Revisiting the Rattlesnake

When discussing the different personal finance animals, we took quite a harsh stance on the rattlesnake. Looking back, I thought it would be a good idea to discuss them a bit more, and explain why there is such a harsh attitude.  There are some good points to the rattlesnakes. The fact that they carry very little debt, if any is certainly a great quality, and something many people strive for in their personal finance goals.  The biggest issue is that they leave too much on the table for their own good.  Below is a side-by-side comparison of the tiger and the rattlesnake, and their financial decisions:

  Tiger Rattlesnake
Interest Rate – Savings/Checking 1.5% 0.0%
Real Compounded Average Investment Return (Tiger – Stocks, Rattlesnake – Gold) 1980-2010 7.7% annually 0.3% annually
Value of spending rewards 1.75% 0.0%

 

The worst part of this is how much money the Rattlesnake loses to inflation.  Notice in the second line of the table, we’re using Real Compounded Average Investment Return. This means that, after adjusting for inflation over the time period, this is the growth of the investment.  In the meantime, over a 10 year period, the Tiger has seen his investment grow to more than double in terms of real value, while the rattlesnake would have been better off keeping his money in Treasury Inflation protected securities (TIPS) that provide a protection from inflation a small premium (normally ½ of 1%, or 500 basis points).

The most important thing to take away from this is that the rattlesnake doesn’t just hole up in his house every day and skip work from fear that he’s going to get hit by a bus, but he does that exact thing with his money.  If the rattle snake sent his money to work, it would mean that soon he would be able to be the one that stays home.

Sunday Morning Game Plan

 

“You need a plan” is the piece of advice people get that is more easily said than done. Everybody wants to get out of debt, but the biggest problem people have is finding a place to start in the process. I’ve always been a big fan of the Getting Things Done  process, and one of the best takeaways was the idea of the weekly review.

Taking a Sunday morning to go over the bills and build a tracker to follow your progress is always a good idea. Different formats work for different people: some prefer a notebook, while others will use excel or an online service like Mint.com. You can even download and modify one to fit your tastes here.  It really doesn’t matter how you track your progress, just that it gets done so you can see where you came from, and where you’re going.

Getting out of debt will make you feel better. The first zero balance is always one of the sweetest in the process, because it provides a glimmer of light in the process. When you get to the second and third, you have momentum going for you, and you’ll find it’s like you have less of a load on your shoulders.  Understanding that it is a process and not an overnight change is key.

With motivation in mind,  I know a few people who keep track of how much interest that they paid in a given month, and how much they received (including anything like cash back rewards as interest), with the goal for the number to be greater each month.  For them, the game works because they are always trying to get a higher score by doing things that they can control.

Take some time to get your debt tracker built, and next week, we’ll talk about debt payoff methods in the Sunday Morning Game Plan.

 

Until next time,  go snack on some debt!

Drawing The Line Between Frugal and Cheap

Two of my guilty pleasures are wash and fold Laundry and Toll Roads. While both of these are seen by many as unnecessary splurges, I happen to love both.  I have a sticker on my car window that lets me zoom through the toll gates without stopping, and I always find I get a little smile on my face as I zoom past all the people who are waiting in line to pay a toll. Even better, the toll provides me with an added benefit: fewer people on the road and a more direct route to get where I want to go. Wash and fold Laundry Provides me with a similar benefit: I don’t have to spend my weekend washing clothes, and making sure I get them out of the dryer in time to ensure they aren’t wrinkled.

Right about now, you’re likely thinking, “But FinanceTiger, both of these things cost money.  Why would you waste money on this if you’re trying to save for retirement?”

The answer is that both of these save me enough time that they are valuable. This is the key differentiation between being frugal and being cheap.  Cheap is the guy who washes his paper plates and hangs them to dry in his kitchen. Frugal is going to some place like Ikea and buying a set of stoneware for around $20, solving the problem of dinnerware for the foreseeable future, and for a much lower total cost.  When you’re frugal, you take into account the full cost of your decisions, when you’re cheap, you look only at saving a little money, often at the cost of your time or, as in the example above, other people’s desire to be around you.

The hardest thing for many people to understand is that you pay for things in life with two things: money and time.  There will always be more ways to get more money, but once you spend your time, it’s gone. The best reason to free up time is for new projects. In the 4-5 hours it takes to wash and fold laundry at home, I could write new posts here, work on a freelance project for a couple hours to recoup the cost of wash and fold, and hit the gym.

Toll roads are a similar situation. You’ll save gas by taking a more direct route and dealing with less traffic, while also reducing the wear and tear on your car and getting to your destination faster.  If you have a cruise card or similar, it makes the trip even better, since you won’t even have to stop to pay a toll. There are two easy ways to determine how much you save taking a toll route instead of the alternate routes. For the first one, subtract the difference in mileage between the two routes, divide by 2 and subtract the tolls – this will give you the savings in vehicle costs. For the second, look at your hourly pay rate, double it, and multiply it by the time you saved, in hours.  If these are positive, then you’re coming out ahead using a toll road.

What are the time savers that you’re willing to pay for? Let us know in the comments.

Does My Credit Card Utilization Matter?

For people new to credit, and even many that have been dealing with their finances for a while, the question of what credit card utilization rate is best comes up quite frequently.  Some people are surprised to see that their zero balances can lower their score in some instances. The reason for this is that credit scoring is a very opaque process that, for the sake of their business, credit bureaus keep tightly guarded.  Credit Utilization makes up a portion of people’s credit scores, and while it is the component of the score that a person has the most control over each month, it really only matters when you are looking to acquire a new line of credit.

The problem with credit card utilization as a factor in a person’s credit score is that it only shows the balance on a single day of the month. As a result,  this means that the only time the balance on your credit cards should be of any concern  is on the closing day of your billing cycle, which is generally 3-10 days after your monthly payment due date.  If somebody wanted to chase this golden apple, they would simply just pay their balance in full on the due date and wait for their statement to close, resulting in a zero balance being reported each month.

While this is responsible behavior, it isn’t optimal behavior, which is what a tiger will strive for. Rather than micromanaging your credit score, you should be concerned with keeping a second number as low as possible: the amount of interest you pay. As a result the optimal action in this situation is to pay the balance of purchases that are about to leave the grace period, maintaining a balance of the value of your purchases that are less than the grace period (typically 25-30 days), so that you ensure that you won’t pay any interest. As a side effect, this will also ensure that you keep your cash as long as possible, meaning you can optimize the amount of money you earn in your high yield checking account.

 

Key Takeaways:

  • Your credit report will only provide the balance of your accounts on their last closing date.
  • If you aren’t opening a new line of credit in the next 60 days, you don’t need to micromanage your credit accounts.
  • Zero Balances aren’t guaranteed to raise your credit score.
  • Utilization under 30%, on each card and in total correlate with higher credit scores.
  • Focus on paying less interest rather than raising your credit score, as this will be the most beneficial for you in the long run.

The Six Personal Finance Animals

I’ve spent a few years around personal finance. Between going to the seminars, reading books, and seeing people online, it quickly becomes apparent that there are six kinds of people you’ll see around personal finance, all of them with their own animal personas:

The Mouse

Shy and quiet, the mouse is generally embarrassed to even be in the room with people. The Mouse is the person that usually comes from an upbringing where his parents have told him that it’s impolite to talk about money. A mouse is more likely to suffer in silence about his financial woes than he is to seek help.  Nearly everybody was a mouse at one point, but once a mouse gets over his skittishness, he’ll usually pick up the traits of one of the other animals.  The only way it could be worse for a mouse is if they are a cow.

The Cow

In some parts of the world, cows are sacred, in other parts they are slaughtered. When it comes to personal finance, cows are the ones that follow the herd, and when they get spooked, they stampede.  When it comes time to invest money, cows are usually the people who shout “sell” and panic when the markets make a slight correction.  Most of the investment advertisements you can hear on talk radio is aimed at the cows, as they want them to come together, get spooked, and start a massive sell-off, or stampede. You can reason with a cow, but they won’t always listen.  To get them to respond, you have to motivate them with fear.

The Rattlesnake

We all know a Rattlesnake or two. The rattle snake is the person that it wouldn’t surprise you if they had a fully stocked bunker in their basement, with a “Don’t Trust Anybody” bumper sticker on the door.  Rattlesnakes will preach about how personal finance is all about going to only pay cash for anything, and keeping gold and other precious metals as an investment vehicle. The reason I call these folks rattlesnakes is because like a rattlesnake, they’ll sit there, coiled up and making noise, causing other people to worry. Be careful with the advice of rattlesnakes – all their worrying is like a rocking chair: it’ll give you something to do, but it won’t get you far.  The best thing to do around rattlesnakes is true in both cases:  just get away and let them be. You can’t reason with a rattlesnake, and it’s better not to get bitten.

The Peacock

If you hang around a personal finance forum or blog, you’ll run into a peacock sooner or later. Normally, they’ll start a post with something along the lines of “How Am I Doing?” and then discloses that he has several million in his retirement accounts now.  It’s hard to feel sorry for the peacock, but they are typically looking for acceptance, and are probably just trying too hard.  The peacock will generally have his finances in order, but he’ll be rich and lonely (and possibly poor later in life) because of the way he flaunts his good fortune.

In general, the peacock is either a liar or a jerk, sometimes both. Don’t be a peacock. Tigers will eat a peacock for lunch.

The Turtle

Slow and steady, the turtle is trying to win the race. Paying off debt and being conservative in his investments, the turtle is moving himself towards a retirement, albeit slowly. The turtle has likely read several personal finance books, and has taken the general advice to heart, thinking that live is long and hard, so you should keep your nose to the grindstone. Turtles will clip coupons, save hard for their house and car, and save any tiny slice of their salary that remains into a 401(k) plan. A turtle will pray that nothing goes wrong in the 50+ years of career work that it will take to get himself enough savings to enjoy a brief retirement. There are worse animals to be than a turtle, but like turtles, the plans they make would be better suited to them if they shared the same life span.

The Tiger

Prowling through the jungle of personal finance is the tiger. He is savvy and always looking for new opportunities to increase both his savings and cash flow.  Credit card companies will call him a dead beat, and he wears it as a badge of honor.  What sets him apart from the other animals in the jungle is his cunning. A tiger will not just save money, but he will invest it and pounce on every opportunity. Every now and then, you’ll hear news about Tigers making attacks on unsuspecting victims, and think two things at the same time, “Why didn’t I think of that?” and “Man, somebody always has to go and ruin it for the rest of us.”

Being a tiger is one of the greatest financial feelings in the world, but it doesn’t come easy. A tiger won’t go and waste money, but instead plans his early retirement by knowing that if he saves 50% of his take-home pay, he could retire in 17 years, or if he saves 75%, he can retire in just 7 years. Knowing this, and knowing the rules of the game make a tiger the force to be reckoned when it comes to personal finance.

***A great example of a tiger attack is what happened when the U.S. Mint sold dollar coins direct to consumers online, in boxes of 250. With no shipping or processing fee, tigers would use their rewards cards to get the airline miles or cash back, and immediately deposit the money in the bank and pay off their credit cards. With the only costs being a trip or two to the bank, they were able to rack up millions of airline miles to be used for things like lifetime status, trips to Tahiti, and free flights all over the world. Unfortunately, the U.S. Mint put an end to the program.

Until next time,  snack on some more debt!

Understanding Cash Flow, or How to Make (a Little) More Money From What You Already Have.

Pop Quiz, Hot Shot.

You have the following credit cards/checking accounts with the following attributes:

Card 1: 24.99% APR, 30-day grace period, $500 limit, No balance, 1.5% Cash back on purchases, accepts balance transfers; no cash back on balance transfers

Card 2: 19.99% APR, 30-day grace period, $900 limit, Current balance of $300 (accruing interest), does not accept balance transfers

Card 3:  10.5% APR, 15-day grace period, $1500 limit, current balance of $900(accruing interest), accepts balance transfers, balance transfer rate is 13.5%, with grace period

Checking account:  2.53% APY, Calculated on the average daily balance of the account

How do you optimize your monthly cash flow over several months with an income of X dollars per month, paid in 2 equal installments of X/2 over the course of each month, when you have monthly expenses of  .75(X)?

You might be thinking, “Whoa, now. The SAT’s were a few years ago, this is awfully complex. Why would I need all this math?”
The answer of course is to maximize the resources you have. A 1.5% discount on your spending might not seem like much, but it’ll make for a nice start when you’re looking to save up.

Basically, this question is about being able to understand and allocate resources in an efficient manner. So, how do you solve this problem?

  1. Balances from Card 2 should be transferred to Card 3, and paid off on the last day of the grace period.
  2. Monthly expenses should be put on the Card 1 to earn cash back,  and then transferred to Card 3 at the end of the grace period (to avoid interest and allow for an extra 15 days grace period),
  3. The existing balances should be paid off at a rate of .25(X) per month, to minimize interest.
  4. (Optional) Call Card 1’s issuer and ask for a limit increase,
  5. After balances are paid off, you should be earning  1.0253(1/12) * (1.5 X + .26125(X*N-1) + (previous months’ interest))  each month, since you now are able to keep  your cash for ~45 days (1.5 months), and thanks to the cash back, you are spending 73.875% of your income on expenses instead of  75%. N represents the number of months since all cards were paid off. Card 2 would be kept open and paid off, both for emergencies, and to lower your utilization.

Right about now, most people are thinking, “What the What? I don’t even…”
Here’s a breakdown of what we did, step-by-step:

  1. Moved the high interest debt to a lower cost opportunity, including 15 days interest-free.
  2. Change the spending habit to put the monthly expenses on a card that gets cash back. This has the net effect of either lowering the amount you pay for things, meaning instead of spending $75 of every hundred dollars, you’re spending $73.875.
  3. Now, we’re aggressively attacking debt, meaning debt will get paid off in the shortest time frame possible with our available resources.
  4. With a low-limit card, a bit more breathing room will make sure you can afford to put as many of your expenses as possible on the card and earn cash back.
  5. This step is a projected balance for few months down the road, but here’s what’s going on:
    1. Your monthly account interest is 1/12 of 2.53% Annual Percentage Yield, so to get that, we use the compound interest formula of 1 + interest rate ^(period).
    2. We multiply our monthly account interest by the balance in the account, which is the sum of
      1.                                                                i.      1.5X – Three Bi-weekly paychecks (45 days)
      2.                                                              ii.      .26125(X*N-1) – Your Monthly Savings Rate (100-73.875=26.125) times the total number of months (N)  since you paid off your credit card debt, minus 1 (which is included in the three bi-weekly paychecks.
      3.                                                             iii.      The sum of the interest paid to you for the last N-1 months.

All of this is a very powerful system. Now, instead of paying around $30 in interest each month, you’re getting $15 from the credit card company, usually applied to the balance of your purchases. Depending on the card, your own spending habits, and the offers available you could end up with double or even triple that amount. The key to all of this is ensuring you keep your credit cards paid off each billing cycle. By doing this, you’re holding on to your money as long as possible, being paid by companies for the privilege to loan you money interest-free, and earning interest.

Until next time, eat a little more debt.

So, What IS “The Plan” For Personal Finance?

The plan will be different for everybody, and the problem with many “personal” finance gurus is that they deal in “general” finance rather than personal finance. While the advice is generally pretty good, it often overwhelms people, much like drinking from the fire hose.  The general advice you’ll hear is (in this order):

  1. Build a small emergency fund (~$1000 or 1 month’s expenses).
  2. Fund your retirement plan to your employer’s match.
  3. Pay off your debt
  4. Fund an emergency fund with 6+ months of expenses.
  5. Fund a Roth IRA to the annual Max
  6. Bump up your retirement plan savings to the annual maximum.
  7. Save into any tax-advantaged plans you have available
  8. Open a taxable investment account and invest in Exchange Traded Funds (ETFs) that track the market as a whole.

Most people have trouble with step 1, and will be lucky to get through step 3. Step 4 is a pipe dream for quite a few people, and the idea of maxing out not just one, but TWO retirement accounts sounds like grounds for an intervention because there is a lot of crack being smoked.

Let’s look at the near worst case scenario

So, what are you to do in this situation? How can you get through all of this when you’re only bringing home around $600 every two weeks? The answer a lot of people will get when they are honest with themselves is that sacrifices will have to be made. Whether it’s cable TV, the new iPhone, or your free time, if you are in this situation where you have this little cash coming in AND you have debt, you probably are either deluding yourself that if you keep on the treadmill things will get better, but the fact is that interest every month when you don’t pay off your cards is speeding that treadmill up, and eventually you’ll fall off.  An overdraft or two, and suddenly you’re eyeing a payday loan place just to solve the problem. Stop. Now. If you’re in this situation, let’s back up the cardiac arrest, take a few deep breaths and give you a rational plan to deal with this:

  1. Gather up all your monthly bills and pay stubs, pull up your online banking, too.
  2. Look at what you spend your money on, and decide what you want to cut.
  3. Keep cutting until your bills and expenses are less than your pay.
  4. Next, make calls to all of your credit card companies, and ask for lower interest rates.
  5. Add up all of your minimum monthly payments and monthly recurring bills.
  6. Open a new checking account, preferably without a debit card.
  7. Set up your direct deposit to go to two accounts: one for half the amount you got in step 5, and one for the remainder.
  8. You’ve now built a self-funding small emergency fund.
  9. The remaining money should cover your expenses (groceries, gas, etc).
  10. At the end of every two weeks, the night before payday, take any remaining money, and pay it on your highest interest account. You’ll pay down your debt a little faster and start to see some progress.
  11. If you’ve made it this far, and you’re still having some trouble making ends meet, go back to step two, and be honest with yourself.  Cutting cable TV alone will save you between 600 and 1200 a year.

“My situation isn’t THAT bad…”

If you just read the last section and didn’t cringe a bit because it hit a bit close to home, then you likely grew up with some good financial habits, or have had the income to mask some problems. So, let’s ask you a few questions:

  • Are you carrying any interest-charging credit card debt? How Much?
  • Do you have a car (or any other type that isn’t student) loan over 5%?
  • How much are you saving each month?

If you have more credit card debt than what you could pay off in your next two pay checks, after expenses, and you’re saving (rather than investing) money above a small emergency fund, congratulations, you’re throwing money away. Anything with an interest rate is considered to be “toxic” debt, and you should eliminate it quickly. 5% is used, because it’s generally accepted that returns on investment will be over 5%, so you would miss out on returns by paying off debts with interest rates under 5% faster than necessary if you were to use investments to do so.

I know you thought you were getting off easy, but you’re still in close to the same boat as the near worst-case folks, but likely without the constant fear of overdrawing your bank account.  Knowing this, you still need to budget, and get rid of the debt you’re throwing money away on. Your plan of attack should be to get organized (see above), and pay off the highest interest accounts first, working your way to the lowest accounts. If you can work without separate accounts feel free, but it will likely be easier to set things on auto pilot.

“Hah! Look at those suckers! I’ve got stuff together, straight cash for me!”

Oh?  You’ve eliminated all your toxic debt and are saving now? Have you optimized your spending habits to make it so credit card companies are providing you with interest free loans AND paying you for the privilege of having you use their card?  If not, you’re still leaving money on the table, just like those “suckers.” We’ll cover this more in the near future, but for now, if you’re at this point, life’s pretty good. Go check on your retirement accounts, and see if you can contribute a bit more in there for now, and we’ll get to the rest soon.

Until next time,  go  hunt down some debt!

Getting Started

Personal finance is quite a jungle. Everywhere we look, there are pitfalls, unexpected emergencies,  interesting opportunities, and predators that, if given the chance, will eat you (and your money) alive.  The important thing to remember about personal finance is that it’s exactly that — personal.  Two people aren’t going to get along with the same advice, and the situations that people find themselves in aren’t always ideal.  Personally, I’ve seen the worst of things happen. Losing a job, defaulting on credit cards and student loans,  resorting to payday loans and getting caught in their trap are all things I both grew up with and saw myself on the path to before I worked my way out of the mess.  At one point, I was in a situation with a car loan for 23% because it was the only thing I could get credit on.  All of this led to quite a sobering epiphany for me: the more you try to hide from your money problems instead of confronting them, the worse they will get.

This blog is brand new, but the ability to talk about finances in a rational manner is what will make everybody involved better off. The fact is, sometimes NOT borrowing money is worse for a person than borrowing too much.  With a background in economics, I want to help people understand where they are going wrong, and move them in the right direction. Some of the information here can be labeled as controversial, but I’ll do my best to provide a heads up when I talk about something that goes off the beaten path from what most personal finance “experts” spoon feed to their audiences. For reference, I’ve put together a quick list of my own “ten commandments” for personal finance, which should  provide some insight.

  1. Be Honest with yourself and your loved ones about finances.  – Lying will only make things bad in the short run at best, and horrible in the long run at worst.
  2. Learn to understand cash flow, and how it impacts your life. –  People don’t get in financial trouble from debt, they get in financial trouble by using debt to augment their cash flow.
  3.  There are two fundamental components to getting out of debt faster: spending less and earning more. – If you are serious about getting out of any debt you have, these are your options.
  4. If you have any question about being able to afford something, you can’t afford it. – Sure, a 70″ LED TV would look great in your living room, but the $1400 it would cost at 26.99% interest that that store card will charge you is not worth it.  Would you rather work 200 hours or 253 hours for something?
  5. If you don’t have a plan, you’re falling behind. – The old saying, “Failing to plan is planning to fail” is  very true with your finances. If you want to get the most out of them, you need to have a plan. Whether you want to systematically eliminate your debts, buy a house, or retire, you’ll need a plan to get there. Living paycheck to paycheck and hoping for things to “just work out” is a recipe for disaster.
  6. Good or bad, own your financial decisions. – Whether you went and bought a boat, or you decided not to take that trip to Mexico with all of your friends, the decisions we make can go beyond our bank accounts, so the important thing to know is that you never want to deprive yourself of experiences, or be unable to make ends meet because of your decision to either save or borrow too much. As with all things, moderation is the key.
  7.  Never be afraid to ask. – When I was young and dumb, I was always afraid to talk to my creditors, so I didn’t.  As a result, I likely missed out on the chance to fix a lot of things, and pay lower interest rate. Just about everything in life is negotiable. Ask for lower interest rates for everything you have to finance.
  8. Don’t become a slave to your credit score. – A single number will not define your value as a human being.  Check your credit report every 3-6 months to make sure it’s up to date, and pay down your balances to under 10% of your utilization (with the optional step of closing your newest credit line) 2 months prior to a major purchase (Home, Car, Boat, etc.)
  9. Pay your bills on time, not early, not late. – If you have an interest checking account, paying early will lower your average daily balance for the monthly interest, and paying late will result in a late fee.  Getting in the habit of paying on the due date will make your life much easier and have a (marginal) financial benefit for you.
  10. If you can’t keep your finances straight, use multiple bank accounts or the envelope method.  – This will help you avoid overdrafts, especially if you have multiple accounts, but only one of them linked to a debit card. Personally, I use a cash back rewards card that gets my spending money transferred to it bi-weekly to pay off the balance.

If you follow these, your financial situation should improve at every turn.  The harshest truth is that the odds are highly unlikely that you will win the lottery and become an instant multi-millionaire.  As a result, it’s going to be better to do the little things right so that you can live the best life possible.

That’s all for now. Until next time, go snack on some debt!