July Roundup

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July had many surprises in store for me. I had collected almost $200 in an emergency fund, and had a car problem that used most of it (thanks emergency fund, though!), our power bill almost doubled its normal value (luckily it’s split 3 ways), and I had a few computer expenses necessary to do some side work. At the end of the month, my total credit card debt comes to a total of $8,875.09, which is almost $200 more than it was last month. Now, the computer expenses I put on my lowest APR account, so it isn’t going to kill me. Hopefully doing the side work will quickly make up for the initial outlay.

At any rate, I am officially over getting late fees and overdrafts, and think I have a handle on things. It is tempting to not go back to spending a ton of money everywhere, but I’m still motivated. My only real difficulty is eating meals prepared at home, instead of going out. August will be my month to really work on that. I’m also excited because September 1 I’m going to make the call to all my creditors asking if I can have a rate decrease. Hopefully that will jump start my process. I decided to wait a few months to do that so I could make payments on time more often and decrease my balances, to show good faith so they will hopefully be a bit nicer.

I’m not feeling too bad even though I have more debt to deal with. I made some extra payments towards my higher-interest accounts, and I have two side jobs that may be bringing in extra income this time around. I have a solid budget I stick to well, and have really worked on all the psychological aspects of why I got myself into so much trouble. I start back to school in a month, and feel like I’ll have much less stress this time around, since I have a handle on other areas of my life.

So, my plan for August is to really work on eating at home and brown-bagging my lunch. In addition, I hope to collect another $200 in an emergency fund, and put an extra $100 towards my higher interest debt. In addition, I have a few more light bulbs to replace with CFLs, and maybe that will help the power drain. I feel like I’m in a good position, and well suited to finish this by the end of 2008.

My 4 Category Budget

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In the article Money Myths for Young Graduates, one of the myths I wrote about was the misconception towards long, detailed budgets. However, I have found that micromanaging every little transaction literally sucks life out of my soul. As I mentioned, I use Wesabe to view my spending, instead of Quicken (as a software developer, I’d rather shoot my eyeballs out than look at Quicken more than a minute). Now, Wesabe is nice because you simply “tag” a transaction. That is, instead of putting a trip to McDonalds into a Food category, you could tag it as “food, fastfood, warning, fat”. At the end of the month, you can then view the Fat category to see how much you pay to gain weight. This really does a great job of eliminating the need to find a tiny category for every expense.

However, despite the agile way Wesabe allows you to view your expenditures, I really needed to find a way to control my spending. Strict categories are good for learning how to spend, because you can easily see “oh, I spent $39 on fast food, when I only budgeted $25”. However, when you create a category list, you can easily get to 30-40 categories without blinking.  My solution was to knock it down to 4, one of them having 2 subcategories. Then, I use Wesabe to view exactly where extra money is going, or where I have done well. Admittedly, these categories may not be appropriate for older married people, because it ignores things you might need to track such as tax-deductable home expenses or such. However, I find it a great tool for those starting out. It keeps things simple, and makes the end-of-the-month sorting process so much quicker. For those of us who are not Type A, it keeps us on our game.

1. Static Expenses. I quickly noticed that if something was going to cost the same amount every month, then why did I need to track it separately? I know my rent is $875, I know my car payment is $250, I know my insurance payment is $100. Why should I track those individually? I found about 7-8 “categories” that fell under this description: required expenses that do not adjust from month to month. Put them all in the Static category.

2. Dynamic Expenses. These are the expenditures that can change from month to month. There are two types of dynamic expenses I saw, Required and Flexible. Required includes the expenses that may differ each month, but you are stuck paying them, such as electricity, gasoline, etc. Flexible includes the expenses that may differ each month, that you can exert some self control to decrease, such as food, entertainment, bank fees, etc. The reason these two go into the same “main category” is to contain in one category the fluid part of your budget, or the part of your budget that has the most activity. For example, if you micro-budget $100/month for gasoline and wind up spending $120, you must “borrow” that money from your Flexible budget. In this way, you can set a main budget for all Dynamic expenses, and if you have to get a second haircut in a month it’s ok; just use money from another sub-category, always prioritizing the Required category. Again, I’m single, so it’s very easy for me to borrow money from my food allowance, I simply eat cheap. This may not work for a family, in which case you can always make food into a Required or Static expense. The whole point is to not follow my format but create your own.

3. Savings. Obviously, this includes any money you put towards any type of savings account. Right now, I am collecting an emergency fund, and have a relatively high Savings budget. When I begin shifting money to debt repayment this may drop to nothing. However, I also use this to track money I use for my retirement account and any money I make in interest or dividends on previous investments.

4. Debt Repayment.  This is the category that takes into account any debts you are actively engaged in paying off. You may keep your mortgage, student loans, or cars under the Static category, since they are stable monthly expenses. However, if you begin paying extra in hopes of being out of debt sooner, you may wish to shift it to this category. My endgame is to eliminate this category entirely.

As a software developer, I pay a lot of attention to design, even reading about architecture and typography. A common theme is that the key to any good design is workable simplicity; that is, the least amount of overhead that allows the same accomplishment. In software, this translates to the fewest clicks it takes to accomplish an action (even if I have to add super advanced logic into the code to “think for the user”). In architecture and photography, this may be the concept of empty space or geometric patterns to gain a desired effect.

In the same way, in order to have a well-designed budget, it should not be any bigger than necessary. You  may find that you still need 30 categories to effectively manage your spending. However, some of you maybe fine with 2-3 categories. I have found that the 4 category system works well for my expenses. However, everyone is different.

My point here is that it’s your responsibility to design a budget, rather than using someone else’s. Take a deep look at what your are spending, and what your common pitfalls were. Design a way to manage things where you will minimize setbacks. Design a budget that allows you to quickly categorize things at the end of the month. If you crack open Quicken, the first thing I recommend is to delete every category and start from scratch. Otherwise, it will always be too complex and unworkable, and the result might be that you give up again. By designing your own budget, you eliminate the chances of failure, because you know yourself better than Quicken knows you. And, like me, if you still wish to track expenses in micro-categories (if you want to know how much you spend to gain weight), try out a tool like Wesabe to help you out. In addition to a small categorized budget, a more flexible tool may work wonders toward your personal financial goals!

Religion in my Wallet?

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Wow. Make one post about religious instructions regarding personal finance, and get a slew of personal attacks, unsubscribe notices, and general ignorant vitriol. How bitter are some of these people who commented? The post never said “these are things you should believe”, it simply stated these were some of the reasons the guest blogger handles finances the way he does. After all, personal finance is, well, personal. Why, then, are people making such a big fuss over things? As a Christian, I’m used to this sort of thing all the time. Mention Jesus around people who don’t know him, and the world implodes around you. I love America, this land of free speech. And all the people who wish to censor it.

Should posts like this receive this type of attention? No. We’re supposed to be a society based upon the free exchange of ideas. While you are quite welcome to choose not to hear others’ ideas, and quite welcome to contribute your own ideas, it’s about time you stopped calling for censorship of the ideas you don’t agree with. Like the mafia, some have used the blogger’s version of extortion — cancelling an RSS subscription — to show how much they hate the very idea of talking about God. This is incredible. When I was an atheist, I didn’t go around shoving religious people around; I simply didn’t care what they had to say. The only thing that can cause the bitter comments attached to that post is a hatred for God, and to hate God you must believe he exists. It’s such a backwards world. After all, I don’t get offended when people talk about the Easter Bunny; I’m simply content to sit back and know he doesn’t exist. Why should atheism be any different; it wasn’t to me.

Now, I won’t wax Christian all the time on this blog. To me, I’m here to write primarily about money. However, I am a Christian, won’t deny it, and won’t be silenced by people who would try to bully me into not talking about it. This is a personal finance blog, and I plan to make it personal; when religion plays a role, I will mention it. And since I tend to follow biblical laws on money, or try to, religion does belong here. However, I will not be giving altar calls at the end of each post, contrary to what some of these people feel is going on. I only hope J.D. won’t stand for being extorted, and will at least claim that all ideas surrounding personal finance belong on his blog, even if those ideas happen to be religious in nature (especially in just 1 out of many hundred posts).

Calling for censorship of any kind is becoming the downfall of our society. Freedom is a strange word; there is no grey area. Either we have freedom, or we do not. There is no such thing as “slightly-censored freedom”. People are getting more thinly-skinned by the day. Al Sharpton gets offended every time a webmaster mentions “#000000”. I have a homosexual friend who gets offended when a rainbow appears in the biblical story of Noah’s Ark (guess what, you were four millennia late on that one). Radical Muslims get offended when infidels even talk about Muhammad, much less try to draw him (here’s a sideways picture of him: 0+< (don’t kill me, please)). Our society, so delicately crafted on the principles of freedom, has arrived at a point where we must either choose freedom, or choose to allow the biggest bullies to keep us from taking part in all of our inherent freedoms, even if what we say offends those bullies.

For personal finance blogs everywhere, here’s hoping J.D. doesn’t capitulate to the bullies on that blog. Censorship of any kind is a very slippery slope, and it takes us all saying “no” before we can end this culture of censorship, thin skin, and victim mentalities. Hopefully, if we stand our ground even a little bit, their delicate skin might start getting a little thicker.

Edit: As I imagined might happen, I’ve been getting a lot of hate mail over this post for whatever reason, most of which miss the irony in calling for me to censor this post. Just to clarify things, if I sound harsh or bitter it’s likely intended to be tongue-in-cheek (i.e. the bit about the rainbow). My goal here is not to convert you to Christianity, it’s to call for an end for this whole censorship thing, and let all viewpoints be heard, even in the personal finance community. I’d love to hear the perspective of a Hindu on personal finance, as well as a Buddhist, or any person with a slightly different perspective on it. The whole point of blogging is that all views are welcome, even when they don’t match yours. How will we ever learn new ways to think about things if all we do is call for opposing viewpoints to be censored? How will I know if I’m wrong about something if I never hear the other way to do it? Even more than being Christians and Atheists or whatever, we’re all human beings, and our primary concern should always be treating others as human beings, rather than dismissing people with labels we don’t like. So please, don’t ask me to censor my own blog, because it’s not happening. And I hope nobody else will censor theirs, either.

A Free Car? Not Really…

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Today I found this post on Dave Ramsey’s “Drive Free” plan via The Simple Dollar, even though it’s been around awhile. Now, I’m a good INTJ and love thinking through scenarios. It’s what makes getting out of debt fun for me! I loved seeing the math on this one, as I heard about this plan a year ago and immediately thought there was something fishy about the math, and the simple reality that cars depreciate. Fast.

Put simply, Dave Ramsey’s plan fails on several grounds. First, you should plan on saving upwards of $450 per month for it to work remotely. Second, you’ll be buying some incredibly unreliable cars at the beginning, causing potential need for major repairs, ruining any chance of this working. Third, you won’t be in a new car for 6-7 years or more at the rate of upgrading. Fourth, you have to pay taxes/tag/title every year! Fifth, it doesn’t change the fact you’re putting away $450 a month for the next decade or more. For someone who has a lot of good monetary advice, it surprised me how wrong he is on this point.

This inspired me to figure out my own scenario. As a nuclear engineer, I was/am all too familiar with the concept of decay, and the types of models they present. I’m not so hot on calculating the cost benefit scenarios of owning a house (yet), but knew I could come up with something that takes advantage of the depreciative value of a new car.

First, I had some conditions. I do not want to ever spend more than $300 per month on a vehicle, unless my financial situation has a major shift in the next decade. Second, I don’t want to buy used again. Third, I want to trade in the car at that sweet spot of few repairs and maximum trade in value, or the plateau in the depreciation curve. I calculated about 7-8 years on most cars for that to happen, given more than average driving (150k miles in 7-8 years). Fourth, I don’t demand an incredibly nice car each time, but I do want to progressively get nicer cars. Fifth, I don’t mind using credit to buy, as long as the monthly payments are ok.

I came up with this:

Car Buying Scenario

As you can see, I’m taking each car long-term. If you have to have the flashy newest car all the time, this isn’t going to work for you. But until I can afford my Bentley, I don’t mind driving a sub-$20k car for the next decade. I prefer to get a small economical car and then upgrade the heck out of it. It makes it feel more luxurious, rather than getting the standard package on a nicer model. I also use consumer reports regularly, so my trade-in values are maximized and I don’t get a lemon. The trade-in values I used in the chart may be a bit off, but the plan still works; just slower.

My current car is a 2005 Impala I bought in Jan 06, with 30k miles at the time. I expect it to last me seven years total before repairs start mounting (compare this to a $4k junker that Dave wants you to buy). At that time, I will have about $8,000 to put towards a new car. This means I can now finance a cheaper amount on a much nicer car, which means I can then drop to a 3-4 year note, rather than 5. This means, in turn, I can upgrade sooner, I can maximize the trade-in value, and will have more years of savings the next time I upgrade. Eventually, I will be able to get a $25k car on a 1-year note, still paying just $250 per month. If you follow it to its natural conclusion, I will one day be able to purchase a $30k+ car with cash.

I purposefully do not calculate in the interest gained during the savings periods. That extra money can be used for the taxes/tag/title. I also do not include the tax benefits in claiming depreciation on the new cars, which also saves you a little bit. If you look at the chart, you can see how even bumping it up to $300 per month would either get me a much better car, or allow me to upgrade more quickly each time. I simply pay $250 or so for the next few decades, and I’ll eventually be in a BMW. Or a nice mini-van, depending on my family situation then.

The issue here is whether or not you feel comfortable using credit wisely. Currently my car note is only 4.8% interest, which would make it stupid to pay cash ahead of time, considering I can earn more than that over five years in one of many available savings accounts. When you factor inflation into the equation, it makes the scenario even better to use credit for a car purchase rather than paying cash up-front. In fact, if you get a good rate like I did, it almost makes more sense to finance the whole car for 5 years every time, and keep your money in savings to use for the monthly payments. I have not run the calculations on that, but I imagine you would be able to add $1-2k to each new car given the extra returns, and a lot of dealers will give you a better deal if they know you’re financing for 4-5 years. Also, if you’re willing to stick with a cheaper car all the time, you can decrease your monthly payment gradually, making your car less of a monthly burden.

The best thing is if problems happen, such as an engine replacement or something major (worst case scenario), it doesn’t ruin your whole plan. You use your current savings, and the next upgrade, you simply buy less of a car or even finance slightly longer. Also, the major thing in all this is that you don’t have to start some plan right away! You simply start where you are (likely making payments on a car), make a commitment to save about two years after repayment before buying again, and let the cascade begin. The point here is that if you don’t have to have the newest thing all the time, and are confident with using credit to your advantage, you can come out better in the long run, without making major sacrifices in the beginning.

Debt vs. Retirement – Perspective From A Young Person

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Yesterday, Trent from The Simple Dollar posted a rebuttal to a comment stating that sometimes it is more appropriate to invest than pay off debt. I mostly agree. After all, if your monthly payments are $200 per month and you have $300 extra, it can decrease your debt repayment time by many years; years in which you can invest $500 or more instead of the $300. Even if the percentages are equal (return vs. debt), it at least makes psychological sense to pay off debts before investing.

However, I know in my case, I have a retirement account that I contribute to faithfully, even though I have a ton of debt. I suspect that most younger people are in a similar situation; a ton of credit card debt, about $200-300 extra per month that can be invested, and an immense hope that they’re a more savvy investor than others. Even though that sounds like trouble from the start, I will give the reasons I choose to invest and why it makes sense in a long-term perspective.

1. Employer Matching

This one is way too overlooked in calculations I see online. A friend of mine refused to start a retirement account because he “had plenty of time to worry about that”, “Social Security would help him out”, and “that’s 5% I can use to pay off my debts”. However, what he did not calculate is employer matching at 3% (as well as the fact that Social Security will never last long enough for current twenty-somethings to benefit). While I could use my contributions to pay off my debt a little faster, the fact it has employer matching and it’s in there working for me right now is literally the difference in $300,000 when I retire compared to using that money to pay off debts right now.

2.  Fixed Limits

Benefits of Roth IRA’s are well known. However, when 2007 is over and you only contributed $2,000 to your IRA, that’s $2,000 you can never put in later. In most jobs, at least in my field, salary increases over time at a rate higher than inflation. This means that my current $8,000 credit card debt may be a big chunk of my current salary, but drawn out over a decade, it will be a pretty minimal amount to what I should be making then. However, a good Roth IRA can also easily beat inflation, meaning that in looking at VALUE of your debt versus the investment, you wind up with more money at the end, taking long term inflation and salary increase into account. Missing out on maximum contributions at such an early age winds up making the difference of hundreds of thousands of dollars at retirement.

3. Learning Experience

I know for me, I read about investing all during high school, and played with a few hundred bucks to test the waters. I also lost it all (mainly due to fees). The point is, it’s difficult to learn proper investing without having your money wrapped up in it. Since opening a retirement account, I have learned how mutual funds work, how to direct your financial adviser to wait longer between buys to save on fees, how to calculate return on investment, and tons of basics about investing that books can’t really teach you. When I finally open an IRA, I will learn more about the stock market and how to predict when things are going bad, how to read the latest news on the company, how to pick long term and short term winners based on the current state of the union, etc. The earlier you start, the more wisdom you gain along the way. Once you wait a year, you will never get that year back. My aforementioned friend is just now opening a retirement account. I’m three years ahead of him in learning how to manage those funds. I will always be three years ahead of him in investing, save for some lucky break. Time is money, and starting early is always a good idea. I only wish I would have started seriously around junior high.

Basically, there are many good reasons a young person should start investing even if he or she owes a lot of debt. It heavily depends on the person’s will-power. Do they have enough will to both invest properly and pay off more than the minimum debt payments (for those debts that are higher APR than their current investment return)? Can they make the proper calculations for their specific situation and see how it plays out in the long run? Is the debt causing mental stress that requires it to be payed off sooner, at emotional expense otherwise?

Personally, I have not opened a Roth IRA and will not until my major debts are payed off. As soon as the high interest credit card debt is gone, I will fund that IRA to the limit, as time is indeed money. Right now, however, I do have an employer-matching retirement plan gaining considerable snowball effect, and calculating the difference that makes in my nest egg, I will never regret that decision. Yes, it put a bit extra time on my debt repayment, but it’s a small price to pay for the benefits that investing early has given me, both monetarily and education-wise. I have run the calculations and my Roth can wait until 2009 with not too much loss on my future retirement, at least compared to the anxiety the debt is causing me right now. Nor would I be able to fund it fully with my current monthly payments.

The true answer is never clear-cut, and I’ve come to find it’s almost never purely mathematical. I think the benefits to investing at an early age easily transcends the obvious mathematical benefit to early debt repayment. For those of us who expect drastic salary increases due to years of experience and getting a degree, it may make more sense to not worry too much about drastic debt repayment measures. For me, it’s a challenge and that forces me to take some frugal steps. But I think for most people there is a happy medium in which you can both repay debt and invest intelligently.