading like a California wildfire? They must have. Did they know that their coffee was expensive? Umm, does a bear shit in the woods? Despite evidence that Americans were becoming poorer and the clear and present fact that their product was expensive and easily replaced by a much less expensive homemade substitute, Starbucks continued to build store after store after store. Now, with profits down for the count, they're closing hundreds of their locations to make up for their grossly overestimated forecasts that, frankly, were as ridiculous and pretentious as their holiday coffee selection.

I'm sorry to pick on Starbucks. What's happening to them is happening to a lot of businesses, which is why so many Americans are losing their jobs and, subsequently, their mortgages. When Americans as a whole strayed from a reasonable and symmetrical expense/income ratio, businesses like Starbucks saw the desert mirage of infinite exponential growth that, in reality, was merely dust. This is why I preach, day after day, the covenants of responsible spending.

Responsible spending helps individuals by allowing them to save for the future. It allows them to keep more of their own money and to live a sustainable and healthy financial life. Responsible spending helps the entire nation by eliminating these false forecasts of eternal growth and profits for businesses. It keeps the economy in check, managing inflation and stabilizing cash flow. Keep in mind that I am an absolute proponent of spending money. Spending is the be-all-end-all of a capitalist society. And if we as a people bought only the bare essentials, we'd eat nothing but rice and all live in caves. But by buying the things that we don't need day after day for years and years, we become a gluttonous society that cannot sustain itself, much like a balloon. Now, because of America's overspending -- much like overeating -- we must reduce our consumption to below normal levels to get back to the point of a healthy equilibrium.

So while irresponsible customer spending helps companies like Starbucks in the short term by giving astounding inflated profits for a few years, it can destroy them in the long term. If Howard Schultz had stuck to a black-coffee, back-to-the-basics management style, he would have recognized the looming bubble and directed the company proportionately. Like black coffee, it would have been simple, yet against the grain, to slow expansion -- but it would have saved his ass. Instead, for years he and his stockholders were swooning over the streams of cash and credit pouring through the doors and laughing all the way to the bank. But who's laughing now?

The Reasoning Behind Golden Parachutes

2008-11-14T06:44:00.008-05:00

There's a reason that McCain and Obama brought up Golden Parachutes so much during the election -- it's a touchy subject and easy to despise (especially by those that are losing their homes). At first glance, paying large sums of money to failing executives seems like a bass-ackwards practice that rewards the rich for simply being rich. Many of us picture a clan of back-slapping, cigar smoking golfers sitting in a country club lounge, deceitfully scheming about how they'll bestow our retirement funds to each other. Though we must keep a watchful eye on those in power -- especially our politicians -- before you grab your torch and sword and storm the castle of Wall Street, know that there is a legitimate reason that executives are given wildly lavish compensation packages. Read on if you dare...

Executives have a fiduciary relationship to company shareholders. Basically that's a legal term that means that executives are legally responsible to act on behalf of the shareholders. So it's their job to see to it that shareholder's wealth is increased. It's up to them to save the company money wherever possible and increase sales. It's also up to them to encourage mergers that would benefit the shareholders. But unfortunately, sometimes mergers lead to eliminating redundant positions -- including executive positions. So even with the legal obligation to serve the shareholder, there is a clear conflict for an executive that's putting his own job on the line.

Let's say that the McDonalds and Burger King people decided to merge. For whatever reason, the CEOs honestly believed that it would be in the best interest of both sets of shareholders for the two restaurants to join forces. So with the paperwork filed and the stroke of a pen, every McDonalds and every Burger King became a McBurgles. The stock soared on day one, but soon after, it became time to start cleaning house. Though each restaurant was making both Big Macs and Whoppers, they only needed one kitchen. So some cooks got laid off. And each franchise didn't need two managers, so some of them got laid off, too. Next came the regional managers and the district managers. The chain of redundant position eliminations worked its way up, one job at a time, all the way to the executives at headquarters. The McDonalds and Burger King CEOs looked like two kids playing musical chairs, squeezing their butts into the only open red-leather seat in the top floor office of the McBurgles building. But it's not like they didn't see this coming.

When the CEOs of these companies started talking Merger, each of them knew that there was a good chance of getting laid off after the smoke cleared -- just like the cooks and managers. But they went through with it anyway. But wouldn't they have to be crazy? I mean, I like my job, but if I thought that there might be someone out there better than me at it, I doubt that I'd call my boss and say, "Hey, you should fire me because I think that Bill over here will do a better job than me." As they say, you've got to look out for Number One. So even though it might be better for the company to hire Bill and let me go (maybe because he doesn't blog during work hours -- just kidding :-) ), I'm not likely to speak up because I don't want to lose my job.

But what if you had an agreement with your boss ahead of time? He wants to make sure that the best person is doing your job; right now he thinks that is you. But should you ever find someone that might do it better than you, you should bring them in for an interview. Noting the inherent conflict of interest, your boss promises that as long as you're acting in the best interest of the company, you personally won't suffer financially. So if you're a carpenter and find someone that can swing a hammer harder than you, the company will pay you to give up your job to the stronger candidate.

Mergers happen all of the time in just about every major industry. Companies may merge to strategically increase shareholder wealth or to cuddle together in the same sleeping bag, living off each other's body heat to survive a frigid night. Those that oversee these complicated mergers are by far the companies' highest paid employees. And would these executives put their own family's livelihood on the line just because the decision would benefit the company? That's a tough question that many executives would answer differently. Essentially, golden parachutes exist to remove the conflicts of interest that are inherent to mergers. Unless some mechanism exists to ensure that executives have nothing to lose personally, it's likely that many mergers would never go through, even if they're in the best interest of everyone else.

Because executives are so highly paid (which is a different story altogether), golden parachutes exist in the form of many millions of dollars. Executives that lose their jobs are losing out on a very lucrative gig, and unless the severance package is big enough, the conflict of interest isn't truly eliminated.

It's easy to criticise those that are getting huge bonuses during a time of such national economic turmoil. But the distinction between reward and conflict resolution is critical. CEOs are often faced with business decisions that may positively affect the company and its shareholders but negatively affect their position. Golden parachutes take executives' personal risk out of the equation -- they're not meant to be a reward. So while it's fair to criticize performance bonuses given to those that don't, well, perform, it's important to know that certain bonuses are given to mitigate the effect of one's personal survival instinct on large-scale business transactions.

The first thing that I learned in my first day of collegiate economics is that people are smart and people are selfish. It's just human nature...

Managing the Finances of a Two-Income Household

2008-11-13T09:45:00.004-05:00

Before I got married, I had been warned that money was the root cause of many marital disagreements. My wife and I hoped that we would be exempt from this trend, noting our comfortable individual salaries and modest tastes. Each of us is good with money and we had no problem agreeing to share it 100% from day one. But we didn't realize that merely sharing money with your spouse, even without financial difficulties, can sometimes prove to be a challenge.

So what's so hard about sharing money with another person? If you can each afford the things you want on your own, how does bringing in another person with his or her own income affect this? I can tell you from experience that joint checking accounts will sometimes test you. In a couple that carefully manages their finances, one may feel controlled by the other, like he or she can't spend a dollar without first asking the other. Or a person risks being sneaky by making a large purchase without a spousal consultation.

Sentiments of control or sneakiness can also be amplified by factors outside of spending, like differences in salary, the number of hours worked each week, or even the amount of chores that one does around the house. If a wife makes more money than her husband, she might feel entitled to spend more than him. Or if she feels like she does more around the house than her husband, she should be able to splurge without first consulting him because, hey -- she earned it. On the other side, the husband, though he makes less money than his wife, might work more hours than she does in a given week. Therefore, he justifies spending money on an expensive leisure item -- maybe a boat or a case of expensive beer.

When we are single, we choose to reward ourselves for varying reasons. We might reward ourselves for something big, like getting a high-paying job, or for something smaller, like finishing a long 60-hour week at the office. These are habits that we probably developed as bachelors and bachelorettes and it's easy for them to be part of the package when we promise to have and to hold and till death-do-us-part. But once you're married and have checks with both of your names on them, it's easy to disagree with the other's spending habits. The good news is that there are a couple of simple things you can do to help ease the transition.

#1 - Talk about money regularly, but only at established intervals
If your wife comes home from the mall with an armload of shopping bags or your husband walks in the door with leftovers from Outback, it's easy to call him or her out on it. "Hey, didn't you just buy new clothes?" or "Hey, isn't steak a little out of our budget?" The opportunities to micro-manage your partner's spending are limitless, but they should be avoided because they can give the impression that you're being controlling.

What I suggest is this: Only review your budget and spending at established periods -- be they weekly, bi-weekly, or monthly -- and not in-between. As you know, I am a huge proponent of using free online personal finance tools, such as Mint.com. Mint has a feature that will email you every Friday with your account balances and month-to-date adherence to your budget. And it gives you the option to send the message to two email addresses. So each period, you and your spouse should look at those items together and note any flags. "Hey, we're way over budget on restaurants this month -- we should start eating in more," or "I've already spent $300 on clothing this month. Maybe I should hold off on another shopping spree for a while." These regular reviews will help prevent micro-management of each others' spending while allowing the two of you to stay on top of your finances as a whole.

#2 - Establish a $100 rule
Call it whatever you want to call it -- the $50 rule, the $100 rule, or the $500 rule. Establish a spending threshold that will constitute a required consultation with your partner. If you have a $100 rule, any time one person is going to spend more than $100 on anything, the other needs to be consulted. You can bypass this by setting up spending limits for trips. For example: "When you're in Pittsburgh, don't spend more than $200." Again, this is a rule to help alleviate sentiments of one controlling the other's spending while ensuring that the couple's financial goals are on track.

It's easy to have be critical of your partner's spending -- especially if you do more around the house, work longer hours, make more money, etc. But if you two have decided to pool your green, forgive the expression, but you'll have to put your money with your mouth is. Check your grievances at the door and manage your finances as an individual with two jobs. Play nice, don't micro-manage, and consult one another on large purchases. Active or passive aggressiveness won't cut it.

How do you and your significant other share finances?

Coping with a layoff

2008-11-10T06:39:00.005-05:00

As of October, the national unemployment rate in the United States is 6.5%. And of those unemployed, one in five have been out of work for more than 27 weeks. So how are you feeling? Are you sitting fat and happy in a plush government job or working on on a sexy, profitable project? Or are you watching your co-workers resign one-by-one or -- even worse -- get laid off in large groups? If you are in any way starting to get a little nervous about losing your job, be proactive! Prepare yourself financially and do whatever you can to keep yourself on the payroll and out of jeopardy. Here are some tips:

1. Prepare your finances
If you're anticipating a layoff, you'll need to do all that you can to make sure that you've got cash in the bank that can cover several months' worth of expenses -- let's say six or seven. Once you've accumulated a pile of green, between unemployment and your savings, you'll be sitting pretty while you look for another job. If you already have that money sitting in the bank, you're clearly a financially responsible person and should probably be visiting Edward Jones instead taking advice from the likes of me.

The easiest way to start saving a bunch of cash is to start living (and spending) like you are unemployed while you are still employed. And do it to a degree equal to that which you're anticipating a job loss. The specifics of determining the likelihood of getting laid off will vary greatly, as anyone that isn't on a contract can be let go at any time, regardless of how long they've been employed, their seniority, etc. But trust your gut here -- though many people are caught off-guard, many more get "that feeling" when they might be in trouble.

So if the future of your current job is very uncertain, fix your budget to ensure that you and your family are as cash-rich as possible. Be sure to consider and adjust two dimensions of your finances: where you're spending and where you're saving.

As far as spending is concerned, start with the big stuff and then work your way down. Postpone your expensive vacation if it isn't already paid for. Don't overdo it with Christmas gifts. Hold off on the HDTV purchase. Delay any of your plans to spend a lot of money on anything non-critical until you're assured of your job security -- whether that assurance comes from your old boss or a new one.

Once you've abandoned the notions to spend lots of money, look at the little things. Start shopping at Walmart instead of Whole Foods (believe me, I know that's difficult for some of you). Downgrade your TV service. Put XM or Sirius on hold and stop going to coffee shops. These little things may seem obvious, but they're important. Look at all of the ways that you spend money, analyzing each one to come up with a method to reduce your spending. You won't always have to live like this, but spending like you're penniless while you're still enjoying a paycheck is critical to accumulate the cash you'll need to stay afloat after a layoff.

After your spending is reduced, it is then important to to analyze where you're saving your money. Why? Because bracing yourself for a layoff is all about liquidity -- ensuring your money can be accessed at the drop of a hat. Cash is the most liquid asset. Your home and specialized savings accounts are much less liquid because a lot more is involved in turning them into groceries or money that can pay bills.

Depending on the degree to which you're concerned about a layoff, consider cutting the amounts that you regularly contribute to a retirement or college savings account. Contact your HR representative and ask about reducing your contributions to your 401(k) -- most let you do that quite easily. Once you're back in the saddle, bring your contributions back to a normal level. But if you're short on cash -- especially during uneasy times -- it's better to have that money in-hand than put away for retirement (again, liquidity). But be careful: If you're going to take money from your retirement, it's much better to simply stop or reduce your future contributions. Don't cash out the money that's already in your 401(k) -- you'll end up paying through the nose with taxes and a 10% penalty.

If you're paying off an auto loan or a mortgage early, pat yourself on the back, but take a breather while you're building your reserves. Once you're assured of your current job security or find a new employer, you can play catch-up with all of the cash you've got laying around. And I hate to say it, but if you've got lots of credit card debt and are facing a likely layoff, I would rather see you with enough cash in the bank to pay the minimum payments on those cards if their balances is greater than your bank account balances. Though it's not ideal to pay interest for a few months, it's better than destroying your credit.

Finally, be careful when anticipating a severance package at your current job. Don't take anything for granted unless it's in writing. All too often people underestimate the impact of a potential layoff because they wrongfully believe their company will provide a severance or separation package. Unless it's already in ink, do yourself a favor and don't rely on it.

2. Step up at work
Aside from getting your personal finances together, be sure to perform at your absolute best at work. If only a few positions are being eliminated, don't give your boss a reason to let you be one of those that is let go. Be outstanding, proactive, and flexible. A good friend of mine works for a major newspaper and was able to avoid getting laid off along with many of his ex-coworkers by doing these three things. The paper was moving in a new direction, and he proactively came up with new ideas for how he could support the new model. The new model would require him to perform many different duties (moving from print to the web) which he accepted with enthusiasm the a promise of his flexibility. And because he wanted to stand out, instead of sucking up, he always did outstanding work.

If you still get laid off, you'll maximize the amount of time you can get by without a paycheck by adjusting your finances. Stay on top of receiving your unemployment benefits. While you're looking for a new job, have an intelligent friend proofread your resumes and make sure you customize it for each position. Never miss an opportunity to apply for a job. Write down all of the companies in your city that are hiring and check their websites every day. And don't forget to browse Craigslist's Jobs section!

Also, don't neglect networking. Accept every dinner invitation, attend local alumni and professional events, and volunteer wherever you can. Most jobs are given to people with connections, and by leaving no social or professional stone unturned, you'll improve your chances of meeting your career's benefactor. This is also the perfect time to reconnect with old friends and coworkers.

Have you had experience with getting laid off recently? How have you prepared yourself? How well would your finances stand if you were laid off today?

The Inability to Say No and Having Ritz-y Taste on a Econo Lodge Budget

2008-11-07T06:40:00.006-05:00

I usually hate to give generic, common-sense financial advice that you can find anywhere on the internet. The most common is "instead of buying a cup of coffee at Starbucks, put that money into a savings account." No shit. My readers are not stupid and I'm not going to insult you by giving that kind of cookie-cutter advice.

Today's post will consist of something like observational humor, except not funny...at all (that was kind of funny, right? No? OK, I'll move on). I'll highlight some of my specific observations related to people's spending habits that drive me nuts -- especially when I see those in question complain about their finances or at least imply their struggles.

#1 - The inability to say "no" to your friends
Many people are aware that they've got financial difficulties, yet accept any invitation to spend money, as if it is OK to do it because it wasn't their idea. If you know that you're going to be short on rent for next month but your friend invites you on a weekend road trip, what should you should say? "Hell no!" Making excuses for spending money is easy. Just because it was someone else's idea doesn't mean it's any less of a poor decision.

If you're invited to spend money and cannot afford it, it's OK to say no. In fact, some of your friends and family might respect you for it. Whether the invite is direct, like "Want to go to Cancun this winter?" or indirect, like "Hey Bob -- all of us bought new Macbook laptops -- where's yours?" you need to learn to say no. There is simply no point in taking the time to come up with spending and financial goals if they can be so easily changed by some peer influence.

#2 - Ritz-y taste, Econo Lodge income
Regardless of the weakness, I see that many people have at least one. Whether it's designer clothing, organic groceries, a certain brand of electronics, or the refusal to cook for oneself, every day I see people that cannot afford their personal luxuries try to justify them. Here are some real, specific examples with fake names:

- Joe is unemployed, has a young child, no savings, and a wife working a low-paying full-time job, recently refused a truck full of free furniture from his grandmother for his new apartment because he's "looking for matching stuff."
- Devin struggles to pay his mortgage and other bills, yet goes out to lunch every day because he hates to cook and thinks it's a good way to socialize.
- Fred has thousands of dollars in credit card debt yet buys expensive designer clothes every month.
- James uses his first paycheck from his first job out of college to buy a Hi-Def TV and a Wii.
- Tom has many tens of thousands of dollars in student loans but goes to the bars with his friends every Friday and Saturday night.
- Tracy has a very low income and is unsure how she'll pay her rent for the month. Yet she refuses to do her grocery shopping at any place other than the specialized organic food store.

Am I trying to say that you can't have matching furniture, a Hi Def TV, or designer clothes? Abosolutely not. Am I saying that you can't eat organic food, go out to lunch, or drink beer at a bar? No. What I'm saying that that you cannot classify these items as affordable simply because they're mainstream and everyone else is consuming them or because you feel entitled to them. If you've got an Econo Lodge income, you can't stay at the Ritz.

Insisting on expensive habits when you cannot afford them is, in my opinion, the biggest reason that people get themselves into financial trouble. Consuming based on our personal preferences gives us a feeling of independence. It makes us feel like we're doing things our way on our terms. But in the end, the choices that we made that once made us feel so independent actually enslave us and forfeit our control to our creditors.

By saying "I'm going to go out to lunch if I want to," or "I'm going to eat organic food if I want to" or "I'm going to go drinking with my friends if they invite me," if you can't afford it, all you're doing is signing over control of your life every time you sign a credit card receipt.

It is often said that the troubles with today's economy stemmed from "securitizing" mortgages, which means taking big bunch of mortgages, putting them all in a box, taping it shut, writing "security #1" on it, and then selling it. Those who buy it don't have the details of what's inside -- just that it's got a bunch of mortgages. To me, not being aware of your individual transactions is the same thing. By refusing to analyze where and how you're specifically spending your money, all you're doing is looking at the credit card bill at the end of the month and seeing one big number that reflects the sum of your monthly spending. Without looking at the individual transactions and evaluating their impact on your big picture, you're simply asking for trouble -- just like the mortgage industry.

So before you start spending on one of your vices, create a budget to see what you can really afford. You may be quite surprised!

Transitioning to a New Job

2008-11-06T06:24:00.008-05:00

I just got a terrific job offer Monday and decided to accept it. I'll no longer be working from home, which means no more shorts-and-t-shirt uniform and no more bedroom-to-home-office commute. But his is a positive move because I won't be required to travel and I'll be able to have more face-to-face interaction on a daily basis with peers and coworkers.

Moving from one job to another can be a stressful experience. In this economy, it can be difficult to find something that not only pays well, but also fits your interest and experience. So if you finally found that dream job, first, pat yourself on the back. Next, consider a few of these points to ensure that your transition is smooth -- particularly on your finances!

Giving notice

Even if you dislike your old boss and have no intention of inviting him or her to your wedding or to your child's birthday, you should still give at least two weeks' notice. Your new employer should respect your decision to do so and give you at least that long to begin. Giving notice will help to make sure that you're not burning any bridges on your way out the door and will hopefully help your chances of getting a good reference in the future. Put yourself in your boss' shoes; it's the right thing to do.

Switching your benefits

If both of your employers offer health benefits, it will be important to make sure that you don't have any gaps. Believe me -- if you get into an accident, you probably can't afford to be hospitalized for very long. Determine whether the benefits at your new job will kick in immediately, on the first of the month following your first day of employment, or after a probationary period. If they're not immediate, you'll most likely need to sign up for COBRA, which will temporarily (and expensively) extend your benefits from your old company.

With COBRA, you can expect to pay up to 102% of the total cost of your benefits for up to one year. However, you usually have a month or more to decide if you want to use them. So if you know your benefits at your new job won't kick in for a few weeks (let's say the first of next month) and your old benefits expire on the last day of employment (let's say the middle of the current month), you can go two weeks without insurance while maintaining your option to use COBRA if you become hospitalized. Essentially, because you have a month or two to "decide" if you want to use COBRA, you can pay out-of-pocket for prescriptions and doctor visits (which cost less than a month of COBRA) and decide not to pay the pricey COBRA fees. However, should you incur extraordinarily expensive medical bills, as long as you're within the month or two deciding period before your new benefits kick in, you can retroactively pay your COBRA premiums and regain your insurance. Be sure to ask your old HR representative about the company's COBRA rules.

In some cases, your benefits from your old company may be valid until the end of the last month that you work there. If this is the case, then you may try and work for the first few calendar days of a month before switching to your new job. This may eliminate any lapse in coverage and keep you from paying the high COBRA premiums.

Rolling over your retirement

First of all, the bad news for you is that you're going to lose any non-vested portion of your retirement savings that you had with your old employer. You get to keep everything that you contibuted, but if your old employer matched some of your contributions, unless you've been with them long enough to become vested, you'll lose all or part of that money. If your new employer has a similar 401(k) or 403(b) plan, they may be able to help you roll-over your money to a new account. If they do not offer assistance or do not have a 401(k), be sure not to cash out your old 401(k) money if you're under retirement age. By cashing out your money, you will pay a 10% penalty as well as regular taxes on the money. If you roll it over to another 401(k) or a traditional IRA if your new company doesn't have a 401(k), as long as a check is not delivered to you, it will be like nothing ever happened to the money.

Taking some time off

Before deciding to take time off between jobs, figure out how much that time will cost you and what impact it will have on your finances. If your new company is offering you a signing bonus, that will help pay for your off days. But if you're not getting a bonus, or if you're living paycheck-to-paycheck, it will be important for you to do a little cash flow analysis before you end your old job and start the new one.

Ask yourself these questions: How often are you currently paid? When will you get your last paycheck? How long will it take before you get your first paycheck at your new job? Will your last and first paychecks be for a normal amount? When will you receive your signing bonus? How much accrued paid time off from your last job will you be able to cash out when you leave?

If you've got some cash savings, you'll probably be able to take some time off to refresh before you start your new job. But if you're tight on cash, create a cash timeline to help you figure out if a gap in income will still allow you to pay your rent/mortgage and credit card bills. Don't assume anything, as first and last paychecks can vary substantially. Once, I started a job with a company that paid its employees once per month, at the end of the month. And each paycheck paid you for last month's work. Because of this, I started work on February 1st and did not receive my first paycheck until March 31st -- two months after I started! So be sure to anticipate this sort of thing before making any decisions about taking time off in-between jobs.

Where to put $1000: Starting a Lifetime Habit of Saving with a Cool Grand

2008-10-31T06:31:00.005-04:00

First let me say that I encourage commenting on my site. I often receive requests for topics via phone calls, emails, or today, Facebook chats. If you ever have a question related to investing, paying down debt, or planning for the future, I welcome anonymous comments and promise to respond promptly.

So you've got a thousand bucks. Where do you put it? Today's post will talk about what you can do with that money instead of spending it. I will give you options based on priority. The options begin with keeping the money close in a savings account, then paying off high-interest debt, saving for retirement, and then investing in the stock market.

Where you should put your thousand dollars depends on who you are:

If you're Bill Gates, you should give it to charity. If you're Joe the Plumber, you should save it to buy your boss' business. John McCain should spend it on campaign ads. Barack Obama should save it for a moving truck, because I've got the sense that he'll be moving to Washington before long. But I digress...you're the one with a thousand dollars.

First of all, let me congratulate you on making the commitment to start saving. Like commiting to lose weight, deciding to save money is a wise decision that will enhance your life, boost your conficdence, and never be regretted.

Where to put your first cool grand is going to start with your financial plan. The highest priority that I recommend in any financial plan is to have a reasonable cash balance before putting money anywhere else. Deposit the thousand dollars that you have in your pocket in a cash account that is easily accessible, like an interest-earning checking or savings account. No, you won't get rich quick, but you should still keep it as close as you can without putting it under the mattress. Here are two reasons why:

1) It is in your best interest to have more cash available than you need on a monthly basis. Some say that it's a good idea to have three, four, five, or even six months worth of expenses in cash. I don't necessarily agree with six, but I could be convinced that three is a good idea. Extra cash is important because annoying financial circumstances arise all the time, and without a buffer, those annoying circumstances are likely to put you into debt. Two weeks ago, my car needed an unexpected repair that cost me $420. If I hadn't had the cash to pay for it, I may have had to borrow the money from a friend or, even worse, a credit card company. Keeping extra cash in the bank is essential to prevent those annoying, yet inevitable, financial inconveniences from becoming financial disasters.

2) The other reason to save money in a cash account is purely psychological. Though you're not going to get rich earning 3% interest, you'll never lose anything, either. Over the past few months, my stock portfolio has decreased about 35% in value. If you put your first thousand dollars of savings into the stock market and end up losing a third of it, you may be discouraged from saving in the future. Before investing in stocks or mutual funds, build up a stable collection of cash that will grow slowly, but surely.

So my first piece of advice about your thousand dollars is pretty simple. Put it in a slow-growing savings or checking account (check out a Schwab or E*Trade checking account) so that the money is accessible if you need it. Once you've built a nice cash reserve, it's time to look at debt.

Notice how my first priority was to build up a small cash reserve before looking at credit card debt. If you've got some cash in the bank, before putting your $1,000 anyplace else, use it to pay down/eliminate any credit card debt that doesn't have a low promotional interest rate (0-4%). Credit card debt is a real leach when it comes to personal finance and it should be eliminated before investing your in-hand money anyplace else. Start with the card with the highest interest rate and then work your way down.

If you've got a thousand dollars to invest and already have a cash reserve that you're comfortable with and no credit card debt, then I'd look into putting it into a Roth IRA. Why a Roth IRA? Well, it's a tax-advantaged retirement account into which you deposit cash-in-hand. Your other retirement options, like a 401(k) and a traditional IRA deal with pre-tax money; if you have $1,000 in-hand, it's after-tax money and can only be deposited into the Roth IRA retirement account. E*Trade, Vanguard, Fidelity, and many more companies offer Roth IRA accounts. Check out the no-load, no fee mutual funds (preferably one that is tied to an index, like the S&P 500), as they have the lowest overhead costs and tend to perform just as well as more expensive managed funds (the ones that charge you fees to employ a manager that tries to beat the market, but rarely does). If you're under 50, you can deposit up to $5,000 per year into a Roth IRA. Those 50 and older may contribute $6,000 per year.

I could go on and on with additional investment advice related to stocks, CDs, money market accounts, or retirement. But we're talking $1,000 here. In summary, if you have an extra pile of cash sitting around, whether it's $100, $500, or $1,000, here's what you should do with it:

#1 - Make sure you've got extra cash in your checking/savings account that you can easily access.
#2 - Once you've got a little extra cash in the bank, use the money to pay down/off any credit card debt that you have, starting with the highest interest rate (not the smallest balance).
#3 - When you have no credit card debt, open a Roth IRA or contribute to one that you've already opened. Be sure to invest in no-load, no-fee funds, as they have very low costs and tend to perform just fine. Look for funds with a Net Expense Ratio under $.50.
#4 - Only after saving up some cash, after paying off high-interest debt, and after putting the maximum amount into a tax-advantaged account should you consider investing any serious amount of money in stocks. With a Roth IRA, your gains will never be taxed. With stocks, all of your gains will be taxed.

If you've made the commitment to start saving, pat yourself on the back. You won't regret the decision to live a financially healthy lifestyle.

What the 1% Fed Funds Rate Means to You, Your Neighbors, and Your Neighborhood Bank

2008-10-30T06:38:00.007-04:00

First let me say that I've got good news for you: If you're reading this blog, you're probably not going to be as affected by the troubles of today's economy as someone not reading my blog. Many of my readers are young 20 or 30-somethings that navigated here from Facebook or Twitter (yes, I keep track of my demographics!). Unfortunately for me (and them), I don't have a lot of older, fixed-income Americans reading my site. And they're the ones that are going to suffer the most in our troubled financial environment.

Yesterday the Fed cut its Funds Rate to 1% -- the lowest it's been since 2003. And the last time it was at 1% prior to 2003 was in about 1960. One might say that, historically, it's an uncommonly low rate. But what does it mean? Why is it so low? Should you be concerned? And who should really be concerned?

What it means:
You may be under the impression that when you go to the bank and ask for a mortgage, the amount the bank can give you is limited to the amount of deposits that it has from your neighbors. If you want to borrow $100,000 for a house, your rich old fogey neighbors down the street need to have at least that much sitting in their CD or savings account if you want the money...right? ...right?!?

Wrong.

Actually, if you want to borrow $100k from the bank, your rich old fogey neighbors only need to have $10,000 in their account. That's because banking regulations say that banks are only required to have 10% of their outstanding loans in reserves, a.k.a. "cash in the bank."

The Fed is the nation's central bank, and has kind of a big brother/little brother relationship with smaller, commercial banks. Commercial banks, eager to make bank (forgive the expression), lend out as much money as they possibly can every day because lending money is how they make money. But at the end of the day, when the little brother sees that he's lent out$150,000 and only has $10,000 in cash reserves, he knows that he's broken the rules (he only has 6.6% reserves, not the required 10%)...and he had better have that 10% before close-of-business (a.k.a "when dad gets home"). So what does he do? He goes to his big brother (the Fed) and asks, "Hey bro, can you spot me five grand before dad gets home? I promise I'll pay you back tomorrow...and with interest!" Big brother lends him the five grand, and the next day, as promised, little brother pays him back with interest equal to the Fed Funds Rate.

Because commercial banks are in the interest of maximizing their profits, they lend out as much as they can every day. But they never really know for sure how much cash they'll have at the end of a given day, so there's no way to know for sure how much they can loan out on a given day. If they lend too much (more than nine times their deposits), they'll need to borrow money from the Fed. But if little brother knows that he can borrow money from his big brother overnight at a mere 1%, he won't be as afraid to lending out more than he's allowed.

Why it's so low:
Big brother knows that loans are important to his little brother and all of the people that he lends to. And big brother helps out wherever he can. Well, the big problem as of late is this: the little brother lent lots of money to subprime borrowers, many of whom never paid him back. So all of the sudden, the cash reserves of his little brother diminished. Now, instead of using his cash in the bank as a reserve for making more loans, he is using that cash to cover his costs associated with foreclosures. And because more and more people aren't making their mortgage payments, he has less and less money that he can use as reserves for new loans.

Think of it this way: if a foreclosure costs a lender $70,000 (which is realistic), it means that lender will have to decline $700,000 in new loans. That means that one foreclosure might prevent three or four qualified people from getting a mortgage.

Many of the little brother's customers -- even those with good credit -- can't get new loans. It isn't anything personal -- he just can't afford to lend to them! These customers are both businesses and individuals. And when businesses can't get the loans they need, it sometimes leads to layoffs, which in turn leads to more individuals defaulting on their loans.

With all of this chaos in the air, big brother stepped in. "Hey little brother -- I see you're having tough times. Go ahead and loan to those people with good credit. If you need to borrow some money, I'll lend it to you for next to nothing." By lowering the Federal Funds Rate again and again -- eventually to 1% -- the Fed is attempting to give banks the wiggle room they need to be able to start lending again.

Should YOU be concerned?
With the Fed lowering rates, it will effectively drive up inflation, which has both upsides and downsides. Lower rates cause inflation because banks can more easily get money. And when money becomes easier to get, that means that it's worth less. As money becomes worth less, more and more money is required to buy the same things.

At first, this sounds bad. But in reality it can help some people. Those with long-term fixed-rate loans, like student loans or a mortgages benefit greatly from inflation. Essentially, they're repaying a loan over a long time with money that's becoming worth less and less. On the flip side, inflation is the key driver for increasing home values. So those that own homes are seeing inflation drive up the value of their property. Because of the fixed-rate nature of mortgages (though some are variable) and the general increase in property values over time, owning property is, for the most part, a good investment. Without inflation, this theory might be different.

Additionally, most working professionals get a raise every year that resembles the rate of inflation. This raise is often referred to as a cost of living increase. It is meant to offset the burden of inflation so that it has less of an effect on our wallet. So if the cost of goods goes up 3% each year, you're going to be just fine if you get a parallel raise of 3%.

So why should you care about the 1% Fed Funds Rate? If you're a working professional that has a fixed-rate mortgage, owns a home in a stabalizing market, and get a cost of living increase each year, you're going to benefit from slightly higher inflation. Your mortgage will become easier to pay, your home will increase in value, and your annual raises will cover most if not all of your increased cost for everyday goods.

Who should really be concerned?
The elderly that are living on fixed incomes for the rest of their lives should be the ones to worry. They're the ones that aren't borrowing money and the ones that won't get a cost of living increase every year. If they're living in the last home that they'll ever own, it will become increasingly difficult for them to keep the home in their family; unless they sell it or get a reverse mortgage, they won't benefit from inflation driving up its value.

Also negatively affected by lower rates and increased inflation are companies and individuals working on a long-term fixed price contract. As money becomes less and less valuable, the benefit that they'll receive as time goes on will decrease until their contracts are renegotiated.

Keep in mind that banks are included in the list of companies that work on long-term contracts (in the form of fixed-rate mortgages). With the Fed lowering rates, though their immediate costs of getting money may go down, they know that inflation will make the money that they'll receive in future payments worth less. Anticipating the decreasing value of the dollar, they'll need to increase the rates at which people borrow from them. Last week 30-year fixed mortgages were at 5.92%. Today, they've shot up to 6.35%. On a $200,000 mortgage, that rate increase would increase your monthly payment by $55.64.

Because of this significant mortgage rate increase, you should be concerned if you have yet to buy a house. A decrease in the Fed Funds Rate will increase mortgage rates and may therefore decrease homeownership. In 1980, inflation was at an astounding 13.58%. Interest rates for mortgages often exceeded 11%. Therefore, in the early 80s, my parents lived in a trailer.

Summary:
- The rate at which the Fed lends to commercial banks was reduced to 1%
- This gives banks wiggle room and makes it easier for them to make new loans to businesses and individuals
- Those that will benefit from the rate cut are homeowners with fixed-rate mortgages and those with jobs that offer annual cost of living pay increases
- Those that will be hurt are those living on fixed incomes and those committed to long-term fixed-rate contracts
- Increased inflation caused by the decreased cost of money will increase mortgage rates and therefore make it more difficult for first-time homebuyers to afford a home.

In case you were wondering: Yes, I was conceived in a trailer.

Three Parts of a Practical, Effective Budget

2008-10-29T06:17:00.005-04:00

Many times I've recommended creating a personal budget to help you meet your financial needs. It doesn't sound too difficult, does it? Believe it or not, the hardest part is finding the discipline to stick with it and give it the care and feeding it needs to be effective. It's easy to add up your income and divide it across all of your expenses/savings goals. But budgeting is more than that. In this post, I'll tell you the three important items that you'll need to have an effective budget: a Budget "Thermometer," Running Total Tracker, and Cash Planner.

1. Budget Thermometer

Here is a sample of my budget thermometer for September. It is simply a screenshot from my favorite free personal finance software, mint.com.

Coming up with categories and their monthly allowances is an important first step and the part of your budget that you will pay the most attention to on a daily basis. Mint.com not only allows you to create your budget, but it will show you a daily thermometer to display how well you're adhering to your plans. Because it's integrated with your bank and credit cards, each day it will classify your spending transactions and tell you whether or not you're on track to meet your monthly goals. If you spend half of your grocery budget by the 5th of the month, Mint will alert you so you can rein in on your shopping until you're back on track. As you spend money in a category, your little "thermometer" will fill in. Its color will change if you're on pace (green) , not on pace (yellow), or over your monthly budget.

I can't tell you how to split up your income each month, but here are some tips:

- Before creating your categories and their associated monthly allowances ($500 on groceries, $200 on restaurants, etc), take a look at where you currently spend your money and don't just pull the numbers out of thin air. If you're using personal finance tool like Mint, Quicken, or Money, you should be able to see a pie chart that shows you how you've spent your money in the past. But make sure your past transactions are classified correctly!

- Next, establish new goals for each of your categories. It's OK (and encouraged!) to spend less each month in certain categories than you have in the past. If you spent $400 last month at restaurants and want to bring that down, this is the perfect time to set those goals. Make sure you're using reasonable and achievable estimates for everything, but don't be afraid of a challenge.

- Don't forget about your savings goals! If you're saving up for something specific like a vacation or an engagement ring, start implementing those goals into your budget as categories after you've figured out what you'll have left over. Whether it's $10 per month or $500 per month, it's important to put money away for the things you'll need in the future.

- Don't budget down to your last penny. We're dealing with your personal finances; you're not an accountant. I like to leave out 2.5% of my monthly net income (after-tax pay) unaccounted for. There's no doubt that at least one of my expense categories will go over one month (as you can see above), so it's nice to have a little buffer for such an occasion without throwing off my other goals.

- If there are expenses that aren't incurred monthly, like car insurance or, in my case, my dog's annual vet visit, split them up in terms of months. Divide your six-month premium by six and use that as your monthly budget. This, of course, means that you'll be under budget some months, and over budget the months that the expense is paid. This point illustrates the need for the other two pieces of an effective budget: a Running Total Tracker and a Cash Planner.

2. Running Total Tracker
Unless you're an incredibly disciplined, you're not going to spend exactly the same amount of money each month on all of your categories. Certain things like your car payment, mortgage, etc are fixed, but other expenditures like groceries, clothing, and utilities will vary a bit. This is why it's important to track running totals.

Mint does not have running total tracking functionality, so I do it myself once a month in a spreadsheet. Two of my columns are identical to my categorical budget columns that are tracked by my personal finance software. One column has the identical category and the next has the monthly budget. Each month, I evaluate my monthly adherence to my budget and note the amount that I was over or under for each category in a new column; I have columns for each month that I have been using the spreadsheet. If my restaurant budget is $140 and I only spend $90 in September, my September column would have a green "$50" because I spent $50 less than budgeted. If I had spent $150, my September column would have a red "$10" because I spent $10 more than budgeted.

Next to the first two columns that display spending categories and their monthly allowances, I have a third column with a number that is either red or green. This number represents the sum of all of the monthly over/under amounts, which I call the "running total."

The running total is important for me to know how well I'm adhering to my budget over time. Also, it keeps track of the balances of certain non-monthly expenses and can help when you create next year's budget. If you see that you're constantly spending more than your budget on gas or groceries, you might need to rethink your amount.

Additionally, the running total column can indicate whether or not my wife or I can afford greater than normal spending in a certain category. Recently she said she wanted to go clothes shopping. We hadn't spent any money on clothes in a few months, so when I checked our running total for clothing, I saw that we were about $123 in the green. Because we hadn't spent our $50 clothing budget in a few months, she was able to go and spend more money on clothes this month. When I update my spreadsheet next month, the running total will be back to zero.

3. Cash Planner
Our incomes and expenses aren't always regular and incremental. There are times of the year when we receive bonuses or incur extra costs. The third piece of budgeting is important to help you determine how much cash you'll have after receiving irregular income (possibly after getting your tax refund) and after paying your abnormal expenses (like the January post-holiday credit card bill).

This budgeting tool is also something that I track manually in Excel. Across the top are columns indicating two periods per month -- one ending on the 15th and the other on last day of the month. It's up to you to determine how small your time increments will be. Depending on how often you're paid, you can have columns represent every Friday from this day forward, or simply the end of the month.

For each column, I have a series of rows for my expenses and incomes. My income is a row and my wife's is another. My expense rows resemble my budget categories, but unlike my running total spreadsheet, they don't follow them explicitly. This is because not all of my expenses are paid on the same day of the month. Many of them, like groceries and my XM bill, are put on my credit card. Since my credit card bill is due only once per month, I have a single row for "credit card" that includes many of my regular expenses. Other expense rows include one for my mortgage, my car loan, and my student loan payment.

Two other important rows include "Additional Income" and "Additional Expenses." These will be places where you can input anticipated fluctuations in your income or expenses. If you know you're planning on spending $350 next month on your quarterly student loan interest, you can plan for that. If you're getting a big tax refund in the spring, put that in your April column. Add as many columns as you're comfortable with. If you want to plan out six months ahead, you may. If you only want to plan two months ahead, that's fine, too.

Next, for each period column, I enter the expected amounts for each row (if any) that will be applied during the period. For example, my mortgage and car payment are paid on the 10th of each month. For the column labeled 10/15 (representing the period from October 1st - 15th), I will enter the amount of my monthly mortgage and car payments as well as any income I expect to receive. Since my credit card and student loan payments aren't due until later in the month, those expenses will show up in the second column for the month, 10/31. Similarly, because my wife is paid only at the end of each month, I'll enter her income only for the second period.

At the bottom of each column, I do a little math to estimate my cash balance. I take the cash balance from the bottom of the previous column, add the incomes from the current column, and then subtract the expenses from the current column. This will result in my new expected cash balance for the period. For example if I had $5,000 at the end of the last period, received $1,000 of total income, and incurred $800 of total expenses, my new cash balance would be $5,200.

While the Budget Thermometer and the Running Total tracker are useful for tactical budgeting, the Cash Planner is great for strategic cash management. If you're trying to develop an emergency fund of a few months' salary, the cash planner will give you a good idea of how long it will take to reach your goal.

As you can see, there's more to budgeting than just coming up with monthly allowances for spending categories. To budget effectively, you must have reasonable monthly goals (derived from your past spending), the ability to monitor your adherence to those goals, a willingness to log your monthly adherence (running totals), and a view into the future to know what your financial situation will be and how soon you can achieve your goals.

What are your own personal budgeting strategies?

What if You're Upside Down on Your Mortgage and Need to Move?

2008-10-27T07:01:00.008-04:00

In my previous post about being upside down on a mortgage, I said that you're probably not going to be able to move anytime soon. Well, what happens if you're upside down and need to move? You have options, but none of them are magical or ideal. This post will describe a few of them: borrowing money to make up the difference, negotiating a short sale, and foreclosing.

Two big variables that will greatly affect your situation are 1) the amount you are upside-down and 2) the degree to which you can afford to keep paying your mortgage. If you are upside down $50,000 versus $5,000, you're in a much more difficult situation. Likewise, if you're able to keep making your mortgage payments until you figure out a long-term solution, you're in a much better position than someone who is unable to make his or her payments. If you can't make your payments now, consider renting out the home after you move or drastically changing your current budget to make ends meet. When you move, rent a small inexpensive place. If your kids are in college, consider asking them to take time off or to absorb some of the costs themselves. Major lifestyle changes are difficult, but the effects of a foreclosure or a short sale can be detrimental; all efforts should be exhausted to ensure that neither of those two occur.

If you are upside down on your mortgage and are put in a position where you need to move -- whether it's because of a job transfer or an unexpected layoff -- the most ideal option is to keep your home until you are no longer upside down. This can be achieved by saving money to match your negative equity or waiting for the market to pick up. Three alternatives are described below in order from best to worst as they relate to your overall financial (and emotional) wellbeing.

Option 1: Borrowing the money
This is an option as long as you're slightly upside down and not really upside down. If your negative equity is no more than $10,000, you're not in such a tough place. By borrowing money to get out of the pinch, you're protecting your credit score from getting hit by a train and ensuring that you'll be able to get another loan sometime in your lifetime.

The best place to get a loan for $10,000 or less would be from a friend or family member. But if you borrow money from someone, they'll need to charge you interest (at least 4.52%) in order for the IRS not to consider it a gift. A person is allowed give gifts to another up to $12,000 per year.

If you're fresh out of rich relatives, there are other places to look. If you, your child, or your spouse is enrolled in college, you may be eligible to take out an additional student loan. The federal government will allow students and parents to borrow money in excess of actual tuition and fees to cover living expenses. It would not be uncommon for students and parents to be able to borrow an extra $7,000 or $8,000 per semester which is available in cash. These loans have a relatively low interest rate (between 6% and 8%), are repayable over a long period of time, and their interest is generally tax deductible.

I hate to say it, but if you're unable to get a favorable loan from a family member or the government, you may have to resort to using a credit card convenience check or obtaining a high-interest personal loan. I'm not usually a proponent of putting things on your credit card that you can't pay off immediately. But in this case, when a foreclosure or a short sale are your only other options, the convenience check is the lesser of two evils. I'd rather see you incur five or ten thousand dollars of credit card debt if it means you'll avoid a foreclosure or a short sale.

Option 2: Negotiating a short sale
Short selling is when you negotiate with the mortgage lender to accept a fair market price for the home instead of the amount that you actually owe. This is more likely to be accepted when home values in a certain area have dropped significantly. Though mortgage lenders are not required to modify your agreement and accept less than you owe, they may be willing to because it may prevent a foreclosure, which is very expensive for a bank. Basically, they would rather forgive $10,000 on your loan than incur $70,000 in costs associated with a foreclosure.

Short selling is similar to foreclosing, but it will ultimately cost the bank less money and permit you to buy another home a bit sooner. It is preferable to a foreclosure, but is only offered by some lenders to some borrowers, depending on the circumstances. I had to do a bit of research to confirm this, but short-selling on your home will cause as much immediate detriment to your credit score as a foreclosure.

Expect your FICO score to drop 200 or 300 points. Your new score will most likely preclude you from qualifying for a rental lease without a cosigner. However, with two years of good credit history following a short sale, you will probably be able to obtain a mortgage through special government-sponsored programs. If you had foreclosed, you most likely would be unable to qualify for another mortgage for at least four years.

If you want to short sell your home, two things need to happen. 1) The mortgage lender has to be willing (it helps to have a lawyer assist with the negotiations) and 2) you need to prove your insolvency. Basically, you need to show that you have no money that can be freed up to pay for the difference between what you owe and what the house is worth. If you have equity in another property, a car that is paid off, or a student enrolled in college, the bank will see these things and ask why you're not dipping into your other equity, selling the car, or taking your kid out of college to pay what you has originally agreed. Essentially, before the bank concedes a short sale, they will need to be assured that foreclosure is the only other option because you have no other means to repay the loan.

Option 3: Foreclosure
This is clearly the worst thing for everyone. Your credit score will be destroyed and its affects will be long lasting. You will be unlikely to receive any other type of loan for a few years. The only good news is that no negative item - including a foreclosure - can stay on your credit report for more than seven years.

Being upside down on a house is a tricky situation -- especially for those that need to move. If you're upside on the mortgage for your current residence, save as much as you can so you can eventually bring get rid of the negative equity. If you need to move, do whatever you can to keep the home until house values go back up. If you cannot keep the home, try to borrow money from a friend or from the Department of Education. Remember that it's better to put an extra five or ten thousand dollars on a credit card than go through a short sale or foreclosure. If you're unable to obtain the cash to get out of the red, try to negotiate a short sale. It's effects on your credit are detrimental, but not as long-lasting as a foreclosure. If your lender is unwilling to engage in a short sale, then foreclosure may be your only option.

How to Spot Your Family and Friends' Financial Troubles

2008-10-24T06:19:00.007-04:00

I'm proud of my audience. I really am. Since becoming a regular reader of my posts, I'm sure you've long-since retired and are enjoying the fruits of your pre-retirement frugality on a secluded beach in the Caribbean or on your 40-ft yacht (for which you paid cash, of course). I'm thrilled that you've achieved financial independence, so today I'm going to reward you with a day off and a break from lending advice on your finances.

Now don't get me wrong -- I'm not going to stop talking about finances. But today, instead of talking about yours, I am going to talk about those of your friends and family and how to spot a problem. I'm going to talk about clues: those that indicate current trouble and those that indicate a future fiasco. The way I see it, family and friends are supposed to help each other through hard times and support each other during painful periods. For many, personal finance is a private subject that offers very little transparency for outsiders. Many times you can't detect problems with your eyes, your ears, and your nose, as you can easily do when it comes to identifying substance abuse. Instead, you will rely on your gut -- playing detective and piecing together the clues to support your argument that a problem -- or even crisis -- really exists.

Before you consider whether or not a friend of yours is having financial problems, you'll need to have an original suspicion; we can't investigate and confront everyone (like the nosy neighbor Martha Huber on Desperate Housewives). Many reasonable suspicions will come from a passing statement about credit card debt, the infrequency of pay days, the inability to pay a bill, the inability to save, or something else. Let's look at a few potential flag statements:

"I have no idea how much credit card debt we have."
Your friend's lack of knowledge of the amount of his credit card debt indicates a detachment from his own finances. Though his personal finances are private and he is unlikely to share his net worth with others, his own accurate view into them is absolutely critical to his financial wellbeing.
"I'm just paying the minimums."
This statement indicates an inability to sacrifice when repaying debt and/or a fundamental misunderstanding of the nature of revolving debt. As I proved in a previous post (the Cost of Credit Card Debt), paying the minimum on a credit card is about the worst financial decision one can make, second only to taking out a payday loan or using cash as kindling. If your friends are paying only the minimums on their credit cards -- especially if they continue to eat out and spend on non-essentials -- it shows that they are in denial of their situation and are likely in need of a friendly nudge to get the ball of debt reduction rolling.
"Thank god that my spouse and I are paid on alternating weeks."
Living paycheck to paycheck is part of being young. When I first graduated from college, it was important for me to analyze my paydays and sync them with my bills' due dates. But as I got older and was able to save a little more, I eventually got to the point where I had an amount equal to one paycheck sitting in my checking account. Once I hit this milestone, life became easier because I didn't need to strategize the days on which I paid my bills. But when you see friends and family in their 40s or 50s worrying about which day of the month they're getting paid, it can indicate a paycheck-to-paycheck lifestyle and therefore, a lack of savings (or at least liquid savings). Assuming he has a moderate salary, that lack of savings might come from excessive minimum payments on loans and credit cards or from current overspending. Additionally, this indicates that your friend struggles with budgeting and planning for expenses that fall far away from payday.

If your family and friends are quiet and don't give these kinds of clues, you can infer financial troubles in different ways. If you're good at doing math in your head, you may be suspicious of their spending habits if they just don't seem to add up. If you know that your friend has a salary of $30,000 per year, yet you see him going out for lunch every day, driving a new car, living without roommates, wearing expensive clothes, and watching a high-def TV, you can assume that he is living outside of his means. It's not easy to look at someone's lavish lifestyle and automatically assume that they're spending more than they make. But it can certainly be grounds for suspicion and, combined with other clues (like some of the statements above) be a strong indicator of financial trouble. If a friend or family member tries to keep up with the Joneses without having the means of the Jonses, they're setting themselves up for trouble.

So why do people get into financial trouble? Clearly, some are presented with circumstances which are out of their control, like a sudden illness or a layoff in a poor economy. But some get into trouble for other reasons. Here's my theory:

Have you ever heard the principle that a liar will begin to believe his own lies if he tells them enough? Eventually, his lies can be spouted off without guilt or remorse. I think the same concept can be applied to those with preventable financial troubles. The snowball will start to roll when the person initially buys something which he cannot afford. He'll lie to himself about the item's affordability, being well aware that he should walk away and abandon the need for instant gratification. "Oh, it's just a lousy TV. I can afford it," knowing deep down that it's not a good idea. Later, when presented with another opportunity to spend unwisely, the same person will more easily convince himself of the affordability of said unwise purchase, despite contrasting evidence. Eventually, when it's told enough, the lie of affordability becomes second nature and is no longer is perceived as a lie; and that's when it becomes dangerous.

Do you remember the first cigarette you ever smoked and how horrifying that first puff was? It was awful and bitter and burning and easily sworn off. But the second one was a bit more tolerable. And the third became somewhat enjoyable. Over time, you developed a habit and never looked back at how terrible that first drag was. On day one, your body was trying to tell you something. You knew it was bad for your health, but you found a reason to do it anyway, probably related to high school popularity (keeping up with the Jonses) or the relief of stress (instant gratification). Whatever cookie-cutter excuse you came up with on that first day, you used it again and again until you didn't need to excuse yourself any longer. Non-smokers, please forgive this example, but I hope you get my point.

I certainly don't condone sniffing into the business of others. Personal finance is often a taboo subject among friends and family and a confrontation can affect a person's sense of independence and pride. However, depending on the situation, financial troubles on their part may result in a bailout on your part. Depending on the size and nature of the debt, what was once their problem may eventually become your problem. The way I see it, family money is family money. The benefits and the detriments to one member most certainly have the ability to benefit or detriment another. In other words, though it may not be your business today, it may become your business tomorrow.

I welcome anonymous comments about the financial stuggles of your friends and family.

Free Legitimate Websites That Actually Help Me Save Money

2008-10-23T07:11:00.007-04:00

Here on tepom.com, I encourage you to spend less money and try to give advice on where to put what's left over. Today I'm going to share some free websites that actually/legitimately/genuinely help me and my family save money.

Upromise - If you're ever going to pay for someone's education, this is a must. It's a free service that rewards you with cash back for making purchases from its marketing partners. The only catch is that the money needs to be used to pay for college, which is enforced by placing your cash rewards into a 529 college savings account. Prices aren't marked up, you retain promotional discounts, and you can shop normally as you always would. There is a neat little toolbar that will detect when you're at a partner's website and will automatically give your reward. For example, ShoeBuy.com claims to have the lowest price on the internet for shoes and they also a partner with Upromise. Last week, I bought a pair of sneakers at an already low price, received ShoeBuy's 20% Columbus Day discount, and then another 10% cash back into my Upromise account. On average, Upromise deposits $270 per year into my college account, and I don't have to change my shopping habits one bit.

You also get credit for shopping at brick-and-mortar stores and restaurants by registering your credit and debit cards with Upromise and using them at the establishments. Additionally, by making travel reservations online, you will receive a percentage back after your stay is complete; I get 3% back on all hotel stays in addition to the other reward points offered by the hotel. And if I had used Upromise before I bought my house, I would have received about $700 for using a Century 21 agent.

Again, Upromise is completely free and easy to set up. You will earn between 1-10% cash back on your purchases and you can continue to shop like you always have for the best prices on goods, services, trips, and more. If you happen to land at a Upromise-sponsored business, you automatically receive your reward. If not, no big deal.

Mint.com - I've spoken of Mint several times on my site. It is a free personal finance website that provides software similar to Quicken, but with a much nicer and simpler user interface. Mint is incredibly easy to use and quite powerful, too.

If you have ever wanted to start a budget or to have a single view into all of your accounts -- be they retirement savings, college funds, checking and savings accounts, mortgage and auto loans, or credit cards -- this is the place to do it. By securely entering your username and password for each account, Mint will access the site and place your transactions into a single list. If you've got an issue with your spending discipline, Mint can keep it in check by showing you your up-to-date adherence to your monthly budget -- how much you've spent so far at restaurants, clothing stores, etc in a graphical, colorful "thermometer."

Also, be sure to check out their new Investments feature that will show how well your individual investments are doing compared to the rest of the market. And if you're interested in comparisons, you can easily see how much you spend at Starbucks or Walmart compared to other people in your city or state.

Craigslist - I hate to sound like a dirty college student, but you'd be amazed at the great deals you can find on Craigslist on all sorts of things. It's local, the stuff is inexpensive, it's super-duper easy and completely free to use for both buyers and sellers.

I don't use it as religiously as some, but before I make any major purchase, I'll look there. When I almost purchased an electric lawn edger at Lowes for $90, I bought the same one on craigslist for $25. When I almost bought the $500 bunkbed set for my guest room, I found the exact same one on Craigslist for $80. When I was inches away from buying a $2,000 digital piano in a music store, I found a comparable one on Craigslist for $400.

And Craigslist is a good way for you to get rid of your old stuff and make money. One Saturday when we cleaned out the garage, I made a Craigslist pile and then turned it into few hundred dollars cash within a week. It was nice to be rid of my old vacuum cleaner, a printer, and an extra coffee table, and I was happy to help some neighbors get their own good deals.

Please leave a comment with your own online all-stars that are legitimate, free, and will put cash in your pocket.

How Young Americans Can Profit From Today's Economy

2008-10-22T06:13:00.012-04:00

Economy got you down? Well then chin up, young folks! You haven't got as much of a reason to worry as your older neighbors do. In fact, today's down market could have an incredible positive impact on your retirement if you play your cards right! I'm going to show you why you shouldn't beat yourself up about the nightmarish economy, but rather why (and how) you should invest. But be careful -- this is by no means a free pass to completely overhaul your personal financial plan (if you have one). My core values still stand: get out of debt, don't spend too much, and save your money. Let's get started.

Random optional side-notes:
First let me say that conspiracy theorists and skeptics and hard-core political enthusiasts are welcome to give me their comments about how the bailout and/or the election of a Republican/Democrat will doom us all. They may think that capitalism as we know it is over and before we know it, the government's interest in our financial institutions will create a socialist (or even communist) state and my words will be rendered irrelevant. Well, I hope that doesn't happen. But if it does, it's completely out of our control. The purpose of this post is to help average young Americans take advantage of this economy so they will benefit later in life. Future relevancy aside, this post assumes that the economy and government will function in the future as it has in the past.

On another side note, if everyone followed my advice and became completely debt free, the nation's economy would actually crumble. But don't worry -- it's impossible for an entire nation to become debt free. There is literally less money out there than there is debt. Sounds crazy, but it's true. :-)

Today's economy could actually help today's youth, and this theory is partially proven with the principle of dollar cost averaging. Essentially, the principle states that an investor's exposure to risk (risk of losing your money, that is) is reduced by buying investments incrementally instead of in one big lump sum. This works because in the short term, the stock market fluctuates frequently and unpredictably. So by buying stocks incrementally, you spread out your investment, buying in small batches for varying prices. On the other hand, the long term market is very predictable and its fluctuations are uncommon, minimal, and easily spotted. As you know, the idea of investing in stocks is to "buy low and sell high." In the short term, because it is difficult to know when you're at a peak and when you're in a valley, it's better to just keep buying a little bit at a time; sometimes you buy at the short term peaks and sometimes you buy at the short term valleys. In the end, you end up buying stocks for a dollar cost that is an average of its short term peaks and valleys.

Let's look at an example of short term fluctuation. You have $1,200 sitting around that you can invest in the stock market. Sure, you can take it all and invest it immediately, but it would be better for you to invest $100 it each month for the next year. Or even better, $50 every two weeks.

If you had invested that $1,200 in a mutual fund last October in one fell swoop, you probably would have lost quite a bit of your money (the Dow was at 14,000 last October and is at about 9,000 today). Let's say you bought the stock at 10 dollars per share -- 120 shares total. Let's also assume that because of the poor economy, the market has gone down 3% each month for a year (a realistic estimate given our recent history). So at the end of a year, your 120 shares would be worth about $912 -- about $7.60 apiece .

Now let's see what would have happened if you had invested $100 per month instead of putting it all in at once. In the first month, you would have bought 10 shares ($100 investment/$10 share price). But in month two, you would have been able to buy more shares with that money. Because the market had gone down, that stock was selling for $9.70. The next month, it would be selling for $9.41, and so on. By investing $100 per month for the full year, because of the discounted price, you would end up with 143 shares instead of 120 -- 19% more.

By investing incrementally, sure, you still lost money, but you also bought 90% of your stock for less than you paid for it when the Dow was at its peak a year ago. Because the market has gone down in the short term, the average price that you paid for that stock has also gone down. But because the market always goes up in the long term, you'll be better off when you eventually sell your stock because you will have a lower average cost per share and therefore, more shares. And the more shares, the better. When the stock eventually goes back up, you'll have 19% more money. When the stock pays a dividend, you'll get dividends for 19% more shares. More shares equals more money.

Of course, this theory goes both ways. Dollar cost averaging minimizes your short term gains as well. But if you want to guarantee your success in the stock market while maintaining your sanity, you need to give up on the notion of becoming a millionaire overnight or being the next Jim Cramer. Yes, dollar cost averaging will minimize both short term losses and gains, but it also ensures that your long term benefits aren't spoiled by the unpredictable daily/weekly/monthly peaks and valleys of the stock market.

Short term fluctuations are impossible to predict unless you've got the research budget of an investment bank. But in the long term, it's much easier to spot your "elevation" and buy when you're in a valley. Since 1978, there are only a few very obvious valleys. There was one in the late 80s, one in the late 90s, one just after September 11th, one in 2003, and one today. Today, stocks are cheap. This stinks for retirees that need to cash out to pay their mortgage, but it's wonderful for younger Americans that are just starting to save.

Just as it's true that short term ups and downs are unpredictable and should be handled with caution, it's also true that long term growth is quite predictable and its ups and downs can be more easily exploited. In the long term, when the market is growing quickly, it becomes proportionately more difficult to make a buck. But in days like these, when the market is down, it's the perfect storm for young folks to buy low and eventually sell high.

Those that understand the principle of dollar cost averaging and incrementally invest will minimize their short term losses (and unfortunately, short term gains, too). And those who, in the long run, slow their investing when the market is up and hasten their investing when the market is down (like today) will retire younger and more quickly enjoy a financially independent lifestyle than their get-rich-quick peers.

What To Do About Student Loan Interest Capitalization

2008-10-21T06:39:00.009-04:00

If you're currently in college and have student loans, you may have recently received one or more quarterly interest statements from Direct Loans. Current students are given the option to delay their monthly payments until they're finished with school, though interest may have already began to accrue. This accrued and unpaid interest is what this form details.

Statements will show a current balance along with a figure for Total Unpaid Interest. Though this is not an actual bill, it looks a lot like one because of the clear bold figure indicating how much you might want to pay and the inclusion of a pre-addressed envelope and remittance form. So should you pay it?

The short answer: Yes, you should probably pay it.

Unless you absolutely cannot afford it or if you have debt with a considerably higher interest rate than the student loan, I'd like to see you pay all of the Unpaid Interest. Basically, unless you're dead broke, have high-interest credit card balances, or if you've got a loan shark chasing after you, grab your purse and start writing a check to the U.S. Department of Education.

Here's why: If you make a payment toward this loan -- especially if it's only for the listed amount on the form -- you're going to decrease your tax liability for the current year. If you're in the 25% tax bracket and you have $100 in unpaid interest, a payment of $100 will increase the size of your refund by $25 even if you're using the standard deduction. This $25 far outweighs how much you would save in interest by sending that same $100 to a loan with a slightly higher interest rate that is not tax deductible.

My wife just received a quarterly interest statement for her student loans. Because she's enrolled in grad school, no payment is due at this time. Currently, the interest rate on her student loans is about 1% less than the rate on our auto loan. So I considered letting it ride on the student loan interest and making a larger payment this month on our auto loan. But because the interest on an auto loan is not tax deductible, even with its higher rate it makes sense to pay the Total Unpaid Interest on the tax-deductible student loan.

But keep this in mind: If you have debt with a higher interest rate than your student loans -- like an auto loan -- only pay the Total Unpaid Interest on your student loan, and never more. Payments toward principal-only should always be made to loans with the highest interest rate.

If you don't have an auto loan or credit card balances, consider paying the Unpaid Interest plus whatever extra principal you can afford on your student loan. But if you have more than one federal student loan and receive multiple corresponding quarterly interest statements, don't pay extra principal on a loan until you have paid the unpaid interest on all of your student loans, regardless of their interest rates. Any payment amounts that exceed the Total Unpaid Interest will go toward the principal balance, which is not considered tax deductible. If you can afford to pay more than the Total Unpaid Interest on all of your loans, first, write a separate check for each account's Total Unpaid Interest, and then write an additional check for the account with the highest interest rate (probably a PLUS loan) in the amount of your extra principal payment.

If you're a student and you don't have any credit card debt or a high-interest auto loan, pat yourself on the back!

Is Prosper.com dead? And what is a secondary market?

2008-10-17T06:52:00.004-04:00

Anyone who borrows, lends, or regularly browses Prosper.com received an email from the site's management team about suspending lending activity for a while while they develop a secondary market. So what does that mean? Will we ever be able to lend or borrow again? And what on earth is a secondary market?

First of all, don't worry. Prosper.com is not dead nor will it be dead anytime soon. They're simply listening to users that write about the pros and cons of peer-to-peer lending (like me). Until recently, Prosper.com has been a very small fish in the big pond of lending. Now, they're growing to a slightly larger, more mature fish; they just need to pull the curtain for a few months while they renovate.

If you read any post on just about and blog that writes about Prosper, you'll notice that one downside for lenders is that any money that they invest is money with which they part until the loan is repaid. For example, if you lend $100 at 25% to someone, you will get approximately four dollars per month for 36 months. And if you all of the sudden you need emergency orthodontic surgery and absolutely had to have back that $100 that you lent, there would be no way for you to get it faster than waiting for the $4 monthly payments to add up.

But let's say you had a really good friend named Steve that noticed you were in a pinch. Steve sees that you lent out this money a few months ago but need it back today. Seeing that the lender still owes you about $120 over the next two and a half years, he offers to give you $100 today if you agree to give him the remainder of your $4 monthly deposits. You benefit by cashing out when you needed to and Steve benefits by taking control over a reasonably profitable investment ($20 in this case) .

But let's say that my other friend, Dave, also sees my predicament. He wants in on the investment, so he says that he'll give me $105 for the remainder of my payments. Sure, he'll make a little less profit than Steve, but he likes the idea of making $15 profit on his $105 investment. Steve isn't willing to pay more than that, so Dave ends up "winning" your loan.

Essentially, the offers of Steve and Dave to purchase of your stake in the loan represent a secondary market. A secondary market is a place where investors can bid on securities -- including bonds, stocks, and in this case, loans -- after initial public offerings have already been made. In the case of Prosper.com, the initial public offering was the original loan listing.

After you bid on a loan and give some money to another person as an investment, a number of things can affect the value of that investment. Let's say that statistics show that borrowers that make their first 10 payments on time are 50% less likely to default than people who have only made their first five payment on time. Therefore, anyone holding a loan to a borrower that has made 10 payments on-time could sell those loans for a higher premium on the secondary market. Or if you're an secondary market investor, you could buy up a bunch of loans that are currently late for pennies on the dollar. The original lenders are happy because they're able to get some money back, but you'll clean up if you can convince the delinquent borrowers to pay up.

The secondary market is a key part of our economy. Without it, stockbrokers on Wall Street would have pretty boring jobs. Without a secondary market, our investments in stocks and bonds would have very little liquidity. If we invested in stocks, we would only be able to cash out when the company agreed to buy that stock back from us. Or if we wanted to get our money out of a 30-year bond, we would have to wait the full 30 years.

Prosper.com wants to create a regulated, large-scale secondary market for their loans. To do this legally, they need to file with the Securities Exchange Commission, which takes time. But after the filing is complete, more people will be encouraged to lend because they won't have as much of a risk of having little liquidity. Basically, current lenders who run into financial troubles of their own will no longer risk not being able to get at least some of their money back. The secondary market will positively affect borrowers, too, who can expect to get lower rates on loans, as the risk to original lenders losing all their money is reduced; lenders whose borrowers are late will be able to sell the loans. And because their liquidity is increased, lenders will more likely invest more money.

Let's just hope that Freddie Mac doesn't start buying up loans made to High Risk borrowers, packaging them together, and selling stock in their "High Risk" fund. As our recent economic troubles showed us, that's just asking for trouble.

Will Prosper.com's development of a secondary market encourage you to start lending?

When Do We Eat? The Value of Financial Individuality

2008-10-16T06:25:00.006-04:00

Do you remember when you were growing up and your mother told you that you were special? Or maybe it was a teacher or your grandmother or a family friend. Chances are, a caring adult in your life encouraged your individuality and, more importantly, your independence. The lesson may have been taught in different ways, but was nonetheless important. Maybe you were encouraged to think twice before jumping off a bridge if all of your friends decided to do it. Maybe you were taught to "just say no" when presented with an opportunity to engage in an activity that threatened your moral fiber. However it was taught to you, I'd like to discuss the lesson's importance and relevance to your financial wellbeing.

Individuality and independence are important traits for people to possess in many respects. The right kind of individuality will set you apart from other candidates when applying for a job or admission into college. The wrong kind of individuality might earn you inquisitive glances from strangers and fearful looks from small children clutching their mothers' legs.

The ability to think critically and independently will also fuel your ability to responsibly manage money and increase your wealth. Lots of Americans have been frightened of the downward trending stock market and have been selling their stocks like nobody's business. The band wagon is speeding away from Wall Street just as fast as its little wheels can carry it, and the value of our investments are falling as a result. But just because so many people are jumping on, should you do it as well?

I guess it depends.

When I was in college, the most popular dining hall was called West End Market. It had a fun atmosphere and the food was diverse and delicious. But in my opinion, it was an absolutely miserable place to be at 6pm. Every evening, West End looked like Times Square on New Years Eve. Hokies arriving at dinnertime lined up like motorists at the DMV, often waiting more than 30 minutes for a sandwich or a plate of the ever-famous Chop House london broil.

I like eating at a normal time like everyone else, but being the impatient person that I am, one experience at West End during dinnertime was enough for me. I avoided it altogether for months, eating at the non-award-winning dining halls, until one day when I decided to pop in an hour early. You'd be amazed at the difference that hour made. At five, though I had worked up less of an appetite, I could hear crickets chirp as I leisurely approached every food station that I desired. Free tables were bountiful and I was able to feast in peace like Kevin McCallister on Christmas Eve. At six o'clock, patrons would be reminded of an overcrowded high school cafeteria on a day where all but one of the lunch ladies called in sick. Sure, it was easy to socialize, but those that came with the crowd wished they had brought a snack for the line.

So what does a dining hall have to do with investing? Well, when everyone is selling -- to the point the Dow falls to its lowest value in five years -- you have to ask yourself what your strategy is. You might not be starving until six, but at six, everyone will be starving. So chances are, you might not eat until seven. So you have to ask yourself, are you a six o'clock person? Or are you a five o'clock person?

The six o'clock person will sell, sell, sell and wait until the market is trending upward before they buy again -- just like everyone else. The five o'clock person will start buying when no one else is. He will understand that stocks are on sale and remind himself of the history of the market, which has always stood the test of time, despite its sometimes significant peaks and valleys. He's not famished yet, but he knows that hunger will come soon and he had better get in line before everyone else does.

Warren Buffet once said "Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well."

Of course, investing in the stock market during a troublesome time is much more complicated than determining what time to go to dinner. But at a high level you have to ask yourself why you're there. Are you there to socialize? Or are you there to eat?

Guidelines for accelerated loan payoffs

2008-10-14T06:39:00.004-04:00

If you've been frustrated with the faltering markets lately, as have most Americans, you've probably been discouraged from investing your disposable income into the stock market. That could very well be the correct choice for you and your family, depending on your financial plans and tolerance for risk. But if you're not investing in the stock market, what are you doing with all that money? Are you putting it in a savings account? Or a CD? Or are you paying down debt?

My personal financial plan calls on paying down my debt during the economic downturn. The markets have been unpredictable (and by unpredictable, I mean they're going straight down) and the amount of debt that my wife and I have will take a relatively short amount of time to pay off. We're hoping that when we're out of debt in a couple of years (excepting our mortgage), the market will be trending upward and we'll have a larger portion of our income to regularly invest, given the fact that we'll have no regular payments for our auto or student loans.

If you're going to start paying down debt in lieu of investing, consider the following three guidelines to help you prioritize where your money is being sent:

1. Pay off the loans with the highest interest rate first (as long as they're not tax advantaged)
Dave Ramsey will tell you to pay off your loan with the smallest amount first instead of the one with the highest interest rate. This adds a layer of subjectivity to your personal finance that, while making you "feel good" about paying down your debt, will cost you money. In a recent post, I discuss the financial disadvantages his plan.

Non-tax-advantaged loans that fall into this category include credit card debt, personal loans, and auto loans. Look for your highest interest rate, and start sending whatever extra money that you can to pay it off.

2. Pay off loans incrementally -- don't save your money and pay it off in one fell swoop
I'll give a personal example here. Though I still have a couple of years' worth of payments remaining on my auto loan, I'm hoping to have it paid off by January. While maintaining my "emergency fund" in my checking account, and have been placing my monthly disposable income into an "auto loan payoff fund" that lives in a savings account. Last I checked, I had a few thousand dollars in there.

I had originally planned to keep making my regular monthly payments and continue saving money in the payoff account until I had enough money to pay off the car. But then I crunched a few numbers and found the flaw in my plan. Here's how it goes:

Whenever you make a regular monthly payment on a loan, a portion of that payment goes toward the principal balance and another portion goes toward interest. Those percentages are determined by a couple of different factors:
1) the time left on the loan (the less time left, the higher the percent that goes toward principal) and
2) the amount of remaining principal balance (the lower the balance, the higher the percent that goes toward principal).

So if my monthly payment is $500, maybe $400 of that goes toward principal and the other $100 goes toward interest. Next month, after the principal balance has been slightly reduced, the payment distribution may be $405/95, and so on. But if I have a few thousand dollars in a savings account that's just waiting to be used to pay off the loan, I am better off sending that money as a principal-only payment immediately. If I reduce my principal by, let's say, $5,000, a much higher percentage of my regular monthly payment will go toward principal. If you're paying off a loan on an accelerated schedule, sending the extra money as soon as you have it instead of saving it and sending one big fat check at the end may save you several hundred dollars over the life of the loan.

3) After non-tax-advantaged loans are repaid, evaluate the tax benefits of other loans before repaying them.
Once your credit cards, personal loans, and auto loans are paid off, hopefully all you'll have left is a mortgage and maybe a student loan. At this time, before deciding to accelerate the payoff on these loans, you should reevaluate the stock market. Has it picked up yet? If you're still not feeling warm and fuzzy, do some math and figure out how much your tax-advantaged debt is really costing you.

If your mortgage has a 5% interest rate, remember that depending on your tax bracket, you'll get maybe 25 or 28 percent of that interest back in your tax refund. So think of the effective cost of the debt to be 3.75% (5%, minus 25% of the 5). Your mortgage is a very long-term loan, and you won't see the benefits of paying it down early for a very long time. Paying it off early won't reduce your monthly payments. Sure, it will be paid off sooner, but even if you double your monthly mortgage payment every month until it is paid off, it will take almost 10 years to pay off a 30-year mortgage. If the effective interest rate on your mortgage (the interest rate less the tax benefit) is only slightly higher than the amount you could earn in a CD or a savings account, I would rather see you hold onto that money just in case you need it.

With all loans, especially those that are tax-advantaged, the lower the interest rate, the less sense it makes to accelerate your payoff. My friend Quang's student loan has a 3% interest rate. I wouldn't pay that off early for the world. But the rate on one of my wife's student loans is 7.9%. I can promise you that as soon as my car is paid off, the next thing to go will be that sucker.

Non-tax advantaged debt is nobody's friend. If you're not satisfied with the performance of your investment portfolio, it could be a wise decision to pay it off early in lieu of investing. But if your only debts are mortgages or student loans, think twice before you start sending extra cash toward the principal. True, you're saving yourself money in the long run, but remember that you're also reducing your tax writeoff and parting with that money for a long, long time. And keep in mind: even if you're using the standard deduction (not itemizing), your student loan interest is still tax deductible!